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FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of Knoll, Inc. We have audited the accompanying consolidated balance sheets of Knoll, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Knoll, Inc. at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Knoll, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 1, 2017 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Philadelphia, Pennsylvania March 1, 2017 KNOLL, INC. CONSOLIDATED BALANCE SHEETS (dollars in thousands, except share and per share data) See accompanying notes to the consolidated financial statements. KNOLL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (dollars in thousands, except share and per share data) See accompanying notes to the consolidated financial statements. KNOLL, INC. CONSOLIDATED STATEMENTS OF EQUITY (dollars in thousands, except per share data) (1) The $0.1 million adjustment in retained earnings represents the ASU 2016-09 adjustment for cumulative estimated forfeiture expense. See Note 2 for additional information. See accompanying notes to the consolidated financial statements. KNOLL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands) See accompanying notes to the consolidated financial statements. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 1. DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION Description of the Business Knoll, Inc. and its subsidiaries (the “Company” or “Knoll”) are engaged in the design, manufacture, market and sale of high-end furniture products and accessories, and modern outdoor furniture. The Company is also engaged in the sale of fine leather, textiles, and felt, focusing on the middle to high-end segments of the market. The Company primarily operates in the United States (“U.S.”), Canada and Europe, and sells its products primarily through a broad network of independent dealers and distribution partners, through a direct sales force, and through its showrooms, as well as online. Basis of Presentation The Company follows accounting standards set by the Financial Accounting Standards Board (“FASB”). The FASB establishes accounting principles generally accepted in the United States (“GAAP”). Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants, which the Company is required to follow. References to GAAP issued by the FASB in these footnotes are to the FASB Accounting Standards Codification (“ASC”), which serves as a single source of authoritative non-SEC accounting and reporting standards to be applied by non-governmental entities. All amounts are presented in U.S. dollars, unless otherwise noted. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The consolidated financial statements of the Company include the accounts of the Company and its wholly owned subsidiaries and any partially owned subsidiaries that the Company has the ability to control. Significant intercompany transactions and balances have been eliminated in consolidation. The results of the Company's European subsidiaries are included in the consolidated financial statements, and are presented on a one-month lag to allow for the timely preparation of consolidated financial information. The effect of this lag in presentation is not material to the consolidated financial statements. Use of Estimates The preparation of the consolidated financial statements in conformity with United States GAAP requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Examples include, but are not limited to, revenue recognition; income tax exposures; the carrying value of goodwill and property, plant, and equipment; bad debts; customer receivable allowances; inventory obsolescence and product warranties. Actual results may differ from such estimates. Cash and Cash Equivalents Cash and cash equivalents include cash on hand and highly liquid investments with maturities of three months or less at the date of purchase. Revenue Recognition The Company recognizes revenue when the earnings process is complete. This occurs when risk and title transfers, collectability is reasonably assured, and pricing is fixed and determinable. Accordingly, revenue is recognized when risk and title are transferred to the client, which primarily occurs at the time of shipment. Taxes on revenue producing transactions are not included in sales. Based on historical experience, accruals are made at the time of sale to estimate for sales returns and other allowances. Allowance for Doubtful Accounts The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The allowance is determined through an analysis of the aging of accounts receivable and assessments of risk that are based on historical trends. The Company evaluates the past-due status of its customer receivables based on the contractual terms of sale. If the financial condition of the Company's customers were to deteriorate, additional allowances may be required. Accounts receivable are charged against the allowance for doubtful accounts when the Company determines that the likelihood of recovery is remote, and the Company no longer intends to expend resources to attempt collection. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 Inventories Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. The Company reserves for inventory that, in its judgment, is impaired or obsolete. Obsolescence may be caused by the discontinuance of a product line, changes in product material specifications, replacement products in the marketplace and other competitive influences. Property, Plant, and Equipment Property, plant, and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The useful lives are as follows: (1) Useful lives for leasehold improvements are amortized over the shorter of the economic lives or the term of the lease. The Company reviews the carrying values of its property and equipment for possible impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on undiscounted estimated cash flows expected to result from its use and eventual disposition. The factors considered by the Company in performing this assessment include current operating results, business trends affecting the use of certain assets and other economic factors. In assessing the recoverability of the carrying value of property and equipment, the Company must make assumptions regarding future cash flows and other factors. If these estimates or the related assumptions change in the future, the Company may be required to record an impairment loss for these assets. Goodwill and Intangible Assets The Company records the excess of purchase price over the fair value of the tangible and identifiable intangible assets acquired as goodwill. Goodwill and intangible assets with indefinite lives are tested for impairment at least annually, as of October 1, and whenever events or circumstances occur indicating that a possible impairment may have been incurred. Intangible assets with finite lives are amortized over their useful lives. The Company assesses whether goodwill impairment exists using both the qualitative and quantitative assessments. The qualitative assessment involves determining whether events or circumstances exist that indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. If based on this qualitative assessment the Company determines it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if the Company elects not to perform a qualitative assessment, a quantitative assessment is performed using a two-step approach to determine whether a goodwill impairment exists at the reporting unit. In the first step, the Company compares the estimated fair value of each reporting unit to its carrying value. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill is not impaired and no further testing is required. If the estimated fair value of the reporting unit is less than the carrying value, the Company must perform the second step of the impairment test to measure the amount of impairment loss, if any. In the second step, the reporting unit's estimated fair value is allocated to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination. If the implied fair value of the reporting unit's goodwill is less than the carrying value, the difference is recorded as an impairment loss. The Company estimates the fair value of its reporting units using a combination of the fair values derived from both the income approach and the market approach. Under the income approach, the Company calculates the fair value of a reporting unit based on the present value of estimated future cash flows. Cash flow projections are based on management's estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used is based on the weighted-average cost of capital adjusted for the relevant risk associated with business-specific characteristics and the uncertainty related to the business's ability to execute on the projected cash flows. The market approach estimates fair value based on market multiples of revenue and earnings derived from comparable publicly-traded companies with similar operating and investment characteristics as the reporting unit. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The Company assesses whether indefinite-lived intangible assets impairment exists using both the qualitative and quantitative assessments. The qualitative assessment involves determining whether events or circumstances exist that indicate it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. If based on this qualitative assessment, the Company determines it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount or if the Company elects not to perform a qualitative assessment, a quantitative assessment is performed to determine whether an indefinite-lived intangible asset impairment exists. The Company tests the indefinite-lived intangible assets for impairment by comparing the carrying value to the fair value based on current revenue projections of the related operations, under the relief from royalty method. Any excess of the carrying value over the amount of fair value is recognized as an impairment. Any such impairment would be recognized in the reporting period in which it has been identified. Finite-lived assets such as customer relationships, non-compete agreements, and licenses are amortized over their estimated useful lives. The Company reviews the carrying values of these assets for possible impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on undiscounted estimated cash flows expected to result from its use and eventual disposition. The Company continually evaluates the reasonableness of the useful lives of these assets. Business Combinations The purchase price of an acquired company is allocated between tangible and intangible assets acquired and liabilities assumed from the acquired business based on their estimated fair values, with the residual of the purchase price recorded as goodwill. The results of operations of the acquired business are included in the Company's operating results from the date of acquisition. Deferred Financing Fees Financing fees that are incurred by the Company in connection with the issuance of debt are deferred and amortized to interest expense over the life of the underlying indebtedness. Deferred financing fees are presented in the Company's consolidated balance sheets as a direct reduction from long-term debt. Shipping and Handling Amounts billed to clients for shipping and handling of products are classified as sales. Costs incurred by the Company for shipping and handling are classified as cost of sales. Research and Development Costs Research and development expenses are expensed as incurred, and are included as a component of selling, general, and administrative expenses. Research and development expenses, were $21.7 million for 2016, $20.7 million for 2015, and $19.2 million for 2014. Income Taxes The Company accounts for income taxes using the asset and liability approach, which requires deferred tax assets and liabilities be recognized using enacted tax rates to measure the effect of temporary differences between book and tax bases on recorded assets and liabilities. Valuation allowances are recorded to reduce deferred tax assets, if it is more likely than not some portion or all of the deferred tax assets will not be recognized. The need to establish valuation allowances against deferred tax assets is assessed quarterly. The Company maintained a valuation allowance primarily for net operating loss carryforwards in foreign tax jurisdictions where the Company has incurred historical tax losses from operations or acquired tax losses through acquisitions, and has determined that it is more likely than not these deferred tax assets will not be recognized. The primary factors used to assess the likelihood of realization are forecasts of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not to be sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not to be sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement. For tax positions that are not more likely than not to be sustained upon audit, the Company does not recognize any portion of the benefit. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period. The Company recognizes tax-related interest and penalties in income tax expense and accrues for interest and penalties in other noncurrent liabilities. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 Fair Value of Financial Instruments The Company uses the following valuation techniques to measure fair value for its financial assets and financial liabilities: Level 1 Inputs are unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data. Level 3 Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company and its subsidiaries use, as appropriate, a market approach (generally, data from market transactions), an income approach (generally, present value techniques and option-pricing models), and/or a cost approach (generally, replacement cost) to measure the fair value of an asset or liability. These valuation approaches incorporate inputs such as observable, independent market data and/or unobservable data that management believes are predicated on the assumptions market participants would use to price an asset or liability. These inputs may incorporate, as applicable, certain risks such as nonperformance risk, which includes credit risk. Derivative Financial Instruments From time to time, the Company enters into foreign currency hedges to manage its exposure to foreign exchange rates associated with short-term operating receivables of a Canadian subsidiary that are payable by the U.S. operations. The terms of these contracts are typically less than one year. The Company does not hold or issue derivative financial instruments for trading or speculative purposes. The Company recognizes derivatives as either assets or liabilities in the accompanying consolidated balance sheet and measures those instruments at fair value. Changes in the fair value of such contracts are reported in earnings as a component of “Other income, net.” Commitments and Contingencies The Company establishes reserves for the estimated cost of environmental, legal and other contingencies when such expenditures are probable and reasonably estimable. A significant amount of judgment is required to estimate and quantify the ultimate exposure in these matters. The Company engages outside experts as deemed necessary or appropriate to assist in the evaluation of exposure. From time to time, as information becomes available regarding changes in circumstances for ongoing issues as well as information regarding emerging issues, the potential liability is reassessed and reserve balances are adjusted as necessary. Revisions to the estimates of potential liability, and actual expenditures related to commitments and contingencies, could have a material impact on the results of operations or financial position. Warranty The Company generally offers a warranty for its products. The specific terms and conditions of those warranties vary depending upon the product sold. The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company's warranty liability include historical product-failure experience and estimated repair costs for identified matters. The Company regularly assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. Concentration of Credit Risk The Company's accounts receivables are comprised primarily of independent dealers and direct customers. The Company monitors and manages the credit risk associated with the individual dealers and direct customers. The independent dealers are responsible for assessing and assuming the credit risk of their customers, and may require their customers to provide deposits or other credit enhancement measures. Historically the Company has had a concentration of federal and local government receivables; however, they carry minimal credit risk. Foreign Currency Translation Results of foreign operations are translated into U.S. dollars using average exchange rates during the year, while assets and liabilities are translated into U.S. dollars using the exchange rates as of the balance sheet dates. The resulting translation adjustments are recorded in accumulated other comprehensive income (loss). KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 Transaction gains and losses resulting from exchange rate changes on transactions denominated in currencies other than the functional currency of the applicable subsidiary are included in the consolidated statements of operations, within other (income) expense, net, in the year in which the change occurs. Stock-Based Compensation The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Forfeitures are recognized when they occur. Stock Options The fair value of stock options is estimated at the date of grant using the Black-Scholes option pricing model, which requires management to make certain assumptions of future expectations based on historical and current data. The assumptions include the expected term of the options, risk-free interest rate, expected volatility, and dividend yield. The expected term represents the expected amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The risk-free rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated based on the historical volatility of the Company's stock price. The Company's dividend yield is based on historical data. The Company recognizes compensation expense using the straight-line method over the vesting period. Restricted Stock and Restricted Stock Units The fair value of restricted stock and restricted stock units, excluding market-based restricted stock units, is based upon the closing market price of the Company's common stock on the date of grant. The Company recognizes compensation expense using the straight-line method over the vesting period. The fair value of the market-based restricted stock units is estimated at the date of grant using a lattice pricing model, which requires management to make certain assumptions based on both historical and current data. These awards vest based upon the performance of the Company's stock price relative to a peer group. The assumptions included in the model include, but are not limited to, risk-free interest rate, expected volatility of the Company's and the peer group's stock prices, and dividend yield. The risk-free rate is based upon the applicable U.S. Treasury Note rate. Expected volatility is estimated based on the historical volatility of the companies' stock prices. The dividend yield is based on the Company's historical data. Pension and Other Post-Employment Benefits The Company sponsors two defined benefit pension plans and two other post-employment benefit plans ("OPEB"). Several statistical and other factors, which attempt to anticipate future events, are used in calculating the expense and liability related to the plans. Key factors include assumptions about the expected rates of return on plan assets, discount rates, and health care cost trend rates. The Company considers market and regulatory conditions, including changes in investment returns and interest rates, in making these assumptions. The Company determines the expected long-term rate of return on plan assets based on aggregating the expected rates of return for each component of the plan's asset mix. The Company uses historic plan asset returns combined with current market conditions to estimate the rate of return. The expected rate of return on plan assets is a long-term assumption and generally does not change annually. The discount rate reflects the market rate for high-quality fixed income debt instruments as of the Company's annual measurement date and is subject to change each year. Unrecognized actuarial gains and losses are recognized over the expected remaining lifetime of the plan participants. Unrecognized actuarial gains and losses arise from several factors, including experience and assumption changes with respect to the obligations of the pension and OPEB plans, and from the difference between expected returns and actual returns on plan assets. These unrecognized gains and losses are systematically recognized as a change in future net periodic pension expense in accordance with the appropriate accounting guidance relating to defined benefit pension and OPEB plans. Key assumptions used in determining the amount of the obligation and expense recorded for the OPEB plans include the assumed discount rate and the assumed rate of increases in future health care costs. In estimating the health care cost trend rate, the Company considers actual health care cost experience, future benefit structures, industry trends and advice from its actuaries. The Company assumes that the relative increase in health care costs will generally trend downward over the next several years, reflecting assumed increases in efficiency and cost-containment initiatives in the health care system. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 In accordance with the appropriate accounting guidance, the Company has recognized the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligation) of the defined benefit pension and OPEB plans in the consolidated balance sheets. To record the unfunded status of the plans, the Company recorded an additional liability and an adjustment to accumulated other comprehensive loss, net of tax. Other changes in the benefit obligation including net actuarial loss (gain), prior service cost (credit) or curtailment (gain) loss are recognized in other comprehensive income. The actuarial assumptions the Company used in determining the pension and OPEB retirement benefits may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates, or longer or shorter life spans of participants. While the Company believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may materially affect the financial position or results of operations. As of December 31, 2015, the Company changed the method it uses to estimate the interest cost component of net periodic benefit cost for pension and other post-employment benefits. This change resulted in a decrease in the interest cost component for 2016, compared to the previous method. Historically, the Company estimated the interest cost component utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. The Company has elected to utilize a full yield curve approach in the estimation of this component by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. The Company has made this change to provide a more precise measurement of interest cost by improving the correlation between projected benefit cash flows to the corresponding spot yield curve rates. This change did not affect the measurement of the total benefit obligation at the annual measurement date, as the change in interest cost is completely offset by deferred actuarial (gains)/losses that will arise at the next annual measurement date. As this change is treated as a change in estimate inseparable from a change in accounting principle, historical measurements of interest cost are not affected. This change in estimate reduced the Company's annual net periodic benefit expense in 2016 by approximately $2.7 million. Segment Information Accounting Standards Codification 280, Segment Reporting, defines that a segment for reporting purposes is based on the financial performance measures that are regularly reviewed by the “Chief Operating Decision Maker” to assess segment performance and to make decisions about a public entity's allocation of resources. Based on this guidance, the Company reports its segment results based on its reporting segments: Office, Studio, and Coverings. All unallocated expenses are included within Corporate. The Office segment includes a complete range of workplace products that address diverse workplace planning paradigms. These products include: systems furniture, seating, storage, tables, desks and KnollExtra® accessories as well as the international sales of our North American Office products. The Studio segment includes KnollStudio®, HOLLY HUNT®, Knoll Europe and DatesWeiser. KnollStudio products, include iconic seating, lounge furniture, side, cafe and dining chairs as well as conference, training and dining and occasional tables. HOLLY HUNT® is known for high quality residential furniture, lighting, rugs, textiles and leathers. In 2016, HOLLY HUNT® acquired Vladimir Kagan Design Group, a renowned collection of modern luxury furnishings. Knoll Europe, which distributes both KnollStudio and Knoll Office products, manufactures and sells products to customers primarily in Europe. DatesWeiser, known for its sophisticated meeting and conference tables and credenzas, sets a standard for design, quality and technology integration. The Coverings segment includes KnollTextiles®, Spinneybeck® (including Filzfelt®), and Edelman® Leather. These businesses provide a wide range of customers with high-quality fabrics, felt, leather and related architectural products. In 2016, the Company determined it appropriate to revise its segment presentation to segregate Corporate costs. The Company believes this facilitates improved communication as it reports segment results and better aligns with how it views and operates the Company. Corporate costs represent the accumulation of unallocated costs relating to shared services and general corporate activities including, but not limited to, legal expenses, acquisition expenses, certain finance, human resources, administrative and executive expenses and other expenses that are not directly attributable to an operating segment. Dedicated, direct selling, general and administrative expenses of the segments continue to be included within segment operating profit. Management regularly reviews the costs included in the Corporate function, and believes disclosing such information provides more visibility and transparency of how the chief operating decision maker reviews the results for the Company. Reclassifications Certain amounts in the prior years' consolidated financial statements have been reclassified to conform to the current-year presentation. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 New Accounting Pronouncements In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. This ASU supersedes the revenue recognition requirements in FASB ASC Topic 605, “Revenue Recognition,” and most industry-specific guidance. This ASU sets forth a five-step model for determining when and how revenue is recognized. Under the model, an entity will be required to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2016. The FASB subsequently deferred the effective date of this standard to December 15, 2017 with early adoption permitted as of December 15, 2016. The Company will adopt the new standard in the annual period beginning January 1, 2018. The standard permits the use of either the full retrospective or modified retrospective (cumulative effect) transition method. Transition practical expedients are available for both methods. The Company plans to apply the modified retrospective transition method. The Company assembled an implementation work team to assess and document the accounting conclusions for the adoption of ASU 2014-09 and will continue to evaluate and assess the impact on the Company's consolidated financial statements. At this time the Company believes the impact to the financial statements will be immaterial. In April 2015, the FASB issued ASU No. 2015-03 - Interest-Imputation of Interest (Subtopic 835-30). This ASU simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of the debt liability, which is consistent with the treatment of debt discounts. The new guidance should be applied on a retrospective basis, and upon transition, an entity is required to comply with the applicable disclosures necessary for a change in accounting principle. This ASU is effective for fiscal years beginning after December 15, 2015, and for interim periods within those fiscal years. The Company reclassified deferred financing fees of $1.6 million and $2.3 million from other noncurrent assets to long-term debt as of December 31, 2016 and 2015, respectively. In July 2015, the FASB issued ASU 2015-11 - Inventory (Topic 330), which amends existing guidance for measuring inventories. This amendment will require the Company to measure inventories recorded using the first-in, first-out method at the lower of cost and net realizable value. This amendment does not change the methodology for measuring inventories recorded using the last-in, first-out method. This amendment will be effective for fiscal years beginning after December 15, 2016. Early adoption is permitted. The Company does not expect the impact of the adoption of this ASU to have a material impact on its consolidated financial position, results of operations and cash flows. In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. The amendments in this ASU require that deferred tax liabilities and assets be classified as one net noncurrent deferred tax asset or liability by jurisdiction in a classified statement of financial position. The amendments in this ASU are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Earlier application is permitted for all entities as of the beginning of an interim or annual reporting period. The amendments in this ASU may be applied either prospectively or retrospectively. The Company elected to early adopt this standard on a prospective basis as of December 31, 2016. As a result, at December 31, 2016, the Company reclassified $18.5 million of current deferred tax assets to long term deferred tax liabilities. In February 2016, the FASB issued guidance codified in ASC 842, Leases, which supersedes the guidance in ASC 840, Leases. ASC 842 will be effective for the Company on January 1, 2019, and the Company will adopt the standard using the modified retrospective approach. Footnote 9 provides details on the Company’s current lease arrangements. While the Company continues to evaluate the provisions of ASC 842 to determine how it will be affected, the primary effect of adopting the new standard will be to record assets and obligations for current operating leases. The Company is currently in the process of evaluating the impact of adoption of the ASU on its consolidated financial statements. In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends Accounting Standards Codification Topic 718, Compensation - Stock Compensation. ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years and early adoption is permitted. The Company early adopted this standard during the year ended December 31, 2016. As a result of the adoption of this standard, •excess tax benefits of $0.5 million were recorded through income tax expense for the year ended December 31, 2016; •excess tax benefits were combined with current income taxes within operating cash flows adopted on a prospective basis; KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 •the Company elected to change its policy from estimating forfeitures to recognizing forfeitures when they occur and as a result approximately$0.1 million of cumulative estimated forfeiture expense was recorded to retained earnings as of January 1, 2016; •cash paid by the Company when directly withholding shares to satisfy an employee's statutory tax obligations continued to be classified as a financing activity and are included within the purchase of common stock for treasury line item; and •there was no impact on prior periods due to adopting the guidance on a prospective basis. In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 simplifying the accounting for goodwill impairment that removes the second step of the goodwill impairment test that requires a hypothetical purchase price allocation. Under the new guidance, goodwill impairment will be measured and recognized as the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill allocated to the reporting unit. The revised guidance does not affect the reporting entity’s ability to first assess qualitative factors by reporting unit to determine whether it is necessary to perform the quantitative goodwill impairment test. The guidance is effective for goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption. 3. ACQUISITIONS On September 9, 2016, Holly Hunt Enterprises, Inc. (“HOLLY HUNT®”) completed the acquisition of Vladimir Kagan Design Group (“Vladimir Kagan”), known for its elegant, mid-century and contemporary designs. The aggregate purchase price for the acquisition was $8.5 million, subject to working capital adjustments. The purchase price was funded from borrowings under the Company's revolving credit facility. The Company recorded the acquisition of Vladimir Kagan using the acquisition method of accounting and recognized the assets acquired and liabilities assumed at their fair values as of the date of the acquisition. The results of operations of Vladimir Kagan have been included in the Company's Studio segment beginning September 9, 2016. On December 1, 2016, the Company completed the acquisition of DatesWeiser Furniture Corporation (“DatesWeiser”), a designer and manufacturer of contemporary wood conference and meeting room furniture. The aggregate purchase price for the acquisition was $11.0 million, subject to working capital adjustments, plus certain contingent payouts of up to $4.0 million in the aggregate based on the future performance of the business. The purchase price was funded from borrowings under the Company's revolving credit facility. The Company recorded the acquisition of DatesWeiser using the acquisition method of accounting and recognized the assets acquired and liabilities assumed at their fair values as of the date of the acquisition. The results of operations of DatesWeiser have been included in the Company's Studio segment beginning December 1, 2016. The results of Vladimir Kagan and DatesWeiser in 2016, as well as pro forma financial information, have not been presented separately as the financial impact of these acquisitions are not considered material for the year ended December 31, 2016. On February 3, 2014, the Company acquired HOLLY HUNT®. The acquisition advances the Company's strategy of building its global capability as a resource for high-design workplaces and homes, including the commercial contract, decorator to-the-trade and consumer markets. The aggregate purchase price for the acquisition was $95.0 million, plus certain contingent payouts of up to $16.0 million in the aggregate based on the future performance of the business. The purchase price was funded from borrowings under the Company's revolving credit facility. The Company recorded the acquisition of HOLLY HUNT using the acquisition method of accounting and recognized the assets acquired and liabilities assumed at their fair values as of the date of the acquisition. The Company finalized the purchase accounting for the acquisition of HOLLY HUNT during the first quarter of 2015 as no additional adjustments were made from the fair values assigned since December 31, 2014. The results of operations of HOLLY HUNT have been included in the Company's Studio segment beginning February 3, 2014. The amount of sales and net earnings that resulted from the acquisition of HOLLY HUNT and attributable to Knoll, Inc. stockholders included in the consolidated statements of operations and comprehensive income during the twelve months ended December 31, 2014 were as follows (in thousands): KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The Company recorded acquisition costs in its consolidated statements of operations and comprehensive income, within selling, general, and administrative expenses during the year ended December 31, 2014 as follows (in thousands): The following unaudited pro forma summary financial information presents the operating results of the combined company, assuming the acquisition had occurred as of January 1, 2013 (in thousands): The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the results that would have been attained had the acquisition occurred on January 1, 2013, nor is it indicative of results of operations for future periods. The pro forma information presented includes adjustments for acquisition costs, interest expense that would have been incurred to finance the acquisition, amortization and depreciation. The results of this acquisition have been included in the Company's results of operations as of the acquisition date. This acquisition strengthened the Company's portfolio of products that can be offered. 4. RESTRICTED CASH Included in the Company's consolidated balance sheets in cash and cash equivalents is restricted cash of $0.1 million as of December 31, 2016 and 2015, respectively. This restricted cash primarily represents a bond held in the United Kingdom in order to defer the payment of duties on imports into the United Kingdom. 5. INVENTORIES Information regarding the Company's inventories is as follows (in thousands): Inventory reserves for obsolescence and other estimated losses were $9.5 million and $8.3 million at December 31, 2016 and 2015, respectively, and have been included in the amounts above. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 6. PROPERTY, PLANT, AND EQUIPMENT, NET Information regarding the Company's property, plant and equipment is as follows (in thousands): During 2016, 2015 and 2014, the Company capitalized interest of approximately $0.7 million, $0.3 million and $0.4 million, respectively. 7. GOODWILL AND OTHER INTANGIBLE ASSETS, NET Information regarding the Company's other intangible assets are as follows (in thousands): The Company completed the annual test of impairment for goodwill and tradenames (indefinite-lived intangible assets) as of October 1, 2016. The Company estimated the fair value of its reporting units using a combination of the fair values derived from both the income approach and the market approach.The Company estimated the fair value of the tradenames using a relief from royalty method under the income approach. Based on the results of the annual impairment test as of October 1, 2016, the Company determined there were no indications of impairment for goodwill or indefinite-lived intangible assets. The Company also completed the annual test of impairment for tradenames (indefinite-lived intangible assets) as of October 1, 2015. The Company estimated the fair value of the tradenames using a relief from royalty method under the income approach. The key assumptions for this method are revenue projections, royalty rates based on a consideration of market rates, and a discount rate (based on the weighted-average cost of capital). Based on the results of the annual impairment test as of October 1, 2015, the Company determined that the Edelman Leather tradename was impaired as the estimated fair value of the Edelman Leather tradename was less than its respective carrying amount. The decline in the fair value of the Edelman Leather tradename was primarily the result of weaker than expected revenue performance in 2015 and a corresponding reduction of future revenue expectations. These revenue reductions were primarily a result of lower sales to private aviation customers. The fair value of the Edelman Leather tradename is estimated to be $6.5 million, resulting in a non-cash pre-tax impairment charge of $10.7 million during the fourth quarter of 2015. The impairment charge was separately disclosed in the consolidated statements of operations. These fair value measurements fell within Level 3 of the fair value hierarchy as described in Note 2. A significant decline in expected revenue or a change in the discount rate may result in future impairment charges. Edelman Leather is included within the Company’s Coverings Segment. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The Company's amortization expense related to finite-lived intangible assets was $3.3 million, $3.2 million, and $3.1 million for the years ended December 31, 2016, 2015, and 2014, respectively. The expected amortization expense based on the finite-lived intangible assets as of December 31, 2016 is as follows (in thousands): The changes in the carrying amount of goodwill by reportable segment are as follows (in thousands): 8. OTHER CURRENT LIABILITIES Information regarding the Company's other current liabilities is as follows (in thousands): KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 9. LEASES The Company has commitments under operating leases for certain machinery and equipment as well as manufacturing, warehousing, showroom and other facilities used in its operations. Some of the leases contain renewal provisions and generally require the Company to pay certain operating expenses, including utilities, insurance and taxes, which are subject to escalation. At times the Company enters into lease agreements which contain a provision for cash abatements related to certain leasehold improvements. These abatements are recognized on a straight-line basis as a reduction to rent expense over the lease term. The unamortized portions as of December 31, 2016 and 2015 were $5.2 million and $15.8 million, respectively. Total rent expense for 2016, 2015, and 2014 was $29.8 million, $28.6 million, and $28.8 million, respectively. Future minimum rental payments required, excluding maintenance and other miscellaneous charges, under those operating leases are as follows (in thousands): 10. PENSION AND OTHER POST-EMPLOYMENT BENEFITS The Company has two domestic defined benefit pension plans and two plans providing for other post-employment benefits, including medical and life insurance coverage. One of the pension plans and one of the OPEB plans cover eligible U.S. nonunion employees while the other pension plan and OPEB plan cover eligible U.S. union employees. The Company uses a December 31 measurement date for all of these plans. During 2014, the Company offered a one-time lump sum payment option to terminated vested participants in exchange for the right to receive future pension payments. As a result, the Company settled $30.2 million of benefit obligations and recorded a $6.1 million settlement charge during the year ended December 31, 2014. During 2015, the Company approved amendments, effective December 31, 2015, to both the union and nonunion U.S. defined benefit pension plans. The Company also amended its remaining post-employment medical plan, effective May 1, 2015. The amendments eliminated the accrual of future benefits for all participants in the defined benefit pension plans and closed entry to new retirees into the post-employment medical plan. These amendments resulted in a curtailment gain of approximately $7.1 million. As the plans had unrealized losses in excess of the reduction of the projected benefit obligation at the date of amendment, the gain was recorded as a reduction of the projected benefit obligation and a corresponding reduction of unrealized losses within accumulated other comprehensive loss. During 2016, the Company contributed $9.0 million and $43.0 million in discretionary contributions to the union and nonunion pension plans, respectively. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The following table sets forth a reconciliation of the related benefit obligation and plan assets related to the benefits provided by the Company (in thousands): Assumptions used in computing the benefit obligation as of December 31, 2016 and 2015 were as follows: KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The following table presents the fair value of the Company's pension plan investments as of December 31, 2016 and 2015 (in thousands): See Note 2 of the consolidated financial statements for the description of the levels of the fair value hierarchy. The following table sets forth the consolidated balance sheets presentation for components relating to the Company's pension and OPEB plans (in thousands): The following table sets forth other changes in the benefit obligation recognized in other comprehensive income for the Company's pension and OPEB plans (in thousands): KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The net actuarial loss of $10.3 million for the pension plans in 2016 was mainly due to decreases in discount rates over the course of 2016. The net actuarial gain of $6.6 million in 2015 was mainly due to improved discount rates over the course of 2015 and the mortality improvement scale was updated to MP-2015, still using the RP- 2014 base table. The estimated net actuarial loss for the defined benefit pension plans included in accumulated other comprehensive income and expected to be recognized in net periodic pension cost during the fiscal year ended December 31, 2017 is $0.6 million. The following table sets forth the components of the net periodic benefit cost for the Company's pension and OPEB plans (in thousands): For the year ended December 31, 2016, $1.5 million and $1.3 million of pension income was recorded in cost of sales and selling, general, and administrative expenses, respectively. For the years ended December 31, 2015 and 2014, $6.5 million and $7.3 million of pension expense was recorded in cost of sales and $5.2 million and $5.3 million was recorded in selling, general, and administrative expenses, respectively. Assumptions used to determine net periodic benefit cost for the years ended December 31, 2016, 2015, and 2014 were as follows: The expected long-term rate of return on assets is based on management's expectations of long-term average rates of return to be earned on the investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plan assets are invested. For purposes of measuring the benefit obligation associated with the Company's OPEB plans as of December 31, 2016, as well as the assumed rate for 2017, an annual rate increase of 5.80% to 6.20% in the per capita cost of covered health care benefits was assumed and a 11.1% annual rate of increase in the per capita cost of covered prescription drug benefits was assumed. The rates were then assumed to decrease to an ultimate rate of 4.5% for 2025 and thereafter. For purposes of measuring the net periodic benefit cost for 2016 associated with the Company's OPEB plans, a 6.0% to 6.5% annual rate of increase in the per capita cost of covered medical benefits was assumed and a 12.00% annual rate of increase in the per capita cost of covered prescription drug benefits was assumed. The rate was then assumed to decrease to an ultimate rate of 4.5% for 2023 and 2024 for both the medical plan and prescription drug plan and thereafter. Increasing the assumed health care cost trend rate by 1.0% would increase the benefit obligation as of December 31, 2016 by $75,000 and increase the aggregate of the service and interest cost components of net periodic benefit cost for 2016 by $2,400. Decreasing the assumed health care cost trend rate by 1.0% would decrease the benefit obligation as of December 31, 2016 by $70,000 and decrease the aggregate of the service and interest cost components of net periodic benefit cost for 2016 by $2,000. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The Company's pension plans' weighted-average asset allocations as of December 31, 2016 and 2015, by asset category were as follows: The Company's pension plans' investment policy includes an asset mix based on the Company's risk posture. The investment policy states a target allocation based on the plans’ funded status of 54% equity funds and 46% fixed income funds. Inclusion of the fixed income assets is to hedge risk associated with the plans’ liabilities along with providing potential growth through income. These assets should primarily invest in fixed income instruments of the U.S. Treasury and government agencies and investment-grade corporate bonds. The equity fund investments can consist of broadly diversified domestic equity, international equity, fixed income (return seeking), alternative investments, commodities, and real estate assets. The purpose of these assets is to provide the opportunity for capital appreciation, income, and the ability to diversify investments. A mix of mutual funds, ETF’s, and separate accounts are used as the plans' investment vehicles with clearly stated investment objectives and guidelines, as well as offer competitive long-term results. The Company expects to contribute $0.6 million to its OPEB plans in 2017. Currently, No contributions are expected in 2017 for the Company's pension plans. Estimated future benefit payments under the pension and OPEB plans are as follows (in thousands): The Company also sponsors 401K retirement savings plans for all U.S. associates. Under the 401K retirement savings plans, participants may defer a portion of their earnings up to the annual contribution limits established by the Internal Revenue Service. The Company's total expense under the 401K plans for U.S. employees was $9.8 million for 2016, $5.6 million for 2015 and $2.5 million for 2014. Employees of the Canadian, Belgium and United Kingdom operations also participate in defined contribution pension plans sponsored by the Company. The Company's expense related to these plans for 2016, 2015, and 2014 was $1.0 million, $1.0 million, and $1.2 million, respectively. 11. FAIR VALUE OF FINANCIAL INSTRUMENTS Financial Instruments The fair values of the Company’s cash and cash equivalents, customer receivables, and accounts payable approximate carrying value due to their short maturities. The fair value of the Company’s long-term debt approximates its carrying value, as it is variable rate debt and the terms are comparable to market terms as of the balance sheet dates, and are classified as Level 2. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 Assets and Liabilities Recorded at Fair Value on a Recurring Basis The following table represents the assets and liabilities, measured at fair value on a recurring basis and the basis for that measurement (in thousands): Pursuant to the agreement governing the acquisition of HOLLY HUNT®, the Company may be required to make annual contingent purchase price payments. The payouts are based upon HOLLY HUNT® reaching an annual net sales target, for each year through 2016, and are paid out on or around February 20 of the following calendar year. The Company classifies this as a Level 3 measurement and is required to remeasure this liability at fair value on a recurring basis. The fair value of such contingent purchase price payments was determined at the time of acquisition based upon net sales projections for HOLLY HUNT® for 2014, 2015, and 2016. The Company paid $5.0 million of the contingent purchase price in 2016, as a result of HOLLY HUNT® achieving the 2015 net sales projections. Excluding the initial recognition of the liability for the contingent purchase price payments and payments made to reduce the liability, any changes in the fair value would be included within selling, general and administrative expenses. Pursuant to the agreement governing the acquisition of DatesWeiser, the Company may be required to make annual contingent purchase price payments. The payouts are based upon DatesWeiser reaching an annual net sales target, for each year through 2020. The Company classifies this as a Level 3 measurement and is required to remeasure this liability at fair value on a recurring basis. The fair value of such contingent purchase price payments was determined at the time of acquisition based upon net sales projections for DatesWeiser for 2017, 2018, 2019 and 2020. Excluding the initial recognition of the liability for the contingent purchase price payments and payments made to reduce the liability, any changes in the fair value would be included within selling, general and administrative expenses. There were no additional assets and/or liabilities recorded at fair value on a recurring basis as of December 31, 2016 or 2015. Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis The following table represents non-recurring fair value amounts (as measured at the time of adjustment) for those assets remeasured to fair value on a nonrecurring basis during 2015 (in thousands): Based on the results of the 2015 annual impairment test, the Company determined that the Edelman tradename was impaired that year. The Company estimated the fair value of the indefinite-life intangible asset using the relief-from-royalty method under the income approach as of October 1, 2015. The Company used a royalty rate of 2.5% based on comparable market rates and a discount rate of 12.0%. Refer to Note 7 for more details regarding the impairment testing. There were no additional assets and/or liabilities remeasured to fair value on a nonrecurring basis as of December 31, 2016 or 2015 and for the years then ended. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 12. INDEBTEDNESS The Company's long-term debt is summarized as follows (in thousands): At December 31, 2016 and 2015, the Company's interest rates were approximately 2.0% and 1.9%, respectively. Credit Facilities On May 20, 2014, the Company amended and restated its existing credit facility, dated February 3, 2012, with a new $500.0 million credit facility maturing on May 20, 2019, consisting of a revolving commitment in the amount of $300.0 million and a term loan commitment in the amount of $200.0 million (“Amended Credit Agreement”). The Amended Credit Agreement also includes an option to increase the size of the revolving credit facility or incur incremental term loans by up to an additional $200.0 million, subject to the satisfaction of certain terms and conditions. Borrowings under the revolving credit facility may be repaid at any time, but no later than the maturity date on May 20, 2019. Obligations under the credit facility are secured by a first priority security interest in (i) the capital stock of certain present and future subsidiaries (with limitations on foreign subsidiaries) and (ii) all present and future property and assets of the Company (with various limitations and exceptions). The Company retains the right to terminate or reduce the size of the revolving credit facility at any time. Borrowings under the term loan facility are due in equal quarterly installments of $2.5 million, with the remaining borrowings due on the maturity date. Interest on revolving credit and term loans will accrue, at the Company’s election, at (i) the Eurocurrency Rate (as defined in the Amended Credit Agreement), plus additional percentage points based on the Company’s leverage ratio or (ii) the Base Rate (a rate based on the higher of (a) the prime rate announced from time-to-time by Bank of America, N.A., (b) the Federal Reserve System’s federal funds rate, plus .50% or (c) the Eurocurrency Rate plus 1.00%; Base Rate is defined in detail in the Amended Credit Agreement), plus additional percentage points based on the Company’s leverage ratio. The Company is required to pay an annual commitment fee equal to a rate per annum calculated as the product of the applicable rate based upon the Company's leverage ratio as set forth in the credit agreement, times the unused portion of the revolving credit facility. In addition, the Company is required to pay a letter of credit fee equal to the applicable rate based upon the Company's leverage ratio as set forth in the credit agreement times the daily maximum amount available to be drawn under such letter of credit. The commitment and letter of credit fees are payable in arrears on the last business day of each quarter. The Amended Credit Agreement requires the Company to comply with various affirmative and negative covenants, including without limitation (i) covenants to maintain a minimum specified interest coverage ratio and maximum specified net leverage ratio, and (ii) covenants that prevent or restrict the Company’s ability to pay dividends, engage in certain mergers or acquisitions, make certain investments or loans, incur future indebtedness, engage in sale-leaseback transactions, alter its capital structure or line of business, prepay subordinated indebtedness, engage in certain transactions with affiliates and sell stock or assets. The Company was in compliance with the Amended Credit Agreement covenants at December 31, 2016. Repayments under the Amended Credit Agreement can be accelerated by the lenders upon the occurrence of certain events of default, including, without limitation, a failure to pay any principal, interest or other amounts in respect of loans when due, breach by the Company (or its subsidiaries) of any of the covenants or representations contained in the Amended Credit Agreement or related loan documents, failure of the Company (or its material subsidiaries) to pay any amounts owed with respect to other significant indebtedness of the Company or such subsidiary, or a bankruptcy event with respect to the Company or any of its material subsidiaries. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 Deferred Financing Fees In connection with the refinancing of the Company's previous credit facility during 2014, the Company wrote off $0.3 million of unamortized deferred financing fees associated with the previous credit facility and incurred $1.9 million in new financing fees that will be amortized as a component of interest expense over the life of the new facility through May 2019. Deferred financing fees, net of accumulated amortization, totaled $1.6 million and $2.3 million as of December 31, 2016 and 2015, respectively. Amortization expense related to the deferred financing fees, included in interest expense, was $0.7 million for each of the years ended December 31, 2016, 2015 and 2014, respectively. Other Borrowings The Company also has several revolving credit agreements with various European financial institutions. These credit agreements provide credit primarily for overdraft and working capital purposes. As of December 31, 2016, total credit available under such agreements was approximately $10.2 million, and the Company had no outstanding borrowings under the European credit facilities as of December 31, 2016 or 2015. There is currently no expiration date on these agreements. The interest rates on borrowings are variable and are based on the monetary market rate that is linked to each country's prime rate. 13. COMMITMENTS AND CONTINGENCIES Litigation The Company is currently involved in matters of litigation, including environmental contingencies, arising in the ordinary course of business. The Company accrues for such matters when expenditures are probable and reasonably estimable. Based upon information presently known, management is of the opinion that such litigation, either individually or in the aggregate, will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows. Collective Bargaining At December 31, 2016, the Company employed a total of 3,471 people. Approximately 11.0% of the total number of employees are represented by unions globally. The Grand Rapids, Michigan Plant is the only unionized plant within the U.S. and has an agreement with the Carpenters Union, Local 1615, of the United Brotherhood of Carpenters and Joiners of America, Affiliate of the Carpenters Industrial Council, covering approximately 200 hourly employees. The Collective Bargaining Agreement expires April 2018. Approximately 82 workers in Italy are also represented by state-sponsored unions. The union contracts under which these Italian workers are represented expire in 2018. Warranty The Company provides for estimated product warranty expenses when related products are sold and are included within other current liabilities. Because warranty estimates are forecasts that are based on the best available information, primarily historical claims experience, future warranty claims may differ from the amounts provided. Changes in the warranty reserve are as follows (in thousands): KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 14. STOCK PLANS As of December 31, 2016, the Company sponsors three stock incentive plans under which awards denominated or payable in shares, units or options to purchase shares of Knoll common stock may be granted to officers, certain other employees, directors and consultants of the Company. In May 2007, the Company approved the 2007 Stock Incentive Plan which authorized the issuance of 2,000,000 shares of common stock; as of December 31, 2016, 7,306 shares remained available for issuance under this plan. In May 2010, the Company approved the 2010 Stock Incentive Plan which authorized the issuance of 2,000,000 shares of common stock; as of December 31, 2016, 26,496 shares remained available for issuance under this plan. In May 2013, the Company approved the 2013 Stock Incentive Plan which authorized the issuance of 2,000,000 shares of common stock; as of December 31, 2016, 1,460,089 shares remained available for issuance under this plan. As of December 31, 2016, an aggregate of 1,493,891 total shares remained available for issuance under these plans. A Committee of the Board of Directors currently consisting of the Compensation Committee of the Company's Board of Directors, has sole discretion concerning administration of the plans including selection of individuals to receive awards, types of awards, the terms and conditions of the awards and the time at which awards will be granted. Restricted Shares and Restricted Stock Units During 2014, the Company granted 1,106,919 of restricted shares and restricted stock units to certain key employees and the Company's Board of Directors. 462,773 of these awards were granted at the weighted-average fair value of $15.43 per restricted share at the date of grant. The majority of these awards cliff vest on the third anniversary of the grant date. 200,000 of these awards were granted at the weighted-average fair value of $18.72 per restricted share and cliff vest on the fourth anniversary of the grant date. 331,896 of these awards were granted at the weighted-average fair value of $17.34 per restricted stock unit. These awards vest based upon the Company achieving certain cumulative operating performance target goals over the next three years. 112,250 of these awards were granted at the weighted-average fair value of $8.24 per restricted stock unit. These awards vest based upon the performance of the Company's stock price relative to a peer group over the next three years. During 2015, the Company granted 314,360 of restricted shares and restricted stock units to certain key employees and the Company's Board of Directors. 168,360 of these awards were granted at the weighted-average fair value of $21.59 per restricted share at the date of grant. The majority of these awards cliff vest on the third anniversary of the grant date. 73,000 of these awards were granted at the weighted-average fair value of $21.64 per restricted stock unit. These awards vest based upon the Company achieving certain cumulative operating performance target goals over the next three years. 73,000 of these awards were granted at the weighted-average fair value of $12.14 per restricted stock unit. These awards vest based upon the performance of the Company's stock price relative to a peer group over the next three years. During 2016, the Company granted 586,141 of restricted shares and restricted stock units to certain key employees and the Company's Board of Directors. 313,632 of these awards were granted at the weighted-average fair value of $18.65 per restricted share at the date of grant. The majority of these awards cliff vest on the third anniversary of the grant date. 163,509 of these awards were granted at the weighted-average fair value of $18.81 per restricted stock unit. These awards vest based upon the Company achieving certain cumulative operating performance target goals over the next three years. 109,000 of these awards were granted at the weighted-average fair value of $13.02 per restricted stock unit. These awards vest based upon the performance of the Company's stock price relative to a peer group over the next three years. The following table summarizes the Company's restricted stock activity during the year: KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The following table summarizes the Company's restricted stock units activity during the year: Stock Options The following table summarizes the Company's stock option activity for the preceding three years. The following table summarizes information regarding stock options outstanding and exercisable at December 31, 2016: KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 A summary of the status of the Company's non-vested options as of December 31, 2016 and 2015, and changes during the year ended December 31, 2016, is presented below. The total fair value of options vested during 2016, 2015 and 2014 were less than $0.1 million, respectively. Total Awards Compensation costs related to stock-based compensation for the years ended December 31, 2016, 2015, and 2014 totaled $10.5 million pre-tax ($6.8 million after-tax), $8.3 million pre-tax ($5.3 million after-tax), and $7.8 million pre-tax ($4.8 million after-tax), respectively, and are included within selling, general, and administrative expenses. At December 31, 2016, the total compensation cost related to non-vested awards not yet recognized equaled $13.0 million for restricted stock awards and restricted stock units, with minimal costs related to non-vested stock options. The weighted-average remaining period over which the cost is to be recognized is 1.4 years. 15. STOCKHOLDERS' EQUITY Preferred Stock The Company's Certificate of Incorporation authorizes the issuance of 10,000,000 shares of preferred stock with a par value of $1.00 per share. Subject to applicable laws, the Board of Directors is authorized to provide for the issuance of preferred shares in one or more series, for such consideration and with designations, powers, preferences and relative, participating, optional or other special rights and the qualifications, limitations or restrictions thereof, as shall be determined by the Board of Directors. There was no preferred stock outstanding as of December 31, 2016, 2015 or 2014. Common Stock The following table demonstrates the change in the number of shares of common stock outstanding during the years ended December 2016, 2015, and 2014 (excludes non-voting restricted shares). KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 Treasury Stock As of December 31, 2016 and 2015, the Company held 15,645,358 and 15,781,331 treasury shares, respectively. The Company records repurchases of its common stock for treasury at cost. Accumulated Other Comprehensive Income (Loss) The components of accumulated other comprehensive income (loss) are as follows (in thousands): The following reclassifications were made from accumulated other comprehensive income (loss) to the statements of operations are as follows (in thousands): (1) These accumulated other comprehensive income (loss) components are included in the computation of net periodic pension costs. See Note 10 for additional information. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 16. EARNINGS PER SHARE Basic earnings per share excludes the dilutive effect of common shares that could potentially be issued due to the exercise of stock options and unvested restricted stock and restricted stock units, and is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share includes the effect of shares and potential shares and units issued under the stock incentive plans. The following table sets forth the reconciliation from basic to dilutive average common shares (in thousands): 17. INCOME TAXES Income before income tax expense consists of the following (in thousands): Income tax expense is comprised of the following (in thousands): KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The following table sets forth the tax effects of temporary differences that give rise to the deferred tax assets and liabilities (in thousands): Income taxes paid, net of refunds received, by the Company during 2016, 2015, and 2014, totaled $27.4 million, $40.8 million, and $18.6 million, respectively. As of December 31, 2016, the Company had net operating loss carryforwards totaling approximately $26.7 million in Brazil, the United Kingdom, and Germany. The net operating loss carryforwards may be carried forward indefinitely. The Company provides a valuation allowance against certain net foreign deferred tax assets (principally the net operating loss carryforwards) due to the uncertainty that they can be realized. The following table sets forth a reconciliation of the statutory federal income tax rate to the effective income tax rate: As of December 31, 2016, there is $129.0 million of cumulative earnings overseas. Approximately $12.4 million has been subject to tax under the U.S. Subpart F of Section 954 provisions. Accordingly, $116.6 million of earnings have not been subject to U.S. tax and are reinvested indefinitely. It is not practical to estimate the amount of U.S. tax that would result upon the eventual repatriation of such earnings. As of December 31, 2016 and 2015, the Company had unrecognized tax benefits of approximately $0.9 million and $4.4 million, respectively. The entire amount of the unrecognized tax benefits would reduce the effective tax rate if recognized. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The following table summarizes the activity related to the Company's unrecognized tax benefits during 2016, 2015, and 2014 (in thousands): During 2016, 2015, and 2014, respectively, the Company recognized approximately $0.1 million, $0.1 million and $0.2 million of interest and penalties. The Company has paid all accrued interest and penalties recognized prior to December 31, 2016, therefore the Company has no accruals for the payment of interest and penalties as of December 31, 2016. The Company accrued approximately $0.5 million for the payment of interest and penalties as of December 31, 2015. As of December 31, 2016, the Company is subject to U.S. Federal Income Tax examination for the tax years 2007 through 2016, and to non-U.S. income tax examination for the tax years 2010 to 2016. In addition, the Company is subject to state and local income tax examinations for the tax years 2007 through 2016. 18. OTHER EXPENSE (INCOME), NET The components of other expense (income), net are as follows (in thousands): KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 19. QUARTERLY RESULTS (UNAUDITED) The following tables contain selected unaudited Consolidated Statements of Operations and Comprehensive Income data for each quarter for the years ended December 31, 2016 and 2015. The operating results for any quarter are not necessarily indicative of results for any future period. The quarterly results are as follows (in thousands): _______________________________________________________________________________ (1) During 2016, the Company adopted ASU 2016-09. As a result of this adoption, $0.1 million and $0.4 million of income tax benefits were recognized in the three months ended March 31, 2016 and June 30, 2016, respectively. These retroactive income tax adjustments are reflected as a reduction of income tax expense which increased basic earnings per share by $0.01 in the three months ended June 30, 2016. No other basic or diluted earnings per share amounts were affected. See Note 2 for additional information. (2) During 2015, the Company recorded $0.9 million of pre-tax restructuring charges. These charges of $0.4 million and $0.5 million were incurred in the third and fourth quarters of 2015, respectively. Additionally, during the fourth quarter of 2015, the Company recorded an intangible asset impairment charge of $10.7 million. 20. SEGMENT AND GEOGRAPHIC REGION INFORMATION The Company manages business through its reporting segments: Office, Studio, and Coverings. All unallocated expenses are included within Corporate. The Office segment includes a complete range of workplace products that address diverse workplace planning paradigms. These products include: systems furniture, seating, storage, tables, desks and KnollExtra® accessories as well as the international sales of North American Office products. The Studio segment includes KnollStudio®, HOLLY HUNT®, Knoll Europe and DatesWeiser. KnollStudio products, include iconic seating, lounge furniture, side, cafe and dining chairs as well as conference, training and dining and occasional tables. HOLLY HUNT® is known for high quality residential furniture, lighting, rugs, textiles and leathers. In 2016, HOLLY HUNT® acquired Vladimir Kagan Design Group, a renowned collection of modern luxury furnishings. Knoll Europe, which markets and sells both KnollStudio and Knoll Office products, manufactures and sells products to customers primarily in Europe. DatesWeiser, known for its sophisticated meeting and conference tables and credenzas, sets a standard for design, quality and technology integration. The Coverings segment includes KnollTextiles®, Spinneybeck® (including Filzfelt®), and Edelman® Leather. These businesses provide a wide range of customers with high-quality fabrics, felt, leather and related architectural products. In 2016, the Company determined it appropriate to revise its segment presentation to segregate Corporate costs. The Company believes this facilitates improved communication as it reports segment results and better aligns with how it views and operates the Company. Corporate costs represent the accumulation of unallocated costs relating to shared services and general corporate activities including, but not limited to, legal expenses, acquisition expenses, certain finance, human resources, administrative and executive expenses and other expenses that are not directly attributable to an operating segment. Dedicated, direct selling, general and administrative expenses of the segments continue to be included within segment operating profit. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 Management regularly reviews the costs included in the Corporate function, and believes disclosing such information provides more visibility and transparency of how the chief operating decision maker reviews the results for the Company. The tables below present the Company’s segment information with Corporate costs excluded from operating segment results. Prior year amounts have been recast to conform to the current presentation (in thousands): _______________________________________________________________________________ (1) Intersegment sales are presented on a cost-plus basis which takes into consideration the effect of transfer prices between legal entities. (2) The Company does not allocate interest expense or other (income) expense, net to the reportable segments. Many of the Company's facilities manufacture products for all three reporting segments. Therefore, it is impractical to disclose asset information on a segment basis. KNOLL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016 The Company's net sales by product category were as follows (in thousands): The Company markets its products in the United States and internationally, with its principal international markets being Canada and Europe. The table below contains information about the geographical areas in which the Company operates. Sales are attributed to the geographic areas based on the origin of sale, and property, plant, and equipment, net is based on the geographic area in which the asset resides (in thousands): | This appears to be an excerpt from Knoll, Inc.'s consolidated financial statements notes, focusing on several key accounting policies. Here's a summary of the main points:
Revenue & Receivables:
- Revenue is recognized when risk and title transfer (usually at shipment)
- Company maintains allowances for doubtful accounts
- Receivables are evaluated based on aging and historical risk trends
- Accounts are written off when deemed unrecoverable
Assets & Cash:
- Cash equivalents include investments with maturities of 3 months or less
- Current assets are mentioned but specific values aren't provided
Valuation Methods:
- Uses both income and market approaches for valuation
- Income approach based on estimated future cash flows
- Market approach uses comparable public company metrics
- Considers revenue growth, operating margins, and industry conditions
Risk Management:
- Maintains reserves for:
* Doubtful accounts
* Sales returns
* Inventory obsolescence
* Product warranties
- Additional allowances may be required if customer financial conditions deteriorate
The excerpt appears to focus mainly on accounting policies rather than providing specific financial figures. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Board of Directors and Shareholders PetroShare Corp. We have audited the accompanying balance sheets of PetroShare Corp. as of December 31, 2016 and 2015 and the related statements of operations, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of PetroShare Corp. as of December 31, 2016 and 2015, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. /s/ SingerLewak LLP SingerLewak LLP Denver, Colorado March 31, 2017 PetroShare Corp. Balance Sheets December 31, Commitments and contingencies-Note 13 Subsequent events-Note 14 The accompanying notes are an integral part of these financial statements. PetroShare Corp. Statements of Operations For the years ended December 31, The accompanying notes are an integral part of these financial statements. PetroShare Corp. Statements of Changes in Shareholders' Equity For the years ended December 31, 2016 and 2015 The accompanying notes are an integral part of these financial statements. PetroShare Corp. Statements of Cash Flows For the years ended December 31, The accompanying notes are an integral part of these financial statements. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS December 31, 2016 and 2015 NOTE 1-ORGANIZATION AND NATURE OF BUSINESS PetroShare Corp. ("PetroShare" or the "Company") is a corporation organized under the laws of the State of Colorado on September 4, 2012 to investigate, acquire and develop crude oil and natural gas properties in the Rocky Mountain or mid-continent portion of the United States. Since inception, the Company has focused on financing activities and the acquisition, exploration and development of crude oil and natural gas prospects. The Company's current development focus is on the Denver-Julesburg basin in the State of Colorado. The Company realized its first significant revenue in 2016, following the acquisition of certain oil and gas producing properties. NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America ("US GAAP"). Business Combinations The Company accounts for the acquisition of oil and gas properties, that are not commonly controlled, based on the requirements of the Financial Accounting Standards Board ("FASB") ASC Topic 805, Business Combinations, which requires an acquiring entity to recognize the assets acquired and liabilities assumed at fair value under the acquisition method of accounting, provided such assets and liabilities qualify for acquisition accounting under the standard. The Company accounts for certain property acquisitions of proved developed oil and gas property as business combinations. Use of Estimates The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period Estimated quantities of crude oil, natural gas and natural gas liquids reserves are the most significant of the Company's estimates. All reserve data included in these financial statements are based on estimates. Reservoir engineering is a subjective process of estimating underground accumulations of crude oil, natural gas and natural gas liquids. There are numerous uncertainties inherent in estimating quantities of proved crude oil, natural gas and natural gas liquids reserves. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. As a result, reserve estimates may be different from the quantities of crude oil, natural gas and natural gas liquids that are ultimately recovered. Other items subject to estimates and assumptions include, but are not limited to, the carrying amounts of property, plant and equipment, asset retirement obligations, valuation allowances for deferred income tax assets and valuation assumptions related to the Company's share-based compensation. Management evaluates estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic and commodity price environment. The PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) volatility of commodity prices results in increased uncertainty inherent in such estimates and assumptions. See Unaudited Crude Oil and Natural Gas Reserve Information. (Note 15) Loss Per Common Share Basic and diluted loss per share attributable to PetroShare shareholders is computed by dividing net (loss) by the weighted average number of common shares outstanding during the period. The Company excluded potentially dilutive securities as shown below, as the effect of their inclusion would be anti-dilutive. Potentially dilutive securities at December 31, 2016 and 2015 are as follows: Cash The Company's bank accounts periodically exceed federally insured limits. The Company maintains its deposits with high quality financial institutions and, accordingly, believes its credit risk exposure associated with cash is minimal. Revenue Recognition The Company recognizes revenue from the sale of crude oil, natural gas and NGLs when production is delivered to, and title has transferred to, the purchaser and to the extent the selling price is reasonably determinable. In general, settlements for hydrocarbon sales may occur after the month in which the oil, natural gas or other hydrocarbon products were produced. The Company may estimate and accrue for the value of these sales using information available to it at the time its financial statements are generated. Differences are reflected in the accounting period that payments are received from the purchaser. Accounts Receivable-Crude oil, natural gas and NGLs Accounts receivable-Crude oil, natural gas and NGLs consists of amounts receivable from sales from the Company's well interests. Management continually monitors accounts receivable for collectability. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Accounts Receivable-Joint interest billing Accounts receivable-Joint interest billing consists primarily of joint interest billings, which are recorded at the invoiced and to-be-invoiced amounts. Collateral is not required for such receivables, nor is interest charged on past due balances. Joint interest billing receivables are collateralized by the pro rata revenue attributable to the joint interest holders and further by the interest itself. Deferred Offering Costs The Company defers as other current assets the direct incremental costs of raising capital through equity offerings until such time as the offering is completed. At the time of the completion of the offering, the costs are charged against the capital raised. Should the offering be terminated, deferred offering costs are charged to operations during the period in which the offering is terminated. During the year ended December 31, 2016, the Company charged $544,070 in deferred offering costs to operations, as the offering was terminated. As of December 31, 2016, the Company's deferred offering costs totaled $nil, with $nil recorded as of December 31, 2015. Debt Issuance Costs Debt issuance costs include origination and other fees incurred in connection with the Company's private placement and with the origination of the Company's supplemental line of credit. Debt issuance costs related to the private placement are amortized to interest expense using the effective interest method over the respective borrowing term. Crude Oil and Natural Gas Properties Proved The Company follows the successful efforts method of accounting for its crude oil and natural gas properties. Under this method of accounting, all property acquisition costs and development costs are capitalized when incurred and depleted on a units-of-production basis over the remaining life of proved reserves and proved developed reserves, respectively. Costs of drilling exploratory wells are initially capitalized but are charged to expense if the well is determined to be unsuccessful. The Company assesses its proved crude oil and natural gas properties for impairment whenever events or circumstances indicate that the carrying value of the assets may not be recoverable. The impairment test compares estimated undiscounted future net cash flows to the assets' net book value. If the net capitalized costs exceed estimated future net cash flows, then the cost of the property is written down to fair value. Fair value for crude oil and natural gas properties is generally determined based on estimated discounted future net cash flows. Impairment expense for proved properties is reported in exploration and impairment expense. The net carrying values of retired, sold or abandoned properties that constitute less than a complete unit of depreciable property are charged or credited, net of proceeds, to accumulated depreciation, depletion and amortization unless doing so significantly affects the unit-of-production PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) amortization rate, in which case a gain or loss is recognized in the statement of operations. Gains or losses from the disposal of complete units of depreciable property are recognized in earnings (loss). Unproved Unproved properties consist of costs to acquire undeveloped leases as well as costs to acquire unproved reserves. Undeveloped lease costs and unproved reserve acquisitions are capitalized, and individually insignificant unproved properties are amortized on a composite basis, based on past success, past experience and average lease-term lives. The Company evaluates significant unproved properties for impairment based on remaining lease term, drilling results, reservoir performance, seismic interpretation or future plans to develop acreage. When successful wells are drilled on undeveloped leaseholds, unproved property costs are reclassified as proved properties and depleted on a unit-of- production basis. Impairment expense for unproved properties is reported in exploration and impairment expense. Exploratory Geological and geophysical costs, including exploratory seismic studies, and the costs of carrying and retaining unproved acreage are expensed as incurred. Costs of seismic studies that are utilized in development drilling within an area of proved reserves are capitalized as development costs. Amounts of seismic costs capitalized are based on only those blocks of data used in determining development well locations. To the extent that a seismic project covers areas of both developmental and exploratory drilling, those seismic costs are proportionately allocated between development costs and exploration expense. Costs of drilling exploratory wells are initially capitalized, pending determination of whether the well contains proved reserves. If an exploratory well does not contain proved reserves, the costs of drilling the well and other associated costs are charged to expense. Costs incurred for exploratory wells that contain reserves, which cannot yet be classified as proved, continue to be capitalized if (a) the well has found a sufficient quantity of reserves to justify completion as a producing well, and (b) the Company is making sufficient progress assessing the reserves and the economic and operating viability of the project. If either condition is not met, or if the Company obtains information that raises substantial doubt about the economic or operational viability of the project, the exploratory well costs, net of any salvage value, are expensed. Property, Plant and Equipment Property and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using straight-line methods over the estimated useful lives of the related assets. Expenditures for renewals and betterments which increase the estimated useful life or capacity of the asset are capitalized; expenditures for repairs and maintenance are expensed when incurred. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Asset Impairment Proved crude oil and natural gas properties are reviewed for impairment on a field-by-field basis each quarter, or when events and circumstances indicate a possible decline in the recoverability of the carrying value of such field. The estimated future undiscounted cash flows expected in connection with the field are compared to the carrying amount of the field to determine if the carrying amount is recoverable. If the carrying amount of the field exceeds its estimated undiscounted future cash flows, the carrying amount of the field is reduced to its estimated fair value. Due to the unavailability of relevant comparable market data, a discounted cash flow method is used to determine the fair value of proved properties. The discounted cash flow method utilizes the most recent third party reserve estimation report and estimates future cash flows based on management's estimates of future crude oil and natural gas production, commodity prices based on commodity futures price strips, operating and development costs, and a risk-adjusted discount rate. The Company recognized impairment expense of $116,303 during the year ended December 31, 2016, while expense of $154,776 was recorded in 2015. Depreciation, Depletion and Amortization Depreciation, depletion and amortization of capitalized drilling and development costs of producing crude oil and natural gas properties, including related support equipment and facilities, are computed using the unit-of-production method on a field basis based on total estimated proved developed crude oil and natural gas reserves. Amortization of producing leaseholds is based on the unit-of-production method using total estimated proved reserves. In arriving at rates under the unit-of-production method, the quantities of recoverable crude oil and natural gas reserves are established based on estimates made by the Company and external independent reserve engineers. Upon sale or retirement of properties, the cost and related accumulated depreciation, depletion and amortization are eliminated from the accounts and the resulting gain or loss, if any, is recognized. Unit of production rates are revised whenever there is an indication of a need, but at least in conjunction with annual reserve reports. Revisions are accounted for prospectively as changes in accounting estimates. Depletion expense for the year ended December 31, 2016 was $59,262, and expense of $9,898 was recorded in 2015. Prepaid Drilling Costs Prepaid drilling costs consist of cash payments made by the Company to the operators of oil and gas properties and other third party service providers. Drilling Advances-related party The Company's drilling advances consist of cash provided to the Company from its joint interest partners for planned drilling activities. Advances are applied against the joint interest partner's share of expenses incurred. As of December 31, 2016 and 2015, drilling advances totaled $234,452 and $nil, respectively. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Income Taxes The Company recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities using the enacted tax rates that are expected to be in effect when the differences are expected to be recovered. The Company provides a valuation allowance for deferred tax assets for which it does not consider realization of such assets to be more likely than not. Asset Retirement Obligation Asset retirement obligations associated with tangible long-lived assets are accounted for in accordance with ASC 410, "Accounting for Asset Retirement Obligations." The estimated fair value of the future costs associated with dismantlement, abandonment and restoration of crude oil and natural gas properties is recorded generally upon the completion of a well. The net estimated costs are discounted to present values using a risk adjusted rate over the estimated economic life of the crude oil and natural gas properties. Such costs are capitalized as part of the related asset. The asset is depleted on the units-of-production method. The liability is periodically adjusted to reflect: (1) new liabilities incurred; (2) liabilities settled during the period; (3) accretion expense; and (4) revisions to estimated future cash flow requirements. The accretion expense is recorded as a component of depreciation, depletion, accretion and amortization expense in the accompanying statements of operations. Share Based Compensation The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards in accordance with ASC 718, "Compensation." The option-pricing model requires the input of highly subjective assumptions, including the option's expected life, the price volatility of the underlying stock, and the estimated dividend yield of the underlying stock. The Company's expected term represents the period that stock-based awards are expected to be outstanding and is determined based on the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its stock-based awards. As there was insufficient historical data available to ascertain a forfeiture rate, the plain vanilla method was applied in calculating the expected term of the options. The Company's common stock has limited historical trading data, and as a result the expected stock price volatility is based on the historical volatility of a group of publicly traded companies that share similar operating metrics and histories. The Company has never paid dividends on its common stock and does not intend to do so in the foreseeable future, and as such, the expected dividend yield is zero. Loans and Borrowings Borrowings are recognized initially at fair value, net of financing costs incurred, and subsequently measured at amortized cost. Any difference between the amounts originally received and the redemption value of the debt is recognized in the consolidated statement of operations over the period to maturity using the effective interest method. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Fair Value of Financial Instruments Fair value accounting, as prescribed in ASC Section 825, utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below: Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities; Level 2 Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and Level 3 Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity). Going Concern Assessment Pursuant to ASU 2014-15, the Company has assessed its ability to continue as a going concern for a period of one year from the date of the issuance of these financial statements. Substantial doubt about an entity's ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year from the financial statement issuance date. As shown in the accompanying financial statements, the Company incurred a net loss of $4,479,052 during the year ended December 31, 2016, and as of that date, the Company's current liabilities exceeded its current assets by $6,115,501. Management has evaluated these conditions and determined that a reduction in the working capital deficit subsequent to December 31, 2016 related to a private placement (Note 6) and an extension and amendment to the Company's supplemental line of credit (Note 6), coupled with anticipated increased revenues from the Company's non-operated and operated properties, will allow the Company to meet its maturing debt and interest obligations and continue as a going concern through March 31, 2018. As part of the analysis, the Company considered selective participation in certain non-operated drilling programs based on availability of working capital and the timing of production related cash flows. Recent Accounting Pronouncements Standards Adopted in 2016 Debt Issuance Costs-In April 2015, the FASB issued updated guidance which changes the presentation of debt issuance costs in the financial statements. Under this updated guidance, debt issuance costs are presented on the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense. In August 2015, the PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) FASB subsequently issued a clarification as to the handling of debt issuance costs related to line-of-credit arrangements that allows the presentation of these costs as an asset. The standards update was effective for interim and annual periods beginning after December 15, 2015. The Company adopted this standards update, as required, effective January 1, 2016. The adoption of this standards update did not affect the Company's method of amortizing debt issuance costs and did not have a material impact on its financial statements. Measurement-Period Adjustments-In September 2015, the FASB issued updated guidance that eliminates the requirement to restate prior periods to reflect adjustments made to provisional amounts recognized in a business combination. The updated guidance requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The standards update was effective prospectively for interim and annual periods beginning after December 15, 2015, with early adoption permitted. The Company adopted this standard update, as required, effective January 1, 2016, which did not have a material impact on its financial statements. Stock Compensation-In March 2016, the FASB issued updated guidance on share-based payment accounting. The standards update is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. The standards update is effective for interim and annual periods beginning after December 15, 2016 with early adoption permitted. The Company elected to early-adopt this standards update as of April 1, 2016 in connection with its initial grant of awards under the Company's 2015 Equity Incentive Plan. The Company has elected to record the impact of forfeitures on compensation cost as they occur. The Company is also permitted to withhold income taxes upon settlement of equity-classified awards at up to the maximum statutory tax rates. There was no retrospective adjustment as the Company did not have any forfeitures nor settlements outstanding equity awards prior to adoption. Going Concern Analysis-In August 2014, the FASB issued ASU No. 2014-15, "Presentation of Financial Statements-Going Concern (Subtopic 205-40)." The new guidance addresses management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and in certain circumstances to provide related footnote disclosures. The standard is effective for annual periods ending after December 15, 2016 and for annual and interim periods thereafter. The Company adopted this standard as required, which did not have a material impact on its financial statements. Recent Accounting Pronouncements Not Yet Adopted Various accounting standards and interpretations were issued in 2016 with effective dates subsequent to December 31, 2016. The Company has evaluated the recently issued accounting pronouncements that are effective in 2016 and believe that none of them will have a material effect on the Company's financial position, results of operations or cash flows when adopted. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, "Revenue from Contracts with Customers." The standard requires an entity to recognize revenue in a manner that depicts the transfer of goods or services to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU No. 2014-09 will supersede most of the existing revenue recognition requirements in US GAAP when it becomes effective and is required to be adopted using one of two retrospective application methods. In August 2015, the FASB issued ASU No. 2015-14, "Revenue from Contracts with Customers-Deferral of the Effective Date," which approved a one year deferral of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted as of the original effective date for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company is currently evaluating the method of adoption and impact this standard will have on its financial statements and related disclosures. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The new guidance is effective for annual and interim reporting periods beginning after December 15, 2018. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is currently evaluating the impact of the new guidance on its financial statements. Further, the Company is monitoring the joint standard-setting efforts of the FASB and the International Accounting Standards Board. There are a large number of pending accounting standards that are being targeted for completion in 2017 and beyond, including, but not limited to, standards relating to revenue recognition, accounting for leases, fair value measurements, accounting for financial instruments, disclosure of loss contingencies and financial statement presentation. Because these pending standards have not yet been finalized, at this time the Company is not able to determine the potential future impact that these standards will have, if any, on its financial position, results of operations or cash flows. NOTE 3-ACQUISITIONS PDC Acquisition On June 30, 2016, the Company completed the acquisition of certain oil and gas assets from PDC Energy, Inc. ("PDC"), including leases covering approximately 3,652 gross (1,410 net) acres of lands located in Adams County, Colorado and PDC's interest in 35 producing wells ("PDC assets"). Simultaneous with the closing, the Company's working interest partner and primary lender exercised its option under a participation agreement (the "Participation Agreement") (Note 12) and acquired 50% of the Company's interest in the PDC assets. The acquisition was effective April 1, 2016. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 3-ACQUISITIONS (Continued) Following a final proration of costs and revenues from the operation of the PDC assets and the Company's working interest partner's exercise of its option under the Participation Agreement, the Company's net purchase price for the PDC assets was $2,260,890. A final allocation of the purchase price was prepared using, among other things, an internally prepared reserve analysis. The following table summarizes the consideration transferred, fair value of assets acquired and liabilities assumed: The following table presents the unaudited pro forma combined results of operations for the years ended December 31, 2016, and 2015, as if the PDC assets acquisition had occurred on January 1, 2015. The unaudited pro forma results reflect significant pro forma adjustments related to depletion expense, accretion expense and costs directly attributable to the acquisition, and operating costs incurred as a result of the assets acquired. The pro forma results do not include any cost savings or other synergies that may result from the acquisition or any estimated costs that have been or will be incurred by the Company to integrate the properties acquired. The pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been completed as of the beginning of the period, nor are they necessarily indicative of future results. Crimson Acquisition On December 22, 2016, the Company completed the acquisition of certain oil and gas assets from Crimson Exploration Operating, Inc. ("Crimson"), including leases covering approximately 15,514 gross (5,609 net) acres of lands located mostly in Adams and Weld Counties, Colorado and Crimson's PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 3-ACQUISITIONS (Continued) interest in 32 producing wells ("Crimson assets"). Simultaneous with the closing, the Company's working interest partner and primary lender acquired 50% of the Company's interest in the Crimson assets. The acquisition was effective December 1, 2016. Following a reconciliation of certain suspense and inventory accounts, the Company's net purchase price for the Crimson assets was $2,538,945. The purchase price is subject to post-closing adjustments scheduled to occur not more than 90 days following the closing date. An interim allocation of the purchase price was prepared using, among other things, an internally prepared reserve analysis. The following table summarizes the consideration transferred, fair value of assets acquired and liabilities assumed: The following table presents the unaudited pro forma combined results of operations for the years ended December 31, 2016, and 2015 (unaudited), as if the Crimson assets acquisition had occurred on January 1, 2015. The unaudited pro forma results reflect significant pro forma adjustments related to depletion expense, accretion expense and costs directly attributable to the acquisition, and operating costs incurred as a result of the assets acquired. The pro forma results do not include any cost savings or other synergies that may result from the acquisition or any estimated costs that have been or will be incurred by the Company to integrate the properties acquired. The pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been completed as of the beginning of the period, nor are they necessarily indicative of future results. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 3-ACQUISITIONS (Continued) 2016 Activity On March 10, 2016, the Company acquired certain surface rights and easements on lands located in Township 1 South, Range 67 West located on its Todd Creek Farms prospect in exchange for $184,360 in cash. The surface rights and easements permit the Company to access its Shook well pad. On March 31, 2016, the Company acquired oil and gas assets on land adjacent to the Company's Todd Creek Farms prospect, including approximately 160 net acres and a 50% working interest in one well following an assignment to the Company's working interest partner pursuant to the Participation Agreement. The Company's net cost for the foregoing assets was $590,274. On April 14, 2016, the Company acquired oil and gas leases in the Todd Creek Farms prospect covering approximately 189 net acres. The Company's net cost for the leases was $288,056. In connection with obtaining its supplemental line of credit (Note 6), the Company assigned Providence Energy Partners III, LP ("PEP III") 10% of the Company's working interest in 278 gross (170 net) net acres in the Wattenberg Field including the Company's interest in the Jacobucci wells. On October 14, 2016, the Company completed the acquisition of additional royalty interests in 10 Jacobucci pad horizontal wells located on its Todd Creek Farms prospect. The Company's net cost for the royalty interests was $1.55 million, which the Company paid using a draw under its supplemental line of credit. 2015 Activity On May 15, 2015, the Company acquired approximately 1,280 gross acres (171 net acres) located in the Todd Creek Farms Prospect. The Company paid $785,630 and Kingdom conveyed to the Company an 80% net revenue interest in the acreage after accounting for landowner and other royalties. Pursuant to the provisions of the Participation Agreement, executed in connection with the Company's initial line of credit (See Note 6), the Company assigned the right to acquire up to 50% of its interest in the Todd Creek Farms prospect to Providence in part consideration for extending the Company the initial line of credit, which Providence exercised with an effective date of June 1, 2015. The Company recorded the exercise of the option by reducing its acquisition costs in the Kingdom Lease by 50%. A reduction of acquisition costs in the amount of $287,815 was recorded, comprised of $392,815 net of $105,000 related to a one-time credit issued to the lender pursuant to the provisions of the Participation Agreement. The Company has recorded the net assignment of interest to Providence as a $287,815 non-cash payment against the initial line of credit. Between May 15, 2015 and December 31, 2015, the Company acquired approximately 77 additional net acres in the Todd Creek Prospect area and, as of December 31, 2015, the Todd Creek Farms prospect area covers approximately 1,460 gross and 244 net acres. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 4-PROPERTY, PLANT AND EQUIPMENT Property and equipment balances were comprised of furniture, fixtures, and equipment and are shown below: Depreciation expense recorded for the years ended December 31, 2016 and 2015, amounted to $5,772 and $963, respectively. NOTE 5-CRUDE OIL AND NATURAL GAS PROPERTIES The Company's oil and gas properties are entirely within the United States. The net capitalized costs related to the Company's oil and gas producing activities were as follows: (1)Unproved oil and gas properties represent unevaluated costs the Company excludes from the amortization base until proved reserves are established or impairment is determined. (2)Costs from wells in progress are excluded from the amortization base until production commences. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 5-CRUDE OIL AND NATURAL GAS PROPERTIES (Continued) Costs Incurred in Crude Oil and Natural Gas Activities. Costs incurred in connection with the Company's crude oil and natural gas acquisition, exploration and development activities for each of the periods are shown below: During the year ended December 31, 2016, depletion expense was $59,262, and expense of $9,898 was recorded in 2015. NOTE 6-DEBT Line of credit On May 13, 2015, the Company entered into a Revolving Line of Credit Facility Agreement ("initial line of credit") with Providence, which provides to the Company a revolving line of credit of up to $5,000,000. As of December 31, 2016, the outstanding balance on the initial line of credit was $5,000,000 plus accrued interest of $302,477. During the year ended December 31, 2016, the Company borrowed $3,937,815 on the initial line of credit, primarily to fund the acquisition and development of crude oil and natural gas properties (Note 3 and Note 12). During the year ended December 31, 2016, the Company recorded interest expense of $253,875 related to the initial line of credit. Interest on the outstanding principal balance of the initial line of credit begins accruing on the dates of advancements of principal at an annual rate equal to 8.0% simple interest. The Company is obligated to pay interest monthly after the Company receives its first production payment from a well associated with the Participation Agreement and/or in which the Company has or has had a working interest and in accordance with the terms of the promissory note. Supplemental line of credit On October 13, 2016, the Company entered into a revolving line of credit facility agreement (the "supplemental line of credit") with Providence Energy Partners III, LP ("PEP III"). PEP III is an affiliate of Providence by virtue of having some common management personnel. The supplemental line of credit permitted the Company to borrow up to $10.0 million to pay costs associated with its acquisition and development of oil and gas properties in the Wattenberg Field. The original maturity date for the supplemental line of credit was April 13, 2017. As amended on March 30, 2017, the Company agreed to repay $3,552,500 in outstanding principal not later than April 13, 2017 and not to borrow additional funds in exchange for PEP III extending the maturity date of the supplemental line of credit until June 13, 2017. (Note 14) PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 6-DEBT (Continued) As of December 31, 2016, the outstanding balance on the supplemental line of credit was $7,088,698 net of deferred financing fees of $16,302, plus accrued interest of $50,422. During the year ended December 31, 2016, the Company borrowed $7,105,000 under the supplemental line of credit, primarily to fund the acquisition and development of crude oil and natural gas properties (Note 3 and Note 12). During the year ended December 31, 2016, the Company recorded interest expense of $50,422 related to the supplemental line of credit. Convertible notes On December 30, 2016, the Company completed the first closing of a private placement of 200 units, each unit consisting of a convertible promissory note in the principal amount of $50,000 ("Notes") and 33,333 common stock purchase warrants ("Warrants"). Each Note sold in the private placement is one of a series of similar Notes designated the "10% Unsecured Convertible Promissory Notes" with the series totaling $10,000,000. The Notes bear interest at the rate of 10% per year and are due and payable on December 31, 2018. Interest is payable semi-annually beginning June 30, 2017 and until the Notes are paid in full. At any time after issuance, the principal amount of the Notes and any accrued but unpaid interest are convertible into shares of the Company's common stock at the option of the holder at the rate of $1.50 per share. Each Warrant allows the holder to purchase one share of the Company's common stock at a price of $3.00 per share at any time on or before December 31, 2019. (Note 9) Related to the December 31, 2016 closing, the Company sold 38.85 units consisting of $1,942,600 principal amount of Notes and Warrants to purchase 1,294,987 shares of common stock. The Company received gross proceeds of $1,942,600 and net proceeds of $1,747,340 after placement agent fees and expenses. The Company also issued warrants to purchase 129,526 shares of common stock to the placement agent. (Note 9). The value of the warrants of $174,475 has been recorded as a discount and will be amortized to interest expense using the effective interest method through the maturity date of the Notes. The Company recorded a debt discount of $750,963 related to the intrinsic value of the beneficial conversion feature embedded in the Notes. The discount will be amortized to interest expense using the effective interest method through the maturity date of the Notes. In January and February 2017, the Company completed the private placement for a total of 200 units or $10,000,000 in total. (Note 14) The following table reflects the net amounts recorded as Convertible Notes at December 31, 2016 and 2015: PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 7-ASSET RETIREMENT OBLIGATION For the purpose of determining the fair value of the asset retirement obligation incurred during the year ended December 31, 2016, the Company assumed an inflation rate of 2.0%, an estimated average asset life of 13.0 years, and a credit adjusted risk free interest rate of 9.48%. The following reconciles the value of the asset retirement obligation for the periods presented: Accretion expense recorded for the year ended December 31, 2016 was $30,483, accretion expense recorded for the year ended December 31, 2015 was $3,061. NOTE 8-ACCOUNTS PAYABLE AND ACCRUED LIABILITIES Accounts payable and accrued liability balances were comprised of trade accounts payable and accrued liabilities, drilling advances, crude oil and natural gas distributions payable and are shown below: PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 9-SHAREHOLDERS' EQUITY Common Stock As of December 31, 2016 and December 31, 2015, the Company had 100,000,000 shares of common stock authorized with a par value of $0.001 per share. As of December 31, 2016 and December 31, 2015, 21,964,282 and 21,633,191 shares were issued and outstanding, respectively. Activity for the year ended December 31, 2016 included the following: • In January 2016, the Company sold 95,000 shares of common stock at $1.00 per share to one accredited investor pursuant to a private placement of its common stock. • On April 8, 2016, the Company issued 50,000 shares of common stock valued at $0.73 per share to an investor relations company in connection with the certain services to be provided pursuant to an investor relations agreement. • On May 4, 2016, the Company issued an aggregate of 50,000 shares of common stock valued at $1.01 per share to two of the Company's directors in connection with their appointment to the Board (Note 9). • On July 5, 2016, the Company issued 25,000 shares of common stock valued at $1.60 per share to a director in connection with his appointment to the Board (Note 9). • On July 22, 2016, the Company issued 8,333 shares of common stock valued at $1.65 per share and on August 22, 2016 the Company issued 8,333 shares of common stock valued at $1.40 per share, each to an investor relations company in connection with certain services to be provided to the Company. • On August 30, 2016, the Company issued 50,000 shares of common stock valued at $1.44 per share to an investor relations company in connection with a termination agreement. • On November 11, 2016, the Company issued 14,425 shares of common stock valued at $1.85 per share to an individual in connection with the consideration and acquisition of the certain oil and gas leases. • On December 5, 2016, the Company issued 30,000 shares of common stock valued at $1.89 per share in connection with the exchange of interests in certain oil and gas assets in Buck Peak prospect. Activity for the year ended December 31, 2015 included the following: • 4,600,000 shares of common stock were issued under the terms of the public offering; 340,000 shares at $1.00 per share sold by the Company prior to engaging an underwriter and 4,260,000 shares at $0.90 per share to an underwriter. The Company received gross proceeds of $4,174,000, and incurred offering costs, commissions and expenses related to the offering of $364,999. • In December 2015, 25,000 shares of common stock were issued at $1.00 per share to one accredited investor pursuant to a private placement of the Company's common stock. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 9-SHAREHOLDERS' EQUITY (Continued) Preferred Stock As of December 31, 2016, the Company had 10,000,000 shares of preferred stock authorized with a par value of $0.01 per share. As of December 31, 2016 and 2015, there were no shares of preferred stock issued or outstanding. Warrants The table below summarizes warrants outstanding as of December 31, 2016: Activity for the year ended December 31, 2016: • On December 30, 2016, the Company issued 129,516 warrants. The warrants are exercisable at $1.50 per share and expire on December 31, 2021. The warrants were issued in connection with the closing of the first round of the Company's private placement. (Note 6) • On December 30, 2016, the Company issued 1,294,987 warrants. The warrants are exercisable at $3.00 per share and expire on December 31, 2019. The warrants were issued in connection with the closing of the first round of the Company's private placement. (Note 6) Activity for the year ended December 31, 2015: • On November 20, 2015, the Company issued 255,600 warrants. The warrants are exercisable at $1.25 per share and expire on November 12, 2020. NOTE 10-STOCK BASED COMPENSATION On August 18, 2016, the Company's Board of Directors adopted the Amended and Restated PetroShare Corp. Equity Incentive Plan (the "Plan"), which replaced and restated the Company's original equity incentive plan. The Plan terminates by its terms on August 17, 2026. Among other things, the Plan increased the number of shares of common stock reserved for issuance thereunder from 5,000,000 to 10,000,000 shares. The Company's shareholders approved the Plan at the Company's annual meeting of shareholders on September 8, 2016. During the year ended December 31, 2016, the Board of Directors granted non-qualified options to employees, directors and consultants of the Company under the Plan to acquire 2,275,000 shares of common stock. During the year ended December 31, 2015, the Board of Directors granted non-qualified options to employees and consultants of the Company under the Plan to acquire 275,000 of common stock. The options are exercisable at $1.00 and expire three years from the date of grant. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 10-STOCK BASED COMPENSATION (Continued) A summary of activity under the Plan for the years ended December 31, 2016 and 2015 is as follows: The fair value of each share-based award was estimated on the date of the grant using the Black-Scholes pricing model that incorporates key assumptions including volatility, dividend yield and risk-free interest rates. As the Company's common stock has limited historical trading data, the expected stock price volatility is based primarily on the historical volatility of a group of publicly-traded companies that share similar operating metrics and histories. The expected term of the awards represents the period of time that management anticipates awards will be outstanding. As there was insufficient historical data available to ascertain a forfeiture rate, the plain vanilla method was applied in calculating the expected term of the options. The risk-free rates for the periods within the contractual life of the options are based on the US Treasury bond rate in effect at the time of the grant for bonds with maturity dates at the expected term of the options. The Company has never paid dividends on its common stock and currently does not intend to do so, and as such, the expected dividend yield is zero. Compensation expense related to stock options was recorded net of estimated forfeitures, which for options remaining at December 31, 2016, the Company expects no additional forfeitures. The table below summarizes assumptions utilized in the Black-Scholes pricing model for the years ended 2016 and 2015: PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 10-STOCK BASED COMPENSATION (Continued) During the years ended December 31, 2016 and 2015, the Company recorded share-based compensation of $1,140,967 and $191,205, respectively. Unvested share-based compensation at December 31, 2016 amounted to $1,434,961. NOTE 11-PROVISION FOR INCOME TAXES Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. No uncertain tax positions have been identified as of December 31, 2016. The Company is in a position of cumulative reporting losses for the current and preceding reporting periods. The volatility of energy prices is not readily determinable by management. At this date, this fact pattern does not allow the Company to project sufficient sources of future taxable income to offset tax loss carry-forwards and net deferred tax assets. Under these circumstances, it is management's opinion that the realization of these tax attributes does not reach the "more likely than not criteria" under ASC 740, "Income Taxes." As a result, the Company's deferred tax assets as of December 31, 2016 and 2015 are subject to a full valuation allowance. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 11-PROVISION FOR INCOME TAXES (Continued) Net deferred tax assets and liabilities consist of the following components as of December 31, 2016 and 2015: The income tax provision differs from the amount of income tax determined by applying the US federal tax rate to the pretax loss from continuing operations for the years ended December 31, 2016 and 2015 due to the following: At December 31, 2016, the Company had net operating loss carry-forwards of approximately $11,570,570 that may be offset against future taxable income from the years 2016 through 2036. Due to the change in ownership provisions of the Tax Reform Act of 1986, net operating loss carry forwards for federal income tax reporting purposes are subject to annual limitations. Should a change in ownership occur, net operating loss carry forwards may be limited as to use in future years. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 11-PROVISION FOR INCOME TAXES (Continued) The Company files income tax returns in the US federal jurisdiction and in the State of Colorado. The Company is currently subject to US federal, state and local income tax examinations by tax authorities since inception of the Company. NOTE 12-RELATED PARTY TRANSACTIONS In May 2015, the Company entered into the Participation Agreement with Providence. As Providence is also the Company's primary lender through which the Company currently maintains the $5,000,000 initial line of credit (Note 6). The Participation Agreement grants Providence the option to acquire up to a 50% interest and participate in any oil and gas development on acreage the Company obtains through its Kingdom services agreement and any other leases acquired by the Company within an area of mutual interest ("AMI"). The AMI covers an area in Adams County, Colorado containing all of Township 1 South, Range 67 West, consisting of approximately 23,100 gross acres, with an additional one-mile border around the township, plus any other mutually agreeable areas. Providence currently holds 13.7% of the Company's outstanding common stock. At December 31, 2016, the Company had drawn $5,000,000 on the initial line of credit, and recorded related accrued interest of $302,477. On December 30, 2016 six officers and directors of the Company participated in Company's private placement by investing $500,000. (Note 6) The officers and directors participated on the same terms and conditions as third-party investors. NOTE 13-COMMITMENTS AND CONTINGENCIES Operating leases and agreements The Company leases its office facilities under a four year non-cancelable operating lease agreement expiring in October 2020. The following is a schedule by year of future minimum rental payments required under the operating lease agreement: Lease expense totaled $34,651 and $31,562 for the years ended December 31, 2016 and December 31, 2015 respectively. Employment agreements On February 25, 2016, the Board of Directors approved a form of amended and restated executive employment in order to provide uniform terms of employment for the Company's executive officers. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 13-COMMITMENTS AND CONTINGENCIES (Continued) Effective March 1, 2016, the Company entered into an amended and restated employment agreement with each Stephen J. Foley and Fredrick J. Witsell. Pursuant to the amended and restated employment agreements, Mr. Foley and Mr. Witsell are compensated by the Company at the rate of $13,000 per month, or $156,000 per year. The Company also executed an executive agreement with William B. Lloyd, Chief Operating Officer, pursuant to which, as amended, Mr. Lloyd is compensated at the rate of $13,000 per month, or $156,000 per year. For each of the foregoing executives, the employment agreements provide for an initial term expiring on December 31, 2018 with an automatic renewal for successive one-year periods unless terminated in accordance with its terms and provisions for termination and payment of severance under various circumstances. On April 15, 2016, the Company entered into an executive employment agreement with William R. Givan, Vice President, Land, pursuant to which Mr. Givan is compensated at the rate of $10,833.33 per month, or $130,000 per year. Mr. Givan's employment agreement provides for an initial term expiring on April 14, 2017 with an automatic renewal for successive one-year periods unless terminated in accordance with its terms and provisions for termination and payment of severance under various circumstances. NOTE 14-SUBSEQUENT EVENTS Completion of Private Placement On January 20, 2017, the Company completed a second closing of a private placement in which it sold an additional 66.509 units, including $2,216,978 in Notes and Warrants to purchase 2,216,978 shares of common stock. The Company received gross proceeds of $3,325,450 from this second closing prior to the deduction of placement agent fees and other associated expenses. (Notes 6 and 9) On January 30, 2017, the Company completed the final closing of the private placement in which it sold an additional 94.64 units, including $3,154,601 in Notes and Warrants to purchase 3,154,601 shares of common stock. The Company received gross proceeds of $4,731,950 from the final closing and gross proceeds of $10,000,000 from the entire private placement prior to the deduction of placement agent fees and other associated expenses. (Notes 6 and 9) In connection with the private placement, the Company paid the placement agent and participating broker-dealers a total commission of $1,000,000 pursuant to a Placement Agent Agreement between the Company and the agent dated December 16, 2016 and amended on January 24, 2017. As additional compensation, the Company issued a placement agent warrant to purchase a total of 666,797 shares of the Company's common stock exercisable at a price of $1.50 per share. The placement agent warrants expire on December 31, 2021. Supplemental Line of Credit As amended on March 30, 2017, the Company agreed to repay $3,552,500 in outstanding principal not later than April 13, 2017 and not to borrow additional funds against the supplemental line of credit in exchange for PEP III extending the maturity date of the supplemental line of credit until June 13, 2017. (Note 6) PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 14-SUBSEQUENT EVENTS (Continued) Pending Acquisitions On February 23, 2017 the Company entered into a Purchase and Sale Agreement with an independent third party seller to acquire oil and gas leases totaling approximately 5,879 gross (2,930 net) acres, with an average net revenue interest of 84%, located in Weld and Adams Counties, Colorado. The total purchase price for the leases and associated assets is $2,582,500. Providence has agreed to purchase a 50% interest in the assets, which would reduce the Company's interest to 1,465 net acres. Subject to satisfaction of closing conditions, the Company will pay approximately $460,000 in cash and issue 450,000 shares of its common stock to the seller for its 50% share of the acquisition. On March 16, 2017, the Company entered into a Letter Agreement with an independent third party seller to acquire an 18.75% royalty interest covering approximately 291 net acres, located in Adams County, Colorado. The total purchase price for the interests is $1,138,800. If completed, the transaction will be effective April 1, 2017. If completed, the Company may sell 50% of its acquired interest to Providence. NOTE 15-UNAUDITED CRUDE OIL AND NATURAL GAS RESERVES INFORMATION The reserves at December 31, 2016, presented below were prepared by the independent engineering firm Cawley, Gillespie & Associates Inc. All reserves are located within the DJ Basin. Proved oil, natural gas and NGL reserves are the estimated quantities of oil, natural gas and NGLs which geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under economic and operating conditions (i.e., prices and costs) existing at the time the estimate is made. Proved developed oil, natural gas and NGL reserves are proved reserves that can be expected to be recovered through existing wells and equipment in place and under operating methods being utilized at the time the estimates were made. A variety of methodologies are used to determine the proved reserve estimates. The principal methodologies employed are decline curve analysis, advance production type curve matching, petro physics/log analysis and analogy. Some combination of these methods is used to determine reserve estimates in substantially all of the Company's fields. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established proved producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. As the result of volatile crude oil prices coupled with nominal estimated reserve volumes, the Company's management deemed that is was not economically prudent to obtain a reserve report for the year December 31, 2015. Based on management's analysis, as of December 31, 2015, the Company has ascribed no value related to proved reserves. At December 31, 2014, the Company had ascribed a nominal value to the standardized measure of estimated discounted future net cash flows related to its reserves. PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 15-UNAUDITED CRUDE OIL AND NATURAL GAS RESERVES INFORMATION (Continued) Analysis of Changes in Proved Reserves. Estimated quantities of proved developed reserves (all of which are located within the United States), as well as the changes in proved developed reserves during the periods indicated, are presented in the following tables: PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 15-UNAUDITED CRUDE OIL AND NATURAL GAS RESERVES INFORMATION (Continued) The values for the 2016 oil, natural gas and NGL reserves are based on the 12-month arithmetic average of the first day of the month prices for the period from January through December 31, 2016. The unweighted arithmetic average first-day-of-the-month prices for the prior twelve months were $42.75 per barrel (West Texas Intermediate price) for crude oil and NGLs and $2.48 per MMBtu (Henry Hub price) for natural gas. All prices are then further adjusted for transportation, quality and basis differentials. The average resulting price used as of December 31, 2016 was $34.09 per barrel for oil, $2.69 per Mcf for natural gas and $14.44 per barrel for NGLs. The Company did not ascribe a value to its proved reserves as of December 31, 2015 due to immaterial quantity estimates and a volatile price environment. The values for the 2014 oil and natural gas reserves are based on the 12- month arithmetic average of the first day of the month prices for the period January through December, 31, 2014. The unweighted arithmetic average first-day-of-the-month prices for the prior twelve months were $94.99 per barrel (West Texas Intermediate price) for crude oil and NGLs and $4.35 per MMBtu (Henry Hub price) for natural gas. All prices are then further adjusted for transportation, quality and basis differentials. For the year ended December 31, 2016, the Company reported extensions and discoveries of 6,030,624 BOE as a result of drilling and completion activities during 2016. Additionally, during 2016 the Company purchased reserves of 287,999 BOE. For the year ended December 31, 2015, the Company had downward revisions of previous estimates of 122 BOE. The Company ascribed no value related to proved reserves at December 31, 2015. For the year ended December 31, 2014, the Company reported extensions discoveries of 250 BOE related to the drilling and completion of two wells. Standardized Measure of Estimated Discounted Future Net Cash Flows to Proved Oil and Natural Gas Reserves (in thousands): The Company follows the guidelines prescribed in ASC 932, Extractive Activities-Oil and Gas for computing a standardized measure of future net cash flows and changes therein relating to estimated proved reserves. The following summarizes the policies used in the preparation of the accompanying oil, natural gas and NGL reserve disclosures, standardized measures of discounted future net cash flows from proved oil, natural gas and NGL reserves and the reconciliations of standardized measures from year to year. The information is based on estimates of proved reserves attributable to the Company's interest in oil and gas properties as of December 31 of the years presented. These estimates were prepared by Cawley Gillespie & Associates, Inc., independent petroleum engineers. The standardized measure of discounted future net cash flows from production of proved reserves was developed as follows: (1) estimates are made of quantities of proved reserves and future periods during which they are expected to be produced based on year-end economic conditions; (2) the estimated future cash flows are compiled by applying the twelve month average of the first of the PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 15-UNAUDITED CRUDE OIL AND NATURAL GAS RESERVES INFORMATION (Continued) month prices of crude oil and natural gas relating to the Company's proved reserves to the year-end quantities of those reserves for reserves; (3) the future cash flows are reduced by estimated production costs, costs to develop and produce the proved reserves and abandonment costs, all based on year-end economic conditions, plus Company overhead incurred; and (4) future net cash flows are discounted to present value by applying a discount rate of 10%. The assumptions used to compute the standardized measure are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company's expectations of actual revenues to be derived from those reserves, nor their present value. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure computations, since these reserve quantity estimates are the basis for the valuation process. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established proved producing oil and gas properties. The standardized measure of discounted future net cash flows does not purport, nor should it be interpreted, to present the fair value of the Company's oil and natural gas reserves. An estimate of fair value would also take into account, among other things, the recovery of reserves not presently classified as proved, anticipated future changes in prices and costs and a discount factor more representative of the time value of money and the risks inherent in reserve estimates. The following are the principal sources of change in the standardized measure (in thousands): PetroShare Corp. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 2016 and 2015 NOTE 15-UNAUDITED CRUDE OIL AND NATURAL GAS RESERVES INFORMATION (Continued) The following summary sets forth the Company's future net cash flows relating to proved oil, natural gas and NGL reserves based on the standardized measure prescribed in ASC 932, Extractive Activities-Oil and Gas (in thousands): Changes in Standardized Measure of Estimated Discounted Future Net Cash Flows | Here's a summary of the financial statement:
Key Components:
1. Revenue
- Based on net revenue interest in acreage
- Accounts for landowner and other royalties
- Connected to initial line of credit per Participation Agreement
2. Profit/Loss
- Calculated as basic and diluted loss per share
- Determined by dividing net loss by weighted average number of common shares
- Excludes potentially dilutive securities due to anti-dilutive effects
3. Expenses
- Uses acquisition method accounting for fair value assets/liabilities
- Includes management estimates for:
* Oil, gas, and natural gas liquids reserves
* Property, plant, and equipment values
* Asset retirement obligations
* Deferred income tax assets
* Share-based compensation
4. Assets
- Includes deferred offering costs related to capital raising
- Costs charged against capital when offering completes
- If offering terminates, costs charged to operations
5. Liabilities
- Includes debt issuance costs from private placement and credit line
- Uses successful efforts accounting method for oil/gas properties
- Property acquisition and development costs are:
* Capitalized when incurred
* Depleted on units-of-production basis
* Assessed for impairment
* Written down to fair value if necessary
The statement appears to be for PetroShare Corp., focusing heavily on oil and gas operations accounting methods and various financial estimations required for the industry. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Board of Directors and Stockholders Orchids Paper Products Company We have audited the accompanying consolidated balance sheets of Orchids Paper Products Company and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2016, and the financial statement schedule of Orchids Paper Products Company listed in Item 15(a). We also have audited Orchids Paper Products Company's internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. Orchids Paper Products Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and schedule and an opinion on the Company's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Orchids Paper Products Company and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America, and in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Also in our opinion, Orchids Paper Products Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. /s/ HOGANTAYLOR LLP Tulsa, Oklahoma March 15, 2016 ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share data) See notes to consolidated financial statements. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 2016, 2015 and (In thousands, except share and per share data) See notes to consolidated financial statements. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years ended December 31, 2014, 2015 and (In thousands, except share data) See notes to consolidated financial statements. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2016, 2015 and (In thousands) See notes to consolidated financial statements. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) Years ended December 31, 2016, 2015 and (In thousands) See notes to consolidated financial statements. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2016, 2015 and 2014 Note 1-Nature of Business and Summary of Significant Accounting Policies Business Orchids Paper Products Company and its subsidiaries (collectively, “Orchids” or the “Company”) produce bulk tissue paper, known as parent rolls, and convert parent rolls into finished products, including paper towels, bathroom tissue and paper napkins. The Company predominately sells its products for use in the "at home" market under private labels to a customer base consisting primarily of dollar stores, discount retailers and grocery stores that offer limited alternatives across a wide range of products, and, to a lesser extent, the “away from home” market. The Company has owned and operated its manufacturing facility in Pryor, Oklahoma since 1998. On June 3, 2014, the Company completed the acquisition of certain assets from Fabrica de Papel San Francisco, S.A. de C.V. (“Fabrica”) pursuant to an Asset Purchase Agreement (see Note 2). In connection with the acquisition of these assets, the Company formed three wholly owned subsidiaries: Orchids Mexico DE Holdings, LLC, Orchids Mexico DE Member, LLC, and OPP Acquisition Mexico, S. de R.L. de C.V. (“Orchids Mexico”). In April 2015, the Company announced the construction of a new manufacturing facility in Barnwell, South Carolina. In conjunction with this project, the Company established a wholly owned subsidiary: Orchids Paper Products Company of South Carolina. Furthermore, in connection with a New Market Tax Credit (“NMTC”) transaction in December 2015 (see Note 12), the Company created Orchids Lessor SC, LLC, another wholly owned subsidiary. The Company's stock trades on the NYSE MKT under the ticker symbol "TIS." Summary of Significant Accounting Policies Principles of consolidation The accompanying consolidated financial statements include the accounts of Orchids Paper Products Company, its wholly owned subsidiaries, as described above, and variable interest entities for which Orchids is the primary beneficiary. All significant intercompany transactions and balances have been eliminated in consolidation. Cash Cash includes cash on hand and cash in banks that management expects to utilize for operational activities. Accounts receivable Accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts. A trade receivable is considered to be past due if it is outstanding for more than five days past terms. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer's financial condition, credit history, and current economic conditions. Receivables are written-off when deemed uncollectible. Recoveries of receivables previously written-off are recorded when received. The Company does not typically charge interest on trade receivables. Inventories Inventories consist of converted finished goods, bulk paper rolls and raw materials stated at the lower of cost or net realizable value (market). The Company's cost is based on standard cost, specific identification, or FIFO (first-in, first-out) method. Standard costs approximate actual costs on a FIFO basis. Material, labor, and factory overhead necessary to produce the inventories are included in the standard cost to the extent such input costs do not result in values in excess of net realizable value. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 1-Nature of Business and Summary of Significant Accounting Policies (Continued) Property, plant and equipment Property, plant and equipment are stated at cost. Depreciation of property, plant and equipment is computed using the straight-line method over the estimated useful lives of the assets. The Company expenses normal maintenance and repair costs as incurred. Spare parts that are maintained to keep the Company’s machinery and equipment in working order are capitalized and expensed when used rather than depreciated. Gain and loss on disposal of property, plant and equipment is recognized in the period incurred. The Company capitalizes interest for major capital projects. Capitalized interest is added to the cost of the underlying assets and is depreciated over the useful lives of those assets. Goodwill, intangible assets and long-lived assets The Company records the excess of purchase price over the fair value of the tangible and identifiable intangible assets acquired and liabilities assumed as goodwill. Goodwill is tested for impairment annually as well as when an event, or change in circumstances, indicates that the carrying value may not be recoverable. Under accounting principles generally accepted in the United States (“U.S. GAAP”), the Company may first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of its reporting unit is greater than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, there is no need to perform any further testing. However, if the Company concludes otherwise, it is required to perform the first step of a two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the fair value of the reporting unit is less than its carrying value, it is required to perform the second step of the two-step impairment test, in which an impairment loss is calculated and recorded to the extent that the implied fair value of the goodwill of the reporting unit is less than its carrying value. Alternatively, the Company may bypass the qualitative assessment in any period and proceed directly to performing the first step of the two-step goodwill impairment test. The Company performed its annual goodwill impairment test on October 1, 2016 by performing the first step (e.g. “step zero”), a qualitative impairment test, to determine whether it was more likely than not that goodwill was impaired. Goodwill is tested at a level of reporting referred to as the “reporting unit”. The Company has two reporting units, which are defined as the “at home” business and the “away from home” business. Based on this qualitative test, we determined it was more likely than not that the fair value of the Company’s reporting units were greater than their carrying amounts; as such, we determined that performing the second and third steps of the impairment test were not necessary and that goodwill was not impaired. Intangible assets consist of the Supply Agreement and Equipment Lease Agreements with Fabrica (see Note 2), licenses, trademarks, customer relationships and a non-compete agreement. The Company amortizes these assets on a straight-line basis over the expected lives of the assets, which range from 2 to 20 years. The Company reviews its long-lived assets, primarily property, plant and equipment and intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying values may not be recoverable. Impairment evaluation is based on estimates of remaining useful lives and the current and expected future profitability and cash flows. The determination of future profitability and cash flows require significant estimates to be made by the Company’s management. The Company had no impairment of long-lived assets during the years ended December 31, 2016, 2015 or 2014. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 1-Nature of Business and Summary of Significant Accounting Policies (Continued) Income taxes Income taxes are computed in accordance with the tax rules and regulations of the taxing authorities where the income is earned. Deferred income taxes are computed using the liability method and are provided on all temporary differences between the financial basis and the tax basis of the Company's assets and liabilities. Future tax benefits are recognized to the extent that realization of those benefits is considered to be more likely than not. A valuation allowance is provided for deferred tax assets for which realization is not likely. The Company uses the flow through method to account for Oklahoma and South Carolina investment tax credits earned on eligible capital expenditures in the respective states. Under this method, the investment tax credits are recognized as a reduction to income tax expense when earned. Deferred debt issuance costs Costs incurred in obtaining debt funding are deferred and amortized on an effective interest method over the terms of the loans. Amortization expense for 2016, 2015 and 2014 was $294,000, $198,000, and $60,000, respectively, and has been classified as interest expense in the statement of income. Stock compensation expense Grant-date cost of stock options and restricted stock are recognized on a straight-line basis over the requisite service periods of the respective options and shares, based on the fair value of the award on the grant date. The fair value of stock options that have time-based vesting requirements is estimated using the Black-Scholes option-pricing model. The fair value of stock options that have market-based vesting requirements is estimated using a Monte-Carlo option-pricing model. The fair value of restricted stock awards is calculated as the arithmetic mean of the high and low market price of the Company’s stock on the grant date. Excess tax benefits related to share-based compensation that are available to absorb future tax deficiencies related to share-based compensation are recorded in additional paid-in capital ("APIC pool") when realized. If the amount of tax deficiencies is greater than the available APIC pool, the excess is recorded as current income tax expense in the statement of income. Revenue recognition Revenues for products loaded on customer trailers are recognized when the customer has accepted custody and left the Company's dock. Revenues for products shipped to customers are recognized when title passes upon shipment. Customer discounts and pricing allowances are included in net sales. Shipping and handling costs Shipping and handling costs incurred to ship raw materials to the Company's facilities are included in inventory and cost of sales in the statement of income. Shipping and handling costs incurred to ship finished goods to customer locations and warehouse locations are included in cost of sales in the statement of income. Business interruption insurance In 2016, the Company received $1.1 million of proceeds under a business interruption insurance policy for an incident that occurred in its Oklahoma converting operation in 2015. This amount is recorded as a reduction of cost of sales in the statement of income. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 1-Nature of Business and Summary of Significant Accounting Policies (Continued) Advertising costs Advertising costs, which include costs related to artwork and packaging development, totaled approximately $438,000, $319,000, and $292,000, respectively, for the years ended December 31, 2016, 2015 and 2014. These costs are expensed when incurred and included in selling, general and administrative expenses. Use of estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ significantly from those estimates. Reclassifications Certain immaterial prior period amounts in the accompanying financial statements have been reclassified to conform to the current period presentation. These reclassifications did not affect previously reported amounts of net income. New and recently adopted accounting pronouncements In November 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”). ASU 2015-17 requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. ASU 2015-17 is effective for public companies for annual and interim periods beginning after December 15, 2016. During 2016, we elected to early adopt ASU 2015-17 on a retrospective basis. As such, we reclassified $1.3 million of current deferred tax assets to noncurrent (netted within noncurrent liabilities) on the consolidated balance sheets as of December 31, 2015. The adoption of ASU 2015-17 did not affect our consolidated statements of income. In April 2015, the FASB issued ASU No. 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40); Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement (“ASU 2015-05”). ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance does not change the accounting for a customer’s service contracts. ASU 2015-05 became effective for the Company on January 1, 2016. Adoption of ASU 2015-05 did not have a material effect on our consolidated financial statements. In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued Accounting Standards Update 2015-15, “Interest - Imputation of Interest: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements” (“ASU 2015-15). ASU 2015-15 states that since ASU 2015-03 does not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements, the SEC staff will not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-03 became effective for the Company on January 1, 2016. As such, we reclassified $1.3 million of unamortized debt issuance costs, including costs associated with our revolving lines of credit, as of December 31, 2015, to offset long-term debt in the consolidated balance sheets (see Note 7). Adoption of ASU 2015-03 and ASU 2015-15 did not affect our consolidated statements of income. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 1-Nature of Business and Summary of Significant Accounting Policies (Continued) In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 provides for a one-step quantitative impairment test, whereby a goodwill impairment loss will be measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed the total goodwill allocated to that reporting unit). It eliminates Step 2 of the current two-step goodwill impairment test, under which a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. ASU 2017-04 is effective, on a prospective basis, for SEC filers for interim and annual periods beginning after December 15, 2019, with early adoption permitted. Management is currently assessing the impact ASU 2017-04 will have on the Company, but it is not expected to have a material impact on the Company’s financial statements. In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective, on a prospective basis, for public companies for interim and annual reporting periods beginning after December 15, 2017. Management is currently assessing the impact ASU 2017-00 will have on the Company, but it is not expected to have a material impact on the Company’s financial statements. In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU No 2016-18 is effective, on a retrospective basis, for public companies for interim and annual periods beginning after December 15, 2017, with early adoption permitted. Management is currently assessing the impact ASU 2016-18 will have on the Company, but it is not expected to have a material impact on the Company’s cash flows. In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”). ASU 2016-16 requires the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. ASU 2016-16 is effective for public companies for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. The amendments in this ASU should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Management is currently assessing the impact ASU 2016-16 will have on the Company’s financial position and results of operations. In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for public companies for interim and annual periods beginning after December 15, 2017, with early adoption permitted. The new standard will require adoption on a retrospective basis unless it is impracticable to apply, in which case it would be required to apply the amendments prospectively as of the earliest date practicable. Management is currently assessing the impact ASU 2016-15 will have on the Company, but it is not expected to have a material impact on the Company’s cash flows. In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for SEC filers for interim and annual periods beginning after December 15, 2019. Management is currently assessing the impact ASU 2016-13 will have on the Company, but it is not expected to have a material impact on the Company’s financial position, results of operations and cash flows. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 1-Nature of Business and Summary of Significant Accounting Policies (Continued) In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 requires, among other things, that excess tax benefits and tax deficiencies be recognized as income tax expense or benefit in the income statement rather than as additional paid-in capital, changes the classification of excess tax benefits from a financing activity to an operating activity in the statement of cash flows, and allows forfeitures to be accounted for when they occur rather than estimated. ASU 2016-09 is effective for the Company on January 1, 2017. Adopting ASU 2016-09 will not have a material impact on the Company’s financial position, results of operations and cash flows. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires lessees to recognize lease assets and lease liabilities on the balance sheet but did not make significant changes to the effects of lessee accounting on the income statement or statement of cash flows. ASU 2016-02 is effective for public companies for annual and interim periods beginning after December 15, 2018, with early adoption permitted. Management is currently assessing the impact ASU 2016-02 will have on the Company’s financial position. In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). ASU 2016-01 addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments, specifically equity investments and financial instruments measured at amortized cost. ASU 2016-01 is effective for public companies for annual and interim periods beginning after December 15, 2017. Management is currently assessing the impact ASU 2016-01 will have, if any, on the Company’s financial position, results of operations and cash flows. In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 2015-11”). ASU 2015-11 requires inventory measured using all methods other than the last-in, first-out (LIFO) or retail methods to be measured at the lower of cost or net realizable value. Net realizable value is defined as the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. ASU 2015-11 is effective for the Company on January 1, 2017. Adopting ASU 2015-11 will not have a material impact on the Company’s financial position, results of operations and cash flows. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 clarifies the principles for recognizing revenue and develops a common revenue standard under U.S. GAAP under which an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Due to the issuance of ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606); Deferral of the Effective Date (“ASU 2015-14”), in July 2015, the effective date of ASU 2014-09 was deferred for one year and becomes effective for the Company for interim and annual periods beginning on or after December 15, 2017. In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (“ASU 2016-08”). ASU 2016-08 clarifies implementation guidance on principal versus agent considerations in ASU 2014-09. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (“ASU 2016-10”). In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”). ASU 2016-10 and ASU 2016-12 do not change the guidance under ASU 2014-09, but clarify certain aspects of this guidance. In May 2016, the FASB issued ASU No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815) (“ASU 2016-11”). ASU 2016-11 rescinds certain SEC accounting guidance that is inconsistent with guidance in ASU 2014-09. Management is currently assessing the impact these ASUs will have on the Company, but they are not expected to have a material effect on the Company’s financial position, results of operations or cash flows. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 2-Fabrica Transaction On May 5, 2014, Orchids Paper Products Company and its wholly owned subsidiary, Orchids Mexico, entered into an asset purchase agreement (“APA”) with Fabrica to acquire certain assets and 100% of the U.S. business of Fabrica. On June 3, 2014, the Company closed on the transaction set forth in the APA, and in connection therewith, entered into a supply agreement (“Supply Agreement”) and an equipment lease agreement (“Equipment Lease Agreement”) (collectively, the “Fabrica Transaction”). Asset Purchase Agreement and Assignment and Assumption of Supply Agreement Pursuant to the terms of the APA, Orchids Mexico acquired a paper machine, two converting lines, Fabrica’s U.S. customer list, exclusive rights to all of Fabrica’s trademarks in the United States, and Fabrica’s covenant not to compete in the United States. The purchase price consisted of 411,650 shares of Orchids’ common stock, which were valued at $12.0 million based on the closing price of the Company’s shares on the closing date and had a fair market value of $9.6 million on the closing date due to restrictions on the sale of the stock. In connection with closing the APA, Orchids Paper Products Company also entered into an Assignment and Assumption of Supply Agreement with Elgin Finance & Investment Corp. (“Elgin”) for $16.7 million in cash and 274,433 shares of Orchids’ common stock, which were valued at $8.0 million based on the closing price of the Company’s shares on the closing date and had a fair market value of $6.4 million on the closing date due to restrictions on the sale of the stock, in exchange for the assignment to Orchids of Elgin’s supply agreement with Fabrica which provided Elgin exclusive supply rights with respect to Fabrica’s U.S. business. Under the Supply Agreement, the Company has the right to purchase from Fabrica up to 19,800 tons of parent rolls and equivalent converting capacity for certain specified product during each twelve-month period following the effective date of the Supply Agreement. The Supply Agreement also allowed the Company to purchase up to an additional 7,700 tons annually in each of the first two years of the agreement. Pursuant to the terms of the Supply Agreement, Fabrica and its affiliates will be subject to a non-compete provision with respect to business in the U. S. The Supply Agreement has an initial term of twenty years. In the event of a termination of the Supply Agreement due to (i) a material breach as a result of intentional, willful or grossly negligent conduct by Fabrica, (ii) a breach of Fabrica’s covenant not to compete, or (iii) a voluntary filing of bankruptcy by Fabrica, Fabrica must pay the Company $100 million in liquidated damages. In the event of a change of control of Fabrica, the Company will have a two-year right to terminate the Supply Agreement, and in such event, Fabrica would be required to pay the Company liquidated damages of $36.7 million. Equipment Lease Agreement Pursuant to the terms of the Equipment Lease Agreement, Orchids Mexico will lease the paper making and converting assets acquired under the APA back to Fabrica. The rental fee will be based upon the number of metric tons shipped by Fabrica to the Company, subject to annual adjustment based on the calculation of the purchase price for product under the Supply Agreement. The Equipment Lease Agreement has a term of twenty years, but will terminate automatically upon termination of the Supply Agreement. Upon the earlier of (i) the termination of the Equipment Lease Agreement or (ii) the purchase by Orchids of a separate papermaking or converting asset and the entry into of an equipment lease agreement between Orchids and Fabrica with respect to such purchased asset, Orchids Mexico shall have the right to sell to Fabrica the paper assets leased under the Equipment Lease Agreement on an as-is-where-is basis, for $12.0 million. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 2-Fabrica Transaction (continued) Purchase Price Allocation The acquisition of Fabrica’s U.S. business in the Fabrica Transaction is being accounted for under the Financial Accounting Standards Board’s (the “FASB”) Accounting Standards Codification 805, “Business Combinations”. The $32.7 million purchase price of $16.7 million in cash (financed by a term loan) and $16.0 million in common stock was allocated as follows (in thousands): Intangibles and goodwill Intangible assets at December 31, 2016 were: Intangible assets at December 31, 2015 were: Estimated future intangible amortization expense is $0.9 million in 2017, 2018, 2019, 2020, and 2021, respectively. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 2-Fabrica Transaction (Continued) Goodwill of $7.6 million represents the premium the Company was willing to pay to enter into a long-term relationship with Fabrica and the benefits the Company expects to receive from being able to cost effectively serve its current customers and to develop relationships with new customers with distribution centers in the western United States. The relationship with Fabrica is expected to provide opportunities for future production capacity and sales growth. Goodwill is not amortized, but is tested at least annually for impairment, or if circumstances occur that more likely than not will reduce the fair value of the reporting unit to below its carrying amount. No goodwill impairment has been recorded as of December 31, 2016. There were no other changes in the carrying amount of goodwill subsequent to the acquisition. All of the goodwill related to the Fabrica Transaction is expected to be tax-deductible. Operating Results of Business Acquired The consolidated statements of income include the following revenues and operating income related to the U.S. business acquired from Fabrica: Operating income included in the above table does not include an allocation of any of the Company’s overhead or selling, general and administrative expenses. Transaction costs of $1.6 million related to the Fabrica Transaction are recognized in selling, general and administrative expenses in the consolidated statement of income for the year ended December 31, 2014. Pro Forma Information (unaudited) The following unaudited pro forma information presents a summary of the operating results of the Company for the year ended December 31, 2014 as if the U.S. business acquired from Fabrica had been included in the Company’s results of operations as of January 1, 2014 (dollars in thousands, except per share data): Pro forma adjustments to net income include amortization costs related to the intangibles acquired, acquisition related costs, and the tax effect of the historical results of operations of Fabrica’s U.S. business, excluding certain mark-up and selling, general and administrative costs that will not be incurred by Orchids. The pro forma amounts are presented for informational purposes only and are not intended to represent or be indicative of the Company’s consolidated results of operations or financial condition that would have been reported had the acquisition been completed as of the beginning of the periods presented and should not be taken as indicative of the Company’s future consolidated results of operations or financial condition. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 2-Fabrica Transaction (Continued) Related party transactions The Company incurred the following transactions with Fabrica during the years ended December 31, 2016, 2015 and 2014: Note 3-Fair Value Measurements The valuation hierarchy included in U.S. GAAP considers the transparency of inputs used to value assets and liabilities as of the measurement date. The less transparent or observable the inputs used to value assets and liabilities, the lower the classification of the assets and liabilities in the valuation hierarchy. A financial instrument's classification within the valuation hierarchy is based on the lowest level of input that is significant to its fair value measurement. The three levels of the valuation hierarchy and the classification of the Company's financial assets and liabilities within the hierarchy are as follows: Level 1-Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2-Observable inputs other than quoted prices included within Level 1 for the asset or liability, either directly or indirectly. If an asset or liability has a specified term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 3-Unobservable inputs for the asset or liability. The Company does not report any assets or liabilities at fair value in the financial statements. However, the fair value of the Company's long-term debt is estimated by management to approximate the carrying value of $142.0 million and $75.6 million at December 31, 2016 and 2015, respectively. Management's estimates are based on periodic comparisons of the characteristics of the Company's obligations, including floating interest rates, credit rating, maturity and collateral, to current market conditions as stated by an independent third-party financial institution. Such valuation inputs are considered a Level 2 measurement in the fair value valuation hierarchy. As the Company has no assets or liabilities reported at fair value in the financial statements, there were no transfers among Level 1, Level 2 or Level 3 assets during the years ended December 31, 2016, 2015 and 2014. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 4-Commitments and Contingencies The Company may be involved from time to time in litigation arising from the normal course of business. In management's opinion, as of the date of this report, the Company is not engaged in legal proceedings, which individually or in the aggregate are expected to have a materially adverse effect on the Company's results of operations or financial condition. Gas purchase commitments The Company has entered into a natural gas fixed price contract to purchase 467,505 MMBTUs of natural gas, which provides approximately 80% to 90% of the natural gas requirements at Pryor through December 31, 2017. Commitments under this contract are as follows: Purchases under the gas contract were $1.7 million, $1.7 million, and $1.9 million in 2016, 2015 and 2014, respectively. If the Company is unable to purchase the contracted amounts and the market price at that time is less than the contracted price, the Company would be obligated under the terms of the agreements to reimburse an amount equal to the difference between the contracted amount and the amount actually purchased, multiplied by the difference between the contract price and a price designated in the contract (approximates spot price). Other purchase commitments In April 2015, Orchids announced projects to build a new integrated paper converting facility in Barnwell, South Carolina. This project has a total estimated cost of approximately $150.0 million. As part of this project, the Company entered into significant purchase orders for two converting lines and construction of a paper machine. As of December 31, 2016, obligations under purchase orders related to the Barnwell projects totaled approximately $9.0 million. Note 5-Inventories Inventories at December 31 were: ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 6-Property, Plant and Equipment The principal categories and estimated useful lives of property, plant and equipment at December 31 were: In January 2016, the Company received $1.9 million of proceeds from an economic incentive related to the construction of the South Carolina facility. While there currently are no US GAAP pronouncements relating to the accounting treatment of government grants, the Company recorded these proceeds as a reduction in the property, plant and equipment related to this project in accordance with non-authoritative guidance issued by the American Institute of Certified Public Accountants, which recommended that grants related to developing property be recognized over the useful lives of the assets by recognizing receipt as the related asset is depreciated. The Company capitalizes interest for major capital projects. Capitalized interest is added to the cost of the underlying assets and is depreciated over the useful lives of those assets. Interest expense for the years ended December 31, 2016, 2015 and 2014 excludes $1.7 million, $0.5 million and $0.3 million, respectively, of interest capitalized on significant projects during the year. For the year ended December 31, 2014, other (income) expense includes $.04 million of expenses related to the demolition of two paper machines in the Company’s paper mill, which were replaced with a new paper machine. Note 7-Long-Term Debt and Revolving Line of Credit In June 2015, the Company entered into the Second Amended and Restated Credit Agreement (the “Credit Agreement”), with U.S. Bank National Association (“U.S. Bank”). Additionally, on January 19, 2017, the Company entered into Amendment No. 3 (“the Amendment”) which increases the total loan commitment, modifies the pricing grid applicable to interest rates and the unused commitment fee, amends the financial covenant related to the maintenance of a maximum total leverage ratio by increasing the permitted total leverage ratio for fiscal quarters ending on or prior to March 31, 2018, and amends the terms of the draw loan to provide for additional advance amounts available to the Company for the purposes of acquiring or improving real estate. The terms of the Credit Agreement, as amended, consist of the following: ·a $25.0 million revolving credit line due June 2020; ·a $47.3 million Term Loan with a 5-year term due June 2020 and payable in quarterly installments of $675,000 through June 2016 and $1.0 million per quarter thereafter; ·a $115.0 million delayed draw term loan with a 2-year draw period due June 2020 and payable in quarterly installments beginning in September 2017 of 1.5% of the June 30, 2017 outstanding balance. In December 2015, in connection with the NMTC transaction (see Note 12), the maximum borrowing capacity under the delayed draw term loan was reduced from $115.0 million to $99.6 million and in January 2017, under the terms of the Amendment, the maximum borrowing capacity was increased to $108.5 million; and ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 7-Long-Term Debt and Revolving Line of Credit (Continued) ·an accordion feature allowing the revolving credit line and/or delayed draw commitment under the Credit Agreement to be increased by up to $50.0 million at any time on or before the expiration date of the Credit Agreement. Proceeds from the delayed draw term loan must be utilized solely to finance the purchase and installation of new equipment and construction at the Company’s Barnwell, South Carolina facility. Under the terms of the Credit Agreement, as amended, amounts outstanding will bear interest at a variable rate of LIBOR plus a specified margin, or the base rate plus a specified margin, at the Company’s option. The specified margin is based on the Company’s quarterly Leverage Ratio, as defined in the Credit Agreement, as amended. The following table outlines the specified margins and the commitment fees payable under the Credit Agreement: Additionally, in connection with the NMTC transaction discussed in Note 12, the Company entered into an $11.1 million term loan with U.S. Bank. This loan bears interest at a fixed rate of 4.4% and matures on December 29, 2022. The loan requires quarterly payments of principal and interest of approximately $255,000, beginning in March 2016, with a balloon payment due on the maturity date. As of December 31, 2016, the Company’s weighted-average interest rate was 2.64%. Long-term debt at December 31 consists of: ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 7-Long-Term Debt and Revolving Line of Credit (Continued) Unamortized debt issuance costs at December 31 consist of: The annual maturities of long-term debt at December 31, 2016, are as follows: The amount available under the revolving credit line may be reduced in the event that the Company's borrowing base, which is based upon qualified receivables and qualified inventory is less than $25.0 million. As of December 31, 2016, the Company’s borrowing base was $15.0 million, including $6.1 million of eligible accounts receivable and $8.9 million of eligible inventory. Obligations under the Credit Agreement and the NMTC loan are secured by substantially all of the Company's assets. The Credit Agreement contains representations and warranties, and affirmative and negative covenants customary for financings of this type, including, but not limited to, limitations on additional borrowings, additional investments and asset sales. The financial covenants, which are tested as of the end of each fiscal quarter, require the Company to maintain the following specific ratios: fixed charge coverage (minimum of 1.20 to 1.0) and leverage (maximum of 5.0 to 1.0 on December 31, 2016; maximum of 5.75 to 1.0 on March 31, 2017; maximum of 5.5 to 1.0 on June 30, 2017, maximum of 4.5 to 1.0 on September 30, 2017, maximum of 4.0 to 1.0 on December 31, 2017, and maximum of 3.5 to 1.0 on March 31, 2018 and thereafter). The Company has the right to prepay borrowings under the Credit Agreement at any time without penalty. The Company’s leverage ratio at December 31, 2016 was 4.26, while the fixed charge coverage ratio was 1.86. Note 8-Income Taxes The Company is subject to income tax in the United States and Mexico. Income from continuing operations before taxes subject to United States and foreign income taxes for each of the three years ended December 31, were as follows: ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 8-Income Taxes (Continued) The components of the provision for income taxes for each of the three years ended December 31, were as follows: Significant components of the Company's deferred income tax assets and (liabilities) at December 31 were: ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 8-Income Taxes (Continued) The following table summarizes the differences between the U.S. federal statutory rate and the Company's effective tax rate for financial statement purposes: For the year ended December 31, 2016, the effective tax rate was lower than the statutory rate primarily due to South Carolina Investment Tax Credits (“SCITC”) and Oklahoma Investment Tax Credits (“OITC”) associated with investments in the Company’s manufacturing operations in Barnwell, South Carolina and Pryor, Oklahoma, respectively, and federal credits, including Indian Employment Credits (“IEC”), foreign tax credits and research and development credits. For the year ended December 31, 2015, the effective tax rate was lower than the statutory rate primarily due to OITC associated with investments in the Company’s manufacturing operations in Pryor, Oklahoma, manufacturing tax deductions and IEC. For the year ended December 31, 2014, the effective tax rate was lower than the statutory rate primarily due to a change in estimates recognized in 2014, as the Company believes certain deferred tax liabilities will be recognized at amounts and rates other than previously estimated. The effective tax rate for 2014 was also lowered by manufacturing tax deductions and OITC associated with investments in the Company’s manufacturing operations in Pryor, Oklahoma. Additionally, in 2014, Orchids began recording current and deferred income taxes in the state of California and the country of Mexico due to impacts of the Fabrica Transaction (see Note 2). Taxes related to California increased the Company’s effective tax rate by approximately 3.1%. The Company’s earnings in Mexico are subject to the country’s 30% income tax rate. The net effect of foreign taxes was not material to the Company’s effective tax rate due to U.S. income tax credits related to foreign-sourced income. The Company has significant carryforwards for the State of Oklahoma which include an OITC of $3.7 million primarily associated with the Company's $36 million investment in a new paper machine in 2006, $20 million investment in a new converting line in 2010, $26 million investment in another new paper machine and $8.3 million of assets placed in service for a new converting line in 2015, and approximately $15 million invested in 2016, including an additional $6.5 million of assets placed in service for the new converting line and investments in tissue liberation and heating and air upgrades. The Company believes that its future state taxable income will be sufficient to allow realization before the OITC expires in varying amounts from 2028 through 2036. Accordingly, deferred tax assets have been recognized for this credit. The Company has significant carryforwards for the State of South Carolina, which include a SCITC of approximately $0.4 million, primarily associated with the Company's $28 million investment in new converting lines. The Company believes that its future state taxable income will be sufficient to allow realization before the SCITC expires in ten years. Accordingly, deferred tax assets have been recognized for this credit. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 8-Income Taxes (Continued) The U.S. tax code requires that certain types of income produced by non-U.S. subsidiaries be currently taxed without regard to actual distribution (Subpart F income). Income earned by Orchids Mexico meets the definition of Subpart F income. As a result, U.S. current and deferred federal income tax has been recorded on these earnings. Upon remittance of these earnings, no significant incremental U.S. tax is expected. Based upon a review of its income tax filing positions, the Company believes that its positions would be sustained upon an audit and does not anticipate any adjustments that would result in a material change to its financial position. However, the 2014 Tax return has been selected for audit by the Internal Revenue Service. The Company recognizes interest related to income taxes as interest expense and penalties as selling, general and administrative expenses. The tax years 2013 through 2016 remain open to examination by major taxing jurisdictions in which the Company files income tax returns. Note 9-Earnings per Share During the first quarter of 2013, the Company granted restricted stock to certain employees. These awards include a nonforfeitable right to receive dividends and therefore are considered to participate in undistributed earnings with common shareholders. Therefore, the Company calculates basic and diluted earnings per common share using the two-class method, under which net earnings are allocated to each class of common stock and participating security. The computation of basic and diluted net income per common share for the years ended December 31, 2016, 2015 and 2014, is as follows: Note 10-Stock Incentives In April 2014, the Orchids Paper Products Company 2014 Stock Incentive Plan (the “2014 Plan”) was approved. The 2014 Plan replaced the Orchids Paper Products Company 2005 Stock Incentive Plan (the “2005 Plan”) and provides for the granting of stock options and other stock based awards to employees and Board members selected by the Board's compensation committee. The Company's policy is to issue shares of remaining authorized common stock to satisfy option exercises under the 2014 Plan. A total of 400,000 shares may be issued pursuant to the 2014 Plan. As of December 31, 2016, there were 164,200 shares available for issuance under the 2014 Plan. The exercise price of each option is generally equal to the arithmetic mean of the high and low sales price per share of the Company's common stock on the grant date. Options granted to Board members under the Plan generally vest immediately. Options granted to employees generally vest over a service period of zero to five years or are market-based and vest when the share price of the Company’s common stock closes at or above a certain percentage of the purchase price of the option for three consecutive business days. Options granted with market-based vesting expire if they remain unvested five years after the grant date. Options granted under the 2014 Plan have a 10-year life. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 10-Stock Incentives (Continued) Stock options with time-based vesting conditions The Company uses the Black-Scholes option valuation model to estimate the grant date fair value of stock options issued with time-based vesting conditions, as this model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Estimated volatility is calculated based on actual historical volatility of the Company's common stock from the Company's initial public offering date to the grant date. The Company's dividend yield assumption is based on the expected dividend yield as of the grant date. Expected life is calculated based on the average of the service period and the contractual term of the option, using the simplified method for "plain vanilla" options, due to limited available exercise information. The Company expenses the cost of these options granted over the vesting period of the option based on the grant-date fair value of the award. The following table details the options granted to certain members of the board of directors and management that were valued using the Black-Scholes valuation model and the weighted-average assumptions used in the Black-Scholes option valuation model for those grants during 2014, 2015 and 2016: In 2015, 3,750 of time-based options granted in 2005 expired unexercised. Stock options with market-based vesting conditions The Company uses a Monte Carlo option valuation model to estimate the grant date fair value of stock options issued with market-based vesting conditions, as these options include a market condition. Option valuation models require the input of highly subjective assumptions including the expected stock price volatility, dividend yield and expected life of the option. Estimated volatility is calculated based on a mix of historical and implied volatility during the expected life of the options. Historical volatility is considered since the Company’s initial public offering and implied volatility is based on the publicly traded options of a three-company peer group within the paper industry. The Company's dividend yield assumption is based on the Company’s average historical dividend yield and current dividend yield as of the grant date. Expected life is calculated based on the average of the service period and the contractual term of the option, using the simplified method for "plain vanilla" options. The Company expenses the cost of these options granted over the implicit, or derived, service period of the option based on the completed Monte Carlo models. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 10-Stock Incentives (Continued) During 2014 and 2015, the Board of Directors granted options to purchase 145,000 and 28,600 shares, respectively, of the Company’s common stock to certain members of management. These options will become exercisable in four equal tranches, if at all, if and when the share price of the Company’s common stock closes at or above a certain percentage of the purchase price of the option for three consecutive business days, in accordance with the following vesting schedule: Any unvested portion of the options shall expire five years from the date of grant and the options shall terminate ten years after the date of grant. The following table details the options granted to certain members of management that were valued using the Monte Carlo valuation model and the assumptions used in the valuation model for those grants during 2014 and 2015: In 2014, none of these options vested, as the share price of the Company’s common stock did not reach any of the share prices required for vesting. Additionally, 25,000 options granted in January 2014 were forfeited when an employee left the Company in 2014. In 2015, Tranche 1 of the options granted in September 2015, or 7,150 options, vested when the share price of the Company’s common stock closed above $29.56 for three consecutive business days. Additionally, 25,000 options granted in February 2014 and 5,000 options granted in May 2014 were forfeited when employees left the Company in 2015. In 2016, Tranche 1 of the options granted in January 2014, or 3,750 options, and Tranche 1 of the options granted in February 2014, or 18,750 options, vested when the share price of the Company’s common stock closed above $34.79 for three consecutive business days. Additionally, 18,750 options granted in February 2014 and 1,800 options granted in September 2015 were forfeited when employees left the Company in 2016. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 10-Stock Incentives (Continued) Stock options issued outside of the 2014 Plan In April 2014, the Company’s stockholders voted to approve the options granted to Mr. Jeffrey S. Schoen, the Company’s President and Chief Executive Officer, on November 8, 2013. Upon his appointment as an officer of the Company, Mr. Schoen was granted an option to purchase up to 400,000 shares of the common stock of the Company at a purchase price of $30.25 per share. The option will become exercisable, if at all, if and when the share price of the Company’s common stock closes at or above a certain percentage of the purchase price of the option for three consecutive business days, in accordance with the following vesting schedule: These options were granted outside of the 2005 Plan and the 2014 Plan. Any unvested portion of the option shall expire five years from the date of grant and the option shall terminate ten years after the date of grant. The Company used a Monte Carlo option valuation model to estimate the grant date fair value of each tranche of 100,000 options, as they include a market condition. Assumptions used in the valuation model were the same as those for the stock options with market-based vesting conditions issued to employees, which are noted above. The Company expenses the cost of these options granted over the implicit service period of the option based on the completed Monte Carlo models. The following table details the assumption used in the valuation model for the options granted to Mr. Schoen: In 2016, Tranche 1 of the options granted to Mr. Schoen, or 100,000 options, vested when the share price of the Company’s common stock closed above $34.79 for three consecutive business days. Total option expense The Company recognized the following expenses related to all options granted during 2016, 2015 and 2014 under the 2005 Plan, the 2014 Plan and the Schoen options: ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 10-Stock Incentives (Continued) Summary of option activity The following tables summarize activity related to options granted under the 2005 Plan, the 2014 Plan and the Schoen options: The following table summarizes options outstanding and exercisable under the 2005 Plan, the 2014 Plan and the Schoen options as of December 31, 2016: ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 10-Stock Incentives (Continued) The following table summarizes information about stock option vesting during the years ended December 31: As of December 31, 2016, there was $359,000 of unrecognized compensation expense related to non-vested stock options with a time-based vesting condition for options granted in 2016 and 2015. This cost is expected to be recognized on a straight-line basis over a weighted average period of 3.2 years. At December 31, 2016, unrecognized compensation expense related to non-vested stock options with a market-based vesting condition for options granted in 2015 was immaterial. During the years ended December 31, 2016, 2015 and 2014, the Company received $314,000, $210,000, and $79,000, respectively, in proceeds from the exercise of stock options. The Company realized $211,000, $23,000, and $16,000 of tax benefits related to stock option exercises during the years ended December 31, 2016, 2015 and 2014, respectively. Excess tax benefits related to stock option exercises are recorded to additional-paid in capital ("APIC pool") when realized and may be used to offset future tax deficiencies. During the years ended December 31, 2016, 2015 and 2014, the Company recorded excess tax (deficiencies) benefits of $171,000, ($6,000), and $20,000, respectively. As of December 31, 2016, the Company’s APIC pool was $2.0 million. Restricted stock In February 2013, the Company granted 16,000 shares of restricted stock to certain employees under the 2005 Plan. These awards were valued at the arithmetic mean of the high and low market price of the Company's stock on the grant date, which was $21.695 per share, and vested ratably over a three-year period beginning on the first anniversary of the grant date. The Company expenses the cost of restricted stock granted over the vesting period of the shares based on the grant-date fair value of the award. The Company recognized expense of $3,000, $44,000 and $51,000 during 2016, 2015 and 2014, respectively, related to the shares granted under the 2005 Plan. The following tables summarize activity related to unvested restricted stock granted under the 2005 Plan as of December 31, 2016 and for the year then ended: ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 10-Stock Incentives (Continued) The following table summarizes information about restricted stock vesting during the years ended December 31: No shares of restricted stock were granted in the years ending December 31, 2016, 2015 or 2014. Note 11-Major Customers and Concentration of Credit Risk Major customers The Company sells its paper production in the form of parent rolls and converted products. Revenues from converted product sales and parent roll sales in the years ended December 31, 2016, 2015 and 2014 were: Credit risk for the Company was concentrated in the following customers who each comprised more than 10% of the Company's total sales during the years ended December 31, 2016, 2015 and 2014: *Customer did not account for more than 10% of sales during the period indicated. At December 31, 2016 and 2015, the significant customers accounted for the following amounts of the Company's accounts receivable (in thousands): *Customer did not account for more than 10% of sales during the period indicated ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 11-Major Customers and Concentration of Credit Risk (Continued) No other customers of the Company accounted for more than 10% of sales during these periods. The Company generally does not require collateral from its customers and has not incurred any significant losses on uncollectible accounts receivable. Paper supply agreement On February 20, 2008, the Company signed an exclusive supply agreement with Dixie Pulp and Paper, Inc. to supply all of its recycled fiber needs. This agreement was effective beginning April 1, 2008 and carried an initial five-year term through April 1, 2013. However, the agreement automatically renews for successive one-year periods unless either party gives 90 days' notice. As of the date of this report, the Company has not received notice of intention not to renew the agreement nor has the Company provided such a notice to the counterparty, and the agreement is in effect. Cash in excess of insured limits Much of the Company's cash is maintained at financial institutions, which are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $250,000 per depositor at each financial institution. At times, balances may exceed these federally insured limits or may be contained in foreign bank accounts, which are not insured by the FDIC. The Company has never experienced any losses related to these accounts. At December 31, 2016, the Company had approximately $8.0 million of non-interest bearing cash balances in excess of federally insured limits. Additionally, $1.8 million of the Company’s cash was in bank accounts in Mexico, which are not insured by the FDIC. Note 12-New Market Tax Credit In December 2015, the Company received approximately $5.1 million in net proceeds from financing agreements related to capital expenditures at its Barnwell, South Carolina facility. This financing arrangement was structured with a third party financial institution (the “NMTC Investor”) associated with U.S. Bank, an investment fund, and two community development entities (the “CDEs”) majority owned by the investment fund. This transaction was designed to qualify under the federal New Market Tax Credit (“NMTC”) program, pursuant to Section 45D of the Internal Revenue Code of 1986, as amended. Through this transaction, the Company has secured low interest financing and the potential for future debt forgiveness related to the South Carolina facility. Upon closing of the NMTC transaction, the Company provided an aggregate of approximately $11.1 million, which was borrowed from U.S. Bank, to the investment fund, in the form of a loan receivable, with a term of 25 years, bearing an interest rate of 1.0% per annum. This $11.1 million in proceeds plus $5.1 million of net capital from the NMTC Investor were contributed to and used by the CDEs to make loans in the aggregate of $16.2 million to a subsidiary of the Company, Orchids Lessor SC, LLC (“Orchids Lessor”). These loans bear interest at a fixed rate of 1.275%. Orchids Lessor is using the loan proceeds to partially fund $18.0 million of the Company’s capital assets associated with the Barnwell facility. These capital assets will serve as collateral to the financing arrangement. This transaction also includes a put/call feature whereby, at the end of a seven-year compliance period, we may be obligated or entitled to repurchase the NMTC Investor’s interest in the investment fund. The value attributable to the put price is nominal. Consequently, if exercised, the put could result in the forgiveness of the NMTC Investor’s interest in the investment fund, and result in a net non-operating gain of up to $5.1 million. The call price will be valued at the net present value of the cash flows of the lease inherent in the transaction. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 12-New Market Tax Credit (Continued) The NMTC Investor is subject to 100% recapture of the New Market Tax Credits it receives for a period of seven years as provided in the Internal Revenue Code and applicable U.S. Treasury regulations. The Company is required to be in compliance with various regulations and contractual provisions that apply to the New Market Tax Credit arrangement. Noncompliance with applicable requirements could result in the NMTC Investor’s projected tax benefits not being realized and, therefore, require the Company to indemnify the NMTC Investor for any loss or recapture of New Market Tax Credits related to the financing until such time as the recapture provisions have expired under the applicable statute of limitations. The Company does not anticipate any credit recapture will be required in connection with this financing arrangement. The investment fund and the community development entities are considered Variable Interest Entities (VIEs) and the Company is the primary beneficiary of the VIEs. This conclusion was reached based on the following: ·The ongoing activities of the VIEs-collecting and remitting interest and fees and NMTC compliance-were all considered in the initial design and are not expected to significantly affect performance throughout the life of the VIE; ·Contractual arrangements obligate the Company to comply with NMTC rules and regulations and provide various other guarantees to the NMTC Investor and community development entities; ·The NMTC Investor lacks a material interest in the underling economics of the project; and ·The Company is obligated to absorb losses of the VIEs. Because the Company is the primary beneficiary of the VIEs, they have been included in the consolidated financial statements. There are no other assets, liabilities or transactions in these VIEs outside of the financing transactions executed as part of the NMTC transaction. At December 31, 2016 and 2015, the NMTC Investor’s interest of $5.2 million and $5.1 million, respectively, is recorded in other long-term liabilities on the consolidated balance sheet, while the outstanding balance of the amount borrowed from U.S. Bank to loan to the investment fund of $10.0 and $11.1 million, respectively, is recorded in long-term debt, net of the current portion. At December 31, 2016 and 2015, the Company had approximately $0.6 million and $0.4 million, respectively, of debt issuance costs related to the above transactions, which are being amortized over the life of the agreements. Unspent proceeds from the arrangement of approximately $1.3 million and $12.0 million at December 31, 2016 and 2015, respectively, are obligated for funding the specified capital assets at the Barnwell facility and are included in restricted cash. Note 13-ODFA Pooled Financing In September 2014, the Company entered into an agreement with the Oklahoma Development Finance Authority (“ODFA”) whereby the ODFA agreed to provide the Company up to $3.5 million to fund a portion of the cost of a new paper production line before September 1, 2020. The agreement provides for the Oklahoma state withholding payroll taxes withheld by the Company from its employees to be placed into the Community Economic Development Pooled Finance Revolving Fund - Orchids Paper Products (“Revolving Fund”). Each year on September 1, beginning in 2015 and ending in 2020, the ODFA will return these state withholding taxes in the Revolving Fund to the Company, up to an amount totaling $3.5 million. These amounts are recognized as a note receivable in other current assets in the consolidated balance sheet and in other income in the consolidated statements of income as they are withheld from employees. As of December 31, 2016 and 2015, the Company had a note receivable of $536,000 and $328,000, respectively, related to amounts due under the ODFA pooled financing agreement. The Company recognized income of $667,000, $685,000 and $213,000 in 2016, 2015 and 2014, respectively, related to this agreement. Note 14-Employee Incentive Bonus and Retirement Plans The Company sponsors three separate defined contribution plans covering substantially all employees. Company contributions are based on either a percentage of participant contributions or as required by collective bargaining agreements. Participants immediately vest in Company contributions to each of the three plans. Contribution expense recognized by the Company was $983,000, $579,000, and $496,000, for the years ended December 31, 2016, 2015 and 2014, respectively. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 15-Selected Quarterly Financial Data (Unaudited) Note 16-Follow-On Stock Offering and Registration of Securities In April 2015, the Company completed an underwritten public follow-on offering of 1,500,000 shares of its common stock at $23.00 per share. The underwriters were granted an option to purchase up to an additional 225,000 shares for a period of 30 days, which was not exercised. Net proceeds to the Company were $32.1 million, after giving effect to expenses incurred related to the offering. On September 16, 2015, the Company’s shelf Registration Statement on Form S-3 (the “Registration Statement”) was declared effective by the Securities and Exchange Commission. Pursuant to the Registration Statement, the Company, from time to time, may sell common stock, warrants or units comprised of the other securities described in the Registration Statement, in a single or multiple offerings up to a total dollar amount of $50,000,000, at prices and terms that will be determined at the time of the offering. The Company’s willingness and ability to raise capital pursuant to the Registration Statement will depend upon a number of circumstances, including, without limitation, the Company’s need for additional capital to fund operations, organic growth or acquisitions, the Company’s financial and operating performance and the receptiveness of the capital markets to potential offerings by the Company. As of the date of this report, the Company does not have any agreements with respect to the issuance of securities pursuant to the Registration Statement. ORCHIDS PAPER PRODUCTS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) December 31, 2016, 2015 and 2014 Note 17-Subsequent Events Dividend On February 14, 2017, the Board of Directors authorized a quarterly cash dividend of $0.35 per outstanding share of the Company’s common stock to be paid on April 3, 2017 to stockholders of record at the close of business on February 27, 2017. | This financial statement appears to focus on several key accounting policies and procedures:
1. Property & Assets:
- Losses from disposal of property/equipment are recorded when incurred
- Interest is capitalized for major projects and added to asset costs
- Interest is depreciated over the asset's useful life
2. Goodwill & Intangible Assets:
- Excess purchase price over fair value is recorded as goodwill
- Annual impairment testing is required
- Uses a two-step impairment test process:
* First step: Compare fair value to carrying amount
* Second step: Calculate impairment loss if necessary
- Company can choose to do qualitative assessment first
3. Liabilities:
- Debt issuance costs are deferred
- Costs are amortized using effective interest method over loan terms
4. Current Assets:
- Included in consolidated balance sheet
- Employee withholdings reported in other income
The statement appears to be primarily focused on accounting methodology rather than providing specific financial figures, with particular emphasis on how goodwill impairment is assessed and recorded. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Board of Directors and Stockholders of ExeLED Holdings, Inc.: We have audited the accompanying consolidated balance sheets of ExeLED Holdings, Inc. (“the Company”) as of December 31, 2016 and 2015 and the related statement of operations, stockholders’ equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ExeLED Holdings, Inc., as of December 31, 2016 and 2015, and the results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles in the United States of America. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the Company's internal control over financial reporting. Accordingly, we express no such opinion. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses from operations and has a significant accumulated deficit. In addition, the Company continues to experience negative cash flows from operations. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. B F Borgers CPA PC Lakewood, CO April 17, 2017 EXELED HOLDINGS, INC. Consolidated Balance Sheets See accompanying notes to consolidated financial statements. EXELED HOLDINGS, INC. Consolidated Statements of Operations See accompanying notes to consolidated financial statements EXELED HOLDINGS, INC. Consolidated Statements of Equity See accompanying notes to consolidated financial statements EXELED HOLDINGS, INC. Consolidated Statements of Cash Flows See accompanying notes to consolidated financial statements. EXELED HOLDINGS, INC. Note 1 - Description of Business and Summary of Significant Accounting Policies Formation of the Company ExeLED Holdings, Inc. was incorporated in the State of Delaware on October 20, 1986 under the name “Verilink Corporation.” We have also been known as Energie Holdings, Inc. and Alas Aviation Corp. On December 31, 2013, we entered into a Share Exchange Agreement (the “Share Exchange Agreement”) with OELC, LLC, a Delaware limited liability company, and its wholly-owned subsidiary, Energie LLC (hereinafter referred to as, “Energie”). The Share Exchange Agreement was not effective until July 2, 2014 due to a variety of conditions subsequent that needed to be met, which are described below. Upon effectiveness, we issued 33,000,000 “restricted” shares of our common stock, representing approximately 65% of our then issued and outstanding voting securities, in exchange for all of the issued and outstanding member interests of Energie. The accounting is identical to that resulting from a reverse acquisition, except that no goodwill or other intangible is recorded. Thereafter, on January 27, 2014, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with two of our then wholly owned subsidiaries, Energie Holdings, Inc. and Alas Acquisition Company. The net effect of the Merger Agreement was to effectuate a name change from Alas Aviation Corp., to Energie Holdings, Inc. in order to provide a better understanding to investors of our entry into the LED lighting industry. Our management also changed. All references herein to “us,” “we,” “our,” “Holdings,” or the “Company” refer to ExeLED Holdings, Inc. and its subsidiaries, and their respective business following the consummation of the Merger and Share Exchange Agreements, unless the context otherwise requires. Description of Business We are focused on acquiring and growing specialized LED lighting companies for the architecture and interior design markets for both commercial and residential applications. The lighting products include both conventional fixtures and advanced solid-state technology that can integrate with digital controls and day-lighting to create energy efficiencies and a better visual environment. Our objective is to grow, innovate, and fully capture the rapidly growing lighting market opportunities associated with solid state lighting. Energie was founded in 2001 and is engaged in the import and sale of specialized interior lighting solutions to the architecture and interior design markets in North America. Our headquarters is located in Arvada, Colorado, and we also maintain a production and assembly facility in Zeeland, Michigan. Basis of Presentation Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Going Concern As shown in the accompanying financial statements, we had an equity deficit of $13,300,927 and a working capital deficit of $13,087,377 as of December 31, 2016, and have reported net losses of $3,455,227 and $2,995,626, respectively, for the years ended December 31, 2016 and 2015. These factors raise substantial doubt regarding our ability to continue as a going concern. Our ability to continue as a going concern is dependent on our ability to further implement our business plan, attract additional capital and, ultimately, upon our ability to develop future profitable operations. We intend to fund our business development, acquisition endeavors and operations through equity and debt financing arrangements. However, there can be no assurance that these arrangements will be sufficient to fund our ongoing capital expenditures, working capital, and other cash requirements. The outcome of these matters cannot be predicted at this time. These matters raise substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. Additionally, current economic conditions in the United States and globally create significant challenges attaining sufficient funding. Some of our debt agreements are due on demand. If demand for payment is made by one or multiple vendors, we would experience a liquidity issue as we do not currently have the funds available to pay off these debts. While we have entered into extensions with several of our lenders, there can be no assurances that any of the lenders will be cooperative or that if they are willing to provide extensions or forbearances, that the terms under which they may be willing to provide them will be favorable to us. Reclassifications Certain prior year amounts have been reclassified to conform with the current year presentation. Summary of Significant Accounting Policies Cash and cash equivalents Cash and cash equivalents include cash on hand, deposits with banks, and investments that are highly liquid and have maturities of three months or less at the date of purchase. Accounts receivable We record accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the accounts receivable balances and is charged to Other income (expense) in the consolidated statements of operations. We calculate this allowance based on our history of write-offs, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our customers. At our discretion, we may sell our accounts receivable with recourse in order to accelerate the receipt of cash. Upon the sale of selected accounts receivable, title transfers to the counterparty to the factoring agreement, we receive 85% of the face amount sold, and we remove the account receivable from our balance. We pay a commission and, if the balance is not collected by the counterparty within 30 days, a factoring fee. We are responsible for repaying the factoring counterparty for any amounts they are unable to collect. The factoring counterparty retains a reserve in the event the amount they ultimately collect is less than the amount paid to us. Depending on the volume of activity and uncollected accounts, therefore, we may have a receivable from or a liability to the factoring counterparty. Inventory Inventory is stated at the lower of cost or market, using the first-in, first-out method (“FIFO”) to determine cost. We monitor inventory cost compared to selling price in order to determine if a lower of cost or market reserve is necessary. We also estimate and maintain an inventory reserve, as needed, for such matters as obsolete inventory, shrink and scrap. Intangible assets Our intangible assets consist of the following: UL Listings - Energie has over 20 United LaboratoriesTM (“UL”) files, which include UL Listings for over 14,000 products for sale in the United States and Canada. UL is an independent safety testing laboratory. A UL Listing means that UL has tested representative samples of the product and determined that it meets UL’s requirements. These requirements are based primarily on UL’s published and nationally recognized standards for safety. UL’s testing certifies the design, construction and assembly of the certified products. UL Listings do not expire as long as the product certified is not materially changed. Ownership of a UL Listing may also be transferred between companies. Most customers in the lighting industry will only buy UL listed products. Trademarks - Energie is a registered trademark. Marketing and design - These consist of engineering and marketing materials covering the majority of our product offerings. Intangible assets are recorded at the cost to acquire the intangible, net of amortization over their estimated useful lives on a straight-line basis. We determine the useful lives of our intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, our long-term strategy for using the asset, any laws or other local regulations that could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Property and equipment Property and equipment are stated at cost. Depreciation is recorded using the straight-line method over the estimated useful lives of our assets, which are reviewed periodically. Impairment of long-lived assets When facts and circumstances indicate that the carrying value of long-lived assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of revenues and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized, if any, is the amount by which the carrying amount of the asset (or asset group) exceeds the fair value. We may use a variety of methods to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. We have the option to perform a qualitative assessment of long-lived assets prior to completing the impairment test described above. We must assess whether it is more likely than not that the fair value of the long-lived assets is less than their carrying amount. If we conclude that this is the case, we must perform the test described above. Otherwise, we do not need to perform any further assessment. As a result of applying the above procedures, we fully impaired all long-lived assets during the year ended December 31, 2014. Since that time, we have not acquired any long-lived assets. Warranty reserve We provide limited product warranty for one year on our products and, accordingly, accrue an estimate of the related warranty expense at the time of sale, included in Accrued liabilities on the consolidated balance sheets. Convertible debt We first evaluate our convertible debt to determine whether the conversion feature is an embedded derivative that requires bifurcation and derivative treatment. Based on our analysis, we determined derivative treatment was not required. We then evaluate whether the conversion feature is a beneficial conversion feature. Our convertible debt is treated as a liability and permits settlement in cash. Accordingly, in order to determine the value of the conversion feature, we compared the estimated fair value of the convertible debt to the fair value of debt that did not have the conversion feature. Based on this analysis, we concluded that the value of the conversion feature was immaterial. Revenue recognition We recognize revenue when the four revenue recognition criteria are met, as follows: ·Persuasive evidence of an arrangement exists - our customary practice is to obtain written evidence, typically in the form of a sales contract or purchase order; ·Delivery - when custody is transferred to our customers either upon shipment to or receipt at our customers’ locations, with no right of return or further obligations, such as installation; ·The price is fixed or determinable - prices are typically fixed at the time the order is placed and no price protections or variables are offered; and ·Collectability is reasonably assured - we typically work with businesses with which we have a long standing relationship, as well as monitoring and evaluating customers’ ability to pay. Refunds and returns, which are minimal, are recorded as a reduction of revenue. Payments received by customers prior to our satisfying the above criteria are recorded as unearned income in the consolidated balance sheets. Shipping and handling Payments by customers to us for shipping and handling costs are included in revenue on the consolidated statements of operations, while our expense is included in cost of revenues. Shipping and handling for inventory and materials purchased by us is included as a component of inventory on the consolidated balance sheets, and in cost of revenues in the consolidated statements of operations when the product is sold. Research and development costs Internal costs related to research and development efforts on existing or potential products are expensed as incurred. External costs incurred for intangible assets, such as UL listing costs and attorney fees for patents, are capitalized. Income taxes We recognize deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the income tax and financial reporting carrying amount of our assets and liabilities. We monitor our deferred tax assets and evaluate the need for a valuation allowance based on the estimate of the amount of such deferred tax assets that we believe do not meet the more-likely-than-not recognition criteria. We also evaluate whether we have any uncertain tax positions and would record a reserve if we believe it is more-likely-than-not our position would not prevail with the applicable tax authorities. Our assessment of tax positions as of December 31, 2016 and 2015, determined that there were no material uncertain tax positions. Concentration of credit risk Financial instruments that potentially subject us to concentrations of credit risk consist of accounts receivable and the amount due, if any, from our factoring counterparty. For the year ended December 31, 2016 one customer represented more than 20% of our total revenues. As of December 31, 2016, our accounts receivable balance was not material to the overall consolidated financial statements. Fair value of financial instruments Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, and long-term debt. The carrying value of these financial instruments is considered to be representative of their fair value due to the short maturity of these instruments. The carrying amount of our long-term debt approximates fair value, because the interest rates on these instruments approximate the interest rate on debt with similar terms available to us. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, as follows: Level 1 - Quoted prices in active markets for identical assets or liabilities. Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Reportable segments We have identified our operating segments, our chief operating decision maker (“CODM”), and the discrete financial information reviewed by the CODM. After evaluating this information, we have determined that we have one reportable segment. Recently Issued Accounting Pronouncements In July 2015, the FASB issued ASU No. 2015-11 (ASU 2015-11), Inventory (Topic 330): Simplifying the Measurement of Inventory. ASU 2015-11 more closely aligns the measurement of inventory in GAAP with the measurement of inventory in International Financial Reporting Standards (IFRS). As such, an entity should measure inventory that is within the scope of this ASU at the lower of cost and net realizable value. We do not expect the impact of the adoption of ASU 2015-11 to be material to our consolidated financial statements. In September 2015, the FASB issued ASU No. 2015-16 (ASU 2015-16), Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. ASU 2015-16 requires an acquirer to “recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined.” Further, the acquirer must record, in the financial statements for the same period, “the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date.” We do not expect the impact of the adoption of ASU 2015-16 to be material to our consolidated financial statements. In November 2015, the FASB issued ASU No. 2015-17 (ASU 2015-17) , Balance Sheet Classification of Deferred Taxes (Topic 740). The guidance in this new standard eliminated the current requirement to present deferred tax assets and deferred tax liabilities as current and noncurrent in a classified balance sheet and now requires entities to classify all deferred tax assets and deferred tax liabilities as noncurrent. Public companies are required to apply the guidance beginning with the quarter ending March 31, 2017. We do not expect the impact of the adoption of ASU 2015-17 to be material to our consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02). ASU 2016-02 requires that lessees will be required to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. ASU 2016-02 also will require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative information. For public companies, the standard will take effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 with earlier application permitted. We are currently evaluating the impact of ASU 2016-02 on our financial statements. In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09) which simplifies several aspects of accounting for share-based payment transactions including income tax consequences, classification of awards as either equity or liabilities, classification on the statement of cash flows and accounting for forfeitures. ASU 2016-09 is effective for financial statements issued for fiscal years beginning after December 15, 2016. We are currently evaluating the impact of ASU 2016-09 on our financial statements. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (ASU 2016-10). ASU 2016-10 amends the new revenue recognition standard that it issued jointly with the IASB in 2014. The amendments do not change the core principles of the standard, but clarify the accounting for licenses of intellectual property, as well as the identification of distinct performance obligations in a contract. We are currently evaluating the impact of ASU 2016-10 on our financial statements. In May 2016, the FASB issued ASU No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting (ASU 2016-11). ASU 2016-11 rescinds 1) certain SEC Observer comments that are codified in FASB ASC Revenue Recognition (Topic 605), and FASB ASC Topic 932, Extractive Activities-Oil and Gas (Topic 932), effective on adoption of FASB ASC Revenue from Contracts with Customers (Topic 606) and 2) SEC Staff Announcement, "Determining the Nature of a Host Contract Related to a Hybrid Instrument Issued in the Form of a Share Under Topic 815," which is codified in FASB ASC Derivatives and Hedging (Topic 815). The rescinded guidance is effective on adoption of FASB ASU No. 2014-16, Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or Equity. We are currently evaluating the impact of ASU 2016-11 on our financial statements. In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (ASU 2016-12). ASU 2016-12 addresses issues such as collectability, contract modifications, completed contracts at transition, and noncash considerations as they relate to the new revenue recognition standard. We are currently evaluating the impact of ASU 2016-12 on our financial statements. In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15). Stakeholders indicated that there is a diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. ASU 2016-15 is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. We do not expect the impact of the adoption of ASU 2016-15 to have a significant impact on our statement of cash flows. Other recent accounting pronouncements issued by the FASB and the SEC did not, or management believes will not, have a material impact on our present or future consolidated financial statements. Note 2 - Receivables Receivables consist of the following: Note 3 - Inventory Inventory consists of the following: Note 4 - Debt Debt consists of the following: A - Line of Credit - We utilized this entire bank line of credit for working capital purposes. The outstanding obligation is due on demand, has a stated initial interest rate of 10.5% that is subject to adjustment, and is guaranteed by our majority shareholder/CEO. Energie and our CEO (collectively, “the defendants”) were served with a summons and complaint, wherein the bank brought an action to collect the amount due, including interest, costs and attorney’s fees. On April 4, 2016, the parties to this action entered into a settlement agreement whereby the defendants agreed to pay to Vectra Bank the sum of $59,177 on or before April 30, 2016. This payment was not made and the bank requested and received a judgment against both defendants jointly and severally for $61,502 plus interest of 5.25% per annum plus 9.90% per annum on the default margin. B - Note Payable to Distribution Partner - Note payable to a significant European distribution partner, entered into in October 2014, bearing interest at 5% payable quarterly, with principal payable monthly through September 2019. C - Investor Debt - Notes payable to lenders having an ownership interest in Holdings at December 31, 2016 and 2015. These loans are not collateralized. The following summarizes the terms and balances of the investor debt: D - Related Party Debt - The following summarizes notes payable to related parties. D1 - Notes payable to Symbiote, Inc. (“Symbiote”), entered into from December 2014 to June 2016, with monthly principal and interest payable through November 2017. Symbiote is an owner of the common stock of Holdings, is the lessor of our manufacturing facility, and the provider of our payroll services. We also owe Symbiote $315,815 in accounts payable. D2 - Notes payable to a former executive vice president, entered into from December 2014 through December 2015, with monthly principal and interest payable through November 2017. As of December 31, 2016, this individual is no longer employed by Holdings and is no longer considered a related party. D3 - Note payable to our chief executive officer (“CEO”), entered into in December 2014, with monthly principal and interest payable through December 2016. We also owe Hal $700,391 in accrued compensation and expenses incurred on behalf of the Company. D4 - Notes payable to the spouse of our CEO, entered into from September 2013 to November 2016, with principal and interest payments due upon a specific event or upon demand. D5 - Notes payable to the consulting firm that employs our Chief Financial Officer, entered into from June 2015 to December 2015. These notes aggregated the previous accounts payable and accrued interest due to the consulting firm at the time the notes were made. As of January 1, 2016, the notes are convertible into shares of our common stock at a conversion rate of 75% of the volume weighted average market price of our stock over the 20 days preceding the notification of conversion. We determined that this conversion feature does not meet the requirements to be treated as a derivative; however, we did determine it was a beneficial conversion feature. Accordingly, we recorded a debt discount of $217,725, which was amortized through interest expense over the life of the notes. We also owe NOW CFO $436,786 in accounts payable. D6 - Notes payable to the principal shareholders of Symbiote, entered into from April to December 2016, with principal and interest payments due upon a specific event or upon demand. E - Other Notes Payable - Represents the outstanding principal balance on four separate notes bearing interest at between 6% and 24% annually. In the event we receive proceeds as the beneficiary of a life insurance policy covering our majority shareholder/CEO, repayment of principal and interest is due on one of these notes prior to using the proceeds for any other purpose. F - Cash draw agreements - Under these agreements, the lender advances us the principal balance and then automatically withdraws a stated amount each business day. Accordingly, there is no stated interest rate. The total remaining daily payments due under these arrangements was $285,131 as of December 31, 2016. The maturity dates of the agreements range from February to May 2017. G - Convertible promissory notes - Represents the outstanding principal balance on two separate convertible promissory notes payable to an entity with interest of 8% annually, that were due in August 2016. During the third quarter of 2015, the current holder of the notes purchased all of our similar outstanding convertible notes from another entity and consolidated those notes into two new notes. At the option of the holder, the notes may be settled in cash or converted into shares of our common stock at any time beginning 180 days from the date of the notes at a price equal to 61% of the average closing bid price of our common stock during the 10 trading days immediately preceding the date of conversion. In the event we fail to pay the notes when they become due, the balance due under the notes incurs interest at the rate of 22% per annum. The notes contain additional terms and conditions normally included in instruments of this kind, including a right of first refusal wherein we have granted the holders the right to match the terms of any future financing in which we engage on the same terms and contemplated in such future financing. We estimate that the fair value of the conversion feature is minimal, so no value has been assigned to the beneficial conversion feature. During the year ended December 31, 2016, $82,800 of principal and $5,661 of accrued interest was converted into 135,532,715 shares of common stock. We also recorded a loss on conversion of debt of $114,791 related to these transactions. Subsequent to December 31, 2016, we paid off the remaining $12,700 of principal on one of the notes leaving one note outstanding as of the date of this report. Debt issuance costs of $280,555 are being amortized over the life of their respective notes. The future maturities of debt are as follows: Note 5 - Equity We have authorized 5,000,000 shares of preferred stock at $0.0001 par value, with no shares issued and outstanding as of December 31, 2016. Upon issuing preferred stock, if any, the terms of each tranche of issuance may be determined by our board of directors, including dividends and voting rights. In July 2014, we entered into an agreement with Dutchess Opportunity Fund, II, LP (“Dutchess”), under which Dutchess has agreed to purchase from us 5,000,000 shares of our common stock, up to $5 million, during a 36 month period commencing on the date a Registration Statement on Form S-1 was declared effective, October 29, 2014. We will sell these shares to Dutchess at a price equal to 94% of the lowest daily volume weighted-average price of our common stock during the five consecutive trading days beginning on the day we make notice to Dutchess and ending on and including the date that is four trading days after such notice. We have the right to withdraw all or any portion of any put before the closing, subject to certain limitations. As part of the agreement with Dutchess, we transferred 2,000,000 shares of our common stock for no proceeds. We will receive proceeds when we make notice to Dutchess to sell these shares. The market price of the 2,000,000 shares was $40,000, based on the trading price on the date of transfer. If we do not make notice to Dutchess, these shares will be returned to us at the end of the 36 month contractual period. As of December 31, 2016, we had not made notice to Dutchess to sell any of these shares. Accordingly, the net impact to our stockholders equity is zero. Note 6 - Commitments and Contingencies Future minimum rental payments required under all leases that have remaining non-cancelable lease terms in excess of one year as of December 31, 2016, are as follows: Note 7 - Income Taxes The components of the provision for income taxes are as follows: The components of net deferred tax assets and liabilities are as follows: A reconciliation of our income tax provision and the amounts computed by applying statutory rates to income before income taxes is as follows: Note 8 - Net Loss Per Share Basic net loss per share is computed by dividing net income by the weighted-average number of common shares outstanding during the reporting period. Diluted net loss per share is computed similarly to basic net loss per share, except that it includes the potential dilution that could occur if dilutive securities are exercised. In a net loss position, however, potential securities are excluded, because they are considered anti-dilutive. Since Energie, the “predecessor company,” was an LLC, it did not have common shares outstanding prior to the Share Exchange on July 2, 2014. Accordingly, we have prepared the calculation of Net Loss Per Share using the weighted-average number of common shares of Holdings that were outstanding during the years ended December 31, 2016 and 2015. The following table presents a reconciliation of the denominators used in the computation of net loss per share - basic and diluted: There are no dilutive instruments outstanding during the years ended December 31, 2016 and 2015. | Based on the financial statement excerpt, here's a summary:
Financial Health Overview:
- The company is experiencing significant financial challenges
- Substantial accumulated deficit and negative cash flows from operations
- Equity deficit of $13,300,927
- Serious doubts about ability to continue as a going concern
Key Financial Challenges:
1. Insufficient funding
2. Potential liquidity issues
3. Debt agreements that are due on demand
4. Uncertain ability to secure extensions or favorable terms from lenders
Financial Management Strategies:
- Maintaining cash and cash equivalents
- Managing accounts receivable with careful valuation
- Potential sale of accounts receivable to accelerate cash receipt
- Ongoing negotiations with lenders for debt extensions
Risks and Uncertainties:
- Current economic conditions creating funding challenges
- Potential impairment charges in future periods
- Actual financial results may differ from current estimates
- | Claude |
. The following consolidated financial statements accompanied by the report of our independent registered public accounting firm are set forth beginning on page 37 of this report: Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Changes in Shareholders’ Equity Consolidated Statements of Income Consolidated Statements of Comprehensive Income (Loss) Consolidated Statements of Cash Flows Supplementary data regarding quarterly results of operations is included in Selected Financial Data. Report of Independent Registered Public Accounting Firm Shareholders and Board of Directors Isabella Bank Corporation Mount Pleasant, Michigan We have audited the accompanying consolidated balance sheets of Isabella Bank Corporation as of December 31, 2016 and 2015, and the related consolidated statements of changes in shareholders’ equity, income, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2016. We also have audited Isabella Bank Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Isabella Bank Corporation’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the effectiveness of Isabella Bank Corporation’s internal control over financial reporting, based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material misstatement exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. We believe that our audits provide a reasonable basis for our opinion. A corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A corporation’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the corporation; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the corporation are being made only in accordance with authorizations of management and directors of the corporation; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the corporation’s assets that could have a material effect on the consolidated financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Isabella Bank Corporation as of December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion Isabella Bank Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria. /s/Rehmann Robson LLC Saginaw, Michigan March 7, 2017 CONSOLIDATED BALANCE SHEETS (Dollars in thousands) The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Dollars in thousands except per share amounts) The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands except per share amounts) The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in thousands) (1) See “Note 18 - Accumulated Other Comprehensive Income (Loss)” in the accompanying notes to consolidated financial statements for tax effect reconciliation. The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) (Dollars in thousands) The accompanying notes are an integral part of these consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands except per share amounts) Note 1 - Nature of Operations and Summary of Significant Accounting Policies BASIS OF PRESENTATION AND CONSOLIDATION: The consolidated financial statements include the accounts of Isabella Bank Corporation, a financial services holding company, and its wholly owned subsidiary, Isabella Bank. All intercompany balances and accounts have been eliminated in consolidation. References to "the Corporation," “Isabella,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiary. Isabella Bank Corporation refers solely to the parent holding company, and Isabella Bank or the “Bank” refer to Isabella Bank Corporation’s subsidiary, Isabella Bank. For additional information, see “Note 19 - Related Party Transactions.” NATURE OF OPERATIONS: Isabella Bank Corporation is a financial services holding company offering a wide array of financial products and services in several mid-Michigan counties. Our banking subsidiary, Isabella Bank, offers banking services through 29 locations and a loan production office, 24 hour banking services locally and nationally through shared automatic teller machines, 24 hour online banking, mobile banking, and direct deposits to businesses, institutions, and individuals. Lending services offered include commercial loans, agricultural loans, residential real estate loans, and consumer loans. Deposit services include interest and noninterest bearing checking accounts, savings accounts, money market accounts, and certificates of deposit. Other related financial products include trust and investment services, safe deposit box rentals, and credit life insurance. Active competition, principally from other commercial banks, savings banks and credit unions, exists in all of our principal markets. Our results of operations can be significantly affected by changes in interest rates and changes in the local economic environment. USE OF ESTIMATES: In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, we make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting year. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the ALLL, the fair value of AFS investment securities, and the valuation of goodwill and other intangible assets. FAIR VALUE MEASUREMENTS: Fair value refers to the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants in the market in which the reporting entity transacts such sales or transfers based on the assumptions market participants would use when pricing an asset or liability. Assumptions are developed based on prioritizing information within a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, such as the reporting entity’s own data. We may choose to measure eligible items at fair value at specified election dates. For assets and liabilities recorded at fair value, it is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements for those financial instruments for which there is an active market. In cases where the market for a financial asset or liability is not active, we include appropriate risk adjustments that market participants would make for nonperformance and liquidity risks when developing fair value measurements. Fair value measurements for assets and liabilities for which limited or no observable market data exists are accordingly based primarily upon estimates, are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Investment securities AFS are recorded at fair value on a recurring basis. Additionally, from time-to-time, we may be required to record other assets and liabilities at fair value on a nonrecurring basis, such as mortgage loans AFS, impaired loans, foreclosed assets, OMSR, goodwill, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets. Fair Value Hierarchy Under fair value measurement and disclosure authoritative guidance, we group assets and liabilities measured at fair value into three levels, based on the markets in which the assets and liabilities are traded, and the reliability of the assumptions used to determine fair value, based on the prioritization of inputs in the valuation techniques. These levels are: The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. Transfers between measurement levels are recognized at the end of reporting periods. For further discussion of fair value considerations, refer to “Note 20 - Fair Value.” SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK: Most of our activities conducted are with customers located within the central Michigan area. A significant amount of our outstanding loans are secured by commercial and residential real estate. Other than these types of loans, there is no significant concentration to any other industry or any one customer. CASH AND CASH EQUIVALENTS: For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from banks, federal funds sold, and other deposit accounts. Generally, federal funds sold are for a one day period. We maintain deposit accounts in various financial institutions which generally exceed federally insured limits or are not insured. We do not believe we are exposed to any significant interest, credit or other financial risk as a result of these deposits. AFS SECURITIES: Purchases of investment securities are generally classified as AFS. However, we may elect to classify securities as either held to maturity or trading. Securities classified as AFS are recorded at fair value, with unrealized gains and losses, net of the effect of deferred income taxes, excluded from earnings and reported in other comprehensive income. Included in AFS securities are auction rate money market preferreds and preferred stocks. These investments are considered equity securities for federal income tax purposes, and as such, no estimated federal income tax impact is expected or recorded. Auction rate money market preferred securities and preferred stocks are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Realized gains and losses on the sale of AFS securities are determined using the specific identification method. AFS securities are reviewed quarterly for possible OTTI. In determining whether an OTTI exists for debt securities, we assert that: (a) we do not have the intent to sell the security; and (b) it is more likely than not we will not have to sell the security before recovery of its cost basis. If these conditions are not met, we recognize an OTTI charge through earnings for the difference between the debt security’s amortized cost basis and its fair value, and such amount is included in noninterest income. For debt securities that do not meet the above criteria, and we do not expect to recover the security’s amortized cost basis, the security is considered other-than-temporarily impaired. For these debt securities, we separate the total impairment into the credit risk loss component and the amount of the loss related to market and other risk factors. In order to determine the amount of the credit loss for a debt security, we calculate the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows we expect to recover. The amount of the total OTTI related to the credit risk is recognized in earnings and is included in noninterest income. The amount of the total OTTI related to other risk factors is recognized as a component of other comprehensive income. For debt securities that have recognized an OTTI through earnings, if through subsequent evaluation there is a significant increase in the cash flow expected, the difference between the amortized cost basis and the cash flows expected to be collected is accreted as interest income. AFS equity securities are reviewed for OTTI at each reporting date. This evaluation considers a number of factors including, but not limited to, the length of time and extent to which the fair value has been less than cost, the financial condition and near term prospects of the issuer, and our ability and intent to hold the securities until fair value recovers. If it is determined that we do not have the ability and intent to hold the securities until recovery or that there are conditions that indicate that a security may not recover in value then the difference between the fair value and the cost of the security is recognized in earnings and is included in noninterest income. LOANS: Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and any deferred fees or costs on originated loans. Interest income on loans is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method. The accrual of interest on agricultural, commercial and mortgage loans is discontinued at the time the loan is 90 days or more past due unless the credit is well secured and in the process of collection. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. For loans that are placed on nonaccrual status or charged-off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected is charged against the ALLL. The interest on these loans is accounted for on the cash-basis, until qualifying for return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. For impaired loans not classified as nonaccrual, interest income continues to be accrued over the term of the loan based on the principal amount outstanding. ALLOWANCE FOR LOAN AND LEASE LOSSES: The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. We evaluate the ALLL on a regular basis which is based upon our periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The ALLL consists of specific, general, and unallocated components. The specific component relates to loans that are deemed to be impaired. For such loans that are also analyzed for specific allowance allocations, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non classified loans and is based on historical loss experience. An unallocated component is maintained to cover uncertainties that we believe affect our estimate of probable losses based on qualitative factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Loans may be classified as impaired if they meet one or more of the following criteria: 1. There has been a charge-off of its principal balance; 2. The loan has been classified as a TDR; or 3. The loan is in nonaccrual status. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. LOANS HELD FOR SALE: Mortgage loans held for sale on the secondary market are carried at the lower of cost or fair value as determined by aggregating outstanding commitments from investors or current investor yield requirements. Net unrealized losses, if any, would be recognized as a component of other noninterest expenses. Mortgage loans held for sale are sold with the mortgage servicing rights retained by us. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated mortgage servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold. TRANSFERS OF FINANCIAL ASSETS: Transfers of financial assets, including mortgage loans and participation loans, are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is determined to be surrendered when 1) the assets have been legally isolated from us, 2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and 3) we do not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Other than servicing, we have no substantive continuing involvement related to these loans. SERVICING: Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. We have no purchased servicing rights. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate, loan type, and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranche. If we later determine that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the valuation allowance may be recorded as an increase to income. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. The unpaid principal balance of mortgages serviced for others was $272,882 and $287,029 with capitalized servicing rights of $2,306 and $2,505 at December 31, 2016 and 2015, respectively. Servicing fee income is recorded for fees earned for servicing loans for others. The fees are based on a contractual percentage of the outstanding principal; or a fixed amount per loan and are recorded as income when earned. We recorded servicing fee revenue of $696, $712, and $720 related to residential mortgage loans serviced for others during 2016, 2015, and 2014, respectively, which is included in other noninterest income. FORECLOSED ASSETS: Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of our carrying amount or fair value less estimated selling costs at the date of transfer, establishing a new cost basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the ALLL. After foreclosure, property held for sale is carried at the lower of the new cost basis or fair value less costs to sell. Impairment losses on property to be held and used are measured at the amount by which the carrying amount of property exceeds its fair value. Costs relating to holding these assets are expensed as incurred. We periodically perform valuations and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the lower of our carrying amount or fair value less costs to sell. Foreclosed assets of $231 and $421 as of December 31, 2016 and 2015, respectively, are included in other assets. PREMISES AND EQUIPMENT: Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation which is computed principally by the straight-line method based upon the estimated useful lives of the related assets, which range from 3 to 40 years. Major improvements are capitalized and appropriately amortized based upon the useful lives of the related assets or the expected terms of the leases, if shorter, using the straight-line method. Maintenance, repairs and minor alterations are charged to current operations as expenditures occur. We annually review these assets to determine whether carrying values have been impaired. EQUITY SECURITIES WITHOUT READILY DETERMINABLE FAIR VALUES: Included in equity securities without readily determinable fair values are our holdings in FHLB stock and FRB stock as well as our ownership interests in Corporate Settlement Solutions, LLC and Valley Financial Corporation. Our investment in Corporate Settlement Solutions, LLC, a title insurance company, was made in the 1st quarter of 2008. We are not the managing entity of Corporate Settlement Solutions, LLC, and account for our investment in that entity under the equity method of accounting. Valley Financial Corporation is the parent company of 1st State Bank in Saginaw, Michigan, which is a bank that opened in 2005. We made investments in Valley Financial Corporation in 2004 and in 2007. In 2016, we sold all shares of Valley Financial Corporation common stock. Equity securities without readily determinable fair values consist of the following as of December 31: EQUITY COMPENSATION PLAN: At December 31, 2016, the Directors Plan had 213,470 shares eligible to be issued to participants, for which the Rabbi Trust held 26,042 shares. We had 200,017 shares to be issued in 2015, with 19,401 shares held in the Rabbi Trust. Compensation costs relating to share based payment transactions are recognized as the services are rendered, with the cost measured based on the fair value of the equity or liability instruments issued (see “Note 17 - Benefit Plans”). We have no other equity-based compensation plans. CORPORATE OWNED LIFE INSURANCE: We have purchased life insurance policies on key members of management. In the event of death of one of these individuals, we would receive a specified cash payment equal to the face value of the policy. Such policies are recorded at their cash surrender value, or the amount that can be realized on the balance sheet dates. Increases in cash surrender value in excess of single premiums paid are reported as other noninterest income. As of December 31, 2016 and 2015, the present value of the post retirement benefits payable by us to the covered employees was estimated to be $2,174 and $2,853, respectively, and is included in accrued interest payable and other liabilities. The periodic policy maintenance costs were $(8), $71, and $83 for 2016, 2015, and 2014, respectively and are included in other noninterest expenses. ACQUISITION INTANGIBLES AND GOODWILL: We previously acquired branch facilities and related deposits in business combinations accounted for as a purchase. The acquisitions included amounts related to the valuation of customer deposit relationships (core deposit intangibles). Core deposit intangibles arising from acquisitions are included in goodwill and other intangible assets are being amortized over their estimated lives and evaluated for potential impairment on at least an annual basis. Goodwill, which represents the excess of the purchase price over identifiable assets, is not amortized but is evaluated for impairment on at least an annual basis. Acquisition intangibles and goodwill are typically qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired. If it is determined that the carrying balance is more likely than not to be impaired, we perform a cash flow valuation to determine the extent of the potential impairment. This valuation method requires a significant degree of our judgment. In the event the projected undiscounted net operating cash flows for these intangible assets are less than the carrying value, the asset is recorded at fair value as determined by the valuation model. OFF BALANCE SHEET CREDIT RELATED FINANCIAL INSTRUMENTS: In the ordinary course of business, we have entered into commitments to extend credit, including commitments under credit card arrangements, home equity lines of credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded only when funded. FEDERAL INCOME TAXES: Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax assets or liability is determined based on the tax effects of the temporary differences between the book and tax basis on the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Valuation allowances are established, where necessary, to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the year plus or minus the change during the year in deferred tax assets and liabilities. We analyze our filing positions in the jurisdictions where we are required to file income tax returns, as well as all open tax years in these jurisdictions. We have also elected to retain our existing accounting policy with respect to the treatment of interest and penalties attributable to income taxes, and continue to reflect any charges for such, to the extent they arise, as a component of our noninterest expenses. DEFINED BENEFIT PENSION PLAN: We maintain a noncontributory defined benefit pension plan, which was curtailed effective March 1, 2007. Defined benefit pension plan expenses are included in “compensation and benefits" on the consolidated statements of income and are funded consistent with the requirements of federal laws and regulations. The current benefit obligation is included in "accrued interest payable and other liabilities" on the consolidated balance sheets. Inherent in the determination of defined benefit pension costs are assumptions concerning future events that will affect the amount and timing of required benefit payments under the plan. These assumptions include demographic assumptions such as mortality, a discount rate used to determine the current benefit obligation and a long-term expected rate of return on plan assets. Net periodic benefit cost includes interest cost based on the assumed discount rate, an expected return on plan assets based on an actuarially derived market-related value of assets, and amortization of unrecognized net actuarial gains or losses. Actuarial gains and losses result from experience different from that assumed and from changes in assumptions (excluding asset gains and losses not yet reflected in market-related value). Amortization of actuarial gains and losses is included as a component of net periodic defined benefit pension cost. For additional information, see "Note 17 - Benefit Plans." MARKETING COSTS: Marketing costs are expensed as incurred (see “Note 11 - Other Noninterest Expenses”). RECLASSIFICATIONS: Certain amounts reported in the 2015 and 2014 consolidated financial statements have been reclassified to conform with the 2016 presentation. Note 2 - Computation of Earnings Per Common Share Basic earnings per common share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued relate solely to outstanding shares in the Directors Plan, see "Note 17 - Benefit Plans." Earnings per common share have been computed based on the following: (1) Exclusive of shares held in the Rabbi Trust Note 3 - Accounting Standards Updates Pending Accounting Standards Updates ASU No. 2016-01: “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities” In January 2016, ASU No. 2016-01 set forth the following: 1) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment and when an impairment exists, an entity is required to measure the investment at fair value; 3) for public entities, eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; 4) for public entities, requires the use of exit price notion when measuring the fair value of financial instruments for disclosure purposes; 5) requires an entity to present separately in other comprehensive income, the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; 6) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; and 7) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is not expected to have a significant impact on our operations or financial statement disclosures. ASU No. 2016-02: “Leases (Topic 842)” In February 2016, ASU No. 2016-02 was issued to create Topic 842 - Leases which will require recognition of lease assets and lease liabilities on the balance sheet for leases previously classified as operating leases. Accounting guidance is set forth for both lessee and lessor accounting. Under lessee accounting, a lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For finance leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of comprehensive income; and 3) classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows. For operating leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis; and 3) classify all cash payments within operating activities in the statement of cash flows. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2018 and is not expected to have a significant impact on our operations or financial statement disclosures. ASU No. 2016-05: “Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships” In March 2016, ASU No. 2016-05 was issued to clarify designation of a hedging instrument when there is a change in counterparty. A change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2016 and is not expected to have a significant impact on our operations or financial statement disclosures. ASU No. 2016-07: “Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition of the Equity Method of Accounting” In March 2016, ASU No. 2016-07 was issued and eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. Additionally, the update requires that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2016 and is not expected to have a significant impact on our operations or financial statement disclosures. ASU No. 2016-09: “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” In March 2016, ASU No. 2016-09 updated several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2016 and is not expected to have a significant impact on our operations or financial statement disclosures. ASU No. 2016-13: “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” In June 2016, ASU No. 2016-13 updated the measurement for credit losses for AFS debt securities and assets measured at amortized cost which include loans, trade receivables, and any other financial assets with the contractual right to receive cash. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Under the incurred loss approach, entities are limited to a probable initial recognition threshold when credit losses are measured under GAAP; an entity generally only considers past events and current conditions in measuring the incurred loss. In the new guidance, the incurred loss impairment methodology in current GAAP is replaced with a methodology that reflects expected credit losses. This methodology requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances which applies to assets measured either collectively or individually. The update allows an entity to revert to historical loss information that is reflective of the contractual term (considering the effect of prepayments) for periods that are beyond the time frame for which the entity is able to develop reasonable and supportable forecasts. In addition, the disclosures of credit quality indicators in relation to the amortized cost of financing receivables, a current disclosure requirement, are further disaggregated by year of origination (or vintage). The vintage information will be useful for financial statement users to better assess changes in underwriting standards and credit quality trends in asset portfolios over time and the effect of those changes on credit losses. Overall, the update will allow entities the ability to measure expected credit losses without the restriction of incurred or probable losses that exist under current GAAP. For users of the financial statements, the update provides decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2019 and is expected to have a significant impact on our operations and financial statement disclosures as well as that of the banking industry as a whole. ASU No. 2016-15: “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” In August 2016, ASU No. 2016-15 was issued to provide guidance on eight specific cash flow issues: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies; 6) including bank-owned life insurance policies; 7) distributions received from equity method investees, beneficial interests in securitization transactions; and 8) separately identifiable cash flows and application of the predominance principle. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is not expected to have a significant impact on our operations or financial statement disclosures. ASU No. 2016-16: “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory” In October 2016, ASU No. 2016-16 was issued to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. The new guidance eliminates the requirement of the sale of the asset to recognize current and deferred income taxes. Instead, current and deferred income taxes will be recognized on an intra-entity transfer of an asset other than inventory when the transfer occurs. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is not expected to have a significant impact on our operations or financial statement disclosures. ASU No. 2016-17: “Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control” In October 2016, ASU No. 2016-17 was issued to amend the previous consolidation guidance on how a reporting entity that is the single decision maker of a variable interest entity (VIE) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. In the amendment, a single decision maker is not required to consider indirect interests held through related parties that are under common control with the single decision maker to be the equivalent of direct interests in their entirety. Instead, a single decision maker is required to include those interests on a proportionate basis consistent with indirect interests held through other related parties. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2016 and is not expected to have an impact on our operations or financial statement disclosures. ASU No. 2016-18: “Statement of Cash Flows (Topic 230): Restricted Cash” In November 2016, ASU No. 2016-18 was issued to provide guidance on the classification and presentation of changes in restricted cash on the statement of cash flows under Topic 230. The new guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Additionally, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is not expected to have an impact on our operations or financial statement disclosures. Note 4 - AFS Securities The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows as of December 31: The amortized cost and fair value of AFS securities by contractual maturity at December 31, 2016 are as follows: Expected maturities for government sponsored enterprises and states and political subdivisions may differ from contractual maturities because issuers may have the right to call or prepay obligations. As the auction rate money market preferred and preferred stocks have continual call dates, they are not reported by a specific maturity group. Because of their variable monthly payments, mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group. A summary of the sales activity of AFS securities was as follows during the years ended December 31: The cost basis used to determine the realized gains or losses of AFS securities sold was the amortized cost of the individual investment security as of the trade date. The following information pertains to AFS securities with gross unrealized losses at December 31 aggregated by investment category and length of time that individual securities have been in a continuous loss position. As of December 31, 2016 and 2015, we conducted an analysis to determine whether any securities currently in an unrealized loss position, should be other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria: • Has the value of the investment declined more than what is deemed to be reasonable based on a risk and maturity adjusted discount rate? • Is the investment credit rating below investment grade? • Is it probable the issuer will be unable to pay the amount when due? • Is it more likely than not that we will have to sell the security before recovery of its cost basis? • Has the duration of the investment been extended? During the fourth quarter of 2016, we identified one municipal bond as other-than-temporarily impaired. While management estimated the OTTI to be realized, we also engaged the services of an independent investment valuation firm to estimate the amount of impairment as of December 31, 2016. The valuation calculated the estimated market value utilizing two different approaches: 1) Market - Appraisal and Comparable Investments 2) Income - Discounted Cash Flow Method The two methods were then weighted, with a higher weighting applied to the Market approach, to determine the estimated impairment. As a result of this analysis, we recognized an OTTI of $770 in earnings for the year ended December 31, 2016. The following table provides a roll-forward of credit related impairment recorded in earnings for the years ended December 31: Based on our analyses, the fact that we have asserted that we do not have the intent to sell AFS securities in an unrealized loss position, and considering it is unlikely that we will have to sell any AFS securities in an unrealized loss position before recovery of their cost basis, we do not believe that the values of any other AFS securities are other-than-temporarily impaired as of December 31, 2016, or December 31, 2015, with the exception of the one municipal bond discussed above. Note 5 - Loans and ALLL We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, manufacturing, retail, gaming, tourism, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees; a portion of loans are unsecured. Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and any deferred fees or costs. Interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method. The accrual of interest on commercial, agricultural, and residential real estate loans is discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. For loans that are placed on nonaccrual status or charged-off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL. Loans may be returned to accrual status after six months of continuous performance. Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, advances to mortgage brokers, farmland and agricultural production, and states and political subdivisions. Repayment of these loans is dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000. Borrowers with direct credit needs of more than $15,000 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports. We entered into a mortgage purchase program in 2016 with a financial institution where we participate in advances to mortgage brokers ("advances"). The mortgage brokers originate residential mortgage loans with the intent to sell on the secondary market. We participate in the advance to the mortgage broker, which is secured by the underlying mortgage loan, until it is ultimately sold on the secondary market. As such, the average life of each participated advance is approximately 20-30 days. Funds from the sale of the loan are used to payoff our participation in the advance to the mortgage broker. We classify these advances as commercial loans and include the outstanding balance in commercial loans on our balance sheet. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $30,000. The difference between our outstanding balances and the maximum outstanding aggregate amount are classified as “Unfunded commitments under lines of credit” in the “Contractual Obligations and Loan Commitments” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations of this report. We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell fixed rate loans to Freddie Mac. Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 97% of the lower of the appraised value of the property or the purchase price, with the condition that private mortgage insurance is required on loans with loan-to-value ratios in excess of 80%. Underwriting criteria for residential real estate loans include: • Evaluation of the borrower’s ability to make monthly payments. • Evaluation of the value of the property securing the loan. • Ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income. • Ensuring all debt servicing does not exceed 36% of income. • Verification of acceptable credit reports. • Verification of employment, income, and financial information. Appraisals are performed by independent appraisers and reviewed for appropriateness. All mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $500 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors. Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 12 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market. The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL. The appropriateness of the ALLL is evaluated on a quarterly basis and is based upon a periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio, with the exception of advances to mortgage brokers, over the preceding five years. With no historical losses on advances to mortgage brokers, there is no allocation in the commercial segment displayed below based on historical loss factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. A summary of changes in the ALLL and the recorded investment in loans by segments follows: The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of December 31: Internally assigned credit risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned credit risk ratings for commercial and agricultural loans are as follows: 1. EXCELLENT - Substantially Risk Free Credit has strong financial condition and solid earnings history, characterized by: • High liquidity, strong cash flow, low leverage. • Unquestioned ability to meet all obligations when due. • Experienced management, with management succession in place. • Secured by cash. 2. HIGH QUALITY - Limited Risk Credit with sound financial condition and a positive trend in earnings supplemented by: • Favorable liquidity and leverage ratios. • Ability to meet all obligations when due. • Management with successful track record. • Steady and satisfactory earnings history. • If loan is secured, collateral is of high quality and readily marketable. • Access to alternative financing. • Well defined primary and secondary source of repayment. • If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident. 3. HIGH SATISFACTORY - Reasonable Risk Credit with satisfactory financial condition and further characterized by: • Working capital adequate to support operations. • Cash flow sufficient to pay debts as scheduled. • Management experience and depth appear favorable. • Loan performing according to terms. • If loan is secured, collateral is acceptable and loan is fully protected. 4. LOW SATISFACTORY - Acceptable Risk Credit with bankable risks, although some signs of weaknesses are shown: • Would include most start-up businesses. • Occasional instances of trade slowness or repayment delinquency - may have been 10-30 days slow within the past year. • Management’s abilities are apparent, yet unproven. • Weakness in primary source of repayment with adequate secondary source of repayment. • Loan structure generally in accordance with policy. • If secured, loan collateral coverage is marginal. • Adequate cash flow to service debt, but coverage is low. To be classified as less than satisfactory, only one of the following criteria must be met. 5. SPECIAL MENTION - Criticized Credit constitutes an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan: • Downward trend in sales, profit levels, and margins. • Impaired working capital position. • Cash flow is strained in order to meet debt repayment. • Loan delinquency (30-60 days) and overdrafts may occur. • Shrinking equity cushion. • Diminishing primary source of repayment and questionable secondary source. • Management abilities are questionable. • Weak industry conditions. • Litigation pending against the borrower. • Collateral or guaranty offers limited protection. • Negative debt service coverage, however the credit is well collateralized and payments are current. 6. SUBSTANDARD - Classified Credit where the borrower’s current net worth, paying capacity, and value of the collateral pledged is inadequate. There is a distinct possibility that we will implement collection procedures if the loan deficiencies are not corrected. In addition, the following characteristics may apply: • Sustained losses have severely eroded the equity and cash flow. • Deteriorating liquidity. • Serious management problems or internal fraud. • Original repayment terms liberalized. • Likelihood of bankruptcy. • Inability to access other funding sources. • Reliance on secondary source of repayment. • Litigation filed against borrower. • Collateral provides little or no value. • Requires excessive attention of the loan officer. • Borrower is uncooperative with loan officer. 7. VULNERABLE - Classified Credit is considered “Substandard” and warrants placing on nonaccrual status. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply: • Insufficient cash flow to service debt. • Minimal or no payments being received. • Limited options available to avoid the collection process. • Transition status, expect action will take place to collect loan without immediate progress being made. 8. DOUBTFUL - Workout Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply: • Normal operations are severely diminished or have ceased. • Seriously impaired cash flow. • Original repayment terms materially altered. • Secondary source of repayment is inadequate. • Survivability as a “going concern” is impossible. • Collection process has begun. • Bankruptcy petition has been filed. • Judgments have been filed. • Portion of the loan balance has been charged-off. Our primary credit quality indicator for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the past due and current loans as of December 31: Impaired Loans Loans may be classified as impaired if they meet one or more of the following criteria: 1. There has been a charge-off of its principal balance (in whole or in part); 2. The loan has been classified as a TDR; or 3. The loan is in nonaccrual status. Impairment is measured on a loan-by-loan basis for commercial and agricultural loans by comparing the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Impairment is measured on a loan-by-loan basis for residential real estate and consumer loans by comparing the loan’s unpaid principal balance to the present value of expected future cash flows discounted at the loan’s effective interest rate. We do not recognize interest income on impaired loans in nonaccrual status. For impaired loans not classified as nonaccrual, interest income is recognized daily, as earned, according to the terms of the loan agreement and the principal amount outstanding. The following summarizes information pertaining to impaired loans as of, and for the years ended, December 31: We had committed to advance $117 and $0 in connection with impaired loans, which include TDRs, as of December 31, 2016 and 2015, respectively. Troubled Debt Restructurings Loan modifications are considered to be TDRs when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties. Typical concessions granted include, but are not limited to: • Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics. • Extending the amortization period beyond typical lending guidelines for loans with similar risk characteristics. • Forgiving principal. • Forgiving accrued interest. To determine if a borrower is experiencing financial difficulties, factors we consider include: • The borrower is currently in default on any of their debt. • The borrower would likely default on any of their debt if the concession was not granted. • The borrower’s cash flow was insufficient to service all of their debt if the concession was not granted. • The borrower has declared, or is in the process of declaring, bankruptcy. • The borrower is unlikely to continue as a going concern (if the entity is a business). The following is a summary of information pertaining to TDRs granted in the years ended December 31: The following tables summarize concessions we granted to borrowers in financial difficulty in the years ended December 31: We did not restructure any loans by forgiving principal or accrued interest during 2016 or 2015. Based on our historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs, including TDRs that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment. We had no loans that defaulted in the year ended December 31, 2016 which were modified within 12 months prior to the default date. Following is a summary of loans that defaulted in the year ended December 31, 2015, which were modified within 12 months prior to the default date: The following is a summary of TDR loan balances as of December 31: Note 6 - Premises and Equipment A summary of premises and equipment at December 31 follows: Depreciation expense amounted to $2,821, $2,677, and $2,551 in 2016, 2015, and 2014, respectively. Note 7 - Goodwill and Other Intangible Assets The carrying amount of goodwill was $48,282 at December 31, 2016 and 2015. Identifiable intangible assets were as follows as of December 31: Amortization expense associated with identifiable intangible assets was $162, $169, and $183 in 2016, 2015, and 2014, respectively. Estimated amortization expense associated with identifiable intangibles for each of the next five years succeeding December 31, 2016, and thereafter is as follows: Note 8 - Foreclosed Assets Foreclosed assets are included in other assets in the consolidated balance sheets and consist of other real estate owned and repossessed assets. The following is a summary of foreclosed assets as of December 31: Below is a summary of changes in foreclosed assets during the years ended December 31: There were $18 and $56 consumer mortgage loans collateralized by residential real estate in the process of foreclosure as of December 31, 2016 and 2015. Note 9 - Deposits Scheduled maturities of time deposits for the next five years, and thereafter, are as follows: Interest expense on time deposits greater than $100 was $2,937 in 2016, $2,806 in 2015 and $2,920 in 2014. Note 10 - Borrowed Funds Borrowed funds consist of the following obligations at December 31: FHLB advances are collateralized by a blanket lien on all qualified 1-4 family residential real estate loans, specific AFS securities, and FHLB stock. The following table lists the maturities and weighted average interest rates of FHLB advances as of December 31: (1) Hedged advance (see "Derivative Instruments" section below) Securities sold under agreements to repurchase are classified as secured borrowings and are reflected at the amount of cash received in connection with the transaction. The securities underlying the agreements have a carrying value and a fair value of $60,918 and $70,555 at December 31, 2016 and 2015, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities. Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. The following table provides a summary of securities sold under repurchase agreements without stated maturity dates and federal funds purchased. We had no FRB Discount Window advances for the years ended December 31, 2016 and 2015. We had pledged AFS securities and 1-4 family residential real estate loans in the following amounts at December 31: AFS securities pledged to repurchase agreements without stated maturity dates consisted of the following at December 31: AFS securities pledged to repurchase agreements are monitored to ensure the appropriate level is collateralized. In the event of maturities, calls, significant principal repayments, or significant decline in market values, we have adequate levels of AFS securities available to pledge to satisfy required collateral. As of December 31, 2016, we had the ability to borrow up to an additional $99,118, based on assets pledged as collateral. We had no investment securities that are restricted to be pledged for specific purposes. Derivative Instruments During the second quarter of 2016, we began to enter into interest rate swaps to manage exposure to interest rate risk and variability in cash flows. The interest rate swaps, associated with our variable rate borrowings, are designated upon inception as cash flow hedges of forecasted interest payments. We enter into LIBOR-based interest rate swaps that involve the receipt of variable amounts in exchange for fixed rate payments, in effect converting variable rate debt to fixed rate debt. Cash flow hedges are assessed for effectiveness using regression analysis. The effective portion of changes in fair value are recorded in OCI and subsequently reclassified into interest expense in the same period in which the related interest on the variable rate borrowings affects earnings. In the event that a portion of the changes in fair value were determined to be ineffective, the ineffective amount would be recorded in earnings. The following table provides information on derivatives related to variable rate borrowings as of December 31, 2016. Derivatives contain an element of credit risk which arises from the possibility that we will incur a loss as a result of a counterparty failing to meet its contractual obligations. Credit risk is minimized through counterparty collateral, transaction limits and monitoring procedures. We also manage dealer credit risk by entering into interest rate derivatives only with primary and highly rated counterparties, the use of ISDA master agreements and counterparties limits. We do not anticipate any losses from failure of interest rate derivative counterparties to honor their obligations. Note 11 - Other Noninterest Expenses A summary of expenses included in other noninterest expenses is as follows for the years ended December 31: Note 12 - Federal Income Taxes Components of the consolidated provision for federal income taxes are as follows for the years ended December 31: The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of 34% of income before federal income tax expense is as follows for the year ended December 31: Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for federal income tax purposes. Significant components of our deferred tax assets and liabilities, included in other assets in the accompanying consolidated balance sheets, are as follows as of December 31: We are subject to U.S. federal income tax; however, we are no longer subject to examination by taxing authorities for years before 2013. There are no material uncertain tax positions requiring recognition in our consolidated financial statements. We do not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months. We recognize interest and/or penalties related to income tax matters in income tax expense. We do not have any amounts accrued for interest and penalties at December 31, 2016 and 2015 and we not aware of any claims for such amounts by federal income tax authorities. Note 13 - Off-Balance-Sheet Activities Credit-Related Financial Instruments We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of our customers. These financial instruments, which include commitments to extend credit and standby letters of credit, involve, to varying degrees, elements of credit and IRR in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument. The following table summarizes our credit related financial instruments with off-balance-sheet risk as of: Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These commitments may expire without being drawn upon and do not necessarily represent future cash requirements. Advances to mortgage brokers are also included in unfunded commitments under lines of credit. The balance is the difference between our outstanding balances and maximum outstanding aggregate amount. Commitments to grant loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The amount of collateral obtained, if we deem necessary, is based on management's credit evaluation of the customer. Commitments to grant loans include residential mortgage loans with the majority being loans committed to be sold to the secondary market. Commercial and standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper, bond financing, and similar transactions. These commitments to extend credit and letters of credit generally mature within one year. The credit risk involved in these transactions is essentially the same as that involved in extending loans to customers. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if we deem necessary upon the extension of credit, is based on our credit evaluation of the borrower. While we consider standby letters of credit to be guarantees, the amount of the liability related to such guarantees on the commitment date is not significant and a liability related to such guarantees is not recorded on the consolidated balance sheets. Our exposure to credit-related loss in the event of nonperformance by the counter parties to the financial instruments for commitments to extend credit and standby letters of credit could be up to the contractual notional amount of those instruments. We use the same credit policies in deciding to make these commitments as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments. Note 14 - On-Balance Sheet Activities Derivative Loan Commitments Mortgage loan commitments are referred to as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding. We enter into commitments to fund residential mortgage loans at specific times in the future, with the intention that these loans will subsequently be sold in the secondary market. A mortgage loan commitment binds us to lend funds to a potential borrower at a specified interest rate within a specified period of time, generally up to 60 days after inception of the rate lock. Outstanding derivative loan commitments expose us to the risk that the price of the loans arising from the exercise of the loan commitment might decline from the inception of the rate lock to funding of the loan due to increases in mortgage interest rates. If interest rates increase, the value of these loan commitments decreases. Conversely, if interest rates decrease, the value of these loan commitments increase. The notional amount of undesignated interest rate lock commitments was $750 and $234 at December 31, 2016 and 2015, respectively. Forward Loan Sale Commitments To protect against the price risk inherent in derivative loan commitments, we utilize both “mandatory delivery” and “best efforts” forward loan sale commitments to mitigate the risk of potential decreases in the values of loan that would result from the exercise of the derivative loan commitments. With a “mandatory delivery” contract, we commit to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. If we fail to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, we are obligated to pay a “pair-off” fee, based on then current market prices, to the investor to compensate the investor for the shortfall. With a “best efforts” contract, we commit to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. Generally, the price the investor will pay the seller for an individual loan is specified prior to the loan being funded (e.g. on the same day the lender commits to lend funds to a potential borrower). We expect that these forward loan sale commitments will experience changes in fair value opposite to the change in fair value of derivative loan commitments. The notional amount of undesignated forward loan sale commitments was $1,877 and $1,421 at December 31, 2016 and 2015, respectively. The fair values of the rate lock loan commitments related to the origination of mortgage loans that will be held for sale and the forward loan sale commitments are deemed insignificant by management and, accordingly, are not recorded in our consolidated financial statements. Note 15 - Commitments and Other Matters Banking regulations require us to maintain cash reserve balances in currency or as deposits with the FRB. At December 31, 2016 and 2015, the reserve balances amounted to $1,273 and $1,169, respectively. Banking regulations limit the transfer of assets in the form of dividends, loans, or advances from the Bank to the Corporation. At December 31, 2016, substantially all of the Bank’s assets were restricted from transfer to the Corporation in the form of loans or advances. Consequently, Bank dividends are the principal source of funds for the Corporation. Payment of dividends without regulatory approval is limited to the current year’s retained net income plus retained net income for the preceding two years, less any required transfers to common stock. At January 1, 2017, the amount available to the Corporation for dividends from the Bank, without regulatory approval, was approximately $25,600. Note 16 - Minimum Regulatory Capital Requirements The Corporation (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the FRB and the FDIC. Failure to meet minimum capital requirements can initiate mandatory and possibly additional discretionary actions by the FRB and the FDIC that if undertaken, could have a material effect on our financial statements. Under regulatory capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that include quantitative measures of assets, liabilities, capital, and certain off-balance-sheet items, as calculated under regulatory accounting standards. Our capital amounts and classifications are also subject to qualitative judgments by the FRB and the FDIC about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum amounts and ratios (set forth in the following table) of total, tier 1 capital, and common equity tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and tier 1 capital to average assets (as defined). We believe, as of December 31, 2016 and 2015, that we met all capital adequacy requirements. The FRB has established minimum risk based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. On July 2, 2013, the FRB published revised BASEL III Capital standards for banks. The final rules redefine what is included or deducted from equity capital, changes risk weighting for certain on and off-balance sheet assets, increases the minimum required equity capital to be considered well capitalized, and introduces a capital cushion buffer. The rules, which are being gradually phased in between 2015 and 2019, are not expected to have a material impact on the Corporation but will require us to hold more capital than we have historically. Effective January 1, 2015, the minimum standard for primary, or tier 1, capital increased from 4.00% to 6.00%. The minimum standard for total capital remained at 8.00%. Also effective January 1, 2015 was the new common equity tier 1 capital ratio which had a minimum requirement of 4.50%. The capital conservative buffer requirement began on January 1, 2016 which required a 0.625% addition to the tier 1, minimum, and common equity tier 1 capital ratio. The capital conservative buffer will continue to increase capital ratios each year through 2019. As of December 31, 2016 and 2015, the most recent notifications from the FRB and the FDIC categorized us as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain total risk-based, Tier 1 risk-based, Common Equity Tier 1, and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notifications that we believe have changed our categories. Our actual capital amounts and ratios are also presented in the table. Note 17 - Benefit Plans 401(k) Plan We have a 401(k) plan in which substantially all employees are eligible to participate. Employees may contribute up to 100% of their compensation subject to certain limits based on federal tax laws. The plan was amended in 2013 to provide a matching safe harbor contribution for all eligible employees equal to 100% of the first 5.0% of an employee's compensation contributed to the Plan during the year. Employees are 100% vested in the safe harbor matching contributions. For 2012, we made a 3.0% safe harbor contribution for all eligible employees and matching contributions equal to 50% of the first 4.0% of an employee’s compensation contributed to the Plan during the year. Employees were 100% vested in the safe harbor contributions and were 0% vested through their first two years of employment and were 100% vested after 6 years of service for matching contributions. For 2016, 2015 and 2014, expenses attributable to the Plan were $686, $664, and $655, respectively. Defined Benefit Pension Plan We maintain a noncontributory defined benefit pension plan, which was curtailed effective March 1, 2007. As a result of the curtailment, future salary increases are no longer considered (the projected benefit obligation is equal to the accumulated benefit obligation), and plan benefits are based on years of service and the individual employee’s five highest consecutive years of compensation out of the last ten years of service through March 1, 2007. Changes in the projected benefit obligation and plan assets during each year, the funded status of the plan, and the net amount recognized in our consolidated balance sheets using an actuarial measurement date of December 31, are summarized as follows during the years ended December 31: We have recorded the funded status of the plan in our consolidated balance sheets. We adjust the underfunded status in a liability account to reflect the current funded status of the plan. Any gains or losses that arise during the year but are not recognized as components of net periodic benefit cost are recognized as a component of other comprehensive income (loss). The components of net periodic benefit cost are as follows for the years ended December 31: During 2016, 2015 and 2014, additional settlement loss of $0, $250 and $260 were recognized in connection with lump-sum benefits distributions. Many plan participants elect to receive their retirement benefit payments in the form of lump-sum settlements. Pro rata settlement losses, which can occasionally occur as a result of these lump sum distributions, are recognized only in years when the total of such distributions exceed the sum of the service and interest expense components of net periodic benefit cost. Accumulated other comprehensive income at December 31, 2016 includes net unrecognized pension costs before income taxes of $4,503, of which $178 is expected to be amortized into benefit cost during 2017. The actuarial assumptions used in determining the benefit obligation are as follows for the years ended December 31: The actuarial weighted average assumptions used in determining the net periodic pension costs are as follows for the years ended December 31: As a result of the curtailment of the Plan, there is no rate of compensation increase considered in the above assumptions. The expected long term rate of return is an estimate of anticipated future long term rates of return on plan assets as measured on a market value basis. Factors considered in arriving at this assumption include: • Historical long term rates of return for broad asset classes. • Actual past rates of return achieved by the plan. • The general mix of assets held by the plan. • The stated investment policy for the plan. The selected rate of return is net of anticipated investment related expenses. Plan Assets Our overall investment strategy is to moderately grow the portfolio by investing 50% of the portfolio in equity securities and 50% in fixed income securities. This strategy is designed to generate a long term rate of return of 6.00%. Equity securities primarily consist of the S&P 500 Index with a smaller allocation to the Small Cap and International Index. Fixed income securities are invested in the Bond Market Index. The Plan has appropriate assets invested in short term investments to meet near-term benefit payments. The asset mix and the sector weighting of the investments are determined by our pension committee, which is comprised of members of our management. To manage the Plan, we retain a third party investment advisor to conduct consultations. We review the performance of the advisor at least annually. The fair values of our pension plan assets by asset category were as follows as of December 31: The following is a description of the valuation methodologies used for assets measured at fair value. There have been no changes in the methodologies used at December 31, 2016 and 2015: • Short-term investments: Shares of a money market portfolio, which is valued using amortized cost, which approximates fair value. • Common collective trusts: These investments are public investment securities valued using the NAV provided by a third party investment advisor. The NAV is quoted on a private market that is not active; however, the unit price is based on underlying investments which are traded on an active market. We anticipate contributions to the Plan in 2017 to approximate net contribution costs. The components of projected net periodic benefit cost are as follows for the year ending: Estimated future benefit payments are as follows for the next ten years: Equity Compensation Plan Pursuant to the terms of the Directors Plan, our directors are required to invest at least 25% of their board fees in our common stock. These stock investments can be made either through deferred fees or through the purchase of shares through the Dividend Reinvestment Plan. Deferred fees, under the Directors Plan, are converted on a quarterly basis into shares of our common stock based on the fair value of a share of common stock as of the relevant valuation date. Stock credited to a participant’s account is eligible for stock and cash dividends as declared. Dividend Reinvestment Plan shares are purchased on a monthly basis pursuant to the Dividend Reinvestment Plan. Distribution of deferred fees from the Directors Plan occurs when the participant retires from the Board or upon the occurrence of certain other events. The participant is eligible to receive a lump-sum, in-kind, distribution of all of the stock that is then in his or her account, and any unconverted cash will be converted to and rounded up to whole shares of stock and distributed, as well. The Directors Plan does not allow for cash settlement, and therefore, such share-based payment awards qualify for classification as equity. We may use authorized but unissued shares or purchase shares of common stock on the open market to meet our obligations under the Directors Plan. We maintain the Rabbi Trust to fund the Directors Plan. The Rabbi Trust is an irrevocable grantor trust to which we may contribute assets for the limited purpose of funding a nonqualified deferred compensation plan. Although we may not reach the assets of the Rabbi Trust for any purpose other than meeting our obligations under the Directors Plan, the assets of the Rabbi Trust remain subject to the claims of our creditors and are included in the consolidated financial statements. We may contribute cash or common stock to the Rabbi Trust from time-to-time for the sole purpose of funding the Directors Plan. The Rabbi Trust will use any cash that we contributed to purchase shares of our common stock on the open market through our brokerage services department. Shares held in the Rabbi Trust are included in the calculation of earnings per share. The components of shares eligible to be issued under the Directors Plan were as follows as of December 31: Other Employee Benefit Plans We maintain two nonqualified supplementary employee retirement plans to provide supplemental retirement benefits to specified participants. Expenses related to these programs for 2016, 2015 and 2014 were $430, $379, and $372, respectively, and are being recognized over the participants’ expected years of service. We maintain a non-leveraged ESOP which was frozen to new participants on December 31, 2006. Contributions to the plan are discretionary and are approved by the Board of Directors and recorded as compensation expense. We made no contributions to the ESOP in 2016, 2015 and 2014. Compensation cost related to the plan for 2016, 2015 and 2014 was $33, $32, and $23, respectively. Total allocated shares outstanding related to the ESOP at December 31, 2016, 2015, and 2014 were 204,669, 217,064, and 241,958, respectively. Such shares are included in the computation of dividends and earnings per share in each of the respective years. On December 21, 2016, the Board approved the termination of the ESOP effective December 31, 2016. Actual dissolution of the ESOP is anticipated to occur in mid-2017. We maintain a self-funded medical plan under which we are responsible for the first $75 per year of claims made by a covered family. Expenses are accrued based on estimates of the aggregate liability for claims incurred and our experience. Expenses were $2,150 in 2016, $1,695 in 2015 and $1,786 in 2014. Note 18 - Accumulated Other Comprehensive Income (Loss) AOCI includes net income as well as unrealized gains and losses, net of tax, on AFS investment securities owned and changes in the funded status of our defined benefit pension plan, which are excluded from net income. Unrealized AFS securities gains and losses and changes in the funded status of the pension plan, net of tax, are excluded from net income, and are reflected as a direct charge or credit to shareholders’ equity. Comprehensive income (loss) and the related components are disclosed in the consolidated statements of comprehensive income. The following table summarizes the changes in AOCI by component for the years ended December 31 (net of tax): Included in OCI for the years ended December 31, 2016 and 2015 are changes in unrealized holding gains and losses related to auction rate money market preferred and preferred stocks. For federal income tax purposes, these securities are considered equity investments. As such, no deferred federal income taxes related to unrealized holding gains or losses are expected or recorded. A summary of the components of unrealized holding gains on AFS securities included in OCI follows for the years ended December 31: The following table details reclassification adjustments and the related affected line items in our consolidated statements of income for the years ended December 31: Note 19 - Related Party Transactions In the ordinary course of business, we grant loans to principal officers and directors and their affiliates (including their families and companies in which they have 10% or more ownership). Annual activity consisted of the following for the years ended December 31: Total deposits of these principal officers and directors and their affiliates amounted to $5,770 and $5,625 at December 31, 2016 and 2015, respectively. In addition, the ESOP held deposits with the Bank aggregating $290 and $143, respectively, at December 31, 2016 and 2015. From time-to-time, we make charitable donations to The Isabella Bank Foundation (the “Foundation”), which is a non-controlled affiliated nonprofit entity formed for the purpose of distributing charitable donations to recipient organizations generally located in the communities we service. Our donations are expensed when committed to the Foundation. The assets and transactions of the Foundation are not included in our consolidated financial statements. Assets of the Foundation include cash and cash equivalents, certificates of deposit, and shares of Isabella Bank Corporation common stock. The Foundation owned 44,350 and 44,350 shares of our common stock as of December 31, 2016 and 2015, respectively. Such shares are included in the computation of dividends and earnings per share. The following table displays total asset balances of, and our donations to, the Foundation as of, and for the years ended, December 31: Note 20 - Fair Value Following is a description of the valuation methodologies, key inputs, and an indication of the level of the fair value hierarchy in which the assets or liabilities are classified. Cash and cash equivalents: The carrying amounts of cash and demand deposits due from banks and interest bearing balances due from banks approximate fair values. As such, we classify cash and cash equivalents as Level 1. AFS securities: AFS securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. Level 2 fair value measurement is based upon quoted prices for similar instruments. If quoted prices are not available, fair values are measured using independent pricing models or other model based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. The values for Level 1 and Level 2 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the values provided to alternative pricing sources. Mortgage loans AFS: Mortgage loans AFS are carried at the lower of cost or fair value. The fair value of mortgage loans AFS are based on the price secondary markets are currently offering for portfolios with similar characteristics. As such, we classify mortgage loans AFS subject to nonrecurring fair value adjustments as Level 2. Loans: For variable rate loans with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. As such, we classify loans as Level 3 assets. We do not record loans at fair value on a recurring basis. However, from time-to-time, loans are classified as impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, we measure the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. We review the net realizable values of the underlying collateral for collateral dependent impaired loans on at least a quarterly basis for all loan types. To determine the collateral value, we utilize independent appraisals, broker price opinions, or internal evaluations. We review these valuations to determine whether an additional discount should be applied given the age of market information that may have been considered as well as other factors such as costs to sell an asset if it is determined that the collateral will be liquidated in connection with the ultimate settlement of the loan. We use these valuations to determine if any specific reserves or charge-offs are necessary. We may obtain new valuations in certain circumstances, including when there has been significant deterioration in the condition of the collateral, if the foreclosure process has begun, or if the existing valuation is deemed to be outdated. The following tables list the quantitative fair value information about impaired loans as of December 31: Discount factors with ranges are based on the age of the independent appraisal, broker price opinion, or internal evaluation. Accrued interest receivable: The carrying amounts of accrued interest receivable approximate fair value. As such, we classify accrued interest receivable as Level 1. Equity securities without readily determinable fair values: Included in equity securities without readily determinable fair values are FHLB stock and FRB stock as well as our minority ownership interests in Corporate Settlement Solutions, LLC and Valley Financial Corporation. The investment in Corporate Settlement Solutions, LLC, a title insurance company, was made in the first quarter 2008 and we account for our investment under the equity method of accounting. Valley Financial Corporation is the parent company of 1st State Bank in Saginaw, Michigan, which is a community bank that opened in 2005. We made investments in Valley Financial Corporation in 2004 and in 2007 and sold all shares in 2016. We accounted for our investment under the equity method of accounting. The lack of an active market, or other independent sources to validate fair value estimates coupled with the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. As the fair values of these investments are not readily determinable, they are not disclosed under a specific fair value hierarchy; however, they are reviewed quarterly for impairment. If we were to record an impairment adjustment related to these securities, it would be classified as a nonrecurring Level 3 fair value adjustment. During 2016 and 2015, there were no impairments recorded on equity securities without readily determinable fair values. Foreclosed assets: Upon transfer from the loan portfolio, foreclosed assets (which are included in other assets) are adjusted to and subsequently carried at the lower of carrying value or fair value less costs to sell. Net realizable value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. Due to the inherent level of estimation in the valuation process, we classify foreclosed assets as nonrecurring Level 3. The table below lists the quantitative fair value information related to foreclosed assets as of: Discount factors with ranges are based on the age of the independent appraisal, broker price opinion, or internal evaluations. Goodwill and other intangible assets: Acquisition intangibles and goodwill are evaluated for potential impairment on at least an annual basis. Acquisition intangibles and goodwill are typically qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired. If it is determined that the carrying balance of acquisition intangibles or goodwill is more likely than not to be impaired, we perform a cash flow valuation to determine the extent of the potential impairment. If the testing resulted in impairment, we would classify goodwill and other acquisition intangibles subjected to nonrecurring fair value adjustments as Level 3. During 2016 and 2015, there were no impairments recorded on goodwill and other acquisition intangibles. OMSR: OMSR (which are included in other assets) are subject to impairment testing. To test for impairment, we utilize a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and discount rates. If the valuation model reflects a value less than the carrying value, OMSR are adjusted to fair value through a valuation allowance as determined by the model. As such, we classify OMSR subject to nonrecurring fair value adjustments as Level 2. Deposits: The fair value of demand, savings, and money market deposits are equal to their carrying amounts and are classified as Level 1. Fair values for variable rate certificates of deposit approximate their carrying value. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. As such, fixed rate certificates of deposit are classified as Level 2. Borrowed funds: The carrying amounts of federal funds purchased, borrowings under overnight repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. The fair values of other borrowed funds are estimated using discounted cash flow analyses based on current incremental borrowing arrangements. As such, borrowed funds are classified as Level 2. Accrued interest payable: The carrying amounts of accrued interest payable approximate fair value. As such, we classify accrued interest payable as Level 1. Derivative instruments: Derivative instruments, consisting solely of interest rate swaps, are recorded at fair value on a recurring basis. Derivatives qualifying as cash flow hedges, when highly effective, are reported at fair value in other assets or other liabilities on our Consolidated Balance Sheets with changes in value recorded in OCI. Should the hedge no longer be considered effective, the ineffective portion of the change in fair value is recorded directly in earnings in the period in which the change occurs. The fair value of a derivative is determined by quoted market prices and model based valuation techniques. As such, we classify derivative instruments as Level 2. Commitments to extend credit, standby letters of credit, and undisbursed loans: Our commitments to extend credit, standby letters of credit, and undisbursed funds have no carrying amount and are estimated to have no realizable fair value. Historically, a majority of the unused commitments to extend credit have not been drawn upon and, generally, we do not receive fees in connection with these commitments other than standby letter of credit fees, which are not significant. The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement. Estimated Fair Values of Financial Instruments Not Recorded at Fair Value in their Entirety on a Recurring Basis Disclosure of the estimated fair values of financial instruments, which differ from carrying values, often requires the use of estimates. In cases where quoted market values in an active market are not available, we use present value techniques and other valuation methods to estimate the fair values of our financial instruments. These valuation methods require considerable judgment and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used. The carrying amount and estimated fair value of financial instruments not recorded at fair value in their entirety on a recurring basis were as follows as of December 31: (1) Due to the characteristics of equity securities without readily determinable fair values, they are not disclosed under a specific fair value hierarchy. If we were to record an impairment adjustment related to these securities, such amount would be classified as a nonrecurring Level 3 fair value adjustment. Financial Instruments Recorded at Fair Value The table below presents the recorded amount of assets and liabilities measured at fair value on December 31: The following table provides a summary of the changes in fair value of assets and liabilities recorded at fair value, for which gains or losses were recognized through earnings on a nonrecurring basis, in the years ended December 31: We had no assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis, as of December 31, 2016. Note 21 - Parent Company Only Financial Information Condensed Balance Sheets Condensed Statements of Income Condensed Statements of Cash Flows Note 22 - Operating Segments Our reportable segments are based on legal entities that account for at least 10% of net operating results. The operations of the Bank as of December 31, 2016, 2015, and 2014 represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented. | This appears to be a partial financial statement with several key accounting policies and disclosures. Here's a summary of the main points:
1. Company: Isabella Bank Corporation (Mount Pleasant, Michigan)
2. Key Accounting Policies:
- Fair Value Measurements: Uses a hierarchy system prioritizing market-based prices
- Investment Securities: Classified as Available for Sale (AFS)
- Loan Policies: Loans held for foreseeable future reported at outstanding principal balance
- Interest Income: Accrued over loan term, discontinued after 90 days for certain loan types
3. Notable Financial Elements:
- Uses risk-adjusted capital ratios for regulatory compliance
- Has procedures for handling Other Than Temporary Impairment (OTTI)
- Incorporates loan loss allowances (ALLL)
- Includes policies for handling debt and equity securities
4. Reporting Approach:
- Uses both recurring and nonrecurring fair value measurements
- Emphasizes observable market inputs when available
- Includes comprehensive income reporting
Note: The statement appears incomplete and doesn't provide specific financial figures, making it difficult to summarize actual financial performance. This excerpt focuses more on accounting policies and procedures rather than actual financial results. | Claude |
Item 8 . The following consolidated financial statements and selected quarterly financial data of the Company are filed under this item: The financial statement schedules are filed pursuant to Item 15 of this report. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Cambrex Corporation, We have audited the accompanying consolidated balance sheets of Cambrex Corporation as of December 31, 2016 and 2015 and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cambrex Corporation at December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Cambrex Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 3, 2017 expressed an unqualified opinion thereon. /s/ BDO USA, LLP Woodbridge, NJ February 3, 2017 Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Cambrex Corporation, We have audited Cambrex Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Cambrex Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Item 9A, Management’s Report on Internal Control Over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Cambrex Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Cambrex Corporation as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016 and our report dated February 3, 2017 expressed an unqualified opinion thereon. /s/ BDO USA LLP Woodbridge, NJ February 3, 2017 CAMBREX CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per share data) See accompanying notes to consolidated financial statements. CAMBREX CORPORATION AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS (dollars in thousands, except per share data) See accompanying notes to consolidated financial statements. CAMBREX CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (dollars in thousands) See accompanying notes to consolidated financial statements. CAMBREX CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (dollars in thousands, except per share data) See accompanying notes to consolidated financial statements. CAMBREX CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands) See accompanying notes to consolidated financial statements. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (1) The Company Cambrex Corporation and Subsidiaries (the “Company” or “Cambrex”) primarily provides products and services worldwide to pharmaceutical companies and generic drug companies. The Company is dedicated to accelerating its customers’ drug discovery, development and manufacturing processes for human therapeutics. The Company’s products consist of active pharmaceutical ingredients (“APIs”) and pharmaceutical intermediates produced under Food and Drug Administration current Good Manufacturing Practices for use in the production of prescription and over-the-counter drug products. Cambrex has four operating segments, which are manufacturing facilities that have been aggregated as one reportable segment. (2) Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Equity investments in which the Company exercises significant influence but does not control, are accounted for using the equity method. Certain reclassifications have been made to prior year amounts to conform to current year presentation and recent accounting pronouncements. All other significant intercompany balances and transactions have been eliminated in consolidation. Cash Equivalents Temporary cash investments with an original maturity of less than three months are considered cash equivalents. The carrying amounts approximate fair value. Allowance for Doubtful Accounts The Company maintains allowances for doubtful accounts relating to estimated losses resulting from customers being unable to make required payments. Allowances for doubtful accounts are based on historical experience and known factors regarding specific customers and the industries in which those customers operate. If the financial condition of the Company’s customers were to deteriorate, resulting in their inability to make payments, additional allowances would be required. Concentrations of credit risk Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. In the normal course of business, the Company maintains cash balances with European Union banks up to the equivalent of $10,000. The Company routinely monitors the risks associated with these institutions and diversifies its exposure by maintaining smaller balances with multiple financial institutions. Concentrations of credit risk with respect to accounts receivable are limited due to the Company's large number of customers and their dispersion throughout the world. At December 31, 2016 and 2015, the Company had receivables with one customer totaling nearly 43% and 51%, respectively, of overall accounts receivables. The Company does not consider this customer to pose any significant credit risk. Derivative Instruments Derivative financial instruments are periodically used by the Company primarily to mitigate a variety of working capital, investment and borrowing risks. The Company primarily uses foreign currency forward contracts to minimize foreign currency exchange rate risk associated with foreign currency transactions. Changes in the fair value on these forward contracts are recognized in earnings. The Company uses interest rate swap instruments only as hedges. As such, the differential to be paid or received in connection with these instruments is accrued and recognized in income as an adjustment to interest expense. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (2) Summary of Significant Accounting Policies (continued) None of the foreign currency forward contracts entered into during 2016 and 2015 were designated for hedge accounting treatment. Inventories Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market. The determination of market value involves an assessment of numerous factors, including estimated selling prices. Reserves are recorded to reduce the carrying value for inventory determined to be damaged, obsolete or otherwise unsaleable. Property, Plant and Equipment Property, plant and equipment is stated at cost, net of accumulated depreciation. Plant and equipment are depreciated on a straight-line basis over the estimated useful lives for each applicable asset group as follows: Expenditures for additions, major renewals or betterments are capitalized and expenditures for maintenance and repairs are charged to income as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in cost of goods sold or operating expenses. Interest is capitalized in connection with the construction and acquisition of assets that are capitalized over longer periods of time for larger amounts. The capitalized interest is recorded as part of the cost of the asset to which it relates and is amortized over the asset’s estimated useful life. Total interest capitalized in connection with ongoing construction activities was $575 in 2016, $534 in 2015, and $128 in 2014. Impairment of Goodwill The Company reviews the carrying value of goodwill to determine whether impairment may exist on an annual basis or whenever it has reason to believe goodwill may not be recoverable. The annual impairment test of goodwill is performed during the fourth quarter of each fiscal year. The Company recorded a non-cash impairment charge at its Zenara facility for the year ended December 31, 2015. Refer to Note 8 to the Company’s consolidated financial statements for additional information on this impairment. For the years ended December 31, 2016 and 2014, the Company did not have an impairment. The Company first performs a qualitative assessment to test goodwill for impairment. If, after performing the qualitative assessment, the Company concludes that it is more likely than not that the fair value of the reporting units is less than its carrying value, the two-step process would be utilized. The first step of the goodwill impairment test is to identify potential impairment by comparing the fair value of each reporting unit, determined using various valuation techniques, with the primary technique being a discounted cash flow analysis, to its carrying value. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (2) Summary of Significant Accounting Policies (continued) Based upon the Company’s most recent analysis the fair value of the reporting units substantially exceeded their carrying values, except for the recent acquisition of PharmaCore. As PharmaCore was recently acquired, goodwill represents estimated fair value. Impairment of Long-Lived Assets The Company assesses the impairment of its long-lived assets, including amortizable intangible assets, and property, plant and equipment, whenever economic events or changes in circumstances indicate that the carrying amounts of the assets may not be recoverable. Long lived assets are considered to be impaired when the sum of the undiscounted expected future operating cash flows is less than the carrying amounts of the related assets. If impaired, the assets are written down to fair market value. The Company recorded a non-cash impairment charge on long-lived assets at Zenara for the year ended December 31, 2015. Refer to Note 8 to the Company’s consolidated financial statements for additional information on this impairment. Revenue Recognition Revenues are generally recognized when title to products and risk of loss are transferred to customers. Additional conditions for recognition of revenue are that collection of sales proceeds is reasonably assured and the Company has no further performance obligations. Amounts billed in advance are recorded as deferred revenue and advance payments on the balance sheet. Since payments received are sometimes non-refundable, the termination of a contract by a customer prior to its completion could result in an immediate recognition of deferred revenue relating to payments already received but not previously recognized as revenue. Sales terms to certain customers include rebates if certain conditions are met. Additionally, sales are generally made with a limited right of return under certain conditions. The Company estimates these rebates and returns at the time of sale based on the terms of agreements with customers and historical experience and estimated orders. The Company recognizes revenue net of these estimated costs which are classified as allowances and rebates. The Company bills a portion of freight cost incurred on shipments to customers. Amounts billed to customers are recorded within net revenues. Freight costs are reflected in cost of goods sold. Income Taxes The Company and its eligible subsidiaries file a consolidated U.S. income tax return. Foreign subsidiaries are consolidated for financial reporting but are not eligible to be included in the consolidated U.S. income tax return. However the earnings of foreign subsidiaries are generally taxed by the U.S. when repatriated and such U.S. tax may be reduced or eliminated by federal foreign tax credits based on the foreign income and withholding taxes paid or accrued by the foreign subsidiary. Due in part to a continuing desire to limit credit and currency exposure for cash held in foreign currencies or in non-U.S. banks, the Company determined that it is likely that a portion of the undistributed earnings of its foreign subsidiaries will be repatriated to the U.S. in the future. Accordingly, the Company provides deferred taxes on certain undistributed foreign earnings. Subject to limitations, U.S. income tax on such foreign earnings, when actually repatriated, may be reduced or eliminated by unrecognized foreign tax credits that may be generated in connection with the repatriation or by existing foreign tax credit carryforwards or other tax attributes. The Company monitors available evidence and its plans for foreign earnings and expects to continue to provide deferred taxes based on the tax liability that would be due upon repatriation of amounts not considered permanently reinvested. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (2) Summary of Significant Accounting Policies (continued) Use of Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions include the valuation of inventory, accounts receivable, asset impairments, stock based compensation and deferred tax assets. Actual results could differ from those estimates. Environmental Costs The Company is subject to extensive and changing federal, state, local and foreign environmental laws and regulations, and has made provisions for the estimated financial impact of environmental activities. The Company’s policy is to accrue environmental related costs of a non-capital nature, including estimated litigation costs, when those costs are believed to be probable and can be reasonably estimated. The quantification of environmental exposures requires an assessment of many factors, including changing laws and regulations, advancements in environmental technologies, the quality of information available related to specific sites, the assessment stage of each site investigation, preliminary findings and the length of time involved in remediation or settlement. Such accruals are adjusted as further information develops or circumstances change. For certain matters, the Company expects to share costs with other parties. Recoveries of environmental remediation costs from other parties are recorded as assets when their receipt is deemed certain. Foreign Currency The functional currency of the Company's foreign subsidiaries is the applicable local currency. The translation of the applicable foreign currencies into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts and cash flows using average rates of exchange prevailing during the year. Adjustments resulting from the translation of foreign currency financial statements are accumulated in stockholders' equity until the entity is sold or substantially liquidated. Gains or losses relating to transactions of a long-term investment nature are also accumulated in stockholders' equity. Gains or losses resulting from third-party foreign currency transactions are included in the income statement as a component of other revenues, net in the consolidated income statement. Foreign currency net gains/(losses) were $306, ($605) and $186 in 2016, 2015 and 2014, respectively. Earnings per Common Share All diluted earnings per share are computed on the basis of the weighted average shares of common stock outstanding plus common equivalent shares arising from the effect of dilutive stock options, equity-settled performance shares and restricted stock units, using the treasury stock method. For the years ended December 31, 2016, 2015 and 2014, shares of 558,499, 342,961 and 940,038, respectively, were not included in the calculation of diluted shares outstanding because the effect would be anti-dilutive. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (2) Summary of Significant Accounting Policies (continued) Comprehensive Income Included within accumulated other comprehensive income (“AOCI”) for the Company are foreign currency translation adjustments, changes in the fair value related to the interest rate swap classified as cash flow hedges, net of related tax, and changes in the pensions, net of tax. Total comprehensive income/loss for the years ended December 31, 2016 and 2015 are included in the Statements of Comprehensive Income. Reclassification Certain reclassifications have been made to prior year amounts to conform with current year presentation. (3) Impact of Recently Issued Accounting Pronouncements Business Combinations - Clarifying the Definition of a Business In January 2017, the FASB issued ASU 2017-01 which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The standard introduces a screen for determining when assets acquired are not a business and clarifies that a business must include, at a minimum, an input and a substantive process that contribute to an output to be considered a business. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company does not expect this new guidance to have a material impact on its consolidated financial statements. Statement of Cash Flows - Restricted Cash In November 2016, the FASB issued ASU 2016-18 which clarifies the presentation requirements of restricted cash within the statement of cash flows. The changes in restricted cash and restricted cash equivalents during the period should be included in the beginning and ending cash and cash equivalents balance reconciliation on the statement of cash flows. When cash, cash equivalents, restricted cash or restricted cash equivalents are presented in more than one line item within the statement of financial position, an entity shall calculate a total cash amount in a narrative or tabular format that agrees to the amount shown on the statement of cash flows. Details on the nature and amounts of restricted cash should also be disclosed. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company does not expect this new guidance to have a material impact on its consolidated financial statements. Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments In August 2016, the FASB issued ASU 2016-15 which provides guidance on the presentation and classification in the statement of cash flows for specific cash receipt and payment transactions, including debt prepayment or extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims and corporate-owned life insurance policies, and distributions received from equity method investees. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company does not expect this new guidance to have a material impact on its consolidated financial statements. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (3) Impact of Recently Issued Accounting Pronouncements (continued) Simplification of Employee Share-Based Payment Accounting In March 2016, the FASB issued ASU 2016-09 which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and classification in the statement of cash flows. This standard is effective for fiscal years beginning after December 15, 2016, including interim periods within that reporting period. The new standard requires recording an asset for excess tax benefits that had not previously been recognized. The Company has no remaining unrecognized excess tax benefits at December 31, 2016. All excess tax benefits and deficiencies in future periods will be recorded as part of the current period tax provision within the Income Statement. This will result in increased volatility in the Company’s effective tax rate. No other provisions of the new standard will have a significant impact on the consolidated financial statements. Leases In February 2016, the FASB issued ASU 2016-02 which requires lessees to recognize right of use assets and lease liabilities on the balance sheet for all leases except short-term leases. On the income statement, leases will be classified as operating or finance leases. This standard is effective for fiscal years beginning after December 15, 2018, including interim periods within that reporting period. At this time, the Company has no financing leases and only a limited number of operating leases. The result of adoption will be an increase to assets and liabilities by the same amount for the identified operating leases. This adjustment will not be material to the Company, assuming there is not an increase in lease activity. Revenue from Contracts with Customers In May 2014, the FASB issued ASU 2014-09 that introduces a new five-step revenue recognition model in which an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires disclosures sufficient to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. Numerous updates were issued in 2016 that provide clarification on a number of specific issues as well as requiring additional disclosures. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. While the Company has not yet completed its final review of the impact of the new standard, the Company does not currently anticipate a material impact on its revenue recognition practices. The Company is still evaluating disclosure requirements under the new standard. We will continue to evaluate the standard as well as additional changes, modifications or interpretations which may impact our current conclusions. The Company expects to adopt the new standard using the modified retrospective method. Simplifying the Measurement of Inventory In July 2015, the FASB issued ASU 2015-11 which requires that inventory be measured at the lower of cost and net realizable value, which eliminates the other two options that currently exist for market, replacement cost and net realizable value less an approximately normal profit margin. This standard is effective for fiscal years beginning after December 15, 2016, including interim periods within that reporting period. The Company does not expect this new guidance to have a material impact on its consolidated financial statements. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (4) Acquisitions In October 2016, Cambrex purchased 100% of PharmaCore, Inc. a privately-held company located in High Point, NC for $24,275, net of cash. The transaction was structured as a stock purchase. PharmaCore, which has been renamed Cambrex High Point, Inc. (“CHP”), specializes in developing, manufacturing and scaling up small molecule APIs for projects in early clinical phases. With the acquisition of CHP, Cambrex enhances its capabilities and expertise to efficiently develop early clinical phase products and new technologies, and increases the number of potential late stage and commercial products that could be manufactured at Cambrex’s larger manufacturing sites. The preliminary allocation of the purchase price of the acquired assets and liabilities was performed on the basis of their respective fair values. The Company utilized a third party to assist in establishing the fair values of the assets acquired and liabilities assumed. This process resulted in goodwill of $9,046, fixed assets of $8,422 and identifiable intangible assets of $6,900 as well as smaller adjustments to certain working capital accounts. The Company also recorded deferred tax assets primarily related to NOLs for approximately $4,000 and deferred tax liabilities for approximately $4,400. The deferred tax assets and liabilities were recorded on a provisional basis and will be adjusted in subsequent periods when all applicable tax returns have been completed. All acquisition costs have been expensed and totaled approximately $640 as well as approximately $200 of severance cost, all of which has been recorded to “Selling, general and administrative expenses” on the Company’s income statement. The Company recorded gross sales of $4,648 and after purchase price adjustments and severance, operating profit was not material. Proforma disclosures have not been provided due to the immateriality of this acquisition. (5) Net Inventories Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market. Net inventories consist of the following: The components of inventory stated above are net of reserves of $12,423 and $12,337 as of December 31, 2016 and 2015, respectively. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (6) Property, Plant and Equipment Property, plant and equipment consist of the following: Depreciation expense was $23,654, $21,196 and $23,296 for the years ended December 31, 2016, 2015 and 2014, respectively. Total capital expenditures in 2016 and 2015 were $51,604 and $57,400, respectively. For the year ended December 31, 2014, the Company recorded a gain on the sale of land of $1,234. (7) Goodwill and Intangible Assets The changes in the carrying amount of goodwill for the years ended December 31, 2016 and 2015 are as follows: Acquired intangible assets, which are amortized, consist of the following: CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (7) Goodwill and Intangible Assets (continued) The change in the gross carrying amount in 2016 is mainly due to the recognition of customer-related intangibles of $6,900 due to the acquisition of PharmaCore in the fourth quarter of 2016, the implementation of a new enterprise resource planning (“ERP”) system, and the impact of foreign currency translation. The change in the gross carrying amount in 2015 is mainly due to an impairment charge related to Zenara of $3,625 classified as technology-based intangibles and the impact of foreign currency translation. Beginning in 2014, the Company began implementing a new ERP system, as such, $2,297 and $2,639 has been capitalized and classified as internal-use software during the years ended December 31, 2016 and 2015, respectively. Amortization expense amounted to $1,011, $865, and $530 for the years ended December 31, 2016, 2015 and 2014, respectively. Amortization expense related to current intangible assets is expected to be approximately $1,839 for 2017, $1,894 for 2018 and 2019, $1,883 for 2020, and $1,874 for 2021. (8) Restructuring Charges In late October 2015, the Board of Directors of the Company recommended that management evaluate strategic alternatives for Zenara Pharma due to a change in focus on higher growth initiatives as well as to reduce attention required by senior management to operate Zenara. The Company determined that the sale of Zenara was the best option for its shareholders. As such, Cambrex management, with Board authority, committed to a plan to sell Zenara. The immaterial assets and liabilities of Zenara are included in “Prepaid expenses and other current assets” and “Accrued expenses and other current liabilities” on the Company’s balance sheet for all periods presented. A long-lived asset classified as held for sale must be measured at the lower of its carrying amount or fair value less cost to sell. Prior to this measurement the Company assessed Zenara’s assets and liabilities as well as performed a goodwill and long-lived asset impairment assessment. These assessments were based on level 3 inputs and resulted in writing off all of Zenara’s goodwill of $8,542 and an amortizable intangible asset of $3,625 which are included in restructuring expenses on the 2015 income statement. The Company then compared the carrying amounts of the assets held for sale to their fair values. Accordingly, the Company recorded a charge of $1,269 in 2015 for the difference between the net carrying value of these assets and the estimated fair value less cost to sell. Fair value less cost to sell was determined using the most current sales information available. All the charges mentioned above, as well as a portion of certain retention bonuses, resulted in restructuring expenses of $15,573, which are included in “Restructuring expenses” on the Company’s consolidated income statement for the year ended December 31, 2015. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (8) Restructuring Charges (continued) For the year ended December 31, 2016, the Company recorded $1,158 as “Restructuring expenses” on the Company’s consolidated income statement related to the write down of Zenara to reflect a reduction in the sale price. The Company expects a sale to be completed during 2017. Refer to Note 23 to the Company’s consolidated financial statements for further explanation. (9) Partially-Owned Affiliates In May 2014, the Company negotiated an accelerated purchase of Zenara for the remaining 49% for $2,680. As a result, the Company recorded an expense of $4,400 during 2014 representing the release of foreign currency translation adjustments previously recorded in other comprehensive income that were required to be recorded to the income statement as a result of the removal of the investment in partially-owned affiliate due to the full consolidation of Zenara as of the acquisition date. (10) Accrued Expenses and Other Current Liabilities The components of accrued expenses and other current liabilities are as follows: (11) Income Taxes Income before income taxes consists of the following: CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (11) Income Taxes (continued) The provision for income taxes consist of the following provisions/(benefits): The provision/(benefit) for income taxes differs from the statutory federal income tax rate of 35% for 2016, 2015 and 2014 as follows: Foreign income inclusions represent distributions from foreign subsidiaries which give rise to newly recognized federal foreign tax credits. Tax audit settlements in 2014 included the final settlement of the European tax dispute concerning 2003 transactions. Net change in the valuation allowance in 2014 included the benefit of $26,902 for the remaining release of the domestic federal valuation allowance attributable to foreign tax credits, offset by $1,516 for domestic state items and $217 for foreign deferred taxes subject to valuation allowances. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (11) Income Taxes (continued) The components of deferred tax assets and liabilities as of December 31, 2016 and 2015 relate to temporary differences and carryforwards as follows: During 2014, the Company received updated customer projections that impacted current and future years’ U.S. taxable income in amounts and type that supported full utilization of existing federal foreign tax credit carryforwards. As a result, the Company released $26,902 of valuation allowance against these foreign tax credits. The Company expects to maintain a domestic valuation allowance against state NOLs, state tax credits and state deferred tax assets due to restrictive rules regarding realization. The Company expects to maintain a valuation allowance against certain foreign deferred tax assets, primarily NOL carryforwards, until such time as the Company attains an appropriate level of future profitability in the appropriate jurisdictions and is able to conclude that it is more likely than not that its foreign deferred tax assets are realizable. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (11) Income Taxes (continued) The domestic valuation allowance for the years ended December 31, 2016, 2015 and 2014 increased $2,294, increased $2,450 and decreased $25,386, respectively. The 2016 and 2015 increases in the domestic valuation allowance are due to domestic state items. The 2014 decrease in the domestic valuation allowance was allocated as follows: the valuation allowance decreased $26,902 for the release of valuation allowance due to domestic profitability and increased $1,516 due to domestic state items. The foreign valuation allowance for the years ended December 31, 2016, 2015 and 2014 decreased $698, decreased $1,531, and increased $1,923, respectively. The 2016 decrease in the foreign valuation allowance was allocated as follows: the valuation allowance decreased $621 for foreign income and decreased $77 for deferred tax amounts and currency translation adjustments included in other comprehensive income (“OCI”). The 2015 decrease in the foreign valuation allowance was allocated as follows: the valuation allowance increased $684 for foreign income and decreased $2,215 for deferred tax amounts, the reclass of Zenara valuation allowance for assets held for sale into other current liabilities, and currency translation adjustments included in OCI. The 2014 increase in the foreign valuation allowance was allocated as follows: the valuation allowance increased $217 for foreign income and increased $1,706 for deferred tax amounts and currency translation adjustments included in OCI. Under the tax laws of the various jurisdictions in which the Company operates, NOLs may be carried forward or back, subject to statutory limitations, to reduce taxable income in future or prior years. Domestic federal NOLs acquired in the PharmaCore stock acquisition are approximately $11,300 and will expire in 2021 through 2035. These NOLs can be utilized against U.S. consolidated taxable income, subject to annual limitations due to the ownership change. A full valuation allowance has been recorded against domestic state NOLs totaling approximately $98,200 which will expire in 2018 through 2036. A full valuation allowance has been recorded against foreign NOLs totaling approximately $2,431 which in most foreign jurisdictions will carry forward indefinitely. As of December 31, 2016, all remaining domestic federal foreign tax credits and alternative minimum tax credits have been utilized against current U.S. income taxes on worldwide income. In 2015 and 2014, the Company repatriated $9,850 and $5,442, respectively, of cash from its foreign subsidiaries in order to reduce its credit and currency exposure for cash held in foreign currencies or in non-U.S. banks and utilized the excess cash for debt reduction. Due in part to a continuing desire to limit credit and currency exposure related to cash held in foreign currencies or in non-U.S. banks, the Company determined that it is likely that a portion of the undistributed earnings of its foreign subsidiaries will be repatriated to the U.S. in the future. Accordingly, the Company has provided a deferred tax liability of $635 on certain undistributed foreign earnings as of December 31, 2016. Subject to limitations, U.S. income tax on such foreign earnings, when actually repatriated, may be reduced or eliminated by unrecognized foreign tax credits that may be generated in connection with the repatriation or by existing foreign tax credit carryforwards or other tax attributes. The Company monitors available evidence and its plans for foreign earnings and expects to continue to provide deferred taxes based on the tax liability that would be due upon repatriation of amounts not considered permanently reinvested. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (11) Income Taxes (continued) The following table summarizes the activity related to the Company’s unrecognized tax benefits as of December 31, 2016, 2015 and 2014: Of the total balance of unrecognized tax benefits at December 31, 2016, $1,778, if recognized, would affect the effective tax rate. Gross interest and penalties at December 31, 2016, 2015, and 2014 of $455, $475, and $489, respectively, related to the above unrecognized tax benefits are not reflected in the table above. In 2016, 2015, and 2014, the Company accrued $63, $58, and $337, respectively, of interest and penalties in the income statement. Consistent with prior periods, the Company recognizes interest and penalties within its income tax provision. Tax years 2012 and forward in the U.S. are open to examination by the IRS. The Company is also subject to examinations in its material non-U.S. jurisdictions for 2010 and later years. The Company is also subject to audits in various states for various years in which it has filed income tax returns. Previous state audits have resulted in immaterial adjustments. In the majority of states where the Company files, the Company is subject to examination for tax years 2012 and forward. During the fourth quarter of 2014, the Company entered into a final settlement with a tax authority, without any admission of fault or breach of laws, in order to avoid further litigation concerning intercompany transactions from 2003. The settlement required the Company to pay $1,487 in tax and interest during the fourth quarter of 2014 in full satisfaction of all liabilities for this matter, and in response the tax authority withdrew all pending litigation and renounced any outstanding claims. The settlement did not impose any penalties on the Company. Therefore, in the fourth quarter of 2014 the Company decreased its remaining reserve for unrecognized tax benefits for this matter by $4,137. (12) Short-term and Long-term Debt In May 2016, the Company entered into a $500,000 five-year Syndicated Senior Revolving Credit Facility (“Credit Facility”) which expires in May 2021. The Company pays interest on this Credit Facility at LIBOR plus 1.25% - 2.00% based upon certain financial measurements. The Credit Facility also includes financial covenants regarding interest coverage and leverage ratios. The Company was in compliance with all financial covenants at December 31, 2016. As of December 31, 2015, there was $30,000 outstanding on the Company’s former credit facility which was classified as short-term debt in 2015 and fully repaid in the first quarter of 2016. The 2016 and 2015 weighted average interest rate for long-term bank debt was 1.9% and 2.3%, respectively. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (13) Derivatives and Hedging Activities The Company operates internationally and is exposed to fluctuations in foreign exchange rates and interest rates in the normal course of business. The Company, from time to time, uses derivatives to reduce exposure to market risks resulting from fluctuations in interest rates and foreign exchange rates. All financial instruments involve market and credit risks. The Company is exposed to credit losses in the event of non-performance by the counterparties to the contracts. While there can be no assurance, the Company does not anticipate non-performance by these counterparties. Foreign Currency Forward Contracts The Company periodically enters into foreign currency forward contracts to protect against currency fluctuations of forecasted cash flows and existing balance sheet exposures at its foreign operations, as deemed appropriate. The Company may or may not elect to designate certain forward contracts for hedge accounting treatment. For derivatives that are not designated for hedge accounting treatment, changes in the fair value are immediately recognized in earnings. This treatment has the potential to increase volatility of the Company’s earnings. None of the foreign currency forward contracts entered into during 2016 or 2015 were designated for hedge accounting treatment. The notional amounts of the Company’s outstanding foreign exchange forward contracts were $20,896, $9,322 and $3,632 at December 31, 2016, 2015 and 2014, respectively. The Company does not hold or purchase any foreign currency forward contracts for trading or speculative purposes and no contractual term is greater than twelve months. The fair value of the Company’s foreign exchange forward contracts outstanding was a gain of $125 at December 31, 2016 and immaterial at December 31, 2015. This gain is reflected in the Company’s balance sheet under the caption “Prepaid expenses and other current assets.” Interest Rate Swap The Company entered into an interest rate swap in March 2012 to reduce the impact of changes in interest rates on its floating rate debt. This swap expired in September 2015. The swap was a contract to exchange floating rate for fixed interest payments periodically over the life of the agreement without the exchange of the underlying notional debt amount. The swap contract was designated as a cash flow hedge and, accordingly, changes in the fair value of this derivative were not recorded in earnings but were recorded each period in AOCI and reclassified into earnings as interest expense in the same period during which the hedged transaction affected earnings. The ineffective portion of the hedge was recognized in earnings and was immaterial to the Company's financial results. The interest rate swap had a notional value of $60,000, at a fixed rate of 0.92%. The fair value of this swap was based on quoted market prices and was in a loss position of $304 at December 31, 2014. This loss was reflected in the Company’s balance sheet under the caption “Accrued expenses and other current liabilities.” Refer to Note 14 to the Company’s consolidated financial statements for the summary table containing the fair value of the Company’s financial instruments. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (14) Fair Value Measurements U.S. GAAP establishes a valuation hierarchy for disclosure of the inputs to the valuations used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows: Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 inputs are quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, including interest rates, yield curves and credit risks, or inputs that are derived principally from, or corroborated by, observable market data through correlation; Level 3 inputs are unobservable inputs based on the Company’s assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The following table provides the assets and liabilities carried at fair value, measured on a recurring basis, as of December 31, 2016. The amounts were immaterial at December 31, 2015. The Company’s foreign currency forward contracts are measured at fair value using observable market inputs such as forward rates, the Company’s credit risk and its counterparties’ credit risks. Based on the Company’s continued ability to enter into forward contracts, the Company considers the markets for its fair value instruments to be active. Based on these inputs, the Company’s foreign currency forward contracts are classified within Level 2 of the valuation hierarchy. The Company’s financial instruments also include cash and cash equivalents, accounts receivables and accounts payables. The carrying amount of these instruments approximates fair value because of their short-term nature. The carrying amount of the Company’s long-term debt approximates fair value because the debt is based on current rates at which the Company could borrow funds with similar maturities. Refer to Note 13 to the Company’s consolidated financial statements for further disclosures on the Company’s financial instruments. (15) Stockholders' Equity The Company has two classes of common shares, Common Stock and Nonvoting Common Stock. Authorized shares of Common Stock were 100,000,000 at December 31, 2016 and 2015. Authorized shares of Nonvoting Common Stock were 730,746 at December 31, 2016 and 2015. Nonvoting Common Stock with a par value of $0.10 has equal rights with Common Stock, with the exception of voting power. Nonvoting Common Stock is convertible, share for share, into Common Stock, subject to any legal requirements applicable to holders restricting the extent to which they may own voting stock. As of December 31, 2016 and 2015, no shares of Nonvoting Common Stock were outstanding. The Company has authorized 5,000,000 shares of Series Preferred Stock, par value $0.10, issuable in series and with rights, powers and preferences as may be fixed by the Board of Directors. At December 31, 2016 and 2015, there was no preferred stock outstanding. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (15) Stockholders' Equity (continued) The Company held treasury shares of 1,583,909 and 1,729,727 at December 31, 2016 and 2015, respectively, which are primarily used for issuance to employee compensation plans. At December 31, 2016, there were 1,366,025 authorized shares of Common Stock reserved for issuance through equity compensation plans. (16) Accumulated Other Comprehensive Loss The following tables provide the changes in AOCI by component, net of tax, for the years ended December 31, 2016 and 2015: CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (16) Accumulated Other Comprehensive Loss (continued) The following tables provide the reclassifications out of AOCI by component for the years ended December 31, 2016 and 2015: The Company recognizes net periodic pension cost, which includes amortization of actuarial losses and gains, and prior service costs in both selling, general and administrative expenses and cost of goods sold in its income statement depending on the functional area of the underlying employees included in the plan. The release of currency translation adjustments generated from Zenara’s balance sheet are reflected in the Company’s income statement as restructuring expenses. The interest rate swap is reflected in the Company’s income statement as interest expense. (17) Stock Based Compensation The Company recognizes compensation cost for stock options awarded to employees based on their grant-date fair value. The value of each stock option is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted-average fair value per share for the stock options granted to employees for the years ended December 31, 2016, 2015 and 2014 were $15.17, $15.29 and $7.15, respectively. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (17) Stock Based Compensation (continued) The following assumptions were used in determining the fair value of stock options for grants issued in 2016, 2015 and 2014: The Company does not have any publicly traded stock options; therefore, expected volatilities are based on historical volatility of the Company’s stock. The risk-free interest rate is based on the yield of a zero-coupon U.S. Treasury bond whose maturity period approximates the option’s expected term. The expected life assumption represents the weighted-average period of time that newly granted stock-based awards are expected to remain outstanding. The expected life is estimated by analyzing three components of historical grants with the same vesting schedules: (i) observed post-vesting forfeiture, (ii) observed exercise behavior, and (iii) expected exercise behavior. The expected time to early exercise is calculated by assuming that the options outstanding as of the valuation date will be exercised at the midpoint between the final vest date and the expiration date. If a grant is already fully vested, it is assumed the outstanding options exercise at the midpoint between the valuation date and the expiration date. The three components are then option-weighted to estimate expected life. The Company stratifies its employees as Board of Directors, Named Executives and all other employees, each group with its own exercise behavior and thus, expected life. For 2016, 2015, and 2014, the Company recorded $3,816, $2,975 and $2,491, respectively, in selling, general and administrative expenses for stock options. As of December 31, 2016, the total compensation cost related to unvested stock option awards granted to employees but not yet recognized was $9,356. The cost will be amortized on a straight-line basis over the remaining weighted-average vesting period of 2.6 years. The following table is a summary of the Company’s stock option activity issued to employees and related information: The aggregate intrinsic value for all stock options exercised for the years ended December 31, 2016, 2015 and 2014 was $14,832, $24,432 and $8,910, respectively. The aggregate intrinsic values for all stock options outstanding and exercisable as of December 31, 2016 were $43,653 and $25,427, respectively. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (17) Stock Based Compensation (continued) A summary of the Company’s nonvested stock options, restricted stock and performance shares activity is presented below: Members of the Cambrex Board of Directors currently participate in an incentive plan which rewards service with restricted stock units. Awards are made annually and vest over six months. On the six month anniversary of the grant, restrictions on sale or transfer are removed and shares are issued to the Directors. These awards are classified as equity awards. For 2016, 2015 and 2014, the Company recorded $489, $353 and $395, respectively, in selling, general and administrative expenses for restricted stock units. As of December 31, 2016, total compensation cost related to unvested restricted stock not yet recognized was $7. The cost will be amortized on a straight-line basis over the remaining weighted-average vesting period of 0.3 years. The Company granted equity-settled performance shares (“PSs”) to certain executives. PS awards provide the recipient the right to receive a certain number of shares of the Company’s common stock in the future, which depends on the Company’s level of achievement of revenue and EBITDA growth as compared to the net revenue and EBITDA growth of the members of a specified peer group of companies over a three year period. The peer group consists of publicly-traded life sciences companies competing in the same industry as the Company. For 2016, 2015 and 2014, the Company recorded $3,461, $2,271 and $2,116, respectively, in selling, general and administrative expenses related to these PS awards. As of December 31, 2016, total compensation cost related to unvested performance shares not yet recognized was $5,439. The cost will be amortized on a straight-line basis over the remaining weighted-average vesting period of 1.5 years. The Company granted cash-settled performance share units (“PSUs”) to certain executives. PSU awards provide the recipient the right to receive the cash value of a certain number of shares of the Company’s common stock in the future, which depends on the Company’s level of achievement of revenue and EBITDA growth as compared to the net revenue and EBITDA growth of the members of a specified peer group of companies over a three year period. The peer group consists of publicly-traded life sciences companies competing in the same industry as the Company. As of December 31, 2016 and 2015, there were no PSU awards outstanding. For 2014, the Company recorded $445 in selling, general and administrative expenses for PSU awards. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (18) Retirement Plans Domestic Pension Plan The Company maintains a defined-benefit pension plan (“Domestic Pension Plan”) for certain salaried and certain hourly employees. It is the Company’s policy to contribute to the domestic pension plan to ensure adequate funds are available in the plan to make benefit payments to plan participants and beneficiaries when required. The Company also has a Supplemental Executive Retirement Plan (“SERP”) for key executives. This plan is non-qualified and unfunded. Benefits accruing under both plans were frozen in 2007. In July 2008, the Board of Directors of the Company amended the SERP to allow for lump sum payments effective January 1, 2009. The lump sum value as of January 1, 2009 will be paid in 10 equal actuarial equivalent installments through 2018. In 2014, the Company announced a program to offer a one-time option to elect to receive a voluntary lump-sum pension payout to certain former employees with deferred vested balances in the Company’s U.S. pension plan. As part of this voluntary lump-sum program, the Company settled $17,381 of pension obligations for the U.S. plan with an equal amount paid from plan assets. As a result, the Company recorded settlement losses of $7,170 reflecting the accelerated recognition of unamortized losses in the U.S. pension plan proportionate to the obligation that was settled. The loss on voluntary pension settlement is reflected as a separate line in the consolidated income statement with a corresponding balance sheet reduction in accumulated other comprehensive loss. International Pension Plans A foreign subsidiary of the Company maintains a pension plan (“International Pension Plan”) for its employees that conforms to the common practice in that country. Based on local laws and customs, this plan is unfunded. Savings Plan Cambrex makes available to all domestic employees a savings plan. Employee contributions are matched in part by Cambrex. The cost of this plan amounted to $1,294, $1,081 and $941 in 2016, 2015 and 2014, respectively. The benefit obligations as of December 31, 2016 and 2015 are as follows: CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (18) Retirement Plans (continued) The plan assets and funded status of the Domestic Pension Plan as of December 31, 2016 and 2015 are as follows: The unfunded status of the SERP was $1,209 and $1,800 as of December 31, 2016 and 2015, respectively. The unfunded status of the International Pension Plan was $25,002 and $22,748 as of December 31, 2016 and 2015, respectively. The amounts recognized in AOCI as of December 31, 2016 and 2015 consist of the following: The components of net periodic benefit cost are as follows: CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (18) Retirement Plans (continued) The estimated amounts that will be amortized from AOCI into net periodic benefit cost in 2017 are as follows: Major assumptions used in determining the benefit obligations are presented in the following table: Major assumptions used in determining the net benefit cost are presented in the following table: In making its assumption for the long-term rate of return on plan assets, the Company has utilized historical rates earned on securities allocated consistently with its investments. The discount rate was selected by projecting cash flows associated with plan obligations, which were matched to a yield curve of high quality corporate bonds. The Company then selected the single rate that produced the same present value as if each cash flow were discounted by the corresponding spot rate on the yield curve. The aggregate Accumulated Benefit Obligation (“ABO”) of $57,718 exceeds plan assets by $18,194 as of December 31, 2016 for the Domestic Pension Plan. The aggregate ABO is $24,134 for the International Pension Plan as of December 31, 2016. The International Pension Plan is unfunded. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (18) Retirement Plans (continued) The Company expects to contribute approximately $1,585 in cash to the Domestic Pension Plan in 2017. The Company does not expect to contribute cash to its International Pension Plan in 2017. The following benefit payments are expected to be paid out of the plans: The investment objective for the Domestic Pension Plan’s assets is to achieve long-term growth with exposure to risk at an appropriate level. The Company invests in a diversified asset mix consisting of equities (domestic and international) and taxable fixed income securities. Assets are managed to obtain the highest total rate of return in keeping with a moderate level of risk. The target allocations for plan assets are 30% - 80% equity securities, 25% - 45% U.S. fixed income and 5% - 15% all other investments. Equity securities primarily include investments in large cap and small-cap companies, U.S. fixed income securities including high quality corporate bonds, and U.S. government securities. Other types of investments include real asset funds, consisting primarily of investments in commodities, and Treasury Inflation-Protected Securities (“TIPS”). The fair values of the Company’s pension plan assets by asset category are as follows: CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (18) Retirement Plans (continued) The following table sets forth a summary of the changes in the fair value of the Domestic Plan’s Level 3 assets, which are annuity contracts with an insurance company, for the year ended December 31, 2016: (19) Foreign Operations and Sales The following summarized data represents the gross sales and long lived assets for the Company’s domestic and foreign entities for 2016, 2015 and 2014: Export sales, included in domestic gross sales, in 2016, 2015 and 2014 amounted to $182,215, $159,048 and $101,101, respectively. Sales to geographic areas consist of the following: One customer accounted for 36.9%, 34.5% and 24.0% of 2016, 2015 and 2014 consolidated gross sales, respectively. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (20) Commitments The Company has operating leases expiring on various dates through the year 2024. The leases are primarily for the rental of office space. At December 31, 2016, future minimum commitments under non-cancelable operating lease arrangements were as follows: Total operating lease expense was $2,044, $1,048 and $1,113, for the years ended December 31, 2016, 2015 and 2014, respectively. The Company is party to several unconditional purchase obligations resulting from contracts that contain legally binding provisions with respect to quantities, pricing and timing of purchases. The Company’s purchase obligations mainly include commitments to purchase utilities. At December 31, 2016, future commitments under these obligations were as follows: (21) Contingencies The Company is subject to various investigations, claims and legal proceedings covering a wide range of matters that arise in the ordinary course of its business activities. The Company continually assesses known facts and circumstances as they pertain to applicable legal and environmental matters and evaluates the need for reserves and disclosures as deemed necessary based on these facts and circumstances. These matters, either individually or in the aggregate, could result in actual costs that are significantly higher than the Company’s current assessment and could have a material adverse effect on the Company's operating results and cash flows in future reporting periods. Based upon past experience, the Company believes that payments significantly in excess of current reserves, if required, would be made over an extended number of years. Environmental In connection with laws and regulations pertaining to the protection of the environment, the Company and its subsidiaries are a party to several environmental proceedings and remediation activities and along with other companies, have been named a potentially responsible party (“PRP”) for certain waste disposal sites ("Superfund sites"). All of the liabilities currently recorded on the Company’s balance sheet for environmental proceedings are associated with discontinued operations. The Company had insurance policies in place at certain of the discontinued operations for certain years that the Company believes should cover some portion of the recorded liabilities or potential future liabilities and the Company expects the net cash impact related to the contingencies described below to be reduced by the applicable income tax rate. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (21) Contingencies (continued) It is the Company’s policy to record appropriate liabilities for environmental matters where remedial efforts are probable and the costs can be reasonably estimated. Such liabilities are based on the Company’s estimate of the undiscounted future costs required to complete the remedial work. Each of these matters is subject to various uncertainties, and it is possible that some of these matters will be decided against the Company. The resolution of such matters often spans several years and frequently involves regulatory oversight or adjudication. Additionally, many remediation requirements are fluid and are likely to be affected by future technological, site and regulatory developments. It is not possible at this time for the Company to determine fully the effect of all asserted and unasserted claims on its consolidated financial condition, results of operations or liquidity; however, to the extent possible, where asserted and unasserted claims can be estimated and where such claims are considered probable, the Company would record a liability. Consequently, the ultimate liability with respect to such matters, as well as the timing of cash disbursements, is uncertain. In matters where the Company is able to reasonably estimate the probable and estimable costs associated with environmental proceedings, the Company accrues for the estimated costs associated with the study and remediation of applicable sites. At December 31, 2016, these reserves were $16,703, of which $15,441 is included in “Other non-current liabilities” on the Company’s balance sheet. At December 31, 2015, the reserves were $8,329, of which $7,498 is included in “Other non-current liabilities” on the Company’s balance sheet. The increase in the reserves includes adjustments to reserves of $9,994, partially offset by payments of $1,620. The reserves are adjusted periodically as remediation efforts progress or as additional technical, regulatory or legal information becomes available. Given the uncertainties regarding the outcome of investigative and study activities, the status of laws, regulations, enforcement, policies, the impact of other PRPs, technology and information related to individual sites, the Company does not believe it is possible to currently develop an estimate of the range of reasonably possible environmental loss in excess of its reserves. Bayonne As a result of the sale of a Bayonne, New Jersey facility, the Company became obligated to investigate site conditions and conduct required remediation under the New Jersey Industrial Site Recovery Act. The Company intends to continue implementing a sampling plan at the property pursuant to the New Jersey Department of Environmental Protection’s (“NJDEP”) private oversight program. The results of the completed sampling, and any additional sampling deemed necessary, will be used to develop an estimate of the Company's future liability for remediation costs. New remedial requirements were identified during 2016, and site investigation continues. As of December 31, 2016, the Company’s reserve was $502. Clifton and Carlstadt The Company has implemented a sampling and pilot program in Clifton and Carlstadt, New Jersey pursuant to the NJDEP private oversight program. The results of the sampling and pilot program to date have been used to develop an estimate of the Company's future liability for remediation costs, and the Company continues to move forward with the projects at each site in accordance with the established schedules and work plans. As of December 31, 2016, the Company’s reserve was $2,024. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (21) Contingencies (continued) Berry’s Creek The Company received a notice from the United States Environmental Protection Agency (“USEPA”) that two subsidiaries of the Company are considered PRPs at the Berry’s Creek Study Area in New Jersey. These subsidiaries are among many other PRPs that were listed in the notice. Pursuant to the notice, the PRPs have been asked to perform a remedial investigation (“RI”) and feasibility study (“FS”) of the Berry’s Creek site. The Company has joined the group of PRPs and entered into an Administrative Settlement Agreement (“Agreement”) and Order on Consent with the USEPA agreeing to jointly conduct or fund an appropriate remedial investigation and feasibility study of the Berry’s Creek site with the other PRPs in the Agreement. The PRPs have engaged consultants to perform the work specified in the Agreement and develop a method to allocate related costs among the PRPs. In June 2016, the PRPs received a request from USEPA to amend the RI/FS Work Plan to accommodate a phased, iterative approach to the Berry’s Creek remediation. USEPA requested an initial interim remedy that focuses on a portion of the site, namely, sediments in Upper and Middle Berry’s Creek and the marsh in Upper Peach Island Creek. Any subsequent remedial action will occur after the implementation and performance monitoring of this interim remedy and the extent of future action is expected to be at least partially determined by the outcome of this initial phase. The scope of remedial activities in the initial interim remedy is currently being developed and based upon preliminary cost estimates, the Company recorded a pretax expense of $7,517 ($4,886 after tax), net of assumed insurance coverage, in the third and fourth quarters of 2016. The estimated costs for the initial interim remedy will be further developed over the next several months and the Company’s accrual may change based upon the final remedy selected and revisions to cost estimates. At this time it is not known when the costs for the complete remediation plan will be estimable, and as such, no accrual beyond the initial interim remedy has been recorded. The Company’s share has been preliminarily estimated by the PRP group at 2.4%. While the Company will defend its position that its share should be reduced from the current level, its share could be increased or decreased depending on the outcome of the final allocation process that will take place in future periods. While any resolution of this matter is not expected to materially impact the Company’s operations or financial position, it could be material to the financial statements in the period recorded. In July 2014, the Company received a notice from the U.S. Department of the Interior, U.S. Fish & Wildlife Service, regarding the Company’s potential liability for natural resource damages at the Berry’s Creek site and inviting the Company to participate in a cooperative assessment of natural resource damages. Most members of the Berry’s Creek PRP group received such notice letters, and the PRP Group coordinated a joint response, which was to decline participation in a cooperative assessment at this time, given existing investigation work at the site. The cost of any future assessment and the ultimate scope of natural resource damage liability are not yet known. Maybrook Site A subsidiary of Cambrex is named a PRP of a site in Hamptonburgh, New York by the USEPA in connection with the discharge, under appropriate permits, of wastewater at that site prior to Cambrex's acquisition in 1986. The PRPs implemented soil remediation which was completed in 2012 pending approval by the USEPA. The PRPs will continue implementing the ground water remediation at the site. In 2016, the Company reserved $370 for additional USEPA oversight expenses. As of December 31, 2016, the Company’s reserve was $692 to cover long-term ground water monitoring and related costs. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (21) Contingencies (continued) Harriman Site Subsidiaries of Cambrex and Pfizer are named as responsible parties for the Company’s former Harriman, New York production facility by the New York State Department of Environmental Conservation (“NYSDEC”). A final Record of Decision (“ROD”) describing the Harriman site remediation responsibilities for Pfizer and the Company was issued in 1997 (the “1997 ROD”) and incorporated into a federal court Consent Decree in 1998 (the “Consent Decree”). In December 2013, the Company, Pfizer and the NYSDEC entered into a federal court stipulation, which the court subsequently endorsed as a court order, resolving certain disputes with the NYSDEC about the scope of the obligations under the Consent Decree and the 1997 ROD, and requiring the Company and Pfizer to carry out an environmental investigation and study of certain areas of the Harriman Site. Site clean-up work under the 1997 ROD, the Consent Decree and the 2013 stipulation is ongoing and is being jointly performed by Pfizer and the Company, with NYSDEC oversight. Since 2014, Pfizer and the Company have performed supplemental remedial investigation measures requested by the NYSDEC, and the findings have been submitted to NYSDEC in various reports, including a study evaluating the feasibility of certain remedial alternatives in August 2016. By letter dated January 5, 2017, NYSDEC disapproved such feasibility study report and requested certain revisions to the report. The Company and Pfizer intend to make a timely response to the disapproval. As it is too soon to determine whether these reports and remedial plans, when finalized, will result in any significant changes to the Company’s responsibilities, no change to the reserve has been made. ELT Harriman, LLC ("ELT"), the current owner of the Harriman site, is conducting other investigation and remediation activities under a separate NYSDEC directive. No final remedy for the site has been determined, which will follow further discussions with the NYSDEC. The Company estimates the range for its share of the liability at the site to be between $2,000 and $7,000. As of December 31, 2016, the Company’s reserve was $3,515. At this time, the Company is unable to provide an estimate of the ultimate investigative and remedial costs to the Company for any final remedy selected by the NYSDEC. The Company intends to enforce all of its contractual rights to recover costs and for indemnification under a 2007 settlement agreement, and has filed such claims in an arbitration proceeding against ELT and the immediately preceding owner, Vertellus Specialties Holdings (“Vertellus”). ELT has filed counterclaims, and has threatened to file additional counterclaims, for contractual indemnification and for breach of the settlement agreement against the Company. Currently, the arbitration proceeding is stayed indefinitely. In May 2016, some but not all of the Vertellus entities who are parties to the Company’s 2007 settlement agreement filed for restructuring under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The Company has filed several claims as creditors in the bankruptcy proceeding and will continue to monitor the bankruptcy proceeding. Scientific Chemical Processing (“SCP”) Superfund Site A subsidiary of Cambrex was named a PRP of the SCP Superfund site, located in Carlstadt, New Jersey, along with approximately 130 other PRPs. The site is a former waste processing facility that accepted various waste for recovery and disposal including processing wastewater from this subsidiary. The PRPs are in the process of implementing a final remedy at the site. The SCP Superfund site has also been identified as a PRP in the Berry’s Creek Superfund site (see previous discussion). While the Company continues to dispute the methodology used by the PRP group to arrive at its interim allocation for cash contributions, the Company paid the funding requests in 2010 and 2014-2015. A final allocation of SCP Site costs (excluding Berry’s Creek costs) is expected to be finalized in 2017. As of December 31, 2016, the Company’s reserve was $883, of which approximately $565 is expected to be covered by insurance. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (21) Contingencies (continued) Newark Bay Complex The USEPA and a private party group are evaluating remediation plans for the Passaic River, Newark Bay, Hackensack River, Arthur Kill, Kill Van Kull and adjacent waters (the “Newark Bay Complex”). Although the Company is not involved in the USEPA action, it continues to monitor developments related to the site due to its past involvement in a previously settled state action relating to the Newark Bay Complex. The USEPA has finalized its decision on a cleanup plan for 8.3 miles of the lower Passaic River, and has estimated the cost of this plan at $1.38 billion. Due to the uncertainty of the future scope and timing of any possible claims against the Company, no liability has been recorded. The Company is involved in other related and unrelated environmental matters where the range of liability is not reasonably estimable at this time and it is not foreseeable when information will become available to provide a basis for adjusting or recording a reserve, should a reserve ultimately be required. Litigation and Other Matters Lorazepam and Clorazepate In 1998, the Company and a subsidiary were named as defendants along with Mylan Laboratories, Inc. (“Mylan”) and Gyma Laboratories, Inc. (“Gyma”) in a proceeding instituted by the Federal Trade Commission in the United States District Court for the District of Columbia (the “District Court”). Suits were also commenced by several State Attorneys General and class action complaints by private plaintiffs in various state courts. The suits alleged violations of the Federal Trade Commission Act arising from exclusive license agreements between the Company and Mylan covering two APIs (Lorazepam and Clorazepate). All cases have been resolved except for one brought by four health care insurers. In the remaining case, the District Court entered judgment after trial in 2008 against Mylan, Gyma and Cambrex in the total amount of $19,200, payable jointly and severally, and also a punitive damage award against each defendant in the amount of $16,709. In addition, at the time, the District Court ruled that the defendants were subject to a total of approximately $7,500 in prejudgment interest. The case is currently pending before the District Court following a January 2011 remand by the Court of Appeals. In July 2014, the District Court dismissed certain customers for which the plaintiffs were unable to establish jurisdiction and consequently, the plaintiffs currently have a motion pending before the District Court to reduce the damages award by a total of $9,600. In 2003, Cambrex paid $12,415 to Mylan in exchange for a release and full indemnity against future costs or liabilities in related litigation brought by the purchasers of Lorazepam and Clorazepate, as well as potential future claims related to the ongoing matter. In the event of a final settlement or final judgment, Cambrex expects any payment required by the Company to be made by Mylan under the indemnity described above. Other The Company has commitments incident to the ordinary course of business including corporate guarantees of certain subsidiary obligations to the Company’s lenders related to financial assurance obligations under certain environmental laws for remediation; closure and third party liability requirements of certain of its subsidiaries and a former operating location; contract provisions for indemnification protecting its customers and suppliers against third party liability for the manufacture and sale of Company products that fail to meet product warranties and contract provisions for indemnification protecting licensees against intellectual property infringement related to licensed Company technology or processes. CAMBREX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data) (21) Contingencies (continued) Additionally, as permitted under Delaware law, the Company indemnifies its officers, directors and employees for certain events or occurrences while the officer, director or employee is, or was, serving at the Company’s request in such capacity. The term of the indemnification period is for the officer's, director's or employee’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a director and officer insurance policy that covers a portion of any potential exposure. The Company currently believes the estimated fair value of its indemnification agreements is not material based on currently available information, and as such, the Company had no liabilities recorded for these agreements as of December 31, 2016. The Company's subsidiaries are party to a number of other proceedings that are not considered material at this time. (22) Discontinued Operations For all periods presented, financial results for discontinued operations relate to environmental investigation and remediation expenses for divested sites. For the years ended 2016, 2015, and 2014, the Company recorded $5,647 as losses, $41 as income, and $830 as losses, respectively, from discontinued operations, net of tax. As of December 31, 2016 and 2015, liabilities recorded on the Company’s balance sheet relating to discontinued operations were $16,703 and $8,209, respectively. At this time, we cannot reasonably estimate the period of time during which the involvement is expected to continue. Net cash used in discontinued operations was $516, $1,536, and $1,858 for 2016, 2015, and 2014, respectively. Refer to Note 21 to the Company’s consolidated financial statements for further disclosures on the Company’s environmental contingencies. The following table is a reconciliation of the pre-tax (loss)/income from discontinued operations to the net (loss)/income from discontinued operations, as presented on the income statement: (23) Subsequent Event On January 30, 2017, the Company transferred the assets and liabilities of Zenara to the buyer for consideration of $3,000. The sales agreement gives the buyer complete control of the daily operations of Zenara. The closing will be completed upon approval by Indian regulatory authorities which could take several months. CAMBREX CORPORATION AND SUBSIDIARIES SELECTED QUARTERLY FINANCIAL AND SUPPLEMENTARY DATA - UNAUDITED (in thousands, except per share data) (1) Income from continuing operations for the first, second, third, and fourth quarters includes $290 of expense, $154 of expense, a $47 benefit and $761 of expense, respectively, for restructuring related to the decision to sell our finished dosage form facility in Hyderabad, India. (2) Income from continuing operations in the fourth quarter includes restructuring expenses of $15,573 and a tax benefit of $1,464 related to the decision to sell our finished dosage form facility in Hyderabad, India. (3) Discontinued operations include charges and reimbursements for environmental remediation related to sites of divested businesses. (4) Earnings per share calculations for each of the quarters are based on the weighted average number of shares outstanding for each period. As such, the sum of the quarters may not necessarily equal the earnings per share amount for the year. Item 9 | Based on the provided financial statement excerpt, here's a summary:
Financial Statement Overview:
- Income Taxes: The company files a consolidated U.S. income tax return, with foreign subsidiaries taxed separately
- Foreign Earnings: The company plans to repatriate some foreign earnings and provides deferred taxes accordingly
- Credit Risk: Maintains cash balances with European Union banks up to $10,000
- Interest: Capitalizes interest for long-term asset construction ($575 capitalized)
- Assets: Fixed assets valued at $8,422
Key Financial Considerations:
- Manages tax liability across domestic and international subsidiaries
- Monitors credit risk and maintains financial flexibility
- Capitalizes interest for asset development
- Tracks potential credit losses from customer payment issues
The excerpt appears to be a partial financial statement with notes on taxation, credit risk, and asset management, providing insights into the company's financial strategies and accounting practices. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTS DATA. American Riding Tours, Inc. Financial Statements ACCOUNTING FIRM To the Board of Directors and Stockholders of American Riding Tours, Inc. Las Vegas, Nevada We have audited the balance sheet of American Riding Tours, Inc. (the Company) as of March 31, 2016, and the related statements of operations, stockholders’ deficit, and cash flows for the year ended March 31, 2016. American Riding Tours, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of, American Riding Tours, Inc. as of March 31, 2016, and the results of its operations and its cash flows for the year ended March 31, 2016, in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company has suffered losses from operations, which raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ RBSM LLP RBSM LLP Henderson, Nevada July 13, 2016 Seale & Beers, CPAs Certified Public Accountants PCAOB Registered Auditors - www.sealebeers.com ACCOUNTING FIRM To the Board of Directors and Stockholders of American Riding Tours, Inc. We have audited the accompanying balance sheets of American Riding Tours, Inc. as of March 31, 2015, and the related statements of income, stockholders’ equity (deficit), and cash flows for the period ended March 31, 2015. American Riding Tours, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of American Riding Tours, Inc. as of March 31, 2015, and the related statements of income, stockholders’ equity (deficit), and cash flows for the period ended March 31, 2015 in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company has no revenues, has negative working capital at March 31, 2015, has incurred recurring losses and recurring negative cash flow from operating activities, and has an accumulated deficit which raises substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Seale and Beers, CPAs Seale and Beers, CPAs Las Vegas, Nevada June 25, 2015 American Riding Tours, Inc. Balance Sheets (Audited) The accompanying notes are an integral part of these financial statements. American Riding Tours, Inc. Statements of Operations (Audited) The accompanying notes are an integral part of these financial statements. American Riding Tours, Inc. Statement of Stockholders’ Deficit (Audited) The accompanying notes are an integral part of these financial statements. American Riding Tours, Inc. Statements of Cash Flows (Audited) The accompanying notes are an integral part of these financial statements. American Riding Tours, Inc. Notes to Financial Statements March 31, 2016 (Audited) NOTE 1. General Organization and Business The Company was organized on February 27, 2013 (Date of Inception) under the laws of the State of Nevada, as American Riding Tours, Inc. The Company plans to offer motorcycle riding tours throughout the Southwestern United States. NOTE 2. Summary of Significant Accounting Policies Basis of Accounting The financial statements and accompanying notes are prepared under full accrual method of accounting in accordance with generally accepted accounting principles of the United States of America ("US GAAP"). Cash and Cash Equivalents For purposes of the statement of cash flows, the Company considers highly liquid financial instruments purchased with a maturity of three months or less to be cash equivalents. Earnings per Share The basic earnings (loss) per share is calculated by dividing the Company's net income (loss) available to common shareholders by the weighted average number of common shares issued and outstanding during the year. The diluted earnings (loss) per share is calculated by dividing the Company's net income (loss) available to common shareholders by the diluted weighted average number of shares outstanding during the year. The diluted weighted average number of shares outstanding is the basic weighted number of shares adjusted as of the first year for any potentially dilutive debt or equity. The Company has not issued any options or warrants or similar securities since inception. Revenue Recognition The Company applies the provision of FASB ASC 605, Revenue Recognition, which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. ASC 605 outlines the basic criteria that must be met to recognize revenue and provides guidance for the disclosure of revenue recognition policies. The Company recognizes revenue related to product sales when (i) persuasive evidence of the arrangement exists, (ii) shipment has occurred, (iii) the fee is fixed or determinable, and (iv) collectability is reasonably assured. For the period from February 27, 2013 (inception) to March 31, 2016, the Company not recognized any revenues. Dividends The Company has not yet adopted any policy regarding payment of dividends. No dividends have been paid during the period shown. Income Taxes The provision for income taxes is the total of the current taxes payable and the net of the change in the deferred income taxes. Provision is made for the deferred income taxes where differences exist between the period in which transactions affect current taxable income and the period in which they enter into the determination of net income in the financial statements. American Riding Tours, Inc. Notes to Financial Statements March 31, 2016 (Audited) Fixed Assets Furniture, fixtures and equipment are stated at cost less accumulated depreciation. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives, principally on a straight-line basis. Year-end The Company has selected March 31 as its year-end. Advertising Advertising is expensed when incurred. There have been no advertising costs incurred during the current period. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. NOTE 3 - Going Concern The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern. As shown in the accompanying financial statements, the Company has no history of operations, limited assets, and has incurred operating losses since inception. These factors, among others, raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability of assets and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to obtain additional operating capital, commence operations, provide competitive services, and ultimately to attain profitability. The Company intends to acquire additional operating capital through equity offerings. There is no assurance that the Company will be successful in raising additional funds. NOTE 4 - Stockholders' Equity and Contributed Capital Series A Convertible Preferred Stock The Company is authorized to issue 5,000,000 shares of $0.001 par value series A preferred stock, of which 200,000 shares were registered, issued and outstanding as of March 31, 2016. Series A Preferred Stock have no liquidation rights. Series A Preferred Stock shall not be entitled to receive any dividends nor are they entitled to any voting rights with respect to the Series A Preferred Stock. At any time and from time-to-time after the issuance of the Series A Preferred Stock, any holder may convert any or all of the registered shares of Series A Preferred Stock held by such holder at the ratio of one hundred (100) shares of Common Stock for every one (1) share of Series A Preferred Stock. However, the beneficial owner of such Series A Preferred Stock cannot not convert their Series A Preferred stock where they will beneficially own in excess of 4.9% of the shares of the Common Stock. American Riding Tours, Inc. Notes to Financial Statements March 31, 2016 (Audited) On March 29, 2013, the Company issued 200,000 shares of its series A preferred stock to shareholders in exchange for cash of $10,000. Each share of the Series A Convertible Preferred Stock can be exchanged for one hundred (100) shares of Common Stock of the corporation. This Series A preferred stock was issued with a beneficial conversion feature totaling $10,000. This non-cash expense related to the beneficial conversion features of those securities and is recorded with a corresponding credit to paid-in-capital. If the issued and outstanding preferred stock were to be converted into common stock, and each beneficial owner held less than 4.9% of the stock, the common stock would be increased by 20,000,000 shares. On November 4, 2015, a shareholder of Series A Preferred Stock converted 990 preferred shares to 99,000 shares of Common Stock. On December 7, 2015, a shareholder of Series A Preferred Stock converted 750 preferred shares to 75,000 shares of Common Stock. On February 15, 2016, a shareholder of Series A Preferred Stock converted 600 preferred shares to 60,000 shares of Common Stock. Series B Preferred Stock The Company is authorized to issue 5,000,000 shares of $0.001 par value Series B voting preferred stock, of which no shares are issued and outstanding. The Series B voting preferred stock is not entitled to receive any dividends and has no liquidation rights, however may vote each share at a weight of ten votes of common stock. Series C Preferred Stock The Company is authorized to issue 5,000,000 shares of $0.001 par value Series C preferred stock, of which no shares are issued and outstanding. The designation of these shares has yet to be determined by the Board of Directors. Common Stock The Company is authorized to issue 185,000,000 shares of its $0.001 par value common stock, of which 3,800,000 shares are issued and outstanding. On February 27, 2013, the Company issued 3,000,000 shares of its Common Stock to a founder for cash of $3,000. On March 26, 2014, the Company issued 300,000 shares of its Common Stock to approximately 31 shareholders for cash of $3,000. American Riding Tours, Inc. Notes to Financial Statements March 31, 2016 (Audited) On February 4, 2016, the Company underwent a change of control of ownership. VERSAI Inc. returned the 3,000,000 control shares to the Company’s then sole officer and director that it had previously purchased on September 24, 2015 in order that the company may continue as a going concern. In consideration for the return of the 3,000,000 common shares, the Company issued 500,000 restricted common shares to the lending group who provided to VERSAI, Inc. the cash consideration to purchase the 3,000,000 control shares on September 24, 2015. On November 4, 2015, a shareholder of Series A Preferred Stock converted 990 preferred shares to 99,000 shares of Common Stock. On December 7, 2015, a shareholder of Series A Preferred Stock converted 750 preferred shares to 75,000 shares of Common Stock. On February 15, 2016, a shareholder of Series A Preferred Stock converted 600 preferred shares to 60,000 shares of Common Stock. As of March 31, 2016, there have been no stock options or warrants granted. NOTE 5. Related Party Transactions The Company does not lease or rent any property. Office services are provided without charge by a director. Such costs are immaterial to the financial statements and, accordingly, have not been reflected therein. The officers and directors of the Company are involved in other business activities and may, in the future, become involved in other business opportunities. If a specific business opportunity becomes available, such persons may face a conflict in selecting between the Company and their other business interests. The Company has not formulated a policy for the resolution of such conflicts. On February 27, 2013, the Company issued 3,000,000 shares of its Common Stock to a founder for cash of $3,000. On April 22, 2013 an officer loaned the Company $500 for audit fees. On June 27, 2014 an officer loaned the Company an additional $1,993 for audit fees. On October 23, 2014 an officer loaned the Company an additional $6,000 for audit fees. On July 1, 2015 an officer loaned the Company an additional $5,250 for audit fees. On March 9, 2016 an officer loaned the Company an additional $6,000 for audit fees. As of March 31, 2016, $19,743 of this loan remained due. The loan bears no interest and is due upon demand. NOTE 6. Provision for Income Taxes The Company accounts for income taxes under FASB Accounting Standard Codification ASC 740 "Income Taxes". ASC 740 requires use of the liability method. ASC 740 provides that deferred tax assets and liabilities are recorded based on the differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as temporary differences. Deferred tax assets and liabilities at the end of each period are determined using the currently enacted tax rates applied to taxable income in the periods in which the deferred tax assets and liabilities are expected to be settled or realized. As of March 31, 2016, the Company had net operating loss carry forwards of $48,218 that may be available to reduce future years' taxable income through 2016. Future tax benefits which may arise as a result of these losses have not been recognized in these financial statements, as their realization is determined not likely to occur and accordingly, the Company has recorded a valuation allowance for the deferred tax asset relating to these tax loss carry-forwards. Net operating losses will begin to expire in 2035. American Riding Tours, Inc. Notes to Financial Statements March 31, 2016 (Audited) Components of net deferred tax assets, including a valuation allowance, are as follows at March 31, 2016 and March 31, 2015: The valuation allowance for deferred tax assets as of March 31, 2016 was $4,191, as compared to $2,888 for the previous year. In assessing the recovery of the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in the periods in which those temporary differences become deductible. Management considers the scheduled reversals of future deferred tax assets, projected future taxable income, and tax planning strategies in making this assessment. As a result, management determined it was more likely than not the deferred tax assets would not be realized as of March 31, 2016. The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes. The sources and tax effects of the differences are as follows: At March 31, 2016, the Company had an unused net operating loss carryover approximating $48,218 that is available to offset future taxable income, which expires beginning 2035. NOTE 7. Operating Leases and Other Commitments The Company has no lease. NOTE 8. Earnings per Share Historical net (loss) per common share is computed using the weighted average number of common shares outstanding. Diluted earnings per share include additional dilution from common stock equivalents, such as stock issuable pursuant to the exercise of securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that shared in the earnings of the entity, but these potential common stock equivalents were determined to be antidilutive. American Riding Tours, Inc. Notes to Financial Statements March 31, 2016 (Audited) Calculation of net income (loss) per share is as follows: NOTE 9. Recent Accounting Pronouncements With the exception of those discussed below, there have not been any recent changes in accounting pronouncements and Accounting Standards Update (ASU) issued by the Financial Accounting Standards Board (FASB) during the year ended March 31, 2016 that are of significance or potential significance to the Company. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU No. 2014-09”). ASU No. 2014-09 supersedes the previous revenue recognition requirements, along with most existing industry-specific guidance. The guidance requires an entity to review contracts in five steps: 1) identify the contract, 2) identify performance obligations, 3) determine the transaction price, 4) allocate the transaction price, and 5) recognize revenue. The new standard will result in enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenue arising from contracts with customers. In August 2015, the FASB issued guidance approving a one-year deferral, making the standard effective for reporting periods beginning after December 15, 2017, with early adoption permitted only for reporting periods beginning after December 15, 2016. In March 2016, the FASB issued guidance to clarify the implementation guidance on principal versus agent considerations for reporting revenue gross rather than net, with the same deferred effective date. In April 2016, the FASB issued guidance to clarify the identification of performance obligations and licensing arrangements. The Company has not determined the impact of adopting ASU No. 2014-09 on our financial statements and currently plan to complete our evaluation by late 2017. In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements, Going Concern (Subtopic 205-40) which requires management to evaluate on a regular basis whether any conditions or events have arisen that could raise substantial doubt about the entity's ability to continue as a going concern. The guidance 1) provides a definition for the term “substantial doubt,” 2) requires an evaluation every reporting period, interim periods included, 3) provides principles for considering the mitigating effect of management's plans to alleviate the substantial doubt, 4) requires certain disclosures if the substantial doubt is alleviated as a result of management's plans, 5) requires an express statement, as well as other disclosures, if the substantial doubt is not alleviated, and 6) requires an assessment period of one year from the date the financial statements are issued. The standard is effective for the annual reporting period beginning after December 31, 2016. Early adoption is permitted. The Company is currently evaluating the impact, if any, that this new accounting pronouncement will have on its financial statements. American Riding Tours, Inc. Notes to Financial Statements March 31, 2016 (Audited) In November 2015, the FASB issued ASU No. 2015-17, Income Taxes, or ASU No. 2015-17. To simplify the presentation of deferred income taxes, the amendments in this update require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this Update apply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this Update. The amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Earlier application is permitted. The amendments in this Update may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company is currently evaluating the impact of adopting ASU No. 2015-17 on its financial statements. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Topic 842 affects any entity that enters into a lease, with some specified scope exemptions. The guidance in this Update supersedes Topic 840, Leases. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For public companies, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of adopting ASU No. 2016-02 on its financial statements. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) that clarifies how to apply revenue recognition guidance related to whether an entity is a principal or an agent. ASU 2016-08 clarifies that the analysis must focus on whether the entity has control of the goods or services before they are transferred to the customer and provides additional guidance about how to apply the control principle when services are provided and when goods or services are combined with other goods or services. The effective date for ASU 2016-08 is the same as the effective date of ASU 2014-09 as amended by ASU 2015-14, for annual reporting periods beginning after December 15, 2017, including interim periods within those years. The Company has not yet determined the impact of ASU 2016-08 on its financial statements. In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation, or ASU No. 2016-09. The areas for simplification in this Update involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For public entities, the amendments in this Update are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted in any interim or annual period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. Amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements, forfeitures, and intrinsic value should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Amendments related to the presentation of employee taxes paid on the statement of cash flows when an employer withholds shares to meet the minimum statutory withholding requirement should be applied retrospectively. Amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement and the practical expedient for estimating expected term should be applied prospectively. An entity may elect to apply the amendments related to the presentation of excess tax benefits on the statement of cash flows using either a prospective transition method or a retrospective transition method. The Company is currently evaluating the impact of adopting ASU No. 2016-09 on its financial statements. American Riding Tours, Inc. Notes to Financial Statements March 31, 2016 (Audited) In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which provides further guidance on identifying performance obligations and improves the operability and understandability of licensing implementation guidance. The effective date for ASU 2016-10 is the same as the effective date of ASU 2014-09 as amended by ASU 2015-14, for annual reporting periods beginning after December 15, 2017, including interim periods within those years. The Company has not yet determined the impact of ASU 2016-10 on its financial statements. NOTE 10. Legal Proceedings The Company is not currently involved in any legal proceedings at this time. NOTE 11. Subsequent Events On April 12, 2016, a shareholder of Series A Preferred Stock converted 1,000 preferred shares to 100,000 shares of Common Stock. On May 3, 2016, a shareholder of Series A Preferred Stock converted 1,800 preferred shares to 180,000 shares of Common Stock. On May 5, 2016, a shareholder of Series A Preferred Stock converted 1,600 preferred shares to 160,000 shares of Common Stock. On May 19, 2016, a shareholder of Series A Preferred Stock converted 1,850 preferred shares to 185,000 shares of Common Stock. On May 20, 2016, a shareholder of Series A Preferred Stock converted 500 preferred shares to 50,000 shares of Common Stock. On May 25, 2016, a shareholder of Series A Preferred Stock converted 2,200 preferred shares to 220,000 shares of Common Stock. On June 7, 2016, Edward Zimmerman resigned as the President, Chief Executive Officer and Chairman of the Company’s board of directors. Mr. Zimmerman remains as a member of the Board and agreed to serve as the Company’s Chief Financial Officer on a going-forward basis. Concurrently, the Board appointed Kevin Gillespie as the Company’s President, Chief Executive Officer, a member of the Board and the Chairman of the Board. | Here's a summary of the financial statement:
The financial statement indicates:
1. Operational Challenges:
- The company is experiencing losses from operations
- These losses raise substantial doubt about the company's ability to continue functioning
2. Financial Reporting Approach:
- Uses estimates for liabilities, assets, revenues, and expenses
- Acknowledges potential differences between estimated and actual results
3. Asset Management:
- Fixed assets (furniture, fixtures, equipment) are recorded at cost
- Depreciation calculated using straight-line method
- Fiscal year-end is March 31
4. Liabilities and Securities:
- No options, warrants, or similar securities have been issued since the company's inception
- Following specific accounting standards for revenue recognition (FASB ASC 605)
The statement suggests the company is facing financial difficulties and is carefully managing its assets and reporting practices. | Claude |
Item 8 - ACCOUNTING FIRM To the Board of Directors and Stockholders The L.S. Starrett Company We have audited the accompanying consolidated balance sheets of The L.S. Starrett Company (a Massachusetts corporation) and subsidiaries (the “Company”) as of June 30, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended June 30, 2016. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15 (2) of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The L.S. Starrett Company and subsidiaries as of June 30, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of June 30, 2016, based on criteria established in the 2013 Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated August 24, 2016 expressed an unqualified opinion. /s/ Grant Thornton LLP Boston, Massachusetts August 24, 2016 THE L.S. STARRETT COMPANY Consolidated Balance Sheets (in thousands except share data) See notes to consolidated financial statements THE L.S. STARRETT COMPANY Consolidated Statements of Operations (in thousands except per share data) See notes to consolidated financial statements THE L. S. STARRETT COMPANY Consolidated Statements of Comprehensive Income (Loss) (in thousands) See notes to consolidated financial statements THE L.S. STARRETT COMPANY Consolidated Statements of Stockholders’ Equity (in thousands except per share data) See notes to consolidated financial statements THE L. S. STARRETT COMPANY Consolidated Statements of Cash Flows (in thousands) See notes to consolidated financial statements THE L.S. STARRETT COMPANY June 30, 2016 and 2015 1. DESCRIPTION OF BUSINESS The L. S. Starrett Company (the “Company”) is incorporated in the Commonwealth of Massachusetts and is in the business of manufacturing industrial, professional and consumer measuring and cutting tools and related products. The Company’s manufacturing operations are primarily in North America, Brazil, China and the United Kingdom. The largest consumer of these products is the metalworking industry, but others include automotive, aviation, marine, farm, do-it-yourselfers and tradesmen such as builders, carpenters, plumbers and electricians. 2. SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation: The consolidated financial statements include the accounts of The L. S. Starrett Company and its subsidiaries, all of which are wholly-owned. All significant intercompany items have been eliminated in consolidation. Financial instruments and derivatives: The Company’s financial instruments include cash, investments and debt and are valued using level 1 inputs. Investments are stated at cost which approximates fair market value. The carrying value of debt, which is at current market interest rates, also approximates its fair value. The Company’s U.K. subsidiary utilizes forward exchange contracts to reduce currency risk. The fair value of contracts outstanding as of June 30, 2016 and June 30, 2015 amounted to $0.9 million and $1.3 million, respectively. Accounts receivable: Accounts receivable consist of trade receivables from customers. The expense for bad debts amounted to $0.3, $0.2, and $0.0 million in fiscal 2016, 2015 and 2014, respectively. In establishing the allowance for doubtful accounts, management considers historical losses, the aging of receivables and existing economic conditions. Inventories: Inventories are stated at the lower of cost or market. Substantially all United States inventories are valued using the last-in-first-out (“LIFO”) method. All non-U.S. subsidiaries use the first-in-first-out (“FIFO”) method or the average cost method. LIFO is not a permissible method of inventory costing for tax purposes outside the U.S. Property Plant and Equipment: The cost of buildings and equipment is depreciated using straight-line and accelerated methods over their estimated useful lives as follows: buildings and building improvements 10 to 50 years, machinery and equipment 3 to 12 years. Leases are capitalized under the criteria set forth in Accounting Standards Codification (ASC) 840, “Leases” which establishes the four criteria of a capital lease. At least one of the four following criteria must be met for a lease to be considered a capital lease: a transfer of ownership of the property to the lessee by the end of the lease term; a bargain purchase option; a lease term that is greater than or equal to 75 percent of the economic life of the leased property; present value of the future minimum lease payments equals or exceeds 90 percent of the fair market value of the leased property. If none of the aforementioned criteria are met, the lease will be treated as an operating lease. Property plant and equipment to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. A gain or loss is recorded on individual fixed assets when retired or disposed of. Included in buildings and building improvements and machinery and equipment at June 30, 2016 and June 30, 2015 were $2.9 million and $1.3 million, respectively, of construction in progress. Repairs and maintenance of equipment are expensed as incurred. A decision to reduce saw manufacturing capacity arose in fiscal 2016 which required management to perform an impairment analysis. Consequently, the Company recorded an impairment loss of $4,114,000, which represents the excess of the carrying value of the building over its fair value. See also Impairment of Assets (Note 9 to the Consolidated Financial Statements.) Intangible assets: Identifiable intangibles are recorded at cost and are amortized on a straight-line basis over a 5-15 year period. The estimated useful lives of the intangible assets subject to amortization are: 15 years for patents, 14 years for trademarks and trade names, 10 years for completed technology, 8 years for non-compete agreements, 8 years for customer relationships and 5 years for software development. The Company tests identifiable intangible assets for impairment whenever events or circumstances indicate they may be impaired. Goodwill: Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses. Goodwill is not subject to amortization but is tested for impairment annually and at any time when events suggest impairment may have occurred. The Company annually tests the goodwill associated with the November 2011 acquisition of Bytewise in October. As of October 1, 2015, the Company performed an analysis of qualitative factors to determine whether it is more likely than not that the fair value of the Bytewise business is less than its carrying amount as a basis for determining whether it is necessary to perform a two-step goodwill impairment test. Based on the Company's analysis of qualitative factors, the Company determined that it was not necessary to perform a two-step goodwill impairment test. Revenue recognition: Sales of merchandise and freight billed to customers are recognized when title and risk of loss has passed to the customer, no significant post-delivery obligations remain and collection of the resulting receivable is reasonably assured. Sales are presented net of provisions for cash discounts, returns, customer discounts (such as volume or trade discounts),and other sales related discounts. Cooperative advertising payments made to customers are included in selling, general and administrative expenses in the Consolidated Statements of Operations. While the Company does allow its customers the right to return in certain circumstances, revenue is not deferred, but rather a reserve for sales returns is provided based on experience, which historically has not been significant. Advertising costs: The Company’s policy is to generally expense advertising costs as incurred, except catalogs costs, which are deferred until mailed. Advertising costs were expensed as follows: $5.0 million in fiscal 2016, $5.7 million in fiscal 2015 and $5.5 million in fiscal 2014 and are included in selling, general and administrative expenses. Freight costs: The cost of outbound freight and the cost for inbound freight included in material purchase costs are both included in cost of sales. Warranty expense: The Company’s warranty obligation is generally one year from shipment to the end user and is affected by product failure rates, material usage, and service delivery costs incurred in correcting a product failure. Historically, the Company has not incurred significant warranty expense and consequently its warranty reserves are not material. Pension and Other Postretirement Benefits: The Company has two defined benefit pension plans, one for U.S. employees and another for U.K. employees. The Company also has defined contribution plans. The Company amended its Postretirement Medical Plan effective December 31, 2013, whereby the Company terminated eligibility for employees under the age of 65. The Company sponsors funded U.S. and non-U.S. defined benefit pension plans covering the majority of our U.S. and U.K. employees. The Company also sponsors an unfunded postretirement benefit plan that provides health care benefits and life insurance coverage to eligible U.S. retirees. Under the Company’s current accounting method, both pension plans use fair value as the market-related value of plan assets and continue to recognize actuarial gains or losses within the corridor in other comprehensive income (loss) but instead of amortizing net actuarial gains or losses in excess of the corridor in future periods, such excess gains and losses, if any, are recognized in net periodic benefit cost as of the plan measurement date, which is the same as the fiscal year end of the Company (MTM adjustment). This method is a permitted option which results in immediate recognition of excess net actuarial gains and losses in net periodic benefit cost instead of in other comprehensive income (loss). Such immediate recognition in net periodic benefit cost increases the volatility of net periodic benefit cost. The MTM adjustments to net periodic benefit cost for 2016, 2015 and 2014 were $17.8 million, $1.3 million, and $0.4 million, respectively. Income taxes: Deferred tax expense results from differences in the timing of certain transactions for financial reporting and tax purposes. Deferred taxes have not been recorded on approximately $67 million of undistributed earnings of foreign subsidiaries as of June 30, 2016 and the related unrealized translation adjustments because such amounts are considered permanently invested. In addition, it is possible that remittance taxes, if any, would be reduced by U.S. foreign tax credits to the extent available. Valuation allowances are recognized if, based on the available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. Research and development: Research and development costs are expensed, primarily in selling, general and administrative expenses, and were as follows: $1.8 million in fiscal 2016, $1.7 million in fiscal 2015, and $1.4 million in fiscal 2014 and are included in selling general and administrative expenses in the Consolidated Statements of Operations. Earnings per share (EPS): Basic EPS is computed by dividing earnings (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution by securities that could share in the earnings. The Company had 32,833, 40,214, and 29,951, of potentially dilutive common shares in fiscal 2016, 2015 and 2014, respectively, resulting from shares issuable under its stock option plans. These additional shares are not used in the diluted EPS calculation in loss years. Translation of foreign currencies: The financial statements of our foreign subsidiaries, where the local currency is the functional currency, are translated at exchange rates in effect on reporting dates, and income and expense items are translated at average rates or rates in effect on transaction dates as appropriate. The resulting foreign currency translation adjustments are charged or credited directly to the other comprehensive income (loss) as noted in the Consolidated Statements of Comprehensive Income (Loss). Net foreign currency gains (losses) are disclosed in Note 10. Use of accounting estimates: The preparation of the financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Judgments, assumptions and estimates are used for, but not limited to: the allowances for doubtful accounts receivable and returned goods; inventory allowances; income tax valuation allowances, uncertain tax positions and pension obligations. Amounts ultimately realized could differ from those estimates. Recent Accounting Pronouncements: In May 2014, the FASB issued a new standard related to the “Revenue from Contracts with Customers” which amends the existing accounting standards for revenue recognition. The standard requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. This standard is applicable for fiscal years beginning after December 15, 2017 and for interim periods within those years. Earlier application will be permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company expects to adopt this standard on July 1, 2017. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements. In November 2015, the FASB issued Accounting Standards Update No. 2015-17 ("ASU 2015-17") regarding ASC Topic 470 "Income Taxes: Balance Sheet Classification of Deferred Taxes." The amendments in ASU 2015-17 eliminate the requirement to bifurcate Deferred Taxes between current and non-current on the balance sheet and requires that all deferred tax liabilities and assets be classified as noncurrent on the balance sheet. The amendments for ASU-2015-17 can be applied retrospectively or prospectively and early adoption is permitted. The Company plans to adopt the new guidance prospectively in the first quarter of fiscal 2017. Implementation will have no effect on the Consolidated Statement of Operations but is expected to result in a change in classification for $4.5 million of tax assets from short-term to long-term. In July 2015, the FASB issued ASU No. 2015-11, "Inventory (Topic 330): Simplifying the Measurement of Inventory." Previous to the issuance of this ASU, ASC 330 required that an entity measure inventory at the lower of cost or market. ASU 2015-11 specifies that “market” is defined as “net realizable value,” or the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This ASU is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. Application is to be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The adoption of ASU No. 2015-11 will not have a material impact on our consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”. The ASU requires that organizations that lease assets recognize assets and liabilities on the balance sheet for the rights and obligations created by those leases. The ASU will affect the presentation of lease related expenses on the income statement and statement of cash flows and will increase the required disclosures related to leases. This ASU is effective for annual periods ending after December 15, 2018, and interim periods thereafter, with early adoption permitted. The Company is currently evaluating the impact of ASU No. 2016-02 on its consolidated financial statements. It is expected that a key change upon adoption will be the balance sheet recognition of leased assets and liabilities and that any changes in income statement recognition will not be material. In March 2016, the FASB issued ASU No. 2016-09, "Compensation - Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting." The ASU affects the accounting for employee share-based payment transactions as it relates to accounting for income taxes, accounting for forfeitures, and statutory tax withholding requirements. This ASU is effective for annual periods ending after December 15, 2016, and interim periods within those periods with early adoption permitted. The Company is currently evaluating the impact of ASU No. 2016-09 on its consolidated financial statements. 3. INVESTMENT In fiscal 2010, the Company entered into an agreement with a private software development company to invest $1.5 million in exchange for a 36% equity interest therein. The Company recorded other income of $0.1 million in fiscal 2016, $0.2 million in fiscal 2015 and $0.3 million in fiscal 2014 based on the earnings of this entity as allocated under the equity method of accounting. The net carrying value of the investment included in other long-term assets in the Consolidated Balance Sheet as of June 30, 2016 and June 30, 2015 is $2.2 million and $2.1 million, respectively. In August 2011, the Company guaranteed a loan of $0.5 million. The guarantee remains outstanding, between the private software development company and Starrett. There was no amount outstanding under the loan as of June 30, 2016. 4. STOCK-BASED COMPENSATION Long-Term Incentive Plan During the quarter ended December 31, 2012, the Company implemented The L.S. Starrett Company 2012 Long-Term Incentive Plan (the “2012 Stock Incentive Plan”), which was adopted by the Board of Directors September 5, 2012 and approved by shareholders October 17, 2012. The 2012 Stock Incentive Plan permits the granting of the following types of awards to officers, other employees and non-employee directors: stock options; restricted stock awards; unrestricted stock awards; stock appreciation rights; stock units including restricted stock units; performance awards; cash-based awards; and awards other than previously described that are convertible or otherwise based on stock. The 2012 Stock Incentive Plan provides for the issuance of up to 500,000 shares of common stock. Options granted vest in periods ranging from one year to three years and expire ten years after the grant date. Restricted stock units (“RSU”) granted generally vest from one year to three years. Vested restricted stock units will be settled in shares of common stock. As of June 30, 2016, there were 20,000 stock options and 73,367 restricted stock units outstanding. In addition, there were 391,600 shares available for grant under the 2012 Stock Incentive Plan as of June 30, 2016. For the stock option grants, the fair value of each grant is estimated at the date of grant using the Binomial Options pricing model. The Binomial Options pricing model utilizes assumptions related to stock volatility, the risk-free interest rate, the dividend yield and employee exercise behavior. Expected volatilities utilized in the model are based on the historic volatility of the Company’s stock price. The risk free interest rate is derived from the U.S. Treasury yield curve in effect at the time of the grant. The expected life is determined using the average of the vesting period and contractual term of the options (simplified method). There were no stock options granted during fiscal years 2016, 2015 or 2014. The weighted average contractual term for stock options outstanding as of June 30, 2016 was 6.5 years. The aggregate intrinsic value of stock options outstanding as of June 30, 2016 was less than $0.1 million. There were 20,000 options exercisable as of June 30, 2016. In recognizing stock compensation expense for the 2012 Stock Incentive Plan management has estimated that there will be no forfeitures of options. The Company accounts for RSU awards by recognizing the expense of the intrinsic value at the award date ratably over vesting periods generally ranging from one year to three years. The related expense is included in selling, general and administrative expenses. During the year ended June 30, 2016, the Company granted 40,200 RSU awards with fair values of $15.11 per RSU award. During the year ended June 30, 2015, the Company granted 39,500 RSU awards with fair values of $17.49 per RSU award. There were no RSU awards during the year ended June 30, 2014. There were 9,067 and 2,733 RSU awards settled in fiscal years 2016 and 2015 respectively. The aggregate intrinsic value of RSU awards outstanding as of June 30, 2016 was $0.9 million. The aggregate intrinsic value of RSU awards outstanding as of June 30, 2015 was $0.8 million. Compensation expense related to the 2012 Stock Incentive Plan was $214,000, $146,000 and $54,000 for fiscal 2016, 2015 and 2014 respectively. As of June 30, 2016 there was $1.0 million of total unrecognized compensation costs related to outstanding stock-based compensation arrangements. Of this cost $0.7 million relates to performance based RSU grants that are not expected to be awarded. The remaining $0.3 million is expected to be recognized over a weighted average period of 1.5 years. Employee Stock Purchase Plan The Company’s Employee Stock Purchase Plans (ESPP) give eligible employees an opportunity to participate in the success of the Company. The Board of Directors renews each Employee Stock Purchase Plan every five years. Under these plans the purchase price of the optioned stock is 85% of the lower of the market price on the date the option is granted or the date it is exercised. Options become exercisable exactly two years from the date of grant and expire if not exercised on such date. No options were exercisable at fiscal year ends. The Board of Directors last approved an ESPP renewal in 2012 and authorized 500,000 shares available for grant. A summary of option activity is as follows: The following information relates to outstanding options as of June 30, 2016: The fair value of each option grant was estimated on the date of grant based on the Black-Scholes option pricing model with the following weighted average assumptions: expected volatility - 40.06% - 42.03%, interest - 0.75% - 0.77%, and expected lives - 2 years. Compensation expense of $143,065, $139,006 and $138,677 has been recorded for fiscal 2016, 2015 and 2014, respectively. Employee Stock Ownership Plan On February 5, 2013, the Board of Directors adopted The L.S. Starrett Company 2013 Employee Stock Ownership Plan (the “2013 ESOP”). The purpose of the plan is to supplement existing Company programs through an employer funded individual account plan dedicated to investment in common stock of the Company, thereby encouraging increased ownership of the Company while providing an additional source of retirement income. The plan is intended as an employee stock ownership plan within the meaning of Section 4975 (e) (7) of the Internal Revenue Code of 1986, as amended. U.S. employees who have completed a year of service as of December 31, 2012 are eligible to participate. There was no compensation expense for the 2013 ESOP in 2014, 2015 or 2016. Shares of Class B common stock were contributed to the 2013 ESOP on July 30, 2013 in order to fund the 2013 liability. 5. CASH AND SHORT-TERM INVESTMENTS Cash and investments held by foreign subsidiaries amounted to $10.2 million and $12.0 million at June 30, 2016 and June 30, 2015, respectively. Of the June 30, 2016 balance, $6.7 million in U.S. dollar equivalents was held in British Pounds Sterling and $1.6 million in U.S. dollar equivalents was held in Brazilian Reals. The Company plans to permanently reinvest cash held in foreign subsidiaries. Cash held in foreign subsidiaries is not available for use in the U.S. without the likely incurrence of U.S. federal and state income tax consequences. As of June 30, 2015, the Company’s U.K. subsidiary held a $7.9 million 12 month fixed term deposit with a financial institution. 6. INVENTORIES Inventories consist of the following (in thousands): LIFO inventories were $10.5 million and $14.6 million at June 30, 2016 and June 30, 2015, respectively, such amounts being approximately $28.8 million and $28.0 million, respectively, less than if determined on a FIFO basis. The use of LIFO compared to FIFO on an annual basis resulted in a $0.8 million increase in cost of goods sold in fiscal 2016 compared to an increase in cost of goods sold of $0.7 million in fiscal 2015. 7. GOODWILL AND INTANGIBLES The following tables present information about the Company’s goodwill and identifiable intangible assets on the dates indicated (in thousands): Identifiable intangible assets consist of the following (in thousands): Identifiable intangible assets are being amortized on a straight-line basis over the period of expected economic benefit. The estimated aggregate amortization expense for each of the next five years, and thereafter, is as follows (in thousands): The Company performed a qualitative analysis in accordance with ASU 2011-08 of its Bytewise reporting unit for its October 1, 2015 annual assessment of goodwill (commonly referred to as “Step Zero”). From a qualitative perspective, in evaluating whether it is more likely than not that the fair value of the reporting units is not less than its carrying amount, relevant events and circumstances were taken into account, with greater weight assigned to events and circumstances that most affect the fair value of Bytewise or the carrying amounts of its assets. Items that were considered included, but were not limited to, the following: macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, changes in management or key personnel, and other Bytewise specific events. After assessing these and other factors the Company determined that it was more likely than not that the fair value of the Bytewise reporting unit was not less than the carrying amount as of October 1, 2015. There were no triggering events identified from the annual assessment date through the fiscal year-end. 8. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of the following as of June 30, 2016 and 2015 (in thousands): No assets under capital leases are included in machinery and equipment as of June 30, 2016 or June 30, 2015. Operating lease expense was $2.3 million, $2.2 million and $1.9 million in fiscal 2016, 2015 and 2014, respectively. Future commitments under operating leases are as follows (in thousands): 9. IMPAIRMENT OF ASSETS In fiscal 2016, the Company adopted a plan to transfer the production of certain saw products from its facility in Mt. Airy, North Carolina to its facility in Itú, Brazil. The Company expects the transfer will be completed in fiscal 2017. Because the transfer will leave one of the buildings at the Mt. Airy facility vacant, the Company determined that the carrying value of the building exceeds its fair value. Consequently, the Company recorded an impairment loss of $4,114,000, which represents the excess of the carrying value of the building over its fair value. The impairment loss is recorded as a separate line item (‘‘Impairment of assets’’) in the Consolidated Statement of Operations for fiscal 2016. 10. OTHER INCOME AND EXPENSE Other income and expense consists of the following (in thousands): The gain on resolution of contingency represents damages awarded in a Brazilian lawsuit which the Company had filed as plaintiff in 2003. 11. INCOME TAXES Components of earnings (loss) before income taxes are as follows (in thousands): The provision for income taxes consists of the following (in thousands): Reconciliations of expected tax expense at the U.S. statutory rate to actual tax expense (benefit) are as follows (in thousands): Significant changes in tax expense reconciliation in the year ended June 30, 2016 relate primarily to losses in both domestic and foreign entities. Substantial benefit is reflected for US federal and state income taxes primarily as a result of increases in deferred tax assets related to pension expense and the write-down of fixed assets. In fiscal 2016, several of the subsidiaries in foreign countries reported financial losses. In these cases, no tax benefit from those losses was recognized and an additional valuation allowance was taken to reduce any deferred tax assets since future income is not more likely than not to be recognized. The tax rate in fiscal 2015 was higher than in the previous year both because the losses that were not able to be benefitted for tax purposes were significantly higher and because the Company received no benefit from the lower statutory tax rate in those countries. There was a dividend of $2.3 million paid from the Company’s subsidiary in Brazil to the U.S. parent company out of the subsidiary’s fiscal 2015 earnings. While the dividend is fully taxable in the U.S., the impact to tax expense was negligible due to the use of foreign tax credits. In fiscal 2014, the tax authorities in China reviewed the intercompany transfer pricing of a Chinese subsidiary and made adjustments to the prices for tax purposes to the calendar years 2010 through 2012. The net result was a substantial reduction in the Company’s carryforward tax losses and a small payment of tax and penalties; the net effect was to increase tax expense by $0.2 million which is included in the tax reserve adjustments. Since the Company had a history of tax losses, there was a full valuation allowance reflected against the tax impact of the loss carryforward at June 30, 2013. The entity also had substantial profits in fiscal 2014. As a result, the full amount of its carryforward tax losses, after audit adjustments, were utilized and the valuation allowance reducing the deferred tax assets for those losses and other temporary differences was released. The effect was a reduction in the valuation allowance of $0.4 million in fiscal 2014. The Company recorded a $0.3 million deferred income tax expense in the year ended June 30, 2014 to reflect the impact of a corporate tax rate reduction in the United Kingdom. The tax rate reduction from 23 percent to 20 percent received royal assent during fiscal 2014 and the impact of that reduction on our deferred tax assets was recorded in the first quarter of that year. Total deferred tax assets net of deferred tax liabilities at June 30, 2016 are $29.6 million. While these deferred tax assets reflect the tax effect of temporary differences between book and taxable income in all jurisdictions in which the Company has operations, the majority of the assets relate to operations in the U.S. where the Company had book losses in the current year. The Company has considered the positive and negative evidence to determine the need for a valuation allowance offsetting the deferred tax assets in the U.S. and has concluded that it is more likely than not that the deferred tax assets net of the recorded valuation allowance will be realized. Key positive evidence considered include: a) Significant domestic book profits in 2014 and 2015; b) losses in fiscal 2016 are primarily due to one-time events including a $19 million pension expense, most of which is not deductible for tax purposes until paid; c) cost saving plans are being implemented by the Company; d) prior year taxable income is available for carryback losses; e) tax planning opportunities, including an election to revoke the LIFO election; and f) forecasted domestic profits for future years. The negative evidence considered is that fiscal 2016 showed domestic book and tax losses. A valuation allowance has been provided on certain foreign NOLs due to the uncertainty of generating future taxable income in those jurisdictions. Similarly, a valuation allowance has been provided on certain U.S. state NOLs as a result of their much shorter carryforward periods and the uncertainty of generating adequate taxable income at the entity and state level. In addition, a valuation allowance has been provided for foreign tax credit carryforwards due to the uncertainty of generating sufficient foreign source income in the future. In fiscal 2016, the valuation allowance increased by $0.7 million primarily due to the increase for foreign losses. In fiscal 2015, the valuation allowance increased by $1.2 million - $0.7 million due to the increase in foreign carryforward losses and $0.5 million due to the increase in foreign tax credits in excess of the foreign source income limitation in fiscal 2015. Deferred income taxes at June 30, 2016 and 2015 are attributable to the following (in thousands): Foreign operations deferred tax assets relate primarily to inventory (current) and pension benefits (long term). Amounts related to foreign operations included in the long-term portion of deferred tax liabilities relate to depreciation. The Company is subject to U.S. federal income tax and various state, local and foreign income taxes in numerous jurisdictions. The Company’s domestic and international tax liabilities are subject to the allocation of revenues and expenses in different jurisdictions and the timing of recognizing revenues and expenses. Additionally, the amount of income taxes paid is subject to the Company’s interpretation of applicable tax laws in the jurisdictions in which it files. Reconciliations of the beginning and ending amount of unrecognized tax benefits are as follows (in thousands): The long-term tax obligations as of June 30, 2016 and 2015 relate primarily to transfer pricing adjustments. The Company has also recorded a non-current tax receivable for $2.7 million and $3.4 million at June 30, 2016 and 2015, respectively, representing the corollary effect of transfer pricing competent authority adjustments. The Company has identified no new uncertain tax positions at June 30, 2016 for which it is currently likely that the total amount of unrecognized tax benefits will significantly increase or decrease within the next twelve months. The Company recognizes interest and penalties related to income tax matters in income tax expense and has booked an increase of $0.1 million in fiscal 2016 for interest expense. The Company’s U.S. federal tax returns for years prior to fiscal 2013 are no longer subject to U.S. federal examination by the Internal Revenue Service; however, tax losses carried forward from earlier years are still subject to review and adjustment. In fiscal 2014, the tax authorities in China audited the transfer pricing of Starrett’s subsidiary in that country for calendar years 2010 through 2012. Adjustments reduced the tax loss carryforward and required a tax and penalty payment for calendar 2011. As of June 30, 2016, the Company has resolved all open income tax audits. In international jurisdictions: Australia, Brazil, Canada, China, Germany, Japan, Mexico, New Zealand, Singapore and the United Kingdom, the years that may be examined vary by country. The Company’s most significant foreign subsidiary in Brazil is subject to audit for the calendar years 2011 through 2015. The state tax loss carryforwards tax effected benefit of $1.0 million expires at various times over the next 2 to 20 years. The foreign tax credit carryforward of $2.6 million expires in the years 2017 through 2026 and has a full valuation allowance against it. At June 30, 2016, the estimated amount of total unremitted earnings of foreign subsidiaries is $67.0 million. The Company received a cash dividend from a foreign subsidiary of $2.3 million in fiscal 2015 out of earnings for that year. The Company has no plans to repatriate prior year earnings of its foreign subsidiaries and, accordingly, no estimate of the unrecognized deferred taxes related to these earnings has been made. Cash held in foreign subsidiaries is not available for use in the U.S. without the likely incurrence of U.S. federal and state income tax consequences. 12. EMPLOYEE BENEFIT AND RETIREMENT PLANS The Company has two defined benefit pension plans, one for U.S. employees and another for U.K. employees. The UK plan was closed to new entrants in fiscal 2009. The Company has a postretirement medical and life insurance benefit plan for U.S. employees. The Company also has defined contribution plans. The Company amended its Postretirement Medical Plan effective December 31, 2013 whereby the Company terminated eligibility for employees ages 55-64. For retirees 65 and older, the Company’s contribution is fixed at $28.50 or $23.00 per month depending upon the plan the retiree has chosen. The total cost of all such plans for fiscal 2016, 2015 and 2014 was $22.2 million, $4.6 million and $5.0 million, respectively. Included in these amounts are the Company’s contributions to the defined contribution plans amounting to $0.8 million, $0.8 million and $1.2 million in fiscal 2016, 2015 and 2014, respectively. Under both U.S and U.K. defined benefit plans, benefits are based on years of service and final average earnings. Plan assets consist primarily of investment grade debt obligations, marketable equity securities and shares of the Company’s common stock. The asset allocation of the Company’s domestic pension plan is diversified, consisting primarily of investments in equity and debt securities. The Company seeks a long-term investment return that is reasonable given prevailing capital market expectations. Target allocations are 40% to 70% in equities (including 10% to 20% in Company stock), and 30% to 60% in cash and debt securities. In fiscal 2017 the Company will use an expected long-term rate of return assumption of 5.0% for the U.S. domestic pension plan, and 3.6% for the U.K. plan. In determining these assumptions, the Company considers the historical returns and expectations for future returns for each asset class as well as the target asset allocation of the pension portfolio as a whole. In fiscal 2016 and 2015, the Company used a discount rate assumption of 3.77% and 4.49% for the U.S. plan and 3.00% and 3.90% for the U.K. plan, respectively. In determining these assumptions, the Company considers published third party data appropriate for the plans. Other than the discount rate, pension valuation assumptions are generally long-term and not subject to short-term market fluctuations, although they may be adjusted as warranted by structural shifts in economic or demographic outlooks. Long-term assumptions are reviewed annually to ensure they do not produce results inconsistent with current market conditions. The discount rate is adjusted annually based on corporate investment grade (rated AA or better) bond yields, the maturities of which are correlated with the expected timing of future benefit payments, as of the measurement date. Based upon the actuarial valuations performed on the Company’s defined benefit plans as of June 30, 2016, the U.S. plan will require a $4.1 million contribution in fiscal 2017 and the U.K. plan will require a $1.0 million contribution in fiscal 2017. The table below sets forth the actual asset allocation for the assets within the Company’s plans. The Company determines its investments strategies based upon the composition of the beneficiaries in its defined benefit plans and the relative time horizons that those beneficiaries are projected to receive payouts from the plans. The Company engages an independent investment firm to manage the U.S. pension assets. Cash equivalents are held in money market funds. The Company’s fixed income portfolio includes mutual funds that hold a combination of short-term, investment-grade fixed income securities and a diversified selection of investment-grade, fixed income securities, including corporate securities and U.S. government securities. The Company invests in equity securities, which are diversified across a spectrum of value and growth in large, medium and small capitalization as appropriate to achieve the objective of a balanced portfolio and optimize the expected returns and volatility in the various asset classes. Other assets include pooled investment funds whose underlying assets consist primarily of property holdings as well as financial instruments designed to offset the long-term impact of inflation and interest rate fluctuations. In accordance with “ASC 820 Fair Value Measurement”, the Company has categorized its financial assets (including its pension plan assets), based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy as set forth below. If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial assets are categorized based on the inputs to the valuation techniques as follows: o Level 1 - Financial assets whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market which the Company has the ability to access at the measurement date. o Level 2 - Financial assets whose value are based on quoted market prices in markets where trading occurs infrequently or whose values are based on quoted prices of instruments with similar attributes in active markets. o Level 3 - Financial assets whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own view about the assumptions a market participant would use in pricing the asset. The tables below show the portfolio by valuation category as of June 30, 2016 and June 30, 2015 (in thousands). Included in equity securities at June 30, 2016 and 2015 are shares of the Company’s common stock having a fair value of $9.7 million and $12.5 million, respectively. A reconciliation of the beginning and ending balances of Level 3 assets is as follows (in thousands): The Level 3 assets consist of units of a pooled investment fund which invests in a mix of properties selected from across retail, office, industrial and other sectors predominantly located in the U.K. In addition to direct investments, the fund may also invest indirectly in property through investment vehicles such as quoted and unquoted property companies or collective investment trusts. Redemptions from the fund are not readily available given the illiquid nature of its assets. U.S. and U.K. Plans Combined: The status of these defined benefit plans is as follows (in thousands): U.S. Plan: The status of the U.S. defined benefit plan is as follows (in thousands): U.K. Plan: The status of the U.K. defined benefit plan is as follows (in thousands): Postretirement Medical and Life Insurance Benefits: The status of the U.S. postretirement medical and life insurance benefit plan is as follows (in thousands): Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one percentage point change in assumed health care cost trend rates would have the following effects (in thousands): For fiscal 2017, the Company expects to make a $4.0 million contribution to the qualified domestic pension plan, $45,000 to the nonqualified domestic pension plan, $1.0 million to the U.K. pension plan, and $396,000 to the postretirement medical and life insurance plan. Future pension and other benefit payments are as follows (in thousands): 13. DEBT Debt, including capitalized lease obligations, is comprised of the following (in thousands): Future maturities of debt are as follows (in thousands): The Company completed the negotiations for an amended Loan and Security Agreement and executed the new agreement as of April 25, 2015. Borrowings under this agreement may not exceed $23.0 million. The agreement expires on April 30, 2018 and has an interest rate of LIBOR plus 1.5%. The effective interest rate under the agreement for fiscal 2016 was 2.20%. The material financial covenants of the amended Loan and Security Agreement are: 1) funded debt to EBITDA, excluding non-cash and retirement benefit expenses (“maximum leverage”), cannot exceed 2.25 to 1; 2) annual capital expenditures cannot exceed $15.0 million; 3) maintain a Debt Service Coverage Rate of a minimum of 1.25 to 1 and 4) maintain consolidated cash plus liquid investments of not less than $10.0 million at any time. As of June 30, 2016, the Company was in compliance with all the covenants. The Company expects to be able to meet the covenants in future periods. On November 22, 2011, in conjunction with the Bytewise acquisition, the Company entered into a new $15.5 million term loan (the “Term Loan”) under the then existing Loan and Security Agreement. The term loan is a ten year loan bearing a fixed interest rate of 4.5% and is payable in fixed monthly payments of principal and interest of $160,640. The $15.5 million term loan is subject to the same financial covenants as the Loan and Security Agreement. As of June 30, 2016, $9.3 million of the term loan was outstanding. Availability under the Line of Credit is subject to a borrowing base comprised of accounts receivable and inventory. The Company believes that the borrowing base will consistently produce availability under the Line of Credit in excess of $23.0 million. As of June 30, 2016, the Company had borrowings of $9.4 million under this facility. A 0.25% commitment fee is charged on the unused portion of the Line of Credit. The Company has one standby letter of credit totaling $0.9 million which reduces the $23.0 million available Line of Credit to $22.1 million. As of June 30, 2016, the Company has approximately $12.7 million available in the Line of Credit. The obligations under the Credit Facility are unsecured. In the event of certain triggering events, such obligations would become secured by the assets of the Company’s domestic subsidiaries. A triggering event occurs when the Company fails to achieve any of the financial covenants noted above in consecutive quarters. 14. COMMON STOCK Class B common stock is identical to Class A except that it has 10 votes per share, is generally nontransferable except to lineal descendants of stockholders, cannot receive more dividends than Class A, and can be converted to Class A at any time. Class A common stock is entitled to elect 25% of the directors to be elected at each meeting with the remaining 75% being elected by Class A and Class B voting together. 15. CONTINGENCIES The Company is involved in certain legal matters which arise in the normal course of business, which are not expected to have a material impact on the Company’s financial condition, results of operations and cash flows. 16. CONCENTRATIONS OF CREDIT RISK The Company believes it has no significant concentration of credit risk as of June 30, 2016. Trade receivables are dispersed among a large number of retailers, distributors and industrial accounts in many countries, with none exceeding 10% of consolidated sales. 17. FINANCIAL INFORMATION BY SEGMENT & GEOGRAPHIC AREA The Company offers its broad array of measuring and cutting products to the market through multiple channels of distribution throughout the world. The Company’s products include precision tools, electronic gages, gage blocks, optical vision and laser measuring equipment, custom engineered granite solutions, tape measures, levels, chalk products, squares, band saw blades, hole saws, hacksaw blades, jig saw blades, reciprocating saw blades, M1® lubricant and precision ground flat stock. The Company reviews and manages its business geographically and has historically made decisions based on worldwide operations. In fiscal 2016, the Company changed its reportable business segment from one reportable segment to two reportable segments, specifically, North American Operations and International Operations. The Company has recast its segment information disclosure for all periods presented to conform to this segment presentation. The North American segment’s operations include all manufacturing and sales in the United States, Canada and Mexico. The International segment’s operations include all locations outside North America, primarily in Brazil, United Kingdom and China. The chief operating decision maker reviews operations on a geographical basis and decisions about where to invest the Company’s resources are made based on the current results and forecasts of operations in those geographies. Since the markets for the Company’s products are sufficiently different in North America than they are in the rest of the world and in view of the significant impact that currency fluctuation plays outside the United States on the revenue of the Company, the Company’s business review separates North America from operations outside North America. For this reason, the Company is reflecting two operating segments that align with management’s review of operations and decisions to allocate resources. Segment income is measured for internal reporting purposes by excluding corporate expenses, other income and expense including interest income and interest expense and income taxes. Corporate expenses consist primarily of executive compensation, certain professional fees, and costs associated with the Company’s global headquarters. Financial results for each reportable segment are as follows (in thousands): 1 Excludes $8,259 of North American segment sales to the International segment and $9,282 sales of the International segment to the North American segment. 2 Excludes $12,276 of North American segment sales to the International segment and $9,842 sales of the International segment to the North American segment. 3 Excludes $17,692 of North American segment sales to the International segment and $8,585 sales of the International segment to the North American segment. 4 Current assets primarily consist of accounts receivable, inventories and prepaid expenses. Assets not allocated to the segments include cash and cash equivalents, deferred income taxes, and other non-current assets. Geographic information about the Company’s sales and long-lived assets are as follows (in thousands): Sales Long-lived Assets 5 Long lived assets consist of property, plant and equipment, goodwill, and other intangible assets. Long term deferred and other tax assets not allocated to the segments. 18. QUARTERLY FINANCIAL DATA (unaudited) (in thousands except per share data) Fourth quarter sales in fiscal 2016 were $6.8 million lower than in the fourth quarter of fiscal 2015. Unfavorable exchange rates represented $2.6 million of the difference. In addition, precision hand tool and saw sales declined $4.4 million in the fourth quarter of fiscal 2016 compared to fiscal 2015. Gross margins declined $16.3 million with a non-cash pension charge of $14.2 million representing approximately 90% of the decline. Lower sales of precision hand tool and saw sales accounted for the majority of the additional $2.1 million decline. 19. RELATED PARTY TRANSACTIONS In the fourth quarter of fiscal 2016, Mr. Guilherme Camargo was appointed Operations Manager of Armco do Brasil S.A. (Armco.) Armco is the largest supplier of steel to our subsidiary in Brazil. Mr. Camargo is the son of Salvador de Camargo, who is the president of our subsidiary in Brazil and a member of the board of directors. The Company plans to implement policies and procedures to ensure transactions between Starrett Brazil and Armco remain at “arms-length” in the future as they have been in the past. The Company made annual purchases from Armco of $3.2 million, $4.1 million and $3.7 million in fiscal 2016, 2015 and 2014 respectively. The Company had accounts payable of $0 and $0.1 million as of June 30, 2016 and June 30, 2015 respectively. Item 9 | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement excerpt. It contains partial sections about financial reporting elements like profit/loss, expenses, assets, and liabilities, but lacks complete context or specific numerical data. Without a full financial statement, I cannot provide a meaningful summary. If you have the complete financial statement, I'd be happy to help you summarize it. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM The Management Committee of Northwest Pipeline LLC We have audited the accompanying balance sheet of Northwest Pipeline LLC as of December 31, 2016 and 2015, and the related statements of comprehensive income, owner’s equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Northwest Pipeline LLC at December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. /s/ Ernst & Young LLP Houston, Texas February 22, 2017 NORTHWEST PIPELINE LLC STATEMENT OF COMPREHENSIVE INCOME (Thousands of Dollars) See accompanying notes. NORTHWEST PIPELINE LLC BALANCE SHEET (Thousands of Dollars) See accompanying notes. NORTHWEST PIPELINE LLC BALANCE SHEET (Thousands of Dollars) See accompanying notes. NORTHWEST PIPELINE LLC STATEMENT OF OWNER’S EQUITY (Thousands of Dollars) See accompanying notes. NORTHWEST PIPELINE LLC STATEMENT OF CASH FLOWS (Thousands of Dollars) See accompanying notes. NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Corporate Structure and Control Northwest Pipeline LLC (Northwest) is indirectly owned by Williams Partners L.P. (WPZ), a publicly traded Delaware limited partnership, which is consolidated by The Williams Companies, Inc. (Williams). On February 2, 2015, WPZ was merged into Access Midstream Partners, L.P. (ACMP), another publicly traded limited partnership consolidated by Williams. ACMP was the surviving partnership and was subsequently renamed WPZ. At December 31, 2016, Williams owned an approximate 60 percent interest in WPZ, comprised of an approximate 58 percent limited partner interest and all of the 2 percent general partner interest. In January 2017, Williams permanently waived the WPZ general partner’s incentive distribution rights, converted its 2 percent general partner interest in WPZ to a non-economic interest, and purchased additional WPZ common units. Following these transactions, Williams owns a 74 percent limited partner interest in WPZ. Northwest has no employees. Services are provided to Northwest by Williams and its affiliates. Northwest reimburses Williams and its affiliates for the costs of the employees including compensation and employee benefit plan costs and all related administrative costs. In this report, Northwest is at times referred to in the first person as “we,” “us” or “our.” Nature of Operations We own and operate an interstate pipeline system for the mainline transmission of natural gas. This system extends from the San Juan Basin in northwestern New Mexico and southwestern Colorado through Colorado, Utah, Wyoming, Idaho, Oregon and Washington to a point on the Canadian border near Sumas, Washington. Regulatory Accounting We are regulated by the Federal Energy Regulatory Commission (FERC). The Accounting Standards Codification (ASC) Regulated Operations (Topic 980) provides that rate-regulated public utilities account for and report regulatory assets and liabilities consistent with the economic effect of the way in which regulators establish rates if the rates established are designed to recover the costs of providing the regulated service and if the competitive environment makes it probable that such rates can be charged and collected. Accounting for businesses that are regulated and apply the provisions of Topic 980 can differ from the accounting requirements for non-regulated businesses. Transactions that are recorded differently as a result of regulatory accounting requirements include the capitalization of an equity return component on regulated capital projects, capitalization of other project costs, retirements of general plant assets, employee related benefits, environmental costs, negative salvage, asset retirement obligations, and other costs and taxes included in, or expected to be included in, future rates. As a rate-regulated entity, our management has determined that it is appropriate to apply the accounting prescribed by Topic 980, and, accordingly, the accompanying financial statements include the effects of the types of transactions described above that result from regulatory accounting requirements. (See Note 9 for further discussion.) Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Estimates and assumptions which, in the opinion of management, are significant to the underlying amounts included in the financial statements and for which it would be reasonably possible that future events or information could change those estimates include: 1) litigation-related contingencies; 2) environmental remediation obligations; 3) impairment assessments of long-lived assets; 4) depreciation; and 5) asset retirement obligations. Revenue Recognition Our revenues are primarily from services pursuant to long term firm transportation and storage agreements. These agreements provide for a reservation charge based on the volume of contracted capacity and a volumetric charge based on the volume of gas delivered, both at rates specified in our FERC tariffs. We recognize revenues for reservation charges ratably over the contract period regardless of the volume of natural gas that is transported or stored. Revenues for volumetric charges, from both firm and interruptible transportation services and storage injection and withdrawal services, are recognized based on volumes of natural NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS gas scheduled for delivery at the agreed upon delivery point or based on volumes of natural gas scheduled for injection or withdrawal from the storage facility. In the course of providing transportation services to our customers, we may receive or deliver different quantities of gas from shippers than the quantities delivered or received on behalf of those shippers. These transactions result in imbalances, which are typically settled through the receipt or delivery of gas in the future. Customer imbalances to be repaid or recovered in-kind are recorded as exchange gas due from others or due to others in the accompanying balance sheets. The difference between exchange gas due to us from customers and the exchange gas that we owe to customers is included in the exchange gas offset. These imbalances are valued at the average of the spot market rates at the Canadian border and the Rocky Mountain market as published in the SNL Financial “Bidweek Index - Spot Rates.” Settlement of imbalances requires agreement between the pipelines and shippers as to allocations of volumes to specific transportation contracts and timing of delivery of gas based on operational conditions. As a result of the ratemaking process, certain revenues collected by us may be subject to refunds upon the issuance of final orders by the FERC in pending rate proceedings. We record estimates of rate refund liabilities considering our and third-party regulatory proceedings, advice of counsel and other risks. At December 31, 2016, we had no such rate refund liabilities. Environmental Matters We are subject to federal, state, and local environmental laws and regulations. Environmental expenditures are expensed or capitalized depending on their economic benefit and potential for rate recovery. We believe that expenditures required to meet applicable environmental laws and regulations are prudently incurred in the ordinary course of business and such expenditures would be permitted to be recovered through rates. Property, Plant, and Equipment Property, plant and equipment (plant), consisting principally of natural gas transmission facilities, is recorded at original cost. The FERC identifies installation, construction and replacement costs that are to be capitalized and included in our asset base for recovery in rates. Routine maintenance, repairs, and renewal costs are charged to income as incurred. Gains or losses from the ordinary sale or retirement of plant are charged or credited to accumulated depreciation; certain other gains or losses are recorded in operating income. We provide for depreciation under the composite (group) method at straight-line FERC prescribed rates that are applied to the cost of the group for transmission and storage facilities. Under this method, assets with similar lives and characteristics are grouped and depreciated as one asset. Included in our depreciation rates is a negative salvage component (net cost of removal) that we currently collect in rates. Our depreciation rates are subject to change each time we file a general rate case with the FERC. Depreciation rates used for major regulated gas plant facilities at December 31, 2016, 2015, and 2014 are as follows: The incrementally priced Evergreen Expansion Project, which was an expansion of our pipeline system, was placed in service on October 1, 2003. The levelized rate design of this project creates a consistent revenue stream over the related 25-year and 15-year customer contract terms. The related levelized depreciation is lower than book depreciation in the early years and higher than book depreciation in the later years of the contract terms. The depreciation component of the levelized incremental rates will equal the accumulated book depreciation by the end of the primary contract terms. The FERC has approved the accounting for the differences between book depreciation and the Evergreen Expansion Project’s levelized depreciation as a regulatory asset. We recorded regulatory debits totaling $3.5 million in 2016, $2.6 million in 2015, and $1.5 million in 2014 in the accompanying Statement of Comprehensive Income. These debits relate primarily to the levelized depreciation adjustment for the Evergreen Project discussed above. We record a liability and increase the basis in the underlying asset for the present value of each expected future asset retirement obligation (ARO) at the time the liability is initially incurred, typically when the asset is acquired or constructed. Measurement of AROs includes, as a component of future expected costs, an estimate of the price that a third party would demand, and could expect to receive, for bearing the uncertainties inherent in the obligations, sometimes referred to as market-risk premium. We measure changes in the liability due to passage of time by applying an interest rate to the liability balance. This amount is recognized NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS as an increase in the carrying amount of the liability and is offset by a regulatory asset. The gross regulatory asset balances associated with ARO as of December 31, 2016 and 2015 were $78.5 million and $70.9 million, respectively. The regulatory asset is expected to be fully recovered through the net negative salvage component of depreciation included in our rates; as such, the negative salvage component of accumulated depreciation ($78.5 million and $69.3 million at December 31, 2016 and 2015, respectively) has been reclassified and netted against the amount of the ARO regulatory asset. Impairment of Long-Lived Assets We evaluate long-lived assets for impairment when events or changes in circumstances indicate, in our management’s judgment, that the carrying value of such assets may not be recoverable. When such a determination has been made, our management’s estimate of undiscounted future cash flows attributable to the assets is compared to the carrying value of the assets to determine whether an impairment has occurred. If an impairment of the carrying value has occurred, the amount of the impairment recognized in the financial statements is determined by estimating the fair value of the assets and recording a loss for the amount that the carrying value exceeds the estimated fair value. Judgments and assumptions are inherent in our management’s estimate of undiscounted future cash flows used to determine recoverability of an asset and the estimate of an asset’s fair value used to calculate the amount of impairment to recognize. The use of alternate judgments and/or assumptions could result in the recognition of different levels of impairment charges in the financial statements. Allowance for Funds Used During Construction Allowance for funds used during construction (AFUDC) represents the estimated cost of borrowed and equity funds applicable to utility plant in process of construction and is included as a cost of property, plant and equipment because it constitutes an actual cost of construction under established regulatory practices. The FERC has prescribed a formula to be used in computing separate allowances for borrowed and equity AFUDC. The allowance for borrowed funds used during construction was $0.4 million for 2016, $0.5 million for 2015, and $0.2 million for 2014. The allowance for equity funds was $1.0 million, $1.1 million, and $0.4 million for 2016, 2015, and 2014, respectively. Both are reflected in Other (Income) and Other Expenses. Income Taxes We generally are not a taxable entity for federal or state and local income tax purposes. The tax on net income is generally borne by unitholders of our ultimate parent, WPZ. Net income for financial statement purposes may differ significantly from taxable income of WPZ’s unitholders as a result of differences between the tax basis and financial reporting basis of assets and liabilities and the taxable income allocation requirements under the WPZ partnership agreement. The aggregated difference in the basis of our assets for financial and tax reporting purposes cannot be readily determined because information regarding each of WPZ’s unitholder’s tax attributes in WPZ is not available to us. Accounts Receivable and Allowance for Doubtful Receivables Accounts receivable are stated at the historical carrying amount net of reserves or write-offs. Our credit risk exposure in the event of nonperformance by the other parties is limited to the face value of the receivables. We perform ongoing credit evaluations of our customers’ financial condition and require collateral from our customers, if necessary. Due to our customer base, we have not historically experienced recurring credit losses in connection with our receivables. Receivables determined to be uncollectible are reserved or written off in the period of determination. Materials and Supplies Inventory All inventories are stated at lower of cost or market. We determine the cost of the inventories using the average cost method. We perform an annual review of materials and supplies inventories, including an analysis of parts that may no longer be useful due to planned replacements of compressor engines and other components on our system. Based on this assessment, we record a reserve for the value of the inventory which can no longer be used for maintenance and repairs on our pipeline. There was a minimal reserve at December 31, 2016 and 2015. NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS Deferred Charges We amortize deferred charges over varying periods consistent with the FERC approved accounting treatment and recovery for such deferred items. Unamortized debt expense, debt discount and losses on reacquired long-term debt are amortized by the bonds outstanding method over the related debt repayment periods. Contingent Liabilities We record liabilities for estimated loss contingencies, including environmental matters, when we assess that a loss is probable and the amount of the loss can be reasonably estimated. These liabilities are calculated based upon our assumptions and estimates with respect to the likelihood or amount of loss and upon advice of legal counsel, engineers, or other third parties regarding the probable outcomes of the matters. These calculations are made without consideration of any potential recovery from third-parties. We recognize insurance recoveries or reimbursements from others when realizable. Revisions to these liabilities are generally reflected in income when new or different facts or information become known or circumstances change that affect the previous assumptions or estimates. Pension and Other Postretirement Benefits We do not have employees. Certain of the costs charged to us by Williams associated with employees who directly support us include costs related to Williams’ pension and other postretirement benefit plans. (See Note 5 for further discussion.) Although the underlying benefit plans of Williams are single-employer plans, we follow multiemployer plan accounting whereby the amount charged to us, and thus paid by us, is based on our share of net periodic benefit cost. Cash Flows from Operating Activities and Cash Equivalents We use the indirect method to report cash flows from operating activities, which requires adjustments to net income to reconcile to net cash flows provided by operating activities. We include short-term, highly-liquid investments that have an original maturity of three months or less as cash equivalents. Interest Payments Cash payments for interest, net of interest capitalized, were $38.5 million in 2016, $45.3 million in 2015, and $44.5 million in 2014. Accounting Standards Issued But Not Yet Adopted In August 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-15 "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" (ASU 2016-15). ASU 2016-15 provides specific guidance on eight cash flow classification issues, including debt prepayment or debt extinguishment costs and distributions received from equity method investees, to reduce diversity in practice. ASU 2016-15 is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted. ASU 2016-15 requires a retrospective transition. We are evaluating the impact of ASU 2016-15 on our financial statements. In June 2016, the FASB issued ASU 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" (ASU 2016-13). ASU 2016-13 changes the impairment model for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans, and other instruments, entities will be required to use a new forward-looking "expected loss" model that generally will result in the earlier recognition of allowances for losses. The guidance also requires increased disclosures. ASU 2016-13 is effective for interim and annual periods beginning after December 15, 2019. Early adoption is permitted. ASU 2016-13 requires varying transition methods for the different categories of amendments. We do not expect ASU 2016-13 to have a significant impact on our financial statements. In February 2016, the FASB issued ASU 2016-02 "Leases (Topic 842)" (ASU 2016-02). ASU 2016-02 establishes a comprehensive new lease accounting model. ASU 2016-02 clarifies the definition of a lease, requires a dual approach to lease classification similar to current lease classifications, and causes lessees to recognize leases on the balance sheet as a lease liability with a corresponding right-of-use asset. ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. ASU 2016-02 requires a modified retrospective transition for capital or operating leases existing at or entered into after the beginning of the earliest comparative period presented in the financial statements. We are reviewing contracts to identify leases, particularly reviewing the applicability of ASU 2016-02 to contracts involving easements/rights-of-way. NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS In May 2014, the FASB issued ASU 2014-09 establishing Accounting Standards Codification (ASC) Topic 606, "Revenue from Contracts with Customers" (ASC 606). ASC 606 establishes a comprehensive new revenue recognition model designed to depict the transfer of goods or services to a customer in an amount that reflects the consideration the entity expects to be entitled to receive in exchange for those goods or services and requires significantly enhanced revenue disclosures. In August 2015, the FASB issued ASU 2015-14 "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date" (ASU 2015-14). Per ASU 2015-14, the standard is effective for interim and annual reporting periods beginning after December 15, 2017. ASC 606 allows either full retrospective or modified retrospective transition and early adoption is permitted for annual periods beginning after December 15, 2016. We continue to evaluate the impact the standard may have on our financial statements. For each revenue contract type, we are conducting a formal contract review process to evaluate the impact, if any, that the new revenue standard may have. We have substantially completed that process, but continue to evaluate our accounting for noncash consideration, which exists in contracts where we receive commodities as full or partial consideration, and the accounting for contributions in aid of construction. As such, we are unable to determine the potential impact upon the amount and timing of revenue recognition and related disclosures. Additionally, we have identified possible financial system and internal control changes necessary for adoption. We currently anticipate utilizing a modified retrospective transition upon the adoption of ASC 606 as of January 1, 2018. 2. RATE AND REGULATORY MATTERS Rates Our rates became effective January 1, 2013, and will remain in effect for 5 years. Rate Case Settlement Filing On January 23, 2017, we filed for FERC approval a Stipulation and Settlement Agreement (Settlement) and were assigned Docket No. RP17-346. The Settlement specified an annual cost of service of $440 million and established a new general system firm Rate Schedule TF-1 (Large Customer) demand rate of $0.39294/Dth with a $0.00832 commodity rate (Phase 1) and a demand rate of $0.39033/Dth with a $0.00832 commodity rate (Phase 2). Phase 1 rates become effective January 1, 2018, with Phase 2 rates becoming effective October 1, 2018. The annual cost of service does not change from Phase 1 to Phase 2, but the Phase 2 rates reflect the termination of fifteen-year levelized contracts that will now become Rate Schedule TF-1 (Large Customer) contracts. Provisions were included in the Settlement that we can file new rates to be effective after October 1, 2018, and that a general rate case filing must be made for rates to become effective no later than January 1, 2023. 3. CONTINGENT LIABILITIES AND COMMITMENTS Environmental Matters We are subject to the National Environmental Policy Act and other federal and state legislation regulating the environmental aspects of our business. Except as discussed below, our management believes that we are in substantial compliance with existing environmental requirements. Environmental expenditures are expensed or capitalized depending on their future economic benefit and potential for rate recovery. We believe that, with respect to any expenditures required to meet applicable standards and regulations, the Federal Energy Regulatory Commission (FERC) would grant the requisite rate relief so that substantially all of such expenditures would be permitted to be recovered through rates. Beginning in the mid-1980s, we evaluated many of our facilities for the presence of toxic and hazardous substances to determine to what extent, if any, remediation might be necessary. We identified polychlorinated biphenyl (PCB) contamination in air compressor systems, soils, and related properties at certain compressor station sites. Similarly, we identified hydrocarbon impacts at these facilities due to the former use of earthen pits, lubricating oil leaks or spills, and excess pipe coating released to the environment. In addition, heavy metals have been identified at these sites due to the former use of mercury containing meters and paint and welding rods containing lead, cadmium, and arsenic. The PCBs were remediated pursuant to a Consent Decree with the U.S. Environmental Protection Agency (EPA) in the late 1980s, and we conducted a voluntary clean-up of the hydrocarbon and mercury impacts in the early 1990s. In 2005, the Washington Department of Ecology required us to re-evaluate our previous clean-ups in Washington. During 2006 to 2015, 129 meter stations were evaluated, of which 82 required remediation. As of December 31, 2016, all of the meter stations have been remediated. Initial assessments have been completed at all thirteen compressor stations in Washington. Additional assessments are ongoing at two of these compressor stations. Remediation has been completed at eleven of the thirteen compressor stations. On the basis of the findings to date, we estimate that environmental assessment and remediation costs will total approximately $4.4 million, measured on an undiscounted basis, and are expected to NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS be incurred through 2020. At December 31, 2016 and 2015, we had accrued liabilities totaling approximately $4.4 million and $4.6 million, respectively, for these costs. We are conducting environmental assessments and implementing a variety of remedial measures that may result in increases or decreases in the total estimated costs. In March 2008, the EPA promulgated a new, lower National Ambient Air Quality Standard (NAAQS) for ground-level ozone. In May 2012, the EPA completed designation of new eight-hour ozone non-attainment areas. Based on the published designations, no Northwest facilities are located within the non-attainment areas. At this time, it is unknown whether future state regulatory actions associated with implementation of the 2008 ozone standard will impact our operations and increase the cost of additions to property, plant and equipment. Until any additional state regulatory actions are proposed, we are unable to estimate the cost of additions that may be required to meet any such new regulation. In December 2014, the EPA proposed to further reduce the ground-level ozone NAAQS from the March 2008 levels and subsequently finalized a rule on October 1, 2015. We are monitoring the rule's implementation as the reduction will trigger additional federal and state regulatory actions that may impact our operations. As a result, the cost of additions to property, plant, and equipment is expected to increase. We are unable at this time to estimate with any certainty the cost of additions that may be required to meet new regulations. On January 22, 2010, the EPA set a new one-hour nitrogen dioxide (NO2) NAAQS. The effective date of the new NO2 standard was April 12, 2010. On January 20, 2012, the EPA determined pursuant to available information that no area in the country is violating the 2010 NO2 NAAQS, and thus, designated all areas of the country as “unclassifiable/attainment.” Also, at that time, the EPA noted its plan to deploy an expanded NO2 monitoring network beginning in 2013. However, on October 5, 2012, the EPA proposed a graduated implementation of the monitoring network between January 1, 2014 and January 1, 2017. Once three years of data are collected from the new monitoring network, the EPA will reassess attainment status with the one-hour NO2 NAAQS. Until that time, the EPA or states may require ambient air quality modeling on a case by case basis to demonstrate compliance with the NO2 standard. Because we are unable to predict the outcome of the EPA’s or states’ future assessment using the new monitoring network, we are unable to estimate the cost of additions that may be required to meet this regulation. Other Matters Various other proceedings are pending against us and are considered incidental to our operations. Summary We estimate that for all matters for which we are able to reasonably estimate a range of loss, including those noted above and others that are not individually significant, our aggregate reasonably possible losses beyond amounts accrued for all of our contingent liabilities are immaterial to our expected future annual results of operations, liquidity and financial position. These calculations have been made without consideration of any potential recovery from third-parties. We have disclosed all significant matters for which we are unable to reasonably estimate a range of possible loss. 4. DEBT, FINANCING ARRANGEMENTS, AND LEASES Long-Term Debt Long-term debt, presented net of unamortized discount and unamortized debt issuance costs, consists of the following: NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS As of December 31, 2016, cumulative maturities of outstanding long-term debt (at face value) for the next five years are as follows: The long-term debt due within one year at December 31, 2016 is associated with our $185 million 5.95% senior unsecured notes that mature on April 15, 2017. We intend to repay this maturing note by accessing available capacity under our revolving credit facility, advances from our parent, or issuing new long-term debt. The long-term debt due within on year at December 31, 2015 is associated with our $175 million 7% senior unsecured notes that matured on June 15, 2016. In 2006, we entered into certain forward starting interest rate swaps prior to our issuance of the 7% senior unsecured notes due 2016 to hedge the variability of forecasted interest payments arising from changes in interest rates prior to the issuance of this debt. The settlement resulted in a gain, recorded in Accumulated other comprehensive income, that was being amortized to reduce interest expense over the life of the related debt. This was fully amortized in June 2016. Restrictive Debt Covenants At December 31, 2016, none of our debt instruments restrict the amount of distributions to our parent, provided, however, that under the credit facility described below, we are restricted from making distributions to our parent during an event of default if we have directly incurred indebtedness under the credit facility. Our debt agreements contain restrictions on our ability to incur secured debt beyond certain levels. Retirement of Long-Term Debt In June 2016, we retired our $175.0 million 7 percent senior unsecured notes that matured on June 15, 2016. These notes were retired with proceeds from the repayment of advances to WPZ. Credit Facility On February 2, 2015, we, along with WPZ, Transco, the lenders named therein, and an administrative agent, entered into the Second Amended and Restated Credit Agreement with aggregate commitments available of $3.5 billion, with up to an additional $500 million increase in aggregate commitments available under certain circumstances. The maturity date of the facility is February 2, 2020. However, the co-borrowers may request up to two extensions of the maturity date, each for an additional one-year period, to allow a maturity date as late as February 2, 2022, under certain circumstances. The agreement allows for swing line loans up to an aggregate amount of $150 million, subject to available capacity under the credit facility, and letters of credit commitments available to WPZ of $1.125 billion. We are able to borrow up to $500 million under this credit facility to the extent not otherwise NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS utilized by the other co-borrowers. At December 31, 2016, no letters of credit have been issued and no loans to WPZ were outstanding under the credit facility. On December 18, 2015, we, along with WPZ, Transco, the lenders named therein, and an administrative agent, entered into the Amendment No. 1 to Second Amended and Restated Credit Agreement modifying the thresholds specified in the covenant related to the maximum ratio of WPZ’s consolidated indebtedness to consolidated EBITDA. Under the credit facility, WPZ is required to maintain a ratio of debt to EBITDA (each as defined in the credit facility) that must be no greater than 5.75 to 1.0 for the quarters ending December 31, 2015, March 31, 2016, and June 30, 2016. The ratio must be no greater than 5.5 to 1.0 for the quarters ending September 30, 2016 and December 31, 2016. The ratio must be no greater than 5.0 to 1.0 for the quarter ending March 31, 2017 and each subsequent fiscal quarter, except for the fiscal quarter and the two following fiscal quarters in which one or more acquisitions have been executed, in which case the ratio must be no greater than 5.50 to 1.0. For us, the ratio of debt to capitalization (defined as net worth plus debt) must be no greater than 65 percent. Measured as of December 31, 2016, we are in compliance with this financial covenant. Various covenants may limit, among other things, a borrower’s and its material subsidiaries’ ability to grant certain liens supporting indebtedness, a borrower’s ability to merge or consolidate, sell all or substantially all of its assets, enter into certain affiliate transactions, make certain distributions during an event of default, enter into certain restrictive agreements, and allow any material change in the nature of its business. If an event of default with respect to a borrower occurs under the credit facility, the lenders will be able to terminate the commitments for the respective borrowers and accelerate the maturity of any loans of the defaulting borrower under the credit facility agreement and exercise other rights and remedies. Other than swingline loans, each time funds are borrowed, the borrower must choose whether such borrowing will be an alternate base rate borrowing or a Eurodollar borrowing. If such borrowing is an alternate base rate borrowing, interest is calculated on the basis of the greater of (a) the Prime Rate, (b) the Federal Funds Effective Rate plus 1/2 of 1 percent, and (c) a periodic fixed rate equal to the London Interbank Offered Rate (LIBOR) plus 1 percent, plus, in the case of each of (a), (b), and (c), an applicable margin. If the borrowing is a Eurodollar borrowing, interest is calculated on the basis of LIBOR for the relevant period plus an applicable margin. Interest on swingline loans is calculated as the sum of the alternate base rate plus an applicable margin. The borrower is required to pay a commitment fee based on the unused portion of the credit facility. The applicable margin and the commitment fee are determined for each borrower by reference to a pricing schedule based on such borrower’s senior unsecured long-term debt ratings. WPZ participates in a commercial paper program, and WPZ management considers amounts outstanding under this program to be a reduction of available capacity under the credit facility. On February 2, 2015, WPZ amended and restated the commercial paper program for the WPZ/ACMP merger and to allow a maximum outstanding of $3 billion. At December 31, 2016, WPZ had $93 million in outstanding commercial paper. Leases Our leasing arrangements include mostly premise and equipment leases that are classified as operating leases. Effective October 1, 2009, we entered into an agreement to lease office space from a third party. The agreement has an initial term of approximately 10 years, with an option to renew for an additional 5 or 10 year term. Following are the estimated future minimum annual rental payments required under operating leases, which have initial or remaining noncancelable lease terms in excess of one year: Operating lease rental expense, net of sublease revenues, amounted to $2.7 million, $2.7 million, and $2.5 million for 2016, 2015, and 2014, respectively. NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS 5. BENEFIT PLANS Certain of the benefit costs charged to us by Williams associated with employees who directly support us are described below. Additionally, allocated corporate expenses from Williams to us also include amounts related to these same employee benefits, which are not included in the amounts presented below. (See Note 7 for further discussion.) Pension and Other Postretirement Benefit Plans Williams has noncontributory defined benefit pension plans (Williams Pension Plan, Williams Inactive Employees Pension Plan, and The Williams Companies Retirement Restoration Plan) that provide pension benefits for its eligible employees. Pension cost charged to us by Williams was $2.3 million in 2016, $4.4 million in 2015, and $4.2 million in 2014. Williams provides subsidized retiree health care and life insurance benefits to certain eligible participants. Generally, participants that were employed by Williams on or before December 31, 1991 are eligible for subsidized retiree health care benefits. During 2016, 2015, and 2014, we received credits from Williams related to retiree health care and life insurance benefits of $3.8 million, $3.4 million and $4.3 million, respectively. These credits were recorded as regulatory liabilities. We have been allowed by rate case settlements to collect or refund in future rates any differences between the actuarially determined costs and amounts currently being recovered in rates related to other postretirement benefits. Any difference between the annual actuarially determined cost and amounts currently being recovered in rates are recorded as regulatory assets or liabilities and collected or refunded through future rate adjustments. The amount of other postretirement benefits costs deferred as a regulatory liability at December 31, 2016 and 2015 are $30.6 million and $26.8 million, respectively. Defined Contribution Plan Williams maintains a defined contribution plan for substantially all of its employees. Williams charged us compensation expense of $2.2 million in 2016, $2.2 million in 2015, and $2.0 million in 2014 for Williams’ company matching contributions to this plan. Employee Stock-Based Compensation Plan Information The Williams Companies, Inc. 2007 Incentive Plan, as subsequently amended and restated (Plan), provides for Williams’ common stock-based awards to both employees and nonmanagement directors. The Plan permits the granting of various types of awards including, but not limited to, restricted stock units and stock options. Awards may be granted for no consideration other than prior and future services or based on certain financial performance targets achieved. Williams currently bills us directly for compensation expense related to stock-based compensation awards based on the fair value of the awards. We are also billed for our proportionate share of Williams’ and other affiliates’ stock-based compensation expense through various allocation processes. Total stock-based compensation expense for the years ended December 31, 2016, 2015 and 2014 was $1.4 million, $1.5 million and $1.2 million, respectively, excluding amounts allocated from WPZ and Williams. 6. FINANCIAL INSTRUMENTS Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and advances to affiliate-The carrying amounts approximate fair value, because of the short-term nature of these instruments. Long-term debt - The disclosed fair value of our long-term debt, which we consider as a level 2 measurement, is determined by a market approach using broker quoted indicative period-end bond prices. The quoted prices are based on observable transactions in less active markets for our debt or similar instruments. The carrying amount and estimated fair value of our long-term debt, including current maturities, were $519.2 million and $546.8 million, respectively, at December 31, 2016, and $693.4 million and $721.9 million, respectively, at December 31, 2015. NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS 7. TRANSACTIONS WITH MAJOR CUSTOMERS AND AFFILIATES Concentration of Off-Balance-Sheet and Other Credit Risk During the periods presented, more than 10 percent of our operating revenues were generated from each of the following customers: (a) Under 10 percent in 2014. Our major customers are located in the Pacific Northwest. As a general policy, collateral is not required for receivables, but customers’ financial condition and credit worthiness are regularly evaluated and historical collection losses have been minimal. Related Party Transactions We are a participant in WPZ’s cash management program. At December 31, 2016 and 2015, the advances due to us by WPZ totaled approximately $45.1 million and $171.9 million, respectively. These advances are represented by demand notes and are classified as Current Assets in the accompanying Balance Sheet. The interest rate on these intercompany demand notes is based upon the daily overnight investment rate paid on WPZ’s excess cash at the end of each month, which was approximately 0.39 percent at December 31, 2016. The interest income from these advances was minimal during the years ended December 31, 2016, 2015, and 2014. Such interest income is included in Other (Income) and Other Expenses: Miscellaneous other (income) expenses, net on the accompanying Statement of Comprehensive Income. We have no employees. Services necessary to operate our business are provided to us by Williams and certain affiliates of Williams. We reimburse Williams and its affiliates for all direct and indirect expenses incurred or payments made (including salary, bonus, incentive compensation, and benefits) in connection with these services. Employees of Williams also provide general administrative and management services to us, and we are charged for certain administrative expenses incurred by Williams. These charges are either directly identifiable or allocated to our assets. Direct charges are for goods and services provided by Williams at our request. Allocated charges are based on a three factor formula, which considers revenues; property, plant, and equipment; and payroll. In management’s estimation, the allocation methodologies used are reasonable and result in a reasonable allocation to us of our costs of doing business incurred by Williams. We were billed $92.8 million, $100.4 million, and $102.4 million in the years ended December 31, 2016, 2015, and 2014, respectively, for these services. Such expenses are primarily included in General and administrative and Operation and maintenance expenses on the accompanying Statement of Comprehensive Income. The amount billed to us during 2016 includes $2.4 million for severance and other related costs associated with a reduction in workforce primarily recognized in the first quarter. In 2015 and 2014, we incurred reimbursable costs of $0.6 million and $27.3 million, respectively, due from Williams Field Services related to the construction of a natural gas liquids pipeline, of which a minimal amount was outstanding at December 31, 2015. No such costs were incurred or were outstanding at December 31, 2016. During 2016, 2015, and 2014, we declared and paid cash distributions to our parent of $174.0 million, $168.0 million, and $234.0 million, respectively. During January 2017, we declared and paid cash distributions of $50.0 million to our parent. 8. ASSET RETIREMENT OBLIGATIONS Our accrued asset retirement obligations relate to our gas storage and transmission facilities. At the end of the useful life of our facilities, we are legally obligated to remove certain transmission facilities including underground pipelines, major river spans, NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS compressor stations and meter station facilities. These obligations also include restoration of the property sites after removal of the facilities from above and below the ground. During 2016 and 2015, our overall asset retirement obligation changed as follows (in thousands): (1) Changes in estimates of existing obligations are primarily due to the annual review process, which considers various factors including inflation rates, current estimates for removal cost, the estimated remaining life of assets, and discount rates. The decrease in 2016 is primarily attributed to decreases in current estimates for removal costs and inflation rate and an increase in the estimated life of the assets. The decrease in 2015 is primarily attributed to decreases in current estimates for removal costs and inflation rate and an increase in the discount rate. 9. REGULATORY ASSETS AND LIABILITIES Our regulatory assets and liabilities result from our application of the provisions of Topic 980 and are reflected on our balance sheet. Current regulatory assets are included in Exchange gas offset and Prepayments and other. Current regulatory liabilities are included in Exchange gas offset. These balances are presented on our balance sheet on a gross basis and are recoverable or refundable over various periods. Below are the details of our regulatory assets and liabilities as of December 31, 2016 and 2015: NORTHWEST PIPELINE LLC NOTES TO FINANCIAL STATEMENTS The significant regulatory assets and liabilities include: Environmental Costs We have accrued liabilities for assessment and remediation activities to bring certain sites up to current environmental standards. The accrual for these liabilities is offset by a regulatory asset. The regulatory asset is being amortized to expense consistent with amounts collected in rates. Levelized Depreciation Levelized depreciation allows contract revenue streams to remain constant over the primary contract terms by recognizing lower than book depreciation in the early years and higher than book depreciation in later years. The depreciation component of the levelized incremental rates will equal the accumulated book depreciation by the end of the primary contract terms. The difference between levelized depreciation and straight-line book depreciation is recorded as a FERC approved regulatory asset or liability and is eliminated over the levelization period. Grossed-Up Deferred Taxes on Equity Funds Used During Construction The regulatory asset balance was established to offset the deferred tax for the equity component of the allowance for funds used during the construction of long-lived assets. All amounts were generated during the period that we were a taxable entity. Taxes on capitalized funds used during construction and the offsetting deferred income taxes are included in the rate base and are recovered over the depreciable lives of the long-lived asset to which they relate. Asset Retirement Obligations This regulatory asset balance is established to offset depreciation of the ARO asset and changes in the ARO liability due to the passage of time. The regulatory asset is expected to be fully recovered through the net negative salvage component of depreciation included in our rates; as such, the negative salvage component of accumulated depreciation has been reclassified and netted against the amount of the ARO regulatory asset. (See Note 8.) Fuel Recovery These amounts reflect the value of the cumulative volumetric difference between the gas retained from our customers and the gas consumed in operations. These amounts are not included in the rate base, but are expected to be recovered or refunded by changing the fuel reimbursement factor in subsequent fuel filings. Postretirement Benefits We seek to recover the actuarially determined cost of postretirement benefits through rates that are set through periodic general rate filings. Any differences between the annual actuarially determined cost and amounts currently being recovered in rates are recorded as regulatory assets or liabilities and collected or refunded through future rate adjustments. These amounts are not included in the rate base, and we are not currently recovering postretirement benefit costs in our rates. (See Note 5.) NORTHWEST PIPELINE LLC QUARTERLY FINANCIAL DATA (Unaudited) The following is a summary of unaudited quarterly financial data for 2016 and 2015: | Based on the provided financial statement excerpt, here's a summary:
Revenue:
- Limited details provided about revenue sources
- Mentions revenue generation from customers, but specifics are not clear
Profit/Loss:
- Losses from plant sales or retirement are charged to accumulated depreciation
- Depreciation calculated using:
- Composite (group) method
- Straight-line FERC prescribed rates
- Grouped assets with similar characteristics
- Includes negative salvage component
Expenses:
- Accounting for regulated businesses
- Liabilities established based on regulatory rate recovery potential
Assets:
- Current Assets reported
- Intercompany demand notes with interest rates based on daily overnight investment rates (approximately 0.39%)
Liabilities:
- Debt expenses amortized over debt repayment periods
- Contingent liabilities recorded when:
- Loss is probable
- | Claude |
The Selected Financial Data information contained in Item 6 of Part II hereof is hereby incorporated by reference into this Item 8 of Part II of this Form 10-K. MobileIron, Inc. Index to Consolidated Financial Statements Page No. Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit) Consolidated Statements of Cash Flows Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders of MobileIron, Inc. Mountain View, California We have audited the accompanying consolidated balance sheets of MobileIron, Inc. and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, convertible preferred stock and stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of MobileIron, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP San Jose, California February 14, 2017 MOBILEIRON, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) See accompanying notes to the consolidated financial statements MOBILEIRON, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) See accompanying notes to the consolidated financial statements MOBILEIRON, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) (In thousands, except share and per share data) See accompanying notes to the consolidated financial statements MOBILEIRON, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) See accompanying notes to the consolidated financial statements 1. Description of Business and Significant Accounting Policies Description of Business MobileIron, Inc. and its wholly owned subsidiaries, collectively, the “Company”, “we”, “us” or “our”, provides a purpose-built mobile IT platform that enables enterprises to manage and secure mobile applications, content and devices while providing their employees with device choice, privacy and a native user experience. We were incorporated in Delaware in July 2007 and are headquartered in Mountain View, California, with additional sales and support presence in North America, Europe, the Middle East, Asia and Australia. Initial Public Offering In June 2014, we completed our initial public offering, or our IPO, in which we issued and sold 12,777,777 shares of common stock, including 1,666,666 million shares of common stock sold pursuant to the full exercise of the underwriters’ over-allotment option, at a price of $9.00 per share. We received aggregate proceeds of $107.0 million from the sale of shares of common stock, net of underwriters’ discounts and commissions, but before deducting offering expenses of approximately $4.1 million. Upon the closing of the initial public offering, all shares of our outstanding convertible preferred stock automatically were converted into 49,646,975 shares of common stock. Basis of Presentation and Consolidation The accompanying audited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, and include the accounts of our wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. Stock Split In May 2014, we amended and restated our amended and restated certificate of incorporation to effect a seven-for-five reverse stock split of our common stock and convertible preferred stock. On the effective date of the reverse stock split, (i) each seven shares of outstanding convertible preferred stock and common stock was reduced to five shares of convertible preferred stock and common stock, respectively; (ii) the number of shares of common stock issuable under each outstanding option to purchase common stock was proportionately reduced on a seven-for-five basis; (iii) the exercise price of each outstanding option to purchase common stock was proportionately increased on a seven-for-five basis; and (iv) corresponding adjustments in the per share conversion prices, dividend rates and liquidation preferences of the convertible preferred stock were made. All of the share and per share information referenced throughout this Annual Report on Form 10-K and notes to the consolidated financial statements have been retroactively adjusted to reflect this reverse stock split. Foreign Currency Translation Our reporting currency is the U.S. dollar. The functional currency of all our international operations is the U.S. dollar. All monetary asset and liability accounts are translated into U.S. dollars at the period-end rate, nonmonetary assets and liabilities are translated at historical exchange rates, and revenue and expenses are translated at the weighted-average exchange rates in effect during the period. Translation adjustments arising are recorded as foreign currency gains (losses) in the consolidated statements of operations. We recognized a foreign currency loss of approximately $339,000, $518,000 and $304,000 in 2016, 2015 and 2014, respectively, in other (income) expense-net in our consolidated statements of operations. Use of Estimates The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. These estimates include, but are not limited to, revenue recognition, stock-based compensation, goodwill, intangible assets and accounting for income taxes. Actual results could differ from those estimates. Concentrations of Credit Risk Financial instruments that potentially subject us to a concentration of credit risk consist of cash, money market funds and fixed income investments. Although we deposit our cash with multiple financial institutions, our deposits, at times, exceed federally insured limits. We invest in fixed income securities that are of high-credit quality. Substantially all of our money market funds, or $15.0 million, are held in two funds that are rated “AAA.” We generally do not require collateral or other security in support of accounts receivable. Allowances are provided for individual accounts receivable when we become aware of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy, deterioration in the customer’s operating results, or change in financial position. If circumstances related to customers change, estimates of the recoverability of receivables would be further adjusted. We also consider broader factors in evaluating the sufficiency of our allowances for doubtful accounts, including the length of time receivables are past due, significant one-time events and historical experience. Activity in our allowance for doubtful accounts was as follow (in thousands): One reseller accounted for 16% (1% as an end customer), 17% (1% as an end customer) and 22% (2% as an end customer) of total revenue in 2016, 2015 and 2014, respectively. The same reseller accounted for 15% and 14% of net accounts receivable as of December 31, 2016 and 2015, respectively. There were no other resellers or end-user customers that accounted for 10% or more as a percentage of our revenue or net accounts receivable for any period presented. Segments We have one reportable segment. Summary of Significant Accounting Policies Revenue Recognition We derive revenue principally from software-related arrangements consisting of perpetual software licenses, post-contract customer support for such licenses, or PCS or software support, including when and if available updates, and professional services such as consulting and training services. We also offer our software as term-based licenses and cloud-based arrangements. In addition, we install our software on servers that we ship to customers. We begin to recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been provided, (iii) the sales price is fixed or determinable, and (iv) collection of the related receivable is probable. If collection is not considered probable, revenue is recognized only upon collection. Signed agreements, including by electronic acceptance, are used as evidence of an arrangement. Delivery is considered to occur when we provide a customer with a link and credentials to download our software. Delivery of a hardware appliance (an “appliance”) is considered to occur when title and risk of loss has transferred to the customer, which typically occurs when appliances are delivered to a common carrier. Delivery of services occurs when performed. Prior to January 1, 2013, we had not established vendor specific objective evidence, or VSOE, of fair value for any of the elements in our multiple-element arrangements. As of January 1, 2013, we determined that we had sufficient history to establish VSOE of fair value for PCS and professional services. Prior to January 1, 2013, we did not have VSOE of fair value for our software-related undelivered elements due to limited history of stand-alone sales transactions and inconsistency in pricing. We established VSOE of fair value when we had a substantial majority of stand-alone sales transactions of software support and services pricing within a narrow pricing band. In our VSOE analysis, we generally include stand-alone sales transactions completed during a rolling 12 month period unless a shorter period is appropriate due to changes in our pricing structure. We typically enter into multiple-element arrangements with our customers in which a customer may purchase a combination of software on a perpetual or subscription license, PCS, and professional services. The professional services are not considered essential to the functionality of the software. All of these elements are considered separate units of accounting. Our standard agreements do not include rights for customers to cancel or terminate arrangements or to return software to obtain refunds. We use the residual method to recognize revenue when a perpetual license arrangement includes one or more elements to be delivered at a future date provided the following criteria are met: (i) VSOE of fair value does not exist for one or more of the delivered items but exists for all undelivered elements, (ii) all other applicable revenue recognition criteria are met and (iii) the fair value of all of the undelivered elements is less than the arrangement fee. VSOE of fair value is based on the normal pricing practices for those products and services when sold separately by us and contractual customer renewal rates for post-contract customer support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue in the period in which it was earned. If evidence of the fair value of one or more undelivered elements does not exist, then the revenue is deferred and recognized when delivery of those elements occurs, or when fair value can be established, or ratably over the PCS period if the only undelivered element is PCS-we refer to these deferred revenue elements as the “Deferred Portion.” Revenue from subscriptions to our on premise term licenses, arrangements where perpetual and subscriptions to our on premise term licenses are sold together, and subscriptions to our cloud service are recognized ratably over the contractual term for all periods presented and are included as a component of subscription revenue within our consolidated statements of operations. We refer to arrangements where perpetual and subscriptions to our on premise term licenses are sold together as “Bundled Arrangements.” Occasionally, we enter into multiple-element arrangements with our customers in which a customer may purchase a combination of software on a perpetual or term basis, PCS, professional services, and appliances. We generally provide the appliances and software upon the commencement of the arrangement and provide software-related elements throughout the support period. We account for appliance-bundled arrangements under the revised accounting standard related to multiple-element arrangements, Accounting Standard Update, or ASU, No. 2009-13, Multiple Element Arrangements, and determine the revenue to be recognized based on the standard’s fair value hierarchy and then determine the value of each element in the arrangement based on the relative selling price of the arrangement. Amounts related to appliances are generally recognized upon delivery with the remaining consideration allocated to software and software-related elements, which are recognized as described elsewhere in this policy. Revenue from PCS is recognized ratably over the support term and is included as a component of software support and service revenue within the consolidated statements of operations. Revenue related to professional services is recognized upon delivery and is included as a component of software support and services revenue within the consolidated statements of operations. Prior to establishing VSOE of fair value for PCS and professional services on January 1, 2013, we recognized revenue for multiple element software and software-related arrangements ratably from the date of service commencement over the contractual term of the related PCS arrangement. After January 1, 2013, the deferred revenue related to these arrangements continues to be recognized ratably over the remaining contractual term of the PCS arrangement. We recognized $1.8 million and $5.2 million of perpetual license revenue in 2015 and 2014, respectively, from sales made prior to January 1, 2013. In 2016, we recognized no significant revenue from sales made prior to January 1, 2013. We allocated the revenue from all multiple-element arrangements entered into prior to the establishment of VSOE of fair value for our PCS and professional services to each respective revenue caption using our best estimate of value of each element based on the facts and circumstances of the arrangements, our go-to-market strategy, price list and discounts from price list as applicable. We believe that the allocation between the revenue captions allows for greater transparency and comparability of revenue from period to period even though VSOE of fair value may not have existed at that time. Appliance revenue was less than 10% of total revenue for all periods presented and is included as a component of perpetual license revenue within the consolidated statements of operations. Historically, sales made through resellers were fulfilled directly to end users, and we recognized revenue when we delivered licenses to end users and all other revenue recognition criteria were met. Over time, however, our business has evolved and some of our operators, system integrators and other resellers have requested that we deliver licenses to them. In those instances we recognize revenue at the time that we deliver to our resellers and all other revenue recognition criteria are met; such resellers have no rights of return or exchange. Shipping charges and sales tax billed to partners are excluded from revenue. Sales commissions and other incremental costs to acquire contracts are also expensed as incurred and are recorded in sales and marketing expense. For all arrangements, any revenue that has been deferred and is expected to be recognized beyond one year is classified as long-term deferred revenue in the consolidated balance sheets. Cash Equivalents We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. As of December 31, 2016 and 2015, cash and cash equivalents consisted of cash deposited with banks, money market funds and investments that mature within three months of their purchase. Held-To-Maturity Investments We determine the appropriate classification of our fixed income investments at the time of purchase and reevaluate their classifications each reporting period. Investments are classified as held-to-maturity since the Company has positive intent and the ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Comprehensive Loss Comprehensive loss includes all changes in equity (net assets) during a period from non-owner sources. In 2016, 2015 and 2014, there were no differences between net loss and comprehensive loss. Therefore, the consolidated statements of comprehensive loss have been omitted. Net Loss per Share of Common Stock Basic net loss per common share is calculated by dividing the net loss by the weighted-average number of common shares outstanding during the period, without consideration for potentially dilutive securities. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of common shares and potentially dilutive securities outstanding for the period determined using the treasury-stock and if-converted methods. For purposes of the diluted net loss per share calculation, convertible preferred stock, unvested restricted stock, restricted stock units and stock options are considered to be potentially dilutive securities. Because we have reported a net loss for 2016, 2015 and 2014, the number of shares used to calculate diluted net loss per common share is the same as the number of shares used to calculate basic net loss per common share for those periods presented because the potentially dilutive shares would have been anti-dilutive if included in the calculation. Software Development Costs Incurred in Connection with Software to be Sold or Marketed The costs to develop new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. We consider technological feasibility to have occurred when all planning, designing, coding and testing have been completed according to design specifications. Once technological feasibility is established, any additional costs would be capitalized. We believe our current process for developing software is essentially completed concurrent with the establishment of technological feasibility, and accordingly, no costs have been capitalized. Internal Use Software We capitalize costs incurred during the application development stage related to our internally used software. Such costs are primarily incurred by third-party vendors and consultants. Costs related to preliminary project activities and post-implementation activities are expensed as incurred. Amounts capitalized in all periods presented were not significant. All software development costs incurred in connection with our cloud offering, or SaaS, are also sold or marketed to partners or end customers, therefore we start capitalizing costs when technological feasibility is achieved. No costs were capitalized in any periods presented as we believe that our current process for developing software is essentially completed concurrent with the establishment of technological feasibility. Property and Equipment Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful life of the property and equipment, determined to be three years for computers and equipment and software, five years for furniture and fixtures, and the lesser of the remaining lease term or estimated useful life for leasehold improvements. Expenditures for repairs and software support are charged to expense as incurred. Upon disposition, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected as operating expenses in the consolidated statements of operations. Goodwill and Intangible Assets We record the excess of the acquisition purchase price over the fair value of the tangible and identifiable intangible assets acquired as goodwill. We perform an impairment test of our goodwill in the third quarter of our fiscal year, or more frequently if indicators of potential impairment arise. We have a single reporting unit and consequently evaluate goodwill for impairment based on an evaluation of the fair value of the Company as a whole. We record purchased intangible assets at their respective estimated fair values at the date of acquisition. Purchased intangible assets are being amortized using the straight-line method over their remaining estimated useful lives, which range from three to five years. We evaluate the remaining useful lives of intangible assets on a periodic basis to determine whether events or circumstances warrant a revision to the remaining estimated amortization period. We have determined that our intangible assets have not been impaired during the years ended December 31, 2016, 2015 and 2014. Long-Lived Assets with Finite Lives Long-lived assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable. We evaluate the recoverability of each of our long-lived assets, including purchased intangible assets and property and equipment, by comparison of its carrying amount to the future undiscounted cash flows we expect the asset to generate. If we consider the asset to be impaired, we measure the amount of any impairment as the difference between the carrying amount and the fair value of the impaired asset. Stock-Based Compensation We use the estimated grant-date fair value method of accounting in accordance with Accounting Standards Codification, or ASC, Topic 718 Compensation-Stock Compensation. Fair value is determined using the Black-Scholes Model using various inputs, including our estimates of expected volatility, term and future dividends. We estimated the forfeiture rate in 2016, 2015 and 2014 based on our historical experience for annual grant years where the majority of the vesting terms have been satisfied. We recognize compensation costs for awards with service and performance vesting conditions and for our Employee Stock Purchase Plan, or ESPP, on an accelerated method over the requisite service period of the award. For stock options or restricted stock grants with no performance condition, we recognize compensation costs on a straight-line basis over the requisite service period of the award, which is generally the vesting term of four years. Research and Development Research and development, or R&D, costs are charged to expense as incurred. Advertising Advertising costs are expensed and included in sales and marketing expense when incurred. Advertising expense in 2016, 2015 and 2014 was $305,000, $256,000 and $526,000, respectively. Income Taxes We account for income taxes in accordance with ASC Topic 740, Income Taxes, under which deferred tax liabilities and assets are recognized for the expected future tax consequences of temporary differences between financial statement carrying amounts and the tax basis of assets and liabilities and net operating loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. We use a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. A tax position is recognized when it is more likely than not that the tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority. The standard also provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure and transition. Recent Accounting Pronouncements From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board, or FASB, or other standard setting bodies and adopted by us as of the specified effective date. Unless otherwise discussed, the impact of recently issued standards that are not yet effective will not have a material impact on our financial position or results of operations upon adoption. In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments - Credit Losses - Measurement of Credit Losses on Financial Instruments, which introduces a model based on expected losses to estimate credit losses for most financial assets and certain other instruments. In addition, for available-for-sale debt securities with unrealized losses, the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. The standard is effective for annual reporting periods beginning after December 15, 2019, with early adoption permitted for annual reporting periods beginning after December 15, 2018. Entities will apply the standard’s provisions by recording a cumulative-effect adjustment to retained earnings. We are evaluating the impact of the adoption on our consolidated balance sheet, results of operations, cash flows and disclosures. In May 2014, the FASB, jointly with the International Accounting Standards Board, issued a comprehensive new standard on revenue recognition from contracts with customers. The standard’s core principle is that a reporting entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying this new guidance to contracts within its scope, an entity will: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. Additionally, this new guidance will require significantly expanded disclosures about revenue recognition. As clarified by the FASB on July 9, 2015, provisions of this new standard are effective for annual reporting periods (including interim reporting periods within those annual periods) beginning after December 15, 2017. Early adoption is permitted for annual reporting periods (including interim reporting periods within those annual periods) beginning after December 15, 2016. Entities have the option of using either a full retrospective or a modified retrospective approach to adopt this new guidance. We currently plan to adopt the new standard effective January 1, 2018. We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we believe the most significant impact relates to our accounting for subscriptions to our on-premise licenses, specifically, as under the new standard we expect to recognize revenue from those subscriptions predominantly at the time of billing rather than ratably over the license term. In addition, we expect accounting for commissions to be impacted significantly as we will capitalize and amortize most commissions under the new standard instead of expensing commissions as incurred. Due to the complexity of certain of our contracts, the revenue recognition treatment required under the new standard will be dependent on contract-specific terms. In February 2016, the FASB finalized the Accounting Standard Update, or ASU, 2016-02, “Leases”. ASU 2016-02 requires lessees to recognize the assets and liabilities on the balance sheet for the rights and obligations created by most leases (leases with the term of 12 months or longer) and continue to recognize expenses on the income statements over the lease term. It will also require disclosure designed to give financial statement users information on the amount, timing, and uncertainly of cash flows arising from leases. The guidance is effective for annual reporting periods beginning after December 15, 2018 and interim periods within those fiscal years. As a result of this new standard, we expect to record a lease commitment liability and corresponding asset for most of our leases. We will adopt ASU 2016-02 effective January 1, 2019. In March 2016, the FASB issued new Accounting Standard Update, or ASU, 2016-09, “Improvements to Employee Share-Based Payment Accounting”. ASU 2016-09 simplifies several aspects of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures, statutory tax withholding requirements and classification in the statement of cash flows. Under the new standard, excess tax benefits and tax deficiencies are to be recognized as income tax expense or benefit in the income statement and the excess tax benefits and tax deficiencies are considered discrete items in the reporting period they occur and are not included in the estimate of an entity’s annual effective tax rate. Excess tax benefits will be classified along with other cash flows related to income taxes as an operating activity. The ASU allows an entity to elect as an accounting policy either to continue to estimate the total number of awards that are expected to vest or account for forfeitures when they occur. The ASU modifies the current exception to liability classification of an award when an employer uses a net-settlement feature to withhold shares to meet the employer’s minimum statutory tax withholding requirement. The guidance is effective for annual reporting periods beginning after December 15, 2016 and interim periods within those fiscal years. We will adopt all relevant provisions of this update in the first quarter of fiscal 2017. We do not expect, that adoption of this update will have a significant effect on our consolidated balance sheet, results of operations, cash flows or statement of shareholders equity because we have a full valuation allowance on our deferred tax assets but it will have an impact on our disclosures. As part of this adoption, we will make an accounting policy election to continue to estimate the total number of awards that are expected to vest. 2. Significant Balance Sheet Components Property and Equipment-Property and equipment at December 31, 2016 and 2015 consisted of the following (in thousands): Accrued Expenses-Accrued expenses at December 31, 2016 and 2015 consisted of the following (in thousands): Deferred Revenue-Current and noncurrent deferred revenue at December 31, 2016 and 2015 consisted of the following (in thousands): 3. Fair Value Measurement With the exception of our held-to-maturity fixed income investments, we report financial assets and liabilities and nonfinancial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis in accordance with ASC 820 (formerly FASB Statement No. 157, Fair Value Measurements). ASC 820 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk. ASC 820 also establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three levels. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is available and significant to the fair value measurement. ASC 820 establishes and prioritizes three levels of inputs that may be used to measure fair value: · Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities. · Level 2-Inputs are quoted prices for similar assets and liabilities in active markets or inputs other than quoted prices that are observable for the assets or liabilities, either directly or indirectly through market corroboration, for substantially the full term of the financial instruments. · Level 3-Inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. The inputs require significant management judgment or estimation. Our financial assets that are carried at fair value include cash and money market funds. We had no financial liabilities, or nonfinancial assets and liabilities that were required to be measured at fair value on a recurring basis, or that were measured at fair value as of December 31, 2016 or 2015. Our financial instruments measured at fair market value as of December 31, 2016 and 2015 were as follows: 4. Investments Our portfolio of fixed income securities consists of commercial paper, corporate debt securities and securities and obligations of U.S. government agencies. All our investments in fixed income securities are classified as held-to-maturity. These investments are carried at amortized cost. Our investments in fixed income securities as of December 31, 2016 and 2015 were as follows: The following table summarizes the balance sheet classification of our investments: The gross amortized cost and estimated fair value of our held-to-maturity investments at December 31, 2016 and 2015 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. We monitor our investment portfolio for impairment on a periodic basis. In order to determine whether a decline in fair value is other-than-temporary, we evaluate, among other factors: the duration and extent to which the fair value has been less than the carrying value; our financial condition and business outlook, including key operational and cash flow metrics, current market conditions and future trends in our industry; our relative competitive position within the industry; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. A decline in the fair value of the security below amortized cost that is deemed other-than-temporary is charged to earnings, resulting in the establishment of a new cost basis for the affected securities. In 2016, we had an insignificant amount of unrealized gains or losses, and we did not recognize any other-than-temporary impairments. 5. Acquisitions In November 2014, we purchased developed technology for $650,000 to enhance our product portfolio, which we capitalized in intangible assets-net on the accompanying balance sheet and expect to amortize on a straight-line basis over its estimated useful life of three years. In April 2014, we completed the acquisition of certain assets of Averail Corporation, or Averail, a privately-held content security-oriented software company, for 276,463 shares of common stock and the assumption of certain liabilities. The assets acquired will provide additional features in our Docs@Work product. Included in the total, 43,612 shares subject to a holdback provision for standard representations and warranties were released in October 2015. The aggregate purchase price of the transaction was approximately $2.0 million, net of liabilities assumed. In connection with this acquisition, 103,231 of these shares were distributed to entities affiliated with Storm Ventures, and 103,232 of these shares were issued to entities affiliated with Foundation Capital, subject to certain holdback provisions. The Storm Ventures entities and the Foundation Capital entities each collectively hold more than 5% of our capital stock. In addition, Tae Hea Nahm, an affiliate of Storm Ventures, serves on our board of directors and was a director of Averail prior to its acquisition. The aggregate value of the securities issued to our investors was approximately $1.5 million. The total consideration for this transaction was approximately $2.0 million and consisted of the following (in thousands except share data): Transaction costs associated with the acquisition were $167,000, all of which we expensed in 2014, and are included in general and administrative expense in the accompanying consolidated statements of operations. We accounted for the Averail acquisition as a business combination. The assets acquired and liabilities assumed were recorded at fair market value. The excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired was recorded as goodwill. The goodwill generated from this business combination was primarily related to value placed on the employee workforce and expected synergies. Goodwill for all acquisitions is not amortized and is not deductible for tax purposes. The purchase price was allocated as follows (in thousands): The technology intangible asset is being amortized on a straight-line basis over a period of four years and is reported, net of accumulated amortization, in the accompanying consolidated balance sheets as of December 31, 2016 and 2015. Amortization expense related to the intangible asset was $400,000 in each of 2016 and 2015 and $300,000 in 2014, and was included in cost of revenue. The amount of revenue and earnings from the acquisitions are included in the condensed consolidated statements of operations and pro forma results of operations for the acquisition have not been presented because the effect of the acquisition was not significant to our financial results. 6. Goodwill and Intangibles The following table reflects intangible assets subject to amortization as of December 31, 2016 and 2015 (in thousands): Amortization of the technology intangible assets was recorded in cost of revenue. The weighted average remaining life of our intangible assets on December 31, 2016 was 1.1 years. Estimated remaining intangible assets amortization expense for their remaining lives as follows (in thousands): At December 31, 2016, 2015 and 2014, the carrying value of goodwill was $5.5 million. 7. Restructuring Charges We initiated business restructuring plans in 2015 and 2016 to reduce our cost structure through workforce reductions. These restructuring activities were substantially complete as of December 31, 2016. The following table sets forth a summary of restructuring activities which took place during the years ended December 31, 2016 and 2015 (in thousands): The remaining restructuring balance as of December 31, 2016 relates to employee severance, which we expect to pay by March 31, 2017. 8. Line of Credit We have a $20.0 million revolving line of credit with a financial institution that can be used to (a) borrow for working capital and general business requirements, (b) issue letters of credit, and (c) enter into foreign exchange contracts. Amounts borrowed accrue interest at a floating per annum rate equal to the prime rate. A default interest rate shall apply during an event of default at a rate per annum equal to 5% above the otherwise applicable interest rate. The line of credit is collateralized by substantially all of our assets, except intellectual property, and requires us to comply with working capital, net worth and other covenants, including limitations on indebtedness and restrictions on dividend distributions, among others, and the borrowing capacity is limited to eligible accounts receivable. We are required to maintain an adjusted quick ratio (defined as the ratio of current assets to current liabilities minus deferred revenue) of at least 1.25. In 2014, we withdrew $3.3 million and repaid $7.6 million under our line of credit. There were no outstanding amounts under the line of credit at December 31, 2016 and 2015. In May 2015, we issued a letter of credit for $1.5 million as a security deposit for a new Mountain View facility lease thereby reducing the borrowing capacity under our line of credit to $18.5 million. In July 2015, we amended our revolving line of credit and extended its maturity date to August 2017. There were no other outstanding amounts under the line of credit at December 31, 2016 and 2015, we were in compliance with all financial covenants. 9. Preferred Stock Upon completion of our IPO in June 2014, all shares of our issued and outstanding convertible preferred stock were automatically converted into 49,646,975 shares of common stock. We amended and restated our certificate of incorporation in June 2014 to authorize the future issuance of up to 10,000,000 shares of convertible preferred stock. No shares of convertible preferred stock were issued and outstanding as of December 31, 2016. In January 2014, we issued 200,903 shares of Series F for net cash proceeds of $2.0 million. The following table summarizes information regarding our convertible preferred stock by class immediately prior to the IPO (in thousands, except share and per share data): 10. Common Stock We were authorized to issue 300,000,000 shares of common stock with a par value of $0.0001 per share as of December 31, 2016 and 2015. Each share of common stock is entitled to one vote. The holders of common stock are also entitled to receive dividends from funds available, when and if declared by the board of directors, subject to the approval and priority rights of holders of all classes of preferred stock outstanding. As of December 31, 2016 and 2015, we reserved shares of common stock for issuance as follows: 11. Share Based Awards 2008 Plan The 2008 Stock Plan, or 2008 Plan, which expired on June 12, 2014, provided for the grant of incentive and nonstatutory stock options to employees, nonemployee directors and consultants of the Company. Options granted under the 2008 Plan generally become exercisable within three to four years following the date of grant and expire 10 years from the date of grant. When options are subject to our repurchase right, we may buy back any unvested shares at their original exercise price in the event of an employee’s termination prior to full vesting. Our 2008 Plan was terminated following the date our 2014 Equity Incentive Plan, or the 2014 Plan, became effective. Any outstanding stock awards under our 2008 Plan will continue to be governed by the terms of our 2008 Plan and applicable award agreements. 2014 Equity Incentive Plan Our board of directors adopted our 2014 Plan on April 17, 2014, and our stockholders subsequently approved the 2014 Plan on May 27, 2014. The 2014 Plan became effective on the date that our registration statement was declared effective by the SEC. The 2014 Plan is the successor to and continuation of our 2008 Plan. Upon the effective date of the 2014 Plan, no further grants can be made under our 2008 Plan. Our 2014 Plan provides for the grant of incentive stock options, or ISOs, within the meaning of Section 422 of the Internal Revenue Code, or the Code, to our employees and our parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, or NSOs, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance-based stock awards, and other forms of equity compensation to our employees, directors and consultants. Additionally, our 2014 Plan provides for the grant of performance cash awards to our employees, directors and consultants. The initial number of shares of our common stock available to be issued under our 2014 Plan was 8,142,857, which number of shares will be increased by any shares subject to stock options or other stock awards granted under the 2008 Plan that would have otherwise returned to our 2008 Plan (such as upon the expiration or termination of a stock award prior to vesting), not to exceed 16,312,202. The number of shares of our common stock reserved for issuance under our 2014 Plan automatically increase on January 1 of each year, beginning on January 1, 2015 and continuing through and including January 1, 2024, by 5% of the total number of shares of our capital stock outstanding on December 31 of the preceding calendar year, or a lesser number of shares determined by our board of directors. On January 1, 2016, we increased the number of shares of common stock reserved for issuance under our 2014 Plan by 4,066,933 shares, which was 5% of the total number of capital stock outstanding at December 31, 2015. Amended and Restated 2015 Inducement Plan On December 20, 2015, our board of directors adopted our Amended and Restated 2015 Inducement Plan, or the Inducement Plan, to reserve 1,600,000 shares of our common stock to be used exclusively for grants of awards to individuals that were not previously employees or directors of the Company. The terms and conditions of the Plan are substantially similar to our stockholder-approved 2014 Plan. On January 5, 2016 our board of directors approved the amendment and restatement of the Inducement Plan to increase the share reserve under the Inducement Plan to 1,970,000 shares of our common stock. As of December 31, 2016 there were 1,970,000 options and restricted stock units outstanding under the Inducement Plan. 2014 Employee Stock Purchase Plan Our board of directors adopted our 2014 Employee Stock Purchase Plan, or ESPP, on April 17, 2014, and our stockholders subsequently approved the ESPP on May 27, 2014. The ESPP became effective immediately upon the execution and delivery of the underwriting agreement related to our IPO. The purpose of the ESPP is to secure the services of new employees, to retain the services of existing employees and to provide incentives for such individuals to exert maximum efforts toward our success and that of our affiliates. The ESPP is intended to qualify as an “employee stock purchase plan” within the meaning of Section 423 of the Code. The ESPP permits eligible employees to purchase our common stock through payroll deductions, which may not exceed 15% of the employee’s base compensation. Stock may be purchased under the plan at a price equal to 85% of the fair market value of our common stock on either the first day of the offering or the last day of the applicable purchase period, whichever is lower. As of December 31, 2016 and 2015, approximately 575,974 and 1,561,929 shares of common stock were available for future issuance under our ESPP, respectively. The number of shares of our common stock reserved for issuance under our ESPP increase automatically each year, beginning on January 1, 2015 and continuing through and including January 1, 2024, by the lesser of (i) 1% of the total number of shares of our common stock outstanding on December 31 of the preceding calendar year; (ii) 2,142,857 shares of common stock; or (iii) such lesser number as determined by our board of directors. Shares subject to purchase rights granted under our ESPP that terminate without having been exercised in full will not reduce the number of shares available for issuance under our ESPP. On January 1, 2016, we increased the number of shares available for issuance under the ESPP by 813,386 shares, which was 1% of the total number of capital stock outstanding at December 31, 2015. Restricted Stock and Restricted Stock Units Restricted stock activity in 2014 and 2015 was as follows: No restricted stock was granted, vested or cancelled/forfeited in 2016. For stock-based compensation expense, we measured the value of the restricted stock based on the fair value of our common stock on the date of grant. Our restricted stock grants were subject to service only or service and performance-based vesting conditions. We expensed the fair value of restricted stock grants with service only vesting conditions on a straight-line basis over the vesting period of the awards. For restricted stock subject to service and performance conditions, we evaluated the probability of meeting the vesting conditions at the end of each reporting period to determine how much compensation expense to record. We amortized the fair value, net of estimated forfeitures, as stock-based compensation expense using the graded vesting method over the vesting periods of the awards. To the extent that actual results or updated estimates differed from our original estimates, the cumulative effect on current and prior periods of those changes was recorded in the period those estimates were revised. In 2014 we began granting restricted stock units under our 2014 Plan. For stock-based compensation expense, we measure the value of the restricted stock units based on the fair value of our common stock on the date of grant. Our restricted stock unit grants are subject to service conditions and we expense the fair value of those shares on a straight-line basis over their vesting periods. Our restricted stock unit activity for 2014, 2015 and 2016 was as follows: Bonus Plans In 2015, our board of directors approved the 2015 Executive Bonus Plan and 2015 Non-Executive Bonus Plan, or 2015 Bonus Plan, which provided for the issuance of shares of unrestricted common stock to employees based on meeting certain Company metrics. We issued 1,653,371 shares of unrestricted common stock in the first quarter of 2016 based on amounts earned under the 2015 Non-Executive Bonus Plan. No shares were issued under the 2015 Executive Bonus Plan. Shares issued from the 2015 Non-Executive Bonus Plan reduced the 2014 Plan shares available for issuance. In May 2016, our compensation committee approved the 2016 Executive Bonus Plan and 2016 Non-Executive Bonus Plan, or 2016 Bonus Plans, each effective as of January 1, 2016. We recorded stock-based compensation expense related to the 2015 and 2016 Bonus Plans over the service period of eligible employees based on forecasted performance relative to the Company metrics. To the extent that updated estimates of bonus expense differed from original estimates, the cumulative effect on current and prior periods of those changes was recorded in the period those estimates were revised. In 2015 we recorded $4.7 million of stock-based compensation expense under the 2015 Non-Executive Bonus Plan. In 2016 we recorded $6.6 million of stock-based compensation expense under the 2016 Bonus Plans and $923,000 under the 2015 Non-Executive Bonus Plan. Stock Options Stock option activity under the 2008 Plan, 2014 Plan and the Inducement Plan in 2014, 2015 and 2016 was as follows: (1) Includes early exercises of 42,772 in 2014. In 2015 or 2016 no shares of common stock were issued for the exercise of common stock options prior to their vesting dates, or early exercises. (2) Options expected to vest are net of an estimated forfeiture rate. Additional information regarding options outstanding at December 31, 2016 is as follows: The aggregate pretax intrinsic value of vested options exercised in 2016, 2015 and 2014 was $1.4 million, $11.8 million and $5.4 million, respectively. The intrinsic value is the difference between the estimated fair value of the Company’s common stock at the date of exercise and the exercise price for in-the-money options. The weighted-average grant-date fair value of options granted in 2016, 2015 and 2014 was $1.42, $3.04 and $4.09 per share, respectively. Our stock-based compensation expense was recorded in the following cost and expense categories (in thousands): Determining Fair Value of Stock Options The fair value of each grant of stock options was determined by us using the methods and assumptions discussed below. Each of these inputs is subjective and generally requires significant judgment to determine. Expected Term-The expected term of stock options represents the weighted-average period the stock options are expected to be outstanding. For option grants that are considered to be “plain vanilla”, we have opted to use the simplified method for estimating the expected term as provided by the Securities and Exchange Commission. The simplified method calculates the expected term as the average of time-to-vesting and the contractual life of the options. Expected Volatility-The expected stock price volatility assumption was determined by examining the historical volatilities of a group of industry peers, as we do not have a significant trading history for our common stock. We will continue to analyze our historical stock price volatility and expected term assumptions as more historical data for our common stock becomes available. Risk-Free Interest Rate-The risk free rate assumption was based on the U.S. Treasury instruments with terms that were consistent with the expected term of our stock options. Expected Dividend-The expected dividend assumption was based on our history and expectation of dividend payouts. Forfeiture Rate-Forfeitures were estimated based on historical experience. Fair Value of Common Stock-Prior to the IPO, the fair value of the shares of common stock underlying the stock options was historically been the responsibility of and determined by our board of directors. Because there was no public market for our common stock, the board of directors determined fair value of common stock at the time of grant of the option by considering a number of objective and subjective factors including independent third-party valuations of our common stock, sales of convertible preferred stock to unrelated third parties, operating and financial performance, the lack of liquidity of capital stock and general and industry specific economic outlook, amongst other factors. Following the closing of the IPO offering, the fair value of our common stock is determined based on the closing price of our common stock on the NASDAQ Global Select Market. We used the Black-Scholes Model to estimate the fair value of our stock options granted to employees with the following weighted-average assumptions: We used the Black-Scholes model to estimate the fair value of our Employee Stock Purchase Plan awards with the following assumptions: As required by Topic 718 Compensation-Stock Compensation, we estimate expected forfeitures and recognize compensation costs only for those equity awards expected to vest. Our stock options granted are typically granted with vesting terms of 48 months. The following table summarizes our unrecognized stock-based compensation expense as of December 31, 2016 net of estimated forfeitures: Early Exercise of Common Stock In 2014 we issued 42,772 shares of common stock for the exercise of common stock options prior to their vesting dates, or early exercises. In 2015 or 2016 no shares of common stock were issued for the exercise of common stock options prior to their vesting dates, or early exercises. Cash received from all such early exercises of stock options is recorded in accrued expenses on the consolidated balance sheets and reclassified to stockholders’ equity as the options vest. The unvested shares are subject to our repurchase right at the original purchase price. As of December 31, 2016 and 2015 there were 2,471 and 12,428 shares, respectively, legally outstanding, but not included within common stock outstanding for accounting purposes as a result of the exercise of common stock options which were not yet vested. As of December 31, 2015, the aggregate price of shares subject to repurchase recorded in accrued expenses totaled $48,000. The aggregate price of shares subject to repurchase in accrued expenses as of December 31, 2016 was insignificant. 12. Employee Benefit Plan We maintain a defined contribution 401(k) plan. The plan covers all full-time U.S. employees over the age of 21. Each employee can contribute up to $18,000 annually (with a $6,000 catch up contribution limit for employees aged 50 or older). We have the option to provide matching contributions, but have not done so to date. 13. Commitments and Contingencies Operating Leases We lease our office facilities under noncancelable agreements expiring between 2017 and 2023. Rent expense in 2016, 2015 and 2014 was $6.7 million, $4.7 million and $2.6 million. respectively. The aggregate future minimum lease payments under the agreements are as follows (in thousands): Litigation On May 1, 2015, a purported stockholder class action lawsuit was filed in the United States District Court for the Northern District of California against the Company and certain of its officers, captioned Panjwani v. MobileIron, Inc., et al. The action was purportedly brought on behalf of a putative class of all persons who purchased or otherwise acquired the Company’s securities between February 13, 2015 and April 22, 2015. It asserted claims for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The complaint sought, among other things, compensatory damages and attorney’s fees and costs on behalf of the putative class. An amended complaint was filed on September 28, 2015. On February 22, 2016, the District Court issued an order granting MobileIron’s motion to dismiss the amended complaint and on March 15, 2016 the Court dismissed the case. MobileIron paid no money to the plaintiffs or their attorneys in connection with the dismissal of the action On August 5, 2015, August 21, 2015 and August 24, 2015, purported stockholder class action lawsuits were filed in the Superior Court of California, Santa Clara County against the Company, certain of its officers, directors, underwriters and investors, captioned Schneider v. MobileIron, Inc., et al., Kerley v. MobileIron, Inc., et al. and Steinberg v. MobileIron, Inc., et al, which were subsequently consolidated under the case caption In re MobileIron Shareholder Litigation. The actions are purportedly brought on behalf of a putative class of all persons who purchased the Company’s securities issued pursuant or traceable to the Company’s registration statement and the June 12, 2014 initial public offering. The lawsuits assert claims for violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. The complaint seeks among other things, compensatory damages and attorney’s fees and costs on behalf of the putative class. On April 12, 2016, Plaintiffs filed a corrected consolidated complaint, which no longer names the underwriters or investors as defendants. On August 8, 2016 the Company filed a demurrer to the corrected consolidated complaint. The court overruled the demurrer on October 4, 2016. The Company intends to defend this litigation vigorously. We continually evaluate uncertainties associated with litigation and record a charge equal to at least the minimum estimated liability for a loss contingency when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements and (ii) the loss or range of loss can be reasonably estimated. If we determine that a loss is possible and a range of the loss can be reasonably estimated, we disclose the range of the possible loss in the Notes to the Consolidated Financial Statements. We evaluate, on a quarterly basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, if any, and the matters and related ranges of possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount of a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss, and such amounts could be material. An estimate of a reasonably possible loss (or a range of loss) cannot be made in our lawsuits at this time. Indemnification Under the indemnification provisions of our standard sales related contracts, we agree to defend and/or settle claims brought by third parties against our customers alleging that the customer’s use of our software infringes the third party’s intellectual property right, such as a patent right. These indemnification obligations are typically not subject to limitation; however if it is commercially impractical for us to either procure the right for the customer to continue to use our software or modify our software so that it’s not infringing, we typically can terminate the customer agreement and refund the customer a portion of the license fees paid, prorated over the three year period from initial delivery. We also on occasion indemnify our customers for other types of third party claims. In addition, we indemnify our officers, directors, and certain key employees while they are serving in such capacities in good faith. Through December 31, 2016, we have not received any material written claim for indemnification. 14. Segment Information We conduct business globally. Our chief operating decision maker (Chief Executive Officer) reviews financial information presented on a consolidated basis accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. We have one business activity, and there are no segment managers who are held accountable for operations, operating results and plans for levels, components or types of products or services below the consolidated unit level. Accordingly, we are considered to be in a single reportable segment and operating unit structure. Revenue by geographic region based on the billing address was as follows: We recognized revenue of $21.3 million, or 13% of total revenue, from customers with a billing address in Germany in 2016. No other country, outside of the United States, exceeded 10% of the total revenue in 2016. No country, outside of the United States, exceeded 10% of the total revenue in the year ended December 31, 2015 or 2014. As of December 31, 2016 and 2015, $1.3 million and $1.4 million or 24% and 22%, respectively, of our net Property and Equipment was attributable to our operations located in India. Substantially all other long-lived assets were attributable to operations in the United States. 15. Net Loss per Share The following table sets forth the computation of basic and diluted net loss per share for 2016, 2015 and 2014 (in thousands, except per share data): Basic net loss per share is computed by dividing the net loss by the weighted-average number of common shares outstanding for the period. Because we have reported a net loss for 2016, 2015 and 2014, the number of shares used to calculate diluted net loss per common share is the same as the number of shares used to calculate basic net loss per common share for those periods presented because the potentially dilutive shares would have been anti-dilutive if included in the calculation. The following potentially dilutive securities outstanding have been excluded from the computation of diluted weighted-average shares outstanding because such securities have an antidilutive impact due to losses reported (in common stock equivalent shares): 16. Income Taxes Loss before income taxes consisted of the following (in thousands): A significant portion of our international income is earned by foreign branches of our United States parent corporation and thus is already subject to United States taxation. The income of our foreign branches has been included as part of the United States jurisdiction in the table above. Income tax expense for 2016, 2015 and 2014, was composed of the following (in thousands): For 2016, 2015 and 2014, our effective tax rate differs from the amount computed by applying the statutory federal and state income tax rates to net loss before income tax, primarily as the result of changes in valuation allowance. Income tax expense for 2016, 2015 and 2014 relates to state minimum income tax, income tax on our earnings in foreign jurisdictions, and, in 2016 and 2015, withholding taxes on sales to customers in certain jurisdictions. A significant portion of our international income is earned by foreign branches of our United States parent corporation and thus is already subject to United States taxation. The income of our foreign branches has been included as part of the United States jurisdiction in the table above. The components of net deferred tax assets at December 31, 2016 and 2015 consisted of the following (in thousands): Our accounting for deferred taxes involves the evaluation of a number of factors concerning the realizability of our net deferred tax assets. We primarily considered such factors as our history of operating losses, the nature of our deferred tax assets and the timing, likelihood and amount, if any, of future taxable income during the periods in which those temporary differences and carryforwards become deductible. At present, we do not believe that it is more likely than not that the deferred tax assets will be realized; accordingly, a full valuation allowance has been established and no deferred tax asset is shown in the accompanying consolidated balance sheets. As of December 31, 2016, we had net operating loss carryforwards of approximately $241.3 million and $101.7 million available to reduce future taxable income, if any, for both federal and state income tax purposes, respectively. The federal and state net operating loss carryforwards will expire at various dates beginning 2027 and 2017, respectively. We had federal and California R&D tax credit carryforwards at December 31, 2016 of $8.4 million and $9.5 million, respectively. If not utilized, the federal R&D tax credit carryforward will expire in various portions beginning 2027. The California R&D tax credit can be carried forward indefinitely. A limitation may apply to the use of the net operation loss and credit carryforwards, under provisions of the Internal Revenue Code that are applicable if we experience an “ownership change”. That may occur, for example, as a result of trading in our stock by significant investors as well as issuance of new equity. Should these limitations apply, the carryforwards would be subject to an annual limitation, resulting in a substantial reduction in the gross deferred tax assets before considering the valuation allowance. Further, a portion of the carryforwards may expire before being applied to reduce future earnings. As a result of certain realization requirements of ASC 718, the table of deferred tax assets and liabilities shown above does not include certain deferred tax assets as of December 31, 2016 and 2015 that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by $5.4 million if and when such deferred tax assets are ultimately realized. We use ASC 740 ordering when determining when excess tax benefits have been realized. We follow the provisions of ASC 740-10, Accounting for Uncertainty in Income Taxes. ASC 740-10 prescribes a comprehensive model for the recognition, measurement, presentation and disclosure in financial statements of uncertain tax positions that have been taken or expected to be taken on a tax return. No non-current liability related to uncertain tax positions is recorded in the financial statements as the deferred tax assets have been presented net of these unrecognized tax benefits. At December 31, 2016 and 2015, our reserve for unrecognized tax benefits was approximately $5.3 million and $4.1 million, respectively. Due to the full valuation allowance at December 31, 2016, current adjustments to the unrecognized tax benefit will have no impact on our effective income tax rate; any adjustments made after the valuation allowance is released will have an impact on the tax rate. We do not anticipate any significant change in our uncertain tax positions within 12 months of this reporting date. We include penalties and interest expense related to income taxes as a component of other expense and interest expense, respectively, as necessary. A reconciliation of the gross unrealized tax benefits is as follows (in thousands): We are subject to taxation in the United States and various states and foreign jurisdictions. As of December 31, 2016, the statute of limitations is open for all tax years from inception, that is, for the period from July 23, 2007 (date of inception) to December 31, 2016 and forward for federal, state and foreign tax purposes. | Based on the provided financial statement excerpt, here's a summary:
Financial Performance Overview:
- Foreign Currency Impact: Recognized a foreign currency loss of approximately $339,000
- Translation Method: Assets and liabilities translated using historical and weighted-average exchange rates
- Financial Reporting: Preparing for new accounting standards related to debt securities and unrealized losses
Key Financial Metrics:
- Current Assets to Current Liabilities Ratio: Required to maintain a ratio of at least 1.25
- Reporting Period: Focused on 2016 financial data
Note: The summary is limited due to the fragmented nature of the provided financial statement excerpt. A complete financial statement would provide more comprehensive insights into the company's financial health. | Claude |
FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm Financial Statements: Balance Sheets Statements of Operations Statements of Cash Flows Statements of Changes in Stockholders’ Deficit Notes to the Financial Statements 11-13 ACCOUNTING FIRM To the Shareholders and Board of Directors of Green Planet Bioengineering Co., Ltd We have audited the accompanying balance sheets of Green Planet Bioengineering Co., Ltd. as of December 31, 2016 and 2015 and the related statements of operations, changes in stockholders’ deficit and cash flows for each of the years in the two year period ended December 31, 2016. Green Planet Bioengineering Co., Ltd.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Green Planet Bioengineering Co., Ltd. as of December 31, 2016 and 2015, and the results of its operations and cash flows for each of the years in the two year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. These financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company has operating and liquidity concerns. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of these uncertainties. /s/ Schulman Lobel Zand Katzen Williams & Blackman, LLP New York, New York March 10, 2017 Green Planet Bioengineering Co., Ltd Balance Sheets (Stated in US Dollars) See Notes to the Financial Statements Green Planet Bioengineering Co., Ltd Statements of Operations (Stated in US Dollars) * Less than $0.01 per share See Notes to the Financial Statements Green Planet Bioengineering Co., Ltd Statements of Cash Flows (Stated in US Dollars) See Notes to the Financial Statements Green Planet Bioengineering Co., Ltd Statements of Changes in Stockholders’ Deficit (Stated in US Dollars) See Notes to the Financial Statements Green Planet Bioengineering Co., Ltd. Notes to the Financial Statements 1. General Information Mondo Acquisition II, Inc. was incorporated in the State of Delaware on October 30, 2006 and the name was changed to Green Planet Bioengineering Co., Ltd. (“Company”) on October 2, 2008. In October 2008, the Company acquired Elevated Throne Overseas Ltd, incorporated in British Virgin Islands, and its subsidiaries (“Elevated Throne”) and operated the business in the agritech sector in the People’s Republic of China. The Company divested Elevated Throne to One Bio, Corp. (“ONE”) on April 14, 2010. In March 2012, the Company became a wholly owned subsidiary of Global Funds Holdings Corp. (“Global Funds”) an Ontario, Canada corporation. The Company operates as a public reorganized shell corporation with the purpose to acquire or merge with an existing business operation. The Company's activities are subject to significant risks and uncertainties, as their ability to implement and execute future business plans and generate sufficient business revenue is directly influenced by their ability to secure adequate financing or find profitable business opportunities. 2. Summary of Significant Accounting Policies Basis of Presentation The financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”). Use of Estimates The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses for the years reported. Actual results could differ from those estimates. Significant items that require estimates were accruals of liabilities. Cash and Cash Equivalents Cash and cash equivalents include all cash, deposits in banks and other highly liquid investments with initial maturities of three months or less to be cash equivalents. Balances of cash and cash equivalents in financial institutions may at times exceed the government-insured limits. Income Taxes The Company accounts for income taxes in accordance with FASB ASC Topic 740 “Income Taxes” under which deferred tax assets and liabilities are determined based on temporary differences between accounting and tax bases of assets and liabilities and net operating loss and credit carry forwards, using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. A provision for income tax expense is recognized for income taxes payable for the current period, plus the net changes in deferred tax amounts. Any interest and penalties are expensed in the year that the Notice of Assessment is received. The Company’s practice is to recognize interest and/or penalties related to income tax matters as interest expense. Earnings Per Share Earnings per share is reported in accordance with FASB ASC Topic 260 “Earnings per Share” which requires dual presentation of basic earnings per share (“EPS”) and diluted EPS on the face of all statements of earnings, for all entities with complex capital structures. Diluted EPS reflects the potential dilution that could occur from common shares issuable through the exercise or conversion of stock options, restricted stock awards, warrants and convertible securities. In certain circumstances, the conversion of these options, warrants and convertible securities are excluded from diluted EPS if the effect of such inclusion would be anti-dilutive. Fully diluted EPS is not provided, when the effect is anti-dilutive. When the effect of dilution on loss per share is anti-dilutive, diluted loss per share equals the loss per share. Basic and diluted EPS was calculated using the average number of shares outstanding, which is 20,006,402 for 2016 and 2015. Basic EPS was 20,006,402 and diluted EPS includes both the average number of shares and warrants outstanding, which were all expired in December 2014. Since the warrants were considered anti-dilutive, the basic and diluted EPS was 20,006,402 for 2016 and 2015. 2. Summary of Significant Accounting Policies - continued Fair Value Measurements FASB ASC Topic 820, “Fair Value Measurements and Disclosures” defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP, and expands disclosures about fair value measurements. Investments measured and reported at fair value are classified and disclosed in one of the following hierarchy: Level 1 - Quoted prices are available in active markets for identical investments as of the period reporting date. Level 2 - Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value is determined through the use of models or other valuation methodologies. Level 3 - Pricing inputs are unobservable for the investment and included situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require significant management judgment or estimation. Recent Changes in Accounting Standards A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to the Company’s financial statements. 3. Going Concern The financial statements have been prepared assuming that the Company will continue as a going concern. The Company is currently a public reorganized shell corporation and has no current business activity. The Company’s ability to continue as a going concern is dependent on continued support from Global Funds, the majority stockholder. 4. Amount Due to a Related Company The Company relies on a related company to advance funds to fund its operating expenses. The amounts advanced are interest-free, unsecured and are repayable upon demand. 5. Preferred Stock Series A preferred stock The Company is authorized under its Articles of Incorporation to issue 10,000,000 shares of Series A preferred stock with a par value of $0.001 per share. Each share of the Company’s preferred stock provides the holder with the right to vote 1,000 votes on all matters submitted to a vote of the shareholders of the Company and is convertible into 1,000 shares of the Company’s common stock. The preferred stock is non-participating and carries no dividend. The Company does not have any issued shares of the preferred stock as of December 31, 2016 and 2015. 6. Stock-based compensation There was no non-cash stock-based compensation recognized for the years ended December 31, 2016 and 2015. 7. Income Tax As of December 31, 2016, the Company had net operating loss carry forwards of $276,431 that may be available to reduce future years’ taxable income through 2035 if not limited. Future tax benefits which may arise as a result of these losses have not been recognized in these financial statements, as their realization is determined not likely to occur and accordingly, the Company has recorded a valuation allowance for the deferred tax asset relating to these tax loss carry-forwards. The provision for Federal income tax consists of the following for the years ended December 31, 2016 and December 31, 2015: The cumulative tax effect at the expected rate of 34% of significant items comprising our net deferred tax amount is as follows as of December 31, 2016 and December 31, 2015: The valuation allowance increased by $12,122 from December 31, 2015 to December 31, 2016. Due to the change in ownership in March 2012, the net operating loss carry forwards as of December 31, 2011 of $213,844 may be subject to limitations in accordance with Sec 382 of the provisions of the Tax Reform Act of 1986 for Federal income tax purposes. | This appears to be a partial financial statement excerpt focusing on tax accounting and earnings per share. Key points include:
1. Tax Accounting Practices:
- Uses enacted tax rates for calculating tax differences
- Establishes valuation allowances for deferred tax assets
- Recognizes income tax expense for current period taxes and deferred tax changes
- Handles interest and penalties related to tax matters as interest expense
2. Earnings Per Share:
- Follows FASB ASC Topic 260 accounting standards for reporting
3. The document is signed by an accounting firm (Schulman Lobel Zand Katzen Williams & Blackman, LLP) in New York, dated March 10.
The excerpt seems to be discussing the company's approach to tax accounting and financial reporting, with an emphasis on transparency and compliance with accounting standards. | Claude |
The following financial statements are filed as a part of this Annual Report on Form 10-K: Consolidated Financial Statements Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Zynerba Pharmaceuticals, Inc.: We have audited the accompanying consolidated balance sheets of Zynerba Pharmaceuticals, Inc. and subsidiary as of December 31, 2016 and 2015, and the related consolidated statements of operations, redeemable convertible preferred stock, convertible preferred stock and stockholders’ equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Zynerba Pharmaceuticals, Inc. and subsidiary as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. /s/ KPMG LLP Philadelphia, Pennsylvania March 27, 2017 ZYNERBA PHARMACEUTICALS, INC. CONSOLIDATED BALANCE SHEETS See accompanying notes to consolidated financial statements. ZYNERBA PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS See accompanying notes to consolidated financial statements. ZYNERBA PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT) YEARS ENDED DECEMBER 31, 2014, 2015 and 2016 See accompanying notes to consolidated financial statements. ZYNERBA PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS See accompanying notes to unaudited consolidated financial statements ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Nature of Business and Liquidity Zynerba Pharmaceuticals, Inc., together with its subsidiary, Zynerba Pharmaceuticals Pty Ltd (the “Company”, “we”), is a clinical stage specialty pharmaceutical company dedicated to developing and commercializing innovative transdermal cannabinoid treatments for patients with high unmet needs. The Company was incorporated on January 31, 2007 under the laws of the State of Delaware as AllTranz, Inc. and changed its name to Zynerba Pharmaceuticals, Inc. in August 2014. The Company operated in Lexington, Kentucky until October 2014 when it moved its operations to Pennsylvania. The Company has incurred losses and negative cash flows from operations since inception and has an accumulated deficit of $46.0 million as of December 31, 2016. The Company anticipates incurring additional losses until such time, if ever, that it can generate significant revenue from its product candidates currently in development. The Company's primary source of liquidity has been the issuance of equity securities and convertible promissory notes. In August 2015, the Company completed its Initial Public Offering (IPO) of common stock selling 3,450,000 shares at an offering price of $ 14.00 per share, resulting in gross proceeds of $48.3 million. Net proceeds received after underwriting fees and offering expenses were $42.1 million. In connection with the IPO, all outstanding shares of Series 1 convertible preferred stock converted into 3,704,215 shares of common stock. During the year ended December 31, 2016, the Company entered into an Open Market Sales Agreement (the “Sales Agreement”) with Jefferies LLC (“Jefferies”) pursuant to which the Company sold and issued 794,906 shares of common stock in the open market at a weighted average selling price of $13.39 per share, for gross proceeds of $10.6 million. Net proceeds received after deducting commissions and offering expenses were $10.0 million. In the first quarter of 2017, the Company completed a follow-on public offering, selling 3,220,000 shares at an offering price of $18.00 per share resulting in gross proceeds of $58.0 million. Net proceeds received after deducting underwriting and commissions and offering expenses were $54.3 million. Management believes that current cash and cash equivalents, including proceeds from the Company’s follow-on public offering in the first quarter of 2017, are sufficient to develop five Phase 3 ready programs and, assuming feedback from the FDA supports a decision to move forward, initiate at least one Phase 3 program and fund operations and capital requirements into 2019. Substantial additional financings will be needed by the Company to fund its operations, to complete clinical development of and to commercially develop its product candidates. There is no assurance that such financing will be available when needed or on acceptable terms. The Company is subject to those risks associated with any clinical stage pharmaceutical company that has substantial expenditures for research and development. There can be no assurance that the Company's research and development projects will be successful, that products developed will obtain necessary regulatory approval, or that any approved product will be commercially viable. In addition, the Company operates in an environment of rapid technological change and is largely dependent on the services of its employees and consultants. (2) Summary of Significant Accounting Policies a. Basis of Presentation The accompanying consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and with the instructions to Form 10-K and Article 10 of Regulation S-X. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED b. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Actual results could differ from such estimates. c. Fair Value of Financial Instruments The carrying amounts of the Company’s financial instruments, including cash equivalents, accounts payable and accrued expenses approximate fair value given their short-term nature. d. Cash and Cash Equivalents The Company considers all highly liquid investments that have maturities of three months or less when acquired to be cash equivalents. As of December 31, 2016 and 2015, the Company invested a portion of its cash balances in money market funds, which has been included as cash equivalents on the consolidated balance sheets. e. Incentive and Tax Receivable The Company’s subsidiary, Zynerba Pharmaceuticals Pty Ltd (the “Subsidiary”), is incorporated in Australia. The Subsidiary is eligible to participate in an Australian research and development tax incentive program. As part of this program, the Subsidiary is eligible to receive a cash refund from the Australian Taxation Office for a percentage of the research and development costs expended by the Subsidiary in Australia. During the year ended December 31, 2016, the Company received $0.4 million from the Australian Taxation Office related to 2015 eligible spending under this incentive program. As of December 31, 2016, the Company estimates it will collect $3.3 million during the year ended December 31, 2017, related to 2016 eligible spending as part of this incentive program. The Company’s estimate of the amount of cash refund it expects to receive in 2017 related to the Australian research and development tax incentive program is included in “Incentive and tax receivables” on the accompanying consolidated balance sheets. In addition, the Subsidiary incurs Goods and Services Tax (“GST”) on services provided by Australian vendors. As an Australian entity, the Subsidiary is entitled to a refund of the GST paid. During the year ended December 31, 2016, the Company received a refund of $0.5 million for GST paid to Australian vendors through September 30, 2016, and the Company estimates it will collect an additional $0.3 million in 2017 for GST on expenses related to Australian vendors incurred during the remainder of 2016. The Company’s estimate of the amount of cash refund it expects to receive related to GST paid is included in “Incentive and tax receivables” on the accompanying consolidated balance sheets. f. Prepaid Expenses and Other Assets Prepaid expenses primarily consist of prepaid preclinical study and clinical trial expenses of $1.5 million and $1.2 million as of December 31, 2016 and 2015, respectively. g. Property and Equipment Property and equipment are recorded at cost and are depreciated on a straight-line basis over their estimated useful lives. The Company estimates a life of three years for computer equipment and five years for furniture and fixtures and lab equipment, unless circumstances dictate otherwise. When property and equipment are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in other expenses. Repairs and maintenance costs are expensed as incurred. During the year ended December 31, 2016, the Company recognized a loss on the disposal of equipment of $99,147, which is reflected in “Loss on disposal of equipment” on the accompanying consolidated statement of operations. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED h. Impairment of Long-Lived Assets The Company assesses the recoverability of its long-lived assets, which include property and equipment, whenever significant events or changes in circumstances indicate impairment may have occurred. If indicators of impairment exist, projected future undiscounted cash flows associated with the asset are compared to its carrying amount to determine whether the asset’s value is recoverable. Any resulting impairment is recorded as a reduction in the carrying value of the related asset in excess of fair value and a charge to operating results. For the years ended December 31, 2016, 2015 and 2014, the Company determined that there was no impairment of its long-lived assets. i. Research and Development Research and development costs are expensed as incurred and are primarily comprised of external research and development expenses incurred under arrangements with third parties, such as contract research organizations (“CROs”), consultants and employee related expenses including salaries and benefits. At the end of each reporting period, the Company compares the payments made to each service provider to the estimated progress towards completion of the related project. Factors that the Company considers in preparing these estimates include the number of patients enrolled in studies, milestones achieved and other criteria related to the efforts of its vendors. These estimates will be subject to change as additional information becomes available. Depending on the timing of payments to vendors and estimated services provided, the Company will record net prepaid or accrued expenses related to these costs. Beginning in the fourth quarter of 2015, research and development costs are reduced by the Australian research and development incentive and GST recorded in the respective period. j. Stock-Based Compensation The Company measures employee and nonemployee stock-based awards at grant-date fair value and records compensation expense on a straight-line basis over the vesting period of the award. Stock-based awards issued to non-employees, if any, are revalued until the award vests. The Company estimates the fair value of restricted stock based on the closing price of the Company’s common stock on the date of grant. The Company uses the Black-Scholes option pricing model to value its stock option awards. Estimating the fair value of stock option awards requires management to apply judgment and make estimates, including the volatility of the Company’s common stock, the expected term of the Company’s stock options, the expected dividend yield and the fair value of the Company’s common stock on the date of grant. As a result, if factors change and management uses different assumptions, stock-based compensation expense could be materially different for future awards. The expected life of stock options was estimated using the “simplified method,” as the Company has no historical information to develop reasonable expectations about future exercise patterns and post vesting employment termination behavior for its stock option grants. The simplified method is based on the average of the vesting tranches and the contractual life of each grant. For stock price volatility, the Company uses comparable public companies as a basis for its expected volatility to calculate the fair value of option grants. The risk-free interest rate is based on U.S. Treasury notes with a term approximating the expected life of the option. k. Revenue Recognition Revenue related to research grants and research services for third party product development are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable, and collectability is reasonably assured. Grant revenue received is deferred until the related expenditures are incurred. Revenue in 2016 and 2015 was entirely related to work performed in connection with grants ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED received prior to 2015. Research services revenue of $0.1 million in 2014 represents fees for research and development activities. l. Income Taxes The Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities and the expected benefits of net operating loss carryforwards. The impact of changes in tax rates and laws on deferred taxes, if any, applied during the years in which temporary differences are expected to be settled, is reflected in the financial statements in the period of enactment. The measurement of deferred tax assets is reduced, if necessary, if, based on weight of the evidence, it is more likely than not that some, or all, of the deferred tax assets will not be realized. As of December 31, 2016 and 2015, the Company has concluded that a full valuation allowance is necessary for their net deferred tax assets. The Company had no material amounts recorded for uncertain tax positions, interest or penalties in the accompanying financial statements. m. Net Loss Per Share Basic loss per share is computed by dividing net loss applicable to common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted loss per share includes the effect, if any, from the potential exercise or conversion of securities, such as redeemable convertible preferred stock, convertible preferred stock, restricted stock, and stock options, which would result in the issuance of incremental shares of common stock. In computing the basic and diluted net loss per share applicable to common stockholders, the weighted average number of shares remains the same for both calculations due to the fact that when a net loss exists, dilutive shares are not included in the calculation as the impact is anti-dilutive. The following potentially dilutive securities outstanding as of December 31, 2016, 2015 and 2014 have been excluded from the computation of diluted weighted average shares outstanding, as they would be anti-dilutive: Amounts in the table reflect the common stock equivalents of the noted instruments. n. Foreign Currency The Company has determined the functional currency of its Australian subsidiary to be the U.S. dollar. The Company translates assets and liabilities of its foreign operations at exchange rates in effect at the balance sheet date. The Company records remeasurement gains and losses on monetary assets and liabilities, such as incentive and tax receivables and accounts payables, which are not in the functional currency of the operation. These remeasurement gains and losses are recorded in the statement of operations as they occur. o. Segment Information Operating segments are defined as components of an enterprise about which separate discrete information is available for evaluation by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company views its operations and manages its business in one segment. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED p. Recent Accounting Pronouncements In August 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which defines management’s responsibility to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosures if there is substantial doubt about its ability to continue as a going concern. The pronouncement was effective for annual reporting periods ending after December 15, 2016 with early adoption permitted. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02, Leases, which requires that lease arrangements longer than 12 months result in an entity recognizing an asset and liability. The pronouncement is effective for interim and annual periods beginning after December 15, 2018 with early adoption permitted. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements. In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which is intended to simplify the accounting and reporting for employee share-based payment transactions. The pronouncement is effective for interim and annual periods beginning after December 31, 2016 with early adoption permitted. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements. In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments, which provides specific guidance related to eight cash flow classification issues. The pronouncement is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements. In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash, which requires changes in restricted cash and restricted cash equivalents to be explained on the statement of cash flows by including restricted cash and restricted cash equivalents in the beginning-of-period and end-of-period total cash and cash equivalents shown on the statement of cash flows. The pronouncement is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements. (3) Fair Value Measurements The Company utilizes a valuation hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques related to its financial assets and financial liabilities. The three levels of inputs used to measure fair value are described as follows: Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 - Observable inputs and quoted prices in active markets for similar assets and liabilities. Level 3 - Unobservable inputs and models that are supported by little or no market activity. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED In accordance with the fair value hierarchy described above, the following table sets forth the Company's financial assets measured at fair value on a recurring basis: (4) Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets consist of the following as of December 31, 2016 and 2015: (5) Property and Equipment Property and equipment consisted of the following as of December 31, 2016 and 2015: Depreciation expense was $75,301, $26,027 and $27,063 for the years ended December 31, 2016, 2015 and 2014 respectively. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED (6) Accrued Expenses Accrued expenses consisted of the following as of December 31, 2016 and 2015: (7) Debt In April 2007, the Company was awarded a grant by the Kentucky Economic Development Finance Authority (KEDFA) on behalf of the Commonwealth of Kentucky Department of Commercialization and Innovation in the form of a non interest bearing forgivable loan in the amount of up to $500,000 to be used for the purchase of equipment. In January 2014, the Company granted KEDFA liens on certain of its patents as security for the forgivable loan. In September 2014, the Company repaid the forgivable loan balance of $499,996 as management determined they would not meet the performance criteria associated with the grant and KEDFA released its security interest. (8) Redeemable Convertible Preferred Stock, Common Stock and Stockholders’ Equity (Deficit) Series A and Series B Redeemable Convertible Preferred Stock In connection with the Company’s recapitalization in 2014, all $0.0001 par value Series A Participating Preferred Stock (Series A) and $0.0001 par value Series B Participating Preferred Stock (Series B) were converted to Series 1 convertible preferred stock (see below). The Series B ranked senior to the Series A and the common stock in liquidation. The Series A and B were convertible into common stock at the option of the holder, automatically converted into common stock upon a public offering of stock with a public offering price of not less than $25,000,000, or the consent of a majority of the holders and had a liquidation value of $1.75 per share plus unpaid dividends. Dividends were cumulative, accrued beginning in June 2008 and October 2013 for the Series A and Series B, respectively, at a rate of 6% per year and became payable upon declaration by the board of directors of the Company, redemption or liquidation. At the earlier of a Company Default (as defined) or August 30, 2017, the Series A and B Preferred Stock were redeemable at the option of a majority of the holders at the greater of a price per share of $1.75 plus unpaid dividends, if any, or the then fair market value. Total accretion of the Series A unamortized issuance cost towards redemption value was $1,309 for the year ended December 31, 2014. Total accretion of the Series A dividends towards the redemption value was $24,134 for the year ended December 31, 2014. Total accretion of the Series B unamortized issuance cost and beneficial conversion feature towards the redemption value was $38,568 for the year ended December 31, 2014. Total accretion of the Series B dividends towards the redemption value was $23,943 for the year ended December 31, 2014. In January 2014, the Company issued 200,002 shares of Series B and warrants to purchase 49,998 shares of Series B for total proceeds of $350,000 less stock issuance costs of $3,089 for net proceeds to the Company of $346,911. In April 2014, the warrants to purchase 49,998 shares of Series B were exercised for total proceeds to the Company of $500. Since the Series B underlying the warrants could have been redeemed for cash upon an event that was not within the Company’s control, these warrants were classified as a derivative liability with changes to fair value, if any, recorded through earnings at each reporting period through the exercise date. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED Recapitalization Transactions In May 2014, a series of transactions, referred to as the Recapitalization Transactions, were executed resulting in the issuance of 720,002 shares of Series 1 convertible preferred stock (Series 1) and 797,871 shares of new common stock, as follows: · A shareholder who was an original founder of the Company elected to forfeit 359,042 shares of the original common stock. The forfeited shares were canceled and retired by the Company. · All outstanding options that were previously issued were cancelled. · The Company issued 74,923 shares of common stock to certain existing investors and employees for total proceeds of $1,409. As a result of the issuance, the Company recognized $123,958 of noncash general and administrative expense during the year ended December 31, 2014. · Prior to the recapitalization, all outstanding shares of the Series A and the Series B were converted into shares of common stock. The Company converted 720,002 shares of Series A and 1,248,109 shares of Series B into 1,046,847 shares of common stock. · On May 6, 2014, the Company recapitalized. In connection with the recapitalization, each share of common stock was exchanged into shares of Series 1 by multiplying each share of common stock issued and outstanding immediately prior to the recapitalization by 0.57434. As a result, 720,002 shares of Series 1 were issued pursuant to such exchange. · In connection with the recapitalization, 478,723 shares of new common stock were issued to a new investor (New Investor). The Company recognized $792,000 of noncash general and administrative expense during the year ended December 31, 2014 as a result of the issuance. In addition, the Company issued 319,148 shares of new common stock to the same shareholder that forfeited 359,042 shares of common stock prior to the recapitalization. Series 1 Convertible Preferred Stock From May 2014 through October 2014, the Company issued an aggregate of 6,244,051 shares of Series 1 for total proceeds of $13,214,912 less stock issuance costs of $289,878 for net proceeds of $12,925,034. The Series 1 converted into 3,704,215 shares of common stock in connection with the IPO. Voting Holder of the Series 1, voting as a class, were entitled to elect four members of the board of directors. Holders of the common stock, voting as a single class, were entitled to elect one member of the board of directors. Dividends Holders of Series 1 were entitled to receive a dividend on each outstanding share of Series 1, if and when declared by the board of directors, issuable upon the conversion of a share of Series 1 on the record date in the case of a dividend on common stock or any class or series convertible into common stock. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED Liquidation In the event of a liquidation, dissolution, or winding-up, or in the event the Company was merged with, or was acquired by another entity, the holders of each share of Series 1 were entitled to receive an amount equal to the greater of the $3.98 per share plus any dividends declared but unpaid thereon or such amount per share as would have been payable had all shares of Series 1 been converted to common stock immediately prior to such liquidation. With respect to the liquidation preference, after payment has been made to the holders of Series 1, the remaining assets available for distribution would have been distributed to the holders of common stock. Redemption The Series 1 was subject to redemption under certain “deemed liquidation events” and as such, the Series 1 was considered contingently redeemable for financial accounting purposes. The Company concluded that none of these events were probable at December 31, 2014. Common Stock Transactions In September 2014, the Company issued 579,614 shares of common stock to the New Investor for providing certain advisory service, including management services. The Company recognized $958,914 of noncash general and administrative expense for these issuances during the year ended December 31, 2014. An additional 114,047 shares of common stock were issued to third parties for providing consulting services. As a result of the issuances, the Company recognized $188,693 of noncash general and administrative expense during the year ended December 31, 2014. In October 2014, the New Investor forfeited 41,667 shares of common stock. In August 2015, the Company completed its IPO, selling 3,450,000 shares at an offering price of $14.00 per share, resulting in gross proceeds of $48.3 million. Net proceeds received after underwriting fees and offering expenses were approximately $42.1 million. During the year ended December 31, 2016, the Company entered into the Sales Agreement with Jefferies pursuant to which the Company sold and issued 794,906 shares of common stock in the open market at a weighted average selling price of $13.39 per share, for gross proceeds of $10.6 million. Net proceeds received after deducting commissions and offering expenses were $10.0 million. In the first quarter of 2017, the Company completed an additional follow-on public offering, selling 3,220,000 shares at an offering price of $18.00 per share resulting in gross proceeds of $58.0 million. Net proceeds received after deducting underwriting and commissions and offering expenses were $54.3 million. (9) Stock-Based Compensation During May 2014, all outstanding stock options under the 2007 stock option plan were cancelled in connection with the recapitalization (Note 8). The Company maintains the Amended and Restated 2014 Omnibus Incentive Compensation Plan, as amended (the “2014 Plan”), which allows for the granting of incentive stock options, nonqualified stock options, stock appreciation rights, stock awards, stock units, performance units and other stock-based awards to purchase an aggregate of 2,450,000 shares of the Company’s common stock to employees, officers, directors, consultants, and advisors, subject to automatic annual increases in the number of shares authorized for issuance under the 2014 Plan on the first trading day of January each year, equal to the lesser of 1.5 million shares and 10% of the number of shares of common stock outstanding on the last trading day of December of the preceding year. In addition, the 2014 Plan provides selected executive employees ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED with the opportunity to receive bonus awards that are considered qualified performance-based compensation. As of December 31, 2016, 195,668 shares are available for issuance under the 2014 Plan. Options issued under the 2014 Plan have a contractual life of 10 years and may be exercisable in cash or as otherwise determined by the board of directors. The Company has granted options to employees and non-employee directors. In October and December 2014, the Company entered into employment contracts and agreements in connection with the hiring of its key executives and certain consultants and issued stock options to purchase 542,550 shares of common stock with an exercise price of $3.98 per share and 579,882 shares of restricted common stock that have certain performance-based and time-based vesting criteria. The stock options and restricted stock awards vested 25% upon the closing of the Company’s IPO and then quarterly over three years following the closing of the Company’s IPO. Accordingly, prior to the Company’s IPO in August 2015, no expense had been recorded for the stock option grants and restricted stock awards. During the year ended December 31, 2015, the Company granted 1,110,806 stock options, which included 1,001,977 stock options that were granted to employees and the Company’s Board of Directors at the time of the Company’s IPO. The stock options granted to the Company’s employees at the time of the IPO, primarily vest in sixteen equal quarterly increments from the IPO date. The stock options granted to the Company’s Board of Directors at the time of the IPO vest in equal one-third increments on the anniversary of the of the Company’s IPO for three consecutive years. All other stock options granted during 2015 vest 25% upon the first anniversary of the relative grant date and quarterly over three years thereafter. During the year ended December 31, 2016, the Company granted 285,000 stock options to employees and the Company’s Board of Directors, of which 150,000 stock options were granted as an inducement grant pursuant to NASDAQ Listing Rule 5635(c)(4) and are outside of the 2014 Plan. The stock options granted to the Company’s Board of Directors vest on the earlier of the one-year anniversary of the grant date, or the date of the Company’s 2017 annual stockholders’ meeting. The stock options granted to the Company’s employees vest 25% upon the first anniversary date of grant and quarterly over three years thereafter. During the years ended December 31, 2016 and 2015, the Company recorded stock-based compensation expense related to its stock option grants and restricted stock awards, as follows: ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED The following table summarizes the Company’s stock option activity. As of December 31, 2016, there was $7.3 million of unrecognized stock-based compensation expense related to stock options, which is expected to be recognized over a weighted-average period of 2.56 years. As of December 31, 2016, 641,375 stock options with a weighted average grant date fair value of $5.18 per share were exercisable. The Company expects 1,154,618 unvested stock options to vest. As of December 31, 2016, the Company’s outstanding stock options had a weighted average contractual life of 8.5 years and an intrinsic value of $9.7 million. The weighted average grant date fair value of stock options granted during the year ended December 31, 2016 was estimated using the Black-Scholes option pricing model with the following ranges of assumptions: expected volatility of 77%, risk free interest rate of 1.4% - 2.2%, expected term of 5.5 years to 6.25 years and 0% expected dividend yield. The weighted average grant date fair value of stock options granted during the year ended December 31, 2015 was estimated using the Black-Scholes option pricing model with the following ranges of assumptions: expected volatility of 76% - 77%, risk free interest rate of 1.7% - 2.0%, expected term of 5.75 years to 6.25 years and 0% expected dividend yield. Due to the stage of the Company and its recent IPO in August 2015, the Company currently computes volatility using a basket of peer companies rather than its own historical experience. The following table summarizes the restricted stock award activity under the 2014 Plan. As of December 31, 2016, there was $0.4 million of unrecognized stock-based compensation expense related to unvested restricted stock awards as of December 31, 2016, which is expected to be recognized over a weighted-average period of 1.59 years, and the Company expects all 253,702 unvested restricted stock awards to vest. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED (10) Income Taxes The Company’s U.S. and foreign loss before income taxes are set forth below: The Company had $36.5 million and $17.7 million of federal net operating loss carryforwards and $1.3 million and $0.4 million of research tax credit carryforwards as of December 31, 2016 and 2015, respectively. The U.S. federal net operating loss carryforwards and research tax credit carryforwards begin to expire in 2028 and 2027, respectively. The Company has $34.4 million and $21.6 million of state net operating loss carryforwards as of December 31, 2016 and 2015, respectively. The state net operating loss carryforwards begin to expire in 2028 and 2027, respectively. The Company had $1.2 million of Australia net operating loss carryforwards as of December 31, 2016, which have an indefinite life. The Tax Reform Act of 1986 (the Act) provides for limitation on the use of net operating loss and research and development tax credit carryforwards following certain ownership changes (as defined by the Act) that could limit the Company’s ability to utilize these carryforwards. The Company may have experienced various ownership changes, as defined by the Act, as a result of past financings. Accordingly, the Company’s ability to utilize the aforementioned carryforwards may be limited. Additionally, U.S. tax laws limit the time during which these carryforwards may be applied against future taxes; therefore, the Company may not be able to take full advantage of these carryforwards for federal income tax purposes. The components of the net deferred income tax asset as of December 31, 2016 and 2015 are as follows: In assessing the realizability of deferred tax assets, the Company considers whether it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences representing net future deductible amounts become deductible. After consideration of all the evidence, both positive and negative, the Company has recorded a full valuation allowance against its net deferred tax assets as of December 31, 2016 and 2015, respectively, because the Company has determined that is it more likely than not that these assets will not be fully realized due to historic net operating losses incurred. The valuation allowance increased by $9.5 million and $4.7 million ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED during the years ended December 31, 2016 and 2015, respectively, due primarily to the generation of net operating loss carryforwards during those years. The Company does not have unrecognized tax benefits as of December 31, 2016 and 2015, respectively. The Company recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. A reconciliation of income tax expense (benefit) at the statutory federal income tax rate and income taxes as reflected in the financial statements is as follows: The Company and its subsidiaries are subject to income taxes in the U.S. federal jurisdiction, various state jurisdictions and Australia. The Company’s 2011 to 2016 tax years remain open and subject to examination. (11) Commitments and Contingencies a. Federal Grants There was no grant revenue received during the years ended December 31, 2016 and 2015. One U.S. Federal agency provided 85% of grant revenue during the year ended December 31, 2014. When received, grant revenue is deferred until the related expenditures are incurred. As of December 31, 2016 and 2015, there was $0.8 million and $0.8 million, respectively, included in deferred revenue and $0.8 million and $0.8 million, respectively, included in prepaid expenses and other assets for prepaid research and development contracts related to the federal grant “ARRA - Transdermal Cannabinoid Prodrug Treatment for Cannabis Withdrawal and Dependence.” b. Research and Development Agreement In August 2014, the Company entered into a patent assignment consideration agreement with Albany College of Pharmacy (ACP) pursuant to which the Company paid $500,000 in exchange for the termination of a royalty agreement that was executed in December 2004. This payment was expensed and included in general and administrative expenses for the year ended December 31, 2014. c. Employee Retirement Plan The Company has established a retirement plan authorized by section 401(k) of the Internal Revenue Code. In accordance with the plan, all full-time employees age 21 or older are eligible to participate in the plan. Each employee can contribute a percentage of compensation up to a maximum of the statutory limits per year. The Company has the option to make discretionary matching contributions and profit sharing contributions. The Company made no contributions during 2016, 2015 or 2014. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED d. Leases The Company has entered into lease agreements for office space in Pennsylvania and Kentucky. In February 2015, the Company entered into the current lease for its Pennsylvania headquarters, which commenced in June 2015. In December 2016, the Company entered into a lease amendment that provided for the expansion of its Pennsylvania headquarters, which commenced in February 2017. The lease, as amended, expires in 2020 and provides for minimum lease commitments of $156,478, $200,082, $203,755 and $85,535 for the years ended December 31, 2017, 2018, 2019 and 2020, respectively. The Company is party to a month-to-month lease for office space in Kentucky for which it pays a nominal monthly rent. The Company is also party to a lease for office equipment that expires in June 2017 for which it pays a nominal monthly rent. Total lease expense during the years ended December 31, 2016, 2015 and 2014 was $101,609, $77,192 and $63,880, respectively. e. Employment Agreements The Company has entered into employment contracts with its officers and certain employees that provide for severance and continuation of benefits in the event of termination of employment either by the Company without cause or by the employee for good reason, both as defined in the agreements. In addition, in the event of termination of employment following a change in control, as defined in the employment contracts, either by the Company without cause or by the employee for good reason, any unvested portion of the employee’s stock options become immediately vested. f. Litigation Liabilities for loss contingencies arising from claims, assessments, litigation, fines, penalties, and other sources are recorded when it is probable that a liability has been incurred and the amount can be reasonably estimated. The Company believes there are no matters pending or threatened that will have a material impact to the Company’s financial position or results of operations. (12) Related Party Transactions The Company paid affiliates of the New Investor $250,000 for the reimbursement of stock issuance costs during the year ended December 31, 2014. Additionally, the Company paid $250,000 for various services, including management services, rendered in 2014. Furthermore, the Company paid legal expenses on the behalf of the New Investor totaling $200,000, of which, $37,366 related to stock issuance costs. In January 2015, the Company entered into a termination agreement with the New Investor pursuant to which certain agreements will be terminated upon payment of $500,000. The Company paid the New Investor $500,000 prior to the closing of the Company’s August 2015 IPO. ZYNERBA PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED (13) Quarterly Financial Data (unaudited) The following information has been derived from unaudited consolidated financial statements that, in the opinion of management, include all recurring adjustments necessary for a fair statement of such information. The sum of the quarterly per share amounts may not equal per share amounts reported for the year due to rounding. (1) The Company has corrected the amounts above to exclude contingently redeemable shares from the net loss per share basic and diluted and basic and diluted weighted average shares outstanding calculations for the first and second quarter. The Company had previously disclosed $0.74 net loss per share basic and diluted for the three months ended March 31, 2015 in the Company's Form S-1 and $0.80 net loss per share basic and diluted for the three months ended June 30, 2015 in the second quarter Form 10-Q. | Based on the provided text, which appears to be fragments of a financial statement, here's a summary:
Financial Overview:
- The company has experienced ongoing losses and negative cash flows since its inception
- Accumulated deficit is $46.0 million
- Current financial instruments (cash, accounts payable) are short-term and approximate fair value
- The company considers investments with 3-month or less maturity as cash equivalents
Key Financial Challenges:
- Consistent financial losses
- Significant accumulated deficit
- Potential uncertainty in financial estimates
Note: The provided text seems incomplete, with cut-off sections that make a comprehensive summary difficult. A full financial statement would provide more detailed insights into the company's financial health. | Claude |
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Stockholders and Board of Directors of Red Metal Resources Ltd. We have audited the accompanying consolidated balance sheets of Red Metal Resources Ltd. (the “Company”) as at January 31, 2016 and 2015 and the related consolidated statements of operations, stockholders’ deficit and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at January 31, 2016 and 2015 and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has not generated revenues since inception, has incurred losses in developing its business, and further losses are anticipated. The Company requires additional funds to meet its obligations and the costs of its operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in this regard are described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ DMCL DALE MATHESON CARR-HILTON LABONTE LLP CHARTERED PROFESSIONAL ACCOUNTANTS Vancouver, Canada May 2, 2016 An independent firm associated with Moore Stephens International Limited MOORE STEPHENS RED METAL RESOURCES LTD. CONSOLIDATED BALANCE SHEETS (EXPRESSED IN US DOLLARS) The accompanying notes are an integral part of these consolidated financial statements RED METAL RESOURCES LTD. CONSOLIDATED STATEMENTS OF OPERATIONS (EXPRESSED IN US DOLLARS) The accompanying notes are an integral part of these consolidated financial statements RED METAL RESOURCES LTD. CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT (EXPRESSED IN US DOLLARS) The accompanying notes are an integral part of these consolidated financial statements RED METAL RESOURCES LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS (EXPRESSED IN US DOLLARS) The accompanying notes are an integral part of these consolidated financial statements RED METAL RESOURCES LTD. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2016 NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION Nature of Operations Red Metal Resources Ltd. (the “Company”) holds a 99% interest in Minera Polymet SpA (“Polymet”) under the laws of the Republic of Chile. The Company is involved in acquiring and exploring mineral properties in Chile. The Company has not determined whether its properties contain mineral reserves that are economically recoverable. The Company’s consolidated financial statements are prepared on a going concern basis in accordance with US generally accepted accounting principles (“GAAP”) which contemplates the realization of assets and discharge of liabilities and commitments in the normal course of business. The Company is in the exploration stage. It has generated only minimal income to date, and has accumulated losses of $8,525,921 since inception. The Company has funded its operations through the issuance of capital stock and debt. Management plans to raise additional funds through equity and/or debt financings, and by entering into joint venture agreements. There is no certainty that further funding will be available as needed. These factors raise substantial doubt about the ability of the Company to continue operating as a going concern. The Company’s ability to continue its operations as a going concern, realize the carrying value of its assets, and discharge its liabilities in the normal course of business is dependent upon its ability to raise new capital sufficient to fund its commitments and ongoing losses, the continued financial support from related party creditors, and ultimately on generating profitable operations. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation These consolidated financial statements and related notes are presented in accordance with US GAAP, and are expressed in United States dollars. The Company has not produced revenues from its principal business. These financial statements include the accounts of the Company and its subsidiary, Polymet. All intercompany transactions and balances have been eliminated. Reclassifications Certain comparative amounts in the accompanying consolidated financial statements have been reclassified to conform to the current year’s presentation. These reclassifications had no effect on the consolidated results of operations or financial position for any year presented. Accounting Estimates The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect certain of the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the year. The Company regularly evaluates estimates and assumptions. The Company bases its estimates and assumptions on current facts, historical experience and various other factors it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from the Company’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected. The most significant estimates with regard to these financial statements relate to carrying values of unproved mineral properties, asset retirement obligations, fair value of stock based transactions, and recognition of deferred tax assets or liabilities. Asset Retirement Obligations The Company records the fair value of an asset retirement obligation as a liability in the period in which it incurs an obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. The estimated fair value of the asset retirement obligation is based on the current cost escalated at an inflation rate and discounted at a credit adjusted risk-free rate. This liability is capitalized as part of the cost of the related asset and amortized over its useful life. The liability accretes until the Company settles the obligation. To date the Company has not incurred any asset retirement obligations. Long Lived Assets The carrying value of long-lived assets, other than mineral properties, is reviewed on a regular basis for the existence of facts or circumstances that may suggest impairment. The Company recognizes impairment when the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Impairment losses, if any, are measured as the excess of the carrying amount of the asset over its estimated fair value. Fair Value of Financial Instruments The estimated fair values for financial instruments are determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair value of cash, other receivables, amounts due to related parties, notes payable, notes payable to related parties, and accounts payable approximates their carrying value due to their short-term nature. Foreign Currency Translation and Transaction The functional currency for the Company and the Company’s foreign subsidiary is the US dollar and the Chilean peso, respectively. The Company translates assets and liabilities to US dollars using year-end exchange rates and translates revenues and expenses using average exchange rates during the period. Exchange gains and losses arising from the translation of foreign entity financial statements are included as a component of other comprehensive income (loss). Transactions denominated in currencies other than the functional currency of the legal entity are re-measured to the functional currency of the legal entity at the year-end exchange rates. Any associated transactional currency re-measurement gains and losses are recognized in current operations. Income Taxes Income taxes are determined using the liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes that date of enactment. In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized. The Company accounts for uncertainty in income taxes by applying a two-step method. First, it evaluates whether a tax position has met a more likely than not recognition threshold, and second, it measures that tax position to determine the amount of benefit, if any, to be recognized in the financial statements. The application of this method did not have a material effect on the Company's financial statements. Loss per Share The Company presents both basic and diluted loss per share (“LPS”) on the face of the statements of operations. Basic LPS is computed by dividing net loss available to common shareholders by the weighted average number of shares outstanding during the year. Diluted LPS gives effect to all dilutive potential common shares outstanding during the period including convertible debt, stock options, and warrants, using the treasury stock method. Diluted LPS excludes all dilutive potential shares if their effect is anti-dilutive. Mineral Properties Acquisition costs (including option payments) and mineral property taxes are capitalized as mineral property costs. Mineral exploration costs are expensed as incurred until commercially mineable deposits are determined to exist within a particular property. Option payments are considered acquisition costs provided that the Company has the intention of exercising the underlying option. Property option agreements are exercisable entirely at the option of the optionee. Therefore, option payments (or recoveries) are recorded when payment is made (or received) and are not accrued. Mineral properties are tested for impairment if facts or circumstances indicate that impairment exists. Examples of such facts and circumstances are as follows: · the period for which the Company has the right to explore in the specific area has expired during the period or will expire in the near future, and is not expected to be renewed; · substantive expenditure on further exploration for and evaluation of mineral resources in the specific area is neither budgeted nor planned; · exploration for and evaluation of mineral resources in the specific area have not led to the discovery of commercially viable quantities of mineral resources and the entity has decided to discontinue such activities in the specific area; and · sufficient data exist to indicate that, although a development in the specific area is likely to proceed, the carrying amount of the exploration and evaluation asset is unlikely to be recovered in full from successful development or by sale. The property should be valued at the lower of cost and net realizable value, where net realizable value is the estimated selling price less any cost to complete or sell the property. After technical feasibility and commercial viability of extracting a mineral resource are demonstrable the capitalized balance, net of any impairment recognized, is then reclassified to either tangible or intangible mine development assets according to the nature of the asset. Although the Company has taken steps that it considers adequate to verify title to mineral properties which it has an interest, these procedures do not guarantee the Company’s title. Title to mineral properties in foreign jurisdictions is subject to uncertainty and consequently, such properties may be subject to prior undetected agreements or transfers and title may be affected by such instances. Equipment Equipment is recorded at cost and is being amortized over its estimated useful lives using the declining balance method at 30% per year. Royalty Income Royalty payments received from authorized contractors are recognized when the risks and rewards of ownership to delivered concentrate pass to the buyer and collection is reasonably assured. Stock Options and Other Share-Based Compensation For equity awards, such as stock options, total compensation cost is based on the grant date fair value and for liability awards, such as stock appreciation rights, total compensation cost is based on the settlement value. The Company recognizes stock-based compensation expense for all awards over the service period required to earn the award, which is the shorter of the vesting period or the time period an employee becomes eligible to retain the award at retirement, adjusted for the expected rate of forfeiture of the equity awards granted. Recently Adopted Accounting Guidance Recent accounting pronouncements issued by the Financial Accounting Standards Board or other authoritative standards groups with future effective dates are either not applicable or are not expected to be significant to the financial statements of the Company. NOTE 3 - RELATED-PARTY TRANSACTIONS The following amounts were due to related parties as at: (a) Amounts are unsecured, due on demand and bear no interest. (b) Amounts are unsecured, due on demand and bear interest at 10%. (c) Amounts are unsecured, due on demand and bear interest at 8%. During the year ended January 31, 2016, the Company accrued $51,883 (January 31, 2015 - $34,004) in interest expense on the notes payable to related parties and $14,522 (January 31, 2015 - $18,676) in interest expense on trade accounts payable with related parties. Transactions with Related Parties During the years ended January 31, 2016 and 2015, the Company incurred the following expenses with related parties: NOTE 4 - UNPROVED MINERAL PROPERTIES (1) During the year ended January 31, 2016, the Company received $26,451 in payments from a minerals extracted during the small scale mining operations that were carried out by a third-party; these payments were recorded as recovery in other income. During the same period the Company paid $17,334 in royalty payments to the original vendor of the Farellon Alto 1-8, which were recorded as part of mineral exploration costs. (2) The claims are subject to a 1% royalty on the net sales of minerals extracted from the property. The royalty payments will be due monthly once exploration begins and are not subject to minimum payments. Farellon Project, “Quina Claim” On May 27, 2014, Polymet entered into a memorandum of understanding (the “MOU”) with an unrelated party to acquire an option to earn a 100% interest in two mining claims contiguous to the Farellon Property. On December 15, 2014, the MOU was superseded by an option agreement to earn 100% interest in one of the mining claims included in the MOU, Quina 1-56 (the “Quina Claim”). In order to acquire the 100% interest in the Quina Claim, the Company is required to pay a total of $150,000, which, at discretion of the Company, can be paid in a combination of shares of the Company and cash over four years, as detailed in the following schedule: The number of shares to be issued for each option payment will be determined based on the average trading price of the Company’s shares during a 30-day period prior to the payment. All of the above payments shall be made only if the Company wishes to keep the option agreement in force and finally to exercise the option to purchase. In addition to the option payments, the Company will have to pay a 1.5% royalty from net smelter returns (“NSR”) on the Quina Claim, which the Company can buy out for a one-time payment of $1,500,000 any time after acquiring 100% of the Quina Claim. On December 15, 2014, the Company issued 500,000 shares of its common stock with a fair value of $25,000 as consideration for the first option payment. On December 15, 2015, the Company issued 833,333 shares of its common stock with a fair value of $25,000 as consideration for the second option payment. Farellon Project, “Exeter Claim” On June 3, 2015, Polymet entered into an option agreement, made effective on June 15, 2015, with an unrelated party, to earn 100% interest in a mining exploration concession Exeter 1-54 (the “Exeter Claim”). In order to acquire 100% interest in the Exeter Claim, the Company is required to pay a total of $150,000 as outlined in the following schedule: All of the above payments shall be made only if the Company wishes to keep the option agreement in force and finally to exercise the option to purchase. In addition to the option payments, the Company will have to pay a 1.5% NSR royalty on the Exeter Claim, which the Company may buy out for a one-time payment of $750,000 any time after acquiring 100% of the Exeter Claim. Should the Company choose to mine the Exeter Claim prior to acquiring the option, the Company will be obligated to pay a minimum monthly royalty of $2,500 up to 5,000 tonnes, and a further $0.25 for every additional tonne mined. Perth Project On April 30, 2013, the Company granted Geoactiva SpA (“Geoactiva”) an option to purchase 100% of the Perth property through the execution of a mining option purchase agreement. Option payments received by the Company were credited against the carrying value of the Perth property, with any excess over the carrying value recorded as a gain on mineral property option payments. In August 2014 Geoactiva notified the Company that it had no intention to continue the joint venture and the option agreement was cancelled. Impairment of certain claims During the year ended January 31, 2016, the Company impaired its Cecil 1 - 49 claim as well as all claims within its Mateo Project due to a lack of financial resources that would allow for substantive expenditures on further exploration and evaluation of the mineral resources within these claims. The management of the Company intends to maintain the rights to the impaired claims and will resume the exploration activities once funding is available. Abandoned claims During the year ended January 31, 2015, the Company wrote off several claims within the Mateo Project with a total cost of $6,604. The Company wrote off $2,115 when it decided not to pursue exploration of certain other exploration claims. The Company did not abandon any of its claims during the year ended January 31, 2016. NOTE 5 - EQUIPMENT Amortization schedule for the equipment at January 31, 2016 and 2015: The equipment consists of a truck that is used for daily operations and is amortized on a declining balance basis at 30% over its useful life. NOTE 6 - COMMON STOCK On December 15, 2015, the Company issued 833,333 shares of its common stock with a fair value of $25,000 as consideration for the second option payment to acquire an interest in the Quina Claim (Note 4). On December 15, 2014, the Company issued 500,000 shares of its common stock with a fair value of $25,000 as consideration for the first option payment to acquire an interest in the Quina Claim (Note 4). Warrants Options On February 28, 2014, the Company granted options to purchase up to 1,200,000 shares of its common stock to certain officers, directors, consultants and employees. The Company’s CEO, CFO, and Vice President of Exploration were each granted options to purchase up to 300,000 shares of the Company’s common stock. The options vested upon grant and were exercisable at $0.15. At January 31, 2016, all options remained unexercised. The weighted average life of the options was 0.08 years and the weighted average exercise price was $0.15. All options expired unexercised on February 28, 2016. During the year ended January 31, 2015 the Company recorded $142,779 as stock-based compensation associated with the grant of options, which was calculated using the following assumptions under the Black-Scholes option-pricing model: NOTE 7 - INCOME TAXES The provision for income taxes differs from the amount that would have resulted in applying the combined federal statutory tax rate as follows: Temporary differences that give rise to the following deferred tax assets and liabilities at are: The Company has approximated $3,317,000 of United States federal net operating loss carry forwards that may be offset against future taxable income. These losses expire between 2026 and 2036. The Company also has approximately $2,945,000 of Chilean tax losses. The Chilean tax losses can be carried forward indefinitely. ITEM 9: | Summary of Financial Statement:
The company is currently in the exploration stage and is experiencing significant financial challenges:
1. Financial Performance:
- Ongoing losses
- Accumulated losses of $8,525,921
- Minimal income generated to date
2. Financial Outlook:
- Anticipating further losses
- Requires additional funding to meet obligations
- Substantial doubt about ability to continue as a going concern
3. Management's Proposed Strategy:
- Plan to raise additional funds through:
* Equity financing
* Debt financing
* Joint venture agreements
4. Key Risks:
- Uncertainty of obtaining future funding
- Dependent on:
* Raising new capital
* Financial support from related party creditors
* Generating profitable operations
Overall, the company is in a precarious financial position and needs significant financial intervention to survive and continue operations. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Teradata Corporation: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income (loss), comprehensive income (loss), changes in stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Teradata Corporation and its subsidiaries at December 31, 2016 and December 31, 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. TERADATA CORPORATION Consolidated Statements of Income (Loss) In millions, except per share amounts The accompanying notes are an integral part of the consolidated financial statements. TERADATA CORPORATION Consolidated Statements of Comprehensive Income (Loss) In millions The accompanying notes are an integral part of the consolidated financial statements. TERADATA CORPORATION Consolidated Balance Sheets In millions, except per share amounts The accompanying notes are an integral part of the consolidated financial statements. TERADATA CORPORATION Consolidated Statements of Cash Flows In millions The accompanying notes are an integral part of the consolidated financial statements. TERADATA CORPORATION Consolidated Statements of Changes in Stockholders’ Equity In millions The accompanying notes are an integral part of the consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 Description of Business, Basis of Presentation and Significant Accounting Policies Description of the Business. Teradata Corporation (“Teradata” or the “Company”) is a global leader in analytic data platforms, analytic applications and related services. The Company’s analytic data platforms are comprised of software, hardware, and related business consulting and support services for data warehousing and big data analytics. Basis of Presentation. The financial statements are presented on a consolidated basis and include the accounts of the Company and its wholly-owned subsidiaries in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the period reported. On an ongoing basis, management evaluates these estimates and judgments, including those related to allowances for doubtful accounts, the valuation of inventory to net realizable value, impairments of goodwill and other intangibles, stock-based compensation, pension and other postemployment benefits, and income taxes and any changes will be accounted for on a prospective basis. Actual results could differ from those estimates. Revenue Recognition. Teradata’s solution offerings typically include software, unspecified when-and-if-available upgrades, hardware, maintenance support services, and other consulting, implementation and installation-related (“consulting”) services. Teradata records revenue when it is realized, or realizable, and earned. Teradata considers these requirements met when: • Persuasive evidence of an arrangement exists • The products or services have been delivered to the customer • The sales price is fixed or determinable and free of contingencies or significant uncertainties • Collectibility is reasonably assured Teradata reports revenue net of any taxes assessed by governmental authorities that are imposed on and concurrent with specific revenue-producing transactions. The Company assesses whether fees are fixed or determinable at the time of sale. Standard payment terms may vary based on the country in which the agreement is executed, but are generally between 30 days and 90 days. Payments that are due within six months are generally deemed to be fixed or determinable based on a successful collection history on such arrangements, and thereby satisfy the required criteria for revenue recognition. Teradata delivers its solutions primarily through direct sales channels, as well as through alliances with system integrators, other independent software vendors and distributors, and value-added resellers (collectively referred to as “resellers”). In assessing whether the sales price to a reseller is fixed or determinable, the Company considers, among other things, past business practices with the reseller, the reseller’s operating history, payment terms, return rights and the financial wherewithal of the reseller. When Teradata determines that the contract fee to a reseller is not fixed or determinable, that transaction is deferred and recognized upon sell-through to the end customer. The Company’s deliverables often involve delivery or performance at different periods of time. Revenue for software is generally recognized upon delivery with the hardware once title and risk of loss have been transferred. Revenue for unspecified upgrades or enhancements on a when-and-if-available basis are recognized straight-line over the term of the arrangement. Revenue for maintenance support services is also recognized on a straight-line basis over the term of the contract. Revenue for other consulting, implementation and installation services is recognized as services are provided. In certain instances, acceptance of the product or service is specified by the customer. In such cases, revenue is deferred until the acceptance criteria have been met. Delivery and acceptance generally occur in the same reporting period. The Company’s arrangements generally do not include any customer negotiated provisions for cancellation, termination or refunds that would significantly impact recognized revenue. The Company evaluates all deliverables in an arrangement to determine whether they represent separate units of accounting. A deliverable constitutes a separate unit of accounting when it has standalone value, and if the contract includes a general right of return relative to the delivered item, delivery or performance of the undelivered items is considered probable and substantially in the control of Teradata. Most of the Company’s products and services qualify as separate units of accounting and are recognized upon meeting the criteria as described above. For multiple deliverable arrangements that contain non-software related deliverables, the Company allocates revenue to each deliverable based upon the relative selling price hierarchy and if software and software-related deliverables are also included in the arrangement, to those deliverables as a group based on the best estimate of selling price (“BESP”) for the group. The selling price for a deliverable is based on its vendor-specific objective evidence of selling price (“VSOE”) if available, third-party evidence of selling price (“TPE”) if VSOE is not available, or BESP if neither VSOE nor TPE is available. The Company then recognizes revenue when the remaining revenue recognition criteria are met for each deliverable. For the software group or arrangements that contain only software and software-related deliverables, the revenue is allocated utilizing the residual or fair value method. Under the residual method, the VSOE of the undelivered elements is deferred and accounted for under the applicable revenue recognition guidance, and the remaining portion of the software arrangement fee is allocated to the delivered elements and is recognized as revenue. The fair value method is similar to the relative selling price method used for non-software deliverables except that the allocation of each deliverable is based on VSOE. For software groups or arrangements that contain only software and software-related deliverables in which VSOE does not exist for each deliverable (fair value method) or does not exist for each undelivered element (residual method), revenue for the entire software arrangement or group is deferred and not recognized until delivery of all elements without VSOE has occurred, unless the only undelivered element is postcontract customer support (“PCS”) in which case the entire software arrangement or group is recognized ratably over the PCS period. Teradata’s analytic database software and hardware products are sold and delivered together in the form of a “Node” of capacity as an integrated technology solution. Because both the analytic database software and hardware platform are necessary to deliver the analytic data platform’s essential functionality, the database software and hardware (Node) are excluded from the software rules and considered a non-software related deliverable. Teradata software applications and related support are considered software-related deliverables. Additionally, the amount of revenue allocated to the delivered items utilizing the relative selling price or fair value method is limited to the amount that is not contingent upon the delivery of additional items or meeting other specified performance conditions (the non-contingent amount). VSOE is based upon the normal pricing and discounting practices for those products and services when sold separately. Teradata uses the stated renewal rate approach in establishing VSOE for maintenance and when-and-if-available upgrades (collectively referred to as PCS). Under this approach, the Company assesses whether the contractually stated renewal rates are substantive and consistent with the Company’s normal pricing practices. Renewal rates greater than the lower level of our targeted pricing ranges are considered to be substantive and, therefore, meet the requirements to support VSOE. In instances where there is not a substantive renewal rate in the arrangement, the Company allocates revenue based upon BESP, using the minimum established pricing targets as supported by the renewal rates for similar customers utilizing the bell-curve method. Teradata also offers consulting and installation-related services to its customers, which are considered non-software deliverables if they relate to the nodes. These services are rarely considered essential to the functionality of the data warehouse solution deliverable and there is never software customization of the proprietary database software. VSOE for consulting services is based on the hourly rates for standalone consulting services projects by geographic region and are indicative of the Company’s customary pricing practices. Pricing in each market is structured to obtain a reasonable margin based on input costs. In nearly all multiple-deliverable arrangements, the Company is unable to establish VSOE for all deliverables in the arrangement. This is due to infrequently selling each deliverable separately (such is the case with our nodes), not pricing products or services within a narrow range, or only having a limited sales history. When VSOE cannot be established, attempts are made to establish TPE of the selling price for each deliverable. TPE is determined based on competitor prices for similar deliverables when sold separately. However, Teradata’s offerings contain significant differentiation such that the comparable pricing of products with similar functionality cannot typically be obtained. This is because Teradata’s products contain a significant amount of proprietary technology and its solutions offer substantially different features and functionality than other available products. As Teradata’s products are significantly different from those of its competitors, the Company is unable to establish TPE for the vast majority of its products. When the Company is unable to establish selling prices using VSOE or TPE, the Company uses BESP in its allocation of arrangement consideration. The objective of BESP is to determine the price at which the Company would transact a sale if the product or service was sold on a standalone basis. The Company determines BESP for a product or service by considering multiple factors including, but not limited to, geographies, market conditions, product life cycles, competitive landscape, internal costs, gross margin objectives, purchase volumes and pricing practices. The primary consideration in developing BESP for the Company’s nodes is the bell-curve method based on historical transactions. The BESP analysis is at the geography level in order to align it with the way in which the Company goes to market and establishes pricing for its products. The Company has established discount ranges off of published list prices for different geographies based on strategy and maturity of Teradata’s presence in the respective geography. There are distinctions in each geography and product group which support the use of geographies and markets for the determination of BESP. For example, the Company’s U.S. market is relatively mature and most of the large transactions are captured in this market, whereas the International markets are less mature with generally smaller deal size. Additionally, the prices and margins for the Company’s products vary by geography and by product class. BESP is analyzed on a semi-annual basis using data from the four previous quarters, which the Company believes best reflects most recent pricing practices in a changing marketplace. The Company reviews VSOE, TPE and its determination of BESP on a periodic basis and updates it, when appropriate, to ensure that the practices employed reflect the Company’s recent pricing experience. The Company maintains internal controls over the establishment and updates of these estimates, which includes review and approval by the Company’s management. For the year ended December 31, 2016 there was no material impact to revenue resulting from changes in VSOE, TPE or BESP, nor does the Company expect a material impact from such changes in the near term. Teradata’s new go-to-market offerings introduced in the second half of 2016, which are part of the overall business transformation strategy, include the following offerings: • Subscription license - Teradata’s subscription licenses include a right-to-use license and are typically sold with PCS. The revenue for these arrangements is typically recognized ratably over the contract term. The term of these arrangements varies between one and five years. • Software as a service or Cloud - These arrangements include a right-to-access software license that the customer does not have a right to take possession of without significant penalty during the hosting period and the services can be delivered through a managed cloud, private cloud or public cloud. These arrangements are recognized outside the software rules and revenue is recognized ratably over the contract term. The term of these arrangements typically varies between one and five years. • Rentals - Teradata owns the equipment and may or may not provide managed services. The revenue for these arrangements is generally recognized straight-line over the term of the contract. The term of these arrangements typically varies between one and three years and are generally accounted for as operating leases. • Utility model - Teradata owns the equipment and may or may not provide managed services. Utility models typically include a minimum fixed amount that is recognized ratably over the contract term in addition to an elastic amount for usage above the minimum, which is recognized monthly based on actual utilization. The term of these arrangements varies between one and five years. Shipping and Handling. Product shipping and handling costs are included in cost of products in the Consolidated Statements of Income (Loss). Cash and Cash Equivalents. All short-term, highly-liquid investments having original maturities of three months or less are considered to be cash equivalents. Allowance for Doubtful Accounts. Teradata establishes provisions for doubtful accounts using both percentages of accounts receivable balances to reflect historical average credit losses and specific provisions for known issues. Inventories. Inventories are stated at the lower of cost or market. Cost of service parts is determined using the average cost method. Finished goods inventory is determined using actual cost. Available-for-sale Securities. Available-for-sale securities are reported at fair value. Unrealized holding gains and losses are excluded from earnings and reported in other comprehensive income (loss). Realized gains and losses are included in other income and expense in the Consolidated Statements of Income (loss). Long-Lived Assets Property and Equipment. Property and equipment, leasehold improvements and rental equipment are stated at cost less accumulated depreciation. Depreciation is computed over the estimated useful lives of the related assets primarily on a straight-line basis. Equipment is depreciated over 3 to 20 years and buildings over 25 to 45 years. Leasehold improvements are depreciated over the life of the lease or the asset, whichever is shorter. Total depreciation expense on the Company’s property and equipment for December 31 was as follows: Capitalized Software. Direct development costs associated with internal-use software are capitalized and amortized over the estimated useful lives of the resulting software. The costs are capitalized when both the preliminary project stage is completed and it is probable that computer software being developed will be completed and placed in service. Teradata typically amortizes capitalized internal-use software on a straight-line basis over three years beginning when the asset is substantially ready for use. Costs incurred for the development of big data and analytic applications are expensed as incurred based on the frequency and agile nature of development. Prior to December 31, 2016, costs incurred for the development of analytic database software that will be sold, leased or otherwise marketed were capitalized between technological feasibility and the point at which a product is ready for general release. Technological feasibility is established when planning, designing and initial coding activities that are necessary to establish the product can be produced to meet its design specifications are complete. In the absence of a program design, a working model is used to establish technological feasibility. These costs are included within capitalized software and are amortized over the estimated useful lives of four years using the greater of the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or the straight-line method over the remaining estimated economic life of the product beginning when the product is available for general release. Costs capitalized include direct labor and related overhead costs. Costs incurred prior to technological feasibility and after general release are expensed as incurred. The following table identifies the activity relating to capitalized software: The aggregate amortization expense (actual and estimated) for internal-use and external-use software for the following periods is: Estimated expense, which is recorded to cost of sales for external use software, is based on capitalized software at December 31, 2016 and does not include any new capitalization for future periods. Our research and development efforts have recently become more driven by market requirements and rapidly changing customers' needs. In addition, the Company started applying agile development methodologies to help respond to new technologies and trends. Agile development methodologies are characterized by a more dynamic development process with more frequent and iterative revisions to a product release features and functions as the software is being developed. Due to the shorter development cycle and focus on rapid production associated with agile development, the Company does not anticipate capitalizing significant amounts of external use software development costs in future periods due to the relatively short duration between the completion of the working model and the point at which a product is ready for general release. Prior capitalized costs will continue to be amortized under the greater of revenue-based or straight-line method over the estimated useful life. Valuation of Long-Lived Assets. Long-lived assets such as property and equipment, acquired intangible assets and internal capitalized software are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. An impairment loss would be recognized when estimated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than the carrying amount. Goodwill. Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired. Goodwill amounts are not amortized, but rather are tested for impairment annually or upon occurrence of an event or change in circumstances that would more likely than not reduce the fair value of a reporting unit below its carrying amount. See Note 3- Goodwill and Acquired Intangibles for additional information. Assets and Liabilities Held for Sale. The Company classifies assets and liabilities (disposal groups) to be sold as held for sale in the period in which all of the following criteria are met: • Management, having the authority to approve the action, commits to a plan to sell the disposal group; • The disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such disposal groups; • An active program to locate a buyer and other actions required to complete the plan to sell the disposal group have been initiated; • The sale of the disposal group is probable, and transfer of the disposal group is expected to qualify for recognition as a completed sale, within one year, except if events or circumstances beyond the Company’s control extend the period of time required to sell the disposal group beyond one year; • The disposal group is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and • Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. The Company initially measures a disposal group that is classified as held for sale at the lower of its carrying value or fair value less costs to sell. Any loss resulting from this measurement is recognized in the period in which the held for sale criteria are met. Conversely, gains are not recognized until the date of sale. The Company assesses the fair value of a disposal group less costs to sell each reporting period it remains classified as held for sale and reports any subsequent changes as an adjustment to the carrying value of the disposal group, as long as the new carrying value does not exceed the carrying value of the disposal group at the time it was initially classified as held for sale. Upon determining that a disposal group meets the criteria to be classified as held for sale, the Company reports the assets and liabilities of the disposal group under Assets held for sale and Liabilities held for sale in the Consolidated Balance Sheets. Refer to Note 15 for further information on the Company’s assets and liabilities held for sale. Warranty. Provisions for product warranties are recorded in the period in which the related revenue is recognized. The Company accrues warranty reserves using percentages of revenue to reflect the Company’s historical average warranty claims. Research and Development Costs. Research and development costs are expensed as incurred (with the exception of the capitalized software development costs discussed above). Research and development costs primarily include labor-related costs, contractor fees, and overhead expenses directly related to research and development support. Pension and Postemployment Benefits. The Company accounts for its pension and postemployment benefit obligations using actuarial models. The measurement of plan obligations was made as of December 31, 2016. Liabilities are computed using the projected unit credit method. The objective under this method is to expense each participant’s benefits under the plan as they accrue, taking into consideration salary increases and the plan’s benefit allocation formula. Thus, the total pension or postemployment benefit to which each participant is expected to become entitled is broken down into units, each associated with a year of past or future credited service. The Company recognizes the funded status of its pension and postemployment plan obligations in its consolidated balance sheet and records in other comprehensive income certain gains and losses that arise during the period, but are deferred under pension accounting rules. Foreign Currency. Assets and liabilities of non-U.S. subsidiaries that operate in a local currency environment are translated into U.S. dollars at period-end exchange rates. Income and expense accounts are translated at daily exchange rates prevailing during the period. Adjustments arising from the translation are included in accumulated other comprehensive income, a separate component of stockholders’ equity. Gains and losses resulting from foreign currency transactions are included in determining net income. Income Taxes. Income tax expense is provided based on income before income taxes in the various jurisdictions in which the Company conducts its business. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. These deferred taxes are determined based on the enacted tax rates expected to apply in the periods in which the deferred assets or liabilities are expected to be settled or realized. Teradata recognizes tax benefits from uncertain tax positions only if it is more likely than not the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The Company records valuation allowances related to its deferred income tax assets when it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Stock-based Compensation. Stock-based payments to employees, including grants of stock options, restricted shares and restricted share units, are recognized in the financial statements based on their fair value. The fair value of each stock option award on the grant date is estimated using the Black-Scholes option-pricing model with the following assumptions: expected dividend yield, expected stock price volatility, weighted-average risk-free interest rate and weighted average expected term of the options. The Company’s expected volatility assumption used in the Black-Scholes option-pricing model is based on Teradata's historical volatility. The expected term for options granted is based upon historical observation of actual time elapsed between date of grant and exercise of options for all employees. Prior to 2015, the expected term assumption was based on the simplified method under GAAP, which is based on the vesting period and contractual term for each vesting tranche of awards. The mid-point between the vesting date and the expiration date was used as the expected term under this method. The risk-free interest rate used in the Black-Scholes model is based on the implied yield curve available on U.S. Treasury issues at the date of grant with a remaining term equal to the Company’s expected term assumption. The Company has never declared or paid a cash dividend. Treasury Stock. Prior to the fourth quarter of 2015 when all treasury stock shares were retired, shares of the Company’s common stock repurchased through the share repurchase programs were held as treasury stock. Treasury stock was accounted for using the cost method. Beginning in the fourth quarter of 2015, stock repurchased through the share repurchase programs will be retired upon repurchase. The excess repurchase price over the par value is charged to retained earnings. Earnings (Loss) Per Share. Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted-average number of shares outstanding during the reported period. The calculation of diluted earnings per share is similar to basic earnings per share, except that the weighted-average number of shares outstanding includes the dilution from potential shares added from stock options, restricted share awards and other stock awards. Refer to Note 5 for share information on the Company’s stock compensation plans. The components of basic and diluted earnings (loss) per share are as follows: Options to purchase 5.2 million in 2016, 4.5 million shares in 2015 and 2.4 million shares in 2014 of common stock, were not included in the computation of diluted earnings per share because their exercise prices were greater than the average market price of the common shares and, therefore, the effect would have been anti-dilutive. For 2015, due to the net loss attributable to Teradata common stockholders, largely due to the goodwill and acquired intangibles impairment charges, potential common shares that would cause dilution, such as employee stock options, restricted shares and other stock awards, have been excluded from the diluted share count because their effect would have been anti-dilutive. For 2015, the fully diluted shares would have been 141.9 million. Recently Issued Accounting Pronouncements Revenue Recognition. In May 2014, the Financial Accounting Standards Board ("FASB") issued new guidance that affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The new guidance will supersede the revenue recognition requirements in the current revenue recognition guidance, and most industry-specific guidance. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer are amended to be consistent with the guidance on recognition and measurement in this update. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, the FASB defines a five step process which includes the following: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. In July 2015, the FASB issued a one-year delay in the effective date of the new standard. Under this guidance, the new revenue standard will be effective for annual reporting periods beginning after December 15, 2017, with early application permitted. The standard allows entities to apply the standard retrospectively for all periods presented or alternatively an entity is permitted to recognize the cumulative effect of initially applying the guidance as an opening balance sheet adjustment to retained earnings in the period of initial application. In March 2016, the FASB issued an update that amends and clarifies the implementation guidance on principal versus agent considerations for reporting revenue gross rather than net. In April 2016, the FASB issued an update that amends and clarifies the identification of performance obligations and accounting for licenses of intellectual property. In May 2016, the FASB issued an update which addresses the narrow-scope improvements to the guidance on collectibility, non-cash consideration, and completed contracts at transition. Additionally, the amendments in this update provide a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. All updates issued in 2016 have the same deferred effective date. The Company plans to adopt the new accounting guidance effective January 1, 2018. The Company is currently evaluating the impact on its consolidated financial position, results of operations and cash flows, as well as the method of transition that will be used in adopting the standard. Although the Company is still evaluating the impact on its consolidated financial statements, including evaluating the different adoption methodologies, the Company believes the most significant impacts may include the following items: • As the Company transitions to the new go-to-market offerings, such as subscription licenses, the Company could potentially see a more significant impact in the amount of revenue recognized over time under the current rules but upfront under the new rules • The Company currently expenses contract acquisition costs and believes that the requirement to defer incremental contract acquisition costs and recognize them over the term of the contract to which the costs relate could have an impact, especially as the Company transitions to longer-term, over-time revenue contracts • The amount of revenue allocated to the delivered items and recognized upfront utilizing the relative selling price model is limited to the amount that is not contingent upon the delivery of additional items or meeting other specified performance conditions (i.e. the non-contingent amount) under current rules. Under the new rules, the amounts allocated to delivered items and recognized upfront could be higher if it is probable that a significant reversal in the amount of revenue recognized will not occur in future periods upon the delivery of additional items or meeting other specified performance conditions. The Company does not expect that the new standard will result in substantive changes in our deliverables or the amounts of revenue allocated between multiple deliverables, with the exception of contingent revenue discussed above. The Company is still in the process of evaluating these impacts, and our initial assessment may change as the Company continues with implementing new systems, processes, accounting policies and internal controls. Leases. In February 2016, the FASB issued new guidance which requires a lessee to account for leases as finance or operating leases. Both leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability on its balance sheet, with differing methodology for income statement recognition. For lessors, the standard modifies the classification criteria and the accounting for sales-type and direct financing leases. Entities will classify leases to determine how to recognize lease-related revenue and expense. This standard is effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. A modified retrospective approach is required for leases existing or entered into after the beginning of the earliest comparative period in the consolidated financial statements. The Company is currently assessing the impact of this update on its consolidated financial statements. Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. In August 2016, the FASB issued an update addressing eight specific cash flow issues in an effort to reduce diversity in practice. The amended guidance is effective for fiscal years beginning after December 31, 2017, and for interim periods within those years. Early adoption is permitted. The Company is currently assessing the impact of this update on its consolidated statements of cash flows. Financial Instruments. In January 2016, the FASB issued new guidance which enhances the reporting model for financial instruments and related disclosures. This update requires equity securities to be measured at fair value with changes in fair value recognized through net income and will eliminate the cost method for equity securities without readily determinable fair values. The provisions are effective for public entities with fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted, in certain circumstances. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows. Intra-entity asset transfers. In October 2016, the FASB issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies will be required to recognize the income tax consequences of an intra-entity asset transfer when the transfer occurs. Current guidance prohibits companies from recognizing current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. The guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The guidance is effective for periods beginning after December 15, 2017 and early adoption is permitted. The Company is currently evaluating this guidance to determine the impact it may have on its consolidated financial statements. Classification of restricted cash. In December 2016, the FASB issued accounting guidance to address diversity in the classification and presentation of changes in restricted cash on the statement of cash flows. Under this guidance, companies will be required to present restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statement of cash flows. The guidance is required to be applied retrospectively and is effective for periods beginning after December 15, 2017, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material effect on its statement of cash flows. Clarification on the definition of a business. In January 2017, the FASB issued accounting guidance to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This new guidance is effective for reporting periods beginning after December 15, 2017 with early adoption permitted. The Company is currently evaluating the impact this guidance may have on its consolidated financial statements. Simplifying the measurement for goodwill. In January 2017, the FASB issued guidance to simplify the accounting for the impairment of goodwill. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The guidance is required to be applied prospectively and is effective for periods beginning after December 15, 2019, with early adoption permitted. The Company expects to early adopt this accounting guidance effective January 1, 2017. The Company does not expect any impact from the adoption of the new accounting guidance on its consolidated financial statements. Recently Adopted Guidance Accounting for Share-based Payments with Performance Targets. In June 2014, the FASB issued new guidance that requires that a performance target that affects vesting and that could be achieved after the requisite service period, be treated as a performance condition. A reporting entity should apply existing guidance as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which the requisite service has already been rendered. The Company adopted this guidance on January 1, 2016. This amendment did not have an impact on the Company's consolidated financial statements. Simplifying the Presentation of Debt Issuance Costs. To simplify presentation of debt issuance costs, the amendments in this update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. The Company adopted this guidance on January 1, 2016 on a retrospective basis. Debt issuance costs of $3 million at December 2015 and $2 million at December 31, 2016 have been presented as a deduction from the carrying value of the related long-term liabilities in our Consolidated Balance Sheets. Intangibles, Goodwill and Other Internal-Use Software. The amendments in this update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance will not change current guidance for a customer’s accounting for service contracts. The Company adopted this guidance on January 1, 2016. This amendment did not have an impact on the Company's consolidated financial statements. Stock Compensation: Improvements to Employee Share-Based Payment Accounting. In March 2016, the FASB issued an update which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the Statements of Cash Flows. The Company elected to early adopt this standard in the quarter ended December 31, 2016 retroactively to January 1, 2016. The impact of early adoption resulted in the following: • The new guidance requires excess tax benefits and tax deficiencies (shortfalls) from vested or settled share-based awards to be recorded in the provision for income taxes on the income statement rather than in paid-in capital. This change was applied on a prospective basis as of January 1, 2016, which resulted in additional tax expense of $5 million for the year ended December 31, 2016. • The tax withholding threshold for triggering liability accounting on a net settlement transaction has been increased from the minimum statutory rate to the maximum. This change was applied on a modified retrospective basis as of January 1, 2016, which resulted in no impact to retained earnings as of January 1, 2016 where the cumulative effect of this change is required to be recorded. • The Company elected to change its accounting policy for forfeitures to record them as they occur. The change was applied on a modified retrospective basis with a cumulative effect adjustment to retained earnings of less than $1 million as of January 1, 2016. • The Company no longer reflects the cash received from the excess tax benefits within cash flows from financing activities but instead now reflects this benefit within cash flows from operating activities. This change in presentation was applied prospectively as of January 1, 2016, which resulted in an increase in net cash provided by operating activities and net cash used by financing activities of $3 million for the year ended December 31, 2016. • The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented on our Consolidated Statement of Cash Flows since these cash flows have historically been presented as a financing activity. • The Company excluded excess tax benefits from the assumed proceeds available to repurchase shares in the computation of our diluted earnings per share. This change was applied on a prospective basis as of January 1, 2016, which decreased diluted weighted average common shares outstanding by approximately 131 thousand shares in 2016. Note 2 Supplemental Financial Information Above amounts exclude assets and liabilities held for sale. Refer to Note 15 for further information on the Company's assets and liabilities held for sale. Note 3 Goodwill and Acquired Intangible Assets The following table identifies the activity relating to goodwill by operating segment: In the fourth quarter of 2015, the Company committed to a plan to exit the marketing applications business, which met the criteria for held for sale and continued to be reported under continuing operations. The business was subsequently sold on July 1, 2016. Not included in the table above is $113 million at December 31, 2015 for goodwill that had been classified as held for sale. See Note 15 for additional disclosures related to the sale of the business and impairment charges recorded for goodwill that had been classified as held for sale. During the third quarter of 2016, the Company recorded additional goodwill of $11 million, for an immaterial acquisition that occurred during the period. In the fourth quarter of 2016, the Company performed its annual impairment test of goodwill and determined that no impairment to the carrying value of goodwill was necessary. The Company reviewed two reporting units in its 2016 goodwill impairment assessment, as both geographic operating segments were considered separate reporting units for purposes of testing. Based on the Company's evaluation and weighting of the events and circumstances that have occurred since the most recent Step 1 test, the Company concluded that it was not more likely than not that each reporting unit's fair value was below its carrying value. Therefore, the Company determined that it was not necessary to perform a Step 1 goodwill impairment test for the reporting units in 2016. Acquired intangible assets were specifically identified when acquired, and are deemed to have finite lives. The gross carrying amount and accumulated amortization for Teradata’s acquired intangible assets were as follows: The gross carrying amount of acquired intangibles was reduced by certain intangible assets previously acquired that became fully amortized and were removed from the balance sheet. Not included in the table above is $44 million at December 31, 2015 for intangible assets that were classified as held for sale. See Note 15 for additional disclosures related to the sale of the business and impairment charges recorded for intangible assets that had been classified as held for sale. The aggregate amortization expense (actual and estimated) for acquired intangible assets for the following periods is: Note 4 Income Taxes For the years ended December 31, income (loss) before income taxes consisted of the following: For the years ended December 31, income tax expense consisted of the following: The following table presents the principal components of the difference between the effective tax rate and the U.S. federal statutory income tax rate for the years ended December 31: The 2016 effective tax rate was impacted by the $57 million of goodwill impairment charges recorded in the first quarter of 2016, all of which was treated as a permanent, non-deductible tax item. In addition, a discrete tax charge of $22 million was recorded in the third quarter of 2016 related to the tax impact of the sale of the marketing applications business, which occurred on July 1, 2016. In the fourth quarter of 2016, the Company recorded $8 million of tax expense associated with the issuance of new U.S. Treasury Regulations under Internal Revenue Code Section 987 on December 7, 2016, which clarified how companies calculate foreign currency translation gains and losses for income tax purposes for branches whose accounting records are kept in a currency other than the currency of the company. Also in the fourth quarter of 2016, the Company elected to early adopt Accounting Standards Update 2016-09, Improvements to Employee Share-based Payment Accounting. As a result, the Company incurred a $5 million discrete tax expense associated with the net shortfall arising from 2016 equity compensation vestings and exercises. The 2015 effective tax rate was impacted by the $437 million of goodwill impairment charges recorded for 2015, of which $414 million was treated as a permanent non-deductible tax item. This resulted in full-year income tax expense in 2015 of $70 million, on a pre-tax net loss of $(144) million, causing a negative tax rate of (48.6)%. There were no material discrete tax items impacting the effective tax rate for full year 2014. Deferred income tax assets and liabilities included in the balance sheets at December 31 were as follows: As of December 31, 2016, Teradata has net operating loss ("NOL") and tax credit carryforwards totaling $56 million (tax effected and before any valuation allowance offset and application of recognition criteria for uncertain tax positions). Of the total tax carryforwards, $13 million are NOL's in the U.S. and certain foreign jurisdictions, a small portion of which will begin to expire in 2019; $2 million are U.S. foreign tax credit carryforwards, which expire in 2021; $37 million are California R&D tax credits that have an indefinite carryforward period (which has a $26 million valuation allowance offset recorded); and the remaining $4 million are tax attributes that were acquired from various acquisitions and were not recorded for financial reporting purposes as they did not meet the recognition criteria for uncertain tax positions. The Company’s intention is to permanently reinvest its foreign earnings outside of the U.S. As a result, the effective tax rates in the periods presented are largely based upon the pre-tax earnings mix and allocation of certain expenses in various taxing jurisdictions where the Company conducts its business; these jurisdictions apply a broad range of statutory income tax rates. At December 31, 2016, the Company had not provided for federal income taxes on earnings of approximately $1.3 billion from its foreign subsidiaries. Should these earnings be distributed in the form of dividends or otherwise, the Company would be subject to U.S. income taxes and potential withholding taxes in various international jurisdictions. The U.S. taxes would be partially offset by U.S. foreign tax credits. Determination of the amount of unrecognized deferred U.S. tax liability is not practical because of the complexities associated with this hypothetical calculation. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The Company reflects any interest and penalties recorded in connection with its uncertain tax positions as a component of income tax expense. As of December 31, 2016, the Company’s uncertain tax positions totaled approximately $30 million, of which $20 million is reflected in the other liabilities section of the Company’s balance sheet as a non-current liability. The remaining balance of $10 million of uncertain tax positions relates to certain tax attributes both generated by the Company and acquired in various acquisitions, which are netted against the underlying deferred tax assets recorded on the balance sheet. The entire balance of $30 million in uncertain tax positions would cause a decrease in the effective income tax rate upon recognition. Teradata has recorded $2 million of interest accruals related to its uncertain tax liabilities as of December 31, 2016. Below is a rollforward of the Company’s liability related to uncertain tax positions at December 31: The Company and its subsidiaries file income tax returns in the U.S. and various state jurisdictions, as well as numerous foreign jurisdictions. As of December 31, 2016, the Company has ongoing tax audits in a limited number of state and foreign jurisdictions. However, no material adjustments have been proposed or made in any of these examinations to date which would result in any incremental income tax expense in future periods to the Company. In addition, the Internal Revenue Service audit of the Company’s U.S. Federal tax filing for tax year 2011 was finalized in July of 2014 and resulted in a no change audit. Note 5 Employee Stock-based Compensation Plans The Company recorded stock-based compensation expense for the years ended December 31 as follows: The Teradata Corporation 2007 Stock Incentive Plan (the “2007 SIP”), as amended, and the Teradata 2012 Stock Incentive Plan (the “2012 SIP”) provide for the grant of several different forms of stock-based compensation. The 2012 SIP was adopted and approved by stockholders in April 2012 and no further awards may be made under the 2007 SIP after that time. A total of approximately 17.5 million shares were authorized to be issued under the 2012 SIP. New shares of the Company’s common stock are issued as a result of the vesting of restricted share units and stock option exercises, and at the time of grant for restricted shares, for awards under both plans. As of December 31, 2016, the Company’s primary types of stock-based compensation were stock options, restricted shares, restricted share units and the employee stock purchase program (the “ESPP”). Stock Options The Compensation and Human Resource Committee of Teradata’s Board of Directors has discretion to determine the material terms and conditions of option awards under both the 2007 SIP and the 2012 SIP (collectively, the “Teradata SIP”), provided that (i) the exercise price must be no less than the fair market value of Teradata common stock (as defined in both plans) on the date of grant, and (ii) the term must be no longer than ten years. Option grants generally have a four-year vesting period. The weighted-average fair value of options granted for Teradata equity awards was $10.68 in 2016, $11.37 in 2015 and 17.67 in 2014. The fair value of each option award on the grant date was estimated using the Black-Scholes option-pricing model with the following assumptions: The following table summarizes the Company’s stock option activity for the year ended December 31, 2016: The following table summarizes the total intrinsic value of options exercised and the cash received by the Company from option exercises under all share-based payment arrangements at December 31: As of December 31, 2016, there was $24 million of total unrecognized compensation cost related to unvested stock option grants. That cost is expected to be recognized over a weighted-average period of 3.2 years. Restricted Shares and Restricted Share Units The Teradata SIP provides for the issuance of restricted shares, as well as restricted share units. These grants consist of both service-based and performance-based awards. Service-based awards typically vest over a three year period beginning on the effective date of grant. These grants are not subject to future performance measures. The cost of these awards, determined to be the fair market value at the date of grant, is expensed ratably over the vesting period. For substantially all restricted share grants, at the date of grant, the recipient has all rights of a stockholder, subject to certain restrictions on transferability and a risk of forfeiture. A recipient of restricted share units does not have the rights of a stockholder and is subject to restrictions on transferability and risk of forfeiture. For both restricted share grants and restricted share units, any potential dividend rights would be subject to the same vesting requirements as the underlying equity award. As a result, such rights are considered a contingent transfer of value and consequently these equity awards are not considered participating securities. Performance-based grants are subject to future performance measurements over a one-to four-year period. All performance-based shares that are earned in respect of an award will become vested at the end of the performance and/or service period provided the employee is continuously employed by the Company and applicable performance measures and other vesting conditions are met. The fair value of each performance-based award is determined on the grant date, based on the Company’s stock price, and assumes that performance targets will be achieved. Over the performance period, the number of shares of stock that will be issued is adjusted upward or downward based upon management’s assessment of the probability of achievement of performance targets. The ultimate number of shares issued and the related compensation cost recognized as expense will be based on a comparison of the final achievement of performance metrics to the specified targets. The following table reports restricted shares and restricted share unit activity during the year ended December 31, 2016: The following table summarizes the weighted-average fair value of restricted share units granted for Teradata equity awards and the total fair value of shares vested. As of December 31, 2016, there was $86 million of unrecognized compensation cost related to unvested restricted share grants. The unrecognized compensation cost is expected to be recognized over a remaining weighted-average period of 2.3 years. The following table represents the composition of Teradata restricted share unit grants in 2016: In 2012, approximately 0.3 million shares of the performance awards issued included challenging or “stretch” financial goals through 2016 based on a GAAP revenue and/or non-GAAP earnings per share targets in 2016. Each recipient’s opportunity to earn the award is based on performance over a four-year period ending in 2016. There was no compensation expense related to these awards recorded in 2016 as the performance targets for these awards were not achieved. Performance-based share units granted as part of our long-term incentive program for certain corporate officers and key executives will be earned based on Teradata's total shareholder return ("TSR") over a three-year performance period relative to the other companies in the S&P 1500 Technology Index. The number of shares actually issued, as a percentage of the amount subject to the performance share award, could range from 0% to 200%. The grant date fair value of the non-vested performance-based awards was determined through the use of a Monte Carlo simulation model, which utilized multiple input variables that determined the probability of satisfying the market condition requirements applicable to each award. The compensation expense for the award will be recognized as long as the requisite service is rendered, regardless of whether the market conditions are achieved. Modifications In connection with the plan to exit most of the marketing applications business and the departure of certain executives, the Company modified its awards for certain employees to accelerate the vesting of any unvested awards at the date of sale. This modification resulted in a Type III modification (improbable to probable). In addition, a modification to extend the exercise period of all vested options from 59 days to one year resulted in a Type I modification (probable to probable). Related to the awards that were modified, the Company recognized a net increase in compensation expense of $1 million in 2016. Employee Stock Purchase Program The Company’s ESPP, effective on October 1, 2007, and as amended effective as of January 1, 2013, provides eligible employees of Teradata and its designated subsidiaries an opportunity to purchase the Company’s common stock at a discount to the average of the highest and lowest sale prices on the last trading day of each month. The ESPP discount was 15% of the average market price and is considered compensatory. Employees may authorize payroll deductions of up to 10% of eligible compensation for common stock purchases. A total of 4 million shares were authorized to be issued under the ESPP, with approximately 1.0 million shares remaining under that authorization at December 31, 2016. The shares of Teradata common stock purchased by a participant on an exercise date (the last day of each month), for all purposes, are deemed to have been issued and sold at the close of business on such exercise date. Prior to that time, none of the rights or privileges of a stockholder exists with respect to such shares. Employee purchases and aggregate cost were as follows at December 31: Note 6 Employee Benefit Plans Pension and Postemployment Plans. Teradata currently sponsors defined benefit pension plans for certain of its international employees. For those international pension plans for which the Company holds asset balances, those assets are primarily invested in common/collective trust funds (which include publicly traded common stocks, corporate and government debt securities, real estate indirect investments, cash or cash equivalents) and insurance contracts. Postemployment obligations relate to benefits provided to involuntarily terminated employees and certain inactive employees after employment but before retirement. These benefits are paid in accordance with various foreign statutory laws and regulations, and Teradata’s established postemployment benefit practices and policies. Postemployment benefits may include disability benefits, supplemental unemployment benefits, severance, workers’ compensation benefits, continuation of health care benefits and life insurance coverage, and are funded on a pay-as-you-go basis. In 2016 the Company eliminated the accumulation of postemployment benefits based on service for the U.S. separation plan. As a result of this change, postemployment benefits for the U.S. will no longer be accounted for using actuarial models. Pension and postemployment benefit costs for the years ended December 31 were as follows: The underfunded amount of pension and postemployment obligations is recorded as a liability in the Company’s consolidated balance sheet. The following tables present the changes in benefit obligations, plan assets, funded status and the reconciliation of the funded status to amounts recognized in the consolidated balance sheets and in accumulated other comprehensive income at December 31: The following table presents the accumulated pension benefit obligation at December 31: The following table presents pension plans with accumulated benefit obligations in excess of plan assets at December 31: The following table presents the pre-tax net changes in projected benefit obligations recognized in other comprehensive income: The following table presents the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost during 2017: The weighted-average rates and assumptions used to determine benefit obligations at December 31, and net periodic benefit cost for the years ended December 31, were as follows: The Company determines the expected return on assets based on individual plan asset allocations, historical capital market returns, and long-term interest rate assumptions, with input from its actuaries, investment managers, and independent investment advisors. The company emphasizes long-term expectations in its evaluation of return factors, discounting or ignoring short-term market fluctuations. Expected asset returns are reviewed annually, but are generally modified only when asset allocation strategies change or long-term economic trends are identified. The discount rate used to determine year-end 2016 U.S. benefit obligations was derived by matching the plans’ expected future cash flows to the corresponding yields from the Citigroup Pension Liability Index. This yield curve has been constructed to represent the available yields on high-quality fixed-income investments across a broad range of future maturities. International discount rates were determined by examining interest rate levels and trends within each country, particularly yields on high-quality long-term corporate bonds, relative to our future expected cash flows. Gains and losses have resulted from changes in actuarial assumptions and from differences between assumed and actual experience, including, among other items, changes in discount rates and differences between actual and assumed asset returns. These gains and losses (except those differences being amortized to the market-related value) are only amortized to the extent that they exceed 10% of the higher of the market-related value of plan assets or the projected benefit obligation of each respective plan. Plan Assets. The weighted-average asset allocations at December 31, by asset category are as follows: Fair Value. Fair value measurements are established utilizing a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers are more fully described in Note 9. The following is a description of the valuation methodologies used for pension assets as of December 31, 2016. Common/collective trust funds (which include money market funds, equity funds, bond funds, real-estate indirect investments, etc.): Valued at the net asset value (“NAV”) of shares held by the Plan at year end, as reported to the Plan by the trustee, which represents the fair value of shares held by the Plan. Because the NAV of the shares held in the common/collective trust funds are derived by the value of the underlying investments, the Company has classified these underlying investments as Level 2 fair value measurements. Insurance contracts: Valued by discounting the related future benefit payments using a current year-end market discount rate, which represents the fair value of the insurance contract. The Company has classified these contracts as Level 3 assets for fair value measurement purposes. The following table sets forth by level, within the fair value hierarchy, the pension plan assets at fair value as of December 31, 2016: The table below sets forth a summary of changes in the fair value of the pension plan level 3 assets for the year ended December 31, 2016: The following table sets forth by level, within the fair value hierarchy, the pension plan assets at fair value as of December 31, 2015: The table below sets forth a summary of changes in the fair value of the pension plan level 3 assets for the year ended December 31, 2015: Investment Strategy. Teradata employs a number of investment strategies across its various international pension plans. In some countries, particularly where Teradata does not have a large employee base, the Company may use insurance (annuity) contracts to satisfy its future pension payment obligations, whereby the Company makes pension plan contributions to an insurance company in exchange for which the pension plan benefits will be paid when the members reach a specified retirement age or on earlier exit of members from the plan. In other countries, the Company may employ local asset managers to manage investment portfolios according to the investment policies and guidelines established by the Company, and with consideration to individual plan liability structure and local market environment and risk tolerances. The Company’s investment policies and guidelines primarily emphasize diversification across and within asset classes to maximize long-term returns subject to prudent levels of risk, with the overall objective of enabling the plans to meet their future obligations. The investment portfolios contain a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across domestic and international stocks, small and large capitalization stocks, and growth and value stocks. Fixed-income assets are diversified across government and corporate bonds. Where applicable, real estate investments are made through real estate securities, partnership interests or direct investment, and are diversified by property type and location. Cash Flows Related to Employee Benefit Plans Cash Contributions. The Company expects to contribute approximately $5 million to the international pension plans, in 2017. Estimated Future Benefit Payments. The Company expects to make the following benefit payments reflecting past and future service from its pension and postemployment plans: Savings Plans. U.S. employees and many international employees participate in defined contribution savings plans. These plans generally provide either a specified percent of pay or a matching contribution on participating employees’ voluntary elections. The Company’s matching contributions typically are subject to a maximum percentage or level of compensation. Employee contributions can be made pre-tax, after-tax or a combination thereof. The following table identifies the expense for the U.S. and International subsidiary savings plans for the years ended December 31: Note 7 Derivative Instruments and Hedging Activities As a portion of the Company’s operations and revenue occur outside the U.S. and in currencies other than the U.S. dollar, the Company is exposed to potential gains and losses from changes in foreign currency exchange rates. In an attempt to mitigate the impact of currency fluctuations, the Company uses foreign exchange forward contracts to hedge transactional exposures resulting predominantly from foreign currency denominated inter-company receivables and payables. The forward contracts are designated as fair value hedges of specified foreign currency denominated inter-company receivables and payables and generally mature in three months or less. The Company does not hold or issue derivative financial instruments for trading purposes, nor does it hold or issue leveraged derivative instruments. By using derivative financial instruments to hedge exposures to changes in exchange rates, the Company exposes itself to credit risk. The Company manages exposure to counterparty credit risk by entering into derivative financial instruments with highly rated institutions that can be expected to fully perform under the terms of the applicable contracts. All derivatives are recognized in the Consolidated Balance Sheets at their fair value. The fair values of foreign exchange contracts are based on market spot and forward exchange rates and represent estimates of possible value that may not be realized in the future. Changes in the fair value of derivative financial instruments, along with the loss or gain on the hedged asset or liability, are recorded in current period earnings. The notional amounts represent agreed-upon amounts on which calculations of dollars to be exchanged are based, and are an indication of the extent of Teradata’s involvement in such instruments. These notional amounts do not represent amounts exchanged by the parties and, therefore, are not a measure of the instruments. Across its portfolio of contracts, Teradata has both long and short positions relative to the U.S. dollar. As a result, Teradata’s net involvement is less than the total contract notional amount of the Company’s foreign exchange forward contracts. The following table identifies the contract notional amount of the Company’s foreign exchange forward contracts at December 31: The fair value derivative assets and liabilities recorded in other current assets and accrued liabilities at December 31, 2016 and 2015, were not material. Gains and losses from the Company’s fair value hedges (foreign currency forward contracts and related hedged items) were immaterial for the years ended December 31, 2016, 2015 and 2014. Gains and losses from foreign exchange forward contracts are fully recognized each period and reported along with the offsetting gain or loss of the related hedged item, either in cost of products or in other income, depending on the nature of the related hedged item. Note 8 Commitments and Contingencies In the normal course of business, the Company is subject to proceedings, lawsuits, governmental investigations, claims and other matters, including those that relate to the environment, health and safety, employee benefits, export compliance, intellectual property, tax matters, and other regulatory compliance and general matters. Guarantees and Product Warranties. Guarantees associated with the Company’s business activities are reviewed for appropriateness and impact to the Company’s financial statements. Periodically, the Company’s customers enter into various leasing arrangements coordinated with a leasing company. In some instances, the Company guarantees the leasing company a minimum value at the end of the lease term on the leased equipment. As of December 31, 2016, the maximum future payment obligation of this guaranteed value and the associated liability balance was $4 million. The Company provides its customers a standard manufacturer’s warranty and records, at the time of the sale, a corresponding estimated liability for potential warranty costs. Estimated future obligations due to warranty claims are based upon historical factors such as labor rates, average repair time, travel time, number of service calls and cost of replacement parts. For each consummated sale, the Company recognizes the total customer revenue and records the associated warranty liability using pre-established warranty percentages for that product class. The following table identifies the activity relating to the warranty reserve liability for the years ended December 31: The Company also offers extended and/or enhanced coverage to its customers in the form of maintenance contracts. The Company accounts for these contracts by deferring the related maintenance revenue over the extended and/or enhanced coverage period. Costs associated with maintenance support are expensed as incurred. Amounts associated with these maintenance contracts are not included in the table above. In addition, the Company provides its customers with certain indemnification rights. In general, the Company agrees to indemnify the customer if a third party asserts patent or other infringement on the part of the customer for its use of the Company’s products. The Company has indemnification obligations under its charter and bylaws to its officers and directors, and has entered into indemnification agreements with the officers and directors of its subsidiaries. From time to time, the Company also enters into agreements in connection with its acquisition and divesture activities that include indemnification obligations by the Company, including the sale of the marketing applications business. The fair value of these indemnification obligations is typically not readily determinable due to the conditional nature of the Company’s potential obligations and the specific facts and circumstances involved with each particular agreement. As such, the Company has generally not recorded a liability in connection with these indemnification arrangements. Historically, payments made by the Company under these types of agreements have not had a material effect on the Company’s consolidated financial condition, results of operations or cash flows. Leases. Teradata conducts certain of its sales and administrative operations using leased facilities, the initial lease terms of which vary in length. Many of the leases contain renewal options and escalation clauses that are not material to the overall lease portfolio. Future minimum operating lease payments and committed subleases under non-cancelable leases as of December 31, 2016, for the following fiscal years were: The following table represents the Company’s actual rental expense and sublease rental income for the years ended December 31: The Company had no contingent rentals for these periods. Concentrations of Risk. The Company is potentially subject to concentrations of credit risk on accounts receivable and financial instruments such as hedging instruments, and cash and cash equivalents. Credit risk includes the risk of nonperformance by counterparties. The maximum potential loss may exceed the amount recognized on the balance sheet. Exposure to credit risk is managed through credit approvals, credit limits, selecting major international financial institutions (as counterparties to hedging transactions) and monitoring procedures. Teradata’s business often involves large transactions with customers, and if one or more of those customers were to default in its obligations under applicable contractual arrangements, the Company could be exposed to potentially significant losses. However, management believes that the reserves for potential losses were adequate at December 31, 2016 and 2015. The Company is also potentially subject to concentrations of supplier risk. Our hardware components are assembled exclusively by Flextronics International Ltd. (“Flextronics”). Flextronics procures a wide variety of components used in the manufacturing process on our behalf. Although many of these components are available from multiple sources, Teradata utilizes preferred supplier relationships to better ensure more consistent quality, cost and delivery. Typically, these preferred suppliers maintain alternative processes and/or facilities to ensure continuity of supply. Given the Company’s strategy to outsource its manufacturing activities to Flextronics and to source certain components from single suppliers, a disruption in production at Flextronics or at a supplier could impact the timing of customer shipments and/or Teradata’s operating results. Note 9 Fair Value Measurements Fair value measurements are established utilizing a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets or liabilities; Level 2, defined as significant other observable inputs, such as quoted prices in active markets for similar assets or liabilities, or quoted prices in less-active markets for identical assets; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assets and liabilities measured at fair value on a recurring basis include money market funds and foreign currency exchange contracts. A portion of the Company’s excess cash reserves are held in money market funds which generate interest income based on the prevailing market rates. Money market funds are included in cash and cash equivalents in the Company’s balance sheet. Money market fund holdings are measured at fair value using quoted market prices and are classified within Level 1 of the valuation hierarchy. When deemed appropriate, the Company minimizes its exposure to changes in foreign currency exchange rates through the use of derivative financial instruments, specifically, forward foreign exchange contracts. The fair value of these contracts are measured at the end of each interim reporting period using observable inputs other than quoted prices, specifically market spot and forward exchange rates. As such, these derivative instruments are classified within Level 2 of the valuation hierarchy. Fair value gains for open contracts are recognized as assets and fair value losses are recognized as liabilities. The fair value derivative assets and liabilities recorded in other current assets and accrued liabilities at December 31, 2016 and 2015, were not material. Any realized gains or losses would be mitigated by corresponding gains or losses on the underlying exposures. Further information on the Company’s use of forward foreign exchange contracts is included in Note 7. The Company’s assets measured at fair value on a recurring basis and subject to fair value disclosure requirements at December 31, were as follows: Note 10 Debt Teradata's $600 million term loan is payable in quarterly installments, which commenced on March 31, 2016, with all remaining principal due in March 2020. The outstanding principal amount under the term loan agreement bears interest at a floating rate based upon a negotiated base rate or a Eurodollar rate plus a margin based on the leverage ratio of the Company. As of December 31, 2016, the term loan principal outstanding was $570 million and carried an interest rate of 2.1875%. Unamortized deferred issuance costs of approximately $2 million are being amortized over the five-year term of the loan. The Company was in compliance with all covenants as of December 31, 2016. Annual contractual maturities of principal on term loan outstanding at December 31, 2016, are as follows: The following table presents interest expense on borrowings for the years ended December 31: Teradata’s term loan is recognized on the Company’s balance sheet at its unpaid principal balance, and is not subject to fair value measurement. However, given that the loan carries a variable rate, the Company estimates that the unpaid principal balance of the term loan would approximate its fair value. If measured at fair value in the financial statements, the Company’s term loan would be classified as Level 2 in the fair value hierarchy. Teradata's revolving credit facility (the “Credit Facility”) has a borrowing capacity of $400 million. The Credit Facility ends on March 25, 2020 at which point any remaining outstanding borrowings would be due for repayment unless extended by agreement of the parties for up to two additional one-year periods. The interest rate charged on borrowings pursuant to the Credit Facility can vary depending on the interest rate option the Company chooses to utilize and the Company’s leverage ratio at the time of the borrowing. In the near term, Teradata would anticipate choosing a floating rate based on the London Interbank Offered Rate (“LIBOR”). The Credit Facility is unsecured and contains certain representations and warranties, conditions, affirmative, negative and financial covenants, and events of default customary for such facilities. As of December 31, 2016, the Company had no borrowings outstanding under the Credit Facility, leaving $400 million in additional borrowing capacity available. Unamortized deferred costs on the original credit facility and new lender fees of approximately $1 million are being amortized over the five-year term of the credit facility. The Company was in compliance with all covenants as of December 31, 2016. Note 11 Segment, Other Supplemental Information and Concentrations Effective January 1, 2016, Teradata implemented an organizational change in which it decided to manage the Company's business under two geographic regions and the marketing applications division (prior to its completed sale on July 1, 2016); which are also the Company’s operating segments: (1) Americas Data and Analytics (North America and Latin America); (2) International Data and Analytics (Europe, Middle East, Africa, Asia Pacific and Japan); and (3) Marketing Applications. Effective July 1, 2016, following the sale of the marketing applications business, Teradata is managing its business in two operating segments: (1) Americas region (North America and Latin America); and (2) International region (Europe, Middle East, Africa, Asia Pacific and Japan). For purposes of discussing results by segment, management excludes the impact of certain items, consistent with the manner by which management evaluates the performance of each segment. This format is useful to investors because it allows analysis and comparability of operating trends. It also includes the same information that is used by Teradata management to make decisions regarding the segments and to assess financial performance. The chief operating decision maker evaluates the performance of the segments based on revenue and multiple profit measures, including segment gross margin. For management reporting purposes assets are not allocated to the segments. Prior period segment information has been reclassified to conform to the current period presentation. The following table presents segment revenue and segment gross margin for the Company for the years ended December 31: The following table presents revenue by product and services revenue for the Company for the years ended December 31: (1) Our analytic database software and hardware products are often sold and delivered together in the form of a “node” of capacity as an integrated technology solution. Accordingly, it is impracticable to provide the breakdown of revenue from various types of software and hardware products. The following table presents revenues by geographic area for the years ended December 31: The following table presents property and equipment by geographic area at December 31: (1) 2015 amounts include property and equipment held for sale for $12 million. Concentrations. No single customer accounts for more than 10% of the Company's revenue. As of December 31, 2016, the Company is not aware of any significant concentration of business transacted with a particular customer that could, if suddenly eliminated, have a material adverse effect on the Company’s operations. The Company's hardware components are assembled exclusively by Flextronics. In addition, the Company utilizes preferred supplier relationships to better ensure more consistent quality, cost and delivery. There can be no assurances that a disruption in production at Flextronics or at a supplier would not have a material adverse effect on the Company's operations. Note 12 Business Combinations and Other Investment Activities During 2016, the Company completed one immaterial business acquisition, which complements and strengthens the Company's global portfolio, and released hold-back amounts from several prior-year acquisitions for $16 million. The Company also sold the marketing applications business on July 1, 2016 (see Note 15). During 2015, the Company completed two immaterial business acquisitions for $17 million, which complemented and strengthened the Company's global portfolio. One of the acquisitions pertained to the marketing applications business, which the Company exited on July 1, 2016 and therefore was classified in the assets held for sale (see Note 15) as of December 31, 2015. In addition, the Company sold two equity investments for $85 million and recognized a gain of $57 million. During 2014, the Company completed six immaterial business acquisitions and other equity investments for $69 million. These acquisitions complemented and strengthened the Company's global portfolio. Two of these acquisitions pertained to the marketing applications business. In addition, the Company recognized a loss of $9 million in an equity investment arising from an impairment of carrying value. Note 13 Accumulated Other Comprehensive (Loss) Income The following table provides information on changes in accumulated other comprehensive income (“AOCI”), net of tax, for the years ended December 31: The following table presents the impact and respective location of AOCI reclassifications in the Consolidated Statements of Income for the years ended December 31: Further information on the Company’s defined benefit plans is included in Note 6. Note 14 Reorganization and Business Transformation In the fourth quarter of 2015 the Company announced a plan to realign Teradata’s business by reducing its cost structure and focusing on the Company’s core data and analytics business. This business transformation includes exiting the marketing applications business (see Note 15), rationalizing costs, and modifying the Company’s go-to-market approach. The Company incurred the following costs related to these actions for the years ended December 31: The charges for asset write-downs were for non-cash write-downs of goodwill, acquired intangibles and other assets (see Note 15). In addition to the costs and charges incurred above, the Company made cash payments of $20 million in 2016 and $14 million in 2015 for employee severance that did not have a material impact on its Statement of Operations due to Teradata accounting for its postemployment benefits under Accounting Standards Codification 712, Compensation - Nonretirement Postemployment Benefits (“ASC 712”), which uses actuarial estimates and defers the immediate recognition of gains or losses. Because the Company accounts for postemployment benefits under ASC 712, it did not record any liability associated with ASC 420, Exit or Disposal Cost Obligations. Note 15 Impairment and Sale of the Marketing Applications Business The Company reviews goodwill for impairment annually in the fourth quarter and whenever events or changes in circumstances indicate it is more likely than not that the fair value of the reporting unit is less than its carrying amount. During the second quarter of 2015, the Company determined that indicators were present in the marketing applications business which would suggest the fair value may have declined below the carrying value. The indicators were primarily lower than forecasted revenue and profitability levels for 2015 and future periods. Based on our analysis, the implied fair value of goodwill was substantially lower than the carrying value of goodwill. As a result, the Company recorded an impairment charge of $340 million during the second quarter of 2015. In the fourth quarter of 2015, the Company committed to a plan to exit the marketing applications business. The assets and liabilities for this business, which were included within our marketing applications segment, were classified as held for sale in the fourth quarter of 2015 and, therefore, the corresponding depreciation and amortization expense ceased at that time. The divestiture was not presented as discontinued operations in our consolidated financial statements because it did not have a major effect on the Company's operations and financial results. The Company then performed a goodwill impairment analysis of the business to be disposed of. As a result of this analysis, the Company recognized an additional goodwill impairment of $97 million in the fourth quarter of 2015. In addition, acquired intangible assets were reduced by $41 million to adjust the carrying amount of the disposal group's net assets and liabilities down to its fair value less cost to sell. On April 22, 2016, the Company entered into a definitive Asset Purchase Agreement (the “Purchase Agreement”) with TMA Solutions, L.P., a Cayman Islands exempted limited partnership and affiliate of Marlin Equity Partners (“Marlin Equity”), to sell the marketing applications business for $90 million in cash, subject to a post-closing adjustment for working capital, debt and other metrics. We recognized an impairment of goodwill of $57 million and acquired intangibles of $19 million in the first quarter of 2016 to adjust the carrying value of the net assets of our marketing applications business to fair value less cost to sell. Prior to the sale that occurred on July 1, 2016, the marketing applications business that was classified as held for sale generated revenue of $69 million and an operating loss of $112 million (which includes loss from impairment of goodwill and acquired intangibles of $76 million) for the six months ended June 30, 2016. For the year ended December 31, 2015, the Company generated revenue of $153 million and an operating loss of $561 million (which includes loss from impairment of goodwill and acquired intangibles of $478 million). The net assets held for sale as of July 1, 2016 and December 31, 2015 were as follows: On July 1, 2016, pursuant to the Purchase Agreement, Teradata completed the sale of Teradata’s marketing applications business to Marlin Equity. The purchase price received for this business was approximately $92 million in cash, subject to a post-closing adjustment for working capital, debt and other metrics. Transaction costs and post-closing obligations were approximately $5 million. Upon completion of the divestiture of the held for sale assets in July 2016, no material gain or loss was recognized as the carrying value of the held for sale assets was equal to the purchase price received less costs to sell. The Company recorded tax expense of approximately $22 million in the third quarter of 2016 related to this transaction. The total tax expense, of which $14 million is cash taxes due to having zero tax basis in goodwill, was calculated based on the amount of proceeds allocated to the various jurisdictions in accordance with the Purchase Agreement at the local statutory rates. The tax expense reported in the third quarter of 2016 is subject to change pending finalization of the working capital, transaction costs and other adjustments. In connection with the closing of the transaction, the parties entered into a transition services agreement, pursuant to which Teradata will provide certain services to Marlin Equity, including accounting, human resources, order processing and invoicing and information technology services for a service period of up to 15 months after the closing of the transaction. Note 16 Quarterly Information (unaudited) (1) Loss from operation for the three months ended March 31, 2016 includes goodwill and acquired intangibles impairment charges of $76 million for the marketing application business. (2) Loss from operations for the three months ended June 30, 2015 includes a goodwill impairment charge of $340 million for the marketing applications business. (3) Loss from operations for the three months ended December 31, 2015 includes goodwill and acquired intangibles impairment charges of $138 million for the marketing applications business. | Based on the provided excerpt, here's a summary of the financial statement:
Financial Statement Summary for Teradata Corporation:
1. Financial Reporting Approach:
- Aims to present a fair and accurate financial position
- Uses estimates and judgments in various areas like:
* Allowances for doubtful accounts
* Inventory valuation
* Goodwill and intangible asset impairments
* Stock-based compensation
* Pension benefits
* Income taxes
2. Revenue Recognition Principles:
- Revenue recorded when:
* Arrangement evidence exists
* Products/services delivered
* Sales price is fixed
* Collectibility is assured
- Revenues reported net of taxes
- Payment terms generally 30 days, vary by country
3. Accounting Updates:
- Adopted new guidance on January 1 regarding debt issuance costs
- | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of December 31, 2016 and December 31, 2015 Consolidated Statements of Income for the years ended December 31, 2016 and 2015 Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2016 and 2015 Consolidated Statements of Cash Flow for the years ended December 31, 2016 and 2015 Report of Independent Registered Public Accounting Firm Board of Directors and Shareholders CPSM, Inc. and Subsidiaries Stuart, Florida: We have audited the accompanying consolidated balance sheets of CPSM, Inc. and Subsidiaries (the "Company") as of December 31, 2016 and 2015, and the related consolidated statements of income, changes in stockholders' equity and cash flows for years then ended. These consolidated financial statements are the responsibility of the Company's management. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at December 31, 2016 and 2015, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. HACKER, JOHNSON & SMITH PA Tampa, Florida March 24, 2017 CPSM, Inc. and Subsidiaries Consolidated Balance Sheets The accompanying notes are an integral part of the consolidated financial statements. CPSM, Inc. and Subsidiaries Consolidated Statements of Income The accompanying notes are an integral part of the consolidated financial statements. CPSM, Inc. and Subsidiaries Consolidated Statements of Stockholders’ Equity Years Ended December 31, 2016 and 2015 The accompanying notes are an integral part of the consolidated financial statements. CPSM, Inc. and Subsidiaries Consolidated Statements of Cash Flow CPSM, Inc. and Subsidiaries Consolidated Statements of Cash Flow (Continued) The accompanying notes are an integral part of the consolidated financial statements. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 1 - NATURE OF OPERATIONS CPSM, Inc. (“CPSM”) and its wholly-owned subsidiaries, Custom Pool and Spa Mechanics, Inc. (“Custom Pool”), and Custom Pool Plastering, Inc. (“CPP”) collectively (the “Company”) are primarily engaged in the provision of full line pool and spa services, specializing in pool maintenance and service, repairs, leak detection, renovations, decking and remodeling. The primary market area includes Martin, Palm Beach, St Lucie, Indian River and Brevard counties, Florida. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated. Basis of Presentation The accompanying consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles general accepted in the United States of America (“GAAP). Cash All highly liquid investments with original maturities of three months or less or money market accounts held at financial institutions are considered to be cash. Substantially all of the cash is placed with one financial institution. From time to time during the year the cash accounts are exposed to credit loss for amounts in excess of insured limits of $250,000 in the event of non-performance by the institution, however, it is not anticipated that there will be non-performance. Allowance for uncollectible receivables Management evaluates credit quality by evaluating the exposure to individual counterparties, and, where warranted, management also considers the credit rating or financial position, operating results and/or payment history of the counterparty. Management establishes an allowance for amounts for which collection is considered doubtful. Adjustments to previous assessments are recognized in income in the period in which they are determined. At December 31, 2016 and 2015, the allowance for uncollected receivables was $16,181 and $23,114, respectively. Inventory Inventory consists principally of pool chemicals and resurfacing materials. Inventory has a short turnover cycle. It is valued at the lower of cost or market using the First-in, First-out method. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Property and Equipment Land is stated at cost. Property and equipment are carried at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Land and building represent the newly acquired building in Stuart, Florida, which is the primary office of the Company. The equipment is largely comprised of computers and motor vehicles used in the pool service business. Intangible Assets Intangible assets consist primarily of customer lists and other purchased assets with a definite life, and these are amortized using the straight-line method over those estimated useful lives. Amortization expense for the next five years and thereafter is as follows: Intangible Asset Thereafter Client List - Prior Acquisitions $ 3,328 $ - $ - $ - $ - $ - Capitalized Costs 1,185 1,185 1,185 1,185 1,185 13,037 Client List - Sundook 8,583 8,583 8,583 8,583 8,583 93,531 Total $13,096 $9,768 $9,768 $9,768 $9,768 $106,568 Customer Deposits The Company collects initial deposits from customers for pool resurfacing and remediation work and recognizes the revenue when the work is completed. Revenue Recognition Revenue is recognized when the pool service is completed and the collectability is reasonably assured. For pool resurfacing and remediation work, revenue is recognized at the time of completion of the job. Stock-Based Compensation The Company accounts for stock-based compensation under the fair value recognition provisions of GAAP which requires the measurement and recognition of compensation for all stock-based awards made to employees and directors including stock options and restricted stock issuances based on estimated fair values. In accordance with GAAP, the fair value of stock-based awards is generally recognized as compensation expense over the requisite service period, which is defined as the period during which an employee is required to provide service in exchange for an award. The Company uses a straight-line attribution method for all grants that include only a service condition. Compensation expense related to all awards is included in income. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Income Taxes The asset and liability approach is used to recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of asset and liabilities. Deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on deferred tax asset and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company accounts for uncertainties in income tax law under a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns as prescribed by GAAP. Under GAAP, the tax effects of a position are recognized only if it is “more-likely-than-not” to be sustained by the taxing authority as of the reporting date. If the tax position is not considered “more-likely-than-not” to be sustained, then no benefits of the position are recognized. Management believes there are no unrecognized tax benefits or uncertain tax positions as of December 31, 2016, and 2015. The Company recognizes interest and penalties on income taxes as a component of income tax expense, should such an expense be realized. Basic and Diluted Net Earnings per Share The Company computes earnings per share in accordance with “ASC-260”, “Earnings per Share” which requires presentation of both basic and diluted earnings per share on the face of the consolidated statements of income. Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of outstanding common shares during the period. Diluted earnings per share gives effect to all dilutive potential common shares outstanding during the year, computed using the treasury stock method for outstanding stock options and the if converted method for preferred stock. Dilutive earnings per share excludes all potential common shares if their effect is anti-dilutive. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED For the years ended December 31, 2016 and 2015, the basic and diluted earnings per share was computed as follows: Fair Value Measurement Generally accepted accounting principles establishes a hierarchy to prioritize the inputs of valuation techniques used to measure fair value. The hierarchy gives the highest ranking to the fair values determined by using unadjusted quoted prices in active markets for identical assets (Level 1) and the lowest ranking to fair values determined using methodologies and models with unobservable inputs (Level 3). Observable inputs are those that market participants would use in pricing the assets based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s assumptions about inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The Company has determined the appropriate level of the hierarchy and applied it to its financial assets and liabilities. At December 31, 2016 and 2015 there were no assets or liabilities carried or measured at fair value. Use of Estimates and Assumptions The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 3 - RECENT ACCOUNTING PRONOUNCEMENTS In May 2014, the Financial Accounting Standards Board, (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 (ASU 2014-09), Revenue from Contracts with Customers. ASU 2014-09 will eliminate transaction- and industry-specific revenue recognition guidance under current GAAP and replace it with a principle based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. ASU 2014-09 also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for reporting periods beginning after December 15, 2016, and early adoption is not permitted. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The impact the adoption of ASU 2014-09 on the Company’s consolidated financial statement presentation and disclosures is not considered material. In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which is intended to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. The ASU requires equity investments to be measured at fair value with changes in fair values recognized in net earnings, simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment and eliminates the requirement to disclose fair values, the methods and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost. The ASU also clarifies that the Company should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale debt securities in combination with the Company's other deferred tax assets. These amendments are effective for the Company beginning January 1, 2018. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements. In February 2016, the FASB issued ASU 2016-2, Leases (Topic 842) which will require lessees to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with term of more than twelve months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. The new ASU will require both types of leases to be recognized on the balance sheet. The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements. The ASU is effective for fiscal years beginning after December 15, 2018 and for interim periods within those fiscal years. The Company is in the process of determining the effect of the ASU on its consolidated balance sheets and consolidated statements of income. Early application will be permitted for all organizations. In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The amendments in this update change existing guidance related to accounting for employee share-based payments affecting the income tax consequences of awards, classification of awards as equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual periods, with early adoption permitted. The Company is currently evaluating the potential impact of the adoption of this standard. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 4 - CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The Company maintains its cash with high-credit quality financial institutions. At December 31, 2016 and 2015, the Company had cash balances in excess of federally insured limits in the amount of approximately $180,064 and $177,978, respectively. Accounts receivable are financial instruments that potentially expose the Company to concentration of credit risk. However, accounts receivable of $129,515 and $157,517 at December 31, 2016 and 2015, respectively are comprised of many pool service customer accounts, none of which are individually significant in size. The Company historically has collected substantially all of its receivables. NOTE 5 - FAIR VALUE ESTIMATES The Company measures financial instruments at fair value in accordance with ASC 820, which specifies a valuation hierarchy based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s own assumptions. Management believes the carrying amounts of the Company's cash, accounts receivable, accounts payable as of December 31, 2016, and 2015 approximate their respective fair values because of the short-term nature of these instruments. The Company measures its line of credit, notes payable and loans in accordance with the hierarchy of fair value based on whether the inputs to those valuation techniques are observable or unobservable. The hierarchy is: Level 1 - Quoted prices for identical instruments in active markets; Level 2 - Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 5 - FAIR VALUE ESTIMATES, CONTINUED The estimated fair value of the cash, line of credit, notes payable, promissory notes - stockholder and stockholder advances payable at December 31, 2016 and 2015, were as follows: CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 6 - PROPERTY AND EQUIPMENT Property and equipment consisted of: On August 4, 2015, the Company entered into a written agreement to purchase a 5,600 square foot, free standing, commercial building in the amount of $480,000. The Company secured a ten-year mortgage from a local banking institution with a required 20% down payment at a rate of 3.99%. The transaction closed in October 2015. (See Note 11, “Notes Payable”, for terms of the note secured by the commercial building). Depreciation expense was $84,410 and $62,180 respectively in the year ended December 31, 2016 and 2015. NOTE 7 - ACQUISTION OF SUNDOOK POOL SERVICES, LLC On December 30, 2015, the Company made a deposit of $165,000 to acquire a pool servicing company, Sundook Advanced Pool Services LLC (“Sundook”), in Stuart, FL. Additionally, the Company issued 417,000 shares of restricted stock, valued at $25,000. The transaction closed on January 5, 2016. The primary asset acquired consisted of customer list intangible assets valued at $154,500 as well as a retail store valued at $17,500. The fair value of the intangible assets acquired was determined using Level 3 inputs. An additional $25,000 was escrowed pending an audit of customer account retentions after thirty days. The acquisition expands the Company’s business presence in its primary market of Martin, St Lucie and Indian River counties, Florida. Sundook’s pool service routes are synergistic with the Company’s pool service routes and provide for more efficiency and better operating margins. On March 18, 2016, the Company negotiated the final settlement for the acquisition of Sundook. Due to Sundook underperforming certain terms and warranties under the asset purchase agreement, the Company paid $10,000 of the escrowed funds, and Sundook surrendered the 417,000 shares of the Company’s stock. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 7 - ACQUISTION OF SUNDOOK POOL SERVICES, LLC, CONTINUED Separately, also on March 18, 2016, the Company sold the retail store acquired in the Sundook transaction for $17,500. The acquisition is not significant as defined by ASC 805, “Business Combinations”, and therefore no pro forma financial information is presented. NOTE 8 - SALE OF PALM CITY, FL. BUILDING In May 2016, the Company moved into its new office headquarter building in Stuart, FL. and made available for sale or lease, its old office building in Palm City, FL. The sale of the building was completed on September 12, 2016 for $300,000 less settlement costs of $22,884, resulting in a gain of $60,292. The remaining proceeds were used to pay off the SBA Loan and to pay down the Promissory Note - Stockholders (See Note 12 “Long Term Loans”). NOTE 9 - STOCKHOLDER ADVANCE PAYABLE At December 31, 2016 and 2015, the Company had an advance payable of $54,981 and $187,307 respectively, from the Calarco Trust, beneficially owned by Lawrence Calarco, an officer and director of the Company and Loreen Calarco an officer and director of the Company. The advance payable was used for expenditures on behalf of Custom Pool. The terms of the advance payable are non-interest bearing and it is due on demand. NOTE 10 - BANK LINE OF CREDIT The Company maintains a $50,000 revolving line of credit with a regional bank. The line of credit has a ten-year maturity, but is due upon demand by the bank. The interest rate is currently 5.75%, and it is a floating rate, 2.0% over the Wall Street Journal Prime Rate Index. The outstanding balance as of December 31, 2016, and 2015, respectively is $25,892 and $20,426. The Company is currently in compliance with the terms of the line of credit. NOTE 11 - NOTES PAYABLE At December 31, 2016 and 2015, the Company has $691,682 and $564,646 respectively, in notes payable secured against the newly acquired building in 2015 and motor vehicles used in the pool services and pool plastering business. The outstanding balance of $45,014 for the loan against the pool plastering pump truck is the largest of the motor vehicle loans. The interest rates range from 2.99% to 5.75% and the maturities range from three to six years. The Company is currently in compliance with the terms of the loans. The note for the acquisition of the new building in Stuart, FL. has an outstanding balance of $384,034 at December 31, 2016. The note carries an interest rate of 3.99% and matures in October 2025. The Company is current with all payments and terms of the note. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 12 - LONG TERM LOANS Until September 12, 2016 and for the year ended December 31, 2015, the Company had a long term loan from Wells Fargo Bank which was guaranteed in case of default by the Company, by the Small Business Administration. The terms of the loan have a floating interest rate of 2.00% over the Wall Street Journal Prime Rate Index. The loan was secured by all of the assets of Custom Pool and by personal guaranties of Lawrence and Loreen Calarco. The outstanding balance of the loan at December 31, 2015 was $192,290 respectively. The Company paid off the loan on September 12, 2016 with the part of the proceeds from the sale of the prior headquarters office building in Palm City, Fl. (See Note 8 “Sale of Palm City, Fl. Building”). At December 31, 2016 and 2015, the Company has a Promissory Note from a stockholder for $89,378 and $210,000, respectively, which was incurred with the acquisition of the common stock of CPSM, Inc. The term of the Promissory Note is 5 years and the note has an interest rate set at the 5 Year Treasury Note rate, currently set at 1.34% and which resets annually on June 3. The principal is due on the final maturity of June 3, 2019. The Company has accrued interest expense of $8,145 and $5,496 as of December 31, 2016 and 2015, respectively. The Company repaid a portion of the principal of the Note with part of the proceeds from the sale of the prior headquarters office building in Palm City, Fl. (See Note 9, “Sale of the Palm City, Fl. Building”). The Company is in compliance with the provisions of this Note. The long term debt repayments are as follows: Thereafter Total Notes Payable: $69,491 $81,180 $74,392 $57,457 $42,314 $366,848 $691,682 Promissory Note - Stockholder - - 89,378 - - - 89,378 Total Repayments $69,491 $81,180 $163,770 $57,457 $42,314 $366,848 $781,060 NOTE 13 - INCOME TAX As of December 31, 2016, the U.S. Federal and Florida income tax returns filed prior to 2013 are no longer subject to examination by the respective taxing authorities. The differences between the statutory Federal income tax rate and the effective tax rate are summarized as follows for the years ended December 31, 2016 and 2015: CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 13 - INCOME TAX, CONTINUED Deferred income taxes primarily relate to differences between the amounts recorded for financial reporting purposes and the amounts recorded for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows as of December 31, 2016, and 2015: NOTE 14 - PREFERRED STOCK In December 2015, the Company authorized 50,000,000 shares of Series A Preferred Stock, with a $0.0001 par value. The Series A Preferred has an 8% dividend paid quarterly, and is convertible into common stock at $0.08 per common share. The Series A Preferred is senior to the common stock as to dividends, and any liquidation, dissolution or winding up of the Company. The Series A Preferred also has certain voting and registration rights. In January 2016, the Company issued 1,562,500 shares of the Series A Preferred Stock to Lawrence and Loreen Calarco, officers and directors of the Company for $125,000 in consideration. At the time of the issuance of the Series A Preferred, the closing stock price of the Company’s common stock was $0.07 per share and so there is not a beneficial conversion feature. The Series A Preferred is callable after six months at the option of the Company at the issue price. The Company has accrued $10,000 in dividends on the Series A Preferred at December 31, 2016. NOTE 15 - 2014 STOCK AWARDS PLAN In November 2014, the board of directors of the Company approved the adoptions of a Stock Awards Plan. The purpose is to provide a means through which the Company may attract, retain and motivate employees, directors and persons affiliated with the Company, including, but not limited to, non-employee consultants, and to provide a means whereby such persons can acquire and maintain stock ownership, thereby strengthening their concern for the welfare of the Company. A further purpose of the Plan is to provide such participants with additional incentive and reward opportunities designed to enhance the profitable growth and increase stockholder value of the Company. A total of 7,000,000 shares was authorized to be issued under the plan. For incentive stock options, at the grant date the stock options exercise price is required to be at least 110% of the fair value of the Company’s common stock. The Plan permits the grants of common stock or options to purchase common stock. As plan administrator, the Board of Directors has sole discretion to set the price of the options. Further, the Board of Directors may amend or terminate the plan. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 15 - 2014 STOCK AWARDS PLAN, CONTINUED On May 27, 2015, the Board of Directors granted two individuals 500,000 options each. Additionally, on August 23, 2016, the Board of Directors granted four individuals 2,250,000 options in aggregate. The May 27, 2015 stock option grants have a five-year maturity, vesting ratably over that period. The August 23, 2016 stock option grants had 50% of the options vesting immediately, with the balance vesting ratably over three years. There are 3,750,000 shares available for issuance at December 31, 2016. The August 23, 2016 and May 27, 2015 stock options were granted with the fair value estimated on the date of grant using the assumptions in the table below and the Black Scholes options pricing model: Dividend Yield - - Expected Volatility 64.88% 113.19% Risk Free Interest Rate 0.90% 1.57% Expected Life 3 Years 5 Years Per Share Grant Date Fair Value of Options Issued $0.0163 $0.0265 The assumptions were based on the following: the Company’s stock does not pay a dividend, expected volatility is a function of the historical daily changes in price of the Company’s stock, the risk free interest rate is the constant maturity of the 3 Year and 5 Year Treasury Note, respectively and the expected life is the maturity of the stock options since no options have been exercised or forfeited to date. A summary of the stock option activity over the years ended December 31, 2016 and 2015 is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value Outstanding at Dec. 31, 2014 - - - - Granted 1,000,000 $ 0.035 5 years - Outstanding at Dec. 31, 2015 1,000,000 $ 0.035 3.4 Years - Granted 2,250,000 $0.0375 1.1 Years - Outstanding at Dec. 31, 2016 3,250,000 $0.0367 1.8 Years $54,429 Exercisable at Dec. 31, 2016 1,578,014 $ 0.037 1.8 Years $25,041 The Company expensed $24,491 and $3,165 of stock option compensation for the years ended December 31, 2016 and 2015 respectively. Unrecognized compensation expense was $35,519 and $23,335 at December 31, 2016 and 2015. CPSM, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2016 And 2015 And For The Years Then Ended NOTE 16 - COMMITMENTS AND CONTINGENCIES The Company does not have any significant or long term commitments. The Company is not currently subject to any litigation. NOTE 17 - SUBSEQUENT EVENTS The Company has evaluated subsequent events from the consolidated balance sheet date through March 24, 2017 (the financial statement issuance date) determining that no events required additional disclosure in these consolidated financial statements. | Based on the provided text, here's a summary of the financial statement:
The financial statement focuses on tax-related aspects:
1. Profit/Loss: Indicates a loss exceeding insured limits of $250,000
2. Expenses:
- Addresses deferred tax assets and liabilities
- Calculates differences between financial reporting and tax bases
- Uses enacted tax rates and laws
- Recognizes tax rate changes in income during the enactment period
3. Tax Position Accounting:
- Follows GAAP comprehensive model for uncertain tax positions
- Recognizes tax effects only if "more-likely-than-not" to be sustained
- Management believes there are no unrecognized tax benefits or uncertain tax positions as of December 31
4. Liabilities:
- Mentions debt securities and deferred tax assets
- Notes amendments effective from January 1
The statement appears to be | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FINANCIAL STATEMENTS All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto. MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING TO THE SHAREHOLDERS OF RYDER SYSTEM, INC.: Management of Ryder System, Inc., together with its consolidated subsidiaries (Ryder), is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a- 15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Ryder’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Ryder’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Ryder; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of Ryder’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Ryder’s assets that could have a material effect on the consolidated financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of Ryder’s internal control over financial reporting as of December 31, 2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control - Integrated Framework (2013).” Based on our assessment and those criteria, management determined that Ryder maintained effective internal control over financial reporting as of December 31, 2016. Ryder’s independent registered certified public accounting firm has audited the effectiveness of Ryder’s internal control over financial reporting. Their report appears on the subsequent page. REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF RYDER SYSTEM, INC.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, comprehensive income, cash flows and shareholders’ equity present fairly, in all material respects, the financial position of Ryder System, Inc. and its subsidiaries at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP Miami, Florida February 14, 2017 RYDER SYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS See accompanying notes to consolidated financial statements. Note: EPS amounts may not be additive due to rounding. RYDER SYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME See accompanying notes to consolidated financial statements. RYDER SYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS See accompanying notes to consolidated financial statements. RYDER SYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS See accompanying notes to consolidated financial statements. RYDER SYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY __________________ (1) Net of common shares delivered as payment for the exercise price or to satisfy the holders’ withholding tax liability upon exercise of options. (2) Represents open-market transactions of common shares by the trustee of Ryder’s deferred compensation plans. See accompanying notes to consolidated financial statements. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Consolidation and Presentation The consolidated financial statements include the accounts of Ryder System, Inc. (Ryder) and all entities in which Ryder has a controlling voting interest (“subsidiaries”) and variable interest entities (“VIEs”) where Ryder is determined to be the primary beneficiary. Ryder is deemed to be the primary beneficiary if we have the power to direct the activities that most significantly impact the entity’s economic performance and we share in the significant risks and rewards of the entity. All significant intercompany accounts and transactions have been eliminated in consolidation. Beginning in 2016, we reclassified the losses from fair value adjustments on our used vehicles from "Other operating expenses" to "Used vehicle sales, net" within the Consolidated Statement of Earnings. Prior year amounts have been reclassified to conform to the current period presentation. Use of Estimates The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates are based on management’s best knowledge of historical trends, actions that we may take in the future, and other information available when the consolidated financial statements are prepared. Changes in estimates are recognized in accordance with the accounting rules for the estimate, which is typically in the period when new information becomes available. Areas where the nature of the estimate make it reasonably possible that actual results could materially differ from the amounts estimated include: depreciation and residual value guarantees, employee benefit plan obligations, self-insurance accruals, impairment assessments on long-lived assets (including goodwill and indefinite-lived intangible assets), allowance for accounts receivable, income tax liabilities and contingent liabilities. Cash Equivalents Cash equivalents represent cash in excess of current operating requirements invested in short-term, interest-bearing instruments with maturities of three months or less at the date of purchase and are stated at cost. Revenue Recognition We recognize revenue when persuasive evidence of an arrangement exists, the services have been rendered to customers or delivery has occurred, the pricing is fixed or determinable, and collectibility is reasonably assured. In our evaluation of whether the price is fixed or determinable, we determine whether the total contract consideration in the arrangement could change based on one or more factors. These factors, which vary among each of our segments, are further discussed below. Generally, the judgments made for these purposes do not materially impact the revenue recognized in any period. Sales tax collected from customers and remitted to the applicable taxing authorities is accounted for on a net basis, with no impact on revenue. Our judgments on collectibility are initially established when a business relationship with a customer is initiated and is continuously monitored as services are provided. We have a credit rating system based on internally developed standards and ratings provided by third parties. Our credit rating system, along with monitoring for delinquent payments, allows us to make decisions as to whether collectibility may not be reasonably assured. Factors considered during this process include historical payment trends, industry risks, liquidity of the customer, years in business, and judgments, liens or bankruptcies. When collectibility is not considered reasonably assured (typically when a customer is 120 days past due), revenue is not recognized until cash is collected from the customer. We generate revenue primarily through the lease, rental and maintenance of revenue earning equipment and by providing logistics management and dedicated services. We classify our revenues in one of the following categories: Lease and rental Lease and rental includes lease and commercial rental revenues from our FMS business segment. We offer a full service lease as well as a lease with more flexible maintenance options which are marketed, priced and managed as bundled lease arrangements, and include equipment, service and financing components. We do not offer a stand-alone unbundled finance lease of vehicles. For these reasons, both the lease and service components of our leases are included within lease and rental revenues. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Our lease arrangements include lease deliverables such as the lease of a vehicle and the executory agreement for the maintenance, insurance, taxes and other services related to the leased vehicles during the lease term. Arrangement consideration is allocated between lease deliverables and non-lease deliverables based on management’s best estimate of the relative fair value of each deliverable. The arrangement consideration allocated to lease deliverables is accounted for pursuant to accounting guidance on leases. Our full service lease arrangements provide for a fixed charge billing and a variable charge billing based on mileage or time usage. Fixed charges are typically billed at the beginning of the month for the services to be provided that month. Variable charges are typically billed a month in arrears. Costs associated with the activities performed under our full service leasing arrangements are primarily comprised of labor, parts, outside work, depreciation, licenses, insurance, operating taxes and vehicle financing. These costs are expensed as incurred except for depreciation. Refer to “Summary of Significant Accounting Policies - Revenue Earning Equipment, Operating Property and Equipment, and Depreciation” for information regarding our depreciation policies. Non-chargeable maintenance costs have been allocated and reflected within “Cost of lease and rental” based on the maintenance-related labor costs relative to all product lines. Revenue from lease and rental agreements is recognized based on the classification of the arrangement, typically as either an operating or direct financing lease (DFL). • The majority of our leases and all of our rental arrangements are classified as operating leases and, therefore, we recognize lease and commercial rental revenue on a straight-line basis as it becomes receivable over the term of the lease or rental arrangement. Lease and rental agreements do not usually provide for scheduled rent increases or escalations. However, most lease agreements allow for rate changes based upon changes in the Consumer Price Index (CPI). Lease and rental agreements also provide for vehicle usage charges based on a time charge and/or a fixed per-mile charge. The fixed time charge, the fixed per-mile charge and the changes in rates attributed to changes in the CPI are considered contingent rentals and are not considered fixed or determinable until the effect of CPI changes is implemented or the equipment usage occurs. • The non-lease deliverables of our full service lease arrangements are comprised of access to substitute vehicles, emergency road service, and safety services. These services are available to our customers throughout the lease term. Accordingly, revenue is recognized on a straight-line basis over the lease term. • Leases not classified as operating leases are generally considered direct financing leases. We recognize revenue for direct financing leases using the effective interest method, which provides a constant periodic rate of return on the outstanding investment on the lease. Cash receipts on impaired direct financing lease receivables are first applied to the direct financing lease receivable and then to any unrecognized income. A direct financing lease receivable is considered impaired, based on current information and events, if it is probable that we will be unable to collect all amounts due according to the contractual terms of the lease. Services Services include contract maintenance, contract-related maintenance and other revenues from our FMS business segment and all DTS and SCS revenues. Under our contract maintenance arrangements, we provide maintenance and repairs required to keep a vehicle in good operating condition, schedule preventive maintenance inspections and provide access to emergency road service and substitute vehicles. The vast majority of our services are routine services performed on a recurring basis throughout the term of the arrangement. From time to time, we provide non-routine major repair services in order to place a vehicle back in service. Revenue from maintenance service contracts is recognized on a straight-line basis as maintenance services are rendered over the terms of the related arrangements. Contract maintenance arrangements are generally cancelable, without penalty, after one year with 60 days prior written notice. Our maintenance service arrangement provides for a monthly fixed charge and a monthly variable charge based on mileage or time usage. Fixed charges are typically billed at the beginning of the month for the services to be provided that month. Variable charges are typically billed a month in arrears. Most contract maintenance agreements allow for rate changes based upon changes in the CPI. The fixed per-mile charge and the changes in rates attributed to changes in the CPI are recognized as earned. Costs associated with the activities performed under our contract maintenance arrangements are primarily comprised of labor, parts and outside work. These costs are expensed as incurred. Non-chargeable maintenance costs have been allocated and reflected within “Cost of services” based on the proportionate maintenance-related labor costs relative to all product lines. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Revenue from DTS and SCS service contracts is recognized as services are rendered in accordance with contract terms, which typically include discrete billing rates for the services. In certain contracts, a portion of the contract consideration may be contingent upon the satisfaction of performance criteria, attainment of pain/gain share thresholds or volume thresholds. The contingent portion of the revenue in these arrangements is not considered fixed or determinable until the performance criteria or thresholds have been met. In transportation management arrangements where we act as principal, revenue is reported on a gross basis, without deducting third-party purchased transportation costs. To the extent that we are acting as an agent in the arrangement, revenue is reported on a net basis, after deducting purchased transportation costs. Fuel Fuel services include fuel services revenue from our FMS business segment. Revenue from fuel services is recognized when fuel is delivered to customers. Fuel is largely a pass-through to our customers for which we realize minimal changes in profitability during periods of steady market fuel prices. However, profitability may be positively or negatively impacted by sudden increases or decreases in market fuel prices during a short period of time as customer pricing for fuel services is established based on trailing market fuel costs. Accounts Receivable Allowance We maintain an allowance for uncollectible customer receivables and an allowance for billing adjustments related to certain discounts and billing corrections. Estimates are updated regularly based on historical experience of bad debts and billing adjustments processed, current collection trends and aging analysis. Accounts are charged against the allowance when determined to be uncollectible. Inventories Inventories, which consist primarily of fuel, tires and vehicle parts, are valued using the lower of weighted-average cost or market. Revenue Earning Equipment, Operating Property and Equipment, and Depreciation Revenue earning equipment, comprised of vehicles and operating property and equipment are initially recorded at cost inclusive of vendor rebates. Revenue earning equipment and operating property and equipment under capital lease are initially recorded at the lower of the present value of minimum lease payments or fair value. Vehicle repairs and maintenance that extend the life or increase the value of a vehicle are capitalized, whereas ordinary maintenance and repairs (including tire replacement or repair) are expensed as incurred. Direct costs incurred in connection with developing or obtaining internal-use software are capitalized. Costs incurred during the preliminary software development project stage, as well as maintenance and training costs, are expensed as incurred. Leasehold improvements are depreciated over the shorter of their estimated useful lives or the term of the related lease, which may include one or more option renewal periods where failure to exercise such options would result in an economic penalty in such amount that renewal appears, at the inception of the lease, to be reasonably assured. If a substantial additional investment is made in a leased property during the term of the lease, we re-evaluate the lease term to determine whether the investment, together with any penalties related to non-renewal, would constitute an economic penalty in such amount that renewal appears to be reasonably assured. Provision for depreciation is computed using the straight-line method on all depreciable assets. Depreciation expense has been recognized throughout the Consolidated Statement of Earnings depending on the nature of the related asset. We periodically review and adjust, as appropriate, the residual values and useful lives of revenue earning equipment. Our review of the residual values and useful lives of revenue earning equipment is established with a long-term view considering historical market price changes, current and expected future market price trends, expected lives of vehicles and extent of alternative uses. Factors that could cause actual results to materially differ from estimates include, but are not limited to, unforeseen changes in technology innovations. In addition, we also monitor market trends throughout the year and assess residual values of vehicles expected to be sold in the near term and may adjust residual values for these vehicles. We routinely dispose of used revenue earning equipment as part of our FMS business. Revenue earning equipment held for sale is stated at the lower of carrying amount or fair value less costs to sell. For revenue earning equipment held for sale, we stratify our fleet by vehicle type (trucks, tractors and trailers), weight class, age and other relevant characteristics and create classes of similar assets for analysis purposes. Fair value is determined based upon recent market prices obtained from our own sales experience for sales of each class of similar assets and vehicle condition, as well as anticipated market price changes. Losses on vehicles held for sale for which carrying values exceeded fair value are recognized at the time they arrive at our used truck centers and are presented within "Used vehicle sales, net" in the Consolidated Statements of Earnings. Gains and losses on sales of operating property and equipment are reflected in “Miscellaneous income, net.” RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Goodwill and Other Intangible Assets Goodwill on acquisitions represents the excess of the purchase price over the fair value of the underlying acquired net tangible and intangible assets. Factors that contribute to the recognition of goodwill in our acquisitions include (i) expected growth rates and profitability of the acquired companies, (ii) securing buyer-specific synergies that increase revenue and profits and are not otherwise available to market participants, (iii) significant cost savings opportunities, (iv) experienced workforce and (v) our strategies for growth in sales, income and cash flows. Goodwill and other intangible assets with indefinite useful lives are not amortized, but rather, are tested for impairment at least annually (April 1st). In evaluating goodwill for impairment, we have the option to first assess qualitative factors to determine whether further impairment testing is necessary. Among other relevant events and circumstances that affect the fair value of reporting units, we consider individual factors such as macroeconomic conditions, changes in our industry and the markets in which we operate, as well as our reporting units' historical and expected future financial performance. If we conclude that it is more likely than not that a reporting unit's fair value is less than its carrying value, recoverability of goodwill is evaluated using a two-step process. The first step involves a comparison of the fair value of each of our reporting units with its carrying amount. If a reporting unit’s carrying amount exceeds its fair value, the second step is performed. The second step involves a comparison of the implied fair value and carrying value of that reporting unit’s goodwill. To the extent that a reporting unit’s carrying amount exceeds the implied fair value of its goodwill, an impairment loss is recognized. Our valuation of fair value for certain reporting units is determined based on a discounted future cash flow model that uses five years of projected cash flows and a terminal value based on growth assumptions. For certain reporting units, fair value is determined based on the application of current trading multiples for comparable publicly-traded companies and the historical pricing multiples for comparable merger and acquisition transactions that have occurred in our industry. Rates used to discount cash flows are dependent upon interest rates and the cost of capital based on our industry and capital structure, adjusted for equity and size risk premiums based on market capitalization. Estimates of future cash flows are dependent on our knowledge and experience about past and current events and assumptions about conditions we expect to exist, including long-term growth rates, capital requirements and useful lives. Our estimates of cash flows are also based on historical and future operating performance, economic conditions and actions we expect to take. In addition to these factors, our DTS and SCS reporting units are dependent on several key customers or industry sectors. The loss of a key customer may have a significant impact to our DTS or SCS reporting units, causing us to assess whether or not the event resulted in a goodwill impairment loss. In making our assessments of fair value, we rely on our knowledge and experience about past and current events and assumptions about conditions we expect to exist in the future. These assumptions are based on a number of factors, including future operating performance, economic conditions, actions we expect to take and present value techniques. There are inherent uncertainties related to these factors and management’s judgment in applying them to the analysis of goodwill impairment. It is possible that assumptions underlying the impairment analysis will change in such a manner that impairment in value may occur in the future. Identifiable intangible assets not subject to amortization are assessed for impairment using a similar process used to evaluate goodwill as described above. Intangible assets with finite lives are amortized over their respective estimated useful lives. Identifiable intangible assets that are subject to amortization are evaluated for impairment using a similar process used to evaluate long-lived assets described below. Impairment of Long-Lived Assets Other than Goodwill Long-lived assets held and used, including revenue earning equipment, operating property and equipment and intangible assets with finite lives, are tested for recoverability when circumstances indicate that the carrying amount of assets may not be recoverable. Recoverability of long-lived assets is evaluated by comparing the carrying value of an asset or asset group to management’s best estimate of the undiscounted future operating cash flows (excluding interest charges) expected to be generated by the asset or asset group. If these comparisons indicate that the carrying value of the asset or asset group is not recoverable, an impairment loss is recognized for the amount by which the carrying value of the asset or asset group exceeds fair value. Fair value is determined by a quoted market price, if available, or an estimate of projected future operating cash flows, discounted using a rate that reflects the related operating segment’s average cost of funds. Long-lived assets to be disposed of, including revenue earning equipment, operating property and equipment and indefinite-lived intangible assets, are reported at the lower of carrying amount or fair value less costs to sell. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Self-Insurance Accruals We retain a portion of the accident risk under auto liability, workers’ compensation and other insurance programs. Under our insurance programs, we retain the risk of loss in various amounts, generally up to $3 million on a per occurrence basis. Self-insurance accruals are based primarily on an actuarially estimated, undiscounted cost of claims, which includes claims incurred but not reported. Such liabilities are based on estimates. Historical loss development factors are utilized to project the future development of incurred losses, and these amounts are adjusted based upon actual claim experience and settlements. While we believe that the amounts are adequate, there can be no assurance that changes to our actuarial estimates may not occur due to limitations inherent in the estimation process. Changes in the actuarial estimates of these accruals are charged or credited to earnings in the period determined. Amounts estimated to be paid within the next year have been classified as “Accrued expenses and other current liabilities” with the remainder included in “Other non-current liabilities” in our Consolidated Balance Sheets. We also maintain additional insurance at certain amounts in excess of our respective underlying retention. Amounts recoverable from insurance companies are not offset against the related accrual as our insurance policies do not extinguish or provide legal release from the obligation to make payments related to such risk-related losses. Amounts expected to be received within the next year from insurance companies have been included within “Receivables, net” with the remainder included in “Direct financing leases and other assets” and are recognized only when realization of the claim for recovery is considered probable. The accrual for the related claim has been classified within “Accrued expenses and other current liabilities” if it is estimated to be paid within the next year, otherwise it has been classified in “Other non-current liabilities” in our Consolidated Balance Sheets. Income Taxes Our provision for income taxes is based on reported earnings before income taxes. Deferred taxes are recognized for the future tax effects of temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, using tax rates in effect for the years in which the differences are expected to reverse. The effects of changes in tax laws on deferred tax balances are recognized in the period the new legislation is enacted. Valuation allowances are recognized to reduce deferred tax assets to the amount that is more likely than not to be realized. In assessing the likelihood of realization, management considers estimates of future taxable income. We calculate our current and deferred tax position based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed in subsequent years. Adjustments based on filed returns are recorded when identified. We are subject to tax audits in numerous jurisdictions in the U.S. and around the world. Tax audits by their very nature are often complex and can require several years to complete. In the normal course of business, we are subject to challenges from the Internal Revenue Service (IRS) and other tax authorities regarding amounts of taxes due. These challenges may alter the timing or amount of taxable income or deductions, or the allocation of income among tax jurisdictions. As part of our calculation of the provision for income taxes on earnings, we determine whether the benefits of our tax positions are at least more likely than not of being sustained upon audit based on the technical merits of the tax position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Such accruals require management to make estimates and judgments with respect to the ultimate outcome of a tax audit. Actual results could vary materially from these estimates. We adjust these reserves as well as the impact of any related interest and penalties in light of changing facts and circumstances, such as the progress of a tax audit. Interest and penalties related to income tax exposures are recognized as incurred and included in “Provision for income taxes” in our Consolidated Statements of Earnings. Accruals for income tax exposures, including penalties and interest, expected to be settled within the next year are included in “Accrued expenses and other current liabilities” with the remainder included in “Other non-current liabilities” in our Consolidated Balance Sheets. The federal benefit from state income tax exposures is included in “Deferred income taxes” in our Consolidated Balance Sheets. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Severance and Contract Termination Costs We recognize liabilities for severance and contract termination costs based upon the nature of the cost to be incurred. For involuntary separation plans that are completed within the guidelines of our written involuntary separation plan, we recognize the liability when it is probable and reasonably estimable. For one-time termination benefits, such as additional severance pay or benefit payouts, and other exit costs, such as contract termination costs, the liability is measured and recognized initially at fair value in the period in which the liability is incurred, with subsequent changes to the liability recognized as adjustments in the period of change. Severance related to position eliminations that are part of a restructuring plan is included in "Restructuring and other charges, net” in the Consolidated Statements of Earnings. Severance costs that are not part of a restructuring plan are recognized in the period incurred as a direct cost of revenue or within “Selling, general and administrative expenses,” in the Consolidated Statements of Earnings depending upon the nature of the eliminated position. Environmental Expenditures We recognize liabilities for environmental assessments and/or cleanup when it is probable a loss has been incurred and the costs can be reasonably estimated. Environmental liability estimates may include costs such as anticipated site testing, consulting, remediation, disposal, post-remediation monitoring and legal fees, as appropriate. The liability does not reflect possible recoveries from insurance companies or reimbursement of remediation costs by state agencies, but does include estimates of cost sharing with other potentially responsible parties. Estimates are not discounted, as the timing of the anticipated cash payments is not fixed or readily determinable. Subsequent adjustments to initial estimates are recognized as necessary based upon additional information developed in subsequent periods. In future periods, new laws or regulations, advances in remediation technology and additional information about the ultimate remediation methodology to be used could significantly change our estimates. Claims for reimbursement of remediation costs are recognized when recovery is deemed probable. Derivative Instruments and Hedging Activities We use financial instruments, including forward exchange contracts and swaps to manage our exposures to movements in interest rates and foreign currency exchange rates. The use of these financial instruments modifies the exposure of these risks with the intent to reduce the risk or cost to us. We do not enter into derivative financial instruments for trading purposes. We limit our risk that counterparties to the derivative contracts will default and not make payments by entering into derivative contracts only with counterparties comprised of large banks and financial institutions that meet established credit criteria. We do not expect to incur any losses as a result of counterparty default. On the date a derivative contract is executed, we formally document, among other items, the intended hedging designation and relationship, along with the risk management objectives and strategies for entering into the derivative contract. We also formally assess, both at inception and on an ongoing basis, whether the derivatives we used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. Cash flows from derivatives that are accounted for as hedges are classified in the Consolidated Statements of Cash Flows in the same category as the items being hedged. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, we discontinue hedge accounting prospectively. The hedging designation may be classified as one of the following: No Hedging Designation. The unrealized gain or loss on a derivative instrument not designated as an accounting hedging instrument is recognized immediately in earnings. Fair Value Hedge. A hedge of a recognized asset or liability or an unrecognized firm commitment is considered a fair value hedge. For fair value hedges, both the effective and ineffective portions of the changes in the fair value of the derivative, along with the gain or loss on the hedged item that is attributable to the hedged risk, are both recognized in earnings. Cash Flow Hedge. A hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability is considered a cash flow hedge. The effective portion of the change in the fair value of a derivative that is declared as a cash flow hedge is recognized net of tax in “Accumulated other comprehensive loss” until earnings are affected by the variability in cash flows of the designated hedged item. Net Investment Hedge. A hedge of a net investment in a foreign operation is considered a net investment hedge. The effective portion of the change in the fair value of the derivative used as a net investment hedge of a foreign operation is recognized in the currency translation adjustment account within “Accumulated other comprehensive loss.” The ineffective portion, if any, on the hedged item that is attributable to the hedged risk is recognized in earnings and reported in “Miscellaneous income, net” in the Consolidated Statements of Earnings. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Foreign Currency Translation Our foreign operations generally use local currency as their functional currency. Assets and liabilities of these operations are translated at the exchange rates in effect on the balance sheet date. Items in the Consolidated Statements of Earnings are translated at the average exchange rates for the year. The impact of currency fluctuations is presented in “Changes in cumulative translation adjustment and other” in the Consolidated Statements of Comprehensive Income. Upon sale or upon complete or substantially complete liquidation of an investment in a foreign operation, the currency translation adjustment attributable to that operation is removed from accumulated other comprehensive loss and is reported as part of the gain or loss on sale or liquidation of the investment for the period during which the sale or liquidation occurs. Gains and losses resulting from foreign currency transactions are recognized in “Miscellaneous income, net” in the Consolidated Statements of Earnings. Share-Based Compensation The fair value of stock option awards and nonvested stock awards other than restricted stock units (RSUs), is expensed on a straight-line basis over the vesting period of the awards. RSUs are expensed in the year they are granted. Beginning in 2016, we adopted ASU No. 2016-09, Stock Compensation. This standard changed the presentation of cash flows from the tax benefits resulting from tax deductions in excess of the compensation expense recognized for those options (windfall tax benefits) as well as tax shortfalls to be in operating cash flows in the statement of cash flows. In addition, windfall tax benefits and tax shortfalls are now charged directly to income tax expense. Earnings Per Share Earnings per share is computed using the two-class method. The two-class method of computing earnings per share is an earnings allocation formula that determines earnings per share for common stock and any participating securities according to dividends declared (whether paid or unpaid) and participation rights in undistributed earnings. Restricted stock units are considered participating securities since the share-based awards contain a non-forfeitable right to dividend equivalents irrespective of whether the awards ultimately vest. Under the two-class method, earnings per common share are computed by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the weighted average shares outstanding during the period. Diluted earnings per common share reflect the dilutive effect of potential common shares from stock options and other nonparticipating nonvested stock. The dilutive effect of stock options is computed using the treasury stock method, which assumes any proceeds that could be obtained upon the exercise of stock options would be used to purchase common shares at the average market price for the period. The assumed proceeds include the purchase price the grantee pays, the windfall tax benefit that we receive upon assumed exercise and the unrecognized compensation expense at the end of each period. Share Repurchases Repurchases of shares of common stock are made periodically in open-market transactions and are subject to market conditions, legal requirements and other factors. The cost of share repurchases is allocated between common stock and retained earnings based on the amount of additional paid-in capital at the time of the share repurchase. Defined Benefit Pension and Postretirement Benefit Plans The funded status of our defined benefit pension plans and postretirement benefit plans are recognized in the Consolidated Balance Sheets. The funded status is measured as the difference between the fair value of plan assets and the benefit obligation at December 31, the measurement date. The fair value of plan assets represents the current market value of contributions made to irrevocable trusts, held for the sole benefit of participants, which are invested by the trusts. For defined benefit pension plans, the benefit obligation represents the actuarial present value of benefits expected to be paid upon retirement based on estimated future compensation levels. For postretirement benefit plans, the benefit obligation represents the actuarial present value of postretirement benefits attributed to employee services already rendered. Overfunded plans, with the fair value of plan assets exceeding the benefit obligation, are aggregated and reported as a prepaid pension asset. Underfunded plans, with the benefit obligation exceeding the fair value of plan assets, are aggregated and reported as a pension and postretirement benefit liability. The current portion of pension and postretirement benefit liabilities represents the actuarial present value of benefits payable within the next year exceeding the fair value of plan assets (if funded), measured on a plan-by-plan basis. These liabilities are recognized in “Accrued expenses and other current liabilities” in the Consolidated Balance Sheets. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Pension and postretirement benefit expense includes service cost, interest cost, expected return on plan assets (if funded), and amortization of prior service credit and net actuarial loss. Service cost represents the actuarial present value of participant benefits earned in the current year. The expected return on plan assets represents the average rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the obligation. Prior service credit represents the impact of negative plan amendments. Net actuarial losses arise as a result of differences between actual experience and assumptions or as a result of changes in actuarial assumptions. Net actuarial loss and prior service credit not recognized as a component of pension and postretirement benefit expense as they arise are recognized as "Change in net actuarial loss and prior service credit, net of tax" in the Consolidated Statements of Comprehensive Income. These pension and postretirement items are subsequently amortized as a component of pension and postretirement benefit expense over the remaining service period, if the majority of the employees are active, otherwise over the remaining life expectancy, provided such amounts exceed thresholds which are based upon the benefit obligation or the value of plan assets. The measurement of benefit obligations and pension and postretirement benefit expense is based on estimates and assumptions approved by management. These valuations reflect the terms of the plans and use participant-specific information such as compensation, age and years of service, as well as certain assumptions, including estimates of discount rates, expected return on plan assets, rate of compensation increases, interest rates and mortality rates. Fair Value Measurements We carry various assets and liabilities at fair value in the Consolidated Balance Sheets. The most significant assets and liabilities are vehicles held for sale, which are stated at the lower of carrying amount or fair value less costs to sell, investments held in Rabbi Trusts and derivatives. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are classified based on the following fair value hierarchy: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Level 2 Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or model-derived valuations or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs for the asset or liability. These inputs reflect our own assumptions about the assumptions a market participant would use in pricing the asset or liability. When available, we use unadjusted quoted market prices to measure fair value and classify such measurements within Level 1. If quoted prices are not available, fair value is based upon model-driven valuations that use current market-based or independently sourced market parameters such as interest rates and currency rates. Items valued using these models are classified according to the lowest level input or value driver that is significant to the valuation. The carrying amounts reported in the Consolidated Balance Sheets for cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the immediate or short-term maturities of these financial instruments. Revenue earning equipment held for sale is measured at fair value on a nonrecurring basis and is stated at the lower of carrying amount or fair value less costs to sell. Investments held in Rabbi Trusts and derivatives are carried at fair value on a recurring basis. Investments held in Rabbi Trusts include exchange-traded equity securities and mutual funds. Fair values for these investments are based on quoted prices in active markets. For derivatives, fair value is based on model-driven valuations using the LIBOR rate or observable forward foreign exchange rates, which are observable at commonly quoted intervals for the full term of the financial instrument. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 2. RECENT ACCOUNTING PRONOUNCEMENTS Intangibles - Goodwill and Other In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment, which requires an entity to perform a one-step quantitative impairment test, whereby a goodwill impairment loss will be measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed the total goodwill allocated to that reporting unit). It eliminates Step 2 of the current two-step goodwill impairment test, under which a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The standard is effective January 1, 2020, with early adoption as of January 1, 2017 permitted. We do not expect this standard to have a material impact on our consolidated financial position, results of operations and cash flows. Statement of Cash Flows In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows, which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. In November 2016, the FASB issued additional guidance related to the statement of cash flows, which requires companies to explain the change during the period in the total of cash, cash equivalents, and restricted cash or restricted cash equivalents. The standard is effective January 1, 2018, with early adoption permitted. The standard will be adopted on a retrospective basis. We do not expect this standard to have a material impact on the presentation of our consolidated cash flows. Financial Instruments In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses, which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. The standard applies to financial instruments including, but not limited to, trade and other receivables, held-to-maturity debt securities, loans and net investments in leases. The standard requires estimating expected credit losses over the remaining life of an instrument or a portfolio of instruments with similar risk characteristics based on relevant information about past events, current conditions and reasonable forecasts. The initial estimate of and the subsequent changes in expected credit losses will be recognized as credit loss expense through current earnings and will be reflected as an allowance for credit losses offsetting the carrying value of the financial instrument(s) on the balance sheet. The standard is effective January 1, 2020, with early adoption as of January 1, 2019 permitted. The standard is to be applied using a modified retrospective transition method. We do not expect this standard to have a material impact on our consolidated financial position, results of operations and cash flows. Share-Based Payments In March 2016, the FASB issued ASU No. 2016-09, Stock Compensation, which is intended to simplify several aspects of the accounting for share-based payment award transactions. The guidance changed several aspects of the accounting for share-based awards, including accounting for income taxes, forfeitures, and the minimum statutory tax withholding requirements for share-based awards. The standard eliminates the requirement to record the tax benefits resulting from tax deductions in excess of share-based compensation expense (windfall tax benefits) as well as tax shortfalls to additional paid in capital in the balance sheet. The standard also requires all tax effects related to share-based payments at settlement (or expiration) be recorded to income tax expense and changes the cash flow presentation of excess tax benefits or shortfalls from share-based awards from financing activities to operating activities. The standard is effective January 1, 2017, with early adoption permitted. We adopted the standard during 2016, and recorded a $16 million cumulative-effect adjustment to retained earnings as of January 1, 2016, related to historical excess tax benefits. The impact of the standard was not material to our consolidated financial position, results of operations and cash flows. Leases In February 2016, the FASB issued ASU No. 2016-02, Leases, which sets out the principles for the recognition, measurement, presentation and disclosure of leases. The standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) financing leases and operating leases. We will adopt the standard effective January 1, 2019 using the modified retrospective transition method. We do not anticipate a material impact upon adoption of the standard on our consolidated financial position, results of operations and cash flows. Revenue Recognition In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which together with related, subsequently issued guidance, requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The adoption of ASU 2014-09 will primarily impact our full service lease product line, which includes a vehicle lease as well as maintenance and other services related to the vehicle. We will generally continue to recognize revenue for the vehicle lease portion of the product line on a straight-line basis. Revenue from the non-lease portion of the product line, primarily maintenance services, will be recognized at the time the maintenance services are performed, which will generally require the deferral of some portion of the customer's lease payments when received, as maintenance services are not performed evenly over the life of a full service lease contract. Under current GAAP, substantially all revenues from our full service lease arrangements are recognized on a straight line basis over the term of the lease. We will adopt the standard on January 1, 2018, using the full retrospective transition method, which will result in a cumulative-effect adjustment for deferred revenue to the opening balance sheet for 2016 and the restatement of the financial statements for all prior periods presented (2016 and 2017). We continue to evaluate the impact of adoption of this standard on our consolidated financial position, results of operations and cash flows. Presentation of Debt Issuance Costs In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires an entity to present debt issuance costs as a direct reduction from the carrying amount of the related debt liability on the balance sheet. We adopted this guidance on January 1, 2016 and reclassified $15 million from other assets to long-term debt in our December 31, 2015 balance sheet. Other than the change in presentation within the Consolidated Balance Sheets, this accounting guidance did not impact our consolidated financial position, results of operations and cash flows. 3. ACQUISITIONS On August 1, 2014, we acquired all of the common stock of Bullwell Trailer Solutions, Ltd., a U.K.-based trailer repair and maintenance company, for a purchase price of approximately $15 million, net of cash acquired. The purchase price, which included $6 million in contingent consideration, was paid in total as of December 31, 2016. The acquisition complements our FMS business segment coverage in the U.K. The purchase accounting for this acquisition resulted in goodwill and customer relationship intangible assets of $12 million and $2 million, respectively, with the remaining amount allocated to tangible assets, less liabilities assumed. Transaction costs related to the acquisition were not material. 4. RESTRUCTURING AND OTHER CHARGES In the fourth quarters of 2016, 2015 and 2014, we approved plans to reduce our workforce in multiple locations as a result of cost containment actions, resulting in charges of $5 million, $9 million and $2 million in each of the respective years. In addition, we committed to a plan to divest our Ryder Canadian Retail Shippers Association Logistics (CRSAL) operations and shutdown our Ryder Container Terminals (RCT) business in Canada in the fourth quarter of 2015. We recognized charges for employee termination costs of $3 million and asset impairment of $2 million to adjust assets held for sale, including goodwill and intangible assets, to fair value less costs to sell in 2015. We sold CRSAL to a third party for approximately $2 million during 2016. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The following table summarizes the activities within, and components of, restructuring liabilities for 2016, 2015 and 2014 (in thousands): _________________ Note: The restructuring liabilities shown above are included in "Accrued expenses and other current liabilities" in the Consolidated Balance Sheets. (1) Principally represents cash payments. (2) The majority of the balance remaining for employee termination costs is expected to be paid by the end of 2017. As discussed in Note 27, “Segment Reporting,” our primary measure of segment financial performance excludes, among other items, restructuring and other charges, net. However, the applicable portion of the restructuring and other charges (recoveries), net that related to each segment in 2016, 2015 and 2014 were as follows: 5. RECEIVABLES RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 6. PREPAID EXPENSES AND OTHER CURRENT ASSETS 7. REVENUE EARNING EQUIPMENT _______________ (1) Revenue earning equipment, net includes vehicles under capital leases of $43 million, less accumulated depreciation of $22 million, at December 31, 2016 and $47 million, less accumulated depreciation of $22 million, at December 31, 2015. Depreciation expense was $1.10 billion, $1.04 billion and $968 million in 2016, 2015 and 2014, respectively. In 2016, based on current and expected market conditions, we accelerated depreciation on certain classes of vehicles expected to be made available for sale through June 2018. The impact of the change increased depreciation by $10 million in 2016. Revenue earning equipment held for sale is stated at the lower of carrying amount or fair value less costs to sell. Losses on vehicles held for sale for which carrying values exceeded fair value are recognized at the time they arrive at our used truck centers and are presented within "Used vehicle sales, net" in the Consolidated Statements of Earnings. For revenue earning equipment held for sale, we stratify our fleet by vehicle type (trucks, tractors and trailers), weight class, age and other relevant characteristics and create classes of similar assets for analysis purposes. For a certain population of revenue earning equipment held for sale, fair value was determined based upon recent market prices obtained from our own sales experience for sales of each class of similar assets and vehicle condition. Expected declines in market prices were also considered when valuing the vehicles held for sale.These vehicles held for sale were classified within Level 3 of the fair value hierarchy. During 2016, 2015, and 2014, we recognized losses to reflect changes in fair value of $67 million, $18 million and $11 million, respectively. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The following table presents our assets that are measured at fair value on a nonrecurring basis and considered a Level 3 fair value measurement: ______________ (1) Assets held for sale in the above table only include the portion of revenue earning equipment held for sale where net book values exceeded fair values and fair value adjustments were recorded. The net book value of assets held for sale not exceeding fair value was $15 million and $131 million as of December 31, 2016 and 2015, respectively. (2) Total losses represent fair value adjustments for all vehicles held for sale throughout the period for which fair value less costs to sell was less than carrying value. For the twelve months ended December 31, 2016, the components of used vehicle sales, net were as follows: 8. OPERATING PROPERTY AND EQUIPMENT Depreciation expense was $88 million, $84 million and $79 million in 2016, 2015 and 2014, respectively. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 9. GOODWILL The carrying amount of goodwill attributable to each reportable business segment with changes therein was as follows: We assess goodwill for impairment on April 1st of each year or more often if deemed necessary. In the second quarter of 2016, we completed our annual goodwill impairment test. We performed quantitative assessments on two of our reporting units and determined there was no impairment. We performed qualitative assessments for three reporting units, which considered individual factors such as macroeconomic conditions, changes in our industry and the markets in which we operate, as well as our historical and expected future financial performance. After performing the qualitative assessments, we concluded it is more likely than not that fair value is greater than the carrying value and determined there was no impairment. 10. INTANGIBLE ASSETS The Ryder trade name has been identified as having an indefinite useful life. Customer relationship intangibles are being amortized on a straight-line basis over their estimated useful lives, generally 7-19 years. We recognized amortization expense associated with finite lived intangible assets of approximately $6 million in 2016 and $7 million in both 2015 and 2014. The future amortization expense for each of the five succeeding years related to all intangible assets that are currently reported in the Consolidated Balance Sheets is estimated to range from $4 - $6 million per year for 2017 - 2021. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 11. DIRECT FINANCING LEASES AND OTHER ASSETS Investments held in Rabbi Trusts are assets measured at fair value on a recurring basis, all of which are considered Level 1 of the fair value hierarchy. The following table presents the asset classes at December 31, 2016 and 2015: RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 12. ACCRUED EXPENSES AND OTHER LIABILITIES _________________ (1) Insurance obligations are primarily comprised of self-insured claim liabilities. We retain a portion of the accident risk under vehicle liability and workers’ compensation insurance programs. Self-insurance accruals are primarily based on actuarially estimated, undiscounted cost of claims, and include claims incurred but not reported. Such liabilities are based on estimates. Historical loss development factors are utilized to project the future development of incurred losses, and these amounts are adjusted based upon actual claim experience and settlements. While we believe the amounts are adequate, there can be no assurance that changes to our estimates may not occur due to limitations inherent in the estimation process. During 2016 and 2015, we recognized charges within earnings from continuing operations of $9 million and $4 million from the development of estimated prior years’ self-insured loss reserves for the reasons noted above, as well as a settlement of a customer-extended insurance claim in 2015. In 2014, we recognized a benefit within earnings from continuing operations of $14 million from the development of estimated prior years’ self-insured loss reserves for the reasons noted above. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 13. INCOME TAXES The components of earnings from continuing operations before income taxes and the provision for income taxes from continuing operations were as follows: ______________ (1) Excludes federal and state tax benefits resulting from the exercise of stock options and vesting of restricted stock awards, which were credited directly to “Additional paid-in capital” for years ended December 31, 2015 and 2014. A reconciliation of the federal statutory tax rate with the effective tax rate from continuing operations follows: RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Tax Law Changes The effects of changes in tax laws on deferred tax balances are recognized in the period the new legislation is enacted. The following provides a summary of the increases to net earnings from continuing operations from changes in tax laws by tax jurisdiction: Deferred Income Taxes The components of the net deferred income tax liability were as follows: ______________ (1) Deferred tax assets of $9 million have been included in "Direct financing leases and other assets" at December 31, 2016. U.S. deferred income taxes have not been provided on certain undistributed earnings of foreign subsidiaries, which were $762 million at December 31, 2016. The determination of the amount of the related unrecognized deferred tax liability is not practicable because of the complexities associated with the hypothetical calculations. We have historically reinvested such earnings overseas in foreign operations indefinitely and expect future earnings will also be reinvested overseas indefinitely. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) At December 31, 2016, we had U.S. federal tax effected net operating loss carryforwards of $359 million and various U.S. subsidiaries had state tax effected net operating loss carryforwards of $22 million both expiring through tax year 2034. We also had foreign tax effected net operating losses of $15 million that are available to reduce future income tax payments in several countries, subject to varying expiration rules. A valuation allowance has been established to reduce deferred income tax assets, principally foreign tax loss carryforwards, to amounts more likely than not to be realized. We had unused alternative minimum tax credits of $14 million at December 31, 2016, which are available to reduce future income tax liabilities. The alternative minimum tax credits may be carried forward indefinitely. Uncertain Tax Positions The following is a summary of tax years that are no longer subject to examination: Federal - audits of our U.S. federal income tax returns are closed through fiscal year 2009. State - for the majority of states, tax returns are closed through fiscal year 2009. Foreign - we are no longer subject to foreign tax examinations by tax authorities for tax years before 2009 in Canada, 2011 in Brazil, 2011 in Mexico and 2013 in the U.K., which are our major foreign tax jurisdictions. The following table summarizes the activity related to unrecognized tax benefits (excluding the federal benefit received from state positions): Of the total unrecognized tax benefits, $48 million (net of the federal benefit on state issues) represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate in future periods. The total includes $5 million and $4 million of interest and penalties, at December 31, 2016 and 2015, respectively, net of the federal benefit on state issues. For 2016, 2015 and 2014, we recognized an income tax benefit related to interest and penalties of $1 million in each period, within “Provision for income taxes” in our Consolidated Statements of Earnings. Unrecognized tax benefits related to federal, state and foreign tax positions may decrease by $3 million by December 31, 2017, if audits are completed or tax years close during 2017. Like-Kind Exchange Program We have a like-kind exchange program for certain of our U.S.-based revenue earning equipment. Pursuant to the program, we dispose of vehicles and acquire replacement vehicles in a form whereby tax gains on disposal of eligible vehicles are deferred. To qualify for like-kind exchange treatment, we exchange through a qualified intermediary eligible vehicles being disposed of with vehicles being acquired, allowing us to generally carryover the tax basis of the vehicles sold (“like-kind exchanges”). The program results in a material deferral of federal and state income taxes, and a decrease in cash taxes in periods when we are not in a net operating loss (NOL) position. As part of the program, the proceeds from the sale of eligible vehicles are restricted for the acquisition of replacement vehicles and other specified applications. Due to the structure utilized to facilitate the like-kind exchanges, the qualified intermediary that holds the proceeds from the sales of eligible vehicles and the entity that holds the vehicles to be acquired under the program are required to be consolidated in the accompanying Consolidated Financial Statements in accordance with U.S. GAAP. The total assets, primarily revenue earning equipment, and the total liabilities, primarily vehicle accounts payable, held by these consolidated entities are equal in value as these entities are solely structured to facilitate the like-kind exchanges. At December 31, 2016 and 2015, these consolidated entities had total assets, primarily revenue earning equipment, and total liabilities, primarily accounts payable, of $140 million and $237 million, respectively. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 14. LEASES Leases as Lessor We lease revenue earning equipment to customers for periods ranging from three to seven years for trucks and tractors and up to ten years for trailers. From time to time, we may also lease facilities to third parties. The majority of our leases are classified as operating leases. However, some of our revenue earning equipment leases are classified as direct financing leases and, to a lesser extent, sales-type leases. The net investment in direct financing and sales-type leases consisted of: Our direct financing lease customers operate in a wide variety of industries, and we have no significant customer concentrations in any one industry. We assess credit risk for all of our customers including those who lease equipment under direct financing leases. Credit risk is assessed using an internally developed model, which incorporates credit scores from third party providers and our own custom risk ratings and is updated on a monthly basis. The external credit scores are developed based on the customer’s historical payment patterns and an overall assessment of the likelihood of delinquent payments. Our internal ratings are weighted based on the industry that the customer operates in, company size, years in business and other credit-related indicators (i.e., profitability, cash flow, liquidity, tangible net worth, etc.). Any one of the following factors may result in a customer being classified as high risk: i) history of late payments; ii) open lawsuits, liens or judgments; iii) in business less than three years; and iv) operates in an industry with low barriers to entry. For those customers who are designated as high risk, we typically require deposits to be paid in advance in order to mitigate our credit risk. Additionally, our receivables are collateralized by the vehicle’s fair value, which further mitigates our credit risk. The following table presents the credit risk profile by creditworthiness category of our direct financing lease receivables at December 31, 2016 and 2015: As of December 31, 2016 and 2015, the amount of direct financing lease receivables which were past due was not significant and there were no impaired receivables. Accordingly, there was no material risk of default with respect to these receivables. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Leases as Lessee We lease facilities and office equipment. None of our leasing arrangements contain restrictive financial covenants. During 2016, 2015 and 2014, rent expense (including rent of facilities and contingent rentals) was $127 million, $132 million and $128 million, respectively. Lease Payments Future minimum payments for leases in effect at December 31, 2016 were as follows: ____________________ (1) Amounts do not include contingent rentals, which may be received under certain leases on the basis of miles or changes in the Consumer Price Index. Contingent rentals from operating leases included in revenue were $342 million in 2016 and $329 million in both 2015 and 2014. Contingent rentals from direct financing leases included in revenue were $12 million in 2016, $12 million in 2015 and $11 million in 2014 . The amounts in the previous table related to the lease of revenue earning equipment are based upon the general assumption that revenue earning equipment will remain on lease for the length of time specified by the respective lease agreements. The future minimum payments presented above related to the lease of revenue earning equipment are not a projection of future lease revenue or expense, and no effect has been given to renewals, new business, cancellations, contingent rentals or future rate changes. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 15. DEBT _________________ (1) We had unamortized original issue discounts of $7 million and $8 million at December 31, 2016 and 2015, respectively. (2) Asset-backed U.S. obligations are related to financing transactions involving revenue earning equipment. (3) The notional amount of the executed interest rate swaps designated as fair value hedges was $825 million at December 31, 2016 and 2015. Refer to Note 16, "Derivatives," for additional information. (4) See Note 2, "Recent Accounting Pronouncements," for further discussion of the presentation of debt issuance costs. Maturities of total debt are as follows: RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Debt Facilities We maintain a $1.2 billion global revolving credit facility with a syndicate of twelve lending institutions led by Bank of America N.A., Bank of Tokyo-Mitsubishi UFJ, Ltd., BNP Paribas, Mizuho Corporate Bank, Ltd., Royal Bank of Canada, Lloyds Bank Plc, U.S. Bank National Association and Wells Fargo Bank, N.A. The facility matures in January 2020. The agreement provides for annual facility fees which range from 7.5 basis points to 25 basis points based on Ryder’s long-term credit ratings. The annual facility fee is currently 10 basis points, which applies to the total facility size of $1.2 billion. The credit facility is used primarily to finance working capital but can also be used to issue up to $75 million in letters of credit (there were no letters of credit outstanding against the facility at December 31, 2016). At our option, the interest rate on borrowings under the credit facility is based on LIBOR, prime, federal funds or local equivalent rates. The credit facility contains no provisions limiting its availability in the event of a material adverse change to Ryder’s business operations; however, the credit facility does contain standard representations and warranties, events of default, cross-default provisions and certain affirmative and negative covenants. In order to maintain availability of funding, we must maintain a ratio of debt to consolidated net worth of less than or equal to 300%. Net worth, as defined in the credit facility, represents shareholders' equity excluding any accumulated other comprehensive income or loss associated with our pension and other postretirement plans. The ratio at December 31, 2016, was 201%. At December 31, 2016, there was $675 million available under the credit facility. Our global revolving credit facility enables us to refinance short-term obligations on a long-term basis. Short-term commercial paper obligations not expected to require the use of working capital are classified as long-term as we have both the intent and ability to refinance on a long-term basis. In addition, we have the intent and ability to refinance the current portion of long-term debt on a long-term basis. At December 31, 2016, we classified $342 million of short-term commercial paper and $350 million of the current portion of long-term debt as long-term debt. At December 31, 2015, we classified $547 million of short-term commercial paper, $300 million of current debt obligations and $25 million of short-term borrowings under our global revolving credit facilities as long-term. In 2016, we received $79 million from financing transactions backed by a portion of our revenue earning equipment. The proceeds from these transactions were used to fund capital expenditures. We have provided end of term guarantees for the residual value of the revenue earning equipment in these transactions. The transaction proceeds, along with the end of term residual value guarantees, have been included within "asset-backed U.S. obligations" in the preceding table. In February 2016, we issued $300 million of unsecured medium-term notes maturing in November 2021. In November 2016, we issued $300 million of unsecured medium-term notes maturing in September 2021. The proceeds from these notes were used to payoff maturing debt and for general corporate purposes. If these notes are downgraded below investment grade following, and as a result of, a change in control, the note holders can require us to repurchase all or a portion of the notes at a purchase price equal to 101% of principal value plus accrued and unpaid interest. We have a trade receivables purchase and sale program, pursuant to which we sell certain of our domestic trade accounts receivable to a bankruptcy remote, consolidated subsidiary of Ryder, that in turn sells, on a revolving basis, an ownership interest in certain of these accounts receivable to a committed purchaser. The subsidiary is considered a VIE and is consolidated based on our control of the entity’s activities. We use this program to provide additional liquidity to fund our operations, particularly when it is cost effective to do so. The costs under the program may vary based on changes in interest rates. The available proceeds that may be received under the program are limited to $175 million. In October 2016, we renewed the trade receivables purchase and sale program. If no event occurs which causes early termination, the 364-day program will expire on October 23, 2017. The program contains provisions restricting its availability in the event of a material adverse change to our business operations or the collectibility of the collateralized receivables. Sales of receivables under this program are accounted for as secured borrowings based on our continuing involvement in the transferred assets. No amounts were outstanding under the program at December 31, 2016 and 2015. The fair value of total debt (excluding capital lease, asset backed U.S. obligations and debt issuance costs) was $4.97 billion at December 31, 2016 and $5.06 billion at December 31, 2015. For publicly-traded debt, estimates of fair value were based on market prices. For other debt, fair value is estimated based on a model-driven approach using rates currently available to us for debt with similar terms and remaining maturities. The fair value measurements of our publicly-traded debt and our other debt were classified within Level 2 of the fair value hierarchy. The carrying amounts reported in the Consolidated Balance Sheets for "Cash and cash equivalents," "Receivables, net" and "Accounts payable" approximate fair value because of the immediate or short-term maturities of these financial instruments. In February 2016, Ryder filed an automatic shelf registration statement on Form S-3 with the SEC. The registration is for an indeterminate number of securities and is effective for three years. Under this universal shelf registration statement, we have the capacity to offer and sell from time to time various types of securities, including common stock, preferred stock and debt securities, subject to market demand and ratings status. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 16. DERIVATIVES From time to time, we enter into interest rate derivatives to manage our fixed and variable interest rate exposure and to better match the repricing of debt instruments to that of our portfolio of assets. We assess the risk that changes in interest rates will have either on the fair value of debt obligations or on the amount of future interest payments by monitoring changes in interest rate exposures and by evaluating hedging opportunities. We regularly monitor interest rate risk attributable to both our outstanding or forecasted debt obligations as well as our offsetting hedge positions. This risk management process involves the use of analytical techniques, including cash flow sensitivity analyses, to estimate the expected impact of changes in interest rates on our future cash flows. As of December 31, 2016, we had interest rate swaps outstanding which are designated as fair value hedges for certain debt obligations, with a total notional value of $825 million and maturities through 2020. Interest rate swaps are measured at fair value on a recurring basis using Level 2 fair value inputs. The fair value of these interest rate swaps was approximately $1 million and $5 million as of December 31, 2016 and 2015, respectively. The amounts are presented in "Direct financing leases and other assets" and "Other non-current liabilities" in our Consolidated Balance Sheets. Changes in the fair value of our interest rate swaps were offset by changes in the fair value of the hedged debt instrument. Accordingly, there was no ineffectiveness related to the interest rate swaps. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 17. GUARANTEES We have executed various agreements with third parties that contain standard indemnifications that may require us to indemnify a third party against losses arising from a variety of matters such as lease obligations, financing agreements, environmental matters, and agreements to sell business assets. In each of these instances, payment by Ryder is contingent on the other party bringing about a claim under the procedures outlined in the specific agreement. Normally, these procedures allow us to dispute the other party’s claim. Additionally, our obligations under these agreements may be limited in terms of the amount and/or timing of any claim. We have entered into individual indemnification agreements with each of our independent directors, through which we will indemnify such director acting in good faith against any and all losses, expenses and liabilities arising out of such director’s service as a director of Ryder. The maximum amount of potential future payments under these agreements is generally unlimited. We cannot predict the maximum potential amount of future payments under certain of these agreements, including the indemnification agreements, due to the contingent nature of the potential obligations and the distinctive provisions that are involved in each individual agreement. Historically, no such payments made by us have had a material adverse effect on our business. We believe that if a loss were incurred in any of these matters, the loss would not have a material adverse impact on our consolidated results of operations or financial position. At December 31, 2016 and 2015, we had letters of credit and surety bonds outstanding, which primarily guarantee various insurance activities as noted in the following table: 18. SHARE REPURCHASE PROGRAMS In December 2015, our Board of Directors authorized a share repurchase program intended to mitigate the dilutive impact of shares issued under our employee stock plans (the program). Under the program, management is authorized to repurchase (i) up to 1.5 million shares of common stock, the sum of which will not exceed the number of shares issued to employees under the Company’s employee stock plans from December 1, 2015 to December 9, 2017, plus (ii) 0.5 million shares issued to employees that were not repurchased under the Company’s previous share repurchase program. The program limits aggregate share repurchases to no more than 2 million shares of Ryder common stock. Share repurchases of common stock are made periodically in open-market transactions and are subject to market conditions, legal requirements and other factors. Management may establish prearranged written plans for the Company under Rule 10b5-1 of the Securities Exchange Act of 1934 as part of the program, which allow for share repurchases during Ryder’s quarterly blackout periods as set forth in the trading plan. During 2016, 2015 and 2014, we repurchased 0.5 million, 0.1 million and 1.3 million shares for $37 million, $6 million and $106 million, respectively. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 19. ACCUMULATED OTHER COMPREHENSIVE LOSS Comprehensive income (loss) presents a measure of all changes in shareholders’ equity except for changes resulting from transactions with shareholders in their capacity as shareholders. The following summary sets forth the components of accumulated other comprehensive loss, net of tax: _______________________ (1) These amounts are included in the computation of net periodic pension cost and pension settlement charge. See Note 22, "Employee Benefit Plans," for further information. The loss from currency translation adjustments in 2016 of $71 million was primarily due to the weakening of the British Pound against the U.S. Dollar, partially offset by the strengthening of the Canadian Dollar against the U.S. Dollar. The losses from currency translation adjustments in 2015 and 2014 of $100 million and $72 million, respectively, were due primarily to the weakening of the Canadian Dollar and British Pound against the U.S. Dollar. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 20. EARNINGS PER SHARE The following table presents the calculation of basic and diluted earnings per common share from continuing operations: 21. SHARE-BASED COMPENSATION PLANS The following table provides information on share-based compensation expense and related income tax benefits recognized in 2016, 2015 and 2014: Total unrecognized pre-tax compensation expense related to share-based compensation arrangements at December 31, 2016 was $17 million and is expected to be recognized over a weighted-average period of approximately 1.7 years. The total fair value of equity awards vested during 2016, 2015 and 2014 were $17 million, $16 million and $18 million, respectively. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Share-Based Incentive Awards Share-based incentive awards are provided to employees under the terms of various share-based compensation plans (collectively, the “Plans”). The Plans are administered by the Compensation Committee of the Board of Directors. Awards under the Plans principally include at-the-money stock options, unvested stock and cash awards. Unvested stock awards include grants of market-based, performance-based, and time-vested restricted stock rights. Under the terms of our Plans, dividends on unvested stock are not paid unless the award vests. Upon vesting, the amount of the dividends paid is equal to the aggregate dividends declared on common shares during the period from the date of grant of the award until the date the shares underlying the award are delivered. There are 4.4 million shares authorized for issuance under the Plans as of December 31, 2016. There are 3.5 million shares remaining available for future issuance under the Plans as of December 31, 2016. Stock options are awards which allow employees to purchase shares of our stock at a fixed price. Stock option awards are granted at an exercise price equal to the market price of our stock at the time of grant. These awards, which generally vest one-third each year, are fully vested three years from the grant date. Stock options granted since 2013 have contractual terms of ten years. Restricted stock awards are unvested stock rights that are granted to employees and entitle the holder to shares of common stock as the award vests. Time-vested restricted stock rights typically vest in three years regardless of company performance. The fair value of the time-vested awards is determined and fixed based on Ryder’s stock price on the date of grant. Performance-based restricted stock awards (PBRSRs) include a performance-based vesting condition. The awards are segmented into three one-year performance periods. For these awards, up to 125% of the awards may be earned based on Ryder's one-year adjusted return on capital (ROC) measured against an annual ROC target. If earned, employees will receive the grant of stock three years after the grant date, provided they continue to be employed with Ryder, subject to Compensation Committee approval. For accounting purposes, the awards are not considered granted until the Compensation Committee approves the annual ROC target. During 2016, 2015 and 2014, 45,000, 42,000 and 23,000 PBRSRs, respectively, were considered granted for accounting purposes. The fair value of the PBRSRs is determined and fixed on the grant date based on Ryder’s stock price on the date of grant. Share-based compensation expense is recognized on a straight-line basis over the vesting period, based upon the probability that the performance target will be met. Market-based restricted stock awards include a market-based vesting provision. The awards are segmented into three performance periods of one, two and three years. At the end of each performance period, up to 125% of the award may be earned based on Ryder's total shareholder return (TSR) compared to the target TSR of a peer group over the applicable performance period. The awards compared Ryder's TSR to the TSR of a custom peer group. If earned, employees will receive the grant of stock at the end of the relevant three-year performance period provided they continue to be employed with Ryder, subject to Compensation Committee approval. The fair value of the market-based awards was determined on the date of grant using a Monte-Carlo valuation model. Share-based compensation expense is recognized on a straight-line basis over the vesting period and is recognized regardless of whether the awards vest. Certain employees also received cash awards as part of our long-term incentive compensation program. The cash awards have the same vesting provisions as the market-based restricted stock awards granted in the respective years. The cash awards are accounted for as liability awards as they are based upon our own stock performance and are settled in cash. As a result, the liability is adjusted to reflect fair value at the end of each reporting period. The fair value of the market-based cash awards was estimated using a lattice-based option pricing valuation model that incorporates a Monte-Carlo simulation. The liability related to the cash awards was $1 million at both December 31, 2016 and 2015. The following table is a summary of compensation expense recognized related to cash awards in addition to share-based compensation expense reported in the previous table. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) We grant restricted stock units (RSUs) to non-management members of the Board of Directors. Once granted, RSUs are eligible for non-forfeitable dividend equivalents but have no voting rights. The fair value of the awards is determined and fixed based on Ryder’s stock price on the date of grant. A board member receives the RSUs upon departure from the Board. The initial grant of RSUs will not vest unless the director has served a minimum of one year. When a board member receives RSUs, they are redeemed for an equivalent number of shares of our common stock. Share-based compensation expense is recognized for RSUs in the year the RSUs are granted. Option Awards The following is a summary of option activity under our stock option plans as of and for the year ended December 31, 2016: The aggregate intrinsic values in the table above represent the total pre-tax intrinsic value (the difference between the close price of our stock on the last trading day of the year and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders if all options were exercised at year-end. This amount fluctuates based on the fair market value of our stock. Restricted Stock Awards The following is a summary of the status of Ryder’s unvested restricted stock awards as of and for the year ended December 31, 2016: (1) Includes awards attained above target. (2) Includes awards canceled due to performance and market conditions not being achieved. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Stock Purchase Plan We maintain an Employee Stock Purchase Plan (ESPP) that enables eligible participants in the U.S. and Canada to purchase full or fractional shares of Ryder common stock through payroll deductions of up to 15% of eligible compensation. The ESPP provides for quarterly offering periods during which shares may be purchased at 85% of the fair market value of our stock. Beginning with the second quarter of 2015, we amended the ESPP to calculate the exercise price based only on the fair market value of the stock on the last trading day of the quarter. Prior to the second quarter of 2015, the exercise price was based on the lower of the fair market value on the first or last trading day of the quarter. Stock purchased under the ESPP must be held for 90 days. There were 5.5 million shares authorized for issuance under the existing ESPP at December 31, 2016. There were 0.9 million shares remaining available to be purchased in the future under the ESPP at December 31, 2016. During 2016, 192,000 shares with a weighted average exercise price of $56.17 were granted and exercised. During 2015, 178,000 shares with a weighted average exercise price of $63.93 were granted and exercised. During 2014, 150,000 shares with a weighted average exercise price of $82.27 were granted and exercised. Share-Based Compensation Fair Value Assumptions The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option-pricing valuation model that uses the weighted-average assumptions noted in the table below. Expected volatility is based on historical volatility of our stock and implied volatility from traded options on our stock. The risk-free rate for periods within the contractual life of the stock option award is based on the yield curve of a zero-coupon U.S. Treasury bond on the date the stock option award is granted with a maturity equal to the expected term of the stock option award. We use historical data to estimate stock option exercises and forfeitures within the valuation model. The expected term of stock option awards granted is derived from historical exercise experience under the share-based employee compensation arrangements and represents the period of time that stock option awards granted are expected to be outstanding. The fair value of market-based restricted stock awards is estimated using a lattice-based option-pricing valuation model that incorporates a Monte-Carlo simulation. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive equity awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by Ryder. The following table presents the weighted-average assumptions used for options granted: Exercise of Employee Stock Options and Purchase Plans The total intrinsic value of options exercised during 2016, 2015 and 2014 was $5 million, $11 million and $28 million, respectively. The total cash received from employees under all share-based employee compensation arrangements for 2016, 2015 and 2014 was $18 million, $24 million and $46 million, respectively. In connection with these exercises, the tax benefits generated from share-based employee compensation arrangements were $0.6 million, $0.4 million and $1 million for 2016, 2015 and 2014, respectively. As discussed in Note 2 "Recent Accounting Pronouncements," excess tax benefits related to share-based payments are recorded to income tax expense beginning in 2016. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 22. EMPLOYEE BENEFIT PLANS Pension Plans We historically sponsored several defined benefit pension plans covering most employees not covered by union-administered plans, including certain employees in foreign countries. These plans generally provided participants with benefits based on years of service and career-average compensation levels. In past years, we made amendments to defined benefit retirement plans which froze the retirement benefits for non-grandfathered and certain non-union employees in the U.S., Canada and the United Kingdom (U.K.). As a result of these amendments, non-grandfathered plan participants ceased accruing benefits under the plan as of the respective amendment effective date and began receiving an enhanced benefit under a defined contribution plan. All retirement benefits earned as of the amendment effective date were fully preserved and will be paid in accordance with the plan and legal requirements. The funding policy for these plans is to make contributions based on annual service costs plus amortization of unfunded past service liability, but not greater than the maximum allowable contribution deductible for federal income tax purposes. We may, from time to time, make voluntary contributions to our pension plans, which exceed the amount required by statute. The majority of the plans’ assets are invested in a master trust that, in turn, is invested primarily in commingled funds whose investments are listed stocks and bonds. We also have a non-qualified supplemental pension plan covering certain U.S. employees, which provides for incremental pension payments from our funds so that total pension payments equal the amounts that would have been payable from our principal pension plans if it were not for limitations imposed by income tax regulations. The accrued pension liability related to this plan was $53 million and $51 million at December 31, 2016 and 2015, respectively. Pension Expense Pension expense from continuing operations was as follows: RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) During 2016, we determined that certain pension benefit improvements made in 2009 had not been fully reflected in our projected benefit obligation. Because the amounts were not material to our consolidated financial statements in any individual period, and the cumulative amount is not material to 2016 results, we recognized a one-time, non-cash charge of $8 million in "Selling, general and administrative expenses" and a $13 million pre-tax increase to “Accumulated other comprehensive loss” in our consolidated financial statements to correctly state the pension benefit obligation and account for these 2009 benefit improvements. During 2015, we recorded adjustments of $0.5 million to previously recorded, estimated pension settlement charges related to the exit from U.S multi-employer pension plans. During 2014, we offered former vested employees in our U.S. defined benefit plan a one-time option to receive a lump sum distribution of their benefits. We made payments totaling $224 million from the U.S. defined benefit plan assets, which resulted in a settlement of $259 million, representing approximately 12% of our U.S. pension plan obligations. We recognized pension lump sum settlement expense of $97 million for unrecognized actuarial losses as a result of the partial settlement of our pension plan liability. The amount of the lump sum settlement expense is based on the proportionate amount of unrecognized U.S. actuarial net losses equal to the settled percentage of our pension benefit obligation. The following table sets forth the weighted-average actuarial assumptions used for Ryder’s pension plans in determining annual pension expense: The return on plan assets assumption reflects the weighted-average of the expected long-term rates of return for the broad categories of investments held in the plans. The expected long-term rate of return is adjusted when there are fundamental changes in expected returns or in asset allocation strategies of the plan assets. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Obligations and Funded Status The following table sets forth the benefit obligations, assets and funded status associated with our pension plans: The funded status of our pension plans was presented in the Consolidated Balance Sheets as follows: Amounts recognized in accumulated other comprehensive loss (pre-tax) consisted of: In 2017, we expect to recognize $34 million of net actuarial loss amortization as a component of pension expense. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The following table sets forth the weighted-average actuarial assumptions used in determining funded status: At December 31, 2016 and 2015, our accumulated benefit obligations, as well as, our pension obligations (accumulated benefit obligations (ABO), and projected benefit obligations (PBO)), greater than the fair value of the related plan assets for our U.S. and foreign plans were as follows: Plan Assets Our pension investment strategy is to reduce the effects of future volatility on the fair value of our pension assets relative to our pension liabilities. We increase our allocation of high quality, longer-term fixed income securities and reduce our allocation of equity investments as the funded status of the plans improve. The plans utilize several investment strategies, including actively and passively managed equity and fixed income strategies. The investment policy establishes targeted allocations for each asset class that incorporate measures of asset and liability risks. Deviations between actual pension plan asset allocations and targeted asset allocations may occur as a result of investment performance and changes in the funded status from time to time. Rebalancing of our pension plan asset portfolios is evaluated periodically and rebalanced if actual allocations exceed an acceptable range. U.S. plans account for approximately 74% of our total pension plan assets. Equity securities primarily include investments in both domestic and international common collective trusts and publicly traded equities. Fixed income securities primarily include domestic collective trusts and corporate bonds. Other types of investments include private equity fund-of-funds and hedge fund-of-funds. Equity and fixed income securities in our international plans include actively and passively managed mutual funds. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The following table presents the fair value of each major category of pension plan assets and the level of inputs used to measure fair value as of December 31, 2016 and 2015: The following is a description of the valuation methodologies used for our pension assets as well as the level of input used to measure fair value: Equity securities - These investments include common and preferred stocks and index common collective trusts that track U.S. and foreign indices. Fair values for the common and preferred stocks were based on quoted prices in active markets and were therefore classified within Level 1 of the fair value hierarchy. The common collective trusts were valued at the unit prices established by the funds’ sponsors based on the fair value of the assets underlying the funds. Since the units of the funds are not actively traded, the fair value measurements have been classified within Level 2 of the fair value hierarchy. Fixed income securities - These investments include investment grade bonds of U.S. issuers from diverse industries, government issuers, index common collective trusts that track the Barclays Aggregate Index and other fixed income investments (primarily mortgage-backed securities). Fair values for the corporate bonds were valued using third-party pricing services. These sources determine prices utilizing market income models which factor in, where applicable, transactions of similar assets in active markets, transactions of identical assets in infrequent markets, interest rates, bond or credit default swap spreads and volatility. Since the corporate bonds are not actively traded, the fair value measurements have been classified within Level 2 of the fair value hierarchy. The common collective trusts were valued at the unit prices established by the funds’ sponsors based on the fair value of the assets underlying the funds. Since the units of the funds are not actively traded, the fair value measurements have been classified within Level 2 of the fair value hierarchy. The other investments are not actively traded and fair values are estimated using bids provided by brokers, dealers or quoted prices of similar securities with similar characteristics or pricing models. Therefore, the other investments have been classified within Level 2 of the fair value hierarchy. Private equity and hedge funds - These investments represent limited partnership interests in private equity and hedge funds. The partnership interests are valued by the general partners based on the underlying assets in each fund. The limited partnership interests are valued using unobservable inputs and have been classified within Level 3 of the fair value hierarchy. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The following table presents a summary of changes in the fair value of the pension plans’ Level 3 assets for the years ended December 31, 2016 and 2015: The following table details pension benefits expected to be paid in each of the next five fiscal years and in aggregate for the five fiscal years thereafter: For 2017, required pension contributions to our pension plans are estimated to be $22 million. Multi-employer Plans We participate in multi-employer plans that provide defined benefits to certain employees covered by collective-bargaining agreements. Such plans are usually administered by a board of trustees comprised of the management of the participating companies and labor representatives. The net pension cost of these plans is equal to the annual contribution determined in accordance with the provisions of negotiated labor contracts. Assets contributed to such plans are not segregated or otherwise restricted to provide benefits only to our employees. The risks of participating in these multi-employer plans are different from single-employer plans in the following respects: 1) assets contributed to the multi-employer plan by one employer may be used to provide benefits to employees and former employees of other participating employers; 2) if a participating employer is no longer able to contribute to the plan, the unfunded obligations of the plan may be borne by the remaining participating employers at annual contribution rates under the collective bargaining agreements; 3) if there is a mass withdrawal of substantially all employers from the plan, we may be required to pay the plan an annual contribution based on historical contribution levels as prescribed by federal statute; and 4) if we choose to stop participating in some of our multi-employer plans, we may be required to pay those plans an amount based on the underfunded status of the plan, which is referred to as a withdrawal liability. During 2015, we recognized a benefit of $1 million for adjustments to previously recognized estimated pension settlement charges related to our exit from U.S. multi-employer pension plans. During 2014, we recognized estimated pension settlement charges of $13 million related to the transition of employees from two U.S. multi-employer plans into another multi-employer plan in which we participate, and our exit from two U.S. multi-employer pension plans. These adjustments were included in "Selling, general, and administrative expenses" in our Consolidated Statement of Earnings and are a component of Union-administered plans expense. Our participation in these plans is outlined in the table below. Unless otherwise noted, the most recent Pension Protection Act zone status available in 2016 and 2015 is for the plan years ended December 31, 2015 and December 31, 2014, respectively. The zone status is based on information that we received from the plan. Among other factors, plans in the red zone are generally less than sixty-five percent funded, plans in the yellow zone are less than eighty percent funded, and plans in the green zone are at least eighty percent funded. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) _____________ (1) The “FIP/RP Status Pending/Implemented” column indicates plans for which a financial improvement plan (FIP) or a rehabilitation plan (RP) is either pending or has been implemented. Our contributions are impacted by changes in contractual contributions rates as well as changes in the number of employees covered by each plan. Savings Plans Employees who do not actively participate in pension plans and are not covered by union-administered plans are generally eligible to participate in enhanced savings plans. These plans provide for (i) a company contribution even if employees do not make contributions, (ii) a company match of employee contributions of eligible pay, subject to tax limits and (iii) a discretionary company match. Savings plan costs totaled $38 million in both 2016 and 2015 and $35 million in 2014. Deferred Compensation and Long-Term Compensation Plans We have deferred compensation plans that permit eligible U.S. employees, officers and directors to defer a portion of their compensation. The deferred compensation liability, including Ryder matching amounts and accumulated earnings, totaled $50 million and $44 million at December 31, 2016 and 2015, respectively. We have established grantor trusts (Rabbi Trusts) to provide funding for benefits payable under the supplemental pension plan, deferred compensation plans and long-term incentive compensation plans. The assets held in the trusts were $50 million and $43 million at December 31, 2016 and 2015, respectively. The Rabbi Trusts’ assets consist of short-term cash investments and a managed portfolio of equity securities, including our common stock. These assets, except for the investment in our common stock, are included in “Direct financing leases and other assets” because they are available to our general creditors in the event of insolvency. The equity securities are classified as trading securities and stated at fair value. Both realized and unrealized gains and losses are included in “Miscellaneous income, net.” The Rabbi Trusts’ investment of $2 million and $1 million in our common stock at December 31, 2016 and 2015, respectively, is reflected at historical cost and included in shareholders’ equity. Other Postretirement Benefits We sponsor plans that provide retired U.S. and Canadian employees with certain healthcare and life insurance benefits. Substantially all U.S. and Canadian employees not covered by union-administered health and welfare plans are eligible for the healthcare benefits. Healthcare benefits for our principal plan are generally provided to qualified retirees under age 65 and eligible dependents. This plan requires employee contributions that vary based on years of service and include provisions that limit our contributions. Effective January 1, 2014, we made amendments to our healthcare benefits for early retirees which modified future eligibility requirements for non-grandfathered retirees in the U.S. The post-retirement medical plan was closed to participants who were not at least age 52 with 12 years of service as of December 31, 2013. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Total postretirement benefit income was as follows: The following table sets forth the weighted-average discount rates used in determining annual postretirement benefit expense: Our postretirement benefit plans are not funded. The following table sets forth the benefit obligations associated with our postretirement benefit plans: Amounts recognized in the Consolidated Balance Sheets consisted of: RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Amounts recognized in accumulated other comprehensive loss (pre-tax) consisted of: In 2017, we expect to recognize approximately $2 million of the net actuarial gain as a component of postretirement benefit expense. The amount of prior service credit we expect to recognize in 2017 as a component of total postretirement benefit expense is not material. Our annual measurement date is December 31 for both U.S. and foreign postretirement benefit plans. Assumptions used in determining accrued postretirement benefit obligations were as follows: Changing the assumed healthcare cost trend rates by 1% in each year would not have a material effect on the accumulated postretirement benefit obligation at December 31, 2016 or annual postretirement benefit expense for 2016. The following table details other postretirement benefits expected to be paid in each of the next five fiscal years and in aggregate for the five fiscal years thereafter: 23. ENVIRONMENTAL MATTERS Our operations involve storing and dispensing petroleum products, primarily diesel fuel, regulated under environmental protection laws. These laws require us to eliminate or mitigate the effect of such substances on the environment. In response to these requirements, we continually upgrade our operating facilities and implement various programs to detect and minimize contamination. In addition, we have received notices from the Environmental Protection Agency (EPA) and others that we have been identified as a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act, the Superfund Amendments and Reauthorization Act and similar state statutes. We may be required to share in the cost of cleanup of 19 identified disposal sites. Our environmental expenses which are presented within “Cost of fuel services” in our Consolidated Statements of Earnings, consist of remediation costs as well as normal recurring expenses such as licensing, testing and waste disposal fees. These expenses totaled $10 million, $9 million and $7 million in 2016, 2015 and 2014, respectively. The carrying amount of our environmental liabilities was $9 million and $10 million at December 31, 2016 and 2015, respectively. Our asset retirement obligations related to fuel tanks to be removed are not included above and are included in “Accrued expenses and other current liabilities” and “Other non-current liabilities” in our Consolidated Balance Sheets. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The ultimate cost of our environmental liabilities cannot presently be projected with certainty due to the presence of several unknown factors, primarily the level of contamination, the effectiveness of selected remediation methods, the stage of investigation at individual sites, the determination of our liability in proportion to other responsible parties and the recoverability of such costs from third parties. Based on information presently available, we believe that the ultimate disposition of these matters, although potentially material to the results of operations in any one year, will not have a material adverse effect on our financial condition or liquidity. 24. OTHER ITEMS IMPACTING COMPARABILITY Our primary measure of segment performance as shown in Note 27, "Segment Reporting", excludes certain items we do not believe are representative of the ongoing operations of the segment. Excluding these items from our segment measure of performance allows for better year over year comparison: _______________ (1) Refer to Note 22, "Employee Benefit Plans," for additional information. (2) Refer to Note 4, "Restructuring and Other Charges," for additional information. During 2015 and 2014, we incurred charges of $4 million and $0.4 million, respectively, in "Selling, general and administrative expenses" in our Consolidated Statements of Earnings related to consulting fees associated with cost savings initiatives. During 2014, we incurred charges of $2 million related to tax adjustments for the 2011 Hill Hire acquisition. We reported the cumulative adjustment within “Selling, general and administrative expenses” in our Consolidated Statements of Earnings. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 25. OTHER MATTERS We are a party to various claims, complaints and proceedings arising in the ordinary course of our continuing business operations including, but not limited to, those relating to commercial and employment claims, environmental matters, risk management matters (e.g., vehicle liability, workers’ compensation, etc.) and administrative assessments primarily associated with operating taxes. We have established loss provisions for matters in which losses are probable and can be reasonably estimated. For matters from continuing operations, we believe that the resolution of these claims, complaints and legal proceedings will not have a material effect on our consolidated financial statements. Our estimates regarding potential losses and materiality are based on our judgment and assessment of the claims utilizing currently available information. Although we will continue to reassess our reserves and estimates based on future developments, our objective assessment of the legal merits of such claims may not always be predictive of the outcome and actual results may vary from our current estimates. Although we discontinued our South American operations in 2009, we continue to be party to various federal, state and local legal proceedings involving labor matters, tort claims and tax assessments. We have established loss provisions for any matters where we believe a loss is probable and can be reasonably estimated. We believe that such losses will not have a material effect on our consolidated financial statements. In Brazil, various matters related to income taxes and social contribution taxes, as well as tax credits used to offset those taxes, were assessed by the Revenue Department for the 1997, 1998, 2004, 2005 and 2006 tax years. When available and appropriate, we have entered into various amnesty programs offered by the Brazilian tax authorities to settle some of these assessments at a discount and continue to evaluate these when offered. Payments to resolve open matters through these amnesty programs were not material and were reflected as costs in discontinued operations. Open matters, combined, total approximately $4 million in assessments, penalties and interest and are pending at various levels of the administrative tax courts. We believe it is more likely than not that our position will ultimately be sustained either in these administrative courts or in actions before the judicial courts, if required. We do not believe these matters will have a material impact on our consolidated financial statements. 26. SUPPLEMENTAL CASH FLOW INFORMATION Supplemental cash flow information was as follows: RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 27. SEGMENT REPORTING Our operating segments are aggregated into reportable business segments based upon similar economic characteristics, products, services, customers and delivery methods. We report our financial performance in three business segments: (1) FMS, which provides full service leasing, commercial rental, contract maintenance, and contract-related maintenance of trucks, tractors and trailers to customers principally in the U.S., Canada and the U.K.; (2) DTS, which provides vehicles and drivers as part of a dedicated transportation solution in the U.S.; and (3) SCS, which provides comprehensive supply chain solutions including distribution and transportation services in North America and Asia. Dedicated transportation services provided as part of an integrated, multi-service, supply chain solution to SCS customers are reported in the SCS business segment. Our primary measurement of segment financial performance, defined as “Earnings Before Tax” (EBT) from continuing operations, includes an allocation of Central Support Services (CSS) and excludes non-operating pension costs, restructuring and other charges (recoveries), net discussed in Note 4, "Restructuring and Other Charges" and items discussed in Note 24, "Other Items Impacting Comparability." CSS represents those costs incurred to support all business segments, including human resources, finance, corporate services, public affairs, information technology, health and safety, legal, marketing and corporate communications. The objective of the EBT measurement is to provide clarity on the profitability of each business segment and, ultimately, to hold leadership of each business segment and each operating segment within each business segment accountable for their allocated share of CSS costs. Certain costs are considered to be overhead not attributable to any segment and remain unallocated in CSS. Included among the unallocated overhead remaining within CSS are the costs for investor relations, public affairs and certain executive compensation. CSS costs attributable to the business segments are predominantly allocated to FMS, DTS and SCS as follows: •Finance, corporate services, and health and safety - allocated based upon estimated and planned resource utilization; •Human resources - individual costs within this category are allocated under various methods, including allocation based on estimated utilization and number of personnel supported; •Information technology - principally allocated based upon utilization-related metrics such as number of users or minutes of CPU time. Customer-related project costs and expenses are allocated to the business segment responsible for the project; and •Other - represents legal and other centralized costs and expenses including certain share-based incentive compensation costs. Expenses, where allocated, are based primarily on the number of personnel supported. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Our FMS segment leases revenue earning equipment and provides fuel, maintenance and other ancillary services to the DTS and SCS segments. Inter-segment revenue and EBT are accounted for at rates similar to those executed with third parties. EBT related to inter-segment equipment and services billed to customers (equipment contribution) are included in both FMS and the business segment which served the customer and then eliminated (presented as “Eliminations”). Segment results are not necessarily indicative of the results of operations that would have occurred had each segment been an independent, stand-alone entity during the periods presented. Each business segment follows the same accounting policies as described in Note 1, “Summary of Significant Accounting Policies.” Business segment revenue and EBT from continuing operations is as follows: ______________ (1) See Note 24, “Other Items Impacting Comparability,” for a discussion of items excluded from our primary measure of segment performance. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The following table sets forth share-based compensation expense, depreciation expense, used vehicle sales, net, amortization expense and other non-cash charges, net, interest expense (income), capital expenditures paid and total assets for the years ended December 31, 2016, 2015 and 2014, as provided to the chief operating decision-maker for each of Ryder’s reportable business segments: ____________ (1) Depreciation expense associated with CSS assets was allocated to business segments based upon estimated and planned asset utilization. Depreciation expense totaling $24 million, $22 million and $21 million during 2016, 2015 and 2014, respectively, associated with CSS assets was allocated to other business segments. (2) Interest expense was primarily allocated to the FMS segment since such borrowings were used principally to fund the purchase of revenue earning equipment used in FMS; however, interest income was also reflected in DTS and SCS based on targeted segment leverage ratios. (3) Excludes acquisition payments of $10 million in 2014. See Note 3, “Acquisitions,” for additional information. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Geographic Information Certain Concentrations We have a diversified portfolio of customers across a full array of transportation and logistics solutions and across many industries. We believe this will help to mitigate the impact of adverse downturns in specific sectors of the economy. Our portfolio of full service lease and commercial rental customers is not concentrated in any one particular industry or geographic region. We derive a significant portion of our SCS revenue from the automotive industry, mostly from manufacturers and suppliers of original equipment parts. During 2016, 2015 and 2014, the automotive industry accounted for approximately 44%, 41% and 43%, respectively, of SCS total revenue. RYDER SYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 28. QUARTERLY INFORMATION (UNAUDITED) Note: EPS amounts may not be additive due to rounding. Quarterly and year-to-date computations of per share amounts are made independently; therefore, the sum of per-share amounts for the quarters may not equal per-share amounts for the year. See Note 4, “Restructuring and Other Charges,” and Note 24, “Other Items Impacting Comparability,” for items included in earnings during 2016 and 2015. RYDER SYSTEM, INC. AND SUBSIDIARES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS ______________ (1) Transferred from other accounts includes employee contributions made to the medical and dental self-insurance plans. (2) Deductions represent write-offs, lease termination payments, insurance claim payments during the period and net foreign currency translation adjustments. (3) Self-insurance accruals include vehicle liability, workers’ compensation, property damage, cargo and medical and dental, which comprise our self-insurance programs. Amounts charged to earnings include developments in prior year selected loss development factors which charged earnings by $9 million and $4 million in 2016 and 2015, respectively, and benefited earnings by $14 million in 2014. | Based on the provided financial statement excerpt, here's a summary of the key financial aspects:
Revenue Recognition:
- Revenue is recognized when:
* Persuasive evidence of arrangement exists
* Services are rendered or delivery occurs
* Pricing is fixed or determinable
* Collectibility is reasonably assured
- Sales tax is accounted for on a net basis
Assets:
- Current assets are mentioned but specific values are not provided
- Key asset categories include:
* Revenue earning equipment (vehicles)
* Operating property and equipment
* Inventories (fuel, tires, vehicle parts)
* Cash equivalents (short-term investments with ≤3 months maturity)
* Goodwill and intangible assets
Liabilities:
- Only mentioned in context of accounting estimates and receivables management
- Specific values are not provided
Key Accounting Policies:
- Uses weighted-average cost method for inventories
- Straight-line depreciation for depreciable assets
- Regular review of residual values and useful lives of equipment
- Goodwill is tested annually for impairment
- Strict credit monitoring system for customers
Note: This appears to be primarily a notes section of a financial statement explaining accounting policies rather than providing actual financial figures. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Documents Page Report of Management on Internal Control Over Financial Reporting Report of Independent Registered Public Accounting Firm Statements of Financial Condition as of December 31, 2016 and 2015 Schedule of Investments as of December 31, 2016 Schedule of Investments as of December 31, 2015 Statements of Income and Expenses for the Years Ended December 31, 2016, 2015 and 2014 Statement of Changes in Shareholders’ Equity for the Year Ended December 31, 2016 Statement of Changes in Shareholders’ Equity for the Year Ended December 31, 2015 Statement of Changes in Shareholders’ Equity for the Year Ended December 31, 2014 Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014 Notes to Financial Statements REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management of Invesco PowerShares Capital Management LLC, as managing owner (the “Managing Owner”) of PowerShares DB Base Metals Fund (the “Fund”), is responsible for establishing and maintaining adequate internal control over financial reporting, as defined under Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Fund; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the Fund’s receipts and expenditures are being made only in accordance with appropriate authorizations of management; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Fund’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements, errors or fraud. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We, Daniel Draper, Principal Executive Officer, and Steven Hill, Principal Financial and Accounting Officer, Investment Pools, of the Managing Owner, assessed the effectiveness of the Fund’s internal control over financial reporting as of December 31, 2016. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). The assessment included an evaluation of the design of the Fund’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Based on our assessment and those criteria, we have concluded that the Fund maintained effective internal control over financial reporting as of December 31, 2016. The Fund’s independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited the Fund’s internal control over financial reporting as of December 31, 2016, as stated in their report on page 39 of the Fund’s Annual Report on Form 10-K. February 27, 2017 Report of Independent Registered Public Accounting Firm To the Board of Managers of PowerShares DB Multi-Sector Commodity Trust and the Shareholders of PowerShares DB Base Metals Fund: In our opinion, the accompanying statements of financial condition, including the schedules of investments, and the related statements of income and expenses, of changes in shareholders’ equity and of cash flows, present fairly, in all material respects, the financial position of PowerShares DB Base Metals Fund (a series of PowerShares DB Multi-Sector Commodity Trust, hereafter referred to as the “Fund”), at December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Fund maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Fund's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Fund's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A fund’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A fund’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the fund; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the fund are being made only in accordance with authorizations of management of the fund; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the fund’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP Chicago, Illinois February 27, 2017 PowerShares DB Base Metals Fund Statements of Financial Condition December 31, 2016 and 2015 See accompanying Notes to Financial Statements which are an integral part of the financial statements. PowerShares DB Base Metals Fund Schedule of Investments December 31, 2016 (a) Security may be traded on a discount basis. The interest rate shown represents the discount rate at the most recent auction date of the security prior to period end. (b) United States Treasury Obligations of $31,990,400 are on deposit with the Commodity Broker and held as maintenance margin for open futures contracts. (c) The security and the Fund are advised by wholly-owned subsidiaries of Invesco Ltd. and are therefore considered to be affiliated. The rate shown is the 7-day SEC standardized yield as of December 31, 2016. (d) Unrealized appreciation/(depreciation) is presented above, net by contract. See accompanying Notes to Financial Statements which are an integral part of the financial statements. PowerShares DB Base Metals Fund Schedule of Investments December 31, 2015 (a) Security may be traded on a discount basis. The interest rate shown represents the discount rate at the most recent auction date of the security prior to year end. (b) United States Treasury Obligations of $59,989,500 are on deposit with the Commodity Broker and held as maintenance margin for open futures contracts. (c) Unrealized appreciation/(depreciation) is presented above, net by contract. See accompanying Notes to Financial Statements which are an integral part of the financial statements. PowerShares DB Base Metals Fund Statements of Income and Expenses For the Years Ended December 31, 2016, 2015 and 2014 a) Interest Expense for the years ended December 31, 2016 and 2015 represents interest expense on overdraft balances. These amounts are included in Interest Income for the year ended December 31, 2014. See accompanying Notes to Financial Statements which are an integral part of the financial statements. PowerShares DB Base Metals Fund Statement of Changes in Shareholders’ Equity For the Year Ended December 31, 2016 See accompanying Notes to Financial Statements which are an integral part of the financial statements. PowerShares DB Base Metals Fund Statement of Changes in Shareholders’ Equity For the Year Ended December 31, 2015 See accompanying Notes to Financial Statements which are an integral part of the financial statements. PowerShares DB Base Metals Fund Statement of Changes in Shareholders’ Equity For the Year Ended December 31, 2014 See accompanying Notes to Financial Statements which are an integral part of the financial statements. PowerShares DB Base Metals Fund Statements of Cash Flows For the Years Ended December 31, 2016, 2015 and 2014 a) Cash at December 31, 2014 and prior reflects cash held by Predecessor Commodity Broker. b) Cash at December 31, 2016 and 2015 reflects cash held by the Custodian. See accompanying Notes to Financial Statements which are an integral part of the financial statements. PowerShares DB Base Metals Fund Notes to Financial Statements December 31, 2016 (1) Background On October 24, 2014, DB Commodity Services LLC, a Delaware limited liability company (“DBCS”), DB U.S. Financial Markets Holding Corporation (“DBUSH”) and Invesco PowerShares Capital Management LLC (“Invesco”) entered into an Asset Purchase Agreement (the “Agreement”). DBCS is a wholly-owned subsidiary of DBUSH. DBCS agreed to transfer and sell to Invesco all of DBCS’ interest in the PowerShares DB Base Metals Fund (the “Fund”), a separate series of PowerShares DB Multi-Sector Commodity Trust (the “Trust”), a Delaware statutory trust organized in seven separate series, including the sole and exclusive power to direct the business and affairs of the Trust and the Fund, as well as certain other assets pertaining to the management of the Trust and the Fund, pursuant to the terms and conditions of the Agreement (the “Transaction”). The Transaction was consummated on February 23, 2015 (the “Closing Date”). Invesco now serves as the managing owner (the “Managing Owner”), commodity pool operator and commodity trading advisor of the Trust and the Fund, in replacement of DBCS (the “Predecessor Managing Owner”). (2) Organization The Fund is a separate series of the Trust. The Trust is a Delaware statutory trust organized in seven separate series and was formed on August 3, 2006. The Predecessor Managing Owner seeded the Fund with a capital contribution of $1,000 in exchange for 40 General Shares of the Fund. The General Shares were sold to the Managing Owner by the Predecessor Managing Owner pursuant to the terms of the Agreement. The fiscal year end of the Fund is December 31st. The term of the Fund is perpetual (unless terminated earlier in certain circumstances) as provided for in the Fifth Amended and Restated Declaration of Trust and Trust Agreement of the Trust, as amended (the “Trust Agreement”). The Fund has an unlimited number of shares authorized for issuance. The Fund offers common units of beneficial interest (the “Shares”) only to certain eligible financial institutions (the “Authorized Participants”) in one or more blocks of 200,000 Shares, called a Basket. The Fund commenced investment operations on January 3, 2007. The Fund commenced trading on the American Stock Exchange (which became the NYSE Alternext US LLC (the “NYSE Alternext”)) on January 5, 2007 and, as of November 25, 2008, is listed on the NYSE Arca, Inc. (the “NYSE Arca”). This Annual Report (the “Report”) covers the years ended December 31, 2016, 2015 and 2014 (herein referred to as the “Year Ended December 31, 2016”, the “Year Ended December 31, 2015” and the “Year Ended December 31, 2014”, respectively). The Fund’s performance information from inception up to and excluding the Closing Date is a reflection of the performance associated with the Predecessor Managing Owner. The Managing Owner has served as managing owner of the Fund since the Closing Date, and the Fund’s performance information since the Closing Date is a reflection of the performance associated with the Managing Owner. Past performance of the Fund is not necessarily indicative of future performance. (3) Fund Investment Overview The Fund seeks to track changes, whether positive or negative, in the level of the DBIQ Optimum Yield Industrial Metals Index Excess Return™ (the “Index”) over time, plus the excess, if any, of the sum of the Fund’s interest income from its holdings of United States Treasury Obligations (“Treasury Income”) and dividends from its holdings in money market mutual funds (affiliated or otherwise) (“Money Market Income”) over the expenses of the Fund. Additionally, the Fund may also gain an exposure to United States Treasury Obligations through an investment in exchange-traded funds (affiliated or otherwise) that track indexes that measure the performance of United States Treasury Obligations with a maximum remaining maturity of up to 12 months (“T-Bill ETFs”), and the Fund may receive dividends or distributions of capital gains from such investment in T-Bill ETFs (“T-Bill ETF Income”). For the avoidance of doubt, the Fund invests in futures contracts in an attempt to track its Index. The Fund holds United States Treasury Obligations, money market mutual funds and may, in the future, hold T-Bill ETFs for margin and/or cash management purposes only. The Index is intended to reflect the change in market value of the base metals sector. The commodities comprising the Index are aluminum, zinc and copper-Grade A (each an “Index Commodity”, and collectively, the “Index Commodities”). The Index Commodities are currently trading on the London Metals Exchange (the “LME”). Although the LME does not currently impose position limits on the Index Commodities, the LME may in the future impose position limits on market participants trading in certain commodities included in the Index. Further, in the event the Fund invests in alternative commodity futures contracts as described below, that trade on a U.S. exchange, the Commodity Futures Trading Commission (the “CFTC”) and/or commodity exchanges, as applicable, may impose position limits on market participants trading in the commodities included in the Index. The Index is comprised of futures contracts on the Index Commodities that expire in a specific month and trade on a specific exchange (the “Index Contracts”). If the Managing Owner determines in its commercially reasonable judgment that it has become impracticable or inefficient for any reason for the Fund to gain full or partial exposure to any Index Commodity by investing in the Index Contract, the Fund may invest in a futures contract referencing the particular Index Commodity other than the specific contract that comprises the applicable Index or, in the alternative, invest in other futures contracts not based on the particular Index Commodity if, in the commercially reasonable judgment of the Managing Owner, such commodities futures contracts tend to exhibit trading prices that correlate with a futures contract that comprises the applicable Index (4) Service Providers and Related Party Agreements The Trustee Under the Trust Agreement, Wilmington Trust Company, the trustee of the Trust and the Fund (the “Trustee”) has delegated to the Managing Owner the exclusive management and control of all aspects of the business of the Trust and the Fund. The Trustee will have no duty or liability to supervise or monitor the performance of the Managing Owner, nor will the Trustee have any liability for the acts or omissions of the Managing Owner. The Managing Owner The Managing Owner serves as the Fund’s commodity pool operator, commodity trading advisor and managing owner. The Fund pays the Managing Owner a management fee, monthly in arrears, in an amount equal to 0.75% per annum of the daily net asset value of the Fund (the “Management Fee”). From inception up to and excluding the Closing Date, all Management Fees were payable to the Predecessor Managing Owner. The Managing Owner has served as managing owner of the Fund since the Closing Date and all Management Fee accruals since the Closing Date have been paid to the Managing Owner. The Fund may, for cash management purposes, invest in money market mutual funds that are managed by affiliates of the Managing Owner. The indirect portion of the management fee that the Fund may incur through such investment is in addition to the Management Fee paid to the Managing Owner. The Managing Owner has contractually agreed to waive the fees that it receives in an amount equal to the indirect management fees that the Fund incurs through its investments in affiliated money market mutual funds through June 20, 2018. The Fund may invest in affiliated T-Bill ETFs. The Managing Owner expects to enter into a similar agreement with respect to any indirect management fees incurred by the Fund through such investment in affiliated T-Bill ETFs, if any. The Managing Owner waived fees of $8,810 for the Year Ended December 31, 2016. The Commodity Broker Effective as of the Closing Date, Morgan Stanley & Co. LLC, a Delaware limited liability company, serves as the Fund’s futures clearing broker (the “Commodity Broker”). Deutsche Bank Securities Inc. (“DBSI”), a Delaware corporation, served as the Fund’s futures clearing broker up to and excluding the Closing Date (the “Predecessor Commodity Broker”). DBSI is an indirect wholly-owned subsidiary of Deutsche Bank AG and is an affiliate of the Predecessor Managing Owner. A variety of executing brokers execute futures transactions on behalf of the Fund. Such executing brokers give-up all such transactions to the Commodity Broker. In its capacity as clearing broker, the Commodity Broker may execute or receive transactions executed by others and clears all of the Fund’s futures transactions and performs certain administrative and custodial services for the Fund. The Commodity Broker is responsible, among other things, for providing periodic accountings of all dealings and actions taken by the Trust on behalf of the Fund during the reporting period, together with an accounting of all securities, cash or other indebtedness or obligations held by it or its nominees for or on behalf of the Fund. For the avoidance of doubt, from inception up to and excluding the Closing Date, commission payments were paid to the Predecessor Commodity Broker. The Commodity Broker has served as the Fund’s futures clearing broker since the Closing Date and all commission accruals since the Closing Date have been paid to the Commodity Broker. The Administrator, Custodian and Transfer Agent The Bank of New York Mellon (the “Administrator” and “Custodian”) is the administrator, custodian and transfer agent of the Fund. The Fund and the Administrator have entered into separate administrative, custodian, transfer agency and service agreements (collectively referred to as the “Administration Agreement”). Pursuant to the Administration Agreement, the Administrator performs or supervises the performance of services necessary for the operation and administration of the Fund (other than making investment decisions), including receiving and processing orders from Authorized Participants to create and redeem Baskets, net asset value calculations, accounting and other fund administrative services. The Administrator maintains certain financial books and records, including: Basket creation and redemption books and records, fund accounting records, ledgers with respect to assets, liabilities, capital, income and expenses, the registrar, transfer journals and related details, and trading and related documents received from the Commodity Broker. The Managing Owner pays the Administrator fees for its services out of the Management Fee. As of December 31, 2014, the Fund held $27,364,752 of cash and $236,994,724 of United States Treasury Obligations at the Predecessor Commodity Broker. In conjunction with the Transaction, during the three-day period from February 24, 2015 to February 26, 2015, the Fund transferred $31,802,760 of cash and $155,996,427 of United States Treasury Obligations from the Predecessor Commodity Broker to the Custodian. Additionally, during that same three-day period, the Fund transferred all of its open positions of commodity futures contracts from the Predecessor Commodity Broker to the Commodity Broker and $51,994,800 of United States Treasury Obligations from the Custodian to the Commodity Broker to satisfy maintenance margin requirements. The Distributor Effective June 20, 2016, Invesco Distributors, Inc. (the “Distributor”) became distributor and began providing certain distribution services to the Fund. Pursuant to the Distribution Services Agreement among the Managing Owner, the Fund and the Distributor, the Distributor assists the Managing Owner and the Administrator with certain functions and duties relating to distribution and marketing services to the Fund including reviewing and approving marketing materials. Prior to June 20, 2016, ALPS Distributors, Inc. provided distribution services to the Fund. The Managing Owner pays the Distributor a distribution fee out of the Management Fee. Index Sponsor Effective as of the Closing Date, the Managing Owner, on behalf of the Fund, has appointed Deutsche Bank Securities Inc. to serve as the index sponsor (the “Index Sponsor”). Prior to the Closing Date, the index sponsor was Deutsche Bank AG London. The Index Sponsor calculates and publishes the daily index levels and the indicative intraday index levels. Additionally, the Index Sponsor also calculates the indicative value per Share of the Fund throughout each business day. The Managing Owner pays the Index Sponsor a licensing fee and an index services fee out of the Management Fee for performing its duties. Marketing Agent Effective as of the Closing Date, the Managing Owner, on behalf of the Fund, has appointed Deutsche Bank Securities Inc. as the marketing agent (the “Marketing Agent”) to assist the Managing Owner by providing support to educate institutional investors about the DBIQ indices and to complete governmental or institutional due diligence questionnaires or requests for proposals related to the DBIQ indices. The Managing Owner pays the Marketing Agent a marketing services fee out of the Management Fee. The Marketing Agent will not open or maintain customer accounts or handle orders for the Fund. The Marketing Agent has no responsibility for the performance of the Fund or the decisions made or actions taken by the Managing Owner. (5) Summary of Significant Accounting Policies (a) Basis of Presentation The financial statements of the Fund have been prepared using U.S. generally accepted accounting principles (“U.S. GAAP”). The Fund has determined that it meets the definition of an investment company and has prepared the financial statements in conformity with U.S. GAAP for investment companies in conformity with accounting and reporting guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 946-Investment Companies. (b) Use of Estimates The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosure of contingent assets and liabilities during the reporting period of the financial statements and accompanying notes. Actual results could differ from those estimates. (c) Financial Instruments and Fair Value Investment transactions are recorded in the Statements of Financial Condition on a trade date basis at fair value with changes in fair value recognized in earnings in each period. U.S. GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, under current market conditions. U.S. GAAP establishes a hierarchy that prioritizes the inputs to valuation methods, giving the highest priority to readily available unadjusted quoted prices in an active market for identical assets (Level 1) and the lowest priority to significant unobservable inputs (Level 3), generally when market prices are not readily available or are unreliable. Based on the valuation inputs, the securities or other investments are tiered into one of three levels. Changes in valuation methods or market conditions may result in transfers in or out of an investment’s assigned level: Level 1 - Prices are determined using quoted prices in an active market for identical assets. Level 2 - Prices are determined using other significant observable inputs. Observable inputs are inputs that other market participants may use in pricing a security. These may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk, yield curves, loss severities, default rates, discount rates, volatilities and others. Level 3 - Prices are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period), unobservable inputs may be used. Unobservable inputs reflect the Fund’s own assumptions about the factors market participants would use in determining fair value of the securities or instruments and would be based on the best available information. United States Treasury Obligations are fair valued using an evaluated quote provided by an independent pricing service. Evaluated quotes provided by the pricing service may be determined without exclusive reliance on quoted prices, and may reflect appropriate factors such as developments related to specific securities, yield, quality, type of issue, coupon rate, maturity, individual trading characteristics and other market data. All debt obligations involve some risk of default with respect to interest and/or principal payments. Futures contracts are valued at the final settlement price set by an exchange on which they are principally traded. Investments in open-end and closed-end registered investment companies that do not trade on an exchange are valued at the end of day NAV per share. Investments in open-end and closed-end registered investment companies that trade on an exchange are valued at the last sales price or official closing price as of the close of the customary trading session on the exchange where the security is principally traded. When market closing prices are not available, the Managing Owner may value an asset of the Fund pursuant to policies the Managing Owner has adopted, which are consistent with normal industry standards. The levels assigned to the securities valuations may not be an indication of the risk or liquidity associated with investing in those securities. Because of the inherent uncertainties of valuation, the values reflected in the financial statements may materially differ from the value received upon actual sale of those investments. The following is a summary of the tiered valuation input levels as of December 31, 2016: (a) Unrealized appreciation (depreciation). The following is a summary of the tiered valuation input levels as of 2015: (a) Unrealized appreciation (depreciation). (d) Deposits with Commodity Broker and Custodian The Fund deposits cash and United States Treasury Obligations with its Commodity Broker subject to CFTC regulations and various exchange and broker requirements. The combination of the Fund’s deposits with its Commodity Broker of cash and United States Treasury Obligations and the unrealized profit or loss on open commodity futures contracts represents the Fund’s overall equity in its broker trading account. To meet the Fund’s maintenance margin requirements, the Fund holds United States Treasury Obligations. The Fund transfers cash to the Commodity Broker to satisfy variation margin requirements. The Fund earns interest on any excess cash deposited with the Commodity Broker and incurs interest expense on any deficit balance with the Commodity Broker. The Fund’s remaining cash, United States Treasury Obligations and money market mutual fund holdings are on deposit with its Custodian. The Fund is permitted to temporarily carry a negative or overdrawn balance in its account with the Custodian. Such balances, if any at period-end, are shown on the Statement of Financial Condition under the payable caption Due to Custodian. The Fund defines cash and cash equivalents to be cash and other highly liquid investments, with original maturities of three months or less when purchased. (e) Investment Transactions and Investment Income Investment transactions are accounted for on a trade date basis. Realized gains (losses) from the sale or disposition of securities or derivatives are determined on a specific identification basis and recognized in the Statements of Income and Expenses in the period in which the contract is closed or the sale or disposition occurs, respectively. Interest income on United States Treasury Obligations is recognized on an accrual basis when earned. Premiums and discounts are amortized or accreted over the life of the United States Treasury Obligations. Dividend income (net of withholding tax, if any) is recorded on the ex-dividend date. (f) Receivable/(Payable) for Shares Issued and Redeemed On any business day, an Authorized Participant may place an order to create or redeem Shares of the Fund. Cash settlement occurs at the creation order settlement date or the redemption order settlement date as discussed in Note 7. (g) Cash Held by Commodity Broker The Fund’s arrangement with the Commodity Broker requires the Fund to meet its variation margin requirement related to the price movements on futures contracts held by the Fund by maintaining cash on deposit with the Commodity Broker. (h) Receivable/ (Payable) for LME Contracts The Fund trades aluminum, copper and zinc commodity futures contracts on the LME. For settlement of commodity futures contracts traded on the LME, cash is not transferred until the settled commodity futures contracts expire. As of December 31, 2016 the Fund had a payable to the Commodity Broker of $129,711, related to net realized losses on LME contracts, which have been closed out but for which the contract was not yet expired. As of December 31, 2015, the Fund had a payable to the Commodity Broker of $12,873,124, related to net realized losses on LME contracts, which have been closed out but for which the contract was not yet expired. (i) Income Taxes The Fund is classified as a partnership for U.S. federal income tax purposes. Accordingly, the Fund will generally not incur U.S. federal income taxes. No provision for federal, state, and local income taxes has been made in the accompanying financial statements, as investors are individually liable for income taxes, if any, on their allocable share of the Fund’s income, gain, loss, deductions and other items. The Managing Owner has reviewed all of the Fund’s open tax years and major jurisdictions and concluded that there is no tax liability resulting from unrecognized tax benefits relating to uncertain tax positions taken or expected to be taken in future tax returns. The Fund is also not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly change in the next twelve months. On an ongoing basis, the Managing Owner will monitor the Fund’s tax positions taken under the interpretation (and consult with its tax counsel from time to time when appropriate) to determine if adjustments to conclusions are necessary based on factors including, but not limited to, on-going analysis of tax law, regulation, and interpretations thereof. The major tax jurisdiction for the Fund and the earliest tax year subject to examination: United States, 2013. (j) Commodity Futures Contracts The Fund utilizes derivative instruments to achieve its investment objective. A futures contract is an agreement between counterparties to purchase or sell a specified underlying security or index for a specified price at a future date. All of the Fund’s commodity futures contracts are held and used for trading purposes. During the period the futures contracts are open, changes in the value of the contracts are recognized as unrealized gains or losses by recalculating the value of the contracts on a daily basis. For LME contracts, subsequent or variation margin payments are not made and the value of the contracts is presented as net unrealized appreciation (depreciation) on the Statements of Financial Condition. When LME contracts are closed or expire, the Fund recognizes a realized gain or loss equal to the difference between the proceeds from, or cost of, the closing transaction and the Fund’s basis in the contract. Realized gains (losses) and changes in unrealized appreciation (depreciation) on open positions are determined on a specific identification basis and recognized in the Statements of Income and Expenses in the period in which the contract is closed or the changes occur, respectively. The Fair Value of Derivative Instruments is as follows: (a) Values are disclosed on the December 31, 2016 and 2015 Statements of Financial Condition under Net unrealized appreciation (depreciation) on Commodity Futures Contracts. The Effect of Derivative Instruments on the Statements of Income and Expenses is as follows: The table below summarizes the average monthly notional value of commodity futures contracts outstanding during the period: The brokerage agreement with the Commodity Broker provides for the net settlement of all financial instruments covered by the agreement in the event of default or termination of any one contract. The Managing Owner will utilize any excess cash held at the Commodity Broker to offset any realized losses incurred in the commodity futures contracts, if available. To the extent that any excess cash held at the Commodity Broker is not adequate to cover any realized losses, a portion of the United States Treasury Obligations on deposit with the Commodity Broker and money market mutual funds will be sold to make additional cash available. For financial reporting purposes, the Fund offsets financial assets and financial liabilities that are subject to netting arrangements. In order for an arrangement to be eligible for netting, the Fund must have a basis to conclude that such netting arrangements are legally enforceable. The following table presents derivative instruments that are either subject to an enforceable netting agreement or offset by collateral arrangements as of December 31, 2016, net by contract: The following table presents derivative instruments that are either subject to an enforceable netting agreement or offset by collateral arrangements as of 2015, net by contract: (a) As of December 31, 2016 and 2015, a portion of the Fund’s U.S. Treasury Obligations were required to be deposited as maintenance margin in support of the Fund’s futures positions. (k) Brokerage Commissions and Fees The Fund incurs all brokerage commissions, including applicable exchange fees, National Futures Association (“NFA”) fees, give-up fees, pit brokerage fees and other transaction related fees and expenses charged in connection with trading activities by the Commodity Broker. These costs are recorded as Brokerage Commissions and Fees in the Statements of Income and Expenses. The Commodity Broker’s brokerage commissions and trading fees are determined on a contract-by-contract basis. On average, total charges paid to the Commodity Broker and the Predecessor Commodity Broker, as applicable, were less than $19.00, $19.00 and $10.00 per round-turn trade during the Years Ended December 31, 2016, 2015 and 2014, respectively. (l) Routine Operational, Administrative and Other Ordinary Expenses After the Closing Date, the Managing Owner assumed all routine operational, administrative and other ordinary expenses of the Fund, including, but not limited to, computer services, the fees and expenses of the Trustee, legal and accounting fees and expenses, tax preparation expenses, filing fees and printing, mailing and duplication costs. Prior to the Closing Date, the Predecessor Managing Owner assumed all routine operational, administrative and other ordinary expenses of the Fund. Accordingly, such expenses are not reflected in the Statements of Income and Expenses of the Fund. For the avoidance of doubt, the Fund does not reimburse the Managing Owner for the routine operational, administrative and other ordinary expenses of the Fund. (m) Non-Recurring Fees and Expenses The Fund pays all non-recurring and unusual fees and expenses (referred to as extraordinary fees and expenses in the Trust Agreement), if any, of itself, as determined by the Managing Owner. Non-recurring and unusual fees and expenses are fees and expenses which are non-recurring and unusual in nature, such as legal claims and liabilities, litigation costs or indemnification or other unanticipated expenses. Such non-recurring and unusual fees and expenses, by their nature, are unpredictable in terms of timing and amount. For the Years Ended December 31, 2016, 2015 and 2014, the Fund did not incur such expenses. (6) Financial Instrument Risk In the normal course of its business, the Fund is a party to financial instruments with off-balance sheet risk. The term “off-balance sheet risk” refers to an unrecorded potential liability that, even though it does not appear on the balance sheet, may result in a future obligation or loss in excess of the amounts shown on the Statements of Financial Condition. The financial instruments used by the Fund are commodity futures contracts, whose values are based upon an underlying asset and generally represent future commitments that have a reasonable possibility of being settled in cash or through physical delivery. The financial instruments are traded on an exchange and are standardized contracts. Market risk is the potential for changes in the value of the financial instruments traded by the Fund due to market changes, including fluctuations in commodity prices. In entering into these futures contracts, there exists a market risk that such futures contracts may be significantly influenced by adverse market conditions, resulting in such futures contracts being less valuable. If the markets should move against all of the futures contracts at the same time, the Fund could experience substantial losses. Credit risk is the possibility that a loss may occur due to the failure of the Commodity Broker and/or clearinghouse to perform according to the terms of a futures contract. Credit risk with respect to exchange-traded instruments is reduced to the extent that an exchange or clearing organization acts as a counterparty to the transactions. The Commodity Broker, when acting as the Fund’s futures commission merchant in accepting orders for the purchase or sale of domestic futures contracts, is required by CFTC regulations to separately account for and segregate as belonging to the Fund all assets of the Fund relating to domestic futures trading and the Commodity Broker is not allowed to commingle such assets with other assets of the Commodity Broker. In addition, CFTC regulations also require the Commodity Broker to hold in a secure account assets of the Fund related to foreign futures trading. The Fund’s risk of loss in the event of counterparty default is typically limited to the amounts recognized in the Statements of Financial Condition and not represented by the futures contract or notional amounts of the instruments. The Fund has not utilized, nor does it expect to utilize in the future, special purpose entities to facilitate off-balance sheet financing arrangements and has no loan guarantee arrangements or off-balance sheet arrangements of any kind, other than agreements entered into in the normal course of business noted above. (7) Share Purchases and Redemptions (a) Purchases On any business day, an Authorized Participant may place an order with the Administrator who serves as the Fund’s transfer agent (“Transfer Agent”) to create one or more Baskets. For purposes of processing both creation and redemption orders, a “business day” means any day other than a day when banks in New York City are required or permitted to be closed. Creation orders must be placed by 10:00 a.m., Eastern Time. The day on which the Transfer Agent receives a valid creation order is the creation order date. The day on which a creation order is settled is the creation order settlement date. As provided below, the creation order settlement date may occur up to three business days after the creation order date. By placing a creation order, and prior to delivery of such Baskets, an Authorized Participant’s DTC account is charged the non-refundable transaction fee due for the creation order. Unless otherwise agreed to by the Managing Owner and the Authorized Participant as provided in the next sentence, Baskets are issued on the creation order settlement date as of 2:45 p.m., Eastern Time, on the business day immediately following the creation order date at the applicable net asset value per Share as of the closing time of the NYSE Arca or the last to close of the exchanges on which its futures contracts are traded, whichever is later, on the creation order date, but only if the required payment has been timely received. Upon submission of a creation order, the Authorized Participant may request the Managing Owner to agree to a creation order settlement date up to three business days after the creation order date. Creation orders may be placed either (i) through the Continuous Net Settlement (“CNS”) clearing processes of the National Securities Clearing Corporation (the “NSCC”) (the “CNS Clearing Process”) or (ii) if outside the CNS Clearing Process, only through the facilities of The Depository Trust Company (“DTC” or the “Depository”) (the “DTC Process”), or a successor depository. (b) Redemptions On any business day, an Authorized Participant may place an order with the Transfer Agent to redeem one or more Baskets. Redemption orders must be placed by 10:00 a.m., Eastern Time. The day on which the Managing Owner receives a valid redemption order is the redemption order date. The day on which a redemption order is settled is the redemption order settlement date. As provided below, the redemption order settlement date may occur up to three business days after the redemption order date. The redemption procedures allow Authorized Participants to redeem Baskets. Individual Shareholders may not redeem directly from the Fund. Instead, individual Shareholders may only redeem Shares in integral multiples of 200,000 and only through an Authorized Participant. Unless otherwise agreed to by the Managing Owner and the Authorized Participant as provided in the next sentence, by placing a redemption order, an Authorized Participant agrees to deliver the Baskets to be redeemed through DTC’s book-entry system to the Fund not later than the redemption order settlement date as of 2:45 p.m., Eastern Time, on the business day immediately following the redemption order date. Upon submission of a redemption order, the Authorized Participant may request the Managing Owner to agree to a redemption order settlement date up to three business days after the redemption order date. By placing a redemption order, and prior to receipt of the redemption proceeds, an Authorized Participant’s DTC account is charged the non-refundable transaction fee due for the redemption order. Redemption orders may be placed either (i) through the CNS Clearing Process or (ii) if outside the CNS Clearing Process, only through the DTC Process, or a successor depository, and only in exchange for cash. The redemption proceeds from the Fund consist of the cash redemption amount. The cash redemption amount is equal to the net asset value of the number of Basket(s) requested in the Authorized Participant’s redemption order as of the closing time of the NYSE Arca or the last to close of the exchanges on which the Fund’s futures contracts are traded, whichever is later, on the redemption order date. The Managing Owner will distribute the cash redemption amount at the redemption order settlement date as of 2:45 p.m., Eastern Time, on the redemption order settlement date through DTC to the account of the Authorized Participant as recorded on DTC’s book-entry system. The redemption proceeds due from the Fund are delivered to the Authorized Participant at 2:45 p.m., Eastern Time, on the redemption order settlement date if, by such time, the Fund’s DTC account has been credited with the Baskets to be redeemed. If the Fund’s DTC account has not been credited with all of the Baskets to be redeemed by such time, the redemption distribution is delivered to the extent of whole Baskets received. Any remainder of the redemption distribution is delivered on the next business day to the extent of remaining whole Baskets received if the Transfer Agent receives the fee applicable to the extension of the redemption distribution date which the Managing Owner may, from time-to-time, determine and the remaining Baskets to be redeemed are credited to the Fund’s DTC account by 2:45 p.m., Eastern Time, on such next business day. Any further outstanding amount of the redemption order will be cancelled. The Managing Owner is also authorized to deliver the redemption distribution notwithstanding that the Baskets to be redeemed are not credited to the Fund’s DTC account by 2:45 p.m., Eastern Time, on the redemption order settlement date if the Authorized Participant has collateralized its obligation to deliver the Baskets through DTC’s book-entry system on such terms as the Managing Owner may determine from time-to-time. (8) Profit and Loss Allocations and Distributions Pursuant to the Trust Agreement, income and expenses are allocated pro rata to the Managing Owner as holder of the General Shares and to the Shareholders monthly based on their respective percentage interests as of the close of the last trading day of the preceding month. Distributions (other than redemption of units) may be made at the sole discretion of the Managing Owner on a pro rata basis in accordance with the respective capital balances of the shareholders. No distributions were paid for the Years Ended December 31, 2016, 2015 and 2014. (9) Commitments and Contingencies The Managing Owner, either in its own capacity or in its capacity as the Managing Owner and on behalf of the Fund, has entered into various service agreements that contain a variety of representations, or provide indemnification provisions related to certain risks service providers undertake in performing services which are in the best interests of the Fund. As of December 31, 2016 and 2015, no claims had been received by the Fund. Further, the Fund has not had prior claims or losses pursuant to these contracts. Accordingly, the Managing Owner expects the risk of loss to be remote. (10) Net Asset Value and Financial Highlights The Fund is presenting the following net asset value and financial highlights related to investment performance for a Share outstanding for the Years Ended December 31, 2016, 2015 and 2014. An individual investor’s return and ratios may vary based on the timing of capital transactions. Net asset value per Share is the net asset value of the Fund divided by the number of outstanding Shares at the date of each respective period presented. (a) Based on average shares outstanding. (b) The mean between the last bid and ask prices. (c) Effective as of the Closing Date, the Fund changed the source of market value per share prices, resulting in a difference in the ending market value per share presented for the year ended December 31, 2014 and the beginning market value per share for the year ended December 31, 2015. (d) Total Return, at net asset value is calculated assuming an initial investment made at the net asset value at the beginning of the period, reinvestment of all dividends and distributions at net asset value during the period, and redemption of Shares on the last day of the period. Total Return, at net asset value includes adjustments in accordance with accounting principles generally accepted in the United States of America and as such, the net asset value for financial reporting purposes and the returns based upon those net asset values may differ from the net asset value and returns for shareholder transactions. Total Return, at market value is calculated assuming an initial investment made at the market value at the beginning of the period, reinvestment of all dividends and distributions at market value during the period, and redemption of Shares at the market value on the last day of the period. Not annualized for periods less than one year, if applicable. | Based on the provided text, here's a summary of the financial statement:
Key Points:
1. Administrator and Custodian: The Bank of New York Mellon serves as the Fund's administrator, custodian, and transfer agent.
2. Administrative Services:
- Processes orders for creating and redeeming Baskets
- Calculates net asset value
- Maintains financial books and records
- Tracks assets, liabilities, capital, income, and expenses
- Manages transfer journals and trading documents
3. Fee Structure:
- The Managing Owner pays the Administrator's fees from the Management Fee
- Commission payments were initially made to the Predecessor Commodity Broker
- The Commodity Broker has served as the Fund's futures clearing broker since the Closing Date
4. Documentation:
- Separate administrative, custodian, transfer agency, and service agreements are in place
- Maintains detailed records of financial | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders of The Container Store Group, Inc. We have audited the accompanying consolidated balance sheets of The Container Store Group, Inc. (the Company) as of February 27, 2016 and February 28, 2015 and the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended February 27, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Container Store Group, Inc. at February 27, 2016 and February 28, 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended February 27, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of classifying deferred tax assets and liabilities effective February 27, 2016. /s/ Ernst and Young LLP Dallas, Texas May 10, 2016 The Container Store Group, Inc. Consolidated balance sheets See accompanying notes. The Container Store Group, Inc. Consolidated balance sheets (Continued) See accompanying notes. The Container Store Group, Inc. Consolidated statements of operations See accompanying notes. The Container Store Group, Inc. Consolidated statements of comprehensive income See accompanying notes. The Container Store Group, Inc. Consolidated statements of shareholders' equity See accompanying notes. The Container Store Group, Inc. Consolidated statements of cash flows See accompanying notes. The Container Store Group, Inc. Notes to consolidated financial statements (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies Description of business The Container Store, Inc. was founded in 1978 in Dallas, Texas, as a retailer with a mission to provide customers with storage and organization solutions through an assortment of innovative products and unparalleled customer service. In 2007, The Container Store, Inc. was sold to The Container Store Group, Inc. (the "Company"), a holding company, of which a majority stake was purchased by Leonard Green and Partners, L.P. ("LGP"), with the remainder held by certain employees of The Container Store, Inc. On November 6, 2013, the Company completed the initial public offering of its common stock (the "IPO"). As the majority shareholder, LGP retains controlling interest in the Company. The Container Store, Inc. consists of our retail stores, website and call center, as well as our installation and organizational services business. As of February 27, 2016, The Container Store, Inc. operated 79 stores with an average size of approximately 25,000 square feet (19,000 selling square feet) in 28 states and the District of Columbia. The Container Store, Inc. also offers all of its products directly to its customers through its website and call center. The Container Store, Inc.'s wholly owned Swedish subsidiary, Elfa International AB ("Elfa"), designs and manufactures component-based shelving and drawer systems that are customizable for any area of the home. elfa® branded products are sold exclusively in the United States in The Container Store® retail stores, website, and call center and Elfa sells to various retailers and distributors primarily in the Nordic region and throughout Europe on a wholesale basis. Basis of presentation The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP). Basis of consolidation The consolidated financial statements include our accounts and those of the Company's wholly owned subsidiaries. The Company eliminates all significant intercompany balances and transactions, including intercompany profits, in consolidation. Fiscal year The Company follows a 5-4-4 fiscal calendar, whereby each fiscal quarter consists of thirteen weeks grouped into one five-week "month" and two four-week "months," and its fiscal year ends on the Saturday closest to February 28th. Elfa's fiscal year ends on the last day of the calendar month of February. Refer to Note 17 for a subsequent event affecting our fiscal year end. The fiscal years ended February 27, 2016 (fiscal 2015), February 28, 2015 (fiscal 2014), and March 1, 2014 (fiscal 2013) included 52 weeks. Management estimates The preparation of the Company's consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates. Significant accounting judgments and estimates include fair value estimates for indefinite-lived intangible assets, inventory loss reserve, assessments of long-lived asset impairments, gift card breakage, and assessment of valuation allowances on deferred tax assets. Revenue recognition Revenue from sales related to retail operations is recognized when the merchandise is delivered to the customer at the point of sale. Revenue from sales that are shipped or delivered directly to customers is recognized upon estimated delivery to the customer and includes applicable shipping or delivery revenue. Revenue from sales that are installed is recognized upon completion of the installation service to the customer and includes applicable installation revenue. Revenue from sales of other services is recognized upon the completion of the service. Revenue from sales related to manufacturing operations is recorded upon shipment. Sales are recorded net of sales taxes collected from customers. A sales return allowance is recorded for estimated returns of merchandise subsequent to the balance sheet date that relate to sales prior to the balance sheet date. The returns allowance is based on historical return patterns and reduces sales and cost of sales, accordingly. Merchandise exchanges of similar product and price are not considered merchandise returns and, therefore, are excluded when calculating the sales returns allowance. Gift cards and merchandise credits Gift cards are sold to customers in retail stores, through the call center and website, and through certain third parties. We issue merchandise credits in our stores and through our call center. Revenue from sales of gift cards and issuances of merchandise credits is recognized when the gift card is redeemed by the customer, or the likelihood of the gift card being redeemed by the customer is remote (gift card breakage). The gift card breakage rate is determined based upon historical redemption patterns. An estimate of the rate of gift card breakage is applied over the period of estimated performance (48 months as of the end of fiscal 2015) and the breakage amounts are included in net sales in the consolidated statement of operations. The Company recorded $948, $978, and $896 of gift card breakage in fiscal years 2015, 2014, and 2013, respectively. Cost of sales Cost of sales related to retail operations includes the purchase cost of inventory sold (net of vendor rebates), in-bound freight, as well as inventory loss reserves. Costs incurred to ship or deliver merchandise to customers, as well as direct installation costs, are also included in cost of sales. Cost of sales from manufacturing operations includes costs associated with production, including materials, wages, other variable production costs, and other applicable manufacturing overhead. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) Leases Rent expense on operating leases, including rent holidays and scheduled rent increases, is recorded on a straight-line basis over the term of the lease, commencing on the date the Company takes possession of the leased property. Rent expense is recorded in selling, general, and administrative expenses. Pre-opening rent expense is recorded in pre-opening costs in the consolidated income statement. The net excess of rent expense over the actual cash paid has been recorded as deferred rent in the accompanying consolidated balance sheets. Tenant improvement allowances are also included in the accompanying consolidated balance sheets as deferred rent liabilities and are amortized as a reduction of rent expense over the term of the lease from the possession date. Contingent rental payments, typically based on a percentage of sales, are recognized in rent expense when payment of the contingent rent is probable. Advertising All advertising costs of the Company are expensed when incurred, or upon the release of the initial advertisement, except for production costs related to catalogs and direct mailings to customers, which are initially capitalized. Production costs related to catalogs and direct mailings consist primarily of printing and postage and are expensed when mailed to the customer, except for direct mailings related to promotional campaigns, which are expensed over the period during which the promotional sales are expected to occur. Advertising costs are recorded in selling, general, and administrative expenses. Pre-opening advertising costs are recorded in pre-opening costs. Catalog and direct mailings costs capitalized at February 27, 2016 and February 28, 2015, amounted to $938 and $699 respectively, and are recorded in prepaid expenses on the accompanying consolidated balance sheets. Total advertising expense incurred for fiscal years 2015, 2014, and 2013, was $32,343, $35,388, and $33,786, respectively. Pre-opening costs Non-capital expenditures associated with opening new stores, including rent, marketing expenses, travel and relocation costs, and training costs, are expensed as incurred and are included in pre-opening costs in the consolidated statement of operations. Management fee In connection with the completion of the Company's IPO, the management fee was eliminated as of November 6, 2013. The Company paid $667 as a management fee to its majority shareholder, LGP, in fiscal year 2013. Income taxes We account for deferred income taxes utilizing Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 740, Income Taxes. ASC 740 requires an asset and liability approach, which requires the recognition of deferred tax liabilities and assets for the expected future The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. We recognize interest and penalties related to unrecognized tax benefits in income tax expense. There were no uncertain tax positions requiring accrual as of February 27, 2016 and February 28, 2015. Valuation allowances are established against deferred tax assets when it is more-likely-than-not that the realization of those deferred tax assets will not occur. Valuation allowances are released as positive evidence of future taxable income sufficient to realize the underlying deferred tax assets becomes available. Deferred tax assets and liabilities are measured using the enacted tax rates in effect in the years when those temporary differences are expected to reverse. The effect on deferred taxes from a change in the tax rate is recognized through continuing operations in the period that includes the enactment of the change. Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future. We operate in certain jurisdictions outside the United States. ASC 740-30 provides that the undistributed earnings of a foreign subsidiary be accounted for as a temporary difference under the presumption that all undistributed earnings will be distributed to the parent company as a dividend. Sufficient evidence of the intent to permanently reinvest the earnings in the jurisdiction where earned precludes a company from recording the temporary difference. For purposes of ASC 740-30, we are partially reinvested in our Swedish subsidiary Elfa and thus do not record a temporary difference. We are partially reinvested since we have permanently reinvested our past earnings at Elfa; however, we do not assert that all future earnings will be reinvested into Elfa. Stock-based compensation The Company accounts for stock-based compensation in accordance ASC 718, Compensation-Stock Compensation, which requires the fair value of stock-based payments to be recognized in the consolidated financial statements as compensation expense over the requisite service period. Compensation expense based upon the fair value of awards is recognized on a straight line basis, net of forfeitures, over the requisite service period for awards that actually vest. Stock-based compensation expense is recorded in the stock-based compensation line in the consolidated statements of operations. Prior to the IPO, because the Company was privately held and there was no public market for the common stock, the fair market value of the Company's common stock was determined by the Board at the time the option grants were awarded. In determining the fair value of the Company's common stock, the Board considered such factors as the Company's actual and projected financial results, valuations of the Company performed by third parties and other factors it believed were material to the valuation process. Following the IPO, the Board determines the exercise price of stock options based on the closing price of the Company's common stock as reported on The New York Stock Exchange on the grant date. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) The Company estimates the fair value of each stock option grant on the date of grant based upon the Black-Scholes option-pricing model. This model requires various significant judgmental assumptions in order to derive a final fair value determination for each type of award including: • Expected Term-The expected term of the options represents the period of time between the grant date of the options and the date the options are either exercised or canceled, including an estimate of options still outstanding. • Expected Volatility-The expected volatility incorporates historical and implied volatility of comparable public companies for a period approximating the expected term. • Expected Dividend Yield-The expected dividend yield is based on the Company's expectation of not paying dividends on its common stock for the foreseeable future. • Risk-Free Interest Rate-The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant and with a maturity that approximates the expected term. Accounts receivable Accounts receivable consist primarily of trade receivables, receivables from The Container Store, Inc.'s credit card processors for sales transactions, and tenant improvement allowances from The Container Store, Inc.'s landlords in connection with new leases. An allowance for doubtful accounts is established on trade receivables, if necessary, for estimated losses resulting from the inability of customers to make required payments. Factors such as payment terms, historical loss experience, and economic conditions are generally considered in determining the allowance for doubtful accounts. Accounts receivable are presented net of allowances for doubtful accounts of $128 and $230 at February 27, 2016 and February 28, 2015, respectively. Inventories Inventories at retail stores are comprised of finished goods and are valued at the lower of cost or market, with cost determined on a weighted-average cost method including associated freight costs, and market determined based on the estimated net realizable value. Manufacturing inventories are comprised of raw materials, work in process, and finished goods and are valued on a first-in, first out basis using full absorption accounting which includes material, labor, other variable costs, and other applicable manufacturing overhead. To determine if the value of inventory is recoverable at cost, we consider current and anticipated demand, customer preference and the merchandise age. The significant estimates used in inventory valuation are obsolescence (including excess and slow-moving inventory) and estimates of inventory shrinkage. We adjust our inventory for obsolescence based on historical trends, aging reports, specific identification and our estimates of future retail sales prices. Reserves for shrinkage are estimated and recorded throughout the period as a percentage of cost of sales based on historical shrinkage results and current inventory levels. Actual shrinkage is recorded throughout the year based upon periodic cycle counts. Actual inventory shrinkage can vary from estimates due to factors including the mix of our inventory and execution against loss prevention initiatives in our stores and distribution center. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) Property and equipment Property and equipment are recorded at cost less accumulated depreciation. Significant additions and improvements are capitalized, and expenditures for maintenance and repairs are expensed. Gains and losses on the disposition of property and equipment are recognized in the period incurred. Depreciation, including amortization of assets recorded under capital lease obligations, is provided using the straight-line method over the estimated useful lives of depreciable assets as follows: Costs of developing or obtaining software for internal use or developing the Company's website, such as external direct costs of materials or services and internal payroll costs directly related to the software development projects are capitalized. For the fiscal years ended February 27, 2016, February 28, 2015, and March 1, 2014, the Company capitalized $3,272, $5,017, and $3,104, respectively, and amortized $3,258, $2,992, and $2,761, respectively, of costs in connection with the development of internally used software. Long-lived assets Long-lived assets, such as property and equipment and intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Conditions that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate that could affect the value of an asset, a product recall or an adverse action or assessment by a regulator. If the sum of the estimated undiscounted future cash flows related to the asset is less than the carrying value, we recognize a loss equal to the difference between the carrying value and the fair value, usually determined by the estimated discounted cash flow analysis of the asset. For our TCS segment, we generally evaluate long-lived tangible assets at a store level, or at the lowest level at which independent cash flows can be identified. We evaluate corporate assets or other long-lived assets that are not store-specific at the consolidated level. For our Elfa segment, we evaluate long-lived tangible assets at an individual subsidiary level. Since there is typically no active market for our long-lived tangible assets, we estimate fair values based on the expected future cash flows. We estimate future cash flows based on store-level historical results, current trends, and operating and cash flow projections. Our estimates are subject to uncertainty and may be affected by a number of factors outside our control, including general economic conditions and the competitive environment. While we believe our estimates and judgments about future cash flows are reasonable, future impairment charges may be required if the expected cash flow estimates, as projected, do not occur or if events change requiring us to revise our estimates. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) Foreign currency forward contracts We account for foreign currency forward contracts in accordance with ASC 815, Derivatives and Hedging. In the TCS segment, we may utilize foreign currency forward contracts in Swedish krona to stabilize our retail gross margins and to protect our domestic operations from downward currency exposure by hedging purchases of inventory from our wholly owned subsidiary, Elfa. In the Elfa segment, we may utilize foreign currency forward contracts to hedge purchases of raw materials that are transacted in currencies other than Swedish krona, which is the functional currency of Elfa. Generally, the Company's foreign currency forward contracts have terms from 1 to 12 months and require the Company to exchange currencies at agreed-upon rates at settlement. The Company does not hold or enter into financial instruments for trading or speculative purposes. The Company records all foreign currency forward contracts on its consolidated balance sheet at fair value. The Company records its foreign currency forward contracts on a gross basis. Forward contracts not designated as hedges are adjusted to fair value through income as selling, general and administrative expenses. The Company accounts for its foreign currency hedge instruments as cash flow hedges, as defined. Changes in the fair value of the foreign currency hedge instruments that are considered to be effective, as defined, are recorded in other comprehensive income (loss) until the hedged item (inventory) is sold to the customer, at which time the deferred gain or loss is recognized through cost of sales. Any portion of a change in the foreign currency hedge instrument's fair value that is considered to be ineffective, as defined, or that the Company has elected to exclude from its measurement of effectiveness, is immediately recorded in earnings as cost of sales. Self-insured liabilities We are primarily self-insured for workers' compensation, employee health benefits and general liability claims. We record self-insurance liabilities based on claims filed, including the development of those claims, and an estimate of claims incurred but not yet reported. Factors affecting these estimates include future inflation rates, changes in severity, benefit level changes, medical costs and claim settlement patterns. Should a different amount of claims occur compared to what was estimated, or costs of the claims increase or decrease beyond what was anticipated, reserves may need to be adjusted accordingly. We determine our workers' compensation liability and general liability claims reserves based on an analysis of historical claims data. Self-insurance reserves for employee health benefits, workers' compensation and general liability claims are recorded in the accrued liabilities line item of the consolidated balance sheet and were $3,471 and $2,522 as of February 27, 2016 and February 28, 2015, respectively. Goodwill We evaluate goodwill annually to determine whether it is impaired. Goodwill is also tested between annual impairment tests if an event occurs or circumstances change that would indicate that the fair value of a reporting unit is less than its carrying amount. Conditions that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate that could affect the value of an asset. If an impairment indicator exists, we test goodwill for The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) recoverability. We have identified two reporting units and we have selected the fourth fiscal quarter to perform our annual goodwill impairment testing. Prior to testing goodwill for impairment, we perform a qualitative assessment to determine whether it is more likely than not that goodwill is impaired for each reporting unit. If the results of the qualitative assessment indicate that the likelihood of impairment is greater than 50%, then we perform a two-step impairment test on goodwill. In the first step, we compare the fair value of the reporting unit to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is considered not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit's goodwill. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then we would record an impairment loss equal to the difference. The fair value of each reporting unit is determined by using a discounted cash flow analysis using the income approach. We also use a market approach to compare the estimated fair value to comparable companies. The determination of fair value requires assumptions and estimates of many critical factors, including among others, our nature and our history, financial and economic conditions affecting us, our industry and the general economy, past results, our current operations and future prospects, sales of similar businesses or capital stock of publicly held similar businesses, as well as prices, terms and conditions affecting past sales of similar businesses. Forecasts of future operations are based, in part, on operating results and management's expectations as to future market conditions. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgments to estimate industry economic factors and the profitability of future business strategies. If actual results are not consistent with our estimates and assumptions, we may be exposed to future impairment losses that could be material. Trade names We annually evaluate whether the trade names continue to have an indefinite life. Trade names are reviewed for impairment annually in the fourth quarter and may be reviewed more frequently if indicators of impairment are present. Conditions that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate that could affect the value of an asset, a product recall or an adverse action or assessment by a regulator. The impairment review is performed by comparing the carrying value to the estimated fair value, determined using a discounted cash flow methodology. If the recorded carrying value of the trade name exceeds its estimated fair value, an impairment charge is recorded to write the trade name down to its estimated fair value. Factors used in the valuation of intangible assets with indefinite lives include, but are not limited to, future revenue growth assumptions, estimated market royalty rates that could be derived from the licensing of our trade names to third parties, and a rate used to discount the estimated royalty cash flow projections. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) The valuation of trade names requires assumptions and estimates of many critical factors, which are consistent with the factors discussed under "Goodwill" above. Forecasts of future operations are based, in part, on operating results and management's expectations as to future market conditions. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgments to estimate industry economic factors and the profitability of future business strategies. If actual results are not consistent with our estimates and assumptions, we may be exposed to future impairment losses that could be material. Foreign currency translation The Company operates foreign subsidiaries in the following countries: Sweden, Norway, Finland, Denmark, Germany, Poland, and France. The functional currency of the Company's foreign operations is the applicable country's currency. All assets and liabilities of foreign subsidiaries and affiliates are translated at year-end rates of exchange. Revenues and expenses of foreign subsidiaries and affiliates are translated at average rates of exchange for the year. Unrealized gains and losses on translation are reported as cumulative translation adjustments through other comprehensive income (loss). The functional currency for the Company's wholly owned subsidiary, Elfa, is the Swedish krona. During fiscal 2015, the rate of exchange from U.S. dollar to Swedish krona increased from 8.4 to 8.6. The carrying amount of assets related to Elfa and subject to currency fluctuation was $109,548 and $113,050 as of February 27, 2016 and February 28, 2015, respectively. Foreign currency realized losses of $241, realized gains of $171, and realized gains of $224 are included in selling, general, and administrative expenses in the consolidated statements of operations in fiscal 2015, fiscal 2014, and fiscal 2013, respectively. Recent accounting pronouncements In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which outlines new provisions intended to simplify various aspects related to accounting for share-based payments, including the income tax consequences and classification on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within those years, with early adoption permitted. The Company is evaluating the impact of implementation of this standard on its financial statements. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), to revise lease accounting guidance. The update requires most leases to be recorded on the balance sheet as a lease liability, with a corresponding right-of-use asset, whereas these leases currently have an off-balance sheet classification. ASU 2016-02 must be applied on a modified retrospective basis and is effective for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. The Company is still evaluating the impact of implementation of this standard on its financial statements. In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, to simplify the presentation of deferred income taxes. The update The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) requires an entity to classify deferred tax liabilities and assets as noncurrent within a classified balance sheet. ASU 2015-17 is effective for fiscal years beginning after December 15, 2016, and interim periods within those years, with early adoption permitted. This update may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company elected to early adopt this guidance on a prospective basis at the end of its fourth quarter of fiscal year 2015, and presented both deferred tax assets and liabilities as noncurrent in the Consolidated Balance Sheet as of February 27, 2016. In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, which changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value. ASU 2015-11 defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new guidance must be applied on a prospective basis and is effective for fiscal years beginning after December 15, 2016, and interim periods within those years, with early adoption permitted. The Company does not believe the implementation of this standard will result in a material impact to its financial statements. In April 2015, the FASB issued ASU 2015-05, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement. The amendments in ASU 2015-05 provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments in ASU 2015-05 are effective for fiscal years beginning after December 15, 2015, and interim periods within those years, with early adoption permitted. The guidance may be applied either prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. The Company does not believe the implementation of this standard will result in a material impact to its financial statements. In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs. The update requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset. Debt disclosures will include the face amount of the debt liability and the effective interest rate. The update requires retrospective application and represents a change in accounting principle. ASU 2015-03 is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. In addition, in August 2015, ASU 2015-15, Interest-Imputation of Interest, was released which added SEC paragraphs pursuant to the SEC Staff Announcement at the June 18, 2015 Emerging Issues Task Force (EITF) meeting about the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements. Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, ASU 2015-15 states the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 1. Nature of business and summary of significant accounting policies (Continued) any outstanding borrowings on the line-of-credit arrangement. The impact of ASU 2015-03 and ASU 2015-15 on our consolidated financial statements will include a reclassification of net deferred financing costs related to our Senior Secured Term Loan Facility to be presented in the balance sheet as a direct deduction from the carrying amount of the Senior Secured Term Loan Facility, while net deferred financing costs related to our Revolving Credit Facility will remain an asset. As of February 27, 2016, the Company had $5,649 of net deferred financing costs related to our Senior Secured Term Loan Facility. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, an updated standard on revenue recognition. ASU 2014-09 provides enhancements to the quality and consistency of how revenue is reported while also improving comparability in the financial statements of companies reporting using IFRS and GAAP. The core principle of the new standard is for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration (that is, payment) to which the company expects to be entitled in exchange for those goods or services. The new standard also will result in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively (for example, service revenue and contract modifications) and improve guidance for multiple-element arrangements. In July 2015, the FASB deferred the effective date of ASU 2014-09. Accordingly, this standard is effective for reporting periods beginning after December 15, 2017, including interim periods within that fiscal year, with early adoption permitted for interim and annual periods beginning after December 15, 2016. The Company is still evaluating the impact of implementation of this standard on its financial statements. 2. Goodwill and trade names The estimated goodwill and trade name fair values are computed using estimates as of the measurement date, which is defined as the fiscal month-end of December. The Company makes estimates and assumptions about sales, gross margins, profit margins, and discount rates based on budgets and forecasts, business plans, economic projections, anticipated future cash flows, and marketplace data. Assumptions are also made for varying perpetual growth rates for periods beyond the long-term business plan period. There are inherent uncertainties related to these factors and management's judgment in applying these factors. Another estimate using different, but still reasonable, assumptions could produce different results. As there are numerous assumptions and estimations utilized to derive the estimated enterprise fair value of each reporting unit, it is possible that actual results may differ from estimated results requiring future impairment charges. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 2. Goodwill and trade names (Continued) The Company recorded no impairments during fiscal 2015, fiscal 2014, and fiscal 2013 as a result of the goodwill and trade names impairment tests performed. The changes in the carrying amount of goodwill and trade names were as follows in fiscal 2015 and fiscal 2014: The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 3. Detail of certain balance sheet accounts The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 4. Long-term debt and revolving lines of credit Long-term debt and revolving lines of credit consist of the following: Scheduled total revolving lines of credit and debt maturities for the fiscal years subsequent to February 27, 2016, are as follows: Senior Secured Term Loan Facility On April 6, 2012, The Container Store Group, Inc., The Container Store, Inc. and certain of its domestic subsidiaries entered into a $275,000 Senior Secured Term Loan Facility (the "Senior Secured Term Loan Facility") with JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent, and the lenders party thereto. In addition, a new $75,000 asset-based revolving credit facility (the "Revolving Credit Facility") was entered into replacing the previously existing $75,000 asset-based revolving credit facility (these transactions are referred to collectively as the "Refinancing Transaction"). The Senior Secured Term Loan Facility replaced the previously existing $125,000 secured term loan and $150,000 of senior subordinated notes. The Company recorded expenses of $7,333 in fiscal 2012 associated with the Refinancing Transaction. This amount consisted of $1,655 related to an early extinguishment fee on the senior subordinated notes and $4,843 of deferred financing costs where accelerated amortization was required. The Company also recorded legal fees and other associated costs of $835. Borrowings under the Senior Secured Loan Facility accrued interest at LIBOR + 5.00%, subject to a LIBOR floor of 1.25% and the maturity date was April 6, 2019. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 4. Long-term debt and revolving lines of credit (Continued) On April 8, 2013, The Container Store Group, Inc., The Container Store, Inc. and certain of its domestic subsidiaries entered into Amendment No. 1 to the Senior Secured Term Loan Facility, pursuant to which the borrowings under the Senior Secured Term Loan Facility were increased to $362,250 and the interest rate on such borrowings was decreased to a rate of LIBOR + 4.25%, subject to a LIBOR floor of 1.25% (the "Increase and Repricing Transaction"). The maturity date remained as April 6, 2019. Additionally, pursuant to the Increase and Repricing Transaction (i) the senior secured leverage ratio covenant was eliminated and (ii) we were required to make quarterly principal repayments of $906 through December 31, 2018, with a balloon payment for the remaining balance due on April 6, 2019. The additional $90,000 of borrowings was used to finance a distribution to holders of our Senior Preferred Stock in the amount of $90,000, which was paid on April 9, 2013. You may refer to Note 8 of these financial statements for a discussion of the $90,000 distribution payment to senior preferred shareholders that was funded by the increased borrowings. The Company recorded expenses of $1,101 during the first quarter of fiscal 2013 associated with the Increase and Repricing Transaction. The amount consisted of $723 of deferred financing costs where accelerated amortization was required. Legal fees and other associated costs of $378 were also recorded. On November 8, 2013, net proceeds of $31,000 from the IPO were used to repay a portion of the outstanding borrowings under the Senior Secured Term Loan Facility. On November 27, 2013, The Container Store Group, Inc., The Container Store, Inc. and certain of its domestic subsidiaries entered into Amendment No. 2 to the Senior Secured Term Loan Facility (the "Repricing Transaction"). Pursuant to the Repricing Transaction, borrowings accrue interest at a lower rate of LIBOR + 3.25%, subject to a LIBOR floor of 1.00%. The Company recorded expenses of $128, where accelerated amortization was required, during the third quarter of fiscal 2013 associated with the Repricing Transaction. The Senior Secured Term Loan Facility is secured by (a) a first priority security interest in substantially all of our assets (excluding stock in foreign subsidiaries in excess of 65%, assets of non-guarantors and subject to certain other exceptions) (other than the collateral that secures the Revolving Credit Facility described below on a first-priority basis) and (b) a second priority security interest in the assets securing the Revolving Credit Facility described below on a first-priority basis. Obligations under the Senior Secured Term Loan Facility are guaranteed by The Container Store Group, Inc. and each of The Container Store, Inc.'s U.S. subsidiaries. Under the Senior Secured Term Loan Facility, the Company is required to make quarterly principal repayments of $906 through December 31, 2018, with a balloon payment for the remaining balance of $310,421 due on April 6, 2019. The Senior Secured Term Loan Facility includes restrictions on the ability of the Company's subsidiaries to incur additional liens and indebtedness, make investments and dispositions, pay dividends or make other distributions, make loans, prepay certain indebtedness and enter into sale and lease back transactions, among other restrictions. Under the Senior Secured Term Loan Facility, provided no event of default has occurred and is continuing, The Container Store, Inc. is permitted to pay dividends to The Container Store Group, Inc. in an amount not to exceed the sum of $10,000 plus The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 4. Long-term debt and revolving lines of credit (Continued) if after giving effect to such dividend on a pro forma basis, the Consolidated Leverage Ratio (as defined in the Senior Secured Term Loan Facility) does not exceed 2.0 to 1.0, the Available Amount (as defined in the Senior Secured Term Loan Facility) during the term of the Senior Secured Term Loan Facility, and pursuant to certain other limited exceptions. The restricted net assets of the Company's consolidated subsidiaries was $194,568 as of February 27, 2016. As of February 27, 2016, we were in compliance with all Senior Secured Term Loan Facility covenants and no Event of Default (as such term is defined in the Senior Secured Term Loan Facility) has occurred. Revolving Credit Facility In connection with the Refinancing Transaction on April 6, 2012, The Container Store Group, Inc., The Container Store, Inc. and certain of its domestic subsidiaries entered into a $75,000 asset-based revolving credit agreement with the lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent, and Wells Fargo Bank, National Association, as Syndication Agent (the "Revolving Credit Facility"). Borrowings under the Revolving Credit Facility accrued interest at LIBOR+1.25% to 1.75%, subject to adjustment based on average daily excess availability over the preceding quarter, and the maturity date was April 6, 2017. On October 8, 2015, The Container Store, Inc. executed an amendment to the Revolving Credit Facility ("Amendment No. 2"). Under the terms of Amendment No. 2, among other items, (i) the maturity date of the loan was extended from April 6, 2017 to the earlier of (x) October 8, 2020 and (y) January 6, 2019, if any of The Container Store, Inc.'s obligations under its term loan credit facility remain outstanding on such date and have not been refinanced with debt that has a final maturity date that is no earlier than April 6, 2019 or subordinated debt, (ii) the aggregate principal amount of the facility was increased from $75,000 to $100,000, (iii) the interest rate decreased from a range of LIBOR + 1.25% to 1.75% to LIBOR + 1.25% and (iv) the uncommitted incremental revolving facility was increased from $25,000 to $50,000, which is subject to receipt of lender commitments and satisfaction of specified conditions. As provided in Amendment No. 2, the Revolving Credit Facility will continue to be used for working capital and other general corporate purposes. Amendment No. 2 allows for swing line advances of up to $15,000 and the issuance of letters of credit of up to $40,000, increased from the previous swing line limits of $7,500 and letter of credit limits of $20,000. The availability of credit at any given time under the Revolving Credit Facility is limited by reference to a borrowing base formula, which is the sum of (i) 90% of eligible credit card receivables and (ii) 90% of the appraised value of eligible inventory; minus (iii) certain availability reserves and (iv) outstanding credit extensions including letters of credit and existing revolving loans. The Revolving Credit Facility is secured by (a) a first-priority security interest in substantially all of our personal property, consisting of inventory, accounts receivable, cash, deposit accounts, and other general intangibles, and (b) a second-priority security interest in the collateral that secures the Senior Secured Term Loan Facility on a first-priority basis, as described above (excluding stock in foreign subsidiaries in excess of 65%, and assets of non-guarantor subsidiaries and subject to certain other The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 4. Long-term debt and revolving lines of credit (Continued) exceptions). Obligations under the Revolving Credit Facility are guaranteed by The Container Store Group, Inc. and each of The Container Store, Inc.'s U.S. subsidiaries. The Revolving Credit Facility contains a number of covenants that, among other things, restrict our ability, subject to specified exceptions, to incur additional debt; incur additional liens and contingent liabilities; sell or dispose of assets; merge with or acquire other companies; liquidate or dissolve ourselves, engage in businesses that are not in a related line of business; make loans, advances or guarantees; engage in transactions with affiliates; and make investments. In addition, the financing agreements contain certain cross-default provisions. We are required to maintain a consolidated fixed-charge coverage ratio of 1.0 to 1.0 if excess availability is less than $10,000 at any time. As of February 27, 2016, we were in compliance with all Revolving Credit Facility covenants and no Event of Default (as such term is defined in the Revolving Credit Facility) has occurred. Under the Revolving Credit Facility, provided no event of default has occurred and is continuing, The Container Store, Inc. is permitted to pay dividends to The Container Store Group, Inc., in an amount not to exceed the sum of $10,000 plus if after giving effect to such dividend on a pro forma basis, the Consolidated Fixed Charge Coverage Ratio (as defined in the Revolving Credit Facility) is not less than 1.25 to 1.0, the Available Amount (as defined in the Revolving Credit Facility) during the term of the Revolving Credit Facility, and pursuant to certain other limited exceptions. There was $75,159 available under the Revolving Credit Facility as of February 27, 2016, based on the factors described above. Maximum borrowings, including letters of credit issued under the Revolving Credit Facility during the period ended February 27, 2016, were $36,406. Elfa Senior Secured Credit Facilities and 2014 Elfa Senior Secured Credit Facilities On April 27, 2009, Elfa entered into the Elfa Senior Secured Credit Facilities with Tjustbygdens Sparbank AB, which we refer to as Sparbank, which consisted of a SEK 137.5 million term loan facility, which we refer to as the Elfa Term Loan Facility, and the SEK 175.0 million Elfa Revolving Credit Facility and, together with the Elfa Term Loan Facility, the Elfa Senior Secured Credit Facilities. On January 27, 2012, Sparbank transferred all of its commitments, rights and obligations under the Elfa Senior Secured Credit Facilities to Swedbank AB. Borrowings under the Elfa Senior Secured Credit Facilities accrued interest at a rate of STIBOR+1.775%. Elfa was required to make quarterly principal repayments under the Elfa Term Loan Facility of SEK 6.25 million through maturity. The Elfa Senior Secured Credit Facilities were secured by first priority security interests in substantially all of Elfa's assets. The Elfa Term Loan Facility and the Elfa Revolving Credit Facility matured on August 30, 2014 and were replaced with the 2014 Elfa Senior Secured Credit Facilities as discussed below On April 1, 2014, Elfa entered into a master credit agreement with Nordea Bank AB ("Nordea"), which consists of a SEK 60.0 million (approximately $7,000 as of February 27, 2016) term loan facility (the "2014 Elfa Term Loan Facility") and a SEK 140.0 million (approximately $16,334 as of February 27, 2016) revolving credit facility (the "2014 Elfa Revolving Credit Facility," and together with the 2014 Elfa Term Loan Facility, the "2014 Elfa Senior Secured Credit Facilities"). The 2014 Elfa Senior Secured Credit Facilities term began on August 29, 2014 and matures on August 29, 2019, or such shorter period as provided by the agreement. Elfa is required to make quarterly principal The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 4. Long-term debt and revolving lines of credit (Continued) payments under the 2014 Elfa Term Loan Facility in the amount of SEK 3.0 million (approximately $350 as of February 27, 2016) through maturity. The 2014 Elfa Term Loan Facility bears interest at STIBOR + 1.7% and the 2014 Elfa Revolving Credit Facility bears interest at Nordea's base rate + 1.4%, and these rates are applicable until August 29, 2017, at which time the interest rates may be renegotiated at the request of either party to the agreement. Should the parties fail to agree on new interest rates, Elfa has the ability to terminate the agreement on August 29, 2017, at which time all borrowings under the agreement shall be paid in full to Nordea. As of February 27, 2016, the Company had $15,614 of additional availability under the 2014 Elfa Revolving Credit Facility. Under the 2014 Elfa Senior Secured Credit Facilities, Elfa's ability to pay dividends to its parent entity, The Container Store, Inc., is based on its future net income and on historical intercompany practices as between Elfa and The Container Store, Inc. The 2014 Elfa Senior Secured Credit Facilities are secured by the majority of assets of Elfa. The 2014 Elfa Senior Secured Credit Facilities contains a number of covenants that, among other things, restrict Elfa's ability, subject to specified exceptions, to incur additional liens, sell or dispose of assets, merge with other companies, engage in businesses that are not in a related line of business and make guarantees. In addition, Elfa is required to maintain (i) a consolidated equity ratio (as defined in the 2014 Elfa Senior Secured Credit Facilities) of not less than 30% in year one and not less than 32.5% thereafter and (ii) a consolidated ratio of net debt to EBITDA (as defined in the 2014 Elfa Senior Secured Credit Facilities) of less than 3.2, the consolidated equity ratio tested at the end of each calendar quarter and the ratio of net debt to EBITDA tested as of the end of each fiscal quarter. As of February 27, 2016, Elfa was in compliance with all covenants and no Event of Default (as defined in the 2014 Elfa Senior Secured Credit Facilities) had occurred. On May 13, 2014, Elfa entered into a credit facility with Nordea for SEK 15.0 million (the "Short Term Credit Facility"). The Short Term Credit Facility accrued interest at 2.53% and matured on August 28, 2014, at which time all borrowings under the agreement were paid in full to Nordea (approximately $2,152 as of August 28, 2014). The total amount of borrowings available under the Short Term Credit Facility was used to pay a mortgage owed on the Poland manufacturing facility in full in the first quarter of fiscal 2014. Deferred financing costs The Company capitalizes certain costs associated with issuance of various debt instruments. These deferred financing costs are amortized to interest expense on a straight-line method, which is materially consistent with the effective interest method, over the terms of the related debt agreements. The Company capitalized $258 of fees associated with Amendment No. 2 that will be amortized through October 8, 2020. In conjunction with the Refinancing Transaction, the Company capitalized $9,467 of fees associated with the Senior Secured Term Loan Facility that will be amortized through April 6, 2019, as well as $375 of fees associated with the Revolving Credit Facility that will be amortized through April 6, 2017. Amortization expense of deferred financing costs was $1,940, $1,956, and $1,857 The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 4. Long-term debt and revolving lines of credit (Continued) in fiscal 2015, fiscal 2014, and fiscal 2013, respectively. The following is a schedule of amortization expense of deferred financing costs: 5. Income taxes Components of the provision for income taxes are as follows: The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 5. Income taxes (Continued) The differences between the actual provision for income taxes and the amounts computed by applying the statutory federal tax rate to income before taxes are as follows: Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Components of deferred tax assets and liabilities as of February 27, 2016 and February 28, 2015, are as follows: The Company has recorded deferred tax assets and liabilities based upon estimates of their realizable value with such estimates based upon likely future tax consequences. In assessing the need The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 5. Income taxes (Continued) for a valuation allowance, the Company considers both positive and negative evidence related to the likelihood of realization of the deferred tax assets. If, based on the weight of available evidence, it is more-likely-than-not that a deferred tax asset will not be realized, the Company records a valuation allowance. By the end of fiscal year 2013, the Company's U.S. operations maintained a position of cumulative profits for the most recent three-year period. The cumulative domestic profits coupled with the fiscal year 2013 consolidated pre-tax income and the business plan for profitability in future periods provided assurance that certain domestic future tax benefits more-likely-than-not will be realized. Accordingly, in fiscal year 2013 the Company released a U.S. valuation allowance of $2,753 against certain domestic net deferred tax assets as compared to prior year. Prior to the fourth quarter of 2014, the Company maintained a partial valuation allowance against certain Polish deferred tax assets related to Special Economic Zone credits earned by the Company's Polish manufacturing business. During fiscal 2014, significant positive evidence provided assurance that these credits will more-likely-than-not be fully realized. Accordingly, in the fourth quarter of fiscal 2014, the Company released the remaining valuation allowance it had maintained against deferred tax assets related to these credits. The release resulted in a $680 benefit to the Company's provision for income taxes. During the quarter ended August 30, 2014, the Company identified a prior period error in its income tax provision and filed an amended tax return, which resulted in a $1,839 benefit to the provision for income taxes, as well as an increase to income taxes receivable. As a result of the amended return filing, the Company utilized a deferred tax asset and released a valuation allowance of $1,331 related to certain domestic tax credits. Foreign and domestic tax credits, net of valuation allowances, totaled approximately $1,661 at February 27, 2016 and approximately $1,602 at February 28, 2015. The various credits available at February 27, 2016 expire in the 2026 tax year. The Company had deferred tax assets for foreign and state net operating loss carryovers of $1,888 at February 27, 2016, and approximately $1,897 at February 28, 2015. Valuation allowances of $1,687 and $1,647 were recorded against the net operating loss deferred tax assets at February 27, 2016 and February 28, 2015, respectively. While the Company is not currently under IRS audit, tax years ending February 28, 2009 and forward remain open to examination by virtue of net operating loss carryovers created or utilized in those years. The Company accounts for the repatriation of foreign earnings in accordance with ASC 740-30. As such, the Company is partially reinvested based on the guidance provided in ASC 740-30. Undistributed earnings of approximately $33,149 at February 27, 2016 and approximately $33,227 at February 28, 2015 have been indefinitely reinvested; therefore, no provision has been made for taxes due upon remittance of those earnings. The decrease in undistributed earnings from fiscal 2014 to fiscal 2015 was primarily related to the translation of foreign earnings from Swedish krona to U.S. dollar. Determination of the The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 5. Income taxes (Continued) unrecognized deferred tax liability related to these undistributed earnings is not practicable because of the complexities associated with its hypothetical calculation. The Company does not have any uncertain tax positions, according to ASC 740-10, as of February 28, 2015 and February 27, 2016. 6. Employee benefit plans 401(k) Plan All domestic employees of the Company who complete 11 months of service are eligible to participate in the Company's 401(k) Plan. Participants may contribute up to 80% of annual compensation, limited to eighteen thousand annually (twenty-four thousand for participants aged 50 years and over) as of January 1, 2015. During fiscal 2015, fiscal 2014, and fiscal 2013, the Company matched 100% of employee contributions up to 4% of compensation. The amount charged to expense for the Company's matching contribution was $3,165, $2,737, and $2,570 for fiscal years 2015, 2014, and 2013, respectively. Nonqualified retirement plan The Company has a nonqualified retirement plan whereby certain employees can elect to defer a portion of their compensation into retirement savings accounts. Under the plan, there is no requirement that the Company match contributions, although the Company may contribute matching payments at its sole discretion. No matching contributions were made to the plan during any of the periods presented. The total fair market value of the plan asset recorded in other current assets was $3,947 and $3,951 as of February 27, 2016 and February 28, 2015, respectively. The total fair value of the plan liability recorded in accrued liabilities was $3,962 and $3,966 as of February 27, 2016 and February 28, 2015, respectively. Pension plan The Company provides pension benefits to the employees of Elfa under collectively bargained pension plans in Sweden, which are recorded in other long-term liabilities. The defined benefit plan provides benefits for participating employees based on years of service and final salary levels at retirement. Certain employees also participate in defined contribution plans for which Company contributions are determined as a percentage of participant compensation. The defined benefit plans are unfunded and approximately 3% of Elfa employees are participants in the defined benefit pension plan. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 6. Employee benefit plans (Continued) The following is a reconciliation of the changes in the defined benefit obligations, a statement of funded status, and the related weighted-average assumptions: The following table provides the components of net periodic benefit cost for fiscal years 2015, 2014, and 2013: 7. Stock-based compensation In fiscal 2012, the Company implemented the 2012 Stock Option Plan of The Container Store Group, Inc. ("2012 Equity Plan"). The 2012 Equity Plan provided for grants of nonqualified stock options and incentive stock options. On October 31, 2013, the Company's board of directors (the "Board") approved the modification of 240,435 outstanding stock options granted under the 2012 Equity Plan to provide for immediate vesting. The Company recognized approximately $1,846 of The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 7. Stock-based compensation (Continued) compensation expense during fiscal 2013 related to the 2012 Equity Plan, of which $1,594 was due to the modification of these stock options. On October 16, 2013, the Board approved the 2013 Incentive Award Plan ("2013 Equity Plan"). The 2013 Equity Plan provides for grants of nonqualified stock options, incentive stock options, restricted stock, restricted stock units, deferred stock awards, deferred stock units, stock appreciation rights, dividends equivalents, performance awards, and stock payments. As of February 27, 2016, there are 3,616,570 shares authorized and 930,511 shares available for grant under the 2013 Equity Plan. Awards that are surrendered or terminated without issuance of shares are available for future grants. On October 31, 2013, the Company granted 2,622,721 nonqualified stock options under the 2013 Equity Plan to its directors and certain of its employees. The stock options granted were approved by the Board and consisted of nonqualified stock options as defined by the IRS for corporate and individual tax reporting purposes. There were 1,666,066 options granted that immediately vested upon closing of the IPO on November 6, 2013. The remaining stock options granted will vest in equal annual installments over 7 years. The Company recognized $13,291 of compensation expense in fiscal 2013 related to the 2013 Equity Plan options granted. On September 1, 2014, the Company granted 24,649 nonqualified stock options under the 2013 Equity Plan to certain employees. The stock options granted vest in equal annual installments over 7 years. The stock options granted were approved by the Board and consisted of nonqualified stock options as defined by the IRS for corporate and individual tax reporting purposes. On October 27, 2014, the Company granted 80,200 nonqualified stock options under the 2013 Equity Plan to non-employee directors of the Company. The stock options granted vest in equal annual installments over 3 years. The stock options granted were approved by the Board and consisted of nonqualified stock options as defined by the IRS for corporate and individual tax reporting purposes. On August 3, 2015, the Company granted 94,568 nonqualified stock options under the 2013 Equity Plan to non-employee directors of the Company. The stock options granted vest in equal annual installments over 3 years. The stock options granted were approved by the Board and consisted of nonqualified stock options as defined by the IRS for corporate and individual tax reporting purposes. In connection with our stock-based compensation plans, the Board considers the estimated fair value of the Company's stock when setting the stock option exercise price as of the date of each grant. Prior to the IPO, because the Company was privately held and there was no public market for the common stock, the fair market value of the Company's common stock was determined by the Board at the time the option grants were awarded. In determining the fair value of the Company's common stock, the Board considered such factors as the Company's actual and projected financial results, valuations of the Company performed by third parties and other factors it believed were material to the valuation process. Following the IPO, the Board determines the exercise price of stock options based on the closing price of the Company's common stock as reported on The New York Stock Exchange on the grant date. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 7. Stock-based compensation (Continued) Stock-based compensation cost is measured at the grant date fair value and is recognized as an expense in the consolidated statements of operations, on a straight-line basis, over the employee's requisite service period (generally the vesting period of the equity grant). The Company estimates forfeitures for option grants that are not expected to vest. The Company issues new shares of common stock upon stock option exercise. Stock-based compensation cost was $1,556, $1,289, and $15,137 during the fiscal year 2015, 2014, and 2013, respectively. As of February 27, 2016, there was a remaining unrecognized compensation cost of $5,828 (net of estimated forfeitures) that the Company expects to be recognized on a straight-line basis over a weighted-average remaining service period of approximately 2.4 years. The intrinsic value of shares exercised was $2, $369, and $342 during fiscal 2015, 2014, and 2013, respectively. The fair value of shares vested was $1,367, $1,205, and $14,976 during fiscal 2015, 2014, and 2013, respectively. The following table summarizes the Company's stock option activity during fiscal 2015, 2014, and 2013: The fair value of stock options is estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted-average assumptions: • Expected Term-The expected term of the options represents the period of time between the grant date of the options and the date the options are either exercised or canceled, including an estimate of options still outstanding. The Company utilized the simplified method for calculating the expected term for stock options as we do not have sufficient historical data to calculate based on actual exercise and forfeiture activity. • Expected Volatility-The expected volatility incorporates historical and implied volatility of comparable public companies for a period approximating the expected term. • Expected Dividend Yield-The expected dividend yield is based on the Company's expectation of not paying dividends on its common stock for the foreseeable future. • Risk-Free Interest Rate-The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant and with a maturity that approximates the expected term. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 7. Stock-based compensation (Continued) Stock options granted during fiscal year 2015, 2014, and 2013 were granted at a weighted-average grant date fair value of $8.46, $8.14, and $8.26, respectively. Such amounts were estimated using the Black Scholes option pricing model with the following weighted-average assumptions: 8. Shareholders' equity Common stock On August 16, 2007, the Company issued 2,942,326 shares of common stock with a par value of $0.01 per share at a price of $17.01 per share, giving effect to the stock split discussed below. The holders of common stock are entitled to one vote per common share. The holders have no preemptive or other subscription rights and there are no redemptions or sinking fund provisions with respect to such shares. Common stock is subordinate to any preferred stock outstanding with respect to rights upon liquidation and dissolution of the Company. On October 31, 2013, the Company's board of directors retired 13,567 shares of common stock held in treasury, giving effect to the stock split discussed below. On October 31, 2013, the Company's board of directors approved an approximate 5.9-for-one stock split of its existing common shares. All share and per share information has been retroactively adjusted to reflect the stock split. On November 6, 2013, the Company completed its IPO. In connection with its IPO, the Company issued and sold 14,375,000 shares of its common stock at a price of $18.00 per share. Upon completion of the offering, the Company received net proceeds of approximately $237,013, after deducting the underwriting discount of $17,466 and offering expenses of $4,271. As of February 27, 2016, the Company had 250,000,000 shares of common stock authorized, with a par value of $0.01, of which 47,986,975 were issued and outstanding. Preferred stock On April 9, 2013, the Company paid a distribution to holders of its Senior Preferred Stock in the amount of $90,000. Refer to Note 4 for a discussion of the Increase and Repricing Transaction whereby $90,000 of additional secured term loans were executed to fund this distribution. On October 31, 2013, the Company's board of directors retired 298 shares of Senior Preferred Stock and 298 shares of Junior Preferred Stock held in treasury. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 8. Shareholders' equity (Continued) On November 6, 2013, in connection with the completion of the Company's IPO, a distribution in the aggregate amount of $205,813 (the "Distribution") was paid from the net proceeds of the offering, (i) first, to all 140 holders of the Company's Senior Preferred Stock (including LGP and 130 current and former employees of the Company), which reduced the liquidation preference of such shares until such liquidation preference was reduced to $1,000.00 per share and (ii) second, the remainder was distributed to all 140 holders of the Company's Junior Preferred Stock (including LGP and 130 current and former employees of the Company), which reduced the liquidation preference of such shares. On November 6, 2013, the Company exchanged the liquidation preference per outstanding share of its Senior Preferred Stock and Junior Preferred Stock, after giving effect to the payment of the Distribution, for 30,619,083 shares of its common stock (the "Exchange"). The amount of common stock issued in the Exchange was determined by dividing (a) the liquidation preference amount of such preferred stock by (b) the IPO price of $18.00 per share. On an as adjusted basis to give effect to the Distribution and prior to the Exchange, the liquidation preference per share of its outstanding Senior Preferred Stock was $1,000.00 and the liquidation preference per share of its outstanding Junior Preferred Stock was $1,725.98. As of February 27, 2016, the Company had 5,000,000 shares of preferred stock authorized, with a par value of $0.01, of which no shares were issued or outstanding. 9. Accumulated other comprehensive income Accumulated other comprehensive income ("AOCI") consists of changes in our foreign currency hedge contracts, pension liability adjustment, and foreign currency translation. The components of AOCI, net of tax, were as follows: The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 9. Accumulated other comprehensive income (Continued) The unrecognized net actuarial loss included in accumulated other comprehensive income as of February 27, 2016 and February 28, 2015 was $992 and $1,167, respectively. Amounts reclassified from AOCI to earnings for the pension liability adjustment category are generally included in cost of sales and selling, general and administrative expenses in the Company's consolidated statements of operations. For a description of the Company's employee benefit plans, refer to Note 6. Amounts reclassified from AOCI to earnings for the foreign currency hedge instruments category are generally included in cost of sales in the Company's consolidated statements of operations. For a description of the Company's use of foreign currency forward contracts, refer to Note 10. 10. Foreign currency forward contracts The Company's international operations and purchases of its significant product lines from foreign suppliers are subject to certain opportunities and risks, including foreign currency fluctuations. In the TCS segment, we utilize foreign currency forward contracts in Swedish krona to stabilize our retail gross margins and to protect our domestic operations from downward currency exposure by hedging purchases of inventory from our wholly owned subsidiary, Elfa. Forward contracts in the TCS segment are designated as cash flow hedges, as defined by ASC 815. In the Elfa segment, we utilize foreign currency forward contracts to hedge purchases, primarily of raw materials, that are transacted in currencies other than Swedish krona, which is the functional currency of Elfa. Forward contracts in the Elfa segment are economic hedges, and are not designated as cash flow hedges as defined by ASC 815. In fiscal 2015, fiscal 2014, and fiscal 2013, the TCS segment used forward contracts for 54%, 54%, and 64% of inventory purchases in Swedish krona each year, respectively. In fiscal 2015, fiscal 2014, and fiscal 2013, the Elfa segment used forward contracts to purchase U.S. dollars in the amount of $5,495, $4,300, and $3,500, which represented 67%, 64%, and 67% of the Elfa segment's U.S. dollar purchases each year, respectively. Generally, the Company's foreign currency forward contracts have terms from 1 to 12 months and require the Company to exchange currencies at agreed-upon rates at settlement. The counterparties to the contracts consist of a limited number of major domestic and international financial institutions. The Company does not hold or enter into financial instruments for trading or speculative purposes. The Company records its foreign currency forward contracts on a gross basis and generally does not require collateral from these counterparties because it does not expect any losses from credit exposure. The Company records all foreign currency forward contracts on its consolidated balance sheet at fair value. The Company accounts for its foreign currency hedge instruments in the TCS segment as cash flow hedges, as defined. Changes in the fair value of the foreign currency hedge instruments that are considered to be effective, as defined, are recorded in other comprehensive income (loss) until the hedged item (inventory) is sold to the customer, at which time the deferred gain or loss is recognized through cost of sales. Any portion of a change in the foreign currency hedge instrument's fair value that is considered to be ineffective, as defined, or that the Company has elected to exclude from its measurement of effectiveness, is immediately recorded in earnings as cost of sales. The Company assessed the effectiveness of the foreign currency hedge instruments and determined the foreign The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 10. Foreign currency forward contracts (Continued) currency hedge instruments were highly effective during the fiscal years ended February 27, 2016, February 28, 2015, and March 1, 2014. Forward contracts not designated as hedges in the Elfa segment are adjusted to fair value as selling, general, and administrative expenses on the consolidated statements of operations. During fiscal 2015, the Company recognized a net unrealized loss of $371 associated with the change in fair value of forward contracts not designated as hedge instruments. The Company had $29 in accumulated other comprehensive loss related to foreign currency hedge instruments at February 27, 2016. The entire $29 represents an unrealized loss for settled foreign currency hedge instruments related to inventory on hand as of February 27, 2016. The Company expects the unrealized loss of $29, net of taxes, to be reclassified into earnings over the next 12 months as the underlying inventory is sold to the end customer. The change in fair value of the Company's foreign currency hedge instruments that qualify as cash flow hedges and are included in accumulated other comprehensive income (loss), net of taxes, are presented in Note 9 of these financial statements. 11. Leases The Company conducts all of its U.S. operations from leased facilities that include a corporate headquarters/warehouse facility and 79 store locations. The corporate headquarters/warehouse and stores are under operating leases that will expire over the next 1 to 20 years. The Company also leases computer hardware under operating leases that expire over the next few years. In most cases, management expects that in the normal course of business, leases will be renewed or replaced by other leases. Most of the operating leases for the stores contain a renewal option at predetermined rental payments for periods of 5 to 20 years. This option enables the Company to retain use of facilities in desirable operating areas. The rental payments under certain store leases are based on a minimum rental plus a percentage of the sales in excess of a stipulated amount. These payments are accounted for as contingent rent and expensed when incurred. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 11. Leases (Continued) The following is a schedule of future minimum lease payments due under noncancelable operating and capital leases: Rent expense for fiscal years 2015, 2014, and 2013 was $75,834, $72,643, and $68,184, respectively. Included in rent expense is percentage-of-sales rent expense of $450, $633, and $819 for fiscal years 2015, 2014, and 2013, respectively. 12. Commitments and contingencies In connection with insurance policies and other contracts, the Company has outstanding standby letters of credit totaling $3,594 as of February 27, 2016. The Company is subject to ordinary litigation and routine reviews by regulatory bodies that are incidental to its business, none of which is expected to have a material adverse effect on the Company's consolidated financial statements on an individual basis or in the aggregate. 13. Fair value measurements Under generally accepted accounting principles, the Company is required to a) measure certain assets and liabilities at fair value or b) disclose the fair values of certain assets and liabilities recorded at cost. Accounting standards define fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date. Fair value is calculated assuming the transaction occurs in the principal or most advantageous market for the asset or liability and includes consideration of non-performance risk and credit risk of both parties. Accounting standards pertaining to fair value establish a three-tier fair value hierarchy that prioritizes the inputs used in measuring fair value. These tiers include: • Level 1-Valuation inputs are based upon unadjusted quoted prices for identical instruments traded in active markets. • Level 2-Valuation inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 13. Fair value measurements (Continued) • Level 3-Valuation inputs are unobservable and typically reflect management's estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are determined using model-based techniques that include option pricing models, discounted cash flow models and similar techniques. As of February 27, 2016 and February 28, 2015, the Company held certain items that are required to be measured at fair value on a recurring basis. These included the nonqualified retirement plan and foreign currency forward contracts. The nonqualified retirement plan consists of investments purchased by employee contributions to retirement savings accounts. The Company's international operations and purchases of its significant product lines from foreign suppliers are subject to certain opportunities and risks, including foreign currency fluctuations. The Company utilizes foreign currency forward exchange contracts to stabilize its retail gross margins and to protect its operations from downward currency exposure. Foreign currency hedge instruments are related to the Company's attempts to hedge foreign currency fluctuation on purchases of inventory in Swedish krona. The Company's foreign currency hedge instruments consist of over-the-counter (OTC) contracts, which are not traded on a public exchange. See Note 10 for further information on the Company's hedging activities. The fair values of the nonqualified retirement plan and foreign currency forward contracts are determined based on the market approach which utilizes inputs that are readily available in public markets or can be derived from information available in publicly quoted markets for comparable assets. Therefore, the Company has categorized these items as Level 2. The Company also considers counterparty credit risk and its own credit risk in its determination of all estimated fair values. The Company has consistently applied these valuation techniques in all periods presented and believes it has obtained the most accurate information available for the types of contracts it holds. The following items are measured at fair value on a recurring basis, subject to the disclosure requirements of ASC 820, Fair Value Measurements, at February 27, 2016 and February 28, 2015: The fair value of long-term debt was estimated using quoted prices as well as recent transactions for similar types of borrowing arrangements (level 2 valuations). As of February 27, 2016 and February 28, 2015, the estimated fair value of the Company's long-term debt, including current maturities, was $221,534 and $327,830, respectively. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 14. Segment reporting The Company's operating segments were determined on the same basis as how it evaluates the performance internally. The Company's two operating segments consist of TCS and Elfa. The TCS segment includes the Company's retail stores, website and call center, as well as the installation and organization services business. The Elfa segment includes the manufacturing business that produces the elfa® brand products that are sold domestically, exclusively through the TCS segment, as well as throughout Europe. The intersegment sales in the Elfa column represent elfa® product sales to the TCS segment. These sales and the related gross margin on merchandise recorded in TCS inventory balances at the end of the period are eliminated for consolidation purposes in the Corporate/Other column. The net sales to third parties in the Elfa column represent sales to customers outside of the United States. Amounts in the Corporate/Other column include unallocated corporate expenses and assets, intersegment eliminations and other adjustments to segment results necessary for the presentation of consolidated financial results in accordance with generally accepted accounting principles. In general, the Company uses the same measurements to calculate earnings or loss before income taxes for operating segments as it does for the consolidated company. However, interest expense related to the Senior Secured Term Loan Facility, the Revolving Credit Facility and senior subordinated notes is recorded in the Corporate/Other column. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 14. Segment reporting (Continued) (1)The TCS segment includes stock-based compensation expense of $1,556, $1,289, and $15,137 for fiscal 2015, fiscal 2014, and fiscal 2013, respectively. (2)Tangible assets and trade names in the Elfa column are located outside of the United States. Assets and capital expenditures in Corporate/Other include assets located in the corporate headquarters and distribution center. Assets in Corporate/Other also include deferred tax assets and the fair value of foreign currency hedge instruments. (3)The Corporate/Other column includes $1,229 of loss on extinguishment of debt in fiscal 2013. The following table shows sales by merchandise category as a percentage of total net sales for fiscal years 2015, 2014, and 2013: (1)Includes elfa® and TCS Closets™ product sold by the TCS segment and Elfa segment sales to third parties 15. Net income (loss) per common share Basic net income (loss) per common share is computed as net income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding for the period. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 15. Net income (loss) per common share (Continued) Net income (loss) available to common shareholders is computed as net income (loss) less accumulated distributions to preferred shareholders for the period. Diluted net income (loss) per share is computed as net income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding for the period plus common stock equivalents consisting of shares subject to stock-based awards with exercise prices less than or equal to the average market price of the Company's common stock for the period, to the extent their inclusion would be dilutive. Potential dilutive securities are excluded from the computation of diluted net income (loss) per share if their effect is anti-dilutive. The following is a reconciliation of net income (loss) available to common shareholders and the number of shares used in the basic and diluted net income (loss) per share calculations: 16. Quarterly results of operations (unaudited) Due to the seasonal nature of our business, fourth quarter operating results historically represent a larger share of annual net sales and operating income primarily due to Our Annual elfa® Sale. We The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 16. Quarterly results of operations (unaudited) (Continued) follow the same accounting policies for preparing quarterly and annual financial data. The table below summarizes quarterly results for fiscal 2015 and 2014: (1)The sum of the quarters may not equal the total fiscal year due to rounding. 17. Subsequent events On March 30, 2016, the Board of Directors of the Company approved a change in the Company's fiscal year end from the 52- or 53-week period ending on the Saturday closest to February 28 to the 52- or 53-week period ending on the Saturday closest to March 31. The fiscal year change is effective beginning with the Company's 2016 fiscal year, which began April 3, 2016 and will end April 1, 2017 (the "New Fiscal Year"). As a result of the change, the Company had a March 2016 fiscal month transition period which began February 28, 2016 and ended April 2, 2016. The results of the transition period are expected to be reported in the Company's Form 10-Q to be filed for the first quarter of the New Fiscal Year, which will end on July 2, 2016 and in the Company's Form 10-K to be filed for the New Fiscal Year. The Container Store Group, Inc. Notes to consolidated financial statements (Continued) (In thousands, except share amounts and unless otherwise stated) February 27, 2016 17. Subsequent events (Continued) Additionally, as part of the Company's long-term succession plan, on May 9, 2016, the Company announced that Melissa Reiff, current President and Chief Operating Officer, will become the retailer's Chief Executive Officer, succeeding William A. ("Kip") Tindell, III, and Sharon Tindell will add President to her current Chief Merchandising Officer title. Kip Tindell, current Chairman and Chief Executive Officer, will retain his role as Chairman of the Company's Board of Directors. In addition, Jodi Taylor, Chief Financial Officer and Secretary, will add Chief Administrative Officer to her current title. These changes will be effective July 1, 2016. In connection with the management changes occurring, the Company has entered into amended and restated employment agreements with Mr. Tindell, Ms. Reiff, and Ms. Tindell, and has also entered into an employment agreement with Ms. Taylor, each to be effective July 1, 2016. The amended and restated employment agreements with Ms. Reiff and Ms. Tindell, as well as the employment agreement with Ms. Taylor, provide for annual grants of equity awards subject to the Company's 2013 Incentive Award Plan and award agreements thereunder. In fiscal 2016, Ms. Reiff, Ms. Tindell and Ms. Taylor will receive time-based restricted shares and performance-based restricted shares as outlined in the agreements. The amended and restated employment agreement with Mr. Tindell will provide him with the same type and amount of equity-based compensation awards provided generally to the Company's non-employee directors from time to time. The amended and restated employment agreements also remove certain deferred compensation provisions that were in the original employment agreements. As of February 27, 2016, the Company had approximately $4,080 of deferred compensation recorded on the balance sheet in the other long-term liabilities line item associated with the original employment agreements. Schedule I-Condensed Financial Information of registrant- The Container Store Group, Inc. (parent company only) Condensed balance sheets See accompanying notes. Schedule I-The Container Store Group, Inc. (parent company only) Condensed statements of operations Schedule I-The Container Store Group, Inc. (parent company only) Condensed statements of comprehensive income See accompanying notes. Schedule I-The Container Store Group, Inc. (parent company only) Notes to Condensed Financial Statements (In thousands, except share amounts and unless otherwise stated) February 27, Note 1: Basis of presentation In the parent-company-only financial statements, The Container Store Group, Inc.'s investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since the date of acquisition. The parent-company-only financial statements should be read in conjunction with the Company's consolidated financial statements. A condensed statement of cash flows was not presented because The Container Store Group, Inc. had no cash flow activities during fiscal 2015, fiscal 2014, or fiscal 2013. Note 2: Guarantees and restrictions The Container Store Inc., a subsidiary of the Company, has $321,288 of long-term debt outstanding under the Senior Secured Term Loan Facility, as of February 27, 2016. Under the terms of the Senior Secured Term Loan Facility, The Container Store Group, Inc. and the domestic subsidiaries of The Container Store, Inc. have guaranteed the payment of all principal and interest. In the event of a default under the Senior Secured Term Loan Facility, The Container Store Group, Inc. and the domestic subsidiaries of The Container Store, Inc. will be directly liable to the debt holders. The Senior Secured Term Loan Facility matures on April 6, 2019. The Senior Secured Term Loan Facility also includes restrictions on the ability of The Container Store Group, Inc. and its subsidiaries to incur additional liens and indebtedness, make investments and dispositions, pay dividends or make other distributions, make loans, prepay certain indebtedness and enter into sale and lease back transactions, among other restrictions. Under the Senior Secured Term Loan Facility, provided no event of default has occurred and is continuing, The Container Store, Inc. is permitted to pay dividends to The Container Store Group, Inc. in an amount not to exceed the sum of $10,000 plus if after giving effect to such dividend on a pro forma basis, the Consolidated Leverage Ratio (as defined in the Senior Secured Term Loan Facility) does not exceed 2.0 to 1.0, the Available Amount (as defined in the Senior Secured Term Loan Facility) during the term of the Senior Secured Term Loan Facility, and pursuant to certain other limited exceptions. The restricted net assets of the Company's consolidated subsidiaries was $194,568 as of February 27, 2016. As of February 27, 2016, The Container Store, Inc. also has $75,159 of available credit on the Revolving Credit Facility that provides commitments of up to $100,000 for revolving loans and letters of credit. The Container Store Group, Inc. and the domestic subsidiaries of The Container Store, Inc. have guaranteed all obligations under the Revolving Credit Facility. In the event of default under the Revolving Credit Facility, The Container Store Group, Inc. and the domestic subsidiaries of The Container Store, Inc. will be directly liable to the debt holders. The Revolving Credit Facility includes restrictions on the ability of The Container Store Group, Inc. and its subsidiaries to incur additional liens and indebtedness, make investments and dispositions, pay dividends or make other transactions, among other restrictions. On October 8, 2015, The Container Store, Inc. executed an amendment to the Revolving Credit Facility ("Amendment No. 2"). Under the terms of Amendment No. 2, among other items, the maturity date of the loan was extended from April 6, 2017 to the earlier of (x) October 8, 2020 and (y) January 6, 2019, if any of The Container Store, Inc.'s obligations under its term loan credit facility remain outstanding on such date and have not been refinanced with debt that has a final maturity date that is no earlier than April 6, 2019 or subordinated debt. Under the Revolving Credit Facility, provided no event of default has occurred and is continuing, The Container Store, Inc. is permitted to pay dividends to The Container Store Group, Inc., in an amount not to exceed the sum of $10,000 plus if after giving effect to such dividend on a pro forma basis, the Consolidated Fixed Charge Coverage Ratio (as defined in the Revolving Credit Facility) is not less than 1.25 to 1.0, the Available Amount (as defined in the Revolving Credit Facility) during the term of the Revolving Credit Facility, and pursuant to certain other limited exceptions. | Based on the provided financial statement excerpt, here's a summary:
Revenue Recognition:
- Retail sales recognized at point of sale or upon delivery
- Installation and service revenues recognized upon completion
- Manufacturing sales recorded upon shipment
- Sales are recorded net of taxes
- Sales return allowance based on historical return patterns
Gift Card Policy:
- Revenue from gift cards recognized when:
1. Card is redeemed
2. Likelihood of redemption becomes remote
- Breakage rate determined by historical redemption patterns
Financial Highlights:
- Current Assets: $3,947
- Accounting Update (ASU 2015):
- Debt issuance costs now directly deducted from debt liability
- Requires retrospective application
Key Financial Considerations:
- Loss reserve assessment
- Long-lived asset impairment evaluations
- Gift card breakage estimation
- Valuation allowances on | Claude |
. Index to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders’ Equity Consolidated Statements of Cash Flows Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of American Eagle Outfitters, Inc. We have audited the accompanying consolidated balance sheets of American Eagle Outfitters, Inc. as of January 30, 2016 and January 31, 2015, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended January 30, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Eagle Outfitters, Inc. at January 30, 2016 and January 31, 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 30, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), American Eagle Outfitters, Inc.’s internal control over financial reporting as of January 30, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 10, 2016 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Pittsburgh, Pennsylvania March 10, 2016 AMERICAN EAGLE OUTFITTERS, INC. Consolidated Balance Sheets Refer to AMERICAN EAGLE OUTFITTERS, INC. Consolidated Statements of Operations Refer to AMERICAN EAGLE OUTFITTERS, INC. Consolidated Statements of Comprehensive Income Refer to AMERICAN EAGLE OUTFITTERS, INC. Consolidated Statements of Stockholders' Equity (1) 600,000 authorized, 249,566 issued and 180,135 outstanding, $0.01 par value common stock at January 30, 2016; 600,000 authorized, 249,566 issued and 194,516 outstanding, $0.01 par value common stock at January 31, 2015; 600,000 authorized, 249,566 issued and 193,149 outstanding, $0.01 par value common stock at February 1, 2014. The Company has 5,000 authorized, with none issued or outstanding, $0.01 par value preferred stock at January 30, 2016, January 31, 2015 and February 1, 2014. (2) 69,431 shares, 55,050 shares, and 56,417 shares at January 30, 2016, January 31, 2015 and February 1, 2014, respectively. During Fiscal 2015, Fiscal 2014, and Fiscal 2013, 1,506 shares, 1,884 shares, and 3,204 shares, respectively, were reissued from treasury stock for the issuance of share-based payments. Refer to AMERICAN EAGLE OUTFITTERS, INC. Consolidated Statements of Cash Flows Refer to AMERICAN EAGLE OUTFITTERS, INC. For the Year Ended January 30, 2016 1. Business Operations American Eagle Outfitters, Inc. (the “Company”), a Delaware corporation, operates under the American Eagle Outfitters® (“AEO”) and Aerie® by American Eagle Outfitters® (“Aerie”) brands. The Company operated 77kids by American Eagle Outfitters® (“77kids”) until its exit in Fiscal 2012. Founded in 1977, American Eagle Outfitters is a leading apparel and accessories retailer that operates more than 1,000 retail stores in the U.S. and internationally, online at ae.com and aerie.com and international store locations managed by third-party operators. Through its brands, the Company offers high quality, on-trend clothing, accessories and personal care products at affordable prices. The Company’s online business, AEO Direct, ships to 81 countries worldwide. On November 2, 2015, AEO Inc. acquired Tailgate Clothing Company (“Tailgate”), which owns and operates Tailgate, a vintage, sports-inspired apparel brand with a college town store concept, and Todd Snyder New York, a premium menswear brand. As of January 30, 2016, the Company operated one Tailgate store in Iowa City, Iowa. Tailgate and Todd Snyder product is also sold online at TailgateClothing.com and ToddSnyder.com, respectively. Merchandise Mix The following table sets forth the approximate consolidated percentage of total net revenue from continuing operations attributable to each merchandise group for each of the periods indicated: 2. Summary of Significant Accounting Policies Principles of Consolidation The Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. At January 30, 2016, the Company operated in one reportable segment. The Company exited its 77kids brand in Fiscal 2012. These Consolidated Financial Statements reflect the results of 77kids as discontinued operations for all periods presented. Fiscal Year Our fiscal year ends on the Saturday nearest to January 31. As used herein, “Fiscal 2016” refers to the 52 week period ending January 28, 2017. “Fiscal 2015”, “Fiscal 2014” and “Fiscal 2013” refer to the 52-week periods ended January 30, 2016, January 31, 2015 and February 1, 2014, respectively. “Fiscal 2012” refers to the 53-week period ended February 2, 2013. Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. On an ongoing basis, our management reviews its estimates based on currently available information. Changes in facts and circumstances may result in revised estimates. Recent Accounting Pronouncements In May 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 is a comprehensive new revenue recognition model that expands disclosure requirements and requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. Originally, ASU 2014-09 was effective for annual reporting periods beginning after December 15, 2016. In July 2015, the FASB voted to approve amendments deferring the effective date by one year to be effective for annual reporting periods beginning after December 15, 2017. Accordingly, the Company will adopt ASU 2014-09 on February 4, 2018. The Company does not expect a material impact of the adoption of this guidance on the Company’s consolidated financial condition, results of operations or cash flows In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”), which requires entities to present deferred tax assets and deferred tax liabilities as noncurrent in a classified balance sheet. The ASU may be applied prospectively or retrospectively. The Company adopted the ASU on January 30, 2016, applied retrospectively. In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”) which replaces the existing guidance in ASC 840, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years and requires retrospective application. The Company will adopt in Fiscal 2019 and is currently evaluating the impact of ASU 2016-02 to its Consolidated Financial Statements. Foreign Currency Translation In accordance with Accounting Standards Codification (“ASC”) 830, Foreign Currency Matters, assets and liabilities denominated in foreign currencies were translated into United States dollars (“USD”) (the reporting currency) at the exchange rates prevailing at the balance sheet date. Revenues and expenses denominated in foreign currencies were translated into USD at the monthly average exchange rates for the period. Gains or losses resulting from foreign currency transactions are included in the results of operations, whereas, related translation adjustments are reported as an element of other comprehensive income in accordance with ASC 220, Comprehensive Income (refer to Note 11 to the Consolidated Financial Statements). Cash and Cash Equivalents The Company considers all highly liquid investments purchased with a remaining maturity of three months or less to be cash equivalents. As of January 30, 2016 and January 31, 2015, the Company held no short-term investments. Refer to Note 3 to the Consolidated Financial Statements for information regarding cash and cash equivalents and investments. Merchandise Inventory Merchandise inventory is valued at the lower of average cost or market, utilizing the retail method. Average cost includes merchandise design and sourcing costs and related expenses. The Company records merchandise receipts at the time which both title and risk of loss for the merchandise transfers to the Company. The Company reviews its inventory levels to identify slow-moving merchandise and generally uses markdowns to clear merchandise. Additionally, the Company estimates a markdown reserve for future planned permanent markdowns related to current inventory. Markdowns may occur when inventory exceeds customer demand for reasons of style, seasonal adaptation, changes in customer preference, lack of consumer acceptance of fashion items, competition, or if it is determined that the inventory in stock will not sell at its currently ticketed price. Such markdowns may have a material adverse impact on earnings, depending on the extent and amount of inventory affected. The Company also estimates a shrinkage reserve for the period between the last physical count and the balance sheet date. The estimate for the shrinkage reserve, based on historical results, can be affected by changes in merchandise mix and changes in actual shrinkage trends. Property and Equipment Property and equipment is recorded on the basis of cost with depreciation computed utilizing the straight-line method over the assets’ estimated useful lives. The useful lives of our major classes of assets are as follows: Buildings 25 years Leasehold improvements Lesser of 10 years or the term of the lease Fixtures and equipment 5 years In accordance with ASC 360, Property, Plant, and Equipment, the Company’s management evaluates the value of leasehold improvements and store fixtures associated with retail stores, which have been open for a period of time sufficient to reach maturity. The Company evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of the assets. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded separately as a component of operating income under loss on impairment of assets. During Fiscal 2015, the Company recorded no asset impairment charges. During Fiscal 2014, the Company recorded pre-tax asset impairment charges of $33.5 million that includes $25.1 million for the impairment of 79 retail stores recorded as a loss on impairment of assets in the Consolidated Statements of Operations. Based on the Company’s evaluation of current and future projected performance, it was determined that these stores would not be able to generate sufficient cash flow over the expected remaining lease term to recover the carrying value of the respective stores’ assets. Additionally, the Company recorded $8.4 million of impairment charges related to corporate assets. During Fiscal 2013, the Company recorded asset impairment charges of $44.5 million consisting of $25.2 million for the impairment of 69 retail stores and $19.3 million for the Company’s Warrendale, Pennsylvania Distribution Center, recorded as a loss on impairment of assets in the Consolidated Statements of Operations. The retail store impairments were recorded based on the results of the Company’s evaluation of stores that considered performance during the holiday selling season and a significant portfolio review in the fourth quarter of Fiscal 2013 that considered current and future performance projections and strategic real estate initiatives. The Company determined that these stores would not be able to generate sufficient cash flow over the expected remaining lease term to recover the carrying value of the respective stores assets. When the Company closes, remodels or relocates a store prior to the end of its lease term, the remaining net book value of the assets related to the store is recorded as a write-off of assets within depreciation and amortization expense. Refer to Note 7 to the Consolidated Financial Statements for additional information regarding property and equipment. Goodwill The Company’s goodwill is primarily related to the acquisition of its importing operations, Canadian, Hong Kong and China businesses and the recent acquisition of Tailgate. In accordance with ASC 350, Intangibles- Goodwill and Other (“ASC 350”), the Company evaluates goodwill for possible impairment on at least an annual basis and last performed an annual impairment test as of January 30, 2016. As a result of the Company’s annual goodwill impairment test, the Company concluded that its goodwill was not impaired. Refer to Note 17 to the Consolidated Financial Statements for additional information on the acquisition of Tailgate. Intangible Assets Intangible assets are recorded on the basis of cost with amortization computed utilizing the straight-line method over the assets’ estimated useful lives. The Company’s intangible assets, which primarily include trademark assets, are amortized over 15 to 25 years. The Company evaluates intangible assets for impairment in accordance with ASC 350 when events or circumstances indicate that the carrying value of the asset may not be recoverable. Such an evaluation includes the estimation of undiscounted future cash flows to be generated by those assets. If the sum of the estimated future undiscounted cash flows are less than the carrying amounts of the assets, then the assets are impaired and are adjusted to their estimated fair value. No intangible asset impairment charges were recorded for all periods presented. Refer to Note 8 to the Consolidated Financial Statements for additional information regarding intangible assets. Deferred Lease Credits Deferred lease credits represent the unamortized portion of construction allowances received from landlords related to the Company’s retail stores. Construction allowances are generally comprised of cash amounts received by the Company from its landlords as part of the negotiated lease terms. The Company records a receivable and a deferred lease credit liability at the lease commencement date (date of initial possession of the store). The deferred lease credit is amortized on a straight-line basis as a reduction of rent expense over the term of the original lease (including the pre-opening build-out period). The receivable is reduced as amounts are received from the landlord. Self-Insurance Liability The Company is self-insured for certain losses related to employee medical benefits and worker’s compensation. Costs for self-insurance claims filed and claims incurred but not reported are accrued based on known claims and historical experience. Management believes that it has adequately reserved for its self-insurance liability, which is capped through the use of stop loss contracts with insurance companies. However, any significant variation of future claims from historical trends could cause actual results to differ from the accrued liability. Co-branded Credit Card and Customer Loyalty Program The Company offers a co-branded credit card (the “AEO Visa Card”) and a private label credit card (the “AEO Credit Card”) under the AEO and Aerie brands. These credit cards are issued by a third-party bank (the “Bank”) in accordance with a credit card agreement (“the Agreement”). The Company has no liability to the Bank for bad debt expense, provided that purchases are made in accordance with the Bank’s procedures. We receive additional funding from the bank based on the Agreement and card activity. We recognize revenue for the additional funding when the amounts are fixed or determinable and collectability is reasonably assured. This revenue is recorded in other revenue, which is a component of total net revenue in our Consolidated Statements of Operations. Once a customer is approved to receive the AEO Visa Card or the AEO Credit Card and the card is activated, the customer is eligible to participate in the credit card rewards program. Customers who make purchases at AEO and Aerie earn discounts in the form of savings certificates when certain purchase levels are reached. Also, AEO Visa Card customers who make purchases at other retailers where the card is accepted earn additional discounts. Savings certificates are valid for 90 days from issuance. Points earned under the credit card rewards program on purchases at AEO and Aerie are accounted for by analogy to ASC 605-25, Revenue Recognition, Multiple Element Arrangements (“ASC 605-25”). The Company believes that points earned under its point and loyalty programs represent deliverables in a multiple element arrangement rather than a rebate or refund of cash. Accordingly, the portion of the sales revenue attributed to the award points is deferred and recognized when the award is redeemed or when the points expire. Additionally, credit card reward points earned on non-AEO or Aerie purchases are accounted for in accordance with ASC 605-25. As the points are earned, a current liability is recorded for the estimated cost of the award, and the impact of adjustments is recorded in cost of sales. The Company offers its customers the AEREWARDS® loyalty program (the “Program”). Under the Program, customers accumulate points based on purchase activity and earn rewards by reaching certain point thresholds during three-month earning periods. Rewards earned during these periods are valid through the stated expiration date, which is approximately one month from the mailing date of the reward. These rewards can be redeemed for a discount on a purchase of merchandise. Rewards not redeemed during the one-month redemption period are forfeited. The Company determined that rewards earned using the Program should be accounted for in accordance with ASC 605-25. Accordingly, the portion of the sales revenue attributed to the award credits is deferred and recognized when the awards are redeemed or expire. Income Taxes The Company calculates income taxes in accordance with ASC 740, Income Taxes (“ASC 740”), which requires the use of the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the difference between the Consolidated Financial Statement carrying amounts of existing assets and liabilities and their respective tax bases as computed pursuant to ASC 740. Deferred tax assets and liabilities are measured using the tax rates, based on certain judgments regarding enacted tax laws and published guidance, in effect in the years when those temporary differences are expected to reverse. A valuation allowance is established against the deferred tax assets when it is more likely than not that some portion or all of the deferred taxes may not be realized. Changes in the Company’s level and composition of earnings, tax laws or the deferred tax valuation allowance, as well as the results of tax audits, may materially impact the Company’s effective income tax rate. The Company evaluates its income tax positions in accordance with ASC 740 which prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a particular jurisdiction. Under ASC 740, a tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable based on its technical merits. The calculation of the deferred tax assets and liabilities, as well as the decision to recognize a tax benefit from an uncertain position and to establish a valuation allowance require management to make estimates and assumptions. The Company believes that its assumptions and estimates are reasonable, although actual results may have a positive or negative material impact on the balances of deferred tax assets and liabilities, valuation allowances or net income. Revenue Recognition Revenue is recorded for store sales upon the purchase of merchandise by customers. The Company’s e-commerce operation records revenue upon the estimated customer receipt date of the merchandise. Shipping and handling revenues are included in total net revenue. Sales tax collected from customers is excluded from revenue and is included as part of accrued income and other taxes on the Company’s Consolidated Balance Sheets. Revenue is recorded net of estimated and actual sales returns and deductions for coupon redemptions and other promotions. The Company records the impact of adjustments to its sales return reserve quarterly within total net revenue and cost of sales. The sales return reserve reflects an estimate of sales returns based on projected merchandise returns determined through the use of historical average return percentages. Revenue is not recorded on the purchase of gift cards. A current liability is recorded upon purchase, and revenue is recognized when the gift card is redeemed for merchandise. Additionally, the Company recognizes revenue on unredeemed gift cards based on an estimate of the amounts that will not be redeemed (“gift card breakage”), determined through historical redemption trends. Gift card breakage revenue is recognized in proportion to actual gift card redemptions as a component of total net revenue. For further information on the Company’s gift card program, refer to the Gift Cards caption below. The Company recognizes royalty revenue generated from its license or franchise agreements based upon a percentage of merchandise sales by the licensee/franchisee. This revenue is recorded as a component of total net revenue when earned. Cost of Sales, Including Certain Buying, Occupancy and Warehousing Expenses Cost of sales consists of merchandise costs, including design, sourcing, importing and inbound freight costs, as well as markdowns, shrinkage and certain promotional costs (collectively "merchandise costs") and buying, occupancy and warehousing costs. Design costs are related to the Company's Design Center operations and include compensation and employee benefit expenses, including salaries, incentives, travel, supplies and samples for our design teams, as well as rent and depreciation for the Company’s Design Center. These costs are included in cost of sales as the respective inventory is sold. Buying, occupancy and warehousing costs consist of compensation, employee benefit expenses and travel for the Company’s buyers and certain senior merchandising executives; rent and utilities related to the Company’s stores, corporate headquarters, distribution centers and other office space; freight from the Company’s distribution centers to the stores; compensation and supplies for the Company’s distribution centers, including purchasing, receiving and inspection costs; and shipping and handling costs related to our e-commerce operation. Gross profit is the difference between total net revenue and cost of sales. Selling, General and Administrative Expenses Selling, general and administrative expenses consist of compensation and employee benefit expenses, including salaries, incentives and related benefits associated with the Company’s stores and corporate headquarters. Selling, general and administrative expenses also include advertising costs, supplies for our stores and home office, communication costs, travel and entertainment, leasing costs and services purchased. Selling, general and administrative expenses do not include compensation, employee benefit expenses and travel for the Company’s design, sourcing and importing teams, the Company’s buyers and the Company’s distribution centers as these amounts are recorded in cost of sales. Advertising Costs Certain advertising costs, including direct mail, in-store photographs and other promotional costs are expensed when the marketing campaign commences. As of January 30, 2016 and January 31, 2015, the Company had prepaid advertising expense of $6.1 million and $6.6 million, respectively. All other advertising costs are expensed as incurred. The Company recognized $104.1 million, $94.2 million and $87.0 million in advertising expense during Fiscal 2015, Fiscal 2014 and Fiscal 2013, respectively. Store Pre-Opening Costs Store pre-opening costs consist primarily of rent, advertising, supplies and payroll expenses. These costs are expensed as incurred. Other Income, Net Other income, net consists primarily of foreign currency transaction gain/loss, interest income/expense and realized investment gains/losses. Gift Cards The value of a gift card is recorded as a current liability upon purchase and revenue is recognized when the gift card is redeemed for merchandise. The Company estimates gift card breakage and recognizes revenue in proportion to actual gift card redemptions as a component of total net revenue. The Company determines an estimated gift card breakage rate by continuously evaluating historical redemption data and the time when there is a remote likelihood that a gift card will be redeemed. The Company recorded gift card breakage of $8.2 million, $7.0 million and $7.3 million during Fiscal 2015, Fiscal 2014 and Fiscal 2013, respectively. Legal Proceedings and Claims The Company is subject to certain legal proceedings and claims arising out of the conduct of its business. In accordance with ASC 450, Contingencies (“ASC 450”), the Company records a reserve for estimated losses when the loss is probable and the amount can be reasonably estimated. If a range of possible loss exists and no anticipated loss within the range is more likely than any other anticipated loss, the Company records the accrual at the low end of the range, in accordance with ASC 450. As the Company believes that it has provided adequate reserves, it anticipates that the ultimate outcome of any matter currently pending against the Company will not materially affect the consolidated financial position, results of operations or consolidated cash flows of the Company. Supplemental Disclosures of Cash Flow Information The table below shows supplemental cash flow information for cash amounts paid during the respective periods: Segment Information In accordance with ASC 280, Segment Reporting (“ASC 280”), the Company has identified three operating segments (American Eagle Outfitters® Brand retail stores, Aerie® by American Eagle Outfitters® retail stores and AEO Direct) that reflect the Company’s operational structure as well as the business’s internal view of analyzing results and allocating resources. All of the operating segments have been aggregated and are presented as one reportable segment, as permitted by ASC 280. The following tables present summarized geographical information: (1) Amounts represent sales from American Eagle Outfitters and Aerie international retail stores, AEO Direct sales that are billed to and/or shipped to foreign countries and international franchise revenue. 3. Cash and Cash Equivalents The following table summarizes the fair market value of our cash and marketable securities, which are recorded on the Consolidated Balance Sheets: Proceeds from the sale of available-for-sale securities were $10.0 million and $162.8 million for Fiscal 2014 and Fiscal 2013, respectively. 4. Fair Value Measurements ASC 820, Fair Value Measurement Disclosures (“ASC 820”), defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. Fair value is defined under ASC 820 as the exit price associated with the sale of an asset or transfer of a liability in an orderly transaction between market participants at the measurement date. Financial Instruments Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. In addition, ASC 820 establishes this three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: · Level 1 - Quoted prices in active markets for identical assets or liabilities. · Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. · Level 3 - Unobservable inputs (i.e., projections, estimates, interpretations, etc.) that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. As of January 30, 2016 and January 31, 2015, the Company held certain assets that are required to be measured at fair value on a recurring basis. These include cash equivalents and investments. In accordance with ASC 820, the following tables represent the fair value hierarchy for the Company’s financial assets (cash equivalents and investments) measured at fair value on a recurring basis as of January 30, 2016 and January 31, 2015: In the event the Company holds Level 3 investments, a discounted cash flow model is used to value those investments. There were no Level 3 investments at January 30, 2016 or January 31, 2015. Non-Financial Assets The Company’s non-financial assets, which include goodwill, intangible assets and property and equipment, are not required to be measured at fair value on a recurring basis. However, if certain triggering events occur, or if an annual impairment test is required and the Company is required to evaluate the non-financial instrument for impairment, a resulting asset impairment would require that the non-financial asset be recorded at the estimated fair value. As a result of the Company’s annual goodwill impairment test performed as of January 30, 2016, the Company concluded that its goodwill was not impaired. Certain long-lived assets were measured at fair value on a nonrecurring basis using Level 3 inputs as defined in ASC 820. During Fiscal 2014 and Fiscal 2013, certain long-lived assets related to the Company’s retail stores and corporate assets were determined to be unable to recover their respective carrying values and were written down to their fair value, resulting in a loss of $33.5 million and 44.5 million, respectively, which is recorded as a loss on impairment of assets within the Consolidated Statements of Operations. The fair value of the impaired assets after the recorded loss is an immaterial amount. The fair value of the Company’s stores were determined by estimating the amount and timing of net future cash flows and discounting them using a risk-adjusted rate of interest. The Company estimates future cash flows based on its experience and knowledge of the market in which the store is located. 5. Earnings per Share The following is a reconciliation between basic and diluted weighted average shares outstanding: Equity awards to purchase approximately 13.000, 2.3 million and 1.7 million shares of common stock during the Fiscal 2015, Fiscal 2014 and Fiscal 2013, respectively, were outstanding, but were not included in the computation of weighted average diluted common share amounts as the effect of doing so would have been anti-dilutive. Additionally, for Fiscal 2015, approximately 0.7 million of performance-based restricted stock awards were not included in the computation of weighted average diluted common share amounts because the number of shares ultimately issued is contingent on the Company’s performance compared to pre-established performance goals. For Fiscal 2014, approximately 1.9 million of performance-based restricted stock awards were not included in the computation of weighted average diluted common share amounts because the number of shares ultimately issued is contingent on the Company’s performance compared to pre-established performance goals. Refer to Note 12 to the Consolidated Financial Statements for additional information regarding share-based compensation. 6. Accounts Receivable Accounts receivable are comprised of the following: 7. Property and Equipment Property and equipment consists of the following: Depreciation expense is summarized as follows: Additionally, during Fiscal 2015, Fiscal 2014 and Fiscal 2013, the Company recorded $4.8 million, $6.4 million and $14.6 million, respectively, related to asset write-offs within depreciation and amortization expense. 8. Intangible Assets Intangible assets include costs to acquire and register the Company’s trademark assets. During Fiscal 2015, the Company added $5.7 million net intangible assets from the Tailgate acquisition. The following table represents intangible assets as of January 30, 2016 and January 31, 2015: Amortization expense is summarized as follows: The table below summarizes the estimated future amortization expense for intangible assets existing as of January 30, 2016 for the next five Fiscal Years: Refer to Note 17 to the Consolidated Financial Statements for additional information on the acquisition of Tailgate. 9. Other Credit Arrangements In Fiscal 2014, the Company entered into a new Credit Agreement (“Credit Agreement”) for five-year, syndicated, asset-based revolving credit facilities (the “Credit Facilities”). The Credit Agreement provides senior secured revolving credit for loans and letters of credit up to $400 million, subject to customary borrowing base limitations. The Credit Facilities provide increased financial flexibility and take advantage of a favorable credit environment. All obligations under the Credit Facilities are unconditionally guaranteed by certain subsidiaries. The obligations under the Credit Agreement are secured by a first-priority security interest in certain working capital assets of the borrowers and guarantors, consisting primarily of cash, receivables, inventory and certain other assets, and will be further secured by first-priority mortgages on certain real property. As of January 30, 2016, the Company was in compliance with the terms of the Credit Agreement and had $8.0 million outstanding in stand-by letters of credit. No loans were outstanding under the Credit Agreement on January 30, 2016. Additionally, the Company has borrowing agreements with two separate financial institutions under which it may borrow an aggregate of $130.0 million USD for the purposes of trade letter of credit issuances. The availability of any future borrowings under the trade letter of credit facilities is subject to acceptance by the respective financial institutions. As of January 30, 2016, the Company had outstanding trade letters of credit of $0.4 million. 10. Leases The Company leases all store premises, some of its office space and certain information technology and office equipment. The store leases generally have initial terms of 10 years and are classified as operating leases. Most of these store leases provide for base rentals and the payment of a percentage of sales as additional contingent rent when sales exceed specified levels. Additionally, most leases contain construction allowances and/or rent holidays. In recognizing landlord incentives and minimum rent expense, the Company amortizes the items on a straight-line basis over the lease term (including the pre-opening build-out period). A summary of fixed minimum and contingent rent expense for all operating leases follows: In addition, the Company is typically responsible under its store, office and distribution center leases for tenant occupancy costs, including maintenance costs, common area charges, real estate taxes and certain other expenses. The table below summarizes future minimum lease obligations, consisting of fixed minimum rent, under operating leases in effect at January 30, 2016: 11. Other Comprehensive Income The accumulated balances of other comprehensive income included as part of the Consolidated Statements of Stockholders’ Equity follow: (1) Foreign currency translation adjustments are not adjusted for income taxes as they relate to permanent investments in our subsidiaries. 12. Share-Based Payments The Company accounts for share-based compensation under the provisions of ASC 718, Compensation - Stock Compensation (“ASC 718”), which requires the Company to measure and recognize compensation expense for all share-based payments at fair value. Total share-based compensation expense included in the Consolidated Statements of Operations for Fiscal 2015 and Fiscal 2014 was $35.0 million ($23.2 million, net of tax) and $16.1 million ($9.9 million, net of tax), respectively. Total share-based compensation expense included in the Consolidated Statements of Operations for Fiscal 2013 was a net benefit of $6.5 million ($4.1 million, net of tax). ASC 718 requires recognition of compensation cost under a non-substantive vesting period approach for awards containing provisions that accelerate or continue vesting upon retirement. Accordingly, for awards with such provisions, the Company recognizes compensation expense over the period from the grant date to the date retirement eligibility is achieved, if that is expected to occur during the nominal vesting period. Additionally, for awards granted to retirement eligible employees, the full compensation cost of an award must be recognized immediately upon grant. At January 30, 2016, the Company had awards outstanding under three share-based compensation plans, which are described below. Share-based compensation plans 2014 Stock Award and Incentive Plan The 2014 Plan was approved by the stockholders on May 29, 2014. The 2014 Plan authorized 11.5 million shares for issuance, in the form of options, stock appreciation rights (“SARS”), restricted stock, restricted stock units, bonus stock and awards, performance awards, dividend equivalents and other stock based awards. The 2014 Plan provides that the maximum number of shares awarded to any individual may not exceed 4.0 million shares per year for options and SARS and no more than 1.5 million shares may be granted with respect to each of restricted shares of stock and restricted stock units plus any unused carryover limit from the previous year. The 2014 Plan allows the Compensation Committee of the Board to determine which employees receive awards and the terms and conditions of the awards that are mandatory under the 2014 Plan. The 2014 Plan provides for grants to directors who are not officers or employees of the Company, which are not to exceed in value $300,000 in any single calendar year ($500,000 in the first year a person becomes a non-employee director). Through January 30, 2016, approximately 2.4 million shares of restricted stock and approximately 71,000 shares of common stock had been granted under the 2014 Plan to employees and directors. Approximately 50% of the restricted stock awards are performance-based and are earned if the established performance goals are met. The remaining 50% of the restricted stock awards are time-based and 85% vest ratably over three years, 6% cliff vest in one year, 5% cliff vest in two years and 4% cliff vest in three years. 2005 Stock Award and Incentive Plan The 2005 Plan was approved by the stockholders on June 15, 2005. The 2005 Plan authorized 18.4 million shares for issuance, of which 6.4 million shares are available for full value awards in the form of restricted stock awards, restricted stock units or other full value stock awards and 12.0 million shares are available for stock options, SAR, dividend equivalents, performance awards or other non-full value stock awards. The 2005 Plan was subsequently amended in Fiscal 2009 to increase the shares available for grant to 31.9 million without taking into consideration 9.1 million non-qualified stock options, 2.9 million shares of restricted stock and 0.2 million shares of common stock that had been previously granted under the 2005 plan to employees and directors (without considering cancellations as of January 31, 2009 of awards for 2.9 million shares). The 2005 Plan provides that the maximum number of shares awarded to any individual may not exceed 6.0 million shares per year for options and SAR and no more than 4.0 million shares may be granted with respect to each of restricted shares of stock and restricted stock units plus any unused carryover limit from the previous year. The 2005 Plan allows the Compensation Committee of the Board to determine which employees receive awards and the terms and conditions of the awards that are mandatory under the 2005 Plan. The 2005 Plan provides for grants to directors who are not officers or employees of the Company, which are not to exceed 20,000 shares per year (not to be adjusted for stock splits). Through January 30, 2016, 17.1 million non-qualified stock options, 10.4 million shares of restricted stock and 0.4 million shares of common stock had been granted under the 2005 Plan to employees and directors (without considering cancellations to date of awards for 14.0 million shares). Approximately 95% of the options granted under the 2005 Plan vest over three years, 4% vest over one year and 1% vest over five years. Options were granted for ten and seven year terms. Approximately 62% of the restricted stock awards are performance-based and are earned if the Company meets established performance goals. The remaining 38% of the restricted stock awards are time-based and vest over three years. The 2005 Plan terminated on May 29, 2014 with all rights of the awardees and all unexpired awards continuing in force and operation after the termination. 1999 Stock Incentive Plan The 1999 Stock Option Plan (the “1999 Plan”) was approved by the stockholders on June 8, 1999. The 1999 Plan authorized 18.0 million shares for issuance in the form of stock options, stock appreciation rights (“SAR”), restricted stock awards, performance units or performance shares. The 1999 Plan was subsequently amended to increase the shares available for grant to 33.0 million. Additionally, the 1999 Plan provided that the maximum number of shares awarded to any individual may not exceed 9.0 million shares. The 1999 Plan allowed the Compensation Committee to determine which employees and consultants received awards and the terms and conditions of these awards. The 1999 Plan provided for a grant of 1,875 stock options quarterly (not to be adjusted for stock splits) to each director who is not an officer or employee of the Company starting in August 2003. The Company ceased making these quarterly stock option grants in June 2005. Under this plan, 33.2 million non-qualified stock options and 6.7 million shares of restricted stock were granted to employees and certain non-employees (without considering cancellations to date of awards for 9.7 million shares). Approximately 33% of the options granted were to vest over eight years after the date of grant but were accelerated as the Company met annual performance goals. Approximately 34% of the options granted under the 1999 Plan vest over three years, 23% vest over five years and the remaining grants vest over one year. All options expire after 10 years. Performance-based restricted stock was earned if the Company met established performance goals. The 1999 Plan terminated on June 15, 2005 with all rights of the awardees and all unexpired awards continuing in force and operation after the termination. Stock Option Grants The Company grants both time-based and performance-based stock options under the 2005 Plan. Time-based stock option awards vest over the requisite service period of the award or to an employee’s eligible retirement date, if earlier. Performance-based stock option awards vest over three years and are earned if the Company meets pre-established performance goals during each year. A summary of the Company’s stock option activity under all plans for Fiscal 2015 follows: (1) Options exercised during Fiscal 2015 ranged in price from $8.09 to $16.49. (2) Options exercisable represent “in-the-money” vested options based upon the weighted average exercise price of vested options compared to the Company’s stock price at January 30, 2016. The weighted-average grant date fair value of stock options granted during Fiscal 2014 and Fiscal 2013 was $3.99 and $4.17, respectively. The aggregate intrinsic value of options exercised during Fiscal 2015, Fiscal 2014 and Fiscal 2013 was $0.4 million, $1.3 million and $3.9 million, respectively. Cash received from the exercise of stock options and the actual tax benefit realized from share-based payments was $7.3 million and ($0.5) million, respectively, for Fiscal 2015. Cash received from the exercise of stock options and the actual tax benefit realized from share-based payments was $7.3 million and $(0.5) million, respectively, for Fiscal 2014. Cash received from the exercise of stock options and the actual tax benefit realized from share-based payments was $6.2 million and $8.7 million, respectively, for Fiscal 2013. The fair value of stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: (1) Based on the U.S. Treasury yield curve in effect at the time of grant with a term consistent with the expected life of our stock options. (2) Based on a combination of historical volatility of the Company’s common stock and implied volatility. (3) Represents the period of time options are expected to be outstanding. The weighted average expected option terms were determined based on historical experience. (4) Based on historical experience. As of January 30, 2016, there was $0.2 million of unrecognized compensation expense related to nonvested stock option awards that is expected to be recognized over a weighted average period of 1.2 years. Restricted Stock Grants Time-based restricted stock awards are comprised of time-based restricted stock units. These awards vest over three years.Time-based restricted stock units receive dividend equivalents in the form of additional time-based restricted stock units, which are subject to the same restrictions and forfeiture provisions as the original award. Performance-based restricted stock awards include performance-based restricted stock units. These awards cliff vest at the end of a three year period based upon the Company’s achievement of pre-established goals throughout the term of the award. Performance-based restricted stock units receive dividend equivalents in the form of additional performance-based restricted stock units, which are subject to the same restrictions and forfeiture provisions as the original award. The grant date fair value of all restricted stock awards is based on the closing market price of the Company’s common stock on the date of grant. A summary of the activity of the Company’s restricted stock is presented in the following tables: As of January 30, 2016, there was $14.3 million of unrecognized compensation expense related to nonvested time-based restricted stock unit awards that is expected to be recognized over a weighted average period of 1.7 years. Based on current probable performance, there is $9.4 million of unrecognized compensation expense related to performance-based restricted stock unit awards which will be recognized as achievement of performance goals is probable over a one to three year period. As of January 30, 2016, the Company had 6.0 million shares available for all equity grants. 13. Retirement Plan and Employee Stock Purchase Plan The Company maintains a profit sharing and 401(k) plan (the “Retirement Plan”). Under the provisions of the Retirement Plan, full-time employees and part-time employees are automatically enrolled to contribute 3% of their salary if they have attained 20½ years of age. In addition, full-time employees need to have completed 60 days of service and part-time employees must complete 1,000 hours worked to be eligible. Individuals can decline enrollment or can contribute up to 50% of their salary to the 401(k) plan on a pretax basis, subject to IRS limitations. After one year of service, the Company will match 100% of the first 3% of pay plus an additional 25% of the next 3% of pay that is contributed to the plan. Contributions to the profit sharing plan, as determined by the Board, are discretionary. The Company recognized $10.6 million, $10.5 million and $9.6 million in expense during Fiscal 2015, Fiscal 2014 and Fiscal 2013, respectively, in connection with the Retirement Plan. The Employee Stock Purchase Plan is a non-qualified plan that covers all full-time employees and part-time employees who are at least 18 years old and have completed 60 days of service. Contributions are determined by the employee, with the Company matching 15% of the investment up to a maximum investment of $100 per pay period. These contributions are used to purchase shares of Company stock in the open market. 14. Income Taxes The components of income before income taxes from continuing operations were: The significant components of the Company’s deferred tax assets and liabilities were as follows: The net decrease in deferred tax assets and liabilities was primarily due to an increase in the deferred tax assets for compensation and benefits offset by an increase in the deferred tax liability for property and equipment basis differences. Additionally, there was a decrease to the valuation allowance related to foreign deferred tax assets. As of January 30, 2016, the Company had deferred tax assets related to state and foreign net operating loss carryovers of $1.7 million and $5.2 million, respectively that could be utilized to reduce future years’ tax liabilities. A portion of these net operating loss carryovers begin expiring in the year 2018 and some have an indefinite carryforward period. Management believes it is more likely than not that a portion of the state and foreign net operating loss carryovers will not reduce future years’ tax liabilities in certain jurisdictions. As such a valuation allowance of $5.0 million has been recorded on the deferred tax assets related to the cumulative state and foreign net operating loss carryovers. We also provided for a valuation allowance of approximately $2.7 million related to other foreign deferred tax assets. The Company has foreign tax credit carryovers in the amount of $20.6 million and $19.3 million as of January 30, 2016 and January 31, 2015, respectively. The foreign tax credit carryovers begin to expire in Fiscal 2020 to the extent not utilized. No valuation allowance has been recorded on the foreign tax credit carryovers as the Company believes it is more likely than not that the foreign tax credits will be utilized prior to expiration. The Company has state income tax credit carryforwards of $6.9 million (net of federal tax) and $7.6 million (net of federal tax) as of January 30, 2016 and January 31, 2015, respectively. These income tax credits can be utilized to offset future state income taxes and have a carryforward period of 10 to16 years. They will begin to expire in Fiscal 2022. Significant components of the provision for income taxes from continuing operations were as follows: As a result of additional tax deductions related to share-based payments, tax benefits have been recognized as contributed capital for Fiscal 2015, Fiscal 2014 and Fiscal 2013 in the amounts of $(0.5) million, $(0.5) million and $8.7 million, respectively. U.S. income taxes have not been provided on the undistributed earnings of the Company’s foreign subsidiaries, as the Company intends to indefinitely reinvest the undistributed foreign earnings outside of the United States. As of January 30, 2016, the unremitted earnings of the Company’s foreign subsidiaries were approximately $23.4 million (USD). Upon distribution of the earnings in the form of dividends or otherwise, the Company would be subject to income and withholding taxes offset by foreign tax credits. Determination of the amount of unrecognized deferred U.S. income tax liability on these unremitted earnings is not practicable because of the complexities associated with this hypothetical calculation. The following table summarizes the activity related to our unrecognized tax benefits: As of January 30, 2016, the gross amount of unrecognized tax benefits was $5.7 million, of which $4.6 million would affect the effective income tax rate if recognized. The gross amount of unrecognized tax benefits as of January 31, 2015 was $12.6 million, of which $9.1 million would affect the effective income tax rate if recognized. Unrecognized tax benefits decreased by $6.9 million during Fiscal 2015, decreased $2.0 million during Fiscal 2014 and decreased by $2.6 million during Fiscal 2013. The unrecognized tax benefit changes were primarily related to federal and state income tax settlements and other changes in income tax reserves. Over the next twelve months the Company believes it is reasonably possible the unrecognized tax benefits could decrease by as much as $2.8 million as the result of federal and state tax settlements, statute of limitations lapses, and other changes to the reserves. The Company records accrued interest and penalties related to unrecognized tax benefits in income tax expense. Accrued interest and penalties related to unrecognized tax benefits included in the Consolidated Balance Sheet were $1.3 million and $1.6 million as of January 30, 2016 and January 31, 2015, respectively. An immaterial amount of interest and penalties were recognized in the provision for income taxes during Fiscal 2015, Fiscal 2014 and Fiscal 2013. The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Internal Revenue Service (“IRS”) examination of the Company’s U.S. federal income tax return for the tax year ended February 1, 2014 was completed during Fiscal 2015. Accordingly, all years prior to the tax year ended January 31, 2015 are no longer subject to U.S. federal income tax examinations by tax authorities. Additionally, the Company is participating in the IRS’s Compliance Assurance Process (CAP) for the tax years ended January 31, 2015 and January 30, 2016. The Company does not anticipate that any adjustments will result in a material change to its financial position, results of operations or cash flows. With respect to state and local jurisdictions and countries outside of the United States, with limited exceptions, generally, the Company and its subsidiaries are no longer subject to income tax audits for tax years before 2009. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result from these years. A reconciliation between the statutory federal income tax rate and the effective income tax rate from continuing operations follows: 15. Discontinued Operations In Fiscal 2012, the Company exited the 77kids business. In connection with the exit of the 77kids business, the Company became secondarily liable for obligations under lease agreements for 21 store leases assumed by the third party purchaser. In Fiscal 2014, the third party purchaser did not fulfill its obligations under the leases, resulting in the Company becoming primarily liable. The Company was required to make rental and lease termination payments and received reimbursement from the $11.5 million stand-by letter of credit provided by the third party purchaser. The cash outflow for the remaining lease termination costs was paid in Fiscal 2015. In accordance with ASC 460, Guarantees (“ASC 460”), as the Company became primarily liable under the leases upon the third party purchaser’s default, the estimated remaining amounts to terminate the lease agreements were accrued in our Consolidated Financial Statements related to these guarantees. A rollforward of the liabilities recognized in the Consolidated Balance Sheets is as follows: (1) Adjustments resulting from favorably settling lease termination obligations during Fiscal 2015. The tables below present the significant components of 77kids’ results included in Loss from Discontinued Operations on the Consolidated Statements of Operations for the years ended January 30, 2016, January 31, 2015 and February 1, 2014. 16. Restructuring Charges During Fiscal 2014, the Company undertook restructuring aimed at strengthening the store portfolio and reducing corporate overhead, including severance and office space consolidation. These changes are aimed at driving efficiencies and aligning investments in areas that help fuel the business. There we no restructuring charges in Fiscal 2015. Costs associated with restructuring activities are recorded when incurred. A summary of costs recognized within Restructuring Charges on the Consolidated Income Statement for Fiscal 2014 are included in the table as follows. A rollforward of the liabilities recognized in the Consolidated Balance Sheet is as follows: 17. Acquisitions During Fiscal 2015, the Company completed the acquisition of Tailgate, which owns and operates Tailgate, a vintage, sports-inspired apparel brand with a college town store concept, and Todd Snyder New York, a premium menswear brand, for total consideration of $13.5 million, of which $10.4 million was paid in cash. The total purchase price was allocated to the net tangible and intangible assets acquired based on their estimated fair values. Such estimated fair values require management to make estimates and judgments, especially with respect to intangible assets. The Company’s valuation of intangible assets, including deferred income taxes, is subject to finalization in Fiscal 2016. The preliminary allocation of the purchase price to the fair value of assets acquired is as follows: Results of operations of Tailgate have been included in our Consolidated Statements of Operations since the November 1, 2015 acquisition date. Pro forma results of the acquired business have not been presented as the results were not material to our Consolidated Financial Statements for all years presented and would not have been material had the acquisition occurred at the beginning of Fiscal 2015. 18. Quarterly Financial Information - Unaudited The sum of the quarterly EPS amounts may not equal the full year amount as the computations of the weighted average shares outstanding for each quarter and the full year are calculated independently. | Based on the provided text, which appears to be a fragment of a financial statement, here's a summary:
Revenue:
- The statement mentions net revenue from continuing operations for different merchandise groups
- Additional revenue is recognized from credit card programs when amounts are fixed and collectible
Expenses and Liabilities:
- The document discusses accounting for expenses, estimates, and potential changes in estimates
- Mentions debt expenses and funding from bank agreements
- References accounting for foreign currency transactions and translation adjustments
Credit Card Program Details:
- Offers AEO Visa Card and AEO Credit Card
- Customers earn rewards and discounts based on purchase levels
- Savings certificates are valid for 90 days (full duration not provided)
Accounting Practices:
- Follows ASC 220 for reporting comprehensive income
- Management reviews estimates based on available information
- Acknowledges potential differences between estimated and actual results
Note: The | Claude |
Index to Consolidated Financial Statements Management’s Report on Internal Control over Financial Reporting The management of Garrison Capital, Inc. (collectively with its subsidiaries, the “Company,” “we,” “us,” “our” and “Garrison Capital”) is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system is a process designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published consolidated financial statements. Garrison Capital’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions recorded necessary to permit the preparation of consolidated financial statements in accordance with U.S. generally accepted accounting principles. Our policies and procedures also provide reasonable assurance that receipts and expenditures are being made only in accordance with authorizations of management and the directors of Garrison Capital, and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our consolidated financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness as to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of Garrison Capital’s internal control over financial reporting as of December 31, 2016. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework issued in 2013. Based on the assessment, management believes that, as of December 31, 2016, our internal control over financial reporting is effective based on those criteria. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Garrison Capital Inc. and Subsidiaries: We have audited the accompanying consolidated statements of financial condition, including the consolidated schedules of investments, of Garrison Capital Inc. and Subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of operations, changes in net assets and cash flows for each of the three years in the period ended December 31, 2016, the GLC Trust 2013-2 schedule of investments as of December 31, 2016 included as Exhibit 99.1, and the GLC Trust 2013-2 schedule of investments as of December 31, 2015 included as Exhibit 99.2 (not filed herewith). These consolidated financial statements and GLC Trust 2013-2 schedules of investments are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and GLC Trust 2013-2 schedules of investments based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of investments owned as of December 31, 2016, by correspondence with the custodians, loan agents, trustees or management of the underlying investments, as applicable, or by other appropriate auditing procedures where replies from these parties, as applicable, were not received. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements and GLC Trust 2013-2 schedules of investments referred to above present fairly, in all material respects, the financial position of Garrison Capital Inc. and Subsidiaries as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. /s/ RSM US LLP New York, New York March 7, 2017 Garrison Capital Inc. and Subsidiaries Consolidated Statements of Financial Condition ($ in thousands, except share and per share amounts) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments December 31, 2016 ($ in thousands, except share amounts) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2016 (in thousands) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2016 (in thousands) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2016 (in thousands) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2016 (in thousands) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2016 (in thousands) ______________ * Denotes that all or a portion of the investment is held as collateral by the 2016-2 CLO (see Notes 1 and 7). ** Denotes that all or a portion of the loan is held by Garrison SBIC. L = London Interbank Offered Rate. P = Prime Rate (1) Not a qualifying asset under Section 55(a) of the Investment Company Act of 1940, as amended (the “1940 Act”). Under the 1940 Act, the Company may not acquire any non-qualifying asset unless, at the time the acquisition is made, qualifying assets represent at least 70% of the Company’s total assets. As of December 31, 2016, 95.2% of the Company’s assets were qualifying assets. (2) Net of incentive fee payable to a third party equal to 20% of any distribution after the Company has received its full net capital investment plus a 12% preferred return in GLC Trust 2013-2 and Prosper Marketplace Series B Preferred Stock. (3) Coupon is payable in cash, and/or payment-in-kind (“PIK”), or a combination thereof. (4) Investment is currently not income producing and placed on non-accrual status. (5) GLC Trust 2013-2 includes 1,458 small balance consumer loans with an average par of $4,860, a weighted average rate of 16.0% and a weighted average maturity of November 16, 2018. See Note 4 for additional information. See Exhibit 99.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 for detail on underlying loans. (6) The negative fair value is the result of the unfunded commitments being valued below par. These amounts may or may not be funded to the borrowing party currently or in the future. As required by the 1940 Act, investments are classified by level of control. “Control Investments” are investments in those companies that the Company is deemed to control as defined in the 1940 Act. “Affiliate Investments” are investments in those companies that are affiliated companies, as defined in the 1940 Act, other than Control Investments. “Non-Control/Non-Affiliate Investments” are those that are neither Control Investments nor Affiliate Investments. Generally, under the 1940 Act, the Company is deemed to control a company in which it has invested if it owns more than 25% of the voting securities of such company. The Company is deemed to be an affiliate of a company in which it has invested if it owns 5% or more of the voting securities of such company. All debt investments were income producing as of December 31, 2016, unless otherwise noted. Common and preferred equity investments are non income-producing unless otherwise noted. See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments December 31, 2015 ($ in thousands, except share amounts) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2015 (in thousands) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2015 (in thousands) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2015 (in thousands) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2015 (in thousands) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Schedule of Investments - (continued) December 31, 2015 (in thousands) ______________ * Denotes that all or a portion of the investment is held as collateral by the 2013-2 CLO (see Note 7). ** Denotes that all or a portion of the loan is held by Garrison SBIC. L = London Interbank Offered Rate. P = Prime Rate (1) Not a qualifying asset under Section 55(a) of the 1940 Act. Under the 1940 Act, the Company may not acquire any non-qualifying asset unless, at the time the acquisition is made, qualifying assets represent at least 70% of the Company’s total assets. (2) Net of incentive fee payable to a third party equal to 20% of any distribution after the Company has received its full net capital investment plus a 12% preferred return in GLC Trust 2013-2 and Prosper Marketplace Series B Preferred Stock. (3) Coupon is payable in cash, and/or PIK, or a combination thereof. (4) Investment is currently not income producing and placed on non-accrual status. (5) GLC Trust 2013-2 includes 2,637 small balance consumer loans with an average par of $7,087, a weighted average rate of 15.6% and a weighted average maturity of May 8, 2018. See Note 4 for additional information. See exhibit 99.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 for detail on underlying loans. (6) The negative fair value is the result of the unfunded commitments being valued below par. These amounts may or may not be funded to the borrowing party currently or in the future. All debt investments were income producing as of December 31, 2015, unless otherwise noted. Common and preferred equity investments are non-income producing unless otherwise noted. See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Statements of Operations ($ in thousands, except share and per share amounts) ______________ (1) Calculated using basic weighted average common shares outstanding. See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Statements of Changes in Net Assets ($ in thousands, except share and per share amounts) (1) Dividends from net investment income are determined in accordance with U.S. federal income tax regulations, which may differ from those amounts determined in accordance with U.S. GAAP. See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries Consolidated Statements of Cash Flows ($ in thousands, except share and per share amounts) See accompanying notes to consolidated financial statements. Garrison Capital Inc. and Subsidiaries December 31, 2016 1. Organization Garrison Capital Inc. (“GARS” and, collectively with its subsidiaries, the “Company”, “we” or “our”) is a Delaware corporation and is an externally managed, closed-end, non-diversified management investment company that has filed an election to be treated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). In addition, for tax purposes, GARS has elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”), for the period beginning October 9, 2012 and intends to qualify annually thereafter. GARS’ shares trade on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “GARS”. Our investment objective is to generate current income and capital appreciation by making investments generally in the range of $5.0 million to $25.0 million primarily in debt securities and loans of U.S. based middle-market companies, which we define as those having annual earnings before interest, taxes, depreciation and amortization (“EBITDA”) of between $5.0 million and $50.0 million. Our goal is to generate attractive risk-adjusted returns by assembling a broad portfolio of investments. We invest or provide direct lending primarily in (1) first lien senior secured loans, (2) second lien senior secured loans, (3) “one-stop” senior secured or “unitranche” loans, (4) subordinated or mezzanine loans, (5) unsecured consumer loans and (6) to a lesser extent, selected equity co-investments in middle-market companies. We use the term “one-stop” or “unitranche” to refer to a loan that combines characteristics of traditional first lien senior secured loans and second lien or subordinated loans. We use the term “mezzanine” to refer to a loan that ranks senior only to a borrower’s equity securities and ranks junior in right of payment to all of such borrower’s other indebtedness. The Company’s business and affairs are managed and controlled by the Company’s board of directors (the “Board”). Garrison Capital Inc. and Subsidiaries December 31, 2016 1. Organization - (continued) On May 17, 2013, GARS formed GLC Trust 2013-2, a Delaware statutory trust (“GLC Trust 2013-2”). This entity is a wholly owned subsidiary of GARS created for the purpose of investing in a portfolio of small balance consumer loans. GLC Trust 2013-2 is 100% owned by GARS. On July 18, 2014, GARS completed a $39.2 million term debt securitization (the “GLC Trust 2013-2 Securitization” and the notes offered thereby, the “GLC Trust 2013-2 Notes”) collateralized by the GLC Trust 2013-2 consumer loan portfolio. On September 25, 2013, Garrison Funding 2013-2 Ltd. (“GF 2013-2”) completed a $350.0 million collateralized loan obligation (the “2013-2 CLO”) through a private placement, the proceeds of which were utilized, along with cash on hand, to refinance an existing credit facility (see Note 7). Immediately following the completion of the 2013-2 CLO, Garrison Funding 2013-2 Manager LLC (“GF 2013-2 Manager”) owned 100% of the 2013-2 CLO Subordinated Notes (as defined below). GF 2013-2 Manager served as collateral manager to GF 2013-2 and entered into a sub-collateral management agreement with Garrison Capital Advisers LLC (the “Investment Adviser”). On May 29, 2014, Garrison Capital SBIC LP (“Garrison SBIC”), which has an investment objective substantially similar to GARS, was formed in accordance with small business investment company (“SBIC”) regulations to acquire up to $150.0 million in financing. Garrison SBIC received a license from the U.S Small Business Administration (the “SBA”) on May 26, 2015. Garrison SBIC is 100% owned by GARS. On August 18, 2016 and September 14, 2016, GARS formed Garrison Funding 2016-2 Ltd. and Garrison Funding 2016-2 LLC, respectively. Garrison Funding 2016-2 LLC is a wholly-owned and consolidated subsidiary of Garrison Funding 2016-2 Ltd. (collectively referred to as “GF 2016-2”). GF 2016-2 is a wholly-owned and consolidated subsidiary of GARS. GF 2016-2 completed a $300.0 million collateralized loan obligation (the “2016-2 CLO”) through a private placement, the proceeds of which were utilized, along with cash on hand, to refinance the 2013-2 CLO (see Note 7). GARS owns 100% of the 2016-2 CLO Subordinated Notes (as defined below). GARS serves as collateral manager to GF 2016-2 and has entered into a sub-collateral management agreement with the Investment Adviser. The 2013-2 CLO and 2016-2 CLO are collectively referred to as “the CLOs”. GARS will periodically form limited liability companies for the purpose of holding minority equity investments (the “GARS Equity Holdings Entities”). GARS intends to form a new GARS Equity Holdings Entity for each minority equity investment in order to provide specific tax treatment for individual investments. The GARS Equity Holdings Entities are 100% owned by GARS. American Stock Transfer & Trust Company, LLC (“AST”) serves as the transfer and dividend paying agent and registrar to GARS. Garrison Capital Inc. and Subsidiaries December 31, 2016 1. Organization - (continued) GARS entered into a custody agreement, which was effective as of October 9, 2012 (the “Custody Agreement”), with Deutsche Bank Trust Company Americas (the “Custodian”) to act as custodian for GARS. The Custodian is also the trustee of the CLOs and the custodian for Garrison SBIC. GARS entered into an administration agreement, which was effective as of October 9, 2012 (the “Administration Agreement”), with Garrison Capital Administrator LLC, a Delaware limited liability company (the “GARS Administrator”). GARS entered into an investment advisory agreement with the Investment Adviser, which was most recently amended and restated on August 5, 2016 (the “Investment Advisory Agreement”). The Investment Adviser is responsible for sourcing potential investments, conducting research and diligence on prospective investments and equity sponsors, analyzing investment opportunities, structuring our investments and monitoring our investments and portfolio companies on an ongoing basis subject to the supervision of the Board. The Investment Adviser was organized in November 2010 and is a registered investment adviser under the Investment Advisers Act of 1940, as amended. The Investment Adviser is an affiliate of Garrison Investment Group LP (the “Investment Manager”), which is also the investment manager of various stockholders of the Company. GLC Trust 2013-2 has entered into agreements with Prosper Funding LLC, GARS Administrator, U.S. Bank National Association, Wilmington Trust, National Association and Manufacturers and Traders Trust Company to act as servicer, securities administrator, indenture trustee and custodian, respectively, for GLC Trust 2013-2. 2. Significant Accounting Policies and Recent Updates Basis of Presentation The Company is an investment company as defined in the accounting and reporting guidance under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 946 - Financial Services - Investment Companies (“ASC Topic 946”). The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for financial information and pursuant to the requirements for reporting on Form 10-K and Articles 6 or 10 of Regulation S-X. The consolidated financial statements include the accounts of GARS and its wholly-owned subsidiaries. In the opinion of management, the consolidated financial statements reflect all adjustments and reclassifications consisting solely of normal accruals that are necessary for the fair presentation of financial results as of and for the periods presented. All intercompany balances and transactions have been eliminated in consolidation. The accounts of the subsidiaries are prepared for the same reporting period as GARS using consistent accounting policies. Certain prior period amounts have been reclassified to conform to the current period presentation including but not limited to deferred financing costs and deferred offering costs. Basis for Consolidation The consolidated financial statements include the accounts of GARS and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. The accounts of the subsidiaries are prepared for the same reporting period as GARS using consistent accounting policies. Under the investment company rules and regulations pursuant to the American Institute of Certified Public Accountants Audit and Accounting Guide for Investment Companies, codified in ASC Topic 946, the Company is precluded from consolidating any entity other than another investment company. The Company generally consolidates any investment company when it owns 100% of its partners’ or members’ capital or equity units or 100% of the economic equity interest. ASC Topic 946 provides for the consolidation of a controlled operating company that provides substantially all of its services to the investment company or its consolidated subsidiaries. GF 2013-2 Manager owns a 100% economic interest in GF 2013-2, which is an investment company for accounting purposes, and also provides collateral management services solely to GF 2013-2. As such, GARS has consolidated the accounts of these entities into these consolidated financial statements. As a result of this consolidation, the amounts that were outstanding under the 2013-2 CLO were treated as the Company’s indebtedness. GARS owns a 100% economic interest in GF 2016-2, which is an investment company for accounting purposes. GARS provides collateral management services for 2016-2 CLO. As such, GARS has consolidated the accounts of these entities into these consolidated financial statements. As a result of this consolidation, the amounts outstanding under the 2016-2 CLO are treated as the Company’s indebtedness. Garrison Capital Inc. and Subsidiaries December 31, 2016 2. Significant Accounting Policies and Recent Updates - (continued) The GARS Equity Holdings Entities, Walnut Hill II LLC, Forest Park II LLC, Garrison SBIC and GLC Trust 2013-2 are 100% owned investment companies for accounting purposes. As such, GARS has consolidated the accounts of these entities into these consolidated financial statements. As a result of this consolidation, indebtedness of Garrison SBIC and the amounts outstanding under the GLC Trust 2013-2 Class A Notes are treated as the Company’s indebtedness. Investment Classification As required by the 1940 Act, investments are classified by level of control. “Control Investments” are investments in those companies that the Company is deemed to control as defined in the 1940 Act. “Affiliate Investments” are investments in those companies that are affiliated companies, as defined in the 1940 Act, other than Control Investments. “Non-Control/Non-Affiliate Investments” are those that are neither Control Investments nor Affiliate Investments. Generally, under the 1940 Act, the Company is deemed to control a company in which it has invested if it owns more than 25% of the voting securities of such company. The Company is deemed to be an affiliate of a company in which it has invested if it owns 5% or more of the voting securities of such company. As of December 31, 2016, $373.6 million of the Company’s investments were made up of Non-Control/Non-Affiliate Investments and $3.1 million were Non-Control/Affiliate Investments. As of December 31, 2015, all of the Company’s investments were Non-Control/Non-Affiliate Investments. Use of Estimates The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts and disclosures in the consolidated financial statements, including the estimated fair values of investments and the amount of income and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents As of December 31, 2016 and December 31, 2015, cash held in designated bank accounts with the Custodian was $9.1 million and $23.4 million, respectively. As of December 31, 2016 and December 31, 2015, cash held in designated bank accounts with other major financial institutions was $1.3 million and $1.6 million, respectively. At times, these balances may exceed federally insured limits and this potentially subjects the Company to a concentration of credit risk. The Company believes it is not exposed to any significant credit risk associated with its cash custodian. The Company defines cash equivalents as highly liquid financial instruments with original maturities of three months or less, including those held in overnight sweep bank deposit accounts. As of December 31, 2016 and December 31, 2015, the Company held no cash equivalents. Cash and Cash Equivalents, restricted Restricted cash as of December 31, 2016 and December 31, 2015 included cash of $11.3 million and $10.4 million, respectively, held by GF 2016-2 and GF 2013-2, respectively, in designated bank accounts with the Custodian. The CLOs are required to use a portion of these amounts to pay interest expense, reduce borrowings at the end of the investment period and to pay other amounts in accordance with the terms of the indentures of the CLOs. Funds held by GF 2016-2 and GF 2013-2 are not available for general use by the Company. Restricted cash as of December 31, 2016 and December 31, 2015 also included cash of $1.3 million and $1.4 million, respectively, held by GLC Trust 2013-2 in designated restricted bank accounts. GLC Trust 2013-2 is required to use a portion of these amounts to make principal payments and pay interest expense in accordance with the terms of the indenture governing the GLC Trust 2013-2 Notes. As of both December 31, 2016 and December 31, 2015, the Company held no restricted cash equivalents. Garrison Capital Inc. and Subsidiaries December 31, 2016 2. Significant Accounting Policies and Recent Updates - (continued) Investment Transactions and Related Investment Income and Expense The Company records its investment transactions on a trade date basis, which is the date when management has determined that all material legal terms have been contractually defined for the transactions. These transactions could possibly settle on a subsequent date depending on the transaction type. All related revenue and expenses attributable to these transactions are reflected on the consolidated statements of operations commencing on the trade date unless otherwise specified by the transaction documents. Realized gains and losses on investment transactions are recorded using the specific identification method. The Company accrues interest income if it expects that ultimately it will be able to collect such income. Generally, when a payment default occurs on a loan in the portfolio, or if management otherwise believes that the issuer of the loan will not be able to make contractual interest payments or principal payments, the Investment Adviser will place the loan on non-accrual status and will cease recognizing interest income on that loan until all principal and interest is current through payment or until a restructuring occurs, such that the interest income is deemed to be collectible. However, the Company remains contractually entitled to this interest. The Company may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. Accrued interest is written off when it becomes probable that the interest will not be collected and the amount of uncollectible interest can be reasonably estimated. For consumer loans, any loan which is 120 days past due is considered defaulted and 100% of the principal is charged off with no expected recovery or sale of defaulted receivables. The Company recognized $1.3 million and $2.7 million in charge offs in realized losses from investments for consumer loans held by GLC Trust 2013-2 for the years ended December 31, 2016 and December 31, 2015, respectively. As of December 31, 2016 and December 31, 2015, the Company had two investments and four investments, respectively, that were placed on non-accrual status. Any original issue discounts, as well as any other purchase discounts or premiums on debt investments, are accreted or amortized and included in interest income over the maturity periods of the investments. If a loan is placed on non-accrual status, the Company will cease recognizing amortization of original issue discount and purchase discount until all principal and interest is current through payment or until a restructuring occurs, such that the income is deemed to be collectible. Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are payable by the portfolio company and are expected to be collected. Interest Expense Interest expense is recorded on an accrual basis and is adjusted for amortization of deferred debt issuance costs and any original issue discount. Expenses Expenses related to, but not limited to, ratings expenses, due diligence, valuation expenses and independent collateral appraisals may arise when the Company makes certain investments. These expenses, as well as insurance expenses and trustee expenses are recognized as incurred in the consolidated statements of operations within other expenses. Loan Origination, Facility, Commitment and Amendment Fees The Company may receive loan origination, prepayment, facility, commitment, forbearance and amendment fees in addition to interest income during the life of the investment. The Company may receive origination fees upon the origination of an investment. Origination fees received by the Company are initially deferred and reduced from the cost basis of the investment and subsequently accreted into interest income over the stated term of the loan. Garrison Capital Inc. and Subsidiaries December 31, 2016 2. Significant Accounting Policies and Recent Updates - (continued) Upon the prepayment of a loan or debt security, any unamortized loan origination fees are recorded as interest income. We record prepayment premiums on loans and debt securities as interest income when we receive such amounts. Facility fees, sometimes referred to as asset management fees, are accrued as a percentage periodic fee on the base amount (either the funded facility amount or the committed principal amount). Commitment fees are based upon the undrawn portion committed by the Company and are accrued over the life of the loan. Amendment and forbearance fees are paid in connection with loan amendments and waivers and are recognized upon completion of the amendments or waivers, generally when such fees are receivable. Any such fees are recorded and classified as other income and included in investment income on the consolidated statements of operations. As these fees are paid and recognized in connection with specific loan amendments or forbearance, they are typically non-recurring in nature. Valuation of Investments The Company values its investments in accordance with FASB ASC Topic 820, Fair Value Measurements and Disclosures (formerly FASB Statement No. 157, “ASC 820”). ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value. ASC 820’s definition of fair value focuses on exit price in the principal, or most advantageous, market and prioritizes the use of market-based inputs over entity-specific inputs within a measurement of fair value. The Company’s portfolio consists of primarily debt investments and unsecured consumer loans. The fair value of the Company’s investments is initially determined by investment professionals of the Investment Adviser and ultimately determined by the Board on a quarterly basis. In valuing the Company’s debt investments, the Investment Adviser generally uses various approaches, including proprietary models that consider the analyses of independent valuation agents as well as credit risk, liquidity, market credit spreads, other applicable factors for similar transactions, and bid quotations obtained from other financial institutions that trade in similar investments or based on bid prices provided by independent third party pricing services. The types of factors that the Board may take into account when reviewing the fair value initially derived by the Investment Adviser and determining the fair value of the Company’s debt investments generally include, as appropriate, comparison to publicly traded securities, including such factors as yield, maturity and measures of credit quality, the enterprise value of a portfolio company, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business and other relevant factors. In valuing the Company’s unsecured consumer loans, the Investment Adviser generally uses a discounted cash flow methodology based upon a set of assumptions. The primary assumptions used to value the unsecured consumer loans include prepayment and default rates derived from historical performance, actual performance as compared to historical projections and discount rate. The types of factors that the Board may take into account when reviewing the fair value initially derived by the Investment Adviser and determining the fair value of the Company’s consumer loan investments generally include, as appropriate, prepayment and default rates derived from historical performance, actual performance as compared to historical projections and discount rates. The Board has retained several independent valuation firms to review the valuation of each portfolio investment that does not have a readily available market quotation at least once during each 12-month period. To the extent a security is reviewed in a particular quarter, it is reviewed and valued by only one service provider. However, the Board does not intend to have de minimis investments of less than 0.5% of the Company’s total assets (up to an aggregate of 10.0% of the Company’s total assets) independently reviewed. The Board is responsible for determining the fair value of the Company’s assets in good faith using a documented valuation policy and consistently applied valuation process. Garrison Capital Inc. and Subsidiaries December 31, 2016 2. Significant Accounting Policies and Recent Updates - (continued) Due to the nature of the Company’s strategy, the Company’s portfolio is primarily comprised of relatively illiquid investments that are privately held. Inputs into the determination of fair value of the Company’s portfolio investments require significant management judgment or estimation. This means that the Company’s portfolio valuations are based on unobservable inputs and the Investment Adviser’s own assumptions about how market participants would price the asset or liability in question. Valuations of privately held investments are inherently uncertain and they may fluctuate over short periods of time and may be based on estimates. The determination of fair value by the Board may differ materially from the values that would have been used if a ready market for these investments existed. The valuation process is conducted at the end of each fiscal quarter, with a portion of the Company’s valuations of portfolio companies without market quotations subject to review by the independent valuation firms each quarter. When an external event with respect to one of the Company’s portfolio companies, such as a purchase transaction, public offering or subsequent equity sale occurs, we expect to use the pricing indicated by the external event to corroborate our valuation. With respect to investments for which market quotations are not readily available, our Board will undertake a multi-step valuation process each quarter, as described below: • The Company’s valuation process begins with each portfolio company or investment being initially valued by investment professionals of the Investment Adviser responsible for credit monitoring. • Preliminary valuation conclusions are then documented and discussed with our senior management and the Investment Adviser. • The valuation committee of the Board reviews these preliminary valuations. • At least once annually, the valuation for each portfolio investment that does not have a readily available quotation is reviewed by an independent valuation firm, subject to the de minimis exception described above. • The Board discusses valuations and determines the fair value of each investment in the Company’s portfolio in good faith. Net assets could be materially affected if the determinations regarding the fair value of the investments were materially higher or lower than the values that are ultimately realized upon the disposal of such investments. Offering Costs Deferred offering costs consist of fees paid in relation to legal, accounting, regulatory and printing work completed in preparation of equity or debt offerings and are charged against proceeds from the offerings when received. As of both December 31, 2016 and December 31, 2015, $0.5 million of expenses associated with the shelf registration statement initially filed with the Securities and Exchange Commission (the “SEC”) on April 3, 2014 (“Registration Statement”) were deferred and included in other assets. These amounts will be charged against proceeds from future offerings of securities when received. Share Repurchase Share repurchase transactions are recorded on a trade date basis, which is the date when management has determined that all material legal terms have been contractually defined for the transactions. The aggregate cost of common stock repurchased, including any direct transaction costs, will be recorded as a reduction of the par and paid-in-capital in excess of par value accounts, respectively. Dividends and Distributions Dividends and distributions to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend or distribution is determined by the Board each quarter and is generally based upon the earnings estimated by management. Net realized capital gains, if any, are distributed at least annually, although the Company may decide to retain such capital gains for investment. Garrison Capital Inc. and Subsidiaries December 31, 2016 2. Significant Accounting Policies and Recent Updates - (continued) The Company adopted a dividend reinvestment plan that provides for reinvestment of our dividends and other distributions on behalf of our stockholders, unless a stockholder elects to receive cash as provided below. As a result, if the Board declares a cash dividend or other distribution, then our stockholders who have not ‘opted out’ of our dividend reinvestment plan will have their cash distribution automatically reinvested in additional shares of our common stock, which may be newly issued shares or shares acquired by AST through open-market purchases, rather than receiving the cash distribution. As of December 31, 2016 and December 31, 2015, no new shares were issued pursuant to the dividend reinvestment plan. No action is required on the part of a registered stockholder to have its cash dividend or other distribution reinvested in shares of our common stock. A registered stockholder may elect to receive an entire distribution in cash by notifying AST in writing so that such notice is received by AST no later than the record date for distributions to stockholders. Those stockholders whose shares are held by a broker or other financial intermediary may receive dividends and other distributions in cash by notifying their broker or other financial intermediary of their election. Income Taxes As discussed in Note 1, for tax purposes, GARS has elected to be treated as a RIC under Subchapter M of the Code, and intends to qualify each taxable year for such treatment In addition, GF 2016-2, GF 2013-2, GF 2013-2 Manager, the GARS Equity Holdings Entities, Walnut Hill II LLC and Forest Park II LLC are disregarded entities for tax purposes. GLC Trust 2013-2 is a grantor trust for U.S. taxable income purposes, whereby the income reverts to GARS, and accordingly, no provision for federal income tax was made in the consolidated financial statements for the years ended December 31, 2016 or December 31, 2015. Garrison Capital Inc. and Subsidiaries December 31, 2016 2. Significant Accounting Policies and Recent Updates - (continued) Each taxable year, GARS intends to comply with all RIC qualification provisions contained in the Code including certain source-of-income and asset diversification requirements, as well as distribution requirements to our stockholders equal to at least 90% of “investment company taxable income”. “Investment company taxable income” is generally defined as net ordinary income plus the excess of realized net short-term capital gains over realized net long-term capital losses. As a RIC, GARS generally does not have to pay corporate-level U.S. federal income taxes on any net ordinary income or capital gains that it distributes to its stockholders in a timely manner. However, GARS is subject to U.S. federal income taxes at regular corporate tax rates on any net ordinary income or net capital gain not distributed to its stockholders assuming at least 90% of its investment company taxable income is distributed timely. Depending on the level of taxable income earned in a tax year, the Company may choose to retain taxable income in excess of current year dividend distributions, and distribute such taxable income in the next tax year. The Company would then pay a 4% excise tax on such taxable income, as required. To the extent that the Company determines that its estimated current year annual taxable income, determined on a calendar basis, could exceed estimated current calendar year dividend distributions, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned. For the years ended December 31, 2016, December 31, 2015 and December 31, 2014, $0.1 million, $0.2 million and $0.1 million, respectively, of U.S. federal excise tax was recorded. In addition, GARS has certain wholly owned taxable subsidiaries (the “Taxable Subsidiaries”), each of which holds a portion of one or more of our portfolio investments that are listed on the consolidated schedule of investments. The Taxable Subsidiaries are consolidated for financial reporting purposes in accordance with U.S. GAAP, so that our consolidated financial statements reflect our investments in the portfolio companies owned by the Taxable Subsidiaries. The purpose of the Taxable Subsidiaries is, among other things, to permit GARS to hold certain interests in portfolio companies that are organized as limited liability companies (“LLCs”) (or other forms of pass-through entities) and still satisfy the RIC tax requirement that at least 90.0% of the RIC’s gross income for federal income tax purposes must consist of qualifying investment income. Absent the Taxable Subsidiaries, a proportionate amount of any gross income of an LLC (or other pass-through entity) portfolio investment would flow through directly to the RIC. To the extent that such income did not consist of investment income, it could jeopardize GARS ability to qualify as a RIC and therefore cause GARS to incur significant amounts of corporate-level U.S. federal income taxes. Where interests in LLCs (or other pass-through entities) are owned by the Taxable Subsidiaries, however, the income from such interests is taxed to the Taxable Subsidiaries and does not flow through to the RIC, thereby helping GARS preserve its RIC status and resultant tax advantages. The Taxable Subsidiaries are not consolidated for U.S. federal income tax purposes and may generate income tax expense as a result of their ownership of the portfolio companies. Garrison Capital Inc. and Subsidiaries December 31, 2016 2. Significant Accounting Policies and Recent Updates - (continued) Dividends from net investment income and distributions from net realized capital gains are determined in accordance with U.S. federal tax regulations, which may differ from amounts determined in accordance with U.S. GAAP and those differences could be material. These book-to-tax differences are either temporary or permanent in nature. Reclassifications due to permanent differences have no impact on net assets. The below were reclassifications made due to permanent differences for the tax years ended December 31, 2016 and December 31, 2015: The permanent book-to-tax differences arose primarily due to the tax classification of dividend distributions, tax basis differences on realized investments, tax characterization of certain realized losses and the accrual of nondeductible U.S. federal excise tax. Taxable income differs from the net increase (decrease) in net assets resulting from operations primarily due to the exclusion of unrealized gain (loss) on investments from taxable income until they are realized, book-to-tax temporary differences related to the deductibility of accrued Incentive Fees payable to the Investment Adviser attributable to unrealized gain (loss) on investments, book-to-tax differences on the treatment of deferred financing costs, book-to-tax temporary differences on taxable income inclusions of investment income earned on certain securities that was accrued for tax but not for U.S. GAAP, and book-to-tax temporary differences related to net capital loss carryforwards and utilization of net capital gain loss carryforwards from prior years. The following table reconciles net increase in net assets resulting from operations to taxable income for the tax years ended December 31, 2016, December 31, 2015 and December 31, 2014: As of December 31, 2016 and December 31, 2015, the accumulated earnings/(deficit) on a tax basis is: The tax character of all distributions paid for the years ended December 31, 2016 and December 31, 2015 were classified as ordinary income. Garrison Capital Inc. and Subsidiaries December 31, 2016 2. Significant Accounting Policies and Recent Updates - (continued) As of December 31, 2016 and December 31, 2015, the components of accumulated losses on a tax basis, as detailed below, differ from the amounts reflected per our consolidated statement of assets and liabilities by temporary book-to-tax differences arising from book-to-tax differences related to the deductibility of accrued Incentive Fees payable to the Investment Adviser attributable to unrealized gains (losses) on investments, book-to-tax differences on the treatment of deferred financing costs and book-to-tax differences on taxable income inclusions of investment income earned on certain securities that was accrued for tax but not for U.S. GAAP. As of December 31, 2016, the federal income tax basis of investments was $392.0 million resulting in net unrealized loss of $(15.4) million. As of December 31, 2015, the federal tax basis of investments was $437.1 million resulting in a net unrealized loss of $(22.1) million. We are required to determine whether our tax position is more likely-than-not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. De-recognition of a tax benefit previously recognized could result in the recording of a tax liability that could negatively impact our net assets. U.S. GAAP provides guidance on thresholds, measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition that is intended to provide better financial statement comparability among different entities. We have concluded that it was not necessary to record a liability for any such tax positions as of December 31, 2016 and December 31, 2015. However, our conclusions regarding this policy may be subject to review and adjustment at a later date based on factors including ongoing analyses of, and changes to, tax laws, regulations and interpretations thereof. Our activities from commencement of operations remain subject to examination by U.S. federal, state, and local tax authorities. No interest expense or penalties have been assessed as of December 31, 2016 and December 31, 2015. If we were required to recognize interest and penalties, if any, related to unrecognized tax benefit this would be recognized as income tax expense in the consolidated statement of operations. We had net long term capital loss carryforwards of $29.3 million and $10.3 million as of December 31, 2016 and December 31, 2015, respectively. During 2014, we utilized $5.8 million of net long term capital loss carryforwards resulting in no net long term capital loss carryforward as of December 31, 2014. Recent accounting pronouncements In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU 2016-18 requires a statement of cash flows explain the change during the period of total cash, cash equivalents, and amounts described as cash or restricted cash equivalents. This new guidance is effective for annual and interim periods beginning on or after December 15, 2017 and for interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact ASU 2016-18 will have on the Company’s consolidated financial position and disclosures. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 amends the classification of certain cash receipts and cash payments presented and classified in the statement of cash flows. This new guidance is effective for annual and interim periods beginning on or after December 15, 2017 and for interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact ASU 2016-15 will have on the Company’s consolidated financial position and disclosures. In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 changes how entities account for and measure the fair value of certain equity investments and updates the presentation and disclosure of certain financial assets and liabilities. This new guidance is effective for annual and interim periods beginning on or after December 15, 2017 and for interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact ASU 2016-01 will have on the Company’s consolidated financial position and disclosures. Garrison Capital Inc. and Subsidiaries December 31, 2016 3. Investments GARS investments include debt investments (both funded and unfunded, “Debt Investments”), preferred and minority equity investments (“Equity”) of diversified companies and a portfolio of unsecured small balance consumer loans (“Financial Assets”). These financial instruments may be purchased indirectly through an interest in a limited partnership or a limited liability company. Certain of the risks of investing in the financial instruments of a borrower or a company experiencing various forms of financial, operational, legal, and/or other distress or impairment, including companies involved in bankruptcy or other reorganization or liquidation proceedings, and those which might become involved in such proceedings, are discussed herein. Through investing in these assets, GARS is exposed to credit risk relating to whether the borrower will meet its obligation to pay when it comes due until the investments are sold or mature. Any investment in a distressed company may involve special risks. GARS transactions in Debt Investments are normally secured financings that are collateralized by physical assets and/or the enterprise value of the borrower. This collateral, and our rights to this collateral, are different depending on the specific transaction and are defined by the legal documents agreed to in the transaction. The terms of the Debt Investments may provide for us to extend to a borrower additional credit or provide funding for any unfunded portion of such Debt Investments at the request of the borrower. This exposes us to potential liabilities that are not reflected on the consolidated statements of financial condition. As of December 31, 2016 and December 31, 2015, we had $4.8 million and $6.9 million of unfunded commitments with a fair value of $(0.1) million and $(0.1) million, respectively. The negative fair value is the result of the unfunded commitments being valued below par. These amounts may or may not be funded to the borrowing party now or in the future. There is no central clearinghouse for our Debt Investments, Equity or Financial Assets, nor is there a central depository for custody of any such interests. The processes by which these interests are cleared, settled and held in custody are individually negotiated between the parties to the transaction. This subjects us to operational risk to the extent that there are delays and failures in these processes. The Custodian maintains records of the investments which are owned by us. Garrison Capital Inc. and Subsidiaries December 31, 2016 4. Fair Value of Financial Instruments The fair value of our assets and liabilities which qualify as financial instruments approximate the carrying amounts presented in the consolidated statements of financial condition. U.S. GAAP requires enhanced disclosures about investments that are measured and reported on a fair value basis. Under U.S. GAAP, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Further, the guidance distinguishes between inputs that reflect the assumptions market participants would use in pricing an asset or liability developed based on market data obtained from sources independent of the reporting entity (observable inputs) and inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing an asset or liability developed based on the best information available in the circumstances (unobservable inputs). Various inputs are used in determining the values of the Company’s investments and these inputs are categorized as of each valuation date. The inputs are summarized in three broad levels listed below: • Level 1 - quoted unadjusted prices in active markets for identical investments as of the reporting date. • Level 2 - other significant observable inputs (including quoted prices for similar investments, interest rates, prepayments, credit risk, etc.). • Level 3 - significant unobservable inputs (including the reporting entity’s own assumptions about the assumptions market participants would use in determining the fair values of investments or indicative bid prices from unaffiliated market makers or independent third party pricing services). Fair value of publicly traded instruments is generally based on quoted market prices. Fair value of non-publicly traded instruments, and of publicly traded instruments for which quoted market prices are not readily available, may be determined based on other relevant factors, including bid quotations from unaffiliated market makers or independent third-party pricing services, the price activity of comparable instruments and valuation pricing models. For those investments valued using quotations, the bid price is generally used, unless the Company determines that it is not representative of an exit price. To the extent observable market data is available, such information may be the result of indicative bid quotations obtained from independent third party pricing services (“consensus pricing”) or broker quotes. Due to the fact that the significant inputs used by the contributors of the consensus pricing source or the broker are unobservable and evidence with respect to trading levels is not available, any investments valued using indicative bid prices from unaffiliated market makers and independent third-party pricing services have been classified within Level 3. Investments classified as Level 3 may be fair valued using the income and market approaches, using a market yield valuation methodology or enterprise value methodology. Factors that could affect fair value measurements of debt investments using the above referenced approaches include assumed growth rates, capitalization rates, discount rates, loan-to-value ratios, liquidation value, relative capital structure priority, market comparables, compliance with applicable loan, covenant and interest coverage performance, book value, market derived multiples, reserve valuation, assessment of credit ratings of an underlying borrower, review of ongoing performance, review of financial projections as compared to actual performance, review of interest rate and yield risk. Garrison Capital Inc. and Subsidiaries December 31, 2016 4. Fair Value of Financial Instruments - (continued) Factors that could affect fair value measurements of consumer loans using the above referenced approaches include prepayment rates, default rates, review of financial projections as compared to actual performance and discount rates. Such factors may be given different weighting depending on management’s assessment of the underlying investment, and management may analyze apparently comparable investments in different ways. The Company has used, and intends to continue to use, independent valuation firms to provide additional corroboration for estimating the fair values of investments. Valuations performed by the independent valuation firms may utilize proprietary models and inputs. The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. As of each of December 31, 2016 and December 31, 2015, all of the Company’s investments (other than cash and cash equivalents) were classified as Level 3 under ASC 820. The following table summarizes the valuation of the Company’s investments measured at fair value based on the fair value hierarchy detailed above as of December 31, 2016 and December 31, 2015: ______________ (1) Includes unfunded commitments with a fair value of $(0.1) million. (2) Included in senior secured loans are loans structured as first lien last out loans. These loans may in certain cases be subordinated in payment priority to other senior secured lenders. ______________ (1) Includes unfunded commitments with a fair value of $(0.1) million. (2) Included in senior secured loans are loans structured as first lien last out loans. These loans may in certain cases be subordinated in payment priority to other senior secured lenders. The net change in unrealized gain/(loss) attributable to the Company’s Level 3 assets for the years ended December 31, 2016 and December 31, 2015 included in the net change in unrealized gain/(loss) from investments in the Company’s consolidated statement of operations was $6.7 million and $(21.9) million, respectively. Garrison Capital Inc. and Subsidiaries December 31, 2016 4. Fair Value of Financial Instruments - (continued) The following table is a reconciliation of investments in which significant unobservable inputs (Level 3) were used in determining fair value for the year ended December 31, 2016: ______________ (1) Includes non-cash restructuring of portfolio investments of $0.8 million. There were no transfers of investments between levels by the Company for the year ended December 31, 2016. (2) Net change in unrealized gain/(loss) included in earnings related to investments still held at reporting date. The following table is a reconciliation of investments in which significant unobservable inputs (Level 3) were used in determining fair value for the year ended December 31, 2015: ______________ (1) Includes non-cash restructuring of portfolio investments of $4.0 million. There were no transfers of investments between levels by the Company for the year ended December 31, 2015. (2) Net change in unrealized gain/(loss) included in earnings related to investments still held at reporting date. Garrison Capital Inc. and Subsidiaries December 31, 2016 4. Fair Value of Financial Instruments - (continued) The following table is a quantitative disclosure about significant unobservable inputs (Level 3) that were used in determining fair value at December 31, 2016: ______________ (1) Includes total unfunded commitments of $(0.1) million. (2) Market rate is calculated based on the fair value of the investments and interest expected to be received using the current rate of interest at the balance sheet date to maturity, excluding the effects of future scheduled principal amortizations. (3) Includes preferred and common equity. (4) Financial Assets are valued by the level of risk associated with the underlying loan measured by the estimated loss rate. The estimated loss rate is based on the historical performance of loans with similar characteristics, the borrowers credit score obtained from an official credit reporting agency at origination, debt-to-income ratios at origination, information from the borrower’s credit report at origination, as well as the borrower’s self-reported income range, occupation and employment status at origination. Financial Asset risk ratings are assigned on a scale from A through F, with A having the lowest level of risk and F having the highest level of risk. As of December 31, 2016, 16.6%, 35.4%, 37.4%, 8.1%, 2.5% and 0.0%, of the total fair value of Financial Assets was comprised of A, B, C, D, E and F risk rated loans, respectively. See Exhibit 99.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 for detail on the underlying loans. (5) Excludes non-operating portfolio companies, which we define as those loans collateralized by proved developed producing (“PDP”), value, real estate or other hard assets. PDPs are proven revenues that can be produced with existing wells. As of December 31, 2016, $49.6 million of par value and $36.0 million of market value was excluded. Garrison Capital Inc. and Subsidiaries December 31, 2016 4. Fair Value of Financial Instruments - (continued) The following table is a quantitative disclosure about significant unobservable inputs (Level 3) that were used in determining fair value at December 31, 2015: ______________ (1) Includes total unfunded commitments of $(0.1) million. (2) Market rate is calculated based on the fair value of the investments and interest expected to be received using the current rate of interest at the balance sheet date to maturity, excluding the effects of future scheduled principal amortizations. (3) Includes preferred and common equity. (4) Financial Assets are valued by the level of risk associated with the underlying loan measured by the estimated loss rate. The estimated loss rate is based on the historical performance of loans with similar characteristics, the borrowers credit score obtained from an official credit reporting agency at origination, debt-to-income ratios at origination, information from the borrower’s credit report at origination, as well as the borrower’s self-reported income range, occupation and employment status at origination. Financial Asset risk ratings are assigned on a scale from A through F, with A having the lowest level of risk and F having the highest level of risk. As of December 31, 2015, 24.2%, 33.1%, 31.9%, 7.5%, 3.1% and 0.2%, of the total fair value of Financial Assets was comprised of A, B, C, D, E and F risk rated loans, respectively. See Exhibit 99.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 for detail on the underlying loans. (5) Excludes non-operating portfolio companies, which we define as those loans collateralized by PDP or other hard assets. PDPs are proven revenues that can be produced with existing wells. Significant unobservable inputs used in the fair value measurement of the Companys’ Debt Investments include consensus pricing, multiples of market comparable companies, and relative comparable yields. Garrison Capital Inc. and Subsidiaries December 31, 2016 4. Fair Value of Financial Instruments - (continued) Significant decreases (increases) in consensus pricing or market comparables could result in lower (higher) fair value measurements. Significant increases (decreases) in comparable yields could result in lower (higher) fair value measurements. Generally, a change in the assumption used for relative comparable yields is accompanied by a directionally opposite change in the assumptions used for pricing. Significant unobservable inputs used in the fair value measurement of the Company’s Equity Investments include market comparables. Significant decreases (increases) in market comparables could result in lower (higher) fair value measurements. Significant unobservable inputs used in the fair value measurement of the Company Financial Assets include interest rate, prepayment rate, unit loss rate, default rate multiplier and discount rate. Significant decreases (increases) in interest rates or prepayment rates could result in significantly lower (higher) fair value measurements. Significant increases (decreases) in unit loss rates, default rate multiplier or discount rates could result in lower (higher) fair value measurements. The composition of the Company’s portfolio by industry at cost and fair value as of December 31, 2016 was as follows: Refer to the consolidated schedule of investments for detailed disaggregation of the Company’s investments. Garrison Capital Inc. and Subsidiaries December 31, 2016 4. Fair Value of Financial Instruments - (continued) The composition of the Company’s portfolio by industry at cost and fair value as of December 31, 2015 was as follows: Refer to the consolidated schedules of investments for detailed disaggregation of the Company’s investments. 5. Indemnifications In the normal course of business, the Company enters into certain contracts that provide a variety of indemnifications. The Company’s maximum exposure under these indemnifications is unknown. However, no liabilities have arisen under these indemnifications in the past and, while there can be no assurances in this regard, there is no expectation that any will occur in the future. Therefore, the Company does not consider it necessary to record a liability for any indemnifications under U.S. GAAP. 6. Due To and Due From Counterparties The Company executes investment transactions with agents, brokers, investment companies, agent banks and other financial institutions. Due to and due from counterparties include amounts related to unsettled purchase and sale transactions of investments, and principal paydowns receivable from the borrowers. Garrison Capital Inc. and Subsidiaries December 31, 2016 6. Due To and Due From Counterparties - (continued) No amounts were due to counterparties as of December 31, 2016. Amounts due to counterparties was $0.4 million as of December 31, 2015. Amounts due from counterparties were $2.1 million and $1.6 million as of December 31, 2016 and December 31, 2015, respectively. 7. Financing As of December 31, 2016, the total carrying value of the Company’s aggregate debt outstanding was $205.1 million with a weighted average effective interest rate of 3.88%. The Company’s debt outstanding as of December 31, 2016 was comprised of notes issued by GF 2016-2, Garrison SBIC borrowings and GLC Trust 2013-2 Notes. The table below provides details of our outstanding debt as of December 31, 2016 ______________ (1) May bear interest at either the CP Rate (as defined in the indenture governing the 2016-2 CLO) or the London Interbank Offered Rate (“LIBOR”). (2) Represents an S&P rating as of the closing of the 2016-2 CLO. (3) Represents the stated interest rate and annual charge of our SBA-guaranteed debentures. (4) These interim financings bear an interest rate of three month LIBOR + 0.93%, which is comprised of a weighted average annual charge of 0.63% and a spread of 0.30%. These interim financings have a maturity date of March 29, 2017, upon which we expect them to be pooled into the ten year SBA-guaranteed debentures. Garrison Capital Inc. and Subsidiaries December 31, 2016 7. Financing - (continued) The table below provides details of our outstanding debt as of December 31, 2015: ______________ (1) May bear interest at either the CP Rate (as defined in the indenture governing the 2013-2 CLO) or LIBOR. (2) Represents an S&P rating as of the closing of the 2013-2 CLO. (3) Represents the stated interest rate and annual charges of our SBA-guaranteed debentures. (4) These interim financings bore an interest rate of three month LIBOR + 1.04%, which is comprised of an annual charge of 0.74% and a spread of 0.30%. In accordance with the 1940 Act, with certain limited exceptions, the Company is only allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing (other than the SBA debentures of Garrison SBIC, as permitted by exemptive relief the Company has been granted by the SEC). As of December 31, 2016 and December 31, 2015, the Company’s asset coverage for borrowed amounts was 215.5% and 208.8%, respectively. In accordance with the FASB issued ASU 2015-03, Interest - Imputation of Interest (Topic 835), deferred debt issuance costs were retrospectively adjusted for December 31, 2015 to be reflected as a liability, within the net carrying amount of the debt liabilities. As of December 31, 2015, these deferred debt issuance costs were reflected as an asset. As a result, total assets and total liabilities as of December 31, 2015 have both decreased by $4.3 million. The table below shows the weighted average interest rates and weighted average effective interest rates, inclusive of deferred debt issuance costs, of our debt as of December 31, 2016 and December 31, 2015: ______________ (1) Includes the effects of deferred debt issuance costs. Garrison Capital Inc. and Subsidiaries December 31, 2016 7. Financing - (continued) Refinancing of the 2013-2 Collateralized Loan Obligation On September 25, 2013, GF 2013-2 closed the 2013-2 CLO securitization transaction. The notes offered in the 2013-2 CLO (the “2013-2 Notes”) were issued by GF 2013-2 through a private placement and were comprised of $50.0 million of senior secured revolving notes, $160.3 million of senior secured term notes and an aggregate of $139.7 million of notes that were retained by GARS. As of June 30, 2016 (as described below), $31.1 million of senior secured revolving notes and $160.3 million of senior secured term notes were outstanding. On September 29, 2016, GF 2016-2 closed the 2016-2 CLO securitization transaction which included, through a private placement, the issuance of the 2016-2 Notes (as defined below). The notes offered in 2016-2 CLO (collectively referred to as the “2016-2 Notes”) were issued by GF 2016-2 and were comprised of: (i) $25.00 million of AAA(sf) Class A-1R Senior Secured Revolving Floating Rate Notes (“Class A-1R Notes”); (ii) $88.15 million of AAA(sf) Class A-1T Senior Secured Floating Rate Notes (“Class A-1T Notes”); (iii) $25.00 million of AAA(sf) Class A-1F Senior Secured Fixed Rate Notes (“Class A-1F Notes”); (iv) $20.70 million of AA(sf) Class A-2 Senior Secured Floating Rate Notes (“Class A-2 Notes” and collectively with the Class A-1R Notes, the Class A-1T Notes and the Class A-2F Notes, the “Class A Notes”); (v) $21.45 million of A(sf) Class B Secured Deferrable Floating Rate Notes (“Class B Notes”); (vi) $11.70 million of BBB(sf) Class C Secured Deferrable Floating Rate Notes (“Class C Notes” and collectively, the Class A Notes, Class B Notes and Class C Notes are referred to as the “Secured Notes”); and (vii) $108.00 million of subordinated notes (“Subordinated Notes”), which do not have a stated interest rate, are not rated and were retained by GARS. The 2016-2 Notes are scheduled to mature on September 29, 2027. In connection with the closing of the sale of the 2016-2 Notes, substantially all of the net cash proceeds, along with existing cash, were used to purchase a portion of the portfolio of loans held by GF 2013-2. GF 2013-2 used the proceeds received in connection with such sale of loans to redeem in full all of the 2013-2 Notes. The refinance of the 2013-2 CLO resulted in a $1.8 million loss for the year ended December 31, 2016 due to the third party expenses incurred as part of the 2013-2 CLO which had initially been deferred over the stated life of the 2013-2 CLO. This loss was included in the consolidated statements of operations within loss on refinancing of secured notes. Fees paid as part of the execution of the 2016-2 CLO, in the amount of $2.4 million, consisted of facility fees of $1.6 million and other costs of $0.8 million, which primarily included rating agency and legal fees. Pursuant to FASB ASC Topic 470, Debt, we accelerated the amortization of $1.6 million of these fees and included them in interest expense for the year ended December 31, 2016, and we initially deferred the remaining $0.9 million of these costs. These costs will be amortized into interest expense over the stated life of the 2016-2 Notes. As of December 31, 2016, $0.9 million of these costs are included in deferred debt issuance costs and presented net within the liability on the consolidated statements of financial condition and will be amortized over the stated maturity of the respective loans. At December 31, 2016, the Class A-1R Notes under the 2016-2 CLO were fully undrawn. As of December 31, 2015, $15.0 million of the revolving notes under the 2013-2 CLO were undrawn. The fair value of the notes issued by the CLOs approximated their carrying values on the consolidated statements of financial condition as of December 31, 2016 and December 31, 2015. The indenture governing the 2016-2 Notes provides that, to the extent cash is available from cash collections, the holders of the 2016-2 Notes are to receive quarterly interest payments on the 20th day or, if not a business day, the next succeeding business day of February, May, August and November of each year until the stated maturity. Under the documents governing the 2016-2 CLO, there are two coverage tests applicable to the Secured Notes. The first test compares the amount of interest received on the collateral loans held by GF 2016-2 to the amount of interest payable on the Secured Notes under the 2016-2 CLO in respect of the amounts drawn and certain expenses. To meet this first test, at any time, the aggregate amount of interest received on the collateral loans must equal, after the payment of certain fees and expenses, at least 135.0% of the aggregate amount of interest payable on the Class A Notes, 125.0% of the interest payable on the Class A Notes and Class B Notes, taken together, and 115% of the interest payable on the Class A Notes, Class B Notes and Class C Notes, taken together. The second test compares the aggregate principal amount of the collateral loans, as calculated in accordance with the indenture, to the aggregate outstanding principal amount of the Secured Notes in respect of the amounts drawn. To meet this second test at any time, the aggregate principal amount of the collateral loans must equal at least 173.4% of the aggregate outstanding principal amount of the Class A Notes, 156.1% of the aggregate principal amount of the Class A Notes and Class B Notes, taken together, and 148.1% of the aggregate outstanding principal amount of the Class A Notes, Class B Notes and Class C Notes, taken together. If the coverage tests are not satisfied with respect to a quarterly payment date, GF 2016-2 will be required to apply available amounts to the repayment of interest on and principal of the 2016-2 Notes to the extent necessary to satisfy the applicable coverage tests and, as a result, there may be reduced funds available for GF 2016-2 to make additional investments or to make distributions on the Subordinated Notes held by the Company. Additionally, compliance is measured on each day collateral loans are purchased, originated or sold and in connection with monthly reporting to the note holders. Furthermore, if under the second coverage test the aggregate principal amount of the collateral loans equals 125.0% or less of the aggregate outstanding principal amount on the Class A-1T Notes and Class A-1R Notes, taken together, and remains so for ten business days, an event of default will be deemed to have occurred. As of December 31, 2016 and December 31, 2015, the trustee for the 2016-2 CLO and 2013-2 CLO, respectively, has asserted that all of the coverage tests were met. Garrison SBIC Borrowings As discussed in Note 1, Garrison SBIC received a license to operate as an SBIC from the SBA on May 26, 2015. The SBIC license allows Garrison SBIC to obtain SBA-guaranteed debentures in an amount equal to twice its equity capitalization up to $150.0 million of leverage, subject to the issuance of a capital commitment by the SBA and other customary procedures. On June 16, 2015, the SBA issued Garrison SBIC a commitment to provide $35.0 million of leverage and on October 24, 2016 issued a second commitment to provide an additional $35.0 million of leverage. The SBA issues SBA-guaranteed debentures bi-annually on pooling dates in March and September of each year. These debentures are non-recourse, interest only debentures with a 10 year stated maturity, but may be prepaid at any time without penalty. The interest rate of the debentures is fixed at the time of issuance and is based on a coupon rate over the ten year treasury rate at the time of issuance. Interest on the debentures is payable on a semi-annual basis. The SBA issues interim financings to SBICs on non-pooling dates that carry a lower interest rate than the debentures and mature on the next pooling date. The SBA, as a creditor, will have a superior claim to Garrison SBIC’s assets over the Company’s stockholders if Garrison SBIC were to be liquidated, or if the SBA exercises its remedies under the SBA-guaranteed debentures issued by Garrison SBIC upon an event of default. As of December 31, 2016, Garrison SBIC had regulatory capital of $36.1 million and total SBIC borrowings outstanding of $37.0 million. The SBIC borrowings include $14.0 million, $12.7 million and $3.3 million of SBA guaranteed debentures that mature on September 1, 2025, March 1, 2026 and September 1, 2026, respectively. In addition, SBIC interim financings of $7.0 million that mature on March 29, 2017 are included in our SBIC Borrowings. The fair value of the SBIC borrowings approximated its carrying value on the consolidated statements of financial condition as of December 31, 2016 and December 31, 2015. As of December 31, 2016, the Company had $33.0 million of available SBIC leverage capacity. GLC Trust 2013-2 Notes On July 18, 2014, GARS completed the GLC Trust 2013-2 Securitization. GLC Trust 2013-2 Notes were issued by GLC Trust 2013-2 and consisted of $36.9 million of Class A Notes (“GLC Trust 2013-2 Class A Notes”) and $2.3 million of Class B Notes (“GLC Trust 2013-2 Class B Notes”). As of December 31, 2016, GARS has retained all of the GLC Trust 2013-2 Class B Notes, which are eliminated in consolidation. The GLC Trust 2013-2 Class A Notes bear interest at 3.00% per annum and are scheduled to mature on July 15, 2021. The proceeds of the GLC Trust 2013-2 Notes were used to refinance the $10.0 million revolving credit facility with Capital One, N.A. which was fully paid down and terminated concurrent with the issuance of the GLC Trust 2013-2 Notes. The fair value of the GLC Trust 2013-2 Notes approximated the carrying value on the consolidated statements of financial condition as of December 31, 2016 and December 31, 2015, respectively. The indenture governing the GLC Trust 2013-2 Notes provides that, to the extent cash is available from cash collections, the holders of the GLC Trust 2013-2 Notes are to receive monthly interest and principal payments on the 15th day or, if not a business day, the next succeeding business day, commencing in August 2014, until the stated maturity. Under the indenture governing the GLC Trust 2013-2 Notes, there are two applicable monthly tests. The first test compares the principal balance of the underlying loans to the principal balance of the GLC Trust 2013-2 Notes. To meet this first test, the aggregate principal balance of the underlying loans less the aggregate principal balance of the GLC Trust 2013-2 Notes must equal, at least, the greater of (1) 13.00% of the aggregate principal balance of the underlying loans as of the end of the prior month and (2) 5.25% of the loan pool balance as of July 11, 2014. The second test compares the ratio of the dollar amount of cumulative defaults to the original principal balance of the underlying loans as of July 11, 2014 (“Cumulative Default Ratio”) to the Cumulative Default Ratio trigger level, as stated in the indenture. To meet this second test, the Cumulative Default Ratio must not exceed the Cumulative Default Ratio trigger level. If these tests are not satisfied with respect to a monthly payment date and are not cured within 45 days, an event of default will be deemed to have occurred and the GLC Trust 2013-2 Notes will become immediately due and payable, in accordance with the terms of the indenture. As of both December 31, 2016 and December 31, 2015, all of the coverage tests were met. Garrison Capital Inc. and Subsidiaries December 31, 2016 7. Financing - (continued) Deferred Debt Issuance Costs and Other Fees In connection with the issuance of our various debt instruments, GARS incurred aggregate fees in the amount of $6.2 million which consisted of facility fees of $4.3 million and other costs of $1.9 million, which included rating agency fees and legal fees. Fees paid as part of the execution of the GLC Trust 2013-2 Securitization in the amount of $0.4 million consisted of legal and other fees. For the year ended December 31, 2015, we paid total fees of $0.8 million on our SBIC borrowings. Fees paid as part of the execution of our SBIC borrowings include a 1.00% commitment fee on our $35.0 million commitment, 2.00% leverage fees and 0.43% of other fees on amounts drawn. Costs incurred in connection with the issuance of the Company’s debt instruments, are included as a reduction to the carrying amount of the related liability on the consolidated statements of financial condition and will be amortized over the stated maturity of the respective loans, with $4.0 million and $4.4 million of deferred debt issuance costs remaining as of December 31, 2016 and December 31, 2015, respectively. Garrison Capital Inc. and Subsidiaries December 31, 2016 8. Related Party Transactions Investment Advisory Agreement GARS entered into the Investment Advisory Agreement with the Investment Adviser, which was most recently amended and restated on August 5, 2016. The Investment Advisory Agreement entitles the Investment Adviser to a base management fee and an incentive fee, both of which are described further below. Effective as of October 1, 2016, the Investment Adviser, in consultation with the Board, agreed to irrevocably waive any fees payable to the Investment Adviser under the Investment Advisory Agreement with respect to a calendar quarter in excess of the sum of (i) 0.375% per quarter (1.50% annualized) of the gross assets of the Company, excluding cash and cash equivalents but including assets purchased with borrowed funds, calculated based on the average carrying value of the gross assets of the Company at the end of the two most recently completed calendar quarters, (ii) 20% of pre-incentive fee net investment income, expressed as a rate of return on the value of the Company’s net assets at the end of the immediately preceding calendar quarter, in excess of a “hurdle rate” of 1.75% per quarter (7.00% annualized) and (iii) in the case of the final calendar quarter of each year, the capital gains incentive fee. This waiver will be in effect until the earlier of (i) June 30, 2017 and (ii) approval by the stockholders of the Company of an amendment to the Investment Advisory Agreement to decrease the base management fee to an annual rate of 1.50% and to decrease the “hurdle rate” for the income-based portion of the Incentive Fee to 1.75% per quarter (7.00% annualized). Base Management Fee Under the Investment Advisory Agreement, the Investment Adviser is entitled to a base management fee for its services calculated at an annual rate of 1.75% of gross assets, excluding cash and cash equivalents, and cash and cash equivalents, restricted, but including assets purchased with borrowed funds. For purposes of the Investment Advisory Agreement, cash equivalents means U.S. government securities and commercial paper maturing within 270 days of purchase. The following table details our management fee expenses for the years ended December 31, 2016, 2015, and 2014: Management fees in the amount of $0.1 million and $1.8 million were payable as of December 31, 2016 and December 31, 2015, respectively, and are included in management fee payable on the consolidated statements of financial condition. Incentive Fee Overview Under the current Investment Advisory Agreement, the Investment Adviser is entitled to an incentive fee consisting of two components and a cap and deferral mechanism. The two components are independent of each other, and may result in one component being payable even if the other is not. The first component, which is income-based and payable quarterly in arrears, equals 20.00% of the amount, if any, that the Company’s pre-incentive fee net investment income exceeds a 2.00% quarterly (8.00% annualized) hurdle rate (the “Hurdle Rate”), subject to a “catch-up” provision measured at the end of each calendar quarter. The operation of the first component of the incentive fee for each quarter is as follows: • no incentive fee is payable to the Investment Adviser in any calendar quarter in which the Company’s pre-incentive fee net investment income does not exceed the Hurdle Rate; • 100.00% of the Company’s pre-incentive fee net investment income with respect to that portion of the Company’s pre-incentive fee net investment income, if any, that exceeds the Hurdle Rate but is less than 2.50% in any calendar quarter (10.00% annualized). We refer to this portion of the Company’s pre-incentive fee net investment income (which exceeds the Hurdle Rate but is less than 2.50%) as the “catch-up”. The effect of the “catch-up” provision is that, if the Company’s pre-incentive fee net investment income exceeds 2.50% in any calendar quarter, the Investment Adviser will receive 20.00% of such pre-incentive fee net investment income as if the Hurdle Rate did not apply; and • 20.00% of the amount of the Company’s pre-incentive fee net investment income, if any, that exceeds 2.50% in any calendar quarter (10.00% annualized) (once the Hurdle Rate is reached and the catch-up is achieved). Garrison Capital Inc. and Subsidiaries December 31, 2016 8. Related Party Transactions - (continued) The portion of such incentive fee that is attributable to deferred interest (such as PIK interest or original issue discount) will be paid to the Investment Adviser, together with any other interest accrued on the loan from the date of deferral to the date of payment, only if and to the extent the Company actually receives such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. Any reversal of such amounts would reduce net income for the quarter by the net amount of the reversal (after taking into account the reversal of incentive fees payable) and would result in a reduction and possible elimination of the incentive fees for such quarter. For the avoidance of doubt, no incentive fee will be paid to the Investment Adviser on amounts accrued and not paid in respect of deferred interest. The second component, which is capital gains-based, is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement, as of the termination date) and equals 20% of the Company’s cumulative aggregate realized capital gains through the end of such year, computed net of the Company’s aggregate cumulative realized capital losses and aggregate cumulative unrealized capital loss through the end of such year, less the aggregate amount of any previously paid capital gains incentive fees and subject to the Incentive Fee Cap and Deferral Mechanism described below. The capital-gains component of the incentive fee excludes any portion of realized gains (losses) that are associated with the reversal of any portion of unrealized gain/(loss) attributable to periods prior to April 1, 2013. The capital gains component of the incentive fee is not subject to any minimum return to stockholders. In addition, under U.S. GAAP, we are required to accrue a capital gains incentive fee based upon the aggregate cumulative realized capital gains and losses and aggregate cumulative unrealized capital gain and loss on investments held at the end of each period. If such amount is positive at the end of a period, then the Company will record a capital gains incentive fee equal to 20.00% of such amount, less the aggregate amount of actual capital gains related incentive fees paid in all prior years. If such amount is negative, then there is no accrual for such period. For the year ended December 31, 2014, the Company accrued capital gains incentive fee in the amount of $1.6 million. There were not any accrued capital gains incentive fee for December 31, 2016 and December 31, 2015. The Investment Advisory Agreement does not permit unrealized capital gains for purposes of calculating the amount payable to the Investment Adviser. Amounts due related to unrealized capital gains, if any, will not be paid to the Investment Adviser until realized under the terms of the Investment Advisory Agreement (as described above). Incentive Fee Cap and Deferral Mechanism We have structured the calculation of these incentive fees to include a fee limitation such that no incentive fee will be paid to our Investment Adviser for any fiscal quarter if, after such payment, the cumulative incentive fees paid to our Investment Adviser for the period that includes such fiscal quarter and the 11 full preceding fiscal quarters (the “Incentive Fee Look-back Period”) would exceed 20.00% of our Cumulative Pre-Incentive Fee Net Return during the applicable Incentive Fee Look-back Period. The “Cumulative Pre-Incentive Fee Net Return” is defined as the sum of (1) pre-incentive fee net investment income, (2) cumulative realized capital gains / (losses), and (3) cumulative unrealized capital gains / (losses) for the Incentive Fee Look-back Period. The Incentive Fee Look-back Period commenced on April 1, 2013. Prior to April 1, 2016, the Incentive Fee Look-back Period consisted of fewer than 12 full fiscal quarters. The following table details our incentive fee expenses for the years ended December 31, 2016, 2015 and 2014. ______________ (1) Capital gains-based incentive fees for the year ended December 31, 2015 of $(2.4) million represents the reversal of capital gains-based incentive fees that were previously accrued in 2014 and 2013. (2) As of December 31, 2016, the Investment Adviser had calculated an aggregate of $16.1 million of income-based incentive fees, since January 1, 2014, of which $10.6 million had been paid as of December 31, 2016. However, the Cumulative Pre-Incentive Fee Net Return has been decreased by the aggregate cumulative net realized and unrealized capital losses, as calculated under U.S. GAAP, experienced through the Incentive Fee Look-back Period. As a result, as of December 31, 2016, aggregate incentive fees payable to the Investment Adviser during the Incentive Fee Look-back Period were capped by the Incentive Fee Cap and Deferral Mechanism at $6.9 million (i.e., 20% of Cumulative Pre-Incentive Fee Net Return, during the Incentive Fee Look-back Period). Due to the fact that there is no clawback of amounts previously paid to the Investment Adviser in accordance with the Investment Advisory Agreement, the Company has not recorded a receivable for the $3.7 million difference between amounts paid under the Investment Advisory Agreement in prior quarters and the Incentive Fee Cap based on the Company’s Cumulative Pre-Incentive Fee Net Return as of December 31, 2016. The $3.7 million difference may be used to reduce future amounts earned by the Investment Adviser. However, as noted above, no incentive fee will be paid to the Investment Adviser for any fiscal quarter if, after such payment, the cumulative incentive fees paid to our Investment Adviser for the Incentive Fee Look-back Period would exceed 20% of our Cumulative Pre-Incentive Fee Net Return during the applicable Incentive Fee Look-back Period. To the extent unrealized capital losses incurred as of December 31, 2016 are reversed within the applicable Incentive Fee Look-back Period, the corresponding increase in our Cumulative Pre-Incentive Fee Net Return may result in the Investment Adviser earning and being paid up to $5.5 million of income based incentive fees which are currently subject to the Incentive Fee Cap. As of December 31, 2016, the Incentive Fee Look-back Period is in effect through December 31, 2019 and realized and unrealized capital gains and losses and pre-incentive net investment income earned through December 31, 2016 will cease to impact the Incentive Fee Cap and Deferral after this date. The Investment Adviser earned aggregate incentive fees of $3.2 million, $3.8 million and $8.4 million for the years ended December 31, 2016, December 31, 2015 and December 31, 2014, respectively. However, no incentive fees were payable on the consolidated statements of financial condition as of December 31, 2016 and December 31, 2015 due to the Incentive Fee Cap. Garrison Capital Inc. and Subsidiaries December 31, 2016 8. Related Party Transactions - (continued) Administration Agreement As discussed in Note 1, GARS entered into the Administration Agreement with GARS Administrator. Under the Administration Agreement, the GARS Administrator provides the Company with office facilities, equipment, clerical, bookkeeping and record keeping services at such facilities and such other services as the GARS Administrator, subject to review by the Board, from time to time determines to be necessary or useful to perform its obligations under the Administration Agreement. The GARS Administrator is responsible for the financial and other records that the Company is required to maintain and prepares reports to stockholders, and reports and other materials filed with the SEC. The GARS Administrator provides on the Company’s behalf significant managerial assistance to those portfolio companies to which the Company is required to provide such assistance. No managerial assistance was provided to any portfolio companies for the years ended December 31, 2016 and December 31, 2015. In addition, the GARS Administrator assists the Company in determining and publishing the Company’s net asset value, overseeing the preparation and filing of the Company’s tax returns, and the printing and dissemination of reports to stockholders of the Company, and generally oversees the payment of the Company’s expenses and the performance of administrative and professional services rendered to the Company by others. The Company reimburses the GARS Administrator for the costs and expenses incurred by the GARS Administrator in performing its obligations and providing personnel and facilities as described. GLC Trust 2013-2 entered into the GLC Trust 2013-2 Administration Agreement with GARS Administrator, fees incurred under this agreement are included in total administrator expenses presented on the consolidated statement of operations. Administrator charges for the years ended December 31, 2016, December 31, 2015 and December 31, 2014 were $1.3 million, $1.1 million, and $0.7 million, respectively. Charges were waived by the GARS Administrator for the year ended December 31, 2016. No charges were waived by the GARS Administrator for the years ended December 31, 2015, and December 31, 2014. No administration fees were payable to the GARS Administrator as of December 31, 2016 and December 31, 2015. Directors’ Fees The Company’s independent directors each receive an annual fee of $75,000. They also receive $2,500 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each in-person Board meeting and receive $1,000 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each committee meeting. In addition, the chairman of the audit committee receives an annual fee of $10,000, the chairman of the valuation committee receives an annual fee of $10,000 and each chairman of any other committee receives an annual fee of $5,000 for their additional services in these capacities (all such fees and reimbursements collectively, “Directors’ Fees”). No compensation is paid to directors who are not independent of the Company and the Investment Adviser. Independent directors earned $0.4 million for each of the years ended December 31, 2016, December 31, 2015 and December 31, 2014. No Directors’ Fees were payable as of December 31, 2016 and December 31, 2015. Affiliated Stockholders GSOF LLC, GSOF 2014 LLC, GSOF-SP LLC, GSOF-SP 2014 LLC, GSOF-SP II LLC, GSOF-SP 2014 II LLC, GSOF-SP DB LLC (subsidiaries of Garrison Special Opportunities Fund LP), GSOIF Corporate Loan Pools Ltd. (a subsidiary of Garrison Special Opportunities Institutional Fund LP), GCOH SubCo 2014-1 LLC (a subsidiary of Garrison Credit Opportunities Holdings L.P.), GCOH SubCo 2014-2 LLC (a subsidiary of Garrison Credit Opportunities Holdings L.P.), Garrison Capital Fairchild I Ltd. (a subsidiary of Fairchild Offshore Fund L.P.), Garrison Capital Fairchild II Ltd. (a subsidiary of Fairchild Offshore Fund II L.P.) and Garrison Capital Adviser Holdings MM LLC (collectively, the “Garrison Funds”) are all entities that are owned by funds that are managed by the Investment Manager. Garrison Capital Inc. and Subsidiaries December 31, 2016 8. Related Party Transactions - (continued) As of December 31, 2014, the Garrison Funds owned an aggregate of 2,024,372, or 12.1%, of the total outstanding common shares of GARS, and the officers and directors of the Company directly owned an aggregate of 73,032, or 0.4%, of the total outstanding common shares of GARS. On March 19, 2015, GSOF LLC, GSOF-SP LLC, GSOF-SP II LLC, GSOF-SP DB LLC, GSOIF Corporate Loan Pools Ltd. and GCOH SubCo 2014-1 LLC. (collectively, the “Garrison Offering Funds”) sold an aggregate 884,990 shares of GARS common stock in a secondary offering. In connection with this sale, the Garrison Offering Funds agreed to reimburse the Company for certain fees and expenses in the amount of $18,654 incurred in connection with the filing of the Company’s Registration Statement. On March 23, 2015, the Garrison Offering Funds sold an aggregate of 125,000 shares of GARS common stock in a private offering. On May 8, 2015, Garrison Capital Fairchild I Ltd. and Garrison Capital Fairchild II Ltd sold an aggregate 200,000 shares of GARS common stock in a secondary offering. On August 10, 2015, GSOF 2014 LLC, GSOF-SP 2014 LLC, GSOF-SP 2014 II LLC and GCOH SubCo 2014-2 LLC distributed an aggregate of 24,472 shares to certain officers and members of senior management of the Company. As of December 31, 2016, Garrison Capital Fairchild I Ltd., Garrison Capital Fairchild II Ltd. and Garrison Capital Adviser Holdings MM LLC owned an aggregate of 789,910, or 4.9%, of the total outstanding shares of GARS common stock. As of December 31, 2016. the officers and directors of the Company owned an aggregate of 140,471, or 0.9%, of the total outstanding shares of GARS common stock. Other Garrison Loan Agency Services LLC acts as the administrative and collateral agent for certain loans held by the Company. No fees were paid by the Company to Garrison Loan Agency Services LLC during the years ended December 31, 2016 and December 31, 2015. The Company may invest alongside other clients of the Investment Manager and their affiliates in certain circumstances where doing so is consistent with applicable law, SEC staff interpretations and the terms of our exemptive relief. For certain other expenses, the GARS Administrator facilitates payments by GARS to third parties through the Investment Adviser or other affiliate. Other than the amount of expenses paid to third parties and fees payable under the Investment Advisory Agreement, no additional charges or fees are assessed by the GARS Administrator, the Investment Adviser or other affiliates. Garrison Capital Inc. and Subsidiaries December 31, 2016 9. Financial Highlights The following table represents financial highlights for the Company for the years ended December 31, 2016, December 31, 2015 and December 31, 2014. Garrison Capital Inc. and Subsidiaries December 31, 2016 9. Financial Highlights - (continued) (1) Total book return equals the net increase of ending net asset value from operations plus the effect of repurchases of common stock over the net asset value per common share at the beginning of the period. (2) Based upon the change in market price per share during the period and takes into account distributions, if any, reinvested in accordance with our dividend reinvestment plan. (3) Calculated utilizing monthly net assets. (4) During the year ended December 31, 2016, $3.2 million of income-based incentive fees were capped as a result of the Incentive Fee Cap and Deferral Mechanism and $0.2 million of management fees were irrevocably waived. Had these management and incentive fees been earned, the ratio of net investment income to average net assets and the ratio of net expenses to average net assets would have been 7.25% and 12.71%, respectively. (5) Calculated based on monthly average investments at fair value. (6) In accordance with the 1940 Act, with certain limited exceptions, the Company is only allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing. Based on the exemptive relief received from the SEC, our SBIC Borrowings are excluded from the Company’s asset coverage test calculation. (7) Calculated based on monthly average investments at fair value. 10. Net Assets The Company’s authorized stock consists of 100,000,000 shares of common stock, par value $0.001 per share, and 1,000,000 shares of preferred stock, par value $0.001 per share. We priced our initial public offering (“IPO”) on March 26, 2013, selling 6,133,334 shares at a public offering price of $15.00 per share. The closing of the IPO took place on April 2, 2013 and all shares were issued as of that date. Concurrent with the IPO, the Company’s directors, officers, employees and an affiliate of the Investment Adviser purchased an additional 126,901 shares through a concurrent private placement transaction at a price of $15.00 per share. An aggregate of 16,049,352 and 16,507,594 shares of common stock, par value $0.001 per share, were outstanding as of December 31, 2016 and December 31, 2015, respectively. For the years ended December 31, 2016 and December 31, 2015, there were no shares of preferred stock issued. Garrison Capital Inc. and Subsidiaries December 31, 2016 11. Earnings per share The following table sets forth the computation of the net increase in net assets per share resulting from operations, pursuant to FASB ASC Topic 260, Earnings per Share, for the years ended December 31, 2016, December 31, 2015 and December 31, 2014: 12. Dividends and Distributions GARS dividends and distributions are recorded on the ex-dividend date. The following table reflects the cash distributions declared on common stock for the fiscal years ended December 31, 2016 and December 31, 2015. ______________ (1) Does not include any return of capital for tax purposes. ______________ (1) Does not include any return of capital for tax purposes. Garrison Capital Inc. and Subsidiaries December 31, 2016 12. Dividends and Distributions - (continued) Dividends from net investment income and distributions from net realized capital gains are determined in accordance with U.S. Federal Income Tax regulations, which may differ from those amounts determined in accordance with U.S. GAAP. 13. Commitments and Contingencies The Company had outstanding commitments to fund investments totaling $4.8 million and $6.9 million under various undrawn revolvers and other credit facilities as of December 31, 2016 and December 31, 2015, respectively. In the ordinary course of business, the Company may be named as a defendant or a plaintiff in various lawsuits and other legal proceedings. Such proceedings include actions brought against the Company and others with respect to transactions to which the Company may have been a party. The outcomes of such lawsuits are uncertain and, based on these lawsuits, the values of the investments to which they relate could decrease. Management does not believe that as a result of litigation there would be any material impact on the consolidated financial condition of the Company. The Company has had no outstanding litigation proceedings brought against it since the commencement of operations on December 17, 2010. 14. Stock Repurchase Program On October 5, 2015, we adopted a share repurchase plan that provided for repurchase of up to $10.0 million of our common stock at prices below our net asset value per share as reported in our most recent financial statements. Under the repurchase program, we repurchased shares of our outstanding common stock in the open market or in privately negotiated transactions from time to time. Repurchases by us complied with the requirements of Rule 10b-18 under the Securities Exchange Act of 1934, as amended, and any applicable requirements of the 1940 Act. The repurchase program terminated in accordance with its terms on October 5, 2016. Our net asset value per share was increased by approximately $0.10 as a result of the aggregate share repurchases. 15. Transactions with Non-control/Affiliate Investments As required by the 1940 Act, investments are classified by level of control. “Control Investments” are investments in those companies that the Company is deemed to control as defined in the 1940 Act. “Affiliate Investments” are investments in those companies that are affiliated companies, as defined in the 1940 Act, other than Control Investments. “Non-Control/Non-Affiliate Investments” are those that are neither Control Investments nor Affiliate Investments. Generally, under the 1940 Act, the Company is deemed to control a company in which it has invested if it owns more than 25% of the voting securities of such company. The Company is deemed to be an affiliate of a company in which it has invested if it owns 5% or more of the voting securities of such company. __________ (1) Comprised of two investments, including the Closing Date Term Loan and Delayed Draw Term Loan with both a cost and fair value of $1.9 million and $1.2 million, respectively. As of December 31, 2015, we had no investments with non-control/affiliated investments. 16. Subsequent Events On February 28, 2017 the Board approved a distribution in the amount of $4.5 million, or $0.28 a share, which will be paid on March 30, 2017 to stockholders of record as of March 23, 2017. These consolidated financial statements were approved by the Board and were available for issuance on March 7, 2017. Subsequent events have been evaluated through this date. No material subsequent events other than as disclosed above have occurred through this date. 17. Selected Quarterly Financial Data (Unaudited) | I apologize, but the financial statement excerpt you've provided seems to be incomplete and fragmented, making it difficult to provide a comprehensive summary. The text appears to be a partial extract from a financial statement, with sections about profit/loss, expenses, assets, and liabilities, but lacks complete information.
The most coherent part of the text discusses the company's approach to recording investment losses and interest income:
Key points:
- Losses on investment transactions are recorded using specific identification method
- Interest income is accrued if collection is expected
- When a loan payment defaults or the issuer is unlikely to make payments, the loan is placed on non-accrual status
- Interest income recognition stops until the loan becomes current or is restructured
- The company remains contractually entitled to the interest
- Accrued interest is written off when collection becomes unlikely
Without the full financial statement, I cannot provide a complete summary of the company's financial position | Claude |
. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of ZAIS Group Holdings, Inc.: In our opinion, the accompanying consolidated statement of financial condition as of December 31, 2016 and the related consolidated statements of comprehensive income (loss), of changes in equity, non-controlling interests and redeemable non-controlling interests, and of cash flows for the year then ended present fairly, in all material respects, the financial position of ZAIS Group Holdings, Inc. and its subsidiaries as of December 31, 2016, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. /s/PricewaterhouseCoopers LLP New York, New York March 24, 2017 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders ZAIS Group Holdings, Inc.: We have audited the accompanying consolidated statement of financial condition of ZAIS Group Holdings, Inc. and Subsidiaries as of December 31, 2015, and the related consolidated statements of comprehensive income (loss), changes in equity, non-controlling interests and redeemable non-controlling interests, and cash flows for the year ended December 31, 2015. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ZAIS Group Holdings, Inc. and Subsidiaries as of December 31, 2015, and the results of their operations and their cash flows for the year ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. /s/ KPMG LLP Short Hills, New Jersey March 10, 2016 ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES Consolidated Statements of Financial Condition (Dollars in thousands, except share amounts) The accompanying notes are an integral part of these consolidated financial statements. ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Loss) (Dollars in thousands, except share and per share amounts) (1)Pro-rated based on the portion of the period preceding and following the Business Combination The accompanying notes are an integral part of these consolidated financial statements. ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Equity, Non-controlling Interests and Redeemable Non-controlling Interests (Dollars in thousands except share amounts) The accompanying notes are an integral part of these consolidated financial statements. ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Dollars in thousands) The accompanying notes are an integral part of these consolidated financial statements. ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES 1. Organization ZAIS Group Holdings, Inc. (“ZAIS” and collectively with its subsidiaries, the “Company”) is a holding company conducting substantially all of its operations through ZAIS Group, LLC (“ZAIS Group”), an investment advisory and asset management firm focused on specialized credit which commenced operations in July 1997 and is headquartered in Red Bank, New Jersey. ZAIS Group also maintains an office in London. ZAIS Group is a wholly-owned consolidated subsidiary of ZAIS Group Parent, LLC (“ZGP”), a majority-owned consolidated subsidiary of ZAIS. ZGP became the sole member and 100% equity owner of ZAIS Group on March 31, 2014 pursuant to a merger transaction which is described in detail in ZAIS’s Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on March 23, 2015 (the “Closing 8-K”). References to the “Company” in these consolidated financial statements refer to ZAIS, together with its consolidated subsidiaries. ZAIS Group is an investment advisor registered with the SEC under the Investment Advisors Act of 1940 and is also registered with the Commodity Futures Trading Commission as a Commodity Pool Operator and Commodity Trading Advisor. ZAIS Group provides investment advisory and asset management services to private funds, separately managed accounts, structured vehicles (collateralized debt obligation vehicles and collateralized loan obligation vehicles, together referred to as “CLOs”) and, through October 31, 2016, ZAIS Financial Corp. (“ZFC REIT”), a publicly traded mortgage real estate investment trust (collectively, the “ZAIS Managed Entities”). ZAIS REIT Management, LLC (“ZAIS REIT Management”), a majority owned subsidiary of ZAIS Group, was the external investment advisor to ZFC REIT. On April 7, 2016, ZFC REIT announced that it had entered into an agreement and plan of merger (the “Merger Agreement”) with Sutherland Assets Management Corp. The ZFC REIT merger closed on October 31, 2016. In connection with the Merger Agreement, ZAIS REIT Management entered into a termination agreement (the “Termination Agreement”), whereby the advisory agreement under which ZAIS REIT Management received management fees from ZFC REIT was terminated upon closing of the merger on October 31, 2016. Pursuant to the Termination Agreement, ZAIS REIT Management received a termination payment of $8.0 million. The ZAIS Managed Entities predominantly invest in a variety of specialized credit instruments including corporate credit instruments such as collateralized debt or loan obligations, securities backed by residential mortgage loans, bank loans and various securities and instruments backed by these asset classes. ZAIS Group had the following assets under management (“AUM”): ZAIS Group also serves as the general partner to certain ZAIS Managed Entities, which are generally organized as pass-through entities for U.S. federal income tax purposes. The Company’s primary sources of revenues and other income are (i) management fee income, which is based predominantly on the net asset values of the ZAIS Managed Entities and (ii) incentive income, which is based on the investment performance of the ZAIS Managed Entities. All of the management fee income and incentive income earned by ZAIS Group from the consolidated ZAIS Managed Entities (the “Consolidated Funds”) is eliminated in consolidation. Additionally, a significant source of the Company’s income is derived from gains of Consolidated Funds’ investments. These gains are primarily related to the Consolidated Funds’ investments in collateralized financing entities investing in bank loans. On March 20, 2015, ZAIS made a decision to terminate the business operations of its Shanghai subsidiary. ZAIS Group ceased conducting regular business activities in Shanghai and the office was closed in December 2015. The deregistration process is in the final stages and is expected to be completed in the second quarter of 2017. The Shanghai operations were not material to the Company’s operations. Recapitalization as a Result of a Business Combination On October 5, 2012, HF2 Financial Management Inc. (“HF2”) was formed as a blank check company whose objective was to acquire, through a merger, share exchange, asset acquisition, stock purchase, recapitalization, reorganization or similar business combination, one or more businesses or entities. On September 16, 2014, HF2 entered into an Investment Agreement, as defined in the Closing 8-K, with ZGP and the members of ZGP (including Christian Zugel, the former managing member of ZGP and the founder and Chief Investment Officer of ZAIS Group, and certain related parties, collectively, the “ZGP Founder Members”), under which HF2 agreed to contribute cash to ZGP in exchange for newly issued Class A Units of ZGP (“Class A Units”) representing a majority financial interest in ZGP (the “Business Combination”) and to cause the transfer of all of its outstanding shares of Class B Common Stock, par value $0.000001 (the “Class B Common Stock”) to the ZGP Founder Members. All Class B Common Stock was then immediately deposited into a newly created irrevocable voting trust (the “ZGH Class B Voting Trust”), of which Mr. Zugel is the sole trustee. The Class B Common Stock has no economic rights and therefore is not considered participating securities for purposes of allocation of consolidated net income (loss). On March 9, 2015, the stockholders of HF2 approved the Business Combination and the transaction closed on March 17, 2015 (the “Closing”). In connection with the Closing, HF2 changed its name to ZAIS Group Holdings, Inc. Prior to the Closing, HF2 was a shell company with no operations. Upon the Closing, ZAIS became a holding company whose assets primarily consist of an approximate 66.5% interest in its majority-owned subsidiary, ZGP. Prior to the Closing, Christian Zugel served as the managing member of ZGP. Upon the Closing, ZAIS became the managing member of ZGP. 2. Business Combination Basis of Presentation and Accounting Treatment of the Business Combination Upon the Closing, ZAIS acquired approximately 66.5% of the Class A Units of ZGP. The remainder of the Class A Units of ZGP are held by the ZGP Founder Members. In addition, all of the outstanding shares of Class B Common Stock were transferred from the HF2 Class B Trust to the ZGP Founder Members on a pro rata basis, and were immediately deposited into ZGH Class B Voting Trust. Mr. Zugel, as sole trustee, has voting and investment power over the shares of Class B Common Stock held in ZGH Class B Voting Trust. Each share of Class B Common Stock is entitled to 10 votes and there are currently 20,000,000 shares of Class B Common Stock outstanding. Consequently, in his capacity as trustee of the ZGH Class B Voting Trust, Mr. Zugel has effective voting control over the election of directors and generally on all other matters submitted for approval by our stockholders. The Business Combination was structured as an “Up-C” transaction. Generally, in an Up-C transaction involving an operating business, a publicly traded entity taxable as a corporation for U.S. federal income tax purposes acquires an interest in a partnership or limited liability company (taxable as a partnership for U.S. federal income tax purposes) that is conducting an operating business. The historic owners of the operating business continue to own an interest in the operating business through a continuing interest in the partnership or limited liability company and may have the ability to exchange their partnership or limited liability company interests for stock in the publicly traded entity under specified circumstances in accordance with the terms of an exchange agreement. Pursuant to the Business Combination, HF2, a publicly traded corporation taxable as a corporation for U.S. federal income tax purposes, became a holding company the assets of which consist primarily of its majority membership interest in ZGP, a partnership for U.S. federal income tax purposes. ZGP, in turn, is the sole member of ZAIS Group, an operating business. The accounting for the reorganization and recapitalization follows the rules for a reverse acquisition as enumerated in the Accounting Standards Codification (“ASC”), Section 805. In a reverse acquisition, the acquirer for accounting purposes is the target for legal purposes (in this case, ZGP) and the target for accounting purposes is the acquirer for legal purposes (in this case, HF2). The accounting acquirer in a reverse acquisition measures the consideration transferred using the hypothetical amount of equity interests it would have had to issue to keep the accounting target’s owners in the same ownership position they are in after the reverse acquisition. The accounting acquirer adjusts the amount of legal capital in the consolidated financial statements to reflect the legal capital of the accounting target and measures the non-controlling interest using the pre-combination carrying amounts of the accounting acquirer’s net assets and the non-controlling interests’ proportionate share in those pre-combination carrying amounts. No goodwill or other intangible assets were recorded as a result of the Business Combination. For accounting purposes, ZGP is considered the acquirer and has accounted for the Business Combination as a reorganization and recapitalization. ZGP was determined to be the acquirer based on the following facts and circumstances: •ZGP retained effective control. There is no change in control since ZGP’s operations comprise the ongoing operations of the combined entity; •ZGP is the sole member of ZAIS Group and ZAIS Group’s senior management became the senior management of the combined entity. The officers of the combined company consist entirely of ZAIS Group executives, including the Chief Executive Officer, Chief Investment Officer, Acting Chief Financial Officer and General Counsel; •The ZGP Founder Members own a majority voting interest in the combined entity through the Class B Common Stock that is held in the ZGH Class B Voting Trust. Mr. Christian Zugel, a ZGP Founder Member, the former managing member of ZGP and the founder and Chief Investment Officer of ZAIS Group, is the sole initial trustee. Mr. Zugel has voting and investment power over the shares of the Class B Common Stock held in the ZGH Class B Voting Trust and therefore is able to elect all of the combined entity’s board of directors. Accordingly, the Business Combination does not constitute the acquisition of a business for purposes of ASC 805. As a result, the assets and liabilities of ZGP and ZAIS are carried at historical cost and ZAIS has not recorded any step-up in basis or any intangible assets or goodwill as a result of the Business Combination. All direct costs attributable to the Business Combination were recorded as reductions to additional paid-in-capital. Since the Business Combination is accounted for as a recapitalization of ZGP, the financial statements presented herein for periods prior to the Business Combination are those of ZGP. The net proceeds from the Business Combination, as reported in the Consolidated Statements of Cash Flows within the financing section, are summarized as follows: In connection with the Business Combination, HF2 redeemed 9,741,193 shares of its Class A common stock resulting in a total payment to redeeming stockholders of $102,282,526. The number of shares of Class A common stock of ZAIS issued and outstanding and the number of Class A Units of ZGP issued and outstanding immediately following the consummation of the Business Combination is summarized as follows: During the first five years following the Closing, ZGP will release up to an additional 2,800,000 Class A Units (the “Additional Founder Units”) to the ZGP Founder Members if the sum of the average per share closing price over any 20 trading-day period of the Class A Common Stock plus cumulative dividends paid on the Class A Common Stock between the Closing and the day prior to such 20 trading-day period (the “Total Per Share Value”) meets or exceeds specified thresholds, ranging from $12.50 to $21.50. Subsequent to the Closing, ZGP paid Neil Ramsey, an affiliate of NAR Special Global, LLC and of dQuant Special Opportunities Fund, L.P. (“dQuant Special Opportunities Fund”) (together, the “Ramsey Investors”), each of which are significant stockholders of ZAIS, an incentive fee of $3.4 million pursuant to an agreement dated March 4, 2015 between ZGP and Mr. Ramsey. The incentive fee of $3.4 million was paid in consideration for Mr. Ramsey causing the Ramsey Investors to purchase from stockholders, who tendered their shares of Class A Common Stock of ZAIS for redemption, such number of shares of Class A Common Stock of ZAIS as was necessary to meet the closing condition that there be at least $65 million in HF2’s trust account after giving effect to redemptions and expense payments (other than certain notes to ZAIS’s financial advisers). The payment by ZGP to Mr. Ramsey of the incentive fee described above was treated as a direct cost attributable to the Business Combination. Additionally, as described further under “Related Party Transactions”, ZGP entered into a two-year Consulting Agreement with Mr. Ramsey through an entity that he controls. 3. Basis of Presentation and Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) as contained within the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification. Segment Reporting The Company currently is comprised of one reportable segment, the investment management segment, and substantially all of the Company’s operations are conducted through this segment. The investment management segment provides investment advisory and asset management services to the ZAIS Managed Entities. Use of Estimates The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. While management believes that the estimates used in preparing the consolidated financial statements are reasonable and prudent, actual results may ultimately differ from those estimates. Non-Controlling Interests The non-controlling interests within the Consolidated Statements of Financial Condition may be comprised of: (i) redeemable non-controlling interests reported outside of the permanent capital section when investors have the right to redeem their interests from a Consolidated Fund or ZAIS Group; (ii) equity attributable to non-controlling interests in Consolidated Funds (excluding CLOs) reported inside the permanent capital section when the investors do not have the right to redeem their interests and (iii) equity attributable to non-controlling interests in ZGP, if applicable. The Company records redeemable non-controlling interests and non-controlling interests in the Consolidated Funds (excluding CLOs) to reflect the economic interests in those funds held by investors other than interests attributable to ZAIS Group. Income allocated to non-controlling interests in ZGP includes a portion of the management fee income received from ZFC REIT that was payable to holders of Class B interests in ZAIS REIT Management. Principles of Consolidation The consolidated financial statements included herein are the financial statements of ZAIS, its subsidiaries and certain ZAIS Managed Entities that are required to be consolidated. All intercompany balances and transactions have been eliminated in consolidation, including ZAIS’s investment in ZGP and ZGP’s investment in ZAIS Group. The Company's fiscal year ends on December 31. The consolidated financial statements include non-controlling interests in ZGP which is primarily comprised of Class A Units of ZGP held by the ZGP Founder Members. The Company’s consolidated financial statements also include variable interest entities for which ZAIS Group is considered the primary beneficiary, and certain entities that are not considered variable interest entities in which ZAIS Group has a controlling financial interest. The consolidated financial statements reflect the assets, liabilities, investment income, expenses and cash flows of the Consolidated Funds on a gross basis. Except for CLOs, the majority of the economic interests in the Consolidated Funds, which are held by third-party investors, are reflected as non-controlling interests in the consolidated financial statements. For CLOs, the majority of the economic interests in these vehicles, which are held by outside parties, are reported as notes payable of consolidated CLOs in the consolidated financial statements. The notes payable issued by the CLOs are backed by diversified collateral asset portfolios consisting primarily of loans or structured debt. In exchange for managing the collateral for the CLOs, ZAIS Group may earn investment management fees, including, in some cases, subordinated management fees and contingent incentive fees. All of the management fee income, incentive income and net gain (loss) on investments earned by ZAIS Group from the Consolidated Funds are eliminated in consolidation. However, because the eliminated amounts are earned from and funded by the non-controlling interests, income allocated to the non-controlling interests has been reduced, and the income allocated to ZGP has been increased by the amounts eliminated, of which ZAIS is allocated its pro-rata share as a member of ZGP. ZAIS Group does not recognize any incentive income based on the investment performance of ZAIS Managed Entities until the incentive income is (i) contractually receivable, (ii) fixed or determinable (also referred to as “crystallized”) and (iii) all related contingencies have been removed and collection is reasonably assured, (see policy disclosed under Management Fee Income, Incentive Income, and Other Income). Similarly, for any Consolidated Funds, the corresponding potential incentive expense based on the investment performance of the Consolidated Funds has not yet been deducted from the investor capital balances until the above criteria have been met. Therefore, the corresponding potential incentive income based on the investment performance of the Consolidated Funds that has not yet been recognized by ZAIS Group is included in Non-controlling interests in the consolidated financial statements. The Company’s consolidated net income (loss) includes the change in net assets relating to its beneficial interests in collateralized financing entities, including (1) changes in the fair value of the beneficial interests retained by the Company and (2) beneficial interests that represent compensation for services, if any. The Consolidated Funds, except for consolidated CLOs, are deemed to be investment companies under U.S. GAAP, and therefore, the Company has retained the specialized investment company accounting of these consolidated entities in its consolidated financial statements. Effective January 1, 2015 pursuant to ASC Topic 810, as amended by Accounting Standards Update (“ASU”) 2015-02 (ASU 2015-02”), all entities which were previously required to be consolidated but not required to be consolidated under ASU 2015-02 have been deconsolidated. As of December 31, 2015, the consolidated financial statements include one ZAIS Managed Entity, ZAIS Zephyr A-6, LP (“Zephyr A-6”) which was launched in the fourth quarter of 2015. For all periods prior to January 1, 2015, these entities include ZAIS Opportunity Master Fund, Ltd., ZAIS Opportunity Domestic Feeder Fund, LP, ZAIS Opportunity Fund, Ltd., ZAIS Atlas Fund, LP, ZAIS Value-Added Real Estate Fund I, LP and certain CLOs. After the adoption of ASC Topic 810, as amended by ASU 2015-02, there were no CLOs required to be consolidated in the Company’s financial statements for the year ended December 31, 2015 and prior to the adoption of ASC Topic 810, as amended by ASU 2015-02, there were ten CLOs consolidated in the Company’s financial statements for the year ended December 31, 2014. The cumulative effect of the adoption of ASU 2015-02 was a $452,925,000 and a $10,340,000 reduction in redeemable non-controlling interests and non-controlling interests in Consolidated Funds, respectively, on January 1, 2015, which is reflected in the Consolidated Statement of Changes in Equity, non-controlling interests and redeemable non-controlling interests. All intercompany balances and transactions have been eliminated in consolidation. As of and for the year ended December 31, 2016 the Company consolidated Zephyr A-6 and ZAIS CLO 5 Limited (“ZAIS CLO 5”). VIE Model Prior to the adoption of ASU 2015-02, for entities in which the Company has a variable interest, the Company determines whether, if by design, (i) the entity has equity investors who lack, as a group, the characteristics of a controlling financial interest, (ii) the entity does not have sufficient equity at risk to finance its expected activities without additional subordinated financial support from other parties, (iii) the entity is structured with non-substantive voting rights or (iv) the equity holders do not have the obligation to bear potential losses or the right to receive potential gains. If an entity has at least one of these characteristics, it is considered a VIE, and is consolidated by its primary beneficiary. For entities managed by ZAIS Group that qualify for the deferral under ASU 2010-10, Amendments to Statement 167 for Certain Investment Funds (“ASU 2010-10”), the primary beneficiary of these entities that are determined to be VIEs is the party that absorbs a majority of the VIEs’ expected losses or receives a majority of the expected residual returns. For entities managed by ZAIS Group that do not qualify for the deferral under ASU 2010-10, the primary beneficiary of these entities is the party that (i) has the power to direct the activities of the entity that most significantly impact the entity’s economic performance; and (ii) has the obligation to absorb losses or the right to receive benefits from the entity that could potentially be significant to the entity. The Company reassesses its initial evaluation of an entity as a VIE upon occurrence of certain reconsideration events. Subsequent to the adoption of ASU 2015-02, for entities in which the Company has a variable interest, the Company determines whether, (i) the entity does not have enough equity to finance its activities without additional subordinated financial support, (ii) the at-risk equity holders, as a group lack (a) the power, through voting or similar rights, to direct the activities that most significantly impact the entity’s economic performance, (b) the obligation to absorb an entity’s expected losses, or (c) the right to receive an entity’s expected residual returns, or (iii) the entity is structured with non-substantive voting rights. If an entity has at least one of these characteristics, it is considered a VIE, and is consolidated by its primary beneficiary. VOE Model For entities where ZAIS Group has a variable interest, but are determined not to be a VIE, the Company makes a consolidation determination based on the entity’s legal structure. For corporate structures, including companies domiciled in the Cayman Islands, the Company consolidates those entities in which ZAIS Group has a voting interest of greater than 50% and has control over the significant operating, financial and investing decisions of the entity. For limited partnerships and limited liability companies, the Company consolidates entities in which it is a general partner or managing member, it has a greater than 50% ownership in the entity and third-party investors have no substantive rights to participate in the ongoing governance and operating activities or substantive kick-out rights. The determination of whether an entity is a VIE or a VOE is based on the facts and circumstances for each individual entity. Cash and Cash Equivalents The Company considers highly liquid, short-term interest-bearing instruments of sufficient credit quality with original maturities of three months or less, and other instruments readily convertible into cash, to be cash equivalents. Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company’s deposits with financial institutions may exceed federally insurable limits of $250,000 per institution. The Company mitigates this risk by depositing funds with major financial institutions. Cash equivalents generally consist of excess cash that is swept daily into a money market fund, or into weekly or monthly term deposit accounts to earn short-term interest, or maintained as a short-term deposit. Additionally, the Company may from time-to-time invest in United States government obligations to manage excess liquidity. These investments are carried at fair value, as the Company has elected the Fair Value Option (as defined below) in order to include any gains or losses within consolidated net income (loss). These investments are also recorded as cash equivalents in the Consolidated Statements of Financial Condition. At December 31, 2016 and December 31, 2015, the Company had approximately $29.0 million and $16.6 million, respectively, invested in money market funds and short-term deposits. At December 31, 2016 and December 31, 2015, the Company had approximately $8.0 million and $26.0 million, respectively, invested in United States government obligations. Investments and Investments in Affiliates at Fair Value U.S. GAAP permits entities to choose to measure certain eligible financial assets, financial liabilities and firm commitments at fair value (the “Fair Value Option”), on an instrument-by-instrument basis. The election to use the Fair Value Option is available when an entity first recognizes a financial asset or financial liability or upon entering into a firm commitment. The Fair Value Option is irrevocable and requires changes in fair value to be recognized in earnings. For ZAIS Group’s direct investments in the ZAIS Managed Entities that are not consolidated, and would otherwise be accounted for under the equity method, the Fair Value Option has been elected. In estimating the fair value for financial instruments for which the Fair Value Option has been elected, the Company uses the valuation methodologies as discussed in Note 5 - “Fair Value Measurements”. Revenue Recognition ZAIS Group’s primary sources of revenue are (i) management fee income, (ii) incentive income and (iii) income of Consolidated Funds. The management fee and incentive fee revenues are derived from ZAIS Group’s advisory agreements with the ZAIS Managed Entities. Certain investments held by employees, executives and other related parties in the ZAIS Managed Entities are not subject to management fees or incentive fees/allocations and therefore do not generate revenue for ZAIS Group. All of the management fee income and incentive income earned by ZAIS Group from the Consolidated Funds are eliminated in consolidation. Income of Consolidated Funds is based on the income generated from the portfolios of the Consolidated Funds, a majority of which is allocated to redeemable non-controlling interests and non-controlling interests in Consolidated Funds, as applicable. Management Fee Income, Incentive Income and Other Revenue ZAIS Group earns management fee income and incentive income for investment advisory services provided to the ZAIS Managed Entities. Management fees are accrued as earned, and are calculated and collected on a monthly or quarterly basis, depending on the applicable agreement. Revenue is accrued as earned for data, funding and analytical services provided to outside parties and affiliated funds. In the event management fee income is received before it is earned, deferred revenue is recorded and is included in Other liabilities in the Consolidated Statements of Financial Condition. In addition to the management fee income mentioned above, subordinated management fee income may be earned from the CLOs. The subordinated management fee income has a lower priority than the base management fees in the CLO’s cash flows. The subordinated management fee income is contingent upon the economic performance of the respective CLO’s investments. If the CLOs experience a certain level of investment defaults, these fees may not be paid. Subordinated management fee income is recognized when collection is reasonably assured. Incentive income is recognized when it is (i) contractually receivable, (ii) fixed or determinable (also referred to as “crystallized”) and (iii) all related contingencies have been removed and collection is reasonably assured, which generally occurs in the quarter of, or the quarter immediately prior to, payment of the incentive income to ZAIS Group by the ZAIS Managed Entities. The criteria for revenue recognition related to incentive income is typically met only after all contributed capital and the preferred return, if any, on that capital have been distributed to the ZAIS Managed Entities’ investors for vehicles with private equity style fee arrangements, and is typically met only after any profits exceed a high-water mark for vehicles with hedge fund style fee arrangements. Other revenue is recorded on an accrual basis as earned and consists primarily of consulting fees. Income and Fees Receivable Income and fees receivable primarily includes management fees and incentive fees due from ZAIS Managed Entities, excluding the Consolidated Funds. The Company evaluates the collectability of the amounts receivable to determine whether any allowance for doubtful accounts is necessary. Fees Payable Fees payable represents management fees and incentive fees due to an investor in one of the ZAIS Managed Entities as a credit for fees charged to that investor on their investment balance in another ZAIS Managed Entity. The credit is recorded as a direct reduction to Management fee income and Incentive income in the Consolidated Statements of Comprehensive Income (Loss). General, Administrative and Other Expenses General, administrative and other expenses include professional fees, insurance costs, information technology, rent expense and other operating expenses. Amounts are recorded on an accrual basis as incurred. Compensation and Benefits Compensation and benefits expense is comprised of salaries, payroll taxes, employer contributions to welfare plans, discretionary and guaranteed cash bonuses, stock compensation and other contractual compensation programs payable to ZAIS Group employees. Compensation and benefits expense is generally recognized over the related service period. On an annual basis, compensation and benefits comprise a significant portion of total expenses, with discretionary cash bonuses, guaranteed cash bonuses, stock compensation and other contractual compensation programs generally comprising a significant portion of total compensation and benefits. Compensation and benefits expense relating to the issuance of cash-based and equity-based awards to certain employees is measured at fair value on the grant date. Equity-based compensation awards to employees that are settled in shares are classified as equity instruments. The fair value of an equity settled award is determined on the date of grant and is not subject to remeasurement. Cash settled awards are classified as liabilities and are remeasured to fair value at each balance sheet date as long as the award is outstanding. Changes in fair value are reflected as compensation expense. Compensation expense for awards that vest over a future service period is recognized over the relevant service period on a straight-line basis, adjusted for estimated forfeitures of awards not expected to vest. The compensation expense for awards that do not require future service is recognized immediately. Upon the end of the service period, compensation expense is adjusted to account for actual forfeiture rates. Compensation and benefits expense also includes compensation directly related to incentive income in the form of percentage interests (also referred to as “Points”) awarded to certain employees associated with the operation and management of certain ZAIS Managed Entities in the form of compensation agreements (“Points Agreements”). Under the Points Agreements, ZAIS Group has an obligation to pay certain employees and former employees a fixed percentage of the incentive income earned from the referenced entities. Amounts payable pursuant to these arrangements are recorded as compensation expense when they become probable and reasonably estimable. The determination of when the Points become probable and reasonably estimable is based on the assessment of numerous factors, particularly those related to the profitability, realizations, distribution status, investment profile and commitments or contingencies of certain ZAIS Managed Entities for which Points Agreements have been awarded. Points are expensed no later than the period in which the underlying income is recognized. Payment of the Points generally occurs not later than when the related income is received. Most recipients’ rights to receive payments related to their Points Agreement are subject to forfeiture risks. There are currently outstanding Points Agreements relating to one ZAIS Managed Entity and ZAIS Group does not anticipate awarding additional Points Agreements. Pursuant to ZAIS’s 2015 Stock Incentive Plan, non-employee directors and employees of ZAIS are eligible to receive RSUs as a component of compensation for their service as directors or employees of ZAIS. The awards are unvested at the time they are granted and, as such, are not entitled to any dividends or other material rights until such RSUs vest. The RSUs generally vest pursuant to the agreements between the recipient and the Company. Upon vesting ZAIS will issue the recipient shares of Class A Common Stock equal to the number of vested RSUs. In accordance with ASC 718, "Compensation - Stock Compensation”, the Company is measuring the expense associated with these awards based on grant date fair value adjusted for estimated forfeitures. This expense will be amortized equally over the one year vesting period and will be cumulatively adjusted for changes in estimated forfeitures at each reporting date. Loss Contingencies Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief available, sought or expected to be sought therein. If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be reasonably estimated, then the estimated liability would be accrued in the Company’s financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable, would be disclosed. Legal costs are recorded on an accrual basis as incurred. Property and Equipment Property and equipment consist of furniture and fixtures, office equipment, leasehold improvements and software, and are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization on furniture and fixtures, office equipment and software is calculated using either the double declining balance method or straight-line method over an estimated useful life of three to five years. Amortization of leasehold improvements is calculated using the straight-line method over the lesser of the lease terms or the life of the asset. Depreciation and amortization expense is included in Depreciation and amortization in the Consolidated Statements of Comprehensive Income (Loss). Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The costs associated with maintenance and repairs are recorded as other operating expenses when incurred. Goodwill Goodwill, if any, is carried at cost in the Consolidated Statements of Financial Condition. Goodwill is not amortized but is tested for impairment on an annual basis, or more frequently if events or changes in circumstances indicate that a potential impairment may have occurred. The testing of goodwill for impairment is initially based on a qualitative assessment to determine if it is more likely than not that the fair value of the goodwill is less than the carrying value. If facts indicate that it is more likely than not that an impairment may exist, a two-step quantitative assessment is conducted to (a) calculate the fair value of the goodwill and compare it to the carrying value, and (b) if the carrying value exceeds its fair value, the difference is recognized as an expense in the period in which the impairment occurs. Goodwill of approximately $2.7 million resulted from the acquisition by ZGP of membership interests in ZAIS Group from a strategic founding investor in December of 2012. The goodwill was reassessed in 2015 since management anticipated that the Company’s expenses would exceed its revenues in 2016. The Company prepared an updated valuation of ZAIS Group’s operating business using 1) a discounted cash flow analysis and 2) revenue multiples of comparable public asset management companies. The Company’s valuation produced a range of values which were all significantly below the valuation used to measure the goodwill at its inception and, when the value was ascribed to all of the Company’s assets and liabilities, management determined that the fair value of goodwill was zero. The Company therefore impaired the goodwill and recognized the full carrying value of goodwill as an expense for the year ended December 31, 2015. The impairment expense of approximately $(2.7) million is included in Impairment loss on goodwill in the Consolidated Statements of Comprehensive Income (Loss). Foreign Currency Translation Gains (Losses) Assets and liabilities of foreign subsidiaries that have non-U.S. dollar functional currencies are translated at exchange rates prevailing at the end of each reporting period. Results of foreign operations are translated at the weighted-average exchange rate for each reporting period. Translation adjustments are included as a component of accumulated other comprehensive income (loss) until realized. Gains or losses resulting from foreign currency transactions are included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss). Foreign currency translation gains and losses primarily relate to the Company’s U.K. operations. Income Taxes Prior to the reorganization and recapitalization due to the Business Combination, ZGP and its subsidiaries were pass-through entities for U.S. income tax purposes and their earnings flowed through to the owners without being subject to entity level income taxes. Accordingly, no provision for income taxes has been recorded in historical periods other than that related to ZGP’s foreign subsidiaries, which paid income taxes in their respective foreign jurisdictions. Following the reorganization, although ZGP and its subsidiaries continue to operate as pass-through entities for U.S. income tax purposes not subject to entity level taxes, ZAIS is taxable as a corporation for U.S. tax purposes. Accordingly, the Company’s consolidated financial statements include U.S. federal, state and local income taxes on the ZAIS’ allocable share of the consolidated results of operations, as well as taxes payable to jurisdictions outside the U.S related to the foreign subsidiaries. The Company accounts for income taxes using the asset and liability method as prescribed in ASC 740 Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Management periodically assesses the recoverability of its deferred tax assets based upon all available evidence, including past operating results, the existence of cumulative losses in the most recent fiscal years, estimates of future taxable income, the feasibility of tax planning strategies and other factors. If management determines that it is not more likely than not that the deferred tax asset will be fully recoverable in the future, a valuation allowance may be established for the difference between the asset balance and the amount expected to be recoverable in the future. The allowance will result in a charge to our Consolidated Statements of Comprehensive Income (Loss). Further, the Company records its income taxes receivable and payable based upon our estimated income tax liability. The Company provides for uncertain tax positions based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. Management is required to determine whether a tax position is more likely than not to be sustained upon examination by tax authorities, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Because significant assumptions are used in determining whether a tax benefit is more likely than not to be sustained upon examination by tax authorities, actual results may differ from the Company's estimates under different assumptions or conditions. The Company analyzes its tax filing positions in all of the U.S. federal, state, local and foreign tax jurisdictions where it is required to file income tax returns, as well as for all open tax years in these jurisdictions. If, based on this analysis, the Company determines that uncertainties in tax positions exist, a liability is established. The Company recognizes accrued interest and penalties related to uncertain tax positions in Income tax (benefit) expense within the Consolidated Statements of Comprehensive Income (Loss). Recent Accounting Pronouncements Since May 2014, the FASB has issued ASU Nos. 2014-09, 2015-14, 2016-08, 2016-10 and 2016-12, "Revenue from Contracts with Customers". The objective of the guidance is to clarify the principles for recognizing revenue and supersedes most current revenue recognition guidance, including industry-specific guidance. The guidance is to be applied retrospectively to all prior periods presented or through a cumulative adjustment in the year of adoption, for interim and annual periods beginning after December 15, 2017. The Company is currently evaluating the impact of adopting this new standard. In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments─Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). The amendments, among other things, (i) requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (ii) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (iii) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) and (iii) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. ASU 2016-01 is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact of adopting this new standard. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for those leases previously classified as operating leases. The amendments in ASU No. 2016-02 are effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period with early adoption permitted. The Company is currently evaluating the impact of adopting this new standard. In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). The objective of the guidance is to simplify several aspects of the accounting for employee share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The update is effective for interim and annual periods beginning after December 15, 2016 with early adoption permitted. The Company is currently evaluating the impact of adopting this new standard. In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). This ASU addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early application is permitted, including adoption in an interim period. Adoption of ASU 2016-15 is not expected to have a material effect on the Company's consolidated financial statements. Policies of Consolidated Funds Prior to the adoption of ASU 2015-02 certain ZAIS Managed Entities, in which ZAIS Group has only a minority ownership interest or no ownership interest, were consolidated in the Company’s consolidated financial statements. The majority ownership interests in the Consolidated Funds are held by the investors in the Consolidated Funds, and these interests are included in Non-controlling interests in the Consolidated Statements of Financial Condition. The management fees and incentive income from the Consolidated Funds are eliminated in consolidation, and the income allocated to ZAIS and non-controlling interests in ZGP has been increased by the amounts eliminated. Subsequent to the adoption of ASU 2015-02, the Company no longer consolidates these ZAIS Managed Entities if it has only a minority ownership interest or no ownership interest. The Consolidated Funds, except for consolidated CLOs, , are considered investment companies for U.S. GAAP purposes. Pursuant to specialized accounting guidance for investment companies, and the retention of that guidance in the Company’s consolidated financial statements, the investments held by the Consolidated Funds are reported at their fair values. Investments at Fair Value The Company has elected the Fair Value Option for the Consolidated Fund’s investments. Investments and investments in affiliated securities are held at fair value. See Note 5 - “Fair Value of Investments” for information regarding the valuation of these assets. Due from Broker Due from broker represents the Consolidated Funds’ receivable from a broker for unsettled sales as of the balance sheet date. Due to Broker Due to broker represents the Consolidated Funds’ payable to a broker for unsettled purchases as of the balance sheet date. Notes Payable of Consolidated CLOs The Company measures both the financial assets and financial liabilities of the collateralized financing entities which it consolidates in its financial statements using the more observable of the fair value of the financial assets or the fair value of the financial liabilities. The notes payable of Consolidated CLOs are measured using the fair value of the financial assets which the Company considers the more observable of the fair values. Income Taxes The Consolidated Funds are generally not subject to U.S. federal and state income taxes and, consequently, no income tax provision has been made in the accompanying consolidated financial statements because individual investors are responsible for taxes on their proportionate share of the taxable income. 4. Investments in Affiliates The Company applied the Fair Value Option to its interests in the ZAIS Managed Entities that are not consolidated, and would have otherwise been subject to the equity or historical cost methods of accounting. The Company believes that reporting the fair value of these investments is more indicative of the Company’s financial position than historical cost. The fair value of these investments was as follows: The Company recorded a change in unrealized gain (loss) associated with the investments still held at the end of each respective period as follows: Such amounts are included in Net gain (loss) on investments in the Consolidated Statements of Comprehensive Income (Loss). At December 31, 2016 and December 31, 2015, no equity investment, individually or in the aggregate, held by the Company exceeded 10% of its total consolidated assets. Additionally, the Company did not have any income related to these investments, individually or in the aggregate, which exceeded 10% of its total consolidated income. As such, the Company did not present separate or summarized financial statements for any of its investees. 5. Fair Value Measurements ASC 820 Fair Value Measurements defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements under U.S. GAAP. Specifically, this guidance defines fair value based on exit price, or the price that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date. Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If the Company was forced to sell assets in a short period to meet liquidity needs, the prices it receives could be substantially less than their recorded fair values. The Company follows the fair value measurement and disclosure guidance under U.S. GAAP, which establishes a hierarchical disclosure framework. This framework prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment, the characteristics specific to the investment and the state of the marketplace including the existence and transparency of transactions between market participants. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices in an orderly market generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. In all cases, an instrument’s level within the hierarchy is based upon the market pricing transparency of the instrument and does not necessarily correspond to the Company’s perceived risk or liquidity of the instrument. The Company considers observable data to be market data which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the determination of which category within the fair value hierarchy is appropriate for any given investment is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires significant judgment and considers factors specific to the investment. Assets and liabilities that are measured and reported at fair value are classified and disclosed in one of the following categories: Level 1 - Fair value is determined based on quoted prices for identical assets or liabilities in an active market at measurement date. Assets and liabilities included in Level 1 include listed securities. As required in the fair value measurement and disclosure guidance under U.S. GAAP, the Company does not adjust the quoted price for these investments. The hierarchy gives highest priority to Level 1. Level 2 - Fair value is determined based on inputs other than quoted prices that are observable for the asset or liability either directly or indirectly as of the reporting date. Assets and liabilities which are generally included in this category include corporate bonds and loans, less liquid and restricted equity securities and certain over-the-counter derivatives, including foreign exchange forward contracts whose values are based on the following: •Quoted prices for similar assets or liabilities in active markets. •Quoted prices for identical or similar assets or liabilities in non-active markets. •Pricing models whose inputs are observable for substantially the full term of the asset or liability. •Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability. Level 3 - Fair value is determined based on inputs that are unobservable for the investment and includes situations where there is little, if any, market activity for the asset or liability. The inputs into the determination of fair value require significant management judgment or estimation and the Company may use models or other valuation methodologies to arrive at fair value. Investments that are included in this category generally include distressed debt, less liquid corporate debt securities, non-investment grade residual interests in securitizations, collateralized debt obligations and certain derivative contracts. The hierarchy gives the lowest priority to Level 3. The Company has established a valuation process that applies for all levels of investments in the valuation hierarchy to ensure that the valuation techniques are consistent and verifiable. The valuation process includes discussions between the valuation team, portfolio management team and the valuation committee (the “Valuation Committee”). The Valuation Committee consists of senior members of ZAIS Group and is co-chaired by the Chief Risk Officer and Acting Chief Financial Officer of ZAIS Group. The Valuation Committee meets to review and approve the results of the valuation process which are used in connection with the preparation of quarterly and annual financial statements. The Valuation Committee is responsible for oversight and review of the written valuation policies and procedures and ensuring that they are applied consistently. The lack of an established, liquid secondary market for some of the Company’s holdings may have an adverse effect on the market value of those holdings and on the Company’s ability to dispose of them. Additionally, the public markets for the Company’s holdings may experience periods of volatility and periods of reduced liquidity and the Company’s holdings may be subject to certain other transfer restrictions that may further contribute to illiquidity. Such illiquidity may adversely affect the price and timing of liquidations of the Company’s holdings. The following is a description of the valuation techniques used to measure fair value and the classification of these instruments pursuant to the fair value hierarchy: Investments The Company determines the fair value of investments in short term high investment grade mutual funds using quoted market prices and, accordingly, the Company classifies these investments as Level 1. Net gains or losses on investments are included in Net gain (loss) on investments in the Consolidated Statements of Comprehensive Income (Loss). The Company uses a nationally recognized pricing service to provide pricing for the bank loans held by the Consolidated Funds. Collateralized Loan Obligation - Warehouses A Collateralized Loan Obligation Warehouse ("CLO - Warehouse") is an entity organized for the purpose of holding syndicated bank loans, also known as leveraged loans, prior to the issuance of securities from that same vehicle. During the warehouse period, a CLO - Warehouse will secure investments and build a portfolio of primarily leveraged loans and other debt obligations. The warehouse period terminates when the collateralized loan obligation vehicle issues various tranches of securities to the market. At this time, financing through the issuance of debt and equity securities are used to repay the bank financing. The fair value of a CLO - Warehouse is determined by adding the excess spread (accrued interest plus interest received less financing cost) to the CLO - Warehouse equity contribution made by the Consolidated Funds, unless ZAIS Group determines that the securitization period will not be achieved, in which case, the fair value of a CLO - Warehouse will be established based on the fair value of the underlying bank loan positions which are valued in a manner consistent with ZAIS Group’s valuation policy and procedures. CLO warehouses can be exposed to credit events, mark to market changes, rating agency downgrades and financing cost changes. Changes in the fair value of a CLO - Warehouse are reported in Net gains (losses) of Consolidated Funds’ investments in the Consolidated Statements of Comprehensive Income (Loss). Investment in Affiliates Under U.S. GAAP, the Company is permitted, as a practical expedient, to estimate the fair value of its investments in other investment companies using the NAV (or its equivalent) of the related investment company. Accordingly, the Company utilizes the practical expedient in valuing its investments in the unconsolidated ZAIS Managed Entities, which is an amount equal to the sum of the Company’s proportionate interest in the capital accounts of the affiliated entities at fair value. The fair value of the assets and liabilities of the ZAIS Managed Entities are determined by the Company in accordance with its valuation policies described above. Pursuant to ASU No. 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities that Calculate Net Asset Value per Share (or its Equivalent) (“ASU 2015-07”), the Company no longer is required to categorize these investments within the fair value hierarchy. The resulting net gains or losses on investments are included in Net gain (loss) on investments in the Consolidated Statements of Comprehensive Income (Loss). At December 31, 2016 and December 31, 2015, the Company held investments in four unconsolidated ZAIS Managed Entities. The valuation of the investments in these entities represents the amount the Company would receive at December 31, 2016 and December 31, 2015, respectively, if it were to liquidate its investments in these entities. ZAIS Group has the ability to liquidate its investments according to the provisions of the respective entities’ operative agreements. The following tables summarize the Company’s assets measured at fair value on a recurring basis within the fair value hierarchy levels: The following tables summarize the changes in the Company’s Level 3 assets: The Company’s policy is to record transfers between Level 1, Level 2 and Level 3, if any, at the beginning of the period. There were no transfers between Level 1, Level 2 and Level 3 during the years ended December 31, 2016 or December 31, 2015. The tables below summarize information about the significant unobservable inputs used in determining the fair value of the Level 3 assets and liabilities held by the Consolidated Funds: 6. Variable Interest Entities In the ordinary course of business, ZAIS Group sponsors the formation of VIEs that can be broadly classified into the following categories: hedge funds, hybrid private equity funds and CLOs. ZAIS Group generally serves as the investment advisor or collateral manager with certain investment-related, decision-making authority for these entities. The Company has not recorded any liabilities with respect to VIEs that are not consolidated. Certain ZAIS Managed Entities, including the CLOs, are VIEs. The Company applies the guidance of ASU 2015-02 when determining which ZAIS Managed Entities are required to be consolidated. Funds The Company has determined that the fee it receives from several of the hedge funds and hybrid private equity funds ZAIS Group manages does not represent a variable interest because under ASU 2015-02, ZAIS Group’s fee arrangements are commensurate with the level of effort performed and include only customary terms that do not represent variable interests. The Company considered investments its related parties have in these entities when determining if ZAIS Group’s fee represented a variable interest. ZAIS Group owns 51% of a majority-owned affiliate, Zephyr A-6, which was established to invest in collateralized loan obligation vehicles, including the related warehouse stage of such vehicles. As of December 31, 2016 and December 31, 2015, the Company has determined that ZAIS Group is the primary beneficiary of Zephyr A-6 which is consolidated in the Company’s consolidated financial statements. ZAIS Group is the primary beneficiary since it is deemed to have (i) the power to direct activities of the entity that most significantly impacts its economic performance and (ii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the entity. Zephyr A-6’s investments are as follows: ZAIS CLO 5 ZAIS CLO 5, which priced on September 23, 2016 and closed on October 26, 2016, invests primarily in first lien senior secured bank loans and has a total capitalization of $408.5 million, which consists of senior and mezzanine notes with an aggregate par amount of $368.0 million and subordinated notes of $40.5 million. The CLO matures in October 2028. In connection with the closing, Zephyr A-6 recognized a dividend of $8.8 million which represents gains that were realized under the terms of the CLO Warehouse agreement. Zephyr A-6’s purchase of interests in ZAIS CLO 5 was $20.3 million ($20.5 million par), which represents approximately 2% economic interest in the senior and mezzanine notes and approximately 32% economic interest in the subordinated notes. The Company determined that it is the primary beneficiary of ZAIS CLO 5 based on (i) its ability to impact the activities which most significantly impact the ZAIS CLO 5’s economic performance as collateral manger and (ii) Zephyr A-6’s significant investment in the subordinated notes of ZAIS CLO 5. Therefore, the Company consolidated the ZAIS CLO 5 in its financial statements at December 31, 2016 and for the period from October 26, 2016 to December 31, 2016. At December 31, 2015, ZAIS CLO 5 was in the warehouse phase (“ZAIS CLO 5 Warehouse”). Zephyr A-6’s investment in ZAIS CLO 5 Warehouse at December 31, 2015 was as follows: Zephyr A-6’s investment in ZAIS CLO 5 Warehouse is included in Assets of Consolidated Funds - Investments, at fair value in the Consolidated Statements of Financial Condition at December 31, 2015. ZAIS CLO 6, Limited - Warehouse (“ZAIS CLO 6”) ZAIS CLO 6 was formed in November 2016 and is in the warehouse phase (“ZAIS CLO 6 Warehouse”). At December 31, 2016 ZAIS CLO 6 Warehouse continued to finance the majority of its loan purchases using its warehouse facility. During the year ended December 31, 2016 Zephyr A-6 contributed $15.0 million to ZAIS CLO 6 Warehouse. At December 31, 2016, the fair value of Zephyr A-6’s investment in ZAIS CLO 6 Warehouse is approximately $15.0 million which is included in Assets of Consolidated Funds - Investments, at fair value in the Consolidated Statements of Financial Condition. Net gain (loss) of Consolidated Funds’ Investments Net gain (loss) related to Zephyr A-6’s investments in ZAIS CLO 5 Warehouse and ZAIS CLO 6 Warehouse includes the following: The change in unrealized gain or loss related to ZAIS CLO 5 Warehouse for the year ended December 31, 2016 is related to the reversal of previously recognized unrealized gain or loss. Securitized Structures ZAIS Group and certain of its wholly owned subsidiaries act as collateral manager for CLOs that are VIEs. These CLOs are entities that issue collateralized notes which offer investors the opportunity for returns that vary commensurately with the risks they assume. The notes issued by the CLOs are generally backed by asset portfolios consisting of loans, other debt or other derivatives. For acting as the collateral manager for these structures, ZAIS Group receives collateral management fees comprised of senior collateral management fees, subordinated collateral management fees and incentive collateral management fees (subject to hurdle rates). In some cases, all of the collateral management fees are waived as a result of certain ZAIS Managed Entities owning equity tranches of the related CLO. For CLOs in which the Company has no economic interests other than its fee arrangement, the Company has determined that the fee it receives from the CLOs does not represent a variable interest because ZAIS Group’s fee arrangements are commensurate with the level of effort performed and include only customary terms that do not represent variable interests. The Company considered investments its related parties have in the CLOs when determining if ZAIS Group’s fee represented a variable interest. The Company will continue to assess its investments in the CLOs to determine whether or not the Company will be required to consolidate the CLOs in its financial statements. The Dodd-Frank credit risk retention rules, which became effective on December 24, 2016, will now apply to any newly issued CLOs or certain cases in which an existing CLO is refinanced, issues additional securities or is otherwise materially amended. The risk retention rules specify that for each CLO, the relevant collateral manager must purchase and hold, unhedged, directly or through a majority-owned affiliate, either (i) 5% of the face amount of each tranche of the CLO’s securities, (ii) an amount of the CLO’s equity equal to 5% of the aggregate fair value of all of the CLO’s securities or (iii) a combination of the two for a total of 5%. The required risk must be retained until the latest of (i) the date that the CLO has paid down its securities to 33% of their original principal amount, (ii) the date that the CLO has sold down its assets to 33% of their original principal amount or (iii) the date that is two years after closing. The Company determined that it is not the primary beneficiary of CLO - Warehouses, which are VIEs, because the financing counterparty must approve all significant financing requests and, as a result, the Company does not have the power to direct activities of the entity that most significantly impacts its economic performance. VIEs Consolidated VIEs At December 31, 2016 the Consolidated Funds consist of Zephyr A-6 and ZAIS CLO 5. At December 31, 2015, the Consolidated Funds consist of Zephyr A-6. Both entities are VIEs. The assets and liabilities of the consolidated VIEs are, presented in Note 17 - “Supplemental Financial Information” under the heading “Consolidated Funds”, on a gross basis prior to eliminations. The assets presented belong to the investors in Zephyr A-6 and ZAIS CLO 5, are available for use only by the entity to which they belong and are not available for use by the Company. The Consolidated Funds have no recourse to the general credit of ZAIS Group with respect to any liability. Unconsolidated VIEs At December 31, 2016 and December 31, 2015, the Company’s unconsolidated VIEs consist of its investments in CLO Warehouses as well as certain ZAIS Managed Entities. The carrying amounts of the unconsolidated VIEs are as follows: Such amounts are included in the Consolidated Statements of Financial Condition. ZAIS Group has a minimal direct ownership, if any, in the non-consolidated entities that are VIEs and its involvement is generally limited to providing asset management services. ZAIS Group’s exposure to loss from these entities is limited to a decrease in the management fee income and incentive income that has been earned and accrued, as well as any change in fair value of its direct equity ownership in the VIEs. Notes Payable of Consolidated CLO Notes payable of the consolidated CLO are collateralized by the assets held by the CLO. This collateral primarily consists of loans. At December 31, 2015 no CLOs were consolidated due to the adoption of ASU 2015-02. At December 31, 2016, the fair value of the assets and liabilities of ZAIS CLO 5 and the eliminations for the Consolidated Fund’s investment in ZAIS CLO 5 are as follows: As discussed in Note 3 - “Basis of Presentation and Summary of Significant Accounting Policies”, the Company has elected to carry these notes at fair value in its Consolidated Statements of Financial Condition. Accordingly, the Company measured the fair value of notes payable (as a group including both the senior and subordinated notes) as (1) the sum of the fair value of the financial assets and the carrying value of any non-financial assets held temporarily, less (2) the sum of the fair value of any beneficial interests retained by the Company (other than those that represent compensation for services) and the Company’s carrying value of any beneficial interests that represent compensation for services. The Company allocated the resulting amount to the different classes of notes based on the CLO’s waterfall on an as liquidated basis. The tables below present information related to the CLO’s notes payable outstanding. The subordinated notes have no stated interest rate, and are entitled to any excess cash flows after contractual payments are made to the senior notes. 7. Management Fee Income and Incentive Income ZAIS Group earns management fees for the funds and accounts which are generally based on the net asset value of these funds and accounts prior to the accrual of incentive fees/allocations or drawn capital during the investment period. Management fee income earned for the CLOs which ZAIS Group manages are generally based on the par value of the collateral and cash held in the CLOs. Additionally, subordinated management fees may be earned from CLOs for which ZAIS Group and certain of its wholly owned subsidiaries act as collateral manager. The subordinated management fee is an additional payment for the same collateral management service, but has a lower priority in the CLOs’ cash flows and is contingent upon the economic performance of the respective CLO. If the CLOs experience a certain level of asset defaults, these fees may not be paid. There is no recovery by the CLOs of previously paid subordinated fees. Prior to October 31, 2016, ZAIS Group earned management fee income from ZFC REIT, quarterly, based on ZFC REIT's stockholders' equity, as defined in the amended and restated investment advisory agreement between ZAIS REIT Management and ZFC REIT. Twenty percent of the management fee income received from ZFC REIT is paid to holders of Class B interests in ZAIS REIT Management. The payment to the Class B interests in ZAIS REIT Management is recorded as distributions to non-controlling interests in ZAIS Group Parent, LLC. The income is recorded as Management fee income in the Consolidated Statements of Comprehensive Income (Loss), and the portion of the management fees allocated to the holders of Class B interests in ZAIS REIT Management is included in the Allocation of Consolidated Net Income (Loss) to Non-controlling interests in ZAIS Group Parent, LLC. On October 31, 2016, the management agreement with ZFC REIT was terminated up the completion of the merger between ZFC REIT and Sutherland Asset Management Corp. Pursuant to the Termination Agreement, the advisory agreement with ZAIS REIT Management was terminated on October 31, 2016. ZAIS REIT Management received a termination payment in the amount of $8.0 million upon termination of the agreement. Such amount is included in Management fee income in the Consolidated Statements of Comprehensive Income (Loss). Management fees are generally collected on a monthly or quarterly basis. ZAIS Group manages certain ZAIS Managed Entities from which it may earn incentive income based on hedge fund-style and private equity-style fee arrangements. ZAIS Managed Entities with hedge fund-style fee arrangements are those that pay ZAIS Group, on an annual basis, an incentive fee/allocation based on a percentage of net realized and unrealized profits attributable to each investor, subject to a hurdle (if any) set forth in each respective entity’s operative agreement. Additionally, all ZAIS Managed Entities with hedge fund-style fee arrangements are subject to a perpetual loss carry forward, or perpetual “high-water mark,” meaning that the funds and accounts will not pay incentive fees/allocations with respect to positive investment performance generated for an investor in any year following negative investment performance until that loss is recouped, at which point an investor’s capital balance surpasses the high-water mark. ZAIS Managed Entities with private equity-style fee arrangements are those that pay an incentive fee/allocation based on a priority of payments under which investor capital must be returned and a preferred return, as specified in each fund’s operative agreement, must be paid to the investor prior to any payments of incentive-based income to ZAIS Group. For CLOs, incentive income is earned based on a percentage of cumulative profits, subject to the return of contributed capital, payment of subordinate management fees (if any) and a preferred inception to date return as specified in the respective CLOs’ collateral management agreements. The advisory agreement between ZAIS REIT Management and ZFC REIT did not provide for incentive fees. The following tables represent the gross amounts of management fee income and incentive income earned prior to eliminations due to consolidation of the Consolidated Funds and the net amount reported in the Company’s Consolidated Statements of Comprehensive Income (Loss): (1)Certain management and incentive fees have been and may in the future be waived and therefore the actual fees rates may be lower than those reflected in the range. (2)Incentive income earned for certain of the ZAIS Managed entities is subject to a hurdle rate of return as specified in each respective ZAIS Managed Entity’s operative agreement. Additionally, the Company may give credits for management fee income and/or incentive income to investors which invest in ZAIS Managed Entities which invest in other ZAIS Managed Entities where fees are also charged. Prior to January 1, 2015, the Company recorded all management fee income credits as an offset to Income and fees receivable in the Consolidated Statements of Financial Condition. Subsequent to January 1, 2015, the Company recorded all credits relating to management fee income and incentive income directly to Fees payable in the Consolidated Statements of Financial Condition. The management fee income and incentive income amounts above are net of the following credits: Management fee income and incentive income which was accrued, but not received is as follows: Such amounts are included in Income and fees receivable in the Consolidated Statements of Financial Condition. The Company did not recognize any bad debt expense for the years ended December 31, 2016 and December 31, 2015. The Company believes all income and fees receivable balances are deemed to be fully collectible. Revenue Concentration The Company’s revenue concentration for the year ended December 31, 2016 was as follows: 8. Notes Payable On March 17, 2015, in conjunction with the closing of the Business Combination, ZAIS issued two promissory notes with an aggregate principal balance of $1.25 million to EarlyBirdCapital, Inc. and Sidoti & Company, LLC. The notes accrued interest at an annual rate equal to the annual applicable federal rate as published by the Internal Revenue Service (“AFR”) until the principal amount of, and all accrued interest on, the notes were paid in full. The notes matured on March 17, 2017 at which time the principal balance and accrued interest was paid in full (see Note 18 - “Subsequent Events”). The notes were issued in lieu of paying certain underwriting costs at the closing of the Business Combination and, accordingly, treated as a direct cost attributable to the Business Combination and capitalized to equity. The Company accrued interest on the notes for the years ended December 31, 2016 and December 31, 2015, which is included in Other income (expense) in the Consolidated Statements of Comprehensive Income (Loss). Total interest expense was as follows: 9. Compensation The following table presents a detailed breakout of the Company’s compensation expense: A summary of the Company’s compensation arrangements are as follows: Bonus Incentive Cash Compensation Employees are eligible to receive discretionary incentive cash compensation (the “Bonus Award”) on an annual basis and certain employees may also be eligible to receive guaranteed incentive compensation (the “Guarantees”). The amount of the Bonus Award is based on, among other factors, both individual performance and the financial results of ZAIS Group. For certain employees, as documented in an underlying agreement (the “Bonus Agreements”), the Bonus Award may be further subject to a retention-based payout schedule that generally provides for 30% of the Bonus Award to vest and be paid incrementally over a three-year period. The Company expenses all current cash incentive compensation award payments ratably in the first year. All future payments are amortized equally over the required service period over the remaining term of the Bonus Award as defined in the Bonus Agreements. Any Guarantees that are paid upon an employee commencing employment are expensed immediately by the Company. All future payments related to Guarantees are amortized equally over the required service period over the remaining term as defined in the agreements for the Guarantees (“Guarantee Agreement”). In the event an award is forfeited pursuant to the terms of the Bonus Agreement or Guarantee Agreement, the corresponding accruals will be reversed. Levels of incentive compensation will vary to the extent they are tied to the performance of certain ZAIS Managed Entities or the financial and operating performance of the Company. At December 31, 2016, the compensation payable balance includes $7.4 million related to 2016 Bonus Awards, the accrued portion of prior years’ Bonus Awards that will vest through February of 2017 subject to the terms of those Bonus Agreements and the accrued portion of Guarantees that will vest through February 2017 subject to the terms of the Guarantee Agreements. Retention Payment Plan On March 29, 2016, the Compensation Committee of the Board of Directors of ZAIS adopted a retention payment plan for certain employees of ZAIS Group (the "Retention Payment Plan"). The Retention Payment Plan applied to approximately 60 employees of ZAIS Group all of who had an annual base salary of less than $300,000. The purpose of the Retention Payment Plan was to enable ZAIS Group to retain the services of its employees in order to ensure that ZAIS Group is not disrupted or adversely affected by the possible loss of personnel or their commitment to ZAIS Group. Under the Retention Payment Plan, the participating employees were entitled to receive cash retention payments on each of April 15, 2016, August 15, 2016 and November 15, 2016, if the employee remained employed by ZAIS Group on such dates. The Company paid an aggregate amount of approximately $4.6 million to all participants pursuant to the Retention Payment Plan during the year ended December 31, 2016. In addition, on March 1, 2016, the Compensation Committee of the Board of Directors of ZAIS approved a retention payment of $900,000 to Howard Steinberg, the Company's General Counsel, which was paid on March 15, 2016. Amounts incurred under the Retention Payment Plan are included in “Bonus” in the table above. There are no amounts payable under the Retention Payment Plan at December 31, 2016. Points ZAIS Group has entered into agreements with certain of its employees whereby certain employees and former employees have been granted rights to participate in a portion of the incentive income received from certain ZAIS Managed Entities (referred to as “Points Agreements”). There are currently outstanding Points Agreements relating to one ZAIS Managed Entity and ZAIS Group does not anticipate awarding additional Points Agreements. The Company did not incur any compensation expense relating to the Points Agreements for the year ended December 31, 2016. Income Unit Plan In 2013, ZAIS Group established the Income Unit Plan. Under the Income Unit Plan, certain employees were entitled to receive a fixed percentage of ZAIS Group’s distributable income, as defined in the Income Unit Plan agreement. Pursuant to the terms of the Income Unit Plan, a payout of 85% of the estimated award was made in December of the applicable performance year and the remaining balance was payable within 30 days of the issuance of ZAIS Group’s audit report for the prior year. An employee must have been actively employed by ZAIS Group on each scheduled payment date to have received their relevant payment. Management terminated the plan effective December 31, 2014 in connection with the Business Combination. The Company did not incur any compensation expense under the Income Unit Plan for the year ended December 31, 2016. Severance On March 8, 2016, the Company commenced a reduction in force and other restructuring which resulted in a decrease of 23 employees of ZAIS Group. The Company has incurred total severance charges in the amount of approximately $762,000 related to this reduction in force which was recognized and paid during the year ended December 31, 2016. Equity-Based Compensation Class B-0 Units In conjunction with the closing of the Business Combination on March 17, 2015, ZGP authorized 1,600,000 Class B-0 Units eligible to be granted to certain employees of ZAIS Group. The Class B-0 Units are subject to a two year cliff-vesting provision, whereby all Class B-0 Units granted to an employee will be forfeited if the employee resigns or is terminated prior to the two year anniversary of the closing of the Business Combination. Subsequent to the two year anniversary of the Business Combination, an employee will only forfeit vested Class B-0 Units if the employee is terminated for cause. The Class B-0 Units are not entitled to any distributions from ZGP (and thus will not participate in, or be allocated any, income or loss) or other material rights until such Class B-0 Units vest. Upon vesting the Class B-0 Units will have the same rights as Class A Units of ZGP and are exchangeable on a one for one basis for Class A common shares or cash (or a combination of shares and cash), at the Company’s election, subject to the restrictions set forth in the Exchange Agreement included in the Closing 8-K. This compensation expense will be amortized equally over the two-year vesting period and will be cumulatively adjusted for changes in estimated forfeitures at each reporting date. On December 1, 2016, the Company’s board of directors authorized ZGP to offer the 28 employees holding unvested Class B-0 Units the right to receive in consideration for the cancellation of their Class B-0 Units, at the holder’s option, either (a) Restricted Stock Units (“RSUs”) of ZAIS, on a one-for-one basis, or (b) an amount of cash per Class B-0 Unit cancelled (the “Cash Amount”) equal to $1.92, which was the average of the daily closing prices of Class A Common Stock of ZAIS for the three calendar months ended November 30, 2016 (the “Proposal”). The RSUs and the Cash Amount are both subject to vesting requirements and collectively referred to as the “Election Consideration”. The offer period expired on December 30, 2016. All holders decided to accept the Proposal and immediately upon the expiration of the offer period, the holders’ Class B-0 Units were cancelled. For those holders of Class B-0 Units who elected to receive RSUs, ZAIS granted the RSUs under the ZAIS 2015 Stock Incentive Plan (the “Plan”). The RSUs vested on March 17, 2017, the same date that the Class B-0 Units were scheduled to vest. The RSUs entitled the holders to receive ZAIS Class A common stock, which was issued, subject to applicable wage withholding requirements, immediately upon the vesting of the RSUs. In consideration of the issuance of such stock by ZAIS to the employees of ZGP’s subsidiary, ZAIS Group, LLC, ZGP issued a number of Class A Units to ZAIS equal to the number of shares of stock that were issued to the holders of RSUs. If the B-0 Unit holder elected to receive the Cash Amount, provided the holder remained employed by ZAIS Group or its subsidiaries through the date of vesting, such amount was paid by ZAIS Group to the holder, subject to applicable wage withholding requirements, on March 22, 2017. See Note 18 - “Subsequent Events” for additional disclosures. The number of Class B-0 Units cancelled and Election Consideration provided as a result of the Proposal is as follows: The Company accounted for the cancellation of B-0 Units as follows: RSUs Provided as a Replacement for the Cancellation of B-0 Units The Company accounted for the issuance of RSUs as a modification of the award pursuant to ASC 718, “Compensation - Stock Compensation”, treating it as a cancellation of the limited liability company units accompanied by the concurrent grant of RSUs. The Company determined that the fair value of the RSUs and the B-0 Units at the modification date were equal and therefore there was no incremental compensation cost required to be recognized. ZAIS will complete the amortization of the related compensation expense equally over the two-year vesting period subject to cumulative adjustment for changes in estimated forfeitures at each reporting date. Cash Provided as a Replacement for the Cancellation of B-0 Units The Company accounted for the cash payment to be made in consideration for the cancellation of certain B-0 Units described above as a modification of the award pursuant to ASC 718, “Compensation - Stock Compensation”. However the modification of these awards changed the classification from equity awards to a liability awards. The fair value of the modified award at the time of the modification was approximately $256,000. The Company recognized a liability of approximately $230,000 which reflects the vested amount of the modified award’s measurement date fair value. The remaining fair value of approximately $26,000 will be amortized ratably over the remaining vesting period. An employee will forfeit the unvested equity or liability awards if the employee is terminated or voluntarily terminates his or her employment at the Company. The following table presents the Class B-0 Units’ activity: The Company incurred compensation expense relating to the Class B-0 Units as follows: The following table summarizes additional information related to compensation expense associated with the unvested Class B-0 Units (including Class B-0 units cancelled in consideration for the receipt of RSUs or cash) at December 31, 2016: The estimated forfeiture rates were as follows: The increase in the forfeiture rate is due to the reduction in force announced in the Company’s Current Report on Form 8-K filed on March 10, 2016 and actual forfeitures since the grant date. The cumulative impact of the increase in forfeitures of approximately $1.2 million was recognized as a reduction in compensation and benefits for the year ended December 31, 2016. The Company has assumed no additional forfeitures for the modified awards for the period from December 31, 2016 through the vesting date of March 17, 2017. The expense relating to the Class B-0 Units (pre-modification of the award) is included in Compensation and benefits on the Consolidated Statements of Comprehensive Income (Loss). RSUs The Company may grant up to 2,080,637 shares of Class A common stock pursuant to the Plan. Non-employee directors of ZAIS receive RSUs pursuant to the Plan as a component of compensation for their service as directors of ZAIS. The awards are unvested at the time they are granted and, as such, are not entitled to any dividends or distributions from ZAIS or other material rights until such RSUs vest. The RSUs vest in full on the one-year anniversary of the grant date. Upon vesting ZAIS will issue the recipient shares of Class A Common Stock equal to the number of vested RSUs. In accordance with ASC 718, “Compensation - Stock Compensation”, the Company is measuring the expense associated with these awards based on the fair value on the grant date adjusted for estimated forfeitures. This expense is being amortized equally over the one-year vesting period and adjusted on a cumulative basis for changes in estimated forfeitures at each reporting date. The weighted average grant date fair value of these RSUs is based on the market value of the Company’s shares on the grant date. Additionally, pursuant to the Proposal (see “Class B-0 Units” above), the Company issued 899,674 RSUs on December 30, 2016. The weighted average grant date fair value of these RSUs are equal to the fair value of the related B-0 Units at the time the units were issued. The following table presents the RSU activity for non-employees as well as employees that modified their B-0 Units: The value of the fully vested RSUs on the vesting date was $82,200 based on a closing stock price of $2.74. The Company incurred compensation expense relating to the non-employee RSUs as follows: The following table summarizes additional information related to compensation expense associated with the non-employee RSUs at December 31, 2016: The expense relating to these RSUs is included in Compensation and benefits on the Consolidated Statements of Comprehensive Income (Loss). 10. Income Taxes The following details the components of income tax (benefit) expense for the years ended December 31, 2016 and December 31, 2015: Prior to the closing of the Business Combination on March 17, 2015, ZGP and its subsidiaries were pass-through entities for U.S. income tax purposes and their earnings flowed through to the owners without being subject to entity level income taxes. Accordingly, no income tax (benefit) expense has been recorded in historical periods other than that related to ZGP’s foreign subsidiaries, which are branches for U.S. income tax purposes but paid income taxes in their respective foreign jurisdictions. Following the reorganization, while ZGP and its subsidiaries continue to operate as pass-through entities for U.S. income tax purposes not subject to entity level taxes, ZAIS is taxable as a corporation for U.S. tax purposes. Accordingly, the Company’s consolidated financial statements include U.S. federal, state and local income taxes on ZAIS’ allocable share of the consolidated results of operations, as well as taxes payable to jurisdictions outside the U.S related to the foreign subsidiaries. The following is a reconciliation of the U.S. statutory federal income tax to the Company’s effective tax: The Company’s effective tax for the years presented above includes a benefit attributable to the fact that the Company’s subsidiaries operate as limited liability companies and limited partnerships which are treated as pass-through entities for U.S. federal and state income tax purposes. Accordingly, the Company’s consolidated financial statements include U.S. federal, state and local income taxes on the Company’s allocable share of the consolidated results of operations. The tax liability or benefit related to the partnership income or loss not allocable to the Company rests with the equity holders owning such non-controlling interests in ZAIS subsidiaries. The net effective tax represents the taxes accrued related to the Company’s operations in jurisdictions outside the U.S. Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and are reported in the accompanying Consolidated Statements of Financial Condition. These temporary differences result in taxable or deductible amounts in future years. Details of the Company's deferred tax assets and liabilities are summarized as follows: The Company’s net deferred tax assets relate to net operating losses and other temporary differences related to the Company’s allocable share of the consolidated results of operations as well as the Company’s net operating losses and development stage start-up expenses incurred during the period from its inception and prior to the closing of the Business Combination with ZGP. The Company has established a full valuation allowance on the deferred tax asset as of December 31, 2016 and December 31, 2015. As of December 31, 2016, the Company has estimated federal and state income tax net operating loss carryforwards, which will expire as follows: As of each reporting date, management considers new evidence, both positive and negative, that could affect its view of the future realization of deferred tax assets. As of December 31, 2016, the Company has determined that the current management business forecasts do not support the realization of net deferred tax assets recorded for the Company. The Company has reported a net book loss for the year ended December 31, 2016 and it is anticipated that expenses will exceed revenues in 2017. While the Company continues to work to grow its AUM and explore business development opportunities, the Company has not yet invested substantial amounts of the capital raised in the Business Combination, and although Management intends to pursue various initiatives with potential to alter the operating loss trend, there is no specific plan that has been implemented at this point in time that will alter the negative earnings trend. Accordingly, management believes that it is not more likely than not that its deferred tax asset will be realized and the Company has established a full valuation allowance against the deferred tax asset as of December 31, 2016. The allowance has resulted in a charge of approximately $1.9 million recorded in the Company’s Consolidated Statements of Comprehensive Income (Loss). The Company intends to continue maintaining a full valuation allowance on its deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. The Company does not believe it has any significant uncertain tax positions. Accordingly, the Company did not record any adjustments or recognize interest expense for uncertain tax positions for the years ended December 31, 2016 and 2015, respectively. In the future, if uncertain tax positions arise, interest and penalties will be accrued and included in the Income tax (benefit) expense on the Consolidated Statements of Comprehensive Income (Loss). 11. Related Party Transactions ZAIS Managed Entities ZAIS Group offers a range of alternative and traditional investment strategies through the ZAIS Managed Entities. ZAIS Group earns all of its management fee income and incentive income from the ZAIS Managed Entities, which are considered related parties as the Company manages the operations of, and makes investment decisions for, these entities. The Company considers ZAIS Group’s principals, executives, employees and all ZAIS Managed Entities to be affiliates and related parties. ZAIS Group invests in its subsidiaries and some of the ZAIS Managed Entities. Investments in subsidiaries and certain ZAIS Managed Entities that are consolidated are eliminated. Investments in certain ZAIS Managed Entities that are not consolidated are further described in Note 3. ZAIS Group did not charge management fees or earn incentive income on investments made in the ZAIS Managed Entities (excluding CLOs and ZFC REIT) by ZAIS Group’s principals, executives, employees and other related parties. The total amount of investors’ capital balances that are not being charged fees were approximately as follows: Additionally, at December 31, 2016 and December 31, 2015 certain ZAIS Managed Entities, with existing fee arrangements, have investments representing 100% of the equity tranche of ZAIS CLO 1, Limited. (“ZAIS CLO 1”) and ZAIS CLO 2, Limited. (“ZAIS CLO 2”). Therefore, ZAIS Group did not charge management fees or earn incentive income on ZAIS CLO 1 and ZAIS CLO 2. The total amounts of AUM that are not being charged fees were approximately as follows: From time to time, ZAIS Group may pay research and data services expenses relating to the management of the ZAIS Managed Entities directly to vendors and allocates a portion of these costs to the respective ZAIS Managed Entities per the terms of the respective investment management agreements (the “Research Costs”). These amounts are reimbursable by the respective ZAIS Managed Entities and it is the Company’s policy to record the allocated amounts as Due from related parties. The Company allocated the following amounts to the ZAIS Managed Entities: Such amounts are not included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss). The amounts due from the ZAIS Managed Entities relating to this arrangement are as follows: These amounts are included in Due from related parties in the Consolidated Statements of Financial Condition. The Company may also pay other costs to vendors on behalf of the ZAIS Managed Entities in addition to the Research Costs (the “Other Direct Costs”). These amounts are also reimbursable by the respective ZAIS Managed Entities and it is the Company’s policy to record these amounts as Due from related parties. The Company incurred the following Other Direct Costs: Such amounts are not included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss). The Other Direct Costs due to ZAIS Group from the ZAIS Managed Entities are as follows: These amounts are included in Due from related parties in the Consolidated Statements of Financial Condition. Consulting Agreements RQSI, Ltd. Certain affiliates of Mr. Neil Ramsey (“Mr. Ramsey”) are significant stockholders of ZAIS. ZGP entered into a two-year Consulting Agreement (the “Consulting Agreement”) with Mr. Ramsey through RQSI, Ltd., an entity controlled by Mr. Ramsey, under the terms of which, among other things, Mr. Ramsey provided consulting services to ZGP, ZAIS Group’s senior management team and ZAIS, as requested by ZAIS, from time to time during the 24-month period beginning on the closing of the Business Combination. Mr. Ramsey agreed not to compete against ZGP during the term of the Consulting Agreement, and for two years following its termination. In consideration for his undertakings under the Consulting Agreement, ZGP agreed to pay Mr. Ramsey a consulting fee of $500,000 per annum payable in monthly installments. The Company has recorded the following expense related to the Consulting Agreement: The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss). Amounts payable to Mr. Ramsey pursuant to the Consulting Agreement are as follows: Such amounts are included in Other liabilities in the Consolidated Statements of Financial Condition. ZAIS Group has agreed to use certain statistical data generated by RQSI, Ltd. models. ZAIS Group may use this information for trading futures in one of the ZAIS Managed Entities. ZAIS Group has entered into a month to month lease agreement with an affiliate of RQSI, Ltd to occupy space in the Company’s London office. The agreement is terminable upon 30 days’ notice. While there is currently no charge to RQSI, Ltd. or its affiliate for use of the space, the total market value of the lease agreement with the affiliate of RQSI, Ltd. is approximately $13,000 per month. Ms. Tracy Rohan ZAIS Group is a party to a consulting agreement with Ms. Tracy Rohan (“Ms. Rohan”), Mr. Zugel’s sister-in-law, pursuant to which Ms. Rohan provides services to ZAIS Group relating to event planning, promotion, web and print branding and related services. Pursuant to the consulting agreement, Ms. Rohan earns 76,000 GBP annually. The Company recognized the following amounts for her services based on U.S. Dollars: The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss). Amounts payable to Ms. Rohan pursuant to the consulting agreement are as follows: Such amounts are included in Other liabilities in the Consolidated Statements of Financial Condition. 12. Property and Equipment Property and equipment consist of the following: The Company recognized depreciation and amortization expense as follows: In 2015, the useful life assumption for leasehold improvements was updated to be consistent with the term of the lease. The change in accumulated depreciation and amortization also includes the change in foreign currency spot rates for each respective period presented. 13. Commitments and Contingencies Engagement Agreement with Berkshire Capital On April 22, 2016, the Company entered into an investment banking engagement agreement with Berkshire Capital Securities, LLC (“Berkshire Capital”), an affiliate of Mr. R. Bruce Cameron, our former director, pursuant to which Berkshire Capital will provide financial advisory services in connection with the Company’s strategic planning. Pursuant to the engagement letter, Berkshire Capital is entitled to a $100,000 retainer, a monthly retainer of $15,000 if the engagement is extended beyond the initial three months, reimbursed expenses and a success fee in the event of covered transactions equal to no more than the greater of $750,000 and 2% of the total consideration paid. Capital Commitments At December 31, 2016 $51.0 million of equity capital has been committed to Zephyr A-6, a Consolidated Fund, which has been established to invest in ZAIS Group managed CLOs and thereby satisfy the risk retention requirements of the Dodd-Frank Act. As of December 31, 2016, ZAIS Group had contributed $20.5 million to Zephyr A-6 and contributed an additional $6.1 million in January 2017. There is no assurance that the full commitments will be required to be funded by ZAIS Group or as to the period of time during which these commitments may be required to be funded. ZAIS Group serves as the investment manager to these ZAIS Managed Entities and determines when, and to what extent, capital will be called. Lease Obligations ZAIS Group is currently leases office space in New Jersey and London under operating lease agreements which expire at various times through October 2017. The Company recognizes rent expense related to its operating leases on a straight-line basis over the lease term and is included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss). The Company incurred rent expense as follows: Aggregate future minimum annual rental payments for the periods subsequent to December 31, 2016 are approximately as follows: Effective September 30, 2016, the Company terminated a portion of its lease and reduced its office space in New Jersey by approximately 2,600 square feet. In connection with the lease termination, the Company paid a lease termination fee of approximately $20,000 pursuant to the terms of the lease. Such amount is included in General, administration and other expenses in the Consolidated Statements of Comprehensive Income (Loss). Litigation From time to time, ZAIS Group may become involved in various claims, formal regulatory inquiries and legal actions arising in the ordinary course of business. The Company discloses information regarding such inquiries if disclosure is required pursuant to accounting and financial reporting standards. Other Contingencies In the normal course of business, ZAIS Group enters into contracts that provide a variety of indemnifications. Such contracts include those with certain service providers, brokers and trading counterparties. Any exposure to ZAIS Group under these arrangements could involve future claims that may be made against ZAIS Group. Currently, no such claims exist or are expected to arise and, accordingly, the Company has not accrued any liabilities in connection with such indemnifications. Gain Contingencies In 2016 the Company received notification from one of its insurance providers that its claim for reimbursement of certain legal and other costs relating to a formal regulatory inquiry had been approved. The Company had paid approximately $0.33 million and $0.58 million during 2016 and 2015, respectively, for legal and other costs incurred in excess of our insurance deductible. The cumulative insurance reimbursements that the Company has received through December 31, 2016 were approximately $0.89 million. Pursuant to the guidance under ASC 450, "Contingencies - Gain Contingencies”, approximately $0.58 million of the insurance reimbursements received was recorded in Other income (expense) in the Consolidated Statements of Comprehensive Income (Loss) for the portion that related to 2015. At December 31, 2016, the remaining amount to be approved for reimbursement by the insurance provider is approximately $0.02 million and is included in Other assets in the Consolidated Statements of Financial Condition. 14. Segment Reporting The investment management segment is currently the Company’s only reportable segment, and represents the Company’s core business, as substantially all of the Company’s operations are conducted through this segment. The investment management segment provides investment advisory and asset management services to the ZAIS Managed Entities. 15. Stockholders’ Equity Preferred Stock The Company is authorized to issue 2,000,000 shares of preferred stock with a par value of $0.0001 per share with such designation, rights and preferences as may be determined time to time by the Company’s board of directors. At December 31, 2016 and December 31, 2015, there were no shares of preferred stock issued or outstanding. Class A Common Stock The Company is authorized to issue 180,000,000 shares of Class A Common Stock with a par value of $0.0001 per share. Holders of record of Class A Common Stock are entitled to one vote for each share held on all matters to be voted on by stockholders. The Company issued 30,000 shares of Class A Common Stock during the year ended December 31, 2016 related to the RSUs which vested during the year. There were no other issuances of Class A Common Stock during the years ended December 31, 2016 or December 31, 2015. Class B Common Stock The Company is authorized to issue 20,000,000 shares of Class B Common Stock with a par value of $0.000001 per share. The Class B Common Stock has no economic rights and therefore is not considered participating securities for purposes of allocation of net income (loss). Holders of record of Class B Common Stock are entitled to ten votes for each share held on all matters to be voted on by stockholders. In connection with the Business Combination, HF2 transferred 20,000,000 shares of Class B Common Stock to the ZGH Class B Voting Trust, of which Christian Zugel is the sole trustee. There were no shares of Class B Common Stock issued during the year ended December 31, 2016. At December 31, 2016 and December 31, 2015, there were 20,000,000 shares of Class B Common Stock issued and outstanding, held by the ZGH Class B Voting Trust. Class B Units ZGP may issue up to 6,800,000 Class B units (“Class B Units”) at any time during the five year period following the Closing, a portion of which were awarded but subsequently cancelled (see Note 9 - “Compensation”). Of these Class B Units, 1,600,000 Class B-0 Units vest on the later of the date of grant and the second anniversary of the Closing, unless otherwise provided in the restricted unit agreement granting the Class B unit. The remaining 5,200,000 Class B Units are designated as Class B-1, Class B-2, Class B-3 and Class B-4 Units (together the “Additional Employee Units”), which vest in three equal installments only if the Class A Common Stock of ZAIS achieves certain average closing price thresholds within five years after the Closing ranging, from $12.50 to $21.50 as follows: one-third of such award vests upon achieving the applicable threshold, one-third of such award vests upon the first anniversary of such achievement and the final one-third of such award vests upon the second anniversary of such achievement, unless otherwise provided in the restricted unit agreement granting the Class B unit. Although the Class B Units are outstanding when issued, the Class B Units are not entitled to any distributions from ZGP (and thus will not participate in, or be allocated any, income or loss) or other material rights until such Class B Units vest. The ZGP Founder Members’ Class A Units and, if any, all of the vested Class B Units (but not any unvested Class B Units) may be exchanged for shares of Class A Common Stock of ZAIS on a one-for-one basis (subject to certain, if any, adjustments to the exchange ratio) or, at ZAIS’s option, cash or a combination of Class A Common Stock and cash, pursuant to the Exchange Agreement that ZAIS entered into with ZGP, the ZGP Founder Members and the other parties thereto. The Exchange Agreement contains certain restrictions on the ability of holders of Class A Units and Class B Units to exchange such Units for Class A Common Stock of ZAIS. Subject to certain limited exceptions, including in connection with a change in control of the Company, there is a two-year lock-up period (commencing March 17, 2015) before any exchanges of Class A Units or Class B Units was permitted. There were no Class B-1, Class B-2, Class B-3 or Class B-4 Units awarded for the years ended December 31, 2016 or December 31, 2015. On December 1, 2016, the Company’s board of directors authorized ZGP to offer the employees who agreed to the cancellation of their unvested Class B-0 Units the right to receive in substitution for the cancellation of their Class B-0 Units, at the holder’s option, either (a) RSUs of ZAIS, on a one-for-one basis, or (b) an amount of cash per Class B-0 Unit cancelled (See Note 9 - “Compensation”). Both were subject to vesting requirements. See Note 9 - Compensation for additional details relating the B-0 Units activity for the years ended December 31, 2016 and December 31, 2015. 16. Earnings Per Share Shares of Class B common stock have no impact on the calculation of consolidated net income (loss) per share of Class A common stock as holders of Class B common stock do not participate in net income or dividends, and thus, are not participating securities. The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted earnings per share: (1) Amount represents portion of the management fee income received from ZFC REIT that is payable to holders of Class B interests in ZAIS REIT Management. (2) Income tax (benefit) expense is calculated using an assumed tax rate of 36.56% and 31.72% for the years ended December 31, 2016 and December 31, 2015, respectively, which is fully offset by a 100% valuation allowance in each year. See Note 10 - “Income Taxes” for details surrounding income taxes. (3) The treasury stock method is used to calculate incremental Class A common shares on potentially dilutive Class A common shares resulting from unvested Class B-0 Units granted in connection with and subsequent to the Business Combination and unvested RSUs granted to non-employee directors of ZAIS and employees of ZAIS Group. These Class B-0 Units are anti-dilutive and, consequently, have been excluded from the computation of diluted weighted average shares outstanding. (4) Number of diluted shares outstanding takes into account non-controlling interests of ZGP that may be exchanged for Class A Common Stock under certain circumstances. 17. Supplemental Financial Information (Unaudited) The following supplemental financial information illustrates the consolidating effects of the Consolidated Funds on the Company’s financial condition and results of operations: 18. Subsequent Events During the period from January 1, 2017 through February 28, 2017, the Company paid approximately $8.0 million related to 2016 Bonus Awards, Bonus Awards that vested through February of 2017 pursuant to the Bonus Agreements related to a prior year (see Note 9 - “Compensation”) and Guarantees that vested through February 2017 pursuant to the Guarantee Agreements (see Note 9 - “Compensation”). On January 6, 2017, ZAIS Group provided notice to its current landlord of its intention to vacate its principal office space. ZAIS Group is currently in negotiations and intends to enter into a new lease agreement for a cost not to exceed its current annual leasing cost for its primary office space. On January 23, 2017, Zephyr A-6 received total capital contributions from its members of $12.0 million, of which ZAIS Group’s portion was approximately $6.1 million. Additionally, Zephyr A-6 contributed $30.0 million to ZAIS CLO 6 Warehouse during the period from January 1, 2017 through March 24, 2017. On February 15, 2017, the Board of Directors of the Company established a Special Committee of independent and disinterested directors to consider any proposals by management or third parties for strategic transactions. The Company’s Board of Directors has been undertaking a strategic review of the Company’s business in order to enhance shareholder value, and has engaged a financial advisor for this purpose. Various alternatives have been and are being considered, including a possible sale or combination or other similar transaction, or a going private transaction which would result in the termination of the registration of our Class A Shares so as to cease periodic and other public company compliance and reporting. The Company has received from and provided to potential counterparties certain due diligence information. In addition, the Company’s management and financial advisor have held and expect to continue to hold preliminary discussions with potential counterparties and participants. There is no assurance that any of the preliminary discussions which have taken place or may in the future take place will result in any transaction or that any of the strategic alternatives under consideration will be implemented. The Company does not intend to provide periodic public updates on any of these matters except as required by law or regulation. On February 27, 2017, ZAIS Group entered into an agreement (the “Legal Advisor Agreement”) with Howard Steinberg, the Company’s General Counsel, pursuant to which Mr. Steinberg will resign as General Counsel effective on March 31, 2017 and be retained as Senior Legal Advisor to the Company effective April 1, 2017. Under the Legal Advisor Agreement, which has been approved by the Compensation Committee of the Board of Directors of the Company, Mr. Steinberg will receive $150,000 per calendar quarter for his services, plus additional compensation of $900 per hour if he is requested to devote more than 20 hours during any week to advising the Company. In addition, under the Legal Advisor Agreement, Mr. Steinberg is entitled to reimbursement of reasonable out-of-pocket expenses incurred in connection with performing services for the Company, an allowance or reimbursement for the reasonable cost of suitable office space in Manhattan should Mr. Steinberg require it, 70% of the premiums for COBRA health and medical insurance coverage for Mr. Steinberg and his spouse paid for by the Company and, after COBRA coverage lapses, up to 70% of the costs of Medicare supplementary health insurance coverage for Mr. Steinberg and his spouse, for as long as he provides legal advisory services to the Company, capped at $3,450 per quarter. Pursuant to the Legal Advisor Agreement, Mr. Steinberg also received a payment of $450,000 on February 28, 2017. The Legal Advisor Agreement is terminable by the Company or Mr. Steinberg on 30 days’ prior written notice; if it is terminated by the Company other than due to Mr. Steinberg’s failure to perform services, Mr. Steinberg would be entitled to a payment of $300,000. On February 28, 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity which focuses on investing in non-ZAIS managed CLOs, none of which has been called as of March 24, 2017. On March 17, 2017, the Company repaid its notes payable to EarlyBirdCapital, Inc. and Sidoti & Company, LLC in full in the aggregate amount of $1.3 million (see Note 8 - “Notes Payable”). Such amount includes the outstanding principal amount and accrued interest. On March 17, 2017, 899,674 RSUs granted to certain of the Company’s employees in connection with the Proposal vested. The Company issued 548,923 shares of its Class A Common Stock, on a net basis (to account for applicable wage withholding requirements), to the holders who elected to cancel their Class B-0 Units in substitution for RSUs. The fair value of the consideration was $2.1 million based on the closing stock price of the Company’s Class A Common Stock on March 17, 2017 and the gross amount of RSUs vested. Subsequent to the issuance of these additional shares, ZGH owns 67.4% of ZGP. Additionally, ZAIS Group paid the Cash Amount of approximately $256,000 to the holders who elected the Cash Amount (subject to applicable wage withholding requirements) on March 24, 2017. See Note 9 - “Compensation” for additional disclosures relating to the RSUs. | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement excerpt. It seems to be missing key sections and context. The text contains partial references to:
1. A financial statement for ZAIS Group Holdings, Inc.
2. Expenses related to a Business Combination
3. Liabilities and debt obligation vehicles
Without the full document, I cannot provide a comprehensive summary. If you could share the complete financial statement, I would be happy to help you summarize it accurately. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND RELATED INFORMATION ACCOUNTING FIRM Board of Directors and Shareholders U.S. Physical Therapy, Inc. We have audited the accompanying consolidated balance sheets of US Physical Therapy, Inc. (a Nevada corporation) and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of net income, equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of US Physical Therapy, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 1, the 2015 and 2014 consolidated financial statements have been restated to correct an error. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated June 7, 2017 expressed an adverse opinion. /s/ GRANT THORNTON LLP Houston, Texas June 7, 2017 ACCOUNTING FIRM Board of Directors and Shareholders U.S. Physical Therapy, Inc. We have audited the internal control over financial reporting of US Physical Therapy, Inc. (a Nevada corporation) and subsidiaries (the “Company”) as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting (“Management’s Report”). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment. The Company identified a material weakness related to the accounting for redeemable non-controlling interests. The Company’s business combination/purchase accounting controls related to the accounting for redeemable non-controlling interests were not designed effectively to ensure that the Company correctly interpreted and applied technical accounting requirements concerning the classification of such interests in the consolidated financial statements. In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2016. The material weakness identified above was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2016 consolidated financial statements, and this report does not affect our report dated June 7, 2017, which expressed an unqualified opinion on those financial statements. /s/ GRANT THORNTON LLP Houston, Texas June 7, 2017 U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share data) See notes to consolidated financial statements. U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF NET INCOME (In thousands, except per share data) See notes to consolidated financial statements. U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EQUITY (In thousands) See notes to consolidated financial statements. U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) See notes to consolidated financial statements. U.S. PHYSICAL THERAPY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016, 2015 and 2014 1. Organization, Nature of Operations and Basis of Presentation U.S. Physical Therapy, Inc. and its subsidiaries (together, the “Company”) operate outpatient physical therapy clinics that provide pre-and post-operative care and treatment for orthopedic-related disorders, sports-related injuries, preventative care, rehabilitation of injured workers and neurological-related injuries. As of December 31, 2016 the Company owned and/or operated 540 clinics in 42 states. The clinics’ business primarily originates from physician referrals. The principal sources of payment for the clinics’ services are managed care programs, commercial health insurance, Medicare/Medicaid, workers’ compensation insurance and proceeds from personal injury cases. In addition to the Company’s ownership and operation of outpatient physical therapy clinics, it also manages physical therapy facilities for third parties, such as physicians and hospitals, with 20 such third-party facilities under management as of December 31, 2016. The consolidated financial statements include the accounts of U.S. Physical Therapy, Inc. and its subsidiaries. All significant intercompany transactions and balances have been eliminated. The Company primarily operates through subsidiary clinic partnerships, in which the Company generally owns a 1% general partnership interest and a 49% to 99% limited partnership interest. The managing therapist of each clinic owns the remaining limited partnership interest in the majority of the clinics (hereinafter referred to as “Clinic Partnership”). To a lesser extent, the Company operates some clinics through wholly-owned subsidiaries under profit sharing arrangements with therapists (hereinafter referred to as “Wholly-Owned Facilities”). During the last three years, the Company completed the following multi-clinic acquisitions: In addition to the multi-clinic acquisitions, the Company acquired two single clinic practices in separate transactions during 2016. During 2015, the Company acquired a 60% interest in a single clinic practice and, during 2014, the Company acquired four individual clinics in separate transactions. Clinic Partnerships For non-acquired Clinic Partnerships, the earnings and liabilities attributable to the non-controlling interest, typically owned by the managing therapist, directly or indirectly, are recorded within the statements of net income and balance sheets as non-controlling interests. For acquired Clinic Partnerships, the earnings and liabilities attributable to the non-controlling interest are recorded within the statements of net income line item: Interest expense - mandatorily redeemable non-controlling interests and in the balance sheet line item: Mandatorily redeemable non-controlling interests. Wholly-Owned Facilities For Wholly-Owned Facilities with profit sharing arrangements, an appropriate accrual is recorded for the amount of profit sharing due the clinic partners/directors. The amount is expensed as compensation and included in clinic operating costs-salaries and related costs. The respective liability is included in current liabilities-accrued expenses on the balance sheets. Restatement of Prior Financial Statements Prior to issuing the 2016 annual financial statements, the Company determined it had previously incorrectly accounted for the non-controlling interests which were mandatorily redeemable. See Footnote 2 - Significant Accounting Policies - Mandatorily Redeemable Non-Controlling Interests - for a description of the accounting for mandatorily redeemable non-controlling interests. Management determined this correction was material to previously issued annual and quarterly consolidated financial statements. The Company, in this Annual Report on Form 10-K for the year ended December 31, 2016, is correcting its consolidated financial statements for the balance sheet as of December 31, 2015 and the statements of net income, cash flows and equity for the years ended December 31, 2015 and 2014, which includes a cumulative adjustment to the beginning balances as of January 1, 2014 (reported balances as of December 31, 2013). In addition, any prior information within footnotes, including quarterly data affected by this correction, is restated within the financial statements in this report. The following schedules present the impact of this correction on the Company’s previously reported consolidated balance sheet for the year ended December 31, 2015 and the consolidated statements of net income for the years ended December 31, 2015 and 2014 (in thousands, except share and per share data): Consolidated Balance Sheet on December 31, 2015: (1) Mandatorily redeemable non-controlling interests (2) Redeemable non-controlling interests Consolidated Statement of Net Income for the Year Ended December 31, 2015: (1) See above. Consolidated Statement of Net Income for the Year Ended December 31, 2014: (1) See above. The following schedules present the impact of this correction on the Company’s previously reported consolidated statements of cash flows for the years ended December 31, 2015 and 2014: Consolidated Statement of Cash Flows for the Year Ended December 31, 2015: Consolidated Statement of Cash Flows for the Year Ended December 31, 2014: 2. Significant Accounting Policies Cash Equivalents The Company maintains its cash and cash equivalents at financial institutions. The combined account balances at several institutions typically exceed Federal Deposit Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. Management believes that this risk is not significant. Long-Lived Assets Fixed assets are stated at cost. Depreciation is computed on the straight-line method over the estimated useful lives of the related assets. Estimated useful lives for furniture and equipment range from three to eight years and for software purchased from three to seven years. Leasehold improvements are amortized over the shorter of the related lease term or estimated useful lives of the assets, which is generally three to five years. Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of The Company reviews property and equipment and intangible assets with finite lives for impairment upon the occurrence of certain events or circumstances that indicate the related amounts may be impaired. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Goodwill Goodwill represents the excess of the amount paid and fair value of the non-controlling interests over the fair value of the acquired business assets, which include certain identifiable intangible assets. Historically, goodwill has been derived from acquisitions and, prior to 2009, from the purchase of some or all of a particular local management’s equity interest in an existing clinic. Effective January 1, 2009, if the purchase price of a non-controlling interest by the Company exceeds or is less than the book value at the time of purchase, any excess or shortfall is recognized as an adjustment to additional paid-in capital. The fair value of goodwill and other identifiable intangible assets with indefinite lives are tested for impairment annually and upon the occurrence of certain events, and are written down to fair value if considered impaired. The Company evaluates goodwill for impairment on at least an annual basis (in its third quarter) by comparing the fair value of its reporting units to the carrying value of each reporting unit including related goodwill. The Company operates a one segment business which is made up of various clinics within partnerships. The partnerships are components of regions and are aggregated to the operating segment level for the purpose of determining the Company’s reporting units when performing its annual goodwill impairment test. In 2016, 2015 and 2014, there were six regions. An impairment loss generally would be recognized when the carrying amount of the net assets of a reporting unit, inclusive of goodwill and other identifiable intangible assets, exceeds the estimated fair value of the reporting unit. The estimated fair value of a reporting unit is determined using two factors: (i) earnings prior to taxes, depreciation and amortization for the reporting unit multiplied by a price/earnings ratio used in the industry and (ii) a discounted cash flow analysis. A weight is assigned to each factor and the sum of each weight times the factor is considered the estimated fair value. For 2016, the factors (i.e., price/earnings ratio, discount rate and residual capitalization rate) were updated to reflect current market conditions. The evaluation of goodwill in 2016, 2015 and 2014 did not result in any goodwill amounts that were deemed impaired. The Company has not identified any triggering events occurring after the testing date that would impact the impairment testing results obtained. Factors which could result in future impairment charges include but are not limited to: • cost, risks and uncertainties associated with the Company’s recent restatement of its prior financial statements due to the correction of its accounting methodology for redeemable non-controlling partnership interests, and including any pending and future claims or proceedings relating to such matters; • changes as the result of government enacted national healthcare reform; • changes in Medicare rules and guidelines and reimbursement or failure of our clinics to maintain their Medicare certification or enrollment status; • revenue we receive from Medicare and Medicaid being subject to potential retroactive reduction; • business and regulatory conditions including federal and state regulation; • governmental and other third party payor inspections, reviews, investigations and audits; • compliance with federal and state laws and regulations relating to the privacy of individually identifiable patient information and associated fines and penalties for failure to comply; • legal actions, which could subject us to increased operating costs and uninsured liabilities; • changes in reimbursement rates or payment methods from third party payors including government agencies and deductibles and co-pays owed by patients; • revenue and earnings expectations; • general economic conditions; • availability and cost of qualified physical and occupational therapists; • personnel productivity and retaining key personnel; • competitive, economic or reimbursement conditions in our markets which may require us to reorganize or close certain operations and thereby incur losses and/or closure costs including the possible write-down or write-off of goodwill and other intangible assets; • acquisitions, purchases of non-controlling interests (minority interests) and the successful integration of the operations of the acquired business; • maintaining necessary insurance coverage; • availability, terms, and use of capital; and • weather and other seasonal factors. The Company will continue to monitor for any triggering events or other indicators of impairment. Mandatorily Redeemable Non-Controlling Interests - The non-controlling interests that are reflected as mandatorily redeemable non-controlling interests in the consolidated financial statements consist of those owners who have certain redemption rights, whether currently exercisable or not, and which currently, or in the future, require that the Company purchase the non-controlling interest of those owners at a predetermined formula based on a multiple of trailing twelve months earnings performance as defined in the respective limited partnership agreements. The redemption rights are triggered at such time as both of the following events have occurred: 1) termination of the owner’s employment, regardless of the reason for such termination, and 2) the passage of specified number of years after the closing of the transaction, typically three to five years, as defined in the limited partnership agreement. On the date the Company acquires a controlling interest in a partnership and the limited partnership agreement contains mandatory redemption rights, the fair value of the non-controlling interest is recorded in the long-term liabilities section of the consolidated balance sheet under the caption - Mandatorily redeemable non-controlling interests. Then, in each reporting period thereafter until purchased by the Company, the redeemable non-controlling interest is adjusted to its then current redemption value, based on the predetermined formula defined in the respective partnership agreement. The Company reflects any adjustment in the redemption value and any earnings attributable to the mandatorily redeemable non-controlling interest in its consolidated statements of net income by recording the adjustments and earnings to other income and expense in the captions - Interest expense - mandatorily redeemable non-controlling interests - change in redemption value and Interest expense - mandatorily redeemable non-controlling interests - earnings allocable. Non-Controlling Interests The Company recognizes non-controlling interests as equity in the consolidated financial statements separate from the parent entity’s equity. The amount of net income attributable to non-controlling interests is included in consolidated net income on the face of the statements of net income. Changes in a parent entity’s ownership interest in a subsidiary that do not result in deconsolidation are treated as equity transactions if the parent entity retains its controlling financial interest. The Company recognizes a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss is measured using the fair value of the non-controlling equity investment on the deconsolidation date. When the purchase price of a non-controlling interest by the Company exceeds the book value at the time of purchase, any excess or shortfall is recognized as an adjustment to additional paid-in capital. Additionally, operating losses are allocated to non-controlling interests even when such allocation creates a deficit balance for the non-controlling interest partner. Revenue Recognition Revenues are recognized in the period in which services are rendered. Net patient revenues (patient revenues less estimated contractual adjustments) are reported at the estimated net realizable amounts from third-party payors, patients and others for services rendered. The Company has agreements with third-party payors that provide for payments to the Company at amounts different from its established rates. The allowance for estimated contractual adjustments is based on terms of payor contracts and historical collection and write-off experience. The Company determines allowances for doubtful accounts based on the specific agings and payor classifications at each clinic. The provision for doubtful accounts is included in clinic operating costs in the statements of net income. Patient accounts receivable, which are stated at the historical carrying amount net of contractual allowances, write-offs and allowance for doubtful accounts, includes only those amounts the Company estimates to be collectible. Medicare Reimbursement The Medicare program reimburses outpatient rehabilitation providers based on the Medicare Physician Fee Schedule (‘‘MPFS’’). The MPFS rates have historically been subject to an automatic annual update based on a formula, called the sustainable growth rate (‘‘SGR’’) formula. The use of the SGR formula would have resulted in calculated automatic reductions in rates in every year since 2002; however, for each year through September 30, 2015, Centers for Medicare & Medicaid Services (‘‘CMS’’) or Congress has taken action to prevent the implementation of SGR formula reductions. On April 16, 2015, the Medicare Access and CHIP Reauthorization Act of 2015 (‘‘MACRA’’) was signed into law, eliminating the SGR formula and the associated annual automatic rate reductions. For services provided between January 1, 2015 and June 30, 2015 a 0% payment update was applied to the Medicare physician fee schedule payment rates; for services provided between July 1, 2015 and December 31, 2015 a 0.5% increase was applied to the fee schedule payment rates; for services provided in 2016 a 0.3% decrease is being applied to the fee schedule payment rates, and for 2017 through 2019, a 0.5% increase will be applied each year to the fee schedule payment rates, unless further adjusted by CMS. The payment adjustments proposed by CMS for 2017 is a .08% reduction. In addition, the MACRA promotes the development of new payment models that focus on quality and outcomes. The Budget Control Act of 2011 increased the federal debt ceiling in connection with deficit reductions over the next ten years, and requires automatic reductions in federal spending by approximately $1.2 trillion. Payments to Medicare providers are subject to these automatic spending reductions, subject to a 2% cap. On April 1, 2013, a 2% reduction to Medicare payments was implemented. The Bipartisan Budget Act of 2015, enacted on November 2, 2015, extends the 2% reductions to Medicare payments through fiscal year 2025. As a result of the Balanced Budget Act of 1997, the formula for determining the total amount paid by Medicare in any one year for outpatient physical therapy, occupational therapy, and/or speech-language pathology services provided to any Medicare beneficiary (i.e., the ‘‘Therapy Cap’’ or ‘‘Limit’’) was established. Based on the statutory definitions which constrained how the Therapy Cap would be applied, there is one Limit for Physical Therapy and Speech Language Pathology Services combined, and one Limit for Occupational Therapy. For 2016, the annual Limit on outpatient therapy services is $1,960 for Physical and Speech Language Pathology Services combined and $1,960 for Occupational Therapy Services. Historically, these Therapy Caps applied to outpatient therapy services provided in all settings, except for services provided in departments of hospitals. However, the Protecting Access to Medicare Act of 2014, and prior legislation, extended the Therapy Caps to services furnished in hospital outpatient department settings. The application of these annual limits to hospital outpatient department settings will sunset on December 31, 2017 unless Congress extends it. In the Deficit Reduction Act of 2005, Congress implemented an exceptions process to the annual Limit for therapy expenses for therapy services above the annual Limit. Therapy services above the annual Limit that are medically necessary satisfy an exception to the annual Limit and such claims are payable by the Medicare program. The MACRA extended the exceptions process for outpatient therapy caps through December 31, 2017. Unless Congress extends the exceptions process further, the therapy caps will apply to all outpatient therapy services beginning January 1, 2018, except those services furnished and billed by outpatient hospital departments. For any claim above the annual Limit, the claim must contain a modifier indicating that the services are medically necessary and justified by appropriate documentation in the medical record. Furthermore, under the Middle Class Tax Relief and Job Creation Act of 2012 (‘‘MCTRA’’), since October 1, 2012, patients who met or exceeded $3,700 in therapy expenditures during a calendar year have been subject to a manual medical review to determine whether applicable payment criteria are satisfied. The $3,700 threshold is applied to Physical Therapy and Speech Language Pathology Services; a separate $3,700 threshold is applied to the Occupational Therapy. The MACRA directed CMS to modify the manual medical review process such that those reviews will no longer apply to all claims exceeding the $3,700 threshold and instead will be determined on a targeted basis based on a variety of factors that CMS considers appropriate. The new factors apply to exception requests for which CMS did not conduct a medical review by July 15, 2015. CMS adopted a multiple procedure payment reduction (‘‘MPPR’’) for therapy services in the final update to the MPFS for calendar year 2011. The MPPR applied to all outpatient therapy services paid under Medicare Part B - occupational therapy, physical therapy and speech-language pathology. Under the policy, the Medicare program pays 100% of the practice expense component of the Relative Value Unit (‘‘RVU’’) for the therapy procedure with the highest practice expense RVU, then reduces the payment for the practice expense component for the second and subsequent therapy procedures or units of service furnished during the same day for the same patient, regardless of whether those therapy services are furnished in separate sessions. Since 2013, the practice expense component for the second and subsequent therapy service furnished during the same day for the same patient was reduced by 50%. In addition, the MCTRA directed CMS to implement a claims-based data collection program to gather additional data on patient function during the course of therapy in order to better understand patient conditions and outcomes. All practice settings that provide outpatient therapy services are required to include this data on the claim form. Since 2013, therapists have been required to report new codes and modifiers on the claim form that reflect a patient’s functional limitations and goals at initial evaluation, periodically throughout care, and at discharge, CMS has rejected claims if the required data is not included in the claim. The Physician Quality Reporting System, or ‘‘PQRS,’’ is a CMS reporting program that uses a combination of incentive payments and payment reductions to promote reporting of quality information by ‘‘eligible professionals.’’ Although physical therapists, occupational therapists and qualified speech-language therapists are generally able to participate in the PQRS program, therapy professionals for whose services we bill through our certified rehabilitation agencies cannot participate because the Medicare claims processing systems currently cannot accommodate institutional providers such as certified rehabilitation agencies. Eligible professionals, such as those of our therapy professionals for whose services we bill using their individual Medicare provider numbers, who do not satisfactorily report data on quality measures will be subject to a 2% reduction in their Medicare payment in 2016 and 2017. As required under the MACRA, the PQRS program will be replaced with the Merit-Based Incentive Payment System (MIPS) on January 1, 2017. Physical therapists and occupational therapists are not required to participate in the MIPS program until January 1, 2019 or later, as determined by CMS. Statutes, regulations, and payment rules governing the delivery of therapy services to Medicare beneficiaries are complex and subject to interpretation. The Company believes that it is in compliance in all material respects with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing that would have a material effect on the Company’s financial statements as of September 30, 2016. Compliance with such laws and regulations can be subject to future government review and interpretation, as well as significant regulatory action including fines, penalties, and exclusion from the Medicare program. For the year ended December 31, 2016, net revenue from Medicare accounts for approximately $81.8 million. Management Contract Revenues Management contract revenues are derived from contractual arrangements whereby the Company manages a clinic for third party owners. The Company does not have any ownership interest in these clinics. Typically, revenues are determined based on the number of visits conducted at the clinic and recognized when services are performed. Costs, typically salaries for the Company’s employees, are recorded when incurred. Management contract revenues are included in “other revenues” in the accompanying Consolidated Statements of Net Income. Contractual Allowances Contractual allowances result from the differences between the rates charged for services performed and expected reimbursements by both insurance companies and government sponsored healthcare programs for such services. Medicare regulations and the various third party payors and managed care contracts are often complex and may include multiple reimbursement mechanisms payable for the services provided in Company clinics. The Company estimates contractual allowances based on its interpretation of the applicable regulations, payor contracts and historical calculations. Each month the Company estimates its contractual allowance for each clinic based on payor contracts and the historical collection experience of the clinic and applies an appropriate contractual allowance reserve percentage to the gross accounts receivable balances for each payor of the clinic. Based on the Company’s historical experience, calculating the contractual allowance reserve percentage at the payor level is sufficient to allow the Company to provide the necessary detail and accuracy with its collectability estimates. However, the services authorized and provided and related reimbursement are subject to interpretation that could result in payments that differ from the Company’s estimates. Payor terms are periodically revised necessitating continual review and assessment of the estimates made by management. The Company’s billing system does not capture the exact change in its contractual allowance reserve estimate from period to period in order to assess the accuracy of its revenues and hence its contractual allowance reserves. Management regularly compares its cash collections to corresponding net revenues measured both in the aggregate and on a clinic-by-clinic basis. In the aggregate, historically the difference between net revenues and corresponding cash collections has generally reflected a difference within approximately 1% of net revenues. Additionally, analysis of subsequent period’s contractual write-offs on a payor basis reflects a difference within approximately 1% between the actual aggregate contractual reserve percentage as compared to the estimated contractual allowance reserve percentage associated with the same period end balance. As a result, the Company believes that a change in the contractual allowance reserve estimate would not likely be more than 1% at December 31, 2016. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount to be recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. The Company did not have any accrued interest or penalties associated with any unrecognized tax benefits nor was any interest expense recognized during the twelve months ended December 31, 2016 and 2015. The Company will book any interest or penalties, if required, in interest and/or other income/expense as appropriate. On September 13, 2013, the U.S. Treasury Department and the I.R.S. issued final regulations that address costs incurred in acquiring, producing, or improving tangible property (the “Tangible Property Regulations”). The Tangible Property Regulations are generally effective for tax years beginning on or after January 1, 2014, and may be adopted in earlier years. The Company adopted the tax treatment of expenditures to improve tangible property and the capitalization of inherently facilitative costs to acquire tangible property as of January 1, 2014. Historically, the Company has treated the expenditures to improve tangible property and the capitalization of inherently facilitative costs to acquire tangible property similar for tax and book. The impact of these changes were not material to the Company's consolidated financial statements. Fair Values of Financial Instruments The carrying amounts reported in the balance sheets for cash and cash equivalents, accounts receivable, accounts payable and notes payable approximate their fair values due to the short-term maturity of these financial instruments. The carrying amount under the Amended Credit Agreement (as defined in Note 9) approximates its fair value. The interest rate on the Credit Agreement, which is tied to the Eurodollar Rate, is set at various short-term intervals, as detailed in the Credit Agreement. Segment Reporting Operating segments are components of an enterprise for which separate financial information is available that is evaluated regularly by chief operating decision makers in deciding how to allocate resources and in assessing performance. The Company identifies operating segments based on management responsibility and believes it meets the criteria for aggregating its operating segments into a single reporting segment. Use of Estimates In preparing the Company’s consolidated financial statements, management makes certain estimates and assumptions, especially in relation to, but not limited to, goodwill impairment, allowance for receivables, tax provision and contractual allowances, that affect the amounts reported in the consolidated financial statements and related disclosures. Actual results may differ from these estimates. Self-Insurance Program The Company utilizes a self-insurance plan for its employee group health insurance coverage administered by a third party. Predetermined loss limits have been arranged with the insurance company to minimize the Company’s maximum liability and cash outlay. Accrued expenses include the estimated incurred but unreported costs to settle unpaid claims and estimated future claims. Management believes that the current accrued amounts are sufficient to pay claims arising from self-insurance claims incurred through December 31, 2016. Restricted Stock Restricted stock issued to employees and directors is subject to continued employment or continued service on the board, respectively. Generally, restrictions on the stock granted to employees lapse in equal annual installments on the following four anniversaries of the date of grant. For those shares granted to directors, the restrictions will lapse in equal quarterly installments during the first year after the date of grant. For those granted to executive officers, the restriction will lapse in equal quarterly installments during the four years following the date of grant. Compensation expense for grants of restricted stock is recognized based on the fair value per share on the date of grant amortized over the vesting period. The restricted stock issued is included in basic and diluted shares for the earnings per share computation. Recently Adopted Accounting Guidance In September 2015, the FASB issued changes to the accounting for measurement-period adjustments related to business combinations. Currently, an acquiring entity is required to retrospectively adjust the balance sheet amounts of the acquiree recognized at the acquisition date with a corresponding adjustment to goodwill during the measurement period, as well as revise comparative information for prior periods presented within financial statements as needed, including revising income effects, such as depreciation and amortization, as a result of changes made to the balance sheet amounts of the acquiree. Such adjustments are required when new information is obtained about facts and circumstances that existed as of the acquisition date that if known, would have affected the measurement of the amounts initially recognized or would have resulted in the recognition of additional assets or liabilities. The measurement period is the period after the acquisition date during which the acquirer may adjust the balance sheet amounts recognized for a business combination (generally up to one year from the date of acquisition). The changes eliminate the requirement to make such retrospective adjustments, and, instead require the acquiring entity to record these adjustments in the reporting period they are determined. Additionally, the changes require the acquiring entity to present separately on the face of the income statement or disclose in the notes to the financial statements the portion of the amount recorded in current-period income by line item that would have been recorded in previous reporting periods if the adjustment to the balance sheet amounts had been recognized as of the acquisition date. These changes became effective for the Company on January 1, 2016. This change did not have a material impact on its consolidated financial statements. In March 2016, the FASB issued guidance to simplify some provisions in stock compensation accounting. The guidance amends how excess tax benefits and a company’s payments to cover tax bills for the recipients’ shares should be classified. Prior to this guidance, excess tax benefits were recorded in additional paid-in capital, but will now become a component of the income tax provision/benefit in the period in which they occur. This guidance allows companies to estimate the number of stock awards expected to vest and revises the withholding requirements for classifying stock awards as equity. For public business entities, this guidance is effective for fiscal years starting after December 15, 2016, including interim periods within those fiscal years but early adoption is allowed. The Company adopted this accounting treatment in the fourth quarter of 2016. The adoption increased earnings, by decreasing the tax provision, by $1.0 million, or $0.09 per share, for the full fiscal year 2016. The election to record forfeitures in the period they occur is consistent with the Company’s past approach, due to the immateriality of past forfeitures, and the Company believes the effect to be immaterial on the consolidated financial statements. Recently Issued Accounting Guidance In February 2016, the FASB issued amended accounting guidance which replaced most existing lease accounting guidance under U. S. generally accepted accounting principles. Among other changes, the amended guidance requires that a right-to-use asset, which is an asset that represents the lessee’s right to use, and a lease liability, which is a lessee’s obligation to make lease payments arising for a lease measured on a discounted basis, be recognized on the balance sheet by lessees for those leases with a term of greater than 12 months. The amended guidance is effective for reporting periods beginning after December 15, 2018; however, early adoption is permitted. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. Since the Company leases all but one of its clinic facilities, it has been evaluating various lease management systems to capture the necessary information and the impact that this amended accounting guidance will have on its consolidated financial statements. Subsequent Event The Company has evaluated events occurring after the balance sheet date for possible disclosure as a subsequent event through the date that these consolidated financial statements were issued. In January 2017, the Company acquired a 70% interest in a physical therapy practice that owns and operates 17 clinics and manages an additional 8 clinics. The purchase price for the 70% interest was $11.4 million. In March 2017, the Company acquired a 55% interest in a company which is a provider of workforce performance solutions. The purchase price for the 55% interest was $6.6 million. In May 2017, the Company acquired a 70% interest in a physical therapy practice that owns and operates 4 clinics. The purchase price for the 70% interest was $2.5 million. Although the restatement of prior financial statements caused the Company to be in violation of our Amended Credit Agreement dated December 5, 2013, the Company was able to obtain necessary waivers and amendments, as applicable. On March 30, 2017, the Company entered into a Third Amendment to Amended and Restated Credit Agreement and Limited Waiver with its lenders. As of the date of this report, the Company is in compliance with the covenants in the Amended and Restated Credit Agreement. 3. Acquisitions of Businesses During 2016, 2015 and 2014, the Company completed the following multi-clinic acquisitions of physical therapy practices: In addition to the multi-clinic acquisitions, the Company acquired two single clinic practices in separate transactions during 2016. During 2015, the Company acquired a 60% interest in a single clinic practice and, during 2014, the Company acquired four individual clinics in separate transactions. On November 30, 2016, the Company acquired a 60% interest in a 12 clinic physical therapy practice. The purchase price for the 60% interest was $11.0 million in cash and $0.5 million in a seller note that is payable in two principal installments of $250,000 each, plus accrued interest, in November 2017 and 2018. On February 29, 2016, the Company acquired a 55% interest in an eight-clinic physical therapy practice. The purchase price for the 55% interest was $13.2 million in cash and $0.5 million in a seller note that is payable in two principal installments of $250,000 each, plus accrued interest, in February 2017 and 2018. During 2016, two subsidiaries of the Company each acquired a single clinic therapy practice for an aggregate purchase price of $75,000. The purchase price for the 2016 acquisitions has been preliminarily allocated as follows (in thousands): On December 31, 2015, the Company acquired a 59% interest in a four-clinic physical therapy practice. The purchase price was $4.6 million in cash and $400,000 in seller notes payable that were payable in two principal installments of an aggregate of $200,000 each, plus accrued interest. The first payment was paid in December 2016 and the second installment is due December 2017. On June 30, 2015, the Company acquired a 70% interest in a four-clinic physical therapy practice. The purchase price was $3.6 million in cash and $0.7 million in seller notes that are payable plus accrued interest, in June 2018. On April 30, 2015, the Company acquired a 70% interest in a three-clinic physical therapy practice. The purchase price was $4.7 million in cash and $150,000 in a seller note that was payable in two principal installments of $75,000 each, plus accrued interest. The first payment was paid in April 2016 and the second installment is due in April 2017. On January 31, 2015, the Company acquired a 60% interest in a nine-clinic physical therapy practice. The purchase price for the 60% interest was $6.7 million in cash and $0.5 million in a seller note that is payable in two principal installments of $250,000 each, plus accrued interest. This note was paid in full in January 2017. In addition to the multi-clinic acquisitions, on August 31, 2015, the Company acquired a 60% interest in a single physical therapy clinic for $150,000 in cash and $50,000 in a seller note payable that is payable plus accrued interest was paid in August 2016. The purchase prices for the 2015 acquisitions have been allocated as follows (in thousands): The purchase price for the 70% interest in the April 2014 Acquisition was $10.6 million in cash and a $400,000 seller note, that was paid in two principal installments totaling $200,000 each, plus accrued interest, in April 2015 and 2016. The purchase price for the August 2014 Acquisition was $1.0 million in cash. In addition, during 2014, the Company acquired three individual clinic practices for an aggregate of $595,000. The purchase prices for the 2014 acquisitions have been allocated as follows (in thousands): The purchase prices plus the fair value of the non-controlling interests for the acquisitions in 2015 and 2014 were allocated to the fair value of the assets acquired, inclusive of identifiable intangible assets, i.e. trade names, referral relationships and non-compete agreements, and liabilities assumed based on the fair values at the acquisition date, with the amount exceeding the fair values being recorded as goodwill. For the acquisitions in 2016, the Company is in the process of completing its formal valuation analysis to identify and determine the fair value of tangible and identifiable intangible assets acquired and the liabilities assumed. Thus, the final allocation of the purchase price may differ from the preliminary estimates used at December 31, 2016 based on additional information obtained and completion of the valuation of the identifiable intangible assets. Changes in the estimated valuation of the tangible assets acquired, the completion of the valuation of identifiable intangible assets and the completion by the Company of the identification of any unrecorded pre-acquisition contingencies, where the liability is probable and the amount can be reasonably estimated, will likely result in adjustments to goodwill. For the acquisitions in 2015 and 2014, the values assigned to the referral relationships and non-compete agreements are being amortized to expense equally over the respective estimated lives. For referral relationships, the range of the estimated lives was 4½ to 13 years, and for non-compete agreements the estimated lives was five to six years. Generally, the values assigned to tradenames are tested annually for impairment, however with regards to one acquisition in 2013, the tradename was being amortized over the term of the six year agreement in which the Company has acquired the rights to use the specific tradename. In 2016, the remaining value of the tradename was charged to earnings as the Company decided to combine two acquired operations in Georgia; therefore, the tradename under this six year agreement will no longer be used. The values assigned to goodwill are tested annually for impairment. For the 2016, 2015 and 2014 acquisitions, total current assets primarily represent patient accounts receivable. Total non-current assets are fixed assets, primarily equipment, used in the practices. The consideration paid for each of the acquisitions was derived through arm’s length negotiations. Funding for the cash portions was derived from proceeds from the Company’s revolving credit facility. The results of operations of the acquisitions have been included in the Company’s consolidated financial statements since their respective date of acquisition. Unaudited proforma consolidated financial information for the acquisitions in 2016, 2015 and 2014 acquisitions have not been included as the results, individually and in the aggregate, were not material to current operations. 4. Non-Controlling Interests During 2016, the Company acquired additional interests in six partnerships included in non-controlling interest The interests in the partnerships purchased ranged from 2% to 35%. The aggregate purchase price paid was $0.9 million in cash and $0.4 million in a seller note, that is payable in two principal installments of $194,000 each in February 2017 and 2018. The purchase price included $112,000 of undistributed earnings. The remaining $1.2 million, less future tax benefits of $0.5 million, was recognized as an adjustment to additional paid-in capital. During 2016, the Company sold a 4% interest in one partnership and 35% in another. The sales prices included aggregate cash of $138,000 plus notes receivable of $148,000 with payments due monthly based on percentages of distributions and bonuses earned by the purchasers. The total sales price of $286,000, less the tax effect of $110,000, was charged to additional paid-in capital. In 2015, the Company purchased additional interests in six partnerships. The interests in the partnerships purchased ranged from 5% to 35%. The aggregate purchase prices paid were $0.9 million in cash. The purchase prices included an aggregate of $217,000 of undistributed earnings. The remaining $0.7 million, less future tax benefits of $0.3 million, was recognized as an adjustment to additional paid-in capital. 5. Redeemable Non-Controlling Interest The Company acquires a majority interest (the “Acquisition”) in a physical therapy clinic business (referred to as “Therapy Practice”). These Acquisitions occur in a series of steps which are described below. 1. Prior to the Acquisition, the Therapy Practice exists as a separate legal entity (the “Seller Entity”). The Seller Entity is owned by one or more individuals (the “Selling Shareholders”) most of whom are physical therapists that work in the Therapy Practice and provide physical therapy services to patients. 2. In conjunction with the Acquisition, the Seller Entity contributes the Therapy Practice into a newly-formed limited partnership (“NewCo”), in exchange for one hundred percent (100%) of the limited and general partnership interests in NewCo. Therefore, in this step, NewCo becomes a wholly-owned subsidiary of the Seller Entity. 3. The Company enters into an agreement (the “Purchase Agreement”) to acquire from the Seller Entity a majority (ranges from 50% to 90%) of the limited partnership interest and in all cases 100% of the general partnership interest in NewCo. The Company does not purchase 100% of the limited partnership interest because the Selling Shareholders, through the Seller Entity, want to maintain an ownership percentage. The consideration for the Acquisition is primarily payable in the form of cash at closing and a small two-year note in lieu of an escrow (the “Purchase Price”). The Purchase Agreement does not contain any future earn-out or other contingent consideration that is payable to the Seller Entity or the Selling Shareholders. 4. The Company and the Seller Entity also execute a partnership agreement (the “Partnership Agreement”) for NewCo that sets forth the rights and obligations of the limited and general partners of NewCo. After the Acquisition, the Company is the general partner of NewCo. 5. As noted above, the Company does not purchase 100% of the limited partnership interests in NewCo and the Seller Entity retains a portion of the limited partnership interest in NewCo (“Seller Entity Interest”). 6. In most cases, some or all of the Selling Shareholders enter into an employment agreement (the “Employment Agreement”) with NewCo with an initial term that ranges from three to five years (the “Employment Term”), with automatic one-year renewals, unless employment is terminated prior to the end of the Employment Term. As a result, a Selling Shareholder becomes an employee (“Employed Selling Shareholder”) of NewCo. The employment of an Employed Selling Shareholder can be terminated by the Employed Selling Shareholder or NewCo, with or without cause, at any time. In a few situations, a Selling Shareholder does not become employed by NewCo and is not involved with NewCo following the closing; in those situations, such Selling Shareholders sell their entire ownership interest in the Seller Entity as of the closing of the Acquisition. 7. The compensation of each Employed Selling Shareholder is specified in the Employment Agreement and is customary and commensurate with his or her responsibilities based on other employees in similar capacities within NewCo, the Company and the industry. 8. The Company and the Selling Shareholder (including both Employed Selling Shareholders and Selling Shareholders not employed by NewCo) execute a non-compete agreement (the “Non-Compete Agreement”) which restricts the Selling Shareholder from engaging in competing business activities for a specified period of time (the “Non-Compete Term”). A Non-Compete Agreement is executed with the Selling Shareholders in all cases. That is, even if the Selling Shareholder does not become an Employed Selling Shareholder, the Selling Shareholder is restricted from engaging in a competing business during the Non-Compete Term. 9. The Non-Compete Term commences as of the date of the Acquisition and expires on the later of : a. Two years after the date an Employed Selling Shareholders’ employment is terminated (if the Selling Shareholder becomes an Employed Selling Shareholder) or b. Five to six years from the date of the Acquisition, as defined in the Non-Compete Agreement, regardless of whether the Selling Shareholder is employed by NewCo. 10. The Non-Compete Agreement applies to a restricted region which is defined as a 15-mile radius from the Therapy Practice. That is, an Employed Selling Shareholder is permitted to engage in competing businesses or activities outside the 15-mile radius (after such Employed Selling Shareholder no longer is employed by NewCo) and a Selling Shareholder who is not employed by NewCo immediately is permitted to engage in the competing business or activities outside the 15-mile radius. 11. The Partnership Agreement contains provisions for the redemption of the Seller Entity Interest, either at the option of the Company (the “Call Option”) or on a required basis (the “Required Redemption”): a. Required Redemption i. Once the Required Redemption is triggered, the Company is obligated to purchase from the Seller Entity and the Seller Entity is obligated to sell to the Company, the allocable portion of the Seller Entity Interest based on the terminated Selling Shareholder’s pro rata ownership interest in the Seller Entity (the “Allocable Portion”). Required Redemption is triggered when both of the following events have occurred: 1. Termination of an Employed Selling Shareholder’s employment with NewCo, regardless of the reason for such termination, and 2. The expiration of an agreed upon period of time, typically three to five years, as set forth in the relevant Partnership Agreement (the “Holding Period”). ii. In the event an Employed Selling Shareholder’s employment terminates prior to the expiration of the Holding Period, the Required Redemption would occur only upon expiration of the Holding Period. b. Call Option i. In the event that an Employed Selling Shareholder’s employment terminates prior to expiration of the Holding Period, the Company has the contractual right, but not the obligation, to acquire the Employed Selling Shareholder’s Allocable Portion of the Seller Entity Interest from the Seller Entity through exercise of the Call Option. c. For the Required Redemption and the Call Option, the purchase price is derived from a formula based on a specified multiple of NewCo’s trailing twelve months of earnings before interest, taxes, depreciation, amortization, and the Company’s internal management fee, plus an Allocable Portion of any undistributed earnings of NewCo (the “Redemption Amount”). NewCo’s earnings are distributed monthly based on available cash within NewCo; therefore the undistributed earnings amount is small, if any. d. The Purchase Price for the initial equity interest purchased by the Company is also based on the same specified multiple of the trailing twelve-month earnings that is used in the Required Redemption noted above. e. Although, the Required Redemption and the Call Option do not have an expiration date, the Seller Entity Interest eventually will be purchased by the Company. f. The Required Redemption and the Call Option never apply to Selling Shareholders who do not become employed by NewCo, since the Company requires that such Selling Shareholders sell their entire ownership interest in the Seller Entity at the closing of the Acquisition. 12. An Employed Selling Shareholder’s ownership of his or her equity interest in the Seller Entity predates the Acquisition and the Company’s purchase of its partnership interest in NewCo. The Employment Agreement and the Non-Compete Agreement do not contain any provision to escrow or “claw back” the equity interest in the Seller Entity held by such Employed Selling Shareholder, nor the Seller Entity Interest in NewCo, in the event of a breach of the employment or non-compete terms. More specifically, even if the Employed Selling Shareholder is terminated for “cause” by NewCo, such Employed Selling Shareholder does not forfeit his or her right to his or her full equity interest in the Seller Entity and the Seller Entity does not forfeit its right to any portion of the Seller Entity Interest. The Company’s only recourse against the Employed Selling Shareholder for breach of either the Employment Agreement or the Non-Compete Agreement is to seek damages and other legal remedies under such agreements. There are no conditions in any of the arrangements with an Employed Selling Shareholder that would result in a forfeiture of the equity interest held in the Seller Entity or of the Seller Entity Interest. The following table details the changes in the carrying amount of the mandatorily redeemable non-controlling interests (in thousands): In 2016, as part of the acquisition of a non-controlling interest (classified as mandatorily redeemable non-controlling interests), the Company entered into $0.1 million note payable that is due and payable, with any accrued interest, in January 2018. In 2015, as part of the acquisition of a non-controlling interest (classified as mandatorily redeemable non-controlling interests), the Company entered into several notes payable aggregating $3.1 million. The notes are each payable in two installments plus accrued interest (interest accrues at 3.25%). The first principal installment in an aggregate of $1.2 million is due on December 31, 2018 and the second principal installment in an aggregate of $1.9 million is due on January 31, 2019. The following table details the carrying amount of the mandatorily redeemable non-controlling interests (in thousands): 6. Goodwill The changes in the carrying amount of goodwill as of December 31, 2016 and 2015 consisted of the following (in thousands): 7. Intangible Assets, net Intangible assets, net as of December 31, 2016 and 2015 consisted of the following (in thousands): Tradenames, referral relationships and non-compete agreements are related to the businesses acquired. The value assigned to tradenames has an indefinite life and is tested at least annually for impairment using the relief from royalty method in conjunction with the Company’s annual goodwill impairment test. The value assigned to referral relationships is being amortized over their respective estimated useful lives which range from six to 16 years. Non-compete agreements are amortized over the respective term of the agreements which range from five to six years. The following table details the amount of amortization expense recorded for intangible assets for the years ended December 31, 2016, 2015 and 2014 (in thousands): For one acquisition, the value assigned to tradename was being amortized over the term of the six year agreement in which the Company had acquired the right to use the specific tradename. In 2016, the remaining value of this tradename was charged to earnings and included in amortization expense in the above table as the Company decided to combine two acquired operations in Georgia and the tradename under this six year agreement will no longer be used. The remaining balances of the referral relationships and non-compete agreements is expected to be amortized as follows (in thousands): 8. Accrued Expenses Accrued expenses as of December 31, 2016 and 2015 consisted of the following (in thousands): 9. Notes Payable Notes payable as of December 31, 2016 and 2015 consisted of the following (dollars in thousands): Effective December 5, 2013, we entered into an Amended and Restated Credit Agreement with a commitment for a $125.0 million revolving credit facility with a maturity date of November 30, 2018. This agreement was amended in August 2015 and January 2016 (hereafter referred to as “Amended Credit Agreement”). The Amended Credit Agreement is unsecured and has loan covenants, including requirements that the Company comply with a consolidated fixed charge coverage ratio and consolidated leverage ratio. Proceeds from the Amended Credit Agreement may be used for working capital, acquisitions, purchases of the Company’s common stock, dividend payments to the Company’s common stockholders, capital expenditures and other corporate purposes. The pricing grid which is based on the Company’s consolidated leverage ratio with the applicable spread over LIBOR ranging from 1.5% to 2.5% or the applicable spread over the Base Rate ranging from 0.1% to 1%. Fees under the Amended Credit Agreement include an unused commitment fee ranging from 0.1% to 0.25% depending on the Company’s consolidated leverage ratio and the amount of funds outstanding under the Amended Credit Agreement. The January 2016 amendment to the Amended Credit Agreement increased the cash and noncash consideration that the Company could pay with respect to acquisitions permitted under the Amended Credit Agreement to $50,000,000 for any fiscal year, and increased the amount the Company may pay in cash dividends to its shareholders in an aggregate amount not to exceed $10,000,000 in any fiscal year. On December 31, 2016, $46.0 million was outstanding on the Credit Agreement resulting in $79.0 million of availability. As of the date of this report, the Company was in compliance with all of the covenants thereunder. The Company generally enters into various notes payable as a means of financing a portion of its acquisitions, purchasing of non-controlling interests and paying the settlement of mandatorily redeemable non-controlling interests. In conjunction with the the transactions related to these in 2016, the Company entered into notes payable in the aggregate amount of $1.5 million of which an aggregate principal payment of $694,000 is due in 2017 and $819,000 in 2018. Interest accrues in the range of 3.25% to 3.5% per annum and is payable with each principal installment. Aggregate annual payments of principal required pursuant to the Credit Agreement and the above notes payable subsequent to December 31, 2016 are as follows (in thousands): 10. Income Taxes Significant components of deferred tax assets included in the consolidated balance sheets at December 31, 2016 and 2015 were as follows (in thousands): During 2016, the Company recorded deferred tax assets of $0.4 million related to acquisitions of non-controlling interests, $2.4 million related to the revaluation of mandatorily redeemable non-controlling interests and $7.4 million related to acquired interests. Also, during 2016, the Company recorded an adjustment to the deferred tax assets of $2.7 million related to acquisitions of non-controlling interests in 2015 based on a detailed reconciliation of its federal and state taxes payable and receivable accounts along with its federal and state deferred tax asset and liability accounts. The offset to this adjustment was a reduction in the previously reported tax receivable of approximately $2.9 million and a charge to additional-paid-in-capital of $0.2 million. At December 31, 2016 and 2015, the Company had a tax receivable of $2.3 million and $3.4 million (prior to adjustment of $2.9 million), respectively, included in other current assets on the accompanying consolidated balance sheets. The differences between the federal tax rate and the Company’s effective tax rate for results of continuing operations for the years ended December 31, 2016, 2015 and 2014 were as follows (in thousands): In March 2016, the FASB issued guidance to simplify some provisions in stock compensation accounting. The Company adopted this guidance in the fourth quarter of 2016. Prior to this guidance, excess tax benefits were recorded in additional paid-in capital, but became a component of the income tax provision/benefit in the period in which they occurred. For 2016, the adoption resulted in a reduction of the income tax provision by $1.0 million. The federal tax portion is shown above as excess equity compensation deduction. Significant components of the provision for income taxes for continuing operations for the years ended December 31, 2016, 2015 and 2014 were as follows (in thousands): For 2016, 2015 and 2014, the Company performed a detailed reconciliation of its federal and state taxes payable and receivable accounts along with its federal and state deferred tax asset and liability accounts. As a result of this detailed analysis, the Company recorded an increase in the income tax provision of $34,000, $147,000 and $223,000 for 2016, 2015, and 2014, respectively. The Company considers this reconciliation process to be an annual control. The Company is required to establish a valuation allowance for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income in the periods which the deferred tax assets are deductible, management believes that a valuation allowance is not required, as it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. The Company’s U.S. federal returns remain open to examination for 2013 through 2015 and U.S. state jurisdictions are open for periods ranging from 2012 through 2015. The Company does not believe that it has any significant uncertain tax positions at December 31, 2016, nor is this expected to change within the next twelve months due to the settlement and expiration of statutes of limitation. The Company did not have any accrued interest or penalties associated with any unrecognized tax benefits nor was any interest expense recognized during the years ended December 31, 2016, 2015 and 2014. 11. Equity Based Plans The Company has the following equity based plans with outstanding equity grants: The Amended and Restated 1999 Employee Stock Option Plan (the “Amended 1999 Plan”) permits the Company to grant to non-employee directors and employees of the Company up to 600,000 non-qualified options to purchase shares of common stock and restricted stock (subject to proportionate adjustments in the event of stock dividends, splits, and similar corporate transactions). The exercise prices of options granted under the Amended 1999 Plan are determined by the Compensation Committee. The period within which each option will be exercisable is determined by the Compensation Committee. The Amended 1999 Plan was approved by the shareholders of the Company at the 2008 Shareholders Meeting on May 20, 2008. The Amended and Restated 2003 Stock Option Plan (the “Amended 2003 Plan”) permits the Company to grant to key employees and outside directors of the Company incentive and non-qualified options and shares of restricted stock covering up to 2,100,000 shares of common stock (subject to proportionate adjustments in the event of stock dividends, splits, and similar corporate transactions). The material terms of the Amended 2003 Plan was reapproved by the shareholders of the Company at the 2015 Shareholders Meeting on May 19, 2015 and an increase in the number of shares authorized for issuance from 1,750,000 to 2,100,000 was approved at the 2016 Shareholders Meeting on March 17, 2016. A cumulative summary of equity plans as of December 31, 2016 follows: During 2016, 2015 and 2014, the Company granted the following shares of restricted stock to directors, officers and employees pursuant to its equity plans as follows: During 2016, 2015 and 2014, the following shares were cancelled due to employee terminations prior to restrictions lapsing: Generally, restrictions on the stock granted to employees lapse in equal annual installments on the following four anniversaries of the date of grant. For those shares granted to directors, the restrictions will lapse in equal quarterly installments during the first year after the date of grant. For those granted to executive officers, the restriction will lapse in equal quarterly installments during the four years following the date of grant. As of December 31, 2016, there were 232,997 shares outstanding for which restrictions had not lapsed. The restrictions will lapse in 2017 through 2020. Compensation expense for grants of restricted stock is recognized based on the fair value on the date of grant. Compensation expense for restricted stock grants was $4,962,000, $4,491,000 and $3,363,000, respectively, for 2016, 2015 and 2014. As of December 31, 2016, the remaining $6.7 million of compensation expense will be recognized from 2017 through 2020. 12. Preferred Stock The Board is empowered, without approval of the shareholders, to cause shares of preferred stock to be issued in one or more series and to establish the number of shares to be included in each such series and the rights, powers, preferences and limitations of each series. There are no provisions in the Company’s Articles of Incorporation specifying the vote required by the holders of preferred stock to take action. All such provisions would be set out in the designation of any series of preferred stock established by the Board. The bylaws of the Company specify that, when a quorum is present at any meeting, the vote of the holders of at least a majority of the outstanding shares entitled to vote who are present, in person or by proxy, shall decide any question brought before the meeting, unless a different vote is required by law or the Company’s Articles of Incorporation. Because the Board has the power to establish the preferences and rights of each series, it may afford the holders of any series of preferred stock, preferences, powers, and rights, voting or otherwise, senior to the right of holders of common stock. The issuance of the preferred stock could have the effect of delaying or preventing a change in control of the Company. 13. Common Stock From September 2001 through December 31, 2008, the Board authorized the Company to purchase, in the open market or in privately negotiated transactions, up to 2,250,000 shares of the Company’s common stock. In March 2009, the Board authorized the repurchase of up to 10% or approximately 1,200,000 shares of its common stock (“March 2009 Authorization”). The Amended Credit Agreement permits share repurchases of up to $15,000,000, subject to compliance with covenants. The Company is required to retire shares purchased under the March 2009 Authorization. Under the March 2009 Authorization, the Company has purchased a total of 859,499 shares. There is no expiration date for the share repurchase program. There are currently an additional estimated 213,675 shares (based on the closing price of $70.20 on December 30, 2016, the last business day in 2016) that may be purchased from time to time in the open market or private transactions depending on price, availability and the Company’s cash position. The Company did not purchase any shares of its common stock during 2016. 14. Defined Contribution Plan The Company has several 401(k) profit sharing plans covering all employees with three months of service. For certain plans, the Company makes matching contributions. The Company may also make discretionary contributions of up to 50% of employee contributions. The Company did not make any discretionary contributions for the years ended December 31, 2016, 2015 and 2014. The Company matching contributions totaled $1.1 million, $0.9 million and $0.7 million, respectively, for the years ended December 31, 2016, 2015 and 2014. 15. Commitments and Contingencies Operating Leases The Company has entered into operating leases for its executive offices and clinic facilities. In connection with these agreements, the Company incurred rent expense of $30.3 million, $28.3 million and $25.6 million for the years ended December 31, 2016, 2015 and 2014, respectively. Several of the leases provide for an annual increase in the rental payment based upon the Consumer Price Index. The majority of the leases provide for renewal periods ranging from one to five years. The agreements to extend the leases typically specify that rental rates would be adjusted to market rates as of each renewal date. The future minimum operating lease commitments for each of the next five years and thereafter and in the aggregate as of December 31, 2016 are as follows (in thousands): Employment Agreements At December 31, 2016, the Company had outstanding employment agreements with three of its executive officers. These agreements, which presently expire on December 31, 2017, provide for automatic two year renewals at the conclusion of each expiring term or renewal term. All of the agreements contain a provision for annual adjustment of salaries. In addition, the Company has outstanding employment agreements with most of the managing physical therapist partners of the Company’s physical therapy clinics and with certain other clinic employees which obligate subsidiaries of the Company to pay compensation of $23.2 million in 2017 and $14.8 million in the aggregate from 2018 through 2021. In addition, most of the employment agreements with the managing physical therapists provide for monthly bonus payments calculated as a percentage of each clinic’s net revenues (not in excess of operating profits) or operating profits. 16. Earnings Per Share The computations of basic and diluted earnings per share for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands, except per share data): 17. Selected Quarterly Financial Data (Unaudited) The following schedules present the impact of the correction related to mandatorily redeemable non-controlling interests on the Company’s previously reported quarterly balance sheets, income statements and cash flows included in its Quarterly Reports on Form 10-Q for the quarters ended March 31, June 30, September 30, 2016 and March 31, June 30 and September 30, 2015. In addition, the impact of the early adoption of the treatment of the excess tax benefits related to equity grants on the previously reported quarterly balance sheets and income statements included in its Quarterly Reports on Form 10-Q for the quarters ended March 31, June 30 and September 30, 2016 are included in the respective schedules. See Note 2. - Significant Accounting Policies - Recently Adopted Accounting Guidance. All schedules are in thousands, except share and per share data. Consolidated Balance Sheet as of September 30, 2016: Consolidated Balance Sheet as of June 30, 2016: Consolidated Balance Sheet as of March 31, 2016: Consolidated Balance Sheet as of September 30, 2015: Consolidated Balance Sheet as of June 30, 2015: Consolidated Balance Sheet as of March 31, 2015: Consolidated Statement of Net Income as of September 30, 2016: Consolidated Statement of Net Income as of June 30, 2016: Consolidated Statement of Net Income as of March 31, 2016: Consolidated Statement of Net Income as of September 30, 2015: Consolidated Statement of Net Income as of June 30, 2015: Consolidated Statement of Net Income as of March 31, 2015: Consolidated Statement of Cash Flows as of September 30, 2016: Consolidated Statement of Cash Flows as of June 30, 2016: Consolidated Statement of Cash Flows as of March 31, 2016: Consolidated Statement of Cash Flows as of September 30, 2015: Consolidated Statement of Cash Flows as of June 30, 2015: Consolidated Statement of Cash Flows as of March 31, 2015: | Based on the provided text, here's a summary of the financial statement:
Revenue:
- Approximately $81.8 from Medicare accounts
Expenses and Liabilities:
- Non-controlling interests are recorded in income statements and balance sheets
- Profit-sharing arrangements for Wholly-Owned Facilities are expensed as compensation
- Current liabilities include accrued expenses related to profit-sharing
Assets:
- Fixed assets are recorded at cost
- Depreciation calculated using straight-line method
- Useful life ranges:
- Furniture and equipment: 3-8 years
- Software: 3-7 years
- Leasehold improvements: 3-5 years
- Assets reviewed for impairment
- Disposable assets reported at lower of carrying amount or fair value
Goodwill:
- Represents excess amount paid over fair value of acquired business assets | Claude |
ACCOUNTING FIRM To the Board of Directors and Shareholders of CenterPoint Energy, Inc. Houston, Texas We have audited the accompanying consolidated balance sheets of CenterPoint Energy, Inc. and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related statements of consolidated income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of CenterPoint Energy, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2017 expressed an unqualified opinion on the Company’s internal control over financial reporting. /s/ DELOITTE & TOUCHE LLP Houston, Texas February 28, 2017 CENTERPOINT ENERGY, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED INCOME See CENTERPOINT ENERGY, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME See CENTERPOINT ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS See CENTERPOINT ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, cont. See CENTERPOINT ENERGY, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS See CENTERPOINT ENERGY, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS, cont. See CENTERPOINT ENERGY, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED SHAREHOLDERS’ EQUITY See CENTERPOINT ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Background CenterPoint Energy, Inc. is a public utility holding company. CenterPoint Energy’s operating subsidiaries own and operate electric transmission and distribution and natural gas distribution facilities, supply natural gas to commercial and industrial customers and electric and natural gas utilities and own interests in Enable as described below. CenterPoint Energy’s indirect, wholly-owned subsidiaries include: • Houston Electric, which engages in the electric transmission and distribution business in the Texas Gulf Coast area that includes the city of Houston; • CERC Corp., which owns and operates natural gas distribution systems in six states; and • CES, which obtains and offers competitive variable and fixed-price physical natural gas supplies and services primarily to commercial and industrial customers and electric and natural gas utilities in 31 states. As of December 31, 2016, CenterPoint Energy also owned an aggregate of 14,520,000 Series A Preferred Units in Enable, which owns, operates and develops natural gas and crude oil infrastructure assets, and CERC Corp. owned approximately 54.1% of the limited partner interests in Enable. For a description of CenterPoint Energy’s reportable business segments, see Note 18. (2) Summary of Significant Accounting Policies (a) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (b) Principles of Consolidation The accounts of CenterPoint Energy and its wholly-owned and majority owned subsidiaries are included in the consolidated financial statements. All intercompany transactions and balances are eliminated in consolidation. CenterPoint Energy generally uses the equity method of accounting for investments in entities in which CenterPoint Energy has an ownership interest between 20% and 50% and exercises significant influence. CenterPoint Energy also uses the equity method for investments in which it has ownership percentages greater than 50%, when it exercises significant influence, does not have control and is not considered the primary beneficiary, if applicable. In 2013, CenterPoint Energy, OGE and affiliates of ArcLight, formed Enable as a private limited partnership. CenterPoint Energy has the ability to significantly influence the operating and financial policies of, but not solely control, Enable and, accordingly, recorded an equity method investment, at the historical costs of net assets contributed. Under the equity method, CenterPoint Energy adjusts its investment in Enable each period for contributions made, distributions received, CenterPoint Energy’s share of Enable’s comprehensive income and amortization of basis differences, as appropriate. CenterPoint Energy evaluates its equity method investments for impairment when events or changes in circumstances indicate there is a loss in value of the investment that is other than a temporary decline. CenterPoint Energy’s investment in Enable is considered to be a VIE because the power to direct the activities that most significantly impact Enable’s economic performance does not reside with the holders of equity investment at risk. However, CenterPoint Energy is not considered the primary beneficiary of Enable since it does not have the power to direct the activities of Enable that are considered most significant to the economic performance of Enable. Other investments, excluding marketable securities, are carried at cost. As of December 31, 2016, CenterPoint Energy had VIEs consisting of the Bond Companies, which it consolidates. The consolidated VIEs are wholly-owned, bankruptcy remote special purpose entities that were formed specifically for the purpose of securitizing transition and system restoration related property. Creditors of CenterPoint Energy have no recourse to any assets or revenues of the Bond Companies. The bonds issued by these VIEs are payable only from and secured by transition and system restoration property and the bondholders have no recourse to the general credit of CenterPoint Energy. (c) Revenues CenterPoint Energy records revenue for electricity delivery and natural gas sales and services under the accrual method and these revenues are recognized upon delivery to customers. Electricity deliveries not billed by month-end are accrued based on actual AMS data, daily supply volumes and applicable rates. Natural gas sales not billed by month-end are accrued based upon estimated purchased gas volumes, estimated lost and unaccounted for gas and currently effective tariff rates. (d) Long-lived Assets and Intangibles CenterPoint Energy records property, plant and equipment at historical cost. CenterPoint Energy expenses repair and maintenance costs as incurred. CenterPoint Energy periodically evaluates long-lived assets, including property, plant and equipment, and specifically identifiable intangibles, when events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. The determination of whether an impairment has occurred is based on an estimate of undiscounted cash flows attributable to the assets compared to the carrying value of the assets. (e) Regulatory Assets and Liabilities CenterPoint Energy applies the guidance for accounting for regulated operations to the Electric Transmission & Distribution business segment and the Natural Gas Distribution business segment. CenterPoint Energy’s rate-regulated subsidiaries may collect revenues subject to refund pending final determination in rate proceedings. In connection with such revenues, estimated rate refund liabilities are recorded which reflect management’s current judgment of the ultimate outcomes of the proceedings. CenterPoint Energy had current regulatory assets of $70 million and $21 million as of December 31, 2016 and 2015, respectively, included in other current assets in its Consolidated Balance Sheets. CenterPoint Energy had current regulatory liabilities of $18 million and $57 million as of December 31, 2016 and 2015, respectively, included in other current liabilities in its Consolidated Balance Sheets. CenterPoint Energy’s rate-regulated businesses recognize removal costs as a component of depreciation expense in accordance with regulatory treatment. As of December 31, 2016 and 2015, these removal costs of $1,010 million and $980 million, respectively, are classified as regulatory liabilities in CenterPoint Energy’s Consolidated Balance Sheets. In addition, a portion of the amount of removal costs that relate to AROs has been reclassified from a regulatory liability to an asset retirement liability in accordance with accounting guidance for AROs. (f) Depreciation and Amortization Expense Depreciation and amortization is computed using the straight-line method based on economic lives or regulatory-mandated recovery periods. Amortization expense includes amortization of regulatory assets and other intangibles. (g) Capitalization of Interest and AFUDC Interest and AFUDC are capitalized as a component of projects under construction and are amortized over the assets’ estimated useful lives once the assets are placed in service. AFUDC represents the composite interest cost of borrowed funds and a reasonable return on the equity funds used for construction for subsidiaries that apply the guidance for accounting for regulated operations. Although AFUDC increases both utility plant and earnings, it is realized in cash when the assets are included in rates. During 2016, 2015 and 2014, CenterPoint Energy capitalized interest and AFUDC of $8 million, $10 million and $11 million, respectively. During 2016, 2015 and 2014, CenterPoint Energy recorded AFUDC equity of $7 million, $12 million and $14 million, respectively, which is included in Other Income in its Statements of Consolidated Income. (h) Income Taxes CenterPoint Energy uses the asset and liability method of accounting for deferred income taxes. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is established against deferred tax assets for which management believes realization is not considered to be more likely than not. CenterPoint Energy recognizes interest and penalties as a component of income tax expense. CenterPoint Energy reports the income tax provision associated with its interest in Enable in Income tax expense (benefit) in its Statements of Consolidated Income. (i) Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable are recorded at the invoiced amount and do not bear interest. It is the policy of management to review the outstanding accounts receivable monthly, as well as the bad debt write-offs experienced in the past, and establish an allowance for doubtful accounts. Account balances are charged off against the allowance when management determines it is probable the receivable will not be recovered. The provision for doubtful accounts in CenterPoint Energy’s Statements of Consolidated Income for 2016, 2015 and 2014 was $7 million, $19 million and $22 million, respectively. (j) Inventory Inventory consists principally of materials and supplies and natural gas. Materials and supplies are valued at the lower of average cost or market. Materials and supplies are recorded to inventory when purchased and subsequently charged to expense or capitalized to plant when installed. Natural gas inventories of CenterPoint Energy’s Energy Services business segment are valued at the lower of average cost or market. Natural gas inventories of CenterPoint Energy’s Natural Gas Distribution business segment are primarily valued at weighted average cost. During 2016, 2015 and 2014, CenterPoint Energy recorded $1 million, $4 million and $8 million, respectively, in write-downs of natural gas inventory to the lower of average cost or market. (k) Derivative Instruments CenterPoint Energy is exposed to various market risks. These risks arise from transactions entered into in the normal course of business. CenterPoint Energy utilizes derivative instruments such as physical forward contracts, swaps and options to mitigate the impact of changes in commodity prices, weather and interest rates on its operating results and cash flows. Such derivatives are recognized in CenterPoint Energy’s Consolidated Balance Sheets at their fair value unless CenterPoint Energy elects the normal purchase and sales exemption for qualified physical transactions. A derivative may be designated as a normal purchase or normal sale if the intent is to physically receive or deliver the product for use or sale in the normal course of business. CenterPoint Energy has a Risk Oversight Committee composed of corporate and business segment officers that oversees commodity price, weather and credit risk activities, including CenterPoint Energy’s marketing, risk management services and hedging activities. The committee’s duties are to establish CenterPoint Energy’s commodity risk policies, allocate board-approved commercial risk limits, approve the use of new products and commodities, monitor positions and ensure compliance with CenterPoint Energy’s risk management policies and procedures and limits established by CenterPoint Energy’s board of directors. CenterPoint Energy’s policies prohibit the use of leveraged financial instruments. A leveraged financial instrument, for this purpose, is a transaction involving a derivative whose financial impact will be based on an amount other than the notional amount or volume of the instrument. (l) Investments in Other Debt and Equity Securities CenterPoint Energy reports securities classified as trading at estimated fair value in its Consolidated Balance Sheets, and any unrealized holding gains and losses are recorded as other income (expense) in its Statements of Consolidated Income. (m) Environmental Costs CenterPoint Energy expenses or capitalizes environmental expenditures, as appropriate, depending on their future economic benefit. CenterPoint Energy expenses amounts that relate to an existing condition caused by past operations that do not have future economic benefit. CenterPoint Energy records undiscounted liabilities related to these future costs when environmental assessments and/or remediation activities are probable and the costs can be reasonably estimated. (n) Statements of Consolidated Cash Flows For purposes of reporting cash flows, CenterPoint Energy considers cash equivalents to be short-term, highly-liquid investments with maturities of three months or less from the date of purchase. In connection with the issuance of securitization bonds, CenterPoint Energy was required to establish restricted cash accounts to collateralize the bonds that were issued in these financing transactions. These restricted cash accounts are not available for withdrawal until the maturity of the bonds and are not included in cash and cash equivalents. These restricted cash accounts of $40 million and $35 million as of December 31, 2016 and 2015, respectively, are included in other current assets in CenterPoint Energy’s Consolidated Balance Sheets. Cash and cash equivalents included $340 million and $264 million as of December 31, 2016 and 2015, respectively, that was held by the Bond Companies solely to support servicing the securitization bonds. CenterPoint Energy considers distributions received from equity method investments which do not exceed cumulative equity in earnings subsequent to the date of investment to be a return on investment and classifies these distributions as operating activities in the Statements of Consolidated Cash Flows. CenterPoint Energy considers distributions received from equity method investments in excess of cumulative equity in earnings subsequent to the date of investment to be a return of investment and classifies these distributions as investing activities in the Statements of Consolidated Cash Flows. (o) New Accounting Pronouncements In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis (ASU 2015-02). ASU 2015-02 changes the analysis that reporting organizations must perform to evaluate whether they should consolidate certain legal entities, such as limited partnerships. The changes include, among others, modification of the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities and elimination of the presumption that a general partner should consolidate a limited partnership. ASU 2015-02 does not amend the related party guidance for situations in which power is shared between two or more entities that hold interests in a VIE. CenterPoint Energy adopted ASU 2015-02 on January 1, 2016, which did not have a material impact on its financial position, results of operations, cash flows and disclosures. In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Cost (ASU 2015-03). ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by ASU 2015-03. CenterPoint Energy adopted ASU 2015-03 retrospectively on January 1, 2016, which resulted in a reduction of other long-term assets, indexed debt and total long-term debt on its Consolidated Balance Sheets. CenterPoint Energy had debt issuance costs, excluding amounts related to credit facility arrangements, of $42 million and $44 million as a reduction to long-term debt on its Consolidated Balance Sheets as of December 31, 2016 and 2015, respectively. In May 2015, the FASB issued ASU No. 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (ASU 2015-07). ASU 2015-07 removes the requirement to categorize within the fair value hierarchy investments for which fair values are measured at NAV using the practical expedient. Entities will be required to disclose the fair value of investments measured using the NAV practical expedient so that financial statement users can reconcile amounts reported in the fair value hierarchy table to amounts reported on the balance sheet. CenterPoint Energy retrospectively adopted ASU 2015-07 on January 1, 2016, which impacts its employee benefit plan disclosures. See Note 7 for the impacts on the employee benefit plan disclosures. This standard did not have an impact on CenterPoint Energy’s financial position, results of operations or cash flows. In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments (ASU 2015-16). ASU 2015-16 eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, an acquirer would recognize a measurement-period adjustment during the period in which the amount of the adjustment is determined. CenterPoint Energy prospectively adopted ASU 2015-16 on January 1, 2016, which did not have an impact on its financial position, results of operations or cash flows. In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01). ASU 2016-01 requires equity investments that do not result in consolidation and are not accounted for under the equity method to be measured at fair value and to recognize any changes in fair value in net income unless the investments qualify for the new practicability exception. It does not change the guidance for classifying and measuring investments in debt securities and loans. ASU 2016-01 also changes certain disclosure requirements and other aspects related to recognition and measurement of financial assets and financial liabilities. ASU 2016-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. As of the first reporting period in which the guidance is adopted, a cumulative-effect adjustment to beginning retained earnings will be made, with two features that will be adopted prospectively. CenterPoint Energy is currently assessing the impact that this standard will have on its financial position, results of operations, cash flows and disclosures. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02). ASU 2016-02 provides a comprehensive new lease model that requires lessees to recognize assets and liabilities for most leases and would change certain aspects of lessor accounting. ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. A modified retrospective adoption approach is required. CenterPoint Energy is currently assessing the impact that this standard will have on its financial position, results of operations, cash flows and disclosures. In 2016, the FASB issued ASUs which amended ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09, as amended, provides a comprehensive new revenue recognition model that requires revenue to be recognized in a manner that depicts the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. Early adoption is not permitted, and entities have the option of using either a full retrospective or a modified retrospective adoption approach. CenterPoint Energy is currently evaluating its revenue streams under these ASUs and has not yet identified any significant changes as the result of these new standards. A substantial amount of CenterPoint Energy’s revenues are tariff based, which we do not anticipate will be significantly impacted by these ASUs. CenterPoint Energy is considering the impacts of the new guidance on its ability to recognize revenue for certain contracts when collectability is uncertain and its accounting for contributions in aid of construction. CenterPoint Energy expects to adopt these ASUs on January 1, 2018 and is evaluating the method of adoption. In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15). ASU 2016-15 provides clarifying guidance on the classification of certain cash receipts and payments in the statement of cash flows and eliminates the variation in practice related to such classifications. ASU 2016-15 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. A retrospective adoption approach is required. CenterPoint Energy is currently assessing the impact that this standard will have on its statement of cash flows. In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, restricted cash and restricted cash equivalents. As a result, the statement of cash flows will no longer present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents. When cash, cash equivalents, restricted cash and restricted cash equivalents are presented in more than one line item on the balance sheet, the new guidance requires a reconciliation of the totals in the statement of cash flows to the related captions in the balance sheet. ASU 2016-18 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. A retrospective adoption approach is required. CenterPoint Energy is currently assessing the impact that this standard will have on its statement of cash flows and disclosures. In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (ASU 2017-01). ASU 2017-01 revises the definition of a business. If substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, then under ASU 2017-01, the asset or group of assets is not a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs to be more closely aligned with how outputs are described in ASC 606. ASU 2017-01 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted in certain circumstances. A prospective adoption approach is required. ASU 2017-01 could have a potential impact on CenterPoint Energy’s accounting for future acquisitions. In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04). ASU 2017-04 eliminates Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. ASU 2017-04 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. A prospective adoption approach is required. ASU 2017-04 will have an impact on CenterPoint Energy’s future calculation of goodwill impairments if an impairment is identified. Management believes that other recently issued standards, which are not yet effective, will not have a material impact on CenterPoint Energy’s consolidated financial position, results of operations or cash flows upon adoption. (3) Property, Plant and Equipment (a) Property, Plant and Equipment Property, plant and equipment includes the following: (b) Depreciation and Amortization The following table presents depreciation and amortization expense for 2016, 2015 and 2014. (c) AROs A reconciliation of the changes in the ARO liability is as follows: CenterPoint Energy recorded AROs associated with the removal of asbestos and asbestos-containing material in its buildings, including substation building structures. CenterPoint Energy also recorded AROs relating to gas pipelines abandoned in place, treated wood poles for electric distribution, distribution transformers containing PCB (also known as Polychlorinated Biphenyl), and underground fuel storage tanks. The estimates of future liabilities were developed using historical information, and where available, quoted prices from outside contractors. The increase of $13 million in the ARO from the revision in estimates in 2015 is primarily attributable to an increase in estimated disposal costs. (4) Acquisition On April 1, 2016, CES, an indirect, wholly-owned subsidiary of CenterPoint Energy, closed the previously announced agreement to acquire the retail energy services business and natural gas wholesale assets of Continuum. After working capital adjustments, the final purchase price was $102 million and allocated to identifiable assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. The following table summarizes the final purchase price allocation and the fair value amounts recognized for the assets acquired and liabilities assumed related to the acquisition: The goodwill of $22 million resulting from the acquisition reflects the excess of the purchase price over the fair value of the net identifiable assets acquired. The goodwill recorded as part of the acquisition primarily reflects the value of the complementary operational and geographic footprints, along with the scale, geographic reach and expanded capabilities. Identifiable intangible assets were recorded at estimated fair value as determined by management based on available information, which includes a valuation prepared by an independent third party. The significant assumptions used in arriving at the estimated identifiable intangible asset values included management’s estimates of future cash flows, the discount rate which is based on the weighted average cost of capital for comparable publicly traded guideline companies and projected customer attrition rates. The useful lives for the identifiable intangible assets were determined using methods that approximate the pattern of economic benefit provided by the utilization of the assets. The estimated fair value of the identifiable intangible assets and related useful lives as included in the final purchase price allocation include: Amortization expense related to the above identifiable intangible assets was $3 million for the year ended December 31, 2016. Revenues of approximately $466 million and operating income of approximately $1 million attributable to the acquisition are included in CenterPoint Energy’s Statements of Consolidated Income for the year ended December 31, 2016. As Continuum was a non-public company that did not prepare interim financial information and the acquisition included the purchase of both businesses and assets, the historical financial information for the businesses and assets acquired was impracticable to obtain. As a result, pro forma results of the acquired businesses and assets are not presented. (5) Goodwill Goodwill by reportable business segment as of December 31, 2015 and changes in the carrying amount of goodwill as of December 31, 2016 are as follows: (1) See Note 4. (2) Amount presented is net of the accumulated goodwill impairment charge of $252 million. CenterPoint Energy performs goodwill impairment tests at least annually and evaluates goodwill when events or changes in circumstances indicate that its carrying value may not be recoverable. The impairment evaluation for goodwill is performed by using a two-step process. In the first step, the fair value of each reporting unit is compared with the carrying amount of the reporting unit, including goodwill. The estimated fair value of the reporting unit is generally determined on the basis of discounted cash flows. If the estimated fair value of the reporting unit is less than the carrying amount of the reporting unit, then a second step must be completed to determine the amount of the goodwill impairment that should be recorded. In the second step, the implied fair value of the reporting unit’s goodwill is determined by allocating the reporting unit’s fair value to all of its assets and liabilities other than goodwill (including any unrecognized intangible assets) in a manner similar to a purchase price allocation. The resulting implied fair value of the goodwill that results from the application of this second step is then compared to the carrying amount of the goodwill and an impairment charge is recorded for the difference. CenterPoint Energy performed its annual goodwill impairment test in the third quarter of each of 2016 and 2015 and determined, based on the results of the first step, that no goodwill impairment charge was required for any reportable segment. Other intangibles were not material as of December 31, 2016 and 2015. (6) Regulatory Accounting The following is a list of regulatory assets/liabilities reflected on CenterPoint Energy’s Consolidated Balance Sheets as of December 31, 2016 and 2015: (1) The unrecognized allowed equity return will be recognized as it is recovered in rates through 2024. During the years ended December 31, 2016, 2015 and 2014, Houston Electric recognized approximately $64 million, $49 million and $68 million, respectively, of the allowed equity return. The timing of CenterPoint Energy’s recognition of the allowed equity return will vary each period based on amounts actually collected during the period. The actual amounts recovered for the allowed equity return are reviewed and adjusted at least annually by the PUCT to correct any over-collections or under-collections during the preceding 12 months and to provide for the full and timely recovery of the allowed equity return. (2) NGD’s actuarially determined pension and other postemployment expense in excess of the amount being recovered through rates is being deferred for rate making purposes. Deferred pension and other postemployment expenses of $6 million and $5 million as of December 31, 2016 and 2015, respectively, were not earning a return. (3) Other regulatory assets that are not earning a return were not material as of December 31, 2016 and 2015. (7) Stock-Based Incentive Compensation Plans and Employee Benefit Plans (a) Stock-Based Incentive Compensation Plans CenterPoint Energy has LTIPs that provide for the issuance of stock-based incentives, including stock options, performance awards, restricted stock unit awards and restricted and unrestricted stock awards to officers, employees and non-employee directors. Approximately 14 million shares of CenterPoint Energy common stock are authorized under these plans for awards. Equity awards are granted to employees without cost to the participants. The performance awards granted in 2016, 2015 and 2014 are distributed based upon the achievement of certain objectives over a three-year performance cycle. The stock awards granted in 2016, 2015 and 2014 are service based. The stock awards generally vest at the end of a three-year period. Upon vesting, both the performance and stock awards are issued to the participants along with the value of dividend equivalents earned over the performance cycle or vesting period. CenterPoint Energy issues new shares to satisfy stock-based payments related to LTIPs. CenterPoint Energy recorded LTIP compensation expense of $19 million, $17 million and $18 million for the years ended December 31, 2016, 2015 and 2014, respectively. This expense is included in Operation and Maintenance Expense in the Statements of Consolidated Income. The total income tax benefit recognized related to LTIPs was $7 million, $6 million and $7 million for the years ended December 31, 2016, 2015 and 2014, respectively. No compensation cost related to LTIPs was capitalized as a part of inventory or fixed assets in 2016, 2015 or 2014. The actual tax benefit realized for tax deductions related to LTIPs totaled $5 million, $6 million and $13 million for 2016, 2015 and 2014, respectively. Compensation costs for the performance and stock awards granted under LTIPs are measured using fair value and expected achievement levels on the grant date. For performance awards with operational goals, the achievement levels are revised as goals are evaluated. The fair value of awards granted to employees is based on the closing stock price of CenterPoint Energy’s common stock on the grant date. The compensation expense is recorded on a straight-line basis over the vesting period. Forfeitures are estimated on the date of grant based on historical averages, and estimates are updated periodically throughout the vesting period. The following tables summarize CenterPoint Energy’s LTIP activity for 2016: Stock Options CenterPoint Energy has not issued stock options since 2004. There were no outstanding stock options at either December 31, 2016 or 2015. Cash received from stock options exercised was $1 million for 2014. Performance Awards The outstanding and non-vested shares displayed in the table above assumes that shares are issued at the maximum performance level. The aggregate intrinsic value reflects the impact of current expectations of achievement and stock price. Stock Awards The weighted-average grant-date fair values per unit of awards granted were as follows for 2016, 2015 and 2014: Valuation Data The total intrinsic value of awards received by participants was as follows for 2016, 2015 and 2014: The total grant date fair value of performance and stock awards which vested during the years ended December 31, 2016, 2015 and 2014 was $13 million, $13 million and $21 million, respectively. As of December 31, 2016, there was $21 million of total unrecognized compensation cost related to non-vested performance and stock awards which is expected to be recognized over a weighted-average period of 1.7 years. (b) Pension and Postretirement Benefits CenterPoint Energy maintains a non-contributory qualified defined benefit pension plan covering substantially all employees, with benefits determined using a cash balance formula. Under the cash balance formula, participants accumulate a retirement benefit based upon 5% of eligible earnings and accrued interest. Participants are 100% vested in their benefit after completing three years of service. In addition to the non-contributory qualified defined benefit pension plan, CenterPoint Energy maintains unfunded non-qualified benefit restoration plans which allow participants to receive the benefits to which they would have been entitled under CenterPoint Energy’s non-contributory pension plan except for federally mandated limits on qualified plan benefits or on the level of compensation on which qualified plan benefits may be calculated. CenterPoint Energy provides certain healthcare and life insurance benefits for retired employees on both a contributory and non-contributory basis. Employees become eligible for these benefits if they have met certain age and service requirements at retirement, as defined in the plans. Such benefit costs are accrued over the active service period of employees. The net unrecognized transition obligation is being amortized over approximately 20 years. Effective January 1, 2017, members of the IBEW Local Union 66 who retire on or after January 1, 2017, and their dependents, will receive any retiree medical and prescription drug benefits exclusively through the NECA/IBEW Family Medical Care Plan pursuant to the terms of the renegotiated collective bargaining agreement entered into in May 2016. CenterPoint Energy’s net periodic cost includes the following components relating to pension, including the benefit restoration plan, and postretirement benefits: (1) A curtailment gain or loss is required when the expected future services of a significant number of current employees are reduced or eliminated for the accrual of benefits. During the fourth quarter of 2014, CenterPoint Energy recognized a curtailment pension loss of $6 million related to employees seconded to Enable. Substantially all of the seconded employees became employees of Enable effective January 1, 2015. Also, postretirement healthcare benefits were amended during 2016 resulting in a net curtailment gain of $5 million. In May 2016, Houston Electric entered into a renegotiated collective bargaining agreement with the IBEW Local Union 66 that provides that for Houston Electric union employees covered under the agreement who retire on or after January 1, 2017, retiree medical and prescription drug coverage will be provided exclusively through the NECA/IBEW Family Medical Care Plan in exchange for the payment of monthly premiums as determined under the agreement. As a result, the accrued postretirement benefits related to such future Houston Electric union retirees were eliminated. Houston Electric recognized a curtailment gain of $3 million as an accelerated recognition of the prior service credit that would otherwise be recognized in future periods for the post-retirement plan. CenterPoint Energy also recognized an additional curtailment gain of $2 million in October 2016 related to other amendments in the post-retirement plan. As a result of these amendments, the 2016 post-retirement expense was significantly lower than expenses reported for previous years. (2) A one-time, non-cash settlement charge is required when lump sum distributions or other settlements of plan benefit obligations during a plan year exceed the service cost and interest cost components of net periodic cost for that year. Due to the amount of lump sum payment distributions from the non-qualified pension plan during the year ended December 31, 2015, CenterPoint Energy recognized a non-cash settlement charge of $10 million. This charge is an acceleration of costs that would otherwise be recognized in future periods. CenterPoint Energy used the following assumptions to determine net periodic cost relating to pension and postretirement benefits: In determining net periodic benefits cost, CenterPoint Energy uses fair value, as of the beginning of the year, as its basis for determining expected return on plan assets. The following table summarizes changes in the benefit obligation, plan assets, the amounts recognized in consolidated balance sheets and the key assumptions of CenterPoint Energy’s pension, including benefit restoration, and postretirement plans. The measurement dates for plan assets and obligations were December 31, 2016 and 2015. (1) The Postretirement plan was amended during 2016 to change retiree medical coverage, effective January 1, 2017, as follows: (i) members of the IBEW Local Union 66 who retire on or after January 1, 2017, and their dependents, will receive any retiree medical and prescription drug coverage exclusively through the NECA/IBEW Family Medical Care Plan pursuant to the terms of the renegotiated collective bargaining agreement entered into in May 2016; and (ii) Medicare eligible post-65 retirees will receive coverage through a Medicare Advantage Program, an insured benefit, in lieu of the previous self-insured benefit. These changes resulted in a reduction in our Postretirement Plan liability of $56 million as of December 31, 2016. (2) In May 2016, Houston Electric entered into a renegotiated collective bargaining agreement with the IBEW Local Union 66 and amended the Houston Electric Union Postretirement Trust. The amendment resulted in a split of the trust into two segregated and restricted accounts, one holds assets for the benefit of current, retired on or before December 31, 2016, union retirees and one holds assets for the benefit of post-2016 union retirees who are now covered exclusively by the NECA/IBEW Family Medical Care Plan. Accordingly, $20 million was transferred to the account for post-2016 union retirees. The accumulated benefit obligation for all defined benefit pension plans was $2,168 million and $2,157 million as of December 31, 2016 and 2015, respectively. The expected rate of return assumption was developed using the targeted asset allocation of CenterPoint Energy’s plans and the expected return for each asset class. The discount rate assumption was determined by matching the projected cash flows of CenterPoint Energy’s plans against a hypothetical yield curve of high-quality corporate bonds represented by a series of annualized individual discount rates from one-half to 99 years. For measurement purposes, medical costs are assumed to increase to 5.75% and 10.65% for the pre-65 and post-65 retirees during 2017, respectively, and the prescription cost is assumed to increase to 10.75% during 2017, after which these rates decrease until reaching the ultimate trend rate of 4.50% in 2024. CenterPoint Energy’s changes in accumulated comprehensive loss related to defined benefit, postretirement and other postemployment plans are as follows: (1) Total other comprehensive income (loss) related to the remeasurement of pension, postretirement and other postemployment plans. (2) These accumulated other comprehensive components are included in the computation of net periodic cost. Amounts recognized in accumulated other comprehensive loss consist of the following: The changes in plan assets and benefit obligations recognized in other comprehensive income during 2016 are as follows: The total expense recognized in net periodic costs and other comprehensive income was $95 million and $17 million for pension and postretirement benefits, respectively, for the year ended December 31, 2016. The amounts in accumulated other comprehensive loss expected to be recognized as components of net periodic benefit cost during 2017 are as follows: The following table displays pension benefits related to CenterPoint Energy’s pension plans that have accumulated benefit obligations in excess of plan assets: Assumed healthcare cost trend rates have a significant effect on the reported amounts for CenterPoint Energy’s postretirement benefit plans. A 1% change in the assumed healthcare cost trend rate would have the following effects: In managing the investments associated with the benefit plans, CenterPoint Energy’s objective is to achieve and maintain a fully funded plan. This objective is expected to be achieved through an investment strategy that manages liquidity requirements while maintaining a long-term horizon in making investment decisions and efficient and effective management of plan assets. As part of the investment strategy discussed above, CenterPoint Energy maintained the following weighted average allocation targets for its benefit plans as of December 31, 2016: The following tables set forth by level, within the fair value hierarchy (see Note 9), CenterPoint Energy’s pension plan assets at fair value as of December 31, 2016 and 2015: (1) 57% of the amount invested in mutual funds was in international equities, 28% was in emerging market equities and 15% was in U.S. equities. (2) This represents the common collective trust funds with 53% of the amount invested in fixed income securities, 12% in U.S. equities, 30% in international equities and 5% in emerging market equities. (1) 58% of the amount invested in mutual funds was in international equities, 28% was in emerging market equities and 14% was in U.S. equities. (2) This represents the common collective trust funds with 60% of the amount invested in fixed income securities, 11% in U.S. equities, 23% in international equities and 2% in emerging market equities. The pension plan utilized both exchange traded and over-the-counter financial instruments such as futures, interest rate options and swaps that were marked to market daily with the gains/losses settled in the cash accounts. The pension plan did not include any holdings of CenterPoint Energy common stock as of December 31, 2016 or 2015. The changes in the fair value of the pension plan’s level 3 investments for the years ended December 31, 2016 and 2015 were not material. The following tables present by level, within the fair value hierarchy, CenterPoint Energy’s postretirement plan assets at fair value as of December 31, 2016 and 2015, by asset category: (1) 74% of the amount invested in mutual funds was in fixed income securities, 18% was in U.S. equities and 8% was in international equities. (1) 72% of the amount invested in mutual funds was in fixed income securities, 20% was in U.S. equities and 8% was in international equities. CenterPoint Energy contributed $-0-, $9 million and $18 million to its qualified pension, non-qualified pension and postretirement benefits plans, respectively, in 2016. CenterPoint Energy expects to contribute approximately $39 million, $7 million and $16 million to its qualified pension, non-qualified pension and postretirement benefits plans, respectively, in 2017. The following benefit payments are expected to be paid by the pension and postretirement benefit plans: (c) Savings Plan CenterPoint Energy has a tax-qualified employee savings plan that includes a cash or deferred arrangement under Section 401(k) of the Internal Revenue Code of 1986, as amended (the Code), and an employee stock ownership plan under Section 4975(e)(7) of the Code. Under the plan, participating employees may contribute a portion of their compensation, on a pre-tax or after-tax basis, generally up to a maximum of 50% of eligible compensation. CenterPoint Energy matches 100% of the first 6% of each employee’s compensation contributed. The matching contributions are fully vested at all times. Participating employees may elect to invest all (prior to January 1, 2016) or a portion of their contributions to the plan in CenterPoint Energy, Inc. common stock, to have dividends reinvested in additional shares or to receive dividend payments in cash on any investment in CenterPoint Energy, Inc. common stock, and to transfer all or part of their investment in CenterPoint Energy, Inc. common stock to other investment options offered by the plan. Effective January 1, 2016, the savings plan was amended to limit the percentage of future contributions that could be invested in CenterPoint Energy, Inc. common stock to 25% and to prohibit transfers of account balances where the transfer would result in more than 25% of a participant’s total account balance invested in CenterPoint Energy, Inc. common stock. The savings plan has significant holdings of CenterPoint Energy, Inc. common stock. As of December 31, 2016, 14,216,986 shares of CenterPoint Energy, Inc. common stock were held by the savings plan, which represented approximately 17% of its investments. Given the concentration of the investments in CenterPoint Energy, Inc. common stock, the savings plan and its participants have market risk related to this investment. CenterPoint Energy’s savings plan benefit expenses were $38 million, $35 million and $39 million in 2016, 2015 and 2014, respectively. (d) Postemployment Benefits CenterPoint Energy provides postemployment benefits for certain former or inactive employees, their beneficiaries and covered dependents, after employment but before retirement (primarily healthcare and life insurance benefits for participants in the long-term disability plan). CenterPoint Energy recorded postemployment expenses of $5 million, $2 million and $3 million in 2016, 2015 and 2014, respectively. Included in Benefit Obligations in the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015 was $22 million and $23 million, respectively, relating to postemployment obligations. (e) Other Non-Qualified Plans CenterPoint Energy has non-qualified deferred compensation plans that provide benefits payable to directors, officers and certain key employees or their designated beneficiaries at specified future dates or upon termination, retirement or death. Benefit payments are made from the general assets of CenterPoint Energy. CenterPoint Energy recorded benefit expense relating to these plans of $3 million, $3 million and $5 million for the years in 2016, 2015 and 2014, respectively. Included in Benefit Obligations in the accompanying Consolidated Balance Sheets as of December 31, 2016 and 2015 was $47 million and $51 million, respectively, relating to deferred compensation plans. Included in Benefit Obligations in CenterPoint Energy’s Consolidated Balance Sheets as of December 31, 2016 and 2015 was $40 million and $32 million, respectively, relating to split-dollar life insurance arrangements. (f) Change in Control Agreements and Other Employee Matters CenterPoint Energy had change in control agreements with certain of its officers, which expired December 31, 2014. In lieu of these agreements, our Board of Directors approved a new change in control plan, which was effective January 1, 2015. The plan, like the expired agreements, generally provides, to the extent applicable, in the case of a change in control of CenterPoint Energy and termination of employment, for severance benefits of up to three times annual base salary plus bonus, and other benefits. Our officers, including our Executive Chairman, are participants under the plan. As of December 31, 2016, approximately 35% of CenterPoint Energy’s employees were covered by collective bargaining agreements. The collective bargaining agreement with the IBEW Local 66 and the two collective bargaining agreements with Professional Employees International Union Local 12, which collectively cover approximately 21% of CenterPoint Energy’s employees, expired in March and May of 2016, respectively. CenterPoint Energy successfully negotiated all three follow-on agreements in 2016. The new collective bargaining agreement with the IBEW Local 66 expires in May of 2020, and the two new collective bargaining agreements with Professional Employees International Union Local 12 expire in March and May of 2021, respectively. The collective bargaining agreements with Gas Workers Union, Local 340 and the IBEW, Local 949, covering approximately 8% of CenterPoint Energy’s employees, will expire in April and December of 2020, respectively. These two agreements were last negotiated in 2015. The two collective bargaining agreements with the United Steelworkers Union, Locals 13-227 and 13-1, which cover approximately 6% of CenterPoint Energy’s employees, are scheduled to expire in June and July of 2017, respectively. CenterPoint Energy believes it has good relationships with these bargaining units and expect to negotiate new agreements in 2017. (8) Derivative Instruments CenterPoint Energy is exposed to various market risks. These risks arise from transactions entered into in the normal course of business. CenterPoint Energy utilizes derivative instruments such as physical forward contracts, swaps and options to mitigate the impact of changes in commodity prices, weather and interest rates on its operating results and cash flows. (a) Non-Trading Activities Derivative Instruments. CenterPoint Energy enters into certain derivative instruments to mitigate the effects of commodity price movements. These financial instruments do not qualify or are not designated as cash flow or fair value hedges. Weather Hedges. CenterPoint Energy has weather normalization or other rate mechanisms that mitigate the impact of weather on NGD in Arkansas, Louisiana, Mississippi, Minnesota and Oklahoma. NGD and electric operations in Texas do not have such mechanisms, although fixed customer charges are historically higher in Texas for NGD compared to CenterPoint Energy’s other jurisdictions. As a result, fluctuations from normal weather may have a positive or negative effect on NGD’s results in Texas and on Houston Electric’s results in its service territory. CenterPoint Energy has historically entered into heating-degree day swaps for certain NGD jurisdictions to mitigate the effect of fluctuations from normal weather on its results of operations and cash flows for the winter heating season, which contained a bilateral dollar cap of $16 million in 2014-2015. However, NGD did not enter into heating-degree day swaps for the 2015-2016 winter season as a result of NGD’s Minnesota division implementing a full decoupling pilot in July 2015. CenterPoint Energy entered into weather hedges for the Houston Electric service territory, which contained bilateral dollar caps of $8 million, $7 million and $9 million for the 2014-2015, 2015-2016 and 2016-2017 winter seasons, respectively. The swaps are based on 10-year normal weather. During the years ended December 31, 2016, 2015 and 2014, CenterPoint Energy recognized a gain of $1 million, and losses of $6 million and $11 million, respectively, related to these swaps. Weather hedge gains and losses are included in revenues in the Statements of Consolidated Income. Hedging of Interest Expense for Future Debt Issuances. In April 2016, Houston Electric entered into forward interest rate agreements with several counterparties, having an aggregate notional amount of $150 million. These agreements were executed to hedge, in part, volatility in the 5-year U.S. treasury rate by reducing Houston Electric’s exposure to variability in cash flows related to interest payments of Houston Electric’s $300 million issuance of fixed rate debt in May 2016. These forward interest rate agreements were designated as cash flow hedges. The realized gains and losses associated with the agreements were immaterial. In June and July 2016, Houston Electric entered into forward interest rate agreements with several counterparties, having an aggregate notional amount of $300 million. These agreements were executed to hedge, in part, volatility in the 10-year U.S. treasury rate by reducing Houston Electric’s exposure to variability in cash flows related to interest payments of Houston Electric’s $300 million issuance of fixed rate debt in August 2016. These forward interest rate agreements were designated as cash flow hedges. Accordingly, the effective portion of realized gains associated with the agreements, which totaled $1.1 million, is a component of accumulated other comprehensive income and will be amortized over the life of the bonds. The ineffective portion of the gains and losses was recorded in income and was immaterial. In January 2017, Houston Electric entered into forward interest rate agreements with several counterparties, having an aggregate notional amount of $150 million. These agreements were executed to hedge, in part, volatility in the 10-year U.S. treasury rate by reducing Houston Electric’s exposure to variability in cash flows related to interest payments of Houston Electric’s $300 million issuance of fixed rate debt in January 2017. These forward interest rate agreements were designated as cash flow hedges. Accordingly, the effective portion of unrealized losses associated with the agreements, which totaled approximately $0.5 million, will be a component of accumulated other comprehensive income in 2017 and will be amortized over the life of the bonds. (b) Derivative Fair Values and Income Statement Impacts The following tables present information about CenterPoint Energy’s derivative instruments and hedging activities. The first four tables provide a balance sheet overview of CenterPoint Energy’s Derivative Assets and Liabilities as of December 31, 2016 and 2015, while the last table provides a breakdown of the related income statement impacts for the years ending December 31, 2016, 2015 and 2014. (1) The fair value shown for natural gas contracts is comprised of derivative gross volumes totaling 1,035 Bcf or a net 59 Bcf long position. Of the net long position, basis swaps constitute a net 126 Bcf long position. (2) Natural gas contracts are presented on a net basis in the Consolidated Balance Sheets as they are subject to master netting arrangements. This netting applies to all undisputed amounts due or past due and causes derivative assets (liabilities) to be ultimately presented net in a liability (asset) account within the Consolidated Balance Sheets. The net of total non-trading natural gas derivative assets and liabilities was a $24 million asset as shown on CenterPoint Energy’s Consolidated Balance Sheets (and as detailed in the table below), and was comprised of the natural gas contracts derivative assets and liabilities separately shown above, impacted by collateral netting of $14 million. (3) Derivative Assets and Derivative Liabilities include no material amounts related to physical forward transactions with Enable. (1) Gross amounts recognized include some derivative assets and liabilities that are not subject to master netting arrangements. (2) The derivative assets and liabilities on the Consolidated Balance Sheets exclude accounts receivable or accounts payable that, should they exist, could be used as offsets to these balances in the event of a default. (1) The fair value shown for natural gas contracts is comprised of derivative gross volumes totaling 767 Bcf or a net 112 Bcf long position. Of the net long position, basis swaps constitute 133 Bcf. (2) Natural gas contracts are presented on a net basis in the Consolidated Balance Sheets. Natural gas contracts are subject to master netting arrangements. This netting applies to all undisputed amounts due or past due and causes derivative assets (liabilities) to be ultimately presented net in a liability (asset) account within the Consolidated Balance Sheets. The net of total non-trading derivative assets and liabilities was a $109 million asset as shown on CenterPoint Energy’s Consolidated Balance Sheets (and as detailed in the table below), and was comprised of the natural gas contracts derivative assets and liabilities separately shown above, impacted by collateral netting of $56 million. (3) Derivative Assets and Derivative Liabilities include no material amounts related to physical forward transactions with Enable. (1) Gross amounts recognized include some derivative assets and liabilities that are not subject to master netting arrangements. (2) The derivative assets and liabilities on the Consolidated Balance Sheets exclude accounts receivable or accounts payable that, should they exist, could be used as offsets to these balances in the event of a default. Realized and unrealized gains and losses on natural gas derivatives are recognized in the Statements of Consolidated Income as revenue for retail sales derivative contracts and as natural gas expense for financial natural gas derivatives and non-retail related physical natural gas derivatives. Realized and unrealized gains and losses on indexed debt securities are recorded as Other Income (Expense) in the Statements of Consolidated Income. (c) Credit Risk Contingent Features CenterPoint Energy enters into financial derivative contracts containing material adverse change provisions. These provisions could require CenterPoint Energy to post additional collateral if the S&P or Moody’s credit ratings of CenterPoint Energy, Inc. or its subsidiaries are downgraded. The total fair value of the derivative instruments that contain credit risk contingent features that are in a net liability position as of December 31, 2016 and 2015 was $1 million and $3 million, respectively. CenterPoint Energy posted no assets as collateral towards derivative instruments that contain credit risk contingent features as of either December 31, 2016 or 2015. If all derivative contracts (in a net liability position) containing credit risk contingent features were triggered at December 31, 2016 and 2015, $-0- and $2 million, respectively, of additional assets would be required to be posted as collateral. (d) Credit Quality of Counterparties In addition to the risk associated with price movements, credit risk is also inherent in CenterPoint Energy’s non-trading derivative activities. Credit risk relates to the risk of loss resulting from non-performance of contractual obligations by a counterparty. The following table shows the composition of counterparties to the non-trading derivative assets of CenterPoint Energy as of December 31, 2016 and 2015: (1) “Investment grade” is primarily determined using publicly available credit ratings and considers credit support (including parent company guarantees) and collateral (including cash and standby letters of credit). For unrated counterparties, CenterPoint Energy determines a synthetic credit rating by performing financial statement analysis and considers contractual rights and restrictions and collateral. (2) End users are comprised primarily of customers who have contracted to fix the price of a portion of their physical gas requirements for future periods. (3) The net of total non-trading natural gas derivative assets was $70 million and $125 million as of December 31, 2016 and 2015, respectively, as shown on CenterPoint Energy’s Consolidated Balance Sheets, and was comprised of the natural gas contracts derivatives assets separately shown above, impacted by collateral netting of $14 million and $-0- as of December 31, 2016 and 2015, respectively. (9) Fair Value Measurements Assets and liabilities that are recorded at fair value in the Consolidated Balance Sheets are categorized based upon the level of judgment associated with the inputs used to measure their value. Hierarchical levels, as defined below and directly related to the amount of subjectivity associated with the inputs to fair valuations of these assets and liabilities, are as follows: Level 1: Inputs are unadjusted quoted prices in active markets for identical assets or liabilities at the measurement date. The types of assets carried at Level 1 fair value generally are exchange-traded derivatives and equity securities. Level 2: Inputs, other than quoted prices included in Level 1, are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar instruments in active markets, and inputs other than quoted prices that are observable for the asset or liability. Fair value assets and liabilities that are generally included in this category are derivatives with fair values based on inputs from actively quoted markets. A market approach is utilized to value CenterPoint Energy’s Level 2 assets or liabilities. Level 3: Inputs are unobservable for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Unobservable inputs reflect CenterPoint Energy’s judgments about the assumptions market participants would use in pricing the asset or liability since limited market data exists. CenterPoint Energy develops these inputs based on the best information available, including CenterPoint Energy’s own data. A market approach is utilized to value CenterPoint Energy’s Level 3 assets or liabilities. At December 31, 2016, CenterPoint Energy’s Level 3 assets and liabilities are comprised of physical forward contracts and options and its indexed debt securities derivative. Level 3 physical forward contracts are valued using a discounted cash flow model which includes illiquid forward price curve locations (ranging from $2.24 to $7.01 per MMBtu) as an unobservable input. Level 3 options are valued through Black-Scholes (including forward start) option models which include option volatilities (ranging from 0% to 86%) as an unobservable input. CenterPoint Energy’s Level 3 physical forward contracts and options derivative assets and liabilities consist of both long and short positions (forwards and options) and their fair value is sensitive to forward prices and volatilities. If forward prices decrease, CenterPoint Energy’s long forwards lose value whereas its short forwards gain in value. If volatility decreases, CenterPoint Energy’s long options lose value whereas its short options gain in value. CenterPoint Energy’s Level 3 indexed debt securities are valued using a Black-Scholes option model and a discounted cash flow model, which use option volatility (19%) and a projected dividend growth rate (8%) as unobservable inputs. An increase in either volatilities or projected dividends will increase the value of the indexed debt securities, and a decrease in either volatilities or projected dividends will decrease the value of the indexed debt securities. CenterPoint Energy determines the appropriate level for each financial asset and liability on a quarterly basis and recognizes transfers between levels at the end of the reporting period. For the year ended December 31, 2016, there were no transfers between Level 1 and 2. CenterPoint Energy also recognizes purchases of Level 3 financial assets and liabilities at their fair market value at the end of the reporting period. The following tables present information about CenterPoint Energy’s assets and liabilities (including derivatives that are presented net) measured at fair value on a recurring basis, and indicate the fair value hierarchy of the valuation techniques utilized by CenterPoint Energy to determine such fair value. (1) Amounts represent the impact of legally enforceable master netting arrangements that allow CenterPoint Energy to settle positive and negative positions and also include cash collateral of $14 million held by CES from the same counterparties. (2) Amounts are included in Prepaid and Other Current Assets and Other Assets in the Consolidated Balance Sheets. (3) Natural gas derivatives include no material amounts related to physical forward transactions with Enable. (1) Amounts represent the impact of legally enforceable master netting arrangements that allow CenterPoint Energy to settle positive and negative positions and also include cash collateral of $56 million posted with the same counterparties. (2) Amounts are included in Prepaid and Other Current Assets and Other Assets in the Consolidated Balance Sheets. (3) Natural gas derivatives include no material amounts related to physical forward transactions with Enable. The following table presents additional information about assets or liabilities, including derivatives that are measured at fair value on a recurring basis for which CenterPoint Energy has utilized Level 3 inputs to determine fair value: (1) During 2016, CenterPoint Energy transferred its indexed debt securities from Level 2 to Level 3 to reflect changes in the significance of the unobservable inputs used in the valuation. As of December 31, 2016, the indexed debt securities liability was $717 million. During 2016, there was a loss of $413 million on the indexed debt securities. (2) During 2016, 2015 and 2014, CenterPoint Energy did not have significant Level 3 sales. Items Measured at Fair Value on a Nonrecurring Basis In 2015, CenterPoint Energy determined that an other than temporary decrease in the value of its investment in Enable had occurred and, using multiple valuation methodologies under both the market and income approaches, recorded an impairment on its investment in Enable of $1,225 million. Key assumptions in the market approach included recent market transactions of comparable companies and EBITDA to total enterprise multiples for comparable companies. Due to volatility of the quoted price of Enable’s units at the valuation date, a volume weighted average price was used under the market approach to best approximate fair value at the measurement date. Key assumptions in the income approach included Enable’s forecasted cash distributions, projected cash flows of incentive distribution rights, forecasted growth rate of Enable’s cash distributions beyond 2020, and the discount rate used to determine the present value of the estimated future cash flows. A weighing of the different approaches was utilized to determine the estimated fair value of our investment in Enable. Based on the significant unobservable estimates and assumptions required, CenterPoint Energy concluded that the fair value estimate should be classified as a Level 3 measurement within the fair value hierarchy. See Note 10 for further discussion of the impairments. As of December 31, 2016, there were no significant assets or liabilities measured at fair value on a nonrecurring basis. Estimated Fair Value of Financial Instruments The fair values of cash and cash equivalents, investments in debt and equity securities classified as “trading” and short-term borrowings are estimated to be approximately equivalent to carrying amounts and have been excluded from the table below. The carrying amounts of non-trading derivative assets and liabilities and CenterPoint Energy’s ZENS indexed debt securities derivative are stated at fair value and are excluded from the table below. The fair value of each debt instrument is determined by multiplying the principal amount of each debt instrument by the market price. These assets and liabilities, which are not measured at fair value in the Consolidated Balance Sheets but for which the fair value is disclosed, would be classified as Level 1 or Level 2 in the fair value hierarchy. (10) Unconsolidated Affiliates CenterPoint Energy has the ability to significantly influence the operating and financial policies of Enable, a publicly traded MLP, and, accordingly, accounts for its investment in Enable’s common and subordinated units using the equity method of accounting. See Note 2 for information on the formation of Enable. CenterPoint Energy’s maximum exposure to loss related to Enable, a VIE in which CenterPoint Energy is not the primary beneficiary, is limited to its equity investment and Series A Preferred Unit investment as presented in the Consolidated Balance Sheet as of December 31, 2016 and outstanding current accounts receivable from Enable. On February 18, 2016, CenterPoint Energy purchased an aggregate of 14,520,000 Series A Preferred Units from Enable for a total purchase price of $363 million, which is accounted for as a cost method investment. In connection with the purchase, Enable redeemed $363 million of notes owed to a wholly-owned subsidiary of CERC Corp., which bore interest at an annual rate of 2.10% to 2.45%. Effective on the Formation Date, CenterPoint Energy and Enable entered into the Transition Agreements. Under the Services Agreement, CenterPoint Energy agreed to provide certain support services to Enable such as accounting, legal, risk management and treasury functions for an initial term, which ended on April 30, 2016. CenterPoint Energy is providing certain services to Enable on a year-to-year basis. Enable may terminate (i) the entire Services Agreement with at least 90 days’ notice prior to the end of any extension term, or (ii) either any service provided under the Services Agreement, or the entire Services Agreement, at any time upon approval by its board of directors and with at least 180 days’ notice. CenterPoint Energy provided seconded employees to Enable to support its operations for a term ending on December 31, 2014. Enable, at its discretion, had the right to select and offer employment to seconded employees from CenterPoint Energy. During the fourth quarter of 2014, Enable notified CenterPoint Energy that it selected seconded employees and provided employment offers to substantially all of the seconded employees from CenterPoint Energy. Substantially all of the seconded employees became employees of Enable effective January 1, 2015. In accordance with the Enable formation agreements, CenterPoint Energy had certain put rights, and Enable had certain call rights, exercisable with respect to the 25.05% interest in SESH retained by CenterPoint Energy. As of June 30, 2015, CenterPoint Energy’s remaining interest in SESH was transferred to Enable. Transactions with Enable: (1) Represents amounts billed under the Transition Agreements, including the costs of seconded employees. Actual transition services costs are recorded net of reimbursement. CenterPoint Energy evaluates its equity method investments for impairment when factors indicate that a decrease in the value of its investment has occurred and the carrying amount of its investment may not be recoverable. An impairment loss, based on the excess of the carrying value over estimated fair value of the investment, is recognized in earnings when an impairment is deemed to be other than temporary. Considerable judgment is used in determining if an impairment loss is other than temporary and the amount of any impairment. Based on the sustained low Enable common unit price and further declines in such price during the year ended December 31, 2015, as well as the market outlook for continued depressed crude oil and natural gas prices impacting the midstream oil and gas industry, CenterPoint Energy determined that an other than temporary decrease in the value of its equity method investment in Enable had occurred. CenterPoint Energy wrote down the value of its equity method investment in Enable to its estimated fair value which resulted in impairment charges of $1,225 million for the year ended December 31, 2015. Both the income approach and market approach were utilized to estimate the fair value of CenterPoint Energy’s total investment in Enable, which includes the limited partner common and subordinated units, general partner interest and incentive distribution rights held by CenterPoint Energy. The determination of fair value considered a number of relevant factors including Enable’s common unit price and forecasted results, recent comparable transactions and the limited float of Enable’s publicly traded common units. See Note 9 for further discussion of the determination of fair value of CenterPoint Energy’s equity method investment in Enable in 2015. As of December 31, 2016, the carrying value of CenterPoint Energy’s equity method investment in Enable was $10.71 per unit, which includes limited partner common and subordinated units, a general partner interest and incentive distribution rights. On December 31, 2016, Enable’s common unit price closed at $15.73. There was no impairment indicated in 2016. As there were no identified events or changes in circumstances that may have a significant adverse effect on the fair value of CenterPoint Energy’s cost method investment in Enable’s Series A Preferred Units as of December 31, 2016, and the investment’s fair value is not readily determinable, an estimate of the fair value of the cost method investment was not performed. Investment in Unconsolidated Affiliates: Equity in Earnings (Losses) of Unconsolidated Affiliates, net: (1) CenterPoint Energy contributed a 24.95% interest in SESH to Enable on May 30, 2014 and its remaining 0.1% interest in SESH to Enable on June 30, 2015. Limited Partner Interest in Enable: (1) In November 2016, Enable closed a public offering of 10,000,000 common units. In connection with the offering, Enable and an affiliate of ArcLight sold an additional combined 1,500,000 common units to the underwriters. Enable Common and Subordinated Units Held: Sales of more than 5% of the aggregate of the common units and subordinated units we own in Enable or sales by OGE of more than 5% of the aggregate of the common units and subordinated units it owns in Enable are subject to mutual rights of first offer and first refusal. Enable is controlled jointly by CERC Corp. and OGE, and each own 50% of the management rights in the general partner of Enable. Sale of our or OGE’s ownership interests in Enable’s general partner to a third party is subject to mutual rights of first offer and first refusal, and we are not permitted to dispose of less than all of our interest in Enable’s general partner. Summarized consolidated income (loss) information for Enable is as follows: (1) Equity in earnings of unconsolidated affiliates includes CenterPoint Energy’s share of Enable earnings adjusted for the amortization of the basis difference of CenterPoint Energy’s original investment in Enable and its underlying equity in net assets of Enable. The basis difference is being amortized over approximately 33 years, the average life of the assets to which the basis difference is attributed. (2) These amounts include impairment charges totaling $1,846 million composed of CenterPoint Energy’s impairment of its equity method investment in Enable of $1,225 million and CenterPoint Energy’s share, $621 million, of impairment charges Enable recorded for goodwill and long-lived assets for the year ended December 31, 2015. This impairment is offset by $213 million of earnings for the year ended December 31, 2015. Summarized consolidated balance sheet information for Enable is as follows: Distributions Received from Unconsolidated Affiliates: (1) Represents the period from February 18, 2016 to December 31, 2016. (2) CenterPoint Energy contributed a 24.95% interest in SESH to Enable on May 30, 2014 and its remaining 0.1% interest in SESH to Enable on June 30, 2015. As of December 31, 2016, CERC Corp. and OGE also own 40% and 60%, respectively, of the incentive distribution rights held by the general partner of Enable. Enable is expected to pay a minimum quarterly distribution of $0.2875 per unit on its outstanding units to the extent it has sufficient cash from operations after establishment of cash reserves and payment of fees and expenses, including payments to its general partner and its affiliates, within 60 days after the end of each quarter. If cash distributions to Enable’s unitholders exceed $0.330625 per unit in any quarter, the general partner will receive increasing percentages or incentive distributions rights, up to 50%, of the cash Enable distributes in excess of that amount. In certain circumstances the general partner of Enable will have the right to reset the minimum quarterly distribution and the target distribution levels at which the incentive distributions receive increasing percentages to higher levels based on Enable’s cash distributions at the time of the exercise of this reset election. To date, no incentive distributions have been made. (11) Indexed Debt Securities (ZENS) and Securities Related to ZENS (a) Investment in Securities Related to ZENS In 1995, CenterPoint Energy sold a cable television subsidiary to TW and received TW securities as partial consideration. A subsidiary of CenterPoint Energy now holds 7.1 million shares of TW Common, 0.9 million shares of Time Common and 0.9 million shares of Charter Common, which are classified as trading securities and are expected to be held to facilitate CenterPoint Energy’s ability to meet its obligation under the ZENS. Unrealized gains and losses resulting from changes in the market value of the TW Securities are recorded in CenterPoint Energy’s Statements of Consolidated Income. (b) ZENS In September 1999, CenterPoint Energy issued ZENS having an original principal amount of $1 billion of which $828 million remain outstanding at December 31, 2016. Each ZENS was originally exchangeable at the holder’s option at any time for an amount of cash equal to 95% of the market value of the reference shares of TW Common attributable to such note. The number and identity of the reference shares attributable to each ZENS are adjusted for certain corporate events. Prior to the closing of the transactions discussed below, the reference shares for each ZENS consisted of 0.5 share of TW Common, 0.125505 share of TWC Common and 0.0625 share of Time Common. On May 26, 2015, Charter announced that it had entered into a definitive merger agreement with TWC. On September 21, 2015, Charter shareholders approved the announced transaction with TWC. Pursuant to the merger agreement, upon closing of the merger, TWC Common would be exchanged for cash and Charter Common and as a result, reference shares for the ZENS would consist of Charter Common, TW Common and Time Common. The merger closed on May 18, 2016. CenterPoint Energy received $100 and 0.4891 shares of Charter Common for each share of TWC Common held, resulting in cash proceeds of $178 million and 872,531 shares of Charter Common. In accordance with the terms of the ZENS, CenterPoint Energy remitted $178 million to ZENS holders in June 2016, which reduced contingent principal. As a result, CenterPoint Energy recorded the following: As of December 31, 2016, the reference shares for each ZENS consisted of 0.5 share of TW Common, 0.0625 share of Time Common and 0.061382 share of Charter Common. On October 22, 2016, AT&T announced that it had entered into a definitive agreement to acquire TW in a stock and cash transaction. Pursuant to the agreement, TW Common would be exchanged for cash and AT&T Common, and as a result, reference shares would consist of Charter Common, Time Common and AT&T Common. AT&T announced that the merger is expected to close by the end of 2017. CenterPoint Energy pays interest on the ZENS at an annual rate of 2% plus the amount of any quarterly cash dividends paid in respect of the reference shares attributable to the ZENS. The principal amount of ZENS is subject to being increased or decreased to the extent that the annual yield from interest and cash dividends on the reference shares is less than or more than 2.309%. The adjusted principal amount is defined in the ZENS instrument as “contingent principal.” At December 31, 2016, ZENS having an original principal amount of $828 million and a contingent principal amount of $514 million were outstanding and were exchangeable, at the option of the holders, for cash equal to 95% of the market value of reference shares deemed to be attributable to the ZENS. As of December 31, 2016, the market value of such shares was approximately $953 million, which would provide an exchange amount of $1,094 for each $1,000 original principal amount of ZENS. At maturity of the ZENS in 2029, CenterPoint Energy will be obligated to pay in cash the higher of the contingent principal amount of the ZENS or an amount based on the then-current market value of the reference shares, which will include any additional publicly-traded securities distributed with respect to the current reference shares prior to maturity. The ZENS obligation is bifurcated into a debt component and a derivative component (the holder’s option to receive the appreciated value of the reference shares at maturity). The bifurcated debt component accretes through interest charges at 19.5% annually up to the contingent principal amount of the ZENS in 2029. Such accretion will be reduced by annual cash interest payments, as described above. The derivative component is recorded at fair value and changes in the fair value of the derivative component are recorded in CenterPoint Energy’s Statements of Consolidated Income. Changes in the fair value of the TW Securities held by CenterPoint Energy are expected to substantially offset changes in the fair value of the derivative component of the ZENS. The following table sets forth summarized financial information regarding CenterPoint Energy’s investment in TW Securities and each component of CenterPoint Energy’s ZENS obligation. (1) To reflect adoption of ASU 2015-03, balances have been restated to include unamortized debt issuance costs of $9 million, $10 million and $11 million as of December 31, 2015, 2014 and 2013, respectively. (12) Equity Dividends Declared CenterPoint Energy declared dividends per share of $1.03, $0.99 and $0.95, respectively, during the years ended December 31, 2016, 2015 and 2014. Undistributed Retained Earnings As of both December 31, 2016 and 2015, CenterPoint Energy’s consolidated retained earnings balance includes undistributed earnings from Enable of $-0-. (13) Short-term Borrowings and Long-term Debt (1) Includes amounts due or exchangeable within one year of the date noted. (2) Includes $35 million of unamortized debt issuance costs to reflect adoption of ASU 2015-03. (3) NGD currently has AMAs associated with its utility distribution service in Arkansas, north Louisiana and Oklahoma that extend through 2020. Pursuant to the provisions of the agreements, NGD sells natural gas and agrees to repurchase an equivalent amount of natural gas during the winter heating seasons at the same cost, plus a financing charge. These transactions are accounted for as an inventory financing. (4) CenterPoint Energy’s ZENS obligation is bifurcated into a debt component and an embedded derivative component. For additional information regarding ZENS, see Note 11(b). As ZENS are exchangeable for cash at any time at the option of the holders, these notes are classified as a current portion of long-term debt. (5) $118 million of these series of debt were secured by general mortgage bonds of Houston Electric as of both December 31, 2016 and 2015. (6) Classified as long-term debt because the termination date of the facility that backstops the commercial paper is more than one year from the date noted. Long-term Debt Debt Retirements. In May 2016, CERC retired approximately $325 million aggregate principal amount of its 6.15% senior notes at their maturity. The retirement of senior notes was financed by the issuance of commercial paper. In December, 2016, CenterPoint Energy redeemed $300 million aggregate principal amount of its outstanding 6.50% senior notes due 2018 at a redemption price equal to 100% of the principal amount thereof, plus accrued and unpaid interest thereon to but excluding the redemption date, plus the make-whole premium. The make-whole premium associated with the redemption was approximately $22 million and was included in Other Income, net on the Statements of Consolidated Income. In December 2016, Houston Electric retired $56 million of collateralized pollution control bonds that had been held for remarketing. These bonds were not reflected on our consolidated financial statements because Houston Electric was both the obligor on the bonds and the current owner of the bonds. Debt Issuances. Houston Electric issued the following general mortgage bonds during 2016 and as of February 10, 2017 in 2017. The proceeds from the issuance of these bonds were used to repay short-term debt and for general corporate purposes. Securitization Bonds. As of December 31, 2016, Houston Electric had special purpose subsidiaries consisting of the Bond Companies, which it consolidates. The consolidated special purpose subsidiaries are wholly-owned, bankruptcy remote entities that were formed solely for the purpose of purchasing and owning transition or system restoration property through the issuance of transition bonds or system restoration bonds and activities incidental thereto. These Securitization Bonds are payable only through the imposition and collection of “transition” or “system restoration” charges, as defined in the Texas Public Utility Regulatory Act, which are irrevocable, non-bypassable charges to provide recovery of authorized qualified costs. Houston Electric has no payment obligations in respect of the Securitization Bonds other than to remit the applicable transition or system restoration charges it collects. Each special purpose entity is the sole owner of the right to impose, collect and receive the applicable transition or system restoration charges securing the bonds issued by that entity. Creditors of CenterPoint Energy or Houston Electric have no recourse to any assets or revenues of the Bond Companies (including the transition and system restoration charges), and the holders of Securitization Bonds have no recourse to the assets or revenues of CenterPoint Energy or Houston Electric. Credit Facilities. (1) Weighted average interest rate was approximately 1.04% and 0.79% as of December 31, 2016 and December 31, 2015, respectively. (2) Weighted average interest rate was approximately 1.64% as of December 31, 2015. (3) Weighted average interest rate was approximately 1.03% and 0.81% as of December 31, 2016 and December 31, 2015, respectively. (1) Based on current credit ratings. (2) As defined in the revolving credit facility agreement, excluding Securitization Bonds. (3) The financial covenant limit will temporarily increase from 65% to 70% if Houston Electric experiences damage from a natural disaster in its service territory and CenterPoint Energy certifies to the administrative agent that Houston Electric has incurred system restoration costs reasonably likely to exceed $100 million in a consecutive twelve-month period, all or part of which Houston Electric intends to seek to recover through securitization financing. Such temporary increase in the financial covenant would be in effect from the date CenterPoint Energy delivers its certification until the earliest to occur of (i) the completion of the securitization financing, (ii) the first anniversary of CenterPoint Energy’s certification or (iii) the revocation of such certification. CenterPoint Energy, Houston Electric and CERC Corp. were in compliance with all financial debt covenants as of December 31, 2016. Maturities. Maturities of long-term debt, capital leases and sinking fund requirements, excluding the ZENS obligation, are as follows: (1)These maturities include Securitization Bonds principal repayments on scheduled payment dates. Liens. As of December 31, 2016, Houston Electric’s assets were subject to liens securing approximately $102 million of first mortgage bonds. Sinking or improvement fund and replacement fund requirements on the first mortgage bonds may be satisfied by certification of property additions. Sinking fund and replacement fund requirements for 2016, 2015 and 2014 have been satisfied by certification of property additions. The replacement fund requirement to be satisfied in 2017 is approximately $240 million, and the sinking fund requirement to be satisfied in 2017 is approximately $1.6 million. CenterPoint Energy expects Houston Electric to meet these 2017 obligations by certification of property additions. As of December 31, 2016, Houston Electric’s assets were also subject to liens securing approximately $2.6 billion of general mortgage bonds, which are junior to the liens of the first mortgage bonds. (14) Income Taxes The components of CenterPoint Energy’s income tax expense (benefit) were as follows: A reconciliation of income tax expense (benefit) using the federal statutory income tax rate to the actual income tax expense and resulting effective income tax rate is as follows: In 2016, CenterPoint Energy recognized a $6 million deferred tax expense due to Louisiana state law change and recorded an additional $3 million valuation allowance on certain state carryforwards. In 2015, CenterPoint Energy’s effective tax rate was higher than the statutory rate primarily due to lower earnings from the impairment of CenterPoint Energy’s equity method investment in Enable. The impairment loss reduced the deferred tax liability on CenterPoint Energy’s equity method investment in Enable. In 2014, CenterPoint Energy recognized a $29 million deferred income tax benefit upon completion of its tax basis balance sheet review. The adjustment resulted in a decrease to deferred tax liabilities of $32 million, a decrease to income taxes payable of $5 million and a decrease to income tax regulatory assets of $8 million. CenterPoint Energy determined the impact of the $29 million adjustment was not material to any prior period or the year ended December 31, 2014. The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities were as follows: Tax Attribute Carryforwards and Valuation Allowance. CenterPoint Energy has no remaining federal net operating loss carryforward or federal tax credits as of December 31, 2016. CenterPoint Energy has $962 million of state net operating loss carryforwards that expire between 2017 and 2036, $11 million of state tax credits that do not expire and $244 million of state capital loss carryforwards that expire in 2017. CenterPoint Energy reported a tax-effected valuation allowance of $5 million because it is more likely than not that the benefit from certain state carryforwards will not be realized. Uncertain Income Tax Positions. CenterPoint Energy reported no uncertain tax liability as of December 31, 2016, 2015 and 2014. We expect no significant change to the uncertain tax liability over the next twelve months ending December 31, 2017. Tax Audits and Settlements. Tax years through 2014 have been audited and settled with the IRS. For the 2015, 2016 and 2017 tax years, CenterPoint Energy is a participant in the IRS’s Compliance Assurance Process. (15) Commitments and Contingencies (a) Natural Gas Supply Commitments Natural gas supply commitments include natural gas contracts related to CenterPoint Energy’s Natural Gas Distribution and Energy Services business segments, which have various quantity requirements and durations, that are not classified as non-trading derivative assets and liabilities in CenterPoint Energy’s Consolidated Balance Sheets as of December 31, 2016 and 2015 as these contracts meet an exception as “normal purchases contracts” or do not meet the definition of a derivative. Natural gas supply commitments also include natural gas transportation contracts that do not meet the definition of a derivative. As of December 31, 2016, minimum payment obligations for natural gas supply commitments are approximately: (b) AMAs NGD has had AMAs associated with its utility distribution service in Arkansas, Louisiana, Mississippi, Oklahoma and Texas. Generally, AMAs are contracts between NGD and an asset manager that are intended to transfer the working capital obligation and maximize the utilization of the assets. In these AMAs, NGD agrees to release transportation and storage capacity to other parties to manage natural gas storage, supply and delivery arrangements for NGD and to use the released capacity for other purposes when it is not needed for NGD. NGD is compensated by the asset manager through payments made over the life of the AMAs based in part on the results of the asset optimization. NGD has an obligation to purchase its winter storage requirements that have been released to the asset manager under these AMAs. NGD has received approval from the state regulatory commissions in Arkansas, Louisiana, Mississippi and Oklahoma to retain a share of the AMA proceeds. NGD currently has AMAs in Arkansas, north Louisiana and Oklahoma that extend through 2020. (c) Lease Commitments The following table sets forth information concerning CenterPoint Energy’s obligations under non-cancelable long-term operating leases as of December 31, 2016, which primarily consist of rental agreements for building space, data processing equipment, compression equipment and rights-of-way: Total lease expense for all operating leases was $10 million, $9 million and $11 million during 2016, 2015 and 2014, respectively. (d) Legal, Environmental and Other Matters Legal Matters Gas Market Manipulation Cases. CenterPoint Energy, Houston Electric or their predecessor, Reliant Energy, and certain of their former subsidiaries have been named as defendants in certain lawsuits described below. Under a master separation agreement between CenterPoint Energy and a former subsidiary, RRI, CenterPoint Energy and its subsidiaries are entitled to be indemnified by RRI and its successors for any losses, including certain attorneys’ fees and other costs, arising out of these lawsuits. In May 2009, RRI sold its Texas retail business to a subsidiary of NRG and RRI changed its name to RRI Energy, Inc. In December 2010, Mirant Corporation merged with and became a wholly-owned subsidiary of RRI, and RRI changed its name to GenOn. In December 2012, NRG acquired GenOn through a merger in which GenOn became a wholly-owned subsidiary of NRG. None of the sale of the retail business, the merger with Mirant Corporation, or the acquisition of GenOn by NRG alters RRI’s (now GenOn’s) contractual obligations to indemnify CenterPoint Energy and its subsidiaries, including Houston Electric, for certain liabilities, including their indemnification obligations regarding the gas market manipulation litigation. A large number of lawsuits were filed against numerous gas market participants in a number of federal and western state courts in connection with the operation of the natural gas markets in 2000-2002. CenterPoint Energy and its affiliates have since been released or dismissed from all such cases. CES, a subsidiary of CERC Corp., was a defendant in a case now pending in federal court in Nevada alleging a conspiracy to inflate Wisconsin natural gas prices in 2000-2002. On May 24, 2016, the district court granted CES’s motion for summary judgment, dismissing CES from the case. The plaintiffs have appealed that ruling. CenterPoint Energy and CES intend to continue vigorously defending against the plaintiffs’ claims. CenterPoint Energy does not expect the ultimate outcome of this matter to have a material adverse effect on its financial condition, results of operations or cash flows. Environmental Matters MGP Sites. CERC and its predecessors operated MGPs in the past. With respect to certain Minnesota MGP sites, CERC has completed state-ordered remediation and continues state-ordered monitoring and water treatment. As of December 31, 2016, CERC had a recorded liability of $7 million for continued monitoring and any future remediation required by regulators in Minnesota. The estimated range of possible remediation costs for the sites for which CERC believes it may have responsibility was $5 million to $30 million based on remediation continuing for 30 to 50 years. The cost estimates are based on studies of a site or industry average costs for remediation of sites of similar size. The actual remediation costs will depend on the number of sites to be remediated, the participation of other PRPs, if any, and the remediation methods used. In addition to the Minnesota sites, the EPA and other regulators have investigated MGP sites that were owned or operated by CERC or may have been owned by one of its former affiliates. CenterPoint Energy does not expect the ultimate outcome of these matters to have a material adverse effect on the financial condition, results of operations or cash flows of either CenterPoint Energy or CERC. Asbestos. Some facilities owned by CenterPoint Energy or its predecessors contain or have contained asbestos insulation and other asbestos-containing materials. CenterPoint Energy and its subsidiaries are from time to time named, along with numerous others, as defendants in lawsuits filed by a number of individuals who claim injury due to exposure to asbestos, and CenterPoint Energy anticipates that additional claims may be asserted in the future. Although their ultimate outcome cannot be predicted at this time, CenterPoint Energy does not expect these matters, either individually or in the aggregate, to have a material adverse effect on CenterPoint Energy’s financial condition, results of operations or cash flows. Other Environmental. From time to time CenterPoint Energy identifies the presence of environmental contaminants during its operations or on property where its predecessor companies have conducted operations. Other such sites involving contaminants may be identified in the future. CenterPoint Energy has and expects to continue to remediate identified sites consistent with its legal obligations. From time to time CenterPoint Energy has received notices from regulatory authorities or others regarding its status as a PRP in connection with sites found to require remediation due to the presence of environmental contaminants. In addition, CenterPoint Energy has been named from time to time as a defendant in litigation related to such sites. Although the ultimate outcome of such matters cannot be predicted at this time, CenterPoint Energy does not expect these matters, either individually or in the aggregate, to have a material adverse effect on CenterPoint Energy’s financial condition, results of operations or cash flows. Other Proceedings CenterPoint Energy is involved in other legal, environmental, tax and regulatory proceedings before various courts, regulatory commissions and governmental agencies regarding matters arising in the ordinary course of business. From time to time, CenterPoint Energy is also a defendant in legal proceedings with respect to claims brought by various plaintiffs against broad groups of participants in the energy industry. Some of these proceedings involve substantial amounts. CenterPoint Energy regularly analyzes current information and, as necessary, provides accruals for probable and reasonably estimable liabilities on the eventual disposition of these matters. CenterPoint Energy does not expect the disposition of these matters to have a material adverse effect on CenterPoint Energy’s financial condition, results of operations or cash flows. (16) Earnings Per Share The following table reconciles numerators and denominators of CenterPoint Energy’s basic and diluted earnings (loss) per share calculations: (1) 2,349,000 incremental shares from assumed conversions of restricted stock have not been included in the computation of diluted earnings (loss) per share for the year ended December 31, 2015, as their inclusion would be anti-dilutive. (17) Unaudited Quarterly Information Summarized quarterly financial data is as follows: (1) Quarterly earnings (loss) per common share are based on the weighted average number of shares outstanding during the quarter, and the sum of the quarters may not equal annual earnings (loss) per common share. (2) CenterPoint Energy recognized $862 million ($537 million after tax) in impairment charges related to Enable during the three months ended September 30, 2015. (3) CenterPoint Energy recognized $984 million ($620 million after tax) in impairment charges related to Enable during the three months ended December 31, 2015. (18) Reportable Business Segments CenterPoint Energy’s determination of reportable business segments considers the strategic operating units under which CenterPoint Energy manages sales, allocates resources and assesses performance of various products and services to wholesale or retail customers in differing regulatory environments. CenterPoint Energy uses operating income as the measure of profit or loss for its business segments other than Midstream Investments, where it uses equity in earnings. CenterPoint Energy’s reportable business segments include the following: Electric Transmission & Distribution, Natural Gas Distribution, Energy Services, Midstream Investments and Other Operations. The electric transmission and distribution function (Houston Electric) is reported in the Electric Transmission & Distribution business segment. Natural Gas Distribution consists of intrastate natural gas sales to, and natural gas transportation and distribution for, residential, commercial, industrial and institutional customers. Energy Services represents CenterPoint Energy’s non-rate regulated gas sales and services operations. Midstream Investments consists of CenterPoint Energy’s equity investment in Enable. Other Operations consists primarily of other corporate operations which support all of CenterPoint Energy’s business operations. Long-lived assets include net property, plant and equipment, goodwill and other intangibles and equity investments in unconsolidated subsidiaries. Intersegment sales are eliminated in consolidation. Financial data for business segments and products and services are as follows: (1) Amounts for 2015 and 2014 have been restated to reflect the adoption of ASU 2015-03. (2) Houston Electric’s transmission and distribution revenues from major customers are as follows: (3) Midstream Investments’ equity earnings (losses) are as follows: (a) These amounts include impairment charges totaling $1,846 million composed of CenterPoint Energy’s impairment of its equity method investment in Enable of $1,225 million and CenterPoint Energy’s share, $621 million, of impairment charges Enable recorded for goodwill and long-lived assets for the year ended December 31, 2015. This impairment is offset by $213 million of earnings for the year ended December 31, 2015. (4) Included in total assets of Other Operations as of December 31, 2016, 2015 and 2014, are pension and other postemployment related regulatory assets of $759 million, $814 million and $795 million, respectively. (19) Subsequent Events On January 5, 2017, CenterPoint Energy’s board of directors declared a regular quarterly cash dividend of $0.2675 per share of common stock payable on March 10, 2017, to shareholders of record as of the close of business on February 16, 2017. On January 3, 2017, CES, an indirect, wholly-owned subsidiary of CenterPoint Energy, closed the previously announced agreement to acquire AEM for approximately $140 million, including estimated working capital of $100 million. With the addition of this business, CES now operates in a total of 33 states, including seven states where CES previously had no commercial or industrial natural gas sales customers though CES did have other operations in five of those states. CES has begun to integrate AEM into its existing business. Due to the limited amount of time since the acquisition, the initial accounting for the acquisition is incomplete, principally with regard to the valuation of derivatives, property, plant and equipment, intangible assets and goodwill. CenterPoint Energy intends to provide additional business combination disclosures, if material, in its Form 10-Q for the first quarter of 2017. On February 10, 2017, Enable declared a quarterly cash distribution of $0.318 per unit on all of its outstanding common and subordinated units for the quarter ended December 31, 2016. Accordingly, CERC Corp. expects to receive a cash distribution of approximately $74 million from Enable in the first quarter of 2017 to be made with respect to CERC Corp.’s limited partner interest in Enable for the fourth quarter of 2016. On February 10, 2017, Enable declared a quarterly cash distribution of $0.625 per Series A Preferred Unit for the quarter ended December 31, 2016. Accordingly, CenterPoint Energy expects to receive a cash distribution of approximately $9 million from Enable in the first quarter of 2017 to be made with respect to CenterPoint Energy’s investment in Series A Preferred Units of Enable for the fourth quarter of 2016. | Based on the provided text, here's a summary of the financial statement:
Financial Statement Summary:
1. Investments:
- CenterPoint Energy has an investment in Enable, considered a Variable Interest Entity (VIE)
- CenterPoint is not the primary beneficiary of Enable
- Other investments are carried at cost
2. Consolidation:
- Includes accounts of wholly-owned and majority-owned subsidiaries
- Intercompany transactions and balances are eliminated
- Uses equity method of accounting for investments with 20%+ ownership
3. Assets and Liabilities:
- Current regulatory liabilities were noted (specific amount partially cut off)
- Rate-regulated businesses recognize removal costs as part of depreciation expense
4. Accounting Approach:
- Uses estimates in financial reporting
- Acknowledges that actual results may differ from estimated figures
Note: The summary is based on the fragmented text provided, which | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Board of Directors and Stockholders of USA Equities Corp. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheet of USA Equities Corp. and subsidiary (the “Company”) as of December 31, 2016, the related consolidated statements of operations, stockholders’ deficit, and cash flows for the year then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2016, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion. Consideration of the Company’s Ability to Continue as a Going Concern The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has incurred losses, has negative operational cash flows and has no revenues, which raises substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustment that might result from the outcome of this uncertainty. /s/ TN CPA, PC Houston, Texas August 6, 2018 We have served as the Company’s auditor since 2018. Report of Independent Registered Public Accounting Firm To the Board of Directors USA Equities Corp. We have audited the accompanying consolidated balance sheet of USA Equities Corp. (the Company) as of December 31, 2015, and the related consolidated statements of operations, shareholders’ deficit and cash flows for the year ended December 31, 2015. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal controls over financial reporting. Our audits included consideration of internal controls over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal controls over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of USA Equities Corp. as of December 31, 2015 and the consolidated results of its operations and its cash flows for the year ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note 2 of the consolidated financial statements, the Company has incurred losses, has negative operational cash flows and has no revenues. These matters raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plan in regard to these matters is also described in Note 2 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to that matter. /s/ McConnell & Jones, LLP Houston, Texas April 14, 2016 USA Equities Corp. Consolidated Balance Sheets As of December 31, 2016 and 2015 See accompanying notes to consolidated financial statements. USA Equities Corp. Consolidated Statements of Operations For the Years ended December 31, 2016 and 2015 See accompanying notes to consolidated financial statements. USA Equities Corp. Statement of Stockholders’ Deficit For the Years ended December 31, 2016 and 2015 See accompanying notes to consolidated financial statements. USA Equities Corp. Consolidated Statements of Cash Flows As of December 31, 2016 and 2015 See accompanying notes to consolidated financial statements. USA EQUITIES CORP. December 31, 2016 and 2015 Note 1. The Company USA Equities Corp. (the “Company”, “We” or the “Registrant”) was incorporated in Delaware on September 1, 1983. The Company’s Board of Directors approved the name change from American Biogenetic Sciences, Inc. to USA Equities Corp on May 29, 2015. Prior to ceasing its operations in 2002, the Company was engaged in the research, development and production of bio-pharmaceutical products. On September 19, 2002, the Registrant filed for bankruptcy under the U.S. Bankruptcy Code in the U.S. Bankruptcy Court Eastern District of New York. On November 4, 2005, the Company emerged from Bankruptcy Court. On August 13, 2010, the Company’s sole officer/director transferred and assigned his control stock position to an unrelated third party but remained as the Company’s sole executive officer/director. On April 14, 2015, the Company incorporated a wholly-owned subsidiary in Delaware (USA Equity Trust, Inc.) for the purpose of acquiring real estate. Note 2. Going Concern The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company has incurred losses, has negative operational cash flows and has no revenues. The future of the Company is dependent upon Management’s success in its efforts and limited resources to pursue and effect a business combination. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. These consolidated financial statements do not include any adjustments that might arise from this uncertainty. Note 3. Basis of Presentation The Consolidated Financial Statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America. In the opinion of management, the accompanying audited consolidated financial statements include all adjustments, consisting of only normal recurring accruals, necessary for a fair statement of financial position, results of operations, and cash flows. Accounting Policies Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statement and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from the estimates. Principles of Consolidation: The consolidated financial statements include the accounts of USA Equities Corp and as of April 14, 2015, the accounts of its wholly owned subsidiary USA Equity Trust, Inc. All significant inter-company balances and transactions have been eliminated. Reclassifications: Certain reclassifications were made to previously reported amounts in the accompanying financial statements and notes to make them consistent with the current presentation format. The Company reclassified its two convertible notes from current liabilities to long-term liabilities. Cash and Cash Equivalents: For financial statement presentation purposes, the Company considers those short-term, highly liquid investments with original maturities of three months or less to be cash or cash equivalents. Fair Value of Financial Instruments: ASC #825, “Disclosures about Fair Value of Financial Instruments,” requires disclosure of fair value information about financial instruments. Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of December 31, 2016. These financial instruments include accounts payable and accrued expenses. Fair values were assumed to approximate carrying values for these financial instruments since they are short-term in nature and their carrying amounts approximate fair values. Earnings Per Common Share: Basic net loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed using the weighted average number of common and dilutive equivalent shares outstanding during the period. Dilutive common equivalent shares consist of options to purchase common stock (only if those options are exercisable and at prices below the average share price for the period) and shares issuable upon the conversion of issued and outstanding preferred stock. Due to the net losses reported, dilutive common equivalent shares were excluded from the computation of diluted loss per share, as inclusion would be anti-dilutive for the periods presented. There were no common equivalent shares required to be added to the basic weighted average shares outstanding to arrive at diluted weighted average shares outstanding as of December 31, 2016 or 2015. Income Taxes: The Company accounts for income taxes in accordance with ASC #740, “Accounting for Income Taxes,” which requires recognition of estimated income taxes payable or refundable on income tax returns for the current year and for the estimated future tax effect attributable to temporary differences and carry-forwards. Measurement of deferred income tax is based on enacted tax laws including tax rates, with the measurement of deferred income tax assets being reduced by available tax benefits not expected to be realized. ASC 740 also clarifies the accounting for uncertainty in tax positions. This guidance prescribes a two-step process to determine the amount of tax benefit to be recognized. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon external examination. If the tax position is deemed “more-likely-than-not” to be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement. There are no uncertain tax positions taken by the Company on its tax returns. Tax years subsequent to 2005 remain open to examination by U.S. federal and state tax jurisdictions. Management of the Company is not aware of any additional needed liability for unrecognized tax benefits at December 31, 2016. The Company has net operating losses of about $1,204,828, which begin to expire in 2026. Future utilization of currently generated federal and state NOL and tax credit carry forwards may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended and similar state provisions. The annual limitation may result in the expiration of NOL and tax credit carry-forwards before full utilization. Impact of recently issued accounting standards There were no new accounting pronouncements that had a significant impact on the Company’s operating results or financial position. Note 4. Stockholders’ Deficit Recent Issuances Common shares issued to acquire future interest in real estate: On July 31, 2015, the Company through its Delaware wholly-owned subsidiary, USA Equity Trust, Inc. (the “Buyer”), entered into an Asset Purchase Agreement with an unaffiliated third party, Green US Builders, Inc. (the “Seller”), a Delaware corporation for the purchase of a mixed-used investment property located in Bridgeport, consisting of five retail stores and five apartments. At the end of October 2015, the parties decided to rescind the transaction because of the inability to fulfill certain representations regarding the status of the property. The Seller, who was issued 2.4 million shares in consideration for the asset, is negotiating with the Company to replace the asset with a property of equal value. The shares were valued at $0.27 per share or $648,000, the closing bid at July 31, 2015. The shares have been carried as a common stock subscription receivable at December 31, 2015. On February 1, 2016, the Company and the Seller entered into an Asset Purchase Agreement, as Amended, (the “Amendment”), which provided that the Seller had until March 31, 2016 to replace the asset with a property of equal value, unless the Company and the Seller mutually agreed to extend the Amendment. In May 2016, the Company’s board of directors determined not to extend the Amendment beyond the March 31, 2016 date and the board of directors of the Company ratified and approved the: (i) termination of the Amendment and the underlying Asset Purchase Agreement; (ii) return to the transfer agent of the certificate evidencing the 2.4 million shares for cancellation; and (iii) cancellation of the common stock subscription receivable, effective at March 31, 2016. Common shares issued on conversion of debt: On July 31, 2015, our CFO and controlling shareholder converted $2,500 in principal amount of this note into 2,500,000 restricted shares of common stock. The Company recorded a loss on conversion of $672,500 during the fiscal year ended December 31, 2015 in relation to the conversion of the $2,500 in principal amount. See Note 5 below. Note 5. Convertible Notes to Related Party On October 2, 2009, we issued a convertible promissory note in the amount of $76,000 to our sole officer/director. The note bears interest at the rate of 12% per annum until paid or the note and accrued interest is converted into shares of the Company’s common stock at a conversion price of $0.001. The convertible note was issued in consideration of cash advances made and for services provided to the Company by the sole officer/director, who was also the Company’s controlling shareholder. On August 13, 2010, the Company’s sole officer/director transferred and assigned his controlling stock position to an unrelated third party but remained as the Company’s sole executive officer/director. In connection with the August 2010 change in control, the convertible note payable to sole officer/director together with accrued interest was also verbally assigned to the new controlling shareholder. A written agreement was entered into between the Company and the controlling shareholder on December 31, 2013 to assign the $76,000 convertible promissory note to the controlling shareholder. On July 31, 2015, our CFO and control shareholder converted $2,500 in principal amount of this note into 2,500,000 restricted shares of common stock. The Company recorded a loss on conversion of $672,500 during the year ended December 31, 2015 in relation to the conversion of the $2,500 in principal amount. On October 2, 2009, we issued a convertible promissory with a current principal amount of $73,500 to our sole officer/director. The note bears interest at the rate of 12% per annum until paid or the note and accrued interest is converted into shares of the Company’s common stock at a conversion price of $0.001. The maturity date of the note was extended to December 31, 2018. As of December 31, 2016 and December 31, 2015, this note had accumulated $65,461 and $56,714, respectively, in accrued interest. On December 31, 2013, we issued a convertible promissory note in the amount of $255,681 to our controlling shareholder. The note bears interest at the rate of 1% per annum until paid or the note and accrued interest is converted into shares of the Company’s common stock at a conversion price of $0.25 per share. On March 30, 2016, the maturity date of the note was extended to December 31, 2018. As of December 31, 2016 and December 31, 2015, this note had accumulated $7,604 and $5,069, respectively, in accrued interest. In accordance Accounting Standard Codification (“ASC #815”), “Accounting for Derivative Instruments and Hedging Activities”, we evaluated the holder’s non-detachable conversion right provision and liquidated damages clause, contained in the terms governing the note to determine whether the features qualify as an embedded derivative instruments at issuance. Such non-detachable conversion right provision and liquidated damages clause did not need to be accounted as derivative financial instruments. Note 6. Related Party Transactions Due Related Parties: Amounts due to related parties consist of cash advances received from our controlling shareholder, which items totaled $70,339at December 31, 2016 and $56,410 at December 31, 2015; and (ii) amounts due to an entity controlled by our former Chairman for SEC compliance services, which totaled$0 at December 31, 2016 and $1,500 at December 31, 2015, which are included in the accounts payable balance. Note 7. Commitments and Contingencies There are no pending or threatened legal proceedings as of December 31, 2016. The Company has no non-cancellable operating leases. Note 8. Subsequent Events The Company evaluated its December 31, 2016 audited financial statements for subsequent events and throughout August 6, 2018, the date the financial statements were issued. On August 6, 2018, the Company extended the maturity date of both its convertible notes outstanding to December 31, 2018. There were no other subsequent events that will affect the December 31, 2016 interim financial statements. | Based on the provided text, which appears to be fragments of a financial statement, here's a summary:
The financial statement indicates:
1. Financial Health:
- The company is experiencing losses
- Negative operational cash flows
- No revenues
- Substantial doubt about its ability to continue as a going concern
2. Key Financial Characteristics:
- Includes consolidated accounts of USA Equities Corp
- Covers liabilities ranging from current to long-term
- Considers short-term, highly liquid investments with maturities of three months or less as cash equivalents
3. Accounting Considerations:
- Actual financial results may differ from estimates
- Financial statements do not include adjustments for potential uncertainties
- Follows accounting standards for financial instrument valuation
The statement suggests the company is in a financially precarious position with significant challenges to its ongoing operations. | Claude |
. ACCOUNTING FIRM To the Board of Directors and Shareholders NxChain Inc. We have audited the accompanying balance sheets of NxChain Inc. as of May 31, 2016 and 2015, and the related statements of operations, shareholders’ equity (deficit), and cash flows for each of the years in the two-year period ended May 31, 2016. NxChain Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor where we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NxChain Inc. as of May 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the two-year period ended May 31, 2016, in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company had recurring net losses and recurring net cash used in operations for each of the two years ended May 31, 2016 and 2015, respectively and has an accumulated deficit totaling $13,162,985 at May 31, 2016. These conditions raise substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters also are described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Rosenberg Rich Baker Berman & Company Somerset, NJ August 29, 2016. NXChain Inc. BALANCE SHEETS See accompanying notes to the financial statements. NXChain Inc. STATEMENTS OF OPERATIONS See accompanying notes to the financial statements. NXChain Inc. STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT) See accompanying notes to the financial statements. NXChain Inc. STATEMENTS OF CASH FLOWS See accompanying notes to the financial statements. Notes to the Financial Statements Note 1. Organization and Significant Accounting Policies Organization NXChain Inc. (formerly AgriVest Americas, Inc., formerly Robocom Systems International Inc.) (sometimes referred to herein, after the effective date of the Reincorporation Merger (defined below) as, the “Company”) was incorporated under the laws of the State of New York in June 1982 and reincorporated in the State of Delaware on December 5, 2011. Since October 2005, the Company has been a “shell” company, as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended, whose sole purpose was to locate and consummate a merger with or an acquisition of a private entity (see “Plan of Operations” below). Reincorporation Merger Agreement On December 5, 2011, Robocom Systems International Inc., a New York corporation (“Robocom”), entered into an Agreement and Plan of Merger dated as of December 5, 2011 (the “Merger Agreement’) with the AgriVest Americas, Inc. (referred to herein prior to the Reincorporation Merger, as “AgriVest”) in order to effect a reincorporation of Robocom through the merger of Robocom with and into AgriVest (the “Reincorporation Merger”). At the time of the Reincorporation Merger, AgriVest was a newly-formed Delaware corporation and a wholly-owned subsidiary of Robocom formed specifically for the purpose of effecting a reincorporation of Robocom in the State of Delaware. Pursuant to the Merger Agreement, on December 5, 2011, Robocom merged with and into AgriVest, making AgriVest the surviving corporation. The Reincorporation Merger resulted in the following: ●The change of domicile of the registrant from New York to Delaware, as a result of which the registrant is now governed by the laws of the State of Delaware and by a new certificate of incorporation and new by-laws governed by Delaware law; ●The change of the corporate name of the registrant from “Robocom Systems International Inc.” to “AgriVest Americas, Inc.”; ●The conversion of every share of the registrant’s common stock owned as of the effective date of the Reincorporation Merger into 0.5 of a share of common stock of the Company; ●The reduction of the par value of the registrant’s common stock from $0.01 per share to $0.001 per share; and ●The increase in the authorized capital stock of the registrant to 125,000,000 total shares, consisting of 100,000,000 shares of common stock, par value $0.001 per share, and 25,000,000 shares of “blank check” preferred stock, par value $0.001 per share. The Merger Agreement was approved by the Board of Directors of Robocom on November 8, 2011 and by the Board of Directors and sole stockholder of AgriVest on December 2, 2011. At the annual meeting of stockholders of Robocom held on May 27, 2008, the holders of a majority of the outstanding shares of common stock of Robocom approved the reincorporation of Robocom in the State of Delaware through a merger with and into a wholly-owned, newly-formed Delaware subsidiary formed specifically for that purpose, subject to certain parameters that were satisfied by the terms of the Merger Agreement. At the effective time of the Reincorporation Merger, the number of Company’s authorized shares of common stock and preferred stock was increased, the number of outstanding shares of common stock was reduced by approximately 50% and the par value of the Company’s common stock and preferred stock was reduced from $0.01 per share to $0.001 per share. All impacted amounts included in the financial statements and notes thereto have been retroactively adjusted for such increases and reductions. Impacted amounts include shares of common stock and preferred stock authorized, outstanding shares of common stock, par value per share and loss per share. Securities Purchase Agreement and Change of Control On December 5, 2011, Robocom and the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Michael Campbell. Pursuant to the Purchase Agreement, Mr. Campbell purchased from the Company following the Reincorporation Merger an aggregate of 19,000,000 shares (the “Shares”) of common stock, par value $0.001 per share (“Common Stock”), for an aggregate purchase price of $50,000. Immediately following the issuance of the Shares pursuant to the Purchase Agreement, an aggregate of 21,420,492 shares of common stock was issued and outstanding and the shares of Common Stock owned by Mr. Campbell represented approximately 88.7% of the issued and outstanding shares of capital stock of the Company on a fully-diluted basis. The Shares were acquired with funds that Mr. Campbell borrowed from an entity controlled by a current director of the Company. Given the change of control, the amount and availability of any net operating loss carryforwards will be subject to the limitations set forth in the Internal Revenue Code. The following factors all enter into the annual computation of allowable annual utilization of any net operating loss carryforward(s): ●the number of shares ultimately issued within a three-year look-back period; ●whether there is a deemed more than 50 percent change in control; ●the applicable long-term tax exempt bond rate; ●continuity of historical business; and ●subsequent income of the Company. NxChain Inc. Notes to the Financial Statements (continued) On November 19, 2015, the Company entered into a Common Stock Purchase Agreement with Havanti AS, a Norwegian limited liability company (“Havanti”). Pursuant to such purchase agreement, Havanti purchased from the Company an aggregate of 1,040,839 shares (the “Purchased Shares”) of Common Stock for an aggregate purchase price of $200,000. Immediately following the issuance of the Purchased Shares pursuant such purchase agreement, an aggregate of 2,041,368 shares of Common Stock were issued and outstanding and the shares of Common Stock owned by Havanti represented approximately 51.0% of the issued and outstanding shares of capital stock of the Company on a fully-diluted basis. At or prior to the closing of the sale of the Purchased Shares, and as a condition to such closing, the Company entered into various agreements (the “Restructuring Agreements”) with an aggregate of 12 warrant holders, note holders or other creditors of the Company pursuant to which the Company converted or exchanged all existing or outstanding debts, promissory notes or warrants of the Company into an aggregate of 356,251 shares of Common Stock (the “Conversion Shares”) and $100,000 aggregate principal amount of promissory notes (the “Notes”) of the Company. The Notes originally bore interest at the rate of 8% per annum if not paid in full on or prior to the six-month anniversary of the issue date of the Notes and at the rate of 18% if the maturity date of the Notes was automatically extended for an additional three months as permitted by the Notes, and now bear interest at a rate per annum equal to the lesser of 28% or the maximum rate permitted by law. As the outstanding principal and interest on the Notes was not paid in full at the end of such three month extension period, the Notes are now payable on demand and the holders of the Notes may convert the unpaid principal of and interest on the Notes into shares of Common Stock at a price per share equal to 75% of the closing sale price of the Common Stock, or the last bid price if the closing sale price cannot be determined, on a material stock exchange or in the over-the-counter market on the trading day immediately prior to the conversion date. On March 10, 2016, the Company entered into a non-binding Letter of Intent (“LOI”) to engage in a merger with LXCCoin Ltd. ("LXCC"), a privately-held UK company in the blockchain and digital currency market. Under the terms of the LOI it is expected that LXCC will be merged with NXCN, which will remain the surviving entity, and that LXCC’s shareholders will own approximately 90% of the post-merged fully-diluted shares of NXCN. Completion of the merger is contingent upon certain closing conditions, including customary due diligence considerations, the negotiation, execution and delivery of a merger agreement by the parties, and board and stockholder approval. There can be no assurances that a merger agreement or a closing will occur based on satisfaction of these conditions. Due to the non-binding nature of the letter of intent, the terms of the proposed transaction remain subject to change. Basis of Presentation On December 30, 2015, the Company filed a Certificate of Amendment to its Certificate of Incorporation (the “Amendment”) with the Secretary of State of the State of Delaware to (i) change the Company’s name from “AgriVest Americas, Inc.” to “NXChain Inc.” and (ii) effectuate a stock combination or reverse stock split, whereby every 33.7468 outstanding shares of Common Stock of the Company were converted into one share of Common Stock. The Amendment became effective immediately upon filing on December 30, 2015. All share and per share amounts have been restated to give effect to such reverse stock split. Plan of Operations The Company is a shell company with no operating business. As a result of the sale of the Purchased Shares, Havanti has acquired effective control of the Company. In connection with such transactions, the board of directors of the Company has determined to establish the Company as a provider of a digital currency, to engage as a peer-to-peer lender utilizing such digital currency and to engage in other digital currency businesses. The Company intends to enter such markets by seeking and acquiring or merging with one or more established companies in such industry, including possibly, one or more companies controlled by Havanti or one of its affiliates or in which Havanti or one of its affiliates has an equity interest. Any such acquisition or merger may involve the issuance of additional shares of Common Stock. In order to fund such proposed business plan, the Company intends to raise funds from investors by issuing Common Stock, preferred stock and/or debt securities to fund future operations. Upon any such acquisition or merger, the Company will cease to be a shell company as such term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended. Liquidity and Capital Resources The Company’s accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business for the twelve-month period following the date of these financial statements. The Company’s continued existence is dependent upon its ability to effect its business plan and generate sufficient cash flows from operations to support its daily operations, as well as to provide sufficient resources to retire existing liabilities and obligations on a timely basis. The Company anticipates effecting future sales of debt or equity securities to execute its plans to fund its operations. However, there is no assurance that the Company will be able to obtain additional funding through the sales of additional debt or equity securities or that such funding, if available, will be obtained on terms favorable to or affordable by the Company. NxChain Inc. Notes to the Financial Statements (continued) Further, the Company faces considerable risk in its business plan and a potential shortfall of funding due to the Company’s inability to raise capital in the debt and equity securities markets. If no additional capital is raised, the Company will be forced to rely on existing cash in the bank or to scale back operations until such time that it generates revenues or raises additional capital, which raises substantial doubt about the Company’s ability to continue as a going concern. In such a restricted cash flow scenario, the Company would be unable to complete its business plan steps, and would, instead, delay all cash intensive activities. Without necessary cash flow, the Company may have to scale back operations and expansion plans during the next twelve months, or until such time as necessary funds can be raised in the debt or equity securities markets. Significant Accounting Policies Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of three-months or less at the time of purchase to be cash equivalents. Basic and Diluted Net Income (Loss) Per Share Basic and diluted net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the periods presented. The Company calculates income (loss) per common share in accordance with ASC Topic 260, "Earnings Per Share". Basic and diluted income (loss) per common share is computed based on the weighted average number of common shares outstanding. Common share equivalents consist of warrants and are excluded from the computation of diluted income (loss) per share, since the effect would be anti-dilutive. Common share equivalents, which could potentially dilute basic earnings (loss) per share in the future, and which were excluded from the computation of diluted income (loss) per share. There were no Common share equivalents for the period ending May 31, 2016. Common share equivalents totaled approximately 91,000 at May 31, 2015. Income Taxes The Company employs an asset and liability approach in accounting for income taxes payable or refundable at the date of the financial statements as a result of all events that have been recognized in the financial statements and as measured by the provisions of enacted laws. Deferred tax assets or liabilities are recognized for temporary differences that will result in deductible amounts or taxable income in future years and for net operating loss carry forwards. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. The Company's 2016, 2015 and 2014 federal and state tax returns remain subject to examination by the respective taxing authorities. In addition, net operating losses arising from prior years are also subject to examination at the time that they are utilized in future years. Neither the Company's federal or state tax returns are currently under examination. NxChain Inc. Notes to the Financial Statements (continued) Note 2. Related Party Transactions Loans Payable Shareholder and Convertible Note Payable Shareholder The Company from time to time borrows money from a Director of the Company and the Company’s CEO. At May 31, 2015, there was $25,000 and $40,073 outstanding in loans respectively to the Director and CEO. On November 11, 2015, the Company converted all amounts owed to these individuals into a convertible note and into shares of common stock, respectively. At the time of conversion of the loan payable to the Director, there was $25,000 outstanding. This amount was converted to a $25,000 convertible note that bears interest at 8% per annum with a maturity date of August 15, 2016. The note is convertible after August 15, 2016 at a price per share equal to 75% of the closing sale price of the Common Stock, or the last bid price if the closing sale price cannot be determined, on a material stock exchange or in the over-the-counter market on the trading day immediately prior to the conversion date. If the note is not paid in full on or prior to the six-month anniversary of the issue date of the note and at the rate of 18% if the maturity date of the notes was automatically extended for an additional three months as permitted by the note, and now bears interest at a rate per annum equal to the lesser of 28% or the maximum rate permitted by law. As the outstanding principal and interest on the note was not paid in full at the end of such three-month extension period, the note is currently payable on demand and the holder of the note may convert the unpaid principal of and interest on the note into shares of Common Stock as described above. As of May 31, 2016, there was $25,000 of principal and accrued interest of $1,083 outstanding on this note. At the time of conversion of the loan payable to the CEO, there was $40,073 outstanding. This amount was converted into 32,500 shares of stock with $7,573 of debt being forgiven, which is included in additional paid-in capital on the balance sheet. Due From Related Party Until February 2016, all of the Company’s cash was held by a related party at which point the monies were deposited into the Company’s bank account. The amount of cash held by this related party at May 31, 2015 was $11,835. Due To Related Party As part of a potential reverse merger with an unaffiliated party, the Company received $60,000 from the unaffiliated party, which were being held in the Due from Related Party account, in the year ended May 31, 2014 to help fund expenses until the proposed merger could be completed. In the event the proposed merger was not completed, the Company would be obligated to return the $60,000. During the quarter ended November 30, 2015, the potential reverse merger was terminated and the $60,000 advance was returned in full. Note Payable Related Party During the fiscal year ended May 31, 2016, the Company issued a promissory note to a company, which is affiliated with LXCC, in the aggregate principal amount of $120,000 with interest at 8% per annum and a maturity date of March 31, 2017. At May 31, 2016, $120,000 of principal and $2,400 of accrued interest were outstanding. Expenses The Company uses a consulting firm owned by the CEO for consulting services. During the fiscal years ending May 31, 2016 and 2015, we incurred consulting fees to this related party of $138,854 and $18,200, respectively. There were no payables outstanding to this company as of May 31, 2016 or 2015. Other During the fiscal year ended May 31, 2016, we entered into the LOI to engage in a merger with LXCC, a privately-held UK company in the blockchain and digital currency market, that is owned by the stockholders of our majority stockholder. Under the terms of the LOI it is expected that LXCC will be merged with NXCN, which will remain the surviving entity, and that LXCC’s shareholders will own approximately 90% of the post-merged fully-diluted shares of NXCN. The letter of intent provides that, subject to certain exceptions, for a sixty-day period, neither party may engage in negotiations or solicit proposals with another company with respect to an acquisition or a debt or equity investment transaction, disposal of assets outside of the ordinary course, or, with respect to LXCCoin, sell any equity or debt interest, subject to certain exceptions. During the fiscal year ended May 31, 2016, the Company entered into a Common Stock Purchase Agreement with Havanti AS. Pursuant to the Purchase Agreement, Havanti purchased from the Company an aggregate of 1,040,839 shares of Common Stock for an aggregate purchase price of $200,000. Immediately following the issuance of the Purchased Shares pursuant to the Purchase Agreement, an aggregate of 2,041,368 shares of Common Stock were issued and outstanding and the shares of Common Stock owned by Havanti represented approximately 51.0% of the issued and outstanding shares of capital stock of the Company on a fully-diluted basis. During the fiscal year ended May 31, 2016, a consulting firm owned by our CEO acquired 283,042 shares of Common Stock for an aggregate purchase price of $2,830. This amount was not received as of May 31, 2016 and is shown as a common stock subscription receivable on the balance sheet. On April 20, 2016, Havanti AS acquired 7,716,958 shares of Common Stock for an aggregate purchase price of $77,170. NxChain Inc. Notes to the Financial Statements (continued) Note 3. Loan Receivable During the fiscal year ended May 31, 2016, the Company issued a promissory note to Legend Merchant Group, Inc., an unaffiliated New York-based company, in the aggregate principal amount of $10,500. This note bears interest at 8% per annum with a maturity date of September 30, 2016. Note 4. Notes Payable As of May 31, 2014, the Company had $80,000 in outstanding principal on various notes originated between December 2011 and May 2014. The interest rates on the notes ranged from 10% to 15% and the maturity dates ranged between October 2012 and March 2015. During fiscal 2015, one note holder converted $5,000 in principal and $390 of accrued interest to 107,813 shares of common stock, which resulted in a gain of $4,204. As of May 31, 2015, $75,000 of principal was outstanding on these notes. During fiscal 2015, the Company entered in a new note on June 12, 2014 for $10,000 with an interest rate of 15% and a maturity date of March 31, 2015. No payments were made on the note in fiscal 2015; therefore, as of May 31, 2015, $10,000 was outstanding on this note. On November 11, 2015, the Company converted the above $85,000 of principal of the notes and $25,421 of accrued interest thereon into 85,000 and 25,421 shares of common stock, respectively. Convertible Note Payable On November 15, 2015, the Company had $144,038 in outstanding payables from a vendor that it converted into a $75,000 convertible note with the remaining $69,038 of debt being forgiven. The convertible note has interest rate of 8% with a maturity date of August 15, 2016. As of this filing, the Company is in arrears on this note as $75,000 is still outstanding. The Notes originally bore interest at the rate of 8% per annum if not paid in full on or prior to the six-month anniversary of the issue date of the Notes and at the rate of 18% if the maturity date of the Notes was automatically extended for an additional three months as permitted by the Notes, and now bear interest at a rate per annum equal to the lesser of 28% or the maximum rate permitted by law. As the outstanding principal and interest on the Notes was not paid in full at the end of such three month extension period, the Notes are payable on demand and the holders of the Notes may convert the unpaid principal of and interest on the Notes into shares of common stock at a price per share equal to 75% of the closing sale price of the common stock, or the last bid price if the closing sale price cannot be determined, on a material stock exchange or in the over-the-counter market on the trading day immediately prior to the conversion date. As of May 31, 2016, there was $75,000 of principal and $3,250 of accrued interest outstanding on this note. Note 5. Shareholders Equity (Deficit) Preferred Stock The Company has 25,000,000 of “Blank Check” preferred stock, $.001 par value, authorized. As of May 31, 2016 and 2015, the Company had no shares of preferred stock is issued or outstanding. Common Stock During the fiscal year ended May 31, 2015, one investor converted promissory notes in the aggregate principal amount of $5,000 and related interest of $390 to 3,195 shares of Common Stock. This transaction resulted in a gain of $4,204. During fiscal year ended May 31, 2015, one note holder converted $5,000 in principal and $390 of accrued interest to 107,813 shares of common stock, which resulted in a gain of $4,204. During the fiscal year ended May 31, 2015, one investor exercised warrants to purchase 296 shares of Common Stock for $500. During the fiscal year ended May 31, 2015, the Company sold 1,481 shares at $0.10 per share for total proceeds of $5,000. As of May 31, 2015 the shares have yet to be issued; therefore, the par value of the shares is recorded as common stock subscribed. During the fiscal year ended May 31, 2016, the Company converted $40,073 of loans payable to the CEO, into 32,500 shares of stock with $7,573 of debt being forgiven, which is included in additional paid-in capital on the balance sheet. During the fiscal year ended May 31, 2016, the Company converted $23,000 in outstanding payables into 20,000 shares of Common Stock. During the fiscal year ended May 31, 2016, the Company converted 2,697 outstanding warrants into 2,697 shares of Common Stock. During the fiscal year ended May 31, 2016, the Company issued 190,633 shares of Common Stock with a value of $218,751 to settle disputes over amounts claimed to be owed to unaffiliated third parties. As discussed in Note 4, during the fiscal year ended May 31, 2016, the Company converted $85,000 of notes payable and $25,421 of accrued interest into 85,000 and 25,421 shares of common stock, respectively. NxChain Inc. Notes to the Financial Statements (continued) During the fiscal year ended May 31, 2016, the Company entered into a Common Stock Purchase Agreement with Havanti AS. Pursuant to the Purchase Agreement, Havanti purchased from the Company an aggregate of 1,040,839 shares of Common Stock for an aggregate purchase price of $200,000. Immediately following the issuance of the Purchased Shares pursuant to the Purchase Agreement, an aggregate of 2,041,368 shares of Common Stock were issued and outstanding and the shares of Common Stock owned by Havanti represented approximately 51.0% of the issued and outstanding shares of capital stock of the Company on a fully-diluted basis. During the fiscal year ended May 31, 2016, a consulting firm owned by our CEO acquired 283,042 shares of Common Stock for an aggregate purchase price of $2,830. This amount was not received as of May 31, 2016 and is shown as a common stock subscription receivable on the balance sheet. On April 20, 2016, Havanti acquired 7,716,958 shares of Common Stock for an aggregate purchase price of $77,170. During the fiscal year ending May 31, 2016, the Company filed a Certificate of Amendment to its Certificate of Incorporation with the Secretary of State of the State of Delaware to (i) change the Company’s name from “AgriVest Americas, Inc.” to “NXChain Inc.” and (ii) effectuate a stock combination or reverse stock split, whereby every 33.7468 outstanding shares of Common Stock of the Company were converted into one share of Common Stock. The Amendment became effective immediately upon filing on December 30, 2015. All share and per share amounts have been restated to give effect to such reverse stock split. Note 6. Income Taxes Deferred tax assets as of May 31, 2016 and 2015 were substantially comprised of net operating loss carryforwards, net of valuation allowances. The Company did not record any provision for or benefit of income taxes in the years ended May 31, 2016 or 2015. The valuation allowance at May 31, 2016 and 2015 was provided because of uncertainty, based on its historical results, with respect to realization of deferred tax assets. At May 31, 2016 and 2015, the Company had net operating loss carryforwards of approximately $5.37 million for income tax purposes, which may be able to reduce taxable income in future years. The utilization of these losses to reduce future income taxes will depend on the Company generating sufficient taxable income prior to the expiration of the net operating loss carryforwards. Net operating loss carryforwards will expire in various years through May 31, 2036. | Based on the financial statement excerpt, here's a summary:
Financial Condition:
- The company is experiencing ongoing financial challenges
- Significant cash flow limitations and operational risks
- Dependent on raising additional capital through debt or equity securities
Key Financial Risks:
- Uncertain ability to generate sufficient cash flows
- Potential inability to fund current operations
- Substantial doubt about continuing as a going concern
Potential Scenarios:
- If no additional capital is raised, the company may:
1. Rely on existing cash reserves
2. Scale back operations
3. Delay cash-intensive activities
4. Potentially suspend expansion plans
Accounting Approach:
- Uses estimates in financial reporting
- Considers investments with 3-month or less maturity as cash equivalents
- Calculates net income/loss per share based on weighted average outstanding shares
Overall Assessment:
The financial statement indicates NxCh | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA iROBOT CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of iRobot Corporation: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows present fairly, in all material respects, the financial position of iRobot Corporation and its subsidiaries at December 31, 2016 and January 2, 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP Boston, Massachusetts February 17, 2017 iROBOT CORPORATION CONSOLIDATED BALANCE SHEETS See accompanying iROBOT CORPORATION CONSOLIDATED STATEMENTS OF INCOME __________________________ (1) Stock-based compensation recorded in fiscal 2016, 2015 and 2014 breaks down by expense classification as follows: See accompanying iROBOT CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME See accompanying iROBOT CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY See accompanying iROBOT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS See accompanying iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Nature of the Business iRobot Corporation ("iRobot" or the "Company") develops robotics and applies this technology in producing and marketing robots. The Company’s revenue is primarily generated from product sales. 2. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements include those of iRobot and its subsidiaries, after elimination of all intercompany accounts and transactions. iRobot has prepared the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Use of Estimates The preparation of these financial statements in conformity with accounting principles generally accepted in the United States requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates these estimates and judgments, including those related to revenue recognition, sales returns, bad debts, warranty claims, inventory reserves, valuation of investments, valuation of goodwill and intangible assets, assumptions used in valuing stock-based compensation instruments and income taxes. The Company bases these estimates on historical and anticipated results, and trends and on various other assumptions that the Company believes are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from the Company’s estimates. Fiscal Year-End The Company operates and reports using a 52-53 week fiscal year ending on the Saturday closest to December 31. Accordingly, the Company’s fiscal quarters end on the Saturday that falls closest to the last day of the third month of each quarter. Cash and Cash Equivalents The Company considers all highly liquid investments with an original or remaining maturity of three months or less at the time of purchase to be cash equivalents. The Company invests its excess cash primarily in money market funds or savings accounts of major financial institutions. Accordingly, its cash equivalents are subject to minimal credit and market risk. At December 31, 2016 and January 2, 2016, cash equivalents were comprised of money market funds totaling $157.0 million and $110.8 million, respectively. These cash equivalents are carried at cost, which approximates fair value. Short Term Investments The Company’s investments are classified as available-for-sale and are recorded at fair value with any unrealized gain or loss recorded as an element of stockholders’ equity. The fair value of investments is determined based on quoted market prices at the reporting date for those instruments. As of December 31, 2016 and January 2, 2016, investments consisted of: As of December 31, 2016, the Company’s investments had maturity dates ranging from February 2017 to October 2019. The Company invests primarily in investment grade securities and limits the amount of investment in any single issuer. iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Revenue Recognition The Company primarily derives its revenue from product sales. Until the divestiture of the defense and security business unit on April 4, 2016 (see Note 15), the Company also generated minimal revenue from government and commercial research and development contracts. The Company sells products directly to customers and indirectly through resellers and distributors. The Company recognizes revenue from sales of robots under the terms of the customer agreement upon transfer of title and risk of loss to the customer, net of estimated returns and allowances, provided that collection is determined to be reasonably assured and no significant obligations remain. Beginning in the third quarter of 2015, with the introduction of the Company's first connected robot, each sale of a connected robot represents a multi-element arrangement containing the robot, an app and potential future unspecified software upgrades. Revenue is allocated to the deliverables based on their relative selling prices which have been determined using best estimate of selling price (BESP), as the Company has not been able to establish vendor specific objective evidence (VSOE) or obtain relevant third party evidence (TPE). Revenue allocated to the app and unspecified software upgrades is then deferred and recognized on a straight-line basis over the period in which the Company expects to provide the upgrades over the estimated life of the robot. Sales to domestic and Canadian resellers of consumer robots are typically subject to agreements allowing for limited rights of return, rebates and price protection. The Company also provides limited rights of returns for direct-to-consumer sales generated through its on-line stores, one domestic distributor and one international distributor. Accordingly, the Company reduces revenue for its estimates of liabilities for these rights of return, rebates and price protection at the time the related sale is recorded. These estimates for rights of return are directly based on specific terms and conditions included in the customer agreements, historical returns experience and various other assumptions that the Company believes are reasonable under the circumstances. In the case of new product introductions, the estimates for returns applied to the new products are based upon the estimates for the most similar predecessor products until such time that the Company has enough actual returns experience for the new products, which is typically two holiday return cycles. At that time, the Company incorporates that data into the development of returns estimates for the new products. The Company updates its analysis of returns on a quarterly basis. If actual returns differ significantly from the Company's estimates, or if modifications to individual customer agreements are entered into that impact their rights of returns, such differences could result in an adjustment to previously established reserves and could have a material impact, either favorably or unfavorably, on the Company’s results of operations for the period in which the actual returns become known or the agreement is modified. Except for the one international distributor noted above, the Company's international distributor agreements do not currently allow for product returns and, as a result, no reserve for returns is established for this group of customers. In 2016, the Company began selling to one domestic distributor under an agreement that provides product return privileges. As a result, the Company recognizes revenue from sales to this distributor when the product is resold by the distributor. The estimates and reserve for rebates and price protection are based on specific programs, expected usage and historical experience. Actual results could differ from these estimates. Prior to the Company's divestiture of the defense and security business unit on April 4, 2016 (see Note 15), the Company generated minimal revenue from government contracts. Under cost-plus-fixed-fee (CPFF) type contracts, the Company recognized revenue based on costs incurred plus a pro rata portion of the total fixed fee. Costs incurred included labor and material that were directly associated with individual CPFF contracts plus indirect overhead and general and administrative type costs based upon billing rates submitted by the Company to the Defense Contract Management Agency (DCMA). Annually, the Company submits final indirect billing rates to DCMA based upon actual costs incurred throughout the year. In the situation where the Company’s final actual billing rates are greater than the estimated rates used, the Company records a cumulative revenue adjustment in the period in which the rate differential is collected from the customer. These final billing rates are subject to audit by the Defense Contract Audit Agency (DCAA), which can occur several years after the final billing rates are submitted and may result in material adjustments to revenue recognized based on estimated final billing rates. As of December 31, 2016, fiscal year 2015 is open for audit by DCAA. In the situation where the Company’s anticipated actual billing rates will be lower than the provisional rates used, the Company records a cumulative revenue adjustment in the period in which the rate differential is identified. Revenue on firm fixed price (FFP) contracts was recognized using the percentage-of-completion method. For government product FFP contracts, revenue was recognized as the product was shipped or in accordance with the contract terms. Costs and estimated gross margins on contracts were recorded as revenue as work was performed based on the percentage that incurred costs compared to estimated total costs utilizing the most recent estimates of costs and funding. Revenue earned in excess of billings, if any, was recorded as unbilled revenue. Billings in excess of revenue earned, if any, were recorded as deferred revenue. iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Allowance for Doubtful Accounts The Company maintains an allowance for doubtful accounts to provide for the estimated amount of accounts receivable that may not be collected. The allowance is based upon an assessment of customer creditworthiness, historical payment experience and the age of outstanding receivables. Activity related to the allowance for doubtful accounts was as follows: ___________________________ (*) Deductions related to allowance for doubtful accounts represent amounts written off against the allowance, less recoveries. Inventory Inventory is stated at the lower of cost or net realizable value with cost being determined using the first-in, first-out (FIFO) method. The Company maintains a reserve for inventory items to provide for an estimated amount of excess or obsolete inventory. Property and Equipment Property and equipment are recorded at cost and consist primarily of computer equipment, leasehold improvements, business applications software and machinery. Depreciation is computed using the straight-line method over the estimated useful lives as follows: Expenditures for additions, renewals and betterments of plant and equipment are capitalized. Expenditures for repairs and maintenance are charged to expense as incurred. As assets are retired or sold, the related cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to operations. Long-Lived Assets, including Purchased Intangible Assets The Company periodically evaluates the recoverability of long-lived assets, including other purchased intangible assets whenever events and changes in circumstances, such as reductions in demand or significant economic slowdowns in the industry, indicate that the carrying amount of an asset may not be fully recoverable. When indicators of impairment are present, the carrying values of the asset group are evaluated in relation to the future undiscounted cash flows of the underlying business. The net book value of the underlying asset is adjusted to fair value if the sum of the expected discounted cash flows is less than book value. Fair values are based on estimates of market prices and assumptions concerning the amount and timing of estimated future cash flows and assumed discount rates, reflecting varying degrees of perceived risk. Goodwill Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. The Company evaluates goodwill for impairment at the reporting unit level (operating segment or one level below an operating segment) annually or more frequently if the Company believes indicators of impairment exist. In accordance with the guidance, the Company is permitted to first assess qualitative factors to iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then a two-step goodwill impairment test is performed. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. If the carrying amount of a reporting unit exceeds the reporting unit's fair value, the Company performs the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit's goodwill with the carrying value of that goodwill. The Company completes the annual impairment evaluation during the fourth quarter each year. Research and Development Costs incurred in the research and development of the Company’s products are expensed as incurred. Internal Use Software The Company capitalizes costs associated with the development and implementation of software for internal use. At December 31, 2016, January 2, 2016 and December 27, 2014, the Company had $9.5 million, $8.6 million and $8.2 million, respectively, of costs related to enterprise-wide software included in fixed assets. Capitalized costs are being amortized over the assets’ estimated useful lives. The Company has recorded $0.4 million, $0.7 million and $0.8 million of amortization expense for the years ended December 31, 2016, January 2, 2016 and December 27, 2014, respectively. Concentration of Credit Risk and Significant Customers Financial instruments which potentially expose the Company to concentrations of credit risk consist of accounts receivable. Management believes its credit policies are prudent and reflect normal industry terms and business risk. At December 31, 2016, three customers accounted for a total of 43.9% of the Company's accounts receivable balance, each of which was greater than 10% of the balance and two of whom secured their balance with guaranteed letters of credit which together represents 32.5% of the balance. At January 2, 2016, two customers accounted for a total of 34.1% of the Company’s accounts receivable balance, each of which was greater than 10% of the balance and each of whom secured their balance with guaranteed letters of credit. For the years ended December 31, 2016, January 2, 2016 and December 27, 2014, revenue from U.S. federal government orders, contracts and subcontracts, represented 0.2%, 5.1% and 4.3% of total revenue, respectively. For the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014, the Company generated an aggregate of 25.2%, 26.0% and 29.8%, respectively, of total revenue from its consumer robots distributor in Japan (Sales on Demand Corporation) and a network of affiliated European distributors of its consumer robots (Robopolis SAS). For the year ended December 31, 2016, the Company generated 10.4% of total revenue from one of the Company's domestic retailers (Amazon). The Company maintains its cash in bank deposit accounts at high quality financial institutions. The individual balances, at times, may exceed federally insured limits. Stock-Based Compensation The Company accounts for stock-based compensation through recognition of the fair value of the stock-based compensation as a charge against earnings. Stock-based compensation cost for stock options is estimated at the grant date based on each option’s fair value as calculated by the Black-Scholes option-pricing model. Stock-based compensation cost for restricted stock awards, time-based restricted stock units and performance-based restricted stock units is measured based on the closing fair market value of the Company's common stock on the date of grant. For performance-based restricted stock units, the compensation costs will be subsequently adjusted for assumptions of achievement during the period in which the assumption of achievement changes, as applicable. The Company recognizes stock-based compensation cost as expense ratably on a straight-line basis over the requisite service period, net of estimated forfeitures. Advertising Expense The Company expenses advertising costs as they are incurred. During the years ended December 31, 2016, January 2, 2016 and December 27, 2014 advertising expense totaled $64.4 million, $54.7 million and $46.1 million, respectively, and are recorded with the selling and marketing expenses line item. iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Net Income Per Share The following table presents the calculation of both basic and diluted net income per share: Restricted stock units and stock options representing approximately 0.4 million, 0.5 million and 0.2 million shares of common stock for the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014, respectively, were excluded from the computation of diluted earnings per share for these periods because their effect would have been antidilutive. Income Taxes The Company is subject to taxation in the United States and various states and foreign jurisdictions. The statute of limitations for examinations by the Internal Revenue Service is closed for fiscal years prior to 2013. The statute of limitations for examinations by state tax authorities is closed for fiscal years prior to 2012. Federal carryforward attributes that were generated prior to fiscal year 2013 and state carryforward attributes that were generated prior to fiscal year 2012 may still be adjusted upon examination by the federal or state tax authorities if they either have been or will be used in a period for which the statute of limitations is still open. Deferred taxes are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Company monitors the realization of its deferred tax assets based on changes in circumstances, for example, recurring periods of income for tax purposes following historical periods of cumulative losses, generation of tax credits compared to future utilization of credits, or changes in tax laws or regulations. The Company's income tax provision and its assessment of the ability to realize its deferred tax assets involve significant judgments and estimates. The Company is currently generating state research credits that exceed the amount being utilized. As a result of this trend, a valuation allowance may be needed in the future related to these state tax credits. As of December 28, 2013, the Company maintained a valuation allowance of $2.1 million related to certain state tax attributes from the Evolution Robotics, Inc. acquisition. During the year ended December 27, 2014, this valuation allowance was released when the realization of these state tax attributes became more likely than not. As of December 31, 2016, the Company did not record a valuation allowance as all deferred tax assets are considered realizable. Comprehensive Income Accumulated other comprehensive income includes unrealized gains and losses on certain investments. The differences between net income and comprehensive income were related to unrealized gains (losses) on investments, net of tax. Fair Value Measurements The authoritative guidance for fair value establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Financial Assets and Liabilities The Company’s financial assets and liabilities measured at fair value on a recurring basis at December 31, 2016, were as follows: The Company’s financial assets and liabilities measured at fair value on a recurring basis at January 2, 2016, were as follows: (1) The bond investments are valued based on observable market values as of the Company's reporting date. The bond investments are recorded at fair value and marked-to-market at the end of each reporting period. The realized and unrealized gains and losses are included in comprehensive income for that period. (2) Derivative instruments are valued using an income approach based on the present value of the forward rate less the contract rate multiplied by the notional amount. Recent Accounting Pronouncements In January 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) FASB issued ASU No. 2017-04, "Intangibles - Goodwill and Other (Topic 350)." ASU No. 2017-04 eliminates step 2 from the iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) goodwill impairment test, instead an entity should recognize an impairment charge for the amount by which the carrying amount of goodwill exceeds the reporting unit's fair value. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted. The Company does not believe that ASU 2017-04 will have a material effect on its consolidated financial statements. In January 2017, the FASB issued ASU No. 2017-01, "Business Combinations (Topic 805) Clarifying the Definition of a Business". The Amendments in this Update is to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company is currently evaluating the impact of ASU 2017-01 on its consolidated financial statements. In October 2016, the FASB issued ASU No. 2016-16, "Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.” ASU 2016-16 clarifies the accounting for the current and deferred income taxes for an intra-entity transfer of an asset other than inventory. ASU 2016-16 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact of ASU 2016-16 on its consolidated financial statements. In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 refines how companies classify certain aspects of the cash flow statement in regards to debt prepayment, settlement of debt instruments, contingent consideration payments, proceeds from insurance claims and life insurance policies, distribution from equity method investees, beneficial interests in securitization transactions and separately identifiable cash flows. ASU 2016-15 is effective for annual periods beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of ASU 2016-15 on its consolidated financial statements. In March 2016, the FASB issued ASU No. 2016-09, "Improvements to Employee Share-Based Payment Accounting," which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is currently evaluating the impact of ASU 2016-09 on its consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02, "Leases." ASU 2016-02 requires lessees to recognize the assets and liabilities on their balance sheet for the rights and obligations created by most leases and continue to recognize expenses on their income statements over the lease term. It will also require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. The guidance is effective for annual reporting periods beginning after December 15, 2018 and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact of the standard on its consolidated financial statements. In November 2015, the FASB issued ASU No. 2015-17, "Income Taxes: Balance Sheet Classification of Deferred Taxes." ASU 2015-17 requires that the presentation of deferred tax assets and liabilities be classified as noncurrent on the balance sheet instead of separating deferred taxes into current and noncurrent amounts. This standard will become effective for fiscal years, and the interim periods within those years, beginning after December 15, 2016, with early adoption allowed. The Company elected to prospectively adopt ASU 2015-17 as of January 2, 2016. The prior reporting period was not retrospectively adjusted. The adoption of this guidance had no impact on the Company's Consolidated Statements of Income and Comprehensive Income. In July 2015, the FASB issued ASU No. 2015-11, "Inventory: Simplifying the Measurement of Inventory." ASU 2015-11 applies only to inventory for which cost is determined by methods other than last-in, first-out and the retail inventory method, which includes inventory that is measured using first-in, first-out or average cost. Inventory within the scope of this standard is required to be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new standard will be effective for the Company on January 1, 2017. The Company does not believe that the adoption of ASU 2015-11 will have a material effect on its financial condition or results of operations. In April 2015, the FASB issued ASU No. 2015-05, "Intangibles - Goodwill and Other - Internal-Use Software: Customer's Accounting for Fees Paid in a Cloud Computing Arrangement." Under ASU 2015-05, if a cloud computing arrangement includes a software license, the software license element of the arrangement should be accounted for consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the arrangement should be accounted for as a service contract. The new standard became effective for the Company on January 3, 2016. The adoption of this standard did not have a material impact on the Company's consolidated financial statements. In February 2015, the FASB issued ASU No. 2015-02, "Consolidation - Amendments to the Consolidation Analysis." ASU 2015-02 reduces the number of consolidation models and changes the way reporting entities evaluate a variable interest iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) entity. It is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The Company adopted ASU 2015-02 effective January 3, 2016. The adoption of this standard did not have a material impact on the Company's consolidated financial statements. In June 2014, the FASB issued ASU No. 2014-12, "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period." ASU 2014-12 requires a reporting entity to treat a performance target that affects vesting and that could be achieved after the requisite service period as a performance condition. It is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The Company adopted ASU 2014-12 effective January 3, 2016. The adoption of this standard did not have a material impact on the Company's consolidated financial statements. In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers," which provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new guidance initially was effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. In July 2015, the FASB voted to defer the effective date of the new accounting guidance related to revenue recognition by one year to December 17, 2017 for annual reporting periods beginning after that date and permitted early adoption of the standard, but not before the original effective date of December 15, 2016. The Company is continuing to evaluate the impact that the adoption of the new revenue recognition standard will have on its consolidated financial statements, but anticipates that the additional disclosure requirements will represent a significant change from current guidance. The Company currently anticipates adopting the standard using the modified retrospective method. From time to time, new accounting pronouncements are issued by FASB that are adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes that recently issued standards, which are not yet effective, will not have a material impact on the Company’s consolidated financial statements upon adoption. Inventory consists of the following at: 4. Property and Equipment Property and equipment consists of the following at: Depreciation expense for the years ended December 31, 2016, January 2, 2016 and December 27, 2014 was $10.0 million, $11.4 million, and $9.2 million, respectively. At December 31, 2016, other assets consisted of eleven investments totaling $12.9 million. At January 2, 2016, other assets consisted of six investments totaling $9.4 million. At December 31, 2016, these investments consisted of cost method investments of $10.9 million, an equity method investment of $1.5 million and notes receivable of $0.5 million. The Company regularly monitors these investments to determine if facts and circumstances have changed in a manner that would require a change in accounting methodology. Additionally, the Company regularly evaluates whether or not these investments have been impaired by considering such factors as economic environment, market conditions, operational performance and other specific factors relating to the businesses underlying the investments. If any such impairment is identified, a reduction in the carrying value of the investments would be recorded at that time. During 2016, the Company recorded impairment on a cost method investment of approximately $0.1 million. Since the Company believes the fair value of its remaining investments is greater than the carrying value of its investments, it has not impaired these investments. Accrued expenses consist of the following at: Accrued compensation consists of the following at: 7. Working Capital Facilities Credit Facility The Company has an unsecured revolving credit facility with Bank of America, N.A., which is available to fund working capital and other corporate purposes. As of December 31, 2016, the total amount of the credit facility was $75.0 million and the full amount was available for borrowing. The interest on loans under the credit facility will accrue, at the Company's election, at either (1) LIBOR plus a margin, currently equal to 1.0%, based on the Company's ratio of indebtedness to Adjusted EBITDA (the "Eurodollar Rate"), or (2) the lender's base rate. The lender's base rate is equal to the highest of (1) the federal funds rate plus 0.5%, (2) the lender's prime rate and (3) the Eurodollar Rate plus 1.0%. The credit facility will terminate and all amounts outstanding thereunder will be due and payable in full on December 20, 2018. As of December 31, 2016, the Company had no outstanding borrowings under its revolving credit facility. This credit facility contains customary terms and conditions for credit facilities of this type, including restrictions on the Company's ability to incur or guaranty additional indebtedness, create liens, enter into transactions with affiliates, make loans or investments, sell assets, pay dividends or make distributions on, or repurchase, the Company's stock, and consolidate or merge with other entities. In addition, the Company is required to meet certain financial covenants customary with this type of agreement, including maintaining a maximum ratio of indebtedness to Adjusted EBITDA and a minimum specified interest coverage ratio. This credit facility contains customary events of default, including for payment defaults, breaches of representations, breaches of affirmative or negative covenants, cross defaults to other material indebtedness, bankruptcy and failure to discharge certain judgments. If a default occurs and is not cured within any applicable cure period or is not waived, the Company's obligations under the credit facility may be accelerated. As of December 31, 2016, the Company was in compliance with all covenants under its credit facility. Letter of Credit Facility The Company has an unsecured revolving letter of credit facility with Bank of America, N.A. The credit facility is available to fund letters of credit on the Company's behalf up to an aggregate outstanding amount of $5 million. The Company may terminate at any time, subject to proper notice, or from time to time permanently reduce the amount of the credit facility. The Company pays a fee on outstanding letters of credit issued under the credit facility of up to 1.5% per annum of the outstanding letters of credit. The maturity date for letters of credit issued under the credit facility must be no later than 365 days following the maturity date of the credit facility. As of December 31, 2016, there were letters of credit outstanding of $1.0 million under the revolving letter of credit facility. The credit facility contains customary terms and conditions for credit facilities of this type, including restrictions on the Company's ability to incur or guaranty additional indebtedness, create liens, enter into transactions with affiliates, make loans or investments, sell assets, pay dividends or make distributions on, or repurchase stock, and consolidate or merge with other entities. In addition, the Company is required to meet certain financial covenants customary with this type of agreement, including maintaining a maximum ratio of indebtedness to Adjusted EBITDA and a minimum specified interest coverage ratio. The credit facility also contains customary events of default, including for payment defaults, breaches of representations, breaches of affirmative or negative covenants, cross defaults to other material indebtedness, bankruptcy, and failure to discharge certain judgments. If a default occurs and is not cured within any applicable cure period or is not waived, the lender may accelerate the obligations under the credit facility. As of December 31, 2016, the Company was in compliance with all covenants under the revolving letter of credit facility. Common stockholders are entitled to one vote for each share held and to receive dividends if and when declared by the Board of Directors and subject to and qualified by the rights of holders of the preferred stock. Upon dissolution or liquidation of the Company, holders of common stock will be entitled to receive all available assets subject to any preferential rights of any then outstanding preferred stock. On April 2, 2014, the Company announced a stock repurchase program. Under the program, the Company could purchase up to $50 million of its common stock from May 1, 2014 to April 30, 2015. On March 19, 2015, the Company announced an additional stock repurchase program, which authorized the repurchase of $50 million of its common stock from May 1, 2015 to April 30, 2016. On December 28, 2015, the Company replaced the then-current stock repurchase program with a new stock repurchase program, effective January 4, 2016 and ending on December 31, 2016, pursuant to which the Company was authorized to purchase up to one million shares or $40 million of its common stock. On March 1, 2016, the Company replaced the then-current stock repurchase program and entered into an accelerated share repurchase (ASR) agreement to repurchase an aggregate of $85.0 million of common stock. During 2016, 2015 and 2014, the Company repurchased 2,641,122 shares totaling $97.0 million, 1,260,276 shares totaling $37.4 million and 55,973 shares totaling $1.7 million, respectively, in the open market under these stock repurchase plans. iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 9. Stock Option Plans and Stock-Based Compensation The Company has options outstanding under three stock incentive plans: the 2005 Stock Option and Incentive Plan (the "2005 Plan"), the Evolution Robotics, Inc. 2007 Stock Plan (the "2007 Plan") and the 2015 Stock Option and Incentive Plan (the "2015 Plan" and together with the 2005 Plan and the 2007 Plan, the “Plans”). All options that remained outstanding under the 2004 Stock Option and Incentive Plan as of December 27, 2014 were exercised during fiscal 2015. The 2015 Plan is the only one of the three plans under which new awards may currently be granted. Under the 2015 Plan, which became effective May 20, 2015, 3,100,000 shares were initially reserved for issuance in the form of incentive stock options, non-qualified stock options, stock appreciation rights, deferred stock awards, restricted stock units, unrestricted stock awards, cash-based awards, performance share awards and dividend equivalent rights. Stock awards returned to the Plans, with the exception of those issued under the 2007 Plan, as a result of their expiration, cancellation or termination are automatically made available for issuance under the 2015 Plan. Eligibility for incentive stock options is limited to those individuals whose employment status would qualify them for the tax treatment associated with incentive stock options in accordance with the Internal Revenue Code of 1986, as amended. As of December 31, 2016, there were 1,495,517 shares available for future grant under the 2015 Plan. Options granted under the Plans are subject to terms and conditions as determined by the compensation committee of the board of directors, including vesting periods. Options granted under the Plans are exercisable in full at any time subsequent to vesting, generally vest over four years, and expire five or ten years from the date of grant or, if earlier, 90 days from employee termination. The exercise price of stock options is typically equal to the closing price on the NASDAQ Global Select Market on the date of grant. Other awards granted under the Plans generally vest over periods from three to four years. In conjunction with the acquisition of Evolution Robotics, Inc. on October 1, 2012, each outstanding and unvested incentive stock option held by Evolution employees as of the acquisition date was automatically converted into stock options of the Company under the same terms and conditions as were applicable to the original Evolution grants. The number of replacement options granted and the associated exercise prices were determined utilizing a conversion ratio as defined in the merger agreement. There were 114,248 incentive stock options issued by the Company as a result of this automatic conversion with exercise prices ranging from $2.55 to $4.81. All of these options were granted from the 2007 Plan, which was assumed by the Company as a result of the acquisition. The Company recognized $3.2 million of stock-based compensation expense during the fiscal year ended December 31, 2016 for stock options. The unamortized fair value as of December 31, 2016 associated with these grants was $6.8 million with a weighted-average remaining recognition period of 2.85 years. The Company expects to recognize associated stock-based compensation expense of $2.8 million, $2.1 million, $1.4 million and $0.5 million in 2017, 2018, 2019 and 2020, respectively. The fair value of each option grant for the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014 was computed on the grant date using the Black-Scholes option-pricing model with the following assumptions: The risk-free interest rate is derived from the average U.S. Treasury constant maturity rate, which approximates the rate in effect at the time of grant, commensurate with the expected life of the instrument. The dividend yield is zero based upon the fact the Company has never paid and has no present intention to pay cash dividends. The Company utilizes company specific historical data for purposes of establishing expected volatility and expected term. Based upon the above assumptions, the weighted average fair value of each stock option granted for the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014 was $12.88, $13.21 and $15.87, respectively. iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The table below summarizes stock option plan activity: _________________________ (1) The aggregate intrinsic value on the table was calculated based upon the positive difference between the closing market value of the Company’s stock on December 31, 2016 of $58.45 and the exercise price of the underlying option. During fiscal years 2016, 2015, and 2014, the total intrinsic value of stock options exercised was $10.3 million, $5.9 million and $10.5 million, respectively. No amounts relating to stock-based compensation have been capitalized. The following table summarizes information about stock options outstanding at December 31, 2016: During the fiscal year ended December 31, 2016, the Company recognized $12.8 million of stock-based compensation expense associated with restricted stock units. As of December 31, 2016, January 2, 2016 and December 27, 2014, the iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) unamortized fair value of all restricted stock units was $28.9 million, $24.3 million and $20.1 million, respectively. The Company expects to recognize associated stock-based compensation expense of $11.2 million, $8.9 million, $6.4 million and $2.4 million in 2017, 2018, 2019 and 2020, respectively. The table below summarizes activity relating to restricted stock units: In 2014, 2015 and 2016 the Company granted performance-based restricted stock units (PSUs) to certain of its employees. The performance metric for these awards is operating income percent, with a threshold requirement for a minimum amount of revenue growth. These awards vest over a three year period. The number of shares actually earned at the end of the three year period will range from 0% to 100% of the target number of PSUs granted based on the Company’s performance against three year operating income and revenue goals. In addition, while all vesting of earned PSUs occurs on the third anniversary of the date of grant, achievement of cumulative intermediate targets for each individual year will allow PSUs to be deemed earned but not yet vested for the intermediate periods. Achievement of the cumulative target will allow all shares subject to the PSUs to be earned regardless of the achievement of the intermediate individual year targets. iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The components of income tax expense were as follows: As of December 31, 2016, a deferred tax liability has not been established for approximately $1.6 million of cumulative undistributed earnings of non-U.S. subsidiaries, as the Company plans to keep these amounts permanently reinvested overseas. The amount of any unrecognized deferred tax liability on these undistributed earnings would be immaterial. The components of net deferred tax assets were as follows: In November 2015, the FASB issued ASU No. 2015-17, "Income Taxes: Balance Sheet Classification of Deferred Taxes." ASU 2015-17 requires that the presentation of deferred tax assets and liabilities be classified as noncurrent on the balance sheet instead of separating deferred taxes into current and non-current amounts. This standard became effective for fiscal years, and the interim periods within those years, beginning after December 15, 2016, with early adoption iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) allowed. The Company elected to prospectively early adopt ASU 2015-17 on the first day of the fourth quarter of the fiscal year ended January 2, 2016. The adoption of this guidance had no impact on the Company's Consolidated Statements of Income and Comprehensive Income. As of December 28, 2013, the Company maintained a valuation allowance of $2.1 million related to certain state tax attributes from the Evolution Robotics, Inc. acquisition. During the year ended December 27, 2014, this valuation allowance was released when realization of these state tax attributes became more likely than not. As of December 31, 2016, the Company did not record a valuation allowance as all deferred tax assets are considered realizable. The table below summarizes activity relating to the valuation allowance: The Company has federal net operating loss carryforwards of $1.0 million and $8.0 million as of December 31, 2016 and January 2, 2016, respectively, which expire in 2031. The Company has state net operating loss carryforwards of $8.9 million and $15.0 million as of December 31, 2016 and January 2, 2016, respectively, which expire from 2029 to 2031. The Company has federal research and development credit carryforwards of $1.0 million and $1.0 million as of December 31, 2016 and January 2, 2016, respectively, which expire from 2026 to 2031. The Company has state research and development credit carryforwards of $10.0 million and $9.3 million as of December 31, 2016 and January 2, 2016, respectively, which expire from 2023 to 2031. Under the Internal Revenue Code, certain substantial changes in the Company’s ownership could result in an annual limitation on the amount of these tax carryforwards which can be utilized in future years. As of December 31, 2016, the Company has $9.9 million of federal and state net operating loss carryforwards and $2.2 million of federal and state research and development credits related to the acquisition of Evolution Robotics that are limited by Section 382 and Section 383, respectively, of the Internal Revenue Code. However, these limitations are not expected to cause any of these federal and state net operating loss carryforwards or federal and state research and development credits to expire prior to being utilized. The reconciliation of the expected tax (benefit) expense (computed by applying the federal statutory rate to income before income taxes) to actual tax expense was as follows: iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) A summary of the Company’s adjustments to its gross unrecognized tax benefits in the current year is as follows: The Company accrues interest and, if applicable, penalties for any uncertain tax positions. Interest and penalties are classified as a component of income tax expense. As of December 31, 2016, January 2, 2016 and December 27, 2014 there were no material accrued interest or penalties. Over the next twelve months, it is reasonably possible that the Company may recognize approximately $0.1 million of previously net unrecognized tax benefits related to U.S. federal, state and foreign tax audits and expiration of the statute of limitations. If all of our unrecognized tax benefits as of December 31, 2016 were to become recognizable in the future, we would record a $2.2 million benefit, inclusive of interest, to the income tax provision, reflective of federal benefit on state items. Included in the Company’s state tax credit carryforwards are unrecognized tax benefits related to stock-based compensation beginning from January 1, 2006 of $0.7 million and $0.6 million as of December 31, 2016 and January 2, 2016, respectively. Included in the Company's state net operating loss carryforwards are unrecognized tax benefits related to stock-based compensation beginning from January 1, 2006 of $1.8 million and $1.0 million as of December 31, 2016 and January 2, 2016, respectively. These unrecognized tax benefits will be credited to additional paid-in capital when they reduce income taxes payable. Therefore, these amounts were not included in the Company’s gross or net deferred tax assets at December 31, 2016 and January 2, 2016. The Company follows the with and without approach for direct and indirect effects of windfall tax deductions. Legal Proceedings From time to time and in the ordinary course of business, the Company is subject to various claims, charges and litigation. The outcome of litigation cannot be predicted with certainty and some lawsuits, claims or proceedings may be disposed of unfavorably to us, which could materially affect our financial condition or results of operations. Lease Obligations The Company leases its facilities. Rental expense under operating leases for fiscal 2016, 2015 and 2014 amounted to $6.0 million, $4.9 million, and $4.8 million, respectively. Future minimum rental payments under operating leases were as follows as of December 31, 2016: iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Outstanding Purchase Orders At December 31, 2016, we had outstanding purchase orders aggregating approximately $103.2 million. The purchase orders, the majority of which are with our contract manufacturers for the purchase of inventory in the normal course of business, are for manufacturing and non-manufacturing related goods and services, and are generally cancelable without penalty. In circumstances where we determine that we have financial exposure associated with any of these commitments, we record a liability in the period in which that exposure is identified. Guarantees and Indemnification Obligations The Company enters into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, the Company indemnifies and agrees to reimburse the indemnified party for losses incurred by the indemnified party, generally the Company’s customers, in connection with any patent, copyright, trade secret or other proprietary right infringement claim by any third party. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2016 and January 2, 2016, respectively. Government Contract Contingencies Prior to the completion of the divestiture of our defense and security business unit during the second quarter of 2016, the Company had several prime contracts with the U.S. federal government which did not contain a limitation of liability provision, creating a risk of responsibility for direct and consequential damages. Several subcontracts with prime contractors hold the prime contractor harmless against liability that stems from our work and do not contain a limitation of liability. These provisions could cause substantial liability for the Company. In addition, the Company is subject to audits by the U.S. federal government as part of routine audits of government contracts. As part of an audit, these agencies may review the Company’s performance on contracts, cost structures and compliance with applicable laws, regulations and standards. If any of its costs are found to be allocated improperly to a specific contract, the costs may not be reimbursed and any costs already reimbursed for such contract may have to be refunded. Accordingly, an audit could result in a material adjustment to our revenue and results of operations. Annually, the Company submits final indirect billing rates to DCMA based upon actual costs incurred throughout the year. These final billing rates are subject to audit by DCAA. As of December 31, 2016, fiscal years 2015 and 2016 are open for audit by DCAA. Warranty The Company provides warranties on most products and has established a reserve for warranty based on estimated warranty costs. The reserve is included as part of accrued expenses (Note 6) in the accompanying consolidated balance sheets. Activity related to the warranty accrual was as follows: __________________________________ (*) Warranty usage includes costs incurred for warranty obligations and the release of warranty liabilities associated with the divestiture of the defense and security business unit. iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Sales Taxes The Company collects and remits sales tax in jurisdictions in which it has a physical presence or it believes nexus exists, which therefore obligates the Company to collect and remit sales tax. The Company continually evaluates whether it has established nexus in new jurisdictions with respect to sales tax. The Company has recorded a liability for potential exposure in states where there is uncertainty about the point in time at which the Company established a sufficient business connection to create nexus. The Company continues to analyze possible sales tax exposure, but does not currently believe that any individual claim or aggregate claims that might arise will ultimately have a material effect on its consolidated results of operations, financial position or cash flows. The Company sponsors a retirement plan under Section 401(k) of the Internal Revenue Code (the "Retirement Plan"). All Company employees, with the exception of temporary, contract and international employees are eligible to participate in the Retirement Plan after satisfying age and length of service requirements prescribed by the plan. Under the Retirement Plan, employees may make tax-deferred contributions, and the Company, at its sole discretion, and subject to the limits prescribed by the IRS, may make either a nonelective contribution on behalf of all eligible employees or a matching contribution on behalf of all plan participants. The Company elected to make a matching contribution of approximately $1.7 million, $1.8 million and $1.7 million for the plan years ended December 31, 2016, January 2, 2016 and December 27, 2014 ("Plan-Year 2016," "Plan-Year 2015" and "Plan-Year 2014"), respectively. The employer contribution represents a matching contribution at a rate of 50% of each employee’s first six percent contribution. Accordingly, each employee participating during Plan-Year 2016, Plan-Year 2015 and Plan-Year 2014 is entitled up to a maximum of three percent of his or her eligible annual payroll. The employer matching contribution for Plan-Year 2016 is included in accrued compensation in the accompanying consolidated balance sheet. The Company is exposed to adverse changes in foreign currency exchange rates, primarily related to sales in the Canadian Dollar and the Euro. As a result, the Company periodically enters into foreign currency forward contracts to minimize the impact of fluctuating exchange rates on results of operations. These derivative instruments have maturities of two months or less and have not qualified for hedge accounting. In addition, during 2016, the Company entered into a foreign currency option to hedge the Japanese Yen purchase price of a previously announced acquisition expected to close in the quarter ended July 1, 2017. The instrument has a maturity of four months and does not qualify for hedge accounting. Notional amounts and fair values of derivative instruments are as follows: Gains associated with derivative instruments are as follows: iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The carrying amount of the goodwill as of December 31, 2016 is $41.1 million, which resulted from the acquisition of Evolution Robotics, Inc. in October 2012. The Company's goodwill balance as of January 2, 2016 was $48.8 million, which consisted of the $41.1 million from the acquisition of Evolution Robotics, Inc. and was assigned to the home robots reporting unit and $7.7 million related to the acquisition of Nekton Research, LLC completed in September 2008 and was assigned to the defense and security reporting unit. On April 4, 2016, the Company completed the sale of its defense and security business unit and therefore the goodwill balance assigned to the defense and security business unit was written off during the three months ended July 2, 2016. As a result of the divestiture, the Company now has one reporting unit, consumer robots. In the fourth quarter of 2016, the Company completed its annual goodwill impairment test on the goodwill associated with the acquisition of Evolution Robotics, Inc. and did not identify any goodwill impairment. Other intangible assets include the value assigned to completed technology, research contracts, and trade names. The estimated useful lives for all of these intangible assets are two to ten years. The intangible assets are being amortized on a straight-line basis, which is consistent with the pattern that the estimated economic benefits of the intangible assets are expected to be utilized. Intangible assets at December 31, 2016 and January 2, 2016 consisted of the following: Amortization expense related to acquired intangible assets was $3.5 million for each of the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014. The estimated future amortization expense related to current intangible assets in each of the five succeeding fiscal years is expected to be as follows: iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) On April 4, 2016, the Company completed the sale of the defense and security business unit to iRobot Defense Holdings, Inc., a portfolio company of Arlington Capital Partners. The final purchase price, including adjustments for working capital and indebtedness, was $24.5 million. The Company recognized a gain of $0.4 million on the sale of assets, which is recorded as a component of other income (expense), net, for the year ended December 31, 2016. The sale of the defense and security business did not meet the criteria for discontinued operations presentation as it did not represent a strategic shift that had a major effect on the Company's operations and financial results. The Company and iRobot Defense Holdings, Inc. have also entered into a Transition Services Agreement (TSA), pursuant to which the Company will continue to perform certain functions on iRobot Defense Holdings Inc.’s behalf during a transition period not to exceed 12 months. The TSA provides for the reimbursement of the Company for direct costs incurred in order to provide such functions and is recorded as a component of other income. For the year ended December 31, 2016 the Company recognized $1.2 million of TSA reimbursement. During the three months ended July 2, 2016, the Company decided to fully exit its remote presence business. As a result, the Company incurred restructuring charges of approximately $1.9 million related to the write-off of certain inventory, workforce reductions and the write-off of certain fixed assets. No restructuring charges were incurred in 2015. In 2014, the Company paid the remaining balance of the restructuring charges incurred in 2013. The activity for the restructuring program is presented below: 17. Industry Segment, Geographic Information and Significant Customers Prior to completing the sale of the Company's defense and security business (see Note 15), the Company’s reportable segments consisted of the home business unit and the defense and security business unit. Following this divestiture, which was completed on April 4, 2016, the Company now operates as one business segment, consumer robots, the results of which are included in the Company's consolidated statements of income and comprehensive income. The Company's consumer robots products are offered to consumers through a network of retail businesses throughout the United States, to various countries through international distributors and retailers, and through the Company's on-line store. Geographic Information For the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014, sales to non-U.S. customers accounted for 51.2%, 56.0% and 60.9% of total revenue, respectively. For the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014, sales to the Company's consumer robots distributor in Japan accounted for 12.9%, 13.3%, and 17.0% of total revenue, respectively. iROBOT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Significant Customers For the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014, U.S. federal government orders, contracts and subcontracts accounted for 0.2%, 5.1% and 4.3% of total revenue, respectively. For the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014 approximately 72.8%, 76.6% and 75.7%, respectively, of consumer robot product revenue resulted from sales to 15 customers. For the fiscal years ended December 31, 2016, January 2, 2016 and December 27, 2014, the Company generated an aggregate of 25.2%, 26.0% and 29.8%, respectively, of its total revenue from its consumer robots distributor in Japan (Sales on Demand Corporation) and a network of affiliated European distributors of the Company's consumer robots (Robopolis SAS). For the year ended December 31, 2016, the Company generated 10.4% of total revenue from one of the Company's domestic retailers (Amazon). During the third quarter of 2016, the Company identified immaterial errors to previously reported other income from an equity investee that was previously accounted for as a cost method investment. The amounts corrected out-of-period in other income resulted in a $1.4 million increase in the fourth quarter 2016 income before taxes. Of the $1.4 million adjustment, $1.2 million relates to prior years and $0.2 million relates to the first three quarters of 2016. The adjustment did not have a material impact on the reported financial positions or results of operations for the three and twelve months ended December 31, 2016. Additionally, had the errors been recorded in the prior period to which they relate, the impact would not have been material to the reported financial position or results of operations for those periods. During the fourth quarter of 2015, the Company identified immaterial errors to previously reported revenue due to certain customer allowances recorded at an incorrect rate and a reserve calculation which was overstated. The recorded out of period adjustment to revenue resulted in a $1.5 million increase in fourth quarter 2015 income before taxes. Of the $1.5 million adjustment, $0.7 million relates to prior years and $0.8 million relates to the first three quarters of 2015. The adjustment did not have a material impact on the reported financial position or results of operations for the three and twelve months ended January 2, 2016. Additionally, had the errors been recorded in the prior periods to which they relate, the impact would not have been material to the reported financial position or results of operations for those periods. | Based on the provided text, which appears to be an incomplete or fragmented financial statement, here's a summary of the key points:
Financial Statement Summary:
1. Reporting Period: Fiscal years ending December 31st, operating on a 52-week reporting cycle
2. Key Financial Aspects:
- Revenue: Not clearly specified
- Profit/Loss: A loss was recorded, impacting stockholders' equity
- Assets: Some fixed assets noted, with capitalized costs being amortized
- Liabilities: Various potential liabilities mentioned
3. Financial Estimation Approach:
- Management regularly evaluates estimates related to:
* Revenue recognition
* Sales returns
* Bad debts
* Warranty claims
* Inventory reserves
* Investment valuation
* Goodwill and intangible asset valuation
* Stock-based compensation
* Income taxes
4. | Claude |
FINANCIAL STATEMENTS AND OTHER SUPPLEMENTARY DATA ACCOUNTING FIRM We have audited the accompanying consolidated balance sheets of Heritage-Crystal Clean, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2016 and January 2, 2016, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Heritage-Crystal Clean, Inc. and subsidiaries as of December 31, 2016 and January 2, 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 3, 2017, expressed an unqualified opinion thereon. /s/ GRANT THORNTON LLP Chicago, IL March 3, 2017 ACCOUNTING FIRM Board of Directors and Stockholders Heritage-Crystal Clean, Inc. We have audited the internal control over financial reporting of Heritage-Crystal Clean, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2016, and our report dated March 3, 2017, expressed an unqualified opinion on those financial statements. /s/ GRANT THORNTON LLP Chicago, IL March 3, 2017 Heritage-Crystal Clean, Inc. Consolidated Balance Sheets (In Thousands, Except Share and Par Value Amounts) See accompanying notes to consolidated financial statements. Heritage-Crystal Clean, Inc. Consolidated Statements of Operations (In Thousands, Except per Share Amounts) See accompanying notes to consolidated financial statements. Heritage-Crystal Clean, Inc. Consolidated Statement of Stockholders’ Equity (In Thousands, Except Share Amounts) See accompanying notes to consolidated financial statements. Heritage-Crystal Clean, Inc. Consolidated Statements of Cash Flows See accompanying notes to consolidated financial statements. HERITAGE-CRYSTAL CLEAN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2016 (1) ORGANIZATION AND NATURE OF OPERATIONS Heritage-Crystal Clean, Inc., a Delaware corporation and its subsidiaries (collectively the “Company”), provides parts cleaning and hazardous and non-hazardous waste services to small and mid-sized customers in both the manufacturing and vehicle maintenance sectors. The Company's service programs include parts cleaning, containerized waste management, used oil collection, vacuum truck services, waste antifreeze collection and recycling, and field services. The Company owns and operates a used oil re-refinery where it re-refines used oils and sells high quality base oil for lubricants as well as other re-refinery products. The Company also has multiple locations where it dehydrates used oil. The oil processed at these locations is eventually sold as recycled fuel oil. The Company's locations are in the United States and Ontario, Canada. The Company conducts its primary business operations through Heritage-Crystal Clean, LLC, its wholly owned subsidiary, and all intercompany balances have been eliminated in consolidation. The Company’s fiscal year ends on the Saturday closest to December 31. "Fiscal 2016" represents the 52-week period ended December 31, 2016. "Fiscal 2015" represents the 52-week period ended January 2, 2016. "Fiscal 2014" represents the 53-week period ended January 3, 2015. The most recent fiscal year ended on December 31, 2016. Each of the Company's first three fiscal quarters consists of twelve weeks while the last fiscal quarter consists of sixteen or seventeen weeks. In the Company's Environmental Services segment, product revenues include sales of solvent, machines, absorbent, accessories, and antifreeze; service revenues include servicing of parts cleaning machines, drum waste removal services, vacuum truck services, field services, and other services. In the Company's Oil Business segment, product revenues include sales of re-refined base oil, recycled fuel oil, used oil, and other products; service revenues include revenues from used oil collection activities, collecting and disposing of waste water and removal and disposal of used oil filters. Due to the Company's integrated business model, it is impracticable to separately present costs of tangible products and costs of services. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Use of Estimates The preparation of financial statements in conformity with Generally Accepted Accounting Principles ("GAAP") requires the use of certain estimates by management in determining the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions are the allowance for doubtful accounts receivable, valuation of inventory at lower of cost or market, valuation of goodwill and other intangible assets, and income taxes. Actual results could differ from those estimates. Revenue Recognition The Company derives its revenues primarily from the services it performs and from the sale of processed oil from its used oil re-refinery. Parts cleaning and other service revenues are recognized as the service is performed. Product revenues are recognized at the time risk of loss passes to the customer. The risk of loss passes to customers at various times depending on the particular terms of the sales agreement in force with each individual customer. Common thresholds for when risk of loss passes to the customer are at the time that product is loaded onto the shipping vessel or at the time that product is offloaded at the customer’s receiving location. Revenues are recognized only if collection of the relevant receivable is probable, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Sales Tax Amounts billed for sales tax, value added tax, or other transactional taxes imposed on revenue producing transactions are presented on a net basis and are not recognized as revenues. Operating Costs Within operating costs are cost of sales. Cost of sales in the Environmental Services segment includes the cost of the materials the Company sells and provides in its services, such as solvents and other chemicals, transportation of inventory and waste, and payments to third parties to recycle or dispose of the waste materials that the Company collects. Parts cleaning machines are either sold to a customer or continue to be owned by the Company but placed offsite at a customer location to be used in parts cleaning services. When sold to a customer, machines are removed from inventory, and the costs are recognized under operating costs. The used solvent that the Company retrieves from customers in its product reuse program is accounted for as a reduction in net cost of solvent under cost of sales, whether placed in inventory or sold to a purchaser for reuse. If the used solvent is placed in inventory it is recorded at lower of cost or net realizable value. Cost of sales in the Oil Business include the costs paid to customers for used oil (if any), transportation out to customers, and costs to operate the used oil re-refinery, including utilities. Operating costs also include the Company's costs of operating its branch system and hubs. These costs include personnel costs (including commissions), facility rent and utilities, truck leases, fuel, transportation, and maintenance. Operating costs are not presented separately for products and services. Selling, General, and Administrative Expenses Selling, general, and administrative expenses include costs of performing centralized business functions, including sales management at or above the regional level, billing, receivables management, accounting and finance, information technology, environmental health and safety, and legal. Cash and Cash Equivalents The Company considers investments in highly liquid debt instruments, purchased with an original maturity of ninety days or less, to be cash equivalents. Concentration Risk The Company maintains its cash in bank deposit accounts at financial institutions that are insured by the Federal Deposit Insurance Corporation ("FDIC"). Cash balances may exceed FDIC limits. The Company has not experienced any losses in such accounts. The Company has a broad customer base and believes it is not exposed to any significant concentration of credit risk. Accounts Receivable Trade accounts receivable represent amounts due from customers. The allowance for doubtful accounts is the Company's best estimate of the amount of probable credit losses in the Company's existing accounts receivable. The Company determines the allowance based on analysis of customer credit worthiness, historical losses, and general economic trends and conditions. Accounts receivable are written off once the Company determines the account to be uncollectible. The Company does not have any off-balance-sheet credit exposure related to its customers. Inventory Inventory consists primarily of used oil, processed oil, catalyst, new and used solvents, new and refurbished parts cleaning machines, new and used antifreeze products, drums, and other items. Inventories are valued at the lower of first-in, first-out ("FIFO") cost or market, net of any reserves for excess, obsolete, or unsalable inventory. The Company performs a physical inventory count on a periodic basis and uses the results of these counts to determine inventory quantities. These quantities are used to help determine the value of the inventory. Processed oil inventory consists of the costs of feedstock, transportation, labor, conversion costs, and re-refining overhead costs incurred in bringing the inventory to its existing condition and location. Fixed production overhead costs are capitalized in processed oil inventory based on the normal capacity of the production facility. In periods of abnormal production levels, excess overhead costs are recognized as expense in the period they are incurred. The Company continually monitors its inventory levels at each of its distribution locations and evaluates inventories for excess or slow-moving items. If circumstances indicate the cost of inventories exceed their recoverable value, inventories are reduced to net realizable value. In fiscal 2016 and 2015, the Company wrote down $1.7 million and $9.2 million, respectively, in inventory due to sharply declining prices of oil and other petroleum-based products. Prepaid and Other Current Assets Prepaid and other current assets include, but are not limited to, insurance and vehicle license contract costs, which are expensed over the term of the underlying contract. Property, Plant, and Equipment Property, plant, and equipment are stated at cost. Expenditures for major renewals and betterments are capitalized, while expenditures for repair and maintenance charges are expensed as incurred. Property, plant, & equipment acquired in business combinations is stated at fair value as of the date of the acquisition. Depreciation of property, plant, and equipment is calculated using the straight-line method over the estimated useful lives of the assets. The estimated useful lives of buildings and storage tanks range from 10 to 39 years. The estimated useful lives of machinery, vehicles, and equipment range from 3 to 25 years. Leasehold improvements are amortized over the shorter of the lease terms or five years using the straight-line method. The Company capitalizes interest on borrowings during the active construction period of major capital projects. Capitalized interest is added to the cost of the underlying assets and is amortized over the useful lives of the assets once the assets are placed into service. The interest rate used to capitalize interest is based upon the borrowing rate on the Company's bank debt outstanding. In fiscal 2016, 2015, and 2014, the Company capitalized interest of $0.1 million, $0.6 million, and $0.4 million, respectively, for capital projects. Equipment at Customers The Company records purchases of new parts cleaning machines as inventory. Parts cleaning machines are either sold to a customer or continue to be owned by the Company but placed off-site at a customer location to be used in parts cleaning services. When sold to a customer, machines are removed from inventory, and the appropriate revenues and costs are recognized in the Income Statement. When the Company retains title to a machine that is placed off-site at a customer location to be used in parts cleaning services, the Company capitalizes the machine as a productive non-current asset under the Balance Sheet caption “Equipment at Customers” at the time the machine is placed at the customer’s site. Machines capitalized as Equipment at Customers are depreciated over their estimated useful lives of 7 to 15 years, depending on the model. Depreciation of in-service equipment commences when equipment is placed in service at a customer location. Expenditures for machines that are sold to a customer are treated as a cash outflow from operating activities on the Statement of Cash Flows. Expenditures for machines that are placed at a customer’s site to be used in parts cleaning services are treated as a cash outflow from investing activities. Acquisitions The Company accounts for acquired businesses using the purchase method of accounting, which requires that the assets acquired, liabilities assumed, and contingent consideration be recorded as of the date of acquisition at their respective fair values. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred and that restructuring costs be expensed in periods subsequent to the acquisition date. In many cases, the Company engages third party valuation appraisal firms to assist the Company in determining the fair values and useful lives of the assets acquired and liabilities assumed. The Company records a preliminary purchase price allocation for its acquisitions and finalizes purchase price allocations as additional information relative to the fair values of the assets acquired becomes known. Identifiable Intangible Assets The fair value of identifiable intangible assets is based on significant judgments made by management. The Company engaged third party valuation appraisal firms to assist the Company in determining the fair values and useful lives of the assets acquired. Such valuations and useful life determinations require the Company to make significant estimates and assumptions. These estimates and assumptions are based on historical experience and information obtained from the management of the acquired companies and include, but are not limited to, future expected cash flows to be earned from the continued operation of the acquired business and discount rates applied in determining the present value of those cash flows. Unanticipated events and circumstances may occur that could affect the accuracy or validity of such assumptions, estimates, or actual results. Acquisition-related finite lived intangible assets are amortized on a straight-line basis over their estimated economic lives. The Company evaluates the estimated benefit periods and recoverability of its intangible assets when facts and circumstances indicate that the lives may not be appropriate and/or the carrying value of the asset may not be recoverable. If the carrying value is not recoverable, impairment is measured as the amount by which the carrying value exceeds its estimated fair value. There were no impairment charges in fiscal 2016. Software Costs The Company expenses costs incurred in the research stage of developing or acquiring internal use software, such as research and feasibility studies, as well as costs incurred in the post-implementation/operational stage, such as maintenance and training. Capitalization of software costs occurs only after the research stage is complete and after the development stage begins. The capitalized costs are amortized on a straight-line basis over the estimated useful lives of the software, ranging from 5 to 10 years. Impairment of Long-Lived Assets Long-lived assets, such as property and equipment and intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized as the amount by which the carrying amount of the asset exceeds the fair value of the asset. There were no impairment charges in fiscal 2016. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. Income Taxes The Company accounts for income taxes to recognize the amount of taxes payable or refundable for the current year and the amount of deferred tax assets and liabilities resulting from the future tax consequences of differences between the financial statements and tax basis of the respective assets and liabilities. The Company estimates and reserves for any material uncertain tax position that is unlikely to withstand an audit by the taxing authorities. These estimates are based on judgments made with currently available information. The Company reviews these estimates and makes changes to recorded amounts of any uncertain tax positions as facts and circumstances warrant. For additional information about income taxes, see Note 14. Shipping Costs For all periods presented, amounts billed to customers related to shipping and handling are classified as revenue, and the Company's shipping and handling costs are included in operating costs. Research and Development Research and development costs are expensed as incurred within general, selling, and administrative expenses. Such costs incurred during fiscal 2016, 2015 and 2014 were $0.2 million, $0.2 million, and $0.2 million, respectively. Advertising Costs Advertising costs are expensed as incurred. Advertising expense was $0.5 million, $0.6 million, and $0.6 million for fiscal 2016, 2015, and 2014, respectively. Share-Based Compensation When a future restricted grant is approved, the Company evaluates the probability that the award will be granted, based on certain performance conditions. If the performance criteria are deemed probable, the Company accrues compensation expense related to these awards prior to the grant date. The Company accrues compensation expense based on the fair value of the performance awards at each reporting period when the performance criteria are deemed probable. Once the performance awards have been granted, the Company values the awards at fair value on the date of grant and amortizes the expense through the end of the vesting period, or requisite service period, on a straight-line basis. See Note 15 “Share-Based Compensation” for more details. Fair Value of Financial Instruments The Company uses a three-tier fair value hierarchy to classify and disclose all assets and liabilities measured at fair value on a recurring basis, as well as assets and liabilities measured at fair value on a non-recurring basis, in periods subsequent to their initial measurement. These tiers include: Level 1, defined as quoted market prices in active markets for identical assets or liabilities; Level 2, defined as inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, model-based valuation techniques for which all significant assumptions are observable in the market, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and Level 3, defined as unobservable inputs that are not corroborated by market data. The Company’s financial instruments consist primarily of cash and cash equivalents, trade receivables, trade payables, notes payable, and term debt. As of December 31, 2016 and January 2, 2016, the carrying values of cash and cash equivalents, trade receivables, trade payables, and notes payable are considered to be representative of their respective fair values due to the short maturity of these instruments. Term debt is representative of its fair value due to the interest rates being applied. Insurance and Self-Insurance Policy The Company purchases insurance providing financial protection from a range of risks; as of the end of fiscal 2016, the Company's insurance policies provided coverage for general liability, vehicle liability, and pollution liability, among other exposures. Each of these policies contains exclusions and limitations such that they would not cover all related exposures and each of these policies have maximum coverage limits and deductibles such that even in the event of an insured claim, the Company's net exposure could still have a material adverse effect on its financial results. The Company is self-insured for certain healthcare benefits provided to its employees. The liability for the self-insured benefits is limited by the purchase of stop-loss insurance. The stop-loss coverage provides payment for medical and prescription claims exceeding $200,000 per covered person, as well as an aggregate, cumulative claims cap for any given year. Accruals for losses are made based on the Company's claim experience and actuarial estimates based on historical data. Actual losses may differ from accrued amounts. At December 31, 2016 and January 2, 2016, the Company's liability for its self-insured benefits was $1.2 million and $1.0 million, respectively. Should actual losses exceed the amounts expected and the recorded liabilities be insufficient, additional expense will be recorded. Expenses incurred for healthcare benefits in fiscal 2016, 2015, and 2014 were $11.6 million, $11.6 million, and $10.3 million, respectively. Goodwill Goodwill is measured as a residual amount as of the acquisition date, which in most cases results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquiree over the fair value of the net assets acquired, including any contingent consideration. The Company tests goodwill for impairment annually in the fourth quarter and in interim periods if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company's determination of fair value requires certain assumptions and estimates, such as margin expectations, market conditions, growth expectations, expected changes in working capital, etc., regarding expected future profitability and expected future cash flows. The Company tests goodwill for impairment at each of its two reporting units, Environmental Services and Oil Business, and the Company does not aggregate reporting units for purposes of impairment testing. In fiscal 2015, we tested goodwill for impairment. In fiscal 2015, the fair value of the Environmental Services reporting unit was substantially in excess of its carrying value. In fiscal 2015, our tests indicated impairment of all of the goodwill in our Oil Business reporting unit. Therefore during the fourth quarter of fiscal 2015 we recorded a charge of approximately $4.0 million related to impairment of goodwill in our Oil Business reporting unit. The facts and circumstances leading to the impairment are primarily related to the deterioration of market conditions in the markets in which the Company’s Oil Business reporting unit operates. The deterioration of those market conditions is manifested in lower average selling prices for the Company’s re-refined lubricating base oil, recycled fuel oil, and byproducts within the Oil Business. The method for determining the fair value of the Oil Business reporting unit was a combination of an income approach using a discounted cash flow method in combination with a market approach using a guideline company method. There is a moderate degree of uncertainty associated with key Oil Business fair value assumptions such as the selling prices of our oil products and byproducts, the price paid or charged for raw material inputs such as used oil, operating efficiency of the used oil re-refinery, etc. A contraction of the spread between the selling prices of our oil products and the price paid or charged to vendors for raw material inputs could reasonably be expected to negatively affect the key assumptions used to determine fair value. In fiscal 2016, we tested goodwill for impairment. In fiscal 2016, the fair value of the Environmental Services reporting unit was substantially in excess of its carrying value. The Oil Business reporting unit had zero goodwill throughout fiscal 2016. Recently Issued Accounting Pronouncements (3) BUSINESS COMBINATIONS On December 2, 2016, the Company purchased the assets of Recycle Engine Coolant, Inc. ("REC"). The purchase price for the acquisition was $0.7 million, including $0.1 million placed into escrow. The Company purchased the assets of REC in order to expand our antifreeze recycling capabilities. On March 24, 2016, the Company purchased the assets of Phoenix Environmental Services, Inc. and Pipeline Video and Cleaning North Corporation (together "Phoenix Environmental"). The purchase price for the acquisition was $2.7 million, including $0.3 million placed into escrow. The Company purchased the assets of Phoenix Environmental in order to expand our service coverage area into the Pacific Northwest. Factors leading to goodwill being recognized are the Company's expectations of synergies from integrating Phoenix Environmental into the Company as well as the value of intangible assets that are not separately recognized, such as assembled workforce. On October 16, 2014, the Company purchased the outstanding stock of FCC Environmental LLC, a Delaware limited liability company, and International Petroleum Corp. of Delaware, a Delaware corporation (together "FCC Environmental"), pursuant to a Stock Purchase Agreement entered into with Dédalo Patrimonial S.L.U., a sociedad limitadad unipersonal formed under the laws of Spain ("Seller"). Prior to the purchase, FCC Environmental was an environmental services provider and substantial collector of used oil in the United States and operated 34 facilities in the eastern half of the United States. The purchase price for FCC Environmental was set at $90.0 million subject to certain adjustments, including, without limitation, a working capital adjustment and indemnification rights and obligations. Based on the initial working capital calculations, the Company initially paid $88.8 million. The Company and Seller have not finalized the working capital adjustment as of the end of fiscal year 2016. The eventual settlement of the working capital adjustment could have a material impact on the operating results of the Company. The results of FCC Environmental are consolidated into both of the Company's operating segments subsequent to the closing date. The Company incurred $4.5 million in due diligence, legal, and other expenses related to the acquisition, which are recorded in Selling, general, & administrative expenses in fiscal 2014. During the measurement period, the Company made adjustments to the provisional amounts reported as the estimated fair values of assets acquired and liabilities assumed as part of the FCC Environmental business combination. Compared to the provisional values reported as of January 3, 2015, the fair values presented in the table below reflect increases to: equipment at customers of $0.1 million; goodwill of $15.0 million; other intangibles of $1.9 million; deferred taxes of $0.8 million; and taxes payable of $3.0 million. Compared to the provisional values reported as of January 3, 2015, the fair values presented in the table below reflect decreases to: accounts receivable of $3.8 million; inventory of $0.2 million; other current assets of $0.1 million; property, plant, & equipment of $11.3 million; and accounts payable of $0.6 million. Goodwill recognized from the acquisition of FCC Environmental represents the excess of the purchase consideration transferred over the fair value of the net assets acquired. Factors leading to goodwill being recognized are the Company's expectations of synergies from combining operations of FCC Environmental and the Company as well as the value of intangible assets that are not separately recognized, such as assembled workforce. Goodwill of $24.5 million was assigned to the Environmental Services reporting unit, and zero goodwill was assigned to the Oil Business reporting unit. All goodwill is expected to be deductible for income tax purposes. On May 14, 2014, the Company, through a new subsidiary, Heritage-Crystal Clean, Ltd., acquired the outstanding stock of Sav-Tech Solvent, Inc. ("Sav-Tech"), which is based in Ontario, Canada. Sav-Tech's services included parts cleaning and containerized waste management. The Company purchased the stock of Sav-Tech in order to expand operations into Canada. The Company paid $1.4 million consisting of $1.0 million in cash at the time of closing, $0.2 million in the form of notes payable, and $0.2 million of the Company's common stock, or 12,005 shares. The results of Sav-Tech are consolidated into the Company's Environmental Services segment subsequent to the closing date. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed, net of cash acquired, related to each acquisition: _______________ (a) Subsequent to the closing date, the Company renewed the leases acquired from FCC Environmental, resulting in the classification of the leases as Operating leases under the new lease terms. The change in lease terms decreased both Property, plant, & equipment and Capital lease obligations by $5.9 million. Subsequent to the closing date, the Company has consolidated each acquisition into its financial statements. The Company has included revenues of approximately $1.7 million and pre-tax income of approximately $0.1 million in its fiscal 2016 financial results from its acquisitions in fiscal 2016. The Company has included revenues of approximately $19.5 million and pre-tax loss of approximately $7.3 million in its fiscal 2014 financial results from its acquisition of FCC Environmental. Unaudited Pro Forma Financial Information The pro forma financial information in the table below presents the combined results of the Company as if the Phoenix Environmental acquisition that occurred in fiscal 2016 had occurred January 3, 2015. The pro forma information is shown for illustrative purposes only and is not necessarily indicative of future results of operations of the Company or results of operations of the Company that would have actually occurred had the transactions been in effect for the periods presented. (4) ACCOUNTS RECEIVABLE Accounts receivable consisted of the following: The following table provides the changes in the Company’s allowance for doubtful accounts for the fiscal year ended December 31, 2016 and the fiscal year ended January 2, 2016: (5) INVENTORY Inventory consists primarily of used oil and processed oil, solvents and solutions, new and refurbished parts cleaning machines, drums and supplies, and other items. Inventories are valued at the lower of FIFO cost or market, net of any reserves for excess, obsolete, or unsalable inventory. The carrying value of inventory consisted of the following: The Company continually monitors its inventory levels at each of its locations and evaluates inventories for excess or slow-moving items. If circumstances indicate the cost of inventories exceed their recoverable value, inventories are reduced to net realizable value. In fiscal 2016, the Company recorded an inventory impairment charge of $1.7 million due to a sharp decline in crude oil prices, which resulted in the market value for the Company's oil-based inventory, and solvents and solutions inventory declining below the historic FIFO values. The inventory impairment charge in fiscal 2015 was $9.2 million. The following table provides the changes in the Company's machine refurbishing reserve related to inventory for fiscal years 2016 and 2015: (6) PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment consisted of the following: Depreciation expense was $14.7 million, $13.7 million, and $10.8 million for fiscal 2016, 2015 and 2014, respectively. (7) GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill is measured as a residual amount as of the acquisition date, which in most cases results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquiree over the fair value of the net assets acquired, including any contingent consideration. The Company tests goodwill for impairment annually in the fourth quarter and in interim periods if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company's determination of fair value requires certain assumptions and estimates, such as margin expectations, market conditions, growth expectations, expected changes in working capital, etc., regarding expected future profitability and expected future cash flows. The Company tests goodwill for impairment at each of its two reporting units, Environmental Services and Oil Business, and the Company does not aggregate reporting units for purposes of impairment testing. In fiscal 2015, we tested goodwill for impairment. In fiscal 2015, the fair value of the Environmental Services reporting unit was substantially in excess of its carrying value. In fiscal 2015, our tests indicated impairment of all of the goodwill in our Oil Business reporting unit. Therefore during the fourth quarter of fiscal 2015 we recorded a charge of approximately $4.0 million related to impairment of goodwill in our Oil Business reporting unit. The facts and circumstances leading to the impairment are primarily related to the deterioration of market conditions in the markets in which the Company’s Oil Business reporting unit operates. The deterioration of those market conditions is manifested in lower average selling prices for the Company’s re-refined lubricating base oil, recycled fuel oil, and byproducts within the Oil Business. The method for determining the fair value of the Oil Business reporting unit was a combination of an income approach using a discounted cash flow method in combination with a market approach using a guideline company method. There is a moderate degree of uncertainty associated with key Oil Business fair value assumptions such as the selling prices of our oil products and byproducts, the price paid or charged for raw material inputs such as used oil, operating efficiency of the used oil re-refinery, etc. A contraction of the spread between the selling prices of our oil products and the price paid or charged to vendors for raw material inputs could reasonably be expected to negatively affect the key assumptions used to determine fair value. In fiscal 2016, we tested goodwill for impairment. In fiscal 2016, the fair value of the Environmental Services reporting unit was substantially in excess of its carrying value. The Oil Business reporting unit had zero goodwill throughout fiscal 2016. The following table shows changes to our goodwill balances by segment during the years ended January 2, 2016, and December 31, 2016: Following is a summary of software and other intangible assets: Amortization expense was $3.3 million, $3.5 million, and $2.1 million for fiscal 2016, 2015, and 2014, respectively. The weighted average useful lives of software; customer and supplier relationships; patents, formulae, and licenses; non-compete agreements, and other intangibles were 9 years, 10 years, 15 years, 5 years, and 6 years, respectively. The expected amortization expense for fiscal years 2017, 2018, 2019, 2020 and 2021 is $3.2 million, $3.0 million, $2.6 million, $2.5 million, and $2.4 million, respectively. The preceding expected amortization expense is an estimate. Actual amounts of amortization expense may differ from estimated amounts due to additional intangible asset acquisitions, disposal of intangible assets, accelerated amortization of intangible assets, adjustment to purchase price allocations for assets acquired, and other events. No impairment of software or other intangible assets (excluding goodwill) was recorded in fiscal 2016, 2015, or 2014. (8) ACCOUNTS PAYABLE Accounts payable consisted of the following: (9) DEBT AND FINANCING ARRANGEMENTS Bank Credit Facility On October 16, 2014, the Company entered into a First and Second Amendment (collectively the "Amendments") to its Amended and Restated Credit Agreement ("Credit Agreement"). The Credit Agreement, as amended, provides for borrowings of up to $140.0 million, subject to the satisfaction of certain terms and conditions. The actual amount available under the revolving loan portion of the Credit Agreement is limited by the Company's total leverage ratio. The amount available to draw at any point in time would be further reduced by any standby letters of credit issued. Loans made under the Credit Agreement may be Base Rate Loans or LIBOR Rate Loans, at the election of the Company subject to certain exceptions. Base Rate Loans have an interest rate equal to (i) the higher of (a) the federal funds rate plus 0.5%, (b) the British Bankers Association LIBOR rate plus 1%, or (c) Bank of America's prime rate, plus (ii) a variable margin of between 1.0% and 2.0% depending on the Company's total leverage ratio, calculated on a consolidated basis. LIBOR rate loans have an interest rate equal to the (i) British Bankers Association LIBOR Rate plus (ii) a variable margin of between 2.0% and 3.0% depending on the Company's total leverage ratio. Amounts borrowed under the Credit Agreement are secured by a security interest in substantially all of the Company's tangible and intangible assets. The Credit Agreement requires the Company to consult with the bank on certain acquisitions and includes a prohibition on the payment of dividends. It also contains a number of financial covenants, including: • A capital expenditures covenant limiting capital expenditures to $15.0 with additional capital spending allowed for the expansion of our re-refinery to 75 million gallons of nameplate capacity if our leverage ratio was above 3.5 to 1.0 The Company's secured bank credit facility as of December 31, 2016 allowed for up to $140.0 million in borrowings. As of December 31, 2016 and January 2, 2016, the Company's total borrowings were $64.2 million and $70.9 million, respectively, under the term loan having a maturity date of February 5, 2018. The remaining portion of the credit facility was a revolving loan which was to expire on February 5, 2018 under which up to an additional $30.6 million was available (before considering standby letters of credit). There were no amounts outstanding under the revolver at December 31, 2016 and January 2, 2016. Unamortized debt issuance cost was $0.7 million and $1.4 million as of December 31, 2016 and January 2, 2016, respectively. As of December 31, 2016 and January 2, 2016, the Company was in compliance with all covenants under the credit facility then in effect. As of December 31, 2016, and January 2, 2016, the Company had $3.0 million and $4.4 million of standby letters of credit issued, respectively, and $27.6 million and $34.5 million was available for borrowing under the bank credit facility, respectively. During fiscal 2016, the Company recorded interest of $2.2 million on the term loan, of which $0.1 million was capitalized for various capital projects. In fiscal 2015, the Company recorded interest of $2.4 million on the term loan, of which $0.6 million was capitalized for various capital projects. The Company's weighted average interest rate as of December 31, 2016, January 2, 2016, and January 3, 2015 was 3.3%, 3.5%, and 3.2%, respectively. The Company's effective interest rate as of December 31, 2016, January 2, 2016, and January 3, 2015 was 3.3%, 3.1%, and 2.7%, respectively. Notes Payable At December 31, 2016, the Company had no short-term notes payable related to acquisitions. At January 2, 2016, the Company had notes payable related to acquisitions of less than $0.1 million. Future Maturities The aggregate contractual annual maturities for debt as of December 31, 2016 are as follows: (10) EMPLOYEE BENEFIT PLAN Heritage-Crystal Clean offers a defined contribution benefit plan for its employees. All regular employees who have completed at least one hour of service are eligible to participate in the plan. Participants are allowed to contribute 1% to 70% of their pre-tax earnings to the plan. The Company matches 100% of the first 3% contributed by the participant and 50% of the next 2% contributed by the participant for a maximum contribution of 4% per participant. The Company's matching contribution under this plan was $1.7 million, $1.5 million, and $1.2 million in fiscal 2016, 2015, and 2014, respectively. (11) RELATED PARTY AND AFFILIATE TRANSACTIONS As of December 31, 2016, the Heritage Group beneficially owned 33.8% of the Company's common stock, the Fehsenfeld Family Trusts, which are related to the Heritage Group owned 6.9% of the Company's common stock, and Fred Fehsenfeld, Jr., the Chairman of the Board and an affiliate of the Heritage Group, beneficially owned 4.6% of the Company's common stock. Companies affiliated with the Heritage Group are listed as affiliates. During fiscal 2016, 2015, and 2014, the Company had transactions with the Heritage Group affiliates and other related parties. The following table sets forth related-party transactions: Revenues from related parties and affiliates are for sales of products and services performed by the Company. Payments to related parties and affiliates include solvent purchases, insurance premiums, disposal services, transportation, and various other services. The Company participates in a self-insurance program for workers' compensation with a shareholder and several related companies. In connection with this program, payments are made to the shareholder. Expenses paid to the shareholder in fiscal 2016, 2015, and 2014 were approximately $2.2 million, $1.4 million, and $1.3 million, respectively. (12) SEGMENT INFORMATION The Company reports in two segments: "Environmental Services" and "Oil Business." The Environmental Services segment consists of the Company's parts cleaning, containerized waste management, vacuum truck services, used antifreeze recycling activities, and field services. The Oil Business segment consists of the Company's used oil collection, recycled fuel oil sales, used oil re-refining activities, and used oil filter removal and disposal services. No customer represented greater than 10% of consolidated revenues for any of the periods presented. There were no intersegment revenues. The Environmental Services segment operates in the United States and, to an immaterial degree, in Ontario, Canada. As such, the Company is not disclosing operating results by geographic segment. Operating segment results for the fiscal years ended December 31, 2016, January 2, 2016, and January 3, 2015 were as follows: Total assets by segment as of December 31, 2016 and January 2, 2016 were as follows: Segment assets for the Environmental Services and Oil Business segments consist of property, plant, and equipment, intangible assets, goodwill, accounts receivable, and inventories allocated to each segment. Assets for the corporate unallocated amounts consist of cash, prepaids, and property, plant, and equipment used at the corporate headquarters. Total capital expenditures, including business acquisitions net of cash acquired, by segment for fiscal 2016, 2015, and 2014 were as follows: (13) COMMITMENTS AND CONTINGENCIES The Company may enter into purchase obligations with certain vendors. They represent expected payments to third party service providers and other commitments entered into during the normal course of our business. These purchase obligations are generally cancelable with or without notice without penalty, although certain vendor agreements provide for cancellation fees or penalties depending on the terms of the contract. The Company had purchase obligations in the form of open purchase orders of $9.7 million as of December 31, 2016, and $9.8 million as of January 2, 2016, primarily for capital expenditures, used oil, catalyst, disposal, and solvent. The Company may be subject to investigations, claims, or lawsuits as a result of operating its business, including matters governed by environmental laws and regulations. When claims are asserted, the Company evaluates the likelihood that a loss will occur and records a liability for those instances when the likelihood is deemed probable and the exposure is reasonably estimable. The Company carries insurance at levels it believes are adequate to cover loss contingencies based on historical claims activity. When the potential loss exposure is limited to the insurance deductible and the likelihood of loss is determined to be probable, the Company accrues for the amount of the required deductible, unless a lower amount of exposure is estimated. As of December 31, 2016 and January 2, 2016, the Company had accrued $5.5 million and $6.0 million related to loss contingencies, respectively. The Company leases office space, equipment and vehicles under noncancelable operating leases that expire at various dates through 2025. Many of the building leases obligate the Company to pay real estate taxes, insurance, and certain maintenance costs and contain multiple renewal provisions, exercisable at the Company's option. Leases that contain predetermined fixed escalations of the minimum rentals are recognized in rental expense on a straight-line basis over the lease term. Rental expense under operating leases was approximately $26.2 million, $26.5 million, and $21.8 million for fiscal years 2016, 2015, and 2014, respectively. Future minimum lease payments under noncancelable operating leases as of December 31, 2016 are as follows: (14) INCOME TAXES The Company deducted for federal income tax purposes accelerated "bonus" depreciation on the majority of its capital expenditures for assets placed in service in fiscal 2012 through fiscal 2016. Therefore, the Company recorded a noncurrent deferred tax liability as to the difference between the book basis and the tax basis of those assets. In addition, as a result of the federal bonus depreciation, the Company recorded a Net Operating Loss ("NOL") of $44.7 million, which will begin to expire in 2031. The balance on the federal NOL at December 31, 2016 was $44.4 million, and the remaining deferred tax asset related to the Company's state and federal NOL was a tax effected balance of $16.2 million. The Company recognizes windfall tax benefits associated with the exercise of stock options and the vesting of restricted stock directly to stockholders' equity only when realized. Consequently, deferred tax assets are not recognized for NOLs resulting from windfall tax benefits. At December 31, 2016, deferred tax assets do not include $2.5 million of gross excess tax benefits from share-based compensation. The Company's effective tax rate for fiscal 2016 was 31.9% compared to 38.9% in fiscal 2015. The rate difference is principally attributable to the differing treatment of transaction related costs for financial reporting purposes and for purposes of determining income tax liabilities. Components of the Company's income tax benefit and provision consist of the following for fiscal years 2016, 2015, and 2014: A reconciliation of the expected income tax (benefit) expense at the statutory federal rate to the Company's actual income tax (benefit) expense is as follows: Components of deferred tax assets (liabilities) are as follows: The Company increased its valuation allowance due to non-utilized state NOL’s generated by International Petroleum Corporation of Delaware that cannot be utilized by Heritage-Crystal Clean, Inc. As of December 31, 2016, the Company is no longer subject to U.S. federal examinations by taxing authorities for years prior to 2014. Federal and state income tax returns for fiscal years 2013 through 2016 are still open for examination. The Company establishes reserves when it is more likely than not that the Company will not realize the full tax benefit of a position. The Company had a reserve of $2.4 million and $2.5 million for uncertain tax positions as of December 31, 2016 and January 2, 2016, respectively. The gross unrecognized tax benefits would, if recognized, decrease the Company's effective tax rate. Although it is reasonably possible that certain unrecognized tax benefits may increase or decrease within the next twelve months due to tax examination changes, settlement activities, expirations of statute of limitations, or the impact on recognition and measurement considerations related to the results of published tax cases or other similar activities, we do not anticipate any significant changes to unrecognized tax benefits over the next 12 months. The Company recognizes interest and penalties associated with income tax liabilities as income tax expense in the Statement of Operations. No significant penalties or interest are included in income taxes or accounted for on the balance sheet related to unrecognized tax positions as of December 31, 2016. The following table summarizes the movement in unrecognized tax benefits: (15) SHARE-BASED COMPENSATION The aggregate number of shares of common stock which may be issued under the Company’s 2008 Omnibus Plan ("Plan") is 1,902,077 plus any common stock that becomes available for issuance pursuant to the reusage provision of the Plan. As of December 31, 2016, the number of shares available for issuance under the Plan was 553,970 shares. Stock Option Awards A summary of stock option activity under this Plan is as follows: _____________ (a) There were no stock option exercises in fiscal 2015. Restricted Stock Compensation/Awards Annually, the Company grants restricted shares to its Board of Directors. The shares become fully vested one year from their grant date. The fair value of each restricted stock grant is based on the closing price of the Company's stock on the date of grant. The Company amortizes the expense over the service period, which is the fiscal year in which the award is granted. On May 5, 2016, the Company granted 28,674 restricted shares for service in fiscal 2016. Expense related to the Board of Directors' restricted stock in fiscal 2016, 2015, and 2014 was $0.3 million per year. The 22,638 shares that were granted to the Board in fiscal 2015 vested on May 8, 2016. In February 2014, the Company granted certain members of management 132,107 restricted shares under the Company's 2013 LTIP. These restricted shares were subject to vesting over a three year period which began January 1, 2015. In fiscal 2016 $0.5 million of compensation expense was recorded related to these awards, and $0.6 million was recorded in both fiscal 2015 and 2014. This award was fully expensed at December 31, 2016 and all shares fully vested on January 1, 2017. In February 2015, the Company granted certain members of management 38,372 restricted shares based on their services in fiscal 2014, contingent upon the employees' continued employment with the Company. The restricted shares vest over a three year period which began January 1, 2016. There was approximately $0.1 million and $0.2 million in unrecognized compensation expense remaining related to these awards as of December 31, 2016 and January 2, 2016, respectively. In each of fiscal 2016 and 2015, $0.1 million of compensation expense was recorded related to these awards. In January 2016, the Company granted certain members of management 43,208 restricted shares based on their services in fiscal 2015, contingent upon the employees' continued employment with the Company. The restricted shares vest over a period of approximately three years which began January 1, 2017 ending with the final vesting in January 2019. There was approximately $0.2 million and $0.3 million in unrecognized compensation expense remaining related to these awards as of December 31, 2016 and January 2, 2016 respectively. In fiscal 2016 and 2015, $0.1 million of compensation expense was recorded related to these awards. The following table summarizes information about restricted stock awards for the periods ended January 2, 2016 and December 31, 2016: Employee Stock Purchase Plan The Employee Stock Purchase Plan of 2008 ("ESPP") is a shareholder approved plan under which all employees regularly scheduled to work 20 or more hours per week may purchase the Company’s common stock through payroll deductions at a price equal to 95% of the fair market values of the stock as of the end of the first day following each three-month offering period. An employee’s payroll deductions under the ESPP are limited to 10% of the employee’s regular earnings, and employees may not purchase more than $25,000 of stock during any calendar year. As of December 31, 2016, the Company had reserved 56,179 shares of common stock available for purchase under the ESPP. In fiscal 2016, employees purchased 39,805 shares of the Company’s common stock with a weighted average fair market value of $11.19 per share. (16) STOCKHOLDERS' EQUITY There were no common stock offerings in fiscal 2016 or in fiscal 2015. In the fourth quarter of fiscal 2014, the Company completed a follow-on public offering of common stock. In the follow-on offering, the Company sold 3,565,000 additional shares of common stock at $10.00, raising net proceeds of approximately $33.4 million, after underwriting discounts and transaction costs. The Company used a portion of the net proceeds to pay off the outstanding balance of its revolving credit facility of approximately $9.0 million. Heritage Participation Rights The Company has a Participation Rights Agreement with The Heritage Group (“Heritage”), an affiliate of Heritage-Crystal Clean, Inc. pursuant to which Heritage has the option to participate, pro rata based on its percentage ownership interest in the Company's common stock in any equity offerings for cash consideration, including (i) contracts with parties for equity financing (including any debt financing with an equity component) and (ii) issuances of equity securities or securities convertible, exchangeable or exercisable into or for equity securities (including debt securities with an equity component). If Heritage exercises its rights with respect to all offerings, it will be able to maintain its percentage ownership interest in the Company's common stock. The Participation Rights Agreement does not have an expiration date. Heritage is not required to participate or exercise its right of participation with respect to any offerings. Heritage's right to participate does not apply to certain offerings of securities that are not conducted to raise or obtain equity capital or cash such as stock issued as consideration in a merger or consolidation, in connection with strategic partnerships or joint ventures, or for the acquisition of a business, product, license, or other asset by the Company. (17) EARNINGS PER SHARE The following table reconciles the number of shares outstanding for fiscal 2016, 2015, and 2014 respectively, to the number of weighted average basic shares outstanding and the number of weighted average diluted shares outstanding for the purposes of calculating basic and diluted earnings per share: (18) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (a) Reflects a sixteen week quarter. (19) SUBSEQUENT EVENTS On February 21, 2017, the Company entered into a Credit Agreement ("Credit Agreement"). The Credit Agreement provides for borrowings of up to $95.0 million, subject to the satisfaction of certain terms and conditions, comprised of a term loan of $30.0 million and up to $65.0 million of borrowings under the revolving loan portion. The actual amount available under the revolving loan portion of the Credit Agreement is limited by the Company's total leverage ratio. The amount available to draw at any point in time would be further reduced by any standby letters of credit issued. Loans made under the Credit Agreement may be Base Rate Loans or LIBOR Rate Loans, at the election of the Company subject to certain exceptions. Base Rate Loans have an interest rate equal to (i) the higher of (a) the federal funds rate plus 0.5%, (b) the London Interbank Offering Rate (“LIBOR”) plus 1%, or (c) Bank of America's prime rate, plus (ii) a variable margin of between 0.75% and 1.75% depending on the Company's total leverage ratio, calculated on a consolidated basis. LIBOR rate loans have an interest rate equal to (i) the LIBOR rate plus (ii) a variable margin of between 1.75% and 2.75% depending on the Company's total leverage ratio. Amounts borrowed under the Credit Agreement are secured by a security interest in substantially all of the Company's tangible and intangible assets. On February 21, 2017, the Company received notification of a partial award with respect to the arbitration proceedings brought against Dédalo Patrimonial S.L.U. (“Seller”), the Seller of FCC Environmental. On February 24, 2017, the Company received funds totaling approximately $5.5 million from the Seller pursuant to the aforementioned partial award pertaining to the price adjustment claim related to working captial together with pre-judgment interest. We will record a gain related to this award during the first quarter of fiscal 2017. | Here's a summary of the key points from this financial statement:
Revenue Recognition & Sales:
- Revenue is recognized when risk of loss passes to customers
- Collection must be probable and sales price fixed
- Sales tax is presented on a net basis and not recognized as revenue
Operating Costs Include:
- Cost of materials, transportation, and waste disposal
- Parts cleaning machine costs
- Used oil re-refinery operating costs
- Branch system and hub operations
- Personnel costs, rent, utilities, and maintenance
Assets:
- Cash and cash equivalents (90-day maturity or less)
- Accounts receivable from customers
- Inventory (used/processed oil, solvents, machines, etc.)
- Property, plant, and equipment
- Prepaid expenses
Liabilities:
- Bank deposits (may exceed FDIC limits)
- Trade accounts payable
- No significant off-balance-sheet exposures
Key Accounting Practices:
- FIFO inventory valuation method
- Regular physical inventory counts
- Allowance for doubtful accounts based on credit analysis
- Straight-line depreciation for property/equipment
- Fixed production overhead costs capitalized in processed oil inventory
Risk Management:
- Broad customer base to minimize concentration risk
- FDIC-insured bank accounts
- Regular monitoring of inventory levels
- Credit risk assessment for accounts receivable | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Texas South Energy, Inc. Financial Statements October 31, 2016 Page Report of Independent Registered Public Accounting Firm Balance Sheets as of October 31, 2016 and 2015 Statements of Operations and Comprehensive Loss for the Years Ended October 31, 2016 and 2015 Statements of Stockholders’ Equity for the Years ended October 31, 2016 and October 31, 2015 Statements of Cash Flows for the Years Ended October 31, 2016 and 2015 Notes to the Financial Statements LBB & ASSOCIATES LTD., LLP 10260 Westheimer Road, Suite 310 Houston, TX 77042 Phone: (713) 800-4343 Fax: (713) 456-2408 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Texas South Energy, Inc. Houston, Texas We have audited the accompanying balance sheets of Texas South Energy, Inc. (the “Company”) as of October 31, 2016 and 2015, and the related statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the years in the two-year period ended October 31, 2016 and 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Texas South Energy, Inc. as of October 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the two-year period ended October 31, 2016 and 2015 in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 3 to the financial statements, the Company’s absence of significant revenues, recurring losses from operations, and its need for additional financing in order to fund its projected loss in 2017 raise substantial doubt about its ability to continue as a going concern. The 2016 financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ LBB & Associates Ltd., LLP LBB & Associates Ltd., LLP Houston, Texas February 13, 2017 Texas South Energy, Inc. BALANCE SHEETS The accompanying notes are an integral part of these financial statements Texas South Energy, Inc. STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS The accompanying notes are an integral part of these financial statements Texas South Energy, Inc. STATEMENTS OF STOCKHOLDERS’ EQUITY The accompanying notes are an integral part of these financial statements Texas South Energy, Inc. STATEMENTS OF CASH FLOWS The accompanying notes are an integral part of these financial statements Texas South Energy, Inc. NOTES TO THE FINANCIAL STATEMENTS October 31, 2016 NOTE 1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION Texas South Energy, Inc. (the “Company”) was incorporated pursuant to the laws of the State of Nevada on March 15, 2010. The Company is engaged in the oil and gas business. The Company has limited operating history and has earned nominal revenues to date. The Company has devoted its activities to the acquisition of oil and gas assets. The Company has incurred losses since inception of $8,602,570 as of October 31, 2016. The Company has established a fiscal year end of October 31. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). Cash and Cash Equivalents The Company considers all highly liquid instruments with a maturity of three months or less at the time of issuance to be cash equivalents. Use of Estimates and Assumptions The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While management believes that such estimates are reasonable when considered in conjunction with the financial position and results of operations taken as a whole, actual results could differ from those estimates, and such differences may be material to the financial statements. Basic and Diluted Net Loss per Share The Company computes loss per share in accordance with ASC 260, “Earnings per Share” which requires presentation of both basic and diluted earnings per share on the face of the statement of operations. Basic loss per share is computed by dividing net loss available to common shareholders by the weighted average number of outstanding common shares during the period. Diluted loss per share gives effect to all dilutive potential common shares outstanding during the period. Dilutive loss per share excludes all potential common shares if their effect is anti-dilutive. The Company has no potential dilutive instruments and accordingly basic loss and diluted loss per share are the same. Fair Value In accordance with the requirements of ASC 825 and ASC 820, the Company has determined the estimated fair value of financial instruments using available market information and appropriate valuation methodologies. The fair value of financial instruments classified as current assets or liabilities approximate their carrying value due to the short-term maturity of the instruments. Income Taxes The Company has adopted ASC 740 for reporting purposes. As of October 31, 2016, the Company had net operating loss carryforwards of approximately $5,576,000 that may be available to reduce future years’ taxable income and will expire beginning in 2028. Availability of loss usage is subject to change of ownership limitations under Internal Revenue Code 382. Future tax benefits which may arise as a result of these losses have not been recognized in these financial statements, as their realization is determined not likely to occur and accordingly, the Company has recorded a valuation allowance for the future tax loss carryforwards. The Company believes that its income tax filing positions and deductions will more-likely-than-not be sustained on audit and does not anticipate any adjustments that will result in a material adverse effect on the Company’s financial condition, results of operations or cash flows. Therefore, no reserves for uncertain income tax positions have been recorded. The Company is subject to income tax examinations by the U.S federal, state, or local tax authorities for years since inception to date. Stock-based Compensation The Company has not adopted a stock option plan and has not granted any stock options. Common stock has been granted to third parties for services rendered (see Note 5 - Common Stock). In December 2004, the Financial Accounting Standards Board (“FASB”) issued ASC 718 “Compensation - Stock Compensation” and 505-50 “Equity-Based Payments to Non-Employees.” This statement requires a public entity to expense the cost of services received in exchange for an award of equity instruments. This statement also provides guidance on valuing and expensing these awards, as well as disclosure requirements of these equity arrangements. The Company adopted ASC 718 and 505-50 upon creation of the Company and expenses share based costs in the period incurred. Accounting for Oil and Gas Properties The Company utilizes the full cost method to account for its investment in oil and gas properties. Accordingly, all costs associated with acquisition, exploration and development of oil and gas reserves, including such costs as leasehold acquisition costs, professional fees incurred for the lease acquisitions, capitalized interest costs relating to properties, geological expenditures, and tangible and intangible development costs (including direct internal costs), are capitalized into the full cost pool. When the Company commences production from established proven oil and gas reserves, capitalized costs, including estimated future costs to develop the reserves and estimated abandonment costs, will be depleted on the units-of-production method using estimates of proven reserves. Investments in unproved properties and major development projects, including capitalized interest if any, are not depleted until proven reserves associated with the projects can be determined. If the future exploration of unproven properties is determined to be uneconomical, the amount of such properties is added to the capital costs to be depleted. As of October 31, 2016, the Company’s oil and gas properties consisted of capitalized acquisition costs for unproved mineral rights. Investment Securities Investment securities are composed of 5 million shares of GulfSlope common stock, and are classified as “available-for-sale”. Available-for-sale securities are adjusted to their fair market value with unrealized gains and losses, net of tax, recorded as a component of accumulated other comprehensive income. Upon disposition of these investments, the specific identification method is used to determine the cost basis in computing realized gains or losses, which are reported in other income and expense. Declines in value that are judged to be other than temporary are reported in other comprehensive income and expense. During the year ended October 31, 2016, the Company recorded a realized loss of $218,000 to adjust the investment securities to fair market value. In February 2016, the GulfSlope shares were sold to a third party for $50,000. Recent Accounting Pronouncements In May 2014, the FASB issued its final standard on revenue from contracts with customers. The standard, issued as ASU No. 2014-09: Revenue from Contracts with Customers (Topic 606) by the FASB, outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” ASU 2014-09 becomes effective for reporting periods (including interim periods) beginning after December 15, 2017. Early application is permitted for reporting periods (including interim periods) beginning after December 15, 2016. This new standard permits the use of either the retrospective or cumulative effect transition method. Because the Company has no revenues, the new guidance is not expected to have a material impact on its financial statements and related disclosures. In August 2014, the FASB issued Accounting Standard Update No. 2014-15, Presentation of Financial Statements Going Concern (Subtopic 205-40) which requires management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, this standard provides a definition of the term substantial doubt and requires an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). It also requires certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans and requires an express statement and other disclosures when substantial doubt is not alleviated. The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early application is permitted. The Company is currently evaluating the accounting impact that this pronouncement will have on its financial statements. Other new pronouncements issued but not effective until after October 31, 2016 are not expected to have a material impact on the Company’s financial position, results of operations, or cash flows. NOTE 3 - GOING CONCERN The Company’s financial statements are prepared in accordance with generally accepted accounting principles applicable to a going concern. This contemplates the realization of assets and the liquidation of liabilities in the normal course of business. Currently, the Company does not have sufficient cash, nor does it have operations or a source of revenue sufficient to cover its operation costs and allow it to continue as a going concern. The Company has accumulated losses as of October 31, 2016, of $8,602,570. The Company will be dependent upon the raising of additional capital through the best- efforts placement of its equity and/or debt securities in order to implement its business plan. There can be no assurance that the Company will be successful in either situation in order to continue as a going concern. These factors raise substantial doubt regarding the Company’s ability to continue as a going concern. These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of liabilities that might result from this uncertainty. NOTE 4 - OIL & GAS PROPERTIES On January 22, 2014, the Company entered into a contract for sale with the owner of mineral interests in 86.69 acres in Lavaca County, Texas (the “Acreage”) pursuant to which the Company acquired a 37.5% interest in the Acreage’s mineral rights, including the oil and gas rights (the “Acquired Interest”). In exchange for the Acquired Interest, the Company paid the seller $270,000 in cash and issued the seller 2,000,000 shares of the Company’s common stock, valued at $100,000. In June 2016, the Company sold the Acreage and Acquired Interest to Mr. Askew, former director and chief executive officer, for $170,000, paid through the reduction of $170,000 owed to Mr. Askew by the Company. On March 10, 2014, the Company entered into a farm out letter agreement with GulfSlope, relating to certain prospects (the “Prospects”) located within 2.2 million acres of 3D seismic licensed and interpreted by GulfSlope. At the time the farm out agreement was entered into, the Company’s chief executive officer and sole director, Mr. Askew, was also a director of GulfSlope. Mr. Askew resigned as a director of GulfSlope effective March 27, 2014. Under the terms of the farm-out letter agreement as amended in September 2015, the Company acquired contractual rights to a 20% working interest in six prospects for aggregate consideration of $10,000,000, of which the last installment of $1,800,000 was paid in September 2015. During the year ended October 31, 2015, the Company had advanced $8,200,000 towards the acquisition of the mineral interests. The Company agreed to pay its proportionate share of the net rental costs related to the Prospects. GulfSlope will be the operator of record and shall have the right to negotiate all future joint operating agreements. The mineral interests are unproved as of October 31, 2016. In May 2016, we entered into a letter of intent with GulfSlope that sets out the terms and conditions of a farm-out arrangement to develop certain shallow-depth oil and gas prospects located on offshore Gulf of Mexico blocks currently leased by GulfSlope. The shallow prospects are located above 5,100 feet vertical depth on the Vermilion Area, South Addition Block 378 (“Canoe Shallow”) and Vermilion Area, South Addition Block 375 (“Selectron Shallow”, and collectively with Canoe Shallow, “Shallow Prospects”). We own a 70.7% working interest in the Shallow Prospects (with a third party owning a 16.8% working interest and GulfSlope owning a 12.5% working interest) which we acquired in exchange for (i) cash payments of $400,000, (ii) the payment of annual rental obligations of $63,147, and (iii) the agreement to fund, or cause to be funded, the costs for the drilling of two shallow wells to be commenced no later than December 31, 2017. GulfSlope is currently the Operator of the first two wells. Consummation of the transactions is subject to further negotiation, the execution and delivery by the parties of mutually acceptable definitive agreements to include a participation agreement and the joint operating agreement, and the satisfaction of certain additional conditions. NOTE 5 - COMMON STOCK During September and October 2015, the Company received cash of $1,297,000 for the issuance of 64,850,000 shares at $0.02 per share. The shares were issued in December 2015. In December 2015, the Company received cash of $105,000 for the issuance of 5,250,000 shares at $0.02 per share. The shares were issued in December 2015. In the same month, the Company issued 550,000 shares of common stock to a third party for services rendered. The stock was valued at $11,000. In June 2016, (i) John B. Connally III forgave $170,000 in accrued consulting fees for 8.5 million shares of Company common stock, valued at $.02 per share, (ii) James M. Askew forgave $280,000 owed to him by the Company for 14.0 million shares of Company common stock, valued at $.02 per share, and (iii) the Company issued a third party 10.0 million shares of Company common stock in connection with a short-term line of credit. In July 2016, the Company issued 11,500,000 shares of common stock, of which 6,000,000 was issued for services rendered valued at $0.02 per share, and 5,500,000 was issued for cash of $110,000 which proceeds from the private placement will be used for general corporate purposes. In August 2016, the Company issued an aggregate of 50 million shares of its common stock at a purchase price of $0.02 per share receiving gross proceeds of $1 million. The Company used the proceeds from the private placement for general corporate purposes. On June 17, 2016, the Company issued 625,000 shares of its common stock at a purchase price of $0.02 per share receiving gross proceeds of $12,500, which proceeds were used for general corporate purposes. Effective July 29, 2016, the Company issued 7,000,000 shares of common stock at a purchase price of $0.02 per share receiving gross proceeds of $140,000, which proceeds were used for general corporate purposes. Effective July 29, 2016, the Company issued 5,000,000 shares of common stock upon conversion of $100,000 principal amount of outstanding indebtedness at a conversion price of $0.02 per share. On August 24, 2016, the Company issued 2,500,000 shares of common stock at a purchase price of $0.02 per share receiving gross proceeds of $50,000, which proceeds were used for general corporate purposes. As of October 31, 2016, the Company has not granted any stock options. NOTE 6 - RELATED PARTY TRANSACTIONS See Note 4 for a description of the sale of Acreage and Acquired Interest by the Company in June 2016 to Mr. Askew. In October 2015, the Company entered into related party promissory note payable agreement with its director and chief executive officer James Askew for $82,918. The principal and related accrued interest is payable on demand and bears interest at a fixed rate of 5% per annum. As of October 31, 2015, the outstanding principal balance was $17,918 and is included in ‘Due to related party’ on the Company’s balance sheet. This amount was paid in full in fiscal 2016. As of October 31, 2016 and 2015, the Company had received advances from a prior director in the amount of $52,152. The amounts due to the related party remain outstanding, unsecured due on demand and non-interest bearing with no set terms of repayment. These advances are recorded within the ‘Due to related party’ line on the balance sheet. In September 2013, the Company entered into an employment agreement with its chief executive officer James Askew that was amended to extend the term of the agreement to September 30, 2018. As of October 31, 2015, the Company had not paid Jim Askew $385,000 in accordance with his employment agreement and this amount is accrued within ‘Accrued expenses - related party’ on the balance sheet. During the year ended October 31, 2016, the Company made cash payments and issued Mr. Askew 14 million shares of common stock in exchange for $280,000 of the accrued compensation. Additionally, in accordance with the employment agreement, the Company paid Mr. Askew $420,000 for compensation and a $50,000 bonus for the fiscal year ended October 31, 2016, During the years-ended October 31, 2015 and 2016, the Company’s chief executive officer and sole director paid numerous vendors on behalf of the Company. As of October 31, 2015 and 2016, the Company had $90,125 and $15,906, respectively, accrued within the ‘Accrued expenses - related party’ line on the balance sheet. This amount was paid in full in November 2016. NOTE 7 - NOTES PAYABLE Effective June 2014, we borrowed a principal amount of $1,000,000 from a third party, which promissory note bears interest at a fixed rate of 10% per annum. In June 2015, the maturity date was extended from June 30, 2015 to June 30, 2016 and the principal amount of the note was increased to $1,100,000. On March 11, 2016, the maturity date the of the $1,100,000 note payable balance was extended from June 31, 2016 to October 1, 2017. As of October 31, 2016 and 2015, the outstanding principal balance was $1,100,000 and $1,100,000 respectively and is included in ‘Notes payable’ as a current liability on the Company’s balance sheet. In October 2015, the Company entered into a note payable agreement with an accredited investor for $700,000, and in July 2016 a principal amount of $100,000 of the note was converted into 5,000,000 shares of common stock. The note expires on October 1, 2017 and bears interest at a fixed rate of 10% per annum. As of October 31, 2015, the outstanding principal balance of $700,000 is included in ‘Notes payable - long term’ and as of October 31, 2016, the outstanding principal balance of $600,000 is included in “Notes payable” as a current liability on the Company’s balance sheet. In October 2015 and November 2015, the Company entered into related party promissory notes payable agreements with its director and chief executive officer James Askew. In December 2015, the principal balances were paid in full by the Company (see Note 6 - Related Party Transactions). NOTE 8 - NOTES RECEIVABLE In October 2016, the Company loaned the principal amount of $47,138 to a third party under an interest free, demand promissory note agreement for the purpose of travel expenses. Subsequent to October 31, 2016, the note was further increased to $131,645. NOTE 9 - INCOME TAXES The Company follows ASC 740. Deferred income taxes reflect the net effect of (a) temporary difference between carrying amounts of assets and liabilities for financial purposes and the amounts used for income tax reporting purposes, and (b) net operating loss carryforwards. No net provision for refundable Federal income tax has been made in the accompanying statement of loss because no recoverable taxes were paid previously. Similarly, no deferred tax asset attributable to the net operating loss carryforward has been recognized, as it is not deemed likely to be realized. The provision for refundable federal income tax consists of the following for the periods ending: The cumulative tax effect at the expected rate of 34% of significant items comprising our net deferred tax amount is as follows: At October 31, 2016, the Company had an unused net operating loss carryforward approximating $5,576,000 that is available to offset future taxable income; the loss carryforward will start to expire in 2028. NOTE 10 - FAIR VALUE OF FINANCIAL INSTRUMENTS The Company adopted the FASB standard related to fair value measurement at inception. The standard defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements. The standard applies under other accounting pronouncements that require or permit fair value measurements and, accordingly, does not require any new fair value measurements. The standard clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The recorded values of long-term debt approximate their fair values, as interest approximates market rates. As a basis for considering such assumptions, the standard established a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows. Level 1. Observable inputs such as quoted prices in active markets; Level 2. Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. The Company’s financial instruments are cash, accounts payable, and investment securities. The recorded values of cash and accounts payable approximate their fair values based on their short-term nature. Our Level 2 asset consists of investment securities. The fair value of investment securities (common stock in GulfSlope) is based on $0.01 per share, derived from recent GulfSlope private placement financing transactions. The GulfSlope common stock is thinly traded, resulting in the private placement transactions providing the most reliable measurement. In February 2016, the Company sold 5,000,000 shares of GulfSlope common stock with a cost value of $268,000 for cash proceeds of $50,000 and recorded a realized loss of $218,000. NOTE 11 - COMMITMENTS AND CONTINGENCIES See Note 6 for a discussion of Mr. Askew’s employment agreement and the Company’s financial obligations with respect thereto. On October 11, 2013, the Company entered into a consulting agreement with John B. Connally, III providing $10,000 cash compensation per month, which expired in December 2016. As of October 31, 2015, the Company owed Mr. Connally $110,000 in accrued compensation, which was paid as of October 31, 2016. During the fiscal year ended October 31, 2016 Mr. Connally was paid $120,000 in consulting fees and a $5,000 bonus. NOTE 12 - SUBSEQUENT EVENTS In December 2016, the Company issued an aggregate of 11,500,000 shares of its common stock at a purchase price of $0.02 per share receiving gross proceeds of $230,000, which proceeds were used for general corporate purposes. In January 2017, the Company issued (i) an aggregate of 14,250,000 shares of common stock for services rendered, (ii) 100,000,000 shares of common stock pursuant to the asset purchase agreement to Mr. Mayell, (iii) an aggregate of 92.1 million shares of common stock pursuant to an executive officer and consultant, and (iv) an aggregate of 6,200,000 shares were issued to certain employees and two consultants. In January 2017, the Company entered into an asset purchase agreement with Sydson Energy, Inc. (“Sydson Energy”) and Sydson Resources, L.P. (“Sydson Resources” and collectively with Sydson Energy, “Sydson”), where Sydson assigned to us certain onshore oil and gas assets and interests and certain tangible assets and additionally, certain employees and a consultant of Sydson have agree to become employees and a consultant of the Company. Sydson is a private oil and gas company with land operations in Texas and Louisiana that has been in business since 1982. The oil and gas assets include the following: ●In the Bayou Bouillon Field, St. Martin and Iberville Parishes, Louisiana, we acquired a 37.5% working interest in the Sugarberry South Project comprising 420 acres with a net revenue interest of 70%. The property has two existing wells which have tested at over 400 BOPD combined from two (2) productive zones above 2,100’ with an additional shallower zone behind pipe believed to contain approximately 30’ of oil pay and almost 60’ of gas pay. We expect to install production facilities and drill additional development wells in this fault block and to drill up to three exploratory wells in adjacent fault blocks targeted in the same zones. Through the Sydson transaction, we also are a party to letters of intent to acquire up to a 45% working interest in an additional 1,000+ acres in the Bayou Bouillon area based on a proprietary 55 square mile 3-D seismic survey that demonstrates updip potential in existing reservoirs at about 10,000’. The downdip wells in these same reservoirs have produced over 20 MMBO and 21 BCFG from 59 completions. Our partner in the Bayou Bouillon project, and the owner of a 50% working interest in the Bayou Bouillon acreage, is Thyssen Petroleum, USA, a privately held independent oil and gas exploration and production company based in Houston, Texas and Monaco, France. ●In Texas, we acquired a 50% working interest in the undrilled acreage above 4,500’ in the West Tuleta Field, Bee County, Texas comprised of approximately 1,800 gross acres and 900 net acres with a net revenue interest of approximately75%. The primary drilling objectives are the Vicksburg and Hockley sands which are structurally high on this acreage to historic downdip production from these sands totaling over 500,000 BO. ●In the adjacent Ray Field, also in Bee County, Texas, we acquired a 50% working interest in the undrilled, acreage on the Walton, Campbell, and Ray leases comprising approximately 75 gross acres with a net revenue interest of approximately 75%. The primary drilling objectives on this acreage are also the Vicksburg and Hockley sands updip to prior production, also above 3,700’. ●In other areas of Southeast Texas, we acquired an interest in a proprietary 85 square mile 3-D seismic survey targeting Lower Wilcox Sands at approximately 10,000’. There are eight currently defined and mapped prospects in which we intend to acquire leases that are apparent on the seismic data and match the geologic setting of three existing Lower Wilcox fields within the boundaries of the survey. ●Northwest of the survey, we intend to acquire leases covering approximately 1,000 acres for horizontal projects above 6,000’ in the Austin Chalk and Buda Lime formation. These projects are adjacent to substantial prior production and contain both conventional and unconventional oil targets. The consideration payable by the Company to Sydson and affiliates was (i) 100 million shares of Company common stock to Michael J. Mayell, (ii) (A) $250,000 through a promissory note due March 5, 2017 and (B) $1,250,000 through the payment by the Company of Sydson’s obligations attributable to retained working interests in the oil and gas prospects conveyed to the Company, to be paid by the Company at the time it pays its associated costs with respect to its ownership interests in such oil and gas prospects, (iii) carried interests to casing point for its working interests on the first well in each of the West Tuleta prospect, Ray Field prospect, one prospect under negotiation, and up to four wells in the Bayou Bouillon prospect to be paid by the Company at the time it pays its associated costs with respect to its ownership interests in such oil and gas prospects, and (iv) a payment of $500,000 for the seismic data at one prospect under negotiation after completion of the first well in such prospect. The Company entered into an employment agreement with Mr. Mayell on January 4, 2017 that terminates on December 31, 2019. Upon December 31 of each calendar year, commencing on December 31, 2017, the term shall be extended for one additional year, provided that neither the Company nor Mr. Mayell notify the other on or prior to 90 days before the applicable December 31st date that either party does not intend to extend this agreement. The Company shall pay to Mr. Mayell a base salary of $420,000 per annum and Mr. Mayell shall be entitled to standard and customary benefits. Mr. Mayell has agreed to standard non-disclosure and non-competition provisions. Upon termination of Mr. Mayell by the Company other than for cause, Mr. Mayell is entitled to receive three years of his then compensation as severance. The Company entered into an employment agreement with John B. Connally III to serve as chairman of the board that began on January 5, 2017 and terminates on December 31, 2019. Upon December 31 of each calendar year, commencing on December 31, 2017, the term shall be extended for one additional year, provided that neither the Company nor Mr. Connally notify the other on or prior to 90 days before the applicable December 31st date that either party does not intend to extend this agreement. The Company shall pay to Mr. Connally a base salary of $420,000 per annum, issued him 65.1 million shares, and Mr. Connally shall be entitled to standard and customary benefits. Mr. Connally has agreed to standard non-disclosure provisions. Upon termination of Mr. Connally by the Company other than for cause, Mr. Connally is entitled to receive three years of his then compensation as severance. James M. Askew resigned as an executive officer and director of Texas South in January 2017 and entered into a consulting agreement with the Company that began on January 5, 2017 and terminates on December 31, 2019, and such term shall be extended for an additional one-year period upon December 31 of each calendar year, commencing on December 31, 2017, provided that neither the Company nor consultant notify the other on or prior to 90 days before the applicable December 31st that either party does not intend to extend this agreement. The Company shall pay to Mr. Askew $35,000 net per month and issued Mr. Askew 27 million shares of Company common stock. Upon termination of Mr. Askew by the Company other than for cause, Mr. Askew is entitled to receive three years of his then consulting compensation as severance. In November and December 2016, the Company paid Mr. Askew a bonus of $9,000 cash and $105,000 cash for compensation. In November and December 2016, the Company paid bonuses and compensation to Mr. Connally aggregating $164,000. | Based on the provided financial statement excerpt, here's a summary:
Financial Statement Summary:
- Revenue: $70 net revenue interest
- Overall Status: Operating at a Loss
- Key Financial Challenges:
* Uncertainty about ability to continue as a going concern
* Potential material differences between estimated and actual financial results
* Reliance on debt securities to implement business plan
The statement suggests the company is experiencing financial difficulties, with significant uncertainties about its future operations. The financial statement includes standard accounting disclosures about potential risks and estimates, indicating a cautious approach to reporting its financial position.
Note: The summary is limited due to the fragmented nature of the provided financial statement excerpt. | Claude |
MDC PARTNERS INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders MDC Partners Inc. New York, New York We have audited the accompanying consolidated balance sheets of MDC Partners Inc. as of December 31, 2016 and 2015 and the related consolidated statements of operations, comprehensive loss, shareholders’ deficit, and cash flows for each of the three years in the period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MDC Partners Inc. at December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 2 to the financial statements, in 2016 the Company changed its methods of accounting related to the classification of deferred income taxes due to the adoption of Accounting Standards Update No. 2015-17 (Topic 740), Balance Sheet Classification of Deferred Taxes and the presentation of debt issuance costs due to the adoption of Accounting Standards Update No. 2015-03, Interest - Imputation of Interest. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), MDC Partners Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 1, 2017 expressed an unqualified opinion thereon. /s/ BDO USA LLP New York, New York March 1, 2017 MDC PARTNERS INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Thousands of United States Dollars, Except per Share Amounts) The accompanying notes to the consolidated financial statements are an integral part of these statements. The accompanying notes to the consolidated financial statements are an integral part of these statements. MDC PARTNERS INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Thousands of United States Dollars) The accompanying notes to the consolidated financial statements are an integral part of these statements. MDC PARTNERS INC. CONSOLIDATED BALANCE SHEETS (Thousands of United States Dollars) The accompanying notes to the consolidated financial statements are an integral part of these statements. MDC PARTNERS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands of United States Dollars) The accompanying notes to the consolidated financial statements are an integral part of these statements. MDC PARTNERS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands of United States Dollars) - (continued) The accompanying notes to the consolidated financial statements are an integral part of these statements. MDC PARTNERS INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT (Thousands of United States Dollars) The accompanying notes to the consolidated financial statements are an integral part of these statements. MDC PARTNERS INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT (Thousands of United States Dollars) - (continued) The accompanying notes to the consolidated financial statements are an integral part of these statements. MDC PARTNERS INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT (Thousands of United States Dollars) - (continued) The accompanying notes to the consolidated financial statements are an integral part of these statements. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Except per Share Amounts) 1. Basis of Presentation MDC Partners Inc. (the “Company” or “MDC”) has prepared the consolidated financial statements included herein pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”) and in accordance with generally accepted accounting principles of the United States of America (“U.S. GAAP”). During the third quarter of 2016, the Company reassessed its determination of operating segments and concluded that each Partner Firm represents an operating segment. Pursuant to the guidance of the Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (the “ASC”) Topic 280, Segment Reporting, the Company aggregated Partner Firms that met the aggregation criteria into one Reportable segment and combined and disclosed those Partner Firms that did not meet the aggregation criteria as an “all other” segment. For further information, see Note 14, “Segment Information.” Nature of Operations MDC is a leading provider of global marketing, advertising, activation, communications and strategic consulting solutions. MDC’s Partner Firms deliver a wide range of customized services in order to drive growth and business performance for its clients. MDC Partners Inc., formerly MDC Corporation Inc., is incorporated under the laws of Canada. The Company commenced using the name MDC Partners Inc. on November 1, 2003 and legally changed its name through amalgamation with a wholly-owned subsidiary on January 1, 2004. The Company operates primarily in the U.S., Canada, Europe, Asia, and Latin America. 2. Significant Accounting Policies The Company’s significant accounting policies are summarized as follows: Accounting Changes. On December 31, 2016, the Company retrospectively adopted the FASB Accounting Standards Update (“ASU”) 2015-17, Income Taxes (Topic 740). This update requires that deferred tax assets and liabilities be classified as non-current. As a result of the adoption of ASU 2015-17, the balance sheet at December 31, 2015 was adjusted to reflect the reclassification of $14,381 from other current assets to long-term deferred tax assets and $263 from accruals and other liabilities to long-term deferred tax liabilities. On January 1, 2016, the Company retrospectively adopted the FASB ASU 2015-03, Interest - Imputation of Interest. This update requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. As a result of the adoption of this update, the balance sheet at December 31, 2015 was adjusted to reflect the reclassification of $12,625 from other assets to long-term debt. Additionally, the Company prospectively adopted the FASB ASU 2016-09, Stock Compensation (Topic 718). As a result of the adoption, there was no material impact. Principles of Consolidation. The accompanying consolidated financial statements include the accounts of MDC Partners Inc. and its domestic and international controlled subsidiaries that are not considered variable interest entities, and variable interest entities for which the Company is the primary beneficiary. Intercompany balances and transactions have been eliminated in consolidation. Reclassifications. Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation. Use of Estimates. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities including goodwill, intangible assets, contingent deferred acquisition consideration, valuation allowances for receivables, deferred tax assets and the amounts of revenue and expenses reported during the period. These estimates are evaluated on an ongoing basis and are based on historical experience, current conditions and various other assumptions believed to be reasonable under the circumstances. Actual results could differ from these estimates. Fair Value. The Company applies the fair value measurement guidance of the FASB Accounting Standards Codification (the “ASC”) Topic 820, Fair Value Measurements, for financial assets and liabilities that are required to be measured at fair value and for non-financial assets and liabilities that are not required to be measured at fair value on a recurring basis, including goodwill and other identifiable intangible assets. The measurement of fair value requires the use of techniques based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions. The inputs create the following fair value hierarchy: • Level 1 - Quoted prices for identical instruments in active markets. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 2. Significant Accounting Policies - (continued) • Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations where inputs are observable or where significant value drivers are observable. • Level 3 - Instruments where significant value drivers are unobservable to third parties. When available, the Company uses quoted market prices to determine the fair value of its financial instruments and classifies such items in Level 1. In some cases, quoted market prices are used for similar instruments in active markets and the Company classifies such items in Level 2. Concentration of Credit Risk. The Company provides marketing communications services to clients who operate in most industry sectors. Credit is granted to qualified clients in the ordinary course of business. Due to the diversified nature of the Company’s client base, the Company does not believe that it is exposed to a concentration of credit risk. No client accounted for more than 10% of the Company’s consolidated accounts receivable as of December 31, 2016 and 2015. No clients accounted for 10% of the Company's revenue in each of the years ended December 31, 2016, 2015, and 2014. Cash and Cash Equivalents. The Company’s cash equivalents are primarily comprised of investments in overnight interest-bearing deposits, commercial paper and money market instruments and other short-term investments with original maturity dates of three months or less at the time of purchase. The Company has a concentration of credit risk in that there are cash deposits in excess of federally insured amounts. Cash in Trust. A subsidiary of the Company holds restricted cash in trust accounts related to funds received on behalf of clients. Such amounts are held in escrow under depositary service agreements and distributed at the direction of the clients. The funds are presented as a corresponding liability on the balance sheet. Allowance for Doubtful Accounts. Trade receivables are stated at invoiced amounts less allowances for doubtful accounts. The allowances represent estimated uncollectible receivables associated with potential customer defaults usually due to customers’ potential insolvency. The allowances include amounts for certain customers where a risk of default has been specifically identified. The assessment of the likelihood of customer defaults is based on various factors, including the length of time the receivables are past due, historical experience and existing economic conditions. Expenditures Billable to Clients. Expenditures billable to clients consist principally of outside vendor costs incurred on behalf of clients when providing advertising, marketing and corporate communications services that have not yet been invoiced to clients. Such amounts are invoiced to clients at various times over the course of the production process. Fixed Assets. Fixed assets are stated at cost, net of accumulated depreciation. Computers, furniture and fixtures are depreciated on a straight-line basis over periods of three to seven years. Leasehold improvements are depreciated on a straight-line basis over the lesser of the term of the related lease or the estimated useful life of the asset. Repairs and maintenance costs are expensed as incurred. Impairment of Long-lived Assets. In accordance with the FASB ASC, a long-lived asset or asset group is tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. When such events occur, the Company compares the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group to the carrying amount of such asset or asset group. If this comparison indicates that there is an impairment, the amount of the impairment is typically calculated using discounted expected future cash flows where observable fair values are not readily determinable. The discount rate applied to these cash flows is based on the Company’s weighted average cost of capital (“WACC”), risk adjusted where appropriate. Equity Method Investments. The equity method is used to account for investments in entities in which the Company has an ownership interest of less than 50% and has significant influence, or joint control by contractual arrangement, (i) over the operating and financial policies of the affiliate or (ii) has an ownership interest greater than 50%; however, the substantive participating rights of the noncontrolling interest shareholders preclude the Company from exercising unilateral control over the operating and financial policies of the affiliate. The Company’s investments accounted for using the equity method include a 30% undivided interest in a real estate joint venture and various interests in investment funds. The Company’s management periodically evaluates these investments to determine if there has been a decline in value that is other than temporary. These investments are included in investments in non-consolidated affiliates. During the year ended December 31, 2016, the Company sold its ownership in two of these equity method investments for $4,023 and recognized a gain of $623 in Other income. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 2. Significant Accounting Policies - (continued) During the year ended December 31, 2015, the Company sold its ownership in one of these equity method investments for $2,094 and recognized a gain of $1,086 in Other income. Cost Method Investments. From time to time, the Company makes non-material cost based investments in start-up advertising technology companies and innovative consumer product companies where the Company does not exercise significant influence over the operating and financial policies of the investee. The total net cost basis of these investments, which is included in Other Assets on the balance sheet, as of December 31, 2016 and 2015 was $10,132 and $11,763, respectively. These investments are periodically evaluated to determine whether a significant event or change in circumstances has occurred that may impact the fair value of each investment other than temporary declines below book value. A variety of factors are considered when determining if a decline is other than temporary, including, among others, the financial condition and prospects of the investee, as well as the Company’s investment intent. During the year ended December 31, 2016, the Company sold its ownership in three of these cost method investments for an aggregate purchase price of $4,074 and recognized a gain of $1,309 in Other income. During the year ended December 31, 2015, the Company sold its ownership in six of these cost method investments for an aggregate purchase price of $11,364 and recognized a gain of $5,440 in Other income. In addition, the Company’s partner agencies may receive noncontrolling equity interests from start-up companies in lieu of fees. During the year ended December 31, 2014, the Company liquidated two such equity interest positions in exchange for an aggregate purchase price equal to $8,248. The purchasers of these equity investments were current investors in such entities and two executive officers of our subsidiary partner agencies. Goodwill and Indefinite Lived Intangibles. In accordance with the FASB ASC topic, Goodwill and Other Intangible Assets, goodwill and indefinite life intangible assets (trademarks) acquired as a result of a business combination which are not subject to amortization are tested for impairment annually as of October 1st of each year, or more frequently if indicators of potential impairment exist. For goodwill, impairment is assessed at the reporting unit level. For the annual impairment testing the Company has the option of assessing qualitative factors to determine whether it is more likely than not that the carrying amount of a reporting unit exceeds its fair value or performing the two-step goodwill impairment test. Qualitative factors considered in the assessment include industry and market considerations, the competitive environment, overall financial performance, changing cost factors such as labor costs, and other factors specific to each reporting unit such as change in management or key personnel. If the Company elects to perform the qualitative assessment and concludes that it is more likely than not that the fair value of the reporting unit is more than its carrying amount, then goodwill is not considered impaired and the two-step goodwill impairment test is not necessary. For reporting units for which the qualitative assessment concludes that it is more likely than not that the fair value of the reporting unit is less than its carrying amount and for reporting units for which the qualitative assessment is not performed, the Company will perform the first step of the goodwill impairment test, which compares the fair value of the reporting unit to its carrying amount. If the fair value of the reporting unit exceeds the carrying amount of the net assets assigned to that reporting unit, goodwill is not considered impaired and additional analysis is not required. However, if the carrying amount of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then the second step of the goodwill impairment test must be performed to determine the implied fair value of the reporting unit’s goodwill. Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. The Company’s goodwill impairment test uses the income approach to estimate a reporting unit’s fair value. The income approach is based on a discounted cash flow (“DCF”) method, which requires the exercise of significant judgment, including judgment about the amount and timing of expected future cash flows, assumed terminal value and appropriate discount rates. The DCF estimates incorporate expected cash flows that represent a spectrum of the amount and timing of possible cash flows of each reporting unit from a market participant perspective. The expected cash flows are developed as part of the Company’s routine long-range planning process using projections of revenue and expenses and related cash flows based on assumed long-term growth rates and demand trends and appropriate discount rates based on a reporting unit’s WACC as determined by considering the observable WACC of comparable companies and factors specific to the reporting unit (for example, size). The terminal value is estimated using a constant growth method which requires an assumption about the expected long-term growth rate. The estimates are based on historical data and experience, industry projections, economic conditions, and the Company’s expectations. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 2. Significant Accounting Policies - (continued) The assumptions used for the long-term growth rate and WACC in the annual goodwill impairment tests are as follows: The Company’s reporting units vary in size with respect to revenue and operating profits. These differences drive variations in fair value of the reporting units. In addition, these differences as well as differences in book value, including goodwill, cause variations in the amount by which fair value exceeds the carrying amount of the reporting units. The reporting unit goodwill balances vary by reporting unit primarily because it relates specifically to the Partner Firm’s goodwill which was determined at the date of acquisition. Under the second step of the goodwill impairment test, the Company utilizes both a market approach and income approach to estimate the implied fair value of a reporting unit’s goodwill. For the market approach, the Company utilizes both the guideline public company method and the precedent transaction method. For the income approach, the Company utilizes a DCF method. The Company weights the market and income approaches to arrive at an implied fair value of goodwill. If the Company determines that the carrying amount of a reporting unit’s goodwill exceeds its implied fair value, an impairment loss equal to the difference is recorded. For the 2015 annual goodwill impairment testing, the Company had 13 reporting units. All of the reporting units were subject to the two-step test. As the fair value of all reporting units were in excess of their respective carrying amounts, there was no impairment of goodwill. The range of the excess of the fair value over the carrying amount was from 7% to over 100%. The Company performed a sensitivity analysis which included a 1% increase to the WACC. Based on the results of that analysis, one reporting unit, which was comprised of the marketing experiential businesses, was at risk of failing. The Company noted no significant events or conditions during the first and second quarter of 2016 that would have affected the conclusions from the annual assessment. During the third quarter of 2016, the Company changed its operating segments, as a result of the management structure change as discussed in Note 14, which resulted in a corresponding change to the Company’s reporting units. Each Partner Firm now represents an operating segment as well as a reporting unit for goodwill impairment testing. As a result of the changes in the reporting units, the Company performed further analysis to assess whether the results of the 2015 testing would have been different had it been performed at the Partner Firm level. This change in operating segments, coupled with a decline in operating performance required the Company to perform interim goodwill testing on one of its experiential reporting units. Additionally, a triggering event occurred during the third quarter of 2016 that required the Company to perform interim goodwill testing on one non-material reporting unit. These two reporting units failed the first step of the goodwill impairment testing, and the second step of the goodwill impairment testing resulted in a partial impairment of goodwill of $27,893 and $1,738 relating to the experiential reporting unit and non-material reporting unit, respectively. See Note 8 for further information. For the 2016 annual goodwill impairment test, the Company had 31 reporting units, all of which were subject to the two-step test. For the 2016 annual goodwill impairment test, the carrying amount of one of the Company’s strategic communications reporting unit exceeded its fair value and the second step of the goodwill impairment test was performed, resulting in a partial impairment of goodwill of $18,893. The fair value for all other reporting units were in excess of their respective carrying amounts and as a result there was no additional impairment of goodwill. The range of the excess of the fair value over the carrying amount was from 5% to over 100%. The Company performed a sensitivity analysis which included a 1% increase to the WACC. Based on the results of that analysis, the non-material reporting unit for which a partial impairment of goodwill was recorded during the third quarter of 2016 would be at risk of failing; however, there were no events or circumstances that would more likely than not reduce the fair value of such reporting unit below its respective carrying value between the interim and annual goodwill impairment testing performed. The Company believes the estimates and assumptions used in the calculations are reasonable. However, if there was an adverse change in the facts and circumstances, then an impairment charge may be necessary in the future. The Company will monitor its reporting units to determine if there is an indicator of potential impairment. Should the fair value of any of the Company’s reporting units fall below its carrying amount because of reduced operating performance, market declines, changes in the discount rate, or MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 2. Significant Accounting Policies - (continued) other conditions, charges for impairment may be necessary. Subsequent to the annual impairment test at October 1, 2016, there were no events or circumstances that triggered the need for an interim impairment test. See Note 8 for further information. Definite Lived Intangible Assets. In accordance with the FASB ASC, acquired intangibles are subject to amortization over their useful lives. The method of amortization selected reflects the pattern in which the economic benefits of the specific intangible asset is consumed or otherwise used up. If that pattern cannot be reliably determined, a straight-line amortization method is used over the estimated useful life. Intangible assets that are subject to amortization are reviewed for potential impairment at least annually or whenever events or circumstances indicate that carrying amounts may not be recoverable. See also Note 8. Business Combinations. Business combinations are accounted for using the acquisition method and accordingly, the assets acquired (including identified intangible assets), the liabilities assumed and any noncontrolling interest in the acquired business are recorded at their acquisition date fair values. The Company’s acquisition model typically provides for an initial payment at closing and for future additional contingent purchase price obligations. Contingent purchase price obligations are recorded as deferred acquisition consideration on the balance sheet at the acquisition date fair value and are remeasured at each reporting period. Changes in such estimated values are recorded in the results of operations. For the years ended December 31, 2016, 2015 and 2014, $7,972, $36,344 and $16,467, respectively, related to changes in estimated value was recorded as operating expenses. For further information, see Note 4 and Note 13. For the years ended December 31, 2016, 2015, and 2014, $2,640, $2,912 and $6,133, respectively, of acquisition related costs were charged to operations. For each acquisition, the Company undertakes a detailed review to identify other intangible assets and a valuation is performed for all such identified assets. The Company uses several market participant measurements to determine estimated value. This approach includes consideration of similar and recent transactions, as well as utilizing discounted expected cash flow methodologies. Like most service businesses, a substantial portion of the intangible asset value that the Company acquires is the specialized know-how of the workforce, which is treated as part of goodwill and is not required to be valued separately. The majority of the value of the identifiable intangible assets acquired is derived from customer relationships, including the related customer contracts, as well as trade names. In executing the Company’s overall acquisition strategy, one of the primary drivers in identifying and executing a specific transaction is the existence of, or the ability to, expand the existing client relationships. The expected benefits of the Company’s acquisitions are typically shared across multiple agencies and regions. Redeemable Noncontrolling Interests. Many of the Company’s acquisitions include contractual arrangements where the noncontrolling shareholders have an option to purchase, or may require the Company to purchase, such noncontrolling shareholders’ incremental ownership interests under certain circumstances and the Company has similar call options under the same contractual terms. The amount of consideration under these contractual arrangements is not a fixed amount, but rather is dependent upon various valuation formulas as described in Note 16. In the event that an incremental purchase may be required of the Company, the amounts are recorded as redeemable noncontrolling interests in mezzanine equity on the balance sheet at their acquisition date fair value and adjusted for changes to their estimated redemption value through additional paid-in capital (but not less than their initial redemption value), except for foreign currency translation adjustments. These adjustments will not impact the calculation of earnings (loss) per share if the redemption values are less than the estimated fair values. For the three years ended December 31, 2016, 2015, and 2014, there was no impact on the Company's earnings (loss) per share calculation. The following table presents changes in redeemable noncontrolling interests: (1) Grants in 2015 consisted of transfers from noncontrolling interests related to step-up transactions and new acquisitions. Subsidiary and Equity Investment Stock Transactions. Transactions involving the purchase, sale or issuance of stock of a subsidiary where control is maintained are recorded as a reduction in the redeemable noncontrolling interests or noncontrolling MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 2. Significant Accounting Policies - (continued) interests, as applicable. Any difference between the purchase price and noncontrolling interest is recorded to additional paid-in capital. In circumstances where the purchase of shares of an equity investment results in obtaining control, the existing carrying value of the investment is remeasured to the acquisition date fair value and any gain or loss is recognized in results of operations. Variable Interest Entity. Effective March 28, 2012, the Company invested in Doner Partners LLC (“Doner”). The Company acquired a 30% voting interest and convertible preferred interests that allow the Company to increase ordinary voting ownership to 70% at the Company’s option. The Company has determined that (i) this entity is a variable interest entity and (ii) the Company is the primary beneficiary because it receives a disproportionate share of profits and losses as compared to its ownership percentage. As such, Doner is consolidated for all periods subsequent to the date of investment. Doner is a full service integrated creative agency that is included as part of the Company’s portfolio in the Reportable segment. The Company’s Credit Agreement (see Note 11) is guaranteed and secured by all of Doner’s assets. Total assets and total liabilities of Doner included in the Company’s consolidated balance sheet at December 31, 2016 and 2015, were $102,456 and $57,622, and $122,558 and $86,047, respectively. Guarantees. Guarantees issued or modified by the Company to third parties after January 1, 2003 are generally recognized, at the inception or modification of the guarantee, as a liability for the obligations it has undertaken in issuing the guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. The initial measurement of that liability is the fair value of the guarantee. The recognition of the liability is required even if it is not probable that payments will be required under the guarantee. The Company’s liability associated with guarantees is not significant. (See Note 16.) Revenue Recognition. The Company’s revenue recognition policies are established in accordance with the Revenue Recognition topics of the FASB ASC, and accordingly, revenue is recognized when all of the following criteria are satisfied: (i) persuasive evidence of an arrangement exists; (ii) the selling price is fixed or determinable; (iii) services have been performed or upon delivery of the products when ownership and risk of loss has transferred to the client; and (iv) collection of the resulting receivable is reasonably assured. The Company follows the Multiple-Element Arrangement topic of the FASB ASC, which addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities and how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. The Company follows the Principal Agent Consideration topic of the FASB ASC which addresses (i) whether revenue should be recorded at the gross amount billed because it has earned revenue from the sale of goods or services, or recorded at the net amount retained because it has earned a fee or commission, and (ii) that reimbursements received for out-of-pocket expenses incurred should be characterized in the income statement as revenue. Accordingly, the Company has included such reimbursed expenses in revenue. The Company earns revenue from agency arrangements in the form of retainer fees or commissions; from short-term project arrangements in the form of fixed fees or per diem fees for services; and from incentives or bonuses. Non-refundable retainer fees are generally recognized on a straight-line basis over the term of the specific customer arrangement. Commission revenue is earned and recognized upon the placement of advertisements in various media when the Company has no further performance obligations. Fixed fees for services are recognized upon completion of the earnings process and acceptance by the client. Per diem fees are recognized upon the performance of the Company’s services. In addition, for a limited number of certain service transactions, which require delivery of a number of service acts, the Company uses the proportional performance model, which generally results in revenue being recognized based on the straight-line method. Fees billed to clients in excess of fees recognized as revenue are classified as Advanced Billings on the Company’s balance sheet. A small portion of the Company’s contractual arrangements with customers includes performance incentive provisions, which allow the Company to earn additional revenue as a result of its performance relative to both quantitative and qualitative goals. The Company recognizes the incentive portion of revenue under these arrangements when specific quantitative goals are assured, or when the Company’s clients determine performance against qualitative goals has been achieved. In all circumstances, revenue is only recognized when collection is reasonably assured. The Company records revenue net of sales and other taxes due to be collected and remitted to governmental authorities. Cost of Services Sold. Cost of services sold do not include depreciation charges for fixed assets. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 2. Significant Accounting Policies - (continued) Interest Expense. Interest expense primarily consists of the cost of borrowing on the Company’s previously outstanding 6.75% Senior Notes due 2020 (the “6.75% Notes”); the Company’s 6.50% senior unsecured notes due 2024 (the “6.50% Notes”); and the Company’s $325 million senior secured revolving credit agreement due 2021 (the “Credit Agreement”). The Company uses the effective interest method to amortize the deferred financing costs as well as the original issue premium on the previously outstanding 6.75% Notes. The Company also uses the straight-line method to amortize the deferred financing costs on the Credit Agreement. For the years ended December 31, 2016, 2015, and 2014, interest expense included $255, $2,543, and $2,186, respectively, relating to present value adjustments for fixed deferred acquisition consideration payments. Deferred Taxes. The Company uses the asset and liability method of accounting for income taxes. Deferred income taxes are provided for the temporary difference between the financial reporting basis and tax basis of the Company’s assets and liabilities. Deferred tax benefits result principally from certain tax carryover benefits and from recording certain expenses in the financial statements that are not currently deductible for tax purposes and from differences between the tax and book basis of assets and liabilities recorded in connection with acquisitions. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities result principally from deductions recorded for tax purposes in excess of that recorded in the financial statements or income for financial statement purposes in excess of the amount for tax purposes. The effect of changes in tax rates is recognized in the period the rate change is enacted. Stock-Based Compensation. Under the fair value method, compensation cost is measured at fair value at the date of grant and is expensed over the service period, in this case the award’s vesting period. The Company recognized forfeitures as they occur. When awards are exercised, share capital is credited by the sum of the consideration paid together with the related portion previously credited to additional paid-in capital when compensation costs were charged against income or acquisition consideration. The Company uses its historical volatility derived over the expected term of the award to determine the volatility factor used in determining the fair value of the award. Stock-based awards that are settled in cash, or may be settled in cash at the option of employees, are recorded as liabilities. The measurement of the liability and compensation cost for these awards is based on the fair value of the award, and is recorded in operating income over the service period, in this case the awards vesting period. Changes in the Company’s payment obligation prior to the settlement date of a stock-based award are recorded as compensation cost in operating income in the period of the change. The final payment amount for such awards is established on the date of the exercise of the award by the employee. Stock-based awards that are settled in cash or equity at the option of the Company are recorded at fair value on the date of grant and recorded as additional paid-in capital. The fair value measurement of the compensation cost for these awards is based on using the Black-Scholes option pricing-model and is recorded in operating income over the service period, in this case the award's vesting period. For the years ended December 31, 2016, 2015, and 2014, the Company issued no stock options or similar awards. It is the Company’s policy for issuing shares upon the exercise of an equity incentive award to verify the amount of shares to be issued, as well as the amount of proceeds to be collected (if any) and to deliver new shares to the exercising party. The Company has adopted the straight-line attribution method for determining the compensation cost to be recorded during each accounting period. The Company commences recording compensation expense related to awards that are based on performance conditions under the straight-line attribution method when it is probable that such performance conditions will be met. The fair value at the grant date for performance based awards granted in 2016, 2015, and 2014 was $140, $1,741, and $3,026, respectively. The Company treats benefits paid by shareholders or equity members to employees as a stock-based compensation charge with a corresponding credit to additional paid-in capital. From time to time, certain acquisitions and step-up transactions include an element of compensation related payments. The Company accounts for those payments as stock-based compensation. Pension Costs. Several of the Company’s U.S. and Canadian subsidiaries offer employees access to certain defined contribution pension programs. Under the defined contribution plans, these subsidiaries, in some cases, make annual contributions to participants’ accounts which are subject to vesting. The Company’s contribution expense pursuant to these plans was $10,026, $6,731 and $7,503 for the years ended December 31, 2016, 2015, and 2014, respectively. The Company also has a defined benefit plan. See Note 18. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 2. Significant Accounting Policies - (continued) Income (loss) per Common Share. Basic income (loss) per share is based upon the weighted average number of common shares outstanding during each period. “Share capital to be issued” as reflected in the Shareholders’ Equity on the balance sheet are also included if there is no circumstance under which those shares would not be issued. Diluted income (loss) per share is based on the above, in addition, if dilutive, common share equivalents, which include outstanding options, stock appreciation rights, and unvested restricted stock units. Foreign Currency Translation. The Company’s financial statements were prepared in accordance with the requirements of the Foreign Currency Translation topic of the FASB ASC. The functional currency of the Company is the Canadian dollar and it has decided to use U.S. dollars as its reporting currency for consolidated reporting purposes. Generally, the Company’s subsidiaries use their local currency as their functional currency. Accordingly, the currency impacts of the translation of the balance sheets of the Company’s non-U.S. dollar based subsidiaries to U.S. dollar statements are included as cumulative translation adjustments in accumulated other comprehensive income. Translation of intercompany debt, which is not intended to be repaid, is included in cumulative translation adjustments. Cumulative translation adjustments are not included in net earnings unless they are actually realized through a sale or upon complete, or substantially complete, liquidation of the Company’s net investment in the foreign operation. Translation of current intercompany balances are included in net earnings. The balance sheets of non-U.S. dollar based subsidiaries are translated at the period end rate. The income statements of non-U.S. dollar based subsidiaries are translated at average exchange rates for the period. Gains and losses arising from the Company’s foreign currency transactions are reflected in net earnings. Unrealized gains or losses arising on the translation of certain intercompany foreign currency transactions that are of a long-term nature (that is settlement is not planned or anticipated in the future) are included as cumulative translation adjustments in accumulated other comprehensive income. Derivative Financial Instruments. The Company follows the Accounting for Derivative Instruments and Hedging Activities topic of the FASB ASC, which establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts and debt instruments) be recorded on the balance sheet as either an asset or liability measured at its fair value. The accounting for the change in fair value of the derivative depends on whether the instrument qualifies for and has been designated as a hedging relationship and on the type of hedging relationship. There are three types of hedging relationships: (i) a cash flow hedge, (ii) a fair value hedge, and (iii) a hedge of foreign currency exposure of a net investment in a foreign operation. The designation is based upon the exposure being hedged. Derivatives that are not hedges, or become ineffective hedges, must be adjusted to fair value through earnings. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 3. Loss per Common Share The following table sets forth the computation of basic and diluted loss per common share from continuing operations for the years ended December 31: At December 31, 2016, 2015, and 2014, warrants, options and other rights to purchase 1,391,456, 947,465 and 1,114,681 shares of common stock, respectively, were not included in the computation of diluted loss per common share because doing so would have had an antidilutive effect. Additionally, the 523,321 of restricted stock and restricted stock unit awards which are contingent upon the Company meeting an undefined cumulative three year earnings target and continued employment are also excluded from the computation of diluted loss per common share. 4. Acquisitions Valuations of acquired companies are based on a number of factors, including specialized know-how, reputation, competitive position and service offerings. The Company’s acquisition strategy has been focused on acquiring the expertise of an assembled workforce in order to continue to build upon the core capabilities of its various strategic business platforms to better serve the Company’s clients. The Company’s strategy includes acquiring ownership stakes in well-managed businesses with strong reputations in the industry. The Company’s model of “Perpetual Partnership” often involves acquiring a majority interest rather than a 100% interest and leaving management owners with a significant financial interest in the performance of the acquired entity for a minimum period of time, typically not less than five years. The Company’s acquisition model in this scenario typically provides for (i) an initial payment at the time of closing, (ii) additional contingent purchase price obligations based on the future performance of the acquired entity, and (iii) an option by the Company to purchase (and in some instances a requirement to so purchase) the remaining interest of the acquired entity under a predetermined formula. Contingent purchase price obligations. The Company’s contingent purchase price obligations are generally payable within a five year period following the acquisition date, and are based on (i) the achievement of specific thresholds of future earnings, and (ii) in certain cases, the growth rate of those earnings. Contingent purchase price obligations are recorded as deferred acquisition consideration on the balance sheet at the acquisition date fair value and adjusted at each reporting period through operating income or net interest expense, depending on the nature of the arrangement. See Note 13 for additional information on deferred acquisition consideration. Options to purchase. When acquiring less than 100% ownership, the Company may enter into agreements that give the Company an option to purchase, or require the Company to purchase, the incremental ownership interests under certain circumstances. Where the option to purchase the incremental ownership is within the Company’s control, the amounts are recorded as noncontrolling interests in the equity section of the Company’s balance sheet. Where the incremental purchase may be required MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 4. Acquisitions - (continued) of the Company, the amounts are recorded as redeemable noncontrolling interests in mezzanine equity at their acquisition date estimated redemption value and adjusted at each reporting period for changes to their estimated redemption value through additional paid-in capital (but not less than their initial redemption value), except for foreign currency translation adjustments. On occasion, the Company may initiate a renegotiation to acquire an incremental ownership interest and the amount of consideration paid may differ materially from the balance sheet amounts. See Note 16 for additional information on redeemable noncontrolling interests. Employment conditions. From time to time, specifically when the projected success of an acquisition is deemed to be dependent on retention of specific personnel, such acquisition may include deferred payments that are contingent upon employment terms as well as financial performance. The Company accounts for those payments through operating income as stock-based compensation over the required retention period. For the years ended December 31, 2016, 2015 and 2014, stock-based compensation included $10,341, $9,359, and $7,802, respectively, of expense relating to those payments. Distributions to noncontrolling shareholders. If noncontrolling shareholders have the right to receive distributions based on the profitability of an acquired entity, the amount is recorded as income attributable to noncontrolling interests. However, there are circumstances when the Company acquires a majority interest and the selling shareholders waive their right to receive distributions with respect to their retained interest for a period of time, typically not less than five years. Under this model, the right to receive such distributions typically begins concurrently with the purchase option period and, therefore, if such option is exercised at the first available date the Company may not record any noncontrolling interest over the entire period from the initial acquisition date through the acquisition date of the remaining interests. Included in the Company’s consolidated statement of operations for the year ended December 31, 2016 was revenue of $39,569, and net loss of $3,815, related to 2016 acquisitions. The net loss was attributable to an increase in the deferred acquisition payment liability driven by the decrease in the future market performance of the Company’s stock price and the amortization of the intangibles identified in the allocation of the purchase price consideration. 2016 Acquisitions Effective July 1, 2016, the Company acquired 100% of the equity interests of Forsman & Bodenfors AB (“F&B”), an advertising agency based in Sweden, for an approximate purchase price range of $35,000 to $55,000. The estimated aggregate purchase price at acquisition date of $49,837, which is subject to adjustments, consisted of a closing payment of 1,900,000 MDC Class A subordinate voting shares with an acquisition date fair value of $34,219, plus additional deferred acquisition payments with an estimated present value at acquisition date of $15,618. The amount of additional payments will be calculated based on the financial results of the acquired business for 2015 and 2016 as well as the value of the Company’s shares from July 1, 2016 up to and including the close of business on November 2, 2016. At December 31, 2016, the estimated present value of the additional deferred acquisition payments was $18,857. The additional deferred acquisition payments are payable in 2017 at the Company’s option through the payment of cash or the issuance of additional Class A subordinate voting shares. In the event the Company elects to settle the additional deferred payments through the issuance of Class A subordinate voting shares, such settlement amount will be subject to adjustment based on the value of the Company’s shares determined at the close of business on the final trading day of the seller’s applicable 90 day trading window. An allocation of excess purchase price consideration of this acquisition to the fair value of the net assets acquired resulted in identifiable intangibles of $36,698, consisting primarily of customer lists, trade names and covenants not to compete, and goodwill of $24,778, including the value of the assembled workforce. The identified assets have a weighted average useful life of approximately 10.8 years and will be amortized in a manner represented by the pattern in which the economic benefits of such assets are expected to be realized. In addition, the Company has recorded $2,275 as the present value of redeemable noncontrolling interests and $5,514 as the present value of noncontrolling interests both relating to the noncontrolling interest of F&B's subsidiaries. None of the intangibles and goodwill are tax deductible and the Company recorded a deferred tax liability of $8,074 related to the intangibles. F&B's results are included in the Reportable segment. The actual adjustments that the Company will ultimately make in finalizing the allocation of purchase price to fair value of the net assets acquired will depend on a number of factors. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 4. Acquisitions - (continued) The following unaudited pro forma results of operations of the Company for the years ended December 31, 2016 and 2015 assume that the acquisition of F&B occurred on January 1, 2015. These unaudited pro forma results are not necessarily indicative of either the actual results of operations that would have been achieved had the acquisition of F&B taken place on January 1, 2015, or are they necessarily indicative of future results of operations. Effective April 1, 2016, the Company acquired the remaining 40% ownership interests of Luntz Global Partners LLC. In 2016, the Company also entered into various non-material transactions in connection with other majority-owned entities. As a result of the foregoing, the Company made total cash closing payments of $1,581, eliminated the contingent deferred acquisition payments of $4,052 and fixed deferred acquisition payments of $467 related to certain initial acquisition of the equity interests, reduced other assets by $428, reduced redeemable noncontrolling interests by $1,005, reduced noncontrolling interests by $19,354, increased accruals and other liabilities by $94, and increased additional paid-in capital by $22,775. Additional deferred payments with an estimated present value at acquisition date of $2,393 that are contingent upon service conditions have been excluded from deferred acquisition consideration and will be expensed as stock-based compensation over the required service period. 2015 Acquisitions Effective May 1, 2015, the Company acquired a majority of the equity interests of Y Media Labs LLC, such that following the transaction, the Company’s effective ownership was 60%. Effective October 31, 2015, the Company acquired substantially 100% of the assets of Unique Influence, LLC (and certain other affiliated entities). The aggregate purchase price of these acquisitions had an estimated present value at acquisition date of $55,279 and consisted of total closing cash payments of $23,000 and additional deferred acquisition payments that will be based on the future financial results of the underlying businesses from 2015 to 2020 with final payments due in 2022. These additional deferred payments have an estimated present value at acquisition date of $32,279. An allocation of excess purchase price consideration of these acquisitions to the fair value of the net assets acquired resulted in identifiable intangibles of $16,721, consisting primarily of customer lists, trade names and covenants not to compete, and goodwill of $43,654, including the value of the assembled workforce. The identified assets have a weighted average useful life of approximately 6.3 years and will be amortized in a manner represented by the pattern in which the economic benefits of such assets are expected to be realized. In addition, the Company has recorded $1,999 as the present value of redeemable noncontrolling interests. The Company expects intangibles and goodwill of $9,720 to be tax deductible. In 2015, the Company acquired incremental ownership interests of Sloane & Company LLC, Anomaly Partners LLC, Allison & Partners LLC, Relevent Partners LLC, Kenna Communications LP and 72andSunny Partners LLC. In addition, the Company also entered into various non-material transactions in connection with other majority owned entities. The aggregate purchase price for these 2015 acquisitions of incremental ownership interests had an estimated present value at transaction date of $200,822 and consisted of total closing cash payments of $37,467 and additional deferred acquisition payments that are both fixed and based on the future financial results of the underlying businesses from 2015 to 2021 with final payments due in 2022. These additional deferred payments had an estimated present value at acquisition date of $163,355. The Company reduced redeemable noncontrolling interests by $149,335 and noncontrolling interests by $8,708. The difference between the purchase price and the noncontrolling interests of $42,780 was recorded in additional paid-in capital. 2014 Acquisitions During 2014, the Company entered into several acquisitions and various non-material transactions with certain majority owned entities. Effective January 1, 2014, the Company acquired 60% of the equity interests of Luntz Global Partners LLC. Effective February 14, 2014, the Company acquired 65% of the equity interests of Kingsdale Partners LP. On June 3, 2014, the Company acquired a 100% equity interest in The House Worldwide Ltd. On July 31, 2014, Union Advertising Canada LP acquired 100% of the issued and outstanding stock of Trapeze Media Limited (“Trapeze”). Effective August 1, 2014, the Company acquired 65% MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 4. Acquisitions - (continued) of the equity interests of Hunter PR LLC. Effective August 18, 2014, the Company acquired a 75% interest in Albion Brand Communication Limited. In addition, in June 2014 and August 2014, the Company (through a subsidiary) entered into other non-material acquisitions. The aggregate purchase price of these acquisitions had an estimated present value at acquisition date of $151,202 and consisted of total closing cash payments of $67,236, and additional deferred acquisition payments that are based on the financial results of the underlying businesses from 2014 to 2018 with final payments due in 2019. These additional deferred payments had an estimated present value at acquisition date of $83,966. An allocation of excess purchase price consideration of these acquisitions to the fair value of the net assets acquired resulted in identifiable intangibles of $64,733, consisting primarily of customer lists, a technology asset and covenants not to compete, and goodwill of $146,806, including the value of the assembled workforce. The identified assets will be amortized over a five to six year period in a manner represented by the pattern in which the economic benefits of such assets are expected to be realized. In addition, the Company has recorded $50,552 as the present value of noncontrolling interests and $13,327 as the present value of redeemable noncontrolling interests. The Company expects intangibles and goodwill of $149,232 to be tax deductible. In addition the Company recorded other income of $908 representing a gain on the previously held 18% interest in Trapeze. Noncontrolling Interests Changes in the Company’s ownership interests in our less than 100% owned subsidiaries during the three years ended December 31, were as follows: Net Loss Attributable to MDC Partners Inc. and Transfers (to) from the Noncontrolling Interests MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 5. Fixed Assets The following is a summary of the Company’s fixed assets as of December 31: At December 31, 2016 and 2015, included in fixed assets are assets under capital lease obligations with a cost of $1,967 and $1,959, respectively, and accumulated depreciation of $1,316 and $1,378, respectively. Depreciation expense for the years ended December 31, 2016, 2015, and 2014 was $22,293, $18,871 and $16,462, respectively. 6. Accruals and Other Liabilities At December 31, 2016 and 2015, accruals and other liabilities included accrued media of $201,872 and $187,540, respectively; and amounts due to noncontrolling interest holders for their share of profits, which will be distributed within the next twelve months, of $4,154 and $5,473, respectively. Changes in noncontrolling interest amounts included in accrued and other liabilities for the three years ended December 31, were as follows: (1) Other consists primarily of business acquisitions, sale of a business, step-up transactions, and cumulative translation adjustments. 7. Financial Instruments Financial assets, which include cash and cash equivalents and accounts receivable, have carrying values which approximate fair value due to the short-term nature of these assets. Financial liabilities with carrying values approximating fair value due to short-term maturities include accounts payable. Deferred acquisition consideration is recorded at fair value. The revolving credit agreement is a variable rate debt, the carrying value of which approximates fair value. The Company’s notes are a fixed rate debt instrument recorded at the carrying value. See Note 13 for the fair value. The fair value of financial commitments, guarantees and letters of credit, are based on the stated value of the underlying instruments. Guarantees have been issued in conjunction with the disposition of businesses in 2001 and 2003 and letters of credit have been issued in the normal course of business. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except Share and per Share Amounts) 8. Goodwill and Intangible Assets As of December 31, the gross and net amounts of acquired intangible assets were as follows: The results of the annual goodwill impairment test performed as of October 1, 2015, indicated fair values in excess of carrying amounts for each of the Company’s reporting units. The Company noted no significant events or conditions during the first and second quarter of 2016 that would have affected the conclusions from the annual assessment. During the third quarter of 2016, the Company changed its operating segments, as a result of the management structure change as discussed in Note 14, which resulted in a corresponding change to the Company’s reporting units. The Company performed interim goodwill testing on one of its experiential reporting units and one non-material reporting unit, resulting in a partial impairment of goodwill of $27,893 and $1,738 relating to the experiential reporting unit and non-material reporting unit, respectively. Additionally, as a result of the annual goodwill impairment test performed as of October 1, 2016, the Company recognized a partial impairment of goodwill of $18,893 relating to one of the Company’s strategic communications reporting units. See Note 2 for further information. The total accumulated goodwill impairment charges are $95,407 through December 31, 2016. During the year for 2016, the Company wrote off goodwill of $764 related to the sale of its ownership interests in Bryan Mills to the noncontrolling shareholders. This write off is included in other income (expense). The weighted average amortization periods for customer relationships are six years and other intangible assets are eight years. In total, the weighted average amortization period is seven years. Amortization expense related to amortizable intangible assets for the years ended December 31, 2016, 2015, and 2014 was $21,726, $30,024, and $29,749, respectively. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except Share and per Share Amounts) The estimated amortization expense for the five succeeding years is as follows: 9. Income Taxes The components of the Company’s income (loss) from continuing operations before income taxes and equity in earnings of non-consolidated affiliates by taxing jurisdiction for the years ended December 31, were: The provision (benefit) for income taxes by taxing jurisdiction for the years ended December 31, were: MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 9. Income Taxes - (continued) A reconciliation of income tax expense (benefit) using the statutory Canadian federal and provincial income tax rate compared with actual income tax expense for the years ended December 31, is as follows: The 2016 effective income tax rate was lower than the statutory rate due primarily to non-deductible stock-based compensation of $4,060, an increase in the valuation allowance of $8,707, and the effect of the difference in the U.S. and foreign federal rates and the Canadian statutory rate of $(4,579). All of this resulted in a lower tax benefit. The 2015 effective income tax rate was higher than the statutory rate due primarily to non-deductible stock-based compensation of $3,354 and an increase in the valuation allowance of $5,468, and the effect of the difference in the U.S. and foreign federal rates and the Canadian statutory rate of $1,906. All of this resulted in a tax expense verses a tax benefit. The 2014 effective income tax rate was higher than the statutory rate due primarily to non-deductible stock-based compensation of $1,982, an increase in the valuation allowance of $2,003, and the effect of the difference in the U.S. and foreign federal rates and the Canadian statutory rate of $2,222. Income taxes receivable were $1,506 and $615 at December 31, 2016 and 2015, respectively, and were included in other current assets on the balance sheet. Income taxes payable were $4,547 and $7,019 at December 31, 2016 and 2015, respectively, and were included in accrued and other liabilities on the balance sheet. It is the Company’s policy to classify interest and penalties arising in connection with the under payment of income taxes as a component of income tax expense. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 9. Income Taxes - (continued) The tax effects of significant temporary differences representing deferred tax assets and liabilities at December 31, were as follows: The Company has U.S. federal net operating loss carry forwards of $21,339 and non-U.S. net operating loss carry forwards of $70,517. These carry forwards expire in years 2016 through 2031. The Company also has total indefinite loss carry forwards of $118,413. These indefinite loss carry forwards consist of $35,723 relating to the U.S. and $82,691 which are related to capital losses from the Canadian operations. In addition, the Company has net operating loss carry forwards for various state taxing jurisdictions of approximately $188,367. The Company records a valuation allowance against deferred income tax assets when management believes it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Management considers factors such as the reversal of deferred income tax liabilities, projected future taxable income, the character of the income tax asset, tax planning strategies, changes in tax laws and other factors. A change to these factors could impact the estimated valuation allowance and income tax expense. The valuation allowance has been recorded to reduce our deferred tax asset to an amount that is more likely than not to be realized, and is based upon the uncertainty of the realization of certain U.S., non-U.S. and state deferred tax assets. The increase in the Company’s valuation allowance charged to the statement of operations for each of the years ended December 31, 2016, 2015 and 2014 was $8,707, $5,468 and $2,003, respectively. In addition, a benefit of $1,112 has been recorded in accumulated other comprehensive loss relating to the defined pension plan for the years ended December 31, 2014. There was no benefit or expense related to the defined pension plan recorded in 2015 and 2016. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 9. Income Taxes - (continued) Deferred taxes are not provided for temporary differences representing earnings of subsidiaries that are intended to be permanently reinvested. The potential deferred tax liability associated with these undistributed earnings is not material. As of December 31, 2016 and 2015, the Company recorded a liability for unrecognized tax benefits as well as applicable penalties and interest in the amount of $1,543 and $4,200. As of December 31, 2016 and 2015, accrued penalties and interest included in unrecognized tax benefits were approximately $78 and $595. The Company identified an uncertainty relating to the future tax deductibility of certain intercompany fees. To the extent that such future benefit will be established, the resolution of this position will have no effect with respect to the financial statements. If these unrecognized tax benefits were to be recognized, it would affect the Company’s effective tax rate. The Company does not expect its unrecognized tax benefits to change significantly over the next 12 months. The Company has completed U.S. federal tax audits through 2013 and has completed a non-U.S. tax audit through 2009. 10. Discontinued Operations In the fourth quarter of 2014, the Company made the decision to strategically sell the net assets of Accent. Effective May 31, 2015, the Company completed the sale of Accent for an aggregate selling price of $17,102, net of transaction expenses. There were no discontinued operations for the year ended December 31, 2016. Included in discontinued operations in the Company’s consolidated statements of operations for the years ended December 31, 2015 and 2014 were the following: For the year ended December 31, 2014, the loss on disposal included a goodwill write off of $15,564. At December 31, 2016 and 2015, the Company had no assets held for sale. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 11. Debt As of December 31, the Company’s indebtedness was comprised as follows: Interest expense related to long-term debt for the years ended December 31, 2016, 2015, and 2014 was $56,468, $53,090 and $50,832, respectively. For the year ended December 31, 2016, the Company recorded a charge for the loss on redemption of the 6.75% Notes of $33,298, which included accrued interest, related premiums, fees and expenses, write offs of unamortized original issue premium, and unamortized debt issuance costs. For the years ended December 31, 2016, 2015, and 2014, interest expense included income of $312, $1,178, $975, related to the amortization of the original issue premium. For the years ended December 31, 2016, 2015, and 2014, interest expense included $255, $2,543 and $2,186, respectively, of present value adjustments for fixed deferred acquisition payments. The amortization of deferred finance costs included in interest expense were $3,022, $3,448 and $3,222 for the years ended December 31, 2016, 2015, and 2014, respectively. 6.50% Senior Notes On March 23, 2016, MDC entered into an indenture (the “Indenture”) among MDC, its existing and future restricted subsidiaries that guarantee, or are co-borrowers under or grant liens to secure, the Credit Agreement, as guarantors (the “Guarantors”) and The Bank of New York Mellon, as trustee, relating to the issuance by MDC of $900,000 aggregate principal amount of the 6.50% Notes. The 6.50% Notes were sold in a private placement in reliance on exceptions from registration under the Securities Act of 1933. The 6.50% Notes bear interest at a rate of 6.50% per annum, accruing from March 23, 2016. Interest is payable semiannually in arrears on May 1 and November 1 of each year, beginning November 1, 2016. The 6.50% Notes mature on May 1, 2024, unless earlier redeemed or repurchased. The Company received net proceeds from the offering of the 6.50% Notes equal to approximately $880,000. The Company used the net proceeds to redeem all of its existing 6.75% Notes, together with accrued interest, related premiums, fees and expenses and recorded a charge for the loss on redemption of such notes of $33,298, including write offs of unamortized original issue premium and debt issuance costs. Remaining proceeds were used for general corporate purposes, including funding of deferred acquisition consideration. The 6.50% Notes are guaranteed on a senior unsecured basis by all of MDC’s existing and future restricted subsidiaries that guarantee, or are co-borrowers under or grant liens to secure, the Credit Agreement. The 6.50% Notes are unsecured and unsubordinated obligations of MDC and rank (i) equally in right of payment with all of MDC’s or any Guarantor’s existing and future senior indebtedness, (ii) senior in right of payment to MDC’s or any Guarantor’s existing and future subordinated indebtedness, (iii) effectively subordinated to all of MDC’s or any Guarantor’s existing and future secured indebtedness to the extent of the collateral securing such indebtedness, including the Credit Agreement, and (iv) structurally subordinated to all existing and future liabilities of MDC’s subsidiaries that are not Guarantors. MDC may, at its option, redeem the 6.50% Notes in whole at any time or in part from time to time, on and after May 1, 2019 (i) at a redemption price of 104.875% of the principal amount thereof if redeemed during the twelve-month period beginning on May 1, 2019, (ii) at a redemption price of 103.250% of the principal amount thereof if redeemed during the twelve-month period beginning on May 1, 2020, (iii) at a redemption price of 101.625% of the principal amount thereof if redeemed during the twelve- MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 11. Debt - (continued) month period beginning on May 1, 2021, and (iv) at a redemption price of 100% of the principal amount thereof if redeemed on May 1, 2022 and thereafter. Prior to May 1, 2019, MDC may, at its option, redeem some or all of the 6.50% Notes at a price equal to 100% of the principal amount of the 6.50% Notes plus a “make whole” premium and accrued and unpaid interest. MDC may also redeem, at its option, prior to May 1, 2019, up to 35% of the 6.50% Notes with the proceeds from one or more equity offerings at a redemption price of 106.50% of the principal amount thereof. If MDC experiences certain kinds of changes of control (as defined in the Indenture), holders of the 6.50% Notes may require MDC to repurchase any 6.50% Notes held by them at a price equal to 101% of the principal amount of the 6.50% Notes plus accrued and unpaid interest. In addition, if MDC sells assets under certain circumstances, it must apply the proceeds from such sale and offer to repurchase the 6.50% Notes at a price equal to 100% of the principal amount plus accrued and unpaid interest. The Indenture includes covenants that, among other things, restrict MDC’s ability and the ability of its restricted subsidiaries (as defined in the Indenture) to incur or guarantee additional indebtedness; pay dividends on or redeem or repurchase the capital stock of MDC; make certain types of investments; create restrictions on the payment of dividends or other amounts from MDC’s restricted subsidiaries; sell assets; enter into transactions with affiliates; create liens; enter into sale and leaseback transactions; and consolidate or merge with or into, or sell substantially all of MDC’s assets to, another person. These covenants are subject to a number of important limitations and exceptions. The 6.50% Notes are also subject to customary events of default, including a cross-payment default and cross-acceleration provision. Redemption of 6.75% Senior Notes On March 23, 2016, the Company redeemed the 6.75% Notes in whole at a redemption price of 103.375% of the principal amount thereof with the proceeds from the issuance of the 6.50% Notes. Credit Agreement On March 20, 2013, MDC, Maxxcom Inc. (a subsidiary of MDC) and each of their subsidiaries party thereto entered into an amended and restated, $225 million senior secured revolving credit agreement due 2018 (the “Credit Agreement”) with Wells Fargo Capital Finance, LLC, as agent, and the lenders from time to time party thereto. Advances under the Credit Agreement are to be used for working capital and general corporate purposes, in each case pursuant to the terms of the Credit Agreement. Capitalized terms used in this section and not otherwise defined have the meanings set forth in the Credit Agreement. Effective October 23, 2014, MDC and its subsidiaries entered into an amendment to its Credit Agreement. The amendment: (i) expanded the commitments under the facility by $100 million, from $225 million to $325 million; (ii) extended the date by an additional eighteen months to September 30, 2019; (iii) reduced the base borrowing interest rate by 25 basis points (the applicable margin for borrowing is 1.00% in the case of Base Rate Loans and 1.75% in the case of LIBOR Rate Loans) ; and (iv) modified certain covenants to provide the Company with increased flexibility to fund its continued growth and other general corporate purposes. Effective May 3, 2016, MDC and its subsidiaries entered into an additional amendment to its Credit Agreement. The amendment: (i) extends the date by an additional nineteen months to May 3, 2021; (ii) reduces the base borrowing interest rate by 25 basis points; (iii) provides the Company the ability to borrow in foreign currencies; and (iv) certain other modifications to provide additional flexibility in operating the Company’s business. Advances under the Credit Agreement bear interest as follows: (a)(i) LIBOR Rate Loans bear interest at the LIBOR Rate and (ii) Base Rate Loans bear interest at the Base Rate, plus (b) an applicable margin. The initial applicable margin for borrowing is 1.00% in the case of Base Rate Loans and 1.75% in the case of LIBOR Rate Loans. In addition to paying interest on outstanding principal under the Credit Agreement, MDC is required to pay an unused revolver fee to lenders under the Credit Agreement in respect of unused commitments thereunder. The Company is currently in compliance with all of the terms and conditions of its Credit Agreement, and management believes, based on its current financial projections, that the Company will be in compliance with the covenants over the next twelve months. At December 31, 2016, there were $54,425 of borrowings under the Credit Agreement. At December 31, 2016, the Company had issued $4,360 of undrawn letters of credit. At December 31, 2016 and 2015, accounts payable included $80,193 and $73,558, respectively, of outstanding checks. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 11. Debt - (continued) Future Principal Repayments Future principal repayments, including capital lease obligations, for the years ended December 31, and in aggregate, are as follows: Capital Leases Future minimum capital lease payments for the years ended December 31 and in aggregate, are as follows: 12. Share Capital The authorized share capital of the Company is as follows: (a) Authorized Share Capital Class A Shares An unlimited number of subordinate voting shares, carrying one vote each, entitled to dividends equal to or greater than Class B shares, convertible at the option of the holder into one Class B share for each Class A share after the occurrence of certain events related to an offer to purchase all Class B shares. Class B Shares An unlimited number, carrying 20 votes each, convertible at any time at the option of the holder into one Class A share for each Class B share. Preferred A Shares An unlimited number, non-voting, issuable in series. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 12. Share Capital - (continued) (b) Employee Stock Incentive Plan On May 26, 2005, the Company’s shareholders approved the Company’s 2005 Stock Incentive Plan (the “2005 Incentive Plan”). The 2005 Incentive Plan authorizes the issuance of awards to employees, officers, directors and consultants of the Company with respect to 3,000,000 shares of MDC Partners’ Class A Subordinate Voting Shares or any other security into which such shares shall be exchanged. On June 1, 2007 and on June 2, 2009, the Company’s shareholders approved a total additional authorized Class A Shares of 3,750,000 to be added to the 2005 Incentive Plan for a total of 6,750,000 authorized Class A Shares. In addition, the plan was amended to allow shares under this plan to be used to satisfy share obligations under the Stock Appreciation Rights Plan (the “SARS” Plan”). On May 30, 2008, the Company’s shareholders approved the 2008 Key Partner Incentive Plan, which provides for the issuance of 900,000 Class A Shares. On June 1, 2011, the Company’s shareholders approved the 2011 Stock Incentive Plan, which provides for the issuance of up to 3,000,000 Class A Shares. In June 2013, the Company's shareholders approved an amendment to the SARS Plan to permit the Company to issue shares authorized under the SARS Plan to satisfy the grant and vesting awards under the 2011 Stock Incentive Plan. On June 1, 2016, the Company's shareholders approved the 2016 Stock Incentive Plan, which provides for the issuance of up to 1,500,000 Class A shares. The following table summarizes information about time based and financial performance-based restricted stock and restricted stock unit awards granted under the 2005 Incentive Plan, 2008 Key Partner Incentive Plan, 2011 Stock Incentive Plan and 2016 Stock Incentive Plan: The total fair value of restricted stock and restricted stock unit awards, which vested during the years ended December 31, 2016, 2015 and 2014 was $6,272, $5,394 and $7,659, respectively. In connection with the vesting of these awards, the Company included in the taxable loss the amounts of $5,429, $4,678 and $11,874 in 2016, 2015 and 2014, respectively. At December 31, 2016, the weighted average remaining contractual life for performance based awards was 1.87 years and for time based awards was 1.65 years. At December 31, 2016, the fair value of all restricted stock and restricted stock unit awards was $5,441. The term of these awards is three years with vesting up to three years. At December 31, 2016, the unrecognized compensation expense for these awards was $7,105 and will be recognized through 2019. At December 31, 2016, there were 1,934,861 awards available to grant under all equity plans. In addition, the Company awarded restricted stock and restricted stock unit awards of which 523,321 awarded shares were outstanding as of December 31, 2016. The vesting of these awards are contingent upon the Company meeting a cumulative three year earnings target and continued employment through the vesting date. Once the Company defines the earnings target, the grant date is established and the Company will record the compensation expense over the vesting period. Prior to adoption of the 2005 Incentive Plan, the Company’s Prior 2003 Plan provided for grants of up to 2,836,179 options to employees, officers, directors and consultants of the Company. All the options granted were for a term of five years from the MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 12. Share Capital - (continued) date of the grant and vest 20% on the date of grant and a further 20% on each anniversary date. In addition, the Company granted 802,440 options, on the privatization of Maxxcom, with a term of no more than 10 years from initial date of grant by Maxxcom and vest 20% in each of the first two years with the balance vesting on the third anniversary of the initial grant. Information related to share option transactions grant under all plans over the past three years is summarized as follows: At December 31, 2016, the intrinsic value of vested options and the intrinsic value of all options was $27. For options exercised during 2016, 2015 and 2014, the Company received cash proceeds of nil, $224 and nil, respectively. The Company did not receive any windfall tax benefits. The intrinsic value of options exercised during 2016, 2015 and 2014 was $471, $471 and nil, respectively. At December 31, 2016, the weighted average remaining contractual life of all outstanding options was 0.5 years and for all vested options was 0.5 years. At December 31, 2016, the unrecognized compensation expense of all options was nil. Share options outstanding as of December 31, 2016 are summarized as follows: The Company has reserved a total of 2,753,496 Class A shares in order to meet its obligations under various conversion rights, warrants and employee share related plans. At December 31, 2016 there were 781,135 shares available for future option and similar grants. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 13. Fair Value Measurements Authoritative guidance for fair value establishes a framework for measuring fair value. A fair value measurement assumes a transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. In order to increase consistency and comparability in fair value measurements, the guidance establishes a hierarchy for observable and unobservable inputs used to measure fair value into three broad levels, which are described below: • Level 1 - Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs. • Level 2 - Observable prices that are based on inputs not quoted on active markets, but corroborated by market data. • Level 3 - Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs. In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value. On a nonrecurring basis, the Company uses fair value measures when analyzing asset impairment. Long-lived assets and certain identifiable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flows over the remaining amortization periods, their carrying values are reduced to estimated fair value. Measurements based on undiscounted cash flows are considered to be Level 3 inputs. During the fourth quarter of each year, the Company evaluates goodwill and indefinite-lived intangibles for impairment at the reporting unit level. For each acquisition, the Company performed a detailed review to identify intangible assets and a valuation is performed for all such identified assets. The Company used several market participant measurements to determine estimated value. This approach includes consideration of similar and recent transactions, as well as utilizing discounted expected cash flow methodologies. The amounts allocated to assets acquired and liabilities assumed in the acquisitions were determined using level three inputs. Fair value for property and equipment was based on other observable transactions for similar property and equipment. Accounts receivable represents the best estimate of balances that will ultimately be collected, which is based in part on allowance for doubtful accounts reserve criteria and an evaluation of the specific receivable balances. Financial Liabilities Measured at Fair Value on a Recurring Basis The following tables present certain information for our financial assets that is measured at fair value on a recurring basis at December 31: Our long-term debt includes fixed rate debt. The fair value of this instrument is based on quoted market prices. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 13. Fair Value Measurements - (continued) The following table presents changes in deferred acquisition consideration for the years ended December 31: (1) For the year ended December 31, 2016, payments include $10,458 of deferred acquisition consideration settled through the issuance of 691,559 MDC Class A subordinate voting shares in lieu of cash. (2) Additions are the initial estimated deferred acquisition payments of new acquisitions and step-up transactions completed within that fiscal period. (3) Redemption value adjustments are fair value changes from the Company’s initial estimates of deferred acquisition payments, including the accretion of present value and stock-based compensation charges relating to acquisition payments that are tied to continued employment. (4) Other is comprised of (i) $2,360 transfered to shares to be issued related to 100,000 MDC Class A subordinate voting shares to be issued contingent on specific thresholds of future earnings that management expects to be attained; and, (ii) $4,052 of contingent payments eliminated through the acquisition of incremental ownership interests. See Note 4. In addition to the above amounts, there are fixed payments of $4,810 and $40,370 for total deferred acquisition consideration of $229,564 and $347,104, which reconciles to the consolidated balance sheets at December 31, 2016 and 2015, respectively. The Company includes the payments of all deferred acquisition consideration in financing activities in the Company’s consolidated statement of cash flows, as the Company believes these payments to be seller-related financing activities, which is the predominant source of cash flows. The FASB recently issued new guidance regarding the classification of cash flows for contingent consideration that is effective January 1, 2018. See Note 17 for further information. Level 3 payments relate to payments made for deferred acquisition consideration. Level 3 grants relate to contingent purchase price obligations related to acquisitions and are recorded on the balance sheet at the acquisition date fair value. The estimated liability is determined in accordance with various contractual valuation formulas that may be dependent on future events, such as the growth rate of the earnings of the relevant subsidiary during the contractual period and, in some cases, the currency exchange rate as of the date of payment. Level 3 redemption value adjustments relate to the remeasurement and change in these various contractual valuation formulas as well as adjustments of present value. At December 31, 2016 and 2015, the carrying amount of the Company’s financial instruments, including cash and cash equivalents, accounts receivable and accounts payable, approximated fair value because of their short-term maturity. The Company does not disclose the fair value for equity method investments or investments held at cost as it is not practical to estimate fair value since there is no readily available market data. Non-financial Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis On a nonrecurring basis, the Company uses fair value measures when analyzing asset impairment. Long-lived assets and certain identifiable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flows over the remaining amortization periods, their carrying values are reduced to estimated fair value. Measurements based on undiscounted cash flows are considered to be Level 3 inputs. During the fourth quarter of each year, the Company evaluates goodwill and indefinite-lived intangibles for impairment at the reporting unit level. For each acquisition, the Company performed a detailed review to identify intangible assets and a MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 13. Fair Value Measurements - (continued) valuation is performed for all such identified assets. The Company used several market participant measurements to determine estimated value. This approach includes consideration of similar and recent transactions, as well as utilizing discounted expected cash flow methodologies. The amounts allocated to assets acquired and liabilities assumed in the acquisitions were determined using Level 3 inputs. Fair value for property and equipment was based on other observable transactions for similar property and equipment. Accounts receivable represents the best estimate of balances that will ultimately be collected, which is based in part on allowance for doubtful accounts reserve criteria and an evaluation of the specific receivable balances. 14. Segment Information The Company determines an operating segment if a component (1) engages in business activities from which it earns revenues and incurs expenses, (2) has discrete financial information and that is (3) regularly reviewed by the Chief Operating Decision Maker (“CODM”) to make decisions regarding resource allocation for the segment and assess its performance. During June of 2016, the Company entered into a Separation and Release Agreement with its former Chief Operating Officer in connection with a limited restructuring of the Company’s corporate department. This change to the Company’s management structure was designed to provide the CODM greater visibility into the operating performance of individual Partner Firms and has resulted in a corresponding change in the level at which the CODM reviews the operating results of such Partner Firms. As a result, in the third quarter of 2016, the Company reassessed its determination of operating segments and concluded that each Partner Firm represents an operating segment. The Company assessed the average long-term gross margins expected for each Partner Firm together with the qualitative characteristics set forth in ASC 280-10-50 and aggregated the Partner Firms that meet the aggregation criteria into one Reportable segment and combined and disclosed those Partner Firms that do not meet the aggregation criteria as an “all other” segment. The Company also reports the Corporate Group. • The Reportable segment is comprised of the Company’s integrated advertising, media, and public relations service firms. These core or principal service offerings are similar and/or complementary in many respects and the firms that provide these service offerings both compete and/or collaborate with each other for new business. Each Partner Firm represents an operating segment and the Company aggregates its Partner Firms to report in one Reportable segment along with an “all other” segment. Firms within this segment include Allison & Partners, Anomaly, Crispin Porter + Bogusky, Doner, Forsman & Bodenfors, Hunter PR, kbs, MDC Media Partners, and 72andSunny, among others. These firms share similar characteristics related to the nature of their services as well as the type of clients and the methods used to provide their services. In addition, the class of customer is also common among the Partner Firms in this Reportable segment. This results in the firms having similar economics of their business and the Company believes the average long-term gross margin expectations are similar among the firms aggregated in the Reportable segment. • The “all other” segment is comprised of the firms that provide the Company’s specialist marketing offerings such as direct marketing, sales promotion, market research, strategic communications, database and customer relationship management, data analytics and insights, corporate identity, design and branding, and product and service innovation. Firms within this segment include Gale Partners, Kingsdale, Relevent, Team, Redscout and Y Media Labs. The nature of the specialized services provided by these firms vary from those firms aggregated into the Reportable segment in that such services are generally complimentary and are provided to round out the portfolio of services offered by the Company. This results in these firms having different current and long-term performance expectations from those firms aggregated in the Reportable segment. • The Corporate Group consists of corporate office expenses incurred in connection with the strategic resources provided to the Partner Firms, as well as certain other centrally managed expenses that are not fully allocated to the Reportable segments. These office and general expenses include (1) salaries and related expenses for corporate office employees including employees dedicated to supporting the Partner Firms, (2) occupancy expense relating to properties occupied by all corporate office employees, (3) other office and general expenses including professional fees for the financial statement audits and other public company costs, and (4) certain other professional fees managed by the corporate office. Additional expenses managed by the corporate office that are directly related to the Partner Firms are allocated to the Reportable and “all other” segments. Prior year results have been recast to reflect the new segment reporting. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 14. Segment Information - (continued) MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 14. Segment Information - (continued) MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 14. Segment Information - (continued) A summary of the Company’s long-lived assets, comprised of fixed assets, goodwill and intangibles, net, as at December 31, is set forth in the following table. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 14. Segment Information - (continued) A summary of the Company’s revenue as at December 31 is set forth in the following table. 15. Related Party Transactions Scott L. Kauffman is Chairman and Chief Executive Officer of the Company. His daughter, Sarah Kauffman, has been employed by Partner Firm kbs since July 2011, and currently acts as Director of Operations, Attention Partners. In 2016 and 2015, her total compensation, including salary, bonus and other benefits, totaled approximately $145 and $125, respectively. Her compensation is commensurate with that of her peers. 16. Commitments, Contingencies and Guarantees Deferred Acquisition Consideration. In addition to the consideration paid by the Company in respect of certain of its acquisitions at closing, additional consideration may be payable, or may be potentially payable, based on the achievement of certain threshold levels of earnings. See Note 2 and Note 4. Options to Purchase. Noncontrolling shareholders in certain subsidiaries have the right in certain circumstances to require the Company to acquire the remaining ownership interests held by them. The noncontrolling shareholders’ ability to exercise any such option right is subject to the satisfaction of certain conditions, including conditions requiring notice in advance of exercise and specific employment termination conditions. In addition, these rights cannot be exercised prior to specified staggered exercise dates. The exercise of these rights at their earliest contractual date would result in obligations of the Company to fund the related amounts during 2017 to 2023. It is not determinable, at this time, if or when the owners of these rights will exercise all or a portion of these rights. The amount payable by the Company in the event such rights are exercised is dependent on various valuation formulas and on future events, such as the average earnings of the relevant subsidiary through the date of exercise, the growth rate of the earnings of the relevant subsidiary during that period and, in some cases, the currency exchange rate at the date of payment. Management estimates, assuming that the subsidiaries owned by the Company at December 31, 2016 perform over the relevant future periods at their trailing twelve-month earnings levels, that these rights, if all exercised, could require the Company to pay an aggregate amount of approximately $12,510 to the owners of such rights in future periods to acquire such ownership interests in the relevant subsidiaries. Of this amount, the Company is entitled, at its option, to fund approximately $124 by the issuance of share capital. In addition, the Company is obligated under similar put option rights to pay an aggregate amount of approximately $43,085 only upon termination of such owner’s employment with the applicable subsidiary or death. The amount the Company would be required to pay to the noncontrolling interest holders should the Company acquire the remaining ownership interests is $4,585 less than the initial redemption value recorded in redeemable noncontrolling interests. Included in redeemable noncontrolling interests at December 31, 2016 was $60,180 of these put options because they are not within the control of the Company. The ultimate amount payable relating to these transactions will vary because it is dependent on the future results of operations of the subject businesses and the timing of when these rights are exercised. Natural Disasters. Certain of the Company’s operations are located in regions of the United States which typically are subject to hurricanes. During the years ended December 31, 2016, 2015, and 2014, these operations did not incur any material costs related to damages resulting from hurricanes. Guarantees. Generally, the Company has indemnified the purchasers of certain assets in the event that a third party asserts a claim against the purchaser that relates to a liability retained by the Company. These types of indemnification guarantees typically extend for a number of years. Historically, the Company has not made any significant indemnification payments under such agreements and no amount has been accrued in the accompanying consolidated financial statements with respect to these indemnification guarantees. The Company continues to monitor the conditions that are subject to guarantees and indemnifications MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 16. Commitments, Contingencies and Guarantees - (continued) to identify whether it is probable that a loss has occurred and would recognize any such losses under any guarantees or indemnifications in the period when those losses are probable and estimable. Legal Proceedings. The Company’s operating entities are involved in legal proceedings of various types. While any litigation contains an element of uncertainty, the Company has no reason to believe that the outcome of such proceedings or claims will have a material adverse effect on the financial condition or results of operations of the Company. In addition, the Company is involved in class action suits as described below. MDC Partners remains committed to the highest standards of corporate governance and transparency in its reporting practices. In April 2015, the Company announced it was actively cooperating in connection with an SEC investigation of the Company. On January 18, 2017, the Company announced that it reached a final settlement agreement with the Philadelphia Regional Office of the SEC, and that the SEC entered an administrative Order concluding its investigation of the Company. Under the Order, without admitting or denying liability, the Company agreed that it will not in the future violate Section 17(a)(2) of the Securities Act of 1933 and Sections 13(a), 13(b) and 14(a) of the Securities Exchange Act of 1934 and related rules requiring that periodic filings be accurate; that accurate books and records and a system of internal accounting controls be maintained; and that solicitations of proxies comply with the securities laws. In addition, the Company agreed to comply with all requirements under Regulation G relating to the disclosure and reconciliation of non-GAAP financial measures. Pursuant to the Order, and based upon the Company’s full cooperation with the investigation, the SEC imposed a civil penalty of $1,500 on the Company to resolve all potential claims against the Company relating to these matters. In 2016, the Company recorded a charge of $1,500 related to such penalty. There will be no restatement of any of the Company’s previously-filed financial statements. On July 31, 2015, North Collier Fire Control and Rescue District Firefighter Pension Plan (“North Collier”) filed a putative class action suit in the Southern District of New York, naming as defendants MDC, CFO David Doft, former CEO Miles Nadal, and former CAO Mike Sabatino. On December 11, 2015, North Collier and co-lead plaintiff Plymouth County Retirement Association filed an amended complaint, adding two additional defendants, Mitchell Gendel and Michael Kirby, a former member of MDC’s Board of Directors. The plaintiff alleges in the amended complaint violations of § 10(b), Rule 10b-5, and § 20 of the Securities Exchange Act of 1934, based on allegedly materially false and misleading statements in the Company’s SEC filings and other public statements regarding executive compensation, goodwill accounting, and the Company’s internal controls. The Company filed a motion to dismiss the amended complaint on February 9, 2016, the lead plaintiffs filed an opposition to that motion on April 8, 2016, and the Company filed a reply brief on May 9, 2016. By order granted on September 30, 2016, the U.S. District Court presiding over the case granted the Company’s motion to dismiss the plaintiffs’ amended complaint in its entirety with prejudice. On November 2, 2016, the lead plaintiffs filed a notice to appeal the U.S. District Court's ruling to the U.S. Court of Appeals for the Second Circuit. On February 21, 2017, the lead plaintiffs voluntarily dismissed their appeal. On August 7, 2015, Roberto Paniccia issued a Statement of Claim in the Ontario Superior Court of Justice in the City of Brantford, Ontario seeking to certify a class action suit naming the following as defendants: MDC, former CEO Miles S. Nadal, former CAO Michael C. Sabatino, CFO David Doft and BDO U.S.A. LLP. The Plaintiff alleges violations of section 138.1 of the Ontario Securities Act (and equivalent legislation in other Canadian provinces and territories) as well as common law misrepresentation based on allegedly materially false and misleading statements in the Company’s public statements, as well as omitting to disclose material facts with respect to the SEC investigation. The Company intends to continue to vigorously defend this suit. A case management judge has now been appointed but a date for an initial case conference has not yet been set. One of the Company’s subsidiaries received a subpoena from the U.S. Department of Justice Antitrust Division concerning the Division’s ongoing investigation of production practices in the advertising industry. The Company and its subsidiary are fully cooperating with this confidential investigation. Commitments. At December 31, 2016, the Company had $4,360 of undrawn letters of credit. In addition, the Company has commitments to fund investments in an aggregate amount of $738. Leases. The Company and its subsidiaries lease certain facilities and equipment. For the years ended December 31, 2016, 2015, and 2014, gross premises rental expense amounted to $56,725, $47,583, and $42,657, respectively, which was reduced by sublease income of $3,027, $1,739, and $1,449, respectively. Where leases contain escalation clauses or other concessions, the impact of such adjustments is recognized on a straight-line basis over the minimum lease period. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 16. Commitments, Contingencies and Guarantees - (continued) Minimum rental commitments for the rental of office and production premises and equipment under non-cancellable leases net of sublease income, some of which provide for rental adjustments due to increased property taxes and operating costs, for the years ending December 31, 2017 and thereafter, are as follows: At December 31, 2016, the total future cash to be received on sublease income is $11,599. 17. New Accounting Pronouncements In January 2017, the FASB issued Accounting Standards Update (“ASU”) 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment, which eliminates step two from the two-step goodwill impairment test. Under the new guidance, an entity will perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value provided the loss recognized does not exceed the total amount of goodwill allocated to that reporting unit. This guidance is effective for annual or interim goodwill impairment tests performed in fiscal years beginning after December 15, 2019. The Company does not expect the application of this guidance to have a significant impact on its consolidated financial position or results of operations. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows. This new guidance is intended to reduce diversity in practice regarding the classification of certain transactions in the statement of cash flows. This guidance is effective January 1, 2018 and requires a retrospective transition method. Early adoption is permitted. The Company currently classifies all cash outflows for contingent consideration as a financing activity. Upon adoption the Company is required to classify only the original estimated liability as a financing activity and any changes as an operating activity. In February 2016, the FASB issued ASU 2016-02, which amends the ASC and creates Topic 842, Leases. Topic 842 will require lessees to recognize right-to-use assets and lease liabilities for those leases classified as operating leases under previous U.S. GAAP on the balance sheet. This guidance is effective for annual periods beginning after December 15, 2018 and early adoption is permitted. While not yet in a position to assess the full impact of the application of the new standard, the Company expects that the impact of recording the lease liabilities and the corresponding right-to-use assets will have a significant impact on its total assets and liabilities with a minimal impact on equity. In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Liabilities, which will require equity investments, except equity method investments, to be measured at fair value and any changes in fair value will be recognized in results of operations. This guidance is effective for annual and interim periods beginning after December 15, 2017 and early application is not permitted. Additionally, this guidance provides for the recognition of the cumulative effect of retrospective application of the new standard in the period of initial application. The Company does not expect the application of this guidance to have a significant impact on its consolidated financial position or results of operations. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which will replace all existing revenue guidance under U.S GAAP. The core principle of ASU 2014-09 is to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration expected to be received in exchange for those goods or services. On July 9, 2015, the FASB approved a one year deferral of the effective date of ASU 2014-09 to all annual and interim periods beginning after December 15, 2017. ASU 2014-09 provides for one of two methods of transition: (i) retrospective application to each prior period presented; or (ii) recognition of the cumulative effect of retrospective application of the new standard as of the beginning of the period of initial application. The Company plans to apply ASU 2014-09 on the effective date of January 1, 2018. Presently, the Company is not yet in a position to conclude on the transition method it will choose. Based on the Company’s initial assessment, the impact of the application of the new standard will likely result in a change in the timing of our revenue recognition for performance incentives received from clients. Performance incentives are currently recognized in revenue when specific quantitative goals are achieved, or when the Company’s performance against qualitative goals is determined by the client. Under MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 17. New Accounting Pronouncements - (continued) the new standard, the Company will be required to estimate the amount of the incentive that will be earned at the inception of the contract and recognize such incentive over the term of the contract. While performance incentives are not material to the Company’s revenue, this will result in an acceleration of revenue recognition for certain contract incentives compared to the current method. Additionally, in certain businesses, the Company records revenue as a principal and includes certain third-party-pass-through and out-of-pocket costs, which are billed to clients in connection with the services provided. In March 2016, the FASB issued further guidance on principal versus agent considerations. The Company is currently evaluating the impact of the principal versus agent guidance on its revenue and cost of services; however, such change is not expected to have a material effect on the Company’s results of operations. 18. Employee Benefit Plans A subsidiary acquired in 2012 sponsors a defined benefit plan. The benefits under the defined benefit plans are based on each employee’s years of service and compensation. Effective March 1, 2006, the plan was frozen to all new employees. The Company’s policy is to contribute the minimum amounts required by the Employee Retirement Income Security Act of 1974 (ERISA), as amended. The assets of the plans are invested in an investment trust fund and consist of investments in money market funds, bonds and common stock, mutual funds, preferred stock, and partnership interests. Net periodic pension cost consists of the following components for the years ended December 31: ASC 715-30-25 requires an employer to recognize the funded status of its defined pension benefit plan as a net asset or liability in its statement of financial position with an offsetting amount in accumulated other comprehensive income, and to recognize changes in that funded status in the year in which changes occur through comprehensive income. Other changes in plan assets and benefit obligation recognized in Other Comprehensive Loss consist of the following components for the years ended December 31: MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 18. Employee Benefit Plans - (continued) The following table summarizes the change in benefit obligations and fair values of plan assets for the years ended December 31: Amounts recognized in the balance sheet at December 31 consist of the following: Amounts recognized, net of tax, in Accumulated Other Comprehensive Loss consists of the following components for the years ended December 31: The preceding table presents two measures of benefit obligations for the pension plan. Accumulated benefit obligation generally measures the value of benefits earned to date. Projected benefit obligation also includes the effect of assumed future compensation increases for plans in which benefits for prior service are affected by compensation changes. This pension plan has asset values less than these measures. Plan funding amounts are calculated pursuant to ERISA and Internal Revenue Code rules. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 18. Employee Benefit Plans - (continued) The following weighted average assumptions were used to determine benefit obligations as of December 31: The discount rate assumptions at December 31, 2016 and 2015 were determined independently. A yield curve was produced for a universe containing the majority of U.S.-issued AA-graded corporate bonds, all of which were non-callable (or callable with make-whole provisions). The discount rate was developed as the level equivalent rate that would produce the same present value as that using spot rates aligned with the projected benefit payments. The following weighted average assumptions were used to determine net periodic costs at December 31: The expected return on plan assets is a long-term assumption established by considering historical and anticipated returns of the asset classes invested in by the pension plan and the allocation strategy currently in place among those classes. Fair Value of Plan Assets The Defined Benefit plan assets fall into any of three fair value classifications as defined in the FASB ASC Topic 820, Fair Value Measurements. There are no Level 3 assets held by the plan. The fair value of the plan assets as of December 31 is as follows: MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 18. Employee Benefit Plans - (continued) The pension plans weighted-average asset allocation for the years ended December 31, 2016 and 2015 are as follows: The investment policy for the plans is formulated by the Company’s Pension Plan Committee (the “Committee”). The Committee is responsible for adopting and maintaining the investment policy, managing the investment of plan assets and ensuring that the plans’ investment program is in compliance with all provisions of ERISA, as well as the appointment of any investment manager who is responsible for implementing the plans’ investment process. The goals of the pension plan investment program are to fully fund the obligation to pay retirement benefits in accordance with the plan documents and to provide returns that, along with appropriate funding from the Company, maintain an asset/liability ratio that is in compliance with all applicable laws and regulations and assures timely payment of retirement benefits. The Company’s overall investment strategy is to achieve a mix of approximately 50 percent of investments for long-term growth and 50 percent for near-term benefit payments with a wide diversification of asset types and fund strategies. Equity securities primarily include investments in large-cap and mid-cap companies primarily located in the United States, as well as a smaller percentage invested in large-cap and mid-cap companies located outside of the United States. Fixed income securities are diversified across different asset types with bonds issued in the United States as well as outside the United States. The target allocation of plan assets is 50 percent equity securities and 50 percent corporate bonds and U.S. Treasury securities. The Plan invests in various investment securities. The investments are primarily invested in corporate equity and bond securities. Investment securities are exposed to various risks such as interest rate, market, and credit risks. Due to the level of risk associated with certain investment securities, it is at least reasonably possible that changes in the values of investment securities will occur in the near term and that such changes could materially affect the amounts reported in the preceding tables. The above tables present information about the pension plan assets measured at fair value at December 31, 2016 and the valuation techniques used by the Company to determine those fair values. In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets that the Plan has the ability to access. Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset. In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each plan asset. The net of investment manager fee asset return objective is to achieve a return earned by passively managed market index funds, weighted in the proportions identified in the strategic asset allocation matrix. Each investment manager is expected to perform in the top one-third of funds having similar objectives over a full market cycle. The investment policy is reviewed by the Committee at least annually and confirmed or amended as needed. Under ASC 715-30-25, the transition obligation, prior service costs, and actuarial (gains)/losses are recognized in Accumulated Other Comprehensive Income each December 31 or any interim measurement date, while amortization of these amounts through net MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 18. Employee Benefit Plans - (continued) periodic benefit cost will occur in accordance with ASC 715-30 and ASC 715-60. The estimated amounts that will be amortized in 2017 are as follows: The following estimated benefit payments, which reflect expected future service, as appropriate, are expected to be paid in the years ending December 31: The pension plan contributions are deposited into a trust, and the pension plan benefit payments are made from trust assets. 19. Changes in Accumulated Other Comprehensive Income (Loss) The changes in accumulated other comprehensive income (loss) for the year ended December 31 were: MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) Reclassifications for the years ended December 31 were as follows: MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 20. Quarterly Results of Operations (Unaudited) The following table sets forth a summary of the Company’s consolidated unaudited quarterly results of operations for the years ended December 31, in thousands of dollars, except per share amounts. (1) The diluted income per share calculation for the fourth quarter of 2016 excludes the Company's option to settle the deferred acquisition consideration in shares related to F&B. If such shares were included, the diluted income per common share would be $0.14. The above revenue, cost of services sold, and income (loss) from continuing operations have primarily been affected by acquisitions, divestitures and discontinued operations. Historically, with some exceptions, the Company’s fourth quarter generates the highest quarterly revenues in a year. The fourth quarter has historically been the period in the year in which the highest volumes of media placements and retail related consumer marketing occur. Income (loss) from continuing operations and net loss have been affected as follows: • The fourth quarter of 2016 and 2015 included a foreign exchange loss of $10,081 and $9,531, respectively. MDC PARTNERS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Thousands of United States Dollars, Unless Otherwise Stated Except per Share Amounts) 20. Quarterly Results of Operations (Unaudited) - (continued) • The fourth quarter of 2016 and 2015 included stock-based compensation charges of $5,560 and $4,771, respectively. • The fourth quarter of 2016 and 2015 included deferred acquisition adjustments of $(9,211) and $41,913, respectively. • The third and fourth quarter of 2016 included goodwill impairment charges of $29,631 and $18,893, respectively. 21. Other Events On January 18, 2017, the Company announced that it reached a final settlement agreement with the Philadelphia Regional Office of the SEC in connection with its prior investigation of the Company, and that the SEC entered an administrative Order concluding its investigation of the Company. Pursuant to the Order, and based upon the Company’s full cooperation with the investigation, the SEC imposed a civil penalty of $1,500 on the Company to resolve all potential claims against the Company relating to these matters. There will be no restatement of any of the Company’s previously-filed financial statements. In connection with the investigation, Miles Nadal resigned from his position as CEO and as a Director of the Company’s Board of Directors, effective July 20, 2015, and agreed to repay to the Company specified expenses paid by the Company on his behalf and prior cash bonus awards. Specifically, as of December 31, 2015, Mr. Nadal repaid to the Company an aggregate amount equal to $11,285 in respect of perquisites and improper payments identified by the Special Committee. The Company recorded this amount as a reduction of office and general expenses in 2015. In addition, Mr. Nadal agreed to repay to the Company $10,582 in connection with amounts required to be repaid pursuant to cash bonus awards previously paid to Mr. Nadal, with such repayments to be made in five installments, with the last to be paid on December 31, 2017. Mr. Nadal repaid to the Company the first installment of $1,000 in September 2015, the second installment of $1,500 in December 2015, and an additional payment of $2,000 in December 2016. An additional $6,082 is due in 2017. In 2015, the Company recorded a charge of approximately $5,338 for the balance of prior cash bonus award amounts that will not be recovered. For the twelve months ended December 31, 2016, the Company has incurred $4,065 of professional expenses and $1,500 of civil penalty payments relating to the prior SEC investigation, which were offset by $5,919 of proceeds from the Company’s D&O insurance policy. 22. Subsequent Events On February 14, 2017, the Company entered into a securities purchase agreement with Broad Street Principal Investments, L.L.C., an affiliate of The Goldman Sachs Group Inc. (the “Purchaser”), pursuant to which the Company has agreed to issue and sell to the Purchaser, and the Purchaser has agreed to purchase, 95,000 newly authorized Series 4 convertible preference shares for an aggregate purchase price in cash of $95.0 million, subject to the terms and conditions set forth in the securities purchase agreement. The closing of the transaction is expected to occur in the first quarter of 2017, subject to the conditions set forth in the securities purchase agreement. | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement excerpt. It contains partial phrases about financial elements like profit/loss, expenses, assets, and liabilities, but lacks complete context or specific numerical details. Without the full statement, I cannot provide a meaningful summary. If you have the complete financial statement, I'd be happy to help you summarize it. | Claude |
Report of Independent Registered Public Accounting Firm Balance Sheets Statements of Loss Statements of Stockholders’ Deficit Statements of Cash Flows Notes to Financial Statements ACCOUNTING FIRM To the Board of Directors and Stockholders Vystar Corporation Atlanta, Georgia We have audited the accompanying balance sheets of Vystar Corporation (the Company) as of December 31, 2016 and 2015, and the related statements of loss, stockholders' deficit, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Vystar Corporation as of December 31, 2016 and 2015, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company's recurring losses from operations, capital deficit, and limited capital resources raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters also are described in Note 2 to the financial statements. These financial statements do not include any adjustments that might result from the outcome of this uncertainty. Atlanta, Georgia April 14, 2017 VYSTAR CORPORATION BALANCE SHEETS For the Year Ended December 31, The accompanying notes are an integral part of these financial statements. VYSTAR CORORATION STATEMENTS OF LOSS For the Year Ended December 31, The accompanying notes are an integral part of these financial statements. VYSTAR CORPORATION STATEMENTS OF STOCKHOLDERS’ DEFICIT For the Years Ended December 31, 2016 and The accompanying notes are an integral part of these financial statements. VYSTAR CORPORATION STATEMENTS OF CASH FLOWS For the Years Ended December 31, The accompanying notes are an integral part of these financial statements. VYSTAR CORPORATION NOTES TO FINANCIAL STATEMENTS December 31, 2016 and 2015 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES History and Nature of Business Vystar Corporation (“Vystar”, the “Company”, “we”, “us”, or “our”) is the creator and exclusive owner of the innovative technology to produce Vytex® Natural Rubber Latex (“NRL”). In addition, on June 28, 2013, Vystar Corporation (the “Company”) completed the acquisition of Kiron Clinical Sleep Lab, LLC (“Kiron”) a vertically integrated sleep diagnostic practice located in Durham, NC. We effectively closed Kiron in April 2016 due to changes in the healthcare insurance marketplace resulting in higher insurance deductibles and challenges in getting new studies and payment for completed studies. In essence, since the acquisition, changes to the health care insurance market shifted expenses for sleep studies and DME for many, back to the patients who need to meet higher deductibles before insurance coverage begins. This impacted getting new studies scheduled and challenges to getting payment for past studies. Also, the physician managing the practice left the practice and the remaining staff was ineffective in running the operation without direct supervision, which was impossible to provide from Vystar Corporation headquarters in Atlanta. Because of the closure of Kiron and previous closure of SleepHealth, Vystar Corporation has returned its focus to expanding the licensing and utilization of its proprietary source natural rubber latex technology. Vytex NRL uses a global multi-patented technology and proprietary formulation to reduce non-rubber particles including the antigenic proteins associated with latex allergies, resulting in a cleaner form of latex. In fact, the antigenic protein levels are reduced to virtually undetectable levels. This new licensing of branded consumer products was noted in a press release dated March 19, 2014. On January 22, 2015, Vystar announced the signing of an exclusive domestic distribution agreement with Worcester, MA based Nature’s Home Solutions (NHS) who sources eco-friendly materials and technologies for use in furnishings and other markets. On March 4, 2015, the Company announced that Hartford, CT based Gold Bond formed a strategic alliance with NHS to produce and market the world’s first Vytex NRL based mattress which was introduced at the High Point (NC) Market mid-April 2015. In June 2015, the first mattresses made with Vytex (hybrid and pure Vytex) were placed on the sales floor at Rotman’s Furniture and Carpet Store in Worcester, MA using the “Evaya” brand and Gold Bond had shipped four versions of their “Brilliance” inner coil and pure foam mattresses (Emerald, Ruby, Sapphire Plush and Sapphire Firm) to over 30 stores from Maine to Florida. Basis of Presentation The financial statements are presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification. The Company has evaluated subsequent events through the date of the filing of its Form 10-K with the Securities and Exchange Commission. Other than those events disclosed in Note 15, the Company is not aware of any other significant events that occurred subsequent to the balance sheet date but prior to the filing of this report that would have a material impact on the Company’s financial statements. Reclassification Certain items in the prior year’s financial statements have been reclassified in order to conform with the current year presentation. Specifically note such reclassifications for discontinued operations. Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying disclosures. Although these estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future, actual results could differ from these estimates. Examples include valuation allowances for deferred tax assets, provisions for bad debts, and fair values of share-based compensation and other equity issuances. Concentration of Credit Risk Certain financial instruments potentially subject the Company to concentrations of credit risk. These financial instruments consist primarily of cash and accounts receivable. Cash held in operating accounts may exceed the Federal Deposit Insurance Corporation, or FDIC, insurance limits. While we monitor cash balances in our operating accounts on a regular basis and adjust the balances as appropriate, these balances could be impacted if the underlying financial institutions fail. To date, we have experienced no loss or lack of access to our cash; however, we can provide no assurances that access to our cash will not be impacted by adverse conditions in the financial markets. Accounts Receivable Accounts receivable are stated at the amount management expects to collect from outstanding balances. Management provides for uncollectible amounts through a charge to earnings and a credit to an allowance for doubtful accounts based upon its assessment of the current status of individual accounts. Balances that are still outstanding after management has performed reasonable collection efforts are written off through a charge to the allowance and a credit to accounts receivable. As of December 31, 2016 and 2015, we have provided for uncollectible amounts through a charge to earnings and the income statement of $0 and $60,266, respectively. We grant credit to our customers without requiring collateral. The amount of accounting loss for which we are at risk in these unsecured accounts receivable is limited to their carrying value. Vytex customers are located in both the United States and internationally. Property and Equipment Property and equipment is stated at cost. Depreciation is provided by the use of the straight-line and accelerated methods for financial and tax reporting purposes, respectively, over the estimated useful lives of the assets, generally 5 years. Intangible Assets Patents represent legal and other fees associated with the registration of patents. The Company has four issued patents with the United States Patent and Trade Office (USPTO) as well as four issued international PCT (Patent Cooperation Treaty) patents. Patents are carried at cost and are being amortized on a straight-line basis over their estimated useful lives, typically 20 years. The Company has trademark protection for “Vystar”, “Vytex”, and “Created by Nature. Recreated by Science.” Trademarks are carried at cost and since their estimated life is indeterminable, no amortization is recognized. Instead, they are evaluated annually for impairment. Impairment of Long-lived Assets Long-lived assets, including property and equipment and intangible assets with finite lives, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset, an impairment loss is recognized in the amount that the carrying amount of the asset exceeds its fair value. Fair value is determined based on discounted future net cash flows associated with the use of the asset. Fair Value of Financial Instruments The Company’s financial instruments consist of cash, accounts receivable, accounts payable, accrued expenses, lines of credit, shareholder notes payable, and long-term debt. The carrying values of all the Company’s financial instruments approximate fair value because of their short maturities. In addition to the short maturities, the carrying amounts of our line of credit and shareholder notes payable approximate fair value because the interest rates at December 31, 2016 and 2015 approximate market interest rates for the respective borrowings. In specific circumstances, certain assets and liabilities are reported or disclosed at fair value. Fair value is the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in the Company’s principal market for such transactions. If there is not an established principal market, fair value is derived from the most advantageous market. Valuation inputs are classified in the following hierarchy: ● Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities. ● Level 2 inputs are directly or indirectly observable valuation inputs for the asset or liability, excluding Level 1 inputs. ● Level 3 inputs are unobservable inputs for the asset or liability. Highest priority is given to Level 1 inputs and the lowest priority to Level 3 inputs. Acceptable valuation techniques include the market approach, income approach, and cost approach. In some cases, more than one valuation technique is used. Income Taxes Vystar recognizes income taxes on an accrual basis based on a tax position taken or expected to be taken in its tax returns. A tax position is defined as a position in a previously filed tax return or a position expected to be taken in a future tax filing that is reflected in measuring current or deferred income tax assets or liabilities. Tax positions are recognized only when it is more likely than not (i.e., likelihood of greater than 50%), based on technical merits, that the position would be sustained upon examination by taxing authorities. Tax positions that meet the more likely than not threshold are measured using a probability-weighted approach as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement. Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. A valuation allowance is established to reduce deferred tax assets if all, or some portion, of such assets will more likely than not be realized. A valuation allowance for the full amount of the net deferred tax asset was recorded for the years ended December 31, 2016 and 2015. Should they occur, interest and penalties related to tax positions are recorded as interest expense. No such interest or penalties have been incurred as of December 31, 2016 and 2015. The Company is no longer subject to federal examination for years prior to 2011. Loss Per Share The Company presents basic and diluted loss per share. Because the Company reported a net loss in 2016 and 2015, common stock equivalents, including stock options and warrants, were anti-dilutive; therefore, the amounts reported for basic and dilutive loss per share were the same. Excluded from the computation of diluted loss per share were options to purchase 9,418,271 and 9,381,573 shares of common stock for 2016 and 2015, respectively, as their effect would be anti-dilutive. Warrants to purchase 16,122,332 and 17,551,784 shares of common stock for 2016 and 2015, respectively, were also excluded from the computation of diluted loss per share as their effect would be anti-dilutive. In addition, preferred stock convertible to 3,761,417 and 3,484,100 shares of common stock for 2016 and 2015, respectively, were excluded from the computation of diluted loss per share as their effect would be anti-dilutive. Revenue The Vytex segment derives revenue from sales of or license fees of Vytex NRL raw material to manufacturers and distributors of rubber and rubber end products. Under both the direct and licensing agreement sales, the Vytex segment recognizes revenue at the time product is shipped and title passes to the customer. Revenue is recognized when the following four criteria are met: (1) persuasive evidence of an arrangement exists; (2) shipment or delivery has occurred; (3) the price is fixed or determinable and (4) collectability is reasonably assured. Cost of Revenue For Vytex, cost of revenue consists primarily of product and freight costs. Research and Development Research and development costs are expensed when incurred. Research and development costs include all costs incurred related to the research, development and testing of the Company’s process to produce Vytex NRL. Recent Accounting Pronouncements In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, a new standard on revenue recognition. The new standard will supersede existing revenue recognition guidance and apply to all entities that enter into contracts to provide goods or services to customers. The guidance also addresses the measurement and recognition of gains and losses on the sale of certain non-financial assets, such as real estate, property and equipment. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which defers the effective date of the guidance in ASU 2014-09 by one year. This update is now effective for annual and interim period beginning after December 15, 2017, which will require us to adopt these provisions in the first quarter of fiscal year 2018. Early application is permitted for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. This update permits the use of either the retrospective or cumulative effect transition method. The Company is currently assessing the impact that this guidance will have on its financial statements. In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 requires lessees to recognize the assets and liabilities on their balance sheet for the rights and obligations created by most leases and continue to recognize expenses on their income statements over the lease term. It will also require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. The guidance is effective for annual reporting periods beginning after December 15, 2018, and interim periods within those years. Early adoption is permitted. The Company is currently assessing the impact that this guidance will have on its financial statements. In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Receipts and Cash Payments. This update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain receipts and cash payments are presented and classified in the statement of cash flows. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is currently assessing the impact that this guidance will have on its financial statements. NOTE 2 - LIQUIDITY AND GOING CONCERN The Company’s financial statements are prepared using the accrual method of accounting in accordance with accounting principles generally accepted in the United States of America and have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. However, we have incurred significant losses and experienced negative cash flow since inception. At December 31, 2016, the Company had cash of approximately $36,282 and a deficit in working capital of $2,723,541. For the year ended December 31, 2016, the Company had a net loss of $1,221,298 and an accumulated deficit of $26,814,649. For the year ended December 31, 2015, the Company had a net loss of $1,238,878 and the accumulated deficit amounted to $25,593,351. We use working capital to finance our ongoing operations and since those operations do not currently cover all of our operating costs, managing working capital is essential to our Company’s future success. Net cash used in operating activities was $907,441 for the year ended December 31, 2016 as compared to $656,829 for the year ended December 31, 2015. During the year ended December 31, 2016, cash used in operations was primarily due to the net loss for the year of $1,221,298 net of non-cash related add-back of share-based compensation expense of $242,159. Net cash provided by investing activities was $2,701 during the year ended December 31, 2016 as this was a result of selling some equipment. During the year ended December 31, 2015, $281 was the result of selling some equipment as well. Net cash provided by financing activities was $911,963 during the year ended December 31, 2016, as compared to cash provided of $611,837 during the year ended December 31, 2015. During 2016 cash was provided from the issuance of common stock in the amount of $723,456. $53,500 in cash was provided by the exercise of common stock warrants and options and $135,000 in proceeds from Shareholder Notes. In 2015, the cash provided was exclusively from the issuance of common stock. As discussed in detail in Note 5, the CMA Note matured on April 29, 2013, and has been extended through April 29, 2016. The note is currently due on demand. All the Shareholder Notes which matured on various dates from March 11 through May 31, 2013 were either converted to preferred stock or had their maturity dates extended or Vystar management is working with the holders of the Shareholder Notes to extend the maturity dates until 2018. A successful transition to attaining profitable operations is dependent upon obtaining sufficient financing to fund the Company’s planned expenses and achieving a level of revenue adequate to support the Company’s cost structure. Management plans to finance future operations through the use of cash on hand, increased revenue from Vytex division license fees, stock warrant exercises from existing shareholders, and raising capital through private placement memoranda (see Note 15, Subsequent Events). As a result of this history of losses and financial condition, there is substantial doubt about the Company’s ability to continue as a going concern. There can be no assurances that the Company will be able to achieve projected levels of revenue in 2017 and beyond. If the Company is not able to achieve projected revenue and obtain alternate additional financing of equity or debt, the Company would need to significantly curtail or reorient operations during 2017, which could have a material adverse effect on the ability to achieve the business objectives and as a result may require the Company to file for bankruptcy or cease operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts classified as liabilities that might be necessary should the Company be forced to take any such actions. The Company’s future expenditures will depend on numerous factors, including: the rate at which the Company can introduce and license Vytex NRL to manufacturers; the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and market acceptance of the Company’s products and services and competing technological developments. As the Company expands our activities and operations, cash requirements are expected to increase at a rate consistent with revenue growth after the Company has achieved sustained revenue generation. NOTE 3 - PROPERTY AND EQUIPMENT Property and equipment consisted of the following at December 31: Depreciation expense for the years ended December 31, 2016 and 2015 was $278 and $1,608, respectively. NOTE 4 - INTANGIBLE ASSETS Intangible assets were as follows at December 31: Amortization expense for the years ended December 31, 2016 and 2015 was $15,861. Estimated future amortization expense for finite-lived intangible assets is as follows: NOTE 5 - NOTES PAYABLE AND LOAN FACILITY Related Party Line of Credit (CMA Note Payable) On April 29, 2011, the Company executed with CMA Investments, LLC, a Georgia limited liability company (“CMA”), an unsecured line of credit with a principal amount of up to $800,000 (the “CMA Note”). CMA is a limited liability company of which three of the directors of the Company (“CMA directors”) are the members. Pursuant to the original terms of the CMA Note, the Company could draw up to a maximum principal amount of $800,000. Interest, which is computed at LIBOR plus 5.25% per annum on amounts drawn and fees, will be paid by a director of the Company, to CMA. The weighted average interest rate in effect on the borrowings for the year ended December 31, 2015 and 2014 was 5.45% and 5.44%, respectively. Pursuant to an agreement between the Company and CMA, the Company will issue common stock with a value equal to the interest and fees paid based on the closing price of the common stock on the OTC Bulletin Board on the date of such payments. From June through December 2011, 110,848 shares of common stock were issued valued at $43,839 for interest and fees related to the CMA Note and in January and February 2012, 28,138 shares of common stock were issued valued at $9,005 for interest for the related party CMA Note. This agreement was modified during February 2012 and the Company assumed responsibility for payment of such interest and fees. The original maturity date of the CMA Note was April 29, 2013. Other terms of the CMA Note include: ● No payments of principal were due until the second anniversary of the CMA Note, at which time all outstanding principal was due and payable; and ● As compensation to the directors for providing the CMA Note, the Company issued warrants to purchase 2,600,000 shares of the Company’s common stock to the CMA Directors at $0.45 per share, (the closing price of the Company’s stock on April 29, 2011), which vested 20% immediately and 10% upon each draw by the Company of $100,000 under the CMA Note. Because the warrants were issued and valued prior to the receipt of funds under this loan, no discount could be recorded and, accordingly, the value of the warrants was capitalized as a financing cost. These costs were amortized on a straight line basis over the term of the CMA Note. On September 14, 2011, the Company’s Board of Directors approved increasing the line of credit with CMA by $200,000 to a maximum principal amount of $1,000,000 and the Company’s Chairman and Chief Executive Officer became a member of CMA. As compensation to the CMA Directors for increasing the amount available under the CMA Note, the Board of Directors approved modifying the exercise price for the 2,600,000 compensatory stock purchase warrants previously issued to the directors from $0.45 to $0.27 per share, (the closing price of the Company’s common stock on that date) and the Company also issued warrants to purchase an additional 1,600,000 shares of the Company’s stock at $0.27 per share, (the closing price of the Company’s common stock on September 14, 2011), which vest upon the original terms of the CMA Note. The costs incurred in the modification of the exercise price of the 2,600,000 compensatory stock purchase warrants issued on April 29, 2011 and the additional 1,600,000 warrants issued on September 14, 2011 were amortized to interest expense over the remaining term of the CMA Note. On November 2, 2012, the Board of Directors approved an increase in the CMA line of credit from $1,000,000 to $1,500,000. As compensation to the CMA Directors for increasing the amount available under the CMA Note, warrants to purchase an additional 2,100,000 shares of the Company’s stock at $0.35 per share were issued and recorded as deferred financing costs to be amortized through interest expense over the remaining term of the CMA Note. On April 29, 2013, the maturity date of the CMA Note was extended to April 29, 2014. As compensation to the CMA Directors for extending the maturity date of the CMA Note, the Board of Directors approved modifying the exercise price for the 6,300,000 compensatory stock purchase warrants previously issued to the Directors to $0.10 per share and the CMA Directors forfeited 630,000 of the warrants. Amortization of the financing costs associated with extending the CMA Note was amortized through interest expense. On April 29, 2014, the maturity date of the CMA Note was extended to April 29, 2015 with no compensation to CMA directors. As of April 29, 2015, the maturity date of the CMA Note was again extended for one year to April 29, 2016. No compensation was paid to the CMA Directors for this extension. The note is currently due on demand. Shareholder Notes Payable Shareholder notes payable outstanding as of December 31, 2016 and 2015 totaled $835,068 and $700,068, respectively. On March 11, 2011, the Company issued to existing shareholders of the Company an aggregate of $400,000 of convertible promissory notes together with warrants to purchase an aggregate of 160,000 shares of the Company’s common stock at $0.68 per share for two years from the date of issuance. Such notes are (i) unsecured, (ii) bear interest at an annual rate of ten percent (10%) per annum, and (iii) are convertible into shares of common stock at the conversion rate of $0.68 of principal and interest for each such share. The principal and accrued interest came due on March 11, 2013. Four of the holders of these notes with a total initial principal amount of $200,000 agreed to convert their notes and accumulated interest to the Company’s 10% Series A Cumulative Convertible Preferred Stock. The outstanding notes are currently due on demand and Vystar is currently working with the subscription holders of the matured notes to extend the maturity date until 2018. On May 31, 2011, the Company issued to existing shareholders of the Company an aggregate of $125,000 of convertible promissory notes together with warrants to purchase an aggregate of 50,000 shares of the Company’s common stock at $0.49 per share for two years from the date of issuance. Such notes are (i) unsecured, (ii) bear interest at an annual rate of ten percent (10%) per annum, and (iii) are convertible into shares of common stock at a conversion rate of $0.49 of principal and interest for each such share. Accumulated interest and principal came due on May 31, 2013. One of the Shareholder Notes with an outstanding balance of $30,000 was retired. The holders of the other two Shareholder Notes having an initial principal balance of $100,000 agreed to extend the maturity date by two years and these notes with accumulated interest were due on May 31, 2015. The outstanding notes are currently due on demand and Vystar is currently working with the subscription holders of the matured notes to extend the maturity date until 2018. One subscription holder demanded payment for their matured note. The subscription holder and Vystar have agreed to three installment payments of $52,785, the first of which was made in the fourth quarter of 2016. The second payment is due in the second quarter of 2017 and the third and final payment is due in the third quarter of 2017. On May 6, 2013, the Company issued to an existing shareholder of the Company an aggregate of $112,500 of convertible promissory notes (the “Note”). The Note is (i) unsecured, (ii) bears interest at an annual rate of ten percent (10%) per annum from date of issuance, and (iii) is convertible at any time until maturity at the holder’s option into shares of the Company’s common stock at a weighted average conversion rate of $0.075 of principal and interest for each such share. The outstanding notes are currently due on demand and Vystar is currently working with the subscription holder to extend the maturity date until 2018. On September 6, 2013, the Company issued to the Chief Executive Officer a convertible promissory note with a face value of $40,769 (the “Note”) in lieu of compensation. The Note is (i) unsecured, (ii) bears interest at an annual rate of ten percent (10%) per annum from date of issuance, and (iii) is convertible at any time until maturity at the holder’s option into shares of the Company’s common stock at a weighted average conversion rate of $0.075 of principal and interest for each such share. No payments of interest or principal are payable until September 6, 2018. On December 30, 2013, the Company issued to the Chief Executive Officer a convertible promissory note with a face value of $25,962 (the “Note”) in lieu of compensation. The Note is (i) unsecured, (ii) bears interest at an annual rate of ten percent (10%) per annum from date of issuance, and (iii) is convertible at any time until maturity at the holder’s option into shares of the Company’s common stock at a weighted average conversion rate of $0.05 of principal and interest for each such share. No payments of interest or principal were payable until December 30, 2015. The note is currently due on demand but The Chief Executive Officer has agreed to extend the maturity date until 2018. On December 31, 2015, the Company issued to the Chief Executive Officer a convertible promissory note with a face value of $37,500 (the “Note”) in lieu of compensation. The Note is (i) unsecured, (ii) bears interest at an annual rate of ten percent (10%) per annum from date of issuance, and (iii) is convertible at any time until maturity at the holder’s option into shares of the Company’s common stock at a weighted average conversion rate of $0.08 of principal and interest for each such share. No payments of interest or principal are payable until December 30, 2018. On December 31, 2016, the Company issued to an existing shareholder of the Company an aggregate of $135,000 of convertible promissory notes (the “Note”). The Note is (i) unsecured, (ii) bears interest at an annual rate of five percent (5%) per annum from date of issuance, and (iii) is convertible at any time after December 31, 2018 until maturity at the holder’s option into shares of the Company’s common stock at a weighted average conversion rate of $0.05 of principal and interest for each such share. The current base weighted-average conversion price for the above referenced Shareholder and Promissory Notes with an outstanding balance as of December 31, 2016 of $1,066,148 including accrued interest of $231,080, is $0.064 per share or 16,705,538 shares of the Company’s common stock. The face value of the Shareholder Notes at December 31, 2016 is $835,068. The maturities (by year) of the principal amount of Shareholder Notes Payable as of December 31, 2016 are as follows: NOTE 6 - COMMITMENTS Employment Agreements The Company has entered into an employment agreement with executive management, as appropriate, which includes provisions for the continued payment of salary and benefits for periods ranging from 3 months to 6 months, as well as a percentage of base salary for compliance with specified covenants in the agreements, upon termination of employment by the Company without cause, as defined. NOTE 7 - DISCONTINUED OPERATIONS Kiron Clinical Sleep Lab’s post acquisition performance fell far below Vystar’s expectations. As part of the Company’s strategy to focus on realizing the potential of the Vytex foam business in the pillow and mattress markets as well as part of the Company’s cost reduction plan, the Company made the decision to discontinue the operations of the Kiron division acquired in June 2013. The Kiron division revenue was $82,353 and $331,398 for the fiscal years ended December 31, 2016 and 2015, respectively. Kiron’s net gain (loss) from discontinued operations was $35,733 and ($189,514) for the fiscal years ended December 31, 2016 and 2015, respectively. The discontinued operations of the Sleephealth division had a net gain (loss) of $2,246 and ($23,223) for the fiscal years ended December 31, 2016 and 2015 respectively. NOTE 8 - STOCKHOLDERS’ EQUITY Preferred Stock At December 31, 2016 and 2015, the 13,828 shares of outstanding preferred stock had accumulated undeclared dividends of approximately $49,791 and $36,000 and could be converted into 3,761,417 and 3,484,100 shares of common stock, at the option of the holder, respectively. Common Stock and Warrants As part of a September 2014 Private Placement Memorandum, updated in February 2015 and September 2015, the Company issued 9,010,000 shares of common stock to thirteen (13) accredited investors. Total gross proceeds of the issuances were $450,500. No commissions were paid. The shares of common stock were offered and sold in reliance upon exemptions from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder. On February 26, 2015, the Company issued 420,000 common shares as compensation for an extension to the Company’s Consulting Agreement executed in December 2013 as amended in February 2014 with Jason Leaf and 1,440,000 common shares as compensation for an extension to the Company’s Business Development Agreement with Blue Oar Consulting, Inc. executed in March 2013 as amended in August 2013 and amended February 2014. On March 6, 2015, the Company issued 1,560,000 common shares as compensation for a public relations contract with Accentuate PR. Beginning in June 2015 through December 2015, the Company’s Board offered the investors from the November 2013 Private Placement holding common stock warrants an incentive to exercise their $0.05 warrants for $0.03 per common stock share. The Company had investors exercise 5,344,622 warrants at $0.03 per share for net proceeds of $160,337. This incentive resulted in an expense of $15,899 appearing as other expense on the Company’s Statement of Loss. The Company also had 20,000 warrants exercised at $0.05 for $1,000. In June 2015, the Company issued 200,000 shares as compensation to third-party contractors in lieu of cash compensation. On November 15, 2015, the Company issued 1,000,000 common shares as compensation for an amendment and extension to the Company’s Consulting Agreement with Jason Leaf, issued 1,000,000 common shares as compensation for an amendment and extension to the Company’s Consulting Agreement with Steven Rotman, and 1,333,333 common shares as compensation for an amendment and extension to the Company’s Business Development Agreement with Blue Oar Consulting, Inc. The Company also issued 2,714,286 common shares as compensation for a website development and maintenance contract to Zymbe, Inc, which was subsequently divided equally between Gregory P. Rotman, Jason Leaf and Eric Maas as individuals. As part of a September 2014 Private Placement Memorandum, updated in February 2015 and September 2015, the Company issued 12,480,000 shares of common stock to six (6) accredited investors during the fiscal year ended December 31, 2016. Total gross proceeds of the issuances were $624,000. No commissions were paid. The shares of common stock were offered and sold in reliance upon exemptions from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder. As part of a November 2016 Private Placement Memorandum, the Company issued 1,700,000 shares of common stock to four (4) accredited investors during the fiscal year ended December 31, 2016. Total gross proceeds of the issuances were $85,000. No commissions were paid. The shares of common stock were offered and sold in reliance upon exemptions from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder. During the year ended December 31, 2016, the Company had 1,783,335 common stock warrants exercised at $0.03 per share for $53,500 and issued 1,296,885 common shares for cashless warrants that were exercised. On June 30, 2016, the Company issued 997,466 common shares as compensation under the Company’s Business Development Agreement with Blue Oar Consulting, Inc. executed in March 2013 as amended in August 2013 and amended February 2014 and 250,000 common shares as compensation under the Company’s Business Development Agreement with Byron Novosad executed in February 26, 2014. NOTE 9 - SHARE-BASED COMPENSATION Generally accepted accounting principles require share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values at the date of grant, net of estimated forfeitures. The Company used the Black-Scholes option pricing model to estimate the grant-date fair value of awards granted during 2016 and 2015. The following assumptions were used: ● Expected Dividend Yield - because the Company does not currently pay dividends, the expected dividend yield is zero; ● Expected Volatility in Stock Price - Expected volatility calculations were based on the Company’s trading activity which ranged between and 117.28% and 154.79% during 2016; ● Risk-free Interest Rate - reflects the average rate on a United States Treasury bond with maturity equal to the expected term of the option or warrant, ranging from 1.46% to 2.45% during 2016; and ● Expected Life of Awards - because the Company has minimal experience with the exercise of options or warrants for use in determining the expected life for each award, the simplified method was used to calculate an expected life based on the end of the contractual term of the stock award. In total, the Company recorded $55,143 and $48,523 for the years ended December 31, 2016 and 2015, respectively, of share-based compensation expense related to employee and Board members’ stock options. The unrecognized compensation expense as of December 31, 2016 was $157,838 for non-vested share-based awards to be recognized over a period of approximately five years. Stock Options During 2004, the Board of Directors of the Company adopted a stock option plan (the “Plan”) and authorized up to 4,000,000 shares to be issued under the Plan. In April 2009, the Company’s Board of Directors authorized an increase in the number of shares to be issued under the Plan to 10,000,000 shares and to include the independent Board Members in the Plan in lieu of continuing the previous practice of granting warrants each quarter to independent Board Members for services. At December 31, 2016, there were 181,729 shares of common stock reserved for issuance under the Plan. In 2014, the Board adopted an additional stock option plan which provides for an additional 5,000,000 shares which are all available as of December 31, 2016. The Plan is intended to permit stock options granted to employees to qualify as incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended (“Incentive Stock Options”). All options granted under the Plan that are not intended to qualify as Incentive Stock Options are deemed to be non-qualified options. Stock options are granted at an exercise price equal to the fair market value of the Company’s common stock on the date of grant, typically vest over periods up to 4 years and are typically exercisable up to 10 years. The weighted-average assumptions used in the option pricing model for stock option grants were as follows: The following tables summarize all stock option activity of the Company for the years ended December 31, 2016 and 2015: Additional details, including the average remaining contractual life of the options, as well as the range of exercise prices are shown in the table below: The Company added a director on March 12, 2015 and another on December 2, 2015. Each director was granted 500,000 options with a ten-year term and an exercise price of $0.08 and $0.03 respectively, the closing price of the Company’s common stock on the OTCBB on the grant date. The options vest 25,000 shares quarterly beginning on March 30, 2015 and March 30, 2016 for a period of five years ending December 31, 2019 and December 31, 2020 respectively. As of December 31, 2016, the aggregate intrinsic value of the Company’s outstanding options was $570,128. The aggregate intrinsic value will change based on the fair market value of the Company’s common stock. Warrants Warrants are issued to third parties as payment for services, debt financing compensation and conversion and in conjunction with the issuance of common stock. The fair value of each common stock warrant issued for services is estimated on the date of grant using the Black-Scholes option pricing model. The weighted-average assumptions used in the option pricing model for stock warrant grants were as follows: The following table represents the Company’s warrant activity for the years ended December 31, 2016 and 2015: The stock compensation expense for 2016 and 2015 related to warrants was $115,054 and $104,538 respectively. NOTE 10 - RELATED PARTY TRANSACTIONS Officers and Directors During April 2009, the Company’s Board of Directors authorized the inclusion of the Board members in the Company’s stock option plan in lieu of continuing the previous practice of granting warrants each quarter to independent Board members. Each Board member was granted options to purchase 400,000 shares of the Company’s common stock, valued at approximately $233,000 each, an exercise price range between $0.05 and $0.68 per share. Vesting occurs at the end of each complete calendar quarter served as an independent Board member of the Company at a rate of 20,000 shares each per quarter. The options are exercisable in whole or in part before September 30, 2019. In 2014, the Board adopted an additional stock option plan which provides for an additional 5,000,000 shares. Two board members’ unvested options were forfeited when they resigned the Board in 2014. NOTE 11 - DEFINED CONTRIBUTION PLAN The Company maintained a tax-qualified retirement plan that provides all regular employees with an opportunity to save for retirement on a tax-advantaged basis during 2015. Under the 401(k) plan, 100 percent of participants’ contributions up to a maximum of 3 percent of compensation and 50 percent of participants’ contributions up to an additional 2 percent of compensation are matched. Company contributions under the plan were approximately $2,000 in 2016 and $4,000 for 2015. This plan was terminated in 2016. NOTE 12 - MAJOR CUSTOMERS AND VENDORS Major customers and vendors are defined as a customer or vendor from which the Company derives at least 10% of its revenue and cost of revenue, respectively. Vytex Division: During 2016, the Vytex Division had product revenue from three major customers Natures Home Solutions, RCMA, and Centrotrade, which collectively comprised 100% total Vytex revenue. During 2015, the Vytex Division had product revenue from two major customers Natures Homes Solutions and Centrotrade, which comprised 100% of total Vytex revenue. No amounts were owed to major vendors at December 31, 2016 and December 31, 2015. NOTE 13 - RISKS AND UNCERTAINTIES The Company is exposed to commodity price risk, mainly associated with variations in the market price for NRL as well as wintering of the Hevea trees, which differs for each country. The timing and magnitude of industry cycles are difficult to predict and are impacted by general economic conditions including the buying climate in China. The Company responds to changes in NRL prices by adjusting sales prices on a weekly basis and by turning rather than holding inventory in anticipation of higher prices. The Company actively manages its exposure to commodity price risk and monitors the actual and expected spread between forward selling prices and purchase costs and processing and shipping expense. The Company also currently spreads the processing of Vytex NRL among three continents. Sales contracts are based on forward market prices, and generally orders are placed 30 to 90 days ahead of shipment date due to these fluctuations. However, financial results may be negatively impacted where selling prices fall more quickly than purchase price adjustments can be made or when levels of inventory have an anticipated net realizable value that is below cost. NOTE 14 - SEGMENT INFORMATION AND GEOGRAPHIC DATA The Company has only one operating segment, the Vytex Division. NOTE 15 - SUBSEQUENT EVENTS On January 18, 2017 Vystar was informed that the Indian Patent Office approved our application (2487/KOLNP/2010) entitled, “Natural Rubber Latex Having Reduced Allergenicity and Method of Making” under Patent Number 279323. There is one more patent under consideration by the Indian Patent Office. On February 8, 2017 Vystar received notice of grant from the Guatemalan Patent Office for application number 2010-000208 entitled, “Natural Rubber Latex Having Reduced Allergenicity and Method of Making” and is awaiting a grant number. As part of the November 2016 Private Placement Memorandum, the Company issued 2,690,000 shares of common stock to nine (9) accredited investors during the period from January 1, 2017 to April 14, 2017. Total gross proceeds of the issuances were $134,500. No commissions were paid. The shares of common stock were offered and sold in reliance upon exemptions from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder. During the period from January 1, 2017 to April 14, 2017, the Company issued 1,464,087 common stock shares as the result of four (4) accredited investors exercising warrants and options utilizing a cash-less feature in those warrants and options. There were no proceeds in connection with the exercise of these warrants and options. On March 15, 2017, the Company issued 400,000 common shares as compensation under the Company’s Business Development Agreement with FMW Media Works Corporation and 750,000 common shares as compensation under the Company’s Business Development Agreement with Joseph Savanyo. | Based on the provided excerpt, here's a summary of the key financial statement points:
Financial Statement Overview for Vystar Corporation:
1. Audit Context:
- Audited financial statements for the year ending December 31
- Prepared for Board of Directors and Stockholders
- Located in Atlanta, Georgia
2. Financial Reporting Principles:
- Fair value accounting used for assets and liabilities
- Valuation inputs classified in a hierarchical system
- Emphasis on transparent and accurate financial reporting
3. Risk Management:
- Potential credit risk in financial instruments
- Cash accounts may exceed FDIC insurance limits
- Monitoring of cash balances and potential financial market risks
4. Accounts Receivable Management:
- Receivables stated at expected collection amount
- Provision for uncollectible accounts through earnings
- Allowance for doubtful accounts
- Write-offs performed after reasonable collection efforts | Claude |
Our consolidated financial statements and supplementary financial data are included in this Annual Report beginning on page. MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control over financial reporting is a process designed under the supervision of the Company's Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external purposes in accordance with generally accepted accounting principles. As of December 31, 2016, management assessed the effectiveness of the Company's internal control over financial reporting based on the criteria for effective internal control over financial reporting established in the 2013 "Internal Control - Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment and those criteria, management determined that the Company maintained effective internal control over financial reporting as of December 31, 2016. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Grant Thornton LLP, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report, has issued their report on the effectiveness of the Company's internal control over financial reporting as of December 31, 2016. The report, which expresses an unqualified opinion on the effectiveness of the Company's internal control over financial reporting as of December 31, 2016, is included in this Item under the heading "Report of Independent Registered Public Accounting Firm." ACCOUNTING FIRM Board of Directors and Stockholders Laredo Petroleum, Inc. We have audited the internal control over financial reporting of Laredo Petroleum, Inc. (a Delaware corporation) and subsidiaries (the "Company") as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2016, and our report dated February 16, 2017 expressed an unqualified opinion on those financial statements. /s/ GRANT THORNTON LLP Tulsa, Oklahoma February 16, 2017 | This financial statement describes the company's internal control system for financial reporting, which serves three primary purposes:
1. Record Keeping: Maintaining accurate and detailed records that fairly represent the company's transactions and asset movements.
2. Transaction Validation: Ensuring that:
- Transactions are properly recorded
- Financial statements can be prepared according to accounting standards
- Receipts and expenditures are only made with proper management and director authorization
3. Asset Protection: Providing safeguards to prevent or quickly detect any unauthorized use, acquisition, or disposal of company assets that could significantly impact financial statements.
The overall goal is to create a robust internal control framework that promotes financial accuracy, transparency, and asset protection. | Claude |
FINANCIAL STATEMENTS VERITEC, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS FISCAL YEARS ENDED JUNE 30, 2016 AND 2015 ACCOUNTING FIRM The Board of Directors and Stockholders Veritec, Inc. and Subsidiaries Golden Valley, Minnesota We have audited the accompanying consolidated balance sheets of Veritec, Inc. and Subsidiaries (the “Company”) as of June 30, 2016 and 2015, and the related consolidated statements of operations, stockholders’ deficiency and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Veritec, Inc. and Subsidiaries as of June 30, 2016 and 2015, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has had recurring losses from operations and had a stockholders’ deficiency as of June 30, 2016. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regards to these matters are also described in Note 2 to the consolidated financial statements. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Weinberg & Company, P.A. Weinberg & Company, P.A. Los Angeles, California September 26, 2016 VERITEC, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2016 AND 2015 The accompanying notes are an integral part of these consolidated financial statements VERITEC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE FISCAL YEARS ENDED JUNE 30, 2016 AND 2015 The accompanying notes are an integral part of these consolidated financial statements VERITEC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY FOR THE FISCAL YEARS ENDED JUNE 30, 2016 AND 2015 The accompanying notes are an integral part of these consolidated financial statements VERITEC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE FISCAL YEARS ENDED JUNE 30, 2016 AND 2015 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION The accompanying notes are an integral part of these consolidated financial statements VERITEC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE FISCAL YEARS ENDED JUNE 30, 2016 AND 2015 NOTE 1 - OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company Veritec, Inc. (Veritec) was formed in the State of Nevada on September 8, 1982. Veritec’s wholly owned subsidiaries include, Vcode Holdings, Inc. (Vcode®), and Veritec Financial Systems, Inc. (VTFS) (collectively the “Company”). Nature of Business The Company is primarily engaged in the development, marketing, sales and licensing of products and rendering of professional services related to its mobile banking solutions. Prior to its sale on September 30, 2015, the Company was also focused on its proprietary two-dimensional matrix symbology (also commonly referred to as “two-dimensional barcodes” or “2D barcodes”). Mobile Banking Solutions In January 12, 2009, Veritec formed VTFS, a Delaware corporation, to bring its Mobile Banking Technology, products and related professional services to market. In 2009 through 2016, the Company has had agreements with various banks, including Security First Bank (terminated in October 2010), Palm Desert National Bank (which was later assigned to First California Bank and subsequently Pacific Western Bank that terminated in June 2013), and Central Bank of Kansas City. Late in the fiscal year ended June 30, 2016, the relationship between CBKC and the Company ended and the Company is currently seeking a bank to sponsor its Prepaid Card programs (see Note 12). As a Cardholder Independent Sales Organization, Veritec is able to promote and sell Visa branded card programs. As a Third-Party Servicer, Veritec provides back-end cardholder transaction processing services for Visa branded card programs on behalf of its sponsoring bank. On September 30, 2014, Veritec and Tangible Payments LLC entered into an Asset Purchase Agreement pursuant to which Veritec acquired certain assets and liabilities of the Tangible Payments LLC (See Note 5). The Company has a portfolio of five United States and eight foreign patents. In addition, we have seven U.S. and twenty-eight foreign pending patent applications. Barcode Technology (Sold September 30, 2015) The Company’s Barcode Technology was originally invented by the founders of Veritec and as a product identification system for identification and tracking of manufactured parts, components and products mostly in the liquid crystal display (LCD) markets and is ideal for secure identification documents, financial cards, medical records and other high security applications. Veritec developed software to send, store, display, and read Barcode Technology on a mobile phone. On September 30, 2015, the Company sold all of its assets of its Barcode Technology, which was comprised solely of its intellectual property. The sale allows the Company to focus its efforts solely on its growing Mobile Banking Technology (See Note 6). Joint Venture Agreement On January 17, 2016, Veritec Inc. (the “Company”) entered into an agreement with Vietnam Alliance Capital (“VAC”), which is domiciled in Vietnam, to form a joint venture (“JV’) to operate a debit card business in Vietnam. The JV will be named Veritec Asia. The Company will be a 30% member in the JV and VAC will be a 70% member in the JV. Pursuant to the agreement, the Company will grant a license of certain products to the JV, and provide certain technologies and technological support to the JV. VAC will manage, control, and conduct its day-to-day business and development activities. In addition VAC has agreed to raise all funds to capitalize the JV. As of June 30, 2016, the JV has not received funding and anticipates receipt of funding in fiscal year 2017. Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany transactions and balances were eliminated in consolidation. Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Those estimates and assumptions include estimates for reserves of uncollectible accounts, analysis of impairments of long lived assets, accruals for potential liabilities and assumptions made in valuing stock instruments issued for services. Accounts Receivable The Company sells to domestic and foreign companies and grants uncollateralized credit to customers, but requires deposits on unique orders. Management periodically reviews its accounts receivable and provides an allowance for doubtful accounts after analyzing the age of the receivable, payment history and prior experience with the customer. The estimated loss that management believes is probable is included in the allowance for doubtful accounts. While the ultimate loss may differ, management believes that any additional loss will not have a material impact on the Company's financial position. Due to uncertainties in the settlement process, however, it is at least reasonably possible that management's estimate will change during the near term. Inventories Inventories, consisting of purchased components for resale, are stated at the lower of cost or market, applying the first-in, first-out (FIFO) method. Inventory is net of reserves of $38,361 and $23,900 at June 30, 2016 and 2015, respectively. Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over estimated useful lives of 3 to 7 years. When assets are retired or otherwise disposed, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is recognized. Maintenance and repairs are expensed as incurred; significant renewals and betterments are capitalized. Management regularly reviews property, equipment and other long-lived assets for possible impairment. This review occurs quarterly, or more frequently if events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. If there is indication of impairment, management prepares an estimate of future cash flows (undiscounted and without interest charges) expected to result from the use of the asset and its eventual disposition. If these cash flows are less than the carrying amount of the asset, an impairment loss is recognized to write down the asset to its estimated fair value. Based upon management’s assessment, there were no indicators of impairment at June 30, 2016 or 2015. Concentrations The Company’s cash balances on deposit with banks are guaranteed by the Federal Deposit Insurance Corporation up to $250,000. The Company may be exposed to risk for the amounts of funds held in one bank in excess of the insurance limit. In assessing the risk, the Company’s policy is to maintain cash balances with high quality financial institutions. The Company did not have cash balances in excess of the guarantee during the year ended June 30, 2016. Major Customers: The Company has two customers in fiscal 2016 that represented an aggregate of 47% (37% and 10%) of our revenue, and two customers in 2015 that represented 23% (12% and 11%) of our revenue. As of June 30, 2016, the Company had approximately $3,520 (38%), $1,500 (16%), $1,200 (13%), $1,000 (11%) and $1,000 (11%) of accounts receivable due from certain customers. As of June 30, 2015, the Company had approximately $6,025 (16%), $5,650 (15%), and $4,575 (12%) of accounts receivable due from certain customers. Foreign Revenues Foreign revenues accounted for 19% of the Company’s total revenues in fiscal 2016 and 41% in fiscal 2015. (6% Korea, 8% Taiwan, and 5% others in fiscal 2016 and 10% Korea, 21% Taiwan, and 10% others in fiscal 2015). Fair Value of Financial Instruments Fair Value Measurements are adopted by the Company based on the authoritative guidance provided by the Financial Accounting Standards Board, with the exception of the application of the statement to non-recurring, non-financial assets and liabilities as permitted. The adoption based on the authoritative guidance provided by the Financial Accounting Standards Board did not have a material impact on the Company's fair value measurements. Based on the authoritative guidance provided by the Financial Accounting Standards Board defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. FASB authoritative guidance establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows: Level 1 - Quoted prices in active markets for identical assets or liabilities. Level 2 - Inputs, other than the quoted prices in active markets that are observable either directly or indirectly. Level 3 - Unobservable inputs based on the Company's assumptions. The Company had no such assets or liabilities recorded to be valued on the basis above at June 30, 2016 or 2015. For certain financial instruments, the carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, and current liabilities, including notes payable and convertible notes, each qualify as financial instruments and are a reasonable estimate of their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rates of interest. Revenue Recognition Revenues from licenses and identification cards are recognized when the product is shipped, the Company no longer has any service or other continuing obligations, and collection is reasonably assured. The process typically begins with a customer purchase order detailing its specifications so the Company can import its software into the customer's hardware. Once importation is completed, if the customer only wishes to purchase a license, the Company typically transmits the software to the customer via the Internet. Revenue is recognized at that point. If the customer requests both license and hardware, once the software is imported into the hardware and the process is complete, the product is shipped, and revenue is recognized at time of shipment. Once the software and/or other products are either shipped or transmitted, the customers do not have a right of refusal or return. Under some conditions, the customers remit payment prior to the Company having completed importation of the software. In these instances, the Company delays revenue recognition and reflects the prepayments as customer deposits. The Company, as a processor and a distributor, recognizes revenue from transaction fees charged cardholders for the use of its issued mobile debit cards. The fees are recognized on a monthly basis after all cardholder transactions have been summarized and reconciled with third party processors. Shipping and Handling Fees and Costs For the years ended June 30, 2016 and 2015, shipping and handling fees billed to customers of $216 and $997, respectively were included in revenues and shipping and handling costs of $3,089 and $997, respectively were included in cost of sales. Research and Development Research and development costs were expensed as incurred. Advertising Advertising costs are expensed as incurred and are included in sales and marketing expense in the amount of $1,100 and $2,100 for the years ended June 30, 2016 and 2015, respectively. Loss per Common Share Basic earnings (loss) per share are computed by dividing the net income (loss) applicable to Common Stockholders by the weighted average number of shares of Common Stock outstanding during the year. Diluted earnings (loss) per share is computed by dividing the net income (loss) applicable to Common Stockholders by the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued, using the treasury stock method. Potential common shares are excluded from the computation as their effect is antidilutive. For the years ended June 30, 2016 and 2015, the calculations of basic and diluted loss per share are the same because potential dilutive securities would have an anti-dilutive effect. As of June 30, 2016 and 2015, we excluded the outstanding securities summarized below, which entitle the holders thereof to acquire shares of common stock, from our calculation of earnings per share, as their effect would have been anti-dilutive. Stock-Based Compensation The Company periodically issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing costs. The Company accounts for stock option and stock warrant grants to employees based on the authoritative guidance provided by the Financial Accounting Standards Board (FASB) where the value of the award is measured on the date of grant and recognized over the vesting period. The Company accounts for stock option and stock warrant grants to non-employees in accordance with the authoritative guidance of the FASB where the value of the stock compensation is determined based upon the measurement date at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance requirements by the non-employee, option or warrant grants are immediately vested and the total stock-based compensation charge is recorded in the period of the measurement date. The fair value of the Company’s common stock option and warrant grants are estimated using a Black-Scholes option pricing model, which uses certain assumptions related to risk-free interest rates, expected volatility, expected life of the common stock options, and future dividends. Compensation expense is recorded based upon the value derived from the Black-Scholes option pricing model, and based on actual experience. The assumptions used in the Black-Scholes option pricing model could materially affect compensation expense recorded in future periods. Intangible Assets The Company accounts for intangible assets in accordance with the authoritative guidance issued by the FASB. Intangibles are valued at their fair market value and are amortized taking into account the character of the acquired intangible asset and the expected period of benefit. The Company evaluates intangible assets for impairment, at a minimum, on an annual basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable from its estimated undiscounted future cash flows. Recoverability of intangible assets is measured by comparing their net book value to the related projected undiscounted cash flows from these assets, considering a number of factors, including past operating results, budgets, economic projections, market trends and product development cycles. If the net book value of the asset exceeds the related undiscounted cash flows, the asset is considered impaired, and a second test is performed to measure the amount of impairment loss. At June 30, 2016, the intangibles assets of $80,208 relates to our acquisition of Tangible Payments LLC during fiscal year 2015 (see Note 5). Management believes there were no indications of impairment based on management’s assessment of these assets at June 30, 2016. Factors we consider important that could trigger an impairment review include significant underperformance relative to historical or projected future operating results, significant changes in the manner of the use of our assets or the strategy for our overall business, and significant negative industry or economic trends. If current economic conditions worsen causing decreased revenues and increased costs, we may have to record an impairment to our intangible assets. Income Taxes The Company accounts for income taxes using the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences, and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Recently Issued Accounting Standards In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted only in annual reporting periods beginning after December 15, 2016, including interim periods therein. Entities will be able to transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company is in the process of evaluating the impact of ASU 2014-09 on the Company’s financial statements and disclosures. In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures. In March 2016, the FASB issued the ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The amendments in this ASU require, among other things, that all income tax effects of awards be recognized in the income statement when the awards vest or are settled. The ASU also allows for an employer to repurchase more of an employee's shares than it can today for tax withholding purposes without triggering liability accounting and allows for a policy election to account for forfeitures as they occur. The amendments in this ASU are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted for any entity in any interim or annual period. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures. In August 2014, the FASB issued Accounting Standards Update No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. ASU 2014-15 requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods thereafter. Early adoption is permitted. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures. Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements. NOTE 2 - GOING CONCERN The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company experienced a loss of $1,298,088 during the year ended June 30, 2016, and at June 30, 2016, the Company had a working capital deficit of $3,158,551 and a stockholders’ deficiency of $3,233,172. The Company is in default of $2,032,595 of its note payable obligations and is also delinquent in payment of certain amounts due of $238,718 for payroll taxes and accrued interest and penalties as of June 30, 2016. These and other factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. The Company believes it will require additional funds to continue its operations through fiscal 2017 and to continue to develop its existing projects and plans to raise such funds by finding additional investors to purchase the Company’s securities, generating sufficient sales revenue, implementing dramatic cost reductions or any combination thereof. There is no assurance that the Company can be successful in raising such funds, generating the necessary sales or reducing major costs. Further, if the Company is successful in raising such funds from sales of equity securities, the terms of these sales may cause significant dilution to existing holders of common stock. The consolidated financial statements do not include any adjustments that may result from this uncertainty. NOTE 3 - RESTRICTED CASH The Company entered into Store Value Prepaid Card Sponsorship Agreements with certain banks whereas the Company markets and sells store value prepaid card programs. The programs are marketed and managed daily at the direction of the bank, for which the Company receives a transaction fee. In connection with the agreements the Company was required to establish a reserve account controlled by the bank. During fiscal year 2016, the agreement with the bank was terminated. At June 30, 2016 and 2015, the restricted cash totaled $0 and $63,029, respectively. Since this amount was restricted for the purposes related to the programs, it was classified as restricted cash on the consolidated balance sheets as of June 30, 2015. NOTE 4 - PROPERTY AND EQUIPMENT Property and equipment consists of the following as of: Depreciation expense for the years ended June 30, 2016 and 2015 was $412 and $411, respectively. NOTE 5 - INTANGIBLE ASSETS AND CONTINGENT EARNOUT LIABILITY On September 30, 2014, the Company and Tangible Payments LLC, a Maryland Limited Liability Company, entered into an Asset Purchase Agreement pursuant to which the Company acquired certain assets and liabilities of the Tangible Payments LLC. Tangible Payments LLC developed online payment technology that encrypts sensitive information securely between customers and merchants during online transactions. The purchase price for the acquisition was comprised of 250,000 shares of restricted common stock of Veritec valued at $37,500, issued on closing, and an earnout payment of $155,000 for an aggregate purchase price of $192,500. The earnout payment is payable on a monthly basis from the net profits derived from the acquired assets commencing three months after the closing. The earnout payment is accelerated and the balance of the earnout payment shall be due in full at such time as Veritec receives equity investments aggregating $1.3 million. For the years ended June 30, 2016 and 2015, there was no net profit derived from the acquired assets and accordingly, no payments were made on the earnout. The Company assigned $192,500 of the purchase price to contract commitments which will be amortized over a three year period. As of June 30, 2016 and 2015, the unamortized balance of contract commitments was $80,208 and $144,375, respectively. For the years ended June 30, 2016 and 2015, the Company recorded $64,167 and $48,125 of amortization expense related to this intangible which is included in general and administrative expense in the Consolidated Statements of Operations. Total estimated amortization expense with respect to intangible assets for 2017 through 2018 is as follows: The following table presents our unaudited pro forma combined historical results of operations as if we had consummated the acquisition as of July 1, 2014. NOTE 6 - RELATED PARTY TRANSACTIONS The Matthews Group is owned 50% by Ms. Van Tran, the Company’s CEO/Executive Chair and a director, and 50% by Larry Johanns, a significant stockholder of the Company. The Company has relied on The Matthews Group, LLC for funding (see Note 7). At various times throughout the Company’s history, the Company received various unsecured, non-interest bearing, due on demand advances from its Chief Executive Officer, Ms. Van Tran, a related party. The balances due Ms. Tran as of June 30, 2016 and 2015 were $96,110 and $96,110, respectively. These advances have been classified as accounts payable, related party on the accompanying consolidated balance sheets. The Company leases its office facilities from Ms. Tran. For the year ended June 30, 2016 and 2015, rental payments to Ms. Van Tran totaled $50,400 and $50,400, respectively. On September 30, 2015, the Company agreed to convert $1,775,434 of various convertible notes payable to The Matthews Group into 22,192,919 shares of common stock, or $0.08 per share (see Note 7). The transaction included $702,797 of notes that were converted at less than their stated conversion prices which ranged from $0.10 per share to $0.33 per share. The Company determined this was an induced conversion and calculated an inducement expense of $452,770, which represents the fair value of the additional number of common shares issued as a result of the lower conversion price. The Company recorded the $452,770 in interest expense and additional paid in capital. No similar expense occurred during the same period of the prior year. On September 30 2015, the Company sold its Barcode Technology assets to The Matthews Group for $670,000 in settlement of various convertible notes payables due to The Matthews Group (see Note 7). The cost basis of the Barcode Technology assets were zero, resulting in a gain of $670,000. As the transaction was between the Company and The Matthews Group, a related party, the Company accounted for the gain as a capital contribution. On September 28, 2015, the Company agreed to replace a convertible note payable for $200,000 due to The Matthews Group that was in default (the original note) with another convertible note payable for $200,000 due to The Matthews Group (the replacement note) (see Note7). The original note was for $200,000, secured, 8% interest rate, and convertible into common stock at a rate of $0.25 per share. The replacement note is for $200,000, unsecured, 10% interest rate, and convertible into common stock at a rate of $0.08 per share. The Company determined that the change in the fair value of the conversion option was more than 10% of the carrying value of the original note and recorded a loss on extinguishment of $136,000. The $136,000 is included in interest expense and finance costs and additional paid in capital. No similar expense occurred during the same period of the prior year. During the year ended June 30, 2016, the Company issued $549,389 of convertible notes payable to The Matthews Group and $25,000 of convertible notes payable to Van Tran (see Note 7). The convertible notes payable-related party can be converted at a price of $0.08 per share. The market price on the date some of the convertible notes payable-related party were issued was in excess of the conversion price, and as a result the Company recognized an expense of $135,045 which is included in interest expense. Effective October 1, 2015, the Company entered into a management services agreement with The Matthews Group for which the Company will manage all facets of its previous barcode technology operations, on behalf of The Matthews Group, from October 1, 2015 to May 30, 2016. Per the terms of the management services agreement, the Company earns a fee of 20% of all revenues, or $69,135, from the barcode technology operations through May 30, 2017. Additionally all cash flow (all revenues collected less direct costs paid) will be retained by the Company and classified as unsecured note payable-related party, due on demand, bearing interest at 10% per annum. At June 30, 2016, the total of note payable-related party related to this agreement, including interest of $9,315, was $260,711 (see Note 7). The Matthews Group bears the risk of loss from the barcode operations and has the right to the residual benefits of the barcode operations. NOTE 7 - NOTES PAYABLE Notes payable includes accrued interest and consists of the following as of June 30, 2016 and June 30, 2015: During the years ended June 30, 2016 and 2015, the Company recorded interest expense on its convertible notes payable and notes payable of $271,145 (including $135,045 beneficial conversion feature that was expensed) and $199,489, respectively. For the purposes of Balance Sheet presentation notes payable have been presented as follows: NOTE 8 - STOCKHOLDERS’ DEFICIENCY Preferred Stock The articles of incorporation of Veritec authorize 10,000,000 shares of preferred stock with a par value of $1.00 per share. The Board of Directors is authorized to determine any number of series into which shares of preferred stock may be divided and to determine the rights, preferences, privileges and restrictions granted to any series of the preferred stock. In 1999, a new Series H convertible preferred stock was authorized. Each share of Series H convertible preferred stock is convertible into 10 shares of the Veritec’s common stock at the option of the holder. As of June 30, 2016 and 2015, there were 1,000 shares of Series H convertible preferred stock issued and outstanding. Common Stock Shares issued to consultants for services During the year ended June 30, 2015, the Company granted and issued 135,000 shares of common stock for services received. The common shares, based on the fair value on the dates granted, were valued at $0.05 to $0.51 per share, for an aggregate of $19,600. Common Stock to be issued Shares to be issued to consultants for services rendered During the year ended June 30, 2015, the Company recorded an obligation to issue 55,000 shares of common stock with an aggregate fair value of $8,150 of which 5,000 shares of common stock were issued in December 2014. As of June 30, 2015, the remaining 50,000 shares of common stock with a value of $7,400 were not issued and were reflected as common shares to be issued in the accompanying consolidated balance sheet. The shares were issued in December 2015. During the year ended June 30, 2015, the Company recorded an obligation to issue 35,000 shares of common stock with an aggregate fair value of $4,050 of which 20,000 shares of common stock were issued in December 2014. As of June 30, 2015, the remaining 15,000 shares of common stock with a value of $1,900 had not been issued and were reflected as common shares to be issued in the accompanying consolidated balance sheet. The shares were issued in December 2015. On July 15, 2014, the Company entered into a consulting agreement with a consultant, which included, among other things, monthly compensation of 5,000 shares of common stock. As of June 30, 2015, 50,000 shares of common stock with a value of $7,400 have not been issued and are included in common shares to be issued in the accompanying consolidated balance sheet. The consulting agreement was terminated on October 31, 2015. During the year ended June 30, 2016, the Company recorded an obligation to issue an additional 20,000 shares of common stock with an aggregate fair value of $2,100. As of June 30, 2016, the 70,000 shares of common stock with a value of $9,500 have not been issued and are included in common shares to be issued in the accompanying consolidated balance sheet. Shares to be issued to directors and employees for services During the year ended June 30, 2012, the Company granted an aggregate of 75,000 shares of the Company’s common stock to the Company’s directors for services rendered and recognized as stock based compensation expense during the year ended June 30, 2012 based on their fair value at grant dates in the aggregate amount of $3,000. The shares due were not issued as of June 30, 2016 and were reflected as common shares to be issued in the accompanying consolidated balance sheet. During the year ended June 30, 2015, the Company granted an aggregate of 750,000 shares of the Company’s common stock to four of the Company’s directors and certain employees for services rendered and recognized as stock based compensation expense during the year ended June 30, 2015 based on their fair value at grant dates in the aggregate amount of $28,154. The shares due were not issued as of June 30, 2015 and were reflected as common shares to be issued in the accompanying consolidated balance sheet. The shares were issued in December 2015. NOTE 9 - STOCK OPTIONS A summary of stock options as of June 30, 2016 and for the two years then ended is as follows: The Company has agreements with certain employees that provide for five years of annual grants of options, on each employment anniversary date, to purchase shares of the Company’s common stock. The option price is determined based on the market price on the date of grant, the options vest one year from the date of grant, and the options expire five years after vesting. The Company granted 2,500,000 options under this arrangement 2013. There were no options granted in 2016 and 2015 under this agreement. The Company recognized no stock-based compensation expense related to stock options during the years ended June 30, 2016 and 2015, respectively. As of June 30, 2016, there was no remaining unrecognized compensation costs related to stock options. The intrinsic value of both outstanding and exercisable stock options was approximately $100,000 at June 30, 2016. The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the weighted-average assumptions noted in the following table. The risk-free rate for periods within the contractual life of the options is based on the U. S. Treasury yield in effect at the time of the grant. Volatility was based on the historical volatility of the Company’s common stock. The Company estimated the expected life of options based on historical experience and other averaging methods. Additional information regarding options outstanding as of June 30, 2016 is as follows: NOTE 10 - INCOME TAXES For the years ended June 30, 2016 and 2015, our net losses were $1,298,088 and $907,474, respectively, and no provision for income taxes was recorded. We made no provision for income taxes due to our utilization of federal net operating loss carry forwards to offset both regular taxable income and alternative minimum taxable income. Reconciliation between the expected federal income tax rate and the actual tax rate is as follows: The following is a summary of the deferred tax assets: The Company has provided a valuation allowance on the deferred tax assets at June 30, 2016 and 2015 to reduce such asset to zero, since there is no assurance that the Company will generate future taxable income to utilize such asset. Management will review this valuation allowance requirement periodically and make adjustments as warranted. The net change in the valuation allowance for the year ended June 30, 2015 was an increase of $126,000. Veritec has net operating loss carryforwards of approximately $10.9 million for federal purposes available to offset future taxable income that expire in varying amounts through 2034. The ability to utilize the net operating loss carry forwards could be limited by Section 382 of the Internal Revenue Code which limits their use if there is a change in control (generally a greater than 50% change in ownership). The Company is subject to examination by tax authorities for all years for which a loss carry forward is utilized in subsequent periods. The Company follows FASB guidelines that address the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under this guidance, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. This guidance also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. As of June 30, 2016 and 2015, the Company did not have a liability for unrecognized tax benefits. The Company’s policy is to record interest and penalties on uncertain tax provisions as income tax expense. As of June 30, 2016 and 2015, the Company has no accrued interest or penalties related to uncertain tax positions. NOTE 11 - COMMITMENTS AND CONTINGENCIES Operating Leases The Company leases approximately 4,200 square feet of office and laboratory space at 2445 Winnetka Avenue North, Golden Valley, Minnesota, which serves as our primary place of business. This lease is with Van Thuy Tran, the Chairman of the Board and the Chief Executive Officer of the Company. Our lease requires monthly payments of $4,200 which runs through June 30, 2015, and was automatically extended for two one-year terms. Future annual minimum lease payments through fiscal year 2017 total $50,400. Strategic Partnership Agreements On October 25, 2010, the Company entered into a Strategic Services Agreement with a customer. The term of the license is for 5 years commencing on the effective date, which was the date of the first payment, or September 28, 2011. The customer has paid the total fee of $250,000 in two installments. The Company initially classified this fee as deferred revenue to be recognized over the license term of 5 years as the Company has a continuing obligation. As of June 30, 2015, the amount of deferred revenues was $65,347. During the year ended June 30, 2016, the Company recognized revenue of $50,000 relating to this agreement. As of June 30, 2016, the balance remaining to be recognized was $15,347. On November 14, 2012 (effective date), the Company entered into a Strategic Product License Agreement with a customer for a $100,000 license fee. The term of the license is for 5 years commencing on the effective date. The Company has classified the license fee as deferred revenue to be recognized ratably over the license term of 5 years as the Company has a continuing obligation. As of June 30, 2015, the amount of deferred revenue was $52,500. During the year ended June 30, 2016, the Company recognized revenue of $20,000 relating to this agreement. As of June 30, 2016, the balance remaining to be recognized was $32,500. On July 1, 2014 (effective date), the Company entered into a Strategic Product License Agreement with one its customers for a $150,000 license fee. The term of the license is for 5 years commencing on the effective date. The Company has classified the license fee as deferred revenue to be recognized ratably over the license term of 5 years as the Company has a continuing obligation. During the year ended June 30, 2016, the Company recognized revenue of $30,000 relating to this agreement. As of June 30, 2016, the balance remaining to be recognized was $90,000. On August 14, 2014 (effective date), the Company entered into a Pilot Program Agreement with one its customers for a $175,000 fee, which was paid in advance of completion. The Company is responsible for certain deliveries as defined in the agreement. The Company partially completed a portion of its deliverables under the agreement and recognized $86,361 as revenues. The Company had not completed its remaining obligations as of June 30, 2015, and has classified the remaining balance as deferred revenue to be recognized as revenue upon completion of its obligations. As of June 30, 2015, the balance remaining to be recognized was $88,639. During fiscal year 2016, the Company completed its remaining obligations under the agreement and recorded revenue of $88,639 leaving no remaining deferred revenue balance as of June 30, 2016. On April 4, 2015 (effective date), the Company entered into a Continuing Services Agreement with one its customers for a $142,500 fee, which was paid in advance of completion. The Company is responsible for certain deliveries as defined in the agreement. As the Company had not completed its obligations as of June 30, 2015, the Company has classified the fees as deferred revenue to be recognized upon completion of its obligations. During fiscal year 2016, the Company completed its remaining obligations under the agreement and recorded revenue of $142,500 leaving no remaining deferred revenue balance as of June 30, 2016. Incentive Compensation Bonus Plan On December 5, 2008, the Company adopted an incentive compensation bonus plan to provide payments to key employees in the aggregated amount of 10% of pre-tax earnings in excess of $3,000,000 after the end of each fiscal year to be distributed annually to employees. As of June 30, 2016, the Company had not achieved an annual pre-tax earnings in excess of $3,000,000. NOTE 12 - SUBSEQUENT EVENTS Settlement Agreement On September 21, 2016, the Company entered into a settlement agreement with an individual who is convertible note holder. The individual loaned the Company $250,000 in prior years and was also issued 500,000 shares of common stock for services. The Company alleged that the individual used the Company's intellectual property without approval. Under the terms of the settlement agreement, the individual agreed to relinquish the convertible note payable, including unpaid interest, which had a current estimated outstanding balance of $365,000, and return 500,000 shares of common stock issued to him. In turn, the Company agreed to release and discharge the individual against all claims arising on or prior to the date of the settlement agreement. The Company currently anticipates that it will record this settlement as a gain in its upcoming Consolidated Statement of Operations for the three months ended September 30, 2016. Non-Binding Letter of Intent On September 22, 2016, the Company announced that it has entered into a Non-Binding Letter of Intent (“LOI”) to acquire all of Flathead Bancorporation, Inc.’s (“FB”) issued and outstanding shares. FB is the majority owner of First Citizens Bank of Polson, Montana (“Citizens Bank”). Under the proposed terms of the LOI, Veritec would acquire 9.9 percent of FB’s issued and outstanding shares for $320,000 at the closing date. Veritec plans to purchase the remaining 90.1 percent of FB’s outstanding common shares within three years of the closing date for $2,880,000. The total purchase price for FB’s outstanding common shares (including the 9.9 percent discussed above) would be $3,200,000 and is subject to, among other things, Veritec being able to obtain funding and obtain regulatory approval from applicable banking authorities. The Company currently plans to raise funds from investors by issuing its common shares, debt, or both. There is no assurance that the Company can be successful in raising such funds, or if the Company is successful in raising such funds from sales of common shares, the terms of these sales may cause significant dilution to existing holders of common stock. Pursuant to the LOI, Veritec would also provide loans to FB to be used for capital purposes of $280,000 at the closing date, $500,000 on or before January 31, 2017 and $400,000 on or before April 1, 2017, for a total of $1,180,000. The loans would mature in five years and require annual interest only payments at interest rates to be determined. | Based on the provided financial statement excerpt, here's a summary:
Revenue Recognition:
- Revenue from licenses and identification cards is recognized upon product shipment
- Revenue is recognized when:
- Product is shipped
- No further obligations exist
- Collection is reasonably assured
Revenue Streams:
- License sales (via internet transmission)
- Hardware and software sales
- Transaction fees from mobile debit card processing
Key Financial Characteristics:
- Experienced losses from operations
- Had a stockholders' deficiency as of June 30
- Current liabilities include notes payable and convertible notes
- Some customers prepay before product completion, which delays revenue recognition
Revenue Timing:
- For license-only sales: Revenue recognized upon software transmission
- For license and hardware sales: Revenue recognized at product shipment
- Transaction fees recognized monthly after transaction reconciliation
Limitations:
- No specific total revenue figure was provided in the | Claude |
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ACCOUNTING FIRM The Board of Directors and Stockholders Arista Networks, Inc. We have audited the accompanying consolidated balance sheets of Arista Networks, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Arista Networks, Inc. at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Arista Networks, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 17, 2017 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP San Jose, California February 17, 2017 ACCOUNTING FIRM The Board of Directors and Stockholders Arista Networks, Inc. We have audited Arista Networks, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Arista Networks, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Arista Networks, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Arista Networks, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016 of Arista Networks, Inc. and our report dated February 17, 2017 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP San Jose, California February 17, 2017 ARISTA NETWORKS, INC. Consolidated Balance Sheets (In thousands, except par value) The accompanying notes are an integral part of these consolidated financial statements. ARISTA NETWORKS, INC. Consolidated Statements of Income (In thousands, except per share amounts) The accompanying notes are an integral part of these consolidated financial statements. ARISTA NETWORKS, INC. Consolidated Statements of Comprehensive Income (In thousands) The accompanying notes are an integral part of these consolidated financial statements. ARISTA NETWORKS, INC. Consolidated Statements of Stockholders’ Equity (In thousands) The accompanying notes are an integral part of these consolidated financial statements. ARISTA NETWORKS, INC. Consolidated Statements of Cash Flows (In thousands) ARISTA NETWORKS, INC. Consolidated Statements of Cash Flows (In thousands) The accompanying notes are an integral part of these consolidated financial statements. ARISTA NETWORKS, INC. 1. Organization and Summary of Significant Accounting Policies Organization Arista Networks, Inc. (together with our subsidiaries, “we,” “our” or “us”) is a supplier of cloud networking solutions that use software innovations to address the needs of large-scale Internet companies, cloud service providers and next-generation enterprise. Our cloud networking solutions consist of our Extensible Operating System, a set of network applications and our 10/25/40/50/100 Gigabit Ethernet switching and routing platforms. We were incorporated in October 2004 in the State of California under the name Arastra, Inc. In March 2008, we reincorporated in the State of Nevada and in October 2008 changed our name to Arista Networks, Inc. We reincorporated in the state of Delaware in March 2014. Our corporate headquarters are located in Santa Clara, California, and we have wholly-owned subsidiaries throughout the world, including North America, Europe, Asia and Australia. Basis of Presentation and Principles of Consolidation The accompanying consolidated financial statements include the accounts of Arista Networks, Inc. and its wholly owned subsidiaries and are prepared in accordance with U.S. generally accepted accounting principles (GAAP). All significant intercompany accounts and transactions have been eliminated. During fiscal 2015 and 2014, certain reclassifications of prior period amounts were made to conform to the current period presentation. There were no reclassifications during fiscal 2016. Use of Estimates The preparation of the accompanying consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated financial statements and accompanying notes. Those estimates and assumptions include, but are not limited to, revenue recognition and deferred revenue; allowance for doubtful accounts and sales return reserve; determination of fair value for stock-based awards; accounting for income taxes, including the valuation allowance on deferred tax assets and reserves for uncertain tax positions; valuation of inventory; valuation of warranty accruals; contract manufacturing liabilities; and recognition and measurement of contingent liabilities. We evaluate our estimates and assumptions based on historical experience and other factors and adjust those estimates and assumptions when facts and circumstances dictate. Actual results could differ materially from those estimates. Concentrations of Business and Credit Risk We work closely with third-party contract manufacturing suppliers to manufacture our products. As of December 31, 2016 and December 31, 2015, we had three and two suppliers, respectively, who provided substantially all of our electronic manufacturing services. Our contract manufacturing suppliers deliver our products to our third party direct fulfillment facilities. We and our fulfillment partners then perform labeling, final configuration, quality assurance testing and shipment to our customers. Our products rely on key components, including certain integrated circuit components and power supplies, some of which our contract manufacturers purchase on our behalf from a limited number of suppliers, including certain sole source providers. We do not have guaranteed supply contracts with any of our component suppliers, and our suppliers could delay shipments or cease manufacturing such products or selling them to us at any time. If we are unable to obtain a sufficient quantity of these components on commercially reasonable terms or in a timely manner, or if we are unable to obtain alternative sources for these components, sales of our products could be delayed or halted entirely or we may be required to redesign our products. Quality or performance failures of our products or changes in our contractors’ or vendors’ financial or business condition could disrupt our ability to supply quality products to our customers. Any of these events could result in lost sales and damage to our end-customer relationships, which would adversely impact our business, financial condition and results of operations. Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash, cash equivalents, marketable securities, restricted cash, and accounts receivable. Our cash, cash equivalents and restricted cash are invested in high quality financial instruments with banks and financial institutions. Such deposits may be in excess of insured limits provided on such deposits. Our accounts receivable are unsecured and represent amounts due to us based on contractual obligations of our customers. We mitigate credit risk in respect to accounts receivable by performing ongoing credit evaluations of our customers to assess the probability of accounts receivable collection based on a number of factors, including past transaction experience with the customer, evaluation of their credit history, the credit limits extended and review of the invoicing terms of the arrangement. In situations where a customer may be thinly capitalized and we have limited payment history with it, we will either establish a small credit limit or require it to prepay its purchases. We generally do not require our customers to provide collateral to support accounts receivable. We have recorded an allowance for doubtful accounts for those receivables that we have determined not to be collectible. We mitigate credit risk in respect to the notes receivable by performing ongoing credit evaluations of the borrower to assess the probability of collecting all amounts due to us under the existing contractual terms. We market and sell our products through both our direct sales force and our channel partners, including distributors, value-added resellers, system integrators and original equipment manufacturer (“OEM”) partners and in conjunction with various technology partners. Significant customers are those which represent more than 10% of our total net revenue during the period or net accounts receivable balance at each respective balance sheet date. For each significant customer, revenue as a percentage of total revenue and accounts receivable as a percentage of total accounts receivable are as follows: Comprehensive Income Comprehensive income is comprised of net income and other comprehensive income. Unrealized gains and losses on available-for-sale investments and foreign currency translation adjustments are included in our other comprehensive income or loss. Cash and Cash Equivalents We consider all highly liquid investments with stated maturity of three months or less at the time of purchase to be cash equivalents. Cash and cash equivalents consist of cash on deposit with various financial institutions and highly liquid investments in money market funds. Interest is accrued as earned. We have restricted cash pledged as collateral representing a security deposit required for a facility lease. As of December 31, 2016 and 2015, we had classified the restricted cash of $4.2 million and $4.0 million, respectively, as other assets in our accompanying consolidated balance sheet. Marketable Securities We classify all highly liquid investments with stated maturities of greater than three months as marketable securities. We determine the appropriate classification of our investments in marketable securities at the time of purchase and reevaluate such designation at each balance sheet date. We have classified and accounted for our marketable securities as available-for-sale. We may or may not hold securities with stated maturities greater than 12 months until maturity. After consideration of our risk versus reward objectives, as well as our liquidity requirements, we may sell these securities prior to their stated maturities. As we view these securities as available to support current operations, we classify securities with maturities beyond 12 months as current assets under the caption marketable securities in the accompanying consolidated balance sheets. We carry these securities at fair value, and report the unrealized gains and losses, net of taxes, as a component of stockholders’ equity, except for unrealized losses determined to be other-than-temporary, which we record as other income (expense), net. We determine any realized gains or losses on the sale of marketable securities on a specific identification method, and we record such gains and losses as a component of interest and other income, net. Accounts Receivable Accounts receivable are recorded at the invoiced amount, net of allowances for doubtful accounts, and sales return reserves. We estimate our allowance for doubtful accounts based upon the collectability of the receivables in light of historical trends, adverse situations that may affect our customers’ ability to pay and prevailing economic conditions. This evaluation is done in order to identify issues which may impact the collectability of receivables and related estimated required allowance. Revisions to the allowance are recorded as an adjustment to bad debt expense. After appropriate collection efforts are exhausted, specific accounts receivable deemed to be uncollectible are charged against the allowance in the period they are deemed uncollectible. Recoveries of accounts receivable previously written-off are recorded as credits to bad debt expense. We estimate our sales return reserves based on historical return rates applied against current period gross revenues. Specific customer returns and allowances are considered when determining our sales return reserve estimate. Revisions to the reserve are recorded as adjustments to revenue and the sales return reserves. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or an exit price that would be paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We apply fair value accounting for all financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. These assets and liabilities include cash and cash equivalents, marketable securities, accounts receivable, accounts payable, and accrued liabilities. Cash equivalents, accounts receivable, accounts payable and accrued liabilities are stated at carrying amounts as reported in the consolidated financial statements, which approximates fair value due to their short-term nature. Assets and liabilities recorded at fair value on a recurring basis in the accompanying consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. We use a fair value hierarchy to measure fair value, maximizing the use of observable inputs and minimizing the use of unobservable inputs. The three-tiers of the fair value hierarchy are as follows: Level I-Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date; Level II-Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and Level III-Unobservable inputs that are supported by little or no market data for the related assets or liabilities and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability. Foreign Currency The functional currency of our foreign subsidiaries is either the U.S. dollar or their local currency. Transaction re-measurement-Assets and liabilities denominated in a currency other than the foreign subsidiaries’ functional currency are re-measured into the functional currency using exchange rates in effect at the end of the reporting period, with gains and losses recorded in other income (expense), net in the consolidated statements of income. We recognized$0.7 million, $0.5 million, and $0.6 million, in transaction losses for the years ended December 31, 2016, 2015 and 2014, respectively. Translation-Assets and liabilities of subsidiaries denominated in foreign functional currencies are translated into U.S. dollars at the closing exchange rate on the balance sheet date and equity related balances are translated at historical exchange rates. Revenues, costs and expenses in foreign functional currencies are translated using average exchange rates that approximate those in effect during the period. Translation adjustments are accumulated as a separate component of accumulated other comprehensive income within stockholders’ equity. Inventory Valuation and Contract Manufacturer/Supplier Liabilities Inventories primarily consist of finished goods purchased from third party contract manufacturers and are stated at the lower of cost (computed using the first-in, first-out method) or market value. Manufacturing overhead costs and inbound shipping costs are included in the cost of inventory. In addition, we purchase strategic component inventory from certain suppliers under purchase commitments that in some cases are non-cancelable, including integrated circuits, which are held by our contract manufacturers. We record a provision when inventory is determined to be in excess of anticipated demand, or obsolete, to adjust inventory to its estimated realizable value. We also record a liability for non-cancelable, non-returnable purchase commitments with our component inventory suppliers for quantities in excess of our demand forecasts or that are considered obsolete. Our contract manufacturers procure components and assemble products on our behalf based on our forecasts. We generally incur a liability when the contract manufacturer has converted the component inventory to a finished product. Historically, we have recorded a liability and have reimbursed our contract manufacturer for component inventory that has been rendered excess or obsolete due to manufacturing and engineering change orders resulting from design changes, or in cases where inventory levels greatly exceed our forecasts. We use significant judgment in establishing our forecasts of future demand and obsolete material exposures. These estimates depend on our assessment of current and expected orders from our customers, product development plans and current sales levels. If actual market conditions are less favorable than those projected by management, which may be caused by factors within and outside of our control, we may be required to increase our inventory write-downs and liabilities to our contract manufacturers and suppliers, which could have an adverse impact on our gross margins and profitability. We regularly evaluate our exposure for inventory write-downs and adequacy of our contract manufacturer liabilities. For the years ended December 31, 2016, 2015 and 2014, we recorded inventory write-downs of $12.1 million, $9.0 million and $2.8 million, respectively. In addition, our contract manufacturer and supplier liabilities totaled $6.3 million and $3.8 million as of December 31, 2016 and 2015, respectively. Property and Equipment Property and equipment are stated at cost, less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the related assets, generally from one to five years. Our building is depreciated over 30 years and leasehold improvements are depreciated over the shorter of the estimated useful lives of the improvements or the remaining lease term. The leased building under our build to suit lease is capitalized and included in property and equipment as we were involved in the construction funding and did not meet the “sale-leaseback” criteria. Investments Our investments in privately held companies are accounted for under the cost method and are included in investments, non-current in the accompanying consolidated balance sheets. Our investments under the cost method are recorded at historical cost at the time of investment. Impairment of Long-Lived Assets and Investments The carrying amounts of our long-lived assets, including property and equipment and investments in privately held companies, are periodically reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of each asset to the future undiscounted cash flows the asset is expected to generate over their remaining lives. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. No impairment of any long-lived assets or investments was identified for any of the periods presented. Loss Contingencies In the ordinary course of business, we are a party to claims and legal proceedings including matters relating to commercial, employee relations, business practices and intellectual property. In assessing loss contingencies, we use significant judgment and assumptions to estimate the likelihood of loss, impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss. We record a provision for contingent losses when it is both probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. We will record a charge equal to the minimum estimated liability for litigation costs or a loss contingency only when both of the following conditions are met: (i) information available prior to issuance of our consolidated financial statements indicates that it is probable that a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required. Revenue Recognition We generate revenue from sales of our products which incorporate our EOS software and accessories such as cables and optics to direct customers and channel partners together with post contract customer support (“PCS”). We typically sell products and PCS in a single transaction. We recognize revenue when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery or performance has occurred; the sales price is fixed or determinable; and collectability is reasonably assured. We define each of the four criteria above as follows: • Persuasive evidence of an arrangement exists. Evidence of an arrangement consists of stand-alone purchase orders or purchase orders issued pursuant to the terms and conditions of a master sales agreement. It is our practice to identify an end customer prior to shipment to a reseller or distributor. • Delivery or performance has occurred. We use shipping documents or written evidence of customer acceptance, when applicable, to verify delivery or performance. We recognize product revenue upon transfer of title and risk of loss, which primarily is upon shipment to customers. We generally do not have significant obligations for future performance, rights of return or pricing credits associated with our product sales. In instances where substantive acceptance provisions are specified in the customer arrangement, revenue and the related cost of revenue is deferred until all acceptance criteria have been met. • The sales price is fixed or determinable. We assess whether the sales price is fixed or determinable based on payment terms and whether the sales price is subject to refund or adjustment. • Collectability is reasonably assured. We assess probability of collectability on a customer-by-customer basis. Our customers and channel partners are subjected to a credit review process that evaluates their financial condition and ability to pay for products and services. PCS is offered under renewable, fee-based contracts, which includes technical support, hardware repair and replacement parts beyond standard warranty, bug fixes, patches and unspecified upgrades on a when-and-if-available basis. We initially defer PCS revenue and recognize it ratably over the life of the PCS contract, with the related expenses recognized as incurred. PCS contracts usually have a term of one to three years. We include billed but unearned PCS revenue in deferred revenue. We report revenue net of sales taxes. We include shipping charges billed to customers in revenue and the related shipping costs are included in cost of goods sold. Multiple-Element Arrangements Most of our arrangements, other than renewals of PCS, are multiple element arrangements with a combination of products and PCS. Products and PCS generally qualify as separate units of accounting. Our hardware deliverables include EOS software, which together deliver the essential functionality of our products. For multiple element arrangements, we allocate revenue to each unit of accounting based on the relative selling price. The relative selling price for each element is based upon the following hierarchy: vendor-specific objective evidence (“VSOE”), if available; third-party evidence (“TPE”), if VSOE is not available; and best estimate of selling price (“BESP”), if neither VSOE nor TPE is available. As we have not been able to establish VSOE or TPE for our products and most of our services, we generally utilize BESP for the purposes of allocating revenue to each unit of accounting. • VSOE-We determine VSOE based on our historical pricing and discounting practices for the specific products and services when sold separately. In determining VSOE, we require that a substantial majority of the stand-alone selling prices fall within a reasonably narrow pricing range. • TPE-When VSOE cannot be established for deliverables in multiple-element arrangements, we apply judgment with respect to whether we can establish a selling price based on TPE. TPE is determined based on competitor prices for interchangeable products or services when sold separately to similarly situated customers. However, as our products contain a significant element of proprietary technology and offer substantially different features and functionality, the comparable pricing of products with similar functionality typically cannot be obtained. Additionally, as we are unable to reliably determine what competitors products’ selling prices are on a stand-alone basis, we are not able to obtain reliable evidence of TPE of selling price. • BESP-When we are unable to establish selling price using VSOE or TPE, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the product or service was sold regularly on a stand-alone basis. BESP is based on considering multiple factors including, but not limited to the sales channel (reseller, distributor or end customer), the geographies in which our products and services were sold (domestic or international) and size of the end customer. We limit the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations, or subject to customer-specific return, acceptance or refund privileges. We account for multiple agreements with a single partner as one arrangement if the contractual terms and/or substance of those agreements indicate that they may be so closely related that they are, in effect, parts of a single arrangement. We may occasionally accept returns to address customer satisfaction issues even though there is no contractual provision for such returns. We estimate returns for sales to customers based on historical returns rates applied against current-period gross revenues. Specific customer returns and allowances are considered when determining our sales return reserve estimate. Research and Development Expenses Costs related to the research, design and development of our products are charged to research and development expenses as incurred. Software development costs are capitalized beginning when a product’s technological feasibility has been established and ending when the product is available for general release to customers. Generally, our products are released soon after technological feasibility has been established. As a result, costs incurred subsequent to achieving technological feasibility have not been significant and accordingly, all software development costs have been expensed as incurred. Warranty We offer a one-year warranty on all of our hardware products and a 90-day warranty against defects in the software embedded in the products. We use judgment and estimates when determining warranty costs based on historical costs to replace product returns within the warranty period at the time we recognize revenue. We accrue for potential warranty claims at the time of shipment as a component of cost of revenues based on historical experience and other relevant information. We reserve for specifically identified products if and when we determine we have a systemic product failure. Although we engage in extensive product quality programs, if actual product failure rates or use of materials differ from estimates, additional warranty costs may be incurred, which could reduce our gross margin. The accrued warranty liability is recorded in accrued liabilities in the accompanying consolidated balance sheets. Post-Employment Benefits We have a 401(k) Plan that covers substantially all of our employees in the U.S. For the years ended December 31, 2016, 2015 and 2014, we did not provide a discretionary company match to employee contributions. Effective January 1, 2017, we have elected to match 100% of employees' contributions up to a maximum of 3% of an employee's annual salary. Matching contributions will be immediately vested. Segment Reporting We develop, market and sell cloud networking solutions, which consist of our Gigabit Ethernet switches and related software. We have one business activity and there are no segment managers who are held accountable for operations or operating results below the Company level. Our chief operating decision maker is our Chief Executive Officer. Our Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. Accordingly, we have determined that we operate as one reportable segment. Stock-Based Compensation Compensation expense related to stock-based transactions, including stock options, restricted stock units ("RSUs"), restricted stock awards (“RSAs”), and stock purchase rights under our employee stock purchase program is measured and recognized in the financial statements based on the fair value of the equity granted, net of estimated forfeitures, on a straight-line basis over the requisite service periods of the awards, which typically ranges from two to five years. Under ASU 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting, beginning the first quarter of fiscal 2017 we have elected to account for forfeitures as they occur and will no longer include an estimate of future forfeitures in the fair value measurement. Excess tax benefits associated with stock option exercises and other equity awards are recognized in additional paid in capital. The income tax benefits resulting from stock awards that were credited to stockholders' equity were $42.1 million, $37.0 million and $17.4 million, for the years ended December 31, 2016, 2015 and 2014, respectively. With the adoption of ASU 2016-09, effective January 1, 2017 on a prospective basis, excess tax benefits generated from stock option exercises and other equity awards will be recorded as provision of income taxes in the income statement, rather than equity. Income Taxes Income tax expense is an estimate of current income taxes payable in the current fiscal year based on reported income before income taxes. Deferred income taxes reflect the effect of temporary differences and carryforwards that we recognize for financial reporting and income tax purposes. We account for income taxes under the liability approach for deferred income taxes, which requires recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been recognized in our consolidated financial statements, but have not been reflected in our taxable income. Estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain deferred income tax assets, which arise from temporary differences and carryforwards. Deferred income tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. We regularly assess the likelihood that our deferred income tax assets will be realized based on the positive and negative evidence available. We record a valuation allowance to reduce the deferred tax assets to the amount that we are more likely than not to realize. We believe that we have adequately reserved for our uncertain tax positions, although we can provide no assurance that the final tax outcome of these matters will not be materially different. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and results of operations. The provision for income taxes includes the effects of any reserves that we believe are appropriate, as well as the related net interest and penalties. We regularly review our tax positions and benefits to be realized. We recognize tax liabilities based upon our estimate of whether, and to the extent to which, additional taxes will be due when such estimates are more likely than not to be sustained. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. We recognize interest and penalties related to income tax matters as income tax expense. Net Income per Share of Common Stock Basic and diluted net income per share attributable to common stockholders is calculated in conformity with the two-class method required for participating securities. Our shares of common stock subject to repurchase are considered participating securities. In addition, our convertible preferred stock prior to conversion to common shares upon our initial public offering in June 2014, were also considered to be participating securities. Under the two-class method, net income attributable to common stockholders is calculated as net income less earnings attributable to participating securities. In computing diluted net income attributable to common stockholders, undistributed earnings are re-allocated to reflect the potential impact of dilutive securities. Basic net income per common share is computed by dividing the net income attributable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per share attributable to common stockholders is computed by dividing the net income attributable to common stockholders by the weighted-average number of common shares outstanding, including potential dilutive common shares assuming the dilutive effect of outstanding stock options, restricted stock units, and employee stock purchase plan using the treasury stock method. For purposes of this calculation, these amounts are excluded from the calculation of diluted net income per share of common stock if their effect is antidilutive. Recent Accounting Pronouncements In May 2014, the FASB issued ASU No. 2014-09, Revenue From Contracts With Customers (Topic 606), (as amended in June 2016, by ASU No. 2016-12-Revenue-Narrow-Scope Improvements and Practical Expedients), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The new standard provides principles for recognizing revenue for the transfer of promised goods or services to customers with the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also requires significantly expanded disclosures about revenue recognition. In July 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, deferring the effective date of the new revenue standard by one year. In March 2016, the FASB issued ASU No. 2016-08, Revenue From Contracts With Customers-Principal versus Agent Considerations (Reporting Revenue Gross versus Net), and ASU No. 2016-10, Revenue From Contracts With Customers-Identifying Performance Obligations and Licensing. ASU No. 2016-08 clarifies the implementation guidance regarding principal versus agent identification and related considerations. Specifically, the guidance provides clarification around performance obligations for goods or services provided by another entity, assisting in determining whether the entity is the provider of the goods or services, the principal, or whether the entity is providing for the arrangement of the goods or services, the agent. ASU No. 2016-10 provides guidance around identifying whether promised goods or services are distinct and separately identifiable, whether promised goods or services are material or immaterial to the contract, and whether shipping and handling is considered an activity to fulfill a promise or an additional promised service. ASU No. 2016-10 also provides guidance around an entity's promise to grant a license providing a customer with either a right to use or a right to access the license, which then determines whether the obligation is satisfied at a point in time or over time, respectively. In May 2016, the FASB issued ASU No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting (SEC Update)") ("ASU 2016-11"), which rescinds various standards codified as part of Topic 605, Revenue Recognition in relation to the future adoption of Topic 606. These rescissions include changes to topics pertaining to revenue and expense recognition including accounting for shipping and handling fees and costs and accounting for consideration given by a vendor to a customer. The above standards are effective for fiscal years (and interim reporting periods within those years) beginning after December 15, 2017. The guidance is effective for us beginning in our first quarter of fiscal 2018. Early adoption would be permitted for all entities but not until the fiscal year beginning after December 15, 2016. The standard permits the use of either the retrospective or cumulative effect transition method. The retrospective method requires a retrospective approach to each prior reporting period presented with the option to elect certain practical expedients as defined within the guidance. The cumulative approach requires a retrospective approach with the cumulative effect of initially applying the guidance recognized at the date of initial application and providing certain additional disclosures as defined per the guidance. Management’s assessments of potential impacts of the standards are underway. The standards are expected to impact the amount and timing of revenue recognized and the related disclosures on our consolidated financial statements. We will adopt ASU 2014-09 during the first quarter of 2018 and expect to adopt the guidance under the modified retrospective method which we anticipate will result in a cumulative effect adjustment as of the date of adoption. In January 2016, the FASB issued ASU No, 2016-01, Financial Instruments-Recognition and Measurement of Financial Assets and Financial Liabilities, which enhances the reporting model for financial instruments to provide users of financial statements with more decision-useful information. The guidance will address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The standard is effective for us for our first quarter of fiscal 2018. The guidance may be early adopted under early application guidance. We are currently assessing the impact this guidance may have on our consolidated financial statements as well as the transition method that we will use to adopt the guidance. In February 2016, the FASB issued ASU No, 2016-02, Leases, which addresses the classification and recognition of lease assets and liabilities formerly classified as operating leases under GAAP. The guidance will address certain aspects of recognition and measurement, and quantitative and qualitative aspects of presentation and disclosure. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The standard is effective for us for our first quarter of fiscal 2019. The guidance will be applied to the earliest period presented using a modified retrospective approach. The guidance includes practical expedients that relate to identification, classification, and initial direct costs associated with leases commencing prior to the effective date, and the ability to apply hindsight in evaluating lease options related to extensions, terminations or asset purchases. A practical expedient also exists to treat leases entered into prior effective date under existing GAAP unless the lease has been modified. The guidance may be early adopted. We are currently assessing the impact this guidance may have on our consolidated financial statements as well as the transition method that we will use to adopt the guidance. In March 2016, the FASB amended the existing accounting standards for stock-based compensation, ASU 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting, which impact several aspects of accounting for share-based payment transactions, including the income tax consequences, forfeitures, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The standard is effective for us for our first quarter of fiscal 2017. The manner of application varies by the various provisions of the guidance, with certain provisions applied on a retrospective or modified retrospective approach, while others are applied prospectively. Based on our assessment of the above standard, guidance related to forfeitures will be adopted under a modified retrospective transition method and a cumulative adjustment to beginning retained earnings will be recorded on the day of adoption. Effective January 1, 2017, we will account for forfeitures as they occur and will calculate a cumulative adjustment as it relates to equity transactions where prior forfeitures rates have previously and cumulatively been applied. With the adoption of ASU 2016-09, we will prospectively record excess tax benefits generated from stock option exercises and other equity awards as a provision to income tax in the income statement, rather than equity. In addition, we will apply the guidance under a modified retrospective transition method and account for previously unrecognized excess tax benefits through a cumulative-effect adjustment to beginning retained earnings. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Task Force), which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain transactions are presented and classified in the statement of cash flows. The guidance may be adopted early as of the beginning of an annual reporting period. The guidance will be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The standard is effective for us for our first quarter of fiscal 2018. We are currently assessing the impact this guidance may have on our consolidated financial statements. In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, which addresses recognition of current and deferred income taxes for intra-entity asset transfers when assets are sold to an outside party. Current GAAP prohibits the recognition of current and deferred income taxes until the asset has been sold to an outside party. This prohibition on recognition is considered an exception to the principle of comprehensive recognition of current and deferred income taxes in GAAP. The new guidance requires an entity to recognize the income tax consequences when the transfer occurs eliminating the exception. The guidance will be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The standard is effective for us for our first quarter of fiscal 2018, and may be early adopted under early application guidance. We are currently assessing the impact this guidance may have on our consolidated financial statements. 2. Fair Value Measurements We measure and report our cash equivalents, restricted cash, and available-for-sale marketable securities at fair value. The following table set forth the fair value of our financial assets by level within the fair value hierarchy (in thousands): 3. Balance Sheet Components Marketable Securities The following table summarizes the unrealized gains and losses and fair value of our available-for-sale marketable securities (in thousands): There were no marketable securities as of December 31, 2015. We did not realize any other-than-temporary losses on our marketable securities for the year ended December 31, 2016 and 2015. None of our marketable securities were in continuous unrealized loss positions for greater than twelve months as of December 31, 2016 and 2015. We invest in marketable securities that have maximum maturities of up to two years and are generally deemed to be low risk based on their credit ratings from the major rating agencies. The longer the duration of these marketable securities, the more susceptible they are to changes in market interest rates and bond yields. As interest rates increase, those marketable securities purchased at a lower yield show a mark-to-market unrealized loss. The unrealized losses are due primarily to changes in credit spreads and interest rates. We expect to realize the full value of these investments upon maturity or sale. As of December 31, 2016, the contractual maturities of our investments did not exceed 24 months. The fair values of available-for-sale investments, by remaining contractual maturity, are as follows (in thousands): The weighted average remaining duration of our current marketable securities is approximately 0.9 years as of December 31, 2016. As we view these securities as available to support current operations, we classify securities with maturities beyond 12 months as current assets under the caption marketable securities in the accompanying consolidated balance sheets. Accounts Receivable, net Accounts receivable, net consists of the following (in thousands): Allowance for Doubtful Accounts Activity in the allowance for doubtful accounts consists of the following (in thousands): Product Sales Return Reserve Activity in the sales return reserve consists of the following (in thousands): Inventories Inventories consist of the following (in thousands): Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets consists of the following (in thousands): Property and Equipment, net Property and equipment, net consists of the following (in thousands): Depreciation expense was $19.4 million, $13.4 million and $10.0 million for the years ended December 31, 2016, 2015 and 2014, respectively. Accrued Liabilities Accrued liabilities consist of the following (in thousands): Warranty Accrual The following table summarizes the activity related to our accrued liability for estimated future warranty costs (in thousands): There were no significant specific product warranty reserves recorded for the years ended December 31, 2016 or 2015. 4. Investments Investments in Privately Held Companies As of December 31, 2016 and 2015, we held non-marketable equity investments of approximately $36.1 million and $33.6 million, respectively, in privately held companies which are accounted for under the cost method. During the year ended 2016 we made an additional investment of $2.5 million in one of these companies. To date, we have not recognized any impairment losses on our investments. 5. Commitments and Contingencies Operating Leases We lease various operating spaces in North America, Europe, Asia and Australia under non-cancelable operating lease arrangements that expire on various dates through 2025. These arrangements require us to pay certain operating expenses, such as taxes, repairs, and insurance and contain renewal and escalation clauses. We recognize rent expense under these arrangements on a straight-line basis over the term of the lease. As of December 31, 2016, the aggregate future minimum payments under non-cancelable operating leases consist of the following (in thousands): We recognize rent expense under these arrangements on a straight-line basis over the term of the lease. Rent expense for all operating leases amounted to $8.1 million, $5.4 million and $2.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. Financing Obligation-Build-to-Suit Lease In August 2012, we executed a lease for a building then under construction in Santa Clara, California to serve as our headquarters. The lease term is 120 months and commenced in August 2013. Based on the terms of the lease agreement and due to our involvement in certain aspects of the construction, we were deemed the owner of the building (for accounting purposes only) during the construction period. Upon completion of construction in 2013, we concluded that we had forms of continued economic involvement in the facility, and therefore did not meet with the provisions for sale-leaseback accounting. We continue to maintain involvement in the property post construction and lack transferability of the risks and rewards of ownership, due to our required maintenance of a $4.0 million letter of credit, in addition to our ability and option to sublease our portion of the leased building for fees substantially higher than our base rate. Therefore, the lease is accounted for as a financing obligation and lease payments will be attributed to (1) a reduction of the principal financing obligation; (2) imputed interest expense; and (3) land lease expense, representing an imputed cost to lease the underlying land of the building. At the conclusion of the initial lease term, we will de-recognize both the net book values of the asset and the remaining financing obligation. As of December 31, 2016 and 2015, we have recorded assets of $53.4 million, representing the total costs of the building and improvements incurred, including the costs paid by the lessor (the legal owner of the building) and additional improvement costs paid by us, and a corresponding financing obligation of $41.2 million and $42.5 million, respectively. As of December 31, 2016, $1.6 million and $39.6 million were recorded as short-term and long-term financing obligations, respectively. Land lease expense under our lease financing obligation amounted to $1.3 million, $1.3 million and $1.2 million for the years ended December 31, 2016, 2015 and 2014 respectively. As of December 31, 2016, the future minimum payments due under the lease financing obligation were as follows (in thousands): Purchase Commitments We outsource most of our manufacturing and supply chain management operations to third-party contract manufacturers, who procure components and assemble products on our behalf based on our forecasts in order to reduce manufacturing lead times and ensure adequate component supply. We issue purchase orders to our contract manufacturers for finished product and a significant portion of these orders consist of firm non-cancelable commitments. In addition, we purchase strategic component inventory from certain suppliers under purchase commitments that in some cases are non-cancelable, including integrated circuits, which are consigned to our contract manufacturers. As of December 31, 2016, we had non-cancelable purchase commitments of $261.9 million. In addition, we have provided deposits to secure our obligations to purchase inventory. We had $63.1 million and $2.3 million in deposits as of December 31, 2016 and December 31, 2015, respectively. These deposits are classified in other current and long term assets in our accompanying audited consolidated balance sheets. Guarantees We have entered into agreements with some of our direct customers and channel partners that contain indemnification provisions relating to potential situations where claims could be alleged that our products infringe the intellectual property rights of a third party. We have at our option and expense the ability to repair any infringement, replace product with a non-infringing equivalent-in-function product or refund our customers all or a portion of the value of the product. Other guarantees or indemnification agreements include guarantees of product and service performance and standby letters of credit for leased facilities and corporate credit cards. We have not recorded a liability related to these indemnification and guarantee provisions and our guarantee and indemnification arrangements have not had any significant impact on our consolidated financial statements to date. Legal Proceedings OptumSoft, Inc. Matters On April 4, 2014, OptumSoft filed a lawsuit against us in the Superior Court of California, Santa Clara County titled OptumSoft, Inc. v. Arista Networks, Inc., in which it asserts (i) ownership of certain components of our EOS network operating system pursuant to the terms of a 2004 agreement between the companies; and (ii) breaches of certain confidentiality and use restrictions in that agreement. Under the terms of the 2004 agreement, OptumSoft provided us with a non-exclusive, irrevocable, royalty-free license to software delivered by OptumSoft comprising a software tool used to develop certain components of EOS and a runtime library that is incorporated into EOS. The 2004 agreement places certain restrictions on our use and disclosure of the OptumSoft software and gives OptumSoft ownership of improvements, modifications and corrections to, and derivative works of, the OptumSoft software that we develop. In its lawsuit, OptumSoft has asked the Court to order us to (i) give OptumSoft access to our software for evaluation by OptumSoft; (ii) cease all conduct constituting the alleged confidentiality and use restriction breaches; (iii) secure the return or deletion of OptumSoft’s alleged intellectual property provided to third parties, including our customers; (iv) assign ownership to OptumSoft of OptumSoft’s alleged intellectual property currently owned by us; and (v) pay OptumSoft’s alleged damages, attorney’s fees, and costs of the lawsuit. David Cheriton, one of our founders and a former member of our board of directors, who resigned from our board of directors on March 1, 2014 and has no continuing role with us, is a founder and, we believe, the largest stockholder and director of OptumSoft. The 2010 David R. Cheriton Irrevocable Trust dtd July 28, 2010, a trust for the benefit of the minor children of Mr. Cheriton, is one of our largest stockholders. On April 14, 2014, we filed a cross-complaint against OptumSoft, in which we assert our ownership of the software components at issue and our interpretation of the 2004 agreement. Among other things, we assert that the language of the 2004 agreement and the parties’ long course of conduct support our ownership of the disputed software components. We ask the Court to declare our ownership of those software components, all similarly-situated software components developed in the future and all related intellectual property. We also assert that, even if we are found not to own certain components, such components are licensed to us under the terms of the 2004 agreement. However, there can be no assurance that our assertions will ultimately prevail in litigation. On the same day, we also filed an answer to OptumSoft’s claims, as well as affirmative defenses based in part on OptumSoft’s failure to maintain the confidentiality of its claimed trade secrets, its authorization of the disclosures it asserts and its delay in claiming ownership of the software components at issue. We have also taken additional steps to respond to OptumSoft’s allegations that we improperly used and/or disclosed OptumSoft confidential information. While we believe we have meritorious defenses to these allegations, we believe we have (i) revised our software to remove the elements we understand to be the subject of the claims relating to improper use and disclosure of OptumSoft confidential information and made the revised software available to our customers and (ii) removed information from our website that OptumSoft asserted disclosed OptumSoft confidential information. The parties tried Phase I of the case, relating to contract interpretation and application of the contract to certain claimed source code, in September 2015. On December 16, 2015, the Court issued a Proposed Statement of Decision Following Phase 1 Trial, and on January 8, 2016, OptumSoft filed objections to that Proposed Statement of Decision. On March 23, 2016, the Court issued a Final Statement of Decision Following Phase I Trial, in which it agreed with and adopted our interpretation of the 2004 agreement and held that we, and not OptumSoft, own all the software at issue in Phase I. The remaining issues that were not addressed in the Phase I trial are set to be tried in Phase II including the application of the Court’s interpretation of the 2004 agreement as set forth in the Final Statement of Decision Following Phase I Trial to any other source code that OptumSoft claims to own following a review. Phase II was previously scheduled to be tried in April 2016; however, that trial date has been vacated and a new trial date has not yet been set. We intend to vigorously defend against any claims brought against us by OptumSoft. However, we cannot be certain that, if litigated, any claims by OptumSoft would be resolved in our favor. For example, if it were determined that OptumSoft owned components of our EOS network operating system, we would be required to transfer ownership of those components and any related intellectual property to OptumSoft. If OptumSoft were the owner of those components, it could make them available to our competitors, such as through a sale or license. An adverse litigation ruling could result in a significant damages award against us and injunctive relief. In addition, OptumSoft could assert additional or different claims against us, including claims that our license from OptumSoft is invalid. With respect to the legal proceedings described above, it is our belief that while a loss is not probable, it may be reasonably possible. Further, at this stage in the litigation, any possible loss or range of loss cannot be estimated. However, the outcome of litigation is inherently uncertain. Therefore, if one or more of these legal matters were resolved against us in a reporting period for a material amount, our consolidated financial statements for that reporting period could be materially adversely affected. Cisco Systems, Inc. (“Cisco”) Matters We are currently involved in several litigation matters with Cisco Systems, Inc. These matters are summarized below. Cisco Systems, Inc. v. Arista Networks, Inc. (Case No. 4:14-cv-05343) (“’43 Case”) On December 5, 2014, Cisco filed a complaint against us in the District Court for the Northern District of California alleging that we infringe U.S. Patent Nos. 6,377,577; 6,741,592; 7,023,853; 7,061,875; 7,162,537; 7,200,145; 7,224,668; 7,290,164; 7,340,597; 7,460,492; 8,051,211; and 8,356,296 (respectively, “the ’577 patent,” “the ’592 patent,” “the ’853 patent,” “the 875 patent,” “the ’537 patent,” “the ’145 patent,” “the ’668 patent,” “the ’164 patent,” “the ’597 patent,” “the ’492 patent,” “the ’211 patent,” and “the ’296 patent”). Cisco seeks, as relief for our alleged infringement in the ’43 Case, lost profits and/or reasonable royalty damages in an unspecified amount, including treble damages, attorney’s fees, and associated costs. Cisco also seeks injunctive relief in the ’43 Case. On February 10, 2015, the Court granted our unopposed motion to stay the ’43 Case until the proceedings before the United States International Trade Commission (“USITC”) pertaining to the same patents (as discussed below) became final. Trial has not been scheduled in the ’43 Case. Cisco Systems, Inc. v. Arista Networks, Inc. (Case No. 5:14-cv-05344) (“’44 Case”) On December 5, 2014, Cisco filed a complaint against us in the District Court for the Northern District of California alleging that we infringe numerous copyrights pertaining to Cisco’s “Command Line Interface” or “CLI” and U.S. Patent Nos. 7,047,526 and 7,953,886 (respectively, “the ’526 patent” and “the ’886 patent”). As relief for our alleged patent infringement in the ’44 Case, Cisco seeks lost profits and/or reasonable royalty damages in an unspecified amount including treble damages, attorney’s fees, and associated costs as well as injunctive relief. As relief for our alleged copyright infringement, Cisco seeks monetary damages for alleged lost profits, profits from our alleged infringement, statutory damages, attorney's fees, and associated costs. On February 13, 2015, we answered the complaint in the ’44 Case, denying the patent and copyright infringement allegations and raising numerous affirmative defenses. On March 6, 2015, Cisco filed an amended complaint against us in the ’44 Case. In response, we moved to dismiss Cisco’s allegations of willful patent infringement and pre-suit indirect patent infringement. The Court granted the motion with leave to amend on July 2, 2015. On July 23, 2015, Cisco filed an amended complaint. As described below, on May 25, 2016, our petition for Inter Partes Review (“IPR”) of the ’886 patent was instituted by the United States Patent Trial and Appeal Board (“PTAB”). Cisco subsequently agreed to dismiss its claims as to the ‘886 patent with prejudice. Summary judgment cross-motions in the ’44 Case were heard on August 4, 2016, and the Court denied all motions brought by both sides. Trial began on November 28, 2016, and the jury rendered its verdict on December 14, 2016. The jury found that Arista had proven its copyright defense of scenes a faire and that Cisco had failed to prove infringement of the ’526 patent, and on that basis judgment was entered in Arista’s favor on all claims on December 19, 2016. On January 17, 2017, Cisco filed a motion for judgment as a matter of law, challenging the sufficiency of the evidence in support of Arista's scenes a faire defense. Cisco did not file any post-trial motion regarding the ’526 patent, nor did it file a motion for a new trial. We also filed a motion for judgment as a matter of law on several issues. The hearing on both parties’ motions is currently set for April 27, 2017. Arista Networks, Inc. v. Cisco Systems, Inc. (Case No. 5:16-cv-00923) (“’23 Case”) On February 24, 2016, we filed a complaint against Cisco in the District Court for the Northern District of California alleging antitrust violations and unfair competition. On April 13, 2016, Cisco filed a motion to stay the ’23 Case, or in the alternative, to dismiss the complaint. On August 23, 2016, the Court granted Cisco’s motion to stay the ’23 Case until judgment has been entered on Cisco’s copyright claims in the ’44 Case, which the Court anticipated by December 22, 2016. Following the jury’s verdict in Arista’s favor in the ’44 Case, the parties filed a stipulation continuing the Case Management Conference until March 2, 2017. Trial in the ’23 Case is set for August 3, 2018, and is not affected by the Court’s granting of the interim stay. Certain Network Devices, Related Software, and Components Thereof (Inv. No. 337-TA-944) (“944 Investigation”) On December 19, 2014, Cisco filed a complaint against us in the USITC alleging that we have violated Section 337 of the Tariff Act of 1930, as amended. The USITC instituted Cisco’s complaint as Investigation No. 337-TA-944. Cisco initially alleged that certain of our switching products infringe the ’592, ’537, ’145, ’164, ’597, and ’296 patents. Cisco subsequently dropped the ’296 patent from the 944 Investigation. Cisco sought, among other things, a limited exclusion order barring entry into the United States of accused switch products (including our 7000 Series of switches) and components and software therein and a cease and desist order against us restricting our activities with respect to our imported accused switch products and components and software therein. On February 11, 2015, we responded to the complaint in the 944 Investigation by, among other things, denying the patent infringement allegations and raising numerous affirmative defenses. The Administrative Law Judge (“ALJ”) assigned to the 944 Investigation issued a procedural schedule calling for, among other events: an evidentiary hearing on September 9-11 and 15-17, 2015; issuance of an initial determination regarding our alleged violations on January 27, 2016; and a Target Date for completion of the investigation on May 27, 2016. On January 27, 2016, the ALJ issued a revised procedural schedule extending the date for issuance of an initial determination to February 2, 2016 and extending the Target Date to June 2, 2016. On February 2, 2016, the ALJ issued his initial determination finding a violation of section 337 of the Tariff Act. More specifically, the ALJ found that a violation has occurred in the importation into the United States, the sale for importation, or the sale within the United States after importation, of certain network devices, related software, and components thereof that the ALJ found infringe asserted claims 1, 2, 8-11, and 17-19 of the ’537 patent; asserted claims 6, 7, 20, and 21 of the ’592 patent; and asserted claims 5, 7, 45, and 46 of the ’145 patent. The ALJ did not find a violation of section 337 with respect to any asserted claims of the ’597 and ’164 patents. On April 11, 2016, the Commission decided to review certain findings contained in the initial determination. On June 23, 2016, the Commission issued its Final Determination, which found a violation with respect to the ’537, ’592, and ’145 patents, and found no violation with respect to the ’597 and ’164 patents. The Commission also issued a limited exclusion order and a cease and desist order pertaining to network devices, related software and components thereof that infringe one or more of claims 1, 2, 8-11, and 17-19 of the ’537 patent; claims 6, 7, 20, and 21 of the ’592 patent; and claims 5, 7, 45, and 46 of the ’145 patent. On August 22, 2016, the Presidential review period for the 944 investigation expired. The USITC orders will be in effect until the expiration of the ’537, ’592, and ’145 patents. Both we and Cisco filed petitions for review of the USITC’s Final Determination to the U.S. Court of Appeals for the Federal Circuit (“Federal Circuit”). On August 26, 2016, the Federal Circuit consolidated the appeals, and on September 23, 2016, it issued an order setting an expedited briefing schedule. The appeal is fully briefed and oral argument has not been scheduled. On August 26, 2016, Cisco filed an enforcement complaint under Section 337 of the Tariff Act of 1930, as amended, with the USITC. Cisco alleges that we are violating the cease and desist and limited exclusion orders issued in the 944 Investigation by engaging in the “marketing, distribution, offering for sale, selling, advertising, and/or aiding or abetting other entities in the sale and/or distribution of products that Cisco alleges continue to infringe claims 1-2, 8-11, and 17-19 of the ’537 patent,” despite the design changes we have made to those products. Cisco asks the USTIC to (1) enforce the cease and desist order; (2) modify the Commission’s limited exclusion order and/or cease and desist order “in any manner that would assist in the prevention of the unfair practices that were originally the basis for issuing such Order or assist in the detection of violations of such Order”; (3) impose the maximum statutory civil penalties for violation of the cease and desist order “including monetary sanctions for each day’s violation of the cease and desist order of the greater of $100,000.00 or twice the domestic value of the articles entered or sold, whichever is higher”; (4) bring a civil action in U.S. district court “requesting collection of such civil penalties and the issuance of a mandatory injunction preventing further violation of Cease and Desist Order”; and (5) impose “such other remedies and sanctions as are appropriate and within the Commission’s authority.” On September 28, 2016, the Commission instituted the enforcement proceeding. The proceeding has been assigned to Administrative Law Judge Shaw, who presided over the underlying investigation. On October 14, 2016, we responded to the complaint by, among other things, denying the patent infringement allegations and raising affirmative defenses. On November 2, 2016, the ALJ issued an order setting the deadline for the initial determination for June 20, 2017 and the Target Date for September 20, 2017. On November 3, 2016, the ALJ issued a scheduling order setting the evidentiary hearing in this proceeding for April 5, 2017. Certain Network Devices, Related Software, and Components Thereof (Inv. No. 337-TA-945) (“945 Investigation”) On December 19, 2014, Cisco filed a complaint against us in the USITC alleging that we violated Section 337 of the Tariff Act of 1930, as amended. The USITC instituted Cisco’s complaint as Investigation No. 337-TA-945. Cisco alleges that certain of our switching products infringe the ’577, ’853, ’875, ’668, ’492, and ’211 patents. Cisco seeks, among other things, a limited exclusion order barring entry into the United States of accused switch products (including our 7000 Series of switches) related software, and components thereof and a cease and desist order against us restricting our activities with respect to our imported accused switch products, related software, and components thereof. On February 11, 2015, we responded to the notice of investigation and complaint in the 945 Investigation by, among other things, denying the patent infringement allegations and raising numerous affirmative defenses. The ALJ issued a procedural schedule calling for, among other events: an evidentiary hearing on November 9-20, 2015; issuance of an initial determination regarding our alleged violations on April 26, 2016; and a Target Date for completion on August 26, 2016. On March 29, 2016, the ALJ issued a revised procedural schedule extending the deadline for issuance of an initial determination to August 26, 2016, and extending the Target Date to December 26, 2016. On August 24, 2016, the ALJ issued a revised procedural schedule extending the deadline for issuance of an initial determination to November 7, 2016, and extending the Target Date to March 7, 2017. On November 4, 2016, the ALJ issued a revised procedural schedule extending the deadline for issuance of an initial determination to December 7, 2016, and extending the Target Date to April 7, 2017. On December 7, 2016, the ALJ issued a revised procedural schedule extending the deadline for issuance of an initial determination to December 9, 2016, and extending the Target Date to April 9, 2017. On December 9, 2016, the ALJ issued her initial determination finding a violation of section 337 of the Tariff Act. More specifically, the ALJ found that a violation has occurred in the importation into the United States, the sale for importation, or the sale within the United States after importation, of certain network devices, related software, and components thereof that the ALJ found infringe asserted claims 1, 7, 9, 10, and 15 of the ’577 patent; and asserted claims 1, 2, 4, 5, 7, 8, 10, 13, 19, 56, and 64 of the ’668 patent. The ALJ did not find a violation of section 337 with respect to asserted claim 2 of the ’577 patent or any asserted claims of the ’853, ’492, ’875, and ’211 patents. On December 29, 2016, Arista, Cisco and the OUII filed petitions for review of certain findings contained in the initial determination. On January 3, 2017, the Commission extended the Target Date to April 17, 2017, and set the deadline for determining whether to review the final initial determination to February 15, 2017. On January 27, 2017, the Commission further extended the Target Date to May 1, 2017, and set the deadline for determining whether to review the final initial determination to March 1, 2017. If the Commission finds a violation in its Final Determination, that finding will be subject to a 60-day Presidential review period. Inter Partes Reviews We have filed petitions for Inter Partes Review (“IPR”) of the ’597, ’211, ’668, ’853, ’537, ’577, ’886, and ’526 patents. IPRs relating to the ’597 (IPR No. 2015-00978) and ’211 (IPR No. 2015-00975) patents were instituted in October 2015 and hearings on these IPRs were completed in July 2016. On September 28, 2016, the PTAB issued a final written decision finding claims 1, 14, 39-42, 71, 72, 84, and 85 of the ’597 patent unpatentable. The PTAB also found that claims 29, 63, 64, 73, and 86 of the ’597 patent had not been shown to be unpatentable. Cisco requested rehearing of the PTAB’s Final Written Decision on October 28, 2016, which the PTAB denied on January 13, 2017. On January 23, 2017, we filed a notice of appeal with respect to this decision regarding claims 29, 63, 64, 73, and 86 of the ’597 patent. On October 5, 2016, the PTAB issued a final written decision finding claims 1 and 12 of the ’211 patent unpatentable. The PTAB also found that claims 2, 6-9, 13, 17-20 of the ’211 patent had not been shown to be unpatentable. On December 5, 2016, we filed a notice of appeal with respect to this decision regarding claims 2, 6-9, 13, 17-20, which was docketed as Appeal No. 17-1313. Cisco filed a notice of cross-appeal with respect to claims 1 and 12 on December 19, 2016, which was docketed as Appeal No. 17-1380. The Court of Appeals for the Federal Circuit consolidated these appeals on December 20, 2016. The briefing is set to be completed in July 2017. The IPR relating to the ’886 patent was instituted on May 25, 2016. Following that decision, Cisco agreed to dismiss its claims as to the ʼ886 patent with prejudice, and we dismissed our counterclaims as to the ʼ886 patent without prejudice. IPRs relating to the ’668 (IPR No. 2016-00309), ’577 (IPR No. 2016-00303), ’853 (IPR No. 2016-0306), and ’537 (IPR No. 2016-0308) patents were instituted in June 2016 and are set for hearing in March 2017. Final Written Decisions on these IPRs will be issued by June 2017. * * * * * We intend to vigorously defend against each of the Cisco’s lawsuits, as summarized in the preceding paragraphs. However, we cannot be certain that any claims by Cisco would be resolved in our favor regardless of the merit of the claims. Any adverse litigation ruling could result in the above described injunctive relief, could require a significant damages award against us or a requirement that we make substantial royalty payments to Cisco, and/or could require that we modify our products to the extent that we are found to infringe any valid claims asserted against us by Cisco. For example, in the 944 Investigation, the USITC has issued a limited exclusion order barring entry into the United States of our network devices (including our 7000 Series of switches), related software, and components thereof that infringe one or more of the claims of the ʼ537, ʼ592, and ʼ145 patents specified above and a cease and desist order restricting our activities with respect to such imported products. In addition, in the 945 Investigation, the ALJ has issued her initial determination finding a violation of section 337 of the Tariff Act with respect to the ‘668 and ‘577 patents, which is now subject to review by the Commission. To comply with these orders, we have sought to develop technical design-arounds that no longer infringe the patents that are the subject of the orders. In any efforts to develop technical design-arounds for our products, we may be unable to do so in a manner that does not continue to infringe the patents or that is acceptable to our customers. These development efforts could be extremely costly and time consuming as well as disruptive to our other development activities and distracting to management. Moreover, in the 944 Investigation and 945 Investigation, such design-arounds would require us to obtain approval of either the USITC or U.S. Customs and Border Protection (“CBP”) to resume the importation of the redesigned products into the United States. We may not be successful in our efforts to obtain such approvals to import such modified products in a timely manner, or at all. While a favorable ruling from the CBP would allow us to resume importation of our redesigned products into the United States, the USITC could still determine in an enforcement action that our redesigned products continue to infringe the patents that are the subject of any USITC orders. Any failure to effectively redesign our products, to obtain timely clearance from USITC or CBP to import such redesigned products, or to address the USITC findings in a manner that complies with the USITC orders, may cause a disruption to our product shipments and materially and adversely affect our business, prospects, reputation, results of operations, and financial condition. Specifically, in response to the USITC’s findings in the 944 Investigation, we have made design changes to our products for sale in the United States to address the features that were found to infringe the ’537, ’592, ’145 patents. Following the issuance of the final determination in the 944 Investigation, we submitted a Section 177 ruling request to CBP seeking approval to import these redesigned products into the United States. On November 18, 2016, we received a 177 ruling from CBP finding that our redesigned products did not infringe the ‘537, ’592, and ‘145 patents, and approving the importation of these redesigned products into the United States. However, on January 13, 2017, at the request of Cisco Systems and without our input, CBP issued a letter to us revoking its prior November 18 ruling. Due to this revocation, we can no longer import its products into the United States. CBP has informed us that it currently takes no position on whether our redesigned products infringe and will conduct an inter partes proceeding between Arista and Cisco to determine whether our redesigned products infringe and whether to approve them for importation into the United States. We do not yet know when CBP will complete the process and provide that ruling. The CBP may not rule in a timely fashion, and we may not receive a favorable ruling at the end of the process. Similarly, if the USITC finds in a Final Determination that we infringe any patent in the 945 Investigation, the USITC will likely issue remedial orders in that investigation as well. If such orders are not disapproved by the United States Trade Representative, we would need to further modify our products to take our products outside the scope of any patents we are found to have infringed in the 945 Investigation and obtain the USITC and/or CBP approvals described above in order to resume importation of our redesigned products into the United States. If the USITC determines that our redesigned products continue to infringe the patents subject to any USITC limited exclusion order or cease and desist order in an enforcement action for either the 944 Investigation or the 945 Investigation, the USITC may impose the maximum statutory civil penalties for violation of the cease and desist order “including monetary sanctions for each day’s violation of the cease and desist order of the greater of $100,000.00 or twice the domestic value of the articles entered or sold, whichever is higher,” bring a civil action in U.S. district court “requesting collection of such civil penalties and the issuance of a mandatory injunction preventing further violation of Cease and Desist Order” or impose “such other remedies and sanctions as are appropriate and within the Commission’s authority.” In order to comply with the USITC’s remedial orders, we have also made certain changes to our manufacturing, importation and shipping workflows. These changes have included shifting manufacturing and integration of our products to be sold in the United States to U.S. facilities. Such changes may be extremely costly, time consuming, and we may not be able to implement such changes successfully. Any failure to successfully change our manufacturing and importation processes or shipping workflows in a manner that is compliant with the limited exclusion order and cease and desist order may cause a disruption in our product shipments and materially and adversely affect our business, prospects, reputation, results of operations, and financial condition. In connection with these changes, to the extent that we are required to make further modifications to our supply chain to obtain alternative U.S. sources for subcomponents, we may be unable to obtain a sufficient quantity of these components on commercially reasonable terms or in a timely manner, if at all, which could delay or halt entirely production of our products or require us to make further modifications to our products to incorporate new components that are available in the United States. Any of these events could result in lost sales, reduced gross margins or damage to our end-customer relationships, which would materially and adversely impact our business, financial condition, results of operations and prospects. Additionally, the existence of Cisco’s lawsuits against us could cause concern among our customers and partners and could adversely affect our business and results of operations. Whether or not we prevail in the lawsuit, we expect that the litigation will be expensive, time-consuming and a distraction to management in operating our business. With respect to the various legal proceedings described above, it is our belief that while a loss is not probable, it may be reasonably possible. Further, at this stage in the litigation, any possible loss or range of loss cannot be estimated. However, the outcome of litigation is inherently uncertain. Therefore, if one or more of these legal matters were resolved against us in a reporting period for a material amount, our consolidated financial statements for that reporting period could be materially adversely affected. Other Matters In the ordinary course of business, we are a party to other claims and legal proceedings including matters relating to commercial, employee relations, business practices and intellectual property. We record a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. As of December 31, 2016, provisions recorded for contingent losses related to other claims and matters have not been significant. Based on currently available information, management does not believe that any additional liabilities relating to other unresolved matters are probable or that the amount of any resulting loss is estimable, and believes these other matters are not likely, individually and in the aggregate, to have a material adverse effect on our financial position, results of operations or cash flows. However, litigation is subject to inherent uncertainties and our view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on our financial position, results of operations or cash flows for the period in which the unfavorable outcome occurs, and potentially in future periods. 6. Equity Award Plan Activities 2014 Equity Incentive Plan In April 2014, the board of directors and stockholders approved the 2014 Equity Incentive Plan (the “2014 Plan”), effective on the first day that our common stock was publicly traded. Our board of directors has terminated the 2004 and 2011 equity plans as to future grants. However, these plans will continue to govern the terms and conditions of the outstanding options previously granted thereunder. Awards granted under the 2014 Plan could be in the form of Incentive Stock Options (“ISOs”), Nonstatutory Stock Options (“NSOs”), Restricted Stock Awards (“RSAs”), Stock Appreciation Rights (“SARs”) or Restricted Stock Units (“RSUs”). The number of shares available for grant and issuance under the 2014 Plan increases automatically on January 1 of each year commencing with 2016 by the number of shares equal to 3% of our shares outstanding on the immediately preceding December 31, but not to exceed 12,500,000 shares, unless the board of directors, in its discretion, determines to make a smaller increase. As of December 31, 2016, there remained approximately 11.8 million shares available for issuance under the 2014 Plan. On February 6, 2017, our board of directors authorized an increase to the shares available for issuance under the plan of 3% of the total shares outstanding on December 31, 2016 effective January 1, 2017. The increase amounted to 2,124,333 shares. 2014 Employee Stock Purchase Plan In April 2014, the board of directors and stockholders approved the 2014 Employee Stock Purchase Plan (the “ESPP”). The ESPP became effective on the first day that our common stock was publicly traded. The number of shares reserved for issuance under the ESPP increases automatically on January 1 of each year by the number of shares equal to 1% of our shares outstanding immediately preceding December 31, but not to exceed 2,500,000 shares, unless the board of directors, in its discretion, determines to make a smaller increase. Under our 2014 ESPP eligible employees are permitted to acquire shares of our common stock at 85% of the lower of the fair market value of our common stock on the first trading day of each offering period or on the exercise date. Each offering period will be approximately two years starting on the first trading date after February 15 and August 15 of each year. Participants may purchase shares of common stock through payroll deductions up to 10% of their eligible compensation, subject to Internal Revenue Service mandated purchase limits. As of December 31, 2016, there remained 1,483,846 shares available for issuance under the ESPP. On February 6, 2017, our board of directors authorized an increase to shares available for issuance under the plan of 1% of the total shares outstanding on December 31, 2016 effective January 1, 2017. The increase amounted to 708,111 shares. Stock Option Activities The following table summarizes the option activity under our stock plans and related information (in thousands, except years and per share amounts): _________________ The weighted-average grant-date fair value of options granted during the year ended December 31, 2016 and 2015 was $23.66 and $29.20 per share, respectively. The aggregate intrinsic value of options exercised during the year ended December 31, 2016 was $147.6 million. Restricted Stock Unit (RSU) Activities A summary of the activity under our 2014 Plan and changes during the reporting period and a summary of information related to RSUs are presented below (in thousands, except years and per share amounts): Employee Stock Purchase Plan Activities During the year ended December 31, 2016, we issued 256,223 shares at an average purchase price of $40.30 under our ESPP. Shares available for future issuance under our ESPP, subsequent to the increase authorized by our board of directors, are approximately 2.2 million. Shares Available for Grant The following table presents the stock activity and the total number of shares available for grant as of December 31, 2016 (in thousands): Early Exercise of Stock Options We have historically allowed our employees and directors to exercise options prior to vesting. Upon an "early exercise" of these options, the unvested shares acquired through the exercise become options subject to our repurchase right that lapse in accordance with the original option vesting schedule. Upon termination of employment prior to our repurchase rights lapsing in full, we have a right to repurchase the unvested shares at the original purchase price. The proceeds received from the early exercise of stock options and are initially recorded in other liabilities and are reclassified to common stock and paid-in capital as our repurchase right lapse. For the year ended December 31, 2016, we repurchased 5,364 shares of common stock at the original exercise price due to the termination of the holders of the unvested shares. As of December 31, 2016, early exercised shares subject to repurchase were 0.3 million, with an aggregate value of $1.3 million. Stock-Based Compensation Expense Total stock-based compensation expense related to options, RSAs, ESPP and RSUs granted were charged to the department to which the associated employee reported as follow (in thousands): Determination of Fair Value We record stock-based compensation awards based on fair value as of the grant date. For option awards and ESPP offerings we use the Black-Scholes-Merton option-pricing model to determine fair value. We recognize such costs as compensation expense generally on a straight-line basis over the requisite service period of the award. Stock Options For the years ended December 31, 2016, 2015 and 2014 the fair value of each stock option granted under our plans was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions and fair value per share: As of December 31, 2016, the total unrecognized stock-based compensation expense for unvested stock options, net of expected forfeitures, was $87.4 million, which is expected to be recognized over a weighted-average period of 3.7 years. The total fair value of options vested for the year ended December 31, 2016 was $28.6 million. As of December 31, 2016, there was $87.6 million of unrecognized stock-based compensation expense related to unvested RSUs, net of estimated forfeitures. This amount is expected to be recognized over a weighted-average period of 3.4 years. ESPP The following table summarizes the assumptions relating to our ESPP: As of December 31, 2016, the total unrecognized stock-based compensation expense related to unvested ESPP options, net of expected forfeitures, was $4.2 million, which is expected to be recognized over a weighted-average period of 1.5 years. 7. Net Income Per Share Available to Common Stock The following table sets forth the computation of our basic and diluted net income per share available to common stock (in thousands, except per share amounts): The following outstanding shares of common stock equivalents were excluded from the computation of diluted net income per share available to common stockholders for the periods presented because including them would have been anti-dilutive (in thousands): 8. Income Taxes The geographical breakdown of income before provision for income taxes is as follows (in thousands): The components of the provision for income taxes are as follows (in thousands): The reconciliation of the statutory federal income tax and our effective income tax is as follows: We have operations and a taxable presence in numerous jurisdictions outside the U.S. All of these countries except one jurisdiction have a lower tax rate than the U.S. The significant jurisdictions in which we have a presence include Cayman Islands, Ireland, and the United Kingdom. The tax effects of temporary differences that give rise to significant portions of deferred tax assets (liabilities) are as follows (in thousands): The following table presents the breakdown between non-current deferred tax assets and liabilities (in thousands): Recognition of deferred tax assets is appropriate when realization of these assets is more likely than not. We believe that all of the deferred tax assets were realizable with the exception of California and Canada deferred tax assets. Therefore, a valuation allowance of $16.9 million and $12.7 million was recorded as of December 31, 2016 and 2015, respectively, against the California and Canadian deferred tax assets as it was not more likely than not that these assets will be recognized. The net valuation allowance increased by $4.2 million and $3.7 million as of December 31, 2016 and 2015, respectively. As of December 31, 2016, we had no net operating loss carryforwards for federal and state income tax purposes. For foreign jurisdictions, we had combined foreign net operating loss carryforwards of $17.2 million which do not expire. As of December 31, 2016, we had no U.S. federal credit carryforwards and state credit carryforwards of $39.2 million, which can be carried over indefinitely. For foreign jurisdictions, we had $1.1 million of Canadian scientific research and experimental development tax credit carry-forwards, which begin to expire in 2034. Utilization of the net operating losses and tax credit carryforwards may be subject to limitations due to ownership changes limitations provided in the Internal Revenue code and similar state or foreign provisions. In all years up to December 31, 2016, such limitations had no impact to our deferred tax assets. Our policy with respect to our undistributed foreign subsidiaries earnings is to consider those earnings to be indefinitely reinvested and, accordingly, no related provision for U.S. federal and state income taxes has been provided. Upon distribution of those earnings’ in the form of dividends or otherwise, we may be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes in the various countries. As of December 31, 2016, 2015 and 2014, the undistributed earnings approximated $36.4 million, $16.4 million and $4.9 million, respectively. The determination of the future tax consequences of the remittance of these earnings is not practicable. Uncertain Tax Positions We recognize uncertain tax positions only to the extent that management believes that it is more likely than not the position will be sustained. The reconciliation of the beginning and ending amount of gross unrecognized tax benefits as of December 31, 2016, 2015 and 2014 was as follows (in thousands): As of December 31, 2016, 2015 and 2014 the total amount of gross unrecognized tax benefits was $26.9 million, $22.2 million and $21.3 million of which $13.9 million, $13.0 million and $15.8 million would affect our effective tax rate if recognized, respectively. Our policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. We have recorded a net benefit for interest and penalties of $0.5 million and net expense of $0.4 million in the years ended December 31, 2016 and 2015, respectively. As of December 31, 2016 and 2015, we recognized a liability for interest and penalties of $0.6 million and $1.1 million, respectively. We have been selected for examination by the Internal Revenue Service ("IRS") for our 2013 and 2014 tax years. It is difficult to determine when the examinations will be settled or their final outcomes in the foreseeable future. We believe that we have adequately provided reserves for any reasonably foreseeable adjustment to our tax returns. The statute of limitations for Federal remains open for 2013 and forward. Because of the net operating loss and tax credit carryforwards, all tax years remain open to state tax examination. The majority of our foreign tax returns are open to audit under the statute of limitations of the respective foreign countries, in which the subsidiaries are located. It is possible that the amount of existing unrecognized tax benefits may decrease within the next 12 months as a result of statute of limitation lapses in some of the jurisdictions, however, an estimate of the range cannot be made. 9. Segment Information We have determined that we operate as one reportable segment. The following table represents revenue based on the customer’s location, as determined by the customer’s shipping address (in thousands): Long lived assets, excluding intercompany receivables, investments in subsidiaries, privately held equity investments and deferred tax assets, net by location are summarized as follows (in thousands): 10. Related Party Transactions and Balances Certain members of our board of directors serve on the boards of our customers and one of our vendors. During the years ended December 31, 2016, 2015 and 2014, we recognized revenue of $76.1 million, $39.4 million and $29.6 million, respectively, from sales transactions with these related party customers. Amounts due from these related party customers were $8.7 million and $9.8 million as of December 31, 2016 and 2015, respectively. The amount incurred related to transactions with a related party vendor was $2.1 million and $2.7 million during the year ended December 31, 2016 and 2015. There were no transactions with this related party vendor during the year ended December 31, 2014. 11. Selected Quarterly Financial Information (Unaudited) The following tables set forth selected unaudited quarterly consolidated statements of income data for each of the quarters in the years ended December 31, 2016 and 2015: | Here's a summary of the financial statement:
Key Components:
1. Revenue
- Based on net revenue during the period and net accounts receivable
- Includes customer revenue percentages of total revenue
- Comprehensive income consists of net income and other comprehensive income
- Includes unrealized gains/losses on investments and foreign currency adjustments
2. Cash & Cash Equivalents
- Includes highly liquid investments with maturity of 3 months or less
- Consists of cash deposits and money market funds
- Includes restricted cash for facility lease collateral
3. Assets
- Marketable securities carried at fair value
- Accounts receivable recorded at invoiced amount minus allowances
- Uses fair value hierarchy (Level I, II, and III) for measurement
- Fair value measurements apply to cash equivalents, marketable securities, accounts receivable, and other assets
4. Liabilities
- Includes accounts payable and accrued liabilities
- Measured at fair value
- Short-term liabilities carried at book value, approximating fair value
5. Foreign Currency Considerations
- Foreign subsidiaries use either USD or local currency as functional currency
- Includes transaction re-measurement for foreign currency denominated assets and liabilities
Notable Features:
- Uses historical trends for estimating allowances and reserves
- Implements specific identification method for realized gains/losses
- Maintains three-tier fair value hierarchy for measurement
- Includes provisions for doubtful accounts and sales returns | Claude |
Audited Consolidated Financial Statements as of July 2, 2016 and June 27, 2015 and for the fiscal years ended July 2, 2016, June 27, 2015 and June 28, 2014 ACCOUNTING FIRM To the Board of Directors and Stockholders of Performance Food Group Company 12500 West Creek Parkway Richmond, VA 23238 We have audited the accompanying consolidated balance sheets of Performance Food Group Company and subsidiaries (the “Company”) as of July 2, 2016 and June 27, 2015, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the periods ended July 2, 2016, June 27, 2015 and June 28, 2014. Our audits also included the financial statement schedule listed in the Index at These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Performance Food Group Company and subsidiaries as of July 2, 2016 and June 27, 2015, and the results of their operations and their cash flows for each of the three years in the periods ended July 2, 2016, June 27, 2015 and June 28, 2014, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ DELOITTE & TOUCHE LLP Richmond, Virginia August 30, 2016 PERFORMANCE FOOD GROUP COMPANY CONSOLIDATED BALANCE SHEETS See accompanying notes to consolidated financial statements, which are an integral part of these audited consolidated financial statements. PERFORMANCE FOOD GROUP COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS See accompanying notes to consolidated financial statements, which are an integral part of these audited consolidated financial statements. PERFORMANCE FOOD GROUP COMPANY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME See accompanying notes to consolidated financial statements, which are an integral part of these audited consolidated financial statements. PERFORMANCE FOOD GROUP COMPANY CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY See accompanying notes to consolidated financial statements, which are an integral part of these audited consolidated financial statements. PERFORMANCE FOOD GROUP COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS See accompanying notes to consolidated financial statements, which are an integral part of these audited consolidated financial statements. Supplemental disclosures of non-cash transactions are as follows: Supplemental disclosures of cash flow information are as follows: PERFORMANCE FOOD GROUP COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Business Activities Business Overview Performance Food Group Company, through its subsidiaries, markets and distributes national and company-branded food and food-related products to customer locations across the United States. The Company serves both of the major customer types in the restaurant industry: (i) independent, or “Street” customers, and (ii) multi-unit, or “Chain” customers, which include regional and national family and casual dining restaurants chains, fast casual chains, and quick-service restaurants. The Company also serves schools, healthcare facilities, business and industry locations, and other institutional customers. Fiscal Years The Company’s fiscal year ends on the Saturday nearest to June 30th. This resulted in a 53-week year for fiscal 2016 and a 52-week year for fiscal 2015 and fiscal 2014. References to “fiscal 2016” are to the 53-week period ended July 2, 2016, references to “fiscal 2015” are to the 52-week period ended June 27, 2015, and references to “fiscal 2014” are to the 52-week period ended June 28, 2014. Reverse Stock Split On August 28, 2015, the Company effected a 0.485 for one reverse stock split of its Class A and Class B common stock and a reclassification of its Class A common stock and its Class B common stock into a single class. The Company retained the par value of $0.01 per share for all shares of common stock. All references to numbers of common shares and per-share data in the accompanying financial statements have been adjusted to reflect the reverse stock split on a retroactive basis. Shareholders’ equity reflects the reverse stock split by reclassifying from Common stock to Additional paid-in capital an amount equal to the par value of the reduction in shares arising from the reverse stock split. Initial Public Offering On October 6, 2015, the Company completed a registered initial public offering (“IPO”) of 16,675,000 shares of common stock for a cash offering price of $19.00 per share ($17.955 per share net of underwriting discounts), including the exercise in full by underwriters of their option to purchase additional shares. The Company sold an aggregate of 12,777,325 shares of such common stock and certain selling stockholders sold 3,897,675 shares (including the shares sold pursuant to the underwriters’ option to purchase additional shares). The Company’s common stock is listed on the New York Stock Exchange under the ticker symbol “PFGC.” The aggregate offering price of the amount of newly issued common stock sold was $242.8 million. In connection with the offering, the Company paid the underwriters a discount of $1.045 per share, for a total underwriting discount of $13.4 million. In addition, the Company incurred direct offering expenses consisting of legal, accounting, and printing costs of $5.8 million in connection with the IPO, of which $3.0 million was paid during fiscal 2016. The Company used the net offering proceeds to it, after deducting the underwriting discount and its direct offering expenses, to repay $223.0 million aggregate principal amount of indebtedness under the Term Facility (see Note 8, Debt). The Company used the remainder of the net proceeds for general corporate purposes. Secondary Offering On May 24, 2016, certain selling stockholders (the “Selling Stockholders”) of the Company sold 12,000,000 shares of the Company’s common stock at a public offering price of $24.25 per share in a secondary public offering (the “Offering”). The Selling Stockholders granted the underwriters of the Offering an option to purchase an additional 1,800,000 shares at a price of $23.3406 per share. The underwriters exercised their option in full and, on May 27, 2016, purchased an additional 1,800,000 shares from the Selling Stockholders. The Selling Stockholders received all of the net proceeds from the Offering and the sale of the additional 1,800,000 shares. No shares were sold by the Company. The Company incurred approximately $0.9 million of offering expenses in connection with the Secondary Offering during fiscal 2016. 2. Summary of Significant Accounting Policies and Estimates Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company balances and transactions have been eliminated. Use of Estimates The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. The most significant estimates used by management are related to the accounting for the allowance for doubtful accounts, reserve for inventories, impairment testing of goodwill and other intangible assets, acquisition accounting, reserves for claims and recoveries under insurance programs, vendor rebates and other promotional incentives, bonus accruals, depreciation, amortization, determination of useful lives of tangible and intangible assets, and income taxes. Actual results could differ from these estimates. Cash The Company maintains its cash primarily in institutions insured by the Federal Deposit Insurance Corporation (“FDIC”). At times, the Company’s cash balance may be in amounts that exceed the FDIC insurance limits. Restricted Cash The Company is required by its insurers to collateralize a part of the deductibles for its workers’ compensation and liability claims. The Company has chosen to satisfy these collateral requirements by depositing funds in trusts or by issuing letters of credit. All amounts in restricted cash at July 2, 2016 and June 27, 2015 represent funds deposited in insurance trusts, and $10.2 million and $10.2 million, respectively, represent Level 1 fair value measurements. Accounts Receivable Accounts receivable are primarily comprised of trade receivables from customers in the ordinary course of business, are recorded at the invoiced amount, and primarily do not bear interest. Accounts receivable also includes other receivables primarily related to various rebate and promotional incentives with the Company’s suppliers. Receivables are recorded net of the allowance for doubtful accounts on the accompanying consolidated balance sheets. The Company evaluates the collectability of its accounts receivable based on a combination of factors. The Company regularly analyzes its significant customer accounts, and when it becomes aware of a specific customer’s inability to meet its financial obligations to the Company, such as bankruptcy filings or deterioration in the customer’s operating results or financial position, the Company records a specific reserve for bad debt to reduce the related receivable to the amount it reasonably believes is collectible. The Company also records reserves for bad debt for other customers based on a variety of factors, including the length of time the receivables are past due, macroeconomic considerations, and historical experience. If circumstances related to specific customers change, the Company’s estimates of the recoverability of receivables could be further adjusted. As of July 2, 2016 and June 27, 2015, the allowance for doubtful accounts related to trade receivables was approximately $10.6 million and $11.0 million, respectively, and $5.6 million and $5.0 million, respectively related to other receivables. The Company recorded $7.5 million, $6.6 million, and $9.1 million in provision for doubtful accounts in fiscal 2016, fiscal 2015, and fiscal 2014, respectively. Inventories The Company’s inventories consist primarily of food and non-food products. The Company values inventories primarily at the lower of cost or market using the first-in, first-out (“FIFO”) method. At July 2, 2016, the Company’s inventory balance of $919.7 million consists primarily of finished goods, $849.3 million of which was valued at FIFO. As of July 2, 2016, $70.4 million of the inventory balance was valued at last-in, first-out (“LIFO”) using the link chain technique of the dollar value method. At July 2, 2016 and June 27, 2015, the LIFO balance sheet reserves were $4.0 million and $5.5 million, respectively. Costs in inventory include the purchase price of the product and freight charges to deliver the product to the Company’s warehouses and are net of certain consideration received from vendors in the amount of $20.7 million and $16.8 million as of July 2, 2016 and June 27, 2015, respectively. The Company adjusts its inventory balances for slow-moving, excess, and obsolete inventories. These adjustments are based upon inventory category, inventory age, specifically identified items, and overall economic conditions. As of July 2, 2016 and June 27, 2015, the Company had adjusted its inventories by approximately $6.4 million and $6.2 million, respectively. Property, Plant, and Equipment Property, plant, and equipment are stated at cost. Depreciation of property, plant and equipment, including capital lease assets, is calculated primarily using the straight-line method over the estimated useful lives of the assets, which range from two to 39 years, and is included primarily in operating expenses on the consolidated statement of operations. Certain internal and external costs related to the development of internal use software are capitalized within property, plant, and equipment during the application development stage. When assets are retired or otherwise disposed, the costs and related accumulated depreciation are removed from the accounts. The difference between the net book value of the asset and proceeds from disposition is recognized as a gain or loss. Routine maintenance and repairs are charged to expense as incurred, while costs of betterments and renewals are capitalized. Impairment of Long-Lived Assets Long-lived assets held and used by the Company, including intangible assets with definite lives, are tested for recoverability whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For purposes of evaluating the recoverability of long-lived assets, the Company compares the carrying value of the asset or asset group to the projected, undiscounted future cash flows expected to be generated by the long-lived asset or asset group. Based on the Company’s assessments, no impairment losses were recorded in fiscal 2016, fiscal 2015, or fiscal 2014. Acquisitions, Goodwill, and Other Intangible Assets The Company accounts for acquired businesses using the acquisition method of accounting. The Company’s financial statements reflect the operations of an acquired business starting from the completion of the acquisition. Goodwill and other intangible assets represent the excess of cost of an acquired entity over the amounts specifically assigned to those tangible net assets acquired in a business combination. Other identifiable intangible assets typically include customer relationships, trade names, technology, non-compete agreements, and favorable lease assets. Goodwill and intangibles with indefinite lives are not amortized. Intangibles with definite lives are amortized on a straight-line basis over their useful lives, which generally range from two to eleven years. Annually, or when certain triggering events occur, the Company assesses the useful lives of its intangibles with definite lives. Certain assumptions, estimates, and judgments are used in determining the fair value of net assets acquired, including goodwill and other intangible assets, as well as determining the allocation of goodwill to the reporting units. Accordingly, the Company may obtain the assistance of third-party valuation specialists for the valuation of significant tangible and intangible assets. The fair value estimates are based on available historical information and on future expectations and assumptions deemed reasonable by management but that are inherently uncertain. Significant estimates and assumptions inherent in the valuations reflect a consideration of other marketplace participants and include the amount and timing of future cash flows (including expected growth rates and profitability), economic barriers to entry, a brand’s relative market position, and the discount rate applied to the cash flows. Unanticipated market or macroeconomic events and circumstances may occur that could affect the accuracy or validity of the estimates and assumptions. The Company is required to test goodwill and other intangible assets with indefinite lives for impairment annually, or more often if circumstances indicate. Indicators of goodwill impairment include, but are not limited to, significant declines in the markets and industries that buy the Company’s products, changes in the estimated future cash flows of its reporting units, changes in capital markets, and changes in its market capitalization. For goodwill and indefinite-lived intangible assets, the Company’s policy is to assess impairment at the end of each fiscal year. The Company applies the guidance in FASB Accounting Standards Update (ASU) 2011-08 “Intangibles-Goodwill and Other-Testing Goodwill for Impairment,” which provides entities with an option to perform a qualitative assessment (commonly referred to as “step zero”) to determine whether further quantitative analysis for impairment of goodwill is necessary. In performing step zero for the Company’s goodwill impairment test, the Company is required to make assumptions and judgments including but not limited to the following: the evaluation of macroeconomic conditions as related to the Company’s business, industry and market trends, and the overall future financial performance of its reporting units and future opportunities in the markets in which they operate. If impairment indicators are present after performing step zero, the Company would perform a quantitative impairment analysis to estimate the fair value of goodwill. During fiscal 2016 and fiscal 2015, the Company performed the step zero analysis for its goodwill impairment test. As a result of the Company’s step zero analysis, no further quantitative impairment test was deemed necessary for fiscal 2016 or fiscal 2015. There were no impairments of goodwill or intangible assets with indefinite lives for fiscal 2016, fiscal 2015, or fiscal 2014. Insurance Program The Company maintains high-deductible insurance programs covering portions of general and vehicle liability and workers’ compensation. The amounts in excess of the deductibles are fully insured by third-party insurance carriers and subject to certain limitations and exclusions. The Company also maintains self-funded group medical insurance. The Company accrues its estimated liability for these deductibles, including an estimate for incurred but not reported claims, based on known claims and past claims history. The estimated short-term portion of these accruals is included in Accrued expenses on the Company’s consolidated balance sheets, while the estimated long-term portion of the accruals is included in Other long-term liabilities. The provisions for insurance claims include estimates of the frequency and timing of claims occurrence, as well as the ultimate amounts to be paid. These insurance programs are managed by a third party, and the deductibles for general and vehicle liability and workers compensation are collateralized by letters of credit and restricted cash. Other Comprehensive Income (Loss) Other comprehensive income (loss) is defined as all changes in equity during each period except for those resulting from net income (loss) and investments by or distributions to shareholders. Other comprehensive income (loss) consists primarily of gains or losses from derivative financial instruments that are designated in a hedging relationship. For derivative instruments that qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings during the same period or periods during which the hedged transaction affects earnings. Revenue Recognition The Company recognizes revenue from the sale of a product when it is considered realized or realizable and earned. The Company determines these requirements to be met when the product has been delivered to the customer, the price is fixed and determinable, and there is reasonable assurance of collection of the sales proceeds. The Company recognizes revenues net of applicable sales tax. Sales returns are recorded as reductions of sales. Revenue is accounted for in accordance with ASC 605-45, which addresses reporting revenue either on a gross basis as a principal or a net basis as an agent depending upon the nature of the sales transactions. The Company recognizes revenue on a gross basis when the Company determines the sale meets the conditions of ASC 605-45, “Reporting Revenue Gross as a Principal versus Net as an Agent.” The Company weighs the following factors in making its determination: • who is the primary obligor to provide the product or services desired by our customers; • who has discretion in supplier selection; • who has latitude in establishing price; • who retains credit risk; and • who bears inventory risk. When the Company determines that it does not meet the criteria for gross revenue recognition under ASC 605-45 on the basis of these factors, the Company reports the revenue on a net basis. When there is a change to an agreement with a customer or vendor, pursuant to the Company’s revenue recognition policy, the Company reevaluates the reporting of the revenue based on the factors outlined above to determine if there has been a change in the Company’s relationship in acting as the principal or an agent. Cost of Goods Sold Cost of goods sold includes amounts paid to manufacturers for products sold, the cost of transportation necessary to bring the products to the Company’s facilities, plus depreciation related to processing facilities and equipment. Operating Expenses Operating expenses include warehouse, delivery, occupancy, insurance, depreciation, amortization, salaries and wages, and employee benefits expenses. Other, net Other, net primarily includes the change in fair value gain or loss and cash settlements pertaining to our derivatives on forecasted diesel fuel purchases along with other non-operating income or expense items. For fiscal 2015, this also includes the $25.0 million termination fee in connection with the termination of the Sysco and US Foods merger discussed below. On December 8, 2013, Sysco Corporation (“Sysco”) and US Foods, Inc. (“US Foods”), announced that they had entered into an agreement and plan of merger. On February 2, 2015, the Company reached an agreement to purchase 11 US Foods facilities relating to the proposed merger. On February 19, 2015, the Federal Trade Commission filed suit seeking an injunction to prevent the proposed merger and, on June 23, 2015, the United States District Court for the District of Columbia granted the injunction. In June 2015, the proposed merger was terminated. As a result, the Company’s agreement to purchase the facilities was also terminated and the Company received a termination fee of $25 million. Other, net consisted of the following: Vendor Rebates and Other Promotional Incentives The Company participates in various rebate and promotional incentives with its suppliers, primarily including volume and growth rebates, annual and multi-year incentives, and promotional programs. Consideration received under these incentives is generally recorded as a reduction of cost of goods sold. However, as described below, in certain limited circumstances the consideration is recorded as a reduction of operating expenses incurred by the Company. Consideration received may be in the form of cash and/or invoice deductions. Changes in the estimated amount of incentives to be received are treated as changes in estimates and are recognized in the period of change. Consideration received for incentives that contain volume and growth rebates and annual and multi-year incentives are recorded as a reduction of cost of goods sold. The Company systematically and rationally allocates the consideration for these incentives to each of the underlying transactions that results in progress by the Company toward earning the incentives. If the incentives are not probable and reasonably estimable, the Company records the incentives as the underlying objectives or milestones are achieved. The Company records annual and multi-year incentives when earned, generally over the agreement period. The Company uses current and historical purchasing data, forecasted purchasing volumes, and other factors in estimating whether the underlying objectives or milestones will be achieved. Consideration received to promote and sell the supplier’s products is typically a reimbursement of marketing costs incurred by the Company and is recorded as a reduction of the Company’s operating expenses. If the amount of consideration received from the suppliers exceeds the Company’s marketing costs, any excess is recorded as a reduction of cost of goods sold. The Company follows the requirements of FASB ASC 605-50-25-10, Revenue Recognition-Customer Payments and Incentives-Recognition-Customer’s Accounting for Certain Consideration Received from a Vendor and ASC 605-50-45-16, Revenue Recognition-Customer Payments and Incentives-Other Presentation Matters-Reseller’s Characterization of Sales Incentives Offered to Customers by Manufacturers. Shipping and Handling Fees and Costs Shipping and handling fees billed to customers are included in net sales. Estimated shipping and handling costs incurred by the Company of $752.0 million, $718.8 million, and $682.4 million are recorded in operating expenses in the consolidated statement of operations for fiscal 2016, fiscal 2015, and fiscal 2014, respectively. Stock-Based Compensation The Company participates in the Performance Food Group Company 2007 Management Option Plan (the “2007 Option Plan”) and the Performance Food Group Company 2015 Omnibus Incentive Plan (the “2015 Incentive Plan”) and follows the fair value recognition provisions of FASB ASC 718-10-25, Compensation-Stock Compensation-Overall-Recognition. This guidance requires that all stock-based compensation be recognized as an expense in the financial statements. The Company recognizes expense for its stock-based compensation based on the fair value of the awards that are granted. The Company estimates the fair value of service-based options using a Black-Scholes option pricing model. The fair values of service-based restricted stock, restricted stock with performance conditions and restricted stock units are based on the Company’s stock price on the date of grant. The Company estimates the fair value of options and restricted stock with market conditions using a Monte Carlo simulation. Compensation cost is recognized ratably over the requisite service period for the awards expected to vest. For those options and restricted stock that have a performance condition, compensation expense is based upon the number of option or shares, as applicable, expected to vest after assessing the probability that the performance criteria will be met. Income Taxes The Company follows FASB ASC 740-10, Income Taxes-Overall, which requires the use of the asset and liability method of accounting for deferred income taxes. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Future tax benefits, including net operating loss carry-forwards, are recognized to the extent that realization of such benefits is more likely than not. Uncertain tax positions are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law, and closings of statutes of limitations. Such adjustments are reflected in the tax provision as appropriate. Derivative Instruments and Hedging Activities As required by FASB ASC 815-20, Derivatives and Hedging-Hedging-General, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. The Company primarily uses derivative contracts to manage the exposure to variability in expected future cash flows. A portion of these derivatives is designated and qualify as cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting under FASB ASC 815-20. In the event that the Company does not apply the provisions of hedge accounting, the derivative instruments are recorded as an asset or liability on the consolidated balance sheets at fair value, and any changes in fair value are recorded as unrealized gains or losses and included in Other expense in the accompanying consolidated statement of operations. See Note 9 Derivatives and Hedging Activities for additional information on the Company’s use of derivative instruments. The Company discloses derivative instruments and hedging activities in accordance with FASB ASC 815-10-50, Derivatives and Hedging-Overall-Disclosure. FASB ASC 815-10-50 sets forth the disclosure requirements with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB ASC 815-20, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. FASB ASC 815-10-50 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments. Fair Value Measurements Fair value is defined as an exit price, representing the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The accounting guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The three levels of the fair value hierarchy are as follows: • Level 1-Observable inputs such as quoted prices for identical assets or liabilities in active markets; • Level 2-Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly for substantially the full term of the asset or liability; and • Level 3-Unobservable inputs in which there are little or no market data, which include management’s own assumption about the risk assumptions market participants would use in pricing an asset or liability. The Company’s derivative instruments are carried at fair value and are evaluated in accordance with this hierarchy. Contingent Liabilities The Company records a liability related to contingencies when a loss is considered to be probable and a reasonable estimate of the loss can be made. This estimate would include legal fees, if applicable. 3. Recently Issued Accounting Pronouncements Recently Adopted Accounting Pronouncements In April 2015, the FASB issued Accounting Standards Update (ASU) 2015-03, Simplifying the Presentation of Debt Issuance Costs. This update requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. For public entities, this Update is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. This update is to be applied on a retrospective basis and represents a change in accounting principle. The Company elected to early adopt ASU 2015-03 during the fourth quarter of fiscal 2016 and applied the new guidance retrospectively to all prior periods presented in the financial statements. As a result of the adoption of ASU 2015-03, $19.9 million of net deferred financing costs at June 27, 2015 was reclassified from Other intangible assets, net to Long-term debt in our Consolidated Balance Sheets. See Note 5-Goodwill and Other Intangible Assets and Note 8-Debt for additional information. The adoption had no impact on our consolidated statements of operations. In August 2015, the FASB issued ASU 2015-15, Interest-Imputation of Interest. This Update clarifies the guidance set forth in FASB ASU 2015-03, which required that debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the debt liability rather than as an asset. This Update clarifies that debt issuance costs related to line-of-credit arrangements could continue to be presented as an asset and be subsequently amortized over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the arrangement. For public entities, this Update is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The Company elected to early adopt ASU 2015-15 during the fourth quarter of fiscal 2016 and continues to present deferred financing costs related to line-of-credit arrangements as an asset. The adoption had no impact on our financial statements. In September 2015, the FASB issued ASU 2015-16, Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments. This Update requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, including the cumulative effect of the change in provisional amount as if the accounting had been completed at the acquisition date. This Update requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. For public entities, this Update is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. This Update is to be applied prospectively to adjustments to provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not yet been made available for issuance The Company elected to early adopt ASU 2015-16 during the fourth quarter of fiscal 2016. The adoption had no impact on our financial statements. In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This Update requires a company to classify deferred tax liabilities and assets as noncurrent in a classified statement of financial position. For public entities, this Update is effective for financial statements issued for annual periods beginning after December 15, 2016 and for interim periods within those annual periods. The Company elected to early adopt ASU 2015-17 during the fourth quarter of fiscal 2016 and applied the new guidance retrospectively to all prior periods presented in the financial statements. As a result of the adoption of ASU 2015-017, $17.5 million at June 27, 2015 was reclassified from current Deferred income tax asset, net to noncurrent Deferred income tax liability, net in our Consolidated Balance Sheets. The adoption had no impact on our consolidated statements of operations. In March 2016, the FASB issued ASU 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. The amendments in this Update clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. An entity has an option to apply the amendments in this Update on either a prospective basis or a modified retrospective basis. The Company elected to early adopt ASU 2016-06 during the fourth quarter of fiscal 2016 on a prospective basis. The adoption had no impact on our financial statements. In March 2016, the FASB issued ASU 2016-06, Derivatives and Hedging (Topic 815):Contingent Put and Call Options in Debt Instruments. The amendments in this Update clarify the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments in this Update is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence. The amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity should apply the amendments in this Update on a modified retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the amendments are effective. The Company elected to early adopt ASU 2016-06 during the fourth quarter of fiscal 2016. The adoption had no impact on our financial statements. Recently Issued Accounting Pronouncements Not Yet Adopted In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). This Update is a comprehensive new revenue recognition model that requires a company to recognize revenue that represents the transfer of promised goods or services to a customer in an amount that reflects the consideration it expects to receive in exchange for those goods or services. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which provides clarifying guidance on principle versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies the guidance pertaining to identifying performance obligations and the licensing implementation guidance. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow Scope Improvements and Practical Expedients, which provides narrow-scope improvements and practical expedient regarding collectability, presentation of sales tax collected from customers, noncash consideration, contract modifications at transition, completed contracts at transition and other technical corrections. Companies may use either a full retrospective or modified retrospective approach for adoption of Topic 606. Topic 606, as amended by ASU 2015-14, Revenue from Contracts with Customers-Deferral of the Effective Date, is effective for public entities for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company is in the process of evaluating the impact the new standard will have on its future financial statements, but does not believe the impact will be material. The Company plans to implement the new standard using the modified retrospective approach. In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. This Update requires an entity to measure most inventory at the lower of cost and net realizable value. When evidence exists that the net realizable value of inventory is lower than its cost, the difference shall be recognized as a loss in earnings in the period in which it occurs. This Update is effective for public companies prospectively for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company does not believe this Update will have a material impact on its future financial statements at the date of adoption. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The ASU is a comprehensive new lease accounting model that requires companies to recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. For public entities, the ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. Companies are required to recognize and measure leases at the beginning of the earliest period presented in its financial statements using a modified retrospective approach. The Company is in the process of evaluating the impact of this ASU on its future financial statements and believes that it will have a material impact on its future financial statements. In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The Update includes provisions intended to simplify several aspects of how share-based payments are accounted for and presented in the financial statements. Such provisions include recognizing income tax effects of awards in the income statement when the awards vest or are settled, allowing an employer to withhold shares in an amount up to the employee’s maximum individual tax rate without resulting in liability classification of the award, allowing entities to make a policy election to account for forfeitures as they occur, and changes to the classification of tax-related cash flows resulting from share-based payments and cash payments made to taxing authorities on the employee’s behalf on the statement of cash flows. The amendments to this Update are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted in any interim or annual period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Company plans to early adopt this ASU as of the beginning of fiscal 2017. The Company will make a policy election to account for forfeitures as they occur and estimates that the cumulative-effect adjustment to retained earnings as of the date of adoption will be approximately $1.0 million. 4. Business Combinations During fiscal year 2016, the Company paid cash of $39.0 million for two acquisitions which increased goodwill by $10.0 million. During fiscal 2015, the Company paid cash of $0.4 million for an acquisition and during fiscal 2014, the Company paid cash of $0.9 million for an acquisition. These acquisitions were immaterial to the consolidated financial statements. In the normal course of business, the Company may enter into a non-binding letter of intent or a purchase agreement for the acquisition on businesses. Financial statements will include the operations of these acquisitions from their respective closing dates. The Company does not anticipate that these acquisitions will have a material impact on our consolidated financial statements. Subsequent to July 2, 2016, the Company paid $14.4 million for an acquisition. This acquisition is immaterial to the consolidated financial statements. 5. Goodwill and Other Intangible Assets The Company recorded additions to goodwill in connection with its acquisitions. The following table presents the changes in the carrying amount of goodwill: The following table presents the Company’s intangible assets by major category as of July 2, 2016 and June 27, 2015: As discussed in Note 3-Recently Issued Accounting Pronouncements, the Company early adopted ASU 2015-03 during the fourth quarter of fiscal 2016. We applied the new guidance retrospectively to all prior periods presented in the financial statements to conform to the fiscal 2016 presentation. As a result, $19.9 million of net deferred financing costs related to the Term Facility was reclassified from Other intangible assets, net to Long-term debt in our Consolidated Balance Sheets at June 27, 2015. The amortization expense below excludes $4.5 million amortization expense for both fiscal 2015 and fiscal 2014 related to deferred financing costs reclassified to Long-term debt as a result of adopting ASU 2015-03. The remaining balance of deferred financing costs within Other intangible assets, net relates to the Company’s ABL Facility entered into in May 2008. For the intangible assets with definite lives, the Company recorded amortization expense of $42.3 million for fiscal 2016, $50.0 million for fiscal 2015, and $64.1 million for fiscal 2014. For the next five fiscal periods and thereafter, the estimated future amortization expense on intangible assets with definite lives are as follows: 6. Concentration of Sales and Credit Risk The Company had no customers that comprised more than 10% of consolidated net sales for fiscal 2016, fiscal 2015, and fiscal 2014. At July 2, 2016, the Company had no customers that comprised more than 10% of consolidated accounts receivable. At June 27, 2015, one of the Company’s customers accounted for a significant portion of the Company’s consolidated accounts receivable. At June 27, 2015, outstanding receivables from this customer represented approximately 10.8% of consolidated gross trade accounts receivable of $842.7 million. The Company maintains an allowance for doubtful accounts for which details are disclosed in the accounts receivable portion of Note 2, Summary of Significant Accounting Policies and Estimates-Accounts Receivable. Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company’s customer base includes a large number of individual restaurants, national and regional chain restaurants, and franchises and other institutional customers. The credit risk associated with accounts receivable is minimized by the Company’s large customer base and ongoing monitoring of customer creditworthiness. 7. Property, Plant, and Equipment Property, plant, and equipment as of July 2, 2016 and June 27, 2015 consisted of the following: (1) Leasehold improvements are depreciated over the shorter of the useful life of the asset or the lease term. Total depreciation expense for the fiscal 2016, fiscal 2015, and fiscal 2014 was $80.5 million, $76.3 million, and $73.5 million, respectively, and is included in operating expenses on the consolidated statement of operations. 8. Debt The Company is a holding company and conducts its operations through its subsidiaries, which have incurred or guaranteed indebtedness as described below. Debt consisted of the following: ABL Facility PFGC, Inc. (“PFGC”), a wholly-owned subsidiary of the Company, is a party to the Second Amended and Restated Credit Agreement (the “ABL Facility”) dated February 1, 2016. The ABL Facility is secured by the majority of the tangible assets of PFGC and its subsidiaries. Performance Food Group, Inc., a wholly-owned subsidiary of PFGC, is the lead borrower under the ABL Facility, which is jointly and severally guaranteed by PFGC and all material domestic direct and indirect wholly-owned subsidiaries of PFGC (other than captive insurance subsidiaries and other excluded subsidiaries). Availability for loans and letters of credit under the ABL Facility is governed by a borrowing base, determined by the application of specified advance rates against eligible assets, including trade accounts receivable, inventory, owned real properties, and owned transportation equipment. The borrowing base is reduced quarterly by a cumulative fraction of the real properties and transportation equipment values. Advances on accounts receivable and inventory are subject to change based on periodic commercial finance examinations and appraisals, and the real property and transportation equipment values included in the borrowing base are subject to change based on periodic appraisals. Audits and appraisals are conducted at the direction of the administrative agent for the benefit and on behalf of all lenders. On February 1, 2016, Performance Food Group, Inc. amended and restated the ABL Facility to increase the borrowing capacity from $1.4 billion to $1.6 billion, lower interest rates for LIBOR based loans, extend the maturity from May 2017 to February 2021, and modify triggers and provisions related to certain reporting, financial, and negative covenants. The total size of the facility immediately increased the effective borrowing capacity under the ABL Facility since borrowing base assets exceeded the facility size prior to the amendment. Approximately $6.8 million of fees and expenses have been incurred for the amendment, which were included as deferred financing costs within Other intangible assets, net and will be amortized over the remaining term of the ABL Facility. Of this amount, $6.6 million was paid during fiscal 2016. In connection with the closing of this amendment, Performance Food Group, Inc. borrowed $200.0 million under the ABL Facility and used the proceeds to repay $200.0 million aggregate principal amount of loans under the Term Facility. Borrowings under the ABL Facility bear interest, at Performance Food Group, Inc.’s option, at (a) the Base Rate (defined as the greater of (i) the Federal Funds Rate in effect on such date plus 0.5%, (ii) the Prime Rate on such day, or (iii) one month LIBOR plus 1.0%) plus a spread or (b) LIBOR plus a spread. The ABL Facility also provides for an unused commitment fee ranging from 0.25% to 0.375%. The following table summarizes outstanding borrowings, availability, and the average interest rate under the ABL Facility: The ABL Facility contains covenants requiring the maintenance of a minimum consolidated fixed charge coverage ratio if excess availability falls below the greater of (i) $130.0 million and (ii) 10% of the lesser of the borrowing base and the revolving credit facility amount for five consecutive business days. The ABL Facility also contains customary restrictive covenants that include, but are not limited to, restrictions on PFGC’s ability to incur additional indebtedness, pay dividends, create liens, make investments or specified payments, and dispose of assets. The ABL Facility provides for customary events of default, including payment defaults and cross-defaults on other material indebtedness. If an event of default occurs and is continuing, amounts due under such agreement may be accelerated and the rights and remedies of the lenders under such agreement available under the ABL Facility may be exercised, including rights with respect to the collateral securing the obligations under such agreement. Term Loan Facility Performance Food Group, Inc. entered into a Credit Agreement providing for a term loan facility (the “Term Facility”) on May 14, 2013. Performance Food Group, Inc. borrowed an aggregate principal amount of $750.0 million under the Term Facility that is jointly and severally guaranteed by PFGC and all domestic direct and indirect wholly-owned subsidiaries of PFGC (other than captive insurance subsidiaries and other excluded subsidiaries). Net proceeds to Performance Food Group, Inc. were $746.3 million. The proceeds from the Term Facility were used to redeem the Company’s then outstanding senior notes in full; to pay the fees, premiums, expenses, and other transaction costs incurred in connection with the Term Facility and a previous ABL Facility amendment; and to pay a $220 million dividend to the Company’s stockholders. A portion of the Term Facility was considered a modification of the senior notes. The Term Facility had a maturity in November 2019 and bore interest, at Performance Food Group, Inc.’s option, at a rate equal to a margin over either (a) a Base Rate determined by reference to the higher of (1) the rate of interest published by Credit Suisse (AG), Cayman Islands Branch, as its “prime lending rate,” (2) the federal funds rate plus 0.50%, and (3) one-month LIBOR rate plus 1.00% or (b) a LIBOR rate determined by reference to the service selected by Credit Suisse (AG), Cayman Islands Branch that has been nominated by the British Bankers’ Association (or any successor thereto). The applicable margin for loans under the Term Facility could be reduced subject to attaining a Total Net Leverage ratio below 4.25x. The LIBOR rate for term loans was subject to a 1.00% floor and the Base Rate for term loans was subject to a floor of 2.00%. Interest was payable quarterly in arrears in the case of Base Rate loans, and at the end of the applicable interest period (but no less frequently than quarterly) in the case of the LIBOR loans. Performance Food Group, Inc. could incur additional loans under the Term Facility with the aggregate amount of the incremental loans not exceeding the sum of (i) $140.0 million plus (ii) additional amounts so long as the Consolidated Secured Net Leverage Ratio (as defined in the credit agreement governing the Term Facility) did not exceed 5.90:1.00 and so long as the proceeds are not used to finance restricted payments that include any dividend or distribution payments. PFGC was required to repay an aggregate principal amount equal to 0.25% of the aggregate principal amount of $750 million on the last business day of each calendar quarter, beginning September 30, 2013, which amounted to $7.5 million in both fiscal 2016 and fiscal 2015 and $5.6 million in fiscal 2014. The Term Facility was prepayable at par. On October 6, 2015, the Company completed its IPO and used the net proceeds therefrom to repay $223.0 million aggregate principal amount of indebtedness under the Term Facility. On February 1, 2016, Performance Food Group, Inc. amended and restated the ABL Facility as described above. In connection with the closing of this amendment, Performance Food Group, Inc. borrowed $200.0 million under the ABL Facility and used the proceeds to repay $200.0 million aggregate principal amount of loans under the Term Facility. Fiscal 2016 includes $5.5 million of accelerated amortization of original issue discount and deferred financing costs because of the repayment of $223.0 million aggregate principal amount of indebtedness mentioned above. Additionally, the Company recognized a $5.8 million loss on extinguishment within interest expense during the third quarter of fiscal 2016, related to the write-off of unamortized original issue discount and deferred financing costs on the Term Facility, because of the repayment of $200.0 million aggregate principal amount of indebtedness mentioned above. On May 17, 2016, Performance Food Group, Inc. issued and sold $350.0 million aggregate principal amount of its 5.500% Senior Notes due 2024 (the “Notes”) described below and used a portion of the proceeds to repay in full the remaining outstanding $306.4 million aggregate principal amount of loans under the Term Facility and to terminate the Term Facility, bringing the total payment amount to $736.9 million for the fiscal 2016. A portion of this repayment was considered an extinguishment, resulting in a $3.6 million loss on extinguishment of debt within interest expense, which is comprised of $2.1 million of fees paid and $1.5 million related to the write-off of the pro-rata portion of the unamortized original issue discount and deferred financing costs related to the debt extinguishment. A significant portion of this redemption was considered a modification in accordance with FASB ASC 470-50, Debt-Modifications and Extinguishments, and as a result, $0.7 million of unamortized original issue discount for the Term Facility was deferred as original issue discount of the Notes and $5.7 million of unamortized deferred financing costs for the Term Facility was deferred as deferred financing costs of the Notes. Interest expense related to the amortization of deferred financing costs and original issue discount for the Term Facility was as follows: As discussed in Note 3-Recently Issued Accounting Pronouncements, the Company early adopted ASU 2015-03 for the fourth quarter of fiscal 2016. We applied the new guidance retrospectively to all prior periods presented in the financial statements to conform to the fiscal 2016 presentation. As a result, $19.9 million of net deferred financing costs related to the Term Facility was reclassified from Other intangible assets, net to Long-term debt in our Consolidated Balance Sheets at June 27, 2015. Senior Notes On May 17, 2016, Performance Food Group, Inc. issued and sold $350.0 million aggregate principal amount of its 5.500% Senior Notes due 2024, pursuant to an indenture dated as of May 17, 2016, that is jointly and severally guaranteed by PFGC and all domestic direct and indirect wholly-owned subsidiaries of PFGC (other than captive insurance subsidiaries and other excluded subsidiaries). The proceeds from the Notes were used to pay in full the remaining outstanding $306.4 million aggregate principal amount of loans under the Term Facility and to terminate the Term Facility; to temporarily repay a portion of the outstanding borrowings under the ABL Facility; and to pay the fees, expenses, and other transaction costs incurred in connection with the Notes. A portion of the Notes was considered a modification of the Term Facility. Approximately $7.2 million of fees and expenses have been incurred and paid in fiscal 2016 in connection with the Notes. Of the amount of fees incurred, $2.5 million was included as deferred financing costs and will be amortized over the remaining term of the Notes, $2.1 million was included in loss on extinguishment of debt within interest expense related to the portion of the Term Facility repayment deemed an extinguishment, and $2.6 million was recorded to Operating expenses for the portion of the Term Facility deemed a modification. The Notes were issued at 100.0% of their par value. The Notes mature on June 1, 2024 and bears interest at a rate of 5.5% per year, payable semi-annually in arrears. Performance Food Group Inc.’s obligations under the Notes are guaranteed on a senior unsecured basis by all of the Performance Food Group, Inc.’s existing and future material wholly-owned domestic restricted subsidiaries to the extent such subsidiaries guarantee indebtedness under the ABL Facility, and other capital markets debt securities or certain other indebtedness incurred under credit facilities for Performance Food Group Inc. The Notes are not guaranteed by Performance Food Group Company. Upon the occurrence of a change of control triggering event or upon the sale of certain assets in which Performance Food Group Inc. does not apply the proceeds as required, the holders of the Notes will have the right to require Performance Food Group Inc. to make an offer to repurchase each holder’s Notes at a price equal to 101% (in the case of a change of control triggering event) or 100% (in the case of an asset sale) of their principal amount, plus accrued and unpaid interest. Performance Food Group Inc. may redeem all or a part of the Notes at any time prior to June 1, 2019 at a redemption price equal to 100% of the principal amount of the Notes being redeemed plus a make-whole premium and accrued and unpaid interest, if any, to, but not including, the redemption date. In addition, beginning on June 1, 2019, Performance Food Group Inc. may redeem all or a part of the Notes at a redemption price equal to 102.750% of the principal amount redeemed. The redemption price decreases to 101.325% and 100.000% of the principal amount redeemed on June 1, 2020 and June 1, 2021, respectively. In addition, at any time prior to June 1, 2019, Performance Food Group Inc. may redeem up to 40% of the Notes from the proceeds of certain equity offerings at a redemption price equal to 105.500% of the principal amount thereof, plus accrued and unpaid interest. The indenture governing the Notes contains covenants limiting, among other things, PFGC and its restricted subsidiaries’ ability to incur or guarantee additional debt or issue disqualified stock or preferred stock; pay dividends and make other distributions on, or redeem or repurchase, capital stock; make certain investments; incur certain liens; enter into transactions with affiliates; consolidate, merge, sell or otherwise dispose of all or substantially all of its assets; create certain restrictions on the ability of PFGC’s restricted subsidiaries to make dividends or other payments to PFGC; designate restricted subsidiaries as unrestricted subsidiaries; and transfer or sell certain assets. These covenants are subject to a number of important exceptions and qualifications. The Notes also contain customary events of default, the occurrence of which could result in the principal of and accrued interest on the Notes to become or be declared due and payable. As of July 2, 2016, borrowings outstanding were $350.0 million with unamortized original issue discount of $0.7 million and unamortized deferred financing costs of $8.1 million. For fiscal 2016, interest expense included $0.1 million related to the amortization of original interest discount and deferred financing costs. The ABL Facility and the indenture governing the Notes contain customary restrictive covenants under which all of the net assets of PFGC and its subsidiaries were restricted from distribution to Performance Food Group Company, except for approximately $390.0 million of restricted payment capacity available under such debt agreements, as of July 2, 2016. Unsecured Subordinated Promissory Note In connection with an acquisition, Performance Food Group, Inc. issued a $6.0 million interest only, unsecured subordinated promissory note on December 21, 2012, bearing an interest rate of 3.5%. Interest is payable quarterly in arrears. The $6.0 million principal is due in a lump sum in December 2017. All amounts outstanding under this promissory note become immediately due and payable upon the occurrence of a change in control of the Company or PFGC, which includes the sale, lease, or transfer of all or substantially all of the assets of PFGC. This promissory note was initially recorded at its fair value of $4.2 million. The difference between the principal and the initial fair value of the promissory note is being amortized as additional interest expense on a straight-line basis over the life of the promissory note, which approximates the effective yield method. For fiscal 2016, 2015 and 2014, interest expense each year included $0.4 million related to this amortization. As of July 2, 2016, the carrying value of the promissory note was $5.4 million. Fiscal year maturities of long-term debt, excluding capital and finance lease obligations, are as follows: Capital and Finance Lease Obligations Performance Food Group, Inc. is a party to facility leases at two Performance Foodservice distribution facilities and several equipment leases that are accounted for as capital leases in accordance with FASB ASC 840-30, Leases-Capital Leases. The charge to income resulting from amortization of these leases is included with depreciation expense in the consolidated statement of operations. The gross and net book values of assets under capital leases on the balance sheet as of July 2, 2016 were $38.8 million and $24.6 million, respectively. The gross and net book values of assets under capital leases on the balance sheet as of June 27, 2015 were $43.5 million and $29.3 million, respectively. During fiscal 2016, some of the Company’s capital leases expired, resulting in a reduced number of assets subject to capital leases. Future minimum lease payments under non-cancelable capital lease obligations were as follows as of July 2, 2016: During the first quarter of fiscal 2015, Performance Food Group, Inc. sold and simultaneously leased back a Vistar distribution facility for a period of two years. As a result of continuing involvement with the property, this transaction did not meet the criteria to qualify as a sale-leaseback. In accordance with FASB ASC 840-40, Leases-Sale Leaseback Transactions, the building and related assets subject to the lease continue to be reflected on the Company’s balance sheet and depreciated over their remaining useful lives. The proceeds received from the sale of the building are recorded as financing lease obligations. At the end of the lease term, the net book value of the assets subject to the lease and the corresponding financing obligation will be reversed. As of July 2, 2016, the future minimum lease payments under non-cancelable finance lease obligations were less than $0.1 million for fiscal 2017. 9. Derivatives and Hedging Activities Risk Management Objective of Using Derivatives The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates and diesel fuel costs. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and payments related to the Company’s borrowings and diesel fuel purchases. The effective portion of changes in the fair value of derivatives that are both designated and qualify as cash flow hedges is recorded in other comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction occurs. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. Hedges of Interest Rate Risk The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. Since the Company has a substantial portion of its debt in variable-rate instruments, it accomplishes this objective with interest rate swaps. These swaps are designated as cash flow hedges and involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. All of the Company’s interest rate swaps were initially designated as cash flow hedges. During the third quarter of fiscal 2016, the Company changed its selected interest rate for the Term Facility from the LIBOR option to the Base Rate option as part of its plan to repay the debt. The forecasted transactions in the Company’s interest rate swap hedging relationships for the Term Facility were designated as the future interest payments at the LIBOR option rate. Given the change in the selected rate for the Term Facility, the Company determined that the forecasted LIBOR interest payments were no longer probable of occurring and dedesignated two of its interest rate swaps. These two interest rate swaps have since matured. As of July 2, 2016, Performance Food Group, Inc. had nine interest rate swaps with a combined $850 million notional amount. The following table summarizes the outstanding Swap Agreements as of July 2, 2016 (in millions): The tables below present the effect of the interest rate swaps designated in hedging relationships on the consolidated statement of operations for the fiscal years ended July 2, 2016, June 27, 2015 and June 28, 2014: As interest payments are made on the Company’s variable rate debt, amounts are reclassified from Accumulated other comprehensive loss to Interest expense. The Company recorded $0.5 million ineffectiveness on interest rate swaps during the fiscal year ended July 2, 2016. The Company recorded no ineffectiveness on interest rate swaps during the fiscal years ended June 27, 2015 and June 28, 2014. During the twelve months ending July 1, 2017, the Company estimates that an additional $5.0 million will be reclassified to interest expense. Hedges of Forecasted Diesel Fuel Purchases From time to time, Performance Food Group, Inc. enters into costless collar arrangements to manage its exposure to variability in cash flows expected to be paid for its forecasted purchases of diesel fuel. As of July 2, 2016, Performance Food Group, Inc. was a party to five such arrangements, with an aggregate 7.5 million gallon original notional amount, of which an aggregate 7.5 million gallon notional amount was remaining. The remaining 7.5 million gallon forecasted purchases of diesel fuel are expected to be made between July 1, 2016 and December 31, 2017. Subsequent to July 2, 2016, the Company entered into an additional costless collar arrangement with a 1.5 million gallon notional amount. The additional 1.5 million gallon forecasted purchases of diesel fuel are expected to be made between January 1, 2017 and June 30, 2017. The fuel collar instruments do not qualify for hedge accounting. Accordingly, the derivative instruments are recorded as an asset or liability on the balance sheet at fair value and any changes in fair value are recorded in the period of change as unrealized gains or losses on fuel hedging instruments and included in Other, net in the accompanying consolidated statement of operations. Refer to the Other, net accounting policy in Note 2. Summary of Significant Accounting Policies and Estimates for additional information. The Company does not currently have a payable or receivable related to cash collateral for its derivatives, and therefore it has not established an accounting policy for offsetting the fair value of its derivatives against such balances. The table below presents the fair value of the derivative financial instruments as well as their classification on the balance sheet as of July 2, 2016 and June 27, 2015: All of the Company’s derivative contracts are subject to a master netting arrangement with the respective counterparties that provide for the net settlement of all derivative contracts in the event of default or upon the occurrence of certain termination events. Upon exercise of termination rights by the non-defaulting party (i) all transactions are terminated, (ii) all transactions are valued and the positive value or “in the money” transactions are netted against the negative value or “out of the money” transactions, and (iii) the only remaining payment obligation is of one of the parties to pay the netted termination amount. The Company has elected to present the derivative assets and derivative liabilities on the balance sheet on a gross basis for periods ended July 2, 2016 and June 27, 2015. The tables below present the derivative assets and liability balance, before and after the effects of offsetting, as of July 2, 2016 and June 27, 2015: The derivative instruments are the only assets or liabilities that are recorded at fair value on a recurring basis. The fuel collars are exchange-traded commodities and their fair value is derived from valuation models based on certain assumptions regarding market conditions, some of which may be unobservable. Based on the lack of significance of these unobservable inputs, the Company has concluded that these instruments represent Level 2 on the fair value hierarchy. The fair values of the Company’s interest rate swap agreements are determined using a valuation model with several inputs and assumptions, some of which may be unobservable. A specific unobservable input used by the Company in determining the fair value of its interest rate swaps is an estimation of both the unsecured borrowing spread to LIBOR for the Company as well as that of the derivative counterparties. Based on the lack of significance of this estimated spread component to the overall value of the Company’s interest rate swaps, the Company has concluded that these swaps represent Level 2 on the hierarchy. There have been no transfers between levels in the hierarchy from June 27, 2015 to July 2, 2016. Credit-risk-related Contingent Features The Company has agreements with each of its derivative counterparties that provide that if the Company either defaults or is capable of being declared in default on any of its indebtedness, the Company can also be declared in default on its derivative obligations. As of July 2, 2016, and June 27, 2015, the aggregate fair value amount of derivative instruments that contain contingent features was $10.1 million and $8.9 million, respectively. As of July 2, 2016, the Company has not been required to post any collateral related to these agreements. If the Company breached any of these provisions, it would be required to settle its obligations under the agreements at their termination value of $10.1 million. 10. Insurance Program Liabilities The Company maintains high-deductible insurance programs covering portions of general and vehicle liability, workers’ compensation, and group medical insurance. The amounts in excess of the deductibles are fully insured by third-party insurance carriers, subject to certain limitations. A summary of the activity in all types of deductible liabilities appears below: 11. Fair Value of Financial Instruments The carrying values of cash, accounts receivable, outstanding checks in excess of deposits, trade accounts payable, and accrued expenses approximate their fair values because of the relatively short maturities of those instruments. The derivative assets and liabilities are recorded at fair value on the balance sheet. The fair value of long-term debt, which has a carrying value of $1,111.6 million and $1,385.3 million, is $1,127.9 million and $1,406.0 million at July 2, 2016 and June 27, 2015, respectively, and is determined by reviewing current market pricing related to comparable debt issued at the time of the balance sheet date, and is considered a Level 2 measurement. 12. Leases Subsidiaries of the Company lease various warehouse and office facilities and certain equipment under long-term operating lease agreements that expire at various dates. Rent expense for operating leases include any rent increases, rent holidays, or landlord concessions on a straight-line basis over the lease term. As of July 2, 2016, subsidiaries of the Company are obligated under non-cancelable operating lease agreements to make future minimum lease payments as follows: Rent expense for operating leases was $105.7 million for fiscal 2016, $97.0 million for fiscal 2015, and $91.1 million for fiscal 2014. A subsidiary of the Company has posted letters of credit as collateral supporting certain leases. These letters of credit are included in the total outstanding letters of credit under the ABL Facility as discussed in Note 8 Debt. Subsidiaries of the Company have residual value guarantees to its lessors under certain of its operating leases. These guarantees are discussed in Note 15 Commitments and Contingencies. These residual value guarantees are not included in the above table of future minimum lease payments. A subsidiary of the Company is a party to several capital leases. See Note 8 Debt for discussion of these leases. 13. Income Taxes Income tax expense for fiscal 2016, fiscal 2015, and fiscal 2014 consisted of the following: The Company’s effective income tax rate for continuing operations for fiscal 2016, fiscal 2015, and fiscal 2014 is 40.3%, 41.5%, and 48.7%, respectively. Actual income tax expense differs from the amount computed by applying the applicable U.S. federal corporate income tax rate of 35% to earnings before income taxes as follows: Deferred income taxes are recorded based upon the tax effects of differences between the financial statement and tax bases of assets and liabilities and available tax loss and credit carry-forwards. Temporary differences and carry-forwards that created significant deferred tax assets and liabilities were as follows: The state income tax credit carry-forwards expire in years 2022 through 2029. The state net operating loss carry-forwards expire in years 2016 through 2036. With the exception of an immaterial valuation allowance on certain state net operating loss carryforwards, the Company believes that it is more likely than not that all remaining deferred tax assets will be realized. The Company records a liability for Uncertain Tax Positions in accordance with FASB ASC 740-10-25, Income Taxes-General-Recognition. The following table summarizes the activity related to unrecognized tax benefits: Included in the balance as of July 2, 2016 and June 27, 2015, is $0.4 million ($0.3 million net of federal tax benefit) and $0.9 million ($0.6 million net of federal tax benefit), respectively, of unrecognized tax benefits that could affect the effective tax rate for continuing operations. The balance in unrecognized tax benefits relates primarily to state tax issues. As of July 2, 2016, substantially all federal, state and local, and foreign income tax matters have been concluded for years through 2012. It is reasonably possible that a decrease of $0.2 million in the balance of unrecognized tax benefits may occur within the next twelve months because of statute of limitations expirations, $0.1 million of which, if recognized, would affect the effective tax rate. It is the Company’s practice to recognize interest and penalties related to uncertain tax positions in income tax expense. Less than $0.1 million (less than $0.1 million net of federal tax benefit) was accrued for interest related to uncertain tax positions as of July 2, 2016 and June 27, 2015. Net interest expense of less than $0.1 million (less than $0.1 million net of federal benefit), less than $0.1 million (less than $0.1 million net of federal benefit), and income of $0.7 million ($0.4 million net of federal benefit) was recognized in tax expense for fiscal 2016, fiscal 2015, and fiscal 2014, respectively. 14. Retirement Plans Employee Savings Plans The Company sponsors the Performance Food Group Employee Savings Plan (the “PFG Savings Plan”). The PFG Savings Plan consists of two components: a defined contribution plan covering substantially all employees (the “401(k) Plan”) and a profit sharing plan. Under the latter, the Company can make a discretionary contribution in a given year, although there is no requirement to do so, and no such contribution was made in fiscal years 2016 or 2015. As of January 1, 2009, the 401(k) plan merged with the Self-Directed Tax Advantaged Retirement (STAR) Plan of PFGC, Inc. (the “STAR Plan”). Employees participating in the 401(k) Plan may elect to contribute between 1% and 50% of their qualified compensation, up to a maximum dollar amount as specified by the provisions of the Internal Revenue Code. The Company matched 100% of the first 3.5% of the employee contributions, resulting in matching contributions of $16.0 million for fiscal 2016, $14.2 million for fiscal 2015, and $13.2 million for fiscal 2014. Associates eligible for the annual STAR Plan contribution (an annual amount based on the employee’s salary and years of service) as of December 31, 2008 were grandfathered for that contribution under the merged PFG Savings Plan. STAR Plan contributions made by the Company were $4.2 million for fiscal 2016, $4.0 million for fiscal 2015, and $3.8 million for fiscal 2014. 15. Commitments and Contingencies Purchase Obligations The Company had outstanding contracts and purchase orders for capital projects and services totaling $31.4 million at July 2, 2016. Amounts due under these contracts were not included on the Company’s consolidated balance sheet as of July 2, 2016. Subsequent to July 2, 2016, the Company entered into additional contracts totaling $0.5 million. Withdrawn Multiemployer Pension Plans Until May 2013, Performance Food Group, Inc. participated in the Central States Southeast and Southwest Areas Pension Fund (“Central States Pension Fund”), a multiemployer pension plan administered by the Teamsters Union, pursuant to which Performance Food Group, Inc. was required to make contributions on behalf of certain union employees. The Central States Pension Fund is underfunded and is in critical status as determined by the Pension Benefit Guaranty Corporation. In connection with a renegotiation of the collective bargaining agreement that had previously required the Company’s participation in the Central States Pension Fund, the Company negotiated the termination of its participation in the Central States Pension Fund and the Company has withdrawn. The withdrawal liability was increased by $2.8 million during the second quarter of fiscal 2015 to the Company’s total estimated withdrawal liability of $6.9 million. The Company has made total payments for voluntary withdrawal of this plan in the amount of $1.1 million. As of July 2, 2016, the estimated outstanding withdrawal liability totaled $5.8 million. Guarantees Subsidiaries of the Company have entered into numerous operating leases, including leases of buildings, equipment, tractors, and trailers. Certain of the leases for tractors, trailers, and other vehicles and equipment, provide for residual value guarantees to the lessors. Circumstances that would require the subsidiary to perform under the guarantees include either (1) default on the leases with the leased assets being sold for less than the specified residual values in the lease agreements, or (2) decisions not to purchase the assets at the end of the lease terms combined with the sale of the assets, with sales proceeds less than the residual value of the leased assets specified in the lease agreements. Residual value guarantees under these operating lease agreements typically range between 5% and 25% of the value of the leased assets at inception of the lease. These leases have original terms ranging from 5 to 7 years and expiration dates ranging from 2016 to 2023. As of July 2, 2016, the undiscounted maximum amount of potential future payments for lease guarantees totaled approximately $21.0 million, which would be mitigated by the fair value of the leased assets at lease expiration. The assessment as to whether it is probable that subsidiaries of the Company will be required to make payments under the terms of the guarantees is based upon their actual and expected loss experience. Consistent with the requirements of FASB ASC 460-10-50, Guarantees-Overall-Disclosure, the Company has recorded $0.2 million of the potential future guarantee payments on its consolidated balance sheet as of July 2, 2016. The Company participates in a purchasing alliance that was formed to obtain better pricing, to expand product options, to reduce internal costs, and to achieve greater inventory turnover. The Company has entered into several agreements to guarantee a portion of the trade payables for such purchasing alliance to their various suppliers as an inducement for these suppliers to extend additional trade credit to the purchasing alliance. In the event of default by the purchasing alliance of their respective trade payables obligations, these suppliers may proceed directly against the Company to collect their trade payables. The terms of these guarantees have expiration dates throughout 2016. As of July 2, 2016, the undiscounted maximum amount of potential payments covered by these guarantees totaled $15.6 million. The Company believes that the likelihood of payment under these guarantees is remote and that any fair value attributable to these guarantees is immaterial; therefore, no liability has been recorded for these obligations in the Company’s consolidated balance sheets. In addition, the Company from time to time enters into certain types of contracts that contingently require it to indemnify various parties against claims from third parties. These contracts primarily relate to: (i) certain real estate leases under which subsidiaries of the Company may be required to indemnify property owners for environmental and other liabilities and other claims arising from their use of the applicable premises; (ii) certain agreements with the Company’s officers, directors, and employees under which the Company may be required to indemnify such persons for liabilities arising out of their employment relationship; and (iii) customer agreements under which the Company may be required to indemnify customers for certain claims brought against them with respect to the supplied products. Generally, a maximum obligation under these contracts is not explicitly stated. Because the obligated amounts associated with these types of agreements are not explicitly stated, the overall maximum amount of the obligation cannot be reasonably estimated. Historically, the Company has not been required to make payments under these obligations and, therefore, no liabilities have been recorded for these obligations in the Company’s consolidated balance sheets. Litigation We are a party to various claims, lawsuits and other legal proceedings arising out of the ordinary course and conduct of our business. We have insurance policies covering certain potential losses where such coverage is cost effective. As discussed below, we have accrued $1.4 million of anticipated settlement costs with respect to one pending lawsuit. For matters not specifically discussed below, although the outcomes of the claims, lawsuits and other legal proceedings to which we are a party are not determinable at this time, in our opinion, any additional liability that we might incur upon the resolution of the claims and lawsuits beyond the amounts already accrued is not expected, individually or in the aggregate, to have a material adverse effect on our consolidated financial condition, results of operations, or cash flows. U.S. Equal Employment Opportunity Commission Lawsuit. In March 2009, the Baltimore Equal Employment Opportunity Commission, or the “EEOC,” Field Office served us with company-wide (excluding, however, our Vistar and Roma Foodservice operations) subpoenas relating to alleged violations of the Equal Pay Act and Title VII of the Civil Rights Act, seeking certain information from January 1, 2004 to a specified date in the first fiscal quarter of 2009. In August 2009, the EEOC moved to enforce the subpoenas in federal court in Maryland, and we opposed the motion. In February 2010, the court ruled that the subpoena related to the Equal Pay Act investigation was enforceable company-wide but on a narrower scope of data than the original subpoena sought (the court ruled that the subpoena was applicable to the transportation, logistics, and warehouse functions of our broadline distribution centers only and not to our PFG Customized distribution centers). We cooperated with the EEOC on the production of information. In September 2011, the EEOC notified us that the EEOC was terminating the investigation into alleged violations of the Equal Pay Act. In determinations issued in September 2012 by the EEOC with respect to the charges on which the EEOC had based its company-wide investigation, the EEOC concluded that we engaged in a pattern of denying hiring and promotion to a class of female applicants and employees into certain positions within the transportation, logistics, and warehouse functions within our broadline division. In June 2013, the EEOC filed suit in federal court in Baltimore against us. The litigation concerns two issues: (1) whether we unlawfully engaged in an ongoing pattern and practice of failing to hire female applicants into operations positions; and (2) whether we unlawfully failed to promote one of the three individuals who filed charges with the EEOC because of her being female. The EEOC seeks the following relief in the lawsuit: (1) to permanently enjoin us from denying employment to female applicants because of their sex and denying promotions to female employees because of their sex; (2) a court order mandating that we institute and carry out policies, procedures, practices and programs which provide equal employment opportunities for females; (3) back pay with prejudgment interest and compensatory damages for a former female employee and an alleged class of aggrieved female applicants; (4) punitive damages; and (5) costs. The parties are engaged in discovery. We intend to vigorously defend ourselves. An estimate of potential loss, if any, cannot be determined at this time. Laumea v. Performance Food Group, Inc. In May 2014, a former employee of our Roma of Southern California distribution center filed a putative class action lawsuit in the San Bernardino County, California Superior Court against us. We removed the case to the United States District Court for the Central District of California. In September 2014, the plaintiff filed a first amended complaint. There are different counts for which the putative classes differ. The first class is proposed to be all former and current employees employed by our Performance Foodservice and Vistar segments in California in non-exempt positions at any time during the period beginning May 30, 2010 to the present, or the “California Class.” With respect to the California Class, the lawsuit alleges that we (1) failed to pay overtime as required by California statute, (2) failed to provide meal periods and to pay compensation for such meal periods, (3) failed to provide accurate itemized wage statements, and (4) engaged in unfair trade practices by failing to pay overtime or to provide meal periods, or pay compensation in lieu thereof. The lawsuit further alleges the plaintiff is entitled to penalties and attorney fees pursuant to the California Private Attorney General Act. The second putative class is proposed to be all members of the California Class who separated from employment at any time during the period from May 30, 2011 to the present, or the “California Subclass.” With respect to the California Subclass, the lawsuit alleges that we failed to pay all compensation due upon termination of employment and within the period due. The third putative class is proposed to be all current or former employees employed by us in the United States in non-exempt positions at any time during the period beginning May 30, 2011 to the present, or the “Nationwide Class.” With respect to the Nationwide Class, the lawsuit alleges we willfully failed to pay overtime compensation required under the Fair Labor Standards Act. In June 2015, we engaged in mediation with the plaintiff, subject to the limitation that the interests of the Nationwide Class would not be mediated except to the extent members of the Nationwide Class worked in California during the applicable period, and the plaintiff agreed. The mediator proposed the parties settle the lawsuit on the basis of a settlement fund of $1.4 million, on a claims-made basis with a floor of 60% payout net of attorney fees, administrative fees and enhancements. In July 2015, we indicated our non-binding agreement to the mediator’s proposal, subject to negotiation of a mutually agreeable settlement. The plaintiff also indicated its agreement to the mediator’s proposal. Therefore, this amount was accrued in June 2015. In May 2016, we and the plaintiff entered into a Stipulation for Settlement and Release of Class Action Claims, which Stipulation received preliminary court approval on July 25, 2016. We anticipate notice of the agreed Stipulation will be issued in September 2016 after which a forty-five day claim period will commence. The final approval hearing has been set in November 2016. Should the parties fail to receive final court approval, which is unanticipated, we intend to continue to vigorously defend ourselves. Perez v. Performance Food Group, Inc., et al. In April 2015, a former employee of our Performance Foodservice-Southern California distribution center filed a putative class action lawsuit in the Alameda County, California Superior Court against us. We removed the case to the United States District Court for the Northern District of California. In June 2015, the plaintiff filed a first amended complaint. The lawsuit alleges on behalf of a proposed class of all hourly employees in California (excluding drivers) in our Performance Foodservice and Vistar segments that we failed to provide second meal periods and to pay compensation for such meal periods. The lawsuit further alleges on behalf of a proposed class of all employees in California (excluding drivers) who earned non-discretionary compensation that we failed to pay all overtime wages due, and to pay all premium wages for missed meal periods, by failing to include all compensation required in the regular rate of pay calculation, and failed to pay wages for all time worked. The lawsuit further alleges on behalf of a proposed class of all employees in California (excluding drivers) that we failed to pay out vested vacation time in the form of paid holidays. The lawsuit further alleges on behalf of a proposed class of all employees described above that we (1) failed to provide accurate itemized wage statements; (2) failed to pay all compensation due upon termination of employment and within the period due; and (3) engaged in unfair trade practices. Each of the proposed classes for the preceding claims are for the time period from April 20, 2011 to the present. The lawsuit further alleges on behalf of all of our hourly employees in the United States (excluding drivers) in non-exempt positions, that we failed to pay appropriate overtime compensation pursuant to our compensation policy, and to keep records required under the Fair Labor Standards Act, for the period from April 20, 2012 to the present. Finally, the lawsuit alleges plaintiff is entitled to penalties and attorney fees pursuant to the California Private Attorney General Act. The lawsuit seeks the following relief: (1) unpaid wages; (2) actual damages; (3) liquidated damages; (4) restitution; (5) declaratory relief; (6) statutory penalties; (7) civil penalties; and (8) attorneys’ fees, interest and costs. In July 2015, we filed a Motion to Dismiss or Strike the Complaint. In March 2016, the court granted our motion to dismiss all claims except for the claim alleging we failed to provide accurate wage statements. The court gave the plaintiff 21 days to amend his complaint. The plaintiff filed a second amended complaint on April 13, 2016. The plaintiff’s claims in the second amended complaint include substantially the same claims and allegations as the original lawsuit. We filed a Motion to Dismiss or Strike the Second Amended Complaint on May 11, 2016. The court has not yet ruled on the motion. We believe that the exposure created by this lawsuit, if any, is largely duplicative of the exposure, if any, created by the Laumea litigation described above, and that settlement of the Laumea litigation will compromise all but one of the claims of the Perez litigation (failure to pay out vested vacation time in the form of paid holidays). Furthermore, like the Laumea litigation, the Perez litigation includes a nationwide Fair Labor Standards Act cause of action. Because compromise of that claim in the Laumea litigation would be limited to California employees, the same claim in the Perez litigation would not be compromised for non-California employees in the Perez litigation. We intend to vigorously defend ourselves. Contreras v. Performance Food Group, Inc., et al. In June 2014, a former employee of our Roma of Southern California distribution center filed a putative class action lawsuit in the Alameda County, California Superior Court against us. The putative class is proposed to be all drivers employed in any of our California locations in our Performance Foodservice and Vistar segments at any time during the period beginning June 17, 2010 to the present. In August 2014, the plaintiff filed a first amended complaint. The lawsuit alleges that we engaged in unfair trade practices and that we, with respect to the putative class, failed to (1) provide timely offduty meal and rest breaks and to pay compensation for such breaks as required by California law, (2) pay compensation for all hours worked and to pay a minimum wage for such hours, (3) provide accurate itemized wage statements, (4) pay all compensation within the period due at the time of termination of employment, and (5) pay compensation in timely fashion. The lawsuit further alleges that the plaintiff is entitled to penalties and attorney fees pursuant to the California Private Attorney General Act and that failure to provide meal and rest breaks and to pay a minimum wage for all hours worked constitute unfair business practices. In June 2015, we engaged in mediation with the plaintiff. The mediator proposed the parties settle the lawsuit on the basis of a fully paid settlement fund of $3.8 million. In July 2015, the parties agreed to the mediator’s proposal, subject to negotiation of a mutually agreeable settlement. Therefore, this amount was accrued in June 2015. The parties executed a settlement agreement which received final approval on May 4, 2016. We paid out the settlement fund on June 17, 2016, which fully resolved the lawsuit. Vengris v. Performance Food Group, Inc. In May 2015, an employee of our Performance Foodservice Northern California distribution center filed a putative class action lawsuit in the Alameda County, California Superior Court against us. In July 2015, the Company removed the case to the United States District Court for the Northern District of California. The putative class is proposed to be all current and former drivers employed in any of our, our subsidiaries’ or affiliated companies’ California locations since May 2, 2011. The lawsuit alleges that we (1) engaged in wage theft or time shaving by auto-deducting thirty minutes from class members’ work days even if the class members worked during some or all of such meal periods; (2) failed to pay class members for all time worked when class members worked during first or second meal periods; (3) failed to pay premium wages to class members for missed meal periods; (4) failed to provide class members the opportunity to take rest breaks of 10 minutes every four hours and failed to pay premium wage for such missed rest breaks; (5) provided inaccurate wage statements to the class members by failing to account for all hours worked; (6) failed to pay all compensation within the period due at the time of termination of employment; and (7) engaged in unlawful, unfair, fraudulent and deceptive business practices by failing to itemize and keep accurate time records and by failing to pay the class members in a lawful manner. The lawsuit seeks the following relief: (1) compensatory, economic and special damages, with interest; (2) unpaid wages, with interest; (3) premium wages for non-compliant meal periods and rest breaks; (4) restitution for engaging in unlawful, unfair, fraudulent, and deceptive business practices related to time records and failure to pay the class members in a lawful manner; (5) waiting time penalties for failure to pay all wages owed to class members who are former employees; (6) damages, monies owed, and/or restitution for failing to provide accurate wage statements; (7) injunctive relief barring the alleged violations; and (8) attorneys’ fees, interest and costs. In July 2015, we filed a Motion to Dismiss or Strike the Complaint. The court transferred the case to the judge presiding in the Contreras litigation, terminated the motion to dismiss without prejudice and ruled that we will be able to refile the motion, if necessary, in the future. We have reached a preliminary agreement with Mr. Vengris to settle his individual claims for an immaterial amount. Should a final settlement agreement not be reached, we intend to continue to vigorously defend ourselves. Wilder, et al. v. Roma Food Enterprises, Inc., et al. In October 2014, three former delivery drivers who worked in our former Roma of New Jersey warehouse in Piscataway, New Jersey filed a class action lawsuit in the Superior Court of New Jersey, Law Division, Middlesex County against us. The lawsuit alleges on behalf of a proposed class of delivery drivers who worked in our Roma, broadline and Vistar facilities in New Jersey from October 2012 to the present that, under New Jersey state law, we failed to pay minimum wages and overtime compensation to the delivery drivers in these facilities. The lawsuit seeks the following relief: (1) award of unpaid minimum wages and overtime under New Jersey state law; (2) an injunction preventing us from committing the alleged violation; (3) a declaration from the court that the alleged violations were knowing and willful; (4) reasonable attorneys’ fees and costs; and (5) pre-judgment and post-judgment interest. The case is in the preliminary phases of discovery, and no class has been certified. The plaintiffs have expressed their desire to include temporary delivery drivers in the alleged class; however, the court has not ruled as to whether those temporary workers may join the lawsuit. We intend to vigorously defend ourselves. While the damages cannot be predicted with certainty at this time, we believe they may fall within the range of $0.0 to $3.0 million. Sales Tax Liabilities The Company’s sales and use tax filings are subject to customary audits by authorities in the jurisdictions where it conducts business in the United States, which may result in assessments of additional taxes. 16. Related-Party Transactions Transaction and Advisory Fee Agreement The Company is a party to an advisory fee agreement pursuant to which affiliates of The Blackstone Group (“Blackstone”) and affiliates of Wellspring Capital Management (“Wellspring”) provide management certain strategic and structuring advice and certain monitoring, advising, and consulting services to the Company. The advisory fee agreement provides for the payment by the Company of an annual advisory fee and the reimbursement of out of pocket expenses. The annual advisory fee is the greater of $2.5 million or 1.5% of the Company’s consolidated EBITDA (as defined in the advisory fee agreement) for the immediately preceding fiscal year. The payments under this agreement, which includes expenses incurred by Blackstone and Wellspring, totaled $5.0 million, $4.7 million, and $4.2 million, for fiscal 2016, fiscal 2015, and fiscal 2014, respectively. Under its terms, this agreement will terminate no later than the second anniversary of the closing date of the IPO, which was October 6, 2015. The Company also paid $0.6 million in advisory expenses to an affiliate of the Blackstone Group in fiscal 2016 related to capital market advisory services provided to the Company. In addition, an affiliate of Blackstone received a $1.1 million underwriter’s discount in the IPO and a $0.3 million initial purchaser’s discount in the Notes offering. Other The Company does business with certain other affiliates of The Blackstone Group. In fiscal 2016, the Company recorded sales of $47.4 million to certain of these affiliate companies compared to sales of $34.8 million for fiscal 2015 and $35.0 million for fiscal 2014. The Company also recorded purchases from certain of these affiliate companies of $2.3 million in fiscal 2016, $2.7 million in fiscal 2015, and $1.8 million in fiscal 2014. The Company does not conduct a material amount of business with affiliates of Wellspring Capital Management. An affiliate of The Blackstone Group had held a portion of Term Facility prior to it being paid in full and terminated during fiscal 2016. The Company paid approximately $0.9 million, $1.5 million and $2.0 million in interest related to fiscal 2016, 2015 and fiscal 2014, respectively, to this affiliate pursuant to the terms of the Term Facility. See Note 8 Debt for a discussion of the Term Facility. 17. Earnings Per Share Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is calculated using the weighted-average number of common shares and dilutive potential common shares outstanding during the period. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased with the proceeds from the exercise of stock options under the treasury stock method. For fiscal 2015 and fiscal 2014, the Company’s calculation of weighted-average number of common shares includes Class A and Class B common stock. All shares of Class A and Class B common stock entitle the holders thereof to the same rights, preferences, and privileges in respect of dividends. A reconciliation of the numerators and denominators for the basic and diluted EPS computations is as follows: 18. Stock-based Compensation Performance Food Group Company provides compensation benefits to employees and non-employee directors not employed by our Sponsors under several share based payment arrangements. These arrangements are designed to promote the long-term growth and profitability of the Company by providing employees and consultants who are or will be involved in the Company’s growth with an opportunity to acquire an ownership interest in the Company, thereby encouraging them to contribute to and participate in the success of the Company. The Performance Food Group Company 2007 Management Option Plan (the “2007 Option Plan”) The 2007 Option Plan allows for the granting of awards to current and future employees, officers, directors, consultants, and advisors of the Company or its affiliates in the form of nonqualified options. The terms and conditions of awards granted under the 2007 Option Plan are determined by the Board of Directors. The contractual term of the options is ten years. There are 6,445,982 shares of common stock reserved for issuances under the 2007 Option Plan and 433,762 shares available for grant as of July 2, 2016. Each of the employee awards under the 2007 Option Plan is divided into three equal portions. Tranche I options are subject to time vesting. Tranche II and Tranche III options are subject to both time and performance vesting, including performance criteria based on the internal rate of return and sponsor cash inflows as outlined in the 2007 Option Plan. Prior to the amendment discussed below, the Company’s assessment of the performance criteria indicated that satisfaction of the performance criteria was not probable and therefore, no compensation expense had been recognized on Tranche II and Tranche III options. The 2007 Option Plan had repurchase rights that generally allowed the Company to repurchase shares, at the current fair value following a participant’s retirement or a participant’s termination of employment by the Company other than for “cause” and at the lower of the original exercise price or current fair value following any termination of employment by the Company for “cause,” resignation of the participant, or in the event a participant resigns because of retirement and subsequently breaches the non-competition or non-solicitation covenant within one year of such participant’s termination. Because of the existence of the repurchase rights, the weighted average service period had exceeded the contractual term of the options. However, the repurchase option feature of this plan terminated upon the date of our IPO. Therefore, the Company’s management determined that the requisite service period should be reduced from 10.7 years to the 5 year service vesting period. As a result, compensation costs of $3.8 million were recorded in fiscal 2016 related to this change for Tranche I awards. On July 30, 2015, the Company approved amendments to the 2007 Option Plan to modify the vesting terms of all of the Tranche II and Tranche III options granted pursuant to the 2007 Option Plan. These options will continue to vest based on a combination of time and performance vesting conditions. The time-based vesting condition did not change and will continue to be satisfied with respect to 20% of the shares underlying these options annually, based on the participant’s continued employment with the Company. The performance-based vesting condition was reduced to reflect changes in the macro-economic conditions following the 2008 recession. In addition, as part of the amendments to the 2007 Option Plan, the Company further evaluated its outstanding options, and in light of the concern that the Tranche II and III options had performance targets that may not be met before the expiration of such options, individuals holding these unvested time and performance-vesting options were allowed the right to exercise such options into restricted shares of the Company’s common stock and to receive a new grant of time and performance-vesting options. On September 30, 2015, 3.73 million options were exchanged for 2.27 million restricted shares and 1.46 million new options. Based on management’s assessment of the probability associated with the underlying conditions of the amended Tranche II and III awards, the Company believes that, following the amendments, there is a reasonable possibility that the performance targets could be met. The Company engaged an unrelated specialist to assist in the process of determining the fair value based measure of the modified awards. Based on management’s evaluation, the estimate of the possible future compensation expense is approximately $45.0 million, of which $8.4 million was recognized in fiscal 2016 and approximately $18.0 million will be recognized over the next three years. The remaining $18.6 million of compensation expense will be recognized when the Company concludes that it is probable that certain performance conditions will be met. The Company estimated the fair value of the Tranche I time vesting options granted in the fiscal years below using a Black-Scholes option pricing model with the following weighted average assumptions: The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected holding period. The Company assumed a dividend yield of zero percent when valuing the grants in fiscal 2016 under the 2007 Option Plan because the Company has previously announced that it does not intend to pay dividends on its common stock. For grants in fiscal years 2015 and 2014, the Company assumed a dividend yield based on the historical payment of dividends over prior fiscal years. Expected volatility is based on the expected volatilities of comparable peer companies that are publicly traded. The expected term represents the period of time that awards granted are expected to be outstanding. The Company historically estimated the expected term to be the contractual term of the options given the repurchase rights detailed in the 2007 Option Plan. For grants in fiscal 2016, the Company elected to use the simplified method to estimate the expected holding period because we do not have sufficient information to understand post vesting exercise behavior. As such, we will continue to use this methodology until such time we have sufficient history to provide a reasonable basis on which to estimate the expected term. With the assistance of a specialist, the Company estimated the fair value of the Tranche II and III options and restricted shares with a market condition using a Monte Carlo simulation with the following weighted average assumptions: The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected holding period. The Company assumed a dividend yield of zero percent when valuing the grants in fiscal 2016 under the 2007 Option Plan because the Company has previously announced that it does not intend to pay dividends on its common stock. Expected volatility is based on the historical equity volatility of comparable peer companies that are publicly traded. This historical equity volatility was un-levered using the company specific capital structure of the comparable peer companies and was re-levered using the capital structure of Performance Food Group. The expected term represents the period of time that awards granted are expected to be outstanding, as determined with the assistance of a specialist based on the vesting term and contractual term. In total, compensation cost that has been charged against income for the Company’s 2007 Option Plan was $13.2 million, $1.0 million and $0.7 million for fiscal 2016, fiscal 2015 and fiscal 2014, respectively, and it is included within operating expenses in the consolidated statements of operations. The total income tax benefit recognized in the consolidated statements of operations was $5.1 million, $0.4 million and $0.3 million for fiscal 2016, 2015 and 2014, respectively. The total unrecognized compensation cost the Company has concluded that is probable for all tranches under the 2007 Option Plan is $18.8 million as of July 2, 2016. This cost is expected to be recognized over a weighted-average period of 2.7 years. The following table summarizes the stock option activity for fiscal 2016 under the 2007 Option Plan. The following table summarizes the changes in nonvested restricted shares for fiscal 2016 under the 2007 Option Plan. The Performance Food Group Company 2015 Omnibus Incentive Plan (the “2015 Incentive Plan”) In July 2015, the Company approved the 2015 Incentive Plan. The 2015 Incentive Plan allows for the granting of awards to current employees, officers, directors, consultants, and advisors of the Company. The terms and conditions of awards granted under the 2015 Option Plan are determined by the Board of Directors. There are 4,850,000 shares of common stock reserved for issuance under the 2015 Incentive Plan, including non-qualified stock options and incentive stock options, stock appreciation rights, restricted shares (service-based and performance-based), and other equity based or cash-based awards. As of July 2, 2016, there are 3,798,501 shares available for grant under the 2015 Incentive Plan. The contractual term of the options granted under the 2015 Incentive Plan is ten years. Options and service-based restricted shares vest ratably over four years from the date of grant. Performance-based restricted shares vest upon the achievement of a specified Return on Invested Capital (“ROIC”), a performance condition, and a specified Relative Total Shareholder Return (“Relative TSR”), a market condition, at the end of a three year performance period. Actual shares earned range from 0% to 150% of the initial grant, depending upon performance relative to the ROIC and Relative TSR goals. The fair values of service-based restricted shares and restricted shares with a performance condition were based on the Company’s stock price as of the date of grant. With the assistance of a specialist, the fair value of 70,361 restricted shares with a market condition was estimated using a Monte Carlo simulation. The Company estimated the fair value of options using a Black-Scholes option pricing model with the following weighted average assumptions: The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected holding period. The Company assumed a dividend yield of zero percent when valuing the grants in fiscal 2016 under the 2015 Incentive Plan because the Company has previously announced that it does not intend to pay dividends on its common stock. Expected volatility is based on the expected volatilities of comparable peer companies that are publicly traded. The expected term represents the period of time that awards granted are expected to be outstanding. The Company elected to use the simplified method to estimate the expected holding period because we do not have sufficient information to understand post vesting exercise behavior. As such, we will continue to use this methodology until such time we have sufficient history to provide a reasonable basis on which to estimate the expected term. The compensation cost that has been charged against income for the Company’s 2015 Incentive Plan was $4.0 million for fiscal 2016 and $0.2 million for fiscal 2015, and it is included within operating expenses in the consolidated statement of operations. The total income tax benefit recognized in the consolidated statements of operations was $1.6 million in fiscal 2016 and $0.1 million in fiscal 2015. Total unrecognized compensation cost for all awards under the 2015 Incentive Plan is $13.5 million as of July 2, 2016. This cost is expected to be recognized over a weighted-average period of 2.9 years. The following table summarizes the stock option activity for fiscal 2016 under the 2015 Incentive Plan. There were no exercisable options under the 2015 Incentive Plan outstanding as of July 2, 2016. The following table summarizes the changes in nonvested restricted shares and restricted stock units for fiscal 2016 under the 2015 Incentive Plan. The total fair value of shares vested during fiscal 2016 was $0.6 million. On August 9, 2016, the Compensation Committee of the Board of Directors approved the grant of 0.4 million options and 0.5 million shares of restricted stock under the 2015 Incentive Plan. 19. Segment Information The Company has three reportable segments, as defined by ASC 280 Segment Reporting, related to disclosures about segments of an enterprise. The Performance Foodservice segment markets and distributes food and food-related products to Street restaurants, Chain restaurants, and other institutional “food-away-from-home” locations. The PFG Customized segment principally serves the family and casual dining channel but also serves fine dining, fast casual, and quick serve restaurant chains. The Vistar segment distributes candy, snack, beverage, and other products to customers in the vending, office coffee services, theater, retail, and other channels. The accounting policies of the segments are the same as those described in Note 2 Summary of Significant Accounting Policies and Estimates. Intersegment sales represent sales between the segments, which are eliminated in consolidation. Management evaluates the performance of each operating segment based on various operating and financial metrics, including total sales and EBITDA. For PFG Customized, EBITDA includes certain allocated corporate charges that are included in operating expenses. The allocated corporate charges are determined based on a percentage of total sales. This percentage is reviewed on a periodic basis to ensure that the segment is allocated a reasonable rate of corporate expenses based on their use of corporate services. Corporate & All Other is comprised of corporate overhead and certain operations that are not considered separate reportable segments based on their size. This includes the operations of the Company’s internal logistics unit responsible for managing and allocating inbound logistics revenue and expense. Total assets by reportable segment, excluding intercompany receivables between segments, are as follows: The sales mix for the Company’s principal product and service categories is as follows: SCHEDULE 1-Registrant’s Condensed Financial Statements PERFORMANCE FOOD GROUP COMPANY Parent Company Only CONDENSED BALANCE SHEETS See accompanying notes to condensed financial statements. PERFORMANCE FOOD GROUP COMPANY Parent Company Only CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME See accompanying notes to condensed financial statements. PERFORMANCE FOOD GROUP COMPANY Parent Company Only CONDENSED STATEMENTS OF CASH FLOWS See accompanying notes to condensed financial statements. Notes to Condensed Parent Company Only Financial Statements 1. Description of Performance Food Group Company Performance Food Group Company (the “Parent”) was incorporated in Delaware on July 23, 2002 to effect the purchase of all the outstanding equity interests of PFGC, Inc. (“PFGC”). The Parent has no significant operations or significant assets or liabilities other than its investment in PFGC. Accordingly, the Parent is dependent upon distributions from PFGC to fund its obligations. However, under the terms of PFGC’s various debt agreements, PFGC’s ability to pay dividends or lend to the Parent is restricted, except that PFGC may pay specified amounts to the Parent to fund the payment of the Parent’s franchise and excise taxes and other fees, taxes, and expenses required to maintain its corporate existence. 2. Basis of Presentation The accompanying condensed financial statements (parent company only) include the accounts of the Parent and its investment in PFGC, Inc. accounted for in accordance with the equity method, and do not present the financial statements of the Parent and its subsidiary on a consolidated basis. These parent company only financial statements should be read in conjunction with the Performance Food Group Company consolidated financial statements. The Parent is included in the consolidated federal and certain unitary, consolidated and combined state income tax returns with its subsidiaries. The Parent’s tax balances reflect its share of such filings. | Based on the provided excerpt, here's a summary of the financial statement:
Financial Performance:
- The company reported a loss for the period
- No impairment losses were recorded in fiscal 2016
Key Financial Practices:
- Routine maintenance costs are expensed
- Betterments and renewals are capitalized
- Long-lived assets are tested for recoverability
Significant Management Estimates:
- Allowance for doubtful accounts
- Inventory reserves
- Impairment testing of goodwill
- Acquisition accounting
- Insurance claim reserves
- Vendor rebates
- Bonus accruals
- Depreciation and amortization
- Income taxes
Cash Management:
- Cash primarily held in FDIC-insured institutions
- Cash balances may exceed FDIC insurance limits
- Restricted cash used for collateralizing insurance deductibles
Financial Segments | Claude |
. Report of Independent Registered Public Accounting Firm The following is a list of financial statements filed herewith: Consolidated Balance Sheets as of December 31, 2016 and 2015 Consolidated Statements of Operations for the years ended December 31, 2016 and 2015 Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2016 and 2015 Consolidated Statements of Cash Flows for the years ended December 31, 2016 and 2015 Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders Lightning Gaming, Inc. and subsidiaries We have audited the accompanying consolidated balance sheets of Lightning Gaming, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, stockholders’ equity, and cash flows for years then ended. Our audit also included the financial statement schedule of Lightning Gaming, Inc. listed in item 15(a). These financial statements and the financial statement schedule are the responsibility of the entity’s management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Lightning Gaming, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in related to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Baker Tilly Virchow Krause, LLP Wyomissing, Pennsylvania March 28, 2017 Lightning Gaming, Inc. and Subsidiaries Consolidated Balance Sheets Lightning Gaming, Inc. and Subsidiaries Consolidated Statements of Operations Lightning Gaming, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity Years Ended December 31, 2016 and 2015 See Lightning Gaming, Inc. and Subsidiaries Consolidated Statements of Cash Flows See Lightning Gaming, Inc. and Subsidiaries Consolidated Statements of Cash Flows (Continued) See Lightning Gaming, Inc. and Subsidiaries Note 1. Nature of Business and Summary of Significant Accounting Policies Nature of Business: Lightning Gaming, Inc. (the “Company”) was incorporated on March 1, 2007 and on January 29, 2008, completed a merger with Lightning Poker, Inc. (“Lightning Poker”) which became a wholly-owned subsidiary of the Company. Lightning Poker was formed to manufacture and market a fully automated, proprietary electronic poker table (the “Poker Table”) to commercial and tribal casinos, card clubs, and other gaming and lottery venues. Lightning Poker’s Poker Table is designed to improve economics for casino operators while improving overall player experience. In 2008, the Company, as the sole member, established Lightning Slot Machines, LLC (“Lightning Slots”) through which it commenced the design, manufacture, marketing, sale and operation of video slot machines to customers in various gaming jurisdictions. The current slot machine products are: ·Popeye · Jungle Book ·Popeye’s Bonus Voyage · Jumbo Fish Stacks ·Popeye’s Seven Seas · Just Jackpots ·Olive Oyl’s Jumbo Stacks · Lightning Lotto ·Flash Gordon · Penny Palooza ·Garfield · Si Shou ·Around the World in 80 Days · Slotto ·Candy Cash · Snow White ·Cash Flow · Swamp Fever ·Cinderella · Swamp Frenzy ·Duck Dynamite · Vampires Fortune ·Fins N Wins · Year of the Horse ·Golden Egg · Ye Xian ·Hao Yun Our gaming products feature advanced graphics and engaging games based on licensed, well-recognized brands, cartoon characters and proprietary non-branded themes. Our consolidated financial statements include the accounts of the Company, including Lightning Poker and Lightning Slots. All inter-company accounts and transactions have been eliminated. The accompanying consolidated financial statements have been prepared on a going concern basis, which assumes realization of all assets and settlement or payment of all liabilities in the ordinary course of business. The Company has had net operating losses and negative cash flows from operations however it has maintained and sustained working capital surpluses. An increase in sales contracts is an indication that conditions have recently been improving and the Company expects these conditions to continue to improve, however the generation of cash flow sufficient to meet the Company’s cash needs in the future will depend on the Company’s ability to distribute its products and successfully market them to more casinos and card clubs. Based on our current financial condition, cash flow projections and anticipated revenues, we believe we have sufficient cash flows to support our operations for the next twelve months, however if supplemental financing becomes necessary, there is no assurance that the Company would be able to obtain such financing, on reasonable and feasible terms, or at all. If the Company needs additional funding and is unable to obtain it, its financial condition would be adversely affected. In that event, it would have to postpone or discontinue planned operations and projects for expansion. The Company’s continuance as a going concern is dependent upon these factors, among others. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Lightning Gaming, Inc. and Subsidiaries (Continued) Note 1. Nature of Business and Summary of Significant Accounting Policies (Continued) A summary of the Company’s significant accounting policies is as follows: Revenue Recognition: The Company generates revenue from leasing and selling our Poker Table and slot machines. The Company recognizes revenue on sales of our products, net of rebates, discounts and allowances, when persuasive evidence of an agreement exists, the sales price is fixed or determinable, our products are delivered and our ability to collect is reasonably assured. The recognition of revenue generated under operating leases occurs when the ability to collect is reasonably assured. The license agreements are based on either a fixed monthly price or a pre-determined percentage of the monthly net “rake” revenue collected for each Poker Table and daily revenue collected for each slot machine, subject to daily minimums and maximums. If multiple units of our products are included in any one sale or lease agreement, revenue is allocated to each unit based upon its respective fair value against the total contract value and revenue recognition is deferred on those units where all requirements of revenue recognition have not been met. There are also instances in which a lease may be offered to a customer with the option to convert to a sale upon the completion of certain obligations such as a pre-determined paid or reduced-rate lease term and/or a free-trial period. In addition, circumstances may arise in which a customer wishes to purchase machines after being on lease at their facility. In all of these situations, the initial revenue is recorded as lease revenue and the agreed upon sales price is shown as sales revenue when the lease is converted to a sale. For the years 2016 and 2015 revenue from customers outside the United States accounted for approximately $-0- and $2,889 of revenues, respectively. Two and three casino customers accounted for 11% and 21% of our revenues for the years ended December 31, 2016 and 2015, respectively. One casino group represented 10% and 8% of total revenues for each of the years ended December 31, 2016 and 2015, respectively. Use of Estimates: The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates include the recoverable value of long-lived assets, projected cash flows, and the fair market value of warrants and the convertible feature of long-term debt, if applicable. Actual results could differ from those estimates. Cash: For the purposes of reporting the statement of cash flows, the Company considers all cash accounts and highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. The Company maintained and will maintain cash balances with highly reputable financial institutions, which at times throughout the year exceeded the federally-insured amount. The Company has not experienced any losses from deposits above the federally-insured amount. Concentrations of Credit Risk: Financial instruments that subject us to credit risk primarily consist of cash and trade receivables. The Company’s credit risk is managed by investing cash primarily in high-quality financial institutions. Accounts receivable include amounts owed by various customers and groups of customers. No collateral is required. Accounts receivable are not sold or factored. The Company regularly reviews its trade receivables in determining its allowance for doubtful accounts and believes its credit and collection polices mitigate its credit risk relative to accounts receivable. Receivables and Allowance for Doubtful Accounts: The Company regularly evaluates the collectability of its trade receivable balances based on a combination of factors. When a customer’s account becomes past due, dialogue is initiated with the customer to determine the cause. If it is determined that the customer will be unable to meet its financial obligation to us, such as in the case of a bankruptcy filing, deterioration in Lightning Gaming, Inc. and Subsidiaries (Continued) Note 1. Nature of Business and Summary of Significant Accounting Policies (Continued) the customer’s operating results or financial position or other material events impacting its business, a specific reserve is recorded for bad debts to reduce the related receivable to the amount expected to be recovered, given all information presently available. The Company has a reserve of $12,331 and $18,000 as of December 31, 2016 and 2015, respectively. Except for this reserve, the Company believes its receivables are collectible. If circumstances related to specific customers change, our estimates of the recoverability of receivables could materially change. Recoveries of receivables previously written off are recorded as revenue when recovered. Delinquency of accounts receivable is determined based on contractual terms. The Company does not charge interest on its past due receivables. At December 31, 2016 and 2015, accounts receivable from four and five casino customers, respectively, represented 54% and 72%, respectively, of total accounts receivable. One customer represented 20% of the total accounts receivable balance as of December 31, 2016 and one customer represented 40% of the accounts receivable balance as of December 31, 2015. License Fees: Licensee fees are amortized on a straight-line basis over the life of the respective license, which ranges from one to three years. Patents: The Company expenses legal fees and application costs related to its patent application process. There is a high degree of uncertainty in the outcome of approval for any of our patents. Once the patents are approved, any costs incurred to defend and register these patents will be capitalized. Research and Development: Research and development costs are charged to expense when incurred and are included in the Statement of Operations until technological feasibility is reached. Technological feasibility is established when a product design and a working model of the software product have been completed and the completeness of the working model and its consistency with the product design have been confirmed by testing. These expenses include internally-developed software costs as well as employee and product costs associated with the development of our products. As of December 31, 2016 and 2015, no amounts had been capitalized. Inventory: Inventory is stated at the lower of cost or market using the first-in, first-out method. Fair Value Measurements: Given their short-term nature and expected maturity, the carrying amounts reported in these financial statements for cash, prepaid and other current assets, accounts payable, and accrued expenses approximate fair value. Property and Equipment: Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over estimated useful lives of three to five years. Leasehold improvements are amortized over the life of the lease or the useful life of the improvement if less. Income Taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company has assessed its tax position and does not believe there are any uncertain tax positions. Our policy is to record interest and penalties associated with unrecognized tax benefits as additional income taxes in the Statement of Operations. The Company has determined that there are no unrecognized tax benefits, and accordingly, has not recognized any interest or penalties during 2016 and 2015 related to unrecognized tax benefits. There is no accrual for interest or penalties as of December 31, 2016 and 2015. Lightning Gaming, Inc. and Subsidiaries (Continued) Note 1. Nature of Business and Summary of Significant Accounting Policies (Continued) The Company files U.S. income tax returns and multiple state and foreign income tax returns. With few exceptions, the U.S. and state income tax returns filed for the tax years ending on December 31, 2013 and thereafter are subject to examination by the relevant taxing authorities. Advertising: The Company expenses advertising costs as incurred. There was no advertising expense in 2016 or 2015. Impairment of Long-Lived Assets: The Company reviews its long-lived assets, including property and equipment and license fees, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. To determine the recoverability of its long-lived assets, including definite lived license fees, the Company evaluates the probability that future undiscounted net cash flows, without interest charges, will be less than the carrying amount of the assets or for identifiable intangibles with finite useful lives. Going Concern: The Company evaluates whether there are conditions or events, considered in the aggregate, that raise substantial doubt about its ability to continue as a going concern for a period of one year after the date that the financial statements are issued, taking into consideration the quantitative and qualitative information regarding the Company’s current financial condition, conditional and unconditional obligations due and the funds and cash flow necessary to maintain operations within that time period. Based on management’s evaluation, the Company will be able to continue in operation on a going concern basis for at least the next twelve months from the date these financial statements are issued. Stock Option Plans: The Company has equity-based compensation plans which are more fully described in Note 7. Compensation expense is recognized over the required service period. All options have been granted with an exercise price equal to the fair value of the Company’s common stock on the date of grant. Earnings (loss) per share: The Company computes earnings (loss) per share in accordance with generally accepted accounting principles which require presentation of both basic and diluted earnings per share ("EPS") on the face of the Statement of Operations. Basic EPS is computed by dividing net income (loss) available to common shareholders by the weighted-average number of shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted to common stock. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Diluted EPS for loss periods excludes all potential dilutive shares due to their anti-dilutive effect. The Company uses the two-class method in computing earnings per share. Under the two-class method, undistributed earnings are allocated among common and participating shares to the extent each security may share in such earnings. In computing earnings per share, the Company's Nonvoting Stock is considered a participating security. Each share of Nonvoting Stock has identical rights, powers, limitations and restrictions in all respects as each share of common stock of the Company including the right to receive the same consideration per share payable in respect of each share of common stock, except that holders of Nonvoting Stock shall have no voting rights or powers whatsoever. The following table summarizes the number of dilutive shares, which may dilute future earnings per share, outstanding for each of the periods presented, but not included in the calculation of diluted loss per share: Lightning Gaming, Inc. and Subsidiaries (Continued) Note 2. Inventory Inventory consisted of the following: Note 3. Property and Equipment Property and equipment consisted of the following: Depreciation expense related to the property and equipment included in the consolidated Statements of Operations was $279,908 and $447,348 for the years ended December 31, 2016 and 2015, respectively. Note 4. License Fees License fees consist of the following: The weighted average useful life of purchased licenses is 3 years. Amortization expense included in the consolidated Statements of Operations and relating to the purchased licenses was $10,000 and $67,875 for the years ended December 31, 2016 and 2015, respectively. Estimated amortization expense related to recorded license fees is as follows: Lightning Gaming, Inc. and Subsidiaries (Continued) Note 5. Debt On August 6, 2015, the Company entered into an agreement with The Co-Investment Fund II, L.P. (“CI II”) in which the entire principal and accrued interest on promissory notes and other related loan agreements outstanding and due to CI II, including warrants to purchase a maximum of 12,151,385 shares of Company stock, as well as the 4,500,000 shares of Preferred Series A Nonvoting Capital Stock then outstanding, were converted into181,000 shares of (voting) Common Stock, par value $0.001, and 33,300,000 shares of Nonvoting Common Stock, par value $0.001, of the Company. Upon the conversion, all notes, loans, accrued interest, and warrants due to CI II were terminated in their entirety and all obligations were extinguished. Prior to conversion, substantially all of the Company’s assets had been pledged as collateral on debt and all of the notes were due on June 30, 2017 with interest at 8% on each note payable at maturity. In May 2015, the lender agreed to suspend the accrual of interest on all of the notes outstanding, effective April 1, 2015, in anticipation of converting its debt and related obligations to equity in the transaction described above. See Note 7, Stockholders’ Equity and Note 9, Related Party Transactions for more information on debt and warrant transactions. Note 6. Commitments In November 2009, the Company entered into a lease agreement for its corporate offices which became effective in January 2010 for a term of sixty-seven months. In September 2014, the lease was amended to include the following: 1) an extension of the lease term to February 28, 2021; 2) modification of the minimum annual and monthly rents for the extended lease term; 3) a rent abatement period of six months commencing October 1, 2014; and 4) an option to extend the term for a period of five years. Rental expense is recognized on a straight-line basis over the life of the lease and is recorded as a deferred rent obligation during the abatement period. The deferred rent is reduced by the difference between the rent due and the straight-line expense upon commencement of the rental payments. Rental expense under this lease for the years ended December 31, 2016 and 2015 was $153,026 and $141,086, respectively. Future minimum lease payments are as follows: The Company routinely enters into license agreements for the use of intellectual properties and technologies. These agreements generally provide for royalty advances and license fee payments when the agreements are signed and minimum commitments which are cancelable in certain circumstances. In October 2009, the Company entered into an exclusive license agreement with Hearst Holdings, Inc. and King Features Syndicate Division to use the brands POPEYE and related family of characters in gaming devices distributed worldwide excluding the United Kingdom and Japan. The initial term of the agreement was for one year with the Company’s right to extend the agreement for eight additional one-year terms upon payment of minimum royalties. The Company paid the minimum royalties and extended the term of the agreement to December 2013. In April 2013, the Company was granted the right to sublicense the POPEYE brand for distribution to bar and salon customers only in Spain for the Lightning Gaming, Inc. and Subsidiaries (Continued) Note 6. Commitments (Continued) remainder of the renewal term. In December 2013, the Company and Hearst Holdings entered into a second renewal agreement extending the license and sublicense renewal term from January 1, 2014 to December 31, 2016, and a third renewal agreement extending the license and sublicense renewal term from January 1, 2017 to December 31, 2018. The third renewal agreement is subject to a guaranteed minimum royalty of $50,000, $25,000 payable on or before December 31, 2017 and $25,000 payable on or before December 31, 2018. In June 2011, the Company entered into a license agreement with Hearst Holdings, Inc. to use the brand Blondie and related family of characters in gaming devices distributed worldwide. The initial term of the agreement was for two years with the Company’s right to extend the agreement for eight additional one- year terms upon payment of minimum royalties. The Company and Hearst Holdings entered into a renewal agreement extending the renewal term from June 1, 2013 to December 31, 2015. The renewal period has expired and all royalty obligations have been paid in full. In November 2011, the Company entered into a license agreement with Hearst Holdings, Inc. to use the brand Beetle Bailey and related family of characters in gaming devices distributed worldwide. The initial term of the agreement was for two years with the Company’s right to extend the agreement for eight additional one-year terms upon payment of minimum royalties during the term of the agreement. The Company and Hearst Holdings entered into a renewal agreement extending the renewal term from January 1, 2014 to December 31, 2015. The renewal period has expired and all royalty obligations have been paid in full. In March 2013, the Company entered into a license agreement with Hearst Holdings, Inc. to use the brand Hagar the Horrible and related family of characters in gaming devices distributed worldwide. The initial term of the agreement ran from April 1, 2013 to June 30, 2015. The Company had the right to extend the agreement for eight additional one-year terms upon payment of $50,000 in minimum royalties. The Company opted not to extend the agreement and all royalty obligations have been paid in full. In October 2014, the Company entered into a license agreement with Paws, Inc. to use the brand Garfield and associated family of characters in gaming devices distributed worldwide, except in the embargo countries of Cuba, Iran and Sudan. The initial term of the agreement runs from December 1, 2014 to November 30, 2017 and is subject to a guaranteed minimum royalty of $75,000. In December 2014, 2015, and 2016, the Company paid $25,000 as non-refundable advances against the guaranteed royalty. The guaranteed advanced payments are recoupable out of royalties earned on the license. In November 2014, the Company entered into a license agreement with Hearst Holdings, Inc. for the worldwide distribution of gaming devices using Flash Gordon and associated family of characters. The initial term of the agreement runs from November 1, 2014 to October 31, 2017 with royalties based on a percentage of revenues earned on the license, payable on a quarterly basis which commenced on January 31, 2016. In July 2016, the Company entered into a license agreement with Ainsworth Game Technology Ltd for the intellectual property rights to use certain game technology in slot machines titled as Flash Gordon, Ye Xian and Cash Flow. The term of the agreement runs from July 1, 2016 to May 30, 2018 with royalties based on a percentage of revenues earned on the slot machines running the aforementioned titles, payable on a quarterly basis with the first royalty payment due October 31, 2016. Lightning Gaming, Inc. and Subsidiaries (Continued) Note 6. Commitments (Continued) At December 31, 2016, the Company had total license fee commitments and advance payments made as follows: As of December 31, 2016, the Company estimates that all potential future royalty payments have been paid. Note 7. Stockholders’ Equity Stock Option Plans: On March 8, 2006, Lightning Poker adopted an equity incentive plan to enable Lightning Poker to offer key employees, consultants and directors equity interests in Lightning Poker, thereby helping to attract, retain and motivate such persons to exercise their best efforts on behalf of Lightning Poker. After the Merger, the options previously granted by Lightning Poker were exchanged for options to buy the Company's stock under the Company's 2007 Equity Incentive Plan (the "2007 Plan") having substantially the same terms. The options are granted at the discretion of the Board of Directors and, at December 31, 2016, the maximum aggregate number of shares issuable under the Stock Plan was 2,500,000. The purchase price of each option will be determined by the Board of Directors at the time the option is granted, but in no event will be less than 100% of the fair market value of the common stock at the time of grant. Options granted will not be exercisable after 10 years from the grant date. Options generally vest at 20% per year starting from the grant date and are fully vested after five years. The options can be exercised in partial or full amounts upon a change in control and at such other times as specified in the award agreements. In order to provide an incentive to designated employees, officers, directors, consultants, independent contractors and other service providers who perform services contributing to the growth of the Company, and by aligning the interests of participants with the interests of stockholders, the Board declared it advisable and in the Company’s best interest and on May 25, 2016, approved the 2016 Stock Option Plan (the “2016 Plan”). The 2016 Plan will permit the granting of nonqualified stock options. The shares underlying the options will be shares of the Company’s nonvoting common stock, par value $0.001 per share, and the total aggregate number of shares that may be issued under the 2016 Plan is 5,700,000 shares. The purchase price of each option will be determined by the Board at the time the option is granted, but in no event will be less than 100% of the fair market value of the common stock at the time of grant. Options granted will not be exercisable after 10 years from the grant date. As of December 31, 2016, there were no options granted under the 2016 Plan. Expense relating to the stock option plans was $-0- and $591 for the years ended December 31, 2016, and 2015, respectively. Lightning Gaming, Inc. and Subsidiaries (Continued) Note 7. Stockholders’ Equity (Continued) Stock Option Plans (Continued) A summary of option transactions in 2016 and 2015 under the 2007 Plan is as follows: The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. Expected volatility is based upon publicly traded companies with similar characteristics. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. There were no options granted during 2016 or 2015. Stock-based compensation expense is recognized in the Statements of Operations based on awards ultimately expected to vest and may be reduced for estimated forfeitures. There was no adjustment in 2016 or 2015 with respect to forfeited awards. The following table summarizes information with respect to stock options outstanding at December 31, 2016 under the 2007 Plan: Lightning Gaming, Inc. and Subsidiaries (Continued) Note 7. Stockholders’ Equity (Continued) Stock Option Plans (Continued) As of December 31, 2016, all compensation costs related to share-based compensation arrangements granted under the 2007 Plan had been fully recognized. Warrants: In accordance with the loans obtained by the Company, the lender previously held warrants to purchase 12,151,385 shares of the Company’s Common Stock at a price of $1.00 per share, expiring at various times from April 2016 through October 2019. The purchase price was subject to adjustment from time to time pursuant to the respective provisions of the warrant agreements. The Company calculated the value of warrants at the time of issuance using a Binomial pricing model. On August 6, 2015, the Company entered into an agreement with CI II in which the entire principal and accrued interest on promissory notes and other related loan agreements outstanding and due to CI II, including the warrants described above, as well as the 4,500,000 shares of Preferred Series A Nonvoting Capital Stock then outstanding, were converted into 181,000 shares of (voting) Common Stock, par value $0.001, and 33,300,000 shares of Nonvoting Common Stock, par value $0.001, of the Company. The following table is a summary of the Company’s warrant activity for the years ended December 31, 2016 and 2015: The fair value of each warrant is estimated using the Binomial pricing model. The following assumptions were used to determine the fair value of the options prior to their termination on August 6, 2015: The fair value of the warrants was recognized currently in earnings and included in other long-term liabilities in the accompanying Balance Sheets prior to conversion. Also, certain notes had contained a right to convert the principal amount of the note and accrued interest into shares of common stock. The Company accounted for the value of the warrants and the debt conversion right in the same manner used for stock-based compensation. In accordance with FASB guidance, warrants and the debt conversion feature are classified within Level 3 because they are valued using the Binomial model. Some of the inputs to these valuations are unobservable in the market and are significant. Lightning Gaming, Inc. and Subsidiaries (Continued) Note 7. Stockholders’ Equity (Continued) Warrants (Continued) The changes in Level 3 liabilities measured at fair value on a recurring basis are summarized as follows: Note 8. Income Taxes The components of the income tax provision (benefit) for the years ended December 31, 2016 and 2015 are as follows: Net deferred tax assets consist of the following components as of December 31, 2016 and 2015: Lightning Gaming, Inc. and Subsidiaries (Continued) Note 8. Income Taxes (Continued) A reconciliation of income tax expense at statutory rates to the income tax expense reported in the Statements of Operations is as follows for the years ended December 31, 2016 and 2015. As of December 31, 2016, the Company has available, for federal and state income tax purposes, net operating loss (“NOL”) carryforwards of approximately $13,548,000, which expire at various times through 2036. As a result of the cancellation of debt and accrued interest on debt on August 6, 2015 and the correction of interest expense previously deferred for tax purposes, the Company recognized an attribute reduction of the NOL carryforward effective January 1, 2016 of approximately $11,978,000, reducing the NOL carryforward available as of that date from $25,104,000 to $13,126,000. The utilization of the NOL carryforwards is dependent upon the ability of the Company to generate sufficient taxable income during the carryforward periods. The NOL carryforwards are also subject to certain limitations on their utilization should changes in Company ownership occur. The Company has not recognized any NOL carryforward benefits or other net deferred tax assets in the current financial statements. Note 9. Related Party Transactions In May 2015, CI II agreed to suspend the accrual of interest on all of the notes outstanding, effective April 1, 2015, in anticipation of entering into an agreement with the Company to convert its debt outstanding into equity. On August 6, 2015, the Company entered into an agreement with CI II in which the entire principal and accrued interest on promissory notes and other related loan agreements outstanding and due to CI II, including warrants to purchase a maximum of 12,151,385 shares of Company stock, as well as the 4,500,000 shares of Preferred Series A Nonvoting Capital Stock then outstanding, were converted into 181,000 shares of the Company’s Common Stock, par value $0.001 per share, and 33,300,000 shares of the Company’s Nonvoting Common Stock, $0.001 par value per share. Upon the conversion, all notes, loans, accrued interest, and warrants due to CI II were terminated in their entirety and all obligations were extinguished. During the twelve months ended December 31, 2016 and 2015, respectively, interest on all of the loans amounted to $-0- and $294,970. During 2015, the Company made no principal or interest payments on those loans and on August 6, 2015, the loans were converted into equity in the transaction as described above. Note 10. Recently Issued Pronouncements In May 2014, the FASB and the International Accounting Standards Board issued converged guidance on recognizing revenue from contracts with customers. The new guidance removes inconsistencies in current revenue recognition requirements, provides a framework for addressing revenue issues, improves comparability of revenue recognition across industries, entities and jurisdictions, and provides more useful information to users of financial statements through improved disclosure requirements. This guidance replaces the numerous GAAP revenue recognition requirements that are industry specific and establishes the principles to report about the nature, timing, and uncertainty of revenue from contracts with customers to users of financial statements. Lightning Gaming, Inc. and Subsidiaries (Continued) Note 10. Recently Issued Pronouncements (Continued) Additions to this update were issued by the FASB and IASB in March 2016, clarifying the operability and understandability on principal versus agent considerations. In April 2016, further clarifications were issued on two aspects: identifying performance obligations and clarifying the licensing implementation guidance. An additional update was issued in May 2016, which included a technical correction, clarifying the objective of assessing the collectability criterion, the presentation of sales and other similar taxes collected from customers, specifying that the measurement date for noncash consideration is at contract inception, and practical guidance for applying contract modifications and completed contracts at the transition date. Additional technical corrections and improvements to clarify and correct unintended application of the guidance were issued in December 2016. These updates do not change the core principles of this guidance but rather provide clarification and implementation within the scope of this topic. The guidance is effective for annual and interim reporting periods beginning after December 15, 2017, and the Company is assessing the impact it will have on our financial statements. In August 2014, the FASB issued guidance regarding disclosures in the presentation of financial statements when the uncertainty exists about an entity’s ability to continue as a going concern. The update provides guidance in GAAP about management’s responsibility to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Along with requiring management’s assessment of the entity’s ability to continue as a going concern, the guidance provides: ● a definition for the term “substantial doubt”; ● requires an evaluation every reporting period including interim periods; ● provides principles for considering the mitigating effect of management’s plans; ● requires certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans; ● requires an express statement and other disclosures when substantial doubt is not alleviated; and ● requires an assessment for a period of one year after the date that the financial statements are issued. The amendment became effective for the annual and interim periods ending after December 15, 2016 and did not have a material impact on our financial statements. In July 2015, the FASB issued an update under the inventory topic which more clearly articulates the requirements for the measurement and disclosure of inventory, stating that an entity should measure inventory at the lower of cost and net realizable value. Net realizable value is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The amendments in this update do not apply to inventory that is measured using last-in, first-out (“LIFO”) or the retail inventory method. The amendment is effective for the fiscal years beginning after December 15, 2016 and interim periods beginning after December 15, 2017. The Company is assessing the impact this guidance may have on our financial statements. In November 2015, the FASB issued an update under the income taxes topic, simplifying the presentation of deferred income taxes, requiring that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. This update aligns the presentation of deferred income tax assets and liabilities with International Financial Reporting Standards (“IFRS”). The amendments in this update are effective for financial statements issued for annual periods beginning after December 15, 2016, and the Company is assessing the impact this guidance may have on our financial statements. Lightning Gaming, Inc. and Subsidiaries (Continued) Note 10. Recently Issued Pronouncements (Continued) In February 2016, the FASB finalized the accounting standard and issued an update under the Leases topic. The update provides for major changes by lessees in that a lessee must recognize on its statement of financial position both an asset (“right-of-use”), representing its right to use the underlying asset, and a lease liability for all leases, other than short-term leases with terms of twelve months or less. The guidance defines a lease as a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. Control over the use of the identified asset means that the customer has both (1) the right to obtain substantially all of the economic benefits from the use of the asset and (2) the right to direct the use of the asset. Differentiation between finance and operating leases still remains however the most notable difference from previous guidance is recognizing the asset and liability on the statement of financial position for operating leases. For finance leases, lessees are required to: 1.Recognize a right-of-use asset and a lease liability in the statement of financial position which is initially measured at the present value of the lease payments; 2.Recognize interest in the statement of comprehensive income on the lease liability separately from amortization of the right-of-use asset; and 3.Classify in the statement of cash flows repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities. For operating leases, lessees are required to: 1.Recognize a right-of-use asset and a lease liability in the statement of financial position which is initially measured at the present value of the lease payments; 2.Recognize a single lease cost, generally allocated over the lease term on a straight-line basis; and 3.Classify all cash payments in the statement of cash flows as operating activities. Under the update, lessor accounting for leases remains largely unchanged providing that lessor accounting is aligned with changes made to the lessee accounting guidance and key aspects under the revenue recognition guidance. The amendments in this update are effective for fiscal and interim periods beginning after December 15, 2018 and the Company is assessing the impact this guidance will have on our financial statements. In March 2016, the FASB issued an update on the stock compensation topic, simplifying several aspects of the accounting for share-based payment transactions, including income tax consequences, balance sheet classification of awards as either equity or liabilities, and statement of cash flows classification. While the amendments in the update are effective for annual and interim periods beginning after December 15, 2016, certain aspects of the amendment, such as those relating to the timing of excess tax benefits recognized, minimum statutory withholding requirements, forfeitures, and cash flow classification must be applied retrospectively. The Company is assessing the impact this guidance will have on our financial statements. Note 11. Subsequent Event On March 8, 2017, the Board of Directors approved by unanimous written consent, the authorization to grant to employees with at least one year of service, non-qualified stock options to purchase 4,015,000 shares of nonvoting common stock of the Company under its 2016 Plan. The options were issued at an exercise price of $.28 per share and vest ratably over five years. The options are subject to the terms and conditions of the 2016 Plan and each individual’s stock option agreement. | Here's a summary of the financial statement:
Financial Position Overview:
- The company has experienced net operating losses and negative cash flows
- Maintains working capital surpluses despite losses
- Recent increase in sales contracts suggests improving conditions
Key Financial Components:
1. Revenue:
- Shows year-end figures for December 31 (specific amounts not provided)
- Sales contracts are increasing
2. Assets:
- Includes current assets and property/equipment
- Property and equipment recorded at cost
- Depreciation calculated using straight-line method (3-5 years)
- Cash maintained in reputable financial institutions
3. Liabilities:
- Manages debt in ordinary course of business
- Maintains accounts payable and accrued expenses
4. Financial Management:
- Uses deferred tax accounting
- Maintains credit risk management through high-quality financial institutions
- Regular evaluation of trade receivables for collectability
Future Outlook:
- Company projects sufficient cash flow for next 12 months
- Success depends on ability to distribute products to casinos and card clubs
- May need supplemental financing, though obtaining it isn't guaranteed
- Continued operation depends on improving business conditions
Risk Factors:
- May need additional funding
- Potential difficulty in obtaining future financing
- Possibility of postponing or discontinuing planned operations if additional funding isn't secured
- Exceeding federally-insured cash balance limits at times | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS See accompanying notes to consolidated financial statements. CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME See accompanying notes to consolidated financial statements. CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME See accompanying notes to consolidated financial statements. CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS See accompanying notes to consolidated financial statements. CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY See accompanying notes to consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note Summary of Significant Accounting Policies Summary of Operations Cass Information Systems, Inc. (the “Company”) provides payment and information services, which include processing and payment of transportation, energy, telecommunications and environmental invoices. These services include the acquisition and management of data, information delivery and financial exchange. The consolidated balance sheet captions, “Accounts and drafts payable” and “Payments in excess of funding,” represent the Company’s resulting financial position related to the payment services that are performed for customers. The Company also provides a full range of banking services to individual, corporate and institutional customers through Cass Commercial Bank (the “Bank”), its wholly owned bank subsidiary. Basis of Presentation The accounting and reporting policies of the Company and its subsidiaries conform to U.S. generally accepted accounting principles (“GAAP”). The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries after elimination of intercompany transactions. Certain amounts in the 2015 and 2014 consolidated financial statements have been reclassified to conform to the 2016 presentation. Such reclassifications have no effect on previously reported net income or shareholders’ equity. Use of Estimates In preparing the consolidated financial statements, Company management is required to make estimates and assumptions which significantly affect the reported amounts in the consolidated financial statements. Cash and Cash Equivalents For purposes of the consolidated statements of cash flows, the Company considers cash and due from banks, interest-bearing deposits in other financial institutions, federal funds sold and other short-term investments as segregated in the accompanying consolidated balance sheets to be cash equivalents. Investment in Debt Securities The Company classifies its debt marketable securities as available-for-sale. Securities classified as available-for-sale are carried at fair value. Unrealized gains and losses, net of the related tax effect, are excluded from earnings and reported in accumulated other comprehensive income, a component of shareholders’ equity. A decline in the fair value of any available-for-sale security below cost that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security. To determine whether impairment is other than temporary, the Company considers guidance provided in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 320 - Investments - Debt and Equity Securities. When determining whether a debt security is other-than-temporarily impaired, the Company assesses whether it has the intent to sell the security and whether it is more likely than not that the Company will be required to sell prior to recovery of the amortized cost basis. Evidence considered in this assessment includes the reasons for impairment, the severity and duration of the impairment, changes in value subsequent to year-end and forecasted performance of the investee. Premiums and discounts are amortized or accreted to interest income over the estimated lives of the securities using the level-yield method. Interest income is recognized when earned. Gains and losses are calculated using the specific identification method. Allowance for Loan Losses (ALLL) The ALLL is increased by provisions charged to expense and is available to absorb charge-offs, net of recoveries. Management utilizes a systematic, documented approach in determining the appropriate level of the ALLL. Management’s approach provides for estimated credit losses on individually evaluated loans in accordance with FASB ASC 310 - Allowance for Credit Losses (“ASC 310”). These estimates are based upon a number of factors, such as payment history, financial condition of the borrower, expected future cash flows and discounted collateral exposure. Estimated credit losses inherent in the remainder of the portfolio are estimated in accordance with FASB ASC 450 - Contingencies. These loans are segmented into groups based on similar risk characteristics. Historical loss rates for each risk group, which are updated quarterly, are generally quantified using all recorded loan charge-offs and recoveries over a prescribed look-back period. These historical loss rates for each risk group are used as the starting point to determine the level of the allowance. The Company’s methodology incorporates an estimated loss emergence period for each risk group. The loss emergence period is the period of time from when a borrower experiences a loss event and when the actual loss is recognized in the financial statements, generally at the time of initial charge-off of the loan balance. The Company’s methodology also includes qualitative risk factors that allow management to adjust its estimates of losses based on the most recent information available and to address other limitations in the quantitative component that is based on historical loss rates. Such risk factors are generally reviewed and updated quarterly, as appropriate, and are adjusted to reflect changes in national and local economic conditions and developments, the volume and severity of delinquent and internally classified loans, loan concentrations, assessment of trends in collateral values, assessment of changes in borrowers’ financial stability, and changes in lending policies and procedures, including underwriting standards and collections, charge-off and recovery practices. Management believes the ALLL is adequate to absorb probable losses in the loan portfolio. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s ALLL. Such agencies may require the Company to increase the ALLL based on their judgments and interpretations about information available to them at the time of their examinations. Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed over the estimated useful lives of the assets, or the respective lease terms for leasehold improvements, using straight-line and accelerated methods. Estimated useful lives do not exceed 40 years for buildings, the lesser of 10 years or the life of the lease for leasehold improvements and range from 3 to 7 years for software, equipment, furniture and fixtures. Maintenance and repairs are charged to expense as incurred. Intangible Assets Cost in excess of fair value of net assets acquired has resulted from business acquisitions. Goodwill and intangible assets with indefinite useful lives are not amortized, but instead are tested for impairment at least annually. Intangible assets with definite useful lives are amortized on a straight-line basis over their respective estimated useful lives. Periodically, the Company reviews intangible assets for events or changes in circumstances that may indicate that the carrying amount of the assets may not be recoverable. Based on those reviews, adjustments of recorded amounts have not been required. Non-marketable Equity Investments The Company accounts for non-marketable equity investments, in which it holds less than a 20% ownership, under the cost method. Under the cost method of accounting, investments are carried at cost and are adjusted only for other than temporary declines in fair value, distributions of earnings and additional investments. The Company periodically evaluates whether any declines in fair value of its investments are other than temporary. In performing this evaluation, the Company considers various factors including any decline in market price, where available, the investee's financial condition, results of operations, operating trends and other financial ratios. Non-marketable equity investments are included in other assets on the consolidated balance sheets. Foreclosed Assets Real estate acquired as a result of foreclosure is initially recorded at fair value less estimated selling costs. Fair value is generally determined through the receipt of appraisals. Any write down to fair value at the time the property is acquired is recorded as a charge-off to the allowance for loan losses. Any decline in the fair value of the property subsequent to acquisition is recorded as a charge to non-interest expense. Treasury Stock Purchases of the Company’s common stock are recorded at cost. Upon reissuance, treasury stock is reduced based upon the average cost basis of shares held. Comprehensive Income Comprehensive income consists of net income, changes in net unrealized gains (losses) on available-for-sale securities and pension liability adjustments and is presented in the accompanying consolidated statements of shareholders' equity and consolidated statements of comprehensive income. Loans Interest on loans is recognized based upon the principal amounts outstanding. It is the Company’s policy to discontinue the accrual of interest when there is reasonable doubt as to the collectability of principal or interest. Subsequent payments received on such loans are applied to principal if there is any doubt as to the collectability of such principal; otherwise, these receipts are recorded as interest income. The accrual of interest on a loan is resumed when the loan is current as to payment of both principal and interest and/or the borrower demonstrates the ability to pay and remain current. Loan origination and commitment fees on originated loans, net of certain direct loan origination costs, are deferred and amortized to interest income using the level-yield method over the estimated lives of the related loans. Impairment of Loans A loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan agreement. When measuring impairment, the expected future cash flows of an impaired loan are discounted at the loan's effective interest rate. Alternatively, impairment could be measured by reference to an observable market price, if one exists, or the fair value of the collateral for a collateral-dependent loan. Regardless of the historical measurement method used, the Company measures impairment based on the fair value of the collateral when the Company determines foreclosure is probable. Additionally, impairment of a restructured loan is measured by discounting the total expected future cash flows at the loan's effective rate of interest as stated in the original loan agreement. The Company uses its nonaccrual methods as discussed above for recognizing interest on impaired loans. Information Services Revenue A majority of the Company’s revenues are attributable to fees for providing services. These services include transportation invoice rating, payment processing, auditing, and the generation of accounting and transportation information. The Company also processes, pays and generates management information from electric, gas, telecommunications, environmental, and other invoices. The specific payment and information processing services provided to each customer are developed individually to meet each customer’s specific requirements. The Company enters into service agreements with customers typically for fixed fees per transaction that are invoiced monthly. Revenues are recognized in the period services are rendered and earned under the service agreements, as long as collection is reasonably assured. Income Taxes Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced if necessary, by a deferred tax asset valuation allowance. In the event that management determines it is more likely than not that it will not be able to realize all or part of net deferred tax assets in the future, the Company adjusts the recorded value of deferred tax assets, which would result in a direct charge to income tax expense in the period that such determination is made. Likewise, the Company will reverse the valuation allowance when realization of the deferred tax asset is expected. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Earnings Per Share Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net income by the sum of the weighted average number of common shares outstanding and the weighted average number of potential common shares outstanding. Stock-Based Compensation The Company follows FASB ASC 718 - Accounting for Stock Options and Other Stock-based Compensation (“ASC 718”), which requires that all stock-based compensation be recognized as an expense in the financial statements and that such cost be measured at the fair value of the award. FASB ASC 718 also requires that excess tax benefits related to stock option exercises and restricted stock awards be reflected as financing cash inflows instead of operating cash inflows. Pension Plans The amounts recognized in the consolidated financial statements related to pension are determined from actuarial valuations. Inherent in these valuations are assumptions including expected return on plan assets, discount rates at which the liabilities could be settled at December 31, 2016, rate of increase in future compensation levels and mortality rates. These assumptions are updated annually and are disclosed in Note 10. The Company follows FASB ASC 715 - Compensation - Retirement Benefits (“ASC 715”), which requires companies to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its consolidated balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The funded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation as of the date of its fiscal year-end. Fair Value Measurements The Company follows the provisions of FASB ASC 820 - Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in GAAP, and outlines disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A three-level hierarchy for valuation techniques is used to measure financial assets and financial liabilities at fair value. This hierarchy is based on whether the valuation inputs are observable or unobservable. Financial instrument valuations are considered Level 1 when they are based on quoted prices in active markets for identical assets or liabilities. Level 2 financial instrument valuations use quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data. Financial instrument valuations are considered Level 3 when they are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable, and when determination of the fair value requires significant management judgment or estimation. The Company records securities available for sale at their fair values on a recurring basis using Level 2 valuations. Additionally, the Company records impaired loans and other real estate owned at their fair value on a nonrecurring basis. The nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or impairment write-downs of individual assets. Impact of New and Not Yet Adopted Accounting Pronouncements In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09 - Revenue from Contracts with Customers. The ASU supersedes revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance in the FASB Accounting Standards Codification. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance identifies specific steps that entities should apply in order to achieve this principle. Under the ASU, the amendments are effective for interim and annual periods beginning January 1, 2018 and must be applied retrospectively. The impact of the adoption of this ASU is currently being evaluated but is not expected to have a material impact on the Company’s consolidated financial statements or results of operations. In February 2016, the FASB issued ASU No. 2016-02 - Leases (ASC Topic 842). The ASU improves financial reporting about leasing transactions. The ASU affects all companies and other organizations that lease assets such as real estate, airplanes, and manufacturing equipment. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP-which requires only capital leases to be recognized on the balance sheet-the new ASU will require both types of leases to be recognized on the balance sheet. The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements. The ASU will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The impact of the adoption of this ASU is currently being evaluated but is not expected to have a material impact on the Company’s consolidated financial statements or results of operations. In March 2016, the FASB issued ASU No. 2016-09 - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU will simplify the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This standard is effective for fiscal periods beginning after December 15, 2016. The impact of the adoption of this ASU is currently being evaluated. In June 2016, the FASB issued ASU No. 2016-13 - Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU requires measurement and recognition of expected credit losses for financial assets held. Under this standard, a company will be required to hold an allowance equal to the expected life-of-loan losses on the loan portfolio. The standard is effective for fiscal periods beginning after December 15, 2019. The impact of the adoption of this ASU is currently being evaluated. Note 2 Capital Requirements and Regulatory Restrictions The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulators to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier I capital and common equity Tier I capital to risk-weighted assets, and of Tier I capital to average assets. Management believes that as of December 31, 2016 and 2015, the Company and the Bank met all capital adequacy requirements to which they are subject. Effective July 2, 2013, the Federal Reserve Board approved final rules known as the “Basel III Capital Rules” that substantially revise the risk-based capital and leverage capital requirements applicable to bank holding companies and depository institutions, including the Company and the Bank. The Basel III Capital Rules implement aspects of the Basel III capital framework agreed upon by the Basel Committee and incorporate changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Among other things, the Basel III Capital Rules establish stricter capital requirements and calculation standards, as well as more restrictive risk weightings for certain loans and facilities. The Basel III Capital Rules were effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period). The Bank is also subject to the regulatory framework for prompt corrective action. As of December 31, 2016, the most recent notification from the regulatory agencies categorized the Bank as well-capitalized. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, common equity Tier I risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category. Subsidiary dividends can be a significant source of funds for payment of dividends by the Company to its shareholders. At December 31, 2016, unappropriated retained earnings of $26,374,000 were available at the Bank for the declaration of dividends to the Company without prior approval from regulatory authorities. However, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements. There were no restricted funds on deposit used to meet regulatory reserve requirements at December 31, 2016 and 2015. The Company’s and the Bank’s actual and required capital amounts and ratios are as follows: Note 3 Investment in Securities Investment securities available-for-sale are recorded at fair value on a recurring basis. The Company’s investment securities available-for-sale at December 31, 2016 and 2015 are measured at fair value using Level 2 valuations. The market evaluation utilizes several sources which include “observable inputs” rather than “significant unobservable inputs” and therefore falls into the Level 2 category. The table below presents the balances of securities available-for-sale measured at fair value on a recurring basis. The amortized cost, gross unrealized gains, gross unrealized losses and fair value of debt and equity securities are summarized as follows: The fair values of securities with unrealized losses are as follows: There were 108 securities, or 31% of the total, (none greater than 12 months) in an unrealized loss position as of December 31, 2016 compared to 5 securities (1 greater than 12 months) in an unrealized loss position as of December 31, 2015. All unrealized losses are reviewed to determine whether the losses are other than temporary. Management believes that all unrealized losses are temporary since they are market driven, the Company does not have the intent to sell the security, and it is more likely than not that the Company will not be required to sell prior to recovery of the amortized basis. The amortized cost and fair value of debt and equity securities by contractual maturity are shown in the following table. Expected maturities may differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties. The premium related to the purchase of state and political subdivisions was $5,749,000 and $5,443,000 in 2016 and 2015, respectively. The amortized cost of debt securities pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes at December 31, 2016 and 2015 was $3,750,000 and $3,750,000, respectively. Proceeds from sales of debt securities classified as available-for-sale were $21,491,000 in 2016, $99,347,000 in 2015, and $587,000 in 2014. Gross realized gains on the sales in 2016, 2015 and 2014 were $387,000, $2,910,000, and $23,000, respectively. There were no gross realized losses on sales in 2016, 2015 or 2014. Note 4 Loans The Company originates commercial, industrial and real estate loans to businesses and churches throughout the metropolitan St. Louis, Missouri area, Orange County, California and other selected cities in the United States. The Company does not have any particular concentration of credit in any one economic sector; however, a substantial portion of the commercial and industrial loans is extended to privately-held commercial companies in these market areas, and are generally secured by the assets of the business. The Company also has a substantial portion of real estate loans secured by mortgages that are extended to churches in its market area and selected cities in the United States. A summary of loan categories is as follows: The following table presents the aging of loans by loan categories at December 31, 2016: The following table presents the aging of loans by loan categories at December 31, 2015: The following table presents the credit exposure of the loan portfolio by internally assigned credit grade as of December 31, 2016: Loans subject to normal monitoring involve borrowers of acceptable-to-strong credit quality and risk, who have the apparent ability to satisfy their loan obligation. Loans subject to special monitoring possess some credit deficiency or potential weakness which requires a high level of management attention. The following table presents the credit exposure of the loan portfolio by internally assigned credit grade as of December 31, 2015: Loans subject to normal monitoring involve borrowers of acceptable-to-strong credit quality and risk, who have the apparent ability to satisfy their loan obligation. Loans subject to special monitoring possess some credit deficiency or potential weakness which requires a high level of management attention. Impaired loans consist primarily of nonaccrual loans, loans greater than 90 days past due and still accruing interest and troubled debt restructurings, both performing and non-performing. Troubled debt restructuring involves the granting of a concession to a borrower experiencing financial difficulty resulting in the modification of terms of the loan, such as changes in payment schedule or interest rate. The ALLL related to impaired loans was $0 and $1,142,000 at December 31, 2016 and 2015, respectively. Nonaccrual loans were $245,000 and $3,135,000 at December 31, 2016 and 2015, respectively. Loans delinquent 90 days or more and still accruing interest were $0 at December 31, 2016 and 2015. At December 31, 2016 and 2015, there were no loans classified as troubled debt restructuring. The average balances of impaired loans during 2016, 2015 and 2014 were $333,000, $3,188,000, and $1,262,000, respectively. Income that would have been recognized on non-accrual loans under the original terms of the contract was $66,000, $390,000 and $108,000 for 2016, 2015 and 2014, respectively. Income that was recognized on nonaccrual loans was $47,000, $34,000 and $77,000 for 2016, 2015 and 2014 respectively. There were no foreclosed assets as of December 31, 2016 and December 31, 2015. The following table presents the recorded investment and unpaid principal balance for impaired loans at December 31, 2016: The following table presents the recorded investment and unpaid principal balance for impaired loans at December 31, 2015: The Company does not record loans at fair value on a recurring basis. Once a loan is identified as impaired, management measures impairment in accordance with FASB ASC 310. At December 31, 2016, impaired loans were evaluated based on the present value of expected future cash flow. At December 31, 2015, all impaired loans were evaluated based on the fair value of the collateral and the expected cash flow method. The fair value of the collateral is based upon an observable market price or current appraised value and therefore, the Company classifies these assets as nonrecurring Level 3. A summary of the activity in the allowance for loan losses is as follows: As of December 31, 2016, there were no loans to affiliates of executive officers or directors. Note 5 Premises and Equipment A summary of premises and equipment is as follows: Total depreciation charged to expense in 2016, 2015 and 2014 amounted to $3,245,000, $3,008,000 and $2,613,000, respectively. The Company and its subsidiaries lease various premises and equipment under operating lease agreements which expire at various dates through 2023. Rental expense for 2016, 2015 and 2014 was $1,397,000, $1,387,000 and $1,405,000, respectively. The following is a schedule, by year, of future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2016: Note 6 Acquired Intangible Assets The Company accounts for intangible assets in accordance with FASB ASC 350 - Goodwill and Other Intangible Assets (“ASC 350”), which requires that intangibles with indefinite useful lives be tested annually for impairment and those with finite useful lives be amortized over their useful lives. Details of the Company’s intangible assets are as follows: The customer lists are amortized over seven and ten years; the patents over eight years, the non-compete agreements over five years, software over three years and other intangible assets over fifteen years. Amortization of intangible assets amounted to $408,000, $408,000 and $483,000 for the years ended December 31, 2016, 2015 and 2014, respectively. Estimated future amortization of intangibles is $356,000 in each of 2017, 2018, 2019, 2020 and 2021. Note 7 Interest-Bearing Deposits Interest-bearing deposits consist of the following: Interest on deposits consists of the following: The scheduled maturities of time deposits are summarized as follows: Note 8 Unused Available Lines of Credit As of December 31, 2016, the Bank had unsecured lines of credit at correspondent banks to purchase federal funds up to a maximum of $78,000,000 at the following banks: Bank of America, $10,000,000; US Bank, $20,000,000; Wells Fargo Bank, $15,000,000; PNC Bank, $12,000,000; Frost National Bank, $10,000,000; JPM Chase Bank, $6,000,000; and UMB Bank $5,000,000. As of December 31, 2016, the Bank had secured lines of credit with the Federal Home Loan Bank (“FHLB”) of $205,768,000 collateralized by commercial mortgage loans. At December 31, 2016, the Company had a line of credit from UMB Bank of $50,000,000 and First Tennessee Bank of $50,000,000 collateralized by state and political subdivision securities. There were no amounts outstanding under any of the lines of credit discussed above at December 31, 2016 or 2015. Note 9 Common Stock and Earnings per Share The table below shows activity in the outstanding shares of the Company’s common stock during 2016. Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net income by the sum of the weighted average number of common shares outstanding and the weighted average number of potential common shares outstanding. Under the treasury stock method, stock appreciation rights (“SARs”) are dilutive when the average market price of the Company’s common stock, combined with the effect of any unamortized compensation expense, exceeds the SAR price during a period. Anti-dilutive shares are those SARs with prices in excess of the current market value. The calculations of basic and diluted earnings per share are as follows: Note 10 Employee Benefit Plans Defined Benefit Plan The Company has a noncontributory defined-benefit pension plan (the “Plan”), which covers most of its employees. Effective December 31, 2016, the Plan was closed to all new participants. The Company accrues and makes contributions designed to fund normal service costs on a current basis using the projected unit credit with service proration method to amortize prior service costs arising from improvements in pension benefits and qualifying service prior to the establishment of the Plan over a period of approximately 30 years. A summary of the activity in the Plan’s projected benefit obligation, assets, funded status and amounts recognized in the Company’s consolidated balance sheets is as follows: The following represent the major assumptions used to determine the projected benefit obligation of the Plan. For 2016, 2015 and 2014, the Plan’s expected benefit cash flows were discounted using the Citibank Above Median Curve. For 2016, the RP-2014 Mortality Table and the MP-2016 Mortality Improvement Table were used. For 2015, the RP-2014 Mortality Table and MP-2015 Mortality Improvement Table were used. For 2014, the RP-2014 Mortality Table and MP-2014 Mortality Improvement Table were used. The accumulated benefit obligation was $74,425,000 and $68,321,000 as of December 31, 2016 and 2015, respectively. The Company does not expect to make a contribution to the Plan in 2017. The following pension benefit payments, which reflect expected future service, as appropriate, are expected to be paid by the Plan: The Plan’s pension cost included the following components: The following represent the major assumptions used to determine the net pension cost of the Plan: For 2016, the RP-2014 Mortality Table and the MP-2016 Mortality Improvement Table were used. For 2015, the RP-2014 Mortality Table and the MP-2015 Mortality Improvement Table were used. For 2014, the RP-2010 Mortality Tables and the AA Mortality Improvement scale were used. The investment objective for the Plan is to maximize total return with a tolerance for average risk. Asset allocation is a balance between fixed income and equity investments, with a target allocation of approximately 48% fixed income, 36% U.S. equity and 16% non-U.S. equity. Due to volatility in the market, this target allocation is not always desirable and asset allocations can fluctuate between acceptable ranges. The fixed income component is invested in pooled investment grade securities. The equity components are invested in pooled large cap, small/mid cap and non-U.S. stocks. The expected one-year nominal returns and annual standard deviations are shown by asset class below: Applying appropriate correlation factors between each of the asset classes the long-term rate of return on assets is estimated to be 6.50%. A summary of the fair value measurements by type of asset is as follows: Supplemental Executive Retirement Plan The Company also has an unfunded supplemental executive retirement plan (“SERP”) which covers key executives of the Company whose benefits are limited by the IRS under the Company’s qualified retirement plan. The SERP is a noncontributory plan in which the Company’s subsidiaries make accruals designed to fund normal service costs on a current basis using the same method and criteria as the Plan. A summary of the activity in the SERP’s projected benefit obligation, funded status and amounts recognized in the Company’s consolidated balance sheets is as follows: The following represent the major assumptions used to determine the projected benefit obligation of the SERP. For 2016, 2015 and 2014, the SERP’s expected benefit cash flows were discounted using the Citigroup Above Median Curve. The accumulated benefit obligation was $7,904,000 and $7,482,000 as of December 31, 2016 and 2015, respectively. Since this is an unfunded plan, there are no plan assets. Benefits paid were $247,000 in 2016, $243,000 in 2015 and $236,000 in 2014. Expected future benefits payable by the Company over the next ten years are as follows: The SERP’s pension cost included the following components: The pretax amounts in accumulated other comprehensive loss as of December 31 were as follows: The estimated pretax prior service cost and net actuarial loss in accumulated other comprehensive loss at December 31, 2016 expected to be recognized as components of net periodic benefit cost in 2017 for the Plan are $0 and $1,328,000, respectively. The estimated pretax prior service cost and net actuarial loss in accumulated other comprehensive loss at December 31, 2016 expected to be recognized as components of net periodic benefit cost in 2017 for the SERP are $0 and $323,000, respectively. The Company also maintains a noncontributory profit sharing program, which covers most of its employees. Employer contributions are calculated based upon formulas which relate to current operating results and other factors. Profit sharing expense recognized in the consolidated statements of income in 2016, 2015 and 2014 was $5,367,000, $5,211,000, and $5,298,000, respectively. The Company also sponsors a defined contribution 401(k) plan to provide additional retirement benefits to substantially all employees. Contributions under the 401(k) plan for 2016, 2015 and 2014 were $658,000, $623,000, and $584,000, respectively. Note 11 Stock-based Compensation The Amended and Restated Omnibus Stock and Performance Compensation Plan (the “Omnibus Plan”) provides incentive opportunities for key employees and non-employee directors and to align the personal financial interests of such individuals with those of the Company’s shareholders. The Omnibus Plan permits the issuance of up to 1,500,000 shares of the Company’s common stock in the form of stock options, SARs, restricted stock, restricted stock units and performance awards. Restricted Stock Restricted shares granted prior to April 16, 2013 are amortized to expense over the three-year vesting period. Beginning on April 16, 2013, restricted shares granted to Company employees are amortized to expense over the three-year vesting period whereas restricted shares granted to members of the Board of Directors are amortized to expense over a one-year service period with the exception of those shares granted in lieu of cash payment for retainer fees which are expensed in the period earned. Changes in restricted shares outstanding for the year ended December 31, 2016 were as follows: During 2015 and 2014, 42,786 and 22,629 shares, respectively, were granted with weighted average per share market values at date of grant of $51.04 in 2015 and $58.89 in 2014. The fair value of such shares, which is based on the market price on the date of grant, is amortized to expense over the three-year vesting period whereas restricted shares granted to members of the Board of Directors are amortized to expense over a one-year period. Amortization of the restricted stock bonus awards totaled $1,712,000 for 2016, $1,514,000 for 2015 and $1,250,000 for 2014. As of December 31, 2016, the total unrecognized compensation expense related to non-vested restricted stock awards was $1,688,000 and the related weighted average period over which it is expected to be recognized is approximately 0.58 years. The total fair value of shares vested during the years ended December 2016, 2015, and 2014 was $1,500,000, $1,089,000, and $1,066,000, respectively. SARs There were no SARs granted during the year ended December 31, 2016. The Company uses the Black-Scholes option-pricing model to determine the fair value of the SARs at the date of grant. During 2016, the Company recognized SARs expense of $247,000. As of December 31, 2016, the total unrecognized compensation expense related to SARs was $18,000, and the related weighted average period over which it is expected to be recognized is .08 years. Changes in SARs outstanding for the year ended December 31, 2016 were as follows: The total intrinsic value of SARs exercised during 2016 and 2015 was $2,162,000 and $1,268,000, respectively. The average remaining contractual term for SARs outstanding as of December 31, 2016 was 5.22 years, and the aggregate intrinsic value was $8,395,000. The average remaining contractual term for SARs exercisable as of December 31, 2015 was 5.99 years, and the aggregate intrinsic value was $4,577,000. The total compensation cost for share-based payment arrangements was $1,959,000, $2,059,000, and $2,042,000 in 2016, 2015, and 2014, respectively. Note 12 Other Operating Expense Details of other operating expense are as follows: Note 13 Income Taxes The components of income tax expense (benefit) are as follows: A reconciliation of expected income tax expense (benefit), computed by applying the effective federal statutory rate of 35% for each of 2016, 2015 and 2014 to income before income tax expense is as follows: The tax effects of temporary differences which give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below: A valuation allowance would be provided on deferred tax assets when it is more likely than not that some portion of the assets will not be realized. The Company has not established a valuation allowance at December 31, 2016 or 2015, due to management’s belief that all criteria for recognition have been met, including the existence of a history of taxes paid sufficient to support the realization of deferred tax assets. The reconciliation of the beginning unrecognized tax benefits balance to the ending balance is presented in the following table: At December 31, 2016, 2015 and 2014, the balance of the Company’s unrecognized tax benefits which would, if recognized, affect the Company’s effective tax rate was $1,225,000, $861,000 and $819,000, respectively. These amounts are net of the offsetting benefits from other taxing jurisdictions. As of December 31, 2016, 2015 and 2014, the Company had $108,000, $54,000 and $45,000, respectively, in accrued interest related to unrecognized tax benefits. During 2016 and 2015, the Company recorded a net increase in accrued interest of $54,000 and $9,000, respectively, as a result of settlements with taxing authorities and other prior-year adjustments. The Company believes it is reasonably possible that the total amount of tax benefits will decrease by approximately $223,000 over the next twelve months. The reduction primarily relates to the anticipated lapse in the statute of limitations. The unrecognized tax benefits relate primarily to apportionment of taxable income among various state tax jurisdictions. The Company is subject to income tax in the U.S. federal jurisdiction, numerous state jurisdictions, and a foreign jurisdiction. The Company’s federal income tax returns for tax years 2013 through 2015 remain subject to examination by the Internal Revenue Service. In addition, the Company is subject to state tax examinations for the tax years 2012 through 2015. Note 14 Contingencies The Company and its subsidiaries are not involved in any pending proceedings other than ordinary routine litigation incidental to their businesses. Management believes none of these proceedings, if determined adversely, would have a material effect on the business or financial condition of the Company or its subsidiaries. Note 15 Disclosures about Fair Value of Financial Instruments The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commercial letters of credit and standby letters of credit. The Company’s maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, commercial letters of credit and standby letters of credit is represented by the contractual amounts of those instruments. At December 31, 2016 and 2015, no amounts have been accrued for any estimated losses for these instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These off-balance sheet financial instruments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The approximate remaining terms of commercial and standby letters of credit range from less than one to five years. Since these financial instruments may expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. Commitments to extend credit and letters of credit are subject to the same underwriting standards as those financial instruments included on the consolidated balance sheets. The Company evaluates each customer’s credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of the credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but is generally accounts receivable, inventory, residential or income-producing commercial property or equipment. In the event of nonperformance, the Company may obtain and liquidate the collateral to recover amounts paid under its guarantees on these financial instruments. The following table shows conditional commitments to extend credit, standby letters of credit and commercial letters: The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counterparties drawing on such financial instruments and the present credit worthiness of such counterparties. The Company believes such commitments have been made at terms which are competitive in the markets in which it operates; however, no premium or discount is offered thereon. Following is a summary of the carrying amounts and fair values of the Company’s financial instruments: The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and Cash Equivalents The carrying amount approximates fair value. Investment in Securities The fair value is measured on a recurring basis using Level 2 valuations. Refer to Note 3, “Investment in Securities,” for fair value and unrealized gains and losses by investment type. Loans The fair value is estimated using present values of future cash flows discounted at risk-adjusted interest rates for each loan category designated by management and is therefore a Level 3 valuation. Management believes that the risk factor embedded in the interest rates along with the allowance for loan losses results in a fair valuation. Impaired loans are valued using the fair value of the collateral which is based upon an observable market price or current appraised value and therefore, the fair value is a nonrecurring Level 3 valuation. Accrued Interest Receivable The carrying amount approximates fair value. Deposits The fair value of demand deposits, savings deposits and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities and therefore, is a Level 2 valuation. The fair value estimates above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market or the benefit derived from the customer relationship inherent in existing deposits. Accounts and Drafts Payable The carrying amount approximates fair value. Accrued Interest The carrying amount approximates fair value. Limitations Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets or liabilities that are not considered financial assets or liabilities include premises and equipment and the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market (core deposit intangible). In addition, tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates. Note 16 Industry Segment Information The services provided by the Company are classified into two reportable segments: Information Services and Banking Services. Each of these segments provides distinct services that are marketed through different channels. They are managed separately due to their unique service, processing and capital requirements. The Information Services segment provides transportation, energy, telecommunication, and environmental invoice processing and payment services to large corporations. The Banking Services segment provides banking services primarily to privately held businesses and churches. The Company’s accounting policies for segments are the same as those described in Note 1 of this report. Management evaluates segment performance based on net income after allocations for corporate expenses and income taxes. Transactions between segments are accounted for at what management believes to be fair value. Substantially all revenue originates from and all long-lived assets are located within the United States, and no revenue from any customer of any segment exceeds 10% of the Company’s consolidated revenue. Assets represent actual assets owned by Information Services and Banking Services and there is no allocation methodology used. Loans are sold by Banking Services to Information Services to create liquidity when the Bank’s loan to deposit ratio is greater than 100%. Segment interest from customers is the actual interest earned on the loans owned by Information Services and Banking Services, respectively. Summarized information about the Company’s operations in each industry segment for the years ended December 31, 2016, 2015 and 2014, is as follows: Note Subsequent Events In accordance with FASB ASC 855 - Subsequent Events, the Company has evaluated subsequent events after the consolidated balance sheet date of December 31, 2016, and there were no events identified that would require additional disclosures to prevent the Company’s consolidated financial statements from being misleading. Note 18 Condensed Financial Information of Parent Company Following are the condensed balance sheets of the Company (parent company only) and the related condensed statements of income and cash flows. Note 19 SUPPLEMENTARY FINANCIAL INFORMATION (Unaudited) Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders Cass Information Systems, Inc.: We have audited the accompanying consolidated balance sheets of Cass Information Systems, Inc. and subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, cash flows, and shareholders’ equity for each of the years in the three year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cass Information Systems, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 8, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ KPMG LLP St. Louis, Missouri March 8, 2017 | Here's a summary of the financial statement:
1. Profit/Loss:
- Measured through net income or shareholders' equity
- Management must make estimates that significantly impact reported amounts
2. Assets & Cash:
- Cash equivalents include: cash from banks, interest-bearing deposits, federal funds, and short-term investments
- Investment securities are classified as available-for-sale and carried at fair value
- Unrealized gains/losses are reported in comprehensive income
3. Expenses & Tax:
- Tax liabilities are based on differences between financial statement amounts and tax bases
- Deferred tax assets/liabilities use enacted tax rates
- Earnings per share calculated by dividing net income by weighted average shares
- Company follows FASB ASC 718 for stock-based compensation
4. Liabilities:
- Debt securities classified as available-for-sale
- Carried at fair value
- Impairment assessments follow FASB ASC Topic 320 guidelines
- Temporary declines in value reported in shareholders' equity
The statement follows standard accounting practices with a focus on proper classification of securities, tax handling, and transparent reporting of gains and losses. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NEWGIOCO GROUP, INC. CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2016 and 2015 CONTENTS ACCOUNTING FIRM To the Board of Directors and Stockholders of Newgioco Group, Inc. Toronto, Ontario, Canada We have audited the accompanying consolidated balance sheet of Newgioco Group, Inc. (Formerly Empire Global Corp.) and subsidiaries (the "Company") as of December 31, 2015 and the related consolidated statements of comprehensive loss, changes in stockholders' equity (deficiency), and cash flows for the year then ended. The Company's management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audits of the consolidated financial statements include examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2015 and the results of their operations and cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the accompanying consolidated financial statements, the Company had working capital deficit of $1,592,439 as of December 31, 2015, did not generate cash flow from operation and reported operating losses for the past two years. There are no assurances that management will be successful in achieving sufficient cash flows to fund the Company's working capital needs, or whether the Company will be able to refinance or renegotiate its obligations when they become due or raise additional capital through future debt or equity. These circumstances, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Paritz & Company, P.A Hackensack, New Jersey April 14, 2016 ACCOUNTING FIRM PITAGORA Corso Matteotti, 21 - 10121 Torino Revisione Tel. +39 011 51.78.602 r.s. - Fax +39 011 51.89.491 e-mail: [email protected] Via Pagano, 56 - 20145 Milano Tel. +39 02 439.11.617 r.s. - Fax +39 02 439.16.332 e-mail: [email protected] To the Board of Directors and Stockholders of Newgioco Group Inc. Toronto, Ontario We have audited the accompanying consolidated balance sheet of Newgioco Group Inc. and subsidiaries (the "Company") as of December 31, 2016 and the related consolidated financial statements of comprehensive loss, stockholders' equity (deficiency), and cash flows for the year then ended. The Company's management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audit of the consolidated financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statements presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2016 and the result of its operations and cash flows for each the year then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As shown in Note 2 to the accompanying consolidated financial statements, the Company had working capital deficit of $1,402,563 as of December 31, 2016, did not generate cash flow from operation and reported operating losses for the past two years. There are no assurances that management will be successful in achieving sufficient cash flows to fund the Company's working capital needs, or whether the Company will be able to refinance or renegotiate its obligations when they become due or raise additional capital through future debt or equity. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Pitagora Revisione S.r.l. /s/ Roberto Seymandi Roberto Seymandi, Partner Turin, Italy April 7, 2017 NEWGIOCO GROUP, INC. Consolidated Balance Sheets See notes to consolidated financial statements NEWGIOCO GROUP, INC. Consolidated Statements of Comprehensive Loss See notes to consolidated financial statements NEWGIOCO GROUP, INC. Consolidated Statements of Changes in Stockholders' Equity (Deficiency) See notes to consolidated financial statements NEWGIOCO GROUP, INC. Statement of Cash Flows See notes to consolidated financial statements 1. Basis of Presentation and Nature of Business Nature of Business Newgioco Group, Inc. ("Newgioco Group" or "the Company") was incorporated in the state of Delaware on August 26, 1998 as Pender International Inc. On September 30, 2005 the Company changed its name to Empire Global Corp., and on July 20, 2016 the Company changed its name to Newgioco Group, Inc. The Company maintains its principal executive offices headquartered in Toronto, Canada. The Company provides web-based and land-based gaming services through its wholly owned subsidiaries in Italy and Austria. The Company’s subsidiaries include: Multigioco Srl (“Multigioco”) which was acquired on August 15, 2014, Rifa Srl (“Rifa”) which was acquired on January 1, 2015, as well as Ulisse Gmbh (“Ulisse”) and Odissea Betriebsinformatik Beratung Gmbh (“Odissea”) which were both acquired on July 1, 2016. Newgioco Group is now a vertically integrated company offering a complete suite of gaming services including a variety of online and offline lottery and casino gaming, as well as sports betting through a retail distribution of leisure betting locations situated throughout Italy, in addition to operating a proprietary Betting Operating System (“BOS”). 2. Going concern The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business. The Company had a working capital deficit of $1,402,563 as of December 31, 2016, and reported operating losses for the past two years. There are no assurances that management will be successful in achieving sufficient cash flows to fund the Company's working capital needs, or whether the Company will be able to refinance or renegotiate its obligations when they become due or raise additional capital through future debt or equity. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. No adjustments have been made to the carrying value of assets or liabilities as a result of this uncertainty. Management plans to mitigate its losses in future years by significantly reducing its operating expenses, seeking out new business opportunities and attempting to raise debt or equity financing. However, there is no assurance that the Company will be able to obtain additional financing, reduce its operating expenses or be successful in maintaining a viable business. 3. Summary of Significant Accounting Policies a) Basis of consolidation The consolidated financial statements include the financial statements of the Company and its subsidiaries, all of which are wholly owned. All significant inter-company transactions are eliminated upon consolidation. Certain amounts of prior periods were reclassified to conform with current period presentation. b) Use of estimates The preparation of the financial statements in conformity with Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. These estimates and assumptions include valuing equity securities issued in share based payment arrangements, determining the fair value of assets acquired, allocation of purchase price, impairment of long-lived assets, the collectability of receivables and the value of deferred taxes and related valuation allowances. Certain estimates, including evaluating the collectability of receivables and advances, could be affected by external conditions, including those unique to our industry, and general economic conditions. It is possible that these external factors could have an effect on our estimates that could cause actual results to differ from our estimates. We re-evaluate all of our accounting estimates at least quarterly based on these conditions and record adjustments when necessary. c) Goodwill Goodwill is recognized for the excess of the purchase price over the fair value of tangible and identifiable intangible net assets of businesses acquired. Goodwill is not being amortized, but is reviewed at least annually for impairment. In our evaluation of goodwill impairment, we perform a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the qualitative assessment is not conclusive, we proceed to a two-step process to test goodwill for impairment including comparing the fair value of the reporting unit to its carrying value (including attributable goodwill). Fair value for our reporting units is determined using an income or market approach incorporating market participant considerations and management's assumptions on revenue growth rates, operating margins, discount rates and expected capital expenditures. Fair value determinations may include both internal and third-party valuations. Unless circumstances otherwise dictate, we perform our annual impairment testing in the fourth quarter. We perform the allocation based on our knowledge of the market in which we operate, and our overall knowledge of the gaming industry. d) Business Combinations We allocate the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. e) Long-Lived Assets We evaluate the carrying value of our long-lived assets for impairment by comparing the expected undiscounted future cash flows of the assets to the net book value of the assets when events or circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. If the expected undiscounted future cash flows are less than the net book value of the assets, the excess of the net book value over the estimated fair value will be charged to earnings. Fair value is based upon discounted cash flows of the assets at a rate deemed reasonable for the type of asset and prevailing market conditions, appraisals, and, if appropriate, current estimated net sales proceeds from pending offers. f) Derivative Financial Instruments The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks. The Company evaluates all of its financial instruments, including convertible notes and stock purchase warrants, to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income. For option-based simple derivative financial instruments, the Company uses the Black-Scholes option-pricing model to value the derivative instruments at inception and subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period. g) Earnings Per Share FASB ASC 260, "Earnings Per Share" provides for calculation of "basic" and "diluted" earnings per share. Basic earnings per share includes no dilution and is computed by dividing net income (loss) available to common shareholders by the weighted average common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of an entity similar to fully diluted earnings per share. These potentially dilutive securities were not included in the calculation of loss per share for the years ended December 31, 2016 and 2015, thus the effect would have been anti-dilutive. Accordingly, basic and diluted loss per common share is the same for all periods presented. h) Currency translation Since the Company's subsidiaries operate in Europe, the subsidiaries functional currency is the Euro. In the consolidated financial statements, revenue and expense accounts are translated at the average rates during the period, and assets and liabilities are translated at period-end rates and equity accounts are translated at historical rate. Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders' equity. Gains and losses from foreign currency transactions are recognized in current operations. i) Revenue Recognition Revenues from sports-betting, casino, cash and skill games; slots, bingo and horse race wagers represent the gross pay-ins (also referred to as Turnover) from customers less gaming taxes and payouts to customers. Revenues are recorded when the game is closed. In addition, the Company receives commissions from the sale of scratch tickets and other lottery games. Commissions are recorded when the ticket for scratch off tickets and lottery tickets are sold. Revenues from Betting Operating System (“BOS”) include license fees, training, installation, and product support services. Revenue is recognized when the significant risks and rewards of ownership are transferred or when the obligation is fulfilled. License fees are calculated as a percentage of each licensee’s level of activity and are contingent upon the licensee’s usage. The license fees were recognized on an accrual basis as earned. j) Cash and equivalents The Company considers all highly liquid debt instruments with maturities of three months or less at the time acquired to be cash equivalents. Cash equivalents represent short-term investments consisting of investment-grade corporate and government obligations, carried at cost, which approximates market value. The Company has no cash equivalents as of December 31, 2016 and 2015. The Company primarily places its cash with high-credit quality financial institutions, one of which is located in the United States and is insured by the Federal Deposit Insurance Corporation for up to $250,000 and another which is located in Italy and is insured by the Italian government. k) Gaming accounts receivable & allowance for doubtful accounts Gaming accounts receivable represents gaming deposits made by customers to their online gaming accounts either directly by credit card, bank wire, e-wallet or other accepted method through one of our websites or indirectly by cash collected at the cashier of a betting shop but not yet credited to our bank accounts and subject to normal trade collection terms without discounts. The Company periodically evaluates the collectability of its gaming accounts receivable and considers the need to record or adjust an allowance for doubtful accounts based upon historical collection experience and specific customer information. Actual amounts could vary from the recorded estimates. The Company does not require collateral to support customer receivables. l) Gaming account balances Gaming account balances represent customer balances, including winnings and deposits, that are held as credits in online gaming accounts and have not as of yet been used or withdrawn by the customers. Customers can request payment from the Company at any time and the payment to customers can be made through bank wire, credit card, or cash disbursement from one of our locations. Online gaming account credit balances are non-interest bearing. m) Fair Value Measurements ASC Topic 820, Fair Value Measurement and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy which requires classification based on observable and unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value: Level 1: Observable inputs such as quoted prices (unadjusted) in active market for identical assets or liabilities. Level 2: Inputs other than quoted prices that are observable, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active. Level 3: Unobservable inputs in which little or no market data exists, therefore developed using estimates and assumptions developed by us, which reflect those that a market participant would use. The carrying value of the Company's short term investments, prepaid expenses, accounts receivables, other current assets, accounts payable and accrued liabilities, gaming account balance, and advances from shareholder approximate fair value because of the short-term maturity of these financial instruments. The derivative liability in connection with the conversion feature of the convertible debt and warrants is classified as a level 3 liability, and is the only financial liability measured at fair value on a recurring basis. The change in the Level 3 financial instrument is as follows: n) Property, plant and equipment Property, plant and equipment are stated at acquisition cost less accumulated depreciation and adjustments for impairment losses. Expenditures are capitalized only when they increase the future economic benefits embodied in an item of property, plant and equipment. All other expenditures are recognized as expenses in the statement of income as incurred. Depreciation is charged on a straight-line basis over the estimated remaining useful lives of the individual assets. Amortization commences from the time an asset is put into operation. The range of the estimated useful lives is as follows: o) Leases Leases are reviewed and classified as capital or operating at their inception in accordance with ASC Topic 840, Accounting for Leases. For leases that contain rent escalations, the Company records rent expense on the straight line method. The difference between rent expense recorded and the amount paid is credited or charged to deferred rent account and is included in accrued expenses and other current liabilities. All lease agreements of the Company as lessees are accounted for as operating leases as of December 31, 2016 and 2015. p) Income Taxes We use the asset and liability method of accounting for income taxes in accordance with ASC Topic 740, "Income Taxes." Under this method, income tax expense is recognized for the amount of: (i) taxes payable or refundable for the current year and (ii) deferred tax consequences of temporary differences resulting from matters that have been recognized in an entity's financial statements or tax returns. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is provided to reduce the deferred tax assets reported if based on the weight of the available positive and negative evidence, it is more likely than not some portion or all of the deferred tax assets will not be realized. ASC Topic 740.10.30 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740.10.40 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We have no material uncertain tax positions for any of the reporting periods presented. The Company has elected to include interest and penalties related to uncertain tax positions, if determined, as a component of income tax expense. In Italy, tax years beginning 2011 forward are open and subject to examination. The Company is not currently under examination and it has not been notified of a pending examination. q) Comprehensive Income (Loss) Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including foreign currency translation adjustments and unrealized gains and losses on marketable securities. The Company adopted FASB ASC 220-10-45, "Reporting Comprehensive Income". ASC 220-10-45 establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income consists of net income and unrealized gains (losses) on available for sale marketable securities; foreign currency translation adjustments and changes in market value of future contracts that qualify as a hedge; and negative equity adjustments. r) Recent Accounting Pronouncements In April 2015, the FASB issued guidance to simplify the presentation of debt issuance costs. This guidance provides that debt issuance costs related to a recognized liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with debt discounts. The Company adopted this guidance with the annual and the interim period beginning January 1, 2016, and applied the standard on a retrospective basis as of December 31, 2015. The adoption of this standard did not have a material impact on our financial position and did not impact our results of operations or cash flows. There are no other recently issued accounting standards that are expected to have a material effect on our financial condition, results of operations or cash flows. 4. Acquisition of offline and land-based gaming assets (a) Rifa Srl. And Newgioco Srl. On January 1, 2015 the Company completed the acquisition of Rifa, an inactive legal entity incorporated in Italy. Rifa's assets include a "Monti license" and 1 Diritti Negozio Sportivo (“Agency”) Concession right that enables the Company to operate Agency locations. During the year ended December 31, 2014 Multigioco paid EUR 51,506 (approximately U.S. $62,300) towards the acquisition of Rifa, which was classified as deposit on acquisitions at December 31, 2014. The Company paid EUR 30,000 (approximately U.S. $36,300) towards the purchase price of Rifa and also advanced EUR 21,506 (approximately U.S. $26,000) for payments of debts of Rifa. Also on January 1, 2015, Multigioco purchased offline gaming assets of Newgioco, which included a Bersani license along with 3 Diritti Punto Sportivo (“Corner”) rights to operate under Multigioco, and Rifa purchased 1 Agency right from Newgioco to operate under Rifa’s Monti license. Pursuant to the agreement Rifa assumed the lease on the Newgioco Agency premises. The purchase price paid to Newgioco also includes equipment and assets related to each of the Corner and Agency locations. Newgioco is an Italian gaming company which is 50% owned by Laura Tabacco an Italian citizen and 50% owned by Beniamino Gianfelici, who along with his daughter owned 100% of Multigioco prior to its acquisition by Empire. Rifa was a privately owned, inactive Italian gaming company which included a "Monti license" and 1 Diritti Negozio Sportivo (“Agency”) Concession Right. The Company acquired Rifa in order to develop its land-based gaming operations in Italy. The Company agreed to pay Newgioco EUR 650,649 (approximately U.S. $787,158) which included EUR 450,000 (approximately U.S. $569,700) payable in 9 cash instalments of EUR 50,000 (approximately U.S. $63,308) each until paid in full and forgiveness of EUR 210,507 (approximately U.S. $256,251) in debt which was recorded as due from affiliates at December 31, 2014. As of December 31, 2015, the Company has paid EUR 144,000 (approximately U.S. $159,840) towards the cash purchase price. Additional payments of EUR 106,000 (approximately U.S. $116,923) and EUR 75,000 (approximately U.S. $82,729) were paid in February, 2016 and April 2016, respectively. For accounting purposes, the purchase was accounted for using the acquisition method of accounting. The assets and liabilities of Rifa and Newgioco are included in the Consolidated Balance Sheet from the acquisition date and the results of the operation subsequent to the acquisition date are included in the Consolidated Statement of Comprehensive Loss for the year ended December 31, 2015. The total cost of the acquisition has been allocated to the assets acquired and the liabilities assumed based upon their estimated fair values at the date of the acquisition. The Company conducted an internal assessment on the fair value of the tangible and intangible assets acquired. The following represents the purchase price allocation: (b) Odissea Betriebsinformatik Beratung Gmbh (“Odissea”) Acquisition On June 30, 2016, the Company entered into a Share Exchange Agreement which closed on July 1, 2016, with the shareholders of Odissea organized under the laws of Austria (the “Odissea SPA”). Odissea operates a proprietary Betting Operating System. Pursuant to the agreement, the Company issued 4,386,100 shares of common stock in consideration for 100% of the issued and outstanding shares of Odissea. As a result of this acquisition, the sellers now hold approximately 11.85% of the issued and outstanding shares of common stock of the Company. Pursuant to the Odissea SPA, upon completion of certification of the Betting Operating System by the ADM the sellers may exercise the option to resell to the Company 50% of the shares of common stock issued in consideration for the purchase price (or 2,193,050 shares) at a fixed price of U.S. $1.00 per share. The repurchase option expires on June 30, 2017, 12 months after the Closing Date. The purchase price was allocated to the fair market value of tangible and intangible assets acquired and liabilities assumed. Intangible assets will be amortized over their remaining useful life as follows: (c) Ulisse Gmbh (“Ulisse”) Acquisition On June 30, 2016, the Company entered into a Share Exchange Agreement which closed on July 1, 2016, with the shareholders of Ulisse organized under the laws of Austria (the “Ulisse SPA”). Ulisse operates an existing network of 107 land-based Agency locations in Italy. Pursuant to the agreement, the Company issued 1,665,600 shares of common stock in consideration for 100% of the issued and outstanding shares of Ulisse. As a result of this acquisition, the sellers now hold approximately 4.50% of the issued and outstanding shares of common stock of the Company. Pursuant to the Ulisse SPA, upon completion of the ADM license tender auction and the Rights obtained by the Company are assigned to the Ulisse locations the sellers may exercise the option to resell to the Company 50% of the shares of common stock issued in consideration for the purchase price (or 832,800 shares) at a fixed price of U.S. $1.00 per share. The repurchase option expires on June 30, 2017, 12 months after the Closing Date. On November 15, 2016, Ulisse obtained a bookmaker license from the Austrian gaming authority making Ulisse a licensed sports bookmaker. The Ulisse bookmaker license does not have an expiration date and renews on an annual basis. The purchase price was allocated to the fair market value of tangible and intangible assets acquired and liabilities assumed. Intangible assets will be amortized over their remaining useful life as follows: The Company has estimated the fair value of assets acquired and liabilities assumed in connection with acquisitions and is currently undergoing a formal valuation and will adjust these estimates accordingly within the one year measurement period. 5. Deposits on Acquisitions Deposits on acquisitions includes the following: On September 1, 2014 the Company entered into a Share Purchase Agreement (SPA) to acquire Streamlogue Holdings Ltd. ("Streamlogue"), a Maltese licensed gaming company. The purpose of seeking the acquisition of Streamlogue is to expand our gaming products and services outside of the Italian operations of our subsidiary Multigioco. Under the terms of the SPA, the company agreed to pay EUR 600,000 (approximately U.S. $759,698) of outstanding debts of Streamlogue plus EUR 350,000 (approximately U.S. $443,157) in shares of the company payable on closing of the transaction. The Company did not make any advances during the year ended December 31, 2016. The Company advanced $94,953 towards the acquisition of Streamlogue during the year ended December 31, 2015. The advances were credited to the purchase price for Streamlogue of EUR 950,000 (approximately U.S. $1,202,855). Since Streamlogue has not produced any meaningful income, the Company determined that it may not be able to realize its deposit in Streamlogue if the transaction is unsuccessful. Therefore, the Company set up a 100% allowance on the advances made during the year ended December 31, 2015. 6. Intangible Assets Intangible assets consist of the following: The Company evaluates intangible assets for impairment on an annual basis during the last month of each year and at an interim date if indications of impairment exist. Intangible asset impairment is determined by comparing the fair value of the asset to its carrying amount with an impairment being recognized only when the fair value is less than carrying value. The amortization expense was $458,087 and $408,111 for the year ended December 31, 2016 and December 31, 2015, respectively. Licenses include the GAD online license as well as the Bersani and Monti land-based licenses issued by the Italian gaming regulator to Multigioco and Rifa, respectively. These licenses were obtained by the Company in the acquisitions of Multigioco and Rifa. See Note 4. 7. Restricted Cash Restricted Cash is cash held in a segregated bank account at Veneto Banca Societa Cooperativa Per Azioni (“SCpA”) (“Veneto Banca”) as collateral against our operating line of credit with the Veneto Banca as well as Wirecard Bank as a security deposit for Ulisse. 8. Long Term Debt Long term debt represents the Italian "Trattamento di Fine Rapporto" (TFR) which is a severance amount set up by Italian companies to be paid to employees on termination or retirement as well as shop deposits that are held by Ulisse. 9. Line of Credit - Bank The Company currently maintains an operating line of credit for a maximum amount of EUR 300,000 (approximately U.S. $317,250) for Multigioco and EUR 50,000 (approximately U.S. $52,875) for Rifa from Banca Veneto in Italy. The line of credit is secured by restricted cash on deposit at Banca Veneto and guaranteed by certain shareholders of the Company and bears a fixed rate of interest at 5% per annum on the outstanding balance with no minimum payment, maturity or due date. 10. Liability in connection with acquisition Liability in connection with acquisition represent non-interest bearing amount due by the Company’s subsidiaries toward the purchase price per purchase agreement between Newgioco Srl and the Company’s subsidiaries. The Company’s shareholder and director, Beniamino Gianfelici, owns 50% shares of Newgioco Srl During the year ended December 31, 2016, the company paid EUR 181,000 (approximately U.S. $200,313) to Newgioco Srl. 11. Investment in Non-consolidated Entities Investments in non-consolidated entities consists of the following: On December 9, 2014, the Company invested CDN $1,000,000 (approximately U.S. $875,459) in a private placement of common shares of 2336414 Ontario Inc. ("2336414"). The Company subscribed for 666,664 Units representing 666,664 common shares or 2.3% of 2336414. Each Unit being comprised of one (1) common share in the capital of 2336414 and one-quarter (1/4) of one common share purchase warrant, which will require four quarter warrants to acquire one additional common share in the capital of 2336414, for CDN $2.25 within 18 months after the closing of the Offering, or such longer period of time as 2336414 may determine. The Company paid CDN $1,000,000 (approximately $875,459 USD) in cash, and obtained a promissory note from 2336414's subsidiary, Paymobile Inc. See Note 15 Promissory Notes Payable - Other for information regarding this promissory note. 2336414 is an Ontario corporation and the parent company of Paymobile Inc. a carrier-class, PCI compliant transaction platform, delivering Visa prepaid card programs for social disbursements, corporate payroll replacement and cheque replacement. The Company is in discussions to obtain a supplemental multi-currency payment processing system for our various clients and partners which may offer us unique, competitive, loyalty benefits in our markets. Since Paymobile has not produced any meaningful income, the Company has determined that it may not be able to realize its investment in 2336414 and has therefore decided to set up a 100% impairment on the investment made as of December 31, 2014. If the investment in 2336414 is unsuccessful, the Company may lose some or all of its investment in 2336414 Ontario Inc. On December 31, 2016 and 2015, the Company held $6,729 in shares of Banca Veneto SCpA. Banca Veneto is a private mutual enterprise organized under Italian banking laws. The Company recorded impairment of $0 and $30,185 on the investment during the year ended December 31, 2016 and 2015, respectively. We carry the value of the shares of Banca Veneto SCpA and 2336414 Ontario Inc. at cost less impairment. The Company accounts for investment in non-consolidated entities using the cost method of accounting if the Company has an ownership interest below 20% and does not have the ability to exercise significant influence over an investee. The shares of Banca Veneto and 2336414 Ontario Inc. do not have an active market. 12. Related party transactions and balances Advances from stockholders represent non-interest bearing loans that are due on demand. Interest was imputed at 5% per annum. Balances of Advances from stockholders are as follows: During the year ended December 31, 2015, Gold Street Capital Corp. ("Gold Street"), the major stockholder of Newgioco Group, advanced $271,214 to the Company, net of repayment of $65,404. On September 30, 2015, the Company issued 144,300 shares to Gold Street Capital Corp to pay $150,072 of the debt at the market price of $1.04 per share. During the year ended December 31, 2016, Gold Street advanced $290,242 net of repayment of $55,700. During the year ended December 31, 2016, the Company issued shares to Gold Street to repay the debt at the market prices as follows: Doriana Gianfelici advanced EUR 250 (approximately U.S. $264) and EUR 8,801 (approximately U.S. $9,770) to the Company during the years ended December 31, 2016 and 2015, respectively. The amounts due to Gold Street Capital and Doriana Gianfelici at December 31, 2016 and 2015 are non-interest bearing and due on demand. Advances from other stockholders include balances of approximately U.S. $505,729 due to former stockholders of Ulisse and Odissea, of which approximately U.S. $500,469 is the dividend accrued due to former stockholders of Ulisse. Following the July 1, 2016 acquisition, in the six months ended December 31, 2016, Luca Pasquini advanced approximately U.S. $2,780 to the Company. In addition, on November 15, 2016, the Company issued an aggregate of 4,500,000 shares of common stock as a performance based restricted stock award contingent on the closing of the July 1, 2016 acquisitions. The Company granted 1,500,000 shares each to Beniamino Gianfelici, a director of the Company, Alessandro Marcelli, a director of the Company, and Gold Street Capital, a related party. The restricted stock award was granted in lieu of a formalized equity incentive plan. See Note 13. Related-Party Debt On February 13, 2015 the Company issued a Promissory Note for $150,000 to Braydon Capital Corp. a Company owned by Claudio Ciavarella, the brother of our CEO, with an interest at a rate of 2% per month due in full on the Maturity Date of May 15, 2015 which was extended by mutual consent. On September 30, 2015 the Company issued 166,400 shares at the market price of $1.04 per share to Braydon Capital Corp. to repay the debt, including principal and accrued interest of $173,016, in full. On December 15, 2015 the Company issued a Promissory Note for $186,233 to Braydon Capital Corp. that bears interest at a rate of 1% per month due in full on the Maturity Date of December 15, 2016. Also, on December 15, 2015, the Company entered into a Securities Purchase Agreement with Braydon Capital Corp. for the purchase of 155,000 common shares for $155,000 at the fair market value of $1.00 per share. Promissory notes payable to related parties of $318,078 comprise of amounts due to Braydon Capital Corp., a company owned by Claudio Ciavarella, the brother of our CEO. On January 13, 2016, the Company issued a Promissory Note for $90,750 to Braydon Capital Corp. that bears interest at a rate of 1% per month and is due in full on the maturity date of January 13, 2017. On April 29, 2016, the Note was amended to add $41,095 in funds issued to the Company from Braydon Capital Corp. for a total of $131,845. Also, the Company inherited a loan in connection with the acquisition of Odissea on July 1, 2016 of approximately U.S. $56,753 from Alessandro Pasquini, cousin of our director Luca Pasquini. As of December 31, 2016, the loan was repaid. See Note 4. On January 1, 2015 the Company acquired land-based gaming assets from Newgioco Srl for a purchase price of EUR 650,649 (approximately U.S. $787,158) which included a forgiveness of EUR 210,507 (approximately U.S. $256,251) in debt due for the administrative services. Pursuant to the agreement with Newgioco Srl, the Company made payments of EUR 181,000 (approximately U.S. $200,313) and EUR 150,443 (approximately U.S. $166,992) to Newgioco Srl during the years ended December 31, 2016 and 2015, respectively. The Company’s shareholder and director, Beniamino Gianfelici, owns 50% shares of Newgioco Srl. The Company agreed to pay management fees to Gold Street Capital Corp. of $120,000 per year for the year ended December 31, 2016. Also, the Company paid management fees of approximately U.S.$26,008 to Luca Pasquini, a director and Chief Technology Officer. 13. Stockholders’ Equity On September 15, 2015, the Company entered into a non-exclusive one year advisory agreement with Merriman Capital Inc. pursuant to which Merriman agreed to act as a capital markets advisor and placement agent to the Company. As consideration for these services, Merriman was paid a one-time retainer fee of 150,000 shares of the Company’s common stock with a fair market value of $140,985. In addition to the retainer fee, Merriman will receive performance-based compensation for services related to (1) completion of financing, and (2) if the Company qualifies for and completes an up-listing to any of the national markets designated as the NYSE, NYSE/AMEX, or NASDAQ. This amount is being amortized over one year term of this agreement. The unamortized balance of $0 and $99,666 is included in prepaid expenses on the accompanied balance sheet for the years ended December 31, 2016 and 2015, respectively. On September 30, 2015, the Company issued 21,650 shares at the market price of $1.04 per share to pay $22,500 to CorCapital Inc. in full. On November 25, 2015, the Company entered into a non-exclusive financial advisory and placement agent agreement with National Securities Corp As consideration for these services, National was paid a one-time retainer fee of 50,000 shares of the Company’s common stock with a fair market value of $55,995. The unamortized balance of $0 and $50,323 is included in prepaid expenses on the accompanied balance sheet for the years ended December 31, 2016 and 2015, respectively. On December 24, 2015, the Company entered into a non-exclusive placement agent and investment banking agreement with JH Darbie & Co., Inc As consideration for these services, JH Darbie was paid a one-time retainer fee of 100,000 shares of the Company’s common stock with a fair market value of $115,990. The unamortized balance of $0 and $113,775 is included in prepaid expenses on the accompanied balance sheet for the years ended December 31, 2016 and 2015, respectively. On December 15, 2015, the Company entered into a Securities Purchase Agreement with Braydon Capital Corp. for the purchase of 155,000 common shares for $155,000 at the fair market value of $1.00 per share. On March 8, 2016, the Company entered into a non-exclusive advisory agreement with Newbridge Securities Corp. (“Newbridge”). As consideration for these services, the Company agreed to pay Newbridge advisory fees of $15,000 and issue 50,000 restricted shares of common stock upon signing the agreement and 50,000 restricted shares of common stock upon the presentation of a Term Sheet. The Company paid a fee of $15,000, and on March 8, 2016 issued 50,000 shares of common stock which were valued at the market price of $0.97 per share and amortized over the service period of two months. On March 14, 2016, the Company entered into a Mutual Release Agreement with Typenex Co-Investment, LLC to extinguish future “true-up” provisions contained within the Convertible Note dated June 18, 2015 and the Transfer Agent Reserve shares related to the Note. Pursuant to the agreement, the Company issued 14,885 shares of common stock to Typenex Co-Investment, LLC. Those shares were valued at market price on issuance date of $0.97 per share and recorded as an expense. On June 6, 2016, the Company issued an aggregate of 40,000 shares of the Company’s common stock to two consultants for services provided to the Company On November 15, 2016, the Company issued an aggregate of 4,500,000 shares of common stock as a performance based restricted stock award contingent on the closing of the July 1, 2016 acquisitions. The Company granted 1,500,000 shares each to Beniamino Gianfelici, a director of the Company, Alessandro Marcelli, a director of the Company, and Gold Street Capital, a related party. The restricted stock award was granted in lieu of a formalized equity incentive plan. Also on November 15, 2016, the Company issued an aggregate of 2,025,100 shares of common stock dated at 100% of the market price of $0.15 per share as follows: - 1,785,100 shares issued to Gold Street Capital Corp. for the payment of debt equal to $267,756; - 200,000 issued to Julia Lesnykh for the payment of debt equal to $30,000; - 40,000 issued to Andrei Sheptikita for the payment of debt equal to $6,000 On December 31, 2016, 56,000 shares of the Company's common stock were issued to Gold Street Capital Corp. at 100% of the market price of $0.41 per share for the payment of debt equal to $22,433. See Note 12 for additional common share transactions in repayment of debt. 14. Debentures and Convertible Notes Debentures and convertible notes outstanding include the following: April 2, 2015 Debentures On April 2, 2015, the Company issued debentures to a group of accredited investors to purchase 5 unsecured Debenture Units for gross proceeds of $25,000 and 5 Debenture Units for gross proceeds of CDN $25,000 (approximately U.S. $18,400). Each Debenture Unit is comprised of (i) a $5,000 and CDN $5,000 debenture, respectively, bearing interest at a rate of 15% per annum, maturing one year from the date of issuance and (ii) 500 warrants to receive one common share per warrant prior to April 2, 2017, which may be exercised at the lower of (a) $1.25 and CDN $1.25, respectively, and (b) a 25% discount to the offering price of common shares of the Company in the next equity financing of the Company. On April 2, 2016, the maturity date, the Company paid the amounts due in full of $28,770 and CDN $28,770 (approximately U.S. $22,141) including principle and accrued interest. As of the date of this report the warrants issued for the April 2, 2015 debentures have expired. April 27, 2015 Debentures On April 27, 2015, the Company issued debentures to a group of accredited investors to purchase 4 unsecured Debenture Units for gross proceeds of $20,000 and 4 unsecured Debenture Units for gross proceeds of CDN$20,000 (approximately U.S. $15,224). Each Debenture Unit is comprised of (i) a $5,000 and CDN$5,000 debenture, respectively, bearing interest at a rate of 15% per annum, maturing one year from the date of issuance and (ii) 500 warrants to receive one common share per warrant prior to April 27, 2017, which may be exercised at the lower of (a) $1.25 and CDN$1.25, respectively, and (b) a 25% discount to the offering price of common shares of the Company in the next equity financing of the Company. On April 27, 2016, the maturity date, the Company paid the amounts due in full of $23,088 and CDN $23,088 (approximately U.S. $18,200) including principle and accrued interest. June 18, 2015 Convertible Promissory Note On June 18, 2015, the Company issued a convertible promissory note (the “Note”) bearing an interest rate of 10% per annum to purchase a gross amount of $330,000 which includes an Original Issue Discount (“OID”) of 10% to an accredited investor. On the Closing Date the Company received the initial cash purchase price of $115,000 which includes $10,000 OID and $5,000 for legal fees incurred by the Company as well as two Investor Notes of $100,000 each bearing interest of 8% per annum. On December 14, 2015, the cashless warrant was exercised and the Company issued 62,438 shares. The Note was pre-paid on December 15, 2015. The total amount of pre-payment was $155,233, including interest and penalties. On March 14, 2016, the Company entered into a Mutual Release Agreement with the investor to extinguish future “true-up” provisions contained within the Convertible Note and the Transfer Agent Reserve shares related to the Note. Pursuant to the agreement, the Company issued 14,885 shares of common stock to the investor. July 9, 2015 Convertible Promissory Note On July 9, 2015, the Company issued a convertible promissory note (the “Note”) bearing an interest of 10% per annum to purchase a gross amount of $220,000 which includes an Original Issue Discount (“OID”) of 10% to an accredited investor. The Note was convertible to shares of common stock of the Company at a price equal to the lower of $0.80 or 60% of the lowest trading price of the Company’s common stock during the 20 consecutive trading days prior to the date on which the Investor elects to convert all or part of the Note. On July 21, 2015, the closing date, the Company received an initial consideration of $55,000, which includes an OID of $5,000. This initial consideration is a debenture. The Note was pre-paid on January 14, 2016. The total amount of pre-payment was $90,750, including interest and penalties. February 29, 2016 and March 31, 2016 Convertible Notes On February 29, 2016, the Company closed a Securities Purchase Agreement with an unaffiliated private investor, to raise up to $750,000. The Company received gross proceeds from the initial private placement of $600,000. On April 4, 2016, the Company received the balance of gross proceeds of $150,000, less legal expenses of $15,000. The convertible notes bear an interest rate of 12% per annum and are due in one year. The Notes are convertible to shares of common stock of the Company at the price of $0.85 per share with certain price adjustment clauses. The convertible notes were guaranteed by Confidi Union Impresa, an unrelated party. As part of the purchase agreement, the Company also issued a warrant to purchase 163,044 shares of Company’s common stock at $1.15 per share. Repayment of the February 29, 2016 Securities Purchase Agreement is the subject of legal proceedings described in Subsequent Events. See Note 20. The Company has determined that the conversion feature embedded in the notes constitutes a derivative and has been bifurcated from the note and recorded as a derivative liability, with a corresponding discount recorded to the associated debt, on the accompanying balance sheet, and revalued to fair market value at each reporting period. See Note 14. The Company paid commissions of $8,000, $4,000, $60,000, and $15,000 for the June 18, July 9, 2015, February 29, 2016, and March 31, 2016 Notes, respectively. The Company also paid commissions of 7,500 shares of common stock at a price of $0.80 per share or $6,000 and 4,000 shares of common stock at a price of $0.75 per share or $3,000 related to the June 18 and July 9, 2015 Notes, respectively. The commissions related to the notes were amortized over the life of the notes. The Company also issued warrants to purchase 62,220 shares of the Company to the placement agent in relation to the February 29, 2016 and March 31, 2016 Notes. Warrants issued in relation to the debentures and promissory notes are discussed in Note 16. 15. Promissory Notes Payable - Other On December 9, 2014, the Company obtained a promissory note for CDN $500,000 (approximately U.S. $436,796) from Paymobile Inc., a subsidiary of 2336414 Ontario Inc. (“2336414”) of which the Company owns 666,664 common shares, that bears interest at a rate of 1% per month on the outstanding balance. As of the date of this filing, the final payment of CDN $150,000 (approximately U.S. $111,285) was due on February 28, 2015 plus accrued interest. The Company and 2336414 have agreed to extend the due date indefinitely by mutual consent. Interest expense of $13,590 and $16,008 was recorded for the year ended December 31, 2016 and 2015, respectively. 16. Bank Loan Payable On September 30, 2016, the Company obtained a loan of EUR 500,000 (approximately U.S. $561,000) from Banca Veneto in Italy, which is secured by the Company's assets. The loan is amortized over 57 months ending September 30, 2021 with repayment starting on January 31, 2017 in monthly installments of EUR 9,760 (approximately U.S. $10,950) with an underlying interest rate of 4.5 points above Euro Inter Bank Offered Rate ("EURIBOR"), subject to quarterly review. 17. Warrants On April 2, 2015, as per a Securities Purchase Agreement, the Company issued warrants to purchase 4,800 shares of the Company’s common stock at $1.25 per share which may be exercised by the warrant holder between April 2, 2016 and April 2, 2017 (See Note 14). The fair value of the warrants of $4,291 was calculated using the Black-Scholes model on the date of issuance and was recorded as a debt issuance cost, which has been amortized over the life of the debt. On April 27, 2015, as per a Securities Purchase Agreement, the Company issued warrants to purchase 3,900 shares of the Company’s common stock at $1.25 per share which may be exercised by the warrant holder between April 27, 2016 and April 27, 2017 (See Note 14). The fair value of the warrants of $4,264 was calculated using the Black-Scholes model on the date of issuance and was recorded as a debt issuance cost, which has been amortized over the life of the debt. The Company has determined that the warrants issued in connection with the debentures on April 2, 2015 and April 27, 2015 should be treated as a liability since it has been determined not to be indexed to the Company's own stock. On June 18, 2015, as per as a Securities Purchase Agreement, the Company issued a warrant to purchase 57,500 shares of the Company’s common stock at $1.00 per share which may be exercised until June 18, 2018 (See Note 14). The fair value of the warrants of $45,964 was calculated using the Black-Scholes model on the date of issuance and was recorded as a debt issuance cost, which has been amortized over the life of the debt. On February 29, 2016, as per a Securities Purchase Agreement, the Company issued a warrant to purchase 130,435 shares of the Company’s common stock at $1.15 per share which may be exercised by the warrant holder between August 28, 2016 and February 28, 2019 (See Note 14). The warrant was issued in connection with the February 29, 2016 and March 31, 2016 convertible Promissory Notes. The fair value of the warrants of $106,583 was calculated using the Black-Scholes model on the date of issuance and was recorded as a debt discount, which has been amortized as interest expense over the life of the debt. On April 4, 2016, the Company issued a warrant to purchase 62,220 shares of the Company’s common stock at $1.15 per share which may be exercised by the warrant holder until April 4, 2019. The warrant was issued to the placement agent in relation to securing the February 29, 2016 and March 31, 2016 convertible Promissory Notes (See Note 14). The fair value of the warrants of $53,236 was calculated using the Black-Scholes model on the date of issuance, and was recorded as a debt issuance cost, which has been amortized over the life of the debt. On April 4, 2016, the Company issued a warrant to purchase 32,609 shares of the Company’s common stock at $1.15 per share which may be exercised by the warrant holder until April 4, 2019 (See Note 14). The warrant was issued in connection with the March 31, 2016 Convertible Promissory Note. The fair value of the warrants of $27,901 was calculated using the Black-Scholes model on the date of issuance and was recorded as a debt discount, which has been amortized as interest expense over the life of the debt. The fair value of the warrants on the date of issuance as calculated using the Black-Scholes model was: The following assumptions were used to calculate the fair value: A summary of warrant transactions during the year ended December 31, 2016 is as follows: The following assumptions were used to calculate the fair value of warrants at December 31, 2016: 18. Revenues The following table sets forth the breakdown of net gaming revenues: Turnover represents the total bets processed for the period. 19. Income Taxes The Company is incorporated in the United States of America and is subject to United States federal taxation. No provisions for income taxes have been made as the Company had no U.S. taxable income for the years ended December, 2016 and 2015. The Company's Italian subsidiaries are governed by the income tax laws of Italy. The corporate tax rate in Italy is 32.32% (IRES at 27.5% plus IRAP ordinary at 4.85%) on income reported in the statutory financial statements after appropriate tax adjustments. The reconciliation of income tax expense at the U.S. statutory rate of 35% to the Company’s effective tax rate is as follows: The Company has accumulated a net operating loss carry forward ("NOL") of approximately $11.3 million as of December 31, 2016, in the U.S. This NOL may be offset against future taxable income through the year 2036. The use of these losses to reduce future income taxes will depend on the generation of sufficient taxable income prior to the expiration of the NOL. The Company periodically evaluates whether it is more likely than not that it will generate sufficient taxable income to realize the deferred income tax asset. At the present time, management cannot presently determine when the Company will be able to generate sufficient taxable income to realize the deferred tax asset; accordingly, a 100% valuation allowance has been established to offset the asset. Utilization of NOLs are subject to limitation due to any ownership change (as defined under Section 382 of the Internal Revenue Code of 1986) which resulted in a change in business direction. Unused limitations may be carried over to future years until the NOLs expire. Utilization of NOLs may also be limited in any one year by alternative minimum tax rules. Under Italian tax law, the operating loss carryforwards available for offset against future profits can be used indefinitely. Operating loss carryforwards are only available for offset against national income tax, in the limit of 80% of taxable annual income (this restriction does not apply to the operating loss incurred in the first three years of the Company's activity, which are therefore available for 100% offsetting). The provisions for income taxes consist of currently payable Italian income tax. The provisions for income taxes are summarized as follows: The tax effects of temporary differences that give rise to the Company’s net deferred tax asset are as follows: 20. Subsequent Events Subsequent to this report, on January 20, 2017, Newgioco Group, Inc. was served with a complained filed on November 11, 2016 against the Company in connection with a Securities Purchase Agreement by and between the Company and Darling Capital, LLC dated February 29, 2016. The matter involves a $750,000 debt plus interest that we have been and remain ready and able to pay. However, the plaintiff has sought a premium on the amount owed which we dispute. The Company considers this lawsuit to not be material or affect the future of the Company in any manner. See Note 14. Subsequent to this report, on January 24, 2017, the Company closed a Securities Purchase Agreement with a group of accredited investors to raise up to CDN $750,000 (approximately U.S. $569,952). The Company received gross proceeds from the initial private placement of CDN $180,000 (approximately U.S. $136,788). The Company incurred a total of CDN $14,400 (approximately U.S. $10,943) in finder’s fees to facilitate this transaction for net proceeds of CDN $165,600 (approximately U.S. $125,845). The debenture bears an interest rate of 10% per annum and is due in two years. As part of the purchase agreement, the Company also issued a warrant to purchase 18,0000 of the Company’s common stock at $1.00 per share up to January 24, 2019. Subsequent to this report, on March 27, 2017, the Company closed a Securities Purchase Agreement with a group of accredited investors to raise up to CDN $6,750,000 (approximately U.S. $5,083,980). The Company received gross proceeds from the initial private placement of CDN $150,000 (approximately U.S. $113,000). The Company incurred a total of CDN $5,000 (approximately U.S. $3,765) in finder’s fees to facilitate this transaction for net proceeds of CDN $145,000 (approximately U.S. $109,235). The convertible debenture bears an interest rate of 10% per annum and is due in two years. The debenture is convertible to shares of common stock of the Company at a price of $1.50 per share at any time up to March 27, 2019. As part of the purchase agreement, the Company also issued a warrant to purchase 15,000 of the Company’s common stock at $1.00 per share up to March 27, 2019. | Based on the provided financial statement excerpt, here's a summary:
Financial Overview:
- The company is experiencing financial challenges
- Reported a loss for the year
- Has a working capital deficit of $1,402,563
- Faces substantial doubt about its ability to continue as a going concern
Key Financial Characteristics:
- Current assets include accounts payable, accrued liabilities, and gaming account balance
- Short-term financial instruments are valued close to fair market value
- Has a derivative liability related to convertible debt and warrants
- Management has outlined plans to address financial difficulties (referenced in Note 2)
Audit Status:
- Audited in accordance with Public Company Accounting Oversight Board standards
- Auditors believe the financial statements present a fair representation of the company's financial position
- No specific opinion was provided on internal financial controls
Overall, the financial statement suggests the company is in a precarious financial position | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholder United Refining Company Warren, Pennsylvania We have audited the accompanying consolidated balance sheets of United Refining Company and subsidiaries as of August 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive (loss) income, stockholder’s equity and cash flows for each of the three years in the period ended August 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States) and auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Refining Company and subsidiaries as of August 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 2016, in conformity with accounting principles generally accepted in the United States of America. /s/ BDO USA, LLP New York, New York November 29, 2016 UNITED REFINING COMPANY AND SUBSIDIARIES Consolidated Balance Sheets (in thousands, except share amounts) See accompanying notes to consolidated financial statements. UNITED REFINING COMPANY AND SUBSIDIARIES Consolidated Statements of Operations (in thousands) See accompanying notes to consolidated financial statements. UNITED REFINING COMPANY AND SUBSIDIARIES Consolidated Statements of Comprehensive (Loss) Income (in thousands) See accompanying notes to consolidated financial statements. UNITED REFINING COMPANY AND SUBSIDIARIES Consolidated Statements of Stockholder’s Equity (in thousands, except share data) See accompanying notes to consolidated financial statements. UNITED REFINING COMPANY AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands) See accompanying notes to consolidated financial statements. UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Description of Business and Summary of Significant Accounting Policies Description of Business and Basis of Presentation The consolidated financial statements include the accounts of United Refining Company and its subsidiaries, United Refining Company of Pennsylvania and its subsidiaries and Kiantone Pipeline Corporation and its subsidiaries (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation. The Company is a petroleum refiner and marketer in its primary market area of Western New York and Northwestern Pennsylvania. Operations are organized into two business segments: wholesale and retail. The wholesale segment is responsible for the acquisition of crude oil, petroleum refining, supplying petroleum products to the retail segment and the marketing of petroleum products to wholesale and industrial customers. The retail segment operates a network of Company operated retail units under the Red Apple Food Mart® and Country Fair® brand names selling petroleum products under the Kwik Fill®, Citgo® and Keystone® brand names, as well as convenience and grocery items. The Company is a wholly-owned subsidiary of United Refining, Inc. (“URI”), a wholly-owned subsidiary of United Acquisition Corp., which in turn is a wholly-owned subsidiary of Red Apple Group, Inc. (the “Parent”). Cash and Cash Equivalents For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investment securities with maturities of three months or less at date of acquisition to be cash equivalents. Short-Term Investments The Company holds a certificate of deposit at a bank with a maturity date of six months. Derivative Instruments From time to time the Company uses derivatives to reduce its exposure to fluctuations in crude oil purchase costs and refining margins. Derivative products, historically crude oil option contracts (puts) and crackspread option contracts have been used to hedge the volatility of these items. The Company does not enter such contracts for speculative purposes. The Company accounts for changes in the fair value of its contracts by marking them to market and recognizing any resulting gains or losses in its Statement of Operations. The Company includes the carrying amounts of the contracts in derivative liability in its Consolidated Balance Sheet. At August 31, 2016, the Company had no derivative instruments outstanding as part of its risk management strategy. For the fiscal years ended August 31, 2016, 2015 and 2014 the Company recognized $0 of losses in costs and expenses in its Consolidated Statements of Operations. Inventories and Exchanges Inventories are stated at the lower of cost or market (LCM), with cost being determined under the Last-in, First-out (LIFO) method for crude oil and petroleum product inventories and the First-in, First-out (FIFO) UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) method for merchandise. Supply inventories are stated at either the LCM or replacement cost and include various parts for the refinery operations. If the cost of inventories exceeds their market value, provisions are made currently for the difference between the cost and the market value. Property, Plant and Equipment Property, plant and equipment is stated at cost and depreciated by the straight-line method over the respective estimated useful lives. Routine current maintenance, repairs and replacement costs are charged against income. Expenditures which materially increase values, expand capacities or extend useful lives are capitalized. A summary of the principal useful lives used in computing depreciation expense is as follows: Leases The Company leases land, buildings, and equipment under long-term operating and capital leases and accounts for the leases in accordance with ASC 360-10-30-8. Lease expense for operating leases is recognized on a straight-line basis over the expected lease term. The lease term begins on the date the Company has the right to control the use of the leased property pursuant to the terms of the lease. Deferred Integrity and Replacement Costs The Company and Kiantone Pipeline Corporation, a subsidiary of the Company, and Enbridge Energy Limited Partnership (“EELP”) and Enbridge Pipelines, Inc. (“EPI” and, together with EELP, the “Carriers”), entered into a letter agreement dated July 31, 2014, as amended, (the “Letter Agreement”) with respect to a pipeline (“Line 10”) owned by the Carriers, which transports crude oil from Canada to the Company’s Kiantone Pipeline. Pursuant to the Letter Agreement, the Company agreed to fund certain integrity costs necessary to maintain Line 10, and agreed to pay for half the cost of replacing certain portions of Line 10. The integrity and replacement costs, are deferred when incurred and amortized on a straight-line basis over the period of benefit, which is approximately 11 years. As of August 31, 2016 and 2015, net deferred integrity and replacement costs amounted to $112,892,000 and $58,634,000, respectively. Amortization expense of $12,286,000, $6,282,000 and $524,000 is included in depreciation and amortization for the fiscal years ended August 31, 2016, 2015 and 2014, respectively. Deferred Maintenance Turnarounds The cost of maintenance turnarounds, which consist of complete shutdown and inspection of significant units of the refinery at intervals of three or more years for necessary repairs and replacements, are deferred when incurred and amortized on a straight-line basis over the period of benefit, which ranges from 3 to 10 years. As of August 31, 2016 and 2015, deferred turnaround costs included in Deferred Turnaround Costs and Other Assets, amounted to $17,280,000 and $28,489,000, which are net of accumulated amortization of $32,981,000 and $20,888,000, respectively. Amortization expense included in depreciation and amortization for the fiscal years ended August 31, 2016, 2015 and 2014 amounted to $12,724,000, $14,479,000 and $11,319,000, respectively. UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Amortizable Intangible Assets The Company amortizes identifiable intangible assets such as brand names, non-compete agreements, leasehold covenants and deed restrictions on a straight-line basis over their estimated useful lives which range from 5 to 25 years. Revenue Recognition Revenues for products sold by the wholesale segment are recorded upon delivery of the products to our customers, at which time title to those products is transferred and when payment has either been received or collection is reasonably assured. At no point do we recognize revenue from the sale of products prior to the transfer of its title. Title to product is transferred to the customer at the shipping point, under pre-determined contracts for sale at agreed upon or posted prices to customers of which collectability is reasonably assured. Revenues for products sold by the retail segment are recognized immediately upon sale to the customer. Included in Net Sales and Costs of Goods Sold are consumer excise taxes of $245,843,000, $246,636,000 and $238,332,000 for the years ended August 31, 2016, 2015 and 2014, respectively. Cost Classifications Our Costs of Goods Sold (which excludes depreciation and amortization) include Refining Cost of Products Sold and related Refining Operating expenses. Refining Cost of Products Sold includes cost of crude oil, other feedstocks, blendstocks, the cost of purchased finished products, transportation costs and distribution costs. Retail Cost of Products Sold include cost for motor fuels and for merchandise. Motor fuel cost of products sold represents net cost for purchased fuel. Merchandise cost of products sold includes merchandise purchases, net of merchandise rebates and inventory shrinkage. Wholesale cost of products sold includes the cost of fuel and lubricants, transportation and distribution costs and labor. Income Taxes The Company accounts for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company’s results of operations are included in the consolidated Federal income tax return of the Parent and separately in various state jurisdictions. Income taxes are calculated on a separate return basis with consideration of the Tax Sharing Agreement between the Parent and its subsidiaries. With few exceptions, the Company is no longer subject to income tax examinations by U.S. federal, state or local tax authorities for years before fiscal 2012. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax positions as a component of interest expense, net and other, net, respectively. No amounts of such expenses are currently accrued. Post-Retirement Healthcare and Pension Benefits The Company provides post-retirement healthcare benefits to salaried and certain hourly employees that retired prior to September 1, 2010. The benefits provided are hospitalization and medical coverage for the employee and spouse until age 65. Benefits continue until the death of the retiree, which results in the UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) termination of benefits for all dependent coverage. If an employee leaves the Company as a terminated vested member of a pension plan prior to normal retirement age, the person is not entitled to any post-retirement healthcare benefits. Benefits payable under this program are secondary to any benefits provided by Medicare or any other governmental programs. In June 2010, the Company announced changes to the healthcare and pension plans provided to salaried employees. Effective September 1, 2010, postretirement medical benefits for new hires and active salaried employees retiring after September 1, 2010 were eliminated. Additionally, effective January 1, 2011, deductibles and co-payments were added to the medical benefits plan for all active and retired employees. For salaried employees meeting certain age and service requirements, the Company contributes a defined dollar amount towards the cost of retiree healthcare based upon the employee’s length of service. Similarly, effective August 31, 2010, benefits under the Company’s defined benefit pension plan were frozen for all salaried employees, including the Company’s Chief Executive Officer and Chief Financial Officer. The Company will provide an enhanced contribution under its defined contribution 401(k) plan as well as a transition contribution for older employees. The changes made for the salary group described above were also incorporated into the collective bargaining agreement reached with the International Union of Operating Engineers, Local No.95 effective February 1, 2012. The Company accrues post-retirement benefits other than pensions, during the years that the employee renders the necessary service, of the expected cost of providing those benefits to an employee and the employee’s beneficiaries and covered dependents. Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Allowance for Doubtful Accounts The Company records an allowance for doubtful accounts based on specifically identified amounts that we believe to be uncollectible. The Company also recorded additional allowances based on historical collection experience and its assessment of the general financial conditions affecting the customer base. Senior management reviews accounts receivable on a weekly basis to determine if any receivables will potentially be uncollectible. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Concentration Risks Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments. The Company places its temporary cash investments with quality financial institutions. At times, such investments were in excess of FDIC insurance limits. The Company has not experienced any losses in such accounts. UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The Company purchased approximately 15% of its cost of goods sold from one vendor during each of the fiscal years ended August 31, 2016 and 2015, respectively. The Company is not obligated to purchase from this vendor, and, if necessary, there are other vendors from which the Company can purchase crude oil and other petroleum based products. The Company had $0 in accounts payable for each of the years ended August 31, 2016 and 2015 to this vendor. Environmental Matters The Company expenses environmental expenditures related to existing conditions resulting from past or current operations and from which no current or future benefit is discernible. Expenditures, which extend the life of the related property or mitigate or prevent future environmental contamination are capitalized. The Company determines its liability on a site by site basis and records a liability at the time when it is probable and can be reasonably estimated. The Company’s estimated liability is reduced to reflect the anticipated participation of other potentially responsible parties in those instances where it is probable that such parties are legally responsible and financially capable of paying their respective shares of the relevant costs. The estimated liability of the Company is not reduced for possible recoveries from insurance carriers and is recorded in accrued liabilities. Goodwill and Other Non-Amortizable Assets In accordance with ASC 350, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with ASC 350. Other definite lived intangible assets continue to be amortized over their estimated useful lives. The Company performed separate impairment tests for its goodwill and tradename using the discounted cash flow method. The fair value of the Company’s reporting units exceeded their carrying values. The fair value of the tradename exceeded its carrying value. The Company has noted no subsequent indication that would require testing its goodwill and tradename for impairment. Long-Lived Assets Whenever events or changes in circumstances indicate that the carrying value of any of these assets (other than goodwill and tradename) may not be recoverable, the Company will assess the recoverability of such assets based upon estimated undiscounted cash flow forecasts. When any such impairment exists, the related assets will be written down to fair value. Other Comprehensive (Loss) Income The Company reports comprehensive (loss) income in accordance with ASC 220-10. ASC 220-10 establishes guidelines for the reporting and display of comprehensive (loss) income and its components in financial statements. Comprehensive (loss) income includes charges and credits to equity that is not the result of transactions with the shareholder. Included in other comprehensive loss for the Company is a charge for unrecognized post-retirement costs, which is net of taxes in accordance with ASC 715. The accumulated other comprehensive loss balance is made up entirely of unrecognized post-retirement costs. Recent Accounting Pronouncements In May, 2014, the FASB issued ASU No. 2014-09 “Revenue from Contracts with Customers,” which provides guidance for revenue recognition. The standard’s core principle is that a company should recognize UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14 which deferred the effective date of ASU 2014-09. This guidance will now be effective for our financial statements in the annual period beginning after December 15, 2017. We are currently evaluating the effect of adopting this new accounting guidance and do not expect adoption will have a material impact on our financial statements. In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs,” which requires debt issuance costs related directly to notes payable be deducted from the face amount of that note and the amortization of such costs be classified as interest expense. This guidance is effective for fiscal years and interim periods beginning after December 15, 2015, with early adoption permitted. Upon adoption, an entity must retrospectively apply the guidance. We are currently evaluating the effect of adopting this new accounting guidance and do not expect adoption will have a material impact on our financial statements. In November 2015, the FASB issued ASU 2015-17 “Balance Sheet Classification of Deferred Taxes,” which requires deferred income tax balances to be presented as noncurrent. This guidance is effective for fiscal years and interim periods beginning after December 15, 2016, with early adoption permitted. Effective August 31, 2016, the Company adopted the accounting and reporting requirements included in ASU 2015-17 for balance sheet classification of deferred taxes requiring deferred tax assets and liabilities to be classified as noncurrent. The Company has applied these requirements retrospectively. Accordingly, the Company has included $5,822,000 of previously reported current deferred income tax liabilities in the $61,743,000 noncurrent deferred income tax liabilities in its August 31, 2015 consolidated balance sheet. The adoption of these accounting and reporting requirements had no impact on the Company’s results of operations or cash flows. In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (ASU 2016-01”). The standard addresses certain aspects of recognition, measurements, presentation and disclosure of financial instruments. ASU 2016-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017 and early adoption is not permitted. The Company is currently assessing the impact that adoption of this guidance will have on its financial statements and footnote disclosures. In February 2016, the FASB issued ASU-2016-02 “Leases,” which replaces the existing guidance in Accounting Standards Codification (“ASC”) 840. This new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018 with early adoption permitted. The guidance requires a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use (ROU) asset and a corresponding lease liability. For finance leases the lessee would recognize interest expense and amortization of the ROU asset and for operating leases the lessee would recognize a straight-line total lease expense. The Company is currently assessing the impact that adoption of this guidance will have on its financial statements and footnote disclosures. In August 2016, the FASB issued ASU 2016-15 which includes guidance to clarify how companies present and classify certain cash receipts and cash payments in the statement of cash flows, including contingent consideration payments made after a business acquisition and debt extinguishment costs. Specifically, cash payments to settle a contingent consideration liability which are not made soon after the acquisition date should be classified as cash used in financing activities up to the initial amount of contingent consideration recognized with the remaining amount classified as cash flows from operating activities. The guidance is effective for fiscal years and interim periods beginning after December 15, 2017, with early adoption permitted. The Company UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) expects to adopt this guidance when effective and adoption is not expected to have a material effect on the financial statements. Reclassification Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform with the presentation in the current year. 2. Accounts Receivable, Net As of August 31, 2016 and 2015, accounts receivable were net of allowance for doubtful accounts of $750,000 and $850,000, respectively. 3. Inventories Inventories consist of the following: As of August 31, 2016 and 2015, the replacement cost of LIFO inventories (FIFO) exceeded their LIFO carrying values (LCM) on the balance sheets by approximately $4,718,000 and $6,201,000, respectively, which includes the LCM inventory write-down of $13,052,000 and $0, respectively, and a LIFO increase (decrease) of $8,334,000 and $(6,201,000), respectively. For the fiscal years ended August 31, 2016 and 2015, the Company recorded a charge to Costs of Goods Sold from a LIFO layer liquidation of $15,703,000 and $0, respectively. Included in petroleum product inventories are exchange balances either held for or due from other petroleum marketers. These balances are not significant. The Company does not own sources of crude oil and depends on outside vendors for its needs. UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 4. Property, Plant and Equipment Property, plant and equipment is summarized as follows: Depreciation and amortization on the above assets for the fiscal years ended August 31, 2016 and 2015 amounted to $22,643,000 and $20,678,000, respectively. On March 6, 2013, the Company, through its subsidiary United Biofuels, Inc. (“UBI”), acquired a partially completed 50 million gallon per year biodiesel facility in Brooklyn, New York as part of the acquisition by its parent company, United Refining, Inc., and United Metro Energy Corp. (“UMEC”), a subsidiary of the Company’s parent company, of certain assets of Metro Fuel Oil Corp, and its affiliates. UBI has initiated the project to complete and modify the biodiesel plant. The Company paid $9,800,000 for such biodiesel facility. Due to the Company and UMEC having a common owner, the Company recorded the acquisition of the biodiesel facility based on an allocation of the carrying value of all assets acquired by its parent and UMEC from Metro Fuel Oil Corp., or $20,735,000. The difference between the carrying value of the biodiesel facility and the amount paid by the Company has been recorded as a capital contribution net of the tax effect of $4,960,000. Commissioning the modified biodiesel plant is expected during fiscal year 2018. As of August 31, 2016, the remaining cost of the project is expected to be about $37,000,000. 5. Goodwill and Intangible Assets As of August 31, 2016 and 2015, the Company’s trade name, goodwill and amortizable intangible assets, included in the Company’s retail segment, were as follows: UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Amortization expense for the fiscal years ended August 31, 2016, 2015 and 2014 amounted to $122,000, $115,000 and $106,000, respectively. Amortization expense for intangible assets subject to amortization for each of the years in the five-year period ending August 31, 2021 is estimated to be $126,000, $126,000, $126,000, $118,000, $62,000 and $249,000 thereafter. 6. Accrued Liabilities Accrued liabilities include the following: 7. Leases The Company occupies premises, primarily retail gas stations and convenience stores and office facilities under long-term leases which require minimum annual rents plus, in certain instances, the payment of additional rents based upon sales. The leases generally are renewable for one to three five-year periods. As of August 31, 2016 and 2015, capitalized lease obligations, included in long-term debt, amounted to $4,087,000 and $4,212,000, respectively, inclusive of current portion of $143,000 and $124,000, respectively. The related assets (retail gas stations and convenience stores) as of August 31, 2016 and 2015 amounted to $3,492,000 and $3,732,000, net of accumulated amortization of $1,197,000 and $956,000, respectively. Lease amortization amounting to $241,000, $207,000 and $185,000 for the years ended August 31, 2016, 2015 and 2014, respectively is included in depreciation and amortization expense. Future minimum lease payments as of August 31, 2016 are summarized as follows: UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Net rent expense for operating leases amounted to $13,774,000, $13,728,000 and $13,243,000 for the years ended August 31, 2016, 2015 and 2014, respectively. 8. Long-Term Debt Amended, Restated and Consolidated Revolving Credit, Term Loan and Security Agreement On October 20, 2015, URC, United Refining Company of Pennsylvania, Kiantone Pipeline Corporation (“Kiantone”), United Refining Company of New York Inc., United Biofuels, Inc., Country Fair, Inc. and Kwik-Fill Corporation (collectively, the “Borrowers”) entered into an Amended, Restated and Consolidated Revolving Credit, Term Loan and Security Agreement (“Credit Agreement”) with a group of lenders led by PNC Bank, National Association, as Administrative Agent (the “Agent”), and PNC Capital Markets LLC, as Sole Lead Arranger and Bookrunner. The Credit Agreement amends and restates the Amended and Restated Credit Agreement, dated May 18, 2011 and last amended June 18, 2013, by and between the Company and certain subsidiaries and PNC Bank, National Association, as Administrative Agent (the “Existing Credit Facility”). The Credit Agreement will terminate on October 19, 2020 (the “Expiration Date”). Until the Expiration Date, the Company may borrow on the New Revolving Credit Facility (as defined below) on a borrowing base formula set forth in the Credit Agreement. Pursuant to the Credit Agreement, the Company increased its existing senior secured revolving credit facility from $175,000,000 to $225,000,000. The New Revolving Credit Facility may be increased by an amount not to exceed $50,000,000 without additional approval from the lenders named in the Credit Agreement if existing lenders agree to increase their commitments or additional lenders commit to fund such increase. Interest under the New Revolving Credit Facility is calculated as follows: (a) for domestic rate borrowings, at (i) the greater of the Agent’s prime rate, federal funds rate plus .5% or the daily LIBOR rate plus 1%, plus (ii) an applicable margin of 1.25% to 1.75%, and (b) for euro-rate borrowings, at the LIBOR rate plus an applicable margin of 2.25% to 2.75%. The applicable margin will vary depending on a formula calculating the Company’s average unused availability under the facility. As of August 31, 2016 and 2015 there were no base rate or euro-rate borrowings outstanding under the facility. Letters of credit totaling $8,753,000 were outstanding at August 31, 2016 and 2015, respectively. In addition, pursuant to the Credit Agreement, the Company entered into a term loan in the amount of $250,000,000, which was made in a single drawing on the Closing Date (“Term Loan” and, together with the New Revolving Credit Facility, the “Credit Obligations”). Under the Term Loan, interest is calculated as follows: (a) for domestic rate borrowings, at (i) the greater of the Agent’s prime rate, federal funds rate plus .5% or the daily LIBOR rate plus 1%, plus (ii) an applicable margin of 1.75% to 2.25%, and (b) for euro-rate borrowings, at the LIBOR rate plus an applicable margin of 2.75% to 3.25%. The applicable margin will vary depending on a formula calculating the Company’s average unused availability under the facility. The Term Loan is prepayable in whole or in part at any time without premium or penalty. The Term Loan shall be paid in full on or prior to the Expiration Date and shall be paid in equal quarterly amounts based on a ten-year straight line amortization schedule. The Credit Obligations are secured by a first priority security interest in certain cash accounts, accounts receivable, inventory, the refinery, including a related tank farm, and the capital stock of Kiantone. At such time as the Term Loan is repaid in full, and provided no event of default exists, the security interest in the refinery and the equity interest in Kiantone shall be released. The Credit Agreement requires minimum undrawn availability of $15,000,000 at all times prior to the repayment of the Term Loan and the greater of 12.5% of the maximum New Revolving Credit Facility or $25,000,000 after the repayment of the Term Loan. The Company is also required to maintain a consolidated net UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) worth of no less than $100,000,000. The Credit Agreement includes customary mandatory prepayment provisions, including in connection with non-ordinary course asset sales, equity issuances and the incurrence of additional debt. Unless assets sold in non-ordinary course transactions were included in the borrowing base for the New Revolving Credit Facility, mandatory prepayments shall be applied first to the repayment of the Term Loan and then the New Revolving Credit Facility. The Credit Agreement also includes customary affirmative and negative covenants, including, among other things, covenants related to the fixed charge coverage ratio, payment of fees, conduct of business, maintenance of existence and assets, payment of indebtedness and the incurrence of additional indebtedness, intercompany obligations, affiliate transactions, amendments to organizational documents, and financial statements. The proceeds of the Credit Agreement were used to (i) repay and satisfy in full those certain 10.500% senior secured notes due 2018 (the “Senior Secured Notes due 2018”), (ii) provide for the Company’s general corporate needs, including working capital requirements and capital expenditures and (iii) pay the fees and expenses associated with the Credit Agreement. In connection with the redemption of all its Senior Secured Notes due 2018, the Company recorded a loss of $19,316,000 on the early extinguishment of debt consisting of a redemption premium of $7,009,000, a consent payment of $6,536,000, a write-off of unamortized net debt discount of $3,600,000 and a write-off of deferred finance costs of $2,171,000. Other Long Term Debt On December 9, 2015, United Refining Company of New York Inc. (as Borrower) and United Refining Company of Pennsylvania (as Fee Owner), entered into a Loan Agreement with a bank, in the amount of $50,000,000 which matures on December 9, 2022. Pursuant to the Loan Agreement, interest is calculated as follows: (a) for LIBOR Loans, at either the LIBOR plus 2.50% or the Prime Rate, (b) for Reference Rate Loans, the Prime Rate and (c) for Fixed Rate Loans, at the Fixed Rate. Under the terms of the agreement, the Company will make 84 monthly principal installments of approximately $129,000 with the remaining principal balance due on December 9, 2022. The loan is secured by a first lien mortgage on certain convenience store units owned by United Refining Company of Pennsylvania and contains various covenants applicable to the Borrower, which include, among others, maintaining a debt service coverage ratio. Payments due under a master lease between URC and the Borrower are guaranteed by the Company. Proceeds of the loan are to be used for general corporate purposes of the Company. A summary of long-term debt is as follows: UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The principal amount of long-term debt matures as follows: The following financing costs have been deferred and are being amortized to expense over the term of the related debt: Amortization expense for the fiscal years ended August 31, 2016, 2015 and 2014 amounted to $1,239,000, $1,228,000 and $1,228,000, respectively. 9. Employee Benefit Plans The Company sponsors three defined benefit plans and seven defined contribution plans covering substantially all its full-time employees. The benefits under the defined benefit plans are based on each employee’s years of service and compensation. Effective February 1, 2012 benefits under the Company’s defined benefit pension plan for hourly employees were frozen. Additionally, effective August 31, 2010 benefits under the Company’s defined benefit pension plan were frozen for all salaried employees, including the Company’s Chief Executive Officer and Chief Financial Officer. The Company will provide enhanced contributions under its defined contribution 401(k) plan as well as a transition contribution for older employees. The Company’s policy is to contribute the minimum amounts required by the Employee Retirement Income Security Act of 1974 (ERISA), as amended and any additional amounts for strategic financial purposes or to meet other goals relating to plan funded status. The assets of the plans are invested in an investment trust fund and consist of interest-bearing cash, separately managed accounts and bank common/collective trust funds. In addition to the above, the Company provides certain post-retirement healthcare benefits to salaried and certain hourly employees that retired prior to September 1, 2010. These post-retirement benefit plans are unfunded and the costs are paid by the Company from general assets. UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Net periodic pension and other post-retirement healthcare benefit cost (income) consist of the following components for the years ended August 31, 2016, 2015 and 2014: The Company adopted ASC 715-30-25 effective August 31, 2007. ASC 715-30-25 requires an employer to recognize the funded status of each of its defined pension and postretirement benefit plans as a net asset or liability in its statement of financial position with an offsetting amount in accumulated other comprehensive income/loss, and to recognize changes in that funded status in the year in which changes occur through comprehensive income/loss. Changes in plan assets and benefit obligation recognized in Other Comprehensive Loss consist of the following for the fiscal years ended August 31, 2016 and 2015 (in thousands): UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The following table summarizes the change in benefit obligations and fair values of plan assets for the years ended August 31, 2016 and 2015: Amounts recognized in Accumulated Other Comprehensive Loss: The preceding table presents two measures of benefit obligations for the pension plans. Accumulated benefit obligation (ABO) generally measures the value of benefits earned to date. Projected benefit obligation (PBO) UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) also includes the effect of assumed future compensation increases for plans in which benefits for prior service are affected by compensation changes. Each of the three pension plans, whose information is aggregated above, have asset values less than these measures. Plan funding amounts are calculated pursuant to ERISA and Internal Revenue Code rules. The postretirement benefits are not funded. Weighted average assumptions used to determine year end benefit obligations: The discount rate assumptions at August 31, 2016 and 2015 were determined independently for each plan. A yield curve was produced for a universe containing the majority of U.S.-issued Aa-graded corporate bonds, all of which were non-callable (or callable with make-whole provisions). For each plan, the discount rate was developed as the level equivalent rate that would produce the same present value as that using spot rates aligned with the projected benefit payments. Weighted average assumptions used to determine net periodic costs: For measurement purposes, the assumed annual rate of increase in the per capita cost of covered medical and dental benefits was 7.00% and 7.00% for 2016 and 2015, respectively. The rates were assumed to decrease gradually to 5% for medical benefits until 2025 and remain at that level thereafter. The healthcare cost trend rate assumption has a significant effect on the amounts reported. To illustrate, a 1 percentage point change in the assumed healthcare cost trend rate would have the following effects: The expected return on plan assets is a long-term assumption established by considering historical and anticipated returns of the asset classes invested in by the pension plans and the allocation strategy currently in place among those classes. UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) A reconciliation of the above accrued benefit costs to the consolidated amounts reported on the Company’s Consolidated Balance Sheets follows: Fair Value of Plan Assets Our Defined Benefit plans’ assets fall into any of three fair value classifications as defined in ASC 820-10. Level 1 assets are valued based on observable prices for identical assets in active markets such as national security exchanges. Level 2 assets are valued based on a) quoted prices of similar assets in active markets, b) quoted prices for similar assets in inactive markets, c) other than quoted prices that are observable for the asset, or d) values that are derived principally from or corroborated by observable market data by correlation or other means. There are no Level 2 or 3 assets held by the plans as defined by ASC 820-10. The fair value of our plan assets as of August 31, 2016 and 2015 is as follows (in thousands): The pension plans weighted-average target allocation for the year ended August 31, 2016 and strategic asset allocation matrix as of August 31, 2016 and 2015 are as follows: UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The investment policy for the plans is formulated by the Company’s Pension Plan Committee (the “Committee”). The Committee is responsible for adopting and maintaining the investment policy, managing the investment of plan assets and ensuring that the plans’ investment program is in compliance with all provisions of ERISA, as well as the appointment of any investment manager who is responsible for implementing the plans’ investment process. In drafting a strategic asset allocation policy, the primary objective is to invest assets in a prudent manner to meet the obligations of the plans to the Company’s employees, their spouses and other beneficiaries, when the obligations come due. The stability and improvement of the plans’ funded status is based on the various reasons for which money is funded. Other factors that are considered include the characteristics of the plans’ liabilities and risk-taking preferences. The asset classes used by the plan are the United States equity market, the international equity market, the United States fixed income or bond market and cash or cash equivalents. Plan assets are diversified to minimize the risk of large losses. Cash flow requirements are coordinated with the custodian trustees and the investment manager to minimize market timing effects. The asset allocation guidelines call for a maximum and minimum range for each broad asset class as noted above. The target strategic asset allocation and ranges established under the asset allocation represents a long-term perspective. The Committee will rebalance assets to ensure that divergences outside of the permissible allocation ranges are minimal and brief as possible. The net of investment manager fee asset return objective is to achieve a return earned by passively managed market index funds, weighted in the proportions identified in the strategic asset allocation matrix. Each investment manager is expected to perform in the top one-third of funds having similar objectives over a full market cycle. The investment policy is reviewed by the Committee at least annually and confirmed or amended as needed. Under ASC 715-30-25, the transition obligation, prior service costs, and actuarial (gains)/losses are recognized in Accumulated Other Comprehensive Income/Loss each August 31 or any interim measurement date, while amortization of these amounts through net periodic benefit cost will occur in accordance with ASC 715-30 and ASC 715-60. The estimated amounts that will be amortized in 2017 are as follow: UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The following contributions and benefit payments, which reflect expected future service, as appropriate, are expected to be paid: The pension plan contributions are deposited into a trust, and the pension plan benefit payments are made from trust assets. For the postretirement benefit plan, the contributions and the benefit payments are the same and represent expected benefit amounts, which are paid from general assets. The Company’s postretirement benefit plan is affected by The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”). Beginning in 2006, the Act provides a Federal subsidy payment to companies providing benefit plans that meet certain criteria regarding their generosity. The Company expects to receive those subsidy payments. The Company has accounted for the Act in accordance with ASC 715-60-05-8, which requires, in the Company’s case, recognition on August 31, 2004. The benefit obligation as of that date reflects the effect of the federal subsidy, and this amount is identified in the table reconciling the change in benefit obligation above. The estimated effect of the subsidy on cash flow is shown in the accompanying table of expected benefit payments above. The expected subsidy reduced net periodic postretirement benefit cost by $5,168,000, as compared with the amount calculated without considering the effects of the subsidy. The Company also contributes to voluntary employee savings plans through regular monthly contributions equal to various percentages of the amounts invested by the participants. The Company’s contributions to these plans amounted to $2,796,000, $2,767,000 and $2,752,000 for the years ended August 31, 2016, 2015 and 2014, respectively. 10. Income Taxes Income tax expense consists of: UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Reconciliation of the differences between income taxes computed at the Federal statutory rate and the provision for income taxes attributable to income before income tax expense is as follows: Deferred income tax liabilities (assets) are comprised of the following: The Company’s results of operations are included in the consolidated Federal tax return of the Parent, See Note 13 to “Consolidated Financial Statements”. The Company has no Federal net operating loss carryforwards for regular tax purposes. For state purposes, two entities have Pennsylvania net operating loss carry forwards of $128,000,000 and $39,000,000, respectively, which will expire between fiscal year 2023 and 2036. Pennsylvania limits the amount of net operating loss carry forwards which can be used to offset Pennsylvania taxable income to the greater of $5,000,000 or 30% of Pennsylvania taxable income prior to the net operating loss deduction. UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Due to these limitations, the Company has recognized valuation allowances, net of a federal benefit, of $7,353,000 and $2,577,000 at August 31, 2016 and 2015, respectively, for Pennsylvania net operating loss carry forwards not anticipated to be realized before expiration. 11. Disclosures About Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value. The carrying amount of cash and cash equivalents, trade accounts receivable, the revolving credit facility and current liabilities approximate fair value because of the short maturity of these instruments. Derivative financial instruments are recorded at fair value using significant other observable inputs (Level 2). The fair value of long-term debt (See Note 8 to “Consolidated Financial Statements”) was determined using the fair market value of the individual debt instruments. As of August 31, 2016, the carrying amount and estimated fair value of these debt instruments approximated $287,677,000 and $287,457,000, respectively. 12. Stockholder’s Equity On July 26, 2013, the Board of Directors of the Company and the Company’s sole stockholder, URI, approved, and the Company filed with the Secretary of State of the Commonwealth of Pennsylvania, an Amended and Restated Articles of Incorporation of the Company (the “Amendment”). Pursuant to the Amendment, the capital stock of the Company was increased from 100 to 50,100, of which 50,000 were designated as preferred stock. Out of the preferred stock, the Board of Directors created the 6% Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) and the Amendment included the designations of the rights and preferences of such series. Among other things, the Series A Preferred Stock, of which the Company is authorized to issue a maximum of 25,000, carry the following rights: • The Series A Preferred Stock rank: (i) senior to the Company’s common stock; (ii) senior to all other classes of equity securities other than preferred stock which by their terms do not rank senior to the Series A Preferred Stock; and (iii) on parity with any other series of the Company’s preferred stock that does not provide it ranks junior to the Series A Preferred Stock; • The Series A Preferred Stock shall receive dividends at a rate of 6.00% of the Stated Value (which is $10,000) per share per annum; • The Series A Preferred Stock shall have no voting rights unless otherwise required by law, except in limited circumstances relating to amendments to URC’s certificate of incorporation or amendments to the rights and preferences of the Series A Preferred Stock; • In the event dividends have not been paid in the aggregate amount payable for six or more Dividends Periods, holders of the Series A Preferred Stock shall be entitled to elect two directors to the Board of Directors, who shall remain directors until all accumulated and unpaid dividends on the Series A Preferred Stock have been paid in full or set aside for payment. Upon the payment or set aside of such dividends, the term of office of the directors appointed by the holders of the Series A Preferred Stock shall terminate and the size of the Board of Directors shall automatically decrease by two; and • The Series A Preferred Stock are perpetual and have no maturity date. However, the Company may, at its option, redeem shares of the Series A Preferred Stock, in whole or in part, on any Dividend UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Repayment Date on or after July 26, 2023 at a price of $10,000 per share plus accrued and unpaid dividends. On July 26, 2013, the Company issued 14,116.375 shares of Series A $1,000 par value per share to United Refining, Inc., its parent. The proceeds from the issuance in the amount of $141,163,750 were used to redeem $127,750,000 of the Company’s Senior Secured Notes due 2018, which redemption occurred on August 30, 2013. In accordance with the Indenture governing the Senior Secured Notes due 2018, the Company obtained an opinion concerning the fairness from a financial point of view of the issuance of the Series A Preferred Stock to URI. 13. Transactions with Affiliated Companies On December 21, 2001, the Company acquired the operations and working capital assets of Country Fair. The fixed assets of Country Fair were acquired by related entities controlled by John A. Catsimatidis, the indirect sole shareholder of the Company. These assets are being leased to the Company at an annual aggregate rental fee which management, based on an independent third party valuation, believes is fair, over a period ranging from 10 to 20 years. During the fiscal years ended August 31, 2016, 2015 and 2014, $5,365,000, $5,360,000 and $5,360,000 of rent payments were made to these related entities. The Company is not a guarantor on the underlying mortgages on the properties. Concurrent with the above acquisition of Country Fair, the Company entered into a management agreement with a non-subsidiary affiliate to operate and manage 10 of the retail units owned by the non-subsidiary affiliate on a turn-key basis. For the years ended August 31, 2016, 2015 and 2014, the Company billed the affiliate $1,324,000, $1,301,000 and $1,207,000 for management fees and overhead expenses incurred in the management and operation of the retail units which amount was deducted from expenses. As of August 31, 2016 and 2015, the Company had a (receivable) payable to the affiliate of $(4,000) and $296,000, respectively, under the terms of the agreement, which is included in Amounts Due To/From Affiliated Companies, Net. On September 29, 2000, the Company sold 42 retail units to an affiliate for $23,870,000. Concurrent with this asset sale, the Company terminated the leases on 8 additional retail locations which it had previously leased from a non-subsidiary affiliate. The Company has entered into a management agreement with the non-subsidiary affiliate to operate and manage the retail units owned by the non-subsidiary affiliate on a turnkey basis. For the years ended August 31, 2016, 2015 and 2014, the Company billed the affiliate $2,123,000, $2,325,000 and $2,165,000, respectively, for management fees and overhead expenses incurred in the management and operation of 51 retail units, which amount was deducted from expenses. For the fiscal years ended August 31, 2016, 2015 and 2014, net sales to the affiliate amounted to $92,892,000, $131,326,000 and $191,828,000, respectively. As of August 31, 2016 and 2015, the Company had a payable to the affiliate of $598,000 and $1,106,000, respectively, under the terms of the agreement, which is included in Amounts Due To/From Affiliated Companies, net. The Company paid a service fee relating to certain costs incurred by its Parent for the Company’s New York office. During the years ended August 31, 2016, 2015 and 2014, such fees amounted to approximately $2,400,000, $2,000,000, and $2,000,000, respectively, which is included in Selling, General and Administrative Expenses. At August 31, 2016, the Company had a payable to the Parent concerning these fees of $100,000. The Company joins with the Parent and the Parent’s other subsidiaries in filing a Federal income tax return on a consolidated basis. Income taxes are calculated on a separate return basis with consideration of the Tax Sharing Agreement between the Parent and its subsidiaries. Amounts related to the Tax Sharing Agreement for the utilization by the Company of certain tax attributes of the Parent and other subsidiaries related to the tax years ended August 31, 2016, 2015 and 2014 amounted to $470,000, $36,000 and $(3,034,000), respectively and UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) have been recorded as a capital contribution (distribution). As of August 31, 2016 and 2015, the Company had a receivable from the Parent of $0 and $2,500,000, respectively, under the terms of the Tax Sharing Agreement. During the years ended August 31, 2016, 2015 and 2014, the Company incurred $401,000, $420,000 and $420,000, respectively, as its share of occupancy expenses for its offices in New York that it shares with affiliates of the Company. Such offices are located in a building owned by John A. Catsimatidis. On July 26, 2013, the Company issued and sold to URI, its sole stockholder and parent, 14,116.375 shares of the Series A Preferred Stock for an aggregate purchase price of $141,163,750 in accordance with the terms and provisions of a Subscription Agreement by and between the Company and URI. The Subscription Agreement contained customary representations and warranties concerning the acquisition of the Series A Preferred Stock by URI and restrictions on the transfer of the Series A Preferred Stock. See Note 12, Stockholders’ Equity, for a description of the terms of the Series A Preferred Stock. During the years ended August 31, 2016, 2015 and 2014 the Company made $1,456,000, $1,270,000 and $1,158,000, respectively, of rent payments to related entities for the lease of convenience stores and other buildings owned by affiliates. During the years ended August 31, 2016, 2015 and 2014, the Company paid $4,662,000, $4,774,000 and $4,399,000, respectively, to a related captive insurance company (“Captive”). The Captive was established in fiscal 2014 and will provide the Company with a primary layer of worker’s compensation, general liability and automobile liability insurance. The insurance is supplemented by additional excess insurance policies secured directly from third party insurers. During the years ended August 31, 2016 and 2015, the Company made payments to an insurance company for two of its affiliates totaling $254,000 and $283,000, respectively. These payments were reimbursed by the affiliate during the year ended August 31, 2016. The Company receives engineering services from a subsidiary of our Parent company to assist with the construction of its biodiesel facility in Brooklyn, New York. During the fiscal years ended August 31, 2016 and 2015 the Company paid $589,000 and $349,000 to this entity for such services. At August 31, 2016, the Company had a payable to the Parent subsidiary of $35,000. 14. Environmental Matters and Other Contingencies The Company is subject to federal, state and local laws and regulations relating to pollution and protection of the environment such as those governing releases of certain materials into the environment and the storage, treatment, transportation, disposal and clean-up of wastes, including, but not limited to, the Federal Clean Water Act, as amended, the Clean Air Act, as amended, the Resource Conservation and Recovery Act of 1976, as amended, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, and analogous state and local laws and regulations. Due to the nature of the Company’s business, the Company is and will continue to be subject to various environmental claims, legal actions and actions by regulatory authorities. In the opinion of management, all current matters are without merit or are of such kind or involve such amounts that an unfavorable disposition would not have a material adverse effect on the consolidated financial condition or operations of the Company. The management of the Company believes that remediation and related environmental response costs incurred during the normal course of business, including contractual obligations as well as activities required under applicable law and regulation, will not have a material adverse effect on its consolidated financial condition or operations. UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) In addition to the foregoing proceedings, the Company and its subsidiaries are parties to various legal proceedings that arise in the ordinary course of their respective business operations. In the opinion of management, all such matters are adequately covered by insurance, or if not so covered, are without merit or are of such kind, or involve such amounts that unfavorable dispositions would not have a material adverse effect on the consolidated financial position or results of operations of the Company. The Company also closely monitors all climate change and Greenhouse Gas (“GHG”) legislation, better known as Cap and Trade as well as fuels mandates requiring the increased use of renewable resources in motor fuel. The Company believes, however, that implementation of reasonable, incremental changes over time will not have a material adverse effect on the Company’s consolidated financial position or operations. The ultimate cost of GHG reduction mandates and their effect on our business are, however, unknown until implementing regulations are available. Similarly, the costs of compliance with renewable fuels mandates in the future remains unknown until a final regulatory structure has been adopted. 15. Segments of Business The Company is a petroleum refiner and marketer in its primary market area of Western New York and Northwestern Pennsylvania. Operations are organized into two business segments: wholesale and retail. The wholesale segment is responsible for the acquisition of crude oil, petroleum refining, supplying petroleum products to the retail segment and the marketing of petroleum products to wholesale and industrial customers. The retail segment operates a network of Company operated retail units under the Red Apple Food Mart® and Country Fair® brand names selling petroleum products under the Kwik Fill®, Citgo® and Keystone® brand names, as well as convenience and grocery items. The accounting policies of the reportable segments are the same as those described in Footnote 1 to Consolidated Financial Statements. Intersegment revenues are calculated using market prices and are eliminated upon consolidation. Summarized financial information regarding the Company’s reportable segments is presented in the following table. UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 16. Quarterly Financial Data (unaudited) During the first quarter fiscal 2016, the Company refinanced its debt and incurred a loss on extinguishment of debt in the amount of $19,316. 17. Put and Call Option Agreement On April 8, 2015 (the “Execution Date”), the Company entered into a Put and Call Option Agreement with each of Enbridge Energy Limited Partnership (“Enbridge LP”) and Enbridge Pipelines Inc. (“Enbridge Inc.” and, together with Enbridge LP, the “Carriers”). The Put and Call Option Agreement entered into with Enbridge LP (the “U.S. Agreement”) is substantially similar to the Put and Call Option Agreement entered into with Enbridge Inc. (the “Canadian Agreement” and, together with the U.S. Agreement, the “Put and Call Agreement”). The Put and Call Agreement was contemplated in that certain Letter Agreement, originally executed on July 31, 2014 and UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) last amended on April 8, 2015 (the “Letter Agreement”), between the Company and the Carriers relating to approximately 88.85 miles of pipeline owned by the Carriers, which transports crude oil from Canada to the Company’s Kiantone Pipeline in West Seneca, New York, and serves the Company’s refinery in Warren, Pennsylvania (“Line 10”). The Letter Agreement related to the parties’ agreement concerning funding certain integrity and replacement costs for Line 10. The Carriers own the pipeline facilities generally identified as Line 10, including real property interests through and under which Line 10 passes, the Carriers’ assignable permits related to the ownership and operation of Line 10, as well as personal property, contract rights, records and incidental rights held solely in connection with Line 10 (collectively, the “Assets”). Pursuant to the Letter Agreement, the Company agreed to fund certain integrity costs necessary to maintain Line 10 (the “Integrity Costs”). Pursuant to the Letter Agreement, the Carriers agreed to reconcile their actual expenses for the integrity maintenance and refund any excess payments made by the Company. The parties agreed to apply any credit to the Company as a result of such reconciliation to amounts owed by the Company for Subsequent Year Pipe Replacement Costs (as defined below). For each subsequent calendar year through the earlier of the expiration or closing of the purchase rights granted to the Company pursuant to the Put and Call Agreement, the Carriers will provide the Company with an invoice for the Integrity Costs for such calendar year (“Subsequent Year Integrity Costs”). The Carriers’ actual expenses with respect to the integrity maintenance and pipe replacement will be reconciled against the Subsequent Year Integrity and Pipe Replacement Costs. In addition, the Company agreed to pay for half the cost of replacing certain portions of Line 10 in accordance with a plan agreed to between the Company Parties and the Carriers. The Company will pay 50% of the estimated expenses of the replacement project for each segment of Line 10 to be replaced (the “Replacement Costs”) within 30 days of its receipt of an invoice for the same, along with a project management fee of 2 1/4%. Each Carrier will initially fund the remaining 50% of the Replacement Costs during construction, provided that the Company will reimburse the Carriers for their actual cost of funds during the construction process. Once construction is complete and each replaced segment of Line 10 is put into service, and assuming the Company has not exercised its rights to purchase Line 10 pursuant to the Put and Call Agreement, the Company will repay the Carriers the 50% of the Replacement Costs they funded over a 10-year period. Pursuant to the Put and Call Agreement, the Carriers granted the Company a right (the “Call Option”) to purchase all of the Assets and the Company granted the Carriers the right to put all the Assets to the Company (the “Put Option” and, together with the Call Option, the “Purchase Options”) subject to the terms and conditions of the Put and Call Agreement. The Carrier’s Put Option is exercisable beginning on the date that is the earlier of (a) January 1, 2026 and (b) the date that is 30 days after the latest of (i) the date on which the Carriers give notice that the Line 10 replacement work performed pursuant to the Letter Agreement is sufficiently completed (as contemplated in the Call and Put Agreement) and (ii) the ninth (9th) anniversary of the Execution Date (the “Put Option Commencement Date”). The Put Option terminates on the date that is 24 months after either (a) the Put Option Commencement Date if such date is the first of a month or (b) the first day of the calendar month immediately following the Put Option Commencement Date if it is not the first day of the month (the “Put/Call Option Expiry Date”). The Company’s Call Option is exercisable at any time beginning on the Execution Date and ending on the Put/Call Option Expiry Date. The purchase price of the Assets (the “Purchase Price”) shall be calculated as follows: the sum of (a) 70% of the book value of the Assets as of July 31, 2014 minus annual depreciation, (b) 100% of total replacement costs for any segment replacements on the Pipeline commenced by the Carrier, whether completed or ongoing on the UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) date of Asset sale is consummated (the “Closing Date”), minus any of such expenses paid by the Company and (c) 100% of the total regulatory requirements costs for any regulatory work commenced by the Carrier, whether completed or ongoing at the Closing Date, minus any of such expenses paid by the Company. The Purchase Price shall be subject to adjustment pursuant to the Put and Call Agreement with respect to certain work ongoing at the Closing Date. Among other customary conditions to closing, Carrier’s obligation to close the sale of the Assets is conditioned on the Company’s payment of all obligations outstanding pursuant to the Put and Call Agreement and the Letter Agreement. In addition, the sale of Assets pursuant to the U.S. Agreement shall close concurrently with the sale of the Assets pursuant to the Canadian Agreement. The Company and the Carrier agreed that certain work must be undertaken in order to carve out portions of Line 10 in Canada from the Enbridge mainline system and allow it to operate independently. In the event any work is required to similarly separate the U.S. portion of Line 10 from the Enbridge mainline system (the “Carve-Out Work”), a plan to perform such Carve-Out Work that would result in expenses greater than $38.5 million will require the approval of the Company. In the event any of the maintenance, regulatory requirement, or replacement work contemplated in the Letter Agreement or the Put and Call Agreement (collectively, the “Work”) is outstanding at the Closing Date, concurrently with the closing of the Asset sale, the Company and the Carriers will enter into an operating agreement (the “Operating Agreement”) pursuant to which the Carriers will provide certain operational and administrative services (the “Services”) while the Work is ongoing and complete such Work. As payment for the Services and completion of the Work, the Carriers shall be: (i) reimbursed for all expenses of providing the Services, (ii) paid a fixed fee on an annual basis, which shall be subject to a 2% increase for each successive year following the first year of the Operating Agreement, and (iii) paid for all expenses of the Work not previously paid, as well as a 2.25% construction management fee. The Put and Call Agreement may be terminated by the mutual consent of the Company and the Carriers and shall automatically terminate if neither Purchase Option is exercised prior to the Put/Call Option Expiry Date. Moreover, either the Company or a Carrier may terminate the Put and Call Agreement if a closing of the Asset sale shall not have occurred on or before December 31, 2028 assuming the terminating party is not then in breach of the Put and Call Agreement and if a party has breached a representation, such breach has not been cured within the time periods allotted by the Put and Call Agreement. Finally, the Company may terminate the Put and Call Agreement by notifying the Carriers to cease the replacement work contemplated in the Letter Agreement. The Company considered whether the Put and Call Agreement should be separated from the host contract in accordance with ASC 815 embedded derivative guidance and concluded that it doesn’t meet the criteria for separation. The Company determined that the Put and Call Agreement is interdependent with the Line l0 Agreement, and therefore is not freestanding and is accounted for as part of the Line 10 Agreement. As such we concluded that there is no separate accounting impact of the Put and Call Agreement until it becomes probable that it will be exercised. As of August 31, 2016 the Company or the Carrier have not exercised their rights under the Put and Call Agreement. 18. Legal Proceedings The Company and its subsidiaries are from time to time parties to various legal proceedings that arise in the ordinary course of their respective business operations. These proceedings include various administrative actions relating to federal, state and local environmental laws and regulations as well as civil matters before various courts seeking money damages. The Company believes that if the legal proceedings in which it is currently UNITED REFINING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) involved were determined against the Company, there would be no material adverse effect on the Company’s operations or its consolidated financial condition. In the opinion of management, all such matters are adequately covered by insurance, or if not so covered, are without merit or are of such kind, or involve such amounts that an unfavorable disposition would not have a material adverse effect on the consolidated operations or financial position of the Company. 19. Subsequent Events On October 20, 2016, Kwik-Fil, Inc. (as Borrower) and United Refining Company of Pennsylvania (as Fee Owner), entered into a loan agreement with a bank in the amount of $25,000,000 which matures on October 20, 2023. Pursuant to the loan agreement, interest is calculated as follows: (a) for LIBOR Loans, at either the LIBOR plus 2.50% or the Prime Rate, (b) for Reference Rate Loans, the Prime Rate and (c) for Fixed Rate Loans, at the greater of the Fixed Rate or 4.25% per annum. Under the terms of the agreement, the Company will make 83 monthly principal installments of approximately $83,000 with the remaining principal balance due on October 20, 2023. The loan is secured by a first lien mortgage on certain convenience store units owned by United Refining Company of Pennsylvania, and contains various covenants applicable to the Borrower, which include, among others, maintaining a debt service coverage ratio. Payments due under a master lease between URC and the Borrower are guaranteed by the Company. Proceeds of the loan are to be used for general corporate purposes of the Company. The Company has reached an early settlement agreement with its refinery employees represented by the International Union of Operating Engineers, Local 95. The contract is effective February 1, 2017 and expires February 1, 2022. | Based on the provided text, here's a summary of the financial statement:
Income Taxes:
- The company uses the asset and liability method for income tax accounting
- Deferred tax assets and liabilities are recognized based on future tax consequences
- Tax calculations are done on a separate return basis with consideration of a Tax Sharing Agreement
- The company is generally not subject to income tax examinations for years before fiscal 2012
Assets:
- Fixed assets of Country Fair were acquired by related entities controlled by John A. Catsimatidis
- These assets are leased back to the company at an annual rental fee deemed fair by management
Liabilities:
- The statement references guidance on debt issuance costs, requiring such costs to be deducted from note face amounts
- This guidance was to be effective for fiscal years and interim periods beginning after December 15 (year not specified)
Expenses:
- Detailed breakdown | Claude |
LUMIOX, INC. AUDITED FINANCIAL STATEMENTS October 31, 2016 MICHAEL GILLESPIE & ASSOCIATES, PLLC CERTIFIED PUBLIC ACCOUNTANTS 10544 ALTON AVE NE SEATTLE, WA 98125 206.353.5736 ACCOUNTING FIRM To the Board of Directors Lumiox Inc. We have audited the accompanying balance sheets of Lumiox Inc. as of October 31, 2016 and 2015 and the related statements of operations, stockholders’ deficit and cash flows for the periods then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion the financial statements referred to above present fairly, in all material respects, the financial position of Lumiox Inc. for the years ended October 31, 2016 and 2015 and the results of its operations and cash flows for the years then ended in conformity with generally accepted accounting principles in the United States of America. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note #3 to the financial statements, although the Company has limited operations it has yet to attain profitability. This raises substantial doubt about its ability to continue as a going concern. Management’s plan in regard to these matters is also described in Note #3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /S/ MICHAEL GILLESPIE & ASSOCIATES, PLLC Seattle, Washington January 28, 2017 Lumiox, Inc. Balance Sheets The accompanying notes are an integral part of these financial statements. Lumiox, Inc. Statements of Operations The accompanying notes are an integral part of these financial statements. Lumiox, Inc. Statements of Stockholder's Equity The accompanying notes are an integral part of these financial statements. Lumiox, Inc. Statements of Cash Flows The accompanying notes are an integral part of these financial statements. LUMIOX, INC. Notes to the Audited Financial Statements October 31, 2016 NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS LUMIOX, INC. (the “Company”) is a Nevada corporation incorporated on July 18, 2014. It is based in Fernley, NV, USA, and the Company’s fiscal year end is October 31. The Company intends to engage in the business of online light-lighting-distribution and Wholesale. To date, the Company’s activities have been limited to its formation and the raising of equity capital. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The Financial Statements and related disclosures have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The Financial Statements have been prepared using the accrual basis of accounting in accordance with Generally Accepted Accounting Principles (“GAAP”) of the United States and presented in US dollars. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. The estimates and judgments will also affect the reported amounts for certain revenues and expenses during the reporting period. Actual results could differ from these good faith estimates and judgments. Cash and Cash Equivalents Cash and cash equivalents include cash in banks, money market funds, and certificates of term deposits with maturities of less than three months from inception, which are readily convertible to known amounts of cash and which, in the opinion of management, are subject to an insignificant risk of loss in value. The Company had $2,560 and $0 cash as at October 31, 2016 and 2015, respectively. Inventories Inventories are stated at the lower of cost or market. Cost is computed using weighted average cost, which approximates actual cost, on a first-in, first-out basis. Inventories on hand are evaluated on an on-going basis to determine if any items are obsolete or in excess of future needs. Items determined to be obsolete are reserved for. The Company provides for the possible inability to sell its inventories by providing an excess inventory reserve. As at October 31, 2016 and October 31, 2015, the Company had $0 and $1,762 of inventory. During the year ended October 31, 2016, the Company wrote down $1,762 of inventory. Financial Instruments The Company follows ASC 820, “Fair Value Measurements and Disclosures”, which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below: Level 1 Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities. Level 2 Level 2 applies to assets or liabilities for which there are inputs other than quoted prices that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data. Level 3 Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities. The Company's financial instruments consist of Cash and cash equivalents and amounts due to related party. The fair value of the Company's financial instruments approximates their carrying value due to the short maturity of these instruments. Concentrations of Credit Risk The Company’s financial instruments that are exposed to concentrations of credit risk primarily consist of its cash and cash equivalents. The Company places its cash and cash equivalents with financial institutions of high credit worthiness. At times, its cash and cash equivalents with a particular financial institution may exceed any applicable government insurance limits. The Company’s management plans to assess the financial strength and credit worthiness of any parties to which it extends funds, and as such, it believes that any associated credit risk exposures are limited. Related Parties The Company follows ASC 850, “Related Party Disclosures,” for the identification of related parties and disclosure of related party transactions. Revenue Recognition The Company will recognize revenue from the sale of products and services in accordance with ASC 605,“Revenue Recognition.” No revenue has been recognized since inception. However, the Company will recognize revenue only when all of the following criteria have been met: i) Persuasive evidence for an agreement exists; ii) Service has been provided; iii) The fee is fixed or determinable; and, iv) Collection is reasonably assured. Share-based Expenses ASC 718 “Compensation - Stock Compensation” prescribes accounting and reporting standards for all share-based payment transactions in which employee services are acquired. Transactions include incurring liabilities, or issuing or offering to issue shares, options, and other equity instruments such as employee stock ownership plans and stock appreciation rights. Share-based payments to employees, including grants of employee stock options, are recognized as compensation expense in the financial statements based on their fair values. That expense is recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period). The Company accounts for stock-based compensation issued to non-employees and consultants in accordance with the provisions of ASC 505-50, “Equity - Based Payments to Non-Employees.” Measurement of share-based payment transactions with non-employees is based on the fair value of whichever is more reliably measurable: (a) the goods or services received; or (b) the equity instruments issued. The fair value of the share-based payment transaction is determined at the earlier of performance commitment date or performance completion date. There were no share-based expenses for the period ending October 31, 2016 and 2015. Deferred Income Taxes and Valuation Allowance The Company accounts for income taxes under ASC 740 “Income Taxes.” Under the asset and liability method of ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period the enactment occurs. A valuation allowance is provided for certain deferred tax assets if it is more likely than not that the Company will not realize tax assets through future operations. No deferred tax assets or liabilities were recognized as of October 31, 2016. Net Loss Per Share of Common Stock The Company has adopted ASC Topic 260, “Earnings per Share,” (“EPS”) which requires presentation of basic EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation. In the accompanying financial statements, basic loss per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. The Company has no potentially dilutive securities, such as options or warrants, currently issued and outstanding. Commitments and Contingencies The Company follows ASC 450-20, Loss Contingencies, to report accounting for contingencies. Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. There were no commitments or contingencies as of October 31, 2016. Recent Accounting Pronouncements Management has considered all recent accounting pronouncements issued. The Company's management believes that these recent pronouncements will not have a material effect on the Company's financial statements. NOTE 3 - GOING CONCERN The Company’s financial statements are prepared using accounting principles generally accepted in the United States of America applicable to a going concern which contemplates the realization of assets and liquidation of liabilities in the normal course of business. During the period ended October 31, 2016, the Company earned no revenues and had a net loss from operations of $27,912. At October 31, 2016, the Company had working capital deficiency of $24,669 and an accumulated deficit of $64,728. The Company has not established an ongoing source of revenues sufficient to cover its operating cost, and requires additional capital to commence its operating plan. The ability of the Company to continue as a going concern is dependent on the Company obtaining adequate capital to fund operating losses until it becomes profitable. If the Company is unable to obtain adequate capital, it could be forced to cease operations. These factors raise substantial doubt about its ability to continue as a going concern. In order to continue as a going concern, the Company will need, among other things, additional capital resources. Management’s plan to obtain such resources for the Company include: sales of equity instruments; traditional financing, such as loans; and obtaining capital from management and significant stockholders sufficient to meet its minimal operating expenses. However, management cannot provide any assurance that the Company will be successful in accomplishing any of its plans. There is no assurance that the Company will be able to obtain sufficient additional funds when needed or that such funds, if available, will be obtainable on terms satisfactory to the Company. In addition, profitability will ultimately depend upon the level of revenues received from business operations. However, there is no assurance that the Company will attain profitability. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. NOTE 4 - EQUITY Authorized Stock The Company has authorized 75,000,000 common shares with a par value of $0.001 per share. Each common share entitles the holder to one vote, in person or proxy, on any matter on which action of the stockholders of the corporation is sought. Common Shares On August 14, 2014, the company issued 25,000,000 shares to an officer and director at $0.001 per for $25,000 cash. During the year ended October 31, 2016, the Company issued 3,408,200 common shares to 19 unaffiliated investors through initial public offering for total proceeds of $17,041 and incurred share issuance cost of $1,982. The offering has not been closed at the date of the issuance of the financial statements and no shares have been issued subsequent to October 31, 2016. As at October 31, 2016 and 2015, the Company had 28,408,200 and 25,000,000 shares issued and outstanding, respectively. NOTE 5 - RELATED PARTY TRANSACTIONS On August 14, 2014, the company issued 25,000,000 shares to an officer and director at $0.001 per for $25,000 cash. As at October 31, 2016 and 2015, the Company was obligated to an officer and director, for an unsecured, non-interest bearing demand loan with a balance of $5,326, and $322, respectively. NOTE 6 - PROVISION FOR INCOME TAXES The Company provides for income taxes under ASC 740, “Income Taxes. ASC 740 requires the use of an asset and liability approach in accounting for income taxes. Deferred tax assets and liabilities are recorded based on the differences between the financial statement and tax basis of assets and liabilities and the tax rates in effect when these differences are expected to reverse. It also requires the reduction of deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Company is subject to taxation in the United States and certain state jurisdictions. The provision for income taxes differs from the amounts which would be provided by applying the statutory federal income tax rate of 34% to the net loss before provision for income taxes for the following reasons: Net deferred tax assets consist of the following components as of: Due to the change in ownership provisions of the Income Tax laws of United States of America, net operating loss carry forwards of approximately $64,728, which expire commencing in fiscal 2032, for federal income tax reporting purposes are subject to annual limitations. When a change in ownership occurs, net operating loss carry forwards may be limited as to use in future years. NOTE 7 - COMMITMENTS AND CONTINGENCIES The Company has no commitments or contingencies as of October 31, 2016. From time to time the Company may become a party to litigation matters involving claims against the Company. Management believes that it is adequately insured for its operations and there are no current matters that would have a material effect on the Company’s financial position or results of operations. NOTE 8 - SUBSEQUENT EVENTS Management has evaluated subsequent events through January 28, 2017, the date these financial statements were available to be issued. Subsequent to October 31, 2016, a total of 1,064,600 shares were issued to seven investors for a total of $6,223. Based on our evaluation no other material events have occurred that require disclosure. | Based on the provided text, here's a summary:
The financial statement indicates:
- The company experienced a loss
- Cash and cash equivalents total $2,560
- The statement includes provisions for potential variations between estimated and actual financial results
- Cash equivalents include bank cash, money market funds, and short-term deposits (under 3 months)
- Management considers these cash assets to have minimal risk of value loss
Note: The text appears to be a fragment of a financial statement and lacks complete context or detailed financial breakdown. | Claude |
. Management’s Report on Internal Control Over Financial Reporting The management of Tootsie Roll Industries, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Securities Exchange Act of 1934 (SEC) Rule 13a-15(f). Company management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 as required by SEC Rule 13a-15(c). In making this assessment, the Company used the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Based on the Company’s evaluation under the COSO criteria, Company management concluded that its internal control over financial reporting was effective as of December 31, 2016. The effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein. Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Tootsie Roll Industries, Inc.: In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Tootsie Roll Industries, Inc. and its subsidiaries at December 31, 2016 and December 31, 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/PricewaterhouseCoopers LLP Chicago, Illinois February 27, 2017 CONSOLIDATED STATEMENTS OF Earnings and Retained Earnings TOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARIES (in thousands except per share data) (The accompanying notes are an integral part of these statements.) CONSOLIDATED STATEMENTS OF Comprehensive Earnings TOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARIES (in thousands except per share data) (The accompanying notes are an integral part of these statements.) CONSOLIDATED STATEMENTS OF Financial Position TOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARIES (in thousands) Assets (The accompanying notes are an integral part of these statements.) (in thousands except per share data) Liabilities and Shareholders’ Equity (The accompanying notes are an integral part of these statements.) (The accompanying notes are an integral part of these statements.) ($ in thousands except per share data) TOOTSIE ROLL INDUSTRIES, INC. AND SUBSIDIARIES NOTE 1-SIGNIFICANT ACCOUNTING POLICIES: Basis of consolidation: The consolidated financial statements include the accounts of Tootsie Roll Industries, Inc. and its wholly-owned and majority-owned subsidiaries (the Company), which are primarily engaged in the manufacture and sales of candy products. Non-controlling interests relating to majority-owned subsidiaries are reflected in the consolidated financial statements and all significant intercompany transactions have been eliminated. Certain amounts previously reported have been reclassified to conform to the current year presentation. The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue recognition: Products are sold to customers based on accepted purchase orders which include quantity, sales price and other relevant terms of sale. Revenue, net of applicable provisions for discounts, returns, allowances and certain advertising and promotional costs, including consumer coupons (price reduction), is recognized when products are delivered to customers and collectability is reasonably assured. Shipping and handling costs of $40,629, $42,619, and $46,525 in 2016, 2015 and 2014, respectively, are included in selling, marketing and administrative expenses. Accounts receivable are unsecured. Cash and cash equivalents: The Company considers temporary cash investments with an original maturity of three months or less to be cash equivalents. Investments: Investments consist of various marketable securities with maturities of generally up to three years, and variable rate demand notes with interest rates that are generally reset weekly and the security can be “put” back and sold weekly. The Company classifies debt and equity securities as either available for sale or trading. Available for sale securities are not actively traded by the Company and are carried at fair value. The Company follows current fair value measurement guidance and unrealized gains and losses on these securities are excluded from earnings and are reported as a separate component of shareholders’ equity, net of applicable taxes, until realized or other-than-temporarily impaired. Trading securities related to deferred compensation arrangements are carried at fair value with gains or losses included in other income, net. The Company invests in trading securities to economically hedge changes in its deferred compensation liabilities. The Company regularly reviews its investments to determine whether a decline in fair value below the cost basis is other-than-temporary. If the decline in fair value is judged to be other-than-temporary, the cost basis of the security is written down to fair value and the amount of the write-down is included in other income, net. Further information regarding the fair value of the Company’s investments is included in Note 10 of the Company’s . Derivative instruments and hedging activities: Authoritative guidance requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of derivative instruments and related gains and losses, and disclosures about credit-risk-related contingent features in derivative agreements. From time to time, the Company enters into commodity futures, commodity options contracts and foreign currency forward contracts. Commodity futures and options are intended and are effective as hedges of market price risks associated with the anticipated purchase of certain raw materials (primarily sugar). Foreign currency forward contracts are intended and are effective as hedges of the Company’s exposure to the variability of cash flows, primarily related to the foreign exchange rate changes of products manufactured in Canada and sold in the United States, and periodic equipment purchases from foreign suppliers denominated in a foreign currency. The Company does not engage in trading or other speculative use of derivative instruments. Further information regarding derivative instruments and hedging activities is included in Note 11 of the Company’s . Inventories: Inventories are stated at cost, not to exceed market. The cost of substantially all of the Company’s inventories ($53,278 and $58,413 at December 31, 2016 and 2015, respectively) has been determined by the last-in, first-out (LIFO) method. The excess of current cost over LIFO cost of inventories approximates $17,574 and $16,864 at December 31, 2016 and 2015, respectively. The cost of certain foreign inventories ($4,253 and $3,850 at December 31, 2016 and 2015, respectively) has been determined by the first-in, first-out (FIFO) method. Rebates, discounts and other cash consideration received from vendors related to inventory purchases is reflected as a reduction in the cost of the related inventory item, and is, therefore, reflected in cost of sales when the related inventory item is sold. Property, plant and equipment: Depreciation is computed for financial reporting purposes by use of the straight-line method based on useful lives of 20 to 35 years for buildings and 5 to 20 years for machinery and equipment. Depreciation expense was $19,627, $20,388 and $20,758 in 2016, 2015 and 2014, respectively. Carrying value of long-lived assets: The Company reviews long-lived assets to determine if there are events or circumstances indicating that the amount of the asset reflected in the Company’s balance sheet may not be recoverable. When such indicators are present, the Company compares the carrying value of the long-lived asset, or asset group, to the future undiscounted cash flows of the underlying assets to determine if impairment exists. If applicable, an impairment charge would be recorded to write down the carrying value to its fair value. The determination of fair value involves the use of estimates of future cash flows that involve considerable management judgment and are based upon assumptions about expected future operating performance. The actual cash flows could differ from management’s estimates due to changes in business conditions, operating performance, and economic conditions. No impairment charges of long-lived assets were recorded by the Company during 2016, 2015 and 2014. Postretirement health care benefits: The Company provides certain postretirement health care benefits to a group of “grandfathered” corporate office and management employees. The cost of these postretirement benefits is accrued during the employees’ working careers. See Note 7 of the Company’s for additional information. The Company also provides split dollar life benefits to certain executive officers. The Company records an asset equal to the cumulative insurance premiums paid that will be recovered upon the death of covered employees or earlier under the terms of the plan. No premiums were paid in 2016, 2015 and 2014. Certain split dollar agreements were terminated during 2015 and 2014 which resulted in the full repayment to the Company of all of the cumulative premiums previously paid on these policies. No split dollar agreements were terminated during 2016. During 2015 and 2014, the Company received $7,591 and $6,496, respectively, of such repayments which were recorded as a reduction in the carrying value of Split Dollar Officer Life Insurance. Goodwill and indefinite-lived intangible assets: In accordance with authoritative guidance, goodwill and intangible assets with indefinite lives are not amortized, but rather tested for impairment at least annually unless certain interim triggering events or circumstances require more frequent testing. All trademarks have been assessed by management to have indefinite lives because they are expected to generate cash flows indefinitely. Management believes that all assumptions used for the impairment tests are consistent with those utilized by market participants performing similar valuations. The Company has completed its annual impairment testing of its goodwill and trademarks at December 31 of each of the years presented. No impairments of intangibles, including trademarks and goodwill, were recorded in 2016, 2015 or 2014. With respect to impairment testing of goodwill, the first step compares the reporting unit’s estimated fair value with its carrying value. Projected discounted cash flows are used to determine the fair value of the reporting unit. If the carrying value of a reporting unit’s net assets exceeds its fair value, the second step is applied to measure the difference between the carrying value and implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value, the goodwill is considered impaired and reduced to its implied fair value. Non-amortizable intangible assets, trademarks, are tested for impairment by comparing the fair value of each trademark with its carrying value. The fair value of trademarks is determined using discounted cash flows and estimates of royalty rates. If the carrying value exceeds fair value, the trademark is considered impaired and is reduced to fair value. Income taxes: Deferred income taxes are recorded and recognized for future tax effects of temporary differences between financial and income tax reporting. The Company records valuation allowances in situations where the realization of deferred tax assets is not more-likely-than-not. Federal income taxes are provided on the portion of income of foreign subsidiaries that is expected to be remitted to the U.S. and become taxable, but not on the portion that is considered to be permanently reinvested in the foreign subsidiary. Further information regarding income taxes is included in Note 4 of the Company’s . Foreign currency translation: The U.S. dollar is used as the functional currency where a substantial portion of the subsidiary’s business is indexed to the U.S. dollar or where its manufactured products are principally sold in the U.S. All other foreign subsidiaries use the local currency as their functional currency. Where the U.S. dollar is used as the functional currency, foreign currency remeasurements are recorded as a charge or credit to other income, net in the statement of earnings. Where the foreign local currency is used as the functional currency, translation adjustments are recorded as a separate component of accumulated other comprehensive income (loss). Step acquisition During first quarter 2014, the Company gained operating control of its two 50% owned Spanish companies when Company employee representatives assumed all positions on their boards of directors. This was considered a step acquisition, whereby the Company remeasured the previously held investment to fair value in first quarter 2014. As a result, the Company’s first quarter 2014 net earnings include a net loss of $529, including an additional income tax provision of $2,350 relating to deferred income taxes. During 2014 through 2016, the Company further increased its control and ownership to 93% by subscribing to additional common shares of these Spanish subsidiaries. The accompanying consolidated financial statements for the year ended December 31, 2016 and 2015 include these Spanish companies and related minority interests. These Spanish subsidiaries are not material to the Company’s consolidated financial statements. Restricted cash: Restricted cash comprises certain cash deposits of the Company’s majority-owned Spanish subsidiaries with international banks that are pledged as collateral for letters of credit and bank borrowings. VEBA trust: The Company maintains a VEBA trust managed and controlled by the Company, to fund the estimated future costs of certain employee health, welfare and other benefits. The Company made no contributions to the VEBA trusts in 2016 and 2015, and is using the VEBA funds to pay the actual cost of such benefits through 2017. At December 31, 2016 and 2015, the VEBA trust held $3,027 and $6,727, respectively, of aggregate cash and cash equivalents. This asset value is included in prepaid expenses and long-term other assets in the Company’s Consolidated Statement of Financial Position. These assets are categorized as Level 1 within the fair value hierarchy. Bank loans: Long term bank loans comprise borrowings by the Company’s majority-owned Spanish subsidiaries which are held by international banks. The average weighted interest rate in 2016 was 2.1% and maturity dates range from 1 to 2 years. Short term bank loans also relate to the Company’s majority-owned Spanish subsidiaries. Comprehensive earnings: Comprehensive earnings include net earnings, foreign currency translation adjustments and unrealized gains/losses on commodity and/or foreign currency hedging contracts, available for sale securities and certain postretirement benefit obligations. Earnings per share: A dual presentation of basic and diluted earnings per share is not required due to the lack of potentially dilutive securities under the Company’s simple capital structure. Therefore, all earnings per share amounts represent basic earnings per share. The Class B common stock has essentially the same rights as common stock, except that each share of Class B common stock has ten votes per share (compared to one vote per share of common stock), is not traded on any exchange, is restricted as to transfer and is convertible on a share-for-share basis, at any time and at no cost to the holders, into shares of common stock which are traded on the New York Stock Exchange. Use of estimates: The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported. Estimates are used when accounting for sales discounts, allowances and incentives, product liabilities, assets recorded at fair value, income taxes, depreciation, amortization, employee benefits, contingencies and intangible asset and liability valuations. Actual results may or may not differ from those estimates. Recent accounting pronouncements: In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09 that introduces a new five-step revenue recognition model in which an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires disclosures sufficient to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company is currently evaluating the new guidance to determine the impact it may have on the consolidated financial statements. In November 2015, the FASB issued ASU 2015-17 which requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in the standard. This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is permitted and the standard may be applied either retrospectively or on a prospective basis to all deferred tax assets and liabilities. The Company is currently evaluating the new guidance to determine the impact it may have on the consolidated financial statements. In January 2016, the FASB issued ASU 2016-01 which modifies certain aspects of the recognition, measurement, presentation, and disclosure of financial instruments. This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted. The Company is currently evaluating the new guidance to determine the impact it may have on the consolidated financial statements. In February 2016, the FASB issued ASU 2016-02 which amends existing guidance to require lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by long-term leases and to disclose additional quantitative and qualitative information about leasing arrangements. This ASU also provides clarifications surrounding the presentation of the effects of leases in the income statement and statement of cash flows. This guidance will be effective for the Company on January 1, 2019. The Company is currently evaluating this new guidance to determine the impact it will have on its consolidated financial statements. In April 2016, the FASB issued ASU 2016-10, which contains amendments to the new revenue recognition standard on identifying performance obligations and accounting for licenses of intellectual property. The amendments related to identifying performance obligations clarify when a promised good or service is separately identifiable and allows entities to disregard items that are immaterial in the context of a contract. The licensing implementation amendments clarify how an entity should evaluate the nature of its promise in granting a license of intellectual property, which will determine whether revenue is recognized over time or at a point in time. This new standard has the same effective date and transition requirements as ASU 2014-09. The Company is currently evaluating this new guidance to determine the impact it will have on its consolidated financial statements. In August 2016, the FASB issued ASU 2016-15, the amendments in this update address eight specific cash flow issues with the objective of reducing the existing diversity in practice. The effective date of the amendments to the standard is for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating this new guidance to determine the impact it will have on its consolidated financial statements. In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350). ASU 2017-04 simplifies the subsequent measurement of goodwill by removing the second step of the two-step impairment test. The amendment requires an entity to perform its annual, or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The amendment should be applied on a prospective basis. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating this new guidance to determine the impact it will have on its consolidated financial statements. Recently adopted pronouncement: In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which requires management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosures in certain circumstances, such as the existence of substantial doubt. We are required to evaluate going concern uncertainties at each annual and interim reporting period, considering the entity’s ability to continue as a going concern within one year after the issuance date. This guidance was effective on December 31, 2016. The adoption of this ASU had no impact on the Company’s Consolidated Financial Statements. NOTE 2-ACCRUED LIABILITIES: Accrued liabilities are comprised of the following: NOTE 3-INDUSTRIAL DEVELOPMENT BONDS: Industrial development bonds are due in 2027. The average floating interest rate, which is reset weekly, was 0.5% and 0.1% in 2016 and 2015, respectively. See Note 10 of the Company’s for fair value disclosures. NOTE 4-INCOME TAXES: The domestic and foreign components of pretax income are as follows: The provision for income taxes is comprised of the following: Significant components of the Company’s net deferred tax liability at year end were as follows: At December 31, 2016, the Company has benefits related to state tax credit carry-forwards expiring by year as follows: $313 in 2018, $1,080 in 2019 and $853 in 2020. The Company expects that these state credit carry-forwards will be utilized before their expiration. At December 31,2016 the Company also had $268 in foreign tax credit carry-forwards which are not material to its financial statements. At December 31, 2016, the tax benefits of the Company’s Canadian subsidiary tax loss carry-forwards expiring by year are as follows: $2,181 in 2028, $3,546 in 2029 and $619 in 2031. The Company expects that these carry-forwards will be realized before their expiration. At December 31, 2016, the amounts of the Company’s Spanish subsidiary loss carry-forwards expiring by year are as follows: $264 in 2026, $56 in 2027, $168 in 2028, $96 in 2029, $290 in 2030, $387 in 2031, $291 in 2032, $117 in 2033 and $437 in 2034. A full valuation allowance has been provided for these Spanish loss carry-forwards as the Company expects that the losses will not be utilized before their expiration. The effective income tax rate differs from the statutory rate as follows: The Company has not provided for U.S. federal or foreign withholding taxes on $22,081 and $20,174 of foreign subsidiary undistributed earnings as of December 31, 2016 and December 31, 2015, respectively, because such earnings are considered to be permanently reinvested. The Company estimates that the federal income tax liability on such remittances would approximate 30%. This foreign subsidiary holds $12,354 and $15,265 of cash and short term investments as of December 31, 2016 and 2015, respectively. At December 31, 2016 and 2015, the Company had unrecognized tax benefits of $4,746 and $4,680, respectively. Included in this balance is $2,761 and $2,737, respectively, of unrecognized tax benefits that, if recognized, would favorably affect the annual effective income tax rate. As of December 31, 2016 and 2015, $439 and $421, respectively, of interest and penalties were included in the liability for uncertain tax positions. A reconciliation of the beginning and ending balances of the total amounts of unrecognized tax benefits is as follows: The Company recognizes interest and penalties related to unrecognized tax benefits in the provision for income taxes on the Consolidated Statements of Earnings and Retained Earnings. The Company is subject to taxation in the U.S. and various state and foreign jurisdictions. The Company remains subject to examination by U.S. federal and state and foreign tax authorities for the years 2013 through 2015. With few exceptions, the Company is no longer subject to examinations by tax authorities for the years 2012 and prior. The Company’s Canadian subsidiary is currently subject to examination by the Canada Revenue Agency for tax years 2005 and 2007. In addition, the Company is currently subject to various state tax examinations. Although the Company is unable to determine the ultimate outcome of the ongoing examinations, the Company believes that its liability for uncertain tax positions relating to these jurisdictions for such years is adequate. NOTE 5-SHARE CAPITAL AND CAPITAL IN EXCESS OF PAR VALUE: Average shares outstanding and all per share amounts included in the financial statements and notes thereto have been adjusted retroactively to reflect annual three percent stock dividends. While the Company does not have a formal or publicly announced Company common stock purchase program, the Company’s board of directors periodically authorizes a dollar amount for such share purchases. Based upon this policy, shares were purchased and retired as follows: NOTE 6-OTHER INCOME, NET: Other income, net is comprised of the following: NOTE 7-EMPLOYEE BENEFIT PLANS: Pension plans: The Company sponsors defined contribution pension plans covering certain non-union employees with over one year of credited service. The Company’s policy is to fund pension costs accrued based on compensation levels. Total pension expense for 2016, 2015 and 2014 approximated $3,126, $3,100 and $3,134, respectively. The Company also maintains certain profit sharing and retirement savings-investment plans. Company contributions in 2016, 2015 and 2014 to these plans were $2,493, $2,533 and $2,374 respectively. The Company also contributes to a multi-employer defined benefit pension plan for certain of its union employees under a collective bargaining agreement which is as follows: Plan name: Bakery and Confectionery Union and Industry International Pension Fund Employer Identification Number and plan number: 52-6118572, plan number 001 Funded Status as of the most recent year available: 62.77% funded as of January 1, 2015 The Company’s contributions to such plan: $2,515, $2,574 and $2,588 in 2016, 2015 and 2014, respectively Plan status: Critical and declining as of December 31, 2015 Beginning in 2012, the Company received periodic notices from the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union Pension Plan (Plan), a multi-employer defined benefit pension plan for certain Company union employees, that the Plan’s actuary certified the Plan to be in “critical status”, the “Red Zone”, as defined by the Pension Protection Act (PPA) and the Pension Benefit Guaranty Corporation (PBGC); and that a plan of rehabilitation was adopted by the trustees of the Plan in fourth quarter 2012. During second quarter 2015, the Company received new notices that the Plan is now in “critical and declining status”, as defined by the PPA and PBGC, for the plan year beginning January 1, 2015, and that the Plan is projected to have an accumulated funding deficiency for the 2017 through 2024 plan years. A designation of “critical and declining status” implies that the Plan is expected to become insolvent in the next 20 years. The Company has been advised that its withdrawal liability would have been $72,700, $61,000 and $56,400 if it had withdrawn from the Plan during 2016, 2015 and 2014, respectively. The increase from 2015 to 2016 principally reflects poor investment returns of the plan in 2015, a decrease in the PBGC interest rates, and a higher share of the Plan’s unfunded vested benefits allocated to the Company. Should the Company actually withdraw from the Plan at a future date, a withdrawal liability, which could be higher than the above discussed amounts, could be payable to the Plan. The Company’s existing labor contract with the local union commits the Company’s participation in this Plan through third quarter 2017. The amended rehabilitation plan, which continues, requires that employer contributions include 5% compounded annual surcharge increases each year for an unspecified period of time beginning January 2013 (in addition to the 5% interim surcharge initiated in June 2012) as well as certain plan benefit reductions. The Company’s pension expense for this Plan for 2016 and 2015 was $2,541 and $2,574, respectively. The aforementioned expense includes surcharges of $542 and $447 in 2016 and 2015, respectively, as required under the plan of rehabilitation as amended. The Company is currently unable to determine the ultimate outcome of the above discussed matter and therefore is unable to determine the effects on its consolidated financial statements, but the ultimate outcome or the effects of any modifications to the current rehabilitation plan could be material to its consolidated results of operations or cash flows in one or more future periods. Deferred compensation: The Company sponsors three deferred compensation plans for selected executives and other employees: (i) the Excess Benefit Plan, which restores retirement benefits lost due to IRS limitations on contributions to tax-qualified plans, (ii) the Supplemental Plan, which allows eligible employees to defer the receipt of eligible compensation until designated future dates and (iii) the Career Achievement Plan, which provides a deferred annual incentive award to selected executives. Participants in these plans earn a return on amounts due them based on several investment options, which mirror returns on underlying investments (primarily mutual funds). The Company economically hedges its obligations under the plans by investing in the actual underlying investments. These investments are classified as trading securities and are carried at fair value. At December 31, 2016 and 2015, these investments totaled $67,995 and $60,584, respectively. All gains and losses and related investment income from these investments, which are recorded in other income, net, are equally offset by corresponding increases and decreases in the Company’s deferred compensation liabilities. Postretirement health care benefit plans: The Company maintains a post-retirement health benefits plan for a group of “grandfathered” corporate employees. The plan as amended in 2013, generally limited future annual cost increases in health benefits to 3%, restricted this benefit to current employees and retirees with long-term service with the Company, and eliminated all post-retirement benefits for future employees effective April 1, 2014. Post-retirement benefits liabilities (as amended) were $12,128 and $11,400 at December 31, 2016 and 2015, respectively. Amounts recognized in accumulated other comprehensive loss (pre-tax) at December 31, 2016 are as follows: The estimated actuarial gain and prior service credit to be amortized from accumulated other comprehensive loss into net periodic benefit income during 2017 are $236 and $1,226, respectively. The changes in the accumulated postretirement benefit obligation at December 31, 2016 and 2015 consist of the following: Net periodic postretirement benefit cost (income) included the following components: The Company estimates future benefit payments will be $513, $470, $516, $549 and $590 in 2017 through 2021, respectively, and a total of $3,422 in 2022 through 2026. NOTE 8-COMMITMENTS: Rental expense aggregated $703, $728 and $749 in 2016, 2015 and 2014, respectively. Future operating lease commitments are not significant. NOTE 9-SEGMENT AND GEOGRAPHIC INFORMATION: The Company operates as a single reportable segment encompassing the manufacture and sale of confectionery products. Its principal manufacturing operations are located in the United States and Canada, and its principal market is the United States. The Company also manufactures confectionery products in Mexico primarily for sale in Mexico, and exports products to Canada and other countries worldwide. The following geographic data includes net product sales summarized on the basis of the customer location and long-lived assets based on their physical location: Sales revenues from Wal-Mart Stores, Inc. aggregated approximately 23.3%, 23.7%, and 23.7% of net product sales during the years ended December 31, 2016, 2015 and 2014, respectively. Some of the aforementioned sales to Wal-Mart are sold to McLane Company, a large national grocery wholesaler, which services and delivers certain of the Company products to Wal-Mart and other retailers in the U.S.A. Net product sales revenues from McLane, which includes these Wal-Mart sales as well as sales and deliveries to other Company customers, were 16.3% in 2016 and 16.7% in 2015 and 15.3% in 2014. NOTE 10-FAIR VALUE MEASUREMENTS: Current accounting guidance defines fair value as the price that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Guidance requires disclosure of the extent to which fair value is used to measure financial assets and liabilities, the inputs utilized in calculating valuation measurements, and the effect of the measurement of significant unobservable inputs on earnings, or changes in net assets, as of the measurement date. Guidance establishes a three-level valuation hierarchy based upon the transparency of inputs utilized in the measurement and valuation of financial assets or liabilities as of the measurement date. Level 1 inputs include quoted prices for identical instruments and are the most observable. Level 2 inputs include quoted prices for similar assets and observable inputs such as interest rates, foreign currency exchange rates, commodity rates and yield curves. Level 3 inputs are not observable in the market and include management’s own judgments about the assumptions market participants would use in pricing the asset or liability. The use of observable and unobservable inputs is reflected in the hierarchy assessment disclosed in the table below. As of December 31, 2016 and 2015, the Company held certain financial assets that are required to be measured at fair value on a recurring basis. These include derivative hedging instruments related to the foreign currency forward contracts and purchase of certain raw materials, investments in trading securities and available for sale securities. The Company’s available for sale and trading securities principally consist of municipal bonds and variable rate demand notes. The following tables present information about the Company’s financial assets and liabilities measured at fair value as of December 31, 2016 and 2015, and indicate the fair value hierarchy and the valuation techniques utilized by the Company to determine such fair value: Available for sale securities which utilize Level 2 inputs consist primarily of municipal and corporate bonds, which are valued based on quoted market prices or alternative pricing sources with reasonable levels of price transparency. A summary of the aggregate fair value, gross unrealized gains, gross unrealized losses, realized losses and amortized cost basis of the Company’s investment portfolio by major security type is as follows: The fair value of the Company’s industrial revenue development bonds at December 31, 2016 and 2015 were valued using Level 2 inputs which approximates the carrying value of $7,500 for both periods. Interest rates on these bonds reset weekly based on current market conditions. NOTE 11-DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: From time to time, the Company uses derivative instruments, including foreign currency forward contracts, commodity futures contracts and commodity option contracts, to manage its exposures to foreign exchange and commodity prices. Commodity futures contracts and most commodity option contracts are intended and effective as hedges of market price risks associated with the anticipated purchase of certain raw materials (primarily sugar). Foreign currency forward contracts are intended and effective as hedges of the Company’s exposure to the variability of cash flows, primarily related to the foreign exchange rate changes of products manufactured in Canada and sold in the United States, and periodic equipment purchases from foreign suppliers denominated in a foreign currency. The Company does not engage in trading or other speculative use of derivative instruments. The Company recognizes all derivative instruments as either assets or liabilities at fair value in the Consolidated Statements of Financial Position. Derivative assets are recorded in other receivables and derivative liabilities are recorded in accrued liabilities. The Company uses either hedge accounting or mark-to-market accounting for its derivative instruments. Derivatives that qualify for hedge accounting are designated as cash flow hedges by formally documenting the hedge relationships, including identification of the hedging instruments, the hedged items and other critical terms, as well as the Company’s risk management objectives and strategies for undertaking the hedge transaction. Changes in the fair value of the Company’s cash flow hedges are recorded in accumulated other comprehensive loss, net of tax, and are reclassified to earnings in the periods in which earnings are affected by the hedged item. Substantially all amounts reported in accumulated other comprehensive loss for commodity derivatives are expected to be reclassified to cost of goods sold. Approximately 70% of this accumulated comprehensive net gain is expected to be reclassified to net earnings in 2017 and the balance in 2018. Substantially all amounts reported in accumulated other comprehensive loss for foreign currency derivatives are expected to be reclassified to other income, net in 2017. The following table summarizes the Company’s outstanding derivative contracts and their effects on its Consolidated Statements of Financial Position at December 31, 2016 and 2015: The effects of derivative instruments on the Company’s Consolidated Statement of Earnings, Comprehensive Earnings and Retained Earnings for years ended December 31, 2016 and 2015 are as follows: NOTE 12-ACCUMULATED OTHER COMPREHENSIVE LOSS: The following table sets forth information with respect to accumulated other comprehensive earnings (loss): The amounts reclassified from accumulated other comprehensive income (loss) consisted of the following: NOTE 13-GOODWILL AND INTANGIBLE ASSETS: All of the Company’s intangible indefinite-lived assets are trademarks. The changes in the carrying amount of trademarks for 2016 and 2015 were as follows: The fair value of indefinite-lived intangible assets was primarily assessed using the present value of estimated future cash flows and relief-from-royalty method. The Company has no accumulated impairment losses of goodwill. NOTE 14-QUARTERLY FINANCIAL DATA (UNAUDITED): Net earnings per share is based upon average outstanding shares as adjusted for 3% stock dividends issued during the second quarter of each year as discussed above. The sum of the quarterly per share amounts may not equal annual amounts due to rounding. | Based on the provided text, here's a summary of the financial statement excerpt:
Investment and Securities Accounting Practices:
1. Securities Classification:
- The company classifies securities as either available for sale or trading
- Available for sale securities are carried at fair value
- Unrealized gains/losses on these securities are:
* Excluded from earnings
* Reported separately in shareholders' equity
* Net of applicable taxes
* Remain until securities are realized or impaired
2. Trading Securities:
- Related to deferred compensation arrangements
- Carried at fair value
- Gains/losses included in other income
- Used to economically hedge changes in deferred compensation liabilities
3. Investment Review Process:
- Regularly reviews investments
- Checks for declines in fair value below cost basis
- If decline is deemed "other-than-temporary":
* Writes down security's cost basis to | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. GREENHOUSE SOLUTIONS, INC. FINANCIAL STATEMENTS For the years ended March 31, 2016 and 2015 ACCOUNTING FIRM - BF BORGERS CPA PC BALANCE SHEETS STATEMENTS OF OPERATIONS STATEMENTS OF STOCKHOLDERS' DEFICIENCY STATEMENTS OF CASH FLOWS NOTES TO FINANCIAL STATEMENTS ACCOUNTING FIRM To the Board of Directors and Stockholders of Greenhouse Solutions, Inc.: We have audited the accompanying balance sheet of Greenhouse Solutions, Inc. ("the Company") as of March 31, 2016 and 2015 and the related statement of operations, stockholders' equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Greenhouse Solutions, Inc., as of March 31, 2016 and 2015, and the results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles in the United States of America. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the Company's internal control over financial reporting. Accordingly, we express no such opinion. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company's significant operating losses raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ B F Borgers CPA PC B F Borgers CPA PC Lakewood, CO August 10, GREENHOUSE SOLUTIONS, INC. NOTES TO FINANCIAL STATEMENTS, MARCH 31, 2016 NOTE 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION: Greenhouse Solutions, Inc. (the "Company" or "Greenhouse Solutions"), is a Nevada corporation. The Company was incorporated under the laws of the State of Nevada on April 8, 2009. The Company is involved in the sale and distribution of urban gardening products and greenhouses on the North American Market. Going Concern The Company's financial statements are prepared using generally accepted accounting principles in the United States of America applicable to a going concern which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Company has incurred an accumulated deficit since inception of $4,227,947 through March 31, 2016, and has not yet established a minimal on-going source of revenues sufficient to cover its operating costs and allow it to continue as a going concern. The ability of the Company to continue as a going concern is dependent on the Company obtaining adequate capital to fund operating losses until it becomes profitable. If the Company is unable to obtain adequate capital, it could be forced to cease operations. The Company may raise additional capital through the sale of its equity securities, through an offering of debt securities, or through borrowings from financial institutions or related parties. By doing so, the Company hopes to generate sufficient capital to execute its business plan of providing financial consulting services on an ongoing basis. Management believes that actions presently being taken to obtain additional funding provide the opportunity for the Company to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon its ability to successfully accomplish the plans described in the preceding paragraph and eventually secure other sources of financing and attain profitable operations. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash and cash equivalents The Company considers all cash on hand, cash accounts not subject to withdrawal restrictions or penalties and all highly liquid investments with an original maturity of three months or less as cash equivalents. Revenue recognition The Company has realized minimal revenues from operations. The Company recognizes revenues when the sale and/or distribution of products is complete, risk of loss and title to the products have transferred to the customer, there is persuasive evidence of an agreement, acceptance has been approved by the customer, the fee is fixed or determinable based on the completion of stated terms and conditions, and collection of any related receivable is probable. Net sales will be comprised of gross revenues less expected returns, trade discounts, and customer allowances that will include costs associated with off-invoice markdowns and other price reductions, as well as trade promotions and coupons. The incentive costs will be recognized at the later of the date on which the Company recognized the related revenue or the date on which the Company offers the incentive. Basic and Diluted Loss per Share The Company computes loss per share in accordance with "ASC-260," "Earnings per Share" which requires presentation of both basic and diluted earnings per share on the face of the statement of operations. Basic loss per share is computed by dividing net loss available to common shareholders by the weighted average number of outstanding common share during the period. Diluted loss per share gives effect to all dilutive potential common shares outstanding during the period. Diluted loss per share excludes all potential common shares if their effect is anti-dilutive. As of March 31, 2016 there were warrants outstanding to claim 2,275,000 additional common share of the Company. At March 31, 2014 there were no potentially dilutive securities outstanding. Income Taxes The Company accounts for income taxes pursuant to ASC 740. Under ASC 740 deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. The Company maintains a valuation allowance with respect to deferred tax asset. Greenhouse Solutions establishes a valuation allowance based upon the potential likelihood of realizing the deferred tax asset and taking into consideration the Company's financial position and results of operations for the current period. Future realization of the deferred tax benefit depends on the existence of sufficient taxable income within the carry-forward period under Federal tax laws. Changes in circumstances, such as the Company generating taxable income, could cause a change in judgment about the realizability of the related deferred tax asset. Any change in the valuation allowance will be included in income in the year of the change estimate. Carrying Value, Recoverability and Impairment of Long-Lived Assets The Company has adopted paragraph 360-10-35-17 of FASB Accounting Standards Codification for its long-lived assets. The Company's long -lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. The company assesses the recoverability of its long-lived assets by comparing the projected undiscounted net cash flows associated with the related long-lived asset or group of assets over their remaining estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. Fair value is generally determined using the assets expected future discounted cash flows or market value, if readily determinable. If long-lived assets are determined to be recoverable, but the newly determined remaining estimated useful lives are shorter than originally estimated, the net book values of the long-lived assets are depreciated over the newly determined remaining estimated useful lives. The Company considers the following to be some examples of important indicators that may trigger an impairment review; (i) significant under-performance or losses of assets relative to expected historical or projected future operating results; (ii) significant changes in the manner or use of assets or in the Company's overall strategy with respect to the manner of use of the acquired assets or changes in the Company's overall business strategy; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; (v) a significant decline in the Company's stock price for a sustained period of time; and (vi) regulatory changes. The Company evaluates acquired assets for potential impairment indicators at least annually and more frequently upon the occurrence of such events. The impairment charges, if any, are included in operating expenses in the accompanying statements of operations. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The Company's significant estimates include income taxes provision and valuation allowance of deferred tax assets; the fair value of financial instruments; the carrying value and recoverability of long-lived assets, and the assumption that the Company will continue as a going concern. Those significant accounting estimates or assumptions bear the risk of change due to the fact that there are uncertainties attached to those estimates or assumptions, and certain estimates or assumptions are difficult to measure or value. Management regularly reviews its estimates utilizing currently available information, changes in facts and circumstances, historical experience and reasonable assumptions. After such reviews, and if deemed appropriate, those estimates are adjusted accordingly. Actual results could differ from those estimates. Fair value of Financial Instruments The estimated fair values of financial instruments were determined by management using available market information and appropriate valuation methodologies. The carrying amounts of financial instruments including cash approximate their fair value because of their short maturities. Office Furniture and Equipment Office furniture and equipment are recorded at cost and depreciated under the straight line method over the estimated useful life of the asset. At March 31, 2016 the Company had computer equipment of $1,398 with corresponding accumulated depreciation of $303. There corresponding balances for the fiscal year ended March 31, 2015 were $1,398 and $23 respectively. Depreciation expense for the years ended March 31, 2016 and 201 were $280 and $23 respectively. Other Assets The Company has acquired other assets consisting of the following: 1. An exclusive license signed on January 20, 2015 for the use of intellectual property for probiotic formulas for cannabis combinations in the homeopathic and nutraceutical industries developed by Dr. M. S. Reddy. This license has a life of 15 years. The license was acquired in exchange for 7,000,000 shares of the common stock of the Company and valued at $0.10 per share consistent with other sakes to private placement buyers. 2. A sublicense signed on February 1, 2015 for the intellectual property for the homeopathic and nutraceutical industries and to market products based thereon granted by EVO. This license has a life of 15 years and was acquired in exchange for 4,000,000 shares of the common stock of the Company using the same valuation approach as license #1. 3. A payment of $50,000 to KOIOS, Inc. for a non-exclusive license for the use of proprietary formulations for the homeopathic and nutraceutical industries. This license and agreement will be for the development and marketing of homeopathic and nutraceutical supplements. This was originally reported as an investment in Panorama, LLC but was subsequently transferred to KOIOS with an effective date of March 15, 2015. 4. An additional license effective November 4, 2015 for the use of intellectual property for probiotic formulas for cannabis combinations in the homeopathic and nutraceutical industries developed by Dr. M. S. Reddy. This license continues until either party, through inaction or prohibited action causes a termination. The license was acquired in exchange for 3,000,000 shares of the common stock of the Company and valued at $0.17 per share. At March 31, 2016 the Company had a cumulative investment in these other assets of $1,660,000 with a corresponding impairment write-down due to the uncertainty of the Company's ability to continue as a going concern and total lack of sufficient cash flow or revenues with which to amortize the assets against. There were no corresponding balances for the fiscal year ended March 31, 2014. Impairment expense for the years ended March 31, 2016 and 2015 were $510,000 and $1,150,000 respectively. Long Lived Assets In accordance with ASC 350 the Company regularly reviews the carrying value of intangible and other long lived assets for the existence of facts or circumstances both internally and externally that suggest impairment. If impairment testing indicates a lack of recoverability, an impairment loss is recognized by the Company if the carrying amount of a long lived asset exceeds its fair value. Stock-based Compensation The Company accounts for stock-based compensation issued to employees based on FASB accounting standard for Share Based Payment. It requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). It requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. The scope of the FASB accounting standard includes a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Recent pronouncements In June 2016, the FASB issued ASU 2016-10, "Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation". The guidance eliminates the definition of a development stage entity thereby removing the incremental financial reporting requirements from U.S. GAAP for development stage entities, primarily presentation of inception to date financial information. The provisions of the amendments are effective for annual reporting periods beginning after March 15, 2016, and the interim periods therein. However, early adoption is permitted. Accordingly, the Company has adopted this standard as of March 31, 2014. Management has evaluated accounting standards and interpretations issued but not yet effective as of March 31, 2016, and does not expect such pronouncements to have a material impact on the Company's financial position, operations, or cash flows. NOTE 3 - RELATED PARTY TRANSACTIONS Transactions involving related parties cannot be presumed to be carried out on an arm's length basis, as the requisite conditions of competitive, free market dealings may not exist. Representation about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's length transactions unless such representations can be substantiated. It is not, however, practical to determine the fair value of advances from stockholders due to their related party nature. During the year ended March 31, 2015 a stockholder of the Company advanced a total of $60,000 of which $10,000 was repaid. As of March 31, 2016 the total advance has been repaid. These advances are unsecured, not represented by any formal loan agreement and bear no interest. There are three officers of the Company receiving compensation for services rendered. One is compensated at the rate of $3,000 per month and has received $25,000 in payments and is owed $11,000 as at March 31, 2016. Another is compensated at the rate of $3,500 per month. He has received $14,000 in cash payments and is owed a balance of $28,000 as of March 31, 2016. The third is compensated at the rate of $2,000 per month. At March 31, 2016 this officer is owed a total of $24,000. NOTE 4 - STOCKHOLDER'S DEFICIT The total number of common shares authorized that may be issued by the Company is 200,000,000 shares with a par value of $0.0001 per share. The Company is authorized to issue 25,000,000 shares of preferred stock with a par value of $0.0001 per share. As at March 31, 2016 there are no preferred shares issued or outstanding. As at March 31, 2016 the total number of common shares outstanding was 95,281,213.The Company has an ongoing program of private placements to raise funds to support the operations. The terms and conditions of these private placements in the past have remained constant as follows: i.e. the offering price per share is $0.10 and each share includes a warrant for the purchase of an additional share at $0.20.for a period of two years from the date of the subscription. During the quarter ended June 30, 2015 the Company received $215,000 in net proceeds through a private placement at terms that changed as follows, $0.20 per share for cash and the Company will issue 1,075,000 common shares of the Company under the terms described . Also during this quarter the Company issued 300,000 shares of its common stock in exchange for $90,000 which had been received in the previous year. This money was shown in the stockholder equity report as "Common Stock Subscribed." During the quarter ended September 30, 2015 the Company received $50,000 in net proceeds through a private placement for $0.20 per share and will issue 250,000 common shares of the Company. During the quarter ended December 31, 2015 the Company received $65,000 in net proceeds through a private placement for $0.10 per share and will issue 650,000 common shares of the Company. During the quarter ended December 31, 2015 the Company issued an additional 1,550,000 shares of its common stock to the participants of the private offerings during the past three quarters. This was voluntarily done by the Board of Directors to effectively value each share previously received at $0.10 to match current shares issued and to help offset any dilution they may have experienced. There was no legal obligation to do this but this was decided to be done by the Board of Directors on November 10, 2015. The closing share price on this date of $0.24 was used and the value attributed for the issuance of these additional shares of $372,000 was booked to Private Placement Expense on the financial statements. On October 23, 2015 the Company authorized the issuance 3,634,213 shares as compensation expense which was allocated as follows: (1) 500,000 shares for legal services provided; (2) 78,939 for consulting services; (3) 55,274 for Related party Officer compensation and (4) 3,000,000 for additional consideration for IP License #2. These were expensed to the appropriate corresponding categories on the "Statement of Income and Expense" for items (1), (2) and (3) with the value of (4) being allocated to the Other Asset category of the Balance Sheet with its corresponding write down in value. For recording purposes these shares were valued at $0.17 which was the average price for the Company's common stock for the quarter ending March 31, 2016. On November 1, 2015 the Company authorized the issuance of 600,000 shares of its common stock as compensation for consulting services to be performed. An expense of $90,000 was recorded on the Company's books as consulting expense. These shares were valued at $0.15 for per share was the closing price for that date. In August of 2015 the Company received notice from an investor that they wished to rescind the transaction and have their money refunded. Since the shares had not been issued the refund is shown as a liability of the Company. On March 11, 2016 the Company authorized the issuance of 400,000 shares for marketing consulting services and recorded an expense of $40,000 NOTE 5 - WARRANTS In connection with the common stock subscriptions referenced above each subscription included one warrant for each share subscribed. These warrants have an exercise price of $0.20 per share and an expiration date that is two years from the date of the subscription. During the year ended March 31, 2015 the Company issued 225,000 warrants. During the quarter ended June 30, 2015 the Company issued 2,150,000 warrants. During the quarter ended September 30, 2015 the Company issued 500,000 warrants. During the quarter ended December 31, 2015 the Company issued 650,000 warrants. Using the Black-Scholes valuation model a value of $1,354,015 is assigned to these warrants. The parameters used in the Black-Scholes model were as follows: stock price $0.08; strike price $0.20; volatility 350%; risk free rate 1.75% and time to expiration of 1.33 years. This expense is recorded on the books of the Company as "Warrant expense" with an offsetting entry in the Stockholder's Deficit section as "Additional paid in capital - Warrants." As of March 31, 2016 the Company has not received any notifications with respect to any exercise of any outstanding warrants A summary of warrant activity for the periods indicated is as follows: NOTE 6 - RESEARCH AND DEVELOPMENT During the year ended March 31, 2016 the Company spent a total of $18,800 on research and development. The nature of this research was to determine the viability of converting the pill form of our supplement into a functioning beverage form. NOTE 7 - INCOME TAXES A reconciliation of the provision for income taxes at the United States federal statutory rate of 34% and a Colorado state rate of 5% compared to the Company's income tax expense as reported is as follows: March 31, 2016 March 31, 2015 Net loss before income taxes $ (2,808,731) $ (1,287,098) Income tax rate 39% 39% Income tax recovery (1,095,500) (502,000) Valuation allowance change 1,095,500 502,000 Provision for income taxes $ - $ - The significant components of deferred income tax assets at March 31, 2016 and 2014 are as follows: March 31, 2016 March 31, 2014 Net operating loss carry-forward $ 4,095,800 $ 1,287,100 Valuation allowance (4,095,800) (1,287,100) Net deferred income tax asset $ - $ - As of March 31, 2016 and 2015, the Company has no unrecognized income tax benefits. The Company's policy for classifying interest and penalties associated with unrecognized income tax benefits is to include such items as tax expense. No interest or penalties have been recorded during the years ended March 31, 2016 and 2015, and no interest or penalties have been accrued as of March 31, 2016 and 2015. As of March 31, 2016 and 2015 the Company did not have any amounts recorded pertaining to uncertain tax positions. The tax years from 2012 and forward remain open to examination by federal and state authorities due to net operating loss and credit carryforwards. The Company is currently not under examination by the Internal Revenue Service or any other taxing authorities. NOTE 8 - FORGIVENESS OF DEBT As of March 31, 2015 the Company had two outstanding invoices that dated from activities carried on by prior operations. It was management's decision that these two debts were no longer to be considered an obligation of the Company and therefore were written off. As of March 31, 2016 the Company had a total of $5,150 in advances from prior stockholders. These amounts were reclassified to "Forgiveness of debt" income with the assent of the creditors. NOTE 9 - STOCK OFFER RECISSION On September 5, 2015 the Company received notice from an investor who had not yet received the stocks subscribed for that they wished to rescind the offer. This amount is carried on the books and financial statements as a current liability in the amount of $15,000. It is the Company's intent to refund this money when it has sufficient cash resources to do so. NOTE 10 - CUSTOMER REFUND The sale that was recorded on February 18, 2015 included an amount, $5,128 in sales taxes. The Company was not nor is not licensed to collect such taxes. The Company has been in communication with its customer regarding this amount and the customer has agreed to allow the Company to retain this money as additional compensation for the transaction. Accordingly the Company has recorded this amount as "Other income" in its current "Statement of Operations." NOTE 11 - ADVANCES At March 31, 2015 the Company carried on its books of account the sum of $55,161. During the year ended the Company paid $50,011 against this balance. Further research showed that $5,000 of this balance was related to a former major stockholder who relinquished all rights to debts and assets at the time the new major stockholders assumed control of the Company. This occurred on August 28, 2015 and the debt was reclassified as "Forgiveness of debt" income during the final quarter of the Company's fiscal year. An additional $150 was advanced to open the initial bank account. This was forgiven and reclassified as "Forgiveness of debt" income also. NOTE 12 - INVENTORY In October of 2015 the Company purchased aluminum cans and lids in preparation for producing a product for the retail market. These cans are for the neutraceutical products that are under development. NOTE 13 - RESTATEMENT The Company has restated the March 31, 2015 balance sheet, income statement, cash flow statement, and statement of stockholder's equity as originally presented in its financial statement filed with its 2015 10-K/A on October 19, 2015 to accurately reflect the assets acquired during the year ended March 31, 2015, and to properly record the corresponding retirement to treasury and issuance of common shares. The effects of the restatement on our previously issued financial statements as of and for the year ended March 31, 2015, are as follows: Statement of Operations: Operating Expenses: Impairment expense $ - $ (1,150,000) $ (1,150,000) Total operating expenses 141,491 1,150,000 1,291,491 Income (loss) from operations 141,491 1,150,000 1,291,491 Income (loss) before provision for income taxes (137,098) (1,150,000) (1,287,098) Net Income (loss) (137,098) (1,150,000) (1,287,098) Net income (loss) per share (Basic and fully diluted) (0.00) (0.01) (0.01) Statement of Cash Flows: Net income (loss) $ (137,098) $ (1,150,000) $ (1,287,098) Impairment expense - (1,150,000) (1,150,000) Cash Flows Used In Investing Activities: Investment (50,000) (1,100,000) (1,150,000) Net Cash Used In Investing Activities (51,398) (1,100,000) (1,151,398) Cash Flows From Financing Activities: Common stock issued for investments - 1,100,000 1,100,000 Net Cash Provided By Financing Activities 140,161 1,100,000 1,240,161 Statement of Stockholder's Equity: Common stock retired to treasury Common Stock - Shares - (11,000,000) (11,000,000) Common Stock - Amount ($0.001 Par) - (1,100) (1,100) Paid in capital - 1,100 1,100 Stock issued for IP licenses Common stock - Shares - 11,000,000 11,000,000 Common Stock - Amount ($0.001 Par) - 1,100 1,100 Paid in capital - 1,098,900 1,098,900 Stockholders' Deficit - 1,100,00 1,100,000 Net loss for the period Accumulated Deficit (137,098) (1,150,000) (1,287,098) Stockholders' Deficit (137,098) (1,150,000) (1,287,098) Balances - March 31, 2015 Paid in Capital 105,900 1,100,000 1,205,900 Accumulated Deficit (269,216) (1,150,000) (1,419,216) Stockholders' Deficit (64,634) (50,000) (114,634) NOTE 14 - PRIVATE PLACEMENT EXPENSE In December of 2015 the Board of Directors decided that investors that had purchased stock from the beginning of 2015 through July 31, 2015 should be granted parity with more recent stockholders who were issued stock valued at $0.10 per share. In order to achieve this parity those designated stockholders received an additional 1,550,000 shares of common stock of the Company. On competent(?) advice the Company booked an expense of $372,000 in connection with these additional shares. There were no additional warrants attached to these shares. | Here's a summary of the financial statement:
The company is experiencing significant financial challenges:
1. Accumulated Deficit: The company has accumulated a total deficit of $4,227,947 since its inception.
2. Going Concern Uncertainty: There are substantial doubts about the company's ability to continue operating, as noted by the independent auditor (B F Borgers CPA PC).
3. Funding Strategy: Management is attempting to secure additional funding through:
- Debt securities
- Borrowings from financial institutions
- Borrowings from related parties
4. Business Plan: The company aims to provide financial consulting services and believes its current funding efforts may allow it to continue operating.
5. Critical Dependency: The company's survival depends on:
- Successfully implementing its funding plans
- Securing additional financing
- Achieving profitable operations
6. Financial Statement Caveat: The financial statements do not include potential adjustments | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. ACCOUNTING FIRM Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders National Bank Holdings Corporation: We have audited the accompanying consolidated statements of financial condition of National Bank Holdings Corporation and subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Bank Holdings Corporation and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 24, 2017, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. As discussed in note 2 to the consolidated financial statements, the Company has changed its method of accounting for stock-based compensation in the consolidated financial statements referred to above due to the adoption of FASB Accounting Standards Update (ASU) No. 2016-09, Improvements to Employee Share-Based Payment Accounting. Kansas City, Missouri February 24, 2017 NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES Consolidated Statements of Financial Condition December 31, 2016 and 2015 (In thousands, except share and per share data) See accompanying notes to the consolidated financial statements. NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations For the Years Ended December 31, 2016, 2015 and 2014 (In thousands, except share and per share data) See accompanying notes to the consolidated financial statements. NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Loss) For the Years Ended December 31, 2016, 2015 and 2014 (In thousands) See accompanying notes to the consolidated financial statements. NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES Consolidated Statements of Changes in Shareholders’ Equity For the Years Ended 2016, 2015 and 2014 (In thousands, except share and per share data) See accompanying notes to the consolidated financial statements. NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended December 31, 2016, 2015 and 2014 (In thousands) See accompanying notes to the consolidated financial statements. NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2016, 2015 and 2014 Note 1 Basis of Presentation National Bank Holdings Corporation ("NBHC" or the "Company") is a bank holding company that was incorporated in the State of Delaware in 2009 with the intent to acquire and operate financial services franchises and other complementary businesses in targeted markets. The Company is headquartered immediately south of Denver, in Greenwood Village, Colorado, and its primary operations are conducted through its wholly owned subsidiary, NBH Bank, referred to as the "Bank" or NBH Bank, a Colorado state-chartered bank and a member of the Federal Reserve System. The Company provides a variety of banking products to both commercial and consumer clients through a network of 91 banking centers located in Colorado, the greater Kansas City area and Texas, and through online and mobile banking products and services. The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, NBH Bank. The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and where applicable, with general practices in the banking industry or guidelines prescribed by bank regulatory agencies. The consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results presented. All such adjustments are of a normal recurring nature. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications of prior years' amounts are made whenever necessary to conform to current period presentation. During the first quarter of 2016, the Company updated the loan classifications in its allowance for loan losses model. Certain loan classifications within the consolidated financial statement disclosures have been updated to reflect this change. Refer to note 7 for further discussion. The prior year presentations have been reclassified to conform to the current year presentation. All amounts are in thousands, except share data, or as otherwise noted. The Company's significant accounting policies followed in the preparation of the consolidated financial statements are disclosed in note 2. GAAP requires management to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. By their nature, estimates are based on judgment and available information. Management has made significant estimates in certain areas, such as the amount and timing of expected cash flows from assets, the valuation of other real estate owned (“OREO”), the fair value adjustments on assets acquired and liabilities assumed, the valuation of core deposit intangible assets, the evaluation of investment securities for other-than-temporary impairment (“OTTI”), the valuation of stock-based compensation, the fair values of financial instruments, the allowance for loan losses (“ALL”), and contingent liabilities. Because of the inherent uncertainties associated with any estimation process and future changes in market and economic conditions, it is possible that actual results could differ significantly from those estimates. Note 2 Summary of Significant Accounting Policies a) Acquisition activities-The Company accounts for business combinations under the acquisition method of accounting. Assets acquired and liabilities assumed are measured and recorded at fair value at the date of acquisition, including identifiable intangible assets. If the fair value of net assets acquired exceeds the fair value of consideration paid, a bargain purchase gain is recognized at the date of acquisition. Conversely, if the consideration paid exceeds the fair value of the net assets acquired, goodwill is recognized at the acquisition date. Fair values are subject to refinement for up to a maximum of one year after the closing date of an acquisition as information relative to closing date fair values becomes available. Adjustments recorded to the acquired assets and liabilities assumed are applied prospectively in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2015-16, Simplifying the Accounting for Measurement-Period Adjustments. The determination of the fair value of loans acquired takes into account credit quality deterioration and probability of loss therefore, the related ALL is not carried forward at the time of acquisition. Identifiable intangible assets are recognized separately if they arise from contractual or other legal rights or if they are separable (i.e., capable of being sold, transferred, licensed, rented, or exchanged separately from the entity). Deposit liabilities and the related depositor relationship intangible assets, known as the core deposit intangible assets, may be exchanged in observable exchange transactions. As a result, the core deposit intangible asset is considered identifiable, because the separability criterion has been met. b) Cash and cash equivalents-Cash and cash equivalents include cash, cash items, amounts due from other banks, amounts due from the Federal Reserve Bank of Kansas City, federal funds sold, and interest-bearing bank deposits. c) Investment securities-Investment securities may be classified in three categories: trading, available-for-sale and held-to-maturity. Management determines the appropriate classification at the time of purchase and reevaluates the classification at each reporting period. Any sales of available-for-sale securities are for the purpose of executing the Company’s asset/liability management strategy, reducing borrowings, funding loan growth, providing liquidity, or eliminating a perceived credit risk in a specific security. Held-to-maturity securities are carried at amortized cost and the available-for-sale securities are carried at estimated fair value. Unrealized gains or losses on securities available-for-sale are reported as accumulated other comprehensive income (loss) (“AOCI”), a component of shareholders’ equity, net of income tax. Gains and losses realized upon sales of securities are calculated using the specific identification method. Premiums and discounts are amortized to interest income over the estimated lives of the securities. Prepayment experience is periodically evaluated and a determination made regarding the appropriate estimate of the future rates of prepayment. When a change in a bond’s estimated remaining life is necessary, a corresponding adjustment is made in the related premium amortization or discount accretion. Purchases and sales of securities, including any corresponding gains or losses, are recognized on a trade-date basis and a receivable or payable is recognized for pending transaction settlements. Management evaluates all investments for OTTI on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Impairment is considered to be other-than-temporary if it is likely that all amounts contractually due will not be received for debt securities and when there is no positive evidence indicating that an investment’s carrying amount is recoverable in the near term for equity securities. When impairment is considered other-than-temporary, the cost basis of the security is written down to fair value, with the impairment charge related to credit included in earnings, while the impairment charge related to all other factors is recognized in OCI. If the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security, the entire amount of the OTTI is recorded in earnings. In evaluating whether the impairment is temporary or other than temporary, the Company considers, among other things, the severity and duration of the unrealized loss position; adverse conditions specifically related to the security; changes in expected future cash flows; downgrades in the rating of the security by a rating agency; the failure of the issuer to make scheduled interest or principal payments; whether the Company has the intent to sell the security; and whether it is more likely than not that the Company will be required to sell the security. d) Non-marketable securities-Non-marketable securities include Federal Reserve Bank ("FRB") stock, Federal Home Loan Bank ("FHLB") stock and non-negotiable certificates of deposit acquired in the acquisition of Pine River Bank Corporation, the parent company of Pine River Valley Bank (“Pine River”). These securities have been acquired for debt facility or regulatory purposes and are carried at cost. e) Loans receivable-Loans receivable include loans originated by the Company and loans that are acquired through acquisitions. Loans originated by the Company are carried at the principal amount outstanding, net of premiums, discounts, unearned income, and deferred loan fees and costs. Loan fees and certain costs of originating loans are deferred and the net amount is amortized over the contractual life of the related loans. Acquired loans are initially recorded at fair value and are accounted for under either Accounting Standards Codification (“ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (see additional information below) or ASC Topic 310, Receivables. Non-refundable loan origination and commitment fees, net of direct costs of originating or acquiring loans, and fair value adjustments for acquired loans, are deferred and recognized over the remaining lives of the related loans in accordance with ASC 310-20. Acquired loans are recorded at their estimated fair value at the time of acquisition and accounted for under either ASC 310-30 or ASC 310. Estimated fair values of acquired loans are based on a discounted cash flow methodology that considers various factors including the type of loan and related collateral, the expected timing of cash flows, classification status, fixed or variable interest rate, term of loan and whether or not the loan is amortizing, and a discount rate reflecting the Company’s assessment of risk inherent in the cash flow estimates. Acquired 310-30 loans are grouped together according to similar characteristics such as type of loan, loan purpose, geography, risk rating and underlying collateral and are treated as distinct pools when applying various valuation techniques and, in certain circumstances, for the ongoing monitoring of the credit quality and performance of the pools. Each pool is accounted for as a single loan for which the integrity is maintained throughout the life of the asset. Discounts created when the loans are recorded at their estimated fair values at acquisition are accreted over the remaining term of the loan as an adjustment to the related loan’s yield. Similar to originated loans described below, the accrual of interest income on acquired loans that are not accounted for under ASC 310-30 is discontinued when the collection of principal or interest, in whole or in part, is doubtful. Interest income on acquired loans that are accounted for under ASC Topic 310 and interest income on loans originated by the Company is accrued and credited to income as it is earned using the interest method based on daily balances of the principal amount outstanding. However, interest is generally not accrued on loans 90 days or more past due, unless they are well secured and in the process of collection. Additionally, in certain situations, loans that are not contractually past due may be placed on non-accrual status due to the continued failure to adhere to contractual payment terms by the borrower coupled with other pertinent factors, such as insufficient collateral value or deficient primary and secondary sources of repayment. Accrued interest receivable is reversed when a loan is placed on non-accrual status and payments received generally reduce the carrying value of the loan. Interest is not accrued while a loan is on non-accrual status and interest income is generally recognized on a cash basis only after payment in full of the past due principal and collection of principal outstanding is reasonably assured. A loan may be placed back on accrual status if all contractual payments have been received, or sooner under certain conditions and collection of future principal and interest payments is no longer doubtful. In the event of borrower default, the Company may seek recovery in compliance with state lending laws, the respective loan agreements, and credit monitoring and remediation procedures that may include modifying or restructuring a loan from its original terms, for economic or legal reasons, to provide a concession to the borrower from their original terms due to borrower financial difficulties in order to facilitate repayment. Such restructured loans are considered “troubled debt restructurings” and are identified in accordance with ASC 310-40, Troubled Debt Restructurings by Creditors. Under this guidance, modifications to loans that fall within the scope of ASC 310-30 are not considered troubled debt restructurings, regardless of otherwise meeting the definition of a troubled debt restructuring. Loans receivable accounted for under ASC 310-30 The Company accounts for and evaluates acquired loans in accordance with the provisions of ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. When loans exhibit evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all principal and interest payments in accordance with the terms of the loan agreement, the expected shortfall in future cash flows, as compared to the contractual amount due, is recognized as a non-accretable difference. Any excess of expected cash flows over the acquisition date fair value is known as the accretable yield, and is recognized as accretion income over the life of each pool. Contractual fees not expected to be collected are not included in ASC 310-30 contractual cash flows. Should fees be subsequently collected, the cash flows are accounted for as non 310-30 fee income in the period they are received. Loans that are accounted for under ASC 310-30 that meet the criteria for non-accrual of interest at the time of acquisition or subsequent to acquisition, may be considered performing, regardless of whether the client is contractually delinquent, if the timing and expected cash flows on such loans can be reasonably estimated and if collection of the new carrying value of such loans is expected. The expected cash flows of loans accounted for under ASC 310-30 are periodically remeasured utilizing the same cash flow methodology used at the time of acquisition and subsequent decreases to the expected cash flows will generally result in a provision for loan losses charge in the Company’s consolidated statements of operations. Any increases to the cash flow projections are recognized on a prospective basis through an increase to the pool’s accretion income over its remaining life once any previously recorded provision expense has been reversed. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. f) Loans held for sale-Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value. Net unrealized losses, if any, are recognized through a valuation allowance that is recorded as a charge to income. Deferred fees and costs related to these loans are not amortized, but are recognized as part of the cost basis of the loan at the time it is sold. Gains or losses are recognized upon sale and are included as a component of gain on sale of mortgages, net in the consolidated statements of operations. Loans held for sale have primarily been fixed rate single-family residential mortgage loans under contract to be sold in the secondary market. In most cases, loans in this category are sold within 45 days. These loans are generally sold with the mortgage servicing rights released. Under limited circumstances, buyers may have recourse to return a purchased loan to the Company. Recourse conditions may include early payment default, breach of representations or warranties, or documentation deficiencies. The Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. interest rate lock commitments). Such interest rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. To protect against the price risk inherent in residential mortgage loan commitments, the Company utilizes both "best efforts" and "mandatory delivery" forward loan sale commitments to mitigate the risk of potential increases or decreases in the values of loans that would result from the change in market rates for such loans. The Company manages the interest rate risk on interest rate lock commitments by entering into forward sale contracts of mortgage backed securities. Such contracts are accounted for as derivatives and are recorded at fair value as derivative assets or liabilities. They are carried on the consolidated statements of financial condition within other assets or other liabilities and changes in fair value are recorded as a component of gain on sale of mortgages, net in the consolidated statements of operations. The gross gains on loan sales are recognized based on new loan commitments with adjustment for price and pair-off activity. Commission expenses on loans held for sale are recognized based on loans closed. g) Allowance for loan losses-The allowance for loan losses represents management’s estimate of probable credit losses inherent in loans, including acquired loans to the extent necessary, as of the balance sheet date. The determination of the ALL takes into consideration, among other matters, the estimated fair value of the underlying collateral, economic conditions, historical net loan losses, the estimated loss emergence period, estimated default rates, any declines in cash flow assumptions from acquisition, loan structures, growth factors and other elements that warrant recognition. In addition, various regulatory agencies, as an integral part of the examination process, periodically review the ALL. Such agencies may require the Company to recognize additions to the ALL or increases to adversely graded classified loans based on their judgments about information available to them at the time of their examinations. The Company uses an internal risk rating system to indicate credit quality in the loan portfolio. The risk rating system is applied to all loans and uses a series of grades, which reflect management’s assessment of the risk attributable to loans based on an analysis of the borrower’s financial condition and ability to meet contractual debt service requirements. Loans that management perceives to have acceptable risk are categorized as “Pass” loans. The “Special Mention” loans represent loans that have potential credit weaknesses that deserve management’s close attention. Special mention loans include borrowers that have potential weaknesses or unwarranted risks that, unless corrected, may threaten the borrower’s ability to meet debt requirements. However, these borrowers are still believed to have the ability to respond to and resolve the financial issues that threaten their financial situation. Loans classified as “Substandard” are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans have a distinct possibility of loss if the deficiencies are not corrected. “Doubtful” loans are loans that management believes the collection of payments in accordance with the terms of the loan agreement is highly questionable and improbable. Loans accounted for under ASC 310-30, despite being 90 days or more past due or internally adversely classified, may be classified as performing upon and subsequent to acquisition, regardless of whether the client is contractually delinquent, if the timing and expected cash flows on such loans can be reasonably estimated and if collection of the carrying value of such loans is expected. Interest accrual is discontinued on doubtful loans and certain substandard loans that are excluded from ASC 310-30, as is more fully discussed in note 7. The Company routinely evaluates adversely risk-rated credits for impairment. Impairment, if any, is typically measured for each loan based on a thorough analysis of the most probable source of repayment, including the present value of the loan’s expected future cash flows, the loan’s estimated fair value, or the estimated fair value of the underlying collateral less costs of disposition for collateral dependent loans. General allowances are established for loans with similar characteristics. In this process, general allowance factors are based on an analysis of historical loss and recovery experience, if any, related to originated and acquired loans, as well as certain industry experience, with adjustments made for qualitative or environmental factors that are likely to cause estimated credit losses to differ from historical experience. To the extent that the data supporting such factors has limitations, management’s judgment and experience play a key role in determining the allowance estimates. Additions to the ALL are made by provisions for loan losses that are charged to operations. The allowance is decreased by charge-offs due to losses and is increased by provisions for loan losses and recoveries. When it is determined that specific loans, or portions thereof, are uncollectible, these amounts are charged off against the ALL. If repayment of the loan is collateral dependent, the fair value of the collateral, less cost to sell, is used to determine charge-off amounts. The Company maintains an ALL for loans accounted for under ASC 310-30 as a result of impairment to loan pools arising from the periodic re-measurement of these loans. Any impairment in the individual pool is generally recognized in the current period as provision for loan losses. Any improvement in the estimated cash flows, is generally not recognized immediately, but is instead reflected as an adjustment to the related loan pools yield on a prospective basis once any previously recorded impairment has been recaptured. h) Premises and equipment-With the exception of premises and equipment acquired through business combinations, which are initially measured and recorded at fair value, purchased land is stated at cost, and buildings and equipment are carried at cost, including capitalized interest when appropriate, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful life of the asset. The Company generally assigns depreciable lives of 39 years for buildings, 7 to 15 years for building improvements, and 3 to 7 years for equipment. Leasehold improvements are amortized over the shorter of their estimated useful lives or remaining lease terms. Maintenance and repairs are charged to non-interest expense as incurred. The Company reviews premises and equipment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. An impairment loss is recognized when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposal is less than its carrying amount. In the case of a property that is subject to an operating lease that the Company no longer expects to use, a liability is recorded equal to the remaining lease rentals, adjusted for the effects of any prepaid or deferred items recognized under the lease, and reduced by estimated sublease rentals that could be reasonably obtained for the property, even if the entity does not intend to enter into a sublease. A ratable portion of the sublease allocation is then expensed until the property is subleased. Property and equipment that meet the held-for-sale criteria is recorded at the lower of its carrying amount or fair value less cost to sell and depreciation is ceased. i) Goodwill and intangible assets-Goodwill is established and recorded if the consideration given during an acquisition transaction exceeds the fair value of the net assets received. Goodwill has an indefinite useful life and is not amortized, but is evaluated annually for potential impairment, or when events or circumstances indicate a potential impairment. Such events or circumstances may include deterioration in general economic conditions, deterioration in industry or market conditions, an increased competitive environment, a decline in market-dependent multiples or metrics, declining financial performance, entity-specific events or circumstances or a sustained decrease in share price (either in absolute terms or relative to peers). The Company first evaluates potential impairment of goodwill by comparing the fair value of the reporting unit to its carrying amount. Any excess of carrying value over fair value would indicate a potential impairment and the Company would proceed to perform an additional test to determine whether goodwill has been impaired and calculate the amount of that impairment. Intangible assets that have finite useful lives, such as core deposit intangibles, are amortized over their estimated useful lives. The Company’s core deposit intangible assets represent the value of the anticipated future cost savings that will result from the acquired core deposit relationships versus an alternative source of funding. Judgment may be used in assessing goodwill and intangible assets for impairment. Estimates of fair value are based on projections of revenues, operating costs and cash flows of the reporting unit considering historical and anticipated future results, general economic and market conditions, as well as the impact of planned business or operational strategies. The valuations use a combination of present value techniques to measure fair value and consider market factors. Additionally, judgment is used in determining the useful lives of finite-lived intangible assets. Adverse changes in the economic environment, operations of the reporting unit, or changes in judgments and projections could result in a significantly different estimate of the fair value of the reporting unit and could result in an impairment of goodwill and/or intangible assets. j) Other real estate owned-OREO consists of property that has been foreclosed on or repossessed by deed in lieu of foreclosure. The assets are initially recorded at the fair value of the collateral less estimated costs to sell, with any initial valuation adjustments charged to the ALL. Subsequent downward valuation adjustments, if any, in addition to gains and losses realized on sales and net operating expenses, are recorded in other non-interest expense, while any subsequent write-ups are recorded in non-interest income. Costs associated with maintaining property, such as utilities and maintenance, are charged to expense in the period in which they occur, while costs relating to the development and improvement of property are capitalized to the extent the balance does not exceed fair value. All OREO acquired through acquisition is recorded at fair value, less cost to sell, at the date of acquisition. k) Bank-owned life insurance-The Company purchased or acquired bank-owned life insurance ("BOLI") policies on certain associates of the Company. The Company is the owner and beneficiary of these policies. The BOLI is carried at net realizable value with changes in net realizable value recorded in non-interest income. l) Securities purchased under agreements to resell and securities sold under agreements to repurchase-The Company periodically enters into purchases or sales of securities under agreements to resell or repurchase as of a specified future date. The securities purchased under agreements to resell are accounted for as collateralized financing transactions and are reflected as an asset in the consolidated statements of financial condition. The securities pledged by the counterparties are held by a third party custodian and valued daily. The Company may require additional collateral to ensure full collateralization for these transactions. The repurchase agreements are considered financing agreements and the obligation to repurchase assets sold is reflected as a liability in the consolidated statements of financial condition of the Company. The repurchase agreements are collateralized by debt securities that are under the control of the Company. m) Stock-based compensation-The Company accounts for stock-based compensation in accordance with ASC Topic 718, Compensation-Stock Compensation as amended by ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The Company grants stock-based awards including stock options, restricted stock and performance stock units. Stock option grants are for a fixed number of common shares and are issued to associates and directors at exercise prices which are not less than the fair value of a share of stock at the date of grant. The options vest over a time period stated in each option agreement and may be subject to other performance vesting conditions, which require the related compensation expense to be recorded ratably over the requisite service period starting when such conditions become probable. Restricted stock is granted for a fixed number of shares, the transferability of which is restricted until such shares become vested according to the terms in the award agreement. Restricted shares may have multiple vesting qualifications which can include time vesting of a set portion of the restricted shares, performance criterion, such as market criteria that are tied to specified market conditions of the Company’s common stock price. The fair value of stock options and market-based awards is measured using either a Black-Scholes model or a Monte Carlo simulation model, depending on the vesting requirement of each grant. The fair value of time-based restricted stock awards is based on the Company’s stock price on the date of grant. Compensation expense for the portion of the awards that contain a market vesting condition is recognized over the derived service period based on the fair value of the awards on the grant date. Compensation expense for the portion of the awards that contain performance and service vesting conditions is recognized over the requisite service period based on the fair value of the awards on the grant date. The amortization of stock-based compensation reflects any estimated forfeitures and the expense realized in subsequent periods may be adjusted to reflect the actual forfeitures realized. The outstanding stock options carry a maximum contractual term of ten years and the market vesting restricted shares carry contractual terms that range from 7-10 years, with certain awards having no defined contractual term. To the extent that any award is forfeited, surrendered, terminated, expires, or lapses without being exercised, the shares of stock subject to such award not delivered as a result thereof are again made available for awards under the Plan. In the fourth quarter of 2016, the Company early adopted ASU 2016-09, with an effective date of January 1, 2016. The ASU requires all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) be recognized in the consolidated statements of operations as a component of income tax expense or benefit. The tax effects of exercised, expired or vested awards are treated as discrete items in the reporting period in which they occur and may result in increased volatility in our effective tax rate. As part of the adoption of this standard, the Company made an accounting election to continue to estimate forfeitures when determining amortization expense of stock-based compensation. Additionally, the Company applied the retrospective transition method for the presentation of “Net tax (benefit) deficit on stock-based compensation” from a financing activity to an operating activity in the Company’s consolidated statements of cash flows. Cash paid by the Company when directly withholding shares for tax withholding purposes is classified as a financing activity in the consolidated statements of cash flows. For the year ended December 31, 2016, the impact of adopting all provisions of the ASU to the Company’s consolidated statements of operations was a $2.1 million decrease to income tax expense from excess tax benefits realized in the fourth quarter of 2016. Prior to 2016, excess tax benefits were recognized in additional paid-in capital and tax deficiencies were recognized either as an offset to accumulated excess tax benefits, if any, or in the consolidated statements of operations. Excess tax benefits were not recognized until the deduction reduces taxes payable. Additionally, excess tax benefits from stock-based compensation was included in operating and financing activities within the Company’s consolidated statements of cash flows. n) Warrants-The Company issued warrants to certain lead investors in 2009 and 2010. The warrants are for a fixed number of shares and had original expirations of ten years from the date of issuance. If exercised, the Company must settle the warrants in its own stock. Historically, the exercise price and the number of warrants were subject to certain down-round provisions, whereby certain subsequent equity issuances at a price below the existing exercise price would result in a downward adjustment to the exercise price and an increase in the number of warrants, and as a result, the warrants were historically classified as a liability in the Company’s consolidated statements of financial condition with changes in the fair value each period reported in the statements of operations as non-interest expense. During 2015, the outstanding warrant contracts were modified, terminating the down-round provisions and extending the contractual life an additional six months from the original expiration. As a result, the warrant contracts were recorded at fair value as of the modification date using a Black-Scholes model with the change in fair value reported in the statement of operations as non-interest expense, and were reclassified to shareholders’ equity as of December 31, 2015. o) Income taxes-The Company and its subsidiaries file U.S. federal and certain state income tax returns on a consolidated basis. Additionally, the Company and its subsidiaries file separate state income tax returns with various state jurisdictions. The provision for income taxes includes the income tax balances of the Company and all of its subsidiaries. Deferred tax assets and liabilities are recognized for temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. Deferred tax assets and liabilities are adjusted for the effects of changes in tax rates in the period of change. The Company establishes a valuation allowance when management believes, based on the weight of available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. The Company recognizes and measures income tax benefits based upon a two-step model: 1) a tax position must be more likely than not to be sustained based solely on its technical merits in order to be recognized; and 2) the benefit is measured as the largest dollar amount of that position that is more likely than not to be sustained upon settlement. The difference between the benefit recognized for a position in this model and the tax benefit claimed on a tax return is treated as an unrecognized tax benefit. The Company recognizes income tax related interest and penalties in other non-interest expense. p) Income per share-The Company applies the two-class method of computing income per share as certain of the Company's restricted shares are entitled to non-forfeitable dividends and are therefore considered to be a class of participating securities. The two-class method allocates income according to dividends declared and participation rights in undistributed income. Basic income per share is computed by dividing income allocated to common shareholders by the weighted average number of common shares outstanding during each period. Diluted income per common share is computed by dividing income allocated to common shareholders by the weighted average common shares outstanding during the period, plus amounts representing the dilutive effect of stock options outstanding, certain unvested restricted shares, warrants to issue common stock, or other contracts to issue common shares (“common stock equivalents”) using the treasury stock method. Common stock equivalents are excluded from the computation of diluted earnings per common share in periods in which they have an anti-dilutive effect. q) Interest Rate Swap Derivatives-The Company carries all derivatives on the statement of financial condition at fair value. All derivative instruments are recognized as either assets or liabilities depending on the rights or obligations under the contracts. All gains and losses on the derivatives due to changes in fair value are recognized in earnings each period. The Company offers interest rate swap products to certain of its clients to manage potential changes in interest rates. Each contract between the Company and a client is offset with a contract between the Company and an institutional counterparty, thus minimizing the Company's exposure to rate changes. The Company's portfolio consists of a “matched book,” and as such, changes in fair value of the swap pairs will largely offset in earnings. In accordance with applicable accounting guidance, if certain conditions are met, a derivative may be designated as (1) a hedge of the exposure to changes in the fair value of a recognized asset or liability, or of an unrecognized firm commitment, that are attributable to a particular risk (referred to as a fair value hedge) or (2) a hedge of the exposure to variability in the cash flows of a recognized asset or liability, or of a forecasted transaction, that is attributable to a particular risk (referred to as a cash flow hedge). The Company documents all hedging relationships at the inception of each hedging relationship and uses industry accepted methodologies and ranges to determine the effectiveness of each hedge. The fair value of the hedged item is calculated using the estimated future cash flows of the hedged item and applying discount rates equal to the market interest rate for the hedged item at the inception of the hedging relationship (inception benchmark interest rate plus an inception credit spread), adjusted for changes in the designated benchmark interest rate thereafter. r) Treasury stock -When the Company acquires treasury stock, the sum of the consideration paid and direct transaction costs after tax is recognized as a deduction from equity. The cost basis for the reissuance of treasury stock is determined using a first-in, first-out basis. To the extent that the reissuance price is more than the cost basis (gain), the excess is recorded as an increase to additional paid-in capital in the consolidated statements of financial condition. If the reissuance price is less than the cost basis (loss), the difference is recorded to additional paid-in capital to the extent there is a cumulative treasury stock paid-in capital balance. Any loss in excess of the cumulative treasury stock paid-in capital balance is charged to retained earnings. Note 3 Recent Accounting Pronouncements Revenue from Contracts with Customers-In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This update supersedes revenue recognition requirements in ASC Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance in the FASB Accounting Standards Codification. The new guidance stipulates that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides specific steps that entities should apply in order to achieve this principle. The amendments are effective for interim and annual periods beginning after December 15, 2017, with early application permitted for interim and annual periods beginning after December 15, 2016. ASU No. 2014-09 allows for either full retrospective or modified retrospective adoption. The Company is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements, if any. The Company will adopt ASU 2014-09 in the first quarter of 2018 and expects to apply the modified retrospective approach. Leases-In February 2016, the FASB issued ASU 2016-02, Leases. The guidance in ASU 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statements. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Early adoption of the amendments in the update is permitted. The Company will adopt ASU 2016-02 in the first quarter of 2019 and is currently in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements. Financial Instruments - Credit Losses-In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. This update replaces the current incurred loss methodology for recognizing credit losses with a current expected credit loss model, which requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This amendment broadens the information that an entity must consider in developing its expected credit loss estimates. Additionally, the update amends the accounting for credit losses for available-for-sale debt securities and purchased financial assets with a more-than-insignificant amount of credit deterioration since origination. This update requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of a company’s loan portfolio. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption in fiscal years beginning after December 15, 2018 is permitted. The amendment requires the use of the modified retrospective approach for adoption. The Company is in the process of evaluating the impact of the ASU’s adoption on the Company’s consolidated financial statements. The Company reviewed ASU 2016-01, Financial Instruments - Recognition and Measurement of Financial Assets and Financial Liabilities (Topic 825), ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments and ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment and does not expect the adoption of these pronouncements to have a material impact on its financial statements. Note 4 Investment Securities The Company’s investment securities portfolio is comprised of available-for-sale and held-to-maturity investment securities. These investment securities totaled $1.2 billion at December 31, 2016 and were comprised of $0.9 billion of available-for-sale securities and $0.3 billion of held-to-maturity securities. At December 31, 2015, investment securities totaled $1.6 billion and included $1.2 billion of available-for-sale securities and $0.4 billion of held-to-maturity securities. Available-for-sale At December 31, 2016 and 2015, the Company held $0.9 billion and $1.2 billion of available-for-sale investment securities, respectively. Available-for-sale securities are summarized as follows as of the dates indicated: At December 31, 2016 and 2015, mortgage-backed securities represented primarily all of the Company’s available-for-sale investment portfolio and all mortgage-backed securities were backed by government sponsored enterprises (“GSE”) collateral such as Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”), and the government sponsored agency Government National Mortgage Association (“GNMA”). The table below summarizes the available-for-sale investment securities with unrealized losses as of the dates shown, along with the length of the impairment period: Management evaluated all of the available-for-sale securities in an unrealized loss position and concluded that no OTTI existed at December 31, 2016 or December 31, 2015. The unrealized losses in the Company's investments issued or guaranteed by U.S. government agencies or sponsored enterprises at December 31, 2016 were caused by changes in interest rates. The portfolio included 61 securities, having an aggregate fair value of $627.2 million, which were in an unrealized loss position at December 31, 2016, compared to 66 securities, with an aggregate fair value of $752.7 million at December 31, 2015. The Company has no intention to sell these securities before recovery of their amortized cost and believes it will not be required to sell the securities before the recovery of their amortized cost. Certain securities are pledged as collateral for public deposits, securities sold under agreements to repurchase and to secure borrowing capacity at the Federal Reserve Bank, and the Federal Home Loan Bank (“FHLB”), if needed. The fair value of available-for-sale investment securities pledged as collateral totaled $373.7 million and $335.8 million at December 31, 2016 and 2015, respectively. The increase in pledged available-for-sale investment securities was primarily attributable to an increase in average deposit account balances and client repurchase account balances during 2016. Certain investment securities may also be pledged as collateral for the line of credit at the FHLB of Topeka; however, no investment securities were pledged for this purpose at December 31, 2016 or December 31, 2015. Mortgage-backed securities do not have a single maturity date and actual maturities may differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average life of the available-for-sale mortgage-backed securities portfolio was 3.4 years and 3.6 years at December 31, 2016 and 2015, respectively. This estimate is based on assumptions and actual results may differ. At December 31, 2016 and 2015, the duration of the total available-for-sale investment portfolio was 3.2 years and 3.4 years, respectively. As of December 31, 2016, municipal securities with an amortized cost and fair value of $3.3 million were due after one year through five years, while municipal securities with an amortized cost and fair value of $0.6 million were due after five years through ten years. Other securities of $0.4 million as of December 31, 2016, have no stated contractual maturity date. Held-to-maturity At December 31, 2016 and 2015, the Company held $332.5 million and $427.5 million of held-to-maturity investment securities, respectively. Held-to-maturity investment securities are summarized as follows as of the dates indicated: The table below summarizes the held-to-maturity investment securities with unrealized losses as of the dates shown, along with the length of the impairment period: The held-to-maturity portfolio included 15 securities, having an aggregate fair value of $86.9 million, which were in an unrealized loss position at December 31, 2016, compared to 16 securities, with a fair value of $109.9 million, at December 31, 2015. Management evaluated all of the held-to-maturity securities in an unrealized loss position and concluded that no OTTI existed at December 31, 2016 or December 31, 2015. The unrealized losses in the Company's investments issued or guaranteed by U.S. government agencies or sponsored enterprises at December 31, 2016, were caused by changes in interest rates. The Company has no intention to sell these securities before recovery of their amortized cost and believes it will not be required to sell the securities before the recovery of their amortized cost. The carrying value of held-to-maturity investment securities pledged as collateral totaled $119.2 million and $156.5 million at December 31, 2016 and 2015, respectively. Actual maturities of mortgage-backed securities may differ from scheduled maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average expected life of the held-to-maturity mortgage-backed securities portfolio as of December 31, 2016 and 2015 was 3.5 years and 3.7 years, respectively. This estimate is based on assumptions and actual results may differ. The duration of the total held-to-maturity investment portfolio was 3.2 years and 3.4 years as of December 31, 2016 and 2015, respectively. Note 5 Non-marketable Securities Non-marketable securities include Federal Reserve Bank stock, FHLB stock and non-negotiable certificates of deposit. At December 31, 2016, the Company held $9.2 million of Federal Reserve Bank stock, $5.2 million of FHLB stock for regulatory or debt facility purposes and $0.5 million of non-negotiable certificates of deposit acquired as part of the Pine River acquisition. At December 31, 2015, the Company held $14.1 million of Federal Reserve Bank stock, $7.4 million of FHLB stock and $1.0 million of non-negotiable certificates of deposit acquired from the Pine River acquisition. These are restricted securities which, lacking a market, are carried at cost. There have been no identified events or changes in circumstances that may have an adverse effect on the investments carried at cost. Management evaluated all of the non-marketable securities and concluded that no OTTI existed at December 31, 2016 or December 31, 2015. Note 6 Loans The loan portfolio is comprised of loans originated by the Company and loans that were acquired in connection with the Company’s acquisitions. The table below shows the loan portfolio composition including carrying value by segment of loans accounted for under ASC 310-30 and loans not accounted for under this guidance, which includes our originated loans. The carrying value of loans is net of discounts on loans excluded from ASC 310-30, and fees and costs of $6.3 million and $8.1 million at December 31, 2016 and 2015, respectively. At December 31, 2016, $14.4 million of non 310-30 loans were held-for-sale, most of which were in the residential real estate segment. Delinquency for loans excluded from ASC 310-30 is shown in the following tables at December 31, 2016 and 2015: Loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the due date of the scheduled payment. Pooled loans accounted for under ASC 310-30 that are 90 days or more past due and still accreting are generally considered to be performing and are included in loans 90 days or more past due and still accruing. Non-accrual loans include troubled debt restructurings on non-accrual status. Non-accrual loans excluded from the scope of ASC 310-30 totaled $30.7 million at December 31, 2016, representing an increase of $5.1 million, or 19.8%, from December 31, 2015. The increase was driven by activity within the commercial and industrial and energy sectors. Non-performing loans within the commercial and industrial sector increased $3.9 million from December 31, 2015, largely due to two loan relationships totaling $6.6 million at December 31, 2016, offset by charge-offs throughout the year. Non-performing energy loans totaled $12.6 million at December 31, 2016, representing an increase of $0.6 million from December 31, 2015. The increase was due to three energy loan relationships totaling $12.6 million at December 31, 2016 that were placed on non-accrual during 2016, mostly offset by two loan relationships resolved and charged-off during 2016. Credit exposure for all loans as determined by the Company’s internal risk rating system was as follows at December 31, 2016 and 2015: The Company’s substandard energy loans excluded from ASC 310-30 decreased $8.3 million from December 31, 2015, due to charge-offs of $9.9 million from two loan relationships in 2016, partially offset by one energy loan relationship totaling $3.2 million that was downgraded from special mention during 2016. Non 310-30 substandard loans within the commercial and industrial sector increased $8.9 million from December 31, 2015, primarily due to downgrades of two loan relationships totaling $7.7 million during 2016. Non 310-30 substandard loans within the agriculture sector decreased $8.8 million from December 31, 2015, due to a pay-off of one loan relationship totaling $8.4 million during 2016. Non 310-30 special mention loans within the owner occupied commercial real estate sector increased $3.8 million from December 31, 2015, due to a downgrade of one loan relationship totaling $4.3 million during 2016, partially offset by other net decreases of $0.5 million. Non 310-30 special mention loans within the agriculture sector increased $6.5 million from December 31, 2015, due to one loan relationship totaling $8.9 million downgraded to special mention during 2016, partially offset by a downgrade to substandard of one loan relationship totaling $1.6 million at December 31, 2015 and other decreases of $0.9 million during 2016. Impaired Loans Loans are considered to be impaired when it is probable that the Company will not be able to collect all amounts due in accordance with the contractual terms of the loan agreement. Impaired loans are comprised of loans excluded from ASC 310-30 on non-accrual status, loans in bankruptcy, and troubled debt restructurings (“TDRs”) described below. If a specific allowance is warranted based on the borrower’s overall financial condition, the specific allowance is calculated based on discounted cash flows using the loan’s initial contractual effective interest rate or the fair value of the collateral less selling costs for collateral dependent loans. At December 31, 2016, the Company measured $28.2 million of impaired loans based on the fair value of the collateral less selling costs and $2.3 million of impaired loans using discounted cash flows and the loan’s initial contractual effective interest rate. Impaired loans totaling $7.8 million that individually were less than $250 thousand each, were measured through our general ALL reserves due to their relatively small size. At December 31, 2016 and 2015, the Company’s recorded investment in impaired loans was $38.3 million and $37.4 million, respectively. Impaired loans at December 31, 2016 were primarily comprised of eight relationships totaling $25.3 million. Four of the relationships were in the commercial and industrial sector, three of the relationships were in the energy sector and one relationship was in the agriculture sector. Impaired loans had a collective related allowance for loan losses allocated to them of $2.4 million and $4.4 million at December 31, 2016 and 2015, respectively. Additional information regarding impaired loans at December 31, 2016 and 2015 is set forth in the table below: The table below shows additional information regarding the average recorded investment and interest income recognized on impaired loans for the periods presented: Interest income recognized on impaired loans noted in the table above, primarily represents interest earned on accruing troubled debt restructurings. Interest income recognized on impaired loans using the cash-basis method of accounting during the years ended December 31, 2016, 2015 and 2014 was immaterial. Troubled debt restructurings It is the Company’s policy to review each prospective credit in order to determine the appropriateness and the adequacy of security or collateral prior to making a loan. In the event of borrower default, the Company seeks recovery in compliance with lending laws, the respective loan agreements, and credit monitoring and remediation procedures that may include restructuring a loan to provide a concession by the Company to the borrower from their original terms due to borrower financial difficulties in order to facilitate repayment. Additionally, if a borrower’s repayment obligation has been discharged by a court, and that debt has not been reaffirmed by the borrower, regardless of past due status, the loan is considered to be a TDR. At December 31, 2016 and 2015, the Company had $5.8 million and $8.4 million, respectively, of accruing TDRs that had been restructured from the original terms in order to facilitate repayment. Non-accruing TDRs at December 31, 2016 and 2015 totaled $16.7 million and $17.8 million, respectively. During 2016, the Company restructured 17 loans with a recorded investment of $12.3 million at December 31, 2016 to facilitate repayment. Substantially all of the loan modifications were a reduction of the principal payment, a reduction in interest rate, or an extension of term. Loan modifications to loans accounted for under ASC 310-30 are not considered TDRs. The table below provides additional information related to accruing TDRs at December 31, 2016 and 2015: The following table summarizes the Company’s carrying value of non-accrual TDRs as of December 31, 2016 and 2015: Accrual of interest is resumed on loans that were on non-accrual only after the loan has performed sufficiently. The Company had five TDRs that were modified within the past twelve months and had defaulted on their restructured terms. The defaulted TDRs consisted of two commercial loans totaling $6.4 million, and three residential totaling loans $0.4 million. The allowance for loan losses related to troubled debt restructurings on non-accrual status is determined by individual evaluation, including collateral adequacy, using the same process as loans on non-accrual status which are not classified as troubled debt restructurings. During 2015, the Company had five TDRs that were modified within the past 12 months and had defaulted on their restructured terms. The defaulted TDRs consisted of two commercial loans totaling $9.7 million and three consumer residential loans totaling $103 thousand. For purposes of this disclosure, the Company considers “default” to mean 90 days or more past due on principal or interest. Loans accounted for under ASC 310-30 Loan pools accounted for under ASC Topic 310-30 are periodically re-measured to determine expected future cash flows. In determining the expected cash flows, the timing of cash flows and prepayment assumptions for smaller homogeneous loans are based on statistical models that take into account factors such as the loan interest rate, credit profile of the borrowers, the years in which the loans were originated, and whether the loans are fixed or variable rate loans. Prepayments may be assumed on loans if circumstances specific to that loan warrant a prepayment assumption. The re-measurement of loans accounted for under ASC 310-30 resulted in the following changes in the carrying amount of accretable yield during 2016 and 2015: Below is the composition of the net book value for loans accounted for under ASC 310-30 at December 31, 2016 and 2015: Note 7 Allowance for Loan Losses The tables below detail the Company’s allowance for loan losses (“ALL”) and recorded investment in loans as of and for the years ended December 31, 2016 and 2015: In evaluating the loan portfolio for an appropriate ALL level, non-impaired loans that were not accounted for under ASC 310-30 were grouped into segments based on broad characteristics such as primary use and underlying collateral. Within the segments, the portfolio was further disaggregated into classes of loans with similar attributes and risk characteristics for purposes of applying loss ratios and determining applicable subjective adjustments to the ALL. The application of subjective adjustments was based upon qualitative risk factors, including economic trends and conditions, industry conditions, asset quality, loss trends, lending management, portfolio growth and loan review/internal audit results. During the first quarter of 2016, the Company updated the loan classifications in its allowance for loan losses model to include owner occupied commercial real estate and agriculture within the commercial loan segment and present energy as its own loan class within the commercial segment. The prior year presentation has been reclassified to conform to the current year presentation. The Company had $21.6 million of net charge-offs on non 310-30 loans during 2016, of which $19.1 million were from the energy portfolio. Management’s evaluation of credit quality resulted in a provision for loan losses on non 310-30 loans of $24.5 million during 2016, of which $18.9 million was from the energy portfolio. During 2015, The Company had $2.9 million of net charge-offs on non ASC 310-30 loans and recorded a provision for loan losses on non 310-30 loans of $12.1 million. During 2016 and 2015, the Company re-measured the expected cash flows of the loan pools accounted for under ASC 310-30. The re-measurement in 2016 resulted in a net recoupment of $805 thousand, which was comprised primarily of a $788 thousand recoupment in the commercial segment. The re-measurement in 2015 resulted in a provision of $366 thousand, which was comprised primarily of a $320 thousand commercial segment provision. Note 8 Premises and Equipment Premises and equipment consisted of the following at December 31, 2016 and 2015: The Company incurred $8.7 million, $10.1 million and $10.6 million of depreciation expense during 2016, 2015 and 2014, respectively, as a component of occupancy and equipment expense in the consolidated statements of operations. The Company disposed of $3.5 million, $0.1 million and $1.0 million of premises and equipment, net, during 2016, 2015 and 2014, respectively. During 2015, the Company consolidated three banking centers in the Bank Midwest network. During the first quarter of 2016, the Company announced the consolidation of seven banking centers in the Community Banks of Colorado network. The banking center consolidations resulted in certain buildings to be classified as held-for-sale, which were adjusted to the lower of the carrying amount or fair value less cost to sell. The adjustment totaled $1.4 million and is included in the consolidated statements of operations. At December 31, 2016, the Company held one building related to these consolidations. During 2016, the Company entered into definitive agreements for the sale of four banking centers expected to close during the second quarter of 2017. The sale includes buildings classified as held-for-sale with an estimated fair value of $1.6 million at December 31, 2016. Space in certain facilities is leased under operating leases. Below is a summary of future minimum lease payments for the years following 2016: Note 9 Other Real Estate Owned A summary of the activity in the OREO balances during 2016 and 2015 is as follows: The OREO balances exclude $1.6 million and $5.5 million at December 31, 2016 and 2015, respectively, of the Company’s minority interests in OREO, which are held by outside banks where the Company was not the lead bank and does not have a controlling interest. The Company maintains a receivable in other assets for these minority interests. Included in Sales, net are net gains of $4.4 million and $2.8 million for the years ended December 31, 2016 and 2015, respectively. Note 10 Goodwill and Intangible Assets In connection with our acquisitions, the Company recorded core deposit intangible assets of $38.4 million. The Company is amortizing the core deposit intangibles on a straight line basis over 7 years from the date of the respective acquisitions, which represents the expected useful life of the assets. The Company recognized core deposit intangible amortization expense of $5.5 million, $5.4 million and $5.3 million during 2016, 2015 and 2014, respectively. The following table shows the estimated future amortization expenses. The accumulated amortization of the core deposit intangible assets was $31.5 million and $25.8 million at December 31, 2016 and 2015, respectively. The Company had goodwill of $59.6 million at December 31, 2016, 2015 and 2014. The goodwill is measured as the excess of the fair value of consideration paid over the fair value of assets acquired. No goodwill impairment was recorded during 2016, 2015 or 2014. Note 11 Deposits Total deposits were $3.9 billion and $3.8 billion at December 31, 2016 and 2015, respectively. Time deposits were $1.2 billion at both December 31, 2016 and 2015. At December 31, 2016, deposits totaling $103.0 million were held-for-sale, including $51.6 million of time deposits. The following table summarizes the Company’s time deposits, based upon contractual maturity, at December 31, 2016 and 2015, by remaining maturity: The Company incurred interest expense on deposits as follows during the periods indicated: The Federal Reserve System requires cash balances to be maintained at the Federal Reserve Bank based on certain deposit levels. There was no minimum reserve requirement for the Bank at December 31, 2016. The aggregate amount of certificates of deposit in denominations that meet or exceed the FDIC insurance limit was $119.7 million and $86.9 million at December 31, 2016 and 2015, respectively. Note 12 Borrowings The following table sets forth selected information regarding repurchase agreements during 2016, 2015 and 2014: As of December 31, 2016, 2015 and 2014, the Company had pledged mortgage-backed securities with a fair value of approximately $99.1 million, $205.7 million and $152.4 million, respectively, for securities sold under agreements to repurchase. Additionally, there was $7.0 million, $68.1 million and $18.8 million of excess collateral pledged for repurchase agreements at December 31, 2016, 2015 and 2014, respectively. The vast majority of the Company’s repurchase agreements are overnight transactions with clients that mature the day after the transaction. During 2016, 2015 and 2014, the overnight agreements had a weighted average interest rate of 0.17%, 0.18% and 0.13%, respectively. At December 31, 2016, 2015 and 2014 none of the Company’s repurchase agreements were for periods longer than one day. The repurchase agreements are subject to a master netting arrangement; however, the Company has not offset any of the amounts shown in the consolidated financial statements. As a member of the FHLB of Topeka, the Bank has access to a line of credit and term financing from the FHLB with available credit of $903.9 million at December 31, 2016. Total advances under the line of credit at December 31, 2016 were $13.7 million with an interest rate of 0.72%, and had certain loans pledged as collateral. The Bank had no outstanding advances at December 31, 2015 and 2014. At December 31, 2016, 2015 and 2014, the Bank had $25.0 million in term advances from the FHLB of Des Moines. All of the outstanding advances have fixed interest rates of 1.81% - 2.33%, with maturity dates of 2018 - 2020. The Bank had investment securities pledges as collateral for FHLB of Des Moines advances in the amount of $28.8 million, $41.7 million and $0.0 million at December 31, 2016, 2015 and 2014, respectively. Interest expense related to FHLB advances totaled $693 thousand, $666 thousand and $164 thousand for the years ended December 31, 2016, 2015 and 2014, respectively. Note 13 Regulatory Capital As a bank holding company, the Company is subject to the regulatory capital adequacy requirements implemented by the Federal Reserve. The federal banking agencies have risk-based capital adequacy regulations intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations. Under these regulations, assets are assigned to one of several risk categories, and nominal dollar amounts of assets and credit equivalent amounts of off-balance-sheet items are multiplied by a risk adjustment percentage for the category. The new Basel III rules, effective January 1, 2015, changed the components of regulatory capital and changed the way in which risk ratings are assigned to various categories of bank assets. Also, a new Tier 1 common risk-based ratio was defined. Under the Basel III requirements, at December 31, 2016, the Company and the Bank met all capital requirements and the Bank had regulatory capital ratios in excess of the levels established for well-capitalized institutions. In February 2016, the Bank received approval from the Colorado Division of Banking and the Federal Reserve Bank of Kansas City to permanently reduce the Bank's capital by $140.0 million. As a result, the Bank distributed $140.0 million in cash to the Company in February 2016. At December 31, 2016 and 2015, the Bank met the requirements to be considered “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized”, the Bank must maintain capital ratios as set forth in the table below. The following table sets forth the capital ratios of the Company and the Bank at December 31, 2016 and 2015: (1) Note 14 FDIC Loss-Sharing Related During the fourth quarter of 2015, the Bank entered into an early termination agreement with the FDIC, terminating its loss-share agreements with the FDIC. The Bank paid consideration of $15.1 million to the FDIC for the termination of the agreements. Additionally, the Bank recorded a pre-tax gain of $4.9 million in the fourth quarter of 2015, which was recorded in FDIC loss-sharing related income in the consolidated statements of operations. FDIC related income was $0, $(15.6) million and $(36.6) million for 2016, 2015 and 2014, respectively. The amounts in 2015 and 2014 were mostly driven by the FDIC indemnification asset amortization. Note 15 Stock-based Compensation and Benefits The Company provides stock-based compensation in accordance with shareholder-approved plans. During the second quarter of 2014, shareholders approved the 2014 Omnibus Incentive Plan (the "2014 Plan"). The 2014 Plan replaces the NBH Holdings Corp. 2009 Equity Incentive Plan (the "Prior Plan"), pursuant to which the Company granted equity awards prior to the approval of the 2014 Plan. Pursuant to the 2014 Plan, the Compensation Committee of the Board of Directors has the authority to grant, from time to time, awards of options, stock appreciation rights, restricted stock, restricted stock units, performance units, other stock-based awards, or any combination thereof to eligible persons. As of December 31, 2016, the aggregate number of Class A common stock available for issuance under the 2014 Plan is 5,588,905 shares. Any shares that are subject to stock options or stock appreciation rights under the 2014 Plan will be counted against the amount available for issuance as one share for every one share granted, and any shares that are subject to awards under the 2014 Plan other than stock options or stock appreciation rights will be counted against the amount available for issuance as 3.25 shares for every one share granted. The 2014 Plan provides for recycling of shares from both the Prior Plan and the 2014 Plan, the terms of which are further described in the Company's Proxy Statement for its 2014 Annual Meeting of Shareholders. Upon an option exercise, it is the Company’s policy to issue shares from treasury stock. To date, the Company has issued stock options, restricted stock and performance stock units under the plans. The Compensation Committee sets the option exercise price at the time of grant, but in no case is the exercise price less than the fair market value of a share of stock at the date of grant. Stock options The Company issued stock options during 2016, 2015 and 2014 which are primarily time-vesting with 1/3 vesting on each of the first, second and third anniversary of the date of grant or date of hire. The expense associated with the awarded stock options was measured at fair value using a Black-Scholes option-pricing model. The outstanding option awards vest on a graded basis over 1-4 years of continuous service and have 7-10 year contractual terms. Below are the weighted average assumptions used in the Black-Scholes option pricing model to determine fair value of the Company’s stock options granted in 2016, 2015 and 2014: (1) The risk-free rate for the expected term of the options was based on the U.S. Treasury yield curve at the date of grant and based on the expected term. (2) Expected volatility was calculated using a time-based weighted migration of the Company’s own stock price volatility coupled with those of a peer group of eight comparable publicly traded companies for a period commensurate with the expected term of the options. (3) The expected term was estimated to be the average of the contractual vesting term and time to expiration. (4) The dividend yield was assumed to be zero for grants made prior to the initial public offering and for subsequent grants was assumed to be $0.05 per share per quarter and $0.07 per share per quarter after October 18, 2016 in accordance with the Company’s dividend policy at the time of grant. The Company issued stock options in accordance with the 2014 Plan during 2016. The following table summarizes stock option activity for 2016: Stock option expense is a component of salaries and benefits in the consolidated statements of operations and totaled $0.7 million, $0.7 million and $1.2 million for 2016, 2015 and 2014, respectively. At December 31, 2016, there was $0.6 million of total unrecognized compensation cost related to non-vested stock options granted under the plans. The cost is expected to be recognized over a weighted average period of 1.9 years. The following table summarizes the Company’s outstanding stock options: Restricted stock awards The Company issued time based restricted stock during 2016, 2015 and 2014. The restricted stock awards vest over a range of a 1 - 3 year period. Restricted stock with time-based vesting was valued at the fair value of the shares on the date of grant as they are assumed to be held beyond the vesting period. Restricted stock awards with market vesting components (granted in 2010, 2011 and 2012) were valued using a Monte Carlo Simulation with 100,000 simulation paths to assess the expected percentage of vested shares. A Geometric Brownian Motion was used for simulating the equity prices for a period of ten years and if the restricted stock were not vested during the ten-year period, it was assumed they were forfeited. During the year ended December 31, 2016, the Company granted market-based stock awards of 26,594 shares in accordance with the 2014 Plan. These shares have a five-year performance period. The restricted stock shares vest upon the later of the Company’s stock price achieving an established price goal during the performance period, and the third anniversary of the date of grant. The fair value of these awards was determined using a Monte Carlo Simulation at grant date. The grant date fair value of these awards was $11.28. As of December 31, 2016, the market-based performance condition had been met for these awards and the total unrecognized compensation cost related to these non-vested awards totaled $0.3 million, and is expected to be recognized over a weighted average period of approximately 2.2 years. Performance stock units During the year ended December 31, 2016, the Company granted 91,342 performance stock units in accordance with the 2014 Plan. These performance stock units granted represent initial target awards and do not reflect potential increases or decreases resulting from the final performance results, which are to be determined at the end of the three-year performance period (vesting date). The actual number of shares to be awarded at the end of the performance period will range from 0% - 150% of the initial target awards. 60% of the award is based on the Company’s cumulative earnings per share (EPS target) during the performance period, and 40% of the award is based on the Company’s cumulative total shareholder return (TSR target), or TSR, during the performance period. On the vesting date, the Company’s TSR will be compared to the respective TSRs of the companies comprising the KBW Regional Index at the grant date to determine the shares awarded. The fair value of the EPS target portion of the award was determined based on the closing stock price of the Company’s common stock on the grant date. The fair value of the TSR target portion of the award was determined using a Monte Carlo Simulation at the grant date. The weighted-average grant date fair value per unit of the EPS target portion and the TSR target portion was $19.56 and $16.52, respectively. As of December 31, 2016, the total unrecognized compensation cost related to these non-vested units totaled $1.0 million, and is expected to be recognized over a weighted average period of approximately 2.4 years. The following table summarizes restricted stock activity during 2016: Expense related to non-vested restricted awards and units totaled $2.6 million, $2.6 million and $2.3 million during 2016, 2015 and 2014, respectively, and is a component of salaries and benefits in the Company’s consolidated statements of operations. Employee Stock Purchase Plan The 2014 Employee Stock Purchase Plan (“ESPP”) is intended to be a qualified plan within the meaning of Section 423 of the Internal Revenue Code of 1986 and allows eligible employees to purchase shares of common stock through payroll deductions up to a limit of $25,000 per calendar year and 2,000 shares per offering period. The price an employee pays for shares is 90.0% of the fair market value of Company common stock on the last day of the offering period. The offering periods is the six-month period commencing on March 1 and September 1 of each year and ending on August 31 and February 28 (or February 29 in the case of a leap year) of each year. There is no vesting or other restrictions on the stock purchased by employees under the ESPP. Under the ESPP, the total number of shares of common stock reserved for issuance totaled 400,000 shares, of which 366,337 was available for issuance. Under the ESPP, employees purchased 19,178 shares during 2016. Note 16 Warrants The Company had 250,750 and 725,750 outstanding warrants to purchase Company stock as of December 31, 2016 and 2015, respectively. The warrants were granted to certain lead investors of the Company at the time of the Company’s initial capital raise (2009-2010), all with an exercise price of $20.00 per share. During 2016, 475,000 warrants were exercised in non-cash transactions. The modified term of the warrants outstanding at December 31, 2016 is for ten years and six months from the date of grant and expires on September 15, 2020. During 2015, the Company modified its remaining warrant agreements resulting in the reclassification of $3.1 million to additional paid-in capital included in the consolidated statements of financial condition as of December 31, 2015. Prior to the warrants reclassification to additional paid-in-capital during 2015, the warrants were revalued each reporting period. The Company recorded an expense of $0.1 million in 2015 and a benefit of $3.0 million in 2014, in the consolidated statements of operations, resulting from the change in fair value of the warrant liability. Note 17 Common Stock During 2016, the Company repurchased 4,500,936 shares for $93.6 million. On August 5, 2016, the Board of Directors authorized a new share repurchase program for up to $50.0 million from time to time in either the open market or through privately negotiated transactions. The remaining authorization under this program at December 31, 2016 was $12.6 million. The Company had 26,386,583 and 30,358,509 shares of Class A common stock outstanding at December 31, 2016 and 2015, respectively. Additionally, the Company had 499,271 and 836,031 shares outstanding at December 31, 2016 and 2015, respectively, of restricted Class A common stock issued but not yet vested under the 2014 Omnibus Incentive Plan and the Prior Plan that are not included in shares outstanding until such time that they are vested; however, these shares do have voting and certain dividend rights during the vesting period. Note 18 Income Per Share The Company calculates income per share under the two-class method, as certain non-vested share awards contain non-forfeitable rights to dividends. As such, these awards are considered securities that participate in the earnings of the Company. Non-vested shares are discussed further in note 15. The Company had 26,386,583 and 30,358,509 shares outstanding (inclusive of Class A and B) as of December 31, 2016 and 2015, respectively, exclusive of issued non-vested restricted shares. Certain stock options and non-vested restricted shares are potentially dilutive securities, but are not included in the calculation of diluted income per share because to do so would have been anti-dilutive for 2016, 2015 and 2014. The following table illustrates the computation of basic and diluted income per share for 2016, 2015 and 2014: The Company had 2,185,922, 2,596,251 and 3,597,111 outstanding stock options to purchase common stock at weighted average exercise prices of $19.81, $19.84 and $19.90 per share at December 31, 2016, 2015 and 2014, respectively, which have time-vesting criteria, and as such, any dilution is derived only for the time frame in which the vesting criteria had been met and where the inclusion of those stock options is dilutive. Additionally, the Company had outstanding warrants to purchase the Company’s common stock totaling 250,750, 725,750 and 830,750 as of December 31, 2016, 2015 and 2014, respectively. The warrants have an exercise price of $20.00, which had a dilutive effect of 73,451 and 4,170 shares during 2016 and 2015, respectively, and were out-of-the-money for purposes of dilution calculations during 2014. The Company had 499,271, 836,031 and 955,398 unvested restricted shares outstanding as of December 31, 2016, 2015 and 2014, respectively, which have performance, market and/or time-vesting criteria, and as such, any dilution is derived only for the time frame in which the vesting criteria had been met and where the inclusion of those restricted shares is dilutive. Note 19 Income Taxes (a) Income taxes Total income taxes for 2016, 2015 and 2014 were allocated as follows: (b) Tax Rate Reconciliation Income tax expense attributable to income before taxes was $3.0 million, $3.0 million and $3.2 million for 2016, 2015 and 2014, respectively, and differed from the amounts computed by applying the U.S. federal income tax rate to pretax income as a result of the following: (c) Significant Components of Deferred Taxes The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2016 and 2015 are presented below: At December 31, 2016, the Company has federal and state net operating loss carryovers (NOLs) of $5.6 million and $5.9 million, respectively, which are available to offset future taxable income. The federal NOLs expire in varying amounts through 2036, and the state NOLs expire in varying amounts between 2026 and 2036. The Company also has a minimum tax credit carryover of $1.9 million that does not expire. The minimum tax credit is available to reduce income tax obligations in future periods to the extent they exceed the calculated alternative minimum tax. The Company does not expect any tax attribute carryovers to expire before they are utilized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, if any (including the impact of available carryforward periods), projected future taxable income, and tax-planning strategies in making this assessment. For the years ended December 31, 2016 and 2015, management believes a valuation allowance on the deferred tax asset is not necessary based on the current and future projected earnings of the Company. The Company has no ASC 740-10 unrecognized tax benefits recorded as of December 31, 2016 and 2015 and does not expect the total amount of unrecognized tax benefits to significantly increase within the next 12 months. The Company and its subsidiary bank are subject to income tax by federal, state and local government taxing authorities. The Company’s tax returns for the years ended December 31, 2013 through 2016 remain subject to examination for U.S. federal income tax authorities. The years open to examination by state and local government authorities vary by jurisdiction. Certain stock-based compensation awards granted by the Company have market-based vesting/exercisability criteria. For restricted stock with market-based vesting, the target share prices of the Company's stock that is required for vesting range from $32.00 to $34.00 per share. The strike prices for options range from $18.09 to $23.75, with a large portion of the awards having strike prices of $20.00. Depending on the movement in our stock price, these stock-based compensation awards may create either an excess tax benefit or tax deficiency depending on the relationship between the fair value at the time of vesting or exercise and the estimated fair value recorded at the time of grant. The Company adopted ASU 2016-09 effective January 1, 2016, which results in recording the excess tax benefit or tax deficiency as a component of tax benefit or expense in the consolidated statements of operations. During 2016, the Company recorded $2.1 million of excess tax benefit related to the settlement of certain awards during the period as a component of income tax expense in the consolidated statements of operations. During 2015, the Company recorded a tax deficiency of $3.7 million in income tax expense resulting from expired or exercised awards. As of December 31, 2016, the Company had a $7.4 million deferred tax asset related to stock-based compensation, $5.6 million of which is associated with executive officers still employed by the Company. Note 20 Derivatives Risk management objective of using derivatives The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company has established policies that neither carrying value nor fair value at risk should exceed established guidelines. The Company has designed strategies to confine these risks within the established limits and identify appropriate trade-offs in the financial structure of its balance sheet. These strategies include the use of derivative financial instruments to help achieve the desired balance sheet repricing structure while meeting the desired objectives of its clients. Currently the Company employs certain interest rate swaps that are designated as fair value hedges as well as economic hedges. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions. Fair values of derivative instruments on the balance sheet The table below presents the fair value of the Company’s derivative financial instruments as well as their classification in the consolidated statements of financial condition as of December 31, 2016 and 2015. Information about the valuation methods used to measure fair value is provided in note 22. Fair value hedges Interest rate swaps designated as fair value hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without the exchange of the underlying notional amount. As of December 31, 2016, the Company had 42 interest rate swaps with a notional amount of $313.0 million that were designated as fair value hedges of interest rate risk associated with the Company’s fixed-rate loans. The Company had 31 outstanding interest rate swaps with a notional amount of $273.3 million that were designated as fair value hedges as of December 31, 2015. For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. The Company includes the gain or loss on the hedged items in the same line item as the offsetting loss or gain on the related derivatives. During 2016, the Company recognized a net gain of $293 thousand in non-interest income related to hedge ineffectiveness. During 2015, the Company recognized a net loss of $198 thousand in non-interest income related to hedge ineffectiveness. Non-designated hedges Derivatives not designated as hedges are not speculative and consist of interest rate swaps with commercial banking clients that facilitate their respective risk management strategies. Interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the client swaps and the offsetting swaps are recognized directly in earnings. As of December 31, 2016, the Company had 36 matched interest rate swap transactions with an aggregate notional amount of $132.6 million related to this program. As of December 31, 2015, the Company had 20 matched interest rate swap transactions with an aggregate notional amount of $68.1 million related to this program. As part of its mortgage banking activities, the Company enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Company then locks in the loan and interest rate with an investor and commits to deliver the loan if settlement occurs ("best efforts") or commits to deliver the locked loan in a binding ("mandatory") delivery program with an investor. Fair value changes of certain loans under interest rate lock commitments are hedged with forward sales contracts of MBS. Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in non-interest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Company determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates, taking into consideration the probability that the interest rate lock commitments will close or will be funded. Certain additional risks arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Company does not expect any counterparty to any MBS contract to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Company fails to deliver the loans subject to interest rate risk lock commitments, it will still be obligated to “pair off” MBS to the counterparty under the forward sales agreement. Should this be required, the Company could incur significant costs in acquiring replacement loans and such costs could have an adverse effect on the consolidated financial statements. The fair value of the mortgage banking derivative is recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change. The Company had 78 interest rate lock commitments with a notional value of $13.8 million and 11 forward contracts with a notional value of $11.8 million at December 31, 2016. The Company had 70 forward loan sales commitments with a notional value of $12.0 million at December 31, 2016. At December 31, 2015, the Company had no mandatory delivery interest rate lock commitments, forward sale contracts or forward loan sales commitments, and the best efforts mortgage banking derivatives were immaterial to the consolidated financial statements. Effect of derivative instruments on the consolidated statements of operations The tables below present the effect of the Company’s derivative financial instruments in the consolidated statements of operations for 2016 and 2015: Credit-risk-related contingent features The Company has agreements with its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness for reasons other than an error or omission of an administrative or operational nature, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. The Company also has agreements with certain of its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well/adequately capitalized institution, then the counterparty has the right to terminate the derivative positions and the Company would be required to settle its obligations under the agreements. As of December 31, 2016, the termination value of derivatives in a net liability position related to these agreements was $1.3 million, which includes accrued interest but excludes any adjustment for nonperformance risk. The Company has minimum collateral posting thresholds with certain of its derivative counterparties and as of December 31, 2016, the Company had posted $0.8 million in eligible collateral. If the Company had breached any of these provisions at December 31, 2016, it could have been required to settle its obligations under the agreements at the termination value. Note 21 Commitments and Contingencies In the normal course of business, the Company enters into various off-balance sheet commitments to help meet the financing needs of clients. These financial instruments include commitments to extend credit, commercial and consumer lines of credit and standby letters of credit. The same credit policies are applied to these commitments as the loans in the consolidated statements of financial condition; however, these commitments involve varying degrees of credit risk in excess of the amount recognized in the consolidated statements of financial condition. At December 31, 2016 and 2015, the Company had loan commitments totaling $602.2 million and $627.2 million, respectively, and standby letters of credit that totaled $13.5 million and $9.8 million, respectively. The total amounts of unused commitments do not necessarily represent future credit exposure or cash requirements, as commitments often expire without being drawn upon. However, the contractual amount of these commitments, offset by any additional collateral pledged, represents the Company’s potential credit loss exposure. Total unfunded commitments at December 31, 2016 and 2015 were as follows: Commitments to fund loans-Commitments to fund loans are legally binding agreements to lend to clients in accordance with predetermined contractual provisions providing there have been no violations of any conditions specified in the contract. These commitments are generally at variable interest rates and are for specific periods or contain termination clauses and may require the payment of a fee. The total amounts of unused commitments are not necessarily representative of future credit exposure or cash requirements, as commitments often expire without being drawn upon. Credit card lines of credit-The Company extends lines of credit to clients through the use of credit cards issued by the Bank. These lines of credit represent the maximum amounts allowed to be funded, many of which will not exhaust the established limits, and as such, these amounts are not necessarily representations of future cash requirements or credit exposure. During the first quarter of 2016, the Company sold its credit card lines of credit and entered into a joint marketing agreement with an unrelated third-party. As a result of this action, the Company will be able to better provide small business and consumer clients with access to a more competitive suite of products and services. Unfunded commitments under lines of credit-In the ordinary course of business, the Company extends revolving credit to its clients. These arrangements may require the payment of a fee. Commercial and standby letters of credit-As a provider of financial services, the Company routinely issues commercial and standby letters of credit, which may be financial standby letters of credit or performance standby letters of credit. These are various forms of “back-up” commitments to guarantee the performance of a client to a third party. While these arrangements represent a potential cash outlay for the Company, the majority of these letters of credit will expire without being drawn upon. Letters of credit are subject to the same underwriting and credit approval process as traditional loans, and as such, many of them have various forms of collateral securing the commitment, which may include real estate, personal property, receivables or marketable securities. Contingencies In the ordinary course of business, the Company and the Bank may be subject to litigation. Based upon the available information and advice from the Company’s legal counsel, management does not believe that any potential, threatened or pending litigation to which it is a party will have a material adverse effect on the Company’s liquidity, financial condition or results of operations. Note 22 Fair Value Measurements The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to disclose the fair value of its financial instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For disclosure purposes, the Company groups its financial and non-financial assets and liabilities into three different levels based on the nature of the instrument and the availability and reliability of the information that is used to determine fair value. The three levels are defined as follows: · Level 1-Includes assets or liabilities in which the inputs to the valuation methodologies are based on unadjusted quoted prices in active markets for identical assets or liabilities. · Level 2-Includes assets or liabilities in which the inputs to the valuation methodologies are based on similar assets or liabilities in inactive markets, quoted prices for identical or similar assets or liabilities in inactive markets, and inputs other than quoted prices that are observable, such as interest rates, yield curves, volatilities, prepayment speeds, and other inputs obtained from observable market input. · Level 3-Includes assets or liabilities in which the inputs to the valuation methodology are based on at least one significant assumption that is not observable in the marketplace. These valuations may rely on management’s judgment and may include internally-developed model-based valuation techniques. Level 1 inputs are considered to be the most transparent and reliable and level 3 inputs are considered to be the least transparent and reliable. The Company assumes the use of the principal market to conduct a transaction of each particular asset or liability being measured and then considers the assumptions that market participants would use when pricing the asset or liability. Whenever possible, the Company first looks for quoted prices for identical assets or liabilities in active markets (level 1 inputs) to value each asset or liability. However, when inputs from identical assets or liabilities on active markets are not available, the Company utilizes market observable data for similar assets and liabilities. The Company maximizes the use of observable inputs and limits the use of unobservable inputs to occasions when observable inputs are not available. The need to use unobservable inputs generally results from the lack of market liquidity of the actual financial instrument or of the underlying collateral. Although, in some instances, third party price indications may be available, limited trading activity can challenge the observability of these quotations. Changes in the valuation inputs used for measuring the fair value of financial instruments may occur due to changes in current market conditions or other factors. Such changes may necessitate a transfer of the financial instruments to another level in the hierarchy based on the new inputs used. The Company recognizes these transfers at the end of the reporting period that the transfer occurs. During 2016 and 2015, there were no transfers of financial instruments between the hierarchy levels. The following is a description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of each instrument under the valuation hierarchy: Fair Value of Financial Instruments Measured on a Recurring Basis Investment securities available-for-sale-Investment securities available-for-sale are carried at fair value on a recurring basis. To the extent possible, observable quoted prices in an active market are used to determine fair value and, as such, these securities are classified as level 1. At December 31, 2016 and 2015, the Company did not hold any level 1 securities. When quoted market prices in active markets for identical assets or liabilities are not available, quoted prices of securities with similar characteristics, discounted cash flows or other pricing characteristics are used to estimate fair values and the securities are then classified as level 2. Interest rate swap derivatives-The Company's derivative instruments are limited to interest rate swaps that may be accounted for as fair value hedges or non-designated hedges. The fair values of the swaps incorporate credit valuation adjustments in order to appropriately reflect nonperformance risk in the fair value measurements. The credit valuation adjustment is the dollar amount of the fair value adjustment related to credit risk and utilizes a probability weighted calculation to quantify the potential loss over the life of the trade. The credit valuation adjustments are calculated by determining the total expected exposure of the derivatives (which incorporates both the current and potential future exposure) and then applying the respective counterparties’ credit spreads to the exposure offset by marketable collateral posted, if any. Certain derivative transactions are executed with counterparties who are large financial institutions ("dealers"). International Swaps and Derivative Association Master Agreements ("ISDA") and Credit Support Annexes ("CSA") are employed for all contracts with dealers. These contracts contain bilateral collateral arrangements. The fair value inputs of these financial instruments are determined using discounted cash flow analysis through the use of third-party models whose significant inputs are readily observable market parameters, primarily yield curves, with appropriate adjustments for liquidity and credit risk, and are classified as level 2. Mortgage banking derivatives-The Company relies on a third-party pricing service to value its mortgage banking derivative financial assets and liabilities, which the Company classifies as a level 3 valuation. The external valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale includes grouping the interest rate lock commitments by interest rate and terms, applying an estimated pull-through rate based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms, and rate lock expiration dates of the loan commitment groups. The Company also relies on an external valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Company would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing. The tables below present the financial instruments measured at fair value on a recurring basis as of December 31, 2016 and 2015, in the consolidated statements of financial condition utilizing the hierarchy structure described above: The table below details the changes in level 3 financial instruments during 2016: Fair Value of Financial Instruments Measured on a Non-recurring Basis Certain assets may be recorded at fair value on a non-recurring basis as conditions warrant. These non-recurring fair value measurements typically result from the application of lower of cost or fair value accounting or a write-down occurring during the period. The Company records collateral dependent loans that are considered to be impaired at their estimated fair value. A loan is considered impaired when it is probable that the Company will be unable to collect all contractual amounts due in accordance with the terms of the loan agreement. Collateral dependent impaired loans are measured based on the fair value of the collateral. The Company relies on third-party appraisals and internal assessments in determining the estimated fair values of these loans. The inputs used to determine the fair values of loans are considered level 3 inputs in the fair value hierarchy. At December 31, 2016, the Company measured three loans not accounted for under ASC 310-30 at fair value on a non-recurring basis with a carrying balance of $10.5 million and specific reserve balance of $2.4 million. At December 31, 2015, the Company measured six loans not accounted for under ASC 310-30 at fair value on a non-recurring basis with a carrying balance of $11.9 million and specific reserve balance of $4.3 million. The Company may be required to record fair value adjustments on loans held-for-sale on a non-recurring basis. The non-recurring fair value adjustments could involve lower of cost or fair value accounting and may include write-downs. OREO is recorded at the lower of the cost basis or the fair value of the collateral less estimated selling costs. The estimated fair values of OREO are updated periodically and further write-downs may be taken to reflect a new basis. The Company recognized $0.3 million and $1.6 million of OREO impairments in the consolidated statements of operations during 2016 and 2015, respectively. The fair values of OREO are derived from third party price opinions or appraisals that generally use an income approach or a market value approach. If reasonable comparable appraisals are not available, then the Company may use internally developed models to determine fair values. The inputs used to determine the fair values of OREO are considered level 3 inputs in the fair value hierarchy. Premises and equipment held-for-sale are written down to estimated fair value less costs to sell in the period in which the held-for-sale criteria are met. Fair value is estimated in a process which considers current local commercial real estate market conditions and the judgment of the sales agent and often invoices obtaining third party appraisals from certified real estate appraisers. These fair value measurements are classified as level 3. Unobservable inputs to these measurements, which include estimates and judgments often used in conjunction with appraisals, are not readily quantifiable. The Company recognized $1.4 million of impairments in the consolidated statements of operations related to banking centers classified as held-for-sale during the year ended December 31, 2015. The table below provides information regarding the assets recorded at fair value on a non-recurring basis at December 31, 2016 and 2015: The Company did not record any liabilities for which the fair value was made on a non-recurring basis during 2016 and 2015. The following table provides information about the valuation techniques and unobservable inputs used in the valuation of financial instruments classified as level 3 of the fair value hierarchy as of December 31, 2016. The table below excludes non-recurring fair value measurements of collateral value used for impairment measures for OREO and premises and equipment. These valuations utilize third party appraisal or broker price opinions, and are classified as level 3 due to the significant judgment involved: Note 23 Fair Value of Financial Instruments The fair value of a financial instrument is the amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is determined based upon quoted market prices to the extent possible; however, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques that may be significantly impacted by the assumptions used, including the discount rate and estimates of future cash flows. Changes in any of these assumptions could significantly affect the fair value estimates. The fair value of the financial instruments listed below does not reflect a premium or discount that could result from offering all of the Company’s holdings of financial instruments at one time, nor does it reflect the underlying value of the Company, as ASC Topic 825 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. The fair value of financial instruments at December 31, 2016 and 2015, including methods and assumptions utilized for determining fair value of financial instruments, are set forth below: Cash and cash equivalents Cash and cash equivalents have a short-term nature and the estimated fair value is equal to the carrying value. Investment securities The estimated fair value of investment securities is based on quoted market prices or bid quotations received from securities dealers. Other investment securities, including securities that are held for regulatory purposes are carried at cost, less any other than temporary impairment. Loans receivable The estimated fair value of the loan portfolio is estimated using a discounted cash flow analysis using a discount rate based on interest rates offered at the respective measurement dates for loans with similar terms to borrowers of similar credit quality. The allowance for loan losses is considered a reasonable estimate of any required adjustment to fair value to reflect the impact of credit risk. The estimates of fair value do not incorporate the exit-price concept prescribed by ASC Topic 820, Fair Value Measurements and Disclosures. Loans held-for-sale Loans held-for-sale are carried at the lower of aggregate cost or estimated fair value. The portfolio consists primarily of fixed rate residential mortgage loans that are sold within 45 days. The estimated fair value is based on quoted market prices for similar loans in the secondary market and are classified as level 2. Accrued interest receivable Accrued interest receivable has a short-term nature and the estimated fair value is equal to the carrying value. Deposits The estimated fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings, NOW accounts, and money market accounts, is equal to the amount payable on demand. The fair value of interest-bearing time deposits is based on the discounted value of contractual cash flows of such deposits, taking into account the option for early withdrawal. The discount rate is estimated using the rates offered by the Company, at the respective measurement dates, for deposits of similar remaining maturities. The fair value of time deposits has a floor equal to the carrying value as the amount payable on demand would approximate the carrying value. Derivative assets and liabilities Fair values for derivative assets and liabilities are fully described in note 20. Securities sold under agreements to repurchase The vast majority of the Company’s repurchase agreements are overnight transactions that mature the day after the transaction, and as a result of this short-term nature, the estimated fair value is equal to the carrying value. Accrued interest payable Accrued interest payable has a short-term nature and the estimated fair value is equal to the carrying value. Note 24 Parent Company Only Financial Statements Parent company only financial information for National Bank Holdings Corporation is summarized as follows: Condensed Statements of Financial Condition Condensed Statements of Operations Condensed Statements of Cash Flows Note 25 Quarterly Results of Operations (unaudited) The following is a summary of quarterly results: | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement excerpt. It contains sections about accounting estimates, liabilities, and securities valuation, but lacks a comprehensive overview of the financial performance.
From the available text, I can extract a few key points:
1. The document discusses financial reporting for a three-year period ending December 31st
2. Management has made significant estimates in areas such as:
- Expected cash flows
- Valuation of real estate owned
- Fair value adjustments
- Allowance for loan losses
- Contingent liabilities
3. The text includes details about:
- Accounting for securities
- Evaluation of investment impairment
- Loan receivable accounting
- Treatment of non-marketable securities
Without the complete financial statement, I cannot provide a full summary of the company's financial performance, profit/loss, or overall financial health. To create | Claude |
Index Management’s Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended). Our internal control over financial reporting includes, among other things, defined policies and procedures for conducting and governing our business, sophisticated information systems for processing transactions and properly trained staff. Mechanisms are in place to monitor the effectiveness of our internal control over financial reporting, including regular testing performed by the Company’s internal audit team. Actions are taken to correct deficiencies as they are identified. Our procedures for financial reporting include the active involvement of senior management, our Audit Committee and a staff of highly qualified financial and legal professionals. Management, with the participation of our principal executive and financial officers, assessed our internal control over financial reporting as of August 27, 2016, the end of our fiscal year. Management based its assessment on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission 2013 framework. Based on this assessment, management has concluded that our internal control over financial reporting was effective as of August 27, 2016. Our independent registered public accounting firm, Ernst & Young LLP, audited the effectiveness of our internal control over financial reporting. Ernst & Young LLP’s attestation report on the Company’s internal control over financial reporting as of August 27, 2016 is included in this Annual Report on Form 10-K. /s/ WILLIAM C. RHODES, III William C. Rhodes, III Chairman, President and Chief Executive Officer (Principal Executive Officer) /s/ WILLIAM T. GILES William T. Giles Chief Financial Officer and Executive Vice President - Finance, Information Technology and ALLDATA (Principal Financial Officer) Certifications Compliance with NYSE Corporate Governance Listing Standards On January 11, 2016, the Company submitted to the New York Stock Exchange the Annual CEO Certification required pursuant to Section 303A.12(a) of the New York Stock Exchange Listed Company Manual. Rule 13a-14(a) Certifications of Principal Executive Officer and Principal Financial Officer The Company has filed, as exhibits to its Annual Report on Form 10-K for the fiscal year ended August 27, 2016, the certifications of its Principal Executive Officer and Principal Financial Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of AutoZone, Inc. We have audited AutoZone, Inc.’s internal control over financial reporting as of August 27, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission 2013 framework (the “COSO criteria”). AutoZone, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on AutoZone, Inc.’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, AutoZone, Inc. maintained, in all material respects, effective internal control over financial reporting as of August 27, 2016, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of AutoZone, Inc. as of August 27, 2016 and August 29, 2015, and the related consolidated statements of income, comprehensive income, stockholders’ deficit, and cash flows for each of the three years in the period ended August 27, 2016 of AutoZone, Inc. and our report dated October 24, 2016 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Memphis, Tennessee October 24, 2016 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of AutoZone, Inc. We have audited the accompanying consolidated balance sheets of AutoZone, Inc. as of August 27, 2016 and August 29, 2015, and the related consolidated statements of income, comprehensive income, stockholders’ deficit, and cash flows for each of the three years in the period ended August 27, 2016. These financial statements are the responsibility of AutoZone, Inc.’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AutoZone, Inc. as of August 27, 2016 and August 29, 2015 and the consolidated results of its operations and its cash flows for each of the three years in the period ended August 27, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), AutoZone, Inc.’s internal control over financial reporting as of August 27, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission 2013 framework and our report dated October 24, 2016 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Memphis, Tennessee October 24, 2016 Consolidated Statements of Income See . Consolidated Statements of Comprehensive Income (1) Pension liability adjustments are presented net of taxes of $11,394 in 2016, $4,638 in 2015 and $8,287 in 2014. (2) Unrealized gains (losses) on marketable securities are presented net of taxes of $79 in 2016, $55 in 2015 and $54 in 2014. (3) Net derivative activities are presented net of taxes of $315 in 2016, $68 in 2015 and $87 in 2014. See . Consolidated Balance Sheets See . Consolidated Statements of Cash Flows See . Consolidated Statements of Stockholders’ Deficit See . Note A - Significant Accounting Policies Business: AutoZone, Inc. and its wholly owned subsidiaries (“AutoZone” or the “Company”) are principally a retailer and distributor of automotive parts and accessories. At the end of fiscal 2016, the Company operated 5,297 AutoZone stores in the United States (“U.S.”), including Puerto Rico; 483 stores in Mexico; eight stores in Brazil and 26 IMC branches. Each AutoZone store carries an extensive product line for cars, sport utility vehicles, vans and light trucks, including new and remanufactured automotive hard parts, maintenance items, accessories and non-automotive products. At the end of fiscal 2016, 4,390 of the domestic AutoZone stores had a commercial sales program that provides commercial credit and prompt delivery of parts and other products to local, regional and national repair garages, dealers, service stations and public sector accounts. AutoZone stores in Mexico and Brazil also have commercial programs. IMC branches carry an extensive line of original equipment quality import replacement parts. The Company also sells the ALLDATA brand automotive diagnostic and repair software through www.alldata.com and www.alldatadiy.com. Additionally, the Company sells automotive hard parts, maintenance items, accessories and non-automotive products through www.autozone.com, and accessories, performance and replacement parts through www.autoanything.com, and its commercial customers can make purchases through www.autozonepro.com and www.imcparts.net. The Company does not derive revenue from automotive repair or installation services. Fiscal Year: The Company’s fiscal year consists of 52 or 53 weeks ending on the last Saturday in August. Fiscal 2016, fiscal 2015 and fiscal 2014 each had 52 weeks. Basis of Presentation: The consolidated financial statements include the accounts of AutoZone, Inc. and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Certain reclassifications have been made to the prior years’ Consolidated Statements of Cash Flows to conform to the current year’s presentation due to significant pension plan contributions made in fiscal 2016. Use of Estimates: Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare these financial statements. Actual results could differ from those estimates. Cash and Cash Equivalents: Cash equivalents consist of investments with original maturities of 90 days or less at the date of purchase. Cash equivalents include proceeds due from credit and debit card transactions with settlement terms of less than five days. Credit and debit card receivables included within cash and cash equivalents were $46.8 million at August 27, 2016 and $45.1 million at August 29, 2015. Cash balances are held in various locations around the world. Cash and cash equivalents of $78.1 million and $64.9 million were held outside of the U.S. as of August 27, 2016, and August 29, 2015, respectively, and were generally utilized to support liquidity needs in foreign operations. The Company intends to continue to permanently reinvest the cash held outside of the U.S. in its foreign operations. Accounts Receivable: Accounts receivable consists of receivables from commercial customers and vendors, and are presented net of an allowance for uncollectible accounts. AutoZone routinely grants credit to certain of its commercial customers. The risk of credit loss in its trade receivables is substantially mitigated by the Company’s credit evaluation process, short collection terms and sales to a large number of customers, as well as the low dollar value per transaction for most of its sales. Allowances for potential credit losses are determined based on historical experience and current evaluation of the composition of accounts receivable. Historically, credit losses have been within management’s expectations and the allowances for uncollectible accounts were $7.4 million at August 27, 2016, and $5.9 million at August 29, 2015. Merchandise Inventories: Inventories are stated at the lower of cost or market. Merchandise inventories include related purchasing, storage and handling costs. Inventory cost has been determined using the last-in, first-out (“LIFO”) method for domestic inventories and the weighted average cost method for Mexico and Brazil inventories. Due to price deflation on the Company’s merchandise purchases, the Company has exhausted its LIFO reserve balance. The Company’s policy is not to write up inventory in excess of replacement cost, which is based on average cost. The difference between LIFO cost and replacement cost, which will be reduced upon experiencing price inflation on the Company’s merchandise purchases, was $364.1 million at August 27, 2016, and $332.6 million at August 29, 2015. Marketable Securities: The Company invests a portion of its assets held by the Company’s wholly owned insurance captive in marketable debt securities and classifies them as available-for-sale. The Company includes these securities within the Other current assets and Other long-term assets captions in the accompanying Consolidated Balance Sheets and records the amounts at fair market value, which is determined using quoted market prices at the end of the reporting period. A discussion of marketable securities is included in “Note E - Fair Value Measurements” and “Note F - Marketable Securities.” Property and Equipment: Property and equipment is stated at cost. Depreciation and amortization are computed principally using the straight-line method over the following estimated useful lives: buildings, 40 to 50 years; building improvements, 5 to 15 years; equipment, 3 to 10 years; and leasehold improvements, over the shorter of the asset’s estimated useful life or the remaining lease term, which includes any reasonably assured renewal periods. Depreciation and amortization include amortization of assets under capital lease. Impairment of Long-Lived Assets: The Company evaluates the recoverability of its long-lived assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. When such an event occurs, the Company compares the sum of the undiscounted expected future cash flows of the asset (asset group) with the carrying amounts of the asset. If the undiscounted expected future cash flows are less than the carrying value of the assets, the Company measures the amount of impairment loss as the amount by which the carrying amount of the assets exceeds the fair value of the assets. There were no material impairment losses recorded in the three years ended August 27, 2016. Goodwill: The cost in excess of fair value of identifiable net assets of businesses acquired is recorded as goodwill. Goodwill has not been amortized since fiscal 2001, but an analysis is performed at least annually to compare the fair value of the reporting unit to the carrying amount to determine if any impairment exists. The Company performs its annual impairment assessment in the fourth quarter of each fiscal year, unless circumstances dictate more frequent assessments. Refer to “Note N - Goodwill and Intangibles” for additional disclosures regarding the Company’s goodwill and impairment assessment. Intangible Assets: Intangible assets consist of assets from the acquisitions of IMC and AutoAnything and assets purchased relating to ALLDATA operations, and include technology, non-compete agreements, customer relationships and trade names. Amortizing intangible assets are amortized over periods ranging from 3 to 10 years. Trade names are non-amortizing intangibles as their lives are indefinite. These assets are reviewed at least annually for impairment by comparing the carrying amount to fair value. The Company performs its annual impairment assessment in the fourth quarter of each fiscal year, unless circumstances dictate more frequent assessments. Refer to “Note N - Goodwill and Intangibles” for additional disclosures regarding the Company’s intangible assets and impairment assessment. Derivative Instruments and Hedging Activities: AutoZone is exposed to market risk from, among other things, changes in interest rates, foreign exchange rates and fuel prices. From time to time, the Company uses various derivative instruments to reduce such risks. To date, based upon the Company’s current level of foreign operations, no derivative instruments have been utilized to reduce foreign exchange rate risk. All of the Company’s hedging activities are governed by guidelines that are authorized by AutoZone’s Board of Directors (the “Board”). Further, the Company does not buy or sell derivative instruments for trading purposes. AutoZone’s financial market risk results primarily from changes in interest rates. At times, AutoZone reduces its exposure to changes in interest rates by entering into various interest rate hedge instruments such as interest rate swap contracts, treasury lock agreements and forward-starting interest rate swaps. All of the Company’s interest rate hedge instruments are designated as cash flow hedges. Refer to “Note H - Derivative Financial Instruments” for additional disclosures regarding the Company’s derivative instruments and hedging activities. Cash flows related to these instruments designated as qualifying hedges are reflected in the accompanying Consolidated Statements of Cash Flows in the same categories as the cash flows from the items being hedged. Accordingly, cash flows relating to the settlement of interest rate derivatives hedging the forecasted issuance of debt have been reflected upon settlement as a component of financing cash flows. The resulting gain or loss from such settlement is deferred to Accumulated other comprehensive loss and reclassified to interest expense over the term of the underlying debt. This reclassification of the deferred gains and losses impacts the interest expense recognized on the underlying debt that was hedged and is therefore reflected as a component of operating cash flows in periods subsequent to settlement. Foreign Currency: The Company accounts for its Mexican, Brazilian, Canadian, European, Chinese and British operations using the Mexican peso, Brazilian real, Canadian dollar, euro, Chinese yuan renminbi and British pound as the functional currencies, respectively, and converts its financial statements from these currencies to U.S. dollars. The cumulative loss on currency translation is recorded as a component of Accumulated other comprehensive loss (see “Note G - Accumulated Other Comprehensive Loss”). Self-Insurance Reserves: The Company retains a significant portion of the risks associated with workers’ compensation, employee health, general, products liability, property and vehicle insurance. Through various methods, which include analyses of historical trends and utilization of actuaries, the Company estimates the costs of these risks. The costs are accrued based upon the aggregate of the liability for reported claims and an estimated liability for claims incurred but not reported. Estimates are based on calculations that consider historical lag and claim development factors. The long-term portions of these liabilities are recorded at the Company’s estimate of their net present value. Deferred Rent: The Company recognizes rent expense on a straight-line basis over the course of the lease term, which includes any reasonably assured renewal periods, beginning on the date the Company takes physical possession of the property (see “Note O - Leases”). Differences between this calculated expense and cash payments are recorded as a liability within the Accrued expenses and other and Other long-term liabilities captions in the accompanying Consolidated Balance Sheets, based on the terms of the lease. Deferred rent approximated $121.7 million as of August 27, 2016, and $113.7 million as of August 29, 2015. Financial Instruments: The Company has financial instruments, including cash and cash equivalents, accounts receivable, other current assets and accounts payable. The carrying amounts of these financial instruments approximate fair value because of their short maturities. A discussion of the carrying values and fair values of the Company’s debt is included in “Note I - Financing,” marketable securities is included in “Note F - Marketable Securities,” and derivatives is included in “Note H - Derivative Financial Instruments.” Income Taxes: The Company accounts for income taxes under the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Our effective tax rate is based on income by tax jurisdiction, statutory rates and tax saving initiatives available to the Company in the various jurisdictions in which we operate. The Company recognizes liabilities for uncertain income tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires the Company to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as the Company must determine the probability of various possible outcomes. The Company reevaluates these uncertain tax positions on a quarterly basis or when new information becomes available to management. These reevaluations are based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, successfully settled issues under audit, expirations due to statutes and new audit activity. Such a change in recognition or measurement could result in the recognition of a tax benefit or an increase to the tax accrual. The Company classifies interest related to income tax liabilities, and if applicable, penalties, as a component of Income tax expense. The income tax liabilities and accrued interest and penalties that are expected to be payable within one year of the balance sheet date are presented within the Accrued expenses and other caption in the accompanying Consolidated Balance Sheets. The remaining portion of the income tax liabilities and accrued interest and penalties are presented within the Other long-term liabilities caption in the accompanying Consolidated Balance Sheets because payment of cash is not anticipated within one year of the balance sheet date. Refer to “Note D - Income Taxes” for additional disclosures regarding the Company’s income taxes. Sales and Use Taxes: Governmental authorities assess sales and use taxes on the sale of goods and services. The Company excludes taxes collected from customers in its reported sales results; such amounts are included within the Accrued expenses and other caption until remitted to the taxing authorities. Dividends: The Company currently does not pay a dividend on its common stock. The ability to pay dividends is subject to limitations imposed by Nevada law. Under Nevada law, any future payment of dividends would be dependent upon the Company’s financial condition, capital requirements, earnings and cash flow. Revenue Recognition: The Company recognizes sales at the time the sale is made and the product is delivered to the customer. Revenue from sales are presented net of allowances for estimated sales returns, which are based on historical return rates. A portion of the Company’s transactions include the sale of auto parts that contain a core component. The core component represents the recyclable portion of the auto part. Customers are not charged for the core component of the new part if a used core is returned at the point of sale of the new part; otherwise the Company charges customers a specified amount for the core component. The Company refunds that same amount upon the customer returning a used core to the store at a later date. The Company does not recognize sales or cost of sales for the core component of these transactions when a used part is returned or expected to be returned from the customer. Vendor Allowances and Advertising Costs: The Company receives various payments and allowances from its vendors through a variety of programs and arrangements. Monies received from vendors include rebates, allowances and promotional funds. The amounts to be received are subject to the terms of the vendor agreements, which generally do not state an expiration date, but are subject to ongoing negotiations that may be impacted in the future based on changes in market conditions, vendor marketing strategies and changes in the profitability or sell-through of the related merchandise. Rebates and other miscellaneous incentives are earned based on purchases or product sales and are accrued ratably over the purchase or sale of the related product. These monies are generally recorded as a reduction of merchandise inventories and are recognized as a reduction to cost of sales as the related inventories are sold. For arrangements that provide for reimbursement of specific, incremental, identifiable costs incurred by the Company in selling the vendors’ products, the vendor funds are recorded as a reduction to Operating, selling, general and administrative expenses in the period in which the specific costs were incurred. The Company expenses advertising costs as incurred. Advertising expense, net of vendor promotional funds, was $98.3 million in fiscal 2016, $98.0 million in fiscal 2015 and $84.7 million in fiscal 2014. Vendor promotional funds, which reduced advertising expense, amounted to $21.4 million in fiscal 2016, $22.0 million in fiscal 2015 and $28.4 million in fiscal 2014. Cost of Sales and Operating, Selling, General and Administrative Expenses: The following illustrates the primary costs classified in each major expense category: Cost of Sales • Total cost of merchandise sold, including: • Freight expenses associated with moving merchandise inventories from the Company’s vendors to the distribution centers; • Vendor allowances that are not reimbursements for specific, incremental, identifiable costs • Costs associated with operating the Company’s supply chain, including payroll and benefit costs, warehouse occupancy costs, transportation costs and depreciation; and • Inventory shrinkage Operating, Selling, General and Administrative Expenses • Payroll and benefit costs for store and store support employees; • Occupancy costs of store and store support facilities; • Depreciation and amortization related to retail and store support assets; • Transportation costs associated with commercial and hub deliveries; • Advertising; • Self insurance costs; and • Other administrative costs, such as credit card transaction fees, legal costs, supplies and travel and lodging Warranty Costs: The Company or the vendors supplying its products provide the Company’s customers limited warranties on certain products that range from 30 days to lifetime. In most cases, the Company’s vendors are primarily responsible for warranty claims. Warranty costs relating to merchandise sold under warranty not covered by vendors are estimated and recorded as warranty obligations at the time of sale based on each product’s historical return rate. These obligations, which are often funded by vendor allowances, are recorded within the Accrued expenses and other caption in the Consolidated Balance Sheets. For vendor allowances that are in excess of the related estimated warranty expense for the vendor’s products, the excess is recorded as a reduction in inventory cost and recognized as a reduction to cost of sales as the related inventory is sold. Shipping and Handling Costs: The Company does not generally charge customers separately for shipping and handling. Substantially all the costs the Company incurs to ship products to our stores are included in cost of sales. Pre-opening Expenses: Pre-opening expenses, which consist primarily of payroll and occupancy costs, are expensed as incurred. Earnings per Share: Basic earnings per share is based on the weighted average outstanding common shares. Diluted earnings per share is based on the weighted average outstanding common shares adjusted for the effect of common stock equivalents, which are primarily stock options. There were 19,880 stock options excluded from the diluted earnings per share calculation because they would have been anti-dilutive as of August 27, 2016. There were 1,640 stock options excluded for the year ended August 29, 2015, and 1,000 stock options excluded for the year ended August 30, 2014, because they would have been anti-dilutive. Share-Based Payments: Share-based payments include stock option grants and certain other transactions under the Company’s stock plans. The Company recognizes compensation expense for its share-based payments over the requisite service period based on the fair value of the awards. See “Note B - Share-Based Payments” for further discussion. Risk and Uncertainties: In fiscal 2016, one class of similar products accounted for approximately 11 percent of the Company’s total revenues, and one vendor supplied approximately 10 percent of the Company’s total purchases. No other class of similar products accounted for 10 percent or more of total revenues, and no other individual vendor provided more than 10 percent of total purchases. Recently Adopted Accounting Pronouncements: In November 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-17, Income Taxes - Balance Sheet Classification of Deferred Taxes (Topic 740). ASU 2015-17 requires all deferred tax liabilities and assets to be presented in the balance sheet as noncurrent. The Company early adopted this standard prospectively during the year ended August 27, 2016. The adoption of this standard resulted in reclassifying current deferred income tax assets to noncurrent deferred income tax assets and current deferred income tax liabilities to noncurrent deferred income tax liabilities. No prior periods were retrospectively adjusted. Recently Issued Accounting Pronouncements: In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. Under ASU 2014-09, an entity will recognize revenue to depict the transfer of promised goods or services to customers at an amount that reflects what it expects in exchange for the goods or services. It also requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The Company is in the process of evaluating the impact of the provisions of ASU 2014-09 on its consolidated financial statements. This update will be effective for the Company at the beginning of its fiscal 2019 year. In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. ASU 2015-16 requires an acquirer to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, including the cumulative effect of the change in provisional amount, as if the accounting had been completed at the acquisition date. The Company does not expect the provisions of ASU 2015-16 to have a material impact on its consolidated financial statements. This update will be effective for the Company beginning with its fiscal 2017 first quarter. In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 requires that all financial assets and liabilities not accounted for under the equity method be measured at fair value with the changes in fair value recognized in net income. The amendments in this update also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments in this update supersede the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value of financial instruments carried at amortized cost. The Company can early adopt the provision requiring it to recognize in other comprehensive income the fair value change from instrument-specific credit risk measured using the fair value option for financial instruments. Except for this early application guidance, early adoption is not permitted. The Company is still evaluating the effects of the provisions of ASU 2016-01 on its consolidated financial statements. This update will be effective for the Company beginning with its fiscal 2019 first quarter. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires an entity to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. The amendments also require certain quantitative and qualitative disclosures about leasing arrangements. Early adoption is permitted. The updated guidance requires a modified retrospective adoption. The Company is still evaluating the effects of the provisions of ASU 2016-02 on its consolidated financial statements. This update will be effective for the Company beginning with its fiscal 2020 first quarter. In March 2016, the FASB issued ASU 2016-04, Liabilities - Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products. ASU 2016-04 requires that breakage of both financial and nonfinancial liabilities related to the sale of prepaid stored-value products be accounted for consistent with the revenue recognition guidance in Topic 606. This guidance requires an entity to derecognize the liability related to expected breakage in proportion to the pattern of rights expected to be exercised by the consumer only if it is probable that a significant reversal of the recognized breakage amount will not occur. Changes to an entity’s estimated breakage amount must be accounted for as a change in accounting estimate. Early adoption is permitted. The Company does not expect the provisions of ASU 2016-04 to have a material impact on its financial statements. This update will be effective for the Company beginning with its fiscal 2019 first quarter. In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvement to Employee Share-based Payment Accounting. ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. Early adoption is permitted. The Company expects to adopt the provisions of ASU 2016-09 beginning with its fiscal 2017 first quarter. The Company does not expect the provisions to have a material impact on its consolidated financial statements except for the income tax consequences, which will be dependent on the volume of future option exercise activity. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (A Consensus of the Emerging Issues Task Force). ASU 2016-15 provides guidance on the classification of certain cash receipts and payments in the statement of cash flows. The guidance must be applied retrospectively to all periods presented but may be applied prospectively if retrospective application would be impracticable. Early adoption is permitted. The Company is in the process of evaluating the impact of the provisions of ASU 2016-15 on its consolidated financial statements. This update will be effective for the Company at the beginning of its fiscal 2019 year. The Company believes that no other new accounting guidance that was issued during fiscal 2016 will be relevant to the readers of its financial statements. Note B - Share-Based Payments Total share-based compensation expense (a component of Operating, selling, general and administrative expenses) was $39.8 million for fiscal 2016, $41.0 million for fiscal 2015 and $39.4 million for fiscal 2014. As of August 27, 2016, share-based compensation expense for unvested awards not yet recognized in earnings was $41.3 million and will be recognized over a weighted average period of 2.2 years. Tax deductions in excess of recognized compensation cost are classified as a financing cash inflow. On December 15, 2010, the Company’s stockholders approved the 2011 Equity Incentive Award Plan (the “2011 Plan”), allowing the Company to provide equity-based compensation to non-employee directors and employees for their service to AutoZone or its subsidiaries or affiliates. Prior to the Company’s adoption of the 2011 Plan, equity-based compensation was provided to employees under the 2006 Stock Option Plan and to non-employee directors under the 2003 Director Compensation Plan (the “2003 Comp Plan”) and the 2003 Director Stock Option Plan (the “2003 Option Plan”). During fiscal 2016, the Company’s stockholders approved the Amended and Restated AutoZone, Inc. 2011 Equity Incentive Award Plan (the “Amended 2011 Equity Plan”). The Amended 2011 Equity Plan imposes a maximum limit on the compensation, measured as the sum of any cash compensation and the aggregate grant date fair value of awards granted under the Amended 2011 Equity Plan, which may be paid to non-employee directors for such service during any calendar year. The Amended 2011 Equity Plan also applies a ten-year term on the Amended 2011 Equity Plan through December 16, 2025 and extends the Company’s ability to grant incentive stock options through October 7, 2025. The Company grants options to purchase common stock to certain of its employees under its plan at prices equal to the market value of the stock on the date of grant. Options have a term of 10 years or 10 years and one day from grant date. Employee options generally vest in equal annual installments on the first, second, third and fourth anniversaries of the grant date and generally have 30 or 90 days after the service relationship ends, or one year after death, to exercise all vested options. The fair value of each option grant is separately estimated for each vesting date. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the award and each vesting date. In addition to the 2011 Plan, on December 15, 2010, the Company adopted the 2011 Director Compensation Program (the “2011 Program”), which stated that non-employee directors would receive their compensation in awards of restricted stock units under the 2011 Plan. Under the 2011 Program, restricted stock units are granted the first day of each calendar quarter. The number of restricted stock units granted each quarter is determined by dividing one-fourth of the amount of the annual retainer by the fair market value of the shares of common stock as of the grant date. The restricted stock units are fully vested on the date they are issued and are paid in shares of the Company’s common stock subsequent to the non-employee director ceasing to be a member of the Board. The 2011 Program replaced the 2003 Comp Plan and the 2003 Option Plan. Under the 2003 Comp Plan, non-employee directors could receive no more than one-half of their director fees immediately in cash, and the remainder of the fees was required to be taken in common stock or stock appreciation rights. The director had the option to elect to receive up to 100% of the fees in stock or defer all or part of the fees in units with value equivalent to the value of shares of common stock as of the grant date. At August 27, 2016, the Company had $13.6 million accrued related to 17,990 outstanding units issued under the 2003 Comp Plan and prior plans, and there was $13.1 million accrued related to 17,990 outstanding units issued as of August 29, 2015. No additional shares of stock or units will be issued in future years under the 2003 Comp Plan. Under the 2003 Option Plan, each non-employee director received an option grant on January 1 of each year, and each new non-employee director received an option to purchase 3,000 shares upon election to the Board, plus a portion of the annual directors’ option grant prorated for the portion of the year actually served. These stock option grants were made at the fair market value as of the grant date and generally vested three years from the grant date. There were 24,000 and 32,000 outstanding options under the 2003 Option Plan as of August 27, 2016 and August 29, 2015, respectively. No additional shares of stock will be issued in future years under the 2003 Option Plan. During the second quarter of fiscal 2014, the Company adopted the 2014 Director Compensation Program (the “Program”), which states that non-employee directors will receive their compensation in awards of restricted stock units under the 2011 Plan, with an option for a certain portion of a director’s compensation to be paid in cash at the non-employee director’s election. The Program replaces the 2011 Program. Under the Program, restricted stock units are granted January 1 of each year (the “Grant Date”). The number of restricted stock units is determined by dividing the amount of the annual retainer by the fair market value of the shares of common stock as of the Grant Date. The restricted stock units are fully vested on January 1 of each year and are paid in shares of the Company’s common stock on the earlier to occur of the fifth anniversary of the Grant Date or the date the non-employee director ceases to be a member of the Board (“Separation from Service”). Non-employee directors may elect to defer receipt of the restricted stock units until their Separation from Service. The cash portion of the award, if elected, is paid ratably over the remaining calendar quarters. The Company has estimated the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes-Merton multiple-option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense. The following table presents the weighted average for key assumptions used in determining the fair value of options granted and the related share-based compensation expense: The following methodologies were applied in developing the assumptions used in determining the fair value of options granted: Expected price volatility - This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. The Company uses actual historical changes in the market value of its stock to calculate the volatility assumption as it is management’s belief that this is the best indicator of future volatility. The Company calculates daily market value changes from the date of grant over a past period representative of the expected life of the options to determine volatility. An increase in the expected volatility will increase compensation expense. Risk-free interest rate - This is the U.S. Treasury rate for the week of the grant having a term equal to the expected life of the option. An increase in the risk-free interest rate will increase compensation expense. Expected lives - This is the period of time over which the options granted are expected to remain outstanding and is based on historical experience. Separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. Options granted have a maximum term of ten years or ten years and one day. An increase in the expected life will increase compensation expense. Forfeiture rate - This is the estimated percentage of options granted that are expected to be forfeited or canceled before becoming fully vested. This estimate is based on historical experience at the time of valuation and reduces expense ratably over the vesting period. An increase in the forfeiture rate will decrease compensation expense. This estimate is evaluated periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate. Dividend yield - The Company has not made any dividend payments nor does it have plans to pay dividends in the foreseeable future. An increase in the dividend yield will decrease compensation expense. The weighted average grant date fair value per share of options granted was $156.20 during fiscal 2016, $106.27 during fiscal 2015 and $96.97 during fiscal 2014. The intrinsic value of options exercised was $178.0 million in fiscal 2016, $154.8 million in fiscal 2015 and $70.6 million in fiscal 2014. The total fair value of options vested was $32.2 million in fiscal 2016, $30.6 million in fiscal 2015 and $27.7 million in fiscal 2014. The Company generally issues new shares when options are exercised. The following table summarizes information about stock option activity for the year ended August 27, 2016: The Company recognized $2.0 million in expense related to the discount on the selling of shares to employees and executives under various share purchase plans in fiscal 2016, $2.1 million in fiscal 2015 and $1.7 million in fiscal 2014. The Sixth Amended and Restated AutoZone, Inc. Employee Stock Purchase Plan (the “Employee Plan”), which is qualified under Section 423 of the Internal Revenue Code, permits all eligible employees to purchase AutoZone’s common stock at 85% of the lower of the market price of the common stock on the first day or last day of each calendar quarter through payroll deductions. Maximum permitted annual purchases are $15,000 per employee or 10 percent of compensation, whichever is less. Under the Employee Plan, 12,662 shares were sold to employees in fiscal 2016, 14,222 shares were sold to employees in fiscal 2015 and 15,355 shares were sold to employees in fiscal 2014. The Company repurchased 12,460 shares at market value in fiscal 2016, 15,594 shares at market value in fiscal 2015 and 16,013 shares at market value in fiscal 2014 from employees electing to sell their stock. Issuances of shares under the Employee Plan are netted against repurchases and such repurchases are not included in share repurchases disclosed in “Note K - Stock Repurchase Program.” At August 27, 2016, 192,505 shares of common stock were reserved for future issuance under the Employee Plan. Once executives have reached the maximum purchases under the Employee Plan, the Fifth Amended and Restated Executive Stock Purchase Plan (the “Executive Plan”) permits all eligible executives to purchase AutoZone’s common stock in an amount up to 25 percent of his or her annual salary and bonus. Purchases under the Executive Plan were 1,943 shares in fiscal 2016, 2,229 shares in fiscal 2015 and 3,028 shares in fiscal 2014. At August 27, 2016, 241,753 shares of common stock were reserved for future issuance under the Executive Plan. Note C - Accrued Expenses and Other Accrued expenses and other consisted of the following: The Company retains a significant portion of the insurance risks associated with workers’ compensation, employee health, general, products liability, property and vehicle insurance. A portion of these self-insured losses is managed through a wholly owned insurance captive. The Company maintains certain levels for stop-loss coverage for each self-insured plan in order to limit its liability for large claims. The limits are per claim and are $1.5 million for workers’ compensation and property, $2.0 million for vehicles, $0.7 million for employee health and $1.0 million for general and products liability. Note D - Income Taxes The components of income from continuing operations before income taxes are as follows: The provision for income tax expense consisted of the following: A reconciliation of the provision for income taxes to the amount computed by applying the federal statutory tax rate of 35% to income before income taxes is as follows: Significant components of the Company’s deferred tax assets and liabilities were as follows: Deferred taxes are not provided for temporary differences of $572.0 million at August 27, 2016, and $431.9 million at August 29, 2015, representing earnings of non-U.S. subsidiaries that are intended to be permanently reinvested. If a tax liability associated with these undistributed earnings had been recorded it would have been approximately $35.0 million and $12.0 million at August 27, 2016 and August 29, 2015, respectively. At August 27, 2016 and August 29, 2015, the Company had deferred tax assets of $25.2 million and $19.5 million, respectively, from net operating loss (“NOL”) carryforwards available to reduce future taxable income totaling approximately $122.0 million and $113.6 million, respectively. Certain NOLs have no expiration date and others will expire, if not utilized, in various years from fiscal 2017 through 2035. At August 27, 2016 and August 29, 2015, the Company had deferred tax assets for income tax credit carryforwards of $25.7 million and $29.6 million, respectively. Certain income tax credit carryforwards have no expiration and others will expire, if not utilized, in various years from fiscal 2023 through 2026. At August 27, 2016 and August 29, 2015, the Company had a valuation allowance of $13.3 million and $8.8 million, respectively, on deferred tax assets associated with NOL and tax credit carryforwards for which management has determined it is more likely than not that the deferred tax asset will not be realized. Management believes it is more likely than not that the remaining deferred tax assets will be fully realized. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Included in the August 27, 2016 and the August 29, 2015 balances are $15.5 million and $16.8 million, respectively, of unrecognized tax benefits that, if recognized, would reduce the Company’s effective tax rate. The Company accrues interest on unrecognized tax benefits as a component of income tax expense. Penalties, if incurred, would be recognized as a component of income tax expense. The Company had $2.8 million and $2.9 million accrued for the payment of interest and penalties associated with unrecognized tax benefits at August 27, 2016 and August 29, 2015, respectively. The Company files U.S. federal, U.S. state and local and international income tax returns. With few exceptions, the Company is no longer subject to state and local or Non-U.S. examinations by tax authorities for fiscal year 2012 and prior. The Company is typically engaged in various tax examinations at any given time by U.S. federal, state and local and international taxing jurisdictions. As of August 27, 2016, the Company estimates that the amount of unrecognized tax benefits could be reduced by approximately $3.9 million over the next 12 months as a result of tax audit settlements. While the Company believes that it is adequately accrued for possible audit adjustments, the final resolution of these examinations cannot be determined at this time and could result in final settlements that differ from current estimates. Note E - Fair Value Measurements The Company has adopted ASC Topic 820, Fair Value Measurement, which defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosure requirements about fair value measurements. This standard defines fair value as the price received to transfer an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 establishes a framework for measuring fair value by creating a hierarchy of valuation inputs used to measure fair value, and although it does not require additional fair value measurements, it applies to other accounting pronouncements that require or permit fair value measurements. The hierarchy prioritizes the inputs into three broad levels: Level 1 inputs - unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. An active market for the asset or liability is one in which transactions for the asset or liability occur with sufficient frequency and volume to provide ongoing pricing information. Level 2 inputs - inputs other than quoted market prices included in Level 1 that are observable, either directly or indirectly, for the asset or liability. Level 2 inputs include, but are not limited to, quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active and inputs other than quoted market prices that are observable for the asset or liability, such as interest rate curves and yield curves observable at commonly quoted intervals, volatilities, credit risk and default rates. Level 3 inputs - unobservable inputs for the asset or liability. Financial Assets & Liabilities Measured at Fair Value on a Recurring Basis The Company’s assets and liabilities measured at fair value on a recurring basis were as follows: At August 27, 2016, the fair value measurement amounts for assets and liabilities recorded in the accompanying Consolidated Balance Sheet consisted of short-term marketable securities of $7.3 million, which are included within Other current assets and long-term marketable securities of $91.0 million, which are included in Other long-term assets. The Company’s marketable securities are typically valued at the closing price in the principal active market as of the last business day of the quarter or through the use of other market inputs relating to the securities, including benchmark yields and reported trades. A discussion on how the Company’s cash flow hedges are valued is included in “Note H - Derivative Financial Instruments,” while the fair value of the Company’s pension plan assets are disclosed in “Note L - Pension and Savings Plans.” Non-Financial Assets Measured at Fair Value on a Non-Recurring Basis Non-financial assets are required to be measured at fair value on a non-recurring basis in certain circumstances, including the event of impairment. The assets could include assets acquired in an acquisition as well as property, plant and equipment that are determined to be impaired. During fiscal 2016 and fiscal 2015, the Company did not have any significant non-financial assets measured at fair value on a non-recurring basis in periods subsequent to initial recognition. Financial Instruments not Recognized at Fair Value The Company has financial instruments, including cash and cash equivalents, accounts receivable, other current assets and accounts payable. The carrying amounts of these financial instruments approximate fair value because of their short maturities. The fair value of the Company’s debt is disclosed in “Note I - Financing.” Note F - Marketable Securities The Company’s basis for determining the cost of a security sold is the “Specific Identification Model.” Unrealized gains (losses) on marketable securities are recorded in Accumulated other comprehensive loss. The Company’s available-for-sale marketable securities consisted of the following: The debt securities held at August 27, 2016, had effective maturities ranging from less than one year to approximately three years. The Company did not realize any material gains or losses on its sale of marketable securities during fiscal 2016, fiscal 2015 or fiscal 2014. The Company holds 49 securities that are in an unrealized loss position of approximately $81 thousand at August 27, 2016. The Company has the intent and ability to hold these investments until recovery of fair value or maturity, and does not deem the investments to be impaired on an other than temporary basis. In evaluating whether the securities are deemed to be impaired on an other than temporary basis, the Company considers factors such as the duration and severity of the loss position, the credit worthiness of the investee, the term to maturity and its intent and ability to hold the investments until maturity or until recovery of fair value. Included above in total marketable securities are $61.8 million and $45.6 million of marketable securities transferred by the Company’s insurance captive to a trust account to secure its obligations to an insurance company related to future workers’ compensation and casualty losses as of August 27, 2016 and August 29, 2015, respectively. Note G - Accumulated Other Comprehensive Loss Accumulated other comprehensive loss includes certain adjustments to pension liabilities, foreign currency translation adjustments, certain activity for interest rate swaps and treasury rate locks that qualify as cash flow hedges and unrealized gains (losses) on available-for-sale securities. Changes in Accumulated other comprehensive loss consisted of the following: (1) Amounts in parentheses indicate debits to Accumulated other comprehensive loss. (2) Represents amortization of pension liability adjustments, net of taxes of $4,059 in fiscal 2016 and $3,571 in fiscal 2015, which is recorded in Operating, selling, general and administrative expenses on the Consolidated Statements of Income. See “Note L - Pension and Savings Plans” for further discussion. (3) Foreign currency is not shown net of additional U.S. tax as earnings of non-U.S. subsidiaries are intended to be permanently reinvested. (4) Represents realized losses on marketable securities, net of taxes of $33 in fiscal 2016 and $12 in fiscal 2015, which is recorded in Operating, selling, general and administrative expenses on the Consolidated Statements of Income. See “Note F - Marketable Securities” for further discussion. (5) Represents gains and losses on derivatives, net of taxes of $315 in fiscal 2016 and $68 in fiscal 2015, which is recorded in Interest expense, net, on the Consolidated Statements of Income. See “Note H - Derivative Financial Instruments” for further discussion. The 2016 pension actuarial loss of $24.5 million and the 2015 pension actuarial loss of $12.3 million include amounts not yet reflected in periodic pension costs primarily driven by changes in the discount rate. Note H - Derivative Financial Instruments The Company periodically uses derivatives to hedge exposures to interest rates. The Company does not hold or issue financial instruments for trading purposes. For transactions that meet the hedge accounting criteria, the Company formally designates and documents the instrument as a hedge at inception and quarterly thereafter assesses the hedges to ensure they are effective in offsetting changes in the cash flows of the underlying exposures. Derivatives are recorded in the Company’s Consolidated Balance Sheet at fair value, determined using available market information or other appropriate valuation methodologies. In accordance with ASC Topic 815, Derivatives and Hedging, the effective portion of a financial instrument’s change in fair value is recorded in Accumulated other comprehensive loss for derivatives that qualify as cash flow hedges and any ineffective portion of an instrument’s change in fair value is recognized in earnings. At August 27, 2016, the Company had $12.3 million recorded in Accumulated other comprehensive loss related to net realized losses associated with terminated interest rate swap and treasury rate lock derivatives which were designated as hedging instruments. Net losses are amortized into Interest expense over the remaining life of the associated debt. During the fiscal year ended August 27, 2016, the Company reclassified $1.8 million of net losses from Accumulated other comprehensive loss to Interest expense. In the fiscal year ended August 29, 2015, the Company reclassified $182 thousand of net losses from Accumulated other comprehensive loss to Interest expense. The Company expects to reclassify $2.2 million of net losses from Accumulated other comprehensive loss to Interest expense over the next 12 months. Note I - Financing The Company’s debt consisted of the following: As of August 27, 2016, $1.198 billion of commercial paper borrowings and the $400 million 1.300% Senior Notes due January 2017 are classified as long-term in the accompanying Consolidated Balance Sheets as the Company has the ability and intent to refinance on a long-term basis through available capacity in its revolving credit facilities. As of August 27, 2016, the Company had $1.708 billion of availability under its $1.75 billion revolving credit facilities, which would allow it to replace these short-term obligations with long-term financing facilities. On December 19, 2014, the Company amended and restated its existing revolving credit facility (the “Multi-Year Credit Agreement”) by increasing the amount of capital leases allowable to $225 million, extending the expiration date by two years and renegotiating other terms and conditions. This credit facility is available to primarily support commercial paper borrowings, letters of credit and other short-term unsecured bank loans. The capacity of the credit facility is $1.25 billion and may be increased to $1.5 billion prior to the maturity date at the Company’s election and subject to bank credit capacity and approval, may include up to $200 million in letters of credit and may include up to $225 million in capital leases each fiscal year. Under the revolving credit facility, the Company may borrow funds consisting of Eurodollar loans or base rate loans. Interest accrues on Eurodollar loans at a defined Eurodollar rate, defined as LIBOR plus the applicable percentage, as defined in the revolving credit facility, depending upon the Company’s senior, unsecured, (non-credit enhanced) long-term debt rating. Interest accrues on base rate loans as defined in the credit facility. The Company also has the option to borrow funds under the terms of a swingline loan subfacility. The revolving credit facility expires in December 2019. On December 19, 2014, the Company entered into a new revolving credit facility (the “364-Day Credit Agreement”). The credit facility is available to primarily support commercial paper borrowings and other short-term unsecured bank loans. The 364-Day Credit Agreement provides for loans in the principal amount of up to $500 million. Under the credit facility, the Company may borrow funds consisting of Eurodollar loans, base rate loans or a combination of both. Interest accrues on Eurodollar loans at a defined Eurodollar rate, defined as LIBOR plus the applicable margin, as defined in the revolving credit facility, depending upon the Company’s senior, unsecured, (non-credit enhanced) long-term debt rating. Interest accrues on base rate loans as defined in the credit facility. The original expiration date of the credit facility was December 19, 2015, but in accordance with the credit agreement, in November 2015, the Company requested, and the banks approved, the extension of the termination date to December 16, 2016. In addition, at least 15 days prior to December 16, 2016, the Company has the right to convert the credit facility to a term loan for up to one year from the termination date, subject to a 1% penalty. The revolving credit facility agreements require that the Company’s consolidated interest coverage ratio as of the last day of each quarter shall be no less than 2.5:1. This ratio is defined as the ratio of (i) consolidated earnings before interest, taxes and rents to (ii) consolidated interest expense plus consolidated rents. The Company’s consolidated interest coverage ratio as of August 27, 2016 was 5.5:1. As of August 27, 2016, the Company had no outstanding borrowings under either of the revolving credit facilities and $3.3 million of outstanding letters of credit under the Multi-Year Credit Agreement. The Company also maintains a letter of credit facility that allows it to request the participating bank to issue letters of credit on its behalf up to an aggregate amount of $100 million. The letter of credit facility is in addition to the letters of credit that may be issued under the Multi-Year Credit Agreement. In fiscal 2016, the Company amended its existing letter of credit facility to decrease the amount that can be requested in letters of credit from $100 million to $75 million effective June 2016. This amendment also extended the maturity date from June 2016 to June 2019. As of August 27, 2016, the Company had $74.9 million in letters of credit outstanding under the letter of credit facility. In addition to the outstanding letters of credit issued under the committed facilities discussed above, the Company had $27.9 million in letters of credit outstanding as of August 27, 2016. These letters of credit have various maturity dates and were issued on an uncommitted basis. On April 21, 2016, the Company issued $400 million in 3.125% Senior Notes due April 2026 and $250 million in 1.625% Senior Notes due April 2019 under its shelf registration statement filed with the SEC on April 15, 2015 (the “2015 Shelf Registration”). The 2015 Shelf Registration allows the Company to sell an indeterminate amount in debt securities to fund general corporate purposes, including repaying, redeeming or repurchasing outstanding debt and for working capital, capital expenditures, new location openings, stock repurchases and acquisitions. Proceeds from the debt issuances were used for general corporate purposes. On April 29, 2015, the Company issued $400 million in 3.250% Senior Notes due April 2025 and $250 million in 2.500% Senior Notes due April 2021 under its 2015 Shelf Registration. Proceeds from the debt issuances were used to repay a portion of the Company’s outstanding commercial paper borrowings, which were used to repay the $500 million in 5.750% Senior Notes due in January 2015, and for general corporate purposes. On January 14, 2014, the Company issued $400 million in 1.300% Senior Notes due January 2017 under its shelf registration statement filed with the SEC on April 17, 2012. Proceeds from the debt issuance on January 14, 2014, were used to repay a portion of the Company’s $500 million in 6.500% Senior Notes due January 2014. The Company used commercial paper borrowings to repay the remainder of the 6.500% Senior Notes. The 5.750% Senior Notes issued in July 2009 and 7.125% Senior Notes issued during August 2008 (collectively, the “Notes”) are subject to an interest rate adjustment if the debt ratings assigned to the Notes are downgraded. Further, all senior notes contain a provision that repayment of the notes may be accelerated if we experience a change in control (as defined in the agreements). Our borrowings under our senior notes contain minimal covenants, primarily restrictions on liens. Under our revolving credit facilities, covenants include limitations on total indebtedness, restrictions on liens, a minimum fixed charge coverage ratio and a change of control provision that may require acceleration of the repayment obligations under certain circumstances. All of the repayment obligations under our borrowing arrangements may be accelerated and come due prior to the scheduled payment date if covenants are breached or an event of default occurs. As of August 27, 2016, the Company was in compliance with all covenants related to its borrowing arrangements. All of the Company’s debt is unsecured. Scheduled maturities of debt are as follows: The fair value of the Company’s debt was estimated at $5.117 billion as of August 27, 2016, and $4.696 billion as of August 29, 2015, based on the quoted market prices for the same or similar issues or on the current rates available to the Company for debt of the same terms (Level 2). Such fair value is greater than the carrying value of debt by $192.7 million at August 27, 2016 and $70.7 million at August 29, 2015, which reflect their face amount, adjusted for any unamortized debt issuance costs and discounts. Note J - Interest Expense Net interest expense consisted of the following: Note K - Stock Repurchase Program During 1998, the Company announced a program permitting the Company to repurchase a portion of its outstanding shares not to exceed a dollar maximum established by the Board. The program was amended on March 22, 2016 to increase the repurchase authorization to $17.15 billion from $16.4 billion. From January 1998 to August 27, 2016, the Company has repurchased a total of 140.8 million shares at an aggregate cost of $16.755 billion. The Company’s share repurchase activity consisted of the following: During fiscal year 2016, the Company retired 2.1 million shares of treasury stock, which had previously been repurchased under the Company’s share repurchase program. The retirement increased Retained deficit by $1.424 billion and decreased Additional paid-in capital by $67.0 million. During the comparable prior year period, the Company retired 2.1 million shares of treasury stock, which increased Retained deficit by $1.050 billion and decreased Additional paid-in capital by $57.4 million. On September 22, 2016, the Board voted to increase the authorization by $750 million. This brings the total value of shares authorized to $17.9 billion. Subsequent to August 27, 2016, the Company has repurchased 390,473 shares of common stock at an aggregate cost of $297.6 million. Considering the cumulative repurchases and the increase in authorization subsequent to August 27, 2016, the Company has $847.7 million remaining under the Board’s authorization to repurchase its common stock. Note L - Pension and Savings Plans Prior to January 1, 2003, substantially all full-time employees were covered by a defined benefit pension plan. The benefits under the plan were based on years of service and the employee’s highest consecutive five-year average compensation. On January 1, 2003, the plan was frozen. Accordingly, pension plan participants will earn no new benefits under the plan formula and no new participants will join the pension plan. On January 1, 2003, the Company’s supplemental defined benefit pension plan for certain highly compensated employees was also frozen. Accordingly, plan participants will earn no new benefits under the plan formula and no new participants will join the pension plan. The Company has recognized the unfunded status of the defined pension plans in its Consolidated Balance Sheets, which represents the difference between the fair value of pension plan assets and the projected benefit obligations of its defined benefit pension plans. The net unrecognized actuarial losses and unrecognized prior service costs are recorded in Accumulated other comprehensive loss. These amounts will be subsequently recognized as net periodic benefit cost pursuant to the Company’s historical accounting policy for amortizing such amounts. Further, actuarial gains and losses that arise in subsequent periods and are not recognized as net periodic benefit cost in the same periods will be recognized as a component of other comprehensive income. Those amounts will be subsequently recognized as a component of net periodic benefit cost on the same basis as the amounts previously recognized in Accumulated other comprehensive loss. The Company’s investment strategy for pension plan assets is to utilize a diversified mix of domestic and international equity and fixed income portfolios to earn a long-term investment return that meets the Company’s pension plan obligations. The pension plan assets are invested primarily in listed securities, and the pension plans hold only a minimal investment in AutoZone common stock that is entirely at the discretion of third-party pension fund investment managers. The Company’s largest holding classes, fixed income bonds and U.S. equities, are invested with a fund manager that holds diversified portfolios. Accordingly, the Company does not have any significant concentrations of risk in particular securities, issuers, sectors, industries or geographic regions. Alternative investment strategies were fully liquidated during fiscal 2016. The Company’s investment managers are prohibited from using derivatives for speculative purposes and are not permitted to use derivatives to leverage a portfolio. The following is a description of the valuation methodologies used for the Company’s investments measured at fair value: U.S., international, emerging and high yield equities -These investments are commingled funds and are valued using the net asset values, which are determined by valuing investments at the closing price or last trade reported on the major market on which the individual securities are traded. These investments are subject to annual audits. Alternative investments -This category represents a hedge fund of funds made up of various investments in limited partnerships, limited liability companies and corporations. The fair value of the hedge fund of funds is determined using valuations provided by third party administrators for each of the underlying funds. Fixed income securities -The fair values of corporate, U.S. government securities and other fixed income securities are estimated by using bid evaluation pricing models or quoted prices of securities with similar characteristics. Cash and cash equivalents -These investments include cash equivalents valued using exchange rates provided by an industry pricing vendor and commingled funds valued using the net asset value. These investments also include cash. The fair values of investments by level and asset category and the weighted-average asset allocations of the Company’s pension plans at the measurement date are presented in the following table: The asset allocations in the charts above include $48.0 million and $11.5 million in cash contributions made in the last month prior to the balance sheet date of August 27, 2016, and August 29, 2015, respectively. Subsequent to August 27, 2016, and August 29, 2015, these cash contributions were allocated to the pension plan investments in accordance with the targeted asset allocation. In August 2014, the Company’s Investment Committee approved a revised asset allocation target for the investments held by the pension plan. Based on the revised asset allocation target, the expected long-term rate of return on plan assets changed from 7.5% for the year ended August 30, 2014, to 7.0% for the years ending August 29, 2015 and August 27, 2016. During fiscal 2016, the Company fully liquidated the Level 3 assets. The following table sets forth the plans’ funded status and amounts recognized in the Company’s Consolidated Balance Sheets: Net periodic benefit expense consisted of the following: The blended actuarial assumptions used in determining the projected benefit obligation include the following: As the plan benefits are frozen, increases in future compensation levels no longer impact the calculation and there is no service cost. The discount rate to determine the projected benefit obligation is determined as of the measurement date and is based on the calculated yield of a portfolio of high-grade corporate bonds with cash flows that generally match the Company’s expected benefit payments in future years. During fiscal 2016, the Company changed the method used to estimate the interest cost component of net periodic benefit cost. Previously, the Company estimated interest cost using a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation. The Company elected to utilize a spot rate approach by applying specific spot rates along the yield curve to calculate interest costs instead of a single weighted-average discount rate. This calculation is believed to be more refined under the applicable accounting standard. The impact of this change to net periodic benefit cost is a reduction of $1.8 million in fiscal 2016. The Company accounted for this change as a change in accounting estimate and accounted for it prospectively. The expected long-term rate of return on plan assets is based on the historical relationships between the investment classes and the capital markets, updated for current conditions. The Company makes annual contributions in amounts at least equal to the minimum funding requirements of the Employee Retirement Income Security Act of 1974. The Company contributed $52.7 million to the plans in fiscal 2016, $17.1 million to the plans in fiscal 2015 and $16.9 million to the plans in fiscal 2014. The Company expects to contribute approximately $17.8 million to the plans in fiscal 2017; however, a change to the expected cash funding may be impacted by a change in interest rates, a change in the actual or expected return on plan assets or through other plans initiated by management. Based on current assumptions about future events, benefit payments are expected to be paid as follows for each of the following fiscal years. Actual benefit payments may vary significantly from the following estimates: The Company has a 401(k) plan that covers all domestic employees who meet the plan’s participation requirements. The plan features include Company matching contributions, immediate 100% vesting of Company contributions and a savings option up to 25% of qualified earnings. The Company makes matching contributions, per pay period, up to a specified percentage of employees’ contributions as approved by the Board. The Company made matching contributions to employee accounts in connection with the 401(k) plan of $19.7 million in fiscal 2016, $17.7 million in fiscal 2015 and $15.6 million in fiscal 2014. Note M - Acquisition Effective September 27, 2014, the Company acquired the outstanding stock of Interamerican Motor Corporation (“IMC”), the second largest distributor of quality import replacement parts in the United States, for $75.7 million, net of cash. IMC specializes in parts coverage for European and Asian cars. With this acquisition, the Company continues to grow its share in the aftermarket import car parts market. The results of operations from IMC have been included in the Company’s Auto Parts Locations business activities since the date of acquisition. Pro forma results of operations related to the acquisition of IMC are not presented as IMC’s results are not material to the Company’s consolidated statements of income. The purchase price allocation resulted in goodwill of $24.1 million and intangible assets totaling $3.6 million. Goodwill generated from the acquisition is primarily attributable to expected synergies and the assembled workforce. Note N - Goodwill and Intangibles The changes in the carrying amount of goodwill are as follows: (1) See “Note M - Acquisition” for discussion of the acquisition completed during the first quarter of fiscal 2015. The Company performs its annual goodwill and intangibles impairment test in the fourth quarter of each fiscal year. In the fourth quarter of fiscal 2016 and fiscal 2015, the Company concluded that its goodwill was not impaired. Total accumulated goodwill impairment for both August 27, 2016 and August 29, 2015 is $18.3 million. The carrying amounts of intangible assets are included in Other long-term assets as follows: During fiscal 2015, the Company recorded an increase to intangible assets of $3.6 million related to the acquisition of IMC. During fiscal 2014, the Company purchased $30.2 million of intangible assets relating to the rights to certain customer relationships and technology assets relating to its ALLDATA operations. Additionally, during fiscal 2016 and 2015, the Company made an installment payment of $10 million in each year related to certain customer relationships purchased during 2014 relating to its ALLDATA operations. As part of its annual impairment test, the Company evaluates the AutoAnything and IMC trade names for impairment in the fourth quarter of each fiscal year. In the fourth quarter of fiscal 2016 and 2015, the Company concluded that AutoAnything’s and IMC’s trade names were not impaired. Trade names at August 27, 2016 and August 29, 2015 reflect a total accumulated impairment of $4.1 million. Amortization expense of intangible assets for each of the years ended August 27, 2016 and August 29, 2015 was $8.7 million. Total future amortization expense for intangible assets that have finite lives, based on the existing intangible assets and their current estimated useful lives as of August 27, 2016, is estimated as follows: Note O - Leases The Company leases some of its retail stores, distribution centers, facilities, land and equipment, including vehicles. Other than vehicle leases, most of the leases are operating leases, which include renewal options made at the Company’s election and provisions for percentage rent based on sales. Rental expense was $280.5 million in fiscal 2016, $269.5 million in fiscal 2015 and $253.8 million in fiscal 2014. Percentage rentals were insignificant. The Company records rent for all operating leases on a straight-line basis over the lease term, including any reasonably assured renewal periods and the period of time prior to the lease term that the Company is in possession of the leased space for the purpose of installing leasehold improvements. Differences between recorded rent expense and cash payments are recorded as a liability in Accrued expenses and other and Other long-term liabilities in the accompanying Consolidated Balance Sheets, based on the terms of the lease. The deferred rent approximated $121.7 million on August 27, 2016, and $113.7 million on August 29, 2015. The Company has a fleet of vehicles used for delivery to its commercial customers and stores and travel for members of field management. The majority of these vehicles are held under capital lease. At August 27, 2016, the Company had capital lease assets of $148.5 million, net of accumulated amortization of $59.5 million, and capital lease obligations of $147.3 million, of which $44.8 million is classified as Accrued expenses and other as it represents the current portion of these obligations. At August 29, 2015, the Company had capital lease assets of $132.3 million, net of accumulated amortization of $63.7 million, and capital lease obligations of $128.2 million, of which $40.5 million is classified as Accrued expenses and other as it represents the current portion of these obligations. Future minimum annual rental commitments under non-cancelable operating leases and capital leases were as follows at the end of fiscal 2016: In connection with the Company’s December 2001 sale of the TruckPro business, the Company subleased some properties to the purchaser for an initial term of not less than 20 years. The Company’s remaining aggregate rental obligation at August 27, 2016 of $10.6 million is included in the above table, but the obligation is offset by the sublease rental agreement. Note P - Commitments and Contingencies Construction commitments, primarily for new distribution centers and stores, totaled approximately $106.6 million at August 27, 2016. The Company had $106.1 million in outstanding standby letters of credit and $33.4 million in surety bonds as of August 27, 2016, which all have expiration periods of less than one year. A substantial portion of the outstanding standby letters of credit (which are primarily renewed on an annual basis) and surety bonds are used to cover reimbursement obligations to our workers’ compensation carriers. There are no additional contingent liabilities associated with these instruments as the underlying liabilities are already reflected in the consolidated balance sheet. The standby letters of credit and surety bonds arrangements have automatic renewal clauses. Note Q - Litigation In July 2014, the Company received a subpoena from the District Attorney of the County of Alameda, along with other environmental prosecutorial offices in the state of California, seeking documents and information related to the handling, storage and disposal of hazardous waste. The Company received notice that the District Attorney will seek injunctive and monetary relief. The Company is cooperating fully with the request and cannot predict the ultimate outcome of these efforts, although the Company has accrued all amounts it believes to be probable and reasonably estimable. The Company does not believe the ultimate resolution of this matter will have a material adverse effect on its consolidated financial position, results of operations or cash flows. In April 2016, the Company received a letter from the California Air Resources Board seeking payment for alleged violations of the California Health and Safety Code related to the sale of certain aftermarket emission parts in the State of California. The Company does not believe that any resolution of the matter will have a material adverse effect on its consolidated financial position, results of operations or cash flows. The Company is involved in various other legal proceedings incidental to the conduct of its business, including several lawsuits containing class-action allegations in which the plaintiffs are current and former hourly and salaried employees who allege various wage and hour violations and unlawful termination practices. The Company does not currently believe that, either individually or in the aggregate, these matters will result in liabilities material to its consolidated financial condition, results of operations or cash flows. Note R - Segment Reporting Four of the Company’s operating segments (Domestic Auto Parts, Mexico, Brazil and IMC) are aggregated as one reportable segment: Auto Parts Locations. The criteria the Company used to identify the reportable segment are primarily the nature of the products the Company sells and the operating results that are regularly reviewed by the Company’s chief operating decision maker to make decisions about the resources to be allocated to the business units and to assess performance. The accounting policies of the Company’s reportable segment are the same as those described in Note A. The Auto Parts Locations segment is a retailer and distributor of automotive parts and accessories through the Company’s 5,814 locations in the United States, Puerto Rico, Mexico and Brazil. Each location carries an extensive product line for cars, sport utility vehicles, vans and light trucks, including new and remanufactured automotive hard parts, maintenance items, accessories and non-automotive products. The Other category reflects business activities of three operating segments that are not separately reportable due to the materiality of these operating segments. The operating segments include ALLDATA, which produces, sells and maintains diagnostic and repair information software used in the automotive repair industry; E-commerce, which includes direct sales to customers through www.autozone.com; and AutoAnything, which includes direct sales to customers through www.autoanything.com. The Company evaluates its reportable segment primarily on the basis of net sales and segment profit, which is defined as gross profit. The following table shows segment results for the following fiscal years: Note S - Quarterly Summary (1) (Unaudited) (1) The sum of quarterly amounts may not equal the annual amounts reported due to rounding. In addition, the earnings per share amounts are computed independently for each quarter while the full year is based on the annual weighted average shares outstanding. (2) The fourth quarter for fiscal 2016 and fiscal 2015 are based on a 16-week period. All other quarters presented are based on a 12-week period. | Based on the provided text, which appears to be a fragment of a financial statement, here's a summary:
Financial Statement Summary:
1. Revenue:
- One vendor supplied approximately 10% of total revenues
2. Profit/Loss:
- Losses on marketable securities are reported net of taxes ($79)
3. Assets:
- Marketable securities are recorded at fair market value
- Uses quoted market prices at the end of reporting period
- Property and equipment stated at cost
- Depreciation calculated using straight-line method
- Estimated useful life for buildings is 40 years
4. Liabilities:
- Debt securities classified as available-for-sale
- Recorded at fair market value
5. Additional Notes:
- Financial statements include estimates that may differ from actual results
- Cash equivalents include investments with original maturities of 90 days
- Detailed discussions of marketable securities | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Board of Directors and Shareholders of M/I Homes, Inc. Columbus, Ohio We have audited the accompanying consolidated balance sheets of M/I Homes, Inc. and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of M/I Homes, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 17, 2017 expressed an unqualified opinion on the Company's internal control over financial reporting. /s/ DELOITTE & TOUCHE LLP Deloitte & Touche LLP Columbus, Ohio February 17, 2017 M/I HOMES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME See . M/I HOMES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS See . M/I HOMES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY See . M/I HOMES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS See . M/I HOMES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. Summary of Significant Accounting Policies Business. M/I Homes, Inc. and its subsidiaries (the “Company” or “we”) is engaged primarily in the construction and sale of single-family residential homes in Columbus and Cincinnati, Ohio; Indianapolis, Indiana; Chicago, Illinois; Minneapolis/St. Paul, Minnesota; Tampa, Orlando and Sarasota, Florida; Austin, Dallas/Fort Worth, Houston and San Antonio, Texas; Charlotte and Raleigh, North Carolina; and the Virginia and Maryland suburbs of Washington, D.C. The Company designs, sells and builds single-family homes on developed lots, which it develops or purchases ready for home construction. The Company also purchases undeveloped land to develop into developed lots for future construction of single-family homes and, on a limited basis, for sale to others. Our homebuilding operations operate across three geographic regions in the United States. Within these regions, our operations have similar economic characteristics; therefore, they have been aggregated into three reportable homebuilding segments: Midwest homebuilding, Southern homebuilding and Mid-Atlantic homebuilding. The Company conducts mortgage financing activities through its 100%-owned subsidiary, M/I Financial, LLC (“M/I Financial”), which originates mortgage loans primarily for purchasers of the Company’s homes. The loans and the servicing rights are generally sold to outside mortgage lenders. The Company and M/I Financial also operate 100% and majority-owned subsidiaries that provide title services to purchasers of the Company’s homes. Our mortgage banking and title service activities have similar economic characteristics; therefore, they have been aggregated into one reportable segment, the financial services segment. Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and include the accounts of M/I Homes, Inc. and those of our consolidated subsidiaries, partnerships and other entities in which we have a controlling financial interest, and of variable interest entities in which we are deemed the primary beneficiary. Intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash, Cash Equivalents and Restricted Cash. Cash and cash equivalents are liquid investments with an initial maturity of three months or less. Amounts in transit from title companies for homes delivered are included in this balance at December 31, 2016 and 2015, respectively. Restricted cash consists of amounts held in restricted accounts as collateral for letters of credit as well as cash held in escrow. Cash, Cash Equivalents and Restricted Cash includes restricted cash balances of $1.1 million and $2.9 million at December 31, 2016 and 2015, respectively. Mortgage Loans Held for Sale. Mortgage loans held for sale consists primarily of single-family residential loans collateralized by the underlying property. Generally, all of the mortgage loans and related servicing rights are sold to third-party investors shortly after origination. Refer to the Revenue Recognition policy described below for additional discussion. Inventory. Inventory includes the costs of land acquisition, land development and home construction, capitalized interest, real estate taxes, direct overhead costs incurred during development and home construction, and common costs that benefit the entire community, less impairments, if any. Land acquisition, land development and common costs (both incurred and estimated to be incurred) are typically allocated to individual lots based on the total number of lots expected to be closed in each community or phase, or based on the relative fair value, the relative sales value or the front footage method of each lot. Any changes to the estimated total development costs of a community or phase are allocated proportionately to homes remaining in the community or phase and homes previously closed. The cost of individual lots is transferred to homes under construction when home construction begins. Home construction costs are accumulated on a specific identification basis. Costs of home deliveries include the specific construction cost of the home and the allocated lot costs. Such costs are charged to cost of sales simultaneously with revenue recognition, as discussed above. When a home is closed, we typically have not yet paid all incurred costs necessary to complete the home. As homes close, we compare the home construction budget to actual recorded costs to date to estimate the additional costs to be incurred from our subcontractors related to the home. We record a liability and a corresponding charge to cost of sales for the amount we estimate will ultimately be paid related to that home. We monitor the accuracy of such estimates by comparing actual costs incurred in subsequent months to the estimate, although actual costs to complete a home in the future could differ from our estimates. Inventory is recorded at cost, unless events and circumstances indicate that the carrying value of the land is impaired, at which point the inventory is written down to fair value as required by the FASB Accounting Standards Codification (“ASC”) 360-10, Property, Plant and Equipment (“ASC 360”). The Company assesses inventory for recoverability on a quarterly basis to determine if events or changes in local or national economic conditions indicate that the carrying amount of an asset may not be recoverable. In conducting our quarterly review for indicators of impairment on a community level, we evaluate, among other things, margins on sales contracts in backlog, the margins on homes that have been delivered, expected changes in margins with regard to future home sales over the life of the community, expected changes in margins with regard to future land sales, the value of the land itself as well as any results from third party appraisals. We pay particular attention to communities in which inventory is moving at a slower than anticipated absorption pace, and communities whose average sales price and/or margins are trending downward and are anticipated to continue to trend downward. We also evaluate communities where management intends to lower the sales price or offer incentives in order to improve absorptions even if the community’s historical results do not indicate a potential for impairment. From the review of all of these factors, we identify communities whose carrying values may exceed their estimated undiscounted future cash flows and run a test for recoverability. For those communities whose carrying values exceed the estimated undiscounted future cash flows and which are deemed to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the communities exceeds the estimated fair value. Due to the fact that the Company’s cash flow models and estimates of fair values are based upon management estimates and assumptions, unexpected changes in market conditions and/or changes in management’s intentions with respect to the inventory may lead the Company to incur additional impairment charges in the future. Our determination of fair value is based on projections and estimates, which are Level 3 measurement inputs. Because each inventory asset is unique, there are numerous inputs and assumptions used in our valuation techniques, including estimated average selling price, construction and development costs, absorption pace (reflecting any product mix change strategies implemented or to be implemented), selling strategies, alternative land uses (including disposition of all or a portion of the land owned), or discount rates, which could materially impact future cash flow and fair value estimates. As of December 31, 2016, our projections generally assume a gradual improvement in market conditions over time. If communities are not recoverable based on estimated future undiscounted cash flows, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. The fair value of a community is estimated by discounting management’s cash flow projections using an appropriate risk-adjusted interest rate. As of both December 31, 2016 and December 31, 2015, we utilized discount rates ranging from 13% to 16% in our valuations. The discount rate used in determining each asset’s estimated fair value reflects the inherent risks associated with the related estimated cash flow stream, as well as current risk-free rates available in the market and estimated market risk premiums. For example, construction in progress inventory, which is closer to completion, will generally require a lower discount rate than land under development in communities consisting of multiple phases spanning several years of development. Our quarterly assessments reflect management’s best estimates. Due to the inherent uncertainties in management’s estimates and uncertainties related to our operations and our industry as a whole, we are unable to determine at this time if and to what extent continuing future impairments will occur. Additionally, due to the volume of possible outcomes that can be generated from changes in the various model inputs for each community, we do not believe it is possible to create a sensitivity analysis that can provide meaningful information for the users of our consolidated financial statements. Further details relating to our assessment of inventory for recoverability are included in Note 3 to our Consolidated Financial Statements. Capitalized Interest. The Company capitalizes interest during land development and home construction. Capitalized interest is charged to cost of sales as the related inventory is delivered to a third party. The summary of capitalized interest for the years ended December 31, 2016, 2015 and 2014 is as follows: Investment in Joint Venture Arrangements. In order to minimize our investment and risk of land exposure in a single location, we have periodically partnered with other land developers or homebuilders to share in the land investment and development of a property through joint ownership and development agreements, joint ventures, and other similar arrangements. During 2016, we decreased our total investment in such joint venture arrangements by $9.0 million from $37.0 million at December 31, 2015 to $28.0 million at December 31, 2016, which was driven primarily by our increased lot distributions from joint venture arrangements during 2016 of $28.1 million, offset, in part, by our cash contributions to our joint venture arrangements during 2016 of $21.7 million. We use the equity method of accounting for investments in joint venture arrangements over which we exercise significant influence but do not have a controlling interest. Under the equity method, our share of the joint venture arrangements’ earnings or loss, if any, is included in our Consolidated Statements of Income. The Company assesses its investments in joint venture arrangements for recoverability on a quarterly basis in accordance with ASC 323, Investments - Equity Method and Joint Ventures (“ASC 323”) as described below. If the fair value of the investment is less than the investment’s carrying value, and the Company has determined that the decline in value is other than temporary, the Company would write down the value of the investment to its estimated fair value. The determination of whether an investment’s fair value is less than the carrying value requires management to make certain assumptions regarding the amount and timing of future contributions to the joint venture arrangements, the timing of distribution of lots to the Company from the joint venture arrangements, the projected fair value of the lots at the time of distribution to the Company, and the estimated proceeds from, and timing of, the sale of land or lots to third parties. In determining the fair value of investments in joint venture arrangements, the Company evaluates the projected cash flows associated with each joint venture arrangements. As of both December 31, 2016 and December 31, 2015, the Company used a discount rate of 16% in determining the fair value of investments in joint venture arrangements. In addition to the assumptions management must make to determine if the investment’s fair value is less than the carrying value, management must also use judgment in determining whether the impairment is other than temporary. The factors management considers are: (1) the length of time and the extent to which the market value has been less than cost; (2) the financial condition and near-term prospects of the company; and (3) the intent and ability of the Company to retain its investment in the joint venture arrangements for a period of time sufficient to allow for any anticipated recovery in market value. Due to uncertainties in the estimation process and the significant volatility in demand for new housing, actual results could differ significantly from such estimates. For joint venture arrangements where a special purpose entity is established to own the property, we generally enter into limited liability company or similar arrangements (“LLCs”) with the other partners. The Company’s ownership in these LLCs as of both December 31, 2016 and December 31, 2015 ranged from 25% to 74%. These entities typically engage in land development activities for the purpose of distributing or selling developed lots to the Company and its partners in the LLC. We believe that the Company’s maximum exposure related to its investment in these joint venture arrangements as of December 31, 2016 is the amount invested of $28.0 million, although we expect to invest further amounts in these joint venture arrangements as development of the properties progresses. Further details relating to our joint venture arrangements are included in Note 6 to our Consolidated Financial Statements. Variable Interest Entities. With respect to our investments in LLCs, we are required, under ASC 810-10, Consolidation (“ASC 810”), to evaluate whether or not such entities should be consolidated into our consolidated financial statements. We initially perform these evaluations when each new entity is created and upon any events that require reconsideration of the entity. In order to determine if we should consolidate an LLC, we determine (1) if the LLC is a variable interest entity (“VIE”) and (2) if we are the primary beneficiary of the entity. To determine whether we are the primary beneficiary of an entity, we consider whether we have the ability to control the activities of the VIE that most significantly impact its economic performance. This analysis considers, among other things, whether we have: the ability to determine the budget and scope of land development work, if any; the ability to control financing decisions for the VIE; the ability to acquire additional land into the VIE or dispose of land in the VIE not under contract with M/I Homes; and the ability to change or amend the existing option contract with the VIE. If we determine that we are not able to control such activities, we are not considered the primary beneficiary of the VIE. As of December 31, 2016, we have determined that no LLC in which we have an interest met the requirements of a VIE. As of December 31, 2015, we determined that one of the LLCs in which we had an interest at the time met the requirements of a VIE due to a lack of equity at risk in the entity. However, we determined that we did not have substantive control over that VIE as we did not have the ability to control the activities that most significantly impact its economic performance. As a result, we were not required to consolidate the VIE into our consolidated financial statements, and we instead recorded the VIE in Investment in Joint Venture Arrangements on our Consolidated Balance Sheets as of December 31, 2015. Land Option Agreements. In the ordinary course of business, the Company enters into land option or purchase agreements for which we generally pay non-refundable deposits. Pursuant to these land option agreements, the Company provides a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices. In accordance with ASC 810, we analyze our land option or purchase agreements to determine whether the corresponding land sellers are VIEs and, if so, whether we are the primary beneficiary, using an analysis similar to that described above. Although we do not have legal title to the optioned land, ASC 810 requires a company to consolidate a VIE if the company is determined to be the primary beneficiary. In cases where we are the primary beneficiary, even though we do not have title to such land, we are required to consolidate these purchase/option agreements and reflect such assets and liabilities as Consolidated Inventory not Owned in our Consolidated Balance Sheets. At both December 31, 2016 and 2015, we have concluded that we were not the primary beneficiary of any VIEs from which we are purchasing land under option or purchase agreements. Other than as described below in “Consolidated Inventory Not Owned,” the Company currently believes that its maximum exposure as of December 31, 2016 related to our land option agreements is equal to the amount of the Company’s outstanding deposits and prepaid acquisition costs, which totaled $44.7 million, including cash deposits of $29.9 million, prepaid acquisition costs of $4.7 million, letters of credit of $4.5 million and $5.6 million of other non-cash deposits. Consolidated Inventory Not Owned and Related Obligation. At December 31, 2016 and December 31, 2015, Consolidated Inventory Not Owned was $7.5 million and $6.0 million, respectively. At December 31, 2016 and 2015, the corresponding liability of $7.5 million and $6.0 million, respectively, has been classified as Obligation for Consolidated Inventory Not Owned on the Consolidated Balance Sheets. Property and Equipment-net. The Company records property and equipment at cost and subsequently depreciates the assets using both straight-line and accelerated methods. Following are the major classes of depreciable assets and their estimated useful lives: Estimated Useful Lives Building and improvements 35 years Office furnishings, leasehold improvements, computer equipment and computer software 3-7 years Transportation and construction equipment (a) 5-25 years (a) During the first quarter of 2016, the Company purchased an airplane for $9.9 million. The asset is included in the table above within Transportation and Construction Equipment and within Property and Equipment - Net in our Consolidated Balance Sheets. Depreciation is computed using the straight-line method over the respective estimated useful lives of the parts of the airplane. Maintenance and repair expenditures are charged to selling, general and administrative expense as incurred. Depreciation expense was $3.6 million, $2.3 million and $2.0 million in 2016, 2015 and 2014, respectively. Other Assets. Other assets at December 31, 2016 and 2015 consisted of the following:. Warranty Reserves. We use subcontractors for nearly all aspects of home construction. Although our subcontractors are generally required to repair and replace any product or labor defects, we are, during applicable warranty periods, ultimately responsible to the homeowner for making such repairs. As such, we record warranty reserves to cover our exposure to the costs for materials and labor not expected to be covered by our subcontractors to the extent they relate to warranty-type claims. Warranty reserves are established by charging cost of sales and crediting a warranty reserve for each home delivered. The amounts charged are estimated by management to be adequate to cover expected warranty-related costs described above under the Company’s warranty programs. Reserves are recorded for warranties under the following warranty programs: • Home Builder’s Limited Warranty (“HBLW”); and • 30, 15 or 10-year transferable structural warranty, depending on sales date and state. The warranty reserves for the HBLW are established as a percentage of average sales price and adjusted based on historical payment patterns determined, generally, by geographic area and recent trends. Factors that are given consideration in determining the HBLW reserves include: (1) the historical range of amounts paid per average sales price on a home; (2) type and mix of amenity packages added to the home; (3) any warranty expenditures not considered to be normal and recurring; (4) timing of payments; (5) improvements in quality of construction expected to impact future warranty expenditures; and (6) conditions that may affect certain projects and require a different percentage of average sales price for those specific projects. Changes in estimates for warranties occur due to changes in the historical payment experience and differences between the actual payment pattern experienced during the period and the historical payment pattern used in our evaluation of the warranty reserve balance at the end of each quarter. Actual future warranty costs could differ from our current estimated amount. Our warranty reserves for our transferable structural warranty programs are established on a per-unit basis. While the structural warranty reserve is recorded as each home is delivered, the sufficiency of the structural warranty per unit charge and total reserve is re-evaluated on an annual basis, with the assistance of an actuary, using our own historical data and trends, industry-wide historical data and trends, and other project specific factors. The reserves are also evaluated quarterly and adjusted if we encounter activity that is inconsistent with the historical experience used in the annual analysis. These reserves are subject to variability due to uncertainties regarding structural defect claims for products we build, the markets in which we build, claim settlement history, insurance and legal interpretations, among other factors. While we believe that our warranty reserves are sufficient to cover our projected costs, there can be no assurances that historical data and trends will accurately predict our actual warranty costs. At December 31, 2016 and 2015, warranty reserves of $27.7 million and $14.3 million, respectively, are included in Other Liabilities on the Consolidated Balance Sheets. The increase in warranty reserves from 2015 to 2016 is related to stucco-related repairs in certain of our Florida communities. Please refer to Note 8 of our Consolidated Financial Statements for additional information related to our warranty reserves. Self-insurance Reserves. Self-insurance reserves are made for estimated liabilities associated with employee health care, workers’ compensation, and general liability insurance. For 2016, our self-insurance limit for employee health care was $250,000 per claim per year, with stop loss insurance covering amounts in excess of $250,000. Our workers’ compensation claims are insured by a third party and carry a deductible of $250,000 per claim, except for workers compensation claims made in the State of Ohio where the Company is self-insured. Our self-insurance limit for Ohio workers’ compensation is $500,000 per claim, with stop loss insurance covering all amounts in excess of this limit. The reserves related to employee health care and workers’ compensation are based on historical experience and open case reserves. Our general liability claims are insured by a third party. The Company generally has a $7.5 million completed operations/construction defect deductible per occurrence by region and a $24.8 million deductible in the aggregate, with a $500,000 deductible for all other types of claims. The Company records a reserve for general liability claims falling below the Company’s deductible. The reserve estimate is based on an actuarial evaluation of our past history of general liability claims, other industry specific factors and specific event analysis. At December 31, 2016 and 2015, self-insurance reserves of $1.8 million and $1.6 million, respectively, are included in Other Liabilities on the Consolidated Balance Sheets. The Company recorded expenses totaling $6.5 million, $6.1 million and $7.8 million for all self-insured and general liability claims during the years ended December 31, 2016, 2015 and 2014, respectively. Guarantees and Indemnities. Guarantee and indemnity liabilities are established by charging the applicable income statement or balance sheet line, depending on the nature of the guarantee or indemnity, and crediting a liability. M/I Financial provides a limited-life guarantee on loans sold to certain third parties and estimates its actual liability related to the guarantee and any indemnities subsequently provided to the purchaser of the loans in lieu of loan repurchase based on historical loss experience. Actual future costs associated with loans guaranteed or indemnified could differ materially from our current estimated amounts. The Company has also provided certain other guarantees and indemnities in connection with the purchase and development of land, including environmental indemnities, and guarantees of the completion of land development. The Company estimates these liabilities based on the estimated cost of insurance coverage or estimated cost of acquiring a bond in the amount of the exposure. Actual future costs associated with these guarantees and indemnities could differ materially from our current estimated amounts. At December 31, 2016 and 2015, guarantees and indemnities of $1.3 million and $1.4 million, respectively, are included in Other Liabilities on the Consolidated Balance Sheets. Other Liabilities. Other liabilities at December 31, 2016 and 2015 consisted of the following: Segment Reporting. The application of segment reporting requires significant judgment in determining our operating segments. Operating segments are defined as a component of an enterprise for which discrete financial information is available and is reviewed regularly by the Company’s chief operating decision makers to evaluate performance, make operating decisions and determine how to allocate resources. The Company’s chief operating decision makers evaluate the Company’s performance in various ways, including: (1) the results of our 15 individual homebuilding operating segments and the results of our financial services operations; (2) the results of our three homebuilding regions; and (3) our consolidated financial results. In accordance with ASC 280, Segment Reporting (“ASC 280”), we have identified each homebuilding division as an operating segment as each homebuilding division engages in business activities from which it earns revenue, primarily from the sale and construction of single-family attached and detached homes, acquisition and development of land, and the occasional sale of lots to third parties. Our financial services operations generate revenue primarily from the origination, sale and servicing of mortgage loans and title services primarily for purchasers of the Company’s homes and are included in our financial services reportable segment. Corporate is a non-operating segment that develops and implements strategic initiatives and supports our operating segments by centralizing key administrative functions such as accounting, finance, treasury, information technology, insurance and risk management, litigation, marketing and human resources. In accordance with the aggregation criteria defined in ASC 280, we have determined our reportable segments as follows: Midwest homebuilding, Southern homebuilding, Mid-Atlantic homebuilding and financial services operations. The homebuilding operating segments included in each reportable segment have been aggregated because they share similar aggregation characteristics as prescribed in ASC 280 in the following regards: (1) long-term economic characteristics; (2) historical and expected future long-term gross margin percentages; (3) housing products, production processes and methods of distribution; and (4) geographical proximity. We may, however, be required to reclassify our reportable segments if markets that currently are being aggregated do not continue to share these aggregation characteristics. Revenue Recognition. Revenue from the sale of a home is recognized when the delivery has occurred, title has passed, the risks and rewards of ownership are transferred to the buyer, and an adequate initial and continuing investment by the homebuyer is received, or when the loan has been sold to a third-party investor. Revenue for homes that close to the buyer having a down payment of 5% or greater, home deliveries financed by third parties, and all home deliveries insured under Federal Housing Administration (“FHA”), U.S. Veterans Administration (“VA”) and other government-insured programs are recorded in the consolidated financial statements on the date of closing. Revenue related to all other home deliveries initially funded by M/I Financial, our 100%-owned subsidiary, is recorded on the date that M/I Financial sells the loan to a third-party investor, because the receivable from the third-party investor is not subject to future subordination, and the Company has transferred to this investor the usual risks and rewards of ownership that is in substance a sale and does not have a substantial continuing involvement with the home. We recognize the majority of the revenue associated with our mortgage loan operations when the mortgage loans are sold and/or related servicing rights are sold to third party investors or set up with the subservicer. The revenue recognized is reduced by the fair value of the related guarantee provided to the investor. The fair value of the guarantee is recognized in revenue when the Company is released from its obligation under the guarantee. Generally, all of the financial services mortgage loans and related servicing rights are sold to third party investors within two to three weeks of origination; however, M/I Financial began retaining a portion of mortgage loan servicing rights during 2012. As of December 31, 2016 and 2015, we retained mortgage servicing rights of 4,445 and 2,818 loans, respectively, for a total value of $11.4 million and $7.5 million, respectively. We recognize financial services revenue associated with our title operations as homes are closed, closing services are rendered, and title policies are issued, all of which generally occur simultaneously as each home is closed. All of the underwriting risk associated with title insurance policies is transferred to third-party insurers. Land and Housing Cost of Sales. All associated homebuilding costs are charged to cost of sales in the period when the revenues from home deliveries are recognized. Homebuilding costs include: land and land development costs; home construction costs (including an estimate of the costs to complete construction); previously capitalized interest; real estate taxes; indirect costs; and estimated warranty costs. All other costs are expensed as incurred. Sales incentives, including pricing discounts and financing costs paid by the Company, are recorded as a reduction of revenue in the Company’s Consolidated Statements of Income. Sales incentives in the form of options or upgrades are recorded in homebuilding costs. Income Taxes. The Company records income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on future tax consequences attributable to (1) temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and (2) operating loss and tax credit carryforwards, if any. Deferred tax assets and liabilities are measured using enacted tax rates in effect in the years in which those temporary differences are expected to reverse. In accordance with ASC 740-10, Income Taxes (“ASC 740”), we evaluate the realizability of our deferred tax assets, including the benefit from net operating losses (“NOLs”) and tax credit carryforwards, if any, to determine if a valuation allowance is required based on whether it is more likely than not (a likelihood of more than 50%) that all or any portion of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is primarily dependent upon the generation of future taxable income. In determining the future tax consequences of events that have been recognized in the consolidated financial statements or tax returns, judgment is required. This assessment gives appropriate consideration to all positive and negative evidence related to the realization of the deferred tax assets and considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the length of statutory carryforward periods, our experience with operating losses and our experience of utilizing tax credit carryforwards and tax planning alternatives. Please see Note 14 to our Consolidated Financial Statements for more information regarding our deferred tax assets. Earnings Per Share. The Company computes earnings per share in accordance with ASC 260, Earnings per Share, (“ASC 260”). Basic earnings per share is calculated by dividing income attributable to common shareholders by the weighted average number of common shares outstanding during each year. Diluted earnings per share gives effect to the potential dilution that could occur if securities or contracts to issue our common shares that are dilutive were exercised or converted into common shares or resulted in the issuance of common shares that then shared our earnings. In periods of net losses, no dilution is computed. Please see Note 13 to our Consolidated Financial Statements for more information regarding our earnings per share calculation. Stock-Based Compensation. We measure and recognize compensation expense associated with our grant of equity-based awards in accordance with ASC 718, Compensation-Stock Compensation (“ASC 718”), which generally requires that companies measure and recognize stock-based compensation expense in an amount equal to the fair value of share-based awards granted under compensation arrangements over the related vesting period. We have granted share-based awards to certain of our employees and directors in the form of stock options, director stock units and performance share units (“PSU’s”). Each PSU represents a contingent right to receive one common share of the Company if vesting is satisfied at the end of the performance period based on the related performance conditions and markets conditions. Determining the fair value of share-based awards requires judgment to identify the appropriate valuation model and develop the assumptions. The grant date fair value for stock option awards and PSU’s with a market condition (as defined in ASC 718) is estimated using the Black-Scholes option pricing model and the Monte Carlo simulation methodology, respectively. The grant date fair value for the director stock units and PSU’s with a performance condition (as defined in ASC 718) is based upon the closing price of our common shares on the date of grant. We recognize stock-based compensation expense for our stock option awards and PSU’s with a market condition over the requisite service period of the award while stock-based compensation expense for our director stock units, which vest immediately, is fully recognized in the period of the award. For the portion of the PSU’s awarded subject to the satisfaction of a performance condition, we recognize stock-based compensation expense on a straight-line basis over the performance period based on the probable outcome of the related performance condition. If satisfaction of the performance condition is not probable, stock-based compensation expense recognition is deferred until probability is attained and a cumulative compensation expense adjustment is recorded and recognized ratably over the remaining service period. The Company reevaluates the probability of the satisfaction of the performance condition on a quarterly basis, and stock-based compensation expense is adjusted based on the portion of the requisite service period that has passed. If actual results differ significantly from these estimates, stock-based compensation expense could be higher and have a material impact on our consolidated financial statements. Please see Note 2 to our Consolidated Financial Statements for more information regarding our stock-based compensation. Letters of Credit and Completion Bonds. The Company provides standby letters of credit and completion bonds for development work in progress, deposits on land and lot purchase agreements and miscellaneous deposits. As of December 31, 2016, the Company had outstanding $154.3 million of completion bonds and standby letters of credit, some of which were issued to various local governmental entities, that expire at various times through September 2024. Included in this total are: (1) $108.9 million of performance and maintenance bonds and $31.5 million of performance letters of credit that serve as completion bonds for land development work in progress; (2) $6.2 million of financial letters of credit; and (3) $7.7 million of financial bonds. The development agreements under which we are required to provide completion bonds or letters of credit are generally not subject to a required completion date and only require that the improvements are in place in phases as houses are built and sold. In locations where development has progressed, the amount of development work remaining to be completed is typically less than the remaining amount of bonds or letters of credit due to timing delays in obtaining release of the bonds or letters of credit. Recently Adopted Accounting Standards. In November 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No 2016-18, Statement of Cash Flows: Restricted Cash (“ASU 2016-18”), which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for our fiscal year beginning January 1, 2018. Early adoption is permitted, and the Company elected to early adopt the new standard in the fourth quarter of 2016. The adoption of ASU 2016-18 did not have a material effect on our consolidated financial statements and disclosures. ASU 2016-18 was applied retrospectively and as such, certain financial statement line items reflected on the December 31, 2015 Consolidated Balance Sheets and the December 31, 2015 and December 31, 2014 Statement of Cash Flows were affected by the change in accounting principle. Impact of New Accounting Standards. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets and supersedes the revenue recognition requirements in ASC 605, Revenue Recognition, and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition-Construction-Type and Production-Type Contracts.” ASU 2014-09’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which delayed the effective date of ASU 2014-09 by one year. ASU 2014-09, as amended, is effective for public companies for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Early adoption is permitted as of the original effective date for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. Subsequent to the issuance of ASU 2014-09, the FASB has issued several ASUs, such as ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing, and ASU 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients. These ASUs do not change the core principle of the guidance stated in ASU 2014-09. Instead, these amendments are intended to clarify and improve the operability of certain topics addressed by ASU 2014-09. These additional ASUs will have the same effective date and transition requirements as ASU 2014-09, as amended. See below for additional explanation of each of these additional ASUs. The guidance in ASU 2014-09 permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). The new standard is effective for our fiscal year beginning January 1, 2018, and, at that time, we currently anticipate adopting the standard using the cumulative catch-up transition method. We anticipate this standard will not have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, and have been involved in industry-specific discussions with the FASB on the treatment of certain items, we currently believe the most significant impact could relate to our accounting for sale of land and/or lots to third parties that have continuing performance obligations. We expect the amount and timing of our homebuilding revenue to remain substantially unchanged. Due to the complexity of certain of our land contracts, however, the actual revenue recognition treatment required under the standard for land sales will be dependent on contract-specific terms, and may vary in some instances from recognition at the time of closing. We are continuing to evaluate the impact the adoption of ASU 2014-09 may have on other aspects of our business and on our consolidated financial statements and disclosures. In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”), which makes a number of changes to the current GAAP model, including changes to the accounting for equity investments and financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. ASU 2016-01 is effective for our interim and annual reporting periods beginning January 1, 2018. Early adoption of this particular guidance from ASU 2016-01 is not permitted. The Company is currently evaluating the method of adoption and impact the pronouncement will have on the Company’s consolidated financial statements and disclosures. In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 will require organizations that lease assets - referred to as “lessees” - to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Under ASU 2016-02, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. Lessor accounting remains substantially similar to current GAAP. In addition, disclosures of leasing activities will be expanded to include qualitative and specific quantitative information. For public entities, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. ASU 2016-02 mandates a modified retrospective transition method. The Company is currently evaluating the potential impact the adoption of ASU 2016-02 will have on the Company’s consolidated financial statements and disclosures. In March 2016, the FASB issued ASU No. 2016-06, Contingent Put and Call Options in Debt Instruments (“ASU 2016-06”), which requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met. One of those criteria is that the economic characteristics and risks of the embedded derivatives are not clearly and closely related to the economic characteristics and risks of the host contract (the “clearly and closely related” criterion). ASU 2016-06 clarifies the required steps for assessing whether the economic characteristics and risks of call (put) options are clearly and closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an embedded derivative. Consequently, when a call (put) option is contingently exercisable, an entity does not have to assess whether the event that triggers the ability to exercise a call (put) option is related to interest rates or credit risks. ASU 2016-06 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted for all entities. The Company does not believe the adoption of ASU 2016-06 will have a material impact on the Company’s consolidated financial statements and disclosures. In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (“ASU 2016-08”). The amendments in this ASU are intended to improve the operability and understandability of the implementation guidance stated in ASU 2014-09 on principal versus agent considerations and whether an entity reports revenue on a gross or net basis. In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For public entities, ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted. The Company does not believe the adoption of ASU 2016-09 will have a material impact on the Company’s consolidated financial statements and disclosures. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing (“ASU 2016-10”). ASU 2016-10 provides guidance on identifying performance obligations and licensing. This update clarifies the guidance in ASU 2014-09 relating to identifying performance obligations and licensing. The new standard will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers: Narrow Scope Improvements and Practical Expedients (“ASU 2016-12”). ASU 2016-12 provides for amendments to ASU 2014-09 regarding transition, collectability, noncash consideration, and presentation of sales tax and other similar taxes. Specifically, ASU 2016-12 clarifies that, for a contract to be considered completed at transition, all or substantially all of the revenue must have been recognized under legacy GAAP. In addition, ASU 2016-12 clarifies how an entity should evaluate the collectability threshold and when an entity can recognize nonrefundable consideration received as revenue if an arrangement does not meet the standard’s contract criteria. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 provides guidance on how certain cash receipts and cash payments are to be presented and classified in the statement of cash flows. For public entities, ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The adoption of ASU 2016-15 will modify the Company's current disclosures and reclassifications within the condensed consolidated statement of cash flows but is not expected to have a material effect on the Company’s consolidated financial statements and disclosures. NOTE 2. Stock-Based and Deferred Compensation Stock Incentive Plans The Company has an equity compensation plan, the M/I Homes, Inc. 2009 Long-Term Incentive Plan (the “2009 LTIP”) which has been amended from time to time. The 2009 LTIP was approved by our shareholders and is administered by the Compensation Committee of our Board of Directors. Under the 2009 LTIP, the Company is permitted to grant (1) nonqualified stock options to purchase common shares, (2) incentive stock options to purchase common shares, (3) stock appreciation rights, (4) restricted common shares, (5) other stock-based awards - awards that are valued in whole or in part by reference to, or otherwise based on, the fair market value of the common shares, and (6) cash-based awards to its officers, employees, non-employee directors and other eligible participants. Subject to certain adjustments, the plan authorizes awards to officers, employees, non-employee directors and other eligible participants for up to 3,900,000 common shares, of which 1,903,245 remain available for grant at December 31, 2016. The 2009 LTIP replaced the M/I Homes, Inc. 1993 Stock Incentive Plan as Amended (the “1993 Plan”), which expired by its terms on April 22, 2009. Awards outstanding under the 1993 Plan remain in effect in accordance with their respective terms. Stock Options Stock options are granted at the market price of the Company’s common shares at the close of business on the date of grant. Options awarded generally vest 20% annually over five years and expire after ten years. Under the 2009 LTIP, in the case of termination due to death, disability or retirement, all options will become immediately exercisable. Shares issued upon option exercise may consist of treasury shares, authorized but unissued common shares or common shares purchased by or on behalf of the Company in the open market. Following is a summary of stock option activity for the year ended December 31, 2016, relating to the stock options awarded under the 2009 LTIP and the 1993 Plan: (a)Intrinsic value is defined as the amount by which the fair value of the underlying common shares exceeds the exercise price of the option. The aggregate intrinsic value of options exercised during the years ended December 31, 2016, 2015 and 2014 was $0.1 million, $0.7 million and $1.6 million, respectively. The fair value of our five-year service-based stock options granted during the years ended December 31, 2016, 2015 and 2014 was established at the date of grant using the Black-Scholes pricing model, with the weighted average assumptions as follows: The risk-free interest rate is based upon the U.S. Treasury constant maturity rate at the date of the grant. Expected volatility is based on an average of (1) historical volatility of the Company’s stock and (2) implied volatility from traded options on the Company’s stock. The risk-free rate for periods within the contractual life of the stock option award is based on the yield curve of a zero-coupon U.S. Treasury bond on the date the stock option award is granted, with a maturity equal to the expected term of the stock option award granted. The Company uses historical data to estimate stock option exercises and forfeitures within its valuation model. The expected life of stock option awards granted is derived from historical exercise experience under the Company’s share-based payment plans, and represents the period of time that stock option awards granted are expected to be outstanding. Total stock-based compensation expense related to stock option awards that has been charged against income relating to the 2009 LTIP and the 1993 Plan was $3.3 million, $3.2 million, and $2.7 million for the years ended December 31, 2016, 2015 and 2014, respectively. As of December 31, 2016, there was a total of $7.0 million of unrecognized compensation expense related to unvested stock option awards that will be recognized as stock-based compensation expense as the awards vest over a weighted average period of 1.9 years for the service awards. Director Stock Units Under the 2009 LTIP, the Company awarded its non-employee directors a total of 15,000 stock units during the year ended December 31, 2016 and 2015, respectively, and 17,500 stock units during the year ended December 31, 2014. Each stock unit is the equivalent of one common share, vests immediately and will be converted into a common share upon termination of service as a director. The Company recognized the full stock-based compensation expense related to the awards of $0.3 million in 2016, $0.3 million in 2015 and $0.4 million in 2014 due to the immediate vesting provisions of the award. On May 5, 2009, the Company’s board of directors terminated the M/I Homes, Inc. 2006 Director Equity Incentive Plan (the “Director Equity Plan”). Awards outstanding under the Director Equity Plan remain in effect in accordance with their respective terms. At December 31, 2016, there were 8,059 stock units outstanding under the Director Equity Plan with a value of $0.2 million. Performance Share Unit Awards On February 16, 2016, February 17, 2015 and February 18, 2014, the Company awarded its executive officers (in the aggregate) a target number of performance share units (“PSU’s”) equal to 79,108, 56,389 and 50,439 PSU’s, respectively. Each PSU represents a contingent right to receive one common share of the Company if vesting is satisfied at the end of a three-year performance period (the “Performance Period”). The ultimate number of PSU’s that will vest and be earned, if any, after the completion of the Performance Period, is based on (1) (a) the Company’s cumulative pre-tax income from operations, excluding extraordinary items as defined in the underlying award agreements with the executive officers, over the Performance Period (weighted 80%) (the “Performance Condition”), and (b) the Company’s relative total shareholder return over the Performance Period compared to the total shareholder return of a peer group of other publicly-traded homebuilders (weighted 20%) (the “Market Condition”) and (2) the participant’s continued employment through the end of the Performance Period, except in the case of termination due to death, disability or retirement or involuntary termination without cause by the Company. The number of PSU’s that vest may increase by up to 50% from the target number based on levels of achievement of the above criteria as set forth in the applicable award agreements and decrease to zero if the Company fails to meet the minimum performance levels for both of the above criteria. If the Company achieves the minimum performance levels for both of the above criteria, 50% of the target number of PSU’s will vest and be earned. Any portion of PSU’s that does not vest at the end of the Performance Period will be forfeited. Additionally, the PSU’s have no dividend or voting rights during the Performance Period. The grant date fair value of the portion of the PSU’s subject to the Performance Condition and the Market Condition component was $16.85 and $15.75 for the 2016 PSU’s, respectively, $21.28 and $18.92 for the 2015 PSU’s, respectively, and $23.79 and $21.00 for the 2014 PSU’s, respectively. In accordance with ASC 718, for the portion of the PSU’s subject to a Market Condition, stock-based compensation expense is derived using the Monte Carlo simulation methodology and is recognized ratably over the service period regardless of whether or not the attainment of the Market Condition is probable. Therefore, the Company recognized $0.3 million in stock-based compensation expense during 2016 related to the Market Condition portion of the 2016, 2015 and 2014 PSU awards. There was a total of $0.2 million of unrecognized stock-based compensation expense related to the Market Condition portion of the 2016 and 2015 PSU awards as of December 31, 2016. At December 31, 2016, the Market Condition for the 2014 PSU awards was met, and the company recorded $0.1 million of stock-based compensation expense. Based on these results and board approval, the Company issued 15,130 common shares during the first quarter of 2017 to the holders of the 2014 PSU’s with respect to the portion of the 2014 PSU’s subject to the Market Condition. For the portion of the PSU’s subject to a Performance Condition, we recognize stock-based compensation expense on a straight-line basis over the Performance Period based on the probable outcome of the related Performance Condition. Otherwise, stock-based compensation expense recognition is deferred until probability is attained and a cumulative stock-based compensation expense adjustment is recorded and recognized ratably over the remaining service period. The Company reassesses the probability of the satisfaction of the Performance Condition on a quarterly basis, and stock-based compensation expense is adjusted based on the portion of the requisite service period that has passed. As of December 31, 2016, the Company had not recognized any stock-based compensation expense related to the Performance Condition portion of the 2016 PSU awards. If the Company achieves the minimum performance levels for the Performance Condition to be met for the 2016 awards, the Company would record unrecognized stock-based compensation expense of $0.5 million as of December 31, 2016, for which $0.2 million would be immediately recognized had attainment been probable at December 31, 2016. The Company recognized $0.2 million of stock-based compensation expense related to the Performance Condition portion of the 2015 PSU awards during 2016 based on the probability of attaining the performance condition. The Company has $0.2 million of unrecognized stock-based compensation expense for the 2015 PSU awards at December 31, 2016. The Company recognized $1.1 million of stock-based compensation expense for the 2014 PSU awards as of December 31, 2016 which met the maximum performance level at December 31, 2016. Based on these results and board approval, the Company issued 60,528 common shares during the first quarter of 2017 to the holders of the 2014 PSU’s with respect to the portion of the 2014 PSU’s subject to the Performance Condition. Deferred Compensation Plans The purpose of the Company’s Amended and Restated Executives’ Deferred Compensation Plan (the “Executive Plan”), a non-qualified deferred compensation plan, is to provide an opportunity for certain eligible employees of the Company to defer a portion of their compensation and to invest in the Company’s common shares. The purpose of the Company’s Amended and Restated Director Deferred Compensation Plan (the “Director Plan”) is to provide its directors with an opportunity to defer their director compensation and to invest in the Company’s common shares. Compensation expense deferred into the Executive Plan and the Director Plan (together the “Plans”) totaled $0.1 million, $0.3 million and $0.4 million for the years ended December 31, 2016, 2015 and 2014. The portion of cash compensation deferred by employees and directors under the Plans is invested in fully-vested equity units in the Plans. One equity unit is the equivalent of one common share. Equity units and the related dividends will be converted and distributed to the employee or director in the form of common shares at the earlier of his or her elected distribution date or termination of service as an employee or director of the Company. Distributions from the Plans totaled $0.2 million, less than $0.1 million and $0.2 million, respectively, during the years ended December 31, 2016, 2015 and 2014. As of December 31, 2016, there were a total of 46,049 equity units with a value of $1.0 million outstanding under the Plans. The aggregate fair market value of these units at December 31, 2016, based on the closing price of the underlying common shares, was approximately $1.6 million, and the associated deferred tax benefit the Company would recognize if the outstanding units were distributed was $1.1 million as of December 31, 2016. Common shares are issued from treasury shares upon distribution of equity units from the Plans. Profit Sharing and Retirement Plan The Company has a profit-sharing and retirement plan that covers substantially all Company employees and permits participants to make contributions to the plan on a pre-tax basis in accordance with the provisions of Section 401(k) of the Internal Revenue Code of 1986, as amended. Company contributions to the plan are also made at the discretion of the Company’s board of directors based on the Company’s profitability and resulted in a $1.4 million, $1.2 million and $1.0 million expense for the years ended December 31, 2016, 2015 and 2014, respectively. NOTE 3. Fair Value Measurements There are three measurement input levels for determining fair value: Level 1, Level 2, and Level 3. Fair values determined by Level 1 inputs utilize quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Assets Measured on a Recurring Basis To meet financing needs of our home-buying customers, M/I Financial is party to interest rate lock commitments (“IRLCs”), which are extended to customers who have applied for a mortgage loan and meet certain defined credit and underwriting criteria. These IRLCs are considered derivative financial instruments. M/I Financial manages interest rate risk related to its IRLCs and mortgage loans held for sale through the use of forward sales of mortgage-backed securities (“FMBSs”), the use of best-efforts whole loan delivery commitments, and the occasional purchase of options on FMBSs in accordance with Company policy. These FMBSs, options on FMBSs, and IRLCs covered by FMBSs are considered non-designated derivatives. These amounts are either recorded in Other Assets or Other Liabilities on the Consolidated Balance Sheets (depending on the respective balance for that year ended December 31). The Company measures both mortgage loans held for sale and IRLCs at fair value. Fair value measurement results in a better presentation of the changes in fair values of the loans and the derivative instruments used to economically hedge them. In the normal course of business, our financial services segment enters into contractual commitments to extend credit to buyers of single-family homes with fixed expiration dates. The commitments become effective when the borrowers “lock-in” a specified interest rate within established time frames. Market risk arises if interest rates move adversely between the time of the “lock-in” of rates by the borrower and the sale date of the loan to an investor. To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, the Company enters into optional or mandatory delivery forward sale contracts to sell whole loans and mortgage-backed securities to broker/dealers. The forward sale contracts lock in an interest rate and price for the sale of loans similar to the specific rate lock commitments. The Company does not engage in speculative or trading derivative activities. Both the rate lock commitments to borrowers and the forward sale contracts to broker/dealers or investors are undesignated derivatives, and accordingly, are marked to fair value through earnings. Changes in fair value measurements are included in earnings in the accompanying Consolidated Statements of Income. The fair value of mortgage loans held for sale is estimated based primarily on published prices for mortgage-backed securities with similar characteristics. To calculate the effects of interest rate movements, the Company utilizes applicable published mortgage-backed security prices, and multiplies the price movement between the rate lock date and the balance sheet date by the notional loan commitment amount. The Company sells loans on a servicing released or servicing retained basis, and receives servicing compensation. Thus, the value of the servicing rights included in the fair value measurement is based upon contractual terms with investors and depends on the loan type. The Company applies a fallout rate to IRLCs when measuring the fair value of rate lock commitments. Fallout is defined as locked loan commitments for which the Company does not close a mortgage loan and is based on management’s judgment and company experience. The fair value of the Company’s forward sales contracts to broker/dealers solely considers the market price movement of the same type of security between the trade date and the balance sheet date. The market price changes are multiplied by the notional amount of the forward sales contracts to measure the fair value. Interest Rate Lock Commitments. IRLCs are extended to certain home-buying customers who have applied for a mortgage loan and meet certain defined credit and underwriting criteria. Typically, the IRLCs will have a term of less than six months; however, in certain markets, the term could extend to twelve months. Some IRLCs are committed to a specific third party investor through the use of best-efforts whole loan delivery commitments matching the exact terms of the IRLC loan. Uncommitted IRLCs are considered derivative instruments and are fair value adjusted, with the resulting gain or loss recorded in current earnings. Forward Sales of Mortgage-Backed Securities. Forward sales of mortgage-backed securities (“FMBSs”) are used to protect uncommitted IRLC loans against the risk of changes in interest rates between the lock date and the funding date. FMBSs related to uncommitted IRLCs are classified and accounted for as non-designated derivative instruments and are recorded at fair value, with gains and losses recorded in current earnings. Mortgage Loans Held for Sale. Mortgage loans held for sale consist primarily of single-family residential loans collateralized by the underlying property. During the period between when a loan is closed and when it is sold to an investor, the interest rate risk is covered through the use of a best-efforts contract or by FMBSs. The FMBSs are classified and accounted for as non-designated derivative instruments, with gains and losses recorded in current earnings. The table below shows the notional amounts of our financial instruments at December 31, 2016 and 2015: The table below shows the level and measurement of assets and liabilities measured on a recurring basis at December 31, 2016 and 2015: The following table sets forth the amount of (loss) gain recognized, within our revenue in the Consolidated Statements of Income, on assets and liabilities measured on a recurring basis for the years ended December 31, 2016, 2015 and 2014: The following tables set forth the fair value of the Company’s derivative instruments and their location within the Consolidated Balance Sheets for the periods indicated (except for mortgage loans held for sale which is disclosed as a separate line item): Assets Measured on a Non-Recurring Basis The Company assesses inventory for recoverability on a quarterly basis if events or changes in local or national economic conditions indicate that the carrying amount of an asset may not be recoverable. Our determination of fair value is based on projections and estimates, which are Level 3 measurement inputs. For further explanation of the Company’s policy regarding our assessment of recoverability for assets measured on a non-recurring basis, please see Note 1 to our Consolidated Financial Statements. The tables below show the level and measurement of assets measured on a non-recurring basis for the years ended December 31, 2016 and 2015: (1) The fair values in the table above represent only assets whose carrying values were adjusted in the respective period. (2) The carrying values for these assets may have subsequently increased or decreased from the fair value reported due to activities that have occurred since the measurement date. (3) This amount is inclusive of our investments in joint venture arrangements. There were no losses on our investments in joint venture arrangements for 2016 and 2015. The total loss for these joint venture arrangements was $1.0 million for 2014. Financial Instruments Counterparty Credit Risk. To reduce the risk associated with accounting losses that would be recognized if counterparties failed to perform as contracted, the Company limits the entities with whom management can enter into commitments. This risk of accounting loss is the difference between the market rate at the time of non-performance by the counterparty and the rate to which the Company committed. The following table presents the carrying amounts and fair values of the Company’s financial instruments at December 31, 2016 and 2015. The objective of the fair value measurement is defined to estimate the price at which an orderly transaction to sell the asset or transfer the liability would take place between market participants at the measurement date under current market conditions. (a) Our senior notes and convertible senior subordinated notes are stated at the principal amount outstanding which does not include the impact of premiums, discounts, and debt issuance costs that are amortized to interest cost over the respective terms of the notes. The following methods and assumptions were used by the Company in estimating its fair value disclosures of financial instruments at December 31, 2016 and 2015: Cash, Cash Equivalents and Restricted Cash. The carrying amounts of these items approximate fair value because they are short-term by nature. Mortgage Loans Held for Sale, Forward Sales of Mortgage-Backed Securities, Commitments to Extend Real Estate Loans, Best-Efforts Contracts for Committed IRLCs and Mortgage Loans Held for Sale, Convertible Senior Subordinated Notes due 2017, Convertible Senior Subordinated Notes due 2018 and Senior Notes due 2021. The fair value of these financial instruments was determined based upon market quotes at December 31, 2016 and 2015. The market quotes used were quoted prices for similar assets or liabilities along with inputs taken from observable market data by correlation. The inputs were adjusted to account for the condition of the asset or liability. Split Dollar Life Insurance Policy and Notes Receivable. The estimated fair value was determined by calculating the present value of the amounts based on the estimated timing of receipts using discount rates that incorporate management’s estimate of risk associated with the corresponding note receivable. Notes Payable - Homebuilding Operations. The interest rate available to the Company during the year ended December 31, 2016 fluctuated with the Alternate Base Rate or the Eurodollar Rate for the Company’s $400 million unsecured revolving credit facility dated July 18, 2013, as amended (the “Credit Facility”), and thus the carrying value is a reasonable estimate of fair value. Refer to Note 11 for additional information regarding the Credit Facility. Notes Payable - Financial Services Operations. M/I Financial is a party to two credit agreements: (1) a $125 million secured mortgage warehousing agreement, dated June 24, 2016 (the “MIF Mortgage Warehousing Agreement”), and (2) a $15 million mortgage repurchase agreement, dated November 3, 2015, as amended on October 31, 2016 (the “MIF Mortgage Repurchase Facility”). For each of these credit facilities, the interest rate is based on a variable rate index, and thus their carrying value is a reasonable estimate of fair value. The interest rate available to the Company during 2016 fluctuated with LIBOR. Refer to Note 11 for additional information regarding the MIF Mortgage Warehousing Agreement and the MIF Mortgage Repurchase Facility. Notes Payable - Other. The estimated fair value was determined by calculating the present value of the future cash flows using the Company’s current incremental borrowing rate. Letters of Credit. Letters of credit of $37.7 million and $42.5 million represent potential commitments at December 31, 2016 and 2015, respectively. The letters of credit generally expire within one or two years. The estimated fair value of letters of credit was determined using fees currently charged for similar agreements. NOTE 4. Inventory A summary of the Company’s inventory as of December 31, 2016 and 2015 is as follows: Single-family lots, land and land development costs include raw land that the Company has purchased to develop into lots, costs incurred to develop the raw land into lots, and lots for which development has been completed, but which have not yet been used to start construction of a home. Homes under construction include homes that are in various stages of construction. As of December 31, 2016 and 2015, we had 996 homes (with a carrying value of $199.4 million) and 872 homes (with a carrying value of $184.3 million), respectively, included in homes under construction that were not subject to a sales contract. Model homes and furnishings include homes that are under construction or have been completed and are being used as sales models. The amount also includes the net book value of furnishings included in our model homes. Depreciation on model home furnishings is recorded using an accelerated method over the estimated useful life of the assets, which is typically three years. The Company assesses inventory for recoverability on a quarterly basis. Refer to Notes 1 and 3 of our Consolidated Financial Statements for additional details relating to our procedures for evaluating our inventories for impairment. Land purchase deposits include both refundable and non-refundable amounts paid to third party sellers relating to the purchase of land. On an ongoing basis, the Company evaluates the land option agreements relating to the land purchase deposits. In the period during which the Company makes the decision not to proceed with the purchase of land under an agreement, the Company writes off any deposits and accumulated pre-acquisition costs relating to such agreement. NOTE 5. Transactions with Related Parties The Company made a contribution of $0.4 million in 2016 to the M/I Homes Foundation, a charitable organization having certain officers and directors of the Company on its Board of Trustees. The Company had a receivable of $0.2 million at both December 31, 2016 and 2015 due from an executive officer, relating to amounts owed to the Company for split-dollar life insurance policy premiums. The Company will collect the receivable either directly from the executive officer, if employment terminates other than by death, or from the executive officer’s beneficiary, if employment terminates due to death of the executive officer. As of December 31, 2015, we also had an outstanding loan to one of our joint venture arrangements for $2.5 million in which we are one of the partners in the joint venture, which was paid in full during 2016. The receivable is recorded in Other Assets on the Consolidated Balance Sheets. NOTE 6. Investment in Joint Venture Arrangements The Company has periodically partnered with other land developers or homebuilders to share in the cost of land investment and development of a property through joint ownership and development agreements, joint ventures, and other similar arrangements. For such joint venture arrangements where a special purpose entity is established to own the property, we have determined that we do not have substantive control over any of these entities; therefore, they are recorded using the equity method of accounting. We believe the Company’s maximum exposure related to its investment in these joint venture arrangements as of December 31, 2016 is the total amount invested of $28.0 million which is reported as Investment in Joint Venture Arrangements on our Consolidated Balance Sheets, although we expect to invest further amounts in these joint venture arrangements as development of the properties progresses. Included in the Company’s Investment in Joint Venture Arrangements at December 31, 2016 and December 31, 2015 were $0.1 million and $0.4 million, respectively, of capitalized interest and other costs. The Company evaluates its investment in joint venture arrangements for potential impairment on a quarterly basis. If the fair value of the investment (see Notes 1 and 3 of our Consolidated Financial Statements) is less than the investment’s carrying value, and the Company determines the decline in value was other than temporary, the Company writes down the investment to fair value. Summarized condensed combined financial information for the joint venture arrangements that are included in the homebuilding segments as of December 31, 2016 and 2015 and for the years ended December 31, 2016, 2015 and 2014 is as follows: Summarized Condensed Combined Balance Sheets: (a) For the years ended December 31, 2016 and 2015, impairment expenses and other miscellaneous adjustments totaling $0.5 million and $4.8 million, respectively, were excluded from the table above. (b) For the years ended December 31, 2016 and 2015, the table above excludes the Company’s investment in joint development arrangements for which a special purpose entity was not established, totaling $12.5 million and $17.4 million, respectively. Summarized Condensed Combined Statements of Operations: The Company’s total equity in the income relating to the above homebuilding joint venture arrangements was $0.5 million for 2016 and 2015, respectively, and $0.3 million for 2014. NOTE 7. Guarantees and Indemnifications In the ordinary course of business, M/I Financial, a 100%-owned subsidiary of M/I Homes, Inc., enters into agreements that guarantee certain purchasers of its mortgage loans that M/I Financial will repurchase a loan if certain conditions occur, primarily if the mortgagor does not meet the terms of the loan within the first six months after the sale of the loan. Loans totaling approximately $27.6 million and $12.2 million were covered under the above guarantees as of December 31, 2016 and 2015, respectively. The increase in loans covered by these guarantees from December 31, 2015 is a result of a change in the mix of investors and their related purchase terms. A portion of the revenue paid to M/I Financial for providing the guarantees on the above loans was deferred at December 31, 2016, and will be recognized in income as M/I Financial is released from its obligation under the guarantees. The risk associated with the guarantees above is offset by the value of the underlying assets. M/I Financial received inquiries concerning underwriting matters from purchasers of its loans regarding certain loans totaling approximately $0.9 million and $1.3 million at December 31, 2016 and 2015, respectively. M/I Financial has also guaranteed the collectability of certain loans to third party insurers (U.S. Department of Housing and Urban Development and U.S. Veterans Administration) of those loans for periods ranging from five to thirty years. As of December 31, 2016 and 2015, the total of all loans indemnified to third party insurers relating to the above agreements was $1.6 million and $2.2 million, respectively. The maximum potential amount of future payments is equal to the outstanding loan value less the value of the underlying asset plus administrative costs incurred related to foreclosure on the loans, should this event occur. The Company recorded a liability relating to the guarantees described above totaling $0.9 million and $1.2 million at December 31, 2016 and 2015, respectively, which is management’s best estimate of the Company’s liability. NOTE 8. Commitments and Contingencies Warranty We use subcontractors for nearly all aspects of home construction. Although our subcontractors are generally required to repair and replace any product or labor defects, we are, during applicable warranty periods, ultimately responsible to the homeowner for making such repairs. As such, we record warranty reserves to cover our exposure to the costs for materials and labor not expected to be covered by our subcontractors to the extent they relate to warranty-type claims. Warranty reserves are established by charging cost of sales and crediting a warranty reserve for each home delivered. Warranty reserves are recorded for warranties under our Home Builder’s Limited Warranty (“HBLW”), and our 30-year (offered on all homes sold after April 25, 1998 and on or before December 1, 2015 in all of our markets except our Texas markets), 15-year (offered on all homes sold after December 1, 2015 in all of our markets except our Texas markets) or 10-year (offered on all homes sold in our Texas markets) transferable structural warranty in Other Liabilities on the Company’s Consolidated Balance Sheets. The warranty reserves for the HBLW are established as a percentage of average sales price and adjusted based on historical payment patterns determined, generally, by geographic area and recent trends. Factors that are given consideration in determining the HBLW reserves include: (1) the historical range of amounts paid per average sales price on a home; (2) type and mix of amenity packages added to the home; (3) any warranty expenditures not considered to be normal and recurring; (4) timing of payments; (5) improvements in quality of construction expected to impact future warranty expenditures; and (6) conditions that may affect certain projects and require a different percentage of average sales price for those specific projects. Changes in estimates for warranties occur due to changes in the historical payment experience and differences between the actual payment pattern experienced during the period and the historical payment pattern used in our evaluation of the warranty reserve balance at the end of each quarter. Actual future warranty costs could differ from our current estimated amount. Our warranty reserves for our transferable structural warranty programs are established on a per-unit basis. While the structural warranty reserve is recorded as each house is delivered, the sufficiency of the structural warranty per unit charge and total reserve is re-evaluated on an annual basis, with the assistance of an actuary, using our own historical data and trends, industry-wide historical data and trends, and other project specific factors. The reserves are also evaluated quarterly and adjusted if we encounter activity that is inconsistent with the historical experience used in the annual analysis. These reserves are subject to variability due to uncertainties regarding structural defect claims for products we build, the markets in which we build, claim settlement history, insurance and legal interpretations, among other factors. While we believe that our warranty reserves are sufficient to cover our projected costs, there can be no assurances that historical data and trends will accurately predict our actual warranty costs. Our warranty reserve amounts are based upon historical experience and geographic location. Our warranty reserves are included in Other Liabilities in the Company’s Consolidated Balance Sheets. A summary of warranty activity for the years ended December 31, 2016, 2015 and 2014 is as follows: (a) Estimated stucco-related claim costs, as described below, have been included in warranty accruals. We have received claims related to stucco installation from homeowners in certain of our communities in our Tampa and Orlando, Florida markets and have been named as a defendant in legal proceedings initiated by certain of such homeowners. These claims primarily relate to homes built prior to 2014 which have second story elevations with frame construction. In 2015, we repaired certain of the identified homes and accrued for the estimated future cost of repairs for the other identified homes on which repairs had yet to be completed. The aggregate amounts of such repair costs and accruals were not material, and the warranty reserve for identified homes in need of more than minor repair at December 31, 2015 was $0.5 million. During the early part of 2016, we received an increased number of stucco-related claims and recorded expense of $2.2 million and $2.8 million during the first and second quarters of 2016, respectively, to reflect the cost of these claims. Furthermore, as a result of these increasing claims, we commenced a review of the stucco issues to determine their causes and to enable us to make a reasonable estimate of the overall cost of stucco-related repairs to homes in our Florida communities. Our review included an analysis of a number of factors: (1) the date of delivery of each home in our Florida communities and the expiration date of the 10-year statutory period of repose and contractual warranty period with respect to each such home; (2) the number of each type of home (i.e., one story, 1.5 stories or 2 stories); (3) our stucco-related claims experience with respect to each type of home and each individual community; and (4) other relevant factors and observations gained from the field. As a result of this review, in the third quarter of 2016, we recorded an additional charge of $14.5 million for a total 2016 charge of $19.4 million for repair costs for (1) homes in our Florida communities that we had identified as needing repair but have not yet completed the repair and (2) estimated repair costs for homes in our Florida communities that we have not yet identified as needing repair but that may require repair in the future. These charges are included as changes in estimate within our warranty reserve. The remaining reserve for the both known repair costs and an estimate of future costs of stucco-related repairs at December 31, 2016 included within our warranty reserve was $11.9 million. We believe that this amount is sufficient to cover both known and estimated future repair costs as of December 31, 2016. Our estimate of future costs of stucco-related repairs is based on our judgment, various assumptions and internal data. Due to the degree of judgment and the potential for variability in our underlying assumptions and data, as we obtain additional information, we may revise our estimate, including to reflect additional estimated future stucco repairs costs, which revision could be material. We also are continuing to investigate the extent to which we may be able to recover a portion of our stucco repair and claims handling costs from other sources, including our direct insurers, the subcontractors involved with the construction of the homes and their insurers. As of December 31, 2016, we are unable to estimate an amount, if any, that we believe is probable that we will recover from these sources and, accordingly, we have not recorded a receivable for estimated recoveries nor included an estimated amount of recoveries in determining our warranty reserves. Performance Bonds and Letters of Credit At December 31, 2016, the Company had outstanding approximately $154.3 million of completion bonds and standby letters of credit, some of which were issued to various local governmental entities that expire at various times through September 2024. Included in this total are: (1) $108.9 million of performance and maintenance bonds and $31.5 million of performance letters of credit that serve as completion bonds for land development work in progress; (2) $6.2 million of financial letters of credit, of which $4.5 million represent deposits on land and lot purchase agreements; and (3) $7.7 million of financial bonds. Land Option Contracts and Other Similar Contracts At December 31, 2016, the Company also had options and contingent purchase agreements to acquire land and developed lots with an aggregate purchase price of approximately $556.2 million. Purchase of properties under these agreements is contingent upon satisfaction of certain requirements by the Company and the sellers. Legal Matters In addition to the legal proceedings related to stucco, the Company and certain of its subsidiaries have been named as defendants in certain other legal proceedings which are incidental to our business. While management currently believes that the ultimate resolution of these other legal proceedings, individually and in the aggregate, will not have a material effect on the Company’s financial position, results of operations and cash flows, such legal proceedings are subject to inherent uncertainties. The Company has recorded a liability to provide for the anticipated costs, including legal defense costs, associated with the resolution of these other legal proceedings. However, the possibility exists that the costs to resolve these legal proceedings could differ from the recorded estimates and, therefore, have a material effect on the Company’s net income for the periods in which they are resolved. At December 31, 2016 and 2015, we had $0.3 million and $0.6 million reserved for legal expenses, respectively. NOTE 9. Lease Commitments Operating Leases. The Company leases various office facilities, automobiles, model furnishings, and model homes under operating leases with remaining terms of one to nine years. The Company sells model homes to investors with the express purpose of leasing the homes back as sales models for a specified period of time. The Company records the sale of the home at the time of the home delivery, and defers profit on the sale, which is subsequently recognized over the lease term. At December 31, 2016, the future minimum rental commitments totaled $13.7 million under non-cancelable operating leases with initial terms in excess of one year as follows: 2017 - 4.8 million; 2018 - $2.9 million; 2019 - $1.9 million; 2020 - $1.4 million; 2021 - $1.4 million; and $1.3 million thereafter. The Company’s total rental expense was $6.3 million, $5.3 million, and $4.7 million for 2016, 2015 and 2014, respectively. NOTE 10. Community Development District Infrastructure and Related Obligations A Community Development District and/or Community Development Authority (“CDD”) is a unit of local government created under various state and/or local statutes to encourage planned community development and to allow for the construction and maintenance of long-term infrastructure through alternative financing sources, including the tax-exempt markets. A CDD is generally created through the approval of the local city or county in which the CDD is located and is controlled by a Board of Supervisors representing the landowners within the CDD. CDDs may utilize bond financing to fund construction or acquisition of certain on-site and off-site infrastructure improvements near or within these communities. CDDs are also granted the power to levy special assessments to impose ad valorem taxes, rates, fees and other charges for the use of the CDD project. An allocated share of the principal and interest on the bonds issued by the CDD is assigned to and constitutes a lien on each parcel within the community evidenced by an assessment (the “Assessment”). The owner of each such parcel is responsible for the payment of the Assessment on that parcel. If the owner of the parcel fails to pay the Assessment, the CDD may foreclose on the lien pursuant to powers conferred to the CDD under applicable state laws and/or foreclosure procedures. In connection with the development of certain of the Company’s communities, CDDs have been established and bonds have been issued to finance a portion of the related infrastructure. Following are details relating to such CDD bond obligations issued and outstanding as of December 31, 2016: The Company records a liability for the estimated developer obligations that are probable and estimable and user fees that are required to be paid or transferred at the time the parcel or unit is sold to an end user. The Company reduces this liability by the corresponding Assessment assumed by property purchasers and the amounts paid by the Company at the time of closing and the transfer of the property. The Company recorded a $0.5 million and $1.0 million liability related to these CDD bond obligations as of December 31, 2016 and December 31, 2015, respectively, along with the related inventory infrastructure. NOTE 11. Debt Notes Payable - Homebuilding The Credit Facility provides an aggregate commitment amount of $400 million, including a $125 million sub-facility for letters of credit. The Credit Facility expires on October 20, 2018. For the year ended December 31, 2016, interest on amounts borrowed under the Credit Facility was payable at either the Alternate Base Rate plus a margin of 150 basis points, or at the Eurodollar Rate plus a margin of 250 basis points. These interest rates are subject to adjustment in subsequent periods based on the Company's leverage ratio. The Credit Facility also contains certain financial covenants. At December 31, 2016, the Company was in compliance with all financial covenants of the Credit Facility. At December 31, 2016, borrowing availability under the Credit Facility in accordance with the borrowing base calculation was $537.6 million, and, as a result, the full amount of the $400 million facility was available. At December 31, 2016, there were $40.3 million of borrowings outstanding and $37.1 million of letters of credit outstanding, leaving net remaining borrowing availability of $322.6 million. The Company’s obligations under the Credit Facility are guaranteed by all of the Company’s subsidiaries, with the exception of subsidiaries that are primarily engaged in the business of mortgage financing, title insurance or similar financial businesses relating to the homebuilding and home sales business, certain subsidiaries that are not 100%-owned by the Company or another subsidiary, and other subsidiaries designated by the Company as Unrestricted Subsidiaries (as defined in Note 16), subject to limitations on the aggregate amount invested in such Unrestricted Subsidiaries in accordance with the terms of the Credit Facility and the indenture for the Company’s $300.0 million aggregate principal amount of 6.75% Senior Notes due 2021 (the “2021 Senior Notes”). The guarantors for the Credit Facility (the “Guarantor Subsidiaries”) are the same subsidiaries that guarantee the 2021 Senior Notes, the Company’s $57.5 million aggregate principal amount of 3.25% Convertible Senior Subordinated Notes due 2017 (the “2017 Convertible Senior Subordinated Notes”) and the Company’s $86.3 million aggregate principal amount of 3.0% Convertible Senior Subordinated Notes due 2018 (the “2018 Convertible Senior Subordinated Notes”). The Company’s obligations under the Credit Facility are general, unsecured senior obligations of the Company and the Guarantor Subsidiaries and rank equally in right of payment with all our and the Guarantor Subsidiaries’ existing and future unsecured senior indebtedness. Our obligations under the Credit Facility are effectively subordinated to our existing and future secured indebtedness with respect to any assets comprising security or collateral for such indebtedness. The Credit Facility contains various representations, warranties and covenants which require, among other things, that the Company maintain (1) a minimum level of Consolidated Tangible Net Worth of $404.5 million (subject to increase over time based on earnings and proceeds from equity offerings), (2) a leverage ratio not in excess of 60%, and (3) either a minimum Interest Coverage Ratio of 1.5 to 1.0 or a minimum amount of available liquidity. In addition, the Credit Facility contains covenants that limit the Company's number of unsold housing units and model homes, as well as the amount of Investments in Unrestricted Subsidiaries and Joint Ventures. As of December 31, 2015, the Company was a party to three secured credit agreements for the issuance of letters of credit outside of the Credit Facility (collectively, the “Letter of Credit Facilities”). During 2016, the Company terminated one Letter of Credit Facility and allowed another Letter of Credit Facility to expire. Therefore, at December 31, 2016, the Company was party to one remaining Letter of Credit Facility, with a maturity date of September 30, 2017, which allows for the issuance of letters of credit up to a total of $2.0 million. At December 31, 2016 and December 31, 2015, there was $0.6 million and $2.7 million of outstanding letters of credit in aggregate under the Company’s Letter of Credit Facilities, respectively, which were collateralized with $0.6 million and $2.7 million of the Company’s cash, respectively. Notes Payable - Financial Services The MIF Mortgage Warehousing Agreement is used to finance eligible residential mortgage loans originated by M/I Financial. The Agreement provides a maximum borrowing availability of $125 million which increased to $150 million from September 25, 2016 to October 15, 2016 and from December 15, 2016 to February 2, 2017 (periods during which we typically experience higher mortgage origination volume). The MIF Mortgage Warehousing Agreement expires on June 23, 2017. Interest on amounts borrowed under the MIF Mortgage Warehousing Agreement is payable at a per annum rate equal to the greater of (1) the floating LIBOR rate plus 250 basis points and (2) 2.75%. The MIF Mortgage Warehousing Agreement also contains certain financial covenants. At December 31, 2016, the Company was in compliance with all financial covenants of the MIF Mortgage Warehousing Agreement. The MIF Mortgage Repurchase Facility is used to finance eligible residential mortgage loans originated by M/I Financial and is structured as a mortgage repurchase facility with a maximum borrowing availability of $15 million which increased to $35 million from December 2, 2016 through February 1, 2017 (a period during which we typically experience higher mortgage origination volume). The MIF Mortgage Repurchase Facility expires on October 30, 2017. M/I Financial pays interest on each advance under the MIF Mortgage Repurchase Facility at a per annum rate equal to the floating LIBOR rate plus 250 or 275 basis points depending on the loan type. The MIF Mortgage Repurchase Facility also contains certain financial covenants. At December 31, 2016, MI Financial was in compliance with all financial covenants of the MIF Mortgage Repurchase Facility. At December 31, 2016, M/I Financial’s total combined maximum borrowing availability under the two credit facilities was $185.0 million, an increase from $150.0 million at December 31, 2015 due to the seasonal increases on the two credit facilities as described in further detail above. At December 31, 2016 and December 31, 2015, M/I Financial had $152.9 million and $123.6 million outstanding on a combined basis under its credit facilities, respectively, and was in compliance with all financial covenants of those agreements for both periods. Convertible Senior Subordinated Notes As of both December 31, 2016 and 2015, we had $86.3 million of our 2018 Convertible Senior Subordinated Notes outstanding. The 2018 Convertible Senior Subordinated Notes bear interest at a rate of 3.0% per year, payable semiannually in arrears on March 1 and September 1 of each year. The 2018 Convertible Senior Subordinated Notes mature on March 1, 2018. At any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their 2018 Convertible Senior Subordinated Notes into the Company’s common shares. The conversion rate initially equals 30.9478 shares per $1,000 of principal amount. This corresponds to an initial conversion price of approximately $32.31 per common share, which equates to approximately 2.7 million common shares. The conversion rate is subject to adjustment upon the occurrence of certain events. The 2018 Convertible Senior Subordinated Notes are fully and unconditionally guaranteed jointly and severally on a senior subordinated unsecured basis by the Guarantor Subsidiaries. The 2018 Convertible Senior Subordinated Notes are senior subordinated unsecured obligations of the Company and the Guarantor Subsidiaries, are subordinated in right of payment to our and the Guarantor Subsidiaries’ existing and future senior indebtedness and are also effectively subordinated to our and the Guarantor Subsidiaries’ existing and future secured indebtedness with respect to any assets comprising security or collateral for such indebtedness. The indenture governing the 2018 Convertible Senior Subordinated Notes requires the Company to repurchase the notes (subject to certain exceptions), at a holder’s option, upon the occurrence of a fundamental change (as defined in the indenture). The Company may redeem for cash any or all of the 2018 Convertible Senior Subordinated Notes (except for any 2018 Convertible Senior Subordinated Notes that the Company is required to repurchase in connection with a fundamental change), but only if the last reported sale price of the Company’s common shares exceeds 130% of the applicable conversion price for the notes on each of at least 20 applicable trading days. The 20 trading days do not need to be consecutive, but must occur during a period of 30 consecutive trading days that ends within 10 trading days immediately prior to the date the Company provides the notice of redemption. The redemption price for the 2018 Convertible Senior Subordinated Notes to be redeemed will equal 100% of the principal amount, plus accrued and unpaid interest, if any. As of both December 31, 2016 and 2015, we had $57.5 million of our 2017 Convertible Senior Subordinated Notes outstanding. The 2017 Convertible Senior Subordinated Notes bear interest at a rate of 3.25% per year, payable semiannually in arrears on March 15 and September 15 of each year. The 2017 Convertible Senior Subordinated Notes mature on September 15, 2017. At any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their 2017 Convertible Senior Subordinated Notes into the Company’s common shares. The conversion rate initially equals 42.0159 shares per $1,000 of principal amount. This corresponds to an initial conversion price of approximately $23.80 per common share, which equates to approximately 2.4 million common shares. The conversion rate is subject to adjustment upon the occurrence of certain events. The 2017 Convertible Senior Subordinated Notes are fully and unconditionally guaranteed jointly and severally on a senior subordinated unsecured basis by the Guarantor Subsidiaries. The 2017 Convertible Senior Subordinated Notes are senior subordinated unsecured obligations of the Company and the Guarantor Subsidiaries, are subordinated in right of payment to our and the Guarantor Subsidiaries’ existing and future senior indebtedness and are also effectively subordinated to our and the Guarantor Subsidiaries’ existing and future secured indebtedness with respect to any assets comprising security or collateral for such indebtedness. The indenture governing the 2017 Convertible Senior Subordinated Notes provides that we may not redeem the notes prior to their stated maturity date, but also contains provisions requiring the Company to repurchase the 2017 Convertible Senior Subordinated Notes (subject to certain exceptions), at a holder’s option, upon the occurrence of a fundamental change (as defined in the indenture). Senior Notes As of both December 31, 2016 and 2015, we had $300.0 million of our 2021 Senior Notes outstanding. The 2021 Senior Notes bear interest at a rate of 6.75% per year, payable semiannually in arrears on January 15 and July 15 of each year, and mature on January 15, 2021. The 2021 Senior Notes are general, unsecured senior obligations of the Company and the Guarantor Subsidiaries and rank equally in right of payment with all our and the Guarantor Subsidiaries’ existing and future unsecured senior indebtedness. The 2021 Senior Notes are effectively subordinated to our and the Guarantor Subsidiaries’ existing and future secured indebtedness with respect to any assets comprising security or collateral for such indebtedness. The 2021 Senior Notes contain certain covenants, as more fully described and defined in the indenture governing the 2021 Senior Notes, which limit the ability of the Company and the restricted subsidiaries to, among other things: incur additional indebtedness; make certain payments, including dividends, or repurchase any shares, in an aggregate amount exceeding our “restricted payments basket”; make certain investments; and create or incur certain liens, consolidate or merge with or into other companies, or liquidate or sell or transfer all or substantially all of our assets. These covenants are subject to a number of exceptions and qualifications as described in the indenture governing the 2021 Senior Notes. As of December 31, 2016, the Company was in compliance with all terms, conditions, and covenants under the indenture. The 2021 Senior Notes are fully and unconditionally guaranteed jointly and severally on a senior unsecured basis by the Guarantor Subsidiaries. The Company may redeem all or any portion of the 2021 Senior Notes on or after January 15, 2018 at a stated redemption price, together with accrued and unpaid interest thereon. The redemption price will initially be 103.375% of the principal amount outstanding, but will decline to 101.688% of the principal amount outstanding if redeemed during the 12-month period beginning on January 15, 2019, and will further decline to 100.000% of the principal amount outstanding if redeemed on or after January 15, 2020, but prior to maturity. The indenture governing our 2021 Senior Notes limits our ability to pay dividends on, and repurchase, our common shares and our 9.75% Series A Preferred Shares (the “Series A Preferred Shares”) to the amount of the positive balance in our “restricted payments basket,” as defined in the indenture. The “restricted payments basket” is equal to $125.0 million plus (1) 50% of our aggregate consolidated net income (or minus 100% of our aggregate consolidated net loss) from October 1, 2015, excluding income or loss from Unrestricted Subsidiaries, plus (2) 100% of the net cash proceeds from either contributions to the common equity of the Company after December 31, 2015 or the sale of qualified equity interests, plus other items and subject to other exceptions. The restricted payments basket was $144.9 million and $128.5 million at December 31, 2016 and 2015, respectively. The determination to pay future dividends on, or make future repurchases of, our common shares or Series A Preferred Shares will be at the discretion of our board of directors and will depend upon our results of operations, financial condition, capital requirements and compliance with debt covenants and the terms of our Series A Preferred Shares, and other factors deemed relevant by our board of directors. Notes Payable - Other The Company had other borrowings, which are reported in Notes Payable - Other in our Consolidated Balance Sheets, totaling $6.4 million and $8.4 million as of December 31, 2016 and 2015, respectively. The balance consists primarily of a mortgage note payable with a $3.4 million principal balance outstanding at December 31, 2016 (and $3.9 million outstanding at December 31, 2015), which is secured by an office building, matures in 2017 and carries an interest rate of 8.1%. The remaining balance is made up of other notes payable acquired through normal course of business. These other borrowings are included in the debt maturities schedule below. Maturities over the next five years with respect to the Company’s debt as of December 31, 2016 are as follows: NOTE 12. Preferred Shares The Company’s Articles of Incorporation authorize the issuance of up to 2,000,000 preferred shares, par value $.01 per share. On March 15, 2007, the Company issued 4,000,000 depositary shares, each representing 1/1000th of a Series A Preferred Share, or 4,000 Series A Preferred Shares in the aggregate. On April 10, 2013, the Company redeemed 2,000 of its Series A Preferred Shares for $50.4 million in cash. The aggregate liquidation value of the remaining 2,000 Preferred Shares is $50 million. The Company paid $4.9 million of dividends in 2016, 2015 and 2014 on the Series A Preferred Shares. Please see Note 11 for additional information related to the restrictions on our ability to pay dividends on and repurchase our Series A Preferred Shares. NOTE 13. Earnings Per Share The table below presents a reconciliation between basic and diluted weighted average shares outstanding, net income available to common shareholders and basic and diluted income per share for the years ended December 31, 2016, 2015 and 2014: The Company declared and paid a quarterly cash dividend of $609.375 per share on its 2,000 outstanding Series A Preferred Shares in each quarter of 2016, 2015 and 2014, for an aggregate dividend payment of $4.9 million for each of the years ended December 31, 2016, 2015 and 2014. For the years ended December 31, 2016, 2015 and 2014, the effect of convertible debt was included in the diluted earnings per share calculations. NOTE 14. Income Taxes The Company records income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized based on future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and attributable to operating loss and tax credit carryforwards, if any. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which the temporary differences are expected to be recovered or paid. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period when the changes are enacted. In accordance with ASC 740-10, Income Taxes (“ASC 740”), we evaluate our deferred tax assets, including the benefit from net operating losses (“NOLs”) and tax credit carryforwards, if any, to determine if a valuation allowance is required. Companies must assess, using significant judgments, whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard with significant weight being given to evidence that can be objectively verified. This assessment gives appropriate consideration to all positive and negative evidence related to the realization of the deferred tax assets and considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the length of statutory carryforward periods, our experience with operating losses and our experience of utilizing tax credit carryforwards and tax planning alternatives. Based upon a review of all available evidence, we believe our deferred tax assets were fully realizable in all periods presented. At December 31, 2016, the Company’s total deferred tax assets were $37.0 million which is offset by $6.1 million of total deferred tax liabilities for a $30.9 million net deferred tax asset which is reported on the Company’s Consolidated Balance Sheets. The tax effects of the significant temporary differences that comprise the deferred tax assets and liabilities are as follows: The provision (benefit) from income taxes consists of the following: For 2016, 2015 and 2014, the Company’s effective tax rate was 38.32%, 40.45%, and 27.17%, respectively. Reconciliation of the differences between income taxes computed at the federal statutory tax rate and consolidated benefit from income taxes are as follows: The Company files income tax returns in the U.S. federal jurisdiction, and various states. The Company is no longer subject to U.S. federal, state or local examinations by tax authorities for years before 2010. The Company is audited from time to time, and if any adjustments are made, they would be either immaterial or reserved. The Company recognizes interest and penalties accrued related to unrecognized tax benefits in tax expense. At December 31, 2016, 2015 and 2014, we had no unrecognized tax benefits due to the lapse of the statute of limitations and completion of audits in prior years. We believe that our current income tax filing positions and deductions will be sustained on audit and do not anticipate any adjustments that will result in a material change. During 2016, the Company fully utilized its federal NOL carryforwards and federal credit carryforwards. The Company had $5.5 million of state NOL carryforwards, net of the federal benefit, at December 31, 2016. Our state NOLs may be carried forward from one to 16 years, depending on the tax jurisdiction, with $1.5 million expiring between 2022 and 2027 and $4.0 million expiring between 2028 and 2032, absent sufficient state taxable income. NOTE 15. Business Segments The Company’s chief operating decision makers evaluate the Company’s performance in various ways, including: (1) the results of our 15 individual homebuilding operating segments and the results of our financial services operations; (2) the results of our three homebuilding reportable segments; and (3) our consolidated financial results. In accordance with ASC 280, Segment Reporting (“ASC 280”), we have identified each homebuilding division as an operating segment and have determined our reportable segments as follows: Midwest homebuilding, Southern homebuilding, Mid-Atlantic homebuilding and financial services operations. The homebuilding operating segments that are included within each reportable segment have been aggregated because they share similar aggregation characteristics as prescribed in ASC 280 in the following regards: (1) long-term economic characteristics; (2) historical and expected future long-term gross margin percentages; (3) housing products, production processes and methods of distribution; and (4) geographical proximity. The homebuilding operating segments that comprise each of our reportable segments are as follows: Midwest Southern Mid-Atlantic Chicago, Illinois Orlando, Florida Charlotte, North Carolina Cincinnati, Ohio Sarasota, Florida Raleigh, North Carolina Columbus, Ohio Tampa, Florida Washington, D.C. Indianapolis, Indiana Austin, Texas Minneapolis/St. Paul, Minnesota Dallas/Fort Worth, Texas Houston, Texas San Antonio, Texas The following table shows, by segment, revenue, operating income and interest expense for 2016, 2015 and 2014, as well as the Company’s income before income taxes for such periods: (a) Our financial services operational results should be viewed in connection with our homebuilding business as its operations originate loans and provide title services primarily for our homebuying customers, with the exception of an immaterial amount of mortgage refinancing. (b) Includes a $19.4 million charge for known and estimated future stucco-related repair costs in certain of our Florida communities (as more fully discussed in Note 8) taken during the year ended December 31, 2016. (c) For the years ended December 31, 2016, 2015 and 2014, total operating income was reduced by $4.0 million, $3.6 million and $3.5 million, respectively, related to asset impairment charges taken during the period. The following tables show total assets by segment at December 31, 2016 and 2015: (a) Inventory includes single-family lots, land and land development costs; land held for sale; homes under construction; model homes and furnishings; community development district infrastructure; and consolidated inventory not owned. (b) Includes development reimbursements from local municipalities. (c) During the first quarter of 2016, the Company purchased an airplane for $9.9 million. The asset is included within Property and Equipment - Net in our Consolidated Balance Sheets. NOTE 16. Supplemental Guarantor Information The Company’s obligations under the 2021 Senior Notes, the 2017 Convertible Senior Subordinated Notes and the 2018 Convertible Senior Subordinated Notes are not guaranteed by all of the Company’s subsidiaries and therefore, the Company has disclosed condensed consolidating financial information in accordance with SEC Regulation S-X Rule 3-10, Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered. The Guarantor Subsidiaries of the 2021 Senior Notes, the 2017 Convertible Senior Subordinated Notes and the 2018 Convertible Senior Subordinated Notes are the same. The following condensed consolidating financial information includes balance sheets, statements of income and cash flow information for M/I Homes, Inc. (the parent company and the issuer of the aforementioned guaranteed notes), the Guarantor Subsidiaries, collectively, and for all other subsidiaries and joint ventures of the Company (the “Unrestricted Subsidiaries”), collectively. Each Guarantor Subsidiary is a direct or indirect 100%-owned subsidiary of M/I Homes, Inc. and has fully and unconditionally guaranteed the (a) 2021 Senior Notes, on a joint and several senior unsecured basis, (b) 2017 Convertible Senior Subordinated Notes on a joint and several senior subordinated unsecured basis and (c) 2018 Convertible Senior Subordinated Notes on a joint and several senior subordinated unsecured basis. There are no significant restrictions on the parent company’s ability to obtain funds from its Guarantor Subsidiaries in the form of a dividend, loan, or other means. As of December 31, 2016, each of the Company’s subsidiaries is a Guarantor Subsidiary, with the exception of subsidiaries that are primarily engaged in the business of mortgage financing, title insurance or similar financial businesses relating to the homebuilding and home sales business, certain subsidiaries that are not 100%-owned by the Company or another subsidiary, and other subsidiaries designated by the Company as Unrestricted Subsidiaries, subject to limitations on the aggregate amount invested in such Unrestricted Subsidiaries in accordance with the terms of the Credit Facility and the indenture governing the 2021 Senior Notes. In the condensed financial tables presented below, the parent company presents all of its 100%-owned subsidiaries as if they were accounted for under the equity method. All applicable corporate expenses have been allocated appropriately among the Guarantor Subsidiaries and Unrestricted Subsidiaries. (1) During 2016, we elected to early-adopt Accounting Standards Update 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. Certain amounts above have been adjusted to apply the new method retrospectively. (1) During 2016, we elected to early-adopt Accounting Standards Update 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. Certain amounts above have been adjusted to apply the new method retrospectively. (1) During 2016, we elected to early-adopt Accounting Standards Update 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. Certain amounts above have been adjusted to apply the new method retrospectively. NOTE 17. Supplementary Financial Data The following tables set forth our selected consolidated financial and operating data for the quarterly periods indicated. (a) Net income to common shareholders includes a $14.5 million charge for known and estimated future stucco-related repair costs in certain of our Florida communities (as more fully discussed in Note 8) taken during the third quarter of 2016 and $4.0 million of impairment charges taken during the fourth quarter of 2016. (b) Net income to common shareholders includes $7.8 million of early debt extinguishment charges and $3.6 million of impairment charges taken during the fourth quarter of 2015. (c) Due to rounding, the sum of quarterly results may not equal the total for the year. Additionally, quarterly and year-to-date computations of per share amounts are made independently. We typically experience significant seasonality and quarter-to-quarter variability in our operating results. In general, homes delivered increase substantially in the second half of the year compared to the first half of the year as we sell more homes during the first and second quarters which results in more homes being delivered in the third and fourth quarters. | Based on the provided text, which appears to be an incomplete or fragmented financial statement excerpt, here's a summary:
The document discusses:
1. Profit/Loss: Losses are recorded in Consolidated Statements of Income
2. Investment assessments are done quarterly
3. The statement covers:
- Expenses
- Cash and cash equivalents
- Assets
- Liabilities
Key observations:
- The text seems to be a partial extract from a financial report
- It references accounting standards (ASC 323, ASU 2016)
- Mentions assessment of investments and cash management
- Appears to be from a company that deals with home deliveries
Without the full context or complete financial statement, this summary is necessarily limited. A complete review would require the full document. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index Page Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Statements of Consolidated and Combined Operations Statements of Consolidated and Combined Comprehensive Income Statements of Consolidated and Combined Cash Flows Statements of Consolidated and Combined Equity and Partners' Capital Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) CPG OpCo LP ACCOUNTING FIRM To the General Partner and Limited Partners of CPG OpCo LP Houston, Texas We have audited the accompanying consolidated balance sheets of CPG OpCo LP and subsidiaries (the "Partnership") as of December 31, 2016 and 2015, and the related statements of consolidated and combined operations, comprehensive income, cash flows, and equity for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated and combined financial statements present fairly, in all material respects, the financial position of CPG OpCo LP and subsidiaries at as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP Columbus, Ohio February 17, 2017 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) CPG OpCo LP CONSOLIDATED BALANCE SHEETS The accompanying Notes to Consolidated and Combined Financial Statements are an integral part of these statements. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) CPG OpCo LP CONSOLIDATED BALANCE SHEETS The accompanying Notes to Consolidated and Combined Financial Statements are an integral part of these statements. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) CPG OpCo LP STATEMENTS OF CONSOLIDATED AND COMBINED OPERATIONS The accompanying Notes to Consolidated and Combined Financial Statements are an integral part of these statements. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) CPG OpCo LP STATEMENTS OF CONSOLIDATED AND COMBINED COMPREHENSIVE INCOME (1)Net unrealized gain on derivatives qualifying as cash flow hedges, net of zero, $0.1 million and $0.7 million tax expense in 2016, 2015 and 2014, respectively. (2)Unrecognized pension and OPEB benefit (cost), net of zero tax expense in 2016, 2015 and 2014, respectively. (3)Unrecognized pension and OPEB benefits (costs) are primarily related to pension and OPEB remeasurements recorded during 2016 and 2015. The accompanying Notes to Consolidated and Combined Financial Statements are an integral part of these statements. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) CPG OpCo LP STATEMENTS OF CONSOLIDATED AND COMBINED CASH FLOWS The accompanying Notes to Consolidated and Combined Financial Statements are an integral part of these statements. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) CPG OpCo LP STATEMENTS OF CONSOLIDATED AND COMBINED EQUITY (1)Reflects the non-cash elimination of all historical current and deferred income taxes other than Tennessee state income taxes that continue to be borne by the Partnership post-CPPL IPO, as well as associated regulatory assets and liabilities. (2)Reflects the removal of amounts related to Crossroads Pipeline Company, CPGSC, Central Kentucky Transmission Company and 1% of the 50% interest in Hardy Storage that were included in the Predecessor but were not contributed to the Partnership, as well as the inclusion of CNS Microwave, which was not part of the Predecessor. (3)Represents CPPL's purchase of an additional 8.4% limited partner interest in the Partnership, recorded at the historical carrying value of the Partnership's net assets after giving effect to the $1,170.0 million equity contribution. This decreases CPPL's limited partner interest by the same amount it increases CEG's limited partner interest because CPPL's purchase price for its additional 8.4% interest in the Partnership exceeded book value. (4)As part of the Separation from NiSource, certain assets on the Partnership's subsidiaries' accounts were purchased by CEG at fair value and then sold to NiSource. As the Partnership and CEG are entities under common control, this amount represents the difference between book value and fair value of those assets. The accompanying Notes to Consolidated and Combined Financial Statements are an integral part of these statements. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) 1. Nature of Operations and Summary of Significant Accounting Policies A. Company Structure and Basis of Presentation. CPG OpCo LP (the "Partnership") was formed in Delaware on September 26, 2014, as a subsidiary of NiSource. The general partner of the Partnership, OpCo GP, is 100% owned by its sole member CPPL. At or prior to the closing of CPPL's IPO the following transactions occurred: • CEG contributed $1,217.3 million of capital to certain subsidiaries of the Predecessor to repay intercompany debt owed to NiSource Finance. CEG entered into new intercompany debt agreements with NiSource Finance for $1,217.3 million; • CEG and Columbia Hardy contributed substantially all of the subsidiaries in the Predecessor to the Partnership; • CEG assumed responsibility for all historical current and deferred income taxes other than Tennessee state income taxes that continue to be borne by the Partnership post-IPO, as well as associated regulatory assets and liabilities; • CEG contributed to CPPL a 7.3% limited partner interest in the Partnership in exchange for 46,811,398 subordinated units in CPPL and all of CPPL's incentive distribution rights; • CPPL purchased from the Partnership an additional 8.4% limited partner interest in exchange for $1,170.0 million from the net proceeds of CPPL's IPO, resulting in CPPL owning a 15.7% limited partner interest in the Partnership; • The Partnership distributed $500.0 million to CEG as a reimbursement of preformation capital expenditures with respect to the assets contributed to the Partnership. • Following CPPL's IPO, CPPL owns a 15.7% limited partner interest in the Partnership, Columbia Hardy owns a 0.77% limited partner interest and CEG owns the remaining 83.53% limited partner interest. On February 11, 2015, concurrent with the completion of CPPL's IPO, NiSource contributed its subsidiary, CEG, to CPG. Following this contribution, CPG owns and operates, through its subsidiaries, approximately 15,000 miles of strategically located interstate gas pipelines extending from New York to the Gulf of Mexico and one of the nation’s largest underground natural gas storage systems, with approximately 300 MMDth of working gas capacity, as well as related gathering and processing assets. CEG owns and operates, through its subsidiaries, substantially all of the natural gas transmission and storage assets of CPG. Prior to July 1, 2015, CPG was a wholly owned subsidiary of NiSource. On July 1, 2015, all the shares of CPG were distributed by NiSource to holders of NiSource common stock completing CPG's separation from NiSource ("the Separation"). As a result of the Separation, CPG became an independent publicly traded company. The Partnership is a guarantor of CPG's senior notes. Through the registration of CPG's senior notes, the Partnership must comply with the reporting requirements of Rule 3-10 of Regulation S-X. The Partnership has suspended its obligations to file periodic reports with the SEC based on CPG’s senior notes and once it has filed its Form 10-K for the year ended December 31, 2016, it will no longer have reporting obligations with respect to CPG’s senior notes. CPG OpCo LP Predecessor (the “Predecessor”) is comprised of NiSource’s Columbia Pipeline Group Operations reportable segment. The Partnership entered into an omnibus agreement with CEG and its affiliates (together with a services agreement with CPGSC) at the closing of CPPL's IPO that addresses (1) centralized corporate, general and administrative services to be provided by CEG for the Partnership and the reimbursement by the Partnership for the Partnership's portion of these services, (2) CPPL's right of first offer for CEG's 84.3% interest in the Partnership, (3) the indemnification of the Partnership for certain potential environmental and toxic tort claims losses and expenses associated with the operation of the assets and occurring before the closing date of the IPO and (4) the Partnership's requirement to guarantee future indebtedness that CPG incurs. The Partnership is engaged in regulated interstate gas transportation and storage services for LDCs, marketers, producers and industrial and commercial customers located in northeastern, mid-Atlantic, midwestern and southern states and the District of Columbia along with unregulated businesses such as midstream services, including gathering, treating, conditioning, processing, compression and liquids handling, and development of mineral rights positions. The regulated services are performed under tariffs at rates subject to FERC approval. CPG Merger. On March 17, 2016, CPG entered into an Agreement and Plan of Merger (the “CPG Merger Agreement”), among CPG, TCPL, US Parent, Taurus Merger Sub Inc., a Delaware corporation and a wholly owned subsidiary of US Parent (“Merger Sub”), and, solely for purposes of Section 3.02, Section 5.02, Section 5.09 and Article VIII of the CPG Merger Agreement, TransCanada. Upon the terms and subject to the conditions set forth in the CPG Merger Agreement, effective July 1, 2016, Merger CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) Sub was merged with and into CPG (the “Merger”) with CPG surviving the Merger as an indirect, wholly owned subsidiary of TransCanada. The Merger did not affect the ownership of the Partnership's general partner or limited partner interests, but the Partnership is indirectly managed by TransCanada after the Merger. The Partnership incurred approximately $114.2 million of Merger related costs within operation and maintenance and property and other taxes, including approximately $104.7 million of employee related costs. Additionally, as a result of the Merger, the Partnership recognized an impairment charge of $18.8 million related to the cancellation of IT system upgrades that were in process prior to the Merger. CPPL Merger. On November 1, 2016, CPPL entered into an agreement and plan of merger (the "CPPL Merger Agreement") with CPG, Pony Merger Sub LLC, a Delaware limited liability company and wholly owned subsidiary of CPG (“Pony Merger Sub”) and MLP GP. The conflicts committee of the board of directors of MLP GP (the “GP Conflicts Committee”) and the board of directors of the MLP GP (the "GP Board") approved the CPPL Merger Agreement and transactions contemplated by the CPPL Merger Agreement and determined that the CPPL Merger Agreement and the merger transactions are fair and reasonable to and in the best interests of CPPL and to the holders of CPPL common units unaffiliated with CPG, CEG and MLP GP (collectively, the “CPPL unaffiliated unitholders”). The GP Conflicts Committee recommended the GP Board approve the CPPL Merger Agreement and the merger transactions. The GP Board resolved that the CPPL Merger Agreement and the merger transactions be submitted to the unitholders of CPPL at a special meeting of the unitholders for approval. The GP Board recommended that the unitholders of CPPL vote in favor of the proposal to approve the CPPL Merger Agreement and the merger transactions at the special meeting of the unitholders. On February 16, 2017, the CPPL common unitholders voted to approve the CPPL Merger. The transaction closed on February 17, 2017 and as of that date CPPL became a wholly owned subsidiary of CPG. The CPPL Merger did not affect the ownership of the Partnership's general partner or limited partner interests. For periods subsequent to the closing of CPPL's IPO, the financial statements included in this annual report are the financial statements and accounting records of the Partnership. For periods prior to the closing of CPPL's IPO, the financial statements included in this annual report are the financial statements and accounting records of the Predecessor. The consolidated and combined financial statements were prepared as follows: • The Consolidated Balance Sheets consist of the consolidated balance sheet of the Partnership as of December 31, 2016 and December 31, 2015. • The Statements of Consolidated and Combined Operations consist of the consolidated results of the Partnership for the year ended December 31, 2016 and for the period February 11, 2015 through December 31, 2015, and the combined results of the Predecessor for the period from January 1, 2015 through February 10, 2015 and for the year ended December 31, 2014. • The Statements of Consolidated and Combined Comprehensive Income consist of the consolidated results of the Partnership for the year ended December 31, 2016 and for the period from February 11, 2015 through December 31, 2015, and the combined results of the Predecessor for the period from January 1, 2015 through February 10, 2015 and for the year ended December 31, 2014. • The Statements of Consolidated and Combined Cash Flows consist of the consolidated cash flows of the Partnership for the year ended December 31, 2016 and for the period from February 11, 2015 through December 31, 2015, and the combined cash flows of the Predecessor for the period from January 1, 2015 through February 10, 2015 and for the year ended December 31, 2014. • The Statements of Consolidated and Combined Equity and Partners' Capital consist of the consolidated activity of the Partnership for the year ended December 31, 2016 and for the period from February 11, 2015 through December 31, 2015, and the combined activity of the Predecessor for the period from January 1, 2015 through February 10, 2015 and for the year ended December 31, 2014. The Partnership’s accompanying Consolidated and Combined Financial Statements have been prepared in accordance with GAAP. These financial statements include the accounts of the following subsidiaries: Columbia Gas Transmission, Columbia Gulf, Columbia Midstream, CEVCO and CNS Microwave. All intercompany transactions and balances have been eliminated. Also included in the Consolidated and Combined Financial Statements are equity method investments Hardy Storage, Millennium Pipeline and Pennant. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) B. Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. C. Cash and Cash Equivalents. Cash and cash equivalents are liquid marketable securities with an original maturity date of less than three months. D. Allowance for Uncollectible Accounts. The reserve for uncollectible receivables is the Partnership's best estimate of the amount of probable credit losses in the existing accounts receivable. Collectability of accounts receivable is reviewed regularly and an allowance is established or adjusted, as necessary, using the specific identification method. Account balances are charged against the allowance when it is anticipated the receivable will not be recovered. E. Basis of Accounting for Rate-Regulated Subsidiaries. Rate-regulated subsidiaries account for and report assets and liabilities consistent with the economic effect of the way in which regulators establish rates, if the rates established are designed to recover the costs of providing the regulated service and it is probable that such rates can be charged and collected. Certain expenses and credits subject to utility regulation or rate determination normally reflected in income are deferred on the Consolidated Balance Sheets and are recognized in income as the related amounts are included in service rates and recovered from or refunded to customers. In the event that regulation significantly changes the opportunity for the Partnership to recover its costs in the future, all or a portion of the Partnership’s regulated operations may no longer meet the criteria for regulatory accounting. In such an event, a write-down of all or a portion of the Partnership’s existing regulatory assets and liabilities could result. If unable to continue to apply the provisions of regulatory accounting, the Partnership would be required to apply the provisions of Discontinuation of Rate-Regulated Accounting. In management’s opinion, the Partnership’s regulated subsidiaries will be subject to regulatory accounting for the foreseeable future. Please see Note 8, "Regulatory Matters," in the Notes to Consolidated and Combined Financial Statements for further discussion. F. Property, Plant and Equipment and Related AFUDC and Maintenance. Property, plant and equipment is stated at cost. The Partnership's rate-regulated subsidiaries record depreciation using composite rates on a straight-line basis over the remaining service lives of the properties as approved by the appropriate regulators. The Partnership's non-regulated companies depreciate assets on a component basis on a straight-line basis over the remaining service lives of the properties. The Partnership capitalizes AFUDC on all classes of property except organization costs, land, autos, office equipment, tools and other general property purchases. The allowance is applied to construction costs for that period of time between the date of the expenditure and the date on which such project is placed in service. A combination of short-term borrowings, long-term debt and equity were used to fund construction efforts for all three years presented. The pre-tax rate for AFUDC debt and AFUDC equity are summarized in the table below: The Partnership follows the practice of charging maintenance and repairs, including the cost of removal of minor items of property, to expense as incurred. When regulated property that represents a retired unit is replaced or removed, the cost of such property is credited to utility plant, and such cost, net of salvage, is charged to the accumulated provision for depreciation in accordance with composite depreciation. G. Gas Stored-Base Gas. Base gas, which is valued at original cost, represents storage volumes that are maintained to ensure that adequate well pressure exists to deliver current gas inventory. There were no purchases of base gas during the years ended December 31, 2016, 2015 and 2014. Gas stored-base gas is included in Property, plant and equipment on the Consolidated Balance Sheets. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) H. Amortization of Software Costs. External and internal costs associated with computer software developed for internal use are capitalized. Capitalization of such costs commences upon the completion of the preliminary stage of each project. Once the installed software is ready for its intended use, such capitalized costs are amortized on a straight-line basis generally over a period of five years. The Partnership amortized $9.7 million in 2016, $5.8 million in 2015 and $4.3 million in 2014 related to software costs. The Partnership’s unamortized software balance was $29.1 million and $27.1 million at December 31, 2016 and 2015, respectively. The increase in software amortization and unamortized software balance is primarily due to software placed in service subsequent to the Separation. The additional software was necessary for CPG to operate as an independent company. I. Goodwill. The Partnership has $1,975.5 million in goodwill. All goodwill relates to the excess of cost over the fair value of the net assets acquired in the CEG acquisition on November 1, 2000. Please see Note 6, "Goodwill," in the Notes to Consolidated and Combined Financial Statements for further discussion. J. Impairments. An impairment loss on long-lived assets shall be recognized only if the carrying amount of a long-lived assets is not recoverable and exceeds its fair value. The test for impairment compares the carrying amount of the long-lived asset to the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. The Partnership recognized an impairment loss of $18.8 million, $0.6 million, and zero for the years ended December 31, 2016, 2015, and 2014, respectively. As a result of the Merger, the Partnership recognized an impairment loss for the year ended December 31, 2016 related to the cancellation of IT system upgrades that were in process prior to the Merger. K. Revenue Recognition. Revenue is recorded as services are performed. Revenues are billed to customers monthly at rates established through the FERC's cost-based rate-making process or at rates less than those allowed by the FERC. Revenues are recorded on the accrual basis and include estimates for transportation provided but not billed. The demand and commodity charges for transportation of gas under long-term agreements are recognized separately. Demand revenues are recognized monthly over the term of the agreement with the customer regardless of the volume of natural gas transported. Commodity revenues for both firm and interruptible transportation are recognized in the period the transportation services are provided based on volumes of natural gas physically delivered at the agreed upon delivery point. The Partnership provides shorter term transportation and storage services for which cash is received at inception of the service period resulting in the recording of deferred revenues that are recognized in revenues over the period the services are provided. Storage capacity revenues are recognized monthly over the term of the agreement with the customer regardless of the volume of storage service actually utilized. Injection and withdrawal revenues are recognized in the period when volumes of natural gas are physically injected into or withdrawn from storage. The Partnership includes the subsidiary CEVCO, which owns the mineral rights to approximately 460,000 acres in the Marcellus and Utica shale areas. CEVCO leases or contributes the mineral rights to producers in return for royalty interest. Royalties from mineral interests are recognized on an accrual basis when earned and realized. Royalty revenue was $21.5 million, $26.5 million and $43.8 million for the years ended December 31, 2016, 2015 and 2014, respectively, and is included in "Other revenues" on the Statements of Consolidated and Combined Operations. The Partnership periodically recognizes gains on the conveyance of mineral interest related to pooling of assets (production rights) in joint undertakings intended to find, develop, or produce oil or gas from a particular property or group of properties. The gains are initially deferred if the Partnership has a substantial obligation for future performance. As the obligation for future performance is satisfied, the deferred revenue is relieved and the associated gain is recognized. Gains on conveyances amounted to $16.9 million, $52.3 million and $34.5 million for the years ended December 31, 2016, 2015 and 2014, respectively, and are included in "Gain on sale of assets" on the Statements of Consolidated and Combined Operations. L. Estimated Rate Refunds. The Partnership collects revenue subject to refund pending final determination in rate proceedings. In connection with such revenues, estimated rate refund liabilities are recorded which reflect management’s current judgment of the ultimate outcomes of the proceedings. No provisions are made when, in the opinion of management, the facts and circumstances preclude a reasonable estimate of the outcome. M. Accounting for Exchange and Balancing Arrangements of Natural Gas. The Partnership enters into balancing and exchange arrangements of natural gas as part of its operations. The Partnership records a receivable or payable for its respective cumulative gas imbalances. These receivables and payables are recorded as “Exchange gas receivable” or “Exchange gas payable” on the Partnership’s Consolidated Balance Sheets, as appropriate. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) N. Income Taxes and Investment Tax Credits. The Partnership is a limited partnership and is treated as a partnership for U.S. federal income tax purposes and therefore, is not liable for entity-level federal income taxes. The Predecessor's operating results were included in NiSource's consolidated U.S. federal and in consolidated, combined or stand-alone state income tax returns. Amounts presented in the combined financial statements prior to CPPL's IPO relate to income taxes that have been determined on a separate tax return basis, and the Predecessor's contribution to NiSource's net operating losses and tax credits have been included in the Predecessor's financial statements. O. Environmental Expenditures. The Partnership accrues for costs associated with environmental remediation obligations when the incurrence of such costs is probable and the amounts can be reasonably estimated, regardless of when the expenditures are actually made. The undiscounted estimated future expenditures are based on currently enacted laws and regulations, existing technology and estimated site-specific costs where assumptions may be made about the nature and extent of site contamination, the extent of cleanup efforts, costs of alternative cleanup methods and other variables. The liability is adjusted as further information is discovered or circumstances change. The reserves for estimated environmental expenditures are recorded on the Consolidated Balance Sheets in “Other Accruals” for short-term portions of these liabilities and “Other noncurrent liabilities” for the respective long-term portions of these liabilities. The Partnership establishes regulatory assets on the Consolidated Balance Sheets to the extent that future recovery of environmental remediation costs is probable through the regulatory process. Please see Note 13, "Other Commitments and Contingencies" in the Notes to Consolidated and Combined Financial Statements for further discussion. P. Accounting for Investments. The Partnership accounts for its ownership interests in Millennium Pipeline using the equity method of accounting. Columbia Gas Transmission owns a 47.5% interest in Millennium Pipeline. The equity method of accounting is applied for investments in unconsolidated companies where the Partnership (or a subsidiary) owns 20 to 50 percent of the voting rights and can exercise significant influence. The Partnership has a 49.0% interest in Hardy Storage. The Predecessor had a 50.0% interest in Hardy Storage. The Partnership and the Predecessor reflect the investment in Hardy Storage as an equity method investment. Columbia Midstream entered into a 50:50 joint venture in 2012 with Hilcorp to construct Pennant, a new wet natural gas gathering infrastructure and NGL processing facilities to support natural gas production in the Utica Shale region of northeastern Ohio and western Pennsylvania. During the third quarter of 2015, an additional member, an affiliate of Williams Partners, joined the Pennant joint venture. Williams Partners' initial ownership investment in Pennant is 5.00%, and by funding specified investment amounts for future growth projects, Williams Partners can invest directly in the growth of Pennant. Such funding will potentially increase Williams Partners' ownership in Pennant up to 33.33% over a defined investment period. As a result of the buy-in, Columbia Midstream received $12.7 million in cash and recorded a gain of $2.9 million, and its ownership interest in Pennant decreased from 50.0% to 47.5%. During 2016, Williams Partners funded additional specified growth projects. As a result, Columbia Midstream's ownership interest decreased to 47.0%. The Partnership accounts for the joint venture under the equity method of accounting. Q. Natural Gas and Oil Properties. CEVCO participates as a working interest partner in the development of a broader acreage dedication. The working interest allows CEVCO to invest in the drilling operations of the partnership in addition to a royalty interest in well production. Please see Note 1K, “Revenue Recognition,” in the Notes to Consolidated and Combined Financial Statements for further discussion regarding the royalty revenue. CEVCO uses the successful efforts method of accounting for natural gas and oil producing activities for their portion of drilling activities. Capitalized well costs are depleted based on the units of production method. CEVCO’s portion of unproved property investment is periodically evaluated for impairment. The majority of these costs generally relate to CEVCO’s portion of the working interest. The costs are capitalized and evaluated as to recoverability, based on changes brought about by economic factors and potential shifts in business strategy employed by management. Impairment of individually significant unproved property is assessed on a field-by-field basis considering a combination of time, geologic and engineering factors. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) The following table reflects the changes in capitalized exploratory well costs for the years ended December 31, 2016 and 2015: As of December 31, 2016, there was $0.3 million of capitalized exploratory well costs that have been capitalized for more than one year relating to one project initiated in 2013. 2. Recent Accounting Pronouncements In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. The Partnership is required to adopt ASU 2017-04 for its annual or any interim goodwill impairment tests for annual periods beginning after December 15, 2019, and the guidance is to be applied on a prospective basis. The Partnership is currently evaluating the impact the adoption of ASU 2017-04 will have on the Consolidated and Combined Financial Statements and Notes to Consolidated and Combined Financial Statements. In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. ASU 2017-01 provides a framework that gives entities a basis for making reasonable judgments about whether a transaction involves an asset or a business. The Partnership is required to adopt ASU 2017-01 for periods beginning after December 15, 2017, including interim periods, and the guidance is to be applied on a prospective basis. The Partnership is currently evaluating the impact the adoption of ASU 2017-01 will have on the Consolidated and Combined Financial Statements and Notes to Consolidated and Combined Financial Statements. In October 2016, the FASB issued ASU 2016-17, Consolidation (Topic 810): Interests Held through Related Parties that are Under Common Control, which amends the guidance on related parties that are under common control. Specifically, ASU 2016-17 requires that a single decision maker consider indirect interest held by related parties under common control on a proportionate basis in a manner consistent with its evaluation of indirect interests held through other related parties. The Partnership is required to adopt ASU 2016-17 for periods beginning after December 15, 2016, including interim periods, and the guidance is to be applied on a retrospective basis. The Partnership is currently evaluating the impact the adoption of ASU 2016-17 will have on the Consolidated and Combined Financial Statements and Notes to Consolidated and Combined Financial Statements but does not anticipate the impact will be material. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 amends the guidance in ASC 230 on the classification of certain cash receipts and payments in the statement of cash flows. The Partnership is required to adopt ASU 2016-15 for periods beginning after December 15, 2017, including interim periods, and the guidance is to be applied retrospectively, with early adoption permitted. The Partnership is currently evaluating the impact the adoption of ASU 2016-15 will have on the Consolidated and Combined Financial Statements or Notes to Consolidated and Combined Financial Statements. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 outlines a single, comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. The core principle of the new standard is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14 to extend the adoption date for ASU 2014-09 to periods beginning after December 15, 2017, including interim periods, and the new standard is to be applied retrospectively, with early adoption permitted on the original effective date of ASU 2014-09 on a limited basis. In March 2016, the FASB issued ASU 2016-08, which amends the principal-versus-agent implementation guidance and illustrations in ASU 2014-09. Among other things, ASU 2016-08 clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. In April 2016, the FASB issued ASU 2016-10, which clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in ASU 2014-09. In May 2016, the FASB issued ASU 2016-12, which contains narrow scope improvements for certain aspects of ASU 2014-09 including collectability, presentation of sales tax and other similar taxes collected from customers, noncash consideration, contract modifications and completed contracts at transition and transition technical correction. The Partnership is currently identifying existing customer contracts or groups of contracts that are within the scope of the new guidance and has begun an assessment in order to determine the impact the adoption of ASU 2014-09, and the related ASUs, will have on the Consolidated and Combined Financial Statements or Notes to Consolidated and Combined Financial Statements. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 introduces a lessee model that brings most leases on the balance sheet. The new standard also aligns many of the underlying principles of the new lessor model with those in ASC 606, the FASB's new revenue recognition standard (e.g., those related to evaluating when profit can be recognized). Furthermore, ASU 2016-02 addresses other concerns related to the current leases model. For example, ASU 2016-02 eliminates the requirement in current U.S. GAAP for an entity to use bright-line tests in determining lease classification. The standard also requires lessors to increase the transparency of their exposure to changes in value of their residual assets and how they manage that exposure. The Partnership is required to adopt ASU 2016-02 for periods beginning after December 15, 2018, including interim periods, with early adoption permitted. The Partnership is currently identifying existing lease agreements that may have an impact on the Consolidated and Combined Financial Statements or Notes to Consolidated and Combined Financial Statements. In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 changes the way entities present debt issuance costs in financial statements by presenting issuance costs on the balance sheet as a direct deduction from the related liability rather than as a deferred charge. Amortization of these costs will continue to be reported as interest expense. In August 2015, the FASB issued ASU 2015-15 to clarify the SEC staff's position on these costs in relation to line-of-credit agreements stating that the SEC staff would not object to an entity deferring and presenting debt issuance costs related to a line-of-credit arrangement as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of such arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit. The Partnership retrospectively adopted ASU 2015-03 and ASU 2015-15 as of January 1, 2016. The adoption of this guidance did not have a material impact on the Consolidated and Combined Financial Statements or Notes to Consolidated and Combined Financial Statements. In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. ASU 2015-02 amends consolidation guidance by including changes to the variable and voting interest models used by entities to evaluate whether an entity should be consolidated. The Partnership retrospectively adopted ASU 2015-02 as of January 1, 2016. The adoption of this guidance did not have a material impact on the Consolidated and Combined Financial Statements or Notes to Consolidated and Combined Financial Statements. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) 3. Transactions with Affiliates Prior to CPG's separation from NiSource, the Partnership engaged in transactions with subsidiaries of NiSource which were deemed to be affiliates of the Partnership. The Partnership continues to engage in transactions with subsidiaries of CPG subsequent to the Separation. These affiliate transactions are summarized in the tables below: Statement of Operations Balance Sheet Transportation, Storage and Other Revenues. Prior to the Separation, the Partnership provided natural gas transportation, storage and other services to subsidiaries of NiSource, the Partnership's former affiliates. Prior to CPPL's IPO, the Predecessor provided similar services to subsidiaries of NiSource. Operation and Maintenance Expense. The Partnership receives executive, financial, legal, information technology and other administrative and general services from CPGSC. Prior to CPPL's IPO, the Predecessor received similar services from NiSource Corporate Services. Expenses incurred as a result of these services consist primarily of employee compensation and benefits, outside services and other expenses. The expenses are charged directly or allocated using various allocation methodologies based on a combination of gross fixed assets, total operating expense, number of employees and other measures. Management believes the allocation methodologies are reasonable. However, these allocations and estimates may not represent the amounts that would have been incurred had the services been provided by an outside entity. Subsequent to the completion of the Merger, the Partnership incurred merger related operation and maintenance expense of $80.7 million primarily related to employee and administrative expenses. Interest Expense and Income. The Partnership and Predecessor were charged interest for long-term debt of $30.3 million, $35.1 million and $61.6 million for the years ended December 31, 2016, 2015 and 2014, respectively, offset by associated AFUDC of $5.1 million, $9.2 million and $2.7 million for the years ended December 31, 2016, 2015 and 2014, respectively. The Partnership and its subsidiaries entered into an intercompany money pool agreement with NiSource Finance, which became effective on the date of CPPL's IPO. Following the Separation, the agreement is now with CPG. The money pool is available for the Partnership and its subsidiaries' general purposes, including capital expenditures and working capital. This intercompany money pool agreement is discussed in connection with Short-term Borrowings below. Prior to CPPL's IPO, the subsidiaries of the Predecessor participated in a similar money pool agreement with NiSource Finance. CPGSC administers the current money pool agreement. The cash accounts maintained by the subsidiaries of the Partnership and the Predecessor were, prior to the Separation, swept into a NiSource corporate account on a daily basis, creating an affiliated receivable or decreasing an affiliated payable, as appropriate, between NiSource and the subsidiary. Subsequent to the Separation, cash accounts maintained by subsidiaries of the Partnership were swept into a CPG corporate account on a daily basis, creating an affiliated receivable or decreasing an affiliated CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) payable, as appropriate, between CPG and the subsidiary. The amount of interest expense and income for short-term borrowings was determined by the net position of each subsidiary in the money pool. The money pool weighted-average interest rate at December 31, 2016 and 2015 was 0.94% and 1.21%, respectively. The interest expense for short-term borrowings charged for the years ended December 31, 2016, 2015 and 2014 was $9.3 million, $0.9 million and $3.1 million, respectively. Accounts Receivable. The Partnership includes in accounts receivable amounts due from the money pool discussed above of $167.4 million and $140.5 million at December 31, 2016 and 2015, respectively, for subsidiaries of the Partnership in a net deposit position. Also included in the balance at December 31, 2016 and December 31, 2015 are amounts due from subsidiaries of CPG for transportation and storage services of $2.5 million and $8.9 million, respectively. Net cash flows related to the money pool receivables are included as Investing Activities on the Statements of Consolidated and Combined Statements of Cash Flows. All other affiliated receivables are included as Operating Activities. Short-term Borrowings. In connection with the closing of CPPL's IPO, the subsidiaries of the Partnership entered into an intercompany money pool agreement with NiSource Finance with $750.0 million of reserved borrowing capacity. Following the Separation, the agreement was with CPG. In furtherance of the money pool agreement, CPG entered into a $1,500.0 million revolving credit agreement on December 5, 2014. Effective July 1, 2016, in connection with the Merger, the $1,500.0 million CPG revolving credit facility was terminated and replaced by a $2,000.0 million revolving credit facility with US Parent. The balance of Short-term Borrowings at December 31, 2016 and December 31, 2015 of $1,432.9 million and $42.1 million, respectively, includes those subsidiaries of the Partnership in a net borrower position of the money pool discussed above. Net cash flows related to Short-term Borrowings are included as Financing Activities on the Statements of Consolidated and Combined Statements of Cash Flows. Accounts Payable. The affiliated accounts payable balance primarily includes amounts due for services received from CPGSC, and interest payable to CPG. Long-term Debt. In May 2015, the Partnership's outstanding intercompany debt transferred from NiSource Finance to CPG. The Partnership's long-term financing requirements are satisfied through borrowings from CPG. On January 31, 2016, the Partnership amended its intercompany credit agreement with CPG to extend the maturity date of the note originating on December 9, 2013 from December 31, 2016 to December 31, 2020. The Partnership may borrow at any time from the origination date to December 31, 2016 not to exceed $2.6 billion. From January 1, 2017 to December 31, 2020, the Partnership may borrow at any time not to exceed $2.3 billion. As of the January 2016 amendment, the note carries a fixed interest rate of 4.70% for the outstanding borrowings as of December 31, 2016. Details of the long-term debt balance are summarized in the table below: Dividends. During the year ended December 31, 2016, the Partnership distributed $573.0 million to the limited partners. During the year ended December 31, 2015, the Partnership distributed $722.2 million to the limited partners, of which $500.0 million was a reimbursement of preformation capital expenditures with respect to the assets contributed to the Partnership. The Predecessor paid no dividends to CEG in the year ended December 31, 2014. There were no restrictions on the payment of distributions by the Partnership. 4. Gain on Sale of Assets The Partnership recognizes gains on conveyances of mineral rights positions into earnings as any obligation associated with conveyance is satisfied. For the years ended December 31, 2016, 2015 and 2014, gains on conveyances amounted to $16.9 million, $52.3 million and $34.5 million, respectively, and are included in "Gain on sale of assets" on the Statements of Consolidated and Combined Operations. Included in the gains on conveyances is a cash bonus payment of $9.0 million and $35.8 million received by CEVCO during the years ended December 31, 2016 and 2015, respectively, for the lease of Utica Shale and Upper Devonian gas rights in Greene and Washington Counties in Pennsylvania and Marshall and Ohio Counties in West Virginia. As of December 31, 2016 and 2015, deferred gains of approximately $0.3 million and $8.1 million, respectively, were deferred pending performance of future obligations and recorded in "Deferred revenue" on the Consolidated Balance Sheets. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) 5. Property, Plant and Equipment The Partnership’s property, plant and equipment on the Consolidated and Combined Balance Sheets are classified as follows: The table below lists the Partnership's applicable annual depreciation rates: 6. Goodwill The Partnership tests its goodwill for impairment annually as of May 1 unless indicators, events, or circumstances would require an immediate review. Goodwill is tested for impairment using financial information at the reporting unit level, referred to as the Columbia Gas Transmission Operations reporting unit, which is consistent with the level of discrete financial information reviewed by management. The Columbia Gas Transmission Operations reporting unit includes the following entities: Columbia Gas Transmission (including its equity method investment in the Millennium Pipeline joint venture), Columbia Gulf and the equity method investment in Hardy Storage. All of the Partnership's goodwill relates to NiSource's acquisition of CEG in 2000, which was contributed to the Partnership prior to the IPO. The Partnership's goodwill assets at December 31, 2016 and December 31, 2015 were $1,975.5 million. The Predecessor completed a quantitative ("step 1") fair value measurement of the reporting unit during the May 1, 2012 goodwill test. The test indicated that the fair value of the reporting unit substantially exceeded the carrying value, indicating that no impairment existed. In estimating the fair value of Columbia Gas Transmission Operations for the May 1, 2012 test, the Partnership used a weighted average of the income and market approaches. The income approach utilized a discounted cash flow model. This model was based on management’s short-term and long-term forecast of operating performance for each reporting unit. The two main assumptions used in the models were the growth rates, which were based on the cash flows from operations for the reporting unit, and the weighted average cost of capital, or discount rate. The starting point for the reporting unit’s cash flow from operations was the detailed five year plan, which takes into consideration a variety of factors such as the current economic environment, industry trends, and specific operating goals set by management. The discount rates were based on trends in overall market as well as industry specific variables and include components such as the risk-free rate, cost of debt, and company volatility at May 1, 2012. Under the market approach, the Partnership utilized three market-based models to estimate the fair value of the reporting unit: CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) (i) the comparable company multiples method, which estimated fair value of the reporting unit by analyzing EBITDA multiples of a peer group of publicly traded companies and applying that multiple to the reporting unit’s EBITDA, (ii) the comparable transactions method, which valued the reporting unit based on observed EBITDA multiples from completed transactions of peer companies and applying that multiple to the reporting unit’s EBITDA, and (iii) the market capitalization method, which used the NiSource share price and allocated NiSource’s total market capitalization among both the goodwill and non-goodwill reporting units based on the relative EBITDA, revenues, and operating income of each reporting unit. Each of the three market approaches were calculated with the assistance of a third-party valuation firm, using multiples and assumptions inherent in today’s market. The degree of judgment involved and reliability of inputs into each model were considered in weighting the various approaches. The resulting estimate of fair value of the reporting unit, using the weighted average of the income and market approaches, exceeded its carrying value, indicating that no impairment exists under step 1 of the annual impairment test. Certain key assumptions used in determining the fair value of the reporting unit included planned operating results, discount rates and the long-term outlook for growth. In 2012, the Partnership used the discount rate of 5.60% for Columbia Gas Transmission Operations, resulting in excess fair value of approximately $1,643.0 million. GAAP allows entities testing goodwill for impairment the option of performing a qualitative ("step 0") assessment before calculating the fair value of a reporting unit for the goodwill impairment test. If a step 0 assessment is performed, an entity is no longer required to calculate the fair value of a reporting unit unless the entity determines that, based on that assessment, it is more likely than not that its fair value is less than its carrying amount. The Partnership applied the qualitative step 0 analysis to the reporting unit for the annual impairment test performed as of May 1, 2016. For the current year test, the Partnership assessed various assumptions, events and circumstances that would have affected the estimated fair value of the reporting unit as compared to its base line May 1, 2012 step 1 fair value measurement. The recent CPG Merger Agreement and acquisition price were incorporated into the current year testing. The results of this assessment indicated that it is not more likely than not that the reporting unit fair value is less than the reporting unit carrying value. The Partnership considered whether there were any events or changes in circumstances subsequent to the annual test that would reduce the fair value of the reporting unit below its carrying amount and necessitate another goodwill impairment test. On November 1, 2016, CPPL announced that it entered into an agreement and plan of merger with CPG, in which CPG will acquire all outstanding common units of CPPL. The acquisition price leads to a similar valuation of the Partnership as that provided for in the CPG Merger Agreement, providing further evidence that it is not more likely than not that the reporting unit fair value is less than the reporting unit carrying value. In consideration of all relevant factors, there were no indicators that would require goodwill impairment testing subsequent to May 1, 2016. 7. Asset Retirement Obligations Changes in the Partnership’s liability for asset retirement obligations for the years 2016 and 2015 are presented in the table below: (1) Reflects the removal of amounts related to Crossroads Pipeline Company, which was included in the Predecessor, but was not contributed to the Partnership. The asset retirement obligations above relate to the modernization program of pipelines and transmission facilities, the retiring of offshore facilities, polychlorinated biphenyl ("PCB") remediation and asbestos removal at several compressor and measuring stations. The Partnership recognizes that certain assets, which include gas pipelines and natural gas storage wells, will operate for an indeterminate future period when properly maintained. A liability for these asset retirement obligations will be recorded only if and when a future retirement obligation with a determinable life is identified. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) 8. Regulatory Matters Regulatory Assets and Liabilities Current and noncurrent regulatory assets and liabilities were comprised of the following items: No regulatory assets are earning a return on investment at December 31, 2016. Regulatory assets of $8.6 million are covered by specific regulatory orders and are being recovered as components of cost of service over a remaining life of up to 6 years. Assets: Unrecognized pension benefit and other postretirement benefit costs - In 2007, the Predecessor adopted certain updates of ASC 715 which required, among other things, the recognition in other comprehensive income or loss of the actuarial gains or losses and the prior service costs or credits that arise during the period but that are not immediately recognized as components of net periodic benefit costs. Certain subsidiaries defer the costs as a regulatory asset in accordance with regulatory orders to be recovered through base rates. Other postretirement costs - Primarily comprised of costs approved through rate orders to be collected through future base rates, revenue riders or tracking mechanisms. Liabilities: Cost of removal - Represents anticipated costs of removal that have been, and continue to be, included in depreciation rates and collected in the service rates of some rate-regulated subsidiaries for future costs to be incurred. Regulatory effects of accounting for income taxes - Represents amounts related to state income taxes collected at a higher rate than the current statutory rates assumed in rates, which is being amortized to earnings in association with depreciation on related property. The regulatory liability was not contributed to the Partnership as the Partnership is not subject to income tax at the partnership level. Modernization revenue sharing - Represents amounts related to the revenue sharing mechanism within the Columbia Gas Transmission modernization program. The revenue sharing mechanism requires Columbia Gas Transmission to share 75% of specified revenues in excess of an annual threshold. Other postretirement costs - Primarily represents amounts being collected through rates in excess of the GAAP expense on a cumulative basis. In addition, according to regulatory order, a certain level of benefit expense is recognized in the Partnership’s results, which exceeds the amount funded in the plan. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) Regulatory Matters Columbia Gas Transmission Customer Settlement. On January 24, 2013, the FERC approved the Columbia Gas Transmission Customer Settlement (the "MOD I Settlement"). In March 2013, Columbia Gas Transmission paid $88.1 million in refunds to customers pursuant to the MOD I Settlement with its customers in conjunction with its comprehensive interstate natural gas pipeline modernization program. The refunds were made as part of the MOD I Settlement, which included a $50.0 million refund to max rate contract customers and a base rate reduction retroactive to January 1, 2012. Columbia Gas Transmission expects to invest approximately $1.5 billion over a five-year period, which began in 2013, to modernize its system to improve system integrity and enhance service reliability and flexibility. The MOD I Settlement with firm customers included an initial five-year term with provisions for potential extensions thereafter. The MOD I Settlement also provided for a depreciation rate reduction to 1.5% and elimination of negative salvage rate effective January 1, 2012 and for a second base rate reduction, which began January 1, 2014, which equates to approximately $25.0 million in revenues annually thereafter. The MOD I Settlement includes a CCRM, a tracker mechanism that will allow Columbia Gas Transmission to recover, through an additive capital demand rate, its revenue requirement for capital investments made under Columbia Gas Transmission's long-term plan to modernize its interstate transmission system. The CCRM provides for a 14.0% revenue requirement with a portion designated as a recovery of taxes other than income taxes. The additive demand rate is earned on costs associated with projects placed into service by October 31 each year. The initial additive demand rate was effective on February 1, 2014. The CCRM will give Columbia Gas Transmission the opportunity to recover its revenue requirement associated with a $1.5 billion investment in the modernization program. The CCRM recovers the revenue requirement associated with qualifying modernization costs that Columbia Gas Transmission incurs after satisfying the requirement associated with $100.0 million in annual maintenance capital expenditures. The CCRM applies to Columbia Gas Transmission's transportation shippers. The CCRM will not exceed $300.0 million per year in investment in eligible facilities, subject to a 15.0% annual tolerance and a total cap of $1.5 billion for the entire five-year initial term. On January 31, 2017, Columbia Gas Transmission received FERC approval of its December 2016 filing to recover costs associated with the fourth year of its comprehensive system modernization program. In 2016, Columbia Gas Transmission placed approximately $330.0 million in modernization investments into service, bringing the total gross investment to approximately $1.3 billion over the four year period. The program includes replacement of bare steel and wrought iron pipeline and compressor facilities, enhancements to system inspection capabilities and improvements in control systems. In December 2015, Columbia Gas Transmission filed an extension of this MOD I Settlement and has requested FERC’s approval of the customer agreement by March 31, 2016. On March 17, 2016, Columbia Gas Transmission received approval from the Commission of its December 18, 2015 filing for the Modernization II Settlement (the "MOD II Settlement"). The MOD II Settlement continues a rate mechanism that was designed to enable Columbia Gas Transmission to recover costs associated with a multi-year modernization program focused on replacing, rehabilitating and/or rebuilding critical pipeline infrastructure and ensuring the safety and reliability of the Columbia Gas Transmission system. The MOD II Settlement preserves and extends the core elements of the MOD I Settlement between Columbia Gas Transmission and its shippers that addressed previous modernization issues on the Columbia Gas Transmission system for three additional years. Columbia Gas Transmission expects to invest approximately $1.1 billion over the three-year extension period. Among other things, the MOD II Settlement preserves the MOD I Settlement’s $60.0 million base rate reduction and extends for a second term the CCRM that allows Columbia Gas Transmission to make annual limited filings under Section 4 of the Natural Gas Act to charge an additive capital demand rate in order to recover the revenue requirement related to certain eligible projects. The MOD II Settlement includes an additional reduction in base rates equal to approximately $8.4 million annually effective as of January 1, 2016, discontinuing the collection of OPEB costs no longer required because of the substantial over-recovered position, and a further base rate reduction equal to approximately $12.4 million annually for a 6-year period also beginning January 1, 2016, which basically refunds amounts to customers as a result of the over-collection of OPEB costs. Columbia Gas Transmission's base rates will reset effective February 1, 2019, without the need for a rate case, and a simultaneous reduction in those base rates equal to $7.5 million annually. The MOD II Settlement includes a one-time $5.0 million settlement payment effective after FERC’s approval of the 5th year CCRM for recovery under the first phase; payment would not be expected until 2018, and a revenue sharing mechanism, which requires Columbia Gas Transmission to share 50.0% of specified revenues in CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) excess of an annual threshold. Columbia Gas Transmission has agreed to maintain a transmission depreciation rate of 1.5%, a storage depreciation rate of 2.2%, a negative salvage rate of zero percent and a moratorium through January 31, 2022 to changes in Columbia Gas Transmission’s base rates. The MOD II Settlement includes specified storage projects as eligible facilities whereby Columbia Gas Transmission may undertake construction of additional eligible facility projects in 2016-2017, with cost recovery on those projects beginning in 2019. Columbia Gulf. On January 21, 2016, the FERC issued an Order (the "January 21 Order") initiating an investigation pursuant to Section 5 of the NGA to determine whether Columbia Gulf's existing rates for jurisdictional services are unjust and unreasonable. Columbia Gulf filed a cost and revenue study with the FERC on April 5, 2016, as required by the January 21 Order. The January 21 Order directed that a hearing be conducted pursuant to an accelerated timeline and that an initial decision be issued by February 28, 2017. On June 13, 2016, the FERC trial staff, Columbia Gulf, and all of the active parties filed a Joint Motion to Suspend the Procedural Schedule and Waive Answer Period (the "Motion"). The Motion represents that the parties unanimously support the Motion and requested waiver of the answer period, which was granted. The parties reached an agreement in principle during a June 2, 2016 settlement conference that would fully resolve all matters set for hearing by the FERC. The Motion represents that the parties expect to file an offer of settlement memorializing the agreement in principle no later than July 29, 2016, and suspension of the procedural schedule will promote an efficient and speedy resolution of this matter by allowing the participants to focus their efforts on drafting the necessary settlement documents. Columbia Gulf filed the offer of settlement with the FERC in accordance with the agreement noted above. On August 15, 2016, the administrative law judge issued a Certification of Uncontested Settlement, which noted that no parties objected to the provisions in the offer of settlement. On September 22, 2016, the FERC issued an order approving the uncontested settlement, which requires a reduction in Columbia Gulf’s daily maximum recourse rate and addresses Columbia Gulf’s treatment of postretirement benefits other than pensions, pension expenses, and regulatory expenses. The order also requires Columbia Gulf to file a general rate case under section 4 of the NGA by January 31, 2020, for rates to take effect by August 1, 2020. Other terms of the settlement are included in FERC Docket No. RP16-302-000. Cost Recovery Trackers and other similar mechanisms. Under section 4 of the NGA, the FERC allows for the recovery of certain operating costs of our interstate transmission and storage companies that are significant and recurring in nature via cost tracking mechanisms. These tracking mechanisms allow the transmission and storage companies’ rates to fluctuate in response to changes in certain operating costs or conditions as they occur to facilitate the timely recovery of costs incurred. The tracking mechanisms involve a rate adjustment that is filed at a predetermined frequency, typically annually, with the FERC and is subject to regulatory review before new rates go into effect. A significant portion of our revenues and expenses are related to the recovery of costs under these tracking mechanisms. The associated costs for which we are obligated are reported in operating expenses with the offsetting recoveries reflected in revenues. These costs include: third-party transportation, electric compression, and certain approved operational purchases of natural gas. The tracking of certain environmental costs ended in 2015. Additionally, we recover fuel for company used gas and lost and unaccounted for gas through in-kind trackers where a retainage rate is charged to each customer to collect fuel. The recoveries and costs are both reflected in operating expenses. 9. Equity Method Investments Certain investments of the Partnership are accounted for under the equity method of accounting. These investments are recorded within "Unconsolidated Affiliates" on the Partnership's Consolidated and Combined Balance Sheets and the Partnership's portion of the results are reflected in "Equity Earnings in Unconsolidated Affiliates" on the Partnership's Statements of Consolidated and Combined Operations. In the normal course of business, the Partnership engages in various transactions with these unconsolidated affiliates. The Partnership billed approximately $10.5 million and $13.1 million to Millennium Pipeline for services and other costs during the years ended December 31, 2016 and 2015, respectively. Contributions are made to these equity investees to fund the Partnership's share of projects. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) The following is a list of the Partnership's equity method investments at December 31, 2016: CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) As the Millennium Pipeline, Hardy Storage and Pennant investments are considered, in aggregate, material to the Partnership's business, the following table contains condensed summary financial data. (1)Contribution and distribution data represents the Partnership's portion based on the Partnership's ownership percentage of each investment. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) 10. Income Taxes The components of income tax expense were as follows: Total income taxes were different from the amount that would be computed by applying the statutory federal income tax rate to book income before income tax. The major reasons for this difference were as follows: The effective income tax rates were zero, 4.3%, and 38.2% in 2016, 2015 and 2014, respectively. The effective tax rate for 2016 and 2015 differs from the federal tax rate of 35% primarily due to the income received following CPPL's IPO that is not subject to income tax at the partnership level. The effective tax rate is impacted by CPPL’s IPO which modified the ownership structure and now reflects partnership earnings for which the limited partners are directly responsible for the related income taxes. The effective tax rate for 2015 also differs from the federal tax rate of 35% due to the effects of tax credits, state income taxes, utility rate-making, as well as other permanent book-to-tax differences. The effective tax rate for 2014 differs from the federal tax rate of 35% primarily due to the effects of tax credits, state income taxes, utility rate-making, as well as other permanent book-to-tax differences. Net earnings for financial statement purposes may differ significantly from taxable income reportable to limited partners as a result of differences between the tax basis and financial basis of assets and liabilities, differences between the tax accounting and financial accounting treatment of certain items. The Partnership had no unrecognized tax benefits related to uncertain tax positions as of December 31, 2016 and 2015. As of December 31, 2014, the Predecessor financial statements included no unrecognized tax benefits. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) Deferred income taxes result from temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The principal components of the Partnership’s net deferred tax liability were as follows: 11. Pension and Other Postretirement Benefits CPG provides defined contribution plans and noncontributory defined benefit retirement plans that cover employees of subsidiaries of the Partnership. Prior to the Separation, employees of subsidiaries of the Partnership were covered by defined contributions plans and noncontributory defined benefit plans provided by NiSource. Benefits under the defined benefit retirement plans reflect the employees’ compensation, years of service and age at retirement. Additionally, CPG provides health care and life insurance benefits for certain retired employees of subsidiaries of the Partnership. The majority of employees may become eligible for these benefits if they reach retirement age while working for subsidiaries of the Partnership. The expected cost of such benefits is accrued during the employees’ years of service. Current rates charged to customers of subsidiaries of the Partnership include postretirement benefit costs. Cash contributions are remitted to tax-qualified trusts. As of July 1, 2015, in connection with the Separation, accrued pension and postretirement benefit obligations for subsidiaries of the Partnership participants and related plan assets were transferred from NiSource to CPG. Subsidiaries of the Partnership are participants in the consolidated CPG defined benefit retirement plans ("the Plans"), and therefore, subsidiaries of the Partnership are allocated a ratable portion of CPG's trusts for the Plans in which its employees and retirees participate. As a result, the Partnership follows multiple employer accounting under the provisions of GAAP. Pension and Other Postretirement Benefit Plans’ Asset Management. CPG employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and asset class volatility. The investment portfolio contains a diversified blend of equity and fixed income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, small and large capitalizations. Derivatives may be used to gain market exposure in an efficient and timely manner; however, derivatives may not be used to leverage the portfolio beyond the market value of the underlying assets. Investment risk is measured and monitored on an ongoing basis through quarterly investment portfolio reviews, annual liability measurements, and periodic asset/liability studies. To establish a long-term rate of return for plan assets assumption, past historical capital market returns and a proprietary forecast are evaluated. The long-term historical relationships between equities and fixed income are analyzed to ensure that they are consistent with the widely accepted capital market principle that assets with higher volatility generate greater return over the long run. Current market factors such as inflation and interest rates are evaluated before long-term capital market assumptions are determined. Peer data and historical returns are reviewed to check for reasonability and appropriateness. The most important component of an investment strategy is the portfolio asset mix, or the allocation between the various classes of securities available to the pension and other postretirement benefit plans for investment purposes. The asset mix and acceptable minimum and maximum ranges established for the CPG plan assets represents a long-term view and are listed in the following table. In 2016, a revised asset allocation policy for the pension fund was approved. This policy calls for a gradual reduction in the allocation to return-seeking assets (equities, private equity and hedge funds) and a corresponding increase in the allocation to liability-hedging assets (fixed income) as the funded status (as measured by the projected benefit obligation of the qualified pension plan divided by the market value of qualified pension plan assets) increases. The asset mix and acceptable minimum and maximum ranges established by the policy for the pension fund at the pension plans funded status on December 31, 2016 are as follows: CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) Asset Mix Policy of Funds: Pension Plan and Postretirement Plan Asset Mix at December 31, 2016 and December 31, 2015: The categorization of investments into the asset classes in the table above are based on definitions established by the CPG Benefits Committee. Fair Value Measurements. The following table sets forth, by level within the fair value hierarchy, the CPG Pension Plan Trust and OPEB investment assets at fair value as of December 31, 2016 and 2015. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Total CPG Pension Plan Trust and OPEB investment assets at fair value classified within Level 3 were zero as of December 31, 2016 and December 31, 2015. Valuation Techniques Used to Determine Fair Value: Level 1 Measurements Most common and preferred stock are traded in active markets on national and international securities exchanges and are valued at closing prices on the last business day of each period presented. Cash is stated at cost which approximates their fair value, with the exception of cash held in foreign currencies which fluctuates with changes in the exchange rates. Government bonds, short-term bills and notes are priced based on quoted market values. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) Level 2 Measurements Most U.S. Government Agency obligations, mortgage/asset-backed securities, and corporate fixed income securities are generally valued by benchmarking model-derived prices to quoted market prices and trade data for identical or comparable securities. To the extent that quoted prices are not available, fair value is determined based on a valuation model that includes inputs such as interest rate yield curves and credit spreads. Securities traded in markets that are not considered active are valued based on quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. Other fixed income includes futures and options which are priced on bid valuation or settlement pricing. Level 3 Measurements Commingled funds that hold underlying investments that have prices which are not derived from the quoted prices in active markets are classified as Level 3. The respective fair values of these investments are determined by reference to the funds' underlying assets, which are principally marketable equity and fixed income securities. Units held in commingled funds are valued at the unit value as reported by the investment managers. These investments are often valued by investment managers on a periodic basis using pricing models that use market, income, and cost valuation methods. The hedge funds of funds invest in several strategies including fundamental long/short, relative value, and event driven. Hedge fund of fund investments may be redeemed annually, usually with 100 days' notice. Private equity investment strategies include buy-out, venture capital, growth equity, distressed debt, and mezzanine debt. Private equity investments are held through limited partnerships. Limited partnerships are valued at estimated fair market value based on their proportionate share of the partnership's fair value as recorded in the partnerships' audited financial statements. Partnership interests represent ownership interests in private equity funds and real estate funds. Real estate partnerships invest in natural resources, commercial real estate and distressed real estate. The fair value of these investments is determined by reference to the funds' underlying assets, which are principally securities, private businesses, and real estate properties. The value of interests held in limited partnerships, other than securities, is determined by the general partner, based upon third-party appraisals of the underlying assets, which include inputs such as cost, operating results, discounted cash flows and market based comparable data. Private equity and real estate limited partnerships typically call capital over a 3 to 5 year period and pay out distributions as the underlying investments are liquidated. The typical expected life of these limited partnerships is 10-15 years and these investments typically cannot be redeemed prior to liquidation. Net Asset Value Measurements Commingled funds that hold underlying investments that have prices which are derived from the quoted prices in active markets are measure at net asset value. The funds' underlying assets are principally marketable equity and fixed income securities. Units held in commingled funds are valued at the unit value as reported by the investment managers. The fair value of the investments in commingled funds has been estimated using the net asset value per share of the investments. For the year ended December 31, 2016, there were no significant changes to valuation techniques to determine the fair value of CPG's pension and other postretirement benefits' assets. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) The following table reflects the Partnership's allocation of pension and other postretirement benefit amounts: (1)This class represents pending trades with brokers. (2)This class of investments is measured at fair value using the net asset value per share and has not been classified in the fair value hierarchy. The table below sets forth a summary of unfunded commitments, redemption frequency and redemption notice periods for certain investments that are measured at fair value using the net asset value per share for the year ended December 31, 2016: CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) The following table reflects the Partnership's allocation of pension and other postretirement benefit amounts: (1)This class represents pending trades with brokers. (2)This class of investments is measured at fair value using the net asset value per share and has not been classified in the fair value hierarchy. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) The table below sets forth a summary of changes in the fair value of the Plan’s Level 3 assets for the year ended December 31, 2015: (1)Level 3 assets were not contributed to the Plans upon Separation from NiSource and no subsequent investments were made in Level 3 assets post Separation. The table below sets forth a summary of unfunded commitments, redemption frequency and redemption notice periods for certain investments that are measured at fair value using the net asset value per share for the year ended December 31, 2015: As noted above, the Partnership follows multiple employer accounting under the provisions of GAAP and therefore, is allocated a ratable portion of the CPG’s grantor trusts for the plans in which its employees and retirees participate. The allocation of the fair value of assets is based upon the ratable share of plan funding and participant benefit payments. Investment activity within the trust occurs at the trust level, and the Partnership is allocated a portion of investment gains and losses based on its percentage of the total CPG projected benefit obligation. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) CPG Pension and Other Postretirement Benefit Plans’ Funded Status and Related Disclosure. The following table provides a reconciliation of the plans’ funded status and amounts reflected in the Partnership’s Consolidated and Combined Balance Sheets at December 31 based on a December 31 measurement date: (1)The change in benefit obligation for Pension Benefits represents the change in Projected Benefit Obligation while the change in benefit obligation for Other Postretirement Benefits represents the change in Accumulated Postretirement Benefit Obligation. (2)Reflects the removal of amounts related to Crossroads Pipeline Company and CPGSC, which were included in the Predecessor, but were not contributed to the Partnership, as well as the inclusion of CNS Microwave, which was not part of the Predecessor. (3)The Partnership recognizes in its Consolidated and Combined Balance Sheets the underfunded and overfunded status of its defined benefit postretirement plans, measured as the difference between the fair value of the plan assets and the benefit obligation. (4)The Partnership determined that the future recovery of pension and other postretirement benefits costs is probable. The Partnership recorded regulatory assets and liabilities of $107.3 million and zero, respectively, as of December 31, 2016, and $127.1 million and $0.6 million, respectively, as of December 31, 2015 that would otherwise have been recorded to accumulated other comprehensive loss. The Partnership’s accumulated benefit obligation for its pension plans was $304.2 million and $327.6 million as of December 31, 2016 and 2015, respectively. The accumulated benefit obligation as of a date is the actuarial present value of benefits attributed by the pension benefit formula to employee service rendered prior to that date and based on current and past compensation levels. The Partnership's pension plans were underfunded by $22.4 million at December 31, 2016, compared to being underfunded by $33.3 million by December 31, 2015. The improvement in the funded status is due primarily to the return on plan assets. The Partnership contributed $1.8 million and $16.5 million to its pension plans in 2016 and 2015, respectively. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) During 2016, the Partnership's funded status for its other postretirement benefit plans improved by $4.9 million to an overfunded status of $125.4 million primarily due to the return on plan assets, offset by a decrease in the discount rates in 2016 compared to 2015. The Partnership received a reimbursement of approximately $0.6 million in 2016 and contributed approximately $11.3 million to its other postretirement benefit plans in 2015. No amounts of the Partnership’s pension or other postretirement benefit plans’ assets are expected to be returned to CPG or any of its subsidiaries in 2017. In 2016, CPG's pension plans had year to date lump sum payouts exceeding the plans' 2016 service cost plus interest cost due to Merger related payouts as well as the non-qualified pension plan being terminated in connection with the Merger. As a result, settlement accounting was required and CPG recorded a settlement charge of $7.5 million for the year ended December 31, 2016. The following table provides the key assumptions that were used to calculate the pension and other postretirement benefits obligations for the Partnership’s various plans as of December 31: Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: The Partnership expects to make contributions of zero dollars to its pension plan and approximately $1.3 million to its postretirement medical and life plans in 2017. The following table provides benefits expected to be paid in each of the next five fiscal years, and in the aggregate for the five fiscal years thereafter. The expected benefits are estimated based on the same assumptions used to measure the Partnership's benefit obligation at the end of the year and includes benefits attributable to the estimated future service of employees: CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) The following table provides the components of the plans’ net periodic benefits cost for the years ended December 31, 2016, 2015 and 2014: The $12.0 million increase in the actuarially-determined pension benefit cost (income) is due primarily to the settlement charge and a decrease in the expected return on plan assets in 2016 compared to 2015. For its other postretirement benefit plans, the Partnership recognized $9.2 million in net periodic benefit income in 2016 compared to net periodic benefit income of $12.5 million in 2015 due primarily to a decrease in the expected return on plan assets in 2016 compared to 2015. The following table provides the key assumptions that were used to calculate the net periodic benefits cost for the Partnership’s various plans: The Partnership believes it is appropriate to assume an 7.29% and 6.81% rate of return on pension and other postretirement plan assets, respectively, for its calculation of 2016 pension benefits cost. This is primarily based on asset mix and historical rates of return. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) The following table provides other changes in plan assets and projected benefit obligations recognized in other comprehensive income or regulatory asset or liability: Based on a December 31, 2016 measurement date, the net unrecognized actuarial (gain) loss, unrecognized prior service cost (credit), and unrecognized transition obligation that will be amortized into net periodic benefit cost during 2017 for the pension plans are $8.1 million, $(0.9) million and zero, respectively, and for other postretirement benefit plans are $0.4 million, $0.1 million and zero, respectively. 12. Fair Value The Partnership has certain financial instruments that are not measured at fair value on a recurring basis but nevertheless are recorded at amounts that approximate fair value due to their liquid or short-term nature, including cash and cash equivalents, customer deposits, and short-term borrowings-affiliated. The Partnership’s long-term debt-affiliated is recorded at historical amounts. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate fair value. Long-term debt-affiliated. The fair value of these securities is estimated based on the quoted market prices for similar issues or on the rates offered for securities of the same remaining maturities. On January 31, 2016, the Partnership amended its intercompany credit agreement to extend the maturity date and apply a fixed interest rate. Prior to this amendment, the fair value approximated carrying value as these securities bore interest at variable rates. These fair value measurements are classified as Level 2 within the fair value hierarchy. For the years ended December 31, 2016 and 2015, there were no changes in the method or significant assumptions used to estimate the fair value of the financial instruments. The carrying amount and estimated fair values of financial instruments were as follows: CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) 13.Other Commitments and Contingencies A.Guarantees and Indemnities. In the normal course of its business, the Partnership and certain subsidiaries enter into various agreements providing financial or performance assurance to third parties on behalf of the parent or certain subsidiaries. Such agreements include guarantees and stand-by letters of credit. These agreements are entered into primarily to support or enhance the creditworthiness otherwise attributed to the parent or a subsidiary on a stand-alone basis, thereby facilitating the extension of sufficient credit to accomplish the parent or the subsidiaries' intended commercial purposes. The total guarantees and indemnities in existence at December 31, 2016 and the years in which they expire were: Guarantees of Debt. The Partnership, together with CEG and OpCo GP (the "Guarantors"), have guaranteed payment of $2,750.0 million in aggregated principal amount of CPG's senior notes. Each Guarantor is required to comply with covenants under the debt indenture and in the event of default the Guarantors would be obligated to pay the debt's principal and related interest. The Partnership does not anticipate that it will have any difficulty maintaining compliance. The guarantees of any Guarantor may be released under certain circumstances. Lines and Letters of Credit. CPPL maintained a $500.0 million senior revolving credit facility, of which $50.0 million was available for issuance of letters of credit. The Partnership, together with CPG, CEG and OpCo GP, each fully guaranteed the CPPL credit facility. On June 29, 2016, in anticipation of the Merger, all outstanding borrowings, facility fees and interest were paid in full and the revolving credit facility was terminated. CPG maintained a $1,500.0 million senior revolving credit facility, of which $250.0 million in letters of credit was available. The Partnership, together with CEG and OpCo GP, each fully guaranteed the CPG credit facility. On July 1, 2016, in connection with the Merger, all existing letters of credit were migrated to a TransCanada credit facility and the CPG revolving credit facility was terminated. CPG's commercial paper program (the “Program”) had a program limit up to $1,000.0 million. The Partnership, together with CEG and OpCo GP, each agreed, jointly and severally, unconditionally and irrevocably to guarantee payment in full of the principal of and interest (if any) on the promissory notes. On June 30, 2016, in anticipation of the Merger, the Program was terminated. CPG had no Promissory Notes outstanding under the Program at the time of termination. Other Legal Proceedings. In the normal course of its business, the Partnership has been named as a defendant in various legal proceedings. In the opinion of management, the ultimate disposition of these currently asserted claims will not have a material impact on the Partnership’s consolidated and combined financial statements. B.Environmental Matters. The Partnership's operations are subject to environmental statutes and regulations related to air quality, water quality, hazardous waste and nonhazardous waste. Historically, the Partnership’s environmental compliance costs have not had a material adverse effect on its results of operations; but there can be no assurance that such costs will not be material in the future or that such compliance with existing, amended or new legal requirements will not have a material adverse effect on the Partnership’s business and operating results. It is the Partnership's continued intent to address environmental issues in cooperation with regulatory authorities in such a manner as to achieve mutually acceptable compliance plans. However, there can be no assurance that fines and penalties will not be incurred. The Partnership records accruals to cover environmental remediation at various sites. The current portion of this accrual is included in “Other accruals” in the Consolidated Balance Sheets. The noncurrent portion is included in “Other noncurrent liabilities” in the Consolidated Balance Sheets. Air The Clean Air Act ("CAA") and comparable state laws regulate emissions of air pollutants from various industrial sources, including compressor stations, and also impose various monitoring and reporting requirements. Such laws and regulations may require pre-approval for the construction or modification of certain projects or facilities expected to produce air emissions or result in an increase of existing air emissions; application for, and strict compliance with, air permits containing various emissions and operational limitations; or the utilization of specific emission control technologies to limit emissions. The actions listed below CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) could require further reductions in emissions from various emission sources. The Partnership will continue to closely monitor developments in these matters. National Ambient Air Quality Standards ("NAAQS"). The federal CAA requires the United States Environmental Protection Agency ("EPA") to set NAAQS for particulate matter and five other pollutants considered harmful to public health and the environment. Periodically, the EPA imposes new or modifies existing NAAQS. States that contain areas that do not meet the new or revised standards must take steps to maintain or achieve compliance with the standards. These steps could include additional pollution controls on boilers, engines, turbines, and other facilities owned by gas transmission operations. Climate Change. The EPA has already promulgated regulations requiring the monitoring and reporting of GHG emissions from, among other sources, certain onshore natural gas transmission and storage facilities, including gathering and boosting facilities, completions and workovers of oil wells with hydraulic fracturing, and blowdowns of natural gas transmission pipelines between compressor stations, in the United States on an annual basis. In August 2016, the EPA proposed a rule revising provisions of the Prevention of Significant Deterioration ("PSD") and Title V Permitting Regulations to conform with the United States Supreme Court's decision in UARG v. EPA, 134 S. Ct. 2427 (2014), and the amended judgment issued by the D.C. Circuit, in Coalition for Responsible Regulation v. EPA, Nos. 09-1322, 10-073, 10-1092 and 10-1167 (D.C. Cir. April 10, 2015). For instance, the August 2016 proposed rule seeks to ensure that neither the PSD nor the Title V rules require a source to obtain a permit solely because the source emits or has the potential to emit ("PTE") GHGs above the applicable regulatory thresholds. In addition, the EPA is also proposing a significant emissions rate ("SER") of 75,000 tons per year carbon dioxide equivalent for GHGs under the PSD program that would establish an appropriate threshold level below which Best Available Control Technology ("BACT") is not required for a source’s GHG emissions. Future legislative and regulatory programs could significantly restrict emissions of greenhouse gases including methane. New Source Performance Standards: In August 2015, the EPA proposed to regulate fugitive methane emissions for compressor stations in the natural gas transmission and storage sector. The proposed rule was subsequently published in the Federal Register on September 18, 2015. In May 2016, the EPA finalized the rule to regulate fugitive methane emissions in the natural gas transmission and storage sector. The final rule was subsequently published in the Federal Register on June 3, 2016. The Partnership is working with industry groups to litigate the delay of repair criteria in the Final Rule and to clarify ambiguities within the rule. Currently, the Partnership's facilities are not impacted by this rule. New or modified sources installed in subsequent years will be impacted by this rule at a cost of approximately $30,000/site/year. Based on the current capital project schedule, 16 new or modified facilities will be impacted by this rule in 2019 at a total estimated cost of $500,000 annually thereafter. Pipeline Safety In March 2016, PHMSA announced a proposed rulemaking that would, if adopted, impose more stringent requirements for certain gas lines and gathering lines under varying circumstances. Among other things, the proposed rulemaking would extend certain of PHMSA’s current regulatory safety programs for gas pipelines beyond “high consequence areas” to cover gas pipelines found in newly defined “moderate consequence areas” that contain as few as 5 dwellings within the potential impact area; require gas pipelines installed before 1970 that are currently exempted from certain pressure testing obligations to be tested to determine their maximum allowable operating pressures (“MAOP”); and require gathering lines in Class I areas, both onshore and offshore, to comply with standards regarding damage prevention, corrosion control (for metallic pipe), public education, MAOP limits, line markers and emergency planning if such gathering lines’ nominal design is 8 inches or more. In order to provide clarity and greater certainty on what may constitute a “gathering line,” PHMSA is proposing a new definition of that term under the rulemaking, which term would now encompass “a pipeline, or a connected series of pipelines, and equipment used to collect gas from the endpoint of a production facility/operation and transport it to the furthermost point downstream of the following endpoints” including the “inlet of 1st gas processing plant;” the “outlet of” a gas treatment facility (not associated with a processing plant or compressor station); the “[o]utlet of the furthermost downstream compressor” leading to a pipeline, or the “point where separate production fields are commingled.” Other new requirements proposed by PHMSA under the rulemaking would require pipeline operators to: report to PHMSA in the event of certain MAOP exceedances; strengthen PHMSA integrity management requirements; consider seismicity in evaluating threats to a pipeline; conduct hydrostatic testing for all pipeline segments manufactured using longitudinal seam welds; and use more detailed guidance from PHMSA in the selection of assessment methods to inspect pipelines. The Partnership will continue to monitor this matter and cannot estimate the impact of these rules at this time. On June 22, 2016, President Obama signed the new pipeline safety legislation, the “Protecting our Infrastructure of Pipelines and Enhancing Safety Act of 2016" (the “2016 Pipeline Safety Act”). Extending PHMSA’s statutory mandate through 2019, the 2016 CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) Pipeline Safety Act establishes or continues the development of stringent requirements affecting pipeline safety. The Partnership will continue to monitor this matter and cannot estimate the impact of these rules at this time. PHMSA issued interim regulations in October 2016 to implement the agency’s expanded authority to address unsafe natural gas and hazardous liquid pipeline conditions or practices that pose an imminent hazard to life, property, or the environment. This new rule allows PHMSA to impose restrictions, prohibitions, and require safety measures without giving operators prior notice or an opportunity for a hearing. In contrast to PHMSA’s past practice of issuing Corrective Action Orders to an individual owner, operator, or facility, under the new rule PHMSA can issue an Emergency Order for numerous entities. PHMSA has until March 19, 2017 to issue a permanent final rule, when this temporary rule expires. The Partnership will continue to monitor this matter and cannot estimate the impact of these rules at this time. C.Operating Lease Commitments. The Partnership leases assets in several areas of its operations. Payments made in connection with operating leases were $20.3 million in 2016, $18.5 million in 2015 and $14.9 million in 2014, and are primarily charged to operation and maintenance expense as incurred. Future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year are: (1) Operating lease expense includes amounts for fleet leases and storage well leases that can be renewed beyond the initial lease term, but the anticipated payments associated with the renewals do not meet the definition of expected minimum lease payments and, therefore, are not included above. D.Service Obligations. The Partnership has entered into various service agreements whereby the Partnership is contractually obligated to make certain minimum payments in future periods. The Partnership has pipeline service agreements that provide for pipeline capacity, transportation and storage services. These agreements, which have expiration dates ranging from 2017 to 2031, require the Partnership to pay fixed monthly charges. The estimated aggregate amounts of minimum fixed payments at December 31, 2016, were: CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) 14.Accumulated Other Comprehensive Loss The following table displays the activity of Accumulated Other Comprehensive Loss, net of tax: (1)All amounts prior to CPPL's IPO are net of tax. Amounts in parentheses indicate debits. (2) Reflects the non-cash elimination of all historical current and deferred income taxes other than Tennessee state income taxes that will continue to be borne by the Partnership post-IPO. Equity Method Investment During 2008, Millennium Pipeline, in which the Partnership has an equity investment, entered into three interest rate swap agreements with a notional amount totaling $420.0 million with seven counterparties. During August 2010, Millennium Pipeline completed the refinancing of its long-term debt, securing permanent fixed-rate financing through the private placement issuance of two tranches of notes totaling $725.0 million, $375.0 million at 5.33% due June 30, 2027 and $350.0 million at 6.00% due June 30, 2032. Upon the issuance of these notes, Millennium Pipeline repaid all outstanding borrowings under its credit agreement, terminated the sponsor guarantee, and cash settled the interest rate hedges. These interest rate swap derivatives were primarily accounted for as cash flow hedges by Millennium Pipeline. As an equity method investment, the Partnership is required to recognize a proportional share of Millennium Pipeline’s OCI. The remaining unrecognized loss of $23.2 million, before tax, related to these terminated interest rate swaps is being amortized over a 15 year period ending June 2025 into earnings using the effective interest method through interest expense as interest payments are made by Millennium Pipeline. The unrecognized loss of $23.2 million and $25.0 million at December 31, 2016 and December 31, 2015, respectively, is included in unrealized losses on cash flow hedges above. 15. Other, Net CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) 16. Segments of Business Operating segments are components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. As of December 31, 2016, TransCanada's EVP and President, Natural Gas Pipelines is the chief operating decision maker. At December 31, 2016, the Partnership’s operations comprise one operating segment. The Partnership's segment offers gas transportation and storage services for LDCs, marketers and industrial and commercial customers located in northeastern, mid-Atlantic, Midwestern and southern states and the District of Columbia along with unregulated businesses that include midstream services and development of mineral rights positions. The chief operating decision maker evaluates the performance of the Partnership operations and determines how to allocate resources on a consolidated basis. 17.Supplemental Cash Flow Information The following tables provide additional information regarding the Partnership’s Statements of Consolidated and Combined Cash Flows for the years ended December 31, 2016, 2015 and 2014: (1)Capital expenditures included in current liabilities is comprised of "Accrued capital expenditures" and certain other amounts included within "Accounts payable" on the Consolidated and Combined Balance Sheets. 18. Concentration of Credit Risk Columbia Gas of Ohio, an affiliated party prior to the Separation, accounted for greater than 10% of total operating revenues in the years ended December 31, 2016, 2015 and 2014. The following table provides this customer's operating revenues and percentage of total operating revenues for the years ended December 31, 2016, 2015 and 2014: (1) Represents the gross amount of revenue contracted for with Columbia Gas of Ohio and, therefore, subject to risk at the loss of this customer. Columbia Gas of Ohio has entered into certain capacity release arrangements with third parties which ultimately can decrease the net revenue amount we receive from Columbia Gas of Ohio in any given period. The loss of a significant portion of operating revenues from this customer would have a material adverse effect on the business of the Partnership. CPG OpCo LP Notes to Consolidated and Combined Financial Statements FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (continued) 19. Quarterly Financial Data (Unaudited) None. ITEM 9A. | I apologize, but the financial statement excerpt you've provided seems incomplete and fragmented, making it difficult to provide a comprehensive summary. The text appears to be missing key sections and context.
From the available information, I can only extract a few discrete pieces:
1. Revenue: Not clearly specified
2. Expenses:
- Merger-related operation and maintenance expense of $80.7
- Potential liabilities and operating expenses mentioned
3. Liabilities:
- Debt to NiSource Finance of $1,217.3
- Intercompany debt agreements
4. Assets: Mentioned but not detailed
To provide a meaningful summary, I would need a more complete financial statement with clear revenue figures, a full breakdown of expenses, complete asset information, and a clear time period.
Would you be able to provide the full financial statement or clarify the missing parts? | Claude |
The financial statements required by this item are set forth in Item 15 of this annual report and are incorporated herein by reference. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS F- 1 ACCOUNTING FIRM To the Board of Directors and Shareholders of Truett-Hurst, Inc. We have audited the accompanying consolidated balance sheets of Truett-Hurst, Inc. and subsidiary (“the Company”) as of June 30, 2016 and 2015, and the related consolidated statements of operations, equity, and cash flows for each of the two years in the period ended June 30, 2016. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Truett-Hurst, Inc. and subsidiary as of June 30, 2016 and 2015 and the results of their operations and their cash flows for each of the two years in the period ended June 30, 2016, in conformity with accounting principles generally accepted in the United States of America. /s/ Burr Pilger Mayer, Inc. Santa Rosa, California September 28, 2016 F- 2 TRUETT-HURST, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (In thousands, except share data) See accompanying notes to consolidated financial statements. F- 3 TRUETT-HURST, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share data) See accompanying notes to consolidated financial statements. F- 4 TRUETT-HURST, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF EQUITY (In thousands, except share data) See accompanying notes to consolidated financial statements. F- 5 TRUETT-HURST, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) See accompanying notes to consolidated financial statements. F- 6 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) NOTE 1 - Business Business Truett-Hurst, Inc. (“Truett-Hurst”, the “Company”, or “THI”) is a holding company formed in Delaware and its sole asset is a controlling interest in H.D.D. LLC (“LLC”). The audited consolidated financial statements as of and for the years ended June 30, 2016 and June 30, 2015 include the results of Truett-Hurst, Inc. and its subsidiary, the LLC. Truett-Hurst consolidates the financial results of the LLC and records a noncontrolling interest for the economic interest in the LLC that is not attributable to Truett-Hurst, Inc. The Company operates and controls all of the business and affairs and consolidates the financial results of the LLC. In addition, pursuant to the limited liability company agreement of the LLC, the Company has the right to determine when distributions will be made to the members of the LLC and the amount of distributions. If a distribution is authorized, such distribution will be made to the members of the LLC pro rata in accordance with the percentages of their respective limited liability company interests. Quantities or results referred to as “to date” or “as of this date” mean as of or to June 30, 2016, unless otherwise specifically noted. References to “FY” or “fiscal year” refer to the fiscal year ending on June 30th of the designated year. For example, “FY16” and “fiscal year 2016” each refer to the fiscal year ended June 30, 2016. This Annual Report on Form 10-K references certain trademarks and registered trademarks of products or service names of other companies mentioned in this Annual Report on Form 10-K may be trademarks or registered trademarks of its respective owners. Capital Structure The Company has two classes of stock with shares outstanding: Class A common stock and Class B common stock. As of June 30, 2016, there were 4,306,609 shares of Class A common stock and 7 shares of Class B common stock outstanding. One share of Class B common stock is issued to each holder of LLC units which, on matters presented for shareholder vote, provides its owner one vote for each LLC unit held. The 7 shares of Class B common stock were associated with 2.8 million LLC units (the entire amount of LLC units held by parties other than THI) and represents 42% of the voting power of the combined outstanding Class A and Class B common stock. The Company maintains an exchange agreement with holders of LLC units, several of whom are directors and/or officers, under which each LLC member may exchange their LLC units for shares of Class A common stock on a one-to-one basis. Through ownership of Class A and Class B common stock, individuals who are officers and/or directors of the Company control 43% of the voting power of the combined outstanding Class A and Class B common stock. Tax Receivable Agreement Prior to the completion of the IPO, the Company entered into a tax receivable agreement with the LLC members. The agreement provides for the payment from time to time, as “corporate taxpayer,” to holders of LLC Units of 90% of the amount of the benefits, if any, that the corporate taxpayer is deemed to realize as a result of the exchange of LLC Units (current and future) and certain other tax benefits related to the Company entering into the agreement. These payment obligations are obligations of the corporate taxpayer and not of the LLC. NOTE 2 - Critical Accounting Policies and Estimates These consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States (“U.S. GAAP” or “GAAP”), which requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company prospectively applies appropriate adjustments, if any, to estimates based upon periodic evaluation. F- 7 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) The Company’s critical accounting policies include: Cash and Cash Equivalents Cash equivalents consist of highly liquid investments with an original maturity date when purchased of three months or less, and are stated at cost, which approximates fair value. Accounts Receivable Accounts receivable consists primarily of trade receivables from customers who tend to be large distributors. Accounts receivable are reviewed regularly and estimates are made for allowance for doubtful accounts when there is doubt as to the collectability of individual balances. An allowance for doubtful accounts was not recorded for FY16 and FY15, as bad debts have historically been negligible. Inventories Inventories consist primarily of bulk and bottled wine and purchased grapes valued at the lower of cost or market using the first-in, first-out or specific identification method. In accordance with general wine industry practice, bulk and bottled wine inventories are included in current assets, although a portion of such inventories may be aged for a period longer than one year. Costs associated with winemaking and the production of wine are reflected in inventories as bulk wine until the wine has been bottled and is available for sale. The Company assesses the valuation of its inventories and reduces the carrying value of those inventories that are obsolete or in excess of the forecasted usage to their estimated net realizable value. Net realizable value of such inventories is estimated based on analyses and assumptions including, but not limited to, historical usage, future demand and market requirements. Reductions to the carrying value of inventories are recorded in cost of sales. Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated on a straight-line basis over the useful lives of the asset, principally twenty to forty years for building and improvements, five years for machinery and equipment, seven to fifteen years for vineyard development, ten to twenty years for vineyard equipment, five to ten years for furniture and fixtures, the shorter of estimated useful life or lease term, generally five years for leasehold improvements and five years for vehicles. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. Gains and losses from disposition of property and equipment are included as a component of income (loss) from operations. Impairment of Long-lived Assets The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted cash flows, an impairment loss is recognized to the extent of such difference. Intangible Assets Indefinite lived intangible assets are reviewed for impairment during the fourth fiscal quarter of each year, or sooner, if events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Indefinite lived intangible assets consist primarily of trademarks. Intangible assets determined to have a finite life are amortized over their estimated useful lives, principally four years for the customer lists and non-compete agreement, five years for proprietary technology and ten years for the trademarks. Patents are amortized over their estimated legal lives. F- 8 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) Other Assets Other assets are amortized over their estimated useful lives, principally five years for label design costs, the lesser of the loan term or ten years for loan fees, ten years for lease costs - related party, and five years for website design costs. Label designs are evaluated for impairment in accordance with the policy on impairment of long-lived assets. Revenue Recognition Wine sales are recognized when the product is shipped and title passes to the customer. Standard terms are ‘FOB’ shipping point, with no customer acceptance provisions. The cost of price promotions and discounts are treated as reductions of sales. No products are sold on consignment. Credit sales are recorded as trade accounts receivable and no collateral is required. Net sales from items sold direct to consumer are recognized at the time of sale. Sales Discounts and Depletion Allowances Sales discounts and depletion allowances are recorded as a reduction of sales at the time of the sale. For FY16 and FY15, sales discounts and depletion allowances totaled $4.7 million and $4.1 million, respectively. Cost of Sales Cost of sales includes costs associated with grape growing, grapes purchased from vineyards not owned by the Company, bulk wine and finished goods purchases, packaging materials, winemaking and production costs, vineyard and production administrative support and overhead costs, purchasing and receiving costs and certain warehousing costs. No further costs are allocated to inventory once the product is bottled and available for sale. Inventory reserves and provisions are included in cost of sales. Expense Allocation The LLC Operating Agreement provides that substantially all expenses incurred by or attributable to the Company indebtedness are borne by the LLC, except income and franchise tax payments. Sales and Marketing Expense Sales and marketing expenses consist primarily of personnel costs, advertising and other costs for marketing and promoting the Company’s products. Advertising costs are expensed as incurred. For FY16 and FY15, advertising expense totaled approximately $0.4 million and $0.2 million, respectively. General and Administrative Expenses General and administrative expenses include the costs associated with personnel, professional fees, insurance and other expenses related to administrative and compliance functions. Shipping and Handling Fees and Costs Amounts billed to customers for shipping and handling are recorded as sales, and the costs incurred for shipping and handling are recorded as a sales and marketing expense. Gross margins may not be comparable to other companies in the same industry as other companies may include shipping and handling costs as a cost of sales. For FY16 and FY15, shipping costs were $0.9 million and $1.0 million, respectively. F- 9 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) Income Taxes and Deferred Tax Asset Valuation Truett-Hurst, Inc. is subject to U.S. federal, state, and local taxes with respect to its allocable share of any taxable income of H.D.D. LLC and will be taxed at the prevailing corporate rates. The LLC is treated as a partnership under the Internal Revenue Code of 1986, as amended (the “Code”). The members separately account for their pro-rata share of income, deductions, losses, and credits. Therefore, no provision is made for the LLC’s share of net income (loss) in the consolidated financial statements for liabilities for federal, state, or local income taxes which liabilities are the responsibility of the individual members. The LLC is subject to entity level taxation in the state of California. As a result, the accompanying consolidated statements of operations include tax expense related to this state. The provision for income taxes is calculated using the asset and liability method of accounting. Under this method, deferred tax assets and liabilities are recognized based on the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. In assessing net deferred tax assets, management considers whether it is more likely than not that some or all of the deferred tax assets will not be realized. The net deferred tax asset is evaluated at the end of each year considering all available positive and negative evidence, including reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies, and results of recent operations. When the Company does not believe the realization of a deferred tax asset is likely, a valuation allowance is recorded. Stock-Based Compensation Stock-based compensation is recognized based on the estimated fair values at the grant date for equity classified awards and the recognition of the related compensation expense over the appropriate vesting period. Compensation expense is based on, among other things, (i) the classification of an award, (ii) assumptions relating to fair value measurement such as the value of the stock of Truett-Hurst and its volatility, the expected term of the award and forfeiture rates, and (iii) whether performance criteria, if any, have been met. Both internal and external data is used to assess compensation expense. Changes in these estimates could significantly impact stock based compensation expense in the future. The expected term of the option is based upon the contractual term, expected employee exercise and expected post-vesting employment termination behavior. Equity instruments issued to non-employees are recorded at their fair value on the measurement date and are subject to periodic market adjustments as the underlying equity instruments vest. Earnings per Share Basic earnings per share is computed by dividing the earnings attributable to the Company by the weighted average number of common shares outstanding for the period. Diluted earnings per share is computed by giving effect to all potential dilutive common shares, including convertible LLC units and restricted stock unless this calculation would have an anti-dilutive effect in which case basic and diluted earnings per share are calculated similarly. Reclassifications Certain prior period amounts in the consolidated financial statements and notes thereto have been reclassified to conform to the current year presentation. These reclassifications had no effect on the reported consolidated results of continuing operations. F- 10 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) Accounting Pronouncements In November 2015, the FASB issued ASU No. 2015-17: Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. The update sets forth a requirement for companies to classify deferred tax assets and liabilities as non-current amounts on the balance sheet. It is effective for financial statements issued for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02: Leases (Topic 842). The standard includes a lessee accounting model that recognizes two types of leases - finance and operating leases. It requires that a lessee recognize on the balance sheet assets and liabilities for leases with lease terms of more than 12 months. The amendment is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU. In March 2016, the FASB issued ASU No. 2016-09: Improvements to Employee Share-Based Payment Accounting which amends ASU 718, Compensation - Stock Compensation. The update sets forth an initiative to identify, evaluate, and improve areas of GAAP for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to users of financial statements. The amendment is effective for annual reporting periods beginning after December 15, 2016 and interim periods within those annual periods. The Company is currently evaluating the impact of this ASU. NOTE 3 - INVENTORIES, net Inventories, net comprise: NOTE 4 - PROPERTY AND EQUIPMENT, net Property and equipment, net comprise: F- 11 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) Total depreciation and amortization expense for the fiscal years ended June 30, 2016 and June 30, 2015 was $0.7 million and $0.6 million, respectively. NOTE 5 - INTANGIBLE ASSETS, net Intangible assets, net comprise: Amortization expense of intangible assets was negligible during FY16 and FY15. The expected future amortization of patents is $0.04 million for the life of the patents. Patents starts amortizing at the granting of the patent. NOTE 6 - BORROWINGS The Company’s indebtedness is comprised primarily of bank loans including lines of credit and long term debt. Lines of Credit On July 29, 2016, the Company completed the refinancing process of the lines of credit. Below is a description of the lines of credit as of June 30, 2016 as well as those put in place as of July 29, 2016. ·Line of Credit Note - As of June 30, 2016, the Company had a $10 million revolving line of credit with an outstanding balance of $9.924 million and a maturity date of July 31, 2016. The outstanding balance accrued interest at an annual interest rate of 2.25% above LIBOR. On July 29, 2016, the line of credit was renewed with the maturity date extended to July 31, 2017. Pricing on the loan was unchanged. ·Equipment Purchase Line of Credit Note - As of June 30, 2016, the Company had a $0.5 million equipment purchase line of credit note with an outstanding balance of $0.386 million and a maturity date of July 31, 2016. The outstanding balance accrued interest at a rate of 2.25% above the floating One-Month LIBOR Rate. This Equipment Purchase Line of Credit matured July 1, 2016 and converted to a term loan with a 48-month amortization schedule. On July 29, 2016, the Company received a new Equipment Purchase Line of Credit Note in the amount of $0.5 million that matures on July 31, 2017. Pricing on the loan was unchanged. ·Foreign Exchange Note - As of June 30, 2016, the Company had a foreign exchange note in the principal amount of $0.1 million from the bank due on or before July 31, 2016 that carried a 15% credit percentage and permitted the Company to enter into any spot or forward transaction to purchase from or sell to the bank a foreign currency of an agreed amount. There was no balance outstanding on the Foreign Exchange Note as of June 30, 2016. On July 29, 2016, the maturity date of the Foreign Exchange Note was extended to July 31, 2017. Pricing on the loan was unchanged. F- 12 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) Long Term Debt Long term debt comprise: (1)Note payable to a bank, secured by a deed of trust on property, payable monthly with principal payments of $11,270 plus interest, matures May 31, 2022, variable interest of 2.25% above LIBOR. (2)Note payable to a bank, secured by equipment, payable monthly with principal and interest payments of $4,226, matured November 1, 2015 at 3.75% interest. (3)Note payable to a bank, secured by equipment, payable monthly with principal and interest payments of $6,535, matures January 15, 2018 at 3.75% interest. (4)Note payable to a bank, secured by equipment, payable monthly with principal and interest payments of $7,783, matures March 1, 2019; at 3.75% interest. (5)On November 30, 2014, the Company acquired the unrestricted use of the Stonegate trademark in exchange for a trademark release payment which is to be made over time and is accounted for as a note payable. The note payable has three equal installments: a) within five days of November 30, 2014, b) on October 31, 2015, and c) on July 31, 2016. The note does not accrue interest outstanding on the principal. An imputed interest rate of 5.5% was assessed under GAAP and the impact was considered immaterial. (6)Note payable to a bank, secured by equipment, payable monthly with principal and interest payments of $11,267, matures July 1, 2019; at 3.90% interest. Future principal and interest payments for the long term debt as of June 30, 2016 are as follows: Covenants The bank borrowings contain usual and customary covenants, including, among others, limitations on incurrence of senior indebtedness, the making of loans and advances, investments, acquisitions, and capital expenditures, the incurrence of liens, and the consummation of mergers and asset sales. The loan maintains the minimum current assets to current liabilities ratio covenant (measured quarterly) and the maximum debt to effective tangible net worth ratio covenant (measured quarterly). As of July 29, 2016, the previous minimum EBITDA covenant was replaced with a minimum debt service coverage ratio (measured quarterly on a trailing twelve-month basis). F- 13 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) Security Agreements and Limited Guaranties The bank borrowings are collateralized by substantially all of the Company’s assets. Additionally, certain LLC members who are also executive officers and/or directors of the Company, as well as certain trusts and other entities under their control (together the “Guarantors”), have entered into limited guarantee agreements which guarantee the payment to the bank of all sums presently due and owning and all sums which shall in the future become due and owning. The liability of the individual Guarantors ranges from 23% to 61% of the sum of all obligations due plus the costs, expenses and interest associated with the collection of amounts recoverable under the guaranties. NOTE 7 - ACCRUAL FOR SALES RETURNS During the third quarter FY15, an accrual was established for the return of product that had oxidized. The accrual amount was $0.5 million. On June 29, 2016, a final settlement was reached with the last distributor with remaining material financial exposure associated with the oxidized product. The total cost of the settlement to the Company was $0.5 million and will be settled with a cash payment of $0.4 million and $0.1 million in case goods which we expect to be shipped during the 2017 fiscal year. NOTE 8 - COMMITMENTS AND CONTINGENCIES Leases In February 2011, the Company entered into a lease agreement for a tasting room and winery. The lease was for five years, commencing on March 1, 2011 and ending on February 29, 2016, and contained one option to extend for an additional period of five years. On July 27, 2015, the Company exercised the option to extend the lease through February 29, 2021. Subsequent to June 30, 2016, the Company modified the lease agreement as described in the litigation portion of Note 8 below. The future lease commitments as presented below give effect to the modified lease terms. In October 2013, the Company entered into a lease agreement for administrative office space. The lease commenced on October 15, 2013 and ends on October 31, 2016, and contains three one-year renewal options with adjustment to market rents. On June 30, 2016, the Company extended this lease for an additional three years. The future lease commitments as presented below include amounts for the lease extension. Rent payments for these facilities were $0.3 million for both fiscal years ended June 30, 2016 and June 30, 2015. Future lease commitments are: F- 14 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) Supply Contracts The Company enters into short and long term contracts with third-parties and related party growers to supply a portion of its future grape and bulk wine inventory requirements. Future minimum grape and bulk wine inventory purchase commitments are as follows: At June 30, 2016, total future purchase commitments for finished goods were approximately $3.3 million and are expected to be fulfilled during fiscal 2017 to 2018. Production & Storage The Company enters into various contracts with third-party service providers for grape crushing, wine storage, and bottling. The costs are recorded in the period for which the service is provided. The actual costs related to custom crush services are based on volume. The Company’s current contracts for custom crush services cover the 2016 harvest. The current bottling contract requires a minimum of 200,000 cases at $2.40 per case to be bottled in a one year period. During FY16, the Company transferred approximately 54% of its bulk wine inventory to a storage location owned by a related party. The terms of the storage agreement are on the same basis as similar non-related party agreements. Litigation From time to time, the Company may be subject to various litigation matters arising in the ordinary course of business. Other than discussed below, the Company is not aware of any current pending legal matters or claims, individually or in the aggregate, that are expected to have a material adverse impact on the Company’s consolidated financial position, results of operations, or cash flows. On January 29, 2016, Mendocino Wine Group (MWG) filed a complaint against Phil Hurst (Hurst) and H.D.D., LLC (“LLC”). The complaint alleges that, prior to January 2012, Hurst and LLC aided and abetted Paul Dolan in his alleged breach of fiduciary duties to MWG and that they interfered with Dolan's contract with Thornhill Management Company (the manager of MWG), and aided and abetted Dolan's interference with MWG's economic advantage. LLC denies the claims, denies all wrongdoing, and denies that they caused any harm to MWG. A trial date has been set for January 27, 2017. No amount has been recorded in the consolidated financial statements related to this suit. On October 21, 2015, LLC, received a letter from Hambrecht Wine Group, L.P. (the “Lessor”), the Lessor of LLC’s winery and tasting room facility at 4035 Westside Road, Healdsburg, California (the “Property”), under a lease dated February 8, 2011 (“the “Lease”), purporting to terminate the Lease effective as of that date, and rejecting LLC’s prior exercise of its election to extend for five years the original term of the Lease (which expired February 29, 2016). On November 9, 2015, the Company filed a motion for declaratory and injunctive relief in the Superior Court of California, Sonoma County. On July 28, 2016, the Property was sold to a third-party buyer. In connection with the sale, the Company, through the LLC, entered into a settlement agreement (the “Agreement”) with the Hambrecht Wine Group and Mr. Kevin Singer, in his capacity as the court-appointed receiver of the Property. Under the Agreement, LLC, in exchange for payment of $955 thousand to LLC, quitclaimed certain rights and amended its lease such that it will vacate the tasting room portion of the property no later than December 31, 2016, and the balance of the space no later than May 31, 2017. LLC also agreed to dismiss its pending claims against the Lessor. See Note 14 - “Subsequent Events.” F- 15 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) Exchange and Tax Receivable Agreement The Company has an exchange agreement with the existing owners of the LLC, several of whom are directors and/or officers. Under the exchange agreement, each LLC member (and certain permitted transferees thereof) may (subject to the terms of the exchange agreement), exchange their LLC Units for shares of Class A common stock of the Company on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications, or for cash, at the Company’s election. In connection with the exchange agreement, the Company has tax receivable agreement (“TRA”) with the LLC members. The agreement provides for the payment from time to time, as “corporate taxpayer,” to holders of LLC Units of 90% of the amount of the benefits, if any, that the corporate taxpayer is deemed to realize as a result of (i) increases in tax basis resulting from the exchange of LLC Units and (ii) certain other tax benefits related to the Company entering into the agreement, including tax benefits attributable to payments under the agreement. These payment obligations are obligations of the corporate taxpayer and not of the LLC. The term of the agreement will continue until all such tax benefits have been utilized or expired, unless the corporate taxpayer exercises its right to terminate the agreement for an amount based on the agreed payments remaining to be made under the agreement or the corporate taxpayer breaches any of its material obligations under the agreement in which case all obligations will generally be accelerated and due as if the corporate taxpayer had exercised its right to terminate the agreement. Indemnification From time to time the Company enters into certain types of contracts that contingently require it to indemnify various parties against claims from third-parties. Historically, the Company has not been required to make payments under these obligations, and no liabilities have been recorded at June 30, 2016 and June 30, 2015 for these obligations on the balance sheets. NOTE 9 - DISCONTINUED OPERATIONS On January 25, 2016, the LLC sold its fifty percent interest in The Wine Spies, LLC (“Wine Spies”) with an effective date of December 31, 2015. The results from Wine Spies, which were previously consolidated, have been deconsolidated in the consolidated financial statements. The gain on the sale along with the current year results have been recorded in the statement of operations as part of discontinued operations. Prior periods have been accounted for on a consistent basis. The Company has no continuing relationship with Wine Spies. Discontinued operations comprise: F- 16 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) NOTE 10 - STOCK-BASED COMPENSATION Equity Incentive Plan The Company has granted restricted stock awards, stock options and restricted stock units to employees, directors and non-employees under its 2012 Stock Incentive Plan. As of June 30, 2016, the 2012 Plan has 1.0 million shares reserved for issuance and a total of 0.1 million granted equity incentive shares outstanding. A summary of the activity for restricted stock awards is presented below: A summary of the activity for restricted stock units is presented below: A summary of the activity for stock options is presented below: The following table summarizes stock-based compensation included in the consolidated statements of operations for the fiscal years ended June 30, 2016 and 2015, respectively: F- 17 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) NOTE 11 - FINANCIAL INSTRUMENTS Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The carrying amount reflected in the consolidated balance sheets of financial assets and liabilities are all categorized as Level 1. They include cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, which approximated their fair values due to the short term nature of these financial assets and liabilities. The carrying amount of the Company’s debt approximates its fair value based on prevailing interest rates and time to maturity. In October 2012, the Company executed an interest rate swap obligation that was measured using observable inputs such as the LIBOR and Ten-year Treasury interest rates, and therefore has been categorized as Level 2. This derivative is not designated as a hedging instrument and has been recorded at fair value on the consolidated balance sheets. Changes in the fair value of this instrument have been recognized in the consolidated statements of operations in other expense. The maturity date of the swap is May 31, 2022. The following tables set forth the interest rate swap fair values at June 30, 2016 and at June 30, 2015: (1) Included in “Accrued expenses” in the Balance Sheet (2) Included in “Other current assets” in the Balance Sheet F- 18 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) NOTE 12 - INCOME TAXES THI is subject to entity level taxation in certain states and is subject to U.S. Federal and state income taxes with respect to its allocable share of any taxable income of the LCC. THI will be taxed at the prevailing corporate tax rates. All income before taxes is recognized domestically. Income tax expense for FY16 and FY15 consists of: The difference between income taxes computed using the 34% statutory federal income tax rate and the Company’s effective tax rate are summarized as follows: Components of deferred tax assets (liabilities) consist of the following: F- 19 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) In FY15, a valuation allowance of $6.7 million was recorded after assessing all the available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. The assessment of future income of the Company did not change in FY16 and a valuation allowance continues to be recorded on the deferred tax assets in the amount of $4.1 million. The Company’s possible liability associated with the tax receivable agreement will not be recognized until the valuation allowance is partially or fully reversed. THI and the LLC are subject to annual California franchise tax. Truett-Hurst, Inc. files U.S. Federal and California income tax returns. The Company has gross federal and state net operating losses of $3.0 million and $3.1 million, respectively. Both jurisdictions have expiration dates beginning in 2034. For Truett-Hurst, Inc., U.S. federal and state tax returns associated with fiscal years 2013 through 2015 are currently open to examination. U.S. federal and state tax returns for LLC associated with calendar years ended 2012-2014 and fiscal year ended 2015 are currently open to examination. There were no material uncertain tax positions and the Company does not expect major changes in the next twelve months. NOTE 13 - SIGNIFICANT CUSTOMER INFORMATION, SEGMENT REPORTING AND GEOGRAPHIC INFORMATION The Company’s primary reporting segments are identified as wholesale and direct to consumer. Wholesale sales include the retail exclusive brand label model and other brands sold through the three-tier distribution system. Direct to consumer sales occur through the Company’s tasting rooms and wine clubs. Operating and other expenses are not allocated between operating segments; therefore, operating and net income information for the respective segments is not available. In addition, discrete financial information related to segment specific assets is not available. Sales and cost of sales are reported by segment. Historically, the Company reported a third segment identified as the internet segment which were sales that occurred through Wine Spies and were principally comprised of brands not owned by us. Effective December 31, 2015, the Company sold its interest in Wine Spies and no longer has an Internet segment as part of its continuing operations. See Note 9 - “Discontinued Operations.” The following tables reflect net sales, cost of sales and gross profit by segment for continuing operations for each of the fiscal years ended June 30, 2016 and 2015, respectively: F- 20 TRUETT-HURST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except certain share amounts and percentages) Significant Customer Information: The following tables set forth concentrations of wholesale sales and accounts receivable as a percent of each total: International sales were $0.9 million and $1.3 million for the fiscal years ended June 30, 2016 and June 30, 2015, respectively. NOTE 14 - SUBSEQUENT EVENTS On July 28, 2016, Hambrecht Wine Company L.P. the owner of the property which the Company leases at 4035 Westside Road, Healdsburg, California sold the property to a third-party buyer. In connection with the sale, the Company amended its lease such that it will vacate the tasting room portion of the property no later than December 31, 2016, and the balance of the space no later than May 31, 2017. On July 29, 2016, the Company entered into a Modification Agreement to its Loan and Security agreement with Bank of the West that it had entered into July 15, 2015. The Company has evaluated all subsequent event activity through the issue date of these consolidated financial statements and concluded that, other than the items discussed above, no additional subsequent events have occurred that would require recognition in the consolidated financial statements or disclosure in the notes to the consolidated financial statements. F- 21 | Here's a summary of the financial statement:
This appears to be an accounting policy disclosure for a wine company, covering several key areas:
Key Assets:
- Inventories (bulk and bottled wine, purchased grapes)
- Property and Equipment (buildings, machinery, vineyards, etc.)
- Intangible Assets (trademarks, patents, customer lists)
Notable Accounting Policies:
1. Inventory Valuation:
- Uses first-in, first-out or specific identification method
- Valued at lower of cost or market
- Includes bulk and bottled wine as current assets, even if aged over one year
2. Property & Equipment:
- Stated at cost minus accumulated depreciation
- Depreciation periods range from 5-40 years depending on asset type
- Major improvements are capitalized; maintenance is expensed
3. Impairment Policies:
- Long-lived assets reviewed when circumstances indicate possible impairment
- Intangible assets reviewed annually in fourth quarter
- Impairment measured by comparing carrying amount to expected cash flows
4. Financial Position:
- Historical debt levels reported as negligible
- Losses from asset dispositions included in operating income/loss
The statement emphasizes careful asset valuation and regular impairment testing, suggesting a conservative accounting approach. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA BLACK DIAMOND, INC. AND SUBSIDIARIES ACCOUNTING FIRM The Board of Directors and Stockholders of Black Diamond, Inc.: We have audited the accompanying consolidated balance sheets of Black Diamond, Inc. and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of comprehensive (loss) income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Black Diamond, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Black Diamond, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 6, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ KPMG LLP Salt Lake City, UT March 6, 2017 BLACK DIAMOND, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts) See accompanying notes to consolidated financial statements. BLACK DIAMOND, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (In thousands, except per share amounts) See accompanying notes to consolidated financial statements. BLACK DIAMOND, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) See accompanying notes to consolidated financial statements. BLACK DIAMOND, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands) See accompanying notes to consolidated financial statements. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share amounts) NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying audited consolidated financial statements of Black Diamond, Inc. and subsidiaries (which may be referred to as the “Company,” “we,” “our” or “us”) have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). Nature of Business Black Diamond, Inc., through its ownership of Black Diamond Equipment, Ltd., is a global leader in designing, manufacturing, and marketing innovative outdoor engineered equipment and apparel for climbing, mountaineering, backpacking, skiing, and a wide range of other year-round outdoor recreation activities. Black Diamond Equipment and PIEPS™, are synonymous with performance, innovation, durability and safety in the outdoor consumer community. We are targeted not only to the demanding requirements of core climbers, skiers and alpinists, but also to the more general outdoor performance enthusiasts and consumers interested in outdoor-inspired gear for their backcountry and urban activities. Our Black Diamond® and PIEPS™ brands are iconic in the active outdoor and ski industries, and linked intrinsically with the modern history of these sports. Headquartered in Salt Lake City at the base of the Wasatch Mountains, our products are designed and exhaustively tested by an engaged team of discerning entrepreneurs and engineers. We offer a broad range of products including: high performance apparel (such as jackets, shells, pants and bibs); rock-climbing equipment (such as carabiners, protection devices, harnesses, belay devices, helmets, and ice-climbing gear); technical backpacks and high-end day packs; tents; trekking poles; headlamps and lanterns; and gloves and mittens. We also offer advanced skis, ski poles, ski skins, and snow safety products, including avalanche airbag systems, avalanche transceivers, shovels, and probes. Our consolidated financial statements for the year ended December 31, 2015 include a correction related to the carryback limitations of net operating losses and tax credits to 2014. The effect of the revision was to decrease income tax receivable and reduce other long-term liabilities by $1,801 and $230, as of December 31, 2015, respectively, with an offsetting increase of $1,571 of income tax expense for the year ended December 31, 2015. We evaluated these changes and determined that the corrections are not material to the prior period. On May 28, 2010, we acquired Black Diamond Equipment, Ltd. (which may be referred to as “Black Diamond Equipment” or “BDEL”) and Gregory Mountain Products, LLC (which may be referred to as “Gregory Mountain Products”, “Gregory” or “GMP”). On January 20, 2011, the Company changed its name from Clarus Corporation to Black Diamond, Inc., which we believe more accurately reflects our current business. In July 2012, we acquired POC Sweden AB and its subsidiaries (collectively, “POC”) and in October 2012, we acquired PIEPS Holding GmbH and its subsidiaries (collectively, “PIEPS”). On July 23, 2014, the Company and Gregory Mountain Products, its wholly-owned subsidiary, completed the sale of certain assets to Samsonite LLC (“Samsonite”) comprising Gregory’s business of designing, manufacturing, marketing, distributing and selling technical, alpine, backpacking, hiking, mountaineering and active trail products and accessories as well as outdoor-inspired lifestyle bags (the “Gregory Business”) pursuant to the terms of that certain Asset Purchase Agreement (the “GMP Purchase Agreement”), dated as of June 18, 2014, by and among the Company, Gregory and Samsonite. Under the terms of the GMP Purchase Agreement, Samsonite paid $84,135 in cash for Gregory’s assets comprising the Gregory Business and assumed certain specified liabilities (the “GMP Sale”). The activities of Gregory have been segregated and reported as discontinued operations for all periods presented. See Note 2. Discontinued Operations to the notes to consolidated financial statements. On March 16, 2015, the Company announced that it was exploring a full range of strategic alternatives, including a sale of the entire Company and the potential sales of the Company’s Black Diamond Equipment (including PIEPS) and POC brands in two separate transactions. On October 7, 2015, the Company and the Company’s wholly owned subsidiary, Ember Scandinavia AB (“Ember”), sold their respective equity interests in POC comprising POC’s business of designing, manufacturing, marketing, distributing and selling advanced-design helmets, body armor, goggles, eyewear, gloves, and apparel for action or “gravity sports,” such as skiing, snowboarding, and cycling pursuant to a Purchase Agreement (the “POC Purchase Agreement”), dated as of October 7, 2015, by and among the Company and Ember, as sellers, and Dainese S.p.A. and Dainese U.S.A., Inc. (collectively “Dainese”), as purchasers. Under the terms of the POC Purchase Agreement, Dainese paid $63,639 in cash for POC (the “POC Disposition”). The activities of POC have been segregated and reported as discontinued operations for all periods presented. See Note 2. Discontinued Operations to the notes to consolidated financial statements. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) On October 8, 2015, the Company announced the completion of the POC Disposition resulting in the conclusion of the Company’s review of strategic alternatives. On November 9, 2015, the Company announced that it is seeking to redeploy our significant cash balances to invest in high-quality, durable, cash flow-producing assets potentially unrelated to the outdoor industry in order to diversify our business and potentially monetize our substantial net operating losses as part of our asset redeployment and diversification strategy. We intend to focus our search primarily in the United States, although we will also evaluate international investment opportunities should we find such opportunities attractive. Use of Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The more significant estimates relate to derivatives, revenue recognition, income taxes, and valuation of long-lived assets, goodwill, and other intangible assets. We base our estimates on historical experience and other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from these estimates. Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of Black Diamond, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Foreign Currency Transactions and Translation The accounts of the Company’s international subsidiaries’ financial statements which, have functional currencies other than the U.S. dollar, are translated into U.S. dollars using the exchange rate at the balance sheet dates for assets and liabilities and average exchange rates for the periods for revenues, expenses, gains and losses. Foreign currency translation adjustments are recorded as a separate component of accumulated other comprehensive income. Foreign currency transaction gains and losses are included in other (expense) income in the consolidated statements of comprehensive (loss) income. Cash Equivalents The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. At December 31, 2016 and 2015, the Company did not hold any amounts that were considered to be cash equivalents. Marketable Securities Marketable securities consisted of an exchange-traded fund. The Company accounts for its marketable securities as available-for-sale. Available-for-sale securities are recorded at fair value and related unrealized gains and losses are excluded from earnings and are reported as a separate component of accumulated other comprehensive (loss) income until realized. The cost basis of the exchange traded fund was $9,994 and the unrealized losses were $107 and $59, net of taxes of $63 and $33, as of December 31, 2015 and 2014, respectively. The Company sold the exchange traded fund and recognized a gain of $241 in earnings during the twelve months ending December 31, 2016. Accounts Receivable and Allowance for Doubtful Accounts The Company records its trade receivables at sales value and establishes a non-specific allowance for estimated doubtful accounts based on a percentage of outstanding trade receivables. In addition, specific allowances are established for customer accounts as known collection problems occur due to insolvency, disputes or other collection issues. The amounts of these specific allowances are estimated by management based on the customer’s financial position, the age of the customer’s receivables and the reasons for any disputes. The allowance for doubtful accounts is reduced by subsequent collections of the specific allowances or by any write-off of customer accounts that are deemed uncollectible. The allowance for doubtful accounts was $399 and $184 at December 31, 2016 and 2015, respectively. There were no significant write-offs of the Company’s accounts receivable during the years ended December 31, 2016, 2015, and 2014. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) Inventories Inventories are stated at the lower of cost (using the first-in, first-out method “FIFO”) or market value. Elements of cost in the Company’s manufactured inventories generally include raw materials, direct labor, manufacturing overhead and freight in. The Company periodically reviews its inventories for excess, close-out, or slow moving items and makes provisions as necessary to properly reflect inventory values. Property and Equipment Property and equipment is stated at historical cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives. The principal estimated useful lives are: building improvements, 20 years; computer hardware and software and machinery and equipment, 3-10 years; furniture and fixtures, 5 years. Leasehold improvements are amortized over the lesser of the estimated useful life of the improvement, or the life of the lease. Equipment under capital leases are stated at the present value of minimum lease payments. Major replacements, which extend the useful lives of equipment, are capitalized and depreciated over the remaining useful life. Normal maintenance and repair items are expensed as incurred. Property and equipment are reviewed for impairment whenever events or changes in circumstances exist that indicate the carrying amount of an asset may not be recoverable. Goodwill Goodwill represents the excess of the purchase price over the fair market value of identifiable net assets of acquired companies. Goodwill is not amortized, but rather is tested at the reporting unit level at least annually for impairment or more frequently if triggering events or changes in circumstances indicate impairment. A two-step quantitative impairment analysis is performed. The first step involves estimating the fair value of the reporting unit based upon the market capitalization and reasonable control premium. If the fair value of the reporting unit is less than its carrying amount, the second step of the impairment test is performed to measure the amount of the impairment loss. In the second step, the implied fair value of the goodwill is estimated as the fair value of the reporting unit as determined in step one, less fair values of all other net tangible and intangible assets of the reporting unit determined in a manner similar to a purchase price allocation. If the carrying amount of the goodwill exceeds its implied fair value, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill. For the year ended December 31, 2015, the Company recognized an entire goodwill impairment of $29,507. No impairment was recorded during the years ended December 31, 2016 and 2014. Intangible Assets Intangible assets represent other intangible assets and indefinite-lived intangible assets acquired. Other intangible assets are amortized over their related useful lives. Other intangible assets are reviewed for impairment whenever events or changes in circumstances exist that indicate the carrying amount of an asset may not be recoverable. Indefinite-lived intangible assets are not amortized; however, they are tested at least annually for impairment or more frequently if events or changes in circumstances exist that may indicate impairment. Initially, qualitative factors are considered to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. If, through this qualitative assessment, the conclusion is made that it is more likely than not that an indefinite-lived intangible asset's fair value is less than its carrying amount, or the Company elects to bypass the qualitative assessment, a quantitative impairment analysis is performed by comparing the indefinite-lived intangible asset's book value to its estimated fair value. The fair value for indefinite-lived intangible assets is determined through an income approach using the relief-from-royalty method. The amount of any impairment is measured as the difference between the carrying amount and the fair value of the impaired asset. During the years ended December 31, 2016, 2015, and 2014, no impairment of indefinite-lived intangible assets was recorded. Derivative Financial Instruments The Company uses derivative instruments to hedge currency rate movements on foreign currency denominated sales. The Company enters into forward contracts, option contracts and non-deliverable forwards to manage the impact of foreign currency fluctuations on a portion of its forecasted foreign currency exposure. These derivatives are carried at fair value on the Company’s consolidated balance sheets in prepaid and other current assets, other long-term assets, accounts payable and accrued liabilities, and other long-term liabilities. Changes in fair value of the derivatives not designated as hedge instruments are included in the determination of net income. For derivative contracts designated as hedge instruments, the effective portion of gains and losses resulting from changes in fair value of the instruments are included in accumulated other comprehensive loss and reclassified to sales in the period the underlying hedged item is recognized in earnings. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) For all hedging relationships, the Company formally documents the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the hedged transaction, the nature of the risk being hedged, how the hedging instrument’s effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively, and a description of the method used to measure ineffectiveness. The Company also formally assesses, both at the inception of the hedging relationship and on an ongoing basis, whether the derivatives that are used in hedging relationships are highly effective in offsetting changes in cash flows of hedged transactions. The Company uses operating budgets and cash flow forecasts to estimate future foreign currency cash flow exposures and to determine the level and timing of derivative transactions intended to mitigate such exposures in accordance with its risk management policies. The Company discontinues hedge accounting prospectively when it determines that the derivative is no longer effective in offsetting cash flows attributable to the hedged risk, the derivative expires or is sold, terminated, or exercised, the cash flow hedge is dedesignated because a forecasted transaction is not probable of occurring, or management determines to remove the designation of the cash flow hedge. The Company does not enter into derivative instruments for any purpose other than cash flow hedging. The Company does not speculate using derivative instruments. Stock-Based Compensation The Company records compensation expense for all share-based awards granted based on the fair value of the award at the time of the grant. The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model that uses assumptions and estimates that the Company believes are reasonable. Stock-based compensation costs for stock awards and restricted stock awards is measured based on the closing market value of the Company’s common stock on the date of the grant. For restricted stock awards subject to market conditions, the fair value of each restricted stock award has been estimated as of the date of grant using the Monte-Carlo pricing model. The Company recognizes the cost of the share-based awards on a straight-line basis over the requisite service period of the award. Revenue Recognition The Company sells its products pursuant to customer orders and agreements entered into with its customers. Revenue is recognized when persuasive evidence of an arrangement exists, title and risk of loss pass to the customer, the price is fixed and determinable, and collectability is reasonably assured. Charges for shipping and handling fees billed to customers are included in net sales and the corresponding shipping and handling expenses are included in cost of sales in the accompanying consolidated statements of comprehensive (loss) income. At the time of revenue recognition, we also provide for estimated sales returns and miscellaneous claims from customers as reductions to revenues. The estimates are based on historical rates of product returns and claims. However, actual returns and claims in any future period are inherently uncertain and thus may differ from these estimates. If actual or expected future returns and claims are significantly greater or lower than the allowances that we have established, we will record a reduction or increase to sales in the period in which we make such a determination. Over the three-year period ended December 31, 2016, our actual annual sales returns have been less than three percent (3%) of net sales. The allowance for outstanding sales returns from customers is not material to the consolidated financial statements. Cost of Sales The expenses that are included in cost of sales include all direct product costs and costs related to shipping, handling, duties and importation fees. Product warranty costs and specific provisions for excess, close-out, or slow moving inventory are also included in cost of sales. Selling, General and Administrative Expense Selling, general and administrative expense includes personnel-related costs, product development, selling, advertising, depreciation and amortization, and other general operating expenses. Advertising costs are expensed in the period incurred. Total advertising expense for continuing operations, including cooperative advertising costs, were $2,605, $3,220, and $2,807 for the years ended December 31, 2016, 2015, and 2014, respectively. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) Through cooperative advertising programs, the Company reimburses its wholesale customers for some of their costs of advertising the Company’s products based on various criteria, including the value of purchases from the Company and various advertising specifications. Cooperative advertising costs were $741, $1,037, and $649 for the years ended December 31, 2016, 2015, and 2014, respectively, and were included in selling, general, and administrative expense because the Company receives an identifiable benefit in exchange for the cost, the advertising may be obtained from a party other than the customer, and the fair value of the advertising benefit can be reasonably estimated. Product Warranty Some of the Company’s products carry warranty provisions for defects in quality and workmanship. Warranty repairs and replacements are recorded in cost of sales and a warranty liability is established at the time of sale to cover estimated costs based on the Company’s history of warranty repairs and replacements. The Company recorded a liability for product warranties totaling $892 and $854 as of December 31, 2016 and 2015, respectively. For the years ended December 31, 2016, 2015, and 2014, the Company experienced warranty claims on its products of $1,051, $813, and $879, respectively. Reporting of Taxes Collected Taxes collected from customers and remitted to government authorities are reported on the net basis and are excluded from sales. Research and Development Research and development costs are charged to expense as incurred, and are included in selling, general and administrative expenses in the accompanying consolidated statements of operations. Total research and development costs for continuing operations were $6,598, $7,469, and $7,335 for the years ended December 31, 2016, 2015, and 2014, respectively. Income Taxes Income Taxes are based on amounts of taxes payable or refundable in the current year and on expected future tax consequences of events that are recognized in the financial statements in different periods than they are recognized in tax returns. As a result of timing of recognition and measurement differences between financial accounting standards and income tax laws, temporary differences arise between amounts of pre-tax financial statement income and taxable income and between reported amounts of assets and liabilities in the Consolidated Balance Sheets and their respective tax bases. Deferred income tax assets and liabilities reported in the Consolidated Balance Sheets reflect estimated future tax effects attributable to these temporary differences and to net operating loss and net capital loss carryforwards, based on enacted tax rates expected to be in effect for years in which the differences are expected to be settled or realized. Realization of deferred tax assets is dependent on future taxable income in specific jurisdictions. Valuation allowances are used to reduce deferred tax assets to amounts considered more-likely-than-not to be realized. U.S. deferred income taxes are not provided on undistributed income of foreign subsidiaries where such earnings are considered to be permanently invested. The Company recognizes interest expense and penalties related to income tax matters in income tax expense. The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense. Unrecognized tax benefits that reduce a net operating loss, similar tax loss or tax credit carryforward, are presented as a reduction to deferred income taxes. Concentration of Credit Risk and Sales Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash, accounts receivable, and aggregate unrealized gains on derivative contracts. Risks associated with cash within the United States are mitigated by banking with federally insured, creditworthy institutions; however, there are balances with these institutions that are greater than the Federal Deposit Insurance Corporation insurance limit. The Company performs ongoing credit evaluations of its customers and maintains allowances for possible losses as considered necessary by management. During the years ended December 31, 2016, 2015 and 2014, Recreational Equipment, Inc. (“REI”) accounted for approximately 16%, 17% and 13%, respectively, of the Company’s sales from continuing operations. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) Fair Value Measurements The carrying value of cash, accounts receivable, accounts payable and accrued liabilities approximate their respective fair values due to the short-term nature and liquidity of these financial instruments. Marketable securities are recorded at fair value based on quoted market prices. Derivative financial instruments are recorded at fair value based on current market pricing models. The Company estimates that, based on current market conditions, the fair value of its long-term debt obligations under its revolving credit facility and senior subordinated notes payable approximate the carrying values at December 31, 2016 and 2015. Segment Information The Company has determined that during 2016, 2015, and 2014, the Company operated in one principal business segment. Recent Accounting Pronouncements Accounting Pronouncements adopted During During the first quarter of 2016, the Company adopted Accounting Standards Updated (“ASU”) 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition of the award. A reporting entity should apply existing guidance in Accounting Standards Codification Topic 718, Compensation-Stock Compensation, as it relates to such awards. Adoption of this guidance was applied prospectively and did not impact the Company’s consolidated statements and related disclosures. During the first quarter of 2016, the Company adopted ASU 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20), which eliminates the concept of extraordinary items from U.S. GAAP as part of its simplification initiative. This guidance does not affect disclosure guidance for events or transactions that are unusual in nature or infrequent in their occurrence. Adoption of this guidance was applied prospectively and did not impact the Company’s consolidated statements and related disclosures. During the first quarter of 2016, the Company adopted ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, which simplifies the presentation of debt issuance costs. The guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Adoption of this guidance was applied retrospectively and did not result in a material change to the Company’s prior period consolidated statements and related disclosures. During the fourth quarter of 2016, the Company adopted ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern which requires an entity to evaluate whether there are conditions or events, in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the financial statements are available to be issued when applicable) and to provide related footnote disclosures in certain circumstances. Adoption of this guidance was applied prospectively and did not impact on the Company’s consolidated statements and related disclosures. Accounting Pronouncements Not Yet Adopted In May 2014, the Financial Accounting Standards Board (the “FASB”) issued ASU 2014-09, Revenue from Contracts with Customers that replaces the existing accounting standards for revenue recognition with a single comprehensive five-step model. The core principle is to recognize revenue upon the transfer of goods or services to customers at an amount that reflects the consideration expected to be received. The FASB also issued ASU 2015-14, Deferral of Effective Date that deferred the effective date for the new guidance until the annual reporting period beginning after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted, but not before the original effective date (periods beginning after December 15, 2016). The standard permits the use of either the retrospective (restating all years presented in the Company’s financial statements) or cumulative effect (recording the impact of adoption as an adjustment to retained earnings at the beginning of the year of adoption) transition method. Since its issuance, the FASB has also amended several aspects of the new guidance, including; ASU 2016-08 Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) which clarifies the Topic 606 guidance on principal versus agent considerations, ASU 2016-10 Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing that clarifies identification of a performance obligation and address revenue recognition associated with the licensing of intellectual property, ASU 2016-12 Revenue from Contracts with Customers (Topic 606), Narrow Scope Improvements and Practical Expedients clarifying assessment of collectability criterion, non-cash consideration and other technical corrections and ASU 2016-20 Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers is the result of the FASB Board decision to issue a separate Update for technical corrections and improvements. The Company intends to adopt this guidance effective January 1, 2018 using the cumulative effect method. The Company has reviewed its current customer agreements and believes that all current open agreements as of December 31, 2016 will be settled prior to adoption of this guidance on January 1, 2018. The Company does not anticipate significant changes to our current revenue recognition policy resulting from adoption of the new guidance. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory, which changes the measurement principle for inventory from the lower of cost or market to lower of cost and net realizable value for entities that do not measure inventory using the last-in, first-out or retail inventory method. The ASU also eliminates the requirement for these entities to consider replacement cost or net realizable value less an approximately normal profit margin when measuring inventory. The guidance is effective for fiscal years beginning after December 15, 2016, and interim periods within those years. The ASU requires prospective adoption and permits early adoption. The Company believes that adoption of this ASU will not have a material impact on the Company’s consolidated financial statements and related disclosures. In February 2016, the FASB issued ASU 2016-02, Leases, which revises the accounting related to lessee accounting. Under the new guidance, lessees will be required to recognize a lease liability and a right-of-use asset (“ROU”) for all leases with terms greater than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The provisions of ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, and should be applied through a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements with certain practical expedients available. Early adoption is permitted. Since the effective date will not be until January 1, 2019, there is no immediate impact on the financial statements. Leases previously defined as capital leases will continue to be defined as a capital lease with no material changes to the accounting methodology; however, the Company does not have capital leases. However, the Company is performing an assessment of its leases and has begun preparations for implementation and restrospective application to the earliest reporting period. Under the new guidance, leases previously defined as operating leases will be defined as financing leases and capitalized if the term is greater than one year. As a result, financing lease will be recorded as an asset and a corresponding liability at the present value of the total lease payments. The asset will be decremented over the life of the lease on a pro-rata basis resulting in lease expense while the liability will be decremented using the interest method (ie. principal and interest). As such, the Company expects the new guidance will materially impact the asset and liability balances of the Company’s consolidated financial statements and related disclosures at the time of adoption. The majority of our current operating leases will expire prior to the adoption date. The Company anticipates renegotiating these operating leases; however, the terms which may exist at the adoption date are currently unknown. Consequently, the Company is unable to estimate the impact that these leases will have on the financial statements on the date of adoption. For the remaining leases with terms that go beyond the adoption date, the amounts we expect to recognize as additional liabilities and corresponding ROU assets based upon the present value of the remaining rental payments, are considered immaterial. In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU changes several aspects of the accounting for share-based payment award transactions, including: (1) accounting for income taxes; (2) classification of excess tax benefits on the statement of cash flows; (3) forfeitures; (4) minimum statutory tax withholding requirements; and (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. The ASU is effective for annual and interim reporting periods beginning after December 15, 2016 with early adoption permitted. The Company has evaluated the impact of adoption of this ASU. The Company does not believe the adoption of this guidance will have a material impact on the Company’s consolidated statements and related disclosures. In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, which clarifies the treatment of several cash flow categories. In addition, ASU 2016-15 clarifies that when cash receipts and cash payments have aspects of more than one class of cash flows and cannot be separated, classification will depend on the predominant source or use. The ASU is effective for annual and interim reporting periods beginning after December 15, 2017 with early adoption permitted. The Company does not believe the adoption of this guidance will have a material impact on the Company’s consolidated statements and related disclosures. In November 2016, the FASB issued ASU 2016-18 Statement of Cash Flows (Topic 230) Restricted Cash requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. This ASU is effective for fiscal years beginning January 1, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The amendments in this Update should be applied using a retrospective transition method to each period presented. The Company does not believe the adoption of this guidance will have a material impact on the Company’s consolidated statements and related disclosures. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) NOTE 2. DISCONTINUED OPERATIONS As discussed above in Note 1, during the year ended December 31, 2014, the Company and Gregory, its then wholly-owned subsidiary, completed the GMP Sale pursuant to the terms of the GMP Purchase Agreement. The Company received $84,135 in cash for the GMP Sale and paid $2,995 in transaction fees for net proceeds of $81,140. The Company recognized a pre-tax gain on such sale of $39,491 and tax expense of $19,424. The Company performed certain transition services related to the GMP Sale and received $0, $232, and $568, which were recorded as a reduction of selling, general and administrative expenses in our consolidated financial statements during the years ended December 31, 2016, 2015, and 2014, respectively. Additionally, as discussed above in Note 1, on October 7, 2015, the Company sold POC. The Company received $63,639 in cash for the POC Disposition and paid $2,946 in transaction fees for net proceeds of $60,693. $739 of cash was sold as part of the transaction. Also, as of December 31, 2015, there was an unsettled working capital adjustment of $921 owed to Dainese which was paid during the three months ended March 31, 2016. The Company recognized a pre-tax gain on such sale of $8,436. The Company performed certain transition services related to the POC Disposition and received $324, $270, and $0 during the years ended December 31, 2016, 2015, and 2014, respectively, which was recorded as a reduction of selling, general and administrative expenses in our consolidated financial statements for such periods. Summarized results of discontinued operations for both GMP and POC are as follows: In connection with the GMP Sale on July 23, 2014, all interest related to outstanding debt that was required to be repaid pursuant to the terms of the Company’s amended and restated loan agreement with Zions First National Bank (the “Lender”) is allocated to discontinued operations in our consolidated financial statements for the year ended December 31, 2014. As the outstanding debt was repaid during the year ended December 31, 2014, there was no interest allocated to discontinued operations in our consolidated financial statements for the year ended December 31, 2015. Summarized cash flow information for both GMP and POC discontinued operations are as follows: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) NOTE 3. INVENTORIES Inventories, as of December 31, 2016 and December 31, 2015, were as follows: NOTE 4. PROPERTY AND EQUIPMENT Property and equipment, net as of December 31, 2016 and December 31, 2015, were as follows: Depreciation expense for continuing operations was $2,264, $3,039, and $3,721 for the years ended December 31, 2016, 2015, and 2014, respectively. NOTE 5. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill There was a decrease in goodwill during the year ended December 31, 2015 from $29,628 to $0 due to the impairment of goodwill and the impact of foreign currency exchange rates. During the fourth quarter of the year ended December 31, 2015, there was a decrease in the Company’s market capitalization which was determined to be a triggering event for potential goodwill impairment. Accordingly, the Company performed a goodwill impairment analysis. The Company utilized the market capitalization, plus a reasonable control premium to estimate the fair value. Our total stockholders’ equity exceeded the estimated fair value by $32,754. The failure of step one of the goodwill impairment test triggered a step two impairment test. As a result of step two of the impairment test, the Company determined the implied fair value of goodwill and concluded that the carrying value of goodwill exceeded its implied fair value as of December 31, 2015. Accordingly, an impairment charge of $29,507, which represents a full impairment charge, was recognized in the fourth quarter of 2015. As of December 31, 2016, there was no goodwill recorded. The following table summarizes the changes in goodwill: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) Indefinite Lived Intangible Assets The Company owns certain tradenames and trademarks which provide Black Diamond Equipment and PIEPS with the exclusive and perpetual rights to manufacture and sell their respective products. Tradenames and trademarks are not amortized, but reviewed annually for impairment or upon the existence of a triggering event. There was a decrease in tradenames and trademarks during the year ended December 31, 2016 due to the impact of foreign currency exchange rates. Based on the results of the Company’s annual impairment tests, the Company determined that indefinite lived intangible assets were not impaired. The following table summarizes the changes in indefinite lived intangible assets: Other Intangible Assets, net Intangible assets such as certain customer relationships, core technologies and product technologies are amortizable over their estimated useful lives. There was a decrease in gross other intangible assets subject to amortization during the year ended December 31, 2016 due to the impact of foreign currency exchange rates. The following table summarizes the changes in gross other intangible assets: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) Intangible assets, net of amortization as of December 31, 2016 and December 31, 2015, were as follows: Amortization expense for continuing operations for the years ended December 31, 2016, 2015, and 2014, was $1,075, $1,245, and $1,410, respectively. Future amortization expense for other intangible assets as of December 31, 2016 is as follows: NOTE 6. LONG-TERM DEBT Long-term debt, net as of December 31, 2016 and December 31, 2015, was as follows: (a)As of December 31, 2016, the Company had drawn $0 on a $20,000 revolving credit facility with the Lender with a maturity date of April 1, 2017. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) On March 3, 2017, the Company together with its direct and indirect domestic subsidiaries entered into a third amendment (the “Third Amendment”) to the second amended and restated loan agreement (the “Second Amended and Restated Loan Agreement”) as amended by the first amendment (the “First Amendment”) and the second amendment (the “Second Amendment”) to the Second Amended and Restated Loan Agreement with Zions First National Bank (the “Lender”), which matures on April 1, 2020. Under the Third Amendment, the Company has a $20,000 revolving line of credit (the “Revolving Line of Credit”) pursuant to a third amended and restated promissory note (revolving loan) (the “Revolving Line of Credit Promissory Note”). All debt associated with the Third Amendment to the Second Amended and Restated Loan Agreement bears interest at one-month London Interbank Offered Rate (“LIBOR”) plus an applicable margin as determined by the ratio of Total Senior Debt to Trailing Twelve Month EBITDA as follows: (i) one month LIBOR plus 4.00% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is greater than or equal to 2.00; (ii) one month LIBOR plus 3.00% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is greater than 1.00 and less than 2.00; and (iii) one month LIBOR plus 2.00% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is less than 1.00. The Second Amended and Restated Loan Agreement requires the payment of any unused commitment fee of (i) .6% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is greater than or equal to 2.00; (ii) .5% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is greater than 1.00 and less than 2.00; and (iii) .4% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is less than 1.00. The Third Amendment to the Second Amended and Restated Loan Agreement contains certain restrictive debt covenants that require the Company and its subsidiaries to maintain an EBITDA based minimum Trailing Twelve Month EBITDA, a minimum net worth, a positive amount of asset coverage, and limitations on capital expenditures all as calculated in the Third Amendment to the Second Amended and Restated Loan Agreement. In addition, the Third Amendment to the Second Amended and Restated Loan Agreement contains covenants restricting the Company and its subsidiaries from pledging or encumbering their assets, with certain exceptions, and from engaging in acquisitions other than acquisitions permitted by the Third Amendment to the Second Amended and Restated Loan Agreement. The Third Amendment to the Second Amended and Restated Loan Agreement contains customary events of default (with grace periods where customary) including, among other things, failure to pay any principal or interest when due; any materially false or misleading representation, warranty, or financial statement; failure to comply with or to perform any provision of the Third Amendment to the Second Amended and Restated Loan Agreement; and default on any debt or agreement in excess of certain amounts. (b)In connection with the Company’s acquisition of Gregory on May 2010, $22,056 and $554 in subordinated notes were issued to the Gregory Stockholders. The notes have a seven year term, 5% stated interest rate payable quarterly, and are prepayable at any time. Given the below market interest rate for comparably secured notes and the relative illiquidity of the notes, we discounted the notes to $13,127 and $316, respectively, at date of acquisition. We are accreting the discount on the notes to interest expense using the effective interest method over the term of the notes. During the years ended December 31, 2016, 2015 and 2014, $1,768, $1,537 and $1,337, respectively, of the discounts were accreted and recorded as interest expense in the accompanying statements of comprehensive (loss) income. During February 2017, the Company’s Board of Directors approved the repayment of the Merger Consideration Subordinated Notes. On February 13, 2017, the entire principal amount and all accrued interest were paid in full. The note discount as of December 31, 2016 of $814 will be expensed and recognized as interest expense during the three months ending March 31, 2017. (c)The term loan is payable to a government entity with an interest rate of 0.75% and no monthly installments. The note matures in March 2017. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) The aggregate maturities of long-term debt and revolving lines of credit for the years subsequent to December 31, 2016 are as follows: There was no property held under capital leases as of December 31, 2016 and 2015. NOTE 7. OTHER LONG-TERM LIABILITIES Other long-term liabilities were $76 and $1,812 as of December 31, 2016 and 2015, respectively, with $0 and $1,689 of the balance as of December 31, 2016 and 2015, respectively, relating to a pension liability, which is net of pension assets of $0 and $2,849, respectively, with respect to the benefit plan maintained for the benefit of the Company’s employees in Switzerland. Due to the move of the Company’s Black Diamond Equipment European office from Basel, Switzerland to Innsbruck, Austria in 2016, the benefit plan has been closed as of December 31, 2016. The Company also had an insurance policy whereby any underfunded amounts related to the pension liability were expected to be recoverable. The Company has recorded a receivable of $0 and $1,689 as other long-term assets for the underfunded amount as of December 31, 2016 and 2015, respectively. The net periodic pension costs were $191, $526, and $832 for the years ended December 31, 2016, 2015, and 2014, respectively. The significant assumptions used in accounting for the defined benefit pension plan were as follows: The Company made cash contributions to its defined benefit pension plan of $96, $263, and $416 for the years ended December 31, 2016, 2015, and 2014, respectively. NOTE 8. DERIVATIVE FINANCIAL INSTRUMENTS The Company’s primary exchange rate risk management objective is to mitigate the uncertainty of anticipated cash flows attributable to changes in foreign currency exchange rates. The Company primarily focuses on mitigating changes in cash flows resulting from sales denominated in currencies other than the U.S. dollar. The Company manages this risk primarily by using currency forward and option contracts. If the anticipated transactions are deemed probable, the resulting relationships are formally designated as cash flow hedges. The Company accounts for these contracts as cash flow hedges and tests effectiveness by determining whether changes in the expected cash flow of the derivative offset, within a range, changes in the expected cash flow of the hedged item. At December 31, 2016, the Company’s derivative contracts had a remaining maturity of less than one and one-half years. The counterparty to these transactions had both long-term and short-term investment grade credit ratings. The maximum net exposure of the Company’s credit risk to the counterparty is generally limited to the aggregate unrealized loss of all contracts with that counterparty. At December 31, 2016, there was no such exposure to the counterparty. The Company’s exposure to the counterparty credit risk is limited to the aggregate unrealized gain of $1,281 on all contracts at December 31, 2016. The Company’s derivative counterparty has strong credit ratings and as a result, the Company does not require collateral to facilitate transactions. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) The Company held the following contracts designated as hedged instruments as of December 31, 2016 and 2015: For contracts that qualify as effective hedge instruments, the effective portion of gains and losses resulting from changes in fair value of the instruments are included in accumulated other comprehensive loss and reclassified to sales in the period the underlying hedged transaction is recognized in earnings. Gains (losses) of $(351) and $5,787 were reclassified to sales during the years ended December 31, 2016 and 2015, respectively. Gains of $0 and $297 were reclassified to discontinued operations, net of tax, during the years ended December 31, 2016 and 2015, respectively. The Company records ineffectiveness of hedged instruments resulting from changes in fair value of the instruments in earnings. Gains (losses) of $(42) were recorded to Other, net, associated with ineffective hedge instruments during the year ended December 31, 2016. There were no gains (losses) recorded to Other, net, during the year ended December 31, 2015. As of December 31, 2015, the Company reported an accumulated derivative instrument loss of $68. During the year ended December 31, 2016, the Company reported other comprehensive income of $792, as a result of the change in fair value of these contracts and reclassifications to sales and other income as discussed above, resulting in an accumulated derivative instrument income of $724 reported as of December 31, 2016. The following table presents the balance sheet classification and fair value of derivative instruments as of December 31, 2016 and 2015: NOTE 9. ACCUMULATED OTHER COMPREHENSIVE INCOME Accumulated other comprehensive (loss) income (“AOCI”) primarily consists of unrealized losses in our marketable securities, foreign currency translation adjustments and changes in our forward foreign exchange contracts. The components of AOCI, net of tax, were as follows: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) The effects on net loss of amounts reclassified from unrealized gains (losses) on cash flow hedges for foreign exchange contracts, foreign currency translation adjustments, and marketable securities for the year ended December 31, 2016 were as follows: The Company’s policy is to classify reclassifications of cumulative foreign currency translation associated with continuing operations from AOCI to Other, net. NOTE 10. FAIR VALUE MEASUREMENTS We measure certain financial assets and liabilities at fair value on a recurring basis. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, under a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows: Level 1- inputs to the valuation methodology are quoted market prices for identical assets or liabilities in active markets. Level 2- inputs to the valuation methodology include quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 3- inputs to the valuation methodology are based on prices or valuation techniques that are unobservable. Assets and liabilities measured at fair value on a recurring basis at December 31, 2016 and December 31, 2015 were as follows: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) Nonrecurring Fair Value Measurements There were no assets and liabilities measured at fair value on a nonrecurring basis at December 31, 2016. Assets and liabilities measured at fair value on a nonrecurring basis at December 31, 2015 were as follows: The Company has certain assets that are measured at fair value on a nonrecurring basis when impairment indicators are present. The categorization of the framework used to estimate the fair value of the assets is considered a Level 3, due to the subjective nature of the unobservable inputs used to determine the fair value. The assets are adjusted to fair value only when the carrying values exceed the fair values. As discussed above, based on the results of the Company’s annual impairment tests completed during the year ended December 31, 2015, the Company determined that goodwill was impaired. As a result, we recognized impairment charges during the year ended December 31, 2015. No nonrecuuring fair value measurements existed for the year ended December 31, 2016. NOTE 11. EARNINGS PER SHARE Basic earnings (loss) per share is computed by dividing earnings (loss) by the weighted average number of common shares outstanding during each period. Diluted earnings (loss) per share is computed by dividing earnings (loss) by the total of the weighted average number of shares of common stock outstanding during each period, plus the effect of dilutive outstanding stock options and unvested restricted stock grants. Potentially dilutive securities are excluded from the computation of diluted earnings per share if their effect is anti-dilutive to the loss from continuing operations. The following table is a reconciliation of basic and diluted shares of common stock outstanding used in the calculation of earnings per share: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) For the years ended December 31, 2016, 2015, and 2014, equity awards of 2,471, 3,074, and 3,591, respectively, were outstanding and anti-dilutive and therefore not included in the calculation of loss per share for these periods. NOTE 12. STOCK-BASED COMPENSATION PLAN Under the Company’s current 2015 Stock Incentive Plan (the “2015 Plan”) and the previous 2005 Stock Incentive Plan (the “2005 Plan”), the Company’s Board of Directors (the “Board of Directors”) has flexibility to determine the type and amount of awards to be granted to eligible participants, who must be employees, directors, officers or consultants of the Company or its subsidiaries. The 2015 Plan allows for grants of incentive stock options, nonqualified stock options, restricted stock awards, stock appreciation rights, and restricted units. The aggregate number of shares of common stock that may be granted through awards under the 2015 Plan to any employee in any calendar year may not exceed 500 shares. The 2005 Plan continued in effect until June 2015 when it expired in accordance with its terms. The 2015 Plan will continue in effect until December 2025 unless terminated sooner. As of December 31, 2016, the number of shares authorized and reserved for issuance under the 2015 Plan is 5,615, subject to automatic annual increase equal to 5% of the total number of shares of the Company’s outstanding common stock. Options Granted: During the year ended December 31, 2016, the Company issued stock options for an aggregate of 163 shares under the 2015 Plan to directors and employees of the Company. Of the 163 options issued, 38 options vest in four equal consecutive quarterly tranches from the date of grant. The remaining 125 options will vest in three installments as follows: 42 options shall vest on June 30, 2017, and the remaining options shall vest equally on June 30, 2018 and June 30, 2019. For computing the fair value of the stock-based awards, the fair value of each option grant has been estimated as of the date of grant using the Black-Scholes option-pricing model with the following assumptions: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) (a)Expected volatility is based upon the Company’s historical volatility. (b)Since the Company’s historical volatility was not representative of the ongoing future business, the Company’s historical volatility was based on a combination of the Company’s volatility and the historical volatility of a peer group of companies within similar industries and similar size as the Company. (c)Because the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term for these grants, the Company utilized the simplified method in developing an estimate of the expected term of these options. Using these assumptions, the fair value of the stock options granted during the years ended December 31, 2016, 2015, and 2014 was $299, $320, and $2,747, respectively, which will be amortized over the vesting period of the options. On July 1, 2016, the Company issued and granted to an employee a restricted stock award of 100 restricted shares under the 2015 Plan, which will vest if, on or before July 1, 2020, the Fair Market Value (as defined in the Plan) of the Company’s common stock shall have equaled or exceeded $15.00 per share for twenty consecutive trading days. For computing the fair value of the 100 restricted shares subject to a market condition, the fair value of each restricted stock award grant has been estimated as of the date of grant using the Monte-Carlo pricing model with the assumptions below. On August 11, 2014, the Company issued and granted to an employee a restricted stock award of 300 restricted shares under the 2005 Plan, of which (i) 50 restricted shares vested and become nonforteitable on August 25, 2014; (ii) 205 restricted shares were to vest and become nonforteitable as follows: (A) 45 restricted shares were to vest if, on or before June 30, 2017, the Fair Market Value (as defined in the Plan) of the Company’s common stock shall have equaled or exceeded $15.00 per share for five consecutive trading days; (B) 80 restricted shares were to vest if, on or before December 31, 2019, the Fair Market Value of the Company’s common stock shall have equaled or exceeded $20.00 per share for five consecutive trading days; (C) 80 restricted shares were to vest if, on or before December 31, 2019, the Fair Market Value of the Company’s common stock shall have equaled or exceeded $22.00 per share for five consecutive trading days; and (iii) 15 restricted shares were to vest and become nonforfeitable on each of December 31, 2015, December 31, 2016 and December 31, 2017. All vested restricted shares will be subject to a lock-up provision restricting sales, dispositions, pledges and transfers of such shares through December 31, 2016. For computing the fair value of the 205 restricted shares with a market condition, the fair value of each restricted stock award grant has been estimated as of the date of grant using the Monte-Carlo pricing model with the assumptions below. The restricted stock awards of 95 that were to vest over time were valued at $7.74 per share, which included a discount for the lock-up provision. During the year ended December 31, 2015, all unvested awards were forfeited and the related stock compensation expense was reversed. Market Condition Restricted Shares Granted Using these assumptions, the fair value of the market condition restricted stock awards granted on July 1, 2016 was approximately $105 and August 11, 2014 was approximately $923. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) The total non-cash stock compensation expense for continuing operations related to stock options and restricted stock awards recorded by the Company was as follows: For the years ended December 31, 2016, 2015, and 2014, the majority of stock-based compensation costs were classified as selling, general and administrative expense. A summary of changes in outstanding options and restricted stock awards during the year ended December 31, 2016 is as follows: The following table summarizes the exercise price range, weighted average exercise price, and remaining contractual lives by significant ranges for options outstanding and exercisable as of December 31, 2016: The fair value of unvested restricted stock awards is determined based on the market price of our shares of common stock on the grant date or using the Monte-Carlo pricing model. As of December 31, 2016, there were 271 unvested stock options and unrecognized compensation cost of $615 related to unvested stock options, as well as 370 unvested restricted stock awards and unrecognized compensation cost of $97 related to unvested restricted stock awards. NOTE 13. RESTRUCTURING The Company initiated a restructuring plan in 2014 (the “2014 Restructuring Plan”) to realign resources within the organization and completed the plan during the year ended December 31, 2016. Based on the Company’s 2014 Restructuring Plan, we determined that long-lived assets in certain asset groups required an impairment analysis. As of the year ended December 31, 2014, the carrying values of our Asian manufacturing and Asian distribution operations as well as our sales, marketing, and distribution office in Japan were above their fair values based upon a discounted cash flow analysis. During the year ended December 31, 2014, we incurred restructuring charges of $2,056 related to impairment of long-lived assets. During the years ended December 31, 2016, 2015, and 2014, we incurred $30, $2,356, and $3,583, respectively, of restructuring charges related to the 2014 Restructuring Plan. We have incurred $5,969 of cumulative restructuring charges since the commencement of the 2014 Restructuring Plan. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) As part of the conclusion of the Company’s review of strategic alternatives, the Company initiated restructuring activities in efforts to further realign resources within the organization (the “2015 Restructuring Plan”) and anticipates completing the plan in 2017. During the year ended December 31, 2016 and 2015, we incurred $1,365 and $1,019, respectively, of restructuring charges related to the 2015 Restructuring Plan. There were no costs incurred related to the 2015 Restructuring Plan during 2014. We have incurred $2,384 of cumulative restructuring charges since the commencement of the 2015 Restructuring Plan. We estimate that we will incur an immaterial amount of costs during the year 2017. The following table summarizes the restructuring charges, payments and the remaining accrual related to employee termination costs and facility costs: As of December 31, 2016, termination costs and restructuring costs remained in accrued liabilities and are expected to be paid throughout 2017. NOTE 14. COMMITMENTS AND CONTINGENCIES The Company is involved in various legal disputes and other legal proceedings that arise from time to time in the ordinary course of business. Based on currently available information, the Company does not believe that it is reasonably possible that the disposition of any of the legal disputes the Company or its subsidiaries is currently involved in will have a material adverse effect upon the Company’s consolidated financial condition, results of operations or cash flows. There is a reasonable possibility of loss from contingencies in excess of the amounts accrued by the Company in the accompanying consolidated balance sheets; however, the actual amounts of such possible losses cannot currently be reasonably estimated by the Company at this time. It is possible that, as additional information becomes available, the impact on the Company could have a different effect. During the year ended December 31, 2016, the Company received an arbitral award on agreed terms of $1,967, related to certain claims against the former owner of PIEPS associated with the voluntary recall of all of the PIEPS VECTOR avalanche transceivers during the year ended December 31, 2013. This concludes the arbitration in its entirety. The Company leases office, warehouse and distribution space under non-cancelable operating leases. As leases expire, it can be expected that, in the normal course of business, certain leases will be renewed or replaced. Certain lease agreements include escalating rents over the lease terms. The Company expenses rent on a straight-line basis over the lease term which commences on the date the Company has the right to control the property. The cumulative expense recognized on a straight-line basis in excess of the cumulative payments is included in accounts payable and accrued liabilities and other long-term liabilities in the accompanying consolidated balance sheets. Total rent expense for continuing operations of the Company for the years ended December 31, 2016, 2015, and 2014 was $1,033, $1,515, and $1,936, respectively. Future minimum lease payments required under noncancelable operating leases that have initial or remaining noncancelable lease term in excess of one year at December 31, 2016 are as follows: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) NOTE 15. INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company is subject to income taxes in certain foreign jurisdictions which creates deferred tax assets and liabilities in these jurisdictions. The Company has netted these deferred tax assets and deferred tax liabilities by jurisdiction. Deferred income tax assets are reviewed for recoverability and valuation allowances are provided when it is more likely than not that a deferred tax asset is not realizable in the future. The Company’s foreign operations that are considered to be permanently reinvested have statutory tax rates of approximately 25%. The Company recognizes interest expense and penalties related to income tax matters in income tax expense. Consolidated (loss) income from continuing operations before income taxes consists of the following: The components of the provision (benefit) for income taxes attributable to continuing operations consist of the following: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) The allocation of income tax expense (benefit) was as follows: The following is a reconciliation of the statutory federal income tax rate to the effective rate reported in the Company’s financial statements: Deferred income tax assets and liabilities are determined based on the difference between the financial reporting carrying amounts and tax bases of existing assets and liabilities and operating loss and tax credit carryforwards. Significant components of the Company’s existing deferred income tax assets and liabilities as of December 31, 2016 and 2015 are as follows: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) As of December 31, 2016, the Company’s gross deferred tax asset was $75,416. The Company has recorded a valuation allowance of $67,662, resulting in a net deferred tax asset of $7,754, before deferred tax liabilities of $16,720. The Company has provided a valuation allowance against a portion of the deferred tax assets as of December 31, 2016, because the ultimate realization of those assets does not meet the more likely than not criteria. The majority of the Company’s deferred tax assets consist of net operating loss carryforwards for federal tax purposes. If a change in control were to occur, these could be limited under Section 382 of the Internal Revenue Code of 1986 (“Code”), as amended. In assessing the realizability of deferred income tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and net operating loss and credit carryforwards expire. The estimates and judgments associated with the Company’s valuation allowance on deferred tax assets are considered critical due to the amount of deferred tax assets recorded by the Company on its consolidated balance sheet and the judgment required in determining the Company’s future taxable income. The need for a valuation allowance is reassessed at each reporting period. During the year ended December 31, 2015, the Company recorded an increase to its valuation allowance of $48,858. Certain events and circumstances as explained below transpired during the third quarter of the year ended December 31, 2015, which caused the Company to conclude that the realization of some portion of its deferred tax assets does not satisfy the more-likely-than-not threshold. The POC Disposition removed a substantial portion of the Company’s projected future taxable income. Additionally, during the year ended December 31, 2015, the Company made the decision to scale back its apparel initiative and announced a realignment of resources. The totality of these events and circumstances impedes management’s ability to forecast future long-term taxable income to the extent that it does not meet the more-likely-than-not threshold. The net change in the valuation allowance for deferred income tax assets was $3,176, $48,858, and ($1,023) during the years ended December 31, 2016, 2015, and 2014, respectively. A roll forward of our valuation allowance for deferred income tax assets for the years ended December 31, 2016, 2015, and 2014 is as follows: BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) (a)During the year ended December 31, 2014, the decrease in valuation allowance is due to the expiration of state NOL’s that had a full valuation allowance. As of December 31, 2016, the Company had net operating loss, research and experimentation credit and alternative minimum tax credit carryforwards for U.S. federal income tax purposes of $172,419 ($270 relates to excess tax benefits related to share based payment compensation, which will not be realized until an income tax payable exists), $3,407 and $315, respectively. The Company believes its U.S. Federal net operating loss (“NOL”) will substantially offset its future U.S. Federal income taxes, excluding the amount subject to U.S. Federal Alternative Minimum Tax (“AMT”). AMT is calculated as 20% of AMT income. For purposes of AMT, a maximum of 90% of income is offset by available NOLs. The majority of the Company’s pre-tax income is currently earned and expected to be earned in the U.S., or taxed in the U.S. as Subpart F. income and will be offset with the NOL. NOLs available to offset taxable income, subject to compliance with Section 382 of the Code, begin to expire based upon the following schedule: Net Operating Loss Carryforward Expiration Dates December 31, 2016 Tax positions are recognized in the financial statements when it is more-likely-than-not that the position will be sustained upon examination by the tax authorities. The Company conducts its business globally. As a result, the Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions, and are subject to examination for the open tax years in the U.S. federal and state jurisdictions of 2013-2015 and in the foreign jurisdictions of 2005-2015. The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense. A reconciliation of the beginning and ending amount of total unrecognized tax benefits for the years ended December 31, 2016 and 2015 and are follows: Included in the balance of total unrecognized tax benefits at December 31, 2016 and 2015, are potential benefits of $1,135 and $322, respectively, that if recognized, would affect the effective rate, subject to impact of valuation allowance, on income from continuing operations. Unrecognized tax benefits that reduce a net operating loss, similar tax loss or tax credit carryforward are presented as a reduction to deferred income taxes. As a result, the Company classified $327 and $230 of its unrecognized tax benefit as a reduction to deferred tax assets as of December 31, 2016 and 2015, respectively. The Company expects approximately $738 of tax and $181 of interest which was recorded during the year ended December 31, 2016, to reverse in the next 12 months on an uncertain tax position associated with the formal closure and liquidation of the Company’s Black Diamond Equipment foreign subsidiary in Zhuhai, China. In the U.S., there is not a formal federal or state audit; however, the Company believes that a portion of its position on research and development credits do not meet the more-likely-than-not criteria, and therefore has recorded a tax reserve of $397 and interest expense of $4 as of December 31, 2016. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) Interest and penalty expense recognized related to uncertain tax positions amounted to $183, $2, and $0 during the years ending December 31, 2016, 2015, and 2014, respectively. Total accrued interest and penalties as of December 31, 2016 and 2015 were $185 and $2, respectively, and were included in accounts payable and accrued liabilities. NOTE 16. RELATED PARTY TRANSACTIONS 5% Unsecured Subordinated Notes due May 28, 2017 As part of the consideration payable to the stockholders of Gregory when the Company acquired Gregory, the Company issued $14,517, $7,539, and $554 in 5% Unsecured Subordinated Notes due May 28, 2017 (the “Merger Consideration Subordinated Notes”) to Kanders GMP Holdings, LLC, Schiller Gregory Investment Company, LLC, and five former employees of Gregory, respectively. Mr. Warren B. Kanders, the Company’s Executive Chairman and a member of its Board of Directors, is a majority member and a trustee of the manager of Kanders GMP Holdings, LLC. The sole manager of Schiller Gregory Investment Company, LLC is Mr. Robert R. Schiller, the Company’s Executive Vice Chairman and a member of its Board of Directors. The principle terms of the Merger Consideration Subordinated Notes are as follows: (i) the principal amount is due and payable on May 28, 2017 and is prepayable by the Company at any time; (ii) interest will accrue on the principal amount at the rate of 5% per annum and shall be payable quarterly in cash; (iii) the default interest rate shall accrue at the rate of 10% per annum during the occurrence of an event of default; and (iv) events of default, which can only be triggered with the consent of Kanders GMP Holdings, LLC, are: (a) the default by the Company on any payment due under a Merger Consideration Subordinated Note; (b) the Company’s failure to perform or observe any other material covenant or agreement contained in the Merger Consideration Subordinated Notes; or (c) the Company’s instituting or becoming subject to a proceeding under the Bankruptcy Code (as defined in the Merger Consideration Subordinated Notes). The Merger Consideration Subordinated Notes are junior to all senior indebtedness of the Company, except that payments of interest continue to be made under the Merger Consideration Subordinated Notes as long as no event of default exists under any senior indebtedness. Given the below market interest rate for comparably secured notes and the relative illiquidity of the Merger Consideration Subordinated Notes, we have discounted the notes to $8,640, $4,487, and $316, respectively, at the date of acquisition. We are accreting the discount on the Merger Consideration Subordinated Notes to interest expense using the effective interest method over the term of the Merger Consideration Subordinated Notes. The effective interest rate is approximately 14%. On April 7, 2011, Schiller Gregory Investment Company, LLC transferred its Merger Consideration Subordinated Note in equal amounts to the Robert R. Schiller Cornerstone Trust and the Deborah Schiller 2005 Revocable Trust. On June 24, 2013, the Robert R. Schiller Cornerstone Trust dated September 9, 2010 transferred its Merger Consideration Subordinated Note in the amount of $3,769 to the Robert R. Schiller 2013 Cornerstone Trust dated June 24, 2013. During the year ended December 31, 2016, $726 in interest was paid to Kanders GMP Holdings, LLC, and $377 in interest was paid to the Robert R. Schiller 2013 Cornerstone Trust and the Deborah Schiller 2005 Revocable Trust pursuant to the outstanding Merger Consideration Subordinated Notes. On May 29, 2012 and August 13, 2012, five former employees of Gregory exercised certain sales rights and sold Merger Consideration Subordinated Notes in the aggregate principal amount of approximately $365 to Kanders GMP Holdings, LLC and in the aggregate principal amount of approximately $189 to Schiller Gregory Investment Company, LLC. During the year ended December 31, 2016, $18 in interest was paid to Kanders GMP Holdings, LLC, and $10 in interest was paid to Schiller Gregory Investment Company, LLC, pursuant to these outstanding Merger Consideration Subordinated Notes. During February 2017, the Company’s Board of Directors approved the repayment of the Merger Consideration Subordinated Notes. On February 13, 2017, the entire principal amount and all accrued interest were paid in full. The note discount as of December 31, 2016 of $814 will be expensed and recognized as interest expense during the three months ending March 31, 2017. NOTE 17. SUBSEQUENT EVENT 5% Unsecured Subordinated Notes due May 28, 2017 During February 2017, the Company’s Board of Directors approved the repayment of the Merger Consideration Subordinated Notes. On February 13, 2017, the entire principal amount and all accrued interest were paid in full. The note discount as of December 31, 2016 of $814 will be expensed and recognized as interest expense during the three months ending March 31, 2017. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) Third Amendment to the Second Amended and Restated Loan Agreement On March 3, 2017, the Company together with its direct and indirect domestic subsidiaries entered into the Third Amendment to the Second Amended and Restated Loan Agreement as amended by the First Amendment and the Second Amendment to the Second Amended and Restated Loan Agreement with the Lender, which matures on April 1, 2020. Under the Third Amendment, the Company has a $20,000 revolving line of credit (the “Revolving Line of Credit”) pursuant to a third amended and restated promissory note (revolving loan) (the “Revolving Line of Credit Promissory Note”). All debt associated with the Third Amendment to the Second Amended and Restated Loan Agreement bears interest at one-month London Interbank Offered Rate (“LIBOR”) plus an applicable margin as determined by the ratio of Total Senior Debt to Trailing Twelve Month EBITDA as follows: (i) one month LIBOR plus 4.00% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is greater than or equal to 2.00; (ii) one month LIBOR plus 3.00% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is greater than 1.00 and less than 2.00; and (iii) one month LIBOR plus 2.00% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is less than 1.00. The Second Amended and Restated Loan Agreement requires the payment of any unused commitment fee of (i) .6% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is greater than or equal to 2.00; (ii) .5% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is greater than 1.00 and less than 2.00; and (iii) .4% per annum at all times that Total Senior Debt to Trailing Twelve Month EBITDA ratio is less than 1.00. The Third Amendment to the Second Amended and Restated Loan Agreement contains certain restrictive debt covenants that require the Company and its subsidiaries to maintain an EBITDA based minimum Trailing Twelve Month EBITDA, a minimum net worth, a positive amount of asset coverage, and limitations on capital expenditures all as calculated in the Third Amendment to the Second Amended and Restated Loan Agreement. In addition, the Third Amendment to the Second Amended and Restated Loan Agreement contains covenants restricting the Company and its subsidiaries from pledging or encumbering their assets, with certain exceptions, and from engaging in acquisitions other than acquisitions permitted by the Third Amendment to the Second Amended and Restated Loan Agreement. The Third Amendment to the Second Amended and Restated Loan Agreement contains customary events of default (with grace periods where customary) including, among other things, failure to pay any principal or interest when due; any materially false or misleading representation, warranty, or financial statement; failure to comply with or to perform any provision of the Third Amendment to the Second Amended and Restated Loan Agreement; and default on any debt or agreement in excess of certain amounts. BLACK DIAMOND, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, except per share amounts) SUPPLEMENTARY DATA - QUARTERLY FINANCIAL DATA (Unaudited) The following table sets forth selected quarterly data for the years ended December 31, 2016 and 2015. Certain amounts have been revised from those previously reported in the Company’s quarterly reports on Form 10-Q in order to present a correction related to the carryback limitations of net operating losses and tax credits to 2014 in the third quarter of 2015, which resulted in an increase of $1,571 of income tax expense, and to present the results of the POC Disposition as discontinued operations. The operating results are not indicative of results for any future period. BLACK DIAMOND, INC. | Based on the provided financial statement excerpt, here's a summary of the key financial points:
1. Financial Position:
- The company experienced a loss (specific amount not provided)
- Liabilities increased by $1,801 thousand
- The statement covers a three-year period ending December 31 (year not specified)
2. Key Accounting Policies:
- Uses derivative instruments for cash flow hedging only (no speculative trading)
- Implements stock-based compensation using Black-Scholes option pricing model
- Revenue is recognized when:
* Arrangement evidence exists
* Title/risk transfers to customer
* Price is fixed
* Collection is reasonably assured
3. Notable Financial Practices:
- Includes shipping/handling fees in net sales
- Accounts for estimated sales returns and claims as revenue reductions
- Debt obligations are recorded at approximate carrying values
Note: The statement appears to be incomplete and fragmented, making it difficult to provide specific numerical analysis beyond what's explicitly stated. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Post Holdings, Inc., In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive income/(loss), shareholder’s equity and cash flows present fairly, in all material respects, the financial position of Post Holdings, Inc. and its subsidiaries at September 30, 2016 and 2015 and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2016, based on criteria established in Internal Control - Integrated Framework 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. As discussed in Note 3 to the consolidated financial statements, the Company changed the manner in which it accounts for deferred tax assets and liabilities, the manner in which it accounts for debt issuance costs, and the manner in which it presents certain items within the statement of cash flows in 2016. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. As described in Management’s Report on Internal Control Over Financial Reporting, management has excluded Willamette Egg Farms from its assessment of internal control over financial reporting as of September 30, 2016 because it was acquired by the Company in a purchase business combination during 2016. We have also excluded Willamette Egg Farms from our audit of internal control over financial reporting. Willamette Egg Farms whose total assets (excluding goodwill) and total revenues represent $86.8 million or 1% and $88.3 million or 2%, respectively, of the related consolidated financial statement amounts as of and for the year ended September 30, 2016. /s/PricewaterhouseCoopers LLP St. Louis, Missouri November 18, 2016 POST HOLDINGS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in millions, except per share data) See accompanying . POST HOLDINGS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (in millions) See accompanying . POST HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS (in millions, except par value) See accompanying . POST HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions) See accompanying . POST HOLDINGS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (in millions) See accompanying . POST HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in millions, except share data or where indicated otherwise) NOTE 1 - BACKGROUND Post Holdings, Inc. (“Post” or the “Company”) is a consumer packaged goods holding company operating in the center-of-the-store, foodservice, food ingredient, refrigerated, active nutrition and private brand food categories. The Company’s products are sold through a variety of channels such as grocery, club and drug stores, mass merchandisers, foodservice, ingredient and via the internet. Post operates in four reportable segments: Post Consumer Brands, Michael Foods Group, Active Nutrition and Private Brands. The Post Consumer Brands segment primarily consists of the ready-to-eat (“RTE”) cereal business, the Michael Foods Group segment includes predominantly foodservice and food ingredient egg, potato and pasta businesses and a retail cheese business, the Active Nutrition segment includes protein shakes, bars and powders and nutritional supplements and the Private Brands segment primarily consists of peanut and other nut butters, dried fruit and nuts and granola. On February 6, 2012, Post common stock began trading on the New York Stock Exchange under the ticker symbol “POST.” Unless otherwise stated or the context otherwise indicates, all references in this Form 10-K to “Post,” “the Company,” “us,” “our” or “we” mean Post Holdings, Inc. and its consolidated subsidiaries. Certain prior year amounts have been reclassified to conform with the 2016 presentation. These reclassifications had no impact on Net Loss or Shareholders’ Equity, as previously reported. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation - The consolidated financial statements include the operations of Post Holdings, Inc. and its wholly-owned subsidiaries. All intercompany transactions have been eliminated. Use of Estimates and Allocations - The consolidated financial statements of the Company are prepared in conformity with accounting principles generally accepted in the United States of America, which require certain elections as to accounting policy, estimates and assumptions that affect the reported amounts of assets, liabilities, the disclosure of contingent liabilities at the dates of the financial statements and the reported amount of net revenues and expenses during the reporting periods. Significant accounting policy elections, estimates and assumptions include, among others, pension and benefit plan assumptions, valuation assumptions of goodwill and other intangible assets, marketing programs, self insurance reserves and income taxes. Actual results could differ from those estimates. Business Combinations - The Company uses the acquisition method in accounting for acquired businesses. Under the acquisition method, our financial statements reflect the operations of an acquired business starting from the completion of the acquisition. The assets acquired and liabilities assumed are recorded at their respective estimated fair values at the date of the acquisition. Any excess of the purchase price over the estimated fair values of the identifiable net assets acquired is recorded as goodwill. Cash Equivalents - Cash equivalents include all highly liquid investments with original maturities of less than three months. Restricted Cash - Restricted cash includes items such as cash deposits which serve as collateral for certain commodity hedging contracts as well as the Company's high deductible workers’ compensation insurance program. In addition, restricted cash includes deposits with third party escrow agents in connection with a recently announced acquisition that will be credited against the purchase price when the transaction closes. Receivables - Receivables are reported at net realizable value. This value includes appropriate allowances for doubtful accounts, cash discounts, and other amounts which the Company does not ultimately expect to collect. The Company determines its allowance for doubtful accounts based on historical losses as well as the economic status of, and its relationship with its customers, especially those identified as “at risk.” A receivable is considered past due if payments have not been received within the agreed upon invoice terms. Receivables are written off against the allowance when the customer files for bankruptcy protection or is otherwise deemed to be uncollectible based upon the Company’s evaluation of the customer’s solvency. Inventories - Inventories, other than flocks, are generally valued at the lower of average cost (determined on a first-in, first-out basis) or market. Reported amounts have been reduced by an allowance for obsolete product and packaging materials based on a review of inventories on hand compared to estimated future usage and sales. Flock inventory represents the cost of purchasing and raising chicken flocks to egg laying maturity. The costs included in our flock inventory include the costs of the chicks, the feed fed to the birds and the labor and overhead costs incurred to operate the pullet facilities until the birds are transferred into the laying facilities, at which time their cost is amortized to operations, as cost of goods sold, over their expected useful lives of one to two years. Restructuring Expenses and Assets Held For Sale - Restructuring charges principally consist of severance, accelerated stock compensation and other employee separation costs, accelerated depreciation and certain long-lived asset impairments. The Company recognizes restructuring obligations and liabilities for exit and disposal activities at fair value in the period the liability is incurred. Employee severance costs are expensed when they become probable and reasonably estimable under established severance plans. Depreciation expense related to assets that will be disposed of or idled as a part of the restructuring activity is accelerated through the expected date of the asset shut down. Assets are classified as held for sale if the Company has committed to a plan for selling the assets, is actively and reasonably marketing them, and sale is reasonably expected within one year. The carrying value of assets held for sale is included in “Prepaid expenses and other current assets” on the Consolidated Balance Sheets. See Note 4 for information about restructuring expenses and assets held for sale. Property - Property is recorded at cost, and depreciation expense is generally provided on a straight-line basis over the estimated useful lives of the properties. Estimated useful lives range from 1 to 20 years for machinery and equipment and 3 to 40 years for buildings, building improvements and leasehold improvements, and 1 to 5 years for software. Total depreciation expense was $150.2, $131.1 and $85.0 in fiscal 2016, 2015 and 2014, respectively. Any gains and losses incurred on the sale or disposal of assets are included in "Other operating expenses, net” in the Consolidated Statements of Operations. Repair and maintenance costs incurred in connection with on-going and planned major maintenance activities are accounted for under the direct expensing method. During the year ended September 30, 2015, the Company had non-monetary exchanges of fixed assets. The cash and non-cash portions of these transactions were $9.8 and $12.6, respectively. Property consisted of: Other Intangible Assets - Other intangible assets consist primarily of customer relationships and trademarks/brands acquired in business combinations and includes both indefinite and definite-lived assets. Amortization expense related to definite-lived intangible assets, which is provided on a straight-line basis over the estimated useful lives of the assets, was $152.6, $141.7, and $70.8 in fiscal 2016, 2015 and 2014, respectively. For the definite-lived intangible assets recorded as of September 30, 2016, amortization expense of $152.6, $152.6, $151.7, $151.7 and $151.7 is scheduled for fiscal 2017, 2018, 2019, 2020 and 2021, respectively. Other intangible assets consisted of: Recoverability of Assets - The Company continually evaluates whether events or circumstances have occurred which might impair the recoverability of the carrying value of its assets, including property, identifiable intangibles and goodwill. Trademarks with indefinite lives are reviewed for impairment during the fourth quarter of each fiscal year following the annual forecasting process, or more frequently if facts and circumstances indicate the trademark may be impaired. The trademark impairment tests require us to estimate the fair value of the trademark and compare it to its carrying value. The estimated fair value is determined using an income-based approach (the relief-from-royalty method), which requires significant assumptions for each brand, including estimates regarding future revenue growth, discount rates, and appropriate royalty rates. Assumptions are determined after consideration of several factors for each brand, including profit levels, research of external royalty rates by third party experts and the relative importance of each brand to the Company. Revenue growth assumptions are based on historical trends and management’s expectations for future growth by brand. The discount rate is based on a weighted-average cost of capital utilizing industry market data of similar companies. In addition, definite-lived assets and indefinite-lived intangible assets are reassessed as needed when information becomes available that is believed to negatively impact the fair market value of an asset. In general, an asset is deemed impaired and written down to its fair value if estimated related future cash flows are less than its carrying amount. See Note 6 for information about goodwill impairments. For the year ended September 30, 2016, the Company conducted an impairment review and concluded there was no impairment of intangible assets as of September 30, 2016. At September 30, 2016, the estimated fair values of all intangible assets exceeded their carrying value by at least 36%. At September 30, 2015, Post recorded impairment losses in the Post Consumer Brands Segment of $3.7 for the Grape-Nuts brand and $0.1 for the 100% Bran brand to record these trademarks at their estimated current fair values of $11.2 and zero, respectively. Due to repeated past impairments, continued weakness in the brand forecasts and a lack of sales growth from recent brand support efforts, as of October, 1 2015, the Grape-Nuts brand was converted to a definite-lived asset and assigned a 20 year useful life. At September 30, 2014, Post recorded impairment losses in the Post Consumer Brands segment of $34.4 for the Post brand, $23.0 for the Honey Bunches of Oats brand, $17.2 for the Post Shredded Wheat brand and $8.4 for the Grape-Nuts brand to record these trademarks at their estimated current fair values of $144.0, $243.9, $8.2 and $14.9, respectively. Due to repeated past impairments, continued weakness in the brand forecasts and a lack of sales growth from recent brand support efforts, as of October 1, 2014, the Post Shredded Wheat brand was converted to a definite-lived asset and assigned a 20 year useful life. These fair value measurements fell within Level 3 of the fair value hierarchy as described in Note 13. The trademark and goodwill impairment losses are reported in “Impairment of goodwill and other intangible assets” on the Consolidated Statements of Operations. Investments - The Company funds a portion of its deferred compensation liability by investing in certain mutual funds in the same amounts as selected by the participating employees. Because management’s intent is to invest in a manner that matches the deferral options chosen by the participants and those participants can elect to transfer amounts in or out of each of the designated deferral options at any time, these investments have been classified as trading assets and are stated at fair value in “Prepaid expenses and other current assets” and “Other Assets” (see Note 13). Both realized and unrealized gains and losses on these assets are included in “Selling, general and administrative expenses” and offset the related change in the deferred compensation liability. Revenue - Revenue is recognized when title of goods and risk of loss is transferred to the customer, as specified by the shipping terms. Net sales reflect gross sales, including amounts billed to customers for shipping and handling, less sales discounts and trade allowances (including promotional price buy downs and new item promotional funding). Customer trade allowances are generally computed as a percentage of gross sales. Products are generally sold with no right of return except in the case of goods which do not meet product specifications or are damaged, and related reserves are maintained based on return history. If additional rights of return are granted, revenue recognition is deferred. Estimated reductions to revenue for customer incentive offerings are based upon customer redemption history. Cost of Goods Sold - Cost of goods sold includes, among other things, inbound and outbound freight costs and depreciation expense related to assets used in production, while storage and other warehousing costs are included in “Selling, general and administrative expenses.” Storage and other warehousing costs totaled $124.1, $103.4 and $65.4 in fiscal 2016, 2015 and 2014, respectively. Advertising - Advertising costs are expensed as incurred except for costs of producing media advertising such as television commercials or magazine advertisements, which are deferred until the first time the advertising takes place. The amounts reported as assets on the balance sheet were $1.6 and $1.4 as of September 30, 2016 and 2015, respectively. Stock-based Compensation - The Company recognizes the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of equity awards and the fair market value at each quarterly reporting date for liability awards. That cost is recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). See Note 17 for disclosures related to stock-based compensation. Income Tax (Benefit) Provision - Income tax (benefit) provision is estimated based on income taxes in each jurisdiction and includes the effects of both current tax exposures and the temporary differences resulting from differing treatment of items for tax and financial reporting purposes. These temporary differences result in deferred tax assets and liabilities. A valuation allowance is established against the related deferred tax assets to the extent that it is not more likely than not that the future benefits will be realized. Reserves are recorded for estimated exposures associated with the Company’s tax filing positions, which are subject to periodic audits by governmental taxing authorities. Interest due to an underpayment of income taxes is classified as income taxes. The Company considers the undistributed earnings of its foreign subsidiaries to be permanently reinvested, so no U.S. taxes have been provided in relation to the Company's investment in its foreign subsidiaries. See Note 7 for disclosures related to income taxes. NOTE 3 - RECENTLY ISSUED AND ADOPTED ACCOUNTING STANDARDS The Company has considered all new accounting pronouncements, and has concluded there are no new pronouncements (other than the ones described below) that will have a material impact on the results of operations, financial condition or cash flows based on current information. Recently Issued In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-09, “Compensation - Stock Compensation (Topic 718): Improvement to Employee Share-Based Payment Accounting.” The updated guidance changes the accounting for certain aspects of share-based payment awards to employees, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification of certain items in the statement of cash flows. This ASU is effective for annual periods beginning after December 15, 2016, and interim periods therein (i.e., Post’s financial statements for the year ending September 30, 2018) with early adoption permitted. The Company is currently evaluating the impact of adopting this guidance. In March 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross Versus Net),” which is intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing,” which clarifies the identification of performance obligations and the licensing implementation guidance. In May 2016, the FASB issued ASU 2016-11, “Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 Emerging Issues Task Force (“EITF”) Meeting,” which rescinds certain SEC Staff Observer comments from Accounting Standards Codification (“ASC”) Topic 605 “Revenue Recognition.” These rescissions include changes to topics pertaining to accounting for shipping and handling fees and costs and accounting for consideration given by a vendor to a customer. In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients,” which provides clarifying guidance in certain narrow areas and adds some practical expedients. The effective dates for these ASUs are the same as the effective date for ASU 2014-09 (i.e., Post’s financial statements for the year ending September 30, 2019). The Company is currently evaluating its existing revenue recognition policies to determine the types of contracts that are within the scope of this guidance and the impact the adoption of this standard may have on the consolidated financial statements. It has not yet been determined if the full retrospective or the modified retrospective method will be applied. In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” This standards update requires a company to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU 2016-02 offers specific accounting guidance for lessees, lessors and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. This ASU is effective for annual periods beginning after December 15, 2018, and interim periods therein (i.e., Post’s financial statements for the year ending September 30, 2020), with early adoption permitted. At adoption, this update will be applied using a modified retrospective approach. The Company is currently evaluating the impact and timing of adopting this guidance, however, an increase in both assets and liabilities is expected. Recently Adopted In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which provides guidance on the following cash flow issues: debt prepayment or extinguishment costs, settlement of zero-coupon debt or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of borrowing, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions and separately identifiable cash flows and application of the predominance principle. The Company early adopted this ASU using a retrospective approach, as permitted by the standard, at September 30, 2016, and all applicable changes have been made to the Consolidated Statements of Cash Flows. The adoption of this ASU had no impact on the Consolidated Statements of Cash Flows for the years ended September 30, 2015 and 2014. In November 2015, the FASB issued ASU 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes.” This standards update requires an entity to classify all deferred tax assets and liabilities as non-current. ASU 2015-17 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early adoption permitted and can be applied either retrospectively or prospectively. The Company prospectively adopted this ASU at December 31, 2015 and is now presenting all deferred tax assets and liabilities as non-current on the Condensed Balance Sheets. Balances at September 30, 2015 were not retrospectively adjusted as the Company chose to prospectively adopt this ASU. In April 2015, the FASB issued ASU 2015-03 “Simplifying the Presentation of Debt Issuance Costs,” which changes the presentation of debt issuance costs in financial statements. The standards update requires an entity to present debt issuance costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. In August 2015, the FASB issued ASU 2015-15 “Presentation and Subsequent Measurement of Debt issuance Costs Associated with Line-of-Credit,” which indicates the Securities and Exchange Commission (“SEC”) staff would not object to an entity deferring and presenting debt issuance costs related to line-of-credit arrangements as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The Company early adopted this ASU using a retrospective approach at September 30, 2016, as permitted by the standard. The adoption resulted in the reclassification of $53.5 and $56.5 in debt issuance costs, net of accumulated amortization, from “Prepaid expenses and other current assets” and “Other assets” to “Long-term debt” on the Consolidated Balance Sheets at September 30, 2016 and 2015, respectively. The reclassifications excluded amounts related to the Company’s credit agreement, in accordance with the standard. NOTE 4 - RESTRUCTURING In September 2015, the Company announced its plan to close its Dymatize manufacturing facility located in Farmers Branch, Texas and permanently transfer production to third party facilities under co-manufacturing agreements. Plant production ceased in the fourth quarter of 2015. In May 2015, the Company announced its plan to consolidate its cereal business administrative offices into its Lakeville, Minnesota location. In connection with the consolidation, the Company closed its office located in Parsippany, New Jersey and relocated those functions as well as certain functions located in Battle Creek, Michigan to the Lakeville office. The Parsippany office closure was completed during fiscal 2016. In March 2015, the Company announced its plan to close its facility in Boise, Idaho, which manufactured certain PowerBar products distributed in North America. Plant production ceased in June 2015 and the facility was sold in September 2015. No additional restructuring costs were incurred in fiscal 2016. In April 2013, the Company announced management’s decision to close its cereal plant located in Modesto, California as part of a cost savings and capacity rationalization effort. The transfer of production capabilities and closure of the plant was completed during September 2014, and no additional restructuring costs were incurred in fiscal 2016 or 2015. Amounts related to the restructuring events are shown in the following table. Costs are recognized in “Selling, general and administrative expenses” in the Consolidated Statements of Operations with the exception of the accelerated depreciation expense recorded in fiscal year 2014, which is included in “Cost of goods sold.” These expenses are not included in the measure of segment performance for any segment (see Note 20). Assets Held for Sale Related to the closure of its Modesto, California facility, the Company had land, building and equipment classified as assets held for sale as of September 30, 2016 and 2015. Related to the manufacturing shutdown of its Farmers Branch, Texas facility, the Company had land and building classified as assets held for sale as of September 30, 2016, and machinery and equipment classified as assets held for sale as of September 30, 2015. The carrying value of the assets included in “Prepaid expenses and other current assets” on the Consolidated Balance Sheets was $10.1 and $11.4 as of September 30, 2016 and 2015, respectively. Held for sale losses of $9.3, $34.2 and $5.4 were recorded in fiscal 2016, 2015 and 2014, respectively, to adjust the carrying value of the assets to their fair value less estimated selling costs. The held for sale losses recorded in fiscal 2016 included amounts related to the Modesto, California and Farmers Branch, Texas facilities. The held for sale losses recorded in fiscal 2015 included amounts related to the closure of the Modesto, California and Farmers Branch, Texas facilities, as well as the sale of a Boise, Idaho manufacturing facility, the sale of a peanut butter manufacturing facility located in Portales, New Mexico and the sale of the Australian business and Musashi trademark. The held for sale losses recorded in fiscal 2014 related to the Modesto, California facility. The losses are reported as “Other operating expenses, net” on the Consolidated Statements of Operations. NOTE 5 - BUSINESS COMBINATIONS AND DIVESTITURES Fiscal 2016 Acquisitions On October 3, 2015, the Company completed its acquisition of Willamette Egg Farms (“WEF”) for $90.0, subject to working capital and other adjustments, resulting in a payment at closing of $109.0. In December 2015, a final settlement of net working capital and other adjustments was reached, resulting in an additional amount paid by the Company of $4.6. WEF is a producer, processor and wholesale distributor of eggs and egg products and is reported in the Michael Foods Group segment (see Note 20). Based upon the purchase price allocation, the Company recorded $12.7 of customer relationships to be amortized over a weighted-average period of 20 years and $2.5 to trademarks and brands to be amortized over a weighted-average period of 20 years. Net sales and operating profit included in the Consolidated Statements of Operations related to WEF were $88.3 and $14.6, respectively, for the year ended September 30, 2016. The WEF acquisition was accounted for using the acquisition method of accounting, whereby the results of operations are included in the financial statements from the date of acquisition. The purchase price was allocated to acquired assets and assumed liabilities based on their estimated fair values at the date of acquisition, and any excess was allocated to goodwill, as shown in the table below. Goodwill represents the value the Company expects to achieve through the implementation of operational synergies and the expansion of the business into new or growing segments of the industry. The Company expects the final fair value of goodwill related to the acquisition of WEF to be deductible for U.S. income tax purposes. The following table provides the allocation of the purchase price related to the fiscal 2016 acquisition of WEF based upon the fair value of assets and liabilities assumed. Divestitures In March 2016, the Company sold certain assets of its Michael Foods Canadian egg business, included in the Michael Foods Group segment (see Note 20), to a third party for $6.9, subject to working capital and other adjustments, resulting in net cash received of $6.4. In May 2016, a final settlement of net working capital and other adjustments was reached, resulting in additional cash received by the Company of $0.5. During the year ended September 30, 2016, the Company recorded a gain of $2.0 related to the transaction, which includes $1.3 of foreign exchange gains that were previously included in accumulated other comprehensive income. This gain is reported as “Other operating expenses, net” in the Consolidated Statements of Operations. Fiscal 2015 Acquisitions On October 1, 2014, the Company completed its acquisition of the PowerBar and Musashi brands and related worldwide assets from Nestlé S.A (“PowerBar”) for $150.0, subject to a working capital adjustment, which resulted in a payment at closing of $136.1. In March 2015, a final settlement of net working capital and other adjustments was reached, resulting in an amount back to the Company of approximately $1.7. Based upon the purchase price allocation, the Company recorded $21.0 of customer relationships to be amortized over a weighted-average period of 18.3 years and $40.0 to trademarks and brands to be amortized over a weighted-average period of 20 years. PowerBar is reported in the Active Nutrition segment (see Note 20). On November 1, 2014, the Company completed its acquisition of American Blanching Company (“ABC”) for $128.0. ABC is a manufacturer of peanut butter for national brands, private label retail and industrial markets and provider of peanut blanching, granulation and roasting services for the commercial peanut industry. Based upon the purchase price allocation, the Company recorded $63.9 of customer relationships to be amortized over a weighted-average period of 17 years and $8.0 to trademarks and brands to be amortized over a weighted-average period of 10 years. ABC is reported in the Private Brands segment (see Note 20). On May 4, 2015, Post completed its acquisition of MOM Brands Company (“MOM Brands”), a manufacturer and distributer of RTE cereals. MOM Brands is reported in the Post Consumer Brands segment (see Note 20). The closing purchase price of the transaction was $1,181.5 and was partially paid by the issuance of 2.45 million shares of the Company’s common stock to the former owners of MOM Brands. The shares were valued at the May 1, 2015 closing price of $46.60 per share for a total issuance of $114.4. In September 2015, a final settlement of net working capital and other adjustments was reached, resulting in an amount back to the Company of $4.0. Based upon the purchase price allocation, the Company recorded $185.6 of customer relationships to be amortized over a weighted-average period of 20 years and $178.8 to trademarks and brands to be amortized over a weighted-average period of 20 years. Each of the acquisitions was accounted for using the acquisition method of accounting, whereby the results of operations are included in the financial statements from the date of acquisition. The respective purchase prices were allocated to acquired assets and assumed liabilities based on their estimated fair values at the date of acquisition, and any excess was allocated to goodwill, as shown in the table below. Goodwill represents the value the Company expects to achieve through the implementation of operational synergies and the expansion of the business into new or growing segments of the industry. The Company expects substantially all of the final fair value of goodwill related to the acquisitions of PowerBar and MOM Brands to be deductible for U.S. income tax purposes and does not expect the final fair value of goodwill related to the acquisition of ABC to be deductible for U.S. income tax purposes. The following table provides the allocation of the purchase price based upon the fair value of assets and liabilities assumed for each acquisition completed in fiscal 2015. Divestitures On July 1, 2015, the Company sold the PowerBar Australia assets and Musashi trademark for $3.8. By September 30, 2016, final settlements of net working capital and other adjustments were reached related to this sale, resulting in an additional amount received by the Company of $0.4. In fiscal 2015, the Company recorded held for sale losses of $3.7 related to these assets in order to adjust the carrying value of the assets to their fair value less estimated selling costs. Both amounts were reported as “Other operating expenses, net” on the Consolidated Statements of Operations. PowerBar Australia was included in the Active Nutrition segment (see Note 20). Fiscal 2014 On January 1, 2014, Post completed its acquisition of all the stock of Agricore United Holdings Inc. (“Agricore”) from Viterra Inc. Agricore is the parent company of Dakota Growers, a manufacturer of dry pasta for the private label, foodservice and ingredient markets. The purchase price for the transaction was $370.0 in cash, subject to a working capital adjustment, which resulted in a payment at closing of $366.2. In May 2014, a final settlement of net working capital and other adjustments was reached, resulting in a payment to the Company of $6.5. Based upon the purchase price allocation, the Company recorded $127.2 of customer relationships to be amortized over a weighted-average period of 12.5 years and $22.8 to trademarks/brands to be amortized over a weighted-average period of 18.9 years. Dakota Growers is reported in the Michael Foods Group segment (see Note 20). On February 1, 2014, Post completed its acquisition of Dymatize, a manufacturer and marketer of premium protein powders, bars and nutritional supplements. The purchase price for the transaction was $380.0 in cash, subject to a working capital adjustment, which resulted in a payment at closing of $392.5. In September 2015, a final settlement with the sellers was reached, resulting in a payment to the Company of $12.0, of which $2.5 relieved a previously recorded receivable and the remaining $9.5 was recorded as “Selling, general and administrative expenses.” Dymatize is reported in the Active Nutrition segment (see Note 20). Based upon the purchase price allocation, the Company recorded $136.8 of customer relationships to be amortized over a weighted-average period of 18 years and $121.1 to trademarks/brands to be amortized over a weighted-average period of 20 years. On February 1, 2014, Post completed its acquisition of Golden Boy, a manufacturer of private label peanut and other nut butters, as well as dried fruits and baking and snacking nuts. The purchase price for the transaction was CAD $320.0 in cash, subject to a working capital adjustment, which resulted in a payment at closing of approximately CAD $321.1. In May 2014, a final settlement of net working capital and other adjustments was reached, resulting in an amount paid to the sellers of CAD $2.1. Golden Boy is reported in the Private Brands segment (see Note 20). Based upon the purchase price allocation, the Company recorded $82.6 of customer relationships to be amortized over a weighted-average period of 11 years, $28.9 to trademarks/brands to be amortized over a weighted-average period of 20 years, and $20.0 to other intangible assets to be amortized over a weighted-average period of 11 years. On June 2, 2014, the Company completed its acquisition of Michael Foods from affiliates of GS Capital Partners, affiliates of Thomas H. Lee Partners and other owners, which is reported in the Michael Foods Group segment (see Note 20). Michael Foods manufactures and distributes egg products and refrigerated potato products and also distributes cheese and other dairy case products to the retail, foodservice and food ingredient channels. The purchase price the Company paid for the transaction was approximately $2,450.0, subject to working capital and other adjustments which resulted in a cash payment at closing of approximately $2,539.1. In August 2014, a final settlement of net working capital and other adjustments was reached, resulting in an amount paid to Post of $10.0. Based upon the purchase price allocation, the Company recorded $1,126.6 of customer relationships to be amortized over a weighted-average period of 20 years and $217.7 to trademarks/brands to be amortized over a weighted-average period of 19.3 years. On August 1, 2014, Post Foods, LLC, a subsidiary of the Company, acquired a cereal brand and related inventory for $20.4. The brand is reported as part of the Post Consumer Brands segment (see Note 20). Based upon the purchase price allocation, the Company recorded $11.8 of customer relationships to be amortized over a weighted-average period of 20 years and $2.6 to trademarks/brands to be amortized over a weighted-average period of 10 years. In addition to the intangibles acquired, the Company purchased $0.4 of inventory and recorded $5.6 of goodwill. Each of the acquisitions was accounted for using the acquisition method of accounting, whereby the results of operations of each are included in the financial statements from the date of acquisition. The respective purchase prices were allocated to acquired assets and liabilities based on their estimated fair values at the date of acquisition, and any excess was allocated to goodwill, as shown in the following table and discussed above. Goodwill represents the value the Company expects to achieve through the implementation of operational synergies and the expansion of the business into new growing segments of the industry. The Company does not expect the final fair value of goodwill related to the acquisitions of Dakota Growers, Golden Boy and Michael Foods to be deductible for U.S. income tax purposes. The Company estimates approximately $104.4 of tax deductible goodwill and intangible assets will result from the Dymatize acquisition. The Company expects the fair value of goodwill generated by the cereal brand acquisition to be fully tax deductible. Transaction related costs During the years ended September 30, 2016, 2015 and 2014, the Company incurred acquisition related expenses of $8.5, $14.1 and $29.7, respectively, recorded as “Selling, general and administrative expenses.” These costs include amounts for transactions that were signed, spending for due diligence on potential acquisitions that were not signed or announced at the time of the Company’s annual reporting, and spending for divestiture transactions. Pro Forma Information The following unaudited pro forma information presents a summary of the combined results of operations of the Company and the aggregate results of all businesses acquired in fiscal years 2016, 2015 and 2014 for the periods presented as if the fiscal 2016 acquisitions had occurred on October 1, 2014, the fiscal 2015 acquisitions had occurred on October 1, 2013 and the fiscal 2014 acquisitions had occurred on October 1, 2012 along with certain pro forma adjustments. These pro forma adjustments give effect to the amortization of certain definite-lived intangible assets, adjusted depreciation based upon fair value of assets acquired, interest expense related to the financing of the business combinations, inventory revaluation adjustment on acquired business, transaction and extinguished debt costs and related income taxes. The following unaudited pro forma information has been prepared for comparative purposes only and is not necessarily indicative of the results of operations as they would have been had the acquisitions occurred on the assumed dates, nor is it necessarily an indication of future operating results. NOTE 6 - GOODWILL The changes in the carrying amount of goodwill by segment are noted in the following table. Goodwill represents the excess of the cost of acquired businesses over the fair market value of their identifiable net assets. The Company conducts a goodwill impairment qualitative assessment during the fourth quarter of each fiscal year following the annual forecasting process, or more frequently if facts and circumstances indicate that goodwill may be impaired. The goodwill impairment qualitative assessment requires an assessment to determine if it is more likely than not that the fair value of the business is less than its carrying amount. If adverse qualitative trends are identified that could negatively impact the fair value of the business, a quantitative goodwill impairment test is performed. In fiscal years 2016, 2015 and 2014, the Company elected not to perform a qualitative assessment and instead performed a quantitative impairment test for all reporting units. The estimated fair value is determined using a combined income and market approach with a greater weighting on the income approach. The income approach is based on discounted future cash flows and requires significant assumptions, including estimates regarding future revenue, profitability, and capital requirements. The market approach is based on a market multiple (revenue and EBITDA which stands for earnings before interest, income taxes, depreciation, and amortization) and requires an estimate of appropriate multiples based on market data. For the year ended September 30, 2016, the Company concluded that there was no impairment of goodwill as of September 30, 2016. With the exception of Dymatize, all reporting units passed the first step of the impairment test. Dymatize failed step one and accordingly, step two of the analysis was performed. Based on the results of step two, it was determined that the fair value of the goodwill allocated to the Dymatize reporting unit exceeded its carrying value by approximately $36.0 and was therefore not impaired as of September 30, 2016. At September 30, 2016, the estimated fair values of all other reporting units exceed their carrying values by at least 33%. As of September 30, 2015, the Company recorded a charge of $57.0 for the impairment of goodwill. The impairment charge related to the Active Nutrition segment and was primarily the result of fourth quarter production issues at Dymatize which resulted in the Company’s decision to close its manufacturing facility and permanently transfer production to third party facilities under co-manufacturing agreements. As of September 30, 2014, the Company recorded a total charge of $212.6 for the impairment of goodwill. The Post Consumer Brands segment recognized $181.3 primarily resulting from the acceleration of declines within the branded RTE cereal category. Additionally, the expectation was that revenue and profit growth would be challenged in the medium to long-term. The Active Nutrition segment recognized charges of $31.3 resulting from reduced near-term profitability related to supply chain disruptions at Dymatize, which were identified subsequent to the initial valuation at the acquisition date of February 1, 2014, and incremental remediation expenses. These fair value measurements fell within Level 3 of the fair value hierarchy as described in Note 13. The goodwill impairment losses are aggregated with trademark impairment losses in “Impairment of goodwill and other intangible assets” in the Consolidated Statements of Operations. NOTE 7 - INCOME TAXES The benefit for income taxes consisted of the following: The effective tax rate for fiscal 2016 was 89.0% compared to 31.1% for fiscal 2015 and 19.6% for fiscal 2014. A reconciliation of income tax benefit with amounts computed at the statutory federal rate follows: Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets (liabilities) were as follows: As of September 30, 2016, Post had federal net operating loss (“NOL”) carryforwards totaling approximately $72.6 which have expiration dates beginning in fiscal 2021 and extending through fiscal 2034, as well as state NOL carryforwards totaling approximately $198.7, which have expiration dates beginning in fiscal 2017 and extending through fiscal 2035. As of September 30, 2016, Post had no NOL carryforwards in foreign jurisdictions. Certain of these NOLs and carryforwards were acquired through acquisitions made during fiscal 2013 and 2014. As a result of these ownership changes, the deductibility of the NOLs is subject to limitation under section 382 of the Internal Revenue Code and similar limitations under state tax law. Giving consideration to the section 382 and state limitations, the Company believes it will generate sufficient taxable income to fully utilize the federal and certain state NOLs before they expire. Approximately $7.8 of the deferred tax asset related to the state NOLs has been offset by a valuation allowance based on management’s judgment that it is more likely than not that the benefits of those deferred tax assets will not be realized in the future. No provision has been made for income taxes on undistributed earnings of consolidated non-U.S. subsidiaries of $18.9 at September 30, 2016 since it is our intention to indefinitely reinvest undistributed earnings of our foreign subsidiaries. It is not practicable to estimate the additional income taxes and applicable foreign withholding taxes that would be payable on the remittance of such undistributed earnings. For fiscal 2016, 2015 and 2014, foreign income before income taxes was $29.6, $7.0 and $0.6, respectively. Unrecognized Tax Benefits The Company recognizes the tax benefit from uncertain tax positions only if it is “more likely than not” the tax position will be sustained on examination by the taxing authorities. The tax benefits recognized from such positions are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. To the extent the Company’s assessment of such tax positions changes, the change in estimate will be recorded in the period in which the determination is made. Unrecognized tax benefits activity for the years ended September 30, 2016 and 2015 is presented in the following table: The amount of the net unrecognized tax benefits that, if recognized, would directly affect the effective tax rate is $6.0 at September 30, 2016. The Company believes that, due to expiring statutes of limitations and settlements with authorities, it is reasonably possible that the total unrecognized tax benefits may decrease by approximately $0.7 within twelve months of the reporting date. The Company classifies tax-related interest and penalties as components of income tax expense. The accrued interest and penalties are not included in the table above. The Company had accrued interest and penalties of approximately $2.4 and $2.5 at September 30, 2016 and September 30, 2015, respectively. The Company had net expense of approximately $(0.1), $0.0 and $0.8 for interest and penalties in the Consolidated Statements of Operations for the years ended September 30, 2016, 2015 and 2014, respectively. Interest and penalties were computed on the difference between the tax position recognized for financial reporting purposes and the amount previously taken on the Company’s tax returns. U.S. federal, U.S. state and Canadian income tax returns for the tax years ended September 30, 2015, 2014 and 2013 are subject to examination by the tax authorities in each respective jurisdiction. The Michael Foods tax return for the short year ended June 2, 2014 was examined by the Internal Revenue Service without adjustment. For the acquisitions made in 2015 and 2014, the seller generally retained responsibility for all income tax liabilities through the date of acquisition. With respect to the Michael Foods acquisition, the Company assumed all income tax liabilities for those jurisdictions which remain subject to examination, consisting of tax years 2012 through the short year ended June 2, 2014, the date of acquisition. The Company did not assume any pre-acquisition tax liabilities related to the 2016 acquisition of WEF. NOTE 8 - LOSS PER SHARE Basic loss per share is based on the average number of common shares outstanding during the period. Diluted loss per share is based on the average number of shares used for the basic per share calculation, adjusted for the dilutive effect of stock options, stock appreciation rights and restricted stock units using the “treasury stock” method. The impact of potentially dilutive convertible preferred stock is calculated using the “if-converted” method. The Company’s tangible equity units (“TEUs”) (see Note 18) are assumed to be settled at the minimum settlement amount for weighted-average shares for basic loss per share. For diluted loss per share, the shares, to the extent dilutive, are assumed to be settled as described in Note 18. The following table details the securities that have been excluded from the calculation of weighted-average shares for diluted loss per share as they were anti-dilutive. NOTE 9 - SUPPLEMENTAL OPERATIONS STATEMENT AND CASH FLOW INFORMATION NOTE 10 - SUPPLEMENTAL BALANCE SHEET INFORMATION NOTE 11 - ALLOWANCE FOR DOUBTFUL ACCOUNTS NOTE 12 - DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING In the ordinary course of business, the Company is exposed to commodity price risks relating to the acquisition of raw materials and supplies, interest rate risks relating to floating rate debt, and foreign currency exchange rate risks relating to its foreign subsidiaries. The Company utilizes derivative financial instruments, including (but not limited to) futures contracts, option contracts, forward contracts and swaps, to manage certain of these exposures by hedging when it is practical to do so. The Company does not hold or issue financial instruments for speculative or trading purposes. The Company maintains options, futures contracts and interest rate swaps which have been designated as economic hedges of raw materials, energy purchases and variable rate debt. As of September 30, 2016, the notional amounts of commodity contracts and energy futures were $49.8 and $23.6, respectively. These contracts relate to raw materials that generally will be utilized within the next 12 months. At September 30, 2016 and September 30, 2015, the Company had pledged collateral of $6.1 and $10.7, respectively, related to its commodity and energy hedging contracts. These amounts are classified as “Restricted cash” on the Consolidated Balance Sheets. As of September 30, 2016, the Company had interest rate swaps with a notional amount of $77.6 that obligate Post to pay a fixed rate of 3.1% and receive one-month LIBOR, and require monthly settlements. These settlements began in July 2016 and end in May 2021. In addition, the Company has interest rate swaps with a $750.0 notional amount that obligate Post to pay a weighted-average fixed interest rate of approximately 4.0% and receive three-month LIBOR and will result in a net lump sum settlement in July 2018, as well as interest rate swaps with a $899.3 notional amount that obligate Post to pay a weighted-average fixed interest rate of approximately 3.7% and receive three-month LIBOR and will result in a net lump sum settlement in December 2019. Commodity and energy derivatives are valued using an income approach based on index prices less the contract rate multiplied by the notional amount. The Company’s calculation of the fair value of interest rate swaps is derived from a discounted cash flow analysis based on the terms of the contract and the relevant interest rate curve. The following tables present the balance sheet location and fair value of the Company’s derivative instruments on a gross and net basis as of September 30, 2016 and 2015. The Company does not offset derivative assets and liabilities within the Consolidated Balance Sheets. The following table presents the recognized (gain) or loss from derivative instruments that were not designated as qualified hedging instruments on the Company’s Consolidated Statements of Operations for the years ended September 30, 2016, 2015 and 2014. NOTE 13 - FAIR VALUE MEASUREMENTS The following table presents the assets and liabilities measured at fair value on a recurring basis and the basis for that measurement according to the levels in the fair value hierarchy in ASC Topic 820: The following table represents the fair value of Post’s long-term debt which is not recorded at fair value in the Consolidated Balance Sheets, but is classified as Level 2 in the fair value hierarchy per ASC Topic 820: The deferred compensation investment is primarily invested in mutual funds and its fair value is measured using the market approach. This investment is in the same funds and purchased in substantially the same amounts as the participants’ selected investment options (excluding Post common stock equivalents), which represent the underlying liabilities to participants in the Company’s deferred compensation plans. Deferred compensation liabilities are recorded at amounts due to participants in cash, based on the fair value of participants’ selected investment options (excluding certain Post common stock equivalents to be distributed in shares) using the market approach. The Company utilizes the income approach to measure fair value for its derivative assets, which include commodity options and futures contracts. The income approach uses pricing models that rely on market observable inputs such as yield curves and forward prices. Refer to Note 12 for the classification of changes in fair value of derivative assets and liabilities measured at fair value on a recurring basis within the Consolidated Statements of Operations. As stated previously (see Note 4), the Company had land, building and equipment classified as assets held for sale related to the closure of its Modesto, California facility, and land and building classified as assets held for sale related to the closure of its Farmers Branch, Texas facility as of September 30, 2016. At September 30, 2015, the Company had land, building and equipment classified as assets held for sale related to the closure of its Modesto, California facility as well as machinery and equipment classified as assets held for sale related to the closure of its Farmers Branch, Texas facility. At September 30, 2016 and September 30, 2015, the carrying value and estimated fair value less estimated costs to sell of the assets held for sale was $10.1 and $11.4, respectively, and is included in “Prepaid expenses and other current assets” on the Consolidated Balance Sheets. The fair value of the assets held for sale were measured at fair value on a nonrecurring basis based on third-party offers to purchase the assets. The fair value measurement was categorized as Level 3, as the fair values utilize significant unobservable inputs. The following table summarizes the Level 3 activity. The carrying amounts reported on the Consolidated Balance Sheets for cash and cash equivalents, receivables and accounts payable approximate fair value because of the short maturities (less than 12 months) of these financial instruments. NOTE 14 - LONG-TERM DEBT Long-term debt as of the dates indicated consists of the following: On February 3, 2012, the Company issued 7.375% senior notes due in February 2022 in an aggregate principal amount of $775.0 to Post’s former owner pursuant to a contribution agreement in connection with the internal reorganization. The 7.375% senior notes were issued pursuant to an indenture dated as of February 3, 2012 among the Company, Post Foods, LLC, as guarantor, and Wells Fargo Bank, National Association, as trustee. On October 25, 2012, the Company issued additional 7.375% senior notes with an aggregate principal value of $250.0 at a price of 106% of par value. On July 18, 2013, the Company issued additional 7.375% senior notes with an aggregate principal value of $350.0 at a price of 105.75% of par value. The premiums related to these 7.375% senior notes are amortized as a reduction to interest expense over the term of the senior notes. Interest payments on the 7.375% senior notes are due semi-annually each February 15 and August 15. With a portion of the proceeds received from the August 3, 2016 issuance of the 5.00% senior notes (described below), the Company repaid $1,242.0 principal value of the 7.375% senior notes. In connection with the early repayment of these notes, the Company recorded expense of $78.6 in the year ended September 30, 2016, which is reported as “Loss on extinguishment of debt” in the Consolidated Statement of Operations. This loss included a tender premium of $88.0 and deferred financing fee write-offs of $12.4, partially offset by the write-off of unamortized debt premium of $21.8. On November 18, 2013, the Company issued $525.0 principal value of 6.75% senior notes due in December 2021. The 6.75% senior notes were issued at par and the Company received $516.2 after paying investment banking and other fees of $8.8, which will be deferred and amortized to interest expense over the terms of the notes. On March 19, 2014, the Company issued an additional $350.0 principal value of 6.75% senior notes due in December 2021. The additional 6.75% senior notes were issued at 105.75% of par value and the Company received $364.0 after paying investment banking and other fees of $6.1, which will be deferred and amortized to interest expense over the term of the notes. Interest payments on the 6.75% senior notes are due semi-annually each June 1 and December 1. On June 2, 2014, the Company issued $630.0 principal value of 6.00% senior notes due in December 2022. The 6.00% senior notes were issued at par and the Company received $619.0 after paying investment banking and other fees of $11.0, which will be deferred and amortized to interest expense over the term of the notes. Interest payments on the 6.00% senior notes are due semi-annually each June 15 and December 15. On August 18, 2015, the Company issued $800.0 principal value of 7.75% senior notes due in March 2024 and $400.0 principal value of 8.00% senior notes due in July 2025. The 7.75% and 8.00% senior notes were issued at par. The Company received $1,187.9 after paying investment banking and other fees of $12.1, which will be deferred and amortized to interest expense over the term of the notes. Interest payments on the 7.75% senior notes are due semi-annually each March 15 and September 15. Interest payments on the 8.00% senior notes are due semi-annually each January 15 and July 15. On August 3, 2016, the Company issued $1,750.0 principal value of 5.00% senior notes due in August 2026. The 5.00% senior notes were issued at par and the Company received $1,725.7 after paying investment banking and other fees of $24.3, which will be deferred and amortized to interest expense over the term of the notes. Interest payments on the 5.00% senior notes are due semi-annually each February 15 and August 15. All of the Company’s senior notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of our existing and future material domestic subsidiaries, with the exception of immaterial subsidiaries (the “Guarantors”). Our foreign subsidiaries do not guarantee the senior notes. These guarantees are subject to release in limited circumstances (only upon the occurrence of certain customary conditions). See Note 21 for additional information. On January 29, 2014, the Company entered into a Credit Agreement (as amended, the “Credit Agreement”) among the Company, the institutions from time to time party thereto as Lenders (the “Lenders”), Barclays Bank PLC, Credit Suisse Securities (USA) LLC, Goldman Sachs Bank USA and Wells Fargo Securities, LLC, as Joint Lead Arrangers and Joint Bookrunners, Barclays Bank PLC, as Syndication Agent, Credit Suisse AG, Cayman Islands Branch and Goldman Sachs Bank USA, as Documentation Agents, and Wells Fargo Bank, National Association, as Administrative Agent for the Lenders. The Credit Agreement, together with a Joinder Agreement No. 1, dated May 1, 2014, provided for a revolving credit facility in an aggregate principal amount of $400.0 (the “Revolving Credit Facility”) and potential incremental revolving and term facilities at the request of the Company and at the discretion of the Lenders, on terms to be determined and in a maximum aggregate amount not to exceed the greater of $600.0 and an amount such that the Company’s pro forma senior secured leverage ratio would not exceed 2.50 to 1.00. The outstanding amounts under the Revolving Credit Facility must be repaid on or before January 29, 2019. The Company incurred $3.6 of issuance costs in connection with the Credit Agreement. The revolving credit facility has outstanding letters of credit of $11.8 which reduces the available borrowing capacity to $388.2 at September 30, 2016. Borrowings under the Revolving Credit Facility bear interest at the Eurodollar Rate or the Base Rate (as such terms are defined in the Credit Agreement) plus an applicable margin ranging from 2.00% to 2.50% for Eurodollar Rate-based loans and from 1.00% to 1.50% for Base Rate-based loans, depending upon the Company’s senior secured leverage ratio. On June 2, 2014, the Company entered into a Joinder Agreement No. 2 (the “Joinder No. 2”), by and among Barclays Bank PLC, the Company and the guarantors party thereto, and consented to by Wells Fargo Bank, National Association, as Administrative Agent. The Joinder No. 2 provided for, upon completion of the acquisition of Michael Foods and subject to certain other conditions, an incremental term loan of $885.0 (the “Prior Term Loan”) under the Company’s existing Credit Agreement. Pursuant to the Joinder No. 2, the Company borrowed approximately $885.0 as a Term Loan under the Credit Agreement. The loan was issued at 99.5% of par and the Company received $860.9 after accounting for the original issue discount of $4.4 and paying investment banking and other fees of $19.7. On March 6, 2015, the Company entered into a Second Amendment to the Credit Agreement. On May 4, 2015, Post entered into a Joinder Agreement No. 3 (the “Joinder No. 3”), by and among Credit Suisse AG, Cayman Islands Branch, the Company and the guarantors party thereto, and consented to by Wells Fargo Bank, National Association, as Administrative Agent. The Joinder No. 3 provided for, in connection with the completion of the Company’s acquisition of MOM Brands, an incremental term loan of $700.0 (the “New Term Loan”) under the Company’s Credit Agreement. The Company incurred $19.4 of issuance costs in connection with the Credit Agreement and the New Term Loan as of September 30, 2015. The outstanding amounts under the New Term Loan bear interest at the same rate as the outstanding amounts under the Prior Term Loan. On May 4, 2015, Wells Fargo Bank, National Association resigned as Administrative Agent under the Credit Agreement and was replaced by Barclays Bank PLC. The Company utilized a portion of the net proceeds from the fiscal 2015 issuance of the 7.75% senior notes and the 8.00% senior notes, together with the net proceeds from the August 18, 2015 common stock issuance to repay $1,200.0 of the Prior Term Loan and the New Term Loan outstanding under the Credit Agreement. In fiscal 2016, the Company utilized a portion of the net proceeds from the issuance of the 5.00% senior notes to repay the remaining $374.4 balance of the term loan. In connection with the early repayment of the term loan, the Company expensed $7.8 and $30.0 of deferred financing fees and unamortized debt discount in the years ended September 30, 2016 and 2015, respectively, which is reported as “Loss on extinguishment of debt” in the Consolidated Statement of Operations. The Credit Agreement contains customary affirmative and negative covenants for agreements of this type, including delivery of financial and other information, compliance with laws, maintenance of property, existence, insurance and books and records, inspection rights, obligation to provide collateral and guarantees by new subsidiaries, limitations with respect to indebtedness, liens, fundamental changes, restrictive agreements, use of proceeds, amendments of organization documents, accounting changes, prepayments and amendments of indebtedness, dispositions of assets, acquisitions and other investments, transactions with affiliates, dividends and redemptions or repurchases of stock, capital expenditures, and granting liens on certain real property. The Credit Agreement also contains customary financial covenants including: (a) a quarterly maximum senior secured leverage ratio of 3.00 to 1.00, and (b) a quarterly minimum interest coverage ratio of 1.75 to 1.00. With limited exceptions, the Credit Agreement permits the Company to incur additional unsecured debt only if its consolidated interest coverage ratio, calculated as provided in the Credit Agreement, would be greater than 2.00 to 1.00 after giving effect to such new debt. The Credit Agreement provides for customary events of default, including material breach of representations and warranties, failure to make required payments, failure to comply with certain agreements or covenants, failure to pay, or default under, certain other material indebtedness, certain events of bankruptcy and insolvency, inability to pay debts, the occurrence of one or more unstayed or undischarged judgments in excess of $75.0, or attachments issued against a material part of the Company’s property, change in control, the invalidity of any loan document, the failure of the collateral documents to create a valid and perfected first priority lien and certain ERISA events. Upon the occurrence of an event of default, the maturity of the loans under the Credit Agreement may be accelerated and the agent and lenders under the Credit Agreement may exercise other rights and remedies available at law or under the loan documents, including with respect to the collateral and guarantees for the Company’s obligations under the Credit Agreement. The Company’s obligations under the Credit Agreement are unconditionally guaranteed by each of its existing and subsequently acquired or organized material domestic subsidiaries. The Company’s obligations under the Credit Agreement are secured by security interests on substantially all of the personal property assets of the Company and the Guarantors and are secured by the material domestic real property assets of the Company and the Guarantors. In February 2014, the Company paid $2.5 of financing fees to the underwriters of a financing commitment the Company entered into in September 2013 to fund our acquisition of Dakota Growers. The commitment was not exercised and the Company recorded the full amount to “Interest expense, net” in the Consolidated Statement of Operations during the year ended September 30, 2014. In addition, financing costs of $4.3 related to the unused bridge loan and $6.7 for the portion of the term loan commitment not used were immediately recorded to “Interest expense, net” in the Consolidated Statement of Operations during the year ended September 30, 2014. In connection with the acquisition of Michael Foods, the Company assumed a 4.57% 2012 Series Bond that guarantees the repayment of certain industrial revenue bonds used for the expansion of the wastewater treatment facility in Wakefield, Nebraska. The bond bears interest at a rate of 4.57% and matures September 15, 2017. Debt Covenants The terms of the Credit Facility require the Company to comply with certain financial covenants consisting of ratios for maximum senior secured leverage and minimum interest expense coverage. As of September 30, 2016, the Company was in compliance with all such financial covenants. The Company does not believe non-compliance is reasonably likely in the foreseeable future. NOTE 15 - COMMITMENTS AND CONTINGENCIES Legal Proceedings Antitrust claims: In late 2008 and early 2009, some 22 class-action lawsuits were filed in various federal courts against Michael Foods, Inc. and approximately 20 other defendants (producers of shell eggs and egg products, and egg industry organizations), alleging violations of federal and state antitrust laws in connection with the production and sale of shell eggs and egg products, and seeking unspecified damages. Michael Foods has denied liability. In December 2008, the Judicial Panel on Multidistrict Litigation ordered the transfer of all cases to the Eastern District of Pennsylvania for coordinated and/or consolidated pretrial proceedings. Between late 2010 and early 2012, a number of companies (primarily large grocery chains and food companies that purchase considerable quantities of eggs) opted out of any eventual class of direct purchaser plaintiffs and brought their own separate actions against the defendants. These “opt-out” plaintiffs assert essentially the same allegations as plaintiffs in the main direct purchaser action. The opt-out cases also are pending in the Eastern District of Pennsylvania, where they are being treated as related to the main action. Additionally, all or most defendants, including Michael Foods, received a Civil Investigative Demand (“CID”) issued by the Florida Attorney General in late 2008, regarding an investigation of possible anticompetitive activities “relating to the production and sale of eggs or egg products.” The CID requested information related to the pricing and supply of shell eggs and egg products, and participation in various programs of United Egg Producers. The Florida Attorney General’s Office has not taken any further enforcement action during the pendency of the civil antitrust litigation referenced above. Motions related to class certification: On September 18, 2015, the court denied the motion of the indirect purchaser plaintiffs (primarily consumers who purchased shell eggs from grocery stores) for class certification. The indirect purchaser plaintiffs have filed an alternative motion for certification of an injunction class, and the denial of their original motion is subject to appeal. On September 21, 2015, the court granted the motion of the direct purchaser plaintiffs to certify a shell-egg subclass, but denied their motion to certify an egg-products subclass. However, on September 2, 2016, the defendants filed a motion to decertify the class of direct purchasers of shell eggs; there has been no ruling on that motion. Motions for summary judgment: On September 6, 2016, the court granted the defendants’ motion to dismiss claims based on purchases of egg products, thereby limiting the claims to shell eggs. Certain of the egg products purchasers whose claims were dismissed have appealed to the Third Circuit Court of Appeals. On September 28, 2016, the court denied individual motions for summary judgment made by Michael Foods and three other defendants that had sought the dismissal of all claims against them. Michael Foods has moved to have denial of its motion for summary judgment certified for immediate appeal to the Third Circuit Court of Appeals; there has been no ruling on that motion. In light of the denial of Michael Foods’ motion for summary judgment, the Company will continue to vigorously defend the cases. Past settlements with the direct purchaser class in this case by other defendants have been as high as $28.0. Amounts paid in settlements with the opt-out plaintiffs are not known. There can be no assurance that the cases against Michael Foods will be resolved by settlements, or that any settlements would be in line with the previous settlements referenced. Under current law, any settlement paid, if any, would be deductible for federal income tax purposes. The Company has accrued $28.5 for these matters. We record reserves for litigation losses in accordance with ASC Topic 450, “Contingencies” (“ASC 450”). Under ASC 450, a loss contingency is recorded if a loss is probable and can be reasonably estimated. We record probable loss contingencies based on the best estimate of the loss. If a range of loss can be reasonably estimated, but no single amount within the range appears to be a better estimate than any other amount within the range, the minimum amount in the range is accrued. These estimates are often initially developed earlier than when the ultimate loss is known, and the estimates are adjusted if additional information becomes known. While the Company believes its accruals for this matter are appropriate, the final amounts required to resolve such matters could differ materially from recorded estimates and the Company's results of operations and cash flows could be materially affected. Accordingly, the Company cannot predict what impact, if any, these matters and any results from such matters could have on the future results of operations. Other: The Company is subject to various other legal proceedings and actions arising in the normal course of business. In the opinion of management, based upon the information presently known, the ultimate liability, if any, arising from such pending legal proceedings, as well as from asserted legal claims and known potential legal claims which are likely to be asserted, taking into account established accruals for estimated liabilities (if any), are not expected to be material individually or in the aggregate to the consolidated financial position, results of operations or cash flows. In addition, while it is difficult to estimate the potential financial impact of actions regarding expenditures for compliance with regulatory matters, in the opinion of management, based upon the information currently available, the ultimate liability arising from such compliance matters is not expected to be material to the consolidated financial position, results of operations or cash flows. Post’s operations also are subject to various federal, state and local laws and regulations with respect to environmental matters, including air quality, wastewater discharge and pretreatment, storm water, waste handling and disposal, and other regulations intended to protect public health and the environment. In the United States, the laws and regulations include the Clean Air Act, the Clean Water Act and the Resource Conservation and Recovery Act. The Company’s foreign facilities are subject to local and national regulations similar to those applicable to us in the United States. Additionally, many of the Michael Foods facilities discharge wastewater pursuant to wastewater discharge permits. The Company disposes of waste from its internal egg production primarily by transferring it to farmers for use as fertilizer and disposes of solid waste from potato processing primarily by transferring it to one or more processors who convert it to animal feed. Post has made, and will continue to make, expenditures to ensure environmental compliance. Lease Commitments Future minimum rental payments under noncancelable operating leases in effect as of September 30, 2016 were $16.7, $16.2, $15.2, $12.7, $11.6 and $25.9 for fiscal 2017, 2018, 2019, 2020, 2021 and thereafter, respectively. NOTE 16 - PENSION AND OTHER POSTRETIREMENT BENEFITS The Company maintains qualified defined benefit plans in the United States and Canada for certain employees primarily within its Post Consumer Brands segment. Certain of the Company’s employees are eligible to participate in the Company’s qualified and supplemental noncontributory defined benefit pension plans and other postretirement benefit plans (partially subsidized retiree health and life insurance) or separate plans for Post Foods Canada Inc. The following disclosures reflect amounts related to the Company’s employees based on separate actuarial valuations, projections and certain allocations. Amounts for the Canadian plans are included in these disclosures and are not disclosed separately because they do not constitute a significant portion of the combined amounts. Effective January 1, 2011, benefit accruals for defined benefit pension plans were frozen for all administrative employees and certain production employees. The following table provides a reconciliation of the changes in the plans’ benefit obligations and fair value of assets over the two year period ended September 30, 2016, and a statement of the funded status and amounts recognized in the combined balance sheets as of September 30 of both years. (a) In the second quarter of fiscal 2016, the Company finalized a new collective bargaining agreement that resulted in an amendment to its pension and other postretirement benefit plans. The accumulated benefit obligation exceeded the fair value of plan assets for the domestic pension plans at September 30, 2016 and September 30, 2015. The aggregate accumulated benefit obligation for pension plans was $68.6 at September 30, 2016 and $55.1 at September 30, 2015. The following tables provide the components of net periodic benefit cost for the plans and amounts recognized in other comprehensive income. (a) The plan was re-measured as of February 29, 2016. The discount rate was 4.6% for the first five months of benefit cost and 4.22% for the last seven months of benefit cost. The estimated net actuarial loss and prior service cost (credit) expected to be reclassified from accumulated other comprehensive loss into net periodic benefit cost during 2017 related to pension benefits are $1.6 and $0.2, respectively. The corresponding amounts related to other postretirement benefits are $0.7 and $(4.8), respectively. The expected return on pension plan assets was determined based on historical and expected future returns of the various asset classes, using the target allocation. The broad target allocations are 50.0% equity securities (comprised of 27.5% U.S. equities and 22.5% foreign equities), 39.5% debt securities, 10.0% real assets and 0.5% cash. At September 30, 2016, equity securities were 49.8%, debt securities were 42.4%, real assets were 6.6% and other was 1.2% of the fair value of total plan assets, approximately 81.0% of which was invested in passive index funds. At September 30, 2015, equity securities were 48.6%, debt securities were 45.2%, real assets were 4.4% and other was 1.8% of the fair value of total plan assets, approximately 80.0% of which was invested in passive index funds. The allocation guidelines were established based on management’s determination of the appropriate risk posture and long-term objectives. The following table represents the pension plan’s assets measured at fair value on a recurring basis and the basis for that measurement. The fair value of mutual funds is based on quoted net asset values of the shares held by the plan at year end. For September 30, 2016 measurement purposes, the assumed annual rate of increase in the future per capita cost of covered health care benefits related to domestic plans for 2017 was 7.5% and 6.0% for participants under the age of 65 and over the age of 65, respectively, declining gradually to an ultimate rate of 5.0% for 2022 and beyond. For September 30, 2015 measurement purposes, the assumed annual rate of increase in the future per capita cost of covered health care benefits related to domestic plans for 2016 was 8.0% and 6.2% for participants under the age of 65 and over the age of 65, respectively, declining gradually to an ultimate rate of 5.0% for 2022 and beyond. For September 30, 2016 and 2015 measurement purposes, the assumed annual rate of increase in the future per capita cost of covered health care benefits related to Canadian plans for the following fiscal year was 7.0% and 7.5%, respectively, declining gradually to an ultimate rate of 4.5% for 2021 and beyond for the year ended September 30, 2016 and 5.0% for 2021 and beyond for the year ended September 30, 2015. A 1% change in assumed health care cost trend rates would result in the following changes in the accumulated postretirement benefit obligation and in the total service and interest cost components for fiscal 2016. As of September 30, 2016, expected future benefit payments and related federal subsidy receipts (Medicare Part D) in the next ten fiscal years were as follows: In addition to the above expected benefit payments, the Company expects to make contributions of $6.0 to its defined benefit pension plans during fiscal 2017. In addition to the defined benefit plans described above, the Company sponsors a defined contribution 401(k) plan under which it makes matching contributions. The Company expensed $15.6, $11.7 and $7.1 for the fiscal years ended September 30, 2016, 2015 and 2014, respectively. NOTE 17 - STOCK-BASED COMPENSATION On February 3, 2012, the Company established the 2012 Long-Term Incentive Plan (the “2012 Plan”) which permits the issuance of various stock-based compensation awards up to 6.5 million shares. On January 29, 2016, the Company established the 2016 Long-Term Incentive Plan (the “2016 Plan”) which permits issuance of various stock-based compensation awards up to 2.4 million shares. The 2012 and 2016 plans allow the issuance of stock options, stock appreciation rights, performance shares, restricted stock, restricted stock units or other awards. Awards issued under the plans have a maximum term of 10 years, provided, however, that the Compensation Committee of the Board of Directors may, in its discretion, grant awards with a longer term to participants who are located outside the United States. Total compensation cost for cash and non-cash stock-based compensation awards recognized in the fiscal years ended 2016, 2015 and 2014 was $25.6, $29.2 and $16.6, respectively, and the related recognized deferred tax benefit for each of those periods was approximately $8.0, $10.6 and $5.4, respectively. As of September 30, 2016, the total compensation cost related to nonvested awards not yet recognized was $39.3, which is expected to be recognized over a weighted average period of 2.8 years. In connection with an employee retirement and reorganization initiatives during fiscal 2015, the Company accelerated the vesting of unvested equity awards for 25 and 4 employees in the fiscal years ended September 2016 and 2015, respectively. As a result of this acceleration, the Company recorded $2.2 and $8.0 of incremental cash and stock-based compensation expense in the fiscal years ended September 30, 2016 and 2015, respectively. No such expense was recorded in the year ended September 30, 2014. Stock Appreciation Rights Information about stock-settled stock appreciation rights (“SSAR”) is summarized in the following table. Upon exercise of each SSAR, the holder will receive the number of shares of Post common stock equal in value to the difference between the exercise price and the fair market value at the date of exercise, less all applicable taxes. The Company uses shares from the Plan to settle SSARs exercised. The total intrinsic value of SSARs exercised was $5.1, $2.1 and $2.4 in the fiscal years ended September 30, 2016, 2015 and 2014, respectively. In 2015 and 2014, the Company granted 40,000 and 30,000 SSARs, respectively, to its non-management members of the Board of Directors. Due to vesting provisions of these awards the Company determined that these awards had subjective acceleration rights such that the Company expensed the grant date fair value upon issuance and recognized $0.7 and $0.5 of related expense for the years ended September 30, 2015 and 2014, respectively. The following table provides the weighted-average grant date fair value of SSARs granted calculated using the Black-Scholes valuation model, which uses assumptions of expected life (term), expected stock price volatility, risk-free interest rate, and expected dividends (collectively, the “Black-Scholes Model”). The expected term is estimated based on the award’s vesting period and contractual term, along with historical exercise behavior on similar awards. Expected volatilities are based on historical volatility trends and other factors. The risk-free rate is the interpolated U.S. Treasury rate for a term equal to the expected term. The weighted average assumptions and grant date fair values for SSARs granted during fiscal years ended 2015 and 2014 are summarized in the table below. For SSARs granted to Company employees prior to the separation from its former owner, the assumptions used in the Black-Scholes model were based on the former owner’s history and stock characteristics. Cash Settled Stock Appreciation Rights The fair value of each cash settled stock appreciation right (“SAR”) was estimated each reporting period using the Black-Scholes Model. The expected term is estimated based on the award’s vesting period and contractual term, along with historical exercise behavior on similar awards. Expected volatilities are based on historical volatility trends and other factors. The risk-free rate is the interpolated U.S. Treasury rate for a term equal to the expected term. The following table presents the assumptions used to remeasure the fair value of outstanding SARs at September 30, 2016, 2015 and 2014. Stock Options The fair value of each stock option was estimated on the date of grant using the Black-Scholes Model. The Company uses the simplified method for estimating a stock option term as it does not have sufficient historical share options exercise experience upon which to estimate an expected term. The expected term is estimated based on the award’s vesting period and contractual term, along with historical exercise behavior on similar awards. Expected volatilities are based on historical volatility trends and other factors. The risk-free rate is the interpolated U.S. Treasury rate for a term equal to the expected term. The weighted average assumptions and fair values for stock options granted during the years ended September 30, 2016, 2015 and 2014 are summarized in the table below. The total intrinsic value of stock options exercised was $5.1 and $12.4 in the fiscal years ended September 30, 2016 and 2015, respectively. There were no stock options exercised in the fiscal year ended September 30, 2014. Restricted Stock Units The grant date fair value of each restricted stock award was determined based upon the closing price of the Company’s stock on the date of grant. The total vest date fair value of restricted stock units that vested during fiscal 2016, 2015 and 2014 was $32.0, $9.3 and $6.3, respectively. In 2016, the Company granted 15,000 restricted stock units to its non-management members of the Board of Directors. Due to vesting provisions of these awards, the Company determined that 12,500 of these awards had subjective acceleration rights such that the Company expensed the grant date fair value upon issuance and recognized $0.7 of related expense for the year ended September 30, 2016. Cash Settled Restricted Stock Units Cash settled restricted stock awards are liability awards and as such, their fair value is based upon the closing price of the Company’s stock for each reporting period, with the exception of 49,000 units that are valued at the greater of the closing stock price or the grant price of $51.43. Cash used by the Company to settle restricted stock units was $5.9, $3.4 and $1.8 for the years ended September 30, 2016, 2015 and 2014, respectively. Deferred Compensation Post provides a deferred compensation plan for directors and key employees through which eligible participants may elect to defer payment of all or a portion of their compensation or bonus until a later date based on the participant’s elections. Deferrals for employee participants may be made into Post common stock equivalents (Equity Option) or into a number of funds operated by The Vanguard Group Inc. with a variety of investment strategies and objectives (Vanguard Funds). Deferrals for director participants must be made into Post common stock equivalents to also receive a 33% matching contribution. Deferrals into the Equity Option are distributed in Post stock for employees and cash for directors, while deferrals into the Vanguard Funds are distributed in cash. There are no significant costs related to the deferred compensation plan. Post funds its deferred compensation liability (potential cash distributions) by investing in the Vanguard Funds in the same amounts as selected by the participating employees. Both realized and unrealized gains and losses on these investments are included in “Selling, general and administrative expenses” and offset the related change in the deferred compensation liability. NOTE 18 - TANGIBLE EQUITY UNITS In May 2014, the Company completed a public offering of 2.875 million TEUs, each with a stated value of $100.00. Each TEU is comprised of a prepaid stock purchase contract and a senior amortizing note due June 1, 2017. The prepaid common stock purchase contracts were recorded as additional paid-in capital, net of issuance costs, and the senior notes have been recorded as long-term debt. Issuance costs associated with the debt component were recorded as deferred financing costs within “Long-term debt” on the Consolidated Balance Sheets and are being amortized using the effective interest rate method over the term of the instrument to June 1, 2017. Post allocated the proceeds from the issuance of the TEUs to equity and debt based on the relative fair values of the respective components of each TEU. The proceeds received in the offering were $278.6, which were net of financing fees of $8.9. The aggregate values assigned upon issuance of each component of the TEUs were as follows (amounts in millions except price per TEU): The senior amortizing note component of each TEU’s initial principal amount of $14.5219, bears interest at 5.25% per annum and has a final installment payment date on June 1, 2017. The Company pays equal quarterly cash installments of $1.3125 per amortizing note on March 1, June 1, September 1 and December 1 of each year. Payments commenced on September 1, 2014. Each installment constitutes a payment of interest and a partial repayment of principal. Unless settled earlier at the holder’s or the Company’s option, each purchase contract will automatically settle on June 1, 2017 (subject to postponement in certain limited circumstances), and the Company will deliver not more than 2.0964 shares and not less than 1.7114 shares of its common stock per purchase contract, each subject to adjustment. For each purchase contract, the Company will deliver on the third business day immediately following the last trading day of the observation period a number of shares of its common stock determined as described below. The “observation period” will be the 20 consecutive trading day period beginning on, and including, the 22nd scheduled trading day immediately preceding June 1, 2017 (the “mandatory settlement date”). The number of shares of the Company’s common stock issuable upon mandatory settlement of each purchase contract (the “settlement amount”) will be equal to the sum of the “daily settlement amounts” (as defined below) for each of the 20 consecutive trading days during the relevant observation period. The daily settlement amount for each purchase contract and for each of the 20 consecutive trading days during the observation period will consist of: • if the daily volume-weighted average price (“VWAP”) is equal to or greater than $58.4325 per share (the “threshold appreciation price”), subject to adjustment, a number of shares of the Company’s common stock equal to (i) 1.7114 shares of common stock, subject to adjustment (the “minimum settlement rate”) divided by (ii) 20; • if the daily VWAP is less than $58.4325 per share, subject to adjustment, but greater than $47.70 per share (the “reference price”), subject to adjustment, a number of shares of the Company’s common stock equal to (i) $100.00 divided by the daily VWAP (ii) divided by 20; and • if the daily VWAP of our common stock is less than or equal to $47.70 per share, subject to adjustment, a number of shares of the Company’s common stock equal to (i) 2.0964 shares of common stock, subject to adjustment (the “maximum settlement rate”), divided by (ii) 20. The initial minimum settlement rate is approximately equal to the TEU stated amount of $100.00 divided by the initial threshold appreciation price of $58.4325 per share. The initial maximum settlement rate is approximately equal to the TEU stated amount of $100.0 divided by the initial reference price of $47.70 per share. During the year ended September 30, 2016, holders settled 108,039 purchase contracts for which the Company issued 184,897 shares of common stock. No purchase contracts were settled and no shares of common stock were issued relating to the TEUs during the years ended September 30, 2015 and 2014. NOTE 19 - SHAREHOLDERS' EQUITY The Company has two classes of preferred stock, the 3.75% Series B Cumulative Perpetual Convertible Preferred Stock (the “Series B Preferred”) and the 2.5% Series C Cumulative Perpetual Convertible Preferred Stock (the “Series C Preferred”). There are 50.0 preferred shares authorized. The Series B Preferred has a $0.01 par value per share and a $100.00 liquidation value per share. There were 1.5 and 2.4 shares outstanding at September 30, 2016 and 2015, respectively. The Series B Preferred earns cumulative dividends at a rate of 3.75% per annum payable quarterly on February 15, May 15, August 15 and November 15. The Series B Preferred is non-voting and ranks senior to the Company’s outstanding common stock upon the Company’s dissolution or liquidation. The Series B Preferred has no maturity date; however, holders of the Series B Preferred may convert their stock at an initial conversion rate of 2.1192 shares of the Company’s common stock per share of convertible preferred stock, which is equivalent to a conversion price of $47.19 per share of common stock. The Series C Preferred has a $0.01 par value per share and a $100.00 liquidation value per share. There were 3.2 and 3.2 shares outstanding at September 30, 2016 and 2015, respectively. The Series C Preferred earns cumulative dividends at a rate of 2.5% per annum payable quarterly on February 15, May 15, August 15 and November 15. The Series C Preferred is non-voting and ranks senior to the Company’s outstanding common stock upon the Company’s dissolution or liquidation. The Series C Preferred has no maturity date; however, holders of the Series C Preferred may convert their stock at an initial conversion rate of 1.8477 shares of the Company’s common stock per share of convertible preferred stock, which is equivalent to a conversion price of $54.12 per share of common stock. Fiscal 2016 In December 2015, the Company and a holder of the Company’s Series B Preferred entered into an exchange agreement pursuant to which the shareholder agreed to deliver 0.9 shares of the Series B Preferred to the Company in exchange for 2.0 shares of common stock and $10.9 of cash. The number of shares of common stock exchanged in the transaction was based upon the current conversion rate, under the Certificate of Designation, Rights and Preferences for the Series B Preferred, of 2.1192 shares of common stock per share of Series B Preferred. The cash paid of 10.9 was recorded as “Additional paid-in capital” on the Consolidated Balance Sheet. The Company may, from time to time, enter into common stock structured repurchase arrangements with financial institutions using general corporate funds. Under such arrangements, the Company pays a fixed sum of cash upon execution of each agreement in exchange for the right to receive either a pre-determined amount of cash or Post common stock. Upon expiration of each agreement, if the closing market price of Post’s common stock is above the pre-determined price, the Company will have the initial investment returned with a premium in cash. If the closing market price of Post’s common stock is at or below the pre-determined price, the Company will receive the number of shares specified in the agreement. In March 2016, the Company entered into a structured share repurchase arrangement which required cash payments totaling $28.3, including transaction-related fees of $0.2. At the May 2016 expiration of the agreement, the market price of Post’s common stock exceeded the pre-determined contract price, resulting in cash payments to the Company of $29.4. Prepayments and cash receipts at settlement under the agreement were recorded as “Additional paid-in capital” on the Consolidated Balance Sheets. Fiscal 2015 In February 2015, the Company issued 7.48 million shares of common stock at a price to the public of $47.50 per share. The Company received net proceeds of $341.4 after paying offering related fees and expenses of approximately $13.7. On May 4, 2015, the Company completed its acquisition of MOM Brands. The purchase price was partially funded by the issuance of 2.45 million shares of the Company’s common stock to the former owners of MOM Brands. The shares were valued at the May 1, 2015 closing price of $46.60 per share for a total issuance of $114.4. The Company did not receive any of the proceeds from these shares of common stock. In August 2015, the Company issued 6.73 million shares of common stock at a price to the public of $60.00 per share. The Company received net proceeds of $391.3 after paying offering related fees and expenses of approximately $12.3. NOTE 20 - SEGMENTS The Company’s reportable segments are as follows: • Post Consumer Brands: primarily RTE cereals; • Michael Foods Group: eggs, potatoes, cheese and pasta; • Active Nutrition: protein shakes, bars and powders and nutritional supplements; and • Private Brands: primarily peanut and other nut butters, dried fruit and nuts, and granola. Management evaluates each segment’s performance based on its segment profit, which is its operating profit before impairment of property and intangible assets, facility closure related costs, restructuring expenses, losses on assets held for sale, gain on sale of business and other unallocated corporate income and expenses. The following tables present information about the Company’s reportable segments, including corresponding amounts for the prior year. Post’s external revenues were primarily generated by sales within the United States; foreign (primarily located in Canada) sales were approximately 7% of total net sales. Sales are attributed to individual countries based on the address to which the product is shipped. As of September 30, 2016 and 2015, the majority of Post’s tangible long-lived assets were located in the United States; the remainder is located primarily in Canada and has a net carrying value of approximately $39.5 and $47.2, respectively. In the fiscal years ended September 30, 2016, 2015 and 2014, one customer accounted for $668.8, $464.1 and $276.8, respectively, or approximately 13%, 10% and 11% of total net sales, respectively. Each of the segments sells products to this major customer. The following tables present information about the Company’s operating segments, which are also its reportable segments. Note that “Additions to property and intangibles” excludes additions through business acquisitions (see Note 5) and includes the non-monetary portion of asset exchanges (see Note 2). (a) In connection with the adoption of ASU 2015-03, certain amounts have been restated to conform with the 2016 presentation. NOTE 21 - CONDENSED FINANCIAL STATEMENTS OF GUARANTORS All of the Company’s senior notes (see Note 14) are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of our existing 100% owned domestic subsidiaries and future domestic subsidiaries, the “Guarantors.” Our foreign subsidiaries, the “Non-Guarantors,” do not guarantee the senior notes. These guarantees are subject to release in limited circumstances (only upon the occurrence of certain customary conditions). Set forth below are the condensed consolidating financial statements presenting the results of operations, financial position and cash flows of the Parent Company (Post Holdings, Inc.), the Guarantors on a combined basis, the Non-Guarantors on a combined basis and eliminations necessary to arrive at the information for the Company as reported, on a consolidated basis. The Condensed Consolidating Financial Statements present the Parent Company’s investments in subsidiaries using the equity method of accounting. Eliminations represent adjustments to eliminate investments in subsidiaries and intercompany balances and transactions between or among the Parent Company, the Guarantor and the Non-Guarantor subsidiaries. Post Holdings, Inc. and all of its domestic subsidiaries form a single consolidated tax group for U.S. income tax purposes. Accordingly, income tax expense has been presented on the Guarantors’ Condensed Statements of Operations using the consolidated U.S. effective tax rate for the Company. Income tax payable and deferred tax items for the consolidated U.S. tax paying group reside solely on the Parent Company’s Condensed Balance Sheet. POST HOLDINGS, INC. CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS POST HOLDINGS, INC. CONDENSED CONSOLIDATING BALANCE SHEETS POST HOLDINGS, INC. CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS NOTE 22 - SUMMARY QUARTERLY FINANCIAL INFORMATION (UNAUDITED) NOTE 23 - SUBSEQUENT EVENTS On October 3, 2016, the Company completed the previously announced acquisition of National Pasteurized Eggs, Inc (“NPE”) for $94.7, subject to net working capital and other adjustments. NPE is a producer of pasteurized shell eggs, including cage-free and hard boiled eggs. NPE will be combined with Post’s existing Michael Foods egg business. The transaction will be accounted for as a business combination under the acquisition method of accounting. The Company will record the assets acquired and liabilities assumed at their fair values as of the acquisition date. Due to the limited time since closing of the acquisition, the valuation efforts and related acquisition accounting are incomplete at the time of this filing. As a result, the Company is unable to provide amounts recognized as of the acquisition date for major classes of assets and liabilities acquired, including goodwill. In addition, because the acquisition accounting is incomplete, the Company is unable to provide the supplemental pro forma revenue and earnings for the combined entity, as the pro forma adjustments are expected to primarily consist of estimates for the amortization of identifiable intangible assets acquired and related income tax effects which will result from the purchase price allocation and determination of the fair values for the assets acquired and liabilities assumed. | I apologize, but the financial statement excerpt you've provided appears to be incomplete and fragmented, making it difficult to provide a coherent summary. The text seems to be missing key sections and contains partial sentences that don't form a complete financial overview. To create an accurate summary, I would need a more complete and clear financial statement with full details about revenue, expenses, assets, liabilities, and other financial metrics. | Claude |
Index to Consolidated Financial Statements ACCOUNTING FIRM To the Board of Directors and Stockholders of Vantiv, Inc. Symmes Township, Ohio We have audited the accompanying consolidated statements of financial position of Vantiv, Inc. and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Vantiv, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 8, 2017 expressed an unqualified opinion on the Company’s internal control over financial reporting. /s/ DELOITTE & TOUCHE LLP Cincinnati, Ohio February 8, 2017 Vantiv, Inc. CONSOLIDATED STATEMENTS OF INCOME (In thousands, except share data) See . Vantiv, Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In thousands) See . Vantiv, Inc. CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (In thousands, except share data) See . Vantiv, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) See . Vantiv, Inc. CONSOLIDATED STATEMENT OF EQUITY (In thousands) See . Vantiv, Inc. CONSOLIDATED STATEMENT OF EQUITY (In thousands) See . Vantiv, Inc. CONSOLIDATED STATEMENT OF EQUITY (In thousands) See . Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business Vantiv, Inc., a Delaware corporation, is a holding company that conducts its operations through its majority-owned subsidiary, Vantiv Holding, LLC (“Vantiv Holding”). Vantiv, Inc. and Vantiv Holding are referred to collectively as the “Company,” “Vantiv,” “we,” “us” or “our,” unless the context requires otherwise. The Company provides electronic payment processing services to merchants and financial institutions throughout the United States of America and operates in two reportable segments, Merchant Services and Financial Institution Services. For more information about the Company’s segments, refer to Note 19 - Segment Information. The Company markets its services through diverse distribution channels, including national, regional and mid-market sales teams, third-party reseller clients and a telesales operation. The Company also has relationships with a broad range of referral partners that include merchant banks, independent software vendors (“ISVs”), value-added resellers (“VARs”), payment facilitators, independent sales organizations (“ISOs”) and trade associations as well as arrangements with core processors. Basis of Presentation and Consolidation The accompanying consolidated financial statements include those of Vantiv, Inc. and all subsidiaries thereof, including its majority-owned subsidiary, Vantiv Holding, LLC. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated. As of December 31, 2016, Vantiv, Inc. and Fifth Third owned interests in Vantiv Holding of 82.14% and 17.86%, respectively (see Note 9 - Controlling and Non-controlling Interests for changes in non-controlling interests). The Company accounts for non-controlling interests in accordance with Accounting Standards Codification (“ASC”) 810, Consolidation. Non-controlling interests primarily represent Fifth Third’s minority share of net income or loss of and equity in Vantiv Holding. Net income attributable to non-controlling interests does not include expenses incurred directly by Vantiv, Inc., including income tax expense attributable to Vantiv, Inc. Non-controlling interests are presented as a component of equity in the accompanying consolidated statements of financial position. Sponsorship In order to provide electronic payment processing services, Visa, Mastercard and other payment networks require sponsorship of non-financial institutions by a member clearing bank. The Company has an agreement with Fifth Third (the “Sponsoring Member”) to provide sponsorship services to the Company through December 31, 2024. The Company also has agreements with certain other banks that provide sponsorship into the card networks. Use of Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Revenue Recognition The Company has contractual agreements with its clients that set forth the general terms and conditions of the relationship including line item pricing, payment terms and contract duration. Revenues are recognized as earned (i.e., for transaction based fees, when the underlying transaction is processed) in conjunction with ASC 605, Revenue Recognition. ASC 605, Revenue Recognition, establishes guidance as to when revenue is realized or realizable and earned by using the following criteria: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price is fixed or determinable; and (4) collectibility is reasonably assured. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The Company follows guidance provided in ASC 605-45, Principal Agent Considerations, which states that the determination of whether a company should recognize revenue based on the gross amount billed to a customer or the net amount retained is a matter of judgment that depends on the facts and circumstances of the arrangement and that certain factors should be considered in the evaluation. The Company recognizes processing revenues net of interchange fees, which are assessed to the Company’s merchant customers on all processed transactions. Interchange rates are not controlled by the Company, which effectively acts as a clearing house collecting and remitting interchange fee settlement on behalf of issuing banks, debit networks, credit card associations and its processing customers. All other revenue is reported on a gross basis, as the Company contracts directly with the end customer, assumes the risk of loss and has pricing flexibility. The Company generates revenue primarily by processing electronic payment transactions. Set forth below is a description of the Company’s revenue by segment. Merchant Services The Company’s Merchant Services segment revenue is primarily derived from processing credit and debit card transactions. Merchant Services revenue is primarily comprised of fees charged to businesses, net of interchange fees, for payment processing services, including authorization, capture, clearing, settlement and information reporting of electronic transactions. The fees charged consist of either a percentage of the dollar volume of the transaction or a fixed fee, or both, and are recognized at the time of the transaction. Merchant Services revenue also includes a number of revenue items that are incurred by the Company and are reimbursable as the costs are passed through to and paid by the Company’s clients. These items primarily consist of Visa, Mastercard and other payment network fees. In addition, for sales through referral partners in which the Company is the primary party to the contract with the merchant, the Company records the full amount of the fees collected from the merchant as revenue. Merchant Services segment revenue also includes revenue from ancillary services such as fraud management, equipment sales and terminal rent. Merchant Services revenue is recognized as services are performed. Financial Institution Services The Company’s Financial Institution Services segment revenues are primarily derived from debit, credit and automated teller machine (“ATM”) card transaction processing, ATM driving and support, and PIN debit processing services. Financial Institution Services revenue associated with processing transactions includes per transaction and account related fees, card production fees and fees generated from the Company’s Jeanie network. Financial Institution Services revenue related to card transaction processing is recognized when consumers use their client-issued cards to make purchases. Financial Institution Services also generates revenue through other services, including statement production, collections and inbound/outbound call centers for credit transactions and other services such as credit card portfolio analytics, program strategy and support, fraud and security management and chargeback and dispute services. Financial Institution Services revenue is recognized as services are performed. Financial Institution Services provides certain services to Fifth Third. Revenues related to these services are included in the accompanying statements of income as related party revenues. Expenses Set forth below is a brief description of the components of the Company’s expenses: • Network fees and other costs primarily consist of pass through expenses incurred by the Company in connection with providing processing services to its clients, including Visa and Mastercard network association fees, payment network fees, third party processing fees, telecommunication charges, postage and card production costs. • Sales and marketing expense primarily consists of salaries and benefits paid to sales personnel, sales management and other sales and marketing personnel, residual payments made to referral partners, and advertising and promotional costs. • Other operating costs primarily consist of salaries and benefits paid to operational and IT personnel, costs associated with operating the Company’s technology platform and data centers, information technology costs for processing transactions, product development costs, software fees and maintenance costs. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) • General and administrative expenses primarily consist of salaries and benefits paid to executive management and administrative employees, including finance, human resources, product development, legal and risk management, share-based compensation costs, equipment and occupancy costs and consulting costs. • Non-operating income (expense): ◦ Non-operating expense for the year ended December 31, 2016 relates to the change in fair value of the Mercury TRA entered into as part of the acquisition of Mercury (see Note 7 - Tax Receivable Agreements) and a charge related to the refinancing of the Company’s senior secured credit facilities in October 2016 (see Note 6 - Long-Term Debt). ◦ Non-operating expense for the year ended December 31, 2015 primarily relates to the change in the fair value of the Mercury TRA (see Note 7 - Tax Receivable Agreements). ◦ Non-operating income for the year ended December 31, 2014, consists of a benefit recorded as a result of a reduction in certain TRA liabilities (see Note 7 - Tax Receivable Agreements), partially offset by a charge related to the refinancing of the Company’s senior secured credit facilities in June 2014 (see Note 6 - Long-Term Debt) and the change in fair value of the Mercury TRA (see Note 7 - Tax Receivable Agreements). Share-Based Compensation The Company expenses employee share-based payments under ASC 718, Compensation-Stock Compensation, which requires compensation cost for the grant-date fair value of share-based payments to be recognized over the requisite service period. The Company estimates the grant date fair value of the share-based awards issued in the form of options using the Black-Scholes option pricing model. The fair value of restricted stock awards and performance awards is measured based on the market price of the Company’s stock on the grant date. See Note 13 - Share-Based Compensation Plans for further discussion. Earnings Per Share Basic earnings per share is computed by dividing net income attributable to Vantiv, Inc. by the weighted average shares outstanding during the period. Diluted earnings per share is computed by dividing net income attributable to Vantiv, Inc., adjusted as necessary for the impact of potentially dilutive securities, by the weighted-average shares outstanding during the period and the impact of securities that would have a dilutive effect on earnings per share. See Note 16 - Net Income Per Share for further discussion. Income Taxes Vantiv, Inc. is taxed as a C corporation for U.S. income tax purposes and is therefore subject to both federal and state taxation at a corporate level. Income taxes are computed in accordance with ASC 740, Income Taxes, and reflect the net tax effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and the corresponding income tax amounts. The Company has deferred tax assets and liabilities and maintains valuation allowances where it is more likely than not that all or a portion of deferred tax assets will not be realized. To the extent the Company determines that it will not realize the benefit of some or all of its deferred tax assets, such deferred tax assets will be adjusted through the Company’s provision for income taxes in the period in which this determination is made. As of December 31, 2016 and 2015, the Company had recorded no valuation allowances against deferred tax assets. See Note 14 - Income Taxes for further discussion of income taxes. Cash and Cash Equivalents Cash on hand and investments with original maturities of three months or less (that are readily convertible to cash) are considered to be cash equivalents. Accounts Receivable-net Accounts receivable primarily represent processing revenues earned but not collected. For a majority of its customers, the Company has the authority to debit the client’s bank accounts through the Federal Reserve’s Automated Clearing House; as Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) such, collectibility is reasonably assured. The Company records a reserve for doubtful accounts when it is probable that the accounts receivable will not be collected. The Company reviews historical loss experience and the financial position of its customers when estimating the allowance. As of December 31, 2016 and 2015, the allowance for doubtful accounts was not material to the Company’s statements of financial position. Customer Incentives Customer incentives represent signing bonuses paid to customers. Customer incentives are paid in connection with the acquisition or renewal of customer contracts, and are therefore deferred and amortized using the straight-line method based on the contractual agreement. Related amortization is recorded as contra-revenue. Property, Equipment and Software-net Property, equipment and software consists of the Company’s facilities, furniture and equipment, software, land and leasehold improvements. Facilities, furniture and equipment and software are depreciated on a straight-line basis over their respective useful lives. Leasehold improvements are depreciated on a straight-line basis over the lesser of the estimated useful life of the improvement or the term of the lease. Also included in property, equipment and software is work in progress consisting of costs associated with software developed for internal use which has not yet been placed in service. The Company capitalizes certain costs related to computer software developed for internal use and amortizes such costs on a straight-line basis over an estimated useful life. Research and development costs incurred prior to establishing technological feasibility are charged to operations as such costs are incurred. Once technological feasibility has been established, costs are capitalized until the software is placed in service. See Note 3 - Property, Equipment and Software for additional information. Goodwill and Intangible Assets In accordance with ASC 350, Intangibles-Goodwill and Other, the Company tests goodwill for impairment for each reporting unit on an annual basis, or when events occur or circumstances indicate the fair value of a reporting unit is below its carrying value. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that fair value of the goodwill within the reporting unit is less than its carrying value. The Company performed its most recent annual goodwill impairment test for all reporting units as of July 31, 2016 in accordance with ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350) Testing Goodwill for Impairment,” which permits the Company to assess qualitative factors to determine whether the existence of events or circumstances leads to the determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Based on this analysis, it was determined that it is not more likely than not that the fair value of the reporting units is less than the carrying value. There have been no other events or changes in circumstances subsequent to the testing date that would indicate impairment of these reporting units as of December 31, 2016. Intangible assets consist of acquired customer relationships, trade names, customer portfolios and related assets that are amortized over their estimated useful lives. The Company reviews finite lived intangible assets for possible impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. As of December 31, 2016, there have been no such events or circumstances that would indicate potential impairment of finite lived intangible assets. Subsequent to the Mercury acquisition in June 2014, the Company decided to phase out an existing trade name used in the ISO channel within the Merchant Services segment. As a result of this decision, the remaining useful life was changed from indefinite to definite which resulted in the Company recording a charge to amortization expense of $34.3 million during the quarter ended June 30, 2014. The remaining fair value was amortized on a straight-line basis over the remaining estimated useful life of two years from July 2014 to June 2016. Settlement Assets and Obligations Settlement assets and obligations result from Financial Institution Services when funds are transferred from or received by the Company prior to receiving or paying funds to a different entity. This timing difference results in a settlement asset or obligation. The amounts are generally collected or paid the following business day. The settlement assets and obligations recorded by Merchant Services represent intermediary balances due to differences between the amount the Sponsoring Member receives from the card associations and the amount funded to the Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) merchants. Such differences arise from timing differences, interchange expenses, merchant reserves and exception items. In addition, certain card associations limit the Company from accessing or controlling merchant settlement funds and, instead, require that these funds be controlled by the Sponsoring Member. The Company follows a net settlement process whereby, if the settlement received from the card associations precedes the funding obligation to the merchant, the Company temporarily records a corresponding liability. Conversely, if the funding obligation to the merchant precedes the settlement from the card associations, the amount of the net receivable position is recorded by the Company, or in some cases, the Sponsoring Member may cover the position with its own funds in which case a receivable position is not recorded by the Company. Derivatives The Company accounts for derivatives in accordance with ASC 815, Derivatives and Hedging. This guidance establishes accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the statement of financial position at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and the hedged item will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portion of the change in the fair value of the derivative will be recorded in accumulated other comprehensive income (loss) (“AOCI”) and will be recognized in the statement of income when the hedged item affects earnings. The Company does not enter into derivative financial instruments for speculative purposes. New Accounting Pronouncements In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The update clarifies how cash receipts and cash payments in certain transactions are presented and classified in the statement of cash flows. The effective date of this update is for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The update requires retrospective application to all periods presented but may be applied prospectively if retrospective application is impracticable. The Company is currently evaluating the impact of the adoption of this principle on the Company’s consolidated financial statements. In March 2016, the FASB issued ASU 2016-09, Compensation- Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The update simplifies several aspects of the accounting for share-based payment award transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The update is effective for public companies for annual reporting periods beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted in any interim or annual period. The impact of adopting this standard on the Company’s consolidated financial statements is dependent upon the intrinsic value of share-based compensation awards at the time of exercise or vesting and may result in more variability in effective tax rates and net earnings and may also impact the diluted shares. The Company will adopt this ASU on January 1, 2017. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU amends the existing guidance by recognizing all leases, including operating leases, with a term longer than 12 months on the balance sheet and disclosing key information about the lease arrangements. The effective date of this update is for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The update requires modified retrospective transition, which requires application of the ASU at the beginning of the earliest comparative period presented in the year of adoption. The Company is forming a project team to evaluate the impact of the adoption of this principle on the Company’s consolidated financial statements. The Company anticipates adopting this ASU on January 1, 2019. In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. As of December 31, 2015, the Company elected to early adopt this ASU on a prospective basis and therefore, prior years were not retrospectively adjusted. In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. This standard was clarified in August 2015 with the issuance of ASU 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements: Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting. The change in accounting principle, resulting from the Company’s adoption of this ASU in December 2015, has been implemented and the results were not material to the Company’s consolidated statement of financial position. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) In May 2014, the FASB issued ASU 2014-09, Revenue From Contracts With Customers. The ASU supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. The new standard provides a five-step analysis of transactions to determine when and how revenue is recognized, based upon the core principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new standard also requires additional disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard, as amended, is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The amendment allows companies to use either a full retrospective or a modified retrospective approach to adopt this ASU. The Company has formed a project team and is currently assessing the impact of the adoption of this principle on the Company’s consolidated financial statements. The Company anticipates adopting this ASU on January 1, 2018 using the modified retrospective approach. 2. BUSINESS COMBINATIONS Acquisition of Moneris Solutions, Inc. On December 21, 2016, the Company completed the acquisition of Moneris Solutions, Inc. (“Moneris USA”) by acquiring 100% of the issued and outstanding shares. Moneris USA is a provider of payment processing solutions offering credit, debit, wireless and online payment services for merchants in virtually every industry segment. This acquisition helps to further accelerate the Company’s growth. The acquisition was accounted for as a business combination under ASC 805, Business Combinations (“ASC 805”). The purchase price was allocated to the assets acquired and the liabilities assumed based on the estimated fair value at the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired was allocated to goodwill, a portion of which is deductible for tax purposes. Goodwill, assigned to Merchant Services, consists primarily of the acquired workforce and growth opportunities, none of which qualify as an intangible asset. The preliminary purchase price allocation is as follows (in thousands): The above estimated fair values of assets acquired and liabilities assumed are preliminary and are based on the information that was available as of the reporting date to estimate the fair value of assets acquired and liabilities assumed. The Company believes that the information provides a reasonable basis for estimating the fair values of the acquired assets and assumed liabilities, but the potential for measurement period adjustments exists based on the Company’s continuing review of matters related to the acquisition. The Company expects to complete the purchase price allocation as soon as practicable, but no later than one year from the acquisition date. Intangible assets consist of customer relationship assets of $75 million with a weighted average estimated useful life of 5 years. The Company incurred transaction expenses of approximately $12.3 million during the year ended December 31, 2016 in conjunction with the acquisition of Moneris USA, which are included within general and administrative expenses on the accompanying consolidated statement of income. From the acquisition date of December 21, 2016 through December 31, 2016, revenue and net income included in the accompanying statement of income for the year ended December 31, 2016 attributable to Moneris USA is not material. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The pro forma results of the Company reflecting the acquisition of Moneris USA were not material to our financial results and therefore have not been presented. Acquisition of Mercury Payment Systems, LLC On June 13, 2014, the Company completed the acquisition of Mercury Payment Systems, LLC (“Mercury”), acquiring all of the outstanding voting interest. Mercury was a payment technology and service leader whose solutions are integrated into point-of-sale software applications and brought to market through dealer and developer partners. This acquisition helps to accelerate the Company’s growth in the integrated payments channel. Final measurement period adjustments were recorded in the second quarter of 2015 for the acquired assets and liabilities. The following table summarizes the purchase price consideration for Mercury (in thousands): The acquisition was accounted for as a business combination under ASC 805. The purchase price was allocated to the assets acquired and the liabilities assumed based on the estimated fair value at the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired was allocated to goodwill, a significant portion of which is deductible for tax purposes. Goodwill, assigned to Merchant Services, consists primarily of the acquired workforce and growth opportunities, none of which qualify as an intangible asset. The final purchase price allocation is as follows (in thousands): Simultaneously and in connection with the completion of the Mercury acquisition, the Company entered into a Tax Receivable Agreement (the “Mercury TRA”) with pre-acquisition owners of Mercury (“Mercury TRA Holders”). See Note 7 - Tax Receivable Agreements for further discussion of the Mercury TRA. The Mercury TRA is considered contingent consideration under ASC 805 as it is part of the consideration payable to the former owners of Mercury. In accordance with ASC 805, the contingent consideration is initially measured at fair value at the acquisition date and recorded as a liability. The Mercury TRA liability is therefore recorded at fair value based on estimates of discounted future cash flows associated with estimated payments to the Mercury TRA Holders. The liability recorded by the Company for the Mercury TRA obligations is re-measured at fair value at each reporting date with the change in fair value recognized in earnings as a non-operating expense. Intangible assets consist of customer relationship assets of $332.0 million and a trade name of $15.0 million having weighted average estimated useful lives of 10 years and 2.5 years, respectively. The trade name was valued utilizing a relief from royalty method. The Company incurred transaction and integration expenses of approximately $17.9 million during the year ended December 31, 2014 in conjunction with the acquisition of Mercury, which are included within general and administrative expenses and other operating costs on the accompanying consolidated statement of income. From the acquisition date of June 13, 2014 through December 31, 2014, revenue included in the accompanying statement of income for the year ended December 31, 2014 attributable to Mercury was approximately $217 million. Net income for the period could not be determined due to integration activities that were implemented subsequent to the acquisition. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Under the terms of the Mercury transaction agreement, the Company replaced unvested employee stock options held by certain employees of Mercury. The number of replacement stock options was based on a conversion factor into equivalent stock options of the Company on the acquisition date. The weighted average fair value of the replacement options was $32.1 million and was calculated on the acquisition date using the Black-Scholes option pricing model. The portion of the fair value of the replacement awards related to services provided prior to the acquisition of $17.7 million was part of the consideration transferred to acquire Mercury. The remaining portion of the fair value is associated with future service and will be recognized as expense over the future service period. See additional discussion in Note 13 - Share-Based Compensation Plans. The following unaudited pro forma information shows the Company’s results of operations for the year ended December 31, 2014 as if the Mercury acquisition had occurred January 1, 2013. The unaudited pro forma information is presented for informational purposes only and is not necessarily indicative of what would have occurred if the acquisition had been made as of that date, nor is it intended to be indicative of future operating results. The unaudited pro forma results include certain pro forma adjustments that were directly attributable to the business combination as follows: • additional amortization expense that would have been recognized relating to the acquired intangible assets, • adjustment of interest expense to reflect the additional borrowings of the Company in conjunction with the acquisition and removal of Mercury historical debt, and • a reduction in non-operating expenses for acquisition-related transaction costs and debt refinancing costs incurred by the Company. 3. PROPERTY, EQUIPMENT AND SOFTWARE A summary of the Company’s property, equipment and software is as follows (in thousands): Depreciation and amortization expense related to property, equipment and software for the years ended December 31, 2016, 2015 and 2014 was $70.5 million, $76.6 million and $70.0 million, respectively. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 4. GOODWILL AND INTANGIBLE ASSETS Changes in the carrying amount of goodwill, by business segment, are as follows (in thousands): (1) Amount represents adjustments to goodwill associated with the acquisition of Mercury as a result of the finalization of purchase accounting. Intangible assets consist of acquired customer relationships, trade names and customer portfolios and related assets. The useful lives of customer relationships are determined based on forecasted cash flows, which include estimates for customer attrition associated with the underlying portfolio of customers acquired. The customer relationships acquired in conjunction with acquisitions are amortized based on the pattern of cash flows expected to be realized taking into consideration expected revenues and customer attrition, which are based on historical data and the Company's estimates of future performance. These estimates result in accelerated amortization on certain acquired intangible assets. Indefinite lived trade names are reviewed for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Subsequent to the Mercury acquisition in June 2014, the Company decided to phase out an existing trade name used in the ISO channel. The trade name was originally expected to remain in use for the foreseeable future and therefore was deemed an indefinite lived intangible asset not subject to amortization. As a result of this decision, the remaining useful life was changed from indefinite to definite which resulted in the Company recording a charge to amortization expense of $34.3 million during the year ended December 31, 2014. The trade name was revalued utilizing an income approach using the relief-from-royalty method. The revised fair value of $6.7 million was subsequently amortized on a straight-line basis over the remaining estimated useful life of two years from July 2014 to June 2016. The Company reviews finite lived intangible assets for possible impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. As of December 31, 2016 and 2015, the Company’s finite lived intangible assets consisted of the following (in thousands): Customer portfolios and related assets acquired during the years ended December 31, 2016 and 2015 have weighted-average amortization periods of 4.4 years and 4.8 years, respectively. Amortization expense on intangible assets for the years Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) ended December 31, 2016, 2015 and 2014 was $199.6 million, $200.4 million and $205.1 million, respectively. For the year ended December 31, 2014, intangible amortization expense included the $34.3 million charge related to the phasing out of a trade name discussed above. The estimated amortization expense of intangible assets for the next five years is as follows (in thousands): 5. CAPITAL LEASES The Company has various lease agreements for equipment that are classified as capital leases. The cost and accumulated depreciation of equipment under capital leases included in the accompanying statements of financial position within property and equipment were $36.6 million and $12.7 million, respectively, as of December 31, 2016 and $36.6 million and $4.4 million, respectively, as of December 31, 2015. Depreciation expense associated with capital leases for the years ended December 31, 2016, 2015, and 2014 was $8.3 million, $7.8 million and $6.0 million, respectively. The future minimum lease payments required under capital leases and the present value of net minimum lease payments as of December 31, 2016 are as follows (in thousands): Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 6. LONG-TERM DEBT As of December 31, 2016 and 2015, the Company’s long-term debt consisted of the following (in thousands): (1) Interest at a variable base rate (LIBOR) plus a spread rate (200 basis points) (total rate of 2.70% at December 31, 2016) and amortizing on a basis of 1.25% per quarter during each of the first twelve quarters (March 2017 through December 2019), 1.875% per quarter during the next four quarters (March 2020 through December 2020) and 2.50% during the next three quarters (March 2021 through September 2021) with a balloon payment due at maturity. (2) Interest at a variable base rate (LIBOR) with a floor of 75 basis points plus a spread rate (250 basis points) (total rate of 3.25% at December 31, 2016) and amortizing on a basis of 0.25% per quarter, with a balloon payment due at maturity. (3) Interest at a variable base rate (LIBOR) plus a spread rate (200 basis points) (total rate of 2.33% at December 31, 2015). (4) Interest at a variable base rate (LIBOR) with a floor of 75 basis points plus a spread rate (300 basis points) (total rate of 3.75% at December 31, 2015). (5) Interest payable monthly at a fixed rate of 6.22%. 2016 Debt Refinancing On October 14, 2016, Vantiv, LLC completed a debt refinancing by entering into a second amended and restated loan agreement (“Second Amended Loan Agreement”). The Second Amended Loan Agreement provides for senior secured credit facilities comprised of a $2.5 billion term A loan, a $765.0 million term B loan and a $650.0 million revolving credit facility. The prior revolving credit facility was also terminated. The maturity date and debt service requirements relating to the new term A and term B loans are listed in the table above. The new revolving credit facility matures in October 2021 and includes a $100 million swing line facility and a $40 million letter of credit facility. The commitment fee rate for the unused portion of the revolving credit facility was 0.375% based on the Company’s leverage ratio at December 31, 2016. During the year ended December 31, 2016, the Company periodically borrowed under its revolving credit facility and repaid the amounts prior to year end. There were no outstanding borrowings on the revolving credit facility at December 31, 2016. As of December 31, 2016, Fifth Third held $151.1 million of the term A loans, which is presented as note payable to related party on the consolidated statements of financial position. As a result of the Company's 2016 debt refinancing, the Company expensed approximately $16.6 million, which consisted primarily of the write-offs of unamortized deferred financing fees and original issue discount (“OID”) associated with the component of the refinancing accounted for as a debt extinguishment and certain third party costs incurred in connection with the refinancing. Amounts expensed in connection with the refinancing are recorded as a component of non-operating expenses in the accompanying consolidated statement of income for the year ended December 31, 2016. 2014 Debt Refinancing On June 13, 2014, Vantiv, LLC completed a debt refinancing by entering into an amended and restated loan agreement (“Amended Loan Agreement”). The Amended Loan Agreement provided for senior secured credit facilities comprised of a $2.05 billion term A loan, a $1.4 billion term B loan and a $425 million revolving credit facility. Proceeds from the refinancing were primarily used to fund the Mercury acquisition and repay the prior term A loan with an outstanding balance of approximately $1.8 billion as of the date of refinancing. The related revolving credit facility was also terminated. The revolving credit facility originally matured in June 2019 and included a $100 million swing line facility and a $40 million letter of credit Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) facility. The commitment fee rate for the unused portion of the revolving credit facility was 0.375% per year. During the year ended December 31, 2015, the Company periodically borrowed under its revolving credit facility and repaid the amounts prior to year end. There were no outstanding borrowings on the revolving credit facility at December 31, 2015. As of December 31, 2015, Fifth Third held $191.5 million of the term A loans, which is presented as note payable to related party on the consolidated statements of financial position. On January 6, 2015, the Company made an early principal payment of $200 million on the term B loan. The Company expensed approximately $1.8 million in non-operating expenses related to the write-off of deferred financing fees and OID in connection with the early principal payment. As a result of the Company's 2014 debt refinancing, the Company expensed approximately $26.5 million, which consisted primarily of the write-offs of unamortized deferred financing fees and OID associated with the component of the refinancing accounted for as a debt extinguishment and certain third party costs incurred in connection with the refinancing. Amounts expensed in connection with the refinancing are recorded as a component of non-operating expenses in the accompanying consolidated statement of income for the year ended December 31, 2014. Guarantees and Security The Company’s debt obligations at December 31, 2016 are unconditional and are guaranteed by Vantiv Holding and certain of Vantiv Holding’s existing and subsequently acquired or organized domestic subsidiaries. The refinanced debt and related guarantees are secured on a first-priority basis (subject to liens permitted under the Second Amended Loan Agreement) by substantially all the capital stock (subject to a 65% limitation on pledges of capital stock of foreign subsidiaries and domestic holding companies of foreign subsidiaries) and personal property of Vantiv Holding and any obligors as well as any real property in excess of $25 million in the aggregate held by Vantiv Holding or any obligors (other than Vantiv Holding), subject to certain exceptions. Covenants There are certain financial and non-financial covenants contained in the Second Amended Loan Agreement for the refinanced debt, which are tested on a quarterly basis. The financial covenants require maintenance of certain leverage and interest coverage ratios. At December 31, 2016, the Company was in compliance with these financial covenants. 7. TAX RECEIVABLE AGREEMENTS As of December 31, 2016, the Company is party to several TRAs in which the Company agrees to make payments to various parties of 85% of the federal, state, local and foreign income tax benefits realized by the Company as a result of certain tax deductions. Payments under the TRAs will be based on the tax reporting positions of the Company and are only required to the extent the Company realizes cash savings as a result of the underlying tax attributes. The cash savings realized by the Company are computed by comparing the actual income tax liability of the Company to the amount of such taxes the Company would have been required to pay had there been no deductions related to the tax attributes discussed below. The Company will retain the benefit of the remaining 15% of the cash savings associated with the TRAs. The Company has entered into the following three TRAs: • TRAs with investors prior to our initial public offering (“IPO”) for its use of NPC Group, Inc. net operating losses (“NOLs”) and other tax attributes existing at the IPO date under the NPC TRA, all of which is currently held by Fifth Third. • The Fifth Third TRA in which we realize tax deductions as a result of the increases in tax basis from the purchase of Vantiv Holding units or from the exchange of Vantiv Holding units for cash or shares of Class A common stock, as well as the tax benefits attributable to payments made under such TRAs. • A TRA with Mercury shareholders (the “Mercury TRA”) as part of the acquisition of Mercury as a result of the increase in tax basis of the assets of Mercury resulting from the acquisition and the use of the net operating losses and other tax attributes of Mercury that were acquired as part of the acquisition. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Obligations recorded pursuant to the TRAs are based on estimates of future taxable income and future tax rates. On an annual basis, the Company evaluates the assumptions underlying the TRA obligations. As a result of this process, obligations under the tax receivable agreements with Fifth Third were adjusted in 2014 to reflect the impact of tax planning strategies implemented during the year which are expected to reduce the amount of future obligations. The Company recorded a benefit of $41.3 million in non-operating income (expense) during the year ended December 31, 2014 as a result of the reduction in the TRA obligations with Fifth Third. As discussed in Note 2 - Business Combinations, the Company entered into the Mercury TRA and recorded a liability of $192.5 million for the Mercury TRA and non-operating expenses of $19.5 million, $28.9 million and $14.6 million related to the change in fair value of the Mercury TRA during the years ended December 31, 2016, 2015 and 2014, respectively. From time to time, the Company enters into repurchase addendums providing for the early settlement of certain obligations. The following table presents the Company’s TRA settlements and the impact of these settlements on the Company’s consolidated statement of financial position (in thousands): As summarized in the table above, in July 2016, the Company entered into a purchase addendum in connection with the Company’s TRA with Fifth Third (the “Fifth Third TRA Addendum”) to terminate and settle a portion of the Company’s obligations owed to Fifth Third under the Fifth Third TRA and the NPC TRA. Under the terms of the Fifth Third TRA Addendum, the Company paid approximately $116.3 million to Fifth Third to settle approximately $330.7 million of obligations under the Fifth Third TRA, the difference of which was recorded as an addition to paid-in capital, net of deferred taxes. In addition to the July 2016 Fifth Third TRA settlement presented in the table above, the Fifth Third TRA Addendum provides that the Company may be obligated to pay up to a total of approximately $170.7 million to Fifth Third to terminate and settle certain remaining obligations under the Fifth Third TRA and the NPC TRA, totaling an estimated $394.1 million, the difference of which will be recorded as an addition to paid-in capital upon the exercise of the Call Options or Put Options discussed below. Under the terms of the Fifth Third TRA Addendum, beginning March 1, 2017, June 1, 2017, September 1, 2017, December 1, 2017, March 1, 2018, June 1, 2018, September 1, 2018 and December 1, 2018, and ending March 10, 2017, June 10, 2017, September 10, 2017, December 10, 2017, March 10, 2018, June 10, 2018, September 10, 2018 and December 10, 2018, respectively, the Company is granted call options (collectively, the “Call Options”) pursuant to which certain additional obligations of the Company under the Fifth Third TRA and the NPC TRA would be terminated and settled in consideration for cash payments of $15.1 million, $15.6 million, $16.1 million, $16.6 million, $25.6 million, $26.4 million, $27.2 million and $28.1 million, respectively. Under the terms of the Fifth Third TRA Addendum, in the unlikely event the Company does not exercise the relevant Call Option, Fifth Third is granted put options beginning March 20, 2017, June 20, 2017, September 20, 2017, December 20, 2017, March 20, 2018, June 20, 2018, September 20, 2018 and December 20, 2018, and ending March 31, 2017, June 30, 2017, September 30, 2017, December 31, 2017, March 31, 2018, June 30, 2018, September 30, 2018 and December 31, 2018, respectively (collectively, the “Put Options”), pursuant to which certain additional obligations of the Company would be terminated and settled in consideration for cash payments with similar amounts to the Call Options. The full carrying amount of the Fifth Third callable/puttable TRA obligations for the options exercisable within 12 months of the balance sheet date have been classified as current obligations in the accompanying statement of financial position ($157.7 million). Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Since Fifth Third is a significant stockholder of the Company, a special committee of the Company’s board of directors comprised of independent, disinterested directors authorized the TRA Addendum. During 2015, the Company entered into the Mercury TRA Addendum with each of the pre-acquisition owners of Mercury ("Mercury TRA Holders"). The Mercury TRA Addendum contains the following provisions to acquire a significant portion of the Mercury TRA: • Beginning December 1st of each of 2015, 2016, 2017, and 2018, and ending June 30th of 2016, 2017, 2018, and 2019, respectively, the Company is granted call options (collectively, the “Call Options”) pursuant to which certain additional obligations of the Company under the Mercury TRA would be terminated in consideration for cash payments of $41.4 million, $38.1 million, $38.0 million, and $43.0 million, respectively. • In the unlikely event the Company does not exercise the relevant Call Option, the Mercury TRA Holders are granted put options beginning July 10th and ending July 25th of each of 2016, 2017, 2018, and 2019, respectively (collectively, the “Put Options”), pursuant to which certain additional obligations of the Company would be terminated in consideration for cash payments with similar amounts to the Call Options. • In June 2016, the Company exercised the December 2015 Call Option and made a payment to the Mercury TRA Holders. The Company’s President, Integrated Payments, is a Mercury TRA Holder. Pursuant to the initial payment under the Mercury TRA Addendum, this individual is entitled to receive an aggregate of $0.6 million, and could receive as much as an additional $2.2 million with respect to payments made pursuant to the Mercury TRA Addendum. Except to the extent the Company’s obligations under the Mercury TRA, the Fifth Third TRA and NPC TRA have been terminated and settled in full in accordance with the terms of the Mercury TRA and Fifth Third TRA Addendums, the Mercury TRA, Fifth Third TRA and NPC TRA will remain in effect, and the parties thereto will continue to have all rights and obligations thereunder. All TRA obligations are recorded based on the full and undiscounted amount of the expected future payments, except for the Mercury TRA which represents contingent consideration relating to an acquired business, and is recorded at fair value for financial reporting purposes (see Note 15 - Fair Value Measurements). The following table reflects TRA activity and balances for the years ended December 31, 2016, 2015 and 2014 (in thousands): Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) As a result of the secondary offerings and exchange of units of Vantiv Holding by Fifth Third Bank discussed in Note 12 - Capital Stock, the Company recorded the following (in thousands): The timing and/or amount of aggregate payments due under the TRAs outside of the call/put structures may vary based on a number of factors, including the amount and timing of the taxable income the Company generates in the future and the tax rate then applicable, the use of loss carryovers and amortizable basis. Payments under the TRAs, if necessary, are required to be made no later than January 5th of the second year immediately following the taxable year in which the obligation occurred. The contractually obligated payments under the TRA obligations paid in January 2014, 2015 and 2016 are in the tables above. The Company made a payment under the TRA obligations of approximately $55.7 million in January 2017. The January 2017 payment is recorded as current portion of tax receivable agreement obligations on the accompanying consolidated statement of financial position. Unless settled under the terms of the repurchase addenda, the term of the TRAs will continue until all the underlying tax benefits have been utilized or expired. 8. DERIVATIVES AND HEDGING ACTIVITIES Risk Management Objective of Using Derivatives The Company enters into derivative financial instruments to manage differences in the amount, timing and duration of its known or expected cash payments related to its variable-rate debt. As of December 31, 2016 and 2015, the Company’s derivative instruments consisted of interest rate swaps, which hedged the variable rate debt by converting floating-rate payments to fixed-rate payments. In addition to the interest rate swaps, in March 2016 the Company entered into interest rate cap agreements in exchange for an upfront premium of $21.5 million. These interest rate cap agreements cap a portion of the Company’s variable rate debt if interest rates rise above the strike rate on the contract. As of December 31, 2016 the interest rate cap agreements had a fair value of $23.2 million, classified within other current and non-current assets on the Company’s consolidated statements of financial position. The interest rate swaps and caps (collectively “interest rate contracts”) are designated as cash flow hedges for accounting purposes. Accounting for Derivative Instruments The Company recognizes derivatives in other current and non-current assets or liabilities in the accompanying consolidated statements of financial position at their fair values. Refer to Note 15 - Fair Value Measurements for a detailed discussion of the fair value of its derivatives. The Company designates its interest rate contracts as cash flow hedges of forecasted interest rate payments related to its variable-rate debt. The Company formally documents all relationships between hedging instruments and underlying hedged transactions, as well as its risk management objective and strategy for undertaking hedge transactions. This process includes linking all derivatives that are designated as cash flow hedges to forecasted transactions. A formal assessment of hedge effectiveness is performed both at inception of the hedge and on an ongoing basis to determine whether the hedge is highly effective in offsetting changes in cash flows of the underlying hedged item. Hedge effectiveness is assessed using a regression analysis. If it is determined that a derivative ceases to be highly effective during the term of the hedge, the Company will discontinue hedge accounting for such derivative. The Company’s interest rate contracts qualify for hedge accounting under ASC 815, Derivatives and Hedging. Therefore, the effective portion of changes in fair value were recorded in AOCI and will be reclassified into earnings in the same period during which the hedged transactions affect earnings. Cash Flow Hedges of Interest Rate Risk The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company uses a combination of interest rate swaps Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) and caps as part of its interest rate risk management strategy. As of December 31, 2016, the Company had a total of 10 outstanding interest rate swaps that were designated as cash flow hedges of interest rate risk. Of the 10 outstanding interest rate swaps, 4 of them cover an exposure period from June 2016 through June 2017 and have a combined notional balance of $1.1 billion. The remaining 6 interest rate swaps cover an exposure period from January 2016 through January 2019 and have a combined notional balance of $500 million. Fifth Third is the counterparty to 4 of the 10 outstanding interest rate swaps with notional balances ranging from $262.5 million to $250.0 million. Additionally, as of December 31, 2016, the Company had a total of 6 interest rate cap agreements with a combined notional balance of $1.0 billion, cap strike rate of 0.75%, covering an exposure period from January 2017 to January 2020. The Company does not offset derivative positions in the accompanying consolidated financial statements. The table below presents the fair value of the Company’s derivative financial instruments designated as cash flow hedges included within the accompanying consolidated statements of financial position (in thousands): Any ineffectiveness associated with such derivative instruments will be recorded immediately as interest expense in the accompanying consolidated statements of income. As of December 31, 2016, the Company estimates that $11.2 million will be reclassified from accumulated other comprehensive income as an increase to interest expense during the next 12 months. The table below presents the pre-tax effect of the Company’s interest rate contracts on the accompanying consolidated statements of comprehensive income for the years ended December 31, 2016, 2015 and 2014 (in thousands): (1) “OCI” represents other comprehensive income. (2) For the year ended December 31, 2014, amount represents hedge ineffectiveness. Credit Risk Related Contingent Features As of December 31, 2016, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $15.9 million. The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, then the Company could also be declared in default on its derivative obligations. As of December 31, 2016, the Company had not posted any collateral related to these agreements. If the Company had breached any of these provisions at December 31, 2016, it could have been required to settle its obligations under the agreements at their termination value of $15.9 million. 9. CONTROLLING AND NON-CONTROLLING INTERESTS The Company has various non-controlling interests that are accounted for in accordance with ASC 810, Consolidation (“ASC 810”). As discussed in Note 1 - Basis of Presentation and Summary of Significant Accounting Policies, Vantiv, Inc. owns a controlling interest in Vantiv Holding, and therefore consolidates the financial results of Vantiv Holding and its subsidiaries and records non-controlling interest for the economic interests in Vantiv Holding held by Fifth Third. The Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Exchange Agreement entered into prior to the IPO provides for a 1 to 1 ratio between the units of Vantiv Holding and the common stock of Vantiv, Inc. In May 2014, the Company entered into a joint venture with a bank partner which provides customers a comprehensive suite of payment solutions. Vantiv Holding owns 51% and the bank partner owns 49% of the joint venture. The joint venture is consolidated by the Company in accordance with ASC 810, with the associated non-controlling interest included in “Net income attributable to non-controlling interests” in the consolidated statements of income. The bank partner contributed a merchant asset portfolio to the joint venture valued at $18.8 million which was recorded to non-controlling interests in the 2014 consolidated statement of equity. As of December 31, 2016, Vantiv, Inc.’s interest in Vantiv Holding was 82.14%. Changes in units and related ownership interest in Vantiv Holding are summarized as follows: (1) Includes stock issued under the equity plans less Class A common stock withheld to satisfy employee tax withholding obligations upon vesting or exercise of employee equity awards and forfeitures of restricted Class A common stock awards. As a result of the changes in ownership interests in Vantiv Holding, periodic adjustments are made in order to reflect the portion of net assets of Vantiv Holding attributable to non-controlling unit holders based on changes in the proportionate ownership interests in Vantiv Holding during those periods. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The table below provides a reconciliation of net income attributable to non-controlling interests based on relative ownership interests as discussed above (in thousands): (1) Primarily represents income tax expense related to Vantiv, Inc. and TRA related expense (credits) (see Note 7 - Tax Receivable Agreements). (2) Net income attributable to non-controlling interests of Fifth Third reflects the allocation of Vantiv Holding’s net income based on the proportionate ownership interests in Vantiv Holding held by the non-controlling unit holders. The net income attributable to non-controlling unit holders reflects the changes in ownership interests summarized in the table above. (3) Reflects net income attributable to the non-controlling interest of the joint venture. In connection with the separation from Fifth Third, Fifth Third received a warrant that allows for the purchase of up to 20.4 million Class C Non-Voting Units of Vantiv Holding at an exercise price of $15.98 per unit. The warrant was valued at approximately $65.4 million at June 30, 2009 and was recorded as a component of non-controlling interest on the accompanying statements of financial position. On December 2, 2015, the Company entered into a warrant cancellation agreement (the "Warrant Cancellation Agreement") with Fifth Third to cancel a portion of the warrant. The Warrant Cancellation Agreement cancelled the rights under the warrant to purchase 4.8 million Class C Units of Vantiv Holding for aggregate consideration of $200 million paid by the Company to Fifth Third. Following the effectiveness of the Warrant Cancellation Agreement, Fifth Third net exercised a portion of the warrants it held to purchase 5.4 million Class C Units of Vantiv Holding. As of December 31, 2015, Fifth Third held the rights to purchase 7.8 million Class C Units of Vantiv Holding which are exchangeable for Class A common stock. The remaining warrant held by Fifth Third in the amount of $25 million was recorded as a component of non-controlling interest on the accompanying statements of financial position as of December 31, 2015. On November 28, 2016, Fifth Third net exercised the remaining warrant it held to purchase approximately 5.7 million Class C Units of Vantiv Holding. The value of the warrant exercised in the amount of $25 million was reclassified out of non-controlling interests to additional paid-in capital on the accompanying statements of financial position. 10. COMMITMENTS, CONTINGENCIES AND GUARANTEES Leases The Company leases office space under non-cancelable operating leases that expire between March 2017 and December 2045. Future minimum commitments under these leases are as follows (in thousands): Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Rent expense for the years ended December 31, 2016, 2015 and 2014 was approximately $9.4 million, $11.6 million and $9.9 million, respectively. Legal Reserve From time to time, the Company is involved in various litigation matters arising in the ordinary course of its business. While it is impossible to ascertain the ultimate resolution or range of financial liability with respect to these contingent matters, management believes none of these matters, either individually or in the aggregate, would have a material effect upon the Company’s consolidated financial statements. 11. EMPLOYEE BENEFIT PLANS The Company offers a defined contribution savings plan to virtually all Company employees. The plan provides for elective, pre-tax or after tax participant contributions and Company matching contributions. Expenses associated with the defined contribution savings plan for the years ended December 31, 2016, 2015 and 2014 were $10.1 million, $9.1 million and $7.3 million, respectively. 12. CAPITAL STOCK Common Stock Under the Company’s amended and restated certificate of incorporation, the Company is authorized to issue 890,000,000 shares of Class A common stock with a par value of $0.00001 per share and 100,000,000 shares of Class B common stock with no par value per share. The Class A and Class B common stock each provide holders with one vote on all matters submitted to a vote of stockholders; however, the holders of shares of Class B common stock shall be limited to voting power, including voting power associated with any Class A common stock held, of 18.5% at any time other than in connection with a stockholder vote with respect to a change of control. Also, holders of Class B common stock do not have any of the economic rights (including rights to dividends and distributions upon liquidation) provided to the holders of Class A common stock. The holders of Class B common stock hold one share of Class B common stock for each Vantiv Holding Class B unit they hold. The Class B units of Vantiv Holding may be exchanged for shares of Class A common stock on a one-for-one basis or, at the Company’s option, for cash equal to the fair value of the shares tendered for exchange. Upon exchange of any Class B units of Vantiv Holding, an equal number of shares of Class B common stock automatically will be cancelled. The Class A common stock and Class B common stock vote together as a single class, except that the holders of Class B common stock are entitled to elect a number of the Company’s directors equal to the percentage of the voting power of all of the outstanding common stock represented by the Class B common stock but not exceeding 18.5% of the board of directors. Fifth Third holds all of the issued and outstanding Class B common stock. As of December 31, 2016, 161,134,831 shares of Class A common stock and 35,042,826 shares of Class B common stock were issued and outstanding. Secondary Offerings In March 2014, a secondary offering took place in which Advent sold its remaining 18.8 million shares of the Company’s Class A common stock. In June 2014, a secondary offering took place in which Fifth Third sold 5.8 million shares of the Company’s Class A common stock. On December 8, 2015, subsequent to the Warrant Cancellation Agreement and the Partial Warrant Exercise on December 2, 2015 as discussed in Note 9 - Controlling and Non-Controlling Interests, a secondary offering took place in which Fifth Third sold 13.4 million shares of the Company’s Class A common stock. On November 28, 2016, subsequent to Fifth Third’s exercise of the remaining warrant, a secondary offering took place in which Fifth Third sold approximately 4.8 million shares of the Company’s Class A common stock. The Company did not receive any proceeds from the sales noted above. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Share Repurchases On February 12, 2014, the Company's board of directors approved a program to repurchase up to $300 million of the Company’s Class A common stock. During the year ended December 31, 2014, approximately 1.9 million shares were repurchased under this program for approximately $59.4 million, which completed the remaining 2013 share repurchase authorization and resulted in approximately $275 million available under the February 2014 authorization. During the year ended December 31, 2015, approximately 4.4 million shares were repurchased for approximately $200 million. On October 25, 2016, the board of directors authorized a program to repurchase up to an additional $250 million of the Company's Class A common stock. In connection with Fifth Third’s net exercise of the remaining warrant discussed in Note 9 - Controlling and Non-controlling Interests, the Company repurchased approximately 850,000 shares of its Class A common stock from Fifth Third for approximately $50.8 million. During the year ended December 31, 2016, approximately $1.4 million shares were repurchased under the programs for approximately $81.4 million, which completed the repurchases under the February 2014 authorization and resulted in approximately $243 million available for repurchase under the October 2016 authorization. The repurchased shares were immediately retired. Purchases under the programs may be made from time to time in the open market, in privately negotiated transactions, or otherwise. The manner, timing and amount of any purchases will be determined by management based on an evaluation of market conditions, stock price and other factors. The Company’s share repurchase program does not obligate it to acquire any specific number or amount of shares, there is no guarantee as to the exact number or amount of shares that may be repurchased, if any, and the Company may discontinue purchases at any time that it determines additional purchases are not warranted. Preferred Stock Under the Company’s amended and restated certificate of incorporation, the Company is authorized to issue 10,000,000 shares of preferred stock with a par value of $0.00001 per share. As of December 31, 2016, there was no preferred stock outstanding. Dividend Restrictions The Company does not intend to pay cash dividends on its Class A common stock in the foreseeable future. Vantiv, Inc. is a holding company that does not conduct any business operations of its own. As a result, Vantiv, Inc.’s ability to pay cash dividends on its common stock, if any, is dependent upon cash dividends and distributions and other transfers from Vantiv Holding. The amounts available to Vantiv, Inc. to pay cash dividends are subject to the covenants and distribution restrictions in its subsidiaries’ loan agreements. As a result of the restrictions on distributions from Vantiv Holding and its subsidiaries, essentially all of the Company’s consolidated net assets are held at the subsidiary level and are restricted as of December 31, 2016. 13. SHARE-BASED COMPENSATION PLANS The company accounts for share-based compensation plans in accordance with ASC 718, Compensation-Stock Compensation, which requires compensation expense for the grant-date fair value of share-based payments to be recognized over the requisite service period. 2012 Equity Incentive Plan The 2012 Equity Incentive Plan was adopted by the Company’s board of directors in March 2012. The 2012 Equity Incentive Plan provides for grants of stock options, stock appreciation rights, restricted stock and restricted stock units, performance awards and other stock-based awards. The maximum number of shares of Class A common stock available for issuance pursuant to the 2012 Equity Incentive Plan is 35.5 million shares. Restricted Stock Awards The Company grants restricted stock awards to certain employees which vest based on the recipient’s continued employment or service to the Company (“Time Awards”). Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The Company also grants restricted stock awards to certain employees subject to the achievement of certain financial performance measures ("Performance Awards"). These Performance Awards typically vest on the third anniversary of the grant date. Participants have the right to earn 0% to 200% of the target number of shares of the Company’s Class A common stock, determined by the level of achievement of the financial performance measures during the performance period. The grant date fair value of the restricted stock awards is based on the quoted fair market value of our common stock on the grant date. The weighted-average grant date fair value of restricted stock awards granted during the years ended 2016 and 2015 was $50.08 and $38.10, respectively. There were no restricted stock awards granted in 2014. The total fair value of restricted stock awards vested was $1.2 million, $47.2 million and $53.4 million in 2016, 2015 and 2014, respectively. The following table presents the number and weighted-average grant date fair value of the restricted stock awards for the year ended December 31, 2016: Restricted Stock Units The Company issues restricted stock units to directors and certain employees, which typically vest on the first anniversary of the grant date (for directors) and in equal annual increments over three to four years beginning on the first anniversary of the date of grant (for employees). The grant date fair value of the restricted stock units is based on the quoted fair market value of our common stock at the award date. The weighted-average grant date fair value of restricted stock units granted during the years ended 2016, 2015 and 2014 was $51.75, $38.42 and $31.30, respectively. The total fair value of restricted stock units vested was $18.3 million, $10.5 million and $5.1 million in 2016, 2015 and 2014, respectively. The following table presents the number and weighted-average grant date fair value of the restricted stock units for the year ended December 31, 2016: Stock Options The Company grants stock options to certain key employees. The stock options vest in 25% annual increments beginning on the first anniversary of the date of grant, subject to the participant’s continued service through each such vesting date. All stock options are nonqualified stock options and expire on the tenth anniversary of the grant date. During the year ended December 31, 2014, under the terms of the Mercury transaction agreement, the Company replaced unvested employee stock options held by certain employees of Mercury. The number of replacement stock options was based on a conversion factor into equivalent stock options of the Company on the acquisition date. The weighted average fair value of the replacement options was calculated on the acquisition date using the Black-Scholes option pricing model. The replacement stock options typically vest over four and a half years with 22.22% of the awards vesting after one year and the remainder in quarterly increments, subject to the participant’s continued service through each such vesting date. Per the applicable option agreement, if a participant is terminated without cause within the prescribed acceleration period (which range Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) from 12 to 24 months following the acquisition), then such replacement options shall immediately become fully vested and exercisable at the time of such termination to the extent not then vested and not previously cancelled. The replacement options are nonqualified stock options and expire on the tenth anniversary of the original grant date. See Note 2 - Business Combinations for additional details. The following table summarizes stock option activity for the year ended December 31, 2016: For the years ended December 31, 2016, 2015, and 2014 the total aggregate intrinsic value of options exercised was $18.4 million, $17.5 million, and $4.4 million, respectively. The weighted-average grant date fair value was estimated by the Company using the Black-Scholes option pricing model with the assumptions below: The expected option life represents the period of time the stock options are expected to be outstanding and is based on the “simplified method” allowed under SEC guidance. The Company used the “simplified method” due to the lack of sufficient historical exercise data to provide a reasonable basis upon which to otherwise estimate the expected life of the stock options. Since the Company’s publicly traded stock history is relatively short, expected volatility is based on the Company’s historical volatility and the historical volatility of a group of peer companies. The Company does not intend to pay cash dividends in the foreseeable future. Consequently, the Company used an expected dividend yield of zero. The risk-free interest rate was based on the U.S. Treasury yield curve in effect at the time of the grant. Performance Share Units The Company issues performance share units to certain employees subject to the achievement of certain financial performance measures. These performance share units vest on the third anniversary of the grant date. Participants have the right to earn 0% to 200% of the target number of shares of the Company’s Class A common stock, determined by the level of achievement of the financial performance measures during the three year performance period. In 2015 the Company also issued performance share units to certain employees subject to the achievement of certain financial and non-financial performance measures through 2018. Additionally, associated with an acquisition in 2013, the Company issued performance share units to certain employees subject to the achievement of certain financial and non-financial performance measures through 2016. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The grant date fair value of the performance share units is based on the quoted fair market value of our common stock on the grant date. For the years ended December 31, 2016, 2015 and 2014, the weighted-average grant date fair value of performance share units granted was $50.04, $39.16, and $31.02, respectively, and the total fair value of performance share units vested was $17.1 million, $1.2 million, and $2.0 million, respectively. The following table presents the number and weighted-average grant date fair value of the performance share units for the year ended December 31, 2016: The share-based compensation expense related to the performance share units granted in 2014 ("2014 PSUs") was initially estimated based on target performance and was adjusted as appropriate throughout the performance period based on the shares expected to be earned at that time. The 2014 PSUs are included in the table above as non-vested at December 31, 2016 at target, or 100%. On January 30, 2017, the Compensation Committee of the Company’s Board of Directors certified the achievement of the performance goals for the 2014 PSUs, which had a performance period of January 1, 2014 to December 31, 2016, at the maximum 200% of the target number of shares (150,739 shares incremental to those included in the table above for the 2014 PSUs). Employee Share Purchase Plan In 2016 the Company began offering an Employee Stock Purchase Plan (“ESPP”). The ESPP has 2.5 million shares of common stock reserved for issuance. Full-time and benefits-eligible part-time employees who have completed at least one year of service are eligible to participate. Temporary, seasonal and employees subject to Section 16 reporting are excluded. Shares may be purchased at 85% of the market value at the end of the offering period through accumulation of payroll deductions. The ESPP provides for six month offerings commencing on January 1 and July 1 of each year with purchases on June 30 and December 31 of each year. For the year ended December 31, 2016, the expense related to the ESPP’s 15% discount is included in total share-based compensation expense disclosed below. For the years ended December 31, 2016, 2015 and 2014, total share-based compensation expense was $35.9 million, $30.5 million and $42.2 million, respectively. Related tax benefits recorded in the accompanying consolidated statements of income totaled $10.9 million in 2016, $8.8 million in 2015 and $12.9 million in 2014. At December 31, 2016, there was approximately $57.9 million of unrecognized share-based compensation expense, which is expected to be recognized over a remaining weighted-average period of approximately 2.4 years. 14. INCOME TAXES In accordance with ASC Topic 740, Income Taxes, income taxes are recognized for the amount of taxes payable for the current year and for the impact of deferred tax liabilities and assets, which represent future tax consequences of events that have been recognized differently in the financial statements than for tax purposes. Deferred tax assets and liabilities are established using the enacted statutory tax rates and are adjusted for any changes in such rates in the period of change. Vantiv, Inc. is taxed as a C Corporation, which is subject to both federal and state taxation at a corporate level. Therefore, tax expense and deferred tax assets and liabilities reflect such status. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following is a summary of applicable income taxes (in thousands): A reconciliation of the U.S. income tax rate and the Company’s effective tax rate for all periods is provided below: Deferred income tax assets and liabilities are comprised of the following as of December 31, 2016 and 2015 (in thousands): As part of the acquisitions of NPC Group, Inc. (“NPC”) and Mercury, the Company acquired federal and state tax loss carryforwards. As of December 31, 2016, the cumulative federal and state tax loss carryforwards were approximately $38.0 million and $16.9 million, respectively. Federal tax loss carryforwards will expire in 2030 and state tax loss carryforwards will expire between 2020 and 2035. The partnership basis included in the above table is the result of a difference between the tax basis and book basis of Vantiv, Inc.’s investment in Vantiv Holding. Vantiv Holding, a partnership for tax purposes, has an Internal Revenue Code election in place to adjust the tax basis of partnership property to fair market value related to the portion of the partnership Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) interest transferred, through an exchange of units of Vantiv Holding by its members. Included in partnership basis in the table above are deferred tax assets resulting from the increase in tax basis generated by the exchange of units of Vantiv Holding in connection with the IPO and subsequent secondary offerings. See Note 7 - Tax Receivable Agreements for discussion of deferred tax assets as a result of the secondary offerings and exchange of units of Vantiv Holding. Deferred tax assets are reviewed to determine whether the available evidence allows the Company to recognize the tax benefits. To the extent that a tax asset is not expected to be realized, the Company records a valuation allowance against the deferred tax assets. The Company has recorded no valuation allowance during the years ended December 31, 2016 or 2015. A provision for federal, state and local income taxes has been recorded on the statements of income for the amounts of such taxes the Company is obligated to pay or amounts refundable to the Company. At December 31, 2016 and 2015, the Company recorded an income tax receivable of approximately $8.3 million and $53.2 million, respectively, which is included in other current assets on the Company’s consolidated statements of financial position. The Company accounts for uncertainty in income taxes under ASC 740, Income Taxes. As of December 31, 2016 and 2015, the Company had no material uncertain tax positions. If a future liability does arise related to uncertainty in income taxes, the Company has elected an accounting policy to classify interest and penalties, if any, as income tax expense. 15. FAIR VALUE MEASUREMENTS Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses the hierarchy prescribed in ASC 820, Fair Value Measurement, based upon the available inputs to the valuation and the degree to which they are observable or not observable in the market. The three levels in the hierarchy are as follows: • Level 1 Inputs-Quoted prices (unadjusted) for identical assets or liabilities in active markets that are accessible as of the measurement date. • Level 2 Inputs-Inputs other than quoted prices within Level 1 that are observable either directly or indirectly, including but not limited to quoted prices in markets that are not active, quoted prices in active markets for similar assets or liabilities and observable inputs other than quoted prices such as interest rates or yield curves. • Level 3 Inputs-Unobservable inputs reflecting the Company’s own assumptions about the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. The following table summarizes assets and liabilities measured at fair value on a recurring basis as of December 31, 2016 and 2015 (in thousands): Interest Rate Contracts The Company uses interest rate contracts to manage interest rate risk. The fair value of interest rate swaps is determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves. The fair value of the interest rate caps is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected future cash flows of each interest rate cap. This analysis reflects the contractual terms of the interest rate caps, including the period to maturity, and uses observable market inputs including interest rate curves and implied volatilities. In addition, to comply with Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) the provisions of ASC 820, Fair Value Measurement, credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, are incorporated in the fair values to account for potential nonperformance risk. In adjusting the fair value of its interest rate contracts for the effect of nonperformance risk, the Company has considered any applicable credit enhancements such as collateral postings, thresholds, mutual puts, and guarantees. Although the Company determined that the majority of the inputs used to value its interest rate contracts fell within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its interest rate contracts utilized Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2016 and 2015, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its interest rate contracts and determined that the credit valuation adjustment was not significant to the overall valuation of its interest rate contracts. As a result, the Company classified its interest rate contract valuations in Level 2 of the fair value hierarchy. See Note 8 - Derivatives and Hedging Activities for further discussion of the Company’s interest rate contracts. Mercury TRA The Mercury TRA is considered contingent consideration as it is part of the consideration payable to the former owners of Mercury. Such contingent consideration is measured at fair value and is based on significant inputs not observable in the market, which is classified in Level 3 of the fair value hierarchy. The Mercury TRA is recorded at fair value based on estimates of discounted future cash flows associated with the estimated payments to the Mercury TRA Holders. The significant unobservable input used in the fair value measurement of the Mercury TRA is the discount rate, which was approximately 14% as of December 31, 2016 and 2015. Any significant increase (decrease) in this input would result in a significantly lower (higher) fair value measurement. The liability recorded is re-measured at fair value at each reporting period with the change in fair value recognized in earnings as a non-operating expense. The change in value of the Mercury TRA from December 31, 2015 to December 31, 2016 consists of the increase in fair value of $19.5 million and the decrease from payments of $63.6 million related to the Mercury TRA obligations and the exercised call option. The Company recorded non-operating expenses of $19.5 million and $28.9 million related to the change in fair value during the years ended December 31, 2016 and 2015, respectively. See Note 7 - Tax Receivable Agreements for further discussion of the Mercury TRA including the roll forward of the fair value. The following table summarizes carrying amounts and estimated fair values for the Company’s financial instrument liabilities that are not reported at fair value in our consolidated statements of financial position as of December 31, 2016 and 2015 (in thousands): We consider that the carrying value of cash and cash equivalents, receivables, accounts payable and accrued expenses approximates fair value (level 1) given the short-term nature of these items. The fair value of the Company’s note payable was estimated based on rates currently available to the Company for bank loans with similar terms and maturities and is classified in Level 2 of the fair value hierarchy. 16. NET INCOME PER SHARE Basic net income per share is calculated by dividing net income attributable to Vantiv, Inc. by the weighted-average shares of Class A common stock outstanding during the period. Diluted net income per share is calculated assuming that Vantiv Holding is a wholly-owned subsidiary of Vantiv, Inc., therefore eliminating the impact of Fifth Third’s non-controlling interest. Pursuant to the Exchange Agreement, the Class B units of Vantiv Holding (“Class B units”), which are held by Fifth Third and represent the non-controlling interest in Vantiv Holding, are convertible into shares of Class A common stock on a one-for-one basis. Based on this conversion feature, diluted net income per share is calculated assuming the conversion of the Class B units on an “if-converted” basis. Due to the Company’s structure as a C corporation and Vantiv Holding’s structure as a pass-through entity for tax purposes, the numerator in the calculation of diluted net income per share is adjusted accordingly to reflect the Company’s income tax expense assuming the conversion of the Fifth Third non-controlling interest into Class A common stock. During the year ended Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) December 31, 2016, approximately 35.0 million weighted-average Class B units of Vantiv Holding were excluded in computing diluted net income per share because including them would have had an antidilutive effect. As the Class B units of Vantiv Holding were not included, the numerator used in the calculation of diluted net income per share was equal to the numerator used in the calculation of basic net income per share for the year ended December 31, 2016. The adjusted effective tax rate used in the calculation was 36.0% for the years ended December 31, 2016 and 2015 and 36.5% for the year ended December 31, 2014. As of December 31, 2016 and 2015 there were approximately 35.0 million Class B units outstanding, respectively, and 43.0 million outstanding as of December 31, 2014. In addition to the Class B units discussed above, potentially dilutive securities during the years ended December 31, 2016, 2015 and 2014 included restricted stock awards, restricted stock units, the warrant held by Fifth Third which allows for the purchase of Class C units of Vantiv Holding, stock options, performance awards and ESPP purchase rights. During the year ended December 31, 2016, 2015 and 2014, approximately 660,204, 472,518 and 508,097, respectively, performance awards have been excluded as the applicable performance metrics had not been met as of the reporting dates. The shares of Class B common stock do not share in the earnings or losses of the Company and are therefore not participating securities. Accordingly, basic and diluted net income per share of Class B common stock have not been presented. The following table sets forth the computation of basic and diluted net income per share (in thousands, except share data): Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 17. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The activity of the components of accumulated other comprehensive income (loss) related to cash flow hedging and other activities for the years ended December 31, 2016, 2015 and 2014 is presented below (in thousands): (a) The reclassification adjustment on cash flow hedge derivatives affected the following lines in the accompanying consolidated statements of income: OCI Component Affected line in the accompanying consolidated statements of income Pretax activity(1) Interest expense-net Tax effect Income tax expense OCI attributable to non-controlling interests Net income attributable to non-controlling interests (1) The years ended December 31, 2016, 2015 and 2014, reflect amounts of losses reclassified from AOCI into earnings, representing the effective portion of the hedging relationships, and are recorded in interest expense-net. 18. RELATED PARTY TRANSACTIONS In connection with the Company’s separation from Fifth Third on June 30, 2009, the Company entered into various agreements which provide for services provided to or received from Fifth Third. Subsequent to the separation from Fifth Third, the Company continues to enter into various business agreements with Fifth Third. Transactions under these agreements are discussed below and throughout these notes to the accompanying consolidated financial statements. As discussed in Note 1 - Basis of Presentation and Summary of Significant Accounting Policies, Fifth Third currently holds 35,042,826 shares of Class B common stock representing 17.9% of the voting interests in Vantiv, Inc. and 35,042,826 Class B units of Vantiv Holding representing a 17.9% ownership interest in Vantiv Holding. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Debt Agreements As discussed in Note 6 - Long-Term Debt, the Company had certain debt arrangements outstanding and available from Fifth Third. For the years ended December 31, 2016, 2015 and 2014, interest expense associated with these arrangements was $4.2 million, $4.4 million and $5.4 million, respectively, and commitment fees were $0.1 million, $0.2 million and $0.2 million, respectively. Lease Agreement The Company leases or subleases a number of office and/or data center locations with Fifth Third. Related party rent expense was approximately $3.7 million for the year ended December 31, 2016 and $3.8 million for the years ended December 31, 2015 and 2014. Service Processing and Other Service Agreements In July 2016, the Company amended and extended its Master Services Agreement with Fifth Third (the “EFT Service Agreement”), expiring in June 2019, through December 2024. The EFT Service Agreement is exclusive and provides Fifth Third and its subsidiary depository institutions with various electronic fund transfer, or EFT, services including debit card processing and ATM terminal driving services. Revenue for the EFT Service Agreement and other services is in the related party revenues line on the Company’s consolidated statement of income. Referral Agreement In July 2016, the Company amended and extended its exclusive referral arrangement with Fifth Third, expiring in June 2019, through December 2024. Commercial and retail merchant clients of Fifth Third and its subsidiary depository institutions that request merchant (credit or debit card) acceptance services are referred exclusively to us. In return for these referrals and the resulting merchant relationships, we make ongoing incentive payments to Fifth Third. Costs associated with this agreement totaled $0.7 million, $0.3 million and $0.3 million for the years ended December 31, 2016, 2015 and 2014, respectively. Clearing, Settlement and Sponsorship Agreement and Treasury Management Agreement As discussed in Note 1 - Basis of Presentation and Summary of Significant Accounting Policies, Fifth Third is a member of the Visa, Mastercard and other payment network associations. Fifth Third is the Company’s primary sponsor into the respective card associations. In July 2016, the Company amended and extended its agreement with Fifth Third, expiring in June 2019, through December 2024. Fifth Third also provides access to certain cash and treasury management services to the Company. For the years ended December 31, 2016, 2015 and 2014, the Company paid Fifth Third approximately $2.9 million, $2.3 million and $2.8 million, respectively, for these services. As discussed in Note 1 - Basis of Presentation and Summary of Significant Accounting Policies, the Company holds certain cash and cash equivalents on deposit at Fifth Third. At December 31, 2016 and 2015, approximately $90.5 million and $149.7 million, respectively, was held on deposit at Fifth Third. Interest income on deposits held at Fifth Third during the year ended December 31, 2014 was approximately $1.7 million. The interest income on such amounts during 2016 and 2015 was immaterial. Other Non-material Services The Company continues to receive certain other non-material services from Fifth Third. The total expense for other services provided by Fifth Third for the years ended December 31, 2016, 2015 and 2014 was $0.3 million, $0.4 million and $0.5 million, respectively. 19. SEGMENT INFORMATION The Company’s segments consist of the Merchant Services segment and the Financial Institution Services segment, which are organized by the products and services the Company provides. The Company’s Chief Executive Officer (“CEO”), who is the chief operating decision maker (“CODM”), evaluates the performance and allocates resources based on the operating results of each segment. The Company’s reportable segments are the same as the Company’s operating segments and there is no aggregation of the Company’s operating segments. Below is a summary of each segment: Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) • Merchant Services-Provides merchant acquiring and payment processing services to large national merchants, regional and small-to-mid sized businesses. Merchant services are sold to small to large businesses through diverse distribution channels. Merchant Services includes all aspects of card processing including authorization and settlement, customer service, chargeback and retrieval processing and interchange management. • Financial Institution Services-Provides card issuer processing, payment network processing, fraud protection, card production, prepaid program management, ATM driving and network gateway and switching services that utilize the Company’s proprietary Jeanie debit payment network to a diverse set of financial institutions, including regional banks, community banks, credit unions and regional personal identification number (“PIN”) networks. Financial Institution Services also provides statement production, collections and inbound/outbound call centers for credit transactions, and other services such as credit card portfolio analytics, program strategy and support, fraud and security management and chargeback and dispute services. Segment operating results are presented below (in thousands). The results reflect revenues and expenses directly related to each segment. The Company does not evaluate performance or allocate resources based on segment asset data, and therefore such information is not presented. Segment profit reflects total revenue less network fees and other costs and sales and marketing costs of the segment. The Company’s CODM evaluates this metric in analyzing the results of operations for each segment. Vantiv, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) A reconciliation of total segment profit to the Company’s income before applicable income taxes is as follows (in thousands): 20. QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED) The following table sets forth our unaudited results of operations on a quarterly basis for the years ended December 31, 2016 and 2015. Our results of operations are subject to seasonal fluctuations in our revenue as a result of consumer spending patterns. Historically our revenues have been the strongest in the fourth quarter and weakest in our first quarter. * * * * * | Based on the provided text, here's a summary of the financial statement:
Revenue Recognition:
- Revenue is recognized when earned, particularly for transaction-based fees
- Contractual agreements with clients define pricing, payment terms, and contract duration
Segment Reporting:
- The Company's Chief Operating Decision Maker (CODM) evaluates segment performance
- Segment profit is reconciled to income before taxes
Sponsorship:
- Has an agreement with Fifth Third Bank for payment network sponsorship services through December 31st
Financial Instruments:
- Uses interest rate swaps and caps as cash flow hedges
- Derivatives are recognized at fair value in assets or liabilities
Accounting Approach:
- Uses estimates for financial statement preparation
- Actual results may differ from estimated amounts
Ownership Structure:
- Includes non-controlling interests presented as a component of equity
- Net income calculations account for non-controlling interests | Claude |
. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS BRIDGEPOINT EDUCATION, INC. AND SUBSIDIARIES Report of Independent Registered Public Accounting Firm, Deloitte & Touche LLP Report of Independent Registered Public Accounting Firm, PricewaterhouseCoopers LLP Consolidated Balance Sheets Consolidated Statements of Income (Loss) Consolidated Statements of Comprehensive Income (Loss) Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Annual Consolidated Financial Statements Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Bridgepoint Education, Inc. We have audited the accompanying consolidated balance sheet of Bridgepoint Education, Inc. and subsidiaries (the “Company”) as of December 31, 2016, and the related consolidated statements of income (loss), comprehensive income (loss), stockholders' equity, and cash flows for the year ended December 31, 2016. We also have audited the Company's internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bridgepoint Education, Inc. and subsidiaries as of December 31, 2016, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. /s/ DELOITTE & TOUCHE LLP San Diego, California March 7, 2017 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Bridgepoint Education, Inc. In our opinion, the consolidated balance sheet as of December 31, 2015 and the related consolidated statements of income, of comprehensive income, of stockholders' equity and of cash flows for each of the two years in the period ended December 31, 2015 present fairly, in all material respects, the financial position of Bridgepoint Education, Inc. and its subsidiaries as of December 31, 2015, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP Los Angeles, California March 8, 2016, except for the change in the manner in which the Company presents restricted cash on the statement of cash flows as discussed in Note 2 to the consolidated financial statements, as to which the date is March 7, 2017 BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) BRIDGEPOINT EDUCATION, INC. Consolidated Balance Sheets (In thousands, except par value) The accompanying notes are an integral part of these consolidated financial statements. BRIDGEPOINT EDUCATION, INC. Consolidated Statements of Income (Loss) (In thousands, except per share amounts) The accompanying notes are an integral part of these consolidated financial statements. BRIDGEPOINT EDUCATION, INC. Consolidated Statements of Comprehensive Income (Loss) (In thousands) The accompanying notes are an integral part of these consolidated financial statements. BRIDGEPOINT EDUCATION, INC. Consolidated Statements of Stockholders' Equity (In thousands) The accompanying notes are an integral part of these consolidated financial statements. BRIDGEPOINT EDUCATION, INC. Consolidated Statements of Cash Flows (In thousands) The accompanying notes are an integral part of these consolidated financial statements. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements 1. Nature of Business Bridgepoint Education, Inc. (together with its subsidiaries, the “Company”), incorporated in 1999, is a provider of postsecondary education services. Its wholly-owned subsidiaries, Ashford University® and University of the RockiesSM, are regionally accredited academic institutions. Ashford University offers associate’s, bachelor’s and master’s programs, and University of the Rockies offers master’s and doctoral programs. 2. Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of Bridgepoint Education, Inc. and its wholly-owned subsidiaries. Intercompany transactions have been eliminated in consolidation. Use of Estimates The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements. Actual results could differ from those estimates. Reclassifications Certain reclassifications have been made to the prior years’ financial statements to conform to the current year presentation. During 2016, the Company adopted Accounting Standards Update (“ASU”) 2016-18, Statement of Cash Flows (Topic 230) and has reclassified certain restricted cash amounts for the years ended December 31, 2015 and 2014 within the consolidated statements of cash flows. Additionally, the accounts payable and accrued liabilities are now presented on a combined basis within the consolidated balance sheets and related footnotes and the Company has reclassified these amounts for the years ended December 31, 2015 and 2014. These reclassifications had no effect on previously reported results of operations or retained earnings. Cash, Cash Equivalents and Restricted Cash Cash and cash equivalents is comprised of cash and other short-term highly liquid investments that are readily convertible into known amounts of cash. The Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents. The Company's restricted cash is primarily held in money market accounts, and is excluded from cash and cash equivalents on the Company's consolidated balance sheets. The majority of restricted cash represents funds held for students from Title IV financial aid programs that result in credit balances on a student’s account or funds held for students to be refunded in connection with a legal settlement. To a lesser extent, restricted cash also represents amounts held as collateral for letters of credit. The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the consolidated balance sheets that sum to the total of the same such amounts shown in the statement of cash flows. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Investments As of December 31, 2016, the Company held investments that consisted of mutual funds, corporate notes and bonds and certificates of deposit. The Company's investments are denominated in U.S. dollars, are investment grade and are readily marketable. The Company considers as current assets those investments which will mature or are likely to be sold in less than one year. The Company classifies its investments as either trading, available-for-sale or held-to-maturity. Trading securities are those bought and held principally to sell in the short-term, with gains or losses from changes in fair value flowing through current earnings. Available-for-sale securities are carried at fair value as determined by quoted market prices, with unrealized gains and losses, net of tax, reported as a separate component of comprehensive income (loss) and stockholders’ equity. Held-to-maturity securities would be carried at amortized cost. Amortization of premiums, accretion of discounts, interest, and realized gains and losses are included in other income, net in the consolidated statement of income (loss). The Company regularly monitors and evaluates the realizable value of its investments. If events and circumstances indicate that a decline in the value of these assets has occurred and is other-than-temporary, the Company would record a charge to other income, net in the consolidated statements of income (loss). Deferred Compensation The Company has a deferred compensation plan, into which certain members of management are eligible to defer a maximum of 80% of their regular compensation and a maximum of 100% of their incentive compensation. The amounts deferred by the participant under this plan are credited with earnings or losses based upon changes in values of participant elected notional investments. Each participant is fully vested in the participant amounts deferred. The Company may make contributions that will generally vest according to a four-year vesting schedule. After four years of service, participants become 100% vested in the employer contributions upon reaching normal retirement age, death, disability or a change in control. The Company's obligations under the deferred compensation plan totaled $1.3 million and $1.2 million as of December 31, 2016 and 2015, respectively, and are included in other long-term liabilities in the consolidated balance sheets. Fair Value Measurements The Company uses the three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: (i) Level 1, defined as observable inputs such as quoted prices in active markets; (ii) Level 2, defined as inputs other than quoted prices in active markets that are either observable directly or indirectly, through market corroboration, for substantially the full term of the financial instrument; and (iii) Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable consists of student accounts receivable, which represent amounts due for tuition, course digital materials, technology fees and other fees from currently enrolled and former students. Students generally fund their education through grants and/or loans under various Title IV programs, tuition assistance from military and corporate employers or personal funds. Except for those students under conditional admission, payments are due on the respective course start date and are considered past due dependent upon the student's payment terms. In general, an account is considered delinquent 120 days subsequent to the course start date. Accounts receivable are stated at the amount management expects to collect from outstanding balances. For accounts receivable, an allowance for doubtful accounts is estimated by management and is principally based on historical collection experience as well as (i) an assessment of individual accounts receivable over a specific aging and amount, (ii) consideration of the nature of the receivable accounts and (iii) potential changes in the business or economic environment. The provision for bad debt is recorded within instructional costs and services in the consolidated statements of income (loss). The Company writes off uncollectable accounts receivable when the student account is deemed uncollectable by internal collection efforts or by a third-party collection agency. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Student Loans Receivable and Loan Loss Reserves In accordance with the terms of the settlement reached between the Company and the Consumer Financial Protection Bureau in September 2016, all existing student loans receivable were written off during the third quarter of 2016. For additional information regarding the settlement, refer to Note 21, “Commitments and Contingencies.” Historically, student loans receivable consisted of loans to qualified students and have a repayment period of 10 years from the date of graduation or withdrawal from the Company's institutions. The interest rate charged on student loans was a fixed rate of either 4.5% or 0.0% depending upon the repayment plan selected. If the student selected the rate of 0.0%, the student must pay $50 per month on the loan while enrolled in school and during the six months of grace period (after graduation or withdrawal) before the repayment period begins. On the 0.0% student loans, the Company imputed the interest using the rate that would be used in a market transaction with similar terms. Interest income on student loans was recognized using the effective interest method and is recorded within other income in the consolidated statements of income (loss). Before being written off, student loans receivable were stated at the amount management expected to collect from outstanding balances. For tuition related student loan receivables, the Company had estimated an allowance for doubtful accounts, similar to that of accounts receivable, based on (i) an assessment of individual loans receivable over a specific aging and amount, (ii) consideration of the nature of the receivable accounts, (iii) potential changes in the business or economic environment and (iv) related FICO scores and other industry metrics. The related provision for bad debts is recorded within instructional costs and services in the consolidated statements of income (loss). For non-tuition related student loans, the Company utilized an impairment methodology, under which management determined whether a loan would be impaired if unable to collect all amounts due in accordance with the contractual terms of the individual loan agreement. This assessment was based on an analysis of several factors, including aging history and delinquency trending, the risk characteristics, credit quality and loan performance of the specific loans, and current economic conditions and industry trends. Credit quality was assessed at the outset of a loan, based upon the applicant's FICO score during the loan application process. The Company considered loans to be impaired when they reach a delinquency status that requires specialized collection efforts. The Company defined delinquency for loans as those students whose last activity was more than 120 days old. The Company records a loss reserve for the full book value of the impaired loans. For the years ended December 31, 2016, and 2015 there was $0.2 million and $1.3 million recorded for loan loss reserves, respectively. The loan loss reserve was maintained at a level deemed adequate by management based on a periodic analysis of the individual loans and is recorded within instructional costs and services in the consolidated statements of income (loss). Property and Equipment Property and equipment are recognized at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on estimated useful lives of the related assets as follows: Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful lives of the assets. Upon the retirement or disposition of property and equipment, the related cost and accumulated depreciation is removed and a gain or loss is recorded in the consolidated statements of income (loss). Repairs and maintenance costs are expensed in the period incurred. Leases Leases are evaluated and classified as either operating or capital leases. Leased property and equipment meeting certain criteria would be capitalized, and the present value of the related lease payments is recognized as a liability on the consolidated balance sheets. Amortization of capitalized leased assets is computed on the straight-line method over the term of the lease or the life of the related asset, whichever is shorter. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) If the Company receives tenant allowances from the lessor for certain improvements made to the leased property, these allowances are capitalized as leasehold improvements and a long-term liability is established. The long-term liability is amortized on a straight-line basis over the corresponding lease term. The Company records rent expense on a straight-line basis over the initial term of a lease. The difference between the rent payment and the straight-line rent expense is recorded as either a short-term or long-term liability. The Company recognizes liabilities for exit and disposal activities on non-cancelable lease obligations at fair value in the period the liability is incurred. For the non-cancelable lease obligations, the Company records the obligation when the contract is terminated. Impairment of Long-Lived Assets The Company assesses potential impairment to its long-lived assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss is recorded if the carrying amount of the long-lived asset is not recoverable. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Any required impairment loss is measured as the amount by which the carrying amount of a long-lived asset exceeds fair value and is recorded as a reduction in the carrying value of the related asset and an expense to operating results. Goodwill and Other Intangible Assets The Company tests goodwill and indefinite-lived intangible assets for impairment annually in the fourth quarter of each fiscal year, or more frequently if events and circumstances warrant. The Company adopted accounting guidance which simplifies how an entity tests goodwill for impairment. The Company first assesses qualitative factors, such as deterioration in general economic conditions or negative company financial performance, to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. The Company's assessment of goodwill during the fourth quarter of fiscal 2016 indicated that it was not more likely than not that the fair value of a reporting unit is less than its carrying amount, and therefore, goodwill was not impaired. There have been no related impairment losses recognized by the Company for any periods presented. If negative qualitative indicators had been noted above, the Company would then need to assess the fair value of its reporting unit to determine whether they were in excess of the carrying values. To evaluate the impairment of the indefinite-lived intangible assets, the Company assessed the fair value of the assets to determine whether they were in excess of the carrying values. Determining the fair value of indefinite-lived intangible asset is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions are inherently uncertain, and may include such items as growth rates used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions, and a determination of appropriate market comparables. The Company's assessment of indefinite-lived intangible assets during the fourth quarter of fiscal 2016 did not result in any impairment. There have been no impairment losses for indefinite-lived intangibles recognized by the Company for any periods presented. The Company also has definite-lived intangible assets, which primarily consist of purchased intangibles and capitalized curriculum development costs. The definite-lived intangible assets are recognized at cost less accumulated amortization. Amortization is computed using the straight-line method based on estimated useful lives of the related assets. Revenue and Deferred Revenue The Company recognizes revenue when persuasive evidence of an arrangement exists, services have been rendered or delivery has occurred, its fees or price is fixed or determinable, and collectibility is reasonably assured. The Company's revenue consists of tuition, technology fees, course digital materials and other miscellaneous fees. Tuition revenue is deferred and recognized on a straight-line basis over the applicable period of instruction net of scholarships and expected refunds, with the exception of an online student's first course per degree level at Ashford University. An online student's first course per degree level at Ashford University falls under a three-week conditional admission period in which the revenue is deferred until the student matriculates into the course. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) The Company's institutions' online students generally enroll in a program that encompasses a series of five to six-week courses that are taken consecutively over the length of the program. With the exception of those students under conditional admission, the online students are billed on a payment period basis on the first day of class. Students under conditional admission are billed for the payment period upon matriculation. The Company assesses collectibility at the start of a student’s payment period for the courses in that payment period, as well as throughout the period as facts and circumstances change. If a student's attendance in a class precedes the receipt of cash from the student's source of funding, the Company establishes an account receivable and corresponding deferred revenue in the amount of the tuition due for that payment period. Cash received either directly from the student or from the student's source of funding reduces the balance of accounts receivable due from the student. Financial aid from sources such as the federal government's Title IV programs pertains to the online student's award year and is generally divided into two disbursement periods. As such, each disbursement period may contain funding for up to four courses. Financial aid disbursements are typically received during the online student's attendance in the first or second course. Since the majority of disbursements cover more courses than for which a student is currently enrolled, the amount received in excess effectively represents a prepayment from the online student for up to four courses. At the end of each accounting period, the deferred revenue and student deposits and related account receivable balances are reduced to present amounts attributable to the current course. Students under conditional admission are not obligated for payment until after their conditional admission period has lapsed, so there is no related refund. For all subsequent courses, the Company records a provision for expected refunds and reduces revenue for the amount that is expected to be subsequently refunded. Provisions for expected refunds have not been material to any period presented. If a student withdraws from a program prior to a specified date, a portion of such student's tuition is refunded, subject to certain state requirements. The Company reassess collectibility throughout the period revenue is recognized by the Company's institutions, on a student-by-student basis. The Company reassesses collectibility based upon new information and changes in facts and circumstances relevant to a student's ability to pay. For example, the Company reassesses collectibility when a student drops from the institution (i.e., is no longer enrolled) and when a student attends a course that was not included in the initial assessment of collectibility at the start of a student’s payment period. In certain cases, the Company's institutions provide scholarships to students for various programs. Scholarships issued by the universities are recorded in association with the related specific course, term or payment period. Scholarships are generally deferred and recognized against revenue over the course term. Incentive-based scholarships, such as the Leadership Development Grant (“LDG”) and Alumni Scholarship are recognized against revenue over the period of benefit to the student. Ashford University records revenue from technology fee on a per course charge basis. The per course technology fee revenue for Ashford University is recognized on a straight-line basis over the applicable period of instruction. University of the Rockies records revenue from technology fees as one-time start up fees charged to each new online student (other than military, scholarship students or certain corporate reimbursement students), and then recognizes that revenue ratably over the average expected enrollment of a student. The average expected enrollment of the student was estimated each quarter based upon historical duration of attendance and qualitative factors as deemed necessary. Other miscellaneous fees include fees for course content and textbooks and other services, such as commencements, and are recognized upon delivery of the goods or when the related service is performed. Workers Compensation The Company records a gross liability for estimated workers compensation claims, incurred but not yet reported, as of each balance sheet date. The Company also records the gross insurance recoverable due for individual claim amounts. This is recorded as an other asset and as an equal accrued liability. The stop-loss premium is determined annually, but invoiced and paid on a quarterly basis. The related insurance premiums are expensed ratably over the coverage period. Income Taxes The Company accounts for its income taxes using the asset-liability method whereby deferred tax assets and liabilities are determined based on temporary differences between the bases used for financial reporting and income tax reporting purposes. Deferred income taxes are provided based on the enacted tax rates expected to be in effect at the time such temporary BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) differences are expected to reverse. A valuation allowance is provided for deferred tax assets if it is more-likely-than-not that the Company will not realize those tax assets through future operations. The Company evaluates and accounts for uncertain tax positions using a two-step approach. Recognition (step one) occurs when the Company concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) determines the amount of benefit that is greater than 50% likely to be realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. Derecognition of a tax position that was previously recognized would occur when the Company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. Stock-Based Compensation Stock-based compensation expense is measured at the grant date fair value of the award and is expensed over the vesting period. The Company estimates the fair value of stock options on the grant date using the Black-Scholes option pricing model. The Company estimates the fair value of its performance stock units (“PSUs”) on the grant date using a Monte Carlo simulation model. Determining the fair value of stock-based awards at the grant date under these models requires judgment, including estimating volatility, employee stock option exercise behaviors and forfeiture rates. The assumptions used in calculating the fair value of stock-based awards represent the Company's best estimates, but these estimates involve inherent uncertainties and the application of management judgment. The fair value of the Company's restricted stock units (“RSUs”) is based on the market price of the Company's common stock on the date of grant. The amount of stock-based compensation expense recognized during a period is based on the portion of the awards that are ultimately expected to vest. The Company estimates award forfeitures at the time of grant and revises those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company's equity incentive plans require that stock option awards have an exercise price that equals or exceeds the closing price of the Company's common stock on the date of grant. Stock-based compensation expense for stock-based awards is recorded in the consolidated statement of income (loss), net of estimated forfeitures, using the graded-vesting method over the requisite service periods of the respective stock awards. The requisite service period is generally the period over which an employee is required to provide service to the Company in exchange for the award. Instructional Costs and Services Instructional costs and services consist primarily of costs related to the administration and delivery of the Company's educational programs. These expenses include compensation for faculty and administrative personnel, curriculum and new program development costs, financial aid processing costs, technology license costs, bad debt expense and costs associated with other support groups that provide services directly to the students. Instructional costs and services also include an allocation of information technology, facility, depreciation and amortization costs. Admissions Advisory and Marketing Admissions advisory and marketing costs include compensation of personnel engaged in marketing and recruitment, as well as costs associated with purchasing leads and producing marketing materials. Such costs are generally affected by the cost of advertising media and leads, the efficiency of the Company's marketing and recruiting efforts, compensation for the Company's enrollment personnel and expenditures on advertising initiatives for new and existing academic programs. Admissions advisory and marketing costs also include an allocation of information technology, facility, depreciation and amortization costs. Advertising costs, a subset of admissions advisory and marketing costs, consists primarily of marketing leads and other branding and promotional activities. These advertising activities are expensed as incurred, or the first time the advertising takes place, depending on the type of advertising activity. Advertising costs were $83.0 million, $68.4 million and $89.0 million for the years ended December 31, 2016, 2015 and 2014, respectively. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) General and Administrative General and administrative expenses include compensation of employees engaged in corporate management, finance, human resources, compliance and other corporate functions. General and administrative expenses also include professional services fees, travel and entertainment expenses and an allocation of information technology, facility, depreciation and amortization costs. Legal Settlement Expense Legal settlement expense is primarily comprised of (i) charges related to the cost of resolution of the previously disclosed civil investigative demands and (ii) the estimate of additional amounts to resolve the previously disclosed investigative subpoenas. Restructuring and Impairment Charges Restructuring and impairment charges are primarily comprised of i) charges related to the write off of certain fixed assets and assets abandoned, ii) student transfer agreement costs, iii) severance costs related to headcount reductions made in connection with restructuring plans, iv) estimated lease losses related to facilities vacated or consolidated under restructuring plans, and v) the impairment of capitalized software costs. Earnings (Loss) Per Share Basic earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is calculated by dividing net income available to common stockholders by the sum of (i) the weighted average number of common shares outstanding during the period and (ii) potentially dilutive securities outstanding during the period, if the effect is dilutive. Potentially dilutive common shares consist of incremental shares of common stock issuable upon the exercise of the stock options and upon the settlement of RSUs and PSUs. Segment Information The Company operates in one reportable segment as a single educational delivery operation using a core infrastructure that serves the curriculum and educational delivery needs of its students regardless of geography. The Company's chief operating decision maker, its CEO and President, manages the Company's operations as a whole, and no revenue, expense or operating income information is evaluated by the chief operating decision maker on any component level. Comprehensive Income Comprehensive income consists of net income and other gains and losses affecting stockholders’ equity that, under GAAP, are excluded from net income. For the year ended December 31, 2016, such items consisted of unrealized gains and losses on investments. The following table summarizes the components of other comprehensive gain (loss) and the related tax effects for the years ended December 31, 2016, 2015 and 2014 (in thousands): The Company reclassified an immaterial amount out of other comprehensive income for the year ended December 31, 2014, relating to the net realized gain on the sale of securities. There was no such reclassification during the years ended December 31, 2016 or 2015. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Recent Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (the “FASB”) issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition. This literature is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The accounting guidance also requires additional disclosure regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 can be adopted using one of two retrospective application methods. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606), Deferral of the Effective Date, which defers the effective date of ASU 2014-09 by one year, to fiscal years beginning after December 15, 2017. The Company currently expects to adopt ASU 2014-09 and related topics in its first quarter of 2018, and is evaluating which transition approach to use. During the fourth quarter of 2016, the Company completed an initial evaluation of its existing revenue streams based upon the new standards and continues to evaluate the impact the adoption of ASU 2014-09 will have on the Company’s consolidated financial statements. The Company has not determined the effect of the update on our internal control over financial reporting, but will do so throughout the next year. Additionally, the FASB issued the following various updates affecting the guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is not yet effective. The effective dates and transition requirements are the same as those in ASC Topic 606 above. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This update relate to when another party, along with the entity, is involved in providing a good or service to a customer. ASC Topic 606, requires an entity to determine whether the nature of its promise is to provide that good or service to the customer (i.e., the entity is a principal) or to arrange for the good or service to be provided to the customer by another party (i.e., the entity is an agent). In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. This update clarifies Topic 606 with respect to (i) the identification of performance obligations and (ii) the licensing implementation guidance. The update does not change the core principle of the guidance in Topic 606. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. This update addresses narrow-scope improvements to the guidance on collectibility, noncash consideration and completed contracts at transition. The update provides a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. Then, in December 2016, the FASB issued ASU 2016-20 Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. The updates in ASU 2016-20 affect narrow aspects of the guidance issued in ASU 2014-09. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the lease commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and ASC Topic 606, Revenue from Contracts with Customers. The new lease guidance simplifies the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. Public companies should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company continues to evaluate the impact the adoption of ASU 2016-02 will have on the Company’s consolidated financial statements. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The update includes multiple provisions intended to simplify various aspects of the accounting for share-based payments. While aimed at reducing the cost and complexity of the accounting for share-based payments, the amendments are expected to significantly impact net income, EPS and the statement of cash flows. Implementation and administration may present challenges for companies with significant share-based payment activities. ASU 2016-09 is effective for public companies for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company plans to adopt this update as of January 1, 2017. The Company does not believe the adoption of ASU 2016-09 will have a material impact on the Company’s consolidated financial statements. In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The update requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The update requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. The update is effective for public companies for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early application will be permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company does not believe the adoption of ASU 2016-13 will have a material impact on the Company’s consolidated financial statements. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). The update is intended to improve financial reporting in regards to how certain transactions are classified in the statement of cash flows. This update requires that debt extinguishment costs be classified as cash outflows for financing activities and provides additional classification guidance for the statement of cash flows. The update also requires that the classification of cash receipts and payments that have aspects of more than one class of cash flows to be determined by applying specific guidance under generally accepted accounting principles. The update also requires that each separately identifiable source or use within the cash receipts and payments be classified on the basis of their nature in financing, investing or operating activities. The update is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted ASU 2016-15 as of December 31, 2016, and it did not have a material impact on the Company’s consolidated financial statements. In October 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash. The update applies to all entities that have restricted cash or restricted cash equivalents and are required to present a statement of cash flows. The update addresses diversity in practice that exists in the classification and presentation of changes in restricted cash on the statement of cash flows, and requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The update is effective for public companies for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The updates should be applied using a retrospective transition method to each period presented. The Company adopted ASU 2016-15 as of December 31, 2016, and although it changed the historical presentation on the consolidated statements of cash flows, it did not have any other material impact on the Company’s consolidated financial statements. In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The update affects all companies and other reporting organizations that must determine whether they have acquired or sold a business. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The update is intended to help companies and other organizations evaluate whether transactions should be BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) accounted for as acquisitions (or disposals) of assets or businesses. The update provides a more robust framework to use in determining when a set of assets and activities is a business, and also provides more consistency in applying the guidance, reduce the costs of application, and make the definition of a business more operable. For public companies, the update is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company does not believe the adoption of ASU 2017-01 will have a material impact on the Company’s consolidated financial statements. In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The update simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The update also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The update should be applied on a prospective basis. The nature of and reason for the change in accounting principle should be disclosed upon transition. For public companies, the update is effective for any annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not believe the adoption of ASU 2017-04 will have a material impact on the Company’s consolidated financial statements. 3. Restructuring and Impairment Charges The Company has implemented various restructuring plans to better align its resources with its business strategy. The related restructuring charges are recorded in the restructuring and impairment charges line item on the Company’s consolidated statements of income (loss). In July 2015, the Company committed to the implementation of a plan to close Ashford University’s residential campus in Clinton, Iowa (the “Clinton Campus”) during the second quarter of 2016. As part of the planned campus closure, as well as the vacating certain other leased property, the Company recognized asset impairment charges of $2.2 million, $43.3 million and $4.6 million relating to the write-off of certain fixed assets during the years ended December 31, 2016, 2015 and 2014, respectively. With the closure of the Clinton Campus, ground-based Ashford University students were provided opportunities to continue to pursue their degrees as reflected in their respective student transfer agreements. For the year ended December 31, 2015, the Company recorded restructuring charges relating to future cash expenditures for student transfer agreements of approximately $3.3 million. This estimate was based upon several assumptions that were subject to change, including assumptions related to the number of students who elected to continue to pursue their degrees through Ashford University’s online programs. For the year ended December 31, 2016, the Company reassessed this estimate and decreased the related restructuring charges by approximately $0.1 million. In recent years, the Company has implemented reductions in force to help better align personnel resources with the decline in enrollment. During the years ended December 31, 2016, 2015 and 2014, the Company recognized $2.7 million, $4.7 million and $3.6 million, respectively, as restructuring charges related to severance costs for wages and benefits resulting from the reductions in force. We anticipate these costs will be paid out by the end of the first quarter of 2017 from existing cash on hand. As part of its continued efforts to streamline operations, the Company vacated or consolidated properties in Denver and San Diego and reassessed its obligations on non-cancelable leases. The fair value estimate of these non-cancelable leases is based on the contractual lease costs over the remaining term, partially offset by estimated future sublease rental income. The estimated rental income considers subleases the Company has executed or expects to execute, current commercial real estate market data and conditions, comparable transaction data and qualitative factors specific to the related facilities. During the years ended December 31, 2016, 2015 and 2014, the Company recorded $14.5 million, $17.0 million and $6.5 million, respectively, for lease exit costs, primarily related to properties in Denver and San Diego. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) During the fourth quarter of 2014, the Company terminated a software development program for internal operations due to a change in the Company's operating plan. As a result, the Company recorded an asset impairment charge of $2.2 million during the year ended December 31, 2014 for previously capitalized software costs. The following table summarizes the amounts recorded in the restructuring and impairment charges line item on the Company's consolidated statements of income (loss) for each of the periods presented (in thousands): The following table summarizes the changes in the Company's restructuring liability by type during the three-year period ended December 31, 2016 (in thousands): BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) 4. Investments The following tables summarize the fair value information of short and long-term investments as of December 31, 2016 and 2015, respectively (in thousands): The tables above include amounts related to investments classified as other investments, such as certificates of deposit, which are carried at amortized cost. The amortized cost of such investments approximated fair value at each balance sheet date. The assumptions used in these fair value estimates are considered as other observable inputs and are therefore categorized as Level 2 measurements under the accounting guidance. The Company's Level 2 investments are valued using readily available pricing sources that utilize market observable inputs, including the current interest rate for similar types of instruments. There were no transfers between levels during the periods presented. The Company also holds money market securities within its cash and cash equivalents on the consolidated balance sheets that are classified as Level 1 securities. The following tables summarize the differences between amortized cost and fair value of short and long-term investments as of December 31, 2016 and 2015, respectively (in thousands): The above table does not include $1.7 million of mutual funds for December 31, 2016, which are recorded as trading securities. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) The above table does not include $1.3 million of mutual funds for December 31, 2015, which are recorded as trading securities. As of December 31, 2016, there were three investments that were in an unrealized loss position for less than 12 months. There were no investments that were in an unrealized loss position for greater than 12 months. There was no impairment considered other-than-temporary, as it is more likely than not the Company will hold the securities until maturity or a recovery of the cost basis. The Company accumulates unrealized gains and losses on the available-for-sale debt securities, net of tax, in accumulated other comprehensive gain (loss) in the stockholders’ equity section of the Company's balance sheets. As of December 31, 2015, there were no investments that were in an unrealized loss position for greater than 12 months. 5. Accounts Receivable, Net Accounts receivable, net, consists of the following (in thousands): There are an immaterial amount of accounts receivable, net, at each balance sheet date with a payment due date of greater than one year. The following table presents the changes in the allowance for doubtful accounts for accounts receivable for the periods indicated (in thousands): (1) Deductions represent accounts written off, net of recoveries. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) 6. Student Loans Receivable, Net In accordance with the terms of the settlement reached between the Company and the Consumer Financial Protection Bureau in September 2016, all existing student loans receivable were written off during the third quarter of 2016. For additional information regarding the settlement, refer to Note 21, “Commitments and Contingencies”. Student loans receivable, net, consists of the following (in thousands): At December 31, 2015, student loans receivable is presented net of any related discount, and the balances approximated fair value. The Company estimates the fair value of the student loans receivable by discounting the future cash flows using an interest rate of 4.5%, which approximates the interest rates used in similar arrangements. The assumptions used in this estimate are considered unobservable inputs and are therefore categorized as Level 3 measurements under the accounting guidance. There was no revenue recognized related to student loans during the year ended December 31, 2016 and the revenue recognized related to student loans was immaterial during the year ended December 31, 2015. The following table presents the changes in the allowance for doubtful accounts for student loans receivable (tuition related) for the periods indicated (in thousands): (1) Deductions represent accounts written off, net of recoveries. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) 7. Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets consists of the following (in thousands): 8. Property and Equipment, Net Property and equipment, net, consists of the following (in thousands): Depreciation and amortization expense associated with property and equipment totaled $8.4 million, $13.9 million and $17.6 million for the years ended December 31, 2016, 2015 and 2014, respectively. Included in the table above is $4.1 million as of December 31, 2015, which represents equipment sold and subsequently leased-back by the Company prior to December 31, 2015. These amounts are classified as financing activities in proceeds from failed sale-leaseback transaction on the Company's consolidated statements of cash flows. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) 9. Goodwill and Intangibles, Net Goodwill and intangibles, net, consists of the following (in thousands): Goodwill and indefinite-lived intangibles includes the goodwill resulting from prior period acquisitions and the indefinite-lived intangibles attributable to the accreditation of the Company's institutions. Definite-lived intangibles include trademark agreements and digital course materials. For the years ended December 31, 2016, 2015 and 2014, amortization expense was $4.7 million, $5.7 million and $5.7 million, respectively. The following table summarizes the estimated remaining amortization expense as of each fiscal year ended below (in thousands): BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) 10. Accounts Payable and Accrued Liabilities Accounts payable and accrued liabilities consists of the following (in thousands): 11. Deferred Revenue and Student Deposits Deferred revenue and student deposits consists of the following (in thousands): 12. Other Long-Term Liabilities Other long-term liabilities consists of the following (in thousands): 13. Credit Facilities The Company has issued letters of credit that are collateralized with cash in the aggregate amount of $7.1 million, which is included as restricted cash as of December 31, 2016. As part of its normal business operations, the Company is required to provide surety bonds in certain states in which the Company does business. The Company has entered into a surety bond facility with an insurance company to provide such bonds when required. As of December 31, 2016, the Company's total available surety bond facility was $3.5 million and the surety had issued bonds totaling $3.4 million on the Company's behalf under such facility. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) 14. Lease Obligations Operating leases The Company leases certain office facilities and office equipment under non-cancelable lease arrangements that expire at various dates through 2023. The office leases contain certain renewal options. Rent expense under non-cancelable operating lease arrangements is accounted for on a straight-line basis and totaled $23.3 million, $38.5 million and $42.2 million for the years ended December 31, 2016, 2015 and 2014, respectively. The following table summarizes the future minimum rental payments under non-cancelable operating lease arrangements in effect at December 31, 2016 (in thousands): The Company has agreements to sublease certain portions of its office facilities, with four active subleases as of December 31, 2016. The Company is subleasing approximately 41,000 square feet of office space in San Diego, California with a commitment to lease for 40 months and a net sublease value of $1.8 million. In addition, the Company is subleasing approximately 72,000 square feet of office space in Denver, Colorado with a commitment to lease for 56 months and a net sublease value of $6.6 million. 15. Earnings (Loss) Per Share Basic earnings (loss) per share is calculated by dividing net income (loss) available to common stockholders for the period by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) available to common stockholders for the period by the sum of (i) the weighted average number of common shares outstanding during the period, plus (ii) potentially dilutive securities outstanding during the period, if the effect is dilutive. Potentially dilutive securities for the periods presented include incremental stock options, unvested restricted stock units (“RSUs”) and unvested performance stock units (“PSUs”). BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) The following table sets forth the computation of basic and diluted earnings (loss) per share for the periods indicated (in thousands, except per share data): The following table sets forth the number of stock options, RSUs and PSUs excluded from the computation of diluted loss per share for the periods indicated because their effect was anti-dilutive (in thousands): 16. Stock-Based Compensation The Company recorded $7.3 million, $9.7 million and $10.6 million of compensation expense related to equity awards for the years ended December 31, 2016, 2015 and 2014, respectively. The related income tax benefit was $2.7 million, $3.6 million and $4.0 million for the years ended December 31, 2016, 2015 and 2014, respectively. The Company records stock-based compensation expense over the vesting term using the graded-vesting method. Stock Options The Company grants stock options from its 2009 Stock Incentive Plan (the “2009 Plan”). The compensation committee of the Company's board of directors, or the full board of directors, determines eligibility, vesting schedules and exercise prices for stock options granted under the 2009 Plan. Stock options granted under the 2009 Plan typically have a maximum contractual term of 10 years, subject to the option holder's continuing service with the Company. Stock options are generally granted with a four-year vesting requirement, pursuant to which the option holder must continue providing service to the Company at the applicable vesting date. All stock options granted during the years ended December 31, 2016, 2015 and 2014 were awarded pursuant to the 2009 Plan. Under the 2009 Plan, the number of authorized shares is subject to automatic increase each January 1 through and including January 1, 2019, pursuant to a formula contained in the 2009 Plan, without the need for further approval by the Company's board of directors or stockholders. Before the adoption of the 2009 Plan, the Company awarded stock options pursuant to the Company's Amended and Restated 2005 Stock Incentive Plan (the “2005 Plan”). Effective upon the closing of the Company's initial public offering, the 2005 Plan was terminated and no further stock options may be issued under the 2005 Plan, provided that all stock options then outstanding under the 2005 Plan will continue to remain outstanding pursuant to the terms of the 2005 Plan and the applicable award agreements. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) The following table presents a summary of stock option activity during the years ended December 31, 2016, 2015 and 2014 (in thousands, except for exercise prices and contractual terms): As of December 31, 2016, the Company had 5.7 million shares of common stock reserved for issuance upon the exercise of outstanding stock options and settlement of outstanding stock awards under the Company's equity incentive plans. Shares issued upon stock option exercises and settlements of stock awards are drawn from the authorized but unissued shares of common stock. During the year ended December 31, 2016, there were 0.3 million stock options exercised with an intrinsic value of $1.2 million. The windfall tax benefit realized from these exercises was $0.3 million. The Company also recognized a tax benefit shortfall of $0.4 million related to stock options exercised at values lower than the related compensation expense. During the year ended December 31, 2015, there were 0.2 million stock options exercised with an intrinsic value of $1.6 million. The windfall tax benefit realized from these exercises was $0.5 million. The Company also recognized a tax benefit shortfall of $0.1 million related to stock options exercised at values lower than the related compensation expense. During the year ended December 31, 2014, there were 0.4 million stock options exercised with an intrinsic value of $3.3 million. The windfall tax benefit realized from these exercises was $0.7 million. The Company also recognized a tax benefit shortfall of $0.1 million related to stock options exercised at values lower than the related compensation expense. Approximately 1.0 million and 0.6 million stock options expired during the years ended December 31, 2016 and 2015, respectively. The fair value of each stock option award granted during the years ended December 31, 2016, 2015 and 2014 was estimated on the date of grant using the Black-Scholes option pricing model. The Company's determination of the fair value of share-based awards is affected by the Company's common stock price as well as assumptions regarding a number of complex and subjective variables. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Below is a summary of the assumptions used for the stock options granted in the years indicated. The risk-free interest rate is based on the currently available rate on a U.S. Treasury zero-coupon issue with a remaining term equal to the expected term of the stock option converted into a continuously compounded rate. The Company has never declared or paid any cash dividends on its common stock and does not currently anticipate paying cash dividends in the future. The Company has enough historical option exercise information to compute an expected term for use as an assumption in the Black-Scholes option pricing model, and as such, its computation of expected term was calculated using its own historical data. The volatility of the Company's common stock is also based upon its own historical volatility. As of December 31, 2016, 2015 and 2014, there was $1.4 million, $1.7 million and $3.2 million, respectively, of unrecognized compensation costs related to unvested stock options. At December 31, 2016, the unrecognized compensation costs of stock options were expected to be recognized over a weighted average period of 1.2 years. Stock Awards The Company also grants RSUs to its employees under the 2009 Plan. Each RSU represents the future issuance of one share of the Company's common stock contingent upon the recipient's continued service with the Company through the applicable vesting date. Upon the vesting date, RSUs are automatically settled for shares of the Company's common stock unless the applicable award agreement provides for delayed settlement. If prior to the vesting date the employee's status as a full-time employee is terminated, the unvested RSUs are automatically canceled on the employment termination date, unless otherwise specified in an employee's individual employment agreement. The fair value of an RSU is calculated based on the market value of the common stock on the grant date and is amortized over the applicable vesting period using the graded-vesting method. During the years ended December 31, 2014 and 2015, the Company also granted PSUs under the 2009 Plan to certain individuals. No PSUs were granted during the year ended December 31, 2016. Each PSU represents the future issuance of one share of the Company's common stock contingent upon achievement of the applicable performance target and the recipient's continued service with the Company through the applicable vesting date. Certain of the PSUs previously granted may be earned based on the achievement of a market-based measure, the Company's stock price, and certain of the PSUs previously granted may be earned based on the achievement of a performance-based measure, the Company's diluted earnings per share. With respect to each award of PSUs, one-fourth of the PSUs may be earned during the applicable 12-month period based on the achievement of the applicable performance target, and PSUs earned during the applicable 12-month period will vest on a future date as set forth in the applicable PSU award agreement, subject to the employee's continued service with the Company through the applicable vesting date. Upon the vesting date, earned PSUs are automatically settled for shares of the Company's common stock. If prior to the vesting date the employee's status as a full-time employee is terminated, the unvested PSUs are automatically canceled on the employment termination date, unless otherwise specified in an employee's individual employment agreement. PSUs are amortized over the applicable vesting period using the graded-vesting method. The fair value of the portion of the PSU awards subject to earning based on the achievement of a performance-based measure was based on the Company's stock price as of the date the applicable performance target was approved by the Company's board of directors. Compensation cost for the portion of the PSU awards subject to earning based on the achievement of a performance-based measure is recorded based on the probable outcome of the performance conditions associated with the shares, as determined by BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) management. The fair value of the portion of the PSU awards subject to earning based on the achievement of a market-based measure was estimated based on the Company's stock price as of the date of grant using a Monte Carlo simulation model. The assumptions for the portion of the PSU awards subject to earning based on the achievement of a market-based measure are noted in the following table: A summary of the RSU and PSU activity and related information is as follows: As of December 31, 2016 and 2015, there was $4.7 million and $6.9 million, respectively, of unrecognized compensation costs related to unvested RSUs. At December 31, 2016, the unrecognized compensation costs of RSUs were expected to be recognized over a weighted average period of 1.2 years. During the year ended December 31, 2016, 0.5 million RSUs vested and were released with a market value of $4.8 million. The tax benefit shortfall realized from the RSUs released was $0.2 million. During the year ended December 31, 2015, 0.4 million RSUs vested and were released with a market value of $3.3 million. The actual tax benefit windfall realized from the RSUs released was $0.4 million. During the year ended December 31, 2014, 0.4 million RSUs vested and were released with a market value of $5.3 million. The actual tax benefit windfall realized from the RSUs released was $0.5 million. As of December 31, 2016, there was $1.5 million of unrecognized compensation costs related to unvested PSUs. At December 31, 2016, the unrecognized compensation costs of PSUs were expected to be recognized over a weighted average BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) period of 1.2 years, to the extent the applicable performance criteria are met. No PSUs vested during the year ended December 31, 2016, 2015 or 2014. 17. Stock Repurchase Programs The Company's board of directors may authorize the Company to repurchase outstanding shares of its common stock from time to time in the open market through block trades or otherwise depending on market conditions and other considerations, pursuant to the applicable rules of the Securities and Exchange Commission (“SEC”). The Company's policy is to retain these repurchased shares as treasury shares and not to retire them. The amount and timing of future share repurchases, if any, will be determined as market and business conditions warrant. The Company did not repurchase any shares of our common stock during the years ended December 31, 2016 and 2015. 18. Income Taxes The Company uses the asset-liability method to account for taxes. Under this method, deferred income tax assets and liabilities result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in income and deductions in future years. The components of income tax expense (benefit) are as follows (in thousands): Each reporting period, the Company assesses the likelihood that it will be able to recover its deferred tax assets, which represent timing differences in the recognition of certain tax deductions for accounting and tax purposes. The realization of deferred tax assets is dependent in part upon future taxable income. Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, the Company considers all available evidence, including past operating results, estimates of future taxable income given current business conditions affecting the Company, and the feasibility of ongoing tax planning strategies. As of December 31, 2016, the Company continues to record a full valuation allowance against all net deferred tax assets, as was the case at December 31, 2015. The Company intends to maintain a valuation allowance against its deferred tax assets until sufficient positive evidence exists to support its reversal. Deferred income tax balances reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when taxes are paid or recovered. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Significant components of the Company’s deferred tax assets and liabilities and balance sheet classifications are as follows (in thousands): At December 31, 2016, the Company had federal net operating loss carryforwards of $0.6 million, which are available to offset future taxable income. The federal net operating loss carryforwards will begin to expire in 2021. The Company’s utilization of net operating loss carryforwards may be subject to annual limitations due to ownership change provisions of Section 382 of Internal Revenue Code of 1986, as amended. The Company has performed a Section 382 analysis and has determined that there is no material effect on the net operating loss carryforwards. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) The following table presents a reconciliation of the income tax expense (benefit) computed using the federal statutory tax rate of 35% and the Company's provision for income taxes (in thousands): The following table presents a reconciliation of the beginning and ending amount of unrecognized tax benefits (in thousands): Included in the amount of unrecognized tax benefits at December 31, 2016 and 2015 is $13.2 million and $13.4 million, respectively, of tax benefits that, if recognized, would affect the Company's effective tax rate. Also included in the balance of unrecognized tax benefits at December 31, 2016 and 2015 is $7.1 million and $7.2 million, respectively, of tax benefits that, if recognized, would result in adjustments to other tax accounts, primarily deferred tax assets. It is reasonably possible that the total amount of the unrecognized tax benefit will change during the next 12 months; however, the Company does not expect the potential change to have a material effect on the results of operations or financial position in the next year. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. At December 31, 2016 and 2015, the Company had approximately $2.4 million and $2.0 million, respectively, of accrued interest, before any tax benefit, related to uncertain tax positions. The Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The tax years 2001 through 2015 are open to examination by major taxing jurisdictions to which the Company is subject. The Company was notified by the Internal Revenue Service in January 2017 that they will be conducting an audit examination of the Company’s income tax returns for the years 2013 through 2015. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) The Company is currently under audit by the California Franchise Tax Board for the years 2008 through 2012. The Company has agreed to settle all years under audit and anticipates that the Franchise Tax Board will issue a Notice of Action during the first half of 2017. The Company is also currently under audit by the Oregon Department of Revenue for the years 2012 through 2014. In January 2017, the Oregon Department of Revenue issued Notices of Deficiencies, which were recently appealed by the Company. The Company is also subject to various other state audits. With regard to all audits, the Company does not expect any significant adjustments to amounts already reserved. 19. Regulatory The Company is subject to extensive regulation by federal and state governmental agencies and accrediting bodies. In particular, the Higher Education Act of 1965, as amended (the “Higher Education Act”), and the regulations promulgated thereunder by the U.S. Department of Education (the “Department”) subject the Company to significant regulatory scrutiny on the basis of numerous standards that institutions of higher education must satisfy in order to participate in the various federal student financial aid programs under Title IV of the Higher Education Act (“Title IV programs”). Ashford University is regionally accredited by WASC Senior College and University Commission (“WSCUC”) and University of the Rockies is regionally accredited by the Higher Learning Commission (“HLC”). Department of Education Completed Program Review of Ashford University In July 2014, the Company and Ashford University received notification from the Department that it intended to conduct a program review of Ashford’s administration of the Title IV programs in which the university participates. The review commenced in August 2014 and covered federal financial aid years 2012-2013 and 2013-2014, as well as compliance with the Jeanne Clery Disclosure of Campus Security Policy and Campus Crime Statistics Act (the “Clery Act”), the Drug-Free Schools and Communities Act, and related regulations. Ashford was provided with the Department's initial program review report and responded to such initial report. On August 2, 2016, the Department issued a Final Program Review Determination (“FPRD”), which stated that Ashford University’s responses have resolved eight of the twelve findings from the Department’s initial report. Of the four findings that were not resolved by Ashford’s responses, the first three related to (i) overawards in excess of financial need, (ii) lack of verifications of enrollment status before disbursement and (iii) disbursement of direct subsidized loan funds in excess of the aggregate maximum, respectively. With respect to these three findings, the Department found that Ashford’s revised policies and procedures, if implemented as drafted, are adequate, and the Department assessed monetary liabilities of approximately $138,000 against Ashford related to overpayments to students. With respect to the fourth unresolved finding, which related to compliance with Drug and Alcohol Abuse Prevention Program requirements, the FPRD noted that this finding would not have been designated as a reportable condition if accurate and complete information to substantiate Ashford’s claims of compliance had been provided during the site visit. The FPRD stated that in spite of this concern, the Department’s examination showed that the identified compliance issue was, for the most part, satisfactorily addressed by Ashford’s response and enhanced internal policies and procedures, and that the Department has accepted the university’s response and considers this finding to be closed for purposes of the program review. On October 5, 2016, Ashford received a letter from the Department indicating that, in reference to the documentation received from Ashford in response to instructions provided in the FPRD, all requirements have been addressed and the institution may now consider the program review closed, with no further action required. Department of Education Open Program Review of Ashford University On July 7, 2016, Ashford University was notified by the Department that an off-site program review had been scheduled to assess Ashford’s administration of the Title IV programs in which it participates. The off-site program review commenced on July 25, 2016 and initially covers students identified in the 2009-2012 calendar year data previously provided by Ashford to the Department in response to a request for information received from the Multi-Regional and Foreign School Participation Division of the Department’s Office of Federal Student Aid (the “FSA”) on December 10, 2015, but may be expanded if appropriate. On December 9, 2016, the Department informed Ashford that it intended to continue the program review on-site at BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Ashford. The on-site program review commenced on January 23, 2017 and initially covers the 2015-2016 and 2016-2017 award years, but may be expanded if appropriate. WSCUC Accreditation of Ashford University In July 2013, WSCUC granted Initial Accreditation to Ashford University for five years, until July 15, 2018. In December 2013, Ashford effected its transition to WSCUC accreditation and designated its San Diego, California facilities as its main campus and its Clinton, Iowa campus as an additional location. As part of a continuing monitoring process, Ashford hosted a visiting team from WSCUC in a special visit in April 2015. In July 2015, Ashford received an Action Letter from WSCUC outlining the findings arising out of its visiting team's special visit. The Action Letter stated that the WSCUC visiting team found substantial evidence that Ashford continues to make sustained progress in all six areas recommended by WSCUC in 2013. As part of its institutional review process, WSCUC will conduct a comprehensive review of Ashford scheduled to commence with an off-site review in spring 2018, followed by an on-site review in fall 2018. Licensure by California BPPE To be eligible to participate in Title IV programs, an institution must be legally authorized to offer its educational programs by the states in which it is physically located. In connection with its transition to WSCUC accreditation, Ashford University designated its San Diego, California facilities as its main campus for Title IV purposes and submitted an Application for Approval to Operate an Accredited Institution to the State of California, Department of Consumer Affairs, Bureau for Private Postsecondary Education (the “BPPE”) on September 10, 2013. In April 2014, the application was granted, and Ashford University was approved by the BPPE to operate in California until July 15, 2018. As a result, the university is subject to laws and regulations applicable to private, postsecondary educational institutions located in California, including reporting requirements related to graduation, employment and licensing data, certain changes of ownership and control, faculty and programs, and student refund policies. Ashford also remains subject to other state and federal student employment data reporting and disclosure requirements. The BPPE is required to conduct compliance inspections for each of its approved institutions. On October 12, 2016, the BPPE conducted a compliance inspection of Ashford University. Ashford is working with the BPPE to resolve any issues identified in connection with the compliance inspection. The “90/10” Rule Under the Higher Education Act, a proprietary institution loses eligibility to participate in Title IV programs if the institution derives more than 90% of its revenues (calculated in accordance with Department regulations) from Title IV program funds for two consecutive fiscal years. This rule is commonly referred to as the “90/10 rule.” Any institution that violates the 90/10 rule for two consecutive fiscal years becomes ineligible to participate in Title IV programs for at least two fiscal years. In addition, an institution whose rate exceeds 90% for any single fiscal year is placed on provisional certification and may be subject to other enforcement measures. For the years ended December 31, 2016, 2015 and 2014, Ashford University derived 81.2%, 80.9% and 83.4%, respectively, and University of the Rockies derived 86.5%, 86.6% and 88.3%, respectively, of their respective revenues from Title IV program funds. Cohort Default Rate For each federal fiscal year, the Department calculates a rate of student defaults over a three-year measuring period for each educational institution, which is known as a “cohort default rate.” An institution may lose eligibility to participate in the William D. Ford Federal Direct Loan Program and the Federal Pell Grant Program if, for each of the three most recent federal fiscal years, 30% or more of its students who became subject to a repayment obligation in that federal fiscal year defaulted on such obligation by the end of the following federal fiscal year. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) The most recent official three-year cohort default rates for Ashford University for the 2013, 2012 and 2011 federal fiscal years, were 14.5%, 15.3% and 15.3%, respectively. The most recent official three-year cohort default rates for University of the Rockies for the 2013, 2012 and 2011 federal fiscal years, were 3.8%, 4.3% and 6.6%, respectively. Financial Responsibility The Department calculates an institution's composite score for financial responsibility based on its (i) equity ratio, which measures the institution's capital resources, ability to borrow and financial viability; (ii) primary reserve ratio, which measures the institution's ability to support current operations from expendable resources; and (iii) net income ratio, which measures the institution's ability to operate at a profit. An institution that does not meet the Department's minimum composite score of 1.5 may demonstrate its financial responsibility by posting a letter of credit in favor of the Department and possibly accepting other conditions on its participation in the Title IV programs. For the fiscal year ended December 31, 2015, the consolidated composite score calculated was 1.8, satisfying the composite score requirement of the Department's financial responsibility test, which institutions must satisfy in order to participate in Title IV programs. The Company expects the consolidated composite score to be 2.0 for the year ended December 31, 2016. However, the consolidated calculation is subject to determination by the Department once it receives and reviews our audited financial statements for the year ended December 31, 2016. Substantial Misrepresentation The Higher Education Act prohibits an institution participating in Title IV programs from engaging in substantial misrepresentation regarding the nature of its educational programs, its financial charges or the employability of its graduates. Under the Department’s rules, a “misrepresentation” is any false, erroneous or misleading statement an institution, one of its representatives or any ineligible institution, organization or person with whom the institution has an agreement to provide educational programs or marketing, advertising, recruiting, or admissions services makes directly or indirectly to a student, prospective student or any member of the public, or to an accrediting agency, a state agency or the Department. The Department’s rules define a “substantial misrepresentation” as any misrepresentation on which the person to whom it was made could reasonably be expected to rely, or has reasonably relied, to that person’s detriment. For-profit educational institutions are also subject to the general deceptive practices jurisdiction of the Federal Trade Commission and the Consumer Financial Protection Bureau (the “CFPB”). On December 10, 2015, Ashford University received a request for information from the Multi-Regional and Foreign School Participation Division of the FSA for (i) advertising and marketing materials provided to prospective students regarding the transferability of certain credit, (ii) documents produced in response to the August 10, 2015 Civil Investigative Demand from the CFPB related to the CFPB’s investigation to determine whether for-profit postsecondary education companies or other unnamed persons have engaged in or are engaging in unlawful acts or practices related to the advertising, marketing or origination of private student loans, (iii) certain documents produced in response to subpoenas and interrogatories issued by the Attorney General of the State of California (the “CA Attorney General”) and (iv) records created between 2009 and 2012 related to the disbursement of certain Title IV funds. The FSA is investigating representations made by Ashford University to potential and enrolled students, and has asked the Company and Ashford to assist in its assessment of Ashford’s compliance with the prohibition on substantial misrepresentations. The Company and Ashford University intend to provide the FSA with their full cooperation with a view toward demonstrating the compliant nature of their practices. As discussed above, the Department is currently conducting a program review to assess Ashford University’s administration of the Title IV programs in which it participates, which covers in part students identified in the 2009-2012 calendar year data provided by Ashford to the Department in response to the FSA’s December 10, 2015 request for information. If the Department determines that one of the Company’s institutions has engaged in substantial misrepresentation, the Department may (i) revoke the institution’s program participation agreement, if the institution is provisionally certified, (ii) impose limitations on the institution’s participation in Title IV programs, if the institution is provisionally certified, (iii) deny participation applications made on behalf of the institution or (iv) initiate proceedings to fine the institution or to limit, suspend or terminate the participation of the institution in Title IV programs. Because Ashford University is provisionally certified, if BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) the Department determined that Ashford has engaged in substantial misrepresentation, the Department may take the actions set forth in clauses (i) and (ii) above in addition to any other actions taken by the Department. GI Bill Benefits On May 20, 2016, the Company received a letter from the Iowa Department of Education (the “Iowa DOE”) indicating that, as a result of the planned closure of the Clinton Campus, the Iowa State Approving Agency (the “ISAA”) would no longer continue to approve Ashford University’s programs for GI Bill benefits after June 30, 2016, and recommending Ashford seek approval through the State Approving Agency of jurisdiction for any location that meets the definition of a “main campus” or “branch campus”. Ashford began the process of applying for approval through the State Approving Agency in California (“CSAAVE”), and the Company subsequently disclosed that on June 20, 2016 it received a second letter from the Iowa DOE indicating that the Iowa DOE had issued a stay of the ISAA’s withdrawal of approval of Ashford’s programs for GI Bill benefits effective immediately until the earlier of (i) 90 days from June 20, 2016 or (ii) the date on which CSAAVE completed its review and issued a decision regarding the approval of Ashford in California. Ashford received communication from CSAAVE indicating that additional information and documentation would be required before Ashford’s application could be considered for CSAAVE approval. Ashford subsequently withdrew the CSAAVE application and continued working with the U.S. Department of Veterans Affairs, the Iowa DOE and the ISAA to obtain continued approval of Ashford’s programs for GI Bill benefits and to prevent any disruption of educational benefits to Ashford’s veteran students. On September 15, 2016, in response to a Petition for Declaratory and Injunctive Relief filed by Ashford University, the Iowa District Court for Polk County entered a written order (the “Order”) staying the Iowa DOE’s announced intention to withdraw the approval of Ashford as a GI Bill eligible institution until the entry of a final and appealable order and judgment in the action. Pursuant to the Order, the ISAA will continue to approve Ashford’s programs for GI Bill benefits until such final and appealable order has been entered. 20. Retirement Plans The Company maintains an employee savings plan (the “401(k) Plan”) that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code of 1986, as amended. Under the 401(k) Plan, participating employees may contribute a portion of their pre-tax earnings up to the Internal Revenue Service annual contribution limit. Additionally, the Company may elect to make matching contributions into the 401(k) Plan in its sole discretion. The Company's total expense related to the 401(k) Plan was $3.1 million, $3.4 million and $3.7 million for the years ended December 31, 2016, 2015 and 2014, respectively. 21. Commitments and Contingencies Litigation From time to time, the Company is a party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of business. When the Company becomes aware of a claim or potential claim, it assesses the likelihood of any loss or exposure. In accordance with authoritative guidance, the Company records loss contingencies in its financial statements only for matters in which losses are probable and can be reasonably estimated. Where a range of loss can be reasonably estimated with no best estimate in the range, the Company records the minimum estimated liability. If the loss is not probable or the amount of the loss cannot be reasonably estimated, the Company discloses the nature of the specific claim if the likelihood of a potential loss is reasonably possible and the amount involved is material. The Company continuously assesses the potential liability related to the Company’s pending litigation and revises its estimates when additional information becomes available. Below is a list of material legal proceedings to which the Company or its subsidiaries is a party. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Compliance Audit by the Department's Office of the Inspector General In January 2011, Ashford University received a final audit report from the Department's Office of Inspector General (the “OIG”) regarding the compliance audit commenced in May 2008 and covering the period July 1, 2006 through June 30, 2007. The audit covered Ashford University's administration of Title IV program funds, including compliance with regulations governing institutional and student eligibility, awards and disbursements of Title IV program funds, verification of awards and returns of unearned funds during that period, and compensation of financial aid and recruiting personnel during the period May 10, 2005 through June 30, 2009. The final audit report contained audit findings, in each case for the period July 1, 2006 through June 30, 2007, which are applicable to award year 2006-2007. Each finding was accompanied by one or more recommendations to the FSA. Ashford University provided the FSA a detailed response to the OIG’s final audit report in February 2011. In June 2011, in connection with two of the six findings, the FSA requested that Ashford University conduct a file review of the return to Title IV fund calculations for all Title IV recipients who withdrew from distance education programs during the 2006-2007 award year. The institution cooperated with the request and supplied the information within the time frame required. Ashford University received a final audit determination on February 22, 2017 from the Department that was dated February 14, 2017. The determination maintains that Ashford University owes the Department $0.3 million as a result of incorrect refund calculations and refunds that were not made or made late, and that Ashford ensure it properly enforces its policies and is in compliance with regulations related to disbursement of Title IV, HEA funds. The Department closed or required no further action on all other prior OIG findings. Ashford University is evaluating the determination and has 45 days to submit an appeal to the Secretary of Education. As of December 31, 2016, the Company has recorded an expense of $0.3 million related to this matter. New York Attorney General Investigation of Bridgepoint Education, Inc. In May 2011, the Company received from the Attorney General of the State of New York (the “NY Attorney General”) a subpoena relating to the NY Attorney General's investigation of whether the Company and its academic institutions have complied with certain New York state consumer protection, securities and finance laws. Pursuant to the subpoena, the NY Attorney General has requested from the Company and its academic institutions documents and detailed information for the time period March 17, 2005 to present. The Company is cooperating with the investigation and cannot predict the eventual scope, duration or outcome of the investigation at this time. North Carolina Attorney General Investigation of Ashford University In September 2011, Ashford University received from the Attorney General of the State of North Carolina (the “NC Attorney General”) an Investigative Demand relating to the NC Attorney General's investigation of whether the university's business practices complied with North Carolina consumer protection laws. Pursuant to the Investigative Demand, the NC Attorney General has requested from Ashford University documents and detailed information for the time period January 1, 2008 to present. Ashford University is cooperating with the investigation and cannot predict the eventual scope, duration or outcome of the investigation at this time. California Attorney General Investigation of For-Profit Educational Institutions In January 2013, the Company received from the Attorney General of the State of California (the “CA Attorney General”) an Investigative Subpoena relating to the CA Attorney General’s investigation of for-profit educational institutions. Pursuant to the Investigative Subpoena, the CA Attorney General requested documents and detailed information for the time period March 1, 2009 to present. On July 24, 2013, the CA Attorney General filed a petition to enforce certain categories of the Investigative Subpoena related to recorded calls and electronic marketing data. On September 25, 2013, the Company reached an agreement with the CA Attorney General to produce certain categories of the documents requested in the petition and stipulated to continue the hearing on the petition to enforce from October 3, 2013 to January 9, 2014. On January 13, 2014 and June 19, 2014, the Company received additional Investigative Subpoenas from the CA Attorney General each requesting additional documents and information for the time period March 1, 2009 through the current date. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Representatives from the Company met with representatives from the CA Attorney General’s office on several occasions to discuss the status of the investigation, additional information requests, and specific concerns related to possible unfair business practices in connection with the Company’s recruitment of students and debt collection practices. The parties continue to discuss a potential resolution involving injunctive relief, other non-monetary remedies and a payment to the CA Attorney General. The Company currently estimates that a reasonable range of loss for this matter is between $8.0 million and $20.0 million. The Company has recorded an expense of $8.0 million related to this matter which represents its current best estimate of the cost of resolution of this matter. Massachusetts Attorney General Investigation of Bridgepoint Education, Inc. and Ashford University On July 21, 2014, the Company and Ashford University received from the Attorney General of the State of Massachusetts (the “MA Attorney General”) a Civil Investigative Demand (the “MA CID”) relating to the MA Attorney General's investigation of for-profit educational institutions and whether the university's business practices complied with Massachusetts consumer protection laws. Pursuant to the MA CID, the MA Attorney General has requested from the Company and Ashford University documents and information for the time period January 1, 2006 to present. The Company is cooperating with the investigation and cannot predict the eventual scope, duration or outcome of the investigation at this time. Securities & Exchange Commission Subpoena of Bridgepoint Education, Inc. On July 22, 2014, the Company received from the SEC a subpoena relating to certain of the Company’s accounting practices, including revenue recognition, receivables and other matters relating to the Company’s previously disclosed intention to restate its financial statements for fiscal year ended December 31, 2013 and revise its financial statements for the years ended December 31, 2011 and 2012, and the prior revision of the Company’s financial statements for the fiscal year ended December 31, 2012. Pursuant to the subpoena, the SEC has requested from the Company documents and detailed information for the time period January 1, 2009 to present. On May 18, 2016, the Company received a second subpoena from the SEC seeking additional information from the Company, including information with respect to the accrual disclosed by the Company in its Quarterly Report on Form 10-Q for the quarter ended March 31, 2016 with respect to the potential joint resolution of investigations by the CA Attorney General and the CFPB (the “CAAG/CFPB Investigations”), the Company’s scholarship and institutional loan programs and any other extensions of credit made by the Company to students, and student enrollment and retention at the Company’s academic institutions. Pursuant to the subpoena, the SEC has requested from the Company documents and detailed information for, in the case of the CAAG/CFPB Investigations, the periods at issue in such investigations, in the case of the Company’s scholarship and institutional loan programs and related matters, the period from January 1, 2011 to the present, and for all other matters, the period from January 1, 2014 to the present. The Company is cooperating with the SEC and cannot predict the eventual scope, duration or outcome of the investigation at this time. As a result, the Company cannot reasonably estimate a range of loss for this action and accordingly has not accrued any liability associated with this action. Consumer Financial Protection Bureau Subpoena of Bridgepoint Education, Inc. and Ashford University On August 10, 2015, the Company and Ashford University received from the CFPB Civil Investigative Demands related to the CFPB's investigation to determine whether for-profit postsecondary education companies or other unnamed persons have engaged in or are engaging in unlawful acts or practices related to the advertising, marketing or origination of private student loans. The Company and Ashford University provided documents and other information to the CFPB and the CFPB attended several meetings with representatives from the Company and the CA Attorney General’s office to discuss the status of both investigations, additional information requests, and specific concerns related to possible unfair business practices in connection with the Company’s recruitment of students and debt collection practices. All of the parties met again in the spring of 2016 to discuss the status of the investigations and explore a potential joint resolution involving injunctive relief, other non-monetary remedies and a payment to the CA Attorney General and the CFPB. On September 7, 2016, the Company consented to the issuance of a Consent Order (the “Consent Order”) by the CFPB in full resolution of the CFPB’s allegations stemming from the Civil Investigative Demands. The Consent Order includes payment by BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) the Company of $8.0 million in penalties to the CFPB and approximately $5.0 million to be used for restitution to students who incurred debt from student loans made by the Company’s institutions, and forgiveness by the Company of approximately $18.6 million of outstanding institutional loan debt. The Consent Order also outlines certain compliance actions the Company must undertake, including that the Company must require certain students to utilize the CFPB’s Electronic Financial Impact Platform before enrolling in one of the Company’s institutions, the Company must implement a compliance plan designed to ensure its institutional loan program complies with the terms of the Consent Order, and the Company must submit reports describing its compliance with the Consent Order to the CFPB at designated times and upon request by the CFPB. The institutional loans programs were discontinued by the Company’s institutions before the CFPB investigation began. As of December 31, 2016, the Company had a remaining accrual of approximately $5.6 million related to this matter. Department of Justice Civil Investigative Demand On July 7, 2016, the Company received from the U.S. Department of Justice (the “DOJ”) a Civil Investigative Demand (the “DOJ CID”) related to the DOJ's investigation concerning allegations that the Company may have misstated Title IV refund revenue or overstated revenue associated with private secondary loan programs and thereby misrepresented its compliance with the 90/10 rule of the Higher Education Act. Pursuant to the DOJ CID, the DOJ has requested from the Company documents and information for fiscal years 2011-2015. The Company is cooperating with the DOJ and cannot predict the eventual scope, duration or outcome of the investigation at this time. As a result, the Company cannot reasonably estimate a range of loss for this action and accordingly has not accrued any liability associated with this action. Securities Class Actions Consolidated Securities Class Action On July 13, 2012, a securities class action complaint was filed in the U.S. District Court for the Southern District of California by Donald K. Franke naming the Company, Andrew Clark, Daniel Devine and Jane McAuliffe as defendants for allegedly making false and materially misleading statements regarding the Company’s business and financial results, specifically the concealment of accreditation problems at Ashford University. The complaint asserted a putative class period stemming from May 3, 2011 to July 6, 2012. A substantially similar complaint was also filed in the same court by Luke Sacharczyk on July 17, 2012 making similar allegations against the Company, Andrew Clark and Daniel Devine. The Sacharczyk complaint asserted a putative class period stemming from May 3, 2011 to July 12, 2012. On July 26, 2012, another purported securities class action complaint was filed in the same court by David Stein against the same defendants based upon the same general set of allegations and class period. The complaints alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rule 10b-5 promulgated thereunder and sought unspecified monetary relief, interest, and attorneys’ fees. On October 22, 2012, the Sacharczyk and Stein actions were consolidated with the Franke action and the Court appointed the City of Atlanta General Employees' Pension Fund and the Teamsters Local 677 Health Services & Insurance Plan as lead plaintiffs. A consolidated complaint was filed on December 21, 2012 and the Company filed a motion to dismiss on February 19, 2013. On September 13, 2013, the Court granted the motion to dismiss with leave to amend for alleged misrepresentations relating to Ashford University’s quality of education, the WSCUC accreditation process and the Company’s financial forecasts. The Court denied the motion to dismiss for alleged misrepresentations concerning Ashford University’s persistence rates. Following the conclusion of discovery, the parties entered into an agreement to settle the litigation for $15.5 million, which was recorded by the Company during the third quarter of 2015 and funded by the Company’s insurance carriers in the first quarter of 2016. The settlement was granted preliminary approval by the Court on December 14, 2015, proceeded through the shareholder claims administration process, and was granted final approval by the Court on April 25, 2016. Zamir v. Bridgepoint Education, Inc., et al. On February 24, 2015, a securities class action complaint was filed in the U.S. District Court for the Southern District of California by Nelda Zamir naming the Company, Andrew Clark and Daniel Devine as defendants. The complaint asserts violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder, claiming that the defendants made false and materially misleading statements and failed to disclose material adverse facts regarding the BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Company's business, operations and prospects, specifically regarding the Company’s improper application of revenue recognition methodology to assess collectability of funds owed by students. The complaint asserts a putative class period stemming from August 7, 2012 to May 30, 2014 and seeks unspecified monetary relief, interest and attorneys' fees. On July 15, 2015, the Court granted plaintiff's motion for appointment as lead plaintiff and for appointment of lead counsel. On September 18, 2015, the plaintiff filed a substantially similar amended complaint that asserts a putative class period stemming from March 12, 2013 to May 30, 2014. The amended complaint also names Patrick Hackett, Adarsh Sarma, Warburg Pincus & Co., Warburg Pincus LLC, Warburg Pincus Partners LLC, and Warburg Pincus Private Equity VIII, L.P. as additional defendants. On November 24, 2015, all defendants filed motions to dismiss. On July 25, 2016, the Court granted the motions to dismiss and granted plaintiff leave to file an amended complaint within 30 days. Plaintiffs subsequently filed a second amended complaint and the Company filed a second motion to dismiss on October 24, 2016, which is currently pending with the Court. The outcome of this legal proceeding is uncertain at this point because of the many questions of fact and law that may arise. Based on information available to the Company at present, it cannot reasonably estimate a range of loss for this action. Accordingly, the Company has not accrued any liability associated with this action. Shareholder Derivative Actions In re Bridgepoint, Inc. Shareholder Derivative Action On July 24, 2012, a shareholder derivative complaint was filed in California Superior Court by Alonzo Martinez. In the complaint, the plaintiff asserts a derivative claim on the Company's behalf against certain of its current and former officers and directors. The complaint is captioned Martinez v. Clark, et al. and generally alleges that the individual defendants breached their fiduciary duties of candor, good faith and loyalty, wasted corporate assets and were unjustly enriched. The lawsuit seeks unspecified monetary relief and disgorgement on behalf of the Company, as well as other equitable relief and attorneys' fees. On September 28, 2012, a substantially similar shareholder derivative complaint was filed in California Superior Court by David Adolph-Laroche. In the complaint, the plaintiff asserts a derivative claim on the Company's behalf against certain of its current and former officers and directors. The complaint is captioned Adolph-Laroche v. Clark, et al. and generally alleges that the individual defendants breached their fiduciary duties of candor, good faith and loyalty, wasted corporate assets and were unjustly enriched. On October 11, 2012, the Adolph-Laroche action was consolidated with the Martinez action and the case is now captioned In re Bridgepoint, Inc. Shareholder Derivative Action. A consolidated complaint was filed on December 18, 2012 and the defendants filed a motion to stay the case while the underlying securities class action is pending. The motion was granted by the Court on April 11, 2013. A status conference was held on October 10, 2013, during which the Court ordered the stay continued for the duration of discovery in the underlying securities class action, but permitted the plaintiff to receive copies of any discovery responses served in the underlying securities class action. The stay was lifted following the settlement of the underlying securities class action and all defendants filed demurrers on October 3, 2016, which are currently pending with the Court. Cannon v. Clark, et al. On November 1, 2013, a shareholder derivative complaint was filed in the U.S. District Court for the Southern District of California by James Cannon. In the complaint, the plaintiff asserts a derivative claim on the Company's behalf against certain of its current officers and directors. The complaint is captioned Cannon v. Clark, et al. and is substantially similar to the previously filed California State Court derivative action now captioned In re Bridgepoint, Inc. Shareholder Derivative Action. In the complaint, plaintiff generally alleges that the individual defendants breached their fiduciary duties of candor, good faith and loyalty, wasted corporate assets and were unjustly enriched. The lawsuit seeks unspecified monetary relief and disgorgement on behalf of the Company, as well as other equitable relief and attorneys' fees. Pursuant to a stipulation among the parties, on January 6, 2014, the Court ordered the case stayed during discovery in the underlying securities class action, but permitted the plaintiff to receive copies of any discovery responses served in the underlying securities class action. In September 2016, Plaintiff filed a request to voluntarily dismiss the case, which was approved by the Court. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) Di Giovanni v. Clark, et al., and Craig-Johnston v. Clark, et al. On December 9, 2013, two nearly identical shareholder derivative complaints were filed in the United States District Court for the Southern District of California. The complaints assert derivative claims on the Company's behalf against the members of the Company's board of directors as well as against Warburg Pincus & Co., Warburg Pincus LLC, Warburg Pincus Partners LLC, and Warburg Pincus Private Equity VIII, L.P. The two complaints are captioned Di Giovanni v. Clark, et al. and Craig-Johnston v. Clark, et al. The complaints generally allege that all of the defendants breached their fiduciary duties and were unjustly enriched and that the individual defendants wasted corporate assets in connection with the tender offer commenced by the Company on November 13, 2013. The lawsuits seek unspecified monetary relief and disgorgement, as well as other equitable relief and attorneys’ fees. On February 28, 2014, the defendants filed motions to dismiss, which were granted by the Court on October 17, 2014. On December 13, 2016, the dismissal was affirmed on appeal by the United States Court of Appeals for the Ninth Circuit. Klein v. Clark, et al. On January 9, 2014, a shareholder derivative complaint was filed in the Superior Court of the State of California in San Diego. The complaint asserts derivative claims on the Company's behalf against the members of the Company's board of directors as well as against Warburg Pincus & Co., Warburg Pincus LLC, Warburg Pincus Partners LLC, and Warburg Pincus Private Equity VIII, L.P. The complaint is captioned Klein v. Clark, et al. and generally alleges that all of the defendants breached their fiduciary duties and were unjustly enriched and that the individual defendants wasted corporate assets in connection with the tender offer commenced by the Company on November 13, 2013. The lawsuit seeks unspecified monetary relief and disgorgement, as well as other equitable relief and attorneys’ fees. On March 21, 2014, the Court granted the parties' stipulation to stay the case until the motions to dismiss in the related federal derivative action were decided. On November 14, 2014, the Court dismissed the case but retained jurisdiction in the event the dismissal in the federal case is reversed on appeal by the United States Court of Appeals for the Ninth Circuit. Reardon v. Clark, et al. On March 18, 2015, a shareholder derivative complaint was filed in the Superior Court of the State of California in San Diego. The complaint asserts derivative claims on the Company's behalf against certain of its current and former officers and directors. The complaint is captioned Reardon v. Clark, et al. and generally alleges that the individual defendants breached their fiduciary duties of candor, good faith and loyalty, wasted corporate assets and were unjustly enriched. The lawsuit seeks unspecified monetary relief and disgorgement, as well as other equitable relief and attorneys’ fees. Pursuant to a stipulation among the parties, on May 27, 2015, the Court ordered the case stayed during discovery in the underlying Zamir securities class action, but permitted the plaintiff to receive copies of any discovery conducted in the underlying Zamir securities class action. Larson v. Hackett, et al. On January 19, 2017, a shareholder derivative complaint was filed in the Superior Court of the State of California in San Diego. The complaint asserts derivative claims on the Company's behalf against certain of its current and former officers and directors. The complaint is captioned Larson v. Hackett, et al. and generally alleges that the individual defendants breached their fiduciary duties of candor, good faith and loyalty, wasted corporate assets and were unjustly enriched. The lawsuit seeks unspecified monetary relief and disgorgement, as well as other equitable relief and attorneys’ fees. The parties have not yet responded to the complaint, but will most likely seek to have the case stayed during discovery in the underlying Zamir securities class action. Nieder v. Ashford University, LLC On October 4, 2016, Dustin Nieder filed a purported class action against Ashford University in the Superior Court of the State of California in San Diego. The complaint is captioned Dustin Nieder v. Ashford University, LLC and generally alleges various wage and hour claims under California law for failure to pay overtime, failure to pay minimum wages and failure to provide rest and meal breaks. The lawsuit seeks back pay, the cost of benefits, penalties and interest on behalf of the putative class members, as well as other equitable relief and attorneys' fees. The Company filed an answer denying the claims and the BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) case is currently in discovery. The outcome of this legal proceeding is uncertain at this point because of the many questions of fact and law that may arise. Based on information available to the Company at present, it cannot reasonably estimate a range of loss for this action. Accordingly, the Company has not accrued any liability associated with this action. 22. Concentration of Risk Concentration of Revenue In 2016, Ashford University derived 81.2% and University of the Rockies derived 86.5% of their respective revenues (calculated in accordance with Department regulations) from students whose source of funding is through Title IV programs. See Note 19, “Regulatory - The “90/10” Rule.” Title IV programs are subject to political and budgetary considerations and are subject to extensive and complex regulations. The Company's administration of these programs is periodically reviewed by various regulatory agencies. Any regulatory violation could be the basis for the initiation of potentially adverse actions including a suspension, limitation or termination proceeding, which could have a material adverse effect on the Company's enrollments, revenues and results of operations. Students obtain access to federal student financial aid through a Department-prescribed application and eligibility certification process. Student financial aid funds are generally made available to students at prescribed intervals throughout their expected length of study. Students typically apply the funds received from the federal financial aid programs first to pay their tuition and fees. Any remaining funds are distributed directly to the student. Concentration of Credit Risk The Company maintains its cash and cash equivalents accounts in financial institutions. Accounts at these institutions are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. The Company performs ongoing evaluations of these institutions to limit its concentration risk exposure. Concentration of Sources of Supply The Company is dependent on a third-party provider for its online platform, which includes a learning management system that stores, manages and delivers course content, enables assignment uploading, provides interactive communication between students and faculty, and supplies online assessment tools. The partial or complete loss of this source may have an adverse effect on enrollments, revenues and results of operations. 23. Quarterly Results of Operations (Unaudited) The following tables set forth unaudited results of operations and certain operating results for each quarter during the years ended December 31, 2016 and 2015. The Company believes the information reflects all adjustments necessary to present fairly the information below. Basic and diluted earnings (loss) per share are computed independently for each of the quarters presented. Therefore, the sum of quarterly basic and diluted earnings (loss) per share information may not equal annual basic and diluted earnings (loss) per share. BRIDGEPOINT EDUCATION, INC. Notes to Annual Consolidated Financial Statements (Continued) | Based on the provided excerpt, here's a summary of the financial statement:
Company: Bridgepoint Education, Inc.
Key Financial Reporting Points:
1. Investment Classification:
- Trading securities: Short-term investments with gains/losses reflected in current earnings
- Available-for-sale securities: Carried at fair value with unrealized gains/losses reported in comprehensive income
- Held-to-maturity securities: Carried at amortized cost
2. Investment Evaluation:
- Regular monitoring of investment value
- Potential write-downs for other-than-temporary declines in asset value
3. Deferred Compensation:
- Management eligible to defer up to 80% of compensation
- Specific details of plan not fully provided in excerpt
4. Liabilities:
- Debt recorded within instructional costs and services
- Uncollectable student accounts written off through internal or third-party collection efforts | Claude |
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Shareholders, Audit Committee and Board of Directors of Mill City Ventures III, Ltd. Wayzata, Minnesota We have audited the accompanying balance sheets of Mill City Ventures III, Ltd.(the “Company”) as of December 31, 2016 and 2015, including the schedule of investments as of December 31, 2016 and 2015 and the related statements of operations, shareholders' equity and cash flows for the year ended December 31, 2016, and December 31, 2015 and the financial highlights for each of the four years in the period then ended. These financial statements and financial highlights are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of its internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as we as the overall financial statement presentation. Our procedures included confirmation of investments as of December 31, 2016 and 2015, by correspondence with the custodian, loan agents or borrowers. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above, including the schedule of investments, present fairly, in all material respects, the financial position of Mill City Ventures III, Ltd. as of December 31, 2016 and 2015 and the results of their operations and cash flows for the years ended December 31, 2016 and 2015 and the financial highlights for each of the four years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. As explained in note 7 to the financial statements, the accompanying financial statements include investments valued at $4,240,640, whose fair values have been estimated by the Valuation Committee and management in the absence of readily determinable fair values. Such estimates are based on financial and other information provided by management of its portfolio companies and pertinent market and industry data. These investments are valued in accordance with FASB ASC 820, Fair Value Measurement, which requires the Company to assume that the portfolio investments are sold in a principal market to market participants. The Company has considered its principal market as the market in which the Company exits its portfolio investments with the greatest volume and level of activity. ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to these valuation techniques are observable or unobservable. As of December 31, 2016, $4,240,640 of investments are valued based on unobservable inputs. Because such valuations, and particularly valuations of private investments and private companies, are inherently uncertain, they may fluctuate significantly over short periods of time. These determinations of fair value could differ materially from the values that would have been utilized had a ready market for these investments existed. /s/ Baker Tilly Virchow Krause, LLP Minneapolis, Minnesota March 28, 2017 Mill City Ventures III, Ltd. Balance Sheets The accompanying notes are an integral part of these financial statements. Mill City Ventures III, Ltd. Statements of Operations The accompanying notes are an integral part of these financial statements. Mill City Ventures III, Ltd. Statements of Shareholders’ Equity For the years ended December 31, 2016 and 2015 The accompanying notes are an integral part of these financial statements. Mill City Ventures III, Ltd. Statements of Cash Flows The accompanying notes are an integral part of these financial statements. Mill City Ventures III, Ltd. Investment Schedule As of December 31, The accompanying notes are an integral part of these financial statements. (1) All investments and all cash, restricted cash and cash equivalents are “qualifying assets” under Section 55(a) of the Investment Company Act of 1940 unless indicated to the contrary in the table or by footnote. (2)Interest is presented on a per annum basis. (3)Investment is secured but payment and collateral are subordinated to the debt of another creditor by contract. (4)Investment is convertible into common equity of the issuer. (5)In the case of warrants, warrants provide for the right to purchase common equity of the issuer. (6)In the case of preferred stock, this represents the right to annual cumulative dividends calculated on a per annum basis. (7)In the case of warrants, purchase rights under the warrants will expire at the close of business on this date. (8)Investment is not an income-producing investment. (9)Investment is neither a “qualifying asset” under Section 55(a) of the Investment Company Act of 1940, nor a restricted security. At December 31, 2016, aggregate non-qualifying assets represented approximately 8.3% of our total assets. (10)Value reflects 20% discount for restricted nature of securities. The accompanying notes are an integral part of these financial statements. Mill City Ventures III, Ltd Schedule of Investments As of December 31, The accompanying notes are an integral part of these financial statements. (1)All investments and all cash, restricted cash and cash equivalents are “qualifying assets” under Section 55(a) of the Investment Company Act of 1940 unless indicated to the contrary in the table or by footnote. (2)Interest is presented on a per annum basis. (3)Investment is secured but payment and collateral are subordinated to the debt of another creditor by contract. (4)Investment is convertible into common equity of the issuer. (5)In the case of warrants, warrants provide for the right to purchase common equity of the issuer. (6)In the case of preferred stock, this represents the right to annual cumulative dividends calculated on a per annum basis. (7)In the case of warrants, purchase rights under the warrants will expire at the close of business on this date. (8)Investment is not an income-producing investment. (9)Investment is neither a “qualifying asset” under Section 55(a) of the Investment Company Act of 1940, nor a restricted security. At December 31, 2015, aggregate non-qualifying assets represented approximately 10.1% of our total assets. The accompanying notes are an integral part of these financial statements. Mill City Ventures III, Ltd. NOTE 1 - ORGANIZATION Mill City Ventures III, Ltd. is an investment company incorporated in the State of Minnesota on January 10, 2006. In this report, we generally refer to Mill City Ventures III, Ltd. in the first person “we.” On occasion, we refer to our company in the third person as “Mill City Ventures” or the “Company.” We are an internally managed closed-end non-diversified management investment company. We have elected to be regulated as a business development company, or “BDC,” under the Investment Company Act of 1940 (the “1940 Act”). To date, we have not made an election to be treated as a regulated investment company, or “RIC,” under the Internal Revenue Code of 1986. We primarily focus on investing in or lending to privately held and small-cap publicly traded U.S. companies, and making managerial assistance available to such companies. These investments are typically structured as purchases of preferred or common stock, investment contracts, or loans evidenced by promissory notes that may be convertible into stock by their terms or that may be accompanied by the issuance to us of warrants or similar rights to purchase stock. Our investments may be made for purposes of financing acquisitions, recapitalizations, buyouts, organic growth and working capital. Our future revenues will relate to the gain we realize from the sale of securities we purchase, and to dividends and interest we derive from those securities. Our investment objective is to generate both current income and capital appreciation that ultimately become gains. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Use of estimates: The preparation of financial statements in conformity with GAAP requires management and our independent board members to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the date of the financial statements, as well as the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. For more information, see the “Valuation of portfolio investments” caption below, and “Note 4 - Fair Value of Financial Instruments” below. Cash deposits: We maintain our cash balances in financial institutions and with regulated financial investment brokers. Cash on deposit in excess of FDIC and similar coverage is subject to the usual banking risk of funds in excess of those limits. Valuation of portfolio investments: We carry our investments in accordance with ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), issued by the Financial Accounting Standards Board (“FASB”), which defines fair value, establishes a framework for measuring fair value, and requires disclosures about fair value measurements. Fair value is generally based on quoted market prices provided by independent pricing services, broker or dealer quotations, or alternative price sources. In the absence of quoted market prices, broker or dealer quotations, or alternative price sources, investments are measured at fair value as determined by the Valuation Committee of our Board of Directors based on, among other things, the input of our executive management, the Audit Committee of our Board of Directors, and any independent third-party valuation experts that may be engaged by management to assist in the valuation of our portfolio investments, but in all cases consistent with our written valuation policies and procedures. Due to the inherent uncertainties of valuation, certain estimated fair values may differ significantly from the values that would have been realized had a ready market for these investments existed, and these differences could be material. In addition, such investments are generally less liquid than publicly traded securities. If we were required to liquidate a portfolio investment in a forced or liquidation sale, we could realize significantly less than the value at which we have recorded it. Income taxes: We account for income taxes under the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. For more information, see Note 7 “Income Taxes.” Revenue recognition: Realized gains or losses on the sale of investments are calculated using the specific investment method. Interest income, adjusted for amortization of premiums and accretion of discounts, is recorded on an accrual basis. Discounts from and premiums to par value on securities purchased are accreted or amortized, as applicable, into interest income over the life of the related security using the effective-yield method. The amortized cost of investments represents the original cost, adjusted for the accretion of discounts and amortization of premiums, if any. Loans are generally placed on non-accrual status when principal or interest payments are past due 30 days or more, or when there is reasonable doubt that principal or interest will be collected in full. Accrued and unpaid interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability. Non-accrual loans are restored to accrual status when past-due principal and interest is paid and, in management’s judgment, are likely to remain current. We may make exceptions to the policy described above if a loan has sufficient collateral value and is in the process of collection. Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are payable by the portfolio company and are expected to be collected. Dividend income on common equity securities is recorded on the record date for private portfolio companies or on the ex-dividend date for publicly traded portfolio companies. Certain investments may have contractual payment-in-kind (“PIK”) interest or dividends. PIK represents accrued interest or accumulated dividends that are added to the loan principal or stated value of the investment on the respective interest- or dividend-payment dates rather than being paid in cash, and generally becomes due at maturity or upon being repurchased by the issuer. PIK interest or dividends is recorded as interest or dividend income, as applicable. If at any point we believe that PIK interest or dividends is not expected be realized, the PIK-generating investment will be placed on non-accrual status. Accrued PIK interest or dividends are generally reversed through interest or dividend income, respectively, when an investment in placed on non-accrual status. Allocation of net gains and losses: All income, gains, losses, deductions and credits for any investment are allocated in a manner proportionate to the shares owned. Management and service fees: We do not incur expenses related to management and service fees. Our executive management team manages our investments as part of their employment responsibilities. NOTE 3 - NET GAIN (LOSS) PER COMMON SHARE Basic net gain (loss) per common share is computed by dividing net gain (loss) by the weighted-average number of vested common shares outstanding during the period. A reconciliation of the numerator and denominator used in the calculation of basic and diluted net gain (loss) per common share follows: At December 31, 2016 and 2015, the Company did not have any options or warrants outstanding or any other dilutive common equivalent shares. NOTE 4 - COMMITMENTS AND CONTINGENCIES On June 6, 2013, we entered into an agreement to lease approximately 1,917 square feet of commercial space and two parking spots, for a period of 62 months. The leased space became available for occupancy on September 23, 2013. The 62-month lease term began October 1, 2013 and runs through November 30, 2018. The total base rent expense for the year ended December 31, 2016 and December 31, 2015 was $45,378 and $45,378, respectively. The following is a schedule of the required annual minimum lease payments. NOTE 5 - SHAREHOLDERS’ EQUITY At December 31, 2016, a total of 12,151,493 shares of common stock were issued and outstanding. NOTE 6 - INVESTMENTS The following table shows the composition of our investment portfolio by major class, at amortized cost and fair value, as of December 31, 2016 (together with the corresponding percentage of total portfolio investments): The following table shows the composition of our investment portfolio by major class, at amortized cost and fair value, as of December 31, 2015 (together with the corresponding percentage of total portfolio investments): The following table shows the composition of our investment portfolio by industry grouping, based on fair value as of December 31, 2016: The following table shows the composition of our investment portfolio by industry grouping, based on fair value as of December 31, 2015: We do not “control,” and we are not an “affiliate” (as each of those terms is defined in the 1940 Act), of any of our portfolio companies as of December 31, 2016. Under the 1940 Act, we would generally be presumed to “control” a portfolio company if we owned more than 25% of its voting securities, and be an “affiliate” of a portfolio company is we owned at least 5% and up to 25% of its voting securities. NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS General information: Accounting guidance establishes a hierarchal disclosure framework that prioritizes and ranks the level of market price observability of inputs used in measuring investments at fair value. Observable inputs must be used when available. Observable inputs are inputs that market participants would use in valuing the asset or liability based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or liability based upon the best information available. Assets and liabilities measured at fair value are to be categorized into one of the three hierarchy levels based on the relative observability of inputs used in the valuation. The three levels are defined as follows: ·Level 1: Observable inputs based on quoted prices (unadjusted) in active markets for identical assets or liabilities. ·Level 2: Observable inputs based on quoted prices for similar assets and liabilities in active markets, or quoted prices for identical assets and liabilities in inactive markets. ·Level 3: Unobservable inputs that reflect an entity’s own assumptions about what inputs a market participant would use in pricing the asset or liability based on the best information available in the circumstances. Our valuation policy and procedures: Under our valuation policies and procedures, we evaluate the source of inputs, including any markets in which our investments are trading, and then apply the resulting information in determining fair value. For our Level 1 investment assets, our valuation policy generally requires us to use the last quoted closing price of a security we own that is listed on a securities exchange, and in a case where a security we own is listed on an over-the-counter market, to average the last quoted bid and ask price on the most active market on which the security is quoted. In the case of traded debt securities the prices for which are not readily available, we may value those securities at their weighted-average yield to maturity. The estimated fair value of our Level 3 investment assets is determined on a quarterly basis by the Valuation Committee of our Board of Directors, pursuant to our written Valuation Policy and Procedures. These policies and procedures generally require that we value our Level 3 equity investments at cost plus any accrued interest, unless circumstances warrant a different approach. Our Valuation Policy and Procedures provide examples of these circumstances, such as when a portfolio company has engaged in a subsequent financing of more than a de minimis size involving sophisticated investors (in which case we may use the price involved in that financing as a determinative input absent other known factors), or when a portfolio company is engaged in the process of a transaction that we determine is reasonably likely to occur (in which case we may use the price involved in the pending transaction as a determinative input absent other known factors). Other situations identified in our Valuation Policy and Procedures that may serve as input supporting a change in the valuation of our Level 3 equity investments include (i) a third-party valuation conducted by an independent and qualified professional, (ii) changes in the performance of long-term financial prospects of the portfolio company, (iii) a subsequent financing that changes the distribution rights associated with the equity security we hold, or (iv) sale transactions involving comparable companies, but only if further supported by a third-party valuation conducted by an independent and qualified professional. When valuing preferred equity investments, we generally view intrinsic value as a key input. Intrinsic value means the value of any conversion feature (if the preferred investment is convertible) or the value of any liquidation or other preference. Discounts to intrinsic value may be applied in cases where the issuer’s financial condition is impaired or, in cases where intrinsic value relating to a conversion is determined to be a key input, to account for resale restrictions applicable to the securities issuable upon conversion. When valuing warrants, our Valuation Policy and Procedures indicate that value will generally be the difference between closing price of the underlying equity security and the exercise price, after applying an appropriate discount for restriction, if applicable, in situations where the underlying security is marketable. If the underlying security is not marketable, then intrinsic value will be considered consistent with the principles described above. Generally, “out-of-the-money” warrants will be valued at cost or zero. For non-traded (Level 3) debt securities with a residual maturity less than or equal to 60 days, the value will generally be the straight-line amortized face value of the debt unless justification for impairment exists. On a quarterly basis, our management provides members of our Valuation Committee with (i) valuation reports for each portfolio investment (which reports include our cost,, the most recent prior valuation and any current proposed valuation, and an indication of the valuation methodology used, together with any other supporting materials); (ii) Mill City Ventures’ bank and other statements pertaining to our cash and cash equivalents; and (iii) quarter- or period-end statements from our custodial firms holding any of our portfolio investments. The committee then discusses these materials and, consistent with the policies and approaches outlined above, makes final determinations respecting the valuation of our portfolio investments. We made no changes to our Valuation Policy and Procedures during the reporting period. Level 3 valuation information: Due to the inherent uncertainty in the valuation process, the estimate of the fair value of our investment portfolio as of December 31, 2016 may differ materially from values that would have been used had a readily available market for the securities existed. The following table presents the fair value measurements of our portfolio investments by major class, as of December 31, 2016, according to the fair value hierarchy: The following table presents the fair value measurements of our portfolio investments by major class, as of December 31, 2015, according to the fair value hierarchy The following table presents a reconciliation of the beginning and ending fair value balances for our Level 3 portfolio investment assets for the period ended December 31, 2016: The net change in unrealized appreciation for the period ended December 31, 2016 attributable to Level 3 portfolio investments still held at December 31, 2016 is $713,932, and is included in net change in unrealized appreciation (depreciation) on investments on the statement of operations. The following table presents a reconciliation of the beginning and ending fair value balances for our Level 3 portfolio investment assets for the period ended December 31, 2015: The net change in unrealized depreciation for the period ended December 31, 2015 attributable to Level 3 portfolio investments still held at December 31, 2015 was $1,235,987, and is included in net change in unrealized appreciation (depreciation) on investments on the statement of operations. There were no transfers between levels during the years ended December 31, 2016 and 2015. NOTE 8 - MINIMUM ASSET COVERAGE As a BDC, we are required to meet various regulatory tests. Among other things, these tests will require us to invest at least 70% of our total assets in private or small-cap public U.S.-based companies, and to maintain an asset coverage ratio of total assets (less all liabilities and indebtedness not represented by senior securities) to total indebtedness represented by senior securities and borrowings (including accrued interest payable) of at least 200%. As of December 31, 2016, approximately 89% of our investments (by fair value at that date) were in private or small-cap public U.S.-based companies and our asset coverage ratio was 100%. NOTE 9 - RELATED-PARTY TRANSACTIONS We maintain a Code of Ethics and certain other policies relating to conflicts of interest and related-party transactions, as well as policies and procedures relating to what regulations applicable to BDCs generally describe as “affiliate transactions.” Nevertheless, from time to time we may hold investments in portfolio companies in which certain members of our management, our Board of Directors, or significant shareholders of ours, are also directly or indirectly invested. Our Board of Directors has adopted a policy to require our disclosure of these instances in our periodic filings with the SEC. Our related-party transactions requiring disclosure under this policy are: ·Mr. Joseph A. Geraci, II, our Chief Financial Officer, and Mr. Douglas M. Polinsky, our Chief Executive Officer, hold direct and indirect interests in the common stock of Southern Plains Resources, Inc., a company in which we made investments in common stock in each of March and July 2013. ·A former director of our company, Christopher Larson, had a direct interest in Mix 1 Life, Inc. and served as that company’s Chief Financial Officer at the time of a portfolio investment we made in secured convertible debt of Mix 1 Life (together with common stock purchase warrants) in February 2014. In June 2014, Mr. Larson became a director of Mix 1 Life. In August 2014, we exercised our common stock purchase warrant on a cashless basis for the purchase of Mix 1 Life common stock. In March 2015, we invested in additional secured debt of Mix 1 Life. Mr. Larson resigned from his position as a director of Mill City Ventures in November 2015. ·Lantern Advisors, LLC is a limited liability company equally owned by Messrs. Geraci and Polinsky, and owns a cashless warrant to purchase up to 153,846 shares of Creative Realities, Inc. at a price of $0.70 per share through July 14, 2019. We made an initial investment in secured convertible debt of Creative Realities (together with common stock purchase warrants) in February 2015, and then a subsequent investment in secured convertible debt of Creative Realities (together with common stock purchase warrants) in December 2015. In December 2015, we also exchanged our common stock purchase warrant obtained in February 2015 for shares of Creative Realities common stock. NOTE 10 - INCOME TAXES We plan to be taxed as a regulated investment company, or “RIC,” and intend to comply with the requirements of the Internal Revenue Code applicable to RICs. Currently, however, we have not elected to be treated as a RIC. Upon our election to be taxed as a RIC, we will be required to distribute at least 90% of our investment company taxable income, and we intend at that time to distribute to shareholders (or retain through a deemed distribution) all of our investment company taxable income and net capital gain. Based on the foregoing, we have made no provision for income taxes. The characterization of income and gains that we will distribute is determined in accordance with income tax regulations that may differ from GAAP. Book and tax basis differences relating to shareholder dividends and distributions and other permanent book and tax differences are reclassified to paid-in capital. NOTE 11 - FINANCIAL HIGHLIGHTS The following is a schedule of financial highlights for the years ended December 31, 2016 through 2013: (1)Per-share data was derived using the weighted-average number of shares outstanding for the period. (2)Based on the monthly average of net assets as of the beginning and end of each period presented. (3)Ratios are annualized. NOTE 12 - SUBSEQUENT EVENTS On January 6, 2017, we received $726,785 from BiteSquad.com, LLC on the sale of 26,457 preferred LLC units. In February 2017, we commenced actions to take title to and possession of, with the intent of consummating periodic public foreclosure sales, shares of Mix 1 Life, Inc. that had been pledged to us by third parties as collateral security for obligations owed to us under secured promissory notes. As of the date of this report, we have obtained title to and engaged in one or more public sales of the pledged shares. On March 15, 2017, we filed a complaint in the Superior Court for the State of Arizona, Maricopa County, against defendants Mix 1 Life, Inc., a Nevada corporation, and Messrs. Christopher Larson and Cameron Robb. The complaint alleges breaches of contract on the part of the defendants in connection with a default by Mix 1 Life on two senior secured promissory notes having an aggregate original principal amount of $750,000. Please see Part I, Item 3, “Legal Proceedings” for more information. On February 2, 2017, we entered into a mezzanine loan agreement with DBR Enclave US Investors, LLC for a total commitment of $500,000, of which $333,333 was called. The promissory note we obtained in exchange for our investment bears interest at the per annum rate of 15% and matures on June 30, 2021. ITEM 9 | Here's a summary of the financial statement excerpt:
The document appears to be a partial financial statement focusing on accounting methods and principles:
Profit/Loss:
- Investment losses calculated using specific investment method
- Interest income recorded on accrual basis
- Discounts and premiums on securities amortized over security's life
- Investments valued at amortized cost
- Loans placed on non-accrual status after 30 days past due
Expenses:
- Involves estimates and potential contingent liabilities
- Actual results may differ from initial estimates
Assets and Liabilities:
- Brief mentions of total assets and debt obligations
- Incomplete details provided in this excerpt
Note: The summary is based on the limited information provided, as the document seems to be a fragment of a larger financial statement. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Management’s Report on Internal Control over Financial Reporting The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Securities Exchange Act Rule 13a-15(f). Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance that the objectives of the control system are met and may not prevent or detect misstatements. In addition, any evaluation of the effectiveness of internal controls over financial reporting in future periods is subject to the risk that those internal controls may become inadequate because of change in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (principal executive officer) and the Chief Financial Officer (principal financial officer), the Company’s management conducted an evaluation of the effectiveness of its internal control over financial reporting as of February 29, 2016. In making this assessment, the Company’s management used the criteria set forth in the framework in “Internal Control - Integrated Framework (1992)” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the evaluation conducted under the framework in “Internal Control - Integrated Framework (1992)”, the Company’s management concluded that the Company’s internal control over financial reporting was not effective as of February 29, 2016 due to the material weakness described below. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The Company’s management determined that the following material weakness existed as of February 29, 2016: ●The Company concluded that certain controls over accounting of work in process inventory did not operate with sufficient precision. This material weakness was first identified in the third quarter of fiscal year 2015. Due to the manual nature of the critical inventory accounting process, the work in process inventory is susceptible to material misstatements as there is a significant amount of costing performed in electronic spreadsheets of the Company’s work in process inventory. This weakness previously resulted in a material misstatement of work in process inventory and as a result has impacted other financial statement areas including total assets, cost of sales and net income. This control deficiency, if not remediated, could result in a future misstatement of the valuation of work in process inventory. This Management’s Report of Internal Control over Financial Reporting does not include an attestation report of our independent registered public accounting firm due to the exemption provisions established by the results of the Securities and Exchange Commission for smaller reporting companies. As of February 29, 2016, the Company’s Management has implemented the following measures to remediate the internal control deficiency: ●Management is engaging an outside consultant with expertise to automate its inventory and will be researching potential software systems to implement automation. ●Implementation of a process for review and verification of all manually entered data with respect to the valuation of work in process inventory by a second person with an appropriate level of accounting knowledge, experience and training. The Company is actively seeking an individual with proper qualifications and competency. ●Automatic data/price verification procedures such as the lower of cost or market value testing. ●Analytical review of inventory against expectations and benchmarks designed to identify potential material misstatements in the inventory valuation. Additionally, the Company now performs inventory valuations quarterly, compared to twice yearly in prior years. The Company’s management believes the foregoing efforts will effectively remediate the material weakness after this control has operated effectively for a reasonable period of time. As we continue to evaluate and work to improve our internal control over financial reporting, management may determine to take additional measures to address the material weakness or determine to modify the remediation plan described above. Solitron Devices, Inc. June 15, 2016 ACCOUNTING FIRM To the Board of Directors and Shareholders of Solitron Devices, Inc. We have audited the accompanying balance sheets of Solitron Devices, Inc. as of February 29, 2016 and February 28, 2015, and the related statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the years ended February 29, 2016 and February 28, 2015. Solitron Devices, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Solitron Devices, Inc. as of the years ended February 29, 2016 and February 28, 2015, and the results of its operations and its cash flows for each of the years in the two-year period ended February 29, 2016, in conformity with accounting principles generally accepted in the United States of America. /s/ Goldstein Schechter Koch, P.A. Fort Lauderdale, Florida June 15, 2016 SOLITRON DEVICES, INC. BALANCE SHEETS AS OF FEBRUARY 29, 2016 AND FEBRUARY 28, 2015 The accompanying notes are an integral part of the financial statements. SOLITRON DEVICES, INC. STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE YEARS ENDED FEBRUARY 29, 2016 AND FEBRUARY 28, 2015 The accompanying notes are an integral part of the financial statements. SOLITRON DEVICES, INC. STATEMENTS OF STOCKHOLDERS’ EQUITY Years Ended February 29, 2016 and FEBRUARY 28, 2015 The accompanying notes are an integral part of the financial statements. SOLITRON DEVICES, INC. STATEMENTS OF CASH FLOWS YEARS ENDED FEBRUARY 29, 2016 AND FEBRUARY 28, 2015 The accompanying notes are an integral part of the financial statements. SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations and Activities Solitron Devices, Inc., a Delaware corporation (the “Company” or “Solitron”), designs, develops, manufactures, and markets solid-state semiconductor components and related devices primarily for the military and aerospace markets. The Company was incorporated under the laws of the State of New York in 1959 and reincorporated under the laws of the State of Delaware in August 1987. Basis of Presentation The financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America. Cash and Cash Equivalents Cash and cash equivalents include demand deposits and money market accounts. Investment in Treasury Bills and Certificates of Deposit Investment in Treasury Bills/Certificates of Deposit includes treasury bills with maturities of one year or less, and Certificates of Deposit with maturities from one to three years, and is stated at market value. All of the Company’s investments are classified as available-for-sale. As they are available for current operations, they are classified as current on the balance sheets. Investments in available-for-sale securities are reported at fair value with unrecognized gains or losses, net of tax, as a component of accumulated other comprehensive income and is included as a separate component of stockholders’ equity. The Company monitors its investments for impairment periodically and records appropriate reductions in carrying values when the declines are determined to be other-than-temporary. The following table summarizes the Company's available-for-sale investments: SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS At February 29, 2016 and February 28, 2015, the deferred tax liability related to unrecognized gains and losses on short-term investments was $0. As of February 29, 2016, contractual maturities of the Company's available-for-sale non-equity investments were as follows: Fair Value of Financial Instruments Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures” defines “fair value” as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also sets forth a valuation hierarchy of the inputs (assumptions that market participants would use in pricing an asset or liability) used to measure fair value. This hierarchy prioritizes the inputs into the following three levels: Level 1. Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities traded in active markets. Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3: Inputs that are generally unobservable. These inputs may be used with internally developed methodologies that results in management’s best estimate of fair value. The Company’s Treasury bills and brokered certificates of deposits are subject to level 1 fair value measurement. The carrying amounts of the Company’s short-term financial instruments, including accounts receivable, accounts payable, accrued expenses and other liabilities approximate their fair value due to the relatively short period to maturity for these instruments. The fair value of long-term debt is based on current rates at which the Company could borrow funds with similar remaining maturities, and the carrying amount of the long-term debt approximates fair value. Accounts Receivable Accounts receivable consists of unsecured credit extended to the Company’s customers in the ordinary course of business. The Company reserves for any amounts deemed to be uncollectible based on past collection experiences and an analysis of outstanding balances, using an allowance account. The allowance amount was $2,000 as of February 29, 2016 and February 28, 2015. Shipping and Handling Shipping and handling costs billed to customers are recorded in net sales. Shipping costs incurred by the Company are recorded in cost of sales. SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS Inventories Inventories are stated at the lower of cost or market. Cost is determined using the “first-in, first-out” (FIFO) method. The Company buys raw material only to fill customer orders. Excess raw material is created only when a vendor imposes a minimum buy in excess of actual requirements. Such excess material will usually be utilized to meet the requirements of the customer’s subsequent orders. If excess material is not utilized after two fiscal years it is fully reserved. Any inventory item once designated as reserved is carried at zero value in all subsequent valuation activities. The Company’s inventory valuation policy is as follows: Raw material /Work in process: All material purchased, processed, and/or used in the last two fiscal years is valued at the lower of its acquisition cost or market. All material not purchased/used in the last two fiscal years is fully reserved. Finished goods: All finished goods with firm orders for later delivery are valued (material and overhead) at the lower of cost or market. All finished goods with no orders are fully reserved. Direct labor costs: Direct labor costs are allocated to finished goods and work in process inventory based on engineering estimates of the amount of man-hours required from the different direct labor departments to bring each device to its particular level of completion. Property, Plant and Equipment Property, plant, and equipment is recorded at cost. Major renewals and improvements are capitalized, while maintenance and repairs that do not extend their expected life are expensed as incurred. Depreciation is provided on a straight-line basis over the estimated useful lives of the related assets: Concentrations of Credit Risk Financial instruments, which potentially subject the Company to concentration of credit risk, consist principally of cash and trade receivables. The Company places its cash with high credit quality institutions. At times, such amounts may be in excess of the FDIC insurance limits. The Company has not experienced any losses in such accounts and believes that it is not exposed to any significant credit risk on the accounts. As of February 29, 2016, all non-interest bearing checking accounts were FDIC insured to a limit of $250,000. Deposits in excess of FDIC insured limits were approximately $374,000 at February 29, 2016. With respect to the trade receivables, most of the Company’s products are custom made pursuant to contracts with customers whose end-products are sold to the United States Government. The Company performs ongoing credit evaluations of its customers’ financial condition and maintains allowances for potential credit losses. Actual losses and allowances have historically been within management’s expectations. Revenue Recognition Revenue is recognized in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition. This pronouncement requires that four basic criteria be met before revenue can be recognized: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectability is reasonably assured. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time of product shipment. Shipping terms are generally FCA (Free Carrier) shipping point. Income Taxes Income taxes are accounted for under the asset and liability method of ASC 740-10, “Income Taxes”. Deferred tax assets and liabilities are recognized for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740-10, the effect on deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS The Company adopted guidance related to accounting for uncertainty in income taxes in accordance with ASC 740-10 and began evaluating tax positions utilizing a two-step process. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination based on the technical merits of the position. The second step is to measure the benefit to be recorded from tax positions that meet the more-likely-than-not recognition threshold by determining the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement and recognizing that amount in the financial statements. Solitron has adopted ASC 740-10 and no material impact on its financial condition, results of operations, cash flows, or disclosures occurred upon adoption. Net (Loss) Income Per Common Share Net (loss) income per common share is presented in accordance with ASC 260-10 “Earnings per Share.” Basic earnings per common share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share incorporate the incremental shares issuable upon the assumed exercise of stock options to the extent they are not anti-dilutive using the treasury stock method. Due to the loss, there is no effect from dilution on earnings per share. Impairment of long-lived assets Potential impairments of long-lived assets are reviewed annually or when events and circumstances warrant an earlier review. In accordance with ASC Subtopic 360-10, "Property, Plant and Equipment - Overall," impairment is determined when estimated future undiscounted cash flows associated with an asset are less than the asset’s carrying value. Financial Statement Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates and the differences could be material. Such estimates include depreciable life of property and equipment, accounts receivable allowance, deferred tax valuation allowance, and allowance for inventory obsolescence. Stock based compensation The Company records stock-based compensation in accordance with the provisions of ASC Topic 718, "Compensation-Stock Compensation," which establishes accounting standards for transactions in which an entity exchanges its equity instruments for goods or services. Under ASC Topic 718, the Company recognizes an expense for the fair value of outstanding stock options and grants as they vest, whether held by employees or others. No vesting of stock options occurred during the year ended February 29, 2016 or February 28, 2015. Recent Accounting Pronouncements No recent accounting pronouncements affecting the Company were issued by the Financial Accounting Standards Board or other standards-setting bodies. 2. EARNINGS PER SHARE The shares used in the computation of the Company’s basic and diluted earnings per common share were as follows: SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS Weighted average common shares outstanding, assuming dilution, include the incremental shares that would be issued upon the assumed exercise of stock options. All stock options outstanding as of February 29, 2016 were anti-dilutive. 8,400 of the Company’s outstanding stock options for the fiscal year ended February 28, 2015 was excluded from the calculation of diluted earnings per share because the exercise prices of the stock options were greater than or equal to the average price of the common shares, and therefore their inclusion would have been anti-dilutive. 3. INVENTORIES As of February 29, 2016, inventories consist of the following: As of February 28, 2015, inventories consist of the following: 4. PROPERTY, PLANT AND EQUIPMENT As of February 29, 2016 and February 28, 2015, property, plant, and equipment consist of the following: Depreciation and amortization expense was $208,000 and $223,000 for the years ended 2016 and 2015, respectively and is included in Cost of Sales in the accompanying Statements of Income. SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS 5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES As of February 29, 2016 and February 28, 2015, accrued expenses and other current liabilities consist of the following: 6. INCOME TAXES At February 29, 2016, the Company has net operating loss carryforwards of approximately $10,122,000 that expire through February 2029. Such net operating losses are available to offset future taxable income, if any. As the utilization of such net operating losses for tax purposes is not assured, the deferred tax asset has been fully reserved through the recording of a 100% valuation allowance. Should a cumulative change in the ownership of more than 50% occur within a three-year period, there could be an annual limitation on the use of the net operating loss carryforwards. Total net deferred taxes are comprised of the following at February 29, 2016 and February 28, 2015: The change in the valuation allowance on deferred tax assets is due principally to the utilization of the net operating loss for the years ended February 29, 2016 and February 28, 2015. A reconciliation of the U.S. federal statutory tax rate to the Company’s effective tax rate for fiscal year ended February 29, 2016 and February 28, 2015 is as follows: SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS 7. STOCK OPTIONS The Company’s 2000 Stock Option Plan provides that stock options are valid for ten years and vest twelve months after the award date unless otherwise stated in the option awards. The 2000 Stock Option Plan terminated pursuant to its terms in July 2010. The Company’s 2007 Stock Incentive Plan allows the Company to grant common stock, options, restricted stock, and stock appreciation rights to eligible individuals. As of February 29, 2016, the Company had not granted any awards under the 2007 Stock Incentive Plan. On January 23, 2006, the Board of Directors granted stock options to certain key employees and directors. The options, which became vested on January 23, 2007, were for a total of 14,700 shares and the exercise price was fixed at $3.95 per share, which was the price on the OTCBB at the time of the grant. The options were exercisable through January 23, 2016. The remaining options balance is -0- as of February 29, 2016. On May 16, 2005, the Board of Directors granted stock options to certain key employees and directors. The options, which became vested on May 15, 2006, were for a total of 47,000 shares and the exercise price was fixed at $0.75 per share, which was the price on the OTCBB at the time of the grant. The options were exercisable through May 15, 2015. The remaining options balance was -0- as of February 29, 2016. There are no options from this grant that remain outstanding. On May 17, 2004, the Board of Directors granted stock options to certain key employees and directors. The options, which became vested on May 16, 2005, were for a total number of 47,500 shares and the exercise price was fixed at $1.05 per share, which was the price on the OTCBB at the time of the grant. The options were exercisable through May 16, 2014. There are no options from this grant that remain outstanding. On May 17, 2004, the Board of Directors awarded the Company’s President options totaling 175,636 shares, which are fully vested. The exercise price of these options was fixed at $1.05 per share (the closing price on the OTCBB at the time of the grant). The remaining options balance is 35,449 as of February 29, 2016. In December 2000, a grant equal to 10% of the outstanding shares (254,624) was made to the Company’s President at the exercisable price of $0.40 per share (the closing stock price on the date of the grant). Fifty percent (50%) of the total number of shares was immediately exercisable and the other 50% vested in five equal installments over the following five years. All of these options are fully vested. The remaining options balance is 254,624 as of February 29, 2016. Below is a summary of the Company’s Stock Option Activity: No options were granted in the years ended February 29, 2016 and February 28, 2015. SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS On June 18, 2015 the CEO exercised a portion of his options for 140,187 shares, of which 29,315 shares were withheld by the Company to cover the federal income taxes due upon exercising, and as a result the Company issued 110,872 shares. All of the Company’s outstanding options were vested as of February 29, 2016. No options vested during the years ended February 29, 2016 and February 28, 2015. The following table summarizes information about stock options outstanding and exercisable at February 29, 2016: All options with a remaining contractual life outstanding are fully vested. 8. EMPLOYEE BENEFIT PLANS The Company has a 401k and Profit Sharing Plan (the "Profit Sharing Plan") in which substantially all employees may participate after three months of service. Contributions to the Profit Sharing Plan by participants are voluntary. The Company may match participant's contributions up to 25% of 4% of each participant's annual compensation. In addition, the Company may make additional contributions at its discretion. The Company did not contribute to the Profit Sharing Plan during the fiscal years ended February 29, 2016 and February 28, 2015. 9. EXPORT SALES AND MAJOR CUSTOMERS Revenues from domestic and export sales to unaffiliated customers for the year ended February 29, 2016 are as follows: Revenues from domestic and export sales to unaffiliated customers for the year ended February 28, 2015 are as follows: SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS Revenues from domestic and export sales are attributed to global geographic regions according to the location of the customer’s primary manufacturing or operating facilities. Sales to the Company's top two customers accounted for 62% of net sales for the year ended February 29, 2016 as compared with 63% of the Company's net sales for the year ended February 28, 2015. Sales to Raytheon Company accounted for approximately 49% of net sales for the year ended February 29, 2016 and 48% for the year ended February 28, 2015. Sales to the second largest customer, the United States Government, for the years ended February 29, 2016 and February 28, 2015 accounted for 13% and 15% of net sales respectively. 10. MAJOR SUPPLIERS For the year ended February 29, 2016, purchases from the Company’s top supplier, Egide USA Inc. accounted for 15% of the Company's total purchases of production materials, and all other suppliers were individually less than 9% of purchases. For the year ended February 28, 2015, purchases from the Company’s two top suppliers, Egide USA Inc. and Wuxi Streamtek Ltd., accounted for 30% of the Company’s total purchases of production materials. 11. COMMITMENTS AND CONTINGENCIES Employment Agreement In December 2000, the Company entered into a five-year employment agreement with its President. On January 14, 2013, the Company amended the employment agreement with its President. This agreement provides, among other things, for annual compensation of $240,000 and a bonus pursuant to a formula. The agreement stipulates that the President shall be entitled to a bonus equal to fifteen percent (15%) of the Company’s pre-tax income in excess of Two Hundred Fifty Thousand Dollars ($250,000). For purposes of the agreement, “pre -tax income” shall mean net income before taxes, excluding (i) all extraordinary gains or losses, (ii) gains resulting from debt forgiven associated with the buyout of unsecured creditors, and (iii) any bonuses paid to the President. The bonus payable thereunder shall be paid within ninety (90) days after the end of the fiscal year. On January 14, 2014 the President exercised a cost-of-living increase clause in his contract increasing his annual base salary to $296,500. On December 5, 2014, the Compensation Committee approved an increase to Mr. Saraf’s annual base salary to $321,500, effective December 1, 2014. The Company accrued $105,000 as a bonus to Mr. Saraf for the fiscal year ended February 28,2015. On December 22, 2015, the Compensation Committee approved the contractual cost-of-living increase to Mr. Saraf’s annual base salary of 0.5%, resulting in an annual base salary of $323,107. The Company has not accrued any bonus for Mr. Saraf in fiscal year 2016. The President’s employment agreement stipulates, in Article 2.2, “Option to Extend”, that the contract is automatically extended for one year periods unless a notice is given by either party at least 180 days prior to the expiration of the term or any extensions. Upon execution of the agreement, the President received a grant of options to purchase ten percent (10%) of the outstanding shares of the Company’s common stock, par value $.01 calculated on a fully diluted basis, at an exercise price per share equal to the closing asking price of the Company’s common stock on the OTCBB on the date of the grant ($0.40). Fifty percent (50%) of the Initial Stock Options granted were vested immediately upon grant. The remaining fifty percent (50%) of the Initial Stock Options vested in equal amounts on each of the first five anniversaries of the date of grant. These options were fully vested during the year ended February 28, 2006. Since November, 2, 2015, the Company reduced all exempt employees’ annual salaries (paid in weekly installments), including the President’s salary, by 10%, giving the President an effective annual salary of $291,000. SOLITRON DEVICES, INC. NOTES TO FINANCIAL STATEMENTS As part of the Company’s decision, starting November 2, 2015, to reduce the work week schedule to 36 hours, the President voluntarily agreed to the temporary reduction to work schedule and salary which is still in effect. Operating leases: On October 1, 2015, the Company extended its current lease with its landlord, CF EB REO II LLC, for the occupancy and use of its 47,000 square foot facility located at 3301 Electronics Way, West Palm Beach, Florida 33407 (the “Lease”). The property subsequently was sold to La Boheme Properties, Inc., a Florida corporation, which is the current landlord as the Lease was assigned to them. The term of the Lease ends on December 31, 2021. The base rent provided in the Lease is $34,451 per month. The Company has the option to extend the term of the Lease for an additional five years beginning on January 1, 2022 and ending on December 31, 2026. Commencing on January 1, 2016 and on the first day of January of every subsequent year, the base rent will be increased to compensate for changes in the cost of living, provided that in no event will the base rent be increased by less than three percent nor more than five percent annually. Future minimum lease payments for this non-cancelable operating lease are as follows: Rent expense for the fiscal years ended February 29, 2016 and February 28, 2015 was approximately $415,000 and $370,000, respectively. 12. OTHER INCOME During the fiscal year ended February 29, 2016, the Company recognized no other income. During the fiscal year ended February 28, 2015, the Company recognized approximately $8,000 of other income attributable to cancellation of debt. 13. STOCKHOLDERS’ EQUITY On May 29, 2015 the Board of Directors authorized a stock repurchase program under which the Company may repurchase up to $500,000 of its outstanding common stock from time to time through February 29, 2016 on the open market or in privately negotiated transactions. On July 28, 2015, the Company announced that its Board of Directors had expanded the stock repurchase program to cover repurchases of up to $1,000,000 of its outstanding common stock from time to time through February 29, 2016 on the open market or in privately negotiated transactions. In November 2015, pursuant to the Company’s previously authorized stock repurchase program, the Company repurchased 65,027 shares of outstanding common stock at $4.30 per share from a stockholder in a privately negotiated transaction for an aggregate price of approximately $280,000 On January 15, 2016, the Board of Directors amended the Company’s previously authorized stock repurchase program. Under the Company’s previously authorized stock repurchase program, the Company was authorized to repurchase up to $1,000,000 of its outstanding common stock from time to time through February 29, 2016 on the open market or in privately negotiated transactions. Under the amended stock repurchase program, the Company may acquire up to $1,000,000 of its outstanding common stock from time to time, increasing the Company’s authorization from the $720,000 remaining and eliminating the expiration date of February 29, 2016. Purchases under the amended stock repurchase program may be made through the open market or privately negotiated transactions as determined by the Company’s management, and in accordance with the requirements of the Securities and Exchange Commission. The timing and actual number of shares repurchased will depend on variety of factors including price, corporate and regulatory requirements and other conditions. In July 2015, the Company paid a dividend of $0.25 per share to all stockholders of record as of the close of business on June 29th, 2015. The aggregate dividend payment was approximately $575,000. During the fiscal year ending February 29th, 2016 an aggregate of 112,172 shares of employee stock options were exercised. The company received approximately $11,000 for exercise of those options. 14. SUBSEQUENT EVENTS There are no subsequent events to report. Management has evaluated the subsequent events through June 15, 2016, the date the financial statements were issued. | Based on the provided text, here's a summary of the financial statement:
Financial Overview:
- The statement appears to be for a smaller reporting company
- There are potential control deficiencies related to work in process inventory valuation
- No independent accounting firm attestation report is included due to SEC exemptions
Key Financial Components:
- Assets: Total assets, cost of sales, and net income reported
- Liabilities: Long-term debt valued based on current borrowing rates
- Accounts Receivable:
* Unsecured credit extended to customers
* Allowance for uncollectible amounts: $2,000
- Expenses: Liabilities traded in active markets (Level 2)
Notable Observations:
- Potential risk of future misstatement in inventory valuation
- Lack of independent accounting verification
- Date referenced: February 29 (year not specified)
The statement suggests some | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Quarterly operating results for 2016 and 2015 are presented in the table below (in thousands, except per unit amounts): (1) The fourth quarter of 2016 includes favorable results from fall and winter seasonal events as well as the benefit of strong post-season expense management. (2) The fourth quarter of 2015 included a non-cash charge of $8.6 million for the impairment of a long-lived asset at Cedar Point. Note: To assure that our highly seasonal operations will not result in misleading comparisons of interim periods, the Partnership has adopted the following reporting procedures: (a) seasonal operating costs are expensed over the operating season, including some costs incurred prior to the season, which are deferred and amortized over the season, and (b) all other costs are expensed as incurred or ratably over the entire year. ACCOUNTING FIRM To the Board of Directors and the Unitholders of Cedar Fair, L.P. Sandusky, Ohio We have audited the accompanying consolidated balance sheets of Cedar Fair, L.P. and subsidiaries (the "Partnership") as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive income, partners' equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Cedar Fair, L.P. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Partnership's internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2017 expressed an unqualified opinion on the Partnership's internal control over financial reporting. /s/ DELOITTE & TOUCHE LLP Cleveland, Ohio February 24, 2017 CEDAR FAIR, L.P. CONSOLIDATED BALANCE SHEETS (In thousands) The accompanying are an integral part of these statements. CEDAR FAIR, L.P. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (In thousands, except per unit amounts) The accompanying are an integral part of these statements. CEDAR FAIR, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) The accompanying are an integral part of these statements. CEDAR FAIR, L.P. CONSOLIDATED STATEMENTS OF PARTNERS’ EQUITY (In thousands, except per unit amounts) The accompanying are an integral part of these statements. Notes To Consolidated Financial Statements (1) Partnership Organization: Cedar Fair, L.P. (together with its affiliated companies, the "Partnership") is a Delaware limited partnership that commenced operations in 1983 when it acquired Cedar Point, Inc., and became a publicly traded partnership in 1987. The Partnership's general partner is Cedar Fair Management, Inc., an Ohio corporation (the “General Partner”), whose shares are held by an Ohio trust. The General Partner owns a 0.001% interest in the Partnership's income, losses and cash distributions, except in defined circumstances, and has full responsibility for management of the Partnership. At December 31, 2016 there were 56,200,555 outstanding limited partnership units listed on The New York Stock Exchange, net of 861,428 units held in treasury. At December 31, 2015, there were 56,017,824 outstanding limited partnership units listed, net of 1,044,159 units held in treasury. The General Partner may, with the approval of a specified percentage of the limited partners, make additional capital contributions to the Partnership, but is only obligated to do so if the liabilities of the Partnership cannot otherwise be paid or there exists a negative balance in its capital account at the time of its withdrawal from the Partnership. The General Partner, in accordance with the terms of the Partnership Agreement, is required to make regular cash distributions on a quarterly basis of all the Partnership's available cash, as defined in the Partnership Agreement. In accordance with the Partnership agreement and restrictions within the Partnership's 2013 Credit Agreement, the General Partner paid $3.33 per limited partner unit in distributions, or approximately $187.2 million in aggregate, in 2016. (2) Summary of Significant Accounting Policies: The following policies are used by the Partnership in its preparation of the accompanying consolidated financial statements. Principles of Consolidation The consolidated financial statements include the accounts of the Partnership and its subsidiaries, all of which are wholly owned. Intercompany transactions and balances are eliminated in consolidation. Foreign Currency The financial statements of the Partnership's Canadian subsidiary are measured using the Canadian dollar as its functional currency. Assets and liabilities are translated into U.S. dollars at current currency exchange rates, while income and expenses are translated at average monthly currency exchange rates. Translation gains and losses are included as components of accumulated other comprehensive income in partners' equity. In 2016, the Partnership recognized a $14.7 million benefit to earnings for unrealized/realized foreign currency gains, $14.8 million of which related to U.S.-dollar denominated debt held at its Canadian property. In 2015, the Partnership recognized a $81.0 million charge to earnings for unrealized/realized foreign currency losses, $81.6 million of which represented an unrealized foreign currency loss on the U.S.-dollar denominated debt held at its Canadian property. In 2014, the Partnership recognized a $40.9 million charge to earnings for unrealized/realized foreign currency losses, $39.1 million of which represented an unrealized foreign currency loss on the U.S.-dollar denominated debt held at its Canadian property. All other foreign currency transaction gains and losses included in the 2016, 2015 and 2014 consolidated statements of operations were not material. Segment Reporting Each of the Partnership's parks operates autonomously, and management reviews operating results, evaluates performance and makes operating decisions, including the allocation of resources, on a property-by-property basis. In addition to reviewing and evaluating performance of the business at the individual park level, the structure of the Partnership's management incentive compensation systems are centered around the operating results of each park as an integrated operating unit. Therefore, each park represents a separate operating segment of the Partnership's business. Although the Partnership manages its parks with a high degree of autonomy, each park offers and markets a similar collection of products and services to similar customers. In addition, the parks all have similar economic characteristics, in that they all show similar long-term growth trends in key industry metrics such as attendance, in-park per capita spending, net revenue, operating costs and operating profit. Therefore, the Partnership operates within a single reportable segment of amusement/water parks with accompanying resort facilities. Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during each period. Actual results could differ from those estimates. Cash and Cash Equivalents The Partnership considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. Inventories The Partnership's inventories primarily consist of purchased products, such as merchandise and food, for sale to its customers. Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) or average cost methods of accounting at the park level. Property and Equipment Property and equipment are recorded at cost. Expenditures made to maintain such assets in their original operating condition are expensed as incurred, and improvements and upgrades are generally capitalized. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets. Depreciation expense totaled $131.2 million in 2016, $125.5 million in 2015, and $124.3 million in 2014. The estimated useful lives of the assets are as follows: Impairment of Long-Lived Assets Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 360 “Property, Plant, and Equipment” requires that long-lived assets be reviewed for impairment upon the occurrence of events or changes in circumstances that would indicate that the carrying value of the assets may not be recoverable. An impairment loss may be recognized when estimated undiscounted future cash flows expected to result from the use of the asset, including disposition, are less than the carrying value of the asset. The measurement of the impairment loss to be recognized is based on the difference between the fair value and the carrying amounts of the assets. Fair value is generally determined based on a discounted cash flow analysis. In order to determine if an asset has been impaired, assets are grouped and tested at the lowest level for which identifiable, independent cash flows are available. Goodwill FASB ASC 350 “Intangibles - Goodwill and Other” requires that goodwill be tested for impairment. An impairment charge would be recognized for the amount, if any, by which the carrying amount of goodwill exceeds its implied fair value. The fair value of a reporting unit and the related implied fair value of its respective goodwill are established using a combination of an income (discounted cash flow) approach and market approach. Goodwill is reviewed annually for impairment, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. All of the Partnership's goodwill is allocated to its reporting units and goodwill impairment tests are performed at the reporting unit level. The Partnership performed its annual goodwill impairment test as of the first days of the fourth quarter for 2016 and 2015, respectively, and concluded there was no impairment of the carrying value of goodwill in either period. Other Intangible Assets The Partnership's other intangible assets consist primarily of trade-names and license and franchise agreements. The Partnership assesses the indefinite-lived trade-names for impairment separately from goodwill. After considering the expected use of the trade-names and reviewing any legal, regulatory, contractual, obsolescence, demand, competitive or other economic factors that could limit the useful lives of the trade-names, in accordance with FASB ASC 350, the Partnership determined that the trade-names had indefinite lives. Pursuant to FASB ASC 350, indefinite-lived intangible assets are reviewed, along with goodwill, annually for impairment or more frequently if impairment indicators arise. The Partnership's license and franchise agreements are amortized over the life of the agreement, generally ranging from four to twenty years. Self-Insurance Reserves Reserves are recorded for the estimated amounts of guest and employee claims and expenses incurred each period. Reserves are established for both identified claims and incurred but not reported (IBNR) claims. Such amounts are accrued for when claim amounts become probable and estimable. Reserves for identified claims are based upon the Partnership's own historical claims experience and third-party estimates of settlement costs. Reserves for IBNR claims, which are not material to our consolidated financial statements, are based upon the Partnership's own claims data history. All reserves are periodically reviewed for changes in facts and circumstances, and adjustments are made as necessary. As of December 31, 2016 and 2015, the accrued self-insurance reserves totaled $27.1 million and $24.0 million, respectively. Derivative Financial Instruments The Partnership is exposed to market risks, primarily resulting from changes in interest rates and currency exchange rates. To manage these risks, it may enter into derivative transactions pursuant to its overall financial risk management program. The Partnership does not use derivative financial instruments for trading purposes. The Partnership accounts for the use of derivative financial instruments according to FASB ASC 815 “Derivatives and Hedging”. For derivative instruments that hedge the exposure of variability in short-term rates, designated as cash flow hedges, the effective portion of the change in fair value of the derivative instrument is reported as a component of “Other comprehensive income (loss)” and reclassified into earnings in the period during which the hedged transaction affects earnings. Any ineffectiveness is recognized immediately in income. Derivative financial instruments used in hedging transactions are assessed both at inception and quarterly thereafter to ensure they are effective in offsetting changes in either the fair value or cash flows of the related underlying exposures. Instruments that do not qualify for hedge accounting or were de-designated are prospectively adjusted to fair value each reporting period through “Net effect of swaps”. Revenue Recognition Revenues on multi-use products are recognized over the estimated number of uses expected for each type of product and are adjusted periodically during the operating season prior to the ticket or product expiration, which occurs no later than the close of the operating season or December 31 each year. Other revenues are recognized on a daily basis based on actual guest spending at our facilities, or over the park operating season in the case of certain marina revenues and certain sponsorship revenues. Revenues on multi-use products for the next operating season are deferred in the year received and recognized as revenue in the following operating season. Admission revenues include amounts paid to gain admission into the Partnership's parks, including parking fees. Revenues related to extra-charge attractions, including premium benefit offerings like front-of-line products, are included in Accommodations, extra-charge products and other revenue. Advertising Costs The Partnership expenses all costs associated with its advertising, promotion and marketing programs as incurred, or for certain costs, over each park's operating season. Advertising expense totaled $60.8 million in 2016, $58.7 million in 2015 and $58.4 million in 2014. Certain prepaid costs incurred through year-end for the following year's advertising programs are included in other current assets. Unit-Based Compensation The Partnership accounts for unit-based compensation in accordance with FASB ASC 718 “Compensation - Stock Compensation” which requires measurement of compensation cost for all equity-based awards at fair value on the date of grant and recognition of compensation over the service period for awards expected to vest. The Partnership uses a binomial option-pricing model for all grant date estimations of fair value. Income Taxes The Partnership's legal entity structure includes both partnerships and corporate subsidiaries. As a publicly traded partnership, the Partnership is subject to an entity-level tax (the "PTP tax"). Accordingly, the Partnership itself is not subject to corporate income taxes; rather, the Partnership's tax attributes (except those of the corporate subsidiaries) are included in the tax returns of its partners. The Partnership's corporate subsidiaries are subject to entity-level income taxes. Neither the Partnership's financial reporting income, nor the cash distributions to unitholders, can be used as a substitute for the detailed tax calculations that the Partnership must perform annually for its partners. Net income from the Partnership is not treated as “passive income” for federal income tax purposes. As a result, partners subject to the passive activity loss rules are not permitted to offset income from the Partnership with passive losses from other sources. The Partnership's corporate subsidiaries account for income taxes under the asset and liability method. Accordingly, deferred tax assets and liabilities are recognized for the future book and tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are determined using enacted tax rates expected to apply in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax law is recognized in income at the time of enactment of such change in tax law. Any interest or penalties due for payment of income taxes are included in the provision for income taxes. The Partnership's total provision for taxes includes PTP taxes owed (see Note 9 to the Consolidated Financial Statements). Earnings Per Unit For purposes of calculating the basic and diluted earnings per limited partner unit, no adjustments have been made to the reported amounts of net income. The unit amounts used in calculating the basic and diluted earnings per limited partner unit for the years ended December 31, 2016, December 31, 2015, and December 31, 2014 are as follows: The effect of out-of-the-money and/or antidilutive unit options for 2016, 2015, and 2014, respectively, had they not been out of the money or antidilutive, would have been immaterial in all periods presented. Adopted Accounting Pronouncements In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Simplifying the Presentation of Debt Issuance Costs ("ASU 2015-03"). The amendments in ASU 2015-03 require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying value of the corresponding debt liability, consistent with debt discounts. This ASU requires retrospective adoption and is effective for annual and interim periods beginning after December 15, 2015. The Partnership adopted this guidance and applied retrospective treatment. The impact of the adoption of this guidance resulted in the reclassification of the unamortized debt issuance cost amounts from other assets to long-term debt on the consolidated balance sheet of $19.7 million at December 31, 2015. In November 2015, the FASB issued Accounting Standards Update No. 2015-17, Balance Sheet Classification of Deferred Taxes ("ASU 2015-17"). The amendments in ASU 2015-17 require that deferred tax assets and liabilities be classified as non-current in the balance sheet. This ASU is effective for fiscal years beginning after December 15, 2016 and for interim periods within those fiscal years with early adoption permitted. The guidance may be applied either prospectively to all deferred tax liabilities and assets, or retrospectively to all periods presented. The Partnership adopted this guidance early and applied retrospective treatment. The impact of the adoption of this guidance resulted in the reclassification of the current deferred tax asset to net against the deferred tax liability in the consolidated balance sheet, which reduced both the current deferred tax asset and deferred tax liability by $12.2 million at December 31, 2015. New Accounting Pronouncements In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"). The amendments in ASU 2014-09 provide for a single, principles-based model for revenue recognition that replaces the existing revenue recognition guidance. ASU 2014-09 is effective for annual and interim periods beginning after December 15, 2017 and will replace most existing revenue recognition guidance under U.S. GAAP when it becomes effective. It permits the use of either a retrospective or cumulative effect transition method, and early adoption is not permitted. The Partnership currently expects to adopt this standard in the first quarter of 2018. The Partnership anticipates the primary impact of the adoption on our consolidated financial statements will be the additional required disclosures around revenue recognition in the notes to the consolidated financial statements. The Partnership does not anticipate adoption of the standard to have a material effect on the consolidated financial statements. In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases ("ASU 2016-02"). The amendments in ASU 2016-02 provide that most leases will now be recorded on the balance sheet. ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018 and will replace most existing lease guidance under U.S. GAAP when it becomes effective. This ASU requires a modified transition method for existing leases and applies to the earliest period presented in the financial statements. The Partnership is in the process of evaluating the effect this standard will have on the consolidated financial statements and related disclosures. In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). The amendments in ASU 2016-09 are meant to simplify the current accounting for share-based payment transactions, specifically the accounting for income taxes, award classification, cash flow presentation, and accounting for forfeitures. ASU 2016-09 is effective for annual and interim periods beginning after December 15, 2016, and early adoption is permitted. The Partnership expects to adopt this standard in the first quarter of 2017 utilizing the methods dictated by the standard. The Partnership does not anticipate the adoption of the standard to have a material effect on the consolidated financial statements. (3) Long-Lived Assets: Long-lived assets are reviewed for impairment upon the occurrence of events or changes in circumstances that would indicate that the carrying value of the assets may not be recoverable. In order to determine if an asset has been impaired, assets are grouped and tested at the lowest level for which identifiable, independent cash flows are available. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in expected future cash flows; a sustained, significant decline in equity price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements. The long-lived asset impairment test involves a two-step process. The first step is a comparison of each asset group's carrying value to its estimated undiscounted future cash flows expected to result from the use of the assets, including disposition. Projected future cash flows reflect management's best estimates of economic and market conditions over the projected period, including growth rates in revenues and costs, estimates of future expected changes in operating margins and cash expenditures. Other significant estimates and assumptions include terminal value growth rates. If the carrying value of the asset group is higher than its undiscounted future cash flows, there is an indication that impairment exists and the second step must be performed to measure the amount of impairment loss. The amount of impairment is determined by comparing the fair value of the asset group to its carrying value in a manner consistent with the highest and best use of those assets. The Partnership estimates fair value of operating assets using an income (discounted cash flows) approach, which uses an asset group's projection of estimated operating results and cash flows that is discounted using a weighted-average cost of capital reflective of current market conditions. If the fair value of the assets is less than their carrying value, an impairment charge is recorded for the difference. Non-operating assets are evaluated for impairment based on changes in market conditions. When changes in market conditions are observed, impairment is estimated using a market-based approach. If the estimated fair value of the non-operating assets is less than their carrying value, an impairment charge is recorded for the difference. At the end of the fourth quarter of 2014, the Partnership concluded based on 2014 operating results and updated forecasts, that a review of the carrying value of operating long-lived assets at Wildwater Kingdom was warranted. After performing its review, the Partnership determined that the park's fixed assets, excluding land, were impaired by $2.4 million. A charge for this amount was recorded in "Loss on impairment / retirement of fixed assets, net" on the consolidated statement of operations and comprehensive income. At the end of the fourth quarter of 2015, the Partnership decided to permanently remove from service a long-lived asset at Cedar Point. Accordingly, the Partnership recognized and recorded an $8.6 million charge for impairment equal to the remaining net book value of this long-lived asset. The amount was recorded in "Loss on impairment / retirement of fixed assets, net" on the consolidated statement of operations and comprehensive income. During the third quarter of 2016, the Partnership ceased operations of Wildwater Kingdom. At the closure date, the only remaining long-lived asset was the approximate 670 acres of land owned by the Partnership. This land has an associated carrying value of $17.1 million. The Partnership assessed the remaining asset and concluded there was no impairment during the third quarter of 2016. The associated acreage is classified as assets held-for-sale within "Other Assets" in the consolidated balance sheet. (4) Goodwill and Other Intangible Assets: Goodwill and other indefinite-lived intangible assets, including trade-names, are reviewed for impairment annually, or more frequently if indicators of impairment exist. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in expected future cash flows; a sustained, significant decline in equity price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group within a reporting unit; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements. The goodwill impairment test involves a two-step process. The first step is a comparison of each reporting unit's fair value to its carrying value. The Partnership estimates fair value using both an income (discounted cash flows) and market approach. The income approach uses a reporting unit's projection of estimated operating results and cash flows that is discounted using a weighted-average cost of capital that reflects current market conditions. The projection uses management's best estimates of economic and market conditions over the projected period including growth rates in revenues and costs, estimates of future expected changes in operating margins and cash expenditures. Other significant estimates and assumptions include terminal value growth rates, future estimates of capital expenditures and changes in future working capital requirements. A market approach estimates fair value by applying cash flow multiples to the reporting unit's operating performance. The multiples are derived from comparable publicly traded companies with similar operating and investment characteristics of the reporting units. If the carrying value of the reporting unit is higher than its fair value, there is an indication that impairment may exist and the second step must be performed to measure the amount of impairment loss. The amount of impairment is determined by comparing the implied fair value of reporting unit goodwill to the carrying value of the goodwill in the same manner as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill is less than the recorded goodwill, an impairment charge is recorded for the difference. A relief-from-royalty model is used to determine whether the fair value of trade-names exceed their carrying amounts. The fair value of the trade-names is determined as the present value of fees avoided by owning the respective trade-name. A summary of changes in the Partnership's carrying value of goodwill for the years ended December 31, 2016 and December 31, 2015 is as follows: (1) See Note 9 to the Consolidated Financial Statements. As of December 31, 2016 and December 31, 2015, the Partnership's other intangible assets consisted of the following: Amortization expense of other intangible assets for 2016, 2015 and 2014 was immaterial and is expected to be immaterial going forward. (5) Long-Term Debt: Long-term debt as of December 31, 2016 and December 31, 2015 consisted of the following: (1) These average interest rates do not reflect the effect of interest rate swap agreements entered into on variable-rate term debt (see Note 6 to the Consolidated Financial Statements). In March 2013, the Partnership issued $500 million of 5.25% senior unsecured notes ("March 2013 notes"), maturing in 2021. Concurrently with this offering, the Partnership entered into an $885 million credit agreement (the "2013 Credit Agreement"), which included a $630 million senior secured term loan facility and a $255 million senior secured revolving credit facility. The terms of the senior secured term loan facility include a maturity date of March 6, 2020 and an interest rate of London InterBank Offering Rate ("LIBOR") plus 250 basis points (bps) with a LIBOR floor of 75 bps. The term loan amortizes at $6.3 million annually. During the second quarter of 2016, $6.0 million of term debt was prepaid, which has resulted in no principal payments due until the third quarter of 2017. The net proceeds from the March 2013 notes and borrowings under the 2013 Credit Agreement were used to repay in full all amounts outstanding under the previous credit facilities. The facilities provided under the 2013 Credit Agreement are collateralized by substantially all of the assets of the Partnership. In June 2014, the Partnership issued $450 million of 5.375% senior unsecured notes ("June 2014 notes"), maturing in 2024. The net proceeds from the offering of the June 2014 notes were used to redeem in full all of the Partnership’s $405 million of 9.125% July 2010 senior unsecured notes that were scheduled to mature in 2018 (and which included $5.6 million of Original Issue Discount ("OID") to yield 9.375%), to satisfy and discharge the indenture governing the notes that were redeemed and for general corporate purposes. Cedar Fair, L.P., Canada’s Wonderland Company ("Cedar Canada"), and Magnum Management Corporation ("Magnum") are the co-issuers of the notes and co-borrowers of the senior secured credit facilities. In December 2014, the Partnership amended its credit agreement in order to add Millennium Operations, LLC, a newly converted wholly-owned limited liability company, as a co-borrower in connection with the Partnership's on-going long term tax planning efforts. The amendment was effective beginning on January 1, 2015. Both the notes and senior secured credit facilities have been fully and unconditionally guaranteed, on a joint and several basis, by each 100% owned subsidiary of Cedar Fair (other than Cedar Canada and Magnum). There are no non-guarantor subsidiaries. Revolving Credit Loans Terms of the 2013 Credit Agreement include a revolving credit facility of a combined $255 million. Under the 2013 Credit Agreement, the Canadian portion of the revolving credit facility has a sub-limit of $15 million. U.S. denominated and Canadian denominated loans made under the revolving credit facility bear interest at a rate of LIBOR plus 225 bps (with no LIBOR floor). The revolving credit facility is scheduled to mature in March 2018 and also provides for the issuance of documentary and standby letters of credit. As of December 31, 2016, no borrowings under the revolving credit facility were outstanding and standby letters of credit totaled $15.9 million. After letters of credit, the Partnership had $239.1 million of available borrowings under its revolving credit facility as of December 31, 2016. The maximum outstanding balance during 2016 was $101.0 million under the revolving credit facility. The 2013 Credit Agreement requires the Partnership to pay a commitment fee of 38 bps per annum on the unused portion of the credit facilities. Term Debt The credit facilities provided under the 2013 Credit Agreement include a $630 million U.S. term loan maturing in March 2020. As of December 31, 2016, the U.S. term loan bore interest at a rate of LIBOR plus 250 bps, with a LIBOR floor of 75 bps. At December 31, 2016, the scheduled annual maturities of term debt were as follows: The Partnership may prepay some or all of its term debt maturing in 2020 without premium or penalty at any time. Notes The Partnership's March 2013 notes pay interest semi-annually in March and September, with the principal due in full on March 15, 2021. The notes may be redeemed, in whole or in part, at any time prior to March 15, 2017 at a price equal to 103.938% of the principal amount of the notes redeemed, together with accrued and unpaid interest, if any, to the redemption date. The notes may be redeemed after this date, in whole or in part, at various prices depending on the date redeemed. The Partnership's June 2014 notes pay interest semi-annually in June and December, with the principal due in full on June 1, 2024. Prior to June 1, 2017, up to 35% of the notes may be redeemed with the net cash proceeds of certain equity offerings at a price equal to 105.375% together with accrued and unpaid interest. The notes may be redeemed, in whole or in part, at any time prior to June 1, 2019 at a price equal to 100% of the principal amount of the notes redeemed plus a “make-whole” premium together with accrued and unpaid interest, if any, to the redemption date. Thereafter, the notes may be redeemed, in whole or in part, at various prices depending on the date redeemed. As market conditions warrant, the Partnership may from time to time repurchase debt securities issued by the Partnership, in privately negotiated or open market transactions, by tender offer, exchange offer or otherwise. Covenants The 2013 Credit Agreement includes two Financial Condition Covenants, which if breached for any reason and not cured, could result in an event of default. At the end of the fourth quarter of 2016 and 2015, the first of these, the Consolidated Leverage Ratio, was set at a maximum of 5.50x and 5.75x consolidated total debt (excluding the revolving debt)-to-consolidated EBITDA, respectively. This required ratio decreased by 0.25x at the beginning of the second quarter of 2016. The final decrease will occur at the beginning of the second quarter of 2017 when the ratio will reach its minimum of 5.25x. The second of these required ratios, the Consolidated Fixed Charge Coverage Ratio, is set at a minimum of 1.1x (consolidated total fixed charges-to-consolidated EBITDA). As of December 31, 2016 and 2015, the Partnership was in compliance with these Financial Condition Covenants and all other covenants under the 2013 Credit Agreement. The Partnership is allowed to make Restricted Payments, as defined in the 2013 Credit Agreement, of up to $60 million annually, so long as no default or event of default has occurred and is continuing and so long as the Partnership would be in compliance with certain financial ratios after giving effect to the payments. Additional Restricted Payments are allowed to be made based on an Excess-Cash-Flow formula should the Partnership's pro-forma Consolidated Leverage Ratio be less than or equal to 5.00x. Pursuant to the terms of the indentures governing the Partnership's June 2014 and March 2013 notes, the Partnership can make Restricted Payments of $60 million annually so long as no default or event of default has occurred and is continuing; and the Partnership's ability to make additional Restricted Payments is permitted should the Partnership's pro forma Total Indebtedness-to-Consolidated-Cash-Flow Ratio be less than or equal to 5.00x. (6) Derivative Financial Instruments: Derivative financial instruments are used within the Partnership’s overall risk management program to manage certain interest rate and foreign currency risks. By utilizing a derivative instrument to hedge our exposure to LIBOR rate changes, the Partnership is exposed to counterparty credit risk, in particular the failure of the counterparty to perform under the terms of the derivative contract. To mitigate this risk, hedging instruments are placed with a counterparty that the Partnership believes poses minimal credit risk. The Partnership does not use derivative financial instruments for trading purposes. In the first quarter of 2016, the Partnership amended each of its four interest rate swap agreements to extend each of the maturities by two years to December 31, 2020 and effectively convert $500 million of variable-rate debt at a rate of 2.64%. As a result of the amendments, the previously existing interest rate swaps were de-designated, and the amounts recorded in AOCI are being amortized into earnings through the original December 31, 2018 maturity. The amended interest rate swap agreements are not designated as hedging instruments. There were no other changes to the terms of the agreements beyond those disclosed. Prior to de-designation, as of December 31, 2015, the interest rate swap agreements effectively converted $500 million of variable-rate debt at a rate of 2.94%. The fair market value of the Partnership's swap portfolio was a liability of $17.7 million and $22.9 million, as of December 31, 2016 and 2015, respectively, and was recorded on the consolidated balance sheet within "Derivative Liability" as listed below. Derivatives Designated as Hedging Instruments Changes in fair value of highly effective hedges are recorded as a component of AOCI in the balance sheet. Any ineffectiveness is recognized immediately in income. Amounts recorded as a component of accumulated other comprehensive income are reclassified into earnings in the same period the forecasted transactions affect earnings. As a result of the first quarter of 2016 amendments, the previously existing interest rate swap agreements were de-designated and the amended interest rate swap agreements were not designated as hedging instruments. As of December 31, 2016, the Partnership has no designated derivatives; therefore, no amount of designated derivatives are forecasted to be reclassified into earnings in the next twelve months. Derivatives Not Designated as Hedging Instruments Instruments that do not qualify for hedge accounting or were de-designated are prospectively adjusted to fair value each reporting period through "Net effect of swaps" within the consolidated statements of operations and comprehensive income. The amounts that were previously recorded as a component of AOCI prior to de-designation are reclassified to earnings, and a corresponding realized gain or loss is recognized when the forecasted cash flow occurs. As a result of the first quarter of 2016 amendments, the previously existing interest rate swap agreements were de-designated, and the amounts previously recorded in AOCI are being amortized into earnings through the original December 2018 maturity. As of December 31, 2016, approximately $18.9 million of losses remain in AOCI related to the effective cash flow hedge contracts prior to de-designation, $9.5 million of which will be reclassified to earnings within the next twelve months. The following table summarizes the effect of derivative instruments on income and other comprehensive income for the years ended December 31, 2016 and December 31, 2015: For 2016, the Partnership recognized $9.9 million of gains on the derivatives not designated as cash flow hedges and $8.7 million of expense representing the regular amortization of amounts in AOCI. The net effect of these amounts resulted in a benefit to earnings for the year of $1.2 million recorded in “Net effect of swaps.” For 2015, the Partnership recognized $11.8 million of gains on the derivatives not designated as cash flow hedges and $4.9 million of expense representing the regular amortization of amounts in AOCI. The net effect of these amounts resulted in a benefit to earnings for the year of $6.9 million recorded in “Net effect of swaps.” (7) Partners' Equity: Special L.P. Interests In accordance with the Partnership Agreement, certain partners were allocated $5.3 million of 1987 and 1988 taxable income (without any related cash distributions) for which they received Special L.P. Interests. The Special L.P. Interests do not participate in cash distributions and have no voting rights. However, the holders of Special L.P. Interests will receive in the aggregate $5.3 million upon liquidation of the Partnership. Equity-Based Incentive Plan The 2016 Omnibus Incentive Plan was approved by the Partnership's unitholders in June 2016 and allows the awarding of up to 2.8 million unit options and other forms of equity as determined by the Compensation Committee of the Board of Directors as an element of compensation to senior management and other key employees. The 2016 Omnibus Incentive Plan supersedes the 2008 Omnibus Incentive Plan which was approved by the Partnership's unitholders in May 2008 and allowed the awarding of up to 2.5 million unit options and other forms of equity. Outstanding awards under the 2008 Omnibus Incentive Plan continue to be in effect and are governed by the terms of that plan. The 2016 Omnibus Incentive Plan provides an opportunity for officers, directors, and eligible persons to acquire an interest in the growth and performance of the Partnership's units and provides employees annual and long-term incentive awards as determined by the Board of Directors. Under the 2016 Omnibus Incentive Plan, the Compensation Committee of the Board of Directors may grant unit options, unit appreciation rights, restricted units, performance awards, other unit awards, cash incentive awards and unrestricted unit awards. Awards Payable in Cash or Equity Phantom Units During 2016, no "phantom units" were awarded. "Phantom unit" awards generally vest over an approximate four-year period and can be settled with cash, limited partnership units, or a combination of both, as determined by the Compensation Committee. The effect of "phantom unit” awards has been included in the diluted earnings per unit calculation for 2015 and 2014, as a portion of the awards were expected to be paid in limited partnership units during those years. Approximately $0.8 million and $1.7 million in compensation expense related to liability “phantom unit” awards was recognized in 2015 and 2014, respectively. No compensation expense related to liability "phantom unit" awards was recognized in 2016. These amounts are included in “Selling, General and Administrative Expense” in the accompanying consolidated statements of operations and comprehensive income. As of December 31, 2015, the Partnership had settled all outstanding “phantom unit” awards. Performance Units During 2016, none of these types of "performance units” were awarded. The number of "performance units” issuable under these awards are contingently based upon certain performance targets over a three-year period and these awards can be paid with cash, limited partnership units, or a combination of both as determined by the Compensation Committee, after the end of the performance period. Certain of these types of performance units were awarded in prior years. The effect of these outstanding "performance unit” awards for which the performance condition has been met has been included in the diluted earnings per unit calculation, as a portion of the awards are expected to be settled in limited partnership units. The effect of these outstanding "performance unit” awards for which the performance condition has not been met has been excluded from the diluted earnings per unit calculation. Approximately $4.6 million, $8.0 million and $5.3 million in 2016, 2015 and 2014, respectively, were recorded in compensation expense related to these types of “performance units” and are included in “Selling, General and Administrative Expense” in the accompanying consolidated statements of operations and comprehensive income. As of December 31, 2016, the Partnership had 151,316 "performance units” outstanding, all of which have been accrued for as a liability at the December 30, 2016 closing price of $64.20 per unit. The estimated aggregate market value of "performance units” contingently issuable under these types of awards at year-end has been reflected on the consolidated balance sheet recorded in "Accrued salaries, wages and benefits" as all outstanding units are current and have a balance of $9.7 million as of December 31, 2016. As of December 31, 2015, the current and long-term portions were $7.4 million and $5.4 million, respectively. As of December 31, 2016, there was no unamortized compensation related to unvested "performance unit” awards of this type. The Partnership expects to settle the remaining outstanding "performance unit" awards of this type upon vesting during 2017. Deferred Units During 2016, 11,220 "deferred units" were awarded at a grant price of $64.20. Compensation expense related to "deferred units" vests ratably over a one-year period and the settlement of these units is deferred until the individual's service to the Partnership ends. The "deferred units" accumulate distribution-equivalents upon determination of the number of units attributable to the participant and will be paid when the restriction ends. The effect of outstanding "deferred unit” awards has been included in the diluted earnings per unit calculation, as a portion of the awards are expected to be settled in limited partnership units. Approximately $1.0 million, $0.8 million, and $0.5 million in 2016, 2015, and 2014, respectively, were recorded in compensation expense related to "deferred units" and are included in "Selling, General, and Administrative Expense" in the accompanying consolidated statement of operations and comprehensive income. As of December 31, 2016, the Partnership had 35,311 "deferred units” outstanding and vested at the December 30, 2016 closing price of $64.20 per unit. The estimated aggregate market value of the "deferred units” at year-end has been reflected as a liability on the consolidated balance sheet, with the current portion being recorded in "Other accrued liabilities" and the long-term portion in “Other Liabilities.” As of December 31, 2016 and 2015, the market value of the "deferred units" totaled $2.3 million and $1.3 million, respectively, all of which was classified as current. As of December 31, 2016, there was no unamortized expense related to unvested "deferred unit” awards. Awards Payable in Equity Performance Units During 2016, 109,605 "performance units” were awarded at a weighted-average grant price of $57.57 per unit. The number of "performance units” issuable under these awards are contingently based upon certain performance targets over the three-year vesting period. The annual performance awards and the related forfeitable distribution equivalents, generally are paid out in the first quarter following the performance period in limited partnership units. The 2014 "performance units" payable in equity were retention grant units that are to be paid out in limited partnership units in December 2017 and December 2018 following a three-year performance period and the forfeitable distribution equivalents would be paid in cash at that same time. The effect of these types of outstanding "performance unit” awards, for which the performance conditions have been met, have been included in the diluted earnings per unit calculation. The effect of these outstanding "performance unit” awards which the performance conditions have not been met, have been excluded from the diluted earnings per unit calculation. Approximately $7.5 million, $3.7 million, and $1.4 million in 2016, 2015, and 2014, respectively, were recorded in compensation expense related to “performance units” under this award and are included in “Selling, General and Administrative Expense” in the accompanying consolidated statements of operations and comprehensive income. As of December 31, 2016, the amount of forfeitable distribution equivalents accrued and recorded on the consolidated balance sheet in "Other Liabilities" was approximately $1.1 million. As of December 31, 2016, the Partnership had 487,864 "performance units” outstanding, 231,785 of which have been accrued for within equity. As of December 31, 2016, unamortized compensation related to these unvested "performance unit” awards totaled approximately $14.4 million, which is expected to be amortized over a weighted average period of 2.2 years. The Partnership expects to settle 62,117 of these outstanding "performance units" upon vesting during 2017. Restricted Units During 2016, 96,536 "restricted units" were awarded. Compensation expense related to 73,068 of the restricted units vests ratably over a three-year period, the restrictions on these units lapse upon vesting, and they were awarded at a weighted-average grant price of $57.57. During the time of restriction, these units accumulate forfeitable distribution-equivalents, which, when the units are fully vested, will be paid in the form accrued. Compensation expense related to the remaining 23,468 restricted units vest following a three-year cliff vesting period and were awarded at a weighted-average grant price of $60.37. During the vesting period, the units accumulate forfeitable distribution-equivalents, which, when the units are fully vested, will also be paid in the form accrued. Approximately $3.9 million, $4.1 million, and $3.7 million in 2016, 2015, and 2014, respectively, were recorded in compensation expense related to "restricted units" and are included in "Selling, General, and Administrative Expense" in the accompanying consolidated statement of operations and comprehensive income. As of December 31, 2016, the amount of forfeitable distribution equivalents accrued and recorded on the consolidated balance sheet in "Other Liabilities" was approximately $0.8 million. As of December 31, 2016, the Partnership had 284,328 "restricted units" outstanding, 136,285 of which have been accrued for within equity. In addition, as of December 31, 2016, unamortized compensation expense related to unvested "restricted unit" awards totaled approximately $8.5 million, which is expected to be amortized over a weighted average period of 2.4 years. The Partnership expects to settle 65,264 of these outstanding "restricted units" upon vesting during 2017. Unit Options The Partnership's "unit options" are issued with an exercise price no less than the market closing price of the Partnership's units on the day before the date of grant. Outstanding "unit options" vest ratably over a three-year period and have a maximum term of ten years. As of December 31, 2016, the Partnership had 399,941 fixed-price "unit options" outstanding under the 2008 Omnibus Incentive Plan. No options have been granted under the 2016 Omnibus Incentive Plan. None of these "unit options" were granted during 2016 and 2015. Non-cash compensation expense relating to unit options in 2016, 2015, and 2014 totaled $0.0 million, $0.6 million, and $0.9 million, respectively. A summary of "unit option" activity for the years ended December 31, 2016 and December 31, 2015 is as follows: There was no cash received from "unit option" exercises in 2016, 2015 and 2014. The following table summarizes the vested "unit options" outstanding as of December 31, 2016: A summary of the status of the Partnership's non-vested "unit options" as of December 31, 2016 is as follows: The total intrinsic value of "unit options" exercised during the years ended December 31, 2016, 2015 and 2014 were $2.8 million, $3.0 million, and $1.0 million, respectively. The Partnership has a policy of issuing limited partnership units from treasury to satisfy "unit option" exercises and expects its treasury unit balance to be sufficient for 2017 based on estimates of "unit option" exercises for that period. (8) Retirement Plans: The Partnership has trusteed, noncontributory retirement plans for the majority of its full-time employees. Contributions are discretionary and amounts accrued were approximately $4.2 million in 2016, $4.3 million in 2015 and $4.3 million in 2014. Additionally, the Partnership has a trusteed, contributory retirement plan for the majority of its full-time employees. This plan permits employees to contribute specified percentages of their salary, matched up to a limit by the Partnership. Matching contributions, net of forfeitures, approximated $2.4 million in 2016, $2.3 million in 2015 and $2.1 million in 2014. In addition, approximately 250 employees are covered by union-sponsored, multi-employer pension plans for which approximately $1.7 million, $1.5 million and $1.5 million were contributed for the years ended December 31, 2016, 2015, and 2014, respectively. The Partnership has no plans to withdraw from any of the multi-employer plans. The Partnership believes that the liability resulting from any such withdrawal, as defined by the Multi-employer Pension Plan Amendments Act of 1980, would not be material. (9) Income and Partnership Taxes: Federal and state tax legislation in 1997 provided a permanent income tax exemption to existing publicly traded partnerships (PTP), such as Cedar Fair, L.P., with a PTP tax levied on partnership gross income (net revenues less cost of food, merchandise and games) beginning in 1998. In addition, income taxes are recognized for the amount of taxes payable by the Partnership's corporate subsidiaries for the current year and for the impact of deferred tax assets and liabilities that represent future tax consequences of events that have been recognized differently in the financial statements than for tax purposes. As such, the Partnership's "Provision for taxes" includes amounts for both the PTP tax and for income taxes on the Partnership's corporate subsidiaries. The Partnership's 2016 tax provision totals $71.4 million, which consists of an $11.4 million provision for the PTP tax and a $60.0 million provision for income taxes. This compares to the Partnership's 2015 tax provision of $22.2 million, which consisted of a $11.7 million provision for the PTP tax and a $10.5 million provision for income taxes, and the 2014 tax provision of $9.9 million, which consisted of a $9.6 million provision for the PTP tax and a $0.3 million provision for income taxes. The calculation of the provision for taxes involves significant estimates and assumptions and actual results could differ from those estimates. Significant components of income (loss) before taxes for the years ended December 31, 2016, December 31, 2015 and December 31, 2014 are as follows: The provision (benefit) for income taxes was comprised of the following for the years ended December 31, 2016, December 31, 2015 and December 31, 2014: The provision (benefit) for income taxes for the Partnership's corporate subsidiaries differs from the amount computed by applying the U.S. federal statutory income tax rate of 35% to the Partnership's income (loss) before taxes. The sources and tax effects of the differences are as follows: Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred tax assets and liabilities as of December 31, 2016 and 2015 are as follows: During the fourth quarter of 2016, management reassessed its accounting for the deferred income tax effects related to its Canadian disregarded entity temporary differences that were recorded in purchase accounting at the time of the acquisition. As a result, to appropriately reflect these tax effects, the Company recorded an adjustment that reduced deferred tax liabilities and goodwill by $33.9 million as of December 31, 2016. The adjustment did not impact the statements of operations and comprehensive income or cash flows for any period presented. The Partnership records a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion, or all, of a deferred tax asset will not be realized. Through December 31, 2015, the Partnership had recorded a $5.7 million valuation allowance related to a $7.6 million deferred tax asset for foreign tax credit carryforwards. The need for this allowance was based on several factors including the ten-year carryforward period allowed for excess foreign tax credits, experience to date of foreign tax credit limitations, and management's long term estimates of domestic and foreign source income. During the third quarter of 2016, the Partnership recognized a $1.5 million tax benefit from a release of valuation allowance based on management's updated projection of future foreign tax credit utilization. The valuation allowance had previously been reduced by $0.0 million and $1.1 million for the years ended December 31, 2015 and 2014, respectively. Further, the Partnership believes based on its update of long term estimates of domestic and foreign source income that no additional adjustments to the valuation allowance are warranted. As of December 31, 2016, the Partnership had a $7.7 million deferred tax asset for foreign tax credit carryforwards and a related $4.2 million valuation allowance. During December 2016, the U.S. Department of Treasury adopted final regulations impacting the recognition of foreign currency gains and losses for the purpose of calculating U.S. taxable income. The regulations change the taxability of future recognized foreign currency gains and losses upon repatriation from a foreign subsidiary. Accordingly, during the fourth quarter the Partnership, using the Fresh Start Transition Method provided in the regulations, recomputed and recorded the future reported tax consequences of the change in tax law. The Partnership recognized an increase in provision for taxes and deferred tax liabilities of $7.4 million related to these changes. Additionally, as of December 31, 2016, the Partnership had $2.0 million of tax attribute carryforwards consisting entirely of the tax effect of state net operating loss carryforwards. Unused state net operating loss carryforwards will expire from 2018 to 2028. The Partnership expects to fully realize these tax attribute carryforwards. As such, no valuation allowance has been recorded relating to these tax attribute carryforwards. The Partnership has recorded a deferred tax asset of $3.0 million and a deferred tax liability of $12.7 million as of December 31, 2016 and 2015, respectively, to account for the tax effect of derivatives and foreign currency translation adjustments included in other comprehensive income. The Partnership has unrecognized income tax benefits as of December 31, 2016. The following is a reconciliation of beginning and ending unrecognized tax benefits: At December 31, 2016, a total of $0.9 million of unrecognized tax benefits was recorded for state and local income tax positions. There were $1.1 million of unrecognized tax positions during 2015 and $1.2 million unrecognized tax positions during 2014. If recognized, the tax benefits would decrease the Partnership taxes by $0.9 million. The Partnership recognizes accrued interest and penalties related to unrecognized tax benefits as income tax expense. Related to the unrecognized tax benefits noted, the Partnership accrued interest of $0.3 million and penalties of $0.2 million during 2016. The Partnership does not anticipate a significant change to the amount of unrecognized tax benefits over the next 12 months. The Partnership and its corporate subsidiaries are subject to taxation in the U.S., Canada and various state and local jurisdictions. The tax returns of the Partnership are subject to examination by state and federal tax authorities. With few exceptions, the Partnership and its corporate subsidiaries are no longer subject to examination by the major taxing authorities for tax years before 2012. (10) Operating Lease Commitments and Contingencies: Operating Lease Commitments The Partnership has commitments under various operating leases at its parks. Future minimum lease payments under non-cancelable operating leases as of December 31, 2016 are as follows: The amount due after 2021 includes the land lease at California's Great America which is renewable in 2039. Lease expense, which includes short-term rentals for equipment and machinery, for 2016, 2015 and 2014 totaled $12.8 million, $14.5 million and $12.7 million, respectively. Contingencies The Partnership is also a party to a number of lawsuits arising in the normal course of business. In the opinion of management, none of these matters are expected to have a material effect in the aggregate on the Partnership's financial statements. (11) Fair Value Measurements: The FASB's Accounting Standards Codification (ASC) 820 "Fair Value Measurements" emphasizes that fair value is a market-based measurement that should be determined based on assumptions (inputs) that market participants would use in pricing an asset or liability. Inputs may be observable or unobservable, and valuation techniques used to measure fair value should maximize the use of relevant observable inputs and minimize the use of unobservable inputs. Accordingly, FASB ASC 820 establishes a hierarchal disclosure framework that ranks the quality and reliability of information used to determine fair values. The hierarchy is associated with the level of pricing observability utilized in measuring fair value and defines three levels of inputs to the fair value measurement process. Quoted prices are the most reliable valuation inputs, whereas model values that include inputs based on unobservable data are the least reliable. Each fair value measurement must be assigned to a level corresponding to the lowest level input that is significant to the fair value measurement in its entirety. The three broad levels of inputs defined by the fair value hierarchy are as follows: • Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. • Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. • Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement. A financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The table below presents the balances of assets and liabilities measured at fair value as of December 31, 2016 and December 31, 2015 on a recurring basis as well as the fair values of other financial instruments: (1) Carrying values of long-term debt balances are before reductions of debt issuance costs of $15.9 million and $19.7 million as of December 31, 2016 and December 31, 2015, respectively. Fair values of the interest rate swap agreements are determined using significant inputs, including LIBOR forward curves, which are considered Level 2 observable market inputs. In addition, the Partnership considered the effect of its credit and non-performance risk on the fair values provided and recognized an adjustment decreasing the net derivative liability by an immaterial amount as of December 31, 2016 and December 31, 2015. The carrying value of cash and cash equivalents, revolving credit loans, accounts receivable, current portion of term debt, accounts payable, and accrued liabilities approximates fair value because of the short maturity of these instruments. There were no assets measured at fair value on a non-recurring basis as of December 31, 2016. (12) Changes in Accumulated Other Comprehensive Income ("AOCI"): The following tables reflect the changes in AOCI related to limited partners' equity for the twelve-month periods ended December 31, 2016 and December 31, 2015: (1) All amounts are net of tax. Amounts in parentheses indicate debits. (2) See Reclassifications Out of Accumulated Other Comprehensive Income table below for reclassification details. (1) All amounts are net of tax. Amounts in parentheses indicate debits. (2) See Reclassifications Out of Accumulated Other Comprehensive Income table below for reclassification details. (1) Amounts in parentheses indicate gains. (13) Consolidating Financial Information of Guarantors and Issuers: Cedar Fair, L.P., Canada's Wonderland Company ("Cedar Canada"), and Magnum Management Corporation ("Magnum") are the co-issuers of the Partnership's 5.375% and 5.25% notes (see Note 5 to the Consolidated Financial Statements). The notes have been fully and unconditionally guaranteed, on a joint and several basis, by each 100% owned subsidiary of Cedar Fair (other than Cedar Canada and Magnum) that guarantees the Partnership's senior secured credit facilities. There are no non-guarantor subsidiaries. The following consolidating schedules present condensed financial information for Cedar Fair, L.P., Cedar Canada, and Magnum, the co-issuers, and each 100% owned subsidiary of Cedar Fair (other than Cedar Canada and Magnum), the guarantors (on a combined basis), as of December 31, 2016 and December 31, 2015 and for the years ended December 31, 2016, December 31, 2015, and December 31, 2014. In lieu of providing separate audited financial statements for the guarantor subsidiaries, the accompanying condensed consolidating financial statements have been included. CEDAR FAIR, L.P. CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 2016 (In thousands) CEDAR FAIR, L.P. CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 2015 (In thousands) CEDAR FAIR, L.P. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME For the Year Ended December 31, 2016 (In thousands) CEDAR FAIR, L.P. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME For the Year Ended December 31, 2015 (In thousands) CEDAR FAIR, L.P. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME For the Year Ended December 31, 2014 (In thousands) CEDAR FAIR, L.P. CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS For the Year Ended December 31, 2016 (In thousands) CEDAR FAIR, L.P. CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS For the Year Ended December 31, 2015 (In thousands) CEDAR FAIR, L.P. CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS For the Year Ended December 31, 2014 (In thousands) | Based on the provided financial statement excerpt, here's a summary:
Financial Statement Overview:
- Business Segment: Single reportable segment of amusement/water parks with resort facilities
Key Accounting Practices:
- Uses generally accepted accounting principles
- Considers cash equivalents as highly liquid instruments with original maturity of 3 months or less
- Inventories valued at lower of cost or market using FIFO or average cost methods
- Property and equipment recorded at cost
- Depreciation computed on straight-line basis
- Depreciation expense: $131.2 (currency not specified)
Financial Management:
- Regular quarterly cash distributions
- Unit-based compensation tracked
- Management makes estimates that could differ from actual results
Limitations:
- Partial financial statement provided
- Some sections are incomplete or cut off
- Specific financial figures are not fully presented
Note: The summary is based on the limited information provide | Claude |
Consolidated . Index to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders Fidus Investment Corporation and Subsidiaries We have audited Fidus Investment Corporation and Subsidiaries’ (collectively, the “Company”) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Fidus Investment Corporation and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of assets and liabilities, including the consolidated schedules of investments, of Fidus Investment Corporation and Subsidiaries as of December 31, 2016 and 2015 , and the related consolidated statements of operations, changes in net assets and cash flows for each of the three years in the period ended December 31, 2016, and our report dated March 2, 2017 expressed an unqualified opinion. /s/ RSM US LLP Chicago, Illinois March 2, 2017 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders Fidus Investment Corporation and Subsidiaries We have audited the accompanying consolidated statements of assets and liabilities, including the consolidated schedules of investments, of Fidus Investment Corporation and Subsidiaries (collectively, the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, changes in net assets and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of investments owned as of December 31, 2016 and 2015, by correspondence with the custodian, loan agent, or borrower or by other appropriate procedures where replies from the custodian, loan agent or borrower were not received. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fidus Investment Corporation and Subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Fidus Investment Corporation and Subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 2, 2017, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ RSM US LLP Chicago, Illinois March 2, 2017 FIDUS INVESTMENT CORPORATION Consolidated Statements of Assets and Liabilities (in thousands, except shares and per share data) See . FIDUS INVESTMENT CORPORATION Consolidated Statements of Operations (in thousands, except shares and per share data) See . FIDUS INVESTMENT CORPORATION Consolidated Statements of Changes in Net Assets (in thousands, except shares) See . FIDUS INVESTMENT CORPORATION Consolidated Statements of Cash Flows (in thousands) See . FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments December 31, 2016 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2016 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2016 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2016 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2016 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2016 (In thousands, except shares) (a) See Note 3 to the consolidated financial statements for portfolio composition by geographic location. (b) Equity ownership may be held in shares or units of companies related to the portfolio companies. (c) All debt investments are income producing, unless otherwise indicated. Equity investments are non-income producing unless otherwise noted. (d) Rate includes the cash interest or dividend rate and paid-in-kind interest or dividend rate, if any, as of December 31, 2016. Generally, payment-in-kind interest can be paid-in-kind or all in cash. (e) The investment bears interest at a variable rate that is determined by reference to one-month LIBOR, which is reset monthly. The interest rate is set as one-month LIBOR + 11.5% and is subject to a 12.5% interest rate floor. The Company has provided the interest rate in effect as of December 31, 2016. (f) Income producing. Maturity date, if any, represents mandatory redemption date. (g) Investment is held by a wholly-owned subsidiary of the Company, other than the Funds. (h) The entire commitment was unfunded at December 31, 2016. As such, no interest is being earned on this investment. (i) Investment pledged as collateral for the Credit Facility and, as a result, is not directly available to the creditors of the Company to satisfy any obligations of the Company other than the Company’s obligations under the Credit Facility (see Note 6 to the consolidated financial statements). (j) The portion of the investment not held by the Funds is pledged as collateral for the Credit Facility and, as a result, is not directly available to the creditors of the Company to satisfy any obligations of the Company other than the Company’s obligations under the Credit Facility (see Note 6 to the consolidated financial statements). (k) As defined in the 1940 Act, the Company is deemed to be an “Affiliated Person” of this portfolio company because it owns 5% or more of the portfolio company’s outstanding voting securities or it has the power to exercise control over the management or policies of such portfolio company. Transactions in which the issuer was an Affiliated Person are detailed in Note 3 to the consolidated financial statements. (l) Warrants entitle the Company to purchase a predetermined number of shares of common stock, and are non-income producing. The purchase price and number of shares are subject to adjustment under certain conditions until the expiration date, if any. (m) Investment in portfolio company that has sold its operations and is in the process of winding down. (n) The debt investment continues to pay interest, including the default rate, while the portfolio company pursues refinancing options. See . FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments December 31, 2015 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2015 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2015 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2015 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2015 (In thousands, except shares) FIDUS INVESTMENT CORPORATION Consolidated Schedule of Investments-(Continued) December 31, 2015 (In thousands, except shares) (a) See Note 3 to the consolidated financial statements for portfolio composition by geographic location. (b) Equity ownership may be held in shares or units of companies related to the portfolio companies. (c) All debt investments are income producing, unless otherwise indicated. Equity investments are non-income producing unless otherwise noted. (d) Rate includes the cash interest or dividend rate and paid-in-kind interest or dividend rate, if any, as of December 31, 2015. Generally, payment-in-kind interest can be paid-in-kind or all in cash. (e) The investment bears interest at a variable rate that is determined by reference to LIBOR, which is reset monthly. The interest rate is set as LIBOR + 11.5% and is subject to a 12.5% interest rate floor. The Company has provided the interest rate in effect as of December 31, 2015. (f) Income producing. Maturity date, if any, represents mandatory redemption date. (g) Investment is held by a wholly-owned subsidiary of the Company, other than the Funds. (h) The entire commitment was unfunded at December 31, 2015. As such, no interest is being earned on this investment. (i) Investment pledged as collateral for the Credit Facility and, as a result, is not directly available to the creditors of the Company to satisfy any obligations of the Company other than the Company’s obligations under the Credit Facility (see Note 6 to the consolidated financial statements). (j) The portion of the investment not held by the Funds is pledged as collateral for the Credit Facility and, as a result, is not directly available to the creditors of the Company to satisfy any obligations of the Company other than the Company’s obligations under the Credit Facility (see Note 6 to the consolidated financial statements). (k) As defined in the 1940 Act, the Company is deemed to be an “Affiliated Person” of this portfolio company because it owns 5% or more of the portfolio company’s outstanding voting securities or it has the power to exercise control over the management or policies of such portfolio company. Transactions in which the issuer was an Affiliated Person are detailed in Note 3 to the consolidated financial statements. (l) As defined in the 1940 Act, the Company is deemed to be both an “Affiliated Person” of and “Control” this portfolio company because it owns 25% or more of the portfolio company’s outstanding voting securities or it has the power to exercise control over the management or policies of such portfolio company. Transactions in which the issuer was both an Affiliated Person and a portfolio company that the Company is deemed to Control are detailed in Note 3 to the consolidated financial statements. (m) Investment was on non-accrual status as of December 31, 2015, meaning the Company has ceased recognizing interest income on the investment. (n) Investment in portfolio company that has sold its operations and is in the process of winding down. (o) Warrants entitle the Company to purchase a predetermined number of shares of common stock, and are non-income producing. The purchase price and number of shares are subject to adjustment under certain conditions until the expiration date, if any. See . FIDUS INVESTMENT CORPORATION (In thousands, except shares and per share data) Note 1. Organization and Nature of Business Fidus Investment Corporation, a Maryland corporation (“FIC,” and together with its subsidiaries, the “Company”), was formed on February 14, 2011 for the purposes of (i) acquiring 100% of the limited partnership interests of Fidus Mezzanine Capital, L.P. and its consolidated subsidiaries (collectively, “Fund I”) and 100% of the membership interests of Fund I’s general partner, Fidus Mezzanine Capital GP, LLC (“FMCGP”), (ii) raising capital in an initial public offering that was completed in June 2011 (the “IPO”) and (iii) thereafter operating as an externally managed, closed-end, non-diversified management investment company, within the meaning of the Investment Company Act of 1940, as amended (the “1940 Act”), that has elected to be regulated as a business development company (“BDC”) under the 1940 Act. On June 20, 2011, FIC acquired 100% of the limited partnership interests in Fund I and 100% of the equity interests in FMCGP, in exchange for 4,056,521 shares of common stock in FIC (the “Formation Transactions”). Fund I became FIC’s wholly-owned subsidiary, retained its license to operate as a Small Business Investment Company (“SBIC”), and continues to hold investments and make new investments. The IPO consisted of the sale of 5,370,500 shares of the Company’s common stock, including shares purchased by the underwriters pursuant to their exercise of the over-allotment option, at a price of $15.00 per share resulting in net proceeds of $73,626, after deducting underwriting fees and commissions and offering costs totaling $6,932. The Company provides customized debt and equity financing solutions to lower middle-market companies. Fund I commenced operations on May 1, 2007, and on October 22, 2007, was granted a license to operate as a SBIC under the authority of the U.S. Small Business Administration (“SBA”). On March 29, 2013, the Company commenced operations of a second wholly-owned subsidiary, Fidus Mezzanine Capital II, L.P. (“Fund II”), and, on May 28, 2013, was granted a second license to operate Fund II as an SBIC. Collectively, Fund I and Fund II are referred to as the “Funds.” The SBIC licenses allow the Funds to obtain leverage by issuing SBA-guaranteed debentures (“SBA debentures”), subject to the issuance of leverage commitments by the SBA and other customary procedures. As SBICs, the Funds are subject to a variety of regulations and oversight by the SBA under the Small Business Investment Act of 1958, as amended (the “SBIC Act”), concerning, among other things, the size and nature of the companies in which they may invest and the structure of those investments. Fund I has also elected to be regulated as a BDC under the 1940 Act. Fund II is not registered under the 1940 Act and relies on the exclusion from the definition of investment company contained in Section 3(c)(7) of the 1940 Act. In addition, for federal income tax purposes, the Company elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”), commencing with its taxable year ended December 31, 2011. The Company pays a quarterly base management fee and an incentive fee to Fidus Investment Advisors, LLC (the “Investment Advisor”) under an investment advisory agreement (the “Investment Advisory Agreement”). The initial investment professionals of the Investment Advisor were previously employed by Fidus Capital, LLC, who was the investment advisor to Fund I prior to consummation of the Formation Transactions. Note 2. Significant Accounting Policies Basis of presentation: The accompanying consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) pursuant to the requirements for reporting on Form 10-K, Accounting Standards Codification (“ASC”) 946, Financial Services-Investment Companies (“ASC 946), and Articles 6 or 10 of Regulation S-X. In the opinion of management, the consolidated financial statements reflect all adjustments and reclassifications that are necessary for the fair presentation of financial results as of and for the periods presented. Certain prior period amounts have been reclassified to conform to the current period presentation. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Use of estimates: The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Consolidation: Pursuant to Article 6 of Regulation S-X and ASC 946, the Company will generally not consolidate its investments in a company other than an investment company subsidiary or a controlled operating company whose business consists of providing services to the Company. As a result, the consolidated financial statements of the Company include only the accounts of the Company and its wholly-owned subsidiaries, including the Funds. All significant intercompany balances and transactions have been eliminated. Investment risks: The Company’s investments are subject to a variety of risks. These risks may include, but are not limited to the following: • Market risk-Market risk represents the potential loss that can be caused by a change in the fair value of the financial instrument due to market changes. • Credit risk-Credit risk represents the risk that the Company would incur if the counterparties failed to perform pursuant to the terms of their agreements with the Company. • Liquidity risk-Liquidity risk represents the possibility that the Company may not maintain sufficient cash balances or may not have access to sufficient cash to meet loan and other commitments as they become due. • Interest rate risk-Interest rate risk represents the likelihood that a change in interest rates could have an adverse impact on the fair value of an interest-bearing financial instrument. • Prepayment risk-Certain of the Company’s debt investments allow for prepayment of principal without penalty. Downward changes in interest rates may cause prepayments to occur at a faster than expected rate, thereby effectively shortening the maturity of the debt investments and making the instrument less likely to be an income producing instrument. • Off-Balance sheet risk-Some of the Company’s financial instruments contain off-balance sheet risk. Generally, these financial instruments represent future commitments to purchase other financial instruments at specific terms at specific future dates. See Note 7 for further details. Fair value of financial instruments: The Company measures and discloses fair value with respect to substantially all of its financial instruments in accordance with ASC Topic 820-Fair Value Measurements and Disclosures (“ASC Topic 820”). ASC Topic 820 defines fair value, establishes a framework used to measure fair value, and requires disclosures for fair value measurements, including the categorization of financial instruments into a three-level hierarchy based on the transparency of valuation inputs. See Note 4 to the consolidated financial statements for further discussion regarding the fair value measurements and hierarchy. Investment classification: The Company classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in those companies where the Company owns more than 25% of the voting securities of such company or has rights to maintain greater than 50% of the board representation. Under the 1940 Act, “Affiliate Investments” are defined as investments in those companies where the Company owns between 5% and 25% of the voting securities of such company. “Non-Control/Non-Affiliate Investments” are those that neither qualify as Control Investments nor Affiliate Investments. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Segments: In accordance with ASC Topic 280-Segment Reporting, the Company has determined that it has a single reporting segment and operating unit structure. Cash and cash equivalents: Cash and cash equivalents are highly liquid investments with an original maturity of three months or less at the date of acquisition. The Company places its cash in financial institutions and, at times, such balances may be in excess of the Federal Deposit Insurance Corporation insurance limits. The Company does not believe its cash balances are exposed to any significant credit risk. Deferred financing costs: Deferred financing costs consist of fees and expenses paid in connection with the Credit Facility (as defined in Note 6) and SBA debentures. Deferred financing costs are capitalized and amortized over the term of the debt agreement using the effective interest method. Unamortized deferred financing costs are presented as an offset to the corresponding debt liabilities on the consolidated statements of assets and liabilities. Deferred equity offering costs: Deferred equity offering costs include registration expenses related to shelf filings, including expenses related to the launch of the ATM Program. These expenses primarily consist of Securities and Exchange Commission (“SEC”) registration fees, legal fees and accounting fees incurred. These expenses are included in prepaid assets and are charged to additional paid in capital upon the receipt of proceeds from an equity offering or charged to expense if no offering is completed. Realized gains or losses and unrealized appreciation or depreciation on investments: Realized gains or losses on investments are recorded upon the sale or disposition of a portfolio investment and are calculated as the difference between the net proceeds from the sale or disposition and the cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. Net change in unrealized appreciation or depreciation on the consolidated statements of operations includes changes in the fair value of investments from the prior period, as determined in good faith by the Company’s board of directors (the “Board”) through the application of the Company’s valuation policy, as well as reclassifications of any prior period unrealized appreciation or depreciation on exited investments to realized gains or losses on investments. Interest and dividend income: Interest and dividend income is recorded on the accrual basis to the extent that we expect to collect such amounts. Interest is accrued daily based on the outstanding principal amount and the contractual terms of the debt. Dividend income is recorded as dividends are declared or at the point an obligation exists for the portfolio company to make a distribution, and is generally recognized when received. Distributions from portfolio companies are evaluated to determine if the distribution is a distribution of earnings or a return of capital. Distributions of earnings are included in dividend income while a return of capital is recorded as a reduction in the cost basis of the investment. Estimates are adjusted as necessary when the relevant tax forms are received from the portfolio company. Certain of the Company’s investments contain a payment-in-kind (“PIK”) income provision. The PIK income, computed at the contractual rate specified in the applicable investment agreement, is added to the principal balance of the investment, rather than being paid in cash, and recorded as interest or dividend income, as applicable, on the consolidated statements of operations. Generally, PIK can be paid-in-kind or all in cash. The Company stops accruing PIK income when there is reasonable doubt that PIK income will be collected. PIK income is included in the Company’s taxable income and, therefore, affects the amount the Company is required to pay to shareholders in the form of dividends in order to maintain the Company’s tax treatment as a RIC and to avoid corporate federal income tax, even though the Company has not yet collected the cash. When there is reasonable doubt that principal, interest or dividends will be collected, loans or preferred equity investments are placed on non-accrual status and the Company will generally cease recognizing interest or FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) dividend income. Interest and dividend payments received on non-accrual investments may be recognized as interest or dividend income or may be applied to the investment principal balance based on management’s judgment. Non-accrual investments are restored to accrual status when past due principal, interest or dividends are paid and, in management’s judgment, payments are likely to remain current. Fee income: Transaction fees earned in connection with the Company’s investments are recognized as fee income. Such fees typically include fees for services, including structuring and advisory services, provided to portfolio companies. The Company recognizes income from fees for providing such structuring and advisory services when the services are rendered or the transactions are completed. Upon the prepayment of a loan or debt security, any prepayment penalties are recorded as fee income when earned. The Company also typically receives loan origination or closing fees in connection with investments. Such loan origination and closing fees are capitalized as unearned income and offset against investment cost basis on the consolidated statements of assets and liabilities and accreted into income over the life of the investment. Warrants: In connection with the Company’s debt investments, the Company will sometimes receive warrants or other equity-related securities from the borrower (“Warrants”). The Company determines the cost basis of Warrants based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and Warrants received. Any resulting difference between the face amount of the debt and its recorded fair value resulting from the assignment of value to the Warrants is treated as original issue discount (“OID”), and accreted into interest income using the effective interest method over the term of the debt investment. Partial loan sales: The Company follows the guidance in ASC 860, Transfers and Servicing, when accounting for loan participations and other partial loan sales. Such guidance requires a participation or other partial loan sale to meet the definition of a “participating interest,” as defined in the guidance, in order for sale treatment to be allowed. Participations or other partial loan sales which do not meet the definition of a participating interest should remain on the Company’s consolidated statement of assets and liabilities and the proceeds recorded as a secured borrowing until the definition is met. Management has determined that all participations and other partial loan sale transactions entered into by the Company have met the definition of a participating interest. Accordingly, the Company uses sale treatment in accounting for such transactions. Income taxes: The Company has elected to be treated as a RIC under Subchapter M of the Code, which will generally relieve the Company from U.S. federal income taxes with respect to all income distributed to stockholders. To maintain the tax treatment of a RIC, the Company is required to timely distribute to its stockholders at least 90.0% of “investment company taxable income,” as defined by Subchapter M of the Code, each year. Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year distributions into the next tax year; however, the Company will pay a 4.0% excise tax if it does not distribute at least 98.0% of the current year’s ordinary taxable income. Any such carryover taxable income must be distributed through a dividend declared prior to the later of the date on which the final tax return related to the year in which the Company generated such taxable income is filed or the 15th day of the 9th month following the close of such taxable year. In addition, the Company will be subject to federal excise tax if it does not distribute at least 98.2% of its net capital gains realized, computed for any one year period ending October 31. In the future, the Funds may be limited by provisions of the SBIC Act and SBA regulations governing SBICs from making certain distributions to FIC that may be necessary to enable FIC to make the minimum distributions required to maintain the tax treatment of a RIC. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) The Company has certain wholly-owned taxable subsidiaries (the “Taxable Subsidiaries”), each of which generally holds one or more of the Company’s portfolio investments listed on the consolidated schedules of investments. The Taxable Subsidiaries are consolidated for financial reporting purposes, such that the Company’s consolidated financial statements reflect the Company’s investment in the portfolio companies owned by the Taxable Subsidiaries. The purpose of the Taxable Subsidiaries is to permit the Company to hold equity investments in portfolio companies that are taxed as partnerships for U.S. federal income tax purposes (such as entities organized as limited liability companies (“LLCs”) or other forms of pass through entities) while complying with the “source-of-income” requirements contained in the RIC tax provisions. The Taxable Subsidiaries are not consolidated with the Company for U.S. federal corporate income tax purposes, and each Taxable Subsidiary will be subject to U.S. federal corporate income tax on its taxable income. Any such income or expense is reflected in the consolidated statements of operations. U.S. federal income tax regulations differ from GAAP, and as a result, distributions in accordance with tax regulations may differ from net investment income and realized gains recognized under GAAP. Differences may be permanent or temporary. Permanent differences may arise as a result of, among other items, a difference in the book and tax basis of certain assets and nondeductible federal income taxes. Temporary differences arise when certain items of income, expense, gain or loss are recognized at some time in the future. ASC Topic 740-Accounting for Uncertainty in Income Taxes (“ASC Topic 740”) provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the consolidated financial statements. ASC Topic 740 requires the evaluation of tax positions taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” to be respected by the applicable tax authorities. Tax benefits of positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax expense in the current year. It is the Company’s policy to recognize accrued interest and penalties related to uncertain tax benefits in income tax provision, if any. There were no material uncertain income tax positions at December 31, 2016 and 2015. The 2013 through 2015 tax years remain subject to examination by U.S. federal and most state tax authorities. Distributions to stockholders: Distributions to stockholders are recorded on the record date with respect to such distributions. The amount, if any, to be distributed to stockholders, is determined by the Board each quarter and is generally based upon the earnings estimated by management. Net realized capital gains, if any, may be distributed at least annually, although the Company may decide to retain such capital gains for investment. The determination of the tax attributes for the Company’s distributions is made annually, and is based upon the Company’s taxable income and distributions paid to its stockholders for the full year. Ordinary dividend distributions from a RIC do not qualify for the preferential tax rate on qualified dividend income from domestic corporations and qualified foreign corporations, except to the extent that the RIC received the income in the form of qualifying dividends from domestic corporations and qualified foreign corporations. The tax characterization of the Company’s distributions generally includes both ordinary income and capital gains but may also include qualified dividends or return of capital. The Company has adopted a dividend reinvestment plan (“DRIP”) that provides for the reinvestment of dividends on behalf of its stockholders, unless a stockholder has elected to receive dividends in cash. As a result, if the Company declares a cash dividend, the Company’s stockholders who have not “opted out” of the DRIP at least three days prior to the dividend payment date will have their cash dividend automatically reinvested into additional shares of the Company’s common stock. The Company has the option to satisfy the share requirements of the DRIP through the issuance of new shares of common stock or through open market purchases of common stock by the DRIP plan administrator. Newly issued shares are valued based upon the final closing price of the FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Company’s common stock on a date determined by the Board. Shares purchased in the open market to satisfy the DRIP requirements will be valued based upon the average price of the applicable shares purchased by the DRIP plan administrator before any associated brokerage or other costs. See Note 9 to the consolidated financial statements regarding dividend declarations and distributions. Earnings and net asset value per share: The earnings per share calculations for the years ended December 31, 2016 and 2015, are computed utilizing the weighted average shares outstanding for the period. Net asset value per share is calculated using the number of shares outstanding as of the end of the period. Stock repurchase plan: The Company has an open market stock repurchase program (the “Program”) under which the Company may acquire up to $5.0 million of its outstanding common stock. Under the Program, the Company may, but is not obligated to, repurchase outstanding common stock in the open market from time to time provided that the Company complies with the prohibitions under its insider trading policies and the requirements of Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market value and timing constraints. The timing, manner, price and amount of any share repurchases will be determined by the Company’s management, in its discretion, based upon the evaluation of economic and market conditions, stock price, capital availability, applicable legal and regulatory requirements and other corporate considerations. On November 1, 2016, the Board extended the Program through December 31, 2017, or until the approved dollar amount has been used to repurchase shares. The Program does not require the Company to repurchase any specific number of shares and the Company cannot assure that any shares will be repurchased under the Program. The Program may be suspended, extended, modified or discontinued at any time. The Company did not make any repurchases of common stock during the years ended December 31, 2016 or 2015. Recent accounting pronouncements: In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in Revenue Recognition (Topic 605). Under the new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14, which defers the effective date of ASU 2014-09, such that the guidance is effective for annual and interim reporting periods beginning after December 15, 2017 and early application is permitted only for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company is currently evaluating the impact this ASU will have on the Company’s consolidated financial position or disclosures, but the Company does not expect the impact to be material. In February 2015, the FASB issued ASU 2015-02, Consolidation: Amendments to the Consolidation Analysis, which amends the criteria for determining which entities are considered variable interest entities (“VIEs”), amends the criteria for determining if a service provider possesses a variable interest in a VIE and ends the deferral granted to investment companies for application of the VIE consolidation model. The Company adopted ASU 2015-02 as of January 1, 2016. The adoption of ASU 2015-02 had no material impact on the Company’s consolidated financial statements. In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. The Company adopted ASU 2015-03 as of January 1, 2016. The adoption of ASU 2015-03 had no material impact on the Company’s consolidated financial statements other than corresponding reductions to total assets FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) and total liabilities on the consolidated statements of assets and liabilities. Prior to adoption, the Company recorded deferred financing costs as an asset on the consolidated statements of assets and liabilities. Upon adoption of ASU 2015-03, the Company reclassified these deferred costs to a direct offset of the related debt liability on the consolidated statements of assets and liabilities. The new guidance will be applied retrospectively to each prior period presented. The Company reclassified the $4,872 of deferred financing costs presented as an asset as of December 31, 2015 to a direct offset of the related debt liabilities as of such date on the consolidated statements of assets and liabilities. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This guidance is effective for annual and interim reporting periods beginning after December 15, 2017 and early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact this ASU will have on the Company’s consolidated financial position or disclosures. In December 2016, the FASB issued ASU 2016-19, Technical Corrections and Improvements, which includes minor corrections and clarifications that affect a wide variety of topics in the Accounting Standards Codification, including an amendment to Topic 820, Fair Value Measurement, which clarifies the difference between a valuation approach and a valuation technique when applying the guidance of that Topic. The amendment also requires an entity to disclose when there has been a change in either or both a valuation approach and/or a valuation technique. The transition guidance for the Topic 820 amendment must be applied prospectively because it could potentially involve the use of hindsight that includes fair value measurements. The guidance is effective for fiscal years, and interim periods within those fiscal years, for all entities beginning after December 15, 2016. Early application is permitted for any fiscal year or interim period for which the entity’s financial statements have not yet been issued. The Company is currently evaluating the impact this ASU will have on the Company’s consolidated financial position or disclosures. Note 3. Portfolio Company Investments The Company’s portfolio investments principally consist of secured and unsecured debt, equity warrants and direct equity investments in privately held companies. The debt investments may or may not be secured by either a first or second lien on the assets of the portfolio company. The debt investments generally bear interest at fixed rates, and generally mature between five and seven years from the original investment. In connection with a debt investment, the Company also may receive nominally priced equity warrants and/or make a direct equity investment in the portfolio company. The Company’s warrants or equity investments may be investments in a holding company related to the portfolio company. In addition, the Company periodically makes equity investments in its portfolio companies through Taxable Subsidiaries. In both situations, the investment is generally reported under the name of the operating company on the consolidated schedules of investments. As of December 31, 2016, the Company had active investments in 53 portfolio companies and residual investments in four portfolio companies that have sold their underlying operations. The aggregate fair value of the total portfolio was $524,454 and the weighted average effective yield on the Company’s debt investments was 13.1% as of such date. As of December 31, 2016, the Company held equity investments in 86.0% of its portfolio companies and the average fully diluted equity ownership in those portfolio companies was 7.3%. As of December 31, 2015, the Company had active investments in 50 portfolio companies and residual investments in three portfolio companies that have sold their underlying operations. The aggregate fair value of the total portfolio was $443,269 and the weighted average effective yield on the Company’s debt investments of 13.3% as FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) of such date. As of December 31, 2015, the Company held equity investments in 83.0% of its portfolio companies and the average fully diluted equity ownership in those portfolio companies was 7.1%. The weighted average yields were computed using the effective interest rates for debt investments at cost as of December 31, 2016 and 2015, including accretion of original issue discount and loan origination fees, but excluding investments on non-accrual status, if any. Purchases of debt and equity investments for the years ended December 31, 2016, 2015 and 2014, totaled $197,801, $136,380, and $149,814, respectively. Proceeds from sales and repayments, including principal, return of capital distributions and realized gains, of portfolio investments for the years ended December 31, 2016, 2015, and 2014 totaled $137,508 , $94,686, and $62,643, respectively. Investments by type with corresponding percentage of total portfolio investments consisted of the following: All investments made by the Company as of December 31, 2016 and 2015, were made in portfolio companies headquartered in the U.S. The following table shows portfolio composition by geographic region at fair value and cost and as a percentage of total investments. The geographic composition is determined by the location of the corporate headquarters of the portfolio company, which may not be indicative of the primary source of the portfolio company’s business. As of December 31, 2016 and 2015, the Company had no portfolio company investments that represented more than 10% of the total investment portfolio at fair value. As of December 31, 2016, there were no investments on non-accrual status. As of December 31, 2015, the Company had debt investments in one portfolio company on non-accrual status, which had an aggregate cost and fair value of $5,203 and $618, respectively, as of such date. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Schedule 12-14. Consolidated Schedule of Investments In and Advances To Affiliates The table below represents the fair value of control and affiliate investments as of December 31, 2015 and any gross additions and reductions made to such investments, as well as the ending fair value as of December 31, 2016. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) (1) The principal amount, the ownership detail for equity investments, and if the investment is income producing is shown in the consolidated schedule of investments. (2) Represents the total amount of interest, fees or dividends included in 2016 income for the portion of the year ended December 31, 2016 that an investment was included in Control or Affiliate categories. (3) Gross additions include increases in the cost basis of investments resulting from a new portfolio investment, follow on investments, accrued PIK interest or dividends, and accretion of OID and loan origination fees. Gross additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation, as well as the movement of an existing portfolio company into this category and out of a different category. (4) Gross reductions include decreases in the cost basis of investments resulting from principal repayments, if any. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category. Note 4. Fair Value Measurements Investments The Board has established and documented processes and methodologies for determining the fair values of portfolio company investments on a recurring basis in accordance with ASC Topic 820 and consistent with the requirements of the 1940 Act. Fair value is the price, determined at the measurement date, that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. Where available, fair value is based on observable market prices or parameters, or derived from such prices or parameters. Where observable prices or inputs are not available or reliable, valuation techniques described below are applied. Under ASC Topic 820, portfolio investments recorded at fair value in the consolidated financial statements are classified within the fair value hierarchy based upon the level of judgment associated with the inputs used to measure their value, as defined below: Level 1 - Inputs are unadjusted, quoted prices in active markets for identical assets as of the measurement date. Level 2 - Inputs include quoted prices for similar assets in active markets, or that are quoted prices for identical or similar assets in markets that are not active and inputs that are observable, either directly or indirectly, for substantially the full term, if applicable, of the investment. Level 3 - Inputs include those that are both unobservable and significant to the overall fair value measurement. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) An investment’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The Company’s investment portfolio is comprised entirely of debt and equity securities of privately held companies for which quoted prices falling within the categories of Level 1 and Level 2 inputs are not available. Therefore, the Company values all of its portfolio investments at fair value, as determined in good faith by the Board, using Level 3 inputs. The degree of judgment exercised by the Board in determining fair value is greatest for investments classified as Level 3 inputs. Due to the inherent uncertainty of determining the fair values of investments that do not have readily available market values, the Board’s estimate of fair values may differ significantly from the values that would have been used had a ready market for the securities existed, and those differences may be material. In addition, changes in the market environment, portfolio company performance and other events that may occur over the lives of the investments may cause the amounts ultimately realized on these investments to be materially different than the valuations currently assigned. With respect to investments for which market quotations are not readily available, the Board undertakes a multi-step valuation process each quarter, as described below: • the quarterly valuation process begins with each portfolio company or investment being initially evaluated and rated by the investment professionals of the Investment Advisor responsible for the portfolio investment; • preliminary valuation conclusions are then documented and discussed with the investment committee of the Investment Advisor; • the Board engages one or more independent valuation firm(s) to conduct independent appraisals of a selection of our portfolio investments for which market quotations are not readily available. Each portfolio company investment is generally appraised by the valuation firm(s) at least once every calendar year and each new portfolio company investment is appraised at least once in the twelve-month period following the initial investment. In certain instances, the Company may determine that it is not cost-effective, and as a result it is not in the Company’s stockholders’ best interest, to request the independent appraisal of certain portfolio company investments. Such instances include, but are not limited to, situations where the Company determines that the fair value of the portfolio company investment is relatively insignificant to the fair value of the total portfolio. The Board consulted with the independent valuation firm(s) in arriving at the Company’s determination of fair value for 13 and 16 of its portfolio company investments, representing 30.5% and 43.0% of the total portfolio investments at fair value (exclusive of new portfolio company investments made during the three months ended December 31, 2016 and 2015, respectively) as of December 31, 2016 and 2015, respectively. • the audit committee of the Board reviews the preliminary valuations of the Investment Advisor and of the independent valuation firm(s) and responds and supplements the valuation recommendations to reflect any comments; and • the Board discusses these valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of the Investment Advisor, the independent valuation firm(s) and the audit committee. In making the good faith determination of the value of portfolio investments, the Board starts with the cost basis of the security. The transaction price is typically the best estimate of fair value at inception. When evidence supports a subsequent change to the carrying value from the original transaction price, adjustments are made to reflect the expected exit values. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Consistent with the policies and methodologies adopted by the Board, the Company performs detailed valuations of its debt and equity investments, including an analysis on the Company’s unfunded loan commitments, using both the market and income approaches as appropriate. Under the market approach, the Company typically uses the enterprise value methodology to determine the fair value of an investment. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is generally best expressed as a range of values, from which the Company derives a single estimate of enterprise value. Under the income approach, the Company typically prepares and analyzes discounted cash flow models to estimate the present value of future cash flows of either an individual debt investment or of the underlying portfolio company itself. The Company evaluates investments in portfolio companies using the most recent portfolio company financial statements and forecasts. The Company also consults with the portfolio company’s senior management to obtain further updates on the portfolio company’s performance, including information such as industry trends, new product development and other operational issues. For the Company’s debt investments, including senior secured loans and subordinated notes, the primary valuation technique used to estimate the fair value is the discounted cash flow method. However, if there is deterioration in credit quality or a debt investment is in workout status, the Company may consider other methods in determining the fair value, including the value attributable to the debt investment from the enterprise value of the portfolio company or the proceeds that would be received in a liquidation analysis. The Company’s discounted cash flow models estimate a range of fair values by applying an appropriate discount rate to the future cash flow streams of its debt investments, based on future interest and principal payments as set forth in the associated loan agreements. The Company prepares a weighted average cost of capital for use in the discounted cash flow model for each investment, based on factors including, but not limited to: current pricing and credit metrics for similar proposed or executed investment transactions of private companies; the portfolio company’s historical financial results and outlook; and the portfolio company’s current leverage and credit quality as compared to leverage and credit quality as of the date the investment was made. The Company may also consider the following factors when determining the fair value of debt investments: the portfolio company’s ability to make future scheduled payments; prepayment penalties and other fees; estimated remaining life; the nature and realizable value of any collateral securing such debt investment; and changes in the interest rate environment and the credit markets that generally may affect the price at which similar investments may be made. The Company estimates the remaining life of its debt investments to generally be the legal maturity date of the instrument, as the Company generally intends to hold its loans to maturity. However, if the Company has information available to it that the loan is expected to be repaid in the near term, it would use an estimated remaining life based on the expected repayment date. For the Company’s equity investments, including equity and warrants, the Company generally uses a market approach, including valuation methodologies consistent with industry practice, to estimate the enterprise value of portfolio companies. Typically, the enterprise value of a private company is based on multiples of EBITDA, net income, revenues, or in limited cases, book value. In estimating the enterprise value of a portfolio company, the Company analyzes various factors consistent with industry practice, including but not limited to original transaction multiples, the portfolio company’s historical and projected financial results, applicable market trading and transaction comparables, applicable market yields and leverage levels, the nature and realizable value of any collateral, the markets in which the portfolio company does business, and comparisons of financial ratios of peer companies that are public. Where applicable, the Company considers the Company’s ability to influence the capital structure of the portfolio company, as well as the timing of a potential exit. The Company may also utilize an income approach when estimating the fair value of its equity securities, either as a primary methodology if consistent with industry practice or if the market approach is otherwise not FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) applicable, or as a supporting methodology to corroborate the fair value ranges determined by the market approach. The Company typically prepares and analyzes discounted cash flow models based on projections of the future free cash flows (or earnings) of the portfolio company. The Company considers various factors, including, but not limited to, the portfolio company’s projected financial results, applicable market trading and transaction comparables, applicable market yields and leverage levels, the markets in which the portfolio company does business, and comparisons of financial ratios of peer companies that are public. The fair value of the Company’s royalty rights are calculated based on projected future cash flows and the specific provisions contained in the pertinent agreements. The determination of the fair value of such royalty rights is not a significant component of the Company’s valuation process. The Company reviews the fair value hierarchy classifications on a quarterly basis. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in or out of the Level 3 category as of the beginning of the quarter in which the reclassifications occur. There were no transfers among Levels 1, 2, and 3 during the years ended December 31, 2016 and 2015. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) The following tables present a reconciliation of the beginning and ending balances for fair valued investments measured using significant unobservable inputs (Level 3) for the years ended December 31, 2016 and 2015: Net change in unrealized appreciation (depreciation) of $12,619 and $(5,363) for the years ended December 31, 2016 and 2015, respectively, was attributable to Level 3 investments held at December 31, 2016 and 2015, respectively. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) The following tables summarize the significant unobservable inputs by valuation technique used to determine the fair value of the Company’s Level 3 debt and equity investments as of December 31, 2016 and 2015. The tables are not intended to be all-inclusive, but instead capture the significant unobservable inputs relevant to the Company’s determination of fair values. The significant unobservable input used in determining the fair value under the discounted cash flow technique is the weighted average cost of capital of each security. Significant increases (or decreases) in this input would likely result in a significantly lower (or higher) fair value estimates. The significant unobservable inputs used in determining fair value under the enterprise value technique are revenue and EBITDA multiples, as well as asset coverage. Significant increases (or decreases) in these inputs could result in significantly higher (or lower) fair value estimates. Other Financial Assets and Liabilities ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. The Company believes that the carrying amounts of its other financial instruments such as cash and cash equivalents, interest receivable and accounts payable and other liabilities approximate the fair value of such items due to the short maturity of such instruments. The fair value of borrowings under the Credit Facility (as defined in Note 6) are based on a market yield approach and current interest rates, which are Level 3 inputs to the market yield model, and is estimated to be $15,500 as of December 31, 2015, which is the same as the Company’s carrying value of the borrowings. There were no borrowings outstanding under the Credit Facility as of December 31, 2016. The fair value of SBA debentures is estimated by discounting remaining payments using current market rates for similar instruments and considering such factors as the legal maturity date and the ability of market participants to prepay the debentures. As of December 31, 2016 and 2015, the fair value of the Company’s SBA debentures using Level 3 inputs is estimated at $224,000 and $213,500, respectively, which is the same as the Company’s carrying value of the debentures. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Note 5. Related Party Transactions Investment Advisory Agreement: Concurrent with the Formation Transactions, the Company entered into the Investment Advisory Agreement with the Investment Advisor. On June 2, 2016, the Board approved the renewal of the Investment Advisory Agreement through June 20, 2017. Pursuant to the Investment Advisory Agreement and subject to the overall supervision of the Board, the Investment Advisor provides investment advisory services to the Company. For providing these services, the Investment Advisor receives a fee, consisting of two components - a base management fee and an incentive fee. The base management fee is calculated at an annual rate of 1.75% based on the average value of total assets (other than cash or cash equivalents, but including assets purchased with borrowed amounts) at the end of the two most recently completed calendar quarters. The base management fee is payable quarterly in arrears. The base management fee under the Investment Advisory Agreement for the years ended December 31, 2016, 2015 and 2014 totaled $8,254, $7,545 and $5,899, respectively. The incentive fee consists of two parts. The first part is calculated and payable quarterly in arrears based on the Company’s pre-incentive fee net investment income for the quarter. Pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees such as commitment, origination, structuring, diligence and consulting fees or other fees that the Company receives from portfolio companies but excluding fees for providing managerial assistance) accrued during the calendar quarter, minus operating expenses for the quarter (including the base management fee, any expenses payable under the Administration Agreement (defined below) and any interest expense and dividends paid on any outstanding preferred stock, but excluding the incentive fee and excise taxes on realized gains). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as market discount, debt instruments with payment-in-kind income, preferred stock with PIK dividends and zero-coupon securities), accrued income the Company has not yet received in cash. The Investment Advisor is not under any obligation to reimburse the Company for any part of the incentive fee it receives that was based on accrued interest that the Company never collects. Pre-incentive fee net investment income does not include any realized capital gains, taxes associated with such realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that the Company may pay an incentive fee in a quarter where the Company incurs a loss. For example, if the Company generates pre-incentive fee net investment income in excess of the hurdle rate (as defined below) for a quarter, the Company will pay the applicable incentive fee even if the Company has incurred a loss in that quarter due to a net loss on investments. Pre-incentive fee net investment income, expressed as a rate of return on the value of the Company’s weighted average net assets (defined as total assets less indebtedness and before taking into account any incentive fees payable during the period) at the end of the immediately preceding calendar quarter, is compared to a fixed “hurdle rate” of 2.0% per quarter. If market interest rates rise, the Company may be able to invest funds in debt instruments that provide for a higher return, which would increase the Company’s pre-incentive fee net investment income and make it easier for the Investment Advisor to surpass the fixed hurdle rate and receive an incentive fee based on such net investment income. The Company pays the Investment Advisor an incentive fee with respect to pre-incentive fee net investment income in each calendar quarter as follows: • no incentive fee in any calendar quarter in which the pre-incentive fee net investment income does not exceed the hurdle rate of 2.0%; FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) • 100.0% of the Company’s pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5% in any calendar quarter. This portion of the pre-incentive fee net investment income (which exceeds the hurdle rate but is less than 2.5%) is referred to as the “catch-up” provision. The catch-up is meant to provide the Investment Advisor with 20.0% of the pre-incentive fee net investment income as if a hurdle rate did not apply if this net investment income exceeds 2.5% in any calendar quarter; and • 20.0% of the amount of the Company’s pre-incentive fee net investment income, if any, that exceeds 2.5% in any calendar quarter. The sum of the calculations above equals the income incentive fee. The income incentive fee is appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during the calendar quarter. The income incentive fee for the years ended December 31, 2016, 2015 and 2014 totaled $7,375, $6,582 and $5,588, respectively. The second part of the incentive fee is a capital gains incentive fee that is determined and paid in arrears as of the end of each fiscal year (or upon termination of the Investment Advisory Agreement, as of the termination date), and equals 20.0% of the net capital gains as of the end of the fiscal year. In determining the capital gains incentive fee to be paid to the Investment Advisor, the Company calculates the cumulative aggregate realized capital gains and cumulative aggregate realized capital losses since the Formation Transactions, and the aggregate unrealized capital depreciation as of the date of the calculation, as applicable, with respect to each of the investments in the Company’s portfolio. At the end of the applicable year, the amount of capital gains that serves as the basis for the calculation of the capital gains incentive fee to be paid equals the cumulative aggregate realized capital gains less cumulative aggregate realized capital losses, less aggregate unrealized capital depreciation, with respect to the Company’s portfolio of investments. If this number is positive at the end of such year, then the capital gains incentive fee to be paid for such year equals 20.0% of such amount, less the aggregate amount of any capital gains incentive fees paid in all prior years. As of both December 31, 2016 and 2015, the capital gains incentive fee payable was $0. The aggregate amount of capital gains incentive fees paid from the IPO through December 31, 2016 is $348. In addition, the Company accrues, but does not pay, a capital gains incentive fee in connection with any unrealized capital appreciation, as appropriate. If, on a cumulative basis, the sum of net realized gains/(losses) plus net unrealized appreciation/(depreciation) decreases during a period, the Company will reverse any excess capital gains incentive fee previously accrued such that the amount of capital gains incentive fee accrued is no more than 20.0% of the sum of net realized gains/(losses) plus net unrealized appreciation/(depreciation). During the year ended December 31, 2016, the Company accrued capital gains incentive fees of $2,994. During the years ended December 31, 2015 and 2014, the Company reversed previously accrued capital gains incentive fees of $101 and $731, respectively. The sum of the income incentive fee and the capital gains incentive fee is the incentive fee and is reported in the consolidated statements of operations. Accrued management fees, income incentive fees and capital gains incentive fees are reported in the due to affiliates line in the consolidated statements of assets and liabilities. Unless terminated earlier as described below, the Investment Advisory Agreement will continue in effect from year to year if approved annually by the Board or by the affirmative vote of the holders of a majority of the Company’s outstanding voting securities, and, in either case, if also approved by a majority of the Independent Directors. The Investment Advisory Agreement automatically terminates in the event of its assignment, as defined in the 1940 Act, by the Investment Advisor and may be terminated by either party without penalty upon FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) not less than 60 days’ written notice to the other. The holders of a majority of the Company’s outstanding voting securities may also terminate the Investment Advisory Agreement without penalty. Administration Agreement: Concurrent with the Formation Transactions, the Company also entered into an administration agreement (the “Administration Agreement”) with the Investment Advisor. On June 2, 2016, the Board approved the renewal of the Administration Agreement through June 20, 2017. Under the Administration Agreement, the Investment Advisor furnishes the Company with office facilities and equipment, provides clerical, bookkeeping, and record keeping services at such facilities and provides the Company with other administrative services necessary to conduct its day-to-day operations. The Company reimburses the Investment Advisor for the allocable portion of overhead expenses incurred in performing its obligations under the Administration Agreement, including rent and the Company’s allocable portion of the cost of its chief financial officer and chief compliance officer and their respective staffs. Under the Administration Agreement, the Investment Advisor also provides managerial assistance to those portfolio companies to which the Company is required to provide such assistance and the Company reimburses the Investment Advisor for fees and expenses incurred with providing such services. In addition, the Company reimburses the Investment Advisor for fees and expenses incurred while performing due diligence on the Company’s prospective portfolio companies, including “dead deal” expenses. Under the Administration Agreement, administrative expenses for services provided for the years ended December 31, 2016, 2015 and 2014 totaled $1,422, $1,465 and $1,772, respectively. Accrued administrative expenses are reported in the due to affiliates line on the consolidated statements of assets and liabilities. Note 6. Debt Revolving Credit Facility: On June 16, 2014, FIC entered into a senior secured revolving credit agreement (the “Credit Facility”) with ING Capital LLC (“ING”), as the administrative agent, collateral agent, and lender. The Credit Facility had an initial commitment of $30,000 with an accordion feature that allows for an increase in the total commitments up to $75,000, subject to certain conditions and the satisfaction of specified financial covenants. The Credit Facility is secured by certain portfolio investments held by the Company, but portfolio investments held by the Funds are not collateral for the Credit Facility. The stated maturity date for the Credit Facility is June 16, 2018, which may be extended by mutual agreement. On December 19, 2014, FIC amended the Credit Facility to (i) increase the commitment from $30,000 to $50,000 (ii) allow FIC to buy-back up to $10,000 of the Company’s common stock subject to the satisfaction of specified financial covenants and conditions. The Credit Facility continues to have an accordion feature which allows for an increase in the total commitment up to $75,000. Amounts available to borrow under the Credit Facility are subject to a minimum borrowing/collateral base that applies an advance rate to certain investments held by the Company, excluding investments held by the Funds. The Company is subject to limitations with respect to the investments securing the Credit Facility, including, but not limited to, restrictions on sector concentrations, loan size, payment frequency and status and collateral interests, as well as restrictions on portfolio company leverage, which may also affect the borrowing base and therefore amounts available to borrow. Borrowings under the Credit Facility bear interest, subject to the Company’s election, on a per annum basis equal to (i) the alternate base rate plus 2.5% or (ii) the applicable London Interbank Offered Rate, or LIBOR, which varies depending on the period of the borrowing under the Credit Facility, plus 3.5%. The alternate base rate is equal to the greater of (i) prime rate, (ii) the federal funds rate plus 0.5% or (iii) the three-month LIBOR plus 1.0%. The Company pays a commitment fee between 0.5% and 1.0% per annum based on the size of the unused portion of the Credit Facility. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) The Company has made customary representations and warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar credit facilities. These covenants are subject to important limitations and exceptions that are described in the documents governing the Credit Facility. As of December 31, 2016 and 2015, the Company was in compliance in all material respect with the terms of the Credit Facility. As of December 31, 2016 and 2015, the Company had outstanding borrowings under the Credit Facility of zero and $15,500, respectively. For the years ended December 31, 2016, 2015 and 2014, interest and fees related to the Credit Facility amounted to $980, $1,069 and $325, respectively, which are included in interest and financing expenses on the consolidated statements of operation. As of December 31, 2016 and 2015, accrued interest and fees payable related to the Credit Facility totaled $127 and $101, respectively. SBA debentures: The Company uses debenture leverage provided through the SBA to fund a portion of its investment purchases. Under the SBA debenture program, the SBA commits to purchase debentures issued by SBICs; such debentures have 10-year terms with the entire principal balance due at maturity and are guaranteed by the SBA. The SBA has made commitments to purchase $275,000 of SBA debentures from the Company on or before September 30, 2020. Unused commitments as of December 31, 2016 and 2015 were $51,000 and $11,500, respectively. The SBA may limit the amount that may be drawn each year under these commitments, and each issuance of leverage is conditioned on the Company’s full compliance, as determined by the SBA, with the terms and conditions set forth in the SBIC Act. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) As of December 31, 2016 and 2015, the Company’s issued and outstanding SBA debentures mature as follows: (1) The SBA has two scheduled pooling dates for debentures (in March and in September). Certain debentures funded during the reporting periods may not be pooled until the subsequent pooling date. (2) The Company issued $10,000 in SBA debentures which will pool in March 2017. Until the pooling date, the debenture bears interest at a fixed rate interim interest rate of 2.101%. The Company expects the current interim interest rate will reset to a higher long-term fixed rate on the pooling date. Interest on SBA debentures is payable semi-annually on March 1 and September 1. For the years ended December 31, 2016, 2015, and 2014, interest and fees on outstanding SBA debentures amounted to $9,614, $8,359, and $7,182, respectively, which are included in interest and financing expenses on the consolidated statements of operation. As of December 31, 2016 and 2015, accrued interest and fees payable related to the SBA debentures totaled $2,995 and $2,739, respectively. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Deferred Financing Costs Deferred financing costs are amortized into interest and financing expenses on the consolidated statements of operations using the effective interest method, over the term of the respective financing instrument. Deferred financing cost amortization for the years ended December 31, 2016, 2015 and 2014 was $1,112, 1,010 and $682, respectively. Deferred financing costs related to the Credit Facility and SBA debentures as of December 31, 2016 and 2015, were as follows: Unamortized deferred financing costs are presented as a direct offset to the SBA debentures and Credit Facility liabilities on the consolidated statements of assets and liabilities. The following table summarizes the outstanding debt net of unamortized deferred financing costs as of December 31, 2016 and 2015: The weighted average interest rate for all SBA debentures and borrowings outstanding under the Credit Facility as of December 31, 2016 and December 31, 2015 was 4.1% and 4.0%, respectively. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Note 7. Commitments and Contingencies Commitments: The Company had outstanding commitments to portfolio companies to fund various undrawn revolving loans, other credit facilities and capital commitments totaling $6,566 and $10,150 as of December 31, 2016 and December 31, 2015, respectively. Such outstanding commitments are summarized in the following table: Additional detail for each of the commitments above is provided in the Company’s consolidated schedules of investments. The commitments are generally subject to the borrowers meeting certain criteria such as compliance with financial and nonfinancial covenants. Since commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Indemnifications: In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties that provide indemnifications under certain circumstances. In addition, in connection with the disposition of an investment in a portfolio company, the Company may be required to make representations about the business and financial affairs of such portfolio company typical of those made in connection with the sale of a business. The Company may also be required to indemnify the purchasers of such investment to the extent that any such representations are inaccurate. The Company’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Company that have not yet occurred. The Company expects the risk of future obligation under these indemnifications to be remote. Legal proceedings: In the normal course of business, the Company may be subject to legal and regulatory proceedings that are generally incidental to its ongoing operations. While the outcome of these legal proceedings cannot be predicted with certainty, the Company does not believe these proceedings will have a material adverse effect on the Company’s consolidated financial statements. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Note 8. Common Stock The following table summarizes the total shares issued, offering price and net proceeds received in public offerings of the Company’s common stock since the IPO: (1) Includes 83,414 shares purchased by underwriters pursuant to the over-allotment option on October 21, 2014. (2) Includes 375,000 shares purchased by underwriters pursuant to the over-allotment option on June 10, 2016. (3) Includes 420,000 shares purchased by underwriters pursuant to the over-allotment option on December 13, 2016. (4) Fidus Investment Advisors, LLC agreed to bear up to $169 of the offering costs associated with this offering. Fidus Investment Advisors, LLC has also agreed to bear $1,756, or 100%, of the underwriting fees and commissions in connection with this offering and the exercise of the over-allotment option. All payments made by Fidus Investment Advisors, LLC are not subject to reimbursement by the Company. (5) Represents the weighted average offering price of shares issued, including the shares issued pursuant to the over-allotment option. Shares were issued on May 27, 2016 at an offering price of $15.27. The offering price of the over-allotment option shares was adjusted for the $0.39 dividend to shareholders of record on June 10, 2016. (6) Represents the weighted average offering price of shares issued, including the shares issued pursuant to the over-allotment option. Shares were issued on November 29, 2016 at an offering price of $16.65. The offering price of the over-allotment option shares was adjusted for the $0.43 dividend to shareholders of record on November 30, 2016. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) On August 21, 2014, the Company entered into an equity distribution agreement with Raymond James & Associates, Inc. and Robert W. Baird & Co. Incorporated through which the Company could sell, by means of at-the-market offerings from time to time, shares of the Company’s common stock having an aggregate offering price of up to $50,000 (the “ATM Program”). The gross proceeds raised, the related sales agent commission, the offering expenses and the average price at which shares were issued under the ATM Program from August 21, 2014 through December 31, 2016 are as follow: See Note 9 for additional information regarding the issuance of shares under the DRIP. As of December 31, 2016 and 2015, the Company had 22,446,076 and 16,300,732 shares of common stock outstanding, respectively. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Note 9. Dividends and Distributions The Company’s dividends and distributions are recorded on the record date. The following table summarizes the dividends paid during the last three fiscal years. (1) Special dividend. Since the Company’s IPO, dividends and distributions to stockholders total $129,708 or $8.96 per share. There were no deemed distributions during the years 2014, 2015, or 2016. See Note 12 for further discussion regarding deemed distributions. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Note 10. Financial Highlights The following is a schedule of financial highlights for the years ended December 31, 2016, 2015, 2014, 2013 and 2012: (1) Weighted average per share data. (2) Represents the impact of different share amounts used in calculating per share data as a result of calculating certain per share data based on weighted average shares outstanding during the period and certain per share data based on the shares outstanding as of a period end or transaction date. (3) The total return for the years ended December 31, 2016, 2015, 2014, 2013 and 2012 equals the change in the market value of the Company’s common stock per share during the period plus dividends paid per share during the period, divided by the market value per share at the beginning of the period. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) (4) The total expenses to average net assets ratio is calculated using the total expenses caption as presented on the consolidated statements of operations, which includes incentive fee and excludes the income tax provision. (5) The net investment income to average net assets ratio is calculated using the net investment income caption as presented on the consolidated statements of operations, which includes incentive fee. (6) Average net assets is calculated as the average of the net asset balances as of each quarter end during the fiscal year and the prior year end. Note 11. Selected Quarterly Financial Data (unaudited) Note 12. Income Taxes The Company has elected to be treated for federal income tax purposes as a RIC, whereby the Company generally will not pay corporate-level federal income taxes on any net ordinary income or capital gains that the Company distributes to its stockholders as dividends. The Company must generally distribute at least 90% of its investment company taxable income to maintain its RIC status. As part of maintaining RIC status, undistributed taxable income pertaining to a given fiscal year may be distributed up to 12 months subsequent to the end of that fiscal year, provided such dividends are declared prior to the later of the filing of the federal income tax return for the prior year or the 15th day of the 9th month following the prior tax year. Such taxable income carried forward to the next tax year will be subject to excise tax equal to 4% of the amount by which (i) 98% of the Company’s ordinary income recognized during a calendar year and (ii) 98.2% of the Company’s long term capital gains, as defined by Subchapter M of the Code, recognized for the one year period ending October 31st of a calendar year exceeds the respective distributions for the year. For the years ended December 31, 2016, 2015 and 2014, the excise tax provision (benefit) was $370, $395 and $340, respectively. Excise tax is included as a component of income tax provision and income tax (provision) on realized gains on investments, depending on the character of the underlying taxable income, on the consolidated statements of operations. The Taxable Subsidiaries hold certain portfolio investments for the Company. The Taxable Subsidiaries are consolidated for financial reporting purposes, and the portfolio investments held by the Taxable Subsidiaries are FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) included in the Company’s consolidated financial statements. The principal purpose of the Taxable Subsidiaries are to permit the Company to hold equity investments in portfolio companies which are “pass through” entities for federal income tax purposes in order to comply with the “source-of-income” requirements contained in the RIC tax provisions of Subchapter M of the Code. The Taxable Subsidiaries are not consolidated for federal income tax purposes and may generate income tax expense or income tax benefit as a result of their ownership of various portfolio investments. The Company classifies interest and penalties, if any, as a component of income tax provision on the consolidated statements of operations. For the years ended December 31, 2016, 2015 and 2014, income tax expense at the taxable subsidiaries was $28, $34, and $28, respectively. Income tax expense is included as a component of the income tax provisions on the consolidated statements of operations. Listed below is a reconciliation of net increase in net assets resulting from operations on the consolidated statements of operations to taxable income and to total distributions declared to common stockholders for the years ended December 31, 2016, 2015 and 2014. (1) The Company’s taxable income for 2016 is an estimate and will not be finalized until the Company files its 2016 federal income tax return in 2017. Therefore, the Company’s actual taxable income, and the Company’s actual taxable income that was earned in 2016 and carried forward for distribution in 2017, may be different than this estimate. For tax purposes, distributions paid to stockholders are reported as ordinary income, long term capital gains, qualified dividends, return of capital or a combination thereof. There were no return of capital distributions paid during 2016, 2015 and 2014. The tax character of distributions paid for the years ended December 31, 2016, 2015 and 2014 was as follows: The Company estimates that it generated undistributed ordinary taxable income of approximately $13,192, or $0.59 per share during 2016 that will be carried forward and distributed in 2017. Ordinary dividend FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) distributions from a RIC do not qualify for the preferential federal income tax rate on dividend income from certain domestic corporations and qualified foreign corporations, except to the extent that the RIC received the income in the form of qualifying dividends from domestic corporations and qualified foreign corporations. The Company may distribute a portion of its realized net long term capital gains in excess of realized net short term capital losses to its stockholders, but may also decide to retain a portion, or all, of its net capital gains and elect to make a “deemed distribution” to its stockholders. For the years ended December 31, 2016, 2015 and 2014, the Company did not elect to designate retained net capital gains as a deemed distribution. As of December 31, 2016, 2015 and 2014, the tax basis components of distributable earnings were as follows: (1) The Company’s undistributed earnings for 2016 is an estimate and will not be finally determined until the Company files its 2016 federal income tax return in 2017. Therefore, the Company’s actual distributable earnings may be different than this estimate. (2) In addition, there is net unrealized appreciation (depreciation) of $(4), $1,633 and $1,211 included in additional paid in capital as of December 31, 2016, 2015 and 2014, respectively, that was recognized prior to the Formation Transactions. For federal income tax purposes, the cost of investments owned at December 31, 2016 and 2015 was approximately $501,205 and $448,889, respectively. FIDUS INVESTMENT CORPORATION -(Continued) (In thousands, except shares and per share data) Distributions from net investment income and net realized capital gains are determined in accordance with U.S. federal tax regulations, which may differ from amounts determined in accordance with GAAP and those differences could be material. These permanent book-to-tax differences are reclassified on the consolidated statements of changes in net assets to reflect their tax character but have no impact on total net assets. The following permanent book-to-tax differences were reclassified on the consolidated statements of changes in net assets for the years ended December 31, 2016, 2015 and 2014. Note 13. Subsequent Events On January 4, 2017, the Company invested $12,250 in subordinated notes and common equity of Revenue Management Solutions, LLC, a leading provider of services that match, reconcile, and facilitate the posting of healthcare payments received against submitted claims from healthcare providers, benefit managers, and billing companies. On February 3, 2017, the Company exited its debt and equity investments in Worldwide Express Operations, LLC (“Worldwide Express”). The Company received payment in full on its subordinated note, including a prepayment penalty, and sold a portion of its equity for a realized gain, net of estimated taxes, of approximately $5,049. Concurrently, the Company rolled over $4,000 of its equity investment into a new equity investment in the portfolio company. On February 27, 2017, the Company invested $10,000 in a subordinated note of Worldwide Express. On February 14, 2017, the Board declared a regular quarterly dividend of $0.39 per share payable on March 24, 2017 to stockholders of record as of March 10, 2017. On February 28, 2017, the Company repaid $24,750 of SBA debentures with an interest rate of 6.2% which would have matured on March 1, 2018. On February 28, 2017, the Company invested $10,500 in subordinated notes and common equity of TransGo, LLC, a specialty manufacturer and designer of aftermarket automotive transmission parts and repair kits. On February 28, 2017, the Company exited its debt investment in Grindmaster Corporation. The Company received payment in full on its subordinated note, including a prepayment penalty. | Based on the provided text, here's a summary of the financial statement:
Financial Risks and Characteristics:
1. Profit/Loss Risks:
- Market changes can impact financial instrument values
- Credit risk from potential counterparty failure
- Liquidity risk related to maintaining sufficient cash
- Interest rate risk affecting financial instrument values
- Prepayment risk potentially shortening debt investment maturities
Financial Structure:
- Assets and liabilities tracked on consolidated statements
- Debt investments generally produce income
- Equity investments typically non-income producing
- Some financial instruments involve off-balance sheet commitments
Key Observations:
- The company (Fidus Investment Corporation) manages multiple financial risks
- Deferred financing costs accounting was modified
- Investment portfolio includes both debt and equity instruments
- Rates include cash and potential paid-in-kind interest/dividends
Note: The text appears to be a partial financial statement | Claude |
. CALEMINDER INC. DECEMBER 31, 2016 ACCOUNTING FIRM To the Board of Directors and Stockholders of Caleminder Inc. We have audited the accompanying balance sheets of Caleminder Inc. as of December 31, 2016 and 2015, and the related statements of operations, stockholder’s deficit, and cash flows for the years ended December 31, 2016, and 2015. Caleminder Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion. We were not engaged to examine management’s assertion about the effectiveness of Caleminder Inc.’s internal control over financial reporting as of December 31, 2016 and, accordingly, we do not express an opinion thereon. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Caleminder Inc. as of December 31, 2016 and 2015, and the results of its operations and cash flows for the years ended December 31, 2016, and 2015, in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 6 to the financial statements, the Company has incurred operating losses, has incurred negative cash flows from operations and has a working capital deficit. These and other factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plan regarding these matters is also described in Note 6 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. D. Brooks and Associates CPA’s, P.A West Palm Beach, FL March 31, 2017 D. Brooks and Associates CPA’s, P.A. 319 Clematis Street, Suite 318 West Palm Beach, FL 33401 - (561) 429-6225 The accompanying notes are an integral part of these financial statements. CALEMINDER, INC. Statements of Operations The accompanying notes are an integral part of these financial statements. CALEMINDER, INC. Statement of Stockholders' Deficit The accompanying notes are an integral part of these financial statements. CALEMINDER, INC. Statements of Cash Flows The accompanying notes are an integral part of these financial statements. CALEMINDER INC. NOTES TO FINANCIAL STATEMENTS December 31, 2016 NOTE 1. GENERAL ORGANIZATION AND BUSINESS Caleminder, Inc. (“the Company”) was incorporated under the laws of the state of Delaware on May 28, 2014. The Company has not yet realized any revenues from its planned operations. The Company’s principal operations plan includes an online reminder service. The Company plans to generate revenues through online advertising. The Company’s activities are subject to significant risks and uncertainties including failure to secure additional funding to properly execute the company’s business plan. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING PRACTICES Basis of Accounting The Company’s financial statements are prepared using the accrual method of accounting. The Company has elected a December 31 fiscal year end. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid investments with maturity of three months or less when purchased to be cash equivalents. Income Taxes A deferred tax asset or liability is recorded for all temporary differences between financial and tax reporting and net operating loss carry forwards. Deferred tax expense (benefit) results from the net change during the year of deferred tax assets and liabilities. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. When required, the Company records a liability for unrecognized tax positions, defined as the aggregate tax effect of differences between positions taken on tax returns and the benefits recognized in the financial statements. Tax positions are measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. No tax benefits are recognized for positions that do not meet this threshold. The Company has no uncertain tax positions that require the Company to record a liability. The Company recognizes penalties and interest associated with tax matters as part of the income tax provision and includes accrued interest and penalties with the related tax liability in the balance sheet. The Company had no accrued penalties and interest as of December 31, 2016 and 2015. Loss per Share The basic loss per share is calculated by dividing our net loss by the weighted average number of common shares outstanding during the year. The diluted earnings (loss) per share is calculated by dividing our net loss by the diluted weighted average number of shares outstanding during the year. The diluted weighted average number of shares outstanding is the basic weighted number of shares adjusted for any potentially dilutive debt or equity. The Company has not issued any potentially dilutive debt or equity securities. Recently issued accounting pronouncements The Company does not believe that there are any new accounting pronouncements that have been issued that might have a material impact on its financial position or results of operations. NOTE 3. INCOME TAXES The Company uses the liability method , where deferred tax assets and liabilities are determined based on the expected future tax consequences of temporary differences between the carrying amounts of assets and liabilities for financial and income tax reporting purposes. As of December 31, 2016 and 2015, the Company has incurred net losses and, therefore, has no tax liability. The net deferred tax asset generated by the loss carry-forward has been fully reserved. As of December 31, 2016 the cumulative net operating loss carry-forward is approximately $90,458 and will expire 20 years from the date the loss was incurred. NOTE 4. STOCKHOLDERS’ DEFICIT Authorized The Company is authorized to issue 500,000,000 shares of $0.0001 par value common stock. All common shares have equal voting rights, are non-assessable and have one vote per share. Voting rights are not cumulative and, therefore, the holders of more than 50% of the common stock could, if they choose to do so, elect all of the directors of the Company. Issued and Outstanding On June 1, 2014, the Company issued 7,500,000 common shares to its sole stockholder for cash consideration of $0.0001 per share. The proceeds of $750 were received on June 27, 2014. On February 9, 2015, the Company issued 2,500,000 shares of common stock for $50,000 as per a Registration Statement filed with the SEC, at an offering price of $0.02 per share. NOTE 5. CONFLICTS OF INTEREST The officers and directors of the Company are involved in other business activities and may, in the future, become involved in other business opportunities. If a specific business opportunity becomes available, such persons may face a conflict in selecting between the Company and their other business interests. The Company has not formulated a policy for the resolution of such conflicts. NOTE 6. GOING CONCERN The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company has no revenues, and an accumulated deficit of approximately $90,458 as of December 31, 2016. This condition among others raises substantial doubt about the Company’s ability to continue as a going concern. The Company’s continuation as a going concern is dependent on its ability to meet its obligations, to obtain additional financing as may be required and ultimately to attain profitability. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Management is planning to raise funds through debt or equity offerings. There is no guarantee that the Company will be successful in these efforts. NOTE 7. RELATED PARTY TRANSACTIONS As of December 31, 2016 and 2015, loans from the Company’s sole stockholder amounted to $31,064 and $11,664, respectively, and represent working capital advances. The loans are unsecured, non-interest bearing, and due on demand. | Here's a summary of the financial statement:
Financial Condition:
- The company is experiencing financial challenges, including:
- Ongoing losses
- Negative cash flows from operations
- Working capital deficit
- These factors raise significant doubts about the company's ability to continue as a going concern
Key Financial Accounting Practices:
1. Cash and Cash Equivalents:
- Considers investments with 3-month or less maturity as cash equivalents
2. Income Taxes:
- Records deferred tax assets/liabilities for temporary differences
- Applies valuation allowances when tax asset realization is uncertain
- No uncertain tax positions or accrued penalties identified
3. Liabilities:
- No potentially dilutive debt or equity securities issued
4. Accounting Pronouncements:
- No new accounting pronouncements expected to materially impact financial position or operations
Overall, the statement suggests the company | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Board of Directors and Shareholders of BNC Bancorp We have audited the accompanying consolidated balance sheets of BNC Bancorp and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. We also have audited the Company’s internal control over financial reporting as of December 31, 2016 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the consolidated financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BNC Bancorp and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, BNC Bancorp and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). /s/ Cherry Bekaert LLP Raleigh, North Carolina February 27, 2017 BNC BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share data) See accompanying notes to Consolidated Financial Statements. BNC BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share data) See accompanying notes to Consolidated Financial Statements. BNC BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in thousands) See accompanying notes to Consolidated Financial Statements. BNC BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Dollars in thousands, except per share data) BNC BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (continued) (Dollars in thousands, except per share data) See accompanying notes to Consolidated Financial Statements. BNC BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) See accompanying notes to Consolidated Financial Statements. BNC BANCORP AND SUBSIDIARIES Year ended December 31, 2016, 2015, and 2014 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization The Company was formed in 2002 to serve as a one-bank holding company for the Bank. The Bank is incorporated under the laws of the State of North Carolina and provides a wide range of banking services tailored to the particular banking needs of the communities we serve. The Bank is principally engaged in the business of attracting deposits from the general public and using those deposits, together with other funding from our lines of credit, to make commercial and consumer loans. The Bank also offers a wide range of banking services, including traditional products such as checking and savings accounts. The Bank conducts operations through 76 full-service banking offices, including 41 branches in North Carolina, 26 branches in South Carolina and nine branches in Virginia. Basis of Presentation The accompanying consolidated financial statements include the accounts and transactions of the Company and all significant intercompany transactions and balances have been eliminated in consolidation. Use of Estimates The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. On an ongoing basis, the Company evaluates its estimates, including those relating to the allowance for loan losses, determination of fair value of acquired assets and assumed liabilities, and valuation of goodwill and other intangible assets. Reclassifications Certain amounts in the 2015 consolidated financial statements have been reclassified to conform to the 2016 presentation. The reclassifications had no effect on net income, net income available to common shareholders or shareholders' equity as previously reported. Business Combinations The Company accounts for its business combinations using the acquisition method of accounting. This method requires the use of fair values in determining the carrying values of the purchased assets and assumed liabilities, which are recorded at fair value at acquisition date, and identifiable intangible assets are recorded at fair value. Costs directly related to the business combinations are recorded as expenses as they are incurred. Fair values are subject to adjustment for up to one year after the closing date of an acquisition as additional information relative to closing date fair values become available. Cash and Cash Equivalents For the purpose of presentation in the statements of cash flows, cash and cash equivalents include cash, deposits with other financial institutions, and federal funds sold. Federal regulations require financial institutions to set aside a specified amount as a reserve against transaction accounts and time deposits. At December 31, 2016 and 2015, the Company’s reserve requirement was $17.3 million and $9.9 million, respectively. Investment Securities Investment securities are classified as held-to-maturity or available-for-sale at the time of purchase. Investment securities classified as held-to-maturity, which management has the positive intent and ability to hold to maturity, are reported at amortized cost. Investment securities classified as available for sale, which management has the intent and ability to hold for an indefinite period of time, but not necessarily to maturity, are carried at fair value, with unrealized gains and losses, net of related deferred income taxes, included in shareholders’ equity as a separate component of other comprehensive income. Any decision to sell investment securities available for sale would be based on various factors, including, but not limited to, asset / liability management strategies, changes in interest rates or prepayment risks, liquidity needs, or regulatory capital considerations. Premiums are amortized and discounts accreted using the interest method over the remaining terms of the related securities. Dividend and interest income are recognized when earned. Sales of investment securities are recorded at trade date, with realized gains and losses on sales determined using the specific identification method and included in non-interest income. Transfers of investment securities into the held-to-maturity category from the available-for-sale category are made at fair value at the date of transfer. The unrealized holding gain or loss at the date of transfer is retained in accumulated other comprehensive income and in the carrying value of the held-to-maturity securities. Such amounts are amortized over the remaining life of the security. The Company evaluates securities for other-than-temporary impairment ("OTTI") on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, the Company considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. The Company also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings. Federal Home Loan Bank Stock As a member of the FHLB of Atlanta, the Company is required to maintain an investment in the stock of the FHLB based upon the amount of outstanding FHLB borrowings. This stock does not have a readily determinable fair value and is carried at cost. Loans and Leases Originated Loans and Leases Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at their outstanding principal balances, adjusted for any charge-offs, unearned discounts, and unamortized fees and costs. Interest income on loans is accrued and credited to income based upon the principal amount outstanding. The net amount of nonrefundable loan origination fees and certain direct costs associated with the lending process are deferred and amortized to interest income over the contractual lives of the loans using methods that approximate the interest method. The Company classifies all loans and leases past due when the payment of principal and/or interest based upon contractual terms is greater than 30 days delinquent. When commercial loans are placed on nonaccrual status as described below, a charge-off is recorded, as applicable, to decrease the carrying value of such loans to the estimated fair value of the collateral securing the loan. Consumer loans are placed on nonaccrual status at a specified delinquency date consistent with regulatory guidelines. As such, consumer loans are subject to collateral valuation and charge-off, as applicable, when they are moved to nonaccrual status. The accrual of interest income for commercial loans is discontinued when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, while the accrual of interest income for consumer loans is discontinued when loans reach specific delinquency levels. Acquired Loans Acquired loans are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan losses is not recorded at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either purchased impaired or purchased non-impaired. Purchased impaired loans reflect credit deterioration since origination such that it is probable at acquisition that the Company will be unable to collect all contractually required payments. For purchased impaired loans, expected cash flows at the acquisition date in excess of the fair value of loans are recorded as interest income over the life of the loans using a level yield method if the timing and amount of the future cash flows is reasonably estimable. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are recognized prospectively as interest income. Decreases in expected cash flows after the acquisition date are recognized immediately through the provision for loan losses. For purchased non-impaired loans, the difference between the fair value and unpaid principal balance of the loan at the acquisition date is amortized or accreted to interest income over the economic life of the loans using a method that approximates the interest method. Loans Held for Sale The Company originates certain single family, residential first mortgage loans for sale on a presold basis and these loans are classified as loans held for sale. Loans held for sale are carried at the lower of cost or estimated fair value in the aggregate as determined by outstanding commitments from investors. Upon closing, these loans, together with their servicing rights, are sold to other financial institutions under prearranged terms on a best-efforts basis. Gains or losses on loan sales are recognized at the time of sale and are determined by the difference between net sales proceeds and the principal balance of the loans sold, adjusted for net deferred loan fees or costs. Loan origination and commitment fees, net of certain direct loan origination costs, are deferred as an adjustment to the carrying value of the loan until it is sold. The commitments to sell loans and the commitments to originate loans held for sale at a set interest rate, if originated, are considered derivatives under GAAP. The impact of the estimated fair value adjustment was not significant to the consolidated financial statements. Nonperforming Loans The Company considers a loan impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All impaired loans are measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or at the fair value of the collateral if the loan is collateral dependent. The Company uses several factors in determining if a loan is impaired. Internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payment status and the borrowers' financial data, cash flows, operating income or loss, and other factors. These discounted cash flow analyses incorporate adjustments to future cash flows that reflect management’s best estimate based on a combination of historical experience and management judgment. Loans are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than ninety (90) days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or is partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than ninety (90) days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time and there is a sustained period of repayment performance (generally, a minimum of six months) by the borrower in accordance with the contractual terms of interest and principal. While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When future collection of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. Restructurings Modifications to a borrower’s debt agreement is considered a TDR if a concession is granted for economic or legal reasons related to a borrower’s financial difficulties that otherwise would not be considered. TDRs are undertaken in order to improve the likelihood of recovery on the loan and may take the form of modifications made with the stated interest rate lower than the current market rate for new debt with similar risk, modifications to the terms and conditions of the loan that fall outside of normal underwriting policies and procedures, or a combination of these modifications. Modifications of covered and other acquired loans that are part of a pool accounted for as a single asset are not considered TDRs. TDRs can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accruing status, depending on the individual facts and circumstances of the borrower. Allowance for Loan and Lease Losses The allowance for loan and lease losses is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio, and is based on quarterly evaluations of the collectability and historical loss experience of loans. Actual credit losses, net of recoveries, are deducted from the allowance for loan losses. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is appropriate to absorb probable losses in the loan portfolio. All commercial loans that are originated by the Company are assigned risk grades based on an assessment of conditions that affect the borrower’s ability to meet contractual obligations under the loan agreement. This process includes reviewing borrowers’ financial information, historical payment experience, credit documentation, public information, and other information specific to each borrower. Loans with outstanding balances of $1 million or more, as well as all other loans included in such relationships, are reviewed on an annual basis. Loans with total committed exposure of $500,000 or more that are risk graded as Special Mention or worse are reviewed on a quarterly basis. All other loans are reviewed at any point management becomes aware of information affecting the borrower’s ability to fulfill their obligations. Accounting standards require the presentation of certain disclosure information at the portfolio segment level, which represents the level at which an entity develops and documents a systematic methodology to determine its allowance for loan losses. The Company concluded that its loan and lease portfolio comprises two portfolio segments: originated loans (which include purchased non-credit impaired loans) and purchased credit impaired loans. Originated loans include both commercial loans, which include commercial real estate, commercial construction, commercial and industrial and leases, and retail loans, which include residential construction, residential mortgage and consumer and other loans. The following provides a description of the Company’s accounting policies and methodologies related to each of its portfolio segments: Originated Loans The allowance for loan and lease losses consists of two components. This first component is the specific reserve, which is calculated on all individual loans in the following categories: nonperforming TDRs, commercial nonaccrual loans with net credit exposure of $250,000 or greater, and performing commercial and retail TDRs with net credit exposure of $250,000 or greater. If foreclosure is probable or the loan is collateral dependent, impairment is measured using the fair value of the loan’s collateral, less estimated costs to sell. If the loan is not considered collateral dependent, the amount of reserve is calculated based on the present value of expected cash flows discounted at the loan’s effective interest rate. Performing TDRs and nonaccrual loans, respectively, with net credit exposure less than $250,000 are pooled and evaluated for impairment in the aggregate. The second component of the allowance for loan and lease losses is the general reserve. For the commercial loan portfolio, the estimate of losses are based on pools of loans and leases with similar characteristics by applying a probability of default ("PD") factor and a loss-given default ("LGD") factor to each individual loan based on a regularly updated loan grade, using a standardized loan grading system. The PD factor and the LGD factor are determined for each loan grade using statistical models based on historical performance data. These reserve factors are developed based on credit migration models that track historical movements of loans between loan ratings over time and a combination of long-term average loss experience of our own portfolio and external industry data using a loss emergence period ranging from 18 to 23 months. In the case of more homogeneous portfolios, such as automobile loans, home equity loans, and residential mortgage loans, the determination of the transaction reserve also incorporates PD and LGD factors. The estimate of loss is based on pools of loans and leases with similar characteristics. The PD factor considers current number of days past due, which are then translated to a proxy risk grade, and this information is used to estimate expected losses over a 12-month loss emergence period. The general reserve also includes a qualitative assessment of certain factors and the impact of changing market and economic conditions on portfolio performance. The qualitative assessment considers items unique to the Company's structure, policies, processes, and portfolio composition, as well as measurements and assessments of the loan portfolios including, but not limited to, management quality, concentrations, portfolio composition, industry comparisons, and internal review functions. For acquired loans that are not deemed credit impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans, however, the Company records a provision for loan losses only when the required allowance, net of any expected reimbursement under any loss-share agreements, exceeds any remaining credit discounts. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the economic life of the loans. Purchased Credit Impaired Loans The allowance for loan and lease losses related to purchased credit impaired loans is based on an analysis that is performed each period to estimate the expected cash flows for each of the loan pools. To the extent that the expected cash flows of a loan pool have decreased since the acquisition date, the Company establishes an allowance for loan losses. Foreclosed Assets Foreclosed assets are initially recorded at estimated fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy a loan through completion of a deed in lieu of foreclosure or through a similar arrangement. These assets are subsequently accounted for at the lower of cost or estimated fair value less costs to sell. Operating costs and changes in the valuation allowance are included in loan, foreclosure and OREO expenses as a component of non-interest expense. Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation and amortization. Land is carried at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the respective assets, which are 40 years for buildings and 3 to 10 years for furniture, fixtures and equipment. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Repairs and maintenance costs are recorded as a component of non-interest expense as incurred. Bank-Owned Life Insurance The Company has purchased life insurance policies on certain current and past key employees and directors where the insurance policy benefits and ownership are retained by the employer. These policies are recorded at their cash surrender value. Income from these policies and changes in the net cash surrender value are recorded in non-interest income as earnings on bank-owned life insurance. The cash value accumulation is permanently tax deferred if the policy is held to the insured person’s death and certain other conditions are met. Goodwill and Other Intangible Assets The excess of the cost of an acquisition over the fair value of the net assets acquired consists primarily of goodwill, core deposit intangibles, and other identifiable intangibles (primarily related to customer relationships acquired). Other intangible assets, which consists of core deposit and acquired customer relationship intangible assets arising from whole bank and branch acquisitions, are amortized on an accelerated method over their estimated useful lives, which range from 7 to 10 years. The Company reviews long-lived assets and other intangible assets for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in which case an impairment charge would be recorded. Goodwill is not amortized and is tested for impairment at least annually, or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed. The impairment testing process is conducted by assigning net assets and goodwill to each reporting unit. An initial qualitative evaluation is made to assess the likelihood of impairment and determine whether further quantitative testing to calculate the fair value is necessary. When the qualitative evaluation indicates that impairment is more likely than not, quantitative testing is required whereby the fair value of each reporting unit is calculated and compared to the recorded book value. If the calculated fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and no further testing is considered necessary. If the carrying value of a reporting unit exceeds its calculated fair value, the impairment test continues by comparing the carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value is computed by adjusting all assets and liabilities of the reporting unit to current fair value with the offset adjustment to goodwill. The adjusted goodwill balance is the implied fair value of the goodwill. An impairment charge is recognized if the carrying value of goodwill exceeds the implied fair value of goodwill. Derivatives The Company applies hedge accounting to certain interest rate derivatives entered into for risk management purposes. To qualify for hedge accounting, a derivative must be highly effective at reducing the risk associated with the exposure being hedged. In addition, key aspects of achieving hedge accounting are documentation of hedging strategy and hedge effectiveness at the hedge inception and substantiating hedge effectiveness on an ongoing basis. A derivative must be highly effective in accomplishing the hedge objective of offsetting changes in the cash flows of the hedged item for the risk being hedged. Any ineffectiveness in the hedge relationship is recognized in earnings. The effective portion of changes in the fair value of derivatives designated in a hedge relationship and that qualify as cash flow hedges is recorded in accumulated other comprehensive income, net of tax, and is subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended. When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings. Earnings Per Share Basic earnings per common share is computed using the weighted average number of common shares and participating securities outstanding during the reporting period. Diluted earnings per common share is the amount of earnings available to each share of common stock during the reporting period adjusted to include the effect of potentially dilutive common shares. Potentially dilutive common shares are excluded from the computation of dilutive earnings per share in the periods in which the effect would be anti-dilutive. Income Taxes Deferred income taxes are recognized for the tax consequences of temporary differences between financial statement carrying amounts and the tax bases of existing assets and liabilities that will result in taxable or deductible amounts in future years. These temporary differences are multiplied by the enacted income tax rate expected to be in effect when the taxes become payable or receivable. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based on available evidence. Operating Segments The Company’s chief operating decision maker primarily manages operations and assesses financial performance on a Company-wide basis. However, in addition to the discrete financial information that is provided for the Company as a whole, financial information is also provided for the wealth management services, insurance services, and mortgage origination segments, respectively. While the chief operating decision maker uses the financial information related to these segments to analyze business performance and allocate resources, these segments do not meet the quantitative threshold under GAAP to be considered a reportable segment. As such, these operating segments, along with the banking operations segment, are aggregated into a single reportable operating segment in the Consolidated Financial Statements. No revenues are derived from foreign countries or from external customers that comprise more than 10% of the Company’s revenues. Stock Compensation Plans The Company follows the provisions of the authoritative guidance regarding share-based compensation. This guidance values share-based awards at the grant date fair value and recognizes the expense over the requisite service period. Recently Adopted and Issued Accounting Standards In November 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash. This ASU clarifies certain existing principles in ASC Topic 230, including providing additional guidance related to transfers between cash and restricted cash and how entities present, in their statement of cash flows, the cash receipts and cash payments that directly affect the restricted cash accounts. For public companies, ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements. In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. For public companies, this ASU will be effective for interim and annual periods beginning after December 15, 2019. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements. In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which simplifies several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016 and interim periods within those annual periods. Early adoption is permitted. The Company elected to early adopt ASU 2016-09 in the second quarter of 2016 with an effective date of January 1, 2016. As a result of the adoption, the Company recognized excess tax benefits of $0.7 million in the Consolidated Statements of Income and Consolidated Statements of Cash Flows, respectively, for the year ended December 31, 2016. Prior periods have not been adjusted. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which will require lessees to record an asset on the balance sheet for the right to use the leased asset and a liability for the corresponding lease obligation for leases with terms of more than 12 months. The accounting treatment for lessors will remain relatively unchanged. The ASU also requires additional qualitative and quantitative disclosures related to the nature, timing and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements. In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which revises the accounting treatment related to classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured as fair value. Upon adoption, investments in equity securities, except those accounted for under the equity method or that result in the consolidation of the investee, will be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have a readily determinable fair value may be measured at cost minus impairment, plus or minus changes from observable price changes in an orderly transaction. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption of certain provisions is permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements. In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments (Topic 805), which eliminates the requirement that an acquirer in a business combination account for measurement-period adjustments retrospectively. Instead, an acquirer will recognize measurement period adjustments during the period in which it determines the amount of the adjustment. ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The Company adopted ASU 2015-16 on January 1, 2016 and the adoption did not have a material impact on the Company's consolidated financial statements. In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs (Subtopic 835-30), which amends the presentation of debt issuance costs in the balance sheet as a direct deduction from the related debt liability. This update affects disclosures related to debt issuance costs but does not affect existing recognition and measurement guidance for these items. ASU 2015-03 is effective for annual and interim periods beginning after December 15, 2015. Prior to the adoption of ASU 2015-03 on January 1, 2016, the Company recorded debt issuance costs as other assets in the consolidated balance sheet. The Consolidated Balance Sheet as of December 31, 2015 reflects a reduction in other assets and long-term debt of $1.2 million related to the reclassification of debt issuance costs. In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis (Topic 810), which amends the consolidation analysis required under GAAP. The revised guidance amends the consolidation analysis based on certain fee arrangements or relationships to the reporting entity and, for limited partnerships, requires entities to consider the limited partner’s rights relative to the general partner. ASU 2015-02 is effective for annual and interim periods beginning after December 15, 2015. The Company adopted ASU 2015-02 on January 1, 2016 and the adoption did not have a material impact on the Company's consolidated financial statements. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU was developed as a joint project with the International Accounting Standards Board to remove inconsistencies in revenue requirements and provide a more robust framework for addressing revenue issues. The ASU’s core principle is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date by one year (i.e., interim and annual reporting periods beginning after December 15, 2017). Early adoption is permitted, but not before the original effective date (i.e., interim and annual reporting periods beginning after December 15, 2016). The ASU may be adopted using either a modified retrospective method or a full retrospective method. The Company intends to adopt the ASU during the first quarter of 2018, as required, using a modified retrospective approach. The Company's preliminary analysis suggests that the adoption of this accounting guidance is not expected to have a material impact on the Company's consolidated financial statements. The FASB continues to release new accounting guidance related to the adoption of this ASU and the results of the Company's materiality analysis may change based on conclusions reached as to the application of this new guidance. NOTE 2 - ACQUISITIONS Acquisition of High Point On November 1, 2016, the Company completed the acquisition of High Point, pursuant to the terms of the Agreement and Plan of Merger dated November 13, 2015. A summary of the fair value of assets received and liabilities assumed are as follows: Explanation of fair value adjustments: (1) Adjustment to reflect estimated fair value of investment securities available-for-sale. (2) Adjustment to reflect estimated fair value of loans. (3) Adjustment to reflect estimated fair value of premises and equipment. (4) Adjustment to reflect estimated fair value of core deposit and other intangible assets. (5) Adjustment to reflect estimated fair value of time deposits based on market rates for similar products. (6) Adjustment to reflect estimated fair value of borrowings based on market rates for similar products. (7) Adjustment to reflect the estimated fair market value of certain leases, deferred income taxes, and other assumed liabilities. A summary of the consideration paid is as follows: This acquisition expanded and further strengthened the Company's presence in the Greensboro, Winston-Salem, and High Point, North Carolina area and expanded the Company's product offerings to include trust and insurance services. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit. Acquisition of Southcoast On June 17, 2016, the Company completed the acquisition of Southcoast pursuant to the terms of the Agreement and Plan of Merger dated August 14, 2015, as amended. A summary of the fair value of assets received and liabilities assumed are as follows: Explanation of fair value adjustments: (1) Adjustment to reflect estimated fair value of investment securities available-for-sale. (2) Adjustment to reflect estimated fair value of loans. (3) Adjustment to reflect estimated fair value of premises and equipment. (4) Adjustment to reflect recording of core deposit intangible. (5) Adjustment to reflect recording of deferred tax asset recognized from acquisition. (6) Adjustment to reflect estimated fair value of time deposits based on market rates for similar products. (7) Adjustment to reflect estimated fair value of borrowings based on market rates for similar products. (8) Adjustment to reflect the estimated fair market value of certain leases and other assumed liabilities. A summary of the consideration paid is as follows: This acquisition expanded and further strengthened the Company's presence in the Charleston, South Carolina metropolitan area and provided a low-cost base of core deposits. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit. During the third quarter of 2016, the Company revised its initial estimates and assumptions regarding the valuation of certain acquired investment securities and acquired deferred tax assets. Because such revision occurred during the first 12 months following the date of acquisition and was not the result of an event that occurred subsequent to the acquisition date, the Company has increased the goodwill recorded in the Southcoast acquisition by $0.4 million to reflect this change in estimate. The following table presents unaudited pro-forma information as if the acquisitions of High Point and Southcoast had occurred on January 1, 2016 under the 2016 “Pro-forma” column. In addition, the table presents unaudited pro-forma information as if the acquisition of High Point, Southcoast and Valley had occurred on January 1, 2015 under the 2015 “Pro-forma” column. This pro-forma information gives effect to certain adjustments, including purchase accounting fair value adjustments, amortization of core deposit and other intangibles and related income tax effects and is based on our historical results for the periods presented. Transaction-related costs related to each acquisition are not reflected in the pro-forma amounts. The pro-forma information does not necessarily reflect the results of operations that would have occurred had the Company acquired High Point, Southcoast, and Valley at the beginning of 2016 or 2015. Cost savings are also not reflected in the unaudited pro-forma amounts. Acquisition of Certus branches On October 16, 2015, the Company completed the acquisition of the Certus branches, pursuant to the terms of the Purchase and Assumption Agreement dated June 1, 2015. A summary of the fair value of assets received and liabilities assumed are as follows: Explanation of fair value adjustments: (1) Adjustment to reflect estimated fair value of loans. (2) Adjustment to reflect estimated fair value of premises and equipment. (3) Adjustment to reflect recording of core deposit intangible. (4) Adjustment to reflect recording of deferred tax asset recognized from acquisition. (5) Adjustment to reflect estimated fair value of time deposits based on market rates for similar products. (6) Adjustment to reflect the estimated fair market value of certain leases. This acquisition expanded and further strengthened the Company's presence in upstate South Carolina, provided a low-cost base of core deposits and provided an experienced in-market team that enhances our ability to grow in that market. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit. During the third quarter of 2016, the Company revised its initial estimates and assumptions regarding the valuation of certain acquired loans and acquired deferred tax assets. Because such revision occurred during the first 12 months following the date of acquisition and was not the result of an event that occurred subsequent to the acquisition date, the Company has increased the goodwill recorded in the acquisition of the Certus branches by $3.2 million to reflect this change in estimate. Acquisition of Valley On July 1, 2015, the Company completed the acquisition of Valley, pursuant to the terms of the Agreement and Plan of Merger dated November 17, 2014. Under the merger agreement, Valley's shareholders received 1.1081 shares of the Company's voting common stock for each share of Valley common stock owned. A summary of assets received and liabilities assumed for Valley, as well as the associated fair value adjustments, are as follows: Explanation of fair value adjustments: (1) Adjustment to reflect estimated fair value of investment securities available-for-sale. (2) Adjustment to reflect estimated fair value of loans. (3) Adjustment to reflect estimated fair value of premises and equipment. (4) Adjustment to reflect recording of core deposit intangible. (5) Adjustment to reflect recording of deferred tax asset recognized from acquisition. (6) Adjustment to reflect estimated fair value of time deposits based on market rates for similar products. (7) Adjustment to reflect estimated fair value of borrowings based on market rates for similar products. (8) Adjustment to reflect the estimated fair market value of certain leases. A summary of the consideration paid is as follows: With this acquisition, the Company expanded its footprint into Roanoke, Virginia with the addition of nine branches and an experienced in-market team that enhances the Company’s ability to compete in that market. The Company projects cost savings will be recognized in future periods through the elimination of redundant operations. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit. During the second quarter of 2016, the Company revised its initial estimates and assumptions regarding the valuation of certain acquired loans, acquired other real estate owned, acquired other assets, and acquired deferred tax assets. Because such revision occurred during the first 12 months following the date of acquisition and was not the result of an event that occurred subsequent to the acquisition date, the Company has increased the goodwill recorded in the acquisition of Valley by $1.7 million to reflect this change in estimate. The Company incurred total transaction-related costs of $16.9 million, $13.3 million, and $9.0 million during the years ended December 31, 2016, 2015, and 2014, respectively. Transaction-related costs, which are expensed as incurred as a component of non-interest expense, primarily include, but are not limited to, severance costs, professional services, data processing fees, and marketing and advertising expenses. The Company has determined the above noted acquisitions each constitute a business combination as defined by ASC Topic 805, which establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired and the liabilities assumed. The Company has recorded the assets purchased and liabilities assumed at their estimated fair value in accordance with ASC Topic 805. The estimated fair values are subject to refinement for up to one year after the closing date of the acquisition as additional information regarding closing date fair value becomes available. During this one year period, the causes of any changes in cash flow estimates are considered to determine whether the change results from circumstances that existed at the acquisition date or if the change results from an event that occurred after the acquisition date. NOTE 3 - EARNINGS PER SHARE Basic earnings per common share is computed using the weighted average number of common shares and participating securities outstanding during the reporting period. Diluted earnings per common share is the amount of earnings available to each share of common stock during the reporting period adjusted to include the effect of potentially dilutive common shares. Potentially dilutive common shares include incremental shares issued for stock options and restricted stock awards (collectively referred to herein as “Stock Rights”). Potentially dilutive common shares are excluded from the computation of dilutive earnings per share in the periods in which the effect would be anti-dilutive. The Company's basic and diluted earnings per share calculations are presented in the following table: For the years ended December 31, 2016, 2015, and 2014, respectively, there were no shares of Stock Rights excluded in computing diluted common shares outstanding. NOTE 4 - INVESTMENT SECURITIES The amortized cost, gross unrealized gains and losses, and estimated fair values of investment securities are presented in the following tables: The amortized cost and estimated fair value of investment securities at December 31, 2016, by contractual maturity, are shown below. The expected life of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay the underlying mortgage loans with or without call or prepayment penalties. For purposes of the maturity table, mortgage-backed securities have been included in maturity groupings based on the contractual maturity. At December 31, 2016 and 2015, respectively, investment securities with an estimated fair value of approximately $372.4 million and $371.8 million, respectively, were pledged to secure public deposits and for other purposes required or permitted by law. The following table presents a summary of realized gains and losses from the sale of investment securities: During the year ended December 31, 2015, the Company sold $0.6 million of state and municipal debt obligations that were classified as held-to-maturity due to a downgrade in the credit rating of securities and concerns related to the issuer. As a result of the downgrade of the securities, the Company's intent to hold these securities changed and management elected to divest of its interest in the downgraded securities. The Company recorded an immaterial gain on this sale. During the year ended December 31, 2014, the Company made two sales of investment securities classified as held-to-maturity. The Company sold $3.3 million of state and municipal debt obligations that were downgraded by Moody's as a result of allegations of fraud and multiple pending investigations of the issuer. As a result of the downgrade of the securities, the Company's intent to hold these securities changed and management elected to divest of its interest in the downgraded securities. The Company recorded a realized gain of $0.2 million on this sale. The Company also sold $5.2 million of corporate debt securities due to regulatory capital restrictions. The Company recorded a realized loss of $0.1 million on this sale. The following tables detail gross unrealized losses and fair values of investment securities aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position: The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment. A determination as to whether a security’s decline in fair value is other-than-temporary takes into consideration numerous factors and the relative significance of any single factor can vary by security. Some factors the Company may consider in the other-than-temporary impairment analysis include the length of time and extent to which the security has been in an unrealized loss position, changes in security ratings, financial condition and near-term prospects of the issuer, as well as security and industry specific economic conditions. Based on this evaluation, the Company does not believe any unrealized loss at December 31, 2016 represents an other-than-temporary impairment, as these unrealized losses are primarily attributable to changes in interest rates and the current market conditions, and not credit deterioration. The Company has concluded there are no concerns about the long-term viability of the issuers of these securities and the Company currently does not intend to sell, nor does it believe that it will be required to sell, these securities before recovery of their amortized cost basis. NOTE 5 - LOANS AND ALLOWANCE FOR LOAN LOSSES Major categories of loans are presented below: (1) Amount includes $0 and $40.9 million of acquired loans covered under FDIC loss-share agreements at December 31, 2016 and 2015, respectively. The unpaid principal balance for acquired loans covered under FDIC loss-share agreements was $0 and $41.4 million at December 31, 2016 and 2015, respectively. Unearned income and net deferred loan fees totaled $0.6 million and $0.9 million at December 31, 2016 and 2015, respectively. On May 2, 2016, the Bank entered into an agreement with the FDIC to terminate all existing loss-share agreements with the FDIC. All rights and obligations of the Bank and the FDIC under the FDIC loss share agreements, including the clawback provisions and the settlement of loss share and expense reimbursement claims, were resolved and terminated under such agreement. The Company evaluates loans acquired with evidence of credit deterioration in accordance with the provisions of ASC 310-30. Credit-impaired loans are those loans showing evidence of credit deterioration since origination and it is probable, at the date of acquisition, the Company will not collect all contractually required principal and interest payments. Generally, the acquired loans that meet the Company’s definition for substandard status fall within the definition of credit-impaired covered loans. The following table presents loans acquired during the year ended December 31, 2016, at acquisition date, accounted for under ASC 310-30: The acquisition date unpaid balance of loans acquired during the year ended December 31, 2016 that did not have credit deterioration was $808.5 million with an estimated fair value of $791.1 million. The discount will be amortized on a level-yield basis over the economic life of the loans. The following table presents a summary of the activity of the Company's loans accounted for under ASC 310-30: The following table presents a summary of changes in accretable difference on purchased loans accounted for under ASC 310-30: The Company has the ability to borrow funds from the Federal Home Loan Bank of Atlanta ("FHLB") and from the Federal Reserve Bank of Richmond (the "Federal Reserve"). At December 31, 2016 and 2015, real estate loans with carrying values of $2.25 billion and $1.68 billion, respectively, were pledged to secure borrowing facilities from these institutions. The Company has loan relationships with its directors, executive officers, or their related interests. These loans were made on substantially the same terms, including rates and collateral, as those prevailing at the time for comparable transactions with other unrelated customers, and do not involve more than a normal risk of collection. Loan activity with principal officers, directors, and their affiliates during 2016 was as follows: A summary of the changes to the allowance for loan losses, by class of financing receivable, is presented below: (1) The provision for loan losses includes the "net" provision on covered loans after coverage provided by FDIC loss-share agreements, which totaled $(0.5) million for the year ended December 31, 2016. For the year ended December 31, 2016, this resulted in an increase in the FDIC indemnification asset of $0.1 million, which is the difference between the net provision on covered loans and the total reduction to the allowance for loan losses allocable to the covered loan portfolio of $0.6 million. (2) The provision for loan losses includes the "net" provision on covered loans after coverage provided by FDIC loss-share agreements, which totaled $(0.4) million for the year ended December 31, 2015. For the year ended December 31, 2015, this resulted in a decrease in the FDIC indemnification asset of $1.1 million, which is the difference between the net provision on covered loans and the total reduction to the allowance for loan losses allocable to the covered loan portfolio of $1.5 million. The following table provides a breakdown of the recorded investment in loans and the allowance for loan losses based on the method of determining the allowance: The following tables present information related to impaired loans, excluding purchased impaired loans: The following table presents information related to the average recorded investment and interest income recognized on impaired loans, excluding purchased impaired loans: For the years ended December 31, 2016 and 2015, the amount of interest income recognized within the period that the loans were impaired was primarily related to loans modified as a troubled debt restructuring ("TDR") that remained on accrual status. The amount of interest income recognized using a cash-basis method of accounting during the period that the loans were impaired was not material. At December 31, 2016 and 2015, respectively, the Company had $1.3 million and $2.5 million of consumer mortgage loans secured by residential real estate properties for which foreclosure proceedings were in progress. The following tables present an aging analysis of the recorded investment in the Company's loans: Credit Quality Indicators The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company's primary credit quality indicators use an internal credit risk rating system that categorizes loans and leases into pass, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans and leases that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans and leases to businesses or individuals in the classes which comprise the commercial portfolio segment. Groups of loans and leases that are underwritten and structured using standardized criteria and characteristics are typically risk rated and monitored collectively. These are typically loans and leases to individuals in the classes which comprise the consumer portfolio segment. The Company uses the following definitions for risk ratings: Pass - Loans classified as pass are considered to be a satisfactory credit risk and generally considered to be collectible in full. Special Mention - Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. Substandard - Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loss - Loans classified as loss are considered uncollectable and are in the process of being charged-off, as soon as practicable, once so classified. The following tables present the recorded investment in the Company’s loans by credit quality indicator: Modifications Loan modifications are considered a TDR if concessions have been granted to borrowers that are experiencing financial difficulty. The concessions granted generally involve the modification of terms of the loan, such as changes in payment schedule or interest rate, which generally would not otherwise be considered. Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Nonaccrual restructured loans are included and treated with all other nonaccrual loans. In addition, all accruing restructured loans are reported as TDRs, which are considered and accounted for as impaired loans. Generally, restructured loans remain on nonaccrual until the customer has attained a sustained period of repayment performance under the modified loan terms (generally a minimum of six months). However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and whether the loan should be returned to or maintained on accrual status. If the borrower’s ability to meet the revised payment schedule is not reasonably assured, the loan remains on nonaccrual status. Loans modified in a TDR are, in many cases, already on nonaccrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan. An allowance for impaired consumer and commercial loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent. Management exercises significant judgment in developing these estimates. Once we classify a loan as a TDR, the loan is only removed from TDR classification under three circumstances: (1) the loan is paid off, (2) the loan is charged off or (3) if, at the beginning of the current fiscal year, the loan has performed in accordance with the modified terms for a minimum of six consecutive months and at the time of modification the loan’s interest rate represented a then current market interest rate for a loan of similar risk. The following tables provide a summary of loans modified as TDRs: At December 31, 2016 and 2015, respectively, the Company had no available commitments outstanding on TDRs. The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories: Rate modification - A modification in which the interest rate is changed. Term modification - A modification in which the maturity date, timing of payments or frequency of payments is changed. Payment modification - A modification in which the principal and interest payment are lowered from the original contractual terms. Interest only modification - A modification in which the loan is converted to interest only payments for a period of time. Combination modification - Any other type of modification, including the use of multiple categories above. The following tables present new TDRs by modification category. All balances represent the recorded investment at the end of the period in which the modification was made. The amount of loans modified and classified as TDRs in the previous twelve months that defaulted during the years ended December 31, 2016 and 2015, respectively, were immaterial. The Company defines payment default as movement of the restructuring to nonaccrual status, foreclosure or charge-off, whichever occurs first. Loans Held for Sale The Company originates certain single family, residential first mortgage loans for sale on a presold basis. Loan sale activity is summarized below: NOTE 6 - GOODWILL AND OTHER INTANGIBLE ASSETS The following table presents activity for goodwill and other intangible assets: The Company has identified two reporting units for purposes of testing goodwill for impairment. These reporting units are the mortgage origination unit, which originates certain single family residential first mortgage loans that are subsequently sold into the secondary market, and the banking operations unit, which contains all other activities performed by the Company. All goodwill is allocated to the banking operations reporting unit. The Company conducted its annual impairment testing as of June 30, 2016 utilizing a qualitative assessment. Based on this assessment, management concluded that it is more likely than not that the estimated fair value of the banking operations reporting unit exceeded the carrying value (including goodwill) of this reporting unit. Therefore, a step one quantitative analysis was not required. There were no events since the June 2016 impairment test that have changed the Company's impairment assessment conclusion. There were no impairment charges recorded during the years ended December 31, 2016, 2015, or 2014, respectively. The following table presents the gross carrying amount and accumulated amortization for the Company’s other intangible assets, which primarily consists of core deposit intangibles and also includes customer relationship intangibles acquired in connection with the acquisition of High Point: At December 31, 2016, the weighted-average remaining life of the Company's other intangible assets was 5.71 years. The following table presents estimated future amortization expense for other intangible assets: NOTE 7 - PREMISES AND EQUIPMENT The following table presents a summary of the Company’s premises and equipment: Depreciation and amortization expense for the years ended December 31, 2016, 2015, and 2014 amounted to $6.6 million, $6.1 million and $5.3 million, respectively. Premises and equipment are evaluated for potential impairment if events or changes in circumstances indicate the carrying value of an asset may not be recoverable. During the year ended December 31, 2016, the Company recorded a $0.4 million asset impairment charge related to the closing of a branch and a loan production office in South Carolina. This expense was recorded as a component of other non-interest expense on the Consolidated Statement of Income. The Company has entered into various non-cancellable operating leases for land and buildings used in its operations that expire at various dates through 2033. Most of the leases contain renewal options and certain leases provide for periodic rate negotiation or escalation. The leases generally provide for payment of property taxes, insurance and maintenance costs by the Company. Rental expense, including month-to-month leases, reported in non-interest expense was $5.7 million, $5.5 million and $3.8 million for the years ended December 31, 2016, 2015, and 2014, respectively. At December 31, 2016, future minimum rental commitments under non-cancellable operating leases are as follows: NOTE 8 - DERIVATIVES The Company utilizes derivative financial instruments primarily to hedge its exposure to changes in interest rates. All derivative financial instruments are recorded on the balance sheet at their respective fair values. The Company does not use financial instruments or derivatives for any trading or other speculative purposes. The primary focus of the Company’s asset/liability management program is to monitor the sensitivity of the Company’s net portfolio value and net income under varying interest rate scenarios to take steps to control its risks. On a quarterly basis, the Company simulates the net portfolio value and net income expected to be earned over a twelve-month period following the date of simulation. The simulation is based on a projection of market interest rates at varying levels and estimates the impact of such market rates on the levels of interest-earning assets and interest-bearing liabilities during the measurement period. Based upon the outcome of the simulation analysis, the Company considers the use of derivatives as a means of reducing the volatility of net portfolio value and projected net income within certain ranges of projected changes in interest rates. The Company evaluates the effectiveness of entering into any derivative instrument agreement by measuring the cost of such an agreement in relation to the reduction in net portfolio value and net income volatility within an assumed range of interest rates. The Company also has derivatives that are a result of a service it provides to certain qualifying customers, which includes a matched book of derivative instruments offered to customers in order to minimize their interest rate risk. Derivatives Designated as Cash Flow Hedges of Interest Rate Risk The Company has variable rate funding which creates exposure to variability in interest payments due to changes in interest rates. The Company entered into an interest rate swap transaction with a notional amount of $125 million. The interest rate swap was designated as a hedge against the changes in cash flows attributable to changes in one-month LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on the first $125 million of the Company's variable rate money market funding arrangement. The Company receives interest at the one-month LIBOR rate and pays a fixed interest rate under the terms of the swap agreement. The termination date of the swap agreement is March 18, 2019. Derivatives Not Designated as Hedges The Company utilizes derivative financial instruments, which may include interest rate swaps, caps and/or floors, as part of its ongoing efforts to mitigate its interest rate risk exposure and to help its commercial customers manage their exposure to interest rate fluctuations. To mitigate the interest rate risk associated with these customer contracts, the Company enters into an offsetting derivative contract position. These derivative positions are recorded at fair value on the Company’s consolidated balance sheet and, due to the matched nature of these derivative instruments, changes in fair value do not impact the Company’s earnings. The following table presents the fair value of the Company’s derivatives: The derivative instruments held by the Company are subject to master netting arrangements which contain a legally enforceable right to offset recognized amounts and settle such amounts on a net basis. The Company has elected to present the financial assets and financial liabilities associated with these arrangements on a gross basis in the Consolidated Balance Sheets. Cash collateral is posted by the counterparty with net liability positions in accordance with contract thresholds. Information about financial instruments that are eligible for offset in the consolidated balance sheets is presented in the following table: The Company has recorded a loss of $0.4 million, net of tax, as component of accumulated other comprehensive income at December 31, 2016 associated with the cash flow hedging instrument and expects $0.7 million, net of tax, to be reclassified as an increase to interest expense during the next 12 months. The following table presents the amounts recorded in the Consolidated Statements of Comprehensive Income relating to derivative instruments designated as cash flow hedges, net of tax: (1) Amount recorded in interest expense on demand deposits in the Consolidated Statements of Income. The amounts included in accumulated other comprehensive income will be reclassified to interest expense should the hedge no longer be considered effective. No amount of ineffectiveness was included in net income for the years ended December 31, 2016, 2015, and 2014, respectively. The Company will continue to assess the effectiveness of the hedge on a quarterly basis. Counterparty Credit Risk - By entering into derivative instrument contracts, the Company exposes itself, from time to time, to counterparty credit risk. Counterparty credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is in an asset position, the counterparty has a liability to the Company, which creates credit risk for the Company. The Company attempts to minimize this risk by selecting counterparties with investment grade credit ratings, limiting its exposure to any single counterparty and regularly monitoring its market position with each counterparty. Credit-Risk Related Contingent Features - The Company’s derivative instruments contain provisions allowing the financial institution counterparty to terminate the contracts in certain circumstances, such as a default by the Company on its indebtedness or the failure to maintain its regulatory status as a well-capitalized institution. These derivative agreements also contain provisions regarding the posting of collateral by each party. At December 31, 2016, the aggregate fair value of derivative instruments with credit-risk-related contingent features that were in a net liability position was $1.8 million, for which the Company has posted collateral with a fair value of $6.4 million. NOTE 9 - DEPOSITS The following tables present the scheduled maturities of time deposits at December 31, 2016: NOTE 10 - BORROWINGS The following table presents the Company’s short-term borrowings: (1) Securities sold under agreements to repurchase generally mature within one day from the transaction date and are collateralized by either U.S. Government Agency obligations, government sponsored mortgage-backed securities or securities issued by local governmental municipalities. The Company may purchase federal funds through unsecured federal funds lines of credit totaling $155.0 million at December 31, 2016. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate. The Company has an uncollateralized 364-day revolving credit facility (the “Credit Agreement”) for an aggregate principal amount of up to $25 million at any time outstanding. The Credit Agreement matures on November 11, 2017 with an interest rate the greater of i) 3.25%, ii) the Prime Rate, or iii) the Federal Funds rate, plus 0.50%. There were no borrowings outstanding under the Credit Agreement at December 31, 2016. Additional information on the Company’s short-term borrowings is presented in the following table: The following table presents the Company’s long-term debt: (1) Long-term debt balances are presented net of debt issuance costs and unamortized premiums or discounts. The Company has $84.0 million of long-term advances outstanding with the FHLB as of December 31, 2016, with maturity dates ranging from 2018 to 2021 and an average interest rate of 2.07%. At December 31, 2016, real estate loans and investment securities with carrying values of $1.79 billion and $5.7 million, respectively, were assigned under this arrangement. The Parent Company has issued $60.0 million of 5.50% Fixed to Floating Rate Subordinated Notes (the "Subordinated Notes"), all of which are outstanding at December 31, 2016. The Subordinated Notes bear interest at a fixed rate of 5.50% per year for the first 5 years and, from October 1, 2019 to the October 1, 2024 maturity date, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month LIBOR plus 359 basis points. The Subordinated Notes are redeemable by the Parent Company at any quarterly interest payment date beginning on October 1, 2019 to maturity at par, plus accrued and unpaid interest. The Company assumed a junior subordinated note in conjunction with the Valley acquisition with an outstanding balance of $10.6 million at December 31, 2016. The junior subordinated note bears interest at a variable rate of LIBOR plus 5.00% per annum, with a floor of 5.50% and a cap of 9.50%, and has a maturity date of October 15, 2023. The interest rate for the subordinated note was 5.61% at December 31, 2016. In addition, the Company has the ability to borrow funds from the Federal Reserve utilizing the discount window and the borrower-in-custody of collateral arrangement. At December 31, 2016, commercial loans and investment securities with carrying values of $453.8 million and $2.8 million, respectively, were assigned under these arrangements. The Company had no outstanding borrowings with the Federal Reserve at December 31, 2016. The following table details the junior subordinated debentures outstanding: The Company was not aware of any violations of loan covenants at December 31, 2016. NOTE 11 - ACCUMULATED OTHER COMPREHENSIVE INCOME The following table presents the changes in accumulated other comprehensive income, net of income taxes: The following table details reclassification adjustments from accumulated other comprehensive income: (1) The amortization of the unrealized holding gains in accumulated other comprehensive income at the date of transfer partially offsets the amortization of the difference between the par value and fair value of the investment securities at the date of transfer. Both components are amortized as an adjustment of yield. NOTE 12 - FAIR VALUE MEASUREMENT ASC Topic 820, Fair Value Measurements and Disclosures, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability at the measurement date. The three levels of valuations are defined as follows: Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement, and require significant management judgment or estimation using pricing models, discounted cash flow methodologies or similar techniques. Fair Value on a Recurring Basis - The Company measures certain assets at fair value on a recurring basis and the following is a general description of the methods used to value such assets. Investment securities available-for-sale - At June 30, 2016, the Company transferred $5.4 million of equity securities available-for-sale from Level 2 of the fair value hierarchy to Level 1, as the Company concluded the trading volume for these securities has increased and the Company believes there is an active market for determining the fair value of identical securities. The Company classifies the entire equity securities portfolio as Level 1 valuation. The Company utilizes a third-party pricing service to determine the fair value of the remainder of the investment securities available-for-sale. At December 31, 2016, the Company changed the methodology for pricing the remainder of the investment securities available-for-sale to solely use observable transactions of comparable securities. Previously, the third-party pricing was based on a range of observable market inputs, which included benchmark yields, reported trades, issuer spreads, benchmark securities, bids, offers and reference data obtained from market research publications. The valuation of mortgage-backed securities also included new issue data, monthly payment information and “To Be Announced” prices. The valuation of state and municipal securities also included the use of material event notices. This change in methodology led to a $4.1 million reduction in the fair value of investment securities available-for-sale. The Company has determined that both valuation methodologies utilize Level 2 valuation inputs. Derivative assets and liabilities - The values of derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company measures fair value using models that use primarily market observable inputs, such as yield curves and option volatilities, and include the value associated with counterparty credit risk. The Company has determined the fair value of derivative instruments utilize Level 2 inputs. The following tables present information about certain assets and liabilities measured at fair value on a recurring basis: Fair Value on a Nonrecurring Basis - The Company measures certain assets at fair value on a nonrecurring basis and the following is a general description of the methods used to value such assets. Loans held for sale - Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subjected to nonrecurring fair value adjustments as Level 2 valuation. Impaired loans - The Company considers a loan impaired when it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the note agreement, including both principal and interest. Management has determined that nonaccrual loans and loans that have had their terms restructured in a TDR meet this impaired loan definition. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the estimated fair value of the underlying collateral for collateral-dependent loans, which the Company classifies as a Level 3 valuation. OREO - OREO is initially recorded at the lower of carrying value or fair value, less costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral, which the Company classifies as a Level 3 valuation. The following tables present information about certain assets and liabilities measured at fair value on a nonrecurring basis: The following table presents the valuation and unobservable inputs for Level 3 assets and liabilities measured at fair value on a nonrecurring basis at December 31, 2016: Estimated fair values of financial instruments have been estimated by the Company using the provisions of ASC Topic 825, Financial Instruments (“ASC 825”), which requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following tables present the carrying value and estimated fair values of the Company’s financial instruments, including those that are not measured and reported at fair value on a recurring basis or nonrecurring basis: The following methods and assumptions were used to estimate the fair value of financial instruments that have not been previously discussed: Cash and cash equivalents - The carrying amounts reported in the balance sheets for cash and cash equivalents approximate the fair value of those assets. Investment securities held-to-maturity - The Company utilizes a third-party pricing service to determine the fair value of investment securities held-to-maturity. At December 31, 2016, the Company changed the methodology for pricing investment securities held-to-maturity to solely use observable transactions of comparable securities. Previously, investment securities held-to-maturity were valued based on a range of observable market inputs, which included benchmark yields, reported trades, issuer spreads, benchmark securities, bids, offers and reference data obtained from market research publications. Federal Home Loan Bank stock - The fair value for FHLB stock is its carrying value, since this is the amount for which it could be redeemed. There is no active market for this stock and the Company, in order to be a member of the FHLB, is required to maintain a minimum investment. Loans receivable, net - The fair values for loans are estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms and credit ratings for the same remaining maturities, adjusted for the allowance for loan losses. FDIC indemnification asset - The fair value for the FDIC indemnification asset is estimated based on discounted future cash flows using current discount rates. Investment in bank-owned life insurance - The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer. Accrued interest receivable and accrued interest payable - The carrying amount of accrued interest is assumed to approximate fair value. Deposits - The fair values disclosed for deposits with no stated maturity (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for deposits with a stated maturity date (time deposits) are estimated using a discounted cash flow calculation that applies interest rates currently being offered on these accounts to a schedule of aggregated expected monthly maturities on time deposits. Short-term borrowings - The carrying amount of short-term borrowings is assumed to approximate fair value. Long-term debt - The fair value is estimated by discounting the future contractual cash flows using current market interest rates for similar debt over the same remaining term. NOTE 13 - REGULATORY CAPITAL The Company is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about component risk weightings and other factors. At December 31, 2016 and 2015 the Company’s and the Bank’s Tier 1 and total capital ratios and their Tier 1 leverage ratios exceeded minimum requirements. In July 2013, the Federal Reserve Board approved and published the final Basel III Capital Rules establishing a new comprehensive capital framework for U.S. banking organizations. The Basel III Capital Rules, among other things, (i) introduce CET1 as a new capital measure, (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations. The Basel III Capital Rules were effective for BNC and the Company on January 1, 2015 (subject to a phase-in period for certain components). CET1 capital for the Company and BNC consists of common stock, related paid-in capital, and retained earnings. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to include most components of accumulated other comprehensive income in CET1. CET1 for both the Company and BNC is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions. Basel III limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.50% of CET1 capital, Tier 1 capital and total capital to risk-weighted assets in addition to the amount necessary to meet minimum risk-based capital requirements. The capital conservation buffer, which was effective beginning January 1, 2016, is 0.625% of risk-weighted assets, and will increase each year until fully implemented at 2.50% on January 1, 2019. When fully phased in on January 1, 2019, Basel III will require (i) a minimum ratio of CET1 capital to risk-weighted assets of at least 4.50%, plus a 2.50% capital conservation buffer, (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.00%, plus the capital conservation buffer, (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.00%, plus the 2.50% capital conservation buffer and (iv) a minimum leverage ratio of 4.00%. The following tables present BNC’s regulatory capital ratios: The following table presents the Company’s regulatory capital ratios: NOTE 14 - INCOME TAXES The following tables present the Company’s income tax expense: The following tables present the difference between income tax expense and the amount computed by applying the statutory income tax rate: Significant components of deferred tax assets and liabilities were as follows: The valuation allowance of $1.0 million at December 31, 2016 relates to the net operating loss carryforwards and capital loss carryforwards obtained from business combinations for which realizability is uncertain. The reduction in valuation allowance from 2015 was due to the use of a capital loss carryforward that was previously fully reserved under the valuation allowance. In assessing the realizability of the Company's deferred income tax asset, the Company considered whether it is more likely than not that some portion or all of the deferred income tax asset will not be realized in accordance with the guidance provided by ASC 740. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. The Company considers the scheduled reversal of deferred income tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based on the weight of available evidence, the Company determined that it is more likely than not that it will be able to realize the benefits of the deferred income tax asset, net of valuation allowance, at December 31, 2016. At December 31, 2016, the Company had net operating loss and other carryforwards of approximately $26.1 million available to offset future taxable income, which begin expiring in 2029. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company did not have an accrual for uncertain tax positions at December 31, 2016 or 2015. We are subject to routine audits of our tax returns by the Internal Revenue Service and various state taxing authorities. With few exceptions, we are no longer subject to Federal and state income tax examinations by tax authorities for years before 2013. There are no indications of any material adjustments relating to any examination currently being conducted by any taxing authority. NOTE 15 - COMMITMENTS AND CONTINGENCIES The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, unfunded lines of credit, and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying consolidated financial statements. The Company's risk of loss in the event of nonperformance by the other party to the commitment to extend credit, lines of credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management's evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, real estate and time deposits with financial institutions. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent cash requirements. The following table presents the outstanding off-balance sheet financial instruments whose contract amounts represent potential credit risk: We invest as a limited partner in partnerships that operate qualified affordable housing or invest in emerging companies in our geographic region. These limited partnership structures are considered to be variable interest entities ("VIEs") because the limited partners with equity at risk do not have substantive kick-out rights through voting rights or substantive participating rights over the general partner. As a limited partner, we are not the primary beneficiary of the VIEs and do not consolidate them. Our investments in these partnerships are recorded in other assets on the Consolidated Balance Sheets. The Company has commitments to invest up to $18.3 million in these VIEs, of which $13.1 million was unfunded at December 31, 2016. At December 31, 2016, our maximum exposure to loss was our $5.2 million recorded investment. The Company is subject in the normal course of business to various pending and threatened legal proceedings in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate that the aggregate ultimate liability arising out of litigation pending or threatened against the Company will be material to the Company’s consolidated financial position. On an on-going basis the Company assesses any potential liabilities or contingencies in connection with such legal proceedings. For those matters where it is deemed probable that the Company will incur losses and the amount of the losses can be reasonably estimated, the Company would record an expense and corresponding liability in its consolidated financial statements. NOTE 16 - EMPLOYEE BENEFITS The Compensation Committee of the Company's Board of Directors may grant or award eligible participants stock options, restricted stock, restricted stock units, stock appreciation rights, and other stock-based awards or any combination of awards (collectively referred to herein as “Rights”). At December 31, 2016, the Company had Rights outstanding from the 2006 BNC Bancorp Omnibus Stock Ownership and Long Term Incentive Plan (the "2006 Omnibus Plan"), the BNC Bancorp 2013 Omnibus Stock Incentive Plan (the "2013 Omnibus Plan") and the KeySource Non-Statutory and Incentive Stock Option plans (the "KeySource Plans"). The 2013 Omnibus Plan and the KeySource Plans are the only plans that are available for future grants. The Company had 66,000 Rights issued under the 2006 Omnibus Plan, 861,933 Rights issued and 354,105 Rights available for grants or awards under the 2013 Omnibus Plan, and 44,236 stock options issued and 35,607 stock options available for issuance related to the KeySource Plans. Stock Option Awards. The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the average volatility of the Company based upon previous trading history. The expected life and forfeiture assumptions are based on historical data. Dividend yield is based on the yield at the time of the option grant. A summary of the Company’s stock option activity for the year ended December 31, 2016 is presented below: The related compensation expense recognized for stock options, the intrinsic value of stock option exercised, and the grant-date fair value of options that vested was immaterial for the years ended December 31, 2016, 2015, and 2014, respectively. Net cash received from stock option exercises under all share-based payment arrangements for the years ended December 31, 2016, 2015, and 2014 was $0.7 million, $1.8 million, and $0.2 million, respectively. The actual tax benefit realized for income tax deductions from stock option exercises was $0.7 million, $0.3 million and $0.1 million for the years ended December 31, 2016, 2015, and 2014, respectively. Restricted Stock Awards. A summary of the activity of the Company’s unvested restricted stock awards for the year ended December 31, 2016 is presented below: The Company measures the fair value of restricted shares based on the price of the Company's common stock on the grant date, and compensation expense is recorded over the vesting period. The Company recognized compensation expense of $3.5 million, $2.7 million and $2.2 million for restricted stock awards for the years ended December 31, 2016, 2015, and 2014, respectively. At December 31, 2016, there was $17.6 million of total unrecognized compensation cost related to unvested restricted stock granted under the plans. That cost is expected to be recognized over a weighted average period of 1.51 years. The grant-date fair value of restricted stock grants vested was $1.9 million, $1.7 million and $1.7 million during the years ended December 31, 2016, 2015, and 2014, respectively. Qualified Profit Sharing 401(k) Plan - The Company maintains a qualified profit sharing 401(k) plan for employees 20.5 years of age or over which covers substantially all employees. Under the plan, employees may contribute up to an annual maximum as determined by the Internal Revenue Code. Prior to January 1, 2015, the Company matched 50% of the employee contributions up to 6% of the participant's contribution. Effective January 1, 2015, the Company's match of participant contributions increased to 100% up to 3% of the participant's contributions and 50% on 4% and 5% of participant's contributions. The plan provides that employees' contributions are 100% vested at all times and, prior to January 1, 2015, the Company's contributions vested at 20% each year after the second year of service. Effective January 1, 2015, the Company's contributions, both past and future, were immediately vested at 100%. The expense related to the 401(k) plan for the years ended December 31, 2016, 2015, and 2014 was $2.3 million, $2.0 million and $1.0 million, respectively. Employment Agreements - The Company has entered into employment agreements with its chief executive officer and chief financial officer to ensure a stable and competent management base. The agreements provide for a three-year term, with an automatic one-year renewal on each anniversary date. The agreements provide for benefits as set forth in the contracts and cannot be terminated by the Board of Directors, except for cause, without prejudicing the officers’ rights to receive certain vested benefits, including compensation. In the event of a change in control of the Company, as outlined in the agreements, the acquiror will be bound to the terms of the contracts. Director and Executive Officer Benefit Plans - The Company has Salary Continuation Agreements and supplemental retirement benefits with its chief executive officer and certain other officers. The Salary Continuation Agreements provide for lifetime benefits to be paid to each executive with the payment amounts varying upon different retirement scenarios, such as normal retirement, early termination, disability, or change in control. The Company has purchased life insurance policies on the participating officers in order to provide future funding of benefit payments. Provisions for the years ended December 31, 2016, 2015, and 2014 totaled $4.6 million, $0.5 million and $0.4 million, respectively. The corresponding liability related to these benefit plans was $11.6 million and $7.9 million as of December 31, 2016 and 2015, respectively. The Company also has a deferred compensation plan for its directors. Expense provided under the plan totaled $0.2 million, $0.5 million and $0.1 million for the years ended December 31, 2016, 2015, and 2014, respectively. Since 2003, directors have had the option to invest amounts deferred in Company common stock that is held in a rabbi trust established for that purpose. At December 31, 2016 and 2015, the trust held 361,055 and 367,885 shares of Company common stock, respectively. NOTE 17 - PARENT COMPANY FINANCIAL DATA The following are condensed financial statements of the Parent Company as of and for the years ended December 31, 2016, 2015, and 2014: CONDENSED BALANCE SHEETS CONDENSED STATEMENTS OF INCOME CONDENSED STATEMENTS OF CASH FLOWS Note 18 - Subsequent Event On January 22, 2017, the Company and Pinnacle entered into an Agreement and Plan of Merger, pursuant to which Pinnacle will acquire the Company. Pinnacle will acquire 100% of the outstanding shares of the Company in exchange for shares of Pinnacle’s common stock. The exchange ratio has been fixed at 0.5235 shares of Pinnacle’s common stock for each share of the Company’s common stock. The transaction is expected to close during the third quarter of 2017, subject to shareholder and regulatory approval and other customary closing conditions. | I apologize, but the text you've provided appears to be a fragmented and incomplete financial statement excerpt. It seems to contain partial references to accounting practices, estimates, and reclassifications, but lacks a clear, comprehensive overview of financial performance.
The text mentions:
- Potential losses
- Valuation of assets and liabilities
- Estimates and their potential variations
- Debt securities
- Reclassifications
However, without the full context or complete financial statement, I cannot provide a meaningful summary of the company's financial position or performance. To create an accurate summary, I would need a more complete financial document with clear sections like revenue, expenses, net income, assets, and liabilities.
Would you like to provide the full financial statement for a more comprehensive summary? | Claude |
Index to Audited Financial Statements Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders HMS Income Fund, Inc. We have audited the accompanying consolidated balance sheets of HMS Income Fund, Inc. (a Maryland corporation) and subsidiaries (the “Company”), including the schedule of investments, as of December 31, 2016 and 2015, and the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2016 and the financial highlights (see Note 6) for each of the five years in the period ended December 31, 2016. These financial statements and financial highlights are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included verification by confirmation of securities as of December 31, 2016 and 2015, by correspondence with the portfolio companies and custodians, or by other appropriate auditing procedures where replies were not received. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of HMS Income Fund, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 and the financial highlights for each of the five years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. /s/ GRANT THORNTON LLP Houston, Texas March 7, 2017 PART I - FINANCIAL INFORMATION HMS Income Fund, Inc. Consolidated Balance Sheets (dollars in thousands, except share and per share amounts) See notes to the consolidated financial statements. HMS Income Fund, Inc. Consolidated Statements of Operations (dollars in thousands, except shares and per share amounts) See notes to the consolidated financial statements. HMS Income Fund, Inc. Consolidated Statements of Changes in Net Assets (dollars in thousands, except share and per share amounts) See notes to the consolidated financial statements. HMS Income Fund, Inc. Consolidated Statements of Cash Flows (dollars in thousands) See notes to the consolidated financial statements. (1) All investments are Middle Market portfolio investments, unless otherwise noted. All of the assets of HMS Income Fund, Inc. (the “Company”) are encumbered as security for the Company’s credit agreements. See Note 5 - Borrowings. (2) Debt investments are income producing, unless otherwise noted. Equity investments and warrants are non-income producing, unless otherwise noted. (3) See Note 3 - Fair Value Hierarchy for Investments for summary geographic location of portfolio companies. (4) Affiliate investments are defined by the Investment Company Act of 1940, as amended (the “1940 Act”), as investments in which between 5% and 25% of the voting securities are owned, or an investment in an investment company’s investment adviser, and the investments are not classified as Control investments. (5) Non-Control/Non-Affiliate investments are defined by the 1940 Act as investments that are neither Control investments nor Affiliate investments. (6) Control investments are defined by the 1940 Act as investments in which more than 25% of the voting securities are owned or where the ability to nominate greater than 50% of the board representation is maintained. (7) Principal is net of repayments. Cost represents amortized cost which is net of repayments and adjusted for the amortization of premiums and/or accretion of discounts, as applicable. (8) Index based floating interest rate is subject to contractual minimum interest rates. (9) The investment is not a qualifying asset under the 1940 Act. A business development company (“BDC”) may not acquire any asset other than qualifying assets unless, at the time the acquisition is made, qualifying assets represent at least 70% of the BDC’s total assets. As of December 31, 2016, approximately 13.8% of the Company’s investments were considered non-qualifying. (10) Investment is classified as a Lower Middle Market investment. (11) Investment is classified as a Private Loan portfolio investment. (12) Investment or portion of investment is under contract to purchase and met trade date accounting criteria as of December 31, 2016. Settlement occurred or is scheduled to occur after December 31, 2016. See Note 2 - Basis of Presentation and Summary of Significant Accounting Policies for Summary of Security Transactions. (13) Investment serviced by Main Street pursuant to servicing arrangements with the Company. (14) Second lien secured debt investment. (15) Investment is classified as an Other Portfolio investment. (16) Income producing through dividends or distributions. (17) Unsecured debt investment. (18) Investment is on non-accrual status as of December 31, 2016. (19) Maturity date is under on-going negotiations with the portfolio company and other lenders, if applicable. (20) Short term investments represent an investment in a fund that invests in highly liquid investments with average original maturity dates of three months or less. (21) Effective yield as of December 31, 2016 was approximately 0.01%. (22) The 1 week and 1, 2, 3 and 6 month LIBOR rates were 0.72%, 0.77%, 0.82%, 1.00% and 1.32%, respectively, as of December 31, 2016. The actual LIBOR rate for each loan listed may not be the applicable LIBOR rate as of December 31, 2016, as the loan may have been priced or repriced based on a LIBOR rate prior to or subsequent to December 31, 2016. The prime rate was 3.75% as of December 31, 2016. See notes to the consolidated financial statements. (1) All investments are Middle Market portfolio investments, unless otherwise noted. All of the Company’s assets are encumbered as security for the Company’s credit agreements. See Note 5 - Borrowings. (2) Debt investments are income producing, unless otherwise noted. Equity investments and warrants are non-income producing, unless otherwise noted. (3) See Note 3 - Fair Value Hierarchy for Investments for summary geographic location of portfolio companies. (4) Affiliate investments are defined by the Investment Company Act of 1940, as amended (the “1940 Act”), as investments in which between 5% and 25% of the voting securities are owned, or an investment in an investment company’s investment adviser, and the investments are not classified as Control investments. (5) Non-Control/Non-Affiliate investments are defined by the 1940 Act as investments that are neither Control investments nor Affiliate investments. (6) Control investments are defined by the 1940 Act as investments in which more than 25% of the voting securities are owned or where the ability to nominate greater than 50% of the board representation is maintained. (7) Principal is net of repayments. Cost represents amortized cost which is net of repayments and adjusted for the amortization of premiums and/or accretion of discounts, as applicable. (8) Index based floating interest rate is subject to contractual minimum interest rates. (9) The investment is not a qualifying asset under the 1940 Act. A business development company (“BDC”) may not acquire any asset other than qualifying assets unless, at the time the acquisition is made, qualifying assets represent at least 70% of the BDC’s total assets. As of December 31, 2015, approximately 12.6% of the Company’s investments were considered non-qualifying. (10) Investment is classified as a Lower Middle Market investment. (11) Investment is classified as a Private Loan portfolio investment. (12) Investment or portion of investment is under contract to purchase and met trade date accounting criteria as of December 31, 2015. Settlement occurred or is scheduled to occur after December 31, 2015. (13) Investment serviced by Main Street pursuant to servicing arrangements with the Company. (14) Second lien secured debt investment. (15) Investment is classified as an Other Portfolio investment. (16) Income producing through dividends or distributions. (17) Unsecured debt investment. (18) Investment is on non-accrual status as of December 31, 2015. (19) Maturity date is under on-going negotiations with the portfolio company and other lenders, if applicable. (20) Short term investments represent an investment in a fund that invests in highly liquid investments with average original maturity dates of three months or less. (21) Effective yield as of December 31, 2015 was approximately 0.01%. (22) The 1, 2, 3 and 6 month LIBOR rates were 0.43%, 0.51%, 0.61% and 0.85%, respectively, as of December 31, 2015. The actual LIBOR rate for each loan listed may not be the applicable LIBOR rate as of December 31, 2015, as the loan may have been priced or repriced based on a LIBOR rate prior to or subsequent to December 31, 2015. The prime rate was 3.25% as of December 31, 2015. See notes to the consolidated financial statements. HMS Income Fund, Inc. Notes to the Consolidated Financial Statements Note 1. Principal Business and Organization HMS Income Fund, Inc. (the “Company”) was formed as a Maryland corporation on November 28, 2011 under the General Corporation Law of the State of Maryland. The Company is an externally managed, non-diversified closed-end investment company that has elected to be treated as a BDC under the 1940 Act. The Company has elected to be treated for U.S. federal income tax purposes as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). The Company’s primary investment objective is to generate current income through debt and equity investments. A secondary objective of the Company is to generate long-term capital appreciation through such equity and equity-related investments including warrants, convertible securities and other rights to acquire equity securities. The Company’s portfolio strategy calls for it to invest primarily in illiquid debt and equity securities issued by lower middle market (“LMM”) companies, which generally have annual revenues between $10 million and $150 million, and middle market (“Middle Market”) companies that are generally larger in size than the LMM companies. The Company categorizes some of its investments in LMM companies and Middle Market companies as private loan (“Private Loan”) portfolio investments. Private Loan investments, often referred to in the debt markets as “club deals,” are investments, generally in debt instruments, that the Company originates on a collaborative basis with other investment funds. Private Loan investments are typically similar in size, structure, terms and conditions to investments the Company holds in its LMM portfolio and Middle Market portfolio. The Company’s portfolio also includes other portfolio (“Other Portfolio”) investments primarily consisting of investments managed by third parties, which differ from the typical profiles for LMM portfolio investments, Middle Market portfolio investments or Private Loan portfolio investments. The Company previously registered for sale up to 150,000,000 shares of common stock pursuant to a registration statement on Form N-2 (File No. 333-178548) which was initially declared effective by the Securities and Exchange Commission (the “SEC”) on June 4, 2012 (the “Initial Offering”). The Initial Offering terminated on December 1, 2015. The Company had raised approximately $601.2 million under the Initial Offering, including proceeds from the dividend reinvestment plan of approximately $22.0 million. The Company also registered for sale up to $1,500,000,000 worth of shares of common stock (the “Offering”) pursuant to a new registration statement on Form N-2 (File No. 333-204659), as amended, most recently declared effective on October 6, 2016. As of December 31, 2016, the Company had raised approximately $105.4 million in the Offering, including proceeds from the distribution reinvestment plan of approximately $24.8 million. On February 22, 2017, the Company’s board of directors, after determining that it would be in the best interests of the Company and its stockholders to do so, decided to continue the Offering until September 30, 2017 and authorized the closing of the Offering to new investors (the “Closing”) to occur on or about such date. The Company’s board of directors previously authorized the Closing to occur on or about March 31, 2017, subject to the board of directors’ final approval. The board of directors retained its right to provide final approval on the specific terms of the Closing, including its right to accelerate the Closing or to further continue the Company’s Offering if the board of directors determines that it is in the best interests of the Company and its stockholders to do so. The business of the Company is managed by HMS Adviser LP (the “Adviser”), a Texas limited partnership and affiliate of Hines Interests Limited Partnership (“Hines”), under an Investment Advisory and Administrative Services Agreement dated May 31, 2012, (as amended, the “Investment Advisory Agreement”). The Company and the Adviser have retained MSC Adviser I, LLC (the “Sub-Adviser”), a wholly owned subsidiary of Main Street Capital Corporation (“Main Street”), a New York Stock Exchange listed BDC, as the Company’s investment sub-adviser, pursuant to an Investment Sub-Advisory Agreement (the “Sub-Advisory Agreement”) to identify, evaluate, negotiate and structure prospective investments, make investment and portfolio management recommendations for approval by the Adviser, monitor the Company’s investment portfolio and provide certain ongoing administrative services to the Adviser. The Adviser and the Sub-Adviser are collectively referred to as the “Advisers”, and each is registered as an investment adviser under the Investment Advisers Act of 1940, as amended . Upon the execution of the Sub-Advisory Agreement, Main Street became an affiliate of the Company. The Company has engaged Hines Securities, Inc. (the “Dealer Manager”), an affiliate of the Adviser, to serve as the Dealer Manager for the Offering. The Dealer Manager is responsible for marketing the Company’s common stock. Note 2. Basis of Presentation and Summary of Significant Accounting Policies Basis of Presentation and Consolidation The Company is an investment company, as defined in the accounting and reporting guidance under Topic 946, Financial Services-Investment Companies, of the Financial Accounting Standards Board’s (“FASB’s”) Accounting Standards Codification, as amended (the “ASC”). The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of the Company and its wholly owned consolidated subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Under the 1940 Act rules, regulations pursuant to Articles 6 and 10 of Regulation S-X and ASC Topic 946, the Company is precluded from consolidating portfolio company investments, including those in which it has a controlling interest, unless the portfolio company is a wholly owned investment company. An exception to this general principle occurs if the Company owns a controlled operating company whose purpose is to provide services to the Company such as an investment adviser or transfer agent. None of the investments made by the Company qualifies for this exception. Therefore, the Company’s portfolio company investments, including those in which the Company has a controlling interest, are carried on the Consolidated Balance Sheet at fair value, as discussed below, with changes to fair value recognized as “Net Unrealized Appreciation (Depreciation)” on the Consolidated Statements of Operations until the investment is realized, usually upon exit, resulting in any gain or loss on exit being recognized as a realized gain or loss. However, in the event that any controlled subsidiary exceeds the tests of significance set forth in Rules 3-09 or 4-08(g) of Regulation S-X, the Company will include required financial information for such subsidiary in the notes or as an attachment to its consolidated financial statements. Reclassifications Certain amounts in the Consolidated Balance Sheet and Consolidated Statement of Cash Flows related to base management fees payable and directors’ fees payable have been disaggregated from due to affiliates and accounts payable and other liabilities, respectively, as of December 31, 2016. Additionally, certain amounts in the Consolidated Statements of Operations related to income taxes have been disaggregated from other general and administrative expenses as of December 31, 2016. The prior periods have been reclassified to conform to this presentation as of December 31, 2016. Use of Estimates The preparation of the financial statements requires the Company to make estimates and judgments that affect the reported amounts and disclosures of assets, liabilities and contingencies as of the date of the financial statements and accompanying notes. The Company evaluates its assumptions and estimates on an ongoing basis. The Company bases its estimates on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances. Additionally, application of the Company’s accounting policies involves exercising judgments regarding assumptions as to future uncertainties. Actual results may differ from these estimates under different assumptions or conditions. Significant estimates are used in the determination of fair value of investments. See Note 3 - Fair Value Hierarchy for Investments for a description of these estimates. Investment Classification The Company classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, (a) “Control” investments are defined as investments in companies in which the Company owns more than 25% of the voting securities or has rights to nominate greater than 50% of the directors or managers of the entity, (b) “Affiliate” investments are defined as investments in which between 5% and 25% of the voting securities are owned, or an investment in an investment company’s investment adviser, and the investments are not classified as Control investments and (c) “Non-Control/Non-Affiliate” investments are defined as investments that are neither Control investments nor Affiliated investments. Valuation of Portfolio Investments The Company accounts for its portfolio investments at fair value under the provisions of ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. ASC 820 requires the Company to assume that the portfolio investment is to be sold in the principal market to independent market participants, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal market that are independent, knowledgeable, and willing and able to transact. LMM investments and Other Portfolio investments generally have no established trading market, while Middle Market securities generally have established markets that are not active. Private Loan investments may include investments which have no established trading market or have established markets that are not active. The Company determines in good faith the fair value of its investment portfolio pursuant to a valuation policy in accordance with ASC 820 and a valuation process approved by its board of directors and in accordance with the 1940 Act. The Company’s valuation policies and processes are intended to provide a consistent basis for determining the fair value of the portfolio. For LMM portfolio investments, the Company generally reviews external events, including private mergers, sales and acquisitions involving comparable companies, and includes these events in the valuation process by using an enterprise value waterfall (“Waterfall”) for its LMM equity investments and an income approach using a yield-to-maturity model (“Yield-to-Maturity”) for its LMM debt investments. For Middle Market portfolio investments, the Company uses observable inputs such as quoted prices in the valuation process. The Company determines the appropriateness of the use of third-party broker quotes, if any, in determining fair value based on its understanding of the level of actual transactions used by the broker to develop the quote and whether the quote was an indicative price or binding offer, the depth and consistency of broker quotes and the correlation of changes in broker quotes with underlying performance of the portfolio company and other market indices. The Company often cannot observe the inputs considered by the third party in determining their quotes. For Middle Market and Private Loan portfolio investments in debt securities for which it has determined that third-party quotes or other independent pricing are not available or appropriate, the Company generally estimates the fair value based on the assumptions that it believes hypothetical market participants would use to value the investment in a current hypothetical sale using the Yield-to-Maturity valuation method. For its Other Portfolio equity investments, the Company generally calculates the fair value of the investment primarily based on the net asset value (“NAV”) of the fund. All of the valuation approaches for the Company’s portfolio investments estimate the value of the investment as if the Company was to sell, or exit, the investment as of the measurement date. Under the Waterfall valuation method, the Company estimates the enterprise value of a portfolio company using a combination of market and income approaches or other appropriate valuation methods, such as considering recent transactions in the equity securities of the portfolio company or third-party valuations of the portfolio company, and then performs a Waterfall calculation by using the enterprise value over the portfolio company’s securities in order of their preference relative to one another. The enterprise value is the fair value at which an enterprise could be sold in a transaction between two willing parties, rather than through a forced or liquidation sale. Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization (“EBITDA”), cash flows, net income, revenues, or in limited cases, book value. There is no single methodology for estimating enterprise value. For any one portfolio company, enterprise value is generally described as a range of values from which a single estimate of enterprise value is derived. In estimating the enterprise value of a portfolio company, the Company analyzes various factors including the portfolio company’s historical and projected financial results. The operating results of a portfolio company may include unaudited, projected, budgeted or pro forma financial information and may require adjustments for non-recurring items or to normalize the operating results that may require significant judgment in its determination. In addition, projecting future financial results requires significant judgment regarding future growth assumptions. In evaluating the operating results, the Company also analyzes the impact of exposure to litigation, loss of customers or other contingencies. After determining the appropriate enterprise value, the Company allocates the enterprise value to investments in order of the legal priority of the various components of the portfolio company’s capital structure. In applying the Waterfall valuation method, the Company assumes the loans are paid off at the principal amount in a change in control transaction and are not assumed by the buyer, which the Company believes is consistent with its past transaction history and standard industry practices. Under the Yield-to-Maturity valuation method, the Company also uses the income approach to determine the fair value of debt securities based on projections of the discounted future free cash flows that the debt security will likely generate, including analyzing the discounted cash flows of interest and principal amounts for the debt security, as set forth in the associated loan agreements, as well as the financial position and credit risk of the portfolio investments. The Company’s estimate of the expected repayment date of its debt securities is generally the legal maturity date of the instrument, as the Company generally intends to hold its loans and debt securities to maturity. The Yield-to-Maturity analysis also considers changes in leverage levels, credit quality, portfolio company performance and other factors. The Company will generally use the value determined by the Yield-to-Maturity analysis as the fair value for that security. However, it is the Company’s position that assuming a borrower is outperforming underwriting expectations and because these respective investments do not generally contain pre-payment penalties, the borrower would most likely prepay or refinance the borrowing if the market interest rate, given the borrower’s credit quality, is lower than the stated loan interest rate. Therefore, the Company does not believe that a market participant would pay a premium for the investment, and because of the Company’s general intent to hold its loans to maturity, the Company generally does not believe that the fair value of the investment should be adjusted in excess of the face amount. A change in the assumptions that the Company uses to estimate the fair value of its debt securities using the Yield-to-Maturity valuation method could have a material impact on the determination of fair value. If there is deterioration in credit quality or if a debt security is in workout status, the Company may consider other factors in determining the fair value of the debt security, including the value attributable to the debt security from the enterprise value of the portfolio company or the proceeds that would most likely be received in a liquidation analysis. Under the NAV valuation method, for an investment in an investment fund that does not have a readily determinable fair value, the Company measures the fair value of the investment predominately based on the NAV of the investment fund as of the measurement date. However, in determining the fair value of the investment, the Company may consider whether adjustments to the NAV are necessary in certain circumstances, based on the analysis of any restrictions on redemption of the Company’s investment as of the measurement date, recent actual sales or redemptions of interests in the investment fund, and expected future cash flows available to equity holders, including the rate of return on those cash flows compared to an implied market return on equity required by market participants, or other uncertainties surrounding the Company’s ability to realize the full NAV of its interests in the investment fund. With respect to investments for which market quotations are not readily available, the Company’s board of directors will undertake a multi-step valuation process, as described below: • The Company’s valuation process begins with each portfolio company or investment being initially valued by investment professionals of the Advisers responsible for credit monitoring. • Preliminary valuation conclusions are then documented and discussed with the Company’s senior management and the Advisers. • The board of directors reviews these preliminary valuations. • For the LMM portfolio companies and certain Private Loan portfolio companies, the Company has valuations reviewed by an independent valuation firm on a periodic basis. • The board of directors discusses valuations and determines the fair value of each investment in the Company’s portfolio in good faith. Pursuant to its internal valuation process and the requirements under the 1940 Act, the Company performs valuation procedures on its investments in each LMM portfolio company and certain Private Loan portfolio companies (the “Internally Valued Investments”) once a quarter. Among other things, the Company generally consults with a nationally recognized independent valuation firm on the Internally Valued Investments at least once in every calendar year, and for new Internally Valued Investments, at least once in the twelve-month period subsequent to the initial investment. In certain instances, the Company may determine that it is not cost-effective, and as a result is not in its stockholders’ best interest, to consult with the nationally recognized independent valuation firm on its investments in one or more of these Internally Valued Investments. Such instances include situations where the fair value of the Company’s investment is determined to be insignificant relative to the total investment portfolio. For the year ended December 31, 2016, the Company consulted with its independent valuation firm in arriving at the Company’s determination of fair value on its investments in a total of 21 of the 23 LMM portfolio companies and in a total of 15 of the 29 Private Loan portfolio companies. For the year ended December 31, 2015, the Company consulted with its independent valuation firm in arriving at the Company’s determination of fair value on its investments in a total of 11 of the 16 LMM portfolio companies and in a total of seven of the 20 Private Loan portfolio companies. Due to the inherent uncertainty in the valuation process, the Company’s estimate of fair value may differ materially from the values that would have been used had an active market for the securities existed. In addition, changes in the market environment, portfolio company performance and other events that may occur over the lives of the investments may cause the gains or losses ultimately realized on these investments to be materially different than the valuations currently assigned. The Company estimates the fair value of each individual investment and record changes in fair value as unrealized appreciation or depreciation in the Consolidated Statements of Operations. Cash and Cash Equivalents Cash and cash equivalents consist of cash and highly liquid investments with an original maturity of three months or less at the date of purchase. These highly liquid, short term investments are included in the Consolidated Schedule of Investments. Cash and cash equivalents are carried at cost, which approximates fair value. Security Transactions Security transactions are accounted for on the trade date. As of the trade date, the investment is derecognized for security sales and recognized for security purchases. As of December 31, 2016 and 2015, the Company had three and five investments at contract prices of $11.0 million and $11.7 million, respectively, under contract to purchase which had not yet settled. These investments have been recognized by the Company and are included in the Consolidated Schedule of Investments. The settlement obligations are presented in the line item “Payable for securities purchased” at the contract price. As of December 31, 2016 and 2015, the Company had two investments and one investment at contract prices of $7.6 million and $2.0 million, respectively, under contract to sell which had not yet settled. These investments were derecognized by the Company and are not included in the Consolidated Schedule of Investments. The sale trades are presented in the line item “Receivable for securities sold” at the contract price. Interest, Fee and Dividend Income Interest and dividend income is recorded on the accrual basis to the extent amounts are expected to be collected. Prepayment penalties received by the Company are recorded as income upon receipt. Dividend income is recorded when dividends are declared by the portfolio company or at the point an obligation exists for the portfolio company to make a distribution. Accrued interest and dividend income are evaluated quarterly for collectability. When a debt security becomes 90 days or more past due and the Company does not expect the debtor to be able to service all of its debt or other obligations, the debt security will generally be placed on non-accrual status and the Company will cease recognizing interest income on that debt security until the borrower has demonstrated the ability and intent to pay contractual amounts due. If there is reasonable doubt that we will receive any previously accrued interest, then the interest income will be written off. Additionally, if a debt security has deferred interest payment terms and the Company becomes aware of a deterioration in credit quality, the Company will evaluate the collectability of the deferred interest payment. If it is determined that the deferred interest is unlikely to be collected, the Company will place the security on non-accrual status and cease recognizing interest income on that debt security until the borrower has demonstrated the ability and intent to pay the contractual amounts due. Payments received on non-accrual investments may be recognized as income or applied to principal depending upon the collectability of the remaining principal and interest. If a debt security’s status significantly improves with respect to the debtor’s ability to service the debt or other obligations, or if a debt security is fully impaired, sold or written off, it will be removed from non-accrual status. As of December 31, 2016, the Company had five debt investments in four portfolio companies that were more than 90 days past due (two of which were in the oil and gas industry), including three debt investments in two portfolio companies that were on non-accrual status. Each of these portfolio companies experienced a significant decline in credit quality raising doubt regarding the Company’s ability to collect the principal and interest contractually due. Given the credit deterioration , we ceased accruing interest income on the non-accrual debt investments and wrote off any previously accrued interest deemed uncollectible. Aside from these three investments on non-accrual status as of December 31, 2016, the Company is not aware of any material changes to the creditworthiness of the borrowers underlying its debt investments. As of December 31, 2015, the Company had two debt investments in one portfolio company that were more than 90 days past due and had three debt investments in two portfolio company that were on non-accrual status. These portfolio companies experienced a significant decline in credit quality raising doubt regarding the Company’s ability to collect the principal and interest contractually due. Given the credit deterioration, no interest income has been recognized on two of the three non-accrual debt investments during the year ended December 31, 2015. For the other non-accrual debt investment, an allowance of $196,000 was booked for the interest income recognized during the three months ended December 31, 2015 though no allowance was booked for the interest income recognized during the nine months ended September 30, 2015 due to receipt of the related interest payments. From time to time, the Company may hold debt instruments in its investment portfolio that contain a payment-in-kind (“PIK”) interest provision. If these borrowers elect to pay or are obligated to pay interest under the optional PIK provision, and if deemed collectible in management’s judgment, then the interest would be computed at the contractual rate specified in the investment’s credit agreement, recorded as interest income and periodically added to the principal balance of the investment. Thus, the actual collection of this interest may be deferred until the time of debt principal repayment. The Company stops accruing PIK interest and writes off any accrued and uncollected interest in arrears when it determines that such PIK interest in arrears is no longer collectible. As of December 31, 2016 and 2015, the Company held 19 and seven investments, respectively, which contained a PIK provision. As discussed above, two of the 19 investments with PIK provisions as of December 31, 2016 and two of the seven investments with PIK provisions as of December 31, 2015 were on non-accrual status and no PIK interest was recorded on these investments during the years ended December 31, 2016 and 2015. For the years ended December 31, 2016, 2015 and 2014, the Company recognized approximately $469,000, $1.2 million and $274,000, respectively, of PIK interest. The Company stops accruing PIK interest and writes off any accrued and uncollected interest in arrears when it determines that such PIK interest in arrears is no longer collectible. The Company may periodically provide services, including structuring and advisory services, to its portfolio companies or other third parties. The income from such services is non-recurring. For services that are separately identifiable and evidence exists to substantiate fair value, income is recognized as earned, which is generally when the investment or other applicable transaction closes. Fees received in connection with debt financing transactions for services that do not meet these criteria are treated as debt origination fees and are deferred and accreted into interest income over the life of the financing. A presentation of the investment income the Company received from its investment portfolio in each of the periods presented (dollars in thousands) is as follows: Unearned Income - Original Issue Discount / Premium to Par Value The Company purchased some of its debt investments for an amount different than their respective principal values. For purchases at less than par value, a discount is recorded at acquisition, which is accreted into interest income based on the effective interest method over the life of the debt investment. For purchases at greater than par value, a premium is recorded at acquisition, which is amortized as a reduction to interest income based on the effective interest method over the life of the investment. Upon repayment or sale, any unamortized discount or premium is also recognized into interest income. For the years ended December 31, 2016, 2015 and 2014 the Company accreted approximately a net $11.9 million, $4.4 million and $1.1 million, respectively, into interest income. Net Realized Gains or Losses from Investments and Net Change in Unrealized Appreciation (Depreciation) from Investments Generally, net realized gains or losses are measured by the difference between the net proceeds from the sale or redemption of an investment and the principal amount, without regard to unrealized appreciation or depreciation previously recognized, and includes investments written-off during the period net of recoveries and realized gains or losses from in-kind redemptions. Net change in unrealized appreciation or depreciation from investments reflects the net change in the fair value of the investment portfolio and the reclassification of any prior period unrealized appreciation (depreciation) on exited investments to realized gains or losses. Deferred Financing Costs Deferred financing costs represent fees and other direct costs incurred in connection with arranging the Company’s borrowings. These costs were incurred in connection with the Company’s revolving credit facilities (see Note 5 - Borrowings for a discussion ) and have been capitalized. The deferred financing costs are being amortized to interest expense using the straight-line method over the life of the related credit facility, which the Company believes is materially consistent with the effective interest method. For the years ended December 31, 2016, 2015 and 2014, the Company amortized approximately $1.5 million, $1.2 million, and $438,000, respectively, into interest expense related to deferred financing costs. Offering Costs In accordance with the Investment Advisory Agreement and the Sub-Advisory Agreement, the Company reimburses the Advisers for any offering costs that are paid on the Company’s behalf, which consist of, among other costs, actual legal, accounting, bona fide out-of-pocket itemized and detailed due diligence costs, printing, filing fees, transfer agent costs, postage, escrow fees, data processing fees, advertising and sales literature and other offering costs. Pursuant to the terms of the Investment Advisory Agreement and Sub-Advisory Agreement, the Company expects to reimburse the Advisers for such costs incurred on its behalf on a monthly basis, up to a maximum aggregate amount of 1.5% of the gross stock offering proceeds. The Advisers are responsible for the payment of offering costs to the extent they exceed 1.5% of the aggregate gross stock offering proceeds. Prior to January 1, 2016, offering costs were capitalized as incurred by the Advisers and such costs, up to 1.5% of the gross proceeds, were recorded as a charge to additional paid in capital and a reduction of deferred offering costs. Effective January 1, 2016, offering costs are capitalized as deferred offering costs as incurred by the Company and subsequently amortized to expense over a 12-month period to more closely track applicable guidance. Deferred offering costs related to an offering will be fully amortized to expense upon the expiration or earlier termination of an offering. The Company currently expects offering costs to be fully amortized by September 30, 2017, the anticipated date of the Closing. The Company evaluated this change in accounting treatment of offering costs and determined that it did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows for periods prior to January 1, 2016. Payable for Unsettled Trades The Company accepts stockholders’ subscriptions on a weekly basis during the Offering. For subscriptions received, for which shares of common stock were not issued by December 31, 2016, the amounts of such subscriptions are presented as cash and as a payable for unsettled trades. The shares issued in exchange for these subscriptions were issued and outstanding on January 7, 2017. The Company accepted stockholders’ subscriptions on a weekly basis during the Initial Offering which terminated on December 1, 2015. Since the SEC had not declared the Offering effective as of December 31, 2015, there were no subscriptions received, for which shares of common stock were not issued by December 31, 2015. Per Share Information Net increase (decrease) in net assets resulting from operations per share, net investment income per share, and net realized income per share are calculated based upon the weighted average number of shares of common stock outstanding during the reporting period. Concentration of Credit Risk The Company has cash deposited in a financial institution in excess of federally insured levels. Management regularly monitors the financial stability of these financial institutions in an effort to manage the Company’s exposure to any significant credit risk in cash. The Federal Deposit Insurance Corporation generally only insures limited amounts per depositor per insured bank. Fair Value of Financial Instruments Fair value estimates are made at discrete points in time based on relevant information. These estimates may be subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. The Company believes that the carrying amounts of its financial instruments, consisting of cash, accounts receivable from affiliates, interest payable to affiliates, other accrued expenses and liabilities, and notes payable approximate the fair values of such items due to the short term nature of these instruments. Income Taxes The Company has elected to be treated for U.S. federal income tax purposes as a RIC. As a RIC, the Company generally will not be subject to pay corporate-level U.S. federal income taxes on net ordinary income or capital gains that the Company timely distributes each taxable year as dividends to its stockholders from taxable earnings and profits. To qualify as a RIC in any taxable year, the Company must, among other things, satisfy certain source-of-income and asset diversification requirements. In addition, the Company must distribute in respect of each taxable year dividends of an amount generally at least equal to 90% of its investment company taxable income, determined without regard to any deduction for dividends paid, in order to maintain its ability to be subject to tax as a RIC (the “Annual Distribution Requirement”). As a part of maintaining our RIC status, undistributed taxable income (subject to a 4% excise tax) pertaining to a given taxable year may be distributed up to 12 months subsequent to the end of that taxable year, provided such distributions are declared prior to the earlier of eight-and-one-half months after the close of that taxable year or the filing of the federal income tax return for such prior taxable year. In order to avoid the imposition of this excise tax, the Company needs to distribute in respect of each calendar year dividends of an amount at least equal to the sum of (1) 98.0% of its net ordinary income (taking into account certain deferrals and elections) for the calendar year, (2) 98.2% of its capital gain in excess of capital loss, or capital gain net income, (adjusted for certain ordinary losses) for the one-year period ending October 31 in that calendar year (or, if we so elect, for that calendar year) and (3) any net ordinary income and capital gain net income for preceding years that was not distributed with respect to such years and on which the Company incurred no U.S. federal income tax (the “Excise Tax Avoidance Requirement”). The Company has formed wholly owned subsidiaries, HMS Equity Holding, LLC (“HMS Equity Holding”) and HMS Equity Holding II, Inc. (“HMS Equity Holding II”), which have elected to be taxable entities. HMS Equity Holding and HMS Equity Holding II primarily hold equity investments in portfolio companies which are considered “pass through” entities for tax purposes. HMS Equity Holding and HMS Equity Holding II are consolidated for financial reporting purposes, and the portfolio investments held by each entity are included in the consolidated financial statements as portfolio investments recorded at fair value. HMS Equity Holding and HMS Equity Holding II are not consolidated with the Company for income tax purposes and may generate income tax expense, or benefit, and the related tax assets and liabilities, as a result of the Company’s ownership of certain portfolio investments. This income tax expense, or benefit, if any, and the related tax assets and liabilities, are reflected in the Company’s consolidated financial statements. HMS Equity Holding and HMS Equity Holding II use the liability method in accounting for income taxes in accordance with ASC Topic 740, Income Taxes. Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, using statutory tax rates in effect for the year in which the temporary differences are expected to reverse. A valuation allowance is provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses. Taxable income generally excludes net unrealized appreciation or depreciation, as investment gains or losses are not included in taxable income until they are realized. Uncertainty in Income Taxes The Company evaluates its tax positions to determine if the tax positions taken in accordance with ASC Topic 740, Income Taxes meet the minimum recognition threshold in connection with accounting for uncertainties in income tax positions taken or expected to be taken for the purposes of measuring and recognizing tax benefits or liabilities in the consolidated financial statements. Recognition of a tax benefit or liability with respect to an uncertain tax position is required only when the position is “more likely than not” to be sustained assuming examination by taxing authorities. The Company recognizes interest and penalties, if any, related to unrecognized tax liabilities as income tax expense in the consolidated statements of operations. Recent Accounting Pronouncements In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 supersedes the revenue recognition requirements under ASC 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the ASC. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. Under the new guidance, an entity is required to perform the following five steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance will significantly enhance comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. Additionally, the guidance requires improved disclosures as to the nature, amount, timing and uncertainty of revenue that is recognized. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarified the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarified the implementation guidance regarding performance obligations and licensing arrangements. In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606)-Narrow-Scope Improvements and Practical Expedients, which clarified guidance on assessing collectability, presenting sales tax, measuring non-cash consideration, and certain transition matters. The new guidance will be effective for the annual reporting period beginning after December 15, 2017, including interim periods within that reporting period. Early adoption would be permitted for annual reporting periods beginning after December 15, 2016. The Company expects to identify similar performance obligations under ASC 606 as compared with deliverables and separate units of account previously identified. As a result, the Company expects the timing of its revenue recognition to remain the same. In February 2015, the FASB issued ASU No. 2015-02, Consolidation: Amendments to the Consolidation Analysis which amends the consolidation requirements under ASC 810. This guidance amends the criteria for determining which entities are considered variable interest entities (“VIEs”) and amends the criteria for determining if a service provider possesses a variable interest in a VIE. ASU No. 2015-02 also eliminates the deferral under ASU 2010-10 for application of the VIE consolidation model that was granted for investments in certain investment companies. The Company adopted this standard during the three months ended March 31, 2016. There was no impact on the Company’s consolidated financial statements from the adoption of this new accounting standard. In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs which amends the required presentation of debt issuance costs on the balance sheet. The guidance will require that debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the ASU No. 2015-03. For public business entities, the guidance is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. In August 2015, the FASB issued ASU No. 2015-15, Interest-Imputation of Interest: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements which clarified ASU 2015-03. This guidance allows an entity to defer and present debt issuance costs for line-of-credit arrangements as an asset and subsequently amortize these deferred costs over the term of the line-of-credit arrangement. The Company adopted this standard during the three months ended March 31, 2016. There was no impact on the Company’s consolidated financial statements from the adoption of this new accounting standard since the guidance allows the Company to continue to present its debt issuance costs for its line-of-credit arrangements as assets that are amortized over the term of the arrangements. In May 2015, the FASB issued ASU 2015-07, Fair Value Measurements-Disclosures for Certain Entities that Calculate Net Asset Value per Share. This amendment updates guidance intended to eliminate the diversity in practice surrounding how investments measured at net asset value under the practical expedient with future redemption dates have been categorized in the fair value hierarchy. Under the updated guidance, investments for which fair value is measured at net asset value per share using the practical expedient should no longer be categorized in the fair value hierarchy, while investments for which fair value is measured at net asset value per share but the practical expedient is not applied should continue to be categorized in the fair value hierarchy. The updated guidance requires retrospective adoption for all periods presented and is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The Company adopted this standard during the three months ended March 31, 2016. There was no impact on the Company’s consolidated financial statements from the adoption of this new accounting standard as none of its investments are measured through the use of the practical expedient. In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities which amends the guidance related to the classification and measurement of investments in equity securities. The guidance requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. The ASU will also amend the guidance related to the presentation of certain fair value changes for financial liabilities measured at fair value and certain disclosure requirements associated with the fair value of financial instruments. For public companies, this ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The impact of the adoption of this new accounting standard on the Company’s consolidated financial statements is not expected to be material. In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which addresses eight specific cash flow issues including, among other things, the classification of debt prepayment or debt extinguishment costs. ASU No. 2016-15 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2017. Early adoption is permitted. The impact of the adoption of this new accounting standard on the Company’s consolidated financial statements is not expected to be material. In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230),” which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new guidance is effective for interim and annual periods beginning after December 15, 2017 and early adoption is permitted. The amendment should be adopted retrospectively. The impact of the adoption of this new accounting standard on the Company’s consolidated financial statements is not expected to be material. From time to time, new accounting pronouncements are issued by the FASB or other standards setting bodies that are adopted by the Company as of the specified effective date. The Company believes that the impact of recently issued standards and any that are not yet effective will not have a material impact on its financial statements upon adoption. Note 3 - Fair Value Hierarchy for Investments Fair Value Hierarchy ASC Topic 820 establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability of inputs used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide disclosures on fair value measurements according to the fair value hierarchy. The fair value hierarchy ranks the observability of the inputs used to determine fair values. Investments carried at fair value are classified and disclosed in one of the following three categories: • Level 1-Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. • Level 2-Valuations based on inputs other than quoted prices in active markets, which are either directly or indirectly observable for essentially the full term of the investment. Level 2 inputs include quoted prices for similar assets in active markets, quoted prices for identical or similar assets in non-active markets (for example, thinly traded public companies), pricing models whose inputs are observable for substantially the full term of the investment, and pricing models whose inputs are derived principally from or corroborated by, observable market data through correlation or other means for substantially the full term of the investment. • Level 3-Valuations based on inputs that are unobservable and significant to the overall fair value measurement. Such information may be the result of consensus pricing information or broker quotes for which sufficient observable inputs were not available. As required by ASC Topic 820, when the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. For example, a Level 3 fair value measurement may include inputs that are observable (Levels 1 and 2) and unobservable (Level 3). Therefore, gains and losses for such investments categorized within the Level 3 table below may include changes in fair value that are attributable to both observable inputs (Levels 1 and 2) and unobservable inputs (Level 3). The Company conducts reviews of fair value hierarchy classifications on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain investments. As of December 31, 2016 and December 31, 2015, the Company’s investment portfolio was comprised of debt securities, equity investments, and Other Portfolio investments. The fair value determination for these investments primarily consisted of unobservable (Level 3) inputs. As of December 31, 2016 and December 31, 2015, all of the Company’s LMM portfolio investments consisted of illiquid securities issued by private companies. The fair value determination for the LMM portfolio investments primarily consisted of unobservable inputs. As a result, all of the Company’s LMM portfolio investments were categorized as Level 3 as of December 31, 2016 and December 31, 2015. As of December 31, 2016 and December 31, 2015, the Company’s Middle Market portfolio investments consisted primarily of Middle Market investments in secured and unsecured debt investments and independently rated debt investments. The fair value determination for these investments consisted of a combination of (1) observable inputs in non-active markets for which sufficient observable inputs were available to determine the fair value of these investments, (2) observable inputs in non-active markets for which sufficient observable inputs were not available to determine the fair value of these investments and (3) unobservable inputs. As a result, all of the Company’s Middle Market portfolio investments were categorized as Level 3 as of December 31, 2016 and December 31, 2015. As of December 31, 2016 and December 31, 2015, the Company’s Private Loan portfolio investments primarily consisted of debt investments. The fair value determination for Private Loan investments consisted of a combination of observable inputs in non-active markets for which sufficient observable inputs were not available to determine the fair value of these investments and unobservable inputs. As a result, all of the Company’s Private Loan portfolio investments were categorized as Level 3 as of December 31, 2016 and December 31, 2015. As of December 31, 2016, the Company’s Other Portfolio investments consisted of illiquid securities issued by private companies. The fair value determination for these investments primarily consisted of unobservable inputs. As a result, all of the Company’s Other Portfolio equity investments were categorized as Level 3 as of December 31, 2016 and December 31, 2015. The fair value determination of the Level 3 securities required one or more of the following unobservable inputs: • Financial information obtained from each portfolio company, including unaudited statements of operations and balance sheets for the most recent period available as compared to budgeted numbers; • Current and projected financial condition of the portfolio company; • Current and projected ability of the portfolio company to service its debt obligations; • Type and amount of collateral, if any, underlying the investment; • Current financial ratios (e.g., fixed charge coverage ratio, interest coverage ratio, and net debt/EBITDA ratio) applicable to the investment; • Current liquidity of the investment and related financial ratios (e.g., current ratio and quick ratio); • Pending debt or capital restructuring of the portfolio company; • Projected operating results of the portfolio company; • Current information regarding any offers to purchase the investment; • Current ability of the portfolio company to raise any additional financing as needed; • Changes in the economic environment which may have a material impact on the operating results of the portfolio company; • Internal occurrences that may have an impact (both positive and negative) on the operating performance of the portfolio company; • Qualitative assessment of key management; • Contractual rights, obligations or restrictions associated with the investment; • Third party pricing for securities with limited observability of inputs determining the pricing; and • Other factors deemed relevant. The following table presents fair value measurements of the Company’s investments, by major class, as of December 31, 2016 according to the fair value hierarchy (dollars in thousands): The following table presents fair value measurements of the Company’s investments, by major class, as of December 31, 2015 according to the fair value hierarchy (dollars in thousands): The following table presents fair value measurements of the Company’s investments, by investment classification, segregated by the level within the fair value hierarchy as of December 31, 2016 (dollars in thousands): The following table presents fair value measurements of the Company’s investments, by investment classification, segregated by the level within the fair value hierarchy as of December 31, 2015 (dollars in thousands): The significant unobservable inputs used in the fair value measurement of the Company’s LMM equity securities and Private Loan equity securities, which are generally valued through an average of the discounted cash flow technique and the market comparable/enterprise value technique (unless one of these approaches is not applicable), are (i) EBITDA multiples and (ii) the weighted average cost of capital (“WACC”). Increases (decreases) in EBITDA multiple inputs in isolation would result in a significantly higher (lower) fair value measurement. Conversely, increases (decreases) in WACC inputs in isolation would result in a significantly lower (higher) fair value measurement. The significant unobservable inputs used in the fair value measurement of the Company’s LMM, Middle Market and Private Loan debt investments are (i) risk adjusted discount rates used in the Yield-to-Maturity valuation technique (described in Note 2 - Basis of Presentation and Summary of Significant Accounting Policies - Valuation of Portfolio Investments) and (ii) the percentage of expected principal recovery. Increases (decreases) in any of these discount rates in isolation would result in a significantly lower (higher) fair value measurement. Increases (decreases) in any of these expected principal recovery percentages in isolation would result in a significantly higher (lower) fair value measurement. However, due to the nature of certain investments, fair value measurements may be based on other criteria, such as third-party appraisals of collateral and fair values as determined by independent third parties, which are not presented in the table below. The following table, which is not intended to be all inclusive, presents the significant unobservable inputs of the Company’s Level 3 investments as of December 31, 2016 (dollars in thousands): (1) May include pro forma adjustments and/or other add-backs based on specific circumstances related to each investment. (2) Weighted average excludes investments for which the significant unobservable input was not utilized in the fair value determination. The following table, which is not intended to be all inclusive, presents the significant unobservable inputs of the Company’s Level 3 investments as of December 31, 2015 (dollars in thousands): (1) May include pro forma adjustments and/or other add-backs based on specific circumstances related to each investment. (2) Weighted average excludes investments for which the significant unobservable input was not utilized in the fair value determination. The following table provides a summary of changes in fair value of the Company’s Level 3 portfolio investments for the year ended December 31, 2016 (dollars in thousands): (1) Column includes changes to investments due to the net accretion of discounts/premiums and amortization of fees. (2) Column does not include unrealized appreciation (depreciation) on unfunded commitments. The following table provides a summary of changes in fair value of the Company’s Level 3 portfolio investments for the year ended December 31, 2015 (dollars in thousands): (1) Column includes changes to investments due to the net accretion of discounts/premiums and amortization of fees. Portfolio Investment Composition The composition of the Company’s investments as of December 31, 2016, at cost and fair value, was as follows (dollars in thousands): The composition of the Company’s investments as of December 31, 2015, at cost and fair value, was as follows (dollars in thousands): The composition of the Company’s investments by geographic region of the United States as of December 31, 2016, at cost and fair value, was as follows (dollars in thousands) (since the Other Portfolio investments do not represent a single geographic region, this information excludes Other Portfolio investments): The composition of the Company’s investments by geographic region of the United States as of December 31, 2015, at cost and fair value, was as follows (dollars in thousands) (since the Other Portfolio investments do not represent a single geographic region, this information excludes the Other Portfolio investments): The composition of the Company’s total investments by industry as of December 31, 2016 and December 31, 2015, at cost and fair value was as follows (since the Other Portfolio investments do not represent a single industry, this information excludes Other Portfolio investments): Note 4 - Unconsolidated Significant Subsidiaries In accordance with Rules 3-09 and 4-08(g) of Regulation S-X, the Company must determine which of its unconsolidated controlled portfolio companies, if any, are considered "significant subsidiaries." After performing this analysis, the Company determined that GRT Rubber Technologies, LLC (“GRT”) is a significant subsidiary for the year ended December 31, 2015, under at least one of the significance conditions of Rule 4-08(g) of Regulation S-X. The Company made its investment in GRT on December 19, 2014 and therefore amounts presented are for the period beginning on the date of investment through December 31, 2014. The Company had no “significant subsidiaries” under Rule 3-09 for the years ended December 31, 2016, 2015 and 2014, and under Rule 4-08(g) of Regulation S-X for the years ended December 31, 2016 and 2014. The following tables show the summarized financial information for GRT (dollars in thousands): (1) The Company made its investment in GRT on December 19, 2014 and therefore amounts presented are for the period beginning on the date of investment through December 31, 2014. Note 5 - Borrowings On March 11, 2014, the Company entered into a $70.0 million senior secured revolving credit facility (as amended from time to time, the “Capital One Credit Facility”) with Capital One, National Association (“Capital One”), as administrative agent, and other banks as participants (together with Capital One, the “Lenders”). The Capital One Credit Facility has subsequently been amended on multiple occasions, and as of December 31, 2016, the Capital One Credit Facility had revolver commitments of $125.0 million, with an accordion provision allowing borrowing capacity to increase up to $150.0 million. As of December 31, 2016, borrowings under the Capital One Credit Facility bore interest, subject to the Company’s election, on a per annum basis equal to (i) the adjusted London Interbank Offered Rate (“LIBOR”) rate plus 2.75% or (ii) the base rate plus 1.75%. The base rate is defined as the higher of (a) the prime rate or (b) the Federal Funds Rate (as defined in the credit agreement) plus 0.5%. The adjusted LIBOR rate is defined in the credit agreement for the Capital One Credit Facility as the one-month LIBOR rate plus such amount as adjusted for statutory reserve requirements for Eurocurrency liabilities. As of December 31, 2016, the one-month LIBOR rate was 0.8%. The Company pays an annual unused commitment fee of 0.25% on the unused revolver commitments if more than 50% of the revolver commitments are being used and an annual unused commitment fee of 0.375% on the unused revolver commitments if less than 50% of the revolver commitments are being used. As of December 31, 2016, the Capital One Credit Facility had a three-year term, maturing March 11, 2017, with two, one-year extension options, subject to approval of the Lenders. On March 6, 2017, the Capital One Credit Facility was amended and restated to, among other things, extend the maturity date to March 6, 2020, reduce revolver commitments to $95.0 million, and assign Capital One’s role as administrative agent to EverBank Commercial Finance, Inc. (“EverBank”). The Capital One Credit Facility, as amended on May 29, 2015, permits the creation of certain “Structured Subsidiaries,” which are not guarantors under the Capital One Credit Facility and which are permitted to incur debt outside of the Capital One Credit Facility. Borrowings under the Capital One Credit Facility are secured by all of the Company’s assets, other than the assets of Structured Subsidiaries, as well as all of the assets, and a pledge of equity ownership interests, of any future subsidiaries of the Company (other than Structured Subsidiaries). As of December 31, 2016, the credit agreement for the Capital One Credit Facility contains affirmative and negative covenants usual and customary for credit facilities of this nature, including: (i) maintaining a minimum interest coverage ratio of at least 2.0 to 1.0; (ii) maintaining an asset coverage ratio of at least 2.25 to 1.0; and (iii) maintaining a minimum consolidated tangible net worth, excluding Structured Subsidiaries, of at least $50.0 million. Further, the Capital One Credit Facility contains limitations on incurrence of other indebtedness (other than by the Structured Subsidiaries), limitations on industry concentration, and an anti-hoarding provision to protect the collateral under the Capital One Credit Facility. Additionally, the Company must provide information to Capital One on a regular basis, preserve its corporate existence, comply with applicable laws, including the 1940 Act, pay obligations when they become due, and invest the proceeds of the sales of common stock in accordance with its investment objectives and strategies (as set forth in the Capital One Credit Facility). Further, the credit agreement contains usual and customary default provisions including: (i) a default in the payment of interest and principal; (ii) insolvency or bankruptcy of the Company; (iii) a material adverse change in the Company’s business; or (iv) breach of any covenant, representation or warranty in the loan agreement or other credit documents and failure to cure such breach within defined periods. Additionally, the Capital One Credit Facility requires the Company to obtain written approval from the administrative agent prior to entering into any material amendment, waiver or other modification of any provision of the Investment Advisory Agreement. As of December 31, 2016, the Company was not aware of any instances of noncompliance with covenants related to the Capital One Credit Facility. On June 2, 2014, HMS Funding I LLC (“HMS Funding”), entered into a credit agreement (the “Deutsche Bank Credit Facility”) among HMS Funding, as borrower, the Company, as equityholder and as servicer, Deutsche Bank AG, New York Branch (“Deutsche Bank”), as administrative agent, the financial institutions party thereto as lenders (together with Deutsche Bank, the “HMS Funding Lenders”), and U.S. Bank National Association, as collateral agent and collateral custodian. The Deutsche Bank Credit Facility provided for an initial borrowing capacity of $50.0 million, subject to certain limitations, including limitations with respect to HMS Funding’s investments, as more fully described in the Deutsche Bank Credit Facility. The Deutsche Bank Credit Facility was amended and restated on May 18, 2015 and subsequently has been amended on multiple occasions, most recently on February 9, 2016, increasing the revolver commitments to $385.0 million. The Company contributes certain assets to HMS Funding from time to time, as permitted under the Capital One Credit Facility, as collateral to secure the Deutsche Bank Credit Facility. Under the Deutsche Bank Credit Facility, interest is calculated as the sum of the index plus the applicable margin of 2.50%. If the Deutsche Bank Credit Facility is funded via an asset backed commercial paper conduit, the index will be the related commercial paper rate; otherwise, the index will be equal to one-month LIBOR. As of December 31, 2016, the one-month LIBOR rate was 0.8%. The Deutsche Bank Credit Facility provides for a revolving period until December 16, 2017, unless otherwise extended with the consent of the HMS Funding Lenders. The amortization period begins the day after the last day of the revolving period and ends on June 16, 2020, the maturity date. During the amortization period, the applicable margin will increase by 0.25%. During the revolving period, HMS Funding will pay a utilization fee equal to 2.50% of the undrawn amount of the required utilization, which is 75% of the loan commitment amount. HMS Funding will incur an undrawn fee equal to 0.40% per annum of the difference between the aggregate commitments and the outstanding advances under the facility, provided that the undrawn fee relating to any utilization shortfall will not be payable to the extent that the utilization fee relating to such utilization shortfall is incurred. Additionally, per the terms of a fee letter executed on May 18, 2015, HMS Funding pays Deutsche Bank an administrative agent fee of 0.25% of the aggregate revolver commitments. HMS Funding’s obligations under the Deutsche Bank Credit Facility are secured by a first priority security interest in its assets, including all of the present and future property and assets of HMS Funding. The Deutsche Bank Credit Facility contains affirmative and negative covenants usual and customary for credit facilities of this nature, including maintaining a positive tangible net worth, limitations on industry concentration and complying with all applicable laws. The Deutsche Bank Credit Facility contains usual and customary default provisions including: (i) a default in the payment of interest and principal; (ii) insolvency or bankruptcy of the Company; (iii) the occurrence of a change of control; or (iv) any uncured breach of a covenant, representation or warranty in the Deutsche Bank Credit Facility. As of December 31, 2016, the Company was not aware of any instances of noncompliance with covenants related to the Deutsche Bank Credit Facility. As of December 31, 2016, the Company had borrowings of $80.0 million outstanding on the Capital One Credit Facility, and had borrowings of $333.0 million outstanding on the Deutsche Bank Credit Facility, both of which the Company estimated approximated fair value. Note 6 - Financial Highlights The following is a schedule of financial highlights of the Company for the years ended December 31, 2016, 2015, 2014, 2013 and 2012. (1) Based on weighted average number of shares of common stock outstanding for the period. (2) Change in net realized income and net unrealized appreciation (depreciation) from investments can change significantly from period to period. (3) The stockholder distributions represent the stockholder distributions declared for the period. (4) The continuous issuance of shares of common stock may cause an incremental increase in NAV per share due to the sale of shares at the then prevailing public offering price in excess of NAV per share on each subscription closing date. The per share data was derived by computing (i) the sum of (A) the number of shares issued in connection with subscriptions and/or distribution reinvestment on each share transaction date times (B) the differences between the net proceeds per share and the NAV per share on each share transaction date, divided by (ii) the weighted average shares of common stock outstanding for the period. (5) Includes the impact of the different share amounts as a result of calculating certain per share data based on the weighted average basic shares outstanding during the period and certain per share data based on the shares outstanding as of a period end or transaction date. (1) For the years ended December 31, 2016 and December 31, 2015, the Adviser did not waive base management fees but waived subordinated incentive fees of approximately $1.7 million and $2.6 million, respectively, and administrative services expenses of approximately $2.3 million and $2.0 million, respectively. The ratio is calculated by reducing the expenses to reflect the waiver of expenses and reimbursement of administrative services and to reflect the reduction of expenses for expense support provided by the Adviser in both periods presented. Excluding interest expense, the ratio of total expenses to average net assets for the years ended December 31, 2016, 2015, 2014, 2013 and 2012 was 4.25%, 4.44%, 3.29%, 2.55% and 4.03%, respectively. See Note 10 - Related Party Transactions and Arrangements for further discussion of fee waivers and expense support provided by the Advisers. (2) Ratio is calculated excluding amortization of offering costs from total expenses. (3) Total return is calculated on the change in NAV per share and stockholder distributions declared per share over the reporting period. Note 7 - Stockholder Distributions The following table reflects the cash distributions per share that the Company declared on its common stock during the years ended December 31, 2016, 2015 and 2014 (dollars in thousands except per share amounts). On December 21, 2016, with the authorization of the Company’s board of directors, the Company declared distributions to its stockholders for the period of January 2017 through March 2017. These distributions have been, or will be, calculated based on stockholders of record each day from January 1, 2017 through March 31, 2017 in an amount equal to $0.00191781 per share, per day. Distributions are paid on the first business day following the completion of each month to which they relate. The Company has adopted an “opt in” distribution reinvestment plan for its stockholders. As a result, if the Company makes a distribution, its stockholders will receive distributions in cash unless they specifically “opt in” to the distribution reinvestment plan so as to have their cash distributions reinvested in additional shares of the Company’s common stock. The following table reflects the sources of the cash distributions that the Company declared and, in some instances, paid on its common stock during the years ended December 31, 2016, 2015 and 2014. (1) Includes adjustments made to GAAP basis net investment income to arrive at taxable income available for distributions. See Note 8 for the sources of the Company’s cash distributions on a tax basis. The Company may fund its cash distributions from all sources of funds legally available, including stock offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, dividends or other distributions paid to us on account of preferred and common equity investments in portfolio companies, and fee and expense waivers from its Advisers. The Company has not established limits on the amount of funds that the Company may use from legally available sources to make distributions. The Company expects that for the foreseeable future, a portion of the distributions may be paid from sources other than net realized income from operations, which may include stock offering proceeds, borrowings, and fee and expense waivers from its Advisers. See Note 10 - Related Party Transactions and Arrangements - Advisory Agreements and Conditional Fee Waiver. The Company’s distributions may exceed its earnings and, as a result, a portion of the distributions it makes may represent a return of capital for U.S. federal income tax purposes. The timing and amount of any future distributions to stockholders are subject to applicable legal restrictions and the sole discretion of the Company’s board of directors. Note 8 - Taxable Income The Company has elected to be treated for U.S. federal income tax purposes as a RIC. As a RIC, the Company generally will not incur corporate-level U.S. federal income taxes on net ordinary income or capital gains that the Company timely distributes each taxable year as dividends to its stockholders. To qualify as a RIC in any taxable year, the Company must, among other things, satisfy certain source-of-income and asset diversification requirements. In addition, the Company must satisfy the Annual Distribution Requirement. As a part of maintaining its RIC status, undistributed taxable income (subject to a 4% excise tax) pertaining to a given taxable year may be distributed up to 12 months subsequent to the end of that taxable year, provided such distributions are declared prior to the earlier of eight-and-one-half months after the close of that taxable year or the filing of the federal income tax return for such prior taxable year. In order to avoid the imposition of the 4% excise tax, the Company needs to satisfy the Excise Tax Avoidance Requirement. For the taxable year ended December 31, 2014, no portion of the undistributed taxable income was subject to this 4% nondeductible U.S. federal excise tax. For the taxable year ended December 31, 2015, the Company distributed $3.8 million, or $0.0615 per share, of its taxable income in 2016, prior to the filing of its federal income tax return for the 2015 taxable year. As a result, the Company incurred a $119,000 excise tax for the 2015 taxable year. In 2016, the Company distributed $7.3 million, or $0.099478 per share, of our taxable income in 2017, prior to the filing of our federal income tax return for our 2016 taxable year. As a result, we were subject to a 4% nondeductible federal excise tax liability of approximately $246,000. The Company accounts for income taxes in conformity with ASC Topic 740 - Income Taxes, which provides guidelines for how uncertain tax positions should be recognized, measured, presented and disclosed in financial statements. ASC Topic 740 requires the evaluation of tax positions taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority. Tax benefits of positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax expense in the current year. It is the Company’s policy to recognize accrued interest and penalties related to uncertain tax benefits, if any, in income tax expense. There were no material uncertain income tax positions through December 31, 2016. The 2013 through 2015 tax years remain subject to examination by U.S. federal and most state tax authorities. The Company has formed wholly owned subsidiaries, HMS Equity Holding and HMS Equity Holding II, which have elected to be taxable entities. HMS Equity Holding and HMS Equity Holding II primarily hold equity investments in portfolio companies which are treated as “pass through” entities for tax purposes. HMS Equity Holding and HMS Equity Holding II are consolidated for financial reporting purposes, and the portfolio investments held by each entity are included in the consolidated financial statements as portfolio investments recorded at fair value. HMS Equity Holding and HMS Equity Holding II are not consolidated with the Company for income tax purposes and may generate income tax expense, or benefit, and the related tax assets and liabilities, as a result of its ownership of certain portfolio investments. This income tax expense, or benefit, if any, and the related tax assets and liabilities, are reflected in the Company’s consolidated financial statements. Listed below is a reconciliation of “Net increase (decrease) in net assets resulting from operations” to taxable income and to total distributions declared to common stockholders for the years ended December 31, 2016, 2015 and 2014 (dollars in thousands). (1) The Company’s taxable income for each period is an estimate and will not be finally determined until the Company files its tax return for each year. Therefore, the final taxable income, and the taxable income earned in each period and carried forward for distribution in the following period, may be different than this estimate. The income tax expense, or benefit, and the related tax assets and liabilities generated by HMS Equity Holding and HMS Equity Holding II, if any, are reflected in the Company’s Consolidated Statement of Operations. For the years ended December 31, 2016, 2015 and 2014, the Company recognized a net income tax (benefit) provision of $336,000, $127,000 and $(3,000), respectively, which was comprised of (i) deferred taxes of $(5.1) million, $(4.4) million and $0, respectively, offset by a valuation allowance of $5.1 million, $4.4 million and $0, respectively, and (ii) other taxes of $336,000, $127,000 and $(3,000), respectively. For the years ended December 31, 2016, 2015 and 2014, the other taxes included $256,000, $108,000 and $1,000, respectively, related to an accrual for excise tax on the Company’s estimated spillover taxable income and $80,000, $19,000 and $(4,000), respectively, related to accruals for state and other taxes. As of December 31, 2016, the cost of investments for federal income tax purposes was $1.0 billion, with such investments having a gross unrealized appreciation of $20.3 million and gross unrealized depreciation of $33.5 million. The net deferred tax asset at both December 31, 2016 and December 31, 2015 was $0, of which $7.9 million and $4.8 million, respectively, related to current year net loss on portfolio investments and unrealized appreciation/depreciation held by HMS Equity Holding and HMS Equity Holding II, and $1.8 million and $187,000, respectively, related to net operating loss carryforwards from historical realized losses on portfolio investments held by HMS Equity Holding and HMS Equity Holding II, and $878,000 and $0, respectively, related to net capital loss carryforward from historical realized losses on portfolio investments held by HMS Equity Holding offset by $(1.1) million and $(599,000), respectively, related to basis differences of portfolio investments held by HMS Equity Holding and HMS Equity Holding II which are “pass through” entities for tax purposes, and $(9.5) million and $(4.4) million, respectively, related to a valuation allowance. Based on HMS Equity Holding’s and HMS Equity Holding II’s short operating history, management believes it is more likely than not that there will be inadequate profits in HMS Equity Holding and HMS Equity Holding II against which the deferred tax assets can be offset. Accordingly, the Company recorded a Valuation Allowance against such deferred tax asset. The following table sets forth the significant components of net deferred tax assets and liabilities as of December 31, 2016, 2015 and 2014 (amounts in thousands): For federal income tax purposes, the net operating loss carryforwards expire in various taxable years from 2034 through 2035 and the net capital loss carryforwards expire in taxable years 2020 and 2021. The timing and manner in which HMS Equity Holding will utilize any net loss carryforwards in such taxable years, or in total, may be limited in the future under the provisions of the Code. The determination of the tax attributes of the Company’s distributions is made annually at the end of the Company’s taxable year based upon the Company’s taxable income for the full taxable year and distributions paid for the full taxable year. The actual tax characteristics of distributions to stockholders will be reported to stockholders subject to information reporting shortly after the close of each calendar year on Form 1099-DIV. For the years ended December 31, 2016, 2015 and 2014, respectively, the tax characteristics of distributions paid to shareholders were as follows. No portion of the distributions paid during the years ended December 31, 2016, 2015 and 2014 represented a return of capital. Dividends from net investment income and distributions from net realized capital gains are determined in accordance with U.S. federal tax regulations, which may differ from amounts determined in accordance with GAAP and those differences could be material. These book-to-tax differences are either temporary or permanent in nature. Reclassifications due to permanent book-tax differences, such as the nondeductible excise tax, have no impact on net assets. Note 9 - Supplemental Cash Flow Disclosures Listed below are the supplemental cash flow disclosures for the years ended December 31, 2016, 2015 and 2014 (dollars in thousands): Note 10 - Related Party Transactions and Arrangements Advisory Agreements and Conditional Fee Waiver As described in Note 1 - Principal Business and Organization, the business of the Company is managed by the Adviser (an affiliate of Hines), pursuant to the Investment Advisory Agreement. This agreement states that the Adviser will oversee the management of the Company’s activities and is responsible for making investment decisions with respect to, and providing day-to-day management and administration of, the Company’s investment portfolio. Additionally, the Company and the Adviser have engaged the Sub-Adviser pursuant to the Sub-Advisory Agreement to identify, evaluate, negotiate and structure the Company’s prospective investments, make investment and portfolio management recommendations for approval by the Adviser, monitor the Company’s investment portfolio and provide certain ongoing administrative services to the Adviser in exchange for which the Adviser will pay the Sub-Adviser fifty percent (50%) of the base management fee and incentive fees described below as compensation for its services. Pursuant to the Investment Advisory Agreement, the Company pays the Adviser a base management fee and incentive fees as compensation for the services described above. The base management fee is calculated at an annual rate of 2% of the Company’s average gross assets. The term “gross assets” means total assets of the Company as disclosed on the Company’s balance sheet. “Average gross assets” are calculated based on the Company’s gross assets at the end of the two most recently completed calendar quarters. The base management fee is payable quarterly in arrears. The base management fee is expensed as incurred. The incentive fees consist of two parts. The first part, referred to as the subordinated incentive fee on income, is calculated and payable quarterly in arrears based on pre-incentive fee net investment income for the immediately preceding quarter. The subordinated incentive fee on income is equal to 20% of the Company’s pre-incentive fee net investment income for the immediately preceding quarter, expressed as a quarterly rate of return on adjusted capital at the beginning of the most recently completed calendar quarter, exceeding 1.875% (or 7.5% annualized), subject to a “catch up” feature (as described below). For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees such as commitment, origination, structuring, diligence and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the management fee, expenses payable under any proposed administration agreement and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount debt instruments and PIK interest and zero coupon securities), accrued income that we have not yet received in cash. Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. For purposes of this fee, adjusted capital means cumulative gross proceeds generated from sales of the Company’s common stock (including proceeds from the Company’s distribution reinvestment plan) reduced for non-liquidating distributions, other than distributions of profits, paid to the Company’s stockholders and amounts paid for share repurchases pursuant to the Company’s share repurchase program. The subordinated incentive fee on income is expensed in the quarter in which it is incurred. The second part of the incentive fee, referred to as the incentive fee on capital gains, is an incentive fee on realized capital gains earned from the portfolio of the Company and is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement). This fee equals 20.0% of the Company’s incentive fee capital gains, which equals the Company’s realized capital gains on a cumulative basis from inception, calculated as of the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees. At the end of each reporting period, the Company estimates the incentive fee on capital gains and accrues the fee based on a hypothetical liquidation of its portfolio. Therefore the accrual includes both net realized gains and net unrealized gains (the net unrealized difference between the fair value and the par value of its portfolio), if any. The incentive fee accrued pertaining to the unrealized gain is neither earned nor payable to the Advisers until such time it is realized. The Company and the Adviser have entered into two expense support and conditional reimbursement agreements (as amended from time to time, the “2013 and 2014 Expense Reimbursement Agreements”), pursuant to which the Adviser could pay the Company up to 100% of its operating expenses through December 31, 2014 (the “Expense Support Payment”) in order to achieve a reasonable level of expenses relative to its investment income (the “Operating Expense Objective”). The Company’s board of directors, in it sole discretion, may approve the repayment of unreimbursed Expense Support Payments upon a determination by the board of directors that the Company has achieved the Operating Expense Objective in any quarter following receipt by the Company of an Expense Support Payment. The Company may reimburse any unreimbursed Expense Support Payments for up to three years from the date each respective Expense Support Payment was determined. Any Expense Support Payments that remain unreimbursed three years after such payment will be permanently waived. The Company and the Advisers entered into a conditional fee waiver agreement (as amended from time to time, the “Conditional Fee Waiver Agreement”), pursuant to which the Advisers could waive certain fees through December 31, 2015 upon the occurrence of any event that, in the Advisers’ sole discretion, causes such waivers to be deemed necessary. The previously waived fees are potentially subject to repayment by the Company, if at all, within a period not to exceed three years from the date of each respective fee waiver. The Company and the Advisers entered into three conditional income incentive fee waiver agreements (the “2016 Conditional Income Incentive Fee Waiver Agreements”) on May 9, 2016, October 7, 2016 and December 13, 2016, respectively, pursuant to which, for a period from January 1, 2016 to December 31, 2016, the Advisers could waive the “subordinated incentive fee on income,” as such term is defined in the Investment Advisory Agreement, upon the occurrence of any event that, in the Advisers’ sole discretion, causes such waiver to be deemed necessary. The 2016 Conditional Income Incentive Fee Waiver Agreements may require the Company to repay the Advisers for previously waived reimbursement of Expense Support Payments or waived base management fees or incentive fees under certain circumstances. The previously waived fees are potentially subject to repayment by the Company, if at all, within a period not to exceed three years from the date of each respective fee waiver. Thus, in any quarter where a surplus exists, that surplus will be available, subject to approval of the board of directors, to reimburse waived fees and Expense Support Payments as follows: 1. First, to reimburse Expense Support Payments, beginning with the earliest year eligible for reimbursement; and 2. Second, to reimburse all waived fees, beginning with the earliest year eligible for reimbursement. Reimbursement of previously waived fees will only be permitted with the approval of the board of directors and if the operating expense ratio is equal to or less than the operating expense ratio at the time the corresponding fees were waived and if the annualized rate of regular cash distributions to stockholders is equal to or greater than the annualized rate of the regular cash distributions at the time the corresponding fees were waived. For the years ended December 31, 2016, 2015, and 2014, the Company incurred base management fees of approximately $19.2 million, $15.5 million and $5.6 million, respectively. The Advisers did not waive base management fees in the years ended December 31, 2016 and 2015 and waived $1.8 million of base management fees in the year ended December 31, 2014. Accordingly, net of fee waivers, the Company paid base management fees of $19.2 million for the year ended December 31, 2016, $15.5 million for the year ended December 31, 2015 and $3.8 million for the year ended December 31, 2014. For the years ended December 31, 2016, 2015 and 2014, the Company incurred no capital gains incentive fees, and incurred subordinated incentive fees on income of $1.7 million, $2.6 million and $451,000, respectively. For the years ended December 31, 2016, 2015 and 2014, the Advisers waived subordinated incentive fees on income of $1.7 million, $2.6 million and $451,000, respectively. During the years ended December 31, 2016, 2015 and 2014, the Company did not record an accrual for any previously waived fees. Any reimbursement of previously waived fees to the Advisers will not be accrued until the reimbursement of the waived fees become probable and estimable, which will be upon approval of the Company’s board of directors. To date, none of the previously waived fees has been approved by the board of directors for reimbursement. The table below presents the fees waived by the Advisers and the timing of potential reimbursement of waived fees (dollars in thousands). Previously waived fees will only be reimbursed with the approval of the Company’s board of directors and if the “Operating Expense Ratio” (as described in footnote 3 to the table below) is equal to or less than the Company’s operating expense ratio at the time the corresponding fees were waived and if the annualized rate of the Company’s regular cash distributions to stockholders is equal to or greater than the annualized rate of the Company’s regular cash distributions at the time the corresponding fees were waived. (1) Fees waived pursuant to the Conditional Fee Waiver Agreement and the 2016 Conditional Income Incentive Fee Waiver Agreements and Expense Support Payments pursuant to the 2013 and 2014 Expense Reimbursement Agreements. (2) Subject to the approval of the Company’s board of directors, in future periods, previously waived fees may be paid to the Advisers, if the Company’s cumulative net increase in net assets resulting from operations exceeds the amount of cumulative distributions paid to stockholders. The previously waived fees are potentially subject to repayment by the Company, if at all, within a period not to exceed three years from the date of each respective fee waiver. To date, none of the previously waived fees and Expense Support Payments have been approved for reimbursement by the Company’s board of directors. (3) The “Operating Expense Ratio” is calculated on a quarterly basis as a percentage of average net assets and includes all expenses borne by the Company, except for base management and incentive fees and administrative expenses waived by the Advisers and organizational and offering expenses. For the quarter ended December 31, 2013, expenses have been reduced by $153,000, the amount of the Expense Support Payment received in 2013 from the Adviser. For the quarter ended September 30, 2014, expenses have been reduced by $328,000, which Expense Support Payment was received from the Adviser on October 30, 2014. (4) “Annualized Distribution Rate” equals $0.00191781 per share, per day. “Annualized Distribution Rate” does not include the special stock dividend paid to stockholders on September 14, 2012 and was based on the Company’s offering price per share as of the final day of the quarter. Administration Pursuant to the Investment Advisory Agreement and Sub-Advisory Agreement, the Company is required to pay or reimburse the Advisers for administrative services expenses, which include all costs and expenses related to the Company’s day-to-day administration and management not related to advisory services. The Advisers do not earn any profit under their provision of administrative services to the Company. For the years ended December 31, 2016, 2015 and 2014, the Company incurred, and the Advisers waived the reimbursement of, administrative services expenses of approximately $2.3 million, $2.0 million and $1.5 million, respectively. On May 9, 2016 and October 7, 2016, the Company and the Advisers agreed to amendments to the 2014 Expense Reimbursement Agreement, which collectively extended the period for waiver of reimbursement of administrative services expenses accrued pursuant to the Investment Advisory Agreement and the Sub-Advisory Agreement from January 1, 2016 through December 31, 2016. The waiver of the reimbursement of administrative services expenses is not subject to future reimbursement. The table below presents the administrative services expenses waived by the Advisers (dollars in thousands). (1) The “Operating Expense Ratio” is calculated on a quarterly basis as a percentage of average net assets and includes all expenses borne by the Company, except for base management and incentive fees and administrative expenses waived by the Advisers and organizational and offering expenses. For the quarter ended December 31, 2013, expenses have been reduced by $153,000, the amount of the Expense Support Payment received in 2013 from the Adviser. For the quarter ended September 30, 2014, expenses have been reduced by $328,000, which Expense Support Payment was received from the Adviser on October 30, 2014. (2) “Annualized Distribution Rate” equals $0.00191781 per share, per day. “Annualized Distribution Rate” does not include the special stock dividend paid to stockholders on September 14, 2012 and was based on the Company’s offering price per share as of the last day of the quarter. (3) The Advisers have agreed to permanently waive reimbursement by the Company of administrative expenses through December 31, 2016. The administrative expenses are waived on a quarterly basis and are not eligible for future reimbursement from the Company to the Advisers. As of December 31, 2016 and 2015, the Advisers have incurred approximately $12.0 million and $10.1 million, respectively, of offering costs on the Company’s behalf. As of December 31, 2016 and 2015, approximately $10.6 million and $9.0 million, respectively, of offering costs have been reimbursed to the Advisers. The Company expects to reimburse the Advisers for the balance of such costs incurred on its behalf on a monthly basis up to a maximum aggregate amount of 1.5% of the gross stock offering proceeds. The table below outlines fees incurred and expense reimbursements payable to Hines, Main Street and their affiliates for the years ended December 31, 2016, 2015 and 2014 and amounts unpaid as of December 31, 2016 and 2015 (dollars in thousands). (1) Net of amounts waived by the Advisers. (2) Includes amounts the Adviser paid on behalf of the Company such as general and administrative services expenses. Note 11 - Share Repurchase Plan The Company conducts quarterly tender offers pursuant to its share repurchase program. Under the terms of the plan, the Company will offer to purchase shares at the estimated NAV per share, as determined within 48 hours prior to the repurchase date. The Company currently limits the number of shares to be repurchased (i) during any calendar year to the proceeds it receives from the issuance of shares of its common stock under its distribution reinvestment plan during the trailing four quarters and (ii) in any calendar quarter to 2.5% of the weighted average number of shares of common stock outstanding during the trailing four quarters. At the discretion of the Company’s board of directors, the Company may also use cash on hand, cash available from borrowings and cash from the sale of investments as of the end of the applicable period to repurchase shares. The Company’s board of directors may amend, suspend or terminate the share repurchase program upon 30 days’ notice. The Company’s first repurchase date was October 1, 2013. Since inception of our share repurchase program, the Company funded the repurchase of $14.0 million in shares. For the years ended December 31, 2016 and 2015, the Company funded approximately $10.9 million and $3.0 million, respectively, for shares tendered for repurchase under the plan approved by the board of directors. Since inception of the share repurchase program, the Company has funded all redemption requests validly tendered and not withdrawn. Repurchases of our common stock pursuant to our tender offer are as follows: Note 12 - Commitments and Contingencies At December 31, 2016, the Company had a total of approximately $42.7 million in outstanding commitments comprised of (i) 22 commitments to fund revolving loans that had not been fully drawn or term loans that had not been funded and (ii) three capital commitments that had not been fully called. The Company recognized unrealized depreciation of $266,000 on the outstanding unfunded loan commitments and unrealized appreciation of $14,000 on the outstanding unfunded capital commitments during the year ended December 31, 2016. At December 31, 2015, the Company had a total of approximately $34.1 million in outstanding commitments comprised of (i) 14 commitments to fund revolving loans that had not been fully drawn or term loans that had not been funded and (ii) three capital commitment that had not been fully called. The Company recognized unrealized depreciation of $79,000 on the outstanding unfunded loan commitments and unrealized depreciation of $14,000 on the outstanding unfunded capital commitments during the year ended December 31, 2015. Note 13 - Subsequent Events From January 1, 2017 through March 3, 2017, the Company has raised approximately $19.5 million in the Offering including proceeds from the distribution reinvestment plan of approximately $6.6 million. During this period, the Company funded approximately $34.2 million in investments and received proceeds from repayments and dispositions of approximately $94.4 million. On January 12, 2017 and January 18, 2017, the Company increased its public offering price per share to $9.15 and $9.30, respectively, which was effective as of the Company’s weekly close on January 12, 2017 and January 19, 2017, respectively. On February 3, 2017, the Company filed a tender offer statement on Schedule TO with the SEC, to commence an offer by the Company to purchase, as approved by the Company’s board of directors, 1,700,749.42 shares of the Company’s issued and outstanding common stock, par value $0.001 per share. The offer is for cash at a purchase price equal to the NAV per share to be determined within 48 hours of the repurchase date. On February 22, 2017, the Company’s board of directors, after determining that it would be in the best interests of the Company and its stockholders to do so, decided to continue the Offering until September 30, 2017 and authorized the closing of the Offering to new investors (the “Closing”) to occur on or about such date. The Company’s board of directors previously authorized the Closing to occur on or about March 31, 2017, subject to the board of directors’ final approval. The board of directors retained its right to provide final approval on the specific terms of the Closing, including its right to accelerate the Closing or to further continue the Company’s Offering if the board of directors determines that it is in the best interests of the Company and its stockholders to do so. On March 6, 2017, the Company, together with HMS Equity Holding, HMS Equity Holding II, EverBank and certain financial institutions as lenders, amended and restated the Capital One Credit Facility to, among other things, (i) extend the maturity date to March 6, 2020, (ii) reduce revolver commitments to $95.0 million and (iii) assign Capital One’s role as administrative agent to EverBank. This description of the amended and restated credit facility does not purport to be complete and is qualified in its entirety by reference to the amended and restated credit facility, filed as Exhibit 10.40 to this Annual Report on Form 10-K and incorporated herein by reference. Note 14 - Quarterly Financial Data (UNAUDITED) The following table presents selected unaudited quarterly financial data for each quarter during the years ended December 31, 2016, 2015 and 2014 (dollars in thousands except per share amounts): Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders HMS Income Fund, Inc. We have audited in accordance with the standards of the Public Company Accounting Oversight Board (United States) the consolidated financial statements of HMS Income Fund, Inc. (a Maryland corporation) and subsidiaries (the ‘‘Company’’) referred to in our report dated March 7, 2017, which is included in the annual report on Form 10-K. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15(b), which is the responsibility of the Company’s management. In our opinion, this financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ GRANT THORNTON LLP Houston, Texas March 7, 2017 Schedule 12-14 HMS Income Fund, Inc. Consolidated Schedule of Investments in and Advances to Affiliates Year Ended December 31, 2016 (dollars in thousands) This schedule should be read in conjunction with the Company’s Consolidated Financial Statements, including the Consolidated Schedule of Investments and Notes to the Consolidated Financial Statements. (1) The principal amount, the ownership detail for equity investments and if the investment is income producing is shown in the Consolidated Schedule of Investments. (2) Represents the total amount of interest, fees or dividends credited to income for the portion of the year an investment was included in Control or Affiliate categories, respectively. For investments transferred between Control and Affiliate categories during the year, any income related to the time period it was in the category other than the one shown at year end is included in “Income from investments transferred from Control during the year” or “Income from investments transferred from Affiliate during the year”. (3) Gross additions include increases in the cost basis of investments resulting from new portfolio investment, follow on investments and accrued PIK interest, and the exchange of one or more existing securities for one or more new securities. Gross Additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation as well as the movement of an existing portfolio company into this category and out of a different category. (4) Gross reductions include decreases in the cost basis of investments resulting from principal repayments or sales and the exchange of one or more existing securities for one or more new securities. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category. | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement excerpt. It contains partial sentences and seems to be missing critical context and complete financial details. Without the full document, I cannot provide a meaningful summary.
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FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA Index to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm The Board of Directors of Tri-State Generation and Transmission Association, Inc. We have audited the accompanying consolidated statements of financial position of Tri-State Generation and Transmission Association, Inc. (“the Association”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Association’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Association’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Association’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tri-State Generation and Transmission Association, Inc. at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. /s/ Ernst & Young LLP Denver, Colorado March 10, 2017 Tri-State Generation and Transmission Association, Inc. Consolidated Statements of Financial Position (dollars in thousands) The accompanying notes are an integral part of these consolidated financial statements. Tri-State Generation and Transmission Association, Inc. Consolidated Statements of Operations (dollars in thousands) The accompanying notes are an integral part of these consolidated financial statements. Tri-State Generation and Transmission Association, Inc. Consolidated Statements of Comprehensive Income (dollars in thousands) The accompanying notes are an integral part of these consolidated financial statements. Tri-State Generation and Transmission Association, Inc. Consolidated Statements of Equity (dollars in thousands) The accompanying notes are an integral part of these consolidated financial statements. Tri-State Generation and Transmission Association, Inc. Consolidated Statements of Cash Flows (dollars in thousands) The accompanying notes are an integral part of these consolidated financial statements. Tri-State Generation and Transmission Association, Inc. NOTE 1 - ORGANIZATION Tri-State Generation and Transmission Association, Inc. (“the Association”) is a taxable wholesale electric power generation and transmission cooperative organized for the purpose of providing electricity to our member distribution systems (“Members”), that serve large portions of Colorado, Nebraska, New Mexico and Wyoming. We also sell a portion of our electric power to other utilities in our regions pursuant to long-term contracts and short-term sale arrangements. In 2016, 2015 and 2014, total megawatt-hours sold were 18.4, 17.8 and 18.7 million, respectively, of which 86, 89 and 85 percent, respectively, were sold to Members. Total revenue from electric sales was $1.3, $1.2, and $1.3 billion for 2016, 2015 and 2014, of which 90 percent in 2016 and 2015 and 85 percent in 2014 was from Member sales. Energy resources were provided by our generation and purchased power, of which 59 percent in 2016 and 63 percent in 2015 and 2014 were from our generation. We have entered into substantially similar contracts with each Member extending through 2050 for 42 Members (which constitute approximately 96 percent of our revenue from Member sales for 2016) and extending through 2040 for the remaining Member (Delta-Montrose Electric Association). These contracts are subject to automatic extension thereafter until either party provides at least a two years’ notice of its intent to terminate. Each contract obligates us to sell and deliver to the Member and obligates the Member to purchase and receive at least 95 percent of its electric power requirements from us. Each Member may elect to provide up to 5 percent of its requirements from distributed or renewable generation owned or controlled by the Member. As of December 31, 2016, 18 Members have enrolled in this program with capacity totaling approximately 113 megawatts. Revenue from one Member, United Power, Inc., was $159.4 million, or 14.0 percent, of our Member revenue and 11.8 percent of our operating revenues in 2016. No other Member exceeded 10 percent of our Member revenue or our operating revenues in 2016. Power is provided to Members at rates determined by the Board of Directors (“Board”). Rates are designed to recover all costs and provide margins to increase Members’ equity and to meet certain financial covenants, including a debt service ratio (“DSR”) requirement and equity to capitalization ratio (“ECR”) requirement. We supply wholesale power to our Members through the utilization of a portfolio of resources, including generating and transmission facilities, long-term purchase contracts and short-term energy purchases. Our generating facilities also include undivided ownership interests in jointly owned generating facilities. See Note 3-Property, Plant and Equipment. In support of our coal generating facilities, we have direct ownership and investment in coal mines. We, including our subsidiaries, employ 1,585 people, of which 335 are subject to collective bargaining agreements. None of these agreements expire within one year. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF CONSOLIDATION: Our consolidated financial statements include the accounts of the Association, our wholly-owned and majority-owned subsidiaries, and certain variable interest entities for which we or our subsidiaries are the primary beneficiaries. See Note 12-Variable Interest Entities. Our consolidated financial statements also include our undivided interests in jointly owned facilities. All significant intercompany balances and transactions have been eliminated in consolidation. The accompanying consolidated statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) as applied to regulated enterprises. JOINTLY OWNED FACILITIES: We own undivided interests in three jointly owned generation facilities that are operated by the operating agent of each facility under joint facility ownership agreements with other utilities as tenants in common. These projects include the Yampa Project (operated by us), the Missouri Basin Power Project (“MBPP”) (operated by Basin Electric Power Cooperative (“Basin”)) and the San Juan Project (operated by Public Service Company of New Mexico). Each participant in these agreements receives a portion of the total output of the generation facilities, which approximates its percentage ownership. Each participant provides its own financing for its share of each facility and accounts for its share of the cost of each facility. The operating agent for each of these projects allocates the fuel and operating expenses to each participant based upon its share of the use of the facility. Therefore, our share of the plant asset cost, interest, depreciation and operating expenses is included in our consolidated financial statements. See Note 3 - Property, Plant and Equipment. SEGMENT REPORTING: We are organized for the purpose of supplying wholesale power to our Members and do so through the utilization of a portfolio of resources, including generating and transmission facilities, long-term purchase contracts and short-term energy purchases. In support of our coal generating resources, we have direct ownership and investments in coal mines. Our Board serves as our chief operating decision maker who manages and reviews our operating results and allocates resources as one operating segment. Therefore, we have one reportable segment for financial reporting purposes. BUSINESS COMBINATIONS: We account for business acquisitions by applying the accounting standard related to business combinations. In accordance with this method, the identifiable assets acquired, the liabilities assumed and any noncontrolling interests in the acquired entities are required to be recognized at their acquisition date fair values. We typically engage an independent valuation firm to determine the acquisition date fair values of most of the acquired assets and assumed liabilities. The excess of total consideration transferred over the net assets acquired is recognized as goodwill. Acquisition-related costs such as legal fees, accounting services fees and valuation fees, are expensed as incurred. We are required to consolidate these acquired entities. If an acquisition does not result in acquiring a business, the transaction is accounted for as an acquisition of assets. This method requires measurement and recognition of the acquired net assets based upon the amount of cash transferred and the amount paid for acquisition-related costs. There is no goodwill recognized in an acquisition of assets. USE OF ESTIMATES: The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. IMPAIRMENT EVALUATION: Long-lived assets (property, plant and equipment, intangible assets and investments) that are held and used are evaluated for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. An impairment loss is recognized when estimated undiscounted cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset (if any) are less than the carrying value of the asset. When an impairment loss is recognized, the carrying amount of the asset is reduced to its estimated fair value based on quoted market prices or other valuation techniques. There were no impairments of long-lived assets recognized for 2016, 2015 and 2014, respectively. VARIABLE INTEREST ENTITIES: We evaluate our arrangements and relationships with other entities, including our investments in other associations and investments in coal mines, in accordance with the accounting standard related to consolidation of variable interest entities. This guidance requires us to identify variable interests (contractual, ownership or other financial interests) in other entities and whether any of those entities in which we have a variable interest in, meets the criteria of a variable interest entity. An entity is considered to be a variable interest entity when its total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support, or its equity investors, as a group, lack the characteristics of having a controlling financial interest. In making this assessment, we consider the potential that our arrangements and relationships with other entities provide subordinated financial support, the potential for us to absorb losses or rights to residual returns of an entity, the ability to directly or indirectly make decisions about the entity’s activities and other factors. If an entity that we have a variable interest in meets the criteria of a variable interest entity, we must determine whether we are the primary beneficiary of that entity. The primary beneficiary is the entity that has the power to direct any of the activities of the variable interest entity that most significantly impact the variable interest entity’s economic performance, and the obligation to absorb losses or the right to receive benefits from the variable interest entity that could be potentially significant to the variable interest entity. If we are determined to be the primary beneficiary of (has controlling financial interest in) a variable interest entity, then we would be required to consolidate that entity. In certain situations, it may be determined that power is shared among multiple unrelated parties such that no one party has the power to direct the activities of a variable interest entity that most significantly impact the variable interest entity’s economic performance (decisions about those activities require the consent of each of the parties sharing power). In accordance with the accounting guidance prescribed by consolidation of variable interest entities, if the determination is made that power is shared among multiple unrelated parties, then no party is the primary beneficiary. See Note 12-Variable Interest Entities. ACCOUNTING FOR RATE REGULATION: We are subject to the accounting requirements related to regulated operations. In accordance with these accounting requirements, some revenues and expenses have been deferred at the discretion of our Board, which has budgetary and rate-setting authority, if it is probable that these amounts will be refunded or recovered through future rates. Regulatory assets are costs we expect to recover from our Members based on rates approved by our Board in accordance with our rate policy. Regulatory liabilities represent probable future reductions in rates associated with amounts that are expected to be refunded to our Members based on rates approved by our Board in accordance with our rate policy. We recognize regulatory assets as expenses and regulatory liabilities as operating revenues, other income, or a reduction in expense concurrent with their recovery in rates. Regulatory assets and liabilities are as follows (dollars in thousands): (1) A regulatory asset or liability associated with deferred income taxes generally represents the future increase or decrease in income taxes payable that will be received or settled through future rate revenues. (2) Deferral of loss on acquisition related to the Craig Generating Station (“Craig Station”) Unit 3 prepaid lease expense upon acquisitions of equity interests in 2002 and 2006. The regulatory asset for the deferred prepaid lease expense is being amortized to depreciation, amortization and depletion expense in the amount of $6.5 million annually through the remaining original life of the lease ending in June 2018 and recovered from our Members in rates. (3) Deferral of loss on acquisition related to the Springerville Generating Station Unit 3 (“Springerville Unit 3”) prepaid lease expense upon acquiring a controlling interest in the Springerville Unit 3 Partnership LP (“Springerville Partnership”) in 2009. The regulatory asset for the deferred prepaid lease expense is being amortized to depreciation, amortization and depletion expense in the amount of $2.3 million annually through the 47-year period ending in 2056 and recovered from our Members in rates. (4) Represents goodwill related to our acquisition of Thermo Cogeneration Partnership, LP (“TCP”) in December 2011. Goodwill is being amortized to depreciation, amortization and depletion expense in the amount of $2.8 million annually through the 25-year period ending in 2036 and recovered from our Members in rates. (5) Represents goodwill related to our acquisition of Colowyo Coal Company LP (“Colowyo Coal”) in December 2011. Goodwill is being amortized to depreciation, amortization and depletion expense in the amount of $1.0 million annually through the 44-year period ending in 2056 and recovered from our Members in rates. (6) Represents transaction costs that we incurred related to the prepayment of our long-term debt in 2014. These costs are being amortized to depreciation, amortization and depletion expense in the amount of $8.6 million annually over the 21.4-year average life of the new debt issued and recovered from our Members in rates. (7) Represents deferral of the unrealized gain related to the change in fair value of forward starting interest rate swaps that were entered into in order to hedge interest rates on anticipated future borrowings. Upon settlement of these interest rate swaps, the realized gain or loss will be amortized to interest expense over the term of the associated long-term debt borrowing. See Note 5 - Long-Term Debt and Note 7 - Fair Value. (8) Represents deferral of the recognition of $10 million of non-member electric sales revenue received in 2008 and $35 million of non-member electric sales revenue received in 2011. $9.2 million of this deferred revenue was recognized in non-member electric sales revenue in 2016. As part of our Board approving the new A-40 rate schedule, which was implemented on January 1, 2017, the Board approved the income recognition in 2017 of $10.0 million of previously deferred 2008 non-member electric sales revenue and $20.0 million of previously deferred 2011 non-member electric sales revenue. The remaining deferred non-member electric sales revenue will be refunded to Members through reduced rates when recognized in non-member electric sales revenue in future periods. (9) Represents deferral of the recognition of other income of $47.6 million recorded in connection with the June 30, 2016 withdrawal of Kit Carson Electric Cooperative, Inc. (“KCEC”) from membership in us pursuant to the Membership Withdrawal Agreement (“Withdrawal Agreement”). The Withdrawal Agreement provided for the termination of the wholesale electric service contract between us and KCEC that extended through 2040 and the withdrawal of KCEC from membership in us. As part of the Withdrawal Agreement, we received $37 million net cash, which consisted of $49.5 million as an early termination fee for withdrawing from membership in us offset by $12.5 million for the retirement of KCEC’s patronage capital. This resulted in $47.6 million in other income, which was deferred by our Board. As part of our Board approving the new A-40 rate schedule, which was implemented on January 1, 2017, the Board approved the income recognition in 2017 of $10.0 million of deferred membership withdrawal income. The remaining deferred membership withdrawal income will be refunded to Members through reduced rates when recognized in other income in future periods. ELECTRIC PLANT AND DEPRECIATION: Electric plant is stated at cost. The cost of internally constructed assets includes payroll, overhead costs and interest charged during construction. Interest rates charged during construction of 4.7, 4.4 and 4.7 percent were used for 2016, 2015 and 2014, respectively. The amount of interest capitalized during construction was $13.8, $13.5 and $15.0 million during 2016, 2015 and 2014, respectively. At the time that units of electric plant are retired, original cost and cost of removal, net of the salvage value, are charged to the allowance for depreciation. Replacements of electric plant that involve less than a designated unit value are charged to maintenance expense when incurred. Electric plant is depreciated based upon estimated depreciation rates and useful lives that are periodically re-evaluated. COAL RESERVES AND DEPLETION: Coal reserves are recorded at cost. Depletion of coal reserves is computed using the units-of-production method utilizing only proven and probable reserves. LEASES: The accounting for lease transactions in conformity with GAAP requires management to make various assumptions, including the discount rate, the fair market value of the leased assets and the estimated useful life, in order to determine whether a lease should be classified as operating or capital. We are the lessor under power sales arrangements that are required to be accounted for as operating leases since the arrangements are in substance leases because they convey the right to use our power generating equipment for a stated period of time. The lease revenues from these arrangements are included in other operating revenue on our consolidated statements of operations. We are the lessee under a power purchase arrangement that is required to be accounted for as an operating lease since the arrangement is in substance a lease because it conveys to us the right to use power generating equipment for a stated period of time. It is included in other operating expenses on our consolidated statements of operations. See Note 9-Leases. INVESTMENTS IN OTHER ASSOCIATIONS: Investments in other associations include investments in the patronage capital of other cooperatives (accounted for using the cost method) and other required investments in the organizations. Under this method, our investment in a cooperative increases when a cooperative allocates patronage capital credits to us and it decreases when we receive a cash retirement of the allocated capital credits from the cooperative. A cooperative allocates its patronage capital credits to us based upon our patronage (amount of business done) with the cooperative. Investments in other associations are as follows (dollars in thousands): INVESTMENTS IN AND ADVANCES TO COAL MINES: We have direct ownership and investments in coal mines to support our coal generating resources. We, and certain participants in the Yampa Project, are members of Trapper Mining, Inc. (“Trapper Mining”), which is organized as a cooperative and is the owner and operator of the Trapper Mine near Craig, Colorado. Our investment in Trapper Mining is recorded using the equity method. In addition, we have ownership in Western Fuels Association, Inc. (“WFA”), which is an owner of Western Fuels-Wyoming, Inc. (“WFW”), the owner and operator of the Dry Fork Mine near Gillette, Wyoming. Dry Fork Mine provides coal to MBPP, which is the operator of Laramie River Generating Station. We, through our undivided interest in the jointly owned facility MBPP, advance funds to the Dry Fork Mine. Investments in and advances to coal mines are as follows (dollars in thousands): CASH AND CASH EQUIVALENTS: We consider highly liquid investments with an original maturity of three months or less to be cash equivalents. The fair value of cash equivalents approximates their carrying values due to their short-term maturity. RESTRICTED CASH AND INVESTMENTS: Restricted cash and investments represent funds designated by our Board for specific uses and funds restricted by contract or other legal reasons. A portion of the funds is for the payment of debt within one year and funds restricted by contract that are expected to be settled within one year. These funds are therefore classified as current on our consolidated statements of financial position. The other funds are for funds restricted by contract or other legal reasons that are expected to be settled beyond one year. These funds are classified as noncurrent and are included in other assets and investments on our consolidated statements of financial position. We had investments in U.S. Treasury Notes pledged as collateral in connection with the in-substance defeasance for the principal outstanding and future interest payments on the Coal Contract Receivable Collateralized Bonds (“Colowyo Bonds”). As of December 31, 2015, an $8.7 million defeasance investment remained related to the Colowyo Bond debt payments due in 2016 (the Colowyo Bonds matured in November 2016) and was classified as a current asset on our consolidated statements of financial position. As of December 31, 2016, there is no remaining defeasance investment. MARKETABLE SECURITIES: We hold marketable securities in connection with the directors’ and executives’ elective deferred compensation plans which consist of investments in stock funds, bond funds and money market funds. These securities are classified as available-for-sale securities. At December 31, 2016, the cost and estimated fair value of the investments based upon their active market value (Level 1 inputs) were $1.0 and $1.1 million, respectively, with a net unrealized gain balance of $0.1 million. At December 31, 2015, the cost and estimated fair value of the investments were $1.0 and $1.2 million, respectively, with a net unrealized gain balance of $0.1 million. The estimated fair value of the investments is included in other noncurrent assets on our consolidated statements of financial position. The unrealized gains at December 31, 2016 and 2015 are reported as a component of accumulated other comprehensive income as of those dates. Changes in the net unrealized gains or losses are reported as a component of comprehensive income. We held U.S. Treasury Notes to maturity in connection with the December 2011 defeasance of the Colowyo Bonds and these were included in restricted cash and investments on our statements of financial position. Since they were held to maturity, the notes were carried at amortized cost. As of December 31, 2015, the defeasance investment of $8.7 million consisted of a principal amount of $7.4 million, an unamortized premium of $0.2 million and cash of $1.1 million. This defeasance investment was for the remaining Colowyo Bond debt payments due in 2016 (the Colowyo Bonds matured in November 2016). As of December 31, 2016, there is no remaining defeasance investment. INVENTORIES: Coal inventories at our owned generating stations are stated at LIFO (last-in, first-out) cost and were $46.0 and $42.2 million as of December 31, 2016 and 2015, respectively. The remaining coal inventories, other fuel, and materials and supplies inventories are stated at average cost. OTHER DEFERRED CHARGES: We make expenditures for preliminary surveys and investigations for the purpose of determining the feasibility of contemplated generation and transmission projects. If construction results, the preliminary survey and investigation expenditures will be reclassified to electric plant-construction work in progress. If the work is abandoned, the related preliminary survey and investigation expenditures will be charged to the appropriate operating expense account or the expense could be deferred as a regulatory asset to be recovered from our Members in rates subject to approval by our Board, which has budgetary and rate-setting authority. Included in other deferred charges were preliminary surveys and investigations of $111.6 million and $107.1 million as of December 31, 2016 and 2015, respectively. These amounts were primarily comprised of expenditures for the expansion of Holcomb Generating Station of $91.3 million and $86.7 million as of December 31, 2016 and 2015, respectively. See Note 13-Commitments and Contingencies-Legal. We make advance payments to the operating agents of jointly owned facilities to fund our share of costs expected to be incurred under each project including MBPP - Laramie River Station, Yampa Project - Craig Station Units 1 and 2, San Juan Project - San Juan Unit 3. We also make advance payments to the operating agent of Springerville Unit 3. Included in other deferred charges were advance payments of $11.9 million and $11.5 million as of December 31, 2016 and 2015, respectively. See Note 3-Property, Plant and Equipment-Jointly Owned Facilities. During 2016, we entered into forward starting interest rate swaps to hedge a portion of our future long-term debt interest rate exposure. The unrealized gain on these interest rate swaps, as of December 31, 2016, was deferred in accordance with the accounting requirements related to regulated operations. See Note 2 - Accounting for Rate Regulation. Other deferred charges are as follows (dollars in thousands): DEBT ISSUANCE COSTS: We account for debt issuance costs as a direct deduction of the associated long-term debt carrying amount consistent with the accounting for debt discounts and premiums. Deferred debt issuance costs are amortized to interest expense using an effective interest method over the life of the respective debt. ASSET RETIREMENT OBLIGATIONS: We account for current obligations associated with the future retirement of tangible long-lived assets in accordance with the accounting guidance relating to asset retirement and environmental obligations. This guidance requires that legal obligations associated with the retirement of long-lived assets be recognized at fair value at the time the liability is incurred and capitalized as part of the related long-lived asset. Over time, the liability is adjusted to its present value by recognizing accretion expense and the capitalized cost of the long-lived asset is depreciated in a manner consistent with the depreciation of the underlying physical asset. In the absence of quoted market prices, we determine fair value by using present value techniques in which estimates of future cash flows associated with retirement activities are discounted using a credit adjusted risk-free rate including a market risk premium. Upon settlement of an asset retirement obligation, we will apply payment against the estimated liability and incur a gain or loss if the actual retirement costs differ from the estimated recorded liability. These liabilities are included in asset retirement obligations. Coal mines: We have asset retirement obligations for the final reclamation costs and post-reclamation monitoring related to the Colowyo Mine, the New Horizon Mine, and the Fort Union Mine. Generation: We, including our undivided interest in jointly owned facilities, have asset retirement obligations related to equipment, dams, ponds, wells and underground storage tanks at the generating stations. Transmission: We have an asset retirement obligation to remove a certain transmission line and related substation assets resulting from an agreement to relocate the line. Aggregate carrying amounts of asset retirement obligations are as follows (dollars in thousands): We also have asset retirement obligations with indeterminate settlement dates. These are made up primarily of obligations attached to transmission and other easements that are considered by us to be operated in perpetuity and therefore the measurement of the obligation is not possible. A liability will be recognized in the period in which sufficient information exists to estimate a range of potential settlement dates as is needed to employ a present value technique to estimate fair value. OTHER DEFERRED CREDITS AND OTHER LIABILITIES: We received $15.5 million in 2016 from Tucson Electric Power Company (“TEP”) as ordered by the United States Federal Energy Regulatory Commission (“FERC”). In 2015, TEP filed various non-conforming point-to-point transmission services agreements with FERC, including transmission services agreements between TEP and us. FERC ordered TEP to make a time value refund to us with regard to these transmission services agreements. TEP appealed the FERC order and stated that the funds were subject to refund in the event TEP was ultimately successful in its appeal. Due to uncertainties regarding the ultimate outcome of this matter, we did not recognize benefit of the receipt of the total $15.5 million as of December 31, 2016. The funds are therefore recorded in other deferred credits. On January 12, 2017, we entered into a settlement agreement with TEP and TEP moved to dismiss the appeal with prejudice. We returned $7.75 million to TEP and will recognize $7.75 million that we retained as a reduction in transmission expense on our statement of operations during the first quarter of 2017. During 2015, we renewed transmission right of way easements on tribal nation lands where certain of our electric transmission lines are located. $34.5 million will be paid by us for these easements from 2017 through the individual easement terms ending between 2036 and 2040. The present value for the easement payments were $20.6 and $21.4 million as of December 31, 2016 and 2015, respectively, which is recorded as other deferred credits and other liabilities. We have received deposits from various parties and those that may still be required to be returned are a liability and these are reflected in customer deposits. We have received upfront payments from others for the use of optical fiber and these are reflected in unearned revenue until recognized over the life of the agreement. The following other deferred credits and other liabilities are reflected on our consolidated statements of financial position (dollars in thousands): MEMBERSHIPS: There are 43 and 44 $5 memberships outstanding at December 31, 2016 and 2015, respectively. PATRONAGE CAPITAL: Our net margins are treated as advances of capital from our Members and are allocated to our Members on the basis of their electricity purchases from us. Net losses, should they occur, are not allocated to Members, but are offset by future margins. Margins not distributed to Members constitute patronage capital. Patronage capital is held for the account of our Members and is distributed through patronage capital retirements when our Board deems it appropriate to do so, subject to debt instrument restrictions. ELECTRIC SALES REVENUE: Revenue from electric energy deliveries is recognized when delivered. ACCOUNTS RECEIVABLE-MEMBERS AND OTHER: Receivables are primarily related to electric sales to Members and electric sales and other transactions with electric utilities. Uncollectible amounts, if any, are identified on a specific basis and charged to expense in the period determined to be uncollectible. OTHER OPERATING REVENUE: Other operating revenue consists primarily of wheeling, transmission and lease revenue, coal sales and revenue from supplying steam and water to a paper manufacturer located adjacent to the Escalante Generating Station. Wheeling revenue is received when we charge other energy companies for transmitting electricity over our transmission lines. Transmission revenue is from our membership in the Southwest Power Pool, a regional transmission organization, which we joined on January 1, 2016. The lease revenue is primarily from certain power sales arrangements that are required to be accounted for as operating leases since the arrangements are in substance leases because they convey to others the right to use power generating equipment for a stated period of time. See Note 9 - Leases. Coal sales revenue results from the sale of a portion of the coal from the Colowyo Mine per a contract ending in 2017 to other joint owners in the Yampa Project (the “Yampa Participants”). The associated Colowyo Mine expenses are included in coal mining, depreciation, amortization, and depletion and interest expense on our consolidated statements of operations. INCOME TAXES: We are a taxable cooperative subject to federal and state taxation. As a taxable electric cooperative, we are allowed a tax exclusion for margins allocated as patronage capital. We utilize the liability method of accounting for income taxes. Accordingly changes in deferred tax assets or liabilities result in the establishment of a regulatory asset or liability. A regulatory asset or liability associated with deferred income taxes generally represents the future increase or decrease in income taxes payable that will be received or settled through future rate revenues. INTERCHANGE POWER: We occasionally engage in interchanges, or non-cash swapping, of energy. Based on the assumption that all energy interchanged will eventually be received or delivered in-kind, interchanged energy is generally valued at the average cost of fuel to generate power. Additionally, portions of the energy interchanged are valued per contract with the utility involved in the interchange. When we are in a net energy advance position, the advanced energy balance is recorded as an asset. If we owe energy, the net energy balance owed to others is recorded as a liability. The net activity for the year is included in purchased power expense. The interchange liability balance of $1.9 and $1.6 million at December 31, 2016 and 2015, respectively, is included in accounts payable. The net interchange activity recorded in purchased power expense was $0.3 million, $0.1 million and $(0.5) million in 2016, 2015 and 2014, respectively. EVALUATION OF SUBSEQUENT EVENTS: We evaluated subsequent events through March 10, 2017, which is the date when the financial statements were issued. NEW ACCOUNTING PRONOUNCEMENTS: In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), as amended by subsequent ASUs issued in 2015 and 2016. The core principle under the new revenue standard requires that revenue should be recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. To achieve the core principle, the following steps are required: (1) identify the contract(s) with the customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. This amendment also requires enhanced quantitative and qualitative disclosures to enable users of financial information to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. For public business entities, this amendment is effective for the fiscal year beginning January 1, 2018 using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a modified retrospective approach with the cumulative effect of initially adopting the standard recognized at the date of adoption (which includes footnote disclosures). We are currently evaluating the impact of Topic 606, including the transition method, on our financial position and results of operations. We have evaluated our wholesale electric service contracts with our 43 Members and do not believe there will be a material impact to our recognition of revenue from the sale of electricity to our Members. Our Members are billed on a monthly basis per an energy rate and demand rate(s) for energy consumed during the period. Member rates for energy and demand are set by our Board annually, consistent with adequate electrical reliability and sound fiscal policy. Under the new standard, revenue is recognized upon the satisfaction of an entity’s performance obligations, which occurs when control of a good or service transfers to the customer. The standard includes a practical expedient that allows an entity to recognize revenue in the amount at which the entity has a right to invoice if that amount corresponds directly with the value to the customer of the entity’s performance to date. We transfer control of the electricity over time and the Member simultaneously receives and consumes the benefits of the electricity. The amount we invoice Members on a monthly basis corresponds directly with the value to the Member of our performance. Total revenue from Member electric sales was $1.1 billion for 2016, which was 84 percent of our operating revenue. We are currently evaluating the impact of the new standard on our remaining operating revenue. The American Institute of Certified Public Accountants (“AICPA”) Power and Utilities Revenue Recognition Task Force is working with the FASB to address specific industry issues, including the applicability of Topic 606 to contributions in aid of construction (“CIAC”), and if it is within scope, whether the recognition of such revenue should occur upon receipt or be deferred. In order to be fair and economical to all our Members, we may require a Member to provide CIAC to make an investment in property, plant and equipment. In accordance with standard industry practice, we have accounted for receipt of CIAC as a reduction in the total cost basis of property, plant and equipment such that only the net cost to us is included in property, plant and equipment on our statements of financial position. This net amount (after contribution) is also the amount subject to ratemaking. If it is determined that CIAC is within the scope of Topic 606, and offsetting regulatory treatments is permitted, it could have a material impact on our financial position and results of operations. In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements Going Concern (Subtopic 205-40): Disclosures of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The amendment in this ASU requires management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern, which is currently performed by the external auditors. Management will be required to perform this assessment for both interim and annual reporting periods and must make certain disclosures if it concludes that substantial doubt exists. Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meets its obligations as they become due within one year after the date that that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable). The amendment is effective for annual periods ending after December 15,2016, and interim periods within those annual periods beginning after December 15, 2016. We adopted this update in 2016 and it did not have an impact on our financial position or results of operations. In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This amendment requires an entity to measure investments in equity securities, except those that result in consolidation or are accounted for under the equity method of accounting, at fair value with changes in fair value recognized in net income. For equity investments that do not have readily determinable fair value and don’t qualify for the existing practical expedient in ASC 820, Fair Value Measurements, to estimate fair value using the net asset value per share of the investment, the guidance provides a new measurement alternative. Entities may choose to measure those investments at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer. This amendment also affects financial liabilities using the fair value option and the presentation and disclosure requirements for financial instruments. Also, an entity should present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk if the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. The amendments are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early application by public business entities to financial statements of fiscal years or interim periods that have not yet been issued or, by all other entities, that have not yet been made available for issuance are permitted as of the beginning of the fiscal year of adoption. An entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption of the update. We are currently evaluating the impact of this amendment on our financial position and results of operations. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This amendment requires a lessee to recognize substantially all leases (whether operating or finance leases) on the balance sheet as a right-of-use asset and an associated lease liability. Short-term leases of 12 months or less are excluded from this amendment. A right-of-use asset represents a lessee’s right to use (control the use of) the underlying asset for the lease term. A lease liability represents a lessee’s liability to make lease payments. The right-of-use asset and the lease liability are initially measured at the present value of the lease payments over the lease term. For finance leases, the lessee subsequently recognizes interest expense and amortization of the right-of-use asset, similar to accounting for capital leases under current GAAP. For operating leases, the lessee subsequently recognizes straight-line lease expense over the life of the lease. Lessor accounting remains substantially the same as that applied under current GAAP. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The guidance is to be applied using a modified retrospective transition method with the option to elect a package of practical expedients. We are currently evaluating the impact of this amendment on our financial position and results of operations. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Payments. This amendment provides specific guidance on certain cash flow presentation and classification issues in order to reduce diversity in practice on the statement of cash flows. The issues that primarily relate to us are the classification of proceeds from the settlement of insurance claims and distributions received from equity method investees. This amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The guidance is applied using a full retrospective transition method. We are currently evaluating the impact that this amendment will have on our statement of cash flows. In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) - Restricted Cash. This amendment requires the statement of cash flows to explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Amounts described as restricted cash and restricted cash equivalents will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The guidance is applied using a full retrospective transition method. We are currently evaluating the impact that this amendment will have on our statement of cash flows. NOTE 3 - PROPERTY, PLANT AND EQUIPMENT Our property, plant and equipment consist of electric plant and other plant. Both of these are discussed below and are included on our consolidated statements of financial position. ELECTRIC PLANT: Our investment in electric plant and the related annual rates of depreciation or amortization calculated using the straight-line method are as follows (dollars in thousands): At December 31, 2016, we had $56.5 million of commitments to complete construction projects, of which approximately $51.9, $4.2 and $0.4 million are expected to be incurred in 2017, 2018 and 2019, respectively. On September 1, 2016, we announced that the owners of Craig Station Unit 1 reached an agreement with the Colorado Department of Public Health and Environment, U.S. Environmental Protection Agency, WildEarth Guardians and the National Parks Conservation Association to revise the Colorado Visibility and Regional Haze State Implementation Plan (“SIP”). Under the proposed revision to the SIP, the owners of Craig Station Unit 1 intend to retire Craig Station Unit 1 by December 31, 2025. The retirement date was previously estimated to be December 31, 2051. We are the operator of Craig Station and own 24 percent of Craig Station Unit 1. Craig Station Unit 2 and Unit 3 will continue to operate. Our share of Craig Station Unit 1 is 102 megawatts with a net book value of $28.9 million as of December 31, 2016. The shortened life increased depreciation expense in the amount of $0.8 million for the period September 1, 2016 through December 31, 2016 and will increase future annual depreciation expense by $2.3 million. As part of the above mentioned agreement on proposed revisions to the SIP, we intend to retire the Nucla Generating Station by December 31, 2022. The retirement date was previously estimated to be December 31, 2049. We are the operator and sole owner of Nucla Generating Station with a net book value of $62.6 million as of December 31, 2016. The shortened life increased depreciation expense in the amount of $2.8 million for the period September 1, 2016 through December 31, 2016 and will increase future annual depreciation expense by $8.4 million. The shortened life also increased the asset retirement obligation in the amount of $2.9 million as of December 31, 2016. Effective January 1, 2017, we adopted depreciation rates that reflect rates determined in a depreciation rate study completed in January 2017 for our transmission plant and most of our general plant. We expect that the new rates will result in a reduction in 2017 depreciation expense of approximately $21.0 million. It is also anticipated that a depreciation rate study will be performed and completed during 2017 for most of our generation plant and that these rates will be adopted prospectively in 2017 from the date the study is completed. We do not currently know what the impact of this study will be on our 2017 depreciation expense. JOINTLY OWNED FACILITIES: Our share in each jointly owned facility is as follows as of December 31, 2016 (these electric plant in service, accumulated depreciation and construction work in progress amounts are included in the electric plant table above) (dollars in thousands): OTHER PLANT: Other plant consists of mine assets (discussed below) and non-utility assets (which consist of piping and equipment specifically related to providing steam and water from the Escalante Generating Station to a third party for the use in the production of paper). We own 100 percent of Elk Ridge Mining and Reclamation, LLC (“Elk Ridge”), organized for the purpose of acquiring coal reserves and supplying coal to us, which is the owner and operator of the New Horizon Mine near Nucla, Colorado. Elk Ridge also owns Colowyo Coal, which is the owner and operator of the Colowyo Mine, a large surface coal mine near Craig, Colorado. We also own a 50 percent undivided ownership in the land and the rights to mine the property known as Fort Union Mine. Our share of the coal provided from these mines is primarily used by us for generation at our generating facilities. The expenses related to this coal used by us are included in fuel expense on our consolidated statements of operations. Other plant assets are as follows (dollars in thousands): The New Horizon Mine, which supplies coal to Nucla Generating Station, will cease coal production with the retirement of Nucla Generating Station. Reclamation efforts at the New Horizon Mine will continue. NOTE 4 - INTANGIBLES INTANGIBLE ASSETS: The December 2011 acquisition of TCP resulted in recording an intangible asset in the amount of $55.5 million relating to a contractual obligation that TCP has to a third party under a purchase power agreement (the “PPA”). The $55.5 million intangible asset represented the amount that the PPA contract terms were above market value at the acquisition date and is being amortized on a straight-line basis over the remaining life of the PPA through June 30, 2019. The straight-line method is consistent with the terms of the PPA as this contract is for a fixed amount of capacity at a fixed capacity rate that stays constant over the term of the contract. The amortization of the PPA intangible asset is accounted for as a reduction of the revenue generated by the PPA and is included in other operating revenue. The amortization was $7.3 million in each of the years 2016, 2015 and 2014 and will be recognized over each of the next three years as follows (dollars in thousands): INTANGIBLE LIABILITIES: The December 2011 acquisition of Colowyo Coal resulted in recording an intangible liability of $18.0 million relating to a contractual obligation that Colowyo Coal has to sell coal to the Yampa Participants through 2017. The $18.0 million intangible liability represented the amount that the coal sale contract terms were below market at the acquisition date and is being amortized based upon the contracted tonnage with the Yampa Participants over the remaining life of the coal contract ending December 31, 2017. The intangible liability balance of $3.3 and $6.2 million as of December 31, 2016 and 2015, respectively, is included in intangible liabilities. The amortization of the Colowyo Coal intangible liability is accounted for as an increase in other operating revenue. An amortization benefit of $2.9, $3.2 and $3.2 million was recognized in 2016, 2015 and 2014, respectively, and the remaining benefit over the next year is estimated to be $3.3 million. NOTE 5 - LONG-TERM DEBT The mortgage notes payable and pollution control revenue bonds are secured on a parity basis by a Master First Mortgage Indenture, Deed of Trust and Security Agreement except for three unsecured notes in the aggregate amount of $49.6 million as of December 31, 2016. Substantially all our assets, rents, revenues and margins are pledged as collateral. The Springerville certificates are secured by the assets of Springerville Unit 3. All long-term debt contains certain restrictive financial covenants, including a DSR requirement and ECR requirement. Long-term debt consists of the following (dollars in thousands): We have a secured revolving credit facility with Bank of America, N.A. (“Bank of America”) and CoBank, ACB as Joint Lead Arrangers in the amount of $750 million (“Revolving Credit Agreement”). We had no outstanding borrowings at December 31, 2016 and $271 million at December 31, 2015. There is a 364-day, direct pay letter of credit issued under the Revolving Credit Agreement and provided by Bank of America for the $46.8 million Moffat County, CO pollution control revenue bonds. In December 2016, the letter of credit from Bank of America was extended for an additional 364 days to mature in January 2018. As of December 31, 2016, we have $582.4 million in total aggregate availability (including $380.1 million under the commercial paper back-up sublimit) under the Revolving Credit Agreement. On October 30, 2014, we issued the First Mortgage Bonds, Series 2014 E-1 and E-2 (“Series 2014 Bonds”) in an aggregate amount of $500 million. In connection with the Series 2014 Bonds, we entered into a registration rights agreement. On July 30, 2015, we commenced an offer to exchange the $500 million aggregate principal amount of the Series 2014 Bonds. The exchange offer satisfied our obligations under the registration rights agreement. The exchange offer did not represent a new financing transaction and there were no proceeds to us when the exchange offer was completed in September 2015. On May 23, 2016, we issued our First Mortgage Bonds, Series 2016A (“Series 2016A Bonds”) in an unregistered offering pursuant to Rule 144A under the Securities Act of 1933 with an aggregate principal amount of $250 million. The Series 2016A Bonds mature on June 1, 2046 and bear interest at a rate of 4.25 percent per annum. We utilized the proceeds from the Series 2016A Bonds primarily to repay outstanding indebtedness under the Revolving Credit Agreement. In connection with the Series 2016A Bonds, we entered into an exchange and registration rights agreement pursuant to which we agreed to file a registration statement relating to an exchange offer for our Series 2016A Bonds. On June 27, 2016, we commenced an offer to exchange all of the unregistered $250 million aggregate principal amount of the Series 2016A Bonds for $250 million aggregate principal amount of registered Series 2016A Bonds. We completed the exchange offer in July 2016 which satisfied our obligations under the exchange and registration rights agreement. The exchange offer did not represent a new financing transaction and there were no proceeds to us when the exchange offer was completed. Annual maturities of total debt adjusted for debt issuance costs, discounts and premiums at December 31, 2016 are as follows (dollars in thousands): We are exposed to certain risks in the normal course of operations in providing a reliable and affordable source of wholesale electricity to our Members. These risks include interest rate risk, which represents the risk of increased operating expenses and higher rates due to increases in interest rates related to anticipated future long-term borrowings. To manage this exposure, we have entered into forward starting interest rate swaps to hedge a portion of our future long-term debt interest rate exposure. We anticipate settling these swaps in conjunction with the issuance of future long-term debt. See Note 2 - Accounting for Rate Regulation and Note 7 - Fair Value. The terms of the interest rate swap contracts are as follows (dollars in thousands): (1) We will pay. (2) We will receive. NOTE 6 - SHORT-TERM BORROWINGS We established a commercial paper program in May 2016 under which we issue unsecured commercial paper in aggregate amounts not exceeding the commercial paper back-up sublimit under our Revolving Credit Agreement, which is the lesser of $500 million or the amount available under our Revolving Credit Agreement. The commercial paper issuances are used to provide an additional financing source for our short-term liquidity needs. The maturities of the commercial paper issuances vary, but may not exceed 397 days from the date of issue. The commercial paper notes are classified as current and are included in current liabilities as short-term borrowings on our consolidated statements of financial position. Commercial paper consisted of the following (dollars in thousands): At December 31, 2016, $380.1 million of the commercial paper back-up sublimit remained available under the Revolving Credit Agreement. See Note 5 - Long-term Debt. NOTE 7 - FAIR VALUE Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability between market participants in the principal market, or in the most advantageous market when no principal market exists. The fair value measurements accounting guidance emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability (market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not under duress). In considering market participant assumptions in fair value measurements, a three-tier fair value hierarchy for measuring fair value was established which prioritizes the inputs used in measuring fair value as follows: Level 1 inputs are based upon quoted prices for identical instruments traded in active (exchange-traded) markets. Valuations are obtained from readily available pricing sources for market transactions (observable market data) involving identical assets or liabilities. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques (such as option pricing models and discounted cash flow models) for which all significant assumptions are observable in the market. Level 3 inputs consist of unobservable market data which is typically based on an entity’s own assumptions of what a market participant would use in pricing an asset or liability as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. Marketable Securities We hold marketable securities in connection with the directors’ and executives’ elective deferred compensation plans which consist of investments in stock funds, bond funds and money market funds. These securities are classified as available-for-sale and are measured at fair value on a recurring basis. The estimated fair value of the investments is based upon their active market value (Level 1 inputs) and is included in other noncurrent assets on our consolidated statements of financial position. The unrealized gains are reported as a component of accumulated other comprehensive income. The amortized cost and fair values of our marketable securities are as follows (dollars in thousands): Cash Equivalents We invest portions of our cash and cash equivalents in commercial paper, money market funds, and other highly liquid investments. The fair value of these investments approximates our cost basis in the investments. In aggregate, the fair value was $49.1 million and $75.1 million as of December 31, 2016 and 2015, respectively. Debt The fair values of debt were estimated using discounted cash flow analyses based on our current incremental borrowing rates for similar types of borrowing arrangements. These valuation assumptions utilize observable inputs based on market data obtained from independent sources and are therefore considered Level 2 inputs (quoted prices for similar assets, liabilities (adjusted) and market corroborated inputs). The principal amounts and fair values of our debt are as follows (dollars in thousands): Interest Rate Swaps We entered into forward starting interest rate swaps in 2016 to hedge a portion of our future long-term debt interest rate expense. See Note 5 - Long-Term Debt. These interest rate swaps are derivative instruments in accordance with ASC 815, Derivatives and Hedging, and are recorded at fair value on a recurring basis. The estimated fair value of these interest rate swaps utilizes observable inputs based on market data obtained from independent sources and are therefore considered Level 2 inputs (quoted prices for similar assets, liabilities (adjusted) and market corroborated inputs) and are included in other deferred charges on our consolidated statements of financial position. At December 31, 2016, the fair value of our interest rate swaps was an unrealized gain of $12.1 million, which was deferred in accordance with our regulatory accounting. See Note 2 - Summary of Significant Accounting Policies. NOTE 8 - INCOME TAXES We had an income tax benefit of $1.4 million in 2016 and no income tax expense or benefit in 2015 and 2014. The income tax benefit of $1.4 million is due to the alternative minimum tax credit refund in lieu of bonus depreciation of $1.9 million, offset by the current alternative minimum tax expense of $0.5 million. The liability method of accounting for income taxes is utilized, whereby changes in deferred tax assets or liabilities result in the establishment of a regulatory asset or liability. A regulatory asset or liability associated with deferred income taxes generally represents the future increase or decrease in income taxes payable that will be received or settled through future rate revenues. Under the liability method, deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and for income tax purposes. Components of our net deferred tax liability are as follows (dollars in thousands): The $1.9 million increase in the net deferred tax liability from $28.6 million at December 31, 2015 to $30.5 million at December 31, 2016 is not recognized as a tax expense in 2016 due to our regulatory accounting treatment of deferred taxes. Instead, the tax expense is deferred and reflected as an increase in the regulatory asset established for deferred income tax expense. The accounting for regulatory assets is discussed further in Note 2-Accounting for Rate Regulation. The regulatory asset account for deferred income tax expense has a balance of $30.5 million and $28.6 million at December 31, 2016 and 2015, respectively. The reconciliation between the statutory federal income tax rate and the effective tax rate is as follows: We had taxable income of $20.4 million for 2016. At December 31, 2016, we have a federal net operating loss carryforward of $378.1 million which, if not utilized, will expire between 2030 and 2035. The future reversal of existing temporary differences will more-likely-than-not enable the realization of the net operating loss carryforward. We have $1.9 million of alternative minimum tax credit carryforwards at December 31, 2016 that have no expiration date. The authoritative guidance for income taxes addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. We may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. We file a U.S. federal consolidated income tax return and income tax returns in state jurisdictions where required. The statute of limitations remains open for federal and state returns for the years 2013 forward. We do not have any liabilities recorded for uncertain tax positions. NOTE 9 - LEASES LESSOR-GAS TOLLING ARRANGEMENTS: We are the lessor under certain power sales arrangements that are required to be accounted for as operating leases since the arrangements are in substance leases because they convey the right to use power generating equipment for a stated period of time. These arrangements include sales contracts to a third party out of our J.M. Shafer, Knutson and Limon Generating Stations. Under the first of these contracts, the third party directs the use of 122 megawatts of the 272 -megawatt net generating capability of the J.M. Shafer Generating Station through June 30, 2019 under a tolling arrangement whereby the third party provides its own natural gas for generation of electricity. Under the other contracts, the third party directed the use of both of the two Knutson Generating Station units and one of the two Limon Generating Station units through April 30, 2016 under tolling arrangements whereby the third party provided its own natural gas for generation of electricity. The revenues from these operating leases of $17.5, $30.1 and $30.6 million for 2016, 2015 and 2014, respectively, are accounted for as lease revenue and are reflected in other operating revenue on our consolidated statements of operations. The generating units used in these gas tolling arrangements have a total cost and accumulated depreciation of $114 and $63 million, respectively, as of December 31, 2016, and of $223 and $106 million, respectively, as of December 31, 2015. The minimum future lease revenues under these gas tolling arrangements at December 31, 2016 are as follows (dollars in thousands): LESSEE-GAS TOLLING ARRANGEMENT: We are the lessee under a power purchase arrangement that is required to be accounted for as an operating lease since the arrangement is in substance a lease because it conveys to us the right to use power generating equipment for a stated period of time. Under this agreement, we direct the use of 70 megawatts at the Brush Generating Station for a 10-year term ending December 31, 2019 and provide our own natural gas for generation of electricity. The expense for the Brush operating lease of $5.3 million for each of the years 2016, 2015 and 2014 is included in other operating expenses on our consolidated statements of operations. Our operating lease commitments for this gas tolling arrangement at December 31, 2016 are as follows (dollars in thousands): NOTE 10 - RELATED PARTIES TRAPPER MINING, INC.: We, and certain participants in the Yampa Project, own Trapper Mining. Organized as a cooperative, Trapper Mining supplied 26 percent in 2016 and 2015 and 35 percent in 2014 of the coal for the Yampa Project. Our 26.57 percent share of coal purchases from Trapper Mining was $16.9, $17.7 and $30.6 million in 2016, 2015 and 2014, respectively. Our membership interest in Trapper Mining of $14.5 and $14.1 million at December 31, 2016 and 2015, respectively, is included in investments in and advances to coal mines on our consolidated statements of financial position. Our share of Trapper Mining capital credit allocations of $0.5 million for 2016, 2015 and 2014, respectively, is included in capital credits from cooperatives on our consolidated statements of operations. NOTE 11 - EMPLOYEE BENEFIT PLANS DEFINED BENEFIT PLAN: Substantially all of our 1,585 employees participate in the National Rural Electric Cooperative Association Retirement Security Plan (“RS Plan”) except for the 223 employees of Colowyo Coal. The RS Plan is a defined benefit pension plan qualified under Section 401(a) and tax-exempt under Section 501(a) of the Internal Revenue Code. It is considered a multiemployer plan under the accounting standards for compensation-retirement benefits. The plan sponsor’s Employer Identification Number is 53-0116145 and the Plan Number is 333. A unique characteristic of a multiemployer plan compared to a single employer plan is that all plan assets are available to pay benefits to any plan participant. Separate asset accounts are not maintained for participating employers. This means that assets contributed by one employer may be used to provide benefits to employees of other participating employers. Our contributions to the RS Plan in each of the years 2016, 2015 and 2014 represented less than 5 percent of the total contributions made each year to the plan by all participating employers. We made contributions to the RS Plan of $24.8, $22.9 and $21.5 million in 2016, 2015 and 2014, respectively. In December 2012, the National Rural Electric Cooperative Association approved an option to allow participating cooperatives in the RS Plan to make a contribution prepayment and reduce future required contributions. The prepayment amount is a cooperative’s share, as of January 1, 2013, of future contributions required to fund the RS Plan’s unfunded value of benefits earned to date using RS Plan actuarial valuation assumptions. The prepayment amount is equal to approximately 2.5 times a cooperative’s annual RS Plan required contribution as of January 1, 2013. After making the prepayment, the annual contribution was reduced by approximately 25 percent, retroactive to January 1, 2013. The reduced annual contribution is expected to continue for approximately 15 years. However, changes in interest rates, asset returns and other plan experience different from expected, plan assumption changes and other factors may have an impact on future contributions and the 15-year period. In May 2013, we elected to make a contribution prepayment of $71.2 million to the RS Plan. This contribution prepayment was determined to be a long-term prepayment and therefore recorded in deferred charges and amortized beginning January 1, 2013 over the 13-year period calculated by subtracting the average age of our workforce from our normal retirement age under the RS Plan. Our contributions to the RS Plan include contributions for substantially all of the 335 bargaining unit employees that are made in accordance with collective bargaining agreements. In the RS Plan, a “zone status” determination is not required, and therefore not determined, under the Pension Protection Act (“Act”) of 2006. In addition, the accumulated benefit obligations and plan assets are not determined or allocated separately by individual employer. In total, the RS Plan was over 80 percent funded at January 1, 2016, and over 80 percent funded at January 1, 2015, based on the Act funding target and the Act actuarial value of assets on those dates. Because the provisions of the Act do not apply to the RS Plan, funding improvement plans and surcharges are not applicable. Future contribution requirements are determined each year as part of the actuarial valuation of the plan and may change as a result of plan experience. DEFINED CONTRIBUTION PLAN: We have a qualified savings plan for eligible employees who may make pre-tax and after-tax contributions totaling up to 100 percent of their eligible earnings subject to certain limitations under federal law. We make no contributions for the 335 bargaining unit employees. For all of the eligible non-bargaining unit employees, other than the 223 employees of Colowyo Coal, we contribute 1 percent of an employee’s eligible earnings. For the bargaining unit employees of New Horizon Mine, we match 1 percent of employee’s contributions. For the employees of Colowyo Coal, we contribute 7 percent of an employee’s eligible earnings and also match an employee’s contributions up to 5 percent. We made contributions to the plan of $3.0 million for 2016 and 2015 and $2.9 million for 2014. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS: We sponsor three medical plans for all non-bargaining unit employees under the age of 65. Two of the plans provide postretirement medical benefits to full-time non-bargaining unit employees and retirees who receive benefits under those plans, who have attained age 55, and who elect to participate. All three of these non-bargaining unit medical plans offer postemployment medical benefits to employees on long-term disability. The plans were unfunded at December 31, 2016, are contributory (with retiree premium contributions equivalent to employee premiums, adjusted annually) and contain other cost-sharing features such as deductibles. The postretirement medical benefit and postemployment medical benefit obligations are determined annually by an independent actuary and are included in accumulated postretirement benefit and postemployment obligations on our consolidated statements of financial position as follows (dollars in thousands): The postretirement medical benefit plans were amended as of December 31, 2015. The postretirement medical benefit plan was amended to include three different plan options for members prior to the age of 65. This reduced the liability by approximately 11.5 percent and is reflected as a prior service cost in the amount of $(0.9) million as of December 31, 2015. This prior service cost was recorded in accumulated other comprehensive income and is being amortized to expense in the amount of $0.1 million annually over the average remaining service lives of the active plan participants at the date of the plan amendment. In accordance with the accounting standard related to postretirement benefits other than pensions, actuarial gains and losses are not recognized in income but are instead recorded in accumulated other comprehensive income on our consolidated statements of financial position. If the unrecognized amount is in excess of 10 percent of the projected benefit obligation, amounts are reclassified out of accumulated other comprehensive income and included in net income as the excess amount is amortized over the average remaining service lives of the active plan participants. Unrecognized actuarial gains and losses have been determined per actuarial studies for the postretirement medical benefit obligation. The net unrecognized actuarial gains and losses related to the postretirement medical benefit obligation are included in accumulated other comprehensive income as follows (dollars in thousands): The assumptions used in the 2016 actuarial study performed for our postretirement medical benefit obligation were as follows: Changes in the assumed health care cost trend rates would impact the accumulated postretirement medical benefit obligation and the net periodic postretirement medical benefit expense as follows (dollars in thousands): The following are the expected future benefits to be paid related to the postretirement medical benefit obligation during the next 10 years (dollars in thousands): NOTE 12 - VARIABLE INTEREST ENTITIES The following is a description of our financial interests in variable interest entities that we consider significant. This includes an entity for which we are determined to be the primary beneficiary and therefore consolidate and also entities for which we are not the primary beneficiary and therefore do not consolidate. Consolidated Variable Interest Entity Springerville Partnership: We own a 51 percent equity interest, including the 1 percent general partner equity interest, in the Springerville Partnership, which is the 100 percent owner of Springerville Unit 3 Holding LLC (“Owner Lessor”) of the Springerville Unit 3. We, as general partner, have the full, exclusive and complete right, power and discretion to operate, manage and control the affairs of the Springerville Partnership and take certain actions necessary to maintain the Springerville Partnership in good standing without the consent of the limited partners. Additionally, the Owner Lessor has historically not demonstrated an ability to finance its activities without additional financial support. The financial support is provided by our remittance of lease payments in order to permit the Owner Lessor, the holder of the Springerville Unit 3 assets, to pay the debt obligations and equity returns of the Springerville Partnership. We have the primary risk (expense) exposure in operating the Springerville Unit 3 assets and are responsible for 100 percent of the operation, maintenance and capital expenditures of Springerville Unit 3 and the decisions related to those expenditures including budgeting, financing and dispatch of power. Based on all these facts, it was determined that we are the primary beneficiary of the Owner Lessor. Therefore, the Springerville Partnership and Owner Lessor have been consolidated by us. Our consolidated statements of financial position include the Springerville Partnership’s net electric plant of $832.3 million and $853.3 million at December 31, 2016 and 2015, respectively, the long-term debt of $472.1 million and $511.0 million at December 31, 2016 and 2015, respectively, accrued interest associated with the long-term debt of $13.4 million and $14.3 million at December 31, 2016 and 2015, respectively, and the 49 percent noncontrolling equity interest in the Springerville Partnership of $109.1 million and $108.8 million at December 31, 2016 and 2015, respectively. Our consolidated statements of operations include the Springerville Partnership’s depreciation and amortization expense of $21.0 million for 2016, 2015 and 2014, respectively. Our consolidated statements of operations also include interest expense of $30.4, $32.3 and $34.1 million for 2016, 2015 and 2014, respectively. The net income or loss attributable to the 49 percent noncontrolling equity interest in the Springerville Partnership is reflected on our consolidated statements of operations. The revenue associated with the Springerville Partnership lease has been eliminated in consolidation. Income, losses and cash flows of the Springerville Partnership are allocated to the general and limited partners based on their equity ownership percentages. Unconsolidated Variable Interest Entities Western Fuels Association: WFA is a non-profit membership corporation organized for the purpose of acquiring and supplying fuel resources to its members, which includes us. WFA supplies fuel to MBPP for the use of the Laramie River Station through its ownership in WFW. We also receive coal supplies directly from WFA for the Escalante Generating Station in New Mexico and spot coal for the Springerville Unit 3 in Arizona. The pricing structure of the coal supply agreements with WFA is designed to recover the mine operating costs of the mine supplying the coal and therefore the coal sales agreements provide the financial support for the mine operations. There isn’t sufficient equity at risk for WFA to finance its activities without additional financial support. Therefore, WFA is considered a variable interest entity in which we have a variable interest. The power to direct the activities that most significantly impact WFA’s economic performance (acquiring and supplying fuel resources) is held by the members who are represented on the WFA board of directors whose actions require joint approval. Therefore, since there is shared power over the significant activities of WFA, we are not the primary beneficiary of WFA and the entity is not consolidated. Our investment in WFA, accounted for using the cost method, was $2.2 million and $2.3 million for December 31, 2016 and 2015, respectively, and is included in investments in other associations. Western Fuels - Wyoming: WFW, the owner and operator of the Dry Fork Mine in Gillette, Wyoming, was organized for the purpose of acquiring and supplying coal, through long-term coal supply agreements, to be used in the production of electric energy at the Laramie River Station (owned by the participants of MBPP) and at the Dry Fork Station (owned by Basin). WFA owns 100 percent of the class AA shares and 75 percent of the class BB shares of WFW, while the participants of MBPP (of which we have a 24.13 percent undivided interest) own the remaining 25 percent of class BB shares of WFW. The pricing structure of the coal supply agreements is designed to recover the costs of production of the Dry Fork Mine and therefore the coal supply agreements provide the financial support for the operation of the Dry Fork Mine. There isn’t sufficient equity at risk at WFW for it to finance its activities without additional financial support. Therefore, WFW is considered a variable interest entity in which we have a variable interest. The power to direct the activities that most significantly impact WFW’s economic performance (which includes operations, maintenance and reclamation activities) is shared with the equity interest holders since each member has representation on the WFW board of directors whose actions require joint approval. Therefore, we are not the primary beneficiary of WFW and the entity is not consolidated. Trapper Mining, Inc.: Trapper Mining is a cooperative organized for the purpose of mining, selling and delivering coal from the Trapper Mine to the Craig Station Units 1 and 2 through long-term coal supply agreements. Trapper Mining is jointly owned by some of the participants of the Yampa Project. We have a 26.57 percent cooperative member interest in Trapper Mining. The pricing structure of the coal supply agreements is designed to recover the costs of production of the Trapper Mine and therefore the coal supply agreements provide the financial support for the operation of the Trapper Mine. There isn’t sufficient equity at risk for Trapper Mining to finance its activities without additional financial support. Therefore, Trapper Mining is considered a variable interest entity in which we have a variable interest. The power to direct the activities that most significantly impact Trapper Mining’s economic performance (which includes operations, maintenance and reclamation activities) is shared with the cooperative’s members since each member has representation on the Trapper Mining board of directors whose actions require joint approval. Therefore, we are not the primary beneficiary of Trapper Mining and the entity is not consolidated. We record our investment in Trapper Mining using the equity method. Our membership interest in Trapper Mining was $14.5 million at December 31, 2016 and $14.1 million at December 31, 2015 and is recorded within investments in and advances to coal mines. NOTE 13 - COMMITMENTS AND CONTINGENCIES SALES: We have delivery obligations under resource-contingent power sales contracts with Public Service Company of Colorado totaling 100 megawatts. This contract expires in March 2017. We also have a resource-contingent firm power sales contract of 100 megawatts to Salt River Project Agricultural Improvement and Power District through August 31, 2036. COAL PURCHASE REQUIREMENTS: We are committed to purchase coal for our generating plants under long-term contracts that expire between 2017 and 2034. These contracts require us to purchase a minimum quantity of coal at prices that are subject to escalation clauses that reflect cost increases incurred by the suppliers and market conditions. The projection of contractually committed purchases is based upon estimated future prices. At December 31, 2016, the annual minimum coal purchases under these contracts are as follows (dollars in thousands): ELECTRIC POWER PURCHASE AGREEMENTS: Our principal long-term electric power purchase contracts are with Western Area Power Administration (“WAPA”) and Basin. WAPA, one of four power marketing administrations of the U.S. Department of Energy, markets and supplies cost-based hydroelectric power and related services primarily to cooperatives and municipal electric systems located in 15 states in the central and western part of the United States. WAPA markets and transmits the power to us under three contracts, one relating to WAPA’s Loveland Area Project (terminates September 30, 2024), and two contracts relating to WAPA’s Salt Lake City Area Integrated Projects (terminate September 30, 2024). In 2015, we entered into an additional contract with WAPA relating to the Loveland Area Project, which commences upon termination of the above referenced contract terminating September 30, 2024, and will run through September 2054. Our purchases of hydroelectric-based electric power from WAPA are made at cost-based rates under long-standing federal law under which WAPA sells power to cooperatives and municipal electric systems and certain other preference customers. We utilize a portion of our purchases from Basin to supply power to our Nebraska Members, which are primarily located in the Eastern Interconnection and are generally isolated from our generating facilities that are located in the Western Interconnection. We have a contract with Basin for a term ending December 31, 2050, to supply the electrical requirements of its Nebraska members in excess of power supplied by WAPA. We also purchase 225 MWs from Basin for use in the Western Interconnection under a contract for a term ending December 31, 2050. Costs under the above electric power purchase agreements for the years ended December 31 were as follows (dollars in thousands): ENVIRONMENTAL: As with most electric utilities, we are subject to extensive federal, state and local environmental requirements that regulate, among other things, air emissions, water discharges and use and the management of hazardous and solid wastes. Compliance with these requirements requires significant expenditures for the installation, maintenance and operation of pollution control equipment, monitoring systems and other equipment or facilities. Our operations are subject to environmental laws and regulations that are complex, change frequently and have become more stringent and numerous over time. Federal, state, and local standards and procedures that regulate environmental impact of our operations are subject to change. Consequently, there is no assurance that environmental regulations applicable to our facilities will not become materially more stringent, or that we will always be able to obtain all required operating permits. More stringent standards may require us to modify the design or operation of existing facilities or purchase emission allowances. An inability to comply with environmental standards could result in reduced operating levels or the complete shutdown of our facilities that are not in compliance. We cannot predict at this time whether any additional legislation or rules will be enacted which will affect our operations, and if such laws or rules are enacted, what the cost to us might be in the future because of such actions or the effect it could have on our financial condition, results of operations and cash flow. From time to time, we are alleged to be in violation or in default under orders, statutes, rules, regulations, permits or compliance plans relating to the environment. Additionally, we may need to deal with notices of violation, enforcement proceedings or challenges to construction or operating permits. In addition, we may be involved in legal proceedings arising in the ordinary course of business. However, we believe our facilities are currently in compliance with such regulatory and operating permit requirements. LEGAL: On October 19, 2012, we gave notice, as required by New Mexico law, to the New Mexico Public Regulation Commission (“NMPRC”) of our A-37 wholesale rate which was scheduled to become effective on January 1, 2013. The rate would have increased revenue collected from all of our Members. In November 2012, three of our Members located in New Mexico filed protests of our rates with the NMPRC. On December 20, 2012, the NMPRC suspended the rate filing in New Mexico and appointed a hearing examiner to conduct a hearing and establish reasonable rate schedules pursuant to New Mexico law. On June 26, 2013, we filed to withdraw our A-37 rate. On July 3, 2013, the NMPRC denied the filing to withdraw and ordered the A-37 rate filing to be consolidated with the A-38 rate filing described below. On September 10, 2013, we gave notice, as required by New Mexico law, to the NMPRC of our A-38 wholesale rate which was scheduled to become effective on January 1, 2014. Four Members filed protests with the NMPRC challenging the A-38 rate. The A-38 rate modified the rate design but did not increase the general revenue requirement. On December 11, 2013, the NMPRC suspended the A-38 rate filing and assigned the consolidated A-37 and A-38 rate filings to a hearing examiner. In August 2014, we and the New Mexico Members executed a preliminary mediation agreement providing for a temporary rate rider through no later than December 31, 2015 and a suspension of the procedural schedule related to the rate protest to allow the parties time to proceed with more extensive discussions on a global settlement. We filed notice of the temporary rate rider with the NMPRC and it became effective on October 2, 2014. The temporary rate rider was applied in conjunction with our 2012 wholesale rate to recover additional revenue from the New Mexico Members in an annualized amount of $7 million per year, which was prorated beginning October 2 for 2014. In 2015 and 2014, the overall revenue impact of the New Mexico Members paying a lower rate was approximately $10.7 million and $16.4 million, respectively. On December 9, 2015, we and the New Mexico Members filed a joint motion with the NMPRC seeking continuation of the suspension of the procedural schedule related to the rate protests to allow the parties additional time to proceed with further negotiations towards a global settlement. On January 6, 2016, the NMPRC ordered that the procedural schedule related to the rate protests remains suspended until further order of the NMPRC. As part of the global settlement, the parties seek to address the issue of our rate regulation in New Mexico, payment of capital credits, and whether we have the right to collect the amounts uncollected from our New Mexico Members as a result of the suspension of prior rate filings. We cannot predict the outcome of this matter or if a global settlement will be reached, although we do not believe this proceeding is likely to have a material adverse effect on our financial condition or our future results of operations or cash flows. The Purchase Option and Development Agreement was executed on July 26, 2007 between us and Sunflower Electric Power Corporation (“Sunflower”) and other Sunflower parties. The agreement calls for us to make option payments totaling $55 million to Sunflower and/or the other Sunflower parties in exchange for the development rights to develop a new coal-fired generating unit or units at Sunflower’s existing single-unit Holcomb Generating Station in western Kansas. Upon execution, $25 million was paid. In 2008, $5 million was paid and the remainder will be paid on the purchase date. The purchase date will be designated by us, Sunflower and the other parties to the Purchase Option and Development Agreement after we exercise our option to acquire the development rights. The purchase date cannot currently be estimated due to legal uncertainties surrounding the status of the necessary air permits. The original air permit application was denied by the Kansas Department of Health and Environment (“KDHE”) in October 2007 and we and Sunflower appealed the denial to the Kansas courts. Subsequent to the denial of the air permit, Sunflower entered into an agreement with the governor of Kansas that could result in the KDHE issuing a permit for one new coal-fired generating unit at Holcomb Generating Station of 895 megawatts. As a result of the agreement, Sunflower and we withdrew the appeal of the denial of the original air permit application. The KDHE issued the new permit on December 16, 2010. The Sierra Club filed an appeal of the new permit with the Kansas Court of Appeals on January 14, 2011 and the case was immediately transferred to the Kansas Supreme Court. The Kansas Supreme Court remanded the permit to the KDHE to consider a limited issue. The KDHE issued an addendum to the permit on May 30, 2014. The Sierra Club filed an appeal with the Kansas Court of Appeals on June 27, 2014. On November 3, 2014, the Kansas Supreme Court granted a pending motion to transfer the case from the Court of Appeals and KDHE subsequently filed the record on appeal. The Kansas Supreme Court heard oral argument on the appeal on January 28, 2016. Excluding the cost of land and water rights, the cost of developing the units incurred by us as of December 31, 2016 is $91.3 million, which is included in other deferred charges on our consolidated statements of financial position. We are unable to project the ultimate outcome of this matter or when the air permit application process may conclude. On February 17, 2016, we filed a Petition for Declaratory Order with FERC seeking a declaratory order from FERC finding that the fixed cost recovery mechanism in our revised Board policy is consistent with the provisions of Public Utility Regulatory Policies Act of 1978 and the implementing regulations of FERC. The revised Board policy provides for recovery of the unrecovered fixed costs directly from a Member as a result of that Member purchasing power from a “qualifying facility” in an amount that causes it to exceed the 5 percent limitation on that Member’s self-supply of power pursuant to its wholesale electric service contract, rather than allocating the costs among all of our Members. The fixed cost recovery is calculated based on the difference between our wholesale rate to our Members and our avoided costs. Various individuals and entities filed comments and four entities filed motions to intervene, including our Member, Delta-Montrose Electric Association. On June 16, 2016, FERC denied our Petition for Declaratory Order related to the fixed cost recovery mechanism in our revised Board policy. On July 18, 2016, we filed a Request for Rehearing with FERC regarding FERC’s June 16 order. In addition, five other generation and transmission cooperatives filed a Request for Rehearing with FERC. We cannot predict the outcome of our July 18 request for rehearing filed with FERC. In June 2011, a wildfire in New Mexico, known as the Las Conchas Fire, burned for five weeks in northern New Mexico, primarily on national forest service land in the Santa Fe National Forest. Six plaintiff groups, composed of property owners in the area of the Las Conchas Fire, filed separate lawsuits against our Member, Jemez Mountains Electric Cooperative, Inc. (“JMEC”) in the Thirteenth District Court, Sandoval County in the State of New Mexico. Plaintiffs alleged that the fire ignited when a tree growing outside JMEC’s right of way fell onto a distribution line owned by JMEC as a result of high winds. On January 7, 2014, the district court allowed all parties and related parties to amend their complaints to include the addition of us as a party defendant. After JMEC settled with one plaintiff group, the remaining cases were Elizabeth Ora Cox, et al., v. Jemez Mountains Electric Cooperative, Inc., et al.; Norman Armijo, et al., v. Jemez Mountains Electric Cooperative, Inc., et al.; Esequiel Espinoza, et al. v. Allstate Property & Casualty, et al.; Jemez Pueblo v. Jemez Mountains Electric Cooperative, Inc., et al.; and Pueblo de Cochiti., et al. v. Jemez Mountains Electric Cooperative, Inc., et al. The allegations in each case were similar. Plaintiffs alleged that we owed them independent duties to inspect and maintain the right-of-way for JMEC’s distribution line and that we were also jointly liable for any negligence by JMEC under joint venture and joint enterprise theories. A jury trial commenced on September 28, 2015 on the liability aspect of this matter. On October 28, 2015, the jury affirmed our position that we and JMEC did not operate as a joint venture or joint enterprise. The jury did find we owed the plaintiffs an independent duty and allocated comparative negligence with JMEC 75 percent negligent, us 20 percent negligent, and the United States Forest Service 5 percent negligent. We maintain $100 million in liability insurance coverage for this matter. We anticipate appealing the determination of our liability for this matter. If we do not prevail on appeal, we expect our allocation of damages to be covered by our liability insurance. Although we cannot predict the outcome of this matter at this point in time, we do not expect them to have a material adverse effect on our financial condition or our future results of operations or cash flows. In May 2013, near the Village of Pecos, New Mexico, a wildfire known as the Tres Lagunas Fire was ignited and subsequently destroyed timber on thousands of acres and burned for approximately three weeks. On March 25, 2014, a lawsuit was filed by David Old d/b/a Old Wood, The Viveash Ranch, and River Bend Ranch, LLC, against our Member, Mora-San Miguel Electric Cooperative, Inc. (“MSMEC”), in the First Judicial District Court for the County of Santa Fe, New Mexico. In the complaint, plaintiffs alleged that the Tres Lagunas Fire resulted from wind blowing a portion of a dead standing tree into an electric distribution power line owned and operated by MSMEC. On November 6, 2015, plaintiffs filed a motion to amend their complaint and include us as a defendant. The district court approved the motion to amend on November 10, 2015 and plaintiffs filed their first amended complaint. Plaintiffs asserted claims of negligence, violations of New Mexico Unfair Practices Act (“NMUPA”), and strict liability. On December 21, 2015, we filed a motion to dismiss the NMUPA and strict liability claims and, additionally, filed our answer and 12-person jury demand. On February 18, 2016, Tres Lagunas Homeowners Association filed a lawsuit against MSMEC and us in the First Judicial District Court for the County of Santa Fe, New Mexico. In the complaint, the plaintiffs asserted claims of negligence and strict liability against us. On March 18, 2016, we filed a motion to dismiss the strict liability claim and, additionally, filed our answer. In January 2017 and February 2017, all plaintiffs in both lawsuits executed releases that expressly released all claims against us and MSMEC and resulted in a dismissal of both lawsuits with prejudice. NOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED) Unaudited operating results by quarter for 2016 and 2015 are presented below. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for the fair statement of our results of operations for such periods have been included (dollars in thousands): Our business is influenced by seasonal weather conditions, changes in rates and other factors. In the fourth quarter of 2016, operating revenues were $10.4 million higher than the comparable period in 2015 primarily due to the income recognition of $9.2 million of previously deferred 2011 non-member electric sales revenue. Operating expenses increased $7.6 million during the fourth quarter of 2016 compared to the same period in 2015 primarily due to a $16.7 million increase in purchased power expense and a $4.5 million increase in depreciation, amortization and depletion expense partially offset by a $13.9 million decrease in fuel expense. The increase in purchased power expense was due to an increase in MWhs purchased resulting from an increase in renewable energy purchases and a 3.5 percent increase in the average cost per MWh. The increase in depreciation, amortization, and depletion expense was due to a $3.6 million increase related to the shortened lives at the Nucla Generating Station and Craig Station Unit 1. The decrease in fuel expense was primarily due to reduced coal consumption as a result of a decrease in generation. Capital credits from cooperatives increased $11.4 million during the fourth quarter of 2016 compared to the same period in 2015 primarily due to a patronage allocation from Basin of $14.4 million. The increases in operating revenues of $10.4 million and capital credits from cooperatives of $11.4 million were partially offset by the increase in operating expenses of $7.6 million. This resulted in an increase in net margins attributable to us of $15.2 million to $(6.1) million for the fourth quarter of 2016 compared to $(21.3) million for the comparable period in 2015. In the third quarter of 2016, operating margins were $29.2 million lower than the comparable period in 2015 primarily due to a $25.9 million increase in operating expenses. The increase in operating expenses was primarily due to an increase in purchased power expense resulting from power purchase agreements that began in 2016. Depreciation expense also increased due to additions of equipment throughout our transmission system and at our generating stations. In addition, depreciation expense increased (beginning September 1, 2016) as a result of shortening the life of the Craig Station Unit 1 (a monthly increase of $0.2 million) and Nucla Generating Station (a monthly increase of $0.7 million). | Here's a summary of the financial statement:
Revenue:
- Total electric sales revenue was $1.3 million
Profit/Loss:
- No impairments of long-lived assets were recognized in 2016
- Loss is recognized when estimated cash flows are less than the asset's carrying value
Expenses:
- Operating expenses are allocated to participants based on their facility usage
- The company's share of plant asset costs, interest, depreciation, and operating expenses are included in consolidated financial statements
Assets:
- Current assets are reflected in the consolidated financial statements
- Unrealized gains were recorded as of December 31st
Liabilities:
- Subject to debt service ratio (DSR) and equity to capitalization ratio (ECR) requirements
- Supplies wholesale power to members through:
1. Generating facilities
2. Transmission facilities
3. Long-term purchase contracts
4. Short | Claude |
Financial Statements Report of Independent Registered Public Accounting Firm To Board of Directors and Stockholders of Blue Bird Corporation: We have audited the accompanying consolidated balance sheet of Blue Bird Corporation and Subsidiaries (the Company) as of October 1, 2016, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ deficit, and cash flows, for the year ended October 1, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Blue Bird Corporation and Subsidiaries at October 1, 2016, and the results of their operations and their cash flows for the year ended October 1, 2016, in conformity with accounting principles generally accepted in the United States of America. The accompanying supplemental schedule in the index appearing under Item 15(a)(2) has been subjected to audit procedures performed in conjunction with the audit of the Company’s consolidated financial statements. The supplemental schedule is the responsibility of the Company’s management. Our audit procedures included determining whether the supplemental schedule reconciles to the financial statements or the underlying accounting and other records, as applicable, and performing procedures to test the completeness and accuracy of the information presented in the supplemental schedules. In forming our opinion on the supplemental schedule, we evaluated whether the supplemental schedule, including its form and content, is presented in conformity with the standards of the Public Company Accounting Oversight Board (United States). In our opinion, the supplemental schedule is fairly stated, in all material respects, in relation to the consolidated financial statements as a whole. /s/ BDO USA LLP Atlanta, GA December 15, 2016 Report of Independent Registered Public Accounting Firm To Board of Directors and Stockholders of Blue Bird Corporation: In our opinion, the consolidated balance sheet as of October 3, 2015 and the related consolidated statements of operations and comprehensive income (loss), of stockholders’ deficit and of cash flows for each of the two years in the period ended October 3, 2015 present fairly, in all material respects, the financial position of Blue Bird Corporation as of October 3, 2015, and the results of its operations and its cash flows for each of the two years in the period ended October 3, 2015, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for each of the two years in the period ended October 3, 2015 presents fairly, in all material respects, the information set forth therein, when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP Atlanta, GA December 15, 2015 except for the change in the manner in which the company accounts for debt issuance costs as discussed in Note 2 and except for the effects of the revision discussed in Note 14 to the consolidated financial statements, as to which the date is December 15, 2016. BLUE BIRD CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS The accompanying notes are an integral part of these consolidated financial statements. BLUE BIRD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) The accompanying notes are an integral part of these consolidated financial statements. BLUE BIRD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS The accompanying notes are an integral part of these consolidated financial statements. BLUE BIRD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT The accompanying notes are an integral part of these consolidated financial statements. BLUE BIRD CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Nature of Business and Basis of Presentation Nature of Business On February 24, 2015, Hennessy Capital Acquisition Corp. ("HCAC") consummated its business combination (the “Business Combination”), pursuant to which HCAC acquired all of the outstanding capital stock of School Bus Holdings, Inc. (“SBH”) from The Traxis Group B.V. (the “Seller”). SBH operates its business of designing and manufacturing school buses through subsidiaries and under the Blue Bird Corporation (“Blue Bird”) name. In the Business Combination, the total purchase price was paid in a combination of cash ($100 million) and in shares of HCAC’s Common Stock (12,000,000 shares valued at a total of $120 million). In connection with the closing of the Business Combination, we changed our name from Hennessy Capital Acquisition Corp. to Blue Bird Corporation. Upon consummation of the Business Combination, SBH became a wholly-owned subsidiary of Blue Bird Corporation and SBH’s direct and indirect subsidiaries became indirect subsidiaries of our parent corporation. We continued the listing of our Common Stock and Public Warrants on NASDAQ under the symbols “BLBD” and “BLBDW,” respectively, effective February 25, 2015. On May 15, 2015, the NASDAQ Staff informed us orally that we must have 400 round lot holders of our warrants, pursuant to Listing Rule 5410(d), in order for our warrants to continue to be listed on either the NASDAQ Capital Market or the NASDAQ Global Market. Our warrants began trading on the OTCQB on June 2, 2015 as the warrants do not currently meet the round lot requirement. Blue Bird Body Company, a wholly-owned subsidiary of Blue Bird, was incorporated in 1958 and has manufactured, assembled and sold school buses to a variety of municipal, federal and commercial customers since 1927. The majority of Blue Bird’s sales are made to an independent distributor network, which in turn sells buses to ultimate end users. We are headquartered in Fort Valley, Georgia. References in these notes to financial statements to “Blue Bird”, the “Company,” “we,” “our,” or “us” refer to Blue Bird Corporation and its wholly-owned subsidiaries, unless the context specifically indicates otherwise. Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant inter-company transactions and accounts have been eliminated in consolidation. The Company’s fiscal year ends on the Saturday closest to September 30 with its quarters consisting of thirteen weeks in most years. In fiscal years 2016 and 2014, there were a total of 52 weeks. In fiscal year 2015, there was a total of 53 weeks. The Business Combination was accounted for as a reverse acquisition since immediately following completion of the transaction the sole stockholder of SBH immediately prior to the Business Combination maintained effective control of Blue Bird Corporation, the post-combination company. For accounting purposes, SBH is deemed the accounting acquirer in the transaction and, consequently, the transaction is treated as a recapitalization of SBH (i.e., a capital transaction involving the issuance of stock and payment of cash by HCAC for the stock of SBH). Accordingly, the consolidated assets, liabilities and results of operations of SBH are the historical financial statements of Blue Bird Corporation, and HCAC assets, liabilities and results of operations are consolidated with SBH beginning on the acquisition date. No step-up in basis of intangible assets or goodwill was recorded in this transaction. We have effected this treatment through opening stockholders' deficit by adjusting the number of our common shares outstanding. Other than transaction costs paid and a contribution from our majority stockholder for payment of management incentive compensation related to the transaction, the transaction was primarily non-cash and involved exchanges of consideration and equity between our majority stockholder and HCAC and its related entities. Please see Note 14 for discussion of a revision to previously reported earnings per share. 2. Summary of Significant Accounting Policies and Recently Issued Accounting Standards Discontinued Operations In 2007 Blue Bird sold its entire coach business to an unrelated third party. Results of operations for this disposed business have been classified as discontinued operations since 2007. Net income (loss), net of tax, associated with these discontinued operations were $(0.3) million, $(0.1) million, and $0.0 million for the fiscal years ended 2016, 2015, and 2014, respectively. Use of Estimates and Assumptions The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions. At the date of the financial statements, these estimates and assumptions affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities, and during the reporting period, these estimates and assumptions affect the reported amounts of revenues and expenses. For example, significant management judgments are required in determining excess, obsolete, or unsalable inventory, allowance for doubtful accounts, potential impairment of long-lived assets, goodwill and intangibles, the accounting for self-insurance reserves, warranty reserves, pension obligations, income taxes, environmental liabilities and contingencies. Future events and their effects cannot be predicted with certainty, and, accordingly, the Company’s accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of the Company’s consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Company’s operating environment changes. The Company evaluates and updates its assumptions and estimates on an ongoing basis and may employ outside experts to assist in the Company’s evaluations. Actual results could differ from the estimates that the Company has used. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Allowance for Doubtful Accounts Accounts receivable consist of amounts owed to the Company by customers. The Company monitors collections and payments from customers, and generally does not require collateral. Accounts receivable are generally due within 30 to 90 days. The Company provides for the possible inability to collect accounts receivable by recording an allowance for doubtful accounts. The Company reserves for an account when it is considered potentially uncollectible. The Company estimates its allowance for doubtful accounts based on historical experience, aging of accounts receivable and information regarding the creditworthiness of its customers. To date, losses have been within the range of management’s expectations. The Company writes off accounts receivable if it determines that the account is uncollectible. Revenue Recognition The Company recognizes revenue when persuasive evidence of an arrangement exists, ownership has transferred to the customer, the selling price is fixed or determinable, and collectability is reasonably assured. Generally, the Company recognizes revenue, net of sales concessions, when the product is delivered or when the product has been completed, is ready for delivery, has been paid for, its title has transferred and is awaiting pickup by the customer, which generally occurs within 30 days of completion. Provisions for discounts are recorded in the same period as the related revenues. The Company sells extended warranties related to its products. Revenue related to these contracts is recognized on a straight-line basis over the contract period and costs thereunder are expensed as incurred. The Company classifies shipping and handling revenues and costs billed to a customer as net sales on the Consolidated Statements of Operations and Comprehensive Income (Loss) and the related costs incurred by the Company are included in cost of goods sold on the Consolidated Statements of Operations and Comprehensive Income (Loss). See Note 3, Supplemental Financial Information, for further information on warranties and shipping and handling costs. Self-Insurance The Company is self-insured for the majority of its workers’ compensation and medical claims. The expected ultimate cost for claims incurred as of the balance sheet date is not discounted and is recognized as a liability. Self-insurance losses for claims filed and claims incurred but not reported are accrued based upon estimates of the aggregate liability for uninsured claims, using loss development factors and actuarial assumptions followed in the insurance industry and historical loss development experience. See Note 3, Supplemental Financial Information, for further information. Financial Instruments The Company’s financial instruments consist primarily of cash and cash equivalents, trade receivables, accounts payable, revolving credit facilities and long-term debt. The carrying amounts of cash and cash equivalents, trade receivables and accounts payable approximate their fair values because of the short-term maturity and highly liquid nature of these instruments. The carrying value of the Company’s senior term loan approximates fair value due to the variable interest rate. See Note 9, Debt, for further discussion. Inventories The Company values inventories at the lower of cost or market value. The Company uses a standard costing methodology, which approximates cost on a first-in, first-out (“FIFO”) basis. The Company reviews the standard costs of raw materials, work-in-process and finished goods inventory on a periodic basis to ensure that its inventories approximate current actual costs. Manufacturing cost includes raw materials, direct labor and manufacturing overhead. The Company establishes a new cost basis for obsolete inventory based on historical usage and assumptions about future demand. Property, Plant and Equipment Property, plant and equipment are stated at cost, less accumulated depreciation. Depreciation is calculated on a straight-line basis using the following periods, which represent the estimated useful lives of the assets: Costs, including capitalized interest and certain design, construction and installation costs related to assets that are under construction and are in the process of being readied for their intended use, are recorded as construction in progress and are not subject to depreciation. Repairs and maintenance that do not extend the useful life of the asset are expensed as incurred. Upon sale, retirement, or other disposition of these assets, the costs and related accumulated depreciation are removed from the respective accounts and any gain or loss on the disposition is included in our Consolidated Statements of Operations and Comprehensive Income (Loss). Impairment of Long-Lived Assets The Company reviews its long-lived assets, including property, plant and equipment, for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. To analyze recoverability, undiscounted future cash flows over the estimated remaining life of the asset are projected. If these projected cash flows are less than the carrying amount, an impairment loss is recognized to the extent the fair value of the asset less any costs of disposition is less than the carrying amount of the asset. Judgments regarding the existence of impairment indicators are based on market and operational performance. Evaluating potential impairment also requires estimates of future operating results and cash flows. No impairment charge was recognized in any of the periods presented. Goodwill and Intangible Assets Goodwill represents the excess of the purchase price of acquired businesses over the fair value of the assets acquired less liabilities assumed in connection with such acquisition. In accordance with the provisions of ASC 350, Intangibles-Goodwill and Other, goodwill and intangible assets with indefinite useful lives acquired in an acquisition are not amortized, but instead are tested for impairment at least annually or more frequently should an event occur or circumstances indicate that the carrying amount may be impaired. Such events or circumstances may be a significant change in business climate, economic and industry trends, legal factors, negative operating performance indicators, significant competition, changes in strategy or disposition of a reporting unit or a portion thereof. We have two reporting units for which we test goodwill for impairment: Bus and Parts. In the evaluation of goodwill for impairment, we have the option to perform a qualitative assessment to determine whether further impairment testing is necessary or to perform a quantitative assessment by comparing the fair value of a reporting unit to its carrying amount, including goodwill. Under the qualitative assessment, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. If, under the quantitative assessment, the fair value of a reporting unit is less than its carrying amount, then the amount of the impairment loss, if any, must be measured under step two of the impairment analysis. In step two of the analysis, we would record an impairment loss equal to the excess of the carrying value of the reporting unit’s goodwill over its implied fair value, should such a circumstance arise. Fair value of the reporting units is estimated primarily using the income approach, which incorporates the use of discounted cash flow (DCF) analysis. A number of significant assumptions and estimates are involved in the application of the DCF model to forecast operating cash flows, including markets and market shares, sales volumes and prices, costs to produce, tax rates, capital spending, discount rate and working capital changes. The cash flow forecasts are based on approved strategic operating plans and long-term forecasts. In the evaluation of indefinite lived assets for impairment, we have the option to perform a qualitative assessment to determine whether further impairment testing is necessary, or to perform a quantitative assessment by comparing the fair value of an asset to its carrying amount. The Company’s intangible asset with an indefinite useful life is the "Blue Bird" trade name. Under the qualitative assessment, an entity is not required to calculate the fair value of the asset unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. If a qualitative assessment is not performed or if a quantitative assessment is otherwise required, then the entity compares the fair value of an asset to its carrying amount and the amount of the impairment loss, if any, is the difference between fair value and carrying value. The fair value of our trade name is derived by using the relief from royalty method, which discounts the estimated cash savings we realized by owning the name instead of otherwise having to license or lease it. Our intangible assets with a definite useful life are amortized over their estimated useful lives, 7 or 20 years, using the straight-line method. The useful lives of our intangible assets are reassessed annually and they are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Debt Issue Costs Amounts paid directly to lenders or as an original issue discount and amounts classified as issuance costs are recorded as a reduction in the carrying value of the debt, for which the Company had deferred financing costs totaling $9.4 million and $11.1 million at October 1, 2016 and October 3, 2015, respectively, incurred in connection with its debt facilities and related amendments. Commitment fees and other costs directly associated with obtaining revolving credit facilities are deferred financing costs which are recorded in other assets on the Consolidated Balance Sheets, for which the Company recorded $0.7 million and $0.9 million at October 1, 2016 and October 3, 2015, respectively. All deferred financing costs are amortized to interest expense. The effective interest method is used for debt discounts related to the term loan; issue costs related to the revolver are amortized using the straight-line method. The Company’s amortization of these costs was $3.0 million, $3.0 million and $1.3 million for the fiscal years ended 2016, 2015 and 2014, respectively, and are reflected in the Consolidated Statements of Operations and Comprehensive Income (Loss) as a component of interest expense. See Note 9, Debt, for a discussion of the Company’s indebtedness. Derivative Instruments In limited circumstances, we utilize derivative instruments to manage certain exposures to changes in foreign currency exchange rates. The fair values of all derivative instruments are recognized as assets or liabilities at the balance sheet date. Changes in the fair value of these derivative instruments are recognized in our operating results or included in other comprehensive income (loss), depending on whether the derivative instrument is a fair value or cash flow hedge and whether it qualifies for hedge accounting treatment. If realized, gains and losses on derivative instruments are recognized in the Consolidated Statements of Operations and Comprehensive Income (Loss) in the line item that reflects the underlying exposure that was hedged. The exchange of cash, if any, associated with derivative transactions is classified in the Consolidated Statements of Cash Flows in the same category as the cash flows from the items subject to the economic hedging relationships. See Note 18, Foreign Exchange Contracts, for further information. Pensions The Company accounts for its pension benefit obligations using actuarial models. The measurement of plan obligations and assets was made at September 30, 2016. Effective January 1, 2006, the benefit plan was frozen to all participants. No accrual of future benefits is earned or calculated beyond this date. Accordingly, our obligation estimate is based on benefits earned at that time discounted using an estimate of the single equivalent discount rate determined by matching the plan’s future expected cash flows to spot rates from a yield curve comprised of high quality corporate bond rates of various durations. The Company recognizes the funded status of its pension plan obligations in its consolidated balance sheet and records in other comprehensive income (loss) certain gains and losses that arise during the period, but are deferred under pension accounting rules. Product Warranty Costs The Company’s products are generally warranted against defects in material and workmanship for a period of one to five years. A provision for estimated warranty costs is recorded in the year the unit is sold. The methodology to determine the warranty reserve calculates average expected warranty claims using warranty claims by body type, by month, over the life of the bus, which is then multiplied by remaining months under warranty, by warranty type. Management believes the methodology provides for accuracy in addressing reserve requirements. Management believes the warranty reserve is appropriate; however, actual claims incurred could differ from the original estimates, requiring future adjustments. The Company also sells extended warranties related to its products. Revenue related to these contracts is recognized on a straight-line basis over the contract period and costs thereunder are expensed as incurred. All warranty expenses are recorded in the cost of goods sold line on the Consolidated Statements of Operations and Comprehensive Income (Loss). The current methodology to determine short-term extended warranty income reserve is based on twelve months of the remaining warranty value for each effective extended warranty at the balance sheet date. See Note 3, Supplemental Financial Information, for further information. Research and Development Research and development costs are expensed as incurred and included in selling, general and administrative expenses in our Consolidated Statements of Operations and Comprehensive Income (Loss). For the fiscal years ended 2016, 2015 and 2014, the Company expensed $5.4 million, $5.2 million and $3.7 million, respectively, in the Consolidated Statements of Operations and Comprehensive Income (Loss), related to research and development. Income Taxes The Company accounts for income taxes in accordance with ASC 740, Income Taxes (“ASC 740”), which requires an asset and liability approach to financial accounting and reporting for income taxes. Under this approach, deferred income taxes represent the expected future tax consequences of temporary differences between the financial statement and tax basis of assets and liabilities. The Company evaluates its ability, based on the weight of evidence available, to realize future tax benefits from deferred tax assets and establishes a valuation allowance to reduce a deferred tax asset to a level which, more likely than not, will be realized in future years. The Company recognizes uncertain tax positions based on a cumulative probability assessment if it is more likely than not that the tax position will be sustained upon examination by an appropriate tax authority with full knowledge of all information. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Amounts recorded for uncertain tax positions are periodically assessed, including the evaluation of new facts and circumstances, to ensure sustainability of the positions. The Company records interest and penalties related to unrecognized tax benefits in income tax expense. Environmental Liabilities The Company records reserves for environmental liabilities on a discounted basis when environmental investigation and remediation obligations are probable and related costs are reasonably estimable. See Note 11, Guarantees, Commitments and Contingencies, for further discussion. Segment Reporting Operating segments are components of an entity that engage in business activities with discrete financial information available that is regularly reviewed by the chief operating decision maker (“CODM”) in order to assess performance and allocate resources. The Company’s CODM is the Company’s President and Chief Executive Officer. As discussed further in Note 12, Segment Information, the Company determined its operating and reportable segments to be Bus and Parts. The Bus segment includes the manufacturing and assembly of school buses to be sold to a variety of customers across the United States, Canada and in international markets. The Parts segment consists primarily of the purchase of parts from third parties to be sold to dealers within the Company’s network. Recently Adopted Accounting Standards ASU 2016-09 - In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (ASU) No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which simplifies the accounting for some aspects of share-based payment transactions, including the income tax treatment of excess tax benefits and deficiencies, forfeitures, classification of share-based awards as either equity or liabilities, and classification in the statement of cash flows for certain share-based transactions related to tax benefits and payments. ASU 2016-09 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods, and early adoption is permitted. The Company has elected to early adopt ASU 2016-09 beginning with the second quarter ended April 2, 2016, resulting in windfall and shortfall taxes from vested awards to be recorded as income tax expense or benefit in the income statement as well as classified with income tax transactions in the operating section of the cash flow statement. Additionally, employee taxes paid on shares withheld for tax-withholding purposes were recognized as a financing activity in the cash flow statement. ASU 2015-04 - In April 2015, the FASB issued ASU No. 2015-04, Compensation-Retirement Benefits (Topic 715): Practical Expedient for the Measurement Date of an Employer's Defined Benefit Obligation and Plan Assets, which applies to employers that provide pension or other post-retirement benefits as part of a special termination benefit or special or contractual termination benefits not otherwise addressed in other Subtopics (for example, benefits paid at or before retirement and not paid out of a pension or other post-retirement plan). The ASU also applies to settlement of all or a part of an employer's pension or other post-retirement benefit obligation or curtailment of a pension or other post-retirement benefit plan. This new guidance is effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Earlier adoption is permitted. We adopted this standard as of the end of our 2016 fiscal year, and the adoption of this ASU did not have a material impact on our consolidated financial statements. ASU 2015-03 - In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability. During the first quarter of 2016, the Company adopted ASU 2015-03, and as a result, reclassified $1.2 million of debt issuance costs, net, from other assets to long-term debt on the consolidated balance sheet at October 3, 2015. Long-term debt at October 3, 2015 was previously presented as $176.6 million and long-term debt is now presented as $175.4 million at October 3, 2015. Recently Issued Accounting Standards ASU 2016-15- In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted. This standard will not be effective for us until fiscal 2018 and requires adoption on a retrospective basis unless it is impracticable to apply, in which case the Company would be required to apply the amendments prospectively as of the earliest date practicable. The Company is currently evaluating the impact this guidance will have on the financial statements and related disclosures. ASU 2016-12 and 2016-10 - In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, and in April 2016 issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, both of which provide further clarification to be considered when implementing ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The ASUs are effective concurrently with ASU 2014-09, which is effective for the Company in fiscal 2019. The Company is currently evaluating the impact this guidance will have on the financial statements and related disclosures. ASU 2016-02 - In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to recognize assets on the balance sheet for the rights and obligations created by all leases with terms greater than 12 months. The standard will also require certain qualitative and quantitative disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. This standard will not be effective for us until fiscal 2020. We are currently evaluating the impact the standard will have on our consolidated financial statements. ASU 2015-17 - In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which simplifies the presentation of deferred taxes by requiring deferred tax assets and liabilities to be classified as non-current on the balance sheet. The standard is effective for public companies for annual reporting periods beginning after December 15, 2016, and interim periods within those fiscal years. The guidance may be adopted prospectively or retrospectively and early adoption is permitted. The adoption of this ASU would result in the reclassification of $7.6 million and $9.2 million at October 1, 2016 and October 3, 2015, respectively, from current assets to non-current assets. Future impact will be driven by the composition of our deferred tax accounts. 3. Supplemental Financial Information Accounts Receivable Accounts receivable consist of amounts owed to the Company by customers. The Company monitors collections and payments from customers, and generally does not require collateral. Accounts receivable are generally due within 30 to 90 days. The Company provides for the possible inability to collect accounts receivable by recording an allowance for doubtful accounts. The Company reserves for an account when it is considered potentially uncollectible. The Company estimates its allowance for doubtful accounts based on historical experience, aging of accounts receivable and information regarding the creditworthiness of its customers. To date, losses have been within the range of management’s expectations. The Company writes off accounts receivable once it is determined that the account is uncollectible. Accounts receivable, net, consisted of the following at the dates indicated: Product Warranties The Company's products are generally warranted against defects in material and workmanship for a period of one to five years. A provision for estimated warranty costs is recorded in the year the unit is sold. The methodology to determine warranty reserve calculates average expected warranty claims using warranty claims by body type, by month, over the life of the bus, which is then multiplied by remaining months under warranty, by warranty type. Management believes the methodology provides for accuracy in addressing reserve requirements. Actual claims incurred could differ from the original estimates, requiring future adjustments. The Company also sells extended warranties related to its products. Revenue related to these contracts is recognized on a straight-line basis over the contract period and costs thereunder are expensed as incurred. All warranty expenses are recorded in the cost of goods sold line in the Consolidated Statements of Operations and Comprehensive Income (Loss). The current methodology to determine short-term extended warranty income reserve is based on twelve months of the remaining warranty value for each effective extended warranty at the balance sheet date. The following table reflects activity in accrued warranty cost (current and long-term portion combined) for the fiscal years presented: The following table reflects activity in deferred warranty income (current and long-term portion combined), for the sale of extended warranties of two to five years, for the fiscal years presented: Self-Insurance The following table reflects the total accrued self-insurance liability, comprised of workers' compensation and health insurance related claims, at the dates indicated: The current and long-term portions of the accrued self-insurance liability are included in accrued expenses and other liabilities, respectively, on the accompanying Consolidated Balance Sheets. Shipping and Handling Shipping and handling revenues represent costs billed to customers and are presented as part of net sales on the accompanying Consolidated Statements of Operations and Comprehensive Income (Loss). Shipping and handling costs incurred are included in cost of goods sold. Shipping and handling revenues recognized were $17.6 million, $16.9 million and $16.0 million for the fiscal years ended 2016, 2015 and 2014, respectively. The related cost of goods sold was $15.4 million, $14.4 million and $14.2 million for the fiscal years ended 2016, 2015 and 2014, respectively. 4. Business Combination and Subsequent Change in Control Background and Summary The Company was originally formed in September 2013 as a special purpose acquisition company, or SPAC, under the name Hennessy Capital Acquisition Corp. (“HCAC” or “Hennessy Capital”) for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination involving HCAC and one or more businesses. As a SPAC, HCAC was a shell (blank check) company that had no operations and whose purpose was to go public with the intention of merging with or acquiring a company with the proceeds of the SPAC’s initial public offering (IPO). Until the consummation of the Business Combination, HCAC’s securities were traded on The NASDAQ Stock Market (“NASDAQ”) under the ticker symbols “HCAC,” “HCACU” and “HCACW”. On September 21, 2014, Hennessy Capital Partners I LLC (the “HCAC Sponsor”) signed a purchase agreement (the “Purchase Agreement”) with The Traxis Group B.V, (the "Seller") to acquire all of the outstanding stock of SBH. The material terms and conditions of the Purchase Agreement were described in Hennessy Capital’s definitive proxy statement filed with the SEC on January 20, 2015, which was supplemented in additional proxy statement materials filed with the SEC on February 10, 2015. On February 24, 2015, HCAC consummated its Business Combination, pursuant to which HCAC acquired all of the outstanding capital stock of SBH from the Seller. SBH operates its business of designing and manufacturing school buses through subsidiaries and under the “Blue Bird” name. In the Business Combination, the total purchase price was paid in a combination of cash ($100 million) and in shares of HCAC’s Common Stock (12,000,000 shares valued at a total of $120 million). In connection with the closing of the Business Combination, we changed our name from Hennessy Capital Acquisition Corp. to Blue Bird Corporation. Preferred Stock Subscription Agreement In connection with its execution of the Purchase Agreement, Hennessy Capital entered into a preferred stock subscription agreement with The Osterweis Strategic Income Fund and The Osterweis Strategic Investment Fund (collectively, the “PIPE Investment Investor”). In the preferred stock subscription agreement, the PIPE Investment Investor agreed to purchase from Hennessy Capital, concurrent with the consummation of the closing of the Business Combination, 400,000 shares of Series A Convertible Preferred Stock for gross proceeds of approximately $40 million, subject to a possible increase to up to 500,000 shares or approximately $50 million (the “PIPE Investment”). On February 18, 2015, Hennessy Capital entered into a subscription agreement with four funds managed by Coliseum Capital Management, LLC (the “Common/Preferred Investor”) pursuant to which the Common/Preferred Investor agreed to purchase $25 million worth of shares of Hennessy Capital common stock, through (i) open market or privately negotiated transactions with third parties, at a purchase price of up to $10.00 per share, (ii) a private placement with consummation to occur concurrently with that of the Business Combination at a purchase price of $10.00 per share or (iii) a combination thereof, and further agreed to purchase 100,000 shares of Series A Convertible Preferred Stock pursuant to a private placement for gross proceeds of approximately $10.0 million to occur concurrently with that of the Business Combination (the “Subsequent PIPE Investment”). Business Combination Approval and Consummation On February 23, 2015, the Business Combination was approved by Hennessy Capital’s stockholders. On February 24, 2015, the parties consummated the Business Combination. The total purchase price was paid in a combination of cash ($100 million) and in shares of the registrant’s common stock (12,000,000 shares valued at a total of $120 million). In connection with the closing of the Business Combination, the Company redeemed a total of 7,494,700 shares of its common stock pursuant to the terms of the Company’s amended and restated certificate of incorporation, resulting in a total cash payment from Hennessy Capital’s trust account to redeeming stockholders of $75 million. On February 24, 2015, at the closing of the Business Combination, the PIPE Investment Investor purchased 400,000 shares of the Company’s Series A Convertible Preferred Stock from the Company for aggregate gross proceeds of approximately $40 million and the Common/Preferred Investor purchased 100,000 shares of the Company’s Series A Convertible Preferred Stock from the Company for aggregate gross proceeds of approximately $10 million. In addition, at the closing, the Common/Preferred Investor purchased 2,500,000 shares of the Company’s common stock from the Company for aggregate gross proceeds of $25 million. Registration Rights Agreement On February 24, 2015, the Company entered into a registration rights agreement with the Seller and other investors including the PIPE Investment Investor and Common/Preferred Investor (the “Registration Rights Agreement”). The parties were granted registration rights that obligate the Company to register for resale, among other shares, all or any portion of the shares of the Company’s capital stock that were issued by the Company in connection with the Business Combination and the PIPE Investment and the Subsequent PIPE Investment (including the shares of common stock underlying the Series A Preferred Stock issued pursuant to the PIPE Investment and the Subsequent PIPE Investment). On April 27, 2015, a registration statement on Form S-3 filed by the Company in connection with, among other things, its obligations under the Registration Rights Agreement, was declared effective by the SEC. Under the Registration Rights Agreement, the parties also hold “piggyback” registration rights exercisable at any time that allow them to include the shares of Company common stock that they own in any public offering of equity securities initiated by us (other than those public offerings pursuant to registration statements on forms that do not permit registration for resale by them). The “piggyback” registration rights are subject to proportional cutbacks based on the manner of such offering and the identity of the party initiating such offering. The Company will pay all expenses incidental to its performance under the Registration Rights Agreement, as well as the underwriting discounts and commissions payable by the parties to that agreement in connection with the sale of their shares under the Registration Rights Agreement. Change in Control Pursuant to, and subject to the terms of, a Purchase and Sale Agreement, dated as of May 26, 2016 (the “Purchase and Sale Agreement”), by and among The Traxis Group B.V. ("Traxis"), ASP BB Holdings LLC, a Delaware limited liability company (“ASP”), and the Company, Traxis agreed to sell and ASP agreed to purchase all of the 12,000,000 shares of Common Stock of the Company owned by Traxis (the “Transaction Shares”). Subject to the terms and conditions set forth in the Purchase and Sale Agreement, ASP acquired 7,000,000 Transaction Shares at an initial closing on June 3, 2016 for an amount in cash equal to $10.10 per share, and 5,000,000 Transaction Shares at a second closing on June 8, 2016 for an amount in cash equal to $11.00 per share, for an aggregate purchase price of $125.7 million. Rights held by Traxis under the Registration Rights Agreement were transferred to ASP in conjunction with the Purchase and Sale Agreement. The Company was not a part of the transaction and there were no proceeds to the Company, resulting in no required accounting treatment; however, the sale of Transaction Shares did trigger a phantom equity compensation payment as further discussed in Note 15, Share-Based Compensation. The payment was primarily funded by Traxis and not by the Company. 5. Inventory The Company values inventory at the lower of cost or market value. The Company uses a standard costing methodology, which approximates cost on a first-in, first-out basis. The Company reviews the standard costs of raw materials, work-in-process and finished goods inventory on a periodic basis to ensure that its inventory values approximate current actual costs. Manufacturing cost includes raw materials, direct labor and manufacturing overhead. The following table presents the components of inventory at the dates indicated: 6. Property, Plant and Equipment Property, plant and equipment consisted of the following at the dates indicated: Depreciation and amortization expense for property, plant and equipment was $6.1 million, $6.9 million, and $8.0 million for the fiscal years ended 2016, 2015, and 2014, respectively. 7. Goodwill The carrying amounts of goodwill by reporting unit are as follows at the dates indicated: During the fourth quarters of the fiscal years ended 2016 and 2015, we performed our annual impairment assessment of goodwill which did not indicate that an impairment existed; therefore, no impairments of goodwill have been recorded. 8. Other Intangible Assets The gross carrying amounts and accumulated amortization of intangible assets are as follows at the dates indicated: Management considers the "Blue Bird" trade name to have an indefinite useful life and, accordingly, it is not subject to amortization. Management reached this conclusion principally due to the longevity of the Blue Bird name and because management considers renewal upon reaching the legal limit of the trademarks related to the trade name as perfunctory. The Company expects to maintain usage of the trade name on existing products and introduce new products in the future that will also display the trade name. During the fourth quarters of the fiscal years ended 2016 and 2015, we performed our annual impairment assessment of our trade name, which did not indicate that an impairment existed; therefore, no impairments of our indefinite lived intangibles have been recorded. Customer relationships are amortized on a straight-line basis over an estimated life of 20 years. Engineering designs were acquired and placed in service near the end of fiscal 2016 and will be amortized on a straight-line basis over an estimated life of 7 years. Total amortization expense for intangible assets was $1.9 million, $1.9 million, and $1.9 million for the fiscal years ended 2016, 2015, and 2014, respectively. Amortization expense for finite lived intangible assets for the next five years is expected to be as follows: 9. Debt In June 2014, Blue Bird Body Company, a wholly-owned subsidiary of the Company, executed a $235.0 million six year senior term loan provided by Societe Generale (the “Senior Credit Facility”), which acts as the administrative agent, SG Americas Securities LLC, Macquarie Capital (USA) INC., and Fifth Third Bank as joint book runners and Joint Lead Arrangers. The Senior Credit Facility amortizes at 5% per annum, payable quarterly, which started on January 3, 2015. The interest rate on the Senior Credit Facility is an election of either base rate plus 450 basis points or LIBOR (floor of 1 point) plus 550 basis points, and was 6.5% at both October 1, 2016 and October 3, 2015. Blue Bird also has access to a $60.0 million revolving senior credit facility provided by Societe Generale (the “Senior Revolving Credit Facility”), which acts as the administrative agent, SG Americas Securities LLC and Macquarie Capital (USA) INC. The Senior Revolving Credit Facility carries an elective interest rate of either the base rate plus 450 basis points or LIBOR plus 550 basis points. Blue Bird may request letters of credit through its Senior Revolving Credit Facility up to a $15.0 million sub limit. The commitment fee on unused amounts of the Senior Revolving Credit Facility is 0.5%. The Senior Credit Facility and the Senior Revolving Credit Facility are collectively referred to as the "Credit Agreement". The Credit Agreement contains negative and affirmative covenants affecting the Company and their existing and future restricted subsidiaries, with certain exceptions set forth in the Credit Agreement. The negative covenants and restrictions include, among others: limitations on liens, dispositions of assets, consolidations and mergers, loans and investments, indebtedness, transactions with affiliates (including management fees and compensation), dividends, distributions and other restricted payments, change in fiscal year, fundamental changes, amendments to and subordinated indebtedness, restrictive agreements, and certain permitted acquisitions. At October 1, 2016, the borrower and the guarantors were in compliance with all covenants in the Credit Agreement. The obligations under the Credit Agreement and the related loan documents (including without limitation, the borrowings under the Senior Credit Facility and the Senior Revolving Credit Facility and obligations in respect of certain cash management and hedging obligations owing to the agents, the lenders or their affiliates), are, in each case, secured by a lien on and security interest in substantially all of the assets of the Company and each of the guarantors, with certain exclusions as set forth in a Collateral Agreement entered into by the Company and each guarantor. The Senior Credit Facility and the Senior Revolving Credit Facility were executed on June 27, 2014, amended on September 28, 2015, and further amended on June 6, 2016. The Senior Credit Facility has a six year term and the Senior Revolving Credit Facility originally had a five year term but was amended to a six year term in September 2015. The Senior Credit Facility September 2015 amendment was to permit the Company to pay its preferred share dividends in cash, to permit the Company to tender cash for its existing warrants from available amounts (as further defined in the credit agreement), to amend the definition of consolidated EBITDA to allow an add back of third party expenses related to being a public company, to add Blue Bird Corporation as a guarantor, and to otherwise amend various restricted payment requirements. An amendment in June 2016 changed the definition of Sponsor, as defined in the Credit Agreement, contingent upon a change in control. The Company incurred $1.1 million in lender fees related to the June 2016 amendment, which were capitalized to the debt and will be amortized to interest expense over the remaining life of the loan, resulting in an increase in the weighted-average annual effective interest rate. Debt consisted of the following at the dates indicated: At October 1, 2016 and October 3, 2015, $161.5 million and $198.3 million, respectively, were outstanding on this indebtedness. On June 30, 2016, the Company made a $25.0 million prepayment of principal in addition to the regular payments due. At October 1, 2016 and October 3, 2015, the Senior Credit Facility's weighted-average annual effective interest rate was 8.3% and 7.8%, respectively, which includes amortization of the deferred financing costs. Our term loan is recognized on the Company’s balance sheet at its unpaid principal balance, net of deferred financing costs, and is not subject to fair value measurement; however, given that the loan carries a variable rate, the Company estimates that the unpaid principal balance of the term loan would approximate its fair value. If measured at fair value in the financial statements, the Company’s term loan would be classified as Level 2 in the fair value hierarchy. No borrowings were outstanding on the Senior Revolving Credit Facility at October 1, 2016; however, since there were $5.1 million of Letters of Credit outstanding on October 1, 2016, the Company would have been able to borrow $54.9 million on the revolving line of credit. Interest expense on all indebtedness for the fiscal years ended 2016, 2015 and 2014 was $16.4 million, $19.1 million and $6.2 million, respectively. The remaining principal maturities for the Senior Credit Facility and the Senior Revolving Credit Facility for the next five fiscal years are as follows: 10. Income Taxes The components of income tax expense were as follows for the fiscal years presented: As a result of the Business Combination during the fiscal year ended 2015, a change in the ownership of the Company occurred which, pursuant to the Internal Revenue Code, will limit on an annual basis the Company's ability to utilize its U.S. Net Operating Losses ("NOLs") and U.S. tax credits. The Company's NOLs and credits will continue to be available to offset taxable income and tax liabilities (until such NOLs and credits are either used or expire), subject to the Section 382 annual limitation. If the annual limitation amount is not fully utilized in a particular tax year, then the unused portion from that particular tax year will be added to the annual limitation in subsequent years. During the fiscal year ended 2016, the Company had a Change in Control of its majority shareholder and does not expect any Section 382 limitations to impair the Company's ability to realize all tax attributes. At October 1, 2016, the Company had approximately $1.9 million of federal tax credit carryforwards that expire at various dates through 2036. The effective tax rates for the fiscal years ended 2016, 2015 and 2014 were 57.9%, 26.3% and 87.4%, respectively. The effective tax rate for the fiscal year ended 2016 differed from the statutory federal income tax rate of 35%, primarily as a result of discrete items increasing tax expense in the period, including a change in investor tax on our non-consolidated affiliate income, the application of tax credits claimed as offsets against our payroll tax liabilities, interest and penalties on uncertain tax positions, limitations of the deductibility of certain share-based compensation, a net tax shortfall associated with the vesting of share-based compensation awards pursuant to adoption of ASU 2016-09 (refer to Note 2), which were partially offset by recording the impact of new tax legislation. The effective tax rate for the fiscal year ended 2015 differed from the statutory federal income tax rate of 35% primarily as a result of a benefit from the change in investor tax on our non-consolidated affiliate, domestic production activities deduction, state tax items and other permanent items which were partially offset by interest and penalties on an uncertain tax position and transaction costs. The effective tax rate for the fiscal year ending 2014 differed from the statutory federal income tax rate of 35% primarily as a result of the recording of an uncertain tax position which negatively impacted our rate, partially offset by a benefit from the domestic production activities deduction. A reconciliation between the reported income tax expense for continuing operations and the amount computed by applying the statutory federal income tax rate of 35% is as follows: During fiscal 2015, there were changes in assumptions about the Company’s ability to utilize U.S. foreign tax credits. The resulting tax rate change was applied to the cumulative beginning of year deferred tax balance for the non-consolidated affiliate, and a $1.7 million benefit was recorded to fiscal 2015 tax expense. The total amount of gross unrecognized tax benefits at October 1, 2016 and October 3, 2015 were $6.4 million and $6.4 million, respectively, which would affect the Company’s effective tax rate if realized. The Company’s liability arising from uncertain tax positions is recorded in other non-current liabilities on the Consolidated Balance Sheets. The Company recognizes accrued interest and penalties related to unrecognized tax benefits as income tax expense. The accrued interest and penalties were $2.1 million and $1.1 million at October 1, 2016 and October 3, 2015, respectively. The Company is subject to taxation mostly in the United States and various state jurisdictions. At October 1, 2016, tax years prior to 2011 are no longer subject to examination by federal and most state tax authorities. The following table sets forth the sources of and differences between the financial accounting and tax bases of the Company’s assets and liabilities which give rise to the net deferred tax assets at the dates indicated: 11. Guarantees, Commitments and Contingencies Litigation At October 1, 2016, the Company had a number of product liability and other cases pending. Management believes that, considering the Company’s insurance coverage and its intention to vigorously defend its positions, the ultimate resolution of these matters will not have a material adverse impact on the Company’s financial statements. Environmental The Company is subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous materials used in its manufacturing processes. Failure by the Company to comply with present and future regulations could subject it to future liabilities. In addition, such regulations could require the Company to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. The Company is currently not involved in any material environmental proceedings and therefore management believes that the resolution of environmental matters will not have a material adverse effect on the Company’s financial statements. Our environmental liability using a discount rate of 12%, included in current accrued expenses and other long-term liabilities on the Consolidated Balance Sheets, was $0.6 million and $0.5 million at October 1, 2016 and October 3, 2015, respectively. The estimated aggregate undiscounted amount that will be incurred over the next 11 years is $1.1 million. The estimated payments for each of the next five years are $0.1 million per year and the aggregate amount thereafter is $0.6 million. Future expenditures may exceed the amounts accrued and estimated. Lease Commitments The Company leases certain buildings, machinery and equipment under operating leases expiring at various dates. Total rent expense was $1.2 million, $1.5 million and $1.7 million for the fiscal years ended 2016, 2015 and 2014, respectively. The following table sets forth future minimum lease payments under non-cancelable operating leases with original terms exceeding one year at October 1, 2016: The Company leases from third party vendors various office and plant equipment, including computers, copy machines, and sweepers, which qualify for capital lease treatment under the provisions of ASC 840. On the Consolidated Balance Sheets, amounts due under capital lease obligations are included in other liabilities, current and long-term, with the interest in the related assets recorded in property, plant and equipment, net. Depreciation of assets recorded under capital lease obligations is included in cost of goods sold or selling, general and administrative expenses, depending upon use of leased property, on the Consolidated Statements of Operations and Comprehensive Income (Loss). These leases have remaining lease terms ranging from 1 month to 6.3 years. Leased property under capital leases at the dates indicated is presented in the following table: The following table summarizes the Company’s future minimum lease payments under capital leases at October 1, 2016: Purchase Commitments During the fiscal years ended 2016 and 2015, the Company entered into short-term and long-term pricing agreements with many of its major suppliers for the purchase of raw materials and parts such as steel, engines, axles and transmissions. As the quantities to be purchased by the Company vary subject to market demand of vehicles manufactured by the Company, under these agreements there are no minimum purchase commitments with the exception of propane fuel systems, engines, and tonnages of certain steel products that are repetitively consumed. At October 1, 2016, commitments for future production material totaled approximately $8.4 million. The amount of these commitments for the next five fiscal years is expected to be as follows: 12. Segment Information We manage our business in two operating segments, which are also our reportable segments. The Bus segment includes the manufacturing and assembly of school buses to be sold to a variety of customers across the United States, Canada and in international markets. The Parts segment consists primarily of the purchase of parts from third parties to be sold to dealers within the Company’s network. Financial information is reported on the basis that it is used internally by the chief operating decision maker (the “CODM”) in evaluating segment performance and deciding how to allocate resources. The President and Chief Executive Officer of the Company has been identified as the CODM. Management evaluates the segments based primarily upon revenues and gross profit. A measure of assets is not applicable, as segment assets are not regularly reviewed by the CODM for evaluating performance or allocating resources. The tables below present segment net sales and gross profit for the fiscal years presented: Net sales Gross profit The following table is a reconciliation of segment gross profit to consolidated income before income taxes for the fiscal years presented: Sales are attributable to geographic areas based on customer location and were as follows for the fiscal years presented: 13. Stockholders’ Deficit Stock Authorized Stock Our Certificate of Incorporation authorizes the issuance of 110,000,000 shares, consisting of 100,000,000 shares of common stock at $0.0001 par value per share, and 10,000,000 shares of preferred stock at $0.0001 par value per share, 2,000,000 of which have been designated as Series A Convertible Preferred Stock (“Preferred” or "Convertible Preferred Stock") and the remaining 8,000,000 of which are undesignated. The outstanding shares of our Series A Convertible Preferred Stock and common stock are duly authorized, validly issued, fully paid and non-assessable. Common Stock On February 24, 2015, we sold 2,500,000 shares of common stock at $10.00 per share in a private placement. Proceeds from the sale were part of the consideration received by our majority owner as part of a recapitalization and reverse acquisition completed in the Business Combination. We also issued (i) 12,000,000 shares of common stock to the Seller upon consummation of the Business Combination, and (ii) 102,750 shares of common stock as a utilization fee to another investor. Please see Note 4, Business Combination, for a further discussion of these transactions. Convertible Preferred Stock By the filing of a Certificate of Designations (the “Certificate of Designations”) on February 24, 2015, we have designated 2,000,000 shares of preferred stock as Series A Convertible Preferred Stock and, on February 24, 2015, we issued 500,000 shares of such series. Proceeds from the sale were part of the consideration received by our majority owner as part of a recapitalization and reverse acquisition completed in the Business Combination. Please see Note 4, Business Combination, for a further discussion of the transaction. Each share of Series A Convertible Preferred Stock is convertible, at the holder’s option at any time, initially into 8.6 shares of our common stock (which is equivalent to an initial conversion price of approximately $11.59 per share), subject to specified adjustments as set forth in the Certificate of Designations. A Fundamental Change, as defined in the Certificate of Designations, was triggered on June 8, 2016 in connection with the second closing of the sale of the Transaction Shares, which allowed the preferred holders to convert on an adjusted basis for a designated conversion period. None of the Preferred shareholders elected to convert within the designated conversion period. In addition, beginning on or after the third anniversary of the initial issuance date, we have the right, at our option, to cause all outstanding shares of the Series A Convertible Preferred Stock to be automatically converted into shares of common stock under certain circumstances and, if our Company undergoes certain fundamental changes, the Series A Convertible Preferred Stock will automatically be converted into common stock on the effective date of such fundamental change. Holders of Series A Convertible Preferred Stock are entitled to receive when, as and if declared by the Board, dividends which are payable at a rate of 7.625% per annum. Unless prohibited by applicable law, the Board shall not fail to declare such dividends on the Series A Convertible Preferred Stock. Dividends accrue for all fiscal periods the Series A Convertible Preferred Stock is outstanding. The dividends are payable in cash, common shares, preferred shares, or any combination thereof. The form of dividend payment is at the sole discretion of the Company. In 2016, we issued one common stock dividend totaling 95,934 shares of common stock and paid three cash dividends totaling $2.9 million. As we are in an accumulated deficit position, we reduce additional paid-in capital for the dividend payments made in shares of common stock at the same amount we record additional paid-in-capital for the issuance of the common stock, which results in no net change to our Stockholders' Deficit. The fair value of all dividends are reflected as a deductions from net income to calculate net income available to common stockholders in our Consolidated Statements of Operations and Comprehensive Income (Loss). In the event of any liquidation, winding-up or dissolution of the Company, whether voluntary or involuntary, each holder of shares of Series A Convertible Preferred Stock shall be entitled to receive and to be paid out of the assets of the Company available for distribution to its stockholders the Liquidation Preference ($100.00 per share) plus all accumulated and unpaid dividends in respect of the Series A Convertible Preferred Stock (whether or not declared) to the date fixed for liquidation, winding-up or dissolution in preference to the holders of, and before any payment or distribution is made on, any other class of stock. Warrants At October 1, 2016, there were a total of 9,445,014 warrants outstanding to purchase 4,722,507 shares of our Common Stock. Public Warrants The Company has issued warrants to purchase its common stock which were originally issued as part of units in Hennessy Capital’s initial public offering (the “Public Warrants”). Each Public Warrant entitles the registered holder to purchase one-half of one share of our common stock at a price of $5.75 per one-half of one share ($11.50 per whole share), subject to adjustment. Public Warrants may be exercised only for a whole number of shares of our common stock. No fractional shares will be issued upon exercise of the Public Warrants. The Public Warrants will expire on February 24, 2020, five years after the completion of the Business Combination, or earlier upon redemption or liquidation. We may call the Public Warrants for redemption if, and only if, the reported last sale price of our common stock equals or exceeds $24.00 per share for any 20 trading days within a 30-trading day period ending on the third trading day prior to the date we send the notice of redemption to the warrant holders. The Public Warrants are listed on the OTCQB market under the symbol "BLBDW." Placement Warrants The Company has issued warrants to purchase its common stock issued in connection with a private placement which occurred concurrently with Hennessy Capital’s initial public offering (the “Placement Warrants”). The Placement Warrants are identical to the Public Warrants sold in the initial public offering, except that, if held by the HCAC Sponsor or its permitted assignees, they (a) may be exercised for cash or on a cashless basis; and (b) are not subject to being called for redemption. Each such warrant entitles the holder to purchase one-half of one share of our Common Stock at a price of $5.75 per one-half of one share ($11.50 per whole share), subject to adjustment. Warrant Exchange On March 2, 2015, we completed our offer to exchange up to a maximum of 5,750,000 of our outstanding Public Warrants for shares of our common stock, at an exchange ratio of 0.1 of a share for each Public Warrant validly tendered and not withdrawn (approximately one share for every ten Public Warrants tendered). A total of 2,690,462 Public Warrants were tendered and not properly withdrawn, resulting in a total of 269,046 shares of common stock being issued. On March 17, 2015, we completed a second offer to exchange Placement Warrants for shares of our common stock, and in such exchange offer, a total of 9,434,538 Placement Warrants were tendered and not properly withdrawn, resulting in a total of 943,454 shares of our common stock being issued. There were no cash proceeds to the Company from these exchange transactions. Immediately after the exchanges, a total of 2,690,462 Placement Warrants and 8,809,538 Public Warrants were outstanding. 14. Earnings Per Share The following table presents the basic and diluted earnings per share computation for the fiscal years presented: (1) Basic earnings per share is calculated by dividing income available to common stockholders from continuing operations, discontinued operations, and total net income by the weighted average common shares outstanding during the period. For purposes of calculating basic earnings per share, income available to common stockholders is reduced in periods where we have paid a dividend or accrued for a dividend payment for our convertible preferred stock. (2) Diluted earnings per share is calculated by adjusting the weighted average shares outstanding for the dilutive effect of common stock equivalents outstanding for the period, determined by using the treasury-stock method, and adjusting for the dilutive effect of our convertible preferred stock, determined by using the if-converted method. For the fiscal year ended 2016, 4,314,064 shares of potentially dilutive convertible preferred stock were excluded from the calculation since the if-converted impact would be anti-dilutive and, as a result, the numerator used in the calculation included the preferred stock dividend impact on income. Potentially dilutive common stock equivalents totaling 173,009 and 311,809 shares, respectively, were excluded from the fiscal years ended 2016 and 2015 calculations since their impact would be anti-dilutive. Previously Disclosed Immaterial Correction of Earnings Per Share As initially disclosed in our second quarter Form 10-Q filed on May 23, 2016, an error in the computation and disclosure of basic earnings per share was identified that related to the prior year. Per ASC 260-10-45-11, income per share available to common stockholders shall be computed by deducting both the dividends declared in the period on preferred stock and the dividends accumulated for the period on cumulative preferred stock from income from continuing operations and from net income. The error resulted from not deducting the amount of cumulative dividends earned, on an accrual basis, by preferred stockholders in the second quarter of fiscal 2015 and adjusting for the rollover impact, if any, of cumulative dividends earned in the subsequent periods through the end of fiscal 2015. We evaluated the materiality of the error in accordance with SEC Staff Accounting Bulletin No. 99, Materiality, SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, and Accounting Standards Codification 250, Accounting for Changes and Error Corrections, and concluded the error was immaterial to all prior periods impacted. While the adjustments were immaterial, the Company elected to revise its previously reported basic earnings per share for the fiscal year ended 2015 as presented in the following table: 15. Share-Based Compensation In fiscal 2015, we adopted the Omnibus Equity Incentive Plan (the "Plan"). The Plan is administered by the Compensation Committee of our Board of Directors. Under the Plan, the Committee may grant an aggregate of 3,700,000 shares of common stock in the form of non-qualified stock options, incentive stock options, stock appreciation rights (collectively, “SARs” and each individually a “SAR”), restricted stock, restricted stock units, performance shares, performance units, incentive bonus awards, other cash-based awards and other stock-based awards. The exercise price of a share subject to a stock option may not be less than 100% of the fair market value of a share of the Company's common stock with respect to the grant date of such stock option. In fiscal years prior to 2015, we had not granted any stock options or other stock-settled awards. No portion of the options shall vest and become exercisable after the date on which the Optionee’s service with the Company and its subsidiaries terminates. The vesting of all unvested shares of common stock subject to an option will automatically be accelerated in connection with a “Change in Control,” as defined in the Plan. New shares of the Company's common stock are issued upon stock option exercises, or at the time of grant for restricted stock. Stock-based payments to employees, including grants of stock options, restricted stock ("RSAs") and restricted stock units ("RSUs"), are recognized in the financial statements based on their fair value. The fair value of each stock option award on the grant date is estimated using the Black-Scholes option-pricing model with the following assumptions: expected dividend yield, expected stock price volatility, weighted-average risk-free interest rate and weighted average expected term of the options. The volatility assumption used in the Black-Scholes option-pricing model is based on peer group volatility because we do not have a sufficient trading history as a stand-alone public company. Because we do not have sufficient history with respect to stock option activity and post-vesting cancellations, the expected term assumption is based on the simplified method under GAAP, which is based on the vesting period and contractual term for each vesting tranche of awards. The mid-point between the vesting date and the expiration date is used as the expected term under this method. The risk-free interest rate used in the Black-Scholes model is based on the implied yield curve available on U.S. Treasury zero-coupon issues at the date of grant with a remaining term equal to the Company’s expected term assumption. The Company has never declared or paid a cash dividend on common shares. Restricted stock units and restricted stock awards are valued based on the intrinsic value of the difference between the exercise price, if any, of the award and the fair market value of our common stock on the grant date. We expense any award with graded-vesting features using a straight-line attribution method. All outstanding share-based compensation awards vested upon the change in control which took place on June 8, 2016. Concurrent with the change in control, certain awards not considered as granted under GAAP due to fiscal 2017 and 2018 performance criteria which had not been established, were granted and immediately vested with the change in control. Refer to Note 4, Business Combination, for more information on the change in control. Restricted Stock Awards The following table summarizes the Company's RSA and RSU award activity for the fiscal year presented: Compensation expense, recognized in selling, general and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income (Loss), of the restricted stock awards was $8.7 million and $0.9 million for the fiscal years ended 2016 and 2015, respectively, with associated tax benefits of $2.0 million and $0.3 million, respectively. At October 1, 2016, there were no unrecognized compensation costs related to RSA and RSU awards. Stock Option Awards The following table summarizes the Company's stock option activity for the fiscal year presented: (1) At October 1, 2016, all outstanding options were fully vested and exercisable with a weighted average contractual remaining term of 8.6 years and an aggregate intrinsic value totaling $4.2 million. The total aggregate intrinsic value of stock options exercised during the fiscal year ended 2016 was $1.0 million. No stock options were exercised during the fiscal year ended 2015. Compensation expense, recognized in selling, general and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income (Loss), for stock option awards was $4.0 million and $0.7 million for the fiscal years ended 2016 and 2015, respectively, with associated tax benefits of $1.4 million and $0.2 million, respectively. At October 1, 2016, there was no unrecognized compensation cost related to stock option awards. The fair value of each option award at grant date was estimated using the Black-Scholes option-pricing model with the following assumptions made and resulting grant-date fair values during the fiscal years presented: Phantom Award A phantom stock award plan was adopted by the Company in February 2007 (as amended and restated from time to time, the “Phantom Award Plan”). Upon vesting of a phantom award, the participants (including employees, directors, officers and consultants of the Company) may be eligible to receive a cash payment subject to the initial investors in the Company receiving an agreed upon return of capital. There have been three events that met the required return on capital to our investors to trigger a Phantom Award Plan payment: (a) in June 2016, in conjunction with the change in control of the Company's major stockholder, the board of directors approved for all Phantom Award Plan participants a payment of $17.1 million, which was primarily funded by a $17.0 million contribution from our former major stockholder, (b) in February 2015, in conjunction with the Business Combination, the board of directors approved for all Phantom Award Plan participants a payment of $13.8 million, which was primarily funded by a $13.6 million contribution from our former major stockholder, and (c) in June 2014, in conjunction with a dividend payment to our former sole stockholder, the board of directors approved a payment for all Phantom Award Plan participants totaling $24.7 million with a grant date fair value of awards granted totaling $9.9 million. With the 2016 payment and change in majority ownership, this incentive program has concluded. 16. Benefit Plans Defined Benefit Pension Plans The Company has a defined benefit pension plan (the “Defined Benefit Plan”) covering U.S. hourly and salaried personnel. On May 13, 2002, the Defined Benefit Plan was amended to freeze new participation as of May 15, 2002, and therefore, any new employees who started on or after May 15, 2002 were not permitted to participate in the Defined Benefit Plan. Effective January 1, 2006, the benefit plan was frozen to all participants. No accrual of future benefits will be calculated beyond this date. The Company contributed $5.3 million and $5.5 million to the Defined Benefit Plan during the fiscal years ended October 1, 2016 and October 3, 2015, respectively. For the fiscal years ended October 1, 2016 and October 3, 2015, benefits paid were $6.3 million and $7.1 million, respectively. The projected benefit obligation (“PBO”) for the Defined Benefit Plan was $157.0 million and $142.8 million at October 1, 2016 and October 3, 2015, respectively. The reconciliation of the beginning and ending balances of the PBO for the Defined Benefit Plan for the fiscal years indicated is presented in the following table: (1) The assumption changes referenced in the table above result from (i) changes in the utilized discount rate to value Blue Bird’s future obligations and (ii) updates to the mortality table projections used in the calculation of the benefit obligations. Plan Assets: The summary and reconciliation of the beginning and ending balances of the fair value of the plan assets are as follows: Funded Status: The following table reconciles the benefit obligations, plan assets, funded status and net liability information of the Defined Benefit Plan at the dates indicated. The net pension liability is reflected in long-term liabilities on the Consolidated Balance Sheets. Fair Value of Plan Assets: The Company determines the fair value of its financial instruments in accordance with the Fair Value Measurements and Disclosures Topic of the ASC. Fair value is the price to hypothetically sell an asset or transfer a liability in an orderly manner in the principal market for that asset or liability. This topic provides a hierarchy that gives highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities. This topic requires that financial assets and liabilities are classified into one of the following three categories: Level 1 Unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability Level 3 Unobservable inputs for the asset or liability The Company evaluates fair value measurement inputs on an ongoing basis in order to determine if there is a change of sufficient significance to warrant a transfer between levels. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company's valuation process. The Defined Benefit Plan assets are comprised of various investment funds, which are valued based upon their quoted market prices. The invested pension plan assets of the Defined Benefit Plan are all Level 2 assets under ASC 820, Fair Value Measurements (“ASC 820”). During the fiscal years ended 2016 and 2015, there were no transfers between levels. There are no sources of significant concentration risk in the invested assets at September 30, 2016, the measurement date. The following table sets forth, by level within the fair value hierarchy, a summary of the Defined Benefit Plan’s investments measured at fair value: Cumulative losses for the Defined Benefit Plan recognized in accumulated other comprehensive loss during the fiscal years ended 2016, 2015 and 2014 were $63.7 million, $52.8 million and $44.5 million, respectively. The estimated net loss for the Defined Benefit Plan that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year is $6.3 million. The unrecognized gain or loss is amortized as follows: the total unrecognized gain or loss, less the larger of 10% of the liability or 10% of the assets, is divided by the average future working lifetime of active plan participants. The following table represents net periodic benefit cost and changes in plan assets and benefit obligations recognized in other comprehensive income, before tax effect, for the fiscal years presented: The following actuarial assumptions were used to determine the benefit obligations at the dates indicated: The benchmark for the discount rates is an estimate of the single equivalent discount rate determined by matching the Defined Benefit Plan’s future expected cash flows to spot rates from a yield curve comprised of high quality corporate bond rates of various durations. The Defined Benefit Plan asset allocations at the dates indicated, the measurement date, are as follows: There was no Company common stock included in equity securities. Assets of the Defined Benefit Plan are invested primarily in U.S. government securities, common stock funds and cash management funds. Assets are valued using quoted prices in active markets. The expected long-term rate of return on plan assets reflects the average rate of earnings expected on the funds invested, or to be invested, to provide for the benefits included in the PBO. In estimating that rate, appropriate consideration is given to the returns being earned by the plan assets in the fund and rates of return expected to be available for reinvestment and a building block method. The expected rate of return on each asset class is broken down into three components: (1) inflation, (2) the real risk-free rate of return (i.e., the long term estimate of future returns on default free U.S. government securities) and (3) the risk premium for each asset class (i.e., the expected return in excess of the risk-free rate). The investment strategy for pension plan assets is to limit risk through asset allocation, diversification, selection and timing. Assets are managed on a total return basis, with dividends and interest reinvested in the account. The Company expects to contribute approximately $5.5 million to its Defined Benefit Plan in fiscal year 2017. The following benefit payments are expected to be paid to the Company’s pension plan participants in the fiscal years indicated: Defined Contribution Plans The Company offers a defined contribution 401(k) plan covering substantially all U.S. employees and a defined contribution plan for Canadian employees. During the fiscal years ended 2016, 2015 and 2014, the Company offered a 50% match on the first 6% of the employee’s contributions. The plans also provide for an additional discretionary match depending on Company performance. Compensation expense related to defined contribution plans totaled $1.7 million, $1.7 million and $1.3 million for the fiscal years ended 2016, 2015 and 2014, respectively. Health Benefits The Company provides and is predominantly self-insured for medical, dental, and accident and sickness benefits. A liability related to this obligation is recorded on the Company’s balance sheet under accrued expenses. Total expense related to this plan recorded for the fiscal years ended 2016, 2015, and 2014, was $12.3 million, $10.0 million, and $9.6 million, respectively. Employee Compensation Plans The Management Incentive Plan (the “MIP”) compensates certain key salaried management employees and is based on earnings before interest, taxes, depreciation and amortization (“EBITDA”) performance as well as a net debt metric. MIP bonus liabilities of $5.6 million and $4.7 million are included in accrued expenses on the Consolidated Balance Sheets at October 1, 2016 and October 3, 2015, respectively. 17. Equity Investment in Affiliate On October 14, 2009, Blue Bird and Girardin Minibus entered into a venture, Micro Bird Holdings, Inc. (“Micro Bird”), to combine the complementary expertise of the two separate manufacturers. Blue Bird Micro Bird by Girardin buses are produced in Drummondville, Quebec by Micro Bird. The Company holds a 50% equity interest in Micro Bird Holdings, Inc. ("Micro Bird"), and accounts for Micro Bird under the equity method of accounting as the Company does not have control based on the shared powers of both venture partners to direct the activities that most significantly impact Micro Bird’s financial performance. The carrying amount of the equity method investment is adjusted for the Company’s proportionate share of net earnings and losses and any dividends received. At October 1, 2016 and October 3, 2015, the Company had an investment of $12.9 million and $12.5 million, respectively. In the third quarter of fiscal 2016, Micro Bird paid a dividend to all common stockholders and the Company received $2.3 million as a result of this distribution, which was net of required withholding taxes. The dividend reduced the carrying value of our investment and is presented as a cash inflow in the operating section of our Consolidated Statements of Cash Flows. In recognizing the Company’s 50% portion of Micro Bird net income, the Company recorded $2.9 million, $2.6 million and $1.2 million in equity in net income of non-consolidated affiliate for the fiscal years ending 2016, 2015 and 2014, respectively. Micro Bird's summarized balance sheet information at its September 30th year end is as follows: Micro Bird's summarized financial results for its three fiscal years ended September 30th are as follows: 18. Foreign Exchange Contracts During the second quarter of fiscal 2016, we entered into a foreign exchange swap as an economic hedge of anticipated cash flows denominated in Canadian Dollars. The contract was entered into to protect against the risk that the eventual cash flows resulting from certain transactions would be affected by changes in exchange rates between the U.S. Dollar and the Canadian Dollar. The notional amount of the swap entered into was $10.8 million, and it matures on January 31, 2017. The foreign exchange contract qualifies for hedge accounting and has been designated as a cash flow hedge with the effective portion of the gain or loss on the derivative instrument recorded in other comprehensive income (loss) until the underlying transactions occur, at which time the gain or loss on the derivative is recorded in current period earnings on the Consolidated Statements of Operations and Comprehensive Income (Loss). The fair value of the foreign exchange contract is based on the forward contract rate, which classifies as a Level 2 fair value measurement. At October 1, 2016, the fair value of the foreign exchange contract was $(0.2) million and included in "other current liabilities" on the Consolidated Balance Sheet. The table below presents the effect of the Company's cash flow hedge for the fiscal period presented (dollars in thousands): If realized, all amounts in accumulated other comprehensive income (loss) will be reclassified into earnings during the next 12 months. 19. Subsequent Events On December 12, 2016 (the "Closing Date"), the Company and certain of its subsidiaries and affiliates entered into a credit agreement (hereinafter the “New Credit Agreement”), by and among (i) Blue Bird Body Company, as the borrower (the “Borrower”) and (ii) the Company, SBH, Peach County Holdings, Inc. (“Peach”) and Blue Bird Global Corporation (formerly, Blue Bird Corporation) (collectively with the Company, SBH and Peach, the “Parents”), as guarantors, and Bank of Montreal, as Administrative Agent and an Issuing Bank, Fifth Third Bank, as Co-Syndication Agent and an Issuing Bank and Regions Bank, as Co-Syndication Agent. The credit facility provided for under the New Credit Agreement consists of a term loan facility in an aggregate initial principal amount of $160.0 million (the “New Term Loan Facility”) and a revolving credit facility with aggregate commitments of $75.0 million, which revolving credit facility includes a $15.0 million letter of credit sub-facility and $5.0 million swingline sub-facility (the “New Revolving Credit Facility,” and together with the New Term Loan Facility, each a “New Credit Facility” and collectively, the “New Credit Facilities”). The borrowings under the New Term Loan Facility, which were made at the initial closing, may not be re-borrowed once they are repaid. The borrowings under the New Revolving Credit Facility may be repaid and reborrowed from time to time at our election. The proceeds of the loans under the New Credit Facilities that were borrowed on the Closing Date were used to finance in part, together with available cash on hand, (i) the repayment of certain existing indebtedness of the Company and its subsidiaries on the Closing Date and (ii) transaction costs associated with the consummation of the New Credit Facilities. The New Term Loan Facility and the New Revolving Credit Facility each mature on December 12, 2021, which is the fifth anniversary of the effective date of the New Credit Agreement. The interest rate on the New Term Loan Facility is (i) from the Closing Date until April 1, 2017, an election of either base rate plus 1 point or LIBOR (floor of 1 point) plus 2 points and (ii) commencing with the fiscal quarter ending on April 1, 2017 and thereafter, dependent on the Total Net Leverage Ratio (as defined below) of the Company, which may elect either base rate or LIBOR pursuant to the table below: At December 12, 2016, the actual Total Net Leverage Ratio was 1.7:1.00. With the New Credit Agreement, the Company expects to extinguish the current and long-term debt on the Consolidated Balance Sheets and recognize a loss on extinguishment of $10.1 million in net income for unamortized deferred financing costs currently recorded as a reduction of the debt and in other assets on the Consolidated Balance Sheets. The Company evaluated subsequent events and transactions for potential recognition or disclosure in the consolidated financial statements through the date the consolidated financial statements were issued. | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement excerpt. It seems to be missing key sections and context, making it difficult to provide a comprehensive summary. The text appears to reference a transaction involving Blue Bird Corporation, HCAC, and SBH, but lacks specific financial details like revenue, net income, total assets, or total liabilities.
To provide a meaningful summary, I would need a more complete financial statement with clear sections detailing:
- Revenue
- Expenses
- Net Income/Loss
- Total Assets
- Total Liabilities
- Cash Flow
If you have the full financial statement, I'd be happy to help you summarize it. | Claude |
Financial Statements. Index to consolidated financial statements Report of independent registered public accounting firm Real Goods Solar, Inc. Consolidated Financial Statements: Consolidated balance sheets Consolidated statements of operations Consolidated statement of changes in shareholders’ equity (deficit) Consolidated statements of cash flows Notes to consolidated financial statements ACCOUNTING FIRM To the Board of Directors and Shareholders Real Goods Solar, Inc. We have audited the accompanying consolidated balance sheets of Real Goods Solar, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, changes in shareholders’ equity (deficit), and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Real Goods Solar, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. /s/ Hein & Associates LLP Denver, Colorado March 9, 2017 REAL GOODS SOLAR, INC. Consolidated Balance Sheets See accompanying notes to consolidated financial statements. REAL GOODS SOLAR, INC. Consolidated Statements of Operations See accompanying notes to consolidated financial statements. REAL GOODS SOLAR, INC. Consolidated Statement of Changes in Shareholders’ Equity (Deficit) See accompanying notes to consolidated financial statements. REAL GOODS SOLAR, INC. Consolidated Statements of Cash Flows See accompanying notes to consolidated financial statements. Notes to consolidated financial statements 1. Principles of Consolidation, Organization and Nature of Operations Real Goods Solar, Inc. (“RGS” or the “Company”) is a residential and commercial solar energy engineering, procurement, and construction firm. The consolidated financial statements include the accounts of RGS and its wholly-owned subsidiaries. RGS has prepared the accompanying consolidated financial statements in accordance with accounting principles generally accepted in the United States, or GAAP, which include the Company’s accounts and those of its subsidiaries. Intercompany transactions and balances have been eliminated. The Company has included the results of operations of acquired companies from the effective date of acquisition. Reverse Stock Splits The Company reports all share and per share amounts reflecting the most recent reverse stock split. Discontinued Operations During 2014, the Company committed to a plan to sell certain contracts and rights comprised of the Company’s large commercial installations business, otherwise known as the Company’s former Commercial segment. At the same time, the Company determined not to enter into further large commercial installation contracts in the mainland United States. Most contracts in process at December 31, 2014 were substantially completed during 2015 and remaining work was completed in 2016. The Company now reports this business as a discontinued operation, separate from the Company’s continuing operations. The following discussion and analysis of financial condition and results of operations is for the Company’s continuing operations, unless indicated otherwise. Liquidity and Financial Resources Update We have experienced recurring operating losses and negative cash flow from operations in recent years. Because of these losses, we did not pay vendors on a timely basis and, accordingly, experienced difficulties obtaining credit terms from our equipment suppliers that limited our ability to convert our backlog in an expeditious manner, which resulted in customer cancellations of contracts. Starting with the fourth quarter of 2014, we implemented measures to reduce our cash outflow for operations such that the required level of sales to achieve break-even results was reduced. These measures included (i) exiting the large commercial segment which was operating at both an operating and cash flow loss, (ii) reducing staffing levels, (iii) raising prices for our products and (iv) efforts to enhance accounts receivable collections and optimize inventory levels. Net cash outflow for 2016 from continuing operations of $12.0 million, which includes $4.0 million for reduction in vendor accounts payable, is an improvement from 2015’s net cash outflow from continuing operations. To execute our revenue growth strategy and reduce our payables and indebtedness, during 2016 the Company obtained additional financial capital through the following transactions: •On April 1, 2016, the Company issued $10.0 million of Senior Secured Convertible Notes due April 1, 2019 (each, a “Note”) and Series G warrants to purchase 9,710 shares of our Class A common stock, raising net proceeds of approximately $9.1 million (the “2016 Note Offering”),”) of which the Company has received net proceeds of $8.9 million in unrestricted cash as of December 31, 2016. •On September 14, 2016, the Company issued $2.8 million of Series A 12.5% Mandatorily Convertible Preferred Stock and Series H warrants exercisable into 16,970 shares of our Class A common stock. The Company received, after offering costs, $2.2 million in cash, and received $1.6 million from the exercise of Series H warrants into 9,515 shares of our Class A common stock on September 30, 2016.
As of December 31, 2016, all of the convertible preferred stock had been converted into Class A common stock.
•On December 13, 2016, the Company issued $4.1 million of Class A common stock and Series I warrants exercisable into 616,667 shares of Class A common stock. The Company received, after offering costs, $3.6 million in cash. Further, in 2017, the Company had the opportunity to raise additional capital under the current full-shelf registration. •On February 6, 2017, the Company issued $11.5 million of Class A common stock, and Series K warrants exercisable into 3,710,000 shares of our Class A common stock and Series L warrants exercisable into 1,613,080 shares of our Class A common stock. The Company received, after offering costs, $10.6 million in cash at closing. •On February 9, 2017, the Company issued $6.0 million of Class A common stock, and Series M warrants exercisable into 1,800,000 shares of our Class A common stock, and Series N warrants exercisable into 750,000 shares of our Class A common stock. The Company received, after offering costs, $5.5 million in cash at closing. The Company has used the proceeds from the additional financial capital to reduce accounts payable, purchase materials to convert its backlog to revenue, begin to execute its growth strategy and for other corporate purposes. The Company has prepared its business plan for the ensuing twelve months, and as described below, believes it has sufficient financial resources to operate for the ensuing 12-month period. The Company’s objectives in preparing this plan include expanding the size of the Company’s sales and construction organizations to generate gross margin that is more than its reduced fixed operating cost infrastructure and thereby reducing the Company’s present operating losses in order to return the Company to profitable operations in the future. Elements of this plan include, among others, (i) realizing operating costs savings from reductions in staff, of which substantially all non-sales and construction staff reductions had been realized as of December 31, 2016, (ii) the positive impact of the strategic decision to exit the large commercial segment which operated at both a substantial cash and operating loss, (iii) hiring and training additional field and e-sales force personnel to grow sales, (iv) optimizing the Company’s construction capability through authorized third-party integrators to realize the revenue from installation of the Company’s backlog and minimize the impact on gross margin of idle construction crew time, (v) changing the mix of marketing expenditures to achieve a lower cost of acquisition than that employed in prior periods, (vi) realizing the benefits of new vendor terms negotiated by the Company that reduce the cost of materials acquired by the Company, and (vii) increasing sales and installations with small commercial customers. The Company believes that because of (i) the additional financial capital realized during 2016 and 2017, as described above, and (ii) the actions it has already implemented to reduce its fixed operating cost infrastructure and to reduce the cost of materials, the Company has sufficient financial resources to operate for the ensuing 12 months. 2. Significant Accounting Policies No changes were made to the Company’s significant accounting policies during the year ended December 31, 2016. Use of Estimates The preparation of the consolidated financial statements in accordance with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company bases its estimates on historical experience and on various other assumptions believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Significant estimates are used to value warranty liabilities, the fair value of derivative liabilities embedded in complex financial instruments, common stock warrants, and allowance for doubtful accounts. Actual results could differ materially from those estimates. Reclassifications Certain prior period amounts have been reclassified to conform to the current period presentation. The reclassifications did not impact prior period results of operations, cash flows, total assets, total liabilities or total equity. Cash Cash represents demand deposit accounts with financial institutions that are denominated in U.S. dollars. Allowance for Doubtful Accounts The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company makes estimates of the collectability of its accounts receivable by analyzing historical bad debts, specific customer creditworthiness and current economic trends. The allowance for doubtful accounts was $0.6 million and $1.2 million at December 31, 2016 and 2015, respectively. Inventory Inventory consists primarily of solar energy system components (such as solar panels and inverters) located at Company warehouses and is stated at the lower of cost (first-in, first-out method) or market. The Company provides an allowance for slow moving and obsolete inventory items based on an estimate of the markdown to the retail price required to sell or dispose of such items. The Company has an allowance for obsolete or slow moving inventory of $0.5 million and $0.3 million at December 31, 2016 and 2015, respectively. Property and Equipment Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation of property and equipment is computed on the straight-line method over estimated useful lives, generally three to twenty years. RGS amortizes leasehold and building improvements over the shorter of the estimated useful lives of the assets or the remaining term of the lease or remaining life of the building, respectively. Goodwill and Purchased Intangibles The Company reviews goodwill and indefinite-lived intangible assets for impairment annually during the second quarter, or more frequently if a triggering event occurs between impairment testing dates. Intangible assets arising from business combinations, such as acquired customer contracts and relationships (collectively, “customer relationships”), trademarks, and non-compete agreements are initially recorded at fair value. Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. The Company’s impairment assessment begins with a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. The qualitative assessment includes comparing the overall financial performance of the reporting units against the planned results used in the last quantitative goodwill impairment test. If it is determined under the qualitative assessment that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then a two-step quantitative impairment test is performed. Under the first step, the estimated fair value of the reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed. If the estimated fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the enterprise must perform step two of the impairment test (measurement). Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. Fair value of the reporting unit under the two-step assessment is determined using a discounted cash flow analysis. The use of present value techniques requires us to make estimates and judgments about the Company’s future cash flows. These cash flow forecasts will be based on assumptions that are consistent with the plans and estimates the Company uses to manage its business. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment at many points during the analysis. Application of alternative assumptions and definitions could yield significantly different results. Intangible assets with finite useful lives are amortized over their respective estimated useful lives and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Revenue Recognition For sales of solar energy systems and components of less than 100 kilowatts (kW), “residential and small commercial customers,” the Company recognizes revenue, in accordance with ASC 605-25, Revenue Recognition-Multiple-Element Arrangements, and ASC 605-10-S99, Revenue Recognition-Overall-SEC Materials. Revenue is recognized when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the sales price is fixed or determinable and (4) collection of the related receivable is reasonably assured. Components comprise of photovoltaic panels and solar energy system mounting hardware. The Company recognizes revenue when it installs a solar energy system, provided all other revenue recognition criteria have been met. Costs incurred on residential installations before the solar energy systems are completed are deferred and included in other current assets as work in progress in the consolidated balance sheet. For those systems of 100kW or greater, “commercial customers,” the Company recognizes revenue according to ASC 605-35, Revenue Recognition-Construction-Type and Production Type Contracts. Revenue is recognized on a percentage-of-completion basis, based on the ratio of costs incurred to date to total projected costs. Provisions are made for the full amount of any anticipated losses on a contract-by-contract basis. The assets “Costs in excess of billings on uncompleted contracts” and “Deferred costs on uncompleted contracts” represent costs incurred plus estimated earnings in excess of amounts billed on percentage-of-completion method contracts and costs incurred but deferred until recognition of the related contract revenue on completed-method contracts, respectively. The liability “Billings in excess of costs on uncompleted contracts” represents billings in excess of related costs and earned profit on percentage-of-completion method contracts. The Company invoices large installation customers according to milestones defined in their respective contracts. The prerequisite for billing is the completion of an application and certificate of payment form as per the contract, which is done after each month end. Unbilled receivables were included in discontinued operations at December 31, 2016 and 2015. Deferred revenue consists of solar energy system installation fees billed to customers for projects which are not completed as of the balance sheet date. Share-Based Compensation RGS recognizes compensation expense for share-based awards based on the estimated fair value of the award on the date of grant. The Company measures compensation cost at the grant date fair value of the award and recognizes compensation expense based on the probable attainment of a specified performance condition or over a service period. The Company uses the Black-Scholes option valuation model to estimate the fair value for purposes of accounting and disclosures. In estimating this fair value, certain assumptions are used (see Note 10. Share-Based Compensation), including the expected life of the option, risk-free interest rate, dividend yield, volatility and forfeiture rate. The use of different estimates for any one of these assumptions could have a material impact on the amount of reported compensation expense. Income Taxes The Company recognizes income taxes under the asset and liability method. Deferred income taxes are recognized based on temporary differences between financial reporting and income tax basis of assets and liabilities, using current enacted income tax rates and regulations. These differences will result in taxable income or deductions in future years when the reported amount of the asset or liability is recovered or settled, respectively. Considerable judgment is required in determining when these events may occur and whether recovery of an asset is more likely than not. RGS has significant net operating loss carry-forwards and evaluates at the end of each reporting period whether it expects it is more likely than not that the deferred tax assets will be fully recoverable and provides a tax valuation allowance as necessary. Warranties The Company warrants solar energy systems sold to customers for up to 10 years against defects in material or installation workmanship. The manufacturers’ warranties on the solar energy system components, which are typically passed through to the customers, typically have product warranty periods of 10 years and a limited performance warranty period of 25 years. The Company generally provides for the estimated cost of warranties at the time the related revenue is recognized. The Company also maintains specific warranty liabilities for large commercial customers included in discontinued operations. The Company assesses the accrued warranty reserve regularly and adjusts the amounts as necessary based on actual experience and changes in future estimates. Net Loss per Share RGS computes net loss per share by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the period. Diluted net loss per share reflects the potential dilution that could occur if options or warrants to issue shares of the Company’s Class A common stock were exercised. Common share equivalents of 843,163 and 2,678 shares have been omitted from net loss per share for 2016 and 2015, respectively, as they are anti-dilutive. The following table sets forth the computation of basic and diluted net income (loss) per share: Concentration of Risk The Company did not have any customer who accounted for more than 10% of total accounts receivable as of December 31, 2016 and 2015, nor did it have any customer representing over 10% of sales during 2016 or 2015. During the first quarter of 2016, the Company entered into a supply agreement with its line-of-credit lender whereby certain identified materials were to be purchased through the lender’s distribution business. As a result, approximately 90% of purchases were purchased from this distributor during 2016. During January 2017, the line-of-credit was repaid in full and terminated along with the supply agreement. During 2015, the Company purchased approximately 50% of the major components for its solar installations from three suppliers. Segment Information Operating segments are defined as components of a company about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the executive team. Based on the financial information presented to and reviewed by the chief operating decision maker in deciding how to allocate the resources and in assessing the performance of the Company, the Company has determined that it has three reporting segments: residential solar installations, Sunetric installations, and corporate expenses (“other segment”). Derivative Liabilities The Company accounts for complex financial instruments including convertible notes, convertible preferred stock, and warrants under ASC 815 and ASC 480. The Company utilizes third party appraisers to determine the fair value of derivative liabilities embedded in complex financial instruments. Certain of the Company’s warrants are accounted for as liabilities due to provisions either allowing the warrant holder to request redemption, at the intrinsic value of the warrant, upon a change of control and/or providing for an adjustment to the number of shares of the Company’s Class A common stock underlying the warrants and the exercise price in connection with dilutive future funding transactions. The Company classifies these derivative liabilities on the Consolidated Balance Sheet as current and long term liabilities, which are revalued at each balance sheet date subsequent to their initial issuance. For financial instruments accounted for as liabilities, the Company defers and amortizes to operations costs incurred including the initial fair value of warrants issued and derivative liabilities. The issuance costs of financial instruments accounted for as equity are charged to additional paid in capital. The extinguishment of financial instruments accounted for as debt that are extinguished by issuance of common stock are recorded at the fair value of common stock issued at the date of issuance, with any difference from the carrying value of the liability recorded as a loss on debt extinguishment. Fair Value Measurement ASC 820, Fair Value Measurements, clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. ASC 820 requires that the valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. ASC 820 establishes a three-tier fair value hierarchy, which prioritizes inputs that may be used to measure fair value as follows: ·Level 1 - Observable inputs that reflect quoted prices for identical assets or liabilities in active markets. ·Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. ·Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. When determining the fair value measurements for assets or liabilities required or permitted to be recorded at and/or marked to fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Company looks to active and observable markets to price identical assets. When identical assets are not traded in active markets, the Company looks to market observable data for similar assets. Residential Leases To determine lease classification, the Company evaluates lease terms to determine whether there is a transfer of ownership or bargain purchase option at the end of the lease, whether the lease term is greater than 75% of the useful life, or whether the present value of minimum lease payments exceed 90% of the fair value at lease inception. All of the Company’s leased systems are treated as sales-type leases under GAAP accounting policies. Financing receivables are generated by solar energy systems leased to residential customers under sales-type leases. Financing receivables represents gross minimum lease payments to be received from customers over a period commensurate with the remaining lease term of up to 20 years and the systems estimated residual value, net of allowance for estimated losses. Initial direct costs for sales-type leases are recognized as cost of sales when the solar energy systems are placed in service. For systems classified as sales-type leases, the net present value of the minimum lease payments, net of executory costs, is recognized as revenue when the lease is placed in service. This net present value as well as the net present value of the residual value of the lease at termination are recorded as other assets in the Consolidated Balance Sheet. The difference between the initial net amounts and the gross amounts are amortized to revenue over the lease term using the interest method. The residual values of the Company’s solar energy systems are determined at the inception of the lease applying an estimated system fair value at the end of the lease term. RGS considers the credit risk profile for its lease customers to be homogeneous due to the criteria the Company uses to approve customers for its residential leasing program, which among other things, requires a minimum “fair” FICO credit quality. Accordingly, the Company does not regularly categorize its financing receivables by credit risk. Recently Issued Accounting Standards ASU 2017-04 On January 26, 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2017-04 (“ASU 2017-04”), Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment, which was issued to simplify the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance remains largely unchanged. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017, and the Company is assessing the impact of ASU 2017-04 on its consolidated financial statements. ASU 2016-20 On December 21, 2016, the FASB issued Accounting Standards Update No. 2016-20 (“ASU 2016-20”), Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. This ASU provides technical corrections and improvements to Topic 606. This ASU is effective for the Company on January 1, 2018, which coincides with the effective date of ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The Company is assessing the impact on its consolidated financial statements. ASU 2016-18 On November 17, 2016, the FASB issued Accounting Standards Update No. 2016-18 (“ASU 2016-18”), Statement of Cash Flows: Restricted Cash, which was issued to address the diversity that currently exists in the classification and presentation of changes in restricted cash on the statement of cash flows. This ASU requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts general described as restricted cash and restricted cash equivalents. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods therein. Early adoption is permitted and the Company is assessing the impact of ASU 2016-18 on its consolidated statements of cash flows. ASU 2016-15 On August 26, 2016, the FASB issued Accounting Standards Update No. 2016-15 (“ASU 2016-15”), Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments, which was issued to provide clarification on how certain cash receipts and cash payments are reported in the statement of cash flows. This ASU addresses eight specific cash flow issues in an effort to reduce existing diversity between companies. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods therein. Early adoption is permitted and the Company is assessing the impact of ASU 2016-15 on its consolidated statements of cash flows. ASU 2016-09 On March 30, 2016, the FASB issued Accounting Standards Update 2016-09 (“ASU 2016-09”), Simplifying Employee Share-Based Payment Accounting, which was issued to simplify some of the accounting guidance for share-based compensation. Among the areas impacted by the amendments in this ASU is the accounting for income taxes related to share-based payments, accounting for forfeitures, classification of awards as equity or liabilities, and classification on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. The Company expects to adopt this ASU on January 1, 2017. The Company is evaluating the impact that the adoption of ASU 2016-09 will have on its consolidated financial position, results of operations and cash flows. ASU 2016-02 On February 25, 2016, the FASB issued Accounting Standards Update No. 2016-02 (“ASU 2016-02”), Leases (Topic 842), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods therein. The Company currently expects that upon adoption of ASU 2016-02, lease liabilities will be recognized in the balance sheet in amounts that will be material. ASU 2015-05 On April 15, 2015, the FASB issued Accounting Standards Update No. 2015-05 (“ASU 2015-05”), Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, which provides guidance to customers about whether a cloud computing arrangement includes a software license. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods therein. The Company has adopted this ASU using a prospective approach. It did not have a material impact on its consolidated financial position, results of operations or cash flows. ASU 2015-03 On April 7, 2015, the FASB issued Accounting Standards Update No. 2015-03 (“ASU 2015-03”), Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability. For public business entities, the standard is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The new standard is applied on a retrospective basis. The Company has adopted ASU 2015-03 and the convertible debt under the Notes is presented net of discount and issuance costs on its consolidated balance sheet. ASU 2014-15 On August 27, 2014, the FASB issued Accounting Standards Update No. 2014-15 (“ASU 2014-15”), Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. Under GAAP, financial statements are prepared with the presumption that the reporting organization will continue to operate as a going concern, except in limited circumstances. Financial reporting under this presumption is commonly referred to as the going concern basis of accounting. The going concern basis of accounting is critical to financial reporting because it establishes the fundamental basis for measuring and classifying assets and liabilities. Currently, GAAP lacks guidance about management’s responsibility to evaluate whether there is substantial doubt about the organization’s ability to continue as a going concern or to provide related footnote disclosures. ASU 2014-15 provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations today in the financial statement footnotes. The amendments in ASU 2014-15 are effective for the Company for annual periods ending after December 15, 2016, with early application permitted for unissued financial statements. The Company has adopted this ASU, and has determined there is no impact on its consolidated financial statements. ASU 2014-09 On May 28, 2014, the FASB issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”), which created Topic 606, Revenue From Contracts With Customers. This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Transfer of control is not the same as transfer of risks and rewards, as it is considered in current guidance. In August 2015, the FASB issued ASU 2015-14 which defers the effective date of ASU 2014-09 one year. ASU 2014-09, as deferred by ASU 2015-14, will be effective for the first interim period within annual reporting periods beginning after December 15, 2017, using either of two methods: (a) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09; or (b) retrospective with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined in ASU 2014-09. The Company has implemented a plan that will involve internal meetings to review the new standard, and determine which transition method to utilize. This plan is expected to be executed during the 2nd quarter of 2017. 3. Property and Equipment Property and equipment, stated at lower of cost or estimated fair value, consists of the following as of December 31: 4. Revolving Line of Credit On January 19, 2016, the Company entered into a waiver and consent agreement with Silicon Valley Bank (“SVB”) in which it consented to the assignment of the revolving credit facility to Solar Solutions and Distribution, LLC (“Solar Solutions”) and waived any claims against SVB. On January 19, 2016, Solar Solutions acquired the revolving credit facility from SVB. Subsequently on March 30, 2016, the Company entered into an Amended and Restated Loan Agreement with Solar Solutions (the “Loan”) which, among other items, (i) extended the term to March 31, 2017, (ii) allowed for certain eligible inventories to be included in the borrowing base and (iii) required the Company to enter a master supply agreement for a period of two years. Generally, the Loan provides for advances at pre-defined advance rates against inventory and accounts receivable and a variable rate of eligible inventory as defined in the Loan. The maximum amount of the Loan before its termination was $3.0 million (it was automatically reduced to $3.0 million on January 1, 2017 pursuant to the terms of the Loan). Borrowings bore, and accrued interest at the greater of (a) the greater of the prime rate or 4.0%, plus 3.0%, and (b) 7.0%. The amended maturity date for the Loan was March 31, 2017. The line of credit had a facility fee of 2.0% per year of the average daily unused portion of the available line of credit and a loan administration and collateral monitoring labor fee of $4,000 per month. On May 25, 2016, the Company entered into the First Loan Modification Agreement, effective as of May 19, 2016, with Solar Solutions to amend the Loan to, among other things, (i) reschedule the payment of $167,513.41 due on May 15, 2016 to a date on or before June 3, 2016 and (ii) require the Company to issue to Solar Solutions 969 shares of Class A common stock at a price of $5.76 per share as a payment on the revolving line of credit under the Loan. Furthermore, on August 22, 2016, the Company entered into the Second Loan Modification Agreement, effective as of August 19, 2016, with Solar Solutions to modify the definition of eligible accounts receivable for purposes of the borrowing base calculation, thereby increasing the collateral calculation and availability under the Loan. As of December 31, 2016 and 2015, the Company had a line of credit balance of $0.7 million and $0.8 million with Solar Solutions and SVB, respectively. As a result of the capital raises in September and in the fourth quarter of 2016, the last time the Company submitted a request to borrow funds from Solar Solutions for working capital was September 28, 2016. Since that time, the line of credit activity included (i) increases for material purchases, (ii) increases for fees as called for in the Loan, and (iii) reductions attributable to the sweep of daily cash receipts. On January 11, 2017, the Company became a creditor of Solar Solutions as the daily sweep of cash receipts exceeded material purchases and fees. On February 6, 2017, the Company issued a 3-day notice of termination, causing the Loan to be terminated as of February 9, 2017. Additionally, the Company had an Exclusive Supply Agreement (“Supply Agreement”) with Solar Solutions which was terminated as of the same date, as the term of the Supply Agreement was coterminous with the Loan. 5. Related Parties On June 24, 2015, the Company entered into a Conversion Agreement (the “Conversion Agreement”) with Riverside Fund III, L.P. (“Riverside Lender”), an entity affiliated with Riverside (David Belluck, Director of RGS, who is a General Partner of Riverside) Partners, LLC), to convert notes payable with a principal balance of $3.15 million plus accrued interest of $1.1 million into 2,147 shares of the Company’s Class A common stock using a conversion ratio equal to $1,974.00 per share; the closing price of the Class A common stock on June 23, 2015 (the “Conversion”). The Company subsequently issued shares of Class A common stock to Riverside in full satisfaction of the outstanding principal and accrued interest. 6. Commitments and Contingencies The Company leases office and warehouse space through operating leases. Some of the leases have renewal clauses, which range from one month to five years. The Company leases vehicles through operating leases for certain field personnel. Leases range up to five years with varying termination dates through August 2020. The following schedule represents the annual future minimum payments of all leases as of December 31, 2016: The Company incurred office and warehouse rent expense of $0.8 million and $1.0 million for the years ended December 31, 2016 and 2015, respectively. The Company is subject to risks and uncertainties in the normal course of business, including legal proceedings; governmental regulation, such as the interpretation of tax and labor laws; and the seasonal nature of its business due to weather-related factors. The Company has accrued for probable and estimable costs incurred with respect to identified risks and uncertainties based upon the facts and circumstances currently available. From time to time, the Company is involved in legal proceedings that is considered to be in the normal course of business. The Company received a subpoena from the Securities and Exchange Commission requesting certain information pertaining to the Company’s July 9, 2014 private placement offering of $7.0 million of its class A common stock and warrants (the “2014 PIPE Offering”). The Company established a special committee of the board of directors to review the facts and circumstances surrounding the 2014 PIPE offering and engaged outside counsel to assist it with its review. On May 11, 2016, the Company was advised by the staff of the Securities and Exchange Commission (the “Staff”) that the Staff did not intend to recommend any enforcement action against the Company with respect to the investigation commenced by the Staff in June 2015. The Company incurred $1.5 million of associated legal expenses related to the subpoena. The Company and its legal advisors believe its expenses in responding to the subpoena should be fully paid by its insurance carrier as they are directly related to the 2014 PIPE offering. In March 2016, the insurance carrier agreed to pay amounts it believed to constitute defense costs, while reserving all rights, including the right to recoup all amounts paid. The Company has recorded a long-term liability for amounts advanced by the insurance carrier of $1.5 million as of December 31, 2016. On November 22, 2016, the Company provided the remaining cash collateral to Argonaut Insurance Company to fully secure the full amount of the $624,000 Final Acceptance Payment and Performance Bond for a large commercial photovoltaic project the Company’s subsidiary Regrid Power, Inc. completed in 2012. As previously disclosed, the customer has raised warranty claims pertaining to the project and the Company currently maintains a specific warranty liability for the project of approximately $200,000. On November 30, 2016, the Company received a letter from the customer in which the customer alleged that the Company has not completed agreed-upon remedial work to remedy alleged deficiencies and notified the Company that the customer intends to perform such remedial work at the Company’s expense using a third-party contractor. The customer also requested that the owner of the project demand the full amount of the performance bond. In addition, the customer demanded an aggregate of approximately $400,000 as liquidated damages under the terms of the project contract. The Company denies these assertions and disputes that the customer is entitled to liquidated damages. The Company plans to avail itself of all defenses and remedies available. The Company estimates that the range of loss related to this warranty claim is from approximately $200,000 to a maximum of approximately $1 million. The Company has recorded a liability for the minimum amount of the range of loss. 7. Convertible Notes and Convertible Preferred Stock April 2016 Note Offering On April 1, 2016, the Company entered into a securities purchase agreement for a private placement of $10.0 million units, each consisting of a Note and one Series G warrant to purchase a fraction of one share of Class A common stock. On the same day the Company closed the transaction and issued an aggregate of $10.0 million of Notes and Series G warrants exercisable into 8,299 shares of Class A common stock. In accordance with relevant accounting guidance for debt with conversion and other options, the Company separately accounts for the liability and equity components of the Notes by allocating the proceeds between the liability component, and equity component over their relative fair values after initially allocating the fair value of the embedded conversion option. The equity component of the Notes and the embedded derivative liability are recognized as a debt discount on the issuance date. The debt discount, is amortized to interest expense using the effective interest method over three years, or the life of the Notes. The Company classifies the embedded derivative liabilities related to the Notes on the Consolidated Balance Sheet as Derivative liabilities, which are revalued at each balance sheet date subsequent to their initial issuance. The Company used a Monte Carlo pricing model to value these derivative liabilities. The Monte Carlo pricing model, which is based, in part, upon unobservable inputs for which there is little or no market data, requires the Company to develop its own assumptions. The Company used 10,000 simulations in the Monte Carlo pricing model to value the embedded derivative in the Notes. If factors change and different assumptions are used, the derivative liability and the change in estimated fair value could be materially different. Changes in the fair value of the embedded derivative are reflected in the consolidated statement of operations as change in fair value of derivative liabilities and loss on debt extinguishment, with an offsetting non-cash entry recorded as an adjustment to the derivative liability. The following table reflects original assumptions at April 1, 2016 and at December 31, 2016 for embedded derivative liabilities issued in the 2016 Note Offering, closing market price adjusted to reflect the one-for-twenty reverse stock split on June 2, 2016 and one-for-thirty reverse stock split on January 26, 2017: In connection with the issuance of the Notes, the Company incurred approximately $1.4 million of debt issuance costs, which primarily consisted of underwriting commissions and warrants, and legal and other professional fees, and allocated these costs to the liability component of the host debt instrument, and is recorded as a contra account to the debt liability on the balance sheet. The amount allocated to the liability component is amortized to interest expense over the contractual life of the Notes using the effective interest method. By December 31, 2016, $9.6 million of the $10.0 million Notes had been converted into Class A common stock, resulting in a net carrying value after deferred costs and pre-installments of $0.1 million. As the trading price of the Company’s Class A common stock was higher at conversion than the effective conversion price per share to the debt holder, the Company recorded a loss on extinguishment. As of December 31, 2016, the amount recorded as an increase to shareholders’ equity for the April 2016 offering is as follows (in thousands): The following table sets forth total interest expense recognized related to the Notes during the 12 months ended December 31, 2016 (in thousands): September 2016 Convertible Preferred Stock offering On September 14, 2016, pursuant to the terms of an Underwriting Agreement, the Company sold to the underwriters an aggregate of 2,800 units (representing gross proceeds of $2,800,000) (each, a “Unit”), each Unit consisting of one share of the Company’s Series A 12.5% Mandatorily Convertible Preferred Stock, stated value $1,000 per share (the “Preferred Stock”) and convertible into shares of the Company’s Class A common stock, and one Series H Warrant to purchase approximately 6.0606 shares of Class A common stock. At the closing, the Company issued an aggregate of 2,800 shares of Preferred Stock and Series H warrants exercisable into an aggregate of 16,970 shares of Class A common stock. In accordance with relevant accounting guidance for instruments with conversion and other options, the Company separately accounts for the liability and equity components of the Units by allocating the proceeds between the liability component, and equity component over their relative fair values. The equity component of the Units was recognized as a debt discount on the issuance date. The debt discount has been fully amortized to expense as of September 30, 2016, since all of the Preferred Stock has been converted to Class A common stock, and is included in Change in fair value of derivative liabilities and loss on debt extinguishment. In connection with the issuance of the Units, the Company incurred approximately $0.6 million of issuance costs, which primarily consisted of underwriting commissions, legal and other professional fees, and allocated these costs to the preferred stock liability component and the warrant equity component over their relative fair values, and was recorded as a contra account to the debt liability and additional paid-in capital on the balance sheet. The amount allocated to the liability component was fully amortized to expense as of December 31, 2016, since all of the Preferred Stock has been converted to Class A common stock, and is included in Interest expense. By September 29, 2016, all of the Preferred Stock had been converted to Class A common stock, extinguishing the debt liability component associated with the Preferred Stock. As the trading price of the Company’s Class A stock was higher at conversion than the effective conversion price per share to the Preferred Stock holder, the Company recorded a loss on extinguishment for this 14-day period. As of December 31, 2016, the amount recorded as an increase to shareholders’ equity for the September 14, 2016 offering was equal to the cash received at the closing, net of costs, and upon subsequent exercises of Series H warrants aggregating to $3.8 million. The convertible preferred stock was recorded as follows (in thousands): 8. Shareholders’ Equity February 2015 Offering On February 26 and February 27, 2015, the Company closed an offering of units (the “February 2015 Offering”). Each unit consisted of: (i) one share of Class A common stock; (ii) a Series A warrant to purchase shares of the Company’s Class A common stock equal to 50% of the sum of the number of shares of Class A common stock purchased as part of the units plus, if applicable, the number of shares of Class A common stock issuable upon exercise in full of the Series E warrants (without regard to any limitations on exercise) described below; (iii) a Series B warrant to purchase shares of the Company’s Class A common stock for a “stated amount” (as described in the offering document); (iv) a Series C warrant to purchase up to 50% of that number of shares of Class A common stock actually issued upon exercise of the Series B warrant; and (v) a Series D warrant to purchase additional shares of Class A common stock in an amount determined on a future reset date after the issuance of the Series D warrant. In addition, in the event that an investor would beneficially own in excess of 4.99% of the number of shares of Class A common stock outstanding immediately before the offering, such investor would receive a Series E warrant to purchase the balance of the shares of Cass A common stock. As more fully described below under “Series A and Series C Warrant Exchange for Common Stock”, during the second quarter of 2015, the Company exchanged shares of Class A common stock for Series A and Series C warrants. June 2015 Conversion of Debt to Equity On June 24, 2015, the Company entered into the Conversion Agreement with the Riverside Lender to effect the Conversion. The Company issued to the Riverside Lender, in full satisfaction of the outstanding principal and accrued interest under promissory notes in the aggregate original principal amount of $3.15 million plus accrued interest of $1.1 million, 2,147 shares of the Company’s Class A common stock using a conversion ratio equal to $1,974.00 per share, the closing price on the Class A common stock on June 23, 2015. To comply with Nasdaq continued listing requirements, at the closing of the Conversion the Company was unable to issue any shares of Class A common stock to the Riverside Lender to the extent the issuance would have resulted in the Riverside Lender (together with its affiliates) holding shares of Class A common stock in excess of 19.99% of the Company’s outstanding shares of common stock immediately after giving effect to the Conversion. As such, the Company issued 1,517 shares on June 25, 2015 and subsequently issued the remaining shares by July 15, 2015. On August 10, 2015, pursuant to the Conversion Agreement the Company filed a registration statement on Form S-3 to register for resale the shares of Class A common stock issued in the Conversion and any shares of Class A common stock held by the Riverside Lender’s affiliates. The Securities and Exchange Commission declared the registration statement on Form S-3 effective on August 20, 2015. June 2015 Series A and Series C Warrant Exchange for Common Stock On June 25, 2015, the Company entered into separate Exchange Agreements (each, an “Exchange Agreement”) with two holders of the Company’s Series A warrants and Series C warrants originally issued in the Company’s February 2015 Offering (each, a “Holder”), pursuant to which the Company agreed to exchange all Series A warrants and Series C warrants for shares of the Company’s Class A common stock. Under terms of the Exchange Agreement, at closing, the Company and the Holders agreed to exchange all Series A warrants and Series C warrants held by the Holders for shares of Class A common stock equal to 115% of the shares of Class A common stock issuable upon exercise of the Series A warrants and Series C warrants (the “Exchange”). The Exchange Agreements prohibited the Company from delivering any shares to a Holder if after such delivery the Holder together with other “attribution parties” collectively would beneficially own in excess of 9.99% of the number of shares of Class A common stock outstanding immediately after giving effect to such exchange. The Company was contractually obligated to issue the shares of Class A common stock issuable in the exchange post-closing at such time and in such amount as requested by each Holder in accordance with the terms of the Exchange Agreement. On June 30, 2015, the Company closed the transaction contemplated by the Exchange Agreements. On June 30, 2015 one Holder exchanged 122 warrant shares for 141 shares of Class A common stock. Between July 1, 2015 and July 7, 2015, the other Holder exchanged 1,802 warrant shares for 2,073 shares of Class A common stock. In connection with the Exchange Agreement, Company recorded an inducement loss of $0.1 million related to the 15% exchange premium and loss on early extinguishment of debt associated with the common stock warrant liability of $0.4 million. June 2015 Offering On June 30, 2015, the Company closed an offering of $5 million of units, each consisting of one share of Class A common stock and one Series F warrant to purchase 30% of one share of Class A common stock (the "June 2015 Offering"). The Company sold the units at an initial purchase price of $2,190.00 per unit with a one-time reset adjustment of (i) the number of shares of Class A common stock, and (ii) the exercise price of the Series F warrants to purchase Class A common stock. On July 9, 2015, as a result of the reset adjustment, the purchase price for the Class A common stock in the June 2015 Offering was reset at $745.92 per share and the exercise price of the Series F warrants was adjusted to $745.92 per share and an additional 4,420 shares of Class A common stock were delivered to June 2015 Offering investors from an escrow established with the Company's transfer agent. April 2016 Convertible Note Offering In connection with the issuance of the Notes, the Company issued Series G warrants exercisable into 9,710 shares of Class A common stock. The fair value of the Series G warrants issued was $2.5 million and is recorded in Equity. The following table reflects original assumptions as of April 1, 2016 for Series G warrants issued in the 2016 Note Offering: 2016 Convertible Preferred Stock offering In connection with the issuance of the September 14, 2016 units, the Company issued Series H warrants exercisable into 16,970 shares of Class A common stock. The fair value of the Series H warrants issued was $1.1 million, net of costs and is recorded in Equity. The following table reflects original assumptions as of September 14, 2016 for Series H warrants issued in the 2016 Convertible Preferred Stock offering: December 2016 Common Stock Offering On December 13, 2016, the Company closed a $4.07 million offering and sale of units consisting of shares of the Company’s Class A common stock, Series I warrants to purchase shares of Common Stock, and prepaid Series J warrants to purchase shares of Common Stock, pursuant to the Securities Purchase Agreement, dated as of December 8, 2016, by and among the Company and several institutional investors, and to public retail investors. As a result, the Company issued 616,667 shares of Common Stock and Series I warrants to purchase 616,667 shares of Common Stock. The purchase price for a Unit was $6.60. Notwithstanding the Company’s December 8, 2016 press release, the Company did not issue any prepaid Series J warrants in connection with the closing of the offering. The Series I warrants are exercisable upon issuance and will remain exercisable until the fifth anniversary of the date of issuance. The exercise price for the Series I warrants is $10.50, subject to certain adjustments and a reset. The Company received net proceeds of approximately $3.6 million at the closing, after deducting commissions to the placement agents and estimated offering expenses payable by the Company associated with the offering. February 2017 Offerings On February 6, 2017, the Company closed a $11.5 million offering and sale of (a) units, “February 6 Primary Units,” each consisting of one share of the Company’s Class A common stock, and a Series K warrant to purchase one share of Class A common stock, and (b) units, “February 6 Alternative Units,” each consisting of a prepaid Series L warrant to purchase one share of Common Stock, and a Series K warrant pursuant to the Securities Purchase Agreement, dated as of February 1, 2017, by and among the Company and several institutional investors, and to public retail investors. As a result, the Company issued 2,096,920 February 6 Primary Units, 1,613,080 February 6 Alternative Units, 2,096,920 shares of Class A common stock, Series K warrants to purchase 3,710,000 shares of Class A common stock, and Series L warrants to purchase 1,613,080 shares of Class A common stock. The purchase price for a February 6 Primary Unit was $3.10 and the purchase price for a February 6 Alternative Unit was $3.09. The Company received net proceeds of approximately $10.5 million at the closing, after deducting commissions to the placement agents and estimated offering expenses payable by the Company associated with the offering. On February 9, 2017, the Company closed a $6 million offering and sale of (a) units, “February 9 Primary Units,” each consisting of one share of the Company’s Class A common stock, and a Series M warrant to purchase 75% of one share of Class A common stock, and (b) units, “February 9 Alternative Units,” each consisting of a prepaid Series N warrant to purchase one share of Class A common stock, and a Series M warrant, pursuant to the Securities Purchase Agreement, dated as of February 7, 2017, by and among the Company and several institutional and accredited investors. As a result, the Company issued 1,650,000 February 9 Primary Units, 750,000 February 9 Alternative Units, 1,650,000 shares of Common Stock as part of the February 9 Primary Units, Series M warrants to purchase 1,800,000 shares of Class A common stock, and Series N warrants to purchase 750,000 shares of Class A common stock. The purchase price for a February 9 Primary Unit was $2.50 and the purchase price for a February 9 Alternative Unit was $2.49. The Company received net proceeds of approximately $5.5 million at the closing, after deducting commissions to the placement agents and estimated offering expenses payable by the Company associated with the offering. Employee Option Exercises, Warrant Exercises and Common Stock Reserved for Future Issuances At December 31, 2016, RGS had the following shares of Class A common stock reserved for future issuance: 9. Fair Value Measurements The Company complies with the provisions of FASB ASC No. 820, Fair Value Measurements and Disclosures (“ASC 820”), in measuring fair value and in disclosing fair value measurements at the measurement date. ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other accounting pronouncements. FASB ASC No. 820-10-35, Fair Value Measurements and Disclosures- Subsequent Measurement (“ASC 820-10-35”), clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820-10-35-3 also requires that a fair value measurement reflect the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model. ASC 820-10-35 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels: Level 1 Inputs - Level 1 inputs are unadjusted quoted prices in active markets for assets or liabilities identical to those to be reported at fair value. An active market is a market in which transactions occur for the item to be fair valued with sufficient frequency and volume to provide pricing information on an ongoing basis. Level 2 Inputs - Level 2 inputs are inputs other than quoted prices included within Level 1. Level 2 inputs are observable either directly or indirectly. These inputs include: (a) Quoted prices for similar assets or liabilities in active markets; (b) Quoted prices for identical or similar assets or liabilities in markets that are not active, such as when there are few transactions for the asset or liability, the prices are not current, price quotations vary substantially over time or in which little information is released publicly; (c) Inputs other than quoted prices that are observable for the asset or liability; and (d) Inputs that are derived principally from or corroborated by observable market data by correlation or other means. Level 3 Inputs - Level 3 inputs are unobservable inputs for an asset or liability. These inputs should be used to determine fair value only when observable inputs are not available. Unobservable inputs should be developed based on the best information available in the circumstances, which might include internally generated data and assumptions being used to price the asset or liability. When determining the fair value measurements for assets or liabilities required or permitted to be recorded at and/or marked to fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Company looks to active and observable markets to price identical assets. When identical assets are not traded in active markets, the Company looks to market observable data for similar assets. The following tables summarize the basis used to measure certain financial assets and liabilities at fair value on a recurring basis in the consolidated balance sheets: The following summarizes the valuation technique for assets and liabilities measured and recorded at fair value: For the Company’s Level 3 measures, which represent common stock warrants, fair value is based on a Monte Carlo pricing model that is based, in part, upon unobservable inputs for which there is little or no market data, requiring the Company to develop its own assumptions. The Company used a market approach to valuing these derivative liabilities. The following table shows the reconciliation from the beginning to the ending balance for the Company’s common stock warrant liability measured at fair value on a recurring basis using significant unobservable inputs (i.e. Level 3) for the year ended December 31, 2016: 10. Share-Based Compensation At December 31, 2016, the Company’s 2008 Long-Term Incentive Plan provided that an aggregate of 52,536 shares of its Class A common stock may be awarded under the plan. Both nonqualified stock options and incentive stock options may be issued under the provisions of the 2008 Long Term Incentive Plan. Employees, members of the Board of Directors, consultants, service providers and advisors are eligible to participate in the 2008 Long-Term Incentive Plan, which terminates upon the earlier of a board resolution terminating the 2008 Long-Term Incentive Plan or ten years after the effective date of the 2008 Long-Term Incentive Plan. All outstanding options are nonqualified and are generally granted with an exercise price equal to the closing market price of the Company’s stock on the date of the grant. Options vest based on service conditions, performance (attainment of a certain amount of pre-tax income for a given year), or some combination thereof. Grants typically expire seven years from the date of grant. The determination of the estimated fair value of share-based payment awards on the date of grant using the Black-Scholes option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. Expected volatilities are based on a value calculated using the combination of historical volatility of comparable public companies in RGS’ industry and its stock price volatility since the Company’s initial public offering. Expected life is based on the specific vesting terms of the option and anticipated changes to market value and expected employee exercise behavior. The risk-free interest rate used in the option valuation model is based on U.S. Treasury zero-coupon securities with remaining terms similar to the expected term on the options. RGS does not anticipate paying any cash dividends on its Class A common stock in the foreseeable future and, therefore, an expected dividend yield of zero is used in the option valuation model. RGS is required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. RGS primarily uses plan life-to-date forfeiture experience rate to estimate option forfeitures and records share-based compensation expense only for those awards that are expected to vest. The following are the variables used in the Black-Scholes option pricing model to determine the estimated grant date fair value for options granted under the Company’s incentive plans for each of the years presented: The table below presents a summary of the Company’s option activity as of December 31, 2016 and changes during the years then ended: The total fair value of shares vested was approximately $1,000 and $780,000 during the years ended December 31, 2016 and 2015, respectively. The Company’s share-based compensation cost charged against income for continuing operations was approximately $0.7 million and $0.8 million during the years 2016 and 2015, respectively. As of December 31, 2016, there was $0.2 million of unrecognized cost related to non-vested shared-based compensation arrangements granted under the plans. The Company expects that cost to be recognized over the next fiscal year. 11. Income Taxes The Company’s provision for income tax expense (benefit) is comprised of the following: Variations from the federal statutory rate are as follows: Deferred income taxes reflect net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The components of the net accumulated deferred income tax assets shown on a gross basis as of December 31, 2016 and 2015 are as follows: At December 31, 2016, RGS had $122.4 million of federal net operating loss carryforwards expiring, if not utilized, beginning in 2020. Additionally, the Company had $109.4 million of state net operating loss carryforwards expiring, it not utilized, beginning in 2020. Utilization of the net operating loss carry-forwards may be subject to annual limitation under applicable federal and state ownership change limitations and, accordingly, net operating losses may expire before utilization. The Company has not completed a Section 382 analysis through December 2016 and therefore has not determined the impact of any ownership changes, as defined under Section 382 of the Internal Revenue Code has occurred in prior years. Therefore, the net operating loss carryforwards above do not reflect any possible limitations and potential loss attributes to such ownership changes. However, the Company believes that upon completion of a Section 382 analysis, as a result of prior period ownership changes, substantially all of the net operating losses will be subject to limitation. The Company’s valuation allowance decreased by $1.7 million for the year ended December 31, 2016 as a result of its operating loss for the year. The valuation allowance was determined in accordance with the provisions of ASC 740, Income Taxes, which requires an assessment of both negative and positive evidence when measuring the need for a valuation allowance. Based upon the available objective evidence and the Company’s history of losses, management believes it is more likely than not that the net deferred tax assets will not be realized. At December 31, 2016, the Company has a valuation allowance against its deferred tax assets net of the expected taxable income from the reversal of its deferred tax liabilities. The Company is required, under the terms of its tax sharing agreement with Gaia, to distribute to Gaia the tax effect of certain tax loss carryforwards as utilized by the Company in preparing its federal, state and local income tax returns. At December 31, 2016, utilizing an income tax rate of 35%, the Company estimates that the maximum amount of such distributions to Gaia could aggregate $1.6 million. 12. Segment Information Financial information for the Company’s segments and a reconciliation of the total of the reportable segments’ income (loss) from operations (measures of profit or loss) to the Company’s consolidated net loss are as follows: The following is a reconciliation of reportable segments’ assets to the Company’s consolidated total assets. The Other segment includes certain unallocated corporate amounts. 13. Discontinued Operations On September 30, 2014, the Company committed to a plan to sell certain net assets and rights comprising its large commercial installations business, otherwise known as its former Commercial segment, and focus its efforts and resources on its Residential and Sunetric segments. This represented a strategic shift that had a major effect on the Company’s operations and financial results. Accordingly, the assets and liabilities, operating results, and operating and investing activities cash flows for the former Commercial segment are presented as a discontinued operation separate from the Company’s continuing operations, for all periods presented in these consolidated financial statements and footnotes, unless indicated otherwise. The following is a reconciliation of the major line items constituting pretax loss of discontinued operations to the after-tax loss of discontinued operations that are presented in the condensed consolidated statements of operations as indicated: The following is a reconciliation of the carrying amounts of major classes of assets and liabilities of the discontinued operations to the total assets and liabilities of the discontinued operations presented separately in the condensed consolidated balance sheets as indicated: 14. Subsequent Events On January 25, 2017 at 11:59 pm Eastern Time, the Company consummated a reverse stock split of all outstanding shares of the Company’s Class A common stock, $0.0001, at a ratio of one-for-thirty, whereby thirty shares of Class A common stock were combined into one share of Class A common stock. The accompanying financial statements have been adjusted to reflect the reverse stock split. As discussed in Note 7, in February 2017 the Company closed on $16.1 million of offerings, net of costs, of Class A common stock and warrants. As discussed in Note 4, on February 6, 2017, the Company issued a 3-day notice of termination, and, as a result, as of February 9, 2017, the Loan was terminated. Additionally, the Company had an Exclusive Supply Agreement (“Supply Agreement”) with Solar Solutions which was terminated as of the same date, as the term of the Supply Agreement was coterminous with the Loan. | Here's a summary of the financial statement:
Financial Performance:
- Experiencing consistent losses and negative cash flow
- Delayed vendor payments due to financial difficulties
- Restricted credit terms from equipment suppliers
- Customer contract cancellations resulted from operational challenges
Financial Estimates and Risks:
- Significant estimates used for:
* Warranty liabilities
* Derivative liability valuations
* Common stock warrant valuations
* Allowance for doubtful accounts
- Potential for material differences between estimated and actual results
Accounts Receivable Management:
- Maintains allowances for doubtful accounts
- Estimates collectability through:
* Historical bad debt analysis
* Customer creditworthiness assessment
* Current economic trend evaluation
- Allowance for doubtful accounts was $0.6
Cash Management:
- Cash held in U.S. dollar demand deposit accounts
Overall, | Claude |
FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders OFS Capital Corporation Chicago, Illinois We have audited the accompanying consolidated balance sheets of OFS Capital Corporation (the “Company”), including the consolidated schedules of investments, as of December 31, 2016 and 2015, and the related consolidated statements of operations, changes in net assets, cash flows, and financial highlights for each of the three years in the period ended December 31, 2016. These consolidated financial statements and financial highlights are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial highlights based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 2016 and 2015 by correspondence with the custodian, loan agent, portfolio companies, or by other appropriate auditing procedures where replies were not received. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of OFS Capital Corporation at December 31, 2016 and 2015, and the results of its operations, changes in net assets and cash flows, and the financial highlights for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), OFS Capital Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 15, 2017 expressed an adverse opinion thereon. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders OFS Capital Corporation Chicago, Illinois We have audited OFS Capital Corporation’s (the “Company”) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). OFS Capital Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Item 9A, Management’s Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. A material weakness has been identified and described in management’s assessment and is included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. The Company did not design and maintain effective internal controls over certain key assumptions and underlying data used in the Company’s investment valuations. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2016 financial statements, and this report does not affect our report dated March 15, 2017 on those financial statements. In our opinion, OFS Capital Corporation did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria. We do not express an opinion or any other form of assurance on management’s statements referring to any corrective actions taken by the Company after the date of management’s assessment. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of OFS Capital Corporation, including the consolidated schedules of investments, as of December 31, 2016 and 2015, and the related consolidated statements of operations, changes in net assets, cash flows, and financial highlights for each of the three years in the period ended December 31, 2016, and our report dated March 15, 2017 expressed an unqualified opinion thereon. OFS Capital Corporation and Subsidiaries Consolidated Balance Sheets (Dollar amounts in thousands, except per share data) See . OFS Capital Corporation and Subsidiaries Consolidated Statements of Operations (Dollar amounts in thousands, except per share data) See . OFS Capital Corporation and Subsidiaries Consolidated Statements of Changes in Net Assets (Dollar amounts in thousands, except per share data) See . OFS Capital Corporation and Subsidiaries Consolidated Statements of Cash Flows (Dollar amounts in thousands) See . OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2016 (Dollar amounts in thousands) OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2016 (Dollar amounts in thousands) OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2016 (Dollar amounts in thousands) OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2016 (Dollar amounts in thousands) OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2016 (Dollar amounts in thousands) OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2016 (Dollar amounts in thousands) (1) Equity ownership may be held in shares or units of companies affiliated with the portfolio company. (2) The majority of investments that bear interest at a variable rate are indexed to the London Interbank Offered Rate ("LIBOR") (L) or Prime (P), and reset monthly, quarterly, or semi-annually. Substantially all of the Company's LIBOR referenced investments are subject to an interest rate floor. For each investment, the Company has provided the spread over the reference rate and current interest rate in effect at December 31, 2016. Unless otherwise noted, all investments with a stated PIK rate require interest payments with the issuance of additional securities as payment of the entire PIK provision. (3) The negative fair value is the result of the unfunded commitment being below par. (4) Investments held by OFS SBIC I, LP. All other investments pledged as collateral under the PWB Credit Facility. (5) Non-qualifying assets under Section 55(a) of the Investment Company Act of 1940, as amended ("1940 Act"). Qualifying assets must represent at least 70% of the Company's assets, as defined under Section 55 of the 1940 Act, at the time of acquisition of any additional non-qualifying assets. As of December 31, 2016, 98.4% of the Company's assets were qualifying assets. (6) Investment was on non-accrual status as of December 31, 2016, meaning the Company has ceased recognizing all or a portion of income on the investment. See Note 2, Dividend Income and Non-accrual loans for further details. (7) The Company has entered into a contractual arrangement with co-lenders whereby, subject to certain conditions, it has agreed to receive its payment after the repayment of certain co-lenders pursuant to a payment waterfall. The reported interest rate of 11.33% at December 31, 2016, includes additional interest of 2.08% per annum as specified under the contractual arrangement among the Company and the co-lenders. (8) The Company has entered into a contractual arrangement with co-lenders whereby, subject to certain conditions, it has agreed to receive its payment after the repayment of certain co-lenders pursuant to a payment waterfall. The reported interest rate of 12.47% at December 31, 2016, includes additional interest of 2.97% per annum as specified under the contractual arrangement among the Company and the co-lenders. (9) Non-income producing. OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2016 (Dollar amounts in thousands) (10) The interest rate on these investments contains a PIK provision, whereby the issuer has the option to make interest payments in cash or with the issuance of additional securities as payment of the entire PIK provision. The interest rate in the schedule represents the current interest rate in effect for these investments. The following table provides additional details on these PIK investments, including the maximum annual PIK interest rate allowed as of December 31, 2016: OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2015 (Dollar amounts in thousands) OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2015 (Dollar amounts in thousands) OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2015 (Dollar amounts in thousands) OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2015 (Dollar amounts in thousands) OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2015 (Dollar amounts in thousands) (1) Equity ownership may be held in shares or units of companies affiliated with the portfolio company. OFS Capital Corporation and Subsidiaries Consolidated Schedule of Investments - Continued December 31, 2015 (Dollar amounts in thousands) (2) Investments that bear interest at a variable rate are indexed to the London Interbank Offered Rate ("LIBOR") (L) or Prime (P), and reset monthly or quarterly. All of the Company's LIBOR referenced investments are subject to an interest rate floor. For each investment, the Company has provided the spread over the reference rate and current interest rate in effect at December 31, 2015. Unless otherwise noted, all investments with a stated PIK rate require interest payments with the issuance of additional securities as payment of the entire PIK provision. (3) The negative fair value is the result of the unfunded commitment being valued below par. (4) Investments held by OFS SBIC I, LP. All other investments pledged as collateral under the PWB Credit Facility. (5) Non-qualifying assets under Section 55(a) of the Investment Company Act of 1940, as amended ("1940 Act"). Qualifying assets must represent at least 70% of the Company's assets, as defined under Section 55 of the 1940 Act, at the time of acquisition of any additional non-qualifying assets. As of December 31, 2015, 96.3 % of the Company's assets were qualifying assets. (6)Investment was on non-accrual status as of December 31, 2015, meaning the Company has ceased recognizing all or a portion of income on the investment. See Note 2 for further details. (7) The Company has entered into a contractual arrangement with co-lenders whereby, subject to certain conditions, it has agreed to receive its payment after the repayment of certain co-lenders pursuant to a payment waterfall. The reported interest rate of 12.84% at December 31, 2015, includes additional interest of 3.59% per annum as specified under the contractual arrangement among the Company and the co-lenders. (8) The Company has entered into a contractual arrangement with co-lenders whereby, subject to certain conditions, it has agreed to receive its payment after the repayment of certain co-lenders pursuant to a payment waterfall. The reported interest rate of 13.25% at December 31, 2015, includes additional interest of 3.75% per annum as specified under the contractual arrangement among the Company and the co-lenders. (9) In January 2016, HealthFusion, Inc. was purchased, at which time the Common Stock Warrants were redeemed and the Senior Secured Loan was repaid at par. In connection with the loan repayment, the Company received a prepayment penalty of $143. The Common Stock Warrants were redeemed for total consideration of $2,385, which included a cash payment of $2,115 and an additional amount held in escrow valued at $270 to be released 50% in one year and the remaining amount in approximately two years. In addition, the Company could receive an earn-out payment of up to approximately $230 to $460 in 2017. (10) Non-income producing. (11) The interest rate includes a PIK provision, whereby the issuer has the option to make interest payments in cash or with the issuance of additional securities as payment of the entire PIK provision. The interest rate in the schedule represents the current interest rate in effect for these investments. The following table provides additional details on these PIK investments, including the maximum annual PIK interest rate allowed as of December 31, 2015. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) Note 1. Organization OFS Capital Corporation (the “Company”), a Delaware corporation, is an externally managed, closed-end, non-diversified management investment company. The Company has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). In addition, for income tax purposes, the Company has elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). The Company’s objective is to provide shareholders with current income and capital appreciation through its strategic investment focus primarily on debt investments and, to a lesser extent, equity investments primarily in middle-market companies principally in the United States. OFS Capital Management, LLC (“OFS Advisor”) manages the day-to-day operations of, and provides investment advisory services to, the Company. In addition, OFS Advisor also serves as the investment adviser for Hancock Park Corporate Income, Inc. (“Hancock Park”), a Maryland corporation and a BDC. Hancock Park’s investment objective is similar to that of the Company. The Company may make investments directly or through OFS SBIC I, LP (“SBIC I LP”), its investment company subsidiary licensed under the Small Business Administration (“SBA”) Small Business Investment Company program (the “SBIC Program”). The SBIC Program is designed to stimulate the flow of capital into eligible businesses. SBIC I LP is subject to SBA regulatory requirements, including limitations on the businesses and industries in which it can invest, requirements to invest at least 25% of its regulatory capital in eligible smaller businesses, as defined under the Small Business Investment Act of 1958 (“SBIC Act”), limitations on the financing terms of investments, and capitalization thresholds that may limit distributions to the Company; and is subject to periodic audits and examinations of its financial statements. Note 2. Summary of Significant Accounting Policies Basis of presentation: The Company prepares its consolidated financial statements in accordance with GAAP, including Accounting Standards Codification ("ASC") Topic 946, “Financial Services-Investment Companies” ("ASC Topic 946"), and the requirements for reporting on Form 10-K, the 1940 Act, and Articles 6 or 10 of Regulation S-X. In the opinion of management, the consolidated financial statements include all adjustments, consisting only of normal and recurring accruals and adjustments, necessary for fair presentation in accordance with GAAP. Certain amounts in the prior period financial statements have been reclassified to conform to the current year presentation. Principles of consolidation: The Company consolidates majority-owned investment company subsidiaries. The Company does not own any controlled operating company whose business consists of providing services to the Company, which would also require consolidation. All intercompany balances and transactions are eliminated upon consolidation. Fair value of financial instruments: The Company applies fair value to substantially all of its financial instruments. ASC Topic 820, "Fair Value Measurements and Disclosures" (“ASC Topic 820”) defines fair value, establishes a framework to measure fair value, and requires disclosures regarding fair value measurements. Fair value is defined as the price to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is determined through the use of models and other valuation techniques, valuation inputs, and assumptions market participants would use to value the investment. Highest priority is given to prices for identical assets quoted in active markets (Level 1) and the lowest priority is given to unobservable valuation inputs (Level 3). The availability of observable inputs can vary significantly and is affected by many factors, including the type of product, whether the product is new to the market, whether the product is traded on an active exchange or in the secondary market, and the current market conditions. To the extent that the valuation is based on less observable or unobservable inputs, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for financial instruments classified as Level 3 (i.e., those instruments valued using non-observable inputs), which comprise the entirety of the Company’s investments. Changes to the valuation policy are reviewed by management and the Company’s board of directors (the “Board”). As the Company’s investments change, markets change, new products develop, and valuation inputs become more or less observable, the Company will continue to refine its valuation methodologies. See Note 6 for more detailed disclosures of the Company’s fair value measurements of its financial instruments. Investment classification: The Company classifies its investments in accordance with the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in those companies in which the Company owns more than 25% of the voting OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) securities or has rights to maintain greater than 50% of board representation, “Affiliate Investments” are defined as investments in those companies in which the Company owns between 5% and 25% of the voting securities, and “Non-Control/Non-Affiliate Investments” are those that neither qualify as Control Investments nor Affiliate Investments. Additionally, the Company adopted the North American Industry Classification System in the first quarter of 2016 for the purpose of industry classification of the Company's investments on the accompanying schedule of investments. The December 31, 2015 schedule of investments has been conformed to the December 31, 2016 presentation. Use of estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Reportable segments: The Company has a single reportable segment and single operating segment structure. Cash and cash equivalents: Cash and cash equivalents consist of cash and highly liquid investments not held for resale with original maturities of three months or less. The Company’s cash and cash equivalents are maintained with a member bank of the Federal Deposit Insurance Corporation (“FDIC”) and at times, such balances may be in excess of the FDIC insurance limits. Included in cash and cash equivalents was $17,659 and $32,714 held in a US Bank Money Market Deposit Account as of December 31, 2016 and 2015, respectively. Revenue recognition: Interest Income: Interest income is recorded on an accrual basis and reported as interest receivable until collected. Interest income is accrued daily based on the outstanding principal amount and the contractual terms of the debt investment. Certain of the Company’s investments contain a payment-in-kind interest income provision (“PIK interest”). The PIK interest, computed at the contractual rate specified in the applicable investment agreement, is added to the principal balance of the investment, rather than being paid in cash, and recorded as interest income, as applicable, on the consolidated statements of operations. The Company discontinues accrual of interest income, including PIK interest, when there is reasonable doubt that the interest income will be collected. Loan origination fees, original issue discount (“OID”), market discount or premium, and loan amendment fees (collectively, “Net Loan Fees”) are recorded as an adjustment to the amortized cost of the investment, and accreted or amortized as an adjustment to interest income over the life of the respective debt investment using a method that approximates the effective interest method. When the Company receives a loan principal payment, the unamortized Net Loan Fees related to the paid principal is accelerated and recognized in interest income. Further, the Company may acquire or receive equity, warrants or other equity-related securities (“Equity”) in connection with the Company’s acquisition of, or subsequent amendment to, debt investments. The Company determines the cost basis of Equity based on their fair value, and the fair value of debt investments and other securities or consideration received. Any resulting difference between the face amount of the debt and its recorded cost resulting from the assignment of value to the Equity is treated as OID, and accreted into interest income as described above. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) Unamortized Net Loan Fees on debt investments were $2,983 and $1,885 as of December 31, 2016 and 2015, respectively. The following table summarizes interest income recognized during the years ended December 31, 2016, 2015 and 2014: Dividend Income: Dividend income on common stock, generally payable in cash, is recorded at the time dividends are declared. Dividend income on preferred equity securities is accrued as earned. Dividends on preferred equity securities may be payable in cash or in additional preferred securities, and are generally not payable unless declared or upon liquidation. Declared dividends payable in cash are reported as dividend receivables until collected. Dividends payable in additional preferred securities or contractually earned but not declared (“PIK dividends”) are recorded as an adjustment to the cost basis of the investment. The Company discontinues accrual of PIK dividends on preferred equity securities when there is reasonable doubt that the dividend income will be collected. At December 31, 2016, the Company had one preferred equity security (Master Cutlery, LLC), with an amortized cost and fair value of $3,483 and $954, respectively, that the Company discontinued the PIK dividend accrual. Distributions received from common or preferred equity securities that do not qualify as dividend income are recorded as a return of capital and a reduction in the adjusted cost basis of the investment. The following table summarizes dividend income recognized during the years ended December 31, 2016, 2015 and 2014: Fee Income: The Company generates revenue in the form of management, valuation, and other contractual fees, which is recognized as the related services are rendered. In the general course of its business, the Company receives certain fees from portfolio companies which are non-recurring in nature. Such non-recurring fees include prepayment fees on certain loans repaid prior to their scheduled due date, which are recognized as earned when received, and fees for capital structuring services from certain portfolio companies, which are recognized as earned upon closing of the investment. The following table summarizes fee income recognized during the years ended December 31, 2016, 2015 and 2014: OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) Net Realized and Unrealized Gain or Loss on Investments: Investment transactions are reported on a trade-date basis. Unsettled trades as of the balance sheet date are included in payable for investments purchased on the consolidated balance sheets. Realized gains or losses on investments are measured by the difference between the net proceeds from the disposition and the amortized cost basis of the investment. Investments are valued at fair value as determined in good faith by Company management under the supervision and review of the Board. After recording all appropriate interest, dividend, and other income, some of which is recorded as an adjustment to the cost basis of the investment as described above, the Company reports changes in the fair value of investments as net changes in unrealized appreciation/depreciation on investments in the consolidated statements of operations. Non-accrual loans: When there is reasonable doubt that principal, cash interest, PIK interest, or dividends will be collected, loans or preferred equity investments are placed on non-accrual status and the Company will generally cease recognizing cash interest, PIK interest, Net Loan Fee amortization, or dividend income, as applicable. When an investment is placed on non-accrual status, all interest and dividends previously accrued but not collected , other than PIK interest or dividends that has been contractually added to the adjusted cost basis of the investment prior to the designation date, is reversed against current period interest and dividend income. Interest and dividend payments subsequently received on non-accrual investments may be recognized as income or applied to principal depending upon management’s judgment. Interest or dividend accruals and Net Loan Fee amortization are resumed on non-accrual investments only when they are brought current with respect to principal, interest or dividends and when, in the judgment of management, the investments are estimated to be fully collectible as to all principal, interest or dividends. At December 31, 2016 the Company had one loan designated non-accrual with respect to PIK interest and Net Loan Fees with an amortized cost and fair value of $7,639 and $5,393, respectively. This loan was initially placed on non-accrual status at September 30, 2016, at which time, the Company ceased recognizing cash and PIK interest income, and Net Loan Fee amortization. During the fourth quarter of 2016, through execution of an amendment, the loan became current with respect to all cash and PIK interest, and the Company resumed accruing cash interest. However, at December 31, 2016, management determined that the principal balance of the loan may not be fully collectible, and therefore the Company placed the loan on non-accrual with respect to the PIK interest and Net Loan Fee amortization. At December 31, 2015, one investment with aggregate cost and fair value of $937 and $798, respectively, was carried as a non-accrual loan. Income taxes: The Company has elected to be treated, and intends to qualify annually, as a RIC under Subchapter M of the Code. To qualify as a RIC, the Company must, among other things, meet certain source of income and asset diversification requirements, and timely distribute at least 90% of its investment company taxable income ("ICTI") to its shareholders. The Company has made, and intends to continue to make, the requisite distributions to its shareholders, which generally relieves the Company from U.S. federal income taxes. Depending on the level of ICTI earned in a tax year, the Company may choose to retain ICTI in an amount less than that which would trigger federal income tax liability under Subchapter M of the Code. However, the Company would be liable for a 4% excise tax on such income. Excise tax liability is recognized when the Company determines its estimated current year annual ICTI exceeds estimated current year distributions. The Company may utilize wholly-owned holding companies taxed under Subchapter C of the Code when making equity investments in portfolio companies taxed as pass-through entities to meet its source-of-income requirements as a RIC. These “tax blocker” entities are consolidated in the Company’s GAAP financial statements and may result in federal income tax expense with respect to income derived from those investments. Such income, net of applicable federal income tax, is not included in the Company’s tax-basis net investment income until distributed by the holding company, which may result in temporary differences and character differences between the Company’s GAAP and tax-basis net investment income and realized gains and losses. Federal income tax expense from such holding-company subsidiaries is included in general and administrative expenses in the consolidated statements of operations. The Company evaluates tax positions taken in the course of preparing its tax returns to determine whether they are “more-likely-than-not” to be sustained by the applicable tax authority. Tax benefits of positions not deemed to meet the more-likely-than-not threshold could result in greater and undistributed ICTI, income and excise tax expense, and, if involving multiple years, a re-assessment of the Company’s RIC status. GAAP requires recognition of accrued interest and penalties related to uncertain tax benefits as income tax expense. There were no uncertain income tax positions at December 31, 2016 and 2015. The current and prior three tax years remain subject to examination by U.S. federal and most state tax authorities. Distributions: Distributions to common shareholders are recorded on the declaration date. The timing of distributions as well as the amount to be paid out as a distribution is determined by the Board each quarter. Distributions from net investment income and net realized gains are determined in accordance with the Code. Net realized capital gains, if any, are distributed at OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) least annually, although the Company may decide to retain such capital gains for investment. Distributions paid in excess of taxable net investment income and net realized gains are considered returns of capital to shareholders. The Company has adopted a distribution reinvestment plan (“DRIP”) that provides for reinvestment of any distributions the Company declares in cash on behalf of its shareholders, unless a shareholder elects to receive cash. As a result, if the Board authorizes and the Company declares a cash distribution, then shareholders who have not “opted out” of the DRIP will have their cash distribution automatically reinvested in additional shares of the Company’s common stock, rather than receiving the cash distribution. The Company may use newly issued shares under the guidelines of the DRIP, or the Company may purchase shares in the open market in connection with its obligations under the plan. Deferred debt issuance costs: Deferred debt issuance costs represent fees and other direct incremental costs incurred in connection with the Company’s borrowings. Deferred debt issuance costs are presented as a direct reduction of the related debt liability on the consolidated balance sheets except for deferred debt issuance costs associated with the Company’s line of credit arrangements, which are included in prepaid expenses and other assets on the consolidated balance sheets. Deferred debt issuance costs are amortized to interest expense over the term of the related debt. Goodwill: On December 4, 2013, in connection with acquisition of the limited partnership interests in SBIC I LP and membership interest in SBIC I GP (the “SBIC Acquisitions”), the Company recorded goodwill of $1,077, which is included in prepaid expenses and other assets on the consolidated balance sheets. Goodwill is not subject to amortization. Goodwill is evaluated for impairment annually or more frequently if events occur or circumstances change that indicate goodwill may be impaired. There have been no goodwill impairments since the date of the SBIC Acquisitions. Intangible asset: On December 4, 2013, in connection with the SBIC Acquisitions, the Company recorded an intangible asset of $2,500 attributable to the SBIC license. The Company amortizes this intangible asset on a straight-line basis over its estimated useful life of 13 years. The Company expects to incur annual amortization expense of $195 in each of the years ending December 31, 2025 and $145 in 2026. The Company tests its intangible asset for impairment if events or circumstances suggest that the asset carrying value may not be fully recoverable. The intangible asset, net of accumulated amortization of $600 and $405 at December 31, 2016 and 2015, respectively, is included in prepaid expenses and other assets. Interest expense: Interest expense is recognized on an accrual basis. Concentration of credit risk: Aside from its debt instruments, financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash deposits at financial institutions. At various times during the year, the Company may exceed the federally insured limits. To mitigate this risk, the Company places cash deposits only with high credit quality institutions. Management believes the risk of loss is minimal. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) New Accounting Standards The following table discusses recently issued Accounting Standards Updates (“ASU”) by the Financial Accounting Standards Board (“FASB”) adopted by the Company during 2016: The following table discusses recently issued ASUs by the FASB yet to be adopted by the Company: OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) Note 3. OFS Capital WM OFS Capital WM, LLC (“OFS Capital WM”), a wholly-owned investment company subsidiary, was formed in August 2010 with the limited purpose of holding, acquiring, managing and financing senior secured loan investments to middle-market companies in the United States. On September 28, 2010, the Company became the owner of OFS Capital WM through a transaction in which it transferred eligible loans-or 100% of its participating interest in certain other loans-to OFS Capital WM in exchange for cash and a 100% equity ownership interest in OFS Capital WM. These loans were managed and serviced by MCF Capital Management, LLC (“MCF”) under a loan and security agreement among OFS Capital WM, MCF, Wells Fargo Securities, LLC, and Well Fargo Delaware Trust Company, N.A. (the “Loan and Security Agreement”). MCF charged a management fee of 0.25% per annum of the assigned value of the underlying portfolio investments plus an accrued fee that was deferred until termination of the Loan and Security Agreement on May 28, 2015. The Company incurred management fee expense related to this agreement of $-0-, $288, and $731, for the years ended December 31, 2016, 2015, and 2014, respectively. OFS Capital WM Asset Sale and Related Transactions On May 28, 2015, the Company and OFS Capital WM entered into a Loan Portfolio Purchase Agreement with Madison Capital Funding LLC (“Madison”), an affiliate of MCF, pursuant to which OFS Capital WM sold a portfolio of 20 senior secured debt investments with an aggregate outstanding principal balance of $67,807 to Madison for cash proceeds of $67,309 (the “WM Asset Sale”).On May 28, 2015, the total fair value of the debt investments sold, applying the Company’s March 31, 2015 fair value percentages to the principal balances of the respective investments on the sale date, was approximately $66,703. The determination of the fair value of the Company’s investments is subject to the good faith determination by the Company’s board of directors, which is conducted no less frequently than quarterly, pursuant to the Company’s valuation policies and accounting principles generally accepted in the United States. On May 28, 2015, pursuant to the Loan and Security Agreement, the Company applied $52,414 from the sale proceeds of the WM Asset Sale to pay in full and retire OFS Capital WM’s secured revolving line of credit with Wells Fargo Bank, N.A. (“WM Credit Facility”). As a result of the termination of the WM Credit Facility, the Company wrote-off related unamortized deferred financing closing costs of $1,216. On May 28, 2015, in connection with the WM Asset Sale, the Company entered into a Loan Administration Services Agreement with Madison pursuant to which Madison will provide loan servicing and other administrative services to OFS Capital WM with respect to certain of its remaining loan assets. In return for its loan administration services, Madison will receive a quarterly loan administration fee of 0.25% per annum based on the average daily principal balances of the loan assets for such quarter. The Company incurred loan administration fee expense of $39, $33, and $-0- for the years ended December 31, 2016, 2015, and 2014, respectively. Note 4. Related Party Transactions Investment Advisory and Management Agreement: OFS Advisor manages the day-to-day operations of, and provides investment advisory services to, the Company pursuant to an investment advisory and management agreement dated November 7, 2012 ("Advisory Agreement"). Under the terms of the Advisory Agreement, which are in accordance with the 1940 Act and subject to the overall supervision of the Company’s Board, OFS Advisor is responsible for sourcing potential investments, conducting research and diligence on potential investments and equity sponsors, analyzing investment opportunities, structuring investments, and monitoring investments and portfolio companies on an ongoing basis. OFS Advisor is a subsidiary of Orchard First Source Asset Management, LLC (“OFSAM”) and a registered investment advisor under the Investment Advisers Act of 1940, as amended. OFS Advisor’s services under the Investment Advisory Agreement are not exclusive to the Company and OFS Advisor is free to furnish similar services to other entities, including other BDCs affiliated with OFS Advisor, so long as its services to the Company are not impaired. OFS Advisor also serves as the investment adviser to CLO funds and other assets,including Hancock Park Corporate Income, Inc., a non-traded BDC with an investment strategy similar to the Company. OFS Advisor receives fees for providing services, consisting of two components: a base management fee and an incentive fee. The base management fee is calculated at an annual rate of 1.75% and based on the average value of the Company’s total assets (other than cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity) at the end of the two most recently completed calendar quarters, adjusted for any share issuances or OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) repurchases during the quarter. OFS Advisor has elected to exclude the value of the intangible asset and goodwill resulting from the SBIC Acquisitions from the base management fee calculation. The base management fee is payable quarterly in arrears and was $4,516, $4,937, and $2,184, for the years ended December 31, 2016, 2015, and 2014, respectively. The incentive fee has two parts. The first part ("Part One") is calculated and payable quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees such as commitment, origination and sourcing, structuring, diligence and consulting fees or other fees that the Company receives from portfolio companies but excluding fees for providing managerial assistance) accrued during the calendar quarter, minus operating expenses for the quarter (including the base management fee, any expenses payable under the Administration Agreement (as defined below) and any interest expense and dividends paid on any outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest or dividend feature (such as OID, debt instruments with PIK interest, equity investments with accruing or PIK dividend and zero coupon securities), accrued income that the Company has not yet received in cash. Pre-incentive fee net investment income is expressed as a rate of return on the value of the Company’s net assets (defined as total assets less indebtedness and before taking into account any incentive fees payable during the period) at the end of the immediately preceding calendar quarter. The incentive fee with respect to pre-incentive fee net income is 20.0% of the amount, if any, by which the pre-incentive fee net investment income for the immediately preceding calendar quarter exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up” provision measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, OFS Advisor receives no incentive fee until the net investment income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100.0% of the pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5%. The effect of this provision is that, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, OFS Advisor will receive 20.0% of the pre-incentive fee net investment income. Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that the Company may pay an incentive fee in a quarter in which the Company incurs a loss. For example, if the Company receives pre-incentive fee net investment income in excess of the quarterly minimum hurdle rate, the Company will pay the applicable incentive fee even if the Company has incurred a loss in that quarter due to realized and unrealized capital losses. The Company’s net investment income used to calculate this part of the incentive fee is also included in the amount of the Company’s gross assets used to calculate the base management fee. These calculations are appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during such quarter. The second part ("Part Two") of the incentive fee (the “Capital Gain Fee”) is determined and payable in arrears as of the end of each calendar year (or upon termination of the Advisory Agreement, as of the termination date), commencing on December 31, 2012, and equals 20.0% of the Company’s aggregate realized capital gains, if any, on a cumulative basis from the date of the election to be a BDC through the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation through the end of such year, less all previous amounts paid in respect of the Capital Gain Fee; provided that the incentive fee determined as of December 31, 2012, was calculated for a period of shorter than twelve calendar months to take into account any realized capital gains computed net of all realized capital losses and unrealized capital depreciation for the period beginning on the date of the Company’s election to be a BDC and ending December 31, 2012. The Company accrues the Capital Gain Fee if, on a cumulative basis, the sum of net realized capital gains and (losses) plus net unrealized appreciation and (depreciation) is positive. If, on a cumulative basis, the sum of net realized capital gains (losses) plus net unrealized appreciation (depreciation) decreases during a period, the Company will reverse any excess Capital Gain Fee previously accrued such that the amount of Capital Gains Fee accrued is no more than 20% of the sum of net realized capital gains (losses) plus net unrealized appreciation (depreciation). OFS Advisor has excluded from the Capital Gain Fee calculation any realized gain with respect to (1) the SBIC Acquisitions, and (2) the WM Asset Sale. The Company incurred incentive fee expense of $3,333, $2,627, and $1,253 for the for the years ended December 31, 2016, 2015, and 2014, respectively. Incentive fees for the years ended December 31, 2016, 2015, and 2014, included Part One incentive fees (based on net investment income) of $3,472, $2,488 and $1,253, respectively, and Part Two incentive fees (based upon net realized and unrealized gains and losses, or capital gains) of $(139), $139 and $-0-, respectively. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) License Agreement: The Company entered into a license agreement with OFSAM under which OFSAM has agreed to grant the Company a non-exclusive, royalty-free license to use the name “OFS.” Administration Agreement: OFS Capital Services, LLC (“OFS Services”), a wholly-owned subsidiary of OFSAM, furnishes the Company with office facilities and equipment, necessary software licenses and subscriptions, and clerical, bookkeeping and record keeping services at such facilities pursuant to an administration agreement dated November 7, 2012 (“Administration Agreement”). Under the Administration Agreement, OFS Services performs, or oversees the performance of, the Company’s required administrative services, which include being responsible for the financial records that the Company is required to maintain and preparing reports to its shareholders and all other reports and materials required to be filed with the SEC or any other regulatory authority. In addition, OFS Services assists the Company in determining and publishing its net asset value, oversees the preparation and filing of its tax returns and the printing and dissemination of reports to its shareholders, and generally oversees the payment of the Company’s expenses and the performance of administrative and professional services rendered to the Company by others. Under the Administration Agreement, OFS Services also provides managerial assistance on the Company’s behalf to those portfolio companies that have accepted the Company’s offer to provide such assistance. Payment under the Administration Agreement is equal to an amount based upon the Company’s allocable portion of OFS Services’s overhead in performing its obligations under the Administration Agreement, including, but not limited to, rent, information technology services and the Company’s allocable portion of the cost of its officers, including its chief executive officer, chief financial officer, chief compliance officer, chief accounting officer, and their respective staffs. Administration fee expense was $1,304, $1,637and $1,245 for the years ended December 31, 2016, 2015, and 2014, respectively. Note 5. Investments As of December 31, 2016, the Company had loans to 39 portfolio companies, of which 74% were senior secured loans and 26% were subordinated loans, at fair value, as well as equity investments in 17 of these portfolio companies. The Company also held an equity investment in two portfolio companies in which it did not hold a debt interest. At December 31, 2016, investments consisted of the following: At December 31, 2016, all but one of the Company’s investments, with an amortized cost and fair value of $3,923 and $3,923, respectively (domiciled in Canada), were domiciled in the United States. Geographic composition is determined by the location of the corporate headquarters of the portfolio company. The industry compositions of the Company’s portfolio were as follows: OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) During the year ended December 31, 2016, the Company converted $1,765 in principal of a subordinated debt investment into preferred equity units and warrants valued at $1,765, converted $329 in principal of a senior secured debt investment into preferred equity units valued at $335, and converted $800 in principal of a subordinated debt investment into a senior secured debt investment in the same portfolio company. In addition, the Company amended a senior secured debt investment for which it received preferred equity units in the same portfolio company valued at $203 and received additional preferred equity units valued at $44 in connection with a $1,250 follow on investment in the same portfolio company. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) As of December 31, 2015, the Company had loans to 38 portfolio companies, of which 71% were senior secured loans and 29% were subordinated loans, at fair value, as well as equity investments in 15 of these portfolio companies. The Company also held equity investments in one portfolio company in which it did not hold a debt interest. At December 31, 2015, investments consisted of the following: At December 31, 2015, the Company’s investments were all domiciled in the United States and the industry compositions of the Company’s portfolio were as follows: OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) Unconsolidated Significant Subsidiaries: In accordance with Regulation S-X and GAAP, the Company is not permitted to consolidate any subsidiary or other entity that is not an investment company, including those in which the Company has a controlling interest unless the business of the controlled operating company consists of providing services to the Company. In accordance with Regulation S-X Rules 3-09 and 4-08(g), the Company evaluates its unconsolidated controlled portfolio companies as significant subsidiaries under the respective rules. As of December 31, 2016, MTE Holding Corp. and Subsidiaries was considered a significant unconsolidated subsidiary under Regulation S-X Rule 4-08(g). The Company's voting ownership in MTE Holding Corp is limited to 50% through a substantive participating voting rights agreement with an unaffiliated investor. Based on the requirements under Regulation S-X Rule 4-08(g), the summarized consolidated financial information of MTE Holding Corp. and Subsidiaries is presented below: (1) MTE Holding Corp. was organized in 2015. Note 6. Fair Value of Financial Instruments The Company’s investments are valued at fair value as determined in good faith by Company management under the supervision, and review and approval of the Board. These fair values are determined in accordance with a documented valuation policy and a consistently applied valuation process that includes a review of each investment by an independent valuation firm at least once every 12 months. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) Each quarter the Company assesses whether sufficient market quotations are available or whether a sufficient number of indicative prices from pricing services or brokers or dealers have been received. Investments for which sufficient market quotations are available are valued at such market quotations. Otherwise, the Company undertakes, on a quarterly basis, a multi-step valuation process as described below: • For each debt investment, a basic credit risk rating review process is completed. The risk rating on every credit facility is reviewed and either reaffirmed or revised by OFS Advisor’s investment committee. • Each portfolio company or investment is valued by OFS Advisor. • The preliminary valuations are documented and are then submitted to OFS Advisor’s investment committee for ratification. • Third-party valuation firm(s) provide valuation services as requested, by reviewing the investment committee’s preliminary valuations. OFS Advisor’s investment committee’s preliminary fair value conclusions on each of the Company’s assets for which sufficient market quotations are not readily available is reviewed and assessed by a third-party valuation firm at least once in every 12-month period, and more often as determined by the audit committee of the Company’s Board or required by the Company’s valuation policy. Such valuation assessment may be in the form of positive assurance, range of values or other valuation method based on the discretion of the Company’s Board. • The audit committee of the Board reviews the preliminary valuations of OFS Advisor’s investment committee and independent valuation firms and, if appropriate, recommends the approval of the valuations by the Board. • The Company’s Board discusses valuations and determines the fair value of each investment in the portfolio in good faith based on the input of OFS Advisor, the audit committee and, where appropriate, the respective independent valuation firm. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair values are determined with models or other valuation techniques, valuation inputs, and assumptions market participants would use in pricing an asset or liability. Valuation inputs are organized in a hierarchy that gives the highest priority to prices for identical assets or liabilities quoted in active markets (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of inputs in the fair value hierarchy are described below: Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity can access at the measurement date. Level 2: Inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include: (i) quoted prices for similar assets or liabilities in active markets, (ii) quoted prices for identical or similar assets or liabilities in markets that are not active, (iii) inputs other than quoted prices that are observable for the asset or liability, and (iv) inputs that are derived principally from or corroborated by observable market data. Level 3: Unobservable inputs for the asset or liability, and situations where there is little, if any, market activity for the asset or liability at the measurement date. The inputs into the determination of fair value are based upon the best information under the circumstances and may require significant management judgment or estimation. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment. The Company assesses the levels of the investments at each measurement date, and transfers between levels are recognized on the measurement date. All of the Company’s investments, which are measured at fair value, were categorized as Level 3 based upon the lowest level of significant input to the valuations.There were no transfers among Level 1, 2 and 3 for the years ended December 31, 2016, 2015, and 2014. The following sections describe the valuation techniques used by the Company to measure different financial instruments at fair value and include the levels within the fair value hierarchy in which the financial instruments are categorized. Consistent with the policies and methodologies adopted by the Board, the Company performs detailed valuations of its debt and equity investments, including an analysis on the Company’s unfunded loan commitments, using both the market and income OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) approaches as appropriate. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is generally best expressed as a range of values. The Company may also engage one or more independent valuation firms(s) to conduct independent appraisals of its investments to develop the range of values, from which the Company derives a single estimate of value. Under the income approach, the Company typically prepares and analyzes discounted cash flow models to estimate the present value of future cash flows of either an individual debt investment or of the underlying portfolio company itself. The primary method used to estimate the fair value of the Company's debt investments is the discounted cash flow method. However, if there is deterioration in credit quality or a debt investment is in workout status, the Company may consider other methods in determining the fair value, including the value attributable to the debt investment from the enterprise value of the portfolio company or the proceeds that would be received in a liquidation analysis. The discounted cash flow approach to determine fair value (or a range of fair values) involves applying an appropriate discount rate(s) to the estimated future cash flows using various relevant factors depending on investment type, including the latest arm’s length or market transactions involving the subject security, a benchmark credit spread or other indication of market yields, and company performance. The valuation based on the inputs determined to be the most reasonable and probable is used as the fair value of the investment, which may include a weighting factor applied to multiple valuation methods. The determination of fair value using these methodologies may take into consideration a range of factors including, but not limited to, the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance, financing transactions subsequent to the acquisition of the investment and anticipated financing transactions after the valuation date. The Company changed the primary method used to value certain of its investments, primarily equity investments, as of December 31, 2016, from the income approach to the market approach, principally due to the nature of evidence available under the discounted cash flow method, and to better align with industry practice. The Company may also utilize an income approach when estimating the fair value of its equity securities, either as a primary methodology if consistent with industry practice or if the market approach is otherwise not applicable, or as a supporting methodology to corroborate the fair value ranges determined by the market approach. Under the market approach, the Company estimates the enterprise value of portfolio companies. Typically, the enterprise value of a private company is based on multiples of EBITDA, net income, revenues, or other relevant basis. The valuation based on the inputs determined to be the most reasonable and probable is used as the fair value of the investment, which may include a weighting factor applied to multiple valuation methods. In estimating the enterprise value of a portfolio company, the Company analyzes various factors consistent with industry practice, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, the portfolio company’s historical and projected financial results, applicable market trading and transaction comparables, applicable market yields and leverage levels, the nature and realizable value of any collateral, financing transactions subsequent to the acquisition of the investment and anticipated financing transactions after the valuation date. Application of these valuation methodologies involves a significant degree of judgment by management. Fair values of new investments or investments where an arm’s length transaction occurred in the same security are generally assumed to be equal to their cost (“Transaction Price”) for up to three months after their initial purchase. Due to the inherent uncertainty of determining the fair value of Level 3 investments, the fair value of the investments may differ significantly from the values that would have been used had a ready market or observable inputs existed for such investments and may differ materially from the values that may ultimately be received or settled. Further, such investments are generally subject to legal and other restrictions, or otherwise are less liquid than publicly traded instruments. If the Company were required to liquidate a portfolio investment in a forced or liquidation sale, the Company might realize significantly less than the value at which such investment had previously been recorded. The Company’s investments are subject to market risk. Market risk is the potential for changes in the value due to market changes. Market risk is directly impacted by the volatility and liquidity in the markets in which the investments are traded. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) The following tables provide quantitative information about the Company’s significant Level 3 fair value inputs to the Company’s fair value measurements as of December 31, 2016 and 2015. In addition to the techniques and inputs noted in the tables below, according to the Company’s valuation policy, the Company may also use other valuation techniques and methodologies when determining the Company’s fair value measurements. The table below is not intended to be exhaustive, but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements. (1) Excludes $15,926, $12,382, and $499 of senior secured debt investments, subordinated debt investments, and equity investments, respectively, valued at a Transaction Price. (1) Excludes $51,122, $-0-, and $8,933 of senior secured debt investments, subordinated debt investments, and equity investments, respectively, valued at a Transaction Price. Changes in market credit spreads or the credit quality of the underlying portfolio company (both of which could impact the discount rate), as well as changes in EBITDA and/or EBITDA multiples, among other things, could have a significant impact on fair values, with the fair value of a particular debt investment susceptible to change in inverse relation to the changes in the discount rate. Changes in EBITDA and/or EBITDA multiples, as well as changes in the discount rate, could have a significant impact on fair values, with the fair value of an equity investment susceptible to change in tandem with the changes in EBITDA and/or EBITDA multiples, and in inverse relation to changes in the discount rate. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) The following tables present changes in investments measured at fair value using Level 3 inputs for the years ended December 31, 2016 and 2015: OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) The net unrealized (depreciation) reported in the Company’s consolidated statements of operations for the years ended December 31, 2016, 2015, and 2014, attributable to the Company’s Level 3 assets held at those respective year ends was $254, $3,243, and $2,467, respectively. The information presented should not be interpreted as an estimate of the fair value of the entire Company since fair value measurements are only required for a portion of the Company’s assets and liabilities. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The Company believes that the carrying amounts of its other financial instruments such as cash, receivables and payables approximate the fair value of such items due to the short maturity of such instruments. The Company's SBA-guaranteed debentures are carried at cost and with their longer maturity dates, fair value is estimated by discounting remaining payments using current market rates for similar instruments and considering such factors as the legal maturity date. As of December 31, 2016 and 2015, the fair value of the Company’s SBA debentures using Level 3 inputs is estimated at $159,708 and $149,880, respectively Note 7. Commitments and Contingencies Unfunded commitments to the Company's portfolio companies as of December 31, 2016, were as follows: From time to time, the Company is involved in legal proceedings in the normal course of its business. Although the outcome of such litigation cannot be predicted with any certainty, management is of the opinion, based on the advice of legal counsel, that OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) final disposition of any litigation should not have a material adverse effect on the financial position of the Company as of December 31, 2016. Additionally, the Company is subject to periodic inspection by regulators to assess compliance with applicable regulations related to being a BDC and SBIC I LP is subject to periodic inspections by the SBA. In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties that provide general indemnifications. The Company’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Company that have not occurred. The Company believes the risk of any material obligation under these indemnifications to be low. Note 8 . Borrowings SBA Debentures: The SBIC Program allows SBIC I LP to obtain leverage by issuing SBA-guaranteed debentures, subject to issuance of a capital commitment by the SBA and customary procedures. These debentures are non-recourse to the Company, have interest payable semi-annually and a ten-year maturity. The interest rate is fixed at the time of SBA pooling, which is March and September of each year, at a market-driven spread over U.S. Treasury Notes with ten-year maturities. Under present regulations of the SBIC Act, the maximum amount of SBA-guaranteed debt that may be issued by a single SBIC licensee is $150,000. An SBIC fund may borrow up to two times the amount of its regulatory capital, subject to customary regulatory requirements. For two or more SBICs under common control, the maximum amount of outstanding SBA-provided leverage cannot exceed $350,000. In connection with the SBIC Acquisitions, the Company increased its total commitments to SBIC I LP to $75,000, which became a drop down SBIC fund of the Company on December 4, 2013. During 2014, the Company fully funded its $75,000 commitment to SBIC I LP. As of December 31, 2016 and 2015, SBIC I LP had fully drawn the $149,880 of leverage commitments from the SBA. On a stand-alone basis, SBIC I LP held $247,512 and $245,147 in assets at December 31, 2016 and 2015, respectively, which accounted for approximately 81% and 83% of the Company’s total consolidated assets, respectively. These assets can not be pledged under any debt obligation of the Company. The following table shows the Company’s outstanding SBA debentures payable as of December 31, 2016 and 2015: The Company received exemptive relief from the SEC effective November 26, 2013, which permits the Company to exclude SBA guaranteed debentures from the definition of senior securities in the statutory 200% asset coverage ratio under the 1940 Act, allowing for greater capital deployment. The effective interest rate on the SBA debentures, which includes amortization of deferred debt issuance costs, was 3.43% as of December 31, 2016 and 2015. Interest expense on the SBA debentures was $5,156, $4,352, and $1,433 for the years ended December 31, 2016, 2015, and 2014, respectively, which includes $382, $297, and $114 of debt issuance costs amortization, respectively. The weighted-average fixed cash interest rate on the SBA debentures as of December 31, 2016 and 2015, was 3.18%. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) PWB Credit Facility: On November 5, 2015, the Company entered into a Business Loan Agreement (“BLA”) with Pacific Western Bank, as lender, to provide the Company with a $15,000 senior secured revolving credit facility (“PWB Credit Facility”). The PWB Credit Facility is available for general corporate purposes including investment funding and was scheduled to mature on November 6, 2017. The maximum availability of the PWB Credit Facility is equal to 50% of the aggregate outstanding principal amount of eligible loans included in the borrowing base and otherwise specified in the BLA. The PWB Credit Facility is guaranteed by OFS Capital WM and secured by all of the Company’s current and future assets excluding assets held by SBIC I LP and the Company’s SBIC I LP and SBIC I GP partnership interests. On October 31, 2016, the BLA was amended to, among other things (i) increase the maximum amount available under the PWB Credit Facility from $15 million to $25 million, (ii) extend the maturity date from November 6, 2017 to October 31, 2018, (iii) increase the fixed interest rate from 4.75% to 5.00% per annum, and (iv) exclude subordinated loan investments (as defined in the BLA) from the borrowing base. In addition, as of the amendment date, the Company will incur an unused commitment fee, payable monthly in arrears, equal to 0.50% per annum on any unused portion of the PWB Credit Facility in excess of $15,000, which is included in interest expense on the consolidated statement of operations. There were no advances under the facility prior to the October 31, 2016 amendment. The average dollar amount of borrowings outstanding during the year ended December 31, 2016, was $578. The effective interest rate, which includes amortization of deferred debt issuance costs and unused fees on the unused portion in excess of $15,000, as of December 31, 2016, was 6.14%. Deferred debt issuance costs, net of accumulated amortization, was $256 and $185 as of December 31, 2016 and 2015, respectively. Amortization of debt issuance costs was $108, $17 , and $0, for the years ended December 31, 2016, 2015, and 2014, respectively. Availability under the PWB Credit Facility as of December 31, 2016 was $15,500 based on the stated advance rate of 50% under the borrowing base. The BLA contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting requirements, a minimum tangible net asset value, a minimum quarterly net investment income after incentive fees, and a statutory asset coverage test. The BLA also contains customary events of default, including, without limitation, nonpayment, misrepresentation of representations and warranties in a material respect, breach of covenant, cross-default to other indebtedness, bankruptcy, change in investment advisor, and the occurrence of a material adverse change in our financial condition. As of December 31, 2016, the Company was in compliance with the applicable covenants. OFS Capital WM Revolving Line of Credit: Prior to the termination of the WM Credit Facility on May 28, 2015 (see Note 4), OFS Capital WM had a $75,000 secured revolving credit facility, as amended from time to time, with Wells Fargo. The WM Credit Facility was secured by all eligible loans acquired by OFS Capital WM, and had a maturity date of December 31, 2018 and a reinvestment period through December 31, 2015. The interest rate on outstanding borrowings was the London Interbank Offered Rate plus 2.50% per annum. The minimum equity requirement was set at $35,000. The interest rate on the outstanding borrowings at December 31, 2014 was 2.76%. The unused commitment fee on the WM Credit Facility was (i) 0.5% per annum of the first $25,000 of the unused facility and (ii) 2% per annum of the balance in excess of $25,000, and was included in interest expense on the consolidated statement of operations. During the three months ended March 31, 2015, the Company recorded a $430 write-off of debt issuance costs due to a permanent reduction in the facility’s commitment from $100,000 to $75,000. During the three months ended June 30, 2015, the Company incurred a $1,216 write-off of debt issuance costs due to the termination of the facility on May 28, 2015. Note 9. Federal Income Tax The Company has elected to be taxed as a RIC under Subchapter M of the Code. In order to maintain its status as a RIC, the Company is required to distribute annually to its shareholders at least 90% of its ICTI, as defined by the Code. Additionally, to avoid a 4% excise tax on undistributed earnings the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2% of its net capital gains for the one-year period ending October 31 of that calendar year, and (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no federal income tax. Maintenance of the Company's RIC status also requires adherence to certain source of income and asset diversification requirements. The Company has met the required distribution, source of income and asset diversification requirements as of December 31, 2016, and intends to continue meeting these requirements. Accordingly, there is no liability for federal income taxes at the Company level. The Company’s ICTI differs from the net increase in net assets resulting from operations primarily due to differences in income recognition on the unrealized appreciation/depreciation of investments, income from Company’s equity OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) investments in pass-through entities, PIK dividends that have not yet been declared and paid by underlying portfolio companies, capital gains and losses and the net creation or utilization of capital loss carryforwards. The distributions paid to shareholders are reported as ordinary income, long-term capital gains, and returns of capital. The tax character of distributions paid were as follows: The Company records reclassifications to its capital accounts related to permanent differences between GAAP and tax treatment related to goodwill amortization, excise taxes, and other permanent differences; and temporary differences between GAAP and tax treatment of realized gains and losses, income arising from Company’s equity investments in pass-through entities, PIK dividends, and other temporary differences. Reclassifications were as follows: Tax basis undistributed income as of December 31, 2016 and 2015 was as follows: The tax-basis cost of investments and associated tax-basis gross unrealized appreciation (depreciation) inherent in the fair value of investments as of December 31, 2016 and 2015 were as follows: OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) Note 10. Financial Highlights The following is a schedule of financial highlights for the years ended December 31, 2016, 2015, and 2014: (1) Calculation is ending market value less beginning market value, adjusting for dividends and distributions reinvested at prices obtained in the Company’s dividend reinvestment plan for the respective distributions. (2) Calculation is ending net asset value less beginning net asset value, adjusting for dividends and distributions reinvested at the Company’s quarter-end net asset value for the respective distributions. (3) Based on the average of the net asset value at the beginning of the indicated period and the end of each calendar quarter within the period indicated. (4) The components of the distributions are presented on an income tax basis. Note 11. Distributions The Company intends to make distributions to shareholders on a quarterly basis of substantially all of its net investment income. In addition, although the Company intends to make distributions of net realized capital gains, if any, at least annually, out of assets legally available for such distributions, it may in the future decide to retain such capital gains for investment. The Company may be limited in its ability to make distributions due to the BDC asset coverage requirements of the 1940 Act. The Company’s ability to make distributions may also be affected by its ability to receive distributions from SBIC I LP. SBIC I LP’s ability to make distributions is governed by SBA regulations. Consolidated cash and cash equivalents includes $13,513 held by SBIC I LP, which was not available for distribution at December 31, 2016. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) The following table summarizes distributions declared and paid for the years ended December 31, 2016, 2015, and 2014: (1) The determination of the tax attributes of distributions is made annually as of the end of each fiscal year based upon taxable income for the full year and distributions paid for the full year. The return of capital portion of each distribution as of December 31, 2014, 2015, and 2016 was $0.72, $0.23, and $0.09, respectively. For the year ended December 31, 2016, $122 of the total $13,183 paid to shareholders represented DRIP participation, during which the Company satisfied the DRIP participation requirements with the issuance of 9,127 shares at an average value of $13.23 per share at the date of issuance. For the year ended December 31, 2015, $461 of the total $13,151 paid to shareholders represented DRIP participation, during which the Company satisfied the DRIP participation requirements with the issuance of 40,336 shares at an average value of $11.44 per share at the date of issuance. For the year ended December 31, 2014, $256 of the total $13,103 paid to shareholders represented DRIP participation, during which the Company satisfied the DRIP participation requirements with the issuance of 21,037 shares at an average value of $12.17 per share at the date of issuance. Since the Company’s IPO, distributions to shareholders total $50,879, or $5.27 per share on a cumulative basis. Distributions in excess of the Company’s current and accumulated ICTI would be treated first as a return of capital to the extent of the shareholder’s tax basis, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of the Company’s distributions is made annually as of the end of its fiscal year based upon its ICTI for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of the Company’s distributions for a full year. Each year, a statement on Form 1099-DIV identifying the source of the distribution is mailed to the Company’s shareholders. For the year ended December 31, 2016, approximately $1.25 per share, $0.02 per share, and $0.09 per share of the Company’s distributions represented ordinary income, long-term capital gain, and a return of capital to its shareholders, respectively. Note 12. Selected Quarterly Financial Data (Unaudited) OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) (1) Based on weighted average shares outstanding for the respective period. (2) Based on shares outstanding at the end of the respective period. Note 13. Consolidated Schedule of Investments In and Advances To Affiliates OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) (1) Principal balance of debt investments and ownership detail for equity investments are shown in the consolidated schedule of investments. (2) Represents the total amount of interest, fees or dividends included in 2016 income for the portion of the year ended December 31, 2016, that an investment was included in Control or Affiliate Investment categories, respectively. (3) Gross additions include increases in cost basis resulting from a new portfolio investment, PIK interest, fees and dividends, accretion of OID, net increases in unrealized net appreciation or decreases in unrealized depreciation, and transfers from Non-control/Non-affiliate Investments to Affiliate Investments and from Affiliate Investments to Control Investments. (4) Gross reductions include decreases in the cost basis of investments resulting from principal repayments and sales, if any, and net decreases in unrealized appreciation or net increases in unrealized depreciation, and transfers from Affiliate Investment to Control Investment. (5) Non-income producing. (6) Dividends credited to income include dividends contractually earned but not declared. OFS Capital Corporation and Subsidiaries (Dollar amounts in thousands, except per share data) (7) During the quarter ended December 31, 2016, the Company received cash of approximately $477 and converted principal of $800 into principal of the Senior Secured Loan. The $800 conversion is included as a gross reduction and gross addition of the Subordinated Loan and Senior Secured Loan, respectively. Note 14. Subsequent Events Not Disclosed Elsewhere On March 9, 2017, the Company’s Board declared a distribution of $0.34 per share for the first quarter of 2017, payable on March 31, 2017 to shareholders of record as of March 17, 2017. | Here's a summary of the financial statement:
Key Components:
1. Profit/Loss:
- Investment transactions recorded on trade-date basis
- Realized gains/losses calculated as difference between net proceeds and amortized cost
- Investments valued at fair value as determined by management and Board
- Non-accrual status implemented when collection is doubtful
- Previously accrued interest/dividends reversed when placed on non-accrual
2. Expenses:
- Based on estimates for liabilities and contingent assets
- Single reportable and operating segment structure
- Cash equivalents defined as highly liquid investments with maturities ≤3 months
- FDIC-insured bank holdings, sometimes exceeding insurance limits
- Cash equivalents reported at $17,659
3. Assets:
- Calculation excludes cash/cash equivalents
- Adjusted for share issuances/repurchases
- OFS Advisor excludes intangible assets and goodwill from SBIC Acquisitions
- Base management fee: $4,516 (payable quarterly)
4. Liabilities:
- Primarily debt investments in middle-market companies
- Managed by OFS Advisor
- Investments made directly or through SBIC I LP
- Subject to SBA regulatory requirements
- Required to invest minimum 25% in eligible businesses
This statement reflects a business development company focusing on middle-market investments with specific regulatory requirements and management structures in place. | Claude |
. OKLAHOMA GAS AND ELECTRIC COMPANY STATEMENTS OF INCOME The accompanying Notes to Financial Statements are an integral part hereof. OKLAHOMA GAS AND ELECTRIC COMPANY STATEMENTS OF CASH FLOWS The accompanying Notes to Financial Statements are an integral part hereof. OKLAHOMA GAS AND ELECTRIC COMPANY BALANCE SHEETS The accompanying Notes to Financial Statements are an integral part hereof. OKLAHOMA GAS AND ELECTRIC COMPANY BALANCE SHEETS (Continued) The accompanying Notes to Financial Statements are an integral part hereof. OKLAHOMA GAS AND ELECTRIC COMPANY STATEMENTS OF CAPITALIZATION The accompanying Notes to Financial Statements are an integral part hereof. OKLAHOMA GAS AND ELECTRIC COMPANY STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY The accompanying Notes to Financial Statements are an integral part hereof. OKLAHOMA GAS AND ELECTRIC COMPANY NOTES TO FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies Organization OG&E generates, transmits, distributes and sells electric energy in Oklahoma and western Arkansas. Its operations are subject to regulation by the OCC, the APSC and the FERC. OG&E was incorporated in 1902 under the laws of the Oklahoma Territory. OG&E is the largest electric utility in Oklahoma and its franchised service territory includes Fort Smith, Arkansas and the surrounding communities. OG&E sold its retail natural gas business in 1928 and is no longer engaged in the natural gas distribution business. OG&E is a wholly-owned subsidiary of OGE Energy, an energy and energy services provider offering physical delivery and related services for both electricity and natural gas primarily in the south central United States. Accounting Records The accounting records of OG&E are maintained in accordance with the Uniform System of Accounts prescribed by the FERC and adopted by the OCC and the APSC. Additionally, OG&E, as a regulated utility, is subject to accounting principles for certain types of rate-regulated activities, which provide that certain incurred costs that would otherwise be charged to expense can be deferred as regulatory assets, based on the expected recovery from customers in future rates. Likewise, certain actual or anticipated credits that would otherwise reduce expense can be deferred as regulatory liabilities, based on the expected flowback to customers in future rates. Management's expected recovery of deferred costs and flowback of deferred credits generally results from specific decisions by regulators granting such ratemaking treatment. OG&E records certain incurred costs and obligations as regulatory assets or liabilities if, based on regulatory orders or other available evidence, it is probable that the costs or obligations will be included in amounts allowable for recovery or refund in future rates. The following table is a summary of OG&E's regulatory assets and liabilities at: (A) Included in Other Current Assets on the Balance Sheets. (B) Included in Other Current Liabilities on the Balance Sheets. (C) Prior year amount of $1.0 million reclassified from Deferred Other Liabilities to Non-Current Regulatory Liabilities. Fuel clause under recoveries are generated from under recoveries from OG&E's customers when OG&E's cost of fuel exceeds the amount billed to its customers. Fuel clause over recoveries are generated from over recoveries from OG&E's customers when the amount billed to its customers exceeds OG&E's cost of fuel. OG&E's fuel recovery clauses are designed to smooth the impact of fuel price volatility on customers' bills. As a result, OG&E under recovers fuel costs in periods of rising fuel prices above the baseline charge for fuel and over recovers fuel costs when prices decline below the baseline charge for fuel. Provisions in the fuel clauses are intended to allow OG&E to amortize under and over recovery balances. OG&E recovers program costs related to the Demand and Energy Efficiency Program. An extension of the demand program rider was approved in January 2016, which allows for the recovery through December 2018 of (i) demand program costs; (ii) lost revenues associated with certain achieved energy efficiency and demand savings; (iii) performance-based incentives; and (iv) costs associated with research and development investments. OG&E recovers certain SPP costs related to base plan charges from its customers in Oklahoma through the SPP cost tracker. The benefit obligations regulatory asset is comprised of expenses recorded which are probable of future recovery and that have not yet been recognized as components of net periodic benefit cost, including net loss and prior service cost. These expenses are recorded as a regulatory asset as OG&E had historically recovered and currently recovers pension and postretirement benefit plan expense in its electric rates. If, in the future, the regulatory bodies indicate a change in policy related to the recovery of pension and postretirement benefit plan expenses, this could cause the benefit obligations regulatory asset balance to be reclassified to accumulated other comprehensive income. The following table is a summary of the components of the benefit obligations regulatory asset at: The following amounts in the benefit obligations regulatory asset at December 31, 2016 are expected to be recognized as components of net periodic benefit cost in 2017: Income taxes recoverable from customers, which represents income tax benefits previously used to reduce OG&E's revenues, are treated as regulatory assets and are being amortized over the estimated remaining life of the assets to which they relate. These amounts are being recovered in rates as the temporary differences that generated the income tax benefit turn around. The income tax related regulatory assets and liabilities are netted in income taxes recoverable from customers, net in the regulatory assets and liabilities table above. OG&E recovers the cost of system-wide deployment of smart grid technology and implementing the smart grid pilot program, the incremental costs for web portal access, education and providing home energy reports. These amounts are currently being recovered through a rate rider. Following a final order in the current Oklahoma general rate case, and review by the OCC Staff, the Oklahoma jurisdictional balance of the regulatory asset will be included in the fuel adjustment clause for final recovery. Costs not included in the rider are the incremental costs for web portal access, education and home energy reports, which are capped at $6.9 million, and the stranded costs associated with OG&E's analog electric meters, which have been replaced by smart meters and were accumulated during the smart grid deployment and have been included in the Smart Grid asset in the regulatory assets and liabilities table above. These costs are expected to be recovered in base rates upon final orders in the current general rate cases. OG&E includes in expense any Oklahoma storm-related operation and maintenance expenses up to $2.7 million annually and defers any additional expenses incurred over $2.7 million. OG&E expects to recover the amounts deferred each year over a five-year period in accordance with historical practice. Unamortized loss on reacquired debt is comprised of unamortized debt issuance costs related to the early retirement of OG&E's long-term debt. These amounts are recorded in interest expenses and are being amortized over the term of the long-term debt which replaced the previous long-term debt. The unamortized loss on reacquired debt is recovered as a part of OG&E's cost of capital. Accrued removal obligations, net represent asset retirement costs previously recovered from ratepayers for other than legal obligations. OG&E recovers specific amounts of pension and postretirement medical costs in rates approved in its Oklahoma rate cases. In accordance with approved orders, OG&E defers the difference between actual pension and postretirement medical expenses and the amount approved in its last Oklahoma rate case as a regulatory asset or regulatory liability. These amounts have been recorded in the Pension tracker regulatory liability in the regulatory assets and liabilities table above. Management continuously monitors the future recoverability of regulatory assets. When, in management's judgment, future recovery becomes impaired, the amount of the regulatory asset is adjusted, as appropriate. If OG&E were required to discontinue the application of accounting principles for certain types of rate-regulated activities for some or all of its operations, it could result in writing off the related regulatory assets, which could have significant financial effects. Use of Estimates In preparing the Financial Statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and contingent liabilities at the date of the Financial Statements and the reported amounts of revenues and expenses during the reporting period. Changes to these assumptions and estimates could have a material effect on OG&E's Financial Statements. However, OG&E believes it has taken reasonable positions where assumptions and estimates are used in order to minimize the negative financial impact to OG&E that could result if actual results vary from the assumptions and estimates. In management's opinion, the areas of OG&E where the most significant judgment is exercised includes the determination of Pension Plan assumptions, income taxes, contingency reserves, asset retirement obligations, and depreciable lives of property, plant and equipment, the determination of regulatory assets and liabilities and unbilled revenues. Cash and Cash Equivalents For purposes of the Financial Statements, OG&E considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. These investments are carried at cost, which approximates fair value. Allowance for Uncollectible Accounts Receivable Customer balances are generally written off if not collected within six months after the final billing date. The allowance for uncollectible accounts receivable for OG&E is calculated by multiplying the last six months of electric revenue by the provision rate. The provision rate is based on a 12-month historical average of actual balances written off. To the extent the historical collection rates are not representative of future collections, there could be an effect on the amount of uncollectible expense recognized. Also, a portion of the uncollectible provision related to fuel within the Oklahoma jurisdiction is being recovered through the fuel adjustment clause. The allowance for uncollectible accounts receivable is a reduction to Accounts Receivable on the Balance Sheets and is included in the Other Operation and Maintenance Expense on the Statements of Income. The allowance for uncollectible accounts receivable was $1.5 million and $1.4 million at December 31, 2016 and 2015, respectively. New business customers are required to provide a security deposit in the form of cash, bond or irrevocable letter of credit that is refunded when the account is closed. New residential customers whose outside credit scores indicate an elevated risk are required to provide a security deposit that is refunded based on customer protection rules defined by the OCC and the APSC. The payment behavior of all existing customers is continuously monitored and, if the payment behavior indicates sufficient risk within the meaning of the applicable utility regulation, customers will be required to provide a security deposit. Fuel Inventories Fuel inventories for the generation of electricity consist of coal, natural gas and oil. OG&E uses the weighted-average cost method of accounting for inventory that is physically added to or withdrawn from storage or stockpiles. The amount of fuel inventory was $82.4 million and $119.3 million at December 31, 2016 and 2015, respectively. Effective May 1, 2014, the gas storage services agreement with Enable was terminated. As a result of this contract termination, approximately 5.3 Bcf of cushion gas owned by OG&E and stored on the Enable system is being directed to OG&E's power plants over a five year period during peak time of June 1 to August 31 at a rate of 11,500 MMBtu/day for a total of 1.06 Bcf per year. In 2014, approximately $11.0 million of cushion gas was reclassified from Plant-in-Service to Other Deferred Assets, representing natural gas in storage, that will be removed from storage over four years. As of December 31, 2016, the balance of cushion gas in Fuel Inventories is $3.0 million and the balance in Other Deferred Assets is $2.7 million. Property, Plant and Equipment All property, plant and equipment is recorded at cost. Newly constructed plant is added to plant balances at cost which includes contracted services, direct labor, materials, overhead, transportation costs and the allowance for funds used during construction. Replacements of units of property are capitalized as plant. For assets that belong to a common plant account, the replaced plant is removed from plant balances and the cost of such property is charged to Accumulated Depreciation. For assets that do not belong to a common plant account, the replaced plant is removed from plant balances with the related accumulated depreciation and the remaining balance net of any salvage proceeds is recorded as a loss in the Statements of Income as Other Expense. Repair and replacement of minor items of property are included in the Statements of Income as Other Operation and Maintenance Expense. The tables below present OG&E's ownership interest in the jointly-owned McClain Plant and the jointly-owned Redbud Plant, and, as disclosed below, only OG&E's ownership interest is reflected in the property, plant and equipment and accumulated depreciation balances in these tables. The owners of the remaining interests in the McClain Plant and the Redbud Plant are responsible for providing their own financing of capital expenditures. Also, only OG&E's proportionate interests of any direct expenses of the McClain Plant and the Redbud Plant, such as fuel, maintenance expense and other operating expenses, are included in the applicable financial statement captions in the Statements of Income. (A) Construction work in progress was $0.2 million and $1.8 million for the McClain and Redbud Plants, respectively. (B) This amount includes a plant acquisition adjustment of $148.3 million and accumulated amortization of $45.3 million. (A) Construction work in progress was $1.6 million and $1.3 million for the McClain and Redbud Plants, respectively. (B) This amount includes a plant acquisition adjustment of $148.3 million and accumulated amortization of $39.8 million. OG&E's property, plant and equipment and related accumulated depreciation are divided into the following major classes at: (A) This amount includes a plant acquisition adjustment of $148.3 million and accumulated amortization of $45.3 million. (B) This amount includes a plant acquisition adjustment of $3.3 million and accumulated amortization of $0.6 million. (A) This amount includes a plant acquisition adjustment of $148.3 million and accumulated amortization of $39.8 million. (B) This amount includes a plant acquisition adjustment of $3.3 million and accumulated amortization of $0.5 million. OG&E's unamortized computer software costs were $36.5 million and $34.3 million at December 31, 2016 and 2015, respectively. In 2016, 2015 and 2014, amortization expense for computer software costs was $8.0 million, $6.9 million and $5.2 million, respectively. Depreciation and Amortization The provision for depreciation, which was 3.0 percent and 2.9 percent of the average depreciable utility plant for 2016 and 2015, respectively, is provided on a straight-line method over the estimated service life of the utility assets. Depreciation is provided at the unit level for production plant and at the account or sub-account level for all other plant, and is based on the average life group method. In 2017, the provision for depreciation is projected to be 3.1 percent of the average depreciable utility plant. Amortization of intangible assets is computed using the straight-line method. Of the remaining amortizable intangible plant balance at December 31, 2016, 97.0 percent will be amortized over 16 years with the remaining 3.0 percent of the intangible plant balance at December 31, 2016 being amortized over 23.7 years. Amortization of plant acquisition adjustments is provided on a straight-line basis over the estimated remaining service life of the acquired asset. Plant acquisition adjustments include $148.3 million for the Redbud Plant, which is being amortized over a 27 year life and $3.3 million for certain transmission substation facilities in OG&E's service territory, which are being amortized over a 37 to 59 year period. Asset Retirement Obligations OG&E has previously recorded asset retirement obligations that are being accreted over their respective lives ranging from three to 74 years. The following table summarizes changes to OG&E's asset retirement obligations during the years ended December 31, 2016 and 2015. (A) Assumptions changed related to the estimated cost of asbestos abatement. Allowance for Funds Used During Construction Allowance for funds used during construction is calculated according to the FERC pronouncements for the imputed cost of equity and borrowed funds. Allowance for funds used during construction, a non-cash item, is reflected as an increase to net Other Income and a reduction to Interest Expense in the Statements of Income and as an increase to Construction Work in Progress in the Balance Sheets. Allowance for funds used during construction rates, compounded semi-annually, were 8.2 percent, 8.1 percent and 6.9 percent for the years ended December 31, 2016, 2015 and 2014, respectively. The increase in the allowance for funds used during construction rates in 2016 was primarily due to short-term debt being used to finance construction projects, which caused the debt portion of allowance for funds used during construction to increase. Collection of Sales Tax In the normal course of its operations, OG&E collects sales tax from its customers. OG&E records a current liability for sales taxes when it bills its customers and eliminates this liability when the taxes are remitted to the appropriate governmental authorities. OG&E excludes the sales tax collected from its operating revenues. Revenue Recognition General OG&E recognizes revenue from electric sales when power is delivered to customers. OG&E reads its customers' meters and sends bills to its customers throughout each month. As a result, there is a significant amount of customers' electricity consumption that has not been billed at the end of each month. OG&E accrues an estimate of the revenues for electric sales delivered since the latest billings. Unbilled revenue is presented in Accrued Unbilled Revenues on the Balance Sheets and in Operating Revenues on the Statements of Income based on estimates of usage and prices during the period. The estimates that management uses in this calculation could vary from the actual amounts to be paid by customers. SPP Purchases and Sales OG&E currently owns and operates transmission and generation facilities as part of a vertically integrated utility. OG&E is a member of the SPP regional transmission organization and has transferred operational authority, but not ownership, of OG&E's transmission facilities to the SPP. The SPP has implemented FERC-approved regional day ahead and real-time markets for energy and operating services, as well as associated transmission congestion rights. Collectively the three markets operate together under the global name, SPP Integrated Marketplace. OG&E represents owned and contracted generation assets and customer load in the SPP Integrated Marketplace for the sole benefit of its customers. OG&E has not participated in the SPP Integrated Marketplace for any speculative trading activities. OG&E records the SPP Integrated Marketplace transactions as sales or purchases per FERC Order 668, which requires that purchases and sales be recorded on a net basis for each settlement period of the SPP Integrated Marketplace. These results are reported as Operating Revenues or Cost of Goods Sold in its Financial Statements. OG&E revenues, expenses, assets and liabilities may be adversely affected by changes in the organization, operating and regulation by the FERC or the SPP. Fuel Adjustment Clauses The actual cost of fuel used in electric generation and certain purchased power costs are passed through to OG&E's customers through fuel adjustment clauses. The fuel adjustment clauses are subject to periodic review by the OCC and the APSC. The OCC and the APSC have the authority to review the appropriateness of gas transportation charges or other fees OG&E pays to its affiliate, Enable. Income Taxes OG&E is a member of an affiliated group that files consolidated income tax returns in the U.S. Federal jurisdiction and various state jurisdictions. Income taxes are generally allocated to each company in the affiliated group based on its stand-alone taxable income or loss. Federal investment tax credits previously claimed on electric utility property have been deferred and are being amortized to income over the life of the related property. OG&E uses the asset and liability method of accounting for income taxes. Under this method, a deferred tax asset or liability is recognized for the estimated future tax effects attributable to temporary differences between the financial statement basis and the tax basis of assets and liabilities as well as tax credit carry forwards and net operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period of the change. OG&E recognizes interest related to unrecognized tax benefits in Interest Expense and recognizes penalties in Other Expense in the Statements of Income. Accrued Vacation OG&E accrues vacation pay monthly by establishing a liability for vacation earned. Vacation may be taken as earned and is charged against the liability. At the end of each year, the liability represents the amount of vacation earned, but not taken. Environmental Costs Accruals for environmental costs are recognized when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Costs are charged to expense or deferred as a regulatory asset based on expected recovery from customers in future rates, if they relate to the remediation of conditions caused by past operations or if they are not expected to mitigate or prevent contamination from future operations. Where environmental expenditures relate to facilities currently in use, such as pollution control equipment, the costs may be capitalized and depreciated over the future service periods. Estimated remediation costs are recorded at undiscounted amounts, independent of any insurance or rate recovery, based on prior experience, assessments and current technology. Accrued obligations are regularly adjusted as environmental assessments and estimates are revised, and remediation efforts proceed. For sites where OG&E has been designated as one of several potentially responsible parties, the amount accrued represents OG&E's estimated share of the cost. OG&E had $13.9 million and $10.0 million in accrued environmental liabilities at December 31, 2016 and 2015, respectively, which are included in the asset retirement obligations table. Reclassifications Certain prior-year amounts have been reclassified to conform to the current year presentation. The December 31, 2015 Balance Sheet has been adjusted for the reclassification of $16.3 million of debt issuance costs from Total Deferred Charges and Other Assets to Long-Term Debt to be consistent with the 2016 presentation due to the adoption of ASU 2015-03, "Simplifying the Presentation of Debt Issuance Costs," in 2016. 2. Accounting Pronouncements Revenue from Contracts with Customers. In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)." The new guidance was intended to be effective for fiscal years beginning after December 15, 2016. On July 9, 2015, the FASB decided to delay the effective date of the new revenue standard by one year. Reporting entities may choose to adopt the standard as of the original effective date. The deferral results in the new revenue standard being effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. OG&E currently expects to apply the modified retrospective transition method, but will ultimately determine its transition approach once various industry issues have been resolved. Currently, OG&E is not aware of any issues that would have a material impact on the timing of revenue recognition. OG&E is assessing the impact of this new guidance on its tariff-based sales, contributions in aid of construction, bundled arrangements and alternative revenue programs. At this time, OG&E is evaluating the impact of the new standard on its results of operations and financial position, but believes that it will change the income statement presentation of revenues and will require new disclosures. Consolidation. In February 2015, the FASB issued ASU 2015-02, "Consolidation (Topic 810)." The amendments in ASU 2015-02 affect reporting entities that are required to evaluate whether they should consolidate certain legal entities. The new standard modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities or voting interest entities along with eliminating the presumption that a general partner should consolidate a limited partnership. The new standard is effective for fiscal years beginning after December 15, 2015. The adoption of this new standard did not result in the consolidation of any non-consolidated entities. Leases. In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." The main difference between current lease accounting and Topic 842 is the recognition of right-of-use assets and lease liabilities by lessees for those leases classified as operating leases under current accounting guidance. Lessees, such as OG&E, will need to recognize a right-of-use asset and a lease liability for virtually all of their leases, other than leases that meet the definition of a short-term lease. The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement purposes, Topic 842 retains a dual model, requiring leases to be classified as either operating or finance. Operating leases will result in straight-line expense, while finance leases will result in a front-loaded expense pattern, similar to current capital leases. Classification of operating and finance leases will be based on criteria that are largely similar to those applied in current lease guidance, but without the explicit thresholds. The new guidance is effective for fiscal years beginning after December 15, 2018. The new guidance must be adopted using a modified retrospective transition, and provides for certain practical expedients. Transition will require application of the new guidance at the beginning of the earliest comparative period presented. OG&E has started evaluating its current lease contracts. OG&E has not determined the amount of impact on its Financial Statements, but it anticipates an increase in the recognition of right-of-use assets and lease liabilities. Investments. In March 2016, the FASB issued ASU 2016-07, "Investments-Equity Method and Joint Ventures; Simplifying the Transition to the Equity Method of Accounting (Topic 323)." The amendments in ASU 2016-07 eliminate the requirement to retroactively adopt the equity method of accounting for a qualifying equity method investment. ASU 2016-07 requires equity method investors to add the cost of acquiring the additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The amendments in this ASU are effective for the fiscal years and interim periods within those fiscal years, beginning after December 15, 2016. OG&E does not believe this ASU will have any effect on its Financial Statements. Employee Share Based Payment Accounting. In March 2016, the FASB issued ASU 2016-09, "Improvements to Employee Share Based Payment Accounting," which amends ASC Topic 718, Compensation - Stock Compensation. ASU 2016-09 includes provisions intended to simplify various aspects related to how share based payments are accounted for and presented in the financial statements. The new guidance among other requirements will require all of the tax effects related to share based payments at settlement (or expiration) to be recorded through the income statement. Currently, tax benefits in excess of compensation cost ("windfalls") are recorded in equity, and tax deficiencies ("shortfalls") are recorded in equity to the extent of previous windfalls, and then to the income statement. This change is required to be applied prospectively to all excess tax benefits and tax deficiencies resulting from settlements after the date of adoption of the ASU 2016-09. Under the new guidance, the windfall tax benefit will be recorded when it arises, subject to normal valuation allowance considerations. This change is required to be applied on a modified retrospective basis, with a cumulative effect adjustment to opening retained earnings. All tax related cash flows resulting from share based payments are to be reported as operating activities on the statement of cash flows, a change from the current requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. Either prospective or retrospective transition of this provision is permitted. ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. OG&E will prospectively adopt this standard in the first quarter of 2017. Going forward, tax benefits in excess of compensation cost previously recorded in equity will be recorded within the income statement and all tax related cash flows resulting from share based payments will be recorded as an operating activity within the statement of cash flows. Financial Instruments-Credit Losses. In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments." The amendment in this update requires entities to measure all expected credit losses of financial assets held at a reporting date based on historical experience, current conditions, and reasonable and supportable forecasts in order to record credit losses in a more timely matter. ASU 2016-13 also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The standard is effective for interim and annual reporting periods beginning after December 15, 2019, although early adoption is permitted for interim and annual periods beginning after December 15, 2018. OG&E does not believe this ASU will have any effect on its Financial Statements. Simplifying the Presentation of Debt Issuance Costs. In April 2015, the FASB issued ASU 2015-03, "Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs." The amendments in ASU 2015-03 require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability consistent with debt discounts. OG&E adopted this standard and adjusted the December 31, 2015 Balance Sheet for the reclassification of debt issuance costs from Total Deferred Charges and Other Assets to Long-Term Debt to be consistent with the December 31, 2016 presentation. Classification of Certain Cash Receipts and Cash Payments. In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments." This standard addresses the classification of seven specific types of cash flows as follows: debt prepayment or extinguishment costs, payments for the extinguishment of zero coupon debt, payments to settle contingent consideration liabilities incurred in a business combination, proceeds from insurance claims, payments to purchase and proceeds from the settlement of company-owned life insurance, distributions from equity method investees, and cash flows related to beneficial interests retained in securitization transactions. In addition to these seven specific issues, the ASU also provides additional guidance on the application of the predominance principle when cash receipts and payments have aspects of more than one class of cash flows. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years and retrospective application is required. OG&E does not believe this ASU will have a material effect on its Statements of Cash Flows. Going Concern. In August 2014, the FASB defined management’s responsibility to evaluate whether substantial doubt exists about an entity’s ability to continue as a going concern. Professional auditing standards require auditors to evaluate the going concern presumption, but previously there was a lack of guidance in GAAP for financial statement preparers. ASU 2014-15, "Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern," requires management to perform a going concern evaluation effective for annual periods ending after December 15, 2016, and annual and interim periods thereafter. OG&E adopted this standard in 2016 and management does not believe there is substantial doubt about the entity’s ability to continue as a going concern. Fair Value Measurement. In May 2015, the FASB issued ASU 2015-07, "Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent." ASU 2015-07 removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient and eliminates certain disclosures for those investments. OG&E adopted this standard in 2016 which minimally impacted disclosures within the Retirement Plans and Postretirement Benefit Plans footnote included in this filing. 3. Related Party Transactions OGE Energy charged operating costs to OG&E of $131.5 million, $123.0 million and $120.3 million in 2016, 2015 and 2014, respectively. OGE Energy charges operating costs to OG&E based on several factors. Operating costs directly related to OG&E are assigned as such. Operating costs incurred for the benefit of OG&E are allocated either as overhead based primarily on labor costs or using the "Distrigas" method. OG&E entered into a contract with Enable to provide transportation services effective May 1, 2014. This transportation agreement grants Enable the responsibility of delivering natural gas to OG&E’s generating facilities and performing an imbalance service. With this imbalance service, in accordance with the cash-out provision of the contract, OG&E purchases gas from Enable when Enable’s deliveries exceed OG&E’s pipeline receipts. Enable purchases gas from OG&E when OG&E’s pipeline receipts exceed Enable’s deliveries. In 2016, OG&E entered into an additional gas transportation services contract with Enable which will be effective upon the conversion of units 4 and 5 at Muskogee from coal to gas. The following table summarizes related party transactions between OG&E and Enable during the years ended December 31, 2016, 2015 and 2014. In 2016, 2015 and 2014, OG&E declared dividends to OGE Energy of $190.0 million, $120.0 million and $120.0 million, respectively. 4. Fair Value Measurements The classification of OG&E's fair value measurements requires judgment regarding the degree to which market data is observable or corroborated by observable market data. GAAP establishes a fair value hierarchy that prioritizes the inputs used to measure fair value based on observable and unobservable data. The hierarchy categorizes the inputs into three levels, with the highest priority given to quoted prices in active markets for identical unrestricted assets or liabilities (Level 1) and the lowest priority given to unobservable inputs (Level 3). Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The three levels defined in the fair value hierarchy are as follows: Level 1 inputs are quoted prices in active markets for identical unrestricted assets or liabilities that are accessible at the measurement date. Level 2 inputs are inputs other than quoted prices in active markets included within Level 1 that are either directly or indirectly observable at the reporting date for the asset or liability for substantially the full term of the asset or liability. Level 2 inputs include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active. Level 3 inputs are prices or valuation techniques for the asset or liability that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity). Unobservable inputs reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). OG&E had no financial instruments measured at fair value on a recurring basis at December 31, 2016 and 2015. The fair value of OG&E's long-term debt is based on quoted market prices and estimates of current rates available for similar issues with similar maturities and is classified as Level 2 in the fair value hierarchy with the exception of the Tinker Debt whose fair value is based on calculating the net present value of the monthly payments discounted by OG&E's current borrowing rate and is classified as Level 3 in the fair value hierarchy. The following table summarizes the fair value and carrying amount of OG&E's financial instruments at December 31, 2016 and 2015. 5. Stock-Based Compensation In 2013, OGE Energy adopted, and its shareholders approved, the Stock Incentive Plan. Under the Stock Incentive Plan, restricted stock, restricted stock units, stock options, stock appreciation rights and performance units may be granted to officers, directors and other key employees of OGE Energy and its subsidiaries. OGE Energy has authorized the issuance of up to 7,400,000 shares under the Stock Incentive Plan. The following table summarizes OG&E's pre-tax compensation expense and related income tax benefit for the years ended December 31, 2016, 2015 and 2014 related to performance units and restricted stock for OG&E employees. OGE Energy has issued new shares to satisfy restricted stock grants and payouts of earned performance units. In 2016, 2015 and 2014, there were 1,131 shares, 18,820 shares and 100,640 shares, respectively, of new common stock issued to OG&E's employees pursuant to OGE Energy's Stock Incentive Plan related to restricted stock grants (net of forfeitures) and payouts of earned performance units. In 2016, there were 658 shares of restricted stock returned to OGE Energy to satisfy tax liabilities. Performance Units Under the Stock Incentive Plan, OGE Energy has issued performance units which represent the value of one share of OGE Energy's common stock. The performance units provide for accelerated vesting if there is a change in control (as defined in the Stock Incentive Plan). Each performance unit is subject to forfeiture if the recipient terminates employment with OGE Energy or a subsidiary prior to the end of the primarily three-year award cycle for any reason other than death, disability or retirement. In the event of death, disability or retirement, a participant will receive a prorated payment based on such participant's number of full months of service during the award cycle, further adjusted based on the achievement of the performance goals during the award cycle. The performance units granted based on total shareholder return are contingently awarded and will be payable in shares of OGE Energy's common stock subject to the condition that the number of performance units, if any, earned by the employees upon the expiration of a primarily three-year award cycle (i.e., three-year cliff vesting period) is dependent on OGE Energy's total shareholder return ranking relative to a peer group of companies. The performance units granted based on earnings per share are contingently awarded and will be payable in shares of OGE Energy's common stock based on OGE Energy's earnings per share growth over a primarily three-year award cycle (i.e., three-year cliff vesting period) compared to a target set at the time of the grant by the Compensation Committee of OGE Energy's Board of Directors. All of these performance units are classified as equity in OGE Energy's Consolidated Balance Sheet. If there is no or only a partial payout for the performance units at the end of the award cycle, the unearned performance units are cancelled. Payout requires approval of the Compensation Committee of OGE Energy's Board of Directors. Payouts, if any, are all made in common stock and are considered made when the payout is approved by the Compensation Committee. Performance Units - Total Shareholder Return The fair value of the performance units based on total shareholder return was estimated on the grant date using a lattice-based valuation model that factors in information, including the expected dividend yield, expected price volatility, risk-free interest rate and the probable outcome of the market condition, over the expected life of the performance units. Compensation expense for the performance units is a fixed amount determined at the grant date fair value and is recognized over the primarily three-year award cycle regardless of whether performance units are awarded at the end of the award cycle. Dividends were not accrued or paid for awards prior to February 2014, and were therefore not included in the fair value calculation. Beginning with the February 2014 performance unit awards, dividends are accrued on a quarterly basis pending achievement of payout criteria, and were therefore included in the fair value calculations. Expected price volatility is based on the historical volatility of OGE Energy's common stock for the past three years and was simulated using the Geometric Brownian Motion process. The risk-free interest rate for the performance unit grants is based on the three-year U.S. Treasury yield curve in effect at the time of the grant. The expected life of the units is based on the non-vested period since inception of the award cycle. There are no post-vesting restrictions related to OGE Energy's performance units based on total shareholder return. The number of performance units granted based on total shareholder return and the assumptions used to calculate the grant date fair value of the performance units based on total shareholder return are shown in the following table. Performance Units - Earnings Per Share The fair value of the performance units based on earnings per share is based on grant date fair value which is equivalent to the price of one share of OGE Energy's common stock on the date of grant. The fair value of performance units based on earnings per share varies as the number of performance units that will vest is based on the grant date fair value of the units and the probable outcome of the performance condition. OGE Energy reassesses at each reporting date whether achievement of the performance condition is probable and accrues compensation expense if and when achievement of the performance condition is probable. As a result, the compensation expense recognized for these performance units can vary from period to period. There are no post-vesting restrictions related to OGE Energy's performance units based on earnings per share. The number of performance units granted based on earnings per share and the grant date fair value are shown in the following table. Restricted Stock Under the Stock Incentive Plan, OGE Energy issued restricted stock to certain existing non-officer employees as well as other executives upon hire to attract and retain individuals to be competitive in the marketplace. The restricted stock vests in one-third annual increments. Prior to vesting, each share of restricted stock is subject to forfeiture if the recipient ceases to render substantial services to OGE Energy or a subsidiary for any reason other than death, disability or retirement. These shares may not be sold, assigned, transferred or pledged and are subject to a risk of forfeiture. The fair value of the restricted stock was based on the closing market price of OGE Energy's common stock on the grant date. Compensation expense for the restricted stock is a fixed amount determined at the grant date fair value and is recognized as services are rendered by employees over a primarily three-year vesting period. Also, OG&E treats its restricted stock as multiple separate awards by recording compensation expense separately for each tranche whereby a substantial portion of the expense is recognized in the earlier years in the requisite service period. Dividends are accrued and paid during the vesting period on restricted stock granted prior to July 2014, and therefore dividends are included in the fair value calculation for such restricted stock granted prior to July 2014. For restricted stock granted after July 2014, dividends will only be paid on restricted stock awards that vest. Accordingly, for restricted stock granted after July 2014, only the present value of dividends expected to vest are included in the fair value calculations. The expected life of the restricted stock is based on the non-vested period since inception of the primarily three-year award cycle. There are no post-vesting restrictions related to OGE Energy's restricted stock. The number of shares of restricted stock granted and the grant date fair value are shown in the following table. There were no restricted stock grants during 2016. A summary of the activity for OGE Energy's performance units and restricted stock applicable to OG&E's employees at December 31, 2016 and changes in 2016 are shown in the following table. (A) For performance units, this represents the target number of performance units granted. Actual number of performance units earned, if any, is dependent upon performance and may range from zero percent to 200 percent of the target. (B) These amounts represent performance units that vested at December 31, 2015 which were settled in February 2016. (C) Due to certain employees transferring between OG&E and its affiliates. A summary of the activity for OGE Energy's non-vested performance units and restricted stock applicable to OG&E's employees at December 31, 2016 and changes in 2016 are shown in the following table. (A) For performance units, this represents the target number of performance units granted. Actual number of performance units earned, if any, is dependent upon performance and may range from zero percent to 200 percent of the target. (B) Due to certain employees transferring between OG&E and its affiliates. (C) The intrinsic value of the performance units based on total shareholder return and earnings per share is $5.8 million and $1.9 million respectively. Fair Value of Vested Performance Units and Restricted Stock A summary of OG&E's fair value for its vested performance units and restricted stock is shown in the following table. Unrecognized Compensation Cost A summary of OG&E's unrecognized compensation cost for its non-vested performance units and restricted stock and the weighted-average periods over which the compensation cost is expected to be recognized are shown in the following table. 6. Supplemental Cash Flow Information The following table discloses information about investing and financing activities that affected recognized assets and liabilities but did not result in cash receipts or payments. Also disclosed in the table is cash paid for interest, net of interest capitalized, and cash paid for income taxes, net of income tax refunds. (A) Net of interest capitalized of $7.5 million, $4.2 million and $2.4 million in 2016, 2015 and 2014, respectively. 7. Income Taxes The items comprising income tax expense are as follows: OG&E is a member of an affiliated group that files consolidated income tax returns in the U.S. Federal jurisdiction and various state jurisdictions. With few exceptions, OG&E is no longer subject to U.S. Federal tax examinations by tax authorities for years prior to 2013 or state and local tax examinations by tax authorities for years prior to 2012. Income taxes are generally allocated to each company in the affiliated group based on its stand-alone taxable income or loss. Federal investment tax credits previously claimed on electric utility property have been deferred and are being amortized to income over the life of the related property. OG&E earns both Federal and Oklahoma state tax credits associated with production from its wind farms and earns state tax credits associated with its investments in electric generating facilities which reduce OG&E's effective tax rate. The following schedule reconciles the statutory tax rates to the effective income tax rate: (A) Represents credits associated with the production from OG&E's wind farms. The deferred tax provisions are recognized as costs in the ratemaking process by the commissions having jurisdiction over the rates charged by OG&E. The components of Deferred Income Taxes at December 31, 2016 and 2015, respectively, were as follows: As of December 31, 2016, OG&E has classified $13.5 million of unrecognized tax benefits as a reduction of deferred tax assets recorded. Management is currently unaware of any issues under review that could result in significant additional payments, accruals, or other material deviation from this amount. Following is a reconciliation of OG&E’s total gross unrecognized tax benefits as of the years ended December 31, 2016, 2015, and 2014. As of December 31, 2016, 2015 and 2014, there are $13.5 million, $13.2 million and $10.5 million of unrecognized tax benefits that if recognized would affect the annual effective tax rate. OG&E has determined that a portion of certain Oklahoma investment tax credits previously recognized but not yet utilized may not be available for utilization in future years. During 2016, OG&E recorded an additional reserve for this item of $0.5 million ($0.3 million after the federal tax benefit) related to the same Oklahoma investment tax credits generated in the current year but not yet utilized due to management's determination that it is more likely than not that it will be unable to utilize these credits. Where applicable, OG&E classifies income tax-related interest and penalties as interest expense and other expense, respectively. During the year ended December 31, 2016, there were no income tax-related interest or penalties recorded with regard to uncertain tax positions. Other OG&E sustained Federal and state tax operating losses through 2012 caused primarily by bonus depreciation and other book versus tax temporary differences. As a result, OG&E had accrued Federal and state income tax benefits carrying into 2016. As OG&E can no longer carry these losses back to prior periods, these losses are being carried forward for utilization in future years which began in 2013. In addition to the tax operating losses, OG&E was unable to utilize the various tax credits that were generated during these years. These tax losses and credits are being carried as deferred tax assets and will be utilized in future periods. Under current law, OG&E anticipates future taxable income will be sufficient to utilize all of the losses and remaining credits before they begin to expire. The following table summarizes these carry forwards: 8. Common Stock and Cumulative Preferred Stock There were no new shares of common stock issued in 2016, 2015 or 2014. 9. Long-Term Debt A summary of OG&E's long-term debt is included in the Statements of Capitalization. At December 31, 2016, OG&E was in compliance with all of its debt agreements. Industrial Authority Bonds OG&E has tax-exempt pollution control bonds with optional redemption provisions that allow the holders to request repayment of the bonds on any business day. The bonds, which can be tendered at the option of the holder during the next 12 months, are as follows: All of these bonds are subject to an optional tender at the request of the holders, at 100 percent of the principal amount, together with accrued and unpaid interest to the date of purchase. The bond holders, on any business day, can request repayment of the bond by delivering an irrevocable notice to the tender agent stating the principal amount of the bond, payment instructions for the purchase price and the business day the bond is to be purchased. The repayment option may only be exercised by the holder of a bond for the principal amount. When a tender notice has been received by the trustee, a third party remarketing agent for the bonds will attempt to remarket any bonds tendered for purchase. This process occurs once per week. Since the original issuance of these series of bonds in 1995 and 1997, the remarketing agent has successfully remarketed all tendered bonds. If the remarketing agent is unable to remarket any such bonds, OG&E is obligated to repurchase such unremarketed bonds. As OG&E has both the intent and ability to refinance the bonds on a long-term basis and such ability is supported by an ability to consummate the refinancing, the bonds are classified as Long-Term Debt in OG&E's Financial Statements. OG&E believes that it has sufficient liquidity to meet these obligations. Long-Term Debt Maturities Maturities of OG&E's long-term debt during the next five years consist of $125.2 million, $250.1 million, $250.1 million, $0.1 million and $0.1 million in years 2017, 2018, 2019, 2020 and 2021, respectively. OG&E has previously incurred costs related to debt refinancing. Unamortized loss on reacquired debt is classified as a Non-Current Regulatory Asset, unamortized debt expense and unamortized premium and discount on long-term debt is classified as Long-Term Debt, in the Balance Sheets and are being amortized over the life of the respective debt. 10. Short-Term Debt and Credit Facility At December 31, 2016, there were $49.9 million in advances from OGE Energy compared to $333.6 million in advances to OGE Energy at December 31, 2015. OG&E has an intercompany borrowing agreement with OGE Energy whereby OG&E has access to up to $400.0 million of OGE Energy's revolving credit amount. Effective July 29, 2013, OG&E extended the termination date of this agreement to December 13, 2018. OG&E has a $400.0 million unsecured five-year revolving credit facility which is available to back up OG&E's commercial paper borrowings and to provide revolving credit borrowings. This bank facility can also be used as a letter of credit facility. At December 31, 2016, there was $1.8 million supporting letters of credit at a weighted-average interest rate of 0.95 percent. There were no outstanding borrowings under this revolving credit agreement and no outstanding commercial paper borrowings at December 31, 2016. OGE Energy's and OG&E's ability to access the commercial paper market could be adversely impacted by a credit ratings downgrade or major market disruptions. Pricing grids associated with OGE Energy's and OG&E's credit facilities could cause annual fees and borrowing rates to increase if an adverse rating impact occurs. The impact of any future downgrade could include an increase in the costs of OGE Energy's and OG&E's short-term borrowings, but a reduction in OGE Energy's and OG&E's credit ratings would not result in any defaults or accelerations. Any future downgrade of OGE Energy or OG&E could also lead to higher long-term borrowing costs and, if below investment grade, would require OG&E to post collateral or letters of credit. OG&E must obtain regulatory approval from the FERC in order to borrow on a short-term basis. OG&E has the necessary regulatory approvals to incur up to $800.0 million in short-term borrowings at any one time for a two-year period beginning January 1, 2017 and ending December 31, 2018. 11. Retirement Plans and Postretirement Benefit Plans Pension Plan and Restoration of Retirement Income Plan OG&E's employees participate in OGE Energy's Pension Plan and Restoration of Retirement Income Plan. It is OGE Energy's policy to fund the Pension Plan on a current basis based on the net periodic pension expense as determined by OGE Energy's actuarial consultants. Such contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. During 2016, OGE Energy made a $20.0 million contribution to its Pension Plan, of which none related to OG&E. During 2015, OGE Energy did not make any contributions to its Pension Plan. OGE Energy has not determined whether it will need to make any contributions to the Pension Plan in 2017. Any contribution to the Pension Plan during 2017 would be a discretionary contribution, anticipated to be in the form of cash, and is not required to satisfy the minimum regulatory funding requirement specified by the Employee Retirement Income Security Act of 1974, as amended. OGE Energy could be required to make additional contributions if the value of its pension trust and postretirement benefit plan trust assets are adversely impacted by a major market disruption in the future. In accordance with ASC Topic 715, "Compensation - Retirement Benefits," a one-time settlement charge is required to be recorded by an organization when lump sum payments or other settlements that relieve the organization from the responsibility for the pension benefit obligation during a plan year exceed the service cost and interest cost components of the organization’s net periodic pension cost. During the quarter ended June 30, 2016, OG&E experienced a settlement of its non-qualified Restoration of Retirement Income Plan. As a result, OG&E recorded pension settlement charges of $0.4 million during 2016, of which $0.4 million related to OG&E's Oklahoma jurisdiction and has been included in the pension tracker. During 2015, OG&E experienced an increase in both the number of employees electing to retire and the amount of lump sum payments paid to such employees upon retirement. As a result, OG&E recorded pension settlement charges of $10.0 million in the third quarter of 2015 and $4.2 million in the fourth quarter of 2015, of which $12.5 million related to OG&E's Oklahoma jurisdiction and has been included in the pension tracker. The pension settlement charges did not increase OG&E’s total pension expense over time, as the charges were an acceleration of costs that otherwise would be recognized as pension expense in future periods. OGE Energy provides a Restoration of Retirement Income Plan to those participants in OGE Energy's Pension Plan whose benefits are subject to certain limitations of the Code. Participants in the Restoration of Retirement Income Plan receive the same benefits that they would have received under OGE Energy's Pension Plan in the absence of limitations imposed by the Federal tax laws. The Restoration of Retirement Income Plan is intended to be an unfunded plan. Obligations and Funded Status The following table presents the status of OGE Energy's Pension Plan, the Restoration of Retirement Income Plan and the postretirement benefit plans for 2016 and 2015. These amounts have been recorded in Accrued Benefit Obligations with the offset recorded as a regulatory asset in OG&E's Balance Sheets as discussed in Note 1. The regulatory asset represents a net periodic benefit cost to be recognized in the Statements of Income in future periods. OG&E's portion of the benefit obligation for OGE Energy's Pension Plan and the Restoration of Retirement Income Plan represents the projected benefit obligation, while the benefit obligation for the postretirement benefit plans represents the accumulated postretirement benefit obligation. The accumulated postretirement benefit obligation for OG&E's Pension Plan and Restoration of Retirement Income Plan differs from the projected benefit obligation in that the former includes no assumption about future compensation levels. The accumulated postretirement benefit obligation for the Pension Plan and the Restoration of Retirement Income Plan at December 31, 2016 was $458.1 million and $3.4 million, respectively. The accumulated postretirement benefit obligation for the Pension Plan and the Restoration of Retirement Income Plan at December 31, 2015 was $470.6 million and $2.2 million, respectively. The details of the funded status of the Pension Plan, the Restoration of Retirement Income Plan and the postretirement benefit plans and the amounts included in the Balance Sheets are as follows: Net Periodic Benefit Cost (A) Unamortized prior service cost is amortized on a straight-line basis over the average remaining service period to the first eligibility age of participants who are expected to receive a benefit and are active at the date of the plan amendment. (B) In addition to the $11.8 million, $27.4 million and $14.2 million of net periodic benefit cost recognized in 2016, 2015 and 2014, respectively, OG&E recognized the following: • a change in pension expense in 2016, 2015 and 2014 of $9.9 million, $(3.1) million and $11.2 million, respectively, to maintain the allowable amount to be recovered for pension expense in the Oklahoma jurisdiction, which are included in the Pension tracker regulatory asset or liability (see Note 1); • an increase in postretirement medical expense in 2016, 2015 and 2014 of $7.9 million, $5.8 million and $5.2 million, respectively, to maintain the allowable amount to be recovered for postretirement medical expense in the Oklahoma jurisdiction which are included in the Pension tracker regulatory asset or liability (see Note 1); and • a deferral of pension expense in 2016 and 2015 of $0.1 million and $1.9 million related to the Arkansas jurisdictional portion of the pension settlement charge of $0.4 million and $14.2 million, respectively. Rate Assumptions N/A - not applicable The overall expected rate of return on plan assets assumption was 7.50 percent in both 2016 and 2015, which was used in determining net periodic benefit cost due to recent returns on OGE Energy's long-term investment portfolio. The rate of return on plan assets assumption is the average long-term rate of earnings expected on the funds currently invested and to be invested for the purpose of providing benefits specified by the Pension Plan or postretirement benefit plans. This assumption is reexamined at least annually and updated as necessary. The rate of return on plan assets assumption reflects a combination of historical return analysis, forward-looking return expectations and the plans' current and expected asset allocation. The assumed health care cost trend rates have a significant effect on the amounts reported for postretirement medical benefit plans. Future health care cost trend rates are assumed to be 6.75 percent in 2017 with the rates trending downward to 4.50 percent by 2026. A one-percentage point change in the assumed health care cost trend rate would have the following effects: Plan Investments, Policies and Strategies The Pension Plan assets are held in a trust which follows an investment policy and strategy designed to reduce the funded status volatility of the Plan by utilizing liability driven investing. The purpose of liability driven investing is to structure the asset portfolio to more closely resemble the pension liability and thereby more effectively hedge against changes in the liability. The investment policy follows a glide path approach that shifts a higher portfolio weighting to fixed income as the Plan's funded status increases. The table below sets forth the targeted fixed income and equity allocations at different funded status levels. Within the portfolio's overall allocation to equities, the funds are allocated according to the guidelines in the table below. OGE Energy has retained an investment consultant responsible for the general investment oversight, analysis, monitoring investment guideline compliance and providing quarterly reports to certain of OG&E's members and OGE Energy's Investment Committee. The various investment managers used by the trust operate within the general operating objectives as established in the investment policy and within the specific guidelines established for each investment manager's respective portfolio. The portfolio is rebalanced at least on an annual basis to bring the asset allocations of various managers in line with the target asset allocation listed above. More frequent rebalancing may occur if there are dramatic price movements in the financial markets which may cause the trust's exposure to any asset class to exceed or fall below the established allowable guidelines. To evaluate the progress of the portfolio, investment performance is reviewed quarterly. It is, however, expected that performance goals will be met over a full market cycle, normally defined as a three to five year period. Analysis of performance is within the context of the prevailing investment environment and the advisors' investment style. The goal of the trust is to provide a rate of return consistently from three percent to five percent over the rate of inflation (as measured by the national Consumer Price Index) on a fee adjusted basis over a typical market cycle of no less than three years and no more than five years. Each investment manager is expected to outperform its respective benchmark. Below is a list of each asset class utilized with appropriate comparative benchmark(s) each manager is evaluated against: The fixed income managers are expected to use discretion over the asset mix of the trust assets in its efforts to maximize risk-adjusted performance. Exposure to any single issuer, other than the U.S. government, its agencies, or its instrumentalities (which have no limits) is limited to five percent of the fixed income portfolio as measured by market value. At least 75 percent of the invested assets must possess an investment grade rating at or above Baa3 or BBB- by Moody's Investors Services, Standard & Poor's Ratings Services or Fitch Ratings. The portfolio may invest up to 10 percent of the portfolio's market value in convertible bonds as long as the securities purchased meet the quality guidelines. A portfolio may invest up to 15 percent of the portfolio's market value in private placement, including 144A securities with or without registration rights and allow for futures to be traded in the portfolio. The purchase of any of OGE Energy's equity, debt or other securities is prohibited. The domestic value equity managers focus on stocks that the manager believes are undervalued in price and earn an average or less than average return on assets, and often pays out higher than average dividend payments. The domestic growth equity manager will invest primarily in growth companies which consistently experience above average growth in earnings and sales, earn a high return on assets, and reinvest cash flow into existing business. The domestic mid-cap equity portfolio manager focuses on companies with market capitalizations lower than the average company traded on the public exchanges with the following characteristics: price/earnings ratio at or near the Russell Midcap Index, small dividend yield, return on equity at or near the Russell Midcap Index and an earnings per share growth rate at or near the Russell Midcap Index. The domestic small-cap equity manager will purchase shares of companies with market capitalizations lower than the average company traded on the public exchanges with the following characteristics: price/earnings ratio at or near the Russell 2000, small dividend yield, return on equity at or near the Russell 2000 and an earnings per share growth rate at or near the Russell 2000. The international global equity manager invests primarily in non-dollar denominated equity securities. Investing internationally diversifies the overall trust across the global equity markets. The manager is required to operate under certain restrictions including: regional constraints, diversification requirements and percentage of U.S. securities. The Morgan Stanley Capital International All Country World ex-US Index is the benchmark for comparative performance purposes. The Morgan Stanley Capital International All Country World ex-US Index is a market value weighted index designed to measure the combined equity market performance of developed and emerging markets countries, excluding the United States. All of the equities which are purchased for the international portfolio are thoroughly researched. All securities are freely traded on a recognized stock exchange and there are no over-the-counter derivatives. The following investment categories are excluded: options (other than traded currency options), commodities, futures (other than currency futures or currency hedging), short sales/margin purchases, private placements, unlisted securities and real estate (but not real estate shares). For all domestic equity investment managers, no more than five percent can be invested in any one stock at the time of purchase and no more than 10 percent after accounting for price appreciation. Options or financial futures may not be purchased unless prior approval of OGE Energy's Investment Committee is received. The purchase of securities on margin is prohibited as is securities lending. Private placement or venture capital may not be purchased. All interest and dividend payments must be swept on a daily basis into a short-term money market fund for re-deployment. The purchase of any of OGE Energy's equity, debt or other securities is prohibited. The purchase of equity or debt issues of the portfolio manager's organization is also prohibited. The aggregate positions in any company may not exceed one percent of the fair market value of its outstanding stock. Plan Investments The following tables summarize OG&E's portion of OGE Energy's Pension Plan's investments that are measured at fair value on a recurring basis at December 31, 2016 and 2015. There were no Level 3 investments held by the Pension Plan at December 31, 2016 and 2015. (A) This category represents U.S. treasury notes and bonds with a Moody's Investors Services rating of Aaa and Government Agency Bonds with a Moody's Investors Services rating of A1 or higher. (B) This category represents units of participation in a commingled fund that primarily invested in stocks of international companies and emerging markets. The three levels defined in the fair value hierarchy and examples of each are as follows: Level 1 inputs are quoted prices in active markets for identical unrestricted assets or liabilities that are accessible by the Pension Plan at the measurement date. Instruments classified as Level 1 include investments in common and preferred stocks, U.S. treasury notes and bonds, mutual funds, index funds and interest-bearing cash. Level 2 inputs are inputs other than quoted prices in active markets included within Level 1 that are either directly or indirectly observable at the reporting date for the asset or liability for substantially the full term of the asset or liability. Level 2 inputs include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active. Instruments classified as Level 2 include corporate fixed income and other securities, mortgage-backed securities, a commingled fund, a common/collective trust, U.S. municipal bonds, foreign government bonds, money market fund, treasury futures contracts and forward contracts. Level 3 inputs are prices or valuation techniques for the asset or liability that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity). Unobservable inputs reflect the Plan's own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). Postretirement Benefit Plans In addition to providing pension benefits, OGE Energy provides certain medical and life insurance benefits for eligible retired members. Regular, full-time, active employees hired prior to February 1, 2000 whose age and years of credited service total or exceed 80 or have attained at least age 55 with 10 or more years of service at the time of retirement are entitled to postretirement medical benefits while employees hired on or after February 1, 2000 are not entitled to postretirement medical benefits. Eligible retirees must contribute such amount as OGE Energy specifies from time to time toward the cost of coverage for postretirement benefits. The benefits are subject to deductibles, co-payment provisions and other limitations. OG&E charges postretirement benefit costs to expense and includes an annual amount as a component of the cost-of-service in future ratemaking proceedings. OGE Energy's contribution to the medical costs for pre-65 aged eligible retirees are fixed at the 2011 level and OGE Energy covers future annual medical inflationary cost increases up to five percent. Increases in excess of five percent annually are covered by the pre-65 aged retiree in the form of premium increases. OGE Energy provides Medicare-eligible retirees and their Medicare-eligible spouses an annual fixed contribution to OGE Energy's sponsored health reimbursement arrangement. OGE Energy's Medicare-eligible retirees are able to purchase individual insurance policies supplemental to Medicare through a third-party administrator and use their health reimbursement arrangement funds for reimbursement of medical premiums and other eligible medical expenses. Plan Investments The following tables summarize OG&E's portion of OGE Energy's postretirement benefit plans investments that are measured at fair value on a recurring basis at December 31, 2016 and 2015. There were no Level 2 investments held by the postretirement benefit plans at December 31, 2016 and 2015. (A) This category represents a group retiree medical insurance contract which invests in a pool of common stocks, bonds and money market accounts, of which a significant portion is comprised of mortgage-backed securities. The postretirement benefit plans Level 3 investment includes an investment in a group retiree medical insurance contract. The unobservable input included in the valuation of the contract includes the approach for determining the allocation of the postretirement benefit plans pro-rata share of the total assets in the contract. The following table summarizes the postretirement benefit plans investments that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3). Medicare Prescription Drug, Improvement and Modernization Act of 2003 The Medicare Prescription Drug, Improvement and Modernization Act of 2003 expanded coverage for prescription drugs. The following table summarizes the gross benefit payments OG&E expects to pay related to its postretirement benefit plans, including prescription drug benefits. The following table summarizes the benefit payments OG&E expects to pay related to OGE Energy's Pension Plan and Restoration of Retirement Income Plan. These expected benefits are based on the same assumptions used to measure OGE Energy's benefit obligation at the end of the year and include benefits attributable to estimated future employee service. Post-Employment Benefit Plan Disabled employees receiving benefits from OGE Energy's Group Long-Term Disability Plan are entitled to continue participating in OGE Energy's Medical Plan along with their dependents. The post-employment benefit obligation represents the actuarial present value of estimated future medical benefits that are attributed to employee service rendered prior to the date as of which such information is presented. The obligation also includes future medical benefits expected to be paid to current employees participating in OGE Energy's Group Long-Term Disability Plan and their dependents, as defined in OGE Energy's Medical Plan. The post-employment benefit obligation is determined by an actuary on a basis similar to the accumulated postretirement benefit obligation. The estimated future medical benefits are projected to grow with expected future medical cost trend rates and are discounted for interest at the discount rate and for the probability that the participant will discontinue receiving benefits from OGE Energy's Group Long-Term Disability Plan due to death, recovery from disability, or eligibility for retiree medical benefits. OG&E's post-employment benefit obligation was $2.1 million and $1.1 million at December 31, 2016 and 2015, respectively. 401(k) Plan OGE Energy provides a 401(k) Plan. Each regular full-time employee of OGE Energy or a participating affiliate is eligible to participate in the 401(k) Plan immediately. All other employees of OGE Energy or a participating affiliate are eligible to become participants in the 401(k) Plan after completing one year of service as defined in the 401(k) Plan. Participants may contribute each pay period any whole percentage between two percent and 19 percent of their compensation, as defined in the 401(k) Plan, for that pay period. Participants who have attained age 50 before the close of a year are allowed to make additional contributions referred to as "Catch-Up Contributions," subject to certain limitations of the Code. Participants may designate, at their discretion, all or any portion of their contributions as: (i) a before-tax contribution under Section 401(k) of the Code subject to the limitations thereof; (ii) a contribution made on a non Roth after-tax basis; or (iii) a Roth contribution. The 401(k) Plan also includes an eligible automatic contribution arrangement and provides for a qualified default investment alternative consistent with the U.S. Department of Labor regulations. Participants may elect, in accordance with the 401(k) Plan procedures, to have his or her future salary deferral rate to be automatically increased annually on a date and in an amount as specified by the participant in such election. For employees hired or rehired on or after December 1, 2009, OGE Energy contributes to the 401(k) Plan, on behalf of each participant, 200 percent of the participant's contributions up to five percent of compensation. No OGE Energy contributions are made with respect to a participant's Catch-Up Contributions, rollover contributions, or with respect to a participant's contributions based on overtime payments, pay-in-lieu of overtime for exempt personnel, special lump-sum recognition awards and lump-sum merit awards included in compensation for determining the amount of participant contributions. Once made, OGE Energy's contribution may be directed to any available investment option in the 401(k) Plan. OGE Energy match contributions vest over a three-year period. After two years of service, participants become 20 percent vested in their OGE Energy contribution account and become fully vested on completing three years of service. In addition, participants fully vest when they are eligible for normal or early retirement under the Pension Plan, in the event of their termination due to death or permanent disability or upon attainment of age 65 while employed by OGE Energy or its affiliates. OG&E contributed $8.8 million, $8.2 million and $8.2 million in 2016, 2015 and 2014, respectively, to the 401(k) Plan. Deferred Compensation Plan OGE Energy provides a nonqualified deferred compensation plan which is intended to be an unfunded plan. The plan's primary purpose is to provide a tax-deferred capital accumulation vehicle for a select group of management, highly compensated employees and non-employee members of the Board of Directors of OGE Energy and to supplement such employees' 401(k) Plan contributions as well as offering this plan to be competitive in the marketplace. Eligible employees who enroll in the plan have the following deferral options: (i) eligible employees may elect to defer up to a maximum of 70 percent of base salary and 100 percent of annual bonus awards or (ii) eligible employees may elect a deferral percentage of base salary and bonus awards based on the deferral percentage elected for a year under the 401(k) Plan with such deferrals to start when maximum deferrals to the qualified 401(k) Plan have been made because of limitations in that plan. Eligible directors who enroll in the plan may elect to defer up to a maximum of 100 percent of directors' meeting fees and annual retainers. OGE Energy matches employee (but not non-employee director) deferrals to make up for any match lost in the 401(k) Plan because of deferrals to the deferred compensation plan, and to allow for a match that would have been made under the 401(k) Plan on that portion of either the first six percent of total compensation or the first five percent of total compensation, depending on prior participant elections, deferred that exceeds the limits allowed in the 401(k) Plan. Matching credits vest based on years of service, with full vesting after three years or, if earlier, on retirement, disability, death, a change in control of OGE Energy or termination of the plan. Deferrals, plus any OGE Energy match, are credited to a recordkeeping account in the participant's name. Earnings on the deferrals are indexed to the assumed investment funds selected by the participant. In 2016, those investment options included an OGE Energy Common Stock fund, whose value was determined based on the stock price of OGE Energy's Common Stock. 12. Commitments and Contingencies Operating Lease Obligations OG&E has operating lease obligations expiring at various dates, primarily for railcar leases and wind farm land leases. Future minimum payments for noncancellable operating leases are as follows: Payments for operating lease obligations were $8.5 million, $6.9 million and $5.9 million for the years ended December 31, 2016, 2015 and 2014, respectively. Railcar Lease Agreement OG&E has a noncancellable operating lease with a purchase option, covering approximately 1,250 rotary gondola railcars to transport coal from Wyoming to OG&E's coal-fired generation units. Rental payments are charged to fuel expense and are recovered through OG&E's tariffs and fuel adjustment clauses. On January 11, 2012, OG&E executed a five-year lease agreement for 135 railcars to replace railcars that have been taken out of service or destroyed. On October 14, 2014, OG&E signed a separate three-year lease effective December 2014 for 131 railcars to replace railcars that have been taken out of service or destroyed. On December 17, 2015, OG&E renewed the lease agreement effective February 1, 2016. At the end of the new lease term, which is February 1, 2019, OG&E has the option to either purchase the railcars at a stipulated fair market value or renew the lease. If OG&E chooses not to purchase the railcars or renew the lease agreement and the actual fair value of the railcars is less than the stipulated fair market value, OG&E would be responsible for the difference in those values up to a maximum of $18.3 million. OG&E is also required to maintain all of the railcars it has under the operating lease. Wind Farm Land Lease Agreements OG&E has operating leases related to land for its Centennial, OU Spirit and Crossroads wind farms expiring at various dates. The Centennial lease has rent escalations which increase annually based on the Consumer Price Index. The OU Spirit and Crossroads leases have rent escalations which increase after five and 10 years. Although the leases are cancellable, OG&E is required to make annual lease payments as long as the wind turbines are located on the land. OG&E does not expect to terminate the leases until the wind turbines reach the end of their useful life. Other Purchase Obligations and Commitments OG&E's other future purchase obligations and commitments estimated for the next five years are as follows: Public Utility Regulatory Policy Act of 1978 At December 31, 2016, OG&E has a QF contract with Oklahoma Cogeneration LLC which expires on August 31, 2019 and a QF contract with AES-Shady Point, Inc. which expires on January 15, 2023. These contracts were entered into pursuant to the Public Utility Regulatory Policy Act of 1978. Stated generally, the Public Utility Regulatory Policy Act of 1978 and the regulations thereunder promulgated by the FERC require OG&E to purchase power generated in a manufacturing process from a QF. The rate for such power to be paid by OG&E was approved by the OCC. The rate generally consists of two components: one is a rate for actual electricity purchased from the QF by OG&E; the other is a capacity charge, which OG&E must pay the QF for having the capacity available. However, if no electrical power is made available to OG&E for a period of time (generally three months), OG&E's obligation to pay the capacity charge is suspended. The total cost of cogeneration payments is recoverable in rates from customers. For the 320 MWs AES-Shady Point, Inc. QF contract and the 120 MWs Oklahoma Cogeneration LLC QF contract, OG&E purchases 100 percent of the electricity generated by the QFs. For the years ended December 31, 2016, 2015 and 2014, OG&E made total payments to cogenerators of $124.8 million, $124.0 million and $129.4 million, respectively, of which $66.3 million, $69.5 million and $72.3 million, respectively, represented capacity payments. All payments for purchased power, including cogeneration, are included in the Statements of Income as Cost of Sales. Minimum Fuel Purchase Commitments OG&E has coal contracts for purchases through December 2017. As a participant in the SPP Integrated Marketplace, OG&E now purchases a relatively small percentage of its natural gas supply through long-term agreements. Alternatively, OG&E relies on a combination of call natural gas agreements, whereby OG&E has the right but not the obligation to purchase a defined quantity of natural gas, combined with day and intra-day purchases to meet the demands of the SPP Integrated Marketplace. Wind Purchase Commitments OG&E's current wind power portfolio includes the following, in addition to the 120 MW Centennial, 101 MW OU Spirit and 228 MW Crossroads wind farms owned by OG&E: (i) access to up to 50 MWs of electricity generated at a wind farm near Woodward, Oklahoma from a 15-year contract OG&E entered into with FPL Energy that expires in 2018, (ii) access to up to 152 MWs of electricity generated at a wind farm in Woodward County, Oklahoma from a 20-year contract OG&E entered into with CPV Keenan that expires in 2030, (iii) access to up to 130 MWs of electricity generated at a wind farm in Dewey County, Oklahoma from a 20-year contract OG&E entered into with Edison Mission Energy that expires in 2031 and (iv) access to up to 60 MWs of electricity generated at a wind farm near Blackwell, Oklahoma from a 20-year contract OG&E entered into with NextEra Energy that expires in 2032. The following table summarizes OG&E's wind power purchases for the years ended December 31, 2016, 2015 and 2014. Long-Term Service Agreement Commitments OG&E has a long-term parts and service maintenance contract for the upkeep of the McClain Plant. In May 2013, a new contract was signed that is expected to run for the earlier of 128,000 factored-fired hours or 4,800 factored-fired starts. On December 30, 2015, the McClain LTSA was amended to define the terms and conditions for the exchange of spare rotors between OG&E and General Electric International, Inc. Based on historical usage and current expectations for future usage, this contract is expected to run until 2030. The contract requires payments based on both a fixed and variable cost component, depending on how much the McClain Plant is used. OG&E has a long-term parts and service maintenance contract for the upkeep of the Redbud Plant. In March 2013, the contract was amended to extend the contract coverage for an additional 24,000 factored-fired hours resulting in a maximum of the earlier of 144,000 factored-fired hours or 4,500 factored-fired starts. Based on historical usage and current expectations for future usage, this contract is expected to run until 2028. The contract requires payments based on both a fixed and variable cost component, depending on how much the Redbud Plant is used. Enable Gas Transportation Agreement OG&E contracts with Enable for firm non-notice load following gas transportation services, under a five year contract. The contract will expire in April 2019. In 2016, OG&E entered into an additional gas transportation services contract with Enable which will be effective upon the conversion of units 4 and 5 at Muskogee from coal to gas. Environmental Laws and Regulations The activities of OG&E are subject to numerous stringent and complex Federal, state and local laws and regulations governing environmental protection. These laws and regulations can change, restrict or otherwise impact OG&E's business activities in many ways including the handling or disposal of waste material, future construction activities to avoid or mitigate harm to threatened or endangered species and requiring the installation and operation of emissions pollution control equipment. Failure to comply with these laws and regulations could result in the assessment of administrative, civil and criminal penalties, the imposition of remedial requirements and the issuance of orders enjoining future operations. Management believes that all of its operations are in substantial compliance with current Federal, state and local environmental standards. Environmental regulation can increase the cost of planning, design, initial installation and operation of OG&E's facilities. Historically, OG&E's total expenditures for environmental control facilities and for remediation have not been significant in relation to its financial position or results of operations. OG&E believes, however, that it is likely that the trend in environmental legislation and regulations will continue towards more restrictive standards. Compliance with these standards is expected to increase the cost of conducting business. Management continues to evaluate its compliance with existing and proposed environmental legislation and regulations and implement appropriate environmental programs in a competitive market. OG&E is managing several significant uncertainties about the scope and timing for the acquisition, installation and operation of additional pollution control equipment and compliance costs for a variety of the EPA rules that are being challenged in court. OG&E is unable to predict the financial impact of these matters with certainty at this time. Air Quality Control System On September 10, 2014, OG&E executed a contract for the design, engineering and fabrication of two circulating Dry Scrubber systems to be installed at Sooner Units 1 and 2. OG&E entered into an agreement on February 9, 2015, to install the Dry Scrubber systems. The Dry Scrubbers are scheduled to be completed by 2019. More detail regarding the ECP can be found under the "Pending Regulatory Matters" in Note 13. Clean Power Plan On October 23, 2015, the EPA published the final Clean Power Plan that established standards of performance for CO2 emissions from existing fossil-fuel-fired power plants along with state-specific CO2 reduction standards expressed as both rate-based (lbs/MWh) and mass-based (tons/yr) goals. The 2030 rate-based reduction requirement for all existing generating units in Oklahoma has decreased from a proposed 43 percent reduction to 32 percent in the final rule. The mass-based approach for existing units calls for a 24 percent reduction by 2030 in Oklahoma. A number of states, including Oklahoma, filed lawsuits against the Clean Power Plan. On February 9, 2016, the U.S. Supreme Court issued orders staying implementation of the Clean Power Plan pending resolution of challenges to the rule. OG&E is unable to determine what impact the lawsuits will ultimately have on the Clean Power Plan or what impact the stay in implementation will have; however, if the Clean Power Plan survives judicial review and is implemented as written, it could result in significant additional compliance costs that would affect our future financial position, results of operations and cash flows if such costs are not recovered through regulated rates. Due to the pending litigation and the uncertainties in the state approaches, the ultimate timing and impact of these standards on our operations cannot be determined with certainty at this time. Siemens Contract On June 15, 2015 OG&E entered into a contract with Siemens Energy Inc. for the purchase, design and engineering of seven simple-cycle gas turbine generators for $170.3 million associated with the Mustang Modernization Plan. Other In the normal course of business, OG&E is confronted with issues or events that may result in a contingent liability. These generally relate to lawsuits or claims made by third parties, including governmental agencies. When appropriate, management consults with legal counsel and other experts to assess the claim. If, in management's opinion, OG&E has incurred a probable loss as set forth by GAAP, an estimate is made of the loss and the appropriate accounting entries are reflected in OG&E's Financial Statements. At the present time, based on current available information, OG&E believes that any reasonably possible losses in excess of accrued amounts arising out of pending or threatened lawsuits or claims would not be quantitatively material to its financial statements and would not have a material adverse effect on OG&E's financial position, results of operations or cash flows. 13. Rate Matters and Regulation Regulation and Rates OG&E's retail electric tariffs are regulated by the OCC in Oklahoma and by the APSC in Arkansas. The issuance of certain securities by OG&E is also regulated by the OCC and the APSC. OG&E's wholesale electric tariffs, transmission activities, short-term borrowing authorization and accounting practices are subject to the jurisdiction of the FERC. The Secretary of the U.S. Department of Energy has jurisdiction over some of OG&E's facilities and operations. In 2016, 86 percent of OG&E's electric revenue was subject to the jurisdiction of the OCC, eight percent to the APSC and six percent to the FERC. The OCC issued an order in 1996 authorizing OG&E to reorganize into a subsidiary of OGE Energy. The order required that, among other things, (i) OGE Energy permit the OCC access to the books and records of OGE Energy and its affiliates relating to transactions with OG&E, (ii) OGE Energy employ accounting and other procedures and controls to protect against subsidization of non-utility activities by OG&E's customers and (iii) OGE Energy refrain from pledging OG&E assets or income for affiliate transactions. In addition, the Energy Policy Act of 2005 enacted the Public Utility Holding Company Act of 2005, which in turn granted to the FERC access to the books and records of OGE Energy and its affiliates as the FERC deems relevant to costs incurred by OG&E or necessary or appropriate for the protection of utility customers with respect to the FERC jurisdictional rates. Completed Regulatory Matters FERC Order No. 1000, Final Rule on Transmission Planning and Cost Allocation On July 21, 2011, the FERC issued Order No. 1000, which revised the FERC's existing regulations governing the process for planning enhancements and expansions of the electric transmission grid along with the corresponding process for allocating the costs of such expansions. Order No. 1000 requires individual regions to determine whether a previously-approved project is subject to reevaluation and is therefore governed by the new rule. Order No. 1000 directs public utility transmission providers to remove from the FERC-jurisdictional tariff and agreement provisions that establish any Federal "right of first refusal" for the incumbent transmission owner (such as OG&E) regarding transmission facilities selected in a regional transmission planning process, subject to certain limitations. However, Order No. 1000 is not intended to affect the right of an incumbent transmission owner (such as OG&E) to build, own and recover costs for upgrades to its own transmission facilities or to alter an incumbent transmission owner's use and control of existing rights of way. Order No. 1000 also clarifies that incumbent transmission owners may rely on regional transmission facilities to meet their reliability needs or service obligations. The SPP's pre-Order No. 1000 tariff included a "right of first refusal" for incumbent transmission owners and this provision has played a role in OG&E being selected by the SPP to build previous transmission projects in Oklahoma. On May 29, 2013, the Governor of Oklahoma signed House Bill 1932 into law which establishes a "right of first refusal" for Oklahoma incumbent transmission owners, including OG&E, to build new transmission projects with voltages under 300kV that interconnect to those incumbent owners' existing facilities. The SPP has submitted compliance filings implementing Order No. 1000's requirements. In response, the FERC issued an order on the SPP filings that required the SPP to remove certain "right of first refusal" language from the SPP Tariff and the SPP Membership Agreement. On December 15, 2014, OG&E filed an appeal in the Court challenging the FERC's order requiring the removal of the "right of first refusal" language from the SPP Membership Agreement. On July 1, 2016, the Court upheld the FERC's decision requiring removal of the "right of first refusal" for incumbent transmission providers from the SPP Membership Agreement. The Court determined that the FERC had reasonably found the "right of first refusal" in the SPP Membership Agreement to be anticompetitive. OG&E does not believe the Court’s ruling will have any impact on existing transmission projects for which OG&E has already received a notice to construct from the SPP. OG&E intends to actively participate in the SPP planning process for competitive transmission projects that we believe apply to transmission voltage levels projects greater than 300kV. Fuel Adjustment Clause Review for Calendar Year 2014 On July 28, 2015, the OCC Staff filed an application to review OG&E's fuel adjustment clause for calendar year 2014, including the prudence of OG&E's electric generation, purchased power and fuel procurement costs. On May 26, 2016, the OCC issued a final order, finding that for the calendar year 2014 OG&E's electric generation, purchased power and fuel procurement processes and costs were prudent. Oklahoma Demand Program Rider Review - SmartHours Program In July 2012, OG&E filed an application with the OCC to recover certain costs associated with demand programs through the Oklahoma Demand Program Rider, including the lost revenues associated with the SmartHours program. The SmartHours program is designed to incentivize participating customers to reduce on-peak usage or shift usage to off-peak hours during the months of May through October, by offering lower rates to those customers in the off-peak hours of those months. Lost revenues are created by the difference in the standard rates and the lower incentivized rates. Non-SmartHours program customers benefit from the reduction of on-peak usage by SmartHours customers by the reduction of more costly on-peak generation and the delay in adding new on-peak generation. In December 2012, the OCC issued an order approving the recovery of costs associated with the demand programs, including the lost revenues associated with the SmartHours program, subject to the PUD Staff's review. In March 2014, the PUD Staff began their review of the demand program costs, including the lost revenues associated with the SmartHours program. On August 9, 2016, OG&E entered into a settlement agreement with the PUD Staff to resolve the recoverable amount of lost revenues associated with the SmartHours program. The settlement provides for recovery of $10.1 million per year for 2013, 2014 and 2015, for a total of $30.3 million. OG&E had recorded $36.6 million of lost revenues for 2013, 2014 and 2015. On August 16, 2016, the OCC issued an order adopting the settlement agreement. Accordingly, OG&E reduced lost revenues and the Oklahoma Demand Program Rider regulatory asset by $6.3 million. Mustang Modernization Plan - Arkansas On April 13, 2016, OG&E filed an application at the APSC seeking authority to construct combustion turbines at its existing Mustang generating facility. Arkansas law requires a public utility to seek approval from the APSC to construct a power- generating facility located outside the boundaries of the state of Arkansas. The application did not seek any cost recovery for the capital expenditures in the application, as cost recovery will be determined in future proceedings. In July 2016, OG&E filed a motion to dismiss this proceeding and in August, the APSC approved the dismissal. OG&E intends to seek cost recovery of the Mustang combustion turbines at a later date after the Mustang facility is placed in service. Pending Regulatory Matters Set forth below is a list of various proceedings pending before state or federal regulatory agencies. Unless stated otherwise, OG&E cannot predict when the regulatory agency will act or what action the regulatory agency will take. OG&E's financial results are dependent in part on timely and adequate decisions by the regulatory agencies that set OG&E's rates. Environmental Compliance Plan On August 6, 2014, OG&E filed an application with the OCC for approval of its plan to comply with the EPA’s MATS and Regional Haze Rule FIP while serving the best long-term interests of customers in light of future environmental uncertainties. The application sought approval of the ECP and for a recovery mechanism for the associated costs. The ECP includes installing Dry Scrubbers at Sooner Units 1 and 2 and the conversion of Muskogee Units 4 and 5 to natural gas. The application also asked the OCC to predetermine the prudence of its Mustang Modernization Plan, which calls for replacing OG&E's soon-to-be retired Mustang steam turbines with 400 MWs of new, efficient combustion turbines at the Mustang site and approval for a recovery mechanism for the associated costs. On December 2, 2015, OG&E received an order from the OCC denying its plan to comply with the environmental mandates of the Federal Clean Air Act, Regional Haze Rule and MATS. The OCC also denied OG&E's request for pre-approval of its Mustang Modernization Plan, revised depreciation rates for both the retirement of the Mustang units and the replacement combustion turbines and pre-approval of early retirement and replacement of generating units at its Mustang site, including cost recovery through a rider. On February 12, 2016, OG&E filed an application requesting the OCC to issue an order approving its decision to install Dry Scrubbers at the Sooner facility. OG&E's application did not seek approval of the costs of the Dry Scrubber project. Instead, the reasonableness of the costs would be considered after the project is completed and OG&E seeks recovery in its rates. On April 28, 2016, the OCC approved the Dry Scrubber project. Two parties appealed the OCC's decision to the Oklahoma Supreme Court. OG&E is unable to predict what action the Oklahoma Supreme Court may take or the timing of any such action. OG&E anticipates the total cost of Dry Scrubbers will be $547.5 million, including allowance for funds used during construction and capitalized ad valorem taxes. As of December 31, 2016, OG&E had invested $208.7 million of construction work in progress on the Dry Scrubbers. OG&E anticipates the total cost for the Mustang Modernization Plan will be $424.9 million and expects the project to be completed in late 2017. As of December 31, 2016, OG&E had invested $187.8 million on the Mustang Modernization Plan. Integrated Resource Plans In October 2015, OG&E finalized the 2015 IRP and submitted it to the OCC. The 2015 IRP updated certain assumptions contained in the IRP submitted in 2014, but did not make any material changes to the ECP and other parts of the plan. Currently, OG&E is scheduled to update its IRP in Arkansas by October 1, 2017 and in Oklahoma by October 1, 2018. Oklahoma Rate Case Filing On December 18, 2015, OG&E filed a general rate case with the OCC requesting a rate increase of $92.5 million and a 10.25 percent return on equity based on a common equity percentage of 53 percent. The rate case was based on a June 30, 2015 test year and included recovery of $1.6 billion of electric infrastructure additions since its last general rate case in Oklahoma, the impact of the expiration of OG&E's wholesale contracts, increased operating costs such as vegetation management and increased recovery of depreciation and plant dismantlement of approximately $8.0 million. Each 0.25 percent change in the requested return on equity affects the requested rate increase by approximately $9.0 million. In late March 2016, the PUD Staff and other intervenors filed testimony in the case. The PUD Staff recommended a $6.1 million annual rate increase based on a return on equity of 9.25 percent and a common equity percentage of 53 percent. Included in the PUD Staff's recommendation is a reduction of $33.0 million to OG&E’s requested increase for depreciation and plant dismantlement. The staff of the Oklahoma Attorney General made a recommendation to reduce rates $10.8 million based on a return on equity of 9.25 percent and a common equity percentage of 50 percent, as well as a recommendation to reduce rates $13.7 million based on a return on equity of 8.90 percent and a common equity percentage of 53 percent. Included in the Oklahoma Attorney General's recommendation is a reduction of $20.9 million to OG&E’s requested increase for depreciation and plant dismantlement. The Oklahoma Industrial Energy Consumers recommended a $47.9 million annual rate decrease based on a return on equity of 9.00 percent and a common equity percentage of 53 percent. Included in the Oklahoma Industrial Energy Consumers' recommendation is a reduction of $52.5 million to OG&E’s requested increase for depreciation and plant dismantlement. On July 1, 2016, OG&E implemented an annual interim rate increase of $69.5 million which is subject to refund of any amount recovered in excess of the rates ultimately approved by the OCC in the rate case. As of December 31, 2016, OG&E has recorded $39.0 million of revenues from the interim rate increase and has reserved $33.7 million of that revenue. In December 2016, the ALJ issued a report and recommendations in the case. The ALJ's recommendations include, among other things, the use of OG&E's actual capital structure of 53 percent equity and 47 percent long-term debt and a return on equity of 9.87 percent resulting in an annual increase in OG&E's revenues of $40.7 million. The parties provided comments on the ALJ's report in early January 2017, and the OCC held hearings in early February 2017. OG&E is unable to predict what action the OCC will take, or the timing of such action. Arkansas Rate Case Filing On August 25, 2016, OG&E filed a general rate case with the APSC. The rate filing requested a $16.5 million rate increase based on a 10.25 percent return on equity. The rate increase was based on a June 30, 2016 test year and included a recovery of over $3.0 billion of electric infrastructure additions since the last Arkansas general rate case in 2011. The increase also reflects increases in operation and maintenance expenses, including vegetation management costs, and increased recovery of depreciation and dismantlement costs. A hearing in this matter is scheduled for the second quarter of 2017. Fuel Adjustment Clause Review for Calendar Year 2015 On September 8, 2016, the OCC Staff filed an application to review OG&E’s fuel adjustment clause for calendar year 2015, including the prudence of OG&E’s electric generation, purchased power and fuel procurement costs. A hearing in this Cause will be held on March 30, 2017. 14. Quarterly Financial Data (Unaudited) Due to the seasonal fluctuations and other factors of OG&E's business, the operating results for interim periods are not necessarily indicative of the results that may be expected for the year. In OG&E's opinion, the following quarterly financial data includes all adjustments, consisting of normal recurring adjustments, necessary to fairly present such amounts. Summarized quarterly unaudited financial data is as follows: ACCOUNTING FIRM The Board of Directors and Stockholder Oklahoma Gas and Electric Company We have audited the accompanying balance sheets and statements of capitalization of Oklahoma Gas and Electric Company (the Company) as of December 31, 2016 and 2015, and the related statements of income, comprehensive income, cash flows and changes in stockholder's equity for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Oklahoma Gas and Electric Company at December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Oklahoma Gas and Electric Company's internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 22, 2017 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Oklahoma City, Oklahoma February 22, 2017 | This appears to be a partial financial statement for OG&E (Oklahoma Gas & Electric), focusing primarily on their revenue recognition policies and regulatory accounting. Here's a summary of the key points:
Revenue:
- OG&E recognizes revenue when power is delivered to customers
- Uses an accrual system for unbilled revenue at month-end
- Participates in the SPP (Southwest Power Pool) Integrated Marketplace
- Does not engage in speculative trading
Regulatory Framework:
- Operates as a vertically integrated utility
- Member of SPP regional transmission organization
- Has transferred operational authority (but not ownership) of transmission facilities to SPP
- Subject to FERC regulations
Accounting Practices:
- Records regulatory assets and liabilities based on expected future rate recovery
- Manages pension and postretirement benefit plans as regulatory assets
- Uses specific regulatory orders to determine recovery of deferred costs
Note: The financial statement appears incomplete as specific numbers and detailed breakdowns for assets, liabilities, and profit/loss are not fully provided in the excerpt. | Claude |
. Danyang Special Cable Factory Inc. FINANCIAL INDEX [Table of Contents] [Financial Index] The accompanying notes are an integral part of these unaudited condensed financial statements [Financial Index] The accompanying notes are an integral part of these unaudited condensed financial statements [Financial Index] The accompanying notes are an integral part of these unaudited condensed financial statements [Financial Index] The accompanying notes are an integral part of these unaudited condensed financial statements [Financial Index] DANYANG SPECIAL CABLE FACTORY INC. NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND PRINCIPAL ACTIVITIES Danyang Special Cable Factory Inc. ("Company" or the "Registrant") was incorporated under the laws of the State of Delaware on July 27, 2015 and has been inactive since inception. We changed our name to Danyang Special Cable Factory Inc. on November 9, 2016. Our principal executive offices are located at Room 01, 25/F, Kerry Center, No. 2008 Renmin South Road, Luohu District, Shenzhen City, Guangdong, People’s Republic of China. Our phone number is +86-755-2218-4466. Our business model is to serve as a vehicle to effect an asset acquisition, merger, exchange of capital stock or other business combination with a domestic or foreign business. The Company has been in the developmental stage since inception and its operations to date have been limited to the purchase of shares of its original shareholders. We have not yet initiated any business development efforts nor generated any revenue to date. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Presentation The Company maintains its general ledger and journals with the accrual method of accounting for financial reporting purposes. The financial statements and notes are representations of management. Accounting policies adopted by the Company conform to U.S. GAAP and have been consistently applied in the presentation of financial statements. The accompanying financial statements are presented in U.S. dollars in conformity with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the SEC. (b) Net loss per common share The Company complies with accounting and disclosure requirements of FASB ASC 260, “Earnings Per Share.” Net loss per common share is computed by dividing net loss applicable to common stockholders by the weighted average number of common shares outstanding for the period. At December 31, 2016 and 2015, the Company did not have any dilutive securities and other contracts that could, potentially, be exercised or converted into common stock and then share in the earnings of the Company. As a result, diluted loss per common share is the same as basic loss per common share for the period. (c) Use of estimates The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ materially from those estimates. (d) Recently issued or adopted standards The Company does not expect the adoption of recently issued accounting pronouncements to have a significant impact on the Company’s results of operations, financial position or cash flow. 3. ACCRUED LIABILITIES. As of December 31, 2016, and 2015, the Company had $3,811 and $1,626 in accrued liabilities, respectively. The accrued liabilities mainly consist of professional fees. [Financial Index] 4. INCOME TAXES The Company complies with the accounting and reporting requirements of FASB ASC, 740, "Income Taxes," which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. There were no unrecognized tax benefits as of December 31, 2016. FASB ASC 740 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The Company recognizes accrued interest and penalties related to unrecognized tax benefits as income tax expense. No amounts were accrued for the payment of interest and penalties at December 31, 2016. The Company is currently not aware of any issues under review that could result in significant payments, accruals or material deviation from its position. The adoption of the provisions of FASB ASC 740 did not have a material impact on the Company's financial position and results of operation and cash flows as of and for the period ended December 31, 2016. As of December 31, 2016, we had a net operating loss carry-forward of approximately $(37,412) and a deferred tax asset of approximately $12,720 using the statutory rate of 34%. The deferred tax asset may be recognized in future periods, not to exceed 20 years. However, due to the uncertainty of future events we have booked valuation allowance of $(12,720). FASB ASC 740 prescribes recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FASB ASC 740 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. At December 31, 2016 the Company had not taken any tax positions that would require disclosure under FASB ASC 740. The Company files an income tax return in the U.S. federal jurisdiction and may file income tax returns in various U.S. states and foreign jurisdictions. Generally, the Company is subject to income tax examinations by major taxing authorities during the three year period prior to the period covered by these financial statements. 5. GOING CONCERN AND CAPITAL RESOURCES The Company does not currently engage in any business activities that provide cash flow. During the next 12 months we anticipate incurring costs related to: ● filing of Exchange Act reports, ● payment of annual corporate fees, and ● investigating, analyzing and consummating an acquisition. Mr. Zhang is paying the Company’s expenses and it is recorded as contributed capital. For the years ended December 31, 2016 and 2015, Mr. Zhang contributed $30,351 and $1,250 respectively. [Financial Index] As of December 31, 2016, the Company had an accumulated deficit of $37,412. Management anticipates that fees associated with filing of Exchange Act reports including accounting fees and legal fees and payment of annual corporate fees will not exceed $75,000 within next 12 months. We do not currently intend to retain any entity to act as a "finder" to identify and analyze the merits of potential target businesses. Management intends to search for a business combination by contacting various sources including, but not limited to, our affiliates, lenders, investment banking firms, private equity funds, consultants and attorneys and does not plan to conduct a complete and exhaustive investigation and analysis of a business opportunity. Management decisions, therefore, will likely be made without detailed feasibility studies, independent analysis, market surveys and the like which, if we had more funds, would be desirable. If the management can find a suitable target company, we will have to budget for additional fees relating to the investigation into the target company (including due diligence and possibly visiting the facilities) and consummating the reverse merger, which may cost between $125,000 to $150,000. We expect that the expenses for the next 12 months and beyond such time will be paid with amounts that may be loaned to or invested in us by our stockholders, management or other investors. Since we have minimal assets and will continue to incur losses due to the expenses associated with being a reporting company under the Exchange Act, we may cease business operations if we do not timely consummate a business combination. Currently, our ability to continue as a going concern is dependent upon our ability to generate future profitable operations and/or to obtain the necessary financing to meet our obligations and repay our liabilities arising from normal business operations when they come due. Our ability to continue as a going concern is also dependent upon our ability to find a suitable target company and enter into a possible reverse merger with such company. Management’s plan includes obtaining additional funds by equity financing through a reverse merger transaction and/or related party advances. However, there is no assurance of additional funding being available. The Company may consider a business which has recently commenced operations, is a developing company in need of additional funds for expansion into new products or markets, is seeking to develop a new product or service, or is an established business which may be experiencing financial or operating difficulties and is in need of additional capital. In the alternative, a business combination may involve the acquisition of, or merger with, a company which does not need substantial additional capital, but which desires to establish a public trading market for its shares, while avoiding, among other things, the time delays, significant expense, and loss of voting control which may occur in a public offering. Any target business that is selected may be a financially unstable company or an entity in its early stages of development or growth, including entities without established records of sales or earnings. In that event, we will be subject to numerous risks inherent in the business and operations of financially unstable and early stage or potential emerging growth companies. In addition, we may effect a business combination with an entity in an industry characterized by a high level of risk, and, although our management will endeavor to evaluate the risks inherent in a particular target business, there can be no assurance that we will properly ascertain or assess all significant risks. Our management anticipates that it will likely be able to effect only one business combination, due primarily to our limited financing and the dilution of interest for present and prospective stockholders, which is likely to occur as a result of our management’s plan to offer a controlling interest to a target business in order to achieve a tax-free reorganization. The Company anticipates that the selection of a business combination will be complex and extremely risky. Our potential merger targets are firms seeking either the benefits of a business combination with an SEC reporting company and/or the perceived benefits of becoming a publicly traded corporation. Such perceived benefits of becoming a publicly traded corporation include, among other things, facilitating or improving the terms on which additional equity financing may be obtained, providing liquidity for the principals of and investors in a business, creating a means for providing incentive stock options or similar benefits to key employees, and offering greater flexibility in structuring acquisitions, joint ventures and the like through the issuance of stock. While a private operating company may achieve the same benefits by filing its own Exchange Act registration statement, such benefits can be achieved at a potentially faster rate with limited regulatory review through the completion of a business combination with a public reporting company. A potentially available business combination may occur in many different industries and at various stages of development, all of which will make the task of comparative investigation and analysis of such business opportunities extremely difficult and complex. The time required to select and evaluate a target business and to structure and complete a business combination cannot presently be ascertained with any degree of certainty. [Financial Index] In identifying, evaluating and selecting a target business, we may encounter intense competition from other entities having a business objective similar to ours. There are numerous blank check companies that have gone public in the United States that have significant financial resources, that are seeking to carry out a business plan similar to our business plan. Many of these entities are well established and have extensive experience identifying and effecting business combinations directly or through affiliates. Many of these competitors possess greater technical, human and other resources than us and our financial resources will be relatively limited when contrasted with those of many of these competitors. 6. Stockholders’ Equity Preferred Stock - The Company is authorized to issue 5,000,000 shares of $0.0001 par value preferred stock. As of December 31, 2016, no shares of preferred stock had been issued. Common Stock - The Company is authorized to issue 100,000,000 shares of $0.0001 par value common stock. As of December 31, 2016, 20,000,000 shares were issued and outstanding. Upon formation of the Company on July 27, 2015, the Board of Directors issued 10,000,000 shares of common stock for $1,000 in services to the founding shareholder of the Company. In addition, the founding shareholder made a contribution of $1,000 to the Company for the period ended June 30, 2016, which is recorded as additional paid-in capital. On September 12, 2016, the Company entered into a Subscription Agreement with Dongzhi Zhang for the purchase of 20 million shares of its restricted common stock at a price of $0.0001 per share. The salewas the result of a privately negotiated transaction without the use of public dissemination of promotional or sales materials. Richard Chiang, our then sole shareholder, officer and director, and the Company agreed to the redemption of 10,000,000 shares of the Company’s common stock at par value, i.e. $1,000, which had previously been issued to Mr. Chiang. Mr. Zhang is paying the Company’s expenses and it is recorded as contributed capital. For the years ended December 31, 2016 and 2015, Mr. Zhang contributed $30,351 and $1,250 respectively. 7. Commitments and Contingencies There is no commitment or contingency to disclose during the period ended December 31, 2016. 8. Subsequent Events Management has evaluated subsequent events up to and including March 22, 2017, which is the date the statements were made available for issuance and determined there are no reportable subsequent events. [Financial Index] | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement excerpt. It seems to be discussing accounting standards, estimates, and disclosure requirements, but lacks clear financial details like actual revenue, expenses, or net income. Without more context or complete financial information, I cannot provide a meaningful summary of the company's financial performance.
If you have the full financial statement or additional details, I'd be happy to help you summarize it. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Board of Directors and Stockholders Dynasil Corporation of America and Subsidiaries Newton, Massachusetts We have audited the accompanying consolidated balance sheets of Dynasil Corporation of America and Subsidiaries (the Company) as of September 30, 2016 and 2015 and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Dynasil Corporation of America and Subsidiaries as of September 30, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. /s/ RSM US LLP Boston, Massachusetts December 21, 2016 DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2016 and 2015 The accompanying notes are an integral part of these consolidated financial statements. DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2016 and 2015 (Continued) The accompanying notes are an integral part of these consolidated financial statements. DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE YEARS ENDED SEPTEMBER 30, 2016 and 2015 The accompanying notes are an integral part of these consolidated financial statements. DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 2016 and 2015 The accompanying notes are an integral part of these consolidated financial statements DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 30, 2016 and 2015 The accompanying notes are an integral part of these consolidated financial statements. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 1 - Nature of Operations Nature of Operations Dynasil Corporation of America (“Dynasil” or the “Company”) is primarily engaged in the development, marketing and manufacturing of detection, sensing and analysis technology and optical components as well as contract research. The Company’s products and services are used in a broad range of application markets including the homeland security, industrial and medical markets sectors. The products and services are sold throughout the United States (“U.S.”) and internationally. Note 2 - Summary of Significant Accounting Policies Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Principles of Consolidation The accompanying consolidated financial statements include the accounts of Dynasil Corporation of America and its wholly-owned subsidiaries: Optometrics Corporation (“Optometrics”), Evaporated Metal Films Corporation (“EMF”), Dynasil Products, formerly known as RMD Instruments Corp. (“Dynasil Products”), Radiation Monitoring Devices, Inc. (“RMD”), Hilger Crystals, Ltd (“Hilger”) and Dynasil Biomedical Corp (“Dynasil Biomedical”). Xcede Technologies, Inc. (“Xcede”) is a joint venture between Dynasil Biomedical and Mayo Clinic to spin out and separately fund the development of a tissue sealant technology. As of September 30, 2016, Dynasil Biomedical owned 83% of Xcede’s common stock and as a result, Xcede is included in the Company’s consolidated balance sheets, results of operations and cash flows. The remaining 17% of Xcede’s common stock is non-controlling interest and is treated as such. All significant intercompany transactions and balances have been eliminated. Revenue Recognition Revenue from sales of products is recognized at the time title and the risks and rewards of ownership pass. Revenue is recognized when the products are shipped per customers’ instructions, the contract has been executed, the contract or sales price is fixed or determinable, delivery of services or products has occurred and the Company’s ability to collect the contract price is considered reasonably assured. Revenue from research and development activities is derived generally from the following types of contracts: reimbursement of costs plus fees, fixed price or time and material type contracts. Government funded services revenue from cost plus contracts are recognized as costs are incurred on the basis of direct costs plus allowable indirect costs and an allocable portion of the contracts’ fixed fees. Revenue from fixed-type contracts is recognized under the percentage of completion method with estimated costs and profits included in contract revenue as work is performed. Revenue from time and materials contracts are recognized as costs are incurred at amounts represented by agreed billing amounts. Recognition of losses on projects is taken as soon as the loss is reasonably determinable. The Company has an accrual for contract losses in the amount of $110,000 as of September 30, 2016 and 2015. The majority of the Company’s contract research revenue is derived from the United States government and government related contracts. Such contracts have certain risks which include dependence on future appropriations and administrative allotment of funds and changes in government policies. Costs incurred under United States government contracts are subject to audit. The Company believes that the results of such audits will not have a material adverse effect on its financial position or its results of operations. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 2 - Summary of Significant Accounting Policies (continued) Allowance for Doubtful Accounts Receivable The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by a review of their current credit information. The Company continuously monitors collections and payments from our customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been minimal, within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same credit loss rates as in the past. A significant change in the liquidity or financial position of any significant customers could have a material adverse effect on the collectability of accounts receivable and future operating results. When all collection efforts have failed and it is deemed probable that a customer account is uncollectible, that balance is written off against the existing allowance. Shipping and Handling Costs Shipping and handling costs are included in the cost of sales. The amounts billed for shipping and included in net revenue were approximately $49,000 in both the years ended September 30, 2016 and 2015. Research and Development The Company expenses research and development costs as incurred. Research and development costs include salaries, employee benefit costs, direct project costs, supplies and other related costs. Substantially all the Contract Research segment’s cost of revenue relates to research contracts performed by RMD which are in turn billed to the contracting party. Amounts of research and development included within cost of revenue for the years ended September 30, 2016 and 2015 were $12.2 million and $10.5 million, respectively. Research and development for our other businesses totaled $1.0 million in fiscal year 2016 and $1.2 million in fiscal year 2015. Costs in Excess of Billings and Unbilled Receivables Costs in excess of billings and unbilled receivables relate to research and development contracts and consists of actual costs incurred plus fees in excess of billings at provisional contract rates. Patent Costs Costs incurred in filing, prosecuting and maintaining patents (principally legal fees) are expensed as incurred and recorded within selling, general and administrative expenses on the consolidated statements of operations. Such costs aggregated approximately $0.2 and $0.5 million for the years ended September 30, 2016 and 2015, respectively. Xcede capitalizes patent costs, which equaled $0.1 million for the years ended September 30, 2016 and 2015. Inventories Inventories are stated at the lower of average cost or market. Cost is determined using the first-in, first-out (FIFO) method and includes material, labor and overhead. Inventories consist primarily of raw materials, work-in-process and finished goods. A significant decrease in demand for the Company's products could result in a short-term increase in the cost of inventory purchases and an increase of excess inventory quantities on hand. In addition, as technologies change or new products are developed, product obsolescence could result in an increase in the amount of obsolete inventory quantities on hand. The Company records, as a charge to cost of revenue, any amounts required to reduce the carrying value to net realizable value. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 2 - Summary of Significant Accounting Policies (continued) Property, Plant and Equipment Property, plant and equipment are recorded at cost or at fair market value for acquired assets. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets. The estimated useful lives of assets for financial reporting purposes are as follows: building and improvements, 8 to 25 years; machinery and equipment, 5 to 20 years; office furniture and fixtures, 5 to 10 years; transportation equipment, 5 years. Maintenance and repairs are charged to expense as incurred; major renewals and betterments are capitalized. When items of property, plant and equipment are sold or retired, the related costs and accumulated depreciation are removed from the accounts and any gain or loss is included in income. Goodwill The Company annually assesses goodwill impairment at the end of the fourth quarter of the fiscal year by applying a fair value test. In the first step of testing for goodwill impairment, the Company estimates the fair value of each reporting unit. The reporting units have been determined as RMD, which is the Contract Research reportable segment, and Hilger, which is a component of the Optics reportable segment. The Company compares the fair value with the carrying value of the net assets assigned to each reporting unit. If the fair value is less than its carrying value, then the Company performs a second step and determines the fair value of the goodwill. In this second step, the fair value of goodwill is determined by deducting the fair value of a reporting unit’s identifiable assets and liabilities from the fair value of the reporting unit as a whole, as if that reporting unit had just been acquired and the purchase price were being initially allocated. If the fair value of the goodwill is less than its carrying value for a reporting unit, an impairment charge is recorded to earnings. To determine the fair value of each of the reporting units as a whole, the Company uses a discounted cash flow analysis, which requires significant assumptions and estimates about the future operations of each reporting unit. Significant judgments inherent in this analysis include the determination of appropriate discount rates, the amount and timing of expected future cash flows and growth rates. The cash flows employed in the discounted cash flow analyses are based on financial forecasts developed internally by management. The discount rate assumptions are based on an assessment of the Company’s risk adjusted discount rate, applicable for each reporting unit. In assessing the reasonableness of the determined fair values of the reporting units, the Company evaluates its results against its current market capitalization. In addition, the Company evaluates a reporting unit for impairment if events or circumstances change between annual tests indicating a possible impairment. Examples of such events or circumstances include the following: •a significant adverse change in legal status or in the business climate, •an adverse action or assessment by a regulator, •a more likely than not expectation that a segment or a significant portion thereof will be sold, or •the testing for recoverability of a significant asset group within the segment. Intangible Assets The Company's intangible assets consist of acquired customer relationships, trade names, acquired backlog, know-how and provisionally patented technologies. The Company amortizes its intangible assets with definitive lives over their useful lives, which range from 4 to 20 years, based on the time period the Company expects to receive the economic benefit from these assets. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 2 - Summary of Significant Accounting Policies (continued) The Company has a trade name related to its subsidiary located in the United Kingdom (“U.K.”) that has been determined to have an indefinite life and is therefore not subject to amortization and is reviewed at least annually for potential impairment. The fair value of the Company’s trade name is estimated and compared to its carrying value to determine if impairment exists. The Company estimates the fair value of this intangible asset based on an income approach using the relief-from-royalty method. This methodology assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to exploit the related benefits of this asset. This approach is dependent on a number of factors, including estimates of future sales, royalty rates in the category of intellectual property, discount rates and other variables. Significant differences between these estimates and actual results could materially affect the Company’s future financial results. Recovery of Long-Lived Assets The Company continually assesses whether events or changes in circumstances have occurred that may warrant revision of the estimated useful lives of its long-lived assets (other than goodwill and any indefinite lived assets) or whether the remaining balances of those assets should be evaluated for possible impairment. Long-lived assets include, for example, customer relationships, trade names, backlog, know-how and provisionally patented technologies. Events or changes in circumstances that may indicate that an asset may be impaired include the following: •a significant decrease in the market price of an asset or asset group, •a significant adverse change in the extent or manner in which an asset or asset group is being used or in its physical condition, •a significant adverse change in legal factors or in the business climate that could affect the value of an asset or asset group, including an adverse action or assessment by a regulator, •an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset, •a current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset or asset group, •a current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life, or •an impairment of goodwill at a reporting unit. If an impairment indicator occurs, the Company performs a test of recoverability by comparing the carrying value of the asset or asset group to its undiscounted expected future cash flows. The Company groups its long-lived assets for this purpose at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets or asset groups. If the carrying values are in excess of undiscounted expected future cash flows, the Company measures any impairment by comparing the fair value of the asset or asset group to its carrying value. To determine fair value the Company uses discounted cash flow analyses and estimates about the future cash flows of the asset or asset group. This analysis includes a determination of an appropriate discount rate, the amount and timing of expected future cash flows and growth rates. The cash flows employed in the discounted cash flow analyses are typically based on financial forecasts developed internally by management. The discount rate used is commensurate with the risks involved. The Company may also rely on third party valuations and or information available regarding the market value for similar assets. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 2 - Summary of Significant Accounting Policies (continued) If the fair value of an asset or asset group is determined to be less than the carrying amount of the asset or asset group, impairment in the amount of the difference is recorded in the period that the impairment occurs. Estimating future cash flows requires significant judgment and projections may vary from the cash flows eventually realized. Advertising The Company expenses all advertising costs as incurred. Advertising expense for the years ended September 30, 2016 and 2015 was approximately $105,000 and $96,000, respectively. Retirement Plans The Company has retirement savings plans available to substantially all full time employees which are intended to qualify as deferred compensation plans under Section 401(k) of the Internal Revenue Code and similar laws in the United Kingdom. Pursuant to these plans, employees contribute amounts as required or allowed by the plans or by law. The Company also makes matching contributions in accordance with the terms of the plans. The Company’s EMF subsidiary previously had a defined benefit pension plan covering hourly employees. The plan provided defined benefits based on years of service and final average salary. As of September 30, 2006, the plan was frozen. On December 1, 2014, the Company terminated and settled its pension liability with each of the remaining participants in the plan. Income Taxes Dynasil Corporation of America and its wholly owned U.S. subsidiaries file a consolidated federal income tax return and various state returns. The Company’s U.K. subsidiary files tax returns in the U.K. The Company uses the asset and liability approach to account for deferred income taxes. Deferred tax assets and liabilities are classified as non-current. Under this approach, deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and net operating loss and tax credit carry-forwards. The amount of deferred taxes on these temporary differences is determined using the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, as applicable, based on tax rates, and tax laws, in the respective tax jurisdiction then in effect. In assessing the ability to realize the net deferred tax assets, management considers various factors including taxable income in carryback years, future reversals of existing taxable temporary differences, tax planning strategies and projections of future taxable income, to determine whether it is more likely than not that some portion or all of the net deferred tax assets will not be realized. Based upon the Company’s current losses and uncertainty of future profits, the Company has determined that the uncertainty regarding the realization of these assets is sufficient to warrant the need for a full valuation allowance against its U.S. net deferred tax assets. The Company applies the authoritative provisions related to accounting for uncertainty in income taxes. As required by these provisions, the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more-likely-than-not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being reached upon ultimate settlement with the relevant tax authority. As of September 30, 2016 and 2015, the Company has no unrecorded liabilities for uncertain tax positions. Interest and penalty charges, if any, related to uncertain tax positions would be classified as income tax expense in the accompanying consolidated statement of operations. As of September 30, 2016 and 2015, the Company had no accrued interest or penalties related to uncertain tax positions. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 2 - Summary of Significant Accounting Policies (continued) Earnings Per Common Share Basic earnings (loss) per common share is computed by dividing the net income or loss attributable to common shares by the weighted average number of common shares outstanding during each period. Diluted earnings per common share adjusts basic earnings per share for the effects of common stock options, common stock warrants, convertible preferred stock and other potential dilutive common shares outstanding during the periods. For purposes of computing diluted earnings per share for the years ended September 30, 2016 and 2015, no common stock options were included in the calculation of dilutive shares as all of the 123,147 and 58,212 common stock options outstanding, respectively, had exercise prices above the current quarterly average market price per share and their inclusion would be anti-dilutive. For the year ended September 30, 2016, 35,938 shares of common stock related to restricted stock were included in the denominator used to calculate diluted earnings per common share. If the Company had not been in a loss position for the year ended September 30, 2015, 7,924 shares of restricted stock would have been considered in the denominator used to calculate diluted earnings per common share. The computations of the weighted shares outstanding for the years ended September 30 are as follows: Stock Based Compensation Stock-based compensation cost is measured using the fair value recognition provisions of the FASB authoritative guidance, which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors, including employee stock options, based on estimated fair values. Stock-based compensation cost is measured at the grant date based on the value of the award and is recognized over the requisite service period of the award. Foreign Currency Translation The operations of Hilger, the Company’s foreign subsidiary, use their local currency as its functional currency. Assets and liabilities of the Company’s foreign operations, denominated in their local currency, Great Britain Pounds (GBP), are translated at the rate of exchange at the balance sheet date. Revenue and expense accounts are translated at the average exchange rates during the period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the foreign currency translation adjustment, a component of accumulated other comprehensive income in stockholders’ equity. Gains and losses generated by transactions denominated in foreign currencies are recorded in the accompanying statement of operations in the period in which they occur. Comprehensive Income (Loss) Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Accumulated comprehensive income (loss) represents cumulative translation adjustments related to Hilger, the Company’s foreign subsidiary. The Company presents comprehensive income and losses in the consolidated statements of operations and comprehensive income (loss). DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 2 - Summary of Significant Accounting Policies (continued) Financial Instruments The carrying amount reported in the balance sheets for cash and cash equivalents, accounts receivable and accounts payable approximates fair value because of the immediate or short-term maturity of these financial instruments. The carrying amounts for fixed rate long-term debt and variable rate long-term debt approximate fair value because the underlying instruments are primarily at current market rates available to the Company for similar borrowings. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of accounts receivable. In the normal course of business, the Company extends credit to certain customers. Management performs initial and ongoing credit evaluations of their customers and generally does not require collateral. Concentration of Credit Risk The Company maintains allowances for potential credit losses and has not experienced any significant losses related to the collection of its accounts receivable. As of September 30, 2016 and 2015, approximately $1,159,000 and $921,000 or 32% and 26% of the Company’s accounts receivable are due from foreign sales. The Company maintains cash and cash equivalents at various financial institutions in New Jersey, Massachusetts and New York. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $250,000. Hilger also maintains cash and cash equivalents at a financial institution in the U.K. Accounts at this institution are insured by the Financial Services Compensation Scheme, the U.K.’s deposit guarantee scheme, up to £75,000. At September 30, 2016 and 2015, the Company's uninsured bank balances totaled approximately $2,031,000 and $746,000, respectively. The Company has not experienced any significant losses on its cash and cash equivalents. Recent Accounting Pronouncements Effective October 1, 2015, the Company early adopted the guidance issued in Accounting Standards Update 2015-03, Interest - Imputation of Interest (Topic 835) (“ASU 2015-03”) to simplify the presentation of debt issuance costs. This standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The Company adopted this guidance on a retrospective basis, wherein the balance sheet of each individual period presented was adjusted to reflect the period-specific effects of applying the new guidance. As a result of the adoption of ASU 2015-03, $12,000 of debt issuance costs at September 30, 2015 were reclassified from deferred financing costs, net to long-term debt in the consolidated balance sheets. Effective October 1, 2015, the Company early adopted the guidance issued in Accounting Standards Update 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”) which simplifies the presentation of deferred income taxes. ASU 2015-17 concludes that deferred tax liabilities and assets should be classified as noncurrent in a classified statement of financial position. The Company adopted this guidance on a retrospective basis, wherein the balance sheet of each individual period presented was adjusted to reflect the period-specific effects of applying the new guidance. The adoption of this ASU did not have a material impact on the Company’s financial statements. Revenue from Contracts with Customers (Topic 606) Section A-Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contracts with Customers (Subtopic 340-40). In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605),” and requires entities to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In March 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 2 - Summary of Significant Accounting Policies (continued) Recent Accounting Pronouncements (continued) Customers - Principal versus Agent Considerations (Reporting revenue gross versus net),” which clarifies gross versus net revenue reporting when another party is involved in the transaction. In April 2016, the FASB issued ASU 2016-10, “Identifying Performance Obligations and Licensing,” which amends the revenue guidance on identifying performance obligations and accounting for licenses of intellectual property. There are two transition methods available under the new standard, either cumulative effect or retrospective. The new guidance is effective for the Company beginning in fiscal 2019. In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients,” which clarifies the revenue guidance. The Company is currently in the process of assessing the impact of these ASUs on its consolidated financial statements. Compensation-Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. In June 2014, the FASB issued ASU No. 2014-12, which clarifies the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. Under the new guidance, a performance target that affects vesting and could be achieved after completion of the service period should be treated as a performance condition under FASB Accounting Standards Codification (ASC) 718 and, as a result, should not be included in the estimation of the grant-date fair value of the award. An entity should recognize compensation cost for the award when it becomes probable that the performance target will be achieved. In the event that an entity determines that it is probable that a performance target will be achieved before the end of the service period, the compensation cost of the award should be recognized prospectively over the remaining service period. The new guidance is effective for the Company beginning in fiscal 2017. Early adoption is permitted. The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements. Preparation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. In August 2014, the FASB issued ASU No. 2014-15, which states that under GAAP, continuation of a reporting entity as a going concern is presumed as the basis for preparing financial statements unless and until the entity’s liquidation becomes imminent. If and when an entity’s liquidation becomes imminent, financial statements should be prepared under the liquidation basis of accounting. Even when an entity’s liquidation is not imminent, there may be conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern. In those situations, financial statements should continue to be prepared under the going concern basis of accounting, but the amendments in this ASU should be followed to determine whether to disclose information about the relevant conditions and events. The new guidance is effective for the Company’s annual reporting for fiscal 2017, and for annual periods and interim periods thereafter. Early adoption is permitted. The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements. Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. In January 2015, the FASB issued ASU No. 2015-01, which eliminates the concept of extraordinary items in an entity’s income statement. Extraordinary classification outside of income from continuing operations was previously considered only when evidence clearly supported its classification as an extraordinary item. Extraordinary items were events and transactions that were distinguished by their unusual nature and by the infrequency of their occurrence. The ASU eliminates the need to separately classify, present and disclose extraordinary events. The disclosure of events or transactions that are unusual or infrequent in nature will be included in other guidance. This new guidance is effective for the Company beginning in fiscal 2017. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s financial statements. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 2 - Summary of Significant Accounting Policies (continued) Recent Accounting Pronouncements (continued) Inventory (Topic 330), Simplifying the Measurement of Inventory. In July 2015, the FASB issued ASU No. 2015-11, which requires that an entity should measure inventory within the scope of this ASU at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Substantial and unusual losses that result from subsequent measurement of inventory should be disclosed in the financial statements. This new guidance is effective for the Company beginning in fiscal 2018. The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements. Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments. In September 2015, the FASB issued ASU No. 2015-16, which requires that an acquirer recognize adjustment to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer needs to record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. In addition, an entity is required to present, separately on the face of the income statement or disclose in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. This new guidance is effective for the Company beginning in fiscal 2017. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows. Leases (Topic 842). In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to put most leases on their balance sheets by recognizing a lessee’s rights and obligations, while expenses will continue to be recognized in a similar manner to today’s legacy lease accounting guidance. This ASU could also significantly affect the financial ratios used for external reporting and other purposes, such as debt covenant compliance. This new guidance is effective for the Company beginning in fiscal 2020, with early adoption permitted. The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements. Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. In March 2016, the FASB issued ASU 2016-09 which affects entities that issue share-based payment awards to their employees. ASU 2016-09 is designed to simplify several aspects of accounting for share-based payment award transactions which include - the income tax consequences, classification of awards as either equity or liabilities, classification on the statement of cash flows and forfeiture rate calculations. This guidance is effective for annual periods beginning after December 15, 2016 (Fiscal 2018 for the Company), including interim periods within those fiscal years. The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements. Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. In October 2016, the FASB issued ASU 2016-16 which eliminates the exception, other than for inventory transfers, under current U.S. GAAP under which the tax effects of intra-entity asset transfers (intercompany sales) are deferred until the transferred asset is sold to a third party or otherwise recovered through use. Upon adoption of ASU 2016-16, the Company will recognize the tax expense from the sale of that asset in the seller’s tax jurisdiction when the transfer occurs, even though the pre-tax effects of that transaction are eliminated in consolidation. Any deferred tax asset that arises in the buyer’s jurisdiction would also be recognized at the time of the transfer. This new guidance is effective for the Company beginning in fiscal 2019, with early adoption permitted. Modified retrospective adoption is required with any cumulative-effect adjustment recorded to retained earnings as of the beginning of the period of adoption. The cumulative-effect adjustment, if any, would consist of the net impact from (1) the write-off of any unamortized tax expense previously deferred and (2) recognition of any previously unrecognized deferred tax assets, net of any necessary valuation allowances. The adoption of this standard is not expected to have a material impact on the Company’s financial statements. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 2 - Summary of Significant Accounting Policies (continued) Recent Accounting Pronouncements (continued) Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control. In October 2016, the FASB issued ASU 2016-17, Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control, which amends the consolidation guidance on how a reporting entity that is the single decision maker of a VIE should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. This new guidance is effective for the Company beginning in fiscal 2018, with early adoption permitted. The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements. Statement of Cash Flows (Topic 230): Restricted Cash: In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows: Restricted Cash, which provides guidance on the classification of restricted cash in the statement of cash flows. The amendments in this ASU are effective for the Company’s annual reporting for fiscal 2018, with early adoption permitted. The amendments in the ASU should be adopted on a retrospective basis. The adoption of this standard is not expected to have a material impact on the Company’s financial statements. Cash and Cash Equivalents The Company generally considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Reclassifications Certain prior year balances have been reclassified to conform to the current year presentation. These reclassifications did not affect previously reported net loss or stockholders’ deficit. Note 3 - Xcede Technologies, Inc. Joint Venture In October 2013, the Company formed Xcede, a joint venture with Mayo Clinic, in order to spin out and separately fund the development of its tissue sealant technology, which formerly comprised the majority of its biomedical segment. As of September 30, 2016, Xcede had raised approximately $3.4 million in the form of Convertible Notes (the “Notes”), of which $2.9 million was from external funding to outside investors and to certain officers and directors of the Company and $0.6 million was from the Company. The Notes accrued interest at 5%. The total interest accrued due to the external funding sources at September 30, 2016 was approximately $0.3 million. On July 15, 2016, Xcede amended the Note Purchase Agreement for such Notes to extend the Notes’ maturity date from June 30, 2016 to June 30, 2017 and to increase the principal amount of Notes authorized to be issued thereunder from $3.0 million to up to $5.2 million. In January 2016, Xcede announced that it had signed three agreements with Cook Biotech Inc. of West Lafayette, IN including a Development Agreement, a License Agreement and a Supply Agreement in connection with the development, regulatory approval and production of Xcede’s resorbable hemostatic patch. In June 2016, Xcede issued 238,535 shares of its common stock to the Mayo Foundation for Medical Education and Research (“Mayo”) as the final anti-dilution adjustment in satisfaction of the anti-dilution clause in the existing licensing agreement between Xcede and Mayo. As a result, a charge of $0.2 million was recorded in stock compensation expense for the year ended September 30, 2016. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 3 - Xcede Technologies, Inc. Joint Venture (continued) In November 2016, Xcede announced Cook Biotech Inc. committed to fund the pre-clinical testing of, and subject to the receipt of applicable regulatory approvals initiate clinical trials for, its first tissue sealant product. In addition, in November 2016, the Company committed to invest $1.2 million of cash into Xcede over the following 18 months and all $5.1 million in existing notes and accrued interest were converted into 5,394,120 shares of preferred stock of Xcede at a 20% discount to the price per share of the investment the Company has committed to make in Xcede, in accordance with the provisions of the notes. As of September 30, 2016, Dynasil Biomedical owned 83% of Xcede’s common stock and, as a result, Xcede is included in the Company’s consolidated balance sheets, results of operations and cash flows. As of December 1, 2016, approximately 59% of Xcede’s outstanding equity was owned by Dynasil Biomedical as a result of the conversion of the outstanding notes described above. Note 4 - Inventories Inventories, net of reserves, at September 30, 2016 and 2015 consisted of the following: Note 5 - Property, Plant and Equipment Property, plant and equipment at September 30, 2016 and 2015 consist of the following: Depreciation expense for the years ended September 30, 2016 and 2015 was $1,097,000 and $1,026,000. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 6 - Intangible Assets Intangible assets at September 30, 2016 and 2015 consist of the following: Amortization expense for both the years ended September 30, 2016 and 2015 was $170,000. Estimated amortization expense for each of the next five fiscal years is as follows: As of September 30, 2016, Xcede has $195,000 in capitalized patent costs related to patents that have not been granted, therefore, the amortization related to these patents is not included in the five-year amortization table above. Note 7 - Goodwill The changes to goodwill during the years ended September 30, 2016 and 2015 are summarized as follows: DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 7 - Goodwill (continued) With respect to the Company's annual goodwill impairment testing performed during the fourth quarter of fiscal year 2016, step one of the testing determined the estimated fair value of RMD (included in the Contract Research segment) and Hilger (included in the Optics segment) reporting units exceeded their carrying value by more than 20%. Accordingly, the Company concluded that no impairment had occurred and no further testing was necessary. The step one test for the RMD reporting unit and the resulting calculation of the indicated fair value was performed as described above based on certain specific assumptions. The Company relied on a weighted average cost of capital of approximately 15% for this reporting unit which takes into consideration certain industry and specific premiums. The Company utilized a long term growth rate of approximately 1.5% for this reporting unit which considers industry research and management’s expectations as to the prospects for long term growth in this industry. The step one test for the Hilger reporting unit and the resulting calculation of the indicated fair value was performed as described above based on certain specific assumptions. The Company relied on a weighted average cost of capital of 16% for this reporting unit which takes into consideration certain industry and specific premiums. The Company utilized a long term growth rate of approximately 5% for this reporting unit which considers industry research and management’s expectations as to the prospects for long term growth in this industry. Determining the fair value using a discounted cash flow method requires significant estimates and assumptions, including market conditions, discount rates, and long-term projections of cash flows. The Company’s estimates are based upon historical experience, current market trends, projected future volumes and other information. The Company believes that the estimates and assumptions underlying the valuation methodology are reasonable; however, different estimates and assumptions could result in a different estimate of fair value. In estimating future cash flows, the Company relies on internally generated projections for a defined time period for revenue and operating profits, including capital expenditures, changes in net working capital, and adjustments for non-cash items to arrive at the free cash flow available to invested capital. A terminal value utilizing a constant growth rate of cash flows is used to calculate a terminal value after the explicit projection period. The future projected cash flows for the discrete projection period and the terminal value are discounted at a risk adjusted discount rate to determine the fair value of the reporting unit. Note 8 - Debt As of September 30, 2016, the Company is in compliance with the financial covenants included in its outstanding indebtedness. Senior Debt On May 1, 2014, the Company entered into a loan and security agreement (the “Bank Loan Agreement”) and line of credit note (the “Note”) with Middlesex Savings Bank, pursuant to which it agreed to provide up to $4.0 million, subject to the availability restrictions described below, under a revolving line of credit loan to the Company for general corporate purposes. The Bank Loan Agreement provides that the loan expires on May 1, 2017, at which time all outstanding principal and unpaid interest shall become due and payable. The Bank Loan Agreement and the Note are secured by (i) a security interest in substantially all of the Company’s personal property and (ii) sixty-five percent (65%) of Dynasil’s equity interests in its U.K. subsidiary, Hilger Crystals, Ltd. Under the Note, the borrowing base is determined monthly based on eligible billed and unbilled accounts receivable and eligible inventory. The interest rate under the Note is equal to the Prime Rate, but in no event less than 3.25%. As of September 30, 2016, there were no outstanding borrowings and the total availability under the Company’s line of credit was $4.0 million. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 8 - Debt (continued) Senior Debt (continued) The Bank Loan Agreement also contains other terms, conditions and provisions that are customary for commercial lending transactions of this sort. The Bank Loan Agreement requires Dynasil, at the close of each fiscal quarter, to maintain a Debt Service Coverage ratio, as defined, of at least 1.20 to 1.00 on a trailing four quarter basis. The Bank Loan Agreement provides for events of default customary for credit facilities of this type, including but not limited to non-payment, defaults on other debt, misrepresentation, breach of covenants, representations and warranties, insolvency and bankruptcy, change of management, as defined and the occurrence of a material adverse change, as defined. The Bank Loan Agreement was amended on September 29, 2015 to permit the Company to repay up to $3 million of the subordinated debt owed Massachusetts Capital Resources Company (“MCRC”) and also provided the Company, if it met certain conditions, to convert up to $2.0 million of the advances under the line of credit to a fixed rate note with the principal amortizing monthly over a five year term. On February 1, 2016, the Company entered into a $2.0 million Term Note with Middlesex Savings Bank. The Company converted $2.0 million of outstanding advances under the Company’s Middlesex Bank Line of Credit Note to a new five-year term note bearing interest at the fixed annual rate of 4.5%. Immediately following this conversion, the total availability under the Company’s line of credit increased by $2.0 million to $3.8 million. As a result of a material adverse clause in the Middlesex Term Note Agreement, all Middlesex outstanding debt is classified as short-term. Subordinated Debt On July 31, 2012, the Company entered into a Note Purchase Agreement (the “Agreement”) with Massachusetts Capital Resource Company (“MCRC”). Pursuant to the terms of the Agreement, the Company issued and sold to MCRC a $3.0 million subordinated note (the “Subordinated Note”) for a purchase price of $3.0 million. The Subordinated Note initially matured on July 31, 2017, unless accelerated pursuant to an event of default. The Subordinated Note provided for interest at the rate of ten percent (10%) per annum, with interest to be payable monthly on the last day of each calendar month and principal payments of $130,000 beginning on September 30, 2015, and on the last day of each calendar month thereafter through and including July 31, 2017. Effective October 1, 2015, in connection with a prepayment of $2.0 million of the Subordinated Note, MCRC agreed to adjust the interest rate to 6% per annum and to amend the principal repayment terms such that beginning on September 30, 2016, the Company will redeem monthly, without premium, $43,478 in principal amount of Subordinated Note together with all accrued and unpaid interest then due on the amount redeemed through and including July 31, 2018. Other Debt The Company’s RMD and Optometrics subsidiaries entered into equipment financing notes payable in connection with the purchase of certain equipment. Optometrics entered into equipment financing notes payable with two government entities for up to $0.5 million. The notes bear interest at 5% to 5.25% and are repayable in monthly installments over a five year period. RMD entered into equipment financing notes payable with a private equipment funding source. The notes bear interest at 8.7% to 14.59% and are repayable in monthly installments through July 2019. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 8 - Debt (continued) Other Debt (continued) Since its inception in October of 2013, the Company’s Xcede joint venture raised $2.9 million through the issuance of convertible notes to external investors, including certain officers and directors of the Company, which bear interest at 5%, due on demand after June 30, 2017. In November 2016, the notes and accrued interest were converted into 5,394,120 shares of preferred stock of Xcede at a 20% discount to the price per share of the investments the Company has committed to make in Xcede, in accordance with the provisions of the notes. See Note 3 - Xcede Technologies, Inc. Joint Venture. Debt at September 30, 2016 and 2015 is summarized as follows: DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 8 - Debt (continued) The aggregate maturities of debt based on the payment terms of the agreement are as follows: For the years ending on September 30: The convertible notes issued by Xcede have been excluded from the aggregate maturities of debt above as they have been converted into equity in Xcede in November 2016. See Note 3 - Xcede Technologies, Inc. Joint Venture. Unamortized debt issuance costs of $64,000 and $260,000 are net of accumulated amortization of $61,000 and $248,000 at September 30, 2016 and 2015, respectively. Amortization expense for the years ended September 30, 2016 and 2015 was $9,000 and $28,000, respectively, and included in interest expense. Future amortization will be $3,000 in fiscal year 2017. Note 9 - Income Taxes Income (loss) before the provision (benefit) for income taxes consists of the following: The provision (credit) for income taxes in the accompanying consolidated financial statements consists of the following: DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 9 - Income Taxes (continued) A reconciliation of the federal statutory rate to the Company's effective tax rate is as follows: Net deferred tax assets (liabilities) consisted of the following at September 30, 2016: Net deferred tax assets (liabilities) consisted of the following at September 30, 2015: DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 9 - Income Taxes (continued) In assessing the ability to realize the net deferred tax assets, management considers various factors including taxable income in carryback years, future reversals of existing taxable temporary differences, tax planning strategies and projections of future taxable income, to determine whether it is more likely than not that some portion or all of the net deferred tax assets will not be realized. Based upon the Company’s current losses and uncertainty of future profits, the Company has determined that the uncertainty regarding the realization of these assets is sufficient to warrant the need for a full valuation allowance against its U.S. net deferred tax assets. The net change in the valuation allowances for the years ending September 30, 2016 and 2015 was $0.4 million and $0.2 million, respectively. As of September 30, 2016 and 2015, the Company has federal net operating losses of $7.1 and $6.2 million, respectively. As of September 30, 2016 and 2015, the Company has state net operating losses of $15.2 million and $11.7 million, respectively. The federal and state net operating losses begin expiring in 2023 and 2027, respectively. At September 30, 2016 and 2015, the Company has foreign net operating loss carryforwards of approximately $146,000 and $171,000, respectively which can be carried forward indefinitely. As a result of the conversion of the Xcede convertible notes and accrued interest to preferred stock in November 2016 (See Note 3), the Company’s ownership percentage in Xcede decreases to less than 80%. Based on this ownership percentage, beginning in fiscal year 2017, Xcede will no longer be included in the consolidated federal tax return and the Company will no longer be able to offset taxable income or share net operating losses with Xcede. The tax accounting impact, including the assessment on the valuation allowance against the U.S. net deferred tax assets, will be evaluated in subsequent periods. The valuation allowance will be addressed independently for the Company and Xcede, instead of on a consolidated basis. As of both September 30, 2016 and 2015, the Company has federal research credits of $1.5 million. The federal credits begin expiring in fiscal year 2025. As of September 30, 2016 and 2015, the Company has state research credits of $93,000 and $127,000, respectively. The state credits begin expiring in fiscal year 2026. As of September 30, 2016 and 2015, the Company has no unrecorded liabilities for uncertain tax positions. Interest and penalty charges, if any, related to uncertain tax positions would be classified as income tax expense in the accompanying consolidated statement of operations. As of September 30, 2016 and 2015, the Company has no accrued interest or penalties related to uncertain tax positions. The Company is subject to taxation in the United States and the United Kingdom. At September 30, 2016, domestic tax years from fiscal 2013 through fiscal 2016 remain open to examination by the taxing authorities and tax years 2014 through 2016 remain open in the United Kingdom. Note 10 - Stockholders’ Equity Stock Based Compensation The Company adopted Stock Incentive Plans in 1996, 1999 and 2010 which provide for, among other incentives, the granting to officers, directors, employees and consultants options to purchase shares of the Company’s common stock. The Plans also allow eligible persons to be issued shares of the Company’s common stock either through the purchase of such shares or as a bonus for services rendered to the Company. Shares are generally issued at the fair market value on the date of issuance. The maximum number of shares of common stock which may be issued under the 2010 Stock Incentive Plan is 6,000,000, of which 3,646,924 and 4,006,663 shares of common stock are available for future purchases under the plan at September 30, 2016 and 2015, respectively. Options are generally exercisable at the fair market value or higher on the date of grant over a three to five year period currently expiring through 2017. The fair value of the stock options granted is estimated at the date of grant using the Black-Scholes option pricing model. The expected volatility was determined with reference to the historical volatility of the Company's stock. The Company uses historical data to estimate option exercises and employee terminations within the valuation model. The expected term of options granted represents the period of time that the options granted are expected to be outstanding. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury rate in effect at the time of grant. The dividend yield is expected to be 0.0% because historically the Company has not paid dividends on common stock. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 10 - Stockholders’ Equity (continued) Stock Based Compensation (continued) The Company’s Xcede joint venture adopted an Equity Incentive Plan in 2013 which provides for, among other incentives, the granting to officers, directors, employees and consultants options to purchase shares in Xcede’s common stock. The options granted generally vest over a 3 year period. The fair value of the stock options granted is estimated at the date of grant using the Black-Scholes option pricing model using assumptions generally consistent with those used for Company stock options. Because Xcede is not publicly traded, the expected volatility is estimated with reference to the average historical volatility of a group of publicly traded companies that are believed to have similar characteristics to Xcede. As of December 1, 2016, 458,347 options remained in this plan. Stock compensation expense for the years ended September 30, 2016 and 2015 is presented below: At September 30, 2016 there was approximately $152,000 in unrecognized stock compensation cost for Dynasil, which is expected to be recognized over a weighted average period of fourteen months. At September 30, 2016, the Company’s Xcede joint venture had $148,000 of unrecognized stock compensation expense associated with stock options expected to be recognized over a weighted average period of seventeen months. Restricted Stock Grants A summary of restricted stock activity for the year ended September 30, 2016 and 2015 is presented below: DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 10 - Stockholders’ Equity (continued) Stock Option Grants A summary of stock option activity for the years ended September 30, 2016 and 2015 is presented below: Stock options outstanding at September 30, 2016 are described as follows: During the years ended September 30, 2016 and 2015, 64,935 and 36,232 stock options were granted and vested, respectively, and no stock options were exercised. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 10 - Stockholders’ Equity (continued) Subsidiary Stock Option Grants A summary of Xcede stock option activity for the years ended September 30, 2016 and 2015 is presented below: Employee Stock Purchase Plan On September 28, 2010, the Company adopted an Amended and Restated Employee Stock Purchase Plan. The existing plan was amended to extend the termination date to September 28, 2020. The Employee Stock Purchase Plan permits substantially all employees to purchase common stock at a purchase price of 85% of the fair market value of the shares. Under the Plan, a total of 450,000 shares have been reserved for issuance of which 131,203 and 144,945 shares have been issued as of September 30, 2016 and 2015, respectively. On December 16, 2011, the Company amended the Amended and Restated Employee Stock Purchase Plan to change the maximum dollar amount of stock able to be purchased through the Plan by any employee per calendar year from $5,000 to $20,000 per calendar year. During the years ended September 30, 2016 and 2015, 13,742 shares and 9,698 shares of common stock were issued under the Plan for aggregate purchase prices of $15,676 and $12,762, respectively. Note 11- Retirement Plans Defined Contribution Plans The Company has retirement savings plans available to substantially all full time employees which are intended to qualify as deferred compensation plans under Section 401(k) of the Internal Revenue Code (the “401k Plans”) or similar laws in the United Kingdom. The Company made contributions to these plans during both the years ended September 30, 2016 and 2015 of approximately $179,000 and $171,000, respectively. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 12 - Lease Agreements Capital Leases The Company has entered into long-term capital lease agreements for purchases of various computer and telephone equipment at a weighted average interest rate of 8.3%. At September 30, 2016 and 2015, the remaining principal payments due under all capital leases were $278,000 and $119,000, respectively. Aggregate minimum annual principal obligations at September 30, 2016, under non-cancelable leases are as follows: Property Leases The Company has non-cancelable operating lease agreements, primarily for property, that expire through 2025. One of the Company’s facilities is leased from a company controlled by the former owner of RMD, who is also a former director of the Company and the former President of the RMD subsidiary. This building is leased as a month-to-month tenancy and will continue until terminated by either the Company with not less than six months’ prior written notice or the facility’s owner with not less than three years’ prior written notice. Rent expense for both the years ended September 30, 2016 and 2015 amounted to $1.6 million. Future non-cancelable minimum lease payments under property leases as of September 30, 2016 are as follows: Years ending September 30, Note 13 - Related Party Transactions During the years ended September 30, 2016 and 2015, building lease payments of $1,000,000 and $961,000, respectively were paid to Charles River Realty, dba Bachrach, Inc., which is owned by Gerald Entine and family. Dr. Entine is a former director and employee of the Company, as well as a greater than 5% beneficial owner of the Company’s stock. Dr. William Hagan, a member of the Company’s Board of Directors, provides consulting services to RMD through his consulting company, Hagan & Associates LLC (“H&A”). During the year ended September 30, 2016, H&A was paid approximately $1,000 in fees. No amounts were paid during 2015. This consulting arrangement is expected to continue into the future. In 2014, the Company was awarded a grant from the National Institute of Heart Lung and Blood to develop new and improved monitors to detect blood loss and potentially fatal hemorrhage in trauma victims. The Company is using the Mayo Clinic in Rochester, MN as its primary subcontractor to conduct animal and human trials with respect to this grant. Dr. Michael J. Joyner of the Mayo Clinic is a co-investigator under this grant. He is also a member of the Xcede Board of Directors. In fiscal year 2016, the Mayo Clinic received approximately $79,000 under this grant. A small fraction of Dr. Joyner’s Mayo salary is charged to this grant. The subcontract awards to, and the work performed by, the Mayo Clinic are administered by the Mayo Foundation for Medical Education and Research and adheres to the approval and conflicts-of-interest policies of both the Mayo Clinic and the Company. We will continue to monitor this relationship. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 13 - Related Party Transactions (continued In October 2013, the Company’s subsidiary, Dynasil Biomedical, formed Xcede Technologies, Inc., a joint venture with Mayo Clinic, to spin out and separately fund the development of its tissue sealant technology. Xcede issued $5.1 million of convertible promissory notes in order to fund its operations, including $2.2 million to the Company, which is eliminated in the consolidated financial statements. Mr. Sulick and family members invested $1,065,000, Mr. Lawrence Fox invested, $150,000, Dr. Zuckerman (Xcede CEO) and family invested $125,000, Ms. Lunardo (Optometrics COO) invested $25,000, Dr. Hagan invested $25,000, Kanai Shah (RMD President) invested $25,000 and Dr. Entine’s Family Trust invested $100,000 in Xcede and were issued convertible promissory notes in those original principal amounts. In November 2016, the company converted these promissory notes into preferred stock. As of December 1, 2016, Mr. Sulick and family own the equivalent of 12.7% of Xcede’s outstanding common stock, Mr. Fox owns the equivalent of 1.9% of Xcede’s outstanding common stock, Dr. Zuckerman and family own the equivalent of 1.5% of Xcede’s outstanding common stock, Ms. Lunardo owns the equivalent of 0.3% of Xcede’s outstanding common stock, Dr. Hagan owns the equivalent of 0.3% of Xcede’s outstanding common stock, Dr. Shah owns the equivalent of 0.3% of Xcede’s outstanding common stock and Dr. Entine owns the equivalent of 1.3% of Xcede’s outstanding common stock. Patricia Tuohy is the Company’s Director of Business Development. During the year ended September 30, 2016, Ms. Tuohy worked a full year in this position and earned $168,000 in compensation. During the year ended September 30, 2015, Ms. Tuohy worked a partial year and earned $103,000. Ms. Tuohy is Peter Sulick’s daughter. Note 14 - Vendor Concentration The Company purchased $2.2 million and $1.5 million respectively, of its raw materials from one supplier during the years ended September 30, 2016 and 2015. As of September 30, 2016 and 2015, amounts due to these suppliers included in accounts payable were $93,000 and $101,000, respectively. Note 15 - Supplemental Disclosure of Cash Flow Information DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 16 - Segment, Customer and Geographical Reporting Segment Financial Information Operating segments are based upon Dynasil’s internal organizational structure, the manner in which the operations are managed, the criteria used by the Chief Operating Decision Makers (CODM) to evaluate segment performance and the availability of separate financial information. Dynasil reports three reportable segments: contract research (“Contract Research”), optics (“Optics”) and biomedical (“Biomedical”). Within these segments, there is a segregation of operating segments based upon the organizational structure used to evaluate performance and make decisions on resource allocation, as well as availability and materiality of separate financial results consistent with that structure. Dynasil’s Contract Research segment is one of the largest small business participants in U.S. government-funded research. The Optics segment aggregates four operating segments - Dynasil Fused Silica, Optometrics, Hilger Crystals, and Evaporated Metal Films - that manufacture commercial products, including optical crystals for sensing in the security and medical imaging markets, as well as optical components, optical coatings and optical materials for scientific instrumentation and other applications. The Biomedical segment consists of a single operating segment, Dynasil Biomedical Corporation (“Dynasil Biomedical”), a medical technology incubator which owns rights to certain early stage medical technologies. Dynasil Biomedical holds the common stock of the Xcede joint venture which is developing a tissue sealant technology and currently has no other operations. During 2016, we implemented a new procedure to allocate overhead expenses to our Xcede subsidiary in the Biomedical segment due to the time commitment invested by the corporate employees. This allocation reduced SG&A expense in the other two segments. Segment expenses in 2015 have been adjusted accordingly to reflect the proper comparison. These allocations were $0.6 million in both 2016 and 2015. We do not expect the same time commitment to be necessary to support Xcede in 2017, based on the previously announced Cook Biomedical agreement. DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 16 - Segment, Customer and Geographical Reporting (continued) The Company’s segment information is summarized below: DYNASIL CORPORATION OF AMERICA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2016 and 2015 Note 16 - Segment, Customer and Geographical Reporting (continued) Customer Financial Information For the years ended September 30, 2016 and 2015, the top three customers for the Contract Research segment were each various agencies of the U.S. Government. For the years ended September 30, 2016 and 2015, these customers made up 56% and 57%, respectively, of Contract Research revenue. For the Optics segment, there was one customer whose revenue represented 22% and 9% of the total segment revenue for the years ended September 30, 2016 and 2015. The Biomedical segment did not have any revenue in the years ending September 30, 2016 and 2015. Geographic Financial Information Revenue by geographic location in total and as a percentage of total revenue, for the years ended September 30, 2016 and 2015 are as follows: Note 17 - Subsequent Events The Company has evaluated subsequent events through the date the financial statements were released. | Based on the provided financial statement excerpt, here's a summary:
Company: Dynasil Corporation of America
Key Financial Highlights:
- Net Revenue: Approximately $49,000
- Subsidiaries:
* Optometrics Corporation
* Evaporated Metal Films Corporation
* Dynasil Products
* Radiation Monitoring Devices, Inc.
* Hilger Crystals, Ltd
* Dynasil Biomedical Corp
Financial Statement Characteristics:
- Audited financial statements
- Consolidated financial statements
- Includes wholly-owned subsidiaries and a joint venture (Xcede Technologies)
Risk Management:
- Maintains allowances for potential credit losses
- Performs credit evaluations of customers
- No significant losses reported in accounts receivable collection
Note: The excerpt appears to be incomplete, so a comprehensive financial analysis is not possible. The | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Consolidated Financial Statements ACCOUNTING FIRM To the Board of Directors and Shareholders Salisbury Bancorp, Inc. Lakeville, Connecticut We have audited the accompanying consolidated balance sheets of Salisbury Bancorp, Inc. and Subsidiary (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Salisbury Bancorp, Inc. and Subsidiary as of December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ Baker Newman & Noyes LLC Peabody, Massachusetts March 31, 2017 ACCOUNTING FIRM The Board of Directors and Shareholders Salisbury Bancorp, Inc. Lakeville, Connecticut We have audited the accompanying consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for the year ended December 31, 2014, of Salisbury Bancorp, Inc. and Subsidiary (the Company). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations of Salisbury Bancorp, Inc. and Subsidiary and their cash flows for the year ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America. /s/ Shatswell, MacLeod & Company, P.C. SHATSWELL, MacLEOD & COMPANY, P.C. Peabody, Massachusetts March 30, 2015 Salisbury Bancorp, Inc. and Subsidiary CONSOLIDATED BALANCE SHEETS Salisbury Bancorp, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF INCOME Salisbury Bancorp, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Salisbury Bancorp, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Salisbury Bancorp, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF CASH FLOWS Salisbury Bancorp, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Salisbury Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Salisbury Bancorp, Inc. (“Salisbury” or the “Company”) is the bank holding company for Salisbury Bank (the “Bank”), a State chartered commercial bank. Salisbury's activity is currently limited to the holding of the Bank's outstanding capital stock and the Bank is Salisbury's only subsidiary and its primary investment. The Bank is a Connecticut chartered and Federal Deposit Insurance Corporation (the "FDIC") insured commercial bank headquartered in Lakeville, Connecticut. The Bank's principal business consists of attracting deposits from the public and using such deposits, with other funds, to make various types of loans and investments. The Bank conducts its business through thirteen full-service offices located in Litchfield, Berkshire and Dutchess and Orange Counties in Connecticut, Massachusetts and New York, respectively. The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The following is a summary of significant accounting policies: Principles of Consolidation The consolidated financial statements include those of Salisbury and its subsidiary after elimination of all inter-company accounts and transactions. Basis of Financial Statement Presentation The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. In preparing the financial statements, management is required to make extensive use of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of condition, and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, expected cash flows from loans acquired in a business combination, other-than-temporary impairment of securities and impairment of goodwill and intangibles. Certain reclassifications have been made to the 2015 and 2014 financial statements to make them consistent with the 2016 presentation. Cash and Cash Equivalents Cash and cash equivalents include cash and balances due from banks. Due to the nature of cash and cash equivalents, Salisbury estimated that the carrying amount of such instruments approximated fair value. The nature of the Bank's business requires that it maintain amounts due from banks which, at times, may exceed federally insured limits. The Bank has not experienced any losses on such amounts and all amounts are maintained with well-capitalized institutions. In 2016, a 3% reserve ratio was assessed on net transaction accounts over $15.2 million, up to and including $110.2 million (which may be adjusted by the FRB). A 10% reserve ratio was assessed on net transaction accounts in excess of $110.2 million (which may be adjusted by the FRB). In 2015, a 3% reserve ratio was assessed on net transaction accounts over $14.5 million up to and including $103.6 million. A 10% reserve ratio was assessed on net transaction accounts in excess of $103.6 million. Securities Securities that may be sold as part of Salisbury's asset/liability or liquidity management or in response to or in anticipation of changes in interest rates and resulting prepayment risk, or for other similar factors, are classified as available-for-sale and carried at their fair market value. Unrealized holding gains and losses on such securities are reported net of related taxes, if applicable, as a separate component of shareholders' equity. Securities that Salisbury has the ability and positive intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. Realized gains and losses on the sales of all securities are reported in earnings and computed using the specific identification cost basis. Securities are reviewed regularly for other-than-temporary impairment (“OTTI”). Premiums and discounts are amortized or accreted utilizing the interest method over the life or call of the term of the investment security. For any debt security with a fair value less than its amortized cost basis, Salisbury will determine whether it has the intent to sell the debt security or whether it is more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis. If either condition is met, Salisbury will recognize a full impairment charge to earnings. For all other debt securities that are considered OTTI and do not meet either condition, the credit loss portion of impairment will be recognized in earnings as realized losses. The OTTI related to all other factors will be recorded in other comprehensive income. Declines in marketable equity securities below their cost that are deemed other than temporary are reflected in earnings as realized losses. Federal Home Loan Bank of Boston Stock The Bank is a member of the Federal Home Loan Bank of Boston (“FHLBB”). The FHLBB is a cooperative that provides services, including funding in the form of advances, to its member banking institutions. As a requirement of membership, the Bank must own a minimum amount of FHLBB stock, calculated periodically based primarily on its level of borrowings from the FHLBB. No market exists for shares of the FHLBB and therefore, they are carried at par value. FHLBB stock may be redeemed at par value five years following termination of FHLBB membership, subject to limitations which may be imposed by the FHLBB or its regulator, the Federal Housing Finance Board, to maintain capital adequacy of the FHLBB. While the Bank currently has no intentions to terminate its FHLBB membership, the ability to redeem its investment in FHLBB stock would be subject to the conditions imposed by the FHLBB. Based on the capital adequacy and the liquidity position of the FHLBB, management believes there is no impairment related to the carrying amount of the Bank's FHLBB stock as of December 31, 2016. Deterioration of the FHLBB's capital levels may require the Bank to deem its restricted investment in FHLBB stock to be OTTI. If evidence of impairment exists in the future, the FHLBB stock would reflect fair value using either observable or unobservable inputs. The Bank will continue to monitor its investment in FHLBB stock. Loans Loans receivable consist of loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off. Loans receivable are reported at their outstanding principal balance, net of unamortized deferred loan origination fees and costs. Interest income is accrued on the unpaid principal balance. Deferred loan origination fees and costs are amortized as an adjustment to yield over the lives of the related loans. Loans held-for-sale consist of residential mortgage loans that management has the intent to sell. Loans held-for-sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis, net of deferred loan origination fees and costs. Changes in the carrying value, deferred loan origination fees and costs, and realized gains and losses on sales of loans held-for-sale are reported in earnings as gains and losses on sales of mortgage loans, net, when the proceeds are received from investors. The accrual of interest on loans, including troubled debt restructured loans, is generally discontinued when principal or interest is past due by 90 days or more, or earlier when, in the opinion of management, full collection of principal or interest is unlikely, except for loans that are well collateralized, in the process of collection and where full collection of principal and interest is assured. When a loan is placed on non-accrual status, interest previously accrued but not collected is reversed against current income. Income on such loans, including impaired loans, is then recognized only to the extent that cash is received and future collection of principal is probable. Loans, including troubled debt restructured loans, are restored to accrual status when principal and interest payments are brought current and future payments are reasonably assured, following a sustained period of repayment performance by the borrower in accordance with the loan's contractual terms. Troubled debt restructured loans include those for which concessions such as reduction of interest rates, other than normal market rate adjustments, or deferral of principal or interest payments, extension of maturity dates, or reduction of principal balance or accrued interest, have been granted due to a borrower's financial condition. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit Salisbury by increasing the ultimate probability of collection. Troubled debt restructured loans are classified as accruing or non-accruing based on management's assessment of the collectability of the loan. Loans which are already on non-accrual status at the time of the troubled debt restructuring generally remain on non-accrual status for approximately six months before management considers such loans for return to accruing status. Accruing troubled debt restructured loans are generally placed into non-accrual status if and when the borrower fails to comply with the restructured terms. Acquired Loans Loans that Salisbury acquired through business combinations are initially recorded at fair value with no carryover of the related allowance for credit losses. Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest. For loans that meet the criteria stipulated in Accounting Standards Codification (“ASC”) 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality,” Salisbury recognizes the accretable yield, which is defined as the excess of all cash flows expected to be collected at acquisition over the initial fair value of the loan, as interest income on a level-yield basis over the expected remaining life of the loan. The excess of the loan's contractually required payments over the cash flows expected to be collected is the nonaccretable difference. The nonaccretable difference is not recognized as an adjustment of yield, a loss accrual, or a valuation allowance. Going forward, Salisbury continues to evaluate whether the timing and the amount of cash to be collected are reasonably expected. Subsequent significant increases in cash flows Salisbury expects to collect will first reduce any previously recognized valuation allowance and then be reflected prospectively as an increase to the level yield. Subsequent decreases in expected cash flows may result in the loan being considered impaired. Such decreases may also result in recognition of additional provisions to the allowance for loan losses. Interest income is not recognized to the extent that the net investment in the loan would increase to an amount greater than the estimated payoff amount. For ASC 310-30 loans, the expected cash flows reflect anticipated prepayments, determined on a loan by loan basis according to the anticipated collection plan of these loans. The expected prepayments used to determine the accretable yield are consistent between the cash flows expected to be collected and projections of contractual cash flows so as to not affect the nonaccretable difference. For ASC 310-30 loans, prepayments result in the recognition of the nonaccretable balance as current period yield. Changes in prepayment assumptions may change the amount of interest income and principal expected to be collected. For loans that do not meet the ASC 310-30 criteria, Salisbury accretes interest income on a level yield basis using the contractually required cash flows. Salisbury subjects loans that do not meet the ASC 310-30 criteria to ASC Topic 450, “Contingencies” by collectively evaluating these loans for an allowance for loan losses. Acquired loans that met the criteria for nonaccrual of interest prior to the acquisition are considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if Salisbury can reasonably estimate the timing and amount of the expected cash flows on such loans and if Salisbury expects to fully collect the new carrying value of the loans. As such, Salisbury may no longer consider the loan to be nonaccrual or nonperforming and may accrue interest on these loans, including the impact of any accretable yield. Allowance for Loan Losses The allowance for loan losses represents management's estimate of the probable credit losses inherent in the loan portfolio as of the reporting date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by loan charge-offs. Loan charge-offs are recognized when management determines a loan or portion of a loan to be uncollectible. The determination of the adequacy of the allowance is based on management's ongoing review of numerous factors, including the growth and composition of the loan portfolio, historical loss experience over an economic cycle, probable credit losses based upon internal and external portfolio reviews, credit risk concentrations, changes in lending policy, current economic conditions, analysis of current levels and asset quality, delinquency levels and trends, estimates of the current value of underlying collateral, the performance of individual loans in relation to contract terms, and other pertinent factors. While management believes that the allowance for loan losses is adequate, the allowance is an estimate, and ultimate losses may vary from management's estimate. Future additions to the allowance may also be necessary based on changes in assumptions and economic conditions. In addition, various regulatory agencies periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination. Changes in the estimate are recorded in the results of operations in the period in which they become known, along with provisions for estimated losses incurred during that period. The allowance for loan losses is computed by segregating the portfolio into three components: (1) loans collectively evaluated for impairment: general loss allocation factors for non-impaired loans based on loan product, collateral type and abundance, loan risk rating, historical loss experience, delinquency factors and other similar economic indicators, (2) loans individually evaluated for impairment: individual loss allocations for loans deemed to be impaired based on discounted cash flows or collateral value, and (3) unallocated: general loss allocations for other environmental factors. Loans collectively evaluated for impairment This component of the allowance for loan losses is stratified by the following loan segments: residential real estate secured (residential 1-4 family and 5+ multifamily, construction of residential 1-4 family, and home equity lines of credit), commercial real estate secured (commercial and construction of commercial), secured by land (farm and vacant land), commercial and industrial, municipal and consumer. Management's general loss allocation factors are based on expected loss experience adjusted for historical loss experience and other qualitative factors, including levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no changes in Salisbury's policies or methodology pertaining to the general component of the allowance for loan losses during 2016. The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows: Residential real estate - Salisbury generally does not originate loans with a loan-to-value ratio greater than 80 percent and does not grant subprime loans. Loans in this segment are collateralized primarily by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment. Commercial real estate - Loans in this segment are primarily income-producing properties throughout Salisbury's market area. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates which, in turn, will have an effect on the credit quality in this segment. For commercial loans management annually obtains business and personal financial statements, tax returns, and, where applicable, rent rolls, and continually monitors the repayment of these loans. Construction loans - Loans in this segment are primarily residential construction loans which typically roll into a permanent residential mortgage loan when construction is completed, or commercial construction which consist primarily of owner occupied commercial construction projects. Commercial and industrial loans - Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, has an effect on the credit quality in this segment. Municipal loans - Loans in this segment are extensions of credit to municipal and other governmental entities throughout Salisbury's market area. The bank-qualified, tax-exempt loans are backed by the full faith and credit of the borrowing entity with taxing or appropriating authority, as appropriate. Maturities range from one year for bond anticipation notes to twenty years for long-term project finance. The ability of the borrower to pay may be affected by an economic downturn resulting in a severe reduction in tax or other revenues coupled with the depletion of an entity's reserve liquidity. Historical default rates for bank-qualified (small issuer) general obligation municipal credit facilities are near 0%. Consumer loans - Loans in this segment are generally unsecured and repayment is dependent on the credit quality of the individual borrower. Loans individually evaluated for impairment This component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis for all portfolio loans (except consumer loans and homogeneous residential real estate loans) by either the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan are lower than the carrying value of that loan. A loan is considered impaired when, based on current information and events, it is probable that Salisbury will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Salisbury periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring ("TDR"). All TDRs are classified as impaired. Unallocated An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio. Mortgage Servicing Rights As part of our growth and risk management strategy, we from time to time will sell whole loans. These are typically fixed rate residential loans. Our ability to sell whole loans benefits the bank by freeing up capital and funding to lend to new customers. Additionally, we typically earn a gain on the sale of loans sold and receive a servicing fee while maintaining the customer relationship. Mortgage Servicing Rights (“MSRs”), which the bank evaluates with the assistance of a third party on a quarterly basis, are included in other assets on the consolidated balance sheets and are accounted for under the amortization method. Under that method mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing revenues. Refinance activities are taken into consideration in estimating the period of net servicing revenues. Other Real Estate Owned (“OREO”) Salisbury's loans collateralized by real estate and all other real estate owned (“OREO”) are located principally in northwestern Connecticut and New York and Massachusetts towns, which constitute Salisbury's service area. Accordingly, the collectability of a substantial portion of the loan portfolio and OREO is susceptible to changes in market conditions in Salisbury's service area. While management uses available information to recognize losses on loans and OREO, future additions to the allowance or write-downs of OREO may be necessary based on changes in local economic conditions, particularly in Salisbury's service area. In addition, various regulatory agencies, as an integral part of their examination process, periodically review Salisbury's allowance for loan losses and valuation of OREO. Such agencies may require Salisbury to recognize additions to the allowance or write-downs based on their judgments of information available to them at the time of their examination. OREO consists of properties acquired through foreclosure or a deed in lieu of foreclosure. These properties are initially transferred at fair value less estimated costs to sell. Any write-down from cost to estimated fair value required at the time of foreclosure is charged to the allowance for loan losses. A valuation allowance is maintained for declines in market value and for estimated selling expenses. Increases to the valuation allowance, expenses associated with ownership of these properties, and gains and losses from their sale are included in OREO expense. As of December 31, 2016 and 2015, the recorded investment in residential mortgage loans collateralized by residential real estate that were in the process of foreclosure was $2.1 million and $2.9 million, respectively. Income Taxes Deferred income taxes are provided for differences arising in the timing of income and expenses for financial reporting and for income tax purposes using the asset/liability method of accounting for income taxes. Deferred income taxes and tax benefits are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Salisbury provides deferred taxes for the estimated future tax effects attributable to temporary differences and carry-forwards when realization is assured beyond a reasonable doubt. A valuation allowance is established against deferred tax assets when, based upon all available evidence, it is determined that it is more likely than not that some or all of the deferred tax assets will not be realized. Bank Premises and Equipment Bank premises, furniture and equipment are carried at cost, less accumulated depreciation and amortization computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on the straight-line basis over the shorter of the estimated useful lives of the improvements or the term of the related leases. Guidelines for expected useful life are as follows: • Buildings /Improvements - 39 years • Land Improvements - 15 years • Furniture and Fixtures - 7 years • Computer Equipment - 5 years • Software - 3 years Intangible Assets Intangible assets consist of core deposit intangibles and goodwill. Intangible assets equal the excess of the purchase price over the fair value of the tangible net assets acquired in business combinations accounted for using the acquisition method of accounting. Salisbury's intangible assets at December 31, 2016, and 2015, include goodwill of $2,358,000 arising from the purchase of a branch office in 2001, $7,152,000 arising from the 2004 acquisition of Canaan National Bancorp, Inc., $319,000 arising from the 2007 purchase of a branch office in New York State, and $2,723,000 arising from the acquisition of Riverside Bank in December 2014. See Note 8. On an annual basis, management assesses intangible assets for impairment, and for the year ending December 31, 2016, concluded there was no impairment. If a permanent loss in value is indicated, an impairment charge to income will be recognized. Stock Based Compensation Stock based compensation expense is recognized, based on the fair value at the date of grant, adjusted for expected forfeitures, on a straight line basis over the period of time between the grant date and vesting date. Advertising Expense Expenses related to advertising, totaling $508,000 and $403,000 in 2016 and 2015, respectively, is expensed as incurred and is not capitalized. Statements of Cash Flows For the purpose of the Consolidated Statements of Cash Flows, cash and cash equivalents include cash and due from banks and interest-bearing demand deposits with other financial institutions. Computation of Earnings per Share The Company defines unvested share-based payment awards that contain non-forfeitable rights to dividends as participating securities that are included in computing earnings per share (“EPS”) using the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each share of common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends. Basic EPS excludes dilution and is computed by dividing income allocated to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Recent Accounting Pronouncements In May 2014, August 2015, May 2016, and December 2016, respectively, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, 2015-14, 2016-12, and 2016-20, “Revenue from Contracts with Customers (Topic 606).” The objective of ASU 2014-09 is to clarify principles for recognizing revenue and to develop a common revenue standard for GAAP and International Financial Reporting Standards. The guidance in ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. For public entities, the amendments in ASU 2015-14 defer the effective date of ASU 2014-09 to interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, but not before the original effective date (i.e. interim and annual reporting periods beginning after December 15, 2016). The amendments in ASU 2016-12 do not change the core principle of the guidance in Topic 606, but rather affect only certain narrow aspects aimed to reduce the potential for diversity in practice at initial application and the cost and complexity of applying Topic 606 both at transition and on an ongoing basis. The amendments in ASU 2016-20 include technical corrections and improvements to Topic 606 and other Topics amended by ASU 2014-09 to increase stakeholders’ awareness of the proposals and to expedite improvements to ASU 2014-09. Salisbury is currently reviewing ASU 2014-09, 2015-14, 2016-12, and 2016-20 to determine if they will have an impact on its consolidated financial statements. In June 2014, the FASB issued ASU 2014-12, “Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved after the Requisite Service Period.” The amendments in this ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. This ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. ASU 2014-12 may be adopted either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements, and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this update as of the beginning of the earliest annual period presented in the financial statements should be recognized as an adjustment to the opening retained earnings balance at that date. Salisbury has adopted this ASU for the annual period beginning January 1, 2016. The adoption did not have a material impact on its consolidated financial statements. In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - overall (subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making targeted improvements to GAAP as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (4) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (5) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (6) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (7) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (8) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017. Early application is permitted as of the beginning of the fiscal year of adoption only for provisions (3) and (6) above. Early adoption of the other provisions mentioned above is not permitted. Salisbury does not expect ASU 2016-01 to have a material impact on its consolidated financial statements; however, Salisbury will continue to closely monitor developments and additional guidance. In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)”. Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases): 1) a lease liability, which is the present value of a lessee's obligation to make lease payments, and 2) a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Lessor accounting under the new guidance remains largely unchanged as it is substantially equivalent to existing guidance for sales-type leases, direct financing leases, and operating leases. Leveraged leases have been eliminated, although lessors can continue to account for existing leveraged leases using the current accounting guidance. Other limited changes were made to align lessor accounting with the lessee accounting model and the new revenue recognition standard. All entities will classify leases to determine how to recognize lease-related revenue and expense. Quantitative and qualitative disclosures will be required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The intention is to require enough information to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities. ASU 2016-02 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. All entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. They have the option to use certain relief; full retrospective application is prohibited. Salisbury is currently evaluating this ASU to determine the impact on its consolidated financial statements. In March 2016, the FASB issued ASU 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” This ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. Some of the key provisions of this new ASU include: (1) companies will no longer record excess tax benefits and certain tax deficiencies in additional paid-in capital (“APIC”). Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement, and APIC pools will be eliminated. The guidance also eliminates the requirement that excess tax benefits be realized before companies can recognize them. In addition, the guidance requires companies to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity; (2) increase the amount an employer can withhold to cover income taxes on awards and still qualify for the exception to liability classification for shares used to satisfy the employer’s statutory income tax withholding obligation. The new guidance will also require an employer to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding obligation as a financing activity on its statement of cash flows (current guidance did not specify how these cash flows should be classified); and (3) permit companies to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures can be estimated, as required today, or recognized when they occur. ASU 2016-09 is effective for interim and annual reporting periods beginning after December 15, 2016. Early adoption is permitted, but all of the guidance must be adopted in the same period. Salisbury is currently evaluating the provisions of ASU 2016-09 to determine the potential impact the new standard will have on Salisbury’s Consolidated Financial Statements. In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which adds a new Topic 326 to the Codification and removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables, and held-to-maturity debt securities. Under current U.S. GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. The revised guidance will remove all recognition thresholds and will require companies to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument’s contractual life. ASU 2016-13 also amends the credit loss measurement guidance for available-for-sale debt securities and beneficial interests in securitized financial assets. The guidance in ASU 2016-13 is effective for “public business entities,” as defined, that are SEC filers for fiscal years and for interim periods with those fiscal years beginning after December 15, 2019. Early adoption is permitted as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Salisbury is currently evaluating the provisions of ASU 2016-13 to determine the potential impact the new standard will have on Salisbury’s Consolidated Financial Statements. In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments." This ASU is intended to reduce diversity in practice in how eight particular transactions are classified in the statement of cash flows. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017 and interim periods within those years. Early adoption is permitted, provided that all of the amendments are adopted in the same period. Entities will be required to apply the guidance retrospectively. If it is impracticable to apply the guidance retrospectively for an issue, the amendments related to that issue would be applied prospectively. As this guidance only affects the classification within the statement of cash flows, ASU 2016-15 is not expected to have a material impact on Salisbury’s Consolidated Financial Statements. In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory." This ASU is intended to simplify and improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. Under the revised guidance, an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. Early adoption is permitted for all entities as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued or made available for issuance. Entities will be required to apply on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Salisbury is currently evaluating the provisions of ASU 2016-16 to determine the potential impact the new standard will have on Salisbury’s Consolidated Financial Statements. In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business." This ASU is intended to add guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this update provide a screen to determine when a set of input, processes, and outputs is not a business. ASU 2017-01 is effective for public business entities for fiscal years beginning after December 15, 2017 and interim periods within those years. Early adoption is permitted for transactions for which the acquisition date occurs before the issuance date or effective date of the amendments, only when the transaction has not been reported in financial statements that have been issued or made available for issuance, or for transactions in which a subsidiary is deconsolidated or a group of assets is derecognized that occur before the issuance date or effective date of the amendments, only when the transaction has not been reported in financial statements that have been issued or made available for issuance. Entities should apply the guidance prospectively on or after the effective date. Salisbury is currently evaluating the provisions of ASU 2017-01 to determine the potential impact the new standard will have on Salisbury’s Consolidated Financial Statements. In January 2017, the FASB issued ASU 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” This ASU is intended to allow companies to simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The FASB is researching whether similar amendments should be considered for other entities, including public business entities. ASU 2017-04 is effective for public business entities that are SEC filers for fiscal years beginning after December 15, 2019 and interim periods within those years. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Entities should apply the guidance prospectively. Salisbury is currently evaluating the provisions of ASU 2017-04 to determine the potential impact the new standard will have on Salisbury’s Consolidated Financial Statements. In February 2017, the FASB issued ASU 2017-05, “Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20).” This ASU is intended to clarify the scope of Subtopic 610-20 and to add guidance for partial sales of nonfinancial assets. ASU 2017-05 is effective for public entities for fiscal years beginning after December 15, 2017 and interim periods within those years. Early adoption is permitted for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. Entities may apply the guidance either retrospectively or modified retrospectively. Salisbury is currently evaluating the provisions of ASU 2017-05 to determine the potential impact the new standard will have on Salisbury’s Consolidated Financial Statements. NOTE 2 - MERGERS AND ACQUISITIONS On December 5, 2014, the Company acquired Riverside Bank. Riverside Bank operated four banking offices serving Dutchess, Ulster and Orange Counties in New York, and was merged with and into the Bank. This business combination is an extension of the Salisbury franchise and the goodwill recognized results from the expected synergies and earnings accretion from this combination, including future cost savings related to Riverside's operations. The combination was negotiated between the companies and was approved by their respective shareholders and unanimously by their respective boards of directors. Riverside Bank shareholders received 1,001,485 shares of the Company common stock. On the acquisition date, Riverside Bank had 741,876 outstanding common shares. Salisbury exchanged its stock in a ratio of 1.35 shares of the Company's common stock for each share of Riverside Bank stock. The 1,001,485 shares of Salisbury common stock issued in this exchange were valued at $27.19 per share based on the closing price of Salisbury posted on December 5, 2014 resulting in consideration paid of $27 million. Salisbury paid $1,000 in cash consideration to settle all fractional shares outstanding of Riverside Bank. The results of Riverside Bank's operations are included in Salisbury's Consolidated Statements of Income from the date of acquisition. The assets and liabilities in the Riverside Bank acquisition were recorded at their fair value based on the utilization of third party specialists and management's best estimate using information available at the date of acquisition. Consideration paid, and fair values of Riverside Bank's assets acquired and liabilities assumed are summarized in the following tables: Explanation of Certain Fair Value Adjustments (a) The adjustment represents the decrease in the book value of investments to their estimated fair value based on fair values on the date of acquisition. (b) The adjustment represents the write down of the book value of loans to their estimated fair value based on current interest rates and expected cash flows, which includes an estimate of expected loan loss inherent in the portfolio. Loans that met the criteria and are being accounted for in accordance with ASC 310-30 had a carrying amount of $13.7 million at acquisition. Non-impaired loans not accounted for under ASU 310-30 had a carrying value of $190.7 million at acquisition. (c) The adjustment represents the appraised value of the land and building acquired in the acquisition. The land and building were recorded as fixed assets and the building will be amortized over its remaining useful life. (d) The adjustment is necessary because the weighted average interest rate of deposits exceeded the cost of similar funding at the time of acquisition. Except for collateral dependent loans with deteriorated credit quality, the fair values for loans acquired from Riverside Bank were estimated using cash flow projections based on the remaining maturity and repricing terms. Cash flows were adjusted by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value using a risk-adjusted market rate for similar loans. For collateral dependent loans with deteriorated credit quality, to estimate the fair value, Salisbury analyzed the value of the underlying collateral of the loans, assuming the fair values of the loans were derived from the eventual sale of the collateral. Those values were discounted using market derived rates of return, with consideration given to the period of time and costs associated with the foreclosure and disposition of the collateral. There was no carryover of Riverside Bank's allowance for credit losses associated with the loans that were acquired as the loans were recorded at fair value upon acquisition. Information about the acquired loan portfolio subject to purchased credit impaired loan accounting guidance (ASC 310-30) as of December 5, 2014 (acquisition date) is as follows: The following table summarizes activity in the accretable yield for the acquired loan portfolio that falls under the purview of ASC 310-30. At December 31, 2016 and 2015, Salisbury ASC 310-30 loans had an outstanding balance totaling $8.1 million and $10.9 million, respectively. The carrying value as of December 31, 2016 and 2015 was $7.1 million and $8.9 million, respectively. The following pro forma information assumes that the acquisition occurred at the beginning of the earliest period presented. The goodwill is not amortized for book purposes, and is not deductible for tax purposes. The fair value of savings and transaction deposit accounts acquired from Riverside Bank was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. The fair value of time deposits was estimated by discounting the contractual future cash flows using market rates offered for time deposits of similar remaining maturities. Direct merger, acquisition and integration costs of the Riverside Bank acquisition were expensed as incurred, and totaled $2.0 million in 2014. NOTE 3 - SECURITIES The composition of securities is as follows: (1)Net of other-than-temporary impairment write-downs recognized in prior years. Sales of securities available-for-sale and gains realized are as follows: The following table summarizes the aggregate fair value and gross unrealized loss of securities that have been in a continuous unrealized loss position as of the dates presented: The amortized cost, fair value and tax equivalent yield of securities, by maturity, are as follows: (1) Yield is based on amortized cost. Salisbury evaluates securities for OTTI where the fair value of a security is less than its amortized cost basis at the balance sheet date. As part of this process, Salisbury considers whether it has the intent to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of these conditions is met, Salisbury recognizes an OTTI charge to earnings equal to the entire difference between the security's amortized cost basis and its fair value at the balance sheet date. For securities that meet neither of these conditions, an analysis is performed to determine if any of these securities are at risk for OTTI. The following summarizes, by security type, the basis for evaluating if the applicable securities were OTTI at December 31, 2016. U.S. Government agency mortgage-backed securities: The contractual cash flows are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Changes in fair values are a function of changes in investment spreads and interest rate movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. Furthermore, Salisbury evaluates these securities for strategic fit and may reduce its position in these securities, although it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity, and does not intend to sell these securities. Therefore, management does not consider the twenty-one securities with unrealized losses at December 31, 2016 to be OTTI. SBA bonds: The contractual cash flows are guaranteed by the U.S. government. Changes in fair values are a function of changes in investment spreads and interest rate movements and not changes in credit quality since time of purchase. Management expects to recover the entire amortized cost basis of these securities. Furthermore, Salisbury evaluates these securities for strategic fit and may reduce its position in these securities, although it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity, and does not intend to sell these securities. Therefore, management evaluated the impairment status of these debt securities, and concluded that the gross unrealized losses were temporary in nature and does not consider these investments to be other-than temporarily impaired at December 31, 2016. Municipal bonds: Salisbury performed a detailed analysis of the municipal bond portfolio. Management believes the unrealized loss position is attributable to interest rate and spread movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. Furthermore, Salisbury evaluates these securities for strategic fit and may reduce its position in these securities, although it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity, and does not intend to sell these securities. Therefore, management evaluated the impairment status of these debt securities, and concluded that the gross unrealized losses were temporary in nature and does not consider these investments to be other-than temporarily impaired at December 31, 2016. Corporate bonds: Salisbury regularly monitors and analyzes its corporate bond portfolio for credit quality. Management believes the unrealized loss position is attributable to interest rate and spread movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. Furthermore, Salisbury evaluates these securities for strategic fit and may reduce its position in these securities, although it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity, and does not intend to sell these securities. Therefore, management evaluated the impairment status of these debt securities, and concluded that the gross unrealized losses were temporary in nature and does not consider these investments to be other-than temporarily impaired at December 31, 2016. Non-agency CMOs: Salisbury performed a detailed cash flow analysis of its non-agency CMOs at December 31, 2016, to assess whether any of the securities were OTTI. Salisbury uses cash flow forecasts for each security based on a variety of market driven assumptions and securitization terms, including prepayment speed, default or delinquency rate, and default severity for losses including interest, legal fees, property repairs, expenses and realtor fees, that, together with the loan amount are subtracted from collateral sales proceeds to determine severity. In 2009, Salisbury determined that five non-agency CMO securities reflected OTTI and recognized losses for deterioration in credit quality of $1,128,000. Salisbury judged the four remaining securities not to have additional OTTI and all other CMO securities not to be OTTI as of December 31, 2016. It is possible that future loss assumptions could change necessitating Salisbury to recognize future OTTI for further deterioration in credit quality. Salisbury evaluates these securities for strategic fit and depending upon such factor could reduce its position in these securities, although it has no present intention to do so, and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis. CRA mutual funds consist of an investment in a fixed income mutual fund ($818,000 in total fair value and $16,000 in total unrealized losses as of December 31, 2016). The severity of the impairment (fair value is approximately 1.92% less than cost) and the duration of the impairment correlates with interest rates in 2016. Salisbury evaluated the near-term prospects of this fund in relation to the severity and duration of the impairment. Based on that evaluation, Salisbury does not consider this investment to be OTTI at December 31, 2016. NOTE 4 - LOANS The composition of loans receivable and loans held-for-sale is as follows: Salisbury has entered into loan participation agreements with other banks and transferred a portion of its originated loans to the participating banks. Transferred amounts are accounted for as sales and excluded from Salisbury's loans receivable. Salisbury and its participating lenders share ratably in any gains or losses that may result from a borrower's lack of compliance with contractual terms of the loan. Salisbury services the loans on behalf of the participating lenders and, as such, collects cash payments from the borrowers, remits payments (net of servicing fees) to participating lenders and disburses required escrow funds to relevant parties. Salisbury also has entered into loan participation agreements with other banks and purchased a portion of the other banks' originated loans. Purchased amounts are accounted for as loans without recourse to the originating bank. Salisbury and its originating lenders share ratably in any gains or losses that may result from a borrower's lack of compliance with contractual terms of the loan. The originating banks service the loans on behalf of the participating lenders and, as such, collect cash payments from the borrowers, remit payments (net of servicing fees) to participating lenders and disburse required escrow funds to relevant parties. At December 31, 2016 and 2015, Salisbury serviced commercial loans for other banks under loan participation agreements totaling $59.8 million and $63.0 million, respectively. During 2016, Salisbury sold participation interests in 3 loans with gross outstanding loan balances of $31.5 million; retaining $18.0 million in net balances. Additionally, Salisbury purchased a participant share in 4 loans with outstanding balances of $0.4 million. There are construction loans in the portfolio that have not been fully drawn as of December 31, 2016. Concentrations of Credit Risk Salisbury's loans consist primarily of residential and commercial real estate loans located principally in northwestern Connecticut, New York and Massachusetts towns, which constitute Salisbury's service area. Salisbury offers a broad range of loan and credit facilities to borrowers in its service area, including residential mortgage loans, commercial real estate loans, construction loans, working capital loans, equipment loans, and a variety of consumer loans, including home equity lines of credit, and installment and collateral loans. All residential and commercial mortgage loans are collateralized by first or second mortgages on real estate. The ability of single family residential and consumer borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the market area and real estate values. The ability of commercial borrowers to honor their repayment commitments is dependent on the general economy as well as the health of the real estate economic sector in Salisbury's market area. Credit Quality Salisbury uses credit risk ratings to determine its allowance for loan losses. Credit risk ratings categorize loans by common financial and structural characteristics that measure the credit strength of a borrower. The rating model has eight risk rating grades, with each grade corresponding to a progressively greater risk of default. Grades 1 through 4 are pass ratings and 5 through 8 are criticized as defined by the regulatory agencies. Risk ratings are assigned to differentiate risk within the portfolio and are reviewed on an ongoing basis and revised, if needed, to reflect changes in the borrowers' current financial position and outlook, risk profiles and the related collateral and structural positions. Loans rated as "special mention" possess credit deficiencies or potential weaknesses deserving management's close attention that if left uncorrected may result in deterioration of the repayment prospects for the loans at some future date. Loans rated as "substandard" are loans where the Bank's position is clearly not protected adequately by borrower current net worth or payment capacity. These loans have well defined weaknesses based on objective evidence and include loans where future losses to the Bank may result if deficiencies are not corrected, and loans where the primary source of repayment such as income is diminished and the Bank must rely on sale of collateral or other secondary sources of collection. Loans rated "doubtful" have the same weaknesses as substandard loans with the added characteristic that the weakness makes collection or liquidation in full, given current facts, conditions, and values, to be highly improbable. The possibility of loss is high, but due to certain important and reasonably specific pending factors, which may work to strengthen the loan, its reclassification as an estimated loss is deferred until its exact status can be determined. Loans classified as "loss" are considered uncollectible and of such little value that continuance as Bank assets is unwarranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather, it is not practical or desirable to defer writing off this loan even though partial recovery may be made in the future. Management actively reviews and tests its credit risk ratings against actual experience and engages an independent third-party to annually validate its assignment of credit risk ratings. In addition, the Bank's loan portfolio is examined periodically by its regulatory agencies, the FDIC and the Connecticut Department of Banking. The composition of loans receivable by risk rating grade is as follows: Business Activities Loans Business Activities Loans The composition of loans receivable by delinquency status is as follows: Business Activities Loans Acquired Loans Business Activities Loans Interest on non-accrual loans that would have been recorded as additional interest income for the years ended December 31, 2016, 2015 and 2014 had the loans been current in accordance with their original terms totaled $681,000, $1,089,000 and $632,000, respectively. Troubled Debt Restructurings (TDRs) Troubled debt restructurings occurring during the periods are as follows: Seven loans were restructured during 2016. No concessions have been made with respect to loans that subsequently defaulted in the current reporting period. Salisbury currently does not have any commitments to lend additional funds to TDR loans. The following table discloses the recorded investment and number of modifications for TDRs within the last year where a concession has been made, that then defaulted in the current reporting period. All TDR loans are included in the Impaired Loan schedule and are individually evaluated. (1)Includes a loan that defaulted during 2015 and was paid off as of December 31, 2015. A separate commercial real estate loan defaulted during 2016 that had a balance of $1,793 as of December 31, 2016. Impaired loans Loans individually evaluated for impairment (impaired loans) are loans for which Salisbury does not expect to collect all principal and interest in accordance with the contractual terms of the loan. Impaired loans include all modified loans classified as TDRs and loans on non-accrual status. The components of impaired loans are as follows: Business Activities Loans Acquired Loans Allowance for Loan Losses Changes in the allowance for loan losses are as follows: The composition of loans receivable and the allowance for loan losses is as follows: Business Activities Loans Acquired Loans Business Activities Loans Acquired Loans The credit quality segments of loans receivable and the allowance for loan losses are as follows: Business Activities Loans Acquired Loans Business Activities Loans Acquired Loans A specific valuation allowance is established for the impairment amount of each impaired loan, calculated using the fair value of expected cash flows or collateral, in accordance with the most likely means of recovery. Certain data with respect to loans individually evaluated for impairment is as follows: Business Activities Loans Acquired Loans Acquired Loans NOTE 5 - MORTGAGE SERVICING RIGHTS Loans serviced for others are not included in the consolidated balance sheets. Balances of loans serviced for others and the fair value of mortgage servicing rights are as follows: Changes in mortgage servicing rights are as follows: (1)Amortization expense and changes in the impairment reserve are recorded in mortgage servicing, net. NOTE 6 - PLEDGED ASSETS The following securities and loans were pledged to secure public and trust deposits, securities sold under agreements to repurchase, FHLBB advances and credit facilities available. At December 31, 2016, securities were pledged as follows: $58.2 million to secure public deposits, $5.5 million to secure repurchase agreements and $0.1 million to secure FHLBB and FRB advances. Additionally, loans receivable are pledged to secure FHLBB advances and credit facilities. NOTE 7 - BANK PREMISES AND EQUIPMENT The components of premises and equipment are as follows: NOTE 8 - GOODWILL AND INTANGIBLE ASSETS Changes in the carrying values of goodwill and intangible assets were as follows: (1)Not subject to amortization. In June 2014, Salisbury acquired the Sharon, Connecticut branch office of Union Savings Bank, and assumed approximately $18.2 million in deposits and acquired approximately $63,000 in loans secured by deposits. Salisbury realized no goodwill and assigned a core deposit intangible of $490,000 to the acquisition. In December 2014, Salisbury acquired Riverside Bank of Poughkeepsie, NY, which had approximately $211.2 million in deposits and $196.3 million in loans, and a property located at 11 Garden Street, Poughkeepsie, NY. Salisbury realized goodwill of $2.7 million and assigned a core deposit intangible of $2.2 million to the acquisition. Salisbury performed an evaluation of its goodwill and intangible assets during 2016. There was no impairment recognized as of December 31, 2016 or 2015. The core deposit intangibles were recorded as identifiable intangible assets and are being amortized over ten years using the sum-of-the-years' digits method. Estimated annual amortization expense of core deposit intangibles is as follows: NOTE 9 - DEPOSITS Scheduled maturities of time certificates of deposit are as follows: The total amount and scheduled maturities of time certificates of deposit in denominations of $250,000 or more were as follows: NOTE 10 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE Salisbury enters into overnight and short-term repurchase agreements with its customers. Securities sold under repurchase agreements are as follows: NOTE 11 - FEDERAL HOME LOAN BANK OF BOSTON ADVANCES AND OTHER BORROWED FUNDS Federal Home Loan Bank of Boston (“FHLBB”) advances are as follows: (1)Net of modification costs (2)Represents the portion of advances that are callable. Callable advances are presented by scheduled maturity. Callable advances are callable quarterly or one time callable by the FHLBB. (3)Weighted average rate based on scheduled maturity dates. In addition to outstanding FHLBB advances, Salisbury has additional available borrowing capacity, based on current capital stock levels, of $94.5 million and access to an unused FHLBB line of credit of $3.5 million at December 31, 2016. Advances from the FHLBB are secured by a blanket lien on qualified collateral, consisting primarily of loans with first mortgages secured by one-to-four family properties, certain unencumbered investment securities and other qualified assets. Two advances were modified during the third quarter 2015, and such modifications were accounted for in accordance with ASC 470-50. The modification extended $21 million in advances a weighted average 39 months. No advances were modified during 2016. Subordinated Debentures: In December 2015, Salisbury completed the issuance of $10.0 million in aggregate principal amount of 6.00% Fixed to Floating Rate Subordinated Notes Due 2025 (the “Notes”) in a private placement transaction to various accredited investors including $500 thousand to certain of Salisbury's related parties. The Notes have a maturity date of December 15, 2025 and bear interest at an annual rate of 6.00% from and including the original issue date of the Notes to, but excluding, December 15, 2020 or the earlier redemption date payable semi-annually in arrears on June 15 and December 15 of each year. Thereafter, from and including December 15, 2020 to, but excluding, December 15, 2025, the annual interest rate will be reset quarterly and equal to the three-month LIBOR, plus 430 basis points, as described in the Notes, payable quarterly, in arrears, on March 15, June 15, September 15 and December 15 of each year during the time that the Notes remain outstanding through December 15, 2025 or earlier redemption date. The notes are redeemable, without penalty, on or after December 15, 2020 and, in certain limited circumstances, prior to that date. As more completely described in the Notes, the indebtedness evidenced by the Notes, including principal and interest, is unsecured and subordinate and junior in right of Salisbury's payments to general and secured creditors and depositors of the Bank. The Notes also contain provisions with respect to redemption features and other matters pertaining to the Notes. The Notes have been structured to qualify as Tier 2 capital for regulatory capital purposes, subject to applicable limitations. Subordinated debentures totaled $9.8 million at December 31, 2016, which includes $212 thousand of remaining unamortized debt issuance costs. The debt issuance costs are being amortized to maturity. The effective interest rate of the subordinated debentures is 6.24%. NOTE 12 - NET DEFERRED TAX ASSET AND INCOME TAXES Salisbury provides deferred taxes for the estimated future tax effects attributable to temporary differences and carry-forwards when realization is more likely than not. The components of the income tax provision were as follows: The following is a reconciliation of the expected federal statutory tax to the income tax provision: The components of Salisbury's net deferred tax assets are as follows: Salisbury will only recognize a deferred tax asset when, based upon available evidence, realization is more likely than not. In accordance with Connecticut legislation, in 2004, Salisbury formed a Passive Investment Company (“PIC”), SBT Mortgage Service Corporation. Salisbury does not expect to pay state income tax in the foreseeable future unless there is a change in Connecticut law. Salisbury's policy is to provide for uncertain tax positions and the related interest and penalties (recorded as a component of income tax expense, if any) based upon management's assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. As of December 31, 2016 and 2015, there were no material uncertain tax positions related to federal and state tax matters. Salisbury is currently open to audit under the statute of limitations by the Internal Revenue Service and state taxing authorities for the years ended December 31, 2013 through December 31, 2016. NOTE 13 - SHAREHOLDERS' EQUITY Capital Requirements Salisbury and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional and discretionary actions by the regulators that, if undertaken, could have a direct material effect on Salisbury's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Salisbury and the Bank must meet specific guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Salisbury and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. In July 2013, the Federal Reserve Bank (FRB) approved the final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for bank holding companies and their bank subsidiaries. On July 9, 2013, the FDIC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the FRB. On April 8, 2014, the FDIC adopted as final its interim final rule, which is identical in substance to the final rules issued by the FRB in July 2013. Under the final rules, minimum requirements increased for both the quantity and quality of capital held by the Bank and Company. The rules include a common equity Tier 1 capital risk-weighted assets minimum ratio of 4.5%, minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, require a minimum ratio of Total capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements. The initial implementation of the capital conservation buffer began phasing in January 1, 2016 at 0.625% of risk-weighted assets and increases each subsequent January 1, by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. As of December 31, 2016, the Bank exceeded the fully phased in regulatory requirement for the capital conservation buffer. Strict eligibility criteria for regulatory capital instruments were also implemented under the final rules. As of December 31, 2016, the Company and the Bank met each of their capital requirements and the most recent notification from the FDIC categorized the Bank as “well-capitalized.” There are no conditions or events since that notification that management believes have changed the Bank's category. Restrictions on Cash Dividends to Common Shareholders Salisbury's ability to pay cash dividends is substantially dependent on the Bank's ability to pay cash dividends to Salisbury. There are certain restrictions on the payment of cash dividends and other payments by the Bank to Salisbury. Under Connecticut law, the Bank cannot declare a cash dividend except from net profits, defined as the remainder of all earnings from current operations. The total of all cash dividends declared by the Bank in any calendar year shall not, unless specifically approved by the Banking Commissioner, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. FRB Supervisory Letter SR 09-4, February 24, 2009, revised March 30, 2009, notes that, as a general matter, the Board of Directors of a Bank Holding Company (“BHC”) should inform the Federal Reserve and should eliminate, defer, or significantly reduce dividends if (1) net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2) the prospective rate of earnings retention is not consistent with capital needs and overall current and prospective financial condition; or (3) the BHC will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Moreover, a BHC should inform the Federal Reserve reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the BHC capital structure. Preferred Stock In August 2011, Salisbury issued to the U.S. Secretary of the Treasury (the “Treasury”) $16 million of its Series B Preferred Stock under the Small Business Lending Fund (the “SBLF”) program. Such Series B Preferred Stock was redeemed by Salisbury in December 2015. The SBLF program is a $30 billion fund established under the Small Business Jobs Act of 2010 to encourage lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. The Preferred Stock qualified as Tier 1 capital for regulatory purposes and ranked senior to the Common Stock. During fourth quarter 2015, the Company completed an offering of $10 million of unsecured 6.00% fixed-to-floating rate subordinated notes due in 2025. The notes qualify as Tier II capital and are included as such within the Company's total risk-based capital ratio. The net proceeds of the offering, along with cash on hand, were used during the fourth quarter 2015 to redeem the $16 million of Senior Non-Cumulative Perpetual Preferred Stock issued in conjunction with the Company's participation in the U.S. Treasury's SBLF program. NOTE 14 - PENSION AND OTHER BENEFITS Salisbury had an insured noncontributory defined benefit retirement plan which was available to employees prior to December 31, 2012 based upon age and length of service. Effective December 31, 2012, the pension plan was frozen by amending the plan to freeze retirement benefits at current levels and discontinue future benefit accruals. The plan was terminated effective October 15, 2014. During 2012, Salisbury decided to complete its transition from providing retirement benefits under a defined benefit pension plan to a defined contribution 401(k) plan, which is discussed below. The components of net periodic cost are as follows: The discount rate used to determine the net periodic benefit cost was 5.10% for 2014; and the expected return on plan assets was 4.35% for 2014. In 2014, Salisbury terminated the Defined Benefit Pension Plan. Excess assets in the amount of $1,018,000 were distributed to the Bank's Defined Contribution Plan (401(k)) and the Employee Stock Ownership Plan (ESOP) for future allocations to employees. The division of the excess pension assets was 66.67% to the 401(k) account (or $679,000) and 33.33% to the ESOP account (or $339,000). 401(k) Plan Salisbury offers a 401(k) Plan to eligible employees. Under the 401(k) Plan, eligible participants may contribute a percentage of their pay subject to IRS limitations. Salisbury may make discretionary contributions to the Plan. Effective December 31, 2012, and simultaneously with the freezing of the pension plan, the 401(k) Plan was amended to include a safe harbor contribution of 4% for all qualifying employees. The Bank’s safe harbor contribution percentage is reviewed annually and, under provisions of the 401(k) Plan, is subject to change in the future. An additional discretionary match may also be made for all employees that meet the 401(k) Plan’s qualifying requirements for such a match. This discretionary matching percentage, if any, is also subject to review under the provisions of the 401(k) Plan. Both the safe harbor and additional discretionary match, if any, vest immediately. Salisbury’s 401(k) Plan contribution expense for 2016, 2015 and 2014 was $832,000, $679,000 and $331,000, respectively. Employee Stock Ownership Plan (ESOP) Salisbury offers an ESOP to eligible employees. Under the Plan, Salisbury may make discretionary contributions to the Plan. Discretionary contributions vest in full upon six years and reflect the following schedule of qualified service: 20% after the second year, 20% per year thereafter, vesting at 100% after six full years of service. Benefit expenses totaled $173,000, $323,000, and $15,000 in 2016, 2015, and 2014, respectively. Other Retirement Plans Salisbury adopted ASC 715-60, “Compensation - Retirement Benefits - Defined Benefit Plans - Other Postretirement" and recognized a liability for Salisbury’s future postretirement benefit obligations under endorsement split-dollar life insurance arrangements. The total liability for the arrangements included in other liabilities was $746,000 and $672,000 at December 31, 2016, and 2015, respectively. Expense under this arrangement was $74,000 for 2016, $91,000 for 2015, and $53,000 for 2014. The Bank entered into a Supplemental Retirement Plan Agreement with its former Chief Executive Officer that provides for supplemental post retirement payments for a ten year period as described in the agreement. The related liability was $68,000 and $88,000 at December 31, 2016, and 2015, respectively. The related expense amounted to $5,000, $7,000 and $8,000 for 2016, 2015 and 2014, respectively. The Bank assumed a Supplemental Retirement Plan Agreement with a former Chief Executive Officer of Riverside Bank that provides for supplemental post retirement payments for a fifteen year period as described in the agreement. The related liability was $589,000 and $629,000 at December 31, 2016 and December 31, 2015, respectively. The related expenses were immaterial for all periods presented. A Non-Qualified Deferred Compensation Plan (the "Plan") was adopted effective January 1, 2013. This Plan was adopted by the Bank for the benefit of certain key employees ("Executive" or "Executives") who have been selected and approved by the Bank to participate in this Plan and who have evidenced their participation by execution of a Non-Qualified Deferred Compensation Plan Participation Agreement ("Participation Agreement") in a form provided by the Bank. This Plan is intended to comply with Internal Revenue Code ("Code") Section 409A and any regulatory or other guidance issued under such Section. In 2016, 2015, and 2014, the Bank awarded nine (9), six (6) and seven (7) Executives, respectively, with discretionary contributions to the plan. Expenses related to this plan amounted to $46,000 in 2016, $39,000 in 2015, and $0 in 2014. In 2014, there was also a recovery of $8,000 of prior expenses from contributions in 2013. Based on the Executive’s date of retirement, the vesting schedule ranges from 7.7% per year to 50% per year. Management Agreements: Salisbury or the Bank has entered into various management agreements with its named executive officers, including a severance agreement with Mr. Cantele, President and Chief Executive Officer, a change in control agreement with Mr. White, Executive Vice President and Chief Financial Officer, and an employment agreement with Mr. Davies, President of the New York Region and Chief Lending Officer. Such agreements are designed to allow Salisbury to retain the services of the designated executives while reducing, to the extent possible, unnecessary disruptions to Salisbury’s operations. NOTE 15 - 2011 LONG TERM INCENTIVE PLAN The Board of Directors adopted the 2011 Long Term Incentive Plan (the “Plan”) on March 25, 2011, and the shareholders approved the Plan at the 2011 Annual Meeting. The Plan was amended on January 18, 2013 and again on January 29, 2016. The purpose of the Plan is to assist Salisbury and the Bank in attracting, motivating, retaining and rewarding employees, officers and directors by enabling such persons to acquire or increase a proprietary interest in Salisbury in order to strengthen the mutuality of interests between such persons and our shareholders, and providing such persons with stock-based long-term performance incentives to expend their maximum efforts in the creation of shareholder value. The terms of the Plan provide for grants of Directors Stock Retainer Awards, Stock Options, Stock Appreciation Rights (“SARs”), Restricted Stock, Restricted Stock Units, Performance Awards, Deferred Stock, Dividend Equivalents, and Stock or Other Stock-Based Awards that may be settled in shares of common stock, cash, or other property (collectively, “Awards”). Under the Plan, the total number of shares of Common Stock reserved and available for issuance in the ten years following adoption of the Plan in connection with Awards under the Plan is 84,000 shares of Common Stock, which represented less than 5% of Salisbury’s outstanding shares of Common Stock at the time the Plan was adopted. Shares of Common Stock with respect to Awards previously granted under the Plan that are cancelled, terminate without being exercised, expire, are forfeited or lapse will again be available for issuance as Awards. Also, shares of Common Stock subject to Awards settled in cash and shares of Common Stock that are surrendered in payment of any Award or any tax withholding requirements will again be available for issuance as Awards. No more than 30,000 shares of Common Stock may be issued pursuant to Awards in any one calendar year. In addition, the Plan limits the total number of shares of Common Stock that may be awarded as Incentive Stock Options (“ISOs”) to 42,000 and the total number of shares of Common Stock that may be issued as Directors Stock Retainer Awards to 15,000. The Directors stock retainer awards were increased from 120 shares per year to 240 shares per year effective January 25, 2013. Effective January 29, 2016, the Directors stock retainer award was increased from 240 shares to 340 shares annually. In 2016, 2015, and 2014, there were 4,760, 2,660 and 2,160 shares issued, respectively, and the related compensation expense was $141,000, $81,000 and $65,000, respectively. On January 29, 2016, the Compensation Committee granted a total of 47,470 Phantom Stock Appreciation Units pursuant to the 2013 Phantom Stock Appreciation Unit and Long-Term Incentive Plan (the “Plan”), including 23,012 units to three Named Executive Officers. Mr. Cantele received 11,484 units, Mr. Davies received 5,963 units and Mr. White received 5,565 units. The units will vest on the third anniversary of the grant date. On January 2, 2015, the Compensation Committee granted a total of 48,894 Phantom Stock Appreciation Units pursuant to the 2013 Phantom Stock Appreciation Unit and Long-Term Incentive Plan (the “Plan”), including 23,012 units to three Named Executive Officers. Mr. Cantele received 11,484 units, Mr. Davies received 5,963 units and Mr. White received 5,565 units. The units will vest on the third anniversary of the grant date. The persons eligible to receive awards under the Plan are the officers, directors and employees of Salisbury and the Bank. The Plan is administered by the Human Resources and Compensation Committee (“Compensation Committee“) appointed by the Board. However, the Board may exercise any power or authority granted to the Compensation Committee. Subject to the terms of the Plan, the Compensation Committee or the Board is authorized to select eligible persons to receive Awards, determine the type and number of Awards to be granted and the number of shares of common stock to which Awards will relate, specify times at which Awards will be exercisable or settleable, including performance conditions that may be required as a condition thereof, set other terms and conditions of Awards, prescribe forms of Award agreements, interpret and specify rules and regulations relating to the Plan, and make all other determinations that may be necessary or advisable for the administration of the Plan. The Compensation Committee or the Board is authorized to grant (i) stock options, including (a) ISOs which can result in potentially favorable tax treatment to the participant, and (b) non-qualified stock options, and (ii) SARs entitling the participant to receive the amount by which the fair market value of a share of Common Stock on the date of exercise exceeds the grant price of the SAR. The exercise price per share subject to an option and the grant price of a SAR are determined by the Compensation Committee or the Board, but shall not be less than the fair market value of a share of Common Stock on the date of grant. The Compensation Committee or the Board is authorized, subject to limitations under applicable law, to grant to participants such other Awards that are payable in, valued in whole or in part by reference to, or otherwise based on or related to, shares of Common Stock, as deemed to be consistent with the purposes of the Plan. These could include shares of Common Stock awarded purely as a “bonus” and not subject to any restrictions or conditions, other rights convertible or exchangeable into shares of Common Stock and Awards valued by reference to book value of the Common Stock or the performance of Salisbury or the Bank. The Compensation Committee or the Board may determine the terms and conditions of such Awards. The Compensation Committee or the Board may amend, modify or terminate the Plan or the Compensation Committee’s authority to grant Awards without further shareholder approval, except shareholder approval must be obtained for any amendment that would (a) materially increase the number of shares of Common Stock available under the Plan; (b) expand the types of awards under the Plan; (c) materially expand the class of persons eligible to participate in the Plan; (d) materially expand the term of the Plan; or (e) be of a nature that would require shareholder approval pursuant to any law or regulation or under the rules of the NASDAQ Capital Market. Unless earlier terminated by the Board, the Plan will terminate on the tenth anniversary of the effective date of the Plan (March 25, 2021) or, if the shareholders approve an amendment that increases the number of shares of Common Stock subject to the Plan, the tenth anniversary of such approval. The termination of the Plan on such date will not affect the validity of any Award outstanding on the date of termination, and any such Awards will continue to be governed by the applicable terms and conditions of the Plan. The Plan provides that award agreements for any Awards that the Committee or the Board reasonably determines to constitute a “non-qualified deferred compensation plan” subject to the requirements of Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”), will be construed in a manner consistent with the requirements of Section 409A and that the Committee or the Board may amend any Award agreement (and the provisions of the Plan) if and to the extent that the Committee or the Board determines that the amendment is necessary or appropriate to comply with the requirements of Section 409A of the Code. The Plan also provides that any such Award will be subject to certain additional requirements specified in the Plan if and to the extent required to comply with Section 409A of the Code. Grants of Restricted Stock On January 29, 2016, Salisbury granted a total of 15,800 shares of restricted stock, pursuant to its 2011 Long Term Incentive Plan, to 42 employees, including 6,000 shares to three Named Executive Officers. Richard J. Cantele, Jr., President and Chief Executive Officer, John Davies, President of the NY Region and Chief Lending Officer and Donald E. White, Chief Financial Officer, were granted 5,000, 500 and 500 shares, respectively. The fair value of the stock for all awards, as of the grant date, was determined to be $466,000 and the stock will become vested three years from the grant date. On March 27, 2015, Salisbury granted a total of 1,000 shares of restricted stock, pursuant to its 2011 Long Term Incentive Plan, to one (1) Named Executive Officer, Richard J. Cantele, Jr., President and Chief Executive Officer. The fair value of the stock as of the grant date was determined to be $29,000 and the stock vested immediately. On January 3, 2014, Salisbury granted a total of 3,000 shares of restricted stock, pursuant to its 2011 Long Term Incentive Plan, to two (2) employees, including 2,000 shares to Donald E. White, Chief Financial Officer, and 1,000 shares to Richard P. Kelly, Executive Vice President and Chief Credit Officer. The stock vested in January 2017, three years from the grant date. On December 4, 2014, Salisbury granted a total of 1,000 shares of restricted stock pursuant to its 2011 Long Term Incentive Plan, to Richard J. Cantele, Jr., President and Chief Executive Officer. These shares, with a fair value of $27,000, vested immediately. On December 5, 2014, Salisbury granted a total of 5,000 shares of restricted stock pursuant to its 2011 Long Term Incentive Plan, to two (2) employees, including 3,000 shares to John Davies, New York Regional President and Chief Lending Officer, and 2,000 shares to Todd Rubino, Senior Vice President and Senior Commercial Loan Officer. Of these 5,000 shares, 1,250 immediately vested with a fair value of $34,000 and the remaining 3,750 shares vest over a period of 36 months. The fair value of vested restricted stock awards during 2016 totaled $562,000. The remaining weighted average vesting period on restricted shares as of December 31, 2016, over which unrecognized compensation cost is expected to be recognized, is 1.58 years. Expense in 2016, 2015, and 2014 totaled $215,000, $222,000 and $216,000, respectively. Unrecognized compensation cost relating to the awards as of December 31, 2016 and 2015 totaled $352,000 and $110,000, respectively. Forfeitures in 2016, 2015, and 2014 totaled 100, 300, and 2,000 shares, respectively. NOTE 16 - STOCK OPTIONS Salisbury issued stock options in conjunction with its acquisition of Riverside Bank in 2014. The table below reflects the remaining outstanding options related to this transaction and presents a summary of the status of Salisbury's outstanding stock options as of and for the year ended December 31, 2016: The total intrinsic value is the amount by which the fair value of the underlying stock exceeds the exercise price of an option on the exercise date. All options are vested and exercisable at December 31, 2016. The total intrinsic value of stock options exercised during the years ended December 31, 2016, 2015 and 2014 was $41,000, $75,000 and $0, respectively. NOTE 17 - RELATED PARTY TRANSACTIONS In the normal course of business the Bank has granted loans to executive officers, directors, principal shareholders and associates of the foregoing persons considered to be related parties. Changes in loans to executive officers, directors and their related associates are as follows (there are no loans to principal shareholders): NOTE 18 - COMPREHENSIVE INCOME Comprehensive income includes net income and any changes in equity from non-owner sources that are not recorded in the income statement (such as changes in net unrealized gains (losses) on securities). The purpose of reporting comprehensive income is to report a measure of all changes in shareholders' equity that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. The components of comprehensive income are as follows: (1) Reclassification adjustments include realized security gains and losses. The gains and losses have been reclassified out of other comprehensive income (loss) and have affected certain lines in the consolidated statements of income as follows: the pretax amount is reflected as gains on securities, net; the tax effect is included in the income tax provision; and the after tax amount is included in net income. The income tax expense related to reclassification of net realized gains was $199,000, $67,000, and $0 in 2016, 2015 and 2014, respectively. The components of accumulated other comprehensive income is as follows: NOTE 19 - COMMITMENTS AND CONTINGENT LIABILITIES Commitments On December 31, 2015, the Bank selected a new provider for core account processing services and other miscellaneous services, and has completed its core systems conversion with the new provider in November of 2016. The agreement will continue until the eighth anniversary of the commencement date, which was November 14, 2016. The Bank leases facilities and equipment under operating leases that expire at various dates through 2024. The leases have varying renewal options, generally require a fixed annual rent, and provide that real estate taxes, insurance, and maintenance are to be paid by Salisbury. Rent expense totaled $245,000, $295,000 and $147,000 for 2016, 2015 and 2014, respectively. Future minimum lease payments at December 31, 2016 are as follows: The Bank leases a facility under a capital lease that expires in 2029 with an option to terminate the lease in 2018. The lease has varying renewal options, requires a fixed annual rent, and provides that real estate taxes, insurance, and maintenance are to be paid by the Bank. The following is a schedule by years of future minimum lease payments under the capital lease with the present value of the net minimum lease payments as of December 31, 2016. Employment and Change in Control Agreements Salisbury has entered into severance agreements with certain senior executives, including with one (1) named executive officer, Richard J. Cantele, Jr., which provide payouts ranging from 0.5 to 2.0 times base salary and other benefits. Salisbury has also entered into several change in control agreements including with named executive officers, Richard J. Cantele, Jr., and Donald E. White, and an employment agreement with named executive officer John Davies, all of which provide a severance payment ranging from 0.5 to 2.9 times base salary and other benefits in the event employment is terminated in conjunction with a defined change in control. Contingent Liabilities The Bank is involved in various claims and legal proceedings, which are not material, arising in the ordinary course of business. As previously disclosed, the Bank, individually and in its capacity as a former Co-Trustee of the Erling C. Christophersen Revocable Trust (the “Trust”), was named as a defendant in litigation filed in the Connecticut Complex Litigation Docket in Stamford, captioned John Christophersen v. Erling Christophersen, et al., X08-CV-08-5009597S (the “First Action”). The Bank also was a counterclaim-defendant in related mortgage foreclosure litigation in the Connecticut Complex Litigation Docket in Stamford, captioned Salisbury Bank and Trust Company v. Erling C. Christophersen, et al., X08-CV-10-6005847-S (the “Foreclosure Action,” together with the First Action, the “Actions”). The other parties to the Actions were John R. Christophersen; Erling C. Christophersen, individually and as Co-Trustee of the Trust; Bonnie Christophersen and Elena Dreiske, individually and as Co-Trustees of the Mildred B. Blount Testamentary Trust; People's United Bank; Law Offices of Gary Oberst, P.C.; Rhoda Rudnick; and Hinckley Allen & Snyder LLP. The Actions involved a dispute over title to certain real property located in Westport, Connecticut, which was secured by a commercial mortgage in favor of the Bank on the Westport property. This mortgage was the subject of the Foreclosure Action brought by the Bank. The Court, in 2016, ruled in favor of the bank as to the foreclosure action and as such brings this matter to a close. As a result of the foreclosure the bank has taken ownership of the property and the carrying value is reflected in the OREO balance as of December 31, 2016. There are no other material pending legal proceedings, other than ordinary routine litigation incidental to the registrant’s business, to which Salisbury is a party or to which any of its property is subject. NOTE 20 - FINANCIAL INSTRUMENTS The Bank, in the normal course of business and to meet the financing needs of its customers, is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to originate loans, letters of credit, and unadvanced funds on loans. The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Commitments to originate loans are agreements to lend to a customer provided there are no violations of any conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies, but may include secured interests in mortgages, accounts receivable, inventory, property, plant and equipment and income producing properties. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. As of December 31, 2016 and 2015, the maximum potential amount of the Bank's obligation was $1,112,000 and $1,401,000, respectively, for financial, commercial and standby letters of credit. If a letter of credit is drawn upon, the Bank may seek recourse through the customer's underlying line of credit. If the customer's line of credit is also in default, the Bank may take possession of the collateral, if any, securing the line of credit. Financial instrument liabilities with off-balance sheet credit risk are as follows: The allowance for off balance sheet commitments is calculated by applying a reserve percentage discounted by a utilization factor to the sum of unguaranteed unused lines of credit and loan contracts that the Bank has committed to but not funded as of year-end. The allowance for off-balance sheet commitments was $81,000 and $93,000 as of December 31, 2016 and December 31, 2015, respectively. NOTE 21 - FAIR VALUE MEASUREMENTS Salisbury uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, other assets are recorded at fair value on a nonrecurring basis, such as loans held for sale, collateral dependent impaired loans, property acquired through foreclosure or repossession and mortgage servicing rights. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or-market accounting or write-downs of individual assets. Salisbury adopted ASC 820-10, “Fair Value Measurement - Overall,” which provides a framework for measuring fair value under generally accepted accounting principles. This guidance permitted Salisbury the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. Salisbury did not elect fair value treatment for any financial assets or liabilities upon adoption. In accordance with ASC 820-10, Salisbury groups its financial assets and financial liabilities measured at fair value in three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. GAAP specifies a hierarchy of valuation techniques based on whether the types of valuation information (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Salisbury's market assumptions. These two types of inputs have created the following fair value hierarchy: •Level 1. Quoted prices in active markets for identical assets. Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 also includes U.S. Treasury, other U.S. Government and agency mortgage-backed securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. •Level 2. Significant other observable inputs. Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities. •Level 3. Significant unobservable inputs. Valuations for assets and liabilities that are derived from other methodologies, including option pricing models, discounted cash flow models and similar techniques, are not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities. A financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Salisbury did not have any significant transfers of assets between levels 1 and 2 of the fair value hierarchy during the year ended December 31, 2016. The following is a description of valuation methodologies for assets recorded at fair value, including the general classification of such assets and liabilities pursuant to the valuation hierarchy. •Securities available-for-sale. Securities available-for-sale are recorded at fair value on a recurring basis. Level 1 securities include exchange-traded equity securities. Level 2 securities include debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes obligations of the U.S. Treasury and U.S. government-sponsored enterprises, mortgage-backed securities, collateralized mortgage obligations, municipal bonds, SBA bonds, corporate bonds and certain preferred equities. Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management's best estimate is used. Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalization and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows. •Collateral dependent loans that are deemed to be impaired are valued based upon the fair value of the underlying collateral less costs to sell. Such collateral primarily consists of real estate and, to a lesser extent, other business assets. Management may adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values resulting from its knowledge of the property. Internal valuations are utilized to determine the fair value of other business assets. Collateral dependent impaired loans are categorized as Level 3. •Other real estate owned acquired through foreclosure or repossession is adjusted to fair value less costs to sell upon transfer out of loans. Subsequently, it is carried at the lower of carrying value or fair value less costs to sell. Fair value is generally based upon independent market prices or appraised values of the collateral. Management adjusts appraised values to reflect estimated market value declines or apply other discounts to appraised values for unobservable factors resulting from its knowledge of the property, and such property is categorized as Level 3. Other than discussed above, the following methods and assumptions were used by management to estimate the fair value of significant classes of financial instruments for which it is practicable to estimate that value. Cash and cash equivalents. Carrying value is assumed to represent fair value for cash and cash equivalents that have original maturities of ninety days or less. Loans held-for-sale. The fair value is determined using a factor based on the estimated gain on sale of the loan. Loans, net. The carrying value of the loans in the loan portfolio is based on their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, the unamortized balance of any deferred fees or costs on originated loans and the unamortized balance of any premiums or discounts on loans purchased or acquired through mergers. The fair value of the loans is estimated by discounting future cash flows using the current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality. Accrued interest receivable/payable. Carrying value approximates fair value. Cash surrender value of life insurance. The carrying value of this asset approximates its fair value. Deposits. The fair value of demand, non-interest bearing checking, savings and money market deposits is determined as the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting the estimated future cash flows using market rates offered for deposits of similar remaining maturities. Borrowed funds. Advances from Federal Home Loan Bank - The fair value of these fixed-maturity advances is estimated by discounting future cash flows using rates currently offered for advances of similar remaining maturities. Subordinated Debentures - The fair value is estimated by using the Mid Line price as indicated for the end of the period on Bloomberg. Assets measured at fair value are as follows: Carrying values and estimated fair values of financial instruments are as follows: NOTE 22 - SALISBURY BANCORP, INC. (PARENT ONLY) CONDENSED FINANCIAL INFORMATION The unconsolidated balance sheets and statements of income and cash flows of Salisbury Bancorp, Inc. are presented as follows: NOTE 23 - EARNINGS PER SHARE The calculation of earnings per share is as follows: NOTE 24 - SUBSEQUENT EVENTS Salisbury has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued. The Board of Directors of Salisbury declared a $0.28 per common share quarterly cash dividend at their January 27, 2017 meeting. The dividend was paid on February 24, 2017 to shareholders of record as of February 10, 2017. On January 27, 2017, the Compensation Committee granted a total of 56,600 Phantom Stock Appreciation Units pursuant to its 2011 Long Term Incentive Plan, which was approved by shareholders at the 2011 Annual Meeting, including 23,100 units to three Named Executive Officers. Richard J. Cantele, Jr., President and Chief Executive Officer received 11,500 units, John Davies, President New York Region and Chief Lending Officer received 6,000 units and Donald E. White, Chief Financial Officer received 5,600 units. The units will vest on the third anniversary of the grant date. On January 17, 2017, the Bank entered into a Purchase Agreement, which is subject to Regulatory and other conditions, for an additional property to support the operations and infrastructure of the bank. On January 12, 2017, the Bank entered into a Purchase and Assumption Agreement with Empire State Bank, pursuant to which the Bank will purchase the New Paltz, New York Branch of Empire State Bank, subject to regulatory approval and other conditions. Upon completion of the transaction the bank will assume approximately $31 million in deposits and purchase approximately $6.8 million in branch related loans. The transaction, in accordance with GAAP, will be accounted for utilizing the purchase accounting method. On February 24, 2017 the Board of Directors approved the 2017 Long Term Incentive Plan which is subject to shareholder approval. The 2017 Long Term Incentive Plan provides the Compensation Committee the ability to grant awards of a similar nature to those available under the 2011 Long Term Incentive Plan. Upon Shareholder approval of the 2017 Long Term Incentive Plan, no further awards will be granted under the 2011 Long Term Incentive Plan and any reserved but ungranted awards will be cancelled. NOTE 25 - SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA (Unaudited) Selected quarterly consolidated financial data for the years ended December 31, 2016 and 2015 is as follows: (a)The above market prices reflect inter-dealer prices, without retail markup, markdown or commissions, and may not necessarily represent actual transactions. Salisbury Bancorp, Inc.'s Common Stock, par value $0.10 per share ("Common Stock") trades on the NASDAQ Capital Market under the symbol: SAL. As of March 1, 2017, there were approximately 2,182 shareholders of record of the Company's Common Stock. Selected quarterly consolidated financial data (unaudited) continued: (a)The above market prices reflect inter-dealer prices, without retail markup, markdown or commissions, and may not necessarily represent actual transactions. | Here's a summary of the financial statement:
1. Profit/Loss:
- Experiencing losses
- Affected by cash flows from acquired loans
- Impacted by impairment of securities, goodwill, and intangibles
2. Expenses:
- Based on estimated liabilities
- Subject to change based on allowance for loan losses
- Includes adjustments from 2015
3. Assets:
- Includes fixed assets and building (subject to amortization)
- Acquired loans from Riverside Bank
- Fair value calculations based on:
* Cash flow projections
* Credit loss estimates
* Prepayment rates
* Collateral values
4. Liabilities:
- Debt securities evaluated for fair value
- Federal Home Loan Bank of Boston (FHLBB) membership requirements:
* Mandatory stock ownership
* Stock carried at par value
* Redemption possible after 5 years of membership termination
* Subject to FHLBB regulations and capital adequacy requirements
Notable aspects: The statement shows significant focus on loan valuations, asset impairment considerations, and FHLBB membership obligations. There appears to be careful consideration of fair value calculations and risk adjustments in their financial reporting. | Claude |
Consolidated Financial Statements. M.D.C. HOLDINGS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Consolidated Financial Statements Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets at December 31, 2016 and December 31, 2015 Consolidated Statements of Operations and Comprehensive Income for each of the Three Years in the Period Ended December 31, 2016 Consolidated Statements of Stockholders' Equity for each of the Three Years in the Period Ended December 31, 2016 Consolidated Statements of Cash Flows for each of the Three Years in the Period Ended December 31, 2016 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of M.D.C. Holdings, Inc. We have audited the accompanying consolidated balance sheets of M.D.C. Holdings, Inc. (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of M.D.C. Holdings, Inc. at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), M.D.C. Holdings, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 1, 2017 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Denver, Colorado February 1, 2017 M.D.C. HOLDINGS, INC. Consolidated Balance Sheets The accompanying Notes are an integral part of these Consolidated Financial Statements. M.D.C. HOLDINGS, INC. Consolidated Statements of Operations and Comprehensive Income The accompanying Notes are an integral part of these Consolidated Financial Statements. M.D.C. HOLDINGS, INC. Consolidated Statements of Stockholders' Equity (Dollars in thousands, except share amounts) The accompanying Notes are an integral part of these Consolidated Financial Statements. M.D.C. HOLDINGS, INC. Consolidated Statements of Cash Flows The accompanying Notes are an integral part of these Consolidated Financial Statements. 1. Summary of Significant Accounting Policies Principles of Consolidation. The Consolidated Financial Statements of M.D.C. Holdings, Inc. ("MDC," “the Company," “we,” “us,” or “our” which refers to M.D.C. Holdings, Inc. and its subsidiaries) include the accounts of MDC and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Certain prior year balances have been reclassified to conform to the current year’s presentation. Description of Business. We have homebuilding operations in Arizona, California, Colorado, Florida, Maryland, (which includes Maryland, Pennsylvania and New Jersey), Nevada, Utah, Virginia and Washington. The primary functions of our homebuilding operations include land acquisition and development, home construction, purchasing, marketing, merchandising, sales and customer service. We build and sell primarily single-family detached homes, which are designed and built to meet local customer preferences. We are the general contractor for all of our projects and retain subcontractors for site development and home construction. Our financial services operations consist of HomeAmerican Mortgage Corporation (“HomeAmerican”), which originates mortgage loans, primarily for our homebuyers, American Home Insurance Agency, Inc. (“American Home Insurance”), which offers third-party insurance products to our homebuyers, and American Home Title and Escrow Company (“American Home Title”), which provides title agency services to the Company and our homebuyers in Colorado, Florida, Maryland, Nevada and Virginia. The financial services operations also include Allegiant Insurance Company, Inc., A Risk Retention Group (“Allegiant”), which provides insurance coverage primarily to our homebuilding subsidiaries and most of our subcontractors for homes sold by our homebuilding subsidiaries and for work performed in completed subdivisions, and StarAmerican Insurance Ltd. (“StarAmerican”), a wholly owned subsidiary of MDC, which is a re-insurer of Allegiant claims. Presentation. Our balance sheet presentation is unclassified due to the fact that certain assets and liabilities have both short and long-term characteristics. Use of Accounting Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents. The Company periodically invests funds in highly liquid investments with an original maturity of three months or less, such as commercial paper, money market funds and time deposits, which are included in cash and cash equivalents in the consolidated balance sheets and consolidated statements of cash flows. Marketable Securities. All of our marketable securities were treated as available-for-sale investments as of December 31, 2016 and 2015. As such, we have recorded all of our marketable securities at fair value with changes in fair value initially being recorded as a component of accumulated other comprehensive income (“AOCI”). However, in accordance with Accounting Standards Codification (“ASC”) Topic 320, Investments (“ASC 320”), if the unrealized loss is determined to be other-than-temporary, an other-than-temporary impairment (“OTTI”) is recorded in the consolidated statements of operations and comprehensive income. When a security is sold, we use the first-in first-out method to determine the cost of the security sold or the amount reclassified out of AOCI. Restricted Cash. We receive cash earnest money deposits from our customers who enter into home sale contracts. In certain states we are restricted from using such deposits for general purposes, unless we take measures to release state imposed restrictions on such deposits received from homebuyers, which may include posting blanket surety bonds. We had $3.8 million and $3.8 million in restricted cash related to homebuyer deposits at December 31, 2016 and 2015, respectively. Trade and Other Receivables. Trade and other receivables primarily includes home sale receivables, which reflects cash to be received from title companies or outside brokers associated with closed homes. Generally, we will receive cash from title companies and outside brokers within a few days of the home being closed. Mortgage Loans Held-for-Sale, net. Mortgage loans held-for-sale are recorded at fair value based on quoted market prices and estimated market prices received from a third-party. Using fair value allows an offset of the changes in fair values of the mortgage loans and the derivative instruments used to hedge them without the burden of complying with the requirements for hedge accounting. Inventories. Our inventories are primarily associated with communities where we intend to construct and sell homes, including models and unsold homes. Costs capitalized to land and land under development primarily include: (1) land costs; (2) land development costs; (3) entitlement costs; (4) capitalized interest; (5) engineering fees; and (6) title insurance, real property taxes and closing costs directly related to the purchase of the land parcel. Components of housing completed or under construction primarily include: (1) land costs transferred from land and land under development; (2) direct construction costs associated with a house; (3) real property taxes, engineering fees, permits and other fees; (4) capitalized interest; and (5) indirect construction costs, which include field construction management salaries and benefits, utilities and other construction related costs. Land costs are transferred from land and land under development to housing completed or under construction at the point in time that construction of a home on an owned lot begins. In accordance with ASC Topic 360, Property, Plant, and Equipment (“ASC 360”), homebuilding inventories, excluding those classified as held for sale, are carried at cost unless events and circumstances indicate that the carrying value of the underlying subdivision may not be recoverable. We evaluate inventories for impairment at each quarter end on a subdivision level basis as each such subdivision represents the lowest level of identifiable cash flows. In making this determination, we review, among other things, the following for each subdivision: • actual and trending “Operating Margin” (which is defined as home sale revenues less home cost of sales and all incremental costs associated directly with the subdivision, including sales commissions and marketing costs); • estimated future undiscounted cash flows and Operating Margin; • forecasted Operating Margin for homes in backlog; • actual and trending net home orders; • homes available for sale; • market information for each sub-market, including competition levels, home foreclosure levels, the size and style of homes currently being offered for sale and lot size; and • known or probable events indicating that the carrying value may not be recoverable. If events or circumstances indicate that the carrying value of our inventory may not be recoverable, assets are reviewed for impairment by comparing the undiscounted estimated future cash flows from an individual subdivision (including capitalized interest) to its carrying value. If the undiscounted future cash flows are less than the subdivision’s carrying value, the carrying value of the subdivision is written down to its then estimated fair value. We generally determine the estimated fair value of each subdivision by determining the present value of the estimated future cash flows at discount rates, which are Level 3 inputs (see Note 6, Fair Value Measurements, in the notes to the financial statements for definitions of fair value inputs), that are commensurate with the risk of the subdivision under evaluation. The evaluation for the recoverability of the carrying value of the assets for each individual subdivision can be impacted significantly by our estimates of future home sale revenues, home construction costs, and development costs per home, all of which are Level 3 inputs. If land is classified as held for sale, in accordance with ASC 360, we measure it at the lower of the carrying value or fair value less estimated costs to sell. In determining fair value, we primarily rely upon the most recent negotiated price which is a Level 2 input (see Note 6, Fair Value Measurements, for definitions of fair value inputs). If a negotiated price is not available, we will consider several factors including, but not limited to, current market conditions, recent comparable sales transactions and market analysis studies. If the fair value less estimated costs to sell is lower than the current carrying value, the land is impaired down to its estimated fair value less costs to sell. Property and Equipment, net. Property and equipment is carried at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the related assets, which range from 2 to 29 years. Depreciation and amortization expense for property and equipment of our homebuilding operations was $4.6 million, $3.9 million and $3.8 million for the years ended December 31, 2016, 2015 and 2014, respectively. The following table sets forth the cost and carrying value of our homebuilding property and equipment by major asset category. Deferred Tax Assets, net. Deferred income taxes reflect the net tax effects of temporary differences between (1) the carrying amounts of the assets and liabilities for financial reporting purposes and (2) the amounts used for income tax purposes. Deferred tax assets and liabilities are measured using current enacted tax rates in effect in the years in which those temporary differences are expected to reverse. A valuation allowance is recorded against a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not (a likelihood of more than 50%) that some portion, or all, of the deferred tax asset will not be realized. Deferred Marketing Costs. Certain marketing costs related to model homes and sales offices are capitalized as they are: (1) reasonably expected to be recovered from the sale of the project; and (2) incurred for (a) tangible assets that are used directly throughout the selling period to aid in the sale of the project or (b) services that have been performed to obtain regulatory approval of sales. Capitalized marketing costs are included in prepaid and other assets in the homebuilding section of the consolidated balance sheets and the associated amortization expense is included in selling, general and administrative (“SG&A”) in the homebuilding section of the consolidated statements of operations and comprehensive income as the homes in the related subdivision are delivered. We allocate all capitalized marketing costs equally to each house within a subdivision and record expense as homes close over the life of a subdivision. All other marketing costs are expensed as incurred. Variable Interest Entities. In accordance with ASC Topic 810, Consolidation (“ASC 810”), we analyze our land option contracts and other contractual arrangements to determine whether the corresponding land sellers are variable interest entities (“VIEs”) and, if so, whether we are the primary beneficiary. Although we do not have legal title to the optioned land, ASC 810 requires a company to consolidate a VIE if the company is determined to be the primary beneficiary. In determining whether we are the primary beneficiary, we consider, among other things, whether we have the power to direct the activities of the VIE that most significantly impact VIE’s economic performance, including, but not limited to, determining or limiting the scope or purpose of the VIE, selling or transferring property owned or controlled by the VIE, or arranging financing for the VIE. We also consider whether we have the obligation to absorb losses of the VIE or the right to receive benefits from the VIE. We have concluded that, as of December 31, 2016, we were not the primary beneficiary of any VIEs from which we are purchasing land under land option contracts. Related Party Assets. Our related party assets are debt security bonds acquired from a quasi-municipal corporation in the state of Colorado. See Note 14 to the Consolidated Financial Statements. Goodwill. In accordance with ASC Topic 350, Intangibles-Goodwill and Other (“ASC 350”), we evaluate goodwill for possible impairment annually or more frequently if events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. We use a three step process to assess the realizability of goodwill. The first step is a qualitative assessment that analyzes current economic indicators associated with a particular reporting unit. For example, we analyze changes in economic, market and industry conditions, business strategy, cost factors, and financial performance, among others, to determine if there are indicators of a significant decline in the fair value of a particular reporting unit. If the qualitative assessment indicates a stable or improved fair value, no further testing is required. If a qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we will proceed to the second step where we calculate the fair value of a reporting unit based on discounted future probability-weighted cash flows. If this step indicates that the carrying value of a reporting unit is in excess of its fair value, we will proceed to the third step where the fair value of the reporting unit will be allocated to assets and liabilities as they would in a business combination. Impairment occurs when the carrying amount of goodwill exceeds its estimated fair value calculated in the third step. Based on our analysis, we have concluded as of December 31, 2016, our goodwill was not impaired. Liability for Unrecognized Tax Benefits. ASC Topic 740, Income Taxes, regarding liabilities for unrecognized tax benefits provides guidance for the recognition and measurement in financial statements of uncertain tax positions taken or expected to be taken in a tax return. The evaluation of a tax position is a two-step process, the first step being recognition. We determine whether it is more-likely-than-not that a tax position will be sustained upon tax examination, including resolution of any related appeals or litigation, based on the technical merits of the position. The technical merits of a tax position derive from both statutory and judicial authority (legislation and statutes, legislative intent, regulations, rulings, and case law) and their applicability to the facts and circumstances of the tax position. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements. The second step is measurement. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate resolution with a taxing authority. Once the gross unrecognized tax benefit is determined, we also accrue for any interest and penalties, as well as any offsets expected from resultant amendments to federal or state tax returns. We record the aggregate effect of these items in income tax expense in the consolidated statements of operations and comprehensive income. To the extent this tax position would be offset against a similar deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed, the liability is treated as a reduction to the related deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward. Otherwise, we record the corresponding liability in accrued liabilities in the homebuilding section of our consolidated balance sheets. Warranty Accrual. Our homes are sold with limited third-party warranties. Under our agreement with the issuer of the third-party warranties, we are responsible for performing all of the work for the first two years of the warranty coverage and paying for substantially all of the work required to be performed during years three through ten of the warranties. We record accruals for general and structural warranty claims, as well as accruals for known, unusual warranty-related expenditures. Warranty accrual is recorded based upon historical payment experience in an amount estimated to be adequate to cover expected costs of materials and outside labor during warranty periods. The determination of the warranty accrual rate for closed homes and the evaluation of our warranty accrual balance at period end are based on an internally developed analysis that includes known facts and interpretations of circumstances, including, among other things, our trends in historical warranty payment levels and warranty payments for claims not considered to be normal and recurring. Warranty payments are recorded against the warranty accrual. Additional reserves may be established for known, unusual warranty-related expenditures not covered through the independent warranty accrual analysis performed by us. Warranty payments incurred for an individual house may differ from the related reserve established for the home at the time it was closed. The actual disbursements for warranty claims are evaluated in the aggregate to determine if an adjustment to the historical warranty accrual should be recorded. We assess the reasonableness and adequacy of the reserve and the per-unit reserve amount originally included in home cost of sales, as well as the timing of the reversal of any excess reserve on a quarterly basis, using historical payment data and other relevant information. Warranty accrual is included in accrued liabilities in the homebuilding section of our consolidated balance sheets and adjustments to our warranty accrual are recorded as an increase or reduction to home cost of sales in the homebuilding section of our consolidated statements of operations and comprehensive income. Insurance Reserves. The establishment of reserves for estimated losses associated with insurance policies issued by Allegiant and re-insurance agreements issued by StarAmerican are based on actuarial studies that include known facts and interpretations of circumstances, including our experience with similar cases and historical trends involving claim payment patterns, pending levels of unpaid claims, product mix or concentration, claim severity, frequency patterns depending on the business conducted, and changing regulatory and legal environments. It is possible that changes in the insurance payment experience used in estimating our ultimate insurance losses could have a material impact on our insurance reserves. Reserves for Construction Defect Claims. The establishment of reserves for estimated losses to be incurred by our homebuilding subsidiaries associated with (1) the self-insured retention (“SIR”) portion of construction defect claims that are expected to be covered under insurance policies with Allegiant and (2) the entire cost of any construction defect claims that are not expected to be covered by insurance policies with Allegiant are based on actuarial studies that include known facts similar to those established for our insurance reserves. It is possible that changes in the payment experience used in estimating our ultimate losses for construction defect claims could have a material impact on our reserves. Litigation Reserves. We and certain of our subsidiaries have been named as defendants in various cases. We reserve for estimated exposure with respect to these cases based upon currently available information on each case. See Note 16 to the Consolidated Financial Statements. Derivative Financial Instruments. The derivative instruments we utilize in the normal course of business are interest rate lock commitments and forward sales of mortgage-backed securities, both of which typically are short-term in nature. Forward sales of mortgage-backed securities are utilized to hedge changes in fair value of our interest rate lock commitments as well as mortgage loans held-for-sale not under commitments to sell. For forward sales of mortgage-backed securities, as well as interest rate lock commitments that are still outstanding at the end of a reporting period, we record the changes in fair value of the derivatives in revenues in the financial services section of our consolidated statements of operations and comprehensive income with an offset to other assets or accounts payable and accrued liabilities in the financial services section of our consolidated balance sheets, depending on the nature of the change. At December 31, 2016 and 2015, we had interest rate lock commitments with aggregate principal balances of approximately $110.9 million and $98.4 million, respectively, at average interest rates of 4.11% and 3.82%, respectively. In addition, we had $42.6 million and $23.1 million of mortgage loans held-for-sale at December 31, 2016 and 2015, respectively, that had not yet been committed to a mortgage purchaser. In order to hedge the changes in fair value of our interest rate lock commitments and mortgage loans held-for-sale which had not yet been committed to a mortgage purchaser, we had forward sales of securities totaling $108.0 million and $84.5 million at December 31, 2016 and 2015, respectively. For the years ended December 31, 2016, 2015 and 2014, we recorded net gains (losses) on our derivatives of $1.5 million, $1.5 million and $(0.8) million, respectively. For further discussion of our policies regarding interest rate lock commitments, see our “Revenue Recognition for HomeAmerican” accounting policy section below. Revenue Recognition for Homebuilding Segments. We recognize revenue from home deliveries and land sales when: (1) the closing has occurred; (2) title has passed to the buyer; (3) possession and other attributes of ownership have been transferred to the buyer; (4) we are not obligated to perform significant additional activities after closing and delivery; and (5) the buyer demonstrates a commitment to pay for the property through an adequate initial and continuing investment. The buyer’s initial investment shall include: (1) cash paid as a down payment; (2) the buyer’s notes supported by irrevocable letters of credit; (3) payments made by the buyer to third-parties to reduce existing indebtedness on the property; and (4) other amounts paid by the buyer that are part of the sales value of the property. Revenue from a home delivery includes the base sales price and any purchased options and upgrades and is reduced for any sales price incentives. We defer Operating Margin related to the sale of a home if all of the following criteria are present: (1) HomeAmerican originates the mortgage loan; (2) HomeAmerican has not sold the mortgage loan, or loans, as of the end of the pertinent reporting period; and (3) the homebuyer’s down payment does not meet the initial or continuing investment criteria. The deferral is subsequently recognized at the time HomeAmerican sells the homebuyer’s mortgage loan, or loans, to a third-party purchaser. In the event the Operating Margin is a loss, we recognize such loss at the time the home is closed. We did not have any loans in inventory at December 31, 2016, 2015 or 2014 that failed to meet the continuing investment criteria. Revenue Recognition for HomeAmerican. Revenues recorded by HomeAmerican primarily reflect (1) origination fees and (2) the corresponding sale, or expected future sale, of a loan, which will include the estimated earnings from either the release or retention of a loan’s servicing rights. Origination fees are recognized when a loan is originated. When an interest rate lock commitment is made to a customer, we record the expected gain on sale of the mortgage, plus the estimated earnings from the expected sale of the associated servicing rights, adjusted for a pull-through percentage (which is defined as the likelihood that an interest rate lock commitment will be originated), as revenue. As the interest rate lock commitment gets closer to being originated, the expected gain on the sale of that loan plus its servicing rights is updated to reflect current market value and the increase or decrease in the fair value of that interest rate lock commitment is recorded through revenues. At the same time, the expected pull-through percentage of the interest rate lock commitment to be originated is updated (typically an increase as the interest lock commitment gets closer to origination) and, if there has been a change, revenues are adjusted as necessary. After origination, our mortgage loans, generally including their servicing rights, are sold to third-party purchasers in accordance with sale agreements entered into by us with a third-party purchaser of the loans. We make representations and warranties with respect to the status of loans transferred in the sale agreements. The sale agreements generally include statements acknowledging the transfer of the loans is intended by both parties to constitute a sale. Sale of a mortgage loan has occurred when the following criteria, among others, have been met: (1) fair consideration has been paid for transfer of the loan by a third party in an arms-length transaction, (2) all the usual risks and rewards of ownership that are in substance a sale have been transferred by us to the third party purchaser; and (3) we do not have a substantial continuing involvement with the mortgage loan. We measure mortgage loans held-for-sale at fair value with the changes in fair value being reported in earnings at each reporting date. The impact of recording changes in fair value to earnings did not have a material impact on our financial position, results of operations or cash flows during the years ended December 31, 2016, 2015 or 2014. Our net gains on the sale of mortgage loans were $34.0 million, $17.8 million and $15.5 million for the years ended December 31, 2016, 2015 and 2014, respectively, and are included as a component of revenues in the financial services section of the consolidated statements of operations and comprehensive income. Home Cost of Sales. Home cost of sales includes the specific construction costs of each home and all applicable land acquisition, land development and related costs, both incurred and estimated to be incurred, warranty costs and finance and closing costs, including closing cost incentives. We use the specific identification method for the purpose of accumulating home construction costs and allocate costs to each lot within a subdivision associated with land acquisition and land development based upon relative fair value of the lots prior to home construction. Lots within a subdivision typically have comparable fair values, and, as such, we generally allocate costs equally to each lot within a subdivision. We record all home cost of sales when a home is closed on a house-by-house basis. When a home is closed, we generally have not yet paid or incurred all costs necessary to complete the construction of the home and certain land development costs. At the time of a home closing, we compare the home construction budgets to actual recorded costs to determine the additional estimated costs remaining to be paid on each closed home. For amounts not incurred or paid as of the time of closing a home, we record an estimated accrual associated with certain home construction and land development costs. Generally, these accruals are established based upon contracted work which has yet to be paid, open work orders not paid at the time of home closing, as well as land completion costs more likely than not to be incurred, and represent estimates believed to be adequate to cover the expected remaining home construction and land development costs. We monitor the adequacy of these accruals on a house-by-house basis and in the aggregate on a subdivision-by-subdivision basis. At December 31, 2016 and 2015, we had $8.7 million and $11.5 million, respectively, of land development and home construction accruals for closed homes. Actual results could differ from such estimates. Stock-Based Compensation Expense. In accordance with ASC Topic 718, Compensation-Stock Compensation (“ASC 718”), stock-based compensation expense for all share-based payment awards is based on the grant date fair value. For stock option awards granted with just service and/or performance conditions, we estimate the fair value using a Black-Scholes option pricing model. For any stock option awards granted that contain a market condition, we estimate the fair value using a Monte Carlo simulation model. We recognize expense for share-based payment awards based on their varying vesting conditions as follows: ● Awards with service conditions only - Expense recognized on a straight-line basis over the requisite service period of the award. ● Awards with performance conditions - Expense recognized on a straight-line basis for each performance criteria tranche (if applicable) over the period between the date that it is determined the performance conditions related to each tranche (if applicable) are probable to be met and the date the award vests ● Awards with market conditions (“Market-Based”) - Expense recognized on a straight-line basis over the requisite service period, which is the lesser of the derived service period or the explicit service period, if one is present. However, if the market condition is satisfied prior to the end of the requisite service period, we will accelerate all remaining expense to be recognized. Earnings (Loss) Per Common Share. For purposes of calculating earnings (loss) per share (“EPS”), a company that has participating security holders (for example, holders of unvested restricted stock that has nonforfeitable dividend rights) is required to utilize the two-class method for calculating earnings per share unless the treasury stock method results in lower EPS. The two-class method is an allocation of earnings/(loss) between the holders of common stock and a company’s participating security holders. Under the two-class method, earnings/(loss) for the reporting period are allocated between common shareholders and other security holders based on their respective rights to receive distributed earnings (i.e., dividends) and undistributed earnings (i.e., net income/(loss)). Our common shares outstanding are comprised of shareholder owned common stock and participating security holders consisting of shareholders of unvested restricted stock. Basic EPS is calculated by dividing income or loss attributable to common stockholders by the weighted average number of shares of common stock outstanding, excluding participating shares in accordance with ASC 260. To calculate diluted EPS, basic EPS is further adjusted to include the effect of potential dilutive stock options outstanding. Recently Issued Accounting Standards. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), which is a comprehensive new revenue recognition model. Under ASU 2014-09, a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services. ASU 2014-09 is effective for our interim and annual reporting periods beginning January 1, 2018, and is to be adopted using either a full retrospective or modified retrospective transition method. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. We do not plan to early adopt the guidance. We expect to adopt the new standard under the modified retrospective approach. Although we are still in the process of evaluating our contracts, we do not believe the adoption of ASU 2014-09 will have a material impact on the amount or timing of our revenues. Although we are still evaluating the accounting for marketing costs under ASC 606, there is a possibility that the adoption of ASU 2014-09 will impact the timing of recognition and classification in our consolidated financial statements of certain marketing costs we incur to obtain sales contracts from our customers. For example, there are various marketing costs that we currently capitalize and amortize with each home delivered in a community. Under the new guidance, these costs may need to be expensed immediately. We are continuing to evaluate the exact impact the update will have on recording revenue and our marketing costs in our consolidated financial statements and related disclosures. In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis (“ASU 2015-02”), which amends the consolidation requirements in ASC Topic 810, Consolidation, primarily related to limited partnerships and variable interest entities. ASU 2015-02 was effective for our interim and annual reporting periods beginning January 1, 2016 and did not have a material impact on our consolidated financial statements. In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”), which makes a number of changes to the current GAAP model, including changes to the accounting for equity investments and financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. Under ASU 2016-01, we will primarily be impacted by the changes to accounting for equity instruments with readily determinable fair values as they will no longer be permitted to be classified as available-for-sale (changes in fair value reported through other comprehensive income) and instead, all changes in fair value will be reported in earnings. ASU 2016-01 is effective for our interim and annual reporting periods beginning January 1, 2018 and is to be applied using a modified retrospective transition method. Early adoption of the applicable guidance from ASU 2016-01 is not permitted. Given the significant amount of our investments in equity securities, and assuming we still have a similar level of investments when this guidance is adopted, we would expect that the impact to our consolidated statements of operations and comprehensive income from this update could be material. Furthermore, depending on trends in the stock market, we may see increased volatility in our consolidated statements of operations and comprehensive income. In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”), which requires a lessee to recognize a right-of-use asset and a corresponding lease liability for virtually all leases. The liability will be equal to the present value of lease payments while the right-of-use asset will be based on the liability, subject to adjustment, such as for initial direct costs. In addition, ASU 2016-02 expands the disclosure requirements for lessees. Upon adoption, we will be required to record a lease asset and lease liability related to our operating leases. ASU 2016-02 is effective for our interim and annual reporting periods beginning January 1, 2019 and is to be applied using a modified retrospective transition method. Early adoption is permitted. We do not plan to early adopt the guidance and we are currently evaluating the impact the update will have on our consolidated financial statements and related disclosures. In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), which amends ASC Topic 718. The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the accounting for income taxes, classification of excess tax benefits on the statement of cash flows, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities, and classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. ASU 2016-09 is effective for our interim and annual reporting periods beginning January 1, 2017, and is to be applied using a retrospective transition method. Though permitted, we did not early adopt the guidance. The primary impact from this guidance on our consolidated financial statements will be to our tax provision line item as any excess tax benefits or deficiencies from (1) the exercise or expiration of options or (2) the vesting of stock awards will now be recognized through our income tax provision as opposed to additional paid-in capital (to the extent we had a sufficient pool of windfall tax benefits). As of December 31, 2016, we had options covering 540,000 shares with exercise prices above the MDC closing share price at December 31, 2016 and the ability to exercise those options will expire at some point during 2017. If the exercise price continues to be greater than the share price of MDC throughout 2017, these options will likely expire unexercised and as a result, we could recognize an additional $2.6 million expense in our tax provision for 2017. We are continuing to evaluate additional impacts the update will have on our consolidated financial statements and related disclosures. In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which requires measurement and recognition of expected credit losses for financial assets held. The amendments in ASU 2016-13 eliminate the probable threshold for initial recognition of a credit loss in current GAAP and reflect an entity’s current estimate of all expected credit losses. ASU 2016-13 is effective for our interim and annual reporting periods beginning January 1, 2021, and is to be applied using a modified retrospective transition method. Earlier adoption is permitted. We do not plan to early adopt the guidance and we are currently evaluating the impact the update will have on our consolidated financial statements and related disclosures. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force) (“ASU 2016-15”), which amends ASC Topic 230, Statement of Cash Flows, to clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. The amendments in ASU 2016-15 are intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for our interim and annual reporting periods beginning January 1, 2018, and is to be applied using a retrospective transition method. Earlier adoption is permitted. We do not plan to early adopt the guidance and do not believe the guidance will have a material impact on our financial statements upon adoption. In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force (“ASU 2016-18”), which requires restricted cash to be included with cash and cash equivalents when reconciling the beginning and ending amounts on the statement of cash flows. ASU 2016-18 is effective for our interim and annual reporting periods beginning January 1, 2018, and is to be applied using a retrospective transition method. Earlier adoption is permitted. We do not plan to early adopt the guidance and do not believe the guidance will have a material impact on our financial statements upon adoption. 2. Supplemental Cash Flow Disclosure The table below sets forth supplemental disclosures of cash flow information and non-cash investing and financing activities. 3. Segment Reporting An operating segment is defined as a component of an enterprise for which discrete financial information is available and is reviewed regularly by the Chief Operating Decision Maker (“CODM”), or decision-making group, to evaluate performance and make operating decisions. We have identified our CODM as two key executives-the Chief Executive Officer and the Chief Operating Officer. We have identified each homebuilding division as an operating segment. Our homebuilding operating segments have been aggregated into the reportable segments noted below because they are similar in the following regards: (1) economic characteristics; (2) housing products; (3) class of homebuyer; (4) regulatory environments; and (5) methods used to construct and sell homes. Our homebuilding reportable segments are as follows: ● West (Arizona, California, Nevada and Washington) ● Mountain (Colorado and Utah) ● East (Virginia, Florida and Maryland, which includes Pennsylvania and New Jersey) Our financial services business consists of the operations of the following operating segments: (1) HomeAmerican; (2) Allegiant; (3) StarAmerican; (4) American Home Insurance Agency, Inc.; and (5) American Home Title and Escrow Company. Due to its contributions to consolidated pretax income we consider HomeAmerican to be a reportable segment (“mortgage operations”). The remaining operating segments have been aggregated into one reportable segment (“other”) because they do not individually exceed 10 percent of: (1) consolidated revenue; (2) the greater of (a) the combined reported profit of all operating segments that did not report a loss or (b) the positive value of the combined reported loss of all operating segments that reported losses; or (3) consolidated assets. Corporate is a non-operating segment that develops and implements strategic initiatives and supports our operating divisions by centralizing key administrative functions such as finance, treasury, information technology, insurance, risk management, litigation and human resources. Corporate also provides the necessary administrative functions to support MDC as a publicly traded company. A portion of the expenses incurred by Corporate are allocated to the homebuilding operating segments based on their respective percentages of assets, and to a lesser degree, a portion of Corporate expenses are allocated to the financial services segments. A majority of Corporate’s personnel and resources are primarily dedicated to activities relating to the homebuilding segments, and, therefore, the balance of any unallocated Corporate expenses is included in the homebuilding operations section of our consolidated statements of operations and comprehensive income. The following table summarizes home and land sale revenues for our homebuilding operations and revenues for our financial services operations. The following table summarizes pretax income (loss) for our homebuilding and financial services operations. The following table summarizes total assets for our homebuilding and financial services operations. The assets in our West, Mountain and East segments consist primarily of inventory while the assets in our Corporate segment primarily include cash and cash equivalents, marketable securities, and our deferred tax assets. The assets in our financial services segment consist mostly of cash and cash equivalents, marketable securities and mortgage loans held-for-sale. 4. Earnings Per Share On November 21, 2016, MDC’s board of directors declared a 5% stock dividend that was distributed on December 20, 2016 to shareholders of record on December 6, 2016. In accordance with ASC 260, basic and diluted earnings per share amounts, weighted-average shares outstanding, and dividends declared per share have been restated for all periods presented to reflect the effect of this stock dividend. The following table shows our basic and diluted EPS calculations: Diluted EPS for the years ended December 31, 2016, 2015 and 2014 excluded options to purchase approximately 5.6 million, 6.2 million and 4.7 million shares, respectively, of common stock because the effect of their inclusion would be anti-dilutive. 5. Accumulated Other Comprehensive Income The following table sets forth our changes in accumulated other comprehensive income: (1) All amounts net-of-tax. (2) See separate table below for details about these reclassifications. The following table sets forth the activity related to reclassifications out of accumulated other comprehensive income (loss) related to available for sale securities: 6. Fair Value Measurements ASC Topic 820, Fair Value Measurements (“ASC 820”), defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs, other than quoted prices in active markets, that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions. The following table sets forth the fair values and methods used for measuring the fair values of financial instruments on a recurring basis: The following methods and assumptions were used to estimate the fair value of each class of financial instruments as of December 31, 2016 and 2015. Cash and cash equivalents, restricted cash, trade and other receivables, prepaid and other assets, accounts payable, accrued liabilities and borrowings on our revolving credit facility. Fair value approximates carrying value. Marketable Securities. As of December 31, 2016 and 2015, we only held marketable equity securities. However, during 2015, we also held marketable debt securities. Our debt securities consisted primarily of fixed and floating rate interest earning debt securities, which included, among others, United States government and government agency debt and corporate debt. As of December 31, 2016 our equity securities consist of holdings in corporate equities, preferred stock and exchange traded funds. As of December 31, 2015, we also invested in holdings in mutual fund securities (which were primarily invested in debt securities). As of December 31, 2016 and 2015, all of our equity securities were treated as available-for-sale investments and as such, were recorded at fair value with all changes in fair value initially recorded through AOCI, subject to an assessment to determine if an unrealized loss, if applicable, is other-than-temporary. Each quarter we assess all of our securities in an unrealized loss position for a potential OTTI. For the years ended December 31, 2016, 2015 and 2014, we recorded pretax OTTIs of $1.4 million, $4.0 million and $4.3 million, respectively, for certain equity investments that were in an unrealized loss position as of the end of each respective period. The OTTIs are included in other-than-temporary impairment of marketable securities in the homebuilding or financial services sections of our consolidated statements of operations and comprehensive income. The following tables set forth the amortized cost and estimated fair value of our available-for-sale marketable securities. As of December 31, 2016 and 2015, our marketable equity securities were in net unrealized gain positions totaling $12.5 million and $5.9 million, respectively. Our individual marketable equity securities that were in unrealized loss positions, excluding those that were impaired as part of any OTTI, aggregated to an unrealized loss of $0.5 million and $0.9 million as of December 31, 2016 and 2015, respectively. The table below sets forth the aggregated unrealized losses for individual equity securities that were in unrealized loss positions but did not have OTTIs recognized. We do not believe the decline in the value of these marketable securities as of December 31, 2016 is other-than-temporary. The following table sets forth gross realized gains and losses from the sale of available-for-sale marketable securities. We record the net amount of these gains and losses to either other expense or interest and other income, dependent upon whether there is a net realized loss or gain, respectively, in the homebuilding section or financial services section of our consolidated statements of operations and comprehensive income. Mortgage Loans Held-for-Sale, Net. Our mortgage loans held-for-sale, which are measured at fair value on a recurring basis include (1) mortgage loans held-for-sale that are under commitments to sell and (2) mortgage loans held-for-sale that are not under commitments to sell. At December 31, 2016 and December 31, 2015, we had $96.2 million and $92.6 million, respectively, of mortgage loans held-for-sale under commitments to sell. The fair value for those loans was based on quoted market prices for those mortgage loans, which are Level 2 fair value inputs. At December 31, 2016 and 2015, we had $42.6 million and $23.1 million, respectively, of mortgage loans held-for-sale that were not under commitments to sell. The fair value for those loans was primarily based upon the estimated market price received from an outside party, which is a Level 2 fair value input. Metropolitan District Bond Securities (Related Party). The Metropolitan District Bond Securities (the “Metro Bonds”) are included in the homebuilding section of our consolidated balance sheets. Refer to Note 14 for details on how these bonds were acquired. Cash flows received by the Company from these securities reflect principal and interest payments from the Metro District, which are generally received in the fourth quarter, and are supported by an annual levy on the taxable assessed value of real estate and personal property within the Metro District’s boundaries. The stated year of maturity for the Metro Bonds is 2037. However, if the unpaid principal and all accrued interest are not paid off by the year 2037, the Company will continue to receive principal and interest payments in perpetuity until the unpaid principal and accrued interest is paid in full. In accordance with ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”), we adjust the bond principal balance using an interest accretion model that utilizes future cash flows expected to be collected. Furthermore, as this investment is accounted for as an available-for-sale asset, we update its fair value on a quarterly basis, with the adjustment being recorded through AOCI. The fair value is based upon a discounted future cash flow model, which uses Level 3 inputs. The primary unobservable inputs used in our discounted cash flow model are (1) the forecasted number of homes to be closed, as they drive increases to the tax paying base for the Metro District, (2) the forecasted assessed value of those closed homes and (3) the discount rate. Cash receipts, which are scheduled to be received in the fourth quarter, reduce the carrying value of the Metro Bonds. The increases in the value of the Metro Bonds during the past two years are primarily based on a larger percentage of future cash flows coming from homes that have closed, which utilize a lower discount rate as those cash flows have a reduced amount of risk. The table below provides quantitative data, as of December 31, 2016, regarding each unobservable input and the sensitivity of fair value to potential changes in those unobservable inputs. The table set forth below summarizes the activity for our Metro Bonds. Mortgage Repurchase Facility. The debt associated with our Mortgage Repurchase Facility (see Note 15 for further discussion) is at floating rates that approximate current market rates and have relatively short-term maturities, generally within 30 days. The fair value approximates carrying value and is based on Level 2 inputs. Senior Notes. The estimated values of the senior notes in the following table are based on Level 2 inputs, which primarily reflect estimated prices for our senior notes which were provided by multiple sources. 7. Inventories The table below sets forth, by reportable segment, information relating to our homebuilding inventories. Included in land and land under development at December 31, 2015 was $1.7 million of land held for sale. We did not have any land held for sale at December 31, 2016. Inventory impairments recognized by segment for the years ended December 31, 2016, 2015 and 2014 are shown in the table below. During the year ended December 31, 2016, we recorded $10.2 million of inventory impairments, of which $7.6 million related to five projects in our East segment, $1.4 million related to one project in our West segment and $1.2 million related to one project in our Mountain segment. During the year ended December 31, 2015, we recorded $10.0 million of inventory impairments, of which $1.2 million was related to impairments on our land held for sale in two communities, one in our West segment and one in our Mountain segment, each of which the Company was actively marketing and planning on selling in the next 12 months. The remaining $8.8 million in impairments related to nine projects with the majority coming from our East segment; four in Maryland totaling $3.3 million and three in Virginia totaling $5.2 million. During the year ended December 31, 2014, we recorded $1.8 million of inventory impairments related to four projects, three of which were in our Maryland division totaling $1 million. The table below provides quantitative data, for the periods presented, used in determining the fair value of the impaired inventory, excluding impairments related to land held for sale. 8. Capitalization of Interest We capitalize interest to inventories during the period of development in accordance with ASC Topic 835, Interest (“ASC 835”). Homebuilding interest capitalized as a cost of inventories is included in cost of sales during the period that related units or lots are delivered. To the extent our homebuilding debt exceeds our qualified assets as defined in ASC 835, we expense a portion of the interest incurred. Qualified homebuilding assets consist of all lots and homes, excluding finished unsold homes or finished models, within projects that are actively selling or under development. The table set forth below summarizes homebuilding interest activity. The homebuilding interest expensed in the table below relates to the portion of interest incurred where our homebuilding debt exceeded our qualified inventory for such periods in accordance with ASC 835. 9. Homebuilding Prepaid and Other Assets The following table sets forth the components of homebuilding prepaid and other assets. 10. Homebuilding Accrued Liabilities and Financial Services Accounts Payable and Accrued Liabilities The following table sets forth information relating to homebuilding accrued liabilities. The following table sets forth information relating to financial services accounts payable and accrued liabilities. 11. Warranty Accrual The table set forth below summarizes accrual, adjustment and payment activity related to our warranty accrual for the years ended December 31, 2016, 2015 and 2014. During 2016 and 2015, we recorded $7.5 million and $0.2 million, respectively, in adjustments to increase our warranty accrual. The adjustments were primarily due to unexpected warranty related expenditures, which began during the second half of 2015 and continued through most of 2016. During 2014, as a result of favorable warranty payment experience relative to our estimates at the time of home closing, we reduced our warranty accrual by $2.6 million. Additionally, from time to time, we change our warranty accrual rates based on payment trends. Any changes made to those rates did not materially affect our warranty expense or gross margin from home sales for the years ended December 31, 2016, 2015 and 2014. 12. Insurance and Construction Defect Claim Reserves The following table summarizes our insurance and defect claim reserves activity for the years ended December 31, 2016, 2015 and 2014. These reserves are included as a component of accrued liabilities in either the financial services or homebuilding sections of the consolidated balance sheets. During 2015, we recorded a $2.5 million adjustment to decrease our insurance and construction defect claim reserves. The adjustments primarily resulted from a decrease in the severity of our insurance claim experience relative to prior period estimates. No such adjustments were required for the years ended December 31, 2016 and 2014. In the ordinary course of business, we make payments from our insurance and construction defect claim reserves to settle litigation claims arising primarily from our homebuilding activities. These payments are irregular in both their timing and their magnitude. As a result, the cash payments, net of recoveries shown for the years ended December 31, 2016, 2015, and 2014, are not necessarily indicative of what future cash payments will be for subsequent periods. 13. Income Taxes Our provision for (benefit from) income taxes for the years ended December 31, 2016, 2015 and 2014 consisted of the following: The provision for (benefit from) income taxes differs from the amount that would be computed by applying the statutory federal income tax rate of 35% to income before income taxes as a result of the following: The year-over-year improvement in our effective tax rate from 2015 to 2016 is primarily the result of (1) a domestic manufacturing deduction, whereas we were not eligible to take this deduction in the prior year due to our utilization of remaining federal net operating loss carryforwards to offset taxable income, and (2) a higher estimated percentage of our homes delivered qualifying for energy credits. The year-over-year improvement in our effective tax rate from 2014 to 2015 is primarily the result of (1) the reversal of a previously established uncertain tax position and (2) a year-over-year decrease in the write-offs of certain unused state net operating losses. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of significant temporary differences that give rise to the net deferred tax asset are as follows: At December 31, 2016, all federal net operating loss carryforwards had been used. Additionally, we had $26.0 million in tax-effected state net operating loss carryforwards. The operating loss carryforwards, if unused, will begin to expire in 2019. At December 31, 2016 we had a valuation allowance of $13.8 million, an increase of $0.9 million from the prior year. $6.1 million of the total valuation allowance is related to various state net operating loss carryforwards where realization is more uncertain at this time due to the more limited carryforward periods that exist in certain states. The remaining $7.7 million is related to the amount by which the carrying value of our Metro Bonds for tax purposes exceeds our carrying value for book purposes that we believe realization is more uncertain at this time. At December 31, 2016 and 2015, our total liability for uncertain tax positions was $0.4 million and $0.4 million, respectively, which has been offset against our state net operating loss carryforward deferred tax asset. The following table summarizes activity for the gross unrecognized tax benefit component of our total liability for uncertain tax positions for the years ended December 31, 2016, 2015 and 2014: Our liability for gross unrecognized tax benefits was $0.6 million and $0.5 million at December 31, 2016 and 2015, respectively, all of which, if recognized, would reduce our effective tax rate. The net expense for interest and penalties reflected in the consolidated statements of operations and comprehensive income for the years ended December 31, 2016, 2015 and 2014 was $0.3 million, $0 and $0.2 million, respectively. The corresponding liabilities in the consolidated balance sheets were $0 and $0 at December 31, 2016 and 2015, respectively. We have taken positions in certain taxing jurisdictions for which it is reasonably possible that the total amounts of unrecognized tax benefits may decrease within the next twelve months. The possible decrease could result from the expiration of various statutes of limitation and the finalization of various state income tax matters. The estimated range of the reasonably possible decrease is $0.1 million to $0. The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. We are subject to U.S. federal income tax examination for calendar tax years ending 2013 through 2016. Additionally, we are subject to various state income tax examinations for the 2012 through 2017 calendar tax years. 14. Related Party Transactions On January 30, 2017, the Company entered into a sublease agreement with CVentures, Inc. Larry A. Mizel, the Chief Executive Officer of the Company, is the President of CVentures, Inc. The sublease is for space CVentures, Inc. has continuously leased from the Company as disclosed in the Form 8-K filed July 27, 2005 and the Form 8-K filed March 28, 2006. The sublease term commenced November 1, 2016 and will continue through October 31, 2021, with an option to extend to October 31, 2026. The sublease agreement is for approximately 5,437 rentable square feet at a base rent that increases over the initial term from $26.50 to $28.68 per rentable square foot per year, and increasing over the extension term from $29.26 to $31.67 per rentable square foot per year. The sublease rent is an allocation of the rent under the master lease agreement based on the sublease square footage. We previously entered into a transaction (the “Transaction”) with The Villages at Castle Rock Metropolitan District No. 6 (the “District”). The District is a quasi-municipal corporation and political subdivision of the State of Colorado. The Board of Directors of the District currently is comprised of employees of the Company. The District was formed to provide funding for certain land development costs associated with the construction of homes in our Cobblestone subdivision. Pursuant to the terms of the Transaction, the District sold to the Company approximately $22.5 million in Limited Tax General Obligation Capital Appreciation Bonds Series 2007 (the “Metro Bonds”) and a $1.6 million Limited Tax General Obligation Subordinate Bond (the “Subordinate Bond”) in exchange for title to approximately $28.6 million in land development improvements to the District. During the years ended December 31, 2016, 2015 and 2014, we received payments from the Metro District in the amount of $1.2 million, $0.7 million and $2.0 million, respectively, and recorded $1.7 million, $1.4 million and $1.4 million, respectively, in interest income. The interest income amounts are included in interest and other income in the homebuilding section of our consolidated statements of operations and comprehensive income. We contributed $1.0 million in cash to the MDC/Richmond American Homes Foundation (the “Foundation”) for each of the years ended December 31, 2016, 2015, and 2014. The Foundation is a Delaware non-profit corporation that was incorporated on September 30, 1999. The Foundation is a non-profit organization operated exclusively for charitable, educational and other purposes beneficial to social welfare within the meaning of Section 501(c)(3) of the Internal Revenue Code. The following Directors and/or officers of the Company served as directors of the Foundation at December 31, 2016, all of whom serve without compensation: Name MDC Title Larry A. Mizel Chairman and Chief Executive Officer David D. Mandarich President Three other individuals, who are independent of the Company, also serve as directors of the Foundation. All directors of the Foundation serve without compensation. 15. Lines of Credit and Total Debt Obligations Revolving Credit Facility. We have an unsecured revolving credit agreement (“Revolving Credit Facility”) with a group of lenders which may be used for general corporate purposes. This agreement has an aggregate commitment of $550 million (the “Commitment”) and was amended on December 18, 2015 to extend the maturity to December 18, 2020. Each lender may issue letters of credit in an amount up to 50% of its commitment. The facility permits an increase in the maximum Commitment amount to $1.0 billion upon our request, subject to receipt of additional commitments from existing or additional lenders and the consent of the designated agent and the co-administrative agent. As defined in the Revolving Credit Facility agreement, interest rates on outstanding borrowings are equal to the highest of (1) 0.0% or (2) a specified eurocurrency rate, federal funds effective rate or prime rate, plus a margin that is determined based on our credit ratings and leverage ratio. At any time at which our leverage ratio, as of the last day of the most recent calendar quarter, exceeds 55%, the aggregate principal amount of all consolidated senior debt borrowings outstanding may not exceed the borrowing base. There is no borrowing base requirement if our leverage ratio, as of the last day of the most recent calendar quarter, is 55% or less. The Revolving Credit Facility is fully and unconditionally guaranteed, jointly and severally, by most of our homebuilding segment subsidiaries. The facility contains various representations, warranties and covenants that we believe are customary for agreements of this type. The financial covenants include a consolidated tangible net worth test and a leverage test, along with a consolidated tangible net worth covenant, all as defined in the facility agreement. A failure to satisfy the foregoing tests does not constitute an event of default, but can trigger a “term-out” of the facility. A breach of the consolidated tangible net worth covenant (but not the consolidated tangible net worth test) or a violation of anti-corruption or sanctions laws would result in an event of default. The Revolving Credit Facility is subject to acceleration upon certain specified events of default, including breach of the consolidated tangible net worth covenant, a violation of anti-corruption or sanctions laws, failure to make timely payments, breaches of certain representations or covenants, failure to pay other material indebtedness, or another person becoming beneficial owner of 50% or more of our outstanding common stock. We believe we were in compliance with the representations, warranties and covenants included in the Revolving Credit Facility as of December 31, 2016. We incur costs associated with unused commitment fees pursuant to the terms of the Revolving Credit Facility. At December 31, 2016 and 2015, there were $23.0 million and $22.5 million, respectively, in letters of credit outstanding, which reduced the amounts available to be borrowed under the Revolving Credit Facility. We had $15.0 million outstanding under the Revolving Credit Facility as of December 31, 2016 and 2015. As of December 31, 2016, availability under the Revolving Credit Facility was approximately $512.0 million. Mortgage Repurchase Facility. HomeAmerican entered into an Amended and Restated Master Repurchase Agreement (the “Mortgage Repurchase Facility”) with U.S. Bank National Association (“USBNA”), effective September 16, 2016. The Mortgage Repurchase Facility amends and restates the prior Master Repurchase Agreement with USBNA dated as of November 12, 2008, as amended, which contained similar terms. The Mortgage Repurchase Facility increases the facility amount from $50 million to $75 million, extends the expiration date to September 15, 2017, adjusts the facility’s sublimits, expands the types of eligible loans, and reduces the facility fee. The Mortgage Repurchase Facility provides liquidity to HomeAmerican by providing for the sale of eligible mortgage loans to USBNA with an agreement by HomeAmerican to repurchase the mortgage loans at a future date. Until such mortgage loans are transferred back to HomeAmerican, the documents relating to such loans are held by USBNA, as custodian, pursuant to the Custody Agreement (“Custody Agreement”), dated as of November 12, 2008, by and between HomeAmerican and USBNA. In the event that an eligible mortgage loan becomes ineligible, as defined under the Mortgage Repurchase Facility, HomeAmerican may be required to repurchase the ineligible mortgage loan immediately. The maximum aggregate commitment of the Mortgage Repurchase Facility was temporarily increased on December 27, 2016 from $75 million to $125 million and was effective through January 25, 2017. The Mortgage Repurchase Facility also had a temporary increase in the maximum aggregate commitment from $50 million to $90 million from December 23, 2015 through January 31, 2016. At December 31, 2016 and December 31, 2015, HomeAmerican had $114.5 million and $88.6 million, respectively, of mortgage loans that HomeAmerican was obligated to repurchase under the Mortgage Repurchase Facility. Mortgage loans that HomeAmerican is obligated to repurchase under the Mortgage Repurchase Facility are accounted for as a debt financing arrangement and are reported as mortgage repurchase facility in the consolidated balance sheets. Advances under the Mortgage Repurchase Facility carry a price range that is LIBOR-based. The Mortgage Repurchase Facility contains various representations, warranties and affirmative and negative covenants that we believe are customary for agreements of this type. The negative covenants include, among others, (i) a minimum Adjusted Tangible Net Worth requirement, (ii) a maximum Adjusted Tangible Net Worth ratio, (iii) a minimum adjusted net income requirement, and (iv) a minimum Liquidity requirement. The foregoing capitalized terms are defined in the Mortgage Repurchase Facility. We believe HomeAmerican was in compliance with the representations, warranties and covenants included in the Mortgage Repurchase Facility as of December 31, 2016. Senior Notes. Our senior notes are not secured and, while the senior note indentures contain some restrictions on secured debt and other transactions, they do not contain financial covenants. Our senior notes are fully and unconditionally guaranteed on an unsecured basis, jointly and severally, by most of our homebuilding segment subsidiaries. We believe that we are in compliance with the representations, warranties and covenants in the senior note indentures. On January 15, 2014, we issued $250 million of 5½% Senior Notes due 2024 (the “5½% Notes”). The 5½% Notes, which pay interest semi-annually in arrears on January 15 and July 15 of each year, with payments commencing July 15, 2014, are general unsecured obligations of MDC and rank equally and ratably with our other general unsecured and unsubordinated indebtedness. We received proceeds of $248.4 million, net of underwriting fees of $1.6 million. During the 2014 first quarter, we redeemed our 5⅜% Senior Notes due December 2014 and, in the 2014 fourth quarter, we redeemed our 5⅜% Senior Notes due July 2015. As a result of these transactions, we paid $517.7 million to extinguish $500 million in debt principal and recorded a total of $18.2 million in losses on early extinguishments of debt. Our debt obligations at December 31, 2016 and 2015, net of any unamortized debt issuance costs or discount, were as follows: 16. Commitments and Contingencies Surety Bonds and Letters of Credit. We are required to obtain surety bonds and letters of credit in support of our obligations for land development and subdivision improvements, homeowner association dues, warranty work, contractor license fees and earnest money deposits. At December 31, 2016, we had outstanding surety bonds and letters of credit totaling $178.8 million and $52.6 million, respectively, including $29.6 million in letters of credit issued by HomeAmerican. The estimated cost to complete obligations related to these bonds and letters of credit were approximately $48.7 million and $18.2 million, respectively. All letters of credit as of December 31, 2016, excluding those issued by HomeAmerican, were issued under our unsecured Revolving Credit Facility (see Note 15 for further discussion of the Revolving Credit Facility). We expect that the obligations secured by these performance bonds and letters of credit generally will be performed in the ordinary course of business and in accordance with the applicable contractual terms. To the extent that the obligations are performed, the related performance bonds and letters of credit should be released and we should not have any continuing obligations. However, in the event any such performance bonds or letters of credit are called, our indemnity obligations could require us to reimburse the issuer of the performance bond or letter of credit. We have made no material guarantees with respect to third-party obligations. Litigation Reserves. Because of the nature of the homebuilding business, we have been named as defendants in various claims, complaints and other legal actions arising in the ordinary course of business, including product liability claims and claims associated with the sale and financing of homes. In the opinion of management, the outcome of these ordinary course matters will not have a material adverse effect upon our financial condition, results of operations or cash flows. At December 31, 2016 and 2015, respectively, we had $1.9 million and $3.6 million of legal accruals. Operating Leases. We have non-cancelable operating leases primarily associated with our office facilities. Rent expense under cancelable and non-cancelable operating leases totaled $5.4 million, $5.0 million and $4.9 million in 2016, 2015 and 2014, respectively, and is included in either selling, general and administrative expenses in the homebuilding section or expenses in the financial services section of our consolidated statements of operations and comprehensive income. The table below shows the future minimum payments under non-cancelable operating leases at December 31, 2016. 17. Concentration of Third-Party Mortgage Purchasers The following table sets forth the percent of mortgage loans sold by HomeAmerican to its primary third party purchasers during 2016, 2015 and 2014. No other third parties purchased greater than 10 percent of our mortgage loans during 2016, 2015 or 2014. 18. Stockholders' Equity Stock Dividends. On November 21, 2016 MDC’s board of directors declared a 5% stock dividend that was distributed on December 20, 2016 to shareholders of record on December 6, 2016. Common Stock Repurchase Program. At December 31, 2016, we were authorized to repurchase up to 4,000,000 shares of our common stock. We did not repurchase any shares of our common stock during the years ended December 31, 2016, 2015 or 2014. We did not hold any treasury stock at December 31, 2016. 19. Equity Incentive and Employee Benefit Plans A summary of our equity incentive plans follows. All share amounts have been adjusted for the stock dividend during distributed during 2016, as applicable. Employee Equity Incentive Plans. Effective March 2001, we adopted the M.D.C. Holdings, Inc. 2001 Equity Incentive Plan (the “2001 Equity Incentive Plan”). Non-qualified option awards previously granted generally vested over periods of up to seven years and expire ten years after the date of grant. Restricted stock awards generally were granted with vesting terms of up to five years. On March 26, 2011, the 2001 Equity Incentive Plan terminated and all stock option grants and restricted stock awards outstanding at the time of the plan termination may continue to be exercised, or become free of restrictions, in accordance with their terms. A total of 1.7 million shares of MDC common stock were reserved for issuance under the 2001 Equity Incentive Plan as of December 31, 2016. On April 27, 2011, our shareholders approved the M.D.C Holdings, Inc. 2011 Equity Incentive Plan (the “2011 Equity Incentive Plan”), which provides for the grant of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units and other equity awards to employees of the Company. Stock options granted under the 2011 Equity Incentive Plan have an exercise price that is at least equal to the fair market value of our common stock on the date the stock option is granted, generally vest in periods up to five years and expire ten years after the date of grant. At December 31, 2016, a total of 4.1 million shares of MDC common stock were reserved for issuance under the 2011 Equity Incentive Plan, of which 0.2 million shares remained available for grant under this plan as of December 31, 2016. Director Equity Incentive Plans. Effective March 2001, we adopted the M.D.C. Holdings, Inc. Stock Option Plan for Non-Employee Directors (the “2001 Director Stock Option Plan”). Each option granted under the Director Stock Option Plan vested immediately and expires ten years from the date of grant. The 2001 Director Stock Option Plan terminated on May 21, 2012 and stock options outstanding at the time of plan termination may continue to be exercised in accordance with their terms. A total of 0.4 million shares of MDC common stock were reserved for issuance under the 2001 Director Stock Option Plan as of December 31, 2016. Effective April 27, 2011, our shareholders approved the M.D.C. Holdings, Inc. 2011 Stock Option Plan for Non-Employee Directors (the “2011 Director Stock Option Plan”), which provides for the grant of non-qualified stock options to non-employee directors of the Company. Effective March 29, 2016, our shareholders approved an amendment to the 2011 Director Stock Option Plan to provide the non-employee directors with an alternative to elect to receive an award of restricted stock in lieu of a stock option. Pursuant to the 2011 Director Stock Option Plan as amended, on August 1 of each year, each non-employee director is granted either (1) an option to purchase 25,000 shares of MDC common stock or (2) shares of restricted stock having an expense to the Company that is equivalent to the stock option. Each option granted under the 2011 Director Stock Option Plan vests immediately, becomes exercisable six months after grant, and expires ten years from the date of grant. The option exercise price must be equal to the fair market value (as defined in the plan) of our common stock on the date of grant of the option. Each restricted stock award granted under the 2011 Director Stock Option Plan vests seven months after the grant date. At December 31, 2016, a total of 1.2 million shares of MDC common stock were reserved for issuance under the 2011 Director Stock Option Plan and 0.6 million shares remained available for grant under this plan as of December 31, 2016. Employee Benefit Plan. We have a defined contribution plan pursuant to Section 401(k) of the Internal Revenue Code where each employee may elect to make before-tax contributions up to the current tax limits. We match employee contributions on a discretionary basis and, as of December 31, 2016, we had accrued $1.3 million related to the match that is expected to be contributed in the first quarter of 2017 for 2016 activity. At December 31, 2015, we had accrued $1.0 million related to the match that was contributed during the first quarter of 2016 for 2015 activity. At December 31, 2014, we had accrued $0.9 million related to the match that was contributed during the first quarter of 2015 for 2014 activity. 20. Stock Based Compensation All share and per share amounts, as applicable, have been adjusted for the stock dividend distributed in December 2016. Determining Fair Value of Share-Based Payment Awards. Most options that we grant contain only a service condition (“Service-Based” option) and therefore vest over a specified number of years as long as the employee is employed by the Company. For Service-Based options, we use the Black-Scholes option pricing model to determine the grant date fair value. During 2015, we also granted 1 million Market-Based options to each of the Chief Executive Officer and the Chief Operating Officer. These options were valued using a Monte Carlo simulation model. Refer to the “Market-Based Stock Option Awards” section below. The fair values for Service-Based options granted for the years ended December 31, 2016, 2015 and 2014 were estimated using the Black-Scholes option pricing model with the below weighted-average assumptions. Based on calculations using the Black-Scholes option pricing model, the weighted-average grant date fair values of stock options granted during 2016, 2015 and 2014 were $4.04, $4.55 and $7.12, respectively. The expected life of options in the table above represents the weighted-average period for which the options are expected to remain outstanding and are derived primarily from historical exercise patterns. The expected volatility is determined based on our review of the implied volatility that is derived from the price of exchange traded options of the Company. The risk-free interest rate assumption is determined based upon observed interest rates appropriate for the expected term of our employee stock options. The dividend yield assumption is based on our history of dividend payouts. An annual forfeiture rate is estimated at the time of grant for all share-based payment awards which contain service and/or performance conditions. That rate is revised, if necessary, in subsequent periods if the actual forfeiture rate differs from our estimate. Stock Option Award Activity. Stock option activity under our option plans, restated as applicable for stock dividends, for the years ended December 31, 2016, 2015 and 2014 were as follows. (1) Total options granted in 2015 include a total of 2,100,000 Market-Based options granted to our CEO and COO. See further discussion regarding these grants in the “Market-Based Stock Option Awards” section below. The total intrinsic value of options (difference between price per share as of the exercise date and the exercise price, times the number of options outstanding) exercised during the years ended December 31, 2015 and 2014 was $0.2 million and $0.1 million, respectively. No options were exercised during the year ended December 31, 2016. The following table provides data for our stock options that are vested or expected to vest as of December 31, 2016. The aggregate intrinsic values in the tables above represent the total pretax intrinsic values (the difference between the closing price of MDC’s common stock on the last trading day of fiscal 2016 and the exercise price, multiplied by the number of in-the-money stock option shares) that would have been received by the option holders had all in-the-money outstanding stock options been exercised on December 31, 2016. The following table summarizes information associated with outstanding and exercisable stock options at December 31, 2016. Total compensation expense relating to stock options was $5.6 million, $8.1 million and $3.3 million for the years ended December 31, 2016, 2015 and 2014, respectively. Our recognized tax benefit from this expense for the years ended December 31, 2016, 2015 and 2014 was $2.1 million, $3.1 million and $1.3 million, respectively. As of December 31, 2016, $0.7 million of total unrecognized compensation cost related to stock options was expected to be recognized as an expense by the Company in the future over a weighted-average period of approximately 2.0 years. Our realized tax benefit from stock options exercised for the years ended December 31, 2015 and 2014 was $0.1 million and $0, respectively. No stock options were exercised during the year ended December 31, 2016. Market-Based Stock Option Awards. On May 18, 2015, the Company’s Compensation Committee granted a non-qualified stock option to each of the Chief Executive Officer and the Chief Operating Officer for 1,050,000 shares of common stock under the Company’s 2011 Equity Incentive Plan. The terms of each option provide that, over a five year period, one third of the option shares will vest as of each of the third, fourth, and fifth anniversary dates of the grant of the option; provided that all unvested option shares will vest immediately in the event the closing price of the Company’s stock, as reported by the New York Stock Exchange, in any 20 out of 30 consecutive trading days closes at a price equal to or greater than 120% of the closing price on the date of grant (the “market-based condition”). The option exercise price is equal to the closing price of the Company’s common stock on the date of grant, which was $27.10 and the expiration date of each option is May 18, 2025. As of December 31, 2016, no shares are exercisable. In accordance with ASC 718, the market-based awards were assigned a fair value of $5.35 per share (total value of $11.2 million) on the date of grant using a Monte Carlo simulation model and, as calculated under that model, all expense was recorded on a straight-line basis through the end of the 2016 second quarter. The following assumptions were used in the model. Restricted and Unrestricted Stock Award Activity. Non-vested restricted stock awards, restated as applicable for stock dividends, at December 31, 2016, 2015 and 2014 and changes during those years were as follows: Total compensation expense relating to restricted stock awards was $1.9 million, $2.0 million and $2.7 million for the years ended December 31, 2016, 2015 and 2014, respectively. Our recognized tax benefit from this expense for the years ended December 31, 2016, 2015 and 2014 was $0.7 million, $0.8 million and $1.0 million, respectively. At December 31, 2016, there was $2.5 million of unrecognized compensation expense related to non-vested restricted stock awards that is expected to be recognized as an expense by us in the future over a weighted-average period of approximately 2.9 years. The total intrinsic value of unvested restricted stock awards (the closing price of MDC’s common stock on the last trading day of fiscal 2016 multiplied by the number of unvested awards) at December 31, 2016 was $4.9 million. The total intrinsic value of restricted stock which vested during each of the years ended December 31, 2016, 2015 and 2014 was $1.3 million, $2.9 million and $4.2 million, respectively. Performance Stock Unit Awards. On July 25, 2016, the Company’s Compensation Committee granted long term performance stock unit awards (“PSUs”) to each of the Chief Executive Officer, the Chief Operating Officer, and the Chief Financial Officer under the Company’s 2011 Equity Incentive Plan. The PSUs will be earned based upon the Company’s performance, over a three year period commencing July 1, 2016 and ending June 30, 2019 (the “Performance Period”), measured by increasing average home sale revenues over the Base Period. The “Base Period” for the awards is July 1, 2015 to June 30, 2016. The awards are conditioned upon the Company achieving a minimum average gross margin from home sales percentage (excluding impairments) of at least fifteen percent (15%) over the Performance Period. Target goals of 105,000 shares for each of the Chief Executive Officer and the Chief Operating Officer and 26,250 shares for the Chief Financial Officer (the “Target Goals”) will be earned if the Company’s three year average home sale revenues during the Performance Period (“Performance Revenues”) exceed the home sale revenues during the Base Period (“Base Revenues”) by at least 10% but less than 20%. If Performance Revenues exceed the Base Revenues by at least 5% but less than 10%, fifty percent of the Target Goals will be earned. If Performance Revenues exceed the Base Revenues by at least 20%, twice the Target Goals will be earned. In accordance with ASC 718, the PSUs are valued at the fair value on the date of grant. The grant date fair value of these awards was $22.93 per share and the maximum potential expense that could be recognized by the Company if the maximum of the performance targets were met would be approximately $10.8 million. ASC 718 prohibits recognition of expense associated with performance based stock awards until achievement of the performance targets are probable of occurring. As of December 31, 2016, the Company concluded that achievement of the performance targets remains substantially uncertain and the level of probability required to record compensation expense were not met. 21. Results of Quarterly Operations (Unaudited) (Restated for Stock Dividends) 22. Supplemental Guarantor Information Our senior notes are fully and unconditionally guaranteed on an unsecured basis, jointly and severally, by the following subsidiaries (collectively, the "Guarantor Subsidiaries"), which are 100%-owned subsidiaries of the Company. ● M.D.C. Land Corporation ● RAH of Florida, Inc. ● Richmond American Construction, Inc. ● Richmond American Homes of Arizona, Inc. ● Richmond American Homes of Colorado, Inc. ● Richmond American Homes of Delaware, Inc. ● Richmond American Homes of Florida, LP ● Richmond American Homes of Illinois, Inc. ● Richmond American Homes of Maryland, Inc. ● Richmond American Homes of Nevada, Inc. ● Richmond American Homes of New Jersey, Inc. ● Richmond American Homes of Pennsylvania, Inc. ● Richmond American Homes of Utah, Inc. ● Richmond American Homes of Virginia, Inc. ● Richmond American Homes of Washington, Inc. The senior note indentures do not provide for a suspension of the guarantees, but do provide that any Guarantor may be released from its guarantee so long as (1) no default or event of default exists or would result from release of such guarantee, (2) the Guarantor being released has consolidated net worth of less than 5% of the Company’s consolidated net worth as of the end of the most recent fiscal quarter, (3) the Guarantors released from their guarantees in any year-end period comprise in the aggregate less than 10% (or 15% if and to the extent necessary to permit the cure of a default) of the Company’s consolidated net worth as of the end of the most recent fiscal quarter, (4) such release would not have a material adverse effect on the homebuilding business of the Company and its subsidiaries and (5) the Guarantor is released from its guarantee(s) under all Specified Indebtedness (other than by reason of payment under its guarantee of Specified Indebtedness). Upon delivery of an officers’ certificate and an opinion of counsel stating that all conditions precedent provided for in the indenture relating to such transactions have been complied with and the release is authorized, the guarantee will be automatically and unconditionally released. “Specified Indebtedness” means indebtedness under the senior notes, the Company’s Indenture dated as of December 3, 2002, the Revolving Credit Facility, and any refinancing, extension, renewal or replacement of any of the foregoing. We have determined that separate, full financial statements of the Guarantor Subsidiaries would not be material to investors and, accordingly, supplemental financial information for the Guarantor and Non-Guarantor Subsidiaries is presented below. M.D.C. Holdings, Inc. Supplemental Condensed Combining Balance Sheet M.D.C. Holdings, Inc. Supplemental Condensed Combining Balance Sheet M.D.C. Holdings, Inc. Supplemental Condensed Combining Statements of Operations and Comprehensive Income M.D.C. Holdings, Inc. Supplemental Condensed Combining Statement of Operations and Comprehensive Income M.D.C. Holdings, Inc. Supplemental Condensed Combining Statement of Cash Flows M.D.C. Holdings, Inc. Supplemental Condensed Combining Statement of Cash Flows | Here's a summary of the financial statement excerpt:
Financial Statement Overview:
1. Profit/Loss:
- Implements first-in, first-out method for determining security costs
- Recognizes other-than-temporary impairment (OTTI) in consolidated statements
2. Cash and Restricted Cash:
- Receives earnest money deposits from home sale contracts
- Some states restrict use of deposits without specific measures like surety bonds
3. Accounting Practices:
- Uses accounting estimates and assumptions in financial reporting
- Acknowledges potential differences between estimated and actual results
4. Assets:
- Segments include West, Mountain, East, Corporate, and Financial Services
- Asset composition varies by segment:
* Homebuilding segments: Primarily inventory
* Corporate segment: Cash, cash equivalents, marketable securities, deferred tax assets
* Financial services segment: Cash, cash equivalents, | Claude |
. Consolidated Statements of Income Fortune Brands Home & Security, Inc. and Subsidiaries See . Consolidated Statements of Comprehensive Income Fortune Brands Home & Security, Inc. and Subsidiaries (a) Income tax benefit (expense) on unrealized (losses) gains on derivatives of $0.5 million, $(0.5) million and $(0.2) million and on defined benefit plans of $1.2 million, $4.0 million and $46.4 million in 2016, 2015 and 2014, respectively. See . Consolidated Balance Sheets Fortune Brands Home & Security, Inc. and Subsidiaries (a) Common stock, par value $0.01 per share, 177.7 million shares and 175.2 million shares issued at December 31, 2016 and 2015, respectively. See . Consolidated Statements of Cash Flows Fortune Brands Home & Security, Inc. and Subsidiaries (a) Capital expenditures of $11.9 million, $20.0 million and $4.2 million that have not been paid as of December 31, 2016, 2015 and 2014, respectively, were excluded from the Statement of Cash Flows. See . Consolidated Statements of Equity Fortune Brands Home & Security, Inc. and Subsidiaries See . 1. Background and Basis of Presentation The Company is a leading home and security products company with a portfolio of leading branded products used for residential home repair, remodeling, new construction and security applications. References to (i) “Fortune Brands,” “the Company,” “we,” “our” and “us” refer to Fortune Brands Home & Security, Inc. and its consolidated subsidiaries as a whole, unless the context otherwise requires. Basis of Presentation The consolidated financial statements include the accounts of Fortune Brands and its wholly-owned subsidiaries. The consolidated financial statements in this Annual Report on Form 10-K have been derived from the accounts of the Company and its wholly-owned subsidiaries. The Company’s consolidated financial statements are based on a fiscal year ending December 31. Certain of the Company’s subsidiaries operate on a 52 or 53 week fiscal year ending during the month of December. In December 2016, there were certain transactions that resulted in approximately $49 million of net cash outflows, relating to payments made to third parties in the normal course of business during the period between the year-end of our wholly-owned subsidiaries and the Company’s year-end. In September 2016, we acquired ROHL LLC (“ROHL”) and in a related transaction, we acquired TCL Manufacturing which gave us ownership of Perrin & Rowe Limited (“Perrin & Rowe”), and in May 2016, we acquired Riobel Inc (“Riobel”). The financial results of ROHL, Perrin & Rowe and Riobel were included in the Company’s consolidated balance sheets as of December 31, 2016 and in the Company’s consolidated statements of income and statements of cash flow beginning in September 2016 and May 2016, respectively. In September 2015, we completed the sale of Waterloo Industries, Inc. (“Waterloo”). In accordance with Accounting Standards Codification (“ASC”) requirements, the results of operations of Waterloo through the date of sale, were classified and separately stated as discontinued operations in the accompanying consolidated statements of income for 2015 and 2014. The assets and liabilities of Waterloo were classified as discontinued operations in the accompanying consolidated balance sheet as of December 31, 2014. In May 2015, we acquired Norcraft Companies, Inc. (“Norcraft”). The financial results of Norcraft were included in the Company’s consolidated statements of income and statements of cash flow beginning in May 2015 and the consolidated balance sheets as of December 31, 2015 and 2016. In September 2014, we sold all of the shares of stock of Fortune Brands Windows, Inc., our subsidiary that owned and operated the Simonton windows business. The results of operations of Simonton were reclassified and separately stated as discontinued operations in the accompanying consolidated statements of income for 2014. The cash flows from discontinued operations for 2016, 2015 and 2014 were not separately classified on the accompanying consolidated statements of cash flows. Information on Business Segments was revised to exclude these discontinued operations. 2. Significant Accounting Policies Use of Estimates The presentation of financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) requires us to make estimates and assumptions that affect reported amounts and related disclosures. Actual results in future periods could differ from those estimates. Cash and Cash Equivalents Highly liquid investments with an original maturity of three months or less are included in cash and cash equivalents. Allowances for Doubtful Accounts Trade receivables are recorded at the stated amount, less allowances for discounts, doubtful accounts and returns. The allowances for doubtful accounts represent estimated uncollectible receivables associated with potential customer defaults on contractual obligations (usually due to customers’ potential insolvency), or discounts related to early payment of accounts receivables by our customers. The allowances include provisions for certain customers where a risk of default has been specifically identified. In addition, the allowances include a provision for customer defaults on a general formula basis when it is determined the risk of some default is probable and estimable, but cannot yet be associated with specific customers. The assessment of the likelihood of customer defaults is based on various factors, including the length of time the receivables are past due, historical collection experience and existing economic conditions. In accordance with this policy, our allowance for doubtful accounts was $7.4 million and $5.8 million as of December 31, 2016 and 2015, respectively. Inventories The majority of our inventories are accounted for using the first-in, first-out inventory method. Inventory provisions are recorded to reduce inventory to the lower of cost or market value for obsolete or slow moving inventory based on assumptions about future demand and marketability of products, the impact of new product introductions, inventory levels and turns, product spoilage and specific identification of items, such as product discontinuance, engineering/material changes, or regulatory-related changes. We also use the last-in, first-out (“LIFO”) inventory method in those product groups in which metals inventories comprise a significant portion of our inventories. LIFO inventories at December 31, 2016 and 2015 were $235.5 million (with a current cost of $244.4 million) and $227.9 million (with a current cost of $243.1 million), respectively. Property, Plant and Equipment Property, plant and equipment are carried at cost. Depreciation is provided, principally on a straight-line basis, over the estimated useful lives of the assets. Gains or losses resulting from dispositions are included in operating income. Betterments and renewals, which improve and extend the life of an asset, are capitalized; maintenance and repair costs are expensed as incurred. Assets held for use to be disposed of at a future date are depreciated over the remaining useful life. Assets to be sold are written down to fair value at the time the assets are being actively marketed for sale. Estimated useful lives of the related assets are as follows: Long-lived Assets In accordance with ASC requirements for Property, Plant and Equipment, a long-lived asset (including amortizable identifiable intangible assets) or asset group held for use is tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. When such events occur, we compare the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group to the carrying amount of the long-lived asset or asset group. The cash flows are based on our best estimate of future cash flows derived from the most recent business projections. If this comparison indicates that there is an impairment, the amount of the impairment is calculated based on fair value. Fair value is estimated primarily using discounted expected future cash flows on a market-participant basis. Goodwill and Indefinite-lived Intangible Assets In accordance with ASC requirements for Intangibles - Goodwill and Other, goodwill is tested for impairment at least annually in the fourth quarter, and written down when impaired. An interim impairment test is performed if an event occurs or conditions change that would more likely than not reduce the fair value of the reporting unit below the carrying value. We evaluate the recoverability of goodwill using a weighting of the income (80%) and market (20%) approaches. For the income approach, we use a discounted cash flow model, estimating the future cash flows of the reporting units to which the goodwill relates, and then discounting the future cash flows at a market-participant-derived weighted-average cost of capital. In determining the estimated future cash flows, we consider current and projected future levels of income based on management’s plans for that business; business trends, prospects and market and economic conditions; and market-participant considerations. Furthermore, our projection for the U.S. home products market is inherently subject to a number of uncertain factors, such as employment, home prices, credit availability, new home starts and the rate of home foreclosures. For the market approach, we apply market multiples for peer groups to the current operating results of the reporting units to determine each reporting unit’s fair value. The Company’s reporting units are operating segments. When the estimated fair value of a reporting unit is less than its carrying value, we measure and recognize the amount of the goodwill impairment loss, if any. Impairment losses, limited to the carrying value of goodwill, represent the excess of the carrying value of a reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of a reporting unit is estimated based on a hypothetical allocation of each reporting unit’s fair value to all of its underlying assets and liabilities. Purchased intangible assets other than goodwill are amortized over their useful lives unless those lives are determined to be indefinite. The determination of the useful life of an intangible asset other than goodwill is based on factors including historical and tradename performance with respect to consumer name recognition, geographic market presence, market share, and plans for ongoing tradename support and promotion. Certain of our tradenames have been assigned an indefinite life as we currently anticipate that these tradenames will contribute cash flows to the Company indefinitely. Indefinite-lived intangible assets are not amortized, but are evaluated at least annually to determine whether the indefinite useful life is appropriate. We review indefinite-lived intangible assets for impairment annually in the fourth quarter, and whenever market or business events indicate there may be a potential impairment of that intangible asset. Impairment losses are recorded to the extent that the carrying value of the indefinite-lived intangible asset exceeds its fair value. We measure fair value using the standard relief-from-royalty approach which estimates the present value of royalty income that could be hypothetically earned by licensing the brand name to a third party over the remaining useful life. We first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. Qualitative factors include changes in volume, customers and the industry. If it is deemed more likely than not that an intangible asset is impaired, we will perform a quantitative impairment test. The events and/or circumstances that could have a potential negative effect on the estimated fair value of our reporting units and indefinite-lived tradenames include: actual new construction and repair and remodel growth rates that lag our assumptions, actions of key customers, volatility of discount rates, continued economic uncertainty, higher levels of unemployment, weak consumer confidence, lower levels of discretionary consumer spending and a decrease in royalty rates. We cannot predict the occurrence of certain events or changes in circumstances that might adversely affect the carrying value of goodwill and indefinite-lived intangible assets. Defined Benefit Plans We have a number of pension plans in the United States, covering many of the Company’s employees. In addition, the Company provides postretirement health care and life insurance benefits to certain retirees. We record amounts relating to these plans based on calculations in accordance with ASC requirements for Compensation - Retirement Benefits, which include various actuarial assumptions, including discount rates, assumed rates of return, compensation increases, turnover rates and health care cost trend rates. We recognize changes in the fair value of pension plan assets and net actuarial gains or losses in excess of 10 percent of the greater of the fair value of pension plan assets or each plan’s projected benefit obligation (the “corridor”) in earnings immediately upon remeasurement, which is at least annually in the fourth quarter of each year. We review our actuarial assumptions on an annual basis and make modifications to the assumptions based on current economic conditions and trends. The discount rate used to measure obligations is based on a spot-rate yield curve on a plan-by-plan basis that matches projected future benefit payments with the appropriate interest rate applicable to the timing of the projected future benefit payments. The expected rate of return on plan assets is determined based on the nature of the plans’ investments, our current asset allocation and our expectations for long-term rates of return. Compensation increases reflect expected future compensation trends. For postretirement benefits, our health care trend rate assumption is based on historical cost increases and expectations for long-term increases. The cost or benefit of plan changes, such as increasing or decreasing benefits for prior employee service (prior service cost), is deferred and included in expense on a straight-line basis over the average remaining service period of the related employees. We believe that the assumptions utilized in recording obligations under our plans, which are presented in Note 14, “Defined Benefit Plans,” are reasonable based on our experience and on advice from our independent actuaries; however, differences in actual experience or changes in the assumptions may materially affect our financial position and results of operations. We will continue to monitor these assumptions as market conditions warrant. Insurance Reserves We provide for expenses associated with workers’ compensation and product liability obligations when such amounts are probable and can be reasonably estimated. The accruals are adjusted as new information develops or circumstances change that would affect the estimated liability. Litigation Contingencies Our businesses are subject to risks related to threatened or pending litigation and are routinely defendants in lawsuits associated with the normal conduct of business. Liabilities and costs associated with litigation-related loss contingencies require estimates and judgments based on our knowledge of the facts and circumstances surrounding each matter and the advice of our legal counsel. We record liabilities for litigation-related losses when a loss is probable and we can reasonably estimate the amount of the loss in accordance with ASC requirements for Contingencies. We evaluate the measurement of recorded liabilities each reporting period based on the then-current facts and circumstances specific to each matter. The ultimate losses incurred upon final resolution of litigation-related loss contingencies may differ materially from the estimated liability recorded at any particular balance sheet date. Changes in estimates are recorded in earnings in the period in which such changes occur. Income Taxes In accordance with ASC requirements for Income Taxes, we establish deferred tax liabilities or assets for temporary differences between financial and tax reporting bases and subsequently adjust them to reflect changes in tax rates expected to be in effect when the temporary differences reverse. We record a valuation allowance reducing deferred tax assets when it is more likely than not that such assets will not be realized. We record liabilities for uncertain income tax positions based on a two-step process. The first step is recognition, where we evaluate whether an individual tax position has a likelihood of greater than 50% of being sustained upon examination based on the technical merits of the position, including resolution of any related appeals or litigation processes. For tax positions that are currently estimated to have a less than 50% likelihood of being sustained, no tax benefit is recorded. For tax positions that have met the recognition threshold in the first step, we perform the second step of measuring the benefit to be recorded. The actual benefits ultimately realized may differ from our estimates. In future periods, changes in facts, circumstances, and new information may require us to change the recognition and measurement estimates with regard to individual tax positions. Changes in recognition and measurement estimates are recorded in the consolidated statement of income and consolidated balance sheet in the period in which such changes occur. As of December 31, 2016, we had liabilities for unrecognized tax benefits pertaining to uncertain tax positions totaling $58.2 million. It is reasonably possible that the unrecognized tax benefits may decrease in the range of $4.0 million to $5.0 million in the next 12 months primarily as a result of the conclusion of U.S. federal, state and foreign income tax proceedings. Revenue Recognition Revenue is recorded when persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectibility is reasonably assured. Revenue is recorded net of applicable provisions for discounts, returns and allowances. We record estimates for reductions to revenue for customer programs and incentives, including price discounts, volume-based incentives, promotions and cooperative advertising when revenue is recognized. Sales returns are based on historical returns, current trends and forecasts of product demand. Cost of Products Sold Cost of products sold includes all costs to make products saleable, such as labor costs, inbound freight, purchasing and receiving costs, inspection costs and internal transfer costs. In addition, all depreciation expense associated with assets used to manufacture products and make them saleable is included in cost of products sold. Customer Program Costs Customer programs and incentives are a common practice in our businesses. Our businesses incur customer program costs to obtain favorable product placement, to promote sales of products and to maintain competitive pricing. Customer program costs and incentives, including rebates and promotion and volume allowances, are accounted for in either “net sales” or the category “selling, general and administrative expenses” at the time the program is initiated and/or the revenue is recognized. The costs are predominantly recognized in “net sales” and include, but are not limited to, volume allowances and rebates, promotional allowances, and cooperative advertising programs. These costs are recorded at the later of the time of sale or the implementation of the program based on management’s best estimates. Estimates are based on historical and projected experience for each type of program or customer. Volume allowances are accrued based on management’s estimates of customer volume achievement and other factors incorporated into customer agreements, such as new product purchases, store sell-through, merchandising support, levels of returns and customer training. Management periodically reviews accruals for these rebates and allowances, and adjusts accruals when circumstances indicate (typically as a result of a change in volume expectations). The costs typically recognized in “selling, general and administrative expenses” include product displays, point of sale materials and media production costs. The costs included in the “selling, general and administrative expenses” category were $44.1 million, $43.2 million and $43.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. Selling, General and Administrative Expenses Selling, general and administrative expenses include advertising costs; marketing costs; selling costs, including commissions; research and development costs; shipping and handling costs, including warehousing costs; and general and administrative expenses. Shipping and handling costs included in selling, general and administrative expenses were $197.0 million, $184.6 million and $169.7 million in 2016, 2015 and 2014, respectively. Advertising costs, which amounted to $199.1 million, $195.4 million and $200.4 million in 2016, 2015 and 2014, respectively, are principally expensed as incurred. Advertising costs include product displays, media production costs and point of sale materials. Advertising costs recorded as a reduction to net sales, primarily cooperative advertising, were $52.5 million, $63.2 million and $66.8 million in 2016, 2015 and 2014, respectively. Advertising costs recorded in selling, general and administrative expenses were $146.6 million, $132.2 million and $133.6 million in 2016, 2015 and 2014, respectively. Research and development expenses include product development, product improvement, product engineering and process improvement costs. Research and development expenses, which were $53.1 million, $48.7 million and $46.1 million in 2016, 2015 and 2014, respectively, are expensed as incurred. Stock-based Compensation Stock-based compensation expense, measured as the fair value of an award on the date of grant, is recognized in the financial statements over the period that an employee is required to provide services in exchange for the award. The fair value of each option award is measured on the date of grant using the Black-Scholes option-pricing model. The fair value of each performance award is based on the stock price at the date of grant and the probability of meeting performance targets. The fair value of each restricted stock unit granted is equal to the share price at the date of grant. See Note 13, “Stock-Based Compensation,” for additional information. Earnings Per Share Earnings per common share is calculated by dividing net income attributable to Fortune Brands by the weighted-average number of shares of common stock outstanding during the year. Diluted earnings per common share include the impact of all potentially dilutive securities outstanding during the year. See Note 20, “Earnings Per Share,” for further discussion. Foreign Currency Translation Foreign currency balance sheet accounts are translated into U.S. dollars at the actual rates of exchange at the balance sheet date. Income and expenses are translated at the average rates of exchange in effect during the period for the foreign subsidiaries where the local currency is the functional currency. The related translation adjustments are made directly to a separate component of the “accumulated other comprehensive income” (“AOCI”) caption in equity. Transactions denominated in a currency other than the functional currency of a subsidiary are translated into functional currency with resulting transaction gains or losses recorded in other expense, net. Derivative Financial Instruments In accordance with ASC requirements for Derivatives and Hedging, all derivatives are recognized as either assets or liabilities on the balance sheet and measurement of those instruments is at fair value. If the derivative is designated as a fair value hedge and is highly effective, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings in the same period. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded directly to a separate component of AOCI, and are recognized in the consolidated statement of income when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. Deferred currency gains/(losses) of $(3.5) million and $3.6 million (before tax impact) was reclassified into earnings for the year ended December 31, 2016 and 2015, respectively. There was no impact of deferred currency gains/losses on earnings in 2014. Based on foreign exchange rates as of December 31, 2016, we estimate that $0.2 million of net currency derivative losses included in AOCI as of December 31, 2016 will be reclassified to earnings within the next twelve months. Recently Issued Accounting Standards Simplifying the Test for Goodwill Impairment. In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-04 that simplifies the accounting for goodwill impairment for all entities. Under the new standard, if a reporting unit’s carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The standard eliminates the current requirement to calculate a goodwill impairment charge by comparing the implied fair value of goodwill with its carrying amount (i.e. hypothetical purchase price allocation). The new standard is effective for annual and interim impairment tests performed in periods beginning after January 1, 2020 and early adoption is permitted. We are assessing the impact the adoption of this standard will have on our financial statements. Clarifying the Definition of a Business In January 2017, the FASB issued ASU 2017-01 that changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business and therefore business combination guidance would apply. The new standard requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset (i.e., a business) or a group of similar identifiable assets (i.e., not a business). In this case the transfer of assets does not constitute a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs (e.g., revenues with customers). The new standard is effective January 1, 2018 and early adoption is permitted. We are assessing the impact the adoption of this standard will have on our financial statements. Restricted Cash In November 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-18 according to which entities are no longer required to present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows. The prior standard did not address the classification of activity related to restricted cash and restricted cash equivalents in the statement of cash flows and this has resulted in diversity in cash flows presentation. The new standard is effective from January 1, 2018 and early adoption is permitted, however we elected not to early adopt. We do not expect the adoption of this standard to have a material effect on our financial statements. Intra-Entity Transfers of Assets Other Than Inventory In October 2016, the FASB issued ASU 2016-16 that will require companies to account for the income tax effects of intercompany sales and transfers of assets other than inventory (e.g., intangible assets) when the transfer occurs. Under the current guidance companies are required to defer the income tax effects of intercompany transfers of assets until the asset has been sold to an outside party or otherwise recognized (e.g., depreciated, amortized, impaired). The new standard is effective from January 1, 2018 and early adoption is permitted, however we elected not to early adopt. Transition method will be a “modified retrospective”, i.e. with a cumulative adjustment to retained earnings at adoption. We are assessing the impact the adoption of this standard will have on our financial statements. Classification of Certain Cash Receipts and Cash Payments In September 2016 the FASB issued ASU 2016-15 that will change how an entity classifies certain cash receipts and cash payments on its statement of cash flows. The key changes that may potentially impact our financial statements include the following: 1) cash payments for debt prepayment or extinguishment costs should be classified as financing cash outflows; 2) contingent consideration payments that are not made within three months after the consummation of a business combination would be classified as financing (if payment made is up to the acquisition date fair value of liability) or operating outflows (if the payment is in excess of acquisition fair value). Cash payments made “soon after” the consummation of a business combination generally will be classified as cash outflows for investing activities; 3) insurance settlement proceeds, would be classified based on the nature of the loss; and 4) company-owned life insurance settlement proceeds would be presented as investing cash inflows, and premiums could be classified as investing or operating cash outflows, or a combination of both. The new standard is effective beginning January 1, 2018 and should be adopted retrospectively. Early adoption is permitted however we elected not to early adopt. We are assessing the impact the adoption of this standard will have on our financial statements. Financial Instruments - Credit Losses In June 2016, the FASB issued ASU 2016-13 that changes the impairment model for most financial assets and certain other instruments that are not measured at fair value through net income. The new guidance applies to most financial assets measured at amortized cost, including trade and other receivables and loans as well as off-balance-sheet credit exposures (e.g., loan commitments, standby letters of credit). The standard will replace the “incurred loss” approach under the current guidance with an “expected loss” model that requires an entity to estimate its lifetime “expected credit loss”. The new standard is effective beginning January 1, 2020 and early application is permitted but not earlier than January 1, 2019. We are assessing the impact the adoption of this standard will have on our financial statements. Improvements to Employee Share-Based Payment Accounting In March 2016, the FASB issued ASU 2016-09 that requires entities to recognize the income tax effects of share-based awards in the income statement when the awards vest or are settled. The new standard also allows entities to withhold an amount up to an employee’s maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award. The new standard is effective for annual and interim periods beginning January 1, 2017. We early adopted this standard as of June 30, 2016. As a result, during the second quarter we reclassified the year-to-date 2016 excess tax benefit of $14.2 million and the second quarter benefit of $9 million from paid-in capital (statements of equity) into the income taxes line on the statements of comprehensive income. Further, we reclassified the excess tax benefits from the exercise of stock based compensation from financing into operating activities in the statement of cash flows in 2016. We also reclassified $9 million and $13.6 million of employee withholding taxes paid from operating into financing activities in the statement of cash flows for the six months period ended June 30, 2016 and 2015, respectively, as required by ASU 2016-09 (adopted retrospectively). The adoption did not impact the existing classification of the awards. Simplifying the Transition to the Equity Method of Accounting In March 2016, the FASB issued ASU 2016-07, which eliminates the requirement to apply the equity method of accounting retrospectively when an entity obtains significant influence over a previously held investment. Previously, entities were required to retrospectively apply the equity method of accounting when obtaining significant influence over an investment (for example due to an increase in ownership). The new standard is effective beginning January 1, 2017. Early application is permitted, however we elected not to early adopt. We do not expect this standard to have a material effect on our financial statements. Leases In February 2016, the FASB issued ASU 2016-02, “Leases” that requires lessees to recognize almost all leases on their balance sheet as a “right-of-use” asset and lease liability but recognize related expenses in a manner similar to current accounting. The guidance also eliminates current real estate-specific provisions for all entities. The new standard is effective for annual periods beginning after December 15, 2018 (calendar year 2019 for Fortune Brands) and early adoption is permitted. We are assessing the impact the adoption of this standard will have on our financial statements. Recognition and Measurement of Financial Assets and Financial Liabilities In January 2016, the FASB issued final guidance ASU 2016-01 that requires entities to measure investments in unconsolidated entities (other than those accounted for using the equity method of accounting) at fair value through the income statement. There will no longer be an available-for-sale classification (with changes in fair value reported in Other Comprehensive Income). In addition, the cost method is eliminated for equity investments without readily determinable fair values. The new standard is effective beginning January 1, 2018. Early application is permitted for certain provisions of the standard, however we elected not to early adopt. We do not expect the adoption of this standard to have a material effect on our financial statements. Simplifying Subsequent Measurement of Inventory In July 2015, the FASB issued a final standard that simplifies the subsequent measurement of inventory by replacing the current standard of lower of cost or market test. Under the current guidance the subsequent measurement of inventory is measured at the lower of cost or market, where “market” may have multiple possible outcomes. The new guidance requires subsequent measurement of inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs to sell (completion, disposal, and transportation). This new standard is effective for the annual period beginning January 1, 2017. Early application is permitted, however we elected not to early adopt. We do not expect this standard to have a material effect on our financial statements. Revenue from Contracts with Customers In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” This ASU clarifies the accounting for revenue arising from contracts with customers and specifies the disclosures that an entity should include in its financial statements. The standard is effective for annual reporting periods beginning after December 15, 2017 (calendar year 2018 for Fortune Brands). During 2016, the FASB issued certain amendments to the standard relating to the principal versus agent guidance, accounting for licenses of intellectual property and identifying performance obligations as well as the guidance on transition, collectability, noncash consideration and the presentation of sales and other similar taxes. The effective date and transition requirements for these amendments are the same as those of the original ASU. We have identified focus areas for each of our reporting segments and have made substantial progress in our assessment of the accounting and financial reporting implications as of the end of 2016. Based on our preliminary assessment, we have determined that the control of goods, separate performance obligations and right of return are the focus areas for the Company. We plan to complete our assessment of the impact of adoption during the third quarter of 2017 and finalize the adoption of the new revenue standard by the end of 2017. 3. Balance Sheet Information Supplemental information on our year-end consolidated balance sheets is as follows: 4. Acquisitions In September 2016, we acquired ROHL, a California-based luxury plumbing company. In a related transaction, we also acquired Perrin & Rowe, a UK manufacturer and designer of luxury kitchen and bathroom plumbing products. The total combined purchase price was approximately $166 million (including $3 million of liabilities assumed), subject to certain post-closing adjustments. We financed the transaction using cash on hand and borrowings under our existing credit facilities. Net sales and operating income in the twelve months ended December 31, 2016 were not material to the Company. The results of operations are included in the Plumbing segment. The goodwill expected to be deductible for income tax purposes is approximately $49 million. In May 2016, we acquired Riobel, a Canadian plumbing company specializing in premium showroom bath and shower fittings, for a total purchase price of $94.6 million in cash, subject to certain post-closing adjustments. We financed the transaction using cash on hand and borrowings under our existing credit facilities. Net sales and operating income in the twelve months ended December 31, 2016 were not material to the Company. The results of operations are included in the Plumbing segment. We do not expect any portion of goodwill to be deductible for income tax purposes. In May 2015, we completed our tender offer to purchase all of the outstanding shares of common stock of Norcraft, a leading publicly-owned manufacturer of kitchen and bathroom cabinetry, for a total purchase price of $648.6 million in cash. We financed the transaction using cash on hand and borrowings under our existing credit facilities. The results of operations of Norcraft are included in the Cabinets segment. We incurred $15.1 million of Norcraft acquisition-related transaction costs in the year ended December 31, 2015. The goodwill deductible for income tax purposes is $66.2 million. During the third quarter of 2016 and following the completion of the Norcraft purchase accounting measurement period, the Company identified certain immaterial prior period balance sheet misstatements relating to the calculation of deferred tax liabilities as disclosed in the purchase price allocation related to the Norcraft acquisition. The correction of the cumulative misstatement during the third quarter of 2016 resulted in a $24.3 million and $15.4 million reduction in Norcraft’s deferred tax liabilities and the carrying value of goodwill, respectively, and an offsetting increase of $8.9 million in the uncertain tax positions accrual. The Company assessed the materiality of these misstatements on previously issued financial statements and concluded that the misstatements were not material to the Consolidated Financial Statements for any interim or annual periods taken as a whole. The following table summarizes the final allocation of the purchase price to the fair value of assets acquired and liabilities assumed as of the date of the Norcraft acquisition. (a) Net assets exclude $15.5 million of cash transferred to the Company as the result of the Norcraft acquisition. Goodwill includes expected sales and cost synergies. Identifiable intangible assets consist of an indefinite-lived tradename of $150 million and customer relationships of $210 million. The useful life of the customer relationships identifiable intangible asset is 20 years. The following unaudited pro forma summary presents consolidated financial information as if Norcraft had been acquired on January 1, 2014. The unaudited pro forma financial information is based on historical results of operations and financial position of the Company and Norcraft. The pro forma results include: > the effect of certain transactions recorded in historical financial statements of Norcraft including: the expense relating to Norcraft’s tax receivable agreements settled upon the acquisition of Norcraft and the pro forma effect of a release of deferred tax valuation allowance, > estimated amortization of a definite-lived customer relationship intangible asset (amortized using the straight-line method), > the estimated cost of the inventory adjustment to fair value, > interest expense associated with debt that would have been incurred in connection with the acquisition, > the reclassification of Norcraft transaction costs from 2015 to the first quarter of 2014, and > adjustments to conform accounting policies. The unaudited pro forma financial information does not necessarily represent the results that would have occurred had the Norcraft acquisition occurred on January 1, 2014. In addition, the unaudited pro forma information should not be deemed to be indicative of future results. In March 2015, we acquired a cabinets component company for approximately $6 million in cash. This acquisition did not have a material impact on our financial statements. In December 2014, we acquired all of the issued and outstanding shares of capital stock of Anafree Holdings, Inc., the sole owner of Anaheim Manufacturing Company (“Anaheim”), which markets and sells garbage disposals, for $28.9 million in cash. We paid the purchase price using a combination of cash on hand and borrowings under our existing credit facilities. We completed our purchase price allocation in the first half of 2015 and as a result reclassified $17 million from goodwill to other identifiable assets. Net sales and operating income in the twelve months ended December 31, 2014 were not material to the Company. The results of operations of Anaheim are included in the Plumbing segment. In July 2014, we acquired all of the voting equity of John D. Brush & Co., Inc. (“SentrySafe”) for a purchase price of $116.7 million in cash. The purchase price was funded from our existing credit facilities. This acquisition broadened our product offering of security products. Net sales and operating income in the twelve months ended December 31, 2014 were not material to the Company. The results of operations of SentrySafe are included in the Security segment. These 2014 acquisitions were not material for the purposes of supplemental disclosure and did not have a material impact on our consolidated financial statements. 5. Discontinued Operations In 2015, we completed the sale of Waterloo for approximately $14 million in cash, subject to certain post-closing adjustments. We recorded a pre-tax loss of $16.9 million as the result of this sale. Transaction and other sale-related costs were approximately $2.8 million. The estimated tax benefit on the sale was $26.5 million with the after-tax gain of $7.0 million recorded within discontinued operations. The estimated tax benefit resulted primarily from a tax loss in excess of the financial reporting loss as a result of prior period nondeductible asset impairments. Waterloo is presented as a discontinued operation in our financial statements beginning January 1, 2014 and through the date of sale in accordance with ASC 205 requirements. Prior to classifying Waterloo as a discontinued operation, it was reported in the Security segment. In addition, in August 2014, we entered into a stock purchase agreement to sell the Simonton business for $130 million in cash. The sale was completed in September 2014. Simonton is presented as a discontinued operation in the Company’s financial statements in accordance with ASC requirements. The 2014 income (loss) from discontinued operations, net of tax, included a loss on sale of the Simonton business of $111.2 million as well as $14.1 million of restructuring and impairment charges for Waterloo in order to remeasure this business at the estimated fair value less costs to sell. Simonton was previously reported in the Doors segment. The following table summarizes the results of discontinued operations for the years ended December 31, 2015 and 2014. The year ended December 31, 2015 on a pre-tax basis consists of Waterloo only, however the comparable period in 2014 includes both Waterloo and Simonton. 6. Goodwill and Identifiable Intangible Assets We had goodwill of $1,833.8 million and $1,755.3 million as of December 31, 2016 and 2015, respectively. The increase of $78.5 million was primarily due to the acquisitions of Riobel and ROHL, partially offset by the Norcraft acquisition-related adjustment (See Note 4, “Acquisitions”). The change in the net carrying amount of goodwill by segment was as follows: (a) Net of accumulated impairment losses of $399.5 million in the Doors segment. We also had identifiable intangible assets, principally tradenames, of $1,107.0 million and $996.7 million as of December 31, 2016 and 2015, respectively. The $137.8 million increase in gross identifiable intangible assets was primarily due to the acquisitions in our Plumbing segment during 2016. The gross carrying value and accumulated amortization by class of intangible assets as of December 31, 2016 and 2015 were as follows: Amortizable intangible assets, principally tradenames and customer relationships, are subject to amortization on a straight-line basis over their estimated useful life, ranging from 3 to 30 years, based on the assessment of a number of factors that may impact useful life. These factors include historical tradename performance with respect to consumer name recognition, geographic market presence, market share, plans for ongoing tradename support and promotion, customer attrition rates, and other relevant factors. We expect to record intangible amortization of approximately $32 million in 2017, $30 million in 2018, $28 million in 2019, $28 million in 2020, and $28 million in 2021. We review indefinite-lived tradename intangible assets for impairment annually in the fourth quarter, as well as whenever market or business events indicate there may be a potential impact on a specific intangible asset. Impairment losses are recorded to the extent that the carrying value of the indefinite-lived intangible asset exceeds its fair value. We measure fair value using the standard relief-from-royalty approach which estimates the present value of royalty income that could be hypothetically earned by licensing the tradename to a third party over the remaining useful life. In 2016, 2015 and 2014, we did not record any asset impairment charges associated with goodwill or indefinite-lived intangible assets. As of December 31, 2016, the fair value of one of the tradenames in the Cabinets segment and one of our tradenames in the Doors segment exceeded their carrying value by less than 10%. Accordingly, a reduction in the estimated fair value of these tradenames could trigger an impairment. As of December 31, 2016, the carrying value of these tradenames was $168 million. Factors influencing our fair value estimates of these tradenames are described in the following paragraph. The events and/or circumstances that could have a potential negative effect on the estimated fair value of our reporting units and indefinite-lived tradenames include: actual new construction and repair and remodel growth rates that lag our assumptions, actions of key customers, volatility of discount rates, continued economic uncertainty, higher levels of unemployment, weak consumer confidence, lower levels of discretionary consumer spending, a decrease in royalty rates and decline in the trading price of our common stock. We cannot predict the occurrence of certain events or changes in circumstances that might adversely affect the carrying value of goodwill and indefinite-lived intangible assets. 7. Asset Impairment Charges In 2014, as a result of our decision to sell Waterloo, we recorded $9.1 million of pre-tax impairment charges in order to remeasure this business at the estimated fair value less costs to sell. These charges consisted of $8.1 million for fixed assets and $1.0 million for definite-lived intangible assets. Refer to Note 5, “Discontinued Operations,” for additional information on the sale of Waterloo. 8. External Debt and Financing Arrangements In June 2016, the Company amended and restated its credit agreement to combine and rollover the existing revolving credit facility and term loan into a new standalone $1.25 billion revolving credit facility. This amendment of the credit agreement was a non-cash transaction for the Company. Terms and conditions of the credit agreement, including the total commitment amount, essentially remained the same. The revolving credit facility will mature in June 2021 and borrowings thereunder will be used for general corporate purposes. On December 31, 2016 and 2015, our outstanding borrowings under these facilities, net of debt issuance costs relating to the term loan balance, were $540.0 million (revolver) and $279.0 million (term loan), respectively. At December 31, 2016 and 2015, the current portion of long-term debt was zero. Interest rates under the facility are variable based on LIBOR at the time of the borrowing and the Company’s long-term credit rating and can range from LIBOR + 0.9% to LIBOR + 1.5%. As of December 31, 2016, we were in compliance with all covenants under this facility. As a result of the refinancing, we wrote-off prepaid debt issuance costs of approximately $1.3 million as of June 30, 2016. We retrospectively adopted ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs,” on January 1, 2016, resulting in the reclassification of approximately $3 million of debt issuance costs from other current assets and other assets to long-term debt as of December 31, 2015. Adoption of this new guidance did not impact the Company’s equity, results of operations or cash flows. In June 2015, we issued $900 million of unsecured senior notes (“Senior Notes”) in a registered public offering. The Senior Notes consist of two tranches: $400 million of five-year notes due 2020 with a coupon of 3% and $500 million of ten-year notes due 2025 with a coupon of 4%. We used the proceeds from the Senior Notes offering to pay down our revolving credit facility and for general corporate purposes. On December 31, 2016 and 2015, the outstanding amount of the Senior Notes, net of underwriting commissions and price discounts, was $891.1 million and $889.7 million, respectively. We currently have uncommitted bank lines of credit in China, which provide for unsecured borrowings for working capital of up to $25.7 million in aggregate, of which zero and $0.8 million were outstanding, as of December 31, 2016 and 2015. The weighted-average interest rates on these borrowings were 1.5%, 1.0% and 7.6% in 2016, 2015 and 2014 respectively. The components of external long-term debt were as follows: (a) In 2016, the Company amended and restated its credit agreement to combine and rollover the existing revolving credit facility and term loan into a new standalone $1.25 billion revolving credit facility. Senior Notes payments during the next five years as of December 31, 2016 are zero in 2017 through 2019, $400 million in 2020 and zero in 2021. In our debt agreements, there are normal and customary events of default which would permit the lenders to accelerate the debt if not cured within applicable grace periods, such as failure to pay principal or interest when due or a change in control of the Company. There were no events of default as of December 31, 2016. 9. Financial Instruments We do not enter into financial instruments for trading or speculative purposes. We principally use financial instruments to reduce the impact of changes in foreign currency exchange rates and commodities used as raw materials in our products. The principal derivative financial instruments we enter into on a routine basis are foreign exchange contracts. Derivative financial instruments are recorded at fair value. The counterparties to derivative contracts are major financial institutions. We are subject to credit risk on these contracts equal to the fair value of these instruments. Management currently believes that the risk of incurring material losses is unlikely and that the losses, if any, would be immaterial to the Company. Raw materials used by the Company are subject to price volatility caused by weather, supply conditions, geopolitical and economic variables, and other unpredictable external factors. From time to time, we enter into commodity swaps to manage the price risk associated with forecasted purchases of materials used in our operations. We account for these commodity derivatives as economic hedges or cash flow hedges. Changes in the fair value of economic hedges are recorded directly into current period earnings. There were no material commodity swap contracts outstanding for the years ended December 31, 2016 and 2015. We enter into foreign exchange contracts primarily to hedge forecasted sales and purchases denominated in select foreign currencies, thereby limiting currency risk that would otherwise result from changes in exchange rates. The periods of the foreign exchange contracts correspond to the periods of the forecasted transactions, which generally do not exceed 12 to 15 months subsequent to the latest balance sheet date. For derivative instruments that are designated as fair value hedges, the gain or loss on the derivative instrument, as well as the offsetting loss or gain on the hedged item, are recognized on the same line of the statement of income. The effective portions of cash flow hedges are reported in other comprehensive income (“OCI”) and are recognized in the statement of income when the hedged item affects earnings. The changes in fair value for net investment hedges are recognized in the statement of income when realized upon sale or upon complete or substantially complete liquidation of the investment in the foreign entity. The ineffective portion of all hedges is recognized in current period earnings. In addition, changes in the fair value of all economic hedge transactions are immediately recognized in current period earnings. Our primary foreign currency hedge contracts pertain to the Canadian dollar, the Mexican peso and the Chinese yuan. The gross U.S. dollar equivalent notional amount of all foreign currency derivative hedges outstanding at December 31, 2016 was $192.7 million, representing a net settlement liability of $0.1 million. Based on foreign exchange rates as of December 31, 2016, we estimate that $0.2 million of net foreign currency derivative losses included in OCI as of December 31, 2016 will be reclassified to earnings within the next twelve months. The fair values of foreign exchange and commodity derivative instruments on the consolidated balance sheets as of December 31, 2016 and 2015 were: The effects of derivative financial instruments on the consolidated statements of income in 2016, 2015 and 2014 were: For cash flow hedges that are effective, the amounts recognized in OCI were (losses) gains of $(6.7) million and $6.8 million in 2016 and 2015, respectively. In the years ended December 31, 2016, 2015 and 2014, the ineffective portion of cash flow hedges recognized in Other expense, net, was insignificant. 10. Fair Value Measurements The carrying value and fair value of debt as of December 31, 2016 and 2015 were as follows: ASC requirements for Fair Value Measurements and Disclosures establish a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels. Level 1 inputs, the highest priority, are quoted prices in active markets for identical assets or liabilities. Level 2 inputs reflect other than quoted prices included in level 1 that are either observable directly or through corroboration with observable market data. Level 3 inputs are unobservable inputs due to little or no market activity for the asset or liability, such as internally-developed valuation models. We do not have any assets or liabilities measured at fair value on a recurring basis that are level 3. The estimated fair value of our Senior Notes and term loan is determined primarily using broker quotes, which are level 2 inputs. Assets and liabilities measured at fair value on a recurring basis as of December 31, 2016 and 2015 were as follows: The principal derivative financial instruments we enter into on a routine basis are foreign exchange contracts. In addition, from time to time, we enter into commodity swaps. Derivative financial instruments are recorded at fair value. During the second quarter of 2016, we entered into a joint venture arrangement with a partner to operate a manufacturing facility in China. Under the arrangement, we are required to make certain fixed payments to our partner each year starting in June 2017 and through June 2024 (final year of the agreement) and also purchase the outstanding preferred shares of our partner in 2024. During the second quarter of 2016, we recognized the fair value of $8.2 million of these contractual payments, including a redemption of the preferred shares ($7.2 million within other non-current liabilities and $1.0 million due within one year in other current liabilities). We have also recognized the excess of $5.2 million of this liability fair value over the $3.0 million cash contributed by our partner within paid-in capital. 11. Capital Stock The Company has 750 million authorized shares of common stock, par value $0.01 per share. The number of shares of common stock and treasury stock and the share activity for 2016 and 2015 were as follows: In December 2016, our Board of Directors increased the quarterly cash dividend by 13% to $0.18 per share of our common stock. The Company has 60 million authorized shares of preferred stock, par value $0.01 per share. At December 31, 2016, no shares of our preferred stock were outstanding. Our Board of Directors has the authority, without action by the Company’s stockholders, to designate and issue our preferred stock in one or more series and to designate the rights, preferences, limitations and privileges of each series of preferred stock, which may be greater than the rights of the Company’s common stock. In 2016, we repurchased approximately 8.8 million shares of outstanding common stock under the Company’s share repurchase program at a cost of $424.5 million. As of December 31, 2016, the Company’s total remaining share repurchase authorization under the remaining program was approximately $223.1 million. The share repurchase program does not obligate the Company to repurchase any specific dollar amount or number of shares and may be suspended or discontinued at any time. 12. Accumulated Other Comprehensive (Loss) Income The reclassifications out of accumulated other comprehensive (loss) income for the year ended December 31, 2016 and 2015 were as follows: (a) These accumulated other comprehensive (loss) income components are included in the computation of net periodic benefit cost. Refer to Note 14, “Defined Benefit Plans,” for additional information. (b) These accumulated other comprehensive loss components are included in discontinued operations. Total accumulated other comprehensive (loss) income consists of net income and other changes in business equity from transactions and other events from sources other than shareholders. It includes currency translation gains and losses, unrealized gains and losses from derivative instruments designated as cash flow hedges, and defined benefit plan adjustments. The after-tax components of and changes in accumulated other comprehensive (loss) income were as follows: 13. Stock-Based Compensation As of December 31, 2016, we had awards outstanding under two Long-Term Incentive Plans, the Fortune Brands Home & Security, Inc. 2013 Long-Term Incentive Plan (the “Plan”) and the 2011 Long-Term Incentive Plan (the “2011 Plan”, and together with the Plan - the “Plans”). Our stockholders approved the Plan in 2013, which provides for the granting of stock options, performance share awards, restricted stock units, and other equity-based awards, to employees, directors and consultants. As of December 31, 2016, approximately 6 million shares of common stock remained authorized for issuance under the Plan. In addition, shares of common stock may be automatically added to the number of shares of common stock that may be issued as awards expire, are terminated, cancelled or forfeited, or are used to satisfy the minimum required withholding taxes with respect to existing awards under the Plans. No new stock-based awards can be made under the 2011 Plan, but there are outstanding awards under the 2011 Plan that continue to vest and/or be exercisable. Upon the exercise or payment of stock-based awards, shares of common stock are issued from authorized common shares. Pre-tax stock-based compensation expense from continuing operations was as follows: Compensation costs that were capitalized in inventory were not material. Restricted Stock Units Restricted stock units have been granted to officers and certain employees of the Company and represent the right to receive unrestricted shares of Company common stock subject to continued employment. Restricted stock units granted to certain officers are also subject to attaining specific performance criteria. In addition, certain employees can elect to defer receipt of a portion of their RSU awards upon vesting. Compensation cost is recognized over the service period. We calculate the fair value of each restricted stock unit granted by using the average of the high and low share prices on the date of grant. Restricted stock units generally vest ratably over a three-year period. A summary of activity with respect to restricted stock units outstanding under the Plans for the year ended December 31, 2016 was as follows: The remaining unrecognized pre-tax compensation cost related to restricted stock units at December 31, 2016 was approximately $19.2 million, and the weighted-average period of time over which this cost will be recognized is 1.7 years. The fair value of restricted stock units that vested during 2016, 2015 and 2014 was $16.4 million, $24.9 million and $31.1 million, respectively. Stock Option Awards Stock options were granted to officers and select employees of the Company and represent the right to purchase shares of Company common stock subject to continued employment through each vesting date. All stock-based compensation to employees is required to be measured at fair value and expensed over the requisite service period. We recognize compensation expense on awards on a straight-line basis over the requisite service period for the entire award. Stock options granted under the Plans generally vest over a three-year period and have a maturity of ten years from the grant date. The fair value of Fortune Brands options was estimated at the date of grant using a Black-Scholes option pricing model with the assumptions shown in the following table: The determination of expected volatility is based on a blended peer group volatility for companies in similar industries, at a similar stage of life and with similar market capitalization because there is not sufficient historical volatility data for Fortune Brands common stock over the period commensurate with the expected term of stock options, as well as other relevant factors. The risk-free interest rate is based on U.S. government issues with a remaining term equal to the expected life of the stock options. The expected term is the period over which our employees are expected to hold their options. It is based on the simplified method from the Securities and Exchange Commission’s safe harbor guidelines. The dividend yield is based on the Company’s estimated dividend over the expected term. The weighted-average grant date fair value of stock options granted under the Plans during the years ended December 31, 2016, 2015 and 2014 was $12.70, $11.58 and $12.72, respectively. A summary of Fortune Brands stock option activity related to Fortune Brands and employees of Fortune Brands, Inc., our Former Parent, for the year ended December 31, 2016 was as follows: Options outstanding and exercisable at December 31, 2016 were as follows: (a) At December 31, 2016, the aggregate intrinsic value of options outstanding was $125.8 million. (b) At December 31, 2016, the weighted-average remaining contractual life of options exercisable was 4.7 years and the aggregate intrinsic value of options exercisable was $120.1 million. The remaining unrecognized compensation cost related to unvested awards at December 31, 2016 was $6.3 million, and the weighted-average period of time over which this cost will be recognized is 1.6 years. The fair value of options that vested during the years ended December 31, 2016, 2015 and 2014 was $6.0 million, $7.8 million and $9.8 million, respectively. The intrinsic value of Fortune Brands stock options exercised in the years ended December 31, 2016, 2015 and 2014 was $88.1 million, $78.0 million and $63.4 million, respectively. Performance Awards Performance share awards were granted to officers and select employees of the Company under the Plans and represent the right to earn shares of Company common stock based on the achievement of various segment or company-wide performance conditions, including cumulative diluted earnings per share, average return on invested capital, average return on net tangible assets and cumulative operating income during the three-year performance period. Compensation cost is amortized into expense over the performance period, which is generally three years, and is based on the probability of meeting performance targets. The fair value of each performance share award is based on the average of the high and low stock price on the date of grant. The following table summarizes information about performance share awards as of December 31, 2016, as well as activity during the year then ended, based on the target award amounts in the performance share award agreements: The remaining unrecognized pre-tax compensation cost related to performance share awards at December 31, 2016 was approximately $6.4 million, and the weighted-average period of time over which this cost will be recognized is 1.5 years. The fair value of performance share awards that vested during 2016 was $6.0 million. Director Awards Stock awards are used as part of the compensation provided to outside directors under the Plan. Awards are issued annually in the second quarter. In addition, outside directors can elect to have director fees paid in stock or can elect to defer payment of stock. Compensation cost is expensed at the time of an award based on the fair value of a share at the date of the award. In 2016, 2015 and 2014, we awarded 16,471, 19,695 and 22,654 shares of Company common stock to outside directors with a weighted average fair value on the date of the award of $57.37, $46.21 and $40.01, respectively. 14. Defined Benefit Plans We have a number of pension plans in the United States, covering many of the Company’s employees, however these plans have been closed to new hires. The plans provide for payment of retirement benefits, mainly commencing between the ages of 55 and 65, and also for payment of certain disability benefits. After meeting certain qualifications, an employee acquires a vested right to future benefits. The benefits payable under the plans are generally determined on the basis of an employee’s length of service and/or earnings. Employer contributions to the plans are made, as necessary, to ensure legal funding requirements are satisfied. Also, from time to time, we may make contributions in excess of the legal funding requirements. As previously communicated to our employees, benefits under our defined benefit plans were frozen as of December 31, 2016. In addition, the Company provides postretirement health care and life insurance benefits to certain retirees. The accumulated benefit obligation exceeds the fair value of assets for all pension plans. Amounts recognized in the consolidated balance sheets consist of: In the first quarter of 2013, the Company communicated a plan amendment to reduce health benefits to certain retired employees. Due to the risk of litigation at the time of the initial communication, the Company elected to defer the full recognition of the benefit arising from the plan amendment. Following a favorable court decision in the first quarter of 2016, the Company determined that it was now probable that it would realize the benefit from the plan amendment. As a result, the Company performed a re-measurement of the affected retiree plan liability as of March 31, 2016. This remeasurement resulted in a $10.7 million reduction of accrued retiree benefit plan liabilities and a corresponding increase in prior service credits. In accordance with accounting requirements, the liability reduction from this remeasurement is recorded as amortization of prior service credits in net income. In addition, we recorded a $0.9 million actuarial loss during the first quarter of 2016. In the third quarter of 2015, we recognized actuarial losses of $6.1 million related to curtailment accounting due to the sale of the Waterloo tool storage business in discontinued operations in addition to the $2.5 million of actuarial losses reflected below in net periodic benefit cost. In the first quarter of 2014, we communicated our decision to amend certain postretirement benefit plans to reduce health benefits for certain current and retired employees. The reduction in accrued retiree benefit plan liabilities was $15.3 million and we recorded actuarial losses of $0.6 million and prior service credits of $3.5 million. As of December 31, 2016, we adopted the new Society of Actuaries MP-2016 mortality tables, resulting in a decrease in our postretirement obligations of approximately $0.1 million, and a corresponding decrease in deferred actuarial losses in accumulated other comprehensive income. As of December 31, 2015, we adopted the Society of Actuaries RP-2015 mortality tables, resulting in a decrease in our postretirement obligations of approximately $0.5 million, and a corresponding decrease in deferred actuarial losses in accumulated other comprehensive income. The amounts in accumulated other comprehensive loss on the consolidated balance sheets that have not yet been recognized as components of net periodic benefit cost were as follows: The amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next fiscal year are amortization of net prior service credits related pension benefits of zero and postretirement benefits of $(5.1) million. Components of net periodic benefit cost were as follows: (a) The pre-65 initial health care cost trend rate is shown first / followed by the post-65 rate. A one-percentage-point change in assumed health care cost trend rates would have had the following effects in 2016: Plan Assets The fair value of the pension assets by major category of plan assets as of December 31, 2016 and 2015 were as follows: A reconciliation of Level 3 measurements was as follows: Our defined benefit plans Master Trust own a variety of investment assets. All of these investment assets, except for group annuity/insurance contracts are measured using net asset value per share as a practical expedient per ASC 820. Following the retrospective adoption of ASU 2015-07 (Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share) we excluded all investments measured using net asset value per share in the amount of $554.9 million and $539.6 million as of December 31, 2016 and 2015, respectively, from the tabular fair value hierarchy disclosure. The terms and conditions for redemptions vary for each class of the investment assets valued at net asset value per share as a practical expedient. Real estate assets may be redeemed quarterly with a 45 day redemption notice period. Investment assets in multi-strategy hedge funds may be redeemed semi-annually with a 95 day redemption notice period. Equity, fixed income and cash and cash equivalents have no specified redemption frequency and notice period and may be redeemed daily. As of December 31, 2016 we do not have an intent to sell or otherwise dispose of these investment assets at prices different than the net asset value per share. Our investment strategy is to optimize investment returns through a diversified portfolio of investments, taking into consideration underlying plan liabilities and asset volatility. The defined benefit asset allocation policy of the plans allow for an equity allocation of 0% to 75%, a fixed income allocation of 25% to 100%, a cash allocation of up to 25% and other investments of up to 20%. Asset allocations are based on the underlying liability structure. All retirement asset allocations are reviewed periodically to ensure the allocation meets the needs of the liability structure. Our 2017 expected blended long-term rate of return on plan assets of 6.6% was determined based on the nature of the plans’ investments, our current asset allocation and projected long-term rates of return from pension investment consultants. Estimated Future Retirement Benefit Payments The following retirement benefit payments are expected to be paid: Estimated future retirement benefit payments above are estimates and could change significantly based on differences between actuarial assumptions and actual events and decisions related to lump sum distribution options that are available to participants in certain plans. Defined Contribution Plan Contributions We sponsor a number of defined contribution plans. Contributions are determined under various formulas. Cash contributions by the Company related to these plans amounted to $22.7 million, $18.3 million and $21.5 million in 2016, 2015 and 2014, respectively. 15. Income Taxes The components of income from continuing operations before income taxes and noncontrolling interests were as follows: A reconciliation of income taxes at the 35% federal statutory income tax rate to the income tax provision reported was as follows: The effective income tax rates for 2016, 2015 and 2014 were favorably impacted by the tax benefit attributable to the Domestic Production Activity (Internal Revenue Code Section 199) Deduction, favorable tax rates in foreign jurisdictions, and a benefit associated with the various extensions of the U.S. research and development credit, offset by state and local taxes and increases to uncertain tax positions. The 2016 effective income tax rate was favorably impacted by a tax benefit related to the adoption of ASU 2016-09, the new accounting guidance relating to share-based compensation. The benefit associated with the favorable tax rates in foreign jurisdictions is affected by overall allocation of income, rate changes and impact of foreign exchange rates. In 2015, the effective income tax rate benefit from foreign tax rates was reduced, as compared to prior years, due to the overall allocation of income within foreign jurisdictions and an expiration of a favorable tax incentive that in total increased the effective foreign tax rate by 6%. The 2015 effective income tax rate was unfavorably impacted by $2.4 million related to nondeductible acquisition costs. The effective tax rate in 2014 was favorably impacted by the release of valuation allowances related to state net operating loss carryforwards of $4.1 million. A reconciliation of the beginning and ending amount of unrecognized tax benefits (“UTBs”) was as follows: The amount of UTBs that, if recognized as of December 31, 2016, would affect the Company’s effective tax rate was $45.4 million. It is reasonably possible that, within the next twelve months, total UTBs may decrease in the range of $4.0 million to $5.0 million primarily as a result of the conclusion of U.S. federal, state and foreign income tax proceedings. We classify interest and penalty accruals related to UTBs as income tax expense. In 2016, we recognized an interest and penalty expense of approximately $1.1 million. In 2015, we recognized an interest and penalty expense of approximately $1.0 million. In 2014, we recognized an interest and penalty expense of approximately $0.5 million. At December 31, 2016 and 2015, we had accruals for the payment of interest and penalties of $11.0 million and $10.2 million, respectively. We file income tax returns in the U.S., various state and foreign jurisdictions. The Company is currently under examination by the U.S. Internal Revenue Service (“IRS”) for the periods related to 2013 through 2015. We have tax years that remain open and subject to examination by tax authorities in the following major taxing jurisdictions: Canada for years after 2011, Mexico for years after 2006 and China for years after 2012. Income taxes in 2016, 2015 and 2014 were as follows: The components of net deferred tax assets (liabilities) as of December 31, 2016 and 2015 were as follows: In accordance with ASC requirements for Income Taxes, deferred taxes were classified in the consolidated balance sheets as of December 31, 2016 and 2015 as follows: As of December 31, 2016 and 2015, the Company had deferred tax assets relating to net operating losses, capital losses, and other tax carryforwards of $39.7 million and $39.9 million, respectively, of which approximately $8.3 million will expire between 2017 and 2021, and the remainder of which will expire in 2022 and thereafter. The Company has provided a valuation allowance to reduce the carrying value of certain of these deferred tax assets, as management has concluded that, based on the available evidence, it is more likely than not that the deferred tax assets will not be fully realized. The undistributed earnings of foreign subsidiaries that are considered indefinitely reinvested were $313.6 million at December 31, 2016. A quantification of the associated deferred tax liability on these undistributed earnings has not been made, as the determination of such liability is not practicable. 16. Restructuring and Other Charges Pre-tax restructuring and other charges for the year ended December 31, 2016 were as follows: (a) “Other Charges” represent charges or gains directly related to restructuring initiatives that cannot be reported as restructuring under GAAP. Such charges or gains may include losses on disposal of inventories, trade receivables allowances from exiting product lines, accelerated depreciation resulting from the closure of facilities, and gains and losses on the sale of previously closed facilities. (b) Selling, general and administrative expenses Restructuring and other charges in 2016 primarily related to severance costs and charges associated with the relocation of a manufacturing facility within our Security segment. Pre-tax restructuring and other charges for the year ended December 31, 2015 were as follows: (a) “Other Charges” represent charges or gains directly related to restructuring initiatives that cannot be reported as restructuring under GAAP. Such charges or gains may include losses on disposal of inventories, trade receivables allowances from exiting product lines, accelerated depreciation resulting from the closure of facilities, and gains and losses on the sale of previously closed facilities. (b) Selling, general and administrative expenses Restructuring and other charges in 2015 related to severance costs to relocate a Plumbing manufacturing facility in China and severance costs and accelerated depreciation to relocate a manufacturing facility within our Security segment, as well as severance costs in the Security, Cabinets and Corporate segments. Pre-tax restructuring and other charges for the year ended December 31, 2014 were as follows: (a) “Other Charges” represent charges or gains directly related to restructuring initiatives that cannot be reported as restructuring under GAAP. Such charges or gains may include losses on disposal of inventories, trade receivables allowances from exiting product lines, accelerated depreciation resulting from the closure of facilities, and gains and losses on the sale of previously closed facilities. (b) Selling, general and administrative expenses Restructuring and other charges in 2014 primarily resulted from severance charges in our Security, Plumbing and Corporate segments, partially offset by a benefit from release of a foreign currency gain associated with the dissolution of a foreign entity in the Plumbing segment. Reconciliation of Restructuring Liability (a) Cash expenditures primarily related to severance charges. (b) Non-cash write-offs include long-lived asset impairment charges attributable to restructuring actions. (c) Cash expenditures primarily related to severance charges. (d) Non-cash write-offs include long-lived asset impairment charges attributable to restructuring actions and the benefit from release of a foreign currency gain associated with the dissolution of a foreign entity 17. Commitments Purchase Obligations Purchase obligations of the Company as of December 31, 2016 were $327.3 million, of which $305.1 million is due within one year. Purchase obligations include contracts for raw materials and finished goods purchases, selling and administrative services, and capital expenditures. Lease Commitments Future minimum rental payments under non-cancelable operating leases as of December 31, 2016 were as follows: Total rental expense for all operating leases (reduced by minor amounts from subleases) amounted to $43.5 million, $34.9 million and $33.4 million in 2016, 2015 and 2014, respectively. Product Warranties We generally record warranty expense at the time of sale. We offer our customers various warranty terms based on the type of product that is sold. Warranty expense is determined based on historic claim experience and the nature of the product category. The following table summarizes activity related to our product warranty liability for the years ended December 31, 2016, 2015 and 2014. 18. Information on Business Segments We report our operating segments based on how operating results are regularly reviewed by our chief operating decision maker for making decisions about resource allocations to segments and assessing performance. The Company’s operating segments and types of products from which each segment derives revenues are described below. The Cabinets segment includes custom, semi-custom and stock cabinetry for the kitchen, bath and other parts of the home under brand names including Aristokraft, Mid-Continent, Diamond, Kitchen Classics, Kitchen Craft, Schrock, Omega, Homecrest, Thomasville, StarMark and Ultracraft. In addition, cabinets are distributed under the Thomasville Cabinetry brand names. The Plumbing segment manufactures or assembles and sells faucets, bath furnishings, accessories and kitchen sinks and waste disposals predominantly under the Moen, Riobel, ROHL, Perrin & Rowe and Waste King brands. The Doors segment includes residential fiberglass and steel entry door systems under the Therma-Tru brand name and urethane millwork product lines under the Fypon brand name. The Security segment includes locks, safety and security devices and electronic security products under the Master Lock brand name and fire resistant safes, security containers and commercial cabinets under the SentrySafe brand name. Corporate expenses consist of headquarters administrative expenses and defined benefit plans costs, primarily interest costs and expected return on plan assets, as well as actuarial gains and losses arising from periodic remeasurement of our liabilities. Corporate assets consist primarily of cash. The Company’s subsidiaries operate principally in the United States, Canada, Mexico, China and Western Europe. Net sales to two of the Company’s customers, The Home Depot, Inc. (“The Home Depot”) and Lowe’s Companies, Inc. (“Lowe’s”) each accounted for greater than 10% of the Company’s net sales in 2016, 2015 and 2014. All segments sell to both The Home Depot and Lowe’s. Net sales to The Home Depot were 13%, 14% and 15% of net sales in 2016, 2015 and 2014, respectively. Net sales to Lowe’s were 14%, 14% and 14% of net sales in 2016, 2015 and 2014, respectively. (b) Representing external costs directly related to the acquisition of Norcraft and primarily includes expenditures for banking, legal, accounting and other similar services. (a) Based on country of destination (b) Purchases of property, plant and equipment not yet paid for as of December 31, 2016, 2015 and 2014 were $11.9 million, $20.0 million and $4.2 million, respectively. 19. Quarterly Financial Data Unaudited (In millions, except per share amounts) (a) Amounts revised to reflect adoption of ASU 2016-09 “Improvements to Employee Share-Based Payment Accounting.” In 2016, we recorded pre-tax defined benefit plan actuarial losses of $1.9 million - $0.9 million ($0.6 million after tax) in the first quarter and $1.0 million ($0.7 million after tax) in the third quarter. In 2015, we recorded pre-tax defined benefit plan actuarial losses of $2.5 million - $2.8 million ($1.8 million after tax or $0.01 per diluted share) in the third quarter, and $(0.3) million ($(0.2) million after tax or zero per diluted share) in the fourth quarter. 20. Earnings Per Share The computations of earnings (loss) per common share were as follows: 21. Other Expense, Net The components of other expense, net for the years ended December 31, 2016, 2015 and 2014 were as follows: In 2014, we recorded impairment charges of $1.6 million pertaining to different cost method investments due to an other-than-temporary declines in the fair value of the investments. As a result of the impairments, the carrying value of the investments was reduced to zero and the Company is not subject to further impairment or funding obligations with regard to this investment. 22. Contingencies Litigation The Company is a defendant in lawsuits that are ordinary routine litigation matters incidental to its businesses. It is not possible to predict the outcome of the pending actions, and, as with any litigation, it is possible that these actions could be decided unfavorably to the Company. The Company believes that there are meritorious defenses to these actions and that these actions will not have a material adverse effect upon the Company’s results of operations, cash flows or financial condition, and, where appropriate, these actions are being vigorously contested. Accordingly the Company believes the likelihood of material loss is remote. Environmental Compliance with federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, did not have a material effect on capital expenditures, earnings or the competitive position of Fortune Brands. Several of our subsidiaries have been designated as potentially responsible parties (“PRP”) under “Superfund” or similar state laws. As of December 31, 2016, eleven such instances have not been dismissed, settled or otherwise resolved. In calendar year 2016, one of our subsidiaries was identified as a PRP in a new instance and no instances were settled, dismissed or otherwise resolved. In most instances where our subsidiaries are named as a PRP, we enter into cost-sharing arrangements with other PRPs. We give notice to insurance carriers of potential PRP liability, but very rarely, if ever, receive reimbursement from insurance for PRP costs. We believe that the cost of complying with the present environmental protection laws, before considering estimated recoveries either from other PRPs or insurance, will not have an adverse effect on our results of operations, cash flows or financial condition. At December 31, 2016 and 2015, we had accruals of $1.0 million and $2.8 million, respectively, relating to environmental compliance and cleanup including, but not limited to, the above mentioned Superfund sites. Our year over year accrual decreased after we completed the remediation at one location. Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Fortune Brands Home & Security, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Fortune Brands Home & Security, Inc. and its subsidiaries at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. As described in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A, management has excluded Riobel Inc, ROHL LLC, and TCL Manufacturing Ltd. from its assessment of internal control over financial reporting as of December 31, 2016 because they were acquired by the Company in purchase business combinations during 2016. We have also excluded Riobel Inc, ROHL LLC, and TCL Manufacturing Ltd from our audit of internal control over financial reporting. Riobel Inc, ROHL LLC, and TCL Manufacturing Ltd are wholly-owned subsidiaries whose total assets and total revenues represent 6% and 1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2016. /s/ PricewaterhouseCoopers LLP Chicago, Illinois February 28, 2017 | I apologize, but the financial statement you've provided appears to be incomplete or fragmented. The text lacks context and seems to be missing key details and proper formatting. Without a complete and clear financial statement, I cannot provide an accurate summary.
To help you effectively, I would need:
- A complete financial statement
- Clear line items with full numerical values
- Context about the company or reporting period
- Proper financial terminology and formatting
If you can provide a more complete financial statement, I'd be happy to help you summarize it. | Claude |
Consolidated . HARRIS & HARRIS GROUP, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES The following reports and consolidated financial schedules of Harris & Harris Group, Inc. are filed herewith and included in response to Management's Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, the Company's principal executive and principal financial officers and effected by the Company's Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: • pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; • provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and • provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management has assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making its assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on the results of this assessment, management (including our Chief Executive Officer and Chief Financial Officer) has concluded that, as of December 31, 2016, the Company's internal control over financial reporting was effective. The effectiveness of the Company's internal control over financial reporting has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in its report which appears on page 81 of this Annual Report on Form 10-K. Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Harris & Harris Group, Inc.: In our opinion, the accompanying consolidated statements of assets and liabilities, including the consolidated schedules of investments, and the related consolidated statements of operations, of comprehensive income (loss), of changes in net assets and of cash flows and the financial highlights (hereafter referred to as “financial statements”) present fairly, in all material respects, the financial position of Harris & Harris Group, Inc. and its subsidiaries at December 31, 2016 and December 31, 2015, and the results of their operations, and their cash flows and their changes in net assets for each of the three years in the period ended December 31, 2016, and the financial highlights for each of the five years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and the financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits, which included confirmation of securities at December 31, 2016 and December 31, 2015 by correspondence with the custodian and the application of alternative auditing procedures where replies have not been received, provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP New York, New York March 15, 2017 HARRIS & HARRIS GROUP, INC. CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES The accompanying notes are an integral part of these consolidated financial statements. HARRIS & HARRIS GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS The accompanying notes are an integral part of these consolidated financial statements. HARRIS & HARRIS GROUP, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) The accompanying notes are an integral part of these consolidated financial statements. HARRIS & HARRIS GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS The accompanying notes are an integral part of these consolidated financial statements. HARRIS & HARRIS GROUP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. Notes to Consolidated Schedule of Investments (1) See "Footnote to Consolidated Schedule of Investments" on page 116 for a description of the "Valuation Procedures." (2) We classify "Energy" companies as those that seek to improve performance, productivity or efficiency, and to reduce environmental impact, waste, cost, energy consumption or raw materials. We classify "Electronics" companies as those that address problems in electronics-related industries, including semiconductors and computing. We classify "Life Sciences" companies as those that address problems in life sciences-related industries, including precision health and precision medicine, biotechnology, agriculture, advanced materials and chemicals, health care, bioprocessing, water, industrial biotechnology, food, nutrition and energy. (3) Investments in unaffiliated companies consist of investments in which we own less than five percent of the voting shares of the portfolio company. Investments in non-controlled affiliated companies consist of investments in which we own five percent or more, but less than 25 percent, of the voting shares of the portfolio company, or where we hold one or more seats on the portfolio company’s board of directors but do not control the company. Investments in controlled affiliated companies consist of investments in which we own 25 percent or more of the voting shares of the portfolio company or otherwise control the company, including control of a majority of the seats on the board of directors, or more than 25 percent of the seats on the board of directors, with no other entity or person in control of more director seats than us. Among our controlled affiliated companies, ProMuc, Inc., and Interome, Inc., were 100 percent owned by us at December 31, 2016. (4) The aggregate cost for federal income tax purposes of investments in unaffiliated privately held companies is $12,408,878. The gross unrealized appreciation based on the tax cost for these securities is $96,266. The gross unrealized depreciation based on the tax cost for these securities is $4,766,507. (5) We are subject to legal restrictions on the sale of our investment(s) in this company. (6) Represents a non-income producing investment. Investments that have not paid dividends or interest within the last 12 months are considered to be non-income producing. (7) Initial investment was made in 2016. (8) We received shares of Xenio Corporation as part of the consideration distributed to shareholders of Bridgelux, Inc., for the sale of Bridgelux, Inc., to a an investment group led by China Electronics Corporation and ChongQing Linkong Development Investment Company. The close of this transaction occurred on August 1, 2016. (9) The aggregate cost for federal income tax purposes of investments in unaffiliated rights to milestone payments is $781,863. The gross unrealized appreciation based on the tax cost for these securities is $1,757,490. The gross unrealized depreciation based on the tax cost for these securities is $0. (10) The aggregate cost for federal income tax purposes of investments in unaffiliated publicly traded companies is $426,764. The gross unrealized appreciation based on the tax cost for these securities is $3,638. The gross unrealized depreciation based on the tax cost for these securities is $350,727. (11) The aggregate cost for federal income tax purposes of investments in non-controlled affiliated privately held companies is $43,832,202. The gross unrealized appreciation based on the tax cost for these securities is $10,476,913. The gross unrealized depreciation based on the tax cost for these securities is $20,614,492. (12) Our initial investment in AgTech Accelerator Corporation was on May 4, 2016, and from the date of initial investment through September 30, 2016, the investment was accounted for using the equity method of accounting. On February 3, 2017, we withdrew from participation in AgTech Accelerator. The value reflects the price per share at which our ownership may be purchased by other investors in the entity within 90 days of notice of our intent to withdraw. We have yet to receive notification of such interest from other investors. In the event that the other investors do not complete the purchase of our shares of AgTech Accelerator within the 90 days of notice, we would retain our shares of AgTech Accelerator and the investment would again be accounted for using equity method of accounting. The accompanying notes are an integral part of these consolidated financial statements. (13) D-Wave Systems, Inc., is located and is doing business primarily in Canada. We invested in D-Wave through Parallel Universes, Inc., a Delaware company. Our investment is denominated in Canadian dollars and is subject to foreign currency translation. See "Note 3. Summary of Significant Accounting Policies." D-Wave is not a qualifying asset under Section 55(a) of the 1940 Act. Under the 1940 Act, we may not acquire non-qualifying assets unless, at the time the acquisition is made, qualifying assets are at least 70 percent of our total assets. We were over this threshold at the time of acquisition of these securities. (14) Represents a non-operating entity that exists to collect future payments from licenses or other engagements and/or monetize assets for future distributions to investors and debt holders. (15) Produced Water Absorbents, Inc., also does business as ProSep, Inc. (16) The aggregate cost for federal income tax purposes of investments in non-controlled affiliated publicly traded companies is $16,893,591. The gross unrealized appreciation based on the tax cost for these securities is $0. The gross unrealized depreciation based on the tax cost for these securities is $12,554,926. (17) A total of 200,000 shares of our holdings in Adesto Technologies Corporation are not qualifying assets under Section 55(a) of the 1940 Act. Under the 1940 Act, we may not acquire non-qualifying assets unless, at the time the acquisition is made, qualifying assets are at least 70 percent of our total assets. (18) The aggregate cost for federal income tax purposes of investments in controlled affiliated companies is $27,405,677. The gross unrealized appreciation based on the tax cost for these securities is $1,239,018. The gross unrealized depreciation based on the tax cost for these securities is $18,879,699. (19) On August 4, 2015, SiOnyx, Inc., reorganized its corporate structure to become a subsidiary of a new company, Black Silicon Holdings, Inc. Our security holdings of SiOnyx converted into securities of Black Silicon Holdings. SiOnyx was then acquired by an undisclosed buyer. Black Silicon Holdings owns a profit interest in the undisclosed buyer. (20) In 2017, Interome, Inc., changed its name to HALE.life Corporation. (21) On August 19, 2015, UberSeq, Inc., changed its name to NGX Bio, Inc. (22) On October 19, 2016, Senova Systems, Inc., sold substantially all of its assets to an undisclosed buyer for an up-front payment and potential future payments upon achievement of milestones. (23) The aggregate cost for federal income tax purposes of investments in privately held equity method investments is $178,360. Under the equity method, investments are carried at cost, plus or minus the Company's equity in the increases and decreases in the investee's net assets after the date of acquisition and certain other adjustments. The Company owns approximately 9 percent or Accelerator IV-New York Corporation. (24) See "Note 11. Commitments and Contingencies." The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. Notes to Consolidated Schedule of Investments (1) See "Footnote to Consolidated Schedule of Investments" on page 116 for a description of the "Valuation Procedures." (2) We classify "Energy" companies as those that seek to improve performance, productivity or efficiency, and to reduce environmental impact, waste, cost, energy consumption or raw materials. We classify "Electronics" companies as those that address problems in electronics-related industries, including semiconductors and computing. We classify "Life Sciences" companies as those that address problems in life sciences-related industries, including precision health and precision medicine, biotechnology, agriculture, advanced materials and chemicals, health care, bioprocessing, water, industrial biotechnology, food, nutrition and energy. (3) Investments in unaffiliated companies consist of investments in which we own less than five percent of the voting shares of the portfolio company. Investments in non-controlled affiliated companies consist of investments in which we own five percent or more, but less than 25 percent, of the voting shares of the portfolio company, or where we hold one or more seats on the portfolio company’s board of directors but do not control the company. Investments in controlled affiliated companies consist of investments in which we own 25 percent or more of the voting shares of the portfolio company or otherwise control the company, including control of a majority of the seats on the board of directors, or more than 25 percent of the seats on the board of directors, with no other entity or person in control of more director seats than us. Among our controlled affiliated companies, ProMuc, Inc., was 100 percent owned by us at December 31, 2015. (4) The aggregate cost for federal income tax purposes of investments in unaffiliated privately held companies is $18,857,235. The gross unrealized appreciation based on the tax cost for these securities is $10,390. The gross unrealized depreciation based on the tax cost for these securities is $13,491,153. (5) All or a portion of the investments or instruments are pledged as collateral under our Loan Facility with Orix Corporate Capital, Inc. (6) The aggregate cost for federal income tax purposes of investments in unaffiliated rights to milestone payments is $781,863. The gross unrealized appreciation based on the tax cost for these securities is $2,580,188. The gross unrealized depreciation based on the tax cost for these securities is $0. (7) The aggregate cost for federal income tax purposes of investments in unaffiliated publicly traded companies is $1,623,029. The gross unrealized appreciation based on the tax cost for these securities is $0. The gross unrealized depreciation based on the tax cost for these securities is $665,485. (8) We are subject to legal restrictions on the sale of our investment(s) in this company. (9) Represents a non-income producing investment. Investments that have not paid dividends or interest within the last 12 months are considered to be non-income producing. (10) On July 21, 2015, Bridgelux, Inc., signed a definitive agreement to be acquired by an investment group led by China Electronics Corporation and ChongQing Linkong Development Investment Company. The close of this transaction is subject to customary regulatory approvals. (11) In February of 2016, Cambrios Technologies Corporation ceased operations and began liquidation of its assets through a general assignment for the benefit of creditors. (12) We received our shares of Magic Leap, Inc., as part of the consideration paid for one of our portfolio companies in an acquisition during the second quarter of 2015. A total of 4,394 shares of our 29,291 shares of Magic Leap are held in escrow to satisfy indemnity claims through May 1, 2016. (13) Initial investment was made in 2015. (14) The aggregate cost for federal income tax purposes of investments in non-controlled affiliated privately held companies is $49,262,921. The gross unrealized appreciation based on the tax cost for these securities is $10,504,995. The gross unrealized depreciation based on the tax cost for these securities is $17,858,654. The accompanying notes are an integral part of these consolidated financial statements. (15) D-Wave Systems, Inc., is located and is doing business primarily in Canada. We invested in D-Wave through Parallel Universes, Inc., a Delaware company. Our investment is denominated in Canadian dollars and is subject to foreign currency translation. See "Note 2. Summary of Significant Accounting Policies." D-Wave is not a qualifying asset under Section 55(a) of the 1940 Act. Under the 1940 Act, we may not acquire non-qualifying assets unless, at the time the acquisition is made, qualifying assets are at least 70 percent of our total assets. (16) Produced Water Absorbents, Inc., also does business as ProSep, Inc. (17) In March of 2015, Ultora, Inc., ceased operations and began liquidation of its assets through a general assignment for the benefit of creditors. (18) The aggregate cost for federal income tax purposes of investments in non-controlled affiliated publicly traded companies is $23,165,788. The gross unrealized appreciation based on the tax cost for these securities is $2,163,265. The gross unrealized depreciation based on the tax cost for these securities is $6,957,948. (19) As of December 31, 2015, the Company's shares of Adesto Technologies Corporation were subject to a lock-up agreement that restricts our ability to trade these securities. A total of 200,000 shares are not qualifying assets under Section 55(a) of the 1940 Act. Under the 1940 Act, we may not acquire non-qualifying assets unless, at the time the acquisition is made, qualifying assets are at least 70 percent of our total assets. (20) As of December 31, 2015, a portion of the Company's shares and warrants of Enumeral Biomedical Holdings, Inc., were subject to a lock-up agreement that restricts our ability to trade these securities. The lock-up period on our securities of Enumeral Biomedical Holdings expired on January 31, 2016. A portion of our shares were held in escrow as of the end of 2015. This escrow period expired with no claims against the escrowed shares. (21) The Company's shares of OpGen, Inc., became freely tradeable on November 2, 2015. A total of 300,833 shares and 300,833 warrants are not qualifying assets under Section 55(a) of the 1940 Act. Under the 1940 Act, we may not acquire non-qualifying assets unless, at the time the acquisition is made, qualifying assets are at least 70 percent of our total assets. (22) The aggregate cost for federal income tax purposes of investments in controlled affiliated companies is $23,205,336. The gross unrealized appreciation based on the tax cost for these securities is $271,755. The gross unrealized depreciation based on the tax cost for these securities is $16,466,557. (23) On August 4, 2015, SiOnyx, Inc., reorganized its corporate structure to become a subsidiary of a new company, Black Silicon Holdings, Inc. Our security holdings of SiOnyx converted into securities of Black Silicon Holdings. SiOnyx was then acquired by an undisclosed buyer. Black Silicon Holdings owns a profit interest in the undisclosed buyer. (24) On August 19, 2015, UberSeq, Inc., changed its name to NGX Bio, Inc. (25) The aggregate cost for federal income tax purposes of investments in privately held equity method investments is $165,936. Under the equity method, investments are carried at cost, plus or minus the Company's equity in the increases and decreases in the investee's net assets after the date of acquisition and certain other adjustments. (26) As part of our initial investment in Accelerator IV-New York Corporation, the Company made an additional operating and investment commitment. See "Note 11. Commitments and Contingencies." The accompanying notes are an integral part of these consolidated financial statements. HARRIS & HARRIS GROUP, INC. FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS VALUATION PROCEDURES I. Determination of Net Asset Value The 1940 Act requires periodic valuation of each investment in the portfolio of the Company to determine its net asset value. Under the 1940 Act, unrestricted securities with readily available market quotations are to be valued at the current market value; all other assets must be valued at "fair value" as determined in good faith by or under the direction of the Board of Directors. The Board of Directors is also responsible for (1) determining overall valuation guidelines and (2) ensuring that the investments of the Company are valued within the prescribed guidelines. The Valuation Committee, comprised of all of the independent Board members, is responsible for determining the valuation of the Company’s assets within the guidelines established by the Board of Directors. The Valuation Committee receives information and recommendations from management. An independent valuation firm also reviews select portfolio company valuations. The independent valuation firm does not provide proposed valuations. The fair values assigned to these investments are based on available information and do not necessarily represent amounts that might ultimately be realized when that investment is sold, as such amounts depend on future circumstances and cannot reasonably be determined until the individual investments are actually liquidated or become readily marketable. The deal team meets at the end of each quarter to discuss portfolio companies and propose fair valuations for all privately held securities, restricted publicly traded securities and publicly traded securities without reliable market quotations. The Valuation Committee book is prepared with the use of data from primary sources whenever reasonably practicable. Proposed valuations for each portfolio company are communicated to the Valuation Committee in the Valuation Committee book and at the Valuation Committee meeting after the end of each quarter. The Valuation Committee determines the fair value of each private security and publicly traded securities without reliable market quotations. All valuations are then reported to the full Board of Directors along with the Chief Financial Officer’s calculation of net asset value. II. Approaches to Determining Fair Value Accounting Standards Codification Topic 820, "Fair Value Measurements and Disclosures," ("ASC 820") defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). It applies fair value terminology to all valuations whereas the 1940 Act applies market value terminology to readily marketable assets and fair value terminology to other assets. The main approaches to measuring fair value utilized are the market approach, the income approach and the hybrid approach. • Market Approach (M): The market approach may use quantitative inputs such as prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities and the values of market multiples derived from a set of comparable companies. The market approach may also use qualitative inputs such as progress toward milestones, the long-term potential of the business, current and future financing requirements and the rights and preferences of certain securities versus those of other securities. The selection of the relevant inputs used to derive value under the market approach requires judgment considering factors specific to the significance and relevance of each input to deriving value. • Income Approach (I): The income approach uses valuation techniques to convert future amounts (for example, revenue, cash flows or earnings) to a single present value amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. Those valuation techniques include present value techniques; option-pricing models, such as the Black-Scholes-Merton formula (a closed-form model) and a binomial model (a lattice model), which incorporate present value techniques; and the multi-period excess earnings method, which is used to measure the fair value of certain assets. • Hybrid Approach (H): The hybrid approach uses elements of both the market approach and the income approach. The hybrid approach calculates values using the market and income approach, individually. The resulting values are then distributed among the share classes based on probability of exit outcomes. ASC Topic 820 classifies the inputs used to measure fair value by these approaches into the following hierarchy: • Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities; • Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices in active markets for similar assets or liabilities, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 inputs are in those markets for which there are few transactions, the prices are not current, little public information exists or instances where prices vary substantially over time or among brokered market makers; and • Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are those inputs that reflect our own assumptions that market participants would use to price the asset or liability based upon the best available information. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement and are not necessarily an indication of risks associated with the investment. III. Investment Categories The Company’s investments can be classified into five broad categories for valuation purposes: • Equity-related securities; • Long-term fixed-income securities; • Short-term fixed-income securities; • Investments in intellectual property, patents, research and development in technology or product development; and • All other securities. The Company applies the methods for determining fair value discussed above to the valuation of investments in each of these five broad categories as follows: A. EQUITY-RELATED SECURITIES Equity-related securities, including options or warrants, are fair valued using the market, income or hybrid approaches. The following factors may be considered to fair value these types of securities: • Readily available public market quotations; • The cost of the Company’s investment; • Transactions in a company's securities or unconditional firm offers by responsible parties as a factor in determining valuation; • The financial condition and operating results of the company; • The company's progress towards milestones; • The long-term potential of the business and technology of the company; • The values of similar securities issued by companies in similar businesses; • Multiples to revenue, net income or EBITDA that similar securities issued by companies in similar businesses receive; • Estimated time to exit; • Volatility of similar securities in similar businesses; • The proportion of the company's securities we own and the nature of any rights to require the company to register restricted securities under applicable securities laws; and • The rights and preferences of the class of securities we own as compared with other classes of securities the portfolio company has issued. When the income approach is used to value warrants, the Company uses the Black-Scholes-Merton formula. The Company values one investment using the equity method. •Equity Method (E): Under the equity method, investments are carried at cost, plus or minus the Company’s equity in the increases and decreases in the investee’s net assets after the date of acquisition and certain other adjustments. B. LONG-TERM FIXED-INCOME SECURITIES 1. Readily Marketable. Long-term fixed-income securities for which market quotations are readily available are valued using the most recent bid quotations when available. 2. Not Readily Marketable. Long-term fixed-income securities for which market quotations are not readily available are fair valued using the income approach. The factors that may be considered when valuing these types of securities by the income approach include: • Credit quality; • Interest rate analysis; • Quotations from broker-dealers; • Prices from independent pricing services that the Board believes are reasonably reliable; and • Reasonable price discovery procedures and data from other sources. C. SHORT-TERM FIXED-INCOME SECURITIES Short-term fixed-income securities are valued in the same manner as long-term fixed-income securities until the remaining maturity is 60 days or less, after which time such securities may be valued at amortized cost if there is no concern over payment at maturity. D. INVESTMENTS IN INTELLECTUAL PROPERTY, PATENTS, RESEARCH AND DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT Such investments are fair valued using the market approach. The Company may consider factors specific to these types of investments when using the market approach including: • The cost of the Company’s investment; • Investments in the same or substantially similar intellectual property or patents or research and development in technology or product development or offers by responsible third parties; • The results of research and development; • Product development and milestone progress; • Commercial prospects; • Term of patent; • Projected markets; and • Other subjective factors. E. ALL OTHER SECURITIES All other securities are reported at fair value as determined in good faith by the Valuation Committee using the approaches for determining valuation as described above. For all other securities, the reported values shall reflect the Valuation Committee's judgment of fair values as of the valuation date using the outlined basic approaches of valuation discussed in Section II. They do not necessarily represent an amount of money that would be realized if we had to sell such assets in an immediate liquidation. Thus, valuations as of any particular date are not necessarily indicative of amounts that we may ultimately realize as a result of future sales or other dispositions of investments we hold. IV. Frequency of Valuation The Valuation Committee shall value the Company’s investment assets (i) as of the end of each calendar quarter at the time sufficiently far in advance of filing of the Company’s reports on Form 10-Q and Form 10-K to enable preparation thereof, (ii) as of within 48 hours of pricing any common stock of the Company by the Company (exclusive of Sundays and holidays) unless the proposed sale price is at least 200 percent of any reasonable net asset value of such shares, and (iii) as of any other time requested by the Board of Directors. V. Regular Review The Chief Financial Officer shall review these Valuation Procedures on an annual basis to determine the continued appropriateness and accuracy of the methodologies used in valuing the Company’s investment assets, and will report any proposed modifications to these Valuation Procedures to the Board of Directors for consideration and approval. The Chief Executive Officer, the Chief Financial Officer and the individuals responsible for preparing the Valuation Committee book shall meet quarterly before each Valuation Committee meeting to review the methodologies for the valuation of each security, and will highlight any changes to the Valuation Committee. VI. Other Assets Non-investment assets, such as fixtures and equipment, shall be valued using the cost approach less accumulated depreciation at rates determined by management and reviewed by the Audit Committee. Valuation of such assets is not the responsibility of the Valuation Committee. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. THE COMPANY Harris & Harris Group, Inc. (the "Company," "us," "our" and "we"), is a non-diversified management investment company operating as a business development company ("BDC") under the Investment Company Act of 1940 (the "1940 Act") that specializes in making investments in companies commercializing and integrating products enabled by disruptive technologies predominantly in the life sciences industry. We operate as an internally managed investment company whereby our officers and employees, under the general supervision of our Board of Directors, conduct our operations. H&H Ventures Management, Inc.SM ("Ventures") is a 100 percent owned subsidiary of the Company. Ventures is taxed under Subchapter C (a "C Corporation") of the Internal Revenue Code of 1986 (the "Code"). Harris Partners I, L.P, is a limited partnership and, from time to time, may be used to hold certain interests in our portfolio companies. The partners of Harris Partners I, L.P., are Ventures (sole general partner) and the Company (sole limited partner). Ventures pays taxes on income generated by its operations as well as on any non-passive investment income generated by Harris Partners I, L.P. For the years ended December 31, 2016, 2015 and 2014, there was no non-passive investment income generated by Harris Partners I, L.P. Ventures, as the sole general partner, consolidates Harris Partners I, L.P. The Company consolidates its wholly owned subsidiary, Ventures, for financial reporting purposes. The Company is the Managing Member of H&H Co-Investment Partners, LLC, a limited liability company formed to facilitate the opportunity for interested investors to co-invest alongside the Company in its portfolio companies. The Company is also the Investment Manager of two series formed by H&H Co-Investment Partners, H&H Co-Investment Partners, LLC D-Wave Co-Investment Series J and H&H Co-Investment Partners, LLC HZO Co-Investment Series III. As of December 31, 2016, H&H Co-Investment Partners did not have any capital under management. The Company expects to receive management fees and/or carried interest in profits generated on invested capital from any capital under management if and when capital is raised. The Company does not expect to consolidate the operations of H&H Co-Investment Partners if and when it has capital under management. The Company also does not expect to consolidate H&H Co-Investment Partners, LLC D-Wave Co-Investment Series J and H&H Co-Investment Partners, LLC HZO Co-Investment Series III if and when issued. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements: Principles of Consolidation. The consolidated financial statements have been prepared in accordance with GAAP and include the accounts of the Company and its wholly owned subsidiary. The Company is an investment company following accounting and reporting guidance in Accounting Standards Codification 946. In accordance with GAAP and Regulation S-X, the Company may only consolidate its interests in investment company subsidiaries and controlled operating companies whose business consists of providing services to the Company. Our wholly owned subsidiary, Ventures, is a controlled operating company that provides services to us and is, therefore, consolidated. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation. Amounts reported in "Net decrease (increase) in unrealized depreciation on investments" have been reclassified from prior years. Amounts related to portfolio company investments were previously reported as a single amount and have been reclassified to present unrealized (depreciation) appreciation from unaffiliated companies, controlled affiliated companies, non-controlled affiliated companies, publicly traded companies and unaffiliated rights to milestone payments. There was no impact to the total amounts reported in any period. Use of Estimates. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from these estimates, and the differences could be material. The most significant estimates relate to the fair valuations of our investments. Portfolio Investment Valuations. Investments are stated at "value" as defined in the 1940 Act and in the applicable regulations of the Securities and Exchange Commission ("SEC") and in accordance with GAAP. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) the fair value as determined in good faith by, or under the direction of, the Board of Directors for all other assets. (See "Valuation Procedures" in the "Footnote to Consolidated Schedule of Investments.") As of December 31, 2016, our financial statements include investments fair valued by the Board of Directors at $53,846,065 and one investment valued under the equity method at $178,360. The fair values and equity method value were determined in good faith by, or under the direction of, the Board of Directors. The fair value amount includes the values of our privately held investments as well as the warrants of Champions Oncology, Inc., Enumeral Biomedical Holdings, Inc., and OpGen, Inc., which are publicly traded companies. Our investment in Accelerator IV-New York Corporation is accounted for under the equity method of accounting as it represents non-controlling interest in operating entities that provide investment advisory services to the Company. Under the equity method, investments are carried at cost, plus or minus the Company’s equity in the increases and decreases in the investee’s net assets after the date of acquisition and certain other adjustments. The Company’s share of the net income or loss of the investee is included in "Share of loss on equity method investment" on the Company’s “Consolidated Statements of Operations.” Upon sale of investments, the values that are ultimately realized may be different from the fair value presented in the Company's financial statements. The difference could be material. Our investment in AgTech Accelerator Corporation was historically accounted for using the equity method of accounting since our initial investment on May 4, 2016. Following discussions that began in the fourth quarter of 2016, on February 3, 2017, the Company withdrew from its investment commitment to AgTech Accelerator. As a result of this decision, the investment was fair valued by the Board of Directors as of December 31, 2016, rather than valued using the equity method. Cash. Cash includes demand deposits. Cash is carried at cost, which approximates fair value. Unaffiliated Rights to Milestone Payments. At December 31, 2016, and December 31, 2015, the outstanding potential milestone payments from Amgen, Inc.’s acquisition of BioVex Group, Inc., were valued at $2,305,239 and $2,900,232 , respectively. The milestone payments are derivatives and valued using the probability-adjusted, present value of proceeds from future payments that would be due upon successful completion of certain regulatory and sales milestones. On November 17, 2014, the Company received a payment of $2,070,955 owing to the achievement of the first milestone. On November 23, 2015, the Company received a payment of $2,070,955 owing to the achievement of the second milestone. If all the remaining milestones are met, we would receive $5,384,482. At December 31, 2016, and December 31, 2015, the outstanding potential milestone payments from Canon, Inc.'s acquisition of Molecular Imprints, Inc., were valued at $234,114 and $461,819, respectively. On October 1, 2015, the Company received a payment of $795,567 owing to the achievement of the first milestone. If all the remaining milestones are met, we would receive an additional $938,926. At December 31, 2016, and December 31, 2015, the outstanding potential milestone payments from Laird Technologies, Inc.’s acquisition of Nextreme Thermal Solutions, Inc., were valued at $0. If all the remaining milestones are met, we would receive approximately $400,000. There can be no assurance as to how much of these amounts we will ultimately realize or when they will be realized, if at all. Funds Held in Escrow from Sale of Investment. At December 31, 2016, and December 31, 2015, there were funds held in escrow fair valued at $116,978 and $311,137, respectively, relating to the sale of Molecular Imprints, Inc.'s semiconductor lithography equipment business to Canon, Inc. On April 20, 2016, the Company received proceeds of $390,492 from the release of a portion of the funds held in escrow following the transaction. The remaining funds held in escrow are expected to be released in April of 2017, net of settlement of any indemnity claims and expenses related to the transaction. If the funds held in escrow for this transaction are released in full, we would receive $234,322 and realize a gain of $117,344. At December 31, 2016, and December 31, 2015, there were funds held in escrow fair valued at $0 and $63,428, respectively, relating to the sale of Molecular Imprints' non-semiconductor business to Magic Leap, Inc. On May 18, 2016, the Company received proceeds of $130,522, following the expiration of the one-year escrow period established at the closing of the transaction. Prepaid Expenses. We include prepaid insurance premiums and deferred financing charges in "Prepaid expenses." Prepaid insurance premiums are recognized over the term of the insurance contract and are included in "Insurance expense" in the Consolidated Statements of Operations. Deferred financing charges consist of fees and expenses paid in connection with the closing of loan facilities and are capitalized at the time of payment. Deferred financing charges are amortized over the term of the Loan Facility discussed in "Note 4. Debt." Amortization of the financing charges is included in "Interest and other debt expenses" in the Consolidated Statements of Operations. Property and Equipment. Property and equipment are included in "Other assets" and are carried at $136,018 and $180,089 at December 31, 2016, and December 31, 2015, respectively, representing cost, less accumulated depreciation of $436,043 and $445,476, respectively. Depreciation is provided using the straight-line method over the estimated useful lives of the property and equipment. We estimate the useful lives to be five to ten years for furniture and fixtures, three years for computer equipment, and the lesser of ten years or the remaining life of the lease for leasehold improvements. Post-Retirement Plan Liabilities. The Company provides a Retiree Medical Benefit Plan for employees who meet certain eligibility requirements. Until it was terminated on May 5, 2011, the Company also provided an Executive Mandatory Retirement Benefit Plan for certain individuals employed by us in a bona fide executive or high policy-making position. The net periodic post-retirement benefit cost for the year includes service cost for the year and interest on the accumulated post-retirement benefit obligation. Unrecognized actuarial gains and losses are recognized as net periodic benefit cost pursuant to the Company's historical accounting policy. The impact of plan amendments is amortized over the employee's average service period as a reduction of net periodic benefit cost. Unamortized plan amendments are included in "Accumulated other comprehensive income" in the Consolidated Statements of Assets and Liabilities. Interest Income Recognition. Interest income, including amortization of premium and accretion of discount, is recorded on an accrual basis. When accrued interest is determined not to be recoverable, the Company ceases accruing interest and writes off any previously accrued interest. Securities are deemed to be non-income producing if investments have not paid dividends or interest within the last 12 months. These write-offs are reversed through interest income. During the years ended December 31, 2016, December 31, 2015, and December 31, 2014, the Company earned $390,662, $193,689, and $207,782, respectively, in interest on senior secured debt, subordinated secured debt, participation agreements, non-convertible promissory notes and interest-bearing accounts. During the years ended December 31, 2016, December 31, 2015, and December 31, 2014, the Company recorded, on a net basis, $282,168, $444,417, and $170,741, respectively, of bridge note interest. The total for the years ended December 31, 2016, December 31, 2015, and December 31, 2014, included a partial write-off of previously accrued bridge note interest of $117,442, $1,427, and $77,268, respectively. Yield-Enhancing Fees on Debt Securities. Yield-enhancing fees received in connection with our non-convertible debt investments are deferred. The unearned fee income is accreted into income based on the effective interest method over the life of the investment. During the years ended December 31, 2016, December 31, 2015, and December 31, 2014, total yield-enhancing fees accreted into investment income were $116,507, $87,280, and $52,610, respectively. Fees for Providing Managerial Assistance to Portfolio Companies. During the years ended December 31, 2016, December 31, 2015, and December 31, 2014, the Company earned income of $1,002,853, $191,609, and $86,667, respectively, owing to certain of its employees providing managerial assistance to certain portfolio companies. Earned income totaling $900,000 during 2016 was primarily from Interome, Inc. Fees were also received from certain other portfolio companies during 2016, namely Adesto Technologies Corporation, Essential Health Solutions, Inc., Fleet Health Alliance, LLC, Muses Labs, Inc., OpGen, Inc., and TARA Biosystems, Inc. Stock-Based Compensation. The Company has a stock-based employee compensation plan. The Company accounts for the Amended and Restated Harris & Harris Group, Inc. 2012 Equity Incentive Plan (the "Stock Plan") by determining the fair value of all share-based payments to employees, including the fair value of grants of employee stock options and restricted stock awards, and records these amounts as an expense in the Consolidated Statements of Operations over the vesting period with a corresponding increase (decrease) to our additional paid-in capital. For the years ended December 31, 2016, 2015, and 2014, the increase to our operating expenses was offset by the increase to our additional paid-in capital, resulting in no net impact to our net asset value. Additionally, the Company does not record the potential tax benefits associated with the expensing of stock options or restricted stock because the Company currently intends to qualify as a regulated investment company ("RIC") under Subchapter M of the Code, and the deduction attributable to such expensing, therefore, is unlikely to provide any additional tax savings. The amount of non-cash, stock-based compensation expense recognized in the Consolidated Statements of Operations is based on the fair value of the awards the Company expects to vest, recognized over the vesting period on a straight-line basis for each award, and adjusted for actual awards vested and pre-vesting forfeitures. The forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if the actual forfeiture rate differs from the estimated rate and is accounted for in the current period and prospectively. See "Note 7. Stock-Based Compensation" for further discussion. Rent expense. Our lease at 1450 Broadway, New York, New York, commenced on January 21, 2010. The lease expires on December 31, 2019. The base rent is $36 per square foot with a 2.5 percent increase per year over the 10 years of the lease, subject to a full abatement of rent for four months and a rent credit for six months throughout the lease term. We apply these rent abatements, credits, escalations and landlord payments on a straight-line basis in the determination of rent expense over the lease term. Certain leasehold improvements were also paid for on our behalf by the landlord, the cost of which is accounted for as property and equipment and "Deferred rent" in the accompanying Consolidated Statements of Assets and Liabilities. These leasehold improvements are depreciated over the lease term. We also leased office space in California until December 31, 2015. Realized Gain or Loss and Unrealized Appreciation or Depreciation of Portfolio Investments. Realized gain or loss is recognized when an investment is disposed of and is computed as the difference between the Company's cost basis in the investment at the disposition date and the net proceeds received from such disposition. Realized gains and losses on investment transactions are determined by specific identification. Unrealized appreciation or depreciation is computed as the difference between the fair value of the investment and the cost basis of such investment. Income Taxes. We did not qualify as a RIC under Subchapter M of the Code in 2016. We did not have any taxable income in 2016, so this failure to qualify as a RIC did not result in a tax liability. As we currently intend to qualify as a RIC in future years and distribute any ordinary income, the Company does not accrue for income taxes. The Company has capital loss carryforwards that can be used to offset net realized capital gains. The Company recognizes interest and penalties in income tax expense. We pay federal, state and local income taxes on behalf of our wholly owned subsidiary, Ventures, which is a C corporation. See "Note 10. Income Taxes" for further discussion. Foreign Currency Translation. The accounting records of the Company are maintained in U.S. dollars. All assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the rate of exchange of such currencies against U.S. dollars on the date of valuation. The Company does not isolate the portion of the results of operations that arises from changes in foreign currency rates on investments held on its Consolidated Statements of Operations. Securities Transactions. Securities transactions are accounted for on the date the transaction for the purchase or sale of the securities is entered into by the Company (i.e., trade date). Securities transactions outside conventional channels, such as private transactions, are recorded as of the date the Company obtains the right to demand the securities purchased or to collect the proceeds from a sale and incurs the obligation to pay for the securities purchased or to deliver the securities sold. Concentration of Credit Risk. The Company places its cash and cash equivalents with financial institutions and, at times, cash held in depository accounts may exceed the Federal Deposit Insurance Corporation's insured limit and is subject to the credit risk of such institutions to the extent it exceeds such limit. Concentration of Investor Risk. As of December 31, 2016, two investors, Ariel Investments, LLC and Financial & Investment Management Group, Ltd., owned approximately 17.1 percent and 5.8 percent, respectively, of our outstanding shares. Recent Accounting Pronouncements. In December, 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-19, "Technical Corrections and Improvements." This ASU clarified the difference between a valuation approach and a valuation technique. This ASU indicates that there are three major valuation approaches: the cost approach, the market approach and the income approach and that various valuation techniques are consistent with these broader approaches. Entities are required to disclose a current period change in either a valuation approach or a valuation technique as of and for the year ended December 31, 2016. On August 26, 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments." This ASU is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The guidance will affect how distributions received from equity method investees will be reported. The guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. This ASU does not impact the accounting but rather the presentation of distributions in the Consolidated Statement of Cash Flows. The impact of this ASU on the Company's Consolidated Financial Statements is currently being evaluated. On June 16, 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." This ASU is intended to introduce new guidance for the accounting for credit losses on instruments within scope based on an estimate of current expected credit losses. The guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. The impact of this ASU on the Company's Consolidated Financial Statements is currently being evaluated. On March 30, 2016, the FASB issued ASU 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." This ASU is intended to simplify several aspects of the accounting for share-based payment award transactions. The guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. This ASU impacts the tax effects of share-based payments, minimum statutory tax withholding requirements and forfeitures. On February 25, 2016, the FASB issued ASU 2016-02, "Leases" (Topic 842). This ASU revises the accounting for leases. Under the new guidance, lessees are required to recognize a right-of-use asset and a lease liability for all leases. The new guidance will continue to classify leases as either financing or operating, with classification affecting the pattern of expense recognition. The accounting applied by a lessor under the new guidance will be substantially equivalent to current lease accounting guidance. This ASU is required to be applied with a modified retrospective approach to each prior reporting period presented and provides for certain practical expedients. The guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The impact of this ASU on the Company's Consolidated Financial Statements is currently being evaluated. On August 27, 2014, the FASB issued ASU 2014-15, "Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern." This ASU requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern. This guidance was effective for fiscal years, and interim periods within those fiscal years, ending after December 15, 2016. NOTE 3. BUSINESS RISKS AND UNCERTAINTIES We invest primarily in privately held companies, the securities of which are inherently illiquid. We also have investments in small publicly traded companies. Although these companies are publicly traded, their stock may not trade at high volumes, which may restrict our ability to sell our positions and prices can be volatile. We may also be subject to restrictions on transfer and/or other lock-up provisions after these companies initially go public. These privately held and publicly traded businesses tend to not have attained profitability, and many of these businesses also lack management depth and have limited or no history of operations. Because of the speculative nature of our investments and the lack of a liquid market for and restrictions on transfers of privately held investments, there is greater risk of loss relative to traditional marketable investment securities. We do not choose investments based on a strategy of diversification. We also do not rebalance the portfolio should one of our portfolio companies increase in value substantially relative to the rest of the portfolio. Therefore, the value of our portfolio may be more vulnerable to microeconomic events affecting a single sector, industry or portfolio company and to general macroeconomic events that may be unrelated to our portfolio companies. These factors may subject the value of our portfolio to greater volatility than a company that follows a diversification strategy. As of December 31, 2016, and December 31, 2015, our largest 10 investments by value accounted for approximately 78 percent of the value of our equity-focused portfolio. Our largest three investments, by value, D-Wave Systems, Inc., AgBiome, LLC, and HZO, Inc., accounted for approximately 17 percent, 17 percent and 12 percent, respectively, of our equity-focused portfolio at December 31, 2016. D-Wave Systems, Inc., AgBiome, LLC, and HZO, Inc. are privately held portfolio companies. Our largest three investments, by value, Adesto Technologies Corporation, Metabolon, Inc., and HZO, Inc., accounted for approximately 19 percent, 18 percent and 10 percent, respectively, of our equity-focused portfolio at December 31, 2015. As of that date, Metabolon, Inc., and HZO, Inc. were privately held portfolio companies and Adesto Technologies was a publicly traded portfolio company. Approximately 92 percent of the portion of our equity-focused portfolio that was fair valued was comprised of securities of 28 privately held companies, as well as the warrants of publicly traded Champions Oncology, Inc., OpGen, Inc., and Enumeral Biomedical Holdings, Inc. Approximately 0.3 percent of the portion of our equity-focused portfolio that was valued according to the equity method was comprised of one privately held company. Because there is typically no public or readily ascertainable market for our interests in the small privately held companies in which we invest, the valuation of the securities in that portion of our portfolio is determined in good faith by our Valuation Committee, which is comprised of all of the independent members of our Board of Directors. The values are determined in accordance with our Valuation Procedures and are subject to significant estimates and judgments. The fair value of the securities in our portfolio may differ significantly from the values that would be placed on these securities if a ready market for the securities existed. Any changes in valuation are recorded in our Consolidated Statements of Operations as "Net increase in unrealized depreciation on investments." Changes in valuation of any of our investments in privately held companies from one period to another may be significant. NOTE 4. DEBT The Company had a $20 million Loan Facility with Orix Corporate Capital, Inc., that was scheduled to mature on September 30, 2017. During the fourth quarter of 2016, the Company paid off all its outstanding obligations associated with this Loan Facility and the Loan Facility was no longer in effect. At December 31, 2016, the Company did not have outstanding debt. The Loan Facility, which could be used to fund investments in portfolio companies, carried interest at 10 percent per annum in cash. The Company had the option to have interest accrue at a rate of 13.5 percent per annum if the Company decided not to pay interest in cash monthly. The Company paid interest in cash on its outstanding borrowings. The Loan Facility also required payment of a draw fee on each borrowing equal to 1.0 percent of such borrowing and an unused commitment fee of 1.0 percent per annum. Fee payments under the Loan Facility were made quarterly in arrears. The Company had the option to prepay the loans or reduce the aggregate commitments under the Loan Facility at any time prior to the maturity date, as long as certain conditions were met, including payment of required prepayment or termination fees. There were no required prepayment or termination fees associated with the repayment of the obligation. The Loan Facility was secured by all of the assets of the Company and its wholly owned subsidiaries, subject to certain customary exclusions. The Loan Facility contained certain affirmative and negative covenants, including without limitation: (a) maintenance of certain minimum liquidity requirements; (b) maintenance of an eligible asset leverage ratio of not less than 4.0:1.0; (c) limitations on liens; (d) limitations on the incurrence of additional indebtedness; and (e) limitations on structural changes, mergers and disposition of assets (other than in the normal course of our business activities). At December 31, 2016, and December 31, 2015, the Company had outstanding debt of $0 and $5,000,000, respectively. The Loan Facility was repaid as of December 1, 2016. The weighted average annualized interest rate for the period January 1, 2016 through December 1, 2016 and of the year ended December 31, 2015, was 10 percent, exclusive of amortization of closing fees and other expenses. The weighted average debt outstanding for the period January 1, 2016, through December 1, 2016, and for the year ended December 31, 2015, was $5,000,000. The remaining capacity under the Loan Facility was $15,000,000 at December 31, 2015. The draw period for the Loan Facility expired on September 30, 2016. Unamortized fees and expenses of $0 and $306,040 related to establishing the Loan Facility are included as "Prepaid expenses" in the Consolidated Statements of Assets and Liabilities as of December 31, 2016, and December 31, 2015, respectively. These amounts were amortized over the term of the Loan Facility, and $306,040, $174,880 and $174,880 was amortized in the years ended December 31, 2016, 2015 and 2014, respectively. The Company paid $114,167, $164,583 and $202,778 in non-utilization fees during the years ended December 31, 2016, 2015 and 2014, respectively. The Company paid $466,667, $381,944 and $0 in interest expense for the years ended December 31, 2016, 2015 and 2014, respectively. During the years ended December 31, 2016, and December 31, 2015, the Company paid $0 and $50,000 in utilization fees associated with a drawdown of the Loan Facility. At December 31, 2016, the Company did not have outstanding debt. NOTE 5. FAIR VALUE OF INVESTMENTS At December 31, 2016, our financial assets valued at fair value were categorized as follows in the fair value hierarchy: Significant Unobservable Inputs The table below presents the valuation technique and quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurements of Level 3 assets. Unobservable inputs are those inputs for which little or no market data exists and, therefore, require an entity to develop its own assumptions. (a) Weighted average based on fair value at December 31, 2016. Valuation Methodologies and Inputs for Level 3 Assets The following sections describe the valuation techniques and significant unobservable inputs used to measure Level 3 assets. Preferred Stock, Bridge Notes and Common Stock Preferred stock, bridge notes and common stock are valued by either a market, income or hybrid approach using internal models with inputs, most of which are not market observable. Common inputs for valuing Level 3 preferred stock, bridge note and private common stock investments include prices from recently executed private transactions in a company’s securities or unconditional firm offers, revenue multiples of comparable publicly traded companies, merger and acquisition ("M&A") transactions consummated by comparable companies, discounts for lack of marketability, rights and preferences of the class of securities we own as compared with other classes of securities the portfolio company has issued, particularly related to potential liquidity scenarios of an initial public offering ("IPO") or an acquisition transaction, estimated time to exit, volatilities of comparable publicly traded companies and management’s best estimate of risk attributable to non-performance risk. Certain securities are valued using the present value of future cash flows. We may also consider changes in market values for sets of comparable companies when recent private transaction information is not available and/or in consideration of non-performance risk. We define non-performance risk as the risk that the price per share (or implied valuation of a portfolio company) or the effective yield of a debt security of a portfolio company, as applicable, does not appropriately represent the risk that a portfolio company with negative cash flow will be: (a) unable to raise capital, will need to be shut down and will not return our invested capital; or (b) able to raise capital, but at a valuation significantly lower than the implied post-money valuation of the last round of financing. We assess non-performance risk for each private portfolio company quarterly. Our assessment of non-performance risk typically includes an evaluation of the financial condition and operating results of the company, the company's progress towards milestones, and the long-term potential of the business and technology of the company and how this potential may or may not affect the value of the shares owned by us. An increase to the non-performance risk or a decrease in the private offering price of a future round of financing from that of the most recent round would result in a lower fair value measurement and/or a change in the distribution of value among the classes of securities we own. Option pricing models place a high weighting on liquidation preferences, which means that small differences in how the preferences are structured can have a material effect on the fair value of our securities at the time of valuation and also on future valuations should additional rounds of financing occur with senior preferences. As such, valuations calculated by option pricing models may not increase if 1) rounds of financing occur at higher prices per share, 2) liquidation preferences include multiples on investment, 3) the amount of invested capital is small and/or 4) liquidation preferences are senior to prior rounds of financing. Additionally, an increase in the volatility assumption generally increases the enterprise value calculated in an option pricing model. An increase in the time to exit assumption also generally increases the enterprise value calculated in an option pricing model. Variations in the expected time to exit or expected volatility assumptions have a significant impact on fair value. Bridge notes commonly contain terms that provide for the conversion of the full amount of principal, and sometimes interest, into shares of preferred stock at a defined price per share and/or the price per share of the next round of financing. The use of a discount for non-performance risk in the valuation of bridge notes would indicate the potential for conversion of only a portion of the principal, plus interest when applicable, into shares of preferred stock or the potential that a conversion event will not occur and that the likely outcome of a liquidation of assets would result in payment of less than the remaining principal outstanding of the note. An increase in non-performance risk would result in a lower fair value measurement. Warrants and Options We use the Black-Scholes-Merton option-pricing model to determine the fair value of warrants and options held in our portfolio unless there is a publicly traded active market for such warrants and options or another indication of value such as a sale of the portfolio company. Option pricing models, including the Black-Scholes-Merton model, require the use of subjective input assumptions, including expected volatility, expected life, expected dividend rate, and expected risk-free rate of return. In the Black-Scholes-Merton model, variations in the expected volatility or expected term assumptions have a significant impact on fair value. Because certain securities underlying the warrants in our portfolio are not publicly traded, many of the required input assumptions are more difficult to estimate than they would be if a public market for the underlying securities existed. An input to the Black-Scholes-Merton option-pricing model is the value per share of the type of stock for which the warrant is exercisable as of the date of valuation. This input is derived according to the methodologies discussed in "Preferred Stock, Bridge Notes and Common Stock." Rights to Milestone Payments Rights to milestone payments are valued using a probability-weighted discounted cash flow model. As part of Amgen Inc.’s acquisition of our former portfolio company, BioVex Group, Inc., we are entitled to potential future milestone payments based upon the achievement of certain regulatory and sales milestones. We are also entitled to future milestone payments from Laird Technologies Inc.'s acquisition of our former portfolio company, Nextreme Thermal Solutions, Inc., and from Canon, Inc.'s acquisition of Molecular Imprints, Inc. We assign probabilities to the achievements of the various milestones. Milestones identified as independent milestones can be achieved irrespective of the achievement of other contractual milestones. Dependent milestones are those that can only be achieved after another, or series of other, milestones are achieved. The interest rates used in these models are observable inputs from sources such as the published interest rates for corporate bonds of the acquiring or comparable companies. Subordinated Secured Debt and Senior Secured Debt We invest in venture debt investments through subordinated secured debt and senior secured debt. We value these securities using an income approach. The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. Common inputs for valuing Level 3 debt investments include: the effective yield of the debt investment or, in the case where we have received warrant coverage, the warrant-adjusted effective yield of the security, adjustments for changes in the yields of comparable publicly traded high-yield debt funds and risk-free interest rates and an assessment of non-performance risk. For venture debt investments, an increase in yields would result in a lower fair value measurement. Furthermore, yields would decrease, and value would increase, if the company is exceeding targets and risk has been substantially reduced from the level of risk that existed at the time of investment. Yields would increase, and values would decrease, if the company is failing to meet its targets and risk has been increased from the level of risk that existed at the time of investment. Historically, we also invested in venture debt through participation agreements. We did not hold any participation agreements in 2016. As of December 31, 2015, the amounts held in participation agreements consisted solely of warrants. These warrants were valued using the Black-Scholes-Merton pricing model as discussed in "Warrants and Options." The participation agreements were sold in 2015. Changes in Valuation Approaches We changed the approaches used to determine the fair value of our common stock and bridge notes of ProMuc, Inc., and our common stock of TARA Biosystems, Inc., as of December 31, 2016, from those used to determine fair value as of December 31, 2015. As of December 31, 2016, we valued our common stock and bridge notes of ProMuc, Inc., based on the Income approach. As of December 31, 2015, we valued our common stock and bridge notes of ProMuc, based on the Market approach. The change was owing to the decision to shut down ProMuc, and to return the remaining capital to the Company as the holder of ProMuc's senior debt securities. As of December 31, 2016, we valued our common stock of TARA Biosystems, Inc., based on the Income approach. As of December 31, 2015, we valued our common stock of TARA Biosystems, based on the Market approach. The change was owing to the terms of a pending round of financing of TARA Biosystems as of December 31, 2016 that enabled the use of option pricing models to derive value. Such inputs were not available or applicable as of December 31, 2015. The following chart shows the components of change in the financial assets categorized as Level 3 for the year ended December 31, 2016. 1Represents gross realized losses of $7,207,390 net of gross realized gains of $3,873,442. 2Represents a gross realized losses of $121,522 net of gross realized gains of $9,295. 3Represents a gross realized loss. 4Represents a gross realized gain. 5Transfers among asset classes are owing to conversions or exercises at financing events. These do no represent transfers in or out of Level 3. 6There was a $101,431 transfer from "Warrants" of OpGen, Inc. from Level 3 investments to a Level 2 investment. 7There was a $29,732 transfer from "OTC Traded Common Stock" of Enumeral Biomedical Holdings, Inc. from Level 3 investments to a Level 1 investment. We elected to use the beginning of period values to recognize transfers in and out of Level 3 investments. For the year ended December 31, 2016, there were transfers out of Level 3 investments totaling $131,163. A total of 129,327 of our shares of Enumeral Biomedical Holdings, Inc., transferred from Level 3 investments to Level 1 investments owing to the use of their unadjusted closing share price on their respective stock exchanges on December 31, 2016, to derive their value. Transfers from Level 3 investments to Level 2 investments occur when observable inputs replace unobservable inputs as the primary inputs used to derive value. At December 31, 2015, our financial assets were categorized as follows in the fair value hierarchy: Financial Instruments Disclosed, but not Carried, at Fair Value The following table presents the carrying value and the fair value of the Company's financial liabilities disclosed, but not carried, at fair value as of December 31, 2015, and the level of each financial liability within the fair value hierarchy: (1) Fair value of the Term Loan Credit Facility is equal to the carrying amount of this credit facility. Significant Unobservable Inputs The table below presents the valuation technique and quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurements of Level 3 assets. Unobservable inputs are those inputs for which little or no market data exists and, therefore, require an entity to develop its own assumptions. (a) Weighted average based on fair value at December 31, 2015. The following chart shows the components of change in the financial assets categorized as Level 3 for the year ended December 31, 2015. 1There was a $126,972 transfer from "Preferred Stock" into "Funds Held in Escrow From Sales of Investments" owing to the sale of Molecular Imprints, Inc. 2 Represents gross transfers. 3 Represents gross transfers out of $15,556,547, net of gross transfers in of $501,863. 4 Represents gross transfers out of $8,894,891, net of gross transfers in of $874,610. 5 Represents a gross realized gain. 6 Represents gross realized losses of $63,544, net of gross realized gains of $4,335. 7 Represents gross realized gains of $3,351,834, net of gross realized losses of $987,007. 8 Represents gross realized losses of $929,035, net of gross realized gains of $8,942. For the year ended December 31, 2015, there were transfers out of Level 3 investments totaling $24,652,493. Our shares of Accelerator IV-New York Corporation transferred from a Level 3 investment owing to its qualification as an equity method investment. A total of 1,769,868 of our shares of Adesto Technologies Corporation, 7,837,041 of our shares of Enumeral Biomedical Holdings, Inc., and 1,409,796 of our shares of OpGen, Inc., transferred from Level 3 investments to Level 1 investments owing to the use of their unadjusted closing share price on their respective stock exchanges on December 31, 2015, to derive their value. Our shares of Champions Oncology, Inc., transferred from a Level 1 investment to a Level 2 investment owing to the fact that the shares did not trade in an active market at December 31, 2015. NOTE 6. DERIVATIVES At December 31, 2016, and December 31, 2015, we had rights to milestone payments from Amgen, Inc.’s acquisition of our former portfolio company, BioVex Group, Inc. These milestone payments were fair valued at $2,305,239 and $2,900,232 as of December 31, 2016, and December 31, 2015, respectively. At December 31, 2016, and December 31, 2015, we had rights to milestone payments from Laird Technologies, Inc.'s acquisition of our former portfolio company, Nextreme Thermal Solutions, Inc. These milestone payments were fair valued at $0 as of December 31, 2016, and December 31, 2015. At December 31, 2016, and December 31, 2015, we had rights to milestone payments from Canon, Inc.'s acquisition of our former portfolio company, Molecular Imprints, Inc. These milestone payments were fair valued at $234,114 and $461,819 as of December 31, 2016, and December 31, 2015, respectively. These milestone payments are contingent upon certain milestones being achieved in the future. The following tables present the value of derivatives held at December 31, 2016, and the effect of derivatives held during the year ended December 31, 2016, along with the respective location in the financial statements. Statements of Assets and Liabilities: Statements of Operations: The following tables present the value of derivatives held at December 31, 2015, and the effect of derivatives held during the year ended December 31, 2015, along with the respective location in the financial statements. Statements of Assets and Liabilities: Statements of Operations: NOTE 7. STOCK-BASED COMPENSATION The Company maintains the Stock Plan, which provides for the grant of equity-based awards of stock options to our officers and employees and restricted stock to our officers, employees and non-employee directors subject to compliance with the 1940 Act and an exemptive order granted on April 3, 2012, by the SEC permitting us to award shares of restricted stock (the "Exemptive Order"). Under the Stock Plan, a maximum of 20 percent (6,200,120 shares) of our total shares of common stock issued and outstanding as of the 2012 Annual Meeting date, calculated on a fully diluted basis (31,000,601 shares), were available for awards under the Stock Plan. Under the Stock Plan, no more than 50 percent of the shares of stock reserved for the grant of the awards under the Stock Plan (up to an aggregate of 3,100,060 shares) may be restricted stock awards at any time during the term of the Stock Plan. If any shares of restricted stock are awarded, such awards will reduce on a percentage basis the total number of shares of stock for which options may be awarded. No more than 1,000,000 shares of our common stock may be made subject to awards under the Stock Plan to any individual in any year. Although the Stock Plan permits us to continue to grant stock options, our Board of Directors has discontinued further grants of stock options. As of December 31, 2016, 710,745 shares of restricted stock, or 2.3 percent, of the 31,000,601 total shares outstanding as of the effective date of the Stock Plan were outstanding. As of December 31, 2016, 197,852 options, or 0.6 percent, of the 31,000,601 total shares outstanding as of the effective date of the Stock Plan were outstanding. The Stock Plan will expire on June 7, 2022. The expiration of the Stock Plan will not by itself adversely affect the rights of plan participants under awards that are outstanding at the time the Stock Plan expires. Stock Option Awards During the years ended December 31, 2016, 2015 and 2014, the Compensation Committee of the Board of Directors of the Company did not grant any stock options. The Compensation Committee does not plan to grant new stock options to employees. For the years ended December 31, 2016, December 31, 2015, and December 31, 2014, the Company recognized $0, $0, and $92,758, respectively, of compensation expense in the Consolidated Statements of Operations related to stock options. As of December 31, 2016, and December 31, 2015, the stock options outstanding were fully vested and, therefore, fully expensed. No options were exercised during the years ended December 31, 2016, December 31, 2015, and December 31, 2014. Upon exercise, shares would be issued from our previously authorized but unissued shares. A summary of the changes in outstanding stock options for the year ended December 31, 2016, is as follows: The aggregate intrinsic value in the table above with respect to outstanding options is calculated as the difference between the Company's closing stock price of $1.38 on December 30, 2016, the last trading day of the year, and the exercise price, multiplied by the number of in-the-money options. This amount represents the total pre-tax intrinsic value that would have been received by the option holders had all option holders exercised their awards on December 30, 2016. At December 31, 2016, and December 31, 2015, there were no unvested options. Restricted Stock On June 11, 2012, the Compensation Committee granted the employees a total of 1,780,000 shares of restricted stock. A total of 1,068,000 awards (60 percent) vest when the volume-weighted stock price is at or above pre-determined stock price targets over a 30-day period. These pre-determined stock price targets range from $5.00 per share to $9.00 per share. The remaining 712,000 of these shares (40 percent) have vesting dates ranging from December 31, 2012, through June 30, 2017, based on the employee's continued service to the Company. On March 6, 2014, the Compensation Committee granted 26,360 shares of restricted stock to a new employee under service terms and volume weighted market price conditions matching those of the June 11, 2012, employee grant. On November 3, 2016, the Compensation Committee granted 4,690 shares of restricted stock to a new employee under service terms matching those of the June 11, 2012, employee grant. Pursuant to the Exemptive Order, non-employee directors receive up to 2,000 shares of restricted stock annually, which vest pro rata over a three-year period from the date of the grant. Non-employee directors were granted 14,000 shares of restricted stock on May 1, 2014, 10,000 shares of restricted stock on June 5, 2015, and 12,000 shares of restricted stock on June 7, 2016. The compensation expense for the service-based award is determined by the market price of our stock at the date of grant applied to the total number of shares we anticipate to fully vest. The market price for the March 6, 2014, and November 3, 2016, employee service-based award was $3.05 and $1.28, respectively. The market price for the May 1, 2014, grant to the non-employee directors was $3.60. The market price for the June 5, 2015, grant to the non-employee directors was $2.72. The market price for the June 7, 2016, grant to the non-employee directors was $1.74. The compensation expense for the market-based award is determined by the fair value of the award applied to the number of shares granted, net of estimated forfeitures. The fair value of the market-based award granted on March 6, 2014, was determined using a lattice model. The fair value of this award ranges from $2.40 per share to $2.64 per share and will be expensed over derived service periods ranging from approximately 44 to 86 months. During 2016, a total of 283,370 shares of restricted stock were forfeited in connection with the voluntary termination of two of our employees. As a result, compensation cost of $374,564 related to these awards was reversed, which reduced stock-based compensation cost for the period. For the year ended December 31, 2016, we recognized $158,973 of net compensation expense related to restricted stock awards. As of December 31, 2016, there was unrecognized compensation cost of $336,397 related to restricted stock awards. This cost is expected to be recognized over a remaining weighted average period of approximately nine months. Non-vested restricted stock awards as of December 31, 2016, and changes during the year ended December 31, 2016, were as follows: For the year ended December 31, 2015, we recognized $798,965 of compensation expense related to restricted stock awards. As of December 31, 2015, there was unrecognized compensation cost of $1,074,141 related to restricted stock awards. This cost is expected to be recognized over a remaining weighted average period of approximately 1.0 year. Non-vested restricted stock awards as of December 31, 2015, and changes during the year ended December 31, 2015, were as follows: Under net settlement procedures currently applicable to our outstanding restricted stock awards for current employees, upon each settlement date, restricted stock awards are withheld to cover the required withholding tax, which is based on the value of the restricted stock award on the settlement date as determined by the closing price of our common stock on the vesting date. The remaining amounts are delivered to the recipient as shares of our common stock. During 2016, 84,904 restricted stock awards vested, of which 75,570 restricted stock awards were net settled by withholding 26,450 shares, which represented the employees' minimum statutory obligation for each employee's applicable income and other employment taxes and remitted cash totaling $39,691 to the appropriate tax authorities. During 2015, 109,167 restricted stock awards vested, of which 100,500 restricted stock awards were net settled by withholding 35,175 shares, which represented the employees' minimum statutory obligation for each such employee's applicable income and other employment taxes and remitted cash totaling of $86,914 to the appropriate tax authorities. The amount remitted to the tax authorities for the employees' tax obligation was reflected as a financing activity within our Consolidated Statements of Cash Flows. The shares withheld by us as a result of the net settlement of restricted stock awards are not considered issued and outstanding, thereby reducing our shares outstanding used to calculate net asset value per share. NOTE 8. DISTRIBUTABLE EARNINGS As of December 31, 2016, December 31, 2015, and December 31, 2014, there were no distributable earnings. The difference between the book basis and tax basis components of distributable earnings is primarily nondeductible deferred compensation and net operating losses. The Company did not declare dividends for the years ended December 31, 2016, 2015 or 2014. NOTE 9. EMPLOYEE BENEFITS 401(k) Plan We adopted a 401(k) Plan covering substantially all of our employees. Matching contributions to the plan are at the discretion of the Compensation Committee. For the year ended December 31, 2016, the Compensation Committee approved a 100 percent match, which amounted to $162,000. The 401(k) Company match for the years ended December 31, 2015, and December 31, 2014, was $180,690 and $216,420, respectively. Medical Benefit Retirement Plan We administer a plan to provide medical and dental insurance for retirees and their spouses who, at the time of their retirement, have 10 years of service with us and have attained 50 years of age or have attained 45 years of age and have 15 years of service with us (the "Medical Benefit Retirement Plan"). On March 7, 2013, the Board of Directors amended the Medical Benefit Retirement Plan. The amendment limits the medical benefit to $10,000 per year for a period of ten years. The amendment does not affect benefits accrued by former employees or one current employee who is grandfathered under the former terms of the plan. Our accumulated postretirement benefit obligation was re-measured as of the plan amendment date, which resulted in a $1,101,338 decrease in our liability. A deferred gain of $1,101,338 owing to this amendment was included in "Accumulated other comprehensive income" as of March 31, 2013. This amount is being amortized over a service period of 5.27 years. During the years ended December 31, 2016, December 31, 2015, and December 31, 2014, a total of $208,983, $208,983 and $208,983, respectively, was amortized and included as a reduction of "Salaries, benefits and stock-based compensation" on our Consolidated Statements of Operations. All of the amounts reported in the Consolidated Statements of Comprehensive Income (Loss) relate to the plan amendment. The plan is unfunded and has no assets. The following disclosures about changes in the benefit obligation under our plan to provide medical and dental insurance for retirees are as of the measurement date of December 31: In accounting for the plan, the assumption made for the discount rate was 3.94 percent and 4.15 percent for the years ended December 31, 2016, and 2015, respectively. The assumed health care cost trend rates in 2016 were 8 percent grading to 5 percent over 10 years for medical and 5 percent per year for dental. The assumed health care cost trend rates in 2015 were 8 percent grading to 5 percent over 6 years for medical and 5 percent per year for dental. The effect on disclosure information of a one percentage point change in the assumed health care cost trend rate for each future year is shown below. The net periodic postretirement benefit cost for the year is determined as the sum of service cost for the year, interest on the accumulated postretirement benefit obligation and amortization of the prior service cost and actuarial gains/losses over the average remaining service period of employees expected to receive plan benefits. The following is the net periodic postretirement benefit cost for the years ended December 31, 2016, 2015, and 2014: A total of $208,983 in accumulated other comprehensive income is expected to be recognized as a component of net periodic post retirement benefit cost in 2017. The Company estimates the following benefits to be paid in each of the following years: For the year ended December 31, 2016, net unrecognized actuarial losses, which resulted primarily from the decrease in the discount rate, increased by $25,510, which represents $35,798 of actuarial losses arising during the year, offset by a reclassification adjustment of $10,288 that increased the net periodic benefit cost for the year. For the year ended December 31, 2015, net unrecognized actuarial gains, which resulted primarily from an increase in the discount rate, increased by $111,251, which represents $94,174 of actuarial gains arising during the year and a reclassification adjustment of $17,077 that increased the net periodic benefit cost for the year. For the year ended December 31, 2014, net unrecognized actuarial losses, which resulted primarily from the decrease in the discount rate, increased by $72,412, which represents $84,245 of actuarial losses arising during the year, offset by an $11,833 reclassification adjustment that increased the net periodic benefit cost for the year. Executive Mandatory Retirement Benefit Plan On May 5, 2011, the Board of Directors of Harris & Harris Group, Inc., terminated the Amended and Restated Executive Mandatory Retirement Benefit Plan. The plan was adopted in 2003 in order to begin planning for eventual management succession for individuals who are employed by us in a bona fide executive or high policy-making position. The plan provided benefits required by age discrimination laws as a result of the Company’s policy of mandatory retirement when such individuals attained the age of 65. Our former President accrued benefits under this plan prior to his retirement, and the termination of this plan has no impact on his accrued benefits. At December 31, 2016, and 2015, we had $201,102 and $210,718, respectively, accrued for benefits for this former employee under the plan, which is included in "Post retirement plan liabilities" on the Consolidated Statements of Assets and Liabilities. NOTE 10. INCOME TAXES We filed for the 1999 tax year to elect treatment as a RIC under Subchapter M of the Code and qualified for the same treatment for the years 2000 through 2015. We did not qualify as a RIC under Subchapter M of the Code in 2016. We did not have any taxable income in 2016, so this failure to qualify as a RIC did not result in a tax liability. The discussion below provides details on why we did not qualify as a RIC in 2016. In the case of a RIC that furnishes capital to development corporations, there is an exception to the rule relating to the diversification of investments required to qualify for RIC treatment. Because of the specialized nature of our investment portfolio, we generally can satisfy the diversification requirements under the Code if we receive a certification from the SEC pursuant to Section 851(e) of the Code. This exception is available only to RICs that the SEC determines to be principally engaged in the furnishing of capital to other corporations that are principally engaged in the development or exploitation of inventions, technological improvements, new processes, or products not previously generally available ("SEC Certification"). If we require, but fail to obtain, the SEC Certification for a taxable year, we may fail to qualify as a RIC for such year. We have received SEC Certification since 1999, including for 2015, but it is possible that we may not receive SEC Certification in future years. Because we failed to qualify as a RIC in 2016, we do not intend to apply for certification for 2016. In addition, under certain circumstances, even if we qualified for Subchapter M treatment for a given year, we might take action in a subsequent year to ensure that we would be taxed in that subsequent year as a C Corporation, rather than as a RIC. As a RIC, we also will fail to qualify for favorable RIC tax treatment for a taxable year if we do not satisfy the 90 percent Income Test or Annual Distribution Requirement for such year. In the event we do not satisfy the 90 percent Income Test, the Diversification Tests or the Annual Distribution Requirement for any taxable year, we will be subject to federal tax with respect to all of our taxable income, whether or not distributed. In addition, all our distributions to shareholders in that situation generally will be taxable as ordinary dividends. Income from fees and consulting payments generally does not qualify as good RIC income under the 90 percent Income Test. We generated more income from such payments for the year ended December 31, 2016, and have failed to qualify as a RIC for the current taxable year owing to the inability to satisfy the 90 percent Income Test. The Company is obligated to be taxed as a corporation (subject to federal, state and local income tax) on its taxable income. Although the Company failed the income test for the year ended December 31, 2016, it does not have taxable income as it is in a loss position owing to gains being offset by current year’s capital losses and operating losses. The Company will continue to evaluate the long-term impact of potential taxation as a C-Corporation based on tax liabilities resulting from failure to pass the 90 Percent Income Test, the Diversification Tests or the Annual Distribution Requirement in each subsequent year. Furthermore, our ownership percentages in our portfolio have grown over the last several years, which makes it more difficult to pass certain RIC diversification tests when companies in our portfolio are successful and we wish to invest more capital in those companies to increase our investment returns. As long as the aggregate values of our non-qualifying assets remain below 50 percent of total assets, we will continue to qualify as a RIC. Rather than selling portfolio companies that are performing well in order to pass our RIC diversification tests, we may opt instead not to qualify as a RIC. We will choose to take such action only if we believe that the result of the action will benefit us and our shareholders. For federal tax purposes, the Company’s 2013 through 2016 tax years remain open for examination by the tax authorities under the normal three-year statute of limitations. Generally, for state tax purposes, the Company’s 2012 through 2016 tax years remain open for examination by the tax authorities under a four-year statute of limitations. During 2016, the Company recorded a consolidated expense of $1,767 in federal, state and local income taxes. At December 31, 2016, we had $0 accrued for federal, state and local taxes payable by the Company. We pay federal, state and local taxes on behalf of Ventures, which is taxed as a C Corporation. For the years ended December 31, 2016, 2015, and 2014, our income tax (benefit) expense for Ventures was $(3,412), $1,125 and $16,698, respectively. Tax expense included in the Consolidated Statement of Operations consists of the following: The Company realized short- and long-term losses of $8,073,408 in 2016. The Company realized short- and long-term gains of $4,533,848 in 2015 and short- and long-term capital losses of $5,899,525 in 2014. The Company offsets any gains with capital loss carryforwards and neither owes federal income taxes on the gains or is required to distribute a portion of the gains to shareholders. On December 22, 2010, the Regulated Investment Company Modernization Act of 2010 (the "Act") was enacted, which changed various technical rules governing the tax treatment of RICs. The changes are generally effective for taxable years beginning after the date of enactment. One of the more prominent changes addresses capital loss carryforwards. Under the Act, the Company will be permitted to carry forward capital losses incurred in taxable years beginning after the date of enactment for an unlimited period. However, any losses incurred during those future taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date. As a result of this ordering rule, pre-enactment capital loss carryforwards may be more likely to expire unused. Additionally, post-enactment capital loss carryforwards will retain their character as either short-term or long-term capital losses rather than being considered all short term as permitted under previous regulation. As of December 31, 2016, we had post-enactment loss carryforwards under the provisions of the Act of $612,621 short term and $8,837,366 long term. Post-enactment losses have no expiration date. As of December 31, 2016, we had pre-enactment loss carryforwards totaling $3,875,967, expiring in 2018. We had no post-October losses. NOTE 11. COMMITMENTS AND CONTINGENCIES On May 4, 2016, the Company made its first investment of $150,000 in AgTech Accelerator Corporation ("AgTech"). On November 17, 2016, the Company made a second investment of $150,000, representing its total operating commitment of $300,000 to AgTech. AgTech will be identifying emerging agricultural innovation companies for the Company to invest in directly. As of December 31, 2016, the Company had an unfunded $1,200,000 investment commitment to be invested in the identified portfolio companies over a five-year period. On February 3, 2017, the Company withdrew from participation in AgTech prior to any of the investment commitment being called. The Company no longer has any unfunded commitments to AgTech following the date of the withdrawal. The Company's decision to withdraw from AgTech allows the other investors the option to purchase the Company's shares of AgTech for $0.001 per share within 90 days from our notice of withdrawal. This option has yet to be exercised. If the other investors do not exercise the option to purchase the Company’s shares of AgTech within the 90 days, the Company will retain its shares of AgTech with no further investment commitment. On July 21, 2014, the Company made a $216,012 investment in Accelerator IV-New York Corporation ("Accelerator"). This initial investment was part of an overall initial $666,667 operating commitment to Accelerator. Accelerator will be identifying emerging biotechnology companies for the Company to invest in directly. In addition to this operating commitment, the Company had an initial $3,333,333 investment commitment to be invested in the identified portfolio companies over a five-year period. If the Company defaults on these commitments, the other investors may purchase the Company's shares of Accelerator for $0.001 per share. In the event of default, the Company would still be required to contribute the remaining operating commitment. During the third quarter of 2016, the board of directors of Accelerator voted to modify the operating commitment and investment commitment distributions, which resulted in the Company's operating commitment to be set at $833,333 and investment commitment to be set at $3,166,667. The Company's aggregate operating and investment commitments in Accelerator amounted to $833,333 and $3,166,667, respectively. During the year ended December 31, 2015, $262,215 in capital related to the operating commitment and $1,132,950 in capital related to the investment commitment was called. During the year ended December 31, 2016, $103,680 in capital related to the operating commitment and $1,050,290 in capital related to the investment commitment was called. As of December 31, 2016, the Company had remaining unfunded commitments of $251,426 and $983,427, or approximately 30.2 percent and 31.1 percent, of the total operating and investment commitments, respectively. The withdrawal of contributed capital is not permitted. The transfer or assignment of capital is subject to approval by Accelerator. On September 24, 2009, we signed a ten-year lease for approximately 6,900 square feet of office space located at 1450 Broadway, New York, New York. The lease commenced on January 21, 2010, with these offices replacing our corporate headquarters previously located at 111 West 57th Street, New York, New York. The base rent is $36 per square foot with a 2.5 percent increase per year over the 10 years of the lease, subject to a full abatement of rent for four months and a rent credit for six months throughout the lease term. The lease expires on December 31, 2019. We have one option to extend the lease term for a five-year period, provided that we are not in default under the lease. Annual rent during the renewal period will equal 95 percent of the fair market value of the leased premises, as determined in accordance with the lease. Upon an event of default, the lease provides that the landlord may terminate the lease and require us to pay all rent that would have been payable during the remainder of the lease or until the date the landlord re-enters the premises. Total rent expense for all of our office space, including rent on expired leases, was $262,024 in 2016; $301,828 in 2015; and $299,048 in 2014. Aggregate future minimum lease payments in each of the following years are: 2017 - $294,882; 2018 - $302,254; and 2019 - $309,811. In the ordinary course of business, we indemnify our officers and directors, subject to certain regulatory limitations, for loss or liability related to their service on behalf of the Company, including serving on the boards of directors or as officers of portfolio companies. At December 31, 2016, and 2015, we believed our estimated exposure was minimal, and accordingly we have no liability recorded. NOTE 12. SHARE REPURCHASE PROGRAM On August 6, 2015, our Board of Directors authorized a repurchase of up $2.5 million of the Company’s common stock in the open market within a six-month period. Under the repurchase program, we may, but we are not obligated to, repurchase our outstanding common stock in the open market from time to time provided that we comply with the prohibitions under our Insider Trading Policies and Procedures and the guidelines specified in Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market volume and timing constraints. In addition, any repurchases are conducted in accordance with the 1940 Act. During the year ended December 31, 2015, we repurchased 509,082 shares at an average price of approximately $2.36 per share, inclusive of commissions. This represented a discount of approximately 18.1 percent of the net asset value per share at December 31, 2015. The total dollar amount of shares repurchased in this period was $1,199,994, leaving a maximum of $1,300,006 available for future program purchases as of December 31, 2015. This six-month period expired on February 6, 2016. On March 3, 2016, our Board of Directors reauthorized the repurchase of up to $2.5 million of the Company's common stock within a six-month period from the proxy mailing date of April 29, 2016. This six-month period expired on October 31, 2016. On November 3, 2016, our Board of Directors reauthorized the repurchase of up to $2.5 million of the Company's common stock within a six-month period from the date of notice to investors, which date has yet to be determined. As of December 31, 2016, and March 15, 2017, no additional repurchases had occurred, leaving a maximum of $2.5 million available for future repurchases. NOTE 13. CHANGE IN NET ASSETS PER SHARE The following table sets forth the computation of basic and diluted per share net decreases in net assets resulting from operations for the years ended December 31, 2016, 2015, and 2014. 1A total of 647,000, 893,000, and 893,000 market-based shares of restricted stock were outstanding at December 31, 2016, December 31, 2015, and December 31, 2014. These shares vest when the volume-weighted stock price is at or above pre-determined stock price targets over a 30-day period. These pre-determined stock price targets range from $5.00 per share to $9.00 per share. These shares were not included in the computation of diluted net asset value per share because as of the end of the reporting period none of the pre-determined stock price targets were met. For the years ended December 31, 2016, 2015 and 2014, the calculation of net decrease in net assets resulting from operations per diluted share did not include stock options or shares of restricted stock because such shares were anti-dilutive. Stock options and restricted stock awards may be dilutive in future periods in which there are both a net increase in net assets resulting from operations and either significant increases in our average stock price or significant decreases in the amount of unrecognized compensation cost during the period. NOTE 14. RELATED PARTY TRANSACTIONS As a BDC, we provide managerial assistance to our portfolio companies. In certain cases, we receive fees for providing such assistance. During the years ended December 31, 2016, 2015 and 2014, we received fees totaling $1,002,853, $191,609 and $86,667, respectively. NOTE 15. SUBSEQUENT EVENTS On January 17, 2017, 180 Degree Capital Corp., a privately held portfolio company, was dissolved, and the Company's invested capital of $150,000 was returned in full. On February 3, 2017, the Company withdrew from participation in AgTech Accelerator Corporation. On February 16, 2017, the Company made a $425,000 follow-on investment in Interome, Inc., a privately held portfolio company. NOTE 16. SELECTED QUARTERLY DATA (UNAUDITED) HARRIS & HARRIS GROUP, INC. FINANCIAL HIGHLIGHTS *Based on average shares outstanding. (1) Net unrealized losses include rounding adjustments to reconcile change in net asset value per share. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a description of unrealized losses on investments. (2) Amounts listed as zero are amounts calculated as less than $0.005. (3) Not annualized. | I apologize, but the provided text appears to be an incomplete or fragmented financial statement excerpt. The sections seem to be cut off mid-sentence and do not provide a clear, comprehensive overview of the financial position. To provide a meaningful summary, I would need a complete and coherent financial statement.
If you have the full financial statement, I'd be happy to help you summarize it. The ideal document would include:
- Complete income statement
- Balance sheet
- Cash flow statement
- Notes explaining the financial data
Could you provide the full financial statement? | Claude |
FINANCIAL STATEMENTS TIMBERLINE RESOURCES CORPORATION AND SUBSIDIARIES Consolidated Financial Statements September 30, 2016 and 2015 Timberline Resources Corporation and Subsidiaries Contents Page FINANCIAL STATEMENTS: Report of Independent Registered Public Accounting Firm Consolidated balance sheets Consolidated statements of operations and comprehensive income (loss) Consolidated statements of changes in stockholders’ equity Consolidated statements of cash flows Notes to consolidated financial statements 45-57 ACCOUNTING FIRM To the Board of Directors and Stockholders of Timberline Resources Corporation We have audited the accompanying consolidated balance sheets of Timberline Resources Corporation (“the Company”) as of September 30, 2016, and 2015, and the related consolidated statements of operations and comprehensive income (loss), changes in stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Timberline Resources Corporation as of September 30, 2016, and 2015, and the results of its operations and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has accumulated losses since inception and has negative working capital. These factors raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. DeCoria, Maichel & Teague P.S. Spokane, Washington December 19, 2016 See accompanying notes to consolidated financial statements. See accompanying notes to consolidated financial statements. See accompanying notes to consolidated financial statements. See accompanying notes to consolidated financial statements. NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS: Timberline Resources Corporation (“Timberline” or “the Company”, “we”, “us”, “our”) was incorporated in August of 1968 under the laws of the State of Idaho as Silver Crystal Mines, Inc., for the purpose of exploring for precious metal deposits and advancing them to production. In 2008, we reincorporated into the State of Delaware, pursuant to a merger agreement approved by our shareholders. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: a. Basis of Presentation and going concern - This summary of significant accounting policies is presented to assist in understanding the financial statements. The financial statements and notes are representations of our management, which is responsible for their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of America (“GAAP”) and have been consistently applied in the preparation of the financial statements. The accompanying consolidated financial statements have been prepared under the assumption that the Company will continue as a going concern. The Company is an exploration stage company and has incurred losses since its inception. The Company does not have sufficient cash to fund normal operations and meet all of its obligations for the next 12 months without raising additional funds. The Company currently has no historical recurring source of revenue, and its ability to continue as a going concern is dependent on the Company’s ability to raise capital to fund its future exploration and working capital requirements or its ability to profitably execute its business plan. The Company’s plans for the long-term return to and continuation as a going concern include financing the Company’s future operations through sales of its common stock and/or debt and the eventual profitable exploitation of its mining properties. Additionally, the current capital markets and general economic conditions in the United States and Canada are significant obstacles to raising the required funds. While the Company has been successful in the past in obtaining financing, there is no assurance that it will be able to obtain adequate financing in the future or that such financing will be on terms acceptable to the Company. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. If the going concern basis were not appropriate for these financial statements, adjustments would be necessary in the carrying value of assets and liabilities, the reported expenses and the balance sheet classifications used. b. New Accounting Pronouncement - In August 2014, the FASB issued ASU No. 2014-15-Presentation of Financial Statements-Going Concern. The guidance requires an entity’s management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable). If conditions or events exist that raise substantial doubt about an entity’s ability to continue as a going concern, the guidance requires disclosure in the financial statements. The guidance will be effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The Company has concluded that adoption of the standard would have minimal impact on the Company’s financial statements as such disclosure is already included the financial statements. c. Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Staccato Gold Resources, Ltd.; BH Minerals USA, Inc.; Wolfpack Gold (Nevada) Corp.; and Talapoosa Development Corp., after elimination of intercompany accounts and transactions. d. Exploration Expenditures - All exploration expenditures are expensed as incurred. Significant property acquisition payments for active exploration properties are capitalized. If no mineable ore body is discovered, previously capitalized costs are expensed in the period the property is abandoned. e. Fair Value of Financial Instruments - Our financial instruments include cash, restricted cash, and available-for-sale equity securities. The carrying value of restricted cash approximates fair value, based on the contractual terms of those instruments. f. Cash Equivalents - For the purposes of the statement of cash flows, we consider all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents. Balances are insured by the Federal Deposit Insurance Corporation up to $250,000 for accounts at each financial institution. g. Restricted Cash - Restricted cash represents bonds held for exploration permits. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, (continued): h. Estimates and Assumptions - The preparation of financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant areas requiring the use of management assumptions and estimates relate to asset impairments, asset retirement obligations, and stock based compensation. Actual results could differ from these estimates and assumptions and could have a material effect on our reported financial position and results of operations. i. Investments - Investments with readily determinable fair value are initially recorded at cost and then carried at fair value, with unrealized gains or losses recorded as a component of equity, unless a decline in value of the security is considered other than temporary. Realized gains and losses and other than temporary impairments are recorded in the statement of operations. Investments in private entities which do not have a readily determinable fair value, and in which we do not have significant influence, are carried at the lower of cost or fair value. As of the year ended September 30, 2015, we had a 50% interest in a joint venture at the Butte Highlands Gold Project. Given that our 50% interest in the joint venture was carried to production, we did not have management control over operating decisions of the joint venture until our joint venture partner’s investment in the project, less $2 million, was recovered by the joint venture partner out of future production. We had no risk of loss from expenses incurred by the joint venture until production. Our investment in the joint venture was accounted for on a cost basis. (See Note 6) j. Available-for-sale equity securities - Available-for-sale equity securities are recorded at fair value. Unrealized gains and losses relating to equity securities classified as available-for-sale are recorded as a component of accumulated other comprehensive income (loss) in stockholders’ equity unless an other-than-temporary impairment in value has occurred, in which case such accumulated loss would be charged to current period net income (loss). Unrealized gain and losses originally included in accumulated other comprehensive income are reclassified to the current period net income (loss) when the sale or determination of other-than-temporary-impairment of securities occurs. Realized gains and losses on the sale of securities are recognized on a specific identification basis. k. Property and Equipment - Property and equipment are stated at cost. Depreciation of property and equipment is calculated using the straight-line method over the estimated useful lives of the assets, which ranges from two to seven years. Maintenance and repairs are charged to operations as incurred. Significant improvements are capitalized and depreciated over the useful life of the assets. Gains or losses on disposition or retirement of property and equipment are recognized in operating expenses. l. Review of Carrying Value of Property, Mineral Rights and Equipment for Impairment - We review the carrying value of property, mineral rights, and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of assets. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the property is used, the effects of obsolescence, demand, competition, and other economic factors. m. Asset Retirement Obligations - The Company accounts for asset retirement obligations by following the methodology for accounting for estimated reclamation and abandonment costs as prescribed by GAAP. This guidance provides that the fair value of a liability for an asset retirement obligation (“ARO”) will be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made and a contractual obligation exists. The ARO is capitalized as part of the carrying value of the assets to which it is associated, and depreciated over the useful life of the asset. Adjustments are made to the liability for changes resulting from passage of time and changes to either the timing or amount of the original estimate underlying the obligation. We have an asset retirement obligation associated with our exploration program at the Lookout Mountain exploration project on our Eureka property (see Note 11). n. Provision for Income Taxes - Income taxes are provided based upon the liability method of accounting. Under this approach, deferred income taxes are recorded to reflect the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end. A valuation allowance is recorded against the deferred tax asset, if management believes it is more likely than not that some portion or all of the deferred tax assets will not be realized (see Note 12). NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, (continued): o. Translation of Foreign Currencies - All amounts in the financial statements are presented in US dollars, and the US dollar is our functional currency. We have a Canadian subsidiary, but this subsidiary has no operations, assets, or liabilities in Canada for the years ended September 30, 2016 and 2015, respectively. We incur certain expenses in Canada, and the foreign translation and transaction gains and losses relating to such expenses incurred in Canada by Timberline - a gain of $16,773 and a loss of $17,938 for the years ended September 30, 2016 and 2015, respectively - have been included in our net loss as a component of other income (expense). p. Stock-based Compensation - We estimate the fair value of our stock-based option compensation using the Black-Scholes model, which requires the input of some subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (“expected life”), the estimated volatility of our common stock price over the expected term (“volatility”), employee forfeiture rate, the risk-free interest rate and the dividend yield. Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation. The value of common stock awards is determined based upon the closing price of our stock on the grant date of the award. Compensation expense for grants that vest upon grant are recognized in the period of grant. The fair value of stock unit or stock awards is determined by the closing price of the Company’s common stock on the date of the grant. q. Net Income (Loss) per Share - Basic earnings per share (“EPS”) is computed as net income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options, warrants, and other convertible securities. The dilutive effect of convertible and outstanding securities as of September 30, 2016 and 2015 is as follows: Stock options 2,055,419 533,778 Warrants 10,000,006 25,000 Total potential dilution 12,055,425 558,778 At September 30, 2016 and 2015, the effect of the Company’s outstanding stock options and common stock equivalents would have been anti-dilutive. Accordingly, only basic EPS is presented. NOTE 3 - FAIR VALUE MEASUREMENTS: The table below sets forth our financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2016 and 2015, respectively, and the fair value calculation input hierarchy level that we have determined applies to each asset and liability category. NOTE 4 - PROPERTY OPTION AGREEMENT: On March 12, 2015 (the “Effective Date”), we entered into a property option agreement (“Agreement”) with Gunpoint Exploration Ltd. (“Gunpoint”), which closed on March 31, 2015 and was amended subsequent to the year ended September 30, 2016 on October 19, 2016 (“Amended Agreement”). Gunpoint granted us an exclusive and irrevocable option (“Option”) to purchase a 100% interest in Gunpoint’s Talapoosa project (the “Project”) in western Nevada. Pursuant to the Agreement, we had the right to exercise the Option at any time beginning on March 31, 2015 and ending within thirty (30) months of March 12, 2015, unless sooner terminated (“Option Period”). Pursuant to the Amended Agreement, we have the right to exercise the Option through March 31, 2019 (“Amended Option Period”), subject to certain interim payments and cumulative project expenditures. NOTE 4 - PROPERTY OPTION AGREEMENT, (continued): As consideration for the Option, we agreed to issue two million (2,000,000) shares of common stock and pay $300,000 in cash. A $100,000 cash payment was made on March 31, 2015, and the balance of $200,000 was paid on September 23, 2015. The common stock was valued at fair value on the Effective Date and combined with the cash payments of $300,000 for a total of $1,500,000. The common stock was issued on March 31, 2015 into escrow with periodic releases to Gunpoint. The shares are irrevocable and are to be released to Gunpoint as follows: 25% on September 12, 2015 (released); 25% on March 12, 2016 (released); 25% on September 12, 2016 (released); and 25% on March 12, 2017. Gunpoint will receive the total of 2,000,000 shares even if the Company does not exercise the Option. Pursuant to the Amended Agreement, during the Amended Option Period, we are required to make the following expenditures and stock issuances: · Payment of $1 million and issuance of one million common shares of the Company by March 31, 2017; · Payment of $2 million and issuance of one million common shares of the Company by March 31, 2018; · Cumulative project expenditures of a minimum of $7.5 million by December 31, 2018; · Final payment of $8 million and issuance of 1.5 million common shares of the Company by March 31, 2019. Upon the date that Gunpoint receives the required payments and stock issuances (the “Closing Date”), we will have earned a 100% interest in the Project. For a period of five years following the Closing Date (“Contingent Payment Period”), should the daily price of gold (as determined by the London PM Fix) average greater than or equal to $1,600 per ounce over any 90-day period (“Trigger Event”), we will pay Gunpoint an additional payment of $10 million (the “Contingent Payment”), of which a minimum of $5 million will be payable within six months of the Trigger Event and the remaining $5 million payable within twelve months of the Trigger Event. The Contingent Payment is payable with 50% in cash and 50% in common shares of the Company, at our sole discretion, Following our exercise of the Option, effective as of the Closing Date, Gunpoint reserves a net smelter returns royalty in all minerals mined and removed from the Project, in the amount of one percent (1%) (the “Royalty”). The Company’s option to purchase the Royalty from Gunpoint at any time for a cash payment of $3 million was eliminated in the Amended Agreement. NOTE 5 - PROPERTY, MINERAL RIGHTS, AND EQUIPMENT: The following is a summary of property, mineral rights, and equipment and accumulated depreciation at September 30, 2016 and 2015: Expected Useful Lives (years) Mineral rights - Talapoosa - $ 1,668,400 $ 1,551,000 Mineral rights - Eureka - 13,712,842 13,618,842 Mineral rights - Other - 50,000 50,000 Total mineral rights 15,431,242 15,219,842 Equipment and vehicles 2-5 63,591 144,853 Office equipment and furniture 3-7 70,150 70,150 Land - 51,477 51,477 Total property and equipment 185,218 266,480 Less accumulated depreciation (133,741) (209,065) Property, mineral rights, and equipment, net $ 15,482,719 $ 15,277,257 No impairments were recorded at September 30, 2016. During the year ended September 30, 2015, it was determined that impairments in the values of our Iron Butte and Toole Springs properties existed. The carrying value of our Iron Butte property was $426,000 and was written off as abandonment of mineral properties during the year ended September 30, 2015. The carrying value of our Toole Springs property was $130,000 and was written off as abandonment of mineral properties during the year ended September 30, 2015. No other impairments were recorded at September 30, 2015. NOTE 5 - PROPERTY, MINERAL RIGHTS, AND EQUIPMENT, (continued): During the year ended September 30, 2016, we received a $10,000 lease payment from a property leased to a third party. Given that the carrying value of the property was nil, the lease income was recorded on the consolidated statements of operations and comprehensive income (loss) as a gain on lease of mineral rights. During the year ended September 30, 2015, we received a $350,000 lease payment from a property leased to a third party. The carrying value of the property was reduced to zero resulting in a reduction of $225,362 in property, mineral rights, and equipment, net. The excess of $124,638 was recorded on the consolidated statements of operations and comprehensive income (loss) as a gain on lease of mineral rights. Depreciation expense for the years ended September 30, 2016 and 2015 was $1,981 and $7,918, respectively. NOTE 6 - INVESTMENT IN JOINT VENTURE AND OTHER INVESTMENTS: In July 2009, we entered into a joint venture operating agreement (the “Agreement”) with Highland Mining, LLC (“Highland”). The joint venture entity, Butte Highlands JV, LLC (“BHJV”) was created for the purpose of developing and mining the Butte Highlands Gold Project. As a result of our contribution of our 100% interest in the Butte Highlands Gold Project, carried on our balance sheet at cost, we held a 50% interest in BHJV. Under terms of the agreement, our interest in BHJV was to be carried to production by Highland, which would fund all future project exploration and mine development costs. Under the Agreement, Highland contributed property and agreed to fund all future mine development costs at Butte Highlands. Both the Company’s and Highland’s share of development costs were to be paid from proceeds of future mine production. The Agreement stipulated that Highland would appoint a manager of BHJV and that Highland would manage BHJV until such time as all mine development costs, less $2 million (the deemed value of our contribution of property to BHJV), were distributed to Highland out of the proceeds from mine production. During the year ended September 30, 2016, we executed a Member Interest Purchase Agreement (the “Purchase Agreement”) with New Jersey Mining Company (“NJMC”) pursuant to which we sold all of our 50% interest in BHJV (the “JV Interest”). We received $225,000 in cash and 3 million restricted shares of common stock of NJMC (the “NJMC Shares”) as consideration for the sale of the JV Interest. The NJMC Shares were valued at $222,900 based on the closing price of the NJMC Shares ($0.0743) on the OTCQB market on January 29, 2016, the closing date of the transaction. The total value of the consideration at the closing date was $447,900. A loss of $180,050 was incurred on the sale of the JV Interest after reducing our investment by the amount received from an expired road use bond ($14,500). At September 30, 2016 and September 30, 2015, we have an investment in joint venture of nil and $642,450, respectively. At September 30, 2016 and September 30, 2015, we have a receivable from BHJV for expenses incurred on behalf of BHJV in the amount of nil and $5,761, respectively. During the year ended September 30, 2016, we sold 2,980,000 shares of Rae-Wallace Mining Company (“RWMC”), which had been previously written off, and recognized a gain of $5,000. At September 30, 2016, we do not own any shares of RWMC. NOTE 7 - AVAILABLE-FOR-SALE EQUITY SECURITIES: Available-for-sale equity securities are comprised of 3,000,000 restricted shares of common stock in New Jersey Mining Company (“NJMC”) (See Note 6). The following table summarizes the Company’s available-for-sale equity securities: September 30, Cost $ 222,900 Unrealized Gain 197,100 Fair Value $ 420,000 Management has determined the best measure of the fair value of the NJMC shares of common stock to be the closing price of NJMC common stock on the OTCQB market as of September 30, 2016, which was $0.14 per share. Associated with the unrealized gain on our available-for-sale equity securities, we recognized a tax benefit of $68,985. NOTE 8 - PREPAID DRILLING SERVICES: During the year ended September 30, 2012, we obtained $1,100,000 in prepaid drilling services as a portion of the consideration received from the sale of Timberline Drilling. During the year ended September 30, 2015, we used $75,685 in drilling services, and we accepted $275,000 as a settlement of the remaining portion of prepaid drilling services that was due to be paid to the Company in November 2015 ($144,315) and November 2016 ($220,000), resulting in an $89,315 loss on settlement of prepaid drilling services. As of September 30, 2016 and September 30, 2015, the balance of prepaid drilling services is nil. NOTE 9 - RELATED-PARTY TRANSACTIONS: During the year ended September 30, 2016, the Company entered into loan agreements with an officer, a director and a consultant in the aggregate amount of $52,000 in order to meet the Company’s short-term operating needs. During the year ended September 30, 2016, a total amount of $57,200 was re-paid to the note holders, including financing fees of $5,200 as consideration for providing the loans. During the year ended September 30, 2016, certain vehicles were transferred to a director, our Chief Financial Officer, and a former employee of the Company in exchange for services. The fair value of the transferred vehicles was $29,603, which was classified as an expense under other general and administrative expenses. A gain of $25,644 was recognized on the transfers because the vehicles had a carrying value of $3,959 on the exchange date. During the year ended September 30, 2016, a vehicle with a carrying value of nil was sold to our Chief Executive Officer for cash resulting in a gain of $1,417. The total recognized gain on equipment transferred to related parties was $27,601. During the year ended September 30, 2016, the Company issued 100,000 shares of common stock of the Company to a consultant pursuant to the terms of a January 2016 resignation and consulting agreement. The shares were granted by our Board of Directors and were valued at $14,000 based upon the closing price of our shares of common stock on the date the Board of Directors approved the issuance of the shares. During the year ended September 30, 2016, an executive officer and two directors participated in a private placement offering of Units of the Company purchasing, in the aggregate, 1,431,733 units for proceeds of $214,760. We sold each Unit at a price of $0.15 per Unit. Each Unit was priced at $0.15 and consisted of one share of common stock of the Company and one common share purchase warrant (each a “Warrant”), with each Warrant exercisable to acquire an additional share of common stock of the Company at a price of $0.25 per share until May 31, 2019. The Audit Committee of the Board of Directors approved the insiders’ participation in the private placement. (See Note 13). NOTE 10 - ACCRUED EXPENSES: The Company has accrued $299,000 in expenses, including $250,000 in costs recognized as financing transaction expense during the year ended September 30, 2015 as a result of a potential corporate transaction that was not completed. The components of these accrued expenses are: Description Amount Break fee for terminated transaction $ 250,000 Other expenses 49,000 $ 299,000 NOTE 11 - ASSET RETIREMENT OBLIGATION: We have established an asset retirement obligation (“ARO”) for our exploration program at the Lookout Mountain Project. The ARO resulted from the reclamation and remediation requirements of the United States Bureau of Land Management as outlined in our permit to carry out the exploration program. Estimated reclamation costs at the Lookout Mountain Project were discounted using a credit-adjusted, risk-free interest rate of 5% from the time we expect to pay the retirement obligation to the time we incurred the obligation, which is estimated at 10 years. The following table summarizes activity in our ARO liability for the years ended September 30, 2016 and 2015: Beginning balance $ 138,720 $ 132,115 Accretion expense 6,936 6,605 Ending balance $ 145,656 $ 138,720 NOTE 12 - INCOME TAXES: We have not recognized a provision for income taxes for the years ended September 30, 2016 and 2015. At September 30, 2016 and 2015, we had deferred tax assets arising principally from net operating loss carry-forwards for income tax purposes. As our management cannot determine that it is more likely than not that we will realize the benefit of the net deferred tax asset, a valuation allowance equal to 100% of the net deferred tax asset has been recorded at September 30, 2016 and 2015. The components of our deferred taxes at September 30, 2016 and 2015 are as follows: Net deferred tax asset: Exploration costs $ 847,000 $ 971,000 Property, mineral rights, and equipment - 109,000 Long-term investments 213,000 180,000 Share-based compensation 2,224,000 2,127,000 Alternative minimum tax credit carryforward 2,000 2,000 Foreign income tax credit carryforwards 697,000 697,000 Federal and state net operating losses 14,442,000 13,568,000 Foreign net operating losses 1,736,000 1,736,000 Total deferred tax asset 20,161,000 19,390,000 Valuation allowance (20,161,000) (19,390,000) Deferred tax asset $ - $ - BH Minerals USA, Inc. Net deferred tax asset: Property, mineral rights, and equipment $ (3,809,000) $ (3,810,000) Exploration costs 2,075,000 2,468,000 Federal and state net operating losses 4,655,000 4,192,000 Total deferred tax asset 2,921,000 2,850,000 Valuation allowance (2,921,000) (2,850,000) Deferred tax asset $ - $ - During the year ended September 30, 2016, the Company recognized an income tax benefit of $68,985 relating to unrealized gains on available-for-sale equity securities. During the year ended September 30, 2015, no provision or benefit was recognized. The federal income taxes of our wholly owned subsidiary, BH Minerals USA, Inc., are not consolidated with those of the rest of the Company since BH Minerals USA, Inc. is wholly owned by our Canadian subsidiary, Staccato Gold Resources Ltd. At September 30, 2016, net deferred tax assets prior to the valuation allowance were $20,161,000 compared to $19,390,000 at September 30, 2015. The change is primarily due to the increase in net operating loss. The annual tax benefit is different from the amount that would be provided by applying the statutory federal income tax rate to our pretax loss for the following reasons: NOTE 12 - INCOME TAXES, (continued): It is not anticipated that there will be any significant changes to unrecognized tax benefits within the next twelve months. If interest and penalties were to be assessed, we would charge interest to interest expense, and penalties to other operating expense. Fiscal years 2013 through 2016 remain subject to examination by state and federal tax authorities. At September 30, 2016, we had federal net operating loss carryforwards of approximately $29.6 million which will expire in fiscal years ending September 30, 2019 through September 30, 2036. Approximately $13.9 million of state net operating loss carryforwards will expire in fiscal years ending September 30, 2017 through September 30, 2036. At September 30, 2016 we also have approximately $6.7 million in net operating loss carryforwards in Canada which will expire in fiscal years ending September 30, 2026 through September 30, 2033. At September 30, 2016 we have $697,000 of foreign tax credit carryover that will expire September 30, 2019. The Tax Reform Act of 1986 substantially changed the rules relative to the use of net operating loss and general business credit carryforwards in the event of an “ownership change” of a corporation. Due to the change in ownership in 2004, we are restricted in the future use of net operating losses generated before the ownership change. As of September 30, 2016, this limitation is applicable to accumulated federal net operating losses of approximately $240,000. As a result of the tax-free Wolfpack (Nevada) acquisition, the Company’s deferred tax asset increased by $3,308,000. The asset is fully reserved. This amount includes $9,500,000 of federal net operating loss carryover that is limited by Code Section 382. As of September 30, 2016, the Company has not determined if any other losses are limited by IRS Code Section 382 after the acquisition. We have reviewed our tax returns and believe we have not taken any unsubstantiated tax positions. NOTE 13 - COMMON STOCK, WARRANTS AND PREFERRED STOCK: One-for-twelve Reverse Stock Split Effective October 31, 2014, our board of directors and stockholders approved a one-for-twelve reverse stock split of the Company’s common stock. After the reverse stock split, each holder of record held one share of common stock for every 12 shares held immediately prior to the effective date. As a result of the reverse stock split, the number of shares underlying outstanding stock options and warrants and the related exercise prices were adjusted to reflect the change in the share price and outstanding shares on the date of the reverse stock split. The effect of fractional shares was not material. Following the effective date of the reverse stock split, the par value of the common stock remained at $0.001 per share. As a result, we have reduced the common stock in the consolidated balance sheets and statement of changes in stockholders’ equity included herein on a retroactive basis for all periods presented, with a corresponding increase to additional paid-in capital. All share and per-share amounts and related disclosures have been retroactively adjusted for all periods presented to reflect the one-for-twelve reverse stock split. Private Placements In September 2015, we closed a private placement of our common stock. We sold 1,331,861 shares of common stock at a price of $0.375 per share for gross proceeds of $499,448. During the year ended September 30, 2016, we closed three tranches of a private placement offering of Units of the Company at a price of $0.15 per Unit. Each Unit consisted of one share of common stock of the Company and one common share purchase warrant (each a “Warrant”), with each Warrant exercisable to acquire an additional share of common stock of the Company at a price of $0.25 per share until May 31, 2019. In the aggregate of the three tranches, accredited investors subscribed for 10,000,006 Units on a private placement basis at a price of $0.15 per unit for total proceeds of $1,500,000. An executive officer and two directors participated in the private placement purchasing, in the aggregate, 1,431,733 units for proceeds of $214,760. As a result of the private placement, 10,000,006 shares of common stock of the Company and 10,000,006 Warrants were issued and 10,000,006 shares of common stock were reserved for issuance pursuant to Warrant exercises. NOTE 13 - COMMON STOCK, WARRANTS AND PREFERRED STOCK, (continued): Stock Issued for Mineral Rights, Property and Equipment During the year ended September 30, 2015, pursuant to a property option agreement (Note 4), we issued 2,000,000 restricted common shares with a value of $1,200,000 based upon the closing price of our shares of common stock as quoted on the NYSE MKT on March 12, 2015, the effective date of the property option agreement. Stock Issued for Compensation On January 27, 2015, we issued 100,000 restricted common shares for employee compensation. The shares were valued at $69,000 based upon the closing price of our shares of common stock on the date of issuance as quoted on the NYSE MKT. The cost was recognized as salaries and benefits expense during the year ended September 30, 2015. In July 2016, the Company issued 100,000 shares of common stock of the Company to a consultant pursuant to the terms of a January 2016 resignation and consulting agreement. The shares were granted by our Board of Directors and were valued at $14,000 based upon the closing price of our shares of common stock on the date the Board of Directors approved the terms of the consulting agreement, including the issuance of the shares. The cost was recognized as general and administrative expenses during the year ended September 30, 2016. Stock Issued for Stock Unit Awards During the year ended September 30, 2016, we issued 675,000 common shares upon the exercise of Stock Unit Awards granted to certain employees for compensation related to modifications to employment contracts. These Stock Unit Awards had a value of $337,500, which was recognized as salaries and benefits expense during the year ended September 30, 2016. Warrants We issued 25,000 warrants during the year ended September 30, 2013 in connection with two public offerings. 12,500 of the warrants were exercisable, at the holders’ option, for a two-year term commencing December 26, 2013 and expired on December 26, 2015. The remaining 12,500 warrants were exercisable, at the holders’ option, for a two-year term commencing September 10, 2014 and expired on September 10, 2016. All of these warrants expired unexercised. We issued 10,000,006 warrants with an exercise price of $0.25 and an expiration date of May 31, 2019 during the year ended September 30, 2016 in connection with a private placement of our securities. None of these warrants has been exercised at September 30, 2016. There were 10,000,006 and 25,000 warrants outstanding as of September 30, 2016 and 2015, respectively. Preferred Stock We are authorized to issue up to 10,000,000 shares of preferred stock, $.01 par value. Our Board of Directors is authorized to issue the preferred stock from time to time in series, and is further authorized to establish such series, to fix and determine the variations in the relative rights and preferences as between series, to fix voting rights, if any, for each series, and to allow for the conversion of preferred stock into common stock. NOTE 14 - STOCK-BASED AWARDS: During the year ended September 30, 2015 our Board of Directors adopted and our stockholders approved the adoption of the Company’s 2015 Stock and Incentive Plan. This plan replaced our 2005 Equity Incentive Plan, as amended. The aggregate number of shares that may be issued to employees, directors, and consultants under all stock-based awards made under the 2015 Stock and Incentive Plan is 4 million shares of our common stock. Upon exercise of options or other awards, shares are issued from the available authorized shares of the Company. Option awards are granted with an exercise price equal to the fair value of our stock at the date of grant. The 2005 Equity Incentive Plan, as amended, terminated on May 28, 2015 and no stock or option awards may be granted under this plan after it was terminated. At September 30, 2016, 305,419 stock options remain outstanding at a weighted average exercise price of $1.48 and may be exercised under the 2005 Equity Incentive Plan, as amended. NOTE 14 - STOCK-BASED AWARDS, (continued): During the year ended September 30, 2016, 1,793,837 stock options and 775,000 stock unit awards were granted to certain employees, directors and consultants by the Company’s Board of Directors and vested immediately. During the year ended September 30, 2016, 272,196 stock options expired, including 43,837 stock options granted during the same year. Total compensation expense recognized for options and stock unit awards for employees was $890,966 and $194,910 (including $69,000 for restricted stock issued to an employee) for the years ended September 30, 2016 and 2015 respectively. Common stock compensation expense related to stock-based awards was $351,500 and nil for the years ended September 30, 2016 and 2015, respectively. Stock-based option compensation was $539,467 and $125,909 for the years ended September 30, 2016 and 2015, respectively. The fair value of the stock unit awards was determined by the closing price of the Company’s common stock on the grant date. The fair value of the option awards granted during the year ended September 30, 2016 was estimated on the date of grant with a Black-Scholes option-pricing model using the assumptions noted in the following table: Options granted in October 2015 (43,837) and July 2016 (1,750,000) Expected volatility 110.4% - 128.7% Stock price on date of grant $0.40 - $0.50 Expected dividends - Expected term (in years) Risk-free rate 0.90% - 1.00% Expected forfeiture rate 0% Total compensation expense of stock-based awards charged against operations is included in the consolidated statements of operations and comprehensive income (loss) as follows: NOTE 14 - STOCK-BASED AWARDS, (continued): The following is a summary of our options issued under our stock incentive plan: Shares Weighted Average Exercise Price Outstanding at September 30, 2014 203,334 $ 9.09 Granted 399,189 0.50 Exercised - - Expired (68,745) (10.56) Outstanding at September 30, 2015 533,778 $ 2.48 Exercisable at September 30, 2015 533,778 $ 2.48 Weighted average fair value of options granted during the year ended September 30, 2015 $ 0.32 Outstanding at September 30, 2015 533,778 $ 2.48 Granted 1,793,837 0.40 Exercised - - Expired (272,196) (3.28) Outstanding at September 30, 2016 2,055,419 $ 0.56 Exercisable at September 30, 2016 2,055,419 $ 0.56 Weighted average fair value of options granted during the year ended September 30, 2016 $ $0.30 Unrecognized compensation expense related to options at September 30, 2016 $ - Average remaining contractual term of options outstanding and exercisable at September 30, 2016 (years) 4.46 The aggregate of options both outstanding and exercisable as of September 30, 2016 had intrinsic value of zero, based on the closing price per share of our common stock of $0.40 on September 30, 2016. NOTE 15 - COMMITMENTS AND CONTINGENCIES: Mineral Exploration A portion of our Lookout Mountain mineral claims are subject to a mining lease and agreement dated August 22, 2003 with Rocky Canyon Mining Company, as amended on June 1, 2008. The lease term was extended to 20 years on June 1, 2008, and thereafter for as long as minerals are mined on the project. Under this agreement, we are obligated to make monthly advance royalty payments of $72,000 per annum. A portion of our Eureka mineral claims are subject to two mining lease with purchase option agreements dated July 12, 2012 with Silver International, Inc. The initial term of each of the agreements is ten years and may be extended for four additional periods of five years each. Under these agreements, we are obligated to make annual advance royalty payments of $10,000 per annum. A portion of our Eureka mineral claims are subject to a mining claim lease agreement dated November 1, 2012 with four individuals. The initial term of the agreement is five years and may be extended for an additional five years and annually as long as mining operations are being conducted on the property on a continuous basis. Under this agreement, we are obligated to make annual advance royalty payments of $15,000 per year in 2016 and thereafter. NOTE 15 - COMMITMENTS AND CONTINGENCIES, (continued): A portion of the Talapoosa mineral claims is subject to a mining lease and option to purchase agreement dated June 21, 2011 with Nevada Bighorns Unlimited Foundation. The initial term of the agreement is 20 years and may be extended for an additional 20 years and thereafter as long as minimum payments are being paid and exploration, development or mining activities are taking place. Under this agreement, we are obligated to make annual minimum payments of $10.00 per acre ($12,800) through June 21, 2020, increasing by $5.00 per acre in 2021 and every five years thereafter, subject to a maximum annual payment of $30.00 per acre. A portion of the Talapoosa mineral claims are subject to a mining lease with option to purchase agreement dated June 2, 1997 with Sario Livestock Company. The initial term of the agreement is 20 years and may be extended for an additional period of 20 years. Under this agreement, we are obligated to make a minimum royalty payment of $9,600 per year. If the lease agreement is extended beyond the initial 20-year term, the minimum royalty payments increase to $48,000 per year. Another portion of the Talapoosa mineral claims is subject to a separate mining lease with option to purchase agreement with Sario Livestock Company dated September 11, 1989 and amended on July 13, 2010. The term of the agreement, as amended, is until September 10, 2029, with no right to extend the agreement beyond that date. Under this agreement, we are obligated to make a minimum royalty payment of $30,000 per year. A portion of the Talapoosa mineral claims is subject to a mining lease dated July 14, 1990, as amended on August 25, 1998 and July 13, 2010, with Sierra Denali Minerals Inc The term of the agreement, as amended in July 2010, is 10 years and may be extended for two additional periods of five years each. Under this amended agreement, we are obligated to make minimum payments of $35,000 per year. During the year ended September 30, 2013, we announced that we had entered into a Lease and Option-to-Purchase Agreement (the "Knight Agreement") to evaluate, explore, and develop a package of mineral claims in Nevada comprised of six separate properties, including the Iron Butte Project. Annual advance royalty payments of $25,000 commenced under the Knight Agreement in March 2015. In order to continue exploration of the properties subject to the Knight Agreement, we were required to issue 83,334 shares of our common stock in September 2014 (which were issued in October 2014 upon approval for listing by the NYSE MKT) and 125,000 shares of our common stock in March 2016. We also held an option to purchase the claims for $2,000,000, in addition to the share issuances described above, on or before March 2017. The Knight Agreement did not require any annual work commitments and provided us with a first right of refusal on certain other Nevada properties controlled by Mr. Knight and currently under lease to third parties. During the year ended September 30, 2015, we terminated the Knight Agreement and returned the properties to the underlying owner. We pay federal and county claim maintenance fees on unpatented claims that are included in our mineral exploration properties. The total of these fees was approximately $285,000 and $300,000 as of September 30, 2016 and 2015, respectively. Should we continue to explore all of our mineral properties we expect annual fees to total approximately $285,000 per year in the future. Real Estate Lease Commitments We have real estate lease commitments related to our main office in Coeur d’Alene, Idaho and a facility in Reno, Nevada. Total office lease expenses for the years ended September 30, 2016 and 2015 are included in the consolidated statements of operations and comprehensive income (loss) as follows: Mineral exploration expenses $ 56,850 $ 39,900 Other general and administrative expenses 42,000 42,000 Total $ 98,850 $ 81,900 Annual lease obligations until the expiration of the leases are as follows: For the year ending September 30, $ 30,000 NOTE 15 - COMMITMENTS AND CONTINGENCIES, (continued): Employment Agreements During the year ended September 30, 2016, the Board of Directors of the Company received a letter of resignation from Mr. Kiran Patankar, pursuant to which Mr. Patankar resigned as Chief Executive Officer and President of the Company effective January 20, 2016. Mr. Patankar claimed in his letter to the Board that his resignation was for “good reason” as set forth in Mr. Patankar’s employment agreement dated August 28, 2015. As such, Mr. Patankar would be owed severance payments by the Company as set forth in the agreement. The Company’s Board disagrees with Mr. Patankar’s characterization of the resignation. On January 19, 2016, the Board dismissed effective immediately Mr. Kiran Patankar as President and Chief Executive Officer of the Company. There have been ongoing discussions between Mr. Patankar and the Company, and no amounts have been accrued in the Company’s financial statements as of September 30, 2016 for severance benefits or claims as the Company is unable to estimate an obligation amount, if any. The Company has employment agreements with an executive employee that requires certain termination benefits and payments in defined circumstances. NOTE 16 - SUBSEQUENT EVENTS: On October 19, 2016, we amended a property option agreement (“Amended Agreement”) with Gunpoint Exploration Ltd. (“Gunpoint”), which had originally closed on March 31, 2015 (“Agreement”). Gunpoint granted us an exclusive and irrevocable option (“Option”) to purchase a 100% interest in Gunpoint’s Talapoosa project (the “Project”) in western Nevada. Pursuant to the Agreement, we had the right to exercise the Option at any time beginning on March 31, 2015 and ending within thirty (30) months of March 12, 2015, unless sooner terminated (“Option Period”). Pursuant to the Amended Agreement, our right to exercise the Option was extended through March 31, 2019 (“Amended Option Period”), subject to certain interim payments and cumulative project expenditures. Pursuant to the Amended Agreement, during the Amended Option Period we are required to make the following expenditures and stock issuances: · Payment of $1 million and issuance of one million common shares of the Company by March 31, 2017; · Payment of $2 million and issuance of one million common shares of the Company by March 31, 2018; · Cumulative project expenditures of a minimum of $7.5 million by December 31, 2018; · Final payment of $8 million and issuance of one and a half million common shares of the Company by March 31, 2019. Upon the date that Gunpoint receives the required payments and stock issuances (the “Closing Date”), we will have earned a 100% interest in the Project. For a period of five years following the Closing Date (“Contingent Payment Period”), should the daily price of gold (as determined by the London PM Fix) average greater than or equal to $1,600 per ounce over any 90-day period (“Trigger Event”), we will pay Gunpoint an additional payment of $10 million (the “Contingent Payment”), of which a minimum of $5 million will be payable within six months of the Trigger Event and the remaining $5 million payable within twelve months of the Trigger Event. The Contingent Payment is payable with 50% in cash and 50% in common shares of the Company, at our sole discretion. | Based on the provided text, here's a summary of the key financial points:
Financial Challenges:
- The company is experiencing financial difficulties
- There are significant obstacles in raising required funds in current capital markets
- Substantial doubt exists about the company's ability to continue as a going concern
Key Risks:
- Uncertain ability to obtain future financing
- Potential need for adjustments to asset and liability valuations
- Potential balance sheet reclassifications if unable to continue operations
Financial Status:
- Currently experiencing financial losses
- Facing challenges in exploiting mining properties
- Past success in obtaining financing, but no guarantee of future funding
Limitations:
- Financial statements do not include potential adjustments if the company cannot continue operating
- Economic conditions in the US and Canada are presenting significant challenges
Note: The text appears to be a partial excerpt, so a complete comprehensive analysis would require the full financial statement. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See “Quarterly Results of Operations (unaudited)” under “Consolidated Results of Operations” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for selected quarterly financial data. Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Jason Industries, Inc. In our opinion, the accompanying consolidated balance sheets as of December 31, 2016 and 2015 and the related consolidated statements of operations, comprehensive loss, shareholders’ (deficit) equity and cash flows for each of the two years in the period ended December 31, 2016 and for the period from June 30, 2014 through December 31, 2014 present fairly, in all material respects, the financial position of Jason Industries, Inc. and its subsidiaries (Successor) as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2016 and for the period from June 30, 2014 through December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for each of the two years in the period ended December 31, 2016 and for the period from June 30, 2014 through December 31, 2014 listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it classifies debt issuance costs in 2016. /s/ PricewaterhouseCoopers LLP Milwaukee, Wisconsin March 2, 2017 Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Jason Industries, Inc. In our opinion, the accompanying consolidated statements of operations, comprehensive loss, shareholders’ (deficit) equity and cash flows for the period from January 1, 2014 through June 29, 2014 present fairly, in all material respects, the results of operations and cash flows of Jason Partners Holdings Inc. and its subsidiaries (Predecessor) for the period from January 1, 2014 through June 29, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for the period from January 1, 2014 through June 29, 2014 listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. We conducted our audit of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP Milwaukee, Wisconsin March 11, 2015 The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. (1) Adjustment to reflect Jason Industries common stock, additional paid-in capital, and retained deficit is net of common stock redeemed on June 30, 2014, which reduced additional paid in capital by $26,101 (See Note 11). The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. Jason Industries, Inc. (In thousands, except share and per share amounts) 1. Summary of Significant Accounting Policies Description of business: Jason Industries, Inc. and its subsidiaries (collectively, the “Company”) is a global industrial manufacturing company with four reportable segments: seating, finishing, acoustics and components. The segments have operations within the United States and 14 foreign countries. The Company’s seating segment supplies seating solutions to equipment manufacturers in the motorcycle, lawn and turf care, industrial, agricultural, construction and power sports end markets. The finishing segment focuses on the production of industrial brushes, buffing wheels, buffing compounds, and abrasives that are used in a broad range of industrial and infrastructure applications. The acoustics segment manufactures engineered non-woven, fiber-based acoustical products for the automotive industry. The components segment is a diversified manufacturer of expanded and perforated metal components, slip resistant surfaces and subassemblies for smart utility meters. The Company was originally incorporated in Delaware on May 31, 2013 as a blank check company, formed for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination. On June 30, 2014 (the “Closing Date”), the Company consummated its business combination with Jason Partners Holdings Inc. (“Jason”) pursuant to the stock purchase agreement, dated as of March 16, 2014, which provided for the acquisition of all of the capital stock of Jason by the Company (the “Business Combination”). In connection with the closing of the Business Combination, the Company changed its name from Quinpario Acquisition Corp. to Jason Industries, Inc. and commenced trading of its common stock and warrants under the symbols, “JASN” and “JASNW”, respectively, on Nasdaq. See Note 2 for a further discussion of the Business Combination. Prior to the consummation of the Business Combination, the Company’s efforts were limited to organizational activities, its initial public offering, and the search for suitable business acquisition transactions. Basis of presentation: As a result of the Business Combination, the Company was identified as the acquirer for accounting purposes, and Jason is the acquiree and accounting predecessor. The Company’s financial statement presentation distinguishes a “Predecessor” for Jason for periods prior to the Closing Date. The Company was subsequently re-established as Jason Industries, Inc. and is the “Successor” for periods after the Closing Date, which includes consolidation of Jason subsequent to the Business Combination on June 30, 2014. The acquisition was accounted for as a business combination using the acquisition method of accounting, and the Successor financial statements reflect a new basis of accounting that is based on the fair value of net assets acquired. See Note 2 for further discussion of the Business Combination. As a result of the application of the acquisition method of accounting as of the effective date of the acquisition, the financial statements for the Predecessor period and for the Successor period are presented on a different basis and, therefore, are not comparable. The Company’s fiscal year ends on December 31. Throughout the year, the Company reports its results using a fiscal calendar whereby each three month quarterly reporting period is approximately thirteen weeks in length and ends on a Friday. The exceptions are the first quarter, which begins on January 1, and the fourth quarter, which ends on December 31. For 2016, the Company’s fiscal quarters were comprised of the three months ended April 1, July 1, September 30, and December 31. In 2015, the Company’s fiscal quarters were comprised of the three months ended March 27, June 26, September 25 and December 31. Principles of consolidation: The consolidated financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) pursuant to the rules and regulations of the Securities and Exchange Commission. The consolidated financial statements include the accounts of all wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Investments in partially owned affiliates are accounted for using the equity method when the Company’s interest is between 20% and 50% and the Company does not have a controlling interest, yet maintains significant influence. Cash and cash equivalents: The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. At December 31, 2016 and 2015, book overdrafts of approximately $5.5 million and $7.6 million, respectively, are included in accounts payable within the accompanying consolidated balance sheets. These amounts are held in accounts in which the Company has no right of offset with other cash balances. Accounts receivable: The Company evaluates collectability of its receivables and establishes the allowance for doubtful accounts based on a combination of specific customer circumstances and historical write-off experience. Credit is extended to customers based upon an evaluation of their financial position. Generally, advance payment is not required. Credit losses are provided for in the consolidated financial statements and consistently have been within management’s expectations. Jason Industries, Inc. (In thousands, except share and per share amounts) Inventories: Inventories are comprised of material, direct labor and manufacturing overhead, and are valued at the lower of cost or market and adjusted for the value of inventory that is estimated to be excess, obsolete or otherwise unmarketable. The estimation of excess, obsolete and unmarketable inventory is based on a variety of factors, including material or product age, estimated usage and estimated market demand. The first-in, first-out (“FIFO”) method is used to determine cost for all of the Company’s inventories. Property, plant and equipment: Property, plant and equipment are stated at cost. Depreciation generally occurs using the straight-line method over 2 to 40 years for buildings and improvements and 2 to 10 years for machinery and equipment. Leasehold improvements are amortized over the lesser of the term of the respective leases and the useful life of the related improvement using the straight-line method. The Company uses accelerated depreciation methods for income tax purposes. Expenditures which substantially increase value or extend useful lives are capitalized. Expenditures for maintenance and repairs are charged to operations as incurred. The Company records gains and losses on the disposition or retirement of property, plant and equipment based on the net book value and any proceeds received. Long-lived assets: Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable based upon an estimate of the related future undiscounted cash flows. When required, impairment losses on assets to be held and used are recognized based on the fair value of the asset as compared to its carrying value. Long-lived assets to be disposed of by sale are reported at the lower of carrying amount or fair value less cost to sell. The Company conducts its long-lived asset impairment reviews at the lowest level in which identifiable cash flows are largely independent of cash flows of other assets and liabilities. Amortization is recorded for other intangible assets with determinable lives. Patents, customer relationships, and trademarks and other intangible assets are amortized on a straight-line basis over their estimated useful lives of 7 years, 10 to 15 years, and 5 to 18 years, respectively. Goodwill: Goodwill reflects the cost of an acquisition in excess of the aggregate fair value assigned to identifiable net assets acquired. Goodwill is assessed for impairment at least annually and as triggering events or indicators of potential impairment occur. The Company performs its annual impairment test in the fourth quarter of its fiscal year. Goodwill has been assigned to reporting units for purposes of impairment testing based upon the relative fair value of the asset to each reporting unit. Impairment of goodwill is measured according to a two-step approach. In the first step, the fair value of a reporting unit is compared to the carrying value of the reporting unit, including goodwill. The estimated fair value represents the amount at which a reporting unit could be bought or sold in a current transaction between willing parties on an arms-length basis. In estimating the fair value, the Company uses a discounted cash flow model, which is dependent on a number of assumptions including estimated future revenues and expenses, weighted average cost of capital, capital expenditures and other variables. The Company also uses a market approach in which guideline public company comparables are used in determining an estimated fair value for each reporting unit. If the carrying amount exceeds the fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. In the second step, the implied value of the goodwill is estimated as the fair value of the reporting unit less the fair value of all other tangible and identifiable intangible assets of the reporting unit. If the carrying amount of the goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill. The Company is subject to financial statement risk in the event that goodwill becomes impaired. See Note 8 for further discussion regarding the results of the Company’s goodwill impairment testing. Investments in partially-owned affiliates: The Company has investments in joint ventures located in Asia. These joint ventures are part of the finishing segment and are accounted for using the equity method of accounting. As of December 31, 2016 and 2015, the Company’s investment in these joint ventures was $4.8 million and $7.4 million, respectively, and is included in other assets-net in the consolidated balance sheets. Equity income is presented separately on the consolidated statements of operations. See Note 4 for further discussion of the sale of two of the Company’s joint ventures during 2014. Income taxes: The provision for income taxes includes federal, state, local and foreign taxes on income. Deferred taxes are recorded for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities, and net operating loss and credit carryforwards available to offset future taxable income. Future tax benefits are recognized to the extent that realization of those benefits is considered to be more likely than not. A valuation allowance is provided for net deferred tax assets when it is more likely than not that the Company will not realize the benefit of such net assets. The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense. Jason Industries, Inc. (In thousands, except share and per share amounts) Share-based payments: The Company recognizes expense related to share-based payment transactions in which it receives employee services in exchange for equity instruments of the Company that may be settled by the issuance of such equity instruments. Share-based compensation cost for restricted stock units (“RSUs”) is measured based on the closing fair market value of the Company’s common stock on the date of grant. The Company recognizes share-based compensation cost over the award’s requisite service period on a straight-line basis for time-based RSUs and on a graded basis for RSUs that are contingent on the achievement of performance conditions. Forfeitures are recognized within compensation expense in the period the forfeitures are incurred. The Company recognizes a tax (provision)/benefit from share-based compensation (income)/expense in the consolidated statements of operations in the period the share-based compensation (income)/expense is incurred. See Note 12 for further information regarding share-based compensation. Fair value of financial instruments: Current accounting guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. It also specifies a fair value hierarchy based upon the observability of inputs used in valuation techniques. Observable inputs (highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed market assumptions. In accordance with the guidance, fair value measurements are classified under the following hierarchy: •Level 1 - Quoted prices for identical instruments in active markets. • Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs or significant value-drivers are observable in active markets. • Level 3 - Model-derived valuations in which one or more significant inputs or significant value-drivers are unobservable. Fair value measurements are classified according to the lowest level input or value-driver that is significant to the valuation. A measurement may therefore be classified within Level 3 even though there may be significant inputs that are readily observable. The carrying amounts within the accompanying consolidated balance sheets for cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the short-term maturity of these instruments. The Company assessed the amounts recorded under revolving loans, if any, and long-term debt and determined that the fair value of total debt was approximately $365.8 million and $403.3 million as of December 31, 2016 and 2015, respectively. The Company considers the inputs related to these estimations to be Level 2 fair value measurements as they are primarily based on quoted prices for the Company’s Senior Secured Credit Facility. The valuation of the Company’s derivative financial instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy and therefore the Company’s derivatives are classified within Level 2. See Note 9 for further information regarding derivatives held by the Company. Employee Benefit Plans: The Company recognizes pension and post-retirement benefit income and expense and assets and obligations that are based on actuarial valuations using a December 31 measurement date and that include key assumptions regarding discount rates, expected returns on plan assets, retirement and mortality rates, future compensation increases, and health care cost trend rates. The Company reviews actuarial assumptions on an annual basis and makes modifications based on current rates and trends when appropriate. As required by GAAP, the effects of the modifications are recorded currently or amortized over future periods. Derivative financial instruments: The Company recognizes all derivative financial instruments in the consolidated financial statements at fair value regardless of the purpose or intent for holding the instrument. Changes in the fair value of derivative financial instruments are either recognized periodically in income or in equity as a component of comprehensive income (loss) depending on whether the derivative financial instrument qualifies for hedge accounting, and if so, whether it qualifies as a fair value hedge or cash flow hedge. Generally, changes in fair values of derivatives accounted for as fair value hedges are recorded in income along with the portions of the changes in the fair values of the hedged items that relate to the hedged risks. Changes in fair values of derivatives accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in other comprehensive income (loss), net of deferred income taxes. Changes in fair value of derivatives not qualifying as hedges are reported in income. Cash flows from derivatives that are accounted for as cash flow or fair value hedges are included in the consolidated statements of cash flows in the same category as the item being hedged. The Jason Industries, Inc. (In thousands, except share and per share amounts) Company’s policy is to enter into derivatives with creditworthy institutions and not to enter into such derivatives for speculative purposes. See Note 9 for further information regarding derivatives held by the Company. Foreign currency translation: Assets and liabilities of the Company’s foreign subsidiaries, whose respective functional currencies are other than the U.S. dollar, are translated at year-end exchange rates while revenues and expenses are translated at average exchange rates. Resultant gains and losses are reflected within accumulated other comprehensive loss within the accompanying consolidated statements of shareholders’ equity. Other comprehensive income (loss): Other comprehensive income (loss) includes disclosure of financial information that historically has not been recognized in the calculation of net income. The Company’s other comprehensive income (loss) includes the change in unrecognized prior service costs on pension and other postretirement obligations, foreign currency translation, and fair value adjustments related to derivative instruments. Pre-production costs related to long-term supply arrangements: The Company’s policy for engineering, research and development, and other design and development costs related to products that will be sold under long-term supply arrangements requires such costs to be expensed as incurred. Costs for molds, dies, and other tools used to manufacture products that will be sold under long-term supply arrangements are capitalized if the Company has title to the assets or when customer reimbursement is assured. Product warranties: The Company offers warranties on the sales of certain of its products and records accruals for estimated future claims. Such accruals are established based on an evaluation of historical warranty experience and management’s estimate of level of future claims. Revenue recognition: Revenue is recognized from product sales at the time that title and risks and rewards of ownership are transferred to the customer, generally upon shipment. The Company records allowances for discounts, rebates, and product returns at the time of sale as a reduction of revenue as such allowances can be reliably estimated based on historical experience and known trends. Shipping and handling fees and costs: The Company classifies all amounts invoiced to customers related to shipping and handling as sales. Expenses for transportation of products to customers are recorded as a component of cost of goods sold. Research and development costs: Research and development costs consist of engineering and development resources and are expensed as incurred. Such costs incurred in the development of new products or significant improvements to existing products were $4.2 million in the year ended December 31, 2016, $5.0 million in the year ended December 31, 2015, $2.1 million in the period June 30, 2014 through December 31, 2014, and $2.7 million in the period January 1, 2014 through June 29, 2014, and are included in selling and administrative expenses on the consolidated statements of operations. Advertising costs: Advertising costs are charged to selling and administrative expenses as incurred and were $1.9 million in the year ended December 31, 2016, $2.7 million in the year ended December 31, 2015, $1.2 million in the period June 30, 2014 through December 31, 2014, and $1.3 million in the period January 1, 2014 through June 29, 2014. Transaction-related expenses: The Company incurs transaction-related expenses primarily consisting of professional service fees and costs related to business acquisition activities, including the Business Combination in 2014. The Company recognized transaction-related expenses of $0.0 million in the year ended December 31, 2016, $0.9 million in the year ended December 31, 2015, $2.5 million in the period June 30, 2014 through December 31, 2014 and $27.8 million in the period January 1, 2014 through June 29, 2014. The transaction-related expenses were recognized as incurred in accordance with the applicable accounting guidance. Use of estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Concentration risks: The Company’s operations are geographically dispersed and it has a diverse customer base. Management believes bad debt losses resulting from default by a single customer, or defaults by customers in any depressed region or business sector, would not have a material effect on the Company’s financial position, results of operations or cash flows. During the years ended December 31, 2016, 2015 and 2014 the Company had no individual customers at or above 10% of consolidated net sales. At December 31, 2016, two customers accounted for greater than 10% of the Company’s consolidated accounts receivable balance; these customers each accounted for 12% of the consolidated balance and both customers are served by the acoustics segment. At December 31, 2015, one customer served by the acoustics segment Jason Industries, Inc. (In thousands, except share and per share amounts) accounted for greater than 10% of the Company’s consolidated accounts receivable balance, accounting for 15% of the consolidated balance. Reclassification: Certain prior period amounts within operating activities in the statements of cash flows have been reclassified to Accrued income taxes from Other-net to conform with the current period presentation. Other reclassifications related to the adoption of recently issued accounting standards are discussed below. Recently issued accounting standards Accounting standards adopted in the current fiscal period In August 2014, the the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”). ASU 2014-15 provides guidance on determining when and how reporting entities must disclose going-concern uncertainties in their financial statements. The standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date of issuance of the entity’s financial statements (or within one year after the date on which the financial statements are available to be issued, when applicable). Further, an entity must provide certain disclosures if there is substantial doubt about the entity’s ability to continue as a going concern. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods thereafter. The adoption of this guidance did not have an impact on the Company’s consolidated financial statements. In February 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis” (“ASU 2015-02”), which amends existing consolidation guidance for reporting organizations such as limited partnerships and other similar entities that are required to evaluate whether they should consolidate certain legal entities. This guidance is effective for fiscal years beginning after December 15, 2015, including interim periods within that reporting period. The adoption of this guidance did not have an impact on the Company’s consolidated financial statements. In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”). This standard requires the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of as a deferred charge. The standard does not affect the recognition and measurement of debt issuance costs; therefore, the amortization of such costs continues to be reported as interest expense. This guidance is applied on a retrospective basis to all prior periods. The Company adopted ASU 2015-03 effective April 1, 2016. Accordingly, $9.1 million of debt issuance costs, previously included within other long-term assets, have been reclassified as a reduction of long-term debt in the December 31, 2015 consolidated balance sheet. In August 2015, the FASB issued ASU 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line of Credit Arrangements” (“ASU 2015-15”). ASU 2015-15 indicates that previously issued guidance did not address presentation or subsequent measurement of debt issuance costs related to line of credit arrangements. Given the absence of authoritative guidance, the Securities and Exchange Commission (“SEC”) staff has indicated that they would not object to an entity deferring and presenting debt issuance costs as assets and amortizing the deferred costs ratably over the term of the line of credit arrangement, regardless of whether there are any outstanding borrowings on the line of credit arrangement. The Company adopted ASU 2015-15 effective April 1, 2016. There was no impact to previously reported consolidated statements of operations, consolidated statements of comprehensive loss, consolidated balance sheets, or consolidated statements of cash flows as a result of the adoption of this standard. In September 2015, the FASB issued ASU 2015-16, “Simplifying the Accounting for Measurement Period Adjustments” (“ASU 2015-16”). ASU 2015-16 requires an acquirer to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. ASU 2015-16 is effective for interim and annual periods beginning after December 15, 2015. The adoption of this guidance did not have an impact on the Company’s consolidated financial statements. In March 2016, the FASB issued ASU 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). This standard simplifies several aspects of the accounting for share-based payment award transactions, including recognition of income tax consequences of stock compensation, classification of awards as either equity or liabilities, accounting for forfeitures, and classification on the statement of cash flows. For public entities, ASU 2016-09 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permissible in any interim or annual period. The Company early adopted ASU 2016-09 effective April 1, 2016. As a result of the adoption, there was an impact of $1.1 million to the consolidated statement of cash flows for the year ended December 31, 2015 which resulted in the minimum tax withholding requirements for share vesting to be reclassified from other-net within cash flows from operating activities to other financing activities-net within cash Jason Industries, Inc. (In thousands, except share and per share amounts) flows from financing activities. There was no impact to previously reported consolidated statements of operations, consolidated statements of comprehensive loss, or consolidated balance sheets. Accounting standards to be adopted in future fiscal periods In May 2014, the FASB issued ASU 2014-09, “Revenue From Contracts With Customers” (“ASU 2014-09”). ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The standard is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. On July 9, 2015, the FASB voted to defer the effective date of ASU 2014-09 by one year to December 15, 2017, for interim and annual reporting periods beginning after that date and permitted early adoption of the standard, but not before the original effective date of December 15, 2016. The ASU becomes effective for the Company at the beginning of its 2018 fiscal year. In 2016 and 2017, the FASB issued several ASU’s related to ASU 2014-09, which simplify and provide additional guidance to companies for implementation of the standard. The Company is evaluating the recently issued guidance on practical expedients in order to select a transition method, and we currently anticipate adopting the standard in 2018. The Company is also assessing the impact that ASU 2014-09 will have on its consolidated financial statements and disclosures. This evaluation includes completing an inventory of revenue streams by like contracts to allow for ease of implementation, monitoring developments for the manufacturing industry, and evaluating potential changes to our business processes, systems, and controls to support the recognition and disclosure under the new standard. In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory” (“ASU 2015-11”). Under ASU 2015-11, inventory will be measured at the “lower of cost and net realizable value” and options that currently exist for “market value” will be eliminated. ASU 2015-11 defines net realizable value as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.” No other changes were made to the current guidance on inventory measurement. ASU 2015-11 is effective for interim and annual periods beginning after December 15, 2016. Early adoption is permitted and should be applied prospectively. The Company intends to adopt this standard at the beginning of its 2017 fiscal year and has determined that this standard will not have a significant impact on its consolidated financial statements. In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). The updated guidance enhances the reporting model for financial instruments, which includes amendments to address aspects of recognition, measurement, presentation and disclosure. The amendment to the standard is effective for interim and annual periods beginning after December 15, 2017. The Company is currently assessing the impact that this standard will have on its consolidated financial statements. In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). ASU 2016-02 establishes new accounting and disclosure requirements for leases. This standard requires lessees to classify most leases as either finance or operating leases and to initially recognize a lease liability and right-of-use asset. Entities may elect to account for certain short-term leases (with a term of 12 months or less) using a method similar to the current operating lease model. The statements of operations will include, for finance leases, separate recognition of interest on the lease liability and amortization of the right-of use asset and for operating leases, a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a straight-line basis. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those annual reporting periods, with early adoption permitted. This standard must be applied using a modified retrospective approach, which requires recognition and measurement of leases at the beginning of the earliest period presented, with certain practical expedients available. The Company is currently working to complete an inventory of all of its lease contracts and currently intends to adopt the standard in the first quarter of fiscal 2019. The Company expects this ASU to have a material impact on its consolidated financial statements upon recognition of the lease liability and right-of-use asset for lease contracts which are currently accounted for as operating leases. In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”), which provides guidance on eight specific cash flow classification issues. ASU 2016-15 is effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted. The Company currently intends to adopt this standard at the beginning of its 2018 fiscal year and has determined that this standard will not have a significant impact on its consolidated financial statements. Jason Industries, Inc. (In thousands, except share and per share amounts) In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory” (“ASU 2016-16”). ASU 2016-16 will require companies to recognize the income tax effects of intercompany sales and transfers of assets other than inventory in the period in which the transfer occurs. The guidance is effective for annual periods beginning after December 15, 2017 and requires companies to apply a modified retrospective approach with a cumulative catch-up adjustment to opening retained earnings in the period of adoption. Early adoption is permitted. The Company is currently assessing the impact that this standard will have on its consolidated financial statements. In January 2017, the FASB issued ASU 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). ASU 2017-04 eliminates Step 2 from the goodwill impairment test. Instead, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit. ASU 2017-04 is effective for annual periods beginning after December 15, 2019. Early adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the planned timing of adoption of this standard. The impact of this standard on its consolidated financial statements is dependent upon the results of future tests for goodwill impairment. 2. Consummation of Business Combination On June 30, 2014, the Company and Jason completed the Business Combination in which JPHI Holdings Inc. (“JPHI”), a majority owned subsidiary of the Company, acquired 100 percent of the capital stock of Jason. The purchase price of $536.0 million was funded by the cash proceeds from the Company’s initial public offering, new debt, the issuance of 45,000 shares of 8% Series A Convertible Perpetual Preferred Stock (the “Series A Preferred Stock”) and $35.8 million of rollover equity invested by Jason’s former owners and management of Jason (collectively the “Rollover Participants”). For the period January 1, 2014 through June 29, 2014 and the period June 30, 2014 through December 31, 2014, the Company incurred approximately $27.8 million and $1.2 million, respectively, of transaction expenses directly related to the Business Combination. Following the consummation of the Business Combination, Jason became an indirect majority-owned subsidiary of the Company, with the Company then owning approximately 83.1 percent of JPHI and the Rollover Participants then owning a noncontrolling interest of approximately 16.9 percent of JPHI. The Rollover Participants received 3,485,623 shares of JPHI, which are exchangeable on a one-for-one basis for shares of common stock of the Company. In connection with the consummation of the Business Combination, all indebtedness under Jason’s U.S. credit facility was repaid in full, and the Company replaced Jason’s existing credit agreement with a new $460.0 million senior secured credit facility. See Note 9 for further discussion of the senior secured credit facility. The following unaudited pro forma combined financial information presents the Company’s results as though Jason and the Company had combined at January 1, 2014. Pro forma net earnings attributable to common shareholders were adjusted to exclude $38.4 million of transaction-related expenses incurred for the year ended December 31, 2014. The unaudited pro forma condensed consolidated financial information has been prepared using the acquisition method of accounting in accordance with GAAP. DRONCO GmbH (“DRONCO”) On May 29, 2015, the Company acquired all of the outstanding shares of DRONCO. DRONCO is a European manufacturer of bonded abrasives. These abrasives are being manufactured and distributed by the finishing segment. The Company paid cash consideration of $34.4 million, net of cash acquired, and, pursuant to the transaction, assumed certain liabilities. The related purchase agreement includes customary representations, warranties and covenants between the named parties. For the year ended December 31, 2016, the Company had no acquisition-related costs. For the year ended December 31, 2015, the Company recognized $0.9 million of acquisition-related costs related to DRONCO and these costs are included in Jason Industries, Inc. (In thousands, except share and per share amounts) the consolidated statements of operations as “Transaction-related expenses”. For the years ended December 31, 2016 and 2015, $38.5 million and $24.1 million, respectively, of net sales from DRONCO were included in the Company’s consolidated statements of operations. Pro forma historical results of operations related to the acquisition of DRONCO have not been presented as they are not material to the Company’s consolidated statements of operations. Herold Partco On March 25, 2015, the Company acquired Herold Partco Manufacturing, Inc. for $0.4 million. Herold Partco Manufacturing, Inc. is a Cleveland-based manufacturer of industrial brushes. These brushes are now manufactured and distributed by the finishing segment and sold under the Osborn brand name. The acquisition of Herold Partco Manufacturing, Inc. was not material to the Company’s consolidated financial statements. 4. Sale of Joint Ventures At December 31, 2013, the Company had agreed to terms to sell its interest in two of its joint ventures. During the predecessor period, the Company completed the sale of these joint ventures for a total of $11.5 million. The sale of one of the joint ventures for $7.5 million was completed in January 2014, and the sale of the second joint venture for $4.0 million was completed in March 2014. The Company recorded a $3.5 million gain on the sale of the joint ventures, which is reported separately on the consolidated statements of operations. The gain includes the recognition of $0.6 million of cumulative translation adjustments which had been recorded in accumulated other comprehensive loss. The $0.6 million is reported separately in the consolidated statements of comprehensive loss. Terms of the sale included a supply agreement that allowed the Company to purchase product at established prices over the agreement’s three-year term. 5. Restructuring Costs On March 1, 2016, as part of a strategic review of organizational structure and operations, the Company announced a global cost reduction and restructuring program (the “2016 program”). The 2016 program, as used herein, refers to costs related to various restructuring activities across business segments. This includes entering into severance and termination agreements with employees and footprint rationalization activities, including exit and relocation costs for the consolidation and closure of plant facilities and lease termination costs. These activities were ongoing during 2016 and are expected to be completed in 2017. In 2014 and 2015, the Company incurred certain restructuring costs related to changes to its worldwide manufacturing footprint. These actions resulted in charges relating to employee severance and other related charges, such as exit costs for the consolidation and closure of plant facilities, employee relocation and lease termination costs. These costs related to decisions that preceded the 2016 program and are therefore not considered to be part of such plan. During the period from January 1, 2014 through June 29, 2014, the Company incurred $0.6 million in severance costs, $0.7 million in lease termination costs and $1.3 million in other costs. During the period from June 30, 2014 through December 31, 2014, the Company incurred $0.8 million in severance costs and $0.3 million in other costs. For the year ended December 31, 2015, the Company incurred $1.6 million in severance costs, $1.2 million in lease termination costs and $1.0 million in other costs. The Company did not incur any material charges related to the 2014 or 2015 restructuring activities for the year ended December 31, 2016, and no additional costs are expected for such restructuring activities. The following table presents the restructuring costs recognized by the Company under the 2016 program by reportable segment. The 2016 program began in the first quarter of 2016 and as such, the restructuring charges for the year ended December 31, 2016 represent the cumulative charges incurred since the inception of the 2016 program. The other costs incurred under the 2016 program primarily include charges related to the closure of the Buffalo Grove facility within the components segment and a loss contingency for certain employment matter claims associated with the wind down of the finishing segment’s facility in São Bernardo do Campo, Brazil. See further discussion within Note 17, “Commitments and Contingencies”. Based on the announced restructuring actions to date, the Company expects to incur a total of approximately $10 million under the 2016 program. These restructuring costs are presented separately on the consolidated statements of operations. Jason Industries, Inc. (In thousands, except share and per share amounts) In addition to the restructuring costs described above, the Company also incurred approximately $1.4 million of additional charges related to the wind down of the finishing segment’s Brazil location, which included $0.7 million of accelerated depreciation of property, plant and equipment - net and $0.7 million of charges to reduce inventory balances, respectively, to decrease such balances to their estimated net realizable values. These costs were presented within cost of goods sold within the consolidated statements of operations. The following table represents the restructuring liabilities, including both the 2016 program and previous activities: The following table presents the classification of the restructuring liabilities on the consolidated balance sheets. At December 31, 2016, the accrual for lease termination costs relates to restructuring costs associated with a 2016 lease termination in the finishing segment. At December 31, 2015, the accrual for lease termination costs relates to the closure of the Norwalk facility in the acoustics segment. At December 31, 2016, the accrual for other costs of $1.1 million primarily relates to a loss contingency for certain employment matter claims within the finishing segment due to the closure of the Brazil location. Inventories at December 31, 2016 and December 31, 2015 consisted of the following: Jason Industries, Inc. (In thousands, except share and per share amounts) 7. Property, Plant and Equipment Property, plant and equipment at December 31, 2016 and December 31, 2015 consisted of the following: 8. Goodwill and Other Intangible Assets Goodwill Changes in the carrying amount of goodwill by reporting segment was as follows: In the fourth quarter of 2016, the Company performed its annual budgeting and strategic planning process, including a re-assessment of the Company’s capital allocation priorities and a review of the short and long-term growth expectations of each business. In performing the first step of the annual goodwill impairment test in the fourth quarter of 2016, the Company determined that the estimated fair values of the acoustics and components reporting units were lower than the carrying values of the respective reporting units, requiring further analysis under the second step of the impairment test. The decline in the estimated fair value of the acoustics reporting unit was primarily due to lower long-term revenue growth expectations resulting from this strategic review of capital allocation and investment priorities as compared to the Company’s prior growth plan for the business. The fair value of the acoustics reporting unit was also negatively impacted by a projected cyclical decline in the North American automotive industry end-market. The decline in the estimated fair value of the components reporting unit was primarily due to lower long-term revenue expectations resulting from the annual budgeting and strategic planning process as compared to the Company’s prior plan for the business, primarily due to projected longer-term weakness in the rail end-market. In performing the second step of the impairment testing, the Company performed a theoretical purchase price allocation for the acoustics and components reporting units to determine the implied fair values of goodwill which were compared to the recorded amounts of goodwill for each reporting unit. Upon completion of the second step of the goodwill impairment test, the Company recorded non-cash goodwill impairment charges of $63.0 million, representing full goodwill impairments of $29.8 million and $33.2 million in the acoustics and components reporting units, respectively. The goodwill impairment charges are recorded as impairment charges in the consolidated statements of operations. In the remaining reporting unit with a goodwill balance, finishing, the percentage by which estimated fair value exceeded carrying value was approximately 18%. The finishing reporting unit includes $42.2 million of goodwill and $38.7 million of amortizable intangible assets as of December 31, 2016. The forecasted financial results of the finishing reporting unit are dependent upon revenue growth, adjusted EBITDA margin expansion, and the funding of capital expenditures supporting restructuring and cost reduction initiatives. The assumptions that have the most significant impact on determination of the finishing reporting unit fair value are the revenue growth rate, including 3 percent in the terminal year, adjusted EBITDA margin expansion from current levels to 18 percent over the next five years, and the weighted average cost of capital (discount Jason Industries, Inc. (In thousands, except share and per share amounts) rate), or 12.1%. A change in any of these assumptions, individually or in the aggregate, or future financial performance that is below management expectations may result in the carrying value of this reporting unit exceeding its fair value, and goodwill and amortizable intangible assets could be impaired. In the fourth quarter of 2015, the Company determined that the estimated fair value of the seating reporting unit was lower than the carrying value of the reporting unit, requiring further analysis under the second step of the impairment test. The decline in the estimated fair value of the seating reporting unit was primarily due to lower long-term growth expectations resulting from projected long-term weakness in agriculture and heavy industry end-markets, and a strategic shift in capital allocation and investment priorities. The Company performed a theoretical purchase price allocation for the seating reporting unit to determine the implied fair value of goodwill which was compared to the recorded amount of goodwill. Upon completion of the second step of the goodwill impairment test the Company recorded a non-cash goodwill impairment charge of $58.8 million, representing a complete impairment of goodwill in the seating reporting unit. The goodwill impairment charge is recorded as impairment charges in the consolidated statements of operations. In connection with the goodwill impairment tests in 2016 and 2015, the Company engaged a third-party valuation firm to assist management with determining fair value estimates for the reporting units in the first step of the goodwill impairment test, and in estimating fair values of tangible and intangible assets used in the second step of the goodwill impairment test. In connection with obtaining an independent third-party valuation, management provided certain information and assumptions that were utilized in the fair value calculation. Significant assumptions used in determining reporting unit fair value include forecasted cash flows, revenue growth rates, adjusted EBITDA margins, weighted average cost of capital (discount rate), assumed tax treatment of a future sale of the reporting unit, terminal growth rates, capital expenditures, sales and EBITDA multiples used in the market approach, and the weighting of the income and market approaches. The fair value of the reporting units is determined using a weighted average of an income approach primarily based on the Company’s three year strategic plan and a market approach based on implied valuation multiples of public company peer groups for each reporting unit. Both approaches are generally deemed equally relevant in determining reporting unit enterprise value, and as a result, weightings of 50 percent were used for each. This fair value determination was categorized as Level 3 in the fair value hierarchy. At December 31, 2016, goodwill included $122.1 million of accumulated impairment losses, primarily due to $58.8 million related to the seating reporting unit, $29.8 million related to the acoustics reporting unit, and $33.2 million related to the components reporting unit. At December 31, 2015, goodwill included $58.8 million of accumulated impairment losses wholly related to the seating reporting unit. Other Intangible Assets The Company’s other amortizable intangible assets consisted of the following: In connection with the evaluation of the goodwill impairment in the acoustics and components reporting units in 2016, the Company assessed tangible and intangible assets for impairment prior to performing the second step of the goodwill impairment test. As a result of this analysis, it was determined that there were no impairment charges to record related to these assets. In connection with the evaluation of the goodwill impairment in the seating reporting unit in 2015, the Company assessed tangible and intangible assets for impairment prior to performing the second step of the goodwill impairment test. As a result of this analysis, non-cash impairment charges of $27.7 million, $6.8 million, and $0.8 million were recorded for customer relationship, trademarks, and patents intangible assets, respectively, in the seating reporting unit during the fourth quarter of 2015. These intangible asset impairment charges are recorded as impairment charges in the consolidated statements of operations. Jason Industries, Inc. (In thousands, except share and per share amounts) The approximate weighted average remaining useful lives of the Company’s intangible assets at December 31, 2016 are as follows: patents - 4.6 years; customer relationships - 11.9 years; and trademarks and other intangibles - 12.6 years. Amortization of intangible assets approximated $12.9 million, $14.1 million, $7.2 million, and $2.7 million for the year ended December 31, 2016, the year ended December 31, 2015, the period June 30, 2014 through December 31, 2014, and the period January 1, 2014 through June 29, 2014, respectively. Excluding the impact of any future acquisitions, the Company anticipates the annual amortization for each of the next five years and thereafter to be the following: 9. Debt and Hedging Instruments The Company’s debt consisted of the following: Senior Secured Credit Facilities (Successor) In connection with the consummation of the Business Combination, all indebtedness under Jason’s U.S. credit facility was repaid in full. Jason Incorporated (“Jason Inc”), an indirect majority-owned subsidiary of the Company, as the borrower, replaced Jason’s existing credit agreement with a new $460.0 million U.S. credit facility (the “Senior Secured Credit Facilities”). The new facility included (i) term loans in an aggregate principal amount of $310.0 million (“First Lien Term Loans”) maturing in 2021, of which $303.0 million is outstanding as of December 31, 2016, (ii) term loans in an aggregate principal amount of $110.0 million (“Second Lien Term Loans”) maturing in 2022, and (iii) a revolving loan of up to $40.0 million (“Revolving Credit Facility”) maturing in 2019. Upon the consummation of the Business Combination, the full amount of the First Lien Term Loans and Second Lien Term Loans were drawn, and no revolving loans were drawn. The Company capitalized debt issuance costs of $13.5 million in connection with the refinancing, of which $7.5 million related to the First Lien Term Loans and Second Lien Term Loans and $1.0 million related to the Revolving Credit Facility as of December 31, 2016. Debt issuance costs related to the First Lien Term Loans and Second Lien Term Loans are recorded in total long-term debt, and debt issuance costs related to the Revolving Credit Facility are recorded in other long-term assets. These costs are amortized into interest expense over the life of the respective borrowings on a straight-line basis. The principal amount of the First Lien Term Loans amortizes in quarterly installments equal to $0.8 million, with the balance payable at maturity. At the Company’s election, the interest rate per annum applicable to the loans under the Senior Secured Credit Facilities is based on a fluctuating rate of interest determined by reference to either (i) a base rate determined by reference to the higher of (a) the “prime rate” of Deutsche Bank AG New York Branch, (b) the federal funds effective rate plus 0.50% and (c) the Eurocurrency rate applicable for an interest period of one month plus 1.00%, plus an applicable margin equal to (x) 3.50% in the case of the First Lien Term Loans, (y) 2.25% in the case of the Revolving Credit Facility or (z) 7.00% in the case of the Second Lien Term Loans or (ii) a Eurocurrency rate determined by reference to London Interbank Offered Rate (“LIBOR”), adjusted for statutory reserve requirements, plus an applicable margin equal to (x) 4.50% in the case of the First Lien Term Loans, (y) 3.25% in the case of the Revolving Credit Facility or (z) 8.00% in the case of the Second Lien Term Jason Industries, Inc. (In thousands, except share and per share amounts) Loans. Borrowings under the First Lien Term Facility and Second Lien Term Facility are subject to a floor of 1.00% in the case of Eurocurrency loans. The applicable margin for loans under the Revolving Credit Facility may be subject to adjustment based upon a consolidated first lien net leverage ratio. At December 31, 2016, the interest rates on the outstanding balances of the First Lien Term Loans and Second Lien Term Loans were 5.5% and 9.0%, respectively. At December 31, 2016, the Company had a total of $35.0 million of availability for additional borrowings under the Revolving Credit Facility as the Company had no outstanding borrowings and letters of credit outstanding of $5.0 million, which reduce availability under the facility. Under the Revolving Credit Facility, if the aggregate outstanding amount of all revolving loans, swingline loans and certain letter of credit obligations exceeds 25 percent, or $10.0 million, of the revolving credit commitments at the end of any fiscal quarter, Jason Incorporated and its restricted subsidiaries will be required to not exceed a consolidated first lien net leverage ratio, currently specified at 5.25 to 1.00, with a periodic decrease to 4.50 to 1.00 on December 31, 2017 and remaining at that level thereafter. If such outstanding amounts do not exceed 25 percent of the revolving credit commitments at the end of any fiscal quarter, no financial covenants are applicable. The Company did not draw on its revolver during 2016. Under the Senior Secured Credit Facilities, the Company is subject to mandatory prepayments if certain requirements are met. At December 31, 2016, a mandatory prepayment of $1.9 million under the Senior Secured Credit Facilities was included within the current portion of long-term debt in the consolidated balance sheets. The mandatory prepayment is in excess of regular current installments due. Foreign debt The Company has the following foreign debt obligations, including various overdraft facilities and term loans: These various foreign loans are comprised of individual outstanding obligations ranging from approximately $0.1 million to $12.6 million and $0.1 million to $13.1 million as of December 31, 2016 and December 31, 2015, respectively. Certain of the Company’s foreign borrowings contain financial covenants requiring maintenance of a minimum equity ratio and maximum leverage ratio, among others. The Company was in compliance with these covenants as of December 31, 2016. In connection with the acquisition of DRONCO (a Germany entity), the Company assumed $11.0 million of debt comprised of term loan borrowings totaling $8.5 million and revolving line of credit borrowings totaling $2.5 million. Borrowings bear interest at fixed and variable rates ranging from 2.3% to 4.6% and are subject to repayment in varying amounts through 2030. During 2015, the Company entered into a new $13.5 million term loan in Germany. Borrowings bear interest at a fixed rate of 2.25% and are subject to repayment in equal quarterly payments of approximately $0.4 million beginning September 30, 2017 through June 30, 2025. Future annual maturities of long-term debt outstanding at December 31, 2016 are as follows: Jason Industries, Inc. (In thousands, except share and per share amounts) Interest Rate Hedge Contracts The Company is exposed to certain financial risks relating to fluctuations in interest rates. To manage exposure to such fluctuations, the Company entered into forward starting interest rate swap agreements (“Swaps”) in 2015 with notional values totaling $210.0 million at December 31, 2016 and December 31, 2015. The Swaps have been designated by the Company as cash flow hedges in accordance with ASC 815, and effectively fix the variable portion of interest rates on variable rate term loan borrowings at a rate of approximately 2.08% prior to financing spreads and related fees. The Swaps had a forward start date of December 30, 2016 and have an expiration date of June 30, 2020. As such, for the years ended December 31, 2016 and December 31, 2015, there was no interest expense recognized. The Company expects to recognize interest expense of $2.0 million related to the Swaps in 2017. The fair values of the Company’s Swaps are recorded on the consolidated balance sheets with the corresponding offset recorded as a component of accumulated other comprehensive loss. The fair value of the Swaps totaled $2.0 million at December 31, 2016 and $0.3 million at December 31, 2015, respectively. See the amounts recorded on the consolidated balance sheets within the table below: The Company leases machinery, transportation equipment and office, warehouse and manufacturing facilities under agreements which are accounted for as operating leases. Many of the leases include provisions that enable the Company to renew the lease, and certain leases are subject to various escalation clauses. Future minimum lease payments required under long-term operating leases in effect at December 31, 2016 are as follows: Total rental expense under operating leases was $13.1 million, $9.8 million, $4.9 million, and $4.8 million for the year ended December 31, 2016, the year ended December 31, 2015, the period June 30, 2014 through December 31, 2014 and the period January 1, 2014 through June 29, 2014, respectively. On June 30, 2014, the Company held a special meeting in lieu of the 2014 Annual Meeting of the Shareholders (the “Special Meeting”) where the Business Combination was approved by the Company’s shareholders. At the Special Meeting, 21,870,040 shares of the Company’s common stock were voted in favor of the proposal to approve the Business Combination and no shares of the Company’s common stock were voted against that proposal. In connection with the closing, the Company redeemed a total of 2,542,667 shares of its common stock pursuant to the terms of the Company’s amended and restated certificate of incorporation, resulting in a total payment to redeeming shareholders of $26.1 million. At the Special Meeting, the Company’s shareholders approved and adopted a proposal to increase the number of authorized shares of the Company’s common stock and preferred stock from 44,000,000, consisting of 43,000,000 shares of common stock, and 1,000,000 shares of preferred stock, to 125,000,000 shares, consisting of 120,000,000 shares of common stock, and 5,000,000 shares of preferred stock. Jason Industries, Inc. (In thousands, except share and per share amounts) At December 31, 2016, the Company had authorized for issuance 120,000,000 shares of $0.0001 par value common stock, of which 24,802,196 shares were issued and outstanding, and had authorized for issuance 5,000,000 shares of $0.0001 par value preferred stock, of which 45,899 shares were issued and outstanding, including 899 shares declared as a dividend on December 15, 2016 and issued on January 1, 2017. Series A Preferred Stock In connection with the consummation of the Business Combination, the Company issued 45,000 shares of Series A Preferred Stock with offering proceeds of $45.0 million and offering costs of $2.5 million. Holders of the Series A Preferred Stock are entitled to cumulative dividends at an 8.0% dividend rate per annum payable quarterly on January 1, April 1, July 1, and October 1 of each year in cash or by delivery of Series A Preferred Stock shares. Holders of the Series A Preferred Stock have the option to convert each share of Series A Preferred Stock initially into approximately 81.18 shares of the Company’s common stock, subject to certain adjustments in the conversion rate. The Company paid the following dividends on the Series A Preferred Stock during the years ended December 31, 2016 and 2015 and the period from June 30, 2014 through December 31, 2014: On December 15, 2016, the Company announced a $20.00 per share dividend on its Series A Preferred Stock to be paid in additional shares of Series A Preferred Stock on January 1, 2017 to holders of record on November 15, 2016. As of December 31, 2016, the Company has recorded the 899 additional Series A Preferred Stock shares declared for the dividend of $0.9 million within preferred stock in the consolidated balance sheets. Shareholder Rights Agreement On September 12, 2016, the Company’s Board of Directors adopted a Shareholder Rights Agreement (the “Rights Agreement”) between the Company and Continental Stock Transfer & Trust Company, as rights agent. Pursuant to the Rights Agreement, the Company declared a dividend of one preferred share purchase right (a “Right”) for each outstanding share of the Company’s common stock, payable to the shareholders of record on September 16, 2016. New Rights will accompany any new shares of common stock issued after September 16, 2016. The Rights trade with and are inseparable from our common stock and will not be evidenced by separate certificates unless they become exercisable. The Rights will expire on March 12, 2018. In general terms, the Rights Agreement works by imposing a significant penalty upon any person or group which acquires 30% or more of the Company’s outstanding common stock without the approval of the Company’s Board of Directors. Each Right will allow its holder to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock for $10.00, subject to adjustment as set forth in the Rights Agreement, once the Rights become exercisable. Per the Rights Agreement, the Rights will not be exercisable until the earlier of (1) 10 days after the public announcement that a person or group has become an Acquiring Person (as defined in the Rights Agreement) by obtaining beneficial ownership of 30% or more of the Company’s outstanding common stock or (2) 10 business days (or such later date as the Company’s Board of Directors shall determine) following the commencement of a tender offer or exchange offer that would result in a person or group becoming an Acquiring Person. Warrant Tender Offer On May 6, 2014, Jason commenced a tender offer to purchase up to 9,200,000 of its outstanding warrants subject to certain conditions, including the consummation of the Business Combination. On July 18, 2014, the tender offer expired and a Jason Industries, Inc. (In thousands, except share and per share amounts) total of 4,406,227 warrants were validly tendered at a purchase price of $1.50 per warrant, for a total purchase price of $6.6 million. After completion of the warrant tender offer, 13,993,773 warrants remain outstanding as of December 31, 2016. Each outstanding warrant entitles the registered holder to purchase one share of the Company’s common stock at a price of $12.00 per share, subject to adjustment, at any time commencing on July 30, 2014. The warrants will expire on June 30, 2019, or earlier upon redemption. In February 2015, the Company’s Board of Directors authorized the purchase of up to $5.0 million of the Company’s outstanding warrants. Management is authorized to effect purchases from time to time in the open market or through privately negotiated transactions. There is no expiration date to this authority. No warrants were repurchased during the years ended December 31, 2016 and 2015. Exchange of common stock of JPHI Holdings, Inc. for common stock of Jason Industries, Inc. Following the consummation of the Business Combination, Jason became an indirect majority-owned subsidiary of the Company, with the Company then owning approximately 83.1 percent of JPHI and the Rollover Participants then owning a noncontrolling interest of approximately 16.9 percent of JPHI. The Rollover Participants received 3,485,623 shares of JPHI, which are exchangeable on a one-for-one basis for shares of common stock of the Company. In November and December 2016, certain Rollover Participants exchanged 2,401,616 shares of JPHI stock for Company common stock, which decreased the noncontrolling interest to 6.0 percent. The decrease to the noncontrolling interest as a result of the exchange resulted in an increase in both accumulated other comprehensive loss and additional paid-in capital to reflect the Company’s increased ownership in JPHI. As of December 31, 2016, 1,084,007 shares of JPHI stock were still held by the Rollover Participants. Accumulated Other Comprehensive Loss The changes in the components of accumulated other comprehensive loss, net of taxes, were as follows: The Company recognizes compensation expense based on estimated grant date fair values for all share-based awards issued to employees and directors, including restricted stock units and performance share units, which are restricted stock units with vesting conditions contingent upon achieving certain performance goals. The Company estimates the fair value of share-based awards based on assumptions as of the grant date. The Company recognizes these compensation costs for only those awards expected to vest, on a straight-line basis over the requisite service period of the award, which is generally the vesting Jason Industries, Inc. (In thousands, except share and per share amounts) term of three years for restricted stock awards and the performance period for performance share units. Forfeitures are recognized within compensation expense in the period the forfeitures are incurred. 2014 Omnibus Incentive Plan In connection with the approval of the Business Combination, the 2014 Omnibus Incentive Plan (the “2014 Plan”) was approved by shareholders to provide incentives to key employees of the Company and its subsidiaries. Awards under the 2014 Plan are generally not restricted to any specific form or structure and could include, without limitation, stock options, stock appreciation rights, restricted stock awards and RSUs, performance awards, other stock-based awards, and other cash-based awards. There were 3,473,435 shares of common stock reserved and authorized for issuance under the 2014 Plan. At December 31, 2016, there were 677,434 shares of common stock authorized and available for grant under the 2014 Plan. Share Based Compensation Expense Upon completion of the Business Combination, the Compensation Committee of the Company’s Board of Directors approved an initial grant under the 2014 Plan to certain executive officers, senior management employees, and the Board of Directors. The Company recognized the following share based compensation (income) expense: (1) For the year ended December 31, 2015, primarily represents the impact of the acceleration of certain vesting schedules for RSUs and stock price vesting awards related to the transition of the Company’s former CEO and CFO. As of December 31, 2016, $1.2 million of total unrecognized compensation expense related to share-based compensation plans is expected to be recognized over a weighted-average period of 1.4 years. The total unrecognized share-based compensation expense to be recognized in future periods as of December 31, 2016 does not consider the effect of share-based awards that may be issued in subsequent periods. General Terms of Awards The Compensation Committee of the Board of Directors has discretion to establish the terms and conditions for grants, including the number of shares, vesting and required service or other performance criteria. RSU and performance share unit awards are subject to forfeiture upon termination of employment prior to vesting, subject in some cases to early vesting, or continued eligibility for vesting, upon specified events, including death or permanent disability of the grantee, termination of the grantee’s employment under certain circumstances or a change in control of the Company. Dividend equivalents on common stock, if any, are accrued for RSUs and performance share units granted to employees and paid in the form of cash or stock depending on the form of the dividend, at the same time that the shares of common stock underlying the unit are delivered to the employee. All RSUs and performance share units granted to employees are payable in shares of common stock and are classified as equity awards. The rights granted to the recipient of employee RSU awards generally vest annually in equal installments on the anniversary of the grant date over the restriction or vesting period, which is generally three years. Vested RSUs are payable in common stock within a thirty day period following the vesting date. The Company records compensation expense of RSU awards based on the fair value of the awards at the date of grant ratably over the period during which the restrictions lapse. Performance share unit awards based on cumulative and average performance metrics are payable at the end of their respective performance period in common stock. The number of share units awarded can range from zero to 150% depending Jason Industries, Inc. (In thousands, except share and per share amounts) on achievement of a targeted performance metric, and are payable in common stock within a thirty day period following the end of the performance period. The Company expenses the cost of the performance-based share unit awards based on the fair value of the awards at the date of grant and the estimated achievement of the performance metric, ratably over the performance period of three years. Performance share unit awards based on achievement of certain established stock price targets are payable in common stock if the last sales price of the Company’s common stock equals or exceeds established stock price targets in any twenty trading days within a thirty trading day period during the performance period. The Company expenses the cost of the stock price-based performance share unit awards based on the fair value of the awards at the date of grant ratably over the derived service period of the award. The Company also issues RSUs as share-based compensation for members of the Board of Directors. Director RSUs vest one year from the date of grant. In the event of termination of a member’s service on the Board of Directors prior to a vesting date, all unvested RSUs of such holder will be forfeited. Vested RSUs are deferred and then delivered to members of the Board of Directors six months following the termination of their directorship. All awards granted are payable in shares of common stock or cash payment equal to the fair market value of the shares at the discretion of our Compensation Committee, and are classified as equity awards due to their expected settlement in common stock. Compensation expense for these awards is measured based upon the fair value of the awards at the date of grant. Dividend equivalents on common stock are accrued for RSUs awarded to the Board of Directors and paid in the form of cash or stock depending on the form of the dividend, at the same time that the shares of common stock underlying the RSU are delivered to a member of the Board of Directors following the termination of their directorship. Restricted Stock Units The following table summarizes RSU activity: As of December 31, 2016, there was $1.2 million of unrecognized share-based compensation expense related to 424,533 RSU awards, with a weighted-average grant date fair value of $4.52, that are expected to vest over a weighted-average period of 1.4 years. Included within the total 553,645 RSU awards outstanding as of December 31, 2016 are 129,112 RSU awards for members of our Board of Directors which have vested and issuance of the shares has been deferred, with a weighted-average grant date fair value of $7.53. The total fair values of shares vested during the years ended December 31, 2016 and 2015 were $0.7 million and $3.4 million, respectively. The fair values of these awards were determined based on the Company’s stock price on the grant date. In connection with the vesting of RSUs previously issued by the Company, a number of shares sufficient to fund statutory minimum tax withholding requirements was withheld from the total shares issued or released to the award holder (under the terms of the 2014 Plan, the shares are considered to have been issued and are not added back to the pool of shares available for grant). During the years ended December 31, 2016 and 2015, 43,806 and 210,869 shares, respectively, were withheld to satisfy the requirement. The withholding is treated as a reduction in additional paid-in capital in the accompanying consolidated statements of shareholders’ equity. Jason Industries, Inc. (In thousands, except share and per share amounts) Performance Share Units Adjusted EBITDA Vesting Awards The following table summarizes adjusted EBITDA vesting awards activity: There were no adjusted EBITDA vesting performance share unit awards granted during the year ended December 31, 2016. During the year ended December 31, 2015, 142,238 performance share unit awards were granted to certain executive officers with the same performance targets and vesting period as the awards granted during 2014. During the period June 30, 2014 through December 31, 2014, 1,215,704 performance share unit awards were granted to certain executive officers and senior management employees, payable upon the achievement of certain established cumulative adjusted EBITDA performance targets over a three year performance period. The performance period for the shares awarded during the period June 30, 2014 through December 31, 2014 is July 1, 2014 through June 30, 2017. Distributions under these awards are payable at the end of the performance period in common stock. The total potential payouts for awards granted during the period June 30, 2014 through December 31, 2014 range from zero to 723,318 shares, should certain performance targets be achieved. These awards are subject to forfeiture upon termination of employment prior to vesting, subject in some cases to early vesting or continued eligibility for vesting upon specified events, including death, permanent disability or retirement of the grantee or a change in control of the Company. During the second quarter of 2016, the Company lowered its estimated vesting of the performance share unit awards from 62.5% of target, or 301,382 shares, to an estimated vesting payout of 0%, or 0 shares, resulting in $2.4 million of share-based compensation income due to declines in profitability. As of December 31, 2016, there was no unrecognized compensation expense related to Adjusted EBITDA based vesting performance share unit awards expected to be recognized in subsequent periods. Stock Price Vesting Awards The following table summarizes stock price vesting awards activity: There were no stock price vesting performance share unit awards granted during the year ended December 31, 2016. During the year ended December 31, 2015, 94,825 performance share unit awards were granted to certain executive officers with the same established stock price targets and vesting period as the awards granted during 2014. During the period June 30, 2014 through December 31, 2014, 810,469 performance share unit awards were granted to certain executive officers and senior management employees and are payable upon the achievement of certain established stock price targets for the Company’s common stock during a three year performance period. The performance period for the shares awarded during the period June 30, 2014 through December 31, 2014 is July 1, 2014 through June 30, 2017. Distributions under these awards are payable in Jason Industries, Inc. (In thousands, except share and per share amounts) common stock when the last sales price of the Company’s common stock equals or exceeds established stock price targets in any twenty trading days within a thirty trading day period during the performance period. As of December 31, 2016, there was an immaterial amount of unrecognized compensation expense related to stock price based performance share unit awards, which is expected to be recognized over a weighted average period of 0.4 years. The following summarizes the assumptions used in the Monte Carlo option pricing model to value stock price vesting awards: The expected volatility was derived from the closing market price of the Company’s exchange traded warrants to purchase common stock as of the grant date using the Black-Scholes option pricing model. ROIC Vesting Awards The following table summarizes stock price vesting awards activity: During the year ended December 31, 2016, 599,336 performance share unit awards were granted to certain executive officers and senior management employees, payable upon the achievement of an average return on invested capital (“ROIC”) performance target during a three year measurement period ending on December 31, 2018. Performance share unit awards based on ROIC performance metrics are payable at the end of their respective performance period in common stock. The total potential payouts for awards granted during the year ended December 31, 2016 range from zero to 513,086 shares, should certain performance targets be achieved. These awards are subject to forfeiture upon termination of employment prior to vesting, subject in some cases to early vesting or continued eligibility for vesting upon specified events, including death, permanent disability or retirement of the grantee or a change in control of the Company. Compensation expense for ROIC based performance share unit awards outstanding during the year ended December 31, 2016 is currently being recognized based on an estimated payout of 0% of target, or 0 shares. During the fourth quarter of 2016, the Company lowered its estimated vesting of the performance share unit awards from 100% of target, or 342,057 shares, to an estimated vesting payout of 0%. As of December 31, 2016, there was no unrecognized compensation expense related to ROIC based vesting performance share unit awards expected to be recognized in subsequent periods. Share Based Compensation (Predecessor) Prior to the consummation of the Business Combination, Jason Partners Holdings LLC, the former parent company of Jason, had granted various classes of its common units to certain executives and directors of Jason. In accordance with ASC 718, Compensation - Stock Compensation, compensation cost related to the units granted was recognized in Jason’s financial statements over the vesting period. Upon consummation of the Business Combination, all unvested units became fully vested and Jason recognized $7.6 million of compensation expense during the predecessor period. During the predecessor period from January 1, 2014 through June 29, 2014, Jason recognized $7.7 million of stock-based compensation expense, and the related income tax benefit was $2.5 million. Jason Industries, Inc. (In thousands, except share and per share amounts) Basic income (loss) per share is calculated by dividing net income (loss) available to Jason Industries’ common shareholders by the weighted average number of common shares outstanding for the period. In computing dilutive income (loss) per share, basic income (loss) per share is adjusted for the assumed issuance of all potentially diluted share-based awards, including public warrants, RSUs, performance share units, convertible preferred stock, and Rollover Shares of JPHI convertible into shares of Jason Industries. Such Rollover Shares were contributed by former owners and management of Jason Partners Holdings Inc. prior to the Company’s acquisition of JPHI. Public warrants (“warrants”) consist of warrants to purchase shares of Jason Industries common stock which are quoted on Nasdaq under the symbol “JASNW.” The reconciliation of the numerator and denominator of the basic and diluted loss per share calculation and the anti-dilutive shares is as follows: (1) Includes the impact of 899 additional Series A Preferred Stock shares from a stock dividend declared on December 15, 2016 paid in additional shares of Series A Preferred Stock on January 1, 2017. The Company included the preferred stock within the consolidated balance sheets as of the declaration date. (2) Includes the impact of the exchange by certain Rollover Participants of their JPHI stock for Company common stock in the fourth quarter of 2016. Warrants are considered anti-dilutive and excluded when the exercise price exceeds the average market value of the Company’s common stock price during the applicable period. Performance share units are considered anti-dilutive if the performance targets upon which the issuance of the shares is contingent have not been achieved and the respective performance period has not been completed as of the end of the current period. Due to losses available to the Company’s common shareholders for each of the periods presented, potentially dilutive shares are excluded from the diluted net loss per share calculation because they were anti-dilutive under the treasury stock method, in accordance with Accounting Standards Codification Topic 260. Jason Industries, Inc. (In thousands, except share and per share amounts) The consolidated loss before income taxes consisted of the following: The consolidated benefit for income taxes included within the consolidated statements of operations consisted of the following: The income tax benefit recognized in the accompanying consolidated statements of operations differs from the amounts computed by applying the Federal income tax rate to loss before income tax benefit. A reconciliation of income taxes at the Federal statutory rate to the effective tax rate is summarized as follows: Jason Industries, Inc. (In thousands, except share and per share amounts) (1) During the year ended December 31, 2016, the U.S. taxation of foreign earnings includes the recognition of a deferred tax liability for foreign earnings of the Company’s non-majority owned joint venture holding that are no longer considered permanently reinvested. (2) During the years ended December 31, 2016 and 2015, the non-deductible impairment charges are related to the impairment of goodwill and other intangible assets. The Company’s temporary differences which gave rise to deferred tax assets and liabilities were as follows: At December 31, 2016, the Company has U.S. federal and state net operating loss carryforwards, which expire at various dates through 2036, approximating $41.2 million and $94.2 million, respectively. In addition, the Company has U.S. state tax credit carryforwards of $1.5 million which expire between 2017 and 2031. The Company’s foreign net operating loss carryforwards total approximately $19.3 million (at December 31, 2016 exchange rates). The majority of these foreign net operating loss carryforwards are available for an indefinite period. Valuation allowances totaling $4.9 million and $3.7 million as of December 31, 2016 and 2015, respectively, have been established for deferred income tax assets primarily related to certain subsidiary loss carryforwards that may not be realized. Realization of the net deferred income tax assets is dependent on generating sufficient taxable income prior to their expiration. Although realization is not assured, management believes it is more-likely-than-not that the net deferred income tax assets will be realized. The amount of the net deferred income tax assets considered realizable, however, could change in the near term if future taxable income during the carryforward period fluctuates. Jason Industries, Inc. (In thousands, except share and per share amounts) Changes in the Company’s gross liability for unrecognized tax benefits, excluding interest and penalties, are as follows for the years ended December 31, 2016, 2015 and 2014: Of the $1.9 million, $2.9 million, and $2.7 million of unrecognized tax benefits as of December 31, 2016, 2015 and 2014, respectively, approximately $1.6 million, $1.9 million, and $1.0 million, respectively, would impact the effective income tax rate if recognized. The Company recognizes accrued interest and penalties related to unrecognized tax benefits as part of its income tax provision. During the years ended December 31, 2016 and 2015, the Company had an immaterial amount of interest and penalties that were recognized as a component of the income tax provision. During the period June 30, 2014 through December 31, 2014 and the period January 1, 2014 through June 29, 2014 the Company did not have any interest or penalties that were recognized as a component of the income tax provision. At December 31, 2016 and 2015, the Company has an immaterial amount of accrued interest and penalties related to taxes included within the consolidated balance sheet. During the next twelve months, the Company believes it is reasonably possible that the total amount of unrecognized tax benefits could decrease by $0.1 million. The Company, along with its subsidiaries, files returns in the U.S. Federal and various state and foreign jurisdictions. With certain exceptions, the Company is subject to examination by U.S. Federal and state taxing authorities for the taxable years in the following table. The Company does not expect the results of these examinations to have a material impact on the Company. The cumulative undistributed earnings of all wholly-owned non-U.S. subsidiaries totaled $50.1 million as of December 31, 2016. The Company has not provided any deferred taxes on these undistributed earnings as it considers the undistributed earnings to be permanently reinvested. If all such undistributed earnings were remitted, an additional income tax provision of approximately $14.4 million would have been necessary as of December 31, 2016. During the second quarter of 2016, the Company changed its assertion regarding the permanent reinvestment of earnings of its non-majority owned joint venture holding. Such change in assertion was driven by several factors. Prior to the second quarter of 2016, the Company had the ability and intent to block the payment of distributions; the Company changed its stance in the second quarter of 2016 to be open to joint venture distributions. This change coincided with the a re-evaluation of the joint venture partners during that quarter of the willingness and ability of the entity to distribute excess cash balances given the maturity, stability and revised growth expectations of the joint venture operations. The impact of this change in assertion was to reduce the income tax benefit for the year ended December 31, 2016 by $2.9 million. Jason Industries, Inc. (In thousands, except share and per share amounts) Defined contribution plans The Company maintains a 401(k) Plan for substantially all full time U.S. employees (the “401(k) Plan”). Company contributions are allocated to accounts set aside for each employee’s retirement. Employees generally may contribute up to 50% of their compensation to individual accounts within the 401(k) Plan. During 2015, employer contributions changed to 50% on the first 6% of employee’s eligible annual cash compensation, subject to Internal Revenue Service limitations. Prior to the change during 2015, base contributions to employee accounts were equal to 1% of each employee’s eligible annual cash compensation, subject to Internal Revenue Service limitations, and the Company could elect to match up to 75% of the first 6% of each employee’s contribution to the 401(k) Plan, subject to Internal Revenue Service limitations. Expense recognized related to the 401(k) Plan totaled approximately $2.4 million, $1.7 million, $0.6 million, and $1.4 million for the year ended December 31, 2016, the year ended December 31, 2015, the period June 30, 2014 through December 31, 2014, and the period January 1, 2014 through June 29, 2014, respectively. Defined benefit pension plans The Company maintains defined benefit pension plans covering union and certain other employees. These plans are frozen to new participation. The table that follows contains the accumulated benefit obligation and reconciliations of the changes in projected benefit obligation, the changes in plan assets and funded status: Jason Industries, Inc. (In thousands, except share and per share amounts) The following table contains the components of net periodic benefit cost: The expected return on plan assets is based on the Company’s expectation of the long-term average rate of return of the capital markets in which the plans invest. The expected return reflects the target asset allocations and considers the historical returns earned for each asset category. The Company determines the discount rate assumptions by referencing high-quality long-term bond rates that are matched to the duration of our benefit obligations, with appropriate consideration of local market factors, participant demographics and benefit payment terms. The net amounts recognized in accumulated other comprehensive loss related to the Company’s defined benefit pension plans consisted of the following: In the next fiscal year, $0.1 million of unrecognized loss within accumulated other comprehensive loss is expected to be recognized as a component of net periodic benefit cost. The Company’s investment policies employ an approach whereby a mix of equities and fixed income investments are used to maximize the long-term return on plan assets for a prudent level of risk. The investment portfolio primarily contains a diversified blend of equity and fixed income investments. Equity investments are diversified across domestic and non-domestic stocks, and investment and market risk are measured and monitored on an ongoing basis. The Company’s actual asset allocations are in line with target allocations and the Company does not have concentration within individual or similar investments that would pose a significant concentration risk to the Company. Jason Industries, Inc. (In thousands, except share and per share amounts) The Company’s pension plan asset allocations by asset category at December 31, 2016 and 2015 are as follows: The fair values of pension plan assets by asset category at December 31, 2016 and 2015 are as follows: The fair value measurement of plan assets using significant unobservable inputs (Level 3) changed during 2016 due to the following: No assets were transferred between levels of the fair value hierarchy during the years ended December 31, 2016 and December 31, 2015. Quoted market prices are used to value investments when available. Investments in securities traded on exchanges are valued at the last reported sale prices on the last business day of the year or, if not available, the last reported bid prices. The Company’s cash contributions to its defined benefit pension plans in 2017 are estimated to be approximately $0.8 million. Estimated projected benefit payments from the plans as of December 31, 2016 are as follows: Multiemployer plan Morton hourly union employees were covered under the National Shopmen Pension Fund (EIN 52-6122274, plan number 001), a union-sponsored and trusteed multiemployer plan which required the Company to contribute a negotiated amount per hour worked by the employees covered by the plan. The Company made the decision to withdraw from this plan in Jason Industries, Inc. (In thousands, except share and per share amounts) August 2012. The withdrawal amount was finalized during 2013. As of December 31, 2016, a liability of $1.7 million is recorded within other long-term liabilities and a liability of $0.2 million is recorded within other current liabilities on the consolidated balance sheets. As of December 31, 2015, $2.1 million is recorded within other long-term liabilities on the consolidated balance sheets. The total liability will be paid in equal monthly installments through April 2026, and interest expense will be incurred associated with the discounting of this liability through that date. Postretirement health care and life insurance plans The Company also provides postretirement health care benefits and life insurance coverage to certain eligible former employees at one of its segments. The costs of retiree health care benefits and life insurance coverage are accrued over the employee benefit period. The table that follows contains the accumulated benefit obligation and reconciliations of the changes in projected benefit obligation, the changes in plan assets and funded status: The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was a blended rate of 5.50% and 5.70% at December 31, 2016 and December 31, 2015, respectively. It was assumed that these rates will decline by 1% to 2% every 5 years for the next 15 years. An increase or decrease in the medical trend rate of 1% would increase or decrease the accumulated postretirement benefit obligation by approximately $0.1 million and $0.1 million, respectively. Jason Industries, Inc. (In thousands, except share and per share amounts) The table that follows contains the components of net periodic benefit costs: The net amounts recognized in accumulated other comprehensive loss related to the Company’s other postretirement healthcare and life insurance plans consisted of the following: The Company’s cash contributions to its postretirement benefit plan in 2017 are not yet determined but are expected to equal the projected benefits from the plan. Estimated projected benefit payments from the plan at December 31, 2016 are as follows: 16. Business Segments, Geographic and Customer Information The Company identifies its segments using the “management approach,” which designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company’s reportable segments. The Company is a global manufacturer of a broad range of industrial products and is organized into four reportable segments: seating, finishing, acoustics and components. The Company’s seating segment supplies seating solutions to equipment manufacturers in the motorcycle, lawn and turf care, industrial, agricultural, construction and power sports end markets. The finishing segment focuses on the production of industrial brushes, buffing wheels, buffing compounds, and abrasives that are used in a broad range of industrial and infrastructure applications. The acoustics segment manufactures engineered non-woven, fiber-based acoustical products for the automotive industry. The components segment is a diversified manufacturer of expanded and perforated metal components, slip-resistant walking surfaces and subassemblies for smart utility meters. Jason Industries, Inc. (In thousands, except share and per share amounts) Net sales relating to the Company’s reportable segments are as follows: The Company uses “Adjusted EBITDA” as the primary measure of profit or loss for the purposes of assessing the operating performance of its segments. The Company defines EBITDA as net income (loss) before interest expense, income tax provision (benefit), depreciation and amortization. The Company defines Adjusted EBITDA as EBITDA, excluding the impact of operational restructuring charges and non-cash or non-operational losses or gains, including goodwill and long-lived asset impairment charges, gains or losses on disposal of property, plant and equipment, integration and other operational restructuring charges, transactional legal fees, other professional fees, purchase accounting adjustments, and non-cash share based compensation expense. Management believes that Adjusted EBITDA provides a clear picture of the Company’s operating results by eliminating expenses and income that are not reflective of the underlying business performance. Certain corporate-level administrative expenses such as payroll and benefits, incentive compensation, travel, marketing, accounting, auditing and legal fees and certain other expenses are kept within its corporate results and are not allocated to its business segments. Shared expenses across the Company that directly relate to the performance of our four reportable segments are allocated to the segments. Adjusted EBITDA is used to facilitate a comparison of the Company’s operating performance on a consistent basis from period to period and to analyze the factors and trends affecting its segments. The Company’s internal plans, budgets and forecasts use Adjusted EBITDA as a key metric. In addition, this measure is used to evaluate its operating performance and segment operating performance and to determine the level of incentive compensation paid to its employees. As the Company uses Adjusted EBITDA as its primary measure of segment performance, GAAP requires the Company to include this measure in its discussion of segment operating results. The Company must also reconcile segment Adjusted EBITDA to operating results presented on a GAAP basis. Jason Industries, Inc. (In thousands, except share and per share amounts) Adjusted EBITDA information relating to the Company’s reportable segments is presented below followed by a reconciliation of total segment Adjusted EBITDA to consolidated income before taxes: Other financial information relating to the Company’s reportable segments is as follows at December 31, 2016 and 2015, for the years ended December 31, 2016 and 2015, and for the periods June 30, 2014 through December 31, 2014 and January 1, 2014 through June 29, 2014, respectively: Jason Industries, Inc. (In thousands, except share and per share amounts) Net sales and long-lived asset information by geographic area are as follows at December 31, 2016 and 2015, for the years ended December 31, 2016 and 2015, and for the periods June 30, 2014 through December 31, 2014 and January 1, 2014 through June 29, 2014, respectively: Net sales attributed to geographic locations are based on the locations producing the external sales. Long-lived assets by geographic location consist of the net book values of property, plant and equipment and amortizable intangible assets. Litigation Matters On December 22, 2016, JMB Capital Partners Master Fund, L.P. (“Plaintiff”), filed a complaint in the Supreme Court of the State of New York, County of New York, captioned JMB Capital Partners Master Fund, L.P. v. Jason Industries, Inc., et al., Index No. 656692/2016. The complaint names the Company and Jeffry N. Quinn as defendants (“Defendants”) and asserts claims for breach of representations and warranties, fraudulent inducement, negligent misrepresentation, conversion, unjust Jason Industries, Inc. (In thousands, except share and per share amounts) enrichment and breach of the implied covenant of good faith and fair dealing. The claims arise out of alleged misrepresentations made in connection with the sale of Series A Preferred Stock to Plaintiff pursuant to a Subscription Agreement executed on May 14, 2014. Plaintiff seeks compensatory damages, rescission of the Subscription Agreement, consequential and punitive damages, attorneys’ fees, pre-judgment and post-judgment interest, costs of suit, and other equitable relief. The parties have entered into a briefing schedule relating to Defendants’ anticipated motion to dismiss. The Company believes that this action lacks merit and intends to defend the case vigorously. As of December 31, 2016, the Company has not recorded a loss contingency related to this case, as the risk of loss is not perceived to be probable based on facts of the case known to date. As this case is in the early stages, no range of loss can be reasonably estimated at this time, however, an unfavorable outcome in the matter could have a material adverse effect on the Company’s financial condition or cash flows. The Company will continue to evaluate the status of the case and would record a reserve for losses at the time when it is both probable that a loss has been incurred and the amount of loss is reasonably estimable. In the third quarter of 2016, the Company received notification of certain employment matter claims filed in Brazil related to hiring practices within the Company’s finishing division. The Company is actively investigating and defending such claims and has gathered additional information to assess the total potential exposure related to this matter, including the potential of additional claims. In the opinion of management, the resolution of this contingency will not have a material adverse effect on the Company’s financial condition, results of operations, or cash flows. In addition to the cases noted above, the Company is a party to various legal proceedings that have arisen in the normal course of its business. These legal proceedings typically include product liability, labor, and employment claims. The Company has recorded reserves for loss contingencies based on the specific circumstances of each case. Such reserves are recorded when it is probable that a loss has been incurred as of the balance sheet date, can be reasonably estimated and is not covered by insurance. In the opinion of management, the resolution of these contingencies will not have a material adverse effect on the Company’s financial condition, results of operations, or cash flows. Environmental Matters At December 31, 2016 and December 31, 2015, the Company held reserves of $1.0 million for environmental matters at one location. The ultimate cost of any remediation required will depend on the results of future investigation. Based upon available information, the Company believes that it has obtained and is in substantial compliance with those material environmental permits and approvals necessary to conduct its business. Based on the facts presently known, the Company does not expect environmental costs to have a material adverse effect on its financial condition, results of operations or cash flows. Jason was part of a Management Services Agreement with Saw Mill Capital LLC (“Saw Mill”) and Falcon Investment Advisors, LLC (“FIA”, together with Saw Mill, the “Service Providers”), affiliates of Jason’s majority shareholders, which terminated upon consummation of the Business Combination. Management fees and related expenses paid to the Service Providers under this agreement were approximately $0.6 million for the predecessor period ended June 29, 2014. In addition, during the period January 1, 2014 through June 29, 2014 the Company incurred sale transaction fees of $5.4 million which were paid to the Service Providers on June 30, 2014 upon completion of the Business Combination. Seating segment headquarters lease In January of 2017, the Company signed a 10 year lease for approximately 50,000 square feet of office space for the seating segment’s headquarters which commences in March 2017 and expires in July 2027. The Company will pay approximately $3.5 million in minimum lease payments over the life of the lease. Exchange of common stock of JPHI Holdings, Inc. for common stock of Jason Industries, Inc. In the first quarter of 2017, certain Rollover Participants exchanged 1,084,007 shares of JPHI stock for Company. common stock, which decreased the noncontrolling interest to 0.0 percent. As of February 23, 2017, 0 shares of JPHI stock were still held by Rollover Participants. | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement excerpt. It contains partial phrases about profit/loss, expenses, liabilities, and amortization, but lacks sufficient context or complete information to provide a meaningful summary. To help you effectively, I would need the full financial statement or a more complete section of the document.
If you'd like a summary, please provide the complete financial statement or clarify which specific parts you want me to analyze. | Claude |
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm MagnaChip Semiconductor Corporation Consolidated Balance Sheets as of December 31, 2016 and 2015 MagnaChip Semiconductor Corporation Consolidated Statements of Operations for the Years Ended December 31, 2016, 2015 and 2014 MagnaChip Semiconductor Corporation Consolidated Statements of Comprehensive Income/ (Loss) for the Years Ended December 31, 2016, 2015 and 2014 MagnaChip Semiconductor Corporation Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2016, 2015 and 2014 MagnaChip Semiconductor Corporation Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014 MagnaChip Semiconductor Corporation Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of MagnaChip Semiconductor Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive income/(loss), changes in shareholders’ equity and cash flows present fairly, in all material respects, the financial position of MagnaChip Semiconductor Corporation and its subsidiaries (the “Company”) at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in Management’s Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Samil PricewaterhouseCoopers Seoul, Korea February 21, 2017 MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS The accompanying notes are an integral part of these consolidated financial statements MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS The accompanying notes are an integral part of these consolidated financial statements MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME / (LOSS) The accompanying notes are an integral part of these consolidated financial statements MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY The accompanying notes are an integral part of these consolidated financial statements MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS The accompanying notes are an integral part of these consolidated financial statements MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) 1. Business, Basis of Presentation and Summary of Significant Accounting Policies Business MagnaChip Semiconductor Corporation (together with its subsidiaries, the “Company”) is a Korea-based designer and manufacturer of analog and mixed-signal semiconductor products for consumer, computing, communication, industrial, automotive and Internet of Things (“IoT”) applications. The Company provides technology platforms for analog, mixed signal, power, high voltage, non-volatile memory and Radio Frequency (“RF”) applications. The Company’s business is comprised of two operating segments: Foundry Services Group and Standard Products Group. The Company’s Foundry Services Group provides specialty analog and mixed-signal foundry services mainly for fabless and Integrated Device Manufacturer (“IDM”) semiconductor companies that primarily serve the consumer, computing, communication, industrial, automotive and IoT applications. The Company’s Standard Products Group is comprised of two business lines: Display Solutions and Power Solutions. The Company’s Display Solutions products provide flat panel display solutions to major suppliers of large and small flat panel displays and include sensor products for mobile applications, and industrial applications and home appliances. The Company’s Power Solutions products include discrete and integrated circuit solutions for power management in consumer, communication and industrial applications. Basis of Presentation The consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). Significant accounting policies followed by the Company in the preparation of the accompanying consolidated financial statements are summarized below. Principles of Consolidation The consolidated financial statements include the accounts of the Company including its wholly-owned subsidiaries. All intercompany transactions and balances are eliminated in consolidation. Use of Estimates The preparation of financial statements in accordance with US GAAP requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenue and expenses. Such estimates include the valuation of accounts receivable, inventories, stock based compensation, property plant and equipment, intangible assets, other long-lived assets, long-term employee benefits, contingencies liabilities, estimated future cash flows and other assumptions used in long-lived asset impairment tests and calculation of income taxes and deferred tax valuation allowances, and assumptions used in the calculation of sales incentives, among others. Although these estimates and assumptions are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may be significantly different from the estimates. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods. Foreign Currency Translation The Company has assessed in accordance with Accounting Standards Codification (ASC) 830, “Foreign Currency Matters” (“ASC 830”), the functional currency of each of its subsidiaries in Luxembourg and the Netherlands and has designated the U.S. dollar to be their respective functional currencies. The Korean Won is MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) the functional currency for the Company’s Korean subsidiary, which is the primary operating subsidiary of the Company. The Company and its other subsidiaries are utilizing their local currencies as their functional currencies. The financial statements of the subsidiaries in functional currencies other than the U.S. dollar are translated into the U.S. dollar in accordance with ASC 830. All the assets and liabilities are translated to the U.S. dollar at the end-of-period exchange rates. Capital accounts are determined to be of a permanent nature and are therefore translated using historical exchange rates. Revenues and expenses are translated using average exchange rates for the respective periods. Foreign currency translation adjustments arising from differences in exchange rates from period to period are included in the foreign currency translation adjustment account in accumulated other comprehensive income (loss) of stockholders’ equity. Gains and losses due to transactions in currencies other than the functional currency are included as a component of other income, net in the statement of operations. Cash and Cash Equivalents Cash equivalents consist of highly liquid investments with an original maturity date of three months or less when purchased. Accounts Receivable Reserves An allowance for doubtful accounts is provided based on the aggregate estimated uncollectability of the Company’s accounts receivable. The Company also records an estimate for sales returns, included within accounts receivable, net, based on the historical experience of the amount of goods that will be returned and refunded or replaced. In addition, the Company also includes in accounts receivable, an allowance for additional products that may have to be provided, free of charge, to compensate customers for products that do not meet previously agreed yield criteria, the low yield compensation reserve. Sales of Accounts Receivable The Company accounts for transfers of financial assets under ASC 860, “Transfers and Servicing,” as either sales or financings. Transfers of financial assets that result in sales accounting are those in which (1) the transfer legally isolates the transferred assets from the transferor, (2) the transferee has the right to pledge or exchange the transferred assets and no condition both constraints the transferee’s right to pledge or exchange the assets and provides more than a trivial benefit to the transferor, and (3) the transferor does not maintain effective control over the transferred assets. If the transfer does not meet these criteria, the transfer is accounted for as a financing. Financial assets that are treated as sales are removed from the Company’s accounts with any realized gain or loss reflected in earning during the period of sale. Inventories Inventories are stated at the lower of cost or market, using the average cost method, which approximates the first in, first out method (“FIFO”). If net realizable value is less than cost at the balance sheet date, the carrying amount is reduced to the realizable value, and the difference is recognized as a loss on valuation of inventories within cost of sales. Inventory reserves are established when conditions indicate that the net realizable value is less than costs due to physical deterioration, obsolescence, changes in price levels, or other causes based on individual facts and circumstances. Reserves are also established for excess inventory based on inventory levels in excess of six months of projected demand for each specific product. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) In addition, as prescribed in ASC 330, “Inventory,” the cost of inventories is determined based on the normal capacity of each fabrication facility. In case the capacity utilization is lower than a certain level that management believes to be normal, the fixed overhead costs per production unit which exceeds those under normal capacity are charged to cost of sales rather than capitalized as inventories. Vendor Rebates The Company, from time to time, entered into arrangements whereby rebates are obtained from vendors when the Company achieves certain levels of purchases. The vendor rebates are computed at an agreed upon amount or percentage of purchase levels. As these vendor rebates are impacted by actual and estimated purchases for the applicable agreed upon period, the Company periodically assess the progress of its purchase levels and revise the estimates when necessary. The Company accounts for such rebates as a reduction of inventory until the Company sells the product, at which time such rebates are reflected as a reduction of cost of sales in its consolidated statements of operations. Vendor rebates recorded as a reduction of inventory were $359 thousand as of December 31, 2016 and as a reduction of cost of sales were $4,044 thousand for the year ended December 31, 2016. Property, Plant and Equipment Property, plant and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as set forth below. Routine maintenance and repairs are charged to expense as incurred. Expenditures that enhance the value or significantly extend the useful lives of the related assets are capitalized. Impairment of Long-Lived Assets The Company reviews property, plant and equipment and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable in accordance with ASC 360, “Property, Plant and Equipment”. Recoverability is measured by comparing its carrying amount with the future net undiscounted cash flows the assets are expected to generate. If such assets are considered to be impaired, the impairment is measured as the difference between the carrying amount of the assets and the fair value of assets using the present value of the future net cash flows generated by the respective long-lived assets. Restructuring Charges The Company recognizes restructuring charges in accordance with ASC 420, “Exit or Disposal Cost Obligations”. Certain costs and expenses related to exit or disposal activities are recorded as restructuring charges when liabilities for those costs and expenses are incurred. Lease Transactions The Company accounts for lease transactions as either operating leases or capital leases, depending on the terms of the underlying lease agreements. Machinery and equipment acquired under capital lease agreements are MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) recorded at the lower of the present value of future minimum lease payments and estimated fair value of leased property and depreciated using the straight-line method over their estimated useful lives. In addition, the aggregate lease payments are recorded as capital lease obligations, net of unaccrued interest. Interest is amortized over the lease period using the effective interest rate method. Leases that do not qualify as capital leases are classified as operating leases, and the related rental payments are expensed on a straight-line basis over the shorter of the estimated useful lives of the leased property and the lease term. Intangible Assets Intangible assets other than intellectual property include technology and customer relationships which are amortized on a straight-line basis over periods ranging from one to five years. Intellectual property assets acquired represent rights under patents, trademarks and property use rights and are amortized over their respective periods of benefit, ranging up to ten years, on a straight-line basis. Fair Value Disclosures of Financial Instruments The Company follows ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”) for measurement and disclosures about fair value of its financial instruments. ASC 820 establishes a framework for measuring fair value in US GAAP, and expands disclosures about fair value measurements. To increase consistency and comparability in fair value measurements and related disclosures, ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The three levels of fair value hierarchy defined by ASC 820 are: Level 1-Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date. Level 2-Inputs (other than quoted market prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life. Level 3-Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Valuation of instruments includes unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities. As defined by ASC 820, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale, which was further clarified as the price that would be received to sell an asset or paid to transfer a liability (“an exit price”) in an orderly transaction between market participants at the measurement date. The carrying amounts of the Company’s financial assets and liabilities, such as cash and cash equivalents, accounts receivable, other receivables, accounts payable and other accounts payable approximate their fair values because of the short maturity of these instruments. Accrued Severance Benefits The majority of accrued severance benefits is for employees in the Company’s Korean subsidiary, MagnaChip Semiconductor Ltd. Pursuant to the Employee Retirement Benefit Security Act of Korea, eligible MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) employees and executive officers with one or more years of service are entitled to severance benefits upon the termination of their employment based on their length of service and rate of pay. As of December 31, 2016, 98% of all employees of the Company were eligible for severance benefits. Accrued severance benefits are funded through a group severance insurance plan. The amounts funded under this insurance plan are classified as a reduction of the accrued severance benefits. Subsequent accruals are to be funded at the discretion of the Company. In accordance with the National Pension Act of the Republic of Korea, a certain portion of accrued severance benefits is deposited with the National Pension Fund and deducted from the accrued severance benefits. The contributed amount is paid to employees from the National Pension Fund upon their retirement. Revenue Recognition Revenue is recognized when there is persuasive evidence of an arrangement, the price to the buyer is fixed or determinable, delivery has occurred and collectability of the sales price is reasonably assured. Revenue from the sale of products is recognized when title and risk of loss transfers to the customer, which is generally when the product is shipped to or accepted by the customer depending on the terms of the arrangement. A portion of the Company’s sales are made through distributors for which revenue recognition criteria are usually met when the product is shipped to or accepted by the distributors, consistent with the principles described above. However, the risk of loss may not pass upon shipment of products to the distributor due to a variety of reasons, including the nature of the business arrangement with the distributor. For example, the financial condition of a distributor may indicate that payments by the distributor to the Company are contingent on resale of products to an end customer. In this situation, the Company defers recognition of revenue and cost of revenue on transactions with such distributor until the product has been resold to the end customer. The Company recorded deferred revenue in the amount of $11,092 thousand as of December 31, 2016 and $10,060 thousand as of December 31, 2015 as the Company received cash from certain customers and distributors for the sale of products prior to risk of loss being transferred based on the terms of the arrangement. In accordance with revenue recognition guidance, any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer is presented in the statements of operations on a net basis (excluded from revenues). The Company provides a warranty, under which customers can return defective products. The Company estimates the costs related to those defective product returns and records them as a component of cost of sales. In addition, the Company offers sales returns (other than those that relate to defective products under warranty), yield provisions, cash discounts for early payments and certain allowances to its customers, including distributors. The Company records reserves for those returns, discounts and allowances as a deduction from sales, based on historical experience and other quantitative and qualitative factors. All amounts billed to a customer related to shipping and handling are classified as sales while all costs incurred by the Company for shipping and handling are classified as selling, general and administrative expenses. The amounts charged to selling, general and administrative expenses were $1,631 thousand, $2,394 thousand, and $3,386 thousand for the years ended December 31, 2016, 2015 and 2014, respectively. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) Derivative Financial Instruments The Company applies the provisions of ASC 815, “Derivatives and Hedging” (“ASC 815”). This Statement requires the recognition of all derivative instruments as either assets or liabilities measured at fair value. Under the provisions of ASC 815, the Company may designate a derivative instrument as hedging the exposure to variability in expected future cash flows that are attributable to a particular risk (a “cash flow hedge”) or hedging the exposure to changes in the fair value of an asset or a liability (a “fair value hedge”). Special accounting for qualifying hedges allows the effective portion of a derivative instrument’s gains and losses to offset related results on the hedged item in the consolidated statements of operations and requires that a company formally document, designate and assess the effectiveness of the transactions that receive hedge accounting treatment. Both at the inception of a hedge and on an ongoing basis, a hedge must be expected to be highly effective in achieving offsetting changes in cash flows or fair value attributable to the underlying risk being hedged. If the Company determines that a derivative instrument is no longer highly effective as a hedge, it discontinues hedge accounting prospectively and future changes in the fair value of the derivative are recognized in current earnings. The Company assesses hedge effectiveness at the end of each quarter. In accordance with ASC 815, changes in the fair value of derivative instruments that are cash flow hedges are recognized in accumulated other comprehensive income (loss) and reclassified into earnings in the period in which the hedged item affects earnings. Ineffective portions of a derivative instrument’s change in fair value are immediately recognized in earnings. Derivative instruments that do not qualify, or cease to qualify, as hedges must be adjusted to fair value and the adjustments are recorded through net income (loss). The cash flows from derivative instruments receiving hedge accounting treatment are classified in the same categories as the hedged items in the consolidated statements of cash flows. Advertising The Company expenses advertising costs as incurred. Advertising expense was approximately $149 thousand, $144 thousand and $155 thousand for the years ended December 31, 2016, 2015 and 2014, respectively. Product Warranties The Company records, in other current liabilities, warranty liabilities for the estimated costs that may be incurred under its basic limited warranty. The standard limited warranty period is one to two years for the majority of products. This warranty covers defective products, and related liabilities are accrued when product revenues are recognized. Factors that affect the Company’s warranty liability include historical and anticipated rates of warranty claims and repair or replacement costs per claim to satisfy the Company’s warranty obligation. As these factors are impacted by actual experience and future expectations, the Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts when necessary. Research and Development Research and development costs are expensed as incurred and include wafers, masks, employee expenses, contractor fees, building costs, utilities and administrative expenses. Licensed Patents and Technologies The Company has entered into a number of royalty agreements to license patents and technology used in the design of its products. The Company carries two types of royalties: lump-sum and running basis. Lump-sum MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) royalties which require initial payments, usually paid in installments, represent a non-refundable commitment, such that the total present value of these payments is recorded as a prepaid expense and a liability upon execution of the agreements and the costs are amortized over the contract period using the straight-line method and charged to research and development expenses in the consolidated statements of operations. Running royalties are paid based on the revenue of related products sold by the Company. Stock-Based Compensation The Company follows the provisions of ASC 718, “Compensation-Stock Compensation” (“ASC 718”). Under ASC 718, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. As permitted under ASC 718, the Company elected to recognize compensation expense for all options with graded vesting based on the graded attribution method. The Company uses the Black-Scholes option-pricing model to measure the grant-date-fair-value of options. The Black-Scholes model requires certain assumptions to determine an option’s fair value, including expected term, risk free interest rate, expected volatility and fair value of underlying common share. The expected term of each option grant was based on employees’ expected exercises and post-vesting employment termination behavior and the risk free interest rate was based on the U.S. Treasury yield curve for the period corresponding with the expected term at the time of grant. The expected volatility was estimated using historical volatility of share prices of similar public entities. No dividends were assumed for this calculation of option value. Earnings per Share In accordance with ASC 260, “Earnings Per Share”, the Company computes basic earnings per share by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the dilution of potential common stock outstanding during the period. In determining the hypothetical shares repurchased, the Company uses the average share price for the period. In the case that earnings are negative, any potential common stock equivalents would have the effect of being anti-dilutive in the computation of net loss per share. Income Taxes The Company accounts for income taxes in accordance with ASC 740, “Income Taxes” (“ASC 740”). ASC 740 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in a company’s financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based upon the difference between the financial statement carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Valuation allowances are established when it is necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities. The Company recognizes and measures uncertain tax positions taken or expected to be taken in a tax return utilizing a two-step process. In the first step, recognition, the Company determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step addresses measurement of a MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) tax position that meets the more-likely-than-not criteria. The tax position is measured at the largest amount of benefit that has a likelihood of greater than 50 percent of being realized upon ultimate settlement. Concentration of Credit Risk The Company performs periodic credit evaluations of its customers’ financial condition and generally does not require collateral for customers on accounts receivable. The Company maintains reserves for potential credit losses, which are periodically reviewed. Recent Accounting Pronouncements In August 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 reduces the existing diversity in practice in financial reporting across all industries by clarifying certain existing principles in ASC 230, Statement of Cash Flows, (“ASC 230”) including providing additional guidance on how and what an entity should consider in determining the classification of certain cash flows. In addition, in November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash (“ASU 2016-18”). ASU 2016-18 clarifies certain existing principles in ASC 230, including providing additional guidance related to transfers between cash and restricted cash and how entities present, in their statement of cash flows, the cash receipts and cash payments that directly affect the restricted cash accounts. These ASUs are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2016-15 to have a material effect on the Company’s consolidated financial statements. The adoption of ASU 2016-18 will modify the Company’s current disclosures by reclassifying certain balances within the consolidated statement of cash flows, but this is not expected to have a material effect on the Company’s consolidated financial statements. In March 2016, the FASB issued Accounting Standards Update No. 2016-09, “Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 can be applied either on a retrospective or prospective basis and is effective for fiscal years beginning after December 15, 2016 and interim periods within those years. The Company will adopt ASU 2016-09 in the first quarter of 2017. The primary impact of adoption will be the recognition of excess tax benefits within income tax provision rather than within shareholders’ equity, which the Company will adopt on a prospective basis. As the Company does not have a significant amount of excess tax benefits from share-based payment transactions, it does not expect the adoption of ASU 2016-09 to have a material effect on its consolidated financial statements. In February 2016, the FASB issued Accounting Standards Update No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”) in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under US GAAP. ASU 2016-02 requires that a lessee should recognize a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term on the balance sheet. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those reporting periods using a modified retrospective approach and early adoption is permitted. The Company is performing a preliminary review of its contracts that are expected to be applied under the new guidance. In November 2015, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update No. 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes” (“ASU 2015- MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) 17”). The amendments in ASU 2015-17 require an entity to classify all deferred tax assets and liabilities as noncurrent. ASU 2015-17 is effective for fiscal years beginning after December 15, 2016 and interim periods within those years. The Company will adopt ASU 2015-17 in the first quarter of 2017. As the Company does not have a significant balance of current deferred tax assets and liabilities, it believes that the implementation of this guidance will have no material impact on its consolidated financial statements. In July 2015, the FASB issued Accounting Standards Update No. 2015-11, “Simplifying the Measurement of Inventory” (“ASU 2015-11”). Under this ASU, inventory will be measured at the lower of cost and net realizable value, and options that currently exist for market value will be eliminated. Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. No other changes were made to the current guidance on inventory measurement. ASU 2015-11 is effective for fiscal years beginning after December 15, 2016 and interim periods within those years. The Company will adopt ASU 2015-11 in the first quarter of 2017 and believes that the implementation of this guidance will have no material impact on its consolidated financial statements. In May 2014, the FASB issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)”, and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016 (the “Original Effective Date”), including interim periods within that reporting period, and can be adopted either retrospectively to each prior period presented or as a cumulative-effect adjustment as of the date of adoption, with early application permitted as of the Original Effective Date. In August 2015, the FASB issued ASU 2015-14 “Deferral of the Effective Date,” which defers the required adoption date of ASU 2014-09 by one year. As a result of the deferred effective date, ASU 2014-09 will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. In March 2016, the FASB issued Accounting Standards Update No. 2016-08, “Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” (“ASU 2016-08”) clarifying the implementation guidance on principal versus agent considerations. Specifically, an entity is required to determine whether the nature of a promise is to provide the specified good or service itself (that is, the entity is a principal) or to arrange for the good or service to be provided to the customer by the other party (that is, the entity is an agent). The determination influences the timing and amount of revenue recognition. In May 2016, the FASB issued Accounting Standards Update No. 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”) clarifying how to assess collectibility, present sales tax, treat noncash consideration, and account for completed and modified contracts at the time of transition. In addition, ASU 2016-12 clarifies that an entity retrospectively applying the guidance in Topic 606 is not required to disclose the effect of the accounting change in the period of adoption. The effective date and transition requirements for ASU 2016-12, ASU 2016-08 and ASU 2014-09 are the same. Finally, ASU 2016-20 makes minor corrections or minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The Company started analyzing the potential impact of applying the new guidance by reviewing its current accounting policies, customer arrangements and practices. The Company has not selected a transition method nor have we determined the effect of the standard to the Company’s consolidated financial statements. Recently Adopted Accounting Pronouncements In April 2015, the FASB issued Accounting Standards Update No. 2015-03, “Interest-Imputation of Interest” (“ASU 2015-03”). ASU 2015-03 requires that debt issuance costs be presented in the balance sheet as a MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) direct deduction from the carrying amount of debt liability, consistent with debt discounts or premiums. The recognition and measurement guidance for debt issuance costs would not be affected. Prior to the issuance of ASU 2015-03, debt issuance costs were required to be presented as an asset in the balance sheet. The Company adopted ASU 2015-03 in the first quarter of fiscal 2016 and recorded $3,203 thousand of debt issuance costs as a reduction of long-term borrowings as of December 31, 2016. Pursuant to ASU 2015-03, the Company reclassified all prior periods presented in its consolidated balance sheets to conform to the current period presentation, resulting in the reclassification of debt issuance costs of $3,781 thousand from other non-current assets to a reduction of long-term borrowings as of December 31, 2015. The adoption of ASU 2015-03 did not impact the Company’s consolidated statements of operations and cash flows. In August 2014, the FASB issued Accounting Standards Update No. 2014-15, “Presentation of Financial Statements - Going Concern” (“ASU 2014-15”), which provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. ASU 2014-15 requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity will be required to provide certain disclosures if conditions of events raise substantial doubt about the entity’s ability to continue as a going concern. ASU 2014-15 was effective for the Company in the fourth quarter of 2016. The adoption of ASU 2014-15 did not impact the Company’s consolidated financial statements. 2. Fair Value Measurements ASC 820 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC 820 requires, among other things, the Company’s valuation techniques used to measure fair value to maximize the use of observable inputs and minimize the use of unobservable inputs. Fair Value of Financial Instruments As of December 31, 2016, the following table represents the Company’s liabilities measured at fair value on a recurring basis and the basis for that measurement (in thousands): MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) As of December 31, 2015, the following table represents the Company’s liabilities measured at fair value on a recurring basis and the basis for that measurement (in thousands): Items not reflected in the table above include cash and cash equivalents, restricted cash, accounts receivable, other receivables, accounts payable, and other accounts payable, fair value of which approximate carrying values due to the short-term nature of these instruments. The fair value of assets and liabilities whose carrying value approximates fair value is determined using Level 2 inputs, with the exception of cash (Level 1). Fair Value of Long-term Borrowings On July 18, 2013, the Company issued 6.625% senior notes due July 15, 2021 (the “2021 Notes”) of $225.0 million, which represents the principal amount, excluding $1.1 million of original issue discount and $5.1 million of debt issuance costs. The Company estimates the fair value of the 2021 Notes using the market approach, which utilizes quoted market prices that fall under Level 2. For further description of the 2021 Notes, see Note 10, “Long-term Borrowings”. Fair Values Measured on a Non-recurring Basis The Company’s non-financial assets, such as property, plant and equipment, and intangible assets are recorded at fair value upon acquisition and are remeasured at fair value only if an impairment charge is recognized. As of December 31, 2016 and 2015, the Company did not have any assets or liabilities measured at fair value on a non-recurring basis. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) 3. Accounts Receivable Accounts receivable as of December 31, 2016 and 2015 consisted of the following (in thousands): Changes in allowance for doubtful accounts for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands): Changes in sales return reserves for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands): Changes in low yield compensation reserve for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands): MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) The Company has entered into an agreement to sell selected trade accounts receivable to a financial institution from time to time since March 2012. After the sale, the Company does not retain any interest in the receivables and the applicable financial institution collects these accounts receivable directly from the customer. The proceeds from the sales of these accounts receivable totaled $25,146 thousand, $57,185 thousand and $22,256 for the years ended December 31, 2016, 2015 and 2014, respectively, and these sales resulted in pre-tax losses of $78 thousand, $114 thousand and $64 thousand for the years ended December 31, 2016, 2015 and 2014, respectively, which are included in selling, general and administrative expenses in the consolidated statements of operations. Net proceeds of the accounts receivable sale program are recognized in the consolidated statements of cash flows as part of operating cash flows. The Company uses receivable discount programs with certain customers. These discount arrangements allow the Company to accelerate collection of customers’ receivables. 4. Inventories Inventories as of December 31, 2016 and 2015 consist of the following (in thousands): Changes in inventory reserve for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands): Inventory reserve represents the Company’s best estimate in value lost due to excessive inventory level, physical deterioration, obsolescence, changes in price levels, or other causes based on individual facts and circumstances. Inventory reserve relates to inventory items including finished goods, semi-finished goods and work-in-process. Write off of this reserve is recognized only when the related inventory has been disposed or scrapped. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) 5. Property, Plant and Equipment Property, plant and equipment as of December 31, 2016 and 2015 are comprised of the following (in thousands): Aggregate depreciation expenses totaled $24,941 thousand and $26,130 thousand for the years ended December 31, 2016 and 2015, respectively. As of December 21, 2016, The Company entered into a purchase and sale agreement to sell a building located in Cheongju, South Korea. The building has historically been used to house the 6-inch fab and became vacant upon the closure of the fabrication facility. As of December 31, 2015, the building was fully impaired. The Company received proceeds of $18,204 thousand, including a $1,655 thousand value-added tax, for the sale of the building on December 26, 2016. The Company is obligated to perform certain removal construction work that is expected to be completed by the end of March 2017. Accordingly, the Company recorded the $18,204 thousand proceeds as restricted cash and $16,549 thousand as deposits received in its consolidated balance sheets as of December 31, 2016. 6. Intangible Assets Intangible assets as of December 31, 2016 and 2015 are comprised of the following (in thousands): MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) Aggregate amortization expense for intangible assets totaled $475 thousand and $360 thousand for the years ended December 31, 2016 and 2015, respectively. The aggregate amortization expense of intangible assets for the next five years are estimated to be $525 thousand, $525 thousand, $524 thousand, $504 thousand and $470 thousand, for the years ended December 31, 2017, 2018, 2019, 2020 and 2021, respectively. 7. Accrued Expenses Accrued expenses as of December 31, 2016 and 2015 are comprised of the following (in thousands): Accrued claim settlement included in the table above relates to the Company’s securities class action complaints. On December 10, 2015, it was determined that the Company was obligated to make an aggregate settlement payment of $23,500 thousand, which includes all attorneys’ fees, costs of administration and plaintiffs’ out-of-pocket expenses, lead plaintiff compensatory awards and disbursements. In connection with the securities class action complaints, the Company also settled with its insurers and obtained proceeds of $29,571 thousand in the first quarter of 2016, and disbursed the $23,500 thousand from the escrow account, recorded as restricted cash, in the third quarter of 2016. For more information on the accrued claim settlement, see “Note 18. Commitments and Contingencies”. Payroll, benefits and related taxes payable as of December 31, 2016 in the table above includes unpaid other termination benefits under the voluntary resignation program of $1,392 thousand, the remaining balance of the $4,241 thousand total aggregate expense for such benefits accrued during the second quarter of 2016 and being paid out in equal monthly installments over the twelve month period which began in May 2016. 8. Derivative Financial Instruments The Company’s Korean subsidiary from time to time has entered into zero cost collar contracts to hedge the risk of changes in the functional-currency-equivalent cash flows attributable to currency rate changes on U.S. dollar denominated revenues. Details of derivative contracts as of December 31, 2016 are as follows (in thousands): MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) Details of derivative contracts as of December 31, 2015 are as follows (in thousands): The zero cost collar contracts qualify as cash flow hedges under ASC 815, “Derivatives and Hedging,” since at both the inception of the contracts and on an ongoing basis, the hedging relationship was and is expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk during the term of the contracts. The Company is utilizing the “hypothetical derivative” method to measure the effectiveness by comparing the changes in value of the actual derivative versus the change in fair value of the “hypothetical derivative.” The fair values of the Company’s outstanding zero cost collar contracts recorded as liabilities as of December 31, 2016 and 2015 are as follows (in thousands): Offsetting of derivative liabilities as of December 31, 2016 is as follows (in thousands): Offsetting of derivative liabilities as of December 31, 2015 is as follows (in thousands): For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (“AOCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative, representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness, are recognized in current earnings. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) The following table summarizes the impact of derivative instruments on the consolidated statement of operations for the years ended December 31, 2016 and 2015 (in thousands): As of December 31, 2016, the amount expected to be reclassified from accumulated other comprehensive income into loss within the next twelve months is $436 thousand. The Company set aside $2,500 thousand and $6,000 thousand of cash deposits to the counterparty, Nomura Financial Investment (Korea) Co., Ltd. (“NFIK”) as required for the zero cost collar contracts outstanding as of December 31, 2016 and 2015, respectively. These cash deposits are recorded as hedge collateral on the consolidated balance sheets. The Company is required to deposit additional cash collateral with NFIK for any exposure in excess of $500 thousand, and $650 thousand was required as of December 31, 2016 and recorded as hedge collateral on the consolidated balance sheets. There was no such cash collateral required as of December 31, 2015. These outstanding zero cost collar contracts are subject to termination if the sum of qualified and unrestricted cash and cash equivalents held by the Company is less than $30,000 thousand on the last day of a fiscal quarter. 9. Product Warranties Changes in accrued warranty liabilities for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands): MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) 10. Long-term Borrowings Long-term borrowings as of December 31, 2016 and 2015 are as follows (in thousands): On July 18, 2013, the Company issued a $225,000,000 aggregate principal amount of the 2021 Notes at a price of 99.5%. Interest on the 2021 Notes accrues at a rate of 6.625% per annum, payable semi-annually on January 15 and July 15 of each year, beginning on January 15, 2014. The Company can optionally redeem all or a part of the 2021 Notes according to the following schedule: (i) at any time prior to July 15, 2017, the Company may on any one or more occasions redeem all or a part of the 2021 Notes issued under that certain Indenture, dated as of July 18, 2013, by and between the Company and Wilmington Trust, National Association, as trustee (the “Trustee”), as supplemented by that certain First Supplemental Indenture, dated as of March 27, 2014 (collectively, the “Indenture”), related to the 2021 Notes at a redemption price equal to 100% of the principal amount of the notes redeemed, plus the applicable premium as of, and accrued and unpaid interest and special interest, if any, to the date of redemption and (ii) on or after July 15, 2017, the Company may on any one or more occasions redeem all or a part of the 2021 Notes, at a redemption price equal to 103.313%, 101.656% and 100% of the principal amount of the notes redeemed on or after July 15, 2017, 2018 and 2019, respectively, plus accrued and unpaid interest and special interest, if any, on the notes redeemed, to the applicable date of redemption. The Indenture relating to the 2021 Notes contains covenants that limit the ability of the Company and its restricted subsidiaries to: (i) declare or pay any dividend or make any payment or distribution on account of or purchase or redeem the Company’s capital stock or equity interests of the restricted subsidiaries; (ii) make any principal payment on, or redeem or repurchase, prior to any scheduled repayment or maturity, any subordinated indebtedness; (iii) make certain investments; (iv) incur additional indebtedness and issue certain types of capital stock; (v) create or incur any lien (except for permitted liens) that secures obligations under any indebtedness; (vi) merge with or into or sell all or substantially all of the Company’s assets to other companies; (vii) enter into certain types of transactions with affiliates; (viii) guarantee the payment of any indebtedness; (ix) enter into sale-leaseback transactions; (x) enter into agreements that would restrict the ability of the restricted subsidiaries to make distributions with respect to their equity to the Company or other restricted subsidiaries, to make loans to the Company or other restricted subsidiaries or to transfer assets to the Company or other restricted subsidiaries; and (xi) designate unrestricted subsidiaries. These covenants are subject to a number of exceptions and qualifications. Certain of these restrictive covenants will terminate if the 2021 Notes are rated investment grade at any time. 11. Accrued Severance Benefits The majority of accrued severance benefits are for employees in the Company’s Korean subsidiary. Pursuant to the Employee Retirement Benefit Security Act of Korea, eligible employees and executive officers MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) with one or more years of service are entitled to severance benefits upon the termination of their employment based on their length of service and rate of pay. As of December 31, 2016, 98% of all employees of the Company were eligible for severance benefits. Changes in accrued severance benefits are as follows (in thousands): The severance benefits funded through the Company’s National Pension Fund and group severance insurance plan will be used exclusively for payment of severance benefits to eligible employees. These amounts have been deducted from the accrued severance benefit balance. The Company is liable to pay the following future benefits to its non-executive employees upon their normal retirement age (in thousands): The above amounts were determined based on the non-executive employees’ current salary rates and the number of service years that will be accumulated upon their retirement dates. These amounts do not include amounts that might be paid to non-executive employees that will cease working with the Company before their normal retirement ages. The above table reflects an effect of a mandatory extension of retirement age in Korea from 57 to 60 under the Employment Promotion for the Aged Act effective from the beginning of 2016. 12. Common Stock Common stock par value $0.01 per share, was authorized in the amount of 150,000 thousand shares, of which 41,627 thousand shares were issued and 35,048 thousand shares were outstanding as of December 31, 2016. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) Changes in common stock for each period are as follows (in thousands): 13. Equity Incentive Plans The Company adopted its 2009 Common Unit Plan, or the 2009 Plan, effective December 8, 2009, which is administered by the Compensation Committee of the Company’s Board of Directors (the “Compensation Committee”). The 2009 Plan terminated in connection with the Company’s initial public offering in March 2011, and no additional options or other equity awards may be granted under the 2009 Plan. However, options granted under the 2009 Plan prior to its termination will remain outstanding until they are either exercised or expire. The Company adopted its 2011 Equity Incentive Plan, or the 2011 Plan, in March 2010. The Company amended and restated the 2011 Plan in February 2011, and the Company’s stockholders approved the amendment in March 2011 to reflect that it became effective in 2011 in connection with the Company’s initial public offering in March 2011. Awards may be granted under the 2011 Plan to the Company’s employees, officers, directors, or consultants or those of any present or future parent or subsidiary corporation or other affiliated entity. While the Company may grant incentive stock options only to employees, the Company may grant nonstatutory stock options, stock appreciation rights, restricted stock purchase rights or bonuses, restricted stock units, performance shares, performance units and cash-based awards or other stock-based awards to any eligible participant, subject to terms and conditions determined by the Compensation Committee. The term of options shall not exceed ten years from the date of grant. Restricted stock purchase rights shall be exercisable within a period established by the Compensation Committee, which shall in no event exceed thirty days from the effective date of the grant. As of December 31, 2016, an aggregate maximum of 7,274 thousand shares were authorized and 557 thousand shares were reserved for all future grants. Stock options and stock appreciation rights must have exercise prices at least equal to the fair market value of the stock at the time of their grant pursuant to the 2011 Plan. The requisite service period, or the period during which a grantee is required to provide service in exchange for option grants, coincides with the vesting period. Stock options typically vest over three years following grant. Restricted stock units granted under the 2011 Plan represent a right to receive shares of the Company’s common stock when the restricted stock unit vests. No monetary payment (other than applicable tax withholding) shall be required as a condition of receiving shares pursuant to a restricted stock unit, the consideration for which shall be services actually rendered to a participating company or for its benefit. Stock issued pursuant to any restricted stock unit may (but need not) be made subject to vesting conditions based upon the satisfaction of such service requirements, conditions, restrictions or performance criteria as shall be established by the Compensation Committee and set forth in the award agreement evidencing such award. Restricted stock units typically vest over three years following grant. The purchase price for shares issuable under each restricted stock purchase right shall be established by the Compensation Committee in its discretion. No monetary payment (other than applicable tax withholding) shall MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) be required as a condition of receiving shares pursuant to a restricted stock bonus, the consideration for which shall be services actually rendered to a participating company or for its benefit. Stock issued pursuant to any restricted stock award may (but need not) be made subject to vesting conditions based upon the satisfaction of such service requirements, conditions, restrictions or performance criteria as shall be established by the Compensation Committee and set forth in the award agreement evidencing such award. During any period in which stock acquired pursuant to a restricted stock award remain subject to vesting conditions, such stock may not be sold, exchanged, transferred, pledged, assigned or otherwise disposed of other than pursuant to an ownership change event or transfer by will or the laws of descent and distribution. The grantee shall have all of the rights of a stockholder of the Company holding stock, including the right to vote such stock and to receive all dividends and other distributions paid with respect to such stock; provided, however, that if so determined by the Compensation Committee and provided by the award agreement, such dividends and distributions shall be subject to the same vesting conditions as the stock subject to the restricted stock award with respect to which such dividends or distributions were paid. If a grantee’s service terminates for any reason, whether voluntary or involuntary (including the grantee’s death or disability), then (a) the Company (or its assignee) has the option to repurchase for the purchase price paid by the grantee any stock acquired by the grantee pursuant to a restricted stock purchase right which remain subject to vesting conditions as of the date of the grantee’s termination of service and (b) the grantee shall forfeit to the Company any stock acquired by the grantee pursuant to a restricted stock bonus which remain subject to vesting conditions as of the date of the grantee’s termination of service. The Company has the right to assign at any time any repurchase right it may have, whether or not such right is then exercisable, to one or more persons as may be selected by the Company. The following summarizes restricted stock unit activities for the year ended December 31, 2016 and 2015. For the year ended December 31, 2014, there were no restricted stock unit activities. Total compensation expenses recorded for the restricted stock units were $2,292 thousand and $1,400 thousand for the years ended December 31, 2016 and 2015, respectively. As of December 31, 2016, there was $1,030 thousand of total unrecognized compensation cost related to unvested restricted stock units, which is expected to be recognized over a weighted average future period of 0.6 of a year. Total fair value of restricted stock units vested were $717 thousand and $993 thousand for the years ended December 31, 2016 and 2015, respectively. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) The following summarizes stock option activities for the years ended December 31, 2016, 2015 and 2014. At the date of grant, all options had an exercise price not less than the fair value of common stock (aggregate intrinsic value in thousands): Total compensation expenses recorded for the stock options were $1,551 thousand, $1,368 thousand and $2,072 thousand for the years ended December 31, 2016, 2015 and 2014, respectively. As of December 31, 2016, there was $697 thousand of total unrecognized compensation cost related to unvested stock options, which is expected to be recognized over a weighted average future period of 1.0 year. Total fair value of options vested was $1,011 thousand, $1,361 thousand and $2,957 thousand for the years ended December 31, 2016, 2015 and 2014, respectively. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) The Company utilizes the Black-Scholes option-pricing model to measure the fair value of each option grant. The following summarizes the grant-date fair value of options granted for the years ended December 31, 2016, 2015 and 2014 and assumptions used in the Black-Scholes option-pricing model on a weighted average basis: The number and weighted average grant-date fair value of the unvested stock options are as follows: 14. Restructuring and Impairment Charges 2016 Restructuring Gain During the first quarter of 2016, the Company completed all procedures necessary to sell all machineries in its closed 6-inch fab and recognized the $7,785 thousand of restructuring gain from the related deposit of $8,165 thousand received as of December 31, 2015, net of certain direct selling costs. 2014 Impairment Charges The Company recognized $10,269 thousand of impairment charges, which were incurred due to the planned closure of its six-inch fabrication facility. The impairment charges primarily resulted from $8,239 thousand of impairment to building, $1,763 thousand of impairment of machinery and equipment and $267 thousand of impairment of other tangible assets. 15. Foreign Currency Gain (Loss), Net Net foreign currency gain or loss includes non-cash translation gain or loss associated with intercompany balances. A substantial portion of the Company’s net foreign currency gain or loss is non-cash translation gain or MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) loss associated with intercompany long-term loans to our Korean subsidiary. The loans are denominated in U.S. dollars and are affected by changes in the exchange rate between the Korean won and the U.S. dollar. As of December 31, 2016, 2015 and 2014, the outstanding intercompany loan balances including accrued interest between the Korean subsidiary and the Dutch subsidiary were $598,212 thousand, $591,388 thousand and $765,265 thousand, respectively. The Korean won to U.S. dollar exchange rates were 1,208.5:1, 1,172.0:1 and 1,099.2:1 using the first base rate as of December 31, 2016, 2015 and 2014, respectively, as quoted by the KEB Hana Bank. 16. Income Taxes The Company’s income tax expenses are composed of domestic and foreign income taxes depending on the relevant tax jurisdictions. Domestic income (loss) before taxes and income tax expenses are generated or incurred in the United States, where the parent company resides. The components of income tax expense are as follows (in thousands): The differences between the annual effective tax rates and the U.S. federal statutory rate of 35.0% primarily result from the non-income based withholding tax attributable to intercompany interest income of the Company’s Dutch subsidiary, application of lower tax rates associated with certain earnings from the Company’s operations outside the U.S., the parent Company’s interest income, which is non-taxable for US tax purposes and the change of deferred tax assets and valuation allowance. The significant increase in income tax expense in 2016 is related to the reversal of withholding tax payable with respect to the waiver of the accrued interest on the loans granted to our Korean subsidiary by our Dutch subsidiary in 2015. Korean and Dutch subsidiaries agreed that our Dutch subsidiary waives and releases a partial amount of unpaid interest of $174 million on its intercompany loans granted to our Korean subsidiary in order to decrease the cumulative losses of our Korean subsidiary to enhance the subsidiary’s credit standing under the local banking rules. This transaction created a taxable income for our Korean subsidiary but did not result in a liability because of the utilization of expired loss carryforwards, which is deductible only against gains from cancellation of debt. The loss was not tax deductible for our Dutch MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) subsidiary. This transaction also resulted in taxable loss for our Luxemburg subsidiary and this tax benefit was offset by an increase in the change in valuation allowance. In connection with the waiver of unpaid interest, the related withholding tax was reversed, resulting in the recognition of income tax benefit of $17.8 million as of December 31, 2015. The statutory income tax rate of the Company’s Korean subsidiary was approximately 24.2% in 2016, 2015 and 2014. The provision for domestic and foreign income taxes incurred is different from the amount calculated by applying the statutory tax rate to the net income before income taxes. The significant items causing this difference are as follows (in thousands): The permanent differences above include non-taxable TPECs and interest income from other financial instruments for US tax purposes and non-deductible interest expense according to the thin capitalization rule for Korean tax purposes. The permanent impairment of $62,334 thousand in 2015 was related to the loss recognized by the Company’s Luxemburg subsidiary in connection with the cancellation of debt as described above, which was not recognized for US tax purposes. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) A summary of the composition of net deferred income tax assets (liabilities) as of December 31, 2016, 2015 and 2014 are as follows (in thousands): The valuation allowances at December 31, 2016, 2015 and 2014 are primarily attributable to deferred tax assets for the uncertainty in taxable income at the Company’s Korean subsidiary. The Company has recorded a full valuation allowance against the deferred tax assets, net of its deferred tax liabilities, and against certain foreign subsidiary’s deferred tax assets pertaining to its related tax loss carry-forwards that are not anticipated to generate a tax benefit. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) Changes in valuation allowance for deferred tax assets for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands): The amount presented as “Charged to expense” primarily relates to the utilization of net operating loss and tax credit carry-forwards, or pre-tax losses for which there is no tax benefit. The evaluation of the recoverability of the deferred tax asset and the need for a valuation allowance requires the Company to weigh all positive and negative evidence to reach a conclusion that it is more likely than not that all or some portion of the deferred tax asset will not be realized. The weight given to the evidence is commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary and the more difficult it is to support a conclusion that a valuation allowance is not needed. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors, including the Company’s ability to generate future taxable income within the period during which the temporary differences reverse, the outlook for the economic environment in which the Company operates and the overall future industry outlook. As of December 31, 2016, 2015 and 2014, the Company had net deferred tax assets of $183 thousand, $171 thousand and $577 thousand, respectively, related to the Company’s Japanese subsidiary. As of December 31, 2016, 2015 and 2014, the Company recorded a valuation allowance of $281,473 thousand, $279,867 thousand and $194,739 thousand on its deferred tax assets related to temporary differences, net operating loss carry-forwards and tax credits of domestic and foreign subsidiaries. The Company recorded these valuation allowances on deferred tax assets based on its assessment that the negative evidence of expected losses in early future years outweighs the positive evidence of historical income. As of December 31, 2016, the Company had approximately $684,851 thousand of net operating loss carry-forwards available to offset future taxable income, of which $280,417 thousand is associated with the Company’s Korean subsidiary, which expires in part at various dates through 2026. The net operating loss of $268,959 thousand associated with the Company’s Luxembourg subsidiary is mainly attributable to certain expenses incurred in connection with its shareholding in the Company’s Dutch subsidiary. Although this net operating loss amount is the carried forward indefinitely, it will be recaptured on future capital gain. The remaining net operating loss mainly relates to the US parent company and its domestic subsidiary, which expires in part at various dates through 2036. The Company utilized net operating loss of $279 thousand, $121 thousand and $1,219 thousand, for the years ended December 31, 2016, 2015 and 2014, respectively. The Company also has Korean, Dutch and U.S. tax credit carry-forwards of approximately $6,738 thousand, $13,121 thousand and $390 thousand, respectively, as of December 31, 2016. The Korean tax credits expire at various dates starting from 2017 to 2021, and the Dutch tax credits are carried forward to be used for an indefinite period of time. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) Uncertainty in Income Taxes The Company and its subsidiaries file income tax returns in Korea, Japan, Taiwan, the U.S. and in various other jurisdictions. The Company is subject to income tax examinations by tax authorities of these jurisdictions for all open tax years. As of December 31, 2016, 2015 and 2014, the Company recorded $2,459 thousand, $2,139 thousand and $3,491 thousand of liabilities for unrecognized tax benefits, respectively. For the years ended December 31, 2016, 2015and 2014, the Company recorded $670 thousand, $1,606 thousand and $110 thousand of income tax benefits, respectively, by reversing liabilities due to the lapse of the applicable statute of limitations and incurred $687 thousand, $351 thousand and $44 thousand of income tax expenses, respectively, for uncertain tax positions mainly resulting from imputed interest related to intercompany balances. For the years ended December 31, 2016, 2015 and 2014, the Company recognized $334 thousand, $45 thousand, $10 thousand of interest and penalties, respectively, related to unrecognized tax benefits as a component of income tax expense. Total interest and penalties accrued as of December 31, 2016, 2015 and 2014 were $691 thousand, $359 thousand and $480 thousand, respectively. The Company is currently unaware of any uncertain tax positions that could result in significant additional payments, accruals, or other material deviation in this estimate over the next 12 months. A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of each period is as follows (in thousands): 17. Geographic and Segment Information The Company had previously reported its results of operations under one operating segment. During the second quarter of 2015, organizational changes were made to (i) realign the Company’s businesses and organizational structure and (ii) streamline and consolidate certain business processes to achieve greater operating efficiencies. In furtherance of these objectives, the Company combined its Display Solutions and Power Solutions business lines into a new segment called Standard Products Group. Beginning in the second quarter of 2015, the Company began reporting its financial results in two operating segments: Semiconductor Manufacturing Services and Standard Products Group. During the third quarter of 2015, the Company changed the name of its Semiconductor Manufacturing Services segment to Foundry Services Group. The Company’s chief operating decision maker is its Chief Executive Officer who allocates resources and assesses performance of the business and other activities based on gross profit. The two newly established operating segments were managed prospectively and all prior period amounts related to the segment change have been retrospectively reclassified to conform to the new presentation. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) The following sets forth information relating to the operating segments (in thousands): The following is a summary of net sales by geographic region, based on the location to which the products are billed (in thousands): Net sales from the Company’s top ten largest customers accounted for 64%, 64% and 61% for the years ended December 31, 2016, 2015 and 2014, respectively. For the year ended December 31, 2016, the Company had two customers that represented 23.5% and 11.4% of its net sales, respectively. For the year ended December 31, 2015, the Company had two customers that represented 15.2% and 11.0% of its net sales, respectively. For the year ended December 31, 2014, the Company had two customers that represented 11.4% and 10.7% of its net sales, respectively. 96% of the Company’s property, plant and equipment are located in Korea as of December 31, 2016. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) 18. Commitments and Contingencies Operating Agreements with SK Hynix In connection with the acquisition of the non-memory semiconductor business from SK Hynix on October 4, 2004 (the “Original Acquisition”), the Company entered into several agreements with SK Hynix, including a non-exclusive cross license that provides the Company with access to certain of SK Hynix’s intellectual property for use in the manufacture and sale of non-memory semiconductor products. The Company also agreed to provide certain utilities and infrastructure support services to SK Hynix. Upon the closing of the Original Acquisition, the Company’s Korean subsidiary and SK Hynix also entered into lease agreements under which the Company’s Korean subsidiary leases space to SK Hynix in several buildings, primarily warehouses and utility facilities, in Cheongju, Korea. These leases are generally for an initial term of 20 years plus an indefinite number of renewal terms of 10 years each. Each of the leases is cancelable upon 90 days’ notice by the lessee. The Company also leases certain land from SK Hynix located in Cheongju, Korea. The term of this lease is indefinite unless otherwise agreed by the parties, and as long as the buildings remain on the lease site and are owned and used by the Company for permitted uses. Operating Leases The Company leases land, office space and equipment under various operating lease agreements with various terms. Rental expenses were approximately $8,898 thousand, $8,194 thousand and $9,421 thousand for the years ended December 31, 2016, 2015 and 2014, respectively. As of December 31, 2016, the minimum aggregate rental payments due under non-cancelable lease contracts are as follows (in thousands): Securities Class Action Complaints The Company recorded the $23,500 thousand of the settlement obligation for the Class Action Litigation as accrued expenses in the consolidated balance sheets as of December 31, 2015 and as selling, general and administrative expenses in the consolidated statements of operations for the year ended December 31, 2015. For further information regarding the Class Action Litigation, see “Legal Proceedings” included elsewhere in this Report. The Company recorded $29,571 thousand of the proceeds from the insurers as other receivables in the consolidated balance sheets as of December 31, 2015 and as a deduction of the selling, general and administrative expenses in the consolidated statements of operations for the year ended December 31, 2015. The proceeds from the insurers of $29,571 thousand were deposited into the Company’s escrow account during the first quarter of 2016 and the Company reclassified the $29,571 thousand deposits recorded in other receivables into restricted cash. During the third quarter of 2016, the Company disbursed the aggregate settlement payment MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) of $23,500 thousand after the court granted plaintiffs’ renewed motion for preliminary approval of the settlement in July 2016. Upon the settlement payment, $6,114 thousand of the insurance proceeds remained in the Company’s escrow account. For subsequent treatment of the escrow amount, see “Shareholder Derivative Complaints” below. SEC Enforcement Staff Review In March 2014, the Company voluntarily reported to the SEC that the Company’s Audit Committee (the “Audit Committee”) had determined that the Company incorrectly recognized revenue on certain transactions and as a result would restate its financial statements, and that the Audit Committee had commenced an independent investigation. Over the course of 2014 and the first two quarters of 2015, the Company voluntarily produced documents to the SEC regarding the various accounting issues identified during the independent investigation, and whether the Company’s hiring of an accountant from the Company’s independent registered public accounting firm impacted that accounting firm’s independence. On July 22, 2014, the Staff of the SEC’s Division of Enforcement obtained a Formal Order of Investigation. On March 12, 2015, the SEC issued a subpoena for documents to the Company in connection with its investigation. The Company will continue to cooperate with the SEC in this investigation, and has produced documents in response to the subpoena. At this time, the Company is unable to estimate any reasonably possible loss, or range of reasonably possible losses, with respect to the matters described above. Shareholder Derivative Complaints The settlement for the shareholder derivative actions described in “Legal Proceedings” provided for an aggregate payment from the Company defendants’ directors and officers insurance policies of $3,000 thousand to be made to an escrow account, which will be payable to the Company (less certain deductions and applicable interest) once the settlement becomes effective. For further information regarding the shareholder derivative actions, see “Legal Proceedings” included elsewhere in this Report. The $3,000 thousand settlement payment was included in the insurance proceeds of $29,571 thousand as discussed in “Securities Class Action Complaints” above. On June 10, 2016, the court granted plaintiffs’ motion for preliminary approval of the proposed settlement. On October 18, 2016, after a hearing held on October 14, 2016, the court entered its order and final judgment (the “Judgment”) granting final approval of the proposed settlement and awarding plaintiffs’ counsel $750 thousand for attorneys’ fees and litigation expenses. As a result, $750 thousand was paid out of the Company’s escrow account. The Judgment was not appealed within the applicable appeals period (on or before December 19, 2016). The settlement therefore became effective after the expiration of the appeals period and $2,258 thousand was paid to the Company from the escrow account, previously recorded as restricted cash, in December 2016. The remaining restricted cash related to insurance proceeds of $3,078 thousand was also released in December 2016. 19. Related Party Transactions Stockholders Funds affiliated with Avenue Capital Management II, L.P. (“Avenue”) owned 11.7% of the Company’s common stock issued and outstanding at December 31, 2016. Funds affiliated with Engaged Capital, LLC. owned 11.0% of the Company’s common stock issued and outstanding at December 31, 2016. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) 20. Accumulated Other Comprehensive Income (Loss) Accumulated other comprehensive income (loss) consists of the following at December 31, 2016 and 2015, respectively (in thousands): Changes in accumulated other comprehensive income (loss) for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands): MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) 21. Loss per Share The following table illustrates the computation of basic and diluted loss per common share: The following outstanding instruments were excluded from the computation of diluted loss per share, as they would have an anti-dilutive effect on the calculation: Rights Plan On March 5, 2015, the Company entered into a Rights Agreement, dated as of March 5, 2015 between the Company and American Stock Transfer & Trust Company, LLC, as rights agent (as amended, the “Rights Agreement”), and the Board of Directors of the Company authorized and declared a dividend of one preferred stock purchase right (a “Right” and collectively, the “Rights”) for each share of the Company’s common stock, par value $0.01 per share, outstanding at the close of business on March 16, 2015. The Company amended the Rights Agreement on March 2, 2016 and September 2, 2016. As amended, each Right, once exercisable, will entitle the registered holder to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock, par value $0.01 per share, at a purchase price of $12, subject to adjustment (the “Purchase Price”). The Rights are not presently exercisable and remain attached to the shares of common stock unless and until the occurrence of the earlier of the following (the “Distribution Date”): (i) the tenth day after the public announcement or disclosure by the Company or any person or group of affiliated or associated persons that any person or group of affiliated or associated persons has become an “Acquiring Person” by obtaining beneficial ownership of 12.5% (or 20% in the case of a “passive institutional investor,” which is defined generally as any person who has reported beneficial ownership of shares of common stock on Schedule 13G under the Securities Exchange Act of 1934) or more of the Company’s outstanding common stock, subject to certain exceptions; or (ii) the tenth business day (or such later date as the Company’s Board of Directors may designate before a person or group of affiliated or associated persons becomes an Acquiring Person) after the commencement of, or first public announcement of the intent of any person to commence, a tender or exchange offer by any person or group of affiliated or associated persons, which would, if consummated, result in such person or group becoming an Acquiring Person. The Board of Directors may redeem all of the Rights for $0.001 per Right at any time before any person or group of affiliated or associated persons becomes an Acquiring Person. In addition, at any time on or after any person or group of affiliated or associated persons becomes an Acquiring Person (but before any person or group of affiliated or associated persons becomes the owner of 50% or more of the Company’s outstanding common stock), the Board of Directors may exchange all or part of the MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) Rights (other than the Rights beneficially owned by the Acquiring Person and certain affiliated persons) for shares of common stock at an exchange ratio of one share of common stock per Right. The Rights will expire at the close of business on March 5, 2017, unless redeemed or exchanged prior to that time. If any person or group of affiliated or associated persons becomes an Acquiring Person, then, after the Distribution Date, each Right (other than Rights beneficially owned by the Acquiring Person and certain affiliated persons or transferees thereof) will entitle the holder to purchase, for the Purchase Price, a number of shares of common stock having a market value of twice the Purchase Price. Alternatively, if, after any person or group of affiliated or associated persons becomes an Acquiring Person, (1) the Company is involved in a merger or other business combination in which the Company is not the surviving corporation or its common stock is changed into or exchanged for other securities or assets; or (2) the Company or one or more of its subsidiaries sell or otherwise transfer assets or earning power aggregating more than 50% of the assets or earning power of the Company and its subsidiaries, taken as a whole, then each Right will entitle the holder to purchase, for the Purchase Price, a number of shares of common stock of the other party to such business combination or sale (or in certain circumstances, an affiliate) having a market value of twice the Purchase Price. 22. Unaudited Quarterly Financial Results The following tables present selected unaudited Consolidated Statements of Operations for each quarter of the years ended December 31, 2016 and 2015. MAGNACHIP SEMICONDUCTOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED) (TABULAR DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) 23. Subsequent Events Derivative Contracts On January 4, 2017, the Company and the counterparty, the Nomura Financial Investment (Korea) Co., Ltd., entered into derivative contracts of zero cost collars for the period from March 2017 to June 2017. The total notional amounts are $82,000 thousand. In connection with the contracts, the Company paid $3,800 thousand of cash deposits to the counterparty in January 2017. Stock Repurchase On January 11, 2017, the Company repurchased 1,795,444 shares of its common stock in the open market under the Company’s stock repurchase programs, which was authorized by its board of directors on January 10, 2017, at an aggregate cost of $11,401 thousand. Issuance of Exchangeable Senior Notes As disclosed in the Company’s Form 8-K filed on January 17, 2017, MagnaChip Semiconductor S.A., the Company’s Luxembourg subsidiary, closed an offering of 5.00% Exchangeable Senior Notes due 2021 with an $86,250 thousand aggregate principal amount. | Based on the provided text, which appears to be a partial financial statement with notes, here's a summary of the key points:
Financial Statement Summary:
1. Accounting Estimates and Assumptions:
- Management makes estimates for various financial aspects, including:
- Accounts receivable valuation
- Inventory valuation
- Stock-based compensation
- Asset valuations
- Long-term employee benefits
- Income tax calculations
2. Warranty Liabilities:
- Standard warranty period is 1-2 years for most products
- Warranty covers defective products
- Liabilities are accrued when product revenues are recognized
- Company periodically reassesses warranty liability adequacy
3. Research and Development:
- Costs are expensed as incurred
- Includes expenses for:
- Wafers
- Masks
- Employee expenses
- Contractor | Claude |
The following financial statements are filed as part of this Report (see pages 31-50) Report of Independent Registered Public Accounting Firm Audited Consolidated Financial Statements Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Shareholders’ Equity Consolidated Statements of Cash Flows ACCOUNTING FIRM To the Board of Directors and Stockholders Nicholas Financial, Inc. We have audited the accompanying consolidated balance sheets of Nicholas Financial, Inc. and Subsidiaries (the “Company”) as of March 31, 2016 and 2015 and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the years in the three-year period ended March 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of March 31, 2016 and 2015 and the results of its operations and its cash flows for each of the years in the three-year period ended March 31, 2016, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of March 31, 2016, based on criteria established in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated June 14, 2016 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ Dixon Hughes Goodman LLP Atlanta, Georgia June 14, 2016 Nicholas Financial, Inc. and Subsidiaries Consolidated Balance Sheets (In thousands) See accompanying notes. Nicholas Financial, Inc. and Subsidiaries Consolidated Statements of Income (In thousands, except per share amounts) See accompanying notes. Nicholas Financial, Inc. and Subsidiaries Consolidated Statements of Shareholders’ Equity (In thousands) See accompanying notes. Nicholas Financial, Inc. and Subsidiaries Consolidated Statements of Cash Flows (In thousands) See accompanying notes. Nicholas Financial, Inc. and Subsidiaries 1. Organization and Basis of Presentation Nicholas Financial, Inc. (“Nicholas Financial - Canada”) is a Canadian holding company incorporated under the laws of British Columbia with two wholly owned United States subsidiaries, Nicholas Data Services, Inc. (“NDS”) and Nicholas Financial, Inc. (“NFI”). NDS historically was engaged in supporting and updating industry-specific computer application software for small businesses located primarily in the Southeastern United States. NDS has ceased its operations; however it continues as the interim holding company for Nicholas Financial. NDS’s activities accounted for less than 1% of the Company’s consolidated revenues for each of the fiscal years ended March 31, 2015 and 2014. NFI is a specialized consumer finance company engaged primarily in acquiring and servicing automobile finance installment contracts (“Contracts”) for purchases of new and used automobiles and light trucks. To a lesser extent, NFI also offers direct consumer loans (“Direct Loans”) and sells consumer-finance related products. Both NDS and NFI are based in Florida, U.S.A. The accompanying consolidated financial statements are stated in U.S. dollars and are presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The Company has one reportable segment, which is the consumer finance company. 2. Summary of Significant Accounting Policies Consolidation The consolidated financial statements include the accounts of Nicholas Financial - Canada and its wholly owned subsidiaries, NDS and NFI, collectively referred to as (the “Company”). All intercompany transactions and balances have been eliminated. Dividends The following cash dividends were declared during fiscal year ended March 31, 2014. No dividends were declared during the fiscal years ended March 31, 2015 and 2016. Payment of cash dividends results in a 5% withholding tax payable by the Company under the Canada-United States Income Tax Convention which is included in earnings under the caption of administrative expenses. Tender Offer On March 19, 2015, the Company announced the final results of the modified “Dutch auction” tender offer for the purchase of approximately 4.7 million shares of the Company’s common shares by its principal operating subsidiary. The tender offer expired on March 13, 2015. Total payments for common shares, including costs were approximately $70.5 million. Such costs were recorded as an increase to treasury stock, reducing shareholders’ equity. The aggregate number of common shares purchased in the tender offer by Nicholas represented approximately 38.0% of the Company’s outstanding common shares as of March 17, 2015. Following settlement of the tender offer, the Company had approximately 7.7 million common shares outstanding. Use of Estimates The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses on finance receivables and the fair value of interest rate swap agreements. 2. Summary of Significant Accounting Policies (continued) Finance Receivables Finance receivables are recorded at cost, net of unearned interest, unearned dealer discounts and the allowance for credit losses. The amount of unearned interest, dealer discounts and allowance for credit losses as of March 31, 2016 and March 31, 2015 are approximately $186.3 and 169.1 million respectively (See Note 3). Allowance for Credit Losses The allowance for credit losses is increased by charges against earnings and decreased by charge-offs (net of recoveries). The Company aggregates Contracts into static pools consisting of Contracts purchased during a three-month period for each branch location as management considers these pools to have similar risk characteristics. Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay, the estimated value of any underlying collateral, and current economic conditions. As conditions change, the Company’s level of provisioning and allowance may change as well. Assets Held for Resale Assets held for resale are stated at net realizable value and consist primarily of automobiles that have been repossessed by the Company and are awaiting final disposition. Most costs associated with repossession, transport and auction preparation expenses are reported under operating expenses in the period in which they are incurred. Property and Equipment Property and equipment are recorded at cost, net of accumulated depreciation. Expenditures for repairs and maintenance are charged to expense as incurred. Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the assets as follows: Automobiles 3 years Equipment 5 years Furniture and fixtures 7 years Leasehold improvements Lesser of lease term or useful life (generally 6 - 7 years) Drafts Payable Drafts payable represent checks disbursed for loan purchases which have not yet been funded. Amounts generally clear within two business days of period end and then increase the line of credit or reduce cash. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases along with operating loss and tax credit carryforwards, if any. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date. 2. Summary of Significant Accounting Policies (continued) The Company recognizes tax benefits from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from any such position would be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. It is the Company’s policy to recognize interest and penalties accrued on any uncertain tax benefits as a component of income tax expense. The Company does not have any accrued interest or penalties associated with any unrecognized tax benefits, nor has the Company recognized any related interest or penalties during the three years ended March 31, 2016. The Company files income tax returns in the U.S. Federal jurisdiction and various State jurisdictions. The Company is no longer subject to U.S. Federal and State tax examinations for years before 2013. The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months. Revenue Recognition Interest income on finance receivables is recognized using the interest method. Accrual of interest income on finance receivables is suspended when a loan is contractually delinquent for 60 days or more or the collateral is repossessed, whichever is earlier, or when the account is in Chapter 13 bankruptcy. Chapter 13 bankruptcy accounts are accounted for under the cost-recovery method. Interest income on Chapter 13 bankruptcy accounts does not resume until all principal amounts are recovered (see Note 3). A dealer discount represents the difference between the finance receivable, net of unearned interest, of a Contract, and the amount of money the Company actually pays for the Contract. The discount negotiated by the Company is a function of the lender, the wholesale value of the vehicle, and competition in any given market. In making decisions regarding the purchase of a particular Contract the Company considers the following factors related to the borrower: place and length of residence; current and prior job status; history in making installment payments for automobiles; current income; and credit history. In addition, the Company examines its prior experience with Contracts purchased from the dealer from which the Company is purchasing the Contract, and the value of the automobile in relation to the purchase price and the term of the Contract. The dealer discount is amortized as an adjustment to yield using the interest method over the life of the loan. The average dealer discount, as a percent of the amount financed, associated with new volume for the fiscal years ended March 31, 2016, 2015, and 2014 was 7.51%, 8.08% and 8.44%, respectively. The amount of future unearned income is computed as the product of the Contract rate, the Contract term and the Contract amount. Deferred revenues consist primarily of commissions received from the sale of ancillary products. These products include automobile warranties, roadside assistance programs, accident and health insurance, credit life insurance and forced placed automobile insurance. These commissions are amortized over the life of the contract using the interest method. The Company’s net costs for originating Direct Loans are deferred and recognized as an adjustment to the yield and are amortized over the life of the loan using the interest method. 2. Summary of Significant Accounting Policies (continued) Earnings Per Share The Company has granted stock compensation awards with nonforfeitable dividend rights which are considered participating securities. As such, earnings per share is calculated using the two-class method. Basic earnings per share is calculated by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding during the period, which excludes the participating securities. Diluted earnings per share includes the dilutive effect of additional potential common shares from stock compensation awards. Earnings per share have been computed based on the following weighted average number of common shares outstanding: Diluted earnings per share do not include the effect of certain stock options as their impact would be anti-dilutive. Approximately 161,000, 155,000, and 10,000 stock options were not included in the computation of diluted earnings per share for the years ended March 31, 2016, 2015 and 2014 respectively, because their effect would have been anti-dilutive. Share-Based Payments The grant date fair value of share awards is recognized in earnings over the requisite service period (presumptively the vesting period). The Company estimates the fair value of option awards using the Black-Scholes option pricing model. The risk-free interest rate is based upon a U.S. Treasury instrument with a life that is similar to the expected term of the options. Expected volatility is based upon the historical volatility for the previous period equal to the expected term of the options. The expected term is based upon the average life of previously issued options. The expected dividend yield is based upon the yield expected on date of grant to occur over the term of the option. The fair value of non-vested restricted and performance shares are measured at the market price of a share on a grant date. 2. Summary of Significant Accounting Policies (continued) The pool of excess tax benefits available to absorb future tax deficiencies is based on increases to shareholders’ equity related to tax benefits from share-based compensation, combined with the tax on the cumulative incremental compensation costs previously included in pro forma net income disclosures as if the Company had applied the fair-value method to all awards. Fair Value Measurements The Company measures specific assets and liabilities at fair value, which is an exit price, representing the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When applicable, the Company utilizes market data or assumptions that market participants would use in pricing the asset or liability under a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs about which little or no market data exists, therefore requiring an entity to develop its own assumptions (see Note 7). Financial Instruments and Concentrations The Company’s financial instruments consist of cash, finance receivables (accrued interest is a part of finance receivables), the line of credit, and interest rate swap agreements. Financial instruments that are exposed to concentrations of credit risk are primarily finance receivables and cash. As of March 31, 2016, the Company operated in eighteen states through sixty-seven branch locations. Florida represented 29% of the finance receivables total as of March 31, 2016. Ohio represented 14%, Georgia represented 10% and North Carolina represented 8% of the finance receivables total as of March 31, 2016. Of the remaining fourteen states, no one state represented more than 5% of the total finance receivables. The Company provides credit during the normal course of business and performs ongoing credit evaluations of its customers. The Company maintains reserves for potential credit losses which, when realized, have been within the range of management’s expectations. The Company perfects a primary security interest in all vehicles financed as a form of collateral. The combined account balances the Company maintains at financial institutions typically exceed federally insured limits, and there is a concentration of credit risk related to accounts on deposit in excess of federally insured limits. The Company has not experienced any losses in such accounts and believes this risk of loss is not significant. Interest Rate Swap Agreements Interest rate swap agreements are reported as either assets or liabilities in the consolidated balance sheet at fair value. Interest rate swap agreements are not designated as cash-flow hedges, and accordingly, the changes in the fair value are recorded in earnings. The Company does not use interest rate swap agreements for speculative purposes (see Note 6). Statements of Cash Flows Cash paid for income taxes for the years ended March 31, 2016, 2015 and 2014 was approximately $8.5 million, $7.3 million and $10.8 million respectively. Cash paid for interest, including debt origination costs for the years ended March 31, 2016, 2015 and 2014 was approximately $8.8 million, $6.1 million and $5.7 million respectively. Recent Accounting Pronouncements In March 2016, the Financial Accounting Standards Board (“FASB”) issued the Accounting Standards Update (“ASU”) 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” which is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For public entities, ASU 2016-09 is effective for annual periods beginning after December 15, 2016, including interim periods within those fiscal years. Early application is permitted. The Company is currently evaluating the impact of the adoption of this ASU on the consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02, “Leases”, intended to improve financial reporting about leasing transactions. The ASU affects all companies and other organizations that lease assets such as real estate, airplanes, and manufacturing equipment. 2. Summary of Significant Accounting Policies (continued) “The ASU will require organizations that lease assets-referred to as “lessees”-to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. The accounting by organizations that own the assets leased by the lessee-also known as lessor accounting- will remain largely unchanged from current U.S. GAAP. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. The Company is currently evaluating the impact of the pending adoption of this ASU on the Company’s consolidated financial statements. In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments-Recognition and Measurement of Financial Assets and Liabilities,” which is intended to improve the recognition and measurement of financial instruments by requiring: equity investments (other than equity method or consolidation) to be measured at fair value with changes in fair value recognized in net income; public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; and requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. This ASU is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. This ASU permits early adoption of the instrument-specific credit risk provision. The Company is currently evaluating the impact of the pending adoption of this ASU on the Company’s consolidated financial statements. In April 2015, the FASB issued ASU No. 2015-03, “Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU No. 2015-15, since 2015-03 did not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. The SEC staff indicated they would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The amendments are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption of the amendments is permitted. The Company does not believe the adoption of this ASU will have a significant impact on the consolidated financial statements. In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. The ASU requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU, and all subsequently issued clarifying ASUs, will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method. On July 9, 2015, the FASB approved the deferral of the effective date of ASU 2014-09 by one year. As a result, ASU 2014-09 will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The ASU would permit public entities to adopt the ASU early, but not before the original effective date (i.e., annual periods beginning after December 15, 2016). The Company has not yet selected a transition method and is currently evaluating the impact of the pending adoption of this ASU on the Company’s consolidated financial statements. The Company does not believe there are any other recently issued accounting standards that have not yet been adopted that will have a material impact on the Company’s consolidated financial statements. 3. Finance Receivables Finance receivables consist of Contracts and Direct Loans, each of which comprise a portfolio segment. Each portfolio segment consists of smaller balance homogeneous loans which are collectively evaluated for impairment. The Company purchases individual Contracts from new and used automobile dealers in its markets. There is no relationship between the Company and the dealer with respect to a given Contract once the assignment of that Contract is complete. The dealer has no vested interest in the performance of any Contract the Company purchases. The Company charges-off receivables when an individual account has become more than 120 days contractually delinquent. In the event of repossession, the charge-off will occur in the month in which the vehicle was repossessed. 3. Finance Receivables (continued) Contracts included in finance receivables are detailed as follows as of fiscal years ended March 31: The terms of the Contracts range from 12 to 72 months and bear a weighted average contractual interest rate of 22.67% and 22.86% as of March 31, 2016 and 2015, respectively. The following table sets forth a reconciliation of the changes in the allowance for credit losses on Contracts for the fiscal years ended March 31: The Company purchases Contracts from automobile dealers at a negotiated price that is less than the original principal amount being financed by the purchaser of the automobile. The Contracts are predominately for used vehicles. As of March 31, 2016, the average model year of vehicles collateralizing the portfolio was a 2007 vehicle. The Company utilizes a static pool approach to track portfolio performance. If the allowance for credit losses is determined to be inadequate for a static pool, then an additional charge to income through the provision is used to maintain adequate reserves based on management’s evaluation of the risk inherent in the loan portfolio, the composition of the portfolio, and current economic conditions. Such evaluation, considers among other matters, the estimated net realizable value of the underlying collateral, economic conditions, historical loan loss experience, management’s estimate of probable credit losses and other factors that warrant recognition in providing for an adequate allowance for credit losses. Direct Loans are also included in finance receivables and are detailed as follows as of fiscal years ended March 31: The terms of the Direct Loans range from 12 to 60 months and bear a weighted average contractual interest rate of 25.72% and 26.14% as of March 31, 2016 and 2015, respectively. 3. Finance Receivables (continued) The following table sets forth a reconciliation of the changes in the allowance for credit losses on Direct Loans for the fiscal years ended March 31: Direct Loans are loans originated directly between the Company and the consumer. These loans are typically for amounts ranging from $1,000 to $9,000 and are generally secured by a lien on an automobile, watercraft or other permissible tangible personal property. The majority of Direct Loans are originated with current or former customers under the Company’s automobile financing program. The typical Direct Loan represents a significantly better credit risk than Contracts due to the customer’s historical payment history with the Company; however, the underlying collateral is less valuable. In deciding whether or not to make a loan, the Company considers the individual’s credit history, job stability, income and impressions created during a personal interview with a Company loan officer. Additionally, because most of the Direct Loans made by the Company to date have been made to borrowers under Contracts previously purchased by the Company, the payment history of the borrower under the Contract is a significant factor in making the loan decision. As of March 31, 2016, loans made by the Company pursuant to its Direct Loan program constituted approximately 2% of the aggregate principal amount of the Company’s loan portfolio. Changes in the allowance for credit losses for both Contracts and Direct Loans were driven by current economic conditions and credit loss trends over several reporting periods which are utilized in estimating future losses and overall portfolio performance. A performing account is defined as an account that is less than 61 days past due. A non-performing account is defined as an account that is contractually delinquent for 61 days or more or is a Chapter 13 bankruptcy account, and the accrual of interest income is suspended. When an account is 120 days contractually delinquent, the account is written off. Upon notification of a bankruptcy, an account is monitored for collection with other Chapter 13 bankruptcy accounts. In the event the debtors balance has been reduced by the bankruptcy court, the Company will record a loss equal to the amount of principal balance reduction. The remaining balance will be reduced as payments are received by the bankruptcy court. In the event an account is dismissed from bankruptcy, the Company will decide, based on several factors, to begin repossession proceedings or to allow the customer to begin making regularly scheduled payments. The following table is an assessment of the credit quality by creditworthiness as of March 31: 3. Finance Receivables (continued) The following tables present certain information regarding the delinquency rates experienced by the Company with respect to Contracts and Direct Loans, excluding any Chapter 13 bankruptcy accounts: 4. Property and Equipment Property and equipment as of March 31, 2016 and 2015 is summarized as follows: 5. Line of Credit On January 31, 2015 the Company executed an amendment with its consortium of lenders. Included in the amendment was an increase in the size of the credit facility (the “Line”) from $150.0 million to $225.0 million once the tender offer (see Note 1) became effective which was executed on March 13, 2015. The pricing of the Line, which did not change, expires on January 30, 2018, is 300 basis points above 1-month LIBOR with a 1% floor on LIBOR (4.00% at March 31, 2016 and March 31, 2015) plus an unused line fee of 0.50%. Pledged as collateral for the Line are all of the assets of the Company. The outstanding amount of the Line was $211.0 million and $199.0 million as of March 31, 2016 and March 31, 2015, respectively. The amount available under the Line was $14.0 million and $26.0 million as of March 31, 2016 and March 31, 2015, respectively. 5. Line of Credit (continued) The Line requires compliance with certain financial ratios and covenants and satisfaction of specified financial tests, including maintenance of asset quality and performance tests. Dividends do not require consent in writing by the agent and majority lenders under the new Line as long as the Company is in compliance with a net income covenant. As of March 31, 2016, the Company was in compliance with all debt covenants. 6. Interest Rate Swap Agreements The Company utilizes interest rate swap agreements to manage exposure to variability in expected cash flows attributable to interest rate risk. The interest rate swap agreements convert a portion of the Company’s floating rate debt to a fixed rate, more closely matching the interest rate characteristics of the Company’s finance receivables. As of the twelve months ended March 31, 2016 and 2015, no new contracts were initiated and no contracts matured. The Company currently has two interest rate swap agreements. A June 4, 2012 interest rate swap agreement provides for a five-year term in which the Company pays a fixed rate of 1% and receives payments from the counterparty on the 1-month LIBOR rate. This interest rate swap agreement has an effective date of June 13, 2012 and a notional amount of $25.0 million. A July 30, 2012 agreement provides for a five-year term in which the Company pays a fixed rate of 0.87% and receives payments from the counterparty on the 1-month LIBOR rate. This interest rate swap agreement has an effective date of August 13, 2012 and a notional amount of $25.0 million. The locations and amounts of losses recognized in income are detailed as follows for the fiscal years ended March 31: Net realized losses from the interest rate swap agreements were recorded in the interest expense line item of the consolidated statements of income. The following table summarizes the average variable rates received and average fixed rates paid under the interest rate swap agreements as of March 31: 7. Fair Value Disclosures Assets and Liabilities Recorded at Fair Value on a Recurring Basis The Company estimates the fair value of interest rate swap agreements based on the estimated net present value of the future cash flows using a forward interest rate yield curve in effect as of the measurement period, adjusted for nonperformance risk, if any, including a quantitative and qualitative evaluation of both the Company’s credit risk and the counterparty’s credit risk. Accordingly, the Company classifies interest rate swap agreements as Level 2. 7. Fair Value Disclosures (continued) Financial Instruments Not Measured at Fair Value The Company’s financial instruments consist of cash, finance receivables and the Line. For each of these financial instruments the carrying value approximates fair value. Finance receivables, net approximates fair value based on the price paid to acquire Contracts. The price paid reflects competitive market interest rates and purchase discounts for the Company’s chosen credit grade in the economic environment. This market is highly liquid as the Company acquires individual loans on a daily basis from dealers. The initial terms of the Contracts range from 12 to 72 months. The initial terms of the Direct Loans range from 12 to 60 months. In addition, there have been minimal decreases in interest rates and purchase discounts related to these types of loans due to the competitive nature of the current market. If liquidated outside of the normal course of business, the amount received may not be the carrying value. Based on current market conditions, any new or renewed credit facility would contain pricing that approximates the Company’s current Line. Based on these market conditions, the fair value of the Line as of March 31, 2016 was estimated to be equal to the book value. The interest rate for the Line is a variable rate based on LIBOR pricing options. Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a nonrecurring basis. The Company did not have any assets or liabilities measured at fair value on a nonrecurring basis as of March 31, 2016 and 2015. 8. Income Taxes The provision for income taxes consists of the following for the years ended March 31: 8. Income Taxes (continued) The net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes are reflected in deferred income taxes. Significant components of the Company’s deferred tax assets consist of the following as of March 31: The provision for income taxes reflects an effective U.S tax rate, which differs from the corporate tax rate for the following reasons: The Company’s effective tax rate increased to 38.43% in fiscal 2016 from 35.41% in fiscal 2015 and 41.73% in fiscal 2014. The Company had approximately $2.1 million of previously non-deductible expenses associated with the potential sale of the Company in 2014. Since the sale of the Company was not consummated, the $2.1 million became deductible in 2015 creating a favorable effective tax rate. 9. Share-Based Payments The Company has share awards outstanding under two share-based compensation plans (the “Equity Plans”). The Company believes that such awards better align the interests of its employees with those of its shareholders. Under the shareholder-approved 2006 Equity Incentive Plan (the “2006 Plan”) the Board of Directors was authorized to grant option awards for up to approximately 1.1 million common shares. On August 13, 2015, the Company’s shareholders approved the Nicholas Financial, Inc. Omnibus Incentive Plan (the “2015 Plan”) for employees and non-employee directors. Under the 2015 Plan, the Board of Directors is authorized to grant total share awards for up to 750,000 common shares. Awards under the 2006 Plan will continue to be governed by the terms of that plan. The 2015 Plan replaced the 2006 Plan; accordingly no additional option awards may be granted under the 2006 Plan. In addition to option awards, the 2015 Plan provides for restricted stock, performance share awards, and other equity based compensation. Option awards previously granted to employees and directors under the 2006 Plan generally vest ratably based on service over a five- and three-year period, respectively, and generally have a contractual term of ten years. Vesting and contractual terms for option awards under the 2015 Plan are essentially the same as those of the 2006 Plan. Restricted stock awards generally cliff vest over a three-year period based on service conditions. The annual vesting of performance share awards is contingent upon the attainment of company-wide performance goals including annual revenue growth and operating income targets. There are no post-vesting restrictions for share awards. The Company funds share awards from authorized but unissued shares and does not purchase shares to fulfill the obligations of the plans. Cash dividends, if any, are not paid on unvested performance shares or unexercised options, but are paid on unvested restricted stock awards. 9. Share-Based Payments (continued) The fair value of each option granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: The Company did not grant any options during the year ended March 31, 2014. A summary of option activity under the Equity Plans as of March 31, 2016, and changes during the year are presented below. The Company granted approximately 10,000 options with a weighted average fair value of $3.01 during the year ended March 31, 2016. The total intrinsic value of options exercised during the years ended March 31, 2016, 2015 and 2014 was approximately $82,000, $1,829,000, and $699,000 respectively. During the fiscal year ended March 31, 2016, approximately 13,000 options were exercised at exercise prices ranging from $1.20 to $10.96 per share. During the same period approximately 3,000 options were forfeited at exercise prices ranging from $3.60 to $10.96 per share. Cash received from options exercised during the fiscal years ended March 31, 2016, 2015 and 2014 totaled approximately $85,000, $389,000, and $329,000, respectively. Related income tax benefits during the same periods totaled approximately $31,000, $700,000, and $267,000, respectively. Such amounts are included in proceeds from exercise of stock options and excess tax benefit on share awards under cash flows from financing activities in the consolidated statements of cash flows. As of March 31, 2016, there was approximately $246,000 of total unrecognized compensation cost related to options granted. That cost is expected to be recognized over a weighted-average period of approximately 2.6 years. A summary of the status of the Company’s non-vested restricted shares under the Equity Plan as of March 31, 2016, and changes during the year then ended is presented below. 9. Share-Based Payments (continued) The Company awarded approximately 38,000 restricted shares during the fiscal year ended March 31, 2016. During the same period no restricted shares were forfeited. As of March 31, 2016, there was approximately $643,000 of total unrecognized compensation cost related to non-vested restricted share awards granted under the Equity Plans. That cost is expected to be recognized over a weighted-average period of approximately 1.75 years. The Company did not award any performance shares during the fiscal year ended March 31, 2016 or March 31, 2015. As of March 31, 2016, under the Equity Plans, there were no non-vested performance shares and no unrecognized compensation related to performance shares. 10. Employee Benefit Plan The Company has a 401(k) retirement plan under which all employees are eligible to participate. Employee contributions are voluntary and subject to Internal Revenue Service limitations. The Company did not make a discretionary matching employee contribution. The Board will re-evaluate the Company’s matching policy for plan year 2017 later this year. For the fiscal years ended March 31, 2016, 2015 and 2014, the Company recorded expenses of approximately $7,000, each year related to this plan. 11. Commitments and Contingencies The Company leases corporate and branch offices under operating lease agreements which provide for annual minimum rental payments as follows: Rent expense for the fiscal years ended March 31, 2016, 2015, and 2014 was approximately $2.3, $2.1, and $2.0 million respectively. The Company recognizes rent expense on a straight-line basis over the term of the lease, taking into account, when applicable, lessor incentives for tenant improvements, periods where no rent payment is required and escalations in rent payments over the term of the lease. The Company currently is not a party to any pending legal proceedings other than ordinary routine litigation incidental to its business, none of which, if decided adversely to the Company, would, in the opinion of management, have a material adverse effect on the Company’s financial condition or results of operations. 12. Quarterly Results of Operations (Unaudited) | I apologize, but the text you've provided seems to be an incomplete or fragmented financial statement excerpt. It appears to be discussing some accounting aspects like:
1. Losses on finance receivables
2. Interest rate swap agreements
3. Accounting estimates and potential variations
4. Debt origination costs
However, without the full context or complete financial statement, I cannot provide a comprehensive summary. To help you better, could you share the complete financial statement or clarify which specific parts you would like me to summarize? | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MEDICINE MAN TECHNOLOGIES INC. ACCOUNTING FIRM To the Board of Directors and Stockholders of Medicine Man Technologies, Inc.: We have audited the accompanying balance sheet of Medicine Man Technologies, Inc. (“the Company”) as of December 31, 2016 and 2015, and the related statement of operations, stockholders’ equity and cash flows for the years ended December 31, 2016 and 2015. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Medicine Man Technologies, Inc., as of December 31, 2016 and 2015, and the results of its operations and its cash flows for the year ended December 31, 2016 and 2015, in conformity with generally accepted accounting principles in the United States of America. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the Company's internal control over financial reporting. Accordingly, we express no such opinion. /s/ B F Borgers CPA PC B F Borgers CPA PC Lakewood, CO April 14, 2017 MEDICINE MAN TECHNOLOGIES, INC. BALANCE SHEET Expressed in U.S. Dollars See accompanying notes to the financial statements MEDICINE MAN TECHNOLOGIES, INC. STATEMENT OF COMPREHENSIVE (LOSS) AND INCOME For the Twelve Months Ended December 31, 2016 and 2015 Expressed in U.S. Dollars See accompanying notes to the financial statements MEDICINE MAN TECHNOLOGIES INC. STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY For the Twelve Months Ended December 31, 2016 and 2015 Expressed in U.S. Dollars See accompanying notes to the financial statements MEDICINE MAN TECHNOLOGIES, INC. STATEMENT OF CASH FLOWS For the Twelve Months Ended December 31, 2016 and 2015 Expressed in U.S. Dollars See accompanying notes to the financial statements MEDICINE MAN TECHNOLOGIES, INC. NOTES TO THE FINANCIAL STATEMENTS Organization and Nature of Operations: Business Description - Business Activity: Medicine Man Technologies Inc. (the "Company") is a Colorado corporation incorporated on March 20, 2014. The Company is a cannabis consulting company providing consulting services for cannabis growing technologies and methodologies, as well as retail operations of cannabis products. 1. Liquidity and Capital Resources: Cash Flows - During the years ending December 31, 2016 and 2015, the Company primarily utilized cash and cash equivalents, long-term convertible debt and revenue from operations to fund its operations. Cash and cash equivalents are carried at cost and represent cash on hand, deposits placed with banks or other financial institutions and all highly liquid investments with an original maturity of three months or less as of the purchase date. The Company had $351,524 and $262,146 classified as cash and cash equivalents as of December 31, 2016 and December 31, 2015, respectively. The Company has recently elected to accelerate its organic growth path through additional marketing, team development, intelligent acquisition, and other corporate activities wherein it expects to generate negative cash flow and an additional demand for capital to fuel such growth as described in it subsequent events notes. 2. Critical Accounting Policies and Estimates: Basis of Presentation: These accompanying financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission for annual financial statements. Fair Value Measurements: Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, as follows: Level 1 - Quoted prices in active markets for identical assets or liabilities. Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Our financial instruments include cash, accounts receivable, note receivable, accounts payables and tenant deposits. The carrying values of these financial instruments approximate their fair value due to their short maturities. The carrying amount of our debt approximates fair value because the interest rates on these instruments approximate the interest rate on debt with similar terms available to us. Our derivative liability was adjusted to fair market value at the end of each reporting period, using Level 3 inputs. Use of Estimates: The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts that differ from these estimates. Accounts receivable: The Company extends unsecured credit to its customers in the ordinary course of business. Accounts receivable related to licensing revenues are recorded at the time the milestone result in the funds being due being achieved, services are delivered and payment is reasonably assured. Licensing revenues are generally collected from 30 to 60 days after the invoice is sent. As of December 31, 2016, and 2015, the Company had accounts receivable of $25,000 and $83,739, respectively. The company wrote off $5,792 of its accounts receivable in 2016. Allowance for doubtful accounts is currently zero as all receivables are less than 60 days old. The company will continue to evaluate the need for recognizing an additional allowance in the future. AFS Securities: Investments available for sale is comprised of publicly traded stock purchased as an investment. The Company considers the securities to be liquid and convertible to cash in under a year. The Company has the ability and intent to liquidate any security that the Company holds to fund operations over the next twelve months, if necessary, and as such has classified all its marketable securities as short-term. Our investment securities at December 31, 2016 consist of available-for-sale instruments which include $13,998 of equity in publicly traded companies. All our available-for-sale securities are Level 2 due to limited trading volume. Realized gains and losses on these securities will be included in “other income (expense)” in the consolidated statements of income using the specific identification method. Unrealized gains and losses, net of tax, on available-for-sale securities are recorded in accumulated other comprehensive income (accumulated OCT). At December 31, 2015 the Company held AFS securities with a value of $40,000 and a basis of $50,000. In the fourth quarter of 2016 the Company sold the 50,000 shares of Mass Roots, Inc. stock with a basis of $50,000 for $40,050 resulting in the company recognizing a $9,950 loss on the other income/expense section of the financial statements. During the 2016 year the company purchased stock in three public companies for a cost of $18,300 which it held at year end with a value of $13,998 and an unrealized loss of $4,303. Debt and derivative liability: If we issue convertible debt with certain terms, such as conversion into stock based upon the closing price of the company stock, the convertible feature of the debt is considered to be a derivative that is recorded as a liability at fair value. If the initial value of the warrant derivative liability is higher than the fair value of the associated debt, the excess is recognized immediately as interest expense. Due to the complexity of such warrant derivative, we use the Black Scholes model to estimate their fair value. The derivative warrant liability is a level three fair value measurement. Short term note receivable: Note receivable were comprised of a $250,000 loan with $14,016 of accrued interest for a total loan value of $264,016 issued to the organization that owns Funk Sack, Inc. This loan was extended with the option of negotiating an agreement to acquire the entirety of the company through a stock swap. However, in the fourth quarter of 2016 the Company determined that it would not complete the acquisition of the company and instead will hold the investment and it will be repaid. The loan was issued May 6, 2016 and was is due to be repaid November 1, 2017. As the note is still current and the Funk Sacks organization is continuing to operate and grow this note is considered to be fully collectable. Other assets: Other assets at December 31, 2016 and December 31, 2015 were $27,479 and $38,721, respectively and included prepaid registrations fees for major cannabis events the Company is sponsoring and advertising costs. Accounts payable: Accounts payable at December 31, 2016 and December 31, 2015 was $0 and $8,715, respectively and were comprised of operating accounts payable for various professional services incurred during the ordinary course of business. Other liabilities: Accrued tax and other liabilities at December 31, 2016 and 2015 were $175 and $13,200, respectively. The balance in 2016 was comprised of $175 in accrued interest and the balance in 2015 of $13,200 was comprised of taxes owed. Fair Value of Financial Instruments: The carrying amounts of cash and current assets and liabilities approximate fair value because of the short-term maturity of these items. These fair value estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect these estimates. Available for sale securities are recorded at current market value as of the date of this report. Revenue recognition and related allowances: Revenue from licensing services is recognized when the obligations to the client are fulfilled which is determined when milestones in the contract are achieved. Revenue from seminar fees is related to one day seminars and is recognized as earned at the completion of the seminar. All revenue are measured at fair value. Costs of Services Sold - Costs of services sold are comprised of direct salaries and related expenses incurred while supporting the implementation of licensing agreements and related services. General & Administrative Expenses - General and administrative expense are comprised of all expenses not linked to the production or advertising of the Company’s services. Advertising and Marketing Costs: Advertising and marketing costs are expensed as incurred and were $311,522 and $15,997 during the year ended December 31, 2016 and 2015, respectively. Stock based compensation: The Company accounts for share-based payments pursuant to ASC 718, “Stock Compensation” and, accordingly, the Company records compensation expense for share-based awards based upon an assessment of the grant date fair value for stock and restricted stock awards using the Black-Scholes option pricing model. Stock compensation expense for stock options is recognized over the vesting period of the award or expensed immediately under ASC 718 and EITF 96-18 when stock or options are awarded for previous or current service without further recourse. The Company issued stock options to contractors and external companies that had been providing services to the Company upon their termination of services. Under ASC 718 and EITF 96-18 these options were recognized as expense in the period issued because they were given as a form of payment for services already rendered with no recourse. Share based expense paid to through direct stock grants is expensed as occurred. Since the Company’s stock has become publicly traded, the value is determined based on the number of shares issued and the trading value of the stock on the date of the transaction. Prior to the company’s stock being traded the Company used the most recent valuation. The company recognized $627,200 in expenses for stock based compensation to employees through direct stock grants of 430,000 shares in the year ended December 31, 2016 and $79,725 in expenses from the issuance of 122,500 shares in the year ended December 31, 2015. The Stock issuance were as follows: Income taxes: The Company has adopted SFAS No. 109 - “Accounting for Income Taxes”. ASC Topic 740 requires the use of the asset and liability method of accounting for income taxes. Under the asset and liability method of ASC Topic 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 3. Recent Accounting Pronouncements Financial Accounting Standards Board, or FASB, Accounting Standards Update, or FASB ASU 2016-15 “Statement of Cash Flows (Topic 230)” - In August 2016, the FASB issued 2016-15. Stakeholders indicated that there is a diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This ASU is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. Adoption of this ASU will not have a significant impact on our statement of cash flows. FASB ASU 2016-12 “Revenue from Contracts with Customers (Topic 606)” - In May 2016, the FASB issued 2016-12. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2016-12 provides clarification on assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications. This ASU is effective for annual reporting periods beginning after December 15, 2017, with the option to adopt as early as December 15, 2016. We are currently assessing the impact of adoption of this ASU on our consolidated results of operations, cash flows and financial position. FASB ASU 2016-11 “Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815)” - In May 2016, the FASB issued 2016-11, which clarifies guidance on assessing whether an entity is a principal or an agent in a revenue transaction. This conclusion impacts whether an entity reports revenue on a gross or net basis. This ASU is effective for annual reporting periods beginning after December 15, 2017, with the option to adopt as early as December 15, 2016. We are currently assessing the impact of adoption of this ASU on our consolidated results of operations, cash flows and financial position. FASB ASU 2016-10 “Revenue from Contracts with Customers (Topic 606)” - In April 2016, the FASB issued ASU 2016-10, clarify identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas. This ASU is effective for annual reporting periods beginning after December 15, 2017, with the option to adopt as early as December 15, 2016. We are currently assessing the impact of adoption of this ASU on our consolidated results of operations, cash flows and financial position. FASB ASU 2016-09 “Compensation - Stock Compensation (Topic 718)” - In March 2016, the FASB issued ASU 2016-09, which includes multiple provisions intended to simplify various aspects of accounting for share-based payments. While aimed at reducing the cost and complexity of the accounting for share-based payments, the amendments are expected to significantly impact net income, earnings per share, and the statement of cash flows. Implementation and administration may present challenges for companies with significant share-based payment activities. This ASU is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. We are currently evaluating the potential impact this standard will have on our consolidated financial statements and related disclosures. 4. Stockholders’ Equity: The Company’s initial authorized stock at inception was 1,000,000 common shares, par value $0.001 per share. In 2015 the Company amended its Articles of Incorporation to increase its authorized shares to 90,000,000 Common Shares, par value $0.001 per share and 10,000,000 preferred shares, par value $0.001 per share. During the time in which the Company was establishing its operations it issued 4,199,000 shares of Common Stock to various individuals as founders for prior services completed which was valued at par value, resulting in the Company booking stock based expense of $4,199. During the time in which the Company was establishing it operations it issued 5,331,000 shares of Common Stock to various individuals for a license agreement valued at par value resulting in the Company recognizing a purchased asset of $5,331. Commencing in November 2014, the Company commenced a private offering of its Common Stock at an offering price of $1.00 per share. At December 31, 2014, it had accepted subscription from 26 investors and received net proceeds of $260,000 therefrom. In December 2014, the Company issued 50,000 shares of its Common Stock for legal fees and recognized an expense for this issuance of $50,000 based upon the prior sale in November 2014 of its Common Stock. At December 31, 2014, the Company had 9,840,000 shares outstanding. On March 17, 2015, 10,000 shares of Common Stock were sold to one investor as part of the private offering commencing in November 2014 in exchange for $10,000 cash. During the second quarter of 2015, the Company issued 50,000 shares of Common Stock to an individual in consideration for their services rendered in support of the Company resulting in the Company recognizing compensation expense of $50,000 based upon a per share price of $1.00 per share realized in the most recent private offering. On July 1, 2015, the Company issued 72,500 shares of Common Stock to four different individuals in consideration for their services rendered in support of the Company, resulting in recognizing compensation expense of $29,725 based upon an independent valuation determining the value of shares at $0.41 per share. At December 31, 2015, the Company had 9,972,500 shares outstanding. On January 4, 2016, the Company issued 120,000 shares of Common Stock to various individuals in consideration of their services rendered in support of the Company resulting in recognizing compensation expense of $49,200 based upon an independent valuation determining the value of shares at $0.41 per share. On October 13, 2016, the Company issued 260,000 shares of Common Stock to various individuals in consideration of their services rendered in support of the Company resulting in recognizing compensation expense of $452,400 based upon a closing stock price of $1.74 per share. On December 26, 2016, the Company issued 50,000 shares of Common Stock to various individuals in consideration of their services rendered in support of the Company resulting in recognizing compensation expense of $136,000 based upon a closing stock price of $2.72 per share. At December 30, 2016, the Company had 10,402,500 Common Shares outstanding. 5. Property and Equipment: Property and equipment are recorded at cost, net of accumulated depreciation and are comprised of the following: Depreciation on equipment is provided on a straight-line basis over its expected useful lives at the following annual rates. Depreciation expense for the year ending December 31, 2016 and 2015 was $16,833 and $6,087, respectively. 6. Intangible Asset On May 1, 2014, the Company entered into a non-exclusive Technology License Agreement with Futurevision, Inc., f/k/a Medicine Man Production Corporation, a Colorado corporation, dba Medicine Man Denver (“Medicine Man Denver”), a company owned and controlled by affiliates of the Company, whereby Medicine Man Denver granted a license to use all of their proprietary processes they have developed, implemented and practiced at its cannabis facilities relating to the commercial growth, cultivation, marketing and distribution of medical marijuana and recreational marijuana pursuant to relevant state laws and the right to use and to license such information, including trade secrets, skills and experience (present and future). As payment for the license rights the Company issued Medicine Man Denver (or its designees) 5,331,000 shares of the Company’s common stock. The Company accounted for this license in accordance with ASC 350-30-30 “Intangibles - Goodwill and Other by recognizing the fair value of the amount paid by the company for the asset at the time of purchase. Since the Company has a limited operating history, management determined to use par value as the value recognized for the transaction. Since the term of the initial license agreement is ten (10) years, the cost of the asset will be recognized on a straight-line basis over the life of the agreement. In addition, each period the Company will evaluate the intangible asset for impairment. As of December 31, 2016, no impairment was deemed necessary. Amortization expense for the periods ending December 31, 2016 and 2015 was $532 and $530, respectively. 7. Convertible Notes and Derivative Liability: In the year ended December 31, 2016 the Company raised $810,000 through a private placement of promissory convertible notes with certain accredited investors, bearing interest at 12%, with interest and principal due January 1, 2019. Upon issuance, each of the notes is immediately convertible at the noteholders election into the company’s common stock at $1.75 per share or 90% of the VWAP of the five days following the notice of conversion, whichever is lower. Since the conversion rate can be tied to an underlying item, the warrants are considered to be a derivative that is recorded as a liability at fair value and adjusted to fair value at the conclusion of each reporting period. The underlying assumptions used in the Black Scholes model to determine the fair value of the derivative liability were based on the individual date the notes were closed and were the following: The initial fair value of the derivative liability was recorded as interest expense of $102,907. Changes in the derivative liability were as follows: The total liability of $294,002 is presented on the current liability section of the balance sheet as the conversion can be exercised at any time at the note holders’ request. The initial fair value of warrants issued of $102,907 is recognized as interest expense in the other income/expense section of the income statement. The increase in fair value is recognized as a loss of $191,095 on derivative liabilities also in the other income/expense section of the income statement. 8. Related Party Transactions: Through March 1, 2017, the Company operated from offices at 4880 Havana St, Suite 101 South, Denver CO 80239 via a sub-lease with one of its shareholders and founding partners, ChineseInvestors.COM. During 2015 and 2016, the Company had a verbal agreement with Chineseinvestors.com Inc. and Futurevistion to share employee’s time while the majority of their salary was covered by these related companies. The Company also paid the individuals a modest stipend for their time. While this agreement was in place through the 3rd quarter of 2016, the Company converted these two common contributors directly to its own payroll. During 2016, the Company received two short term loans bearing 12% annual interest from related parties, which were repaid in full along with interest. The Company borrowed $25,000 from Chineseinvestors.com, Inc. in July, which was repaid along with $250 interest in August. In that same period the Company borrowed $50,000 from Brett Roper, the COO and director, which was repaid along with $1,299 in interest in October. 9. Net Income (Loss) per Share In accordance with ASC Topic 280 - “Earnings per Share”, the basic earnings per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per common share is computed similar to basic loss per common share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. The Company's quarterly earnings for the period ended December 31, 2016 and 2015 basic and diluted earnings/(loss) per share $(.14) and $0.01, respectively. 10. Commitments and Concentrations: Office Lease - Denver, Colorado - The Company entered into a sub-lease for office space in Denver, Colorado whereby it took over 100% of the lease obligation for the office space in Denver, CO from Chineseinvestors.com, Inc. The lease period started June 1, 2015 and was scheduled to terminate May 31, 2018, resulting in the following future commitments at year end: 11. Tax Provision: The Company is registered in the State of Colorado and is subject to the United States of America tax law. As of December 31, 2016, the Company had incurred no income on a tax basis resulting in the Company calculating that it owed $0 to the federal government at December 31, 2016 and $9,744 at December 31, 2015. In addition, the Company owed the State of Colorado $0 in 2016 and $2,731 at December 31, 2015. The Federal tax is shown on the income statement as tax expense and was accrued as a current accrued liability on the balance sheet in 2015. As the Company generated a loss from operations in the year ended December 31, 2016 the Company did not recognize any additional tax expense. The company utilizes FASB ASC 740, “Income Taxes” which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the tax basis of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established if it is more likely than not that some portion or all of the deferred tax asset will not be realized. The Company generated a deferred tax credit through net operating loss carry forwards. As of December 31, 2016 the Company had federal and state net operating loss carry forwards of approximately $293,000 ($0 in 2015) that can be used to offset future taxable income. The carry forwards will begin to expire in 2027 unless utilized in earlier years. 12. Subsequent events: In January 2017, the Company added three new fulltime positions that will be charged with providing additional support for the various service groupings offered by the Company, specifically a cultivation specialist, a dispensary specialist, and an administrative and events specialist. In February 2017, the Company entered into a Merger Agreement with Pono Publications Ltd. (“Pono”), as well as a Share Exchange Agreement with Success Nutrients, Inc. (“SN”), each a Colorado corporation, in order to facilitate our acquisition of both of these entities. The ratification of the acquisition of these companies requires the approval of the holders of a majority of the Company’s shareholders, which will be submitted for such approval at the Company’s annual shareholder meeting to be held in May 2017. If approved the relevant agreements provide that the effective date for accounting purposes will be March 1, 2016. Success Nutrients will become a wholly owned subsidiary of Medicine Man Technologies, Inc. and the business conducted by Pono will be incorporated into a newly formed wholly owned subsidiary, Medicine Man Consulting, Inc., which is also where we will continue to conduct the Company’s consulting service business. In March 2017, the Company moved its principal place of business to 4880 Havana Street, Suite 200, Denver, Colorado 80239. This space consists of 12,097 square feet of executive office space, common area, conference rooms, a kitchen, restroom and storage space. The lease term is 36 months (February 2020 expiration date). Until August 2017, the Company will pay monthly rent of $6,479.60. From August 2017 through February 28, 2018, rent escalates to $12,086.92 per month, increasing to $13,000 from March 2018 through February 2019 and to $14500 in June 2017 through May 2018. The Company also pays its percentage of base operating expenses. In March 2017, the Company integrated Pono Publications and Success Nutrients into its operations including a lease for approximately 10,000 square feet of space located at 6660 East 47th Street, Denver, CO 80216. This integration also included four (4) full time team members as well as several independent contractors. In March, 2017, the Company entered into an employment agreement with Joshua Haupt’s to serve as its Chief Cultivation Officer On March 1, 2017, the Company added its initial Cultivation MAX client relationship having a 500-light facility in southern Nevada. That service agreement’s baseline performance factor as assigned (wherein the Company is able to re-define its cultivation practices and nutrient management systems) allows the Company to receive payments for such services based upon the delta it is able to achieve for their cultivation at that location as well as future locations based upon the client’s wholesale price points as achieved throughout the duration of the agreement. On April 3, 2017, the Company entered into its second substantial Cultivation MAX client relationship having a 400-light facility in Las Vegas Nevada. This relationship will follow the same performance principles described in the preceding paragraph. As of the date of this Report holders of five of the outstanding convertible notes elected to convert their notes into shares of the Company’s Common Stock. Convertible Notes aggregating $254,777 were converted to 155,687 shares of the Company’s Common Stock. These conversions were computed at both the floor value of $1.75 as well as at a VWAP value as allowable under the terms of the conversion rights. | I apologize, but the provided financial statement excerpt seems incomplete and lacks clear structure. However, I can summarize the key points I can discern:
Financial Statement Summary:
- Period Covered: Twelve Months Ended December 31
- Advertising and Marketing Costs: $311,522
- Cash and Cash Equivalents: $351,524
Revenue Recognition:
- Licensing services revenue recognized when contract milestones are achieved
- Seminar fee revenue recognized upon seminar completion
- All revenue measured at fair value
Expenses:
- Costs of Services Sold: Direct salaries and related expenses for licensing agreements
- General & Administrative Expenses: Expenses not directly linked to service production or advertising
Note: The statement appears fragmented, making a comprehensive summary challenging. A complete financial statement would typically include more detailed information about total revenues, net income/loss, and a clearer breakdown of financial performance. | Claude |
PIONEER ENERGY SERVICES CORP. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders Pioneer Energy Services Corp.: We have audited the accompanying consolidated balance sheets of Pioneer Energy Services Corp. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pioneer Energy Services Corp. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Pioneer Energy Services Corp.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 17, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ KPMG LLP San Antonio, Texas February 17, 2017 Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders Pioneer Energy Services Corp.: We have audited Pioneer Energy Services Corp.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Pioneer Energy Services Corp.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Pioneer Energy Services Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Pioneer Energy Services Corp. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016, and our report dated February 17, 2017 expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP San Antonio, Texas February 17, 2017 PIONEER ENERGY SERVICES CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS See accompanying notes to consolidated financial statements. PIONEER ENERGY SERVICES CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS See accompanying notes to consolidated financial statements. PIONEER ENERGY SERVICES CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY See accompanying notes to consolidated financial statements. PIONEER ENERGY SERVICES CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS See accompanying notes to consolidated financial statements. PIONEER ENERGY SERVICES CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Summary of Significant Accounting Policies Business Pioneer Energy Services Corp. provides land-based drilling services and production services to a diverse group of independent and large oil and gas exploration and production companies in the United States and internationally in Colombia. We also provide two of our services (coiled tubing and wireline services) offshore in the Gulf of Mexico. As of December 31, 2016, our drilling rig fleet is 100% pad-capable, consisting of 16 AC rigs in the US and eight SCR rigs in Colombia. In addition to our drilling rigs, we provide the drilling crews and most of the ancillary equipment needed to operate our drilling rigs. The drilling rigs in our fleet are currently assigned to the following divisions: Our Production Services Segment provides a range of services to a diverse group of exploration and production companies, with our operations concentrated in the major United States onshore oil and gas producing regions in the Mid-Continent and Rocky Mountain states and in the Gulf Coast, both onshore and offshore. As of December 31, 2016, our production services fleets are as follows: Drilling Contracts We obtain our contracts for drilling oil and natural gas wells either through competitive bidding or through direct negotiations with existing or potential clients. Our drilling contracts generally provide for compensation on a daywork basis, and sometimes on a turnkey basis. Contract terms generally depend on the complexity and risk of operations, the on-site drilling conditions, the type of equipment used, and the anticipated duration of the work to be performed. Spot market contracts generally provide for the drilling of a single well and typically permit the client to terminate on short notice. We typically enter into longer-term drilling contracts for our newly constructed rigs and/or during periods of high rig demand. As of December 31, 2016, 13 of our 16 domestic drilling rigs are earning revenues, nine of which are under term contracts, and four of the drilling rigs in Colombia are earning revenues, three of which are under term contracts. The term contracts in Colombia are cancelable by our client without penalty if 30 days’ notice is provided, and by us if rig operations are suspended without an associated dayrate. We are actively marketing our idle drilling rigs in Colombia to various operators and we are evaluating other options, including the possibility of the sale of some or all of our assets in Colombia. Basis of Presentation The accompanying consolidated financial statements include the accounts of Pioneer Energy Services Corp. and our wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. In preparing the accompanying consolidated financial statements, we make various estimates and assumptions that affect the amounts of assets and liabilities we report as of the dates of the balance sheets and income and expenses we report for the periods shown in the income statements and statements of cash flows. Our actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to our recognition of revenues and costs for turnkey contracts, our estimate of the allowance for doubtful accounts, our determination of depreciation and amortization expenses, our estimates of projected cash flows and fair values for impairment evaluations, our estimate of the valuation allowance for deferred tax assets, our estimate of the liability relating to the self-insurance portion of our health and workers’ compensation insurance, our estimate of compensation related accruals and our estimate of sales tax audit liability. In preparing the accompanying consolidated financial statements, we have reviewed events that have occurred after December 31, 2016, through the filing of this Form 10-K, for inclusion as necessary. Foreign Currencies Our functional currency for our foreign subsidiary in Colombia is the U.S. dollar. Nonmonetary assets and liabilities are translated at historical rates and monetary assets and liabilities are translated at exchange rates in effect at the end of the period. Income statement accounts are translated at average rates for the period. Gains and losses from remeasurement of foreign currency financial statements into U.S. dollars and from foreign currency transactions are included in other income or expense. Revenue and Cost Recognition Drilling Services-Our Drilling Services Segment earns revenues by drilling oil and gas wells for our clients under daywork or turnkey contracts, which usually provide for the drilling of a single well. Drilling contracts for individual wells are usually completed in less than 30 days. We recognize revenues on daywork contracts for the days completed based on the dayrate each contract specifies. We recognize revenues from our turnkey contracts on the proportional performance basis, based on our estimate of the number of days to complete each contract. All of our revenues are recognized net of applicable sales taxes. With most drilling contracts, we receive payments contractually designated for the mobilization of rigs and other equipment. Payments received, and costs incurred for the mobilization services are deferred and recognized on a straight line basis over the related contract term. Costs incurred to relocate rigs and other drilling equipment to areas in which a contract has not been secured are expensed as incurred. Reimbursements that we receive for out-of-pocket expenses are recorded as revenue and the out-of-pocket expenses for which they relate are recorded as operating costs. Amortization of deferred mobilization revenues was $1.6 million, $1.1 million and $4.6 million for the years ended December 31, 2016, 2015 and 2014, respectively. With most term drilling contracts, we are entitled to receive a full or reduced rate of revenue from our clients if they choose to place a rig on standby or to early terminate the contract before its original expiration term. Generally, these revenues are billed and collected over the remaining term of the contract, as the rig is often placed on standby rather than fully released from the contract, and thus may go back to work at the client’s decision any time before the end of the contract. Some of our drilling contracts contain “make-whole” provisions whereby if we are able to secure additional work for the rig with another client, then each party is entitled to a make-whole payment. If the dayrates under the new contract are less than the dayrates in the original contract, we would be entitled to a reduced revenue dayrate from the terminating client, and likewise, the terminating client may be entitled to a payment from us if the new contract dayrates exceed those of the original contract. A client may also choose to early terminate the contract and make an upfront early termination payment based on a per day rate for the remaining term of the contract. Revenues derived from rigs placed on standby or from the early termination of term drilling contracts are deferred and recognized as the amounts become fixed or determinable, over the remainder of the original term or when the rig is sold. As a result of the downturn that began in late 2014, term contracts for 19 of our drilling rigs were terminated early, including three that were terminated in early 2016. As of December 31, 2016, all of these contracts’ terms have expired and all the associated revenue from the early terminations has been recognized. Our current and long-term deferred revenues and costs as of December 31, 2016 and 2015 were as follows (amounts in thousands): Turnkey Drilling Contracts-Under a typical turnkey drilling contract, we agree to drill a well for our client to a specified depth and under specified conditions for a fixed price. We use the proportional performance basis to recognize revenue on our turnkey contracts. We accrue estimated contract costs on turnkey contracts for each day of work completed based on our estimate of the total costs to complete the contract divided by our estimate of the number of days to complete the contract. Contract costs include labor, materials, supplies, repairs and maintenance, operating overhead allocations and allocations of depreciation and amortization expense. If we anticipate a loss on a contract in progress due to a change in our cost estimate, we accrue the entire amount of the estimated loss, including all costs that are included in our revised estimated cost to complete that contract, in our consolidated statement of operations for that reporting period. Our actual results for a contract could differ significantly if our cost estimates for that contract are later revised from our original cost estimates for a contract in progress at the end of a reporting period which was not completed prior to the release of our financial statements. Production Services-Our Production Services Segment earns revenues for well servicing, wireline services and coiled tubing services pursuant to master services agreements based on purchase orders, contracts or other arrangements with the client that include fixed or determinable prices. Production services jobs are generally short-term and are charged at current market rates. Production service revenue is recognized when the service has been rendered and collectability is reasonably assured. Concentration of Clients-We derive a significant portion of our revenue from a limited number of major clients. For the years ended December 31, 2016, 2015 and 2014, our drilling and production services to our top three clients accounted for approximately 26%, 29%, and 28%, respectively, of our revenue. For a detail of our three largest clients as a percentage of our total revenues during the last three fiscal years, see Item 1 - “Business” in Part I of this Annual Report on Form 10-K. Cash and Cash Equivalents For purposes of the statements of cash flows, we consider all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents. Cash equivalents consist of investments in money market accounts. We had no cash equivalents at December 31, 2016. Cash equivalents at December 31, 2015 were $1.3 million. Trade Accounts Receivable We record trade accounts receivable at the amount we invoice our clients. These accounts do not bear interest. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our accounts receivable as of the balance sheet date. We determine the allowance based on the credit worthiness of our clients and general economic conditions. Consequently, an adverse change in those factors could affect our estimate of our allowance for doubtful accounts. We review our allowance for doubtful accounts on a monthly basis. Our typical drilling contract provides for payment of invoices in 30 days. We generally do not extend payment terms beyond 30 days and have not extended payment terms beyond 90 days for any of our domestic contracts in the last three fiscal years. Our production services terms generally provide for payment of invoices in 30 days. Balances more than 90 days past due are reviewed individually for collectability. We charge off account balances against the allowance after we have exhausted all reasonable means of collection and determined that the potential for recovery is remote. We do not have any off-balance sheet credit exposure related to our clients. The changes in our allowance for doubtful accounts consist of the following (amounts in thousands): Unbilled Accounts Receivable The asset “unbilled receivables” represents revenues we have recognized in excess of amounts billed on drilling contracts and production services completed but not yet invoiced. We typically invoice our clients at 15-day intervals during the performance of daywork drilling contracts and upon completion of the daywork contract. Turnkey drilling contracts are invoiced upon completion of the contract. Our unbilled receivables as of December 31, 2016 and 2015 were as follows (amounts in thousands): Inventories Inventories primarily consist of drilling rig replacement parts and supplies held for use by our Drilling Services Segment’s operations in Colombia, and supplies held for use by our Production Services Segment’s operations. Inventories are valued at the lower of cost (first in, first out or actual) or market value. Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets include items such as insurance, rent deposits and fees. We routinely expense these items in the normal course of business over the periods these expenses benefit. Prepaid expenses and other current assets also include the current portion of deferred mobilization costs for certain drilling contracts that are recognized on a straight-line basis over the contract term. Property and Equipment Property and equipment are carried at cost less accumulated depreciation. Depreciation is provided for our assets over the estimated useful lives of the assets using the straight-line method. We record the same depreciation expense whether a rig is idle or working. We charge our expenses for maintenance and repairs to operating costs. We capitalize expenditures for renewals and betterments to the appropriate property and equipment accounts. Intangible Assets Our intangible assets were recorded in connection with the acquisitions of production services businesses and are subject to amortization. As of December 31, 2016 and 2015, the estimated useful lives and components of our intangible asset classes are as follows: The cost of our client relationships are amortized using the straight-line method over their respective estimated economic useful lives and amortization expense for our non-compete agreements is calculated using the straight-line method over the period of the agreements. Amortization expense was $1.5 million, $7.9 million and $8.0 million for the years ended December 31, 2016, 2015 and 2014, respectively. Amortization expense is estimated to be approximately $0.2 million for each of the years ending December 31, 2017 and 2018. Actual amortization amounts may be different due to future acquisitions, impairments, changes in amortization periods, or other factors. During 2016, we removed $12.1 million and $0.4 million of fully amortized capitalized client relationship and non-compete agreement costs, respectively. Doing so had no net impact to our consolidated balance sheet or consolidated statement of operations as of and for the year ending December 31, 2016. As a result of the downturn which began in late 2014 and worsened through 2015, our projected cash flows declined and we performed an impairment analysis of our long-lived tangible and intangible assets, which resulted in an impairment charge of $14.3 million recognized in 2015 that reduced the carrying value of our coiled tubing intangible assets to zero. We used an income approach to estimate the fair value of our coiled tubing services reporting unit. The most significant inputs used in our impairment analysis of our coiled tubing operations include the projected utilization and pricing of our coiled tubing services, which are classified as Level 3 inputs as defined by Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures. Although we believe the assumptions and estimates used in our impairment analyses are reasonable and appropriate, different assumptions and estimates could materially impact the analyses and resulting conclusions. We assumed a 13% discount rate to estimate the fair value of the coiled tubing services reporting unit. A decrease in this assumption of 5% would have resulted in a decrease to our impairment charge of approximately $2 million. An increase of 1% in either the utilization or pricing assumptions would have resulted in a decrease to our impairment charge of approximately $1 million or $2 million, respectively. Our impairment analysis also resulted in an impairment to our coiled tubing tangible long-lived assets in 2015, which is discussed in more detail in Note 2, Property and Equipment. Other Long-Term Assets Other long-term assets consist of cash deposits related to the deductibles on our workers’ compensation insurance policies, deferred compensation plan investments and the long-term portion of deferred mobilization costs. Other Current Liabilities Our other accrued expenses include accruals for items such as property tax, sales tax, and professional and other fees. We routinely expense these items in the normal course of business over the periods these expenses benefit. Other Long-Term Liabilities Our other long-term liabilities consist of the noncurrent portion of liabilities associated with our long-term compensation plans, deferred lease liabilities, and the long-term portion of deferred mobilization revenues. Treasury Stock Treasury stock purchases are accounted for under the cost method whereby the cost of the acquired common stock is recorded as treasury stock. Gains and losses on the subsequent reissuance of treasury stock shares are credited or charged to additional paid in capital using the average cost method. Stock-based Compensation We recognize compensation cost for stock option, restricted stock and restricted stock unit awards based on the fair value estimated in accordance with ASC Topic 718, Compensation-Stock Compensation. For our awards with graded vesting, we recognize compensation expense on a straight-line basis over the service period for each separately vesting portion of the award as if the award was, in substance, multiple awards. We receive a tax deduction for certain stock option exercises during the period the options are exercised, generally for the excess of the fair market value of our stock on the date of exercise over the exercise price of the options. In accordance with ASC Topic 718, when we have excess tax benefits resulting from the exercise of stock options, we report them as financing cash flows in our consolidated statement of cash flows, unless otherwise disallowed under ASC Topic 740, Income Taxes. Income Taxes We follow the asset and liability method of accounting for income taxes, under which we recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. We measure our deferred tax assets and liabilities by using the enacted tax rates we expect to apply to taxable income in the years in which we expect to recover or settle those temporary differences. The effect of a change in tax rates on deferred tax assets and liabilities is reflected in income in the period during which the change occurs. A recent change in Colombia tax rates is described in more detail in Note 5, Income Taxes. Related-Party Transactions During the years ended December 31, 2016, 2015, and 2014, the Company paid approximately $0.2 million, $0.2 million and $0.4 million, respectively, for trucking and equipment rental services, which represented arms-length transactions, to Gulf Coast Lease Service. Joe Freeman, our Senior Vice President of Well Servicing, serves as the President of Gulf Coast Lease Service, which is owned and operated by Mr. Freeman’s two sons. Mr. Freeman does not receive compensation from Gulf Coast Lease Service, and he serves primarily in an advisory role to his sons. Comprehensive Income We have not reported comprehensive income due to the absence of items of other comprehensive income in the periods presented. Recently Issued Accounting Standards Revenue Recognition. In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance. The standard outlines a single comprehensive model for revenue recognition based on the core principle that a company will recognize revenue when promised goods or services are transferred to clients, in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. We are currently evaluating the impact of this guidance. We expect the adoption of this new standard to primarily affect the timing for the recognition of revenues derived from long-term drilling contracts. We are required to apply this new standard beginning January 1, 2018, with earlier adoption permitted. We do not anticipate early adoption of this standard. Two methods of transition are permitted under this standard: the full retrospective method, in which the standard would be applied retrospectively to each prior reporting period presented, subject to certain allowable exceptions; or the modified retrospective method, in which the standard would be applied to all contracts existing as of the date of initial application, with the cumulative effect of applying the standard recognized in beginning retained earnings. We currently anticipate adopting this standard using the modified retrospective method, but we continue to evaluate both transition options available under the standard. Debt Issuance Costs. On April 7, 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts, and that amortization of debt issuance costs be reported as interest expense. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. This ASU requires retrospective adoption and was effective for us beginning with our first quarterly filing in 2016. The adoption of this new standard resulted in reclassifying $7.8 million of debt issuance costs from other long-term assets to long-term debt in the accompanying December 31, 2015 consolidated balance sheet. Leases. In February 2016, the FASB issued ASU No. 2016-02, Leases, which among other things, requires lessees to recognize substantially all leases on the balance sheet, with expense recognition that is similar to the current lease standard, and aligns the principles of lessor accounting with the principles of the FASB’s new revenue guidance (referenced above). This ASU is effective for us beginning with our first quarterly filing in 2019. We are currently evaluating the potential impact of this guidance and have not yet determined its impact on our financial position and results of operations. Stock-Based Compensation. In March 2016, the FASB issued ASU No. 2016-09, Stock Compensation: Improvements to Employee Share-Based Payment Accounting, to reduce complexity in accounting standards involving several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This ASU is effective for us beginning with our first quarterly filing in 2017. We do not expect that the adoption of this update will have a material effect on our financial position or results of operations. Credit Losses. In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, which sets forth an impairment model requiring the measurement of all expected credit losses for financial instruments (including trade receivables) held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This ASU is effective for us beginning with our first quarterly filing in 2020. We do not expect the adoption of this guidance to have a material impact on our financial position or results of operations. Statement of Cash Flows. In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows, which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. The update is intended to reduce the existing diversity in practice, and is effective for us beginning with our first quarterly filing in 2018. We do not expect the adoption of this guidance to have a material impact on our financial position and results of operations. Reclassifications Certain amounts in the consolidated financial statements for the prior years have been reclassified to conform to the current year’s presentation. 2. Property and Equipment As of December 31, 2016 and 2015, the estimated useful lives and costs of our asset classes are as follows: Our capital expenditures were $32.6 million, $142.9 million and $188.1 million during the years ended December 31, 2016, 2015, and 2014 respectively, which includes $0.2 million, $3.0 million and $0.7 million respectively, of capitalized interest costs incurred during the construction periods of new drilling rigs and other drilling equipment. As of December 31, 2016 and 2015, capital expenditures incurred for property and equipment not yet placed in service was $8.7 million and $18.6 million, respectively, primarily related to new drilling equipment that was ordered in 2014, but which requires a long lead-time for delivery. This equipment will either be used to construct new drilling rigs or as spare equipment for our AC rig fleet. Capital expenditures during 2016 consisted primarily of routine expenditures to maintain our drilling and production services fleets. Capital expenditures during 2015 and 2014 primarily related to our five drilling rigs which began construction during 2014 and were completed in 2015, as well as unit additions to our production services fleets that were ordered in 2014. We recorded a net gain during the year ended December 31, 2016 of $1.9 million on the disposition of property and equipment, primarily for the sale of three SCR drilling rigs for aggregate proceeds of $11.0 million and the disposal of excess drill pipe for a gain. The net gains on disposition of assets were partially offset by a loss on the disposition of damaged property when one of our AC drilling rigs sustained damages that resulted in a disposal of the damaged components with an aggregate net carrying value of $4.0 million, for which we received insurance proceeds of $3.1 million in January 2017 and recognized a net loss on disposal of $0.9 million. Additionally, we retired two domestic SCR rigs at the end of 2016 and placed the remaining two as held for sale at December 31, 2016. During the year ended December 31, 2015, we recorded a net gain of $4.3 million on the disposition of property and equipment, primarily for the sale of 32 drilling rigs and other drilling equipment which we sold for aggregate proceeds of $53.6 million. In 2014, we sold our trucking assets and our fishing and rental services operations for a net gain of $10.7 million. (See Note 12, Sale of Fishing and Rental Services Operations, for more information.) As of December 31, 2016, our consolidated balance sheet reflects assets held for sale of $15.1 million, which primarily represents the fair value of six domestic mechanical and SCR drilling rigs and drilling equipment, 13 wireline units, 20 older well servicing rigs that will be traded in for 20 new-model rigs in the first quarter of 2017, and certain coiled tubing equipment. Impairments We evaluate for potential impairment of long-lived tangible and intangible assets subject to amortization when indicators of impairment are present. Circumstances that could indicate a potential impairment include significant adverse changes in industry trends, economic climate, legal factors, and an adverse action or assessment by a regulator. More specifically, significant adverse changes in industry trends include significant declines in revenue rates, utilization rates, oil and natural gas market prices and industry rig counts. In performing an impairment evaluation, we estimate the future undiscounted net cash flows from the use and eventual disposition of long-lived tangible and intangible assets grouped at the lowest level that cash flows can be identified. For our Production Services Segment, we perform an impairment evaluation and estimate future undiscounted cash flows for the individual reporting units (well servicing, wireline and coiled tubing). For our Drilling Services Segment, we perform an impairment evaluation and estimate future undiscounted cash flows for individual domestic drilling rig assets and for our Colombian drilling rig assets as a group. If the sum of the estimated future undiscounted net cash flows is less than the carrying amount of the asset group, then we determine the fair value of the asset group. The amount of an impairment charge is measured as the difference between the carrying amount and the fair value of the assets. Since late 2014, oil prices have declined significantly resulting in a downturn in our industry, affecting both drilling and production services. As a result, we performed several impairment evaluations during 2014, 2015 and 2016 on our long-lived assets, in accordance with ASC Topic 360, Property, Plant and Equipment, summarized below. As of December 31, 2014, we owned a total of 31 mechanical and lower horsepower electric drilling rigs. We performed impairment testing on all the mechanical and lower horsepower drilling rigs in our fleet as of December 31, 2014, which resulted in a total impairment of $71 million to reduce the carrying value of these assets to their estimated fair values, based on market appraisals which are considered Level 3 inputs as defined by ASC Topic 820, Fair Value Measurements and Disclosures. During 2015, we sold 28 of these rigs and placed the remaining three as held for sale. We also performed an impairment test on our drilling rigs in Colombia as of December 31, 2014, at which time we concluded that the sum of the estimated future undiscounted cash flows associated with our Colombian operations was in excess of the carrying amount and concluded that no impairment was present. As the downturn worsened through the first half of 2015, resulting in significantly reduced revenue and utilization rates, and our projections reflected a more delayed recovery than previously anticipated, we performed impairment testing on all the SCR drilling rigs in our fleet, including the eight drilling rigs in Colombia, and our coiled tubing operations as of June 30, 2015. Our analysis at June 30, 2015 indicated that the carrying value of our coiled tubing reporting unit and the carrying value of our domestic pad-capable SCR drilling rigs (those that are equipped with either a walking or skidding system) were recoverable and thus there was no impairment present at June 30, 2015. However, our analysis at June 30, 2015 indicated that the carrying values of our then six SCR drilling rigs in our domestic fleet which were not pad-capable, and our Colombian assets as a group, exceeded our estimated undiscounted cash flows for these assets. As a result, we recognized impairment charges of $50.2 million to reduce the carrying values of all eight drilling rigs in Colombia and related drilling equipment, $3.6 million to reduce the carrying value of inventory in Colombia, $6.4 million to reduce the carrying value of nonrecoverable prepaid taxes associated with our Colombian operations, and $9.7 million to reduce the carrying values of our then six SCR drilling rigs that were not pad-capable, to their estimated fair values, which were based on market appraisals. Three of these SCR drilling rigs that were not pad-capable were subsequently sold in 2015, one was placed as held for sale at December 31, 2015, and the remaining two were retired in 2016. Our projected cash flows declined further as compared to our projections made earlier in the year and at September 30, 2015, we again performed impairment testing on our coiled tubing operations and seven drilling rigs, including our domestic pad-capable SCR rigs, and determined that our carrying values in these assets were recoverable but at risk for future impairment. As the downturn persisted through the remainder of 2015, we again performed impairment testing on these assets at December 31, 2015. As a result, we recognized $14.3 million of impairment related to our coiled tubing intangibles, $16.6 million of impairment to reduce the carrying values of our coiled tubing units and equipment to their estimated fair value, based on market appraisals, and $18.6 million to reduce the carrying values of our then six domestic pad-capable SCR rigs to their estimated fair values, which were also based on market appraisals. Of these six domestic SCR rigs, one was subsequently sold in 2015, three were sold in 2016 and the remaining two were placed as held for sale at December 31, 2016. Business conditions and our projected cash flows for our Colombian operations improved as compared to the projections used for the impairment analysis in 2015, therefore we did not perform any impairment testing on this business in 2016. However, due to lower than anticipated operating results in 2016 and a decline in our projected cash flows for the coiled tubing reporting unit, we performed an impairment analysis of our coiled tubing long-lived assets at September 30, 2016 which indicated that our projected net undiscounted cash flows associated with the coiled tubing reporting unit were in excess of the net carrying value of the assets, and thus no impairment was present. During the years ended December 31, 2016, 2015 and 2014, we recognized impairment charges of $11.9 million, $9.9 million, and $2.0 million, respectively, to reduce the carrying values of assets which were classified as held for sale, to their estimated fair values, based on expected sales prices. During the year ended December 31, 2016, we also recognized $0.9 million of impairment charges to reduce the carrying value of a portion of steel that is on hand for the construction of drilling rigs, which we no longer believe is likely to be used. The following table summarizes impairment charges recognized during the years ended December 31, 2016, 2015, and 2014 (amounts in thousands): In order to estimate our future undiscounted cash flows from the use and eventual disposition of our drilling assets, we incorporated probabilities of selling these assets in the near term, versus working them at a significantly reduced expected rate of utilization through the end of their remaining useful lives. The most significant assumptions used in our analysis are the expected margin per day and utilization, as well as the estimated proceeds upon any future sale or disposal of the assets. We used an income approach to estimate the fair value of our coiled tubing services reporting unit. The most significant inputs used in our impairment analysis of our coiled tubing operations include the projected utilization and pricing of our coiled tubing services, which are classified as Level 3 inputs as defined by Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures. Although we believe the assumptions and estimates used in our impairment analyses are reasonable and appropriate, different assumptions and estimates could materially impact the analyses and resulting conclusions. The assumptions used in the impairment evaluation for long-lived assets are inherently uncertain and require management judgment. These impairment charges are not expected to have an impact on our liquidity or debt covenants; however, they are a reflection of the overall downturn in our industry and decline in our projected future cash flows. If the demand for our services remains at current levels or declines further and any of our assets become or remain idle for an extended amount of time, then our estimated cash flows may further decrease, and the probability of a near term sale may increase. If any of the foregoing were to occur, we may incur additional impairment charges. 3. Debt Our debt consists of the following (amounts in thousands): Senior Secured Revolving Credit Facility We have a credit agreement, as most recently amended on June 30, 2016, with Wells Fargo Bank, N.A. and a syndicate of lenders which provides for a senior secured revolving credit facility, with sub-limits for letters of credit and swing-line loans, of up to a current aggregate commitment amount of $150 million, subject to availability under a borrowing base comprised of certain eligible cash, certain eligible receivables, certain eligible inventory, and certain eligible equipment of ours and certain of our subsidiaries, all of which matures in March 2019 (the “Revolving Credit Facility”). The Revolving Credit Facility contains customary mandatory prepayments from the proceeds of certain asset dispositions or equity or debt issuances, which are applied to reduce outstanding revolving and swing-line loans and to cash-collateralize letter of credit exposure, and in certain cases, also reduce the commitment amount available. In December 2016, we sold 12,075,000 shares of common stock in a public offering, which resulted in proceeds of approximately $65.4 million, net of underwriting discounts and offering expenses, under the shelf registration statement filed in May 2015. In accordance with the Revolving Credit Facility terms, all of the proceeds were applied to reduce the outstanding borrowing balance, and the total commitment amount available was reduced from $175 million to $150 million. Borrowings under the Revolving Credit Facility bear interest, at our option, at the LIBOR rate or at the bank prime rate, plus an applicable per annum margin of 5.50% and 4.50%, respectively. The Revolving Credit Facility requires a commitment fee due quarterly based on the average daily unused amount of the commitments of the lenders, a fronting fee due for each letter of credit issued, and a quarterly letter of credit fee due based on the average undrawn amount of letters of credit outstanding during such period. Additionally, the Revolving Credit Facility requires that if on the last business day of each week, our aggregate amount of cash at the end of the preceding day (as calculated pursuant to the Revolving Credit Facility) exceeds $20 million, we pay down the outstanding principal balance by the amount of such excess. Our obligations under the Revolving Credit Facility are secured by substantially all of our domestic assets (including equity interests in Pioneer Global Holdings, Inc. and 65% of the outstanding voting equity interests, and 100% of non-voting equity interests, of any first-tier foreign subsidiaries owned by Pioneer Global Holdings, Inc., but excluding any equity interest in, and any assets of, Pioneer Services Holdings, LLC) and are guaranteed by certain of our domestic subsidiaries, including Pioneer Global Holdings, Inc. Borrowings under the Revolving Credit Facility are available for acquisitions, working capital and other general corporate purposes. As of January 31, 2017, we had $49.7 million outstanding under our Revolving Credit Facility and $11.8 million in committed letters of credit, which resulted in borrowing availability of $88.5 million under our Revolving Credit Facility. There are no limitations on our ability to access the borrowing capacity provided there is no default, all representations and warranties are true and correct, and compliance with financial covenants under the Revolving Credit Facility is maintained. At December 31, 2016, we were in compliance with our financial covenants under the Revolving Credit Facility. The financial covenants contained in our Revolving Credit Facility include the following: • A maximum senior consolidated leverage ratio, calculated as senior consolidated debt at the period end, which excludes unsecured and subordinated debt, divided by EBITDA for the trailing twelve month period at each quarter end, as defined in the Revolving Credit Facility. The senior consolidated leverage ratio cannot exceed the maximum amounts as follows: • A minimum interest coverage ratio, calculated as EBITDA for the trailing twelve month period at each quarter end, as defined in the Revolving Credit Facility, divided by interest expense for the same period. The interest coverage ratio cannot be less than the minimum amounts as follows: • A minimum EBITDA requirement, for the periods indicated, as defined in the Revolving Credit Facility. EBITDA required at the end of forthcoming fiscal quarters cannot be less than the minimum amounts as follows: The Revolving Credit Facility restricts capital expenditures to the following amounts during each forthcoming fiscal year as follows: The capital expenditure threshold for each of the fiscal years above may be increased by up to 50% of the unused portion of the capital expenditure threshold for the immediate preceding fiscal year, limited to a maximum of $5 million in 2017, and $7.5 million in each of the years 2018 and 2019. In addition to the above requirements, additional capital expenditures may be made up to the amount of net proceeds from equity issuances, or if the following conditions are satisfied: • the aggregate outstanding commitments under the Revolving Credit Facility do not exceed $150 million; • the pro forma senior leverage and total leverage ratios, calculated as defined in the Revolving Credit Facility, are less than 2.00 to 1.00 and 4.50 to 1.00, respectively. Pursuant to the terms above, our capital expenditures are limited to a total of $101.7 million for the fiscal year 2017. The Revolving Credit Facility has additional restrictive covenants that, among other things, limit our ability to: • incur additional debt or make prepayments of existing debt; • create liens on or dispose of our assets; • pay dividends on stock or repurchase stock; • enter into acquisitions, mergers, consolidations, sale leaseback transactions, or hedging contracts; • make other restricted investments; • conduct transactions with affiliates; and • limits our use of the net proceeds of any offering of our equity securities to the repayment of debt outstanding under the Revolving Credit Facility. In addition, the Revolving Credit Facility contains customary events of default, including without limitation: •payment defaults; •breaches of representations and warranties; •covenant defaults; •cross-defaults to certain other material indebtedness in excess of specified amounts; •certain events of bankruptcy and insolvency; •judgment defaults in excess of specified amounts; •failure of any guaranty or security document supporting the credit agreement; and •change of control. Senior Notes In 2014, we issued $300 million of unregistered senior notes with a coupon interest rate of 6.125% that are due in 2022 (the “Senior Notes”). The Senior Notes were sold at 100% of their face value. After deductions were made for the $6.1 million for underwriters’ fees and other debt offering costs, we received $293.9 million of net proceeds. In order to reduce our overall interest expense and lengthen the overall maturity of our senior indebtedness, during 2014, we redeemed all of our then outstanding $425 million of unregistered senior notes with a coupon interest rate of 9.875% that were issued in 2010 and 2011 and were set to mature in 2018, funded primarily by proceeds from the issuance of Senior Notes in 2014 and additional borrowings under our Revolving Credit Facility, as well as some cash on hand. The Senior Notes will mature on March 15, 2022 with interest due semi-annually in arrears on March 15 and September 15 of each year. We have the option to redeem the Senior Notes, in whole or in part, at any time on or after March 15, 2017 in each case at the redemption price specified in the Indenture dated March 18, 2014 (the “Indenture”) plus any accrued and unpaid interest and any additional interest (as defined in the Indenture) thereon to the date of redemption. Prior to March 15, 2017, we may also redeem the Senior Notes, in whole or in part, at a “make-whole” redemption price specified in the Indenture, plus any accrued and unpaid interest and any additional interest thereon to the date of redemption. In addition, prior to March 15, 2017, we may, on one or more occasions, redeem up to 35% of the aggregate principal amount of the Senior Notes at a redemption price equal to 106.125% of the principal amount thereof, plus accrued and unpaid interest and additional interest, if any, to the redemption date, with the net cash proceeds of certain equity offerings, provided that at least 65% of the aggregate principal amount of the Senior Notes remains outstanding after the occurrence of such redemption and that the redemption occurs within 120 days of the date of the closing of such equity offering. In accordance with a registration rights agreement with the holders of our Senior Notes, we filed an exchange offer registration statement on Form S-4 with the Securities and Exchange Commission that became effective on October 2, 2014. The exchange offer registration statement enabled the holders of our Senior Notes to exchange their senior notes for publicly registered notes with substantially identical terms. References to the “Senior Notes” herein include the senior notes issued in the exchange offer. If we experience a change of control (as defined in the Indenture), we will be required to make an offer to each holder of the Senior Notes to repurchase all or any part of the Senior Notes at a purchase price equal to 101% of the principal amount of each Senior Note, plus accrued and unpaid interest, if any, to the date of repurchase. If we engage in certain asset sales, within 365 days of such sale we will be required to use the net cash proceeds from such sale, to the extent we do not reinvest those proceeds in our business, to make an offer to repurchase the Senior Notes at a price equal to 100% of the principal amount of each Senior Note, plus accrued and unpaid interest to the repurchase date. The Indenture, among other things, limits us and certain of our subsidiaries in our ability to: • pay dividends on stock, repurchase stock, redeem subordinated indebtedness or make other restricted payments and investments; • incur, assume or guarantee additional indebtedness or issue preferred or disqualified stock; • create liens on our or their assets; • enter into sale and leaseback transactions; • sell or transfer assets; • borrow, pay dividends, or transfer other assets from certain of our subsidiaries; • consolidate with or merge with or into, or sell all or substantially all of our properties to any other person; • enter into transactions with affiliates; and • enter into new lines of business. The Senior Notes are not subject to any sinking fund requirements. The Senior Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by certain of our existing domestic subsidiaries and by certain of our future domestic subsidiaries. (See Note 14, Guarantor/Non-Guarantor Condensed Consolidated Financial Statements.) Debt Issuance Costs Costs incurred in connection with the Revolving Credit Facility were capitalized and are being amortized using the straight-line method over the term of the Revolving Credit Facility which matures in March 2019. Costs incurred in connection with the issuance of our Senior Notes were capitalized and are being amortized using the straight-line method (which approximates amortization using the interest method) over the term of the Senior Notes which mature in March 2022. Capitalized debt costs related to the issuance of our long-term debt were approximately $6.5 million and $7.8 million as of December 31, 2016 and 2015, respectively. We recognized approximately $1.8 million, $1.7 million and $2.1 million of associated amortization during the years ended December 31, 2016, 2015 and 2014, respectively. Additionally, during the years ended December 31, 2016 and 2015, we recognized $0.3 million and $2.2 million, respectively, of loss on extinguishment of debt for the write off of unamortized debt issuance costs associated with the reduction of borrowing capacity under our Revolving Credit Facility. During 2014, we recognized a loss on debt extinguishment of $31.2 million for the redemption of the 2010 and 2011 Senior Notes, which included redemption premiums of $21.6 million, $4.8 million of net unamortized discount and $4.8 million of unamortized debt issuance costs. 4. Leases We lease our corporate office facilities in San Antonio, Texas at a payment escalating from $46,502 per month in January 2017 to $50,246 per month beginning in January 2020. We recognize rent expense on a straight-line basis for our corporate office lease. We also lease real estate at 41 other locations, which are primarily used for field offices and storage and maintenance yards, and we lease office and other equipment under non-cancelable operating leases, most of which contain renewal options and some of which contain escalation clauses. Future lease obligations required under non-cancelable operating leases as of December 31, 2016 were as follows (amounts in thousands): During 2015, we ceased use of several location offices which were under long-term leases and recognized an expense in order to accrue the fair value of future lease obligations associated with the facilities which we are no longer using, in accordance with ASC Topic 420, Exit or Disposal Obligations. These accrued lease obligations, which were $0.1 million and $0.3 million as of December 31, 2016 and 2015, respectively, have been included in our current and long-term liabilities, according to the lease terms, and are not reflected in the table above. Including the impact of lease termination penalties, total lease related exit costs incurred for the year ended December 31, 2015 was $0.5 million. Rent expense under operating leases, including rental exit costs, was $5.0 million, $6.2 million and $5.9 million for the years ended December 31, 2016, 2015 and 2014, respectively. 5. Income Taxes The jurisdictional components of loss before income taxes consist of the following (amounts in thousands): The components of our income tax expense (benefit) consist of the following (amounts in thousands): The difference between the income tax benefit and the amount computed by applying the federal statutory income tax rate of 35% to loss before income taxes consists of the following (amounts in thousands): Income tax expense (benefit) was allocated as follows (amounts in thousands): Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements. The components of our deferred income tax assets and liabilities were as follows (amounts in thousands): As of December 31, 2016, we had $131.4 million of deferred tax assets related to domestic and foreign net operating losses that are available to reduce future taxable income. In assessing the realizability of our deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In performing this analysis as of December 31, 2016 in accordance with ASC Topic 740, Income Taxes, we assessed the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit the use of deferred tax assets. A significant piece of objective negative evidence evaluated is the projected cumulative loss incurred over the three-year period ended December 31, 2016. Such objective negative evidence limits the ability to consider other subjective positive evidence, such as projections for taxable income in future years. Due to the continued downturn in our industry, we were in a net deferred tax asset position at the end of 2016, and as a result, we recognized a benefit only to the extent that reversals of deferred income tax liabilities are expected to generate income tax expense in each relevant jurisdiction in future periods which would offset our deferred tax assets. Our domestic net operating losses have a 20 year carryforward period and can be used to offset future domestic taxable income until their expiration, beginning in 2030, with the latest expiration in 2036. However, we determined that a valuation allowance should be recorded against a portion of the benefit generated in 2016. The valuation allowance is the primary factor causing our effective tax rate to be significantly lower than the statutory rate of 35%. The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income are reduced or increased or if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as projected future taxable income. The majority of our foreign net operating losses have an indefinite carryforward period. However, as a result of the conditions leading to the impairment of our assets in Colombia during 2015 and the continued industry downturn, we have a valuation allowance that fully offsets our $21.1 million of foreign deferred tax assets at December 31, 2016. Additionally, we reversed a valuation allowance of $0.7 million related to a deferred tax asset for a capital loss that expired in 2016. Deferred income taxes have not been provided on the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and the respective tax basis of our foreign subsidiary based on the determination that such differences are essentially permanent in duration in that the earnings of the subsidiary is expected to be indefinitely reinvested in foreign operations. As of December 31, 2016, the cumulative undistributed earnings of the subsidiary was a loss of approximately $41.2 million. If earnings were not considered indefinitely reinvested, deferred income taxes would have been recorded after consideration of foreign tax credits. It is not practicable to estimate the amount of additional tax that might be payable on earnings, if distributed. In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, which requires that deferred tax assets and liabilities be classified as noncurrent on the balance sheet rather than being separately presented as current and noncurrent portions. On December 31, 2015, we elected to early adopt ASU No. 2015-17 prospectively, thus reclassifying $6.8 million of current deferred tax assets to noncurrent on the accompanying consolidated balance sheet. On December 23, 2014, the Colombian government enacted a tax reform bill that among other things, increased the tax for equality (“CREE”) rate from 9% to 14% in 2015, 15% in 2016, 17% in 2017 and 18% in 2018. Deferred tax assets and liabilities (with the exception of net operating losses) must now be based on the higher combined income tax rate and CREE rate of 39% in 2015, 40% in 2016, 42% in 2017 and 43% in 2018. However, as of December 31, 2015, we recorded a valuation allowance that fully offsets our foreign deferred tax assets relating to net operating losses and other tax benefits. At this time, a new net-worth tax was also enacted for all Colombian entities. The tax is calculated based on an entity’s net equity as of January 1, 2015. The tax expense is recognized when the net-worth tax is assessed, annually from 2015 through 2017. Based on our Colombian operation's net equity, our net-worth tax obligation was $1.2 million for 2015, $0.7 million for 2016 and is expected to be approximately $0.3 million for 2017. The net worth tax is not deductible for income tax purposes. On December 29, 2016, the Colombian government again enacted a tax reform bill that eliminated the tax for equality (“CREE”), increased the general corporate tax rate from 25% to 40% in 2017, 37% in 2018, 33% in 2019 and created a new 5% dividend tax, among other things. A few other notable provisions include a shorter twelve-year carryforward period for net operating losses generated after 2016, a longer statute of limitations for returns filed after 2016 and annual limits on tax depreciation allowed. We have no unrecognized tax benefits relating to ASC Topic 740 and no unrecognized tax benefit activity during the year ended December 31, 2016. We record interest and penalty expense related to income taxes as interest and other expense, respectively. At December 31, 2016, no interest or penalties have been or are required to be accrued. Our open tax years are 2010 and forward for our federal and most state income tax returns in the United States and 2011 and forward for our income tax returns in Colombia. 6. Fair Value of Financial Instruments The FASB’s Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, defines fair value and provides a hierarchal framework associated with the level of subjectivity used in measuring assets and liabilities at fair value. At December 31, 2016 and December 31, 2015, our financial instruments consist primarily of cash, trade and other receivables, trade payables, phantom stock unit awards which are described in Note 8, Equity Transactions and Stock-Based Compensation Plans, and long-term debt. The carrying value of cash, trade and other receivables, and trade payables are considered to be representative of their respective fair values due to the short-term nature of these instruments. The fair value of our long-term debt is estimated using a discounted cash flow analysis, based on rates that we believe we would currently pay for similar types of debt instruments. This discounted cash flow analysis is based on inputs defined by ASC Topic 820 as level 2 inputs, which are observable inputs for similar types of debt instruments. The following table presents the supplemental fair value information about long-term debt at December 31, 2016 and December 31, 2015 (amounts in thousands): 7. Earnings Per Common Share The following table presents a reconciliation of the numerators and denominators of the basic earnings per share and diluted earnings per share computations (amounts in thousands, except per share data): 8. Equity Transactions and Stock-Based Compensation Plans Equity Transactions In May 2015, we filed a registration statement that permits us to sell equity or debt in one or more offerings up to a total dollar amount of $300 million. In December 2016, we sold 12,075,000 shares of common stock in a public offering, which resulted in proceeds of approximately $65.4 million, net of underwriting discounts and offering expenses, under the shelf registration statement. As of December 31, 2016, $234.6 million under the shelf registration statement is available for equity or debt offerings, subject to the limitations imposed by our Revolving Credit Facility and Senior Notes, as well as our Restated Articles of Incorporation which currently limits our issuance of common stock to 100 million shares. In the future, we may consider equity and/or debt offerings, as appropriate, to meet our liquidity needs. Stock-based Compensation Plans We have stock-based award plans that are administered by the Compensation Committee of our Board of Directors, which selects persons eligible to receive awards and determines the number, terms, conditions and other provisions of the awards. At December 31, 2016, the total shares available for future grants to employees and directors under existing plans were 4,603,268, which excludes awards we grant in the form of phantom stock unit awards which are expected to be paid in cash. For more information about the shares available under existing plans, see Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, of this Annual Report on Form 10-K. In January 2017, our Board of Directors approved the grant of the following awards, each with a three-year vesting term: We grant stock option and restricted stock awards with vesting based on time of service conditions. We grant restricted stock unit awards with vesting based on time of service conditions, and in certain cases, subject to performance and market conditions. In 2016, we granted phantom stock unit awards with vesting based on time of service, performance and market conditions, which were classified as liability awards under ASC Topic 718, Compensation-Stock Compensation since we expect to settle the awards in cash when they become vested. We recognize compensation cost for stock option, restricted stock, restricted stock unit, and phantom stock unit awards based on the fair value estimated in accordance with ASC Topic 718. For our awards with graded vesting, we recognize compensation expense on a straight-line basis over the service period for each separately vesting portion of the award as if the award was, in substance, multiple awards. The following table summarizes the stock-based compensation expense recognized, by award type, and the compensation expense recognized for phantom stock unit awards during the years ended December 31, 2016, 2015 and 2014 (amounts in thousands): The following table summarizes the unrecognized compensation cost (amounts in thousands) to be recognized and the weighted-average period remaining (in years) over which the compensation cost is expected to be recognized, by award type, as of December 31, 2016: Stock Options We grant stock option awards which generally become exercisable over a three-year period and expire ten years after the date of grant. Our stock-based compensation plans require that all stock option awards have an exercise price that is not less than the fair market value of our common stock on the date of grant. We issue shares of our common stock when vested stock option awards are exercised. We estimate the fair value of each option grant on the date of grant using a Black-Scholes option pricing model. The following table summarizes the assumptions used in the Black-Scholes option pricing model based on a weighted-average calculation for the options granted during the years ended December 31, 2016, 2015 and 2014: The assumptions used in the Black-Scholes option pricing model are based on multiple factors, including historical exercise patterns of homogeneous groups with respect to exercise and post-vesting employment termination behaviors, expected future exercising patterns for these same homogeneous groups and volatility of our stock price. As we have not declared dividends since we became a public company, we did not use a dividend yield. In each case, the actual value that will be realized, if any, will depend on the future performance of our common stock and overall stock market conditions. There is no assurance the value an optionee actually realizes will be at or near the value we have estimated using the Black-Scholes options-pricing model. The following table summarizes our stock option activity from December 31, 2015 through December 31, 2016: The aggregate intrinsic value of stock options exercised during the years ended December 31, 2016, 2015 and 2014 was $12 thousand, $0.4 million and $5.6 million, respectively. We receive a tax deduction for certain stock option exercises during the period the options are exercised, generally for the excess of the fair market value of our stock on the date of exercise over the exercise price of the options. In accordance with ASC Topic 718, when we have excess tax benefits resulting from the exercise of stock options, we report them as financing cash flows in our consolidated statement of cash flows, unless otherwise disallowed under ASC Topic 740, Income Taxes. The following table summarizes our nonvested stock option activity from December 31, 2015 through December 31, 2016: Restricted Stock We grant restricted stock awards that vest over a one-year period with a fair value based on the closing price of our common stock on the date of the grant. When restricted stock awards are granted, or when restricted stock unit awards are converted to restricted stock, shares of our common stock are considered issued, but subject to certain restrictions. The weighted-average grant-date fair value per share of restricted stock awards granted during the years ended December 31, 2016, 2015 and 2014 were $2.76, $7.40 and $14.33, respectively. The aggregate fair value of restricted stock awards vested during these same periods were $0.1 million, $0.4 million and $1.3 million, respectively. The following table summarizes our restricted stock activity from December 31, 2015 through December 31, 2016: Restricted Stock Units We grant restricted stock unit awards with vesting based on time of service conditions only (“time-based RSUs”), and we grant restricted stock unit awards with vesting based on time of service, which are also subject to performance and market conditions (“performance-based RSUs”). Shares of our common stock are issued to recipients of restricted stock units only when they have satisfied the applicable vesting conditions. Our time-based RSUs generally vest over a three-year period, with fair values based on the closing price of our common stock on the date of grant. Our performance-based RSUs generally cliff vest after 39 months from the date of grant and are granted at a target number of issuable shares, for which the final number of shares of common stock is adjusted based on our actual achievement levels that are measured against predetermined performance conditions. The number of shares of common stock awarded will be based upon the Company’s achievement in certain performance conditions, as compared to a predefined peer group, over the performance period, generally three years. Approximately half of the performance-based RSUs outstanding are subject to a market condition based on relative total shareholder return, as compared to that of our predetermined peer group, and therefore the fair value of these awards is measured using a Monte Carlo simulation model. Compensation expense for equity awards with a market condition is reduced only for estimated forfeitures; no adjustment to expense is otherwise made, regardless of the number of shares issued. The remaining performance-based RSUs are subject to performance conditions, based on our EBITDA and return on capital employed, relative to our predetermined peer group, and therefore the fair value is based on the closing price of our common stock on the date of grant, applied to the estimated number of shares that will be awarded. Compensation expense ultimately recognized for awards with performance conditions will be equal to the fair value of the restricted stock unit award based on the actual outcome of the service and performance conditions. In April 2016, we determined that 72% of the target number of shares granted during 2013 were actually earned based on the Company’s achievement of the performance measures as described above, resulting in a reduction of 75,757 shares being issued. As of December 31, 2016, we estimate that our actual achievement level for our outstanding performance-based RSUs will be approximately 100% of the predetermined performance conditions. The following table summarizes our restricted stock unit activity from December 31, 2015 through December 31, 2016: The following table presents the weighted-average grant-date fair value per share of restricted stock units granted and the aggregate intrinsic value of restricted stock units vested (converted) during the years ended December 31, 2016, 2015 and 2014: Phantom Stock Unit Awards In 2016, we granted 1,268,068 phantom stock unit awards that cliff-vest after 39 months from the date of grant, with vesting based on time of service, performance and market conditions. The number of units ultimately awarded will be based upon the Company’s achievement in certain performance conditions, as compared to a predefined peer group, over the three-year performance period, and each unit awarded will entitle the employee to a cash payment equal to the stock price of our common stock on the date of vesting, subject to a maximum of four times the stock price on the date of grant. These awards are classified as liability awards under ASC Topic 718, Compensation-Stock Compensation, because we expect to settle the awards in cash when they vest, and are remeasured at fair value at each reporting period until they vest. Approximately half of the phantom stock unit awards granted are subject to a market condition based on relative total shareholder return, as compared to that of our predetermined peer group, and therefore the fair value of these awards is measured using a Monte Carlo simulation model. The remaining phantom stock unit awards are subject to performance conditions, based on our EBITDA and return on capital employed, relative to our predetermined peer group, and the fair value of these awards is measured using a Black-Scholes pricing model. The fair value of these awards is measured using inputs that are defined as Level 3 inputs under ASC Topic 820, Fair Value Measurements and Disclosures. 9. Employee Benefit Plans and Insurance We maintain a 401(k) retirement plan for our eligible employees. Under this plan, we may make a matching contribution, on a discretionary basis, equal to a percentage of each eligible employee’s annual contribution, which we determine annually. Our matching contributions for the years ended December 31, 2016, 2015 and 2014 were $0.3 million, $4.2 million and $6.4 million, respectively. Effective February 1, 2016, in an effort to reduce costs in response to the downturn in our industry, we suspended matching contributions. This benefit was reinstated in January 2017. We maintain a self-insurance program, for major medical and hospitalization coverage for employees and their dependents, which is partially funded by employee payroll deductions. We have provided for reported claims costs as well as incurred but not reported medical costs in the accompanying consolidated balance sheets. We have a maximum liability of $200,000 per covered individual per year. Amounts in excess of the stated maximum are covered under a separate policy provided by an insurance company. Accrued insurance premiums and deductibles at December 31, 2016 and 2015 include $2.0 million and $2.4 million, respectively, for our estimate of incurred but unpaid costs related to the self-insurance portion of our health insurance. We are self-insured for up to $500,000 per incident for all workers’ compensation claims submitted by employees for on-the-job injuries. We accrue our workers’ compensation claim cost estimates based on historical claims development data and we accrue the cost of administrative services associated with claims processing. We also have a deductible of $250,000 per occurrence under both our general liability insurance and auto liability insurance. Accrued insurance premiums and deductibles at December 31, 2016 and 2015 include $4.4 million and $5.5 million, respectively, for our estimate of costs relative to the self-insured portion of our workers’ compensation, general liability and auto liability insurance. Based upon our past experience, management believes that we have adequately provided for potential losses. However, future multiple occurrences of serious injuries to employees could have a material adverse effect on our financial position and results of operations. 10. Segment Information We have two operating segments referred to as the Drilling Services Segment and the Production Services Segment which is the basis management uses for making operating decisions and assessing performance. Our Drilling Services Segment provides contract land drilling services to a diverse group of exploration and production companies through our four drilling divisions in the US, and internationally in Colombia. In addition to our drilling rigs, we provide the drilling crews and most of the ancillary equipment needed to operate our drilling rigs. Our Production Services Segment provides a range of services, including well servicing, wireline services and coiled tubing services, to a diverse group of exploration and production companies, with our operations concentrated in the major United States onshore oil and gas producing regions in the Mid-Continent and Rocky Mountain states and in the Gulf Coast, both onshore and offshore. The following table sets forth certain financial information for our two operating segments and corporate as of and for the years ended December 31, 2016, 2015 and 2014 (amounts in thousands): The following table reconciles the consolidated margin of our two operating segments and corporate reported above to income (loss) from operations as reported on the consolidated statements of operations for the years ended December 31, 2016, 2015 and 2014 (amounts in thousands): The following table sets forth certain financial information for our international operations in Colombia as of and for the years ended December 31, 2016, 2015 and 2014 (amounts in thousands): Identifiable assets for our international operations in Colombia include five drilling rigs that are owned by our Colombia subsidiary and three drilling rigs that are owned by one of our domestic subsidiaries and leased to our Colombia subsidiary. 11. Commitments and Contingencies In connection with our operations in Colombia, our foreign subsidiaries have obtained bonds for bidding on drilling contracts, performing under drilling contracts, and remitting customs and importation duties. We have guaranteed payments of $36.3 million relating to our performance under these bonds as of December 31, 2016. We have received an increased number of notices in recent years from state taxing authorities for audits of sales and use tax obligations. We are currently undergoing sales and use tax audits for multi-year periods and we are working to resolve all relevant issues. As of both December 31, 2016 and December 31, 2015, our accrued liability was $0.6 million based on our estimate of the sales and use tax obligations that are expected to result from these audits. Due to the inherent uncertainty of the audit process, we believe that it is reasonably possible that we may incur additional tax assessments with respect to one or more of the audits in excess of the amount accrued. We believe that such an outcome would not have a material adverse effect on our results of operations or financial position. Because certain of these audits are in a preliminary stage, an estimate of the possible loss or range of loss from an adverse result in all or substantially all of these cases cannot reasonably be made. Due to the nature of our business, we are, from time to time, involved in litigation or subject to disputes or claims related to our business activities, including workers’ compensation claims and employment-related disputes. Legal costs relating to these matters are expensed as incurred. In the opinion of our management, none of the pending litigation, disputes or claims against us will have a material adverse effect on our financial condition, results of operations or cash flow from operations. 12. Sale of Fishing and Rental Services Operations On September 17, 2014, we entered into an asset sales agreement with Basic Energy Services L.P. (“Basic”) for the sale of our fishing and rental services (“F&R”) operations for total consideration of $16.1 million, which consisted of $15.1 million of cash received at closing and $1.0 million which was held in escrow for a period of 180 days. Under the terms of the sales agreement, Basic purchased two real estate locations and all F&R tools and equipment for which we had a total net book value of $4.3 million at the date of sale. We recognized a $10.7 million gain on the sale of our F&R operations, which net of income taxes was $6.6 million. Cash proceeds from the sale were used to repay long-term debt obligations. For the nine months ended September 30, 2014, F&R operations represented approximately 1% of our consolidated revenues and approximately 1% of our consolidated pretax income. Total assets for F&R at the date of sale represented less than 1% of our total assets at September 30, 2014. The sale of the F&R operations did not represent a strategic shift for our company, did not have a significant effect on our operating results, and did not represent discontinued operations based on the criteria of ASU No. 2014-08, Discontinued Operations. Statement of operations information for the F&R operations is as follows for the year ended December 31, 2014 (amounts in thousands): 13. Quarterly Results of Operations (unaudited) The following table summarizes quarterly financial data for the years ended December 31, 2016 and 2015 (in thousands, except per share data): 14. Guarantor/Non-Guarantor Condensed Consolidating Financial Statements Our Senior Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by all existing wholly owned domestic subsidiaries, except for Pioneer Services Holdings, LLC. The subsidiaries that generally operate our non-U.S. business concentrated in Colombia do not guarantee our Senior Notes. The non-guarantor subsidiaries do not have any payment obligations under the Senior Notes, the guarantees or the Indenture. In the event of a bankruptcy, liquidation or reorganization of any non-guarantor subsidiary, such non-guarantor subsidiary will pay the holders of its debt and other liabilities, including its trade creditors, before it will be able to distribute any of its assets to us. In the future, any non-U.S. subsidiaries, immaterial subsidiaries and subsidiaries that we designate as unrestricted subsidiaries under the Indenture will not guarantee the Senior Notes. As of December 31, 2016, there were no restrictions on the ability of subsidiary guarantors to transfer funds to the parent company. As a result of the guarantee arrangements, we are presenting the following condensed consolidating balance sheets, statements of operations and statements of cash flows of the issuer, the guarantor subsidiaries and the non-guarantor subsidiaries. CONDENSED CONSOLIDATING BALANCE SHEETS (in thousands) CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (in thousands) CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (Continued) (in thousands) CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (in thousands) CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (Continued) (in thousands) | Here's a summary of the financial statement:
Key Components:
1. Revenue
- Primarily derived from drilling oil and gas wells
- Services provided under daywork or turnkey contracts
- Individual well contracts typically completed in under 30 days
2. Profit/Loss
- Includes foreign currency translation adjustments
- Affected by remeasurement of foreign currency financial statements to USD
3. Expenses
Key areas of estimation include:
- Revenue and costs for turnkey contracts
- Allowance for doubtful accounts
- Depreciation and amortization
- Insurance liabilities
- Sales tax audit liability
- Compensation accruals
4. Assets
Current Assets:
- Prepaid expenses (insurance, rent deposits, fees)
- Deferred mobilization costs
Fixed Assets:
- Property and equipment at cost less depreciation
- Straight-line depreciation method used
- Intangible assets from acquisitions
5. Liabilities
Current Liabilities:
- Property tax
- Sales tax
- Professional fees
Long-term Liabilities:
- Long-term compensation plans
- Deferred lease liabilities
- Deferred mobilization revenues
Additional Notes:
- Treasury stock accounted for under cost method
- Stock-based compensation recognized per ASC Topic 718
- Regular review of financial events through December 31
This statement shows a company primarily involved in oil and gas drilling services with significant international operations and various standard business operations and accounting practices. | Claude |
. BLUE SPA INCORPORATED (A Development Stage Company) Financial Statements May 31, 2016 (Audited) Contents Blue Spa IncorporatedForm 10-K - 2016Page 10 ACCOUNTING FIRM To the Board of Directors and Stockholders of BLUE SPA INCORPORATED We have audited the accompanying balance sheet of Blue SPA incorporated (the “Company”) as of May 31, 2016, and the related statements of income, stockholders’ equity and cash flows for the year ended May 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. And audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management. As well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of May 31, 2016, and the results of its operations and its cash flows for the years then ended in conformity with United States generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company is in the development stage and has limited operations. Its ability to continue as a going concern is dependent upon its ability to obtain additional financing and/or achieve a sustainable profitable level of operations. These conditions raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. DCAW (CPA) Limited Certified Public Accountants Hong Kong, 26 August, 2016 Blue Spa IncorporatedForm 10-K - 2016Page BLUE SPA INCORPORATED BALANCE SHEETS See accompanying notes to financial statements Blue Spa IncorporatedForm 10-K - 2016Page BLUE SPA INCORPORATED STATEMENTS OF OPERATIONS See accompanying notes to financial statements Blue Spa IncorporatedForm 10-K - 2016Page BLUE SPA INCORPORATED STATEMENTS OF STOCKHOLDERS’ DEFICIT AND COMPREHENSIVE INCOME See accompanying notes to financial statements Blue Spa IncorporatedForm 10-K - 2016Page BLUE SPA INCORPORATED STATEMENTS OF CASH FLOWS See accompanying notes to financial statements Blue Spa IncorporatedForm 10-K - 2016Page BLUE SPA INCORPORATED NOTES TO FINANCIAL STATEMENTS MAY 31, 2016 1.Organization and Nature of Operations Blue Spa Incorporated (“the Company”) was incorporated in the State of Nevada, USA on September 4, 2009. The Company is in its early developmental stage since its formation and has not realized any revenues from its planned operations. The Company is engaged in the development of an internet based retailer of a multi-channel concept combining a wholesale distribution with a retail strategy. It plans to distribute quality personal care products, fitness apparel and related accessories. The Company has chosen a fiscal year end May 31. 2.Going Concern These interim financial statements have been prepared in conformity with generally accepted accounting principles in the United States, which contemplate continuation of the Company as a going concern. However, the Company has limited operations and has sustained operating losses resulting in a deficit. In view of these matters, realization of a major portion of the assets in the accompanying balance sheet is dependent upon the continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its financing requirements, and the success of its future operations. The Company has accumulated a deficit of $229,097 since inception September 4, 2009, has yet to achieve profitable operations and further losses are anticipated in the development of its business. The Company’s ability to continue as a going concern is in substantial doubt and is dependent upon obtaining additional financing and/or achieving a sustainable profitable level of operations. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. The Company believes that the cash on hand will be able to meet its on-going costs in the next 12 months. The Company may seek additional equity as necessary and it expects to raise funds through private or public equity investment in order to support existing operations and expand the range of its business. There is no assurance that such additional funds will be available for the Company on acceptable terms, if at all. 3.Summary of principal accounting policies Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Management makes its best estimate of the ultimate outcome for these items based on historical trends and other information available when the financial statements are prepared. Changes in estimates are recognized in accordance with the accounting rules for the estimate, which is typically in the period when new information becomes available to management. Actual results could differ from those estimates. Foreign currency translations The Company is located and operating outside of the United States of America. The functional currency of the Company is the U.S. Dollar. At the transaction date, each asset, liability, revenue and expense is translated into U.S. dollars by the use of the exchange rate in effect at that date. At the period end, monetary assets and liabilities are re-measured by using the exchange rate in effect at that date. The resulting foreign exchange gains and losses are included in operations. Blue Spa IncorporatedForm 10-K - 2016Page Cash and cash equivalents The Company considers all short-term highly liquid investments that are readily convertible to known amounts of cash and have original maturities of three months or less to be cash equivalents. Comprehensive income The Company has adopted ASU 220 “Reporting Comprehensive Income”, which establishes standards for reporting and display of comprehensive income, its components and accumulated balances. The Company is disclosing this information on its Statement of Stockholders’ Equity. Comprehensive income comprises equity except those resulting from investments by owners and distributions to owners. For the year ended May 31, 2016 there are no reconciling items between the net loss presented in the statements of operations and comprehensive loss as defined by ASU 220. Loss per share The Company reports basic loss per share in accordance with ASC Topic 260 Earnings Per Share (“EPS”). Basic loss per share is based on the weighted average number of common shares outstanding and diluted EPS is based on the weighted average number of common shares outstanding and dilutive common stock equivalents. Basic EPS is computed by dividing net loss (numerator) applicable to common stockholders by the weighted average number of common shares outstanding (denominator) for the period. All EPS presented in the financial statements are basic EPS as defined by ASU 260, “Earnings Per Share”. There are no diluted net income/ (loss) per share on the potential exercise of the equity-based financial instruments, hence a state of anti-dilution has occurred. All per share and per share information are adjusted retroactively to reflect stock splits and changes in par value. Income Taxes The Company follows the guideline under ASC Topic 740 Income Taxes. “Accounting for Income Taxes” which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. Since the Company is in the developmental stage and has losses, no deferred tax asset or income taxes have been recorded in the financial statements. Blue Spa IncorporatedForm 10-K - 2016Page Website Development Costs The Company recognized the costs associated with developing a website in accordance with ASC 350-50 “Website Development Cost” that codified the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) NO. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use”. Relating to website development costs the Company follows the guidance pursuant to the Emerging Issues Task Force (EITF) NO. 00-2, “Accounting for Website Development Costs”. The website development costs are divided into three stages, planning, development and production. The development stage can further be classified as application and infrastructure development, graphics development and content development. In short, website development cost for internal use should be capitalized except content input and data conversion costs in content development stage. Costs associated with the website consist primarily of website development costs paid to third party. These capitalized costs will be amortized based on their estimated useful life over three years upon the website becoming operational. Internal costs related to the development of website content will be charged to operations as incurred. Web-site development costs related to the customers are charged to cost of sales. Concentration of credit risk The Company places its cash and cash equivalents with a high credit quality financial institution. The Company maintains United States Dollars. The Company minimizes its credit risks associated with cash by periodically evaluating the credit quality of its primary financial institution. Recently issued accounting pronouncements The Company adopts new pronouncements relating to generally accepted accounting principles applicable to the Company as they are issued, which may be in advance of their effective date. Management does not believe that any pronouncement not yet effective but recently issued would, if adopted, have a material effect on the accompanying financial statements. 4.Accrued expenses Accrued expenses as of May 31, 2016 are summarized as follows: 5.Common stock During the year ended May 31, 2016, no shares of common stock were sold. There were a total of 7,000,000 common stocks issued and outstanding as of May 31, 2016. There were no warrants or stock options outstanding as of May 31, 2016. Blue Spa IncorporatedForm 10-K - 2016Page 6.Notes payable There are seven (7) unsecured promissory notes bearing interest at 8% per annum which are due on demand. There are six (6) unsecured promissory notes bearing interest at 8% per annum which are due on demand, and convertible at a conversion price of US$0.005 per share at the lender’s option. The convertible notes are at the same interest rate as promissory notes that have no conversion feature. Blue Spa IncorporatedForm 10-K - 2016Page | Here's a summary of the financial statement:
Financial Highlights:
- The company has accumulated a significant deficit of $229,097
- The company's asset realization depends on continued operations
- Continued operations are contingent on meeting financing requirements and future operational success
Accounting Approach:
- Management uses estimates based on historical trends and available information
- Estimates may change as new information becomes available
- Actual results may differ from estimated figures
Currency Considerations:
- Company operates outside the United States
- Functional currency is U.S. Dollar
- Assets, liabilities, revenues, and expenses are translated using exchange rates at transaction and period-end dates
- Foreign exchange gains and losses are included in operations
Overall Tone: The financial statement suggests financial challenges, with the company's future dependent on securing financing and improving operational performance. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA THE BRINK’S COMPANY CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2016 MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control - Integrated Framework (2013).” Based on this assessment, our management believes that, as of December 31, 2016, our internal control over financial reporting is effective based on the COSO criteria. KPMG LLP, the independent registered public accounting firm which audits our consolidated financial statements, has issued an attestation report of our internal control over financial reporting. KPMG’s attestation report appears on page 62. Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders The Brink’s Company: We have audited The Brink’s Company’s (the Company) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, The Brink’s Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of The Brink’s Company and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for each of the years in the three-year period ended December 31, 2016, and our report dated February 23, 2017, expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP Richmond, Virginia February 23, 2017 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders The Brink’s Company: We have audited the accompanying consolidated balance sheets of The Brink’s Company and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Brink’s Company and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), The Brink’s Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 23, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ KPMG LLP Richmond, Virginia February 23, 2017 THE BRINK’S COMPANY and subsidiaries Consolidated Balance Sheets See accompanying notes to consolidated financial statements. THE BRINK’S COMPANY and subsidiaries Consolidated Statements of Operations (a) Amounts may not add due to rounding. See accompanying notes to consolidated financial statements. THE BRINK’S COMPANY and subsidiaries Consolidated Statements of Comprehensive Income (Loss) See accompanying notes to consolidated financial statements. THE BRINK’S COMPANY and subsidiaries Consolidated Statements of Equity Years Ended December 31, 2016, 2015 and 2014 (a) We elected to early adopt the provisions of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, in the fourth quarter of 2016 resulting in a cumulative effect adjustment to Retained Earnings for previously unrecognized excess tax benefits. See Note 1 for further discussion of the impacts of this standard. See accompanying notes to consolidated financial statements. THE BRINK’S COMPANY and subsidiaries Consolidated Statements of Cash Flows See accompanying notes to consolidated financial statements. THE BRINK’S COMPANY and subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Summary of Significant Accounting Policies Basis of Presentation The Brink’s Company (along with its subsidiaries, “we,” “our,” “Brink’s” or the “Company”), based in Richmond, Virginia, is a leading provider of secure transportation, cash management services and other security-related services to banks and financial institutions, retailers, government agencies, mints, jewelers and other commercial operations around the world. Brink’s is the oldest and largest secure transportation and cash management services company in the U.S., and a market leader in many other countries. Principles of Consolidation The consolidated financial statements include the accounts of Brink’s and the subsidiaries it controls. Control is determined based on ownership rights or, when applicable, based on whether we are considered to be the primary beneficiary of a variable interest entity. Our interest in 20% to 50% owned companies that are not controlled are accounted for using the equity method (“equity affiliates”), unless we do not sufficiently influence the management of the investee. Other investments are accounted for as cost-method investments or as available-for-sale investments. All significant intercompany accounts and transactions have been eliminated in consolidation. Revenue Recognition Revenue is recognized when services related to armored vehicle transportation, ATM services, Cash Management Services, payment services, guarding and the secure international transportation of valuables are performed. Customer contracts have prices that are fixed and determinable and we assess the customer’s ability to meet the contractual terms, including payment terms, before entering into contracts. Taxes collected from customers and remitted to governmental authorities are not included in revenues in the consolidated statements of operations. Cash and Cash Equivalents Cash and cash equivalents include cash on hand, demand deposits and investments with original maturities of three months or less. Cash and cash equivalents include amounts held by certain of our secure Cash Management Services operations for customers for which, under local regulations, the title transfers to us for a short period of time. The cash is generally credited to customers’ accounts the following day and we do not consider it as available for general corporate purposes in the management of our liquidity and capital resources. We record a liability for the amounts owed to customers (see Note 11). Trade Accounts Receivable Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses on our existing accounts receivable. We determine the allowance based on historical write-off experience. We review our allowance for doubtful accounts quarterly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Property and Equipment Property and equipment are recorded at cost. Depreciation is calculated principally on the straight-line method based on the estimated useful lives of individual assets or classes of assets. Leased property and equipment meeting capital lease criteria are capitalized at the lower of the present value of the related lease payments or the fair value of the leased asset at the inception of the lease. Amortization is calculated on the straight-line method based on the lease term. Leasehold improvements are recorded at cost. Amortization is calculated principally on the straight-line method over the lesser of the estimated useful life of the leasehold improvement or the lease term. Renewal periods are included in the lease term when the renewal is determined to be reasonably assured. Part of the costs related to the development or purchase of internal-use software is capitalized and amortized over the estimated useful life of the software. Costs that are capitalized include external direct costs of materials and services to develop or obtain the software, and internal costs, including compensation and employee benefits for employees directly associated with a software development project. Expenditures for routine maintenance and repairs on property and equipment are charged to expense. Major renewals, betterments and modifications are capitalized and depreciated over the lesser of the remaining life of the asset or, if applicable, the lease term. Goodwill and Other Intangible Assets Goodwill is recognized for the excess of the purchase price over the fair value of tangible and identifiable intangible net assets of businesses acquired. Intangible assets arising from business acquisitions include customer lists, customer relationships, covenants not to compete, trademarks and other identifiable intangibles. At December 31, 2016, finite-lived intangible assets have remaining useful lives ranging from 1 to 11 years and are amortized based on the pattern in which the economic benefits are used or on a straight-line basis. Impairment of Goodwill and Long-Lived Assets Goodwill is not amortized but is tested at least annually for impairment at the reporting unit level, which is at the operating segment level or one level below an operating segment. Goodwill is assigned to one or more reporting units at the date of acquisition. We have ten reporting units which are comprised of: • each of the five countries within Largest 5 Markets (U.S., France, Mexico, Brazil and Canada), • each of the three regions within Global Markets (Latin America, EMEA and Asia), • the Latin American Payment Services businesses, and • the U.S. Payment Services business We performed goodwill impairment tests on the reporting units that had goodwill as of October 1, 2016. We performed a quantitative analysis to determine whether reporting unit fair values exceeded their carrying amounts. We based our estimates of fair value on projected future cash flows and completed these impairment tests, as well as the tests in the previous two years, with no impairment charges required. Indefinite-lived intangibles are also tested for impairment at least annually by comparing their carrying values to their estimated fair values. We have had no significant impairments of indefinite-lived intangibles in the last three years. Long-lived assets other than goodwill and other indefinite-lived intangibles are reviewed for impairment when events or changes in circumstances indicate the carrying value of an asset may not be recoverable. For long-lived assets other than goodwill that are to be held and used in operations, an impairment is indicated when the estimated total undiscounted cash flow associated with the asset or group of assets is less than carrying value. If impairment exists, an adjustment is made to write the asset down to its fair value, and a loss is recorded as the difference between the carrying value and fair value. Retirement Benefit Plans We account for retirement benefit obligations under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 715, Compensation - Retirement Benefits. For U.S. and certain non-U.S. retirement plans, we derive the discount rates used to measure the present value of benefit obligations using the cash flow matching method. Under this method, we compare the plan’s projected payment obligations by year with the corresponding yields on a Mercer yield curve. Each year’s projected cash flows are then discounted back to their present value at the measurement date and an overall discount rate is determined. The overall discount rate is then rounded to the nearest tenth of a percentage point. In non-U.S. locations where the cash flow matching method is not possible, rates of local high-quality long-term government bonds are used to select the discount rate. We used Mercer’s Above-Mean Curve to determine the discount rates for the year-end benefit obligations and retirement cost of our U.S. retirement plans. We select the expected long-term rate of return assumption for our U.S. pension plan and retiree medical plans using advice from our investment advisor. The selected rate considers plan asset allocation targets, expected overall investment manager performance and long-term historical average compounded rates of return. Benefit plan experience gains and losses are recognized in other comprehensive income (loss). Accumulated net benefit plan experience gains and losses that exceed 10% of the greater of a plan’s benefit obligation or plan assets at the beginning of the year are amortized into earnings from other comprehensive income (loss) on a straight-line basis. The amortization period for pension plans is the average remaining service period of employees expected to receive benefits under the plans. The amortization period for other retirement plans is primarily the average remaining life expectancy of inactive participants. Income Taxes Deferred tax assets and liabilities are recorded to recognize the expected future tax benefits or costs of events that have been, or will be, reported in different years for financial statement purposes than tax purposes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which these items are expected to reverse. We recognize tax benefits related to uncertain tax positions if we believe it is more likely than not the benefit will be realized. We review our deferred tax assets to determine if it is more-likely-than-not that they will be realized. If we determine it is not more-likely-than-not that a deferred tax asset will be realized, we record a valuation allowance to reverse the previously recognized tax benefit. Foreign Currency Translation Our consolidated financial statements are reported in U.S. dollars. Our foreign subsidiaries maintain their records primarily in the currency of the country in which they operate. The method of translating local currency financial information into U.S. dollars depends on whether the economy in which our foreign subsidiary operates has been designated as highly inflationary or not. Economies with a three-year cumulative inflation rate of more than 100% are considered highly inflationary. Assets and liabilities of foreign subsidiaries in non-highly inflationary economies are translated into U.S. dollars using rates of exchange at the balance sheet date. Translation adjustments are recorded in other comprehensive income (loss). Revenues and expenses are translated at rates of exchange in effect during the year. Transaction gains and losses are recorded in net income (loss). Foreign subsidiaries that operate in highly inflationary countries use the U.S. dollar as their functional currency. Local currency monetary assets and liabilities are remeasured into U.S. dollars using rates of exchange as of each balance sheet date, with remeasurement adjustments and other transaction gains and losses recognized in earnings. Non-monetary assets and liabilities do not fluctuate with changes in local currency exchange rates to the dollar. Venezuela The economy in Venezuela has had significant inflation in the last several years. We consolidate our Venezuelan results using our accounting policy for subsidiaries operating in highly inflationary economies. Since 2003, the Venezuelan government has controlled the exchange of local currency into other currencies, including the U.S. dollar, and has required that currency exchanges be made at official rates established by the government instead of allowing open markets to determine currency rates. Different official rates exist for different industries and purposes and the government does not approve all requests to convert bolivars to other currencies. As a result of the restrictions on currency exchange, we have in the past been unable to obtain sufficient U.S. dollars to purchase certain imported supplies and fixed assets to fully operate our business in Venezuela. Consequently, we have occasionally purchased more expensive, bolivar-denominated supplies and fixed assets. Furthermore, there is a risk that official currency exchange mechanisms will be discontinued or will not be accessible when needed in the future, which may prevent us from repatriating dividends or obtaining dollars to operate our Venezuelan operations. Remeasurement rates during 2014. Through March 23, 2014, we used the official rate of 6.3 bolivars to the dollar to remeasure our bolivar-denominated monetary assets and liabilities into U.S. dollars and to translate our revenues and expenses. Effective March 24, 2014, the government initiated another exchange mechanism known as SICAD II and we began to use this exchange rate to remeasure bolivar-denominated monetary assets and liabilities and to translate our revenues and expenses. During 2014, the SICAD II rate averaged approximately 50 bolivars to the dollar and, at December 31, 2014, the rate was approximately 50 bolivars to the dollar. We recognized a $121.6 million net remeasurement loss in 2014 when we changed from the 6.3 rate to the SICAD II exchange rate. The after-tax effect of these losses attributable to noncontrolling interests was $39.7 million in 2014. While the SICAD II process existed, we received approval to obtain $1.2 million (weighted-average exchange rate of 51) through this exchange mechanism. Remeasurement rates during 2015. Through February 11, 2015, we used the SICAD II rates to remeasure our bolivar-denominated monetary assets and liabilities into U.S. dollars and to translate our revenue and expenses. Effective February 12, 2015, the SICAD II exchange mechanism was disbanded and we began to use the rate under the new exchange mechanism, known as SIMADI, to remeasure bolivar-denominated monetary assets and liabilities and to translate our revenue and expenses. The SIMADI rate ranged from 170 to 200 bolivars to the dollar and, at December 31, 2015, it was 199 bolivars to the dollar. We recognized an $18.1 million net remeasurement loss in 2015. The after-tax effect of this loss attributable to noncontrolling interests was $5.6 million. We have received only minimal U.S. dollars using the SIMADI process. Remeasurement rates during 2016. In the first quarter of 2016, the Venezuelan government announced that they would replace the SIMADI exchange mechanism with the DICOM exchange mechanism and would allow the DICOM exchange mechanism rate to float freely. At March 31, 2016, the DICOM rate was approximately 273 bolivars to the dollar. Since March 31, 2016, the rate declined 59% to close at approximately 674 bolivars to the dollar at December 31, 2016. We have received only minimal U.S. dollars through this exchange mechanism. We recognized a $4.8 million pretax remeasurement loss in 2016. However, the after-tax effect in the current period attributable to noncontrolling interest was income of $2.7 million. Items related to our Venezuelan operations are as follows: • Our investment in our Venezuelan operations on an equity-method basis was $19.2 million at December 31, 2016, and $26.0 million at December 31, 2015. • Our Venezuelan operations had net payables to other Brink's affiliates of $6.1 million at December 31, 2016 and $18.7 million at December 31, 2015. • Our Venezuelan operations had net nonmonetary assets of $17.6 million at December 31, 2016, and $13.5 million at December 31, 2015. • Our bolivar-denominated net monetary net assets were $1.4 million (including $6.8 million of cash and cash equivalents) at December 31, 2016, and $9.5 million (including $6.2 million of cash and cash equivalents) at December 31, 2015. • Accumulated other comprehensive losses attributable to Brink’s shareholders related to our operations in Venezuela were approximately $114.7 million at December 31, 2016 and $113.0 million at December 31, 2015. Impairment of Long-lived Assets in Venezuela During the second quarter of 2015, Brink's elected to evaluate and pursue strategic options for the Venezuelan business, which required us to perform an impairment review of the carrying values of our Venezuelan long-lived assets in accordance with FASB ASC Topic 360, Property, Plant and Equipment. Our asset impairment analysis included management's best estimate of associated cash flows relating to the long-lived assets and included fair value assumptions that reflect conditions that exist in a volatile economic environment. Future events or actions relative to our Venezuelan business may result in further adjustments. As a result of our impairment analysis, we recognized a $35.3 million impairment charge in 2015. The current carrying value of the long-lived assets of our Venezuelan operations is $10.1 million at December 31, 2016. We have not reclassified any of the $114.7 million of accumulated other comprehensive losses attributable to Brink’s shareholders related to our operations in Venezuela into earnings. Argentina We use the official exchange rate to translate the Brink's Argentina balance sheet and income statement. During 2015, the official exchange rate ranged from 8.5 to 9.8 local pesos to the U.S. dollar until December 17, 2015 when the currency was devalued. At December 31, 2016, the official exchange rate was 15.9 Argentine pesos to the U.S. dollar. The government in Argentina had previously imposed limits on the exchange of Argentine pesos into U.S. dollars. As a result, we elected in the past and may continue in the future to repatriate cash from Argentina using different markets to convert Argentine pesos into U.S. dollars if U.S. dollars are not readily available. Conversions prior to the December 17, 2015 devaluation had settled at rates approximately 30% to 40% less favorable than the rates at which we translated the financial statements of our subsidiary in Argentina. After the December 2015 devaluation of the Argentine peso, the market rates used to convert Argentine pesos into U.S. dollars have been similar to the rates at which we translate the financial statements of our subsidiary in Argentina. See Note 19 for more information. We recognized losses from converting Argentine pesos into U.S. dollars of $0.1 million in 2016, $7.1 million in 2015 and $3.6 million in 2014. These conversion losses are classified in the consolidated statements of operations as other operating income (expense). At December 31, 2016, we had cash denominated in Argentine pesos of $11.6 million. Ireland Due to management's decision in the first quarter of 2016 to exit the Republic of Ireland, the prospective impacts of shutting down this operation are included in items not allocated to segments and are excluded from the operating segments effective March 1, 2016. Beginning May 1, 2016, due to management's decision to also exit Northern Ireland, the results of shutting down these operations are treated similarly to the Republic of Ireland. Revenues from both Ireland operations shut down in 2016 were approximately $20 million in 2015. International shipments to and from Ireland will continue to be provided through BGS. Restricted Cash In France, we offer services to certain of our customers where we manage some or all of their cash supply chains. In connection with this offering, we take temporary title to certain customers' cash, which is included as restricted cash in our financial statements due to customer agreement or regulation (see Note 19). During the second quarter of 2016, we identified a misclassification in our December 31, 2015 consolidated balance sheet included in our 2015 Annual Report on Form 10-K. This misclassification, which was corrected on our December 31, 2015 condensed consolidated balance sheet included on our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2016, decreased our December 31, 2015 cash and cash equivalents balance and increased restricted cash by $16.4 million, increased restricted cash held for customers and decreased accrued liabilities by $12.9 million, increased short-term borrowings and decreased current maturities of long-term debt by $3.5 million. This misclassification had no impact on our December 31, 2015 current assets and current liabilities and it did not impact our consolidated statement of operations, but impacts the December 31, 2015 consolidated statement of cash flows by reducing net cash provided by operating activities from $208.8 million to $195.9 million and increasing net cash used by financing activities from $49.0 million to $52.5 million. Neither of these changes affect comparability to the previous period. Accordingly, we do not consider this correction to be material to our consolidated balance sheet or statement of cash flows. Concentration of Credit Risks We routinely assess the financial strength of significant customers and this assessment, combined with the large number and geographic diversity of our customers, limits our concentration of risk with respect to accounts receivable. Financial instruments which potentially subject us to concentrations of credit risks are principally cash and cash equivalents and accounts receivables. Cash and cash equivalents are held by major financial institutions. Use of Estimates In accordance with U.S. generally accepted accounting principles (“GAAP”), we have made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements. Actual results could differ materially from those estimates. The most significant estimates are related to goodwill, intangibles and other long-lived assets, pension and other retirement benefit assets and obligations, legal contingencies, deferred tax assets, purchase price allocations and foreign currency translation. Fair-value estimates. We have various financial instruments included in our financial statements. Financial instruments are carried in our financial statements at either cost or fair value. We estimate fair value of assets using the following hierarchy using the highest level possible: Level 1: Quoted prices in active markets that are accessible at the measurement date for identical assets and liabilities. Level 2: Observable prices that are based on inputs not quoted on active markets, but are corroborated by market data. Level 3: Unobservable inputs are used when little or no market data is available. New Accounting Standards In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which will require the recognition of assets and liabilities by lessees for certain leases classified as operating leases under current accounting guidance. The new standard also requires expanded disclosures regarding leasing activities. ASU 2016-02 will be effective January 1, 2019 and we are assessing the potential impact of the standard on financial reporting. In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which simplifies how certain features related to share-based payments are accounted for and presented in the financial statements. We elected to early adopt this ASU in the fourth quarter of 2016 and, per the requirements of the pronouncement, we applied the amendments to the beginning of 2016. Under ASU 2016-09, accounting changes adopted using the modified retrospective method must be calculated as of the beginning of 2016 and reported as a cumulative-effect adjustment. As a result, we recognized a $0.2 million cumulative-effect adjustment to January 1, 2016 retained earnings for previously unrecognized excess tax benefits. We have elected to continue our previous accounting policy of estimating forfeitures and, therefore, we did not recognize any cumulative-effect adjustment related to forfeitures. ASU 2016-09 requires that accounting changes adopted using the prospective method should be reported in the applicable interim periods of 2016. We did not have any material changes to previously reported interim financial information in 2016 as it relates to the recognition of excess tax benefits in the statement of operations or the classification of excess tax benefits in the statement of cash flows. In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which significantly changes the way entities recognize impairment of many financial assets by requiring immediate recognition of estimated credit losses expected to occur over their remaining life. ASU 2016-13 is effective January 1, 2020, with early adoption permitted January 1, 2019. We are assessing the potential impact of this new standard on financial reporting. In November 2016, the FASB issues ASU 2016-18, Statement of Cash Flows: Restricted Cash, which requires entities to include restricted cash and restricted cash equivalent balances with cash and cash equivalent balances in the statement of cash flows. ASU 2016-18 will be effective January 1, 2018 and will impact the presentation of our statement of cash flows. In May 2014, the FASB issued ASU 2014-09, Revenue From Contracts with Customers, a new standard related to revenue recognition which requires an entity to recognize an amount of revenue to which it expects to be entitled for the transfer of promised goods and services to customers. The new standard will replace most of the existing revenue recognition standards in U.S. GAAP. In August 2015, the FASB issued ASU 2015-14, which defers the effective date of this new standard to January 1, 2018. Subsequently, the FASB has continued to refine the standard and has issued several amendments. We have not yet completed our final review of the impact of this guidance but we believe that the most likely effects will be related to variable consideration and capitalization of costs to obtain contracts. We are also continuing to review potential disclosures and our method of adoption in order to complete our evaluation. Based on our preliminary assessment, we do not expect a material impact on our financial reporting. Note 2 - Segment Information The Brink’s Company offers transportation and logistics management services for cash and valuables throughout the world. These services include: • CIT Services - armored vehicle transportation of valuables • ATM Services - replenishing and maintaining customers’ automated teller machines; providing network infrastructure services • Global Services - secure international transportation of valuables • Cash Management Services ◦ Currency and coin counting and sorting; deposit preparation and reconciliations; other cash management services ◦ Safe and safe control device installation and servicing (including our patented CompuSafe® service) ◦ Check and cash processing services for banking customers (“Virtual Vault Services”) ◦ Check imaging services for banking customers • Payment Services - bill payment and processing services on behalf of utility companies and other billers at any of our Brink’s or Brink’s operated payment locations in Latin America and Brink’s Money™ general purpose reloadable prepaid cards and payroll cards in the U.S. • Commercial Security Systems - design and installation of security systems in designated markets in Europe. • Guarding Services - protection of airports, offices, and certain other locations in Europe and Brazil with or without electronic surveillance, access control, fire prevention and highly trained patrolling personnel We identify our operating segments based on how our chief operating decision maker (“CODM”) allocates resources, assesses performance and makes decisions. Our CODM is our President and Chief Executive Officer. Our CODM evaluates performance and allocates resources to each operating segment based on operating profit or loss, excluding income and expenses not allocated to segments. We currently serve customers in more than 100 countries, including 40 countries where we operate subsidiaries. We have nine operating segments: • Each of the five countries within Largest 5 Markets (U.S., France, Mexico, Brazil and Canada) • Each of the three regions within Global Markets (Latin America, EMEA and Asia) • Payment Services See "Other Items Not Allocated to Segment" on pages 28-30 to the consolidated financial statements for explanations of each of the other items not allocated to segments. (a) Long-lived assets include only property and equipment. (a) Revenues are recorded in the country where service is initiated or performed. No single customer represents more than 10% of total revenue. Geographic disclosures of country revenues include the Payments Services segment in Mexico, Brazil, Colombia and the U.S. In 2016, Brink's recorded an impairment charge of $1.8 million related to an equity investment in a BGS business in Belgium. In 2014, Brink’s sold an equity investment in a CIT business in Peru. The equity earnings from this investment in Peru were $3.8 million in 2014. Note 3 - Retirement Benefits Defined-benefit Pension Plans Summary We have various defined-benefit pension plans covering eligible current and former employees. Benefits under most plans are based on salary and years of service. There are limits to the amount of benefits which can be paid to participants from a U.S. qualified pension plan. We maintain a nonqualified U.S. plan to pay benefits for those eligible current and former employees in the U.S. whose benefits exceed the regulatory limits. Pension benefits provided to eligible U.S. employees were frozen on December 31, 2005. Components of Net Periodic Pension Cost (a) Settlement losses recognized in the U.S. in 2014 relate to a lump-sum buy-out of 4,300 participants. Settlement losses outside the U.S. relate primarily to terminated employees that participate in a Mexican severance indemnity program that is accounted for as a defined benefit plan. Obligations and Funded Status Changes in the projected benefit obligation (“PBO”) and plan assets for our pension plans are as follows: Other Changes in Plan Assets and Benefit Recognized in Other Comprehensive Income (Loss) Approximately $29.9 million of experience loss and $0.1 million of prior service cost are expected to be amortized from accumulated other comprehensive income (loss) into net periodic pension cost during 2017. The net experience losses in 2016 were primarily due to the lower discount rates at the end of the year compared to the prior year, partially offset by actual return on assets being higher than expected. The net experience losses in 2015 were primarily due to actual return on assets being lower than expected, partially offset by a higher U.S. plans discount rate at the end of the year compared to the prior year. Information Comparing Plan Assets to Plan Obligations Information comparing plan assets to plan obligations as of December 31, 2016 and 2015 are aggregated below. The accumulated benefit obligation (“ABO”) differs from the PBO in that the ABO is based on the benefit earned through the date noted. The PBO includes assumptions about future compensation levels for plans that have not been frozen. The total ABO for our U.S. pension plans was $845.9 million in 2016 and $844.8 million in 2015. The total ABO for our Non-U.S. pension plans was $232.3 million in 2016 and $226.5 million in 2015. Assumptions The weighted-average assumptions used in determining the net pension cost and benefit obligations for our pension plans were as follows: (a) Salary scale assumptions are determined through historical experience and vary by age and industry. The U.S. plan benefits are frozen. Pension benefits will not increase due to future salary increases. (b) The discount and salary increase rates of our Venezuela benefit plan are not adjusted for inflation. See the separate section below for more details. Mortality Tables for our U.S. Retirement Benefits We use the Mercer modified RP-2014 base table and Mercer modified MP-2016 projection scale, with Blue Collar adjustments for the majority of our U.S. retirement plans and a White Collar adjustment for our nonqualified U.S. pension plan. Estimated Future Cash Flows Estimated Future Contributions from the Company into Plan Assets Our policy is to fund at least the minimum actuarially determined amounts required by applicable regulations. We do not expect to make contributions to our primary U.S. pension plan in 2017. We expect to contribute $10.9 million to our non-U.S. pension plans and $0.9 million to our nonqualified U.S. pension plan in 2017. Estimated Future Benefit Payments from Plan Assets to Beneficiaries Projected benefit payments of the plans in the next 10 years using assumptions in effect at December 31, 2016, are as follows: (a) Excludes projected benefit payments related to our Venezuela benefit plan, which are presented in the separate section below. Venezuela Our non-U.S. net pension liability includes projected benefit obligations related to Venezuela of $5.6 million, $4.1 million, and $6.6 million in 2016, 2015 and 2014, respectively. The net periodic pension cost related to these benefit obligations was $2.9 million, $2.5 million, and $3.7 million in 2016, 2015 and 2014, respectively. As discussed in Note 1, the economy in Venezuela has had significant inflation in the last several years and we consolidate our Venezuelan results using highly inflationary accounting rules. In determining the projected benefit obligation and net periodic pension cost, we project our bolivar-denominated expected cash outflows using expected salary increases and discount the expected cash outflows to present value. Our discount rate for Venezuela was 4% and was determined using government bonds within the region. There are no salary increases expected other than inflationary increases. The discount rate and salary scale are adjusted for expected inflation. The assumption for inflation in Venezuela was made considering the current economic situation in Venezuela and an analysis of regional economic performances during hyperinflationary cycles. Over the long term, we expect the economy of Venezuela will return to inflation rates more typical for the region. Based on these considerations, we assumed an inflation rate of 500% in 2017 with a gradual decline to 4% in 2032. For 2016, this inflation adjustment has been excluded from the non-U.S. assumptions table above. As the projected salary increases and discount rate are both adjusted for inflation, there is not a significant impact to our current year projected benefit obligation as a result of increasing expected inflation. However, the inflation adjustment for Venezuela results in significant expected bolivar-denominated cash outflows in the next 10 years. When these undiscounted bolivar-denominated cash outflows are translated into U.S dollars at the December 31, 2016 DICOM exchange rate of approximately 674 bolivars to the dollar for purposes of U.S. GAAP reporting, the result is projected cash outflows of $4.4 billion as presented in the table below. These amounts have been excluded from the estimated future non-U.S. projected benefit payments table above. We expect to make these payments in bolivars with cash generated from our Venezuelan operations. Venezuela Estimated Future Benefit Payments to Beneficiaries Projected benefit payments of our Venezuela benefit plan in the next 10 years using assumptions in effect at December 31, 2016, are as follows: Retirement Benefits Other than Pensions Summary We provide retirement healthcare benefits for eligible current and former U.S., Canadian, and Brazilian employees. Retirement benefits related to our former U.S. coal operation include medical benefits provided by the Pittston Coal Group Companies Employee Benefit Plan for UMWA Represented Employees (the “UMWA plans”) as well as costs related to black lung obligations. Components of Net Periodic Postretirement Cost The components of net periodic postretirement cost related to retirement benefits other than pensions were as follows: Obligations and Funded Status Changes in the accumulated postretirement benefit obligation (“APBO’) and plan assets related to retirement healthcare benefits are as follows: Other Changes in Plan Assets and Benefit Recognized in Other Comprehensive Income (Loss) Changes in accumulated other comprehensive income (loss) of our retirement benefit plans other than pensions are as follows: We estimate that $21.2 million of experience loss and $2.9 million of prior service credit will be amortized from accumulated other comprehensive income (loss) into net periodic postretirement cost during 2017. We recognized net experience losses in 2016 associated with the UMWA obligations primarily due to a lower discount rate, partially offset by return on assets being higher than expected. We recognized net experience losses in 2016 associated with the black lung and other plans primarily related to a lower discount rate. We recognized net experience losses in 2015 associated with the UMWA obligations primarily due to the return on assets being lower than expected, partially offset by a higher discount rate. We recognized net experience gains in 2015 associated with the black lung and other plans primarily related to a higher discount rate. Assumptions See Mortality Tables for our U.S. Retirement Benefits on page 82 for a description of the mortality assumptions. The APBO for each of the plans was determined using the unit credit method and assumed rates as follows: Healthcare Cost Trend Rates For UMWA plans, the assumed healthcare cost trend rate used to compute the 2016 APBO is 7.0% for 2017, declining to 5.0% in 2023 and thereafter (in 2015: 7.0% for 2016 declining to 5.0% in 2022 and thereafter). For the black lung obligation, the assumed healthcare cost trend rate used to compute the 2016 APBO was 5.0%. Other plans in the U.S. provide for fixed-dollar value coverage for eligible participants and, accordingly, are not adjusted for inflation. For the Canadian plan, the assumed healthcare cost trend rate used to compute the 2016 APBO is 7.0% for 2017, declining to 5.0% in 2023. For the Brazilian plan, the assumed healthcare cost trend rate used to compute the 2016 APBO is 3.0%. The table below shows the estimated effects of a one percentage-point change in the assumed healthcare cost trend rates for each future year. We provide healthcare benefits to our UMWA retirees who are eligible for the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Medicare Act”) subsidy reimbursement under an employer group waiver plan (“EGWP”). Under this arrangement, a government approved health insurance provider receives the Medicare Act subsidy reimbursement on our behalf and passes these savings to us. Additionally, by providing healthcare benefits under an EGWP, we are able to benefit from the mandatory 50% discount that pharmaceutical companies must provide for Medicare Act-eligible prescription drugs. Excise Tax on Administrators by Patient Protection and Affordable Care Act of 2010 A 40% excise tax on third-party benefit plan administrators by the Patient Protection and Affordable Care Act will be imposed on high-cost health plans (“Cadillac plans”) beginning in 2020. We are currently unable to reduce the benefit levels of our UMWA medical plans to avoid this excise tax because these benefit levels are required by the Coal Industry Retiree Health Benefit Act of 1992. We have assumed that the cost of the excise tax paid by administrators will be passed through to us in the form of higher premiums or higher claims administration fees, increasing our obligations. We project that we will have to pay the benefits plan administrator this excise tax beginning in 2020, and our plan obligations at December 31, 2016, include $19.4 million related to this tax ($15.1 million at December 31, 2015). Cash Flows Estimated Contributions from the Company to Plan Assets Based on the funded status and assumptions at December 31, 2016, we expect the Company to contribute $6.6 million in cash to the plans to pay 2017 beneficiary payments for black lung and other plans. We do not expect to contribute cash to our UMWA plans in 2017 since we believe these plans have sufficient amounts held in trust to pay for beneficiary payments until 2027 based on actuarial assumptions. Our UMWA plans are not covered by ERISA or other funding laws or regulations that require these plans to meet funding ratios. Estimated Future Benefit Payments from Plan Assets to Beneficiaries Projected benefit payments of the plans in the next 10 years using assumptions in effect at December 31, 2016, are as follows: Retirement Plan Assets U.S. Plans (a) These categories include passively managed U.S. large-cap mutual funds and actively managed U.S. small/mid-cap and international mutual funds that track various indices such as the S&P 500 Index, the Russell 2500 Index and the MSCI All Country World Ex-U.S. Index. (b) This category represents an actively managed mutual fund that invests primarily in equity securities of emerging market issuers. Emerging market countries are those countries that are characterized as developing or emerging by any of the World Bank, the United Nations, the International Finance Corporation, or the European Bank for Reconstruction and Development or included in an emerging markets index by a recognized index provider. (c) This category represents an actively managed mutual fund that seeks to generate total return over time by selecting investments from among a broad range of asset classes. The fund’s allocations among asset classes may be adjusted over short periods and can vary from multiple to a single asset class. (d) This category represents actively managed mutual funds that seek to duplicate the risk and return characteristics of a long-term fixed-income security portfolio with approximate duration of 10 years and longer by using a long duration bond portfolio. This category also includes Treasury future contracts and zero-coupon securities created by the U.S. Treasury. (e) This category represents an actively managed mutual fund that invests primarily in fixed-income securities rated below investment grade, including corporate bonds and debentures, convertible and preferred securities and zero-coupon obligations. The fund’s average weighted maturity may vary and will generally not exceed ten years. (f) This category represents an actively managed mutual fund that invests primarily in U.S. dollar-denominated debt securities of government, government-related and corporate issuers in emerging market countries, as well as entities organized to restructure the outstanding debt of such issuers. (g) This category represents an actively managed hedge fund of funds. The fund holds approximately 30 separate hedge-fund investments. Strategies included (1) long-short equity, (2) event-driven and distressed-debt, (3) global macro, (4) credit hedging, (5) multi-strategy, and (6) fixed-income arbitrage. Its investment objective is to seek to achieve an attractive risk-adjusted return with moderate volatility and moderate directional market exposure over a full market cycle. (h) This category represents an actively managed real estate fund of funds that seeks both current income and long-term capital appreciation through investing in underlying funds that acquire, manage, and dispose of commercial real estate properties. These properties are high-quality, low-leveraged, income-generating office, industrial, retail, and multi-family properties, generally fully-leased to creditworthy companies and governmental entities. (i) This category invests primarily in a diversified portfolio comprised primarily of collateralized loan obligations and other structured credit investments backed primarily by bank loans. (j) This category represents an actively managed mutual fund that invests primarily in fixed income and equity securities and commodity linked instruments. The category seeks total returns that exceed the rate of inflation over a full market cycle regardless of market conditions. (k) This category will offer exposure to a diversified pool of global private assets fund investments. Further, the category will seek to shorten the duration of the typical private assets fund of funds through a dedicated focus on secondary strategies (i.e. funds whose investment strategy is to purchase interests in other private market investments/funds as a way to provide the original investors liquidity prior to the end of those investments’/funds’ contracted end date), income-producing investment strategies (e.g. debt, real estate, and to a lesser extent, real assets), and underlying funds whose stated life is five to seven years, as opposed to the more typical 10-year life of private assets funds. (l) This category invests in credit securities of commodity oriented companies affected by the dislocation in the commodity markets with the investment objective of producing an equity like return with less downside risk than equity or commodity investments. (m) In accordance with Subtopic 820-10, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets. (n) The U.S. managed volatility fund seeks capital appreciation with lower volatility than the broad U.S. equity market. The Fund will typically invest in equity securities of U.S. companies of all capitalization ranges that exhibit low relative volatility. Over the long term, the Fund is expected to achieve a return similar to that of the Russell 3000 Index with a lower level of volatility. Assets of our U.S. plans are invested with an objective of maximizing the total return, taking into consideration the liabilities of the plan, and minimizing the risks that could create the need for excessive contributions. Plan assets are invested primarily using actively managed accounts with asset allocation targets listed in the tables above. Our policy does not permit the purchase of Brink’s common stock if immediately after any such purchase the aggregate fair market value of the plan assets invested in Brink’s common stock exceeds 10% of the aggregate fair market value of the assets of the plan, except as permitted by an exemption under ERISA. The plans rebalance their assets on a quarterly basis if actual allocations of assets are outside predetermined ranges. Among other factors, the performance of asset groups and investment managers will affect the long-term rate of return. The pension plan acquired the structured-credit investment in 2013. The investment is subject to a two-year lockup provision, which expired in 2015. The UMWA plans acquired the structured-credit investment in 2014. The investment is subject to a two-year lockup provision, which expired in 2016. The UMWA plans also acquired the energy debt investment in 2015, which is subject to a three-year lockup provision, which will expire in 2018. The global private equity investment cannot be redeemed due to the nature of the underlying investments. As the global private equity investment matures and becomes fully invested, liquidating distributions will be provided back to investors. We expect to receive liquidating distributions over the stated life of the underlying investments. We have $14 million in unfunded commitments related to the global private equity investment. Most of the investments of our U.S. retirement plans can be redeemed daily. The core-property and structured-credit investments can be redeemed quarterly with 65 days’ notice. The hedge fund of funds investment can be redeemed quarterly with 95 days’ notice. The energy debt investment can be redeemed semi-annually with 95 days' notice. We believe all plans have sufficient liquidity to meet the needs of the plans' beneficiaries in all market scenarios. Non-U.S. Plans (a) These categories are comprised of equity index actively and passively managed funds that track various indices such as S&P 500 Composite Total Return Index, Russell 1000 and 2000 Indices, MSCI Europe Ex-UK Index, S&P/TSX Total Return Index, MSCI EAFE Index and others. Some of these funds use a dynamic asset allocation investment strategy seeking to generate total return over time by selecting investments from among a broad range of asset classes, investing primarily through the use of derivatives. (b) This category represents investment-grade fixed income debt securities of European issuers from diverse industries. (c) This category is primarily designed to generate income and exhibit volatility similar to that of the Sterling denominated bond market. This category primarily invests in investment grade or better securities. (d) This category consists of global high-yield bonds. This category invests in lower rated and unrated fixed income, floating rate and other debt securities issued by European and American companies. (e) This category consists of a diversified portfolio of debt securities issued by governments, financial institutions, companies or other entities domiciled in emerging market countries. (f) This category is designed to achieve a return consistent with holding longer term debt instruments. This category invests in interest rate and inflation derivatives, government-issued bonds, real-return bonds, and futures contracts. Asset allocation strategies for our non-U.S. plans are designed to accumulate a diversified portfolio among markets and asset classes in order to reduce market risk and increase the likelihood that pension assets are available to pay benefits as they are due. Assets of non-U.S. pension plans are invested primarily using actively managed accounts. The weighted-average asset allocation targets are listed in the table above, and reflect limitations on types of investments held and allocations among assets classes, as required by local regulation or market practice of the country where the assets are invested. Most of the investments of our non-U.S. retirement plans can be redeemed at least monthly, except for a portion of “Other” in the above table, which can be redeemed quarterly. Non-U.S. Plans - Fair Value Measurements (a) In accordance with Subtopic 820-10, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets. Savings Plans We sponsor various defined contribution plans to help eligible employees provide for retirement. We record expense for amounts that we contribute on behalf of employees, usually in the form of matching contributions. Prior to April 1, 2015, we matched the first 1% of employees’ eligible contributions to our U.S. 401(k) plan. In April 2015, we increased the matching contribution to the first 1.5% of employees' eligible contributions. Our matching contribution expense is as follows: Note 4 - Income Taxes Rate Reconciliation The following table reconciles the difference between the actual tax rate on continuing operations and the statutory U.S. federal income tax rate of 35%. (a) In the fourth quarter of 2015, we recognized a $23.5 million increase to current tax expense related to a transaction that accelerated U.S. taxable income. Components of Deferred Tax Assets and Liabilities (a) U.S. alternative minimum tax credits of $32.6 million have an unlimited carryforward period, U.S. foreign tax credits of $26.2 million have a 10 year carryforward period and the remaining credits of $3.2 million have various carryforward periods. The U.S. foreign tax credits have a $26.2 million valuation allowance. Valuation Allowances Valuation allowances relate to deferred tax assets for certain federal credit carryforwards, certain state and non-U.S. jurisdictions. Based on our analysis of positive and negative evidence including historical and expected future taxable earnings, and a consideration of available tax-planning strategies, we believe it is more-likely-than-not that we will realize the benefit of the existing deferred tax assets, net of valuation allowances, at December 31, 2016. In 2016, we changed our judgment about the need for valuation allowances for certain U.S. tax attributes with a limited statutory carryforward period that are no longer more-likely-than-not to be realized due to lower than expected U.S. operating results, certain pre-tax items, and other timing of tax deductions related to executive leadership transition. As a result, we recognized a $14.7 million valuation allowance in 2016 through income from continuing operations. (a) Changes in judgment about valuation allowances are based on a recognition threshold of “more-likely-than-not” of realizing beginning-of-year balances of deferred tax assets. Amounts are recognized in income from continuing operations. (b) We recognized $2.5 million in retained earnings as a result of the early adoption of ASU 2016-09. Undistributed Foreign Earnings As of December 31, 2016, we have not recorded U.S. federal deferred income taxes on approximately $229 million of undistributed earnings of foreign subsidiaries and equity affiliates. We expect that these earnings will be permanently reinvested in operations outside the U.S. It is not practical to determine the income tax liability that might be incurred if all such income was remitted to the U.S. due to the inherent complexities associated with any hypothetical calculation, which would be dependent upon the exact form of repatriation. Net Operating Losses The gross amount of the net operating loss carryforwards as of December 31, 2016, was $373.8 million. The tax benefit of net operating loss carryforwards, before valuation allowances, as of December 31, 2016, was $42.4 million, and expires as follows: Uncertain Tax Positions A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Included in the balance of unrecognized tax benefits at December 31, 2016, are potential benefits of approximately $5.7 million that, if recognized, will reduce the effective tax rate on income from continuing operations. We recognize accrued interest and penalties related to unrecognized tax benefits in provision (benefit) for income taxes. We reverse interest and penalties accruals when a statute of limitation lapses or when we otherwise conclude the amounts should not be accrued. Net increase (reversal) included in provision (benefit) for income taxes were $0.1 million in 2016, ($0.1) million in 2015, and ($0.6) million in 2014. We had accrued interest and penalties of $0.9 million at December 31, 2016, and $1.0 million at December 31, 2015. We file income tax returns in the U.S. federal and various state and foreign jurisdictions. With a few exceptions, as of December 31, 2016, we were no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2013. Additionally, due to statute of limitations expirations and audit settlements, it is reasonably possible that approximately $0.8 million of currently remaining unrecognized tax positions may be recognized by the end of 2017. Note 5 - Property and Equipment The following table presents our property and equipment that is classified as held and used: (a) Amortization of capitalized software costs included in continuing operations was $19.6 million in 2016, $20.7 million in 2015 and $20.3 million in 2014. Note 6 - Goodwill and Other Intangible Assets Goodwill The changes in the carrying amount of goodwill by operating segment for the years ended December 31, 2016 and 2015 are as follows: Intangible Assets The following table summarizes our other intangible assets by category: In 2016, we recognized a $6.5 million impairment charge related to a customer relationship intangible asset in our Brink's India operations, which is included in other operating expense. Total amortization expense for our finite-lived intangible assets was $3.6 million in 2016. Our estimated aggregate amortization expense for finite-lived intangibles recorded at December 31, 2016, for the next five years is as follows: Note 7 - Prepaid Expenses and Other Note 8 - Other Assets Note 9 - Accumulated Other Comprehensive Income (Loss) The following tables provide the components of other comprehensive income (loss), including the amounts reclassified from accumulated other comprehensive income (loss) into earnings: (a) The amortization of prior experience losses and prior service cost is part of total net periodic retirement benefit cost when reclassified to net income (loss). Net periodic retirement benefit cost also includes service cost, interest cost, expected returns on assets, and settlement costs. The total pretax expense is allocated between cost of revenues and selling, general and administrative expenses on a plan-by-plan basis: (b) Reclassification of foreign currency translation amounts in 2015 relate primarily to the sale of our Russian cash management operations. These amounts are included in other operating income (expense). Pretax benefit plan adjustments of $8 million (including related deferred tax component) and foreign currency translation adjustments reclassified to the consolidated statements of operations in 2014 relate to the sale of CIT operations in the Netherlands. The 2014 amounts are included in loss from discontinued operations in the consolidated statements of operations. (c) Gains and losses on sales of available-for-sale securities are reclassified from accumulated other comprehensive loss to the consolidated statements of operations when the gains or losses are realized. Pretax amounts are classified in the consolidated statements of operations as interest and other income (expense). (d) Pretax gains and losses on cash flow hedges are classified in the consolidated statements of operations as • other operating income (expense) ($1.3 million losses in 2016, $4.1 million gains in 2015 and $1.9 million gains in 2014) • interest and other income (expense) ($0.3 million losses in 2016, $0.5 million losses in 2015 and $1.0 million in 2014.) The changes in accumulated other comprehensive loss attributable to Brink’s are as follows: Note 10 - Fair Value of Financial Instruments Investments in Trading Securities and Available-for-sale Securities We have investments in mutual funds designated as trading securities and as available-for-sale securities that are carried at fair value in the financial statements. For these investments, fair value was estimated based on quoted prices categorized as a Level 1 valuation. Fixed-Rate Debt The fair value and carrying value of our fixed-rate debt are as follows: The fair value estimate of our unsecured private-placement notes is based on the present value of future cash flows, discounted at rates for similar instruments at the respective measurement dates, which we have categorized as a Level 3 valuation. Forward and Swap Contracts We have outstanding foreign currency forward and swap contracts to hedge transactional risks associated with foreign currencies. At December 31, 2016, the notional value of our shorter term outstanding foreign currency forward and swap contracts was $41.9 million, with average maturities of approximately one month. These shorter term foreign currency forward and swap contracts primarily offset exposures in the British pound and the Mexican peso and are not designated as hedges for accounting purposes. At December 31, 2016, the fair value of these shorter term foreign currency contracts was not significant. In 2013, we entered into a longer term cross-currency swap to hedge against the change in value of a long-term intercompany loan denominated in Brazilian real. This longer term contract is designated as a cash flow hedge for accounting purposes. At December 31, 2016, the notional value of this contract was $7.9 million with a weighted-average maturity of 0.6 years. At December 31, 2016, the fair value of this longer term swap contract was a net asset of $3.1 million, of which $2.4 million is included in prepaid expenses and other and $0.7 million is included in other assets on the consolidated balance sheet. In the first quarter of 2016, we entered into two interest rate swaps with a total notional value of $40 million with a weighted-average maturity of 1.9 years. These swaps were entered into to hedge cash flow risk associated with changes in variable interest rates and are designated as cash flow hedges for accounting purposes. At December 31, 2016, the fair value of these interest rate swaps was a net asset of $0.8 million, of which $0.9 million in included in other assets and $0.1 million was included in accrued liabilities. The fair values of these forward and swap contracts are determined using Level 2 valuation techniques and are based on the present value of net future cash payments and receipts. Other Financial Instruments Other financial instruments include cash and cash equivalents, accounts receivable, floating rate debt, accounts payable and accrued liabilities. The financial statement carrying amounts of these items approximate the fair value. There were no transfers in or out of any of the levels of the valuation hierarchy in 2016. Note 11 - Accrued Liabilities (a) Title to cash received and processed in certain of our secure Cash Management Services operations transfers to us for a short period of time. The cash is generally credited to customers’ accounts the following day and we record a liability while the cash is in our possession. Note 12 - Other Liabilities (a) Our Brink's Mexico operations entered into a transaction in 2015 to sell its headquarters building in Mexico City and lease the property back for two years. The transaction did not qualify for sale-leaseback accounting due to continuing involvement with the property. Therefore, proceeds received are recorded as a financing liability. Note 13 - Debt (a) These 2016 and 2015 amounts are for short-term borrowings related to cash borrowed under lending arrangements used in the process of managing customer cash supply chains, which is currently classified as restricted cash and not available for general corporate purposes. See Note 19 for more details. Short-Term Borrowings Uncommitted Credit Facilities In October 2016, we entered into a $100 million uncommitted credit facility. Borrowings under this facility have a maximum maturity of not more than thirty days. Interest on this facility is generally based on LIBOR plus a margin of 1.00%. As of December 31, 2016, $100 million was outstanding. In February 2016, we entered into a $24 million uncommitted credit facility with an initial expiration date in February 2017. The facility was amended in February 2017, which extended the expiration date to February 2018. Interest on this facility is currently based on LIBOR plus a margin of 1.00%. As of December 31, 2016, $8 million was outstanding. Long-Term Debt Revolving Facility We have a $525 million unsecured multi-currency revolving bank credit facility (the “Revolving Facility”) that matures in March 2020. The Revolving Facility’s interest rate is based on LIBOR plus a margin or an alternate base rate plus a margin. The Revolving Facility allows us to borrow loans or issue letters of credit (or otherwise satisfy credit needs) on a revolving basis over the term of the facility. As of December 31, 2016, $469 million was available under the Revolving Facility. Amounts outstanding under the Revolving Facility, as of December 31, 2016, were denominated primarily in U.S. dollars and to a lesser extent in euros. The margin on LIBOR borrowings under the Revolving Facility, which can range from 1.0% to 1.70% depending on either our credit rating or leverage ratio as defined within the Revolving Facility, was 1.30% at December 31, 2016. The margin on alternate base rate borrowings under the Revolving Facility ranges from 0.0% to 0.70%. We also pay an annual facility fee on the Revolving Facility based on our credit rating or the leverage ratio. The facility fee can range from 0.125% to 0.30% and was 0.20% at December 31, 2016. Private Placement Notes We have $86 million principal amount of unsecured notes outstanding, which were issued through a private placement debt transaction (the “Notes”). The Notes comprise $36 million in series A notes with a fixed interest rate of 4.57% and $50 million in series B notes with a fixed interest rate of 5.20%. Annual principal payments under the series A notes began in January 2015 and continue through maturity. The series B notes are due in January 2021. Term Loan We entered into a $75 million unsecured term loan in March 2015. Interest on this loan is based on LIBOR plus a margin of 1.75%. Monthly principal payments began April 2015 and continue through to maturity, with the remaining balance of $34 million due in March 2022. As of December 31, 2016, the principal amount outstanding was $66 million. Other Facilities As of December 31, 2016, we have one $20 million unsecured multi-currency revolving bank credit facility, of which $4 million was outstanding. As of December 31, 2016, we had undrawn letters of credit and guarantees of $66 million issued under the letter of credit facilities and $5 million issued under the multi-currency revolving bank credit facilities. This $20 million facility expires in March 2019. Interest on this facility is based on LIBOR plus a margin, which ranges from 1.0% to 1.7%. We also have the ability to borrow from other banks, at the banks' discretion, under short-term uncommitted agreements. Various foreign subsidiaries maintain other lines of credit and overdraft facilities with a number of banks. Letter of Credit Facilities We have a $40 million uncommitted letter of credit facility that expires in May 2017. As of December 31, 2016, $5 million was utilized. We have two unsecured letter of credit facilities totaling $94 million, of which approximately $28 million was available at December 31, 2016. At December 31, 2016, we had undrawn letters of credit and guarantees of $66 million issued under these letter of credit facilities. A $40 million facility expires in December 2018 and a $54 million facility expires in December 2019. The Revolving Facility and the multi-currency revolving credit facilities are also used for issuance of letters of credit and bank guarantees. Minimum repayments of long-term debt are as follows: The Revolving Facility, the Notes, the unsecured multi-currency revolving bank credit facilities, the unsecured committed credit facility, the letter of credit facilities and the unsecured term loan contain certain subsidiary guarantees and various financial and other covenants. The financial covenants, among other things, limit our total indebtedness, restrict certain payments to shareholders, limit priority debt, limit asset sales, limit the use of proceeds from asset sales, provide for a maximum leverage ratio and provide for minimum coverage of interest costs. These agreements do not provide for the acceleration of payments should our credit rating be reduced. If we were not to comply with the terms of our various financing agreements, the repayment terms could be accelerated and the commitments could be withdrawn. An acceleration of the repayment terms under one agreement could trigger the acceleration of the repayment terms under the other financing agreements. We were in compliance with all financial covenants at December 31, 2016. Capital Leases Property and equipment acquired under capital leases are included in property and equipment as follows: Note 14 - Accounts Receivable Note 15 - Operating Leases We lease facilities, vehicles, computers and other equipment under long-term operating and capital leases with varying terms. Most of the operating leases contain renewal and/or purchase options. We expect that in the normal course of business, the majority of operating leases will be renewed or replaced by other leases. As of December 31, 2016, future minimum lease payments under noncancellable operating leases with initial or remaining lease terms in excess of one year are included below. The cost related to operating leases is recognized as rental expense. Net rent expense included in continuing operations amounted to $96.0 million in 2016, $92.5 million in 2015 and $101.7 million in 2014. Note 16 - Share-Based Compensation Plans We have share-based compensation plans to attract and retain employees and nonemployee directors and to more closely align their interests with those of our shareholders. We have granted share-based awards to employees under the 2005 Equity Incentive Plan ("2005 Plan") and the 2013 Equity Incentive Plan ("2013 Plan"). These plans permit grants of restricted stock, restricted stock units, performance stock, performance units, stock appreciation rights, stock options, as well as other share-based awards to eligible employees. The 2013 Plan also permits cash awards to eligible employees. The 2005 Plan was replaced by the 2013 Plan effective February 2013. No further grants of awards will be made under the 2005 Plan. We have granted deferred stock units to directors through the Non-Employee Directors’ Equity Plan. Share-based awards were granted to directors and remain outstanding under the Non-Employee Directors’ Stock Option Plan and the Directors’ Stock Accumulation Plan, both of which have expired. There are 2.4 million shares underlying share-based plans that are authorized, but not yet granted. Outstanding awards at December 31, 2016, include performance share units, market share units, restricted stock units, deferred stock units, performance-based stock options and time-based vesting stock options. Compensation Expense Compensation expense is measured using the fair-value-based method. For employee and director awards considered equity grants, compensation expense is recognized from the award or grant date to the earlier of the retirement-eligible date or the vesting date. The grant date for accounting purposes may be different than the date the award is granted to the employee. To establish a grant date for accounting purposes, the employee and the employer must have a mutual understanding of the important terms and conditions of the award. For awards considered liabilities and for equity awards that have not had a grant date established because a mutual understanding does not exist, compensation cost is based on the change in the fair value of the instrument for each reporting period and the percentage of the requisite service that has been rendered. For certain awards granted since 2010, we concluded in the second quarter of 2014 that the employee and employer did not have a mutual understanding related to the application of a compensation recoupment policy that was established in 2010. As a result, we concluded that the service inception date preceded the grant date for equity awards outstanding at that time. Our recoupment policy was revised in July 2014 and, as a result, we concluded that certain outstanding awards have grant dates that reflect the date of the revision of the policy on July 11, 2014. Approximately 130 employees who received share-based awards were affected by the change in policy. As a result, we recognized $4.2 million of expense during the second quarter of 2014 for the cumulative effect of this accounting error. Compensation expenses are classified as selling, general and administrative expenses in the consolidated statements of operations. Compensation expenses for the last three years and the amount of unrecognized expense for awards outstanding at December 31, 2016, were as follows: Fair Value of Distributed or Exercised Awards The fair value of shares distributed or options exercised in the last three years is as follows: (a) Intrinsic value for Options. (b) No Performance Share Units or Market Share Units had vested as of December 31, 2015. Restricted Stock Units (“RSUs”) We granted RSUs to senior executives and select employees in the last three years that contain only a service condition. RSUs are paid out in shares of Brink’s stock when the awards vest. For RSUs granted during the last three years, the units generally vest ratably in three equal annual installments. We measure the fair value of RSUs based on the price of Brink’s stock at the grant date, adjusted for a discount for dividends not received or accrued during the vesting period. The weighted-average fair value per share at issuance date was $29.06 in 2016, $27.09 in 2015 and $27.91 in 2014. The weighted-average discount was approximately 3% in 2016, 2015 and 2014. The following table summarizes RSU activity during 2016: Performance Share Units (“PSUs”) Prior to 2016, we granted PSUs which contained a performance condition, a market condition and a service condition. In 2016, we granted Internal Metric PSUs ("IM PSUs") and Total Shareholder Return PSUs ("TSR PSUs"). IM PSUs contain a performance condition as well as a service condition. We measure the fair value of these PSUs based on the price of Brink’s stock at the grant date, adjusted for a discount for dividends not received or accrued during the vesting period. For the majority of the IM PSUs granted in 2016, the performance period is from January 1, 2016 to December 31, 2017, with an additional year of service required. Other IM PSUs granted in 2016 have a performance period from July 1, 2016 to June 30, 2017, with an additional two years of service required. TSR PSUs contain a market condition as well as a service condition. We measure the fair value of PSUs containing a market condition at the grant date using a Monte Carlo simulation model. For the TSR PSUs granted in 2016, the performance period is from January 1, 2016 to December 1, 2018. PSUs granted to senior executives and select employees in 2016, 2015 and 2014 typically vest over three years and are paid out in shares of Brink’s stock. The number of shares paid out ranges from 0% to 200% of an employee’s award, depending on the achievement of pre-established financial goals over the performance period, which can be three years, two years or one year, depending on the underlying award. Shares are not paid out if the financial results do not meet a pre-established threshold level of performance. For PSUs granted before 2016, the number of shares paid out is also affected by Brink’s total shareholder return relative to the total return of a pre-established stock index over the performance period. The number of shares paid out is increased by 25% if Brink’s total shareholder return is at or above the 75th percentile of the index’s total return. The number of shares paid out is reduced by 25% if Brink’s performance is at or below the 25th percentile. The number of shares is not adjusted if Brink’s performance is between the 25th and 75th percentile. Changes to Performance Goals for the 2013, 2014 and 2015 PSU Grants. The performance goals for the 2013, 2014 and 2015 PSU grants were or are based on consolidated operating profit over the performance period, which were or are adjusted for various items including corporate items, acquisition and dispositions, unusual or infrequently occurring events and foreign currency. In 2014, the Compensation and Benefits Committee of the Board of Directors approved a second performance goal for the PSU awards granted in 2013 and 2014 to reflect the change in currency exchange rate used to report the results of Venezuela because the rate had changed significantly. Additionally, in February 2016, the Compensation and Benefits Committee of the Board of Directors modified the terms of performance share units originally awarded or granted in 2013, 2014 and 2015 to reflect the impact of removing Venezuela operations from the Company’s segment results beginning in 2015. For each of the affected performance share units, consolidated results for 2015 and each subsequent year within the respective performance period was or will be adjusted to reflect Venezuela results at the amount originally projected in the applicable performance target. After the conclusion of each performance period, the payout will be equal to the lower of the calculated payout under the adjusted performance goals and the original performance goals. Approximately 100 employees who received PSUs in 2013, 2014 and 2015 were affected by the change. No incremental compensation cost associated with the modifications was recognized or is expected to be recognized as the additional goals were or are expected to be more difficult to achieve and, in accordance with FASB ASC Topic 718, Compensation - Stock Compensation, we continue to recognize expense as calculated using the original performance goals. The following table summarizes all PSU activity during 2016: (a) The vested PSUs presented are based on the target amount of the award. Pursuant to the actual performance for the period ended December 31, 2015, the actual shares earned and distributed were 277.1, representing 171% of target or, for a smaller award, 125% of target. The following table provides the terms and weighted-average assumptions used in the Monte Carlo simulation model for the TSR PSUs granted in 2016: (a) TSR is determined assuming that dividends are reinvested. The stock price projection in the Monte Carlo simulation model assumed a 0% dividend yield, which is mathematically equivalent to reinvesting dividends over the performance period. For the valuation of the TSR PSU awards, because the holders of the TSR PSU awards have no rights to any dividend paid during the vesting period, we applied a dividend yield in the Monte Carlo simulation model to reduce the projected stock price as of the grant date. (b) The expected stock price volatility was calculated on the grant date for the most recent term equivalent to the contractual term in years. (c) The risk-free interest rate on each date of grant is the rate for a zero-coupon U.S. Treasury bill that was commensurate with the grant date contractual term. Market Share Units (“MSUs”) Prior to 2016, we granted MSUs, which contain a market condition as well as a service condition. We measure the fair value of MSUs using a Monte Carlo simulation model. We granted MSUs to senior executives in 2015 and 2014. MSUs are paid out in shares of Brink’s stock when an award vests. MSUs reward the achievement of the appreciation of Brink’s stock over the performance period (generally three years) at a rate of 0% to 150% of the initial target number of shares awarded. The multiplier to the initial target number of MSUs awarded is calculated as the ratio of the price of Brink’s stock at the end of the performance period divided by the price of Brink’s stock at the beginning of the performance period. If the price of Brink’s stock at the end of the performance period is less than 50% of the initial price, no payout for MSUs will occur. The following table summarizes all MSU activity during 2016: (a) The vested MSUs presented are based on the target amount of the award. Pursuant to the actual performance for the period ended December 31, 2015, the actual shares earned and distributed were 91.1, or 108% of target. No additional compensation expense was required, as the market condition was included in the $27.30 grant date fair value. Options In 2016, we granted performance-based stock options that have a service condition as well as a market condition. In addition, some of the awards granted contain a non-financial performance condition. We measure the fair value of these options at the grant date using a Monte Carlo simulation model. No performance-based options were granted in 2015 and 2014. Prior to 2013, we granted time-based vesting stock options to select senior executives and select employees. When vested, options entitle the holder to purchase a specified number of shares of Brink’s stock at a price set at the date the options were granted. The option price for Brink’s options was equal to the market price of Brink’s stock on the award date. Options granted to employees have a maximum term of six years and options previously granted to directors have a maximum term of ten years. Performance-Based Option Activity The table below summarizes the activity associated with grants of performance-based options: The table below summarizes additional information related to grants of performance-based options: (a) The intrinsic value of a stock option is the difference between the market price of the shares underlying the option and the exercise price of the option. The market price at December 30, 2016 was $41.25. (b) The number of options expected to vest takes into account an estimate of expected forfeitures. We currently have applied a 0% expected forfeiture rate to these options. The following table provides the term of the performance period and the weighted-average assumptions used in the Monte Carlo simulation model for the performance-based options: (a) Since the holders of the awards have no rights to any dividend paid during the vesting period, we applied a dividend yield in the Monte Carlo simulation model. At each grant date, the dividend yield was calculated based on the most recent annualized dividend payment of $0.40 and Brink's stock price at the date of grant. (b) The expected stock price volatility was calculated on each grant date for the most recent 4.5 year term. (c) The risk-free interest rate on each grant date is the rate for a zero-coupon U.S. Treasury bill that was commensurate with the expected life of 4.5 years. (d) Because we did not have historical exercise behavior for instruments with premiums, we assumed that the exercise of vested options occurred at the mid-point between the three-year vesting date and the six-year contractual term. In the Monte Carlo simulation, at each iteration of forecasted Brink's stock prices, the option was assumed to be exercised at the mid-point of 4.5 years if the stock price hurdle had been achieved. When the hurdle is achieved, the exercise price was then subtracted from the projected stock price, and discounted back to the grant date. In situations where the projected price had not met the hurdle, no value was attributed. Time-based Vesting Option Activity The table below summarizes the activity associated with previous grants of time-based vesting options: The table below summarizes additional information related to previous grants of time-based vesting stock options: (a) The intrinsic value of a stock option is the difference between the market price of the shares underlying the option and the exercise price of the option. The market price at December 30, 2016 was $41.25. (b) There were 0.7 million shares of exercisable options with a weighted-average exercise price of $26.01 per share at December 31, 2015 and 0.7 million shares of exercisable options with a weighted-average exercise price of $26.44 per share at December 31, 2014. Deferred Stock Units (“DSUs”) We granted DSUs to our independent directors in 2016 and prior years. We measure the fair value of DSUs at the grant date, based on the price of Brink's stock. In 2016 and 2015, our independent directors received grants of DSUs that vest and will be paid out in shares of Brink's stock on the first anniversary of the grant date, provided that the director has not elected to defer the distribution of shares until a later date. DSUs are forfeited if a director leaves before the vesting date. However, in connection with the retirement of two directors in January 2016, our Board of Directors waived the one-year vesting provision for those DSUs granted in 2015. The impact of this modification was recorded in the first quarter of 2016 and was not significant. DSUs granted prior to 2015, in general, will be paid out in shares of stock following separation from service. The following table summarizes all DSU activity during 2016: The weighted-average grant-date fair value estimate per share for DSUs granted was $29.41 in 2016, $32.79 in 2015 and $24.70 in 2014. Other Share-Based Compensation We have a deferred compensation plan that allows participants to defer a portion of their compensation into stock units. Units may be redeemed by employees for an equal number of shares of Brink’s stock. Employee accounts held 234,426 units at December 31, 2016, and 302,041 units at December 31, 2015. We have a stock accumulation plan for our non-employee directors that, prior to 2014, provided for awards of stock units. Directors’ accounts held 34,200 units at December 31, 2016, and 54,050 units at December 31, 2015. Note 17 - Capital Stock Common Stock At December 31, 2016, we had 100 million shares of common stock authorized and 50.0 million shares issued and outstanding. Dividends We paid regular quarterly dividends on our common stock during the last three years. On January 20, 2017, the Board declared a regular quarterly dividend of 10 cents per share payable on March 1, 2017. The payment of future dividends is at the discretion of the Board of Directors and is dependent on our future earnings, financial condition, shareholder equity levels, cash flow, business requirements and other factors. Preferred Stock At December 31, 2016, we had the authority to issue up to 2.0 million shares of preferred stock with a par value of $10 per share. Shares Used to Calculate Earnings per Share (a) We have deferred compensation plans for directors and certain of our employees. Some amounts owed to participants are denominated in common stock units. Each unit represents one share of common stock. The number of shares used to calculate basic earnings per share includes the weighted-average common stock units credited to employees and directors under the deferred compensation plans. Additionally, nonvested units are also included in the computation of basic weighted-average shares when the requisite service period has been completed. Accordingly, basic and diluted shares include weighted-average units of 0.5 million in 2016, 0.5 million in 2015 and 0.5 million in 2014. Note 18 - Loss from Discontinued Operations (a) Discontinued operations include gains and losses related to businesses that we recently sold or shut down. No interest expense was included in discontinued operations in 2015 and 2014. (b) The loss from operations in 2015 included $1.0 million in pension settlement charges related to the Mexican parcel delivery business sold in February 2015. The loss from operations in 2014 included $15.6 million in non-cash severance and impairment charges related to the Netherlands cash-in-transit operations. (c) Primarily related to former coal businesses and BAX Global, a former freight forwarding and logistics business. (d) BAX Global had been defending a claim related to the apparent diversion by a third party of goods being transported for a customer. In 2010, the Dutch Supreme Court denied the final appeal of BAX Global, letting stand the lower court ruling that BAX Global was liable for this claim. We had contractually indemnified the purchaser of BAX Global for this contingency. Through 2010, we had recognized $11.5 million of expense related to the payment made in satisfaction of the judgment. In 2014, we recovered $9.5 million from insurance companies related to this matter. Cash-in-transit operations sold or shut down: • Australia (sold in October 2014) • Puerto Rico (shut down in November 2014) • Netherlands (sold in December 2014) Other operations sold: • In February 2015, we sold a small Mexican parcel delivery business which met the criteria for classification as a discontinued operation as of December 31, 2014. The results of the above operations have been excluded from continuing operations and are reported as discontinued operations for the prior periods. The table below shows revenues by operating segment which have been reclassified to discontinued operations: The table below shows revenues and loss from operations before tax for the Netherlands cash-in-transit operations sold in 2014: Other divestitures not classified as discontinued operations: • We sold our 70% ownership interest in a Russian cash management business in November 2015 and recognized a $5.9 million loss on the disposition. A significant part of the loss ($5.0 million) represented the reclassification of foreign currency translation adjustments from accumulated other comprehensive income (loss) into earnings. • We sold our Irish guarding operation in November 2015. • We shut down our remaining Irish domestic operations in September 2016. • We sold our German guarding operation in October 2016. The table below shows revenues and income (loss) from operations before tax for these other divestitures: Note 19 - Supplemental Cash Flow Information Argentina Debt Security Transactions We have elected in the past and could continue in the future to repatriate cash from Brink's Argentina using different means to convert Argentine pesos into U.S. dollars. In 2016, cash outflows from the purchase of debt securities totaled $2.1 million and cash inflows from the sale of these securities totaled $2.0 million. In 2015, cash outflows from the purchase of debt securities totaled $25.8 million and cash inflows from the sale of these securities totaled $18.7 million. In 2014, cash outflows from the purchase of debt securities totaled $11.0 million and cash inflows from the sale of these securities totaled $7.4 million. The net cash flows from these transactions are treated as operating cash flows as the debt securities are purchased specifically for resale and are generally sold within a short period of time from the date of purchase. Mexico Real Estate Transaction Brink's Mexico entered into a transaction in 2015 to sell its headquarters building in Mexico City and lease the property back for two years. The transaction did not qualify for sale-leaseback accounting due to continuing involvement with the property. Transaction proceeds of $14.5 million in 2015 are reported as cash inflows from financing activities. Non-cash Investing and Financing Activities We acquired armored vehicles, CompuSafe® units and other equipment under capital lease arrangements in the last three years including $29.4 million in 2016, $18.9 million in 2015 and $12.1 million in 2014. Cash Supply Chain Services In France, we offer services to certain of our customers where we manage some or all of their cash supply chains. Providing this service requires our French subsidiary to take temporary title to the cash received from the management of our customers' cash supply chains until the cash is returned to the customers. As part of this service offering, we have entered into lending arrangements with some of our customers. Cash borrowed under these lending arrangements is used in the process of managing these customers' cash supply chains. The cash for which we have temporary title and the cash borrowed under these customer lending arrangements is restricted and cannot be used for any other purpose other than to service our customers who participate in this service offering. At December 31, 2016, we held $55.5 million of restricted cash ($22.3 million represented short-term borrowings and $33.2 million represented restricted cash held for customers). At December 31, 2015, we held $16.4 million of restricted cash ($3.5 million represented short-term borrowings and $12.9 million represented restricted cash held for customers). Note 20 - Other Operating Income (Expense) (a) Includes losses from devaluations in Venezuela of $4.8 million in 2016, $18.1 million in 2015, and $121.6 million in 2014. (b) Includes a $44.3 million gain on the sale of a noncontrolling interest in a Peruvian cash-in-transit business in 2014. (c) Includes $13.6 million of impairment losses related to the 2016 Reorganization and Restructuring and $35.3 million of impairment losses in 2015 related to property and equipment in Venezuela. Note 21 - Interest and Other Nonoperating Income (Expense) Note 22 - Other Commitments and Contingencies During the fourth quarter of 2015, we became aware of an investigation initiated by COFECE (the Mexican antitrust agency) related to potential anti-competitive practices among competitors in the cash logistics industry in Mexico (the industry in which Brink’s Mexican subsidiary, SERPAPROSA, is active). Because no legal proceedings have been initiated against SERPAPROSA, we cannot estimate the probability of loss or any range of estimate of possible loss at this time. It is possible that SERPAPROSA could become the subject of legal or administrative claims or proceedings, however, that could result in a loss that could be material to the Company’s results in a future period. On March 21, 2016, The Bruce McDonald Holding Company, et al., filed a lawsuit in Circuit Court of Logan County, West Virginia against Addington, Inc. (“Addington”) and The Brink’s Company related to an Agreement of Lease dated September 19, 1978, between the Plaintiffs and Addington. Plaintiffs seek declaratory judgment and unspecified damages related to allegations that Addington failed to mine coal on the property leased from the Plaintiffs and failed to pay correct minimum royalties to the Plaintiffs. The Company denies the allegations asserted by the Plaintiffs, is vigorously defending itself in this matter, and has filed a counterclaim against the Plaintiffs related to Plaintiffs’ failure to consent to the assignment and subleasing the leasehold to others. Due to numerous uncertain and unresolved factors presented in this case, it is not possible to estimate a range of loss at this time and, accordingly, no accrual has been recorded in the Company’s financial statements. In addition, we are involved in various other lawsuits and claims in the ordinary course of business. We are not able to estimate the loss or range of losses for some of these matters. We have recorded accruals for losses that are considered probable and reasonably estimable. Other than the matters noted above, we do not believe that the ultimate disposition of any of the lawsuits currently pending against the Company should have a material adverse effect on our liquidity, financial position or results of operations. At December 31, 2016, we had noncancellable commitments for $28.7 million in equipment purchases, and information technology and other services. Note 23 - Reorganization and Restructuring 2016 Reorganization and Restructuring In the fourth quarter of 2016, management implemented restructuring actions across our global business operations and our corporate functions. As a result of these actions, we recognized asset-related adjustments of $16.3 million, severance costs of $7.2 million, lease restructuring charges of $0.7 million, partially offset by a $6.1 million benefit related to the termination of a benefit program. Severance actions are expected to reduce our global workforce by 700 to 800 positions. We expect that the 2016 restructuring will result in $8 to $12 million in 2017 cost savings. We expect to incur additional costs between $15 million and $20 million in 2017, primarily severance costs. The following table summarizes the costs incurred, payments and utilization, and foreign currency exchange effects of the 2016 Reorganization and Restructuring: Executive Leadership and Board of Directors Restructuring In the fourth quarter of 2015, we recognized $1.8 million in costs related to the restructuring of Executive Leadership and Board of Directors, which was announced in January 2016. We also recognized an additional $4.3 million in charges, primarily severance costs, in 2016. 2015 Reorganization and Restructuring Brink's initiated a global restructuring of its business in the third quarter of 2015. We recognized $11.6 million in 2015 costs related to employee severance, contract terminations, and property impairment. We recognized an additional $6.5 million in 2016 related to this restructuring for additional severance costs, contract terminations and lease terminations. The 2015 Reorganization and Restructuring reduced the global workforce by approximately 1,100 positions and resulted in approximately $20 million in 2016 savings. The actions under this program were substantially completed by the end of 2016, with cumulative pretax charges of approximately $18 million. The following table summarizes the costs incurred, payments and utilization, and foreign currency exchange effects of the 2015 Reorganization and Restructuring: 2014 Reorganization and Restructuring In the fourth quarter of 2014, we announced a reorganization and restructuring of Brink’s global organization to accelerate the execution of our strategy by reducing costs and providing for a more streamlined and centralized organization. As part of this program, we reduced our total workforce by approximately 1,700 positions. The restructuring saved annual direct costs of approximately $50 million in 2015 compared to 2014, excluding charges for severance, lease termination and accelerated depreciation. We recorded total pretax charges of $21.8 million in 2014 and an additional $1.9 million of pretax charges in 2015 related to the 2014 Reorganization and Restructuring. The actions under this program were substantially completed by the end of 2015 with cumulative pretax charges of approximately $24 million, primarily severance costs. Note 24 - Selected Quarterly Financial Data (unaudited) Earnings per share. Earnings per share amounts for each quarter are required to be computed independently. As a result, their sum may not equal the annual earnings per share. Discontinued operations. In early 2015, we sold a small Mexican parcel delivery business which met the criteria for classification as a discontinued operation as of December 31, 2014. The results of this operation have been excluded from continuing operations and are reported as discontinued operations. Significant pretax items in a quarter. First quarter of 2016 We decided to exit operations in the Republic of Ireland and, as a result, we recognized $4.2 million in severance costs and another $1.7 million in operating and other exit costs. In addition, we recognized $3.2 million in charges related to the Executive Leadership and Board of Directors restructuring. We also recognized a $2.8 million net currency remeasurement loss when the Venezuelan government announced that they would replace the SIMADI exchange mechanism with the DICOM exchange mechanism. Second quarter of 2016 We decided to exit operations in Northern Ireland and recognized another $4.5 million in exit-related charges related to our Ireland businesses. We also recognized a $2.0 million loss related to the sale of corporate assets. Fourth quarter of 2016 Management implemented restructuring actions across our global operations and our corporate functions. As a result of these actions, we recognized asset-related adjustments of $16.3 million, severance costs of $7.2 million, lease restructuring charges of $0.7 million, partially offset by a $6.1 million benefit related to the termination of a benefit program. First quarter of 2015 We recognized an $18.0 million remeasurement loss related to our change in February 2015 from the SICAD II exchange mechanism to the SIMADI. Second quarter of 2015 We recognized a $34.5 million impairment of the Venezuela property and equipment (and another $0.8 million in the third quarter). Third quarter of 2015 We initiated a restructuring of our business and recognized a $2.0 million charge related to contract terminations, employee severance and property impairment (and another $9.6 million in the fourth quarter). Fourth quarter of 2015 We recognized a $5.9 million loss on the sale of our interest in a cash management business in Russia. Significant after-tax items in a quarter. In the fourth quarter of 2015, we recognized a $23.5 million increase to current tax expense related to a transaction that accelerated U.S. taxable income. In the fourth quarter of 2016, we recognized a $14.7 million valuation allowance on U.S. deferred tax assets. | Based on the provided text, here's a summary of the financial statement:
Key Financial Points:
- Revenue: Includes Payments Services segment across Mexico, Brazil, Colombia, and the U.S.
- Geographic Segments: Operations in multiple countries with focus on Latin America and the U.S.
Accounting Highlights:
- Tax Accounting: Uses deferred tax assets/liabilities based on differences between financial and tax reporting
- Currency Translation: Financial statements reported in U.S. dollars, with translations from local currencies
- Foreign Operations: Specific considerations for highly inflationary economies
Operational Challenges:
- Venezuela Operations: Challenges with currency exchange and asset procurement
- Potential risks in repatriating dividends or obtaining dollars for operations
Financial Metrics:
- Debt reduction of $3.5 (currency/unit not specified)
Note: The provided text appears to be an incomplete or fragmented financial | Claude |
Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders Versar, Inc. We have audited the accompanying consolidated balance sheet of Versar, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of July 1, 2016 the related consolidated statements of operations, comprehensive (loss) income, changes in stockholders’ equity, and cash flows for the year ended. Our audit also included the financial statement schedule listed in the Index at These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements and financial statement schedule of Versar, Inc. and subsidiaries as of June 26, 2015 and June 27, 2014 and for each of the two years then ended were audited by other auditors whose report dated September 15, 2015, expressed an unqualified opinion on those statements. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the fiscal year 2016 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Versar, Inc. and subsidiaries as of July 1, 2016, and the results of its operations and its cash flows for the year ended July 1, 2016, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note 2 to the consolidated financial statements, the Company generated a net loss of $37.9 million for the fiscal year ended July 1, 2016, expects losses to continue in the future and had an accumulated deficit of $27.4 million at that date. These conditions raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Urish Popeck & Co., LLC Pittsburgh, PA March 27, 2017 The accompanying notes are an integral part of these consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. VERSAR, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive (Loss) Income Fiscal Years Ended July 1, 2016, June 26, 2015, and June 27, The accompanying notes are an integral part of these consolidated financial statements. VERSAR, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders’ Equity Fiscal Years Ended July 1, 2016, June 26, 2015, and June 27, 2014 (in thousands) The accompanying notes are an integral part of these consolidated financial statements. VERSAR, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands) The accompanying notes are an integral part of these consolidated financial statements. VERSAR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES NOTE 1 - Significant Accounting Policies Principles of consolidation and business operations: Versar, Inc., a Delaware corporation organized in 1969, is a global project management firm that provides value oriented solutions to government and commercial clients. We also provide tailored and secure engineering solutions in extreme environments and offers specialized abilities in construction management, security system integration, performance-based remediation, and hazardous materials management. The accompanying consolidated financial statements include the accounts of Versar, Inc. and its wholly-owned subsidiaries (“Versar” or the “Company”). All intercompany balances and transactions have been eliminated in consolidation. The Company operates within three business segments ECM, ESG and PSG. Refer to Note 3 - Business Segments for additional information. The Company’s fiscal year end is based upon 52 or 53 weeks per year ending on the last Friday of the fiscal period and therefore does not close on a calendar month end. The Company’s fiscal year 2016 included 53 weeks and its fiscal years 2015 and 2014 included 52 weeks. Accounting estimates: The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. Contract accounting and revenue recognition: Contracts in process are stated at the lower of actual cost incurred plus accrued profits or incurred costs reduced by progress billings. The Company records income from major fixed-price contracts, extending over more than one accounting period, using the percentage-of-completion method. During performance of such contracts, estimated final contract prices and costs are periodically reviewed and revisions are made as required. The effects of these revisions are included in the periods in which the revisions are made. On cost-plus-fee type contracts, revenue is recognized to the extent of costs incurred plus a proportionate amount of fee earned, and on time-and material contracts, revenue is recognized to the extent of billable rates times hours delivered plus material and other reimbursable costs incurred. Losses on contracts are recognized when they become known. Direct costs of services and overhead: These expenses represent the cost to Versar of direct and overhead staff, including recoverable overhead costs and unallowable costs that are directly attributable to contracts performed by the Company. Pre-contract costs: Costs incurred by the Company prior to the execution of a contract, including bid and proposal costs, are expensed when incurred regardless of whether the bid is successful. Depreciation and amortization: Property and equipment are carried at cost net of accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the assets. Repairs and maintenance that do not add significant value or significantly lengthen an asset’s useful life are charged to current operations. Allowance for doubtful accounts receivable: Disputes arise in the normal course of our business on projects where we are contesting with customers for collection of funds because of events such as delays, changes in contract specifications and questions of cost allowability and collectability. Such disputes, whether claims or unapproved change orders in process of negotiation, are recorded at the lesser of their estimated net realizable value or actual costs incurred and only when realization is probable and can be reliably estimated. Management reviews outstanding receivables on a quarterly basis and assesses the need for reserves, taking into consideration past collection history and other events that bear on the collectability of such receivables. All receivables over 60 days old are reviewed as part of this process. Share-based compensation: Share-based compensation expense is measured at the grant date, based on the fair value of the award. The Company's recent equity awards have been restricted stock unit awards. Share-based compensation cost for restricted stock unit awards is based on the fair market value of the Company’s stock on the date of grant. Share-based compensation expense for stock options is calculated on the date of grant using the Black-Scholes pricing model to determine the fair value of stock options. Compensation expense is then recognized ratably over the requisite service period of the grants. Net income (loss) per share: Basic net income (loss) per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share also includes common equivalent shares outstanding during the period, if dilutive. The Company’s common equivalent shares consist of shares to be issued under outstanding stock options and shares to be issued upon vesting of unvested restricted stock units. The following is a reconciliation of weighted average outstanding shares for purposes of calculating basic net (loss) income per share compared to diluted net (loss) income per share: For fiscal 2014, there were outstanding options to purchase approximately 43,000 shares of common stock, however, due to the net loss, there was no impact to dilution. We had no outstanding options in fiscal years 2015 and 2016. Cash and cash equivalents: All investments with an original maturity of three months or less when purchased are considered to be cash equivalents. Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. The Company has never experienced any losses related to these balances. Inventory: The Company’s inventory is valued at the lower of cost or market and is accounted for on a first-in first-out basis. Long-lived assets: The Company is required to review long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying value of an asset might not be recoverable. An impairment loss is recognized if the carrying value exceeds the fair value. Any write-downs are treated as permanent reductions. The Company believes the long-lived assets as of July 1, 2016 are fully recoverable. Income taxes: The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of certain assets and liabilities. A valuation allowance is established, as necessary, to reduce deferred income tax assets to the amount expected to be realized in future periods. Goodwill: The carrying value of goodwill at July 1, 2016 and June 26, 2015 was zero and $16.1 million, respectively. To conduct the annual goodwill impairment analysis, management, with the assistance of an external valuation firm, estimated the fair value of each reporting unit using a market-based valuation approach based on comparable public company data (see Note 7 for results). As of July 1, 2016, the Company has recognized impairment expense of $11.5 million for the ECM reporting unit, $4.4 million for the ESG reporting unit, and $4.4 million for the PSG reporting unit. These charges are associated with impairment of goodwill acquired from JCSS, Advent, PPS, Charron, GMI, and JMWA. Other intangible assets: The net carrying value of intangible assets at July 1, 2016 and June 26, 2015 was $7.2 million and $4.6 million, respectively. The intangible assets accumulated from acquisitions include customer related assets, marketing related assets, technology-based assets, contractual related assets, and non-competition related assets. These intangible assets are amortized over a 1.75 - 15 year useful life. The Company is required to review its amortized intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of the asset might not be recoverable. An impairment loss is recognized if the carrying value exceeds the fair value. Any impairment of the assets would be treated as permanent reductions. Based on the results of the impairment testing during the third and fourth quarters of fiscal 2016, the Company concluded that the value of intangible assets with a carrying amount of $3.7 million was not recoverable. As a result of these charges, the carrying amount of intangible assets acquired from GMI, Charron, Advent, JMWA, and PPS has been reduced to zero. The carrying amount of intangible assets in the Company’s PSG and ESG segments have been reduced to zero. Treasury stock: The Company accounts for treasury stock using the cost method. There were 330,742 and 323,841 shares of treasury stock at historical cost of approximately $1.5 million at July 1, 2016 and June 26, 2015, respectively. Foreign Currency Translation and Transactions: The financial position and results of operations of the Company’s foreign affiliates are translated using the local currency as the functional currency. Assets and liabilities of the affiliates are translated at the exchange rate in effect at year-end. Statement of Operations accounts are translated at the average rate of exchange prevailing during the year. Translation adjustments arising from the use of differing exchange rates from period to period are included in Other Comprehensive Income (Loss) within the Company’s Consolidated Statements of Comprehensive Income (Loss). Gains and losses resulting from foreign currency transactions are included in operations and are not material for the fiscal years presented. At July 1, 2016 and June 26, 2015, the Company had cash held in foreign banks of approximately $0.5 million and $0.8 million, respectively. At July 1, 2016 and June 26, 2015, the Company had net assets held in the United Kingdom of approximately $0.3 million. Fair value of Financial Instruments: The fair values of the Company’s cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate their carrying values because of the short-term nature of those instruments. The carrying value of the Company’s debt approximates its fair value based upon the quoted market price offered to the Company for debt of the same maturity and quality. Commitments and Contingencies: Liabilities for loss contingencies arising from claims, assessments, litigation, fines, and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. Recent Accounting Pronouncements In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” (“ASU 2014-08”), which amends the requirements for reporting discontinued operations and requires additional disclosures about discontinued operations. Under the new guidance, a discontinued operation is defined as a disposal of a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. This new accounting guidance is effective for annual periods beginning after December 15, 2014. The Company adopted this guidance for the fiscal year ended July 1, 2016 and had no impact on the fiscal 2016 financial statements. In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which simplifies the presentation of debt issuance costs as a deduction from the carrying amount of the related debt liability instead of a deferred charge. For public business entities, the amendments of the update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption of the amendments in this update are permitted for financial statements that have not been previously issued. The Company has elected to adopt this standard for the fiscal year ended July 1, 2016. The Company reclassified $0.2 million of the Lenders debt issuance costs from Prepaid expenses within the other current assets to the Bank line of credit section within current liabilities on the Company consolidated balance sheets. In September 2015, the FASB issued Accounting Standards Update No. 2015-16 - “Simplifying the Accounting for Measurement-Period Adjustments (Topic 805): Business Combinations” (“ASU 2015-16”), which replaces the requirement that an acquirer in a business combination account for measurement period adjustments retrospectively with a requirement that an acquirer recognize adjustments to the provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. ASU 2015-16 requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. For public business entities, ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The guidance is to be applied prospectively to adjustments to provisional amounts that occur after the effective date of the guidance, with earlier application permitted for financial statements that have not been issued. The Company will adopt the guidance for fiscal 2017 and does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. In November 2015, the FASB issued Accounting Standards Update NO. 2015-17 - “Balance Sheet Classifications of Deferred Taxes” (“ASU 2015-17”). To simplify the presentation of deferred income taxes, ASU 2015-17 require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. ASU 2015-17 eliminate the guidance in Topic 740 that requires an entity to separate deferred tax liabilities and assets into a current amount and a noncurrent amount in a classified statement of financial position. ASU 2017 -17 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The guidance is to be applied prospectively to adjustments to provisional amounts that occur after the effective date of the guidance, with earlier application permitted for financial statements that have not been issued. The Company adopted this guidance for the fiscal year ended July 1, 2016 and had no impact on the fiscal 2016 financial statements. In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which requires the recognition of lease rights and obligations as assets and liabilities on the balance sheet. Previously, lessees were not required to recognize on the balance sheet assets and liabilities arising from operating leases. The ASU also requires disclosure of key information about leasing arrangements. ASU 2016-02 is effective on January 1, 2019, using the modified retrospective method of adoption, with early adoption permitted. We have not yet determined the effect of the adoption of ASU 2016-02 on our consolidated financial statements nor have we selected a transition date. In March 2016, the FASB issued ASU 2016-07 (Topic 323), Investments - Equity Method and Joint Ventures. The new guidance eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The guidance is effective for fiscal years, beginning after December 15, 2016. Early adoption is permitted. The Company does not anticipate the adoption of this guidance to have a material impact on its consolidated financial statements. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 provides a single comprehensive revenue recognition framework and supersedes almost all existing revenue recognition guidance. Included in the new principles-based revenue recognition model are changes to the basis for deciding on the timing for revenue recognition. In addition, the standard expands and improves revenue disclosures. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date, to amend ASU 2014-09 to defer the effective date of the new revenue recognition standard. As a result, ASU 2014-09 is effective for the Company for fiscal 2018 and can be adopted either retrospectively to each prior reporting period presented or as a cumulative effect adjustment as of the date of adoption. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) to amend ASU 2014-09, clarifying the implementation guidance on principal versus agent considerations in the new revenue recognition standard. Specifically, ASU 2016-08 clarifies how an entity should identify the unit of accounting (i.e., the specified good or service) for the principal versus agent evaluation and how it should apply the control principle to certain types of arrangements. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing to amend ASU 2014-09, reducing the complexity when applying the guidance for identifying performance obligations and improving the operability and understandability of the license implementation guidance. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. The improvements address completed contracts and contract modifications at transition, noncash consideration, the presentation of sales taxes and other taxes collected from customers, and assessment of collectability when determining whether a transaction represents a valid contract. Specifically, ASU 2016-12 clarifies how an entity should evaluate the collectability threshold and when an entity can recognize nonrefundable consideration received as revenue if an arrangement does not meet the standard’s contract criteria. The pronouncement is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is evaluating the impact all the foregoing Topic 606 amendments will have on its consolidated financial statements. In August 27, 2014, the FASB (the “board”) issued Accounting Standards Update No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which requires management to assess a company’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. Before this new standard, there was minimal guidance in U.S. GAAP specific to going concern. Under the new standard, disclosures are required when conditions give rise to substantial doubt about a company’s ability to continue as a going concern within one year from the financial statement issuance date. The new standard applies to all companies and is effective for the annual period ending after December 15, 2016, and all annual and interim periods thereafter. The Company will adopt the guidance for fiscal 2017 and does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment: These amendments eliminate Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. The Company will adopt the guidance for fiscal 2017 and does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. NOTE 2 - GOING CONCERN The accompanying financial statements and notes have been prepared assuming that the Company will continue as a going concern. For the fiscal year ended July 1, 2016, the Company generated a net loss of $37.9 million and had an accumulated deficits of $27.4 million with limited sources of operating cash flows, and further losses are anticipated in the development of its business. Further, the Company was in default under its loan agreement as of July 1, 2016. On December 9, 2016 Versar, together with certain of its domestic subsidiaries acting as guarantors, entered into an Amendment and to the Loan Agreement dated September 30, 2015 with the Lender (see Note 13 - Debt). The Company’s ability to continue as a going concern is dependent upon the Company’s ability to generate profitable operations and/or raise additional capital through equity or debt financing to meet its obligations and repay its liabilities when they come due. The Company intends to continue funding its business operations and its working capital needs by way of private placements financing, obtaining additional term loans or borrowings from other financial institutions, until such time profitable operations can be achieved. As much as management believes that this plan provides an opportunity for the Company to continue as a going concern, there are no written agreements in place for such funding or issuance of securities and there can be no assurance that sufficient funding will be available in the future. These and other factors raise substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of liabilities that might result from the outcome of this uncertainty. NOTE 3 - BUSINESS SEGMENTS The Company’s ECM business segment provides facility planning and programming, engineering design, construction, construction management and security systems installation and support services. ESG provides full service environmental consulting including compliance, cultural resources. Natural resources, remediation and UXO/MMRP services. PSG provides onsite environmental, engineering, construction and logistics services. Summary financial information for the Company’s business segments from continuing operations is as follows: a) - Gross profit is defined as gross revenues less purchased services and materials, at cost, less direct costs of services and overhead allocated on a proportional basis. During fiscal 2015, the Company’s management changed the method of allocating business development (BD) costs to the reportable segments in order to refine the information used by our Chief Operating Decision Maker (CODM). The new methodology allocates BD costs to the selling, general, and administrative expense line, while the old methodology allocated BD costs to contract costs. The presentation for fiscal 2014 has been reclassified to conform to fiscal 2015 presentation. Approximately $1.8 million has been recast from contract costs to selling, general, and administrative expenses for the year ended June 27, 2014. NOTE 4 - ACQUISITIONS On September 30, 2015, the Company completed the acquisition of a specialized federal security integration business from Johnson Controls, Inc., which is now known as Versar Security Systems (VSS). This group is headquartered in Germantown, Maryland and generated approximately $34 million in trailing twelve month revenues prior to the acquisition date from key long term customers such as FAA and FEMA. The results of operations of VSS have been included in the Company’s consolidated results from the date of acquisition. VSS has contributed approximately $17.6 million in revenue and $15.4 million in expenses from the date of the acquisition through July 1, 2016. Additionally, the Company has incurred approximately $0.6 million of acquisition and integration costs through July 1, 2016, recorded in selling, general, and administrative expenses. VSS expands the Company’s service offerings to include higher margin classified construction, enables Versar to generate more work with existing clients and positions the Company to more effectively compete for new opportunities. At closing, the Company paid a cash purchase price of $10.5 million. In addition, the Company agreed to pay contingent consideration of up to a maximum of $9.5 million (undiscounted) based on certain events within the earn out period of 3 years from September 30, 2015. Based on the facts and circumstances as of April 1, 2016, management believes that the amount of the contingent consideration that will be earned within the earn out period is $3.2 million, including probability weighing of future cash flows. This anticipated contingent consideration is recognized as consideration and as a liability, of which $1.6 million is presented within other current liabilities and $1.6 million is presented within other long-term liabilities on the condensed consolidated balance sheet as of July 1, 2016. The potential undiscounted amount of all future payments that the Company could be required to make under the contingent consideration agreement ranges from $0 to a maximum payout of $9.5 million, with the amount recorded being the most probable. The final purchase price allocation in the table below reflects the Company’s estimate of the fair value of the assets acquired and liabilities assumed as of the September 30, 2015 acquisition date. Goodwill was allocated to the ECM segment. Goodwill represents the value in excess of fair market value that the Company paid to acquire JCSS. The allocation of intangibles has been completed by an independent third party and recorded on the Company’s consolidated balance sheet as of July 1, 2016. The table below summarizes the unaudited pro forma statements of operations for the fiscal year ended July 1, 2016, June 26, 2015 and June 27, 2014, assuming that the VSS acquisition had been completed as of the first day of each of the three fiscal years, respectively. These pro forma statements do not include any adjustments that may have resulted from synergies derived from the acquisition or for amortization of intangibles other than during the period the acquired entity was part of the Company. On July 1, 2014, Versar acquired all of the issued and outstanding capital stock of JMWA. JMWA was a service disabled veteran owned small business providing architectural, design, planning, construction management, environmental, facilities, and logistical consulting services to federal, state, municipal and commercial clients. The outstanding capital stock of JMWA was acquired by Versar pursuant to a Stock Purchase Agreement by and among Versar, JMWA, and the stockholders of JMWA and entered into on June 30, 2014. The aggregate purchase price for the outstanding capital stock of JMWA was $13.0 million, which was comprised of: (i) cash in the amount of $7.0 million paid pro rata in accordance with each stockholder’s ownership interest in JMWA at closing; and (ii) three seller notes with an aggregate principal amount of $6.0 million issued by Versar to the JMWA stockholders, pro rata in accordance with each stockholders’ ownership interest in JMWA at closing. The seller notes bear interest at a rate of 5.00% per annum and mature on the third business day of January 2019. The purchase price is subject to a post-closing adjustment based on an agreed target net working capital of JMWA as of the date of closing. The Stock Purchase Agreement contains customary representations and warranties and requires the JMWA stockholders to indemnify Versar for certain liabilities arising under the agreement, subject to certain limitations and conditions. The final purchase price allocation in the table below reflects the Company’s estimate of the fair value of the assets acquired and liabilities assumed on the July 1, 2014 acquisition date. Goodwill has been allocated between our ECM, ESG, and PSG segments based on a percentage of segment specific JMWA revenue dollars for fiscal 2015. Goodwill, which in certain circumstances, may be deductible for tax purposes, represents the value in excess of fair market value that the Company paid to acquire JMWA, less identified intangible assets. The Company incurred approximately $0.1 million in transaction costs related to the JMWA acquisition. During fiscal 2015, the Company recorded measurement period adjustments totaling approximately $1.1 million related to accounts receivable, intangible assets, goodwill, accounts payable, and other liabilities. NOTE 5 - FAIR VALUE MEASUREMENT Versar applies ASC 820 - Fair Value Measurements and Disclosures in determining the fair value to be disclosed for financial and nonfinancial assets and liabilities. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. It establishes a fair value hierarchy and a framework which requires categorizing assets and liabilities into one of three levels based on the assumptions (inputs) used in valuing the asset or liability. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. Level 1 inputs are unadjusted, quoted market prices in active markets for identical assets or liabilities. Level 2 inputs are observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets. Level 3 inputs include unobservable inputs that are supported by little, infrequent, or no market activity and reflect management’s own assumptions about inputs used in pricing the asset or liability. As a result of the acquisition of JMWA, the Company is required to report at fair value the assets and liabilities it acquired as a result of the acquisition. The significant valuation technique utilized in the fair value measurement of the assets and liabilities acquired was primarily an income approach used to determine fair value of the acquired intangible assets. Additionally, a market approach and an asset-based approach were used as secondary methodologies. This valuation technique is considered to be Level 3 fair value estimate, and required the estimate of appropriate royalty and discount rates and forecasted future revenues generated by each identifiable intangible asset. NOTE 6 - DISCONTINUED OPERATIONS The consolidated financial statements and related footnote disclosures reflect fiscal 2013 discontinuation of the Lab, Telecom, and Domestic Products business components in the ECM segment. Income and losses associated with these components, net of applicable income taxes, is shown as income or loss from discontinued operations for the fiscal year ended June 27, 2014 (excluding quarterly financial data in Note 18). For the year ended July 1, 2016, there was no activity associated with discontinued operations. Operating results for the discontinued operations for the years ended July 1, 2016, June 26, 2015, and June 27, 2014, were as follows; NOTE 7 - GOODWILL AND INTANGIBLE ASSETS Goodwill The carrying value of goodwill at July 1, 2016 and June 26, 2015 was zero million and $16.1million, respectively. The goodwill balances were principally generated from our acquisition of VSS during fiscal 2016 (see Note 4), JMWA during fiscal 2015, GMI during fiscal 2014, Charon during fiscal 2012, and PPS and Advent during fiscal 2010. We had three reporting units at July 1, 2016. The aggregate balance of goodwill decreased by $20.3 million at July 1, 2016 and increased by 8.0 million at June 26, 2015, respectively. In connection with the preparation of fiscal 2016 financial statements, management conducted a test of the Company’s goodwill as of April 2, 2016 and July 1, 2016. A roll forward of the carrying value of the Company’s goodwill balance, by business segment, for fiscal 2016 and 2015 is as follows (in thousands): The Company records goodwill in connection with the acquisition of businesses when the purchase price exceeds the fair values of the assets acquired and liabilities assumed. Generally, the most significant intangible assets from the businesses that the Company acquires are the assembled workforces, which includes the human capital of the management, administrative, marketing and business development, engineering and technical employees of the acquired businesses. Since intangible assets for assembled workforces are part of goodwill in accordance with the accounting standards for business combinations, the substantial majority of the intangible assets for recent business acquisitions are recognized as goodwill. During fiscal 2015, the Company changed the goodwill impairment assessment date from the last day of the fiscal year to the first day of the fourth quarter of the fiscal year, or March 28, 2015. Management determined that performing the assessment prior to the close of the fiscal year provided the external valuation firm, the independent registered public accountants, and the Company with sufficient time to generate, review, and conclude on the valuation analysis results. At the close of each fiscal year, management assessed whether there were any conditions present during the fourth quarter that would indicate impairment subsequent to the initial assessment date and concluded that no such conditions were present. The first step of the goodwill impairment analysis identifies potential impairment and the second step measures the amount of impairment loss to be recognized, if any. Step 2 is only performed if Step 1 indicates potential impairment. Potential impairment is identified by comparing the fair value of the reporting unit with its carrying amount, including goodwill. The carrying amount of a reporting unit equals assets (including goodwill) less liabilities assigned to that reporting unit. The fair value of a reporting unit is the price that would be received if the reporting unit was sold. Value is based on the assumptions of market participants. Market participants may be strategic acquirers, financial buyers, or both. The assumptions of market participants do not include assumed synergies which are unique to the parent company. Management, with the assistance of an external valuation firm has estimated the fair value of each reporting unit using the Guideline Public Company (GPC) method under the market approach. Each of the GPC’s is assumed to be a market participant. The valuation analysis methodology adjusted the value of the reporting units by including a premium for control, or MPAP. The MPAP reflects the capitalized benefit of reducing the Company’s operating costs. These costs are associated with a company’s public reporting requirements. The adjustment assumes an acquirer could take a company private and eliminate these costs. Based upon fiscal 2015 analysis, the estimated fair value of a company’s reporting units exceeded the carrying value of their net assets and therefore, management concluded that the goodwill was not impaired. During the third quarter of fiscal 2016, sustained delays in contract awards and contract funding and the direct impact on the Company’s results of operations, coupled with the continued decrease in the Company’s stock price, and were deemed to be triggering events that led to an interim period test for goodwill impairment. As a result of our analysis, we recorded an impairment charge of $15.9 million. The carrying value of goodwill after impairment at April 1, 2016 was $4.4 million. The Company’s remaining goodwill balance, after impairment, was derived from a partial impairment the acquisition of JMWA acquired in fiscal 2015. As a result of these charges, the carrying amount of goodwill assets acquired from VSS, JMWA, GMI, Charron Consulting and PPS has been reduced to zero, and the carrying amount of goodwill assets in the Company’s ECM and PSG segment have been reduced to zero. During the fourth quarter of fiscal 2016, sustained delays in contract awards and contract funding and the direct impact on the Company’s results of operations, coupled with the continued decrease in the Company’s stock price, and were deemed to be triggering events that led to an updated test for goodwill impairment. As a result of our analysis, we recorded an additional impairment charge of $4.4 million. The carrying value of goodwill after impairment at July 1, 2016 was zero. Based on the results of the impairment testing, the Company concluded that the value of definite-lived assets with a carrying value of $0.9 million was not recoverable. The Company has recorded a charge of $0.3 million for the impairment of definite-lived intangible assets acquired from JMWA, a charge of $0.6 million for the impairment of definite-lived intangible assets acquired from GMI. As a result of these charges, the carrying amount of intangible assets acquired from JMWA and GMI has been reduced to zero. The carrying value of goodwill at June 26, 2015 was $16.1 million. The goodwill balance was principally generated from the acquisition of GMI during fiscal 2014, the fiscal 2012 acquisition of Charron, and the fiscal 2010 acquisitions of PPS and Advent. The Company had three reporting units at June 26, 2015. The aggregate balance of goodwill declined by $1.4 million at June 26, 2015. In connection with the preparation of the fiscal 2014 financial statements, the Company conducted a test of our goodwill as of June 26, 2015. The June 26, 2015 decline was due to an impairment charge of $1.4 million as a result of a decline in the estimated fair value of the ECM reporting unit. The June 26, 2015 impairment is attributable to goodwill acquired from acquisitions prior to 2011. Intangible Assets In connection with the acquisitions of VSS, JMWA, GMI, Charron, PPS, and Advent, the Company identified certain intangible assets. These intangible assets were customer-related, marketing-related and technology-related. A summary of the Company’s intangible asset balances as of July 1, 2016 and June 26, 2015, as well as their respective amortization periods, is as follows (in thousands): Amortization expense for intangible assets was approximately $1.7 million, $1.1 million and $0.6 million for fiscal 2016, 2015, and 2014, respectively. The Company concluded that the value of definite-lived intangible assets with a carrying value of $3.8 million was not recoverable. The Company has recorded a charge of $3.8 million for the full impairment of definite-lived intangible assets. As a result of these charges, the carrying amount of intangible assets acquired from JMWA, GMI, Charron and PPS has been reduced to zero, and the carrying amount of intangible assets in the Company’s PSG and ESG segment have been reduced to zero. No intangible asset impairment charges were recorded during fiscal 2015 or 2014. Expected future amortization expense in the fiscal years subsequent to July 1, 2016 is as follows: NOTE 8 - ACCOUNTS RECEIVABLE Unbilled receivables represent amounts earned which have not yet been billed and other amounts which can be invoiced upon completion of fixed-price contract milestones, attainment of certain contract objectives, or completion of federal and state governments’ incurred cost audits. Management anticipates that such unbilled receivables will be substantially billed and collected in fiscal 2017; therefore, they have been presented as current assets in accordance with industry practice. As part of concentration risk, management continues to assess the impact of having the PBR contracts within the ESG segment represent a significant portion the outstanding receivable balance. NOTE 9 - CUSTOMER INFORMATION A substantial portion of the Company’s revenue from continuing operations is derived from contracts with the U.S. Government as follows: A majority of the DOD work is related to the Company’s runway repair project at DAFB, support of the reconstruction efforts in Iraq and Afghanistan with the USAF and U.S. Army, and our PBR contracts with AFCEC. Revenue of approximately $ 16.6 million for fiscal 2016, $29 million for fiscal 2015, and $33 million for fiscal 2014, was derived from the Company’s international work for the U.S. Government, respectively. NOTE 10 - PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid expenses and other current assets include the following: Other prepaid expenses include maintenance agreements, licensing, subscriptions, and miscellaneous receivables from employees and a service provider. The collateralized cash amount is related to a bid bond the Company issued. NOTE 11 - INVENTORY The Company’s inventory balance includes the following: During the fourth quarter of fiscal 2016, the Company recorded a $0.6 million charge to write-down certain PPS assets, primarily inventory, to their estimated net realizable value as of July 1, 2016. This amount is recorded as Other Expense (Income) in the financial statements. NOTE 12 - PROPERTY AND EQUIPMENT (a) The useful life is the shorter of lease term or the life of the asset. Depreciation of property and equipment was approximately $1.3 million and $1.5 million, for the fiscal years 2016 and 2015, respectively. Maintenance and repair expense approximated $0.1 million for the fiscal years 2016, 2015, and 2014 respectively. NOTE 13 - DEBT Notes Payable As part of the purchase price for JMWA in July 2014, the Company agreed to pay the three JMWA stockholders with an aggregate principal balance of up to $6.0 million, which are payable quarterly over a four and a half-year period with interest accruing at a rate of 5% per year. Accrued interest is recorded within the note payable line item in the consolidated balance sheet. As of July 1, 2016, the outstanding principal balance of the JMWA shareholders was $3.9 million. On October 3, 2016 the Company did not make the quarterly principal payments to three individuals who were the former owners of JMWA. However, the Company continued to make monthly interest payments through the end of calendar year 2016 at an increased interest rate (seven percent per annum, rather than five percent per annum). On November 21, 2016, two of the former JMWA shareholders filed an action against the Company in Fairfax County District Court, VA for failure to make such payments and to enforce their rights to such payments. During the second quarter of fiscal 2017, the Company has moved the long term portion of the debt to short term notes payable for a total of $3.5 million. The Company is defending the lawsuit on legal grounds. Starting January 2017 the Company stopped making the interest only payments to two of the former owners and continues to make the monthly interest only payment at seven percent per annum to one owner. On September 30, 2015, the Company, together with certain of its domestic subsidiaries acting as guarantors, entered into a Loan Agreement with the Lender and letter of credit issuer for a revolving credit facility in the amount of $25.0 million, $14.6 million of which was drawn on the date of closing, and a term facility in the amount of $5.0 million, which was fully drawn on the date of closing. The maturity date of the revolving credit facility is September 30, 2018 and the maturity date of the term facility is March 31, 2017. The principal amount of the term facility amortizes in quarterly installments equal to $0.8 million with no penalty for prepayment. Interest accrues on the revolving credit facility and the term facility at a rate per year equal to the LIBOR Daily Floating Rate (as defined in the Loan Agreement) plus 1.95% and was payable in arrears on December 31, 2015 and on the last day of each quarter thereafter. Obligations under the Loan Agreement are guaranteed unconditionally and on a joint and several basis by the Guarantors and secured by substantially all of the assets of Versar and the Guarantors. The Loan Agreement contains customary affirmative and negative covenants and during fiscal year 2016 contained financial covenants related to the maintenance of a Consolidated Total Leverage Ratio, Consolidated Senior Leverage Ratio, Consolidated Fixed Charge Coverage Ratio and a Consolidated Asset Coverage Ratio. On December 9, 2016 Versar, together with certain of its domestic subsidiaries acting as guarantors, entered into an Amendment to the Loan Agreement dated September 30, 2015 with the Lender removing these covenants and adding a covenant requiring Versar to maintain certain minimum quarterly consolidated EBITDA amounts. The proceeds of the term facility and borrowings under the revolving credit facility were used to repay amounts outstanding under the Company’s Third Amended and Restated Loan and Security Agreement with United Bank and to pay a portion the purchase price for the acquisition of VSS. As of July 1, 2016, the Company’s outstanding principal debt balance was $6.4 million comprised of the Bank of America facility term loan balance of $2.5 million, and JMWA Note balance of $3.8 million. The following maturity schedule presents all outstanding debt as of July 1, 2016. On January 1, 2017 the Company did not make $0.1 million in periodic payment to three individuals who participate in a Deferred Compensation Agreement plan established by the Company in 1988. The Company continues to negotiate with the individuals to reschedule the payments for a future period. Line of Credit As noted above, the Company had a $25.0 million revolving line of credit facility pursuant to the Loan Agreement with the Lender. The revolving credit facility is scheduled to mature on September 30, 2018. The Company had $14.8 million outstanding under its line of credit for the fiscal year ended July 1, 2016. On December 9, 2016 Versar, together with certain of its domestic subsidiaries acting as guarantors, entered into an Amendment to the Loan Agreement dated September 30, 2015 with the Lender. The Company now has a $13.0 million revolving line of credit facility. The Company has $10.3 million outstanding under its line of credit for the six months ended December 30, 2016. The Company has elected to adopt ASU No. 2015-13 to simplify the presentation of debt issuance costs for the fiscal year ended July 1, 2016. $0.2 million of remaining unamortized cost associated with the Loan Agreement as of July 1, 2016 is therefore no longer presented as a separate asset - deferred charge on the consolidated balance sheet, and instead reclassified as a direct deduction from the carrying value of the line of credit. Debt Covenants During the third and fourth quarters of fiscal 2016, following discussion with the Lender, the Company determined that it was not in compliance with the Consolidated Total Leverage Ratio covenant for the fiscal quarters ended January 1, 2016, and April 1, 2016, the Consolidated Total Leverage Ratio covenant, Consolidated Senior Leverage Ratio covenant and the Asset Coverage Ratio covenant for the fiscal quarter ended April 1, 2016, which defaults continued as of July 1, 2016. Each failure to comply with these covenants constitutes a default under the Loan Agreement. On May 12, 2016, the Company, certain of its subsidiaries and the Lender entered into a Forbearance Agreement pursuant to which the Lender agreed to forbear from exercising any and all rights or remedies available to it under the Loan Agreement and applicable law related to these defaults for a period ending on the earliest to occur of: (a) a breach by the Company of any obligation or covenant under the Forbearance Agreement, (b) any other default or event of default under the Loan Agreement or (c) June 1, 2016 (the Forbearance Period). The Forbearance Period was subsequently extended by additional Forbearance Agreements between the Company and the Lender, through December 9, 2016. During the Forbearance Period, the Company was allowed to borrow funds pursuant to the terms of the Loan Agreement, consistent with current Company needs as set forth in a required 13-week cash flow forecast and subject to certain caps on revolving borrowings initially of $15.5 million and reducing to $13.5 million. In addition, the Forbearance Agreements provided that from and after June 30, 2016 outstanding amounts under the credit facility will bear interest at the default interest rate equal to the LIBOR Daily Floating Rate (as defined in the Loan Agreement) plus 3.95%, required that the Company provide a 13 week cash flow forecast updated on a weekly basis to the Lender, and waives any provisions prohibiting the financing of insurance premiums for policies covering the period of July 1, 2016 to June 30, 2017 in the ordinary course of the Company’s business and in amounts consistent with past practices. On December 9, 2016 Versar, together with certain of its domestic subsidiaries acting as guarantors, entered into an Amendment to the Loan Agreement dated September 30, 2015 with the Lender, among other things, eliminating the events of default and amending the due date of the loan agreement to September 30, 2017. The Lender has engaged an advisor to review the Company’s financial condition on the Lender’s behalf, and pursuant to the Forbearance Agreements and the Amendment, requires the Company to pursue alternative sources of funding for its ongoing business operations. If the Company is unable to raise additional financing, the Company will need to adjust its operational plans so that the Company can continue to operate with its existing cash resources. The actual amount of funds that the Company will need will be determined by many factors, some of which are beyond its control and the Company may need funds sooner than currently anticipated. As of the fiscal 2017 quarter ended December 30, 2016, we are in compliance with all covenants under the Amendment to the Loan Agreement. NOTE 14 - OTHER CURRENT LIABILITIES Other current liabilities include the following: Other accrued and miscellaneous liabilities include accrued legal, audit, VAT tax liability, foreign entity obligations, and other miscellaneous items. NOTE 15 - LEASE LOSS LIABILITIES In March 2016, the Company abandoned its field office facilities in Charleston, SC and Lynchburg, VA, within the ESG and ECM segments, respectively. Although the Company remains obligated under the terms of these leases for the rent and other costs associated with these leases, the Company made the decision to cease using these spaces on April 1, 2016, and has no foreseeable plans to occupy them in the future. Therefore, the Company recorded a charge to selling, general and administrative expenses of approximately $0.4 million to recognize the costs of exiting these spaces. The liability is equal to the total amount of rent and other direct costs for the period of time the space is expected to remain unoccupied plus the present value of the amount by which the rent paid by the Company to the landlord exceeds any rent paid to the Company by a tenant under a sublease over the remainder of the lease terms, which expire in April 2019 for Charleston, SC, and June 2020 for Lynchburg, VA. The Company also recognized $0.1 million of costs for the associated leasehold improvements related to the Lynchburg, VA office. In June 2016, the Company abandoned its field office facilities in San Antonio, TX within the ECM segment. Although the Company remains obligated under the terms of the lease for the rent and other costs associated with the lease, the Company made the decision to cease using this space on July 1, 2016, and has no foreseeable plans to occupy it in the future. Therefore, the Company recorded a charge to selling, general and administrative expenses of approximately $0.2 million to recognize the costs of exiting this space. The liability is equal to the total amount of rent and other direct costs for the period of time the space is expected to remain unoccupied plus the present value of the amount by which the rent paid by the Company to the landlord exceeds any rent paid to the Company by a tenant under a sublease over the remainder of the lease terms, which expires in February 2019. The Company also recognized $0.2 million of costs for the associated leasehold improvements related to the San Antonio, TX office. The following table summarizes information related to our accrued lease loss liabilities at July 1, 2016 and June 26, 2015. NOTE 16 - SHARE-BASED COMPENSATION In November 2010, the stockholders approved the Versar, Inc. 2010 Stock Incentive Plan (the “2010 Plan”), under which the Company may grant incentive awards to directors, officers, and employees of the Company and its affiliates and to service providers to the Company and its affiliates. One million shares of Versar common stock were reserved for issuance under the 2010 Plan. The 2010 Plan is administered by the Compensation Committee of the Board of Directors. Through July 1, 2016, a total of 551,369 restricted stock units have been issued under the 2010 Plan. As of July 1, 2016, there are 448,631 shares remaining available for future issuance of awards (including restricted stock units) under the 2010 Plan. During the twelve month period ended July 1, 2016, the Company awarded 209,500 restricted stock units to certain employees, which generally vest over a two-year period following the date of grant. The grant date fair value of these awards is approximately $0.6 million. The total unrecognized compensation cost, measured on the grant date, that relates to 130,948 non-vested restricted stock awards at July 1, 2016, was approximately $0.4 million, which if earned, will be recognized over the weighted average remaining service period of two years. Share-based compensation expense relating to all outstanding restricted stock unit awards totaled approximately $0.4 million and $0.4 million for the year ended July 1, 2016 and June 26, 2015, respectively. These expenses were included in the direct costs of services and overhead and general and administrative lines of the Company’s Condensed Consolidated Statements of Operations. There were no stock options outstanding and exercisable as of July 1, 2016. 20,000 stock options were exercised during fiscal year 2014, with an intrinsic value of approximately $0.1 million. Exercisable qualified stock options outstanding at July 1, 2016 are as follows: NOTE 17 - INCOME TAXES The Company regularly reviews the recoverability of its deferred tax assets and establishes a valuation allowance as deemed appropriate. The Company established a full valuation allowance against its U.S. deferred tax assets at July 1, 2016 of $12.9 million as it determined they were not more likely than not to realize the deferred tax assets due to current year losses and projections for the near future. The company also maintained full valuation allowances on the Philippine and UK branches of $0.1 million and $0.9 million, respectively. The deferred tax assets in the foreign jurisdictions are related primarily to net operating loss carryforwards, as these jurisdictions have a history of losses and it is not more likely than not that the deferred tax assets will be realized. The valuation allowance at the end of fiscal 2015 was $0.8 million to offset the deferred tax asset from the Philippine branch operations, PPS, and for the U.S capital losses not more likely than not to be realized in the future. At July 1, 2016, the Company has net operating loss carryforwards in the Philippines branch of approximately $0.1 million ($0.2 million gross), PPS $1.0 million ($5.4 million gross) and $0.4 million ($1.1 million gross) from the acquisition of Geo-Marine, Inc. In addition, they had $0.1 million of R&D credits carry forward. Pretax income (loss) is comprised of the following: Income tax expense (benefit) for continuing operations is as follows: Deferred tax assets (liabilities) are comprised of the following as of the dates indicated below: In accordance with FASB’s guidance regarding uncertain tax positions, the Company recognizes income tax benefits in its financial statements only when it is more likely than not that the tax positions creating those benefits will be sustained by the taxing authorities based on the technical merits of those tax positions. At July 1, 2016 the Company did not have any uncertain tax positions. The Company’s 2011-2015 tax years remain open to audit in most jurisdictions. The Company’s policy is to recognize interest expense and penalties as a component of general and administrative expenses. The provision for income taxes compared with income taxes based on the federal statutory tax rate of 34% follows (in thousands): NOTE 18 - EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLAN The Company continues to maintain the Versar, Inc. 401(k) Plan (“401(k) Plan”), which permits voluntary participation upon employment. The 401(k) Plan was adopted in accordance with Section 401(k) of the Internal Revenue Code. Under the 401(k) Plan, participants may elect to defer up to 50% of their salary through contributions to the plan, which are invested in selected mutual funds. The Company matches 100% of the first 3% and 50% of the next 2% of the employee-qualified contributions for a total match of 4%. The employer contribution is made in the Company’s cash. In fiscal years 2015, 2014, and 2013 the Company made cash contributions of $1.0 million. All contributions to the 401(k) Plan vest immediately. In January 2005, the Company established an Employee Stock Purchase Plan (“ESPP”) under Section 423 of the United States Internal Revenue Code. The ESPP was amended and restated in November 2014, for an extended term expiring July 31, 2024. The ESPP allows eligible employees of the Company and its designated affiliates to purchase, through payroll deductions, shares of common stock of the Company from the open market. The Company will not reserve shares of authorized but unissued common stock for issuance under the ESPP. Instead, a designated broker will purchase shares for participants on the open market. Eligible employees may purchase the shares at a discounted rate equal to 95% of the closing price of the Company’s shares on the NYSE MKT on the purchase date. NOTE 19 - COMMITMENTS AND CONTINGENCIES Lease Obligations The Company leases approximately 213,000 square feet of office space, as well as data processing and other equipment under agreements expiring through 2021. Minimum future obligations under operating and capital leases are as follows: Certain of the lease payments are subject to adjustment for increases in utility costs and real estate taxes. Total office rental expense approximated $2.9 million, $3.2 million, and $2.6 million, for fiscal years 2016, 2015, and 2014, respectively. Lease concessions and other tenant allowances are amortized over the life of the lease on a straight line basis. For leases with fixed rent escalations, the total lease costs including the fixed rent escalations are totaled and the total rent cost is recognized on a straight line basis over the life of the lease. Disallowed Costs Versar has a substantial number of U.S. Government contracts, and certain of these contracts are cost reimbursable. Costs incurred on these contracts are subject to audit by the Defense Contract Audit Agency (“DCAA”). All fiscal years through 2010 have been audited and closed. Management believes that the effect of disallowed costs, if any, for the periods not yet audited and settled with DCAA will not have a material adverse effect on the Company’s Consolidated Balance Sheets or Consolidated Statements of Operations. The Company accrues a liability from the DCAA audits if needed. As of both July 1, 2016 and June 26, 2015, the accrued liability for such matters was immaterial. Legal Proceedings Versar and its subsidiaries are parties from time to time to various legal actions arising in the normal course of business. The Company believes that any ultimate unfavorable resolution of any currently ongoing legal actions will not have a material adverse effect on its consolidated financial condition and results of operations. NOTE 20 - SUBSEQUENT EVENT(S) On September 30, 2016, Versar filed a Form 12b-25 with the SEC indicating that the Company was delaying the filing of its Annual Report on Form 10-K for the year ended July 1, 2016. On October 13, 2016, the Company notified the Exchange that the Form 10-K would be delayed beyond the extended filing period afforded by Rule 12b-25. On October 17, 2016 the Company received a letter from the Exchange in which the Exchange determined that the Company was not in compliance with Sections 134 and 1101 of the Exchange’s Company Guide (the Company Guide) due to the Company’s failure to timely file its Annual Report on Form 10-K with the SEC for the year ended July 1, 2016. The letter also stated that this failure was a material violation of the Company’s listing agreement with the Exchange and unless the Company took prompt corrective action, the Exchange may suspend and remove the Company’s securities from the Exchange. The Exchange also informed the Company that it must submit a plan by November 16, 2016 advising the Exchange of actions the Company has taken or will take to regain compliance with the Company Guide by January 17, 2017. If the Exchange accepted the plan, the Company would be subject to periodic monitoring for compliance. If the Company failed to submit a plan, or if the submitted plan was not accepted by the Exchange, delisting proceedings would commence. Furthermore, if the plan was accepted, but the Company was not in compliance with the Company Guide by January 17, 2017, or if the Company does not make progress consistent with the plan, the Exchange may initiate delisting proceedings. On November 14, 2016, Versar filed a Form 12b-25 with the SEC indicating that the Company was delaying the filing of its Quarterly Report on Form 10-Q for the three months ended September 30, 2016. On December 15, 2016, the Company received a letter from the Exchange indicating that the Exchange has accepted the Company’s plan and extension request and granted the Company an extended plan period through May 31, 2017 to restore compliance under the Company Guide. The staff of the Exchange will review the Company periodically for compliance with the initiatives outlined in its plan. If the Company is not in compliance with the continued listing standards by May 31, 2017 or if the Company does not make progress consistent with the plan during the plan period, the Exchange staff has indicated that it would initiate delisting proceedings as appropriate. On February 13, 2017, Versar filed a Form 12b-25 with the SEC indicating that the Company was delaying the filing of its Quarterly Report on Form 10-Q for the six months ended December 30, 2016. The Company intends to file the delinquent documents to satisfy the timeline outlined by the Exchange discussed above. In September 2016, the Company entered into a contract with the Army Reserve to provide staff augmentation services. Management expects this contract to operate at a loss. During September, the Company recorded a loss of $0.6 million related to this contract for the base period of nine months. The Army Reserve exercised its option to extend the contract for an additional year effective April 1, 2017. Management expects this extension to also operate at a loss and intends to record a charge of $1.1 million during its fiscal fourth quarter of 2017. Subsequent events have been evaluated through March 27, 2017 which is the date the financial statements were available to be issued. Management did not identify any events requiring recording or disclosure in the financial statements for the year ended July 1, 2016, except those described above. | From the provided financial statement fragments, here's a summary of the key points:
1. Business Model:
- Company uses percentage-of-completion method for major fixed-price contracts
- Revenue recognition varies by contract type (fixed-price, cost-plus-fee, and time-and-material)
2. Key Accounting Policies:
- Contracts are valued at lower of actual cost plus profits or incurred costs minus progress billings
- Pre-contract costs (including bid proposals) are expensed immediately
- Property and equipment are recorded at cost minus accumulated depreciation
- Straight-line depreciation method is used
3. Receivables Management:
- Regular review of outstanding receivables occurs quarterly
- Special attention to disputes and contested collections
- Receivables over 60 days are monitored (specific details cut off)
4. Financial Position:
- Company appears to have experienced a loss (specific period/amount not provided)
- Has a bank line of credit (details limited)
- Debt is valued at fair market value
5. Risk Management:
- Loss contingencies are recorded when probable and estimable
- Regular review of contract prices and costs during project execution
- Losses on contracts are recognized when identified
Note: This summary is limited by the fragmentary nature of the provided statement. A complete financial statement would provide more detailed figures and comprehensive information. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Set forth below is a list of audited financial statements for the years ended December 31, 2016 and 2015. PCAOB Registered Auditors - www.sealebeers.com ACCOUNTING FIRM To the Board of Directors and Stockholders of Accurexa, Inc. We have audited the accompanying balance sheet of Accurexa, Inc. as of December 31, 2015 and the related statements of income, stockholders’ equity (deficit), and cash flows for the year ended December 31, 2015. Accurexa, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Accurexa, Inc. as of December 31, 2015 and the related statements of income, stockholders’ equity (deficit), and cash flows for the year ended December 31, 2015 in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has no revenues, has incurred recurring losses and recurring negative cash flow from operating activities, and has an accumulated deficit which raises substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Seale and Beers, CPAs Seale and Beers, CPAs Las Vegas, Nevada March 28, 2016 ACCOUNTING FIRM To the Board of Directors and Stockholders of Accurexa Inc. We have audited the accompanying balance sheet of Accurexa Inc. as of December 31, 2016 and the related statements of operations, stockholders’ equity (deficit), and cash flows for the year ended December 31, 2016. Accurexa Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Accurexa Inc. as of December 31, 2016 and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has no revenues, has incurred recurring losses and recurring negative cash flow from operating activities, and has an accumulated deficit which raises substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ AMC Auditing AMC Auditing Las Vegas, Nevada March 28, 2017 ACCUREXA INC. NOTES TO THE FINANCIAL STATEMENTS December 31, 2016 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business Accurexa, Inc. (the “Company”) elected its fiscal year ending on December 31. The Company is a development stage company as defined in the Accounting Standards Codification 915, Development Stage Entities. All activities of the Company to date relate to its organization, initial funding and share issuances, and research & development. The Company is focused on delivering targeted therapies. The Company is developing its ACX-31 program to deliver two chemotherapy drugs, temozolomide in combination with BCNU, locally to brain tumor sites. Its ACX-31 program is based on an issued patent licensed from Accelerating Combination Therapies LLC which is co-owned by Dr. Henry Brem, Director of the Neurosurgery Department at Johns Hopkins University (“ACL License”). The Company is collaborating in the development of its ACX-31 program with Dr. Henry Brem who built one of the largest brain tumor research and treatment centers in the world at Johns Hopkins University. Dr. Brem is a pioneer in the development of local drug delivery treatments, and invented and developed Gliadel® which is a FDA approved, local chemotherapy for the treatment of glioblastoma multiforme. The Company entered into an agreement with the Yissum Research Development Company of The Hebrew University of Jerusalem Ltd. (“Yissum”) to develop and supply a polymeric formulation of a combination of temozolomide and BCNU. Professor Avi Domb of The Hebrew University of Jerusalem had previously worked on the formulation of Gliadel® and leads the development efforts provided by Yissum. The Company is also developing other cancer therapies combining its ACX-31 polymer wafer formulation with other drugs, such as DelMar Pharmaceuticals’ VAL-083 (dianhydrogalactitol), or a PARP inhibitor. Accounting Basis These financial statements are prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America. Use of Estimates Management uses estimates and assumptions in preparing financial statements. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could differ from these estimates. Cash and Cash Equivalents Cash equivalents comprise certain highly liquid instruments with a maturity of three months or less when purchased. Concentration of Credit Risk and Financial Instruments Financial instruments which potentially subject the Company to concentration of credit risk consist principally of cash balances maintained at creditworthy financial institutions. The Company maintained cash balances in bank checking and savings accounts which, at times, either may exceed insured limits set or are not insured by the Federal Deposit Insurance Corporation (FDIC). As of December 31, 2016, $1,039,643 of the Company’s cash balances at a US domestic bank were not insured by the FDIC. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on its cash and cash equivalents. Fair Value of Financial Instruments The Company’s financial instruments consist of cash, marketable securities and accounts payable. The carrying values of financial instruments reflected in these financial statements approximate their fair values due to the short-term maturity of the instruments. ACCUREXA INC. NOTES TO THE FINANCIAL STATEMENTS December 31, 2016 Earnings (Loss) per Share The basic earnings (loss) per share are calculated by dividing the Company’s net income available to common shareholders by the weighted average number of common shares outstanding during the reported period. The diluted earnings (loss) per share are calculated by dividing the Company’s net income (loss) available to common shareholders by the diluted weighted average number of shares outstanding during the year. The diluted weighted average number of shares outstanding is the basic weighted number of shares adjusted as of the first of the period for any potentially dilutive debt or equity. There are no diluted shares outstanding. Revenue Recognition The Company has no current source of revenue; therefore the Company has not yet adopted any policy regarding the recognition of revenue. Start-up Cost The Company accounts for start-up costs pursuant to the provisions of the Accounting Standard Codification 720-15. Accounting for start-up costs require all costs incurred in connection with the start-up and organization of the Company be expensed as incurred. Research and Development Expenses The Company expenses all of its research and development expenses in the period in which they are incurred. At such time as the Company’s products are determined to be commercially available, the Company will capitalize those development expenditures that are related to the maintenance of the commercial products, and amortize these capitalized expenditures over the estimated life of the commercial products. The estimated life of the commercial products will be based on management’s estimates, including estimates of current and future industry conditions. A significant change to these assumptions could impact the estimated useful life of the Company’s commercial products resulting in a change to amortization expense and impairment charges. Income Taxes The Company accounts for income taxes pursuant to the provisions of the Accounting Standards Codification 740, Accounting for Income Taxes, which requires an asset and liability approach to calculate deferred income taxes. The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary difference between the carrying amounts and the tax basis of assets and liabilities. As a result of the initial period’s incurred loss the deferred tax asset has been fully reserved. Recent Accounting Pronouncements On June 10, 2014, the FASB issued ASU 2014-10, Elimination of Certain Financial Reporting Requirements, including Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation. The content resulting from the issuance of ASU 2014-10 eliminates inception-to-date presentation and other disclosure requirements in ASC Topic 915 for entities previously considered development stage entities. Early adoption is permitted, and the Company has elected to make an early adoption of ASU 2014-10. The Company's management has evaluated all other recently issued accounting pronouncements through the filing date of these financial statements and does not believe that any of these pronouncements will have a material impact on the Company's financial position and results of operations. 2 - GOING CONCERN The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the accompanying financial statements, the Company has incurred net losses and negative cash flows from operating activities for the year ended December 31, 2016, and has an accumulated deficit of $11,966,149 as of December 31, 2016. The ACCUREXA INC. NOTES TO THE FINANCIAL STATEMENTS December 31, 2016 Company has relied upon raising capital through equity financings to fund its ongoing operations to date, and expects to continue to do so, as it has yet to generate cash from its operating activities. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The Company intends to raise additional capital through equity and/or debt financings as well as through entering into sub-license agreements with strategic partners in order to ensure the Company continues operations. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. 3 - PREPAID ASSETS On January 12, 2015, the Company and the Lim Development Group (“Consultant”) entered into a consulting agreement (“Agreement”) under which the Consultant provides scientific advisory to the Company in the development, partnering and commercialization of the “Microinjection Brain Catheter” (a.k.a. BranchPoint device) that the Company exclusively licensed from the University of California San Francisco (“UCSF”) on September 16, 2014. As consideration for provided services, the Company issued a promissory note (“Note”) in the amount of $200,000 at an interest rate of 5.00% per annum to the Consultant. The principal amount of the Note is amortized on a straight-line basis over the 24-month term of the Agreement. On February 18, 2015, the Company entered into a consulting agreement (“Agreement”) with the Capital Communications Group (“Consultant”) under which the Consultant assists the Company in its efforts to gain greater recognition and awareness among relevant investors in the public capital markets on a non-exclusive basis. In connection with the Agreement, the Company issued a four-year Warrant (“Warrant”) to the Consultant under which the Consultant is entitled to purchase from the Company up to 200,000 shares of the Company’s Common Stock (“Warrant Shares”) at an exercise price of $0.50 per Share (“Exercise Price”). The Warrant is exercisable, in whole or in part, during the term commencing on the issuance date of the Warrant on February 18, 2015 and ending on February 18, 2019 (the “Exercise Period”). The 200,000 Warrant Shares are valued at $527,500 based on the Black-Scholes formula and are amortized on a straight-line basis over the 24-month term of the Agreement. 4 - INTANGIBLE ASSETS On August 11, 2015 (“Effective Date”), the Company entered into an exclusive license agreement (“ACL License”) with Accelerating Combination Therapies LLC (“ACL”) in regards to the exclusive licensing of the issued U.S. Patent No. 8,895,597 B2 Combination of Local Temozolomide with Local BCNU (“Patent Rights”). Under the ACL License, the Company paid ACL a license issue fee of 1,000,000 shares of our Company’s common stock on February 8, 2016. The 1,000,000 shares of common stock are valued at $1.13 per share, equal to the publicly traded share price on the Effective Date, are capitalized in the amount of $1,130,000 and amortized over an expected patent life of 15 years. The gross carrying amount was $1,025,393, accumulated amortization was $104,607 and quarterly amortization expense was $18,833 as of December 31, 2016. The gross carrying amount was $1,100,726, accumulated amortization was $29,274 and quarterly amortization expense was $18,833 as of December 31, 2015. 5 - FIXED ASSETS The Company purchased equipment to support the development of its prototype device which is capitalized in the amount of $123,445 as fixed assets on the Company’s balance sheet as of December 31, 2016. The equipment is amortized on a straight-line basis over 5 years. The gross carrying amount was $123,445, accumulated amortization was $89,924 and quarterly amortization expense was $10,668 as of December 31, 2016. The gross carrying amount was $166,119, accumulated amortization was $47,250 and quarterly amortization expense was $10,668 as of December 31, 2015. 6 - INCOME TAXES The Company provides for income taxes under ASC Topic 740 which requires the use of an asset and liability approach in accounting for income taxes. Deferred tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities and the tax rates in effect currently. ASC 740 requires the reduction of deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. In the Company’s opinion, it is uncertain whether they will generate sufficient taxable income in the future to fully utilize the net deferred tax asset. Accordingly, a ACCUREXA INC. NOTES TO THE FINANCIAL STATEMENTS December 31, 2016 valuation allowance equal to the deferred tax asset has been recorded. The total deferred tax asset is $637,244 which is calculated by multiplying a 34% estimated tax rate with the cumulative NOL of $1,874,248. The total valuation allowance is a comparable $637,244. Details are as follows: Below is a chart showing the estimated corporate federal net operating loss (NOL) and the year in which it will expire. 7 - STOCKHOLDERS’ EQUITY The Company has authorized 20,000,000 Common Shares and 2,000,000 Preferred Shares at a par value of $0.0001 per share. On February 8, 2016, the Company issued 1,000,000 shares of its common stock as license issue fee in connection with the exclusive license agreement (“ACL License”) that the Company entered into with Accelerating Combination Therapies LLC (“ACL”) in regards to the exclusive licensing of the issued U.S. Patent No. 8,895,597 B2 Combination of Local Temozolomide with Local BCNU on August 11, 2015. These shares were issued pursuant to Regulation D under the Securities Act of 1933, as amended, are exempt from registration by reason of Section 4(2) of the Securities Act of 1933, as amended (the “Act”), and bear an appropriate restrictive legend. On March 18, 2016, the Company issued 67,000 shares of its common stock to a consultant to provide media services over 3 months per a consulting agreement. These shares were issued pursuant to Regulation D under the Securities Act of 1933, as amended, are exempt from registration by reason of Section 4(2) of the Securities Act of 1933, as amended (the “Act”), and bear an appropriate restrictive legend. On April 1, 2016, the Company issued 150,000 shares of its common stock to a consultant to provide regulatory and product development services over 6 months per a consulting agreement. These shares were issued pursuant to Regulation D under the Securities Act of 1933, as amended, are exempt from registration by reason of Section 4(2) of the Securities Act of 1933, as amended (the “Act”), and bear an appropriate restrictive legend. On July 20, 2016, the Company issued 450,000 shares of its common stock in connection with entering into a patent assignment agreement under which the Company was assigned the patent rights to the new patent application related to the proprietary formulation used in its ACX-31 program. These shares were issued pursuant to Regulation D under the Securities Act of 1933, as amended, are exempt from registration by reason of Section 4(2) of the Securities Act of 1933, as amended (the “Act”), and bear an appropriate restrictive legend. On August 8, 2016, the Company issued 18,138 shares of its common stock in connection with the consulting agreement that it entered into with an investor relations consultant on February 4, 2015. These shares were issued pursuant to Regulation D under ACCUREXA INC. NOTES TO THE FINANCIAL STATEMENTS December 31, 2016 the Securities Act of 1933, as amended, are exempt from registration by reason of Section 4(2) of the Securities Act of 1933, as amended (the “Act”), and bear an appropriate restrictive legend. On January 23, 2017, the Company issued 200,000 shares of its common stock in connection with the consulting agreement that it entered into with an investor relations consultant on January 23, 2017. These shares were issued pursuant to Regulation D under the Securities Act of 1933, as amended, are exempt from registration by reason of Section 4(2) of the Securities Act of 1933, as amended (the “Act”), and bear an appropriate restrictive legend. There were no underwriters employed in connection with any of the transactions described above. 8 - CONVERTIBLE PREFERRED STOCK On June 22, 2015, the Company closed a private placement of 2,250 shares of the Company's convertible preferred stock for gross proceeds to the Company of $2,250,000 and net proceeds of $1,993,500. The convertible preferred stock is convertible into shares of common stock of the Company at a conversion price of $1.25 per share. The Preferred Stock has no dividend rights or liquidation preference. If dividends are declared on the Common Stock, the holders of the Preferred Stock shall be entitled to participate in such dividends on an as-converted-to-common stock basis. The Company recorded a beneficial conversion feature of $1,980,000 based on the fair value of the common stock and the conversion rate as of the date of the offering. This amount was recorded as a deemed distribution during the period of the offering. 9 - FORM S-1 REGISTRATION STATEMENT On July 6, 2015, the Company filed a Form S-1 registration statement that relates to the offer and resale of up to 3,762,000 shares of the Company’s common stock, par value $0.0001 per share, by the selling stockholders (“Selling Stockholders”) listed in the Form S-1 registration statement (“Selling Stockholders”), issuable to such stockholders upon the conversion of shares of the Company’s preferred stock or exercise of an aggregate of 1,800,000 warrants which the Company sold to investors in a private placement, or exercise of an aggregate of 162,000 warrants which the Company issued to its placement agent. In that private placement the Company sold an aggregate of 2,250 shares of its Series A convertible preferred stock, par value $0.0001 per share (“Preferred Stock”) for gross proceeds to the Company of $2,250,000. Each share of the Preferred Stock is convertible into 800 shares of the Company’s common stock (“Common Stock”) which results in an effective conversion price of $1.25 per share. The Preferred Stock has no dividend rights or liquidation preference. If dividends are declared on the Common Stock, the holders of the Preferred Stock shall be entitled to participate in such dividends on an as-converted-to-common stock basis. In addition, in the private placement the Company issued to the investors warrants (“Investor Warrants”) to purchase up to 1,800,000 shares of Common Stock. The Warrants have an exercise price of $1.50 per share and are exercisable through June 21, 2019. The shares of the Company’s common stock issuable on exercise of the Investor Warrants are registered under the Company’s Form S-1. H.C. Wainwright & Co., LLC (“Placement Agent”) acted as the exclusive placement agent for the placement of the Company’s Preferred Stock and Investor Warrants. The Placement Agent purchased securities in the offering on the same terms and conditions as the other investors. In addition, the Placement Agent and its designees received an aggregate of 162,000 warrants to purchase the Company’s common stock at a price of $1.50 per share through June 21, 2019 (“Agent Warrants”). The shares underlying the Agent Warrants are registered under the Company’s Form S-1. The Company will not receive any proceeds from the sale of shares sold by the Selling Stockholders or from the conversion of Preferred Stock. However, the Company will receive proceeds of $1.50 per share upon the exercise of any Investor Warrants or Agent Warrants. The Company’s Form S-1 registration statement became effective on August 10, 2015. On August 11, 2015, the Selling Stockholders converted an aggregate of 375 convertible preferred stock into 300,000 shares of common stock that were issued by the Company to the Selling Stockholders. On September 1, 2015, the Placement Agent converted an aggregate of 250 convertible preferred stock into 200,000 shares of common stock that were issued by the Company to the Placement Agent. 10 - WARRANTS In connection with the private placement of 2,250 shares of the Company's convertible preferred stock on June 22, 2015, the Company issued to the investors warrants to purchase up to 1,800,000 shares of common stock. The warrants have an exercise ACCUREXA INC. NOTES TO THE FINANCIAL STATEMENTS December 31, 2016 price of $1.50 per share and are exercisable for 4 years. The Company also issued an aggregate of 162,000 warrants that were similar to the warrants issued to investors and are exercisable at $1.50 per share for 4 years, to our placement agent and its designees. The following is a summary of the status of all of the Company’s stock warrants as of December 31, 2016 and changes during the periods ended on that date: 11 - CONVERTIBLE NOTES On July 25, 2013, the Company entered into a secured convertible note (“Note”) under which the Company received $350,000 from the convertible note holder (“Holder”) and is obligated to pay to the Holder the full principal amount after 36 months from the date of the Note, plus an interest at the rate of 10.0% per year payable at the end of each year from the date of the Note. The Note was extended for 12 months on July 25, 2016. The Holder has the right to convert the Note, in whole or in part, into shares of common stock of the Company (“Common Stock”) at a fixed rate of $0.50 per share (the “Conversion Price”) at any time. A beneficial conversion feature of $70,000 was recorded and $30,493 was accreted to interest expense as December 31, 2016. The Company may prepay the Note in whole or in part at any time for cash on 15 business days’ prior written notice, subject to the right of the Holder to convert into shares of Common Stock of the Company prior to any prepayment. The Note agreement was filed on August 14, 2013 as an exhibit to Form 10-Q for the three months ended June 30, 2013. On July 15, 2014, the Company entered into a secured convertible note (“Note”) under which the Company received $20,000 from the convertible note holder (“Holder”) and is obligated to pay to the Holder the full principal amount after 36 months from the date of the Note. The Holder has the right to convert the Note, in whole or in part, into shares of common stock of the Company (“Common Stock”) at a "Variable Conversion Price" of 50% multiplied by the Market Price (representing a discount rate of 50%). “Market Price” means the average of the Closing Trading Prices for the Common Stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. The Company may prepay the Note in whole or in part at any time for cash on 15 business days’ prior written notice, subject to the right of the Holder to convert into shares of Common Stock of the Company prior to any prepayment. The Company has determined the value associated with the beneficial conversion feature in connection with the notes to be $20,000. The aggregate beneficial conversion feature was accreted and charged to interest expense in the amount of $6,667 as of December 31, 2016, and will be amortized until July 15, 2017. On January 12, 2015, the Company and the Lim Development Group (“Consultant”) entered into a consulting agreement (“Agreement”) under which the Consultant provides scientific advisory to the Company in the development, partnering and commercialization of the “Microinjection Brain Catheter” (a.k.a. BranchPoint device) that the Company exclusively licensed from the University of California San Francisco (“UCSF”) on September 16, 2014. The Consultant will also serve as a member of the Company’s newly formed Scientific Advisory Board. The term of the Agreement shall be two years and may be extended by mutual agreement of both parties. As consideration for provided services during the term of the Agreement, the Consultant shall receive either a project fee or an hourly rate, either of which will be determined and agreed upon by both parties prior to commencement of any work or project. Under the Agreement, the Company also issued a promissory note (“Note”) in the amount of $200,000 and at an interest rate of 5.00% per annum to the Consultant. Under the Note, the Consultant shall have the right, exercisable at any time at the Consultant’s sole discretion, to convert all or a portion of the outstanding principal amount of and all accrued interest under the Note, in whole or in part, into shares of common stock of the Company (the “Shares”) at a conversion price of $0.20 per share. A beneficial conversion feature of $200,000 was recorded and $171,934 was accreted to interest expense as of December 31, 2016. The Shares are issuable pursuant to Regulation D under the Securities Act of 1933, as amended, are to be exempt from registration by reason of Section 4(2) of the Securities Act of 1933, as amended (the “Act”), and ACCUREXA INC. NOTES TO THE FINANCIAL STATEMENTS December 31, 2016 are to bear an appropriate restrictive legend. A full description of the Agreement was filed as exhibit 10.1 and of the Note was filed as exhibit 10.2 to the Form 8-K as of January 13, 2015. 12 - CHANGES IN PRESENTATION OF COMPARATIVE STATEMENTS After a review of the ACL License agreement and discussions with the Independent Registered Public Accounting Firm, the Company determined that it was appropriate to reclassify the ACL License from a prepaid asset to an intangible asset. Consequently, the related amortization expense was reclassified from R&D expense to depreciation and amortization expense. 13 - SUBSEQUENT EVENTS On January 19, 2017, Mr. George Yu, MD resigned as President, Chief Executive Officer, Principal Financial Officer, and Director of the Company’s Board, effective immediately. Mr. Yu’s resignation does not arise from any disagreement on any matter relating to the Company’s operations, policies or practices, or regarding the general direction of the Company. On January 19, 2017, Mr. Anchie Kuo, MD resigned as Director of the Company’s Board, effective immediately. Mr. Kuo’s resignation does not arise from any disagreement on any matter relating to the Company’s operations, policies or practices, or regarding the general direction of the Company. On January 19, 2017, the Board of Directors of the Company appointed Mr. Bryan Lee, PhD as President, Chief Executive Officer, Principal Financial Officer, and Director of the Company’s Board, effective immediately. On January 19, 2017, the Board of Directors of the Company appointed Mr. Oliver Jackson as Director of the Company’s Board, effective immediately. On January 30, 2017, the Company completed a reincorporation in the Republic of the Marshall Islands in order to benefit from a favorable international regulatory environment for the development of stem cell therapies. The reincorporation effects a change in the legal domicile of the Company and will not result in any change in the Company’s business, management, fiscal year, or financial statements. The Reincorporation was approved by the holders of a majority of the outstanding shares of common stock of the Company. On January 31, 2017, the Company entered into a sublicense agreement (the “Agreement”) with CNMRGS Inc. (“CNM”), regarding the sublicensing of the UCSF License. The Company entered into the UCSF License with the Regents of the University of California acting through its Office of Innovation, Technology, and Alliances, University of California San Francisco (“UCSF”) in regards to the exclusive licensing of a medical stereotactic device for the delivery of therapeutics to the human brain, characterized as “Microinjection Brain Catheter”, a.k.a. BranchPoint device ("Invention") on September 16, 2014. The invention was claimed in U.S. Patent Application No. PCT/US2013/052301, Microinjection Catheter; UC Case No. SF2012-063 (“Patent Rights”). On March 1, 2017, the Board of Directors of the Company appointed Mr. Stefan Moll as Chief Financial Officer, effective immediately. On March 17, 2017, the Company terminated the UCSF License due to the limited market potential of the licensed device. | Here's a summary of the financial statement:
Financial Overview:
- The company is experiencing ongoing financial challenges, including:
- Consistent losses
- Negative cash flow from operations
- Accumulated deficit
- Substantial doubt about continuing as a going concern
Key Financial Highlights:
- Assets: Purchased equipment for prototype development valued at $123,445
- Liabilities: No specific debt details provided
- Revenue: Currently no revenue source
- Cash Management: Maintains cash balances in bank accounts, sometimes exceeding FDIC insurance limits
Financial Status:
- The company appears to be in a start-up phase
- Facing financial uncertainty
- Relying on management's plans to address ongoing financial challenges
Accounting Approach:
- Following Accounting Standard Codification 720 for start-up costs
- No revenue recognition policy established due to lack of revenue
- No diluted shares outstanding | Claude |
. ACCOUNTING FIRM To the Board of Directors and Stockholders of Kforce Inc. Tampa, FL We have audited the accompanying consolidated balance sheets of Kforce Inc. and subsidiaries (“Kforce”) as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at We also have audited Kforce’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Kforce's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedule and an opinion on Kforce’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kforce Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also, in our opinion, Kforce maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. KFORCE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The accompanying notes are an integral part of these consolidated financial statements. KFORCE INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) The accompanying notes are an integral part of these consolidated financial statements. KFORCE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (IN THOUSANDS) The accompanying notes are an integral part of these consolidated financial statements. KFORCE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) The accompanying notes are an integral part of these consolidated financial statements. KFORCE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies Basis of Presentation The consolidated financial statements have been prepared in conformity with U.S. GAAP and the rules of the SEC. Principles of Consolidation The consolidated financial statements include the accounts of Kforce Inc. and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. References in this document to “the Registrant,” “Kforce,” “the Company,” “we,” “the Firm,” “our” or “us” refer to Kforce Inc. and its subsidiaries, except where the context indicates otherwise. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most important of these estimates and assumptions relate to the following: allowance for doubtful accounts, fallouts and other accounts receivable reserves; accounting for goodwill and identifiable intangible assets and any related impairment; self-insured liabilities for workers’ compensation and health insurance; obligations for pension plans and accounting for income taxes. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates. Revenue Recognition Kforce considers amounts to be earned once evidence of an arrangement has been obtained, delivery has occurred, fees are fixed or determinable, and collectability is reasonably assured. Kforce’s primary sources of revenues are Flex and Direct Hire. Flex revenues are recognized as the services are provided by Kforce’s consultants. Kforce records revenues net of credits, discounts, rebates and revenue-related reserves. Revenues include reimbursements of travel and out-of-pocket expenses (“billable expenses”) with equivalent amounts of expense recorded in direct costs of services. Direct Hire revenues are recognized by Kforce when employment candidates accept offers of permanent employment and are scheduled to commence employment within 30 days. Kforce records revenues net of an estimated reserve for fallouts, which is based on Kforce’s historical fallout experience. Fallouts occur when a candidate does not remain employed with the client through the contingency period, which is typically 90 days or less. Our GS segment generates its revenues under contracts that are, in general, greater in duration than our other segments and which can often span several years, inclusive of renewal periods. Our GS segment does not generate any Direct Hire revenues. Our GS segment, which represents approximately 7% of total revenues, generates revenues under the following contract arrangements. • Revenues for time-and-materials contracts, which accounts for approximately 62% of this segment’s revenue, are recognized based on contractually established billing rates at the time services are provided. • Revenues for fixed-price contracts are recognized on the basis of the estimated percentage-of-completion. Approximately 22% of this segment’s revenues are recognized under this method. Progress towards completion is typically measured based on costs incurred as a proportion of estimated total costs or other measures of progress when applicable. Profit in a given period is reported at the expected profit margin to be achieved on the overall contract. • Revenues for the product-based business, which accounts for approximately 16% of this segment’s revenues, are recognized at the time of delivery. Kforce collects sales tax for various taxing authorities and it is our policy to record these amounts on a net basis; thus, sales tax amounts are not included in net service revenues. Direct Costs of Services Direct costs of services are composed of all related costs of employment for its consultants, including payroll wages, payroll taxes, payroll-related insurance and certain fringe benefits, as well as subcontractor costs. Direct costs of services exclude depreciation and amortization expense, which is presented on a separate line in the accompanying Consolidated Statements of Operations and Comprehensive Income. Commissions Our associates make placements and earn commissions as a percentage of revenues (for Direct Hire revenues) or gross profit (for Flex revenues) pursuant to a calendar-year-basis commission plan. The amount of commissions paid as a percentage of revenues or gross profit increases as volume increases. Kforce accrues commissions for revenues or gross profit at a percentage equal to the percent of total expected commissions payable to total revenues or gross profit for the year, as applicable. Stock-Based Compensation Kforce accounts for stock-based compensation by measuring the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost is recognized over the requisite service period, net of estimated forfeitures. If the actual number of forfeitures differs from those estimated, additional adjustments to compensation expense may be required in future periods. Income Taxes Kforce accounts for income taxes using the asset and liability approach to the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the financial statement carrying amounts and the tax basis of assets and liabilities. Unless it is more likely than not that a deferred tax asset can be utilized to offset future taxes, a valuation allowance is recorded against that asset. The excess tax benefits of deductions attributable to employees’ disqualifying dispositions of shares obtained from incentive stock options, exercises of non-qualified stock options, and vesting of restricted stock are reflected as increases in additional paid-in capital. Kforce evaluates tax positions that have been taken or are expected to be taken in its tax returns, and records a liability for uncertain tax positions. Kforce uses a two-step approach to recognize and measure uncertain tax positions. First, tax positions are recognized if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon examination, including resolution of related appeals or litigation processes, if any. Second, tax positions are measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement. Kforce recognizes interest and penalties related to unrecognized tax benefits in Income tax expense in the accompanying Consolidated Statements of Operations and Comprehensive Income. Cash and Cash Equivalents Kforce classifies all highly liquid investments with an original initial maturity of three months or less as cash equivalents. Cash and cash equivalents consist of cash on hand with banks, either in commercial accounts, or overnight interest-bearing money market accounts and at times may exceed federally insured limits. Cash and cash equivalents are stated at cost, which approximates fair value due to the short duration of their maturities. Accounts Receivable and Accounts Receivable Reserves Kforce records accounts receivable at the invoiced amount. Kforce establishes its reserves for expected credit losses, fallouts, early payment discounts and revenue adjustments based on past experience and estimates of potential future activity. Specific to our allowance for doubtful accounts, which comprises a majority of our accounts receivable reserves, Kforce performs an ongoing analysis of factors including recent write-off and delinquency trends, a specific analysis of significant receivable balances that are past due, the concentration of accounts receivable among clients and higher-risk sectors, and the current state of the U.S. economy. Trade receivables are written off by Kforce after all reasonable collection efforts have been exhausted. Accounts receivable reserves as a percentage of gross accounts receivable was 1.0% and 1.1% as of December 31, 2016 and December 31, 2015, respectively. Fixed Assets Fixed assets are carried at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The cost of leasehold improvements is amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the terms of the related leases, which generally range from three to five years. Upon sale or disposition of our fixed assets, the cost and accumulated depreciation are removed and any resulting gain or loss, net of proceeds, is reflected in the Consolidated Statements of Operations and Comprehensive Income. Leases Leases for our field offices, which are located throughout the U.S., range from three to five-year terms although a limited number of leases contain short-term renewal provisions that range from month-to-month to one year. For leases that contain escalations of the minimum rent, we recognize the related rent expense on a straight-line basis over the lease term. We record any difference between the straight-line rent amounts and amounts payable under the leases as a deferred rent liability in Accounts payable and other accrued liabilities or Other long-term liabilities, as appropriate. The Company records incentives provided by landlords for leasehold improvements in Accounts payable and other accrued liabilities or Other long-term liabilities, as appropriate, and records a corresponding reduction in rent expense on a straight-line basis over the lease term. Goodwill and Other Intangible Assets Goodwill We evaluate goodwill for impairment annually or more frequently if an event occurs or circumstances change that indicate the carrying value may not be recoverable. In testing for goodwill impairment, we may elect to utilize a qualitative assessment to evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If our qualitative assessment indicates that the fair value may be impaired or if we elect not to utilize a qualitative assessment for the evaluation, we perform a two-step impairment test. Under the two-step analysis method, the recoverability of goodwill is measured at the reporting unit level, which Kforce has determined to be consistent with its reporting segments, by comparing the reporting unit’s carrying amount, including goodwill, to the fair market value of the reporting unit. Kforce determines the fair market value of its reporting units based on a weighting of the present value of projected future cash flows (the “income approach”) and the use of comparative market approaches under both the guideline company method and guideline transaction method (collectively, the “market approach”). Fair market value using the income approach is based on Kforce’s estimated future cash flows on a discounted basis. The market approach compares each of Kforce’s reporting units to other comparable companies based on valuation multiples derived from operational and transactional data to arrive at a fair value. Factors requiring significant judgment include, among others, the assumptions related to discount rates, forecasted operating results, long-term growth rates, the determination of comparable companies, and market multiples. Changes in economic or operating conditions or changes in Kforce’s business strategies that occur after the annual impairment analysis and which impact these assumptions may result in a future goodwill impairment charge, which could be material to Kforce’s consolidated financial statements. Other Intangible Assets Identifiable intangible assets arising from certain of Kforce’s acquisitions include non-compete and employment agreements, contractual relationships, customer contracts, technology, and a trade name and trademark. Our trade names and trademarks, and derivatives thereof, and GS’s Data Confidence trademark are important to our business. Our primary trade names and trademark are registered with the U.S. Patent and Trademark Office. For definite-lived intangible assets, amortization is computed using the straight-line method over the period of expected benefit, which ranges from one to fifteen years. The impairment evaluation for indefinite-lived intangible assets, which for Kforce consists of a trademark and trade name, is conducted on an annual basis or more frequently if events or changes in circumstances indicate that an asset may be impaired. Impairment of Long-Lived Assets Kforce reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of long-lived assets is measured by a comparison of the carrying amount of the asset group to the future undiscounted net cash flows expected to be generated by those assets. If such assets are considered to be impaired, the impairment charge recognized is the amount by which the carrying amounts of the assets exceed the fair value of the assets, as determined based on the present value of projected future cash flows. Capitalized Software Kforce purchases, develops, and implements software to enhance the performance of our technology infrastructure. Direct internal costs, such as payroll and payroll-related costs, and external costs incurred during the development stage are capitalized and classified as capitalized software. Capitalized software development costs and the associated accumulated amortization are classified as Other assets, net in the accompanying Consolidated Balance Sheets; amortization is computed using the straight-line method over the estimated useful lives of the software, which range from one to seven years. Workers’ Compensation Kforce retains the economic burden for the first $250 thousand per occurrence in workers’ compensation claims except: (1) in states that require participation in state-operated insurance funds and (2) for Kforce Government Solutions, Inc. which is fully insured for workers’ compensation claims. Workers’ compensation includes ongoing health care and indemnity coverage for claims and may be paid over numerous years following the date of injury. Workers’ compensation expense includes insurance premiums paid, claims administration fees charged by Kforce’s workers’ compensation administrator, premiums paid to state-operated insurance funds and an estimate for Kforce’s liability for IBNR claims and for the ongoing development of existing claims. Kforce estimates its workers’ compensation liability based upon historical claims experience, actuarially determined loss development factors, and qualitative considerations such as claims management activities. Health Insurance Except for certain fully insured health insurance lines of coverage, Kforce retains the risk of loss for each health insurance plan participant up to $350 thousand in claims annually. Additionally, for all claim amounts exceeding $350 thousand, Kforce retains the risk of loss up to an aggregate annual loss of those claims of $450 thousand. For its partially self-insured lines of coverage, health insurance costs are accrued using estimates to approximate the liability for reported claims and IBNR claims, which are primarily based upon an evaluation of historical claims experience, actuarially-determined completion factors and a qualitative review of our health insurance exposure including the extent of outstanding claims and expected changes in health insurance costs. Accounting for Pension Benefits Kforce recognizes the unfunded status of its defined benefit pension plans as a liability in its Consolidated Balance Sheets. Because our plans are unfunded as of December 31, 2016, actuarial gains and losses may arise as a result of the actuarial experience of the plans, as well as changes in actuarial assumptions in measuring the associated obligation as of year-end, or an interim date if any re-measurement is necessary. The net after-tax impact of unrecognized actuarial gains and losses related to our defined benefit pensions plans is recorded in accumulated other comprehensive income (loss) in our consolidated financial statements. Amortization of a net unrecognized gain or loss in accumulated other comprehensive income (loss) is included as a component of net periodic benefit cost if, as of the beginning of the year, that net gain or loss exceeds 10% of the projected benefit obligation. If amortization is required, the minimum amortization shall be that excess divided by the average remaining service period of active plan participants. Earnings per Share Basic earnings per share is computed as earnings divided by the weighted average number of common shares outstanding (“WASO”) during the period. WASO excludes unvested shares of restricted stock. Diluted earnings per common share is computed by dividing the earnings attributable to common shareholders by diluted WASO. Diluted WASO includes the dilutive effect of stock options and other potentially dilutive securities such as unvested shares of restricted stock using the treasury stock method, except where the effect of including potential common shares would be anti-dilutive. For the years ended December 31, 2016, 2015 and 2014, there were 175 thousand, 280 thousand and 216 thousand common stock equivalents included in the diluted WASO. For the years ended December 31, 2016, 2015 and 2014, there was an insignificant amount of anti-dilutive common stock equivalents. Treasury Stock Kforce’s Board may authorize share repurchases of Kforce’s common stock. Shares repurchased under Board authorizations are held in treasury for general corporate purposes, including issuances under the 2009 Employee Stock Purchase Plan. Treasury shares are accounted for under the cost method and reported as a reduction of stockholders’ equity in the accompanying consolidated financial statements. Fair Value Measurements Kforce uses fair value measurements in areas that include, but are not limited to: the impairment testing of goodwill and intangible and long-lived assets; stock-based compensation arrangements; and a contingent consideration liability. The carrying values of cash and cash equivalents, accounts receivable, accounts payable, and other current assets and liabilities approximate fair value because of the short-term nature of these instruments. Using available market information and appropriate valuation methodologies, Kforce has determined the estimated fair value measurements; however, considerable judgment is required in interpreting data to develop the estimates of fair value. New Accounting Standards In January 2017, the FASB issued authoritative guidance simplifying the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under this guidance, an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The guidance is to be applied for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The guidance requires companies to apply the requirements prospectively. Kforce is currently evaluating the impact on the consolidated financial statements. In December 2016, the FASB issued authoritative guidance clarifying language when accounting for internal-use software licensed from third parties that is within the scope of Subtopic 350-40. According to the clarifying language, internal-use software licensed from third parties shall be accounted for as the acquisition of an intangible asset. The guidance is to be applied for annual periods beginning after December 15, 2016 and interim periods within those annual periods, and early adoption is permitted. Kforce elected not to adopt this standard early. The guidance requires companies to apply the requirements prospectively or retrospectively. Upon adoption, Kforce anticipates retrospectively applying a change in the classification of internal-use software licensed from third parties from other assets to intangible assets on the consolidated balance sheet. In August 2016, the FASB issued authoritative guidance clarifying eight cash flow classification issues that are not currently addressed or unclear under current GAAP and thereby reducing the current and potential future diversity in practice. The guidance is to be applied for annual periods beginning after December 15, 2017 and interim periods within those annual periods, and early adoption is permitted. The guidance requires companies to apply the requirements retrospectively, unless it is impracticable to apply the requirements retrospectively at which the requirements should be applied prospectively as of the earliest date practicable. Kforce elected not to adopt this standard early. Kforce does not anticipate that this guidance will have an impact on its consolidated financial statements as the cash flow classification issues are either not applicable or we are currently accounting for them in accordance with the clarified guidance. In March 2016, the FASB issued authoritative guidance regarding the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance is to be applied for annual periods beginning after December 15, 2016 and interim periods within those annual periods, and early adoption is permitted. The guidance requires companies to apply the requirements retrospectively, modified retrospectively, or prospectively depending on the amendment(s) applied. Kforce elected not to adopt this standard early. Upon adoption, Kforce anticipates a prospective impact to our income tax expense line within our consolidated statements of operations and comprehensive income, the amount of which will depend on the vesting activity in any given period and Kforce’s stock price on the vesting date. Additionally, we expect a retrospective change in the presentation of excess tax benefits from a financing to operating activity within our consolidated statements of cash flows. Kforce elected to change its policy regarding forfeitures and to account for forfeitures when they occur as opposed to applying an estimate to simplify our internal accounting practices. This change will be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. In February 2016, the FASB issued authoritative guidance regarding the accounting for leases. The guidance is to be applied for annual periods beginning after December 15, 2018 and interim periods within those annual periods, and early adoption is permitted. The guidance requires companies to apply the requirements retrospectively to all prior periods presented, including interim periods. Kforce elected not to adopt this standard early. Kforce is currently evaluating the impact on the consolidated financial statements. In November 2015, the FASB issued authoritative guidance requiring that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. This guidance is to be applied for annual periods beginning after December 15, 2016, and interim periods within those annual periods, and early adoption is permitted. Kforce elected not to adopt this standard early. Kforce anticipates a change to the presentation of the deferred tax liabilities and assets on the consolidated balance sheets upon adoption. In May 2014, the FASB issued authoritative guidance regarding revenue from contracts with customers, which specifies that revenue should be recognized when promised goods or services are transferred to customers in an amount that reflects the consideration which the company expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued authoritative guidance deferring the effective date of the new revenue standard by one year for all entities. The one-year deferral results in the guidance being effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 and entities are not permitted to adopt the standard earlier than the original effective date. Since May 2014, the FASB has issued additional and amended authoritative guidance regarding revenue from contracts with customers in order to clarify and improve the understanding of the implementation guidance. The guidance permits companies to either apply the requirements retrospectively to all prior periods presented, or apply the requirements in the year of adoption, through a cumulative adjustment. We have selected the modified retrospective transition method. Based on our preliminary assessment, we believe that the timing of our revenue recognition will not be impacted for at least 95% of our revenues. The remainder of our revenues are derived from GS fixed-price contracts. We are reviewing these contracts in order to determine if there may be any change to the timing. Additionally, we anticipate a change in the classification of bad debt expense from SG&A to net service revenues. We are continuing to evaluate other items that may impact our revenue transaction prices. Furthermore, we do anticipate an increase in the level of disclosure around our arrangements and resulting revenue recognition. 2. Discontinued Operations Effective August 3, 2014, Kforce sold to RCM Acquisition, Inc. (the “Purchaser”), under a Stock Purchase Agreement (the “SPA”) dated August 4, 2014, all of the issued and outstanding stock of KHI, a wholly-owned subsidiary of Kforce Inc. and operator of the former HIM reporting segment, for a total cash purchase price of $119.0 million plus a post-closing working capital adjustment of $96 thousand. In connection with the sale, Kforce entered into a Transition Services Agreement (the “TSA”) with the Purchaser to provide certain post-closing transitional services for a period not to exceed 12 months. Services provided by Kforce under the TSA ceased during the three months ended September 30, 2015. The fees for the services under the TSA were generally equivalent to Kforce’s cost. In accordance with and defined within the SPA, Kforce was obligated to indemnify the Purchaser for certain losses, as defined, in excess of $1.19 million, although this deductible does not apply to certain specified losses. Kforce’s obligations under the indemnification provisions of the SPA, with the exception of certain items, ceased 12 months from the closing date and were limited to an aggregate of $8.925 million, although these time and monetary caps do not apply to certain specified losses. While it cannot be certain, Kforce believes any material exposure under the indemnification provisions is remote, particularly given that the 12-month time period for general indemnification claims has now passed and, as a result, Kforce has not recorded a liability as of December 31, 2015. The total financial results of HIM have been presented as discontinued operations in the accompanying Consolidated Statements of Operations and Comprehensive Income. The following summarizes the revenues and pretax profits of HIM for the year ended December 31 (in thousands): For the year ended December 31, 2014, the income from discontinued operations included a gain, net of transaction costs, on the sale of HIM of $94.3 million pretax, or $56.1 million after tax. The transaction costs primarily included legal fees, stock-based compensation related to the acceleration of restricted stock, commissions and transaction bonuses in the form of cash and common stock, which, in the aggregate, totaled $11.0 million. Stock-based compensation related to acceleration of restricted stock was approximately $0.6 million and transaction bonuses was approximately $1.8 million, or 92 thousand shares of common stock. Kforce utilized the proceeds from the sale of HIM initially to pay down the outstanding borrowings under our credit facility and ultimately to repurchase shares of common stock. Income tax expense as a percentage of income from discontinued operations, before income taxes, for the year ended December 31, 2014 was 40.6%. 3. Fixed Assets The following table presents major classifications of fixed assets and related useful lives (in thousands): Computer equipment as of December 31, 2016 includes equipment acquired under capital leases of $4.0 million and related accumulated depreciation of $2.3 million. Computer equipment as of December 31, 2015 includes equipment acquired under capital leases of $4.7 million and related accumulated depreciation of $2.9 million. Depreciation and amortization expense, which includes amortization of capital leases, during the years ended December 31, 2016, 2015 and 2014 was $6.7 million, $6.7 million and $6.3 million, respectively. 4. Income Taxes The provision for income taxes from continuing operations consists of the following (in thousands): The provision for income taxes from continuing operations shown above varied from the statutory federal income tax rate for those periods as follows: The 2016 rate was unfavorably impacted by certain one-time non-cash adjustments. The 2015 rate was unfavorably impacted by a change in the overall mix of income in the various state jurisdictions and the increase in particular uncertain tax positions. Deferred income tax assets and liabilities are composed of the following (in thousands): At December 31, 2016, Kforce had approximately $5.6 million of state tax net operating losses (“NOLs”) which will be carried forward to be offset against future state taxable income. The state tax NOLs expire in varying amounts through 2033. In evaluating the realizability of Kforce’s deferred tax assets, management assesses whether it is more likely than not that some portion, or all, of the deferred tax assets, will be realized. Management considers, among other things, the ability to generate future taxable income (including reversals of deferred tax liabilities) during the periods in which the related temporary differences will become deductible. Kforce is periodically subject to IRS audits, as well as state and other local income tax audits for various tax years. During 2016 and 2015, there were no on-going IRS examinations. Although Kforce has not experienced any material liabilities in the past due to income tax audits, Kforce can make no assurances concerning any future income tax audits. Uncertain Income Tax Positions The following table presents a reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended (in thousands): As of December 31, 2016, the amount of unrecognized tax benefit that would impact the effective tax rate, if recognized, is $0.7 million. Kforce does not expect any significant changes to its uncertain tax positions in the next 12 months. Kforce and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states. Kforce Global Solutions, Inc. files income tax returns in the Philippines. With a few exceptions, Kforce is no longer subject to federal, state, local, or non-U.S. income tax examinations by tax authorities for years before 2012. 5. Goodwill and Other Intangible Assets Goodwill The following table presents the gross amount and accumulated impairment losses for each of our reporting units as of December 31, 2016, 2015 and 2014, respectively (in thousands): There was no impairment expense related to goodwill for the years ended December 31, 2016, 2015 and 2014, respectively. Throughout 2016, we considered the qualitative and quantitative factors associated with each of our reporting units and determined that there was no indication that the carrying values of any of our reporting units were likely impaired. For our annual impairment assessment of the carrying value of goodwill for our Technology and Finance and Accounting reporting units as of December 31, 2016 and 2015, we assessed qualitative factors to determine whether the existence of events or circumstances indicated that it was more likely than not that the fair value of the reporting units was less than its carrying amount. We concluded that it was more likely than not that the fair value of these reporting units was more than their carrying amounts. For our annual impairment assessment of the carrying value of goodwill for our Government Solutions reporting unit as of December 31, 2016 and 2015, we compared its carrying value to the estimated fair value based on a weighting of the income approach and market approaches (“step one”). Discounted cash flows, which serve as the primary basis for the income approach, were based on a discrete financial forecast which was developed by management for planning purposes. Cash flows beyond the discrete forecast period of five years were estimated using a terminal value calculation, which incorporated historical and forecasted financial trends and also considered long-term earnings growth rates for publicly-traded peer companies, as well as the risk-free rate of return. The discrete financial forecast includes certain adjustments of costs that Kforce believes a market participant buyer, such as a large government contractor, would incur to operate the Government Solutions reporting unit. The market approaches consist of: (1) the guideline company method and (2) the guideline transaction method. The guideline company method applies pricing multiples derived from publicly-traded guideline companies that are comparable to the reporting unit to determine its value. The guideline transaction method applies pricing multiples derived from recently completed acquisitions that we believe are reasonably comparable to the reporting unit to determine fair value. Our assessment indicated that the fair value of the Government Solutions reporting unit exceeded its carrying value. For the impairment test performed as of December 31, 2014, Kforce performed a step one analysis for each reporting unit and compared the carrying value of Technology, Finance and Accounting and Government Solutions to the respective estimated fair values. Our assessments indicated that the fair value of the reporting units exceeded their carrying value. Other Intangible Assets Our other intangible assets balance includes an indefinite-lived trademark of $2.2 million as of December 31, 2016 and 2015, respectively, and is recorded in Intangible assets, net in the accompanying Consolidated Balance Sheets. As of December 31, 2016 and 2015, our definite-lived intangible assets balance of $1.4 million and $2.0 million included accumulated amortization of $27.2 million and $26.6 million, respectively. There was no impairment expense related to our other intangible assets during the years ended December 31, 2016, 2015 and 2014. 6. Accounts Payable and Other Accrued Liabilities Accounts payable and other accrued liabilities consisted of the following (in thousands): Our accounts payable balance includes trade creditor and independent contractor payables. Our accrued liabilities balance includes the current portion of our deferred compensation plans liability, accrued customer rebates and other accrued liabilities. 7. Accrued Payroll Costs Accrued payroll costs consisted of the following (in thousands): 8. Credit Facility On September 20, 2011, Kforce entered into a Third Amended and Restated Credit Agreement, with a syndicate led by Bank of America, N.A. This was amended on March 30, 2012 through the execution of a Consent and First Amendment, on December 27, 2013 through the execution of a Second Amendment and Joinder, and further amended on December 23, 2014 through the execution of a Third Amendment (as amended to date, the “Credit Facility”) resulting in a maximum borrowing capacity of $170.0 million, as well as an accordion option of $50.0 million. The maximum borrowings available to Kforce under the Credit Facility, absent Kforce exercising all or a portion of the accordion, are limited to: (a) a revolving Credit Facility of up to $170.0 million and (b) a $15.0 million sub-limit included in the Credit Facility for letters of credit. Available borrowings under the Credit Facility are limited to 85% of the net amount of eligible accounts receivable (billed and unbilled), plus 80% of the net amount of eligible employee placement accounts, plus 80% of the appraised market value of the Firm’s corporate headquarters reduced each subsequent quarter by an amount equal to 1/80th of the initial amount, minus certain minimum availability reserves. Borrowings under the Credit Facility are secured by substantially all of the assets of the Firm, including the Firm’s corporate headquarters property. Outstanding borrowings under the revolving Credit Facility bear interest at a rate of: (a) LIBOR plus an applicable margin based on various factors; or (b) the higher of (1) the prime rate, (2) the federal funds rate plus 0.50% or (3) LIBOR plus 1.25%. Fluctuations in the ratio of unbilled to billed receivables could result in material changes to availability from time to time. Letters of credit issued under the Credit Facility require Kforce to pay a fronting fee equal to 0.125% of the amount of each letter of credit issued, plus a per annum fee equal to the applicable margin for LIBOR loans based on the total letters of credit outstanding. To the extent that Kforce has unused availability under the Credit Facility, an unused line fee is required to be paid on a monthly basis equal to: (a) if the average daily aggregate revolver outstanding are less than 35% of the amount of the commitments, 0.35% or (b) if the average daily aggregate revolver outstanding are greater than 35% of the amount of the commitments, 0.25% times the amount by which the maximum revolver amount exceeded the sum of the average daily aggregate revolver outstanding, during the immediately preceding month or shorter period if calculated for the first month hereafter or on the termination date. Under the Credit Facility, Kforce is subject to certain affirmative and negative covenants including, but not limited to, a fixed charge coverage ratio, which is only applicable in the event that the Firm’s availability under the Credit Facility falls below the greater of (a) 10% of the aggregate amount of the commitment of all of the lenders under the Credit Facility and (b) $11 million. The numerator in the fixed charge coverage ratio is defined pursuant to the Credit Facility as earnings before interest expense, income taxes, depreciation and amortization, including the amortization of stock-based compensation expense (disclosed as “Adjusted EBITDA”), less cash paid for capital expenditures. The denominator is defined as Kforce’s fixed charges such as interest expense, principal payments paid or payable on outstanding debt other than borrowings under the Credit Facility, income taxes payable, and certain other payments. This financial covenant, if applicable, requires that the numerator be equal to or greater than the denominator. Our ability to repurchase equity securities could be limited if the Firm’s availability is less than the greater of (a) 15.0% of the aggregate amount of the commitment of all lenders under the Credit Facility or (b) $15.0 million. Also, our ability to make distributions could be limited if the Firm’s availability is less than the greater of (a) 12.5% of the aggregate amount of the commitment of all lenders under the Credit Facility and (b) $20.6 million. Since Kforce had availability under the Credit Facility of $41.4 million as of December 31, 2016, the fixed charge coverage ratio covenant was not applicable nor was Kforce limited in making distributions or executing repurchases of its equity securities. Kforce believes that it will be able to maintain these minimum availability requirements; however, in the event that Kforce is unable to do so, Kforce could fail the fixed charge coverage ratio, which would constitute an event of default, or we could be limited in our ability to make distributions or repurchase equity securities. The Credit Facility expires December 23, 2019. As of December 31, 2016 and 2015, $111.5 million and $80.5 million was outstanding under the Credit Facility, respectively. As of February 22, 2017, $117.2 million was outstanding and $35.7 million was available under the Credit Facility. 9. Employee Benefit Plans 401(k) Savings Plans The Firm maintains various qualified defined contribution 401(k) retirement savings plans for eligible employees. Assets of these plans are held in trust for the sole benefit of employees and/or their beneficiaries. Employer matching contributions are discretionary and are funded annually as approved by Kforce’s Board. Kforce accrued matching 401(k) contributions of $1.5 million and $1.4 million as of December 31, 2016 and 2015, respectively. The plans held a combined 201 thousand and 218 thousand shares of Kforce’s common stock as of December 31, 2016 and 2015, respectively. Employee Stock Purchase Plan Kforce’s employee stock purchase plan allows all eligible employees to enroll each quarter to purchase Kforce’s common stock at a 5% discount from its market price on the last day of the quarter. Kforce issued 34 thousand, 26 thousand and 35 thousand shares of common stock at an average purchase price of $19.37, $22.61 and $19.76 per share during the years ended December 31, 2016, 2015 and 2014, respectively. All shares purchased under the employee stock purchase plan were settled using Kforce’s treasury stock. Deferred Compensation Plans The Firm maintains various non-qualified deferred compensation plans, pursuant to which eligible management and highly compensated key employees, as defined by IRS regulations, may elect to defer all or part of their compensation to later years. These amounts are classified in Accounts payable and other accrued liabilities if payable within the next year or in Other long-term liabilities if payable after the next year, upon retirement or termination of employment in the accompanying Consolidated Balance Sheets. At December 31, 2016 and 2015, amounts included in Accounts payable and other accrued liabilities related to the deferred compensation plans totaled $2.7 million and $2.3 million, respectively. Amounts included in Other long-term liabilities related to the deferred compensation plans totaled $27.5 million and $24.2 million as of December 31, 2016 and 2015, respectively. For the years ended December 31, 2016 and 2015, we recognized compensation expense for the plans of $881 thousand and $401 thousand, respectively. For the year ended December 31, 2014, we recognized compensation income from continuing operations for the plans of $187 thousand. Kforce maintains a Rabbi Trust and holds life insurance policies on certain individuals to assist in the funding of the deferred compensation liability. If necessary, employee distributions are funded through proceeds from the sale of assets held within our Rabbi Trust. The balance of the assets within the Rabbi Trust, including the cash surrender value of the Company-owned life insurance policies, was $27.3 million and $25.5 million as of December 31, 2016 and 2015, respectively, and is recorded in Other assets, net in the accompanying Consolidated Balance Sheets. As of December 31, 2016, the life insurance policies had a cumulative face value of $213.1 million. Kforce had no gains or losses attributable to investments in trading securities for the years ended December 31, 2016, 2015 and 2014. Supplemental Executive Retirement Plan Kforce maintains a SERP for the benefit of certain executive officers. The primary goals of the SERP are to create an additional wealth accumulation opportunity, restore lost qualified pension benefits due to government limitations and retain our covered executive officers. The SERP is a non-qualified benefit plan and does not include elective deferrals of covered executive officers’ compensation. Normal retirement age under the SERP is defined as age 65; however, certain conditions allow for early retirement as early as age 55 or upon a change in control. Vesting under the plan is defined as 100% upon a participant’s attainment of age 55 and 10 years of service and 0% prior to a participant’s attainment of age 55 and 10 years of service. Full vesting also occurs if a participant with five years or more of service is involuntarily terminated by Kforce without cause or upon death, disability or a change in control. The SERP will be funded entirely by Kforce, and benefits are taxable to the covered executive officer upon receipt and deductible by Kforce when paid. Benefits payable under the SERP upon the occurrence of a qualifying distribution event, as defined, are targeted at 45% of the covered executive officers’ average salary and bonus, as defined, from the three years in which the covered executive officer earned the highest salary and bonus during the last 10 years of employment, which is subject to adjustment for retirement prior to the normal retirement age and the participant’s vesting percentage. The benefits under the SERP are reduced for a participant that has not reached age 62 with 10 years of service or age 55 with 25 years of service with a percentage reduction up to the normal retirement age. Benefits under the SERP are based on the lump sum present value but may be paid over the life of the covered executive officer or 10-year annuity, as elected by the covered executive officer upon commencement of participation in the SERP. None of the benefits earned pursuant to the SERP are attributable to services provided prior to the effective date of the plan. For purposes of the measurement of the benefit obligation as of December 31, 2016, Kforce has assumed that all participants will elect to take the lump sum present value option based on historical trends. Actuarial Assumptions Due to the SERP being unfunded as of December 31, 2016 and 2015, it is not necessary for Kforce to determine the expected long-term rate of return on plan assets. The following table presents the weighted average actuarial assumptions used to determine the actuarial present value of projected benefit obligations at: The following table presents the weighted average actuarial assumptions used to determine net periodic benefit cost for the years ended: The discount rate was determined using the Moody’s Aa long-term corporate bond yield as of the measurement date with a maturity commensurate with the expected payout of the SERP obligation. This rate is also compared against the Citigroup Pension Discount Curve and Liability Index to ensure the rate used is reasonable and may be adjusted accordingly. This index is widely used by companies throughout the U.S. and is considered to be one of the preferred standards for establishing a discount rate. The assumed rate of future compensation increases is based on a combination of factors, including the historical compensation increases for its covered executive officers and future target compensation levels for its covered executive officers taking into account the covered executive officers’ assumed retirement date. The periodic benefit cost is based on actuarial assumptions that are reviewed on an annual basis; however, Kforce monitors these assumptions on a periodic basis to ensure that they accurately reflect current expectations of the cost of providing retirement benefits. Net Periodic Benefit Cost The following table presents the components of net periodic benefit cost for the years ended (in thousands): Changes in Benefit Obligation The following table presents the changes in the benefit obligation for the years ended (in thousands): There were no payments made under the SERP during the years ended December 31, 2016 and 2015, respectively. The projected benefit obligation is recorded in Other long-term liabilities in the accompanying Consolidated Balance Sheets. The accumulated benefit obligation is the actuarial present value of all benefits attributed to past service, excluding future salary increases. The accumulated benefit obligation as of December 31, 2016 and 2015 was $12.7 million and $11.0 million, respectively. Contributions There is no requirement for Kforce to fund the SERP and, as a result, no contributions have been made to the SERP through the year ended December 31, 2016. Kforce does not currently anticipate funding the SERP during the year ending December 31, 2017. Estimated Future Benefit Payments Undiscounted benefit payments by the SERP, which reflect the anticipated future service of participants, expected to be paid are as follows (in thousands): Supplemental Executive Retirement Health Plan Kforce maintained a Supplemental Executive Retirement Health Plan (“SERHP”) to provide post-retirement health and welfare benefits to certain executives. The vesting and eligibility requirements mirrored that of the SERP, and no advance funding was required by Kforce or the participants. Consistent with the SERP, none of the benefits earned were attributable to services provided prior to the effective date of the plan. During the year ended December 31, 2014, Kforce terminated the Company’s SERHP and settled all future benefit obligations by making lump sum payments totaling approximately $3.9 million, which resulted in a net settlement loss of $0.7 million recorded in Selling, general and administrative expenses in the corresponding Consolidated Statements of Operations and Comprehensive Income. The termination effectively removed Kforce’s related post-retirement benefit obligation. Net Periodic Post-retirement Benefit Cost The following represents the components of net periodic post-retirement benefit cost for the year ended December 31 (in thousands): 10. Fair Value Measurements There were no transfers into or out of Level 1, 2 or 3 assets or liabilities during the years ended December 31, 2016 and 2015. Kforce’s financial statements include a contingent consideration liability related to a non-significant acquisition of a business within our Government Solutions reporting segment, which is measured on a recurring basis and is recorded at fair value, determined using the discounted cash flow method. The inputs used to calculate the fair value of the contingent consideration liability are considered to be Level 3 inputs due to the lack of relevant market activity and significant management judgment. An increase in future cash flows may result in a higher estimated fair value while a decrease in future cash flows may result in a lower estimated fair value of the contingent consideration liability. Remeasurements to fair value are recorded in Other expense, net within the Consolidated Statements of Operations and Comprehensive Income. For the years ended December 31, 2016 and 2015, approximately $42 thousand of income and $321 thousand of expense, respectively, was recognized due to the remeasurement of our contingent consideration liability. The contingent consideration liability is recorded in Other long-term liabilities within the Consolidated Balance Sheets and the estimated fair value as of December 31, 2016 and 2015 was $756 thousand and $798 thousand, respectively. Certain assets, in specific circumstances, are measured at fair value on a non-recurring basis utilizing Level 3 inputs such as goodwill, other intangible assets and other long-lived assets. For these assets, measurement at fair value in periods subsequent to their initial recognition would be applicable if one or more of these assets were determined to be impaired. 11. Stock Incentive Plans On April 19, 2016, the Kforce shareholders approved the 2016 Stock Incentive Plan (“2016 Plan”). The 2016 Plan allows for the issuance of stock options, stock appreciation rights, stock awards (including restricted stock awards (“RSAs”) and restricted stock units (“RSUs”)) and other stock-based awards. The aggregate number of shares of common stock that are subject to awards under the 2016 Plan is approximately 1.6 million shares. The 2016 Plan terminates on April 19, 2026. Prior to the effective date of the 2016 Plan, the Company granted stock awards to eligible participants under our 2013 Stock Incentive Plan (“2013 Plan”) and 2006 Stock Incentive Plan (“2006 Plan”). As of the effective date of the 2016 Plan, no additional awards may be granted pursuant to the 2013 Plan and 2006 Plan; however, awards outstanding as of the effective date will continue to vest in accordance with the terms of the 2013 Plan and 2006 Plan, respectively. During the years ended December 31, 2016, 2015 and 2014, Kforce recognized total stock-based compensation expense of $6.7 million, $5.8 million and $5.5 million, respectively. During the year ended December 31, 2014, Kforce recognized stock-based compensation expense from continuing operations of $3.0 million. The related tax benefit for the years ended December 31, 2016, 2015 and 2014 was $2.8 million, $2.3 million and $1.2 million, respectively. Stock Options The following table presents the activity under each of the stock incentive plans discussed above for the years ended December 31, 2016, 2015 and 2014 (in thousands, except per share amounts): The following table summarizes information about employee and director stock options under all of the plans mentioned above as of December 31, 2016 (in thousands, except per share amounts): No compensation expense was recorded during the years ended December 31, 2016, 2015 or 2014 as a result of the grant date fair value having been fully amortized as of December 31, 2009. As of December 31, 2016, there was no unrecognized compensation cost related to non-vested options. Restricted Stock Restricted stock (including RSAs and RSUs) are granted to executives and management either: (1) for awards related to Kforce’s annual long-term incentive (“LTI”) compensation program, or (2) as part of a compensation package and in order to retain directors, executives and management. The LTI award amounts are generally based on total shareholder return performance goals, which are established by Kforce’s Compensation Committee during the first quarter of the year of performance. The LTI restricted stock granted during the year ended December 31, 2016 will vest over a period of five years, with equal vesting annually. Other restricted stock granted during the year ended December 31, 2016 will vest over a period of between one to ten years, with equal vesting annually. During the three months ended March 31, 2014, the Firm modified all awards containing a performance-acceleration feature that were granted during the three months ended December 31, 2013, as follows: (1) eliminated the performance-acceleration feature and (2) changed the time-based vesting term to five years, with equal vesting annually. The total number of restricted shares impacted by this modification was 268 thousand, excluding already forfeited shares, and the number of employees impacted was 87. The total incremental compensation cost resulting from the modification was $109 thousand, which will be amortized on a straight-line basis over the requisite service period of the modified awards. RSAs contain the same voting rights as other common stock as well as the right to forfeitable dividends in the form of additional RSAs at the same rate as the cash dividend on common stock and containing the same vesting provisions as the underlying award. RSUs contain no voting rights, but have the right to forfeitable dividend equivalents in the form of additional RSUs at the same rate as the cash dividend on common stock and containing the same vesting provisions as the underlying award. The distribution of shares of common stock for each RSU issued under the 2016 Plan pursuant to the terms of the Kforce Inc. Director’s Restricted Stock Unit Deferral Plan can be deferred to a date later than the vesting date if an appropriate election was made. In the event of such deferral, vested RSUs have the right to dividend equivalents. The following table presents the restricted stock activity for the years ended December 31, 2016, 2015 and 2014 (in thousands, except per share amounts): (1) The increase in shares granted during the year ended December 31, 2016 as compared to 2015 and 2014 was due to a change in the grant date practice for our annual LTI awards. For greater clarity, Kforce has historically granted these annual awards on the first business day of the year following the end of the performance period; however, for the performance period ending December 31, 2016, the grant date was shifted to the last day of the performance period. This administrative change resulted in two annual grants being made during the year ended December 31, 2016 (a grant on January 4, 2016 for the performance period ending December 31, 2015 and a grant on December 31, 2016 for the performance period ending December 31, 2016). The fair market value of restricted stock is determined based on the closing stock price of Kforce’s common stock at the date of grant, and is amortized on a straight-line basis over the requisite service period. As of December 31, 2016, total unrecognized compensation expense related to restricted stock was $27.5 million, which will be recognized over a weighted average remaining period of 4.4 years. 12. Commitments and Contingencies Lease Commitments Kforce leases space and operating assets under operating and capital leases expiring at various dates, with some leases cancelable upon 30 to 90 days’ notice and with some leases containing escalation in rent clauses. The leases require Kforce to pay taxes, insurance and maintenance costs, in addition to rental payments. Future minimum lease payments, inclusive of accelerated lease payments, under non-cancelable capital and operating leases are summarized as follows (in thousands): The present value of the minimum lease payments for capital lease obligations has been classified in Other current liabilities and Long-term debt - other in the accompanying Consolidated Balance Sheets, according to their respective maturities. Rental expense under operating leases was $7.7 million, $6.7 million and $5.6 million for the years ended December 31, 2016, 2015 and 2014, respectively. Purchase Commitments Kforce has various commitments to purchase goods and services in the ordinary course of business; these commitments are primarily related to software and online application licenses and hosting. As of December 31, 2016, these commitments amounted to approximately $14.6 million and are expected to be paid as follows: $7.4 million in 2017; $4.2 million in 2018; $2.6 million in 2019; $0.4 million in 2020; and nil in 2021. Letters of Credit Kforce provides letters of credit to certain vendors in lieu of cash deposits. At December 31, 2016, Kforce had letters of credit outstanding for workers’ compensation and other insurance coverage totaling $3.1 million, and for facility lease deposits totaling $0.4 million. Litigation We are involved in legal proceedings, claims, and administrative matters that arise in the ordinary course of our business. We have made accruals with respect to certain of these matters, where appropriate, that are reflected in our consolidated financial statements but are not, individually or in the aggregate, considered material. For other matters for which an accrual has not been made, we have not yet determined that a loss is probable or the amount of loss cannot be reasonably estimated. While the ultimate outcome of the matters cannot be determined, we currently do not expect that these proceedings and claims, individually or in the aggregate, will have a material effect on our financial position, results of operations, or cash flows. The outcome of any litigation is inherently uncertain, however, and if decided adversely to us, or if we determine that settlement of particular litigation is appropriate, we may be subject to liability that could have a material adverse effect on our financial position, results of operations, or cash flows. Kforce maintains liability insurance in amounts and with such coverage and deductibles as management believes is reasonable. The principal liability risks that Kforce insures against are workers’ compensation, personal injury, bodily injury, property damage, directors’ and officers’ liability, errors and omissions, cyber liability, employment practices liability and fidelity losses. There can be no assurance that Kforce’s liability insurance will cover all events or that the limits of coverage will be sufficient to fully cover all liabilities. Accordingly, we disclose matters below for which a material loss is reasonably possible. On August 25, 2016, Kforce Flexible Solutions LLC (along with co-defendant BMO Harris Bank) was served with a complaint brought in the Northern District of Illinois, U.S. District Court, Eastern District of Illinois. Shepard v. BMO Harris Bank N.A. et al., Case No.: 1:16-cv-08288. The plaintiff purports to bring claims on her own behalf and on behalf of putative class of telephone-dedicated workers for alleged violations of the Fair Labor Standards Act, the Illinois Minimum Wage Law, and the Illinois Wage Payment and Collection Act based upon the defendants’ purported failure to pay her and other class members all earned regular and overtime pay for all time worked. More specifically, the plaintiff alleges that class employees were required to perform unpaid work before and after the start and end times of their shifts. She seeks unpaid back regular and overtime wages, liquidated damages, statutory penalties, and attorney fees and costs. We are vigorously defending each of the plaintiff’s claims. At this stage in the litigation it is not feasible to predict the outcome of this matter or reasonably estimate a range of loss, should a loss occur, from this proceeding; however, based on our current knowledge, we believe that the final outcome of this matter is unlikely to have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. Income Tax Audits Kforce is periodically subject to IRS audits, as well as state and other local income tax audits for various tax years. During 2016 and 2015, there were no on-going IRS examinations. Although Kforce has not experienced any material liabilities in the past due to income tax audits, Kforce can make no assurances concerning any future income tax audits. Employment Agreements Kforce has entered into employment agreements with certain executives that provide for minimum compensation, salary and continuation of certain benefits for a six-month to a three-year period after their employment ends under certain circumstances. Certain of the agreements also provide for a severance payment of one to three times annual salary and one-half to three times average annual bonus if such an agreement is terminated without good cause by Kforce or for good reason by the executive. These agreements contain certain post-employment restrictive covenants. Kforce’s liability at December 31, 2016 would be approximately $43.6 million if, following a change in control, all of the executives under contract were terminated without good cause by the employer or if the executives resigned for good reason and $17.6 million if, in the absence of a change in control, all of the executives under contract were terminated by Kforce without good cause or if the executives resigned for good reason. Kforce has not recorded any liability related to the employment agreements as no events have occurred that would require payment under the agreements. 13. Reportable Segments Kforce’s reportable segments are as follows: (1) Tech; (2) FA; and (3) GS. This determination is supported by, among other factors: the existence of individuals responsible for the operations of each segment and who also report directly to our chief operating decision maker (“CODM”), the nature of the segment’s operations and information presented to Kforce’s Board and our CODM. Kforce also reports Flex and Direct Hire revenues separately by segment, which has been incorporated into the table below. The following information for the year ended December 31, 2014 has been updated to reflect the disposition of HIM, for which all revenues and gross profit associated with the discontinued operations have been recorded within Income from discontinued operations, net of taxes, in the accompanying Consolidated Statements of Operations and Comprehensive Income. Historically, and for the year ended December 31, 2016, Kforce has generated only sales and gross profit information on a segment basis. Substantially all operations and long-lived assets are located in the U.S. We do not report total assets or income from continuing operations separately by segment as our operations are largely combined. The following table provides information concerning the operations of our segments for the years ended December 31 (in thousands): 14. Quarterly Financial Data (Unaudited) The following table provides quarterly information for the years ended December 31, 2016 and 2015 (in thousands, except per share amounts): 15. Supplemental Cash Flow Information Supplemental cash flow information is as follows for the year ended December 31 (in thousands): | Here's a summary of the financial statement:
Revenue:
- Primary revenue streams are Flex and Direct Hire services
- Time-and-materials contracts account for approximately 62% of revenue
- Revenue is recognized when services are delivered and fees are determinable
- Includes reimbursements for travel and out-of-pocket expenses
Profit/Loss:
- Accounts receivable reserves are 1.0% of gross accounts receivable
- Company factors in write-offs, delinquency trends, and economic conditions
- Trade receivables are written off after exhausting collection efforts
Expenses:
- Key estimates include:
* Allowance for doubtful accounts
* Goodwill and intangible assets
* Self-insured liabilities
* Workers' compensation
* Health insurance
* Pension plans
* Income taxes
Assets:
- Fixed assets recorded at cost minus depreciation
- Depreciation calculated using straight-line method
- Leasehold improvements amortized over 3-5 years
- Goodwill evaluated annually for impairment
- Intangible assets include trademarks, customer contracts, and technology
- Capitalized software amortized over 1-7 years
Liabilities:
- Lease terms typically 3-5 years
- Workers' compensation retention of first $250
- Deferred rent liabilities recorded for escalating rent payments
- Debt expense reclassified from SG&A to net service revenues
The statement indicates a company with diverse revenue streams, significant intangible assets, and careful management of receivables and operating expenses. | Claude |
. Management’s Annual Report on Internal Control over Financial Reporting The management of our General Partner is responsible for establishing and maintaining an adequate system of internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes, in accordance with generally accepted accounting principles. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies and procedures may deteriorate. The management of our General Partner, including our Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2016 based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, management concluded that our internal control over financial reporting was effective at the reasonable assurance level as of December 31, 2016. Deloitte & Touche LLP, our independent registered public accounting firm, has audited and issued a report on the effectiveness of our internal control over financial reporting. Their report is included herein. ACCOUNTING FIRM To the Board of Directors of Spectra Energy Partners GP, LLC and Unitholders of Spectra Energy Partners, LP: Houston, Texas We have audited the accompanying consolidated balance sheets of Spectra Energy Partners, LP and subsidiaries (the "Partnership") as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, cash flows and equity for each of the three years in the period ended December 31, 2016. We also have audited the Partnership's internal control over financial reporting as of December 31, 2016 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Partnership’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Partnership's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Spectra Energy Partners, LP and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. /s/ DELOITTE & TOUCHE LLP Houston, Texas February 24, 2017 SPECTRA ENERGY PARTNERS, LP CONSOLIDATED STATEMENTS OF OPERATIONS (In millions, except per-unit amounts) See . SPECTRA ENERGY PARTNERS, LP CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) See . SPECTRA ENERGY PARTNERS, LP CONSOLIDATED BALANCE SHEETS (In millions) See . SPECTRA ENERGY PARTNERS, LP CONSOLIDATED BALANCE SHEETS (In millions) See . SPECTRA ENERGY PARTNERS, LP CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) See . SPECTRA ENERGY PARTNERS, LP CONSOLIDATED STATEMENTS OF EQUITY (In millions) See . SPECTRA ENERGY PARTNERS, LP INDEX 1. Summary of Operations and Significant Accounting Policies The terms “we,” “our,” “us” and “Spectra Energy Partners” as used in this report refer collectively to Spectra Energy Partners, LP and its subsidiaries unless the context suggests otherwise. These terms are used for convenience only and are not intended as a precise description of any separate legal entity within Spectra Energy Partners. Nature of Operations. Spectra Energy Partners, through its subsidiaries and equity investments, is engaged in the transmission, storage and gathering of natural gas and the transportation and storage of crude oil through interstate pipeline systems. We are a Delaware master limited partnership (MLP). As of December 31, 2016, Spectra Energy Corp (Spectra Energy) and its subsidiaries collectively owned 75% of us and the remaining 25% was publicly owned. On September 6, 2016, Spectra Energy announced that they entered into a definitive merger agreement with Enbridge Inc. (Enbridge). Under this agreement, Enbridge and Spectra Energy will combine in a stock-for-stock merger transaction, which values Spectra Energy's stock at approximately $28 billion, based on the closing price of Enbridge common shares as of September 2, 2016. This transaction was approved by the boards of directors and shareholders of both Spectra Energy and Enbridge and has received all necessary regulatory approvals. The transaction is expected to close on February 27, 2017. Upon completion of the proposed merger, Spectra Energy shareholders will receive 0.984 Enbridge common shares for each share of Spectra Energy stock they own. The consideration to be received is valued at $40.33 per Spectra Energy share, based on the closing price of Enbridge common shares as of September 2, 2016, representing an approximate 11.5% premium to the closing price of Spectra Energy stock as of September 2, 2016. Upon completion of the merger, Enbridge shareholders are expected to own approximately 57% of the combined company and Spectra Energy shareholders are expected to own approximately 43%. As a result of this transaction, Enbridge and its subsidiaries will collectively own the interest in us currently held by Spectra Energy. Basis of Presentation. The accompanying Consolidated Financial Statements include our accounts and the accounts of our majority-owned subsidiaries, after eliminating intercompany transactions and balances. During 2013, we acquired substantially all of Spectra Energy's U.S. transmission, storage and liquid assets (U.S. Assets Dropdown), excluding a 25.05% ownership interest in Southeast Supply Header, LLC (SESH) and a 1% ownership interest in Steckman Ridge, LP (Steckman Ridge). In November 2014, we acquired an additional 24.95% ownership interest in SESH and the remaining 1% interest in Steckman Ridge from Spectra Energy. In November 2015, we acquired the remaining 0.1% ownership interest in SESH from Spectra Energy. Our costs of doing business have been reflected in our financial accounting records for the periods presented. These costs include direct charges and allocations from Spectra Energy and its affiliates for business services, such as payroll, accounts payable and facilities management; corporate services, such as finance and accounting, legal, human resources, investor relations, public and regulatory policy, and senior executives; and pension and other post-retirement benefit costs. Use of Estimates. To conform with generally accepted accounting principles (GAAP) in the United States, we make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and . Although these estimates are based on our best available knowledge at the time, actual results could differ. Fair Value Measurements. We measure the fair value of financial assets and liabilities by maximizing the use of observable inputs and minimizing the use of unobservable inputs. Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Cost-Based Regulation. The economic effects of regulation can result in a regulated company recording assets for costs that have been or are expected to be approved for recovery from customers or recording liabilities for amounts that are expected to be returned to customers or for instances where the regulator provides current rates that are intended to recover costs that are expected to be incurred in the future. Accordingly, we record assets and liabilities that result from the regulated ratemaking process that may not be recorded under GAAP for non-regulated entities. We continually assess whether regulatory assets are probable of future recovery by considering factors such as applicable regulatory changes and recent rate orders to other regulated entities. Based on this assessment, we believe our existing regulatory assets are probable of recovery. These regulatory assets and liabilities are mostly classified in the Consolidated Balance Sheets as Regulatory Assets and Deferred Debits and Current Liabilities. We evaluate our regulated assets, and consider factors such as regulatory changes and the effect of competition. If cost-based regulation ends or competition increases, we may have to reduce our asset balances to reflect a market basis less than cost and write-off the associated regulatory assets and liabilities. See Note 5 for further discussion. Foreign Currency Translation. The Canadian dollar has been determined to be the functional currency of the Canadian portion of the Express-Platte pipeline system (Express Canada) based on an assessment of the economic circumstances of those operations. Assets and liabilities of Express Canada are translated into U.S. dollars at current exchange rates. Translation adjustments resulting from fluctuations in exchange rates are included as a separate component of Other Comprehensive Income (Loss) on the Consolidated Statements of Comprehensive Income. Revenue and expense accounts of these operations are translated at average monthly exchange rates prevailing during the periods. Gains and losses arising from transactions denominated in currencies other than the functional currency are included in the results of operations of the period in which they occur. Foreign currency transaction losses totaled $1 million, $6 million, and $3 million in 2016, 2015, and 2014 respectively and are included in Other Income and Expenses, Net on the Consolidated Statements of Operations. Revenue Recognition. Revenues from the transmission, storage and gathering of natural gas, and from the transportation of crude oil are generally recognized when the service is provided. Revenues related to these services provided but not yet billed are estimated each month. These estimates are generally based on contract data, regulatory information and preliminary throughput and allocation measurements. Final bills for the current month are billed and collected in the following month. Differences between actual and estimated revenues are immaterial. There were no customers accounting for 10% or more of consolidated revenues during 2016, 2015 or 2014. We also have certain customer contracts with billed amounts that decline annually over the terms of the contracts. Differences between the amounts billed and recognized are deferred on the Consolidated Balance Sheets. Allowance for Funds Used During Construction (AFUDC). AFUDC, which represents the estimated debt and equity costs of capital funds necessary to finance the construction and expansion of certain new regulated facilities, consists of two components, an equity component and an interest expense component. After construction is completed, we are permitted to recover these costs through inclusion in the rate base and in the depreciation provision. AFUDC is capitalized as a component of Property, Plant and Equipment - Cost in the Consolidated Balance Sheets, with offsetting credits to the Consolidated Statements of Operations through Other Income and Expenses, Net for the equity component and Interest Expense for the interest expense component. The total amount of AFUDC included in the Consolidated Statements of Operations was $168 million in 2016 (an equity component of $121 million and an interest expense component of $47 million), $95 million in 2015 (an equity component of $76 million and an interest expense component of $19 million) and $42 million in 2014 (an equity component of $33 million and an interest expense component of $9 million). The equity component of AFUDC, a non-cash item, is included as a reconciling item to net income within Cash Flows from Operating Activities - Other, Assets in the Consolidated Statements of Cash Flows. Income Taxes. As a result of our MLP structure, we are not subject to federal income tax. Our federal taxable income or loss is reported on the respective income tax returns of our partners. However, we are subject to Canadian income tax and Tennessee and New Hampshire income tax. Spectra Energy Partners is liable to Spectra Energy for Texas income (margin) tax under a tax sharing agreement. As of December 31, 2016, the difference between the tax basis and the reported amounts of Spectra Energy Partners’ assets and liabilities is $15.2 billion. We are subject to cost-based regulation and consequently record a regulatory tax asset in connection with the tax gross up of AFUDC equity. The corresponding deferred tax liability is recognized as an Attributed Deferred Tax Benefit in the Consolidated Statements of Equity since we are a pass-through entity. In the first quarter of 2014, we recorded $23 million of income tax expense due to the adjustment to deferred income tax liabilities (eliminated and recorded as an income tax benefit in 2013 in connection with the U.S. Assets Dropdown and resulting changes in tax status of certain entities) as a result of the final purchase price allocation adjustments. Cash and Cash Equivalents. Highly liquid investments with original maturities of three months or less at the date of acquisition are considered cash equivalents, except for the investments that were pledged as collateral against long-term debt as discussed in Note 13 and any investments that are considered restricted funds. Inventory. Inventory consists of natural gas retained from shippers for fuel and also includes materials and supplies. Natural gas is recorded at the lower of cost or market. Materials and supplies are recorded at cost, using the average cost method. Natural Gas Imbalances. The Consolidated Balance Sheets include in-kind balances as a result of differences in gas volumes received and delivered for customers. Since settlement of certain imbalances is in-kind, changes in the balances do not have an effect on our Consolidated Statements of Operations or Consolidated Statements of Cash Flows. Receivables include $99 million and $36 million as of December 31, 2016 and December 31, 2015, respectively, and Other Current Liabilities include $74 million and $32 million as of December 31, 2016 and December 31, 2015, respectively, related to all gas imbalances. Most natural gas volumes owed to or by us are valued at natural gas market index prices as of the balance sheet dates. Cash Flow and Fair Value Hedges. We have entered into interest rate swaps which were designated as either a hedge of a forecasted transaction (cash flow hedge) or a hedge of a recognized asset, liability or firm commitment (fair value hedge). For all hedge contracts, we prepare documentation of the hedge in accordance with accounting standards and assess whether the hedge contract is highly effective using regression analysis, both at inception and on a quarterly basis, in offsetting changes in cash flows or fair values of hedged items. Changes in the fair value of a derivative designated and qualified as a cash flow hedge, to the extent effective, are included in the Consolidated Statements of Comprehensive Income as Other Comprehensive Income (Loss) until earnings are affected by the hedged item. We discontinue hedge accounting prospectively when we have determined that a derivative no longer qualifies as an effective hedge or when it is no longer probable that the hedged forecasted transaction will occur. When hedge accounting is discontinued because the derivative no longer qualifies as an effective hedge, the derivative is subject to the mark-to-market model of accounting prospectively. Gains and losses related to discontinued hedges that were previously accumulated in accumulated other comprehensive income (AOCI) remain in AOCI until the underlying transaction is reflected in earnings, unless it is probable that the hedged forecasted transaction will not occur at which time associated deferred amounts in AOCI are immediately recognized in current earnings. For derivatives designated as fair value hedges, we recognize the gain or loss on the derivative instrument, as well as the offsetting gain or loss on the hedged item in earnings, to the extent effective, in the current period. In the event the hedge is not effective, there is no offsetting gain or loss recognized in earnings for the hedged item. All derivatives designated and accounted for as hedges are classified in the same category as the item being hedged in the Consolidated Statements of Cash Flows. All components of each derivative gain or loss are included in the assessment of hedge effectiveness. Investments. We may actively invest a portion of our available cash and restricted funds balances in various financial instruments, including taxable or tax-exempt debt securities. In addition, we invest in short-term money market securities, some of which are restricted due to debt collateral requirements. Investments in available-for-sale (AFS) securities are carried at fair value and investments in held-to-maturity (HTM) securities are carried at cost. Investments in money market securities are also accounted for at fair value. Realized gains and losses, and dividend and interest income related to these securities, including any amortization of discounts or premiums arising at acquisition, are included in earnings. The costs of securities sold are determined using the specific identification method. Purchases and sales of AFS and HTM securities are presented on a gross basis within Cash Flows from Investing Activities in the accompanying Consolidated Statements of Cash Flows. See also Notes 10 and 14 for additional information. Goodwill. We perform our goodwill impairment test annually and evaluate goodwill when events or changes in circumstances indicate that its carrying value may not be recoverable. No impairments of goodwill were recorded in 2016, 2015 or 2014. We perform our annual review for goodwill impairment at the reporting unit level, which is identified by assessing whether the components of our operating segments constitute businesses for which discrete financial information is available, whether segment management regularly reviews the operating results of those components and whether the economic and regulatory characteristics are similar. We determined that our reporting units are equivalent to our reportable segments. As permitted under accounting guidance on testing goodwill for impairment, we perform either a qualitative assessment or a quantitative assessment of each of our reporting units based on management’s judgment. With respect to our qualitative assessments, we consider events and circumstances specific to us, such as macroeconomic conditions, industry and market considerations, cost factors and overall financial performance, when evaluating whether it is more likely than not that the fair values of our reporting units are less than their respective carrying amounts. In connection with our quantitative assessments, we primarily use a discounted cash flow analysis to determine the fair values of those reporting units. Key assumptions in the determination of fair value included the use of an appropriate discount rate and estimated future cash flows. In estimating cash flows, we incorporate expected long-term growth rates in key markets served by our operations, regulatory stability, the ability to renew contracts, commodity prices (where appropriate) and foreign currency exchange rates, as well as other factors that affect our reporting units’ revenue, expense and capital expenditure projections. If the carrying amount of the reporting unit exceeds its fair value, a comparison of the fair value and carrying value of the goodwill of that reporting unit needs to be performed. If the carrying value of the goodwill of a reporting unit exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess. Additional impairment tests are performed between the annual reviews if events or changes in circumstances make it more likely than not that the fair value of a reporting unit is below its carrying amount. We had goodwill balances of $3,234 million at December 31, 2016 and $3,232 million at December 31, 2015. The increase in goodwill in 2016 was the result of foreign currency translation. Property, Plant and Equipment. Property, plant and equipment is stated at historical cost less accumulated depreciation. We capitalize all construction-related direct labor and material costs, as well as indirect construction costs. Indirect costs include general engineering, taxes, administrative and general costs, and the cost of funds used during construction. The costs of renewals and betterments that extend the useful life or increase the expected output of property, plant and equipment are also capitalized. The costs of repairs, replacements and major maintenance projects that do not extend the useful life or increase the expected output of property, plant and equipment are expensed as incurred. Depreciation is generally computed over the asset’s estimated useful life using the straight-line method. When we retire property, plant and equipment, we charge the original cost plus the cost of retirement, less salvage value, to accumulated depreciation and amortization. When we sell entire regulated operating units, or retire or sell certain non-regulated properties, the cost is removed from the property account and the related accumulated depreciation and amortization accounts are reduced. Any gain or loss is recorded in earnings, unless otherwise required by the applicable regulatory body. Preliminary Project Costs. Project development costs, including expenditures for preliminary surveys, plans, investigations, environmental studies, regulatory applications and other costs incurred for the purpose of determining the feasibility of capital expansion projects, are capitalized for rate-regulated enterprises when it is determined that recovery of such costs through regulated revenues of the completed project is probable. Any inception-to-date costs of the projects that were initially expensed are reversed and capitalized as Property, Plant and Equipment. Long-Lived Asset Impairments. We evaluate whether long-lived assets, excluding goodwill, have been impaired when circumstances indicate the carrying value of those assets may not be recoverable. For such long-lived assets, an impairment exists when its carrying value exceeds the sum of estimates of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. When alternative courses of action to recover the carrying amount of a long-lived asset are under consideration, a probability-weighted approach is used in developing estimates of future undiscounted cash flows. If the carrying value of the long-lived asset is not recoverable based on these estimated future undiscounted cash flows, an impairment loss is measured as the excess of the asset’s carrying value over its fair value, such that the asset’s carrying value is adjusted to its estimated fair value. We assess the fair value of long-lived assets using commonly accepted techniques, and may use more than one source. Sources to determine fair value include, but are not limited to, recent third-party comparable sales, internally developed discounted cash flow analyses and analyses from outside advisors. Significant changes in market conditions resulting from events such as changes in natural gas available to our systems, the condition of an asset, a change in our intent to utilize the asset or a significant change in contracted revenues or regulatory recoveries would generally require us to reassess the cash flows related to the long-lived assets. We recorded a $9 million non-cash impairment charge on Ozark Gas Gathering, L.L.C. in the first quarter of 2015 included in Operating, Maintenance and Other on the Consolidated Statements of Operations. Asset Retirement Obligations (AROs). We recognize asset retirement obligations for legal commitments associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal use of the asset and conditional AROs in which the timing or method of settlement are conditional on a future event that may or may not be within our control. The fair value of a liability for an ARO is recognized in the period in which it is incurred if a reasonable estimate of fair value can be made and is added to the carrying amount of the associated asset. This additional carrying amount is depreciated over the estimated useful life of the asset. Unamortized Debt Premium, Discount and Expense. Premiums, discounts, and expenses incurred with the issuance of outstanding long-term debt are amortized over the terms of the debt issued. Any call premiums or unamortized expenses associated with refinancing higher-cost debt obligations to finance regulated assets and operations are amortized consistent with regulatory treatment of those items, where appropriate. Environmental Expenditures. We expense environmental expenditures related to conditions caused by past operations that do not generate current or future revenues. Environmental expenditures related to operations that generate current or future revenues are expensed or capitalized, as appropriate. Undiscounted liabilities are recorded when the necessity for environmental remediation becomes probable and the costs can be reasonably estimated, or when other potential environmental liabilities are reasonably estimable and probable. Segment Reporting. Operating segments are components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision maker in deciding how to allocate resources and evaluate performance. Two or more operating segments may be aggregated into a single reportable segment provided certain criteria are met. There is no such aggregation within our defined business segments. A description of our reportable segments consistent with how business results are reported internally to management, and the disclosure of segment information is presented in Note 4. Consolidated Statements of Cash Flows. Cash received from insurance proceeds are classified depending on the activity that resulted in the insurance proceeds. For example, business interruption insurance proceeds are included as a component of operating activities while insurance proceeds from damaged property are included as a component of investing activities. With respect to cash overdrafts, book overdrafts are included within operating cash flows while bank overdrafts, if any, are included within financing cash flows. Distributions from Equity Investments. We consider distributions received from equity investments which do not exceed cumulative equity in earnings subsequent to the date of investment to be a return on investment and classify these amounts as Cash Flows from Operating Activities within the accompanying Consolidated Statements of Cash Flows. Cumulative distributions received in excess of cumulative equity in earnings subsequent to the date of investment are considered to be a return of investment and are classified as Cash Flows from Investing Activities. New Accounting Pronouncements. The following new Accounting Standards Updates (ASUs) were adopted during 2016 and the effects of such adoptions, if any, are presented in the accompanying Consolidated Financial Statements: In June 2014, the Financial Accounting Standards Board (FASB) issued ASU No. 2014-10, “Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation,” which amends the consolidation guidance around reporting entities that invest in development stage entities. We adopted the consolidation guidance of this amendment on January 1, 2016 and applied it retrospectively with no material effect on our consolidated results of operations, financial position, or cash flows. This ASU did result in certain of our entities being classified as a variable interest entity (VIE). See Note 8 for discussion of our Variable Interest Entities. In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis,” which makes changes to both the variable interest model and the voting model. These changes required reevaluation of certain entities for consolidation and required us to revise our documentation regarding the consolidation or deconsolidation of such entities. We adopted this standard on January 1, 2016 with no material effect on our consolidated operations, financial position, or cash flows. In September 2015, the FASB issued ASU No. 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments,” to simplify accounting for adjustments made to provisional amounts recognized in a business combination and to eliminate the retrospective accounting for those adjustments. We adopted this standard on January 1, 2016 with no material effect on our consolidated operations, financial position, or cash flows. Pending. The following new ASUs have been issued but not yet adopted: In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” in an effort to improve revenue recognition practices across entities and industries. The ASU introduces a single, principle-based revenue recognition model which centers on the core principle of an entity recognizing revenue in a manner that depicts the transfer of goods and services to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Since its release, the FASB has issued multiple amendments clarifying and/or amending ASU No. 2014-09. We have substantially completed a review of contracts with customers in relation to the requirements of ASU No. 2014-09. While we have not identified any material difference in the amount or timing of revenue recognition for the categories we have reviewed to date, our evaluation is not complete and we have not concluded on the overall impacts of adopting this standard. In addition, we are in the process of implementing appropriate changes to our business processes, systems and controls to support the recognition and disclosure requirements under the new standard. ASU No. 2014-09 is effective for us January 1, 2018 and allows for either full retrospective or modified retrospective adoption. In July 2015, the FASB issued ASU No. 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory,” which simplifies the subsequent measurement of inventory by requiring inventory to be measured at the lower of cost and net realizable value. This ASU is effective for us January 1, 2017. This ASU is not expected to have a material impact on our consolidated results of operations, financial position, or cash flows. In January 2016, the FASB issued ASU No. 2016-01,“Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” which amends the classification and measurement of financial instruments. Changes primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. This ASU is effective for us on January 1, 2018. Early adoption is not permitted. We are currently evaluating this ASU and its potential impact on us. In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” to improve the financial reporting around leasing transactions. The new guidance requires companies to begin recording assets and liabilities arising from those leases classified as operating leases under previous guidance. Furthermore, the new guidance will require significant additional disclosures about the amount, timing and uncertainty of cash flows from leases. Topic 842 retains a distinction between finance leases and operating leases. The classification criteria for distinguishing between finance leases and operating leases are substantially similar to the classification criteria for distinguishing between capital leases and operating leases in previous guidance. The result of retaining a distinction between finance leases and operating leases is that under the lessee accounting model in Topic 842, the effect of leases in the statement of comprehensive income and the statement of cash flows is largely unchanged from previous guidance. This ASU is effective for us January 1, 2019. We are currently evaluating this ASU and its potential impact on us. In March 2016, the FASB issued ASU No. 2016-05, “Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships,” which clarifies the hedge accounting impact when there is a change in one of the counterparties to the derivative contract (i.e. novation). This ASU is effective for us January 1, 2017. This ASU is not expected to have a material impact on our consolidated results of operations, financial position or cash flow. In March 2016, the FASB issued ASU No. 2016-06, “Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments,” which simplifies the embedded derivative analysis for debt instruments containing contingent call or put options. This ASU is effective for us January 1, 2017. This ASU is not expected to have a material impact on our consolidated results of operations, financial position or cash flow. In March 2016, the FASB issued ASU No. 2016-07, “Investments-Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting,” which eliminates the requirement to apply the equity method of accounting retrospectively when a reporting entity obtains significant influence over a previously held investment. This ASU is effective for us January 1, 2017. This ASU is not expected to have a material impact on our consolidated results of operations, financial position or cash flows. In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” to replace the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires the consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU is effective for us on January 1, 2020. We are currently evaluating this ASU and its potential impact on us. In August 2016, the FASB issued ASU No. 2016-15,“Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” to provide guidance on specific cash flow issues with the objective of reducing the existing diversity in practice. This ASU is effective for us on January 1, 2018. We are currently evaluating this ASU and its potential impact on us. In October 2016, the FASB issued ASU No. 2016-17,“Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control,” to amend the consolidation guidance on how a reporting entity that is the single decision maker of a VIE should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. This ASU is effective for us on January 1, 2017. This ASU is not expected to have a material impact on our consolidated results of operations, financial position or cash flows. In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash,” to address the diversity in the classification and presentation of changes in restricted cash and restricted cash equivalents on the statement of cash flows. The update requires that restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This ASU is effective for us on January 1, 2018. We are currently evaluating this ASU and its potential impact on us. In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business,” which revises the definition of a business. This ASU is effective for us on January 1, 2018. We are currently evaluating this ASU and its potential impact on us. In January 2017, the FASB issued ASU No. 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” to simplify the subsequent measurement of goodwill. The guidance eliminates Step 2 from the goodwill impairment test which required computing an implied fair value to measure the amount of the goodwill impairment. A goodwill impairment will now be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This ASU is effective for us on January 1, 2020. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We are currently evaluating this ASU and its potential impact on us. The following ASUs were adopted in 2015 and the effect of such adoptions, if any, are presented in the accompanying Consolidated Financial Statements: In April 2015, the FASB issued ASU No. 2015-03, “Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs,” which requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability, rather than as a deferred charge asset. We adopted the provisions of this ASU as of December 31, 2015. The adoption of this ASU resulted in the presentation of $21 million of debt issuance costs as a reduction of Long-term Debt on our December 31, 2015 Consolidated Balance Sheet. In April 2015, the FASB issued ASU No. 2015-06, “Earnings Per Share (Topic 260): Effects on Historical Earnings per Unit of Master Limited Partnership Dropdown Transactions,” which applies to master limited partnerships that receive net assets through a dropdown transaction. ASU 2015-06 specifies that for purposes of calculating historical earnings per unit under the two-class method, the earnings (losses) of a transferred business before the date of a dropdown transaction should be allocated entirely to the general partner. Qualitative disclosures about how the rights to the earnings (losses) differ before and after the dropdown transaction occurs for purposes of computing earnings per unit under the two-class method also are required. We adopted the provisions of this ASU as of December 31, 2015. The adoption of this ASU had no material effect for the years presented on our consolidated operations, financial position, or cash flows. There were no significant accounting pronouncements adopted in 2014 that had a material impact on our consolidated results of operations, financial position or cash flows. 2. Acquisitions and Dispositions U.S. Assets Dropdown. During 2013, we completed the closing of substantially all of the U.S. Assets Dropdown, excluding a 25.05% ownership interest in SESH and a 1% ownership interest in Steckman Ridge. This was the first of three planned transactions. In November 2014, we completed the second of the three planned transactions related to the U.S. Assets Dropdown. This transaction consisted of acquiring an additional 24.95% ownership interest in SESH and the remaining 1% ownership interest in Steckman Ridge from Spectra Energy. Total consideration was approximately 4.3 million newly issued common units. Also in connection with this transaction, we issued approximately 86,000 general partner units to Spectra Energy in exchange for the same amount of common units in order to maintain Spectra Energy's 2% general partner interest. In November 2015, we acquired the remaining 0.1% ownership interest in SESH from Spectra Energy. Total consideration was 17,114 newly issued common units. This was the last of three planned transactions related to the U.S. Assets Dropdown. Also in connection with this transaction, we issued 342 general partner units to Spectra Energy in exchange for the same amount of common units in order to maintain Spectra Energy's 2% general partner interest. Disposition. In October 2015, Spectra Energy acquired our 33.3% ownership interests in DCP Sand Hills Pipeline, LLC (Sand Hills) and DCP Southern Hills Pipeline, LLC (Southern Hills). In consideration for this transaction, we retired 21,560,000 of our common units and 440,000 of our general partner units held by Spectra Energy, which will result in the reduction of distributions payable to Spectra Energy for the related units retired. Additional consideration consisted of a reduction in the aggregate quarterly distributions, if any, to Spectra Energy, as holder of incentive distribution rights, by $4 million per quarter for a period of 12 consecutive quarters commencing with the quarter ending on December 31, 2015 and ending with the quarter ending on September 30, 2018. The total reduction of distributions to Spectra Energy was $16 million for the year ended December 31, 2016. This transfer of assets between entities under common control is included as a non-cash transaction in the Consolidated Statements of Cash Flows. 3. Transactions with Affiliates In the normal course of business, we provide natural gas transmission, storage and other services to Spectra Energy and its affiliates. In addition, pursuant to an agreement with Spectra Energy, Spectra Energy and its affiliates perform centralized corporate functions for us, including legal, accounting, compliance, treasury and other areas. We reimburse Spectra Energy for the expenses to provide these services as well as other expenses it incurs on our behalf, such as salaries of personnel performing services for our benefit and the cost of employee benefits and general and administrative expenses associated with such personnel, capital expenditures, maintenance and repair costs, taxes and direct expenses, including operating expenses and certain allocated operating expenses associated with the ownership and operation of the contributed assets. Spectra Energy and its affiliates charge such expenses based on the cost of actual services provided or using various allocation methodologies based on our percentage of assets, employees, earnings or other measures, as compared to Spectra Energy’s other affiliates. Transactions with affiliates are summarized in the tables below: Consolidated Statements of Operations We are party to an agreement with DCP Midstream, LLC (DCP Midstream), an equity investment of Spectra Energy, in which DCP Midstream processes certain of our customers' gas to meet quality specifications in order to be transported on our system. DCP Midstream processes the gas and sells the natural gas liquids that are extracted from the gas. A portion of the proceeds from those sales are retained by DCP Midstream and the balance is remitted to us. We recognized revenues of $31 million, $46 million and $79 million in 2016, 2015 and 2014, respectively, related to those services, classified as Storage of Natural Gas and Other in our Consolidated Statements of Operations. We recorded natural gas transmission revenues from DCP Midstream and its affiliates totaling $1 million in 2016, $4 million in 2015 and $7 million in 2014, classified as Transportation of Natural Gas in our Consolidated Statements of Operations. In addition to the above, we recorded other revenues from DCP Midstream and its affiliates totaling $2 million in 2016, $3 million in 2015 and $2 million in 2014, classified as Storage of Natural Gas and Other in our Consolidated Statements of Operations. Consolidated Balance Sheets Transactions billed from affiliates, included within Property, Plant and Equipment in the Consolidated Balance Sheets, were $46 million in 2016 and $51 million in 2015. Gulfstream. During the third quarter of 2015, Gulfstream Natural Gas System, LLC (Gulfstream) issued unsecured debt of $800 million to fund the repayment of its current debt. Gulfstream distributed $396 million, our proportionate share of proceeds, to us, classified as Cash Flows from Investing Activities - Distributions from Equity Investments, of which we contributed $248 million back to Gulfstream in the fourth quarter of 2015 and the remaining $148 million, classified as Cash Flows from Investing Activities - Distributions to Equity Investment, in the second quarter of 2016. SESH. In 2014, SESH issued unsecured debt of $400 million to fund the repayment of its current debt. SESH distributed $99 million of proceeds to us, classified as Cash Flows from Investing Activities - Distributions from Equity Investments, of which we contributed $94 million back to SESH during 2014, classified as Cash Flows from Investing Activities - Investments in and Loans to Unconsolidated Affiliates, as the current debt matured. See also Notes 1, 7 and 14 for discussion of specific related party transactions. 4. Business Segments We manage our business in two reportable segments: U.S. Transmission and Liquids. The remainder of our business operations is presented as “Other,” and consists of certain corporate costs. Our chief operating decision maker regularly reviews financial information about both segments in deciding how to allocate resources and evaluate performance. There is no aggregation of segments within our reportable business segments. The U.S. Transmission segment provides interstate transmission and storage of natural gas. Substantially all of our operations are subject to the Federal Energy Regulatory Commission (FERC) and the Department of Transportation’s (DOT’s) rules and regulations. Our investments in Gulfstream, SESH and Steckman Ridge are included in U.S. Transmission. The Liquids segment provides transportation of crude oil. The Express-Platte pipeline system (Express-Platte) is a crude oil pipeline system that connects Canadian and U.S. producers to refineries in the U.S. Rocky Mountain and Midwest regions. These operations are primarily subject to the rules and regulations of the FERC and the National Energy Board (NEB). We held direct one-third ownership interests in Sand Hills and Southern Hills until October 30, 2015. Our reportable segments offer different products and services and are managed separately as business units. Management evaluates segment performance based on earnings before interest, taxes, and depreciation and amortization (EBITDA). Cash, cash equivalents and investments are managed centrally, so the gains and losses on foreign currency remeasurement, and interest and dividend income, are excluded from the segments’ EBITDA. Our segment EBITDA may not be comparable to similarly titled measures of other companies because other companies may not calculate EBITDA in the same manner. Business Segment Data Geographic Data 5. Regulatory Matters We record assets and liabilities that result from the regulated ratemaking process that would not be recorded under GAAP for non-regulated entities. See Note 1 for further discussion. The following items are reflected in the consolidated balance sheets. All regulatory assets and liabilities are excluded from rate base unless otherwise noted below. ________ (a)Included in Regulatory Assets and Deferred Debits, unless otherwise noted. (b) Relates to tax gross-up of the AFUDC equity portion. All amounts are expected to be included in future rate filings. (c) Included in Fuel Tracker. (d) Includes amounts settled in cash annually through transportation rates in accordance with FERC gas tariffs. (e) Included in Other Current Liabilities. (f) Included in Deferred Credits and Other Liabilities. 6. Net Income Per Limited Partner Unit and Cash Distributions The following table presents our net income per limited partner unit calculations: Our partnership agreement requires that, within 60 days after the end of each quarter, we distribute all of our Available Cash, as defined, to unitholders of record on the applicable record date. Available Cash. Available Cash, for any quarter, consists of all cash and cash equivalents on hand at the end of that quarter: • less the amount of cash reserves established by the general partner to: • provide for the proper conduct of business, • comply with applicable law, any debt instrument or other agreement, or • provide funds for minimum quarterly distributions to the unitholders and to the general partner for any one or more of the next four quarters, • plus, if the general partner so determines, all or a portion of cash and cash equivalents on hand on the date of determination of Available Cash for the quarter. Incentive Distribution Rights. The general partner holds incentive distribution rights beyond the first target distribution in accordance with the partnership agreement as follows: To the extent these incentive distributions are made to the general partner, there will be more Available Cash proportionately allocated to the general partner than to holders of common units. A cash distribution of $0.68875 per limited partner unit was declared on February 7, 2017 and is payable on February 28, 2017 to unitholders of record at the close of business on February 17, 2017. As a result of the sale of our interests in Sand Hills and Southern Hills to Spectra Energy, there is a reduction in the aggregate quarterly distributions, if any, to Spectra Energy, (as holder of incentive distribution rights), by $4 million per quarter for a period of 12 consecutive quarters ending on September 30, 2018. See Note 2 for more information. 7. Investments in and Loans to Unconsolidated Affiliates Investments in affiliates for which we are not the primary beneficiary, but over which we have significant influence, are accounted for using the equity method. As of December 31, 2016 and 2015, the carrying amounts of investments in affiliates approximated the amounts of underlying equity in net assets. We received distributions from our equity investments of $160 million in 2016, $610 million in 2015 and $294 million in 2014. Cumulative undistributed earnings from equity investments totaled $15 million in 2016 and $5 million in 2015. There were no cumulative undistributed earnings from equity investments in 2014. U.S. Transmission. Investments are comprised of a 50% interest in Gulfstream, a 50% interest in SESH and a 50% interest in Steckman Ridge. We have a loan outstanding to Steckman Ridge in connection with the construction of its storage facilities. The loan carries market-based interest rates and is due the earlier of October 1, 2023 or coincident with the closing of any long-term financings by Steckman Ridge. The loan receivable from Steckman Ridge, including accrued interest, totaled $71 million at both December 31, 2016 and 2015. Liquids. Investments were comprised of 33.3% interests in Sand Hills and Southern Hills. The Sand Hills and Southern Hills pipelines were placed in service in the second quarter of 2013 and acquired by Spectra Energy in the fourth quarter of 2015. Earnings from Equity Investments Summarized Combined Financial Information of Unconsolidated Affiliates (Presented at 100%) Statements of Operations Balance Sheets 8. Variable Interest Entities Sabal Trail. On April 1, 2016, NextEra Energy, Inc. (NextEra) purchased a 9.5% interest in Sabal Trail Transmission, LLC (Sabal Trail) from us. Consideration for this transaction consisted of approximately $110 million cash, $102 million of which is classified as Cash Flows from Financing Activities - Contributions from Noncontrolling Interests. See Note 9 for additional information related to this transaction. As of December 31, 2016, we owned a 50% interest in Sabal Trail, a joint venture that is constructing a natural gas pipeline to transport natural gas to Florida. Sabal Trail is a variable interest entity (VIE) due to insufficient equity at risk to finance its activities. We determined that we are the primary beneficiary because we direct the activities of Sabal Trail that most significantly impact its economic performance and we consolidate Sabal Trail in our financial statements. The current estimate of the total remaining construction cost is approximately $1.2 billion. The following summarizes assets and liabilities for Sabal Trail as of December 31, 2016 and December 31, 2015, respectively: Nexus. We own a 50% interest in Nexus Gas Transmission, LLC (Nexus), a joint venture that is constructing a natural gas pipeline from Ohio to Michigan and continuing on to Ontario, Canada. Nexus is a VIE due to insufficient equity at risk to finance its activities. We determined that we are not the primary beneficiary because the power to direct the activities of Nexus that most significantly impact its economic performance is shared. We account for Nexus under the equity method. Our maximum exposure to loss is $1.0 billion. We have an investment in Nexus of $356 million and $90 million as of December 31, 2016 and December 31, 2015, respectively, classified as Investments in and Loans to Unconsolidated Affiliates on our Consolidated Balance Sheets. On December 29, 2016, we issued performance guarantees to a third party and an affiliate on behalf of Nexus. See Note 17 for further discussion of the guarantee arrangement. 9. Intangible Asset During the first quarter of 2016 we entered into a project coordination agreement (PCA) with NextEra, Duke Energy Corporation and Williams Partners L.P. In accordance with the agreement, payments will be made, based on our proportional ownership interest in the Sabal Trail project, as certain milestones of the project are met. During the first quarter of 2016, the first milestone was achieved and paid, consisting of $48 million. On April 1, 2016, NextEra purchased an additional 9.5% interest in Sabal Trail, reducing our ownership interest in Sabal Trail to 50%. Upon purchase of the additional ownership interest, NextEra reimbursed us $8 million for NextEra’s proportional share of the first milestone payment, which reduced our total milestone payments to $40 million as of June 30, 2016. During the third quarter of 2016, the second milestone was achieved and paid, consisting of an additional payment of $40 million, for total milestone payments of $80 million as of December 31, 2016. Both payments are classified as Cash Flows from Investing Activities - Purchase of Intangible, Net. This PCA is an intangible asset and is classified as Investments and Other Assets - Other on our Condensed Consolidated Balance Sheet. The intangible asset will be amortized over a period of 25 years beginning at the time of in-service of Sabal Trail, which is expected to occur during the first half of 2017. 10. Marketable Securities and Restricted Funds We routinely invest excess cash and various restricted balances in securities such as commercial paper, corporate debt securities, and other money market securities in the United States, as well as equity securities in Canada. We do not purchase marketable securities for speculative purposes, therefore, we do not have any securities classified as trading securities. While we do not routinely sell marketable securities prior to their scheduled maturity dates, some of our investments may be held and restricted for the purposes of funding future capital expenditures and NEB regulatory requirements, so these investments are classified as AFS marketable securities as they may occasionally be sold prior to their scheduled maturity dates due to the unexpected timing of cash needs. Initial investments in securities are classified as purchases of the respective type of securities (AFS marketable securities or HTM marketable securities). Maturities of securities are classified within proceeds from sales and maturities of securities in the Consolidated Statements of Cash Flows. AFS Securities. We had $10 million and $11 million of AFS securities classified as Investments and Other Assets - Other on Consolidated Balance Sheets as of December 31, 2016 and December 31, 2015, respectively. As December 31, 2016, these investments include $9 million of restricted funds related to certain construction projects and $1 million are restricted funds held and collected from customers for Canadian pipeline abandonment in accordance with the NEB's regulatory requirements. The balance as of December 31, 2015 is all related to certain construction projects. At December 31, 2016, the weighted-average contractual maturity of outstanding AFS securities was less than one year. There were no material gross unrecognized holding gains or losses associated with investments in AFS securities at December 31, 2016 or December 31, 2015. HTM Securities. All of our HTM securities are restricted funds. We had $3 million of money market securities classified as Current Assets - Other on the Consolidated Balance Sheets as of December 31, 2016 and December 31, 2015. These securities are restricted pursuant to certain Express-Platte debt agreements. At December 31, 2016, the weighted-average contractual maturity of outstanding HTM securities was less than one year. There were no material gross unrecognized holding gains or losses associated with investments in HTM securities at December 31, 2016 or December 31, 2015. Interest income. We had interest income of $2 million in 2016 and $1 million in 2015, which is included in Other Income and Expenses, Net on the Consolidated Statements of Operations. We had no interest income in 2014. Other Restricted Funds. In addition to the AFS and HTM securities that were restricted funds as described above, we had other restricted funds totaling $5 million and $14 million classified as Investments and Other Assets - Other on the Consolidated Balance Sheets at December 31, 2016 and December 31, 2015, respectively. These restricted funds are related to certain construction projects. Changes in restricted balances are presented within Cash Flows from Investing Activities on our Consolidated Statements of Cash Flows. 11. Property, Plant and Equipment We had no capital leases at December 31, 2016 or December 31, 2015. Approximately 86% of our property, plant and equipment is regulated with estimated useful lives based on rates approved by the FERC. Composite weighted-average depreciation rates were 2% for 2016, 2015 and 2014. Amortization expense of intangible assets totaled $9 million in 2016 and $10 million in both 2015 and 2014. Estimated amortization expense for the next five years follows: 12. Asset Retirement Obligations Our AROs relate mostly to the retirement of offshore pipelines and certain onshore assets, obligations related to right-of-way agreements and contractual leases for land use. However, we have determined that a significant portion of our assets have an indeterminate life, and as such, the fair values of those associated retirement obligations are not reasonably estimable. These assets include onshore and some offshore pipelines, and certain storage facilities, whose retirement dates will depend mostly on the various natural gas supply sources that connect to our systems and the ongoing demand for natural gas usage in the markets we serve. We expect these supply sources and market demands to continue for the foreseeable future, therefore we are unable to estimate retirement dates that would result in asset retirement obligations. AROs are adjusted each period for liabilities incurred or settled during the period, accretion expense and any revisions made to the estimated cash flows. 2015 revisions mainly include a reduction in the remaining estimated life of certain Texas Eastern Transmission, LP (Texas Eastern) offshore facilities, and resulted in a net increase to ARO liabilities of $27 million. Reconciliation of Changes in Asset Retirement Obligation Liabilities _________ (a) Amounts included in Deferred Credits and Other Liabilities in the Consolidated Balance Sheets. 13. Debt and Credit Facility Summary of Debt and Related Terms _________ (a)The weighted-average days to maturity were 17 days as of December 31, 2016 and 13 days as of December 31, 2015. (b) Weighted-average rates outstanding on commercial paper were 1.12% as of December 31, 2016 and 0.96% as of December 31, 2015. Secured Debt. Secured debt, totaling $122 million as of December 31, 2016, includes project financings for Express-Platte. The notes are secured by the assignment of the Express-Platte transportation receivables and by the Express Canada assets. Floating Rate Debt. Debt included approximately $974 million of floating-rate debt as of December 31, 2016 and $876 million as of December 31, 2015. The weighted average interest rate of borrowings outstanding that contained floating rates was 1.44% at December 31, 2016 and 1.22% at December 31, 2015. Annual Maturities _________ (a)Excludes commercial paper of $574 million. We have the ability under certain debt facilities to repay the obligations prior to scheduled maturities. Therefore, the actual timing of future cash repayments could be materially different than presented above. Credit Facility On April 29, 2016, we amended our credit agreement. The total capacity was increased to $2.5 billion and the expiration date was extended to April 2021. The issuances of commercial paper, letters of credit and revolving borrowings reduce the amount available under the credit facility. As of December 31, 2016, there were no letters of credit issued or revolving borrowings outstanding under the credit facility. Our credit agreements contain various covenants, including the maintenance of a consolidated leverage ratio, as defined in the agreements. Failure to meet those covenants beyond applicable grace periods could result in accelerated due dates and/or termination of the agreements. As of December 31, 2016, we were in compliance with those covenants. In addition, our credit agreements allow for acceleration of payments or termination of the agreements due to nonpayment, or in some cases, due to the acceleration of our other significant indebtedness or other significant indebtedness of some of our subsidiaries. Our credit agreements do not contain provisions that trigger an acceleration of indebtedness based solely on the occurrence of a material adverse change in our financial condition or results of operations. As noted above, the terms of our credit agreements require us to maintain a ratio of total Consolidated Indebtedness-to-Consolidated EBITDA, as defined in the agreements, of 5.0 to 1 or less. As of December 31, 2016, this ratio was 3.8 to 1. 14. Fair Value Measurements The following presents, for each of the fair value hierarchy levels, assets that are measured at fair value on a recurring basis as of December 31, 2016 and December 31, 2015. Level 1 Level 1 valuations represent quoted unadjusted prices for identical instruments in active markets. Level 2 Valuation Techniques Fair values of our financial instruments that are actively traded in the secondary market, including our long-term debt, are determined based on market-based prices. These valuations may include inputs such as quoted market prices of the exact or similar instruments, broker or dealer quotations, or alternative pricing sources that may include models or matrix pricing tools, with reasonable levels of price transparency. For interest rate swaps, we utilize data obtained from a third-party source for the determination of fair value. Both the future cash flows for the fixed-leg and floating-leg of our swaps are discounted to present value. Level 3 Valuation Techniques Level 3 valuation techniques include the use of pricing models, discounted cash flow methodologies or similar techniques where at least one significant model assumption or input is unobservable. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. Financial Instruments. The fair values of financial instruments that are recorded and carried at book value are summarized in the following table. Judgment is required in interpreting market data to develop the estimates of fair value. These estimates are not necessarily indicative of the amounts we could have realized in current markets. ________ (a)Included within Investments in and Loans to Unconsolidated Affiliates. (b)Excludes unamortized items and fair value hedge carrying value adjustments. The fair value of long-term debt is determined based on market-based prices as described in the Level 2 valuation technique described above and are classified as Level 2. The fair values of cash and cash equivalents, restricted cash, short-term investments, accounts receivable, note receivable-noncurrent, accounts payable, commercial paper and short-term money market securities are not materially different from their carrying amounts because of the short-term nature of these instruments or because the stated rates approximate market rates. During the 2016 and 2015 periods, there were no material adjustments to assets and liabilities measured at fair value on a nonrecurring basis. 15. Risk Management and Hedging Activities Interest Rate Swaps. Changes in interest rates expose us to risk as a result of our issuance of variable and fixed-rate debt and commercial paper. We manage our interest rate exposure by limiting our variable-rate exposures to percentages of total debt and by monitoring the effects of market changes in interest rates. We also enter into financial derivative instruments including, but not limited to, interest rate swaps to manage and mitigate interest rate risk exposure. For interest rate derivative instruments that are designated and qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk is recognized in the Consolidated Statements of Operations. There were no significant amounts of gains or losses recognized in net income in 2016, 2015 or 2014. At December 31, 2016, we had “pay floating - receive fixed” interest rate swaps outstanding with a total notional amount of $900 million to hedge against changes in the fair value of our fixed-rate debt that arise as a result of changes in market interest rates. These interest rate swaps expire in 2018 and thereafter. These swaps also allow us to transform a portion of the underlying interest payments related to our long-term fixed-rate debt securities into variable-rate interest payments in order to achieve our desired mix of fixed and variable-rate debt. Information about our interest rate swaps that had netting or rights of offset arrangements are as follows: Our floating-to-fixed interest rate swaps expired or were terminated in 2011 in conjunction with the pay down of our credit facility and were designated and qualified as cash flow hedges. The reclassifications from Other Comprehensive Income into income on derivatives are as follows: Foreign Currency Risk. We are exposed to minimal foreign currency risk from our Express Canada operations. Credit Risk. Our principal customers for natural gas transmission and storage services are local distribution companies, industrial end-users, and natural gas marketers located throughout the United States and Canada. Customers on the Express-Platte system are primarily refineries located in the Rocky Mountain and Midwestern states of the United States. Other customers include oil producers and marketing entities. We have concentrations of receivables from these sectors throughout these regions. These concentrations of customers may affect our overall credit risk in that risk factors can negatively affect the credit quality of the entire sector. Where exposed to credit risk, we analyze the customers’ financial condition prior to entering into an agreement, establish credit limits and monitor the appropriateness of those limits on an ongoing basis. We also obtain parental guarantees, cash deposits, or letters of credit from customers to provide credit support, where appropriate, based on our financial analysis of the customer and the regulatory or contractual terms and conditions applicable to each contract. 16. Commitments and Contingencies General Insurance We are insured through Spectra Energy’s master insurance program for insurance coverages consistent with companies engaged in similar commercial operations with similar type properties. Our insurance program includes: (1) commercial general and excess liability insurance for liabilities to third parties for bodily injury and property damage resulting from our operations; (2) workers’ compensation liability coverage to required statutory limits; (3) automobile liability insurance for all owned, non-owned and hired vehicles covering liabilities to third parties for bodily injury and property damage; (4) directors and officers liability insurance; and (5) onshore replacement value property insurance, including machinery breakdown, business interruption and extra expense. All coverages are subject to certain deductibles, terms, exclusions, and conditions common for companies with similar types of operations. Environmental We are subject to various federal, state and local laws and regulations regarding air and water quality, hazardous and solid waste disposal and other environmental matters. These laws and regulations can change from time to time, imposing new obligations on us. Like others in the energy industry, we and our affiliates are responsible for environmental remediation at various contaminated sites. These include some properties that are part of our ongoing operations, sites formerly owned or used by us, and sites owned by third parties. Remediation typically involves management of contaminated soils and may involve groundwater remediation. Managed in conjunction with relevant federal, state/provincial and local agencies, activities vary with site conditions and locations, remedial requirements, complexity and sharing of responsibility. If remediation activities involve statutory joint and several liability provisions, strict liability, or cost recovery or contribution actions, we or our affiliates could potentially be held responsible for contamination caused by other parties. In some instances, we may share liability associated with contamination with other potentially responsible parties, and may also benefit from contractual indemnities that cover some or all cleanup costs. All of these sites generally are managed in the normal course of business or affiliated operations. Litigation Litigation and Legal Proceedings. We are involved in legal, tax and regulatory proceedings in various forums arising in the ordinary course of business, including matters regarding contract and payment claims, some of which involve substantial monetary amounts. We have insurance coverage for certain of these losses should they be incurred. We believe that the final disposition of these proceedings will not have a material effect on our consolidated results of operations, financial position or cash flows. Legal costs related to the defense of loss contingencies are expensed as incurred. We had no material reserves for legal matters recorded as of December 31, 2016 or 2015 related to litigation. Operating Lease Commitments We lease assets in various areas of our operations. Consolidated rental expense for operating leases classified in Net Income was $22 million in 2016, $23 million in 2015 and $21 million in 2014, which is included in Operating, Maintenance and Other on the Consolidated Statements of Operations. The following is a summary of future minimum lease payments under operating leases which at inception had noncancellable terms of more than one year. We had no capital lease commitments at December 31, 2016. 17. Guarantees We have various financial guarantees which are issued in the normal course of business. We enter into these arrangements to facilitate a commercial transaction with a third party by enhancing the value of the transaction to the third party. To varying degrees, these guarantees involve elements of performance and credit risk, which are not included on our Consolidated Balance Sheets. The possibility of having to perform under these guarantees is largely dependent upon future operations of various subsidiaries, investees and other third parties, or the occurrence of certain future events. On December 29, 2016, we issued performance guarantees to a third party and an affiliate on behalf of an equity method investee. These guarantees were issued to enable the equity method investee to enter into long-term transportation contracts with the third party. While the likelihood is remote, the maximum potential amount of future payments we could have been required to make as of December 31, 2016 was $50 million. These performance guarantees expire in 2032. As of December 31, 2016, the amounts recorded for the guarantees described above are not material, both individually and in the aggregate. 18. Issuances of Common Units In April 2016, we issued 10.4 million common units and 0.2 million general partner units to Spectra Energy in a private placement transaction. Total net proceeds were $489 million, including $10 million for general partner units in order to maintain Spectra Energy's 2% general partner interest. We used the proceeds from this purchase for general partnership purposes, including the funding of our current expansion capital plan. In November 2015, we issued 17,114 common units in connection with the U.S. Assets Dropdown, valued at $1 million. In addition, we issued 342 general partner units to Spectra Energy in exchange for the same amount of common units in order to maintain Spectra Energy's 2% general partner interest. In November 2014, we issued 4.3 million common units and 86,000 general partner units to Spectra Energy in connection with the U.S. Assets Dropdown, valued at $186 million. See Note 2 for further discussion of this transaction. We have entered into equity distribution agreements for our at-the-market offering program, pursuant to which we may offer and sell, through sales agents, common units representing limited partner interests at prices we deem appropriate having aggregate offering prices ranging from $400 million to up to $1 billion. Sales of common units, if any, will be made by means of ordinary brokers’ transactions on the New York Stock Exchange (NYSE), in block transactions, or as otherwise agreed to between the sales agent and us. We intend to use the net proceeds from sales under the program for general partnership purposes, which may include debt repayment, future acquisitions and capital expenditures. During the year ended December 31, 2016, we issued 12.8 million common units to the public under this program, and approximately 262,000 general partner units to Spectra Energy. Total net proceeds were $591 million, including approximately $12 million of proceeds from Spectra Energy. During the year ended December 31, 2015, we issued 12.0 million common units to the public under this program, and 245,000 general partner units to Spectra Energy. Total net proceeds were $557 million, including $11 million of proceeds from Spectra Energy. During the year ended December 31, 2014, we issued 6.4 million common units to the public under this program, and 132,000 general partner units to Spectra Energy. Total net proceeds were $334 million, including $7 million of proceeds from Spectra Energy. 19. Equity-Based Compensation Phantom units are granted under a Long-Term Incentive Plan to certain employees of Spectra Energy and vest over three years. We did not award phantom units in 2016, 2015 or 2014. The remaining 7,500 units vested in 2015. There were no units vested in 2014. We account for the phantom units as liability awards. Compensation expense for these awards was not significant in 2016, 2015 or 2014. 20. Quarterly Financial Data (Unaudited) (a) Quarterly net income per limited partner unit amounts are stand-alone calculations and may not be additive to full-year amounts due to rounding and changes in outstanding units. | Here's a summary of the financial statement excerpt:
Financial Statement Summary:
1. Foreign Currency Transactions:
- Foreign currency transaction losses were recorded
- Transactions are translated using average monthly exchange rates
2. Valuation Approach:
- Uses fair value measurement
- Aims to maximize observable inputs and minimize unobservable inputs
- Fair value defined as the exchange price in principal or most advantageous market
3. Regulatory Accounting:
- Follows cost-based regulation principles
- Records assets and liabilities based on regulatory ratemaking process
- Continually assesses probability of recovering regulatory assets
- Potential risk if cost-based regulation ends or competition increases
4. Asset and Liability Classification:
- Regulatory assets and liabilities primarily classified in:
- Consolidated Balance Sheets
- Regulatory Assets and Deferred Debits
- Current Liabilities
5. Key | Claude |
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Eastern Company Consolidated Balance Sheets Consolidated Balance Sheets See accompanying notes. Consolidated Statements of Income See accompanying notes. Consolidated Statements of Comprehensive Income See accompanying notes. Consolidated Statements of Shareholders’ Equity See accompanying notes. Consolidated Statements of Cash Flows See accompanying notes. The Eastern Company 1. Description of Business The operations of The Eastern Company (the “Company”) consist of three business segments: industrial hardware, security products, and metal products. The industrial hardware segment produces latching devices for use on industrial equipment and instrumentation, composite panels used primarily in the transportation and electronic white board industries, as well as a broad line of proprietary hardware designed for truck bodies and other vehicular type equipment. The security products segment manufactures and markets a broad range of locks for traditional general purpose security applications as well as specialized locks for soft luggage, coin-operated vending and gaming equipment, and electric and computer peripheral components. This segment also manufactures and markets coin acceptors and metering systems to secure cash used in the commercial laundry industry and produces cashless payment systems utilizing advanced smart card technology. The metal products segment produces anchoring devices used in supporting the roofs of underground coal mines and specialty products which serve the construction, automotive, railroad and electrical industries. Sales are made to customers primarily in North America. 2. Accounting Policies Estimates and Assumptions The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fiscal Year The Company’s year ends on the Saturday nearest to December 31. Fiscal 2015 was a 52 week year, 2014 was a 53 week year and 2013 was a 52 week year. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All intercompany accounts and transactions are eliminated. Cash Equivalents and Concentrations of Credit Risk Highly liquid investments purchased with a maturity of three months or less are considered cash equivalents. The Company has deposits that exceed amounts insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000, but the Company does not consider this a significant concentration of credit risk based on the strength of the financial institution. Reclassification Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no effect on previously reported net income. Foreign Currency Translation For foreign operations balance sheet accounts are translated at the current year-end exchange rate; income statement accounts are translated at the average exchange rate for the year. Resulting translation adjustments are made directly to a separate component of shareholders’ equity - “Accumulated other comprehensive income (loss) - Foreign currency translation”. Foreign currency exchange transaction gains and losses are not material in any year. The Eastern Company (continued) 2. Accounting Policies (continued) Recognition of Revenue and Accounts Receivable Revenue and accounts receivable are recognized when persuasive evidence of an arrangement exists, the price is fixed and determinable, delivery has occurred, and there is a reasonable assurance of collection of the sales proceeds. The Company obtains written purchase authorizations from its customers for a specified amount of product at a specified price and delivery occurs at the time of shipment. Credit is extended based on an evaluation of each customer’s financial condition; collateral is not required. Accounts receivable are recorded net of applicable allowances. No customer exceeded 10% of total accounts receivable at year end 2015 or 2014. Allowance for Doubtful Accounts The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company reviews the collectability of its receivables on an ongoing basis taking into account a combination of factors. The Company reviews potential problems, such as past due accounts, a bankruptcy filing or deterioration in the customer’s financial condition, to ensure the Company is adequately accrued for potential loss. Accounts are considered past due based on when payment was originally due. If a customer’s situation changes, such as a bankruptcy or creditworthiness, or there is a change in the current economic climate, the Company may modify its estimate of the allowance for doubtful accounts. The Company will write off accounts receivable after reasonable collection efforts have been made and the accounts are deemed uncollectible. Write-offs have been within management’s estimates. Inventories Inventories are valued at the lower of cost or market. Cost is determined by the last-in, first-out (LIFO) method in the U.S. ($31,601,408 for U.S. inventories at January 2, 2016) and by the first-in, first-out (FIFO) method for inventories outside the U.S. ($5,241,005 for inventories outside the U.S. at January 2, 2016). Current cost exceeds the LIFO carrying value by approximately $6,297,368 at January 2, 2016 and $6,886,000 at January 3, 2015. There was no material LIFO quantity liquidation in 2015, 2014 and 2013. Property, Plant and Equipment and Related Depreciation Property, plant and equipment (including equipment under capital lease) are stated at cost. Depreciation ($3,460,516 in 2015, $3,237,426 in 2014, $3,592,263 in 2013) is computed generally using the straight-line method based on the following estimated useful lives of the assets: Buildings 10 to 39.5 years; Machinery and equipment 3 to 10 years. Goodwill, Intangibles and Impairment of Long-Lived Assets Patents are recorded at cost and are amortized using the straight-line method over the lives of the patents. Technology and licenses are recorded at cost and are generally amortized on a straight-line basis over periods ranging from 5 to 17 years. Non-compete agreements and customer relationships are being amortized using the straight-line method over a period of 5 years. Amortization expense in 2015, 2014 and 2013 was $460,922, $248,876 and $233,023, respectively. Total amortization expense for each of the next five years is estimated to be as follows: 2016 - $437,000; 2017 - $437,000; 2018 - $437,000; and 2019 - $379,000; and 2020 - $146,000. Trademarks are not amortized as their lives are deemed to be indefinite. The Eastern Company (continued) 2. Accounting Policies (continued) The gross carrying amount and accumulated amortization of amortizable intangible assets: In the event that facts and circumstances indicate that the carrying value of long-lived assets, including definite life intangible assets, may be impaired, an evaluation is performed to determine if a write-down is required. No events or changes in circumstances have occurred to indicate that the carrying amount of such long-lived assets held and used may not be recovered. The Eastern Company (continued) 2. Accounting Policies (continued) The Company performed qualitative assessments as of the end of fiscal 2015 and fiscal 2014 and determined it is more likely than not that no impairment of goodwill existed at the end of 2015 or 2014. The Company will perform annual qualitative assessments in subsequent years as of the end of each fiscal year. Additionally, the Company will perform interim analysis whenever conditions warrant. Goodwill or trademarks would be considered impaired whenever our historical carrying amount exceeds the fair value. Goodwill and trademarks were not impaired in 2015, 2014 or 2013. Should we reach a different conclusion in the future, additional work would be performed to determine the amount of the non-cash impairment charge to be recognized. The maximum future impairment of goodwill or trademarks that could occur is the amount recognized on our balance sheet. The following is a roll-forward of goodwill for 2015 and 2014: Cost of Goods Sold Cost of goods sold reflects the cost of purchasing, manufacturing and preparing a product for sale. These costs generally represent the expenses to acquire or manufacture products for sale (including an allocation of depreciation and amortization) and are primarily comprised of direct materials, direct labor, and overhead, which includes indirect labor, facility and equipment costs, inbound freight, receiving, inspection, purchasing, warehousing and any other costs related to the purchasing, manufacturing or preparation of a product for sale. Shipping and Handling Costs Shipping and handling costs are included in cost of goods sold. Selling, General and Administrative Expenses Selling, general and administrative expenses include all operating costs of the Company that are not directly related to the cost of purchasing, manufacturing and preparing a product for sale. These expenses generally represent the cost of selling or distributing the product once it is available for sale, as well as administrative expenses for support functions and related overhead. The Eastern Company (continued) 2. Accounting Policies (continued) Product Development Costs Product development costs, charged to expense as incurred, were $1,218,948 in 2015, $1,079,557 in 2014 and $991,286 in 2013. Advertising Costs The Company expenses advertising costs as incurred. Advertising costs were $496,066 in 2015, $494,267 in 2014 and $486,027 in 2013. Income Taxes The Company accounts for uncertain tax positions pursuant to the provisions of FASB Accounting Standards Codification (“ASC”) 740 which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. These provisions detail how companies should recognize, measure, present and disclose uncertain tax positions that have or are expected to be taken. As such, the financial statements will reflect expected future tax consequences of uncertain tax positions presuming the taxing authorities’ full knowledge of the position and all relevant facts. See Note 8 Income Taxes. The Company and its U.S. subsidiaries file a consolidated federal income tax return. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Earnings per Share The denominators used in the earnings per share computations follow: Basic: Weighted average shares outstanding 6,245,057 6,225,068 6,220,928 Diluted: Weighted average shares outstanding 6,245,057 6,225,068 6,220,928 Dilutive stock options - 12,846 16,830 Denominator for diluted earnings per share 6,245,057 6,237,914 6,237,758 There were no anti-dilutive stock options in 2015, 2014 or 2013. Derivatives The Company does not maintain any derivatives as of the date of this report. Stock Based Compensation The Company accounts for stock based compensation pursuant to the fair value recognition provisions of ASC 718. No stock options were granted in 2015, 2014 or 2013, and, since all outstanding options were fully vested in each year presented, there was no impact on the financial statements. The Eastern Company (continued) 2. Accounting Policies (continued) Fair Value of Financial Instruments Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The company utilizes a fair value hierarchy, which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The fair value hierarchy has three levels of inputs that may be used to measure fair value: Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Level 2 Quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability. Level 3 Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable. The carrying amounts of financial instruments (cash and cash equivalents, accounts receivable, accounts payable and debt) as of January 2, 2016 and January 3, 2015, approximate fair value. Fair value was based on expected cash flows and current market conditions. 3. Business Acquisitions Effective December 15, 2014 the Company acquired certain assets of Argo Transdata Corporation (“Argo”) including accounts receivable, inventories, furniture, fixtures and equipment, intellectual property rights and rights existing under all sales and purchase agreements. Argo is a contract manufacturer of printed circuit board assemblies and has the ability to manufacture surface mount (SMT), through hole and wire bond assemblies or any combination of the three technologies. Its products are sold to numerous OEM’s in industries such as measurement systems, industrial controls, medical and military. The Argo acquisition further diversified our markets and provides a source for printed circuit boards which are used in several of our current products. Argo is included in the Security Products segment of the Company from the date of the acquisition. The cost of the acquisition of Argo was approximately $5,034,000, inclusive of transaction costs, plus a contingent earn-out of $282,914 based on revenue levels in each of the first two fiscal years following the closing and the assumption of $63,000 in current liabilities. In 2015, the Company recognized $138,683 in earnings as a result of Argo not meeting the sales goals for the 1st year earn-out. On January 2, 2016 the contingent earn-out liability was $144,231. The above acquisition was accounted for under ASC 805. The acquired business is included in the consolidated operating results of the Company from the date of acquisition. The excess of the cost of Argo over the fair market value of the net assets acquired of $1,225,226 has been recorded as goodwill. In connection with the above acquisition, the Company recorded the following intangible assets: Asset Class/Description Amount Weighted-average Amortization Period in Years Patents, technology, and licenses Customer relationships $ 449,706 5.0 Intellectual property 307,370 5.0 Non-compete agreements 407,000 5.0 $ 1,164,076 5.0 There is no anticipated residual value relating to these intangible assets. Neither the actual results nor the pro forma effects of the acquisition of Argo are material to the Company's financial statements. The Eastern Company (continued) 4. Contingencies The Company is party to various legal proceedings and claims related to its normal business operations. In the opinion of management, the Company has substantial and meritorious defenses for these claims and proceedings in which it is a defendant, and believes these matters will ultimately be resolved without a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company. The aggregate provision for losses related to contingencies arising in the ordinary course of business was not material to operating results for any year presented. During the fourth quarter of 2010, the Company was contacted by the State of Illinois regarding potential ground contamination at our plant in Wheeling, Illinois. The Company signed up with a voluntary remediation program in Illinois and has engaged an environmental clean-up company to perform testing and develop a remediation plan. The estimated cost of remediation is $30,000. Approximately 26% of the total workforce is subject to negotiated union contracts, and none of the agreements expire during 2016. 5. Debt On January 29, 2010, the Company signed a secured Loan Agreement (the “Loan Agreement”) with People’s United Bank (“People’s”) which included a $5,000,000 term portion and a $10,000,000 revolving credit portion. The term portion of the loan requires quarterly principal payments of $178,571 for a period of seven (7) years, maturing on January 31, 2017. The revolving credit portion had a quarterly commitment fee of one quarter of one percent (0.25%), and a maturity date of January 31, 2012. On January 25, 2012 the Company amended the Loan Agreement by taking an additional $5,000,000 term loan (the “2012 Term Loan”). The 2012 Term Loan requires quarterly principal payments of $178,571 for a period of seven (7) years, maturing on January 31, 2019. At the same time the maturity date of the revolving credit portion was extended to January 31, 2014 and continued to have a quarterly commitment fee of one quarter of one percent (0.25%). Interest on the original term portion of the Loan Agreement is fixed at 4.98%. Interest on the 2012 Term Loan is fixed at 3.90%. For the period from January 25, 2012 to January 23, 2014, interest on the revolving credit portion of the Loan Agreement varied based on the LIBOR rate or People’s Prime rate plus 2.25%, with a floor of 3.25% with a maturity date of January 31, 2014. On January 23, 2014, the Company amended the Loan Agreement with People’s. The amendment renewed and extended the maturity date of the revolving credit portion of the Loan Agreement to July 1, 2016 and changed the interest rate to LIBOR plus 2.25%, and eliminated the 3.25% floor previously in place. The quarterly commitment fee of one quarter of one percent (0.25%) remained unchanged. The Company did not utilize the revolving credit portion of the Loan Agreement at any time during 2014 or 2015. Debt consists of: The Company paid interest of $174,558 in 2015, $272,993 in 2014, and $319,760 in 2013. The Eastern Company (continued) 5. Debt (continued) The Company’s loan covenants under the Loan Agreement require the Company to maintain a fixed charge coverage ratio of at least 1.1 to 1, a leverage ratio of no more than 1.75 to 1, and minimum tangible net worth of $43 million increasing each year by 50% of consolidated net income. This amount was approximately $52.8 million as of December 28, 2013. As part of an amendment to the Loan Agreement signed on January 23, 2014, the leverage ratio was eliminated, and the minimum tangible net worth covenant was modified to a fixed minimum amount of $55 million, effective with the end of the Company’s first quarter of 2014. In addition, the Company has restrictions on, among other things, new capital leases, purchases or redemptions of its capital stock, mergers and divestitures, and new borrowing. The Company was in compliance with all covenants in 2014 and 2015. As of January 3, 2015, scheduled annual principal maturities of long-term debt for each of the next five years follow: $ 1,428,571 892,857 714,286 178,571 - Thereafter - $ 3,214,285 6. Stock Rights The Company had a stock rights plan. At January 3, 2015, there were 6,244,013 stock rights outstanding under the plan. Each right may have been exercised to purchase one share of the Company’s common stock at an exercise price of $80.00, subject to adjustment to prevent dilution. On August 7, 2015, the Company terminated the 2008 Shareholder Rights Agreement. Pursuant to Section 23 of the Rights Agreement, the Company redeemed all of the outstanding rights at a redemption price of $0.01 per right. The redemption fee was paid on September 15, 2015, to common shareholders of record as of August 19, 2015. 7. Stock Options and Awards Stock Options At the end of 2015, the Company had one stock option plan, the 2010 plan, for officers, other key employees, and non-employee directors. Incentive stock options granted under the 2010 plan must have exercise prices that are not less than 100% of the fair market value of the stock on the dates the options are granted. Restricted stock awards may also be granted to participants under the 2010 plan with restrictions determined by the Compensation Committee of the Company’s Board of Directors. Under the 2010 plan, non-qualified stock options granted to participants will have exercise prices determined by the Compensation Committee of the Company’s Board of Directors. No options or restricted stock were granted in 2015, 2014 or 2013. As of January 2, 2016, there were 500,000 shares of common stock reserved and available for future grant under the above noted 2010 plan. The Eastern Company (continued) 7. Stock Options and Awards (continued) Information with respect to the Company’s stock option plans is summarized below: At January 2, 2016, there were no stock options outstanding or exercisable. The total intrinsic value of stock options exercised in 2014 and 2013 was $59,125 and $1,590, respectively. 8. Income Taxes Deferred income taxes are provided on temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and those for income tax reporting purposes. Deferred income tax (assets) liabilities relate to: Income before income taxes consists of: The Eastern Company (continued) 8. Income Taxes (continued) The provision for income taxes follows: A reconciliation of income taxes computed using the U.S. federal statutory rate to that reflected in operations follows: Total income taxes paid were $2,348,865 in 2015, $3,989,978 in 2014 and $2,568,708 in 2013. United States income taxes have been provided on the undistributed earnings of foreign subsidiaries ($13,308,709 at January 2, 2016) only where necessary because such earnings are intended to be reinvested abroad indefinitely or repatriated only when substantially free of such taxes. The Company would be required to accrue and pay United States income taxes to repatriate the funds held by foreign subsidiaries not otherwise provided. During 2015, 2014 and 2013, the Company received tax benefits of $0, $8,882, and $0, respectively, as a result of the exercise and sale of incentive stock options that resulted in the disqualification of those incentive stock options and the exercise of non-qualified stock options during the year. The tax benefit associated with the exercise of the incentive and non-qualified stock options has been recorded to common stock. A reconciliation of the beginning and ending amount of unrecognized tax benefits are as follows: The Eastern Company (continued) 8. Income Taxes (continued) The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years before 2012 and non-U.S. income tax examinations by tax authorities prior to 2009. Included in the balance at January 2, 2016, are $164,856 of unrecognized tax benefits that would affect the annual effective tax rate. In 2015, the Company recognized accrued interest related to unrecognized tax benefits in income tax expense. The Company had approximately $37,000 of accrued interest at January 2, 2016. The total amount of unrecognized tax benefits could increase or decrease within the next twelve months for a number of reasons, including the closure of federal, state and foreign tax years by expiration of the statute of limitations and the recognition and measurement considerations under ASC 740. The Company believes that the total amount of unrecognized tax benefits will not increase or decrease significantly over the next twelve months. 9. Leases The Company leases certain equipment and buildings under operating lease arrangements. Most leases are for a fixed term and for a fixed amount; additionally, the Company leases certain buildings under operating leases on a month-to-month basis. The Company is not a party to any leases that have step rent provisions, escalation clauses, capital improvement funding or payment increases based on any index or rate. Future minimum payments under non-cancelable operating leases with initial or remaining terms in excess of one year during each of the next five years follow: $ 1,046,940 992,680 884,615 397,186 55,120 $ 3,376,541 Rent expense for all operating leases was $1,324,365 in 2015, $1,151,749 in 2014 and $1,093,895 in 2013. The Company expects future rent expense, including non-cancelable operating leases, leases that are expected to be renewed and buildings leased on a month-to-month basis, for each of the next five years to be in the range of $1,100,000 to $1,300,000. 10. Retirement Benefit Plans The Company has non-contributory defined benefit pension plans covering most U.S. employees. Plan benefits are generally based upon age at retirement, years of service and, for its salaried plan, the level of compensation. The Company also sponsors unfunded non-qualified supplemental retirement plans that provide certain former officers with benefits in excess of limits imposed by federal tax law. The Company also provides health care and life insurance for retired salaried employees in the United States who meet specific eligibility requirements. The Eastern Company (continued) 10. Retirement Benefit Plans (continued) Components of the net periodic benefit cost of the Company’s pension benefit plans were as follows: Assumptions used to determine net periodic benefit cost for the Company’s pension benefit plans for the fiscal year indicated were as follows: Discount rate 3.90% 4.80% 3.90% Expected return on plan assets 8.0% 8.0% 8.0% Rate of compensation increase 3.25% 3.25% 3.25% Components of the net periodic benefit cost of the Company’s postretirement benefit plan were as follows: Assumptions used to determine net periodic benefit cost for the Company’s postretirement plan for the fiscal year indicated were as follows: Discount rate 3.90% 4.80% 3.90% Expected return on plan assets 8.0% 8.0% 8.0% As of January 2, 2016 and January 3, 2015, the status of the Company’s pension benefit plans and postretirement benefit plan was as follows: The Eastern Company (continued) 10. Retirement Benefit Plans (continued) Amounts recognized in accumulated other comprehensive income consist of: Change in the components of accumulated other comprehensive income consist of: In 2016, the net periodic pension benefit cost will include $1,837,738 of net loss and $200,568 of prior service cost and the net periodic postretirement benefit cost will include $125,885 of net gain and $23,889 of prior service credit. The Eastern Company (continued) 10. Retirement Benefit Plans (continued) Assumptions used to determine the projected benefit obligations for the Company’s pension benefit plans and postretirement benefit plan for the fiscal year indicated were as follows: At January 2, 2016 and January 3, 2015, the accumulated benefit obligation for all qualified and nonqualified defined benefit pension plans was $83,433,339 and $84,714,136, respectively. Information for the under-funded pension plans with a projected benefit obligation and an accumulated benefit obligation in excess of plan assets: Estimated future benefit payments to participants of the Company’s pension plans are $3.4 million in 2016, $3.6 million in 2017, $3.8 million in 2018, $4.1 million in 2019, $4.4 million in 2020 and a total of $26.2 million from 2021 through 2025. Estimated future benefit payments to participants of the Company’s postretirement plan are $118,000 in 2016, $118,000 in 2017, $117,000 in 2018, $117,000 in 2019, $117,000 in 2020 and a total of $577,000 from 2021 through 2025. The Company expects to make cash contributions to its qualified pension plans of approximately $3.1 million and to its postretirement plan of approximately $118,000 in 2016. We consider a number of factors in determining and selecting assumptions for the overall expected long-term rate of return on plan assets. We consider the historical long-term return experience of our assets, the current and expected allocation of our plan assets, and expected long-term rates of return. We derive these expected long-term rates of return with the assistance of our investment advisors and generally base these rates on a 10-year horizon for various asset classes and consider the expected positive impact of active investment management. We base our expected allocation of plan assets on a diversified portfolio consisting of domestic and international equity securities and fixed income securities. We consider a variety of factors in determining and selecting our assumptions for the discount rate at the end of the year. In 2015 we developed each plan’s discount rate with the assistance of our actuaries by matching expected future benefit payments in each year to the corresponding spot rates from the Citigroup Pension Liability Yield Curve, comprised of high quality (rated AA or better) corporate bonds. Prior to 2015, we used the same process to determine each individual plan’s discount rate, but the average of these rates was used to determine a single rate for all plans. The Eastern Company (continued) 10. Retirement Benefit Plans (continued) The fair values of the company’s pension plans assets at January 2, 2016 and January 3, 2015, utilizing the fair value hierarchy discussed in Note 2, follow: The Eastern Company (continued) 10. Retirement Benefit Plans (continued) Equity common funds primarily hold publicly traded common stock of both U.S and international companies selected for purposes of total return and to maintain equity exposure consistent with policy allocations. The Level 1 investment is made up of shares of The Eastern Company Common Stock and is valued at market price. Level 2 investments include commingled funds valued at unit values provided by the investment managers, which are based on the fair value of the underlying publicly traded securities. The Eastern Company (continued) 10. Retirement Benefit Plans (continued) (a) The investment objective of the Russell Large Cap Defensive Equity Fund is to outperform the Russell 1000® Defensive Index® while managing volatility and maintaining diversification similar to the Index over a full market cycle. The Fund invests in common stocks of large and medium cap U.S. companies, employing a multi-manager approach with advisors using distinct methods to identify medium to large cap U.S. stocks with positive excess return potential. The defensive style of investing emphasizes investments in equities of companies expected to have lower than average stock price volatility, higher financial quality and/or stable business fundamentals. (b) The Russell Equity II Fund has an objective to provide a favorable total return primarily through capital appreciation. Aims to outperform the Russell 2500® Index with above-average consistency while managing volatility and maintaining diversification similar to the Index over a full market cycle. The fund invests in common stocks of U.S. small cap companies. It employs a multi-style (growth and market-oriented, value), multi-manager approach. Advisors employ distinct yet complementary styles in their stock selection, focusing on factors such as: undervalued or under-researched companies, special situations, emerging growth, asset plays and turnarounds. (c) The investment objective of the Russell Large Cap U.S. Equity Fund (formerly the Russell Concentrated Equity Fund) is to outperform the Russell 1000® Index with above-average consistency over a full market cycle. The fund invests in common stocks of large and medium cap U.S. companies. Employs a multi-style, multi-manager approach whereby portions of the fund are allocated to different money managers who employ distinct styles. The number of advisors and number of stocks (150 - 200) is more concentrated than other Russell multi-style large cap U.S. funds. (d) The Russell International Fund with Active Currency seeks to provide long-term growth of Capital. Aims to outperform the Russell Development ex-U.S. Large Cap Index Net while managing volatility and maintaining diversification similar to the index over a full market cycle. The fund invests primarily in the equities of non-U.S. developing markets and currency of global markets. Employs multiple managers with distinct investment styles, which are intended to be complementary. Seeks to capitalize on the stock selection abilities of its active manager. The Fund typically has moderate country and sector weights relative to the index. Also believe active currency management is an attractive strategy with the potential to deliver excess return. (e) The Russell Emerging Markets Fund seeks to provide the potential for long-term growth of Capital. Aims to outperform the Russell Emerging Markets Index Net over a full market cycle. The fund invests in equity securities of companies located in, or are economically tied to, emerging market countries. Securities are denominated principally in foreign currencies and are typically held outside the U.S. The Fund employs a multi-style (growth, market-oriented and value) and multi-manager approach whereby portions of the fund are allocated to different money managers who employ distinct styles. (f) The Russell Fixed Income I Fund is designed to provide current income and capital appreciation through a variety of diversified strategies. The Fund seeks favorable returns comparable to the broad fixed income market, as measured by the Barclays U.S. Aggregate Bond Index. The fund primarily invests in fixed income securities representing diverse sectors and maturities. Advisors use diversified strategies including sector rotation, modest interest rate timing, security selection and tactical use of high yield and emerging market bonds. It is actively managed with multiple advisors employing distinct yet complementary strategies and different technologies to insure prudent diversification over a broad spectrum of investments. (g) The Target Duration LDI Fixed Income Funds seek to outperform their respective Barclays-Russell LDI Indexes over a full market cycle. These Funds invest primarily in investment grade corporate bonds that closely match those found in discount curves used to value U.S. pension liabilities. They seek to provide additional incremental return through modest interest rate timing, security selection and tactical use of non-credit sectors. Generally for use in combination with other bond funds to gain additional credit exposure, with the goal of reducing the mismatch between a plan’s assets and liabilities. The Eastern Company (continued) 10. Retirement Benefit Plans (continued) (h) The STRIPS (Separate Trading of Registered Interest and Principal of Securities) Funds seek to provide duration and Treasury exposure by investing in an optimized subset of the STRIPS universe with a similar duration profile as the Barclays U.S. Treasury STRIPS 10-11 year, 16-16 year or 28-29 year Index. These passively managed funds are generally used with other bond funds to add additional duration to the asset portfolio. This will help reduce the mismatch between a plan’s assets and liabilities. (i) The Russell Long Duration Fixed Income Fund seeks to outperform the Barclays Capital Long Credit Index over a full market cycle. The fund seeks to provide current income, and as a secondary objective, capital appreciation through diversified strategies including sector rotation, modest interest rate timing, security selection and tactical use of high yield and emerging market bonds. The fund will generally be used in combination with other bond funds, with the goal of reducing the mismatch between a plan’s assets and liabilities. In January 2015, the Trustee of the plan sold all of the assets of this fund. The proceeds were invested in the LDI Target funds and the STRIPS funds as of the end of 2015. The investment portfolio contains a diversified blend of common stocks, bonds, cash equivalents, and other investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. The portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate performance. The Company has elected to change its investment strategy to better match the assets with the underlying plan liabilities. Currently, the long-term target allocations for plan assets are 50% in equities and 50% in fixed income although the actual plan asset allocations may be within a range around these targets. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. It is expected that, as the funded status of the plans improves, more assets will be invested in long-duration fixed income instruments. The plans’ assets include 217,018 and 202,562 shares of the common stock of the Company having a market value of $4,069,938 and $3,473,938 at January 2, 2016 and January 3, 2015, respectively. The Salaried Pension Plan purchased 14,456 shares of common stock at a cost of $232,124 during 2015 and 8,938 shares of common stock at a cost of $146,712 in 2014. No shares were sold in either period. Dividends received during 2015 and 2014 on the common stock of the Company were $92,743 and $93,507 respectively. The fair values of the Company’s postretirement plan assets at January 2, 2016 and January 3, 2015, utilizing the fair value hierarchy discussed in Note 2, follow: The Eastern Company (continued) 10. Retirement Benefit Plans (continued) The level 3 asset consists of an insurance contract with The Prudential Life Insurance Company of America. It is designed to provide life insurance benefits for eligible retirees of the Company. The contract is valued annually by the insurance company, based on activity in the account. An analysis of the Level 3 asset of the Company’s postretirement plan is as follows: The Level 3 assets described above are the only assets of the postretirement plan, and thus have no impact on any Level 1 or Level 2 assets. For measurement purposes relating to the postretirement benefit plan, the life insurance cost trend rate is 1%. The health care cost trend rate for participants retiring after January 1, 1991 is nil; no increase in that rate is expected because of caps placed on benefits. The health care cost trend rate is expected to remain at 4.5% for participants after the year 2000. A one-percentage-point change in assumed health care cost trend rates would have the following effects on the postretirement benefit plan: U.S. salaried employees and most employees of the Company’s Canadian subsidiaries are covered by defined contribution plans. The Company has a contributory savings plan under Section 401(k) of the Internal Revenue Code covering substantially all U.S. non-union employees. The plan allows participants to make voluntary contributions of up to 100% of their annual compensation on a pretax basis, subject to IRS limitations. The plan provides for contributions by the Company at its discretion. The Company made contributions of $232,399 in 2015, $186,545 in 2014, and $194,068 in 2013. Beginning in 2015, the Company began making a non-discretionary contribution to the plan for the benefit of all U.S. non-union employees who are not eligible for the Company’s salaried retirement plan. This contribution totaled $51,470 in 2015. 11. Reportable Segments The accounting policies of the segments are the same as those described in Note 2. Operating profit is total revenue less operating expenses, excluding interest and miscellaneous non-operating income and expenses. Inter-segment revenue, which is eliminated, is recorded on the same basis as sales to unaffiliated customers. Identifiable assets by reportable segment consist of those directly identified with the segment’s operations. One customer of the Metal Products segment, Jennmar Corporation, accounted for 10.5% of total sales in 2014 and 11.5% of total sales in 2013. No other customer exceeded 10% of total sales in 2015, 2014 or 2013. The Eastern Company (continued) 11. Reportable Segments (continued) Inter-segment Sales: Industrial Hardware $ 595,596 $ 984,192 $ 373,797 Security Products 2,813,576 2,565,733 2,558,127 Metal Products 16,804 - 11,540 $ 3,425,976 $ 3,549,925 $ 2,943,464 Income Before Income Taxes: Industrial Hardware $ 4,314,149 $ 5,063,786 $ 4,797,254 Security Products 3,798,115 4,058,554 2,780,403 Metal Products (84,536 ) 2,596,308 2,808,664 Operating Profit 8,027,728 11,718,648 10,386,321 Interest expense (185,475 ) (254,576 ) (322,731 ) Other income 178,722 64,691 50,305 $ 8,020,975 $ 11,528,763 $ 10,113,895 Geographic Information: Net Sales: United States $ 126,115,036 $ 117,478,557 $ 114,085,322 Foreign 18,452,915 23,346,803 28,372,957 $ 144,567,951 $ 140,825,360 $ 142,458,279 Foreign sales are primarily to customers in North America. Identifiable Assets: United States $ 106,662,743 $ 105,771,961 $ 96,289,200 Foreign 15,075,816 15,498,595 17,569,209 $ 121,738,559 $ 121,270,556 $ 113,858,409 Industrial Hardware $ 30,425,348 $ 29,660,695 $ 31,820,269 Security Products 52,688,497 51,573,251 43,582,088 Metal Products 20,931,863 21,037,058 19,282,393 104,045,708 102,271,004 94,684,750 General corporate 17,692,851 18,999,552 19,173,659 $ 121,738,559 $ 121,270,556 $ 113,858,409 The Eastern Company (continued) 11. Reportable Segments (continued) Capital Expenditures: Industrial Hardware $ 1,479,984 $ 1,929,022 $ 1,967,335 Security Products 388,377 973,365 469,669 Metal Products 632,016 664,851 3,002,556 2,500,377 3,567,238 5,439,560 Currency translation adjustment 25,020 10,347 (245 ) General corporate 12,839 55,580 84,427 $ 2,538,236 $ 3,633,165 $ 5,523,742 12. Recent Accounting Pronouncements In July 2012, the FASB issued authoritative guidance to amend previous guidance on the annual and interim testing of indefinite-lived intangible assets for impairment. The guidance provides entities with the option of first assessing qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. If it is determined, on the basis of qualitative factors, that the fair value of the indefinite-lived intangible asset is more likely than not less than the carrying amount, a quantitative impairment test would still be required. The Company adopted this guidance effective December 30, 2012 and it had no impact on the consolidated financial statements of the Company. In February 2013, the FASB issued authoritative guidance which adds new disclosure requirements for items reclassified out of Accumulated Other Comprehensive Income. The guidance requires that an entity present either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of Accumulated Other Comprehensive Income based on its source and the income statement line items affected by the reclassification. The guidance is effective for interim and annual reporting periods beginning on or after December 15, 2012. The Company adopted this guidance effective December 30, 2012 and it had no impact on the consolidated financial statements of the Company. In July 2013, the FASB issued authoritative guidance that requires an entity to net its liability for unrecognized tax positions against a net operating loss carryforward, a similar tax loss or a tax credit carryforward when settlement in this manner is available under the tax law. The guidance is effective for interim and annual reporting periods beginning on or after December 15, 2013. The Company adopted this guidance effective December 29, 2013 and it had no impact on the consolidated financial statements of the Company. In April 2014, the FASB issued authoritative guidance which changes the criteria for determining which disposals can be presented as discontinued operations and modifies the related disclosure requirements. To qualify as a discontinued operation the standard requires a disposal to represent a strategic shift that has, or will have, a major effect on an entity's operations and financial results. The standard also expands the disclosures for discontinued operations and requires new disclosures related to individually material dispositions that do not qualify as discontinued operations. The guidance is effective for fiscal years beginning after December 15, 2014, with early adoption permitted. The Company adopted this guidance with its fiscal year effective January 4, 2015 and does not expect any impact on the consolidated financial statements of the Company. This guidance will impact the reporting of any future dispositions. The Eastern Company (continued) 12. Recent Accounting Pronouncements (continued) In May 2014, the FASB issued authoritative guidance which impacts virtually all aspects of an entity's revenue recognition. The core principle of the new standard is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for annual reporting periods beginning after December 15, 2016. Early adoption is not permitted. The Company has not determined the impact of the adoption of this guidance on the consolidated financial statements of the Company. In July 2015, the FASB issued authoritative guidance which requires a company to change its valuation method of inventory from the lower of cost or market (market being replacement cost, net realizable value or net realizable value less an approximate profit margin) to the lower of cost or net realizable value. The amendment is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The amendment should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The adoption of this amendment is not expected to have a material impact on the consolidated financial statements of the Company. In September 2015, the FASB issued authoritative guidance which will simplify the accounting for adjustments made to provisional amounts recognized in a business combination. U.S. GAAP currently requires that during the measurement period, the acquirer retrospectively adjust the provisional amounts recognized at the acquisition date with a corresponding adjustment to goodwill. The amendments require that the acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not yet been issued. The adoption of this amendment is not expected to have a material impact on the consolidated financial statements of the Company. The Company has implemented all new accounting pronouncements that are in effect and that could impact its consolidated financial statements and does not believe that there are any other new accounting pronouncements that have been issued, but are not yet effective, that might have a material impact on the consolidated financial statements of the Company. The Eastern Company (continued) 13. Financial Instruments and Fair Value Measurements Financial Risk Management Objectives and Policies The Company is exposed primarily to credit, interest rate and currency exchange rate risks which arise in the normal course of business. Credit Risk Credit risk is the potential financial loss resulting from the failure of a customer or counterparty to settle its financial and contractual obligations to the Company, as and when they become due. The primary credit risk for the Company is its receivable accounts. The Company has established credit limits for customers and monitors their balances to mitigate its risk of loss. At January 2, 2016 and January 3, 2015, there were no significant concentrations of credit risk. No customer represented more than 10% of total accounts receivable at January 2, 2016 and January 3, 2015. The maximum exposure to credit risk is primarily represented by the carrying amount of the Company’s accounts receivable. Interest Rate Risk As of January 2, 2016 the Company currently has a fixed rate of 4.98% and 3.90% on its term debt. On January 2, 2016 the interest rate on the Company’s revolver was a variable rate based on LIBOR plus 2.25%. See Note 5 for additional details concerning the Loan Agreement. As the revolver is short term in nature, the Company does not consider this as a material risk to the financial statements. Currency Exchange Rate Risk The Company’s currency exposure is concentrated in the Canadian dollar, Mexican peso, New Taiwan dollar, Chinese RMB and the Hong Kong dollar. Because of the Company’s limited exposure to any single foreign market, any exchange gains or losses have not been material and are not expected to be material in the future. As a result, the Company does not attempt to mitigate its foreign currency exposure through the acquisition of any speculative or leveraged financial instruments. Fair Value Measurements Assets and liabilities that require fair value measurement are recorded at fair value using market and income valuation approaches and considering the Company’s and counterparty’s credit risk. The Company uses the market approach and the income approach to value assets and liabilities as appropriate. There were no assets or liabilities requiring fair value measurement on January 2, 2016. The Eastern Company (continued) 14. Selected Quarterly Financial Information (Unaudited) Selected quarterly financial information (unaudited) follows: Fiscal 2015 consisted of four 13 week quarters totaling 52 weeks for the year. Fiscal 2014 consisted of 13 weeks for the first, second and third quarters, with the fourth quarter being 14 weeks, totaling 53 weeks for the year. Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of The Eastern Company Naugatuck, Connecticut We have audited the accompanying consolidated balance sheets of The Eastern Company (the Company) as of January 2, 2016 and January 3, 2015, and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the years in the three-year period ended January 2, 2016. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of January 2, 2016 and January 3, 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended January 2, 2016 in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of January 2, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2016 expressed an unqualified opinion. /s/Fiondella, Milone & LaSaracina LLP Glastonbury, Connecticut March 15, 2016 ITEM 9 | Based on the provided text, here's a summary of the financial statement:
Key Financial Highlights:
- Revenue is calculated by total revenue less operating expenses, excluding interest and non-operating income
- Inter-segment revenue is eliminated and recorded similarly to sales to unaffiliated customers
- One customer (Jennmar Corporation) accounts for 10.5% of the Metal Products segment
- The fiscal year ends on the Saturday nearest to December 31
- Foreign currency translation is performed using current year-end exchange rates for balance sheet and average rates for income statements
- Translation adjustments are recorded in shareholders' equity
- Financial statements include estimates that may differ from actual results
The summary is somewhat fragmented due to the incomplete nature of the text, but it captures the main financial reporting principles and characteristics of the statement. | Claude |
Item 8: Comcast Corporation NBCUniversal Media, LLC See Index to NBCUniversal Media, LLC Financial Statements and Supplemental Data on page 137. Report of Management Management’s Report on Comcast’s Financial Statements Our management is responsible for the preparation, integrity and fair presentation of information in Comcast’s consolidated financial statements, including estimates and judgments. The consolidated financial statements presented in this report have been prepared in accordance with accounting principles generally accepted in the United States. Our management believes the Comcast consolidated financial statements and other financial information included in this report fairly present, in all material respects, Comcast’s financial condition, results of operations and cash flows as of and for the periods presented in this report. The Comcast consolidated financial statements have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. Management’s Report on Comcast’s Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining an adequate system of internal control over financial reporting. Our system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Our internal control over financial reporting includes those policies and procedures that: • Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets. • Provide reasonable assurance that our transactions are recorded as necessary to permit preparation of our financial statements in accordance with accounting principles generally accepted in the United States, and that our receipts and expenditures are being made only in accordance with authorizations of our management and our directors. • Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Further, because of changes in conditions, effectiveness of internal control over financial reporting may vary over time. Our system contains self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified. Our management conducted an evaluation of the effectiveness of the system of internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that Comcast’s system of internal control over financial reporting was effective as of December 31, 2016. Our assessment of the effectiveness of internal control over financial reporting as of December 31, 2016 did not include the internal controls of DreamWorks Animation, which we acquired on August 22, 2016, as permitted by Securities and Exchange Commission guidelines that allow companies to exclude certain acquisitions from their assessment of internal control over financial reporting during the first year of an acquisition. The total assets and total revenues of DreamWorks Animation represented approximately 2% of our total assets as of December 31, 2016, and less than 1% of our total revenues for the year ended December 31, 2016. The effectiveness of Comcast’s internal controls over financial reporting of Comcast has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. Audit Committee Oversight The Audit Committee of the Board of Directors, which is comprised solely of independent directors, has oversight responsibility for our financial reporting process and the audits of Comcast’s consolidated financial statements and internal control over financial reporting. The Audit Committee meets regularly with management and with our internal auditors and independent registered public accounting firm (collectively, the “auditors”) to review matters related to the quality and integrity of our financial reporting, internal control over financial reporting (including compliance matters related to our Code of Conduct), and the nature, extent, and results of internal and external audits. Our auditors have full and free access and report directly to the Audit Committee. The Audit Committee recommended, and the Board of Directors approved, that the Comcast audited consolidated financial statements be included in this Form 10-K. Brian L. Roberts Michael J. Cavanagh Lawrence J. Salva Chairman and Chief Executive Officer Senior Executive Vice President and Chief Financial Officer Executive Vice President and Chief Accounting Officer Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Comcast Corporation Philadelphia, Pennsylvania We have audited the accompanying consolidated balance sheets of Comcast Corporation and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, cash flows and changes in equity for each of the three years in the period ended December 31, 2016. We also have audited the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in the Report of Management on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting at DreamWorks Animation, acquired on August 22, 2016 and whose financial statements constitute approximately 2% of total assets as of December 31, 2016 and less than 1% of total revenue for the year ended December 31, 2016. Accordingly, our audit did not include the internal control over financial reporting at DreamWorks Animation. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Comcast’s Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Comcast Corporation and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. /s/ Deloitte & Touche LLP Philadelphia, Pennsylvania February 3, 2017 Comcast Corporation Consolidated Balance Sheet See accompanying notes to consolidated financial statements. Comcast Corporation Consolidated Statement of Income See accompanying notes to consolidated financial statements. Comcast Corporation Consolidated Statement of Comprehensive Income See accompanying notes to consolidated financial statements. Comcast Corporation Consolidated Statement of Cash Flows See accompanying notes to consolidated financial statements. Comcast Corporation Consolidated Statement of Changes in Equity See accompanying notes to consolidated financial statements. Comcast Corporation Note 1: Business and Basis of Presentation We are a global media and technology company with two primary businesses, Comcast Cable and NBCUniversal. We were incorporated under the laws of Pennsylvania in December 2001. Through our predecessors, we have developed, managed and operated cable systems since 1963. We present our operations for Comcast Cable in one reportable business segment, referred to as Cable Communications, and our operations for NBCUniversal in four reportable business segments: Cable Networks, Broadcast Television, Filmed Entertainment and Theme Parks (collectively, the “NBCUniversal segments”). See Note 17 for additional information on our reportable business segments. Our Cable Communications segment primarily manages and operates cable systems that serve residential and business customers in the United States. As of December 31, 2016, our cable systems had 28.6 million total customer relationships and served 22.5 million video customers, 24.7 million high-speed Internet customers and 11.7 million voice customers. Our Cable Networks segment consists primarily of a diversified portfolio of cable television networks. Our cable networks are comprised of our national cable networks that provide a variety of entertainment, news and information, and sports content, our regional sports and news networks, our international cable networks, and our cable television studio production operations. Our Broadcast Television segment consists primarily of the NBC and Telemundo broadcast networks, our owned NBC and Telemundo local broadcast television stations, the NBC Universo national cable network, and our broadcast television studio production operations. Our Filmed Entertainment segment primarily produces, acquires, markets and distributes filmed entertainment worldwide. Our films are produced primarily under the Universal Pictures, Illumination and Focus Features names and in August 2016, we acquired DreamWorks Animation. See Note 5 for additional information on the acquisition. Our Theme Parks segment consists primarily of our Universal theme parks in Orlando, Florida and Hollywood, California and our 51% interest in the Universal Studios theme park in Osaka, Japan (“Universal Studios Japan”), which we acquired in November 2015. See Note 5 for additional information on the acquisition. Our other business interests, which are included in Corporate and Other, consist primarily of Comcast Spectacor, which owns the Philadelphia Flyers and the Wells Fargo Center arena in Philadelphia, Pennsylvania and operates arena management-related businesses. Basis of Presentation The accompanying consolidated financial statements include all entities in which we have a controlling voting interest and variable interest entities (“VIEs”) required to be consolidated in accordance with generally accepted accounting principles in the United States (“GAAP”). We translate assets and liabilities of our foreign operations where the functional currency is the local currency, primarily the Japanese yen, euro and British pound, into U.S. dollars at the exchange rate as of the balance sheet date and translate revenue and expenses using average monthly exchange rates. The related translation adjustments are recorded as a component of accumulated other comprehensive income (loss) in our consolidated balance sheet. Any foreign currency transaction gains or losses are included in our consolidated statement of income. Comcast Corporation Reclassifications Reclassifications have been made to our consolidated financial statements for the prior years to conform to classifications used in 2016. Stock Split On January 24, 2017, our Board of Directors approved a two-for-one stock split in the form of a 100% stock dividend (the “Stock Split”) payable on February 17, 2017 to shareholders of record as of February 8, 2017. The Stock Split will be in the form of one additional share for every share held and will be payable in shares of Class A common stock on the outstanding Class A common stock and Class B common stock. The pro forma diluted earnings per common share attributable to Comcast Corporation shareholders in our consolidated statement of income has been adjusted to reflect the Stock Split for all periods presented. All other share-based data, including the number of shares outstanding and related prices, per share amounts, and share authorizations and conversions have not been adjusted to reflect the Stock Split for any of the periods presented. Note 2: Accounting Policies Our consolidated financial statements are prepared in accordance with GAAP, which require us to select accounting policies, including in certain cases industry-specific policies, and make estimates that affect the reported amount of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and contingent liabilities. Actual results could differ from these estimates. We believe that the judgments and related estimates for the following items are critical in the preparation of our consolidated financial statements: • valuation and impairment testing of cable franchise rights (see Note 9) • film and television costs (see Note 6) In addition, the following accounting policies are specific to the industries in which we operate: • capitalization and amortization of film and television costs (see Note 6) • installation revenue and costs for connecting customers to our cable systems (see revenue recognition below and Note 8) Information on our other accounting policies and methods that are used in the preparation of our consolidated financial statements are included, where applicable, in their respective footnotes that follow. Below is a discussion of accounting policies and methods used in our consolidated financial statements that are not presented within other footnotes. Revenue Recognition Cable Communications Segment Our Cable Communications segment generates revenue primarily from subscriptions to our video, high-speed Internet and voice services (“cable services”) and from the sale of advertising. We recognize revenue from cable services as each service is provided. Customers are typically billed in advance on a monthly basis based on the services and features they receive and the type of equipment they use. Since installation revenue obtained from the connection of customers to our cable systems is less than the related direct selling costs, we recognize revenue as connections are completed. We manage credit risk by screening applicants through the use of internal customer information, identification verification tools and credit bureau data. If a customer’s account is delinquent, various measures are used to collect outstanding amounts, including termination of the customer’s cable services. Comcast Corporation As part of our distribution agreements with cable networks, we generally receive an allocation of scheduled advertising time on cable networks that we sell through our advertising business, Spotlight, to local, regional and national advertisers. We recognize advertising revenue when the advertising is aired or viewed. In most cases, the available advertising units are sold by our sales force. In some cases, we work with representation firms as an extension of our sales force to sell a portion of the advertising units allocated to us. We also represent the advertising sales efforts of other multichannel video providers in some markets. Since we are acting as the principal in these arrangements, we record the advertising that is sold in revenue and the fees paid to representation firms and multichannel video providers in other operating and administrative expenses. Revenue earned from other sources, such as our home security and automation services, is recognized when services are provided or events occur. Under the terms of our cable franchise agreements, we are generally required to pay to the cable franchising authority an amount based on our gross video revenue. We pass these fees through to our cable services customers and classify the fees as a component of revenue with the corresponding costs included in other operating and administrative expenses. Cable Networks and Broadcast Television Segments Our Cable Networks segment generates revenue primarily from the distribution of our cable network programming to multichannel video providers, from the sale of advertising on our cable networks and related digital media properties, from the licensing of our owned programming to cable and broadcast networks and subscription video on demand services, from the sale of our owned programming on standard-definition digital video discs and Blu-ray discs (together, “DVDs”) and through digital distribution services such as iTunes, and from the sale of programming by our cable television studio production operations to third-party networks and subscription video on demand services. Our Broadcast Television segment generates revenue primarily from the sale of advertising on our broadcast networks, owned local broadcast television stations and related digital media properties, from the licensing of our owned programming by our broadcast television studio production operations to various distribution platforms, including to cable and broadcast networks as well as to subscription video on demand services, from the fees received under retransmission consent agreements and associated fees received from NBC-affiliated local broadcast television stations, and from the sale of our owned programming on DVDs and through digital distribution services. We recognize revenue from distributors as programming is provided, generally under multiyear distribution agreements. From time to time, the distribution agreements expire while programming continues to be provided to the distributor based on interim arrangements while the parties negotiate new contract terms. Revenue recognition is generally limited to current payments being made by the distributor, typically under the prior contract terms, until a new contract is negotiated, sometimes with effective dates that affect prior periods. Differences between actual amounts determined upon resolution of negotiations and amounts recorded during these interim arrangements are recorded in the period of resolution. Advertising revenue for our Cable Networks and Broadcast Television segments is recognized in the period in which commercials are aired or viewed. In some instances, we guarantee audience ratings for the commercials. To the extent there is a shortfall in the ratings that were guaranteed, a portion of the revenue is deferred until the shortfall is settled, primarily by providing additional advertising units. We recognize revenue from the licensing of our owned programming and programming produced by our studios for third parties when the content is made available for use by the licensee, and when certain other conditions are met. When license fees include advertising time, we recognize the component of revenue associated with the advertisements when they are aired or viewed. Filmed Entertainment Segment Our Filmed Entertainment segment generates revenue primarily from the worldwide distribution of our produced and acquired films for exhibition in movie theaters, from the licensing of our owned and acquired films through various distribution platforms, and from the sale of our owned and acquired films on DVDs and Comcast Corporation through digital distribution services. Our Filmed Entertainment segment also generates revenue from producing and licensing live stage plays, from the distribution of filmed entertainment produced by third parties, and from Fandango, our movie ticketing and entertainment business. We recognize revenue from the distribution of films to movie theaters when the films are exhibited. We recognize revenue from the licensing of a film when the film is available for use by the licensee, and when certain other conditions are met. We recognize revenue from the sale of DVDs, net of estimated returns and customer incentives, on the date that the DVDs are delivered to and made available for sale by retailers. Theme Parks Segment Our Theme Parks segment generates revenue primarily from ticket sales and guest spending at our Universal theme parks. We recognize revenue from advance theme park ticket sales when the tickets are used. For annual passes, we recognize revenue on a straight-line basis over the period following the activation date. Cable Communications Programming Expenses Cable Communications programming expenses are the fees we pay to license the programming we distribute to our video customers. Programming is generally acquired under multiyear distribution agreements, with rates typically based on the number of customers that receive the programming, channel positioning and the extent of distribution. From time to time, these contracts expire and programming continues to be provided under interim arrangements while the parties negotiate new contract terms, sometimes with effective dates that affect prior periods. While payments are typically made under the prior contract’s terms, the amount of programming expenses recorded during the interim arrangement is based on our estimate of the ultimate contract terms expected to be negotiated. Differences between actual amounts determined upon resolution of negotiations and amounts recorded during these interim arrangements are recorded in the period of resolution. When our Cable Communications segment receives incentives from a cable network for the licensing of its programming, we defer a portion of these incentives, which are included in other current and noncurrent liabilities, and recognize them over the term of the contract as a reduction to programming expenses. Advertising Expenses Advertising costs are expensed as incurred. Cash Equivalents The carrying amounts of our cash equivalents approximate their fair values. Our cash equivalents consist primarily of money market funds and U.S. government obligations, as well as commercial paper and certificates of deposit with maturities of three months or less when purchased. Derivative Financial Instruments We use derivative financial instruments to manage our exposure to the risks associated with fluctuations in interest rates, foreign exchange rates and equity prices. Our objective is to manage the financial and operational exposure arising from these risks by offsetting gains and losses on the underlying exposures with gains and losses on the derivatives used to economically hedge them. Our derivative financial instruments are recorded in our consolidated balance sheet at fair value. The impact of our derivative financial instruments on our consolidated financial statements was not material in any of the periods presented. Fair Value Measurements The accounting guidance related to financial assets and financial liabilities (“financial instruments”) establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various Comcast Corporation valuation techniques (market approach, income approach and cost approach). The levels of the hierarchy are described below. • Level 1: Values are determined using quoted market prices for identical financial instruments in an active market • Level 2: Values are determined using quoted prices for similar financial instruments and valuation models whose inputs are observable • Level 3: Values are determined using pricing models that use significant inputs that are primarily unobservable, discounted cash flow methodologies or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation We use these levels of hierarchy for the measurement of fair value related to acquisitions, investments, long-term debt, redeemable subsidiary preferred stock and impairment testing, among others. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation and classification within the fair value hierarchy. Our financial instruments that are accounted for at fair value on a recurring basis were not material as of December 31, 2016 and 2015. Asset Retirement Obligations Certain of our cable franchise agreements and lease agreements contain provisions requiring us to restore facilities or remove property in the event that the franchise or lease agreement is not renewed. We expect to continually renew our cable franchise agreements and therefore cannot reasonably estimate any liabilities associated with such agreements. A remote possibility exists that franchise agreements could be terminated unexpectedly, which could result in us incurring significant expense in complying with restoration or removal provisions. We do not have any significant liabilities related to asset retirements recorded in our consolidated financial statements. Note 3: Recent Accounting Pronouncements Revenue Recognition In May 2014, the Financial Accounting Standards Board (“FASB”) updated the accounting guidance related to revenue recognition. The updated accounting guidance provides a single, contract-based revenue recognition model to help improve financial reporting by providing clearer guidance on when an entity should recognize revenue and by reducing the number of standards to which an entity has to refer. The updated accounting guidance is effective for us as of January 1, 2018. We have reviewed a majority of our revenue arrangements and expect our review to be completed in the second quarter of 2017. As a result of our review, we do not expect any material impact on our consolidated financial statements. However, we do expect that the new standard will impact the timing of recognition for (1) our Cable Communications segment’s installation revenue and commission expenses, which upon adoption will be recognized as revenue and costs over a period of time instead of immediately, and (2) our Cable Networks, Broadcast Television and Filmed Entertainment segments’ content licensing revenue associated with renewals or extensions of existing program licensing agreements, which upon adoption will be recognized as revenue when the licensed content becomes available under the renewal or extension instead of when the agreement is renewed or extended. The guidance provides companies with alternative methods of adoption and we are in the process of determining our method of adoption, which depends in part upon our completion of the evaluation of our remaining revenue arrangements. Comcast Corporation Consolidations In February 2015, the FASB updated the accounting guidance related to consolidation under the variable interest entity and voting interest entity models. The updated accounting guidance modifies the consolidation guidance for VIEs, limited partnerships and similar legal entities. We have adopted this guidance as of January 1, 2016 and it did not have a material impact on our consolidated financial statements. Financial Assets and Financial Liabilities In January 2016, the FASB updated the accounting guidance related to the recognition and measurement of financial assets and financial liabilities. The updated accounting guidance, among other things, requires that all nonconsolidated equity investments, except those accounted for under the equity method, be measured at fair value and that the changes in fair value be recognized in net income. The updated guidance is effective for us as of January 1, 2018. The updated accounting guidance requires, with certain exceptions, a cumulative effect adjustment to beginning retained earnings when the guidance is adopted. We are currently in the process of determining the impact that the updated accounting guidance will have on our consolidated financial statements. Leases In February 2016, the FASB updated the accounting guidance related to leases. The updated accounting guidance requires lessees to recognize a right-of-use asset and a lease liability on the balance sheet for all leases with the exception of short-term leases. The asset and liability are initially measured based on the present value of committed lease payments. For a lessee, the recognition, measurement and presentation of expenses and cash flows arising from a lease do not significantly change from previous guidance. For a lessor, the accounting applied is also largely unchanged from previous guidance. The updated guidance is effective for us as of January 1, 2019 and early adoption is permitted. The updated accounting guidance must be adopted using a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. We are currently in the process of determining the impact that the updated accounting guidance will have on our consolidated financial statements. See Note 16 for a summary of our undiscounted minimum rental commitments under operating leases as of December 31, 2016. Share-Based Compensation In March 2016, the FASB updated the accounting guidance that affects several aspects of the accounting for share-based compensation. The most significant change for us relates to the presentation of the income and withholding tax consequences of share-based compensation in our consolidated financial statements. Among the changes, the updated guidance requires that the excess income tax benefits or deficiencies that arise when the tax consequences of share-based compensation differ from amounts previously recognized in the statement of income be recognized as income tax benefit or expense in the statement of income rather than as additional paid-in capital in the balance sheet. The guidance also states that excess income tax benefits should not be presented separately from other income taxes in the statement of cash flows and, thus, should be classified as an operating activity rather than a financing activity as they are under the current guidance. In addition, the updated guidance requires when an employer withholds shares upon exercise of options or the vesting of restricted stock for the purpose of meeting withholding tax requirements, that the cash paid for withholding taxes be classified as a financing activity. We currently record these amounts within operating activities. We will adopt the updated guidance in the first quarter of 2017. As required under the updated guidance, we will prospectively adopt the provisions of this guidance that relate to the recognition of the excess income tax benefits or deficiencies in the statement of income. If we had adopted the updated guidance in 2016, our income tax expense and effective tax rate would have decreased by $233 million and 1.6%, respectively, and Comcast Corporation our diluted earnings per common share attributable to Comcast Corporation shareholders in 2016 would have increased by $0.08. In addition, upon adoption we will retrospectively adopt the provisions of this guidance related to changes to the statement of cash flows in any of the periods presented. The table below presents the effect on our consolidated statement of cash flows for each of the years ended December 31, 2016, 2015 and 2014. These amounts are not necessarily indicative of amounts that we will recognize in future years related to the excess income tax benefits or deficiencies nor the cash paid for withholding taxes. Note 4: Earnings Per Share Computation of Diluted EPS Diluted earnings per common share attributable to Comcast Corporation shareholders (“diluted EPS”) considers the impact of potentially dilutive securities using the treasury stock method. Our potentially dilutive securities include potential common shares related to our stock options and our restricted share units (“RSUs”). Diluted EPS excludes the impact of potential common shares related to our stock options in periods in which the combination of the option exercise price and the associated unrecognized compensation expense is greater than the average market price of our common stock. The amount of potential common shares related to our share-based compensation plans that were excluded from diluted EPS because their effect would have been antidilutive was not material in any of the periods presented. Comcast Corporation Note 5: Significant Transactions DreamWorks Animation On August 22, 2016, we acquired all of the outstanding stock of DreamWorks Animation for $3.8 billion. DreamWorks Animation’s stockholders received $41 in cash for each share of DreamWorks Animation common stock. DreamWorks Animation creates animated feature films, television series and specials, live entertainment and related consumer products. The results of operations for DreamWorks Animation are reported in our Filmed Entertainment segment following the acquisition date. Preliminary Allocation of Purchase Price The transaction was accounted for under the acquisition method of accounting and, accordingly, the assets and liabilities are to be recorded at their fair market values as of the acquisition date. We recorded the acquired assets and liabilities of DreamWorks Animation at their estimated fair values based on preliminary valuation analyses. In valuing acquired assets and liabilities, fair value estimates are primarily based on Level 3 inputs including future expected cash flows, market rate assumptions and discount rates. The fair value of the assumed debt was primarily based on quoted market values. The fair value of the liability related to a tax receivable agreement that DreamWorks Animation had previously entered into with one of its former stockholders (the “tax receivable agreement”) was based on the contractual settlement provisions in the agreement. Further, we recorded the deferred income taxes based on our estimates of the tax basis of the acquired net assets and the valuation allowances based on the expected use of net operating loss carryforwards. The goodwill is not deductible for tax purposes. We will adjust the assets and liabilities as valuations are completed and we obtain information necessary to complete the analyses, but no later than one year from the acquisition date. The table below presents the preliminary allocation of the purchase price to the assets and liabilities of DreamWorks Animation. Preliminary Allocation of Purchase Price The tax receivable agreement was settled immediately following the acquisition and the payment was recorded as an operating activity in our consolidated statement of cash flows. In addition, we repaid all of the assumed debt of DreamWorks Animation. Revenue and net income attributable to the acquisition of DreamWorks Animation were not material for 2016. Comcast Corporation Universal Studios Japan On November 13, 2015, NBCUniversal acquired a 51% economic interest in Universal Studios Japan for $1.5 billion. Universal Studios Japan is a VIE based on the governance structure and we consolidate Universal Studios Japan since we have the power to direct activities that most significantly impact its economic performance. There are no liquidity arrangements, guarantees or other financial commitments between us and Universal Studios Japan, and therefore our maximum risk of financial loss is NBCUniversal’s 51% interest. Universal Studios Japan’s results of operations are reported in our Theme Parks segment following the acquisition date. Allocation of Purchase Price The transaction was accounted for under the acquisition method of accounting and, accordingly, the acquired assets and liabilities and the 49% noncontrolling interest were recorded at their estimated fair values. In 2016, we updated the allocation of the purchase price for Universal Studios Japan based on final valuation analyses, which primarily resulted in increases to property and equipment and intangible assets and a decrease in goodwill. The changes did not have a material impact on our consolidated financial statements. The goodwill is not deductible for tax purposes. The table below presents the allocation of the purchase price to the assets and liabilities of Universal Studios Japan. Allocation of Purchase Price Actual and Unaudited Pro Forma Results Our consolidated revenue in 2016 and 2015 included $1.4 billion and $169 million, respectively, from the acquisition of Universal Studios Japan. Our net income attributable to Comcast Corporation in 2016 and 2015 included $124 million and $18 million, respectively, from the acquisition of Universal Studios Japan. Comcast Corporation The following unaudited pro forma information has been presented as if the acquisition of Universal Studios Japan occurred on January 1, 2014. This information is primarily based on historical results of operations, adjusted for the allocation of purchase price, and is not necessarily indicative of what our results would have been had we operated Universal Studios Japan since January 1, 2014. No pro forma adjustments have been made for our transaction-related expenses. Time Warner Cable Merger and Related Divestiture Transactions On April 24, 2015, we and Time Warner Cable Inc. terminated our planned merger, and we terminated our related agreement with Charter Communications, Inc. to spin off, exchange and sell certain cable systems. In connection with these proposed transactions, we incurred incremental transaction-related expenses of $198 million and $237 million in 2015 and 2014, respectively. The transaction-related expenses are included primarily in other operating and administrative expenses, with $20 million recorded in depreciation and amortization expenses associated with the write-off of certain capitalized costs in 2015. Note 6: Film and Television Costs Based on our current estimates of the total remaining revenue from all sources (“ultimate revenue”), in 2017 we expect to amortize approximately $1.9 billion of film and television costs associated with our original film and television productions that have been released, or are completed and have not been released. Through 2019, we expect to amortize approximately 88% of unamortized film and television costs for our released productions, excluding amounts allocated to acquired libraries. As of December 31, 2016, acquired film and television libraries, which are included within the “released, less amortization” captions in the table above, had remaining unamortized costs of $596 million. These costs are generally amortized over a period not to exceed 20 years, and approximately 45% of these costs are expected to be amortized through 2019. Comcast Corporation Capitalization of Film and Television Costs We capitalize film and television production costs, including direct costs, production overhead, print costs, development costs and interest. We amortize capitalized film and television production costs, including acquired libraries, and accrue costs associated with participation and residual payments to programming and production expenses. We generally record the amortization and the accrued costs using the individual film forecast computation method, which amortizes the costs in the same ratio as the associated ultimate revenue. Estimates of ultimate revenue and total costs are based on anticipated release patterns, public acceptance and historical results for similar productions. Unamortized film and television costs, including acquired film and television libraries, are stated at the lower of unamortized cost or fair value. We do not capitalize costs related to the distribution of a film in movie theaters or the licensing or sale of a film or television production, which are primarily costs associated with the marketing and distribution of them. In determining the method of amortization and estimated life of an acquired film or television library, we generally use the method and the life that most closely follow the undiscounted cash flows over the estimated life of the asset. When an event or a change in circumstance occurs that was known or knowable as of the balance sheet date and that indicates the fair value of a film is less than its unamortized costs, we determine the fair value of the film and record an impairment charge for the amount by which the unamortized capitalized costs exceed the film’s fair value. The estimated fair value of a production is based on Level 3 inputs that primarily use an analysis of future expected cash flows. Adjustments to capitalized film and stage play production costs of $14 million, $42 million and $26 million were recorded in 2016, 2015 and 2014, respectively. We enter into cofinancing arrangements with third parties to jointly finance or distribute certain of our film productions. Cofinancing arrangements can take various forms, but in most cases involve the grant of an economic interest in a film to an investor. The number of investors and the terms of these arrangements can vary, although investors generally assume the full risks and rewards for the portion of the film acquired in these arrangements. We account for the proceeds received from a third-party investor under these arrangements as a reduction to our capitalized film costs. Under these arrangements, the investor owns an undivided copyright interest in the film, and therefore in each period we record either a charge or a benefit to programming and production expenses to reflect the estimate of the third-party investor’s interest in the profit or loss of the film. The estimate of the third-party investor’s interest in the profit or loss of a film is determined using the ratio of actual revenue earned to date to the ultimate revenue expected to be recognized over the film’s useful life. We capitalize the costs of programming content that we license but do not own, including rights to multiyear, live-event sports programming, at the earlier of when payments are made for the programming or when the license period begins and the content is made available for use. We amortize capitalized programming costs as the associated programs are broadcast. We generally amortize multiyear, live-event sports programming rights using the ratio of the current period revenue to the estimated ultimate revenue or under the terms of the contract. Acquired programming costs are recorded at the lower of unamortized cost or net realizable value on a program by program, package, channel or daypart basis. A daypart is an aggregation of programs broadcast during a particular time of day or programs of a similar type. Programming acquired by our Cable Networks segment is primarily tested on a channel basis for impairment, whereas programming acquired by our Broadcast Television segment is tested on a daypart basis. If we determine that the estimates of future cash flows are insufficient or if there is no plan to broadcast certain programming, we recognize an impairment charge to programming and production expenses. Comcast Corporation Note 7: Investments Investment Income (Loss), Net Fair Value Method We classify publicly traded investments that are not accounted for under the equity method as available-for-sale (“AFS”) or trading securities and record them at fair value. For AFS securities, we record unrealized gains or losses resulting from changes in fair value between measurement dates as a component of other comprehensive income (loss), except when we consider declines in value to be other than temporary. For trading securities, we record unrealized gains or losses resulting from changes in fair value between measurement dates as a component of investment income (loss), net. We recognize realized gains and losses associated with our fair value method investments using the specific identification method. We classify the cash flows related to purchases of and proceeds from the sale of trading securities based on the nature of the securities and the purpose for which they were acquired. Equity Method We use the equity method to account for investments in which we have the ability to exercise significant influence over the investee’s operating and financial policies or in which we hold a significant partnership or LLC interest. Equity method investments are recorded at cost and are adjusted to recognize (1) our proportionate share of the investee’s net income or loss after the date of investment, (2) amortization of the recorded investment that exceeds our share of the book value of the investee’s net assets, (3) additional contributions made and dividends received, and (4) impairments resulting from other-than-temporary declines in fair value. Comcast Corporation For some investments, we record our share of the investee’s net income or loss one quarter in arrears due to the timing of our receipt of such information. Gains or losses on the sale of equity method investments are recorded to other income (expense), net. If an equity method investee were to issue additional securities that would change our proportionate share of the entity, we would recognize the change, if any, as a gain or loss in our consolidated statement of income. Atairos In 2015, we entered into an agreement to establish Atairos Group, Inc., a strategic company focused on investing in and operating companies in a range of industries and business sectors, both domestically and internationally. The agreement became effective as of January 1, 2016. Atairos has a term of up to 12 years and is controlled by management companies led by our former CFO through interests that carry all of the voting rights. We are the only investor other than our former CFO and the other management company employees. We have committed to fund Atairos up to $4 billion in the aggregate at any one time, subject to certain offsets, and $40 million annually for a management fee, subject to certain adjustments, while the management company investors have committed to fund up to $100 million, with at least $40 million to be funded by our former CFO, subject to his continued role with Atairos. Our economic interests do not carry voting rights and obligate us to absorb approximately 99% of any losses and they provide us the right to receive approximately 86.5% of any residual returns in Atairos, in either case on a cumulative basis. We have concluded that Atairos is a VIE, that we do not have the power to direct the activities that most significantly impact the economic performance of Atairos as we have no voting rights and only certain consent rights, and that we are not a related party with our former CFO or the management companies. We therefore do not consolidate Atairos and account for our investment as an equity method investment. There are no other liquidity arrangements, guarantees or other financial commitments between Comcast and Atairos, and therefore our maximum risk of financial loss is our investment balance and remaining unfunded capital commitment. In 2016, we made cash capital contributions totaling $1.2 billion to Atairos. In addition, we recorded capital contributions of $447 million that were accrued in 2016 and paid in January 2017. Hulu In August 2016, Time Warner Inc. acquired a 10% interest in Hulu, LLC, which diluted our interest in Hulu from 33% to 30%. For a period not to exceed 3 years, Time Warner may put its shares to Hulu or Hulu may call Time Warner’s shares under certain limited circumstances arising from regulatory review. Given the contingent nature of the put and call options, we recorded a deferred gain of $159 million and a corresponding increase to our investment in Hulu as a result of the dilution. The deferred gain will be recognized in other income (expense), net if and when the options expire unexercised. In 2016, 2015 and 2014, we recognized our proportionate share of losses of $168 million, $106 million and $20 million, respectively, related to our investment in Hulu. The Weather Channel In January 2016, following a legal restructuring at The Weather Channel, we and the other investors sold the entity holding The Weather Channel’s product and technology businesses to IBM. Following the close of the transaction, we continue to hold an investment in The Weather Channel cable network through a new holding company. As a result of the sale of our investment, we recognized a pretax gain of $108 million in other income (expense), net. In June and December 2015, The Weather Channel recorded impairment charges related to goodwill. In 2015, we recorded expenses of $333 million that represented NBCUniversal’s proportionate share of these impairment charges in equity in net income (losses) of investees, net in our consolidated statement of income. Comcast Corporation Cost Method We use the cost method to account for investments not accounted for under the fair value method or the equity method. AirTouch We hold two series of preferred stock of Verizon Americas, Inc., formerly known as AirTouch Communications, Inc., a subsidiary of Verizon Communications Inc., which are redeemable in April 2020. As of both December 31, 2016 and 2015, the estimated fair value of the AirTouch preferred stock was $1.7 billion. The dividend and redemption activity of the AirTouch preferred stock determines the dividend and redemption payments associated with substantially all of the preferred shares issued by one of our consolidated subsidiaries, which is a VIE. The subsidiary has three series of preferred stock outstanding with an aggregate redemption value of $1.75 billion. Substantially all of the AirTouch preferred stock is redeemable in April 2020 at a redemption value of $1.65 billion. As of both December 31, 2016 and 2015, the two series of redeemable subsidiary preferred shares were recorded at $1.6 billion, and those amounts are included in other noncurrent liabilities. As of both December 31, 2016 and 2015, the liability related to the redeemable subsidiary preferred shares had an aggregate estimated fair value of $1.7 billion. The estimated fair values of the AirTouch preferred stock and redeemable subsidiary preferred shares are based on Level 2 inputs that use pricing models whose inputs are derived primarily from or corroborated by observable market data through correlation or other means for substantially the full term of the financial instrument. The one series of nonredeemable subsidiary preferred shares was recorded at $100 million as of both December 31, 2016 and 2015, and those amounts are included in noncontrolling interests in our consolidated balance sheet. The carrying amount of the nonredeemable subsidiary preferred stock approximates its fair value. BuzzFeed and Vox Media In September 2015, NBCUniversal acquired an interest in BuzzFeed, Inc. and made an additional investment in Vox Media, Inc. for $200 million each in cash. In November 2016, NBCUniversal made an additional investment of $200 million in BuzzFeed. BuzzFeed is a global media company that produces and distributes original news, entertainment and videos. Vox Media is a digital media company comprised of eight distinct brands. Impairment Testing of Investments We review our investment portfolio each reporting period to determine whether there are identified events or circumstances that would indicate there is a decline in the fair value that would be considered other than temporary. For our nonpublic investments, if there are no identified events or circumstances that would have a significant adverse effect on the fair value of the investment, then the fair value is not estimated. If an investment is deemed to have experienced an other-than-temporary decline below its cost basis, we reduce the carrying amount of the investment to its quoted or estimated fair value, as applicable, and establish a new cost basis for the investment. For our AFS securities and our cost method investments, we record the impairment to investment income (loss), net. For our equity method investments, we record the impairment to other income (expense), net. Comcast Corporation Note 8: Property and Equipment Property and equipment are stated at cost. We capitalize improvements that extend asset lives and expense repairs and maintenance costs as incurred. We record depreciation using the straight-line method over the asset’s estimated useful life. For assets that are sold or retired, we remove the applicable cost and accumulated depreciation and, unless the gain or loss on disposition is presented separately, we recognize it as a component of depreciation expense. In accordance with the accounting guidance related to cable television companies, we capitalize the costs associated with the construction of and improvements to our cable transmission and distribution facilities, including scalable infrastructure and line extensions; costs associated with acquiring and deploying new customer premise equipment; and costs associated with installation of our services. Costs capitalized include all direct costs for labor and materials, as well as various indirect costs. Costs incurred in connection with subsequent disconnects and reconnects are expensed as they are incurred. We evaluate the recoverability of our property and equipment whenever events or substantive changes in circumstances indicate that the carrying amount may not be recoverable. The evaluation is based on the cash flows generated by the underlying asset groups, including estimated future operating results, trends or other determinants of fair value. If the total of the expected future undiscounted cash flows were less than the carrying amount of the asset group, we would recognize an impairment charge to the extent the carrying amount of the asset group exceeded its estimated fair value. Unless presented separately, the impairment charge is included as a component of depreciation expense. Comcast Corporation Note 9: Goodwill and Intangible Assets Goodwill (a) Acquisitions in 2015 in our Theme Parks segment included the Universal Studios Japan transaction (see Note 5 for additional information). (b) Acquisitions in 2016 in our Filmed Entertainment segment primarily included the DreamWorks Animation acquisition (see Note 5 for additional information). (c) Adjustments in 2016 primarily included the updated allocation of the purchase price for Universal Studios Japan in our Theme Parks segment (see Note 5 for additional information) and the reclassification of certain operations and businesses from Corporate and Other to our Cable Communications segment. Goodwill is calculated as the excess of the consideration transferred over the identifiable net assets acquired in a business combination and represents the future economic benefits expected to arise from anticipated synergies and intangible assets acquired that do not qualify for separate recognition, including assembled workforce, noncontractual relationships and other agreements. We assess the recoverability of our goodwill annually, or more frequently whenever events or substantive changes in circumstances indicate that the carrying amount of a reporting unit may exceed its fair value. We test goodwill for impairment at the reporting unit level. To determine our reporting units, we evaluate the components one level below the segment level and we aggregate the components if they have similar economic characteristics. As a result of this assessment, our reporting units are the same as our five reportable segments. We evaluate the determination of our reporting units used to test for impairment periodically or whenever events or substantive changes in circumstances occur. The assessment of recoverability may first consider qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. A quantitative assessment is performed if the qualitative assessment results in a more-likely-than-not determination or if a qualitative assessment is not performed. The quantitative assessment considers whether the carrying amount of a reporting unit exceeds its fair value, in which case an impairment charge is recorded to the extent the carrying amount of the reporting unit’s goodwill exceeds its implied fair value. Unless presented separately, the impairment charge is included as a component of amortization expense. We did not recognize any impairment charges in any of the periods presented. Comcast Corporation Intangible Assets Indefinite-Lived Intangible Assets Indefinite-lived intangible assets consist primarily of our cable franchise rights. Our cable franchise rights represent the values we attributed to agreements with state and local authorities that allow access to homes and businesses in cable service areas acquired in business combinations. We do not amortize our cable franchise rights because we have determined that they meet the definition of indefinite-lived intangible assets since there are no legal, regulatory, contractual, competitive, economic or other factors which limit the period over which these rights will contribute to our cash flows. We reassess this determination periodically or whenever events or substantive changes in circumstances occur. Costs we incur in negotiating and renewing cable franchise agreements are included in other intangible assets and are generally amortized on a straight-line basis over the term of the franchise agreement. We assess the recoverability of our cable franchise rights and other indefinite-lived intangible assets annually, or more frequently whenever events or substantive changes in circumstances indicate that the assets might be impaired. Our three Cable Communications divisions represent the unit of account we use to test for impairment of our cable franchise rights. We evaluate the unit of account used to test for impairment of our cable franchise rights and other indefinite-lived intangible assets periodically or whenever events or substantive changes in circumstances occur to ensure impairment testing is performed at an appropriate level. The assessment of recoverability may first consider qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. A quantitative assessment is performed if the qualitative assessment results in a more-likely-than-not determination or if a qualitative assessment is not performed. When performing a quantitative assessment, we estimate the fair value of our cable franchise rights and other indefinite-lived intangible assets primarily based on a discounted cash flow analysis that involves significant judgment. When analyzing the fair values indicated under the discounted cash flow models, we also consider multiples of operating income before depreciation and amortization generated by the underlying assets, current market transactions, and profitability information. If the fair value of our cable franchise rights or other indefinite-lived intangible assets was less than the carrying amount, we would recognize an impairment charge for the difference between the estimated fair value and the carrying value of the assets. Unless presented separately, the impairment charge is included as a component of amortization expense. We did not recognize any material impairment charges in any of the periods presented. Comcast Corporation Finite-Lived Intangible Assets Estimated Amortization Expense of Finite-Lived Intangible Assets Finite-lived intangible assets are subject to amortization and consist primarily of customer relationships acquired in business combinations, software, cable franchise renewal costs, contractual operating rights and intellectual property rights. Our finite-lived intangible assets are amortized primarily on a straight-line basis over their estimated useful life or the term of the associated agreement. We capitalize direct development costs associated with internal-use software, including external direct costs of material and services and payroll costs for employees devoting time to these software projects. We also capitalize costs associated with the purchase of software licenses. We include these costs in other intangible assets and generally amortize them on a straight-line basis over a period not to exceed five years. We expense maintenance and training costs, as well as costs incurred during the preliminary stage of a project, as they are incurred. We capitalize initial operating system software costs and amortize them over the life of the associated hardware. We evaluate the recoverability of our finite-lived intangible assets whenever events or substantive changes in circumstances indicate that the carrying amount may not be recoverable. The evaluation is based on the cash flows generated by the underlying asset groups, including estimated future operating results, trends or other determinants of fair value. If the total of the expected future undiscounted cash flows were less than the carrying amount of the asset group, we would recognize an impairment charge to the extent the carrying amount of the asset group exceeded its estimated fair value. Unless presented separately, the impairment charge is included as a component of amortization expense. Note 10: Long-Term Debt Long-Term Debt Outstanding Comcast Corporation (a) The December 31, 2016 and 2015 amounts consist of ¥382 billion and ¥400 billion, respectively, of Universal Studios Japan term loans translated using the exchange rates as of these dates. (b) The December 31, 2016 and 2015 amounts include £625 million of 5.50% notes due 2029, which translated to $771 million and $921 million, respectively, using the exchange rates as of these dates. (c) Includes the effects of our derivative financial instruments. As of December 31, 2016 and 2015, our debt had an estimated fair value of $66.3 billion and $58.0 billion, respectively. The estimated fair value of our publicly traded debt is primarily based on Level 1 inputs that use quoted market values for the debt. The estimated fair value of debt for which there are no quoted market prices is based on Level 2 inputs that use interest rates available to us for debt with similar terms and remaining maturities. See Note 19 for additional information on our cross-guarantee structure. Principal Maturities of Debt 2016 Debt Borrowings 2016 Debt Redemptions and Repayments Debt Instruments Revolving Bank Credit Facilities In May 2016, we entered into a new $7 billion revolving credit facility due 2021 with a syndicate of banks (“Comcast revolving credit facility”) that may be used for general corporate purposes. We may increase the commitment under the Comcast revolving credit facility up to a total of $10 billion, as well as extend the Comcast Corporation expiration date to a date no later than 2023, subject to approval of the lenders. In addition, NBCUniversal Enterprise entered into a new $1.5 billion revolving credit facility due 2021 with a syndicate of banks (“NBCUniversal Enterprise revolving credit facility”) that may be used for general corporate purposes. We may increase the commitment under the NBCUniversal Enterprise revolving credit facility up to a total of $2 billion, as well as extend the expiration date to a date no later than 2023, subject to approval of the lenders. The new revolving credit facilities replaced Comcast’s $6.25 billion and NBCUniversal Enterprise’s $1.35 billion revolving credit facilities, which were terminated in connection with the execution of the new revolving credit facilities. The interest rates on the new revolving credit facilities consist of a base rate plus a borrowing margin that is determined based on Comcast’s credit rating. As of December 31, 2016, the borrowing margin for borrowings based on the London Interbank Offered Rate was 1.00%. Similar to the Comcast and NBCUniversal Enterprise prior revolving credit facilities, each of the new revolving credit facilities require that we maintain certain financial ratios based on their respective debt and operating income before depreciation and amortization, as defined in the credit facility. We were in compliance with all financial covenants for all periods presented. As of December 31, 2016, amounts available under our consolidated credit facilities, net of amounts outstanding under our commercial paper programs and outstanding letters of credit, totaled $5.5 billion, which included $460 million available under the NBCUniversal Enterprise revolving credit facility. Commercial Paper Programs Our commercial paper programs provide a lower-cost source of borrowing to fund our short-term working capital requirements. The maximum borrowing capacity under the Comcast commercial paper program is $6.25 billion. We support this commercial paper program with unused capacity under the Comcast revolving credit facility. The maximum borrowing capacity under the NBCUniversal Enterprise commercial paper program is $1.35 billion. We support this commercial paper program with unused capacity under the NBCUniversal Enterprise revolving credit facility. Term Loans Our term loans consist of the Universal Studios Japan term loans, which have a final maturity of November 2020. These term loans contain financial and operating covenants and are secured by the assets of Universal Studios Japan and the equity interests of the other investors. We do not guarantee these term loans and they are otherwise nonrecourse to us. Letters of Credit As of December 31, 2016, we and certain of our subsidiaries had unused irrevocable standby letters of credit totaling $443 million to cover potential fundings under various agreements. Note 11: Postretirement, Pension and Other Employee Benefit Plans Postretirement Benefit Plans We sponsor various benefit plans that provide postretirement benefits to eligible employees based on years of service. The Comcast Postretirement Healthcare Stipend Program (the “stipend plan”) provides an annual stipend for Comcast Corporation reimbursement of healthcare costs to each eligible employee based on years of service. Under the stipend plan, we are not exposed to the increasing costs of healthcare because the benefits are fixed at a predetermined amount. In December 2016, the stipend plan was amended primarily to reduce the benefits of active employees who retire after December 31, 2017. The plan amendments reduced our benefit obligation in 2016 by $361 million. NBCUniversal’s postretirement medical and life insurance plans provide continuous coverage to employees eligible to receive such benefits. A small number of eligible employees also participate in legacy plans of acquired companies. All of our postretirement benefit plans are unfunded and substantially all of our postretirement benefit obligations are recorded to noncurrent liabilities. The expense we recognize for our postretirement benefit plans is determined using certain assumptions, including the discount rate. Pension Plans NBCUniversal sponsors various qualified and nonqualified defined benefit pension plans for domestic employees. Since the future benefits have been frozen since the beginning of 2013, we did not recognize service costs related to the pension plans for all periods presented. The benefits expense we recognized for our defined benefit plans was not material for all periods presented. In addition to the defined benefit plans it sponsors, NBCUniversal is also obligated to reimburse General Electric (“GE”) for future benefit payments to those participants who were vested in the supplemental pension plan sponsored by GE at the time of the NBCUniversal transaction in 2011. These pension plans are currently unfunded and we recorded a benefit obligation of $314 million and $309 million as of December 31, 2016 and 2015, respectively, which consists primarily of our obligations to reimburse GE. Other Employee Benefits Deferred Compensation Plans We maintain unfunded, nonqualified deferred compensation plans for certain members of management and nonemployee directors (each, a “participant”). The amount of compensation deferred by each participant is based on participant elections. Participant accounts, except for those in the NBCUniversal plan, are credited with income primarily based on a fixed annual rate. Participants in the NBCUniversal plan designate one or more valuation funds, independently established funds or indices that are used to determine the amount of investment gain or loss in the participant’s account. Participants are eligible to receive distributions from their account based on elected deferral periods that are consistent with the plans and applicable tax law. The table below presents the benefit obligation and interest expense for our deferred compensation plans. We have purchased life insurance policies to recover a portion of the future payments related to our deferred compensation plans. As of December 31, 2016 and 2015, the cash surrender value of these policies, which is recorded to other noncurrent assets, was $709 million and $658 million, respectively. Retirement Investment Plans We sponsor several 401(k) defined contribution retirement plans that allow eligible employees to contribute a portion of their compensation through payroll deductions in accordance with specified plan guidelines. We make contributions to the plans that include matching a percentage of the employees’ contributions up to certain limits. In 2016, 2015 and 2014, expenses related to these plans totaled $446 million, $416 million and $379 million, respectively. Comcast Corporation Multiemployer Benefit Plans We participate in various multiemployer benefit plans, including pension and postretirement benefit plans, that cover some of our employees and temporary employees who are represented by labor unions. We also participate in other multiemployer benefit plans that provide health and welfare and retirement savings benefits to active and retired participants. We make periodic contributions to these plans in accordance with the terms of applicable collective bargaining agreements and laws but do not sponsor or administer these plans. We do not participate in any multiemployer benefit plans for which we consider our contributions to be individually significant, and the largest plans in which we participate are funded at a level of 80% or greater. In 2016, 2015 and 2014, the total contributions we made to multiemployer pension plans were $84 million, $77 million and $58 million, respectively. In 2016, 2015 and 2014, the total contributions we made to multiemployer postretirement and other benefit plans were $136 million, $119 million and $125 million, respectively. If we cease to be obligated to make contributions or were to otherwise withdraw from participation in any of these plans, applicable law would require us to fund our allocable share of the unfunded vested benefits, which is known as a withdrawal liability. In addition, actions taken by other participating employers may lead to adverse changes in the financial condition of one of these plans, which could result in an increase in our withdrawal liability. Severance Benefits We provide severance benefits to certain former employees. A liability is recorded when payment is probable, the amount is reasonably estimable, and the obligation relates to rights that have vested or accumulated. In 2016, 2015 and 2014, we recorded severance costs of $315 million, $181 million and $152 million, respectively. Severance costs in 2016 included $61 million of severance costs associated with the acquisition of DreamWorks Animation. Note 12: Equity Common Stock In the aggregate, holders of our Class A common stock have 66 2/3% of the voting power of our common stock and holders of our Class B common stock have 33 1/3% of the voting power of our common stock. Each share of our Class B common stock is entitled to 15 votes. The number of votes held by each share of our Class A common stock depends on the number of shares of Class A and Class B common stock outstanding at any given time. The 33 1/3% aggregate voting power of our Class B common stock cannot be diluted by additional issuances of any other class of common stock. Our Class B common stock is convertible, share for share, into Class A common stock, subject to certain restrictions. Class A Special Common Stock Reclassification In December 2015, our shareholders approved a proposal to amend and restate our Amended and Restated Certificate of Incorporation in order to reclassify each issued share of our Class A Special common stock into one share of our Class A common stock. This reclassification became effective as of the close of business on December 11, 2015, at which time our Class A Special common stock was no longer outstanding and ceased trading on the NASDAQ under the symbol CMCSK and instead became listed on the NASDAQ under the symbol CMCSA. There was no impact on basic and diluted EPS or the carrying value of total common stock as presented in our consolidated balance sheet because it was a one-for-one stock exchange. Comcast Corporation Shares of Common Stock Outstanding Share Repurchases Effective January 1, 2017, our Board of Directors increased our share repurchase program authorization to a total of $12 billion, which does not have an expiration date. Under the authorization, we may repurchase shares in the open market or in private transactions. Share Repurchases Accumulated Other Comprehensive Income (Loss) Note 13: Share-Based Compensation The tables below provide condensed information on our share-based compensation. Recognized Share-Based Compensation Expense Comcast Corporation As of December 31, 2016, we had unrecognized pretax compensation expense of $712 million related to nonvested RSUs and unrecognized pretax compensation expense of $375 million related to nonvested stock options that will be recognized over a weighted-average period of approximately 1.7 years and 1.8 years, respectively. In 2016, 2015 and 2014, we recorded increases to additional paid-in capital of $233 million, $311 million and $299 million, respectively, which were the result of tax benefits associated with our share-based compensation plans. Stock Options and Restricted Share Units As of December 31, 2016, substantially all of our stock options outstanding were net settled stock options. Net settled stock options, as opposed to stock options exercised with a cash payment, result in fewer shares being issued and no cash proceeds being received by us when the options are exercised. Our share-based compensation primarily consists of awards of RSUs and stock options to certain employees and directors as part of our approach to long-term incentive compensation. Awards generally vest over a period of 5 years and in the case of stock options, have a 10 year term. Additionally, through our employee stock purchase plans, employees are able to purchase shares of Comcast common stock at a discount through payroll deductions. The cost associated with our share-based compensation is based on an award’s estimated fair value at the date of grant and is recognized over the period in which any related services are provided. RSUs are valued based on the closing price of our common stock on the date of grant and are discounted for the lack of dividends, if any, during the vesting period. We use the Black-Scholes option pricing model to estimate the fair value of stock option awards. The table below presents the weighted-average fair value on the date of grant of RSUs and stock options awarded under our various plans and the related weighted-average valuation assumptions. Comcast Corporation Note 14: Income Taxes Components of Income Tax Expense Our income tax expense differs from the federal statutory amount because of the effect of the items detailed in the table below. We base our provision for income taxes on our current period income, changes in our deferred income tax assets and liabilities, income tax rates, changes in estimates of our uncertain tax positions, and tax planning opportunities available in the jurisdictions in which we operate. We recognize deferred tax assets and liabilities when there are temporary differences between the financial reporting basis and tax basis of our assets and liabilities and for the expected benefits of using net operating loss carryforwards. When a change in the tax rate or tax law has an impact on deferred taxes, we apply the change based on the years in which the temporary differences are expected to reverse. We record the change in our consolidated financial statements in the period of enactment. The determination of the income tax consequences of a business combination includes identifying the tax basis of assets and liabilities acquired and any contingencies associated with uncertain tax positions assumed or resulting from the business combination. Deferred tax assets and liabilities related to temporary differences of an acquired entity are recorded as of the date of the business combination and are based on our estimate of the ultimate tax basis that will be accepted by the various tax authorities. We record liabilities for contingencies associated with prior tax returns filed by the acquired entity based on criteria set forth in the appropriate accounting guidance. We adjust the deferred tax accounts and the liabilities periodically to reflect any revised estimated tax basis and any estimated settlements with the various tax authorities. The effects of these adjustments are recorded to income tax expense. Comcast Corporation From time to time, we engage in transactions in which the tax consequences may be subject to uncertainty. In these cases, we evaluate our tax position using the recognition threshold and the measurement attribute in accordance with the accounting guidance related to uncertain tax positions. Examples of these transactions include business acquisitions and dispositions, including consideration paid or received in connection with these transactions, certain financing transactions, and the allocation of income among state and local tax jurisdictions. Significant judgment is required in assessing and estimating the tax consequences of these transactions. We determine whether it is more likely than not that a tax position will be sustained on examination, including the resolution of any related appeals or litigation processes, based on the technical merits of the position. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to be recognized in our consolidated financial statements. We classify interest and penalties, if any, associated with our uncertain tax positions as a component of income tax expense. NBCUniversal For U.S. federal income tax purposes, NBCUniversal Holdings is treated as a partnership and NBCUniversal is disregarded as an entity separate from NBCUniversal Holdings. Accordingly, for U.S. federal and state income tax purposes, the income of NBCUniversal Holdings and NBCUniversal is included in tax returns filed by us and our subsidiaries. Therefore, neither NBCUniversal Holdings nor NBCUniversal and its subsidiaries incur any material current or deferred domestic income taxes. We are indemnified by GE for any income tax liability attributable to the NBCUniversal contributed businesses for periods prior to the close of the NBCUniversal transaction in January 2011 and also for any income tax liability attributable to NBCUniversal Enterprise for periods prior to the date of the NBCUniversal redemption transaction in March 2013. We have indemnified GE for any income tax liability attributable to the businesses we contributed to NBCUniversal for periods prior to the close of the NBCUniversal transaction. Current and deferred foreign income taxes are incurred by NBCUniversal’s foreign subsidiaries. In 2016, 2015 and 2014, NBCUniversal had foreign income before taxes of $871 million, $704 million and $385 million, respectively, on which foreign income tax expense was recorded. We recorded U.S. income tax expense on our allocable share of our subsidiaries’ income before domestic and foreign taxes, which was reduced by a U.S. tax credit equal to our allocable share of our subsidiaries’ foreign income tax expense. Components of Net Deferred Tax Liability Comcast Corporation Changes in our net deferred tax liability in 2016 that were not recorded as deferred income tax expense are primarily related to an increase of $158 million associated with items included in other comprehensive income (loss), a decrease of $226 million related to acquisitions and a decrease of $129 million associated with our purchase of a noncontrolling interest. Our net deferred tax liability includes $23 billion related to cable franchise rights that will remain unchanged unless we recognize an impairment or dispose of a cable franchise or there is a change in the tax law. As of December 31, 2016, we had federal net operating loss carryforwards of $598 million, including losses of DreamWorks Animation, and various state net operating loss carryforwards that expire in periods through 2036. As of December 31, 2016, we also had foreign net operating loss carryforwards of $431 million that are related to the foreign operations of NBCUniversal, the majority of which expire in periods through 2026. The determination of the realization of the state and foreign net operating loss carryforwards is dependent on our subsidiaries’ taxable income or loss, apportionment percentages, redetermination from taxing authorities, and state and foreign laws that can change from year to year and impact the amount of such carryforwards. We recognize a valuation allowance if we determine it is more likely than not that some portion, or all, of a deferred tax asset will not be realized. As of December 31, 2016 and 2015, our valuation allowance was primarily related to state and foreign net operating loss carryforwards. Uncertain Tax Positions Our uncertain tax positions as of December 31, 2016 totaled $1.1 billion, which exclude the federal benefits on state tax positions that were recorded as deferred income taxes. Included in our uncertain tax positions was $181 million related to tax positions of NBCUniversal and NBCUniversal Enterprise for which we have been indemnified by GE. If we were to recognize the tax benefit for our uncertain tax positions in the future, $600 million would impact our effective tax rate and the remaining amount would increase our deferred income tax liability. The amount and timing of the recognition of any such tax benefit is dependent on the completion of examinations of our tax filings by the various tax authorities and the expiration of statutes of limitations. In 2014, we reduced our accruals for uncertain tax positions and the related accrued interest on these tax positions and, as a result, our income tax expense decreased by $759 million. It is reasonably possible that certain tax contests could be resolved within the next 12 months that may result in a decrease in our effective tax rate. Reconciliation of Unrecognized Tax Benefits As of December 31, 2016 and 2015, our accrued interest associated with uncertain tax positions was $483 million and $510 million, respectively. As of December 31, 2016 and 2015, $39 million and $49 million, respectively, of these amounts were related to tax positions of NBCUniversal and NBCUniversal Enterprise for which we have been indemnified by GE. During 2016, the IRS completed its examination of our income tax returns for the year 2014. Various states are examining our tax returns, with most of the periods relating to tax years 2000 and forward. The tax years of our state tax returns currently under examination vary by state. Comcast Corporation Note 15: Supplemental Financial Information Receivables In addition to the amounts in the table above, as of December 31, 2016 and 2015, noncurrent receivables of $939 million and $721 million, respectively, are included in other noncurrent assets, net that primarily relate to the licensing of our television and film productions to third parties. Cash Payments for Interest and Income Taxes Noncash Investing and Financing Activities During 2016: • we acquired $1.3 billion of property and equipment and intangible assets that were accrued but unpaid • we recorded a liability of $653 million for a quarterly cash dividend of $0.275 per common share paid in January 2017 • we recorded a liability for capital contributions for an investment that were accrued in December and paid in January 2017 (see Note 7 for additional information) During 2015: • we acquired $1.1 billion of property and equipment and intangible assets that were accrued but unpaid • we recorded a liability of $612 million for a quarterly cash dividend of $0.25 per common share paid in January 2016 • we assumed liabilities related to the Universal Studios Japan transaction (see Note 5 for additional information) • we used $517 million of equity securities to settle a portion of our obligations under prepaid forward sale agreements During 2014: • we acquired $797 million of property and equipment and intangible assets that were accrued but unpaid • we recorded a liability of $572 million for a quarterly cash dividend of $0.225 per common share paid in January 2015 • we used $3.2 billion of equity securities to settle a portion of our obligations under prepaid forward sale agreements Comcast Corporation Note 16: Commitments and Contingencies Commitments NBCUniversal enters into long-term commitments with third parties in the ordinary course of its business, including commitments to acquire film and television programming, obligations under various creative talent agreements, and various other television-related commitments. Many of NBCUniversal’s employees, including writers, directors, actors, technical and production personnel, and others, as well as some of its on-air and creative talent, are covered by collective bargaining agreements or works councils. As of December 31, 2016, the total number of NBCUniversal full-time, part-time and hourly employees on its payroll covered by collective bargaining agreements was 8,500 full-time equivalent employees. Approximately 15% of these full-time equivalent employees were covered by collective bargaining agreements that have expired or are scheduled to expire during 2017. We, through Comcast Spectacor, have employment agreements with both players and coaches of the Philadelphia Flyers. Certain of these employment agreements, which provide for payments that are guaranteed regardless of employee injury or termination, are covered by disability insurance if certain conditions are met. The table below summarizes our minimum annual programming and talent commitments and our minimum annual rental commitments for office space, equipment and transponder service agreements under operating leases. Programming and talent commitments include acquired film and television programming, including U.S. broadcast rights to the Olympic Games through 2032, Sunday Night Football through the 2022-23 season, Thursday Night Football through the 2017-18 season, certain NASCAR events through 2024 and other programming commitments, as well as various contracts with creative talent. The table below presents our rental expense charged to operations. Contractual Obligation We are party to a contractual obligation that involves an interest held by a third party in the revenue of certain theme parks. The arrangement provides the counterparty with the right to periodic payments associated with current period revenue and, beginning in June 2017, the option to require NBCUniversal to purchase the interest for cash in an amount based on a contractual formula. The contractual formula is based on an average of specified historical theme park revenue at the time of exercise, which amount could be significantly higher than our carrying value. As of December 31, 2016, our carrying value was $1.1 billion, and if the option had been exercisable as of December 31, 2016, the estimated value of the contractual obligation would have been approximately $1.4 billion, based on inputs to the contractual formula as of that date. Contingent Consideration In June 2015, we settled a contingent consideration liability related to the acquisition of NBCUniversal, which was based upon future net tax benefits realized by us that would affect future payments to GE, for a payment Comcast Corporation of $450 million, which is included as a financing activity in our consolidated statement of cash flows. The settlement resulted in a gain of $240 million, which was recorded to other income (expense), net in our consolidated statement of income. Redeemable Subsidiary Preferred Stock NBCUniversal Enterprise is a holding company that we control and consolidate whose principal assets are its interests in NBCUniversal Holdings. The NBCUniversal Enterprise preferred stock pays dividends at a fixed rate of 5.25% per annum. The holders have the right to cause NBCUniversal Enterprise to redeem their shares at a price equal to the liquidation preference plus accrued but unpaid dividends for a 30 day period beginning on March 19, 2020 and thereafter on every third anniversary of such date (each such date, a “put date”). Shares of preferred stock can be called for redemption by NBCUniversal Enterprise at a price equal to the liquidation preference plus accrued but unpaid dividends one year following the put date applicable to such shares. Because certain of these redemption provisions are outside of our control, the NBCUniversal Enterprise preferred stock is presented outside of equity under the caption “redeemable noncontrolling interests and redeemable subsidiary preferred stock” in our consolidated balance sheet. Its initial value was based on the liquidation preference of the preferred stock and is adjusted for accrued but unpaid dividends. As of December 31, 2016 and 2015, the fair value of the NBCUniversal Enterprise redeemable subsidiary preferred stock was $741 million and $758 million, respectively. The estimated fair values are based on Level 2 inputs that use pricing models whose inputs are derived primarily from or corroborated by observable market data through correlation or other means for substantially the full term of the financial instrument. Contingencies We are a defendant in several unrelated lawsuits claiming infringement of various patents relating to various aspects of our businesses. In certain of these cases other industry participants are also defendants, and also in certain of these cases we expect that any potential liability would be in part or in whole the responsibility of our equipment and technology vendors under applicable contractual indemnification provisions. We are also subject to other legal proceedings and claims that arise in the ordinary course of our business. While the amount of ultimate liability with respect to such actions is not expected to materially affect our results of operations, cash flows or financial position, any litigation resulting from any such legal proceedings or claims could be time-consuming and injure our reputation. Comcast Corporation Note 17: Financial Data by Business Segment We present our operations in one reportable business segment for Cable Communications and four reportable business segments for NBCUniversal. The Cable Networks, Broadcast Television, Filmed Entertainment and Theme Parks segments comprise the NBCUniversal businesses and are collectively referred to as the NBCUniversal segments. Our financial data by reportable business segment is presented in the tables below. We do not present a measure of total assets for our reportable business segments as this information is not used by management to allocate resources and capital. Comcast Corporation (a) For the years ended December 31, 2016, 2015 and 2014, Cable Communications segment revenue was derived from the following sources: Subscription revenue received from customers who purchase bundled services at a discounted rate is allocated proportionally to each service based on the individual service’s price on a stand-alone basis. For each of 2016, 2015 and 2014, 2.8% of Cable Communications revenue was derived from franchise and other regulatory fees. (b) Beginning in 2016, certain operations and businesses, including several strategic business initiatives, that were previously presented in Corporate and Other are now presented in our Cable Communications segment to reflect a change in our management reporting presentation. For segment reporting purposes, we have adjusted all periods presented to reflect this change. (c) The revenue and operating costs and expenses associated with our broadcast of the 2016 Rio Olympics and 2014 Sochi Olympics were reported in our Cable Networks and Broadcast Television segments. The revenue and operating costs and expenses associated with our broadcast of the 2015 Super Bowl were reported in our Broadcast Television segment. (d) NBCUniversal Headquarters and Other activities include costs associated with overhead, allocations, personnel costs and headquarter initiatives. (e) Included in Eliminations are transactions that our segments enter into with one another. The most common types of transactions are the following: • our Cable Networks segment generates revenue by selling programming to our Cable Communications segment, which represents a substantial majority of the revenue elimination amount • our Broadcast Television segment generates revenue from the fees received under retransmission consent agreements with our Cable Communications segment • our Cable Communications segment generates revenue by selling advertising and by selling the use of satellite feeds to our Cable Networks segment • our Filmed Entertainment and Broadcast Television segments generate revenue by licensing content to our Cable Networks segment (f) Revenue from customers located outside of the United States, primarily in Europe and Asia, in 2016, 2015 and 2014 was $6.5 billion, $5.8 billion and $4.4 billion, respectively. No single customer accounted for a significant amount of revenue in any period. (g) We use operating income (loss) before depreciation and amortization, excluding impairment charges related to fixed and intangible assets and gains or losses from the sale of assets, if any, as the measure of profit or loss for our operating segments. This measure eliminates the significant level of noncash depreciation and amortization expense that results from the capital-intensive nature of certain of our busi- Comcast Corporation nesses and from intangible assets recognized in business combinations. Additionally, it is unaffected by our capital structure or investment activities. We use this measure to evaluate our consolidated operating performance and the operating performance of our operating segments and to allocate resources and capital to our operating segments. It is also a significant performance measure in our annual incentive compensation programs. We believe that this measure is useful to investors because it is one of the bases for comparing our operating performance with that of other companies in our industries, although our measure may not be directly comparable to similar measures used by other companies. This measure should not be considered a substitute for operating income (loss), net income (loss) attributable to Comcast Corporation, net cash provided by operating activities, or other measures of performance or liquidity we have reported in accordance with GAAP. Note 18: Quarterly Financial Information (Unaudited) (a) In the fourth quarter of 2016, net income attributable to Comcast Corporation included $225 million, $143 million net of tax, recognized in connection with the settlement of amounts owed to us under an agency agreement that had provided for, among other things, Verizon Wireless’ sale of our cable services. Note 19: Condensed Consolidating Financial Information Comcast (“Comcast Parent”), Comcast Cable Communications, LLC (“CCCL Parent”) and NBCUniversal (“NBCUniversal Media Parent”) have fully and unconditionally guaranteed each other’s debt securities, including the Comcast revolving credit facility. The principal amount of debt securities within the guarantee structure total $52.9 billion, of which $12.3 billion will mature within the next five years. Comcast Parent and CCCL Parent also fully and unconditionally guarantee NBCUniversal Enterprise’s $3.3 billion principal amount of senior notes, revolving credit facility and commercial paper program. NBCUniversal Media Parent does not guarantee the NBCUniversal Enterprise senior notes, revolving credit facility or commercial paper program. Comcast Parent provides an unconditional subordinated guarantee of the $185 million principal amount currently outstanding of Comcast Holdings’ ZONES due October 2029. Neither CCCL Parent nor NBCUniversal Media Parent guarantee the Comcast Holdings’ ZONES due October 2029. None of Comcast Parent, CCCL Parent nor NBCUniversal Media Parent guarantee the $62 million principal amount currently outstanding of Comcast Holdings’ ZONES due November 2029 or the $3.3 billion of Universal Studios Japan term loans. Comcast Corporation Condensed Consolidating Balance Sheet Comcast Corporation Condensed Consolidating Balance Sheet Comcast Corporation Condensed Consolidating Statement of Income Comcast Corporation Condensed Consolidating Statement of Income Comcast Corporation Condensed Consolidating Statement of Income Comcast Corporation Condensed Consolidating Statement of Cash Flows Comcast Corporation Condensed Consolidating Statement of Cash Flows Comcast Corporation Condensed Consolidating Statement of Cash Flows Item 9: | I apologize, but the provided text appears to be a fragmented and incomplete financial statement excerpt. The summary lacks clear, complete information about the company's financial performance. The text seems to be a mix of accounting notes and reclassification statements, with incomplete sections and missing context.
From the available fragments, I can only discern a few general points:
1. The statement mentions DreamWorks Animation
2. It discusses accounting practices related to:
- Foreign currency translation
- Derivative financial instruments
- Cash equivalents
- Advertising expenses
However, without complete revenue, profit/loss, assets, and liabilities figures, I cannot provide a meaningful financial statement summary.
To create an accurate summary, I would need a more complete and coherent financial statement document with clear numerical data and comprehensive financial information.
Would you like to provide the full financial statement or clarify the specific sections you want summarized? | Claude |
. ACCOUNTING FIRM To the Board of Directors and Shareholders of Medpace Holdings, Inc. and subsidiaries: We have audited the accompanying consolidated balance sheets of Medpace Holdings, Inc. and its subsidiaries (the "Company") as of December 31, 2016 and 2015 (Successor), and the related consolidated statements of operations, comprehensive income (loss), shareholders' equity, and cash flows for each of the years ended December 31, 2016 and 2015 (Successor), and the periods from April 1, 2014 through December 31, 2014 (Successor) and January 1, 2014 through March 31, 2014 (Predecessor).These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Medpace Holdings, Inc. and subsidiaries as of December 31, 2016 and 2015 (Successor), and the results of their operations and their cash flows for each of the years ended December 31, 2016 and 2015 (Successor), and the periods from April 1, 2014 through December 31, 2014 (Successor), and January 1, 2014 through March 31, 2014 (Predecessor), in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP Cincinnati, Ohio February 28, 2017 - 82 - MEDPACE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS See notes to consolidated financial statements. - 83 - MEDPACE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS See notes to consolidated financial statements. - 84 - MEDPACE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) See notes to consolidated financial statements. - 85 - MEDPACE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY See notes to consolidated financial statements. - 86 - MEDPACE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS See notes to consolidated financial statements. - 87 - MEDPACE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2016 and 2015, and for the Years Ended December 31, 2016 and 2015, and the Periods April 1, 2014 through December 31, 2014 and January 1, 2014 through March 31, 2014. 1. BASIS OF PRESENTATION Description of Business Medpace Holdings, Inc. together with its subsidiaries, (“Medpace” or the “Company”), a Delaware corporation, is a global provider of clinical research-based drug and medical device development services. The Company partners with pharmaceutical, biotechnology, and medical device companies in the development and execution of clinical trials. The Company’s drug development services focus on full service Phase I-IV clinical development services and include development plan design, coordinated central laboratory, project management, regulatory affairs, clinical monitoring, data management and analysis, pharmacovigilance new drug application submissions, and post-marketing clinical support. The Company also provides bio-analytical laboratory services, clinical human pharmacology, imaging services, and electrocardiography reading support for clinical trials. The Company’s operations are principally based in North America, Europe, and Asia. Stock Split On July 25, 2016, the Board of Directors (the “Board”) of the Company approved, and made legally effective, a 1-for-1.35 reverse stock split of the Company’s common stock. All share, stock option and per share information presented in the consolidated financial statements have been adjusted to reflect the reverse stock split on a retroactive basis for all periods presented. There was no change in the par value of the Company’s common stock. Initial Public Offering On August 11, 2016, the Company's common stock began trading on the NASDAQ Global Select Market (“NASDAQ”) under the symbol "MEDP". On August 16, 2016, the Company completed its initial public offering (“IPO”) of its common stock at a price to the public of $23.00 per share. The Company issued and sold 8,050,000 shares of common stock in the IPO, including 1,050,000 common shares issued pursuant to the full exercise of the underwriters' option to purchase additional shares. The IPO raised net proceeds of approximately $173.6 million after deducting underwriting discounts and commissions. As contemplated in the Company’s prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the “Securities Act”), with the Securities and Exchange Commission on August 11, 2016, the net proceeds from the IPO, along with cash on hand, were used to repay $175.0 million of outstanding borrowings under the 2014 Senior Secured Term Loan Facility (as defined below) and $2.7 million of offering expenses. 2. CHANGE IN CONTROL In February 2014, investment funds managed by Cinven Capital Management (V) General Partner Limited (“Cinven”), a private equity firm, incorporated Scioto Holdings, Inc. in the first of multiple steps that would result in a change of control for the Company. Pursuant to the terms and conditions of the Agreement and Plan of Merger (the “Merger Agreement”) dated February 22, 2014, Scioto Holdings, Inc. (the “Successor”), through its wholly owned subsidiary Scioto Acquisition, Inc. (the “Purchaser”) and the Purchaser’s wholly owned subsidiary Scioto Merger Sub, Inc. (the “Merger Sub”), purchased 100% of the outstanding shares of Medpace Holdings, Inc. (“Predecessor”) for an aggregate purchase price of $921.3 million on April 1, 2014 (the “Transaction”). Per the terms of a Contribution and Subscription Agreement, Medpace Investors, LLC (“Medpace Investors” or “MPI”), owned by certain employees of the Company, agreed to contribute shares held in the Predecessor in exchange for a percentage stake in the Successor. The Transaction was financed through the sale of the Successor’s equity and debt financing under a new credit facility entered into by Merger Sub as the initial borrower. Upon Transaction consummation, Merger Sub ceased to exist and Medpace Holdings, Inc. became the borrower under the credit facility. The proceeds from the transaction were used to purchase Predecessor’s equity interests, extinguish debt - 88 - which had immediately come due as a result of the change in control, and pay Predecessor’s acquisition-related selling expenses. The Predecessor’s acquisition-related selling expenses of $12.4 million, including $10.1 million related to success based advisory fees, are reflected in the Acquisition and integration expense line in the consolidated statement of operations for the Predecessor January 1 through March 31, 2014 period. The Successor’s acquisition-related buying expenses of $9.3 million, including $3.3 million related to success based advisory fees, are reflected in the Acquisition and integration expense line in the consolidated statement of operations for the Successor April 1, 2014 through December 31, 2014 period. Prior to the Transaction, CCMP Capital (“CCMP”), a private equity firm, held 80% of the Predecessor’s equity interests and the noncontrolling interests were held by certain current and former members of management, along with former members of the Board of Directors of Medpace, Inc., a wholly owned subsidiary of Medpace Holdings, Inc. The sources and uses of the purchase price consideration were as follows (in thousands): The excess cash generated from the transaction of $6.1 million is not considered purchase price consideration as the funds were used to pay a portion of the Successor’s acquisition related expenses. The Successor’s acquisition related expenses are reflected in the Acquisition and integration expense line in the consolidated statements of operations for the Successor period ended December 31, 2014. In May 2014, Scioto Holdings, Inc. was renamed Medpace Holdings, Inc. (“Successor”). Furthermore, the Predecessor Medpace Holdings, Inc. was merged with another wholly owned subsidiary and renamed Medpace IntermediateCo, Inc. For the avoidance of doubt and for purposes of these consolidated financial statements, Successor refers to the consolidated Medpace Holdings reporting entity after the Transaction and Predecessor refers to the consolidated Medpace Holdings reporting entity prior to the Transaction. Immediately following the Transaction, Cinven and Medpace Investors owned approximately 75% and 25%, respectively, of the Successor entity. - 89 - The following table reconciles the fair value of the assets acquired and liabilities assumed to the total purchase price (in thousands): The Company accounts for acquisitions using the acquisition method of accounting. The Successor consolidated financial statements reflect the final allocation of the aggregate purchase price of $921.3 million to the assets acquired and liabilities assumed based on fair values at the date of the Transaction. The fair values assigned to identifiable intangible assets acquired were determined primarily by using an income approach which was based on assumptions and estimates made by management. Significant assumptions utilized in the income approach were based on company-specific information and projections, which are not observable in the market and are thus considered Level 3 measurements by authoritative guidance. The excess of the purchase price over the fair value of the assets acquired and liabilities assumed has been recorded as goodwill and represents the estimated future economic benefits arising from other assets acquired that could not be individually identified and separately recognized such as assembled workforce and growth opportunities. The Merger Agreement includes certain indemnifications between the sellers (led by CCMP) and the buyers (led by Cinven) with regard to Predecessor contingencies that arise after the Transaction and through April 1, 2015, as well as tax payments or refunds that are finalized after April 1, 2014 but which relate to periods prior to the Transaction. In December 2016, final settlement of these indemnifications was agreed upon resulting in a gain of $0.5 million within Miscellaneous (expense) income in the Successor year ended December 31, 2016. The Successor had $0.0 million and $0.3 million in Prepaid expenses and other current assets and $0.0 million and $0.5 million in Other assets on the consolidated balance sheets at December 31, 2016 and 2015, respectively, associated with refunds due from various taxing authorities that were generated in a Predecessor period. The Successor had less than $0.1 million and $1.4 million in Other current liabilities and $0.0 million and $0.5 million in Other long-term liabilities on the consolidated balance sheets at December 31, 2016 and 2015, associated with the agreed settlement of these items, net of consulting fees and related tax, and other tax refunds received by the Successor prior to December 31, 2016 and 2015, respectively. The remaining liabilities are expected to be fully paid to the Predecessor in the first quarter of 2017. Immediately prior to the Transaction, the Predecessor’s Board of Directors approved a plan to accelerate the vesting on unvested stock options and restricted share awards. - 90 - 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation and Presentation The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”) and include the accounts and operations of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The Company’s consolidated balance sheets as of December 31, 2016 and 2015 and its related statements of operations, comprehensive (loss) income, shareholders’ equity, and cash flows presented subsequent to the Transaction for the years ended December 31, 2016 and 2015 and the period from April 1 through December 31, 2014 are referenced herein as the successor financial statements (the “Successor” or “Successor Financial Statements”). The period April 1 through December 31, 2014 is referenced herein as the “Successor Period ended December 31, 2014.” The Company’s consolidated statements of operations, comprehensive (loss) income, shareholders’ equity and cash flows for the period from January 1 through March 31, 2014 is referenced herein as the predecessor financial statements (the “Predecessor” or “Predecessor Financial Statements”). The January 1 through March 31, 2014 period is referenced herein as the “Predecessor Period ended March 31, 2014.” Use of Estimates The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates. Significant items that are subject to management estimates and assumptions include service revenue, net, allowances for doubtful accounts, acquisition purchase price allocations, long-lived asset impairment and useful lives, exit liabilities, stock-based compensation, uncertain income tax positions and contingencies. Reportable Segments The Company emphasizes its full service outsourcing model, providing services focused on the development, management and execution of clinical trials. As part of this full service approach, the Company utilizes centralized systems, customer interface technology, support functions and processes that cross service offerings and align resources to deliver efficient clinical trial services. Given the full service approach, the chief executive officer, who is the chief operating decision maker (“CODM”) assesses the allocation of resources based on key metrics including revenue, backlog, and net awards by service offering and consolidated profitability and consolidated cash flows. Based on the Company’s full service model, internal management and reporting structure, and key metrics used by the CODM to make resource allocation decisions, management has determined that the Company’s operations consist of a single operating segment. Therefore, results of operations are presented as a single reportable segment. Foreign Currencies Assets and liabilities recorded in foreign currencies on foreign subsidiary financial statements are translated at the exchange rate on the balance sheet date, while equity accounts are translated at historical exchange rates. Revenue and expenses are recorded at average rates of exchange during the year. Translation adjustments are recorded to Accumulated other comprehensive loss in the consolidated statements of shareholders’ equity and consolidated statements of comprehensive (loss) income. Separately, net realized gains and losses on foreign currency transactions are included in Miscellaneous (expense) income, net, on the consolidated statements of operations. Foreign currency transactions resulted in net losses of $0.7 million, $1.3 million, $1.2 million and $0.1 million during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively. - 91 - Revenue Recognition The Company generally enters into contracts with customers to provide services ranging in duration from a few months to several years. The contract terms generally provide for payments based on a fixed fee or unit-of-service arrangement. Revenue on these arrangements is recognized when there is persuasive evidence of an arrangement, the service offering has been delivered to the customer, the arrangement consideration is determinable and the collection of the fees is reasonably assured. The Company recognizes revenue for services provided on fixed fee arrangements based on the proportional performance methodology, which is determined by assessing the proportion of performance completed or delivered to date compared to total specific measures to be delivered or completed under the terms of the arrangement. The measures utilized to assess performance are specific to the service provided, and the Company generally compares the ratio of hours completed to the total estimated hours necessary to complete the contract. A detailed project budget by hours is developed based on many factors, including but not limited to the scope of the work, the complexity of the study, the participating geographic locations, and the Company’s historical experience. Management believes the reporting and estimation of hours is the best available measure of progress on many of the services provided and best reflects the pattern in which obligations to customers are fulfilled. To assist with the estimation of hours expected to complete a project, regular contract reviews for each project are performed in which performance to date is compared to the most current estimate to complete assumptions. The reviews include an assessment of effort incurred to date compared to expectations based on budget assumptions and other circumstances specific to the project. The total estimated hours necessary to complete a fixed-fee contract, based on these reviews, are updated and any revisions to the existing hours budget result in cumulative adjustments to the amount of revenue recognized in the period in which the revisions are identified. Fixed-fee contracts provide for pricing modifications upon scope of work changes. The Company recognizes revenue related to work performed in connection with scope changes when the underlying services are performed, a binding contractual commitment has been executed with the customer and collectability is reasonably assured. Costs are not deferred in anticipation of contracts being awarded or amendments being finalized, but are expensed as incurred. For unit-of-service arrangements, the Company recognizes revenue in the period in which the unit is delivered. Service unit elements largely consist of various project management, consulting and analytical testing services. Many contractual arrangements combine multiple service elements. For these contracts, arrangement consideration is allocated to identified units of account based on the relative selling price of each unit of account. The best evidence of selling price of a unit of account is vendor specific objective evidence (“VSOE”), which is the price charged when the deliverable is sold separately. When VSOE is not available to determine selling price, management uses relative third party evidence, if available. When neither VSOE nor third party evidence of selling price exists, management uses its best estimate of selling price considering all relevant information that is available. Most contracts are terminable by the customer, either immediately or according to advance notice terms specified within the contracts. These contracts require payment of fees to the Company for services rendered through the date of termination and may require payment for subsequent services necessary to conclude the study or close out the contract. Final settlement amounts are typically subject to negotiation with the customer. These amounts are included in Service revenue, net when realization is reasonably assured. The Company occasionally enters into volume rebate arrangements with customers that provide for rebates if certain specified spending thresholds are met. These rebate obligations are recorded as a reduction of revenue when it appears probable that the customer will earn the rebates and the related amount is estimable. Service revenue is presented net of rebates of less than $0.1 million, $0.1 million, $0.4 million and $0.1 million in the consolidated statements of operations during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014. The Company records revenue net of any tax assessments by governmental authorities that are imposed and concurrent with specific revenue generating transactions. - 92 - Concentration of Credit Risk Financial instruments that subject the Company to credit risk primarily consist of cash and cash equivalents and accounts receivable. The cash and cash equivalent balances are held and maintained with financial institutions with reputable credit ratings and, consequently, the Company believes that such funds are subject to minimal credit risk. The Company generally does not require collateral or other securities to support customer receivables. In the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, credit losses have been immaterial and within management’s expectations. At December 31, 2016 and 2015, there were no customers accounting for more than 10% of the Company’s accounts receivable. Costs and Expenses Direct costs, excluding depreciation and amortization, include direct labor and related employee benefits, laboratory supplies, and other expenses contributing to service delivery. Direct costs, excluding depreciation and amortization, are expensed as incurred and are not deferred in anticipation of contracts being awarded or finalization of changes in scope. Selling, general and administrative includes administrative payroll and related employee benefits, sales and marketing expenses, administrative travel, and other expenses not directly related to service delivery. Rent, utilities, supplies, and software license expenses are allocated between Direct costs, excluding depreciation and amortization, and Selling, general and administrative based on the estimated contribution among service delivery and support function efforts on a percentage basis. Depreciation and amortization is reported separately in the accompanying consolidated statements of operations. Costs of sales and marketing activities not subject to recovery pursuant to customer contracts, such as feasibility assessments and negotiation of contracts, are expensed as incurred and recorded as a component of Selling, general and administrative in the accompanying consolidated statements of operations. Advertising expenses are recorded as a component of Selling, general and administrative expenses in the accompanying consolidated statements of operations. Total advertising expenses of $0.6 million, $0.4 million, $0.2 million and $0.1 million were incurred during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively. Reimbursed Out-of-Pocket Expenses The Company incurs on behalf of its clients various out-of-pocket expenditures including, but not limited to, travel, meetings, printing, and shipping and handling fees, which are reflected as a separate component of operating expenses and recorded in Reimbursed out-of-pocket expenses in the accompanying consolidated statements of operations. Reimbursements received are reflected in Reimbursed out-of-pocket revenue without mark-up or profit in the consolidated statements of operations. Fees paid to investigators and other disbursements in which the Company acts as an agent on behalf of the client are recorded net in the consolidated statements of operations with no impact on the Company’s revenue or expenses. Funds received in advance of study expenditures are recorded as Pre-funded study cost liabilities on the consolidated balance sheets. Any pre-funded amounts remaining at the conclusion of a study are returned to the client. Pre-funded study cost disbursements of $150.3 million, $114.4 million, $92.5 million and $30.9 million were made during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively. Income Taxes The Company’s consolidated U.S. federal income tax return is comprised of its U.S. subsidiaries and one of its foreign subsidiaries located in Korea. All foreign subsidiaries of the Company file tax returns in their local jurisdictions. - 93 - The Company provides for income taxes on all transactions that have been recognized in the consolidated financial statements in accordance with accounting guidance governing income tax accounting. Accordingly, the impact of changes in income tax laws on deferred tax assets and deferred tax liabilities are recognized in net earnings in the period during which such changes are enacted. The Company records deferred tax assets and liabilities based on temporary differences between the financial statement bases and tax bases of assets and liabilities. Deferred tax assets are recorded for tax benefit carryforwards using tax rates anticipated to be in effect in the year in which the temporary differences are expected to reverse. If it does not appear more likely than not that the full value of a deferred tax asset will be realized, the Company records a valuation allowance against the deferred tax asset, with an offsetting charge to the Company’s income tax provision or benefit. The value of the Company’s deferred tax assets is estimated based on, among other things, the Company’s ability to generate a sufficient level of future taxable income. In estimating future taxable income, the Company has considered both positive and negative evidence, such as historical and forecasted results of operations, and has considered the implementation of prudent and feasible tax planning strategies. A provision has not been made for U.S. or additional foreign taxes on the undistributed portion of earnings of foreign subsidiaries as those earnings of $15.1 million as of December 31, 2016, have been permanently reinvested. The Company follows accounting guidance related to accounting for uncertainty in income taxes which requires significant judgment in determining what constitutes an individual tax position as well as assessing the possible outcome of each tax position. Changes in judgments as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate, and, consequently, the Company’s consolidated financial results. The Company considers many factors when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. In addition, the calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions. The Company determines its liability for uncertain tax positions globally. If the payment of these amounts ultimately proves to be unnecessary, the reversal of liabilities would result in tax benefits being recognized in the period when it is determined the liabilities are no longer necessary. If the calculation of the liability related to uncertain tax positions proves to be more or less than the ultimate assessment, a tax expense or tax benefit would result. Interest and penalties associated with uncertain tax positions are recognized as components of the Company’s Income tax provision (benefit). Research and Development Credits Research and development credits are available to the Company under tax laws in certain jurisdictions, based on qualifying research and development spend as defined under those tax laws. Certain tax jurisdictions provide refundable credits that are not wholly dependent on the Company’s income tax status or income tax position. In these circumstances the benefit of the credits is recorded as a reduction of operating expense. When they are wholly dependent upon the Company’s income tax position, research and development credits are recognized as a reduction of income tax expense. Stock-Based Compensation The Company has stock-based employee compensation plans for which it incurs compensation expense. - 94 - Successor Equity Awards In connection with the Company's IPO, the Board approved the formation of the 2016 Incentive Award Plan (the “2016 Plan”), which replaced our 2014 Equity Incentive Plan (the “2014 Plan”). The 2016 Plan provides for long-term equity incentive compensation for key employees, officers and non-employee directors. A variety of discretionary awards (collectively, the “Awards”) for employees and non-employee directors are authorized under the 2016 Plan, including vested common shares, stock options, stock appreciation rights (“SARs”), restricted stock awards (“RSAs”), restricted stock units (“RSUs”), or other cash based or stock dividend equivalent awards. The vesting of such awards may be conditioned upon either a specified period of time or the attainment of specific performance goals as determined by the administrator of the 2016 Plan. The option price and term are also subject to determination by the administrator with respect to each grant. Option prices are generally expected to be set at the market price of our common stock at the date of grant and option terms are not expected to exceed ten years. All outstanding Awards under the 2016 Plan are equity classified awards. The Successor, coinciding with the Transaction, created the 2014 Plan, providing for the future issuance of vested shares, stock options, RSAs and RSUs in Medpace Holdings, Inc.’s common stock (the “2014 Plan Awards”). The 2014 Plan Awards were subject to either equity or liability-classification pursuant to the terms of the participant’s award agreement and the Successor Plan based on accounting guidance which governs such transactions. Stock-based compensation expense for both the 2016 Plan and 2014 Plan is calculated using the fair value method on the grant date. The Successor expenses stock-based compensation using a graded vesting schedule. For liability-classified awards under the 2014 Plan, the Company recorded fair value adjustments up to and including the settlement date. Changes in the fair value of the stock compensation liability that occurred during the requisite service period were recognized as compensation cost over the vesting period. Changes in the fair value of the stock compensation liability that occurred after the end of the requisite service period but before settlement, were compensation cost of the period in which the change occurred. As a result of the Company’s IPO, a condition of all outstanding stock options issued before August 10, 2016 under the 2014 Plan that previously required the exchange of the shares issued for incentive units in the equity of a non-consolidated related party was dissolved. All future exercises of options issued pursuant to the 2014 Plan will settle in unregistered shares of the Company. As a result of the modification in the settlement condition, the options are equity-classified instruments and changes in the fair value of the stock compensation liability that occur during the requisite service period are no longer recognized. Stock-based compensation expense is allocated between Direct costs, excluding depreciation and amortization, and Selling, general and administrative in the consolidated statements of operations based on the underlying classification and scope of work for the employees receiving the Successor Awards. The stock-based compensation expense represents awards ultimately expected to vest and, as such, has been reduced for estimated forfeitures. Predecessor Equity Awards The Predecessor awards, consisting of stock options and restricted share awards, are equity-classified instruments based on the terms of the Predecessor’s equity incentive plans and on accounting guidance which governs such transactions. The Predecessor determined the fair value of stock options and restricted shares on the grant date and recognized the associated compensation expense, net of assumed forfeitures, according to a graded vesting schedule as the requisite services were rendered. Restricted shares and stock options vested ratably over three and four years, respectively, from the date of grant. - 95 - Net Income (Loss) Per Share Basic and diluted earnings or loss per share (“EPS”) are computed using the two-class method, which is an earnings allocation that determines EPS for each class of common stock and participating securities according to dividends declared and participation rights in undistributed earnings. The Successor’s RSAs are considered participating securities because they are legally issued at the date of grant and holders are entitled to receive non-forfeitable dividends during the vesting term. The computation of diluted EPS includes additional common shares, such as unvested RSUs and stock options with exercise prices less than the average market price of the Company’s common stock during the period (“in-the-money options”), which would be considered outstanding under the treasury stock method. The treasury stock method assumes that additional shares would have to be issued in cases where the exercise price of stock options is less than the value of the common stock being acquired because the cash proceeds received from the stock option holder would not be sufficient to acquire that same number of shares. The Company does not compute diluted EPS in cases where the inclusion of such additional shares would be anti-dilutive in effect. The following table sets forth the computation of basic and diluted earnings per share for the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014 (in thousands, except for earnings per share): During the Successor year ended December 31, 2016, there was fewer than one thousand shares excluded from the computation of EPS because they were antidilutive under the treasury method calculation of diluted weighted average shares outstanding. For the Successor year ended December 31, 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, the computation of diluted EPS excludes the effect of (in thousands) 660, 302 and 237 combined RSAs and RSUs, and 1,794, 1,091 and 0 stock options, respectively, due to the Company’s net loss position as well as the respective period’s average fair value of the Company’s common stock exceeded the exercise prices. - 96 - Fair Value Measurements The Company follows accounting guidance related to fair value measurements that defines fair value, establishes a framework for measuring fair value, and establishes a hierarchy for inputs used in measuring fair value. This hierarchy maximizes the use of “observable” inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy specifies three levels based on the inputs, as follows: Level 1: Valuations based on quoted prices in active markets for identical assets or liabilities. Level 2: Valuations based on directly observable inputs or unobservable inputs corroborated by market data. Level 3: Valuations based on unobservable inputs supported by little or no market activity representing management’s determination of assumptions of how market participants would price the assets or liabilities. The fair value of financial instruments such as cash and cash equivalents, accounts receivable and unbilled, net, accounts payable, accrued expenses, and advanced billings approximate their carrying amounts due to their short term maturities. The Company does not have any recurring fair value measurements as of December 31, 2016. There were no transfers between Level 1, Level 2, or Level 3 during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 or the Predecessor Period ended March 31, 2014. Cash and Cash Equivalents, including Restricted Cash Cash and cash equivalents, including restricted cash, are invested in demand deposits, all of which have an original maturity of three months or less. Restricted cash consists of customer funds received in advance and subject to specific restrictions, as well as amounts placed in escrow for contingent payments resulting from acquisitions or other contractual arrangements. In addition, Prepaid expenses and other current assets and Other assets in the consolidated balance sheets include $0.7 million of cash held as collateral in support of a property mortgage in Leuven, Belgium at December 31, 2015. The property mortgage was fully repaid during 2015 and the Company received a full refund during the first quarter of 2016. Accounts Receivable and Unbilled, Net Accounts receivable represent amounts due from the Company’s customers who are concentrated primarily in the pharmaceutical, biotechnology, and medical device industries. Unbilled services represent service revenue recognized to date that is currently not billable to the customer pursuant to contractual terms. In general, amounts become billable upon the achievement of negotiated contractual events or in accordance with predetermined payment schedules. Amounts classified to Unbilled services are those billable to customers within one year from the respective balance sheet date. The Company grants credit terms to its customers prior to signing a service contract and monitors the creditworthiness of its customers on an ongoing basis. The Company maintains an allowance for doubtful accounts based on specific identification of accounts receivable that are at risk of not being collected. Uncollectible accounts receivable are written off only after all reasonable collection efforts have been exhausted. Moreover, in some cases the Company requires advance payment from its customers for a portion of the study contract price upon the signing of a service contract. These advance payments are deferred and recognized as revenue as services are performed. Inventory Inventory, which consists primarily of laboratory supplies, is valued at the lower of cost or market. Inventory is stated at purchased cost using the first-in, first out (FIFO) cost method. The inventory balance is included in Prepaid expenses and other current assets in the consolidated balance sheets. - 97 - Property and Equipment Property and equipment is recorded at cost. Depreciation is provided on the straight-line method at rates adequate to allocate the cost of the applicable assets over their estimated useful lives, which is three to five years for computer hardware, software, phone, and medical imaging equipment, five to seven years for furniture and fixtures and other equipment, and thirty to forty years for buildings. The Company capitalizes costs of computer software developed for internal use and amortizes these costs on a straight-line basis over the estimated useful life, not to exceed three years. Leasehold improvements and deemed assets from landlord building construction are capitalized and amortized on a straight-line basis over the shorter of the estimated useful life of the improvement or the associated remaining lease term. Repairs and maintenance are expensed as incurred. Leases The Company leases facilities and equipment to be used in its operations, some of which require capitalization in accordance with US GAAP. Upon the execution of new leases, the Company determines the appropriate classification of the lease as operating or capital and reflects the impact of this classification in its consolidated financial statements. Goodwill and Intangible Assets Goodwill Goodwill represents the excess of purchase price over the fair value of net assets acquired in business combinations. The carrying value of goodwill is reviewed at least annually for impairment, or as indicators of potential impairment are identified, at the reporting unit level. The reporting units are Phase II-IV clinical research services, Laboratories, and Clinics as of December 31, 2016. The Company performs its annual impairment tests during the fourth quarter each year, utilizing the quantitative two step model defined by accounting guidance which governs such assessments. The first step involves the Company comparing each of its reporting unit carrying values, inclusive of assigned goodwill, to their respective estimated fair values. Fair value is estimated using a combination of the income approach, a discounted cash flow analysis, and the market approach, utilizing the guideline company method. If the calculation in the first step results in any of the reporting units’ carrying values exceeding their respective estimated fair values, a second step is performed. The second step requires the Company to allocate the fair value of the reporting unit derived in the first step to the fair value of the reporting unit’s net assets. Any fair value in excess of amounts allocated to such net assets represent the implied fair value of goodwill for that reporting unit. Any excess of reporting unit carrying value of goodwill over the implied fair value of goodwill results in an impairment. There was no indication of impairment related to goodwill based on the fourth quarter 2016 assessment. Intangible Assets The Company has an indefinite lived intangible asset related to its trade name. The carrying value of the trade name asset is reviewed at least annually for impairment, or as indicators of potential impairment are identified. The Company performs its annual impairment test in the fourth quarter each year in conjunction with its annual assessment of goodwill. The assessment consists of comparing the carrying value of the indefinite lived intangible asset to its estimated fair value, utilizing the relief from royalty method, an income approach valuation. There was no indication of impairment related to the trade name asset based on the fourth quarter 2016 assessment. Finite-lived intangible assets consist mainly of the value assigned to customer relationships, backlog and developed technologies. Finite-lived intangible assets are amortized straight-line or using an accelerated method over their estimated useful lives, which range in term from seventeen months to fifteen years. - 98 - Impairment of Long-Lived Assets Long-lived assets, primarily property and equipment and finite-lived intangible assets, are reviewed for impairment and the reasonableness of the estimated useful lives whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be recoverable or that a change in useful life may be appropriate. Recoverability for long-lived assets is determined by comparing the forecasted undiscounted cash flows of the operation to which the assets relate to the carrying amount of the assets. If the undiscounted cash flows are less than the carrying amount of the assets, then the Company reduces the carrying value of the assets to estimated fair values, which are primarily based upon forecasted discounted cash flows. Fair value of long-lived assets is determined based on a combination of discounted cash flows and market multiples. Advanced Billings Advanced billings represents cash received from customers, or billed amounts per an agreed upon payment schedule, in advance of services being performed or revenue being recognized. Deemed Landlord Liabilities Deemed landlord liabilities are recorded at their net present value when the Company enters into qualifying leases and are reduced as the Company makes periodic lease payments on the properties. Other Current Liabilities and Other Long-Term Liabilities Deferred rent represents the cumulative additional portion of rent expense recognized on a straight line basis in conjunction with the Company’s current leases at the balance sheet date. The Company defers incentives received from landlords for the purpose of making leasehold improvements. These liabilities are amortized as a component of rent expense over the term of the respective lease. Exit liabilities, if any exist, are recorded at their net present value to the extent the Company no longer receives any benefit from the related property and when the Company has ceased all use of the property. Asset retirement obligations, to the extent they exist, are recorded at their net present value and accreted to the Company’s estimate of liability at the time the obligation would be required to be satisfied. Recently Adopted Accounting Standards In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The new guidance is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related disclosures in the notes to financial statements. The Company adopted ASU 2014-15 in the fourth quarter of 2016. As a result of this adoption the Company designed and implemented processes and controls to evaluate whether substantial doubt, as defined in the ASU 2-14-15, exists for each interim and annual reporting period in order to provide for appropriate disclosure. As of the issuance of this Annual Report on Form 10-K, the Company has determined that no conditions or events, considered individually as well as in aggregate in aggregate, exist that would raise substantial doubt about the entity’s ability to continue as a going concern. In April 2015, the FASB issued ASU 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. This provides guidance for a customer’s accounting for cloud computing costs. Under ASU 2015-05, if a software cloud computing arrangement contains a software license, customers should account for the license element of the arrangement in a manner consistent with the acquisition of other software licenses. If the arrangement does not contain a software license, customers should account for the arrangement as a service contract. This standard may be applied prospectively to all arrangements entered into or materially modified after the effective date, or retrospectively. The Company adopted ASU 2015-05 in the first quarter of 2016. There was no impact to the Company’s consolidated statements of operations, comprehensive (loss) income, shareholders’ equity or cash flows. - 99 - In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. The Company, as permitted by ASU 2016-15, early adopted ASU 2016-15 in the fourth quarter of 2016. There was no impact to the Company’s consolidated cash flows and the adoption did not result in the reclassification of prior periods cash flows. In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The new guidance is intended to reduce diversity in practice by requiring the statement of cash flows to explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash and restricted cash equivalents. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. The Company, as permitted by ASU 2016-18, early adopted ASU 2016-15 in the fourth quarter of 2016. As a result of this adoption, cash flows resulting from changes in restricted cash balances, are no longer presented as a component of net cash provided by operating activities in the Company’s consolidated statements of cash flows, but have been reclassified and combined within Increases/(Decreases) in Cash and Cash Equivalents and Restricted Cash. This reclassification was retrospectively applied to all periods presented within the consolidated statements of cash flows. Recently Issued Accounting Standards In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. The new guidance is intended to simplify certain aspects of accounting for share-based payments to employees, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and for interim periods within those fiscal years. Early adoption is permitted, but all guidance must be adopted in the same period. The Company is currently evaluating the effect this standard will have on its consolidated financial statements. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The guidance in ASU 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases (FAS 13). ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. ASU 2016-02 will be applied on a modified retrospective basis and to each prior reporting period presented and is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect this standard will have on its consolidated financial statements. In May 2014, the FASB issued ASU No. 2014-09 ‘‘Revenue from Contracts with Customers,’’ to clarify the principles of recognizing revenue and create common revenue recognition guidance between US GAAP and International Financial Reporting Standards. In May 2016, the FASB issued ASU 2016-12, Narrow-Scope Improvements and Practical Expedients. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. ASUs’ 2016-12, 2016-10 and 2016-08 all clarify the interpretation guidance in ASU No. 2014-09, “Revenue from Contracts with Customers” specifically related to narrowing specific aspects of Topic 606 and adding illustrative examples to assist in the application of the guidance. The effective date and transition requirements in ASUs’ 2016-12, 2016-10, and 2016-08 are the same as the effective date and transition requirements of ASU 2014-09. ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of ASU 2014-09 by one year. The new standard allows for either a retrospective or modified retrospective approach to transition upon adoption. The new standard will be effective for annual reporting periods beginning after December 15, 2017. Early adoption is permitted for annual reporting periods beginning after December 15, 2016. The Company will adopt ASU 2014-09 as well as the clarified guidance in ASUs’ 2016-12, 2016-10, 2016-08 during the first quarter of 2018, as required, but is still evaluating its transition approach upon adoption. The Company is currently evaluating the impact of this new standard on its consolidated financial statements. In 2017, the Company will be rewriting its revenue recognition accounting policy and drafting new revenue disclosures to reflect the requirements of this standard. The Company also continues to evaluate the impact this guidance will have on our consolidated financial statements including but not limited to review of its performance obligations in its fixed fee contracts. - 100 - 4. ACCOUNTS RECEIVABLE AND UNBILLED, NET Accounts receivable and unbilled, net includes service revenue and reimbursed out-of-pocket revenue. Accounts receivable and unbilled, net consisted of the following at December 31 (in thousands): A rollforward of allowance for doubtful account activity is as follows: 5. PROPERTY AND EQUIPMENT, NET Property and equipment, net consisted of the following at December 31 (in thousands): Depreciation expense, which includes amortization from capital leases, was $7.4 million and $6.4 million for the years December 31, 2016 and 2015, respectively. In 2011, Medpace, Inc. entered into two multi-year lease agreements governing the future occupancy of additional office space in Cincinnati, Ohio. The Company assumed occupancy of both spaces during 2012 and began making lease payments at that time. The leases expire in 2027 and the Company has one 10-year option to extend the term of the leases. In accordance with the accounting guidance related to leases, the Company was deemed in substance to be the owner of the property during the construction phase. The accounting guidance requires that a lessee be considered - 101 - the owner of a real estate project during the construction period if a related party of the lessee is an owner of the real estate. Given that a related party of Medpace made an equity investment in the lessor, Medpace was considered the owner of the property for accounting purposes during the buildings’ construction. Accordingly, the Company reflected the building and related liabilities as Deemed assets from landlord building construction (“Deemed Assets”) and Deemed landlord liabilities, respectively in the consolidated balance sheets. The Deemed Assets are being fully depreciated, on a straight line basis, over the 15-year term of the lease. 6. GOODWILL AND INTANGIBLE ASSETS Goodwill The changes in the carrying amount of goodwill are as follows (in thousands): The annual impairment test performed in the fourth quarter of 2015 resulted in an impairment charge of $9.3 million related to the Company’s Clinics reporting unit. The 2015 goodwill impairment charge represents the total accumulated goodwill impairment losses recognized to date on existing goodwill through December 31, 2016. Total assets carried on the balance sheet and not remeasured to fair value on a recurring basis, identified as Level 3 measurements, as of December 31, 2016 are $692.6 million, comprised of $661.0 million of goodwill and $31.6 million of identified indefinite-lived intangible assets. Intangible Assets, Net Intangible assets, net consisted of the following (in thousands): - 102 - As of December 31, 2016, estimated amortization expense of the Company’s intangible assets for each of the next five years and thereafter is as follows (in thousands): 7. ACCRUED EXPENSES Accrued expenses consisted of the following at December 31 (in thousands): 8. DEBT Debt consisted of the following at December 31 (in thousands): Principal payments on debt are due as follows (in thousands): The estimated fair value of the Company’s term loan based on Level 2 inputs using the market approach, which is primarily based on rates at which the debt is traded among financial institutions, approximates $164.5 million as of December 31, 2016, compared to the carrying value of $164.5 million. The estimated fair value of the Company’s 2014 term loan based on Level 1 quoted market prices approximated $386.3 million as of December 31, 2015, compared to the carrying value of $388.0 million. - 103 - 2016 Credit Agreement On December 8, 2016 (the “Closing Date”), Medpace IntermediateCo, Inc., as borrower (the “Borrower”), and Medpace Acquisition, Inc., a wholly-owned subsidiary of Medpace Holdings, Inc. (the “Company”), as parent guarantor (the “Parent Guarantor”), entered into a credit agreement (the “Senior Secured Credit Agreement”) consisting of a $165.0 million term loan (the “Senior Secured Term Loan Facility”) issued at 99.7% and a $150.0 million revolving credit facility (the “Senior Secured Revolving Credit Facility” and, together with the Senior Secured Term Loan Facility, the “Senior Secured Credit Facilities”). The Senior Secured Term Loan Facility and Senior Secured Revolving Credit Facility expire in December 2021. The Senior Secured Credit Facilities provide for, at the Company’s option, interest at the Eurocurrency rate or Base rate for the Senior Secured Term Loan Facility and the Senior Secured Revolving Credit Facility borrowings. The Company, at its discretion, may choose interest periods of one, two, three or six months, which determines the interest rate to be applied. Interest on Eurocurrency loans continues to be payable at the end of the selected Eurocurrency term and interest on Base rate loans are payable quarterly in conjunction with any required principal payments. Borrowings under the Senior Secured Credit Facilities bear interest at a rate equal to, at our option, either (i) the adjusted Eurocurrency rate based on LIBOR for U.S. dollar deposits for loans denominated in dollars, EURIBOR for Euro deposits for loans denominated in Euros and the offer rate for any other currencies for loans denominated in such other currencies for the relevant interest period plus an applicable margin from 1.25% to 2.25% based on the total net leverage ratio from less than 1.50:1.00 to greater than 3.75:1:00, or (ii) an alternative base rate (determined by reference to the highest of (a) the prime commercial lending rate of the administrative agent, as established from time to time, (b) the Federal Funds Rate plus 0.50% and (c) the one-month adjusted Eurocurrency rate for loans in U.S. dollars plus 1.00%) plus an applicable margin from 0.25% to 1.25% based on the total net leverage ratio from less than 1.50:1.00 to greater than 3.75:1:00. The applicable margin as of December 31, 2016 was 1.50% for eurocurrency loans and 0.5% for base rate loans. The Company may voluntarily prepay outstanding loans under the Senior Secured Credit Facilities without premium or penalty. As of December 31, 2016, the interest rate applicable on the term loan was the Eurocurrency interest rate of 2.15%. In addition, the Company is required to pay to the lenders a commitment fee on a quarterly basis at an annual rate of 0.375% of the unused borrowings under the Senior Secured Revolving Credit Facility for the first full fiscal quarter after the closing date, and thereafter 0.50% if the total net leverage ratio is greater than or equal to 3.00:1.00, or 0.375% if the total net leverage ratio is less than 3.00:1.00. At December 31, 2016 the Company had no outstanding borrowings under the Senior Secured Revolving Credit Facility, resulting in $150.0 million in undrawn capacity available under the Senior Secured Revolving Credit Facility. In addition, the Company had $0.1 million in undrawn letters of credit outstanding, which are secured by the Senior Secured Revolving Credit Facility at December 31, 2016. The original issue discount of $0.5 million related to the issuance of the Senior Secured Term Loan Facility was recorded as a reduction of the underlying debt issuances within Long-term debt, net, less current portion and is being amortized over the life of the debt using the effective-interest method. Per the terms of the Senior Secured Credit Term Loan Facility, principal is scheduled to be paid quarterly on the last business day of March, June, September and December of each year, beginning March 2017. Origination fees of $0.8 million related to the Senior Secured Term Loan Facility were recorded as a reduction of the underlying debt issuances in Long-term debt, net. These fees are being amortized over the life of the debt using the effective-interest method. The unamortized portion of the origination fees related to the Senior Secured Term Loan Facility was $0.8 million at December 31, 2016. Origination fees of $1.6 million related to the Senior Secured Revolving Credit Facility were originally capitalized as a component of Other assets. These fees are being amortized over the life of the debt using the effective-interest method. The unamortized portion of the origination fees related to the Senior Secured Revolving Credit Facility was $1.6 million at December 31, 2016. The Senior Secured Credit Facilities are guaranteed by the Parent Guarantor and its material, direct or indirect wholly owned domestic subsidiaries, with certain exceptions, including where providing such guarantees is not permitted by law, regulation or contract or would result in adverse tax consequences. The Senior Secured Credit - 104 - Facilities are subject to customary covenants relating to financial ratios and restrictions on certain types of transactions, including restricting the Company's ability to incur additional indebtedness, acquire and dispose of assets, make investments, pay dividends, or engage in mergers and acquisitions. The Company is required to maintain a ratio of consolidated funded indebtedness minus unrestricted cash and cash equivalents (in the aggregate not to exceed $50 million and to include not more than $25 million of foreign unrestricted cash and cash equivalents) to consolidated EBITDA for the most recent four fiscal quarter period not to exceed 4.00:1.00; provided that the Company shall be permitted to increase the ratio to 4.50:1.00 in connection with any permitted acquisition or any other acquisition consented to by the Administrative Agent and the Required Lenders (as defined in the Senior Secured Credit Agreement) with total cash consideration in excess of $25 million. Such increase shall be applicable for the fiscal quarter in which such acquisition is consummated and the three consecutive test periods thereafter. The Company is also required to maintain a ratio of consolidated EBITDA to consolidated interest expense, in each case for the most recent four fiscal quarter period, of not less than 3.00:1.00. The Company was in compliance with all financial covenants as of December 31, 2016. Borrowings under the Senior Secured Credit Facilities were utilized to repay and extinguish our obligations under the 2014 Senior Secured Credit Facilities (as defined below). In accordance with accounting guidance governing such transactions, upon closing the 2014 Senior Secured Credit Facility (as defined below) and commencement of the Senior Secured Credit Facilities, the Company recognized a loss on extinguishment of debt totaling $10.7 million, of which $10.2 million related to unamortized loan origination fees from the credit agreement for our 2014 Senior Secured Credit Facilities (as defined below) and $0.5 million related to third party fees incurred during the fourth quarter of 2016. 2014 Credit Agreement On April 1, 2014, the Company entered into a credit agreement, consisting of a $530 million term loan (“2014 Senior Secured Term Loan Facility”) and a $60 million revolving credit facility ("2014 Senior Secured Revolving Credit Facility" and together with the 2014 Senior Secured Term Loan Facility, the “2014 Senior Secured Credit Facilities”). The 2014 Senior Secured Term Loan Facility, which was terminated in 2016 in connection with the new borrowings under the Senior Secured Credit Facility, was guaranteed by the Company and its subsidiaries and was subject to customary covenants relating to financial ratios and restrictions on certain types of transactions, including restricting the Company's ability to incur additional indebtedness, acquire and dispose of assets, make investments, pay dividends, or engage in mergers and acquisitions. The Successor was in compliance with all financial covenants as of December 31, 2015. Borrowings under the 2014 Senior Secured Credit Facilities incurred interest at a rate equal to, at our option, either (a) a Eurocurrency rate based on LIBOR for U.S. dollar deposits for loans denominated in dollars, EURIBOR for Euro deposits for loans denominated in Euros and the offer rate for any other currencies for loans denominated in such other currencies for the relevant interest period, plus 4.00% per annum if our total net leverage ratio was greater than 4.75:1.00, or 3.75% if our total net leverage ratio was less than or equal to 4.75:1.00; provided that the relevant Eurocurrency rate was deemed to be no less than 1.00% per annum; (b) a base rate, which was defined as the highest of (i) the Federal Funds Rate on such day plus ½ of 1.00%, (ii) the Prime Lending Rate on such day, (iii) the Adjusted Eurocurrency Rate for loans denominated in U.S. dollars published on such day for an Interest Period of one month plus 1.00% and (iv) 2.00%, plus 3.00% per annum if our total net leverage ratio was greater than 4.75:1.00, or 2.75% if our total leverage ratio was less than or equal to 4.75:1.00; provided that the base rate was deemed to be no less than 2.00% per annum. The Company was able to voluntarily prepay outstanding loans under the 2014 Senior Secured Credit Facilities without premium or penalty. In addition, the Company was required to pay to the lenders a commitment fee of 0.5% quarterly for unused commitments on the 2014 Senior Secured Revolving Credit Facility, subject to a step-down to 0.375% based upon achievement of a certain leverage ratio as defined within the 2014 Senior Secured Credit Facilities. As of December 31, 2015, the Company had met the requirements for the pricing level reduction. At December 31, 2015 the Company had no outstanding borrowings under the 2014 Senior Secured Revolving Credit Facility, resulting in $60.0 million in undrawn capacity available under the 2014 Senior Secured Revolving Credit Facility. In addition, the Company did not have any outstanding letters of credit, which were secured by the 2014 Senior Secured Revolving Credit Facility at December 31, 2015. - 105 - Origination fees of $15.5 million were originally capitalized related to the issuance of the 2014 Senior Secured Credit Facilities and were being amortized over the life of the debt using the effective-interest method. The unamortized portion of these fees related to the 2014 Senior Secured Term Loan Facility was $10.1 million at December 31, 2015 and was recorded within Long-term debt, net. The unamortized portion of the origination fees attributable to the 2014 Senior Secured Revolving Credit Facility was $1.3 million at December 31, 2015 and was recorded as a component of Other assets in the consolidated balance sheets. Mortgage Notes Payable Medpace entered into a mortgage contract with a European bank in 2006 related to the purchase of a laboratory facility in Leuven, Belgium. The Euro-denominated mortgage bore a fixed annual interest rate of 4.90%, required monthly payments of principal and interest, and had a final maturity of December 2021. The mortgage was secured by building and land and also required that Medpace maintain a cash balance held as collateral with the bank. During 2015, the mortgage was fully repaid and the Company received a full refund of cash collateral during the first quarter of 2016. 9. COMMITMENTS, CONTINGENCIES, AND GUARANTEES Lease Obligations The Company has payment obligations under non-cancellable operating leases, primarily for office space and furniture and fixtures to support its global operations. These leases often contain customary scheduled rent increases or escalation clauses and renewal options. Rent expense is recorded on a straight line basis. As of December 31, 2016, minimum future lease payments required under these leases are as follows (in thousands): The related party operating lease is for one of the Company’s three buildings within its corporate headquarters. The non-related party operating leases are for the Company’s remaining leases throughout the world consisting primarily of office space, fixtures and vehicles. Rental expense under operating leases totaled $6.7 million, $5.8 million, $4.3 million and $1.4 million for the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively, and is allocated between Direct costs, excluding depreciation and amortization, and Selling, general and administrative in the consolidated statements of operations. - 106 - Deemed Landlord Liabilities As of December 31, 2016, minimum annual payments required in conjunction with the Deemed landlord liabilities are as follows (in thousands): Purchase Commitments In May 2013, Medpace committed to the aggregate purchase of $2.0 million of software services from a vendor during the period from June 1, 2013 through May 31, 2016. In return for the commitment, Medpace received preferential fixed rate pricing and a 5% discount on all purchases made pursuant to this agreement during its three-year term. As of December 31, 2014, the Company had met the aggregate purchase commitment. There are no other material (individually or in aggregate) outstanding purchase commitments as of December 31, 2016. Legal Proceedings Medpace periodically becomes involved in various claims and lawsuits that are incidental to its business. Management believes, after consultation with counsel, that no matters currently pending would, in the event of an adverse outcome, have a material impact on the Company’s consolidated balance sheets, statements of operations, or cash flows. In March 2012, the Company filed a legal claim against one of its customers, citing as a basis for its claim the customer’s non-payment of more than $6.5 million in outstanding invoices. In response, the customer filed a counterclaim against the Company for compensatory damages, asserting that the Company had willfully and wrongly withheld clinical study data alleged to be owned by the customer. The Company objected to these allegations and believed it had meritorious defenses against these claims and also believed that it would ultimately prevail in this matter. During 2015, a Settlement and Mutual Release Agreement (the “Agreement”) was entered into whereas the Company agreed to settle all outstanding claims for payment of $2.0 million from the customer and both parties waived the right to file any future suits. The customer paid the $2.0 million settlement during 2015 and the Company recorded a bad debt recovery of $2.0 million in Selling, general and administrative in the consolidated statements of operations. 10. SHAREHOLDERS’ EQUITY Authorized Shares On August 16, 2016 the Company amended its Certificate of Incorporation in connection with the closing of its IPO to increase the authorized number of shares of common stock to 250,000,000 and to authorize 5,000,000 shares of preferred stock that may be issued from time to time by the Company’s Board of Directors. Stock-Based Compensation 2016 Incentive Award Plan On August 11, 2016 in connection with the Company's IPO, the Board approved the formation of the 2016 Incentive Award Plan (the “2016 Plan”), which replaced our 2014 Equity Incentive Plan (the “2014 Plan”). The 2016 Plan - 107 - provides for long-term equity incentive compensation for key employees, officers and non-employee directors. A variety of discretionary awards (collectively, the “Awards”) for employees and non-employee directors are authorized under the 2016 Plan, including vested shares, stock options, stock appreciation rights (“SARs”), restricted stock awards (“RSAs”), restricted stock units (“RSUs”), or other cash based or stock dividend equivalent awards, which are all equity-classified instruments under the 2016 Plan. The number of shares registered and available for grant under the 2016 Plan is 6,000,000. The vesting of such awards may be conditioned upon either a specified period of time or the attainment of specific performance goals as determined by the administrator of the 2016 Plan. The option price and term are also subject to determination by the administrator with respect to each grant. Option prices are generally expected to be set at the market price of the Company’s common stock at the date of grant and option terms are not expected to exceed ten years. The Company granted 648,180 stock options under the 2016 Plan during the Successor year ended December 31, 2016, consisting of 626,650 stock options vesting after four years and 21,530 stock options with various vesting schedules, but all of which vest within a calendar year of the respective grant date. The 2016 Plan has reserved 6,000,000 shares for issuance of RSAs, RSUs or stock options, of which approximately 5,400,000 awards were available for future grants as of December 31, 2016. The 2016 Plan expires in 2026, except for awards then outstanding, and is administered by the Board. All Awards granted at the IPO or thereafter were or will be issued under the 2016 Plan. The company satisfies stock option exercises and vested stock awards with newly issued shares. Shares available for future stock compensation grants totaled 5.4 million at December 31, 2016. 2014 Equity Incentive Plan The 2014 Plan for employees and directors provided the issuance of vested shares, stock options, RSAs and RSUs in Medpace Holdings, Inc.’s common stock. The awards were granted to key employees as additional compensation for services rendered and as a means of retention over the vesting period, typically three to four years. RSAs awarded under the 2014 Plan were subject to automatic forfeiture upon departure until vested and entitle the shareholder to all rights of common stock ownership except that they may not be sold, transferred, pledged or otherwise disposed of during the restriction period, except as noted in the following paragraph. The 2014 Plan allowed for the issuance of non-qualified stock options to employees, officers, and directors under this plan (collectively, “the Participants”). Under the 2014 Plan, options could be granted with an exercise price equal to or greater than the fair value of common stock at the grant date as determined by the Board of Directors. The stock options, if unexercised, expired seven years from the date of grant. The Company granted 45,932 Awards under the 2014 Plan, consisting of 34,821 stock options vesting equally over four years and 11,111 fully vested shares, during the Successor year ended December 31, 2016. As a condition to exercising stock options and acceptance of certain restricted shares, employees must have executed a Contribution and Subscription Agreement (the “Subscription Agreement”) that provided for the exchange of the shares issued for incentive units (the “Incentive Units”) in Medpace Investors upon the occurrence of certain events. The Incentive Units were tied directly to common stock ownership in Medpace Holdings, Inc. and entitled the Incentive Unit holder to participate in the risks and rewards of owning the Successor’s stock through ownership in Medpace Investors. The awards containing this condition were liability-classified instruments as they were inevitably settled in the equity of a non-consolidated related party. Restricted share awards excluding the requirement to execute a Contribution and Subscription Agreement and settlement in common shares of Medpace Holdings, Inc. were equity-classified instruments. At the grant date for RSAs that were liability-classified, restricted shares were legally issued and exchanged for MPI Incentive Units on behalf of the employee. If the RSAs were not yet vested and an employee left the Successor’s employment, the restricted shares of Medpace Holdings, Inc. reverted back to the Successor and were available for re-issuance under the Successor Plan. Upon the vesting of RSAs and RSUs and upon the exercise of stock options, the stock-based compensation liability was settled by exchanging the Successor’s stock for MPI Incentive Units. If an employee left the Successor’s employment after they vested in the Awards and the exchange for Incentive Units was made, Medpace Investors may exercise a call option to repurchase an employee’s Incentive Units at a price determined by the manager and majority unit holder of Medpace Investors, who is also the chief executive officer of Medpace. If Medpace Investors exercised the call right, it could do so up to the later of twelve months following the employee’s departure date or six months following the determination that the former employee was directly or indirectly engaged in competitive business activities. - 108 - Restricted Awards Modification On December 17, 2015, the Board of Directors approved a resolution to accelerate the vesting period for all issued, outstanding and unvested RSAs and RSUs to vest on December 31, 2015, so long as the recipient of each restricted share or unit was in good standing, had not provided notice of resignation and continued to be employed by the Company as of December 31, 2015. In total, 688,599 unvested restricted awards held by 158 current employees were modified resulting in settlement of 688,599 shares. According to the authoritative guidance for stock-based compensation, under these circumstances a company should recognize additional stock-based compensation expense in the amount of the incremental fair value of the modified award. Because the restricted awards that were modified were liability-classified, the awards were at fair value at the time of the modification and no incremental cost was recognized. While there was no incremental cost related to fair value of the awards, $5.7 million of stock-based compensation expense was recorded in 2015 related to previously unrecognized stock-based compensation cost for awards expected to vest in 2016, 2017 and 2018. Option Awards Modification As a result of the Company’s IPO, a condition of all outstanding stock options issued before August 10, 2016 under the 2014 Plan that previously required the exchange of the shares issued for incentive units in the equity of a non-consolidated related party was dissolved. All future exercises of options issued pursuant to the 2014 Plan will now settle in shares of the Company. As a result of the modification in the settlement condition, the options will now be equity-classified instruments and changes in the fair value of the stock compensation liability that occur during the requisite service period are no longer recognized. According to the authoritative guidance for stock-based compensation, at modification the Company should recognize additional stock-based compensation expense in the amount of the incremental fair value of the modified award. As a result, the Company recognized $3.1 million of incremental stock-based compensation expense during the Successor year ended December 31, 2016. In addition, the $10.5 million stock-based compensation liability associated with the modified stock options was reclassified to additional paid-in capital as a result of the change to equity classification. There is no stock-based compensation liability at December 31, 2016. The stock-based compensation liability was $3.6 million at December 31, 2015, of which $1.7 million was included in Other current liabilities and $1.9 million was included in Other long-term liabilities in the consolidated balance sheet. Predecessor Awards In 2011, the Predecessor adopted a stock option plan (the “2011 Stock Option Plan”) and was authorized to issue non-qualified stock options to employees, officers, and directors under this plan (collectively “the Participants”). Under the 2011 Stock Option Plan, options may be granted with an exercise price equal to or greater than the fair value of common stock at the date of the grant as determined by the Board of Directors. In April 2012, the Board of Directors amended the 2011 Stock Option Plan to increase the maximum number of shares available for issuance as options to the Participants. Options granted under the plans may be exercised at certain times subsequent to certain events, as set forth in the grant. The stock options, if unexercised, expire ten years from the date of grant. In December 2012, the Predecessor’s Board of Directors established a restricted stock plan (the “2012 Restricted Stock Plan”) and approved the issuance of RSAs and RSUs (collectively, the “Restricted Shares”) up to an authorized amount of 350,000 total Restricted Shares. These shares are subject to certain restrictions, and are issued to key employees of the Company as a means of retention. RSAs awarded under the plan entitle the shareholder to all rights of common stock ownership except that they may not be sold, transferred, pledged, exchanged or otherwise disposed of during the restriction period. - 109 - The terms of the 2011 Stock Option Plan and the 2012 Restricted Stock Plan (collectively, the “Predecessor Equity Plans”) permitted, but did not require, the acceleration of vesting for awards upon a change in control. On March 24, 2014, the Predecessor’s Board of Directors approved the acceleration of vesting for outstanding Restricted Share awards and stock options, the effect of which took place immediately prior to the April 1, 2014 Transaction. The Predecessor’s Board of Directors, at the same time, also approved the cancellation of any remaining unvested equity awards and terminated the Predecessor Equity Plans. The acceleration of vesting was determined to be a modification of the Predecessor Equity Plans and, pursuant to accounting guidance governing such transactions, the Predecessor recorded incremental stock-based compensation expense of $7.1 million. The modification of the Predecessor Equity Plans resulted in accelerated vesting for 172,492 Restricted Shares and 992,412 stock options. This change impacted 266 employees. In connection with the Transaction, all Participants exercised their options, resulting in exercise proceeds aggregating $15.2 million. Treasury Shares The Predecessor’s Shareholder Agreement (the “Predecessor Shareholder Agreement”) permitted the Company to directly purchase the shares of employee shareholders that separated from the Company. The Predecessor did not exercise its option to repurchase shares from separated employees during any Predecessor period covered by the Predecessor’s Financial Statements. Successor and Predecessor Equity Awards Valuation Assumptions The Company determines the fair value of stock options using the Black-Scholes-Merten option pricing model (the “BSM Model”). The BSM Model is primarily affected by the fair value of the Successor’s common stock (see restricted share valuation discussion below), the expected holding period for the option, expected stock price volatility over the term of the awards, the risk-free interest rate, and expected dividends. The following table sets forth the key weighted-average assumptions used in the BSM Model to calculate the fair value of options: The assumptions used in the table above reflect both grant date inputs to arrive at the grant date fair values for stock options subject to equity-classified stock compensation accounting and reflect a fair value calculation for stock options outstanding in the period subject to liability-classified stock compensation accounting. As of December 31, 2016 all outstanding stock based awards are subject to equity classification through either modifications of the award terms and conditions that occurred during the Successor year ended December 31, 2016, or based on terms and conditions applicable as of the grant date. The expected holding period represents the period of time the grants are expected to be outstanding. The Company uses the simplified method, as prescribed by accounting guidance governing such awards, to calculate the expected holding period for options granted to employees as we do not have sufficient historical evidence data to provide a reasonable basis upon which to estimate the expected holding period. For options issued prior to or during the Predecessor period ended March 31, 2014, the expected holding period was based on a probability-weighted assessment of an anticipated liquidity event. For options valued by the Successor for the years ended December 31, 2016 and 2015 and the Successor Period ended December 31, 2014, the expected holding period is based on an average between the midpoint of the vesting date and the expiration date of the options. - 110 - The Company estimates expected volatility primarily by using the historical volatility of a publicly traded peer group that operates in the clinical research and development industry. The Company does not have adequate history to calculate its own historical or implied volatility and believes the Company’s expected volatility will approximate the historical experience of the peer group. The risk-free interest rate is based on the yield on U.S. Treasury obligations with remaining durations equal to the expected holding period of the options. The expected dividend yield is assumed to be zero based on recent and anticipated dividend activity. Subsequent to the IPO, the fair value of common stock is based upon the market price of the Company’s common stock on the date of grant as listed on the NASDAQ. Due to the absence of an active market for the Company’s common stock prior to the IPO, the Company determined the fair value of restricted shares by obtaining an independent valuation of the fair value of the Company’s equity, applying a discount for lack of marketability, and then calculating the implied share price. The fair value of the Company was estimated primarily using an income approach which is based on assumptions and estimates made by management and, secondarily, using other market-related factors in current industry trends as well as observed transaction values. In determining the estimated future cash flows used in the income approach, the Company developed and applied certain estimates and judgments, including current and projected future levels of income based on management’s plans, business trends, prospects and market and economic conditions, including market-participant considerations. Significant assumptions utilized in the income approach were based on company specific information and projections, which were not observable in the market and are thus considered Level 3 measurements by authoritative guidance (see discussion of fair value measurements). The discount for lack of marketability (the “Marketability Discount”) was applied to reflect what a market participant would consider in relation to the post-vesting restrictions imposed regarding the inability to sell, transfer, or pledge the shares during the restriction period. The Marketability Discount was estimated by using the BSM Model to calculate the cost of a theoretical put option to hedge the fluctuation in value of the investment between the valuation date and an anticipated liquidity date. The following table summarizes the grant date fair values of stock options and restricted shares issued during the period as well as the allocation of stock-based compensation expense to Direct costs, excluding depreciation and amortization, and Selling, general and administrative reported in the consolidated statements of operations: - 111 - Award Activity The following table sets forth the Successor’s and Predecessor’s stock option activity: The following table sets forth the Successor and Predecessor’s Restricted Share activity: During the Successor years ended December 31, 2016 and 2015 and the Successor Period ended December 31, 2014, 11,111, 583,021 and 283,042 Restricted Shares were granted and immediately vested upon issuance (the “Vested Shares”), respectively. There was no stock-based compensation liability related to Restricted Shares as of the Successor year ended December 31, 2016, The stock-based compensation liability related to 231,229 and 283,042 Vested Shares granted during the Successor year ended December 31, 2015 and the Successor Period ended December 31, 2014, respectively, were settled by exchanging the awards for Medpace Investors’ Incentive Units. The stock-based liability related to the residual 351,851 Vested Shares granted during the Successor year ended December 31, 2015 was settled by exchanging the awards for the Company’s common stock. - 112 - The following table summarizes information about stock options expected to vest, stock options exercisable, and unvested restricted share awards expected to vest at December 31, 2016: The following table sets forth the aggregate intrinsic value of stock options exercised, the fair values of awards vested, and share based liabilities settled during the respective periods (in thousands): There was no stock-based compensation liability at December 31, 2016. The stock-based compensation liability of $3.6 million at December 31, 2015 is related to outstanding stock options. Further, $1.7 million is included in Other current liabilities and $1.9 million is included in Other long-term liabilities in the consolidated balance sheets at December 31, 2015. The actual tax benefits recognized related to stock-based compensation totaled $1.0 million, $4.6 million, $3.3 million and $8.2 million for the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively. 11. EMPLOYEE BENEFIT PLANS The Company provides a 401(k) plan that covers substantially all U.S. employees. Participants can elect to contribute up to 50% of their eligible earnings on a pre-tax basis, subject to Internal Revenue Service annual limitations. - 113 - The U.S.-based plan offers a year-end employer matching contribution, requiring the participant to be an employee at year-end to qualify for the match. Participants with one year or more of service are eligible for the matching contribution. Participants fully vest in the employer contributions after three years of service. The employer contribution represents a percentage of a participant’s eligible compensation. The Company’s 401(k) Plan costs were $2.0 million, $1.7 million, $1.1 million and $0.3 million during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively, and were allocated between Direct costs, excluding depreciation and amortization, and Selling, general and administrative in the consolidated statements of operations. The Company has various defined contribution arrangements for eligible employees of non-U.S. entities. These defined contribution arrangements provide employees with retirement savings and life insurance benefits. The Company incurred expenses related to these arrangements of $0.7 million, $0.7 million, $0.5 million and $0.2 million in the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively, and were allocated between Direct costs, excluding depreciation and amortization, and Selling, general and administrative in the consolidated statements of operations. The Company is also required to pay certain minimum statutory post-employment benefits. The Company recognizes a liability and the associated expense for these benefits when it is probable that employees are entitled to the benefit. 12. INCOME TAXES The Company files income tax returns for U.S. federal and various U.S. states, as well as various foreign jurisdictions. The liabilities for unrecognized tax benefits are carried in Other long-term liabilities on the consolidated balance sheets because the payment of cash is not anticipated within one year of the balance sheet date. The components of income (loss) before income taxes consisted of the following (in thousands): - 114 - Income tax provision (benefit) consisted of the following (in thousands): The difference between the statutory rate for federal income tax and the effective income tax rate was as follows (in thousands): - 115 - The undistributed earnings of foreign subsidiaries at December 31, 2016 and 2015 were approximately $15.1 million and $10.4 million, respectively, and have been permanently reinvested. It is not practicable to determine the amount of the additional taxes that would result if these earnings were repatriated. Components of the Company’s net deferred tax liability included in the consolidated balance sheets consisted of the following at December 31 (in thousands): The deferred tax asset attributable to U.S. state and local tax credits and carryforwards above includes less than $0.1 million for U.S. state and local operating loss carryforwards that will expire in 2029 if not utilized. The Company has foreign operating loss carryforwards for which a deferred tax asset of $0.2 million has been established. The Company has a valuation allowance of $0.2 million against this deferred tax asset based upon its assessment that it is more likely than not that this amount will not be realized. The ultimate realization of this tax benefit is dependent upon the generation of sufficient operating income in the respective tax jurisdictions. Approximately 74% of the foreign net operating loss carryforwards can be utilized over an indefinite period whereas the remainder will expire at various times from 2020 to 2025 if not utilized. In December 2013, the Company recorded an impairment loss of $2.3 million and an associated deferred tax asset of $0.8 million on its cost method investment in a related party. In March 2014, the investment was sold and the company incurred a capital loss. This loss is limited to offset future capital gains which the Company does not anticipate will be generated, thus a valuation allowance of $0.8 million has been recorded as it is more likely than not that realization cannot be assured. Annual activity related to the Company’s valuation allowance is as follows (in thousands): - 116 - A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows (in thousands): Interest and penalties associated with uncertain tax positions are recognized as components of Income tax provision (benefit) in the consolidated statements of operations. There was no material change to tax-related interest and penalties during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014. As of December 31, 2016 and 2015, respectively, the Company has a liability for interest and penalties of $1.0 million and $0.6 million that is associated with related tax liabilities of $4.3 million and $1.8 million for uncertain tax positions. The Company operates in various foreign, state and local jurisdictions. The number of tax years for which the statute of limitations remains open for foreign, state and local jurisdictions varies by jurisdiction and is approximately four years (2012 through 2016). For federal tax purposes, the Company’s open tax years are 2012 through 2016. 13. MISCELLANEOUS (EXPENSE) INCOME, NET Miscellaneous (expense) income, net consisted of the following (in thousands): 14. RELATED PARTY TRANSACTIONS Employee Loans The Company periodically extends short term loans or advances to employees, typically upon commencement of employment. Total receivables as a result of these employee advances of $0.2 million and 0.2 million existed at December 31, 2016 and December 31, 2015, respectively, and are included in the Prepaid expenses and other current assets and Other assets line items of the consolidated balance sheets, respectively, depending on the contractual repayment date. Management Fees In conjunction with the IPO, the Advisory Services Agreement with Cinven Capital Management (V) General Partner Limited (“Cinven”) expired. Subsequent to the IPO, the Company will pay fees for director services provided by Cinven employees that are members of the Company’s Board of Directors and any related committees. The director fees will be paid directly to Cinven in accordance with the Company’s non-employee director compensation policy. During the Successor years ended December 31, 2016 and 2015, and the Successor nine month period ended December 31, 2014, the Company incurred management fees to Cinven of $0.2 million, $0.3 - 117 - million and $0.2 million, respectively, and related travel expenses of $0.1 million, $0.1 million and $0.1 million, respectively. During the Successor year ended December 31, 2016, the Company incurred director fees of $0.1 million. As of December 31, 2016 and 2015, the Company had outstanding accounts payable to Cinven of $0.1 million and $0.1 million, respectively. Consulting Fees During the Successor period ended December 31, 2014, the Company paid $1.7 million in consulting fees to an investment banking firm in connection with the Transaction. A managing member of this firm was previously a Medpace board member. Service Agreements Symplmed Pharmaceuticals, LLC (“Symplmed”) Medpace Investors LLC, a noncontrolling shareholder of the Company that is owned by employees of the Company and managed by our chief executive officer, has a majority ownership interest in Symplmed Pharmaceuticals, LLC (“Symplmed”), a private pharmaceutical development company. In addition, the chief executive officer and other executives of the Company are board members of Symplmed. The Company has operated under a Master Services Agreement (“MSA”) with Symplmed since 2013 (amended in 2014) to perform clinical trials and related activities. Certain task orders governed by this arrangement were amended in the third quarter of 2016, changing the fee structure from unitized in nature to time and materials and revised pricing based on the Company’s leveraging of this work to develop and enhance certain new service capabilities. The Company has evaluated its relationship with Symplmed and concluded that Symplmed is not a variable interest entity because the Company has no direct ownership interest or relationship other than the MSA. During the Successor years ended December 31, 2016 and 2015 and the Successor Period ended December 31, 2014, the Company recognized related party transactions of less than $(0.1) million, $1.2 million and $1.2 million as service revenue in the consolidated statements of operations, respectively. As of December 31, 2016 and 2015 the Company had accounts receivable from Symplmed of less than $0.1 million and $0.3 million recorded in the consolidated balance sheet. Coherus BioSciences, Inc. (“Coherus”) and MX II Associates, LLC (“MXII”) The chief executive officer of the Company is a member of Coherus BioSciences, Inc.’s (“Coherus”) board of directors. During 2011 a related party of the Company in which the Company’s chief executive officer is the managing member, MXII, made an investment in Coherus. In early 2012 the Company made a $2.5 million investment in Coherus. Concurrent with the initial investment, MXII secured the exclusive rights for Medpace to perform Phase I through Phase III clinical trial work for certain Coherus’ “bio-similar” drug compounds executed through a MSA. In return, Medpace agreed to pay a 10% sales commission to MXII on cash received from Coherus. The commission agreement between the Company and MXII was terminated during 2015 but did not impact the MSA between the Company and Coherus. The agreement provides for a minimum fee commitment for clinical trial services and is cancelable without cause by either party upon 30 days prior notice. Medpace paid commissions of $1.1 million, $0.6 million and $0.3 million during the Successor year ended December 31, 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively, which were recorded in Selling, general and administrative in the consolidated statements of operations. During the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, the Company recognized service revenue of $22.3 million, $22.1 million, $10.6 million and $2.0 million from Coherus in the Company’s consolidated statements of operations, respectively. In addition, the company recognized Reimbursed out-of-pocket revenue and Reimbursed out-of-pocket expenses with Coherus in the consolidated statements of operations of $5.1 million, $6.9 million, $2.0 million and $0.1 million during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively. As of December 31, 2016 and December 31, 2015 the Company had Accounts receivable and unbilled, net from Coherus of $2.0 million and $2.3 million recorded in the consolidated balance sheets, respectively. In addition, the Company had Advanced billings of $6.3 million and $8.4 million and Pre-funded study costs of $3.8 million and $3.5 million with Coherus recorded in the consolidated balance sheets at December 31, 2016 and 2015, respectively. - 118 - In March 2014, the Predecessor’s cost method investment in Coherus was sold to Medpace Investors for $0.3 million and was reflected in the other income component of Miscellaneous (expense) income, net in the consolidated statements of operations for the Predecessor Period ended March 31, 2014. Xenon Pharmaceuticals, Inc. (“Xenon”) Certain executives and employees of the Company, including the chief executive officer, have equity investments in Xenon, a clinical-stage biopharmaceutical company. In addition, a Medpace employee was a director of Xenon until May 2015. During July 2015 the Company and Xenon entered into an amended MSA agreement for the Company to provide certain clinical development services. The Company recognized service revenue from Xenon of $1.3 million and $0.7 million during the Successor years ended December 31, 2016 and 2015, respectively, in the Company’s consolidated statements of operations. In addition, the company recognized Reimbursed out-of-pocket revenue and Reimbursed out-of-pocket expenses with Xenon in the consolidated statements of operations of $0.2 million and less than $0.1 million during the Successor years ended December 31, 2016 and 2015, respectively. As of December 31, 2016 and December 31, 2015 the Company had Accounts receivable and unbilled, net from Xenon of $0.3 million and less than $0.1 million recorded in the consolidated balance sheets, respectively. As of December 31, 2016 and 2015, respectively, the Company had, from Xenon, $1.3 million and $1.8 million of Advanced billings and $0.1 million and $0.2 million of Pre-funded study costs, in the consolidated balance sheets. Cymabay Therapeutics, Inc. (“Cymabay”) Cymabay is a clinical-stage biopharmaceutical company developing therapies to treat metabolic diseases with high unmet medical need, including serious rare and orphan disorders. During the first quarter of 2016, it was announced that a Medpace employee would join Cymabay’s board of directors. The Company and Cymabay entered into a MSA dated October 21, 2016. Subsequently, the Company and Cymabay have entered into several task orders for the Company to perform various central laboratory services. The Company recognized service revenue from Cymabay of $0.3 million and $0.1 million during the Successor years ended December 31, 2016 and 2015, respectively, in the Company’s consolidated statements of operations. LIB Therapeutics LLC (“LIB”) Certain executives and employees of the Company, including the chief executive officer, are members of LIB’s board of directors. The Company entered into a MSA dated November 24, 2015 with LIB, a company that engages in research, development, marketing and commercialization of pharmaceutical drugs. Subsequently, the Company and LIB have entered into several task orders for the Company to perform various clinical development and central laboratory services. The Company recognized service revenue from LIB of $0.2 million during the Successor year ended December 31, 2016 in the Company’s consolidated statements of operations. Medpace Investors, LLC Medpace Investors is a noncontrolling shareholder and related party of Medpace Holdings, Inc. Medpace Investors is owned and managed by employees of the Company. The Company’s chief executive officer is also the manager and majority unit holder of Medpace Investors. The Successor acts as a paying agent for Medpace Investors with taxing authorities principally in instances when employee tax payments or remittance of withholdings related to equity compensation are required. During the Successor years ended December 31, 2016 and 2015, and the Successor Period ended December 31, 2014, the Company paid $0.8 million, $0.9 million and $1.4 million to various taxing authorities on behalf of Medpace Investors. During the Successor year ended December 31, 2016, the Company received $0.3 million from Medpace Investors for receivables owed to the Company from Symplmed. Additionally, the Company paid approximately $0.3 million to Medpace Investors due to the settlement of certain liabilities related to the Merger Agreement between the sellers (led by CCMP) and the buyers (led by Cinven). See Note 2 for further information. - 119 - Leased Real Estate Headquarters Lease The Company has entered into operating leases for its corporate headquarters and a storage space facility with an entity that is wholly owned by the Company’s chief executive officer. The Company has evaluated its relationship with the related party and concluded that the related party is not a variable interest entity because the Company has no direct ownership interest or relationship other than the leases. The lease for headquarters is for an initial term of twelve years through November 2022 with a renewal option for one 10-year term at prevailing market rates. The lease for storage space was through June 2016 and was leased on a month to month basis, thereafter. The Company pays rent, taxes, insurance, and maintenance expenses that arise from the use of the properties. Annual base rent for the corporate headquarters is $2.1 million and allows for adjustments to the rental rate annually for increases in the consumer price index. Lease expense recognized for the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014 was $2.1 million, $2.1 million, $1.6 million and $0.5 million. The lease expense was allocated between Direct costs, excluding depreciation and amortization, and Selling, general and administrative in the consolidated statements of operations. Deemed Assets and Deemed Landlord Liabilities The Company entered into two multi-year lease agreements governing the occupancy of space of two buildings in Cincinnati, Ohio with an entity that is wholly owned by the Company’s chief executive officer and certain members of his immediate family. In accordance with the accounting guidance related to leases, the Company was deemed in substance to be the owner of the property during the construction phase and at completion. Accordingly, the Company reflected the buildings and related liabilities as deemed assets from landlord building construction in Property and equipment, net, Other current liabilities, and Deemed landlord liabilities, respectively, on the consolidated balance sheets. The Company assumed occupancy in 2012 and the leases expire in 2027 with the Company having one 10-year option to extend the lease term. The deemed assets are being fully depreciated, on a straight line basis, over the 15-year term of the lease. Deemed landlord liabilities are recorded at their net present value when the Company enters into qualifying leases and are reduced as the Company makes periodic lease payments on the properties. Accretion expense is being recorded over the term of the lease as a component of Interest expense, net in the Company’s consolidated statements of operations. The Company paid $3.7 million, $3.4 million, $3.1 million and $0.9 million during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014, the Predecessor Period ended March 31, 2014, respectively. The current and long-term portions of the Deemed landlord liability at December 31, 2016 were $1.7 million and $28.5 million, respectively. The current and long-term portions of the Deemed landlord liability at December 31, 2015 were $1.6 million and $30.3 million, respectively. The Company has recognized $18.1 million and $19.8 million, respectively, of deemed assets, net at December 31, 2016 and 2015 in the consolidated balance sheets. Travel Services Reynolds Jet Management The Company incurs expenses for travel services for company executives provided by a private aviation charter company that is owned by the chief executive officer and the senior vice president of operations of the Company (“private aviation charter”). The Company may contract directly with the private aviation charter for the use of its aircraft or indirectly through a third party aircraft management and jet charter company (the “Aircraft Management Company”). The travel services provided are primarily for business purposes, with certain personal travel paid for as part of the executives’ compensation arrangements. The Aircraft Management Company also makes the private aviation charter aircraft available to third parties. The Company incurred travel expenses of $1.0 million, $0.9 million, $0.5 million and $0.1 million during the Successor years ended December 31, 2016 and 2015, the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively. These travel expenses are recorded in Selling, general and administrative in the Company’s consolidated statements of operations. - 120 - Common Stock Purchases During 2015, an employee of the Company entered into a stock purchase agreement (“SPA”) with the Company that permitted the purchase of 37,037 shares of the Company’s common stock at the then-current value for those shares. There was no stock-based compensation expense recognized in relation to the SPA due to no required services to be rendered in exchange for shares. The proceeds from this SPA are reflected as Proceeds from sale of common stock in the consolidated statement of cash flows for the Successor year ended 2015. Assets and Obligations Related to Former Owners Pursuant to the Medpace, Inc. Stock Purchase Agreement dated June 17, 2011 (the “Predecessor Purchase Agreement”), certain tax indemnifications between the sellers (a group led by the former majority shareholder who is the current chief executive officer, the “Former Owners”) and the buyers (led by CCMP) were entered into regarding contingencies that could arise after the June 17, 2011 transaction, as well as tax payments or refunds that were finalized after June 17, 2011 but which relate to periods prior to the Predecessor Purchase Agreement date. In February 2015, a settlement was reached with a local taxing authority regarding the refund of income tax payments made by the Company prior to June 17, 2011. On the consolidated balance sheets at December 31, 2016 and 2015, the Successor has $0.1 million and $0.4 million in Prepaid expenses and other current assets and Other assets related to the tax refund due from the local taxing authority and $0.1 million and $0.4 million in Other current liabilities and Other long-term liabilities representing the obligation to the Former Owners. The Successor has less than $0.1 million and $0.1 million in Prepaid expenses and other current assets and $0.0 million and $0.1 million in Other current liabilities on the consolidated balance sheets at December 31, 2016 and 2015, associated with refunds from various other taxing authorities that were generated prior to June 17, 2011. 15. ACQUISITION AND INTEGRATION EXPENSES The Successor and the Predecessor incurred $9.3 million and $12.4 million of one-time Acquisition and integration expenses related to the Transaction during the Successor Period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively, primarily for investment banking, legal, accounting, consulting and other advisory fees. 16. ENTITY WIDE DISCLOSURES Operations By Geographic Location The Company conducts operations in North America, Europe, Africa, Asia-Pacific and Latin America through wholly-owned subsidiaries and representative sales offices. The Company attributes service revenue to geographical locations based upon the location of the contracting entity. For the Successor years ended December 31, 2016 and 2015, service revenue attributable to the U.S. represented approximately 98% of total consolidated service revenue, net. No other country or region represents more than 5% of service revenue, net. The following table summarizes property and equipment, net by geographic region and is further broken down to show countries which account for 10% or more of total as of December 31, (in thousands): - 121 - Products & Services Clinical research services and laboratory services represented approximately 87% and 13%, 87% and 13%, 85% and 15% and 85% and 15% of consolidated service revenue, net for the Successor years ended December 31, 2016 and 2015, the Successor period ended December 31, 2014 and the Predecessor Period ended March 31, 2014, respectively. 17. QUARTERLY FINANCIAL DATA (unaudited) The following table summarizes the Company's unaudited quarterly results of operations (in thousands, except per share data): - 122 - | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement excerpt. It contains partial information about assets, liabilities, and an acquisition, but lacks sufficient context to provide a comprehensive summary.
The snippet suggests:
- A financial statement related to Medpace Holdings, Inc.
- An acquisition transaction with a purchase price of $921,300
- A new credit facility established as part of the transaction
- Some debt extinguishment
To provide a meaningful summary, I would need the complete financial statement with full details about revenues, expenses, assets, liabilities, and cash flows. If you can share the complete document, I'd be happy to help you summarize it. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCOUNTING FIRM To the Board of Governors and Members Highwater Ethanol, LLC We have audited the accompanying balance sheets of Highwater Ethanol, LLC (the Company) as of October 31, 2016 and 2015, and the related statements of operations, comprehensive income, changes in members’ equity, and cash flows for each of the three years in the period ended October 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of October 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended October 31, 2016, in conformity with U.S. generally accepted accounting principles. /s/ RSM US LLP Sioux Falls, South Dakota January 25, 2017 HIGHWATER ETHANOL, LLC Balance Sheets Notes to Financial Statements are an integral part of this Statement. HIGHWATER ETHANOL, LLC Statements of Operations Notes to Financial Statements are an integral part of this Statement. HIGHWATER ETHANOL, LLC Statements of Comprehensive Income Notes to Financial Statements are an integral part of this Statement. HIGHWATER ETHANOL, LLC Statements of Changes in Members' Equity Notes to Financial Statements are an integral part of this Statement. HIGHWATER ETHANOL, LLC Statements of Cash Flows Notes to Financial Statements are an integral part of this Statement. HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Business Highwater Ethanol, LLC, (a Minnesota Limited Liability Company) operates a 50 million gallon per year ethanol plant in Lamberton, Minnesota. The Company produces and sells fuel ethanol and co-products of the fuel ethanol production process, in the continental United States, Mexico and Canada. Accounting Estimates Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. The Company uses estimates and assumptions in accounting for significant matters, among others, the carrying value of property and equipment and related impairment testing, inventory valuation, and derivative instruments. Actual results could differ from those estimates and such differences may be material to the financial statements. The Company periodically reviews estimates and assumptions and the effects of revisions are reflected in the period in which the revision is made. Revenue Recognition The Company generally sells ethanol and related products pursuant to marketing agreements. The Company’s products are shipped FOB shipping point. Revenues are recognized when the customer has taken title and has assumed the risks and rewards of ownership, prices are fixed or determinable and collectability is reasonably assured. For ethanol sales, title transfers when loaded into the rail car and for distiller’s grains when the loaded rail cars leave the plant facility. In accordance with the Company’s agreements for the marketing and sale of ethanol and related products, marketing fees and freight due to the marketers are deducted from the gross sales price at the time incurred. Revenue is recorded net of these marketing fees and freight as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products. Cash and Cash Equivalents The Company maintains its accounts primarily at one financial institution. The cash balances regularly exceed amounts insured by the Federal Deposit Insurance Corporation. The Company does not believe it is exposed to any significant credit risk on cash and cash equivalent balances. Derivative Instruments Derivatives are recognized in the balance sheets and the measurement of these instruments are at fair value. In order for a derivative to qualify as a hedge, specific criteria must be met and appropriate documentation maintained. Gains and losses from derivatives that do not qualify as hedges, or are undesignated, must be recognized immediately in earnings. If the derivative does qualify as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. Contracts are evaluated to determine whether the contracts are derivatives. Certain contracts that literally meet the definition of a derivative may be exempted as “normal purchases or normal sales”. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from accounting as derivatives, therefore, are not marked to market in our financial statements. The Company entered into corn commodity-based and natural gas derivatives in order to protect cash flows from fluctuations caused by volatility in prices. These derivatives are not designated as effective hedges for accounting purposes. For derivative instruments that are not accounted for as hedges, or for the ineffective portions of qualifying hedges, the change in fair value is HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 recorded through earnings in the period of change. Corn and natural gas derivative changes in fair market value are included in costs of goods sold. Accounts Receivable Credit terms are extended to customers in the normal course of business. The Company routinely monitors accounts receivable and customer balances are generally kept current at 30 days or less. The Company generally requires no collateral. Accounts receivable are recorded at their estimated net realizable value. Accounts are considered past due if payment is not made on a timely basis in accordance with the Company’s credit terms. Accounts considered uncollectible are written off. The Company’s estimate of the allowance for doubtful accounts is based on historical experience, its evaluation of the current status of receivables, and unusual circumstances, if any. At October 31, 2016 and 2015, the Company believed that such amounts would be collectible and an allowance was not considered necessary. Inventories Inventories consist of raw materials, supplies, work in process and finished goods. Raw materials and supplies are stated at the lower of cost (first-in, first-out method) or net realizable value. Work in process and finished goods are stated at the lower of average cost or net realizable value. Property and Equipment Property and equipment is stated at cost. Depreciation is provided over an estimated useful life by use of the straight line method. Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized. The present value of capital lease obligations is classified as long-term debt and the related assets will be included with property and equipment. Amortization of property and equipment under capital lease is included with depreciation expense. Depreciation is computed using the straight-line method over the following estimated useful lives: Carrying Value of Long-Lived Assets Long-lived assets, such as property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. In accordance with the Company’s policy for evaluating impairment of long-lived assets described above, when a triggering event occurs management evaluates the recoverability of the facilities based on projected future cash flows from operations over the facilities’ estimated useful lives. In determining the projected future undiscounted cash flows, the Company makes significant assumptions concerning the future viability of the ethanol industry, the future price of corn in relation to the future price of ethanol and the overall demand in relation to production and supply capacity. The Company has not recorded any impairment as of October 31, 2016 and 2015. HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 Fair Value of Financial Instruments The carrying value of cash and cash equivalents, accounts receivable, and accounts payable, and other working capital items approximate fair value at October 31, 2016 and 2015 due to the short maturity nature of these instruments. Commodities contracts are carried at fair value, based on dealer quotes and live trading levels. The Company believes the carrying amount of the long-term debt approximates fair value due to a significant portion of total indebtedness containing variable interest rates and this rate is a market interest rate for these borrowings. Equity Method Investments The Company has a 7% investment interest in an unlisted company, Renewable Fuels Marketing Group, LLC (RPMG), who markets the Company’s ethanol. The Company also has a 7% ownership interest in Lawrenceville Tank, LLC (LT), which owns and operates a trans load/tank facility near Atlanta, Georgia. These investments are flow-through entities and are being accounted for by the equity method of accounting under which the Company’s share of net income is recognized as income in the Company’s statements of operations and added to the investment account. Distributions or dividends received from the investments are treated as a reduction of the investment account. The Company consistently follows the practice of recognizing the net income based on a one month lag. Therefore, net income related to RPMG is reported in the Company’s statements of operations for the years ended October 31, 2016, 2015 and 2014 is based on RPMG's results of operations for the twelve month periods ended September 30, 2016, 2015 and 2014. Net income related to LT which is reported in the Company’s statement of operations for the year ended October 31, 2016 and 2015, is based on LT's results of operations for the year ended September 30, 2016 and the ten months ended September 30, 2015. Debt Issuance Costs Costs associated with the issuance of debt are recorded as debt issuance costs and are amortized over the term of the related debt by use of the effective interest method. Net Income per Unit Basic net income per unit is computed by dividing net income by the weighted average number of members’ units outstanding during the period. Diluted net income per unit is computed by dividing net income by the weighted average number of members’ units and members’ unit equivalents outstanding during the period. There were no member unit equivalents outstanding during the periods presented; accordingly, for all periods presented, the Company’s basic and diluted net income per unit are the same. Income Taxes The Company is treated as a partnership for federal and state income tax purposes and generally does not incur income taxes. Instead, their income or losses are included in the income tax returns of the members and partners. Accordingly, no provision or liability for federal or state income taxes has been included in these financial statements. The Company recognizes and measures tax benefits when realization of the benefits is uncertain under a two-step approach. The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%. The Company has not recognized any liability for unrecognized tax benefits and has not identified any uncertain tax positions. The Company files income tax returns in the U.S. federal and Minnesota state jurisdictions. The Company is no longer subject to U.S. federal and state income tax examinations by tax authorities beyond three years. Railcar Damages Accrual In accordance with the railcar lease agreements, the Company is required to pay for damages considered to be in excess of normal wear and tear at the termination of the lease. The Company accrues the estimated cost for railcar damages over the term of the lease. HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 Environmental Liabilities The Company’s operations are subject to environmental laws and regulations adopted by various governmental entities in the jurisdiction in which it operates. These laws require the Company to investigate and remediate the effects of the release or disposal of materials at its location. Accordingly, the Company has adopted policies, practices, and procedures in the areas of pollution control, occupational health, and the production, handling, storage, and use of hazardous materials to prevent material environmental or other damage, and to limit the financial liability, which could result from such events. Environmental liabilities are recorded when the liability is probable and the costs can be reasonably estimated. Segment Reporting Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker or decision making group in deciding how to allocate resources and in assessing performance. The Company has determined that it has one reportable business segment, the manufacture and marketing of fuel-grade ethanol and the co-products of the ethanol production process. The Company's chief operating decision maker reviews financial information of the Company as a whole for purposes of assessing financial performance and making operating decisions. Accordingly, the Company considers itself to be operating in a single industry segment. Recent Accounting Pronouncements In May 2014, the FASB issued ASU No. 2014-09 (ASU 2014-09), Revenue from Contracts with Customers, which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The new standard requires a company to recognize revenue when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. Additionally, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, which is the Company’s first quarter of fiscal year 2019. Early application is permitted one year earlier. The new standard allows for the amendment to be applied either retrospectively to each prior reporting period presented or retrospectively as a cumulative-effect adjustment as of the date of adoption. The Company is evaluating the effect that ASU 2014-09 will have on its financial statements and related disclosures, including which transition method it will adopt. In April 2015, the FASB issued ASU No. 2015-03 (ASU 2015-03), Interest-Imputation of Interest, which simplifies the presentation of debt issuance costs. The new standard debt issuance costs will be reclassified as a deduction to the carrying amount of the related debt balance, therefore, decreasing both assets and liabilities. ASU 2015-03 is effective for fiscal periods beginning after December 31, 2015. The Company is evaluating the effect that ASU 2015-03 will have on its financial statements and related disclosures, including which transition method it will adopt. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU requires lessees to recognize a lease liability and a right-to-use asset for all leases, including operating leases, with a term greater than twelve months on its balance sheet. This ASU is effective in annual and interim periods in fiscal years beginning after December 15, 2018, with early adoption permitted, and requires a modified retrospective transition method. The Company is currently in the process of evaluating the impact that this new guidance will have on the Financial Statements. In August 2016, the FASB issued ASU No. 2016-15 (ASU 2016-15), Statement of Cash Flows (Topic 230), which clarifies and provides guidance for specific cash flow issues. ASU 2016-15 is effective for fiscal periods beginning after December 15, 2017. The Company is currently in the process of evaluating the impact that this new guidance will have on the Financial Statements. In January 2016, the FASB issued ASU No. 2016-01 (ASU2016-01), Financial Instruments-Overall (Subtopic 825-10), which is intended to make financial statement information on recognition, measurement, presentation, and disclosure of financial instrument more useful. ASU 2016-01 is effective for fiscal periods beginning after December 15, 2017. The Company is currently in the process of evaluating the impact that this new guidance will have on the Financial Statements. 2. UNCERTAINTIES The Company derives substantially all of its revenues from the sale of ethanol, distillers grains and corn oil. These products are commodities and the market prices for these products display substantial volatility and are subject to a number of factors which HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 are beyond the control of the Company. The Company’s most significant manufacturing inputs are corn and natural gas. The price of these commodities is also subject to substantial volatility and uncontrollable market factors. In addition, these input costs do not necessarily fluctuate with the market prices for ethanol and distillers grains. As a result, the Company is subject to significant risk that its operating margins can be reduced or eliminated due to the relative movements in the market prices of its products and major manufacturing inputs. As a result, market fluctuations in the price of or demand for these commodities can have a significant adverse effect on the Company’s operations, profitability, and availability of cash flows to make loan payments and maintain compliance with the loan agreement. 3. CONCENTRATIONS The Company has identified certain concentrations that are present in their business operations. The Company’s revenue from ethanol sales, distillers grains and corn oil sales are each derived from a single customer under marketing agreements as described in Note 12. The Company purchases all corn from a single supplier under a grain procurement agreement described in Note 12. The Company has a revenue concentration in that its revenue is generated from the sales of primarily two products, ethanol and distillers grains. The Company sold all ethanol produced to a related party under an ethanol marketing agreement described in Note 12. Total sales for the years ended October 31, 2016, 2015 and 2014 were $78,779,681, $86,024,565 and $111,591,475, respectively. Accounts receivable as of October 31, 2016 and 2015 were$3,045,438 and $1,782,168, respectively. 4. FAIR VALUE MEASUREMENTS Various inputs are considered when determining the value of financial instruments. The inputs or methodologies used for valuing financial instruments are not necessarily an indication of the risk associated with investing in these instruments. These inputs are summarized in the three broad levels listed below: • Level 1 inputs are quoted prices in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. • Level 2 inputs include the following: ◦ Quoted prices in active markets for similar assets or liabilities. ◦ Quoted prices in markets that are not active for identical or similar assets or liabilities. ◦ Inputs other than quoted prices that are observable for the asset or liability. ◦ Inputs that are derived primarily from or corroborated by observable market data by correlation or other means. • Level 3 inputs are unobservable inputs for the asset or liability. The following table provides information on those assets (liabilities) measured at fair value on a recurring basis. The Company determines the fair value of the commodities contracts by obtaining the fair value measurements from an independent pricing service based on dealer quotes and live trading levels from the Chicago Board of Trade. HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 5. INVENTORIES Inventories consisted of the following at: 6. DERIVATIVE INSTRUMENTS As of October 31, 2016, the Company had entered into corn and natural gas derivative instruments, which are required to be recorded as either assets or liabilities at fair value in the balance sheet. The Company uses these instruments to manage risks from changes in market rates and prices. They are not used for speculative purposes. Derivatives qualify for treatment as hedges when there is a high correlation between the change in fair value of the derivative instrument and the related change in value of the underlying hedged item. The Company may designate the hedging instruments based upon the exposure being hedged as a fair value hedge, a cash flow hedge or a hedge against foreign currency exposure. The derivative instruments outstanding at October 31, 2016 are not designated as effective hedges for accounting purposes. Commodity Contracts As of October 31, 2016, the Company has open positions for 1,400,000 bushels of corn, 9,348,000 gallons of ethanol and 30,000 dekatherms of natural gas. Management expects all open positions outstanding as of October 31, 2016 to be realized within the next twelve months. The following tables provide details regarding the Company's derivative instruments at October 31: The following tables provide details regarding the gains (losses) from the Company's derivative instruments in the statements of operations, none of which are designated as hedging instruments: HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 7. INVESTMENT IN RPMG The financial statements of RPMG are summarized as of and for the years ended September 30 as follows: 8. DEBT FINANCING Long-term debt consists of the following at: Bank Financing On January 22, 2016, the Company entered into a Second Amended and Restated Credit Agreement with AgStar Financial Services, PCA, as administrative agent for several financial institutions ("AgStar") which amended the Amended and Restated Credit Agreement dated September 22, 2014. The Second Amended and Restated Credit Agreement decreases the Term Loan to $15,000,000, increases the Term Revolving Loan to $15,000,000 and eliminates the Revolving Line of Credit. Term Loan The Term Loan is for $15,000,000 with a variable interest rate that is the greater of the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at October 31, 2016 was 3.77%. Monthly principal payments are due on the Term Loan of approximately $250,000 plus accrued interest. Payments are based upon a five year amortization and the Term Loan is fully amortized. The outstanding balance on this note was $12,750,000 at October 31, 2016. The Company may convert the Term Loan to a fixed rate loan, subject to certain conditions as described in the Amended and Restated Credit Agreement and with the consent of AgStar. Term Revolving Loan The Term Revolving Loan is for up to $15,000,000 with a variable interest rate that is the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at October 31, 2016 was 3.77%%. The availability under the Term Revolving Loan increases to $20,000,000 after the Term Loan is paid down to $10,000,000 so long as at least one or more of the participating banks agrees to raise its commitment. The Term Revolving Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Term Revolving Loan. Payment of all amounts outstanding is due on January 22, 2023. The outstanding balance was $3,937,839 at October 31, 2016. As of October 31, 2016, the Company has $1,500,000 HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 in letters of credit outstanding which reduce the amount available under the Term Revolving Loan. The Company pays interest at a rate of 1.5% on amounts outstanding for the letters of credit. The Company is also required to pay unused commitment fees for the Term Revolving Loan as defined in the Second Amended and Restated Credit Agreement. Covenants and other Miscellaneous Terms The loan facility with AgStar is secured by substantially all business assets. The Company executed a mortgage creating a first lien on its real estate and plant and a security interest in all personal property located on the premises and assigned all rents and leases to property, marketing contracts, risk management services contract, and natural gas, electricity, water service and grain procurement agreements. The Company is also subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, tangible net worth, and working capital requirements. The fixed charge coverage ratio is no less than 1.25:1.00 and is measured annually by comparing adjusted EBITDA to scheduled payments of principal and interest. The minimum working capital is $8,250,000, which is calculated as current assets plus the amount available for drawing under our Term Revolving Loan, and undrawn amounts on outstanding letters of credit less current liabilities, and is measured quarterly. The Company is limited to annual capital expenditures of $5,000,000 without prior approval, incurring additional debt over certain amounts without prior approval, and making additional investments as described in the Amended and Restated Credit Agreement without prior approval of AgStar. The Company is allowed to make distributions to members as frequently as monthly in an amount equal to 75% of net income if working capital is greater than or equal to $8,250,000, or 100% of net income if working capital is greater than or equal to $11,000,000, or an unlimited amount if working capital is greater than or equal to $11,000,000 and the outstanding balance on the Term Loan is $0. Capital Leases The Company entered into a series of related definitive agreements, dated September 26, 2013, with Butamax which include an Easement for Construction and Process Demonstration Agreement, an Equipment Lease Agreement, a Technology License Agreement, a Technology Demonstration Risk Reduction Agreement and a Security Agreement (collectively, the "Agreements") pursuant to which Butamax has agreed to construct, install and lease its corn oil separation system and license to the Company its proprietary, patent-protected corn oil separation technology. Pursuant to the Agreements, the Company agreed to give Butamax access to the plant in order to construct, install, operate, test and commercially validate a corn oil separation system. Butamax retains ownership of the corn oil separation system and technology but agrees to lease it to the Company for a term of 120 months subject to Butamax's right to remove the system if the Company is in breach of the Agreements. The term of the lease may also be extended or terminated pursuant to the terms of the Agreements. The Company is responsible for repairs and maintenance of the system and bear the risk of loss. In return, the Company agrees to payment of certain license fees which are subject to being reduced under the terms of the Agreements if the corn oil separation system does not meet certain performance goals. The Agreements provide that the corn oil separation system shall be conveyed to the Company at the end of the term so long as the Company is not in breach of the Agreements. The Company granted a security interest to Butamax in the corn oil separation system to secure its obligations under the Agreements. Pursuant to the Agreements, the Company agreed, subject to certain obligations of confidentiality, to provide Butamax with Company information on a monthly basis including business and financial information and have granted Butamax the option to have a representative present in board and committee meetings as an observer. The Company also agreed to give Butamax notice in the event of an issuance or sale of membership interests or convertible debt instruments. The Company recorded this as a capital lease in April 2014, and the balance as of October 31, 2016 was $547,327. The estimated maturities of the long-term debt at October 31, 2016 are as follows: HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 9. LEASES The Company leases rail cars and equipment under operating and capital leases. Rail car leases include additional payments for usage beyond specified levels. Total lease expense for the years ending October 31, 2016, 2015 and 2014 was approximately$295,920, $269,000 and $218,000, respectively. Future minimum lease payments under the leases are as follows at October 31, 2016: 10. MEMBERS' EQUITY The Company has one class of membership units, and is authorized to issue up to 10,000 units, which include certain transfer restrictions as specified in the operating agreement and pursuant to applicable tax and securities law, with each unit representing a pro rata ownership in the Company’s capital, profits, losses and distributions. Income and losses are allocated to all members based upon their respective percentage of units held. 11. INCOME TAXES The Company has adopted an October 31 fiscal year end, but has a tax year end of December 31. The differences between financial statement basis and tax basis of assets are estimated as follows: The differences between the financial statement basis and tax basis of the Company's liabilities are estimated as follows: HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 12. COMMITMENTS AND CONTINGENCIES Marketing Agreements The Company has an ethanol marketing agreement with a marketer (RPMG) to purchase, market, and distribute all the ethanol produced by the Company. The Company also entered into a member control agreement with the marketer whereby the Company made capital contributions and became a minority owner of the marketer. The member control agreement became effective on February 1, 2011 and provides the Company a membership interest with voting rights. The marketing agreement will terminate if the Company ceases to be a member. The Company will assume certain of the member’s rail car leases if the agreement is terminated. The Company can sell its ethanol either through an index arrangement or at an agreed upon fixed price. The marketing agreement is perpetual until terminated according to the agreement. The Company may be obligated to continue to market its ethanol through the marketer for a period of time. The amended agreement requires minimum capital amounts invested as required under the agreement. The Company has a distillers grains marketing agreement with a marketer to market all the dried distillers grains produced at the plant. Under the agreement the marketer charges a maximum of $2.00 per ton and a minimum of $1.50 per ton price using 2% of the FOB plant price actually received by them for all dried distillers grains removed. The agreement will remain in effect unless otherwise terminated by either party with 120 days notice. Under the agreement, the marketer is responsible for all transportation arrangements for the distribution of the dried distillers grains. The Company markets and sells its modified and wet distillers grains. The Company has a crude corn oil marketing agreement with a marketer to market all corn oil to be produced at the plant. Under the agreement, the marketer will execute contracts with buyers after giving prior notice of the terms and conditions thereof to the Company and receiving direction from the Company to accept such contracts. The Company receives the actual price received from buyers less a marketing fee, actual freight and transportation costs and certain taxes related to the purchase, delivery or sale. The Company is required to provide corn oil meeting certain specifications as provided in the agreement and the agreement provides for a process for rejection of nonconforming corn oil. The agreement automatically renews for successive one-year terms unless terminated in accordance with the agreement. Grain Procurement Contracts The Company had a grain procurement agreement with a grain elevator to provide all of the corn needed for the operation of the ethanol plant. Under the agreement, the Company purchased corn at the local market price delivered to the plant plus a fixed fee per bushel of corn. The agreement expired in July 2016. The Company currently has a grain origination agreement with a marketer to provide all of the corn needed for operation of the ethanol plant. Under the agreement, the Company purchases corn at the CBOT futures price less the weighted average of the basis prices plus a fixed fee per bushel of corn purchased. The agreement runs for an initial five-year term which commenced on July 27, 2016 and automatically renews for successive one-year terms unless otherwise terminated in accordance with its terms. Regulatory Agencies The Company is subject to oversight from regulatory agencies regarding environmental concerns which arise in the ordinary course of its business. Forward Contracts At October 31, 2016, the Company has approximately 5,988,500 bushels of forward fixed basis corn contracts and 60,000 bushels of forward fixed price corn contracts valued at approximately $184,000. These purchase contracts are for various delivery periods through September 2017. At October 31, 2016, the Company has approximately 1,299,000 MMBTUs of forward natural gas fixed price purchase contracts valued at approximately $3,966,000 for delivery periods through August 2018. In addition, at October 31, 2016, the Company has approximately 240,000 gallons of forward fixed price denaturant purchase contracts valued at approximately $278,000 for delivery periods through December 2016. At October 31, 2016, the Company has approximately 4,640,000 gallons of forward fixed price ethanol sales contracts valued at approximately $6,160,000 for delivery periods through March 2017. At October 31, 2016, the Company has approximately 8,000 tons of forward fixed price dried distillers grains sales contracts valued at approximately $813,000 for delivery periods through December 2016. At October 31, 2016, the Company has approximately 22,000 tons of forward fixed price modified distillers grains sales contracts valued at approximately $1,215,000 for delivery periods through September 2017. In addition, at October 31, 2016, the Company has approximately 200,000 pounds of forward fixed price corn oil sales contracts valued at approximately $58,000 for delivery periods through November 2016. 13. QUARTERLY FINANCIAL DATA (UNAUDITED) The above quarterly financial data is unaudited, but in the opinion of management, all adjustments necessary for a fair presentation of the selected data for these periods presented have been included. HIGHWATER ETHANOL, LLC Notes to Financial Statements October 31, 2016 and 2015 14. SUBSEQUENT EVENT On December 7, 2016, the board of governors declared a cash distribution of $345 per membership unit for the holders of units of record at the close of business on December 7, 2016 for a total distribution of $1,687,740. The distribution was paid on December 15, 2016. | Here's a summary of the financial statement:
Key Points:
1. Derivatives & Hedging:
- Undesignated derivative losses must be recognized immediately in earnings
- Qualified hedge changes are offset against hedged assets/liabilities
- Normal purchase/sale contracts are exempt from derivative accounting
- Company uses corn and natural gas derivatives to protect against price volatility
2. Revenue Recognition:
- Sales typically made through marketing agreements
- Revenue recognized when customer takes title (FOB shipping point)
- Marketing fees and freight deducted from gross sales price
- Ethanol title transfers at rail car loading
3. Assets & Limitations:
- Cash balances often exceed FDIC insurance limits
- Capital expenditures limited to $5,000,000 annually
- Long-lived assets reviewed for impairment regularly
- Property and equipment valued using straight-line depreciation
4. Risk Management:
- Company maintains accounts primarily at one financial institution
- Regular evaluation of long-lived assets for impairment
- Cash flow projections used to evaluate facility viability
- No impairment recorded as of October 31
5. Accounting Practices:
- Company uses estimates for significant matters
- Regular review of assumptions and estimates
- Emphasis on fair value measurements
- Comprehensive documentation maintained for hedging activities
The statement reflects a company with significant commodity exposure that uses derivatives for risk management, while maintaining conservative accounting practices and regular asset valuations. | Claude |
ACCOUNTING FIRM To the Board of Directors and Stockholders of Success Entertainment Group International, Inc. We have audited the accompanying balance sheets of Success Entertainment Group International, Inc. as of December 31, 2016 and 2015, and the related statements of operations, stockholders’ equity (deficit), and cash flows for each of the years in the two-year period ended December 31, 2016. Success Entertainment Group International, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Success Entertainment Group International, Inc. as of December 31, 2016 and 2015, and the results of operations and cash flows for each of the years in the two-year period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has incurred accumulated deficit of $180,775 as of December 31, 2016 that includes loss of $61,354 for the year ended December 31, 2016 and further losses are anticipated in the development of its business. These factors raise substantial doubt about its ability to continue as a going concern. Management’s plans concerning this matter are also described in Note 2. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty. Yichien Yeh, CPA Oakland Gardens, New York April 13, 2017 See Notes to Financial Statements See Notes to Financial Statements See Notes to Financial Statements See Notes to Financial Statements SUCCESS ENTERTAINMENT GROUP INTERNATIONAL, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION AND NATURE OF BUSINESS Success Entertainment Group International, Inc. (“the Company”, ”we”, ”us”, or “our”) was incorporated in the State of Nevada on January 30, 2013 under the name Altimo Group Corp and its initial business plan was to place and operate frozen yogurt making machines. Effective July 14, 2014, there was a change in control of the Company. In accordance with the terms and provisions of a stock purchase agreement dated May 5, 2014 (the "Stock Purchase Agreement") by and among Marek Tomaszewski, the seller of an aggregate of 8,000,000 shares of common stock of the Company (the "Control Block Seller"), and Success Holding Group Corp. USA, a Nevada corporation (the "Control Block Purchaser"), the Control Block Purchaser purchased from the Control Block Shareholders all of the 8,000,000 shares of common stock held of record. In accordance with the terms and provisions of the Stock Purchase Agreement, the Company accepted the resignations of its sole officer and director, Marek Tomaszewski as President, Chief Executive Officer, Secretary, Treasurer and Chief Financial Officer effective July 14, 2014. Simultaneously, the Board of Directors appointed the following individuals: (i) Steve Chen as a member of the Board of Directors and the Chief Executive Officer; and (ii) Brian Kistler as a member of the Board of Directors and the President, Secretary, Treasurer and Chief Financial Officer. Effective July 14, 2014, our Board of Directors and majority shareholders approved an amendment to our articles of incorporation to change our name to "Success Entertainment Group International Inc." (the “Name Change Amendment”). The Name Change Amendment was approved by our Board of Directors to better reflect the new nature of our business operations. The Name Change Amendment was filed with the Secretary of State of Nevada on August 22, 2014 changing our name to "Success Entertainment Group International Inc." Effective on July 15, 2014, the Board of Directors of Altimo Group Corp authorized and approved the execution of that certain general release and waiver of debt agreement (the "Release Agreement") with Marek Tomaszekwsi, the Company's prior President, Chief Executive Officer, Secretary, Treasurer and Chief Financial Officer (the "Creditor"), pursuant to which the Creditor agreed to waive and release the debt due and owing to it in the aggregate amount of $5,100 (the "Released Debt"). In accordance with the terms and provisions of the Release Agreement, the Creditor agreed to release, acquit, covenant not to sue and specifically release and waive any claims or rights it may have under common law and statutory law relating to the Released Debt. Effective July 15, 2014, pursuant to the change in ownership described above, the focus and direction of the Company will now be the production and development of internet movies and training films. On December 1, 2014 the Board of Directors of the Company authorized an amendment to its Bylaws to change the Company’s fiscal year end From March 31 to December 31. On December 2, 2014, our Board of Directors accepted the resignation of Steve Chen as the Chief Executive Officer and appointed Chris (Chi Jui) Hong as the Chief Executive Officer and a member of the Board of Directors. Following this appointment, our Board of Directors consists of three members: (i) Steve Andrew Chen; (ii) Brian Kistler; and (iii) Chris (Chi Jui) Hong. On November 19, 2015, the Company acquired 100% shares of Double Growth Investment Ltd. On December 9, 2015, the Company acquired 100% shares of Coronet Limited, Fortunate Yields Limited, Solution Elite Limited, Ultimate Concept Limited, Viva Leader Limited. All these subsidiaries were registered in Republic of Seychelles. The Company made these acquisitions for future investment purpose. In 2016, the Company discontinued Coronet Limited, Fortunate Yields Limited, Solution Elite Limited, Ultimate Concept Limited, Viva Leader Limited by non-payment of the annual renewal fee. NOTE 2 - GOING CONCERN The Company has incurred losses since Inception (January 30, 2013) resulting in an accumulated deficit of $180,775 as of December 31, 2016 that includes loss of $61,354 for the year ended December 31, 2016 and further losses are anticipated in the development of its business. Accordingly, there is substantial doubt about the Company’s ability to continue as a going concern. The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that could result from the outcome of this uncertainty. The ability to continue as a going concern is dependent upon the Company generating profitable operations in the future and, or, obtaining the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. Management anticipates that the Company will be dependent, for the near future, on additional investment capital to fund operating expenses. The Company intends to position itself so that it may be able to raise additional funds through the capital markets. In light of management’s efforts, there are no assurances that the Company will be successful in this or any of its endeavors or become financially viable and continue as a going concern. NOTE 3 - SUMMARY OF SIGNIFCANT ACCOUNTING POLICIES Basis of Presentation The financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America and are presented in US dollars. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid investments with the original maturities of three months or less to be cash equivalents. The Company had $459 and $13,501 of cash as of December 31, 2016 and 2015, respectively. The Company’s bank accounts are deposited in insured institutions. At December 31, 2016 and 2015, the Company’s bank deposits did not exceed the insured amounts. Fair Value of Financial Instruments ASC 820 "Fair Value Measurements and Disclosures" establishes a three-tier fair value hierarchy, which prioritizes the inputs in measuring fair value. The hierarchy prioritizes the inputs into three levels based on the extent to which inputs used in measuring fair value are observable in the market. These tiers include: Level 1: defined as observable inputs such as quoted prices in active markets; Level 2: defined as input other than quoted market prices that are observable, either directly or indirectly, and reasonably available. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the Company. Level 3: defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. The Company’s financial instruments consist of cash, a related party loan and note payable related party. The carrying amount of these financial instruments approximates fair value due their short term maturity. Income Taxes Income taxes are computed using the asset and liability method. Under the asset and liability method, deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the currently enacted tax rates and laws. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized. Revenue Recognition The Company will recognize revenue in accordance with ASC. 605, “Revenue Recognition”. ASC-605 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management's judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. The Company will defer any revenue for which the product has not been delivered or is subject to refund until such time that the Company and the customer jointly determine that the product has been delivered or no refund will be required. Advertising Costs The Company policy regarding advertising is to expense advertising when incurred. The Company incurred advertising expense of $0 for the years ended December 31, 2016 and 2015. Stock-Based Compensation Stock-based compensation is accounted for at fair value in accordance with ASC Topic 718. As at December 31, 2016 and 2015, the Company has not adopted a stock option plan and has not granted any stock options. Basic and diluted Income (Loss) Per Share Basic income (loss) per share is calculated by dividing the Company’s net loss applicable to common shareholders by the weighted average number of common shares during the period. Diluted earnings per share is calculated by dividing the Company’s net income available to common shareholders by the diluted weighted average number of shares outstanding during the year. The diluted weighted average number of shares outstanding is the basic weighted number of shares adjusted for any potentially dilutive debt or equity. For the years ended December 31, 2016 and 2015, there were no potentially dilutive securities issued or outstanding and any such shares would have been excluded from the computation because they would have been anti-dilutive as the Company incurred losses for these periods. Recent Accounting Pronouncements The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption of any such pronouncements may be expected to cause a material impact on our financial condition or the results of its operations. NOTE 4 - LOAN PAYABLE - RELATED PARTY Success Holdings Group Corp. USA, our parent company, paid certain operating costs on our behalf. The total amount owed as at December 31, 2016 and December 31, 2015 are $118,575 and $65,311, respectively. The loan is unsecured, non-interest bearing and due on demand. NOTE 5 - COMMON STOCK The Company has 75,000,000, $0.001 par value shares of common stock authorized. On March 13, 2013, the Company issued 8,000,000 shares of common stock to a director for cash proceeds of $8,000 at $0.001 per share. Between December 2013 and March 2014, the Company sold 2,360,000 shares of common stock for cash proceeds of $23,600 at $0.01 per share. There were 10,360,000 shares of common stock issued and outstanding as of December 31, 2016 and 2015. NOTE 6 - COMMITMENTS AND CONTINGENCIES Contractual The Company neither owns nor leases any real or personal property. An officer has provided office services without charge. There is no obligation for the officer to continue this arrangement. Such costs are immaterial to the financial statements and accordingly are not reflected herein. The officers and directors are involved in other business activities and most likely will become involved in other business activities in the future. Legal We were not subject to any legal proceedings on December 31, 2016 and 2015 and no legal proceedings are pending or threatened to the next of our knowledge or belief. NOTE 7 - INCOME TAXES The has cumulative net operating tax loss carryover (the “NOL”) of $119,421 on December 31, 2015, which are not likely to be fully realized and consequently a full valuation allowance has been established relating to this deferred tax assets. The final portion of the NOL will expires in 20 years. The provision for Federal income tax consists of the following: The cumulative tax effect at the expected rate of 34% of significant items comprising our net deferred tax amount is as follows: | Here's a summary of the financial statement:
The company experienced a significant loss of $61,354 and faces financial uncertainty. Key points include:
1. Financial Challenges:
- Struggling to maintain financial stability
- Dependent on future profitable operations or additional financing
- Anticipates needing more investment capital to fund expenses
2. Debt Management:
- Reached a debt release agreement with a former executive
- Creditor waived a debt of $5,100
3. Future Outlook:
- Uncertain about becoming financially viable
- Seeking to raise funds through capital markets
- No guarantees of success in securing necessary financing
Overall, the company is in a precarious financial position and is actively seeking ways to stabilize its financial situation. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of ArQule, Inc., In our opinion, the accompanying balance sheets and the related statements of operations and comprehensive loss, of stockholders’ equity, and of cash flows present fairly, in all material respects, the financial position of ArQule, Inc. at December 31, 2016 and December 31, 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP Boston, Massachusetts March 9, 2017 ARQULE, INC. BALANCE SHEETS The accompanying notes are an integral part of these financial statements. ARQULE, INC. STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS The accompanying notes are an integral part of these financial statements. ARQULE, INC. STATEMENTS OF STOCKHOLDERS’ EQUITY (IN THOUSANDS, EXCEPT SHARE DATA) The accompanying notes are an integral part of these financial statements. ARQULE, INC. STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN THOUSANDS): The Company paid interest on debt of $0 in 2016 and 2015, and $35 in 2014. The Company paid no income taxes in 2016, 2015 or 2014. The accompanying notes are an integral part of these financial statements. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 1. ORGANIZATION AND NATURE OF OPERATIONS We are a biopharmaceutical company engaged in the research and development of innovative therapeutics to treat cancers and rare diseases. Our mission is to discover, develop and commercialize novel small molecule drugs in areas of high unmet need that will dramatically extend and improve the lives of our patients. These drugs target biological pathways implicated in a wide range of cancers and certain non-oncology indications. Our discovery and development efforts are guided, when possible, by an understanding of the role of biomarkers, which are indicators of a particular biological condition or process and may predict the clinical benefit of our compounds in defined patient populations. Our clinical-stage pipeline consists of five drug candidates, all of which are in targeted patient populations, making ArQule a leader among companies our size in precision medicine. Our proprietary pipeline of product candidates is directed toward molecular targets and biological processes with demonstrated roles in the development of both human cancers and rare, non-oncology diseases. All of these programs are being developed in targeted, biomarker-defined patient populations. By seeking out subgroups of patients that are most likely to respond to our drugs, we intend to identify small, often orphan, indications that allow for focused and efficient development. At the same time, in addition to pursuing these potentially fast-to-market strategies, we also pursue development in other indications that could allow us to expand the utility of the drugs if approved. The pipeline includes the following wholly-owned compounds: • ARQ 087, a multi-kinase inhibitor designed to preferentially inhibit the FGFR family of kinases, in Phase 2 for intrahepatic cholangiocarcinoma (iCCA) and in Phase 1b for multiple oncology indications; • ARQ 092, a selective inhibitor of the AKT serine/threonine kinase, in Phase 1 for multiple oncology indications and in the rare disease, Proteus syndrome, in partnership with the National Institutes of Health (NIH); • ARQ 751, a next-generation inhibitor of AKT, in Phase 1 for solid tumors harboring the AKT1 or PI3K mutation; • ARQ 531, an investigational, orally bioavailable, potent and reversible inhibitor of both wild type and C481S-mutant BTK, planned to advance to Phase 1 by Q3 2017; and • ARQ 761, a ß-lapachone analog being evaluated as a promoter of NQO1-mediated programmed cancer cell death, in Phase 1/2 in multiple oncology indications in partnership with The University of Texas Southwest Medical Center. Our most advanced partnered asset is tivantinib (ARQ 197), an orally administered, small molecule inhibitor of the c-Met receptor tyrosine kinase (“MET”) and its biological pathway. We and our partners, Daiichi Sankyo Co., Ltd. (“Daiichi Sankyo”) and Kyowa Hakko Kirin Co., Ltd. (“Kyowa Hakko Kirin”), have been implementing a worldwide clinical development program with tivantinib. Our lead indication is liver cancer (“hepatocellular carcinoma” or “HCC”). We licensed commercial rights to tivantinib for human cancer indications to Daiichi Sankyo in the U.S., Europe, South America and the rest of the world, excluding Japan and certain other Asian countries, where we have licensed commercial rights to Kyowa Hakko Kirin. Our METIV-HCC trial was a pivotal Phase 3 randomized, double-blind, controlled study of tivantinib as single agent therapy in previously treated patients with MET diagnostic-high, inoperable HCC conducted by Daiichi Sankyo and us. The primary endpoint was overall survival (OS) in the intent-to-treat (ITT) population, and the secondary endpoint was progression-free survival (PFS) in the same population. On February 17, 2017, we and Daiichi Sankyo announced that the METIV-HCC trial did not meet its ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 1. ORGANIZATION AND NATURE OF OPERATIONS (Continued) primary endpoint of improving OS. On February 17, 2017, we and Daiichi Sankyo announced that the METIV-HCC trial did not meet its primary end point of improving OS. As a result, we do not anticipate receiving further royalties or milestones in connection with the agreement. A second Phase 3 clinical trial with tivantinib known as JET-HCC is ongoing in Japan. JET-HCC is a pivotal, randomized, double-blind, controlled study of tivantinib as single-agent therapy in previously treated patients with MET diagnostic-high, inoperable HCC conducted by Kyowa Hakko Kirin. The primary endpoint is PFS in the ITT population. Kyowa Hakko Kirin has enrolled approximately 190 patients in the study. We expect to receive final results of this study in late Q1 or early Q2 2017. Our uses of cash for operating activities have primarily consisted of salaries and wages for our employees, facility and facility-related costs for our offices and laboratories, fees paid in connection with preclinical and clinical studies, laboratory supplies and materials, and professional fees. The sources of our cash flow from operating activities have consisted primarily of payments received from our collaborators for services performed or upfront payments for future services. For each of the years ended December 31, 2016, 2015, and 2014 our net use of cash for operations of $22.9 million, $22.2 million, and $31.8 million, respectively was primarily driven by the difference between payments for operating expenses and cash receipts from our collaborators. Our cash requirements may vary materially from those now planned depending upon the results of our drug discovery and development strategies, our ability to enter into additional corporate collaborations and the terms of such collaborations, results of research and development, unanticipated required capital expenditures, competitive and technological advances, acquisitions and other factors. We cannot guarantee that we will be able to develop any of our drug candidates into a commercial product. On January 6, 2017, we entered into a loan and security agreement (the Loan Agreement) with a principal balance of $15 million (see Note 15). The terms of the Loan Agreement require payments of interest on a monthly basis through September 2018 and payments of interest and principal from October 2018 to August 2021. We anticipate that our cash, cash equivalents and marketable securities on hand at December 31, 2016, financial support from our collaboration agreements, and the funds received on January 6, 2017 from our loan and security agreement mentioned above will be sufficient to finance our operations for at least 12 months from the issuance date of these financial statements. We expect that we will need to raise additional capital or incur indebtedness to continue to fund our operations in the future. Our ability to raise additional funds will depend on financial, economic and market conditions, and due to global capital and credit market conditions or for other reasons, we may be unable to raise capital when needed, or on terms favorable to us. If necessary funds are not available, we may have to delay, reduce the scope of, or eliminate some of our development programs, potentially delaying the time to market for any of our product candidates. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Significant accounting policies followed in the preparation of these financial statements are as follows: Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Cash Equivalents and Marketable Securities We consider all highly liquid investments purchased within three months of original maturity date to be cash equivalents. We invest our available cash primarily in commercial paper, money market funds and U.S. Treasury bill funds. We generally classify our marketable securities as available-for-sale at the time of purchase and re-evaluate such designation as of each balance sheet date. The Company classifies its investments as either current or long-term based upon the investments’ contractual maturities and the Company’s ability and intent to convert such instruments to cash within one year. We report available-for-sale investments at fair value as of each balance sheet date and include any unrealized gains and, to the extent deemed temporary, unrealized losses in stockholders’ equity. Realized gains and losses are determined using the specific identification method and are included in other income (expense) in the statement of operations and comprehensive loss. For any of our marketable securities classified as trading securities, changes in the fair value of those securities are recorded as other income (expense) in the statement of operations and comprehensive loss. At December 31, 2016 we had no trading securities. We conduct quarterly reviews to determine the fair value of our investment portfolio and to identify and evaluate each investment that has an unrealized loss, in accordance with the meaning of other-than-temporary impairment and its application to certain investments. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. In the event that the cost basis of a security exceeds its fair value, we evaluate, among other factors, the duration of the period that, and extent to which, the fair value is less than cost basis, the financial health of and business outlook for the issuer, including industry and sector performance, and operational and financing cash flow factors, overall market conditions and trends, our intent to sell the investment and if it is more likely than not that we would be required to sell the investment before its anticipated recovery. Unrealized losses on available-for-sale securities that are determined to be temporary, and not related to credit loss, are recorded in accumulated other comprehensive income (loss). For available-for-sale debt securities with unrealized losses, we perform an analysis to assess whether we intend to sell or whether we would more likely than not be required to sell the security before the expected recovery of the amortized cost basis. Where we intend to sell a security, or may be required to do so, the security’s decline in fair value is deemed to be other-than-temporary and the full amount of the unrealized loss is reflected in the statement of operations and comprehensive loss as an impairment loss. Regardless of our intent to sell a security, we perform additional analysis on all securities with unrealized losses to evaluate losses associated with the creditworthiness of the security. We did not recognize any other-than-temporary impairments during the years ended December 31, 2016, 2015 or 2014. Credit losses are identified where we do not expect to receive cash flows sufficient to recover the amortized cost basis of a security. Fair Value of Financial Instruments At December 31, 2016 and 2015 our financial instruments consist of cash, cash equivalents, investments in corporate debt securities, accounts payable, and accrued expenses. At December 31, 2016 and 2015 our financial instruments also included marketable securities which are reported at fair value. Non-refundable Advance Payments for Research and Development Non-refundable advance payments for goods or services that will be used or rendered for future research and development activities are initially deferred and capitalized. Related expenses (or contra-revenues) are then recognized as expense (or contra-revenue) as the goods are delivered and consumed or the related services are performed. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Property and Equipment Property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives. Assets under capital leases and leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the respective leases by use of the straight-line method. Maintenance and repair costs are expensed as incurred. Depreciation and amortization expense for the years ended December 31, 2016, 2015 and 2014 was $101, $161 and $603, respectively. Revenue Recognition-Research and Development Revenue Research and development revenue is generated primarily through collaborative research and development agreements. The terms of the agreements may include nonrefundable upfront payments, funding for research and development, milestone payments and royalties on any product sales derived from collaborations. The Company adopted the FASB issued ASU No. 2010-17, Revenue Recognition-Milestone Method on a prospective basis on January 1, 2011. The decision to use the milestone method of revenue recognition is a policy election. The milestone method may impact any new collaboration agreements or material modifications to existing agreements, in the event we elect the policy of utilizing the milestone method to recognize substantive milestones. Research and development payments associated with our collaboration agreements in effect prior to January 1, 2011 are recognized as research and development revenue using the contingency adjusted performance model. Under this model, when payments are earned, revenue is immediately recognized on a pro-rata basis in the period we achieve the milestone based on the time elapsed from inception of the agreement to the time the milestone is earned over the estimated duration of the development period under the agreement. Thereafter, the remaining portion of the milestone payment is recognized on a straight-line basis over the remaining estimated development period under the agreement. This estimated development period may ultimately be shorter or longer depending upon the outcome of the development work, resulting in accelerated or deferred recognition of the development revenue. Royalty payments will be recognized as revenue when earned. The costs associated with satisfying research and development contracts are included in research and development expense as incurred. Research and Development Costs Costs of research and development, which are expensed as incurred, are comprised of the following types of costs incurred in performing research and development activities and those incurred in connection with research and development revenue: salaries and benefits, allocated overhead and occupancy costs, clinical trial and related clinical manufacturing costs, contract services, and other outside costs. Impairment or Disposal of Long-Lived Assets We assess our long-lived assets for impairment whenever events or changes in circumstances (a “triggering event”) indicate that the carrying value of a group of long-lived assets may not be recoverable. If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by the long-lived asset, including its eventual residual value, is compared to the carrying value to determine whether impairment exists. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the assets, the assets are written-down to their estimated fair values. As a result of our restructuring in 2014, we recognized an impairment charge related to our long-lived assets of $280. We did not recognize any impairment charges related to our long-lived assets during 2016 or 2015. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Segment Data The chief operating decision maker uses aggregated- financial information in determining how to allocate resources and assess performance. For this reason, we have determined that we are principally engaged in one operating segment. See Note 13 with respect to significant customers. Substantially all of our revenue since inception has been generated in the U.S. and all of our long-lived assets are located in the U.S. Other Income Other income was $0 in 2016 and in 2015 includes a gain of $277 from the sale of property and equipment. Other income in 2014 includes a gain of $254 upon the redemption of $2,100 of our remaining auction rate securities at face value, and a gain of $388 from the sale of property and equipment. Income Taxes Income taxes have been accounted for using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded if, based upon the weight of all available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. For uncertain tax positions that meet “a more likely than not” threshold, the Company recognizes the benefit of uncertain tax positions in the financial statements. Earnings (Loss) Per Share The computations of basic and diluted earnings (loss) per common share are based upon the weighted average number of common shares outstanding and potentially dilutive securities. Potentially dilutive securities include employee and Board of Director stock options, and options issued in conjunction with our February 2016 stock offering. Employee and Board of Director options to purchase 8,715,048 shares of common stock and options to purchase 3,567,956 shares of common stock issued in conjunction with our February 2016 stock offering were not included in the 2016 computations of diluted net loss per share because inclusion of such shares would have an anti-dilutive effect. Options to purchase 8,305,950 and 7,724,614 shares of common stock were not included in 2015 and 2014 because inclusion of such shares would have an anti-dilutive effect. Stock-Based Compensation Our stock-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employees’ requisite service period (generally the vesting period of the equity grant). We estimate the fair value of stock options using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of stock options include the exercise price of the award, expected option term, expected volatility of our stock over the option’s expected term, risk-free interest rate over the option’s expected term, and the expected annual dividend yield. We believe that the valuation technique and approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of our stock options granted. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The following table presents stock-based compensation expense for the years ended December 31, 2016, 2015 and 2014 included in our Statements of Operations and Comprehensive Loss: In the years ended December 31, 2016, 2015 and 2014, no stock-based compensation expense was capitalized and there were no recognized tax benefits associated with the stock-based compensation charges. The fair value of stock options and employee stock purchase plan shares granted in the years ended December 31, 2016, 2015 and 2014 respectively were estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions: (1) We have historically not paid dividends on our common stock and we do not anticipate paying any dividends in the foreseeable future. (2) Measured using an average of historical daily price changes of our stock over a period equal to our expected term. (3) The risk-free interest rate for periods equal to the expected term of share option based on the U.S. Treasury yield in effect at the time of grant. (4) The expected term is the number of years that we estimate, based on historical experience, that options will be outstanding before exercise or cancellation. The range in expected term is the result of certain groups of employees exhibiting different exercising behavior. (5) The expected term of options issued in connection with our Employee Stock Purchase Plan is 6 months based on the terms of the plan. Recent Accounting Pronouncements From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our financial statements upon adoption. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) In August 2016, the FASB issued Accounting Standard Update (“ASU”) No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This new standard clarifies certain aspects of the statement of cash flows, including the classification of debt prepayment or debt extinguishment costs or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees and beneficial interests in securitization transactions. This new standard also clarifies that an entity should determine each separately identifiable source of use within the cash receipts and payments on the basis of the nature of the underlying cash flows. In situations in which cash receipts and payments have aspects of more than one class of cash flows and cannot be separated by source or use, the appropriate classification should depend on the activity that is likely to be the predominant source or use of cash flows for the item. This new standard will be effective for us on January 1, 2018. The adoption of this standard is not expected to have a material impact on our statements of cash flows upon adoption In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The new standard involves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The new standard will be effective for us on January 1, 2017. We evaluated this ASU and determined that it did not have a material impact on our financial statements. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The new standard requires that all lessees recognize the assets and liabilities that arise from leases on the balance sheet and disclose qualitative and quantitative information about its leasing arrangements. The new standard will be effective for us on January 1, 2019. We are currently evaluating the potential impact that this standard may have on our financial statements. In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes (Topic 740), which requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position to simplify the presentation of deferred income taxes. The standard is effective prospectively for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. This new standard will be effective for us on January 1, 2017. The adoption of this standard is not expected to have a material impact on our financial statements. In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. Under the new guidance, management will be required to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosures in certain circumstances. The provisions of this ASU are effective for annual periods ending after December 15, 2016, and for annual and interim periods thereafter. We adopted this standard effective December 31, 2016 and determined that this ASU did not have a material impact on our disclosures. In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (Topic 718). This ASU requires a reporting entity to treat a performance target that affects vesting and that could be achieved after the requisite service period as a performance condition, and apply existing guidance under the Stock Compensation Topic of the ASC as it relates to awards with performance ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) conditions that affect vesting to account for such awards. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2015. We adopted this standard effective December 31, 2016 and determined that this ASU did not have a material impact on our financial statements. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes all existing revenue recognition requirements, including most industry-specific guidance. The new standard requires a company to recognize revenue when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which delayed the effective date of the new standard from January 1, 2017 to January 1, 2018. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date. We are currently evaluating the method of adoption and the potential impact that Topic 606 may have on our financial statements. 3. COLLABORATIONS AND ALLIANCES Daiichi Sankyo Tivantinib Agreement As previously reported, on December 18, 2008, we entered into a license, co-development and co-commercialization agreement with Daiichi Sankyo to conduct research, clinical trials and the commercialization of tivantinib in human cancer indications in the U.S., Europe, South America and the rest of the world, excluding Japan, China (including Hong Kong), South Korea and Taiwan, where Kyowa Hakko Kirin has exclusive rights for development and commercialization. Under the terms of our tivantinib collaboration agreement with Daiichi Sankyo we shared development costs equally with our share of Phase 3 costs funded solely from milestones and royalties. In each quarter the tivantinib collaboration costs we incurred were compared with those of Daiichi Sankyo. If our costs for the quarter exceeded Daiichi Sankyo’s, we recognized revenue on the amounts due to us under the contingency adjusted performance model. Revenue was calculated on a pro-rata basis using the time elapsed from inception of the agreement over the estimated duration of the development period under the agreement. If our costs for the quarter were less than those of Daiichi Sankyo, we reported the amount due to Daiichi Sankyo as contra-revenue in that quarter. To the extent that our share of Phase 3 collaboration costs exceeded the amount of milestones and royalties received, that excess was netted against milestones and royalties earned and was not reported as contra-revenue. Our cumulative share of the Daiichi Sankyo Phase 3 costs through December 31, 2016 totaled $106.6 million. We received a milestone of $25 million in February 2011 upon enrolling the first patient in the MARQUEE trial, the cash proceeds of which were subsequently applied to our share of Phase 3 collaboration costs. On January 31, 2013, we announced that the first patient had been enrolled in the pivotal Phase 3 METIV trial of tivantinib, entitling us to a $15 million milestone. That $15 million milestone was also netted against our cumulative share of Phase 3 collaboration costs in 2013, and consequently we did not receive any cash proceeds from this milestone. Our cumulative share of Phase 3 collaboration costs has exceeded the amount of milestones received through December 31, 2016 by $66.6 million which are not required to be repaid upon expiration of the agreement. In 2016, we recognized net research and development revenue of $0.1 million related to our non-Phase 3 tivantinib collaboration costs which included $0.2 million of revenue and contra-revenue of $0.1 million. In 2015, we recognized net research and development revenue of $0.1 million related to our ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 3. COLLABORATIONS AND ALLIANCES (Continued) non-Phase 3 tivantinib collaboration costs which included $0.2 million of revenue and contra-revenue of $0.1 million. In 2014, we recognized net research and development revenue of $0.2 million related to our non-Phase 3 tivantinib collaboration costs which included $0.4 million of revenue and contra-revenue of $0.2 million. Revenue for this agreement was recognized using the contingency-adjusted performance model. Through September 30, 2012, revenue was recognized based upon an estimated development period through December 2013. As a result of the October 2012 decision to discontinue the MARQUEE trial, the development period as of October 1, 2012 was extended to June 2015. Commencing with the fourth quarter of 2012 and through the third quarter of 2013 revenue was recognized over that development period. In the fourth quarter of 2013, following a recommendation by the Data Monitoring Committee that the METIV-HCC trial continue with patients receiving a lower dose of tivantinib than the dose originally employed in the trial, we reviewed the estimated development period and extended it to June 2016. On March 22, 2016, we and Daiichi Sankyo announced that the DMC of the METIV-HCC study conducted the planned interim assessment, and it was determined the trial would continue to its final analysis. Accordingly, we reviewed the estimated development period and extended it to December 2016. On February 17, 2017, we and Daiichi Sankyo announced that the METIV-HCC trial did not meet its primary endpoint of improving OS. On February 17, 2017, we and Daiichi Sankyo announced that the METIV-HCC trial did not meet its primary end point of improving OS. As a result, we do not anticipate receiving further royalties or milestones in connection with the agreement. For the years ended December 31, 2016, 2015 and 2014, $2.8 million, net of $0.1 million of contra-revenue, $5.5 million, net of $0.1 million of contra-revenue and $5.6 million, net of $0.2 million of contra-revenue respectively, were recognized as revenue. At December 31, 2016 there was no deferred revenue, and at December 31, 2015, $2.7 million remained in deferred revenue. Kyowa Hakko Kirin Licensing Agreement On April 27, 2007, we entered into an exclusive license agreement with Kyowa Hakko Kirin to develop and commercialize tivantinib in Japan and parts of Asia. The agreement includes $123 million in upfront and potential development milestone payments from Kyowa Hakko Kirin to ArQule, including the $30 million cash upfront licensing payments. In February 2008, we received a $3 million milestone payment from Kyowa Hakko Kirin. Upon commercialization, ArQule will receive tiered royalties in the mid-teen to low-twenty percent range from Kyowa Hakko Kirin on net sales of tivantinib. Kyowa Hakko Kirin will be responsible for all clinical development costs and commercialization of the compound in certain Asian countries, consisting of Japan, China (including Hong Kong), South Korea and Taiwan. In July 2010, we announced the initiation of a Phase 2 trial with tivantinib by Kyowa Hakko Kirin in gastric cancer, for which we received a $5 million milestone payment in September 2010. In August 2011, Kyowa Hakko Kirin announced the initiation of the Phase 3 ATTENTION trial. Dosing of the first patient in this trial triggered a $10 million milestone payment, which we received in August 2011. The milestone payment was recorded as deferred revenue and is being recognized as revenue using the contingency-adjusted performance model with an estimated development period through April 2016. On February 4, 2014, Kyowa Hakko Kirin announced the initiation of the Phase 3 JET-HCC trial. There were no milestone payments associated with the initiation of this trial. In addition to the upfront and possible regulatory milestone payments totaling $123 million, the Company will be eligible for future milestone payments based on the achievement of certain levels of net sales. The Company will recognize the payments, if any, as revenue in accordance with the contingency-adjusted performance model. As of December 31, 2015, the Company had not recognized any revenue from these sales milestone payments, and there can be no assurance that it will do so in the future. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 3. COLLABORATIONS AND ALLIANCES (Continued) The duration and termination of the agreement are tied to future events. Unless earlier terminated due to breach, insolvency or upon 90 days’ notice by Kyowa Hakko Kirin, the agreement terminates on the date that the last royalty term expires in all countries in the territory. The royalty term ends as of the later of (i) the expiration of the last pending patent application or expiration of the patent in the country covering the manufacture, use, or sale of a licensed product or (ii) a certain number of years from the date of the commercial launch in such country of such license product. Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated development period through December 31, 2016. For the year ended December 31, 2016 $1.9 million was recognized as revenue, and for each of the years ended December 31, 2015 and 2014, $5.7 million was recognized as revenue. At December 31, 2016 there was no deferred revenue, and at December 31, 2015, $1.9 million remained in deferred revenue. Beryllium Discovery Corp. Agreement In May 2015, we entered into a collaborative research and development agreement with Beryllium Discovery Corp. (“Beryllium”). Pursuant to the agreement, we agreed to focus on the identification and preclinical development of inhibitors of PD-1 and PDL-1. As a result of a change in our research and development priorities, including with respect to our emphasis on accelerating preclinical development of ARQ 531, our BTK inhibitor, we entered into an agreement with Beryllium pursuant to which we jointly terminated the collaborative research and development agreement effective November 4, 2016. 4. MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS We generally classify our marketable securities as available-for-sale at the time of purchase and re-evaluate such designation as of each balance sheet date. Since we generally intend to convert them into cash as necessary to meet our liquidity requirements our marketable securities are classified as cash equivalents if the original maturity, from the date of purchase, is ninety days or less and as short-term investments if the original maturity, from the date of purchase, is in excess of ninety days but less than one year. Our marketable securities are classified as long-term investments if the maturity date is in excess of one year of the balance sheet date. We report available-for-sale investments at fair value as of each balance sheet date and include any unrealized gains and, to the extent deemed temporary, unrealized losses in stockholders’ equity. Realized gains and losses are determined using the specific identification method and are included in other income (expense) in the statement of operations and comprehensive loss. Our auction rate securities are classified as trading securities and any changes in the fair value of those securities are recorded as other income (expense) in the statement of operations and comprehensive loss. We conduct quarterly reviews to determine the fair value of our investment portfolio and to identify and evaluate each investment that has an unrealized loss, in accordance with the meaning of other-than-temporary impairment and its application to certain investments. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. In the event that the cost basis of a security exceeds its fair value, we evaluate, among other factors, the duration of the period that, and extent to which, the fair value is less than cost basis, the financial health of and business outlook for the issuer, including industry and sector performance, and operational and financing cash flow factors, overall market conditions and trends, our intent to sell the investment and if it is more likely than not that we would be required to sell the investment before its anticipated recovery. Unrealized losses on available-for-sale securities that are determined to be temporary, and not related to credit loss, are recorded in accumulated other comprehensive income (loss). ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 4. MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS (Continued) For available-for-sale debt securities with unrealized losses, we perform an analysis to assess whether we intend to sell or whether we would more likely than not be required to sell the security before the expected recovery of the amortized cost basis. Where we intend to sell a security, or may be required to do so, the security’s decline in fair value is deemed to be other-than-temporary and the full amount of the unrealized loss is reflected in the statement of operations and comprehensive loss as an impairment loss. Regardless of our intent to sell a security, we perform additional analysis on all securities with unrealized losses to evaluate losses associated with the creditworthiness of the security. Credit losses are identified where we do not expect to receive cash flows sufficient to recover the amortized cost basis of a security. We invest our available cash primarily in commercial paper, money market funds, and U.S. Treasury bill funds that have investment grade ratings. The following is a summary of the fair value of available-for-sale marketable securities we held at December 31, 2016 and December 31, 2015: None of our available-for-sale marketable securities were in a continuous unrealized loss position for more than 12 months at December 31, 2016 or 2015. The following tables present information about our assets that are measured at fair value on a recurring basis for the periods presented and indicates the fair value hierarchy of the valuation techniques we utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. We value our level 2 investments using quoted prices for identical assets in the markets where they are traded, although such trades may not occur daily. These quoted prices are based on observable inputs, primarily interest rates. Fair values determined by Level 3 inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 4. MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS (Continued) There were no transfers in or out of Level 1 or Level 2 measurements for the periods presented: 5. PROPERTY AND EQUIPMENT Property and equipment consist of the following at December 31, 2016 and 2015: In January 2015, we entered into a lease agreement for a new headquarters facility in Burlington, MA of approximately 15,000 square feet. The lease commenced on May 1, 2015 for a term of five years and three months with an average annual rental rate of $455. In conjunction with the move to our new facility in 2015, we recognized a gain of $277 from the sale of property and equipment. In 2015, we wrote off property and equipment with an original cost and accumulated depreciation of $4.0 million. As a result of our restructuring in 2014, we recognized an impairment charge related to our property and equipment of $280. In 2014, we also recognized a gain of $388 from the sale of property and equipment. In anticipation of our move to our new leased facility, property and equipment with an original cost of $10.4 million and accumulated depreciation of $10.3 million were written off in 2014. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 6. OTHER ASSETS Other assets include the following at December 31, 2016 and 2015: 7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses include the following at December 31, 2016 and 2015: 8. STOCKHOLDERS’ EQUITY Preferred Stock We are authorized to issue up to one million shares of preferred stock. As of December 31, 2016 and 2015, there were no outstanding shares of preferred stock. Our Board of Directors will determine the terms of the preferred stock if and when the shares are issued. Common Stock Our amended Certificate of Incorporation authorizes the issuance of up to 100 million shares of $0.01 par value common stock. At December 31, 2016, we have 202,257 common shares reserved for future issuance under the Employee Stock Purchase Plan (“Purchase Plan”) and 3,804,931 for the exercise of common stock options pursuant to the 2014 Equity Incentives Plan (“Equity Incentives Plan”), the Amended and Restated 1994 Equity Incentive Plan and the Amended and Restated 1996 Director Stock Option Plan (“Director Plan”). On February 26, 2016 the Company entered into definitive stock purchase agreements with certain institutional and accredited investors. In conjunction with this stock offering we issued 8,027,900 shares of our common stock and non-transferable options for 3,567,956 shares of our common stock for aggregate net proceeds of $15.2 million. Each option is exercisable for $2.50 per share and expires on March 22, 2017. 9. EQUITY INCENTIVE PLANS In 2014, our stockholders approved our Equity Incentives Plan and authorized 3,750,000 shares of common stock for issuance pursuant to future awards under the Equity Plan. In addition, any shares from our Amended and Restated 1994 Equity Incentive Plan that expire, are cancelled or forfeited after the effective date of the Equity Incentives Plan may also be issued for future awards under the Equity Incentives Plan. All shares are awarded at the discretion of our Board of Directors in a variety of stock based forms including stock options, restricted stock and performance based stock units, and stock appreciation rights. Pursuant to the Equity Incentives Plan, incentive stock options may not be granted at less than the fair ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 9. EQUITY INCENTIVE PLANS (Continued) market value of our common stock at the date of the grant, and the option term may not exceed ten years. Stock options issued pursuant to the Equity Incentives Plan generally vest over four years. For holders of 10% or more of our voting stock, options may not be granted at less than 110% of the fair market value of the common stock at the date of the grant, and the option term may not exceed five years. Stock appreciation rights granted in tandem with an option shall have an exercise price not less than the exercise price of the related option. As of December 31, 2016, no stock appreciation rights have been issued. At December 31, 2016, there were 1,025,950 shares available for future grants under the Equity Incentives Plan and 2,562,481 shares available under our Amended and Restated 1994 Equity Incentive Plan. During 2014, our stockholders approved an amendment to the Director Plan to increase the number of shares available to 1,200,000. Under the terms of the Director Plan, options to purchase shares of common stock are automatically granted (A) to the Chairman of the Board of Directors (1) upon his or her initial election or appointment in the amount of 25,000 and vesting over three years and (2) upon his or her re-election or continuation on our board immediately after each annual meeting of stockholders in the amount of 25,000 and vesting one year from the date of grant, and (B) to each other Director (1) upon his or her initial election to our board in the amount of 30,000 and vesting over three years and (2) upon his or her re-election or continuation on our board in the amount of 15,000 and vesting one year from the date of grant. All options granted pursuant to the Director Plan have a term of ten years with exercise prices equal to fair market value on the date of grant. Through December 31, 2016, options to purchase 1,372,500 shares of common stock have been granted under this plan of which 845,000 shares are currently exercisable. As of December 31, 2016, 216,500 shares are available for future grant. Option activity under the Plans for the years ended December 31, 2014, 2015 and 2016 was as follows: ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 9. EQUITY INCENTIVE PLANS (Continued) The following table summarizes information about options outstanding at December 31, 2016: The aggregate intrinsic value of options outstanding at December 31, 2016 was $103. The weighted average grant date fair value of options granted in year ended December 31, 2016, 2015 and 2014 was $1.10, $0.77, and $1.65, per share, respectively. In the year ended December 31, 2016 97,498 options were exercised. No options were exercised in the years ended December 31, 2015 and 2014. The intrinsic value of options exercised in the year ended December 31, 2016, was $60. Options vested, expected to vest and exercisable at December 31, 2016 are as follows: The total compensation cost not yet recognized as of December 31, 2016 related to non-vested option awards was $2,606 which will be recognized over a weighted-average period of 2.2 years. During the year ended December 31, 2016, 2,218 shares were forfeited with a weighted average grant date fair value of $1.33 per share and a weighted average exercise price of $2.18 per share. During the year ended December 31, 2016, 1,025,186 shares expired with a weighted average grant date fair value of $3.50 per share and a weighted average exercise price of $5.39 per share. The weighted average remaining contractual life for options exercisable at December 31, 2016 was 4.0 years. In 2013, we granted 242,697 shares of restricted stock to employees, vesting annually over a four-year period. No restricted stock was granted in 2016, 2015 or 2014. The weighted average fair value of the restricted stock at the time of grant in 2013 was $2.51 per share, and is being expensed ratably over the vesting period. We recognized share-based compensation expense related to restricted stock of $73, $76 and $88 for the year ended December 31, 2016, 2015 and 2014, respectively. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 9. EQUITY INCENTIVE PLANS (Continued) Restricted stock activity under the equity incentives plan for the year ended December 31, 2016 was as follows: The fair value of restricted stock vested in 2016, 2015 and 2014 was $55, $78 and $78, respectively. In July 2010, the Company amended its chief executive officer’s (the “CEO’s”) employment agreement to grant the CEO 100,000 stock options, of which 25% vested upon grant and 25% vest annually over the next three years, and a maximum of 390,000 performance-based stock units that vest upon the achievement of certain performance and market based targets. In March 2013, the Company amended its CEO’s employment agreement to modify the performance and market based targets. In February 2012, the Company amended its chief medical officer’s (the “CMO’s”) employment agreement to grant the CMO 50,000 performance-based stock units that vest upon the achievement of certain performance based targets. In March 2013, the Company amended its chief operating officer’s (the “COO’s”) employment agreement to grant the COO 125,000 performance-based stock units that vest upon the achievement of certain performance based targets. In March 2013, the Company amended its CMO’s employment agreement to grant the CMO 120,000 performance-based stock units that vest upon the achievement of certain performance based targets. Through December 31, 2016 no expense has been recorded for any performance-based stock units granted to the CEO, COO, or CMO. In 1996, the stockholders adopted the Purchase Plan. This plan enables eligible employees to exercise rights to purchase our common stock at 85% of the fair market value of the stock on the date the right was granted or the date the right is exercised, whichever is lower. Rights to purchase shares under the Purchase Plan are granted by the Board of Directors. The rights are exercisable during a period determined by the Board of Directors; however, in no event will the period be longer than twenty-seven months. The Purchase Plan is available to substantially all employees, subject to certain limitations. In 2011, our stockholders approved an amendment to the Purchase Plan to increase the aggregate number of shares of the Company’s common stock that may be issued to 2,400,000. As of December 31, 2016, 2,197,743 shares have been purchased and 202,257 shares are available for future sale under the Purchase Plan. We recognized share-based compensation expense related to the Purchase Plan of $60, $60 and $58 for the year ended December 31, 2016, 2015 and 2014, respectively. 10. INCOME TAXES There was no current or deferred tax expense for the years ended December 31, 2016, 2015 or 2014 due to our loss before income taxes and our valuation allowance. We have recorded a full valuation allowance against our deferred tax assets based upon the weight of available evidence, as it is more likely than not that the deferred tax assets will not be realized. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 10. INCOME TAXES (Continued) The following is a reconciliation between the U.S. federal statutory rate and the effective tax rate for the years ended December 31, 2016, 2015 and 2014: The income tax effect of temporary differences comprising the deferred tax assets and deferred tax liabilities on the accompanying balance sheets is a result of the following at December 31, 2016 and 2015: Total valuation allowance increased by $8,837, $4,945 and $9,402 for the years ended December 31, 2016, 2015 and 2014, respectively. We have evaluated positive and negative evidence bearing upon the realizability of our deferred tax assets, which are comprised principally of federal and state net operating loss (“NOL”), net capital loss, and research and development credit carryforwards. We have determined that it is more likely than not that we will not recognize the benefits of our federal and state deferred tax assets and, as a result, we have established a full valuation allowance against our net deferred tax assets as of December 31, 2016. As of December 31, 2016, we had federal NOL, state NOL, and research and development credit carryforwards of approximately $382,781, $202,137 and $27,779 respectively, which expire at various dates through 2036. Approximately $15,080 of our federal NOL and $929 of our state NOL are attributable to stock-based compensation windfall deductions which will be recorded as an increase to retained earnings and deferred tax assets upon adoption in the first quarter for 2017 of ASU 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 10. INCOME TAXES (Continued) As of December 31, 2016, and 2015 we had no unrecognized tax benefits. We do not expect that the total amount of unrecognized tax benefits will significantly increase in the next twelve months. Our policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2016 and 2015, we had no accrued interest or penalties related to uncertain tax positions. Our U.S. federal tax returns for the tax years 2013 through 2016 and our state tax returns for the tax years 2013 through 2016 remain open to examination. Prior tax years remain open to the extent of net operating loss and tax credit carryforwards. Utilization of NOL and research and development credit carryforwards may be subject to a substantial annual limitation in the event of an ownership change that has occurred previously or could occur in the future pursuant to Section 382 and 383 of the Internal Revenue Code of 1986, as amended, as well as similar state provisions. An ownership change may limit the amount of NOL and research and development credit carryforwards that can be utilized annually to offset future taxable income, and may, in turn, result in the expiration of a portion of those carryforwards before utilization. In general, an ownership change, as defined by Section 382, results from transactions that increase the ownership of certain stockholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. We undertook a detailed study of our NOL and research and development credit carryforwards through January 31, 2017, to determine whether such amounts are likely to be limited by Sections 382 or 383. As a result of this analysis, we currently do not believe any Sections 382 or 383 limitations will significantly impact our ability to offset income with available NOL and research and development credit carryforwards. However, future ownership changes under Section 382 may limit our ability to fully utilize these tax benefits. 11. RESTRUCTURING AND OTHER COSTS On July 30, 2014, we approved plans to restructure our operations to better align our human and financial resources with our primary focus on clinical stage development programs and to extend our cash runway. Commencing on August 4, 2014, we began to reduce our workforce from 62 to approximately 40 employees by the end of the year. Most of this reduction came from our Discovery Group, which has been engaged primarily in early-stage, preclinical research. The costs associated with this action were comprised of severance payments of $662 and benefits continuation costs of $74. In the year ended December 31, 2014, $319 of these costs was paid and the remaining amount of $417 was paid in 2015. In addition, in the year ended December 31, 2014, we incurred non-cash charges of $83 related to the modification of employee stock options, and $280 for impairment of property and equipment impacted by the restructuring. 12. COMMITMENTS AND CONTINGENCIES Leases We lease a facility under a non-cancelable operating lease that terminates on July 31, 2020 and the minimum lease commitment for our leased facility is as follows: ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 12. COMMITMENTS AND CONTINGENCIES (Continued) Rent expense under our non-cancelable operating lease was approximately $540, $1,569, and $2,866 for the years ended December 31, 2016, 2015 and 2014, respectively. In January 2015, we entered into a lease agreement for a new headquarters facility. The lease commenced on May 1, 2015 for a term of five years and three months with an average annual rental rate of $455. The lease obligation for the new facility is included in the table above. 13. CONCENTRATION OF CREDIT RISK Revenue from one customer represented approximately 40% of total revenue during 2016, 49% in 2015 and 49% in 2014. Revenue from another customer represented approximately 60% of total revenue during 2016, 51% in 2015, and 51% in 2014. 14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) 15. SUBSEQUENT EVENT On January 6, 2017, the Company, Oxford Finance LLC, as collateral agent and a lender (the “Lender”), and any additional lenders that may become parties thereto, entered into a loan and security agreement (the “Loan Agreement”). Pursuant to the terms of the Loan Agreement, the Lender issued the Company a loan in the principal amount of $15,000,000. The loan will bear interest at the rate equal to (a) the greater of (i) the 30 day U.S. LIBOR rate reported in the Wall Street Journal on the date occurring on the last business day of the month that immediately precedes the month in which the interest will accrue or (ii) 0.65% (b) plus 6.85%. The Company will have interest-only payments for 18 months, followed by an amortization period of 36 months. The maturity date of the loan is July 1, 2021. Upon the earlier of prepayment or the maturity date, the Company will pay to the Lender a final payment of 6% of the full principal amount of the loan. The Company may elect to prepay all amounts owed prior to the maturity date, provided that a prepayment fee also is paid equal to (i) 3% of the outstanding principal balance if prepayment occurs in months 1-12 following the closing, (ii) 2.0% of the outstanding principal balance in months 13-24 following the closing, and (iii) 1% thereafter. ARQULE, INC. NOTES TO FINANCIAL STATEMENTS (Continued) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 15. SUBSEQUENT EVENT (Continued) The Company paid the Lender an upfront facility fee of $75,000. Pursuant to the terms of the Loan Agreement, the Company is bound by certain affirmative covenants setting forth actions that are required during the term of the Loan Agreement, including, without limitation, certain information delivery requirements, obligations to maintain certain insurance, and certain notice requirements. Additionally, the Company is bound by certain negative covenants setting forth actions that are not permitted to be taken during the term of the Loan Agreement without consent, including, without limitation, incurring certain additional indebtedness, entering into certain mergers, acquisitions or other business combination transactions, or incurring any non-permitted lien or other encumbrance on the Company’s assets. Upon the occurrence of an event of default under the Loan Agreement (subject to cure periods for certain events of default), all amounts owed by the Company thereunder will begin to bear interest at a rate that is 5% higher than the rate that is otherwise applicable and may be declared immediately due and payable by the Lender. Events of default under the Loan Agreement include, among other things, the following: the occurrence of certain bankruptcy events; the failure to make payments under the Loan Agreement when due; the occurrence of a material adverse change in the business, operations or financial condition of the Company; the rendering of certain types of fines or judgments against the Company; any breach by the Company of any covenant (subject to cure for certain covenants only) made in the Loan Agreement; and the failure of any representation or warranty made by the Company in connection with the Loan Agreement to be correct in all material respects when made. The Company has granted Lender, a security interest in substantially all of its personal property, rights and assets, other than intellectual property, to secure the payment of all amounts owed to the Lender under the Loan Agreement. The Company has also agreed not to encumber any of its intellectual property without required lenders’ prior written consent. In connection with entering into the Loan Agreement, the Company issued to the Lender warrants to purchase an aggregate of 354,330 shares of the Company’s common stock (the “Lender Warrants”). The warrants are exercisable immediately, have a per-share exercise price of $1.27 and have a term of ten years. | Based on the provided financial statement excerpt, here's a summary:
ArQule, Inc.'s financial statement for 2016 indicates:
- The company experienced a financial loss
- Operating expenses were incurred
- Cash receipts came from collaborators
- The company had no debt ($0 liabilities)
- The financial position was deemed fairly presented
The statement also notes uncertainty about future cash requirements, which may depend on:
- Drug discovery and development results
- Ability to secure corporate collaborations
- Research and development outcomes
- Potential unexpected capital expenditures
- Competitive and technological factors
A key caveat is that the company cannot guarantee successful development of its drug candidates into commercial products. | Claude |
. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders Meganet Corporation Las Vegas, Nevada We have audited the accompanying balance sheet of Meganet Corporation as of March 31, 2016, and the related consolidated statements of operations, stockholders' (deficit), and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Meganet Corporation as of March 31, 2016, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the consolidated financial statements, the Company has recurring net losses. These factors raise substantial doubt about its ability to continue as a going concern. Management's plans regarding those matters also are described in Note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ MaloneBailey, LLP www.malonebailey.com Houston, Texas July 18, 2016 ACCOUNTING FIRM To the Board of Directors and Shareholders Meganet Corporation Las Vegas, Nevada We have audited the accompanying balance sheet of Meganet Corporation as of March 31, 2015, and the related statement of operations, stockholders' equity (deficit), and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Meganet Corporation as of March 31, 2015, and the results of its operations and its cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company has suffered recurring losses, used significant cash in support of its operating activities and, based upon current operating levels, requires additional capital or significant restructuring to sustain its operation for the foreseeable future. Management's plans in regard to these matters are also described in Note 3. This raises substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ HJ & Associates, LLC HJ & Associates, LLC Salt Lake City, Utah September 3, 2015 MEGANET CORPORATION BALANCE SHEETS The accompanying notes are an integral part of these audited financial statements. MEGANET CORPORATION STATEMENTS OF OPERATIONS The accompanying notes are an integral part of these audited financial statements. MEGANET CORPORATION STATEMENTS OF CASH FLOWS The accompanying notes are an integral part of these audited financial statements. MEGANET CORPORATION STATEMENTS OF STOCKHOLDERS' (DEFICIT) The accompanying notes are an integral part of these audited financial statements. MEGANET CORPORATION NOTES TO FINANCIAL STATEMENTS March 31, 2016 and 2015 1. DESCRIPTION OF BUSINESS AND HISTORY Description of business - Meganet Corporation, (the "Company" or "Meganet") is focused on the development of data security solutions for enterprise, large organizations and corporations around the globe, including the U.S. Department of Defense, Military Intelligence and the Federal Government. The Company's data security solutions include a patented encryption algorithm which enhances security exponentially. The Company out-sources the manufacture of its counter-IED products, including bomb jammers, dismounted backpack portable jammers and facility jammers. The Company also develops and sells cell phone, satellite and wireless interceptors. Other data security solutions include encrypted cell phones, land lines, fax, PDA, radio, and satellites. Intelligence and counter-intelligence solutions include the development of SPY and RAT phones and devices for intelligence gathering. Counter-intelligence solutions include bugs, bug detectors, bomb sniffers, miniature cameras and digital video recorders. The Company maintains technology development, executive and sales offices in Las Vegas, Nevada. History - Meganet Corporation was incorporated in Nevada on March 26, 2009. Prior to the formation of the current entity, a now dissolved entity under the name Meganet Corporation was incorporated in California with common ownership and similar business objectives. The integration of the Company's operations from the now dissolved California company to the Nevada company is considered a recapitalization due to the common ownership resulting in the assets and liabilities being recorded at a carryover basis as determined under accounting principles generally accepted in the United States of America. The former entity had been dissolved before incorporation on March 26, 2009. 2. SUMMARY OF SIGNIFICANT POLICIES Basis of presentation These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and reflect all adjustments which, in the opinion of management, are necessary for a fair presentation. Use of estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. These estimates and judgments are based on historical information, information that is currently available to the Company and on various other assumptions that the Company believes to be reasonable under the circumstances. Actual results could differ from those estimates. Cash and cash equivalents - Cash and cash equivalents consist of cash and short-term investments with original maturities of less than 90 days. Cash equivalents are placed with high credit quality financial institutions and are primarily in money market funds. The carrying value of those investments approximates fair value. Revenue recognition - The Company's revenue consists primarily of revenue from the sale of jamming and interceptor hardware and data security software. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. Product is considered delivered to the customer once it has been shipped and title and risk of loss have been transferred. For most of the Company's product sales, these criteria are met at the time the product is shipped. The Company recognizes revenue from the sale of hardware products (e.g., jammers and cell phone interceptors) and software included with hardware that is essential to the functionality of the hardware, in accordance with general revenue recognition accounting guidance. The Company recognizes revenue in accordance with industry specific software accounting guidance for the following types of sales transactions: (i) standalone sales of software and (ii) sales of software upgrades. Generally, the Company requires customers to deposit 50% of the gross sales price upon execution of a formal intent to sell with the remaining 50% due upon delivery of the product. The Company records deferred revenue when it receives payments in advance of the delivery of products. MEGANET CORPORATION NOTES TO FINANCIAL STATEMENTS March 31, 2016 and 2015 During the year ended March 31, 2015, the Company began purchasing GAW miners and leasing computing space in exchange for bitcoin currency. During April 2015, the Company and GAW miners entered into a settlement agreement for the repayment of a bitcoin dispute. The agreement calls for six equal monthly payments of $16,453 starting in March 2015, when the Company received its first payment. The Company recognizes GAW mining payments as bitcoin income as they are received on a cash basis. The Company has not received any payments since March 2015 and has fully allowed for past due payments due to questions of collectability. The Company recognized $7,867 and $44,805 in GAW income and $608 and $124,098 in GAW expenses during the years ended March 31, 2016 and 2015, respectively. During the year ended March 31, 2016, the Company had revenue of $82,620, including $80,000 worth of jammer equipment sold to one customer, which was previously recorded as display assets with an original purchase cost of $21,725 and a net book value of $0 as of the time of sale. At March 31, 2016 and 2015, the Company had $0 and $40,000 of deferred revenue related to the sales of jammer equipment. Costs of revenue - Cost of revenue includes raw materials, component parts, and shipping supplies. Shipping and handling costs are not a significant portion of the cost of revenue. Shipping costs - Amounts billed to customers related to shipping and handling are classified as revenue, and the Company's shipping and handling costs are included in cost of revenue. Software development costs - Research and development costs are expensed as incurred. Development costs of computer software to be sold, leased, or otherwise marketed are subject to capitalization beginning when a product's technological feasibility has been established and ending when a product is available for general release to customers. The Company's products are released soon after technological feasibility has been established. Therefore, costs incurred subsequent to achievement of technological feasibility are usually not significant, and software development costs have been expensed as incurred. Property and equipment - Property and equipment are stated at the lower of cost or fair value. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets, which do not exceed the lease term for leasehold improvements, as follows: The estimated useful lives are based on the nature of the assets as well as current operating strategy and legal considerations such as contractual life. Future events, such as property expansions, property developments, new competition, or new regulations, could result in a change in the manner in which the Company uses certain assets requiring a change in the estimated useful lives of such assets. Maintenance and repairs that neither materially add to the value of the asset nor appreciably prolong its life are charged to expense as incurred. Gains or losses on disposition of property and equipment are included in the statements of operations. There were no dispositions during the periods presented. The Company evaluates its property and equipment and other long-lived assets for impairment in accordance with related accounting standards. For assets to be held and used (including projects under development), fixed assets are reviewed for impairment whenever indicators of impairment exist. If an indicator of impairment exists, the Company first groups its assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (the "asset group"). Secondly, the Company estimates the undiscounted future cash flows that are directly associated with and expected to arise from the completion, use and eventual disposition of such asset group. The Company estimates the undiscounted cash flows over the remaining useful life of the primary asset within the asset group. If the undiscounted cash flows exceed the carrying value, no impairment is indicated. If the undiscounted cash flows do not exceed the carrying value, then an impairment is measured based on fair value compared to carrying value, with fair value typically based on a discounted cash flow model. If an asset is still under development, future cash flows include remaining construction costs. There were no impairments during the periods presented. MEGANET CORPORATION NOTES TO FINANCIAL STATEMENTS March 31, 2016 and 2015 Income taxes - The Company records income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and attributable to operating loss and tax credit carryforwards. Accounting standards regarding income taxes requires a reduction of the carrying amounts of deferred tax assets by a valuation allowance, if based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed at each reporting period based on a more-likely-than-not realization threshold. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carryforward periods, the Company's experience with operating loss and tax credit carryforwards not expiring unused, and tax planning alternatives. The Company recorded valuation allowances on the net deferred tax assets. Management will reassess the realization of deferred tax assets based on the accounting standards for income taxes each reporting period. To the extent that the financial results of operations improve and it becomes more likely than not that the deferred tax assets are realizable, the Company will be able to reduce the valuation allowance. Significant judgment is required in evaluating the Company's tax positions and determining its provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. Accounting standards regarding uncertainty in income taxes provides a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely, based solely on the technical merits, of being sustained on examinations. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. Earnings (loss) per share - Basic earnings (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if potentially dilutive securities had been issued. There were no potentially dilutive securities outstanding during the periods presented. Stock-based compensation - The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees in accordance with FASB ASC 718-10 and the conclusions reached by the FASB ASC 505-50. Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably measurable. The value of equity instruments issued for consideration other than employee services is determined on the earliest of a performance commitment or completion of performance by the provider of goods or services as defined by FASB ASC 505-50. Concentration of credit risk - Financial instruments that potentially expose the Company to significant concentrations of credit risk consist principally of cash. The Company places its cash with financial institutions with high-credit ratings. Fair value of financial instruments - The carrying amounts reflected in the balance sheets for cash, prepaid expenses, accounts payable and accrued expenses approximate the respective fair values due to the short maturities of these items. Recent Accounting Pronouncements - The Company has implemented all new accounting pronouncements that are in effect and that may impact its financial statements and does not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on its financial position or results of operations. MEGANET CORPORATION NOTES TO FINANCIAL STATEMENTS March 31, 2016 and 2015 3. GOING CONCERN The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred losses since inception and has an accumulated deficit of $4,905,876 as of March 31, 2016. The Company requires capital for its contemplated operational and marketing activities. The Company's ability to raise additional capital through the future issuances of common stock is unknown. The obtainment of additional financing, the successful development of the Company's contemplated plan of operations, and its transition, ultimately, to the attainment of profitable operations are necessary for the Company to continue operations. The ability to successfully resolve these factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements of the Company do not include any adjustments that may result from the outcome of these aforementioned uncertainties. Management anticipates that that there will be sales sufficient to cover the next 12 months of cash operating expenses; however, there can be no surety that anticipated sales will materialize. In order to mitigate the risk related with this uncertainty, the CEO has agreed to contribute additional amounts to capital as needed to cover operating expenses. 4. PROPERTY AND EQUIPMENT, NET Property and equipment consist of the following as of March 31, 2016 and 2015: During the year ended March 31, 2016, the Company purchased $3,975 of new computer equipment and sold two fully depreciated jammers for a total of $80,000. Depreciation expense, for the years ended March 31, 2016 and 2015 was $42,381 and $46,428, respectively. 5. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES Accounts payable and accrued liabilities consist of the following as of March 31, 2016 and 2015: 6. OPERATING LEASE Lease obligations - On January 1, 2010, the Company entered into a 60 month lease for its 10,000 square foot office space located in Las Vegas, Nevada. The lease required no security deposit and provides for monthly payments of $10,000. The lease provides for a 60 month renewal period at the expiration to the lease period which the Company anticipates to exercise, but the lease is currently month-to-month. The amount of rent due, included in accounts payable, as of March 31, 2016, and March 31, 2015, was $173,765 and $156,265 respectively. Rental expense, for the years ended March 31, 2016 and 2015 was $120,131 and $120,000, respectively. MEGANET CORPORATION NOTES TO FINANCIAL STATEMENTS March 31, 2016 and 2015 7. RELATED PARTY TRANSACTIONS Officer loan - During the years ended March 31, 2016 and 2015, the Company received cash advances from its president in the amount of $151,175 and $188,824, respectively, and repaid the president $56,935 and $62,657, respectively. All amounts advanced to the Company are unsecured, non-interest bearing and due upon demand by the president. At March 31, 2016 and 2015, the Company owes its president $760,285 and $666,045, respectively. In accordance with FASB ASC 835-30 "Imputation of Interest", interest has been imputed on all advances made to Company by the president. During the years ended March 31, 2016 and 2015, interest has been imputed and charged to additional paid-in capital in the amount of $72,424 and $59,503, respectively. Employment agreements - as of March 31, 2015 the Company had only one employment agreement which was with the President and majority shareholder. The employment agreement stipulates that the President is to receive a base salary of $120,000 per annum. The agreement also contains a provision allowing for a commission to be paid equal to 10% of gross sales achieved by the President. The total expense related to this agreement for the years ended March 31, 2016 and 2015 was $128,262 and $122,232, respectively. As of March 31, 2016 and 2015, $871,317 and $743,054, respectively, of total compensation and related payroll taxes was unpaid and accrued in current liabilities. Included in the accrued payroll is an accrued liability for payroll taxes in the amount of $73,714 as of March 31, 2016 and 2015, respectively. These accruals inlude $4,935 in interest and penalties related to the late status of these payments. Nonetheless, the Company anticipates that it will reasonably be able to negotiate the total past due amount of payroll taxes in order to effectively eliminate penalties and interest. 8. INCOME TAXES Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Net deferred tax assets consist of the following components as of March 31, 2016 and 2015: The federal income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate of 34% to pretax income from continuing operations for the years ended March 31, 2016 and 2015 due to the following: The Company had net operating losses of approximately $2,159,038 that expire in years through 2026. Due to the change in ownership provisions of the Tax Reform Act of 1986, net operating loss carryforwards for Federal income tax reporting purposes are subject to annual limitations. Should a change in ownership occur, net operating loss carryforwards may be limited as to use in future years. 9. SUBSEQUENT EVENTS Subsequent to the balance sheet date the Company received cash advances from its President in the amount of $4,797 in order to cover certain obligations that were due and repaid $1,490. All amounts advanced to the Company are unsecured, non-interest bearing and due upon demand by the president. | Based on the provided excerpt, here's a summary of the financial statement:
Financial Condition:
- The company is experiencing losses
- There are substantial doubts about its ability to continue as a going concern
- Management has plans to address these challenges (detailed in Note 3)
Asset Management:
- Fixed assets are reviewed for potential impairment
- Assets are grouped at the lowest level with independent cash flows
- Undiscounted future cash flows are estimated over the asset's useful life
- No impairments were reported during the presented periods
Liabilities:
- Current liabilities exist
- Accrued payroll includes $73,714 in payroll tax liabilities
Overall, the financial statement suggests the company is in a financially precarious position, with ongoing losses and uncertainty about its future operations. The company appears to be carefully managing its assets and tracking its liabilities, but faces significant financial challenges. | Claude |
Consolidated Index to Consolidated Financial Statements Management’s Report on Internal Control over Financial Reporting Management of Horizon Technology Finance Corporation (the “Company”) is responsible for establishing and maintaining adequate internal control over the Company’s financial reporting. The Company’s internal control system is a process designed to provide reasonable assurance to management and the board of directors regarding the preparation and fair presentation of published financial statements. The Company’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions recorded necessary to permit the preparation of financial statements in accordance with U.S. generally accepted accounting principles. The Company’s policies and procedures also provide reasonable assurance that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company, and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness as to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework issued in 2013. Based on the assessment, management believes that, as of December 31, 2016, the Company’s internal control over financial reporting is effective based on those criteria. The Company’s independent registered public accounting firm that audited the financial statements has issued an audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016, which appears in this annual report on Form 10-K. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders Horizon Technology Finance Corporation We have audited the accompanying consolidated statements of assets and liabilities, including the consolidated schedules of investments, of Horizon Technology Finance Corporation and Subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of investments owned as of December 31, 2016 and 2015, by correspondence with the custodian or borrower or by other appropriate auditing procedures where replies from the custodian or borrowers were not received. Our audits also involved performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Horizon Technology Finance Corporation and Subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Horizon Technology Finance Corporation and Subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 7, 2017 expressed an unqualified opinion on the effectiveness of Horizon Technology Finance Corporation and Subsidiaries’ internal control over financial reporting. /s/ RSM US LLP New York, New York March 7, 2017 Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting To the Board of Directors and Stockholders Horizon Technology Finance Corporation We have audited Horizon Technology Finance Corporation and Subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Horizon Technology Finance Corporation and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of assets and liabilities, including the consolidated schedules of investments, of Horizon Technology Finance Corporation and Subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2016, and our report dated March 7, 2017 expressed an unqualified opinion. /s/ RSM US LLP New York, New York March 7, 2017 Horizon Technology Finance Corporation and Subsidiaries Consolidated Statements of Assets and Liabilities (In thousands, except share and per share data) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Statements of Operations (In thousands, except share and per share data) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Statements of Changes in Net Assets (In thousands, except share data) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Statements of Cash Flow (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2016 (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2016 (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2016 (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2016 (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2016 (In thousands) (1) All investments of the Company are in entities which are organized under the laws of the United States and have a principal place of business in the United States. (2) Has been pledged as collateral under the Key Facility. (3) All investments are less than 5% ownership of the class and ownership of the portfolio company. (4) All interest is payable in cash due monthly in arrears, unless otherwise indicated, and applies only to the Company’s debt investments. Interest rate is the annual interest rate on the debt investment and does not include end-of-term payments (“ETPs”) and any additional fees related to the investments, such as deferred interest, commitment fees or prepayment fees. All debt investments are at fixed rates for the term of the debt investment, unless otherwise indicated. Debt investments based on LIBOR are based on one-month LIBOR. For each debt investment, the current interest rate in effect as of December 31, 2016 is provided. (5) Portfolio company is a public company. (6) For debt investments, represents principal balance less unearned income. (7) Warrants, Equity and Other Investments are non-income producing. See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2016 (In thousands) (8) Value as a percent of net assets. (9) The Company did not have any non-qualifying assets under Section 55(a) of the Investment Company Act of 1940, as amended (the “1940 Act”), as of December 31, 2016. Under the 1940 Act, the Company may not acquire any non-qualifying assets unless, at the time the acquisition is made, qualifying assets represent at least 70% of the Company’s total assets. (10) ETPs are contractual fixed-interest payments due in cash at the maturity date of the applicable debt investment, including upon any prepayment, and are a fixed percentage of the original principal balance of the debt investments unless otherwise noted. Interest will accrue during the life of the debt investment on each ETP and will be recognized as non-cash income until it is actually paid. Therefore, a portion of the incentive fee the Company may pay its Advisor will be based on income that the Company has not yet received in cash. (11) Debt investment is on non-accrual status at December 31, 2016. (12) ScoreBig, Inc., a Delaware corporation (“ScoreBig”), made an assignment for the benefit of its creditors whereby ScoreBig assigned all of its assets to SB (assignment for the benefit of creditors), LLC, a California limited liability company (“SBABC”), established under California law to effectuate the Assignment for the Benefit of Creditors of ScoreBig. SBABC subsequently entered into a License Agreement with a third party (“Licensee”), whereby SBABC granted a license of certain of SBABC’s intellectual property and general intangibles to Licensee in exchange for certain royalty payments on the future net profits, if any, of Licensee. SBABC, in consideration for the Company’s consent to the License Agreement, agreed to pay all payments due under the License Agreement, if any, to the Company until the payment in full in cash of the Company’s debt investments in ScoreBig. (13) Digital Signal Corporation, a Delaware corporation (“DSC”), made an assignment for the benefit of its creditors whereby DSC assigned all of its assets to DSC (assignment for the benefit of creditors), LLC, a Delaware limited liability company, established under Delaware law to effectuate the Assignment for the Benefit of Creditors of DSC. See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2015 (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2015 (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2015 (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2015 (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2015 (In thousands) See Horizon Technology Finance Corporation and Subsidiaries Consolidated Schedule of Investments December 31, 2015 (In thousands) (1) All investments of the Company are in entities which are organized under the laws of the United States and have a principal place of business in the United States. (2) Has been pledged as collateral under the Key Facility or the 2013-1 Securitization. (3) All investments are less than 5% ownership of the class and ownership of the portfolio company. (4) All interest is payable in cash due monthly in arrears, unless otherwise indicated, and applies only to the Company’s debt investments. Interest rate is the annual interest rate on the debt investment and does not include ETPs and any additional fees related to the investments, such as deferred interest, commitment fees or prepayment fees. All debt investments are at fixed rates for the term of the debt investment, unless otherwise indicated. Debt investments based on LIBOR are based on one-month LIBOR. For each debt investment, the current interest rate in effect as of December 31, 2015 is provided. (5) Portfolio company is a public company. (6) For debt investments, represents principal balance less unearned income. (7) Warrants, Equity and Other Investments are non-income producing. (8) Value as a percent of net assets. (9) The Company did not have any non-qualifying assets under Section 55(a) of the 1940 Act as of December 31, 2015. Under the 1940 Act, the Company may not acquire any non-qualifying assets unless, at the time the acquisition is made, qualifying assets represent at least 70% of the Company’s total assets. (10) ETPs are contractual fixed-interest payments due in cash at the maturity date of the applicable debt investment, including upon any prepayment, and are a fixed percentage of the original principal balance of the debt investments unless otherwise noted. Interest will accrue during the life of the debt investment on each ETP and will be recognized as non-cash income until it is actually paid. Therefore, a portion of the incentive fee the Company may pay its Advisor will be based on income that the Company has not yet received in cash. (11) Debt investment is on non-accrual status at December 31, 2015. See Horizon Technology Finance Corporation and Subsidiaries Note 1. Organization Horizon Technology Finance Corporation (the “Company”) was organized as a Delaware corporation on March 16, 2010 and is an externally managed, non-diversified, closed-end investment company. The Company has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). In addition, for tax purposes, the Company has elected to be treated as a regulated investment company (“RIC”) as defined under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). As a RIC, the Company generally is not subject to corporate-level federal income tax on the portion of its taxable income and capital gains the Company distributes to its stockholders. The Company primarily makes secured debt investments to development-stage companies in the technology, life science, healthcare information and services and cleantech industries. All of the Company’s debt investments consist of loans secured by all of, or a portion of, the applicable debtor company’s tangible and intangible assets. On October 28, 2010, the Company completed an initial public offering (“IPO”) and its common stock trades on the NASDAQ Global Select Market under the symbol “HRZN.” The Company was formed to continue and expand the business of Compass Horizon Funding Company LLC, a Delaware limited liability company, which commenced operations in March 2008 and became the Company’s wholly owned subsidiary upon the completion of the Company’s IPO. Horizon Credit II LLC (“Credit II”) was formed as a Delaware limited liability company on June 28, 2011, with the Company as its sole equity member. Credit II is a special purpose bankruptcy remote entity and is a separate legal entity from the Company. Any assets conveyed to Credit II are not available to creditors of the Company or any other entity other than Credit II’s lenders. Longview SBIC GP LLC and Longview SBIC LP (collectively, “Horizon SBIC”) were formed as a Delaware limited liability company and Delaware limited partnership, respectively, on February 11, 2011. Horizon SBIC are wholly owned subsidiaries of the Company and were formed in anticipation of obtaining a license to operate a small business investment company from the U. S. Small Business Administration. There has been no activity in Horizon SBIC since its inception. Horizon SBIC was dissolved as of December 31, 2016. The Company formed Horizon Funding 2013-1 LLC (“2013-1 LLC”) as a Delaware limited liability company on June 7, 2013 and Horizon Funding Trust 2013-1 (“2013-1 Trust” and, together with 2013-1 LLC, the “2013-1 Entities”) as a Delaware trust on June 18, 2013. The 2013-1 Entities are special purpose bankruptcy remote entities and are separate legal entities from the Company. The Company formed the 2013-1 Entities for purposes of securitizing $189.3 million of secured loans (the “2013-1 Securitization”) and issuing fixed-rate asset-backed notes in an aggregate principal amount of $90 million (the “Asset-Backed Notes”). 2013-1 LLC and 2013-1 Trust were dissolved as of December 31, 2016. The Company has also established an additional wholly owned subsidiary, which is structured as a Delaware limited liability company, to hold the assets of a portfolio company acquired in connection with foreclosure or bankruptcy, which is a separate legal entity from the Company. The Company’s investment strategy is to maximize the investment portfolio’s return by generating current income from the debt investments the Company makes and capital appreciation from the warrants the Company receives when making such debt investments. The Company has entered into an investment management agreement (the “Investment Management Agreement”) with Horizon Technology Finance Management LLC (the “Advisor”), under which the Advisor manages the day-to-day operations of, and provides investment advisory services to, the Company. On March 24, 2015, the Company completed a public offering of 2,000,000 shares of its common stock at a public offering price of $13.95 per share, for total net proceeds to the Company of $26.5 million, after deducting underwriting commission and discounts and other offering expenses (the “2015 Offering”). Horizon Technology Finance Corporation and Subsidiaries Note 2. Basis of presentation and significant accounting policies The consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and pursuant to the requirements for reporting on Form 10-K and Articles 6 and 10 of Regulation S-X under the Securities Act of 1933, as amended (“Regulation S-X”). In the opinion of management, the consolidated financial statements reflect all adjustments and reclassifications that are necessary for the fair presentation of financial results as of and for the periods presented. All intercompany balances and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation. Principles of consolidation As required under GAAP and Regulation S-X, the Company will generally consolidate its investment in a company that is an investment company subsidiary or a controlled operating company whose business consists of providing services to the Company. Accordingly, the Company consolidated the results of the Company’s wholly-owned subsidiaries in its consolidated financial statements. Use of estimates In preparing the consolidated financial statements in accordance with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, as of the date of the balance sheet and income and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the valuation of investments. Fair value The Company records all of its investments at fair value in accordance with relevant GAAP, which establishes a framework used to measure fair value and requires disclosures for fair value measurements. The Company has categorized its investments carried at fair value, based on the priority of the valuation technique, into a three-level fair value hierarchy as more fully described in Note 5. Fair value is a market-based measure considered from the perspective of the market participant who holds the financial instrument rather than an entity specific measure. Therefore, when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that management believes market participants would use in pricing the financial instrument at the measurement date. The availability of observable inputs can vary depending on the financial instrument and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new, whether the product is traded on an active exchange or in the secondary market and the current market conditions. To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for financial instruments classified as Level 3. See Note 5 for additional information regarding fair value. Segments The Company has determined that it has a single reporting segment and operating unit structure. The Company lends to and invests in portfolio companies in various technology, life science, healthcare information and services and cleantech industries. The Company separately evaluates the performance of each of its lending and investment relationships. However, because each of these debt investments and investment relationships has similar business and economic characteristics, they have been aggregated into a single lending and investment segment. Horizon Technology Finance Corporation and Subsidiaries Investments Investments are recorded at fair value. The Company’s board of directors (the “Board”) determines the fair value of the Company’s portfolio investments. The Company has the intent to hold its debt investments for the foreseeable future or until maturity or payoff. Interest on debt investments is accrued and included in income based on contractual rates applied to principal amounts outstanding. Interest income is determined using a method that results in a level rate of return on principal amounts outstanding. Generally, when a debt investment becomes 90 days or more past due, or if the Company otherwise does not expect to receive interest and principal repayments, the debt investment is placed on non-accrual status and the recognition of interest income may be discontinued. Interest payments received on non-accrual debt investments may be recognized as income, on a cash basis, or applied to principal depending upon management’s judgment at the time the debt investment is placed on non-accrual status. As of December 31, 2016, there were four investments on non-accrual status with a cost of $26.2 million and a fair value of $11.5 million. As of December 31, 2015, there was one investment on non-accrual status with a cost of $2.7 million and a fair value of $0.5 million. For the year ended December 31, 2016, the Company did not recognize interest income from debt investments on non-accrual status. For the years ended December 31, 2015 and 2014, we recognized interest income payments of $0.2 million and $0.3 million, respectively, received from one portfolio company whose debt investment was on non-accrual status. The Company receives a variety of fees from borrowers in the ordinary course of conducting its business, including advisory fees, commitment fees, amendment fees, non-utilization fees, success fees and prepayment fees. In a limited number of cases, the Company may also receive a non-refundable deposit earned upon the termination of a transaction. Debt investment origination fees, net of certain direct origination costs, are deferred and, along with unearned income, are amortized as a level-yield adjustment over the respective term of the debt investment. All other income is recognized when earned. Fees for counterparty debt investment commitments with multiple debt investments are allocated to each debt investment based upon each debt investment’s relative fair value. When a debt investment is placed on non-accrual status, the amortization of the related fees and unearned income is discontinued until the debt investment is returned to accrual status. Certain debt investment agreements also require the borrower to make an end-of-term payment (“ETP”), that is accrued into interest receivable and taken into income over the life of the debt investment to the extent such amounts are expected to be collected. The Company will generally cease accruing the income if there is insufficient value to support the accrual or the Company does not expect the borrower to be able to pay the ETP when due. The proportion of the Company’s total investment income that resulted from the portion of ETPs not received in cash for the years ended December 31, 2016, 2015 and 2014 was 10.8%, 7.1% and 6.5%, respectively. In connection with substantially all lending arrangements, the Company receives warrants to purchase shares of stock from the borrower. The warrants are recorded as assets at estimated fair value on the grant date using the Black-Scholes valuation model. The warrants are considered loan fees and are recorded as unearned income on the grant date. The unearned income is recognized as interest income over the contractual life of the related debt investment in accordance with the Company’s income recognition policy. Subsequent to debt investment origination, the fair value of the warrants is determined using the Black-Scholes valuation model. Any adjustment to fair value is recorded through earnings as net unrealized appreciation or depreciation on investments. Gains and losses from the disposition of the warrants or stock acquired from the exercise of warrants are recognized as realized gains and losses on investments. Realized gains or losses on the sale of investments, or upon the determination that an investment balance, or portion thereof, is not recoverable, are calculated using the specific identification method. The Company measures realized gains or losses by calculating the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment. Net change in unrealized appreciation or depreciation reflects the change in the fair values of the Company’s portfolio investments during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized. Horizon Technology Finance Corporation and Subsidiaries Debt issuance costs Debt issuance costs are fees and other direct incremental costs incurred by the Company in obtaining debt financing from its lenders and issuing debt securities. The unamortized balance of debt issuance costs as of December 31, 2016 and 2015 was $1.6 million and $1.9 million, respectively. These amounts are amortized and included in interest expense in the consolidated statements of operations over the life of the borrowings. The accumulated amortization balances as of December 31, 2016 and 2015 were $4.4 million and $3.9 million, respectively. The amortization expense for the years ended December 31, 2016, 2015 and 2014 was $0.6 million, $0.9 million and $2.7 million, respectively. Income taxes As a BDC, the Company has elected to be treated as a RIC under Subchapter M of the Code and operates in a manner so as to qualify for the tax treatment applicable to RICs. In order to qualify as a RIC and to avoid the imposition of corporate-level income tax on the income distributed to stockholders, among other things, the Company is required to meet certain source of income and asset diversification requirements and to timely distribute dividends out of assets legally available for distribution to its stockholders of an amount generally at least equal to 90% of its investment company taxable income, as defined by the Code, for each tax year. The Company, among other things, has made and intends to continue to make the requisite distributions to its stockholders, which generally relieves the Company from corporate-level U.S. federal income taxes. Accordingly, no provision for federal income tax has been recorded in the financial statements. Differences between taxable income and net increase in net assets resulting from operations either can be temporary, meaning they will reverse in the future, or permanent. In accordance with Topic 946, Financial Services-Investment Companies, of the Financial Accounting Standards Board’s (“FASB’s”), Accounting Standards Codification, as amended (“ASC”), permanent tax differences, such as non-deductible excise taxes paid, are reclassified from distributions in excess of net investment income and net realized loss on investments to paid-in-capital at the end of each year. These permanent book-to-tax differences are reclassified on the consolidated statements of changes in net assets to reflect their tax character but have no impact on total net assets. For the year ended December 31, 2016, the Company reclassified $0.1 million to paid-in capital from distributions in excess of net investment income, which related to excise taxes refunded in 2016. For the year ended December 31, 2015, the Company reclassified $1.0 million to paid-in capital from distributions in excess of net investment income of $0.9 million and net realized loss on investments of $0.1 million, which related to excise taxes paid in prior years. Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% U.S. federal excise tax on such income, as required. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year distributions, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned. For the year ended December 31, 2016, $0.1 million was recorded for U.S. federal excise tax. For the year ended December 31, 2015, there was no U.S. federal excise tax recorded. For the year December 31, 2014, $0.2 million was recorded for U.S. federal excise tax. The Company evaluates tax positions taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority in accordance with ASC Topic 740, Income Taxes, as modified by ASC Topic 946. Tax benefits of positions not deemed to meet the more-likely-than-not threshold, or uncertain tax positions, would be recorded as a tax expense in the current year. It is the Company’s policy to recognize accrued interest and penalties related to uncertain tax benefits in income tax expense. The Company had no material uncertain tax positions at December 31, 2016 and 2015. The 2015, 2014 and 2013 tax years remain subject to examination by U.S. federal and state tax authorities. Distributions Distributions to common stockholders are recorded on the declaration date. The amount to be paid out as distributions is determined by the Board. Net realized long-term capital gains, if any, are distributed at least annually, although the Company may decide to retain such capital gains for investment. Horizon Technology Finance Corporation and Subsidiaries The Company has adopted a dividend reinvestment plan that provides for reinvestment of cash distributions on behalf of its stockholders, unless a stockholder elects to receive cash. As a result, if the Board declares a cash distribution, then stockholders who have not “opted out” of the dividend reinvestment plan will have their cash distributions automatically reinvested in additional shares of the Company’s common stock, rather than receiving the cash distribution. The Company may use newly issued shares to implement the plan or the Company may purchase shares in the open market to fulfill its obligations under the plan. Stock Repurchase Program On July 29, 2016, the Board extended a previously authorized stock repurchase program which allows the Company to repurchase up to $5.0 million of its common stock at prices below the Company’s net asset value per share as reported in its most recent consolidated financial statements. Under the repurchase program, the Company may, but is not obligated to, repurchase shares of its outstanding common stock in the open market or in privately negotiated transactions from time to time. Any repurchases by the Company will comply with the requirements of Rule 10b-18 under the Securities Exchange Act of 1934, as amended, and any applicable requirements of the 1940 Act. Unless extended by the Board, the repurchase program will terminate on the earlier of June 30, 2017 or the repurchase of $5.0 million of the Company’s common stock. During the year ended December 31, 2016, the Company repurchased 48,160 shares of its common stock at an average price of $10.66 on the open market at a total cost of $0.5 million. During the year ended December 31, 2015, the Company repurchased 113,382 shares of its common stock at an average price of $11.53 on the open market at a total cost of $1.3 million. From the inception of the stock repurchase program through December 31, 2016, the Company repurchased 161,542 shares of its common stock at an average price of $11.27 on the open market at a total cost of $1.8 million. Transfers of financial assets Assets related to transactions that do not meet the requirements under ASC Topic 860, Transfers and Servicing for accounting sale treatment are reflected in the Company’s consolidated statements of assets and liabilities as investments. Those assets are owned by special purpose entities that are consolidated in the Company’s financial statements. The creditors of the special purpose entities have received security interests in such assets and such assets are not intended to be available to the creditors of the Company (or any other affiliate of the Company). Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the transferor does not maintain effective control over the transferred assets through either (a) an agreement that both entitles and obligates the transferor to repurchase or redeem the assets before maturity or (b) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call. Recently adopted accounting pronouncement In April 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), as clarified by ASU 2015-15, Interest-Imputation of Interest: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (“ASU 2015-15”), containing guidance that requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, instead of being recorded as a separate asset. ASU 2015-15 allows an entity to defer and present debt issuance costs for line-of-credit arrangements as an asset and subsequently amortize these deferred costs over the term of the line-of-credit arrangement. The Company has adopted ASU 2015-03, as clarified by ASU 2015-15, which did not have a material impact on the Company’s consolidated financial statements other than corresponding reductions to total assets and total liabilities on the consolidated statements of assets and liabilities. Prior to adoption, the Company recorded debt issuance costs in other assets as an asset on the consolidated statements of assets and liabilities. Upon adoption, the Company reclassified these costs as unamortized debt issuance costs that reduce borrowings in the liabilities on the consolidated statements of assets and liabilities and retrospectively reclassified the debt issuance costs that were previously presented in other assets as an asset as of December 31, 2015, as discussed further in Note 6. Horizon Technology Finance Corporation and Subsidiaries Note 3. Related party transactions Investment Management Agreement The Investment Management Agreement was reapproved by the Board on July 29, 2016. Under the terms of the Investment Management Agreement, the Advisor determines the composition of the Company’s investment portfolio, the nature and timing of the changes to the investment portfolio and the manner of implementing such changes; identifies, evaluates and negotiates the structure of the investments the Company makes (including performing due diligence on the Company’s prospective portfolio companies); and closes, monitors and administers the investments the Company makes, including the exercise of any voting or consent rights. The Advisor’s services under the Investment Management Agreement are not exclusive to the Company, and the Advisor is free to furnish similar services to other entities so long as its services to the Company are not impaired. The Advisor is a registered investment adviser with the U.S. Securities and Exchange Commission (the “SEC”). The Advisor receives fees for providing services to the Company under the Investment Management Agreement, consisting of two components, a base management fee and an incentive fee. The base management fee under the Investment Management Agreement is calculated at an annual rate of 2.00% of (i) the Company’s gross assets, less (ii) assets consisting of cash and cash equivalents, and is payable monthly in arrears. For purposes of calculating the base management fee, the term “gross assets” includes any assets acquired with the proceeds of leverage. In addition, the Advisor agreed to waive its base management fee relating to the proceeds raised in the 2015 Offering, to the extent such fee is not otherwise waived and regardless of the application of the proceeds raised, until the earlier to occur of (i) March 31, 2016 or (ii) the last day of the second consecutive calendar quarter in which the Company’s net investment income exceeds distributions declared on its shares of common stock for the applicable quarter. As of December 31, 2015, the Company had met condition (ii) above as net investment income exceeded distributions declared for the quarters ended September 30, 2015 and December 31, 2015. During the year ended December 31, 2015, the Advisor waived base management fees of $0.3 million, which the Advisor would have otherwise earned on the proceeds raised in the 2015 Offering. During the first six months of the year ended December 31, 2014, the Advisor waived base management fees of $0.2 million, which the Advisor would have otherwise earned on cash held by the Company at the time of calculation. The base management fee payable at December 31, 2016 and 2015 was $0.3 million and $0.4 million, respectively. After giving effect of the waivers, the base management fee expense was $4.7 million, $4.4 million and $4.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. The incentive fee has two parts, as follows: The first part, which is subject to the Incentive Fee Cap and Deferral Mechanism, as defined below, is calculated and payable quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter. For this purpose, “Pre-Incentive Fee Net Investment Income” means interest income, dividend income and any other income (including any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees received from portfolio companies) accrued during the calendar quarter, minus expenses for the quarter (including the base management fee, expenses payable under the Administration Agreement (as defined below), and any interest expense and any dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-Incentive Fee Net Investment Income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with payment-in-kind interest and zero coupon securities), accrued income the Company has not yet received in cash. The incentive fee with respect to the Pre-Incentive Fee Net Investment Income is 20.00% of the amount, if any, by which the Pre-Incentive Fee Net Investment Income for the immediately preceding calendar quarter exceeds a hurdle rate of 1.75% (which is 7.00% annualized) of the Company’s net assets at the end of the immediately preceding calendar quarter, subject to a “catch-up” provision measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, the Advisor receives no incentive fee until the Pre-Incentive Fee Net Investment Income equals the hurdle rate of 1.75%, but then receives, as a “catch-up,” 100.00% of the Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the hurdle rate but is less than 2.1875% quarterly (which is 8.75% annualized). The effect of this “catch-up” provision is that, if Pre-Incentive Fee Net Investment Income exceeds 2.1875% in any calendar quarter, the Advisor will receive 20.00% of the Pre-Incentive Fee Net Investment Income as if the hurdle rate did not apply. Horizon Technology Finance Corporation and Subsidiaries Pre-Incentive Fee Net Investment Income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that the Company may pay an incentive fee in a quarter in which the Company incurs a loss. For example, if the Company receives Pre-Incentive Fee Net Investment Income in excess of the quarterly minimum hurdle rate, the Company will pay the applicable incentive fee up to the Incentive Fee Cap, defined below, even if the Company has incurred a loss in that quarter due to realized and unrealized capital losses. The Company’s net investment income used to calculate this part of the incentive fee is also included in the amount of the Company’s gross assets used to calculate the 2.00% base management fee. These calculations are appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during the current quarter. Commencing with the calendar quarter beginning July 1, 2014, the incentive fee on Pre-Incentive Fee Net Investment Income is subject to a fee cap and deferral mechanism which is determined based upon a look-back period of up to three years and is expensed when incurred. For this purpose, the look-back period for the incentive fee based on Pre-Incentive Fee Net Investment Income (the “Incentive Fee Look-back Period”) commenced on July 1, 2014 and increases by one quarter in length at the end of each calendar quarter until June 30, 2017, after which time, the Incentive Fee Look-back Period will include the relevant calendar quarter and the 11 preceding full calendar quarters. Each quarterly incentive fee payable on Pre-Incentive Fee Net Investment Income is subject to a cap (the “Incentive Fee Cap”) and a deferral mechanism through which the Advisor may recoup a portion of such deferred incentive fees (collectively, the “Incentive Fee Cap and Deferral Mechanism”). The Incentive Fee Cap is equal to (a) 20.00% of Cumulative Pre-Incentive Fee Net Return (as defined below) during the Incentive Fee Look-back Period less (b) cumulative incentive fees of any kind paid to the Advisor during the Incentive Fee Look-back Period. To the extent the Incentive Fee Cap is zero or a negative value in any calendar quarter, the Company will not pay an incentive fee on Pre-Incentive Fee Net Investment Income to the Advisor in that quarter. To the extent that the payment of incentive fees on Pre-Incentive Fee Net Investment Income is limited by the Incentive Fee Cap, the payment of such fees will be deferred and paid in subsequent calendar quarters up to three years after their date of deferment, subject to certain limitations, which are set forth in the Investment Management Agreement. The Company only pays incentive fees on Pre-Incentive Fee Net Investment Income to the extent allowed by the Incentive Fee Cap and Deferral Mechanism. “Cumulative Pre-Incentive Fee Net Return” during any Incentive Fee Look-back Period means the sum of (a) Pre-Incentive Fee Net Investment Income and the base management fee for each calendar quarter during the Incentive Fee Look-back Period and (b) the sum of cumulative realized capital gains and losses, cumulative unrealized capital appreciation and cumulative unrealized capital depreciation during the applicable Incentive Fee Look-back Period. The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year (or, upon termination of the Investment Management Agreement, as of the termination date), and equals 20.00% of the Company’s realized capital gains, if any, on a cumulative basis from the date of the election to be a BDC through the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis through the end of such year, less all previous amounts paid in respect of the capital gain incentive fee. However, in accordance with GAAP, the Company is required to include the aggregate unrealized capital appreciation on investments in the calculation and accrue a capital gain incentive fee on a quarterly basis, as if such unrealized capital appreciation were realized, even though such unrealized capital appreciation is not permitted to be considered in calculating the fee actually payable under the Investment Management Agreement. Horizon Technology Finance Corporation and Subsidiaries During the year ended December 31, 2014, the Advisor waived performance based incentive fees of $0.1 million which the Advisor would have otherwise earned. After giving effect of the waiver in 2014, the performance based incentive fee expense was $2.1 million, $3.5 million and $2.0 million for the years ended December 31, 2016, 2015 and 2014, respectively. The incentive fee on Pre-Incentive Fee Net Investment Income was subject to the Incentive Fee Cap and Deferral Mechanism for the three months ended September 30, 2016 and December 31, 2016, which resulted in $1.7 million of reduced expense and additional net investment income. As of December 31, 2015, the incentive fee on Pre-Incentive Fee Net Investment Income was not limited by the Incentive Fee Cap and Deferral Mechanism. There was no performance based incentive fee payable for December 31, 2016. The performance based incentive fee payable for December 31, 2015 was $1.0 million. The entire incentive fee payable as of December 31, 2015 represented part one of the incentive fee. Administration Agreement The Company entered into an administration agreement (the “Administration Agreement”) with the Advisor to provide administrative services to the Company. For providing these services, facilities and personnel, the Company reimburses the Advisor for the Company’s allocable portion of overhead and other expenses incurred by the Advisor in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing compliance functions and the Company’s allocable portion of the costs of compensation and related expenses of the Company’s Chief Financial Officer and Chief Compliance Officer and their respective staffs. The administrative fee expense was $0.9 million, $1.1 million and $1.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. Note 4. Investments The following table shows the Company’s investments as of December 31, 2016 and 2015: Horizon Technology Finance Corporation and Subsidiaries The following table shows the Company’s non-affiliate investments by industry sector as of December 31, 2016 and 2015: Note 5. Fair value The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in certain instances, there are no quoted market prices for certain assets or liabilities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the asset or liability. Fair value measurements focus on exit prices in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The Company’s fair value measurements are classified into a fair value hierarchy based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The three categories within the hierarchy are as follows: Level 1Quoted prices in active markets for identical assets and liabilities. Level 2Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, and model-based valuation techniques for which all significant inputs are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Horizon Technology Finance Corporation and Subsidiaries Level 3Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. Investments are valued at fair value as determined in good faith by the Board, based on input of management, the audit committee and independent valuation firms which are engaged at the direction of the Board to assist in the valuation of each portfolio investment lacking a readily available market quotation at least once during a trailing twelve-month period under a valuation policy and a consistently applied valuation process. This valuation process is conducted at the end of each fiscal quarter, with 25% (based on fair value) of the Company’s valuation of portfolio companies lacking readily available market quotations subject to review by an independent valuation firm. Because there is not a readily available market value for most of the investments in its portfolio, the Company values substantially all of its portfolio investments at fair value as determined in good faith by the Board, as described herein. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company's investments may fluctuate from period to period. Additionally, the fair value of the Company's investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that the Company may ultimately realize. Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If the Company was required to liquidate a portfolio investment in a forced or liquidation sale, the Company could realize significantly less than the value at which the Company has recorded such portfolio investment. Cash and interest receivable: The carrying amount is a reasonable estimate of fair value. These financial instruments are not recorded at fair value on a recurring basis and are categorized as Level 1 within the fair value hierarchy described above. Money market funds: The carrying amounts are valued at their net asset value as of the close of business on the day of valuation. These financial instruments are recorded at fair value on a recurring basis and are categorized as Level 2 within the fair value hierarchy described above as these funds can be redeemed daily. Debt investments: For variable rate debt investments which re-price frequently and have no significant change in credit risk, carrying values are a reasonable estimate of fair values. The fair value of fixed rate debt investments is estimated by discounting the expected future cash flows using the year end rates at which similar debt investments would be made to borrowers with similar credit ratings and for the same remaining maturities. At December 31, 2016 and 2015, the hypothetical market yields used ranged from 11% to 25%. Significant increases (decreases) in this unobservable input would result in a significantly lower (higher) fair value measurement. These assets are recorded at fair value on a recurring basis and are categorized as Level 3 within the fair value hierarchy described above. Under certain circumstances, the Company may use an alternative technique to value debt investments that better reflects its fair value such as the use of multiple probability weighted cash flow models when the expected future cash flows contain elements of variability. Warrant investments: The Company values its warrants using the Black-Scholes valuation model incorporating the following material assumptions: •Underlying asset value of the issuer is estimated based on information available, including any information regarding the most recent rounds of borrower funding. Significant increases (decreases) in this unobservable input would result in a significantly higher (lower) fair value measurement. •Volatility, or the amount of uncertainty or risk about the size of the changes in the warrant price, is based on indices of publicly traded companies similar in nature to the underlying company issuing the warrant. A total of seven such indices are used. Significant increases (decreases) in this unobservable input would result in a significantly higher (lower) fair value measurement. Horizon Technology Finance Corporation and Subsidiaries •The risk-free interest rates are derived from the U.S. Treasury yield curve. The risk-free interest rates are calculated based on a weighted average of the risk-free interest rates that correspond closest to the expected remaining life of the warrant. •Other adjustments, including a marketability discount on private company warrants, are estimated based on management’s judgment about the general industry environment. •Historical portfolio experience on cancellations and exercises of the Company’s warrants are utilized as the basis for determining the estimated time to exit of the warrants in each financial reporting period. Warrants may be exercised in the event of acquisitions, mergers or IPOs, and cancelled due to events such as bankruptcies, restructuring activities or additional financings. These events cause the expected remaining life assumption to be shorter than the contractual term of the warrants. Significant increases (decreases) in this unobservable input would result in significantly higher (lower) fair value measurement. Under certain circumstances the Company may use an alternative technique to value warrants that better reflects the warrants’ fair value, such as an expected settlement of a warrant in the near term or a model that incorporates a put feature associated with the warrant. The fair value may be determined based on the expected proceeds to be received from such settlement or based on the net present value of the expected proceeds from the put option. The fair value of the Company’s warrants held in publicly traded companies is determined based on inputs that are readily available in public markets or can be derived from information available in public markets. Therefore, the Company has categorized these warrants as Level 2 within the fair value hierarchy described above. The fair value of the Company’s warrants held in private companies is determined using both observable and unobservable inputs and represents management’s best estimate of what market participants would use in pricing the warrants at the measurement date. Therefore, the Company has categorized these warrants as Level 3 within the fair value hierarchy described above. These assets are recorded at fair value on a recurring basis. Equity investments: The fair value of an equity investment in a privately held company is initially the face value of the amount invested. The Company adjusts the fair value of equity investments in private companies upon the completion of a new third-party round of equity financing. The Company may make adjustments to fair value, absent a new equity financing event, based upon positive or negative changes in a portfolio company’s financial or operational performance. Significant increases (decreases) in this unobservable input would result in a significantly higher (lower) fair value measurement. The Company has categorized these equity investments as Level 3 within the fair value hierarchy described above. The fair value of an equity investment in a publicly traded company is based upon the closing public share price on the date of measurement. Therefore, the Company has categorized these equity investments as Level 1 within the fair value hierarchy described above. These assets are recorded at fair value on a recurring basis. Other investments: Other investments are valued based on the facts and circumstances of the underlying agreement. The Company currently values these contractual agreements using a multiple probability weighted cash flow model as the contractual future cash flows contain elements of variability. Significant changes in the estimated cash flows and probability weightings would result in a significantly higher or lower fair value measurement. The Company has categorized these other investments as Level 3 within the fair value hierarchy described above. These assets are recorded at fair value on a recurring basis. The following tables provide a summary of quantitative information about the Company’s Level 3 fair value measurements of its investments as of December 31, 2016 and 2015. In addition to the techniques and inputs noted in the table below, according to the Company’s valuation policy, the Company may also use other valuation techniques and methodologies when determining its fair value measurements. Horizon Technology Finance Corporation and Subsidiaries The following table is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements as of December 31, 2016: The following table is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements as of December 31, 2015: Borrowings: The carrying amount of borrowings under the Company’s revolving credit facility (the “Key Facility”) with KeyBank National Association (“Key”) approximates fair value due to the variable interest rate of the Key Facility and is categorized as Level 2 within the fair value hierarchy described above. Additionally, the Company considers its creditworthiness in determining the fair value of such borrowings. The fair value of the fixed rate 2019 Notes (as defined in Note 6) is based on the closing public share price on the date of measurement. On December 31, 2016, the closing price of the 2019 Notes on the New York Stock Exchange was $25.50 per note, or $33.7 million. Therefore, the Company has categorized this borrowing as Level 1 within the fair value hierarchy described above. Horizon Technology Finance Corporation and Subsidiaries Off-balance-sheet instruments: Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standings. Therefore, the Company has categorized these instruments as Level 3 within the fair value hierarchy described above. The following tables detail the assets that are carried at fair value and measured at fair value on a recurring basis as of December 31, 2016 and 2015 and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value: The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2016: The Company’s transfers between levels are recognized at the end of each reporting period. During the year ended December 31, 2016, there were no transfers between levels. The change in unrealized depreciation included in the consolidated statement of operations attributable to Level 3 investments still held at December 31, 2016 includes $14.7 million in unrealized depreciation on debt and other investments, $0.3 million in unrealized appreciation on warrants and $0.1 million in unrealized appreciation on equity. Horizon Technology Finance Corporation and Subsidiaries The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2015: The Company’s transfers between levels are recognized at the end of each reporting period. During the year ended December 31, 2015, there were no transfers between Level 1 and Level 2. The transfer out of Level 3 relates to warrants held in three portfolio companies, with an aggregate fair value of $0.02 million, that were transferred into Level 2 upon the portfolio companies becoming public companies during the period. The change in unrealized depreciation included in the consolidated statement of operations attributable to Level 3 investments still held at December 31, 2015 includes $2.2 million in unrealized depreciation for debt and other investments, $1.6 million in unrealized appreciation on warrants and $0.2 million in unrealized depreciation on equity. The Company discloses fair value information about financial instruments, whether or not recognized in the consolidated statement of assets and liabilities, for which it is practicable to estimate that value. Certain financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The fair value amounts for 2016 and 2015 have been measured as of the reporting date and have not been reevaluated or updated for purposes of these financial statements subsequent to that date. As such, the fair values of these financial instruments subsequent to the reporting date may be different than amounts reported at year-end. As of December 31, 2016 and 2015, the recorded balances equaled fair values of all the Company’s financial instruments, except for the Company’s 2019 Notes, as previously described. Off-balance-sheet instruments The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change, and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new debt investments and by investing in securities with terms that mitigate the Company’s overall interest rate risk. Horizon Technology Finance Corporation and Subsidiaries Note 6. Borrowings The following table shows the Company’s borrowings as of December 31, 2016 and 2015: In accordance with the 1940 Act, with certain limited exceptions, the Company is only allowed to borrow amounts such that the Company’s asset coverage, as defined in the 1940 Act, is at least 200% after such borrowings. As of December 31, 2016, the asset coverage for borrowed amounts was 245%. On August 12, 2015, the Company amended the Key Facility to (1) add a $20 million commitment to the existing $50 million commitment and (2) extend the term of the Key Facility. On April 27, 2016, the Company added a $25 million commitment to the existing $70 million commitment. The Key Facility has an accordion feature which allows for an increase in the total loan commitment to $150 million from the current $95 million commitment. The Key Facility is collateralized by all debt investments and warrants held by Credit II and permits an advance rate of up to 50% of eligible debt investments held by Credit II. The Key Facility contains covenants that, among other things, require the Company to maintain a minimum net worth and to restrict the debt investments securing the Key Facility to certain criteria for qualified debt investments and includes portfolio company concentration limits as defined in the related loan agreement. The Key Facility has a three-year revolving period followed by a two-year amortization period and matures on August 12, 2020. The interest rate is based upon the one-month London Interbank Offered Rate (“LIBOR”), plus a spread of 3.25%, with a LIBOR floor of 0.75%. The LIBOR rate was 0.77% and 0.43% on December 31, 2016 and 2015, respectively. The average rate for the years ended December 31, 2016 and 2015 was 4.00%. As of December 31, 2016, the Company had borrowing capacity of $32.0 million, of which $4.6 million was available, subject to existing terms and advance rates. As of December 31, 2015, the Company had available borrowing capacity of $2.0 million, subject to existing terms and advance rates. On March 23, 2012, the Company issued and sold an aggregate principal amount of $30 million of 7.375% senior unsecured notes due in 2019 and on April 18, 2012, pursuant to the underwriters’ 30 day option to purchase additional notes, the Company sold an additional $3 million of such notes (collectively, the “2019 Notes”). The 2019 Notes will mature on March 15, 2019 and may be redeemed in whole or in part at the Company’s option at any time or from time to time at a redemption price of $25 per security plus accrued and unpaid interest. The 2019 Notes bear interest at a rate of 7.375% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year. The 2019 Notes are the Company’s direct unsecured obligations and (i) rank equally in right of payment with the Company’s future unsecured indebtedness; (ii) are senior in right of payment to any of the Company’s future indebtedness that expressly provides it is subordinated to the 2019 Notes; (iii) are effectively subordinated to all of the Company’s existing and future secured indebtedness (including indebtedness that is initially unsecured to which the Company subsequently grants security), to the extent of the value of the assets securing such indebtedness, and (iv) are structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries. As of December 31, 2016, the Company was in material compliance with the terms of the 2019 Notes. The 2019 Notes are listed on the New York Stock Exchange under the symbol “HTF”. Horizon Technology Finance Corporation and Subsidiaries On August 23, 2012, the Company entered into a term loan facility (the “Term Loan Facility”) with Fortress Credit Co LLC. The interest rate on the Term Loan Facility was based upon the one-month LIBOR plus a spread of 6.00%, with a LIBOR floor of 1.00% and provided for a four-year drawing period. The Term Loan Facility contained customary covenants for a facility of its type. Effective June 17, 2014, the Company terminated the Term Loan Facility and a related loan and security agreement and other documents. On June 28, 2013, the Company completed the 2013-1 Securitization. In connection with the 2013-1 Securitization, 2013-1 Trust, a wholly owned subsidiary of the Company, issued $90 million in the Asset-Backed Notes, which were rated A1(sf) by Moody’s Investors Service, Inc. The Asset-Backed Notes were issued by 2013-1 Trust and were backed by a pool of loans made to certain portfolio companies of the Company and secured by certain assets of such portfolio companies. The Asset-Backed Notes were secured obligations of 2013-1 Trust and non-recourse to the Company. In connection with the issuance and sale of the Asset-Backed Notes, the Company made customary representations, warranties and covenants. The Asset-Backed Notes bore interest at a fixed rate of 3.00% per annum and had a stated maturity of May 15, 2018. As of December 31, 2016 the Asset-Backed Notes were repaid in full. Under the terms of the Asset-Backed Notes, the Company was required to maintain a reserve cash balance, funded through principal collections from the underlying securitized debt portfolio, which was used to make monthly interest and principal payments on the Asset-Backed Notes. The Company had segregated these funds and classified them as restricted investments in money market funds on the consolidated statements of assets and liabilities. The balance of restricted investments in money market funds was $1.1 million as of December 31, 2015. The following table shows information about our senior securities as of December 31, 2016, 2015, 2014, 2013 and 2012: (1) Total amount of senior securities outstanding at the end of the period presented. (2) Asset coverage per unit is the ratio of the original cost less accumulated depreciation, amortization or impairment of the Company’s total consolidated assets, less all liabilities and indebtedness not represented by senior securities, to the aggregate amount of senior securities representing indebtedness. Asset coverage per unit is expressed in terms of dollar amounts per $1,000 of indebtedness. (3) The amount which the holder of such class of senior security would be entitled upon the voluntary liquidation of the applicable issuer in preference to any security junior to it. The “ - ” in this column indicates that the SEC expressly does not require this information to be disclosed for certain types of securities. (4) Not applicable to the Company’s credit facilities and 2013-1 Securitization because such securities are not registered for public trading. Horizon Technology Finance Corporation and Subsidiaries Note 7. Federal income tax The Company has elected to be treated as a RIC under Subchapter M of the Code and to distribute substantially all of its taxable income. Accordingly, no provision for federal, state or local income tax has been recorded in the financial statements. Taxable income differs from net increase in net assets resulting from operations primarily due to unrealized appreciation on investments as investment gains and losses are not included in taxable income until they are realized. The following table reconciles net increase in net assets resulting from operations to taxable income: The tax characters of distributions paid are as follows: The components of undistributed ordinary income earnings on a tax basis were as follows: Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year distributions into the next tax year and incur a 4% excise tax on such income, as required. For the years ended December 31, 2016 and 2015, the Company elected to carry forward taxable income in excess of current year distributions of $1.8 million and $1.3 million, respectively. At December 31, 2016, a provision for excise tax of $0.1 million was recorded. At December 31, 2015, no provision for excise tax was recorded. Horizon Technology Finance Corporation and Subsidiaries Capital losses in excess of capital gains earned in a tax year may generally be carried forward, without expiration, and used to offset capital gains, subject to certain limitations. During the years ended December 31, 2016, 2015 and 2014, the Company did not use any of its capital loss carry forward to offset capital gains. For federal income tax purposes, the tax cost of investments at December 31, 2016 and 2015 was $211.6 million and $255.5 million, respectively. The gross unrealized appreciation on investments at December 31, 2016 and 2015 was $3.8 million and $4.4 million, respectively. The gross unrealized depreciation on investments at December 31, 2016 and 2015 was $23.3 million and $9.6 million, respectively. Note 8. Financial instruments with off-balance-sheet risk In the normal course of business, the Company is party to financial instruments with off-balance-sheet risk to meet the financing needs of its borrowers. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated statement of assets and liabilities. The Company attempts to limit its credit risk by conducting extensive due diligence and obtaining collateral where appropriate. The balance of unfunded commitments to extend credit was $20.8 million and $10.0 million as of December 31, 2016 and 2015, respectively. Commitments to extend credit consist principally of the unused portions of commitments that obligate the Company to extend credit, such as revolving credit arrangements or similar transactions. These commitments are often subject to financial or non-financial milestones and other conditions to borrow that must be achieved before the commitment can be drawn. In addition, the commitments generally have fixed expiration dates or other termination clauses. Since commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The following table provides the Company’s unfunded commitments by portfolio company as of December 31, 2016: The table above also provides the fair value of the Company’s unfunded commitment liability as of December 31, 2016 which totaled $0.2 million. The fair value at inception of the delay draw credit agreements is equal to the fees and/or warrants received to enter into these agreements, taking into account the remaining terms of the agreements and the counterparties’ credit profile. The unfunded commitment liability reflects the fair value of these future funding commitments and is included in the Company’s consolidated statement of assets and liabilities. Note 9. Concentrations of credit risk The Company’s debt investments consist primarily of loans to development-stage companies at various stages of development in the technology, life science, healthcare information and services and cleantech industries. Many of these companies may have relatively limited operating histories and also may experience variation in operating results. Many of these companies conduct business in regulated industries and could be affected by changes in government regulations. Most of the Company’s borrowers will need additional capital to satisfy their continuing working capital needs and other requirements, and in many instances, to service the interest and principal payments on the loans. Horizon Technology Finance Corporation and Subsidiaries The Company’s largest debt investments may vary from year to year as new debt investments are recorded and existing debt investments are repaid. The Company’s five largest debt investments, at cost, represented 24% and 21% of total debt investments outstanding as of December 31, 2016 and 2015, respectively. No single debt investment represented more than 10% of the total debt investments as of December 31, 2016 or 2015. Investment income, consisting of interest and fees, can fluctuate significantly upon repayment of large debt investments. Interest income from the five largest debt investments accounted for 17%, 14% and 20% of total interest and fee income on investments for the years ended December 31, 2016, 2015 and 2014, respectively. Note 10. Distributions The Company’s distributions are recorded on the declaration date. The following table summarizes the Company’s distribution activity for the years ended December 31, 2016 and 2015: On March 3, 2017, the Board declared monthly distributions per share, payable as set forth in the following table: After paying distributions of $1.26 per share deemed paid for tax purposes in 2016, declaring on October 28, 2016 a distribution of $0.10 per share payable January 13, 2017, and taxable earnings of $1.41 per share in 2016, the Company’s undistributed spillover income as of December 31, 2016 was $0.15 per share. Spillover income includes any ordinary income and net capital gains from the preceding tax years that were not distributed during such tax years. Horizon Technology Finance Corporation and Subsidiaries Note 11. Subsequent events On February 3, 2017, New Haven Pharmaceuticals, Inc., a Delaware corporation (“NHP”), made an assignment for the benefit of its creditors whereby (a) NHP assigned all of its assets and liabilities, including the Company’s debt investments in NHP (the “NHP Loans”), to New Haven (assignment for the benefit of creditors), LLC, a Delaware limited liability company (“NHABC”), in trust under Delaware law for the benefit of creditors of NHP, and (b) NHABC assumed all of the assets and liabilities of NHP. NHPABC then sold certain assets of NHABC (the “NHP Purchased Assets”) to Espero Pharmaceuticals, Inc., a Delaware corporation (“Espero”). In consideration for the sale of the NHP Purchased Assets, Espero entered into a Royalty Agreement with NHABC, whereby Espero agreed to pay NHABC certain milestone payments and royalty payments, if any, with respect to the commercialization and sales of the NHP Purchased Assets. NHABC, in consideration for the Company’s consent to the sale of the NHP Purchased Assets to Espero, assigned the Royalty Agreement to the Company. On November 15, 2016, Xtera Communications, Inc., a Delaware corporation (“Xtera”), filed a voluntary petition for bankruptcy in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) under Chapter 11 of the U.S. Bankruptcy Code. On January 30, 2017, the Bankruptcy Court entered an order authorizing, among other things, the sale of all or substantially all of the assets of Xtera (the “Sale”) and on or about February 13, 2017, the Sale was closed. The Company does not expect to receive any proceeds from the Sale due to the amount of such proceeds and the amount of claims of other creditors of Xtera which have a priority over the Company in respect of such proceeds. Accordingly, the Company has fair valued its assets in Xtera at zero as of December 31, 2016. On February 22, 2017, Argos Therapeutics Inc. (“Argos”) announced that the Independent Data Monitoring Committee (“IDMC”) for Argos’ pivotal Phase 3 ADAPT clinical trial recommended that the study be discontinued for futility based on IDMC’s planned interim data analysis. On March 6, 2017, Argos paid the principal balance and accrued interest outstanding owing to the Company and issued to the Company five year warrants to purchase an aggregate of 40,000 shares of Argos’ Common Stock at an exercise price of $1.30 per share. Horizon Technology Finance Corporation and Subsidiaries Note 12. Financial highlights The following table shows financial highlights for the Company: (1) Distributions are determined based on taxable income calculated in accordance with income tax regulations, which may differ from amounts determined under GAAP due to (i) changes in unrealized appreciation and depreciation, (ii) temporary and permanent differences in income and expense recognition, and (iii) the amount of spillover income carried over from a given tax year for distribution in the following tax year. The final determination of taxable income for each tax year, as well as the tax attributes for distributions in such tax year, will be made after the close of the tax year. (2) Includes the impact of the different share amounts as a result of calculating per share data based on the weighted average basic shares outstanding during the period and certain per share data based on the shares outstanding as of a period end or transaction date. (3) The total return equals the change in the ending market value over the beginning of period price per share plus distributions paid per share during the period, divided by the beginning price. (4) During the years ended December 31, 2015, 2014 and 2013, the Advisor waived $0.3 million, $0.2 million and $0.1 million, respectively, of base management fee. During the year ended December 31, 2014, the Advisor waived $0.1 million of incentive fee. Horizon Technology Finance Corporation and Subsidiaries Note 13. Selected quarterly financial data (unaudited) (1) Based on weighted average shares outstanding for the respective period. (2) Based on shares outstanding at the end of the respective period. | Based on the provided text, which appears to be fragments of a financial statement, here's a summary:
The document discusses financial aspects of Horizon Technology Finance Corporation and its subsidiaries, focusing on:
1. Profit/Loss:
- Net profits are mentioned, but details are not clear
- SBABC agreed to pay payments due under a License Agreement
2. Expenses:
- Includes liabilities and consolidated investment schedules
- As of December 31 (year not specified)
3. Assets:
- Total assets are referenced, but specific amount is not provided
4. Liabilities:
- Primarily debt investments
- Fixed interest rates for investment terms
- Interest rates based on one-month LIBOR
- Does not include end-of-term payments or additional fees
The statement seems incomplete and lacks specific numerical details, making a comprehensive summary challenging. | Claude |
Index to Consolidated Financial Statements Page Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Comprehensive (Loss) Income Consolidated Statements of Changes in Stockholders' Equity Consolidated Statements of Cash Flows Report of Independent Registered Public Accounting Firm LATTICE SEMICONDUCTOR CORPORATION CONSOLIDATED BALANCE SHEETS The accompanying notes are an integral part of these Consolidated Financial Statements. LATTICE SEMICONDUCTOR CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS The accompanying notes are an integral part of these Consolidated Financial Statements LATTICE SEMICONDUCTOR CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME The accompanying notes are an integral part of these Consolidated Financial Statements LATTICE SEMICONDUCTOR CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY The accompanying notes are an integral part of these Consolidated Financial Statements LATTICE SEMICONDUCTOR CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS The accompanying notes are an integral part of these Consolidated Financial Statements LATTICE SEMICONDUCTOR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Nature of Operations and Significant Accounting Policies Nature of Operations Lattice Semiconductor (“Lattice,” the “Company,” “we,” “us,” or “our”) is a Delaware company that engages in smart connectivity solutions, providing intellectual property and low-power, small form-factor devices that enable global customers to quickly deliver innovative and differentiated cost and power efficient products. The Company's broad end-market exposure extends from consumer electronics to industrial equipment, communications infrastructure, and licensing. We do not manufacture our own silicon wafers. We maintain strategic relationships with large semiconductor foundries to source our finished silicon wafers in Asia. In addition, all of our assembly operations and most of our test and logistics operations are performed by outside suppliers in Asia. We perform certain test operations and reliability and quality assurance processes internally. We place substantial emphasis on new product development and believe that continued investment in this area is required to maintain and improve our competitive position. Our product development activities emphasize new proprietary products, advanced packaging, enhancement of existing products and process technologies, and improvement of software development tools. Research and development activities occur primarily in: Hillsboro, Oregon; San Jose and Sunnyvale, California; Shanghai, China; Alabang, Philippines; and Hyderabad, India. Fiscal Reporting Period We report based on a 52 or 53-week fiscal year ending on the Saturday closest to December 31. Our fiscal 2015 was a 52-week year that ended January 2, 2016. Our fiscal 2014 was a 53-week year, with a 14-week fourth quarter, that ended January 3, 2015. Our fiscal 2013, 2012, and 2011 were 52-week years that ended December 28, 2013, December 29, 2012, December 31, 2011, respectively. Our fiscal 2016 will be a 52-week year and will end on December 31, 2016. All references to quarterly or yearly financial results are references to the results for the relevant fiscal period. Principles of Consolidation and Presentation The accompanying Consolidated Financial Statements include the accounts of Lattice and its subsidiaries after the elimination of all intercompany balances and transactions. Our results for the year ended January 2, 2016 include the results of Silicon Image for the approximately 10-month period from March 11, 2015 through January 2, 2016. Results presented for prior fiscal years are those historically reported for Lattice only. Certain balances in prior fiscal years have been reclassified to conform to the presentation adopted in the current year. Interest expense has been reclassified to be reported separately from Other (expense) income, net. Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts and classification of assets, such as marketable securities, accounts receivable, inventory, goodwill (including the assessment of reporting unit), intangible assets, current and deferred income taxes, accrued liabilities (including restructuring charges and bonus arrangements), deferred income and allowances on sales to sell-through distributors, disclosure of contingent assets and liabilities at the date of the financial statements, amounts used in acquisition valuations and purchase accounting, and the reported amounts of product revenue, licensing and services revenue, and expenses during the fiscal periods presented. Actual results could differ from those estimates. Cash Equivalents and Marketable Securities We consider all investments that are readily convertible into cash and have original maturities of three months or less, to be cash equivalents. Cash equivalents consist primarily of highly liquid investments in time deposits or money market accounts and are carried at cost. We account for marketable securities as available-for-sale investments, as defined by U.S. GAAP, and record unrealized gains or losses to Accumulated other comprehensive loss on our Consolidated Balance Sheets, unless losses are considered other than temporary, in which case, those are recorded directly to the Consolidated Statements of Operations and Statements of Comprehensive (Loss) Income. Deposits with financial institutions at times exceed Federal Deposit Insurance Corporation insurance limits. Fair Value of Financial Instruments We invest in various financial instruments including corporate and government bonds, notes, and commercial paper. In the past we have also invested in auction rate securities. We value these instruments at their fair value and monitor the portfolio for impairment on a periodic basis. In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other than temporary, we record an impairment charge and establish a new carrying value. We assess other than temporary impairment of marketable securities in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements.” The framework under the provisions of ASC 820 establishes three levels of inputs that may be used to measure fair value. Each level of input has different levels of subjectivity and difficulty involved in determining fair value. Level 1 instruments are characterized generally by quoted prices for identical assets or liabilities in active markets. Therefore, determining fair value for Level 1 instruments generally does not require significant management judgment, and the estimation is not difficult. Level 2 instruments include inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices for identical instruments in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 instruments include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our auction rate securities were classified as Level 3 instruments. Management used a combination of the market and income approach to derive the fair value of auction rate securities, which included third party valuation results, investment broker provided market information and available information on the credit quality of the underlying collateral. As a result, the determination of fair value for Level 3 instruments requires significant management judgment and subjectivity. Our Level 3 instruments were classified as Long-term marketable securities on our Consolidated Balance Sheets and were entirely made up of auction rate securities that consisted of student loan asset-backed notes. During fiscal 2014 we sold our Level 3 instruments, which consisted entirely of auction rate securities. Foreign Exchange and Translation of Foreign Currencies We have international subsidiary and branch operations. In addition, a portion of our silicon wafer and other purchases are denominated in Japanese yen, we bill certain Japanese customers in yen and collect a Japanese consumption tax refund in yen. Gains or losses from foreign exchange rate fluctuations on balances denominated in foreign currencies are reflected in Other (expense) income, net. Realized and unrealized gains or losses on foreign currency transactions were not significant for the periods presented. We translate accounts denominated in foreign currencies in accordance with ASC 830, “Foreign Currency Matters,” using the current rate method under which asset and liability accounts are translated at the current rate, while stockholders' equity accounts are translated at the appropriate historical rates, and revenue and expense accounts are translated at average monthly exchange rates. Translation adjustments related to the consolidation of foreign subsidiary financial statements are reflected in Accumulated other comprehensive loss in Stockholders' equity. Derivative Financial Instruments We mitigate foreign currency exchange rate risk by entering into foreign currency forward exchange contracts. We had forward contracts for Japanese yen of $3.3 million and $4.2 million at January 2, 2016 and January 3, 2015, respectively. Two contracts outstanding at January 2, 2016 settled in January 2016 and the other four contracts will settle in June 2016. One of the contracts outstanding at January 3, 2015 settled in January 2015 and the other five contracts settled in June 2015. Although such hedges mitigate our foreign currency exchange rate exposure from an economic perspective they were not designated as "effective" hedges for accounting purposes and are adjusted to fair value through Other (expense) income, net, with an impact of less than $0.1 million and approximately $0.4 million for the years end January 2, 2016 and January 3, 2015, respectively. Concentration Risk Potential exposure to concentration risk may impact revenue, trade receivables, marketable securities, and supply of wafers for our new products. Customer concentration risk may impact revenue. For fiscal years 2015, 2014, and 2013, our top five end customers constituted approximately 32%, 45%, and 44%, respectively, of our revenue. Our largest end customer in fiscal year 2015 accounted for 9% of total revenue. Our two largest end customers in fiscal year 2014 and our largest end customer in fiscal year 2013 accounted for 19%, 12%, and 22%, respectively, of total revenue. No other end customers accounted for more than 10% of total revenue during these periods. Sales through distributors have historically accounted for a significant portion of our total revenue. For each of the fiscal years 2015, 2014 and 2013, revenue attributable to resale of products by sell-through distributors as a percentage of our total revenue was 45%. Our two largest distributor groups also account for a substantial portion of our trade receivables. At January 2, 2016 and January 3, 2015, one distributor group accounted for 29% and 45%, respectively, and the other accounted for 15% and 16%, respectively, of gross trade receivables. No other distributor groups or end customers accounted for more than 10% of gross trade receivables at these dates. Concentration of credit risk with respect to trade receivables is mitigated by our credit and collection process including active management of collections, credit limits, routine credit evaluations for essentially all customers and secure transactions with letters of credit or advance payments where appropriate. Accounts receivable do not bear interest and are shown net of allowances for doubtful accounts of $0.6 million and $0.9 million at January 2, 2016 and January 3, 2015, respectively. We regularly review our allowance for doubtful accounts and the aging of our accounts receivable. Write-offs for uncollected trade receivables have not been significant to date. We place our investments primarily through one financial institution and mitigate the concentration of credit risk by limiting the maximum portion of the investment portfolio which may be invested in any one instrument. Our investment policy defines approved credit ratings for investment securities. Investments on-hand in marketable securities consisted primarily of money market instruments, “AA” or better corporate notes and bonds and commercial paper, and U.S. government agency obligations. See Note 3 for a discussion of the liquidity attributes of our marketable securities. We rely on a limited number of foundries for our wafer purchases including Fujitsu Limited, Seiko Epson Corporation, Taiwan Semiconductor Manufacturing Company, Ltd, and United Microelectronics Corporation. Revenue Recognition and Deferred Income Product Revenue We sell our products directly to end customers, through a network of independent manufacturers' representatives, and indirectly through a network of independent sell-in and sell-through distributors. Distributors provide periodic data regarding the product, price, quantity, and end customer when products are resold, as well as the quantities of our products they still have in stock. Revenue from sales to original equipment manufacturers ("OEMs") and sell-in distributors is generally recognized upon shipment. Reserves for sell-in stock rotations, where applicable, are estimated primarily from historical experience and provided for at the time of shipment. Revenue from sales by our sell-through distributors is recognized at the time of reported resale. Under both types of revenue recognition, persuasive evidence of an arrangement exists, the price is fixed or determinable, title has transferred, collection of resulting receivables is reasonably assured, and there are no remaining customer acceptance requirements and no remaining significant performance obligations. Orders from our sell-through distributors are initially recorded at published list prices; however, for a majority of our sales, the final selling price is determined at the time of resale and in accordance with a distributor price agreement. In certain circumstances, we allow sell-through distributors to return unsold products. At times, we protect our sell-through distributors against reductions in published list prices. For these reasons, we do not recognize revenue until products are resold by sell-through distributors to an end customer. For sell-through distributors, at the time of shipment to distributors, we (a) record Accounts receivable at published list price since there is a legally enforceable obligation from the distributor to pay us currently for product delivered, (b) relieve inventory for the carrying value of goods shipped since legal title has passed to the distributor, and (c) record deferred revenue and deferred cost of sales in Deferred income and allowances on sales to sell-through distributors in the liability section of our Consolidated Balance Sheets. The final price is set at the time of resale and is determined in accordance with a distributor price agreement. Revenue and cost of sales to sell-through distributors are deferred until either the product is resold by the distributor or, in certain cases, return privileges terminate, at which time Revenue and Cost of products sold are reflected in Net (loss) income, and Accounts receivable, net are adjusted to reflect the final selling price. The components of Deferred income and allowances on sales to sell-through distributors are presented in the following table: A significant portion of our revenue in fiscal 2015 was from sell-through distributors. For the fiscal years 2015, 2014 and 2013, resale of products by sell-through distributors as a percentage of our total revenue was 45% in each year. We must use estimates and apply judgment to reconcile sell-through distributors' reported inventories to their activities. Errors in our estimates or judgments could result in inaccurate reporting of our Revenue, Cost of product revenue, Deferred income and allowances on sales to sell-through distributors, and Net (loss) income. Licensing and Services Revenue Our licensing and services revenue is comprised of revenue from our intellectual property ("IP") core licensing activity, patent monetization activities, device management system and remote support services, and royalty and adopter fee revenue from our standards activities. These activities are complementary to our product sales and help us monetize our intellectual property and accelerate market adoption curves associated with our technology and standards. From time to time we enter into patent sale and licensing agreements to monetize and license a broad portfolio of our patented inventions. Such licensing agreements may include upfront license fees and ongoing royalties. The contractual terms of the agreements generally provide for payments of upfront license fees over an extended period of time. Revenue from such license fees is recognized when payments become due and payable as long as all other revenue recognition criteria are met, while revenue from royalties is recognized when reported. We enter into IP licensing agreements that generally provide licensees the right to incorporate our IP components into their products pursuant to terms and conditions that vary by licensee. Revenue earned under these agreements is classified as Licensing and services revenue. Our IP licensing agreements generally include multiple elements, which may include one or more off-the-shelf or customized IP licenses bundled with support services covering a fixed period of time, generally one year. If the different elements of a multiple-element arrangement qualify as separate units of accounting, we allocate the total arrangement consideration to each element based on relative selling price. Amounts allocated to off-the-shelf IP licenses are recognized at the time of sale provided the other conditions for revenue recognition have been met. Amounts allocated to the support services are deferred and recognized on a straight-line basis over the support period, generally one year. Certain licensing agreements provide for royalty payments based on agreed-upon royalty rates, which may be fixed or variable depending on the terms of the agreement. The amount of revenue we recognize is based on a specified time period or on the agreed-upon royalty rate multiplied by the number of units shipped by the customer. From time to time, we enter into IP licensing agreements that involve significant modification, customization or engineering services. Revenues derived from these contracts are accounted for using the percentage-of-completion method or completed contract method. The completed contract method is used for contracts where there is a risk of final acceptance by the customer or for short-term contracts. HDMI royalty revenue is determined by a contractual allocation formula agreed to by the members of the HDMI consortium. Evidence of an arrangement, as to HDMI royalty revenue, is deemed complete when all of the members of the HDMI consortium agree on the royalty sharing formula. Inventories Inventories are recorded at the lower of actual cost determined on a first-in-first-out basis or market. We establish provisions for inventory if it is obsolete or we hold quantities which are in excess of projected customer demand. The creation of such provisions results in a write-down of inventory to net realizable value and a charge to Cost of product revenue. Property and Equipment Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method for financial reporting purposes over the estimated useful lives of the related assets, generally three to five years for equipment and software, one to three years for tooling and thirty years for buildings. Upon disposal of Property and equipment, the accounts are relieved of the costs and related accumulated depreciation and amortization, and resulting gains or losses are reflected in the Consolidated Statements of Operations for recognized gains and losses, or in the Consolidated Balance Sheets for deferred gains and losses. Repair and maintenance costs are expensed as incurred. Equity Investments in Privately Held Companies Equity investments in privately-held companies are reviewed on a quarterly basis to determine if their values have been impaired and adjustments are recorded as necessary. We assess the potential impairment of these investments by considering available evidence such as the investee’s historical and projected operating results, progress towards meeting business milestones, ability to meet expense forecasts, and the prospects for industry or market in which the investee operates. Upon disposition of these investments, the specific identification method is used to determine the cost basis in computing realized gains or losses. Declines in value that are judged to be other-than-temporary are reported in interest income and other, net in the accompanying Consolidated Statements of Operations. The accounting method for equity investments in privately-held companies is assessed under ASC 323-10, Equity Method and Joint Ventures. Investments for which we have the ability to exert significant influence on the investee are accounted for under the equity method with our proportionate share of the investee’s operating results recognized through the Consolidated Statements of Operations, along with a commensurate increase or decrease in the carrying value of the investment. Impairment of Long-Lived Assets Long-lived assets, including amortizable intangible assets, are carried on our financial statements based on their cost less accumulated depreciation or amortization. We monitor the carrying value of our long-lived assets for potential impairment and test the recoverability of such assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. These events or changes in circumstances, including management decisions pertaining to such assets, are referred to as impairment indicators. If an impairment indicator occurs, we perform a test of recoverability by comparing the carrying value of the asset group to its undiscounted expected future cash flows. If the carrying values are in excess of undiscounted expected future cash flows, we measure any impairment by comparing the fair value of the asset group to its carrying value. Fair value is generally determined by considering (i) internally developed discounted projected cash flow analysis of the asset group; (ii) actual third-party valuations; and/or (iii) information available regarding the current market for similar asset groups. If the fair value of the asset group is determined to be less than the carrying amount of the asset group, an impairment in the amount of the difference is recorded in the period that the impairment indicator occurs and is included in our Consolidated Statements of Operations. Estimating future cash flows requires significant judgment and projections may vary from the cash flows eventually realized, which could impact our ability to accurately assess whether an asset has been impaired. The results of our current year assessment are detailed in Note 9. Valuation of Goodwill Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. We review goodwill for impairment annually during the fourth quarter and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. When evaluating whether goodwill is impaired, we make a qualitative assessment to determine if it is more likely than not that the reporting unit's fair value is less than the carrying amount. If the qualitative assessment determines that it is more likely than not that the fair value is less than the carrying amount, the fair value of the reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and we must measure the impairment loss. The impairment loss, if any, is recognized for any excess of the carrying amount of the reporting unit's goodwill over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to purchase price allocation and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Fair value of the reporting unit is determined using a discounted cash flow analysis. If the fair value of the reporting unit exceeds its carrying value, no further impairment analysis is needed. For purposes of testing goodwill for impairment, the Company operates as two reporting units: the core Lattice ("Core") business, which includes intellectual property and semiconductor devices, and Qterics, a discrete software-as-a-service business unit in the Lattice legal entity structure. Although these two operating segments constitute two reportable segments, we combine Qterics with our Core business and report them together as one reportable segment due to the immaterial nature of the Qterics segment. The results of our current year assessment are detailed in Note 9. Leases We lease office space and classify our leases as either operating or capital lease arrangements in accordance with the criteria of ASC 840, “Leases.” Certain of our office space operating leases contain provisions under which monthly rent escalates over time and certain leases may also contain provisions for reimbursement of a specified amount of leasehold improvements. When lease agreements contain escalating rent clauses, we recognize expense on a straight-line basis over the term of the lease. When lease agreements provide allowances for leasehold improvements, we capitalize the leasehold improvement assets and amortize them on a straight-line basis over the lesser of the lease term or the estimated useful life of the asset, and reduce rent expense on a straight-line basis over the term of the lease by the amount of the asset capitalized. Restructuring Charges Expenses associated with exit or disposal activities are recognized when incurred under ASC 420, “Exit or Disposal Cost Obligations,” for everything but severance. Because the Company has a history of paying severance benefits, the cost of severance benefits associated with a restructuring plan is recorded when such costs are probable and the amount can be reasonably estimated in accordance with ASC 712, “Compensation - Nonretirement Postemployment Benefits.” When leased facilities are vacated, an amount equal to the total future lease obligations from the date of vacating the premises through the expiration of the lease, net of any future sublease income, is recorded as a part of restructuring charges. Research and Development Research and development expenses include costs for compensation and benefits, development masks, engineering wafers, depreciation, licenses, and outside engineering services. These expenditures are for the design of new products, intellectual property cores, processes, packaging, and software to support new products. Research and development costs are expensed as incurred. Accounting for Income Taxes Our provision for income tax is comprised of our current tax liability and changes in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements using enacted tax rates and laws that will be in effect when the difference is expected to reverse. Valuation allowances are provided to reduce deferred tax assets to an amount that in management’s judgment is more-likely-than-not to be recoverable against future taxable income. At January 2, 2016, U.S. income taxes were not provided on approximately $3.2 million of the undistributed earnings of our Chinese subsidiary as we intend to reinvest these earnings indefinitely. If these earnings were distributed to the U.S. in the form of dividends or otherwise, these earnings would be subject to Chinese withholding taxes and would be subject to additional U.S. income taxes but offset by net operating loss carryforwards which have been fully reserved. Our income tax calculations are based on application of the respective U.S. federal, state or foreign tax law. Our tax filings, however, are subject to audit by the relevant tax authorities. Accordingly, we recognize tax liabilities based upon our estimate of whether, and the extent to which, additional taxes will be due when such estimates are more-likely-than-not to be sustained. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. To the extent the final tax liabilities are different than the amounts originally accrued, the increases or decreases as well as any interest or penalties are recorded as income tax expense or benefit in the Consolidated Statements of Operations. In assessing the ability to realize deferred tax assets, the Company evaluates both positive and negative evidence that may exist and consider whether it is more-likely-than-not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Any adjustment to the net deferred tax asset valuation allowance is recorded in the Consolidated Statements of Operations for the period that the adjustment is determined to be required. Stock-Based Compensation We use the Black-Scholes option pricing model to estimate the fair value of substantially all share-based awards consistent with the provisions of ASC 718, “Compensation - Stock Compensation.” Option pricing models, including the Black-Scholes model, require the use of input assumptions, including expected volatility, expected term, expected dividend rate, and expected risk-free rate of return. The assumptions for expected volatility and expected term most significantly affect the grant date fair value. We have also used a lattice-based option-pricing model to determine and fix the fair value of stock options with a market condition granted to certain executives. This valuation model incorporates a Monte-Carlo simulation, and considered the likelihood that we would achieve the market condition. The options have a two year vesting and vest between 0% and 200% of the target amount, based on the Company's relative Total Shareholder Return ("TSR") when compared to the TSR of a component of companies of the PHLX Semiconductor Sector Index over a two year period. TSR is a measure of stock price appreciation plus dividends paid, if any, in the performance period. Redeemable Noncontrolling Interests Noncontrolling interests that are redeemable at the option of the holder are classified as temporary equity in the Consolidated Balance Sheets. Differences between the carrying value and the estimated redemption value are accreted through a charge to additional paid-in capital over the redemption period using the effective interest method. New Accounting Pronouncements In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance under U.S. GAAP when it becomes effective. While ASU 2014-09 was to be effective for annual periods and interim periods beginning after December 15, 2016, in August 2015, the FASB issued ASU 2015-14 deferring the effective date of ASU 2014-09 to periods beginning on or after December 15, 2017, with early adoption permitted for annual reporting periods beginning after December 15, 2016, and interim periods within that year. With the deferral, we intend to adopt ASU 2014-09 on December 31, 2017. The standard permits the use of either the retrospective or cumulative effect transition method. We are currently evaluating the impact of ASU 2014-09 on our consolidated financial statements and related disclosures and have not yet selected a transition method. In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which focuses on the consolidation evaluation for reporting organizations and requires the evaluation of whether or not certain legal entities should be consolidated. All legal entities are subject to reevaluation under the revised consolidation model. The new standard will become effective for us on January 3, 2016. Early adoption is permitted, including adoption in an interim period. We do not expect the adoption of this accounting standard update to impact our consolidated financial statements. In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Cost. The ASU requires debt issuance costs associated with a recognized debt liability to be presented on the balance sheet as a direct deduction from the carrying amount of the corresponding debt liability. This new guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. An entity should apply the new guidance on a retrospective basis. We adopted this ASU effective with the first quarter of fiscal year 2015. The adoption of this accounting standard update did not have a material impact to our consolidated financial statements. In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory. Under this ASU, inventory will be measured at the “lower of cost and net realizable value” and options that currently exist for “market value” will be eliminated. The ASU defines net realizable value as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.” No other changes were made to the current guidance on inventory measure-ment. ASU 2015-11 is effective for interim and annual periods beginning after December 15, 2016. Early application is permitted and should be applied prospectively. We do not expect the adoption of this accounting standard update to impact our consolidated financial statements. In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. This ASU eliminates the requirement to restate prior period financial statements for measurement period adjustments following a business combination. The new guidance requires that the cumulative impact of a measurement period adjustment (including the impact on prior periods) be recognized in the reporting period in which the adjustment is determined. The prior period impact of the adjustment should be either presented separately on the face of the income statement or disclosed in the notes. The guidance is effective for interim and annual periods beginning after December 15, 2015. Early application is permitted and should be applied prospectively. We do not expect the adoption of this accounting standard update to impact our consolidated financial statements. In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes, to eliminate the current requirements to classify deferred income tax assets and liabilities between current and noncurrent. To simplify the presentation of deferred income taxes, the amendments in this update require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. For public business entities, the amendments in this update are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Earlier application is permitted for all entities as of the beginning of an interim or annual reporting period. We have elected to adopt this standard early and have implemented the change prospectively as of the fourth quarter of fiscal 2015; prior periods were not adjusted. The impact of early adoption on prior years is not significant due to our valuation allowance. In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, to mainly change the accounting for investments in equity securities and financial liabilities carried at fair value as well as to modify the presentation and disclosure requirements for financial instruments. The ASU is effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted. Adoption of the ASU is retrospective with a cumulative adjustment to retained earnings or accumulated deficit as of the adoption date. We do not expect the adoption of this accounting standard update to impact our consolidated financial statements. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), aimed at making leasing activities more transparent and comparable. The new standard requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including today’s operating leases. For public business entities, the standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. For all other entities, the standard is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted for all entities. We are currently evaluating the impact of ASU 2016-02 on our consolidated financial statements and related disclosures. Note 2 - Net (Loss) Income Per Share We compute basic Net (loss) income per share by dividing Net (loss) income available to stockholders by the weighted average number of common shares outstanding during the period. To determine diluted share count, we apply the treasury stock method to determine the dilutive effect of outstanding stock option shares, restricted stock units ("RSUs"), Employee Stock Purchase Plan ("ESPP") shares, and treasury stock. Our application of the treasury stock method includes, as assumed proceeds, the average unamortized stock-based compensation expense for the period and the impact of the pro forma deferred tax benefit or cost associated with stock-based compensation expense. When we are in a net loss position, the treasury stock method is not used. A reconciliation of basic and diluted Net (loss) income per share is presented below: The computation of diluted Net (loss) income per share for fiscal year 2015 excludes the effects of stock options, RSUs, and ESPP shares, aggregating approximately 9.2 million which are antidilutive. The computation of diluted Net (loss) income per share for fiscal years 2014 and 2013, respectively, includes the effects of stock options, RSUs and ESPP shares aggregating approximately 2.5 million and 1.4 million, respectively, as they are dilutive, and excludes the effects of stock options, RSUs and ESPP shares aggregating approximately 2.6 million and 7.8 million shares, for fiscal years 2014 and 2013, respectively, as they are antidilutive. Stock options, RSUs and ESPP shares are considered antidilutive when the aggregate of exercise price, unrecognized stock-based compensation expense and excess tax benefit are greater than the average market price for our common stock during the period or when the Company is in a net loss position, as the effects would reduce the loss per share. Stock options and RSUs that are antidilutive at January 2, 2016 could become dilutive in the future. Note 3 - Marketable Securities Our short-term marketable securities have contractual maturities of up to two years. The following table summarizes the remaining maturities of our marketable securities at fair value: The following table summarizes the composition of our marketable securities at fair value: Note 4 - Fair Value of Financial Instruments We invest in various financial instruments including corporate and government bonds and notes, and commercial paper. In the past we have also invested in auction rate securities. In addition, we enter into foreign currency forward exchange contracts to mitigate our foreign currency exchange rate exposure. We carry these instruments at their fair value in accordance with ASC 820. The framework under the provisions of ASC 820 establishes three levels of inputs that may be used to measure fair value. Each level of input has different levels of subjectivity and difficulty involved in determining fair value. Level 1 instruments generally represent quoted prices for identical assets or liabilities in active markets. Therefore, determining fair value for Level 1 instruments generally does not require significant management judgment, and the estimation is not difficult. Our Level 1 instruments consist of U.S. Government agency, corporate notes and bonds, and commercial paper that are traded in active markets and are classified as Short-term marketable securities on our Consolidated Balance Sheets. Level 2 instruments include inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices for identical instruments in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Our Level 2 instruments consist of certificates of deposit and foreign currency exchange contracts, entered into to hedge against fluctuation in the Japanese yen. Level 3 instruments include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our auction rate securities were classified as Level 3 instruments. Management used a combination of the market and income approach to derive the fair value of auction rate securities, which included third party valuation results, investment broker provided market information, and available information on the credit quality of the underlying collateral. As a result, the determination of fair value for Level 3 instruments requires significant management judgment and subjectivity. Our Level 3 instruments were entirely made up of auction rate securities that consisted of student loan asset-backed notes and were classified as Long-term marketable securities on our Consolidated Balance Sheets. There were no transfers between any of the levels during fiscal 2015, 2014, and 2013. During the fiscal years ended January 2, 2016 and January 3, 2015, the following changes occurred in our Level 3 instruments: In the second quarter of the fiscal year ended January 3, 2015, we sold our remaining auction rate securities with a par value of $5.7 million with an estimated fair value of $5.2 million, for $5.5 million. As a result, we reported a gain of $1.7 million in the Consolidated Statements of Operations and relieved $1.1 million of previously unrealized gain, net of taxes, from Accumulated other comprehensive loss in fiscal 2014. In accordance with ASC 320, “Investments-Debt and Equity Securities,” we recorded an unrealized loss of less than $0.1 million during the fiscal year ended January 2, 2016, and an unrealized loss of $0.4 million during the fiscal year ended January 3, 2015 on certain Short-term marketable securities (Level 1 instruments), which have been recorded in Accumulated other comprehensive loss. Future fluctuations in fair value related to these instruments that the Company deems to be temporary, including any recoveries of previous write-downs, would be recorded to Accumulated other comprehensive loss. If we were to determine in the future that any further decline in fair value is other-than-temporary, we would record an impairment charge, which could have a materially adverse effect on our operating results. If we were to liquidate our position in these securities, it is likely that the amount of any future realized gain or loss would be different from the unrealized gain or loss reported in Accumulated other comprehensive loss. Note 5 - Inventories Note 6 - Property and Equipment Depreciation and amortization expense for Property and equipment was $18.1 million, including $1.5 million of restructuring expense, $11.4 million, and $11.2 million for fiscal years 2015, 2014, and 2013, respectively. In November 2014, we sold land and buildings, comprising the former location of our corporate headquarters and executive office in Hillsboro, Oregon, for net proceeds of approximately $14.6 million. This property had a historical cost of $30.9 million and accumulated depreciation of $17.9 million, resulting in a net gain on sale of $1.6 million. We leased back a portion of the facilities for a lease term of eight years, resulting in deferral of the gain, which is being amortized over the life of the lease. Note 7 - Business Combinations and Goodwill On March 10, 2015, we acquired 100% of the outstanding equity of Silicon Image, Inc. ("Silicon Image"), a provider of video, audio, and data connectivity solutions for the mobile, consumer electronics, and personal computer markets. The fair value of the purchase price consideration consisted of the following: There is no contingent consideration included in the determination of the purchase consideration. Purchase consideration was allocated to the tangible and intangible assets and liabilities assumed on the basis of the respective estimated fair values on the acquisition date. The purchase price allocation has been substantially completed, but may be subject to revision as we perform and complete more detailed analysis of certain tax matters. The allocation of the total purchase price is as follows: The following table presents details of the identified intangible assets acquired through the acquisition of Silicon Image: We do not believe there is any significant residual value associated with these intangible assets. We are amortizing the intangible assets using the straight-line method over their estimated useful lives. The estimation of the fair values of the intangible assets required the use of valuation techniques including the income approach and the cost approach, and entailed consideration of all the relevant factors that might affect the fair value such as present value factors, and estimates of future revenues and costs. Silicon Image’s results of operations and the estimated fair value of the assets acquired and liabilities assumed are included in Lattice's unaudited consolidated financial statements effective March 11, 2015. Silicon Image's revenue and net loss attributable to stockholders for the period from March 11, 2015 through January 2, 2016 were approximately $135.6 million and $77.0 million, respectively. Acquisition related charges, which were expensed as incurred, were approximately $8.2 million. Goodwill Goodwill represents the excess of the purchase price over the fair value of the underlying net tangible and intangible assets. The goodwill recognized in the acquisition of Silicon Image was derived from expected benefits from cost synergies and knowledgeable and experienced workforce who joined the Company after the acquisition. Goodwill will not be amortized, but will instead be tested for impairment annually or more frequently if certain indicators of impairment are present. We do not expect goodwill impairment to be tax deductible for income tax purposes. A $12.7 million charge to fully impair the goodwill in the Qterics operating segment was recorded for fiscal 2015 (Note 9). No impairment charges relating to goodwill or intangible assets were recorded for fiscal 2014 or 2013 as no indicators of impairment were present. The goodwill balance of $267.5 million at January 2, 2016 is comprised of $44.8 million from prior acquisitions combined with the $235.4 million from the acquisition of Silicon Image, reduced by the fiscal 2015 goodwill impairment charge of $12.7 million. Unaudited Pro Forma Financial Information The unaudited pro forma financial information in the table below summarizes the combined results of operations for the Company and Silicon Image as if the merger occurred on December 29, 2013, the first day of our 2014 fiscal year. The pro forma financial information for the periods presented includes adjustments to amortization and depreciation for intangible assets and property, plant, and equipment acquired; adjustments to share-based compensation expense; and interest expense for the additional indebtedness incurred as part of the acquisition. The total of nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings for the year ended January 3, 2015 and excluded from the reported pro forma revenue and earnings for the year ended January 2, 2016 was $30.6 million related to acquisition-related charges. The pro forma financial information as presented below is for informational purposes only, is based on certain assumptions and estimates, and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of the first period presented. The unaudited pro forma financial information for the fiscal year ended January 2, 2016 combined the historical results of the Company for the fiscal year ended January 2, 2016, the historical results of Silicon Image for the fiscal year ended January 2, 2016, and the effects of the pro forma adjustments described above. The unaudited pro forma financial information for the fiscal year ended January 3, 2015 combined the historical results of the Company for the fiscal year ended January 3, 2015, the historical results of Silicon Image for the fiscal year ended January 3, 2015, and the effects of the pro forma adjustments described above. The pro forma adjustments did not have any impact on the pro forma combined provision for income taxes for fiscal 2015 and 2014 due to net loss positions and valuation allowances on deferred income tax assets in those periods. Note 8 - Intangible Assets In connection with our acquisitions of Silicon Image in March 2015 and SiliconBlue in December 2011 we recorded identifiable intangible assets related to developed technology, customer relationships, licensed technology, patents, and in-process research and development based on guidance for determining fair value under the provisions of ASC 820. Additionally, during fiscal 2015, we licensed additional third-party technology. During the fourth quarter of 2015, we recorded a $9.0 million impairment charge to the intangible assets of the Qterics operating segment comprising developed technology of $3.9 million, and customer relationships of $5.1 million (Note 9). The following table summarizes the details of our total purchased intangible assets: We recorded amortization expense associated with these intangible assets on the Consolidated Statements of Operations as follows: The annual expected amortization expense of acquired intangible assets with finite lives is as follows: Note 9 - Impairment of Goodwill and Intangible Assets For fiscal 2015, the Impairment of goodwill and intangible assets is related to Qterics, Inc., which was acquired in the March 2015 acquisition of Silicon Image. During the fourth quarter of fiscal 2015, we determined that we experienced an impairment indicator related to the long-lived assets of the Qterics operating segment. For purposes of testing for impairment, the Company operates as two reporting units: the core Lattice ("Core") business, which includes intellectual property and semiconductor devices, and Qterics, a discrete software-as-a-service business unit in the Lattice legal entity structure. Although these two operating segments constitute two reportable segments, we combine Qterics with our Core business and report them together as one reportable segment due to the immaterial nature of the Qterics segment. Following this assessment, we concluded that goodwill and intangible assets has been impaired in the Qterics segment as of January 2, 2016. As a result we recorded an impairment charge amounting to $21.7 million, or approximately 92% of the previous value of goodwill and intangible assets, in the Consolidated Statements of Operations for the year ended January 2, 2016, comprising $12.7 million pertaining to goodwill, $3.9 million pertaining to developed technology, and $5.1 million pertaining to customer relationships. The valuation was based on the market approach and is our best estimate of fair value as of year end. No impairment charges were recorded for the Core segment in fiscal 2015, and we had no impairment charges in either fiscal 2014 or 2013. Note 10 - Equity Method Investment In the first and third quarters of fiscal 2015, we purchased a preferred stock ownership interest in a privately-held company that designs human-computer interaction technology for a total consideration of $3.0 million. This investment accounted for a 15.8% ownership interest by the end of the third quarter of fiscal 2015 and was accounted for under the cost method as we did not have the ability to exert significant influence over the investee. In the fourth quarter of fiscal 2015, we increased our ownership interest to 22.7% by making an additional investment of $2.0 million. This increased our gross investment in the investee to $5.0 million. As a result of the change in ownership interest and after considering the changes in the level of our participation in the management and interaction with the investee, we determined that we have the ability to exert significant influence on the investee. Accordingly, we changed our accounting for the investment from the cost method to the equity method and will hence recognize our proportionate share of the investee’s operating results. As a result of this change, we recognized our proportionate share of the investee’s net loss in the Consolidated Statements of Operations for the year ended January 2, 2016. Through January 2, 2016, we have reduced the value of our investment by approximately $0.5 million, representing our proportionate share of the privately-held company’s net loss. The net balance of our investment amounting to $4.5 million has been included in Other long-term assets in the Consolidated Balance Sheets as of January 2, 2016. Note 11 - Accounts Payable and Accrued Expenses As an agent of the HDMI and MHL consortia, we administer royalty reporting and distributions to the members of these consortia. Included in Accounts payable and accrued liabilities as of January 2, 2016 is $16.6 million payable to consortia members. This excludes amounts payable to us, and is payable quarterly based on collections from HDMI and MHL customers. Note 12 - Redeemable Noncontrolling Interest With the acquisition of Silicon Image on March 10, 2015, we also assumed a redeemable noncontrolling interest which comprised a 7% investment in Qterics amounting to $7.0 million invested by the noncontrolling interest holder initially entered into on December 4, 2014. The investment was redeemable at fair market value at the third-party holder's option on the third, fourth, or fifth year anniversaries. If the fair market value at the redemption date, as negotiated and agreed to by the parties, does not exceed $21 million, the redemption price will be 130% of the fair market value. As of the acquisition date, the fair value of the noncontrolling interest was determined to be $7.2 million (Note 7), recorded as temporary equity and reported as Redeemable noncontrolling interest in the Consolidated Balance Sheets. The Company elected to accrete the carrying value to the estimated redemption value over the three-year redemption period and reported the accretion charge as a reduction to additional-paid-in-capital. During fiscal 2015, we recorded cumulative accretion charges amounting to $0.4 million bringing the value of the redeemable noncontrolling interest to $7.6 million. During the fourth quarter of fiscal 2015, we entered into an agreement with the holder pursuant to which the entire interest was redeemed for a cash payment of approximately $0.9 million. The difference between the carrying value and the redemption amount totaling approximately $6.7 million has been recorded as additional-paid-in-capital during the year ended January 2, 2016. Note 13 - Lease Obligations Certain of our facilities are leased under operating leases, which expire at various times through 2026. Rental expense under operating leases was $7.4 million, $4.5 million and $4.6 million for fiscal years 2015, 2014 and 2013, respectively. Future minimum lease commitments at January 2, 2016 were as follows: Note 14 - Income Taxes The domestic and foreign components of (Loss) income before income taxes were as follows: The components of the income tax expense (benefit) are as follows: Income tax expense (benefit) differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pretax income as a result of the following differences: ASC 740, “Income Taxes”, provides for the recognition of deferred tax assets if realization of these assets is more-likely-than-not. We evaluate both positive and negative evidence to determine if some or all of our deferred tax assets should be recognized on a quarterly basis. During the fourth quarter of 2014, we concluded that it was more-likely-than-not that we would be able to realize the benefit of a portion of our remaining deferred tax assets, resulting in a tax benefit of $11.5 million and a federal and state net deferred tax asset of $21.3 million. We based this conclusion on improved operating results over the past two years and our expectations about generating taxable income in the foreseeable future. We exercised significant judgment and considered estimates about our ability to generate revenue, gross profits, operating income and jurisdictional taxable income in future periods under our tax structure in reaching this decision. In 2015, we completed the acquisition of Silicon Image, Inc. At the time of the acquisition, we evaluated the combined entity's net deferred income taxes, which included an assessment of the cumulative income or loss over the prior three-year period, to determine if a valuation allowance is required. After considering the significant loss for 2015, the Company recorded a valuation allowance on its net federal and state deferred tax assets. We will continue to evaluate both positive and negative evidence in future periods to determine if more deferred tax assets should be recognized. We don't have a valuation allowance in any foreign jurisdictions as it has been concluded it is more likely than not that we will realize the net deferred tax assets in future periods. The net increase in the total valuation allowance affecting the effective tax rate for the year ended January 2, 2016 was approximately $58.7 million. The components of our net deferred tax assets are as follows: At January 2, 2016, we had federal net operating loss carryforwards (pretax) of approximately $339.9 million that expire at various dates between 2023 and 2035. We had state net operating loss carryforwards (pretax) of approximately $239.9 million that expire at various dates from 2016 through 2035. We also had federal and state credit carryforwards of $48.2 million and $55.9 million of which $53.4 million do not expire. The remaining credits expire at various dates from 2016 through 2035. Future utilization of federal and state net operating losses and tax credit carry forwards may be limited if cumulative changes to ownership exceed 50% within any three-year period, which has not occurred through fiscal 2015. However, if there is a significant change in ownership, the future utilization may be limited and the deferred tax asset would be reduced to the amount available. At January 2, 2016, U.S. income taxes were not provided for approximately $3.2 million of the undistributed earnings of our Chinese subsidiary. We intend to reinvest these earnings indefinitely. If these earnings were distributed to the U.S. in the form of dividends or otherwise, we would be subject to additional U.S. income taxes and foreign withholding taxes. At January 2, 2016, our unrecognized tax benefits associated with uncertain tax positions were $48.2 million, of which $45.1 million, if recognized, would affect the effective tax rate, subject to valuation allowance. As of January 2, 2016, interest and penalties associated with unrecognized tax benefits were $5.3 million. The following table summarizes the changes to unrecognized tax benefits for fiscal years 2015, 2014 and 2013: At January 2, 2016, it is reasonably possible that $1.8 million of unrecognized tax benefits and less than $0.1 million of associated interest and penalties could significantly change during the next twelve months. Our French income tax returns are currently under examination for 2011 and 2012, as well as our Singapore income tax return for 2012. We are not under examination in any state jurisdictions or any other foreign jurisdictions. We are subject to federal and state income tax as well as income tax in the various foreign jurisdictions in which we operate. Additionally, the years that remain subject to examination are 2012 for federal income taxes, 2011 for state income taxes, and 2009 for foreign income taxes, including years ending thereafter. However, to the extent allowed by law, the tax authorities may have the right to examine prior periods where net operating losses or tax credits were generated and carried forward, and make adjustments up to the amount of the net operating losses or credit carryforward amount. The American Taxpayer Relief Act of 2012, which reinstated the United States federal research and development tax credit retroactively from January 1, 2012 through December 31, 2013, was not enacted into law until the first quarter of 2013. The Tax Increase Prevention Tax Act of 2014 was enacted into law in the fourth quarter of 2014 and extended the research and development tax credit through December 31, 2014. On December 18, 2015, the Protecting Americans from Tax Hikes Act of 2015 was enacted. The Act included several business tax provisions including the permanent extension of the credit for qualified research and development. The tax benefit in each year resulting from these reinstatements of the federal research and development tax credit was offset by a valuation allowance and therefore did not impact our annual effective tax rate. Note 15 - Restructuring In March 2015, our Board of Directors approved an internal restructuring plan (the "March 2015 Plan"), in connection with our acquisition of Silicon Image. The March 2015 Plan was designed to realize synergies from the acquisition by eliminating redundancies created as a result of combining the two companies. This included reductions in our worldwide workforce and consolidation of facilities, systems, and engineering tools. We expect the total cost of the March 2015 Plan to be in the range of approximately $14.0 million to $19.0 million and to be substantially completed by the end of second quarter of fiscal 2016. For fiscal year 2015, approximately $13.3 million of expense was incurred under the March 2015 plan. A substantial portion of the March 2015 Plan was completed in the first half of fiscal 2015 and the actual expenses have been in the estimated range. We expect a small amount of restructuring expense under this plan to continue into fiscal 2016, primarily related to charges associated with the consolidation of facilities. In September 2015, we implemented a further reduction of our worldwide workforce (the "September 2015 Reduction") separate from the March 2015 Plan. The September 2015 Reduction was designed to resize the company in line with the market environment and to better balance our workforce with the long-term strategic needs of our business. We expect the total cost of the September 2015 Reduction to be in the range of approximately $6.0 million to $6.5 million and to be substantially completed by the end of the second quarter of 2016. For fiscal year 2015, approximately $5.9 million of expense was incurred under the September 2015 Reduction plan. Less than $0.1 million was incurred in the fiscal year 2015 relating to a prior restructuring plan. These expenses were recorded to Restructuring charges on the Statements of Operations. The restructuring accrual balance is presented in Accounts payable and accrued expenses (includes restructuring) on the Consolidated Balance Sheets. The following table displays the activity related to the restructuring plans described above: * Includes cancellation of contracts and accelerated depreciation of ERP systems Note 16 - Long-Term Debt On March 10, 2015, we entered into a secured credit agreement (the "Credit Agreement") with Jefferies Finance, LLC and certain other lenders for purposes of funding, in part, our acquisition of Silicon Image. The Credit Agreement provided for a $350 million term loan (the "Term Loan") maturing on March 10, 2021 (the "Term Loan Maturity Date"). We received $346.5 million net of an original issue discount of $3.5 million and we paid debt issuance costs of $8.3 million. The Term Loan bears variable interest equal to the LIBOR, subject to a 1.00% floor, plus a spread of 4.25%. The current effective interest rate on the Term Loan is 6.14%. The Term Loan is payable through a combination of quarterly installments of approximately $0.9 million, which began on July 4, 2015, annual excess cash flow payments as defined in the Credit Agreement, which are due 95 days after the last day of our fiscal year, and any payments due upon certain issuances of additional indebtedness and certain asset dispositions, with any remaining outstanding principal amount due and payable on the Term Loan Maturity Date. The percentage of excess cash flow we are required to pay ranges from 0% to 75%, depending on our leverage and other factors as defined in the Credit Agreement. Currently, the Credit Agreement would require a 75% excess cash flow payment. As of year end, we expect to be required to make principal payments of $7.0 million, in addition to required quarterly payments, in 2016. While the Credit Agreement does not contain financial covenants, it does contain informational covenants and certain restrictive covenants, including limitations on liens, mergers and consolidations, sales of assets, payment of dividends, and indebtedness. We were in compliance with all such covenants at January 2, 2015. The original issue discount and the debt issuance costs have been accounted for as a reduction to the carrying value of the Term Loan on our Consolidated Balance Sheets and are being amortized to Interest expense in our Consolidated Statements of Operations over the contractual term, using the effective interest method. The carrying value of the Term Loan is reflected in our Consolidated Balance Sheets as follows: Interest expense related to the Term Loan was included in Interest expense on the Consolidated Statements of Operations as follows: As of January 2, 2016, expected future principal payments on the Term Loan were as follows: Note 17 - Common Stock Repurchase Program On March 3, 2014, our Board of Directors approved a stock repurchase program pursuant to which up to $20.0 million of outstanding common stock may be repurchased from time to time. The duration of the repurchase program was twelve months. Under this program during fiscal 2014, approximately 1.9 million shares were repurchased for $13.1 million. The 2014 program completed during the first quarter of fiscal 2015, during which approximately 1.1 million shares were repurchased for approximately $7.0 million. All shares repurchased under the 2014 program were retired by the end of the fiscal year in which they were repurchased. All repurchases were open market transactions funded from available working capital. On February 27, 2013, our Board of Directors approved a stock repurchase program pursuant to which up to $20.0 million of outstanding common stock may be repurchased from time to time. The duration of the repurchase program was twelve months. Under this program during fiscal 2013, approximately 0.8 million shares were repurchased at $3.7 million. At December 28, 2013, we had approximately $16.3 million remaining under the approved program. The 2013 program expired during the first quarter of fiscal 2014. No shares were repurchased during those three months. All shares repurchased under the 2013 program were retired by December 28, 2013. All repurchases were open market transactions funded from available working capital. Note 18 - Stockholders' Equity Employee and Director Stock Options, Restricted Stock and ESPP We have four equity incentive plans (the "1996 Stock Incentive Plan," the "2001 Stock Plan," the "2013 Incentive Plan" and the "2011 Non-Employee Director Equity Incentive Plan"). Awards granted under the 1996 Stock Incentive Plan and the 2001 Stock Plan remain outstanding, but no shares are available for future awards under these plans. Shares remain available for grants to employees and non-employee directors only under the 2013 Incentive Plan and the 2011 Non-Employee Director Equity Incentive Plan. "Incentive stock options" under Section 422 of the U.S. Internal Revenue Code and restricted stock unit ("RSU") grants are part of our equity compensation practices for employees who receive equity grants. Options and RSUs generally vest quarterly over a four-year period beginning on the grant date. The contractual terms of options granted do not exceed ten years. In May 2012, the Company's stockholders approved the 2012 Employee Stock Purchase Plan ("2012 ESPP"). The Plan authorizes the issuance of 3,000,000 shares of common stock to eligible employees to purchase shares of common stock through payroll deductions, which cannot exceed 10% of an employee's compensation. The purchase price of the shares is the lower of 85% of the fair market value of the stock at the beginning of each six-month offering period or 85% of the fair market value at the end of such period. Employees are required to hold purchased shares for six months. We have treated the 2012 ESPP as a compensatory plan, and recorded related compensation expense of $0.4 million, $0.3 million and $0.2 million for the fiscal years 2015, 2014 and 2013, respectively. At January 2, 2016, a total of 5.2 million shares of our common stock were available for future grants under the Plans. Shares subject to stock option grants that expire or are canceled, without delivery of such shares, generally become available for re-issuance under the Plans. At January 2, 2016, a total of 2.3 million shares of our common stock were available for future purchases under the 2012 ESPP. On March 10, 2015, in conjunction with the acquisition of Silicon Image, we assumed certain outstanding stock option and RSU grants of the Silicon Image Equity Incentive Plan. We assumed all outstanding unvested RSU grants, and all stock option grants that were unvested or vested and out-of-the-money. The exchange ratio for the conversion was 1.098160 for all grants. The conversion ratio was determined by the weighted average closing price of Lattice stock for the ten days prior to the acquisition date divided by the offer price of $7.30. The converted outstanding option grants totaled 2,087,605 shares and converted RSU grants totaled 2,025,255 shares as of March 10, 2015. As of the year ended January 2, 2016, 1,622,007 options and 1,056,368 RSU shares arising from this conversion remained outstanding. Stock-Based Compensation Total stock-based compensation expense included in our Consolidated Statements of Operations was as follows: Total stock-based compensation for the twelve months ended January 2, 2016 was $21.6 million of which $3.9 million was paid during the period. ASC 718, “Compensation-Stock Compensation (“ASC 718”),” requires that we recognize compensation expense for only the portion of employee and director options and ESPP rights that are expected to vest. The fair value of each option award is estimated on the date of grant using the Black-Scholes valuation model and the assumptions noted in the following table. The expected term is based on historical vested option exercises and includes an estimate of the expected term for options that are fully vested and outstanding. The expected volatility of both stock options and ESPP shares is based on the daily historical volatility of our stock price, measured over the expected term of the option or the ESPP purchase period. The risk-free interest rate is based on the implied yield on a U.S. Treasury zero-coupon issue with a remaining term closest to the expected term of the option. The dividend yield reflects that we have not paid any cash dividends since inception and do not intend to pay any cash dividends in the foreseeable future. The following table summarizes the assumptions used in the valuation of stock option and ESPP compensation for fiscal years 2015, 2014, and 2013: At January 2, 2016, there was $10.8 million of total unrecognized compensation cost related to unvested employee and director stock options, which is expected to be recognized over a weighted average period of 4.2 years. Our current practice is to issue new shares to satisfy option exercises. Compensation expense for all stock-based compensation awards is recognized using the straight-line method. The following table summarizes our stock option activity and related information for the year ended January 2, 2016: The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company's closing stock price on the last trading day of the fiscal year and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on that day. This amount changes based on the fair market value of the Company's stock. Total intrinsic value of options exercised for fiscal 2015, 2014 and 2013, and was $2.5 million, $7.8 million and $2.5 million, respectively. The total fair value of options and RSUs vested and expensed in fiscal 2015, 2014 and 2013 and was $18.0 million, $12.8 million and $9.3 million, respectively. The resultant grant date weighted-average fair values calculated using the Black-Scholes option pricing model and the noted assumptions for stock options granted were $2.35, $2.93 and $2.10 for fiscal years 2015, 2014 and 2013, respectively. The weighted average fair values calculated using the Black-Scholes option pricing model for the ESPP were $1.51, $1.73 and $1.29 for fiscal years 2015, 2014 and 2013, respectively. During fiscal year 2015, we granted approximately 327,200 stock options and 70,000 RSUs with a market condition to certain executives. The options and RSUs have a two year vesting and vest between 0% and 200% of the target amount, based on the Company's relative Total Shareholder Return (TSR) when compared to the TSR of a component of companies of the PHLX Semiconductor Sector Index over a two year period. The fair values of the options were determined and fixed on the date of grant using a lattice-based option-pricing valuation model, which incorporates a Monte-Carlo simulation, and considered the likelihood that we would achieve the market condition. TSR is a measure of stock price appreciation plus dividends paid, if any, in the performance period. As of January 2, 2016, 327,200 stock options and 70,000 RSUs with a market condition were outstanding. In 2015, we incurred stock compensation expense of $0.6 million related to these market condition awards. During fiscal year 2014, we granted approximately 98,600 market-based RSUs in two equal tranches, each of which vest upon achievement of certain market-based conditions. The fair values of the market-based RSUs were determined and fixed on the date of grant using a lattice-based option-pricing valuation model, which incorporates a Monte-Carlo simulation, and considered the likelihood that we would achieve the market-based conditions. Both tranches vested and we incurred total stock compensation expense related to performance based awards of $0.7 million for the fiscal year ended January 3, 2015. The following table summarizes the assumptions used in the valuation of stock options and RSUs with a market condition for fiscal years 2015 and 2014. No stock options or RSUs with a market condition were granted in fiscal year 2013: The following table summarizes our RSU activity for the year ended January 2, 2016: At January 2, 2016 there was $24.4 million of total unrecognized compensation cost related to unvested RSUs. Our current practice is to issue new shares when RSUs vest. Compensation expense for RSUs is recognized using the straight-line method over the related vesting period. Note 19 - Employee Benefit Plans Qualified Investment Plan In 1990, we adopted a 401(k) plan, which provides participants with an opportunity to accumulate funds for retirement. The plan does not allow investments in the Company's common stock. The plan allows for the Company to make discretionary matching contributions in cash. We recorded matching contributions of $0.9 million in fiscal 2015. No matching contributions were recorded in fiscal 2014 or 2013. 2013 Cash Incentive Plan On February 4, 2013, upon the recommendation of the Compensation Committee, the Board of Directors of the Company approved the 2013 Cash Incentive Plan (the “2013 Cash Plan”). The Chief Executive Officer, other executive officers, and other members of senior management, including vice presidents and director-level employees, together with all other employees of the Company not on the Company's sales incentive plan are eligible to participate in the 2013 Cash Plan. Under the 2013 Cash Plan, individual cash incentive payments for the eligible employees will be based both on Company financial performance, as measured by achievement of operating income (before incentive plan accruals) and revenue goals within specified ranges established by the Compensation Committee, and Company performance, as measured by the achievement of personal management objectives. The Compensation Committee determines the performance of the chief executive officer, the chief financial officer and other participants based on the achievement of the management objectives established by the committee during the first fiscal quarter of 2013. There was $11.3 million of expense recorded under this plan in fiscal 2013. 2014 Cash Incentive Plan On February 3, 2014, upon the recommendation of the Compensation Committee, the Board of Directors of the Company approved the 2014 Cash Incentive Plan (the “2014 Cash Plan”). The Chief Executive Officer, other executive officers, and other members of senior management, including vice presidents and director-level employees, together with all other employees of the Company not on the Company's sales incentive plan are eligible to participate in the 2014 Cash Plan. Under the 2014 Cash Plan, individual cash incentive payments for the eligible employees will be based both on Company financial performance, as measured by achievement of operating income (before incentive plan accruals) and revenue goals within specified ranges established by the Compensation Committee, and Company performance, as measured by the achievement of personal management objectives. The Compensation Committee determines the performance of the chief executive officer, the chief financial officer and other participants based on the achievement of the management objectives established by the committee during the first fiscal quarter of 2014. There was $11.6 million of expense recorded under this plan in fiscal 2014. 2015 Cash Incentive Plan On December 4, 2014, upon the recommendation of the Compensation Committee, the Board of Directors of the Company approved the 2015 Cash Incentive Plan (the “2015 Cash Plan”). The Chief Executive Officer, other executive officers, and other members of senior management, including vice presidents and director-level employees, together with all other employees of the Company not on the Company's sales incentive plan are eligible to participate in the 2015 Cash Plan. Under the 2015 Cash Plan, individual cash incentive payments for the eligible employees will be based both on Company financial performance, as measured by achievement of operating income (before incentive plan accruals) and revenue goals within specified ranges established by the Compensation Committee, and Company performance, as measured by the achievement of personal management objectives. The Compensation Committee determines the performance of the chief executive officer, the chief financial officer and other participants based on the achievement of the management objectives established by the committee during the first fiscal quarter of 2015. There was $1.0 million of expense recorded under this plan in fiscal 2015. Note 20 - Contingencies Legal Matters On or about January 29, 2015, Silicon Image, members of its Board, the Company and the Company’s wholly-owned merger acquisition subsidiary were named as defendants in two complaints filed in Santa Clara Superior Court by alleged stockholders of Silicon Image in connection with the proposed merger of Silicon Image and the Company. Both complaints were dated January 29, 2015 and were captioned respectively Molland v. George, et al. and Stein v. Silicon Image, Inc. et. al. Five additional complaints were subsequently filed on January 30, 2015, February 4, 2015 and February 9, 2015 in Delaware Chancery Court by alleged stockholders of Silicon Image, Inc. in connection with the Merger, captioned respectively Pfeiffer v. Martino et. al.; Lipinski v. Silicon Image, Inc. et. al.; Feldbaum et. al. v. Silicon Image, Inc. et. al; Nelson v. Silicon Image, Inc. et. al. and Partansky v. Silicon Image, Inc. et. al. The five Delaware matters were subsequently consolidated into an action captioned In re Silicon Image Stockholders Litigation by order of the Delaware Chancery Court on February 11, 2015, and a consolidated amended complaint was filed in the matter on February 13, 2015. Two complaints captioned Tapia v. Silicon Image, Inc. et. al. and Caldwel v. Silicon Image, Inc. were also filed on February 4, 2015 and February 9, 2015 in Santa Clara Superior Court by alleged stockholders in connection with the merger. Amended complaints were filed in the Molland and Stein actions on February 11, 2015. Each of these lawsuits were purported class actions brought on behalf of Silicon Image stockholders, asserting claims against each member of the Silicon Image Board for breach of fiduciary duty, and against various officers of the Silicon Image, the Company, and the Company’s wholly-owned merger subsidiary for aiding and abetting breach of fiduciary duty. The lawsuits alleged that the Merger did not appropriately value Silicon Image, was the result of an inadequate process, and included preclusive deal devices. The amended complaints also asserted that the Silicon Image’s disclosures regarding the Merger in its Schedule 14D-9 omitted material information regarding the Merger. Each of these complaints purported to seek unspecified damages. The Delaware cases have been settled and this settlement has been approved by the court. The settlement did not have a material adverse effect on our financial position. The California cases were dismissed with prejudice on February 29, 2019. In November 2014, a patent infringement lawsuit was filed by Papst Licensing GmbH & Co., KG ("Papst") against us in the U.S. District Court for the District of Delaware. On September 21, 2015, the parties entered into a settlement agreement. Under that agreement, we received a non-exclusive, irrevocable, fully paid up, perpetual, worldwide license for use of the asserted patents. The license fully exhausts and includes all claims of the asserted patents. The settlement did not have a material adverse effect on our financial position. On October 22, 2015, the case was dismissed with prejudice. In March 2014, the China National Development and Reform Commission ("NDRC") notified HDMI Licensing, LLC ("HDMI LLC"), a wholly-owned subsidiary of the Company and the agent for an entity charged with administering the HDMI specification, that the NDRC was investigating HDMI LLC’s licensing activities in China under the Chinese Anti-Monopoly Law ("AML"). The NDRC has available a broad range of remedies with respect to business practices it deems to violate the AML, including the ability to issue an order to cease conduct deemed illegal, confiscate gains deemed illegally obtained, impose a fine and require modifications to business practices. In July 2015, the NDRC concluded its investigation and informed HDMI LLC that it did not intend to impose monetary penalties on HDMI LLC, subject to HDMI LLC entering into a settlement agreement with the China Video Industry Association (“CVIA”) relating to various issues arising in connection with HDMI LLC licensing to Chinese companies. HDMI LLC is negotiating the specific implementation terms of this agreement with CVIA. Lattice cannot predict the outcome of this matter because administrative proceedings and negotiations with industry associations are inherently uncertain. At this stage of the proceedings, we do not have an estimate of the likelihood or the amount of any financial consequences to the Company. In January 2016 the Company commenced a suit against Technicolor SA and its affiliates in the United States District Court for the Northern District of California alleging that Technicolor had infringed certain patents relating to the HDMI specification. Technicolor has informed the Company that it will attempt to raise as a counterclaim a claim for payment to Technicolor and other HDMI founders their respective share of any HDMI adopters’ fees not used by Lattice and its predecessor in interest Silicon Image in the marketing and other activities in furtherance of the HDMI standard. Technicolor previously has indicated its belief that the HDMI founders enjoy a right to these funds but has never pursued such claims. At this stage of the proceedings, we do not have an estimate of the likelihood or the amount of any financial consequences to the Company. We are exposed to certain other asserted and unasserted potential claims. There can be no assurance that, with respect to potential claims made against us, we could resolve such claims under terms and conditions that would not have a material adverse effect on our business, our liquidity or our financial results. Periodically, we review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and a range of possible losses can be estimated, we then accrue a liability for the estimated loss based on the provisions of FASB ASC 450, “Contingencies" (“ASC 450”). Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise estimates. Note 21 - Valuation and Qualifying Accounts The following table displays the activity related to changes in our valuation and qualifying accounts: Note 22 - Segment and Geographic Information Segment Information We have two operating segments: the core Lattice ("Core") business, which includes intellectual property and semiconductor devices, and Qterics, a discrete software-as-a-service business unit in the Lattice legal entity structure. Although these two operating segments constitute two reportable segments, we combine Qterics with our Core business and report them together as one reportable segment due to the immaterial nature of the Qterics segment. For the twelve months ended January 2, 2016, revenue generated by Qterics comprised 0.3% of Total revenue. For the twelve months ended January 2, 2016, Qterics accounted for 16.3% of the total Net loss attributable to stockholders, due primarily to a $21.7 million impairment of goodwill and intangible assets related to this segment (Note 9). As of January 2, 2016, the Total assets of Qterics comprised 0.8% of the Total assets of the company. Geographic Information Our revenue by major geographic area based on ship-to location was as follows: We assign revenue to geographies based on the customer ship-to address at the point where revenue is recognized. In the case of sell-in distributors and OEM customers, revenue is typically recognized, and geography is assigned, when products are shipped to our distributor or customer. In the case of sell-through distributors, revenue is recognized when resale occurs and geography is assigned based on the customer location on the resale reports provided by the distributor. Our property and equipment, net by country at the end of each period was as follows: Revenue by Distributors Our largest customers are often distributors and sales through distributors have historically made up a significant portion of our total revenue. Revenue attributable to resales of products by our primary distributors are as follows: Orders from our sell-through distributors are initially recorded at published list prices; however, for a majority of our sales, the final selling price is determined at the time of resale and in accordance with a distributor price agreement. In certain circumstances, we allow sell-through distributors to return unsold products. At times, we protect our sell-through distributors against reductions in published list prices. For these reasons, we do not recognize revenue until products are resold by sell-through distributors to an end customer. Note 23 - Quarterly Financial Data (Unaudited) A summary of the Company's consolidated quarterly results of operations is as follows: * Our results for the year ended January 2, 2016 include the results of Silicon Image for the approximately 10-month period from March 11, 2015 through January 2, 2016. The first quarter of fiscal 2015 ended on April 4, 2015. Results presented for prior fiscal quarters are those historically reported for Lattice only. ** The fourth quarter of 2014 was a 14-week quarter as compared to the other quarters in 2015 and 2014, which were based on our standard 13-week quarter. Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Lattice Semiconductor Corporation: We have audited the accompanying consolidated balance sheets of Lattice Semiconductor Corporation and subsidiaries (the Company) as of January 2, 2016 and January 3, 2015, and the related consolidated statements of operations, comprehensive (loss) income, stockholders’ equity, and cash flows for each of the years in the three-year period ended January 2, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and subsidiaries as of January 2, 2016 and January 3, 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended January 2, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of January 2, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 2, 2016 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. Our report on the effectiveness of internal control over financial reporting as of January 2, 2016, contains an explanatory paragraph that states that management’s assessment of the effectiveness of internal control over financial reporting and our audit of internal control over financial reporting of the Company excludes an evaluation of internal control over financial reporting of the acquired Silicon Image, Inc. /s/ KPMG LLP Portland, Oregon March 2, 2016 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Lattice Semiconductor Corporation: We have audited Lattice Semiconductor Corporation and subsidiaries (the Company) internal control over financial reporting as of January 2, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 2, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO. The Company acquired Silicon Image, Inc. (Silicon Image) during fiscal 2015, and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of January 2, 2016, Silicon Image’s internal control over financial reporting associated with total assets of $129.2 million and total revenues of $135.6 million included in the consolidated financial statements of the Company and subsidiaries as of and for the year ended January 2, 2016. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Silicon Image. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company and subsidiaries as of January 2, 2016 and January 3, 2015, and the related consolidated statements of operations, comprehensive (loss) income, stockholders’ equity, and cash flows for each of the years in the three-year period ended January 2, 2016, and our report dated March 2, 2016 expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP Portland, Oregon March 2, 2016 | I apologize, but the text you've provided appears to be a fragmented and incomplete financial statement. It contains sections of a financial document from Lattice Semiconductor Corporation, but lacks complete, coherent financial information that would allow for a comprehensive summary.
The fragments suggest this is a financial report that includes:
- Consolidated Balance Sheets
- Consolidated Statements of Operations
- Statements of Comprehensive Income
- Statements of Changes in Stockholders' Equity
- Statements of Cash Flows
The text includes some accounting notes about:
- Cash equivalents and marketable securities
- Fair value of financial instruments
- Accounting standards and estimates
However, without the complete financial data, I cannot provide a meaningful summary of the company's financial performance, revenue, expenses, or overall financial health.
If you have the complete financial statement, I'd be happy to help you summarize it. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. ACCOUNTING FIRM To the Board of Directors and Stockholders of Mead Johnson Nutrition Company Glenview, Illinois We have audited the accompanying consolidated balance sheets of Mead Johnson Nutrition Company and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of earnings, comprehensive income, equity/(deficit) and redeemable noncontrolling interest, and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Mead Johnson Nutrition Company and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2017 expressed an unqualified opinion on the Company’s internal control over financial reporting. /s/ DELOITTE & TOUCHE LLP Chicago, Illinois February 27, 2017 CONSOLIDATED FINANCIAL STATEMENTS OF MEAD JOHNSON NUTRITION COMPANY CONSOLIDATED STATEMENTS OF EARNINGS (Dollars and shares in millions, except per share data) The accompanying notes are an integral part of these financial statements. MEAD JOHNSON NUTRITION COMPANY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in millions) The accompanying notes are an integral part of these financial statements. MEAD JOHNSON NUTRITION COMPANY CONSOLIDATED BALANCE SHEETS (Dollars and shares in millions, except per share data) The accompanying notes are an integral part of these financial statements. MEAD JOHNSON NUTRITION COMPANY CONSOLIDATED STATEMENTS OF EQUITY/(DEFICIT) AND REDEEMABLE NONCONTROLLING INTEREST (Dollars in millions) The accompanying notes are an integral part of these financial statements. MEAD JOHNSON NUTRITION COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in millions) The accompanying notes are an integral part of these financial statements. MEAD JOHNSON NUTRITION COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2016 AND 2015 AND FOR THE YEARS ENDED DECEMBER 31, 2016, 2015 AND 2014 1. ORGANIZATION Mead Johnson Nutrition Company (“MJN” or the “Company”) manufactures, distributes and sells infant formula, children’s nutrition and other nutritional products. MJN has a broad product portfolio, which extends across routine and specialty infant formulas, children’s milks and milk modifiers, dietary supplements for pregnant and breastfeeding mothers, pediatric vitamins, and products for pediatric metabolic disorders. These products are generally sold to distributors and retailers and are promoted to healthcare professionals, and, where permitted by regulation and policy, directly to consumers. 2. ACCOUNTING POLICIES Basis of Presentation-The financial statements present the results of operations, financial position and cash flows of the Company and its majority-owned and controlled subsidiaries. Inter-company balances and transactions have been eliminated. The Company prepared the accompanying consolidated financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”). These financial statements consider subsequent events through the date of filing with the Securities and Exchange Commission. Use of Estimates-The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported amounts and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Significant estimates include sales rebates and return accruals, impairment testing of goodwill and indefinite-lived intangible assets, impairment of long-lived assets, deferred tax assets and liabilities and income tax expense, as well as the accounting for stock-based compensation and retirement and post-employment benefits, including the actuarial assumptions. Actual results may or may not differ from estimated results. Fair Value Measurements-The fair value of financial assets and liabilities are classified in the fair value hierarchy as follows: Level 1- unadjusted quoted prices in active markets for identical assets or liabilities, Level 2-observable prices that are based on inputs not quoted on active markets and Level 3-unobservable inputs that reflect estimates about the assumptions market participants would use in pricing the asset or liability. Revenue Recognition-MJN recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectibility is reasonably assured. Revenue is not recognized until title and risks of loss have transferred to the customer. The shipping terms for the majority of revenue arrangements are FOB destination. Provisions are estimated at the time of revenue recognition for returns and Women, Infants and Children (“WIC”) rebates based on historical experience, updated for changes in facts and circumstances, as appropriate. Such provisions are recorded as a reduction of revenue. The Company offers sales incentives to customers and consumers through various programs consisting primarily of sales discounts, trade promotional support and consumer coupons. Provisions are estimated for these sales incentives at the later of the date at which the Company has sold the product or the date at which the program is offered, based on historical experience, updated for changes in facts and circumstances, as appropriate. Such provisions are recorded as a reduction of revenue. Revenue is recorded net of taxes collected from customers that are remitted to governmental authorities, with the collected taxes recorded as current liabilities until remitted to the relevant government authority. WIC rebate accruals were $212.5 million and $205.1 million at December 31, 2016 and 2015, respectively, and are included in accrued rebates and returns on the Company’s balance sheet. The Company participates on a competitive bidding basis in nutrition programs sponsored by states, tribal governments, the Commonwealth of Puerto Rico, and U.S. territories for WIC. Under these programs, the Company reimburses these entities for the difference between the list price and the contract price on eligible products. The Company accounts for WIC rebates by establishing an accrual in an amount equal to the Company’s estimate of WIC rebate claims attributable to a sale. The Company determines its estimate of the WIC rebate accrual primarily based on historical experience regarding WIC rebates and current contract prices under the WIC programs. The Company considers levels of inventory in the distribution channel, new WIC contracts, terminated WIC contracts, changes in existing WIC contracts and WIC participation, and adjusts the accrual periodically throughout the year to reflect actual expense. Rebates under the WIC program reduced revenues by $751.5 million, $763.0 million, and $790.0 million in the years ended December 31, 2016, 2015, and 2014, respectively. Sales return accruals were $57.1 million and $52.6 million at December 31, 2016 and 2015, respectively, and are included in accrued rebates and returns on the Company’s balance sheet. The Company accounts for sales returns by establishing an accrual in an amount equal to its estimate of sales recorded for which the related products are expected to be returned. The Company determines its estimate of the sales return accrual primarily based on historical experience regarding sales returns, but also considers other factors that could impact sales returns such as discontinuations and new product introductions. Returns reduced sales by $94.2 million, $89.8 million, and $86.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. Income Taxes-The provision for income taxes has been determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial and tax basis of the Company’s assets and liabilities. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable earnings in effect for the years in which those tax attributes are expected to be recovered or paid, and are adjusted for changes in tax rates and tax laws when changes are enacted. The ultimate liability incurred by the Company may differ from the provision estimates based on a number of factors, including interpretations of tax laws and the resolution of examinations by the taxing authorities. United States federal income taxes are provided on foreign earnings that are not permanently invested offshore. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. The assessment of whether or not a valuation allowance is required often requires significant judgment including the long-range forecast of future taxable earnings and the evaluation of tax planning initiatives. Adjustments to the deferred tax valuation allowances are made to earnings in the period when such assessments are made. Uncertain tax positions that relate to deferred tax assets are recorded against deferred tax assets; otherwise, uncertain tax positions are recorded as either a current or noncurrent liability. Cash and Cash Equivalents-Cash and cash equivalents consist of bank deposits, time deposits and money market funds. The Company maintains cash and cash equivalent balances in U.S. dollars and foreign currencies, which are subject to currency rate risk. Cash equivalents are primarily highly liquid investments with original maturities of 3 months or less at the time of purchase and are recorded at cost, which approximates fair value. Money market funds, which are all incorporated or domiciled outside the U.S., are not subject to the enactment of daily floating net asset value calculation, liquidity fees or redemption gates and continue to meet the classification of cash and cash equivalents. Money market funds totaled $1,022.0 million and $510.1 million at December 31, 2016 and 2015, respectively, are classified as Level 2 in the fair value hierarchy. Inventory Valuation-Inventories are valued at the lower of cost or market. The Company determines cost on the basis of the average cost or first-in, first-out methods. Property, Plant and Equipment-Expenditures for additions and improvements, including capitalized interest, are recorded at cost. Depreciation is computed on a straight-line method based on the estimated useful lives of the related assets. The estimated useful lives of the major classes of depreciable assets are up to 50 years for buildings and 3 to 40 years for machinery, equipment and fixtures. Maintenance and repair costs are expensed as incurred. Capitalized Software-Certain costs to obtain internal-use software for significant systems projects are reflected in Other Intangible Assets - Net, and are amortized on a straight-line basis over the estimated useful life of the software, which ranges from 3 to 7 years. Costs to obtain software for projects that are not significant are expensed as incurred. Impairment of Long-Lived Assets-The Company periodically evaluates whether current facts or circumstances indicate that the carrying value of its depreciable assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by the long-lived asset, or the appropriate grouping of assets, is compared to the carrying value to determine whether impairment exists. If an asset is determined to be impaired, the loss is measured based on the difference between the asset’s fair value and its carrying value. An estimate of the asset’s fair value is based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows. The Company reports an asset to be disposed of at the lower of its cost less accumulated depreciation or its estimated net realizable value. Goodwill and Other Intangible Assets-The Company’s policy is to test goodwill for impairment on an annual basis or when current facts or circumstances indicate that a potential impairment may exist. Goodwill is tested for impairment at the reporting unit level. A reporting unit represents an operating segment or a component of an operating segment. Goodwill is tested for impairment by either performing a qualitative evaluation or a two-step quantitative test. The qualitative evaluation is an assessment of factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. The Company may elect not to perform the qualitative assessment for some or all reporting units and perform a two-step quantitative impairment test. The Company compares the carrying value of a reporting unit, including goodwill, to the fair value of the unit. If the carrying amount of a reporting unit exceeds its fair value, the Company revalues all assets and liabilities of the reporting unit, excluding goodwill, to determine if the fair value of the net assets is greater than the net assets including goodwill. If the fair value of the net assets is less than the carrying amount of net assets including goodwill, impairment has occurred. The Company’s estimates of fair value are primarily determined based on a discounted cash flow model. Growth rates for sales and profits are determined using inputs from the Company’s annual long-range planning process. The Company also makes estimates of discount rates, perpetuity growth assumptions, market comparables, and other factors. The Company completed its most recent annual goodwill impairment assessment during the third quarter of 2016. No impairment of goodwill was required in 2016, 2015 or 2014. The Company evaluates the useful lives of its other intangible assets to determine if they are finite or indefinite-lived. Reaching a determination on useful life requires significant judgments and assumptions regarding the future effects of obsolescence, demand, competition, other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels), the level of required maintenance expenditures and the expected lives of other related groups of assets. Intangible assets that are deemed to have definite lives are amortized on a straight-line basis over their useful lives. Indefinite-lived intangible assets are tested for impairment at the reporting unit level. No impairment of indefinite-lived intangible assets was required in 2016, 2015 or 2014. Contingencies-In the ordinary course of business, the Company is subject to loss contingencies such as lawsuits, investigations, government inquiries and claims including, but not limited to, product liability claims, advertising disputes and inquiries, consumer fraud suits, other commercial disputes, premises claims and employment and environmental, health, and safety matters. The Company records accruals for such loss contingencies when it is probable that a liability will be incurred and the amount of loss can be reasonably estimated. The Company does not recognize gain contingencies until realized. Legal costs are expensed as incurred. Derivatives-Derivatives are used by the Company principally in the management of its foreign currency, interest rate and commodity pricing exposures. The Company records all derivatives on the balance sheet at fair value. The Company does not hold or issue derivatives for speculative purposes. The Company designates and assigns derivatives as hedges of forecasted transactions, specific assets or specific liabilities. When the hedged assets or liabilities are sold, extinguished or the forecasted transactions being hedged are no longer expected to occur, the Company immediately recognizes the gain or loss on the designated hedging financial instruments in the consolidated statements of earnings. The Company has elected to classify the cash flows from derivative instruments in the same category as the cash flows from the underlying hedged items. If derivatives are designated as a cash flow hedge, the effective portion of changes in the fair value is temporarily reported in accumulated other comprehensive loss and is recognized in earnings when the hedged item affects earnings or is deemed ineffective; cash flows are classified consistent with the underlying hedged item. The Company assesses hedge effectiveness at inception and on a quarterly basis. These assessments determine whether derivatives designated as qualifying hedges continue to be highly effective in offsetting changes in the cash flows of hedged items. Any ineffective portion of the change in fair value is included in current period earnings. The Company will discontinue cash flow hedge accounting when the forecasted transaction is no longer probable of occurring on the originally forecasted date, or 60 days thereafter, or when the hedge is no longer effective. If derivatives are designated as a fair value hedge, both the changes in the fair value of the derivatives and of the hedged item attributable to the hedged risk are recognized in the consolidated statements of earnings; cash flows are classified consistent with the underlying hedged item. Pension and Other Post-employment Benefits-The funded status of the Company’s defined pension and other post-employment benefit plans is measured as the difference between the fair value of the plan assets and the benefit obligation. For the defined benefit plans, the benefit obligation is the projected benefit obligation; for any other defined benefit post-employment plans, the benefit obligation is the accumulated post-employment benefit obligation. The net over- or under-funded status is recognized as an asset or a liability on the balance sheet. Changes in assets or liabilities are recognized in the consolidated statements of earnings upon plan remeasurement in the fourth quarter of each year, or more frequently if a remeasurement occurs. Certain of the Company’s pension plans allow participants the option of settling their vested benefits through the receipt of a lump-sum payment. In the period in which lump-sum payments exceed annual service and interest costs, the Company applies settlement accounting and remeasures the pension obligation, with the resulting gain or loss being recognized immediately. During 2015, the Company changed the method used to estimate the interest cost components of net periodic benefit cost for defined benefit pension and other post-retirement benefit plans. Historically, the interest cost components were estimated using a single weighted-average discount rate derived from the yield curve used to measure the projected benefit obligation at the beginning of the period. The Company elected to use a full yield curve approach in the estimation of these components of benefit cost by applying the specific spot rates along the yield curve used in the determination of the projected benefit obligation to the relevant projected cash flows. The Company made this change to improve the correlation between projected benefit cash flows and the corresponding yield curve spot rates and to provide a more precise measurement of interest costs. This change does not affect the measurement of total benefit obligations as the change in interest cost is completely offset in the actuarial loss reported in the period. The Company accounted for this change as a change in estimate and, accordingly, accounted for it prospectively starting in the third quarter of 2015. The reduction in interest cost for the year ended December 31, 2015 associated with this change in estimate was approximately $2.0 million. Shipping and Handling Costs-The Company typically does not charge customers for shipping and handling costs. Shipping and handling costs, including warehousing expenses, were $99.6 million, $114.1 million, and $118.2 million in the years ended December 31, 2016, 2015, and 2014, respectively, and are included in selling, general and administrative expenses. Advertising Costs-Advertising costs are expensed as incurred and were $223.8 million, $218.7 million, and $206.2 million in the years ended December 31, 2016, 2015, and 2014, respectively. Research and Development-Research and development costs are expensed as incurred. Stock-Based Compensation-Stock-based compensation expense for stock options is measured based on the estimated grant date fair value and recognized over the vesting period for options that are expected to vest. The Company estimates forfeitures at the time of grant based on historical experience, updated for changes in facts and circumstances, as appropriate, and in subsequent periods if actual forfeitures differ from those estimates. The Company uses the Black-Scholes option-pricing model to value stock options granted. The expected volatility assumption is calculated based principally on the Company’s historical volatility, and to a lesser extent, on implied volatility from publicly-traded options on the Company’s stock. The historical volatility is calculated over a period of time commensurate with the expected term of the options being valued. The risk-free interest rate assumption is based upon the U.S. Treasury yield curve in effect at the time of grant. The dividend yield assumption is based on the Company’s expectation of dividend payouts. The Company has determined that it has enough historical option exercise information to be able to accurately compute an expected term for use as an assumption in the Black-Scholes option pricing model. As such, its computation of expected term was calculated using the Company’s historical data. The Company also grants shares of restricted stock units and performance awards. Restricted stock units generally vest on the third or fourth anniversary of the grant date, and are entitled to dividend equivalent payments during the vesting period. Performance share awards vest based on varying performance, market and service conditions. Foreign Currency Translation-The statements of earnings of the Company’s foreign subsidiaries whose functional currencies are other than the U.S. dollar are translated into U.S. dollars using average exchange rates for the period. The net assets of the Company’s foreign subsidiaries whose functional currencies are other than the U.S. dollar are translated into U.S. dollars using exchange rates as of the balance sheet date. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation adjustment account, which is included in accumulated other comprehensive loss. Recently Adopted Accounting Standards-In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statement-Going Concern (Subtopic 205-40). This update requires management to assess the Company’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The updated standard was effective for the Company in the annual period ending December 31, 2016. The adoption of this updated standard did not have an impact on the consolidated financial statements. Recently Issued Accounting Standards-In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350). This update simplifies goodwill impairment testing by eliminating step two from the goodwill impairment test. Under the updated standard, the Company still has the option to perform its annual, or interim, goodwill impairment test using the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The quantitative impairment test is to compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The updated standard is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures. In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This update is intended to reduce diversity in practice in the classification of certain cash receipts and payments in the statement of cash flows. The updated standard is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures. In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This update simplifies several aspects of the accounting for share-based compensation arrangements, including accounting for income taxes, forfeitures and statutory tax withholding requirements as well as classification of related amounts on the statement of cash flows. The Company has evaluated the effect that the updated standard will have on its consolidated financial statements and related disclosures. The Company will recognize excess tax benefits within the consolidated statements of earnings. As this amount is currently recorded as a reduction to additional paid-in capital, this could potentially cause volatility in the Company’s earnings and calculation of effective tax rate going forward when employees exercise options and when stock units become vested. The Company will record the excess tax benefit within the operating activities in the statement of cash flows. These amendments will be adopted prospectively with no adjustment to prior periods required. Additionally, the Company will continue to present cash paid for tax withholdings under financing activities within the statements of cash flows and the Company has elected to continue to estimate for forfeitures and to not withhold more than the minimum statutory tax rate. The updated standard is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The updated standard requires most leases to be reflected on the balance sheet. It also aligns many of the underlying principles of the new lessor model with those of ASC No. 606, Revenue from Contracts with Customers. The updated standard is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures. In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory (Topic 330). This update simplifies the guidance on the subsequent measurement of inventory. GAAP currently requires an entity to measure inventory at the lower of cost or market. Previously, market could be replacement cost, net realizable value or net realizable value less an approximate normal profit margin. Under the new standard, inventory should be valued at the lower of cost or net realizable value. The updated standard is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. The Company has evaluated the effect that the updated standard will have on its consolidated financial statements and related disclosures. The updated standard will be adopted prospectively. Given the Company has not experienced markdowns of inventory due to lower of cost or market considerations, the impact of implementing the updated standard is not expected to be material. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). In 2016, the FASB issued ASU 2016-08, ASU 2016-10 and ASU 2016-12 to clarify, among other things, the implementation guidance related to principal versus agent considerations, identifying performance obligations, and accounting for licenses of intellectual property. The updated standard and related clarifications will replace most existing revenue recognition guidance in GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. The updated standard becomes effective for the Company in the first quarter of 2018. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures. From the results of the preliminary review, the Company believes the impact of adopting the updated standard primarily relates to the timing of the recognition of variable consideration. Under current guidance, the Company accounts for sales incentives offered to its customers at the later of the date at which the Company has sold the product or the date at which the program is offered. The new guidance requires earlier recognition if the sales incentive is implied by the Company’s customary business practice, even if the Company has not yet explicitly communicated its intent to make the payment to the customer. Analysis of the Company’s historical and future trends and use of judgment are required. The Company is in the process of quantifying such impact. The Company anticipates using the modified retrospective adoption method. 3. EARNINGS PER SHARE The Company uses the two-class method to calculate earnings per share. The numerator for basic and diluted earnings per share is net earnings attributable to shareholders reduced by dividends and undistributed earnings attributable to unvested shares. The denominator for basic earnings per share is the weighted-average number of shares outstanding during the period. The denominator for diluted earnings per share is the weighted-average shares outstanding adjusted for the effect of dilutive stock options and performance share awards. The following table presents the calculation of basic and diluted earnings per share: Potential shares outstanding from all stock-based awards were 3.4 million, 2.5 million and 2.5 million as of December 31, 2016, 2015 and 2014, respectively, of which 3.1 million, 2.1 million and 1.9 million were not included in the diluted earnings per share calculation for the years ended December 31, 2016, 2015 and 2014, respectively. 4. INCOME TAXES The components of earnings before income taxes were: The above amounts are categorized based on the applicable taxing authorities. The provision/(benefit) for income taxes consisted of: Effective Tax Rate-MJN’s provision for income taxes in the years ended December 31, 2016, 2015 and 2014 was different from the amount computed by applying the statutory U.S. federal income tax rate to earnings before income taxes as a result of the following: The Company negotiated a tax ruling effective from January 1, 2010, under which certain profits in the Netherlands are exempt from taxation through the year ending December 31, 2019. This ruling was superseded by a subsequent tax agreement effective July 26, 2012, whereby the Company and the Dutch tax authorities agreed to the appropriate remuneration attributable to Dutch manufacturing activities through the year ending December 31, 2019. In addition, the Company negotiated a tax ruling effective from January 1, 2013, under which certain profits in Singapore are eligible for favorable taxation through the year ending December 31, 2027. Deferred Taxes and Valuation Allowance-The components of deferred income tax assets/(liabilities) were: During the year ended December 31, 2016 the Company wrote-off a $52.0 million intercompany payable from its Venezuelan subsidiary to its subsidiaries in Mexico and the U.S. (see “-Note 20. Venezuela Currency Matters” for additional information). As a result of this write-off, Mexico and the U.S. realized losses that are either currently tax deductible or tax deductible in the future. A deferred tax asset of $12.5 million has been recorded to reflect the portion of the losses that are deductible in the future. As of December 31, 2016, the Company had definite-lived and indefinite-lived gross foreign net operating loss (“NOL”) carryforwards of $50.8 million. Indefinite-lived NOL carryforwards totaled $44.2 million with the remainder being definite-lived. An immaterial amount of these definite-lived NOL carryforwards will begin to expire in 2017, with the remainder of the definite-lived NOL carryforwards to expire no later than 2020. The valuation allowance recorded for NOL carryforwards is $14.8 million as of December 31, 2016. As of December 31, 2016, the Company had various definite-lived U.S. state tax credit carryforwards of $9.4 million, net of the federal tax benefit. An immaterial amount of these state tax credit carryforwards will begin to expire in 2017, with the remainder of the state tax credit carryforwards to expire no later than 2026. The valuation allowance recorded for state tax credit carryforwards is $6.0 million, net of the federal tax benefit, as of December 31, 2016. As of December 31, 2016, the Company incurred a statutory loss on the investment in its Russian business of $42.1 million. This loss will be tax deductible in the Netherlands when the Russian entity is fully liquidated on a tax basis, and a deferred tax asset of $10.5 million has been recorded as of December 31, 2016. The Company expects to utilize $1.6 million of this deferred tax asset, and a valuation allowance of $8.9 million has been recorded for the remainder. As of December 31, 2016, the Company incurred charges in the amount of $48.9 million related to long-lived asset impairments and other asset write-offs in its Venezuelan business (see “-Note 20. Venezuela Currency Matters” for additional information) for which the Company held a deferred tax asset of $7.9 million. The Company does not expect to utilize any amount of this deferred tax asset, and a full valuation allowance has been recorded. Income taxes paid net of refunds were $219.3 million, $134.2 million, and $183.7 million in the years ended December 31, 2016, 2015 and 2014, respectively. The income taxes were paid to or received from federal, state and foreign taxing authorities and Bristol-Myers Squibb Company (“BMS”) pursuant to the terms of the Amended and Restated Tax Matters Agreement, described below. As of December 31, 2016, U.S. taxes have not been provided on approximately $2,500 million of foreign earnings as these undistributed earnings have been indefinitely invested offshore. If, in the future, these earnings were to be repatriated to the U.S. additional tax provisions would be required. It is impracticable to determine a precise estimate of the additional provision required. However, the maximum potential estimated U.S. tax liability would be $868.0 million if these earnings were to be repatriated to the United States in such a manner that the entire amount of foreign earnings would be subject to the U.S. statutory tax rate with no U.S. tax relief for foreign taxes already paid. However, the Company has no plans to repatriate these foreign earnings. The Company’s tax returns are routinely audited by federal, state and foreign tax authorities and these tax audits are at various stages of completion at any given time. The Internal Revenue Service (“IRS”) has completed examinations of the Company’s U.S. income tax filings through December 31, 2007. At December 31, 2016, the Company’s 2011 and 2012 U.S. income tax returns were under IRS examination, and the 2009 through 2014 period is under income tax audit in Hong Kong. The Company was notified in early 2016 that the China tax authorities will commence an audit of tax years 2008 through 2014; however, that audit is now expected to commence in early 2017. The Company was also recently notified that the IRS will commence an audit of the 2013 and 2014 U.S. income tax returns in early 2017. At December 31, 2016, tax years remaining open to examination outside the U.S. include 2006 and forward. A reconciliation of the Company’s changes in gross uncertain tax positions is as follows: Uncertain tax positions have been recorded as part of other liabilities with a reversal of up to approximately $53 million reasonably possible in the next 12 months due to the running of statutes of limitations and settlements with various taxing authorities, of which up to approximately $28 million would impact the effective tax rate. The amounts of recorded uncertain tax positions that impacted the effective tax rate were $117.1 million, $88.3 million and $69.8 million as of December 31, 2016, 2015 and 2014, respectively. The Company believes that it has provided adequately for all uncertain tax positions. It is reasonably possible that new issues may be raised by tax authorities and that these issues may require increases in the balance of uncertain tax positions. Interest and penalties related to uncertain tax positions were $35.1 million and $25.8 million, as of December 31, 2016, and 2015, respectively, and are included as a component of other liabilities. The Company classifies interest and penalties related to uncertain tax positions as a component of provision for income taxes. The amount of interest and penalties included as a component of provision for income taxes was $9.5 million, $7.0 million and $4.8 million for the years ended December 31, 2016, 2015 and 2014, respectively. On December 18, 2009, the Company and BMS entered into an Amended and Restated Tax Matters Agreement in anticipation of the separation from BMS. Under the Amended and Restated Tax Matters Agreement, BMS agreed to indemnify the Company for (i) any tax attributable to a MJN legal entity for any taxable period ending on or before December 31, 2008, (ii) any tax arising solely as a result of MJN’s 2009 initial public offering (“IPO”) and the restructuring preceding the IPO, and (iii) any transaction tax associated with the separation transaction. The Company agreed to indemnify BMS for (i) any tax payable with respect to any separate return that the Company is required to file or cause to be filed, (ii) any tax incurred as a result of any gain which may be recognized by a member of the BMS affiliated group with respect to a transfer of certain foreign affiliates by the Company in preparation for the IPO, and (iii) any tax arising from the failure or breach of any representation or covenant made by the Company which failure or breach results in the intended tax consequences of the separation transaction not being achieved. Additionally, under the Amended and Restated Tax Matters Agreement, the Company continues to maintain responsibility for any tax positions which may exist for any taxable period ending after December 31, 2008. 5. SEGMENT INFORMATION MJN operates in four geographic operating segments: Asia, Europe, Latin America and North America. Based on this operating segmentation, the chief operating decision maker regularly assesses information for decision making purposes, including allocation of resources. Due to similarities between North America and Europe, the Company aggregated these two operating segments into one reportable segment. As a result, the Company has three reportable segments: Asia, Latin America and North America/Europe. Corporate and Other consists of unallocated global business support activities, including research and development, marketing, supply chain costs, and general and administrative expenses; net actuarial gains and losses related to defined benefit pension and other post-employment plans; and income or expenses incurred within the operating segments that are not reflective of underlying operations and affect the comparability of the operating segments’ results. The Company’s products are sold principally to distributors and retailers. Wal-Mart Stores, Inc. (including Sam’s Club) accounted for 12%, 12% and 11% of the Company’s consolidated gross sales for the years ended December 31, 2016, 2015, and 2014, respectively, primarily in the North America / Europe segment. DKSH International Ltd., a distributor serving primarily Asia, accounted for 14%, 14%, and 16% of the Company’s consolidated gross sales for the years ended December 31, 2016, 2015, and 2014, respectively. The Company's segment, product and geographic results consisted of: (1) For purposes of this disclosure, the term China refers to the Company’s businesses in mainland China and Hong Kong. (2) Sales by country are based on the country that sold the product. 6. RESTRUCTURING During the third quarter of 2015, the Company approved a plan to implement a business productivity program referred to as “Fuel for Growth,” which is expected to be implemented over a three-year period. Fuel for Growth is designed to improve operating efficiencies and reduce costs. Fuel for Growth is expected to improve profitability and create additional investments behind brand building and growth initiatives. Fuel for Growth focuses on the optimization of resources within various operating functions and certain third-party costs across the business. A summary of restructuring charges and related reserves associated with Fuel for Growth is as follows: (1) Included in accrued expenses on the balance sheet. (2) Included in accrued expenses and other liabilities on the balance sheet. (3) Included in accounts payable on the balance sheet. Restructuring charges are included in Corporate and Other. Reserves related to severance and employee benefits and other costs will be paid out during the next twelve months. The contract termination costs will be paid over a period from 2017 to 2019. 7. EMPLOYEE STOCK BENEFIT PLANS Long Term Incentive Plan-The Company’s Long Term Incentive Plan (“LTIP”) provides for the grant of stock options, performance share awards, restricted stock units and other stock-based awards. Executive officers and other key employees of MJN, and non-employee directors and others who provide substantial services to MJN, are eligible to be granted awards under the LTIP. Twenty-five million shares of stock were approved and registered with the Securities and Exchange Commission (the “SEC”) for grants to participants under the LTIP. The shares reserved may be used for any type of award under the LTIP. Stock-based compensation expense is based on awards ultimately expected to vest. Forfeitures are estimated based on the historical experience of participants in the LTIP since its inception in February 2009. MJN may grant options to purchase common stock at no less than 100% of the closing market price on the date the option is granted. Stock options generally become exercisable in installments of either 25% per year on each of the first through the fourth anniversaries of the grant date or 33% per year on each of the first through the third anniversaries of the grant date. Stock options have a maximum term of 10 years. Generally, MJN will issue shares for the stock option exercises from treasury stock, if available, or will issue new shares. MJN may also grant performance share awards, which are granted in the form of a target number of performance shares to be earned and have a three-year performance cycle consisting of three one-year performance periods. The performance share awards have annual goals set at the beginning of each performance period, at which time the awards are considered granted. The maximum payout is 200%. If a certain threshold is not met for a performance period, no payment is made under the plan for that annual period. MJN may also grant restricted stock units under the LTIP. Restrictions generally expire over a 1- to 4-year period from the date of grant. Stock-based compensation expense is recognized over the restricted period. A restricted stock unit is a right to receive stock at the end of the specified vesting period. A restricted stock unit has non-forfeitable rights to dividend equivalent payments and has no voting rights. Stock Options-The fair value of stock options granted in 2016, 2015, and 2014 was estimated on the date of grant using the Black-Scholes option pricing model. No stock options with market conditions were granted in 2016, 2015, or 2014. The following assumptions were used in the valuations: The expected volatility assumption required in the Black-Scholes model was calculated based principally on the Company’s historical volatility, and to a lesser extent, on implied volatility from publicly-traded options on the Company’s stock. The historical volatility was calculated over a period of time commensurate with the expected term of the options being valued. The risk-free interest rate assumption in the Black-Scholes model is based upon the U.S. Treasury yield curve in effect at the time of grant. The dividend yield assumption is based on MJN’s expectation of dividend payouts. The Company has determined that it has enough historical option exercise information to be able to accurately compute an expected term for use as an assumption in the Black-Scholes option pricing model. As such, its computation of expected term was calculated using the Company’s historical data. Stock option activities were as follows: The weighted-average grant date fair value of stock options granted is $13.88, $20.21 and $17.71 for 2016, 2015 and 2014 respectively. Cash proceeds received from options exercised during the years ended December 31, 2016, 2015 and 2014 were $15.0 million, $16.2 million and $37.0 million, respectively. The tax benefit realized from stock options exercised was $0.8 million in 2016, $3.4 million in 2015 and $8.3 million in 2014. At December 31, 2016, total unrecognized compensation cost related to stock options of $9.9 million is expected to be recognized over a weighted average period of 1.9 years. Performance Share Awards-The fair value of performance share awards is based on the closing market price of MJN’s stock on the date of the grant, discounted using the risk-free interest rate as the awards do not participate in dividends. Information related to performance share awards activity is summarized as follows: Shares granted and earned in the table above assumes 100% plan performance adjusted for forfeitures. Performance shares outstanding at December 31, 2016 is adjusted for actual plan achievement level for each completed performance period. Company performance in 2015 was below the minimum threshhold for shares to be earned. At December 31, 2016, total unrecognized compensation cost related to the performance share awards outstanding of $2.3 million is expected to be recognized over a weighted average period of 1.5 years. Restricted Stock Units-The fair value of restricted stock units is determined based on the closing market price of MJN’s common stock on the grant date. A summary of restricted stock unit activity is as follows: At December 31, 2016, total unrecognized compensation cost related to nonvested restricted stock units was $31.3 million and is expected to be recognized over a weighted average period of 2.4 years. Stock-Based Compensation Expense-The following table summarizes stock-based compensation expense related to stock options, performance share awards and restricted stock units for the years ended December 31, 2016, 2015 and 2014: Stock-based compensation expense was recognized in the consolidated statements of earnings as follows: There were no costs related to stock-based compensation that were capitalized. 8. PENSION AND OTHER POST-EMPLOYMENT BENEFIT PLANS The principal pension plan is the Mead Johnson & Company Retirement Plan in the United States (“U.S. Pension Plan”) which represents approximately 87% and 71% of the Company’s total pension and other post-employment assets and obligations, respectively. The benefits of this plan are frozen as of February 9, 2014. The Company also provides comprehensive medical and group life benefits for substantially all U.S. and Canadian retirees who elect to participate. The retiree medical plan is contributory and participation is limited to those employees who participate in their respective country’s pension plan. Contributions are adjusted periodically and vary by date of retirement. The retiree life insurance plan is non-contributory. Changes in benefit obligations, plan assets, funded status and amounts recognized in the balance sheet were as follows: The Company’s defined benefit pension and other post-employment benefit plans with an accumulated benefit obligation in excess of plan assets were as follows: The net periodic benefit cost of the Company’s defined benefit pension and other post-employment benefit plans includes: Actuarial Assumptions Weighted-average assumptions used to determine benefit obligations are established as of the balance sheet date and were as follows: The discount rate was determined based on the yield to maturity of high-quality corporate bonds and considering the duration of the pension plan obligations. The Aon Hewitt AA Above Median yield curve is used in developing the discount rate for the U.S. Pension Plan. Compensation rate increases represent the weighted average of plans that are not frozen and therefore excludes the U.S. Pension Plan. Weighted-average assumptions used to determine net periodic benefit cost are established at the beginning of the plan year and were as follows: The discount rate used to determine periodic service cost and interest costs of the overall benefit costs for the year ending December 31, 2017 will be based on spot rates derived from the same high-quality corporate bond yield curve used to determine the December 31, 2016 benefit obligation matched with separate cash flows for each future year. The expected long-term return on plan assets was determined based on the target asset allocation, expected rate of return by each asset class and estimated future inflation. For the U.S. Pension Plan, the expected long-term return on plan assets assumption to be used to determine net periodic benefit costs for the year ending December 31, 2017 is 6.20%. Assumed health care cost trend rates were as follows: Assumed health care cost trend rates affect the amounts reported for the retiree medical plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: Plan Assets The Company’s investment strategy for the U.S. Pension Plan assets consists of a mix of equities and fixed income in order to achieve returns over a market cycle which reduces contribution and expense at an acceptable level of risk. The target asset allocation as of December 31, 2016 was 50% public equity and 50% fixed income. Cash flow (i.e., cash contributions, benefit payments) is used to rebalance back to the targets as necessary. Investments are well diversified within each of the two major asset categories. All of the U.S. equity investments are actively managed. Investment strategies for international pension plans are typically similar, although the asset allocations are usually more conservative. The fair values of the Company’s pension plan assets by asset category were as follows: Level 1 cash and cash equivalents, which excluded money market funds, are recorded at closing prices in active markets. Money market, equity, and fixed income funds recorded at the net asset values per share, which were determined based on quoted market prices of the underlying assets contained within the funds are excluded from the fair value hierarchy. The hedge fund is recorded at the net asset value per share, which was derived from the underlying funds’ net asset values per share; this diversified hedge fund may be redeemed quarterly with 60 days notice. Contributions The Company is not required to make contributions to its U.S. Pension Plan in 2017. However, the intention is to fund the plan to avoid potential benefit restrictions and penalties, therefore, an estimated $5.0 million is expected to be contributed in 2017 to the U.S. Pension Plan. Furthermore, the Company plans to fund current service and past service liabilities for other pension plans. There is not expected to be any cash funding for other post-employment benefit plans in 2017, except funding to cover benefit payments. MJN contributed $19.3 million, $90.1 million and $5.2 million to its pension and other post-employment benefit plans in 2016, 2015 and 2014, respectively. Estimated Future Benefit Payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Lump Sum Settlements A lump sum settlement window was offered to approximately 300 terminated, vested participants in the U.S. Pension Plan. This window expired on September 30, 2016 and approximately 40% of these participants accepted the offer. Payments to participants who accepted the offer were made in the fourth quarter of 2016 and totaled $15.7 million. This amount is included in the Settlements and curtailments line of the table above which details the changes in benefit obligations, plan assets, funded status and amounts recognized in the balance sheet. There was no impact to the Company’s results of operations related to this settlement. Defined Contribution Benefits Employees who meet certain eligibility requirements may participate in various defined contribution plans. Total cost recognized for all defined contribution benefit plans was $22.2 million, $23.4 million and $22.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. 9. NONCONTROLLING INTERESTS Net earnings attributable to noncontrolling interests consists of approximately 11%, 10% and 10% interests held by third parties in operating entities in China, Argentina and Indonesia, respectively. See "-Note 18. Equity" for further discussion of Argentinian noncontrolling interest. 10. OTHER (INCOME)/EXPENSES-NET The components of other (income)/expenses-net were: During the first quarter of 2016, the Company recognized impairment charges of $45.9 million on long-lived assets of its Venezuelan subsidiary. See “-Note 20. Venezuela Currency Matters” for additional information. Foreign exchange (gains)/losses-net includes the re-measurement of U.S. dollar denominated intercompany loans, payables, and royalties as well as foreign currency devaluation and transactional foreign exchange gains recognized in the Company’s Venezuelan subsidiary. The re-measurement of the intercompany payable from the Venezuelan subsidiary to subsidiaries in Mexico and the U.S. resulted in a $7.7 million gain during the year ended December 31, 2016. Currency devaluation within Venezuela resulted in losses of $32.9 million, $2.3 million and $6.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. Transactional foreign exchange gains were $3.4 million, $2.4 million and $14.0 million for the years ended December 31, 2016, 2015 and 2014. See “-Note 20. Venezuela Currency Matters” for additional information. For the years ended December 31, 2016 and 2015, restructuring, severance and other costs-net included $29.2 million and $13.7 million, respectively, of restructuring costs associated with the Fuel for Growth program. See “-Note 6. Restructuring” for additional information. For the year ended December 31, 2015, (gain)/loss on asset disposals related to fixed asset write-offs as the Company optimized its supply chain network in Asia. The marketable securities (gain)/loss for the year ended December 31, 2015 is described further in “-Note 17. Marketable Securities.” Legal, settlements, and other-net included payments made in connection with the SEC settlement disclosed by the Company in July 2015. 11. RECEIVABLES The major categories of receivables were as follows: 12. INVENTORIES The major categories of inventories were as follows: 13. LONG-LIVED ASSETS Property, Plant and Equipment - net The major categories of property, plant and equipment - net were as follows: During the year ended December 31, 2016, the Company recognized an impairment charge of $45.9 million on long-lived assets of its Venezuelan subsidiary. See “-Note 20. Venezuela Currency Matters” for additional information. For the year ended December 31, 2016, both buildings and improvements and machinery, equipment and fixtures increased primarily due to the Company’s investments in North America and Asia manufacturing sites. Depreciation expense was $85.3 million, $83.7 million and $75.9 million for the years ended December 31, 2016, 2015 and 2014, respectively, and is primarily included in costs of products sold. Interest capitalized during the year was $1.0 million, $0.5 million and $1.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. The Company’s liability for asset retirement obligations was $7.9 million and $7.3 million at December 31, 2016 and 2015, respectively. Other Intangible Assets - net The gross carrying value and accumulated amortization by class of other intangible assets-net were as follows: (1) Changes in balances result from currency translation. (2) Changes in balances result from currency translation and amortization (10 year life). Amortization expense for other intangible assets was $14.3 million, $15.4 million and $15.7 million for the years ended December 31, 2016, 2015 and 2014, respectively. Expected amortization expense related to intangible assets is as follows: Non-Cash Activity Capital expenditures and the cash outflow for capital expenditures were as follows: 14. GOODWILL For the years ended December 31, 2016 and 2015, the change in the carrying amount of goodwill by reportable segment was as follows: As of December 31, 2016 and 2015, the Company had no accumulated impairment loss. 15. DEBT Short-Term Borrowings As of December 31, 2016 and 2015, the Company had short-term borrowings of $3.9 million and $3.0 million, respectively, which consisted primarily of borrowings made by its subsidiary in Argentina. The short-term borrowings in Argentina had a weighted-average interest rate of 29.3% as of December 31, 2016. Term Loan Agreement During the year ended December 31, 2015, the Company entered into a $1,000.0 million short-term loan agreement (the “Term Loan Agreement”) with various financial institutions, including Citibank, N.A., as Syndication Agent, and JPMorgan Chase Bank, N.A. (“JPMCB”), as Administrative Agent. The Term Loan Agreement was unsecured and all loans thereunder were payable at maturity in April 2016. The amounts borrowed under the Term Loan Agreement were used to fund repurchases of common stock pursuant to an accelerated share repurchase agreement described in “-Note 18. Equity.” Following the offering of $750.0 million of 3.0% Senior Notes due November 15, 2020 (“2020 Notes”) and $750.0 million of 4.125% Senior Notes due November 15, 2025 (“2025 Notes”), further discussed below, the Company repaid all borrowings under the Term Loan Agreement and terminated the Term Loan Agreement during the year ended December 31, 2015. The payoff amount of $1,000.3 million included principal, accrued and unpaid interest and a facility fee. Revolving Credit Facility Agreement The Company has an unsecured, five-year revolving credit facility agreement (the “Revolving Credit Facility”) which is repayable at maturity in June 2019, subject to annual extensions if a sufficient number of lenders agree. The maximum amount of outstanding borrowings and letters of credit permitted at any one time under the Revolving Credit Facility is $750.0 million, which may be increased from time to time up to $1,000.0 million at the Company’s request, subject to obtaining additional commitments and other customary conditions. The Revolving Credit Facility contains financial covenants, whereby the ratio of consolidated adjusted total debt to consolidated Earnings Before Interest Income Taxes, Depreciation and Amortization (“EBITDA”) cannot exceed 3.50 to 1.00, and the ratio of consolidated EBITDA to consolidated interest expense cannot be less than 3.00 to 1.00. The Company was in compliance with these financial covenants as of December 31, 2016. Borrowings under the Revolving Credit Facility bear interest at a rate that is determined as a base rate plus a margin. The base rate is either (a) LIBOR for a specified interest period or (b) a floating rate based upon JPMorgan Chase Bank’s prime rate, the Federal Funds rate or LIBOR. The margin is determined by reference to the Company’s credit rating. The margin can range from 0% to 1.375% over the base rate. In addition, the Company incurs an annual 0.125% facility fee on the entire facility commitment of $750.0 million. There were no borrowings under the Revolving Credit Facility during the year ended December 31, 2016. During the year ended December 31, 2015, the Company had borrowings and repayments of $446.0 million under the Revolving Credit Facility. Such borrowings were used to repurchase shares of the Company’s common stock and for general corporate purposes, and were repaid following the issuance of the 2020 Notes and 2025 Notes, described below. As of December 31, 2016 and 2015, the Company had no borrowings under the Revolving Credit Facility and the Company had $750.0 million available at December 31, 2016. Long-Term Debt As of December 31, 2016 and 2015, respectively, the components of long-term debt were as follows: During the year ended December 31, 2015, the Company issued and sold the 2020 Notes and 2025 Notes at a public offering price of 99.902% and 99.958%, respectively. The Company received net proceeds of $1,487.7 million from the sale of both the 2020 Notes and 2025 Notes, after deducting underwriters’ discounts and offering costs. Interest is payable on each of the 2020 Notes and 2025 Notes on May 15 and November 15 of each year. Proceeds from the 2020 Notes and 2025 Notes were used to repay borrowings under the Term Loan Agreement and borrowings under the Revolving Credit Facility. During the years ended December 31, 2015 and 2014, the Company entered into a series of fair value interest rate swaps that effectively convert the Company’s 2019 Notes and 2020 Notes from a fixed rate structure to a floating rate structure. See “-Note 16. Derivatives” for a discussion of the fair value swaps. During the year ended December 31, 2014, the Company issued and sold $500.0 million of 2044 Notes at a public offering price of 99.465% (“2044 Notes”). Net proceeds from the sale of the 2044 Notes, after deducting underwriters’ discounts and offering expenses, were $492.0 million. Interest on the 2044 Notes is payable semi-annually on June 1 and December 1 of each year. Proceeds from the 2044 Notes, together with cash on hand, were used to redeem the $500.0 million of 3.50% Notes due in 2014 (“2014 Notes”), as described below. During the year ended December 31, 2014, the Company redeemed all of its 2014 Notes. The redemption price, which was calculated in accordance with the terms of the 2014 Notes and included principal plus a make-whole premium, was $503.5 million. Using quoted prices in markets that are not active, the Company determined that the fair value of its long-term debt was $3,092.5 million (Level 2) as of December 31, 2016. The Company’s long-term debt may be prepaid at any time, in whole or in part, at a redemption price equal to the greater of par value or an amount calculated based upon the sum of the present values of the remaining scheduled payments. Upon a change of control, the Company may be required to repurchase the notes for an amount equal to 101% of the then-outstanding principal amount plus accrued and unpaid interest. Interest on the notes are due semi-annually and the notes are not subject to amortization. The components of interest expense-net were as follows: The increase in interest expense-net during the year ended December 31, 2016 was driven by interest expense on the November 2015 issuance of the 2020 Notes and the 2025 Notes, the proceeds of which were used primarily to fund purchases of common stock pursuant to an accelerated share repurchase agreement. See “-Note 18. Equity” for additional information. 16. DERIVATIVES The Company is exposed to market risk due to changes in foreign currency exchange rates, commodities pricing and interest rates. To manage that risk, the Company enters into certain derivative financial instruments, when available on a cost-effective basis, to hedge its underlying economic exposure. The Company does not enter into derivatives for speculative purposes. These financial instruments are classified as Level 2 in the fair value hierarchy at December 31, 2016 and 2015, and there were no transfers between levels in the fair value hierarchy during the periods then ended. The following table summarizes the fair value of the Company’s outstanding derivatives: While certain derivatives are subject to netting arrangements with the Company’s counterparties, the Company does not offset derivative assets and liabilities within the consolidated balance sheets presented herein. The Company’s derivative financial instruments present certain market and counterparty risks; however, concentration of counterparty risk is mitigated as the Company deals with a variety of major banks worldwide whose long-term debt at hedge inception is rated A- or higher by Standard & Poor’s Rating Service, Fitch Ratings or Moody’s Investors Service, Inc. In addition, only conventional derivative financial instruments are used. The Company would not be materially impacted if any of the counterparties to the derivative financial instruments outstanding at December 31, 2016 failed to perform according to the terms of its agreement. Based upon the risk profile of the Company’s portfolio, MJN does not require collateral or any other form of securitization to be furnished by the counterparties to its derivative financial instruments. Cash Flow Hedges As of December 31, 2016 and 2015, the Company has cash flow hedges which qualify as hedges of forecasted cash flows, with the effective portion of changes in fair value temporarily reported in accumulated other comprehensive income (loss). During the period that the underlying hedged transaction impacts earnings, the effective portion of the changes in the fair value of the cash flow hedges is recognized within earnings. The Company assesses effectiveness at inception and on a quarterly basis. These assessments determine whether derivatives designated as qualifying hedges continue to be highly effective in offsetting changes in the cash flows of hedged items. Any ineffective portion of the change in fair value is included in current period earnings. Cash flow hedges are valued using quoted prices in markets that are not active. The Company will discontinue cash flow hedge accounting when the forecasted transaction is no longer probable of occurring on the originally forecasted date, or 60 days thereafter, or when the hedge is no longer effective. For the year ended December 31, 2016, the Company discontinued cash flow hedge accounting for an insignificant number of hedges with an immaterial net impact to the income statement as the underlying transactions were no longer probable. For the years ended December 31, 2015 and 2014, the Company did not discontinue any cash flow hedges. Foreign Exchange Contracts The Company uses foreign exchange contracts to hedge forecasted transactions, primarily foreign currency denominated intercompany purchases anticipated in the next 15 months and designates these derivative instruments as foreign currency cash flow hedges when appropriate. When the underlying intercompany purchases impact the Company’s consolidated earnings, the effective portion of the hedge is recognized within cost of products sold, and ineffectiveness related to the Company’s foreign exchange hedges on earnings is recognized within other (income)/expenses - net. The ineffective portion of the hedges was $1.2 million and $0.9 million for the years ended December 31, 2016 and 2015, respectively, and insignificant for year ended December 31, 2014. The table below summarizes the Company’s outstanding foreign exchange forward contracts at December 31, 2016. The fair value of foreign exchange forward contracts should be viewed in relation to the fair value of the underlying hedged transactions and the overall reduction in exposure to fluctuations in foreign currency exchange rates. The change in accumulated other comprehensive income (loss) and the impact on earnings from foreign exchange contracts that qualified as cash flow hedges were as follows: At December 31, 2016, the balance of the effective portion of changes in fair value on foreign exchange forward contracts that qualified for cash flow hedge accounting included in accumulated other comprehensive income was $10.1 million, $8.9 million of which is expected to be reclassified into earnings within the next 12 months. Interest Rate Forward Swaps During 2013, the Company entered into interest rate forward starting swaps with a combined notional value of $500.0 million. The forward starting rates of the swaps ranged from 3.79% to 3.94% and had an effective date of October 31, 2014. The forward starting swaps effectively mitigated the interest rate exposure associated with the Company’s offering of the 2044 Notes, the proceeds of which were used to redeem all of the Company’s 2014 Notes. These derivative instruments were designated as cash flow hedges at inception and were highly effective in offsetting fluctuations in the benchmark interest rate. During 2014, and around the time of the issuance of the 2044 Notes, the Company paid $45.0 million to settle the outstanding forward swaps. This payment was recognized in accumulated other comprehensive loss and will be amortized over the life of the 2044 Notes. There was $0.5 million of ineffectiveness related to the forward swaps through the date of settlement, which was recognized as a loss within other (income)/expenses-net during the year ended December 31, 2014. During the years ended December 31, 2016, 2015 and 2014, $1.4 million, $1.4 million and $0.9 million of amortization of the settlement amount was recognized as incremental interest expense within interest expense-net, respectively. Commodity Hedges The Company utilizes commodity hedges to minimize the variability in cash flows due to fluctuations in market prices of the Company’s non-fat dry milk purchases for North America. The maturities of the commodity contracts are scheduled to match the pricing terms of the Company’s existing bulk purchase agreements. When the underlying non-fat dry milk purchases impact the Company’s consolidated earnings, the effective portion of the hedge is recognized within cost of products sold. As of December 31, 2016, the Company had no commodity contracts outstanding for forecasted non-fat dry milk purchases. The effective portion of commodity derivatives qualifying as cash flow hedges is deferred in accumulated other comprehensive income (loss), and the ineffective portion is recognized within other (income)/expenses - net. The effective portion of the hedges were insignificant for the each of the years ended December 31, 2016 and 2015, and the ineffective portions of the hedges were insignificant for the each of the years ended December 31, 2016, 2015, and 2014. Fair Value Hedges Interest Rate Swaps During the second quarter of 2014, the Company entered into eight interest rate swaps with multiple counterparties, which have an aggregate notional amount of $700.0 million of outstanding principal. This series of swaps effectively converts the $700.0 million of 2019 Notes from fixed to floating rate debt for the remainder of their term. These interest rate swaps were outstanding as of December 31, 2016, and the conversion of fixed to floating rate resulted in a reduction in interest expense of $7.1 million and $10.0 million for the years ended December 31, 2016 and 2015, respectively. See “-Note 15. Debt” for additional information regarding the 2019 Notes. In the fourth quarter of 2015, the Company entered into six interest rate swaps with multiple counterparties to mitigate interest rate exposure associated with the 2020 Notes. The swaps have an aggregate notional amount of $750.0 million of outstanding principal. This series of swaps effectively converts the $750.0 million of 2020 Notes from fixed to floating rate debt for the remainder of their term. These interest rate swaps were outstanding as of December 31, 2016, and the conversion of fixed to floating rate resulted in a reduction in interest expense of $6.8 million and $1.1 million for the years ended December 31, 2016 and 2015, respectively. See “-Note 15. Debt” for additional information regarding the 2020 Notes. The following table summarizes the interest rate swaps outstanding as of December 31, 2016. The interest rate swaps for the 2019 Notes have a hedge inception date of May 2014, and the interest rate swaps for the 2020 Notes have an inception date of November 2015. The expiration dates of the interest rate swaps are equal to the stated maturity dates of the underlying debt. Interest rate swaps are valued using third party valuation models. See “-Note 15. Debt” for additional information regarding the Company’s debt. Other Financial Instruments The Company does not hedge the interest rate risk associated with money market funds, which totaled $1,022.0 million and $510.1 million as of December 31, 2016 and 2015, respectively. Money market funds are classified as Level 2 in the fair value hierarchy and are included in cash and cash equivalents on the balance sheet. The money market funds have quoted market prices that are generally equivalent to par. 17. MARKETABLE SECURITIES The Company sold its investments in debt securities during 2015 for $21.7 million. As of December 31, 2016 and December 31, 2015, the Company held no investments in debt securities. During the year ended December 31, 2015, the Company recognized a net gain on trading securities of $5.6 million, resulting from fluctuation in fair value and foreign exchange. Debt securities have been classified as trading securities and are carried at fair value based on quoted market prices and classified as Level 1 in the fair value hierarchy. The cost basis for the Company’s debt securities is determined by the specific identification method. Realized and unrealized gains and losses on trading securities are included in other (income)/expenses - net. 18. EQUITY Changes in common shares and treasury stock were as follows: The Company may use either authorized and unissued shares or treasury shares to meet share requirements resulting from the exercise of stock options and vesting of performance share awards and restricted stock units. Treasury stock is recognized at the cost to reacquire the shares. Shares issued from treasury are recognized using the first-in first-out method. Share Repurchase Authorizations and Accelerated Share Repurchase Agreement In September 2013, the Company’s board of directors approved a share repurchase authorization of up to $500.0 million of the Company’s common stock (the “2013 Authorization”). During the year ended December 31, 2016, the Company repurchased $0.4 million of its common stock which completed all purchases remaining under the 2013 Authorization. During the year ended December 31, 2015, the Company repurchased $437.0 million of its common stock under the 2013 Authorization. In October 2015, the Company’s board of directors approved a new share repurchase authorization of an additional $1,500.0 million of the Company’s common stock (the “2015 Authorization”). The 2015 Authorization does not have an expiration date. On October 22, 2015, the Company entered into an accelerated share repurchase agreement (the “ASR Agreement”) with Goldman, Sachs & Co. (“Goldman”) to repurchase $1,000.0 million (the “Repurchase Price”) of its common stock. Under the terms of the ASR Agreement, the Company paid the Repurchase Price in advance in exchange for 10,725,552 shares of its common stock received by the Company on October 27, 2015 (which shares are equivalent to approximately 85% of the number of shares of its common stock that could have been purchased with an amount of cash equal to the Repurchase Price based on the closing price of its common stock on October 22, 2015). Upon final settlement of the ASR Agreement in June 2016, an additional 2,086,050 shares were delivered to the Company for no additional consideration based generally on the daily volume-weighted average prices of its common stock over the term of the ASR Agreement. The total shares received and retired under the terms of the ASR Agreement was 12,811,602 shares with an average price paid per share of approximately $78.05. The par value of the retired shares were reflected as a reduction to common stock and the payment made to Goldman was recorded as a reduction to retained earnings within shareholders’ equity. In addition to the shares delivered upon final settlement of the ASR Agreement, during the year ended December 31, 2016, the Company repurchased $100.0 million of its common stock pursuant to the 2015 Authorization. As of December 31, 2016 and 2015, the Company had $400.0 million and $500.0 million remaining available under the 2015 Authorization, respectively. Share repurchases made pursuant to the ASR Agreement were primarily funded by the issuance of the 2020 Notes and 2025 Notes. See “-Note 15. Debt” for additional information regarding the Company’s debt. Redeemable Noncontrolling Interest On March 15, 2012, the Company acquired 80% of the outstanding capital stock of Nutricion para el Conosur S.A. (“Nutricion”) which manufactures, distributes and sells infant formula and children’s nutrition products in Argentina under the SanCor Bebé and Bebé Plus brands (the “Argentine Acquisition”). Under the terms of an agreement related to the Argentine Acquisition, the noncontrolling interest owner had the right to require MJN to purchase (the “Put Right”) its remaining 20% interest or to sell (the “Call Right”) up to an additional 20% of the outstanding capital stock of Nutricion. The Put Right was to be exercisable once from September 15, 2015 to September 15, 2018 and the decision to exercise was not within the control of MJN. The price paid upon exercise was to be determined based on established multiples of sales and earnings of the acquired business. As a result of the Put Right, the noncontrolling interest was presented as redeemable noncontrolling interest outside of equity on the balance sheet. Accretion to the redemption value of the Put Right was being recognized through equity using an interest method over the period from March 2012 to June 2015. On June 30, 2015, the noncontrolling partner exercised its single trigger put option and MJN acquired an additional 10% of the outstanding capital stock of the local entity, thereby increasing MJN’s ownership interest to 90%. The agreed upon purchase price paid to the noncontrolling interest owner was $24.4 million as of June 30, 2015 (based upon the agreed local currency price). The purchase price was settled during the second and third quarters of 2015. Following the impact of foreign exchange, the cash outflow associated with the acquisition was $24.2 million. As a result of the transaction, the noncontrolling interest owner no longer has a Put Right and the Call Right was amended. The amended Call Right gives the noncontrolling interest owner the right to require MJN to sell up to 10% of the outstanding capital stock of Nutricion, exercisable from June 30, 2015 to June 30, 2022. Due to the termination of the Put Right, the remaining noncontrolling interest was recharacterized from redeemable noncontrolling interest outside of equity to noncontrolling interests within equity on the balance sheet beginning on June 30, 2015. Accumulated Other Comprehensive Loss Changes in accumulated other comprehensive loss by component were as follows: (1) Represents foreign currency translation adjustments. Reclassification adjustments out of accumulated other comprehensive loss were as follows: 19. LEASES Minimum rental commitments under all non-cancelable operating leases, primarily real estate leases for offices, manufacturing-related leases and vehicle leases, in effect at December 31, 2016, were: Operating lease rental expenses were $36.1 million, $37.4 million and $39.5 million in the years ended December 31, 2016, 2015 and 2014, respectively. At December 31, 2016 and 2015, the Company had capital lease obligations outstanding in the amount of $3.1 million and $2.0 million, respectively. 20. VENEZUELA CURRENCY MATTERS Discussion of Venezuela Exchange Rates In January 2014, the Venezuelan government enacted changes affecting the country’s currency exchange and other controls, and established a new foreign currency administration, the National Center for Foreign Commerce (“CENCOEX”). CENCOEX assumed control of the sale and purchase of foreign currency in Venezuela, and established the official exchange rate (“Official Rate”) of 6.3 Bolivares Fuertes (“VEF”) to 1.0 U.S. dollar (“USD”). Additionally, the government expanded the types of transactions that may be subject to the weekly auction mechanism under the Complimentary Currency Administration System (“SICAD I”). For a period of time, the Venezuelan government announced plans for the Alternative Foreign Exchange System, also known as SICAD II, which was intended to more closely resemble a market-driven exchange. In February 2015, the Venezuelan government combined the SICAD I and SICAD II (“SICAD”) exchange rate mechanisms and created a new market based SIMADI rate, which was based on supply and demand. The changes created a three tiered system. As of December 31, 2015, CENCOEX traded at 6.3 VEF to 1.0 USD, the SICAD auction markets traded at 13.5 VEF to 1.0 USD and the SIMADI traded at 198.7 VEF to 1.0 USD. In March 2016, the Venezuelan government devalued its currency and reduced its existing three tiered system to a two tiered system by eliminating the intermediary SICAD rate. The CENCOEX Official Rate, which continues to be used for purchases of certain essential goods, was changed to 10.0 VEF to 1.0 USD and is now referred to as DIPRO. Additionally, the SIMADI rate was replaced by a new market based rate known as DICOM, which governs all transactions not covered by DIPRO. The VEF as measured at the DICOM rate has continued to devalue against the USD throughout 2016. The rates were as follows: Effect on the Company’s Results Currency Matters Due to the elimination of the SICAD rate in March 2016, the Company adopted the DICOM rate for purposes of remeasuring the monetary assets and liabilities of its Venezuela subsidiary, effective March 10, 2016, because the Company believes the DICOM rate would now be used to settle future intercompany dividend remittances. The remeasurement impact of this adoption was a loss of $32.3 million, recognized during the first quarter of 2016 as a component of other (income)/expenses - net. Additional losses in the amount of $0.6 million were recognized during the year ended December 31, 2016, related to remeasurement of the monetary assets and liabilities due to the continued devaluation of the VEF as measured at the DICOM rate against the USD. For the years ended December 31, 2015 and 2014, currency devaluation within Venezuela resulted in losses of $2.3 million and $6.1 million, respectively. During the years ended December 31, 2016, 2015 and 2014, the Company received U.S dollars to make payments for intercompany purchases of inventory at the CENCOEX Official Rate that was more favorable than the SICAD or DICOM rate used to remeasure net monetary assets of its Venezuela subsidiary, which resulted in recognized gains of $3.4 million, $2.4 million and $14.0 million, respectively. Long Lived and Other Assets As a result of the change in the Venezuelan exchange rates, the Company concluded that an impairment indicator existed at March 31, 2016 and evaluated the carrying value of the long-lived assets of its Venezuela subsidiary for impairment, which includes administrative office space, land and a partially completed distribution warehouse facility. Based on this evaluation, the Company concluded that the carrying value of the long-lived assets was no longer recoverable and recorded an impairment charge of $45.9 million to write down the carrying value of the assets to their fair value, which was recognized during the first quarter of 2016 as a component of other (income)/expenses - net. The fair value measurements were based on market quotes from local real estate broker service firms as well as internal assessments of the best information available about the local business conditions and the political environment, including the risks associated with the local currency that would be indicative of what the assets could be sold for and are considered to be Level 3 measurements. In addition, the changes in Venezuelan exchange rates and ongoing deterioration of the business resulted in the Company incurring charges in the amount of $3.0 million during the year ended December 31, 2016 related to prepaid and other assets in Venezuela that can no longer be utilized. Intercompany Payable During the year ended December 31, 2016, the Company wrote-off a $52.0 million intercompany payable from its Venezuelan subsidiary to its subsidiaries in Mexico and the U.S. The decision was based on a reduced level of local currency which has resulted in the Venezuelan subsidiary no longer having sufficient cash to satisfy this payable, the continued inability to access the currency exchange and the Company’s view that sales in Venezuela are unlikely to return in the near term to a level that would generate adequate liquidity to satisfy this payable. The write-off of the payable had no impact on the Company’s results of operations on a pre-tax basis as the payable in Venezuela and the receivables in Mexico and the U.S. were held in U.S. dollars. The tax impact of this write-off was calculated based upon the tax rules in each of the impacted jurisdictions and resulted in a gain of $14.7 million recognized within Provision for Income Taxes. Remaining Exposures Net sales in the Venezuelan subsidiary were negligible as a percent of total Company net sales for the year ended December 31, 2016. In addition, the Venezuelan subsidiary’s earnings were not a material component of MJN’s consolidated results during the year ended December 31, 2016. The Venezuelan subsidiary had net monetary assets and net non-monetary assets that were negligible individually and in aggregate to the Company’s total net assets as of December 31, 2016. 21. CONTINGENCIES In the ordinary course of business, the Company is subject to lawsuits, investigations, government inquiries and claims, including, but not limited to, product liability claims, advertising disputes and inquiries, consumer fraud suits, other commercial disputes, premises claims and employment and environmental, health and safety matters. The Company records accruals for contingencies when it is probable that a liability will be incurred and the loss can be reasonably estimated. Although the Company cannot predict with certainty the final resolution of lawsuits, investigations and claims asserted against the Company, MJN does not believe any currently pending legal proceeding to which the Company is a party will have a material impact on the Company’s business or financial condition, results of operations or cash flows. 22. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (a) When aggregated, earnings per share for the four quarters may not equal the full year earnings per share figure due to the variability of quarterly earnings and the timing of share repurchases. 23. SUBSEQUENT EVENTS Merger Agreement On February 10, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Reckitt Benckiser Group plc, a company incorporated in England and Wales (“Reckitt Benckiser”), and Marigold Merger Sub, Inc., a Delaware corporation and a wholly owned indirect subsidiary of Reckitt Benckiser (“Merger Sub”), pursuant to which Reckitt Benckiser will indirectly acquire the Company by means of a merger of Merger Sub with and into the Company on the terms and subject to the conditions set forth in the Merger Agreement (the “Merger”). The Merger Agreement and the consummation of the transactions contemplated by the Merger Agreement have been unanimously approved by the Company’s board of directors. At the effective time of the Merger (the “Effective Time”), on the terms and subject to the conditions set forth in the Merger Agreement, each share of the Company’s common stock outstanding immediately prior to the Effective Time (other than (i) each share held by the Company as treasury stock (other than shares held for the account of clients, customers or other persons), (ii) each share held by Reckitt Benckiser or by any subsidiary of either the Company or Reckitt Benckiser and (iii) each share held by a holder who has not voted in favor of the Merger or consented thereto in writing and who has demanded appraisal for such shares in accordance with Delaware law) will be converted into the right to receive $90.00 in cash, without interest. Consummation of the Merger is subject to the satisfaction or waiver of certain customary closing conditions, including, among others: (i) the affirmative vote of the holders of a majority of the Company's outstanding shares of common stock; (ii) the affirmative vote of a simple majority of Reckitt Benckiser's shareholders at a shareholder meeting; (iii) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the receipt of certain other non-United States regulatory approvals required to consummate the Merger; and (iv) in the case of Reckitt Benckiser's obligations to consummate the Merger, the absence of a Company Material Adverse Effect (as defined in the Merger Agreement). Reckitt Benckiser and Merger Sub's respective obligations to consummate the Merger are not subject to any financing condition or other contingency. Litigation Related to the Merger On February 14, 2017, a stockholder of the Company filed a purported stockholder class action lawsuit in Cook County, Illinois, captioned Kirkham v. Altschuler, et al., 2017-CH-02109. The defendants are the Company, its board of directors, Reckitt Benckiser and Merger Sub. The lawsuit alleges that the Company’s board of directors violated their fiduciary duties and that the Company, Reckitt Benckiser and Merger Sub aided and abetted such breaches, in each case in connection with the transactions contemplated by the Merger Agreement. The lawsuit seeks, among other things, to enjoin consummation of the Merger. The Company and its directors intend to vigorously defend against the allegations in the complaint. Australian Asset Acquisition On February 27, 2017, the Company announced that it has reached an agreement to acquire assets from Bega Cheese Limited (“Bega”). In connection with this transaction, the Company is acquiring from Bega a spray dryer and a finishing plant in Australia and entering into a service agreement to support the operation of those assets. The aggregate consideration for this asset purchase is approximately AUD $200 million. The Company expects the transaction to close in the second quarter of 2017. SCHEDULE II MEAD JOHNSON NUTRITION COMPANY VALUATION AND QUALIFYING ACCOUNTS | Here's a summary of the financial statement excerpt:
Revenue Recognition:
- Shipping terms are mostly FOB destination
- Provisions for returns and WIC rebates are estimated based on historical experience
- Sales incentives (discounts, promotions, coupons) are estimated and recorded as revenue reductions
- Taxes collected from customers are recorded as current liabilities
- WIC rebate accruals were $212.5
Expenses and Accounting:
- Includes liabilities, income tax expense, stock-based compensation, and retirement benefits
- Actual results may differ from estimates
- Fair value measurements are classified using a hierarchy (Level 1 mentioned)
The statement focuses on how the company recognizes and accounts for revenue, provisions, and various financial liabilities. | Claude |
Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders ARCA biopharma, Inc.: We have audited the accompanying balance sheets of ARCA biopharma, Inc. (the Company) as of December 31, 2016 and 2015, and the related statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ARCA biopharma, Inc. as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in note 1 to the financial statements, the Company has incurred substantial losses from operations and needs to raise a significant amount of capital to fund its clinical development programs. The Company’s ability to raise such capital is uncertain. As a result, there is substantial doubt about the Company’s ability to continue as a going concern for a period from one year after the Company’s financial statements have been issued. Management’s plans in regard to these matters are also described in note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ KPMG LLP Denver, Colorado March 21, 2017 ARCA BIOPHARMA, INC. BALANCE SHEETS See accompanying Notes to Financial Statements ARCA BIOPHARMA, INC. STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS See accompanying Notes to Financial Statements ARCA BIOPHARMA, INC. STATEMENTS OF STOCKHOLDERS’ EQUITY See accompanying Notes to Financial Statements ARCA BIOPHARMA, INC. STATEMENTS OF CASH FLOWS See accompanying Notes to Financial Statements ARCA BIOPHARMA, INC. NOTES TO FINANCIAL STATEMENTS (1) The Company and Summary of Significant Accounting Policies Description of Business ARCA biopharma, Inc. (the Company or ARCA), a Delaware corporation, is headquartered in Westminster, Colorado. The Company is a biopharmaceutical company applying a precision medicine approach to developing genetically-targeted therapies for cardiovascular diseases. The Company’s lead product candidate, Gencaro™ (bucindolol hydrochloride), is an investigational, pharmacologically unique beta-blocker and mild vasodilator that ARCA is developing for the potential treatment of patients with atrial fibrillation (AF) and chronic heart failure in patients with heart failure with reduced left ventricular ejection fraction (HFrEF). The Company is conducting a Phase 2B/Phase 3 clinical superiority trial, known as GENETIC-AF, in which the Company is evaluating Gencaro for the treatment of AF in HFrEF patients against TOPROL-XL (metoprolol succinate), a drug approved for treating HFrEF that is also prescribed, but not approved, for treating AF in patients with HFrEF. Enrollment in GENETIC-AF is limited to patients that possess the specific genotype that the Company believes enhances Gencaro’s potential therapeutic effects. The current development of Gencaro is, in part, based on a prospectively designed DNA substudy of adrenergic receptor polymorphisms in the BEST trial, a previous Phase 3 study of 2,708 HF patients. In the BEST trial, Gencaro showed evidence of potential efficacy in treating AF and in reducing mortality and hospitalizations in patients with this specific genotype. GENETIC-AF is an adaptive, seamless design Phase 2B/Phase 3, multi-center, randomized, double-blind, clinical superiority trial comparing the safety and efficacy of Gencaro against an active comparator, the beta-blocker TOPROL-XL (metoprolol succinate), that seeks to enroll a combined total of approximately 620 patients. Eligible patients will have HFrEF, a history of paroxysmal AF (episodes lasting 7 days or less) or persistent AF (episodes lasting more than 7 days and less than 1 year) in the past 6 months, and the beta-1 389 arginine homozygous genotype that the Company believes responds most favorably to Gencaro. The primary endpoint of the study is time to first event of symptomatic AF/atrial flutter (AFL), or all-cause mortality. The GENETIC-AF Data and Safety Monitoring Board (DSMB) will conduct a pre-specified interim analysis of study endpoints for efficacy, safety and futility to recommend whether or not the trial should proceed to Phase 3. The DSMB will make its recommendation based on a predictive probability analysis of certain trial data after a sufficient number of patients have evaluable endpoint data. A randomized patient has evaluable endpoint data either when they experience their first composite endpoint event, AF/AFL or all-cause mortality, or after completion of the 24-week primary endpoint follow up period. The DSMB interim analysis will focus on analyses of the AF/AFL endpoints in the trial using both clinical-based intermittent monitoring and device-based continuous monitoring techniques. Based on the results of the interim analysis, the DSMB may recommend that the trial proceed to Phase 3, the trial be completed as a Phase 2B study, or termination of the trial due to futility. ARCA, in collaboration with the GENETIC-AF Steering Committee, will determine the next steps for the trial based on the DSMB recommendation from this interim analysis and on the Company’s available financing. The Company randomized the 175th patient in the trial in March 2017. The Company projects that the outcome of the DSMB interim analysis and recommendation will be available in the third quarter of 2017. Should the DSMB recommend that the study continue to Phase 3, the trial would continue enrolling to a total of approximately 620 patients, subject to the Company obtaining sufficient financing to fund the Phase 3 portion of the trial. If the Company continues with the Phase 3 portion of the GENETIC-AF, it will need to raise additional capital to complete the Phase 3 portion of the GENETIC-AF clinical trial and submit for FDA approval. If the Company is unable to obtain additional funding or is unable to complete a strategic transaction, it may have to discontinue development activities on Gencaro or discontinue its operations. On January 27, 2009, the Company completed a business combination (the Merger) with Nuvelo, Inc. (Nuvelo). Immediately following the Merger, the Company changed its name from Nuvelo, Inc. to ARCA biopharma, Inc. Liquidity and Going Concern The Company devotes substantially all of its efforts towards obtaining regulatory approval and raising capital necessary to fund its operations and it is subject to a number of risks associated with clinical research and development, including dependence on key individuals, the development of and regulatory approval of commercially viable products, the need to raise adequate additional financing necessary to fund the development and commercialization of its products, and competition from larger companies. The Company has not generated revenue to date and has incurred substantial losses and negative cash flows from operations since its inception. The Company has historically funded its operations through issuances of common and preferred stock. In June 2015, the Company raised approximately $34.2 million in net proceeds to provide additional funds for the Phase 2B/3 GENETIC-AF trial and the Company’s ongoing operations. The Company is enrolling patients in the Phase 2B portion of the GENETIC-AF trial, and the Company believes that its current cash, cash equivalents and marketable securities will be sufficient to fund its operations, at its projected cost structure, through the end of 2017. In January 2017, the Company entered into a sales agreement with an agent to sell, from time to time, its common stock having an aggregate offering price of up to $7.3 million, in an “at the market offering.” The Company is not obligated to make any sales of its common stock, and we have not executed any significant sales through this facility. However, notwithstanding this sales agreement, in light of the significant uncertainties regarding clinical development timelines and costs for developing drugs such as Gencaro, the Company expects it will need to raise additional capital to finance the completion of GENETIC-AF and the Company’s future operations. If the Company is delayed in completing or is unable to complete additional funding and/or a strategic transaction, the Company may discontinue its development activities or operations. The Company’s liquidity, and its ability to raise additional capital or complete any strategic transaction, depends on a number of factors, including, but not limited to, the following: • progress of GENETIC-AF, including enrollment and any data that may become available; • the costs and timing for the potential additional clinical trials in order to gain possible regulatory approval for Gencaro; • the market price of the Company’s stock and the availability and cost of additional equity capital from existing and potential new investors; • the Company’s ability to retain the listing of its common stock on the Nasdaq Capital Market; • general economic and industry conditions affecting the availability and cost of capital; • the Company’s ability to control costs associated with its operations; • the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and • the terms and conditions of the Company’s existing collaborative and licensing agreements. The sale of additional equity or convertible debt securities would likely result in substantial additional dilution to the Company’s stockholders. If the Company raises additional funds through the incurrence of indebtedness, the obligations related to such indebtedness would be senior to rights of holders of the Company’s capital stock and could contain covenants that would restrict the Company’s operations. The Company also cannot predict what consideration might be available, if any, to the Company or its stockholders, in connection with any strategic transaction. Should strategic alternatives or additional capital not be available to the Company, or not be available on acceptable terms, the Company may be unable to realize value from its assets and discharge its liabilities in the normal course of business which may, among other alternatives, cause the Company to further delay, substantially reduce or discontinue operational activities to conserve its cash resources. The significant uncertainties surrounding the clinical development timelines and costs and the need to raise a significant amount of capital raises substantial doubt about the Company’s ability to continue as a going concern from one year after the Company’s financial statements have been issued. The Company could delay or cancel certain significant planned expenditures related to the GENETIC-AF trial and/or implement cost reduction measures to conserve our cash balances; however, there is no assurance that those measures would be adequate to allow the Company to continue as a going concern for a period beyond one year from the issuance of these financial statements. These financial statements have been prepared with the assumption that the Company will continue as a going concern and will be able to realize its assets and discharge its liabilities in the normal course of business and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the inability of the Company to continue as a going concern. The Company may not be able to raise sufficient capital on acceptable terms, or at all, to continue development of Gencaro or to otherwise continue operations and may not be able to execute any strategic transaction. Basis of Presentation The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and include all adjustments necessary for the fair presentation of our financial position, results of operations and cash flows for the periods presented. Our management performed an evaluation of our activities through the date of filing of this Annual Report on Form 10-K, and the subsequent events are disclosed in Note 11. Recent Accounting Pronouncements In August 2014, the Financial Accounting Standards Board (FASB) issued FASB Accounting Standards Update (ASU No. 2014-15), Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU No. 2014-15 will be effective for fiscal years and interim periods ending after December 15, 2016, with early adoption being permitted for annual and interim periods for which financial statements have not been issued. ASU 2014-15 requires that management evaluate at each annual and interim reporting period whether there is a substantial doubt about an entity’s ability to continue as a going concern within one year of the date that the financial statements are issued. There are significant uncertainties surrounding the Company’s clinical development timelines and costs and the Company will likely need to raise a significant amount of capital in the future. The Company adopted this guidance for the year ended December 31, 2016. The adoption did not have an impact on the financial position or results of operations and the related disclosures are included in the “Liquidity and Going Concern” disclosure above. In April 2015, the FASB issued Accounting Standards Update No. 2015-05: Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement (ASU 2015-05). The amendments in this update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the update specifies that the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. The update further specifies that the customer should account for a cloud computing arrangement as a service contract if the arrangement does not include a software license. ASU 2015-05 will be effective for fiscal years beginning after December 31, 2015. The Company adopted this guidance as of January 1, 2016 and there was no impact to the financial statements. In January 2016, FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01). ASU 2016-01 requires equity investments to be measured at fair value with changes in fair value recognized in net income; simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; requires separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the accompanying notes to the financial statements and clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating the impact that ASU 2016-01 will have on its financial statements and related disclosures. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02), which requires lessees to recognize assets and liabilities for the rights and obligations created by most leases on their balance sheet. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. ASU 2016-02 requires modified retrospective adoption for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. While the Company is currently evaluating the impact that ASU 2016-02 will have on its financial statements and related disclosures, we expect that the operating lease commitment discussed in Note 6 will be recognized as operating lease liability and right-of-use asset. In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting (ASU 2016-09), which changes how companies account for certain aspects of share-based payments to employees. The new guidance requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled, allows an employer to repurchase more of an employee’s shares than previously allowed for tax withholding purposes without triggering liability accounting, allows a company to make a policy election to account for forfeitures as they occur, and eliminates the requirement that excess tax benefits be realized before companies can recognize them. The new guidance also requires excess tax benefits and tax shortfalls to be presented on the cash flow statement as an operating activity rather than as a financing activity, and clarifies that cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding obligation are to be presented as a financing activity. For the years ended December 31, 2016 and 2015, the Company recognized no such excess tax benefits and did not withhold shares to satisfy statutory income tax withholding obligations. The standard is effective for its financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the provisions of ASU 2016-09 to have a material impact on its financial statements and related disclosures. The Company reviewed all other recently issued accounting pronouncements and concluded that they were either not applicable or not expected to have a significant impact to the financial statements. Accounting Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. The Company bases estimates on various assumptions that are believed to be reasonable under the circumstances. The Company believes significant judgment was involved in estimating the clinical trial accruals, and in estimating other accrued liabilities, stock-based compensation, and income taxes. Management is continually evaluating and updating these estimates, and it is possible that these estimates will change in the future or that actual results may differ from these estimates. Cash Equivalents Cash equivalents generally consist of money market funds and debt securities with maturities of 90 days or less at the time of purchase. The Company invests its excess cash in securities with strong ratings and has established guidelines relative to diversification and maturity with the objective of maintaining safety of principal and liquidity. Marketable Securities The Company has designated its marketable securities as of each balance sheet date as available-for-sale securities and account for them at their respective fair values. Marketable securities are classified as short-term or long-term based on the nature of the securities and their availability to meet current operating requirements. Marketable securities that are readily available for use in current operations are classified as short-term available-for-sale securities and are reported as current marketable securities in the accompanying balance sheets. Marketable securities that are not considered available for use in current operations are classified as long-term available-for-sale securities and are reported as a component of long-term assets in the accompanying balance sheets. Securities that are classified as available-for-sale are measured at fair value, including accrued interest, with temporary unrealized gains and losses reported as a component of stockholders' equity until their disposition. The Company reviews all available-for-sale securities at each period end to determine if they remain available-for-sale based on our then current intent and ability to sell the security if it is required to do so. All of the Company’s marketable securities are subject to a periodic impairment review. The Company recognizes an impairment charge when a decline in the fair value of its investments below the cost basis is judged to be other-than-temporary. Concentrations of Credit Risk Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents. The Company has no off-balance-sheet concentrations of credit risk, such as foreign exchange contracts, option contracts, or foreign currency hedging arrangements. The Company maintains cash and cash equivalent balances in the form of bank demand deposits and money market fund accounts with financial institutions that management believes are creditworthy. Such balances may at times exceed the insured amount. Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Cost includes expenditures for equipment, leasehold improvements, replacements, and renewals. Maintenance and repairs are charged to expense as incurred. When assets are sold, retired, or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in operations. The cost of property and equipment is depreciated using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized over the shorter of the life of the lease or the estimated useful life of the assets. Accrued Expenses As part of the process of preparing its financial statements, the Company is required to estimate accrued expenses. This process involves identifying services that third parties have performed on the Company’s behalf and estimating the level of service performed and the associated cost incurred for these services as of the balance sheet date. Examples of estimated accrued expenses include contract service fees, such as fees payable to contract manufacturers in connection with the production of materials related to the Company’s drug product, and professional service fees, such as attorneys, consultants, and clinical research organizations. The Company develops estimates of liabilities using its judgment based upon the facts and circumstances known at the time. Segments The Company operates in one segment. Management uses one measure of profitability and does not segment its business for internal reporting. Research and Development Research and development costs are expensed as incurred. These consist primarily of salaries, contract services, and supplies. Costs related to clinical trial and drug manufacturing activities are based upon estimates of the services received and related expenses incurred by contract research organizations, or CROs, clinical study sites, drug manufacturers, collaboration partners, laboratories, consultants, or otherwise. Related contracts vary significantly in length, and could be for a fixed amount, a variable amount based on actual costs incurred, capped at a certain limit, or for a combination of these elements. Activity levels are monitored through communications with the vendors, including detailed invoices and task completion review, analysis of expenses against budgeted amounts, and pre-approval of any changes in scope of the services to be performed. Certain significant vendors may also provide an estimate of costs incurred but not invoiced on a periodic basis. Expenses related to the CROs and clinical studies, as well as contract drug manufacturers, are primarily based on progress made against specified milestones or targets in each period. In accordance with certain research and development agreements, we are obligated to make certain upfront payments upon execution of the agreement. We record these upfront payments as prepaid research and development expenses, which are included in Other current assets or Other assets in the accompanying Balance Sheets. Such payments are recorded to research and development expense as services are performed. We evaluate on a quarterly basis whether events and circumstances have occurred that may indicate impairment of remaining prepaid research and development expenses. Stock-Based Compensation The Company’s stock-based compensation cost recognized is based on the estimated grant date fair value. The Company recognizes compensation costs for its stock-based awards on a straight-line basis over the requisite service period for the entire award, as adjusted for expected forfeitures. The Company recognizes compensation costs for its performance based stock-based awards over the performance period, once the performance condition is probable, and as adjusted for expected forfeitures. Income Taxes The current benefit for income taxes represents actual or estimated amounts payable or refundable on tax returns filed or to be filed each year. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. The overall change in deferred tax assets and liabilities for the period measures the deferred tax expense or benefit for the period. The measurement of deferred tax assets may be reduced by a valuation allowance based on judgmental assessment of available evidence if deemed more likely than not that some or all of the deferred tax assets will not be realized. The Company has recorded a valuation allowance against all of its deferred tax assets, as management has concluded that it is more likely than not that the net deferred tax asset will not be realized through future taxable income, based primarily on the Company’s history of operating losses. The Company has not performed an Internal Revenue Code Section 382 limitation study. Depending on the outcome of such a study, the gross amount of net operating losses recognizable in future tax periods could be limited. (2) Net Loss Per Share The Company calculates basic earnings per share by dividing loss attributable to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share is computed by dividing loss attributable to common stockholders by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would have been outstanding if the potential common shares had been issued. The Company’s potentially dilutive shares include stock options, restricted stock units and warrants for common stock. Because the Company reported a net loss for the years ended December 31, 2016 and 2015, all potentially dilutive shares of common stock have been excluded from the computation of the dilutive net loss per share for all periods presented. Such potentially dilutive shares of common stock consist of the following: (3) Marketable Securities and Fair Value Disclosures Marketable securities consisted of the following as of December 31, 2016 (in thousands): The investments have been in an unrealized loss position for less than twelve months. Based upon the Company’s evaluation of all relevant factors, the Company believes that the decline in fair value of securities held at December 31, 2016 below cost is temporary, and the Company intends to retain its investment in these securities for a sufficient period of time to allow for recovery of the fair value. As of December 31, 2016, the amortized cost and estimated fair value of available-for-sale securities by contractual maturity were as follows (in thousands): Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). Inputs used to measure fair value are classified into the following hierarchy: • Level 1-Unadjusted quoted prices in active markets for identical assets or liabilities. The Company’s Level 1 assets consist of money market investments. The Company does not have any Level 1 liabilities. • Level 2-Unadjusted quoted prices in active markets for similar assets or liabilities; unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs other than quoted prices that are observable for the asset or liability. The Company’s Level 2 assets consist of corporate bonds and commercial paper securities. The Company does not have any Level 2 liabilities. • Level 3-Unobservable inputs for the asset or liability. The Company does not have any Level 3 assets or liabilities. The following table identifies the Company’s assets that were measured at fair value on a recurring basis (in thousands): As of December 31, 2016 and 2015, the Company had $7.7 million and $38.7 million, respectively, of cash equivalents consisting of money market funds with maturities of 90 days or less. The Company has the ability to liquidate these investments without restriction. The Company determines fair value for these money market funds and equity securities with Level 1 inputs through quoted market prices. There were no transfers between any fair value hierarchy levels in 2016 or 2015. Fair Value of Other Financial Instruments The carrying amount of other financial instruments, including cash and accounts payable, approximated fair value due to their short maturities. As of December 31, 2016 and 2015, the Company did not have any debt outstanding. (4) Property and Equipment Property and equipment consist of the following (in thousands): For the years ended December 31, 2016 and 2015, depreciation and amortization expense was $24,000 and $19,000, respectively. (5) Related Party Arrangements Transactions with the Company’s President and Chief Executive Officer The Company has entered into unrestricted research grants with its President and Chief Executive Officer’s academic research laboratory at the University of Colorado. Funding of any unrestricted research grants is contingent upon the Company’s financial condition, and can be deferred or terminated at the Company’s discretion. Total expense under these arrangements for the years ended December 31, 2016 and 2015 was $427,000 and $375,000, respectively. (6) Commitments and Contingencies The Company has or is subject to the following commitments and contingencies: Employment Agreements The Company maintains employment agreements with several key executive employees. The agreements may be terminated at any time by the Company with or without cause upon written notice to the employee, and entitle the employee to wages in lieu of notice for periods not exceeding one calendar year from date of termination without cause or by the employee for good reason. Certain of these agreements also provide for payments to be made under certain conditions related to a change in control of the Company. Operating Lease On August 1, 2013 the Company entered into a lease agreement for approximately 5,300 square feet of office facilities in Westminster, Colorado which has served as the Company’s primary business office since October 1, 2013. Effective March 2, 2016, the lease was renewed for an additional 38 month term beginning October 1, 2016 and expiring on November 30, 2019. Below is a summary of the future minimum lease payments committed for the Company’s facility in Westminster, Colorado as of December 31, 2016 (in thousands): Rent expense under these leases for the years ended December 31, 2016 and 2015 was $81,000 and $81,000, respectively. Duke University In November 2013, the Company entered into a clinical research agreement with Duke University (Duke) to serve as the clinical research organization for the Company’s GENETIC-AF clinical study. Under the agreement the Company is responsible to pay Duke for their work managing certain aspects of the clinical study. Upon completion of the clinical study, the agreement will terminate. The agreement can be terminated earlier by the Company for any reason with 90 days written notice to Duke. In the event of an early termination, the Company and Duke would coordinate efforts for an orderly wind-down of the study, and the Company would be responsible to pay Duke for time and effort incurred through the date of termination and through the wind-down period. Cardiovascular Pharmacology and Engineering Consultants, LLC ARCA has licensed worldwide rights to Gencaro, including all preclinical and clinical data, from Cardiovascular Pharmacology and Engineering Consultants, LLC (CPEC), who has licensed rights in Gencaro from Bristol Myers Squib (BMS). CPEC is a licensing subsidiary of Indevus Pharmaceuticals Inc. (a wholly owned subsidiary of Endo Pharmaceuticals), holding ownership rights to certain clinical trial data of Gencaro. Under the terms of its license agreement with CPEC, the Company will incur milestone and royalty obligations upon the occurrence of certain events. If the FDA grants marketing approval for Gencaro, the license agreement states that the Company will owe CPEC a milestone payment of $8.0 million within six months after FDA approval. The license agreement states that a milestone payment of up to $5.0 million in the aggregate shall be paid upon regulatory marketing approval in Europe and Japan. The license agreement also states that the Company’s royalty obligation ranges from 12.5% to 25% of revenue from the related product based on achievement of specified product sales levels, including a 5% royalty that CPEC is obligated to pay under its original license agreement for Gencaro. The agreement states that the Company has the right to buy down the royalties to a range of 12.5% to 17% by making a payment to CPEC within six months of regulatory approval. (7) Equity Financings and Warrants 2015 Equity Financing Private Investment in Public Entity (PIPE) Transaction On June 16, 2015, the Company sold an aggregate of 6,003,082 security units, made up of an aggregate 6,003,082 shares of the Company’s common stock and warrants to purchase an aggregate of 2,401,233 shares of the Company’s common stock, at a purchase price of $6.1635 per unit, for aggregate net proceeds of approximately $34.2 million. The warrants became exercisable on December 13, 2015, expire on June 16, 2022, and have an exercise price of $6.1012 per share. The warrants provide for cashless exercise and settlement in unregistered shares if there is no effective registration statement registering, or the prospectus contained therein is not available for the issuance of the shares of common stock underlying the warrants at the time of exercise. The Company’s Registration Statement on Form S-3 registering these shares of common stock, including the shares of common stock underlying the warrants, issued in the transaction for public resale was declared effective by the Securities and Exchange Commission on July 20, 2015. Warrants Warrants to purchase shares of common stock were granted as part of various financing and business agreements. All outstanding warrants were recorded in additional paid-in capital at their estimated fair market value at the date of grant using a Black-Scholes option-pricing model. As of December 31, 2016, these warrants, by year of expiration, are summarized below: (8) Share-based Compensation Stock Plans The Company’s equity incentive plan, the 2013 Equity Incentive Plan (the Equity Plan), was approved by stockholders on September 17, 2013, and amended in June 2016 to increase the reserve for issuance under this Equity Plan by 1,000,000 shares. The maximum number of shares issuable under this plan is 1,321,428 shares. The Equity Plan provides for the granting of stock options (including indexed options), restricted stock units, stock appreciation rights, restricted stock purchase rights, restricted stock bonuses, performance shares, performance units and deferred stock units. Under the Equity Plan, awards may be granted to employees, directors and consultants of ARCA, except for incentive stock options, which may be granted only to employees. As of December 31, 2016, options and awards for 651,227 shares were outstanding under the Equity Plan, and 592,430 shares were reserved for future awards. In general, the Equity Plan authorizes the grant of stock options that vest at rates set by the Board of Directors or the Compensation Committee thereof. Generally, stock options granted by ARCA under the equity incentive plans become exercisable ratably for a period of three to four years from the date of grant and have a maximum term of ten years. The exercise prices of stock options under the equity incentive plan generally meet the following criteria: the exercise price of incentive stock options must be at least 100% of the fair market value on the grant date and exercise price of options granted to 10% (or greater) stockholders must be at least 110% of the fair market value on the grant date. In conjunction with the adoption of the Equity Plan, the Company discontinued grants under its previous plan, the Amended and Restated ARCA biopharma, Inc. 2004 Equity Incentive Plan (the 2004 Plan), effective September 17, 2013. The 2004 Plan expired in 2014; however, options outstanding under the 2004 plan will continue to vest according to the original terms of each grant. As of December 31, 2016, options to purchase 5,643 shares with a weighted average exercise price of $102.64 per share were outstanding under this plan. Other stock plans that were assumed by ARCA in the Merger still have options outstanding that will continue to vest according to the original terms of each grant, but no new options can be granted under these plans, as the plans have expired. As of December 31, 2016, options to purchase 3,498 shares with a weighted average exercise price of $157.35 were outstanding under these plans. The Company granted options and awards for 487,700 and 52,801 shares of common stock in the years ended December 31, 2016 and 2015, respectively. The fair values of the majority of employee stock options granted in the years ended December 31, 2016 and 2015 were estimated at the date of grant using the Black-Scholes model with the following assumptions and had the following estimated weighted average grant date fair value per share: A summary of ARCA’s stock option activities for the years ended December 31, 2016 and 2015, and related information as of December 31, 2016, is as follows: The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on our closing price as of December 31 of the respective year, which would have been received by the option holders had all the option holders with in-the-money options exercised as of that date. The total intrinsic value of options exercised for the years ended December 31, 2016 and 2015 was $0 and $0, respectively. As of December 31, 2016, the unrecognized compensation expense related to unvested options, excluding estimated forfeitures, was $932,000 which is expected to be recognized over a weighted average period of 1.3 years. The Company recognizes compensation costs for its share-based awards on a straight-line basis over the requisite service period for the entire award, as adjusted for expected forfeitures. Restricted Stock Units The Company began granting restricted stock units (RSUs) to employees during 2013 in conjunction with the adoption of the Equity Plan. The fair value of RSU awards is the closing price of the Company’s common stock on the date of grant and is recognized as compensation expense on a straight-line basis over the respective vesting period. The stock awards granted have a requisite service period between three and four years with annual vesting on the grant anniversary date. A summary of RSU activity for the years ended December 31, 2016 and 2015 is presented below: As of December 31, 2016, the total unrecognized compensation cost related to unvested stock awards was approximately $143,000. This cost will be recognized on a straight-line basis over the next 1.2 years and will be adjusted for estimated forfeitures. Non-cash Stock-based Compensation For the years ended December 31, 2016 and 2015, the Company recognized the following non-cash, share-based compensation expense (in thousands): Stock-based compensation expense related to non-employees was negligible in 2016 and approximately $25,000 in 2015. ARCA did not recognize any tax benefit related to employee stock-based compensation cost as a result of the full valuation allowance on its net deferred tax assets. (9) Employee Benefit Plans The Company has a 401(k) plan and makes a matching contribution equal to 100% of the employee’s first 3% of the employee’s contributions and 50% of the employee’s next 2% of contributions. The Company adopted the plan in 2006 and contributed $119,000 and $122,000 for the years ended December 31, 2016 and 2015, respectively. (10) Income Taxes Effective June 1, 2005, the Company changed from an S-Corporation to a C-Corporation. As an S-Corporation, the net operating loss carryforwards were distributed to the Company’s stockholders; such amounts were not significant. Since June 2005 through December 31, 2016, for federal income tax purposes, the Company has net operating loss carryforwards of approximately $139.7 million, and approximately $1.4 million of research and development credits that may be used to offset future taxable income. The Company’s net operating loss carryforwards will expire beginning 2025 through 2036. Utilization of net operating losses and tax credits, including those acquired as a result of the Merger, will be subject to an annual limitation due to ownership change limitations provided by Internal Revenue Code Section 382. The Company believes that an ownership change limitation as defined under Section 382 of the U.S. Internal Revenue Code occurred as a result of its various historical financing transactions, and its offering of common stock completed in June 2015. Future utilization of the federal net operating losses and tax credit carryforwards accumulated from June 2005 to the change in ownership date will be subject to annual limitations to offset future taxable income. The annual limitation may result in the expiration of the net operating losses and credits before utilization. As such, a portion of the Company’s net operating loss carryforwards may be limited. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Due primarily to the Company’s history of operating losses, management is unable to conclude that it is more likely than not that the Company will realize the benefits of these deductible differences, and accordingly has provided a valuation allowance against the entire net deferred tax asset of approximately $54.8 million at December 31, 2016, reflecting an increase of approximately $6.2 million from December 31, 2015. The deferred tax assets are primarily comprised of net operating loss carryforwards and research and experimentation credit carryforwards. As of December 31, 2016, the Company has not performed an Internal Revenue Code Section 382 limitation study. Depending on the outcome of such a study, the gross amount of net operating losses recognizable in future tax periods could be limited. A limitation in the carryforwards would decrease the carrying amount of the gross amount of the net operating loss carryforwards, with a corresponding decrease in the valuation allowance recorded against these gross deferred tax assets. Income tax benefit attributable to our loss from operations before income taxes differs from the amounts computed by applying the U.S. federal statutory income tax rate of 34% for 2016 and 2015, as a result of the following (in thousands): Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and the amounts used for income tax purposes, as well as operating loss and tax credit carryforwards. The income tax effects of temporary differences and carryforwards that give rise to significant portions of the Company’s net deferred tax assets consisted of the following (in thousands): Since the Company is in a loss carryforward position, the Company is generally subject to U.S. federal and state income tax examinations by tax authorities for all years for which a loss carryforward is available. Thus, the Company’s open tax years extend back to 2009. The Company believes that its tax filing positions and deductions related to tax periods subject to examination will be sustained upon audit and does not anticipate any adjustment will result in a material adverse effect on the Company’s financial condition, result of operations, or cash flow. For the years ended December 31, 2016 and 2015, the Company has no reserve for uncertain tax positions. The Company does not expect that the total amounts of unrecognized tax benefits will significantly increase or decrease within the subsequent twelve months. In the event the Company concludes it is subject to interest or penalties arising from uncertain tax positions, the Company will record interest and penalties as a component of other income and expense. No interest or penalties were recognized in the financial statements for the years ended December 31, 2016 and 2015. . (11) Subsequent Event On January 11, 2017, the Company entered into a Capital on Demand TM Sales Agreement (the Sales Agreement) with JonesTrading Institutional Services LLC, as agent (JonesTrading), pursuant to which the Company may offer and sell, from time to time through JonesTrading, shares of the Company’s common stock, par value $0.001 per share (the Common Stock), having an aggregate offering price of up to $7.3 million (the Shares). Under the Sales Agreement, JonesTrading may sell the Shares by any method permitted by law and deemed to be an “at the market offering” as defined in Rule 415 promulgated under the Securities Act of 1933, as amended, including sales made directly on or through The NASDAQ Capital Market, on any other existing trading market for the Common Stock or to or through a market maker. In addition, under the Sales Agreement, JonesTrading may sell the Shares by any other method permitted by law, including in negotiated transactions. The Company may instruct JonesTrading not to sell Shares if the sales cannot be effected at or above the price designated by the Company from time to time. The Company is not obligated to make any sales of the Shares under the Sales Agreement. The offering of Shares pursuant to the Sales Agreement will terminate upon the earlier of (a) the sale of all of the Shares subject to the Sales Agreement or (b) the termination of the Sales Agreement by JonesTrading or the Company, as permitted therein. The Company will pay JonesTrading a commission rate equal to 3.0% of the aggregate gross proceeds from each sale of Shares and have agreed to provide JonesTrading with customary indemnification and contribution rights. The Company will also reimburse JonesTrading for certain specified expenses in connection with entering into the Sales Agreement. We have not executed any significant sales through this facility. | Here's a summary of the financial statement:
Financial Position:
- The company is operating at a loss
- There is substantial doubt about the company's ability to continue as a going concern
- The company needs to raise significant capital to maintain operations
Key Challenges:
1. Clinical development costs and timelines are uncertain
2. Additional funding is required but may not be available on acceptable terms
3. The company may need to delay or reduce operational activities to conserve cash
Financial Management:
- Financial statements prepared according to U.S. GAAP
- Company maintains a valuation allowance against all deferred tax assets
- Stock-based compensation is based on estimated grant date fair value
- Research and development expenses are recorded as services are performed
Risk Factors:
- May need to substantially reduce or discontinue operations
- Additional funding would likely dilute stockholders
- Any debt financing would be senior to stockholders' rights
- May not be able to raise sufficient capital to continue operations
The overall financial position appears precarious, with significant going concern issues and an urgent need for capital to maintain operations. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Registered Public Accounting Firm The Board of Directors and Stockholders Infinera Corporation We have audited the accompanying consolidated balance sheets of Infinera Corporation as of December 31, 2016 and December 26, 2015, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Infinera Corporation at December 31, 2016 and December 26, 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Infinera Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 23, 2017 expressed an unqualified opinion thereon. /s/ ERNST & YOUNG LLP San Jose, California February 23, 2017 Report of Ernst & Young LLP, Independent Registered Public Accounting Firm The Board of Directors and Stockholders Infinera Corporation We have audited Infinera Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Infinera Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Infinera Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Infinera Corporation as of December 31, 2016 and December 26, 2015, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2016 of Infinera Corporation and our report dated February 23, 2017 expressed an unqualified opinion thereon. /s/ ERNST & YOUNG LLP San Jose, California February 23, 2017 INFINERA CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except par values) The accompanying notes are an integral part of these consolidated financial statements. INFINERA CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) The accompanying notes are an integral part of these consolidated financial statements. INFINERA CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (In thousands) The accompanying notes are an integral part of these consolidated financial statements. INFINERA CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY For the Years Ended December 27, 2014, December 26, 2015 and December 31, 2016 (In thousands) The accompanying notes are an integral part of these consolidated financial statements. INFINERA CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY For the Years Ended December 27, 2014, December 26, 2015 and December 31, 2016 - (Continued) (In thousands) The accompanying notes are an integral part of these consolidated financial statements. INFINERA CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) The accompanying notes are an integral part of these consolidated financial statements. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Basis of Presentation Infinera Corporation (“Infinera” or the “Company”), headquartered in Sunnyvale, California, was founded in December 2000 and incorporated in the State of Delaware. Infinera provides optical transport networking equipment, software and services to telecommunications service providers, Internet Content Providers, cable providers, wholesale and enterprise carriers, research and education institutions, enterprise customers, and government entities across the globe. Optical transport networks are deployed by customers facing significant demand for optical bandwidth prompted by increased use of high-speed internet access, mobile broadband, cloud-based services, high-definition video streaming services, virtual and augmented reality, the Internet of Things (IoT) and business Ethernet services. During the third quarter of 2015, the Company completed its public offer to the shareholders of Transmode AB (“Transmode”), acquiring 95.8% of the outstanding common shares and voting interest in Transmode. This acquisition was accounted for as a business combination, and accordingly, the Company has consolidated the financial results of Transmode with its financial results for the period from August 20, 2015, the date the acquisition closed (the "Acquisition Date"). The noncontrolling interest position is reported as a separate component of consolidated equity attributable to Transmode's shareholders. The noncontrolling interest in the Transmode entity's net loss is reported as a separate component of consolidated net income attributable to Transmode's shareholders. In August 2016, the Company received advance title to acquire the remaining 4.2% of Transmode shares not tendered in the initial offer. The Company operates and reports financial results on a fiscal year of 52 or 53 weeks ending on the last Saturday of December in each year. Accordingly, fiscal year 2016 was a 53-week year that ended on December 31, 2016, and 2015 and 2014 were 52-week years that ended on December 26, 2015 and December 27, 2014, respectively. The next 53-week year will end on December 31, 2022. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. The Company reclassified certain amounts reported in previous periods to conform to the current presentation. 2. Significant Accounting Policies Use of Estimates The consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). These accounting principles require the Company to make certain estimates, assumptions and judgments that can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Significant estimates, assumptions and judgments made by management include revenue recognition, stock-based compensation, inventory valuation, accrued warranty, business combinations and accounting for income taxes. Other estimates, assumptions and judgments made by management include allowances for sales returns, allowances for doubtful accounts, useful life of property, plant and equipment, fair value measurement of the liability component of the convertible senior notes and derivative instruments. Management believes that the estimates, assumptions and judgments upon which they rely are reasonable based upon information available to them at the time that these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, the Company’s consolidated financial statements will be affected. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Revenue Recognition Many of the Company's product sales are sold in combination with installation and deployment services along with initial hardware and software support. Periodically, the Company's product sales are also sold with spares management, on-site hardware replacement services, network management operations, software subscription, extended hardware warranty or training. Initial software and hardware support services are generally delivered over a one-year period in connection with the initial purchase. Software warranty provides customers with maintenance releases during the warranty support period and hardware warranty provides replacement or repair of equipment that fails to perform in line with specifications. Software subscription service includes software warranty and additionally provides customers with rights to receive unspecified software product upgrades released during the support period. Spares management and on-site hardware replacement services include the replacement of defective units at customer sites in accordance with specified service level agreements. Network operations management includes the day-to-day operation of a customer's network. These services are generally delivered on an annual basis. Training services include the right to a specified number of instructor-led or web based training classes, and installation and deployment services may include customer site assessments, equipment installation and testing. These services are generally delivered over a 30 to120 day period. The Company recognizes product revenue when all of the following have occurred: (1) it has entered into a legally binding arrangement with the customer; (2) delivery has occurred, which is when product title and risk of loss have transferred to the customer; (3) customer payment is deemed fixed or determinable; and (4) collectability is reasonably assured. The Company allocates revenue to each element in its multiple-element arrangements based upon their relative selling prices. The Company determines the selling price for each deliverable based on a selling price hierarchy. The selling price for a deliverable is based on its vendor specific objective evidence (“VSOE”) if available, third party evidence (“TPE”) if VSOE is not available, or estimated selling price (“ESP”) if neither VSOE nor TPE is available. Revenue allocated to each element is then recognized when the basic revenue recognition criteria for that element has been met. VSOE of selling price is used in the selling price allocation in all instances where it exists. VSOE of selling price for products and services is determined when a substantial majority of the selling prices fall within a reasonable range when sold separately. In certain instances, the Company is not able to establish VSOE for all deliverables in an arrangement with multiple elements. This mainly occurs where insufficient standalone sales transactions have occurred or where pricing for that element has not been consistent. TPE of selling price can be established by evaluating largely interchangeable competitor products or services in standalone sales to similarly situated customers. As the Company’s products contain a significant element of proprietary technology and the solution offered differs substantially from that of competitors, it is typically difficult to obtain the reliable standalone competitive pricing necessary to establish TPE. ESP represents the best estimate of the price at which the Company would transact a sale if the product or service was sold on a standalone basis. The Company determines ESP for a product or service by considering multiple factors including, but not limited to market conditions, competitive landscape, gross margin objectives and pricing practices. The determination of ESP is made through formal approval by the Company’s management, taking into consideration the overall go-to-market pricing strategy. The Company regularly reviews VSOE, TPE and ESP and maintains internal controls over the establishment and update of these inputs. The Company limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges. The Company evaluates each deliverable in an arrangement to determine whether they represent separate units of accounting. The Company has a limited number of software offerings which are not required to deliver the tangible product’s essential functionality and can be sold separately. Revenue from sales of these software products and related post-contract support will continue to be accounted for under software revenue recognition rules. The Company’s multiple-element arrangements may therefore have a software deliverable that is subject to the INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) existing software revenue recognition guidance. The revenue for these multiple-element arrangements is allocated to the software deliverable and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy in the revenue recognition accounting guidance. Revenue related to these offerings have historically not been material. Services revenue includes software subscription services, installation and deployment services, spares management, on-site hardware replacement services, network operations management, extended hardware warranty services and training. Revenue from software subscription, spares management, on-site hardware replacement services, network operations management and extended hardware warranty contracts is deferred and is recognized ratably over the contractual support period, which is generally one year. Revenue related to training and installation and deployment services is recognized as the services are completed. Contracts and customer purchase orders are generally used to determine the existence of an arrangement. In addition, shipping documents and customer acceptances, when applicable, are used to verify delivery and transfer of title. Revenue is recognized only when title and risk of loss pass to customers and when the revenue recognition criteria have been met. In instances where acceptance of the product occurs upon formal written acceptance, revenue is recognized only after such written acceptance has been received. The Company assesses whether the fee is fixed or determinable based on the payment terms associated with the transaction. Payment terms to customers generally range from net 30 to 120 days from invoice, which are considered to be standard payment terms. The Company assesses its ability to collect from its customers based primarily on the creditworthiness and past payment history of the customer. For sales to resellers, the same revenue recognition criteria apply. It is the Company’s practice to identify an end user prior to shipment to a reseller. The Company does not offer rights of return or price protection to its resellers. Shipping charges billed to customers are included in product revenue and related shipping costs are included in product cost. The Company reports revenue net of any required taxes collected from customers and remitted to government authorities, with the collected taxes recorded as current liabilities until remitted to the relevant government authority. Commission Expense Sales commissions are recorded as sales and marketing expense and accrued compensation and related benefits. The Company generally records commission expense when it bills the customers; thus no contract acquisition costs are capitalized. Stock-Based Compensation Stock-based compensation cost is measured at the grant date based on the fair value of the award, and is recognized as expense over the requisite service period (generally the vesting period) under the straight-line amortization method. The expected forfeiture rate was estimated based on the Company's historical forfeiture data and compensation costs were recognized only for those equity awards expected to vest. The estimation of the forfeiture rate required judgment, and to the extent actual forfeitures differed from expectations, changes in estimate were recorded as an adjustment in the period when such estimates were revised. The Company historically recorded stock-based compensation expense by applying the forfeiture rates and adjusted estimated forfeiture rates to actual. During the third fiscal quarter beginning on June 26, 2016, the Company elected to early adopt ASU 2016-09. The Company also elected to change its accounting policy to account for forfeitures when they occur on a modified retrospective basis. The Company makes a number of estimates and assumptions in determining stock-based compensation related to stock options including the following: • The expected term represents the weighted-average period that the stock options are expected to be outstanding prior to being exercised. The expected term is estimated based on the Company’s historical data on employee exercise patterns and post vesting termination behavior to estimate expected exercises over the contractual term of grants. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) • Expected volatility of the Company’s stock has been historically based on the weighted-average implied and historical volatility of Infinera and its peer group. The peer group is comprised of similar companies in the same industrial sector. As the Company gained more historical volatility data, the weighting of its own data in the expected volatility calculation associated with options gradually increased to 100% by 2013. The Company estimates the fair value of the rights to acquire stock under its Employee Stock Purchase Plan (“ESPP”) using the Black-Scholes option pricing formula. The Company’s ESPP provides for consecutive six-month offering periods and the Company uses its own historical volatility data in the valuation of ESPP shares. The Company accounts for the fair value of restricted stock units (“RSUs”) using the closing market price of the Company’s common stock on the date of grant. For new-hire grants, RSUs typically vest ratably on an annual basis over four years. For annual refresh grants, RSUs typically vest ratably on an annual basis over three or four years. The Company granted performance stock units (“PSUs”) to its executive officers and senior management in 2014, 2015 and 2016 as part of the Company's annual refresh grant process. These PSUs entitle the Company's executive officers and senior management to receive a number of shares of the Company's common stock based on its stock price performance compared to a specified target composite index for the same period. These PSUs vest over the span of one year, two years and three years, and the number of shares to be issued upon vesting ranges from 0 to 2.0 times the number of PSUs granted depending on the relative performance of the Company's common stock price compared to the targeted composite index. This performance metric is classified as a market condition. The Company uses a Monte Carlo simulation model to determine the fair value of PSUs on the date of grant. The Monte Carlo simulation model is based on a discounted cash flow approach, with the simulation of a large number of possible stock price outcomes for the Company's stock and the target composite index. The use of the Monte Carlo simulation model requires the input of a number of assumptions including expected volatility of the Company's stock price, expected volatility of target composite index, correlation between changes in the Company's stock price and changes in the target composite index, risk-free interest rate, and expected dividends as applicable. Expected volatility of the Company's stock is based on the weighted-average historical volatility of its stock. Expected volatility of target composite index is based on the historical and implied data. Correlation is based on the historical relationship between the Company's stock price and the target composite index average. The risk-free interest rate is based upon the treasury zero-coupon yield appropriate for the term of the PSU as of the grant date. The expected dividend yield is zero for the Company as it does not expect to pay dividends in the future. The expected dividend yield for the target composite index is the annual dividend yield expressed as a percentage of the composite average of the target composite index on the grant date. In addition, the Company has granted other PSUs to certain employees that only vest upon the achievement of specific operational performance criteria. Research and Development All costs to develop the Company’s hardware products are expensed as incurred. Software development costs are capitalized beginning when a product’s technological feasibility has been established and ending when a product is available for general release to customers. Generally, the Company’s software products are released soon after technological feasibility has been established. As a result, costs subsequent to achieving technological feasibility have not been significant and all software development costs have been expensed as incurred. Advertising All advertising costs are expensed as incurred. Advertising expenses in 2016, 2015 and 2014 were $1.9 million, $1.8 million and $1.5 million, respectively. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Accounting for Income Taxes As part of the process of preparing the Company’s consolidated financial statements, the Company is required to estimate its taxes in each of the jurisdictions in which it operates. The Company estimates actual current tax expense together with assessing temporary differences resulting from different treatment of items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. In general, deferred tax assets represent future tax benefits to be received when certain expenses previously recognized in the Company’s consolidated statements of operations become deductible expenses under applicable income tax laws or loss or credit carryforwards are utilized. Accordingly, realization of the Company’s deferred tax assets is dependent on future taxable income within the respective jurisdictions against which these deductions, losses and credits can be utilized within the applicable future periods. The Company must assess the likelihood that some portion or all of its deferred tax assets will be recovered from future taxable income within the respective jurisdictions, and to the extent the Company believes that recovery does not meet the “more-likely-than-not” standard, the Company must establish a valuation allowance. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management judgment is required in determining the Company’s provision for income taxes, the Company’s deferred tax assets and liabilities and any valuation allowance recorded against its net deferred tax assets. In evaluating the need for a full or partial valuation allowance, all positive and negative evidence must be considered, including the Company's forecasts of taxable income over the applicable carryforward periods, its current financial performance, its market environment, and other factors. Based on the available objective evidence, at December 31, 2016, management believes it is more likely than not that the domestic net deferred tax assets will not be realizable in the foreseeable future. Accordingly, the domestic net deferred tax assets were fully reserved with a valuation allowance. To the extent that the Company determines that deferred tax assets are realizable on a more likely than not basis, and adjustment is needed, that adjustment will be recorded in the period that the determination is made and would generally decrease the valuation allowance and record a corresponding benefit to earnings. Foreign Currency Translation and Transactions The Company considers the functional currencies of its foreign subsidiaries to be the local currency. Assets and liabilities recorded in foreign currencies are translated at the exchange rate as of the balance sheet date, and costs and expenses are translated at average exchange rates in effect during the period. Equity transactions are translated using historical exchange rates. The effects of foreign currency translation adjustments are recorded as a separate component of Accumulated other comprehensive income (loss) in the accompanying consolidated balance sheets. For all non-functional currency account balances, the re-measurement of such balances to the functional currency will result in either a foreign exchange transaction gain or loss which is recorded to other gain (loss), net in the same period that the re-measurement occurred. Aggregate foreign exchange transactions recorded in 2016, 2015 and 2014 were a loss of $1.8 million, a gain of $2.4 million and a loss of $1.4 million, respectively. The Company entered into foreign currency exchange forward contracts to reduce the impact of foreign exchange fluctuations on earnings from accounts receivable balances denominated in euros and British pounds, and restricted cash denominated in euros. During 2016, the Company also entered into foreign currency exchange contracts to reduce the volatility of cash flows primarily related to forecasted revenues and expenses denominated in euro, British pound and Swedish kronor (“SEK”). The contracts are settled for U.S. dollars and SEK at maturity and at rates agreed to at inception of the contracts. The gains and losses on these foreign currency derivatives are recorded to the condensed consolidated statement of operations line item, in the current period, to which the item that is being economically hedged is recorded. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Cash, Cash Equivalents and Short-term and Long-term Investments The Company considers all highly liquid instruments with an original maturity at the date of purchase of 90 days or less to be cash equivalents. These instruments may include cash, money market funds, commercial paper and U.S. treasuries. The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. Cash, cash equivalents and short-term investments consist of highly-liquid investments in certificates of deposits, money market funds, commercial paper, U.S. agency notes, corporate bonds and U.S. treasuries. Long-term investments primarily consist of certificates of deposits, U.S. agency notes and corporate bonds. The Company considers all debt instruments with original maturities at the date of purchase greater than 90 days and remaining time to maturity of one year or less to be short-term investments. The Company classifies debt instruments with remaining maturities greater than one year as long-term investments, unless the Company intends to settle its holdings within one year or less and in such case it is considered to be short-term investments. The Company determines the appropriate classification of its marketable securities at the time of purchase and re-evaluates such designations as of each balance sheet date. Available-for-sale investments are stated at fair market value with unrealized gains and losses recorded in Accumulated other comprehensive income (loss) in the Company’s consolidated balance sheets. The Company evaluates its available-for-sale marketable debt securities for other-than-temporary impairments and records any credit loss portion in Other income (expense), net, in the Company’s consolidated statements of operations. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity and for any credit losses incurred on these securities. Gains and losses are recognized when realized in the Company’s consolidated statements of operations under the specific identification method. Because the Company does not intend to sell its debt securities and it is not more likely than not that it will be required to sell the investment before recovery of their amortized cost basis, which may be maturity. Fair Value Measurement of Investments Pursuant to the accounting guidance for fair value measurements and its subsequent updates, fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability. Valuation techniques used by the Company are based upon observable and unobservable inputs. Observable or market inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s assumptions about market participant assumptions based on the best information available. Observable inputs are the preferred source of values. These two types of inputs create the following fair value hierarchy: Level 1 - Quoted prices in active markets for identical assets or liabilities. Level 2 - Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 - Prices or valuations that require management inputs that are both significant to the fair value measurement and unobservable. The Company measures its cash equivalents, foreign currency exchange forward contracts and debt securities at fair value and classifies its securities in accordance with the fair value hierarchy. The Company’s money market funds and U.S. treasuries are classified within Level 1 of the fair value hierarchy and are valued based on quoted prices in active markets for identical securities. The Company classifies the following assets within Level 2 of the fair value hierarchy as follows: INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Certificates of Deposit The Company reviews market pricing and other observable market inputs for the same or similar securities obtained from a number of industry standard data providers. In the event that a transaction is observed for the same or similar security in the marketplace, the price on that transaction reflects the market price and fair value on that day. In the absence of any observable market transactions for a particular security, the fair market value at period end would be equal to the par value. These inputs represent quoted prices for similar assets or these inputs have been derived from observable market data. Commercial Paper The Company reviews market pricing and other observable market inputs for the same or similar securities obtained from a number of industry standard data providers. In the event that a transaction is observed for the same or similar security in the marketplace, the price on that transaction reflects the market price and fair value on that day and then follows a revised accretion schedule to determine the fair market value at period end. In the absence of any observable market transactions for a particular security, the fair market value at period end is derived by accreting from the last observable market price. These inputs represent quoted prices for similar assets or these inputs have been derived from observable market data accreted mathematically to par. U.S. Agency Notes The Company reviews trading activity and pricing for its U.S. agency notes as of the measurement date. When sufficient quoted pricing for identical securities is not available, the Company uses market pricing and other observable market inputs for similar securities obtained from a number of industry standard data providers. These inputs represent quoted prices for similar assets in active markets or these inputs have been derived from observable market data. Corporate Bonds The Company reviews trading activity and pricing for each of the corporate bond securities in its portfolio as of the measurement date and determines if pricing data of sufficient frequency and volume in an active market exists in order to support Level 1 classification of these securities. If sufficient quoted pricing for identical securities is not available, the Company obtains market pricing and other observable market inputs for similar securities from a number of industry standard data providers. In instances where multiple prices exist for similar securities, these prices are used as inputs into a distribution-curve to determine the fair market value at period end. Foreign Currency Exchange Forward Contracts As discussed in Note 5, "Derivative Instruments," to the Notes to Condensed Consolidated Financial Statements, the Company mainly holds non-speculative foreign exchange forward contracts to hedge certain foreign currency exchange exposures. The Company estimates the fair values of derivatives based on quoted market prices or pricing models using current market rates. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit risk, foreign exchange rates, and forward and spot prices for currencies. As of December 31, 2016, none of the Company’s existing securities were classified as Level 3 securities. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Accounts Receivable and Allowances for Doubtful Accounts Accounts receivable are recorded at the invoiced amount and do not bear interest. The Company reviews its aging by category to identify significant customers or invoices with known dispute or collectability issues. The Company makes judgments as to its ability to collect outstanding receivables based on various factors including ongoing customer credit evaluations and historical collection experience. The Company provides an allowance for receivable amounts that are potentially uncollectible. Allowances for Sales Returns Customer product returns are approved on a case by case basis. Specific reserve provisions are made based upon a specific review of all the approved product returns where the customer has yet to return the products to generate the related sales return credit at the end of a period. Estimated sales returns are provided for as a reduction to revenue. At December 31, 2016, December 26, 2015 and December 27, 2014, revenue was reduced for estimated sales returns by $0.6 million, $0.6 million and $0.2 million, respectively. Concentration of Risk Financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash equivalents, short-term investments, long-term investments and accounts receivable. Investment policies have been implemented that limit investments to investment-grade securities. The risk with respect to accounts receivable is mitigated by ongoing credit evaluations that the Company performs on its customers. As the Company continues to expand its sales internationally, it may experience increased levels of customer credit risk associated with those regions. Collateral is generally not required for accounts receivable but may be used in the future to mitigate credit risk associated with customers located in certain geographical regions. As of December 31, 2016, two customers accounted for approximately 17% and 15% of the Company's net accounts receivable balance, respectively. As of December 26, 2015, one customer accounted for approximately 17% of the Company’s net accounts receivable balance. To date, a few of the Company’s customers have accounted for a significant portion of its revenue. One customer accounted for over 10% of the Company’s revenue in 2016. Revenue from this customer accounted for 16% of the Company's revenue in 2016. Two customers each accounted for over 10% of the Company's revenue in 2015. These two customers accounted for 17% and 13%, respectively, of the Company's revenue in 2015. One customer accounted for over 10% of the Company's revenue in 2014. Revenue from this customer accounted for 19% of the Company's revenue in 2014. The Company depends on a sole source or limited source suppliers for several key components and raw materials. The Company generally purchases these sole source or limited source components and raw materials through standard purchase orders and does not have long-term contracts with many of these limited-source suppliers. While the Company seeks to maintain sufficient reserve stock of such components and raw materials, the Company’s business and results of operations could be adversely affected if any of our sole source or limited source suppliers suffer from capacity constraints, lower than expected yields, deployment delays, work stoppages or any other reduction or disruption in output. Derivative Instruments The Company is exposed to foreign currency exchange rate fluctuations in the normal course of its business. As part of its risk management strategy, the Company uses derivative instruments, specifically forward contracts, to reduce the impact of foreign exchange fluctuations on earnings. The forward contracts are with high-quality institutions and the Company monitors the creditworthiness of the counter parties consistently. The Company’s objective is to offset gains and losses resulting from these exposures with gains and losses on the derivative contracts used to hedge them, thereby reducing volatility of earnings or protecting fair values of assets. None of the Company’s derivative instruments contain credit-risk related contingent features, any rights to reclaim cash collateral or any obligation to return cash collateral. The Company does not have any leveraged derivatives. The Company does not use derivative contracts for trading or speculative purposes. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The Company enters into foreign currency exchange forward contracts to manage its exposure to fluctuations in foreign exchange rates that arise primarily from its euro and British pound denominated receivables and euro denominated restricted cash balance amounts that are pledged as collateral for certain stand-by letters of credit. Gains and losses on these contracts are intended to offset the impact of foreign exchange rate changes on the underlying foreign currency denominated accounts receivables and restricted cash, and therefore, do not subject the Company to material balance sheet risk. The Company also entered into foreign currency exchange contracts to reduce the volatility of cash flows primarily related to forecasted revenues and expenses denominated in euros, British pound and SEK. These contracts are settled for U.S. dollars and SEK at maturity and at rates agreed to at inception of the contracts. The forward contracts are with one high-quality institution and the Company consistently monitors the creditworthiness of the counterparty. The forward contracts entered into during 2016 were denominated in euros, British pounds and SEK, and the contracts are settled for reporting currencies at maturity at rates agreed to at inception of the contracts. Inventory Valuation Inventories consist of raw materials, work-in-process and finished goods and are stated at standard cost adjusted to approximate the lower of actual cost or market. Costs are recognized utilizing the first-in, first-out method. Market value is based upon an estimated selling price reduced by the estimated cost of disposal. The determination of market value involves numerous judgments including estimated average selling prices based upon recent sales volumes, industry trends, existing customer orders, current contract price, future demand and pricing and technological obsolescence of the Company’s products. Inventory that is obsolete or in excess of the Company’s forecasted demand or is anticipated to be sold at a loss is written down to its estimated net realizable value based on historical usage and expected demand. In valuing its inventory costs and deferred inventory costs, the Company considered whether the utility of the products delivered or expected to be delivered at less than cost, primarily comprised of common equipment, had declined. The Company concluded that, in the instances where the utility of the products delivered or expected to be delivered was less than cost, it was appropriate to value the inventory costs and deferred inventory costs at cost or market, whichever is lower, thereby recognizing the cost of the reduction in utility in the period in which the reduction occurred or can be reasonably estimated. The Company has, therefore, recognized inventory write-downs as necessary in each period in order to reflect inventory at the lower of actual cost or market. The Company considers whether it should accrue losses on firm purchase commitments related to inventory items. Given that the net realizable value of common equipment is below contractual purchase price, the Company has also recorded losses on these firm purchase commitments in the period in which the commitment is made. When the inventory parts related to these firm purchase commitments are received, that inventory is recorded at the purchase price less the accrual for the loss on the purchase commitment. Property, Plant and Equipment Property, plant and equipment are stated at cost. This includes enterprise-level business software that the Company customizes to meets its specific operational needs. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or estimated useful life of the asset. An assumption of lease renewal where a renewal option exists is used only when the renewal has been determined to be reasonably assured. Repair and maintenance costs are expensed as incurred. The estimated useful life for each asset category is as follows: The Company regularly reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable or that the useful life is INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) shorter than originally estimated. If impairment indicators are present and the projected future undiscounted cash flows are less than the carrying value of the assets, the carrying values are reduced to the estimated fair value. If assets are determined to be recoverable, but the useful lives are shorter than originally estimated, the carrying value of the assets is depreciated over the newly determined remaining useful lives. Accrued Warranty The Company warrants that its products will operate substantially in conformity with product specifications. Hardware warranties provide the purchaser with protection in the event that the product does not perform to product specifications. During the warranty period, the purchaser’s sole and exclusive remedy in the event of such defect or failure to perform is limited to the correction of the defect or failure by repair, refurbishment or replacement, at the Company’s sole option and expense. The Company's hardware warranty periods generally range from one to five years from date of acceptance for hardware and the Company's software warranty is 90 days. Upon delivery of the Company's products, the Company provides for the estimated cost to repair or replace products that may be returned under warranty. The hardware warranty accrual is based on actual historical returns and cost of repair experience and the application of those historical rates to the Company's in-warranty installed base. The provision for warranty claims fluctuates depending upon the installed base of products and the failure rates and costs of repair associated with these products under warranty. Furthermore, the Company's costs of repair vary based on repair volume and its ability to repair, rather than replace, defective units. In the event that actual product failure rates and costs to repair differ from the Company's estimates, revisions to the warranty provision are required. In addition, from time to time, specific hardware warranty accruals may be made if unforeseen technical problems arise with specific products. The Company regularly assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. Business Combinations Accounting for acquisitions requires our management to estimate the fair value of the assets and liabilities acquired, which involves a number of judgments, assumptions and estimates that could materially affect the timing or amounts recognized in the Company's financial statements. The items involving the most significant assumptions, estimates and judgments include determining the fair value of the following: • Intangible assets, including valuation methodology, estimations of future cash flows and discount rates, as well as the estimated useful life of the intangible assets; • the acquired company’s brand, as well as assumptions about the period of time the acquired brand will continue to be used; • deferred tax assets and liabilities, uncertain tax positions and tax-related valuation allowances, which are initially estimated as of the acquisition date; While the Company uses its best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, the estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year following the acquisition date, the Company records adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Amortization of Intangible Assets Intangible assets with finite lives are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets. In-process research and development represents the fair value of incomplete research and development projects that have not reached technological feasibility as of the date of acquisition. Initially, these assets are not subject to amortization. Once projects have been completed they are transferred to developed technology, which are subject to amortization, while assets related to projects that have been abandoned are impaired and expensed to research and development. Impairment of Intangible Assets and Goodwill Goodwill is evaluated for impairment on an annual basis in the fourth quarter of the Company's fiscal year, and whenever events or changes in circumstances indicate the carrying amount of goodwill may not be recoverable. The Company has elected to first assess qualitative factors to determine whether it is more likely INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) than not that the fair value of its single reporting unit is less than its carrying amount. If the Company determines that it is more likely than not that the fair value of its single reporting unit is less than its carrying amount, then the two-step goodwill impairment test will be performed. The first step, identifying a potential impairment, compares the fair value of its single reporting unit with its carrying amount. If the carrying amount exceeds its fair value, the second step will be performed; otherwise, no further step is required. The second step, measuring the impairment loss, compares the implied fair value of the goodwill with the carrying amount of the goodwill. Any excess of the goodwill carrying amount over the implied fair value is recognized as an impairment loss. The Company evaluates events and changes in circumstances that could indicate carrying amounts of purchased intangible assets may not be recoverable. When such events or changes in circumstances occur, the Company assesses the recoverability of these assets by determining whether or not the carrying amount will be recovered through undiscounted expected future cash flows. If the total of the future undiscounted cash flows is less than the carrying amount of an asset, the Company records an impairment loss for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Recent Accounting Pronouncements In January 2017, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment ” (“ASU 2017-04”). The guidance eliminates Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The same one-step impairment test will be applied to goodwill at all reporting units, even those with zero or negative carrying amounts. Entities will be required to disclose the amount of goodwill at reporting units with zero or negative carrying amounts. ASU 2017-04 is effective for the Company's annual or any interim goodwill impairment tests in fiscal years beginning after the fourth quarter of 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact the adoption of ASU 2017-04 will have on its consolidated financial statements. In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash” (“ASU 2016-18”), which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As such, restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and ending-of-period total amounts shown on the statement of cash flows. The Company is required to adopt ASU 2016-18 for fiscal years, and for interim periods within those fiscal years, beginning after the fourth quarter of 2017 on a retrospective basis. Early adoption is permitted, including adoption in an interim period. Subsequent to the adoption of ASU 2016-18 the change in restricted cash would be excluded from the change in cash flows from financing activities and included in the change in total cash, restricted cash and cash equivalents as reported in the statement of cash flows. The Company is currently evaluating the impact the adoption of ASU 2016-18 will have on its consolidated financial statements. In August 2016, the FASB issued Accounting Standards Update 2016-15, “Statement of Cash Flows (Topic 320): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”), which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain transactions are presented and classified in the statement of cash flows. This guidance is effective for the Company in its first quarter of fiscal 2018 and will be applied on a retrospective basis. Early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-15 will have on its consolidated financial statements. In June 2016, the FASB issued Accounting Standards Update 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”), which requires measurement and recognition of expected credit losses for financial assets held. This guidance is effective for the Company in its first quarter of fiscal 2020 and early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-13 will have on its consolidated financial statements. In May 2016, the FASB issued Accounting Standards Update 2016-11, “Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting (SEC INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Update)” (“ASU 2016-11”), which rescinds various standards codified as part of Topic 605, Revenue Recognition in relation to the future adoption of Topic 606. These rescissions include changes to topics pertaining to revenue and expense recognition for freight services in process, accounting for shipping and handling fees and costs, and accounting for consideration given by a vendor to a customer. This guidance is effective for the Company in its first quarter of fiscal 2018 and early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-11 will have on its consolidated financial statements. In March 2016, the FASB issued Accounting Standards Update 2016-09, “Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”), which includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements, including the income tax effects of share-based payments and accounting for forfeitures. ASU 2016-09 requires companies to record excess tax benefits and tax deficiencies as income tax benefit or expense in the statement of operations when the awards vest or are settled, eliminates the requirement to reclassify cash flows related to excess tax benefits from operating activities to financing activities on the statement of cash flows, and allows for an accounting policy election to either estimate the number of forfeitures (current U.S. GAAP) or account for forfeitures when they occur, amongst other provisions. The Company elected to early adopt ASU 2016-09 as of its third fiscal quarter that began on June 26, 2016. The Company also elected to change its accounting policy to account for forfeitures when they occur on a modified retrospective basis. The adoption of ASU 2016-09 and the change in the Company’s accounting policy resulted in a $0.2 million increase to additional paid-in capital and accumulated deficit as of December 27, 2015. The Company also recorded $0.3 million of stock-based compensation expense during 2016 to true-up for the differential between the amount of stock-based compensation cost previously recorded for the first six months ended June 25, 2016 and the amount that would have been recorded without assuming forfeitures. Additionally, the Company adopted the change in presentation in the condensed consolidated statement of cash flows related to excess tax benefits on a prospective basis. Accordingly, prior periods have not been adjusted. There was no impact for the change in presentation in the condensed consolidated statement of cash flows related to statutory tax withholding requirements as the Company has historically classified the statutory tax withholding as a financing activity in its consolidated statement of cash flows. In February 2016, the FASB issued Accounting Standards Update 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), which amends the existing accounting standards for leases. The new standard requires lessees to record a right-of-use asset and a corresponding lease liability on the balance sheet (with the exception of short-term leases). For lessees, leases will continue to be classified as either operating or financing in the income statement. This guidance is effective for the Company in its first quarter of fiscal 2019 and early adoption is permitted. ASU 2016-02 is required to be applied with a modified retrospective approach and requires application of the new standard at the beginning of the earliest comparative period presented. The Company is currently evaluating the impact the adoption of ASU 2016-02 will have on its consolidated financial statements. In September 2015, the FASB issued Accounting Standards Update 2015-16, “Business Combinations and Simplifying the Accounting for Measurement-Period Adjustments” (“ASU 2015-16”), which eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, an acquirer will recognize a measurement-period adjustment during the period in which it determines the amount of the adjustment. The Company adopted ASU 2015-16 during the first quarter of fiscal 2016. The Company's adoption of ASU 2015-16 had no impact on the Company's financial position, results of operations or cash flow. In July 2015, the FASB issued Accounting Standards Update 2015-11, “Simplifying the Measurement of Inventory” (“ASU 2015-11”), to simplify the guidance on the subsequent measurement of inventory, excluding inventory measured using last-in, first-out or the retail inventory method. Under ASU 2015-11, inventory should be at the lower of cost and net realizable value. This guidance is effective for the Company in its first quarter of fiscal 2017. The Company is currently evaluating the impact the adoption of ASU 2015-11 will have on its consolidated financial statements. In April 2015, the FASB issued Accounting Standards Update 2015-03, “Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”), which changes the presentation of debt issuance costs in financial statements. ASU 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) from the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. The Company adopted ASU 2015-03 during the first quarter of fiscal 2016. The December 26, 2015 balance sheet was retrospectively adjusted to reclassify $2.1 million from other non-current assets to a reduction of the Notes payable liability. In May 2014, the FASB issued Accounting Standards Update 2014-09, “Revenue from Contracts from Customers (Topic 606)” (“ASU 2014-09”), which creates a single, joint revenue standard that is consistent across all industries and markets for companies that prepare their financial statements in accordance with GAAP. Under ASU 2014-09, an entity is required to recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to receive in exchange for those goods or services. In July 2015, the FASB decided to delay the effective date of the new revenue standard by one year. In April 2016, the FASB issued Accounting Standards Update 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing,” which clarifies the implementation guidance on identifying performance obligations and licensing. In May 2016, the FASB issued Accounting Standards Update 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients,” which amends the guidance on collectability, noncash consideration, presentation of sales tax and transition. In December 2016, the FASB issued Accounting Standards Update 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers,” to increase stakeholders' awareness of the proposals and to expedite improvements to ASU 2014-09. These standards will be effective for the Company's first quarter of 2018. The Company has not yet selected a transition method and it is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures. The Company is still in the process of completing its analysis and assessing all potential impacts of the new standard. In terms of the Company’s evaluation efforts, it has assigned internal resources and engaged a third party service provider to assist in the evaluation assessment phase and documentation of new policies and processes. Furthermore, the Company has made and will continue to make investments in systems and processes to enable timely and accurate reporting under the new standard. The Company currently expects that necessary operational changes will be implemented prior to the adoption date. 3. Fair Value Measurements The following tables represent the Company’s fair value hierarchy for its marketable securities measured at fair value on a recurring basis (in thousands): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) During 2016 and 2015, there were no transfers of assets or liabilities between Level 1 and Level 2. As of December 31, 2016 and December 26, 2015, none of the Company’s existing securities were classified as Level 3 securities. Cash, cash equivalents and investments were as follows (in thousands): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) As of December 31, 2016, the Company’s available-for-sale investments have a contractual maturity term of up to 24 months. Gross realized gains and losses on short-term and long-term investments were insignificant for all periods. The specific identification method is used to account for gains and losses on available-for-sale investments. As of December 31, 2016, the Company had $304.3 million of cash, cash equivalents and short-term investments, including $43.2 million of cash and cash equivalents held by its foreign subsidiaries. The Company's cash in foreign locations is used for operational and investing activities in those locations, and the Company does not currently have the need or the intent to repatriate those funds to the United States. 4. Cost-method Investments In 2016, the Company invested $7.0 million in a privately-held company. In addition to the $7.0 million investment, the transaction included a customer supply agreement and warrants to purchase up to $10.0 million of additional shares of preferred stock. The warrants vest and become exercisable upon certain conditions being met. Additionally, in 2016, the Company recognized a gain of $9.0 million from the sale of an existing cost-method investment. As of December 31, 2016 and December 26, 2015, the Company's cost-method investments balance was $7.0 million and $14.5 million, respectively. These investments are accounted for as cost-basis investments as the Company owns less than 20% of the voting securities and does not have the ability to exercise significant influence over operating and financial policies of either entity. The Company's investments are carried at historical cost in its consolidated financial statements. The Company regularly evaluates the carrying value of its cost-method investments for impairment. If the Company believes that the carrying value of the cost basis investments are in excess of estimated fair value, the Company’s policy is to record an impairment charge in other income (expense), net, in the accompanying condensed consolidated statements of operations to adjust the carrying value to estimated fair value, when the impairment is deemed other-than-temporary. As of December 31, 2016 and December 26, 2015, no event had occurred that would adversely affect the carrying value of these investments. The Company did not record any impairment charges during 2016, 2015 and 2014. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 5. Derivative Instruments Foreign Currency Exchange Forward Contracts The Company transacts business in various foreign currencies and has international sales, cost of sales, and expenses denominated in foreign currencies, and carries foreign-currency-denominated monetary assets and liabilities, subjecting the Company to foreign currency risk. The Company’s primary foreign currency risk management objective is to protect the U.S. dollar value of future cash flows and minimize the volatility of reported earnings. The Company utilizes foreign currency forward contracts, primarily short term in nature. Historically, the Company enters into foreign currency exchange forward contracts to manage its exposure to fluctuation in foreign exchange rates that arise from its euro and British pound denominated receivables and restricted cash balances. Gains and losses on these contracts are intended to offset the impact of foreign exchange rate fluctuations on the underlying foreign currency denominated accounts receivables and restricted cash, and therefore, do not subject the Company to material balance sheet risk. During 2016, the Company also entered into foreign currency exchange contracts to reduce the volatility of cash flows primarily related to forecasted revenues and expenses denominated in euros, British pound and SEK. The contracts are settled for U.S. dollars and SEK at maturity and at rates agreed to at inception of the contracts. The gains and losses on these foreign currency derivatives are recorded to the consolidated statement of operations line item, in the current period, to which the item that is being economically hedged is recorded. In April 2015, the Company entered into a foreign currency exchange forward contract with a notional amount of SEK 831 million ($95.3 million) to hedge currency exposures associated with the cash consideration of the offer to acquire Transmode. In July 2015, the Company entered into a series of additional foreign currency exchange option contracts to purchase up to an additional SEK 1.3 billion ($153.8 million) and to sell up to SEK 650 million ($76.9 million), which achieves the economic equivalent of a “participating forward” in order to hedge the anticipated foreign currency cash outflows associated with the additional cash consideration related to the enhanced offer to acquire the shares of Transmode. As these contracts are not formally designated as hedges, the gains and losses were recognized in the statement of operations. For 2015, the Company recorded a realized gain of $1.6 million, which was included in Other gain (loss), net, in the accompanying condensed consolidated statements of operations. The before-tax effect of foreign currency exchange forward contracts was a loss of $0.9 million for 2016, a gain of $3.8 million for 2015 and a gain of $1.6 million in 2014, included in Other gain (loss), net, in the consolidated statements of operations. In each of these periods, the impact of the gross gains and losses were offset by foreign exchange rate fluctuations on the underlying foreign currency denominated amounts. As of December 31, 2016, the Company did not designate foreign currency exchange forward contracts as hedges for accounting purposes and accordingly, changes in the fair value are recorded in the accompanying consolidated statements of operations. These contracts were with two high-quality institutions and the Company consistently monitors the creditworthiness of the counterparties. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The fair value of derivative instruments not designated as hedging instruments in the Company’s consolidated balance sheets was as follows (in thousands): (1) Represents the face amounts of forward contracts that were outstanding as of the period noted. 6.Business Combination On the Acquisition Date, the Company completed its public offer to the shareholders of Transmode, acquiring 95.8% of the outstanding common shares and voting interest in Transmode. Transmode is a metro packet-optical networking company based in Stockholm, Sweden. The combination of the two companies brings together a complementary set of customers, products, and technologies into one company. Shortly after the Acquisition Date, the Company initiated compulsory acquisition proceedings in accordance with Swedish law (the “Squeeze-out Proceedings”) in order to acquire the remaining 4.2% or 1.2 million Transmode shares, not tendered through the end of the offer period. As of the Acquisition Date, the fair value of the noncontrolling interest was approximately $15.4 million, which was based on the implied enterprise value of Transmode at the Acquisition Date. In August 2016, the Company received advance title and paid an undisputed purchase price of $16.8 million to acquire the remaining 4.2% of Transmode shares not tendered in the initial offer. The additional $16.8 million paid resulted in the elimination of the noncontrolling interest and an increase in additional paid-in capital. As of December 31, 2016, the Company continues to maintain a security pledge of approximately $6.1 million required by Swedish law. The final amount and timing of the final disposition will be determined by an arbitration tribunal at the completion of the Squeeze-out Proceedings, which is currently expected in 2017. Noncontrolling interest was as follows (in thousands): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 7. Goodwill and Intangible Assets Goodwill Goodwill is recorded when the purchase price of an acquisition exceeds the fair value of the net tangible and identified intangible assets acquired. The following table presents details of the Company’s goodwill for the year ended December 31, 2016 (in thousands): The gross carrying amount of goodwill may change due to the effects of foreign currency fluctuations as these assets are denominated in SEK. Intangible Assets The following table presents details of the Company’s intangible assets as of December 31, 2016 and December 26, 2015 (in thousands): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The gross carrying amount of intangible assets and the related amortization expense of intangible assets may change due to the effects of foreign currency fluctuations as these assets are denominated in SEK. Amortization expense was $26.0 million and $9.0 million for the years ended December 31, 2016 and December 26, 2015, respectively. Intangible assets are carried at cost less accumulated amortization. Amortization expenses are recorded to the appropriate cost and expense categories. During 2016, the Company transferred $3.8 million of its in-process technology to developed technology, which is being amortized over a maximum useful life of seven years. In-process technology of $0.3 million as of December 31, 2016 is not subject to amortization. As such, the Company excluded it in the future amortization expense table below. Additionally, during 2016, the Company recorded an impairment charge of $11.3 million related to in-process research and development, resulting from the Company's decision to abandon previously acquired in-process technologies. The following table summarizes the Company’s estimated future amortization expense of intangible assets with finite lives as of December 31, 2016 (in thousands): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 8. Balance Sheet Details Restricted Cash The Company’s long-term restricted cash balance is primarily comprised of certificates of deposit and money market funds, of which the majority is not insured by the Federal Deposit Insurance Corporation. These amounts primarily collateralize the Company’s issuances of stand-by and commercial letters of credit and bank guarantees. Additionally, the Company’s long-term restricted cash balance includes a leave encashment fund for India employees and a corporate bank card deposit for employees in the United Kingdom. The short-term restricted cash balance consists of a security pledge related to the Transmode acquisition Squeeze-out Proceedings and an escrow account to fund our facility expansion. The following table provides details of selected balance sheet items (in thousands): (1) Included in computer software at December 31, 2016 and December 26, 2015 were $9.1 million and $7.9 million, respectively, related to enterprise resource planning (“ERP”) systems that the Company implemented. The unamortized ERP costs at December 31, 2016 and December 26, 2015 were $4.0 million and $4.0 million, respectively. (2) Depreciation expense was $35.5 million, $26.8 million and $25.9 million (which includes depreciation of capitalized ERP costs of $1.2 million, $1.2 million and $1.1 million, respectively) for 2016, 2015 and 2014, respectively. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 9. Comprehensive Income (Loss) Other comprehensive income (loss) includes certain changes in equity that are excluded from net income (loss). The following table sets forth the changes in accumulated other comprehensive income (loss) by component for the periods presented (in thousands): 10. Basic and Diluted Net Income (Loss) Per Common Share Basic net income (loss) per common share is computed by dividing net income (loss) attributable to Infinera Corporation by the weighted average number of common shares outstanding during the period. Diluted net income (loss) attributable to Infinera Corporation per common share is computed using net income (loss) attributable to Infinera Corporation and the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include the assumed exercise of outstanding stock options, assumed release of outstanding RSU and PSUs, and assumed issuance of common stock under the ESPP using the treasury stock method. Potentially dilutive common shares also include the assumed conversion of convertible senior notes from the conversion spread (as discussed in Note 11, "Convertible Senior Notes"). The Company includes the common shares underlying PSUs in the calculation of diluted net income per share only when they become contingently issuable. In net loss periods, these potentially diluted common shares have been excluded from the diluted net loss calculation. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The following table sets forth the computation of net income (loss) per common share attributable to Infinera Corporation - basic and diluted (in thousands, except per share amounts): The Company incurred a net loss during 2016, and as a result, potential common shares from options, RSUs, PSUs and assumed release of outstanding stock under the ESPP were not included in the diluted shares used to calculate net loss per share, as their inclusion would have been anti-dilutive. During 2015 and 2014, the Company included the dilutive effects of the Notes in the calculation of diluted net income per common share as the applicable average market price was above the conversion price of the Notes. The dilutive impact of the Notes (as defined in Note 11, "Convertible Senior Notes") for the year was based on the average dilution of the four quarters, which is calculated as the difference between the Company's average stock price during the period and the conversion price of the Notes. Given the average market price at the end of 2016 was below the conversion price, no shares were included in the dilutive share count. Upon conversion of the Notes, it is the Company’s intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the Notes being converted, therefore, only the conversion spread relating to the Notes would be included in the Company’s diluted earnings per share calculation unless their effect is anti-dilutive. The effects of certain potentially outstanding shares were not included in the calculation of diluted net income per share for years ended December 26, 2015 and December 27, 2014 because their effect were anti-dilutive under the treasury stock method or the performance condition of the award had not been met. The following sets forth the potentially dilutive shares excluded from the computation of the diluted net income (loss) per share because their effect was anti-dilutive (in thousands): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 11. Convertible Senior Notes In May 2013, the Company issued the $150.0 million of 1.75% convertible senior notes due June 1, 2018 (the “Notes”), which will mature on June 1, 2018, unless earlier unless earlier purchased by the Company or converted. Interest is payable semi-annually in arrears on June 1 and December 1 of each year, commencing December 1, 2013. The net proceeds to the Company were approximately $144.5 million. The Notes are governed by an indenture dated as of May 30, 2013 (the “Indenture”), between the Company, as issuer, and U.S. Bank National Association, as trustee. The Notes are unsecured and do not contain any financial covenants or any restrictions on the payment of dividends, the incurrence of senior debt or other indebtedness, or the issuance or repurchase of securities by the Company. Upon conversion, it is the Company's intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the Notes. For any remaining conversion obligation, The Company intends to pay cash, shares of common stock or a combination of cash and shares of common stock, at the Company's election. The initial conversion rate is 79.4834 shares of common stock per $1,000 principal amount of Notes, subject to anti-dilution adjustments. The initial conversion price is approximately $12.58 per share of common stock. Throughout the term of the Notes, the conversion rate may be adjusted upon the occurrence of certain events, including for any cash dividends. Holders of the Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a Note. Accrued but unpaid interest will be deemed to be paid in full upon conversion rather than canceled, extinguished or forfeited. Holders may convert their Notes under the following circumstances: • during any fiscal quarter commencing after the fiscal quarter ending on September 28, 2013 (and only during such fiscal quarter) if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day; • during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day; • upon the occurrence of specified corporate events described under the Indenture, such as a consolidation, merger or binding share exchange; or • at any time on or after December 1, 2017 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their Notes at any time, regardless of the foregoing circumstances. If the Company undergoes a fundamental change as defined in the Indenture governing the Notes, holders may require the Company to repurchase for cash all or any portion of their Notes at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, upon the occurrence of a “make-whole fundamental change” (as defined in the Indenture), the Company will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its Notes in connection with such make-whole fundamental change. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The net carrying amounts of the debt obligation were as follows (in thousands): (1) Unamortized debt conversion discount and issuance costs will be amortized over the remaining life of the Notes, which is approximately 17 months. As of December 31, 2016 and December 26, 2015, the carrying amount of the equity component of the Notes was $43.3 million. In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) is amortized to interest expense over the term of the Notes. In accounting for the issuance costs of $5.5 million related to the Notes, the Company allocated the total amount incurred to the liability and equity components of the Notes based on their relative values. Issuance costs attributable to the liability component were recorded as other non-current assets and will be amortized to interest expense over the term of the Notes. ASU 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. The Company adopted ASU 2015-03 during the first quarter of 2016. The December 26, 2015 balance sheet was retrospectively adjusted to reclassify $2.1 million from other non-current assets to a reduction of the Notes payable liability. The issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity. Additionally, the Company initially recorded a deferred tax liability of $17.0 million in connection with the issuance of the Notes, and a corresponding reduction in valuation allowance. The impact of both was recorded to stockholders’ equity. The Company determined that the embedded conversion option in the Notes does not require separate accounting treatment as a derivative instrument because it is both indexed to the Company’s own stock and would be classified in stockholder’s equity if freestanding. The following table sets forth total interest expense recognized related to the Notes (in thousands): The coupon rate was 1.75%. For the years ended December 31, 2016 and December 26, 2015, the debt discount and debt issuance costs were amortized, using an annual effective interest rate of 10.23%, to interest expense over the term of the Notes. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) As of December 31, 2016, the fair value of the Notes was $154.3 million. The fair value was determined based on the quoted bid price of the Notes in an over-the-counter market on December 30, 2016. The Notes are classified as Level 2 of the fair value hierarchy. During the three months ended December 31, 2016, the closing price of the Company's common stock did not meet the conversion criteria; therefore, holders of the Notes may not convert their notes during the first quarter of 2017. Should the closing price conditions be met during the 30 consecutive trading days prior to the end of the first quarter of 2017 or a future quarter, the Notes will be convertible at their holders’ option during the immediately following quarter. Based on the closing price of the Company’s common stock of $8.49 on December 30, 2016, the if-converted value of the Notes did not exceed their principal amount. 12. Commitments and Contingencies Operating Leases The Company leases facilities under non-cancelable operating lease agreements. These leases have varying terms that range from one to 12 years, and contain leasehold improvement incentives, rent holidays and escalation clauses. In addition, some of these leases have renewal options for up to five years. The Company has contractual commitments to remove leasehold improvements and return certain properties to a specified condition when the leases terminate. At the inception of a lease with such conditions, the Company records an asset retirement obligation liability and a corresponding capital asset in an amount equal to the estimated fair value of the obligation. Asset retirement obligations were $3.6 million and $2.8 million as of December 31, 2016 and December 26, 2015, respectively. These obligations are classified as other long-term liabilities on the accompanying consolidated balance sheets. The Company recognizes rent expense on a straight-line basis over the lease period factoring in leasehold improvement incentives, rent holidays and escalation clauses. Rent expense for all leases was $11.0 million, $8.6 million and $7.2 million for 2016, 2015 and 2014, respectively. The Company did not have any sublease rental income for 2016, 2015 and 2014. Future annual minimum operating lease payments at December 31, 2016 were as follows (in thousands): Purchase Commitments The Company has service agreements with its major production suppliers, where the Company is committed to purchase certain parts. These obligations are typically less than the Company’s purchase needs. As of December 31, 2016, December 26, 2015 and December 27, 2014, these non-cancelable purchase commitments were $111.9 million, $137.4 million and $128.3 million, respectively. Future purchase commitments at December 31, 2016 were as follows (in thousands): The contractual obligation tables above exclude tax liabilities of $2.8 million related to uncertain tax positions because the Company cannot reliably estimate the timing and amount of future payments, if any. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Legal Matters On November 23, 2016, Oyster Optics, LLP (“Oyster Optics”) filed a complaint against the Company in the United States District Court for the Eastern District of Texas. The complaint asserts U.S. Patent Nos. 6,469,816, 6,476,952, 6,594,055, 7,099,592, 7,620,327, 8,374,511 and 8,913,898 (collectively, the “Oyster Optics patents in suit”). The complaint seeks unspecified damages and a permanent injunction. The Company believes that it does not infringe any valid and enforceable claim of the Oyster Optics patents in suit, and intends to litigate this action vigorously. Because this action is in the early stages, the Company is unable to reasonably estimate the possible loss or range of loss, if any, arising from this matter. In addition to the matter described above, the Company is subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company does not expect that the ultimate costs to resolve these matters will have a material effect on its consolidated financial position, results of operations or cash flows. Loss Contingencies The Company is subject to the possibility of various losses arising in the ordinary course of business. These may relate to disputes, litigation and other legal actions. In the preparation of its quarterly and annual financial statements, the Company considers the likelihood of loss or the incurrence of a liability, including whether it is probable, reasonably possible or remote that a liability has been incurred, as well as the Company’s ability to reasonably estimate the amount of loss, in determining loss contingencies. In accordance with U.S. GAAP, an estimated loss contingency is accrued when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. The Company regularly evaluates current information to determine whether any accruals should be adjusted and whether new accruals are required. As of December 31, 2016, the Company has accrued the estimated liabilities associated with these potential loss contingencies. Indemnification Obligations From time to time, the Company enters into certain types of contracts that contingently require it to indemnify parties against third party claims. The terms of such indemnification obligations vary. These contracts may relate to: (i) certain real estate leases under which the Company may be required to indemnify property owners for environmental and other liabilities, and other claims arising from the Company’s use of the applicable premises; and (ii) certain agreements with the Company’s officers, directors and certain key employees, under which the Company may be required to indemnify such persons for liabilities. In addition, the Company has agreed to indemnify certain customers for claims made against the Company’s products, where such claims allege infringement of third party intellectual property rights, including, but not limited to, patents, registered trademarks, and/or copyrights. Under the intellectual property indemnification clauses, the Company may be obligated to defend the customer and pay for the damages awarded against the customer under an infringement claim as well as the customer’s attorneys’ fees and costs. These indemnification obligations generally do not expire after termination or expiration of the agreement containing the indemnification obligation. In certain cases, there are limits on and exceptions to the Company’s potential liability for indemnification. The Company cannot estimate the amount of potential future payments, if any, that it might be required to make as a result of these agreements. The maximum potential amount of any future payments that the Company could be required to make under these indemnification obligations could be significant. To date, the Company has not incurred any material costs as a result of the indemnification obligations and has not accrued any liabilities related to such obligations in the Company’s consolidated financial statements. As permitted under Delaware law and the Company’s charter and bylaws, the Company has agreements whereby it indemnifies certain of its officers and each of its directors. The term of the indemnification period is for the officer’s or director’s lifetime for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements could be significant; however, the Company has a director and officer insurance policy that may reduce its exposure and enable it to recover all or a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 13. Guarantees Product Warranties Activity related to product warranty was as follows (in thousands): (1) The Company records hardware warranty liabilities based on the latest quality and cost information available as of that date. The changes in estimate shown here are due to changes in overall actual failure rates, the mix of new versus used units related to replacement of failed units, and changes in the estimated cost of repair. Over time, the Company's failure rates and repair costs have generally declined leading to favorable changes in warranty reserves. Letters of Credit and Bank Guarantees The Company had $8.7 million of standby letters of credit and bank guarantees outstanding as of December 31, 2016. These consisted of $4.5 million related to property leases, $3.1 million related to customer performance guarantees and $1.1 million related to a value added tax and customs authorities' licenses. The Company had $5.2 million of standby letters of outstanding as of December 26, 2015. These consisted of $3.1 million related to customer performance guarantees, $1.2 million related to a value added tax license and $0.9 million related to property leases. As of December 31, 2016 and December 26, 2015, the Company has a line of credit for approximately $1.1 million and $1.5 million, respectively, to support the issuance of letters of credit, of which $0.3 million had been issued and outstanding for both periods. The Company has pledged approximately $4.5 million and $4.7 million of assets of a subsidiary to secure this line of credit and other obligations as of December 31, 2016 and December 26, 2015, respectively. 14. Stockholders’ Equity 2000 Stock Plan, 2007 Equity Incentive Plan, 2016 Equity Incentive Plan and Employee Stock Purchase Plan In December 2000, the Company adopted the 2000 Stock Plan (“2000 Plan”). Under the 2000 Plan, as amended, the Company had reserved an aggregate of 14.2 million shares of its common stock for issuance. As of December 31, 2016, options to purchase 20 thousand shares of the Company’s common stock were outstanding under the 2000 Plan. The Company has not granted any additional options or other awards under the 2000 Plan since the Company's initial public offering (the “IPO”) in 2007. The 2000 Plan expired on December 6, 2010. However, the 2000 Plan will continue to govern the terms and conditions of the outstanding options previously granted under the 2000 Plan since prior to the IPO. In February 2007, the Company’s board of directors adopted the 2007 Equity Incentive Plan (“2007 Plan”) and the Company’s stockholders approved the 2007 Plan in May 2007. The Company has reserved a total of 46.8 million shares of common stock for issuance under the 2007 Plan. Upon stockholder approval of the 2016 Equity Incentive Plan (“2016 Plan”), the Company has ceased granting equity awards under the 2007 Plan, however the 2007 Plan will continue to govern the terms and conditions of the outstanding options previously granted under the 2007 Plan. As December 31, 2016, options to purchase 1.6 million shares of the Company's common stock were outstanding and 5.5 million RSUs were outstanding under the 2007 Plan. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) In February 2016, the Company's board of directors adopted the 2016 Plan and the Company's stockholders approved the 2016 Plan in May 2016. As of December 31, 2016, the Company reserved a total of 7.5 million shares of common stock for issuance of stock options, RSUs and PSUs to employees, non-employees, consultants and members of the Company's board of directors, pursuant to the 2016 Plan, plus any shares subject to awards granted under the Company’s 2007 Equity Incentive Plan (the “2007 Plan”) that, after the effective date of the 2016 Plan, expire, are forfeited or otherwise terminate without having been exercised in full to the extent such awards were exercisable, and shares issued pursuant to awards granted under the 2007 Plan that, after the effective date of the 2016 Plan, are forfeited to or repurchased by the Company due to failure to vest. The 2016 Plan has a maximum term of 10 years from the date of adoption, or it can be earlier terminated by the Company's board of directors. The ESPP was adopted by the board of directors in February 2007 and approved by the stockholders in May 2007. The ESPP was last amended by the stockholders in May 2014 to increase the shares authorized under the ESPP to 16.6 million shares of common stock. The ESPP has a 20-year term. Eligible employees may purchase the Company’s common stock through payroll deductions at a price equal to 85% of the lower of the fair market values of the stock as of the beginning or the end of six-month offering periods. An employee’s payroll deductions under the ESPP are limited to 15% of the employee’s compensation and employees may not purchase more than $25,000 of stock during any calendar year. Shares Reserved for Future Issuances Common stock reserved for future issuance was as follows (in thousands): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Stock-based Compensation Plans The Company has stock-based compensation plans pursuant to which the Company has granted stock options, RSUs and PSUs. The Company also has an ESPP for all eligible employees. The following tables summarize the Company’s equity award activity and related information (in thousands, except per share data): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) (1) Represents the additional PSUs awarded resulting from the achievement of performance goals above the performance targets established at grant. The aggregate intrinsic value of unexercised options is calculated as the difference between the closing price of the Company’s common stock of $8.49 at December 30, 2016 and the exercise prices of the underlying stock options. The aggregate intrinsic value of the options which have been exercised is calculated as the difference between the fair market value of the common stock at the date of exercise and the exercise price of the underlying stock options. The aggregate intrinsic value of unreleased RSUs and unreleased PSUs is calculated using the closing price of the Company's common stock of $8.49 at December 30, 2016. The aggregate intrinsic value of RSUs and PSUs released is calculated using the fair market value of the common stock at the date of release. The following table presents total stock-based compensation cost for instruments granted but not yet amortized, net of estimated forfeitures, of the Company’s equity compensation plans as of December 31, 2016. These costs are expected to be amortized on a straight-line basis over the following weighted-average periods (in thousands, except for weighted-average period): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The following table summarizes information about options outstanding at December 31, 2016. Employee Stock Options The weighted-average remaining contractual term of options outstanding and exercisable was 3.0 years as of December 31, 2016. The Company did not grant any stock options during 2016 or 2015. Total fair value of stock options granted to employees and directors that vested during 2016 was insignificant and was approximately $0.2 million and $0.8 million for 2015 and 2014, respectively, based on the grant date fair value. Amortization of stock-based compensation expense related to stock options in 2016 was insignificant, and was $0.2 million and $0.7 million in 2015 and 2014, respectively. The estimated values of stock options, as well as assumptions used in calculating these values were based on estimates as follows (expense amounts in thousands): Employee Stock Purchase Plan The fair value of the ESPP shares was estimated at the date of grant using the following assumptions: INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The Company’s ESPP activity for the following periods was as follows (in thousands): Restricted Stock Units The Company granted RSUs to employees and members of the Company’s board of directors to receive shares of the Company’s common stock. All RSUs awarded are subject to each individual's continued service to the Company through each applicable vesting date. The Company accounted for the fair value of the RSUs using the closing market price of the Company’s common stock on the date of grant. Amortization of stock-based compensation expense related to RSUs in 2016, 2015 and 2014 was approximately $29.6 million, $22.9 million and $21.6 million, respectively. Performance Stock Units Pursuant to the 2007 Plan, the Company has granted PSUs to certain of the Company’s executive officers, senior management and certain employees. All PSUs awarded are subject to each individual's continued service to the Company through each applicable vesting date and if the performance metrics are not met within the time limits specified in the award agreements, the PSUs will be canceled. A number of PSUs granted to the Company’s executive officers and senior management are based on the total shareholder return of the Company's common stock price as compared to the total shareholder return of the S&P North American Technology Multimedia Networking Index (“SPGIIPTR”) over the span of one year, two years and three years. The number of shares to be issued upon vesting of these PSUs range from 0 to 2.0 times the target number of PSUs granted depending on the Company’s performance against the SPGIIPTR. The ranges of estimated values of the PSUs granted that are compared to the SPGIIPTR, as well as the assumptions used in calculating these values were based on estimates as follows: INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) In addition, the Company has granted other PSUs to certain employees that only vest upon the achievement of specific operational performance criteria. The following table summarizes by grant year, the Company’s PSU activity for the year ended December 31, 2016 (in thousands): (1) Represents the additional PSUs awarded resulting from the achievement of performance goals above the performance targets established at grant since the original grants were at 100% of target amounts. Amortization of stock-based compensation expense related to PSUs in 2016, 2015 and 2014 was approximately $6.6 million, $5.0 million and $2.2 million, respectively. Stock-based Compensation Expense The following tables summarize the effects of stock-based compensation on the Company’s consolidated balance sheets and statements of operations for the periods presented (in thousands): (1) Represents stock-based compensation expense deferred to inventory and deferred inventory costs in prior periods and recognized in the current period. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 15. Income Taxes The following is a geographic breakdown of the provision for (benefit from) income taxes (in thousands): Loss before provision for income taxes from international operations was $23.1 million and $6.3 million, respectively, for the years ended December 31, 2016 and December 26, 2015. Income before provision for income taxes from international operations was $5.6 million for the year ended December 27, 2014. The provisions benefit for (benefit from) income taxes differ from the amount computed by applying the statutory federal income tax rates as follows: The Company recognized an income tax benefit of $4.8 million on a loss before income taxes of $29.2 million, income tax expense of $1.1 million on income before income taxes of $52.0 million and income tax expense of $2.8 million on income before income taxes of $16.4 million in fiscal years 2016, 2015 and 2014, respectively. The resulting effective tax rates were (16.3)%, 2.1% and 16.8% for 2016, 2015 and 2014, respectively. The 2016 and 2015 effective tax rates differ from the expected statutory rate of 35% based upon the utilization of unbenefited U.S. loss carryforwards, offset by state income taxes, non-deductible stock-based compensation expenses and foreign taxes provided on foreign subsidiary earnings. The 2016 income tax benefit compared to the 2015 income tax expense primarily relates to the tax benefit of acquisition related amortization expenses and charges, lower state income taxes because of lower profit in our U.S. operations, and reduction in tax reserves, offset by an increase in taxable foreign profits in certain jurisdictions. The tax expense for 2015 was INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) less than 2014 due to acquisition related amortization expenses and charges offset by higher state taxes, additional tax reserves, and an increase in taxable foreign profits. Because of the Company's significant loss carryforward position and corresponding full valuation allowance, in all periods, the Company has not been subject to federal or state tax on its U.S. income because of the availability of loss carryforwards, with the exception of certain states’ taxes for which the losses are limited by statute or amount in 2016 and more significantly in 2015, and fed and state taxes associated with a discontinued US subsidiary. If these losses and other tax attributes become fully utilized, our taxes will increase significantly to a more normalized, expected rate on U.S. earnings. The release of transfer pricing reserves in the future will have a beneficial impact to tax expense, but the timing of the impact depends on factors such as expiration of the statute of limitations or settlements with tax authorities. No significant releases are expected in the near future based on information available at this time. Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets are as follows (in thousands): The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company must consider all positive and negative evidence, including the Company's forecasts of taxable income over the applicable carryforward periods, its current financial performance, its market environment, and other factors in evaluating the need for a full or partial valuation allowance against its net U.S. deferred tax assets. Based on the available objective evidence, management believes it is more likely than not that the domestic net deferred tax assets will not be realizable in the foreseeable future. Accordingly, the Company has provided a full valuation allowance against its domestic deferred tax assets, net of deferred tax liabilities, as of December 31, 2016 and December 26, 2015. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) To the extent that the Company determines that deferred tax assets are realizable on a more likely than not basis, and adjustment is needed, that adjustment will be recorded in the period that the determination is made and would generally decrease the valuation allowance and record a corresponding benefit to earnings. As of December 31, 2016, the Company has net operating loss carryforwards of approximately $205.9 million for federal tax purposes and $104.0 million for state tax purposes. The carryforward balance reflects expected utilization of both federal and state net operating losses for the year ended December 31, 2016. Federal net operating loss carryforwards will begin to expire in 2025 while certain unutilized California losses have expired in 2016. Additionally, the Company has federal and California research and development credits available to reduce future income taxes payable of approximately $35.0 million and $39.4 million, respectively, as of December 31, 2016. Infinera Canada Inc., an indirect wholly owned subsidiary, has Scientific Research and Experimental Development Expenditures (“SRED”) credits available of $2.2 million to offset future Canadian income tax payable as of December 31, 2016. The federal research credits will begin to expire in the year 2022 if not utilized and the California research credits have no expiration date. Canadian SRED credits will begin to expire in the year 2030 if not fully utilized. On March 30, 2016, FASB issued Accounting Standards Update 2016-09, which the Company early adopted as of June 26, 2016. As a result of the adoption of ASU 2016-09, excess windfall tax benefits and tax deficiencies related to our stock option exercises and RSU vestings are recognized as an income tax benefit or expense in our condensed consolidated statements of operations. The adoption of ASU 2016-09 did not have any material impact on our income tax expense for the year ended December 31, 2016 due primarily to our valuation allowance position. Under the Tax Reform Act of 1986, the amount of benefit from net operating loss and tax credit carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50 percent as defined over a three-year testing period. As of December 31, 2016, the Company had determined that while ownership changes had occurred in the past, the resulting limitations were not significant enough to impact the utilization of the tax attributes against its taxable profits earned to date. The Company’s policy with respect to its undistributed foreign subsidiaries’ earnings is to consider those earnings to be indefinitely reinvested and, accordingly, no related provision for U.S. federal and state income taxes has been provided. Upon distribution of those earnings in the form of dividends or otherwise, the Company may be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes in the various foreign countries. At December 31, 2016, the undistributed earnings approximated $28.5 million. The future tax consequence of the remittance of these earnings is negligible because of the significant net operating loss carryforwards for U.S. and state purposes and full valuation allowance provided against such carryforwards. The aggregate changes in the balance of gross unrecognized tax benefits were as follows (in thousands): INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) As of December 31, 2016, the cumulative unrecognized tax benefit was $22.3 million, of which $20.0 million was netted against deferred tax assets, which would have otherwise been subjected with a full valuation allowance. Of the total unrecognized tax benefit as of December 31, 2016, approximately $2.3 million, if recognized, would impact the Company’s effective tax rate. As of December 31, 2016, December 26, 2015 and December 27, 2014, the Company had $0.5 million, $0.5 million and $0.4 million, respectively, of accrued interest or penalties related to unrecognized tax benefits, of which less than $0.2 million was included in the Company’s provision for income taxes in each of the years ended December 31, 2016, December 26, 2015 and December 27, 2014, respectively. The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the Company’s provision for income taxes. The Company is potentially subject to examination by the Internal Revenue Service and the relevant state income taxing authorities under the statute of limitations for years 2002 and forward. The Company has received assessments of tax resulting from transfer pricing examinations in India for all but two years in the range of fiscal years ending March 2005 through March 2014. While some of the assessment years have been settled with no change from the original tax return position, the Company intends to appeal all remaining assessment years, and does not expect a significant adjustment to unrecognized tax benefits as a result of these inquiries. The Company believes that the resolution of these disputed issues will not have a material impact on our financial statements. The Company does not currently believe there to be a reasonable possibility of a significant change in total unrecognized tax benefits that would occur within the next 12 months and, as such, amounts are classified as other long-term liabilities on the accompanying consolidated balance sheets as of December 31, 2016. 16. Segment Information Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the Company’s Chief Executive Officer ("CEO"). The Company’s CEO reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. The Company has one business activity as a provider of optical transport networking equipment, software and services. Accordingly, the Company is considered to be in a single reporting segment and operating unit structure. Revenue by geographic region is based on the shipping address of the customer. The following tables set forth revenue and long-lived assets by geographic region (in thousands): Revenue INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Property, plant and equipment, net 17. Employee Benefit Plan Defined Contribution Plans The Company has established a savings plan under Section 401(k) of the Internal Revenue Code (the “401(k) Plan”). As allowed under Section 401(k) of the Internal Revenue Code, the 401(k) Plan provides tax-deferred salary contributions for eligible U.S. employees. Employee contributions are limited to a maximum annual amount as set periodically by the Internal Revenue Code. The Company made voluntary cash contributions and matched a portion of employee contributions of $2.1 million and $1.7 million for 2016 and 2015, respectively. Expenses related to the 401(k) Plan were insignificant for 2016, 2015 and 2014. In connection with the Company's acquisition of Transmode during the third quarter of 2015, the Company has an ITP pension plan covering its Swedish employees. Commitments for old-age and survivors' pension for salaried employees in Sweden are vested through an insurance policy. Expenses related to the ITP pension plan were $2.6 million for 2016 and $0.8 million from the Acquisition Date through December 26, 2015. The Company also provides defined contribution plans in certain foreign countries where required by local statute or at the Company's discretion. INFINERA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 18. Financial Information by Quarter (Unaudited) The following table sets forth the Company’s unaudited quarterly consolidated statements of operations data for 2016 and 2015. The data has been prepared on the same basis as the audited consolidated financial statements and related notes included in this report. The table includes all necessary adjustments, consisting only of normal recurring adjustments that the Company considers necessary for a fair presentation of this data. The Company operates and reports financial results on a fiscal year of 52 or 53 weeks ending on the last Saturday of December in each year. Accordingly, fiscal year 2016 was a 53-week year that ended on December 31, 2016, and fiscal year 2015 was a 52-week year that ended on December 26, 2015 . The quarters for fiscal years 2016 and 2015 were 14-week and 13-week quarters, respectively. During the third quarter of 2015, the Company completed its public offer to the shareholders of Transmode, acquiring 95.8% of the outstanding common shares and voting interest in Transmode. This acquisition was accounted for as a business combination, and accordingly, the Company has consolidated the financial results of Transmode with its financial results since the Acquisition Date. During the fourth quarter of 2016, the Company recorded an impairment charge of $11.3 million related to in-process research and development, resulting from the Company's decision to abandon previously acquired in-process technologies. Additionally, during the same period, the Company recognized a gain of $9.0 million on the sale of a cost-method investment. | Based on the provided financial statement excerpt, here's a summary of the key points:
1. Financial Position:
- The company (Infinera Corporation) appears to be operating at a loss
- Specific financial figures are not provided in the excerpt
2. Key Business Activities:
- Product sales with bundled services including:
* Installation and deployment
* Hardware/software support
* Spares management
* Network operations
* Training services
3. Notable Accounting Practices:
- Revenue Recognition: Complex, involving multiple elements and service periods
- Stock-Based Compensation:
* Measured at grant date based on fair value
* Recognized over vesting period
* Includes forfeiture rate estimations
- Sales Commissions: Recorded as sales and marketing expense when customers are billed
4. Management Considerations:
- Relies on significant estimates and judgments for:
* Revenue recognition
* Stock-based compensation
* Inventory valuation
* Warranty accruals
* Business combinations
* Income tax accounting
Note: This appears to be a partial financial statement, focusing mainly on accounting policies rather than specific financial figures. | Claude |
Item 8 - . Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Lakeland Bancorp, Inc.: We have audited the accompanying consolidated balance sheets of Lakeland Bancorp, Inc. and Subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lakeland Bancorp, Inc. and Subsidiaries as of December 31, 2016 and 2015 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ KPMG LLP Short Hills, New Jersey March 15, 2017 Lakeland Bancorp, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS The accompanying notes are an integral part of these statements. Lakeland Bancorp, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME The accompanying notes are an integral part of these statements. Lakeland Bancorp, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME The accompanying notes are an integral part of these statements. Lakeland Bancorp, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY For the Years Ended December 31, 2016, 2015 and 2014 The accompanying notes are an integral part of these statements. Lakeland Bancorp, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS Lakeland Bancorp, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) The accompanying notes are an integral part of these statements. Lakeland Bancorp, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF ACCOUNTING POLICIES Lakeland Bancorp, Inc. (the “Company”) is a bank holding company whose principal activity is the ownership and management of its wholly owned subsidiary, Lakeland Bank (“Lakeland”). Lakeland operates under a state bank charter and provides full banking services and, as a state bank, is subject to regulation by the New Jersey Department of Banking and Insurance. Lakeland generates commercial, mortgage and consumer loans and receives deposits from customers located primarily in Northern and Central New Jersey. Through a third party, Lakeland also provides non-deposit products, such as securities brokerage services, including mutual funds and variable annuities. Lakeland operates as a commercial bank offering a wide variety of commercial loans and leases and, to a lesser degree, consumer credits. Its primary strategic aim is to establish a reputation and market presence as the “small and middle market business bank” in its principal markets. Lakeland funds its loans primarily by offering time, savings and money market, and demand deposit accounts to both commercial enterprises and individuals. Additionally, it originates residential mortgage loans, and services such loans which are owned by other investors. Lakeland also has an equipment finance division which provides equipment lease financing primarily to small and medium sized business clients and an asset based lending department which specializes in utilizing particular assets to fund the working capital needs of borrowers. The Company and Lakeland are subject to regulations of certain state and federal agencies and, accordingly, are periodically examined by those regulatory authorities. As a consequence of the extensive regulation of commercial banking activities, Lakeland’s business is particularly susceptible to being affected by state and federal legislation and regulations. Basis of Financial Statement Presentation The accounting and reporting policies of the Company and its subsidiaries conform with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and predominant practices within the banking industry. The consolidated financial statements include the accounts of the Company, Lakeland, Lakeland NJ Investment Corp., Lakeland Investment Corp., Lakeland Equity, Inc. and Lakeland Preferred Equity, Inc. All intercompany balances and transactions have been eliminated. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions also affect reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Significant estimates in these financial statements are as follows. The principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan and lease losses, the valuation of the Company’s investment securities portfolio, the realizability of the Company’s deferred tax asset and the analysis of goodwill and intangible impairment. The policies regarding these estimates are discussed below. The Company’s operating segments are components of its enterprise for which separate financial information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. The Company’s chief operating decision maker is its Chief Executive Officer. All of the Company’s financial services activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, commercial lending is dependent upon the ability of Lakeland to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. The situation is also similar for consumer and residential mortgage lending. Moreover, the Company primarily operates in one market area, Northern and Central New Jersey and contiguous areas. Therefore, all significant operating decisions are based upon analysis of the Company as one operating segment or unit. Accordingly, the Company has determined that it has one operating segment and thus one reporting segment. Cash and Due from Banks Cash and cash equivalents are defined as cash on hand, cash items in the process of collection, amounts due from banks and federal funds sold with an original maturity of three months or less. A portion of Lakeland’s cash on hand and on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements. Investment Securities Investment securities are classified in one of three categories: held to maturity, trading, or available for sale. Investments in debt securities, for which management has both the ability and intent to hold to maturity, are carried at cost, adjusted for the amortization of premiums and accretion of discounts computed by the effective interest method. Investments in debt and equity securities, which management believes may be sold prior to maturity due to changes in interest rates, prepayment risk, liquidity requirements, or other factors, are classified as available for sale. Net unrealized gains and losses for such securities, net of tax effect, are reported as other comprehensive income (loss) and excluded from the determination of net income. The Company does not engage in securities trading. Gains or losses on disposition of investment securities are based on the net proceeds and the adjusted carrying amount of the securities sold using the specific identification method. Losses are recorded through the statement of income when the impairment is considered other-than-temporary, even if a decision to sell has not been made. The Company evaluates its portfolio for impairment each quarter. In estimating other-than-temporary losses, the Company considers the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and whether the Company is more likely than not to sell the security before recovery of its cost basis. If a security has been impaired for more than twelve months, and the impairment is deemed other-than-temporary, a write down will occur in that quarter. If a loss is deemed to be other-than-temporary, it is recognized as a realized loss in the income statement with the security assigned a new cost basis. If the Company intends to sell an impaired security, the Company records an other-than-temporary loss in an amount equal to the entire difference between the fair value and amortized cost. If a security is determined to be other-than-temporarily impaired, but the Company does not intend to sell the security, only the credit portion of the estimated loss is recognized in earnings in gain (loss) on securities, with the other portion of the loss recognized in other comprehensive income. If a determination is made that an equity security is other-than-temporarily impaired, the unrealized loss will be recognized as an other-than-temporary impairment charge in noninterest income as a component of gain (loss) on investment securities. Loans and Leases and Allowance for Loan and Lease Losses Loans and leases that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal and are net of unearned discount, unearned loan fees and an allowance for loan and lease losses. Interest income is accrued as earned on a simple interest basis, adjusted for prepayments. All unamortized fees and costs related to the loan are amortized over the life of the loan using the interest method. Accrual of interest is discontinued on a loan or lease when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that full collection of interest and principal is doubtful. When a loan or lease is placed on such non-accrual status, all accumulated accrued interest receivable is reversed out of current period income. Commercial loans and leases are placed on a non-accrual status with all accrued interest and unpaid interest reversed if (a) because of the deterioration in the financial position of the borrower they are maintained on a cash basis (which means payments are applied when and as received rather than on a regularly scheduled basis), (b) payment in full of interest or principal is not expected, or (c) principal and interest have been in default for a period of 90 days or more unless the obligation is both well-secured and in process of collection. Residential mortgage loans are placed on non-accrual status at the time principal and interest have been in default for a period of 90 days or more, except where there exists sufficient collateral to cover the defaulted principal and interest payments, and the loans are well-secured and in the process of collection. Consumer loans are generally placed on non-accrual and reviewed for charge-off when principal and interest payments are four months in arrears unless the obligations are well-secured and in the process of collection. Interest thereafter on such charged-off consumer loans is taken into income when received only after full recovery of principal. As a general rule, a non-accrual asset may be restored to accrual status when none of its principal or interest is due and unpaid, satisfactory payments have been received for a sustained period (usually six months), or when it otherwise becomes well-secured and in the process of collection. Loans and leases are considered impaired when, based on current information and events, it is probable that Lakeland will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is measured based on the present value of expected cash flows discounted at the loan’s effective interest rate, or as a practical expedient, Lakeland may measure impairment based on a loan’s observable market price, or the fair value of the collateral, less estimated costs to sell, if the loan is collateral-dependent. Regardless of the measurement method, Lakeland measures impairment based on the fair value of the collateral when it is determined that foreclosure is probable. Most of Lakeland’s impaired loans are collateral-dependent. Lakeland groups impaired commercial loans under $500,000 into a homogeneous pool and collectively evaluates them. Interest received on impaired loans and leases may be recorded as interest income. However, if management is not reasonably certain that an impaired loan and lease will be repaid in full, or if a specific time frame to resolve full collection cannot yet be reasonably determined, all payments received are recorded as reductions of principal. Purchased Credit-Impaired (“PCI”) loans are loans acquired through acquisition or purchased at a discount that is due, in part, to credit quality. PCI loans are accounted for in accordance with ASC Subtopic 310-30 and are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance (i.e., the allowance for loan losses). The difference between the undiscounted cash flows expected at acquisition and the initial carrying amount (fair value) of the covered loans, or the “accretable yield,” is recognized as interest income utilizing the level-yield method over the life of the loans. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “non-accretable difference,” are not recognized as a yield adjustment, as a loss accrual or a valuation allowance. Reclassifications of the non-accretable difference to the accretable yield may occur subsequent to the loan acquisition dates due to increases in expected cash flows of the loans and results in an increase in yield on a prospective basis. Valuation allowances (recognized in the allowance for loan and lease losses) on these impaired loans reflect only losses incurred after the acquisition (representing all cash flows that were expected at acquisition but currently are not expected to be received). Loans are classified as troubled debt restructured loans in cases where borrowers experience financial difficulties and Lakeland makes certain concessionary modifications to contractual terms. Restructured loans typically involve a modification of terms such as a reduction of the stated interest rate, an extended moratorium of principal payments and/or an extension of the maturity date at a stated interest rate lower than the current market rate for a new loan with similar risk. Nonetheless, restructured loans are classified as impaired loans. If an obligation has been restructured, it will continue to be classified as restructured until the obligation is fully repaid or until it meets all of the following criteria: 1) the borrower is no longer experiencing financial difficulties, 2) the rate is not less than the rate provided for similar credit risk, 3) other terms are no less favorable than similar new debt and 4) no concessions were granted (any prior principal forgiveness is deemed to be an ongoing concession). The allowance for loan and lease losses is established through a provision for loan and lease losses charged to expense. Loan principal considered to be uncollectible by management is charged against the allowance for loan and lease losses. The allowance is an amount that management believes will be adequate to absorb losses on existing loans and leases that may become uncollectible based upon an evaluation of known and inherent risks in the loan and lease portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the loan and lease portfolio, overall portfolio quality, specific problem loans and leases, and current economic conditions which may affect the borrowers’ ability to pay. The evaluation also analyzes historical losses by loan and lease category, and considers the resulting loss rates when determining the reserves on current loan and lease total amounts. Additionally, management assesses the loss emergence period for each loan segment and adjusts each historical loss factor accordingly. The loss emergence period is the estimated time from the date of a loss event (such as a personal bankruptcy) to the actual recognition of the loss (typically via the first full or partial loan charge-off), and is determined based upon a study of our past loss experience by loan segment. Loss reserves for specified problem loans and leases are also detailed. All of the factors considered in the analysis of the adequacy of the allowance for loan and lease losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan and lease losses may be required that would adversely impact earnings in future periods. The determination of the adequacy of the allowance for loan and lease losses and the periodic provisioning for estimated losses included in the consolidated financial statements is the responsibility of management and the Board of Directors. The evaluation process is undertaken on a quarterly basis. Methodology employed for assessing the adequacy of the allowance consists of the following criteria: • The establishment of reserve amounts for all impaired loans and leases that have been designated as requiring attention by Lakeland. • The establishment of reserves for pools of homogeneous types of loans and leases not subject to specific review, including impaired loans under $500,000, leases, 1 - 4 family residential mortgages, and consumer loans. • The establishment of reserve amounts for the unimpaired loans and leases in each portfolio based upon the historical average loss experience as modified by management’s assessment of the loss emergence period for these portfolios and management’s evaluation of key factors. Consideration is given to the results of ongoing credit quality monitoring processes, the adequacy and expertise of Lakeland’s lending staff, underwriting policies, loss histories, delinquency trends, and the cyclical nature of economic and business conditions. Since many of Lakeland’s loans depend on the sufficiency of collateral as a secondary source of repayment, any adverse trend in the real estate markets could affect underlying values available to protect Lakeland from loss. A loan that management designates as impaired is reviewed for charge-off when it is placed on non-accrual status with a resulting charge-off if the loan is not secured by collateral having sufficient liquidation value to repay the loan. Charge-offs are recommended by the Chief Credit Officer and approved by the Board. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value. Gains and losses on sales of loans are specifically identified and accounted for in accordance with U.S. GAAP which requires that an entity engaged in mortgage banking activities classify the retained mortgage-backed security or other interest, which resulted from the securitization of a mortgage loan held for sale, based upon its ability and intent to sell or hold these investments. Bank Premises and Equipment Bank premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation. Depreciation expense is computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are depreciated over the shorter of the estimated useful lives of the improvements or the terms of the related leases. Other Real Estate Owned and Other Repossessed Assets Other real estate owned (OREO) and other repossessed assets, representing property acquired through foreclosure (or deed-in-lieu-of-foreclosure), are carried at fair value less estimated disposal costs of the acquired property. Costs relating to holding the assets are charged to expense. An allowance for OREO or other repossessed assets is established, through charges to expense, to maintain properties at fair value less estimated costs to sell. Operating results of OREO and other repossessed assets, including rental income and operating expenses, are included in other expenses. Mortgage Servicing Lakeland performs various servicing functions on loans owned by others. A fee, usually based on a percentage of the outstanding principal balance of the loan, is received for these services. At December 31, 2016 and 2015, Lakeland was servicing approximately $26.9 million and $30.0 million, respectively, of loans for others. Lakeland originates certain mortgages under a definitive plan to sell or securitize those loans and service the loans owned by the investor. Upon the transfer of the mortgage loans in a sale or a securitization, Lakeland records the servicing assets retained. Lakeland records mortgage servicing rights and the loans based on relative fair values at the date of origination and evaluates the mortgage servicing rights for impairment at each reporting period. Lakeland also originates loans that it sells to other banks and investors and does not retain the servicing rights. Mortgage Servicing Rights When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. As of December 31, 2016 and 2015, Lakeland had originated mortgage servicing rights of $124,000 and $167,000, respectively. Under the amortization measurement method, Lakeland subsequently measures servicing rights at fair value at each reporting date and records any impairment in value of servicing assets in earnings in the period in which the impairment occurs. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses. Servicing fee income, which is reported on the income statement as commissions and fees, is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan, and are recorded as income when earned. Transfers of Financial Assets Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, put presumptively beyond the reach of the transferor and its creditors even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Derivatives Lakeland enters into interest rate swaps (“swaps”) with loan customers to provide a facility to mitigate the fluctuations in the variable rate on the respective loans. These swaps are matched in offsetting terms to swaps that Lakeland enters into with an outside third party. The swaps are reported at fair value in other assets or other liabilities. Lakeland’s swaps qualify as derivatives, but are not designated as hedging instruments, thus any net gain or loss resulting from changes in the fair value is recognized in other noninterest income. The credit risk associated with derivatives executed with customers is similar as that involved in extending loans and is subject to normal credit policies. Collateral is obtained based on management’s assessment of the customer. The positions of customer derivatives are recorded at fair value and changes in value are included in noninterest income on the consolidated statement of income. Cash flow hedges are used primarily to minimize the variability in cash flows of assets or liabilities, or forecasted transactions caused by interest rate fluctuations. Changes in the fair value of derivatives designated as cash flow hedges are recorded in accumulated other comprehensive income and are reclassified into the line item in the income statement in which the hedged item is recorded in the same period the hedged item affects earnings. Hedge ineffectiveness and gains and losses on the component of a derivative excluded in assessing hedge effectiveness are recorded in the same income statement line item. Further discussion of Lakeland’s financial derivatives is set forth in Note 18 to the Consolidated Financial Statements. Earnings Per Share Earnings per share is calculated on the basis of the weighted average number of common shares outstanding during the year. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. Unless otherwise indicated, all weighted average, actual shares or per share information in the financial statements have been adjusted retroactively for the effect of stock dividends. Employee Benefit Plans The Company has certain employee benefit plans covering substantially all employees. The Company accrues such costs as incurred. We recognize the overfunded or underfunded status of pension and postretirement benefit plans in accordance with U.S. GAAP. Actuarial gains and losses, prior service costs or credits, and any remaining transition assets or obligations are recognized as a component of Accumulated Other Comprehensive Income, net of tax effects, until they are amortized as a component of net periodic benefit cost. Comprehensive Income (Loss) The Company reports comprehensive income (loss) in addition to net income from operations. Other comprehensive income (loss) Includes items recorded directly in equity such as unrealized gains or losses on securities available for sale as well unrealized gains (losses) recorded on derivatives and benefit plans. Goodwill and Other Identifiable Intangible Assets Goodwill is presumed to have an indefinite useful life and is tested, at least annually, for impairment at the reporting unit level. Impairment exists when the carrying amount of goodwill exceeds its implied fair value. For purposes of our goodwill impairment testing, we have identified a single reporting unit, community banking. U.S. GAAP permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. The Company completed its annual qualitative assessment as of November 30, 2016 and concluded that there was less than a 50% probability that the fair value of the reporting unit is less than its carrying amount and, therefore, the two-step goodwill impairment test was not required. Bank Owned Life Insurance Lakeland invests in bank owned life insurance (“BOLI”). BOLI involves the purchasing of life insurance by Lakeland on a chosen group of employees. Lakeland is owner and beneficiary of the policies. At December 31, 2016 and 2015, Lakeland had $72.4 million and $65.4 million, respectively, in BOLI. Income earned on BOLI was $2.6 million, $2.0 million and $1.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. BOLI is accounted for using the cash surrender value method and is recorded at its net realizable value. Deferred Income Taxes The Company accounts for income taxes under the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. The principal types of differences between assets and liabilities for financial statement and tax return purposes are allowance for loan and lease losses, core deposit intangibles, deferred loan fees and deferred compensation. The Company evaluates tax positions that may be uncertain using a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Additional information regarding the Company’s uncertain tax positions is set forth in Note 10 to the Consolidated Financial Statements. Variable Interest Entities Management has determined that Lakeland Bancorp Capital Trust II and Lakeland Bancorp Capital Trust IV (collectively, “the Trusts”) qualify as variable interest entities. The Trusts issued mandatorily redeemable preferred stock to investors and loaned the proceeds to the Company. The Trusts hold, as their sole asset, subordinated debentures issued by the Company. The Company is not considered the primary beneficiary of the Trusts, therefore the Trusts are not consolidated in the Company’s financial statements. The Company’s maximum exposure to the Trusts is $30.0 million at December 31, 2016 which is the Company’s liability to the Trusts and includes the Company’s investment in the Trusts. The Federal Reserve has issued guidance on the regulatory capital treatment for the trust preferred securities issued by the Trusts. The rule retains the current maximum percentage of total capital permitted for trust preferred securities at 25%, but enacts other changes to the rules governing trust preferred securities that affect their use as part of the collection of entities known as “restricted core capital elements.” The rule allows bank holding companies to continue to count trust preferred securities as Tier 1 Capital. The Company’s capital ratios continue to be categorized as “well-capitalized” under the regulatory framework for prompt corrective action. Under the Collins Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, any new issuance of trust preferred securities by the Company would not be eligible as regulatory capital. New Accounting Pronouncements In January 2017, the Financial Accounting Standards Board (“FASB”) issued an update to simplify the test for goodwill impairment. This amendment eliminates Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. This update will be effective for the Company’s financial statements for fiscal years beginning after December 15, 2019. The adoption of this update is not expected to have a material impact on the Company’s financial statements. In January 2017, the FASB issued an update that clarifies the definition of a business as it pertains to business combinations. This amendment affects all companies and other reporting organizations that must determine whether they have sold or acquired a business. This update will be effective for the Company’s financial statements for fiscal years beginning after December 15, 2017. The adoption of this update is not expected to have a material impact on the Company’s financial statements. In September 2016, the FASB issued an accounting standards update to address diversity in presentation in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This update will be effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2017. The adoption of this update is not expected to have a material impact on the Company’s financial statements. In June 2016, the FASB issued an accounting standards update pertaining to the measurement of credit losses on financial instruments. This update requires the measurement of all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable and supportable financials. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. This update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. This update will be effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2019. The Company is currently assessing the impact that the guidance will have on the Company’s consolidated financial statements. In March 2016, the FASB issued an accounting standards update to simplify employee share-based payment accounting. The areas for simplification in this update involve several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This update will be effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2016. The adoption of this update is not expected to have a material impact on the Company’s financial statements. In March 2016, the FASB issued an accounting standards update that requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met, including the “clearly and closely related” criterion. The amendments in this update clarify the requirements for assessing whether contingent call or put options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. This update will be effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2016. This guidance will be applied on a modified retrospective basis as of the beginning of the fiscal year that the amendment is effective. The adoption of this update is not expected to have a material impact on the Company’s financial statements. In February 2016, FASB issued accounting guidance that requires all lessees to recognize a lease liability and a right-of-use asset, measured at the present value of the future minimum lease payments, at the lease commencement date. Lessor accounting remains largely unchanged under the new guidance. The guidance is effective for fiscal years beginning after December 15, 2018, including interim reporting periods within that reporting period, with early adoption permitted. A modified retrospective approach must be applied for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company is currently assessing the impact of the new guidance on its consolidated financial statements. The Company expects to recognize a right-of-use asset and a lease liability for its operating lease commitments. Please refer to Note 14 for the Company’s commitments under operating lease obligations. In January 2016, the FASB issued an accounting standards update intended to improve the recognition and measurement of financial instruments. Specifically, the accounting standards update requires all equity instruments, with the exception of those that are accounted for under the equity method of accounting, to be measured at fair value with changes in the fair value recognized through net income. Additionally, public business entities are required to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. The amendments in this update also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. This amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The adoption of this update is not expected to have a material impact on the Company’s financial statements. In September 2015, the FASB issued an accounting standards update simplifying the accounting for adjustments made to provisional amounts recognized in a business combination, eliminating the requirement to retrospectively account for those adjustments. To simplify the accounting for adjustments made to provisional amounts, the amendments in the accounting standards update require that the acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amount is determined. The acquirer is required to also record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. In addition, an entity is required to present separately on the face of the income statement or disclose in the notes to the financial statements the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. This amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of this update did not have a material impact on the Company’s financial statements. In May 2015, the FASB issued an accounting standards update clarifying how investments valued using the net asset value practical expedient within the fair value hierarchy should be classified. The accounting standards update was issued to address diversity in practice by exempting investments measured using the net asset value expedient from categorization in the fair value hierarchy. This accounting standards update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of this update did not have a material impact on the Company’s financial statements. In April 2015, the FASB issued an accounting standards update requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability consistent with the presentation of debt discounts. The purpose of this update is to simplify the presentation of debt issuance costs and to align the U.S. GAAP presentation of debt more closely with international accounting standards. In August 2015, the FASB issued a subsequent update which discussed presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements. These amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of these updates did not have a material impact on the Company’s financial statements. In January 2015, the FASB issued an accounting standards update regarding the elimination of the concept of the extraordinary items from the statement of operations. The purpose of this update is to simplify the statement of operations presentation and to align the U.S. GAAP income statement more closely with international accounting standards. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of this update did not have a material impact on the Company’s financial statements. In May 2014, the FASB issued an accounting standards update that clarifies the principles for recognizing revenue. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to a customer in an amount that reflects the consideration to which the entity expects to be entitled in exchange for these goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. In 2016, the FASB issued further implementation guidance regarding revenue recognition. This additional guidance included clarification on certain principal versus agent considerations within the implementation of the guidance as well as clarification related to identifying performance obligations and licensing. The guidance along with its updates is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is still evaluating the potential impact on the Company’s financial statements. In evaluating this standard, management has determined that the majority of revenue earned by the Company is from revenue streams not included in the scope of this standard and therefore management does not expect the new revenue recognition guidance to have a material impact on its consolidated financial statements. NOTE 2 - ACQUISITIONS Harmony Bank On July 1, 2016, the Company completed its acquisition of Harmony Bank (“Harmony”), a bank located in Ocean County, NJ. Effective upon the opening of business on July 1, 2016, Harmony was merged into Lakeland Bank. Harmony operated three branches in Ocean County, New Jersey. This merger allows the Company to expand its presence to Ocean County. The merger agreement provided that shareholders of Harmony would receive 1.25 shares of the Company’s common stock for each share of Harmony Bank common stock that they owned at the effective time of the merger. The Company issued an aggregate of 3,201,109 shares of its common stock in the merger. Outstanding Harmony stock options were paid out in cash at the difference between $14.31 (Lakeland’s closing stock price on July 1, 2016 of $11.45 multiplied by 1.25) and the average strike price of $9.07 for a total cash payment of $869,000. During the fourth quarter of 2016, the Company revised the estimate of the fair value of the acquired assets as of the acquisition date as a result of additional information obtained. The adjustment, related to the fair market value of certain loans, resulted in a $645,000 decrease to goodwill. The acquisition was accounted for under the acquisition method of accounting. Accordingly, the assets acquired and liabilities assumed in the acquisition were recorded at their estimated fair values based on management’s best estimates using information available at the date of the acquisition, including the use of a third party valuation specialist. The fair values are preliminary estimates and subject to adjustment for up to one year after the closing date of the acquisition. The following table summarizes the estimated fair value of the acquired assets and liabilities assumed at the date of acquisition for Harmony, net of cash consideration paid. Loans acquired in the Harmony acquisition were recorded at fair value, and there was no carryover related allowance for loan and lease losses. The fair values of loans acquired from Harmony were estimated using cash flow projections based on the remaining maturity and repricing terms. Cash flows were adjusted for estimated future credit losses and the rate of prepayments. Projected cash flows were then discounted to present value using a risk-adjusted market rate for similar loans. The following is a summary of the loans accounted for in accordance with ASC 310-30 that were acquired in the Harmony acquisition as of the closing date. The core deposit intangible totaled $1.0 million and is being amortized over its estimated useful life of approximately 10 years using an accelerated method. The goodwill will be evaluated annually for impairment. The goodwill is not deductible for tax purposes. The fair values of deposit liabilities with no stated maturities such as checking, money market and savings accounts, were assumed to equal the carrying amounts since these deposits are payable on demand. The fair values of certificates of deposits and IRAs represent the present value of contractual cash flows discounted at market rates for similar certificates of deposit. Pascack Bancorp On January 7, 2016, the Company completed its acquisition of Pascack Bancorp, Inc. (“Pascack”), a bank holding company headquartered in Waldwick, New Jersey. Pascack was the parent of Pascack Community Bank, which operated 8 branches in Bergen and Essex Counties in New Jersey. This acquisition enabled the Company to broaden its presence in Bergen and Essex counties. Effective as of the close of business on January 7, 2016, Pascack merged into the Company, and Pascack Community Bank merged into Lakeland Bank. The merger agreement provided that the shareholders of Pascack would receive, at their election, for each outstanding share of Pascack common stock that they owned at the effective time of the merger, either 0.9576 shares of Lakeland Bancorp common stock or $11.35 in cash, subject to proration as described in the merger agreement, so that 90% of the aggregate merger consideration was shares of Lakeland Bancorp common stock and 10% was cash. Lakeland Bancorp issued 3,314,284 shares of its common stock in the merger and paid approximately $4.5 million in cash, including the cash paid in connection with the cancellation of Pascack stock options. Outstanding Pascack stock options were paid out in cash at the difference between $11.35 and an average strike price of $7.37 for a total cash payment of $122,000. This transaction resulted in $15.3 million of goodwill and generated $1.5 million in core deposit intangibles. During the second quarter of 2016, the Company revised the estimated fair value of the acquired assets as of the acquisition date as the result of additional information obtained. The adjustment related to the fair market value of certain fixed assets which resulted in a $158,000 decrease in goodwill. The acquisition was accounted for under the acquisition method of accounting. Accordingly, the assets acquired and liabilities assumed in the acquisition were recorded at their estimated fair values based on management’s best estimates using information available at the date of the acquisition, including the use of a third party valuation specialist. The fair values are preliminary estimates and subject to adjustment for up to one year after the closing date of the acquisition. The following table summarizes the estimated fair value of the acquired assets and liabilities assumed at the date of acquisition for Pascack, net of cash consideration paid. Loans acquired in the Pascack acquisition were recorded at fair value, and there was no carryover related allowance for loan and lease losses. The fair values of loans acquired from Pascack were estimated using cash flow projections based on the remaining maturity and repricing terms. Cash flows were adjusted for estimated future credit losses and the rate of prepayments. Projected cash flows were then discounted to present value using a risk-adjusted market rate for similar loans. The following is a summary of the loans accounted for in accordance with ASC 310-30 that were acquired in the Pascack acquisition as of the closing date. The core deposit intangible totaled $1.5 million and is being amortized over its estimated useful life of approximately 10 years using an accelerated method. The goodwill will be evaluated annually for impairment. The goodwill is not deductible for tax purposes. The fair values of deposit liabilities with no stated maturities such as checking, money market and savings accounts, were assumed to equal the carrying amounts since these deposits are payable on demand. The fair values of certificates of deposits and IRAs represent the present value of contractual cash flows discounted at market rates for similar certificates of deposit. Direct costs related to the Pascack and Harmony acquisitions were expensed as incurred. During the year ended December 31, 2016 and 2015, the Company incurred $4.1 million and $1.2 million, respectively, of merger and acquisition integration-related expenses, which have been separately stated in the Company’s consolidated statements of income. Supplemental Pro Forma Financial Information The following table provides unaudited condensed pro forma financial information assuming that the Pascack and Harmony acquisitions had been completed as of January 1, 2016, for the year ended December 31, 2016 and as of January 1, 2015 for the year ended December 31, 2015. The table below has been prepared for comparative purposes only and is not necessarily indicative of the actual results that would have been attained had the acquisitions occurred as of the beginning of the periods presented, nor is it indicative of future results. Furthermore, the unaudited pro forma information does not reflect management’s estimate of any revenue-enhancing opportunities nor anticipated cost savings or the impact of conforming certain accounting policies of the acquired companies to the Company’s policies that may have occurred as a result of the integration and consolidation of Pascack’s and Harmony’s operations. The pro forma information shown reflects adjustments related to certain purchase accounting fair value adjustments; amortization of core deposit and other intangibles; and related income tax effects. The Company has not provided separate information regarding revenue and earnings of Pascack since the acquisition because of the manner in which Pascack’s branches and lending team were immediately merged into Lakeland’s branches and lending team, making such information impracticable to provide. Harmony contributed net interest income, net income and earnings per share of $6.6 million, $3.3 million and $0.07, respectively, for the year ended December 31, 2016. NOTE 3 - EARNINGS PER SHARE The Company uses the two class method to compute earnings per common share. Participating securities include non-vested restricted stock. The following tables present the computation of basic and diluted earnings per share for the periods presented. There were no antidilutive options to purchase common stock to be excluded from the above computation. There were no antidilutive options to purchase common stock to be excluded from the above computation. Options to purchase 115,831 shares of common stock at a weighted average of $12.06 per share were not included in the computation of diluted earnings per share because the option price and the grant date price were greater than the average market price during the period. NOTE 4 - INVESTMENT SECURITIES The amortized cost, gross unrealized gains and losses, and the fair value of the Company’s available for sale and held to maturity securities are as follows: The following table lists contractual maturities of investment securities classified as available for sale and held to maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The following table shows proceeds from sales of securities, gross gains and gross losses on sales and calls of securities for the periods indicated: The above sale proceeds in 2014 include sales of $1.4 million in held to maturity mortgage-backed securities of which the Company had already collected over 90% of the principal outstanding. The Company realized $73,000 in gains on sales of these securities. Gains or losses on sales of securities are based on the net proceeds and the adjusted carrying amount of the securities sold using the specific identification method. Securities with a carrying value of approximately $443.4 million and $347.7 million at December 31, 2016 and 2015, respectively, were pledged to secure public deposits and for other purposes required by applicable laws and regulations. The following table indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2016 and 2015: Management has evaluated the securities in the above table and has concluded that none of the securities with unrealized losses has impairments that are other-than-temporary. Fair value below cost is solely due to interest rate movements and is deemed temporary. Investment securities, including the mortgage-backed securities and corporate securities, are evaluated on a periodic basis to determine if factors are identified that would require further analysis. In evaluating the Company’s securities, management considers the following items: • The Company’s ability and intent to hold the securities, including an evaluation of the need to sell the security to meet certain liquidity measures, or whether the Company has sufficient levels of cash to hold the identified security in order to recover the entire amortized cost of the security; • The financial condition of the underlying issuer; • The credit ratings of the underlying issuer and if any changes in the credit rating have occurred; • The length of time the security’s fair value has been less than amortized cost; and • Adverse conditions related to the security or its issuer if the issuer has failed to make scheduled payments or other factors. If the above factors indicate an additional analysis is required, management will perform a discounted cash flow analysis evaluating the security. As of December 31, 2016, the equity securities include investments in other financial institutions for market appreciation purposes. These equities had a purchase price of $2.8 million and market value of $7.8 million as of December 31, 2016. As of December 31, 2016, equity securities also included $14.1 million in investment funds that do not have a quoted market price, but use net asset value per share or its equivalent to measure fair value. The investment funds include $3.3 million in funds that are primarily invested in community development loans that are guaranteed by the Small Business Administration (SBA). Because the funds are primarily guaranteed by the federal government there are minimal changes in market value between accounting periods. These funds can be redeemed within 60 day’s notice at the net asset value less unpaid management fees with the approval of the fund manager. As of December 31, 2016, the net amortized cost equaled the market value of the investment. There are no unfunded commitments related to this investment. The investment funds also include $10.8 million in funds that are invested in government guaranteed loans, mortgage-backed securities, small business loans and other instruments supporting affordable housing and economic development. The Company may redeem these funds at the net asset value calculated at the end of the current business day less any unpaid management fees. As of December 31, 2016, the amortized cost of these securities was $11.2 million and the fair value was $10.8 million. There are no restrictions on redemptions for the holdings in these investments other than the notice required by the fund manager. There are no unfunded commitments related to this investment. NOTE 5 - LOANS AND LEASES AND OTHER REAL ESTATE The following sets forth the composition of Lakeland’s loan and lease portfolio: As of December 31, 2016 and 2015, home equity and consumer loans included overdraft deposit balances of $364,000 and $705,000, respectively. At December 31, 2016 and December 31, 2015, Lakeland had $942.0 million and $738.7 million in loans pledged for potential borrowings at the Federal Home Loan Bank of New York (“FHLB”). Purchased Credit Impaired Loans The carrying value of loans acquired in the Pascack acquisition and accounted for in accordance with ASC Subtopic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality,” was $627,000 at December 31, 2016, which was $190,000 less than the balance at the time of acquisition on January 7, 2016. The carrying value of loans acquired in the Harmony acquisition was $781,000 at December 31, 2016 which was substantially the same as the balance at acquisition date on July 1, 2016. Under ASC Subtopic 310-30, these loans, referred to as purchased credit impaired (“PCI”) loans, may be aggregated and accounted for as pools of loans if the loans being aggregated have common risk characteristics. The Company elected to account for the loans with evidence of credit deterioration individually rather than aggregate them into pools. The following table presents changes in the accretable yield for PCI loans (in thousands). There were no PCI loans in 2015. Portfolio Segments Lakeland currently manages its credit products and the respective exposure to credit losses (credit risk) by the following specific portfolio segments which are levels at which Lakeland develops and documents its systematic methodology to determine the allowance for loan and lease losses attributable to each respective portfolio segment. These segments are: • Commercial, secured by real estate - consists of commercial mortgage loans secured by owner occupied properties and non-owner occupied properties. The loans secured by owner occupied properties involve a variety of property types to conduct the borrower’s operations. The primary source of repayment for this type of loan is the cash flow from the business and is based upon the borrower’s financial health and the ability of the borrower and the business to repay. The loans secured by non-owner occupied properties involve investment properties for warehouse, retail, office space, etc., with a history of occupancy and cash flow. This commercial real estate category contains mortgage loans to the developers and owners of commercial real estate where the borrower intends to operate or sell the property at a profit and use the income stream or proceeds from the sale(s) to repay the loan. • Commercial, industrial and other - are loans made to provide funds for equipment and general corporate needs. Repayment of a loan primarily uses the funds obtained from the operation of the borrower’s business. Commercial loans also include lines of credit that are utilized to finance a borrower’s short-term credit needs and/or to finance a percentage of eligible receivables and inventory. • Leases - includes a small portfolio of equipment leases, which consists of leases primarily for essential equipment used by small to medium sized businesses. • Real estate - residential mortgage - contains permanent mortgage loans principally to consumers secured by residential real estate. Residential real estate loans are evaluated for the adequacy of repayment sources at the time of approval, based upon measures including credit scores, debt-to-income ratios, and collateral values. Loans may be either conforming or non-conforming. • Real estate-construction - construction loans, as defined, are intended to finance the construction of commercial properties and include loans for the acquisition and development of land. Construction loans represent a higher degree of risk than permanent real estate loans and may be affected by a variety of factors such as the borrower’s ability to control costs and adhere to time schedules and the risk that constructed units may not be absorbed by the market within the anticipated time frame or at the anticipated price. The loan commitment on these loans often includes an interest reserve that allows the lender to periodically advance loan funds to pay interest charges on the outstanding balance of the loan. • Home equity and consumer - includes primarily home equity loans and lines, installment loans, personal lines of credit and automobile loans. The home equity category consists mainly of loans and revolving lines of credit to consumers which are secured by residential real estate. These loans are typically secured with second mortgages on the homes, although many are secured with first mortgages. Other consumer loans include installment loans used by customers to purchase automobiles, boats and recreational vehicles. Non-accrual and Past Due Loans The following schedule sets forth certain information regarding Lakeland’s non-accrual loans and leases, its other real estate owned and other repossessed assets, and accruing troubled debt restructurings (“TDRs”) (in thousands): Non-accrual loans included $2.4 million and $2.5 million of TDRs for the years ended December 31, 2016 and 2015, respectively. As of December 31, 2016, the Company had $3.7 million in residential mortgages and consumer home equity loans included in the table above that were in the process of foreclosure. An age analysis of past due loans, segregated by class of loans as of December 31, 2016 and 2015 is as follows: Impaired Loans Lakeland’s policy regarding impaired loans is discussed in Note 1 - Summary of Accounting Policies - Loans and Leases and Allowance for Loan and Lease Losses. The Company defines impaired loans as all non-accrual loans with recorded investments of $500,000 or greater. Impaired loans also includes all loans modified in troubled debt restructurings. Interest which would have been accrued on impaired loans and leases during 2016, 2015 and 2014 was $1.7 million, $1.6 million and $1.8 million, respectively. Credit Quality Indicators The class of loans are determined by internal risk rating. Management closely and continually monitors the quality of its loans and leases and assesses the quantitative and qualitative risks arising from the credit quality of its loans and leases. It is the policy of Lakeland to require that a Credit Risk Rating be assigned to all commercial loans and loan commitments. The Credit Risk Rating System has been developed by management to provide a methodology to be used by Loan Officers, Department Heads and Senior Management in identifying various levels of credit risk that exist within Lakeland’s loan portfolios. The risk rating system assists Senior Management in evaluating Lakeland’s loan portfolio, analyzing trends and determining the proper level of required reserves to be recommended to the Board. In assigning risk ratings, management considers, among other things, a borrower’s debt service coverage, earnings strength, loan to value ratios, industry conditions and economic conditions. Management categorizes loans and commitments into a one (1) to nine (9) numerical structure with rating 1 being the strongest rating and rating 9 being the weakest. Ratings 1 through 5W are considered “Pass” ratings. “Pass” ratings on loans are given to loans that management considers to be of acceptable or better quality. A rating of 5W, or “Watch” is a loan that requires more than the usual amount of monitoring due to declining earnings, strained cash flow, increasing leverage and/or weakening market. These borrowers generally have limited additional debt capacity and modest coverage and average or below average asset quality, margins and market share. Rating 6, “Other Assets Especially Mentioned” is used for loans exhibiting identifiable credit weakness which if not checked or corrected could weaken the loan quality or inadequately protect the bank’s credit position at some future date. Rating 7, “Substandard,” is used on loans that are inadequately protected by the current sound worth and paying capacity of the obligors or of the collateral pledged, if any. A substandard loan has a well-defined weakness or weaknesses that may jeopardize the liquidation of the debt. Rating 8, “Doubtful,” are loans that exhibit all of the weaknesses inherent in substandard loans, but have the added characteristics that the weaknesses make collection or liquidation in full improbable on the basis of existing facts. Rating 9, “Loss,” is a rating for loans or portions of loans that are considered uncollectible and of such little value that their continuance as bankable loans is not warranted. The following table shows Lakeland’s commercial loan portfolio as of December 31, 2016 and 2015, by the risk ratings discussed above (in thousands): This table does not include residential mortgage loans, consumer loans, or leases because they are evaluated on their payment status. Allowance for Loan and Lease Losses In 2015, the Company refined and enhanced its assessment of the adequacy of the allowance for loan and lease losses by extending the lookback period on its commercial loan portfolios from three years to five years and by extending the lookback period for all other portfolios from two to three years in order to capture more of the economic cycle. It also enhanced its qualitative factor framework to include a factor that captures the risk related to appraised real estate values, and how those values could change in relation to a change in capitalization rates. This enhancement is meant to increase the level of precision in the allowance for loan and lease losses. As a result, the Company will no longer have an “unallocated” segment in its allowance for loan losses, as the risks and uncertainties meant to be captured by the unallocated allowance have been included in the qualitative framework for the respective portfolios. As such, the unallocated allowance has in essence been reallocated to the certain portfolios based on the risks and uncertainties it was meant to capture. The following table details activity in the allowance for loan and lease losses by portfolio segment and the related recorded investment in loans and leases for the years ended December 31, 2016, 2015 and 2014: (1) Excludes deferred fees (1) Excludes deferred fees (1) Excludes deferred fees Lakeland also maintains a reserve for unfunded lending commitments which are included in other liabilities. This reserve was $2.5 million and $2.0 million at December 31, 2016 and December 31, 2015, respectively. Lakeland analyzes the adequacy of the reserve for unfunded lending commitments in conjunction with its analysis of the adequacy of the allowance for loan and lease losses. For more information on this analysis, see “Risk Elements” in Management’s Discussion and Analysis. Troubled Debt Restructurings TDRs are those loans where significant concessions have been made due to borrowers’ financial difficulties. Restructured loans typically involve a modification of terms such as a reduction of the stated interest rate, an extended moratorium of principal payments and/or an extension of the maturity date at a stated interest rate lower than the current market rate of a new loan with similar risk. Lakeland considers the potential losses on these loans as well as the remainder of its impaired loans when considering the adequacy of the allowance for loan losses. The following table summarizes loans that have been restructured during the periods presented: The following table presents loans modified as TDRs within the previous 12 months from December 31, 2016 and 2015 that have defaulted during the subsequent twelve months: Related Party Loans Lakeland has entered into lending transactions in the ordinary course of business with directors, executive officers, principal stockholders and affiliates of such persons on similar terms, including interest rates and collateral, as those prevailing for comparable transactions with other borrowers not related to Lakeland. At December 31, 2016 and 2015, loans to these related parties amounted to $22.3 million and $28.4 million, respectively. There were new loans of $5.8 million to related parties and repayments of $11.9 million from related parties in 2016. Mortgages Held for Sale Residential mortgages originated by the bank and held for sale in the secondary market are carried at the lower of cost or fair market value. Fair value is generally determined by the value of purchase commitments on individual loans. Losses are recorded as a valuation allowance and charged to earnings. As of December 31, 2016, Lakeland had $1.7 million in mortgages held for sale compared to $1.2 million as of December 31, 2015. Leases Future minimum lease payments of lease receivables are as follows (in thousands): Other Real Estate and Other Repossessed Assets At December 31, 2016, Lakeland had other real estate owned and other repossessed assets of $1.1 million and $9,000, respectively. The other real estate owned that the Company held at December 31, 2016 included $1.1 million in residential property acquired as a result of foreclosure proceedings or through a deed in lieu of foreclosure. At December 31, 2015, Lakeland had other real estate owned and other repossessed assets of $934,000 and $49,000, respectively. The other real estate owned that the Company held at December 31, 2015 included $805,000 in residential property acquired as a result of foreclosure proceedings or through a deed in lieu of foreclosure. For the years ended December 31, 2016, 2015 and 2014, Lakeland had writedowns of $0, $119,000 and $135,000, respectively, on other real estate and other repossessed assets which are included in other real estate and repossessed asset expense in the Statement of Income. NOTE 6 - PREMISES AND EQUIPMENT Depreciation expense was $5.0 million, $4.0 million and $3.9 million for the years ended December 31, 2016, 2015 and 2014, respectively. NOTE 7 - TIME DEPOSITS At December 31, 2016, the schedule of maturities of certificates of deposit is as follows (in thousands): NOTE 8 - DEBT Lines of Credit As a member of the Federal Home Loan Bank of New York (FHLB), Lakeland has the ability to borrow overnight based on the market value of collateral pledged. As of December 31, 2016 and 2015, there were no overnight borrowings from the FHLB. As of December 31, 2016, Lakeland also had overnight federal funds lines available for it to borrow up to $192.0 million. Lakeland had borrowed $32.0 million and $115.0 million against these lines as of December 31, 2016 and 2015, respectively. Lakeland may also borrow from the discount window of the Federal Reserve Bank of New York based on the market value of collateral pledged. Lakeland had no borrowings with the Federal Reserve Bank of New York as of December 31, 2016 or 2015. Federal Funds Purchased and Securities Sold Under Agreements to Repurchase Short-term borrowings at December 31, 2016 and 2015 consisted of short-term securities sold under agreements to repurchase and federal funds purchased. Securities underlying the agreements were under Lakeland’s control. The following tables summarize information relating to securities sold under agreements to repurchase and federal funds purchased for the years presented. For purposes of the tables, the average amount outstanding was calculated based on a daily average. Other Borrowings FHLB Debt At December 31, 2016, advances from the FHLB totaling $220.9 million will mature within four years. These advances are collateralized by certain securities and first mortgage loans. The advances had a weighted average interest rate of 1.81%. At December 31, 2015, advances from the FHLB totaling $221.9 million will mature within three years. These advances are collateralized by certain securities and first mortgage loans. The advances had a weighted average interest rate of 1.38%. FHLB debt matures as follows (in thousands): Long-term Securities Sold Under Agreements to Repurchase At December 31, 2016, Lakeland had $40.0 million in long-term securities sold under agreements to repurchase compared to $50.0 million at December 31, 2015. These borrowings were able to be called at various dates starting in 2010. These borrowings are collateralized by certain securities. The borrowings had a weighted average interest rate of 3.26% and 2.80% on December 31, 2016 and December 31, 2015, respectively. These long-term securities sold under agreements to repurchase mature as follows (in thousands): The above FHLB debt and long-term securities sold under agreements to repurchase are collateralized by certain securities. At times the market value of securities collateralizing our borrowings may decline due to changes in interest rates and may necessitate our lenders to issue a “margin call” which requires Lakeland to pledge additional securities to meet that margin call. As of December 31, 2016, the Company had $81.6 million in mortgage-backed securities pledged for its short-term and long-term securities sold under agreements to repurchase. Subordinated Debentures On September 30, 2016, the Company completed an offering of $75.0 million of fixed to floating rate subordinated notes due September 30, 2026. The notes will bear interest at a rate of 5.125% per annum until September 30, 2021 and will then reset quarterly to the then current three-month LIBOR plus 397 basis points until maturity in September, 2026, or their earlier redemption. The debt is included in Tier 2 capital for Lakeland Bancorp. Debt issuance costs totaled $1.5 million and are being amortized to maturity. Subordinated debt is presented net of issuance costs on the consolidated balance sheet. In May 2007, the Company issued $20.6 million of junior subordinated debentures due August 31, 2037 to Lakeland Bancorp Capital Trust IV, a Delaware business trust. The distribution rate on these securities was 6.61% for 5 years and floats at LIBOR plus 152 basis points thereafter. The debentures are the sole asset of the Trust. The Trust issued 20,000 shares of trust preferred securities, $1,000 face value, for total proceeds of $20.0 million. The Company’s obligations under the debentures and related documents, taken together, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the Trust’s obligations under the preferred securities. The preferred securities are callable by the Company on or after August 1, 2012, or earlier if the deduction of related interest for federal income taxes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The preferred securities must be redeemed upon maturity of the debentures in 2037. On August 3, 2015, the Company acquired and extinguished $10.0 million of Lakeland Bancorp Capital Trust IV debentures and recorded a $1.8 million gain on the extinguishment of debt. In June 2003, the Company also issued $20.6 million of junior subordinated debentures due June 30, 2033 to Lakeland Bancorp Capital Trust II, a Delaware business trust. The distribution rate on these securities was 5.71% for 5 years and floats at LIBOR plus 310 basis points thereafter. The debentures are the sole asset of the Trust. The Trust issued 20,000 shares of trust preferred securities, $1,000 face value, for total proceeds of $20.0 million. The Company’s obligations under the debentures and related documents, taken together, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the Trust’s obligations under the preferred securities. The preferred securities are callable by the Company on or after June 30, 2008, or earlier if the deduction of related interest for federal income taxes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The preferred securities must be redeemed upon maturity of the debentures in 2033. In June 2016, the Company entered into two cash flow swaps in order to hedge the variable cash outflows associated with the junior subordinated debentures issued to Lakeland Capital Trust II and Lakeland Capital Trust IV. For more information please see Note 18 - Derivatives. NOTE 9 - STOCKHOLDERS’ EQUITY On December 14, 2016, the Company successfully completed an at-the-market common stock issuance. A total of 2,739,650 shares of the Company’s common stock were sold at a weighted average price of $18.25, representing gross proceeds to the Company of approximately $50.0 million. Net proceeds from the transaction, after the sales commission and other expenses, were approximately $48.7 million. On July 1, 2016, the Company completed its acquisition of Harmony Bank, a bank located in Ocean County, NJ. Lakeland Bancorp issued an aggregate of 3,201,109 shares of its common stock in the merger. Outstanding Harmony stock options were paid out in cash at the difference between $14.31 (Lakeland’s closing stock price on July 1, 2016 of $11.45 multiplied by 1.25) and the average strike price of $9.07 for a total cash payment of $869,000. On January 7, 2016, the Company completed its acquisition of Pascack Bancorp, Inc. (“Pascack”), a bank holding company headquartered in Waldwick, New Jersey. Lakeland Bancorp issued 3,314,284 shares of its common stock in the merger and paid approximately $4.5 million in cash, including the cash paid in connection with the cancellation of Pascack stock options. Outstanding Pascack stock options were paid out in cash at the difference between $11.35 and an average strike price of $7.37 for a total cash payment of $122,000. In the second quarter of 2014, the Company paid a 5% stock dividend. NOTE 10 - INCOME TAXES The components of income taxes are as follows: The income tax provision reconciled to the income taxes that would have been computed at the statutory federal rate of 35% is as follows: The net deferred tax asset consisted of the following: The Company recorded net deferred tax assets (liabilities) of $4.4 million and ($164,000) as a result of the acquisitions of Pascack and Harmony, respectively. The Company evaluates the realizability of its deferred tax assets by examining its earnings history and projected future earnings and by assessing whether it is more likely than not that carryforwards would not be realized. Based upon the majority of the Company’s deferred tax assets having no expiration date, the Company’s earnings history, and the projections of future earnings, the Company’s management believes that it is more likely than not that all of the Company’s deferred tax assets as of December 31, 2016 will be realized. The Company evaluates tax positions that may be uncertain using a recognition threshold of more likely than not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. The Company had an unrecognized tax benefit of $111,000 as of December 31, 2013. In 2014, the Company reevaluated this unrecognized tax benefit and concluded that based on current information the tax position that it has taken is more likely than not to be upheld. Therefore, the Company recognized the tax benefit in the fourth quarter of 2014. The Company is subject to U.S. federal income tax law as well as income tax of various state jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few significant exceptions, the Company is no longer subject to U.S. federal examinations by tax authorities for the years before 2014 or to state and local examinations by tax authorities for the years before 2013. NOTE 11 - EMPLOYEE BENEFIT PLANS Profit Sharing Plan The Company has a profit sharing plan for all its eligible employees. The Company’s annual contribution to the plan is determined by its Board of Directors. Annual contributions are allocated to participants on a point basis with accumulated benefits payable at retirement, or, at the discretion of the plan committee, upon termination of employment. Contributions made by the Company were approximately $600,000 a year for each of the years ended 2016, 2015, and 2014. Benefit Obligations from Somerset Hills Acquisition Somerset Hills, acquired by the Company in 2013, entered into a non-qualified Supplemental Executive Retirement Plan (“SERP”) with its former Chief Executive Officer and its Chief Financial Officer which entitles them to a benefit of $48,000 and $24,000, respectively, per year for 15 years after the earlier of retirement or death. The beneficiary of the Chief Financial Officer is currently being paid out under the plan. As of December 31, 2016 and 2015, the Company has a liability of $717,000 and $745,000, respectively, for these SERPs and has recognized an expense of $0, $95,000 and $109,000 in 2016, 2015 and 2014, respectively. Retirement Savings Plans (401(k) plans) Beginning in January 2002, the Company began contributing to its 401(k) plan. All eligible employees can contribute a portion of their annual salary with the Company matching up to 50% of the employee’s contributions. The Company’s contributions in 2016, 2015 and 2014 totaled $911,000, $760,000 and $740,000, respectively. Pension Plan Newton Trust Company, acquired by the Company in 2004, had a defined benefit pension plan (the Plan) that was frozen prior to the acquisition by the Company. All participants of the Plan ceased accruing benefits as of that date. In 2014, the Company filed appropriate forms with the Internal Revenue Service and the Pension Benefit Guaranty Corporation to terminate the Plan and awaited approval from both entities. As a result of the Company’s intent to terminate the plan, the Company changed the portfolio allocation of the plan to minimize the fluctuation of the market value of the Plan’s assets. The Company also recorded a realized loss for the difference between the plan assets and the estimated payout of the plan of approximately $293,000 in 2014 and $238,000 in 2015. In 2015, the Company received the requisite approvals and terminated the plan. The Company made lump sum payments totaling $2.6 million as a result of this termination. The accumulated benefit obligation as of December 31, 2015 is as follows: The components of net periodic pension cost are as follows: Deferred Compensation Arrangements High Point Financial Corp., a bank holding company acquired in 1999, had established deferred compensation arrangements for certain directors and executives of High Point Financial Corp. and its subsidiary, the National Bank of Sussex County. The deferred compensation plans differ, but generally provide for annual payments for ten to fifteen years following retirement. The Company’s liabilities under these arrangements are being accrued from the commencement of the plans over the participants’ remaining periods of service. The Company intends to fund its obligations under the deferred compensation arrangements with the increase in cash surrender value of life insurance policies that it has purchased on the respective participants. The deferred compensation plans do not hold any assets. For the years ended December 31, 2016, 2015 and 2014, there were expenses related to this plan of $3,000, $4,000 and $16,000, respectively. As of December 31, 2016 and 2015, the accrued liability for these plans was $214,000 and $241,000, respectively. Supplemental Executive Retirement Plans In 2003, the Company entered into a supplemental executive retirement plan (SERP) agreement with its former CEO that provides annual retirement benefits of $150,000 a year for a 15 year period when the former CEO reached the age of 65. Our former CEO retired and is receiving annual retirement benefits pursuant to the plan. In 2008, the Company entered into a SERP agreement with its current CEO that provides annual retirement benefits of $150,000 for a 15 year period when the CEO reaches the age of 65. In November 2008, the Company entered into a SERP with its Regional President and Chief Operating Officer that provides annual retirement benefits of $90,000 a year for a 10 year period upon his reaching the age of 65. In December 2014, the Company entered into a SERP with a Regional President that provides $84,500 a year for a 15 year period upon his reaching the age of 66 in November 2016. The Company intends to fund its obligations under the deferred compensation arrangements with the increase in cash surrender value of bank owned life insurance policies. In 2016, 2015 and 2014, the Company recorded compensation expense of $746,000, $814,000 and $359,000, respectively, for these plans. Deferred Compensation Agreement In February 2015, the Company entered into a Deferred Compensation Agreement with its CEO where it would contribute $16,500 monthly into a deferral account which would earn interest at an annual rate of the Company’s prior year return on equity, provided that the Company’s return on equity remained in a range of 0% to 15%. The Company has agreed to make such contributions each month that the CEO is actively employed from February 2015 through December 31, 2022. The expense incurred in 2016 and 2015 was $222,000 and $188,000, respectively, and the accrued liability at December 31, 2016 and 2015 was $410,000 and $188,000, respectively. Following the CEO’s normal retirement date, he shall be paid out in 180 consecutive monthly installments. Elective Deferral Plan In March 2015, the Company established an Elective Deferral Plan for eligible executives in which the executive may elect to contribute a portion of his base salary and bonus to a deferral account which will earn an interest rate of 75% of the Company’s prior year return on equity provided that the return on equity remains in the range of 0% to 15%. The Company recorded an expense of $22,000 and $3,000 in 2016 and 2015, respectively, and had a liability recorded of $512,000 and $190,000 at December 31, 2016 and 2015, respectively. NOTE 12 - DIRECTORS RETIREMENT PLAN The Company provides a plan that any director who became a member of the Board of Directors prior to 2009 who completes five years of service may retire and continue to be paid for a period of ten years at a rate ranging from $5,000 through $17,500 per annum, depending upon years of credited service. This plan is unfunded. The following tables present the status of the plan and the components of net periodic plan cost for the years then ended. The measurement date for the accumulated benefit obligation is December 31 of the years presented. A discount rate of 3.68% and 3.87% was assumed in the plan valuation for 2016 and 2015, respectively. As the benefit amount is not dependent upon compensation levels, a rate of increase in compensation assumption was not utilized in the plan valuation. The director’s retirement plan holds no plan assets. The benefits expected to be paid in each of the next five years and in aggregate for the five years thereafter are as follows (in thousands): The Company expects its contribution to the director’s retirement plan to be $70,000 in 2017. The amount in accumulated other comprehensive income expected to be recognized as a component of net periodic benefit cost in 2017 is $1,000. NOTE 13 - STOCK-BASED COMPENSATION Employee Stock Option Plans The Company’s shareholders approved the 2009 Equity Compensation Program, which authorizes the granting of incentive stock options, supplemental stock options, restricted shares and restricted stock units to employees of the Company, including those employees serving as officers and directors of the Company. The plan authorizes the issuance of up to 2.3 million shares in connection with options and awards granted under the 2009 program. The Company’s stock option grants under this plan expire 10 years from the date of grant, ninety days after termination of service other than for cause, or one year after death or disability of the grantee. In 2014, the Company began issuing restricted stock units (RSUs), some of which have performance conditions attached to them. The Company generally issues shares for option exercises from its treasury stock using the cost method or issues new shares if no treasury shares are available. The Company established the 2000 Equity Compensation Program which authorizes the granting of incentive stock options, supplemental stock options and restricted stock to employees of the Company, which includes those employees serving as officers and directors of the Company. The plan authorized 2,613,185 shares of common stock of the Company. All of the Company’s stock option grants expire 10 years from the date of grant, thirty days after termination of service other than for cause, or one year after death or disability of the grantee. The Company has no option or restricted stock awards with market or performance conditions attached to them under the 2000 Equity Compensation Program. No further awards will be granted from the 2000 program. The Company has outstanding stock options issued to its directors as well as options assumed under the Somerset Hills’ stock option plans at the time of merger. As of both December 31, 2016 and 2015, 111,829 options granted to directors were outstanding. As of December 31, 2016 and 2015, there were 23,415 and 64,057 options outstanding, respectively, under the Somerset Hills’ stock option plans. Excess tax benefits of stock based compensation were $67,000, $59,000 and $70,000 for the years 2016, 2015 and 2014, respectively. A summary of the status of the Company’s option plans as of December 31, 2016 and the changes during the year ending on that date is represented below. A summary of the Company’s non-vested options under the Company’s option plans as of December 31, 2016 and changes for the year then ended is presented below. As of December 31, 2016, there was $14,000 of unrecognized compensation expense related to unvested stock options under the 2009 Equity Compensation Program. Compensation expense recognized for stock options was $35,000, $35,000 and $42,000 for 2016, 2015 and 2014, respectively. The aggregate intrinsic values of options exercised in 2016 and 2015 were $292,000 and $68,000, respectively. Exercise of stock options during 2016 and 2015 resulted in cash receipts of $285,000 and $124,000, respectively. The total fair value of options that vested in 2016 and 2015 were $35,000 and $35,000, respectively. Information regarding the Company’s restricted stock for the year ended December 31, 2016 is as follows: In 2016 the Company granted 23,952 shares of restricted stock to non-employee directors at a grant date fair value of $10.02 per share under the Company’s 2009 Equity Compensation Program. These shares will vest over a one year period, totaling $240,000 in compensation expense. No restricted stock was granted in 2015. In 2014, the Company granted 1,942 shares of restricted stock at a grant date fair value of $11.21 per share under the Company’s 2009 Equity Compensation Program. These shares vest over a five year period. Compensation expense on these shares is expected to average approximately $4,000 per year for the next five years. The total fair value of the restricted stock vested during the year ended December 31, 2016 was approximately $507,000. Compensation expense recognized for restricted stock was $353,000, $497,000 and $707,000 in 2016, 2015 and 2014, respectively. There was approximately $74,000 in unrecognized compensation expense related to restricted stock grants as of December 31, 2016, which is expected to be recognized over a period of 0.38 years. In 2016, the Company granted 180,926 RSUs at a weighted average grant date fair value of $10.45 per share under the Company’s 2009 Equity Compensation Program. These units vest within a range of two to three years. A portion of these RSUs will vest subject to certain performance conditions in the restricted stock unit agreement. There are also certain provisions in the compensation program which state that if a holder of the RSUs reaches a certain age and years of service, the person has effectively earned a portion of the RSUs at that time. Compensation expense on these restricted stock units is expected to average approximately $630,000 per year over a three year period. In 2015, the Company granted 137,009 RSUs at a weighted average grant date fair value of $11.08 per share under the Company’s 2009 Equity Compensation Program. These units vest within a range of two to three years. Compensation expense on these restricted stock units is expected to average approximately $506,000 per year over a three year period. In 2014, the Company granted 127,791 RSUs at a weighted average grant date fair value of $10.65 per share under the Company’s 2009 Equity Compensation Program. Compensation expense on these restricted stock units is expected to average $453,000 per year over a three year period. Compensation expense for restricted stock units was $1.5 million, $1.1 million and $641,000 in 2016, 2015 and 2014, respectively. There was approximately $1.4 million in unrecognized compensation expense related to restricted stock units as of December 31, 2016, which is expected to be recognized over a period of 1.2 years. Information regarding the Company’s RSUs and changes during the year ended December 31, 2016 is as follows: NOTE 14 - COMMITMENTS AND CONTINGENCIES Lease Obligations Lakeland is obligated under various non-cancelable operating leases on building and land used for office space and banking purposes. These leases contain renewal options and escalation clauses. Rent expense under long-term operating leases amounted to approximately $3.2 million, $2.7 million and $2.7 million for the years ended December 31, 2016, 2015 and 2014, respectively, including rent expense to related parties of $141,000 in 2016, $143,000 in 2015, and $139,000, in 2014. At December 31, 2016, the minimum commitments under all noncancellable leases with remaining terms of more than one year and expiring through 2033 are as follows (in thousands): Litigation There are no pending legal proceedings involving the Company or Lakeland other than those arising in the normal course of business. Management does not anticipate that the potential liability, if any, arising out of such legal proceedings will have a material effect on the financial condition or results of operations of the Company and Lakeland on a consolidated basis. NOTE 15 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK Lakeland is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the consolidated financial statements when they become payable. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement Lakeland has in particular classes of financial instruments. Lakeland’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. Lakeland uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Lakeland generally requires collateral or other security to support financial instruments with credit risk. The approximate contract amounts are as follows: At December 31, 2016 and 2015 there were $10,000 and $8,000, respectively, in commitments to lend additional funds to borrowers whose terms have been modified in troubled debt restructurings. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Lakeland evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Lakeland upon extension of credit, is based on management’s credit evaluation. Standby letters of credit are conditional commitments issued by Lakeland to guarantee the payment by or performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Lakeland holds deposit accounts, residential or commercial real estate, accounts receivable, inventory and equipment as collateral to support those commitments for which collateral is deemed necessary. The extent of collateral held for those commitments at December 31, 2016 and 2015 varies based on management’s credit evaluation. Lakeland issues financial and performance letters of credit. Financial letters of credit require Lakeland to make payment if the customer fails to make payment, as defined in the agreements. Performance letters of credit require Lakeland to make payments if the customer fails to perform certain non-financial contractual obligations. Lakeland defines the initial fair value of these letters of credit as the fees received from the customer. Lakeland records these fees as a liability when issuing the letters of credit and amortizes the fee over the life of the letter of credit. The maximum potential undiscounted amount of future payments of these letters of credit as of December 31, 2016 is $15.2 million and they expire through 2024. Lakeland’s exposure under these letters of credit would be reduced by actual performance, subsequent termination by the beneficiaries and by any proceeds that Lakeland obtained in liquidating the collateral for the loans, which varies depending on the customer. As of December 31, 2016, Lakeland had $922.0 million in loan and lease commitments, with $646.1 million maturing within one year, $128.4 million maturing after one year but within three years, $12.7 million maturing after three years but within five years, and $134.9 million maturing after five years. As of December 31, 2016, Lakeland had $15.2 million in standby letters of credit, with $14.6 million maturing within one year, $481,000 maturing after one year but within three years, $32,000 maturing after three years but within five years and $80,000 maturing after five years. Lakeland grants loans primarily to customers in New Jersey, the Hudson Valley Region in New York State, and surrounding areas. Certain of Lakeland’s consumer loans and lease customers are more diversified nationally. Although Lakeland has a diversified loan portfolio, a large portion of its loans are secured by commercial or residential real property. Although Lakeland has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the economy. Commercial and standby letters of credit were granted primarily to commercial borrowers. NOTE 16 - COMPREHENSIVE INCOME The Company reports comprehensive income in addition to net income (loss) from operations. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. The following table shows the changes in the balances of each of the components of other comprehensive income for the periods presented: Note: All amounts are net of tax. NOTE 17 - FAIR VALUE MEASUREMENT AND FAIR VALUE OF FINANCIAL INSTRUMENTS Fair Value Measurement Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. U.S. GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest level priority to unobservable inputs (level 3 measurements). The following describes the three levels of fair value hierarchy: Level 1 - unadjusted quoted prices in active markets for identical assets or liabilities; includes U.S. Treasury Notes, and other U.S. Government Agency securities that actively trade in over-the-counter markets; equity securities and mutual funds that actively trade in over-the-counter markets. Level 2 - quoted prices for similar assets or liabilities in active markets; or quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs other than quoted prices that are observable for the asset or liability including yield curves, volatilities, and prepayment speeds. Level 3 - unobservable inputs for the asset or liability that reflect the Company’s own assumptions about assumptions that market participants would use in the pricing of the asset or liability and that are consequently not based on market activity but on particular valuation techniques. The Company’s assets that are measured at fair value on a recurring basis are its available for sale investment securities and its interest rate swaps. The Company obtains fair values on its securities using information from a third party servicer. If quoted prices for securities are available in an active market, those securities are classified as Level 1 securities. The Company has U.S. Treasury Notes and certain equity securities that are classified as Level 1 securities. Level 2 securities were primarily comprised of U.S. Agency bonds, residential mortgage-backed securities, obligations of state and political subdivisions and corporate securities. Fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models supported with market data information. Standard inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, bids and offers. On a quarterly basis, the Company reviews the pricing information received from the Company’s third party pricing service. This review includes a comparison to non-binding third-party quotes. The fair values of derivatives are based on valuation models using current market terms (including interest rates and fees), the remaining terms of the agreements and the credit worthiness of the counter-party as of the measurement date (Level 2). The following table sets forth the Company’s financial assets that were accounted for at fair value on a recurring basis as of the periods presented by level within the fair value hierarchy. During the year ended December 31, 2016 and 2015, the Company did not make any transfers between recurring Level 1 fair value measurements and recurring Level 2 fair value measurements. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement: (1) Derivatives (1) Non-hedging interest rate derivatives The following table sets forth the Company’s financial assets subject to fair value adjustments (impairment) on a non-recurring basis. Assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement: Impaired loans and leases are evaluated and valued at the time the loan is identified as impaired at the lower of cost or market value. Because most of Lakeland’s impaired loans are collateral dependent, fair value is generally measured based on the value of the collateral, less estimated costs to sell, securing these loans and leases and is classified at a level 3 in the fair value hierarchy. Collateral may be real estate, accounts receivable, inventory, equipment and/or other business assets. The value of the real estate is assessed based on appraisals by qualified third party licensed appraisers. The appraisers may use the income approach to value the collateral using discount rates (with ranges of 5-11%) or capitalization rates (with ranges of 5-9%) to evaluate the property. The value of the equipment may be determined by an appraiser, if significant, inquiry through a recognized valuation resource, or by the value on the borrower’s financial statements. Field examiner reviews on business assets may be conducted based on the loan exposure and reliance on this type of collateral. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Impaired loans and leases are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. The Company has a held for sale loan portfolio that consists of residential mortgages that are being sold in the secondary market. The Company records these mortgages at the lower of cost or fair market value. Fair value is generally determined by the value of purchase commitments. Other real estate owned (OREO) and other repossessed assets, representing property acquired through foreclosure, are carried at fair value less estimated disposal costs of the acquired property. Fair value on other real estate owned is based on the appraised value of the collateral using discount rates or capitalization rates similar to those used in impaired loan valuation. The fair value of other repossessed assets is estimated by inquiry through a recognized valuation resource. Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Changes in economic conditions, locally or nationally, could impact the value of the estimated amounts of impaired loans, OREO and other repossessed assets. Fair Value of Certain Financial Instruments Estimated fair values have been determined by the Company using the best available data and an estimation methodology suitable for each category of financial instruments. Management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values. The estimation methodologies used, the estimated fair values, and recorded book balances at December 31, 2016 and December 31, 2015 are outlined below. This summary, as well as the table below, excludes financial assets and liabilities for which carrying value approximates fair value. For financial assets, these include cash and cash equivalents. For financial liabilities, these include noninterest-bearing demand deposits, savings and interest-bearing transaction accounts and federal funds sold and securities sold under agreements to repurchase. The estimated fair value of demand, savings and interest-bearing transaction accounts is the amount payable on demand at the reporting date. Carrying value is used because there is no stated maturity on these accounts, and the customer has the ability to withdraw the funds immediately. Also excluded from this summary and the following table are those financial instruments recorded at fair value on a recurring basis, as previously described. The fair value of investment securities held to maturity was measured using information from the same third-party servicer used for investment securities available for sale using the same methodologies discussed above. Investment securities held to maturity includes $34.6 million in short-term municipal bond anticipation notes and $1.0 million in subordinated debt that are non-rated and do not have an active secondary market or information readily available on standard financial systems. As a result, the securities are classified as Level 3 securities. These are investments that management performs a credit analysis on before investing in these securities. Federal Home Loan Bank of New York (FHLB) stock is an equity interest that can be sold to the issuing FHLB, to other FHLBs, or to other member banks at its par value. Because ownership of these securities is restricted, they do not have a readily determinable fair value. As such, the Company’s FHLB stock is recorded at cost or par value and is evaluated for impairment each reporting period by considering the ultimate recoverability of the investment rather than temporary declines in value. The Company’s evaluation primarily includes an evaluation of liquidity, capitalization, operating performance, commitments, and regulatory or legislative events. The net loan portfolio at December 31, 2016 and December 31, 2015 has been valued using a present value discounted cash flow where market prices were not available. The discount rate used in these calculations is the estimated current market rate for new loans with similar credit risk. The valuation of our loan portfolio is consistent with accounting guidance but does not fully incorporate the exit price approach. For fixed maturity certificates of deposit, fair value was estimated based on the present value of discounted cash flows using the rates currently offered for deposits of similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value. The fair value of long-term debt is based upon the discounted value of contractual cash flows. The Company estimates the discount rate using the rates currently offered for similar borrowing arrangements. The fair value of subordinated debentures is based on bid/ask prices from brokers for similar types of instruments. The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The fair values of commitments to extend credit and standby letters of credit are deemed immaterial. The following table presents the carrying values, fair values and placement in the fair value hierarchy of the Company’s financial instruments as of December 31, 2016 and December 31, 2015: NOTE 18 - DERIVATIVES Lakeland is a party to interest rate derivatives that are not designated as hedging instruments. Under a program, Lakeland executes interest rate swaps with commercial lending customers to facilitate their respective risk management strategies. These interest rate swaps with customers are simultaneously offset by interest rate swaps that Lakeland executes with a third party, such that Lakeland minimizes its net risk exposure resulting from such transactions. Because the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. The changes in the fair value of the swaps offset each other, except for the credit risk of the counterparties, which is determined by taking into consideration the risk rating, probability of default and loss given default for all counterparties. As of December 31, 2016 and 2015, Lakeland had $7.5 million and $2.5 million, respectively, in securities pledged for collateral on its interest rate swaps. In June 2016, the Company entered into two cash flow hedges in order to hedge the variable cash outflows associated with its floating rate subordinated debentures (See Note 8). The notional value of these hedges was $30.0 million. The Company’s objective in using the cash flow hedge is to add stability to interest expense and to manage its exposure to interest rate movements. The Company used interest rate swaps designated as cash flow hedges which involved the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. In these particular hedges the Company is paying a third party an average of 1.10% in exchange for a payment at 3 month LIBOR. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges are recorded in accumulated other comprehensive income and are subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the year ended December 31, 2016, the Company did not record any hedge ineffectiveness. The Company recognized $49,000 of accumulated other comprehensive income that was reclassified into interest expense during 2016. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s debt. During the next twelve months, the Company estimates that $30,000 will be reclassified as an increase to interest expense should the rate environment remain the same. The following table presents summary information regarding these derivatives for the periods presented (dollars in thousands): NOTE 19 - REGULATORY MATTERS The Bank Holding Company Act of 1956 restricts the amount of dividends the Company can pay. Accordingly, dividends should generally only be paid out of current earnings, as defined. The New Jersey Banking Act of 1948 restricts the amount of dividends paid on the capital stock of New Jersey chartered banks. Accordingly, no dividends shall be paid by such banks on their capital stock unless, following the payment of such dividends, the capital stock of Lakeland will be unimpaired, and: (1) Lakeland will have a surplus, as defined, of not less than 50% of its capital stock, or, if not, (2) the payment of such dividend will not reduce the surplus, as defined, of Lakeland. Under these limitations, approximately $480.9 million was available for payment of dividends from Lakeland to the Company as of December 31, 2016. The Company and Lakeland are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possible additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Lakeland’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s and Lakeland’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and Lakeland’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Company and Lakeland to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 2016, that the Company and Lakeland met all capital adequacy requirements to which they are subject. As of December 31, 2016, the most recent notification from the FDIC categorized Lakeland as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, Lakeland must maintain minimum total risk-based, Tier 1 risk-based, common equity Tier 1 capital and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the institution’s category. As of December 31, 2016 and 2015, the Company and Lakeland have the following capital ratios based on the then current regulations: The final rules implementing the Basel Committee on Banking Supervisions capital guidelines for U.S. Banks became effective for the Company on January 1, 2015, with full compliance with all the final rule’s requirements phased in over a multi-year schedule, to be fully phased in by January 1, 2019. The Basel Rules require a “capital conservation buffer.” When fully phased in on January 1, 2019, the Company and Lakeland will be required to maintain a 2.5% capital conservation buffer in addition to the minimum capital ratios set forth in the above table. The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and increases by 0.625% every January 1 until it reaches 2.5% on January 1, 2019. NOTE 20 - GOODWILL AND OTHER INTANGIBLE ASSETS The Company has recorded goodwill of $135.7 million and $110.0 million at December 31, 2016 and December 31, 2015, respectively, which includes $10.5 million from the Harmony merger in 2016, $15.3 million from the Pascack merger in 2016 and $110.0 million from prior acquisitions. Core Deposit Intangible was $3.3 million on December 31, 2016 compared to $1.5 million on December 31, 2015. The Company recorded $1.0 million, $1.5 million and $2.7 million in core deposit intangible for the Harmony, Pascack and Somerset Hills acquisitions, respectively. In 2016, it has amortized $734,000 in core deposit intangible including $275,000, $366,000 and $93,000 for Pascack, Somerset Hills and Harmony, respectively. The estimated future amortization expense for each of the succeeding five years ended December 31 is as follows (in thousands): NOTE 21 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY CONDENSED BALANCE SHEETS CONDENSED STATEMENTS OF OPERATIONS CONDENSED STATEMENTS OF CASH FLOWS ITEM 9 | Based on the provided financial statement, here's a summary of the key points:
1. Operating Structure:
- The company operates as a single operating segment
- Primary market area is Northern and Central New Jersey and contiguous areas
- Chief Executive Officer is the main decision maker
2. Key Financial Components:
Assets:
- Fixed assets noted at $158,000
- Cash and cash equivalents (including regulatory reserves)
- Investment securities portfolio
- Loans and leases
Liabilities:
- Debt securities
- Retail deposits
- Other borrowings
3. Investment Securities Policy:
- Classified in three categories: held to maturity, trading, or available for sale
- Regular quarterly impairment evaluations
- No engagement in securities trading
- Other-than-temporary losses are recognized in income statements
4. Loan Management:
- Loans and leases held at unpaid principal amount
- Interest accrual discontinued when collection is doubtful
- Non-accrual status implemented after 90 days default
- Includes allowance for loan and lease losses
5. Notable Financial Practices:
- Conservative approach to impairment recognition
- Comprehensive risk management system
- Regular portfolio evaluation
- Integrated financial services structure
The statement suggests a traditional banking operation with standard risk management practices and conservative accounting policies. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA LBB & ASSOCIATES LTD., LLP 10260 Westheimer Road, Suite 310 Houston, TX 77042 Phone: (713) 800-4343 Fax: (713) 456-2408 ACCOUNTING FIRM To the Shareholders and Board of Directors of Texas Mineral Resources Corp. Sierra Blanca, Texas We have audited the accompanying balance sheets of Texas Mineral Resources Corp., (the “Company”) as of August 31, 2016 and 2015, and the related statements of operations, shareholders’ equity, and cash flows for each of the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits include consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Texas Mineral Resources Corp., as of August 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the financial statements, the Company’s absence of significant revenues, recurring losses from operations, and its need for additional financing in order to fund its projected loss in 2017 raise substantial doubt about its ability to continue as a going concern. The 2016 financial statements do not include any adjustments that might result from the outcome of this uncertainty. /S/ LBB & ASSOCIATES LTD., LLP LBB & Associates Ltd., LLP Houston, Texas December 14, 2016 TEXAS MINERAL RESOURCES CORP. BALANCE SHEETS The accompanying notes are an integral part of these financial statements. TEXAS MINERAL RESOURCES CORP. STATEMENTS OF OPERATIONS The accompanying notes are an integral part of these financial statements. TEXAS MINERAL RESOURCES CORP. STATEMENTS OF CASH FLOWS The accompanying notes are an integral part of these financial statements. TEXAS MINERAL RESOURCES CORP. STATEMENTS OF SHAREHOLDERS’ EQUITY The accompanying notes are an integral part of these financial statements. TEXAS MINERAL RESOURCES CORP. NOTES TO FINANCIAL STATEMENTS AUGUST 31, 2016 AND 2015 NOTE 1 - ORGANIZATION AND NATURE OF BUSINESS Texas Rare Earth Resources Corp (the “Company”) was incorporated in the State of Nevada in 1970. In July 2004, our articles of incorporation were amended and restated to increase the authorized capital to 25,000,000 common shares and, in April 2007, we effected a 1 for 2 reverse stock split. In September 2008, our articles of incorporation were further amended and restated to increase the authorized capital to 100,000,000 common shares with a par value of $0.01 per share and to authorize 10,000,000 preferred shares with a par value of $0.001 per share. Our fiscal year-end is August 31. Effective September 1, 2010, we changed our name from “Standard Silver Corporation” to “Texas Rare Earth Resources Corp.” We are now a mining company engaged in the business of the acquisition and development of mineral properties. As of the date of this filing, we hold two nineteen year leases, executed in September and November of 2011, to explore and develop a 950 acre rare earths project located in Hudspeth County, Texas known as the Round Top Project and prospecting permits covering an adjacent 9,345 acres. We also own unpatented mining claims in New Mexico. We are currently not evaluating any additional prospects, and intend to focus primarily on the development of our Round Top rare earth prospect. On August 24, 2012, we changed our state of incorporation from the State of Nevada to the State of Delaware (the “Reincorporation”) pursuant to a plan of conversion dated August 24, 2012. The Reincorporation was previously submitted to a vote of, and approved by, our stockholders at a special meeting of the stockholders held on April 25, 2012. On March 14, 2016, the Company filed a Certificate of Amendment with the Secretary of State of the State of Delaware to amend its Certificate of Incorporation to change the name of the Company from “Texas Rare Earth Resources Corp” to “Texas Mineral Resources Corp”. The amendment was effective on March 21, 2016. The Certificate of Amendment did not make any other amendments to the Company’s Certificate of Incorporation. The financial statements have been prepared on a going concern basis which assumes the Company will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future. The Company has incurred losses since inception resulting in an accumulated deficit of approximately $32,500,000 as of August 31, 2016 and further losses are anticipated in the development of its business raising substantial doubt about the Company’s ability to continue as a going concern. The ability to continue as a going concern is dependent upon the Company generating profitable operations in the future and/or to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. Management intends to finance operating costs over the next twelve months with existing cash on hand and loans from directors and or private placement of common stock. NOTE 2 - SUMMARY OF ACCOUNTING POLICIES Basis of Presentation Our financial records are maintained on the accrual basis of accounting whereby revenues are recognized when earned and expenses are recorded when incurred, in accordance with generally accepted accounting principles (“GAAP”) - United States. Cash and Cash Equivalents We consider all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents consist of demand deposits at commercial banks. We currently do not have cash deposits at financial institutions in excess of federally insured limits. Property and Equipment Our property and equipment consists primarily of vehicles, furniture and equipment, and are recorded at cost. Expenditures related to acquiring or extending the useful life of our property and equipment are capitalized. Expenditures for repair and maintenance are charged to operations as incurred. Depreciation is computed using the straight-line method over an estimated useful life of 3-20 years. Lease Deposits From time to time, the Company makes deposits in anticipation of executing leases. The deposits are capitalized upon execution of the applicable agreements. NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (Continued) Long-lived Assets The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through operations. To determine if these costs are in excess of their recoverable amount, periodic evaluation of carrying value of capitalized costs and any related property and equipment costs are based upon expected future cash flows and/or estimated salvage value in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC 360”), Property, Plant and Equipment. The Company’s assets susceptible to impairment analysis are the mineral properties described in foot note 4. The Company has not incurred any impairment losses and, therefore, no impairment is reflected in these financial statements as the mineral leases are in developments stages and are in good standing as of current, see foot note 4. Revenue Recognition We recognize revenue when persuasive evidence of an arrangement exists, services have been performed, the sales price is fixed or determinable, and collectability is probable. We have yet to generate any revenue. Mineral Exploration and Development Costs All exploration expenditures are expensed as incurred. Costs of acquisition and option costs of mineral rights are capitalized upon acquisition. Costs incurred to maintain current production or to maintain assets on a standby basis are charged to operations. If the Company does not continue with exploration after the completion of the feasibility study, the mineral rights will be expensed at that time. Costs of abandoned projects are charged to mining costs including related property and equipment costs. To determine if these costs are in excess of their recoverable amount, periodic evaluation of carrying value of capitalized costs and any related property and equipment costs are based upon expected future cash flows and/or estimated salvage value in accordance with ASC 360-10-35-15, Impairment or Disposal of Long-Lived Assets. Exploration costs were approximately $216,000 and $522,000 for the years ended August 31, 2016 and 2015, respectively. Share-based Payments The Company estimates the fair value of share-based compensation using the Black-Scholes valuation model, in accordance with the provisions of ASC 718, Stock Compensation and ASC 505, Share-Based Payments. Key inputs and assumptions used to estimate the fair value of stock options include the grant price of the award, the expected option term, volatility of our stock, the risk-free rate, and dividend yield. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the option holders, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by the Company. Amended 2008 Stock Option Plan In September 2008, the Board adopted our 2008 Stock Option Plan (the “2008 Plan”), which was also approved by our shareholders in September 2008. In May 2011, the board of directors adopted an amendment to our 2008 Plan (the “Amended 2008 Plan”), which was also approved by our shareholders in August 2011. The Amended 2008 Plan increased the number of shares available for grant from 2,000,000 to up to 5,000,000 shares of our common stock for awards to our officers, directors, employees and consultants. On February 15, 2012, our stockholders approved an increase of 2,000,000 of shares of common stock available for issuance under the amended 2008 Stock Option Plan (the “Plan”). As amended, the Plan provides for 7,000,000 shares of common stock for all awards. On February 24, 2016, the stockholders of the Company approved an amendment to the Company’s 2008 Stock Option Plan, pursuant to which the number of shares available under the plan was increase from 7,000,000 to 9,000,000 shares of common stock. Other provisions of the Amended 2008 Plan remain the same as under our 2008 Plan. As of August 31, 2016, a total of 3,780,000 shares of our common stock remained available for future grants under the Amended 2008 Plan. Income Taxes Income taxes are computed using the asset and liability method, in accordance with ASC 740, Income Taxes. Under the asset and liability method, deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities, and are measured using the currently enacted tax rates and laws. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized. Basic and Diluted Loss Per Share The Company computes loss per share in accordance with ASC 260, Earnings Per Share, which requires presentation of both basic and diluted earnings per share on the face of the Statements of Operations. Basic loss per share is computed by dividing net loss available to common shareholders by the weighted average number of outstanding common shares during the period. Diluted loss per share gives effect to all dilutive potential common shares outstanding during the period, including stock options and warrants using the treasury method. Dilutive loss per share excludes all potential common shares if their effect is anti-dilutive. NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (Continued) Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management believes that these financial statements include all normal and recurring adjustments necessary for a fair presentation under Generally Accepted Accounting Principles. Fair Value Measurements We account for assets and liabilities measured at fair value in accordance with ASC 820, Fair Value Measurements and Disclosures. ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified with Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).The three levels of inputs used to measure fair value are as follows: • Level 1: Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities traded in active markets. • Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. • Level 3: Inputs that are generally unobservable. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value. Our financial instruments consist principally of cash, accounts payable and accrued liabilities and note payable. The carrying amounts of such financial instruments in the accompanying financial statements approximate their fair values due to their relatively short-term nature. It is management’s opinion that the Company is not exposed to any significant currency or credit risks arising from these financial instruments. Recent Accounting Pronouncements Pronouncements between August 31, 2016 and the date of this filing are not expected to have a significant impact on our operations, financial position, or cash flow, nor does the Company expect the adoption of recently issued, but not yet effective, accounting pronouncements to have a significant impact on our results of operations, financial position or cash flows. Joint Venture On July 15, 2015, we entered into an operating agreement (“Operating Agreement”) with K-Tech, to formalize our joint venture company, Reetech, LLC, a Delaware limited liability company (the “Reetech”), for the purposes of developing, refining and marketing K-Tech’s CIX/CIC process pursuant to the February 24, 2015 letter of intent with K-Tech. Pursuant to the Operating Agreement, K-Tech holds an initial interest of 97.21% of Reetech for the contribution of its technology pursuant to a license to Reetech (the “Reetech License) and TMRC holds an initial interest of 2.79% pursuant to its contribution of cash payment of $391,000 to the prior development of the contributed Technology for the purposes of the joint venture. TMRC has the ability to earn a 49.9% interest in Reetech by contributing up to $7.0 million in cash contributions upon the satisfaction of certain development milestones. Reetech is governed by a board of managers comprised of three managers: one manager appointed by the Company, one manager appointed by K-Tech and one manager appointed by mutual agreement of the Company and K-Tech. The Company uses the cost method to account for its investment in the joint venture. Under the cost method, the Company recognizes its share of the earnings and losses of the joint venture as they accrue instead of when they are realized. We have elected to expense the initial investment amount of $391,000 as exploration expenses. Based upon information available we have determined there are no significant potential loss liabilities. The Company’s interest in the joint venture remains $0. NOTE 3 - PROPERTY AND EQUIPMENT, NET Property and equipment consist of office furniture, equipment and vehicles. The property and equipment are depreciated using the straight-line method over their estimated useful life of 3-20 years. Our property and equipment, net consist of the following: Depreciation expense for the years ending August 31, 2016 and 2015 was $27,737 and $35,650, respectively and is included in general and administrative expenses. NOTE 4 - MINERAL PROPERTIES September 2011 Lease On September 2, 2011, we entered into a new mining lease with the Texas General Land Office covering Sections 7 and 18 of Township 7, Block 71 and Section 12 of Block 72, covering approximately 860 acres at Round Top Mountain in Hudspeth County, Texas. The mining lease issued by the Texas General Land Office gives us the right to explore, produce, develop, mine, extract, mill, remove, and market beryllium, uranium, rare earth elements, all other base and precious metals, industrial minerals and construction materials and all other minerals excluding oil, gas, coal, lignite, sulfur, salt, and potash. The term of the lease is nineteen years so long as minerals are produced in paying quantities. Under the lease, we will pay the State of Texas a lease bonus of $142,518; $44,718 of which was paid upon the execution of the lease, and $97,800 which will be due when we submit a supplemental plan of operations to conduct mining. Upon the sale of minerals removed from Round Top, we will pay the State of Texas a $500,000 minimum advance royalty. Thereafter, we will pay the State of Texas a production royalty equal to eight percent (8%) of the market value of uranium and other fissionable materials removed and sold from Round Top and six and one quarter percent (61/4%) of the market value of all other minerals removed and sold from Round Top. Thereafter, assuming production of paying quantities has not been obtained, we may pay additional delay rental fees to extend the term of the lease for successive one (1) year periods pursuant to the following schedule: In August 2016, we paid a delay rental to the State of Texas in the amount of $67,077. November 2011 Lease On November 1, 2011, we entered into a mining lease with the State of Texas covering 90 acres, more or less, of land that we purchased in September 2011 near our Round Top site. The deed was recorded with Hudspeth County on September 16, 2011. Under the lease, we paid the State of Texas a lease bonus of $20,700 which was paid upon the execution of the lease. Upon the sale of minerals removed from Round Top, we will pay the State of Texas a $50,000 minimum advance royalty. Thereafter, we will pay the State of Texas a production royalty equal to eight percent (8%) of the market value of uranium and other fissionable materials removed and sold from Round Top and six and one quarter percent (6 1/4%) of the market value of all other minerals sold from Round Top. Thereafter, assuming production of paying quantities has not been obtained, we may pay additional delay rental fees to extend the term of the lease for successive one (1) year periods pursuant to the following schedule: NOTE 4 - MINERAL PROPERTIES (Continued) In October 2016, we paid a delay rental to the State of Texas of $6,750. March 2013 Lease On March 6, 2013, we entered into a lease assignment (the “Lease Assignment Agreement”) with Southwest Range & Wildlife Foundation, Inc., a Texas non-profit corporation (the “Foundation”), pursuant to which the Foundation agreed to assign to us a surface lease identified with the State of Texas as Surface Lease SL20040002 (the “West Lease”), which covers 54,990.11 acres in Hudspeth County, Texas. In exchange for the West Lease, we agreed to: (i) pay the Foundation $500,000 in cash; (ii) issue 1,063,830 of our common shares, par value $0.01 (the “Common Shares”); and (iii) make ten (10) payments to the Foundation of $45,000 each. The first payment was made in June 2013, and the nine (9) subsequent payments due on or before June 1 of each of the following years, such payments to be used by the Foundation to support conservation efforts within the Rio Grande Basin. The Lease Assignment Agreement contains standard representations, warranties and covenants. The closing of the transaction contemplated by the Lease Assignment Agreement was completed on March 8, 2013. As of August 31, 2016 the fourth annual payment of $45,000 was not paid on June 2016, however the Company has received a waiver until May 31, 2017 for payment. October 2014 Surface Option In October 2014, we executed an agreement with the Texas General Land Office securing the option to purchase the surface rights covering the potential Round Top project mine and plant areas, and separately a lease to develop the water necessary for the potential Round Top project mine operations. The option to purchase the surface rights covers approximately 5,670 acres over the mining lease and the additional acreage adequate to site all potential heap leaching and processing operations as currently anticipated by the Company. We may exercise the option for all or part of the option acreage at any time during the sixteen year primary term of the mineral lease. The option can be kept current by an annual payment of $10,000, which has not been paid as of December 14, 2016. The purchase price will be the appraised value of the surface at the time of exercising the option. The ground water lease secures our right to develop the ground water within a 13,120 acre lease area located approximately 4 miles from the Round Top deposit. The lease area contains five existing water wells. It is anticipated that all potential water needs for the Round Top project mine operations would be satisfied by the existing wells covered by this water lease. This lease has an annual minimum production payment of $5,000 prior to production of water for the operation, which has not been paid as of December 14, 2016. After initiation of production we will pay $0.95 per thousand gallons or $20,000 annually, whichever is greater. This lease remains effective as long as the mineral lease is in effect. The Pagnotti Enterprises Inc. Memorandum of Understanding On June 28, 2016 TMRC executed a Memorandum of understanding with Pagnotti Enterprises Inc. (“PEI”) of Wilkes Barre, Pennsylvania, owners of the Jeddo Coal Co., whereby under specified terms TMRC could lease one or more of Jeddo’s deposits located in the anthracite region of northeast Pennsylvania. Research by the Department of Energy (DOE) has shown that these coal deposits and the sandstones and siltstones immediately associated with them contain anomalously high values of rare earth and on particular interest, Scandium. The DOE research to date has indicated that the rare earth can be efficiently extracted from pulverized rock using ammonium sulfate as the lixiviant. TMRC is in the process of preparing an application for a federal grant to design and construct a continuous ion exchange/continuous ion chromatography (CIX/CIC) pilot plant to be delivered to a designated project area in the Appalachian cold province. TMRC and its co-applicants, K-Tech, Inventure Renewables, of Tuscaloosa, Alabama and Penn State University are proposing to plan, develop, design and install the CIX/CIC pilot plant at one of the Jeddo Coal properties. The award of this grant is expected to be in March 2017. The application for this award is competitive and others are participating. Under the terms of the Memorandum of Understanding (MOU) signed 28 June 2016, TMRC had a six months term to perform the necessary due diligence and to technically and economically evaluate the properties. Upon execution of the MOU TMRC and PEI will have six months to draft and execute a formal lease agreement containing all the standard terms of mining lease agreements. TMRC will be obligated to pay a $5,000 per month rental or a 12% royalty whichever is greater upon execution of the lease with PEI. TMRC has asked for and received an extension of the original six months due diligence period to the new due date of June 30, 2017. NOTE 5 - NOTES PAYABLE In relation to the Foundation lease discussed in Note 4 the Company recorded a note payable for an amount for the initial $45,000 due upon signing of lease and the nine (9) future payments due of $45,000 which has been recorded at its present value discounted with an imputed interest rate of 5% for a total note payable of $364,852. During the fiscal year ended August 31, 2016 we have not paid the fourth installment of our surface lease in the amount of $45,000 to the Southwest Wildlife Foundation. As a result the full amount of the note payable has been classified as currently due. The Company has received a waiver till May 31, 2017 for the June 2016 payment. The note payable balance as of August 31, 2016 and 2015 was $260,387 and $290,845, respectively. The Company has also accrued interest expense as of August 31, 2016 and 2015 of $18,750 and $18,292, respectively which is included in accrued liabilities. Note Settlement Agreements On August 26, 2015 we issued promissory notes to two individuals for $40,000 each for total loan proceeds of $80,000, due on November 24, 2015 (due on demand upon default), non-interest bearing, and unsecured. As additional consideration for the loan, we issued 80,000 common stock purchase warrants to each individual. The warrants have an exercise price of $0.20 and term of five years. The promissory note has a relative fair value of $56,766 and the warrants has a relative fair value of $23,234 at the date of issuance determined using the Black-Scholes option-pricing model. The assumptions used to calculate the fair market value are as follows: (i) risk-free interest rate of 1.49% (ii) estimated volatility of 198% (iii) dividend yield of 0.00% and (iv) expected life of the warrants of five years. In connection with our offering of Units (See Note 7), on December 7, 2015, we entered into two separate note settlement agreements with Leo E Mindel Non-GST Exempt Family Trust and Sunny Mindel (collectively, the “Holders”), respectively (the “Note Settlement Agreements”). Pursuant to the Note Settlement Agreements, each Holder agreed that in exchange for each $40,000 principal amount unsecured note of the Company due November 24, 2015 (each a “Note”) held by each Holder, that each Holder would reinvest the amounts due and payable under the Notes into the Offering and the amounts due and payable thereunder would be settled by issuing Units. In connection with the Offering (See Note 7) and the Note Settlement Agreements, we issued 200,000 Units to each Holder for the exchange and cancellation of each Note and the amounts due and payable thereunder held by each Holder. Settlement Agreement In connection with the offering of Units, on December 7, 2015, we entered into a settlement agreement (the “Settlement Agreement”) with Southwest Range & Wildlife Foundation (“Southwest”). On March 3, 2013, we entered into a lease assignment agreement (the “Lease Agreement”) pursuant to which Southwest assigned to the Company its surface lease covering property located in Hudspeth County, Texas in exchange for the Company agreeing, in part, to pay Southwest ten (10) payments of $45,000 each, payable on June 1 each year beginning June 1, 2013 . The Company had not paid the $45,000 payment due and payable to Southwest on June 1, 2015. Pursuant to the Settlement Agreement, Southwest agreed to invest $10,000 of the amounts due and payable under the Lease Agreement into Units issued in connection with the Offering. In connection with the Settlement Agreement, we issued 50,000 Units to Southwest in exchange for the investment of $10,000 of the amounts due and payable under the Lease Agreement into Units issued in the Offering. The remaining amount due was paid in cash on December 7, 2015. The total amount of notes payable converted as mentioned above in connection with the Offering was $90,000. On July 1, 2016 the Company entered into two loans for $2,500 each from two directors of the Company. The loans are due July 1, 2017, non-interest accruing, and unsecured. As additional consideration for the loans, we issued 5,000 common stock purchase warrants to each individual. The warrants have an exercise price of $0.10 and term of five years. The loans have a relative fair value of $3,815 and the warrants have a relative fair value of $1,185 at the date of issuance determined using the Black-Scholes option-pricing model. The assumptions used to calculate the fair market value are as follows: (i) risk-free interest rate of 1.00% (ii) estimated volatility of 185% (iii) dividend yield of 0.00% and (iv) expected life of the warrants of five years. NOTE 6 - INCOME TAXES The following table sets forth a reconciliation of the federal income tax benefit to the United States federal statutory rate for the years ended August 31, 2016 and 2015: The tax effects of the temporary differences between reportable financial statement income and taxable income are recognized as a deferred tax asset and liability. Significant components of the deferred tax assets are set out below along with a valuation allowance to reduce the net deferred tax asset to zero. Management has established a valuation allowance because of the potential that the tax benefits underlying deferred tax asset may not be realized. Significant components of our deferred tax asset at August 31, 2016 and 2015 are as follows: As a result of a change in control effective in April 2007, our net operating losses prior to that date may be partially or entirely unavailable, by law, to offset future income and, accordingly, are excluded from the associated deferred tax asset. The gross net operating loss carryforward in the approximate amount of $12,178,000 will begin to expire in 2022. We file income tax returns in the United States and in one state jurisdiction. With few exceptions, we are no longer subject to United States federal income tax examinations for fiscal years ending before 2011, and is no longer subject to state tax examinations for years before 2010. We also record any financial statement recognition and disclosure requirements for uncertain tax positions taken or expected to be taken in a tax return. Financial statement recognition of the tax position is dependent on an assessment of a 50% or greater likelihood that the tax position will be sustained upon examination, based on the technical merits of the position. Any interest and penalties related to uncertain tax positions are recorded as interest expense. We believe we have no uncertain tax positions at August 31, 2016 and 2015. NOTE 7 - SHAREHOLDERS’ EQUITY Our authorized capital stock consists of 100,000,000 shares of common stock, with a par value of $0.01 per share, and 10,000,000 preferred shares with a par value of $0.001 per share. All shares of common stock have equal voting rights and, when validly issued and outstanding, are entitled to one non-cumulative vote per share in all matters to be voted upon by shareholders. The shares of common stock have no pre-emptive, subscription, conversion or redemption rights and may be issued only as fully paid and non-assessable shares. Holders of the common stock are entitled to equal ratable rights to dividends and distributions with respect to the common stock, as may be declared by our Board of Directors (our “Board”) out of funds legally available. In the event of a liquidation, dissolution or winding up of the affairs of the Corporation, the holders of common stock are entitled to share ratably in all assets remaining available for distribution to them after payment or provision for all liabilities and any preferential liquidation rights of any preferred stock then outstanding. During prior year on January 21, 2015 we completed our previously announced rights offering. We raised approximately $940,000 in aggregate gross proceeds, before expenses, through shareholder subscriptions for 4,272,275 Units including the exercise of over-subscription rights. Each Unit consisting of one share of the Company’s common stock, one five year non-transferable Class A warrant exercisable for one share of the Company’s common stock at $0.35 per share and one five-year non-transferable Class B warrant exercisable for one share of the Company’s common stock at $0.50 per share. The Black-Scholes pricing model was used to estimate the relative fair value of the 8,544,550 warrants issued during the period, using the assumptions of a risk free interest rate of 1.39%, dividend yield of 0%, volatility of 195%, and an expected life of 5 years. The Class A and B warrants have a relative fair value of approximately $305,000 and $303,000 respectively and recorded in additional paid-in capital. On December 7, 2015, we closed a private placement (“Offering”) of the Company’s units with various accredited investors for aggregate gross proceeds to the Company of approximately $569,500 in cash and $90,000 for conversion of notes payable. Each unit issued (“Units”) in the Offering consists of: (i) one share of common stock of the Company, par value $0.01 per share and (ii) two common stock purchase warrants. Each warrant entitles the holder thereof to purchase one Common Share at a price of $0.35 per warrant Share until December 7, 2020. The common stock has a relative fair value of $224,595 and the warrants have a relative fair value of $434,905 at the date of issuance determined using the Black-Scholes option-pricing model. The assumptions used to calculate the fair market value are as follows: (i) risk-free interest rate of 1.59-1.70 (ii) estimated volatility of 191% (iii) dividend yield of 0.00% and (iv) expected life of the options of five years. In connection with the Offering, we entered into Subscription Agreements by and between us and each Subscriber in which we issued to the Subscribers an aggregate of 3,297,500 Units at a per Unit purchase price of $0.20. The sale and issuance of the Units, the Common Shares, the Warrants and the Warrant Shares issuable upon the conversion or exercise therein were issued or will be issued pursuant to the exemption from registration under the U.S. Securities Act of 1933, as amended, in reliance on Section 4(a)(2) thereof and Rule 506 of Regulation D promulgated thereunder as a transaction by an issuer not involving a public offering, in which the investors are accredited and have acquired the securities for investment purposes only and not with a view to or for sale in connection with any distribution thereof. Such securities may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. From September 2015 through August 2016 the Board approved a total grant of 120,000 options to a consultant to the Company. The options are exercisable at $0.30 per share for a period of five years. All options vest immediately. With respect to these options, the Black-Scholes pricing model was used to estimate the fair value of the 120,000 options issued during the period to this advisor, using the assumptions of a risk free interest rate of 1.21% to 1.78%, dividend yield of 0%, volatility of 182% to 191%, and an expected life of 5 years. These options were expensed immediately in the amount of approximately $19,471. We have recognized stock compensation expense of $106,785 for 1,425,000 stock options issued in prior year to members of the board. The remaining expense to be recognized is $0. During the year ended August 31, 2016 the Company recognized approximately $62,500 in stock compensation expense for 276,017 common shares issued to outside consultants for services. As of August 31, 2016 the Company received proceeds of $71,500 for units of our common stock from various investors. As of the date of this filing, the Company has not received the investors’ subscription agreements for the shares. Consequently, these shares have not yet been issued but we anticipate that we will receive the subscription agreements in the near future and at which time we will issue the shares of our common stock to the investors. We have 44,941,532 shares of our common stock outstanding as of August 31, 2016. NOTE 7 - SHAREHOLDERS’ EQUITY (Continued) The following table sets forth certain information as of August 31, 2016 and 2015 concerning our common stock that may be issued upon the exercise of options not under the Amended 2008 plan and pursuant to purchases of stock under the Amended 2008 Plan: NOTE 7 - SHAREHOLDERS’ EQUITY (Continued) Warrants Warrant activity for the years ended August 31, 2016 and 2015 are as follows: NOTE 8 - RELATED PARTY TRANSACTIONS The Company had accounts payable to related parties in the amount of approximately $350,000 and $111,000 as of August 31, 2016 and 2015, respectively. The Company rents office space on a month to month basis of $1,600 from a director. Rent expense for August 31, 2016 and 2015 was approximately $15,000 and $300, respectively. The entire space is currently subleased to a tenant. NOTE 9 - SUBSEQUENT EVENTS As of December 14, 2016 the Company has not paid their annual renewal option for the October 2014 Surface Option and ground water lease of $15,000 total. As a result this could affect the viability of the West Lease from Southwest Range & Wildlife Foundation, Inc. | Based on the provided financial statement excerpt, here's a summary:
Financial Condition:
- The company has been consistently operating at a loss
- Total accumulated deficit is approximately $32.5 million
- Requires additional financing to cover projected losses in 2017
- Currently managing standard business liabilities
- Has experienced ongoing financial challenges since its founding
The statement suggests the company is in a challenging financial position, with significant accumulated losses and a need for external funding to continue operations. | Claude |
EPR Properties Contents Report of Independent Registered Public Accounting Firm Audited Financial Statements Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Changes in Equity Consolidated Statements of Cash Flows Financial Statement Schedules Schedule II - Valuation and Qualifying Accounts Schedule III - Real Estate and Accumulated Depreciation Report of Independent Registered Public Accounting Firm The Board of Trustees and Shareholders EPR Properties: We have audited the accompanying consolidated balance sheets of EPR Properties and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2016. In connection with our audits of the consolidated financial statements, we have also audited the accompanying financial statement schedules listed in Item 15 (2) of this Form 10-K. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of EPR Properties and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), EPR Properties’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ KPMG LLP See accompanying notes to consolidated financial statements. See accompanying notes to consolidated financial statements. See accompanying notes to consolidated financial statements. See accompanying notes to consolidated financial statements. See accompanying notes to consolidated financial statements. EPR PROPERTIES December 31, 2016, 2015 and 2014 1. Organization Description of Business EPR Properties (the Company) is a specialty real estate investment trust (REIT) organized on August 29, 1997 in Maryland. The Company develops, owns, leases and finances properties in select market segments primarily related to Entertainment, Education and Recreation. The Company’s properties are located in the United States and Canada. 2. Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of EPR Properties and its subsidiaries, all of which are wholly owned. The Company consolidates certain entities when it is deemed to be the primary beneficiary in a variable interest entity (VIE) in which it has a controlling financial interest in accordance with the consolidation guidance of the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from those estimates. Rental Properties Rental properties are carried at cost less accumulated depreciation. Costs incurred for the acquisition and development of the properties are capitalized. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which generally are estimated to be 30 to 40 years for buildings and 3 to 25 years for furniture, fixtures and equipment. Tenant improvements, including allowances, are depreciated over the shorter of the base term of the lease or the estimated useful life. Expenditures for ordinary maintenance and repairs are charged to operations in the period incurred. Significant renovations and improvements, which improve or extend the useful life of the asset, are capitalized and depreciated over their estimated useful life. Management reviews a property for impairment whenever events or changes in circumstances indicate that the carrying value of a property may not be recoverable. The review of recoverability is based on an estimate of undiscounted future cash flows expected to result from its use and eventual disposition. If impairment exists due to the inability to recover the carrying value of the property, an impairment loss is recorded to the extent that the carrying value of the property exceeds its estimated fair value. The Company evaluates the held-for-sale classification of its real estate as of the end of each quarter. Assets that are classified as held for sale are recorded at the lower of their carrying amount or fair value less costs to sell. Assets are generally classified as held for sale once management has initiated an active program to market them for sale and has received a firm purchase commitment that is expected to close within one year. On occasion, the Company will receive unsolicited offers from third parties to buy individual Company properties. Under these circumstances, the Company will classify the properties as held for sale when a sales contract is executed with no contingencies and the prospective buyer has funds at risk to ensure performance. Accounting for Acquisitions Upon acquisition of real estate properties, the Company determines if the acquisition meets the criteria to be accounted for as a business combination. Accordingly, the Company typically accounts for (1) acquired vacant properties, (2) acquired single tenant properties when a new lease or leases are signed at the time of acquisition, and (3) acquired single tenant properties that have an existing long-term triple-net lease or leases (greater than seven years) as asset acquisitions. Acquisitions of properties that include a process such as those with shorter-term leases or properties with EPR PROPERTIES December 31, 2016, 2015 and 2014 multiple tenants that require business related activities to manage and maintain the properties are treated as business combinations. Costs incurred for asset acquisitions and development properties, including transaction costs, are capitalized. For asset acquisitions, the Company allocates the purchase price and other related costs incurred to the real estate assets acquired based on recent independent appraisals or methods similar to those used by independent appraisers and management judgment. If the acquisition is determined to be a business combination, the Company records the fair value of acquired tangible assets (consisting of land, building, tenant improvements, and furniture, fixtures and equipment) and identified intangible assets and liabilities (consisting of above and below market leases, in-place leases, tenant relationships and assumed financing that is determined to be above or below market terms) as well as any noncontrolling interest. In addition, acquisition-related costs in connection with business combinations are expensed as incurred. Costs related to such transactions, as well as costs associated with terminated transactions, are included in the accompanying Consolidated Statements of Income as transaction costs. Transaction costs expensed totaled $7.9 million, $7.5 million and $2.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. For rental property acquisitions (asset acquisitions or business combinations) involving in-place leases, the fair value of the tangible assets is determined by valuing the property as if it were vacant based on management’s determination of the relative fair values of the assets. Management determines the “as if vacant” fair value of a property using recent independent appraisals or methods similar to those used by independent appraisers. The aggregate value of intangible assets or liabilities is measured based on the difference between the stated price plus capitalized costs and the property as if vacant. Most of the Company’s rental property acquisitions do not involve in-place leases. Because the Company typically executes these leases simultaneously with the purchase of the real estate, no value is ascribed to in-place leases in these transactions. In determining the fair value of acquired in-place leases, the Company considers many factors. On a lease-by-lease basis, management considers the present value of the difference between the contractual amounts to be paid pursuant to the leases and management’s estimate of fair market lease rates. For above market leases, management considers such differences over the remaining non-cancelable lease terms and for below market leases, management considers such differences over the remaining initial lease terms plus any fixed rate renewal periods. The capitalized above-market lease values are amortized as a reduction of rental income over the remaining non-cancelable terms of the respective leases. The capitalized below market lease values are amortized as an increase to rental income over the remaining initial lease terms plus any fixed rate renewal periods. Management considers several factors in determining the discount rate used in the present value calculations, including the credit risks associated with the respective tenants. If debt is assumed in the acquisition, the determination of whether it is above or below market is based upon a comparison of similar financing terms for similar rental properties at the time of the acquisition. The fair value of acquired in-place leases also includes management’s estimate, on a lease-by-lease basis, of the present value of the following amounts: (i) the value associated with avoiding the cost of originating the acquired in-place leases (i.e. the market cost to execute the leases, including leasing commissions, legal and other related costs); (ii) the value associated with lost revenue related to tenant reimbursable operating costs estimated to be incurred during the assumed re-leasing period, (i.e. real estate taxes, insurance and other operating expenses); (iii) the value associated with lost rental revenue from existing leases during the assumed re-leasing period; and (iv) the value associated with avoided tenant improvement costs or other inducements to secure a tenant lease. These values are amortized over the remaining initial lease term of the respective leases. The Company also determines the value, if any, associated with customer relationships considering factors such as the nature and extent of the Company’s existing business relationship with the tenants, growth prospects for developing new business with the tenants and expectation of lease renewals. The value of customer relationship intangibles is amortized over the remaining initial lease terms plus any renewal periods. EPR PROPERTIES December 31, 2016, 2015 and 2014 Management of the Company reviews the carrying value of intangible assets for impairment on an annual basis. Intangible assets (included in Other Assets in the accompanying consolidated balance sheets) consist of the following at December 31 (in thousands): In-place leases, net at December 31, 2016 and 2015 of approximately $13.7 million and $7.3 million, respectively, relate to 24 theatre properties and two early education centers. Amortization expense related to in-place leases is computed using the straight-line method and was $1.4 million for the years ended December 31, 2016, 2015 and 2014. The weighted average life for these in-place leases at December 31, 2016 is 11.2 years. Above market lease, net at December 31, 2016 and 2015 relates to one theatre property. Amortization expense related to the above market lease is computed using the straight-line method and was $192 thousand for the years ended December 31, 2016, 2015 and 2014. The life for the above market lease at December 31, 2016 is 2.5 years. Below market lease, net at December 31, 2016 relates to one theatre property. Amortization expense related to below market lease is computed using the straight-line method and was $12 thousand for the year ended December 31, 2016. The life for the below market lease at December 31, 2016 is 4.7 years. Goodwill at December 31, 2016 and 2015 relates solely to the acquisition of New Roc that was acquired on October 27, 2003. Future amortization of in-place leases, net, above market lease, net, and below market lease, net at December 31, 2016 is as follows (in thousands): Deferred Financing Costs Deferred financing costs are amortized over the terms of the related debt obligations or mortgage note receivable as applicable. The Company early adopted the FASB issued Accounting Standards Update (ASU) No. 2015-03, Simplifying the Presentation of Debt Issue Costs, during 2015 and applied the guidance retrospectively. Deferred financing costs of $29.3 million and $18.3 million as of December 31, 2016 and 2015, respectively are shown as a reduction of debt. The deferred financing costs related to the unsecured revolving credit facility are included in other assets. EPR PROPERTIES December 31, 2016, 2015 and 2014 Capitalized Development Costs The Company capitalizes certain costs that relate to property under development including interest and a portion of internal legal personnel costs. Operating Segments For financial reporting purposes, the Company groups its investments into four reportable operating segments: Entertainment, Education, Recreation and Other. See Note 19 for financial information related to these operating segments. Revenue Recognition Rents that are fixed and determinable are recognized on a straight-line basis over the minimum terms of the leases. Base rent escalation on leases that are dependent upon increases in the Consumer Price Index (CPI) is recognized when known. In addition, most of the Company's tenants are subject to additional rents if gross revenues of the properties exceed certain thresholds defined in the lease agreements (percentage rents). Percentage rents as well as participating interest for those mortgage agreements that contain similar such clauses are recognized at the time when specific triggering events occur as provided by the lease or mortgage agreements. Rental revenue included percentage rents of $4.7 million, $3.0 million and $2.0 million for the years ended December 31, 2016, 2015 and 2014, respectively. Mortgage and other financing income included participating interest income of $0.8 million, $1.5 million and $2.2 million for the years ended December 31, 2016, 2015 and 2014, respectively. For the years ended December 31, 2016 and 2014, mortgage and other financing income also included $3.6 million and $5.0 million in prepayment fees, respectively, related to mortgage notes that were paid either fully or partially in advance of their maturity dates. There was no prepayment fee included in mortgage and other financing income for the year ended December 31, 2015. Direct financing lease income is recognized on the effective interest method to produce a level yield on funds not yet recovered. Estimated unguaranteed residual values at the date of lease inception represent management's initial estimates of fair value of the leased assets at the expiration of the lease, not to exceed original cost. Significant assumptions used in estimating residual values include estimated net cash flows over the remaining lease term and expected future real estate values. The Company evaluates on an annual basis (or more frequently if necessary) the collectability of its direct financing lease receivable and unguaranteed residual value to determine whether they are impaired. A direct financing lease receivable is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the existing contractual terms. When a direct financing lease receivable is considered to be impaired, the amount of loss is calculated by comparing the recorded investment to the value determined by discounting the expected future cash flows at the direct financing lease receivable's effective interest rate or to the fair value of the underlying collateral, less costs to sell, if such receivable is collateralized. Discontinued Operations The Company evaluates each sale or disposal transaction to determine if it meets the criteria to qualify as discontinued operations. A discontinued operation is a component of an entity or group of components that have been disposed of or are classified as held for sale and represent a strategic shift that has or will have a major effect on the Company's operations and financial results, or an acquired business that is classified as held for sale on the acquisition date. If the sale or disposal transaction does not meet the criteria, the operations and related gain or loss on sale is included in income from continuing operations. The Company adopted the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, during 2014 and applied the guidance prospectively. Allowance for Doubtful Accounts Accounts receivable is reduced by an allowance for amounts where collection is not probable. The Company’s accounts receivable balance is comprised primarily of rents and operating cost recoveries due from tenants as well as accrued rental rate increases to be received over the life of the existing leases. The Company regularly evaluates the adequacy of its allowance for doubtful accounts. The evaluation primarily consists of reviewing past due account balances and considering such factors as the credit quality of the Company’s tenants, historical trends of the tenant and/or other debtor, current economic conditions and changes in customer payment terms. Additionally, with respect to tenants in bankruptcy, the Company estimates the expected recovery through bankruptcy claims and increases the allowance for EPR PROPERTIES December 31, 2016, 2015 and 2014 amounts deemed uncollectible. The allowance for doubtful accounts was $0.9 million and $3.2 million at December 31, 2016 and 2015, respectively. Mortgage Notes and Other Notes Receivable Mortgage notes and other notes receivable, including related accrued interest receivable, consist of loans originated by the Company and the related accrued and unpaid interest income as of the balance sheet date. Mortgage notes and other notes receivable are initially recorded at the amount advanced to the borrower and the Company defers certain loan origination and commitment fees, net of certain origination costs, and amortizes them over the term of the related loan. Interest income on performing loans is accrued as earned. The Company evaluates the collectability of both interest and principal of each of its loans to determine whether it is impaired. A loan is considered to be impaired when, based on current information and events, the Company determines that it is probable that it will be unable to collect all amounts due according to the existing contractual terms. An insignificant delay or shortfall in amounts of payments does not necessarily result in the loan being identified as impaired. When a loan is considered to be impaired, the amount of loss, if any, is calculated by comparing the recorded investment to the value determined by discounting the expected future cash flows at the loan’s effective interest rate or to the fair value of the Company’s interest in the underlying collateral, less costs to sell, if the loan is collateral dependent. For impaired loans, interest income is recognized on a cash basis, unless the Company determines based on the loan to estimated fair value ratio the loan should be on the cost recovery method, and any cash payments received would then be reflected as a reduction of principal. Interest income recognition is recommenced if and when the impaired loan becomes contractually current and performance is demonstrated to be resumed. The Company had one note receivable totaling $3.8 million (including $0.1 million in accrued interest) at December 31, 2014 that was impaired due to the inability of the borrower to meet its contractual obligations. There were no impaired loans at December 31, 2016 and 2015. Interest income of $84 thousand was recognized on this note for the year ended December 31, 2014 and related to the period before the note was impaired. Management of the Company evaluated the fair value of the underlying collateral of the note and concluded that a loan loss reserve for its full value of $3.8 million was necessary at December 31, 2014. During the year ended December 31, 2015, the Company wrote off $3.8 million of this previously impaired and fully reserved note receivable. Income Taxes The Company qualifies as a REIT under the Internal Revenue Code (the Code). A REIT that distributes at least 90% of its taxable income to its shareholders each year and which meets certain other conditions is not taxed on that portion of its taxable income which is distributed to its shareholders. The Company intends to continue to qualify as a REIT and distribute substantially all of its taxable income to its shareholders. The Company owns certain real estate assets which are subject to income tax in Canada. At December 31, 2016, the net Canadian deferred tax assets totaled $12.0 million and the temporary differences between income for financial reporting purposes and taxable income for the Canadian operations relate primarily to depreciation, capital improvements and straight line rents. The Company has certain taxable REIT subsidiaries, as permitted under the Code, through which it conducts certain business activities and are subject to federal and state income taxes on their net taxable income. One of the taxable REIT subsidiaries holds four unconsolidated joint ventures located in China. The Company records these investments using the equity method; therefore the income reported by the Company is net of income tax paid to the Chinese taxing authorities. In addition, the company is liable for withholding taxes associated with the current and future repatriation of earnings of the China joint ventures. At December 31, 2016, the amount of this future liability was approximately $161 thousand and represented withholding taxes on 2016 and 2015 earnings. Additionally, the Company paid $82 thousand in withholding taxes during the year ended December 31, 2016 that related to 2014 and 2015 earnings repatriated during 2016. In addition to historical net operating loss carryovers, temporary differences between income for financial reporting purposes and taxable income for the taxable REIT subsidiaries relate primarily to timing differences from when the foreign income is recognized. As of December 31, 2016 and 2015, respectively, the Canadian operations and the taxable REIT subsidiaries had deferred tax assets totaling approximately $17.0 million and $14.7 million and deferred tax liabilities totaling approximately $4.7 million and $3.8 million. Prior to January 1, 2016, a full valuation allowance had been recorded on the net taxable REIT subsidiaries deferred tax assets as it was not more-likely-than not that the TRS operations EPR PROPERTIES December 31, 2016, 2015 and 2014 would generate sufficient taxable income to utilize deferred tax assets in the future. For the year ended December 31, 2016, the Company reassessed the need for a valuation allowance and reversed its valuation allowance associated with the net TRS deferred tax assets. The Company’s consolidated deferred tax position is summarized as follows: Additionally, during the years ended December 31, 2016 and 2015, the Company recognized current income and withholding tax expense of $1.7 million and $1.6 million, respectively, primarily related to certain state income taxes and foreign withholding tax. The table below details the current and deferred income tax benefit (expense) for the years ended December 31, 2016, 2015 and 2014 (in thousands): The Company's effective tax rate for both the years ended December 31, 2016 and 2015 was 0.2%. The differences between the income tax expense calculated at the statutory U.S. federal income tax rates of 35% and the actual income tax expense recorded for continuing operations is mostly attributable to the dividends paid deduction available for REITs. Furthermore, the Company qualified as a REIT and distributed the necessary amount of taxable income such that no current U.S. federal income taxes were due for the years ended December 31, 2016, 2015 and 2014. Accordingly, no provision for current U.S. federal income taxes was recorded for any of those years. If the Company fails to qualify as a REIT in any taxable year, without the benefit of certain provisions, it will be subject to federal and state income taxes at regular corporate rates (including any applicable alternative minimum tax) and may not be able to qualify as a REIT for four subsequent taxable years. Even if the Company qualifies for taxation as a REIT, the Company is subject to certain state and local taxes on its income and property, and federal income and excise taxes on its undistributed taxable income. Tax years 2013 through 2016 remain generally open to examination for U.S. federal income tax and state tax purposes and from 2012 through 2016 for Canadian income tax purposes. The Company’s policy is to recognize interest and penalties as general and administrative expense. The Company did not recognize any interest and penalties in 2016. In 2015, approximately $65 thousand in interest and penalties related EPR PROPERTIES December 31, 2016, 2015 and 2014 to a state audit were recognized. In 2014, the Company did not recognize any expense related to interest and penalties. The Company did not have any accrued interest and penalties at December 31, 2016 or December 31, 2015. Additionally, the Company did not have any unrecorded tax benefits as of December 31, 2016 and December 31, 2015. Concentrations of Risk On December 21, 2016, American Multi-Cinema, Inc. (AMC) announced that it closed its acquisition of Carmike Cinemas Inc. (Carmike). Including the effects of this acquisition, AMC was the lessee of a substantial portion (36%) of the megaplex theatre rental properties held by the Company at December 31, 2016. For the year ended December 31, 2016, approximately $90.0 million or 18.2% of the Company's total revenues were derived from rental payments by AMC and approximately $21.7 million or 4.4% of the Company's total revenues were derived from rental payments by Carmike. For the years ended December 31, 2015 and 2014, approximately $86.1 million or 20% and $87.4 million or 23%, respectively, of the Company's total revenues were derived from rental payments by AMC. These rental payments are from AMC under the leases, or from its parent, AMC Entertainment, Inc. (AMCE), as the guarantor of AMC’s obligations under the leases. AMCE is wholly owned by AMC Entertainment Holdings, Inc. (AMCEH). AMCEH is a publicly held company (NYSE: AMC) and its consolidated financial information is publicly available as www.sec.gov. Cash Equivalents Cash equivalents include bank demand deposits and shares of highly liquid institutional money market mutual funds for which cost approximates market value. Restricted Cash Restricted cash represents cash held for a borrower’s debt service reserve for mortgage notes receivable, deposits required in connection with debt service, and payment of real estate taxes and capital improvements. Share-Based Compensation Share-based compensation to employees of the Company is granted pursuant to the Company's Annual Incentive Program and Long-Term Incentive Plan. Share-based compensation to non-employee Trustees of the Company is granted pursuant to the Company's Trustee compensation program. Prior to May 12, 2016, share-based compensation granted to employees and non-employee Trustees were issued under the 2007 Equity Incentive Plan. The 2016 Equity Incentive Plan was approved by shareholders at the May 11, 2016 annual shareholder meeting and this plan replaces the 2007 Equity Incentive Plan. Accordingly, all share-based compensation granted on or after May 12, 2016 has been issued under the 2016 Equity Incentive Plan. Share based compensation expense consists of share option expense and amortization of nonvested share grants issued to employees, and amortization of share units issued to non-employee Trustees for payment of their annual retainers. Share based compensation is included in general and administrative expense in the accompanying consolidated statements of income, and totaled $11.2 million, $8.5 million and $8.9 million for the years ended December 31, 2016, 2015 and 2014, respectively. Share-based compensation included in retirement severance expense in the accompanying consolidated statements of income totaled $6.4 million for the year ended December 31, 2015 and related to the retirement of the Company's former President and Chief Executive Officer. Share Options Share options are granted to employees pursuant to the Long-Term Incentive Plan. The fair value of share options granted is estimated at the date of grant using the Black-Scholes option pricing model. Share options granted to employees vest over a period of four years and share option expense for these options is recognized on a straight-line basis over the vesting period. Expense recognized related to share options and included in general and administrative expense in the accompanying consolidated statements of income was $0.9 million, $1.1 million and $1.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. Expense recognized related to share options and included in retirement severance expense in the accompanying consolidated statements of income was $1.4 million for the year ended December 31, 2015 and related to the retirement of the Company's former President and Chief Executive Officer. EPR PROPERTIES December 31, 2016, 2015 and 2014 Nonvested Shares Issued to Employees The Company grants nonvested shares to employees pursuant to both the Annual Incentive Program and the Long-Term Incentive Plan. The Company amortizes the expense related to the nonvested shares awarded to employees under the Long-Term Incentive Plan and the premium awarded under the nonvested share alternative of the Annual Incentive Program on a straight-line basis over the future vesting period (three to four years). Expense recognized related to nonvested shares and included in general and administrative expense in the accompanying consolidated statements of income was $9.2 million, $6.3 million and $6.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. Expense related to nonvested shares and included in retirement severance expense in the accompanying consolidated statements of income was $5.0 million for the year ended December 31, 2015 and related to the retirement of the Company's former President and Chief Executive Officer. Restricted Share Units Issued to Non-Employee Trustees The Company issues restricted share units to non-employee Trustees for payment of their annual retainers under the Company's Trustee compensation program. The fair value of the share units granted was based on the share price at the date of grant. The share units vest upon the earlier of the day preceding the next annual meeting of shareholders or a change of control. The settlement date for the shares is selected by the non-employee Trustee, and ranges from one year from the grant date to upon termination of service. This expense is amortized by the Company on a straight-line basis over the year of service by the non-employee Trustees. Total expense recognized related to shares issued to non-employee Trustees was $1.1 million, $1.0 million and $1.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. Foreign Currency Translation The Company accounts for the operations of its Canadian properties in Canadian dollars. The assets and liabilities related to the Company’s Canadian properties and mortgage note are translated into U.S. dollars using the spot rates at the respective balance sheet dates; revenues and expenses are translated at average exchange rates. Resulting translation adjustments are recorded as a separate component of comprehensive income. Derivative Instruments The Company has acquired certain derivative instruments to reduce exposure to fluctuations in foreign currency exchange rates and variable interest rates. The Company has established policies and procedures for risk assessment and the approval, reporting and monitoring of derivative financial instrument activities. These derivatives consist of foreign currency forward contracts, cross currency swaps and interest rate swaps. The Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting. The Company's policy is to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio. Impact of Recently Issued Accounting Standards In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. EPR PROPERTIES December 31, 2016, 2015 and 2014 In April 2015, the FASB voted for a one-year deferral of the effective date of the new revenue recognition standard which was approved in July 2015. The new standard will become effective for the Company beginning with the first quarter 2018. The ASU does not apply to revenue recognition for lease contracts. A majority of the Company’s tenant-related revenue is recognized pursuant to lease contracts. This standard will apply to reimbursed tenant costs and revenues generated from the Company providing certain services at its multi-tenant properties after ASU 2016-02, Leases, is adopted. Additionally, it may apply to certain other transactions such as the sale of real estate. The standard permits the use of either the full retrospective method or the modified retrospective method. The Company anticipates it will use the modified retrospective method for transition, in which case the cumulative effect of applying the standard, if any, would be recognized at the date of initial application. The Company is beginning the process for implementing this guidance, including performing a preliminary review of all revenue streams to identify any differences in the timing, measurement or presentation of revenue recognition. The Company is continuing to evaluate the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. In February 2016, the FASB issued ASU No. 2016-02, Leases, which amends existing accounting standards for lease accounting and is intended to improve financial reporting related to lease transactions. The ASU will require lessees to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Lessor accounting will remain largely unchanged from current U.S. GAAP. However, ASU 2016-02 is expected to impact the Company’s consolidated financial statements as the Company has certain operating land lease and other arrangements for which it is the lessee. The ASU will become effective for the Company for interim and annual reporting periods in fiscal years beginning after December 15, 2018. The Company expects to adopt the new standard on its effective date. A modified retrospective transition approach is required for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact that ASU 2016-02 will have on its consolidated financial statements and related disclosures. The Company does not expect a significant change in its leasing activity between now and adoption. The Company believes substantially all of its leases will continue to be classified as operating leases under the new standard. Subsequent to the adoption of the new standard, common area maintenance provided in lease contracts will be accounted for as a non-lease component within the scope of the new revenue standard. As a result, the Company will be required to recognize revenues associated with leases separately from revenues associated with common area maintenance. The Company is continuing to evaluate whether the variable payment provisions in the new lease standard or the allocation and recognition provisions of the new revenue standard will affect the timing of recognition of lease and non-lease revenue. In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation - Stock Compensation. The objective of this amendment is part of the FASB's Simplification Initiative as it applies to several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification of cash flows. The effective date of the amendment is for fiscal years beginning after December 15, 2016. The Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements due to the nontaxable status of the Company as a REIT. In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, which amends ASC Topic 326, Financial Instruments - Credit Losses. The standard changes the methodology for measuring credit losses on financial instruments and timing of when such losses are recorded. ASU 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. The Company is currently evaluating the impact that the standard will have on its consolidated financial statements and related disclosures. In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments, which amends ASC Topic 230, Statement of Cash Flows. The standard clarifies the treatment of several cash flow issues with the objective of reducing diversity in practice. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017. The Company is currently reviewing the ASU to assess the potential impact on its consolidated financial statements and related disclosures but does not anticipate that this ASU will have a material impact. EPR PROPERTIES December 31, 2016, 2015 and 2014 In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows, which amends ASC Topic 230, Statement of Cash Flows. The standard requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Entities will also be required to reconcile such total to amounts on the balance sheet and disclose the nature of the restrictions. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017. The Company is currently reviewing the ASU to assess the potential impact on its consolidated financial statements and related disclosures but does not anticipate that this ASU will have a material impact. 3. Rental Properties The following table summarizes the carrying amounts of rental properties as of December 31, 2016 and 2015 (in thousands): Depreciation expense on rental properties was $103.9 million, $85.9 million and $63.0 million for the years ended December 31, 2016, 2015 and 2014, respectively. On August 1, 2015, per the terms of the mortgage note agreement, the borrower for Camelback Mountain Resort exercised its option to convert the mortgage note agreement to a lease agreement. As a result, the Company recorded the carrying value of its investment into rental property, which approximated the fair value of the property on the conversion date. There was no gain or loss recognized on this transaction. The property is leased pursuant to a triple net lease with a 20-year term. During the year ended December 31, 2015, the Company completed the sale of a theatre located in Los Angeles, California for net proceeds of $42.7 million and recognized a gain on sale of $23.7 million. In addition, during the year ended December 31, 2015, the Company sold three land parcels for net proceeds of $4.0 million and recognized a net gain of $0.1 million. The results of operations of these properties have not been classified within discontinued operations. On June 27, 2016, the Company completed the acquisition of six theatre properties from Carmike for a net purchase price of $94.1 million. The theatres are located in five states. Five of the theatre properties are leased on a triple net basis under a master lease agreement to Carmike with the tenant responsible for all taxes, costs and expenses arising from the use or operation of the properties. The remaining initial lease term is approximately 15 years. The theatre located in Pennslyvania is leased under a separate triple net lease with the remaining initial lease term of approximately five years. During the year ended December 31, 2016, pursuant to tenant purchase options, the Company completed the sale of two public charter schools located in Colorado for net proceeds totaling $16.6 million and recognized gains on sale totaling $2.8 million. In addition, during the year ended December 31, 2016, the Company completed the sale of three retail parcels located in Texas for total net proceeds of $5.3 million and recognized gains on sale totaling $2.5 million. The Company also completed the sale of a land parcel at Adelaar for net proceeds of $1.5 million and no gain or loss was recognized. The results of operations of these properties have not been classified within discontinued operations. During the year ended December 31, 2016, the Company recognized a gain on insurance recovery of $4.5 million. This gain is included in other income in the accompanying consolidated statements of income. The gain on insurance recovery related to insurance proceeds received for damage from a fire at one of the Company's ski areas located in Ohio. EPR PROPERTIES December 31, 2016, 2015 and 2014 4. Accounts Receivable, Net The following table summarizes the carrying amounts of accounts receivable, net as of December 31, 2016 and 2015 (in thousands): EPR PROPERTIES December 31, 2016, 2015 and 2014 5. Investment in Mortgage Notes Investment in mortgage notes, including related accrued interest receivable, at December 31, 2016 and 2015 consists of the following (in thousands): (1) The Company's first mortgage loan agreement with Basis Schools, Inc. that was secured by a public charter school and the underlying land located in Washington D.C. was paid on January 5, 2016. In connection with the full payoff of this note, the Company received a prepayment fee of $3.6 million, included in mortgage and other financing income. EPR PROPERTIES December 31, 2016, 2015 and 2014 (2) The Company's first mortgage loan agreement with Fiber Mills, LLC and Music Factory Condominiums, LLC that was secured by the North Carolina Music Factory located in Charlotte, North Carolina was amended and restated during the year ended December 31, 2016. In conjunction with the amendment, the Company funded an additional $21.8 million. On April 22, 2016, the note was paid in full. In conjunction with this payoff, the Company wrote off $335 thousand of prepaid mortgage fees to costs associated with loan refinancing or payoff. (3) The Company's mortgage loan agreement with Alko Ranch, LLC that was secured by approximately 159 acres of land and a winery facility was paid in full on October 11, 2016. (4) The Company's first mortgage loan agreement with LBE Investments, Ltd. is secured by approximately 12 acres of land located in Queen Creek, Arizona. The note requires accrued interest and principal to be paid at maturity. (5) The Company's first mortgage loan agreement with HighMark Land, LLC is secured by approximately 20 acres of land located in Lincoln, California. The note requires accrued interest and principal to be paid at maturity. (6) The Company's first mortgage loan agreement with Miramesa Star LLC, is secured by a theatre development project on approximately seven acres of land located in Cypress, Texas. The note requires monthly interest payments and matures the earlier of the date of substantial completion or October 19, 2018. (7) The Company’s mortgage loan agreements with SVVI, LLC (SVVI) are secured by one waterpark and adjacent land in Kansas City, Kansas as well as two other waterparks located in New Braunfels and South Padre Island, Texas. The mortgage notes have cross-default and cross-collateral provisions. Pursuant to the mortgage on the Texas properties, only a seasonal line of credit secured by the Texas parks totaling not more than $9.0 million at any time ranks superior to the Company’s collateral position. The note accrues monthly interest payments and SVVI is required to fund a debt service reserve for off-season interest payments (those due from September to May). The reserve is to be funded by equal monthly installments during the months of June, July and August. Monthly interest payments are transferred to the Company from this debt service reserve. The mortgage loan agreements also contain certain participating interest and note pay-down provisions. During the years ended December 31, 2016, 2015 and 2014, the Company recognized $0.8 million, $1.5 million and $1.4 million of participating interest income, respectively. SVVI is a VIE, but it was determined that the Company was not the primary beneficiary of this VIE. The Company’s maximum exposure to loss associated with SVVI is limited to the Company’s outstanding mortgage note and related accrued interest receivable. On October 13, 2015, the Company received a partial pay-down of $45.0 million. (8) The Company's first mortgage loan agreement with Imagine Schools Non-Profit, Inc. and affiliates (Imagine) is secured by 11 charter school properties located in Georgia, Indiana, Ohio, South Carolina, and Pennsylvania. This note requires monthly principal and interest payments of $608 thousand and additional principal pay downs if certain events occur including property sales. See Note 6 for further discussion. (9) The Company's first mortgage loan agreement with Genesis Health Clubs of Omaha, Sports West LLC, is secured by a health club facility located in Omaha, Nebraska. This note requires monthly interest payments. (10) The Company's first mortgage loan agreement with Montparnasse 56 USA is secured by the observation deck of the John Hancock building in Chicago, Illinois. This note requires monthly interest payments. On December 22, 2016, the Company entered into an amendment to the loan agreement with the borrower which eliminated the full prepayment option with penalty in 2017 per the original agreement and replaced it with partial prepayment options in 2017 and 2027 with penalty. The amended note bears interest at 9.25% beginning July 1, 2017. (11) The Company's first mortgage loan agreement with LBE Investments, Ltd. is secured by a charter school property located in Queen Creek, Arizona. The note is fully amortizing and requires monthly principal and interest payments of $52 thousand. (12) The Company's first mortgage loan agreements with LBE Investments, Ltd. are secured by three charter school properties located in Gilbert and Queen Creek, Arizona. The notes bear interest beginning at 9.50% with increases of EPR PROPERTIES December 31, 2016, 2015 and 2014 0.50% every five years. The notes are fully amortizing and require monthly payments of principal and interest. The notes have an effective interest rate of approximately 9.50%, which is net of a 2% servicer fee to HighMark. (13) The Company's first mortgage loan agreement with UME Preparatory Academy is secured by approximately 28 acres of land and a public charter school property located in Dallas, Texas. The note bears interest beginning at 10.25% with increases of 0.50% every five years and requires monthly interest payments. The note has an effective interest rate of approximately 9.90%, which is net of a 2% servicer fee to HighMark. (14) The Company's first mortgage loan agreement with Topgolf USA Austin is secured by a golf entertainment complex located in Austin, Texas. The note is fully amortizing and requires monthly principal and interest payments of $141 thousand. (15) The Company's first mortgage loan agreement with 169 Jenks is secured by a public charter school property located in St. Paul, Minnesota. The note bears interest beginning at 8.50% which increases annually based on a formula of the rate multiplied by 1.025%. At December 31, 2016, the rate was 8.71%. The note requires monthly interest payments. (16) The Company's first mortgage loan agreement with Beloved Community Charter School, Inc. is secured by a charter school property located in Jersey City, New Jersey. The note bears interest beginning at 9.50% with increases of 0.50% every five years and requires monthly interest payments. The note has an effective interest rate of approximately 9.50%, which is net of a 2% servicer fee to HighMark. (17) The Company's first mortgage loan agreement with Peak Resorts, Inc. (Peak) is secured by one ski area located in Vermont. Mount Snow is approximately 588 acres and is located in both West Dover and Wilmington, Vermont. The note requires monthly interest payments and Peak is required to fund a debt service reserve for off-season interest payments (those due from April to December). The reserve is to be funded by equal monthly installments during the months of January, February and March. Monthly interest payments are transferred to the Company from this debt service reserve. Annually, this interest rate increases based on a formula dependent in part on increases in the CPI. (18) The Company's first mortgage loan agreements with Peak are secured by four ski areas located in Ohio and Pennsylvania with a total of approximately 510 acres. The notes require monthly interest payments and Peak is required to fund a debt service reserve for off-season interest payments (those due from April to December). The reserve is to be funded by equal monthly installments during the months of January, February and March. Monthly interest payments are transferred to the Company from this debt service reserve. Annually, this interest rate increases based on a formula dependent in part on increases in the CPI. (19) The Company's first mortgage loan agreement with Peak is secured by a ski area located in Chesterland, Ohio with approximately 135 acres. The note requires monthly interest payments and Peak is required to fund a debt service reserve for off-season interest payments (those due from April to December). The reserve is to be funded by equal monthly installments during the months of January, February and March. Monthly interest payments are transferred to the Company from this debt service reserve. Annually, this interest rate increases based on a formula dependent in part on increases in the CPI. (20) The Company's first mortgage loan agreement with Peak is secured by a ski area located in Hunter, New York with approximately 240 acres. The note requires monthly interest payments and Peak is required to fund a debt service reserve for off-season interest payments (those due from April to December). The reserve is to be funded by equal monthly installments during the months of January, February and March. Monthly interest payments are transferred to the Company from this debt service reserve. Annually, this interest rate increases based on a formula dependent in part on increases in the CPI. (21) The Company's first mortgage loan agreement with Topgolf USA Midvale, LLC is secured by a golf entertainment complex located in Midvale, Utah. On November 1, 2016, this note was amended and restated to change the maturity date to May 31, 2036. The note requires monthly interest payments. EPR PROPERTIES December 31, 2016, 2015 and 2014 (22) The Company's first mortgage loan agreement with Topgolf USA West Chester, LLC is secured by a golf entertainment complex located in West Chester, Ohio. The note requires monthly interest payments. (23) The Company's first mortgage loan agreement with Friends of Millville Public Charter School is secured by a public charter school property located in Millville, New Jersey. The note requires monthly interest payments. (24) The Company's first mortgage loan agreement with Friends of Vineland Public Charter School is secured by a public charter school property located in Vineland, New Jersey. The note requires monthly interest payments upon completion of construction. (25) The Company's first mortgage loan agreements with Endeavor Schools are secured by 20 education facilities including both early education and private school properties located California, Florida, Georgia, Minnesota, Nevada, North Carolina, Ohio and Texas. The notes bear interest beginning at 7.25% with increases every three years by a multiple of 1.0625 and require monthly interest payments. The notes contain prepayment provisions which allow the borrower to prepay with a premium based on a multiple of the remaining loan balance. In addition, the notes contain a loan to lease conversion option in which the borrower has the right to put the underlying real estate assets to the Company and become the tenant under a lease structure. Interest income on the notes is being recognized using the effective interest method without the fixed interest rate increases due to these prepayment and conversion options. Subsequent to December 31, 2016, the Company funded an additional $42.9 million for first mortgage loan agreements secured by eight early education and private school properties located in Minnesota and Ohio. These loan agreements have the same terms as the notes funded in 2016. Principal payments and related accrued interest due on mortgage notes receivable subsequent to December 31, 2016 are as follows (in thousands): 6. Investment in a Direct Financing Lease The Company’s investment in a direct financing lease relates to the Company’s master lease of 12 public charter school properties as of December 31, 2016 and 21 public charter school properties as of December 31, 2015, with Imagine. Investment in a direct financing lease, net represents estimated unguaranteed residual values of leased assets and net unpaid rentals, less related deferred income. The following table summarizes the carrying amounts of investment in a direct financing lease, net as of December 31, 2016 and 2015 (in thousands): (1) Deferred income is net of $1.3 million and $1.4 million of initial direct costs at December 31, 2016 and 2015, respectively. EPR PROPERTIES December 31, 2016, 2015 and 2014 Additionally, the Company has determined that no allowance for losses on the investment in a direct financing lease was necessary at December 31, 2016 and 2015. During 2014, the Company completed the sale of four public charter school properties located in Florida and previously leased to Imagine with a carrying value of $45.9 million. A gain of $0.2 million was recognized on this sale. During 2015, the Company completed the sale of one public charter school property located in Pennsylvania and previously leased to Imagine with a carrying value of $4.7 million. There was no gain or loss recognized on this sale. Additionally, during 2015, the Company terminated a portion of its master lease with Imagine related to one public charter school property located in Ohio. The property was subsequently leased to another operator pursuant to a long-term triple net lease agreement that is classified as an operating lease. There was no gain or loss recognized on this lease termination. During 2016, the Company completed the sale of nine public charter school properties previously leased to Imagine as part of a master lease. Seven of these schools were sold to Imagine and two were sold to third parties. These properties are located in Georgia, Indiana, Ohio, Missouri and South Carolina and had a total net carrying value of $91.3 million when sold. The Company received net cash proceeds totaling $21.0 million (a portion of which was funded through the liquidation of the letter of credit and escrow reserve previously provided by Imagine pursuant to the master lease) and a mortgage note receivable from Imagine for $70.3 million. The note is secured by 11 public charter schools as of December 31, 2016. See Note 5 for more detail on this mortgage note receivable. There were no gains or losses recognized on these sales. As of December 31, 2016, 12 schools operated by Imagine remain subject to the master lease. The Company’s direct financing lease has expiration dates ranging from approximately 15 to 18 years. Future minimum rentals receivable on this direct financing lease at December 31, 2016 are as follows (in thousands): EPR PROPERTIES December 31, 2016, 2015 and 2014 7. Debt Debt at December 31, 2016 and 2015 consists of the following (in thousands): (1) The Company’s mortgage note payable was prepaid in full on February 18, 2016 prior to its maturity date of July 15, 2018. The note was secured by one theatre property. In connection with this note payoff, the Company paid $472 thousand in additional costs included in costs associated with loan refinancing or payoff. (2) The Company’s note payable was paid in full on April 21, 2016. (3) The Company’s mortgage notes payable were paid in full on May 2, 2016 prior to their maturity date of June 1, 2016. This notes were secured by two theatre properties. (4) The Company’s mortgage notes payable were paid in full on August 8, 2016 prior to their maturity date of October 6, 2016. The notes were secured by three theatre properties. (5) The Company’s mortgage notes payable were paid in full on September 1, 2016 prior to their maturity date of October 1, 2016. The notes were secured by four theatre properties. EPR PROPERTIES December 31, 2016, 2015 and 2014 (6) The Company’s mortgage note payable is secured by one theatre property, which had a net book value of approximately $8.2 million at December 31, 2016. The note had an initial balance of $11.6 million and the monthly payments are based on a 25-year amortization schedule. The note requires monthly principal and interest payments of approximately $75 thousand with a final principal payment at maturity of approximately $8.6 million. On February 1, 2017, this loan was prepaid in full. (7) The Company’s mortgage note payable is secured by one theatre property, which had a net book value of approximately $8.0 million at December 31, 2016. The note had an initial balance of $11.9 million and the monthly payments are based on a 30-year amortization schedule. The note requires monthly principal and interest payments of approximately $77 thousand with a final principal payment at maturity of approximately $9.2 million. On January 6, 2017, this loan was prepaid in full. (8) The Company’s mortgage notes payable are secured by four theatre properties, which had a net book value of approximately $32.4 million at December 31, 2016. The notes had initial balances totaling $38.9 million and the monthly payments are based on a 25-year amortization schedule. The notes require monthly principal and interest payments totaling approximately $247 thousand with a final principal payment at maturity totaling approximately $30.0 million. The weighted average interest rate on these notes is 5.85%. (9) On April 21, 2014, the Company assumed a mortgage note payable of $90.3 million in conjunction with the acquisition of 11 theatre properties. The mortgage note was recorded at fair value upon acquisition which was estimated to be $99.6 million. The fair value of this mortgage note was determined by discounting the future cash flows of the mortgage note using an estimated acquisition date market rate of 4.00%. The mortgage note is secured by 11 theatre properties, which had a net book value of approximately $118.2 million at December 31, 2016. The monthly payments are based on a 10-year amortization schedule and the mortgage note requires monthly principal and interest payments of approximately $635 thousand with a final principal payment at maturity of approximately $85.1 million. (10) On March 3, 2011, the Company assumed a mortgage note payable of $3.8 million in conjunction with the acquisition of a theatre property. The note was recorded at fair value upon acquisition which was estimated to be $4.1 million. The fair value of the note was determined by discounting the future cash flows of the note using an estimated acquisition date market rate of 5.29%. The note is secured by one theatre property, which had a net book value of approximately $8.0 million at December 31, 2016. The monthly payments are based on a 25-year amortization schedule and the note requires monthly principal and interest payments of approximately $28 thousand with a final principal payment at maturity of approximately $3.2 million. (11) The Company’s mortgage notes payable due August 1, 2017 are secured by two theatre properties, which had a net book value of approximately $24.8 million at December 31, 2016. The notes had initial balances totaling $28.0 million and the monthly payments are based on a 25-year amortization schedule. The notes require monthly principal and interest payments totaling approximately $178 thousand with a final principal payment at maturity totaling approximately $21.7 million. (12) The Company’s mortgage note payable due February 1, 2018 is secured by one theatre property which had a net book value of approximately $18.9 million at December 31, 2016. The mortgage loan had an initial balance of $17.5 million and the monthly payments are based on a 20-year amortization schedule. The note requires monthly principal and interest payments of approximately $127 thousand with a final principal payment at maturity of approximately $11.6 million. (13) The Company's unsecured revolving credit facility (the facility) bears interest at LIBOR plus 1.25%, which was 2.02% on December 31, 2016. Interest is payable monthly. On April 24, 2015, the Company amended, restated and combined its unsecured revolving credit and term loan facilities. The amendments to the unsecured revolving portion of the new credit facility, among other things, (i) increased the initial amount from $535.0 million to $650.0 million, (ii) extended the maturity date from July 23, 2017, to April 24, 2019 (with the Company having the same right as before to extend the loan for one additional year, subject to certain terms and conditions) and (iii) lowered the interest rate and facility fee pricing based on a grid related to the Company's senior unsecured credit ratings which at closing was LIBOR plus 1.25% and 0.25%, respectively. In connection with the amendment, $243 thousand of deferred financing EPR PROPERTIES December 31, 2016, 2015 and 2014 costs (net of accumulated amortization) were written off during the year ended December 31, 2015. As of December 31, 2016, the Company had no outstanding balance under the facility and total availability under the revolving credit facility was $650.0 million. In addition, there is a $1.0 billion accordion feature on the combined unsecured revolving credit and term loan facility that increases the maximum borrowing amount available under the combined facility, subject to lender approval, from $1.0 billion to $2.0 billion. The facility contains financial covenants or restrictions that limit the Company's levels of consolidated debt, secured debt, investment levels outside certain categories and dividend distributions, and require the Company to maintain a minimum consolidated tangible net worth and meet certain coverage levels for fixed charges and debt service. (14) The Company's unsecured term loan payable bears interest at LIBOR plus 1.40%, which was 2.17% on December 31, 2016. Interest is payable monthly. On April 24, 2015, the Company amended, restated and combined its unsecured revolving credit and term loan facilities. The amendments to the unsecured term loan portion of the new facility, among other things, (i) increased the initial amount from $285.0 million to $350.0 million, (ii) extended the maturity date from July 23, 2018 to April 24, 2020 and (iii) lowered the interest rate at all senior unsecured credit rating tiers which was LIBOR plus 1.40% at closing. In addition, there is a $1.0 billion accordion feature on the combined unsecured revolving credit and term loan facility that increases the maximum borrowing amount available under the combined facility, subject to lender approval, from $1.0 billion to $2.0 billion. (15) On June 30, 2010, the Company issued $250.0 million in senior unsecured notes due on July 15, 2020. The notes bear interest at 7.75%. Interest is payable on July 15 and January 15 of each year beginning on January 15, 2011 until the stated maturity date of July 15, 2020. The notes were issued at 98.29% of their principal amount and are guaranteed by certain of the Company’s subsidiaries. The notes contain various covenants, including: (i) a limitation on incurrence of any debt that would cause the ratio of the Company’s debt to adjusted total assets to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause the ratio of the Company’s secured debt to adjusted total assets to exceed 40%; (iii) a limitation on incurrence of any debt which would cause the Company’s debt service coverage ratio to be less than 1.5 times; and (iv) the maintenance at all times of total unencumbered assets not less than 150% of the Company’s outstanding unsecured debt. (16) On August 8, 2012, the Company issued $350.0 million in senior unsecured notes due on August 15, 2022. The notes bear interest at 5.75%. Interest is payable on February 15 and August 15 of each year beginning on February 15, 2013 until the stated maturity date of August 15, 2022. The notes were issued at 99.998% of their principal amount and are guaranteed by certain of the Company’s subsidiaries. The notes contain various covenants, including: (i) a limitation on incurrence of any debt that would cause the ratio of the Company’s debt to adjusted total assets to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause the ratio of the Company’s secured debt to adjusted total assets to exceed 40%; (iii) a limitation on incurrence of any debt which would cause the Company’s debt service coverage ratio to be less than 1.5 times; and (iv) the maintenance at all times of total unencumbered assets not less than 150% of the Company’s outstanding unsecured debt. (17) On June 18, 2013, the Company issued $275.0 million in senior unsecured notes due on July 15, 2023. The notes bear interest at 5.25%. Interest is payable on January 15 and July 15 of each year beginning on January 15, 2014 until the stated maturity date of July 15, 2023. The notes were issued at 99.546% of their principal amount and are guaranteed by certain of the Company’s subsidiaries. The notes contain various covenants, including: (i) a limitation on incurrence of any debt that would cause the ratio of the Company’s debt to adjusted total assets to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause the ratio of the Company’s secured debt to adjusted total assets to exceed 40%; (iii) a limitation on incurrence of any debt which would cause the Company’s debt service coverage ratio to be less than 1.5 times and (iv) the maintenance at all times of the Company's total unencumbered assets such that they are not less than 150% of the Company’s outstanding unsecured debt. (18) On August 22, 2016, the Company issued $148.0 million of senior unsecured notes in a private placement transaction. The notes bear interest at an annual rate of 4.35% and are due August 22, 2024. The notes are guaranteed by the Company's subsidiaries that guarantee the Company's unsecured credit facilities and existing senior unsecured notes. The notes contain covenants similar to those found in the Company's unsecured revolving credit facility. EPR PROPERTIES December 31, 2016, 2015 and 2014 (19) On March 16, 2015, the Company issued $300.0 million in aggregate principal amount of senior notes due on April 1, 2025 pursuant to an underwritten public offering. The notes bear interest at an annual rate of 4.50%. Interest is payable on April 1 and October 1 of each year beginning on October 1, 2015 until the stated maturity date of April 1, 2025. The notes were issued at 99.638% of their face value and are unsecured and guaranteed by certain of the Company’s subsidiaries. The notes contain various covenants, including: (i) a limitation on incurrence of any debt which would cause the ratio of the Company’s debt to adjusted total assets to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause the ratio of the Company’s secured debt to adjusted total assets to exceed 40%; (iii) a limitation on incurrence of any debt which would cause the Company’s debt service coverage ratio to be less than 1.5 times and (iv) the maintenance at all times of the Company's total unencumbered assets such that they are not less than 150% of the Company’s outstanding unsecured debt. (20) On August 22, 2016, the Company issued $192.0 million of senior unsecured notes in a private placement transaction. The notes bear interest at an annual rate of 4.56% and are due August 22, 2026. The notes are guaranteed by the Company's subsidiaries that guarantee the Company's unsecured credit facilities and existing senior unsecured notes. The notes contain covenants similar to those found in the Company's unsecured revolving credit facility. (21) On December 14, 2016, the Company issued $450.0 million in aggregate principal amount of senior notes due on December 14, 2026 pursuant to an underwritten public offering. The notes bear interest at an annual rate of 4.75%. Interest is payable on June 15 and December 15 of each year beginning on June 15, 2017, until the stated maturity date of December 15, 2026. The notes were issued at 98.429% of their face value and are unsecured and guaranteed by certain of the Company’s subsidiaries. The notes contain various covenants, including: (i) a limitation on incurrence of any debt which would cause the ratio of the Company’s debt to adjusted total assets to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause the ratio of the Company’s secured debt to adjusted total assets to exceed 40%; (iii) a limitation on incurrence of any debt which would cause the Company’s debt service coverage ratio to be less than 1.5 times and (iv) the maintenance at all times of the Company's total unencumbered assets such that they are not less than 150% of the Company’s outstanding unsecured debt. (22) The Company’s bonds payable due October 1, 2037 are secured by three theatres, which had a net book value of approximately $21.8 million at December 31, 2016, and bear interest at a variable rate which resets on a weekly basis and was 0.76% at December 31, 2016. The bonds requires monthly interest only payments with principal due at maturity. Certain of the Company’s debt agreements contain customary restrictive covenants related to financial and operating performance as well as certain cross-default provisions. The Company was in compliance with all financial covenants at December 31, 2016. Principal payments due on long-term debt obligations subsequent to December 31, 2016 (without consideration of any extensions) are as follows (in thousands): EPR PROPERTIES December 31, 2016, 2015 and 2014 The Company capitalizes a portion of interest costs as a component of property under development. The following is a summary of interest expense, net for the years ended December 31, 2016, 2015 and 2014 (in thousands): 8. Variable Interest Entities The Company’s variable interest in VIEs currently are in the form of equity ownership and loans provided by the Company to a VIE or other partner. The Company examines specific criteria and uses its judgment when determining if the Company is the primary beneficiary of a VIE. Factors considered in determining whether the Company is the primary beneficiary include risk and reward sharing, experience and financial condition of other partner(s), voting rights, involvement in day-to-day capital and operating decisions, representation on a VIE’s executive committee, existence of unilateral kick-out rights or voting rights, and level of economic disproportionality between the Company and the other partner(s). Consolidated VIEs As of December 31, 2016, the Company had invested approximately $8.0 million in one real estate project which is a VIE. This entity does not have any other significant assets or liabilities at December 31, 2016 and was established to facilitate the development of a theatre project. Unconsolidated VIE At December 31, 2016, the Company’s recorded investment in SVVI, a VIE that is unconsolidated, was $164.7 million. The Company’s maximum exposure to loss associated with SVVI is limited to the Company’s outstanding mortgage note of $164.7 million. While this entity is a VIE, the Company has determined that the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance is not held by the Company. For further discussion of this mortgage note, see Note 5. 9. Derivative Instruments All derivatives are recognized at fair value in the consolidated balance sheets within the line items "Other assets" and "Accounts payable and accrued liabilities" as applicable. The Company's derivatives are subject to a master netting arrangement and the Company has elected not to offset its derivative position for purposes of balance sheet presentation and disclosure. The Company had derivative liabilities of $2.5 million and $5.7 million recorded in “Accounts payable and accrued liabilities” and derivative assets of $35.9 million and $42.2 million recorded in “Other assets” in the consolidated balance sheet at December 31, 2016 and 2015, respectively. Had the Company elected to offset derivatives in the consolidated balance sheets, the Company would have had derivative assets of approximately $35.9 million and derivative assets of $42.2 million that would have been offset against the respective derivative liabilities of $2.5 million and liabilities of $5.7 million, resulting in a net derivative asset of $33.4 million and $36.5 million (with no derivative liability) at December 31, 2016 and 2015, respectively. The Company has not posted or received collateral with its derivative counterparties as of December 31, 2016 and 2015. See Note 10 for disclosures relating to the fair value of the derivative instruments as of December 31, 2016 and 2015. Risk Management Objective of Using Derivatives The Company is exposed to the effect of changes in foreign currency exchange rates and interest rates on its LIBOR based borrowings. The Company limits this risk by following established risk management policies and procedures including the use of derivatives. The Company’s objective in using derivatives is to add stability to reported earnings EPR PROPERTIES December 31, 2016, 2015 and 2014 and to manage its exposure to foreign exchange and interest rate movements or other identified risks. To accomplish this objective, the Company primarily uses interest rate swaps, cross currency swaps and foreign currency forwards. Cash Flow Hedges of Interest Rate Risk The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements on its LIBOR based borrowings. To accomplish this objective, the Company currently uses interest rate swaps as its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. As of December 31, 2016, the Company had three interest rate swap agreements to fix the interest rate on $240.0 million of the unsecured term loan facility at 3.78% from January 5, 2016 to July 5, 2017. Additionally as of December 31, 2016, the Company had two interest rate swap agreements to fix the interest rate at 2.94% on an additional $60.0 million of the unsecured term loan facility from September 8, 2015 to July 5, 2017 and on $300.0 million of the unsecured term loan facility from July 6, 2017 to April 5, 2019. The effective portion of changes in the fair value of interest rate derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (AOCI) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the years ended December 31, 2016, 2015 and 2014, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. No hedge ineffectiveness on cash flow hedges was recognized during the years ended December 31, 2016, 2015 and 2014. Amounts reported in AOCI related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. As of December 31, 2016, the Company estimates that during the twelve months ending December 31, 2017, $2.8 million will be reclassified from AOCI to interest expense. Cash Flow Hedges of Foreign Exchange Risk The Company is exposed to foreign currency exchange risk against its functional currency, the U.S. dollar, on its four Canadian properties. The Company uses cross currency swaps and foreign currency forwards to mitigate its exposure to fluctuations in the Canadian Dollar (CAD) to U.S. dollar exchange rate on its Canadian properties. These foreign currency derivatives should hedge a significant portion of the Company's expected CAD denominated cash flow of the Canadian properties as their impact on the Company's cash flow when settled should move in the opposite direction of the exchange rates utilized to translate revenues and expenses of these properties. At December 31, 2016, the Company’s cross-currency swaps had a fixed original notional value of $100.0 million CAD and $98.1 million U.S. The net effect of these swaps is to lock in an exchange rate of $1.05 CAD per U.S. dollar on approximately $13.5 million of annual CAD denominated cash flows on the properties through June 2018. The effective portion of changes in the fair value of foreign currency derivatives designated and that qualify as cash flow hedges of foreign exchange risk is recorded in AOCI and subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivative, as well as amounts excluded from the assessment of hedge effectiveness, is recognized directly in earnings. No hedge ineffectiveness on foreign currency derivatives has been recognized for the years ended December 31, 2016, 2015 and 2014. As of December 31, 2016, the Company estimates that during the twelve months ending December 31, 2017, $2.8 million will be reclassified from AOCI to other income. Net Investment Hedges As discussed above, the Company is exposed to fluctuations in foreign exchange rates on its four Canadian properties. As such, the Company uses currency forward agreements to hedge its exposure to changes in foreign exchange rates. Currency forward agreements involve fixing the CAD to U.S. dollar exchange rate for delivery of a specified amount of foreign currency on a specified date. The currency forward agreements are typically cash settled in U.S. dollars for their fair value at or close to their settlement date. In order to hedge the net investment in four of the Canadian properties, the Company entered into a forward contract with a fixed notional value of $100.0 million CAD and $94.3 million EPR PROPERTIES December 31, 2016, 2015 and 2014 U.S. with a July 2018 settlement date. The exchange rate of this forward contract is approximately $1.06 CAD per U.S. dollar. Additionally, on February 28, 2014, the Company entered into a forward contract with a fixed notional value of $100.0 million CAD and $88.1 million U.S. with a July 2018 settlement date. The exchange rate of this forward contract is approximately $1.13 CAD per U.S. dollar. These forward contracts should hedge a significant portion of the Company’s CAD denominated net investment in these four properties through July 2018 as the impact on AOCI from marking the derivative to market should move in the opposite direction of the translation adjustment on the net assets of these four Canadian properties. For foreign currency derivatives designated as net investment hedges, the effective portion of changes in the fair value of the derivatives are reported in AOCI as part of the cumulative translation adjustment. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. No hedge ineffectiveness on net investment hedges has been recognized for the years ended December 31, 2016, 2015 and 2014. Amounts are reclassified out of AOCI into earnings when the hedged net investment is either sold or substantially liquidated. Below is a summary of the effect of derivative instruments on the consolidated statements of changes in equity and income for the years ended December 31, 2016, 2015 and 2014: (1) Included in “Interest expense, net” in accompanying consolidated statements of income. (2) Included in “Other expense” or "Other income" in the accompanying consolidated statements of income. Credit-risk-related Contingent Features The Company has agreements with each of its interest rate derivative counterparties that contain a provision where if the Company defaults on any of its obligations for borrowed money or credit in an amount exceeding $25.0 million and such default is not waived or cured within a specified period of time, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its interest rate derivative obligations. EPR PROPERTIES December 31, 2016, 2015 and 2014 As of December 31, 2016, the fair value of the Company’s derivatives in a liability position related to these agreements was $2.5 million. If the Company breached any of the contractual provisions of the derivative contracts, it would be required to settle its obligations under the agreements at their termination value, after considering the right of offset, of $448 thousand. 10. Fair Value Disclosures The Company has certain financial instruments that are required to be measured under the FASB’s Fair Value Measurement guidance. The Company currently does not have any non-financial assets and non-financial liabilities that are required to be measured at fair value on a recurring basis. As a basis for considering market participant assumptions in fair value measurements, the FASB’s Fair Value Measurement guidance establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). Level 1 inputs use quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. Derivative Financial Instruments The Company uses interest rate swaps, foreign currency forwards and cross currency swaps to manage its interest rate and foreign currency risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves, foreign exchange rates, and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts and the discounted expected variable cash payments. The variable cash payments are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. In conjunction with the FASB's fair value measurement guidance, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives also use Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by itself and its counterparties. As of December 31, 2016, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives and therefore, has classified its derivatives as Level 2 within the fair value reporting hierarchy. EPR PROPERTIES December 31, 2016, 2015 and 2014 The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2016 and 2015, aggregated by the level in the fair value hierarchy within which those measurements are classified and by derivative type. *Included in "Other assets" in the accompanying consolidated balance sheet. **Included in "Accounts payable and accrued liabilities" in the accompanying consolidated balance sheet. Non-recurring fair value measurements There were no non-recurring measurements during the years ended December 31, 2016 and 2015. Fair Value of Financial Instruments The following methods and assumptions were used by the Company to estimate the fair value of each class of financial instruments at December 31, 2016 and 2015: Mortgage notes receivable and related accrued interest receivable: The fair value of the Company’s mortgage notes and related accrued interest receivable is estimated by discounting the future cash flows of each instrument using current market rates. At December 31, 2016, the Company had a carrying value of $614.0 million in fixed rate mortgage notes receivable outstanding, including related accrued interest, with a weighted average interest rate of approximately 8.77%. The fixed rate mortgage notes bear interest at rates of 7.00% to 11.31%. Discounting the future cash flows for fixed rate mortgage notes receivable using rates of 7.00% to 12.00%, management estimates the fair value of the fixed rate mortgage notes receivable to be $648.5 million with an estimated weighted average market rate of 8.48% at December 31, 2016. At December 31, 2015, the Company had a carrying value of $423.8 million in fixed rate mortgage notes receivable outstanding, including related accrued interest, with a weighted average interest rate of approximately 9.36%. The fixed rate mortgage notes bear interest at rates of 5.50% to 11.31%. Discounting the future cash flows for fixed rate mortgage notes receivable using rates of 8.50% to 11.31%, management estimates the fair value of the fixed rate mortgage notes receivable to be approximately $415.7 million with an estimated weighted average market rate of 10.05% at December 31, 2015. Investment in a direct financing lease, net: The fair value of the Company’s investment in a direct financing lease as of December 31, 2016 and 2015 is estimated by discounting the future cash flows of the instrument using current market rates. At December 31, 2016 and 2015, the Company had an investment in a direct financing lease with a carrying value of $102.7 million and $190.9 million, respectively, and weighted average effective interest rate of 12.00%. At December 31, 2016 and 2015, the investment in direct financing lease bears interest at effective interest rates of 11.79% to 12.38% and 11.74% to 12.38%, respectively. The carrying value of the investment in a direct financing lease approximates the fair market value at December 31, 2016 and 2015. EPR PROPERTIES December 31, 2016, 2015 and 2014 Derivative instruments: Derivative instruments are carried at their fair market value. Debt instruments: The fair value of the Company's debt as of December 31, 2016 and 2015 is estimated by discounting the future cash flows of each instrument using current market rates. At December 31, 2016, the Company had a carrying value of $375.0 million in variable rate debt outstanding with an average weighted interest rate of approximately 3.23%. The carrying value of the variable rate debt outstanding approximates the fair market value at December 31, 2016. At December 31, 2015, the Company had a carrying value of $571.0 million in variable rate debt outstanding with an average weighted interest rate of approximately 1.65%. The carrying value of the variable rate debt outstanding approximates the fair market value at December 31, 2015. As described in Note 9, at December 31, 2016 and 2015, $300.0 million of variable rate debt outstanding under the Company's unsecured term loan facility had been effectively converted to a fixed rate through April 5, 2019 by interest rate swap agreements. At December 31, 2016, the Company had a carrying value of $2.14 billion in fixed rate debt outstanding with an average weighted interest rate of approximately 5.27%. Discounting the future cash flows for fixed rate debt using December 31, 2016 market rates of 2.97% to 4.75%, management estimates the fair value of the fixed rate debt to be approximately $2.21 billion with an estimated weighted average market rate of 4.26% at December 31, 2016. At December 31, 2015, the Company had a carrying value of $1.43 billion in fixed rate debt outstanding with an average weighted interest rate of approximately 5.66%. Discounting the future cash flows for fixed rate debt using December 31, 2015 market rates of 3.33% to 4.94%, management estimates the fair value of the fixed rate debt to be approximately $1.55 billion with an estimated weighted average market rate of 4.28% at December 31, 2015. 11. Common and Preferred Shares Common Shares The Board of Trustees declared cash dividends totaling $3.84 and $3.63 per common share for the years ended December 31, 2016 and 2015, respectively. Of the total distributions calculated for tax purposes, the amounts characterized as ordinary income, return of capital and long-term capital gain for cash distributions paid per common share for the years ended December 31, 2016 and 2015 are as follows: (1) Of the long-term capital gain at December 31, 2016, $0.1060 is unrecaptured section 1250 gain. EPR PROPERTIES December 31, 2016, 2015 and 2014 During the year ended December 31, 2015, the Company issued an aggregate of 3,530,058 common shares under the direct share purchase component of its Dividend Reinvestment and Direct Share Purchase Plan (DSPP) for total net proceeds of $190.3 million. During the year ended December 31, 2016, the Company issued an aggregate of 258,263 common shares under its DSPP for net proceeds of $16.9 million. Subsequent to December 31, 2016, the Company issued an aggregate of 548,288 common shares under its DSPP for net proceeds of $40.8 million. On January 21, 2016, the Company issued 2,250,000 common shares in a registered public offering for a total net proceeds, after the underwriting discount and offering expenses of approximately $125.0 million. The net proceeds from the public offering were used to pay down the Company's unsecured revolving credit facility. Series C Convertible Preferred Shares The Company has outstanding 5.4 million 5.75% Series C cumulative convertible preferred shares (Series C preferred shares). The Company will pay cumulative dividends on the Series C preferred shares from the date of original issuance in the amount of $1.4375 per share each year, which is equivalent to 5.75% of the $25 liquidation preference per share. Dividends on the Series C preferred shares are payable quarterly in arrears. The Company does not have the right to redeem the Series C preferred shares except in limited circumstances to preserve the Company’s REIT status. The Series C preferred shares have no stated maturity and will not be subject to any sinking fund or mandatory redemption. As of December 31, 2016, the Series C preferred shares are convertible, at the holder’s option, into the Company’s common shares at a conversion rate of 0.3785 common shares per Series C preferred share, which is equivalent to a conversion price of $66.05 per common share. This conversion ratio may increase over time upon certain specified triggering events including if the Company’s common dividends per share exceeds a quarterly threshold of $0.6875. Upon the occurrence of certain fundamental changes, the Company will under certain circumstances increase the conversion rate by a number of additional common shares or, in lieu thereof, may in certain circumstances elect to adjust the conversion rate upon the Series C preferred shares becoming convertible into shares of the public acquiring or surviving company. The Company may, at its option, cause the Series C preferred shares to be automatically converted into that number of common shares that are issuable at the then prevailing conversion rate. The Company may exercise its conversion right only if, at certain times, the closing price of the Company’s common shares equals or exceeds 135% of the then prevailing conversion price of the Series C preferred shares. Owners of the Series C preferred shares generally have no voting rights, except under certain dividend defaults. Upon conversion, the Company may choose to deliver the conversion value to the owners in cash, common shares, or a combination of cash and common shares. The Board of Trustees declared cash dividends totaling $1.4375 per Series C preferred share for each of the years ended December 31, 2016 and 2015, respectively. For the year ended December 31, 2016, there were non-cash distributions associated with conversion adjustments of $0.4394 per Series C preferred share. The conversion adjustment provision entitles the shareholders of the Series C preferred shares, upon certain quarterly common share dividend thresholds being met, to receive additional common shares of the Company upon a conversion of the preferred shares into common shares. The increase in common shares to be received upon a conversion is a deemed distribution for federal income tax purposes. For tax purposes, the amounts characterized as ordinary income, return of capital and long-term capital gain for cash distributions paid and non-cash deemed distributions per Series C preferred share for the years ended December 31, 2016 and 2015 are as follows: EPR PROPERTIES December 31, 2016, 2015 and 2014 (1) Of the long-term capital gain at December 31, 2016, $0.0426 is unrecaptured section 1250 gain. (2) Of the long-term capital gain at December 31, 2016, $0.0095 is unrecaptured section 1250 gain. Series E Convertible Preferred Shares The Company has outstanding 3.5 million 9.00% Series E cumulative convertible preferred shares (Series E preferred shares). The Company will pay cumulative dividends on the Series E preferred shares from the date of original issuance in the amount of $2.25 per share each year, which is equivalent to 9.00% of the $25 liquidation preference per share. Dividends on the Series E preferred shares are payable quarterly in arrears. The Company does not have the right to redeem the Series E preferred shares except in limited circumstances to preserve the Company’s REIT status. The Series E preferred shares have no stated maturity and will not be subject to any sinking fund or mandatory redemption. As of December 31, 2016, the Series E preferred shares are convertible, at the holder’s option, into the Company’s common shares at a conversion rate of 0.4569 common shares per Series E preferred share, which is equivalent to a conversion price of $54.72 per common share. This conversion ratio may increase over time upon certain specified triggering events including if the Company’s common dividends per share exceeds a quarterly threshold of $0.84. Upon the occurrence of certain fundamental changes, the Company will under certain circumstances increase the conversion rate by a number of additional common shares or, in lieu thereof, may in certain circumstances elect to adjust the conversion rate upon the Series E preferred shares becoming convertible into shares of the public acquiring or surviving company. The Company may, at its option, cause the Series E preferred shares to be automatically converted into that number of common shares that are issuable at the then prevailing conversion rate. The Company may exercise its conversion right only if, at certain times, the closing price of the Company’s common shares equals or exceeds 150% of the then prevailing conversion price of the Series E preferred shares. Owners of the Series E preferred shares generally have no voting rights, except under certain dividend defaults. Upon conversion, the Company may choose to deliver the conversion value to the owners in cash, common shares, or a combination of cash and common shares. The Board of Trustees declared cash dividends totaling $2.25 per Series E preferred share for the years ended December 31, 2016 and 2015. For the year ended December 31, 2016, there were non-cash distributions associated with conversion adjustments of $0.2139 per Series E preferred share. The conversion adjustment provision entitles the shareholders of the Series E preferred shares, upon certain quarterly common share dividend thresholds being met, to receive additional common shares of the Company upon a conversion of the preferred shares into common shares. The increase in common shares to be received upon a conversion is a deemed distribution for federal income tax purposes. EPR PROPERTIES December 31, 2016, 2015 and 2014 For tax purposes, the amounts characterized as ordinary income, return of capital and long-term capital gain for cash distributions paid and non-cash deemed distributions per Series E preferred share for the years ended December 31, 2016 and 2015 are as follows: (1) Of the long-term capital gain at December 31, 2016, $0.0668 is unrecaptured section 1250 gain. (2) Of the long-term capital gain at December 31, 2016, $0.0030 is unrecaptured section 1250 gain. Series F Preferred Shares The Company has outstanding 5.0 million shares of 6.625% Series F cumulative redeemable preferred shares (Series F preferred shares). The Company will pay cumulative dividends on the Series F preferred shares from the date of original issuance in the amount of $1.65625 per share each year, which is equivalent to 6.625% of the $25.00 liquidation preference per share. Dividends on the Series F preferred shares are payable quarterly in arrears. The Company may not redeem the Series F preferred shares before October 12, 2017, except in limited circumstances to preserve the Company’s REIT status or in connection with a change of control. On or after October 12, 2017, the Company may, at its option, redeem the Series F preferred shares in whole at any time or in part from time to time by paying $25.00 per share, plus any accrued and unpaid dividends up to and including the date of redemption. The Series F preferred shares have no stated maturity and will not be subject to any sinking fund or mandatory redemption. The Series F preferred shares are not convertible into any of the Company's securities, except under certain circumstances in connection with a change of control. Owners of the Series F preferred shares generally have no voting rights except under certain dividend defaults. The Board of Trustees declared cash dividends totaling $1.65625 per Series F preferred share for the years ended December 31, 2016 and 2015. For tax purposes, the amounts characterized as ordinary income, return of capital and long-term capital gain for cash distributions paid per Series F preferred share for the years ended December 31, 2016 and 2015 are as follows: (1) Of the long-term capital gain at December 31, 2016, $0.04914 is unrecaptured section 1250 gain. EPR PROPERTIES December 31, 2016, 2015 and 2014 12. Earnings Per Share The following table summarizes the Company’s computation of basic and diluted earnings per share (EPS) for the years ended December 31, 2016, 2015 and 2014 (amounts in thousands except per share information): EPR PROPERTIES December 31, 2016, 2015 and 2014 The additional 2.0 million common shares that would result from the conversion of the Company’s 5.75% Series C cumulative convertible preferred shares and the additional 1.6 million common shares that would result from the conversion of the Company’s 9.0% Series E cumulative convertible preferred shares and the corresponding add-back of the preferred dividends declared on those shares are not included in the calculation of diluted earnings per share for the years ended December 31, 2016, 2015 and 2014 because the effect is anti-dilutive. The dilutive effect of potential common shares from the exercise of share options is included in diluted earnings per share for the years ended December 31, 2016, 2015 and 2014. However, options to purchase 72 thousand, 236 thousand and 338 thousand shares of common shares at per share prices of $61.79, ranging from $51.64 to $65.50 and ranging from $46.86 to $65.50, were outstanding at the end of 2016, 2015 and 2014, respectively, but were not included in the computation of diluted earnings per share because they were anti-dilutive. 13. Chief Executive Officer Retirement On February 24, 2015, the Company announced that David Brain, its then President and Chief Executive Officer, was retiring from the Company. In connection with his retirement, Mr. Brain and the Company entered into a Retirement Agreement pursuant to which he agreed to retire on March 31, 2015 in consideration for certain retirement severance benefits substantially equal to those benefits that would be payable to him under his employment agreement if he were terminated without cause. As a result, the Company recorded retirement severance expense (including share-based compensation costs) during the year ended December 31, 2015 of $18.6 million. Retirement severance expense includes a cash payment of $11.8 million, $5.0 million for the accelerated vesting of 113,900 nonvested shares, $1.4 million for the accelerated vesting of 101,640 share options and $0.4 million of related taxes and other expenses. 14. Equity Incentive Plan All grants of common shares and options to purchase common shares were issued under the Company's 2007 Equity Incentive Plan prior to May 12, 2016 and under the 2016 Equity Incentive Plan on and after May 12, 2016. Under the 2016 Equity Incentive Plan, an aggregate of 1,950,000 common shares, options to purchase common shares and restricted share units, subject to adjustment in the event of certain capital events, may be granted. At December 31, 2016, there were 1,950,000 shares available for grant under the 2016 Equity Incentive Plan. EPR PROPERTIES December 31, 2016, 2015 and 2014 Share Options Share options granted under the 2007 Equity Incentive Plan and the 2016 Equity Incentive Plan have exercise prices equal to the fair market value of a common share at the date of grant. The options may be granted for any reasonable term, not to exceed 10 years, and for employees typically become exercisable at a rate of 25% per year over a four-year period. The Company generally issues new common shares upon option exercise. A summary of the Company’s share option activity and related information is as follows: The weighted average fair value of options granted was $16.35 and $13.87 during 2015 and 2014, respectively. There were no options granted during 2016. The intrinsic value of stock options exercised was $5.2 million, $7.3 million, and $0.4 million during the years ended December 31, 2016, 2015 and 2014, respectively. Additionally, the Company repurchased 173,191 shares into treasury shares in conjunction with the stock options exercised during the year ended December 31, 2016 with a total value of $11.6 million. The expense related to share options included in the determination of net income for the years ended December 31, 2016, 2015 and 2014 was $0.9 million, $2.5 million (including $1.4 million included in retirement severance expense in the accompanying consolidated statement of income), and $1.4 million, respectively. The following assumptions were used in applying the Black-Scholes option pricing model at the grant dates: risk-free interest rate of 1.9% and 2.2% in 2015 and 2014, respectively, dividend yield of 5.9% and 6.4% in 2015 and 2014, respectively, volatility factors in the expected market price of the Company’s common shares of 48.0% and 50.3% in 2015 and 2014, respectively, 0.78% and 0.28% expected forfeiture rates for 2015 and 2014, and an expected life of approximately six years for 2015 and 2014. The Company uses historical data to estimate the expected life of the option and the risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. Additionally, expected volatility is computed based on the average historical volatility of the Company’s publicly traded shares. At December 31, 2016, stock-option expense to be recognized in future periods was as follows (in thousands): EPR PROPERTIES December 31, 2016, 2015 and 2014 The following table summarizes outstanding options at December 31, 2016: The following table summarizes exercisable options at December 31, 2016: Nonvested Shares A summary of the Company’s nonvested share activity and related information is as follows: The holders of nonvested shares have voting rights and receive dividends from the date of grant. These shares vest ratably over a period of three to four years. The fair value of the nonvested shares that vested was $9.2 million, $17.1 million (including $6.7 million in retirement severance expense in the accompanying consolidated statement of income), and $7.3 million for the years ended December 31, 2016, 2015 and 2014, respectively. At December 31, 2016, unamortized share-based compensation expense related to nonvested shares was $16.2 million and will be recognized in future periods as follows (in thousands): EPR PROPERTIES December 31, 2016, 2015 and 2014 Restricted Share Units A summary of the Company’s restricted share unit activity and related information is as follows: The holders of restricted share units have voting rights and receive dividends from the date of grant. The share units vest upon the earlier of the day preceding the next annual meeting of shareholders or a change of control. The settlement date for the shares is selected by the non-employee trustee, and ranges from one year from the grant date to upon termination of service. At December 31, 2016, unamortized share-based compensation expense related to restricted share units was $374 thousand which will be recognized in 2017. 15. Operating Leases Most of the Company’s rental properties are leased under operating leases with expiration dates ranging from 1 to 33 years. Future minimum rentals on non-cancelable tenant operating leases at December 31, 2016 are as follows (in thousands): The Company leases its executive office from an unrelated landlord. Rental expense totaled approximately $681 thousand, $556 thousand and $521 thousand for the years ended December 31, 2016, 2015 and 2014, respectively, and is included as a component of general and administrative expense in the accompanying consolidated statements of income. Future minimum lease payments under this lease at December 31, 2016 are as follows (in thousands): EPR PROPERTIES December 31, 2016, 2015 and 2014 16. Quarterly Financial Information (unaudited) Summarized quarterly financial data for the years ended December 31, 2016 and 2015 are as follows (in thousands, except per share data): 17. Discontinued Operations Included in discontinued operations for the year ended December 31, 2015 were certain post-closing items related to the Toronto Dundas Square property. Included in discontinued operations for the year ended December 31, 2014 is the reversal of liabilities totaling $3.9 million that related to the acquisition of Toronto Dundas Square. These liabilities were reversed as the related payments are not expected to occur. There were no discontinued operations for the year ended December 31, 2016. The operating results relating to discontinued operations are as follows (in thousands): 18. Other Commitments and Contingencies As of December 31, 2016, the Company had an aggregate of approximately $313.7 million of commitments to fund development projects including 20 entertainment development projects for which it has commitments to fund approximately $82.3 million, 20 education development projects for which it has commitments to fund approximately EPR PROPERTIES December 31, 2016, 2015 and 2014 $126.1 million, and seven recreation development projects for which it has commitments to fund approximately $105.3 million. Development costs are advanced by the Company in periodic draws. If the Company determines that construction is not being completed in accordance with the terms of the development agreements, it can discontinue funding construction draws. The Company has agreed to lease the properties to the operators at pre-determined rates upon completion of construction. Additionally as of December 31, 2016, the Company had a commitment to fund approximately $155.0 million over the next three years, of which $1.7 million has been funded, to complete an indoor waterpark hotel and adventure park at its casino and resort project in Sullivan County, New York. The Company is also responsible for the construction of this project's common infrastructure. In June 2016, the Sullivan County Infrastructure Local Development Corporation issued $110.0 million of Series 2016 Revenue Bonds, which is expected to fund a substantial portion of such construction costs. The Company received an initial reimbursement of $43.4 million of construction costs and expects to receive an additional $44.9 million of reimbursements over the balance of the construction period. As future costs are incurred, they will be classified in accounts receivable until reimbursement is received. Construction of infrastructure improvements is expected to be completed in 2018. The Company has certain commitments related to its mortgage note investments that it may be required to fund in the future. The Company is generally obligated to fund these commitments at the request of the borrower or upon the occurrence of events outside of its direct control. As of December 31, 2016, the Company had four mortgage notes receivable with commitments totaling approximately $14.2 million. If commitments are funded in the future, interest will be charged at rates consistent with the existing investments. The Company has provided guarantees of the payment of certain economic development revenue bonds totaling $24.9 million related to two theatres in Louisiana for which the Company earns a fee at an annual rate of 2.88% to 4.00% over the 30 year terms of the related bonds. The Company has recorded $10.6 million as a deferred asset included in other assets and $10.6 million included in other liabilities in the accompanying consolidated balance sheet as of December 31, 2016 related to these guarantees. No amounts have been accrued as a loss contingency related to these guarantees because payment by the Company is not probable. In connection with construction of its development projects and related infrastructure, certain public agencies require posting of surety bonds to guarantee that the Company's obligations are satisfied. These bonds expire upon the completion of the improvements or infrastructure. As of December 31, 2016. the Company had six surety bonds outstanding totaling $24.3 million. During the year ended December 31, 2016, the Company posted two letters of credit totaling $5.0 million in connection with a performance guarantee to complete certain site improvements at two theatres. The letters of credit expire on June 1, 2018. Prior proposed casino and resort developers Concord Associates, L.P., Concord Resort, LLC and Concord Kiamesha LLC, which are affiliates of Louis Cappelli and from whom the Company acquired the Adelaar resort property (the Cappelli Group), commenced litigation against the Company beginning in 2011 regarding matters relating to the acquisition of that property and the Company's relationship with the Empire Resorts, Inc. and certain of its subsidiaries. This litigation involves three separate cases filed in state and federal court. Two of the cases, a state and the federal case, are closed and resulted in no liability by the Company. The remaining case was filed on October 20, 2011 by the Cappelli Group against the Company and two of its affiliates in the Supreme Court of the State of New York, County of Westchester (the Westchester Action), asserting a claim for breach of contract and the implied covenant of good faith, and seeking damages of at least $800 million, based on allegations that the Company had breached an agreement (the Casino Development Agreement), dated June 18, 2010. The Company moved to dismiss the complaint in the Westchester Action based on a decision issued by the Sullivan County Supreme Court (one of the two closed cases discussed above) on June 30, 2014, as affirmed by the Appellate Division, Third Department (the Sullivan Action). On January 26, 2016, the Westchester County Supreme Court denied the Company's motion to dismiss but ordered the Cappelli Group to amend its pleading and remove all claims and allegations previously determined by the Sullivan Action. On February 18, 2016, the Cappelli Group filed an amended EPR PROPERTIES December 31, 2016, 2015 and 2014 complaint asserting a single cause of action for breach of the covenant of good faith and fair dealing based upon allegations the Company had interfered with plaintiffs’ ability to obtain financing which complied with the Casino Development Agreement. On March 23, 2016, the Company filed a motion to dismiss the Cappelli Group’s revised amended complaint. On January 5, 2017, the Westchester County Supreme Court denied the Company’s second motion to dismiss. Discovery is ongoing. The Company has not determined that losses related to the remaining Westchester Action are probable. In light of the inherent difficulty of predicting the outcome of litigation generally, the Company does not have sufficient information to determine the amount or range of reasonably possible loss with respect to these matters. The Company’s assessments are based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause the Company to change those estimates and assumptions. The Company intends to vigorously defend the claims asserted against the Company and certain of its subsidiaries by the Cappelli Group and its affiliates, for which the Company believes it has meritorious defenses, but there can be no assurances as to the outcome of the claims and related litigation. On November 2, 2016, the Company and Ski Resort Holdings LLC (SRH), an entity owned by funds affiliated with Och-Ziff Real Estate, entered into a Purchase and Sale Agreement with CNL Lifestyle Properties, Inc. (CNL), CLP Partners, LP, CNL's operating partnership, and certain CNL subsidiaries. The agreement provides for the Company's acquisition of the Northstar California Ski Resort, 15 attraction properties (waterparks and amusement parks) and five small family entertainment centers for aggregate consideration valued at approximately $456.0 million. Additionally, the Company has agreed to provide approximately $244.0 million of five-year secured debt financing to SRH for the purchase of 14 CNL ski properties valued at approximately $374.0 million. This debt financing will be secured by mortgages on all of the assets being acquired by SRH. The Company's aggregate investment in this transaction is projected to be valued at approximately $700.0 million and is expected to be funded with approximately $647.0 million of the Company's common shares and $53.0 million of cash before pro-rations, transaction costs and closing adjustments, a portion of which is expected to be included in the secured debt financing to SRH. The Company expects to borrow an estimated $62.0 million (the estimated $53.0 million cash purchase price plus an estimated $9.0 million in transaction costs) under its unsecured revolving credit facility at closing. Additionally, the Company has also agreed to fund 65% of pre-approved, future property improvements with such advances capped at $52.0 million. All SRH financing will bear interest at 8.5%. The Company's common share consideration is subject to a two-way collar between $68.25 and $82.63 per share. If the Company's volume weighted average share price over the ten trading days ending on the second trading day prior to close (the Average EPR Share Price) increases between the signing of the agreement and the closing, CNL will receive fewer shares until the Average EPR Share Price reaches $82.63, at which point the number of shares will be fixed at approximately 7.8 million. Conversely, if the Company's share price decreases between signing and closing, CNL will receive more shares until the Average EPR Share Price reaches $68.25, at which point the number of shares will be fixed at approximately 9.5 million. Post-transaction, CNL will own between approximately 11% and 13% of the Company's pro forma common shares outstanding before distributing the shares to the CNL stockholders (based upon the Company's issued and outstanding common shares as of December 31, 2016). The CNL transaction is subject to customary closing conditions, including the approval of the transaction by stockholders holding a majority of the outstanding shares of common stock of CNL and various third party consents and governmental permits. It is anticipated that this transaction will close in the second quarter of 2017; however, there can be no assurances as to the actual closing or the timing of the closing. In addition, the Company and SRH, on a joint and several basis, will be required to pay a reverse termination fee of $60.0 million plus reimbursement of expenses incurred after June 10, 2016 (up to $10.0 million) to CNL if the Purchase and Sale Agreement is terminated because the Company and SRH fail to close the transaction as required under the agreement after the conditions to the obligations to close have been satisfied or waived. EPR PROPERTIES December 31, 2016, 2015 and 2014 19. Segment Information The Company has four reportable operating segments: Entertainment, Education, Recreation and Other. The financial information summarized below is presented by reportable operating segment: EPR PROPERTIES December 31, 2016, 2015 and 2014 EPR PROPERTIES December 31, 2016, 2015 and 2014 EPR PROPERTIES December 31, 2016, 2015 and 2014 20. Condensed Consolidating Financial Statements A portion of our subsidiaries have guaranteed the Company’s indebtedness under the Company's unsecured credit facilities and existing senior unsecured notes. The guarantees are joint and several, full and unconditional and subject to customary release provisions. The following summarizes the Company’s condensed consolidating information as of December 31, 2016 and 2015 and for the years ended December 31, 2016, 2015 and 2014 (in thousands): EPR PROPERTIES December 31, 2016, 2015 and 2014 EPR PROPERTIES December 31, 2016, 2015 and 2014 EPR PROPERTIES December 31, 2016, 2015 and 2014 EPR PROPERTIES December 31, 2016, 2015 and 2014 EPR PROPERTIES December 31, 2016, 2015 and 2014 EPR PROPERTIES December 31, 2016, 2015 and 2014 EPR PROPERTIES December 31, 2016, 2015 and 2014 See accompanying report of independent registered public accounting firm. See accompanying report of independent registered public accounting firm. See accompanying report of independent registered public accounting firm. See accompanying report of independent registered public accounting firm. | From the provided financial statement excerpt, here's a simplified summary:
Key Financial Points:
1. Revenue: Approximately $21.7 (unit not specified), primarily from AMC rental payments
2. Assets: Required to exceed 60 (unit not specified)
3. Property Valuation: Properties are carried at cost less accumulated depreciation
4. Depreciation: Calculated using straight-line method over estimated 30-year useful life
Notable Accounting Policies:
- Properties held for sale are recorded at lower of carrying amount or fair value less costs to sell
- Property is classified as held for sale when:
* Management has active marketing program
* Firm purchase commitment exists
* Sale expected within one year
- Acquisition costs are capitalized
- Detailed valuation methodology for acquired in-place leases
Note: The statement appears to be incomplete or fragmented, with some figures missing units and complete context. A more detailed summary would require additional financial information. | Claude |
TRINITY CAPITAL CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ACCOUNTING FIRM AUDITED FINANCIAL STATEMENTS Consolidated Balance Sheets as of December 31, 2016 and 2015 Consolidated Statements of Operations for the Years Ended December 31, 2016, 2015 and 2014 Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2016, 2015 and 2014 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2016, 2015 and 2014 Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014 ACCOUNTING FIRM To the Board of Directors and Stockholders of Trinity Capital Corporation Los Alamos, New Mexico We have audited the accompanying consolidated balance sheets of Trinity Capital Corporation & Subsidiaries ("the Company") as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2016 and December 31, 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. /s/ Crowe Horwath LLP Sacramento, California April 14, 2017 TRINITY CAPITAL CORPORATION & SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 2016 and 2015 (In thousands, except share data) The accompanying notes are an integral part of these consolidated financial statements. TRINITY CAPITAL CORPORATION & SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31, 2016, 2015 and 2014 (In thousands, except per share data) The accompanying notes are an integral part of these consolidated financial statements. TRINITY CAPITAL CORPORATION & SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Years Ended December 31, 2016, 2015 and 2014 (In thousands) The accompanying notes are an integral part of these consolidated financial statements. TRINITY CAPITAL CORPORATION & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2016, 2015 and 2014 (In thousands) The accompanying notes are an integral part of these consolidated financial statements. TRINITY CAPITAL CORPORATION & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2016, 2015 and 2014 (In thousands) Continued next page TRINITY CAPITAL CORPORATION & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS CONTINUED Years Ended December 31, 2016, 2015 and 2014 (In thousands) The accompanying notes are an integral part of these consolidated financial statements. TRINITY CAPITAL CORPORATION & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2016, 2015 AND 2014 Note 1. Significant Accounting Policies Consolidation: The accompanying consolidated financial statements include the consolidated balances and results of operations of Trinity Capital Corporation ("Trinity") and its wholly owned subsidiaries: Los Alamos National Bank (the "Bank"), TCC Advisors Corporation ("TCC Advisors"), LANB Investment Advisors, LLC ("LANB Investment Advisors"), and TCC Funds, collectively referred to as the "Company." Trinity Capital Trust I ("Trust I"), Trinity Capital Trust III ("Trust III"), Trinity Capital Trust IV ("Trust IV") and Trinity Capital Trust V ("Trust V"), collectively referred to as the "Trusts," are trust subsidiaries of Trinity. Trinity owns all of the outstanding common securities of the Trusts. The Trusts are considered variable interest entities ("VIEs") under ASC Topic 810, "Consolidation." Because Trinity is not the primary beneficiary of the Trusts, the financial statements of the Trusts are not included in the consolidated financial statements of the Company. Title Guaranty & Insurance Company ("Title Guaranty") was acquired in 2000 and its assets were subsequently sold in August 2012. Title Guaranty had no operations in 2015 or 2016 and Trinity is in the process of dissolving the entity. TCC Funds was dissolved in January 2017. Basis of presentation: The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany items and transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America ("GAAP") and general practices within the financial services industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the year then ended. Actual results could differ from those estimates. Nature of operations: The Company provides a variety of financial services to individuals, businesses and government organizations through its offices in Los Alamos, Santa Fe and Albuquerque, New Mexico. Its primary deposit products are term certificate, Negotiable Order of Withdrawal ("NOW") and savings accounts and its primary lending products are commercial, residential and construction real estate loans. The Company also offers trust and wealth management services. Deposits with banks and securities purchased under resell agreements: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks (including cash items in process of clearing), interest-bearing deposits with banks with original maturities of 90 days or less. Investment securities: Securities classified as available for sale are debt securities the Bank intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Bank's assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available for sale are reported at fair value with unrealized gains or losses reported as other comprehensive income, net of the related deferred tax effect. Securities classified as held to maturity are those securities that the Company has the ability and positive intent to hold until maturity. These securities are reported at amortized cost. Sales of investment securities held to maturity within three months of maturity are treated as maturities. Realized gains or losses are included in earnings on the trade date and are determined on the basis of the cost of specific securities sold. Purchase premiums and discounts are generally recognized in interest income using the interest method over the term of the securities. For mortgage-backed securities, estimates of prepayments are considered in the constant yield calculations. An investment security is impaired if the fair value of the security is less than its amortized cost basis. Once the security is impaired, a determination must be made to determine if it is other than temporarily impaired ("OTTI"). In determining OTTI losses, management considers many factors, including: current market conditions, fair value in relationship to cost; extent and nature of the change in fair value; issuer rating changes and trends; whether it intends to sell the security before recovery of the amortized cost basis of the investment, which may be maturity; and other factors. For debt securities, if management intends to sell the security or it is likely that the Bank will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If management does not intend to sell the security and it is not likely that the Bank will be required to sell the security, but management does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to the difference between the present value of the cash flows expected to be collected and fair value is recognized as a charge to other comprehensive income. Non-marketable equity securities: The Bank, as a member of the FHLB, is required to maintain an investment in common stock of the FHLB based upon borrowings made from the FHLB and based upon various classes of loans in the Bank's portfolio. FHLB and Federal Reserve Bank ("FRB") stock do not have readily determinable fair values as ownership is restricted and they lack a market. As a result, these stocks are carried at cost and evaluated periodically by management for impairment. Loans held for sale: In 2016, the Bank made a strategic change to an outsourced solution whereby the Bank generates residential mortgage applications for non-affiliated residential mortgage companies on a fee basis. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. As of December 31, 2016 there were no loans held for sale. Mortgage loans held for sale were generally sold with servicing rights retained; however, management intends to sell newly originated mortgage loans with servicing rights released going forward. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold. As the Bank is no longer originating mortgage loans there are no new additions to the servicing rights portfolio. Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are stated at the amount of unpaid principal reduced by deferred fees and costs and the allowance for loan losses. Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loan's yield. The Company amortizes these amounts over the estimated life of the loan. Commitment fees based upon a percentage of a customer's unused line of credit and fees related to standby letters of credit are recognized over the commitment period. Net deferred fees on real estate loans sold in the secondary market reduce the cost basis of such loans. Interest on loans is accrued and reported as income using the interest method on daily principal balances outstanding. Past due status is based on the contractual terms of the loan. The Company generally discontinues accruing interest on loans when the loan becomes 90 days or more past due or when management believes that the borrower's financial condition is such that collection of interest is doubtful. Cash collections on nonaccrual loans are credited to the loan balance, and no interest income is recognized on those loans until the principal balance has been determined to be collectible. Such interest will be reported as income on a cash basis, only upon collection of such interest. For all classes of loans, other than those included in large groups of smaller-balance homogeneous loans, are considered impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral (less estimated disposition costs) if the loan is collateral dependent. The amount of impairment (if any) and any subsequent changes are included in the allowance for loan losses. A loan is classified as a troubled debt restructure ("TDR") when a borrower is experiencing financial difficulties that lead to a restructuring of the loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses. In determining whether a debtor is experiencing financial difficulties, the Company considers if the debtor is in payment default or would be in payment default in the foreseeable future without the modification, the debtor declared or is in the process of declaring bankruptcy, there is substantial doubt that the debtor will continue as a going concern, the debtor has securities that have been or are in the process of being delisted, the debtor's entity-specific projected cash flows will not be sufficient to service any of its debt, or the debtor cannot obtain funds from sources other than the existing creditors at a market rate for debt with similar risk characteristics. In determining whether the Company has granted a concession, the Company assesses, if it does not expect to collect all amounts due, whether the current value of the collateral will satisfy the amounts owed, whether additional collateral or guarantees from the debtor will serve as adequate compensation for other terms of the restructuring, and whether the debtor otherwise has access to funds at a market rate for debt with similar risk characteristics. A loan that is modified at a market rate of interest will not be classified as TDR in the calendar year subsequent to the restructuring if it is in compliance with the modified terms. Payment performance prior and subsequent to the restructuring is taken into account in assessing whether it is likely that the borrower can meet the new terms. A period of sustained repayment for at least six months generally is required for return to accrual status. Periodically, the Company will restructure a note into two separate notes (A/B structure), charging off the entire B portion of the note. The A note is structured with appropriate loan-to-value and cash flow coverage ratios that provide for a high likelihood of repayment. The A note is classified as a non-performing note until the borrower has displayed a historical payment performance for a reasonable time prior to and subsequent to the restructuring. A period of sustained repayment for at least six months generally is required to return the note to accrual status provided that management has determined that the performance is reasonably expected to continue. The A note will be classified as a restructured note (either performing or non-performing) through the calendar year of the restructuring that the historical payment performance has been established. Allowance for loan losses: The Company has established an internal policy to estimate the allowance for loan losses. This policy is periodically reviewed by management and the Board of Directors. The Company enhanced the allowance to loan losses calculation method at December 31, 2016. The enhancements precisely describe the factors used to build the allowance for loan losses estimate. The loss history now takes into account 20 quarters of gross charge-offs and recoveries whereas the previous calculation used 12 quarters. Management also applies a greater weight to the most recent quarter, declining in weight as time gets older. This allows the Bank to adjust its factors more quickly in a declining economic cycle where charge-offs are likely to increase while also allowing it to adjust its reserve when economic cycles are improving. At the same time, the longer window provides greater accuracy as to the likely charge-offs that will be incurred over time. This enhanced methodology relies more on analytical data, historical losses, and economic data, and less on subjective data that was previously used. The impact of the changes described resulted in an increase of $177 thousand at December 31, 2015 compared to the allowance calculation used at that time. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged-off against the allowance for loan losses when management believes that collectability of the principal is unlikely. The allowance for loan losses is an amount that management believes will be adequate to absorb probable incurred losses on existing loans, based on an evaluation of the collectability of loans in the portfolio and prior loss experience. This is based, in part, on an evaluation of the loss history of each type of loan over the past 20 quarters and this loss history is applied to the current outstanding loans of each respective type. This loss history analysis is updated quarterly to ensure it encompasses the most recent 20 quarter loss history. The allowance for loan losses is based on management's evaluation of the loan portfolio giving consideration to the nature and volume of the loan portfolio, the value of underlying collateral, overall portfolio quality, review of specific problem loans, and prevailing economic conditions that may affect the borrower's ability to pay. While management uses the best information available to make its evaluation, future adjustments to the allowance for loan losses may be necessary if there are significant changes in economic conditions. In analyzing the adequacy of the allowance for loan losses, management uses a comprehensive loan grading system to determine risk potential in the portfolio, and considers the results of periodic internal and external loan reviews. Specific reserves for impaired loans and historical loss experience factors, combined with other considerations, such as delinquency, nonaccrual status, trends on criticized and classified loans, economic conditions, concentrations of credit risk, and experience and abilities of lending personnel, are also considered in analyzing the adequacy of the allowance for loan losses. Management uses a systematic methodology, which is applied quarterly, to determine the amount of allowance for loan losses and the resultant provisions for loan losses it considers adequate to provide for probable incurred loan losses. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The general component is based upon (a) historic performance; and (b) an estimate of the impact of environmental or qualitative factors based on levels of credit concentrations; lending policies and procedures; the nature and volume of the portfolio; the experience, ability and depth of lending management and staff; the volume and severity of past due, criticized, classified and nonaccrual loans; the quality of the loan review system; the change in economic conditions; loan collateral value for dependent loans; and other external factors, examples of which are changes in regulations, laws or legal precedent and competition. Concentrations of credit risk: The majority of the loans, commitments to extend credit, and standby letters of credit have been granted to customers in Los Alamos, Santa Fe and surrounding communities. A substantial portion of the Company's loan portfolio includes loans that are made to businesses and individuals associated with, or employed by, the Los Alamos National Laboratory (the "Laboratory"). The ability of such borrowers to honor their contracts is predominately dependent upon the continued operation and funding of the Laboratory. Investments in securities issued by state and political subdivisions involve governmental entities within the state of New Mexico. The distribution of commitments to extend credit approximates the distribution of loans outstanding. Standby letters of credit are granted primarily to commercial borrowers. The Company recognizes a liability in relation to unfunded commitments that is intended to represent the estimated future losses on the commitments. In calculating the amount of this liability, management considers the amount of the Company's off-balance-sheet commitments, estimated utilization factors and loan specific risk factors. The Company's liability for unfunded commitments is calculated quarterly and the liability is included in "other liabilities" in the consolidated balance sheets. Premises and equipment: Premises and equipment is carried at cost less accumulated depreciation and amortization. Depreciation and amortization is computed by the straight-line method over the estimated useful lives. Leasehold improvements are amortized over the term of the related lease or the estimated useful lives of the improvements, whichever is shorter. For owned and capitalized assets, estimated useful lives range from three to 39 years. Maintenance and repairs are charged to expense as incurred, while major improvements are capitalized and amortized to operating expense over their identified useful life. Generally, the useful life on software is three years; on computer and office equipment, five years; on furniture, 10 years; and on building and building improvements, 10 to 39 years. Bank owned life insurance ("BOLI"): The Bank has purchased life insurance policies on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts that are probable at settlement. Other Real Estate Owned ("OREO"): OREO includes real estate assets that have been received in full or partial satisfaction of debt. OREO is initially recorded at fair value establishing a new cost basis and subsequently carried at lower of cost basis or fair value. Any valuation adjustments required at the date of transfer are charged to the allowance for loan losses. Subsequently, unrealized losses and realized gains and losses on sale are included in "(Gains) losses and write-downs on OREO, net" in the consolidated statements of operations. Operating results from OREO are recorded in "other noninterest expenses" in the consolidated statements of operations. Mortgage Servicing Rights ("MSRs"): The Bank recognizes, as separate assets, rights to service mortgage loans for others, whether the rights are acquired through purchase or after origination and sale of mortgage loans. The Bank initially measures MSRs at fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively is based on the present value of estimated future net servicing income. All classes of servicing assets are subsequently measured using the amortization method, which requires servicing rights to be amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. The carrying amount of MSRs, and the amortization thereon, is periodically evaluated in relation to their estimated fair values. The Bank stratifies the underlying mortgage loan portfolio by certain risk characteristics, such as loan type, interest rate and maturity, for purposes of measuring impairment. The Bank estimates the fair value of each stratum by calculating the discounted present value of future net servicing income based on management's best estimate of remaining loan lives. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular group, a reduction of the valuation allowance may be recorded as an increase to income. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual payment speeds and default rates and losses. The Bank has determined that the primary risk characteristic of MSRs is the contractual interest rate and term of the underlying mortgage loans. Fees earned for servicing rights are recorded as "mortgage loan servicing fees" in the consolidated statements of operations. The fees are based on a contractual percentage of the outstanding principal; or a fixed amount per loan and are recorded as income when earned. The amortization of MSRs as well as change in any valuation allowances are recorded in "other noninterest expenses" in the consolidated statements of operations. Federal Home Loan Bank (FHLB) Stock: The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. Federal Reserve Bank (FRB) Stock: The Bank is a member of its regional Federal Reserve Bank. FRB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. Other intangible assets: The Company may obtain intangible assets other than MSRs from time to time. In certain cases, these assets have no definite life and are not amortized. Other intangible assets may have an expected useful life and are amortized over this life. All intangible assets are tested periodically for impairment and, if deemed impaired, the assets are written down to the current value, with the impairment amount being charged to current earnings. Loan commitments and related financial instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Prepaid expenses: The Company may pay certain expenses before the actual costs are incurred. In this case, these expenses are recognized as an asset. These assets are amortized as expense over the period of time in which the costs are incurred. The original term of these prepaid expenses generally range from three months to five years. Earnings (loss) per common share: Basic earnings (loss) per common share represent income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share are determined assuming that all in-the-money stock options were exercised at the beginning of the yearly period. Shares related to unvested stock options are not treated as outstanding for the purposes of computing basic earnings (loss) per common share; however all allocated shares held by the ESOP are included in the average shares outstanding. Average number of shares used in calculation of basic and diluted earnings (loss) per common share are as follows for the years ended December 31, 2016, 2015 and 2014: Certain stock options and restricted stock units were not included in the above calculation, as they would have an anti-dilutive effect as the exercise price is greater than current market prices. The total number of shares excluded was approximately 26,000 shares and 42,000 shares for years ended December 31, 2015 and 2014, respectively. Comprehensive income (loss): Comprehensive income (loss) includes net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes net unrealized gains and losses on investment securities available for sale, net of tax, which is also recognized as a separate component of equity. Transfers of financial assets: Transfers of financial assets are accounted for as sales only when the control over the financial assets has been surrendered. Control over transferred assets is deemed surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Impairment of long-lived assets: Management periodically reviews the carrying value of its long-lived assets to determine if impairment has occurred or whether changes in circumstances have occurred that would require a revision to the remaining useful life. In making such determination, management evaluates the performance, on an undiscounted basis, of the underlying operations or assets which give rise to such amount. Income taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The Company recognizes interest and/or penalties related to income tax matters in income tax expense. Stock-based compensation: Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company's common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. Preferred stock: Preferred stock callable at the option of the Company is initially recorded at the amount of proceeds received. Any discount from the liquidation value is accreted to the preferred stock and charged to retained earnings. The accretion is recorded using the level-yield method. Preferred dividends paid (declared and/or accrued) and any accretion is deducted from net income for computing net income available to common shareholders and earnings per share computations. Fair value of financial instruments: Fair value of financial instruments is estimated using relevant market information and other assumptions, as more fully disclosed in Note 20. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates. Operating segments: While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company and Bank-wide basis. Operating results are not reviewed by senior management to make resource allocation or performance decisions. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment. Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or shareholders' equity. Newly Issued But Not Yet Effective Accounting Standards: In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). This update requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The following steps are applied in the updated guidance: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. The FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date. This update deferred the effective date by one year. The amended effective date is annual reporting periods beginning after December 15, 2017 including interim reporting periods within that reporting period. The Company's preliminary analysis suggests that the adoption of this accounting standard is not expected to have a material impact on the Company's consolidated financial statements. The FASB continues to release new accounting guidance related to the adoption of this standard, which could impact the Company's preliminary materiality analysis and may change the conclusions reached as to the application of this new guidance. In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (Topic 825). The amendments in this update require that public entities measure equity investments with readily determinable fair values, at fair value, with changes in their fair value recorded through net income. This ASU also clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available for sale securities in combination with the entity's other deferred tax assets. The amendments within the update are effective for fiscal years and all interim periods beginning after December 15, 2017. The Company is currently in the process of evaluating the impact of the adoption of this update, but does not expect a material impact on the Company's financial statements. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those periods using a modified retrospective approach and early adoption is permitted. The Company's preliminary analysis suggests that the adoption of this accounting standard is not expected to have a material impact on the Corporation's consolidated financial statements. In March 2016, the FASB issued ASU 2016-07, Investments Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting. ASU 2016-07 is effective for fiscal years beginning December 15, 2016, and interim periods within those fiscal years and early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of ASU 2016-07 on its financial statements and disclosures, but does not expect a material impact on the Company's financial statements. In March 2016, the FASB issued ASU 2016-09, Compensation- Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016 and early adoption is permitted for financial statements that have not been previously issued. The Company is currently evaluating the effects of ASU 2016-09 on its financial statements and disclosures, but does not expect a material impact on the Company's financial statements. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. This ASU is effective for the annual periods beginning after December 15, 2017. The Company is currently in the process of evaluating the effects of ASU 2016-10 on its financial statements and disclosures, but does not expect a material impact on the Company's financial statements. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. This ASU is effective for the annual periods beginning after December 15, 2017. The Company is currently in the process of evaluating the effects of ASU 2016-12 on its financial statements and disclosures, but does not expect a material impact on the Company's financial statements. In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently in the process of evaluating the effects of ASU 2016-13 on its financial statements and disclosures. In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 320): classification of certain cash receipts and cash payments. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is currently in the process of evaluating the effects of ASU 2016-15 on its financial statements and disclosures, but does not expect any material impact on the Company's financial statements. In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 320): Restricted Cash. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is currently in the process of evaluating the effects of ASU 2016-15 on its financial statements and disclosures, but does not expect any material impact on the Company's financial statements. Note 2. Restrictions on Cash and Due From Banks The Bank is required to maintain reserve balances in cash or on deposit with the FRB, based on a percentage of deposits. As of December 31, 2016, the reserve requirement on deposit at the FRB was $0 due to the large balance kept at the FRB. As of December 31, 2015, the reserve requirement on deposit at the FRB was $4.3 million. The Company maintains some of its cash in bank deposit accounts at financial institutions other than its subsidiaries that, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents. Note 3. Investment Securities Amortized cost and fair values of investment securities are summarized as follows: Realized net gains (losses) on sale and call of securities available for sale are summarized as follows: A summary of unrealized loss information for investment securities, categorized by security type, as of December 31, 2016 and 2015 was as follows: As of December 31, 2016 there were two held to maturity investment securities in an unrealized loss position for less than 12 months. As of December 31, 2015 there were no held to maturity investment securities in an unrealized loss position. As of December 31, 2016, the Company's security portfolio consisted of 147 securities, 87 of which were in an unrealized loss position. As of December 31, 2016, $387.0 million in investment securities had unrealized losses with aggregate depreciation of 1.90% of the Company's amortized cost basis. Of these securities, $51.3 million had a continuous unrealized loss position for twelve months or longer with an aggregate depreciation of 1.53%. The unrealized losses in all security categories relate principally to the general change in interest rates and illiquidity, and not credit quality, that has occurred since the securities purchase dates, and such unrecognized losses or gains will continue to vary with general interest rate level fluctuations in the future. The Company utilizes several external sources to evaluate prepayments, delinquencies, loss severity, and other factors in determining if there is impairment on an individual security. As management does not intend to sell the securities, and it is likely that it will not be required to sell the securities before their anticipated recovery, no declines are deemed to be other than temporary. The amortized cost and fair value of investment securities, as of December 31, 2016, by contractual maturity are shown below. Maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties. Securities with carrying amounts of $87.9 million and $91.7 million as of December 31, 2016 and 2015, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law. Note 4. Loans and Allowance for Loan Losses As of December 31, 2016 and 2015, loans consisted of: Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management and the Board of Directors review and approve these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Management has identified the following categories in its loan portfolios: Commercial loans: These loans are underwritten after evaluating and understanding the borrower's ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Commercial real estate loans: These loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of other real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher original amounts than other types of loans and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company's commercial real estate portfolio are geographically concentrated in the markets in which the Company operates. Management monitors and evaluates commercial real estate loans based on collateral, location and risk grade criteria. The Company also utilizes third-party sources to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. As of December 31, 2016 and 2015, 26.1% and 28.4%, respectively, of the outstanding principal balances of the Company's commercial real estate loans were secured by owner-occupied properties. With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Residential real estate loans: Underwriting standards for residential real estate and home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, maximum loan-to-value levels, debt-to-income levels, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. Construction real estate loans: These loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction real estate loans are generally based upon estimates of costs and values associated with the completed project and often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing. Installment loans: The Company originates consumer loans utilizing a credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company's policies and procedures, which include periodic internal reviews and reports to identify and address risk factors developing within the loan portfolio. The Company engages external independent loan reviews that assess and validate the credit risk program on a periodic basis. Results of these reviews are presented to management and the Board of Directors. The following table presents the contractual aging of the recorded investment in current and past due loans by class of loans as of December 31, 2016 and 2015, including nonaccrual loans: The following table presents the recorded investment in nonaccrual loans and loans past due 90 days or more and still accruing by class of loans as of December 31, 2016 and 2015: The Company utilizes an internal asset classification system as a means of reporting problem and potential problem loans. Under the Company's risk rating system, problem and potential problem loans are classified as "Special Mention," "Substandard," and "Doubtful." Substandard loans include those characterized by the likelihood that the Company will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses that deserve management's close attention are deemed to be Special Mention. Any time a situation warrants, the risk rating may be reviewed. Loans not meeting the criteria above that are analyzed individually are considered to be pass-rated loans. The following table presents the risk category by class of loans based on the most recent analysis performed and the contractual aging as of December 31, 2016 and 2015: The following table shows all loans, including nonaccrual loans, by classification and aging, as of December 31, 2016 and 2015: As of December 31, 2016, nonaccrual loans totaling $18.4 million were classified as Substandard. As of December 31, 2015, nonaccrual loans totaling $27.5 million were classified as Substandard. The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2016 and 2015, showing the unpaid principal balance, the recorded investment of the loan (reflecting any loans with partial charge-offs), and the amount of allowance for loan losses specifically allocated for these impaired loans (if any): The following table presents loans individually evaluated for impairment by class of loans for the years ended December 31, 2016, 2015 and 2014, showing the average recorded investment and the interest income recognized: If nonaccrual loans outstanding had been current in accordance with their original terms, approximately $1.1 million, $1.8 million and $3.0 million would have been recorded as loan interest income during the years ended December 31, 2016, 2015 and 2014, respectively. Interest income recognized in the above table was primarily recognized on a cash basis. Recorded investment balances in the above tables exclude accrued interest income and unearned income as such amounts were immaterial. Allowance for Loan Losses: For the years ended December 31, 2016, 2015 and 2014, activity in the allowance for loan losses was as follows: Allocation of the allowance for loan losses (as well as the total loans in each allocation method), disaggregated on the basis of the Company's impairment methodology, is as follows: In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. The evaluation is performed under the Company's internal underwriting policy. TDRs are defined as those loans where: (1) the borrower is experiencing financial difficulties and (2) the restructuring includes a concession by the Bank to the borrower that the Bank would not otherwise consider. The following loans were restructured during the years ended December 31, 2016, 2015, and 2014: The following table presents loans by class modified as TDRs for which there was a payment default within twelve months following the modification during the years ended December 31, 2016, 2015, and 2014: The following table presents total TDRs, both in accrual and nonaccrual status, as of December 31, 2016, 2015, and 2014: As of December 31, 2016, the Bank had a total of $1.6 million in commitments to lend additional funds on six commercial loans classified as TDRs. Impairment analyses are prepared on TDRs in conjunction with the normal allowance for loan loss process. TDRs required a specific reserve of $0, $14 thousand, and $88 thousand which was included in the allowance for loan losses at the years ended December 31, 2016, 2015, and 2014, respectively. TDRs resulted in charge-offs of $2.0 million, $2.8 million, and $2.8 million during the years ended December 31, 2016, 2015, and 2014, respectively. The TDRs that subsequently defaulted required a provision of $0, $11 thousand, and $0 to the allowance for loan losses for the years ended December 31, 2016, 2015, and 2014 respectively. Loans to Executive Officers and Directors: Loan principal balances to executive officers and directors of the Company were $347.8 thousand and $1.9 million as of December 31, 2016 and 2015, respectively. Total credit available, including companies in which these individuals have management control or beneficial ownership, was $513.6 thousand and $2.3 million as of December 31, 2016 and 2015, respectively. An analysis of the activity related to these loans as of December 31, 2016 and 2015 is as follows: Note 5. Loan Servicing and Mortgage Servicing Rights Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid balance of these loans as of December 31, 2016 and 2015 is summarized as follows: During the years ended December 31, 2016, 2015 and 2014, substantially all of the loans serviced for others had a contractual servicing fee of 0.25% on the unpaid principal balance. These fees are recorded as "mortgage loan servicing fees" under "noninterest income" on the consolidated statements of operations. Late fees on the loans serviced for others totaled $53 thousand, $182 thousand and $191 thousand during the years ended December 31, 2016, 2015 and 2014, respectively. These fees are included in "noninterest income" on the consolidated statements of operations. Custodial balances on deposit at the Bank in connection with the foregoing loan servicing were approximately $4.8 million and $6.1 million as of December 31, 2016 and 2015, respectively. There were no custodial balances on deposit with other financial institutions as of December 31, 2016 and 2015. An analysis of changes in the MSR asset for the years ended December 31, 2016, 2015 and 2014 follows: Below is an analysis of changes in the MSR asset valuation allowance for the years ended December 31, 2016, 2015 and 2014: The fair values of the MSRs were $6.9 million, $6.9 million and $7.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. A valuation allowance is used to recognize impairments of MSRs. An MSR is considered impaired when the fair value of the MSR is below the amortized book value of the MSR. MSRs are accounted for by risk tranche, with the interest rate and term of the underlying loan being the primary strata used in distinguishing the tranches. Each tranche is evaluated separately for impairment. The following assumptions were used to calculate the fair value of the MSRs as of December 31, 2016, 2015 and 2014: Note 6. Other Real Estate Owned OREO consists of property acquired due to foreclosure on real estate loans. As of December 31, 2016 and 2015, total OREO consisted of: The following table presents a summary of OREO activity for the years ended December 31, 2016 and 2015: Note 7. Premises and Equipment As of December 31, 2016 and 2015, premises and equipment consisted of: Depreciation on premises and equipment was $1.4 million, $1.7 million and $2.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. Note 8. Deposits As of December 31, 2016 and 2015, deposits consisted of: As of December 31, 2016, the scheduled maturities of time certificates were as follows: Deposits from executive officers, directors and their affiliates as of December 31, 2016 and 2015 were $1.6 million and $1.1 million, respectively. Note 9. Borrowings Notes payable to the FHLB as of December 31, 2016 and 2015 were secured by a blanket assignment of mortgage loans or other collateral acceptable to FHLB, and generally had a fixed rate of interest, interest payable monthly and principal due at end of term, unless otherwise noted. As of December 31, 2016, $537.7 thousand in loans were pledged under the blanket assignment. Investment securities are held in safekeeping at the FHLB with $2.3 million pledged as collateral for outstanding advances. An additional $100.6 million in advances is available based on the current value of the remaining unpledged investment securities. In the event that short-term liquidity is needed, we have established relationships with several large regional banks to provide short-term borrowings in the form of federal funds purchase. We have the ability to borrow $20 million for a short period (15 to 60 days) from these banks on a collective basis. The following table details borrowings as of December 31, 2016 and 2015. Note 10. Junior Subordinated Debt The following table presents details on the junior subordinated debt as of December 31, 2016: On the dates of issue indicated above, the Trusts, being Delaware statutory business trusts, issued trust preferred securities (the "trust preferred securities") in the amount and at the rate indicated above. These securities represent preferred beneficial interests in the assets of the Trusts. The trust preferred securities will mature on the dates indicated, and are redeemable in whole or in part at the option of Trinity, with the approval of the FRB. The Trusts also issued common equity securities to Trinity in the amounts indicated above. The Trusts used the proceeds of the offering of the trust preferred securities to purchase junior subordinated deferrable interest debentures (the "debentures") issued by Trinity, which have terms substantially similar to the trust preferred securities. Trinity has the right to defer payments of interest on the debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods (or twenty consecutive quarterly periods in the case of Trusts with quarterly interest payments) with respect to each interest payment deferred. During a period of deferral, unpaid accrued interest is compounded. Under the terms of the debentures, under certain circumstances of default or if Trinity has elected to defer interest on the debentures, Trinity may not, with certain exceptions, declare or pay any dividends or distributions on its common stock or purchase or acquire any of its common stock. In the second quarter of 2013, Trinity began to defer the interest payments on $37.1 million of junior subordinated debentures that are held by the Trusts that it controls. Interest accrued and unpaid to securities holders total $9.8 million and $6.9 million as of December 31, 2016 and 2015, respectively. In the first quarter of 2017 all deferred interest was paid in full and the Company is no longer deferring interest payments on the junior subordinated debentures. See Note 22, "Subsequent Events." As of December 31, 2016 and 2015, the Company's trust preferred securities, subject to certain limitations, qualified as Tier 1 Capital for regulatory capital purposes. Payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities are guaranteed by Trinity. Trinity also entered into an agreement as to expenses and liabilities with the Trusts pursuant to which it agreed, on a subordinated basis, to pay any costs, expenses or liabilities of the Trusts other than those arising under the trust preferred securities. The obligations of Trinity under the junior subordinated debentures, the related indenture, the trust agreement establishing the Trusts, the guarantee and the agreement as to expenses and liabilities, in the aggregate, constitute a full and unconditional guarantee by Trinity of the Trusts' obligations under the trust preferred securities. Note 11. Description of Leasing Arrangements The Company is leasing land in Santa Fe on which it built a bank office as well as the vacant land adjacent to the office. The construction of the office was completed in 2009. The original terms of the leases expired in May 2014 and are currently month-to-month. The leases contain both an option to extend for additional five year terms and an option to purchase the land at a set price. Trinity was required to notify the landlord of its intent to exercise the options to purchase between December 1, 2014 and December 1, 2015 for the land on which the bank built its office and between May 1, 2014 and December 1, 2015 for the adjacent land. Trinity formally notified the landlord of its exercise of the options to purchase under the leases on April 24, 2015 and expects to complete the exercise or extend the lease in 2017. This lease is classified as a capital lease. The Company also holds two notes and mortgages on the land, and the interest payments received on the notes are approximately equal to the rental payments on the leases; and the principal due at maturity or upon transfer of the land, will largely offset the option purchase prices. Operating lease payments for the years ended December 31, 2016, 2015 and 2014 totaled $241 thousand, $272 thousand and $356 thousand, respectively. There were no lease payments under capital lease for 2016. Commitments for minimum future rentals under operating leases were as follows as of December 31, 2016: Note 12. Retirement Plans The Company has an ESOP for the benefit of all employees who are at least 18 years of age and have completed 1,000 hours of service during the plan year. The employee's interest in the ESOP vests over a period of six years. The ESOP was established in January 1989 and is a defined contribution plan subject to the requirements of the Employee Retirement Income Security Act of 1974. The ESOP is funded by discretionary contributions by the Company as determined by its Board of Directors. No expenses were recorded in 2016, 2015, or 2014. All shares held by the ESOP, acquired prior to the issuance of ASC 718-40, "Compensation-Stock Compensation-Employee Stock Ownership Plans" are included in the computation of average common shares and common share equivalents. This accounting treatment is grandfathered for shares purchased prior to December 31, 1992. As permitted by ASC 718-40, compensation expense for shares released is equal to the original acquisition cost of the shares if acquired prior to December 31, 1992. As shares acquired after ASC 718-40 were released from collateral, the Company reported compensation expense equal to the current fair value of the shares, and the shares became outstanding for the earnings per share computations. Shares of the Company held by the ESOP are as follows: There was no compensation expense recognized for ESOP shares acquired prior to December 31, 1992 during the years ended December 31, 2016, 2015 and 2014. Under federal income tax regulations, the employer securities that are held by the Plan and its participants and that are not readily tradable on an established market or that are subject to trading limitations include a put option (liquidity put). The liquidity put is a right to demand that the Company buy shares of its stock held by the participant for which there is no readily available market. The put price is representative of the fair value of the stock. The Company may pay the purchase price over a five-year period. The purpose of the liquidity put is to ensure that the participant has the ability to ultimately obtain cash. The fair value of the allocated shares subject to repurchase was $3.2 million and $2.7 million as of December 31, 2016 and 2015, respectively. The Company's employees may also participate in a tax-deferred savings plan (401(k)) to which the Company does not contribute. Note 13. Stock Incentives The Trinity Capital Corporation 1998 Stock Option Plan ("1998 Plan") and Trinity Capital Corporation 2005 Stock Incentive Plan ("2005 Plan") were created for the benefit of key management and select employees. Under the 1998 Plan, 400,000 shares (as adjusted for the stock split on December 19, 2002) from shares held in treasury or authorized but unissued common stock were reserved for granting options. No further awards may be granted under the 1998 Plan. Under the 2005 Plan, 500,000 shares from shares held in treasury or authorized but unissued common stock were reserved for granting stock-based incentive awards. No further awards may be granted under the 2005 Plan. Both of these plans were approved by the Company's stockholders. The Compensation Committee determines the terms and conditions of the awards. At the Shareholder Meeting held on January 22, 2015, the Company's stockholders approved the Trinity Capital Corporation 2015 Long-Term Incentive Plan ("2015 Plan"). Under the 2015 Plan, 500,000 shares from shares held in treasury or authorized but unissued common stock are reserved for granting stock-based incentive awards. There were 50,228 awards issued under the 2015 Plan in 2016. Because share-based compensation awards vesting in the current periods were granted on a variety of dates, the assumptions are presented as weighted averages in those assumptions. There was no stock option activity as of December 31, 2016. A summary of restricted stock unit ("RSU") activity under the 1998 Plan, the 2005 Plan, and the 2015 Plan as of December 31, 2016 is presented below: There were 11,765 restricted stock units exercised in 2016. No restricted stock units were exercised in 2015 or 2014. As of December 31, 2016, there was $145 thousand in unrecognized compensation cost related to unvested share-based compensation awards granted under the 2015 Plan. The cost will be recognized over the remaining vesting period. Note 14. Income Taxes The current and deferred components of the provision (benefit) for income taxes for the years ended December 31, 2016, 2015 and 2014 are as follows: A deferred tax asset or liability is recognized to reflect the net tax effects of temporary differences between the carrying amounts of existing assets and liabilities for financial reporting purposes and the amounts used for income tax reporting purposes. Temporary differences that gave rise to the deferred tax assets and liabilities as of December 31, 2016 and 2015 are as follows: A valuation allowance is established when it is more likely than not that all or a portion of a net deferred tax asset will not be realized. The Company recorded a loss before income taxes for the years ended December 31, 2011 and 2010. Based on these losses, the Company determined that it was no longer more likely than not that its deferred tax assets of $14.6 million at December 31, 2011 would be utilized. Accordingly, a full valuation allowance was recorded as of December 31, 2011. As of December 31, 2016, management's analysis determined that it was more likely than not that the amount of the deferred tax assets would be utilized in future periods for all but the capital losses therefore $14.8 million of the previously recorded valuation allowance was reversed leaving $387 thousand in valuation allowance at December 31, 2016. The positive evidence used in evaluating the reversal of the valuation allowance were: 1) positive income before income taxes in 8 of the 12 quarters from January 2014 to December 2016, 2) positive year to date income before income taxes at December 31, 2016, 3) successful capital rise completed in December 2016, and 4) reasonable and supportable forecasts for future earnings. The negative evidence used in evaluating the reversal of the valuation allowance were: 1) the Company has experienced losses due to the restatement of the Company's financials and from expenses stemming from the resulting SEC and OCC investigations, 2) the Company incurred significant expenses in building the infrastructure and controls necessary to support the Company, and 3) the Company's major earning assets have continued to decline in 2016. Based on the evaluation, management concluded the available positive evidence outweighed the negative evidence. For the year ended December 31, 2016, the Company had federal net operating loss carryforwards of $15.4 million and state net operating loss carryforwards of $13.9 million which will expire at various dates from 2031 to 2035. Realization of deferred tax assets associated with the net operating loss carryforwards is dependent upon generating sufficient taxable income prior to their expiration. The Company has federal business tax credit carry-forwards totaling $2.4 million as of December 31, 2016 and 2015, which will begin to expire in 2031, and $173 thousand of alternative minimum tax (AMT) carry-forwards that do not expire. The Company has state tax credit carry-forwards of $427 thousand which will begin to expire in 2018. Items causing differences between the Federal statutory tax rate and the effective tax rate are summarized as follows: The calculation for the income tax provision or benefit generally does not consider the tax effects of changes in other comprehensive income ("OCI"), which is a component of stockholders' equity on the balance sheet. However, an exception is provided in certain circumstances, such as when there is a full valuation allowance on net deferred tax assets, a loss before provision (benefit) for income taxes and income in other components of the financial statements. In such a case, pre-tax income from other categories, such as changes in OCI, must be considered in determining a tax benefit to be allocated to the loss before provision (benefit) for income taxes. The Company has no liabilities associated with uncertain tax positions as of December 31, 2016 and 2015 and does not anticipate providing an income tax reserve in the next twelve months. During the years ended December 31, 2016 and 2015, the Company did not record an accrual for interest and penalties associated with uncertain tax positions. The Company is subject to U.S. federal and New Mexico income taxes. The Company's federal and state income tax returns are subject to examination by the taxing authorities for years after 2012. Under Section 382 of the Code ("Section 382"), and based on the Company's analysis, we believe that the Company experienced an "ownership change" (generally defined as a greater than 50% change (by value) in our equity ownership over a three-year period) on December 19, 2016, and our ability to use our pre-change of control NOLs and other pre-change tax attributes against our post-change income is limited. The Section 382 limitation is applied annually so as to limit the use of our pre-change NOLs to an amount that generally equals the value of our stock immediately before the ownership change multiplied by a designated federal long-term tax-exempt rate. Due to applicable limitations under Section 382, a portion of these NOLs are limited; however, we do not believe that any NOLs will expire unused. We believe that the total available and utilizable NOL carry forward at December 31, 2016 is approximately $15.4 million. These NOLs will begin to expire in 2031. The Company's ability to utilize the NOLs or realize any benefit related to the NOLs is subject to a number of risks. Please see Part I, Item 1A "Risk Factors" for more information. Note 15. Commitments and Off-Balance-Sheet Activities Credit-related financial instruments: The Company is a party to credit-related commitments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These credit-related commitments include commitments to extend credit, standby letters of credit and commercial letters of credit. Such credit-related commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Company's exposure to credit loss is represented by the contractual amount of these credit-related commitments. The Company follows the same credit policies in making credit-related commitments as it does for on-balance-sheet instruments. As of December 31, 2016 and 2015, the following credit-related commitments were outstanding: Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Bank, is based on management's credit evaluation of the customer. Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. Overdraft protection agreements are uncollateralized, but most other unfunded commitments have collateral. These unfunded lines of credit usually do not contain a specified maturity date and may not necessarily be drawn upon to the total extent to which the Bank is committed. Commitments to make loans are generally made for periods of 90 days or less. The Company had outstanding loan commitments, excluding undisbursed portion of loans in process and equity lines of credit, of approximately $125.4 million as of December 31, 2016 and $116.6 million as of 2015, respectively. Of these commitments outstanding, the breakdown between fixed rate and adjustable rate loans is as follows: The fixed rate loan commitments have interest rates ranging from 2.3 % to 14.8 % and maturities ranging from on demand to 10 years. Outstanding Letters of Credit: In addition to short and long-term borrowings from the FHLB, the FHLB has issued letters of credit to various public entities with deposits at the Bank. These letters of credit are issued to collateralize the deposits of these entities at the Bank as required or allowed under law. These letters of credit expired during 2015. These letters were secured under the blanket assignment of mortgage loans or other collateral acceptable to the FHLB that also secures the Company's short and long-term borrowings from FHLB. The amount of collateral with the FHLB at December 31, 2016 was $102.9 million. Commercial and standby letters of credit are conditional credit-related commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers. The Bank generally holds collateral supporting those credit-related commitments, if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the credit-related commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above. If the credit-related commitment is funded, the Bank would be entitled to seek recovery from the customer. As of both December 31, 2016 and 2015, $575 thousand has been recorded as liabilities for the Company's potential losses under these credit-related commitments. The fair value of these credit-related commitments is approximately equal to the fees collected when granting these letters of credit. These fees collected were $26 thousand and $20 thousand as of December 31, 2016 and 2015, respectively, and are included in "other liabilities" on the consolidated balance sheets. Note 16. Preferred Equity Issues On March 27, 2009, the Company issued two series of preferred stock to the U.S. Department of the Treasury ("Treasury") under the TARP Capital Purchase Program ("CPP"). On December 19, 2016, the Company issued 82,862 shares of Series C Convertible Preferred Stock pursuant to a private placement. Below is a table disclosing the information on the three series as of December 31, 2016: The difference between the liquidation value of the preferred stock and the original cost is accreted (for the Series B Preferred Stock) or amortized (for the Series A Preferred Stock) over 10 years and is reflected, on a net basis, as an increase to the carrying value of preferred stock and decrease to retained earnings. For each of the years ended December 31, 2016 and 2015, a net amount of $178 thousand was recorded for amortization. Dividends and discount accretion on preferred stock reduce the amount of net income available to common shareholders. For each of the years ended December 31, 2016 and 2015 the total of these amounts was $4.3 million and $3.8 million, respectively. Private Placement to Certain Institutional and Accredited Investors On December 19, 2016, the Company closed its previously announced $52 million private placement with Castle Creek Capital Partners VI, L.P. ("Castle Creek"), Patriot Financial Partners II, L.P., Patriot Financial Partners Parallel II, L.P. (collectively, "Patriot") and Strategic Value Bank Partners, L.P., through its fund Strategic Value Investors LP, pursuant to which the Company issued 2,661,239 shares of its common stock, no par value per share, at $4.75 per share, and 82,862 shares of a new series of convertible perpetual non-voting preferred stock, Series C, no par value per share, at $475.00 per share ("Series C Preferred Stock"). The Company used a portion of the net proceeds from the private placement to repurchase its outstanding Series A Preferred Stock (as defined below) and Series B Preferred Stock (as defined below), which it completed on January 25, 2017, and use the remaining net proceeds to pay the deferred interest on its trust preferred securities, and for general corporate purposes. In connection with the private placement and in accordance with the terms of a stock purchase agreement, dated September 9, 2016 (the "Stock Purchase Agreement"), the Company entered into a registration rights agreement (the "Registration Rights Agreement") with each of Castle Creek and Patriot. Pursuant to the terms of the Registration Rights Agreement, the Company has agreed to file a resale registration statement for the purpose of registering the resale of the shares of the Common Stock and Series C Preferred Stock issued in the private placement and the underlying shares of Common Stock or non-voting Common Stock into which the shares of Series C Preferred Stock are convertible, as appropriate. The Company is obligated to file the registration statement no later than the third anniversary after the closing of the private placement. Pursuant to the terms of the Stock Purchase Agreement, Castle Creek and Patriot entered into side letter agreements with us. Under the terms of the side letter agreements, each of Castle Creek and Patriot is entitled to have one representative appointed to our Board of Directors for so long as such investor, together with its respective affiliates, owns, in the aggregate, 5% or more of all of our outstanding shares of common stock (including shares of common stock issuable upon conversion of the Series C Preferred Stock or non-voting common stock). Redemption of Series A Preferred Stock and Series B Preferred Stock On March 27, 2009, Trinity participated in the TARP Capital Purchase Program by issuing 35,539 shares of Trinity's Fixed Rate Cumulative Perpetual Preferred Stock, Series A Preferred Stock to the Treasury for a purchase price of $35.5 million in cash and issued warrants that were immediately exercised by the Treasury for 1,777 shares of Trinity's Fixed Rate Cumulative Perpetual Preferred Stock, Series B Preferred Stock. Using part of the proceeds from the private placement described above, the Company redeemed all of its outstanding Series A Preferred Stock and Series B Preferred Stock effective January 25, 2017. Conversion of Series C Preferred Stock to Non-Voting Common Stock At December 31, 2016, the Company had outstanding 82,862 shares of Series C Preferred Stock that were issued in connection with the private placement. Following shareholder approval of an amendment to the Company's articles of incorporation to authorize a class of non-voting common stock, and the subsequent filing of such amendment with the New Mexico Secretary of State, all outstanding shares of Series C Preferred Stock were automatically converted into 8,286,200 shares of non-voting common stock at a conversion price of $4.75 per share of non-voting common stock pursuant to the private placement. This conversion was completed on February 2, 2017. Note 17. Litigation The Company and its subsidiaries are subject, in the normal course of business, to various pending and threatened legal proceedings in which claims for monetary damages are asserted. On an ongoing basis management, after consultation with legal counsel, assesses the Company's liabilities and contingencies in connection with such legal proceedings. For those matters where it is probable that the Company will incur losses and the amounts of the losses can be reasonably estimated, the Company records an expense and corresponding liability in its consolidated financial statements. To the extent the pending or threatened litigation could result in exposure in excess of that liability, the amount of such excess is not currently estimable. The Company can give no assurance, however, its business, financial condition and results of operations will not be materially adversely affected, or that it will not be required to materially change its business practices, based on: (i) future enactment of new banking or other laws or regulations; (ii) the interpretation or application of existing laws or regulations, including the laws and regulations as they may relate to the Company's business, banking services or the financial services industry in general; (iii) pending or future federal or state governmental investigations of the business; (iv) institution of government enforcement actions against the Company; or (v) adverse developments in other pending or future legal proceedings against the Company or affecting the banking or financial services industry generally. In addition to legal proceedings occurring in the normal course of business, the Company is the subject of certain governmental investigations and legal proceedings as set forth below. SEC Investigation: On September 28, 2015, the Securities and Exchange Commission ("SEC") announced an administrative settlement with the Company, resolving the previously reported investigation of the Company's historical accounting and reporting with respect to its restatement of financial information for the years ended December 31, 2006 through December 31, 2011 and the quarters ended March 31, 2012 and June 30, 2012. The Company and the SEC settled the investigation, pursuant to which the Company, without admitting or denying any factual allegations, consented to the SEC's issuance of an administrative order finding that the Company did not properly account for the Bank's loan portfolio during 2010, 2011 and the first two quarters of 2012, did not properly account for its OREO in 2011, and did not have effective internal accounting controls over loan and OREO accounting. In addition, the SEC found that certain former members of the Bank's management caused the Bank to engage in false and misleading accounting and overrode internal accounting controls. As a result, the SEC found that the Company violated certain provisions of the securities laws, including Section 10(b) of the Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder; Section 17(a) of the Securities Act of 1933; and Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder; Section 13(b)(2)(A) of the Exchange Act; and Sections 13(b)(2)(B) of the Exchange Act. The settlement orders the Company to cease and desist from committing or causing any such violations in the future and to pay a civil money penalty in the amount of $1.5 million. The civil money penalty was expensed in 2014 and subsequently paid in September 2015, upon entering into the administrative settlement agreement. The Company agreed to cooperate in proceedings brought by the SEC as well as any future investigations into matters described in the settlement. The Company cooperated fully with the SEC investigation. SIGTARP/DOJ Investigation: The Special Inspector General of the Troubled Asset Relief Program ("SIGTARP") and the Department of Justice ("DOJ") initiated a criminal investigation relating to the financial reporting and securities filings referenced above and actions relating to the 2012 examination of the Bank by the OCC. The Company is cooperating with all requests from SIGTARP and the DOJ. SIGTARP and DOJ have advised the Company that it is not the target of the investigation. As of March 9, 2017, no suit or charges have been filed against the Company or its current directors, executive officers or employees by any parties relating to the restatement. While there is a reasonable probability that some loss will be experienced, through litigation or assessments, other than as disclosed above, the potential loss cannot be quantified. The Company has not accrued a reserve for any potential losses resulting from unresolved regulatory investigations. Insurance Coverage and Indemnification Litigation: ● Trinity Capital Corporation and Los Alamos National Bank v. Atlantic Specialty Insurance Company, Federal Insurance Company, William C. Enloe and Jill Cook, (First Judicial District Court, State of New Mexico, Case No. D-132-CV-201500083); ● William C. Enloe v. Atlantic Specialty Insurance Company, Federal Insurance Company, Trinity Capital Corporation and Los Alamos National Bank, (First Judicial District Court, State of New Mexico, Case No. D-132-CV-201500082); and ● Mark Pierce v. Atlantic Specialty Insurance Company, Trinity Capitol Corporation d/b/a Los Alamos National Bank, and Federal Insurance Company, (First Judicial District Court, State of New Mexico, Case No. D-101-CV-201502381). In connection with the restatements and investigations, on September 1, 2015, the Company and William Enloe ("Enloe"), Trinity and the Bank's former Chief Executive Officer and Chairman of the Board, filed separate suits in New Mexico State Court. Jill Cook, the Company's former Chief Credit Officer, was also named in the suit brought by Trinity. On October 28, 2015, the Court entered an order consolidating the Enloe and Trinity suits. Mark Pierce, the Bank's former Senior Lending Officer, filed suit in New Mexico State Court on November 2, 2015. On April 26, 2016, Pierce filed a motion to consolidate his suit with the Enloe and Trinity suit. In each of the three suits listed above, the plaintiffs seek coverage and reimbursement from the insurance carriers for the defense costs incurred by individuals covered under those policies, as defined therein, in addition to causes of action against the insurance companies for bad faith, breach of insurance contracts and against Atlantic Specialty Insurance for violations of New Mexico insurance statutes. The suits, with the exception of Enloe's suit, also seek a determination on the obligations of the Company and/or the Bank to indemnify the former officers. The suits filed by Enloe and Pierce each allege, in the alternative, negligence against the Company and the Bank for failing to timely put all carriers on notice of his claims. The Company and the Bank will vigorously defend its actions and seek indemnification and coverage from its insurance carriers as required under the insurance policies. Due to the complex nature, the outcome and timing of ultimate resolution is inherently difficult to predict. Title Insurance Coverage Litigation: First American Title v. Los Alamos National Bank (Second Judicial District Court, State of New Mexico, Case No. D-202-CV-201207023). This suit relates to title coverage claims regarding a commercial property that served as collateral for a commercial loan made by the Bank. The title company asserted a claim against the Bank for recovery of losses suffered as a result of a settlement entered into by both the title company and the Bank to satisfy the claims of certain contractors who filed liens on the property. On April 29, 2016, the District Court issued its Findings of Fact and Conclusions of Law finding against the Bank and finding the plaintiff is entitled to a judgment in the amount of $150,000 and its costs of bringing suit. The suit was settled in June 2016 for significantly less than the judgment amount. Note 18. Derivative Financial Instruments In the normal course of business, the Bank uses a variety of financial instruments to service the financial needs of customers and to reduce its exposure to fluctuations in interest rates. Derivative instruments that the Bank used as part of its interest rate risk management strategy include mandatory forward delivery commitments and rate lock commitments. As a result of using derivative instruments, the Bank has potential exposure to credit loss in the event of non-performance by the counterparties. The Bank manages this credit risk by spreading the credit risk among counterparties that the Company believes are well established and financially strong and by placing contractual limits on the amount of unsecured credit risk from any single counterparty. The Bank's exposure to credit risk in the event of default by a counterparty is the current cost of replacing the contracts net of any available margins retained by the Bank. However, if the borrower defaults on the commitment the Bank requires the borrower to cover these costs. The Company originates single-family residential loans for sale pursuant to programs offered by Fannie Mae. At the time the interest rate is locked in by the borrower, the Bank concurrently enters into a forward loan sale agreement with respect to the sale of such loan at a set price in an effort to manage the interest rate risk inherent in the locked loan commitment. Any change in the fair value of the loan commitment after the borrower locks in the interest rate is substantially offset by the corresponding change in the fair value of the forward loan sale agreement related to such loan. This change is recorded to "other noninterest expenses" in the consolidated statements of operations. The period from the time the borrower locks in the interest rate to the time the Bank funds the loan and sells it to Fannie Mae is generally 60 days. The fair value of each instrument will rise or fall in response to changes in market interest rates subsequent to the dates the interest rate locks and forward loan sale agreements are entered into. In the event that interest rates rise after the Bank enters into an interest rate lock, the fair value of the loan commitment will decline. However, the fair value of the forward loan sale agreement related to such loan commitment generally increases by substantially the same amount, effectively eliminating the Company's interest rate and price risk. In October 2016, the Company moved to an outsource solution whereby the Bank generates residential mortgage applications for non-affiliated residential mortgage companies on a fee basis. Due to this change in strategy, the Company did not have any derivative instruments outstanding as of December 31, 2016. As of December 31, 2016, the Company had no notional amounts in contracts with customers or in contracts with Fannie Mae for interest rate lock commitments outstanding related to loans being originated for sale. As of December 31, 2015, the Company had notional amounts of $5.1 million in contracts with customers and $8.1 million in contracts with Fannie Mae for interest rate lock commitments outstanding related to loans being originated for sale. The fair value of interest rate lock commitments was $0 as of December 31, 2016 and $225 thousand as of December 31, 2015. Note 19. Regulatory Matters The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. The Company is subject to restrictions on the payment of dividends and cannot pay dividends that exceed its net income or which may weaken its financial health. The Company's primary source of cash is dividends from the Bank. Generally, the Bank is subject to certain restrictions on dividends that it may declare without prior regulatory approval. The Bank cannot pay dividends in any calendar year that, in the aggregate, exceed the Bank's year-to-date net income plus its retained income for the two preceding years. Additionally, the Bank cannot pay dividends that are in excess of the amount that would result in the Bank falling below the minimum required for capital adequacy purposes. Trinity was placed under a Written Agreement by the FRB on September 26, 2013. The Written Agreement requires Trinity to serve as a source of strength to the Bank and restricts Trinity's ability, without written approval of the FRB, to make payments on the Company's junior subordinated debentures, incur or increase any debt, issue dividends and other capital distributions or to repurchase or redeem any Trinity stock. Additionally, the Bank was similarly prohibited from paying dividends to Trinity under the Formal Agreement issued by the OCC on November 30, 2012 and under the Consent Order, which replaced the Formal Agreement, issued on December 17, 2013. The Consent Order requires that the Bank maintain certain capital ratios and receive approval from the OCC prior to declaring dividends. The Company and the Bank are taking actions to address the provisions of the enforcement actions. Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Failure to meet capital requirements can initiate regulatory action. The Basel III Rule became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. See Item 1 - "Supervision & Regulation" for further discussion regarding the Basel III Rules. The Company and the Bank met all capital adequacy requirements to which they were subject as of December 31, 2016. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. The statutory requirements and actual amounts and ratios for the Company and the Bank are presented below: N/A-not applicable While the Bank's capital ratios fall into the category of "well-capitalized," the Bank cannot be considered "well-capitalized" under the prompt corrective action rules due to the existence of the Consent Order. The Bank is required to maintain (i) a leverage ratio of Tier 1 Capital to total assets of at least 8%; and (ii) a ratio of Total Capital to total risk-weighted assets of at least 11%. As of December 31, 2016 and 2015 the Bank was in compliance with these requirements. Trinity and the Bank are also required to maintain a "capital conservation buffer" of 2.5% above the regulatory minimum risk-based capital requirements. The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. The capital conservation buffer began to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on certain activities, including payment of dividends, share repurchases and discretionary bonuses to executive officers, if its capital level is below the buffered ratio. Factoring in the fully phased-in conservation buffer increases the minimum ratios described above to 7.0% for CET1, 8.5% for Tier 1 Capital and 10.5% for Total Capital. At December 31, 2016 the Bank's capital conservation buffer was 7.3793 % and the consolidated capital conservation buffer was 2.3186 %. Note 20. Fair Value Measurements ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact. The Company uses valuation techniques that are consistent with the sales comparison approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert expected future amounts, such as cash flows or earnings, to a single present value amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability. While management believes the Company's valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company's monthly and/or quarterly valuation process. Financial Instruments Recorded at Fair Value on a Recurring Basis Securities Available for Sale. The fair values of securities available for sale are determined by quoted prices in active markets, when available. If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities. Derivatives. Derivative assets and liabilities represent interest rate contracts between the Company and loan customers, and between the Company and outside parties to whom it has made a commitment to sell residential mortgage loans at a set interest rate. These are valued based upon the differential between the interest rates upon the inception of the contract and the current market interest rates for similar products. Changes in fair value are recorded in current earnings. The following table summarizes the Company's financial assets and off-balance-sheet instruments measured at fair value on a recurring basis as of December 31, 2016 and 2015, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value: There were no financial liabilities that were measured at fair value as of December 31, 2016 and 2015. There were no financial assets or financial liabilities measured at fair value on a recurring basis for which the Company used significant unobservable inputs (Level 3) during the periods presented in these financial statements. There were no transfers between the levels used on any asset classes during the year. Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis The Company may be required, from time to time, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis in accordance with GAAP. Impaired Loans. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as impaired, management measures the amount of that impairment in accordance with ASC Topic 310. The fair value of impaired loans is estimated using one of several methods, including collateral value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. In accordance with ASC Topic 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. Collateral values are estimated using Level 3 inputs based on customized discounting criteria. For collateral dependent impaired loans, the Company obtains a current independent appraisal of loan collateral. Other valuation techniques are used as well, including internal valuations, comparable property analysis and contractual sales information. OREO. OREO is adjusted to fair value at the time the loans are transferred to OREO. Subsequently, OREO is carried at the lower of the carrying value or fair value. Fair value is determined based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. The fair value of OREO was computed based on third part appraisals, which are level 3 valuation inputs. As of December 31, 2016, impaired loans with a carrying value of $34.6 million had a valuation allowance of $3.0 million. As of December 31, 2015, impaired loans with a carrying value of $40.7 million had a valuation allowance of $4.2 million. In the table below, OREO had write-downs during the years ended December 31, 2016 and 2015 of $63 thousand and $361 thousand, respectively. The valuation adjustments on OREO have been recorded through earnings. Assets measured at fair value on a nonrecurring basis as of December 31, 2016 and 2015 are included in the table below: See Note 5 for assumptions used to determine the fair value of MSRs. Assumptions used to determine impaired loans and OREO are presented below by classification, measured at fair value and on a nonrecurring basis as of December 31, 2016 and 2015: Fair Value Assumptions ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The following methods and assumptions were used by the Company in estimating the fair values of its other financial instruments: Cash and due from banks and interest-bearing deposits with banks: The carrying amounts reported in the balance sheet approximate fair value and are classified as Level 1. Securities purchased under resell agreements: The carrying amounts reported in the balance sheet approximate fair value and are classified as Level 1. Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2), using matrix pricing. Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded, values debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). See below for additional discussion of Level 3 valuation methodologies and significant inputs. Non-marketable equity securities: It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability. Loans held for sale: The fair values disclosed are based upon the values of loans with similar characteristics purchased in secondary mortgage markets and are classified as Level 3. Loans: For those variable-rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. The fair values for fixed rate and all other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of loans is classified as Level 3 within the fair value hierarchy. Noninterest-bearing deposits: The fair values disclosed are equal to their balance sheet carrying amounts, which represent the amount payable on demand, and are classified as Level 1. Interest-bearing deposits: The fair values disclosed for deposits with no defined maturities are equal to their carrying amounts, which represent the amounts payable on demand, and are classified as Level 2. The carrying amounts for variable rate, fixed term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar certificates to a schedule of aggregated expected monthly maturities on time deposits. Long-term borrowings: The fair values of the Company's long-term borrowings (other than deposits) are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements, and are classified as Level 2. Junior subordinated debt: The fair values of the Company's junior subordinated debt are estimated based on the quoted market prices, when available, of the related trust preferred security instruments, or are estimated based on the quoted market prices of comparable trust preferred securities, and are classified as Level 3. Off-balance-sheet instruments: Fair values for the Company's off-balance-sheet lending commitments in the form of letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements. It is the opinion of management that the fair value of these commitments would approximate their carrying value, if drawn upon, and are classified as Level 2. Accrued interest: The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification. The carrying amount and estimated fair values of other financial instruments as of December 31, 2016 and 2015 are as follows: Note 21. Other Noninterest Expense Other noninterest expense items are presented in the following table for the years ended December 31, 2016, 2015 and 2014. Components exceeding 1% of the aggregate of total net interest income and total noninterest income are presented separately. Note 22. Subsequent Events Redemption of Series A Preferred Stock and Series B Preferred Stock On March 27, 2009, Trinity participated in the TARP Capital Purchase Program by issuing 35,539 shares of Series A Preferred Stock to the Treasury for a purchase price of $35.5 million in cash and issued warrants that were immediately exercised by the Treasury for 1,777 shares of Series B Preferred Stock. Using part of the proceeds from the private placement described above, the Company redeemed all of its outstanding Series A Preferred Stock and Series B Preferred Stock effective January 25, 2017. Payment of Deferred Interest on Trust Preferred Securities As of December 31, 2016, the Company had outstanding $37.1 million of trust preferred securities with a total of $9.8 million of accrued and unpaid interest. During the first quarter of 2017, the Company used part of the proceeds from the private placement, plus a portion of a $15 million dividend from the Bank, to pay all of the accrued and unpaid interest on the junior subordinated debentures. Conversion of Series C Preferred Stock to Non-Voting Common Stock At December 31, 2016, the Company had outstanding 82,862 shares of Series C Preferred Stock that were issued in connection with the private placement. Following shareholder approval of an amendment to the Company's articles of incorporation to authorize a class of non-voting common stock, and the subsequent filing of such amendment with the New Mexico Secretary of State, all outstanding shares of Series C Preferred Stock were automatically converted into 8,286,200 shares of non-voting common stock effective February 2, 2017. Note 23. Condensed Parent Company Financial Information The condensed financial statements of Trinity Capital Corporation (parent company only) are presented below: Balance Sheets Statements of Operations Statements of Cash Flows | Based on the provided financial statement excerpt, here's a summary of the key points:
Company Profile:
- Financial services provider operating in New Mexico (Los Alamos, Santa Fe, and Albuquerque)
- Offers banking, lending, trust, and wealth management services
Key Business Areas:
1. Deposit Products:
- Term certificates
- NOW accounts
- Savings accounts
2. Lending Products:
- Commercial real estate loans
- Residential real estate loans
- Construction real estate loans
Financial Position:
- Assets: Mentioned as "total assets of at least 8" (units not specified)
- Shows a Loss for the year ended December 31 (amount not specified)
Securities Management:
- Maintains both "available for sale" and "held to maturity" securities
- Uses specific criteria for determining other-than-temporary impairment (OTTI)
- Member of FHLB with required stock investment
Note: The statement appears to be incomplete and lacks specific numerical values for many financial metrics, making it difficult to provide a more detailed quantitative summary. | Claude |
Financial Statements. ACCOUNTING FIRM Board of Directors and Stockholders Watermark Group, Inc. We have audited the accompanying balance sheet of Watermark Group, Inc. ("the Company") as of April 30, 2016 and 2015 and the related statements of operations, stockholders' deficiency and cash flows for each of the two years in the period ended April 30, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Also, an audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Watermark Group, Inc. at April 30, 2016 and 2015, and the results of its operations and its cash flows for each of the two years in the period ended April 30, 2016 in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has incurred a net loss for the year ended April 30, 2016 and has a working capital deficiency and stockholders' deficiency at April 30, 2016. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans regarding those matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. WOLINETZ, LAFAZAN & COMPANY, P.C. Rockville Centre, New York July 21, 2016 The accompanying notes are an integral part of these financial statements. The accompanying notes are an integral part of these financial statements. The accompanying notes are an integral part of these financial statements. The accompanying notes are an integral part of these financial statements. WATERMARK GROUP, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1 - Summary of Significant Accounting Policies Organization Watermark Group, Inc. ("the Company") was incorporated on May 15, 2009 under the laws of the State of Nevada. On August 18, 2015 the Company consummated the merger of WNS Studios, Inc. with its newly formed and wholly-owned subsidiary Watermark Group, Inc., a Nevada corporation. As a result of the merger, the name of the issuer was changed from WNS Studios, Inc. to Watermark Group, Inc. The Company has not yet generated revenues from planned principal operations. The Company intends to promote, sell and distribute films for studios. There is no assurance, however, that the Company will achieve its objectives or goals. Cash and Cash Equivalents The Company considers all highly-liquid investments purchased with a maturity of three months or less to be cash equivalents. Revenue Recognition For revenue from product sales, the Company will recognize revenue in accordance with Staff Accounting Bulletin No. 104, "Revenue Recognition" (SAB No. 104), which superseded Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB No. 101). SAB No. 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management's judgment regarding the fixed nature of the selling prices of the products delivered and the collectibility of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments will be provided for in the same period the related sales are recorded. Advertising Costs Advertising costs will be charged to operations when incurred. The Company did not incur any advertising costs during the years ended April 30, 2016 and 2015. Income Taxes The Company accounts for income taxes using the asset and liability method, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting and the tax bases of the Company's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. A valuation allowance related to deferred tax assets is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Loss Per Share The computation of loss per share is based on the weighted average number of common shares outstanding during the period presented. Diluted loss per common share is the same as basic loss per common share as there are no potentially dilutive securities outstanding (options and warrants). WATERMARK GROUP, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1 - Summary of Significant Accounting Policies (Continued) Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reported period. Actual results could differ from those estimates. Research and Development Research and development costs will be charged to expense as incurred. The Company did not incur any research and development costs during the years ended April 30, 2016 and 2015. Fair Value Measurements The authoritative guidance for fair value measurements defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or the most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact. The guidance describes a fair value hierarchy based on the levels of inputs, or which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following: Level 1: Quoted prices in active markets for identical assets or liabilities. Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active, or other inputs that are observable or corroborated by observable market data or substantially the full term of the assets of liabilities. Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the value of the assets or liabilities. The Company's financial instruments include cash and equivalents, accrued liabilities, and notes payable. Those items are determined to be Level 1 fair value measurements. The carrying amounts of cash and cash equivalents and accrued liabilities approximates fair value because of the short maturity of these instruments. The recorded value of notes payable approximates its fair value as the terms and rates approximate market rates. Reclassification of Accounts Certain reclassifications have been made to prior-year comparative financial statements to conform to the current year presentation. These reclassifications had no effect on previously reported results of operations or financial position. WATERMARK GROUP, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1 - Summary of Significant Accounting Policies (Continued) Recent Accounting Pronouncements In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09) "Revenue from Contracts with Customers." ASU 2014-09 supersedes the revenue recognition requirements in "Revenue Recognition (Topic 605)", and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflect the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. We are currently in the process of evaluating the impact of the adoption of ASU 2014-09 on our financial statements. In November 2015, the FASB issued Accounting Standards Update No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (ASU 2015-17), which simplifies the presentation of deferred income taxes by requiring that deferred tax assets and liabilities be classified as non-current. The amendment is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Earlier application is permitted as of the beginning of an interim or annual reporting period. We are currently in the process of evaluating the impact of the adoption of ASU 2015-17 on our financial statements. NOTE 2 - Going Concern The Company has not commenced planned principal operations. The Company has no revenues and has incurred a net loss of $50,735 and $37,906 for the years ended April 30, 2016 and 2015, respectively. In addition, the Company has a working capital deficiency of $13,712 and stockholders' deficiency of $169,485 at April 30, 2016. These factors raise substantial doubt about the Company's ability to continue as a going concern. There can be no assurance that sufficient funds required during the next year or thereafter will be generated from operations or that funds will be available from external sources such as debt or equity financings or other potential sources. The lack of additional capital resulting from the inability to generate cash flow from operations or to raise capital from external sources would force the Company to substantially curtail or cease operations and would, therefore, have a material adverse effect on its business. Furthermore, there can be no assurance that any such required funds, if available, will be available on attractive terms or that they will not have a significant dilutive effect on the Company's existing stockholders. The accompanying financial statements do not include any adjustments related to the recoverability or classification of asset-carrying amounts or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern. The Company is attempting to address its lack of liquidity by raising additional funds, either in the form of debt or equity or some combination thereof. On November 1, 2011, the Company began borrowing funds from P&G Holdings LLC., an entity of which Moses Gross, the Company's CEO, has a 33% ownership interest under the terms of a note whereby the borrowing cannot exceed $250,000. As of April 30, 2016 the Company has an outstanding balance of $135,726 (see Note 3). There can be no assurances that the Company will be able to raise the additional funds it requires. WATERMARK GROUP, INC. NOTES TO FINANCIAL STATEMENTS NOTE 3 - Note Payable - Related Party On November 1, 2011 the Company issued a promissory note to P&G Holdings LLC, an entity that is 33% owned by Moses Gross, the Company's CEO and significant stockholder. The note bears interest at 6% per annum; principal and interest were due on November 1, 2016. Under the terms of the note, the Company may borrow from P&G, from time to time, any amount in increments of up to $100,000, however that the aggregate principal amount outstanding under the note could not exceed $126,275. On July 7, 2015 the note was amended to increase the maximum aggregate principal amount to $250,000. On December 11, 2015 the note was amended to extend the maturity date to November 1, 2017. All other terms of the note remained the same. As of April 30, 2016 and 2015, the total outstanding principal was $135,726 and $78,474, respectively. NOTE 4 - Preferred Stock The Company's Board of Directors may, without further action by the Company's stockholders, from time to time, direct the issuance of any authorized but unissued or unreserved shares of preferred stock in series and at the time of issuance, determine the rights, preferences and limitations of each series. The holders of preferred stock may be entitled to receive a preference payment in the event of any liquidation, dissolution or winding-up of the Company before any payment is made to the holders of the common stock. Furthermore, the board of directors could issue preferred stock with voting and other rights that could adversely affect the voting power of the holders of the common stock. NOTE 5 - Common Stock In December 2014, the Company's Board of Directors authorized the cancellation of 220,000 shares of common stock previously issued in error. NOTE 6 - Income Taxes At April 30, 2016, the Company had available net operating loss carryforwards of $215,745, which may be applied against future taxable income, if any, at various times through 2036. Certain significant changes in ownership of the Company may restrict the future utilization of these tax loss carryforwards. At April 30, 2016, the Company has a deferred tax asset of approximately $116,000 representing the benefit of its net operating loss carryforwards. The Company has not recognized the tax benefit because realization of the tax benefit is uncertain and thus a valuation allowance has been fully provided against the deferred tax asset. The difference between the Federal Statutory Rate of 34% with the combined state and local tax rate of 20% and the Company's effective tax rate of 0% is due to an increase in the valuation allowance of approximately $27,000 for the year ended April 30, 2016. NOTE 7 - Subsequent Events The Company has evaluated subsequent events through the date the financial statements were issued and up to the time of filing of the financial statements with the Securities and Exchange Commission. During May and June 2016, the Company borrowed an additional $24,500 from P&G Holdings, LLC, thereby increasing the principal amount owed to P&G Holdings, LLC to $160,226 (see Note 3). | Based on the provided financial statement excerpt, here's a summary:
Financial Highlights:
- The company (Watermark Group, Inc.) reported a loss for the year ended April 30
- Experiencing significant liquidity challenges
- Unable to generate sufficient cash flow from operations
- Struggling to raise additional capital
Key Financial Challenges:
- Potential inability to continue as a going concern
- Seeking debt or equity financing to sustain operations
- Risk of having to curtail or cease operations if additional funding is not secured
Accounting Notes:
- Deferred tax assets with a valuation allowance
- Loss per share calculation based on weighted average common shares
- No potentially dilutive securities (options/warrants)
Financial Outlook:
- Uncertain future due to lack of liquidity
- Actively attempting to raise funds through debt or equity
- No guarantee of securing funding on favorable terms
- Potential significant dil | Claude |
INDEX ACCOUNTING FIRM To the Board of Directors and Shareholders of Aehr Test Systems We have audited the accompanying consolidated balance sheets of Aehr Test Systems and subsidiaries (the “Company”) as of May 31, 2016 and 2015, and the related consolidated statements of operations, shareholders’ equity (deficit) and comprehensive (loss) income, and cash flows for each of the years in the three-year period ended May 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor have we been engaged to perform, an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Aehr Test Systems and subsidiaries as of May 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended May 31, 2016, in conformity with accounting principles generally accepted in the United States of America. /s/ Burr Pilger Mayer, Inc. E. Palo Alto, California August 29, 2016 AEHR TEST SYSTEMS AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) The accompanying notes are an integral part of these consolidated financial statements. AEHR TEST SYSTEMS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) The accompanying notes are an integral part of these consolidated financial statements. AEHR TEST SYSTEMS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (IN THOUSANDS) The accompanying notes are an integral part of these consolidated financial statements. AEHR TEST SYSTEMS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS) The accompanying notes are an integral part of these consolidated financial statements. AEHR TEST SYSTEMS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) The accompanying notes are an integral part of these consolidated financial statements. AEHR TEST SYSTEMS AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: BUSINESS: Aehr Test Systems (the “Company”) was incorporated in California in May 1977 and primarily designs, engineers and manufactures test and burn-in equipment used in the semiconductor industry. The Company’s principal products are the Advanced Burn-In and Test System, or ABTS, the FOX full wafer contact parallel test and burn-in systems, the MAX burn-in system, WaferPak full wafer contactor, the DiePak carrier and test fixtures. LIQUIDITY: Since inception, the Company has incurred substantial cumulative losses and negative cash flows from operations. In recent years, the Company has recognized significantly lower sales levels compared to the net sales of the years immediately preceding fiscal 2009, as a result of a major customer filing bankruptcy and a slowdown in the semiconductor manufacturing industry. In response to the low levels of net sales, the Company took significant steps to minimize expense levels and to increase the likelihood that it will have sufficient cash to support operations during the slow business periods. Those steps included reductions in headcount, reduced compensation for officers and other salaried employees, Company-wide shutdowns and lower fees paid to the Board of Directors, among other spending cuts. The Company will continue to explore methods to reduce its costs as necessary. In March 2013, the Company sold 1,158,000 shares of its common stock in a private placement transaction with certain Directors and Officers of the Company and other accredited investors. The purchase price per share of the common stock sold in the private placement was $1.00, resulting in gross proceeds to the Company of $1,158,000, before offering expenses. The net proceeds after offering expenses were $1,138,000. In November 2014, the Company sold 1,065,000 shares of its common stock in a private placement transaction with certain Directors and Officers of the Company and other accredited investors. The purchase price per share of the common stock sold in the private placement was $2.431, resulting in gross proceeds to the Company of $2,589,000, before offering expenses. The net proceeds after offering expenses were $2,574,000. In August 2011, the Company entered into a working capital credit facility agreement with Silicon Valley Bank allowing the Company to borrow up to $1.5 million based upon qualified U.S. based and foreign customer receivables, and export-related inventory. In May 2012, the credit agreement was amended to increase the borrowing limit to $2.0 million. In September 2012, the credit agreement was amended to increase the borrowing limit to $2.5 million. On April 10, 2015, the Company terminated the working capital credit facility agreement with Silicon Valley Bank and entered into a Convertible Note Purchase and Credit Facility Agreement (the “Purchase Agreement”) with QVT Fund LP and Quintessence Fund L.P. (the “Purchasers”) providing for (a) the Company’s sale to the Purchasers of $4,110,000 in aggregate principal amount of 9.0% Convertible Secured Notes due 2017 (the “Convertible Notes”) and (b) a secured revolving loan facility (the “Credit Facility”) in an aggregate principal amount of up to $2,000,000. The Company received $3.8 million in net proceeds from the issuance of the Convertible Notes in fiscal 2015. In fiscal 2016 the Company drew $2.0 million against the Credit Facility. Refer to Note 9, “CONVERTIBLE NOTES AND LINE OF CREDIT”, for further discussion of the Credit Facility and the Convertible Notes. During fiscal 2016, 2015 and 2014, the Company experienced negative cash flow from operating activities. The Company anticipates that the existing cash balance together with income from operations, collections of existing accounts receivable, revenue from our existing backlog of products, the sale of inventory on hand, and deposits and down payments against significant orders will be adequate to meet its short-term working capital and capital equipment requirements. The Company extended the maturity date of the Convertible Notes to April 10, 2019 which improves our ability to meet current liabilities for fiscal 2017. Refer to Note 16, “SUBSEQUENT EVENTS”. Depending on its rate of growth and profitability, and its ability to obtain significant orders with down payments, the Company may require additional equity or debt financing to meet its working capital requirements or capital equipment needs. There can be no assurance that additional financing will be available when required, or if available, that such financing can be obtained on terms satisfactory to the Company. CONSOLIDATION AND EQUITY INVESTMENTS: The consolidated financial statements include the accounts of the Company and both its wholly-owned and majority-owned foreign subsidiaries. Intercompany accounts and transactions have been eliminated. Equity investments in which the Company holds an equity interest less than 20 percent and over which the Company does not have significant influence are accounted for using the cost method. Dividends received from investees accounted for using the cost method are included in other (expense) income, net on the Consolidated Statements of Operations. FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS: Assets and liabilities of the Company’s foreign subsidiaries and a branch office are translated into U.S. Dollars from their functional currencies of Japanese Yen, Euros and New Taiwan Dollars using the exchange rate in effect at the balance sheet date. Additionally, their net sales and expenses are translated using exchange rates approximating average rates prevailing during the fiscal year. Translation adjustments that arise from translating their financial statements from their local currencies to U.S. Dollars are accumulated and reflected as a separate component of shareholders’ equity (deficit). Transaction gains and losses that arise from exchange rate changes denominated in currencies other than the local currency are included in the Consolidated Statements of Operations as incurred. See Note 12 for the detail of foreign exchange transaction gains and losses for all periods presented. USE OF ESTIMATES: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates in the Company’s consolidated financial statements include allowance for doubtful accounts, valuation of inventory at the lower of cost or market, and warranty reserves. CASH EQUIVALENTS AND INVESTMENTS: Cash equivalents consist of money market instruments purchased with an original maturity of three months or less. These investments are reported at fair value. FAIR VALUE OF FINANCIAL INSTRUMENTS AND MEASUREMENT: The Company’s financial instruments are measured at fair value consistent with authoritative guidance. This authoritative guidance defines fair value, establishes a framework for using fair value to measure assets and liabilities, and disclosures required related to fair value measurements. The guidance establishes a fair value hierarchy based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels: Level 1 - instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 - instrument valuations are obtained from readily-available pricing sources for comparable instruments. Level 3 - instrument valuations are obtained without observable market values and require a high level of judgment to determine the fair value. The following table summarizes the Company’s financial assets measured at fair value on a recurring basis as of May 31, 2016 (in thousands): The following table summarizes the Company’s financial assets measured at fair value on a recurring basis as of May 31, 2015 (in thousands): There were no financial liabilities measured at fair value as of May 31, 2016 and 2015. There were no transfers between Level 1 and Level 2 fair value measurements during the fiscal year ended May 31, 2016 and 2015. Financial instruments include cash, cash equivalents, receivables, accounts payable and certain other accrued liabilities. The fair value of cash, cash equivalents, receivables, accounts payable and certain other accrued expenses are valued at their carrying value, which approximates fair value due to their short maturities. The carrying value of the debt approximates the fair value. The Company has at times invested in debt and equity of private companies, and may do so again in the future, as part of its business strategy. ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS: Accounts receivable are derived from the sale of products throughout the world to semiconductor manufacturers, semiconductor contract assemblers, electronics manufacturers and burn-in and test service companies. Accounts receivable are recorded at the invoiced amount and are not interest bearing. The Company maintains an allowance for doubtful accounts to reserve for potentially uncollectible trade receivables. The Company also reviews its trade receivables by aging category to identify specific customers with known disputes or collection issues. The Company exercises judgment when determining the adequacy of these reserves as the Company evaluates historical bad debt trends, general economic conditions in the United States and internationally, and changes in customer financial conditions. Uncollectible receivables are recorded as bad debt expense when all efforts to collect have been exhausted and recoveries are recognized when they are received. No significant adjustments to the allowance for doubtful accounts were recorded during the years ended May 31, 2016, 2015 or 2014. CONCENTRATION OF CREDIT RISK: The Company sells its products primarily to semiconductor manufacturers in North America, Asia, and Europe. As of May 31, 2016, approximately 7%, 68% and 25% of gross accounts receivable were from customers located in Asia, Europe and North America, respectively. As of May 31, 2015, approximately 70%, 3% and 27% of gross accounts receivable were from customers located in Asia, Europe and North America, respectively. One customer accounted for 67% of gross accounts receivable as of May 31, 2016. Two customers accounted for 41% and 32% of gross accounts receivable as of May 31, 2015. Two customers accounted for 47% and 32% of net sales in fiscal 2016. Two customers accounted for 45% and 11% of net sales in fiscal 2015. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company uses letter of credit terms for some of its international customers. The Company’s cash and cash equivalents are generally deposited with major financial institutions in the United States, Japan, Germany and Taiwan. The Company invests its excess cash in money market funds. The money market funds bear the risk associated with each fund. The money market funds have variable interest rates. The Company has not experienced any material losses on its money market funds or short-term cash deposits. CONCENTRATION OF SUPPLY RISK: The Company relies on subcontractors to manufacture many of the components and subassemblies used in its products. Quality or performance failures of the Company’s products or changes in its manufacturers’ financial or business condition could disrupt the Company’s ability to supply quality products to its customers and thereby have a material and adverse effect on its business and operating results. Some of the components and technologies used in the Company’s products are purchased and licensed from a single source or a limited number of sources. The loss of any of these suppliers may cause the Company to incur additional transition costs, result in delays in the manufacturing and delivery of its products, or cause it to carry excess or obsolete inventory and could cause it to redesign its products. INVENTORIES: Inventories include material, labor and overhead, and are stated at the lower of cost (first-in, first-out method) or market. Provisions for excess, obsolete and unusable inventories are made after management’s evaluation of future demand and market conditions. The Company adjusts inventory balances to approximate the lower of its manufacturing costs or market value. If actual future demand or market conditions become less favorable than those projected by management, additional inventory write-downs may be required, and would be reflected in cost of product revenue in the period the revision is made. PROPERTY AND EQUIPMENT: Property and equipment are stated at cost less accumulated depreciation and amortization. Major improvements are capitalized, while repairs and maintenance are expensed as incurred. Leasehold improvements are amortized over the lesser of their estimated useful lives or the term of the related lease. Furniture and fixtures, machinery and equipment, and test equipment are depreciated on a straight-line basis over their estimated useful lives. The ranges of estimated useful lives are generally as follows: Furniture and fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 to 6 years Machinery and equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 to 6 years Test equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 to 6 years REVENUE RECOGNITION: The Company recognizes revenue upon the shipment of products or the performance of services when: (1) persuasive evidence of the arrangement exists; (2) goods or services have been delivered; (3) the price is fixed or determinable; and (4) collectibility is reasonably assured. When a sales agreement involves multiple deliverables, such as extended support provisions, training to be supplied after delivery of the systems, and test programs specific to customers’ routine applications, the multiple deliverables are evaluated to determine the unit of accounting. Judgment is required to properly identify the accounting units of multiple element transactions and the manner in which revenue is allocated among the accounting units. Judgments made, or changes to judgments made, may significantly affect the timing or amount of revenue recognition. Revenue related to the multiple elements are allocated to each unit of accounting using the relative selling price hierarchy. Consistent with accounting guidance, the selling price is based upon vendor specific objective evidence (VSOE). If VSOE is not available, third party evidence (TPE) is used to establish the selling price. In the absence of VSOE or TPE, estimated selling price is used. The Company has adopted this guidance effective with the first quarter of fiscal 2012. During the first quarter of fiscal 2013, the Company entered into an agreement with a customer to develop a next generation system. The project identifies multiple milestones with values assigned to each. The consideration earned upon achieving the milestone is required to meet the following conditions prior to recognition: (i) the value is commensurate with the vendor’s performance to meet the milestone, (ii) it relates solely to past performance, (iii) and it is reasonable relative to all of the deliverables and payment terms within the arrangement. Revenue is recognized for the milestone upon acceptance by the customer. Sales tax collected from customers is not included in net sales but rather recorded as a liability due to the respective taxing authorities. Provisions for the estimated future cost of warranty and installation are recorded at the time the products are shipped. Royalty-based revenue related to licensing income from performance test boards and burn-in boards is recognized upon the earlier of the receipt by the Company of the licensee’s report related to its usage of the licensed intellectual property or upon payment by the licensee. The Company’s terms of sales with distributors are generally FOB shipping point with payment due within 60 days. All products go through in-house testing and verification of specifications before shipment. Apart from warranty reserves, credits issued have not been material as a percentage of net sales. The Company’s distributors do not generally carry inventories of the Company’s products. Instead, the distributors place orders with the Company at or about the time they receive orders from their customers. The Company’s shipment terms to our distributors do not provide for credits or rights of return. Because the Company’s distributors do not generally carry inventories of our products, they do not have rights to price protection or to return products. At the time the Company ships products to the distributors, the price is fixed. Subsequent to the issuance of the invoice, there are no discounts or special terms. The Company does not give the buyer the right to return the product or to receive future price concessions. The Company’s arrangements do not include vendor consideration. PRODUCT DEVELOPMENT COSTS AND CAPITALIZED SOFTWARE: Costs incurred in the research and development of new products or systems are charged to operations as incurred. Costs incurred in the development of software programs for the Company’s products are charged to operations as incurred until technological feasibility of the software has been established. Generally, technological feasibility is established when the software module performs its primary functions described in its original specifications, contains features required for it to be usable in a production environment, is completely documented and the related hardware portion of the product is complete. After technological feasibility is established, any additional costs are capitalized. Capitalization of software costs ceases when the software is substantially complete and is ready for its intended use. Capitalized costs are amortized over the estimated life of the related software product using the greater of the units of sales or straight-line methods over ten years. No system software development costs were capitalized or amortized in fiscal 2016, 2015 and 2014. IMPAIRMENT OF LONG-LIVED ASSETS: In the event that facts and circumstances indicate that the carrying value of assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset’s carrying value to determine if a write-down is required. ADVERTISING COSTS: The Company expenses all advertising costs as incurred and the amounts were not material for all periods presented. SHIPPING AND HANDLING OF PRODUCTS: Amounts billed to customers for shipping and handling of products are included in net sales. Costs incurred related to shipping and handling of products are included in cost of sales. INCOME TAXES: Income taxes have been provided using the liability method whereby deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and net operating loss and tax credit carryforwards measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse or the carryforwards are utilized. Valuation allowances are established when it is determined that it is more likely than not that such assets will not be realized. A full valuation allowance was established against all deferred tax assets, as management determined that it is more likely than not that deferred tax assets will not be realized, as of May 31, 2016 and 2015. The Company accounts for uncertain tax positions consistent with authoritative guidance. The guidance prescribes a “more likely than not” recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company does not expect any material change in its unrecognized tax benefits over the next twelve months. The Company recognizes interest and penalties related to unrecognized tax benefits as a component of income taxes. Although the Company files U.S. federal, various state, and foreign tax returns, the Company’s only major tax jurisdictions are the United States, California, Germany and Japan. Tax years 1997 - 2016 remain subject to examination by the appropriate governmental agencies due to tax loss carryovers from those years. STOCK-BASED COMPENSATION: Stock-based compensation expense consists of expenses for stock options, restricted stock units, or RSUs, and employee stock purchase plan, or ESPP, purchase rights. Stock-based compensation cost for stock options and ESPP purchase rights are measured at each grant date, based on the fair value of the award using the Black-Scholes option valuation model, and is recognized as expense over the employee’s requisite service period. This model was developed for use in estimating the value of publicly traded options that have no vesting restrictions and are fully transferable. The Company’s employee stock options have characteristics significantly different from those of publicly traded options. All of the Company’s stock-based compensation is accounted for as an equity instrument. The following table summarizes compensation costs related to the Company’s stock-based compensation for the years ended May 31, 2016, 2015 and 2014 (in thousands, except per share data): During fiscal 2016, 2015 and fiscal 2014, the Company recorded stock-based compensation related to stock options and restricted stock units of $894,000, $857,000 and $723,000, respectively. As of May 31, 2016, the total compensation cost related to unvested stock-based awards under the Company’s 1996 Stock Option Plan and 2006 Equity Incentive Plan, but not yet recognized, was $1,102,000 which is net of estimated forfeitures of $3,000. This cost will be amortized on a straight-line basis over a weighted average period of approximately 2.1 years. During fiscal 2016, 2015 and fiscal 2014, the Company recorded stock-based compensation related to its ESPP of $122,000, $140,000 and $130,000, respectively. As of May 31, 2016, 2015 and 2014, stock-based compensation costs of $0, $20,000 and $24,000, respectively, were capitalized as part of inventory. As of May 31, 2016, the total compensation cost related to purchase rights under the ESPP but not yet recognized was $138,000. This cost will be amortized on a straight-line basis over a weighted average period of approximately 1.2 years. Valuation Assumptions Valuation and Amortization Method. The Company estimates the fair value of stock options granted using the Black-Scholes option valuation method and a single option award approach. The fair value under the single option approach is amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Expected Term. The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on historical experience, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as evidenced by changes to the terms of its stock-based awards. Expected Volatility. Volatility is a measure of the amounts by which a financial variable such as stock price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company uses the historical volatility for the past five years, which matches the expected term of most of the option grants, to estimate expected volatility. Volatility for each of the ESPP’s four time periods of six months, twelve months, eighteen months, and twenty-four months is calculated separately and included in the overall stock-based compensation cost recorded. Dividends. The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation method. Risk-Free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes option valuation method on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with a remaining term equivalent to the expected term of the stock awards including the ESPP. Estimated Forfeitures. When estimating forfeitures, the Company considers voluntary termination behavior as well as analysis of actual option forfeitures. Fair Value. The fair values of the Company’s stock options granted to employees shares in fiscal 2016, 2015 and 2014 were estimated using the following weighted average assumptions in the Black-Scholes option valuation method: The fair value of our ESPP purchase rights for the fiscal 2016, 2015 and 2014 was estimated using the following weighted-average assumptions: During the fiscal years ended May 31, 2016, 2015 and 2014, ESPP purchase rights of 304,000, 222,000, and 172,000 shares, respectively, were granted. Total ESPP shares issued during the fiscal years ended May 31, 2016, 2015, and 2014 were 86,000, 87,000, and 120,000 shares, respectively. As of May 31, 2016 there were 182,000 ESPP shares available for issuance. EARNINGS PER SHARE (“EPS”): Basic EPS is determined using the weighted average number of common shares outstanding during the period. Diluted EPS is determined using the weighted average number of common shares and potential common shares (representing the dilutive effect of stock options, and employee stock purchase plan shares) outstanding during the period using the treasury stock method. The following table presents the computation of basic and diluted net (loss) income per share attributable to Aehr Test Systems common shareholders (in thousands, except per share data): For the purpose of computing diluted earnings per share, weighted average potential common shares do not include stock options with an exercise price greater than the average fair value of the Company’s common stock for the period, as the effect would be anti-dilutive. In the fiscal year’s ended May 31, 2016 and 2015, potential common shares have not been included in the calculation of diluted net loss per share as the effect would be anti-dilutive. As such, the numerator and the denominator used in computing both basic and diluted net loss per share for these periods are the same. Stock options to purchase 3,201,000, 3,686,000, and 301,000 shares of common stock were outstanding on May 31, 2016, 2015 and 2014, respectively, but were not included in the computation of diluted net (loss) income per share, because the inclusion of such shares would be anti-dilutive. ESPP rights to purchase 304,000, 175,000 and 131,000 ESPP shares were outstanding on May 31, 2016, 2015 and 2014, respectively, but were not included in the computation of diluted net (loss) income per share, because the inclusion of such shares would be anti-dilutive. RSUs for 35,000 shares were outstanding at May 31, 2016 but not included in the computation of diluted net (loss) income per share, because the inclusion of such shares would be anti-dilutive. The shares convertible under the Convertible Notes outstanding at May 31, 2016 were not included in the computation of diluted net (loss) income per share, because the inclusion of such shares would be anti-dilutive. COMPREHENSIVE (LOSS) INCOME: Comprehensive (loss) income generally represents all changes in shareholders’ equity (deficit) except those resulting from investments or contributions by shareholders. Unrealized gains and losses on foreign currency translation adjustments are included in the Company’s components of comprehensive (loss) income, which are excluded from net (loss) income. Comprehensive (loss) income is included in the statements of shareholders’ equity (deficit) and comprehensive (loss) income. RECLASSIFICATION Certain reclassifications have been made to the consolidated financial statements to conform to the current period presentation. These reclassifications did not result in any change in previously reported net loss, total assets or shareholders’ equity (deficit). RECENT ACCOUNTING PRONOUNCEMENTS: In May 2014, as part of its ongoing efforts to assist in the convergence of US GAAP and International Financial Reporting Standards (“IFRS”), the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606).” The new guidance sets forth a new five-step revenue recognition model which replaces the prior revenue recognition guidance in its entirety and is intended to eliminate numerous industry-specific pieces of revenue recognition guidance that have historically existed in US GAAP. The underlying principle of the new standard is that a business or other organization will recognize revenue to reflect the transfer of promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. The standard also requires more detailed disclosures and provides additional guidance for transactions that were not addressed completely in the prior accounting guidance. The ASU provides alternative methods of initial adoption and will become effective for us beginning in the first quarter of fiscal 2019. The FASB has issued several updates to the standard which i) defer the original effective date from January 1, 2017 to January 1, 2018, while allowing for early adoption as of January 1, 2017 (ASU 2015-14). ii) clarify the application of the principal versus agent guidance (ASU 2016-08). and iii) clarify the guidance on inconsequential and perfunctory promises and licensing (ASU 2016-10). In May 2016, the FASB issued ASU 2016-12, ‘Revenue from Contracts with Customers (Topic 606) Narrow-Scope Improvements and Practical Expedients”, to address certain narrow aspects of the guidance including collectibility criterion, collection of sales taxes from customers, noncash consideration, contract modifications and completed contracts. This issuance does not change the core principle of the guidance in the initial topic issued in May 2014. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements. In August 2014, the FASB issued ASU No. 2014-15, Presentation of Going Concern. This standard requires management to evaluate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern and whether or not it is probable that the entity will be unable to meet its obligations as they become due within one year after the date the financial statements are issued. The new standard will apply to all entities and will be effective for us in the fiscal year 2017, with early adoption permitted. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements. In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest. This standard requires management to simplify the presentation of debt issuance costs by presenting the costs related to obtaining a debt liability as a direct deduction from that debt liability. The debt issuance costs, or discount, is amortized over the life of the debt liability. The new standard is effective for us in fiscal 2017, with early adoption permitted. The Company has adopted this update for the fiscal year ended May 31, 2015. Refer to Note 9 of , “CONVERTIBLE NOTES AND LINE OF CREDIT” for further discussion of the Credit Facility and Convertible Notes. In July 2015, the FASB issued ASU No. 2015-11, Inventory. This standard requires management to measure inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This new standard will be effective for us in the fiscal year 2018, with early adoption permitted. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements. In August 2015, the FASB issued ASU No. 2015-15, Imputation of Interest. This standard clarifies ASU 2015-03, Debt Issuance Costs discussed above, in which an entity may defer and present debt issuance costs for line of credit arrangements as an asset and subsequently amortize the costs over the term of the line of credit agreement regardless of whether any amounts are outstanding. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements. In November 2015, FASB issued ASU No. 2015-17, Income Taxes. This standard simplifies the presentation of deferred income taxes to be classified as noncurrent in the consolidated balance sheet. This new standard will be effective for us in the fiscal year 2018, with early adoption permitted. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements. In February 2016, FASB issued ASU No. 2016-02, Leases. This standard requires management to present all leases greater than one year on the balance sheet as a liability to make payments and an asset as the right to use the underlying asset for the lease term. This new standard will be effective for us in the fiscal year 2020, with early adoption permitted. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements. In January 2016, FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. This standard changes accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements for financial instruments. In addition, it clarifies guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. ASU 2016-01 is effective for us in fiscal year 2020. Early adoption is permitted. The Company is currently evaluating the impact of this new guidance on its consolidated financial statements. In March 2016, FASB released ASU 2016-09, Compensation - Stock Compensation. The standard simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, forfeitures, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The accounting standard will be effective for the Company beginning the first quarter of fiscal 2018, and early adoption is permitted. The Company is currently evaluating the impact of this new guidance on its consolidated financial statements. 2. ACCOUNTS RECEIVABLE: Accounts receivable comprise (in thousands): * Deductions include write-offs of uncollectible accounts and collections of amounts previously reserved. 3. INVENTORIES: Inventories comprise (in thousands): 4. PROPERTY AND EQUIPMENT, NET: Property and equipment, net comprise (in thousands): Depreciation expense was $203,000, $135,000 and $141,000 for fiscal 2016, 2015, and 2014, respectively. 5. PRODUCT WARRANTIES: The Company provides for the estimated cost of product warranties at the time revenues are recognized on the products shipped. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, the Company’s warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from the Company’s estimates, revisions to the estimated warranty liability would be required. The standard warranty period is one year for systems and ninety days for parts and service. Following is a summary of changes in the Company’s liability for product warranties during the fiscal years ended May 31, 2016 and 2015 (in thousands): The accrued warranty balance is included in accrued expenses on the consolidated balance sheets. 6. ACCRUED EXPENSES: Accrued expenses comprise (in thousands): 7. INCOME TAXES: Domestic and foreign components of (loss) income before income tax (expense) benefit are as follows (in thousands): The income tax (expense) benefit consists of the following (in thousands): The Company’s effective tax rate differs from the U.S. federal statutory tax rate, as follows: The components of the net deferred tax assets are as follows (in thousands): The valuation allowance increased by $421,000 during fiscal 2016, increased by $2,223,000 during fiscal 2015, and decreased by $206,000 during fiscal 2014. As of May 31, 2016 and 2015, the Company concluded that it is more likely than not that the deferred tax assets will not be realized and therefore provided a full valuation allowance against the deferred tax assets. The Company will continue to evaluate the need for a valuation allowance against its deferred tax assets on a quarterly basis. At May 31, 2016, the Company had federal and state net operating loss carryforwards of $45,272,000 and $31,110,000, respectively. The federal and state net operating loss carryforwards will begin to expire in 2024 and began expiring in 2015, respectively. At May 31, 2016, the Company also had federal and state research and development tax credit carryforwards of $1,769,000 and $4,894,000, respectively. The federal credit carryforward will begin to expire in 2019, and the California credit will carryforward indefinitely. These carryforwards may be subject to certain limitations on annual utilization in case of a change in ownership, as defined by tax law. The Company also has alternative minimum tax credit carryforwards of $91,000 for federal tax purposes and $34,000 for state purposes. The credits may be used to offset regular tax and do not expire. The Company has made no provision for U.S. income taxes on undistributed earnings of certain foreign subsidiaries because it is the Company’s intention to permanently reinvest such earnings in its foreign subsidiaries. If such earnings were distributed, the Company would be subject to additional U.S. income tax expense. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable. Foreign net operating loss carryforwards of $848,000 are available to reduce future foreign taxable income. The foreign net operating losses will begin to expire in 2018. The Company maintains liabilities for uncertain tax positions. These liabilities involve considerable judgment and estimation and are continuously monitored by management based on the best information available. The aggregate changes in the balance of gross unrecognized tax benefits are as follows (in thousands): The ending balance of $789,000 of unrecognized tax benefits as of May 31, 2016, if recognized, would not impact the effective tax rate. Although the Company files U.S. federal, various state, and foreign tax returns, the Company’s only major tax jurisdictions are the United States, California, Germany and Japan. Tax years 1997 - 2016 remain subject to examination by the appropriate governmental agencies due to tax loss carryovers from those years. 8. CUSTOMER DEPOSITS AND DEFERRED REVENUE: Customer deposits and deferred revenue (in thousands): 9. CONVERTIBLE NOTES AND LINE OF CREDIT: On April 10, 2015, the Company entered into a Convertible Note Purchase and Credit Facility Agreement (the “Purchase Agreement”) with QVT Fund LP and Quintessence Fund L.P. (the “Purchasers”) providing for (a) the Company’s sale to the Purchasers of $4,110,000 in aggregate principal amount of 9.0% Convertible Secured Notes due 2017 (the “Convertible Notes”) and (b) a secured revolving loan facility (the “Credit Facility”) in an aggregate principal amount of up to $2,000,000. On August 22, 2016 the Purchase Agreement was amended to extend the maturity date of the Convertible Notes to April 10, 2019, decrease the conversion price from $2.65 per share to $2.30 per share, decrease the forced conversion price from $7.50 per share to $6.51 per share, and allow for additional equity awards. Refer to Note 16, “SUBSEQUENT EVENTS”. The Convertible Notes bear interest at an annual rate of 9.0% and will mature on April 10, 2019 unless repurchased or converted prior to that date. Interest is payable quarterly on March 1, June 1, September 1 and December 1 of each year. Debt issuance costs of $356,000, which represent an effective interest rate of 4.3%, were offset against the loan balance and are amortized over the life of loan. During fiscal years ended May 31, 2016 and 2015, $177,000 and $31,000, respectively, of amortization costs were recognized as interest expense. The conversion price for the Convertible Notes is $2.30 per share of the Company’s common stock and is subject to adjustment upon the occurrence of certain specified events (as adjusted, the “Conversion Price”). Holders may convert all or any part of the principal amount of their Convertible Notes in integrals of $10,000 at any time prior to the maturity date. Upon conversion, the Company will deliver shares of its common stock to the holder of Convertible Notes electing such conversion. The Company may not redeem the Convertible Notes prior to maturity. Advances under the Credit Facility must be supported by outstanding valid purchase orders at least equal to the amount of the requested drawdown plus the principal amount of all outstanding 5.0% Notes as defined under the Purchase Agreement. Advances will bear interest at an annual rate of 5.0%. Each advance under the Credit Facility and any accrued and unpaid interest thereon must be repaid within 90 days from the date on which such advance is made. Unless paid in full at maturity, amounts owing under the credit facility may be converted by the holder into Convertible Notes. Advances under the Credit Facility may be prepaid without any prepayment premium or penalty and may be reborrowed (unless converted into Convertible Notes). The Company’s obligations under the Purchase Agreement are secured by substantially all of the assets of the Company. During fiscal 2016, the Company borrowed $2,000,000 against the credit facility. During fiscal 2016, $900,000 of the borrowing was converted into Convertible Notes upon maturity. As of May 31, 2016 and 2015, the Company had a balance of $1,100,000 and zero against the Credit Facility, respectively. The balance available to borrow under the Credit Facility as of May 31, 2016 was zero. Upon maturity in July 2016, the $1,100,000 balance of the Credit Facility was converted into Convertible Notes. The May 31, 2016 balance was reclassified to Convertible Notes with the amendment of the Purchase Agreement. Refer to Note 16, “SUBSEQUENT EVENTS”. Convertible Notes, net of debt issuance costs (in thousands): 10. CAPITAL STOCK: STOCK OPTIONS: In October 1996, the Company’s Board of Directors approved the 1996 Stock Option Plan (the “Stock Plan”), which provided for granting of incentive and non-qualified stock options to our employees and directors. The Stock Plan provides that qualified options be granted at an exercise price equal to the fair market value at the date of grant, as determined by the Board of Directors (85% of fair market value in the case of non-statutory options and purchase rights and 110% of fair market value in certain circumstances). Options generally expire within five years from date of grant. Most options become exercisable in increments over a four-year period from the date of grant. In October 2006, the Company’s 2006 Equity Incentive Plan and 2006 Employee Stock Purchase Plan (“2006 Plans”) were approved by the shareholders, which provide for granting of incentive stock options, nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance units, performance shares and other stock or cash awards as the Company’s Board of Directors may determine. A total of 5,450,000 shares of common stock have been reserved for issuance under the Company’s 2006 Equity Incentive Plan. Options granted under the 2006 Equity Incentive Plan are generally for periods not to exceed ten years (five years if the option is granted to a 10% stockholder) and are granted at the fair market value of the stock at the date of grant as determined by the Board of Directors. The 2006 Plans respectively replace the Company’s Amended and Restated 1996 Stock Option Plan, which would otherwise have expired in 2006; and the Company’s 1997 Employee Stock Purchase Plan, which would have otherwise expired in 2007. As of May 31, 2016, out of the 5,083,000 shares authorized for grant under the 2006 Equity Incentive Plan, approximately 3,201,000 shares were outstanding. The following tables summarize the Company’s stock option and RSUs transactions during fiscal 2016, 2015 and 2014 (in thousands, except per share data): The options outstanding and exercisable at May 31, 2016 were in the following exercise price ranges (in thousands, except per share data): The total intrinsic values of options exercised were $185,000, $540,000 and $520,000 during fiscal 2016, 2015 and 2014, respectively. The weighted average contractual life of the options exercisable and expected to be exercisable at May 31, 2016 was 4.08 years. Options to purchase 2,390,000, 2,189,000 and 1,892,000 shares were exercisable at May 31, 2016, 2015 and 2014, respectively. These exercisable options had weighted average exercise prices of $3.69, $1.43 and $1.22 as of May 31, 2016, 2015 and 2014, respectively. During the fiscal year ended May 31, 2016, RSUs were granted to an employee for 35,000 shares. The market value on the date of the grant was $2.16 per share. The RSUs are performance based and immediately vest upon attainment of goals established and have a term of one year. The 35,000 RSUs were outstanding and fully vested at May 31, 2016. The intrinsic value of the outstanding RSUs at May 31, 2016 was $35,000. There were no RSUs granted during fiscal 2015 or 2014. 11. EMPLOYEE BENEFIT PLANS: EMPLOYEE STOCK OWNERSHIP PLAN: The Company has a non-contributory, trusteed employee stock ownership plan for full-time employees who have completed three consecutive months of service and for part-time employees who have completed one year of service and have attained an age of 21. The Company can contribute either shares of the Company’s stock or cash to the plan. The contribution is determined annually by the Company and cannot exceed 15% of the annual aggregate salaries of those employees eligible for participation in the plan. On May 31, 2007, the Company converted the Aehr Test Systems Employee Stock Bonus Plan into the Aehr Test Systems Employee Stock Ownership Plan (the “Plan”). The stock bonus plan was converted to an employee stock ownership plan (“ESOP”) to enable the Plan to better comply with changes in the law regarding Company stock. Individuals’ account balances vest at a rate of 20% per year commencing upon completion of two years of service. Non-vested balances, which are forfeited following termination of employment, are allocated to the remaining employees in the Plan. Under the Plan provisions, each employee who reaches age fifty-five (55) and has been a participant in the Plan for ten years will be offered an election each year to direct the transfer of up to 25% of his/her ESOP account to the employee self-directed account in the Savings and Retirement Plan. For anyone who met the above prerequisites, the first election to diversify holdings was offered after May 31, 2008. In the sixth year, employees will be able to diversify up to 50% of their ESOP accounts. Contributions of $60,000 per year were authorized for the plan during fiscal 2016, 2015 and 2014. The contribution amounts are recorded as compensation expense, in the period authorized and included in accrued expenses, in the period authorized. Contributions of 25,000 shares were made to the ESOP during fiscal 2016 for fiscal 2015. Contributions of 26,548 shares were made to the ESOP during fiscal 2015 for fiscal 2014. Contributions of 41,666 shares were made to the ESOP during fiscal 2014 for fiscal 2013. The contribution for fiscal 2016 will be made in fiscal 2017. Shares held in the ESOP are included in the EPS calculation. 401(K) PLAN: The Company maintains a defined contribution savings plan (the “401(k) Plan”) to provide retirement income to all qualified employees of the Company. The 401(k) Plan is intended to be qualified under Section 401(k) of the Internal Revenue Code of 1986, as amended. The 401(k) Plan is funded by voluntary pre-tax contributions from employees. Contributions are invested, as directed by the participant, in investment funds available under the 401(k) Plan. The Company is not required to make, and did not make, any contributions to the 401(k) Plan during fiscal 2016, 2015 and 2014. EMPLOYEE STOCK PURCHASE PLAN: In October 2006, the Company’s shareholders approved the 2006 Employee Stock Purchase Plan, or 2006 Purchase Plan. The 2006 Purchase Plan replaced the 1997 Employee Stock Purchase Plan which would have otherwise expired in 2007. A total of 1,150,000 shares of the Company’s common stock were reserved for issuance under the 2006 Purchase Plan. The 2006 Purchase Plan has consecutive, overlapping, twenty-four month offering periods. Each twenty-four month offering period includes four six month purchase periods. The offering periods generally begin on the first trading day on or after April 1 and October 1 each year. The first exercise date under the 2006 Purchase Plan was April 1, 2007. All employees who work a minimum of 20 hours per week and are customarily employed by the Company (or an affiliate thereof) for at least five months per calendar year are eligible to participate. Under the 2006 Purchase Plan, shares are purchased through employee payroll deductions at exercise prices equal to 85% of the lesser of the fair market value of the Company’s common stock at either the first day of an offering period or the last day of the purchase period. If a participant’s rights to purchase stock under all employee stock purchase plans of the Company accrue at a rate which exceeds $25,000 worth of stock for a calendar year, such participant may not be granted an option to purchase stock under the 2006 Purchase Plan. The maximum number of shares a participant may purchase during a single purchase period is 3,000 shares. For the years ended May 31, 2016, 2015 and 2014, approximately 86,000, 87,000 and 120,000 shares of common stock, respectively, were issued under the plans. To date, 968,000 shares have been issued under the 2006 Purchase Plan. 12. OTHER (EXPENSE) INCOME, NET: Other (expense) income, net comprises the following (in thousands): 13. SEGMENT INFORMATION: The Company operates in one reportable segment: the design, manufacture and marketing of advanced test and burn-in products to the semiconductor manufacturing industry. The following presents information about the Company’s operations in different geographic areas. Net sales are based upon ship-to location (in thousands). The Company’s Japanese and German subsidiaries primarily comprise the foreign operations. Substantially all of the sales of the subsidiaries are made to unaffiliated Japanese or European customers. Net sales from outside the United States include those of Aehr Test Systems Japan K.K. and Aehr Test Systems GmbH. 14. RELATED PARTY TRANSACTIONS: Mario M. Rosati, one of the Company’s directors, is also a member of Wilson Sonsini Goodrich & Rosati, Professional Corporation, which has served as the Company’s outside corporate counsel and has received compensation at normal commercial rates for these services. At May 31, 2016, the Company had $111,000 payable to Wilson Sonsini Goodrich & Rosati. 15. COMMITMENTS AND CONTINGENCIES: COMMITMENTS The Company leases most of its manufacturing and office space under operating leases. The Company entered into non-cancelable operating lease agreements for its United States manufacturing and office facilities and maintains equipment under non-cancelable operating leases in Germany. The Company’s principal administrative and production facilities are located in Fremont, California, in a 51,289 square foot building. The Company’s lease was renewed in November, 2014 and expires in June 2018. The Company has an option to extend the lease for an additional three year period at rates to be determined. The Company’s facility in Japan is located in a 418 square foot office in Tokyo under a cancellable lease which expires in June 2019. The Company also maintains a 1,585 square foot warehouse in Yamanashi under a lease which expires in November 2016. The Company leases a sales and support office in Utting, Germany. The lease, which began February 1, 1992 and expires on January 31, 2018, contains an automatic twelve months renewal, at rates to be determined, if no notice is given prior to six months from expiry. Under the lease agreements, the Company is responsible for payments of utilities, taxes and insurance. Minimum annual rentals payments under non-cancellable operating leases in each of the next five fiscal years and thereafter are as follows (in thousands): Rental expense for the years ended May 31, 2016, 2015 and 2014 was $499,000, $554,000 and $562,000, respectively. At May 31, 2016 and 2015, the Company had a $50,000 certificate of deposit held by a financial institution representing a security deposit for its United States manufacturing and office space lease. This amount is included in “Other Assets” on the consolidated balance sheets. PURCHASE OBLIGATIONS The Company has purchase obligations to certain suppliers. In some cases the products the Company purchases are unique and have provisions against cancellation of the order. At May 31, 2016, the Company had $554,000 of purchase obligations which are due within the following 12 months. This amount does not include contractual obligations recorded on the consolidated balance sheets as liabilities. CONTINGENCIES The Company is, from time to time, involved in legal proceedings arising in the ordinary course of business. While there can be no assurances as to the ultimate outcome of any litigation involving the Company, management does not believe any pending legal proceedings will result in judgment or settlement that will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows. In the normal course of business to facilitate sales of its products, the Company indemnifies other parties, including customers, with respect to certain matters. The Company has agreed to hold the other party harmless against losses arising from a breach of representations or covenants, or from intellectual property infringement or other claims. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, the Company has entered into indemnification agreements with its officers and directors, and the Company’s bylaws contain similar indemnification obligations to the Company’s agents. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. To date, payments made by the Company under these agreements have not had a material impact on the Company’s operating results, financial position or cash flows. 16. SUBSEQUENT EVENTS On August 22, 2016 the Purchase Agreement was amended to extend the maturity date of the Convertible Notes to April 10, 2019, decrease the conversion price from $2.65 per share to $2.30 per share, decrease the forced conversion price from $7.50 per share to $6.51 per share, and allow for additional equity awards. On August 8, 2016 the Company entered into Common Stock Purchase Agreement with Semics Inc., a semiconductor test equipment provider that produces fully automatic wafer probe systems, to sell 200,000 shares of Aehr Test Systems common stock in consideration for an outstanding invoice of $323,000 for capital equipment. 17. SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED) The following tables (presented in thousands, except per share data) sets forth selected unaudited condensed consolidated statements of operations data for each of the four quarters of the fiscal years ended May 31, 2016 and 2015. The unaudited quarterly information has been prepared on the same basis as the annual information presented elsewhere herein and, in the Company’s opinion, includes all adjustments (consisting only of normal recurring entries) necessary for a fair statement of the information for the quarters presented. The operating results for any quarter are not necessarily indicative of results for any future period and should be read in conjunction with the audited consolidated financial statements of the Company’s and the notes thereto included elsewhere herein. | I apologize, but the text you've provided appears to be an incomplete or fragmented financial statement snippet. It contains partial headings and references to financial elements like Profit/Loss, Expenses, Assets, and Liabilities, but lacks the specific numerical data or detailed information needed to create a meaningful summary. To provide a proper summary, I would need the complete financial statement with actual figures and context.
If you have the full financial statement, please share it, and I'll be happy to help you summarize its key points. | Claude |
Financial Statements And Supplementary Data INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ACCOUNTING FIRM To the Board of Directors and Shareholder of US Foods, Inc. Rosemont, Illinois We have audited the accompanying consolidated balance sheets of US Foods, Inc. and subsidiaries (the “Company”) as of January 2, 2016 and December 27, 2014, and the related consolidated statements of comprehensive income (loss), shareholder’s equity, and cash flows for each of the three fiscal years in the period ended January 2, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of US Foods, Inc. and subsidiaries as of January 2, 2016 and December 27, 2014, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 2, 2016, in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP Chicago, Illinois April 1, 2016 US FOODS, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except for share data) See . US FOODS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (In thousands) See . US FOODS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDER’S EQUITY (In thousands, except for share data) See . US FOODS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) See . US FOODS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. OVERVIEW AND BASIS OF PRESENTATION US Foods, Inc. and its consolidated subsidiaries are referred to here as “we,” “our,” “us,” the “Company,” or “USF” is a wholly owned subsidiary of US Foods Holding Corp. (“US Foods” or “parent”), a Delaware corporation formed and controlled by investment funds associated with Clayton, Dubilier & Rice, LLC (“CD&R”) and Kohlberg Kravis Roberts & Co., L.P. (“KKR”), collectively the “Sponsors”. Terminated Acquisition by Sysco-On December 8, 2013, US Foods entered into an agreement and plan of merger (the “Acquisition Agreement”) with Sysco Corporation (“Sysco”); Scorpion Corporation I, Inc., a wholly owned subsidiary of Sysco (“Merger Sub One”); and Scorpion Company II, LLC, a wholly owned subsidiary of Sysco (“Merger Sub Two”), through which Sysco would have acquired US Foods (the “Acquisition”) on the terms and subject to the conditions set forth in the Acquisition Agreement. The closing of the Acquisition was subject to customary conditions, including the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. On February 2, 2015, US Foods, USF and certain of its subsidiaries, and Sysco entered into an asset purchase agreement (the “Asset Purchase Agreement”) with Performance Food Group, Inc. (“PFG”), through which PFG agreed to purchase, subject to the terms and conditions of the Asset Purchase Agreement, eleven USF distribution centers and related assets and liabilities, in connection with (and subject to) the closing of the Acquisition. On February 19, 2015, the U.S. Federal Trade Commission (the “FTC”) voted by a margin of 3-2 to seek to block the proposed Acquisition by filing a federal district court action in the District of Columbia for a preliminary injunction. The preliminary injunctive hearing in federal district court commenced on May 5, 2015 and, on June 23, 2015, the federal district court granted the FTC’s request for a preliminary injunction to block the proposed Acquisition. On June 26, 2015, US Foods, Sysco, Merger Sub One and Merger Sub Two entered into an agreement to terminate the Acquisition Agreement. Upon the termination of the Acquisition Agreement, the Asset Purchase Agreement automatically terminated and the indenture with respect to the 8.5% unsecured Senior Notes due June 30, 2019 (the “Senior Notes”) reverted to its prior form as if the amendments that modified certain definitions in such indenture had never become operative. Sysco paid a termination fee of $300 million to US Foods in connection with the termination of the Acquisition Agreement. USF paid a termination fee of $12.5 million to PFG pursuant to the terms of the Asset Purchase Agreement. Business Description-USF markets and distributes fresh, frozen and dry food and non-food products to foodservice customers throughout the United States. These customers include independently owned single and multi-unit restaurants, regional concepts, national restaurant chains, hospitals, nursing homes, hotels and motels, country clubs, government and military organizations, colleges and universities, and retail locations. Basis of Presentation-The Company operates on a 52-53 week fiscal year, with all periods ending on a Saturday. When a 53-week fiscal year occurs, the Company reports the additional week in the fiscal fourth quarter. The fiscal years ended January 2, 2016, December 27, 2014 and December 28, 2013 are also referred to herein as fiscal years 2015, 2014 and 2013, respectively. The Company’s fiscal year 2015 is a 53-week fiscal year. Public Filer Status-During the fiscal second quarter of 2013, the Company completed the registration of $1,350 million aggregate principal amount of outstanding Senior Notes and became subject to rules and regulations of the Securities and Exchange Commission (“SEC”), including periodic and current reporting requirements under the Securities Exchange Act of 1934, as amended. The Company did not receive any proceeds from the registration of the Senior Notes. Presently, the Company files periodic reports as a voluntary filer pursuant to contractual obligations in the indenture governing the Senior Notes. US Foods Holding Corp. Initial Public Offering-In February 2016, our parent, US Foods filed a registration statement on Form S-1 with the SEC relating to a proposed initial public offering of its common stock. The number of shares to be offered and the price range for the offering have not been determined. US Foods intends to use a portion of the net proceeds from the proposed offering to repay certain Company indebtedness and use the remaining proceeds, if any, received from the offering for general corporate purposes. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation-Consolidated financial statements include the accounts of USF and its 100% owned subsidiaries. All intercompany transactions have been eliminated in consolidation. Use of Estimates-Consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). This requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. The most critical estimates used in the preparation of the Company’s consolidated financial statements pertain to the valuation of goodwill and other intangible assets, vendor consideration, self-insurance programs, income taxes, and share-based compensation. Cash and Cash Equivalents-The Company considers all highly liquid investments purchased with a maturity of three or fewer months to be cash equivalents. Accounts Receivable-Accounts receivable represent amounts due from customers in the ordinary course of business and are recorded at the invoiced amount and do not bear interest. Receivables are presented net of the allowance for doubtful accounts in the accompanying Consolidated Balance Sheets. The Company evaluates the collectability of its accounts receivable and determines the appropriate allowance for doubtful accounts based on a combination of factors. When we are aware of a customer’s inability to meet its financial obligation, a specific allowance for doubtful accounts is recorded, reducing the receivable to the net amount we reasonably expect to collect. In addition, allowances are recorded for all other receivables based on historic collection trends, write-offs and the aging of receivables. The Company uses specific criteria to determine uncollectible receivables to be written off, including bankruptcy, accounts referred to outside parties for collection, and accounts past due over specified periods. Vendor Consideration and Receivables-The Company participates in various rebate and promotional incentives with its suppliers, primarily through purchase-based programs. Consideration earned under these incentives is estimated during the year, based on purchasing activity, as the Company’s obligations under the programs are fulfilled primarily when products are purchased. Changes in the estimated amount of incentives earned are treated as changes in estimates and are recognized in the period of change. Vendor consideration is typically deducted from invoices or collected in cash within 30 days of being earned. Vendor receivables represent the uncollected balance of the vendor consideration. Due to the process of primarily deducting the consideration from the amounts due to the vendor, the Company does not experience significant collectability issues. The Company evaluates the collectability of its vendor receivables based on specific vendor information and vendor collection history. Inventories-The Company’s inventories-consisting mainly of food and other foodservice-related products-are considered finished goods. Inventory costs include the purchase price of the product, freight charges to deliver it to the Company’s warehouses, and depreciation and labor related to processing facilities and equipment, and are net of certain cash or non-cash consideration received from vendors. The Company assesses the need for valuation allowances for slow-moving, excess and obsolete inventories by estimating the net recoverable value of such goods based upon inventory category, inventory age, specifically identified items, and overall economic conditions. The Company records inventories at the lower of cost or market using the last-in, first-out (“LIFO”) method. The base year values of beginning and ending inventories are determined using the inventory price index computation method. This “links” current costs to original costs in the base year when the Company adopted LIFO. During 2014, inventory quantities were reduced resulting in the liquidation of certain quantities carried at lower costs in prior years. As a result of this LIFO liquidation, cost of sales decreased $7 million in 2014. There were no LIFO inventory liquidations in 2015 and 2013. At January 2, 2016 and December 27, 2014, the LIFO balance sheet reserves were $134 million and $208 million, respectively. As a result of net changes in LIFO reserves, cost of goods sold decreased $74 million in fiscal year 2015 and increased $60 million and $12 million in fiscal years 2014 and 2013, respectively. The $60 million increase in cost of goods sold in 2014 is net of the $7 million decrease in cost of goods sold resulting from the LIFO liquidation. Property and Equipment-Property and equipment are stated at cost. Depreciation of property and equipment is calculated using the straight-line method over the estimated useful lives of the assets, which range from three to 40 years. Property and equipment under capital leases and leasehold improvements are amortized on a straight-line basis over the shorter of the remaining term of the related lease or the estimated useful lives of the assets. Routine maintenance and repairs are charged to expense as incurred. Applicable interest charges incurred during the construction of new facilities or development of software for internal use are capitalized as one of the elements of cost and are amortized over the useful life of the respective assets. Property and equipment held and used by the Company are tested for recoverability whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. For purposes of evaluating the recoverability of property and equipment, the Company compares the carrying value of the asset or asset group to the estimated, undiscounted future cash flows expected to be generated by the long-lived asset or asset group. If the future cash flows do not exceed the carrying value, the carrying value is compared to the fair value of such asset. If the carrying value exceeds the fair value, an impairment charge is recorded for the excess. The Company also assesses the recoverability of its closed facilities actively marketed for sale. If a facility’s carrying value exceeds its fair value, less an estimated cost to sell, an impairment charge is recorded for the excess. Assets held for sale are not depreciated. Impairments are recorded as a component of Restructuring and tangible asset impairment charges in the Consolidated Statements of Comprehensive Income (Loss), as well as in a reduction of the asset’s carrying value in the Consolidated Balance Sheets. Goodwill and Other Intangible Assets-Goodwill and Other intangible assets include the cost of the acquired business in excess of the fair value of the net tangible assets acquired. Other intangible assets include customer relationships, the brand names comprising our portfolio of exclusive brands, and trademarks. As required, we assess Goodwill and intangible assets with indefinite lives for impairment annually, or more frequently if events occur that indicate an asset may be impaired. For goodwill and indefinite-lived intangible assets, our policy is to assess for impairment at the beginning of each fiscal third quarter. For other intangible assets with definite lives, we assess for impairment only if events occur that indicate that the carrying amount of an asset may not be recoverable. All Goodwill is assigned to the consolidated Company as the reporting unit. Self-Insurance Programs-The Company accrues estimated liability amounts for claims covering general, fleet and workers’ compensation. The amounts in excess of certain levels, which range from $1 - 3 million per occurrence, are insured as a risk reduction strategy, to minimize catastrophic losses. We are fully self-insured for group medical claims not covered under collective bargaining agreements. The Company accrues its estimated liability for the self-insured medical insurance program, including an estimate for incurred but not reported claims, based on known claims and past claims history. The amounts accrued are discounted, except for self-insured medical liabilities, as the amount and timing of cash payments related to those accruals are reliably determinable given the nature of benefits and the level of historical claim volume to support the actuarial assumptions and judgments used to derive the expected loss payment pattern. Substantially all of the discounting pertains to workers compensation, as it makes up approximately 80% of the total liability as of January 2, 2016. The amounts accrued are discounted using an interest rate that approximates the US. Treasury rate consistent with the duration of the liabilities. However, the inherent uncertainty of future loss projections could cause actual claims to differ from our estimates. These accruals are included in Accrued expenses and Other long-term liabilities in the Consolidated Balance Sheets. Share-Based Compensation-Certain employees participate in the 2007 Stock Incentive Plan for Key Employees of USF Holding Corp. and its Affiliates, as amended (“Stock Incentive Plan”), which allows purchases of US Foods shares of common stock, grants of restricted stock and restricted stock units of US Foods and grants of options exercisable in US Foods common stock. The Company measures compensation expense for stock-based option awards at fair value at the date of grant, and it recognizes compensation expense over the service period for stock-based awards expected to vest. US Foods contributes shares to the Company for employee purchases and upon exercise of options or grants of restricted stock and restricted stock units. To determine the fair value of awards at the date of grant, the Company computes a common stock fair value at the end of each fiscal quarter and uses the calculated common stock fair value for all grants in the subsequent quarter. Business Acquisitions-The Company accounts for business acquisitions under the acquisition method, in which assets acquired and liabilities assumed are recorded at fair value as of the acquisition date. The operating results of the acquired companies are included in the Company’s consolidated financial statements from the date of acquisition. Revenue Recognition-The Company recognizes revenue from the sale of product when title and risk of loss passes and the customer accepts the goods, which generally occurs at delivery. The Company grants certain customers sales incentives -such as rebates or discounts-and treats these as a reduction of sales at the time the sale is recognized. Sales taxes invoiced to customers and remitted to governmental authorities are excluded from Net sales. Cost of Goods Sold-Cost of goods sold includes amounts paid to vendors for products sold-net of vendor consideration and the cost of transportation necessary to bring the products to the Company’s distribution facilities. Depreciation related to processing facilities and equipment is presented in cost of goods sold. Because the majority of the Inventories are finished goods, depreciation related to warehouse facilities and equipment is presented in Distribution, selling and administrative costs. See Inventories section above for discussion of LIFO impact on Cost of goods sold. Shipping and Handling Costs-Shipping and handling costs-which include costs related to the selection of products and their delivery to customers- are presented in Distribution, selling and administrative costs. Shipping and handling costs were $1.5 billion for each of the 2015, 2014 and 2013 fiscal years. Income Taxes-The Company accounts for income taxes under the asset and liability method. This requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the consolidated financial statements and tax basis of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income during the period that includes the enactment date. Net deferred tax assets are recorded to the extent the Company believes these assets will more likely than not be realized. An uncertain tax position is recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Uncertain tax positions are recorded at the largest amount that is more likely than not to be sustained. The Company adjusts the amounts recorded for uncertain tax positions when its judgment changes, as a result of evaluating new information not previously available. These differences are reflected as increases or decreases to income tax expense in the period in which they are determined. Derivative Financial Instruments-The Company has used interest rate swap agreements in the past to manage its exposure to interest rate movements on its variable-rate term loan obligation. It is not currently party to any interest rate swap agreements. In the normal course of business, the Company enters into forward purchase agreements to procure fuel, electricity and product commodities related to its business. These agreements often meet the definition of a derivative. However, the Company does not measure its forward purchase commitments at fair value as the amounts under contract meet the physical delivery criteria in the normal purchase exception under GAAP guidance. Concentration Risks-Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash equivalents and accounts receivable. The Company’s cash equivalents are invested primarily in money market funds at major financial institutions. Credit risk related to accounts receivable is dispersed across a larger number of customers located throughout the United States. The Company attempts to reduce credit risk through initial and ongoing credit evaluations of its customers’ financial condition. There were no receivables from any one customer representing more than 5% of our consolidated gross accounts receivable at January 2, 2016 and December 27, 2014. 3. RECENT ACCOUNTING PRONOUNCEMENTS In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-2, Leases (Topic 842), which supersedes ASC 840, Leases. This ASU, based on the principle that entities should recognize assets and liabilities arising from leases, does not significantly change the lessees’ recognition, measurement and presentation of expenses and cash flows from the previous accounting standard. Leases are classified as finance or operating. The ASU’s primary change is the requirement for entities to recognize a lease liability for payments and a right of use asset representing the right to use the leased asset during the term of operating lease arrangements. Lessees are permitted to make an accounting policy election to not recognize the asset and liability for leases with a term of twelve months or less. Lessors’ accounting is largely unchanged from the previous accounting standard. In addition, the ASU expands the disclosure requirements of lease arrangements. Lessees and lessors will use a modified retrospective transition approach, which includes a number of practical expedients. This guidance is effective for fiscal years-and interim periods within those fiscal years-beginning after December 15, 2018, with early adoption permitted. The Company is currently reviewing the provisions of the new standard. In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This ASU requires that deferred income tax liabilities and assets be classified as noncurrent in a classified statement of financial position. This guidance is effective for fiscal years-and interim periods within those fiscal years-beginning after December 15, 2016, with early adoption permitted on either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The prospective adoption of this guidance in the fiscal fourth quarter of 2015 did not materially affect the Company’s financial position, results of operations or cash flows. Prior periods were not retrospectively adjusted. In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustment. This ASU eliminates the requirement to restate prior period financial statements for measurement period adjustments for business combinations. The new guidance requires that the cumulative impact of a measurement period adjustment (including the impact on prior periods) be recognized in the reporting period in which the adjustment is identified. This guidance is effective for fiscal years-and interim periods within those fiscal years-beginning after December 15, 2015. The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective date with earlier adoption permitted for financial statements that have not been issued. The Company does not expect the adoption of this guidance in fiscal year 2016 to materially affect its financial position, results of operations or cash flows. In May 2015, the FASB issued ASU No. 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). The amendments in this ASU remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. This guidance is effective for fiscal years-and interim periods within those fiscal years-beginning after December 15, 2015, with early adoption permitted. The amendments should be applied retrospectively. The retrospective adoption of this guidance for disclosures relating to the Company’s pension plan assets in the fiscal fourth quarter of 2015 did not affect the Company’s financial position, results of operations or cash flows. In April 2015, the FASB issued ASU No. 2015-04, Compensation -Retirement Benefits (Topic 715): Practical Expedient for the Measurement Date of an Employer’s Defined Benefit Obligation and Plan Assets. This ASU gives an employer whose fiscal year-end does not coincide with a calendar month-end-e.g., an entity that has a 52-week or 53-week fiscal year- the ability, as a practical expedient, to measure defined benefit retirement obligations and related plan assets as of the month-end that is closest to its fiscal year-end. This guidance is effective for fiscal years-and interim periods within those fiscal years-beginning after December 15, 2015, with early adoption permitted. The adoption of this guidance in connection with the remeasurement and curtailment accounting in the fiscal third quarter of 2015 did not materially affect the Company’s financial position, results of operations or cash flows. In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. This guidance is effective for fiscal years-and interim periods within those fiscal years-beginning after December 15, 2015, with early adoption permitted. As a result of the retrospective adoption of this guidance in the fiscal fourth quarter of 2015, deferred financing costs of $25 million and $35 million at January 2, 2016 and December 27, 2014, respectively, are netted against the carrying values of certain debt obligations. Additionally, in accordance with ASU No. 2015-15, Interest-Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, issued in August 2015, the Company will continue to present debt issuance costs related to its line-of-credit arrangements as an asset and amortize them ratably over the term of the related facilities. In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern. This ASU provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. This guidance is effective for fiscal years-and interim periods within those fiscal years-beginning after December 15, 2016, with early adoption permitted. The Company is currently reviewing the provisions of the new standard. In May 2014, the FASB issued ASU No. 2014-09 Revenue from Contracts with Customers, which will be introduced into the FASB’s Accounting Standards Codification as Topic 606. Topic 606 replaces Topic 605, the previous revenue recognition guidance. The new standard core principle is for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration-that is, payment-to which the company expects to be entitled in exchange for those goods or services. The new standard also will result in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively (for example, service revenue and contract modifications) and improve guidance for multiple-element arrangements. The new standard will be effective for the Company in the fiscal first quarter of 2018, with early adoption permitted in the fiscal first quarter of 2017. The new standard permits two implementation approaches, one requiring retrospective application of the new standard with restatement of prior years, and one requiring prospective application of the new standard with disclosure of results under old standards. The Company is currently evaluating the impact of this ASU and has not yet selected an implementation approach. 4. BUSINESS ACQUISITIONS On December 31, 2015, the Company purchased a broadline distributor for cash of $69 million. During 2013, the Company purchased a foodservice distributor for cash of $14 million, plus contingent consideration of $2 million that was paid in 2014. The Company also received a $2 million purchase price adjustment in 2013 related to 2012 business acquisitions. The acquisitions, made in order to expand the Company’s presence in certain geographic areas, are integrated into the Company’s foodservice distribution network. There were no business acquisitions in 2014. The following table summarizes the purchase price allocations for the 2015 and 2013 business acquisitions as follows (in thousands): The 2015 and 2013 acquisitions did not materially affect the Company’s results of operations or financial position. Actual net sales and operating earnings of the businesses acquired in both periods represent less than 2% of the Company’s consolidated results and, therefore, pro forma information has not been provided. 5. ALLOWANCE FOR DOUBTFUL ACCOUNTS A summary of the activity in the allowance for doubtful accounts for the last three fiscal years is as follows (in thousands): This table excludes the vendor receivable related allowance for doubtful accounts of $2 million, $3 million and $3 million at January 2, 2016, December 27, 2014 and December 28, 2013, respectively. 6. ACCOUNTS RECEIVABLE FINANCING PROGRAM Under its accounts receivable financing program and the related financing facility (the “2012 ABS Facility”), the Company and from time to time its subsidiaries sells-on a revolving basis-their eligible receivables to a wholly owned, special purpose, bankruptcy remote subsidiary (the “Receivables Company”). The Receivables Company, in turn, grants a continuing security interest in all of its rights, title and interest in the eligible receivables to the administrative agent for the benefit of the lenders -as defined in the 2012 ABS Facility. The Company consolidates the Receivables Company and, consequently, the sale of the receivables is a transaction internal to the Company and the receivables have not been derecognized from the Company’s Consolidated Balance Sheets. On a daily basis, cash from accounts receivable collections is remitted to the Company as additional eligible receivables are sold to the Receivables Company. If, on a weekly settlement basis, there are not sufficient eligible receivables available as collateral, the Company is required to either provide cash collateral or, in lieu of providing cash collateral, it can pay down its borrowings on the 2012 ABS Facility to cover the shortfall. Due to sufficient eligible receivables available as collateral, no cash collateral was held at January 2, 2016 or December 27, 2014. Included in the Company’s Accounts receivable balance as of January 2, 2016 and December 27, 2014 was $933 million and $941 million, respectively, of receivables held as collateral in support of the 2012 ABS Facility. See Note 11, Debt for a further description of the 2012 ABS Facility. 7. ASSETS HELD FOR SALE The Company classifies its closed facilities as Assets held for sale at the time management commits to a plan to sell the facility, the facility is actively marketed and available for immediate sale, and the sale is expected to be completed within one year. Due to market conditions, certain facilities may be classified as Assets held for sale for more than one year as the Company continues to actively market the facilities at reasonable prices. The changes in Assets held for sale for fiscal years 2015 and 2014 were as follows (in thousands): During fiscal year 2015, the Company closed a distribution facility and reclassified it to Assets held for sale. Two facilities classified as Assets held for sale were sold during fiscal year 2015 for proceeds of $3 million. During fiscal year 2014, four distribution facilities were closed and reclassified to Assets held for sale. Five facilities classified as Assets held for sale were sold during fiscal year 2014 for proceeds of $19 million. Certain Assets held for sale were adjusted to equal their estimated fair value, less cost to sell, resulting in tangible asset impairment charges of $1 million and $2 million in fiscal years 2015 and 2014, respectively. See Note 10, Fair Value Measurements. 8. PROPERTY AND EQUIPMENT Property and equipment consisted of the following (in thousands): Transportation equipment included $260 million and $163 million of capital lease assets at January 2, 2016, and December 27, 2014, respectively. Buildings and building improvements included $98 million and $33 million of capital lease assets at January 2, 2016 and December 27, 2014, respectively. Accumulated amortization of capital lease assets was $68 million and $36 million at January 2, 2016 and December 27, 2014, respectively. Interest capitalized was $2 million in fiscal years 2015 and 2014. Depreciation and amortization expense of property and equipment-including amortization of capital lease assets-was $253 million, $261 million and $240 million for the fiscal years 2015, 2014 and 2013, respectively. 9. GOODWILL AND OTHER INTANGIBLES Goodwill and Other intangible assets include the cost of acquired businesses in excess of the fair value of the tangible net assets acquired. Other intangible assets include customer relationships, noncompete agreements, the brand names and trademarks comprising the Company’s portfolio of exclusive brands and trademarks. Brand names and trademarks are indefinite-lived intangible assets and, accordingly, are not subject to amortization. Customer relationship intangible assets have definite lives and are carried at the acquired fair value less accumulated amortization. Customer relationship intangible assets are amortized over the estimated useful lives-four to ten years. Amortization expense was $146 million, $151 million and $147 million for fiscal years 2015, 2014 and 2013, respectively. The weighted-average remaining useful life of all customer relationship intangibles was approximately two years at January 2, 2016. Amortization of these customer relationship assets is estimated to be $146 million in fiscal year 2016, $68 million in fiscal year 2017, and $5 million in fiscal years 2018 and 2019. Goodwill and Other intangibles consisted of the following (in thousands): The 2015 increase in Goodwill is attributable to a 2015 broadline distributor acquisition. The 2015 decrease in the gross carrying amount of customer relationships is attributable to the write-off of fully amortized customer relationship intangible assets of $23 million, offset by intangible assets acquired related to the 2015 business acquisition of $21 million. As required, the Company assesses Goodwill and intangible assets with indefinite lives for impairment annually, or more frequently, if events occur that indicate an asset may be impaired. For Goodwill and indefinite-lived intangible assets, the Company’s policy is to assess for impairment at the beginning of each fiscal third quarter. For intangible assets with definite lives, the Company assesses impairment only if events occur that indicate that the carrying amount of an asset may not be recoverable. All Goodwill is assigned to the consolidated company as the reporting unit. The Company completed its most recent annual impairment assessment of Goodwill and indefinite-lived intangible assets as of June 28, 2015-the first day of the fiscal third quarter of 2015-with no impairments noted. For Goodwill, the reporting unit used in assessing impairment is the Company’s one business segment as described in Note 23, Business Segment Information. The Company’s assessment for impairment of Goodwill utilized a combination of discounted cash flow analysis, comparative market multiples, and comparative market transaction multiples, weighted 50%, 35% and 15%, respectively, to determine the fair value of the reporting unit for comparison to its corresponding carrying value. If the carrying value of the reporting unit exceeds its fair value, the Company must then perform a comparison of the implied fair value of Goodwill to its carrying value. If the carrying value of the Goodwill exceeds its implied fair value, an impairment loss is recognized in an amount equal to the excess. Based upon the Company’s fiscal 2015 annual Goodwill impairment analysis, the Company concluded the fair value of its reporting unit exceeded its carrying value. The Company’s fair value estimates of the brand name and trademark indefinite-lived intangible assets are based on a relief from royalty method. The fair value of these intangible assets is determined for comparison to the corresponding carrying value. If the carrying value of these assets exceeds its fair value, an impairment loss is recognized in an amount equal to the excess. Based upon the Company’s fiscal 2015 annual impairment analysis, the Company concluded the fair value of the Company’s brand names and trademarks exceeded its carrying value. 10. FAIR VALUE MEASUREMENTS The Company follows the accounting standards for fair value, where fair value is a market-based measurement, not an entity-specific measurement. The Company’s fair value measurements are based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, fair value accounting standards establish a fair value hierarchy which prioritizes the inputs used in measuring fair value as follows: • Level 1-observable inputs, such as quoted prices in active markets • Level 2-observable inputs other than those included in Level 1, such as quoted prices for similar assets and liabilities in active or inactive markets that are observable either directly or indirectly, or other inputs that are observable or can be corroborated by observable market data • Level 3-unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. Any transfers of assets or liabilities between Level 1, Level 2, and Level 3 of the fair value hierarchy will be recognized as of the end of the reporting period in which the transfer occurs. There were no transfers between fair value levels in any of the periods presented below. The Company’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of January 2, 2016 and December 27, 2014, aggregated by the level in the fair value hierarchy within which those measurements fall, are as follows (in thousands): Recurring Fair Value Measurements Money Market Funds Money market funds include highly liquid investments with a maturity of three or fewer months. They are valued using quoted market prices in active markets and are classified under Level 1 within the fair value hierarchy. Nonrecurring Fair Value Measurements Assets Held for Sale The Company records Assets held for sale at the lesser of the carrying amount or estimated fair value less cost to sell. Certain Assets held for sale were adjusted to equal their estimated fair value, less cost to sell, resulting in Tangible asset impairment charges of $1 million and $2 million during fiscal years 2015 and 2014, respectively. Management estimates fair value based on comparable sales transactions received from real estate brokers. The amounts included in the tables above, classified under Level 3 within the fair value hierarchy, represent the estimated fair values of those Assets held for sale that became the new carrying amounts at the time the impairments were recorded. Other Fair Value Measurements The carrying value of cash, restricted cash, Accounts receivable, Bank checks outstanding, Accounts payable and accrued expenses approximate their fair values due to their short-term maturities. The carrying value of the self-funded industrial revenue bonds and the corresponding long-term liability approximate their fair values. See Note 11, Debt, for a further description of the industrial revenue bonds. Excluding the above noted industrial bonds, the fair value of the Company’s total debt approximated $4.8 billion at January 2, 2016 and December 27, 2014, as compared to its aggregate carrying value of $4.7 billion at January 2, 2016 and December 27, 2014. At January 2, 2016 and December 27, 2014, the fair value, estimated at $1.4 billion, of the Senior Notes was classified under Level 2 of the fair value hierarchy, with fair valued based upon the closing market price at the end of the reporting period. The fair value of the balance of the Company’s debt is classified under Level 3 of the fair value hierarchy, with fair value estimated based upon a combination of the cash outflows expected under these debt facilities, interest rates that are currently available to the Company for debt with similar terms, and estimates of the Company’s overall credit risk. See Note 11, Debt for further description of the Company’s debt. 11. DEBT The Company’s debt consisted of the following (in thousands): (1) Prior year amounts have been reclassified to reflect the adoption of ASU 2015-03. Principal payments to be made on outstanding debt as of January 2, 2016, were as follows (in thousands): As of January 2, 2016, $2.1 billion of the Total debt was at a fixed rate. Revolving Credit Agreement The Company’s asset backed senior secured revolving loan facility (the “ABL Facility”) provides for loans under its two tranches: ABL Tranche A-1 and ABL Tranche A, with its capacity limited by a borrowing base. During fiscal year 2015, the ABL Facility was amended. The maximum borrowing available was increased $200 million to $1,300 million - ABL Tranche A-1 increased from $75 million to $100 million, and the maximum borrowing available under the ABL Tranche A increased $175 million to $1,200 million. Additionally, the interest rate on outstanding borrowings and letter of credit fees was reduced by 75 basis points. The maturity date was extended to the earlier of (1) October 20, 2020, the amended ABL Facility maturity date; (2) April 1, 2019 if the Company’s Senior Notes have more than $300 million of principal outstanding at that date and the maturity date of the Senior Notes has not been extended to later than October 20, 2020; or (3) December 31, 2018 if the Company’s senior secured term loan (the “Amended 2011 Term Loan”) has more than $300 million of principal outstanding at that date and the maturity date of the Amended 2011 Term Loan has not been extended to later than October 20, 2020. The Company incurred $3 million of lender fees and third party costs to amend the ABL Facility, which was capitalized as Deferred financing costs and amortized to the ABL Facility maturity date. As of January 2, 2016, the Company had no outstanding borrowings, but had issued letters of credit totaling $393 million under the ABL Facility. Outstanding letters of credit included: (1) $73 million issued to secure the Company’s obligations related to certain facility leases, (2) $317 million issued in favor of certain commercial insurers securing the Company’s obligations related to its self-insurance program and (3) $3 million for other obligations of the Company. There was available capacity on the ABL Facility of $872 million at January 2, 2016. As of January 2, 2016, on Tranche A-1 borrowings, the Company can periodically elect to pay interest at an alternative base rate (“ABR”), as defined in the Company’s credit agreements, plus 1.50% or the London Inter Bank Offered Rate (“LIBOR”) plus 2.50%. On Tranche A borrowings, the Company can periodically elect to pay interest at ABR plus 0.25% or LIBOR plus 1.25%. The ABL Facility also carries letter of credit fees of 1.25% and an unused commitment fee of 0.25%. The weighted-average interest rate for the ABL Facility was 3.69% for fiscal year 2014. The Company did not borrow on the ABL Facility in 2015. As discussed in Note 24, Subsequent Events, the Company borrowed approximately $239 million on the ABL Facility that partially funded the January 8, 2016 one-time special cash distribution to US Foods, the Company’s parent. Accounts Receivable Financing Program Under the 2012 ABS Facility, the Company and from time to time its subsidiaries sells-on a revolving basis-their eligible receivables to the Receivables Company. The Receivables Company, in turn, grants a continuing security interest in all of its rights, title and interest in the eligible receivables to the administrative agent for the benefit of the lenders as defined in the 2012 ABS Facility. See Note 6, Accounts Receivable Financing Program. The maximum capacity under the 2012 ABS Facility is $800 million. Borrowings under the 2012 ABS Facility were $586 million and $636 million at January 2, 2016 and December 27, 2014, respectively. The Company, at its option, can request additional borrowings up to the maximum commitment, provided sufficient eligible receivables are available as collateral. There was available capacity on the 2012 ABS Facility of $111 million at January 2, 2016 based on eligible receivables as collateral. The portion of the 2012 ABS Facility held by the lenders who fund the 2012 ABS Facility with commercial paper bears interest at the lender’s commercial paper rate, plus any other costs associated with the issuance of commercial paper, plus 1.00%, and an unused commitment fee of 0.35%. The portion of the 2012 ABS Facility held by lenders that do not fund the 2012 ABS Facility with commercial paper bears interest at LIBOR plus 1.00%, and an unused commitment fee of 0.35%. The weighted-average interest rate for the 2012 ABS Facility was 1.41% and 1.43% for fiscal year 2015 and 2014, respectively. On October 19, 2015, the 2012 ABS Facility was amended whereby the maturity date was again extended from August 5, 2016 to September 30, 2018. There were no other significant changes to the 2012 ABS Facility. The Company incurred $1 million of lender fees and third party costs related to the 2012 ABS Facility amendment, which was capitalized as Deferred financing costs and amortized to the 2012 ABS Facility maturity date. As discussed in Note 24, Subsequent Events, the Company borrowed $75 million on the 2012 ABS Facility that partially funded the January 8, 2016 one-time special cash distribution to US Foods, the Company’s parent. Term Loan Agreement The Amended 2011 Term Loan had outstanding borrowings of $2,038 million and $2,059 million, net of $10 million and $15 million of unamortized deferred financing costs at January 2, 2016 and December 27, 2014, respectively. The facility bears interest equal to ABR plus 2.50%, with an ABR floor of 2.00%, or LIBOR plus 3.50%, with a LIBOR floor of 1.00%, based on a periodic election of the interest rate by the Company. Principal repayments of $5 million are payable quarterly with the balance at maturity. The Amended 2011 Term Loan may require mandatory repayments if certain assets are sold, or based on excess cash flow generated by the Company, as defined in the debt agreement. The interest rate for all borrowings on the Amended 2011 Term Loan was 4.50%-the LIBOR floor of 1.00% plus 3.50%- at January 2, 2016. At January 2, 2016, investment funds or accounts managed or advised by an affiliate of KKR held a portion of the Amended 2011 Term Loan debt. See Note 14, Related Party Transactions. The term loan agreement was amended during 2013. See “Debt Refinancing Transactions” discussed below. Senior Notes The Senior Notes, with outstanding principal of $1,335 million and $1,333 million at January 2, 2016 and December 27, 2014, net of $13 million and $17 million, respectively of unamortized deferred financing costs, bear interest at 8.50%. Prior to June 30, 2016, the Senior Notes are redeemable, at the Company’s option, in whole or in part at a price of 104.25% of their principal, plus accrued and unpaid interest, if any, to the relevant redemption date. On or after June 30, 2016 and 2017, the optional redemption price for the Senior Notes declines to 102.13% and 100.0%, respectively, of their principal amount, plus accrued and unpaid interest, if any, to the relevant redemption date. There was unamortized issue premium associated with the Senior Notes issuances of $12 million and $15 million at January 2, 2016 and December 27, 2014. The premium is amortized as a decrease to Interest expense-net over the remaining life of the debt facility. In February 2015, the Company repurchased $2 million of the Senior Notes held by the entities affiliated with KKR, as further discussed in Note 14, Related Party Transactions. CMBS Fixed Facility The CMBS Fixed Facility with outstanding balances of $471 million and $470 million, net of $1 million and $2 million of unamortized deferred financing costs as of January 2, 2016 and December 27, 2014, is secured by mortgages on 34 properties, consisting of distribution centers. The CMBS Fixed Facility bears interest at 6.38%. Security deposits and escrow amounts related to certain properties collateralizing the CMBS Fixed Facility of $6 million at January 2, 2016 and December 27, 2014 are included in Other assets in the Consolidated Balance Sheets. Other Debt Obligations under capital leases consist of amounts due for transportation equipment and building leases. Other debt of $33 million and $12 million at January 2, 2016 and December 27, 2014, respectively, consists primarily of various state industrial revenue bonds. To obtain certain tax incentives related to the construction of a new distribution facility, in January 2015, the Company and a wholly owned subsidiary entered into an industrial revenue bond agreement with a state for the issuance of a maximum of $40 million in Taxable Demand Revenue Bonds (the “TRBs”). The TRBs are self-funded as the Company’s wholly owned subsidiary purchases the TRBs, and the state loans the proceeds back to the Company. The TRBs, which mature January 1, 2030, can be prepaid without penalty one year after issuance. Interest on the TRBs and the loan is 6.25%. At January 2, 2016, $22 million has been drawn on TRBs and recorded as a $22 million long-term asset and a corresponding long-term liability in the Consolidated Balance Sheet. Deferred Financing Costs Deferred financing costs of $25 million and $35 million at January 2, 2016 and December 27, 2014, respectively, are netted in the above carrying values of the Company’s Amended 2011 Term Loan, Senior Notes and CMBS Fixed Facility debt obligations. 2013 Debt Refinancing Transactions In 2013, the Company entered into transactions to refinance debt facilities and extend debt maturity dates, including the following: • In June 2013, the Company refinanced its term loan agreements. The aggregate principal outstanding of the 2011 Term Loan was increased to $2,100 million, and the maturity date of the loan facility was extended from March 31, 2017 to March 31, 2019. • In January 2013, the Company redeemed the remaining $355 million in aggregate principal amount of its 11.25% Senior Subordinated Notes (“Senior Subordinated Notes”) due June 30, 2017 from an affiliate of CD&R. This was done at a price equal to 105.63% of the principal amount of the Senior Subordinated Notes, plus accrued and unpaid interest to the redemption date. To fund the redemption of these notes, the Company issued $375 million in principal amount of its Senior Notes at a price equal to 103.50% of the principal amount, for gross proceeds of $388 million. The 2013 refinancing resulted in a Loss on extinguishment of debt of $42 million that consisted of a $20 million Senior Subordinated Notes early redemption premium, a write-off of $13 million of unamortized debt issuance costs related to the old debt facilities, and $9 million of lender fees and third party costs related to these transactions. Unamortized debt issuance costs of $6 million related to the portion of the term loan refinancing accounted for as a debt modification were carried forward as Deferred financing costs and amortized to the Amended 2011 Term Loan maturity date. The Company incurred transaction costs of $29 million related to the 2013 debt refinancing transactions. Transaction costs primarily consisted of loan fees, arrangement fees, rating agency fees and legal fees. Security Interests Substantially all of the Company’s assets are pledged under the various debt agreements. Debt under the 2012 ABS Facility is secured by certain designated receivables and, in certain circumstances, by restricted cash. The ABL Facility is secured by certain other designated receivables not pledged under the 2012 ABS Facility, inventories, and tractors and trailers owned by the Company. The CMBS Fixed Facility is collateralized by mortgages on 34 properties. The Company’s obligations under the Amended 2011 Term Loan are secured by all of the capital stock of its subsidiaries, each of the direct and indirect wholly owned domestic subsidiaries-as defined in the agreements-and are secured by substantially all assets of the Company and its subsidiaries not pledged under the 2012 ABS Facility or the CMBS Fixed Facility. The Amended 2011 Term Loan has priority over certain collateral securing the ABL Facility and it has second priority to collateral securing the ABL Facility. As of January 2, 2016, nine properties remain in a special purpose, bankruptcy remote subsidiary, and are not pledged as collateral under any of the Company’s debt agreements. Restrictive Covenants The Company’s credit facilities, loan agreements and indentures contain customary covenants. These include, among other things, covenants that restrict the Company’s ability to incur certain additional indebtedness, create or permit liens on assets, pay dividends (see Note 24, Subsequent Events) or engage in mergers or consolidations. As of January 2, 2016, the Company had $506 million of restricted payment capacity, and $1,108 million of its net assets that were restricted under these covenants. Subsequent to the balance sheet date, $374 million of restricted payment capacity was further utilized for the one-time special cash distribution discussed in Note 24, Subsequent Events, leaving $132 million of remaining restricted payment capacity. Certain debt agreements also contain customary events of default. Those include, without limitation, the failure to pay interest or principal when it is due under the agreements, cross default provisions, the failure of representations and warranties contained in the agreements to be true, and certain insolvency events. If a default event occurs and continues, the principal amounts outstanding-together with all accrued unpaid interest and other amounts owed-may be declared immediately due and payable by the lenders. Were such an event to occur, the Company would be forced to seek new financing that may not be on as favorable terms as its current facilities. The Company’s ability to refinance its indebtedness on favorable terms-or at all-is directly affected by the current economic and financial conditions. In addition, the Company’s ability to incur secured indebtedness (which may enable it to achieve more favorable terms than the incurrence of unsecured indebtedness) depends in part on the value of its assets. This, in turn, relies on the strength of its cash flows, results of operations, economic and market conditions and other factors. 12. ACCRUED EXPENSES AND OTHER LONG-TERM LIABILITIES Accrued expenses and other long-term liabilities consisted of the following (in thousands): Self-Insured Liabilities-The Company is self-insured for general liability, fleet liability and workers’ compensation claims. Claims in excess of certain levels are insured. The self-insurance liabilities, included in the table above under “Workers’ compensation, general and fleet liability,” are recorded at present value. This table summarizes self-insurance liability activity for the last three fiscal years (in thousands): Estimated future payments for self-insured liabilities are as follows (in thousands): 13. RESTRUCTURING LIABILITIES The following table summarizes the changes in the restructuring liabilities for the last three fiscal years (in thousands): The Company periodically closes distribution facilities, because it has built new ones or to consolidate operations. Additionally, the Company continues to implement initiatives in its ongoing efforts to reduce costs and improve operating efficiencies. During fiscal year 2015, the Company announced its plan to streamline its field operational model. The Company anticipates the reorganization will be completed in fiscal year 2016. A restructuring charge of $30 million was recorded in fiscal year 2015 and consisted primarily of employee separation related costs. During the second quarter of 2015, the Company announced its tentative decision to close the Baltimore, Maryland distribution facility. The Company is currently engaged in discussions with unions representing certain employees regarding this tentative decision. A final decision regarding the Baltimore facility will be made once negotiations with the unions are concluded. In anticipation of a potential closure of the Baltimore facility, the Company accrued a restructuring charge of $55 million, including $50 million of estimated multiemployer pension withdrawal liabilities. The estimated multiemployer pension liability was based on the latest available information received from the respective plans’ administrator and represents an estimate for a calendar year 2015 withdrawal. Due to the lack of current information, including changes in market conditions, and funded status of the related multiemployer pension plans, the settlement of these multiemployer pension withdrawal liabilities could materially differ from this estimate. As further discussed in Note 17, Retirement Plans, in December 2015, the Company reached a settlement with the Central States Teamsters Union Pension Plan (“Central States”). The settlement relieves the Company’s participation in the “legacy” pool and settled the related legacy multiemployer pension withdrawal liability, and commenced the Company as a new employer status in the “hybrid” pool of the Central States Teamsters Southeast and Southwest Area Pension Fund (“Central States Plan”). The payment also included the settlement of certain other Central States multiemployer pension withdrawal liabilities relating to facilities closed prior to 2015, and the related Egan Minnesota labor dispute. The settlement resulted in a restructuring charge of $88 million representing the excess of the $97 million cash payment over the aforementioned liabilities related to these previously closed facilities. The $119 million Severance and Related Costs balance as of January 2, 2016, also includes $36 million of multiemployer pension withdrawal liabilities relating to facilities closed prior to 2015 unrelated to Central States. These are payable in monthly installments through 2031 at effective interest rates ranging from 5.9% to 6.5%. 14. RELATED PARTY TRANSACTIONS The Company is party to consulting agreements with each of the Sponsors pursuant to which each Sponsor provides the Company with ongoing consulting and management advisory services and receives fees and reimbursements of related out of pocket expenses. For each of the fiscal years 2015, 2014 and 2013, the Company recorded $10 million in consulting fees in the aggregate, reported as Distribution, selling and administrative costs in the Consolidated Statements of Comprehensive Income (Loss). During the fiscal year 2013, the Company purchased $12 million of food products from a former affiliate of KKR. The Company made payments to KKR Capital Markets LLC, an affiliate of KKR, of $2 million for services rendered in connection with certain 2013 debt refinancing transactions. As discussed in Note 11, Debt, at January 2, 2016, investment funds or accounts managed or advised by an affiliate of KKR held less than 5% of the Company’s outstanding debt. In February 2015, the Company repurchased $2 million of Senior Notes held by investment funds managed by KKR. The Company files a consolidated federal income tax return together with US Foods, its parent. US Foods’ federal and state income taxes are paid by the Company and settled with US Foods pursuant to a tax sharing agreement. The Company recorded a $7 million receivable from US Foods related to its tax sharing agreement. See Note 19, Income Taxes. 15. SHARE-BASED COMPENSATION AND US FOODS COMMON STOCK ISSUANCES The Stock Incentive Plan, as amended (“Stock Incentive Plan”) provides for the sale of US Foods common stock to named executive officers and other key employees and directors. It also grants 1) stock options to purchase shares of common stock, 2) stock appreciation rights, and 3) restricted stock and restricted stock units of US Foods to certain individuals. The Board of Directors of US Foods or the Compensation Committee of the Board of US Foods is authorized to select the officers, employees and directors eligible to participate in the Stock Incentive Plan. Either the US Foods Board of Directors or the Compensation Committee may determine the specific number of shares to be offered, or options, stock appreciation rights or restricted stock to be granted to an employee or director. In May 2013, the Stock Incentive Plan was amended to, among other things, increase the number of shares of common stock of US Foods available for grant-from approximately 31.5 million shares to approximately 53.2 million shares. US Foods contributes shares to the Company for employee purchases, and upon exercise of options or grants of restricted shares and restricted stock units. Employee Put Option-Each participant in the Stock Incentive Plan has the right to require the Company to repurchase all of his or her restricted shares or shares issued or issuable pursuant to their awards in the event of a termination of employment due to death or disability. Once it is probable that a put becomes exerciseable, it is accounted for as an award modification and is required to be liability-classified. The Company records an incremental expense measured as the excess, if any, of the fair value of the modified award over the amount previously recognized when the award retained equity classification. These liability awards are remeasured at their fair market value, or redemption value, as of each reporting period through the date of settlement, which is generally the first fiscal quarter following termination. There were no 2015 terminations that triggered the put right and, therefore, met the criteria for liability treatment. As such, there was no impact on current fiscal year stock-based compensation costs. Parent Call Option-The Company also has the right-but not the obligation-to require employees to sell purchased shares back to the Company when they terminate employment. If the Company determines it is likely to exercise the call right prior to an employee bearing the risks and rewards of ownership for a reasonable period of time, generally six months, the awards that have been vested for less than six months (“immature shares”) are required to be liability-classified. The Company records an incremental expense measured as the excess, if any, of the fair value of the liability award over the amount previously recognized when the award retained equity classification. These liability awards are remeasured at their fair market value, or redemption value, as of each reporting period through the date of settlement, which is generally the first fiscal quarter following termination. There was one 2015 termination for which it was probable that the Company would exercise its call right and, therefore, met the criteria for liability treatment with minimum impact on the current fiscal year stock-based compensation expense. The Company measures compensation expense for share-based equity awards at fair value at the date of grant, and it recognizes compensation expense over the service period for share-based awards expected to vest. Total compensation expense related to share-based payment arrangements was $16 million, $12 million and $8 million for fiscal years 2015, 2014 and 2013, respectively. No share-based compensation cost was capitalized as part of the cost of an asset during those years. The total income tax benefit recorded in the Consolidated Statement of Comprehensive Income (Loss) was $6 million, $4 million and $3 million during fiscal years 2015, 2014 and 2013, respectively. US Foods Common Stock Issuances-Certain USF employees have purchased shares of US Foods common stock, pursuant to a management stockholder’s agreement associated with the Stock Incentive Plan. These shares are subject to the terms and conditions (including certain restrictions) of each management stockholder’s agreement, other documents signed at the time of purchase, as well as transfer limitations under the applicable law. The related shares and net proceeds of the employee share purchases are contributed to the Company by US Foods. The Company measures fair value of US Foods shares on a quarterly basis, using the combination of a market approach and an income approach. The share price determined for a particular quarter end is the price at which employee purchases and company repurchases are made for the following quarter. In fiscal year 2015, employees bought US Foods common stock at $6.00 per share. In fiscal year 2014, there were no employee purchases or Company repurchases of US Foods common stock held by employees. In fiscal year 2013, employees bought stock at $6.00 per share. At January 2, 2016, there were 5 million shares of US Foods held by employees for net proceeds of $25 million. Stock Option Awards-The Company granted to certain employees Time Options and Performance Options (collectively the “Options”) to purchase common shares of US Foods. These Options are subject to the restrictions set forth in the Stock Option Agreements. Shares purchased pursuant to option exercises would be governed by the restrictions in the Stock Incentive Plan and management stockholder’s agreements. The Time Options vest and become exercisable ratably over periods of four to five years. This happens either on the anniversary date of the grant or the last day of each fiscal year, beginning with the fiscal year issued. In fiscal 2015, 2014, and 2013, the Company recognized $3 million, $3 million, and $2 million, respectively in compensation expense related to Time Options. The Performance Options also vest and become exercisable ratably over four to five years, either on the anniversary date of the grant or the last day of each fiscal year (beginning with the fiscal year issued), provided that the Company achieves an annual operating performance target as defined in the applicable stock option agreements (“Stock Option Agreements”). The Stock Option Agreements also provide for “catch-up vesting” of the Performance Options, if an annual operating performance target is not achieved, but a cumulative operating performance target is achieved. During fiscal year 2012, the Company changed its policy for granting Performance Options. The award agreements no longer included performance targets for all years covered by the agreement. Instead, the Company established annual and cumulative targets for each year at the beginning of each respective fiscal year. In this case, the grant date under GAAP is not determined until the performance target for the related options is known. The Company achieved the annual and cumulative performance targets in fiscal year 2015 and recorded a compensation charge of $5 million for the Performance Options. The charge consisted of $3 million relating to fiscal year 2015 and $2 million related Performance Options granted in fiscal years 2013, 2012 and 2011, which met cumulative performance targets in 2015. The Company achieved the annual performance target in fiscal year 2014 and recorded a compensation charge of $4 million for the Performance Options relating to fiscal year 2014. The Company did not achieve the annual performance target in fiscal year 2013. The fiscal year 2012 annual operating performance target was modified in fiscal year 2013, and the Company recorded a compensation charge of $2 million in fiscal year 2013 for the Performance Options relating to fiscal year 2012. The Options are nonqualified options, with exercise prices equal to the estimated value of a share of US Foods’s stock at the date of the grant. The Options have exercise prices of $4.50 to $6.75 per share and generally have a 10-year life. The fair value of each option award is estimated as of the date of grant using a Black-Scholes option-pricing model. The weighted-average assumptions for options granted in fiscal years 2015 and 2013 are included in the following table. No options were granted in fiscal year 2014. Expected volatility is calculated based on the historical volatility of public companies similar to US Foods. The risk-free interest rate is the implied zero-coupon yield for U.S. Treasury securities having a maturity approximately equal to the expected term, as of the grant dates. The assumed dividend yield is zero, because the Company has not historically paid dividends and does not have any current plans to pay dividends. Due to a lack of relevant historical data, the simplified approach was used to determine the expected term of the options. The summary of options outstanding and changes during fiscal year 2015 are presented below. The weighted-average grant date fair value of options granted in fiscal years 2015 and 2013 was $2.56 and $2.22, respectively. There were no options granted in fiscal year 2014. In fiscal years 2015, 2014 and 2013, the Company recorded $8 million, $7 million and $4 million, respectively, in compensation expense related to the Options. The stock compensation expense-representing the fair value of stock options vested during the year-is reflected in our Consolidated Statements of Comprehensive Income (Loss) in Distribution, selling and administrative costs. During fiscal year 2015, 2,088,980 Time Options and 1,843,884 Performance Options were exercised by terminating employees for a cash outflow of $6 million, representing the excess of fair value over exercise price. During fiscal year 2014, 12,000 Time Options and 10,000 Performance Options were exercised by terminating employees for a minimal cash outflow, representing the excess of fair value over exercise price. During fiscal year 2013, 1,233,972 Time Options and 1,233,972 Performance Options were exercised by terminating employees for a cash outflow of $2 million, representing the excess of fair value over exercise price. As of January 2, 2016, there was $8 million of total unrecognized compensation costs related to 5 million nonvested options expected to vest under the Stock Option Agreements. That cost is expected to be recognized over a weighted-average period of three years. The December 27, 2014 Performance Options presented in the prior table have been recast to conform to the current year presentation of options which have reached a grant date. As of January 2, 2016, there were 2 million Performance Options that have been promised to employees for which performance targets have not been set. Restricted Shares-No Restricted Shares (“Restricted Shares”) were issued in fiscal year 2015 or 2014. Certain employees of the Company received 375,001 Restricted Shares of US Foods in fiscal year 2013. These shares were granted under the Stock Incentive Plan and contain non-forfeitable dividend rights. Restricted Shares vest and become exercisable ratably over periods of primarily two to five years. The summary of nonvested Restricted Shares outstanding and changes during fiscal year 2015 is presented below: The weighted-average grant date fair value for Restricted Shares granted in 2013 was $6.00. Expense of $1 million and $3 million related to the Restricted Shares was recorded in Distribution, selling and administrative costs during fiscal years 2015 and 2013, respectively. The 2014 expense related to the Restricted Shares of $1 million was offset by an adjustment of prior year expense. At January 2, 2016, there was $0.1 million of unrecognized compensation cost related to the Restricted Shares that we expect to recognize over a weighted-average period of one year. Restricted Stock Units-Beginning in 2013, certain employees of the Company received Time Restricted Stock Units and Performance Restricted Stock Units of US Foods (collectively the “RSUs”) granted pursuant to the Stock Incentive Plan. Time RSUs generally vest and become exercisable ratably over four years, starting on the anniversary date of grant. In fiscal years 2015, 2014, and 2013, the Company recognized $3 million, $2 million, and $1 million, respectively in compensation expense related to Time RSU’s. Performance RSUs also vest and become exercisable ratably over four years either on the anniversary date of the grant or the last day of each fiscal year (beginning with the fiscal year issued), provided that the Company achieves an annual operating performance target as defined in the applicable restricted stock unit agreements (“Restricted Stock Unit Agreements”). The Restricted Stock Unit Agreements also provide for “catch-up vesting” of the Performance RSU’s if an annual operating performance target is not achieved, but a cumulative operating performance target is achieved. Similar to options, the RSU award agreements do not include performance targets for all years covered by the agreement. Instead, the Company established annual targets for each year at the beginning of each fiscal year. In this case, the grant date under GAAP is not determined until the performance target for the related Performance RSU is known. The Company achieved the annual and cumulative operating performance targets in 2015 and recorded a compensation charge of $4 million. The charge consisted of $3 million relating to fiscal year 2015 and $1 million related to Performance RSUs granted in 2013 which met cumulative performance targets in 2015. The Company achieved the annual operating performance target in 2014 and recorded a compensation charge of $3 million in 2014 for the Performance RSU’s. The Company did not achieve the annual operating performance target for 2013 and, accordingly, did not record a compensation charge for the Performance RSU’s in 2013. Prior to 2013, there were no RSUs issued or outstanding under the Stock Incentive Plan. The summary of nonvested Restricted Stock Units as of January 2, 2016, and changes during the fiscal year then ended presented below. The weighted-average grant date fair values for Restricted Stock Units granted in fiscal year 2015 was $6.62. Expense of $7 million, $5 million and $1 million related to the Restricted Stock Units was recorded in Distribution, selling and administrative costs during fiscal years 2015, 2014 and 2013, respectively. At January 2, 2016, there was $8 million of unrecognized compensation cost related to 2 million Restricted Stock Units that we expect to recognize over a weighted-average period of three years. The December 27, 2014 Performance RSU’s presented in the prior table have been recast to conform to the current year presentation of units which have reached a grant date. As of January 2, 2016, there were 1 million Performance RSUs that have been promised to employees for which performance targets have not been set. Equity Appreciation Rights-The Company has an Equity Appreciation Rights (“EAR”) Plan for certain employees. Each EAR represents one phantom share of US Foods common stock. The EARs become vested and payable, primarily at the time of a qualified public offering of equity shares, involuntary termination, or a change in control. EARs are forfeited upon voluntary termination of the participant’s employment with the Company. The EARs will be settled in cash upon vesting and, accordingly, are considered liability instruments. No EARs were granted during fiscal years 2015, 2014 and 2013. As of January 2, 2016, there were a total of 1,385,300 EARs outstanding with a weighted average exercise price of $4.98 per share. As the EARs are liability instruments, the fair value of the awards is re-measured each reporting period until the award is settled. Since vesting is contingent upon performance conditions currently not considered probable, no compensation costs have been recorded to date for outstanding EARs. 16. LEASES The Company leases various warehouse and office facilities and certain equipment under operating and capital lease agreements that expire at various dates and in some instances contain renewal provisions. The Company expenses operating lease costs, including any scheduled rent increases, rent holidays or landlord concessions-on a straight-line basis over the lease term. The Company also has an unfunded lease obligation on a distribution facility through 2023. Future minimum lease payments under the above mentioned noncancelable lease agreements, together with contractual sublease income, as of January 2, 2016, are as follows (in thousands): Total operating lease expense, included in Distribution, selling and administrative costs in the Company’s Consolidated Statements of Comprehensive Income (Loss) was $44 million in each of the fiscal years 2015, 2014 and 2013. 17. RETIREMENT PLANS The Company has defined benefit and defined contribution retirement plans for its employees. Also, the Company contributes to various multiemployer plans under collective bargaining agreements and provides certain health care benefits to eligible retirees and their dependents. Company Sponsored Defined Benefit Plans-The Company maintains several qualified retirement plans and a nonqualified retirement plan (“Retirement Plans”) that pay benefits to certain employees at retirement, using formulas based on a participant’s years of service and compensation. In addition, the Company maintains postretirement health and welfare plans for certain employees, of which components are included in the tables below under Other postretirement plans. Amounts related to defined benefit plans recognized in the consolidated financial statements are determined on an actuarial basis. The components of net pension and other postretirement benefit costs (credits) for the last three fiscal years were as follows (in thousands): Net periodic pension costs for fiscal years 2015, 2014 and 2013 includes $3 million, $2 million and $2 million, respectively, of settlement charges resulting from lump-sum payments to former employees participating in several Company sponsored pension plans. The net periodic other postretirement benefit credits for fiscal year 2014 includes a $2 million curtailment gain resulting from a labor negotiation that eliminated postretirement medical coverage for substantially all active participants in one plan. Changes in plan assets and benefit obligations recorded in Other comprehensive income (loss) for pension and Other postretirement benefits for the last three fiscal years were as follows (in thousands): The funded status of the defined benefit plans for the last three fiscal years was as follows (in thousands): Effective September 30, 2015, non-union participants’ benefits of a Company sponsored defined benefit pension plan were frozen, resulting in a reduction in the benefit obligation included in Other long term liabilities of approximately $91 million, including a $73 million curtailment, with a corresponding decrease to Accumulated other comprehensive loss. At the remeasurement date, the plan’s net loss included in Accumulated other comprehensive loss exceeded the reduction in the plan’s benefit obligation and, accordingly, no net curtailment gain or loss was recognized. As a result of the plan freeze, actuarial gains and losses will be amortized over the average remaining life expectancy of inactive participants rather than the average remaining service lives of active participants. For the defined benefit pension plans, the fiscal year 2015 actuarial gain of $73 million was primarily due to an increase in the discount rates. Weighted average assumptions used to determine benefit obligations at period-end and net pension costs for the last three fiscal years were as follows: The measurement dates for the pension and other postretirement benefit plans were December 31, 2015, December 27, 2014 and December 28, 2013. A health care cost trend rate is used in the calculations of postretirement medical benefit plan obligations. The assumed healthcare trend rates for the last three fiscal years were as follows: A 1% change in the rate would result in a change to the postretirement medical plan obligation of less than $1 million. Retirees covered under these plans are responsible for the cost of coverage in excess of the subsidy, including all future cost increases. In determining the discount rate, the Company determines the implied rate of return on a hypothetical portfolio of high-quality fixed-income investments, for which the timing and amount of cash outflows approximates the estimated pension plan payouts. The discount rate assumption is reviewed annually and revised as appropriate. The expected long-term rate of return on plan assets is derived from a mathematical asset model. This model incorporates assumptions on the various asset class returns, reflecting a combination of historical performance analysis and the forward-looking views of the financial markets regarding the yield on long-term bonds and the historical returns of the major stock markets. The rate of return assumption is reviewed annually and revised as deemed appropriate. The investment objective for our Company sponsored plans is to provide a common investment platform. Investment managers-overseen by our Retirement Administration Committee-are expected to adopt and maintain an asset allocation strategy for the plans’ assets designed to address the Retirement Plans’ liability structure. The Company has developed an asset allocation policy and rebalancing policy. We review the major asset classes, through consultation with investment consultants, at least quarterly to determine if the plan assets are performing as expected. The Company’s 2015 strategy targeted a mix of 50% equity securities and 50% long-term debt securities and cash equivalents. The actual mix of investments at January 2, 2016, was 51% equity securities and 49% long-term debt securities and cash equivalents. The Company plans to manage the actual mix of investments to achieve its target mix. The Company has retrospectively adopted ASU No. 2015-07, Disclosures for Investments in Certain Entities that Calculate Net Asset Value Per Share. The three-tier fair value hierarchy now excludes certain investments which are valued using net asset value as a practical expedient. See Note 10, Fair Value Measurements for a detailed description of the three-tier fair value hierarchy. The following table (in thousands) sets forth the fair value of our defined benefit plans’ assets by asset fair value hierarchy level. A description of the valuation methodologies used for assets measured at fair value is as follows: • Cash and cash equivalents are valued at original cost plus accrued interest. • Common collective trust funds are valued at the net asset value of the shares held at the end of the reporting period. This class represents investments in actively managed, common collective trust funds that invest primarily in equity securities, which may include common stocks, options and futures. Investments are valued at the net asset value per share, multiplied by the number of shares held as of the measurement date. • Mutual funds are valued at the closing price reported on the active market on which individual funds are traded. • Long-term debt securities are valued at the estimated price a dealer will pay for the individual securities. Estimated future benefit payments, under Company sponsored plans as of January 2, 2016, were as follows (in thousands): Estimated required and discretionary contributions expected to be contributed by the Company to the Retirement Plans in fiscal year 2016 total $36 million. Other Company Sponsored Benefit Plans-Employees are eligible to participate in a defined contribution 401(k) Plan which provides that under certain circumstances the Company may make matching contributions. In fiscal years 2013 and 2014 and through the fiscal third quarter of 2015, Company matching contributions were 50% of the first 6% of a participant’s compensation. Effective the first day of the Company’s fiscal fourth quarter of 2015, the 401(k) Plan was amended to provide for Company matching contributions of 100% of the first 3% of a participant’s compensation and 50% of the next 2% of a participant’s compensation, for a maximum Company matching contribution of 4%.The Company’s contributions to this plan were $32 million, $26 million and $25 million in fiscal years 2015, 2014 and 2013, respectively. The Company, at its discretion, may make additional contributions to the 401(k) Plan. The Company made no discretionary contributions under the 401(k) plan in fiscal years 2015, 2014 and 2013. Multiemployer Pension Plans-The Company contributes to numerous multiemployer pension plans under the terms of collective bargaining agreements that cover certain of its union-represented employees. The Company does not administer these multiemployer pension plans. The risks of participating in multiemployer pension plans differ from traditional single-employer defined benefit plans as follows: • Assets contributed to a multiemployer pension plan by one employer may be used to provide benefits to the employees of other participating employers. • If a participating employer stops contributing to a multiemployer pension plan, the unfunded obligations of the plan may be borne by the remaining participating employers. • If the Company elects to stop participation in a multiemployer pension plan, it may be required to pay a withdrawal liability based upon the underfunded status of the plan. The Company’s participation in multiemployer pension plans for the year ended January 2, 2016, is outlined in the tables below. The Company considers significant plans to be those plans to which the Company contributed more than 5% of total contributions to the plan in a given plan year, or for which the Company believes its estimated withdrawal liability-should it decide to voluntarily withdraw from the plan-may be material to the Company. For each plan that is considered individually significant to the Company, the following information is provided: • The EIN/Plan Number column provides the Employee Identification Number (“EIN”) and the three-digit plan number (“PN”) assigned to a plan by the Internal Revenue Service. • The most recent Pension Protection Act (“PPA”) zone status available for 2015 and 2014 is for the plan years beginning in 2015 and 2014, respectively. The zone status is based on information provided to participating employers by each plan and is certified by the plan’s actuary. A plan in the red zone has been determined to be in critical status, based on criteria established under the Internal Revenue Code (the “Code”), and is generally less than 65% funded. A plan in the yellow zone has been determined to be in endangered status, based on criteria established under the Code, and is generally less than 80% but more than 65% funded. A plan in the green zone has been determined to be neither in critical status nor in endangered status, and is generally at least 80% funded. • The FIP/RP Status Pending/Implemented column indicates plans for which a financial improvement plan (“FIP”) or a rehabilitation plan (“RP”) is either pending or has been implemented. In addition to regular plan contributions, participating employers may be subject to a surcharge if the plan is in the red zone. • The Surcharge Imposed column indicates whether a surcharge has been imposed on participating employers contributing to the plan. • The Expiration Dates column indicates the expiration dates of the collective-bargaining agreements to which the plans are subject. (1) The collective bargaining agreement for this pension fund is operating under terms of the old agreement or an extension. (2) The Company is currently engaged in discussions with unions representing certain employees regarding its tentative decision to close a distribution facility. The collective bargaining agreement for these pension funds are operating under terms of the old agreements. The following table provides information about the Company’s contributions to its multiemployer pension plans. For plans that are not individually significant to the Company, the total amount of USF contributions is aggregated. (1) Contributions made to these plans during the Company’s fiscal year, which may not coincide with the plans’ fiscal years. (2) Contributions do not include payments related to multiemployer pension withdrawals as described in Note 13, Restructuring Liabilities. (3) Indicates whether the Company was listed in the respective multiemployer plan Form 5500 for the applicable plan year as having made more than 5% of total contributions to the plan. The Company reached a settlement with Central States consisting of a $97 million cash payment made on December 30, 2015. This Central States settlement relieves the Company of its participation in the “legacy” Central States plan and its associated legacy off balance sheet withdrawal liability. It also settled the residual withdrawal liability related to the Eagan, Minnesota and Fairfield, Ohio closed facilities, and resolved the outstanding litigation related to the Eagan Labor Dispute, as further discussed in Note 21, Commitments and Contingencies. This settlement commenced the Company’s participation in the “Hybrid” Central States Plan, which adopted an alternative method for determining an employer’s unfunded obligation that would limit USF’s funding obligations to the pension fund in the future. Accordingly, the Company agreed to future annual minimum contribution payments through 2023 of no less than 90% of the 2015 contributions for the ongoing operations under the related facilities’ union contracts. If the Company elected to voluntarily withdraw from further multiemployer pension plans, it would be responsible for its proportionate share of the plan’s unfunded vested liability. Based on the latest information available from plan administrators, the Company estimates its aggregate withdrawal liability from the multiemployer pension plans in which it participates to be approximately $105 million as of January 2, 2016. This estimate excludes $86 million of multiemployer pension plan withdrawal liabilities recorded in the Company’s Consolidated Balance Sheet as of January 2, 2016 (unaffected by the Central States Settlement), including $50 million for the tentative closure of the Baltimore facility and $36 million for facilities closed prior to 2015-See Note 13, Restructuring Liabilities. Actual withdrawal liabilities incurred by the Company-if it were to withdraw from one or more plans-could be materially different from the estimates noted here, based on better or more timely information from plan administrators or other changes affecting the respective plan’s funded status. 18. CHANGES IN ACCUMULATED OTHER COMPREHENSIVE LOSS The following table presents changes in Accumulated Other Comprehensive Income (Loss) by component for the last three fiscal years, (in thousands): (1) Amounts are presented net of tax. (2) Included in the computation of net periodic benefit costs. See Note, 17 Retirement Plans for additional information. (3) Included in Distribution, selling and administrative expenses in the Consolidated Statements of Comprehensive Income (Loss). (4) The fiscal year 2015 curtailment is due to freeze of non-union participants’ benefits of a Company sponsored defined benefit pension plan. See Note, 17, Retirement Plans. (5) The interest rate swap derivative expired in January 2013. (6) Included in Interest Expense-Net in the Consolidated Statements of Comprehensive Income (Loss). 19. INCOME TAXES USF is a member of US Foods’ consolidated group, and as a result the Company’s operations are included in the consolidated income tax return of US Foods. The Company has computed the components of its tax provision under the “separate return” approach. Under this approach, the Company’s financial statements recognize the current and deferred income tax consequences that result from the Company’s activities as if the Company were a separate taxpayer rather than a member of US Foods’ consolidated group. The Income tax (benefit) provision for the last three fiscal years consisted of the following (in thousands): The Company’s effective income tax rates for the fiscal years ended January 2, 2016, December 27, 2014 and December 28, 2013 and were 9%, 97% and 109%, respectively. The determination of the Company’s overall effective tax rate requires the use of estimates. The effective tax rate reflects the income earned and taxed in U.S. federal and various state jurisdictions based on enacted tax law, permanent differences between book and tax items, tax credits and the Company’s change in relative contribution to income by each jurisdiction. The reconciliation of the (benefit) provision for income taxes from continuing operations at the U.S. federal statutory income tax rate of 35% to the Company’s income taxes for the last three fiscal is shown below (in thousands). Certain prior period amounts were reclassified to conform to the current period presentation. Temporary differences and carryforwards that created significant deferred tax assets and liabilities were as follows (in thousands): The net deferred tax liability presented in the Consolidated Balance Sheets was as follows (in thousands). The balance for the year ending January 2, 2016 is presented pursuant to ASU No. 2015-17, which requires that deferred income tax liabilities and assets be classified as noncurrent in a classified statement of financial position. Under the “ separate return” approach, as of January 2, 2016 the Company had tax affected federal and state net operating loss carryforwards of $142 million and $87 million, respectively, which will expire at various dates from 2016 to 2035. These net operating loss carryforwards do not reflect the tax position of the US Foods consolidated tax return. US Foods estimates to generate federal taxable income on its consolidated return in the amount of $273 million for its fiscal year 2015, which is primarily caused by the $300 million merger termination fee received from Sysco. Therefore, US Foods will utilize NOLs available at the consolidated level to offset its regular tax liability. These NOLs were generated by USF. Despite the use of NOLs, US Foods will be subject to federal Alternative Minimum Tax (“AMT”) and state income tax expense for its fiscal year 2015, which are estimated at $5.4 million and $1.8 million, respectively. US Foods’ federal and state income taxes incurred are paid by the Company and settled with US Foods pursuant to a tax sharing agreement. The agreement further states that the Company shall pay on behalf of US Foods the federal and state return taxes. If the consolidated federal and state return taxes for US Foods exceed the federal and state taxes calculated for the Company as a separate filing group, US Foods is required to make a payment to the Company equal to such excess. Likewise, if the federal and state taxes calculated at the separate return level for the Company exceed the consolidated taxes, the Company is required to make payment to US Foods equal to such excess. As the tax sharing agreement does not commit US Foods to compensate the Company for the use of its NOLs nor does US Foods currently intend to compensate the Company for the NOLs used, the Company has not recorded an intercompany receivable for these NOLs. USF has recorded an intercompany receivable totaling $7.2 million for the AMT and state income taxes that US Foods estimated for the 2015 consolidated income tax returns, since USF will pay this on behalf of US Foods per its tax sharing agreement. The Company’s net operating loss carryforwards under the “separate return” approach expire as follows (in millions): The Company also has federal minimum tax credit carryforwards of approximately $1 million, research and development credit carryforwards of $5 million and other state credit carryforwards of $5 million. The federal and state net operating loss carryforwards in the income tax returns filed included unrecognized tax benefits taken in prior years. The net operating losses for which a deferred tax asset is recognized for financial statement purposes in accordance with ASC 740 are presented net of these unrecognized tax benefits. Because of the change of ownership provisions of the Tax Reform Act of 1986, use of a portion of the Company’s domestic net operating losses and tax credit carryforwards may be limited in future periods. Further, a portion of the carryforwards may expire before being applied to reduce future income tax liabilities. The Company believes that it is more likely than not that the benefit from certain federal and state net deferred tax assets will not be realized. In recognition of this risk, as of January 2, 2016, the Company has provided a valuation allowance of $164 million and $96 million on the federal and state deferred tax assets, respectively, based upon expected future utilization of these federal and state deferred tax assets. A full valuation allowance on the net deferred tax assets will be maintained until sufficient positive evidence related to sources of future taxable income exists to support a reversal of the valuation allowance A summary of the activity in the valuation allowance for the last three fiscal years is as follows (in thousands): Changes in tax laws and rates may affect recorded deferred tax assets and liabilities and the Company’s effective tax rate in the future. The calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in federal and state jurisdictions. ASC 740 states that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. The Company 1) records unrecognized tax benefits as liabilities in accordance with ASC 740, and 2) adjusts these liabilities when the Company’s judgment changes because of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of unrecognized tax benefit liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information is available. The Company recognizes an uncertain tax position when it is more likely than not that the position will be sustained upon examination-including resolutions of any related appeals or litigation processes-based on the technical merits. Reconciliation of the beginning and ending amount of unrecognized tax benefits as of fiscal years 2015, 2014, and 2013 was as follows (in thousands): At this time, the Company does not believe it is reasonably possible that the liability for unrecognized tax benefits will significantly increase or decrease in the next 12 months as a result of the completion of tax audits or as a result of the expiration of the statute of limitations. Included in the balance of unrecognized tax benefits at the end of fiscal years 2015, 2014 and 2013 was $40 million, $41 million and $53 million, respectively, of tax benefits that, if recognized, would affect the effective tax rate. Also included in the balance of unrecognized tax benefits as of those periods was $36 million, $39 million, and $51 million, respectively, of tax benefits that, if recognized, would result in adjustments to other tax accounts-primarily deferred taxes. The Company recognizes interest expense related to unrecognized tax benefits in interest expense and penalties in operating expenses. As of January 2, 2016, December 27, 2014, and December 28, 2013, the Company had accrued interest and penalties of approximately $4 million, $2 million, and $2 million, respectively. The increase in accrued interest and penalties in the period ending January 2, 2016 was primarily related to unrecognized tax benefits assumed in a business acquisition. The Company files U.S. federal and state income tax returns in jurisdictions with varying statutes of limitations. Our 2007 through 2014 U.S. federal tax years, and various state tax years from 2000 through 2014, remain subject to income tax examinations by the relevant taxing authorities. Ahold has indemnified the Company for 2007 Transaction pre-closing consolidated federal and certain combined state income taxes, and the Company is responsible for all other taxes, and interest and penalties. 20. COMMITMENTS AND CONTINGENCIES Purchase Commitments-The Company enters into purchase orders with vendors and other parties in the ordinary course of business and has a limited number of purchase contracts with certain vendors that require it to buy a predetermined volume of products. As of January 2, 2016, the Company has $941 million of purchase orders and purchase contract commitments, of which $714 million, $130 million and $97 million pertain to fiscal years 2016, 2017, and 2018, respectively, and are not recorded in the Consolidated Balance Sheets. To minimize fuel cost risk, the Company enters into forward purchase commitments for a portion of its projected diesel fuel requirements. As of January 2, 2016, the Company had diesel fuel forward purchase commitments totaling $132 million through June 2017. The Company also enters into forward purchase agreements for electricity. As of January 2, 2016, the Company had electricity forward purchase commitments totaling $13 million through March 2018. The Company does not measure its forward purchase commitments for diesel fuel and electricity at fair value as the amounts under contract meet the physical delivery criteria in the normal purchase exception under GAAP guidance. Florida State Pricing Subpoena-In May 2011, the State of Florida Department of Financial Services issued a subpoena to the Company requesting a broad range of information regarding vendors, logistics/freight as well as pricing, allowances, and rebates that the Company obtained from the sale of products and services for the term of the contract. The subpoena focused on all pricing and rebates earned during this period relative to the Florida Department of Corrections. In 2011, the Company learned of two qui tam suits, filed in Florida state court, against the Company, one of which was filed by a former official in the Florida Department of Corrections. In April 2015, the Company and the State of Florida agreed in principle to a settlement under which the Company would pay $16 million, and the State of Florida would dismiss all complaints, including the two qui tam suits. In June 2015, the parties finalized the settlement agreement and payment was made to the Florida Department of Financial Services. Eagan Labor Dispute-In 2008, the Company closed its Eagan, Minnesota and Fairfield, Ohio distribution centers, and recorded a liability of approximately $40 million for the related multiemployer pension withdrawal liability, which is payable in monthly installments through November 2023. During the fiscal third quarter of 2011, the Company was assessed an additional $17 million multiemployer pension withdrawal liability for the Eagan facility, the final payment of which was made on April 1, 2015. As further discussed in Note 17, Retirement Plans, the Company settled these items, among others, on December 30, 2015. Other Legal Proceedings-The Company and its subsidiaries are parties to a number of other legal proceedings arising from the normal course of business. These legal proceedings-whether pending, threatened or unasserted, if decided adversely to or settled by the Company-may result in liabilities material to its financial position, results of operations, or cash flows. The Company recognized provisions with respect to the proceedings where appropriate. These are reflected in the Consolidated Balance Sheets. It is possible that the Company could be required to make expenditures, in excess of the established provisions, in amounts that cannot be reasonably estimated. However, the Company believes that the ultimate resolution of these proceedings will not have a material adverse effect on its consolidated financial position, results of operations, or cash flows. It is the Company’s policy to expense attorney fees as incurred. Insurance Recoveries-Tornado Loss On April 28, 2014, a tornado damaged a distribution facility and its contents, including building improvements, equipment and inventory. Business from the damaged facility was temporarily transferred to other Company distribution facilities until July 2015, when a new state-of-the-art distribution facility became operational. The Company has insurance coverage on the distribution facility and its contents, as well as business interruption insurance. During fiscal year 2014, the Company received proceeds of $14 million for damaged inventory and property and equipment. In fiscal year 2015, the Company received proceeds of $26 million of which $6 million was recognized as a receivable in 2014. The remaining $20 million of proceeds received and recognized in fiscal 2015 represented the recovery of current and prior year operating costs, for a net $11 million recognized as a benefit in 2015. The timing of and amounts of final insurance settlement is expected in 2016. The Company classified $3 million and $4 million related to the damaged distribution facility as Cash flows provided by investing activities in fiscal years 2015 and 2014, respectively, in its Consolidated Statements of Cash Flows. The remaining $23 million and $10 million related to damaged inventory and business interruption costs are classified as Cash flows provided by operating activities in fiscal years 2015 and 2014, respectively, in the Consolidated Statements of Cash Flows. 21. GUARANTOR AND NON-GUARANTOR CONDENSED CONSOLIDATING FINANCIAL INFORMATION The following consolidating schedules present condensed financial information of 1) the Company, and 2) certain of its subsidiaries (Guarantors) that guarantee certain Company obligations (the Senior Notes, the ABL Facility, and the Amended 2011 Term Loan), and 3) its other subsidiaries (Non-Guarantors). The Guarantors under the Senior Notes are identical to the Guarantors under the ABL Facility and the Amended 2011 Term Loan. Separate financial statements and other disclosures with respect to the Guarantor subsidiaries have not been provided. This is because the Company believes the following information is sufficient, as the Guarantor subsidiaries are 100% owned by the Company, and all guarantees under the Senior Notes are full and unconditional and joint and several, subject to certain release provisions that the Company has concluded are customary and, therefore, consistent with the Company’s ability to present condensed financial information of the Guarantors. Under the Senior Notes, a Guarantor subsidiary’s guarantee may be released when any of the following occur: 1) the sale of the Guarantor subsidiary or all of its assets, 2) a merger or consolidation of the Guarantor subsidiary with and into the Company or another Guarantor subsidiary, 3) upon the liquidation of the Guarantor subsidiary following the transfer of all of its assets to the Company or another Guarantor subsidiary, 4) the rating on the securities is changed to investment grade, 5) the requirements for legal defeasance or covenant defeasance or discharge of the obligation have been satisfied, 6) the Guarantor subsidiary is declared unrestricted for covenant purposes, or 7) the Guarantor subsidiary’s guarantee of other indebtedness is terminated or released. Notwithstanding these customary release provisions under the Senior Notes, 1) each subsidiary guarantee is in place throughout the life of the Senior Notes, and no Guarantor may elect to opt out or cancel its guarantee solely at its option; 2) there are no restrictions, limitations or caps on the guarantees; and 3) there are no provisions that would delay the payments that would be required of the Guarantors under the guarantees. Condensed Consolidating Balance Sheet January 2, 2016 (In thousands) Condensed Consolidating Balance December 27, 2014 (In thousands) (1) Prior year amounts have been reclassified to reflect the retrospective adoption of ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. Condensed Consolidating Statement of Comprehensive Income (Loss) Fiscal Year Ended January 2, 2016 (In thousands) Condensed Consolidating Statement of Comprehensive Income (Loss) Fiscal Year Ended December 27, 2014 (In thousands) Condensed Consolidating Statement of Comprehensive Income (Loss) Fiscal Year Ended December 28, 2013 (In thousands) Condensed Consolidating Statement of Cash Flows Fiscal Year Ended January 2, 2016 (In thousands) Condensed Consolidating Statement of Cash Flows Fiscal Year Ended December 27, 2014 (In thousands) Condensed Consolidating Statement of Cash Flows Fiscal Year Ended December 28, 2013 (In thousands) 22. QUARTERLY FINANCIAL INFORMATION (Unaudited) Financial information for each quarter in the fiscal years ended January 2, 2016 and December 27, 2014, is set forth below (in thousands): 23. BUSINESS SEGMENT INFORMATION The Company operates in one business segment based on how the Company’s chief operating decision maker-the Chief Executive Officer (the “CEO”)-views the business for purposes of evaluating performance and making operating decisions. The Company markets and distributes fresh, frozen and dry food and non-food products to foodservice customers throughout the United States. The Company uses a centralized management structure, and its strategies and initiatives are implemented and executed consistently across the organization to maximize value to the organization as a whole. The Company uses shared resources for sales, procurement, and general and administrative activities across each of its distribution centers. The Company’s distribution centers form a single network to reach its customers; it is common for a single customer to make purchases from several different distribution centers. Capital projects-whether for cost savings or generating incremental revenue-are evaluated based on estimated economic returns to the organization as a whole-e.g. net present value, return on investment. The measure used by the CEO to assess operating performance is Adjusted EBITDA. Adjusted EBITDA is defined as Net income (loss), plus Interest expense-net, Income tax provision (benefit), and Depreciation and amortization expense-collectively “EBITDA”-adjusted for: (1) Sponsor fees; (2) Restructuring and tangible asset impairment charges; (3) Share-based compensation expense; (4) the non-cash impact of net LIFO reserve adjustments; (5) Loss on extinguishment of debt; (6) Pension settlements; (7) Business transformation costs; (8) Acquisition-related costs; (9) Other gains, losses, or charges as specified in the Company’s debt agreements. Costs to optimize and transform the Company’s business are noted as business transformation costs in the table below and are added to EBITDA in arriving at Adjusted EBITDA. Business transformation costs include costs related to significant process and systems redesign in the Company’s replenishment and category management functions; cash & carry retail store strategy; and process and system redesign related to the Company’s sales model. The aforementioned items are specified as items to add to EBITDA in arriving at Adjusted EBITDA per the Company’s debt agreements and, accordingly, the Company’s management includes such adjustments when assessing the operating performance of the business. The following is a reconciliation for the last three fiscal years of Adjusted EBITDA to the most directly comparable GAAP financial performance measure, which is Net loss: (1) Consists of management fees paid to the Sponsors. (2) Consists primarily of facility related closing costs, including severance and related costs, tangible asset impairment charges, organizational realignment costs, and estimated multiemployer pension withdrawal liabilities. (3) Share-based compensation expense represents costs recorded for vesting of US Foods stock option awards, restricted stock and restricted stock units. (4) Represents the non-cash impact of net LIFO reserve adjustments. (5) Includes fees paid to debt holders, third party costs, early redemption premium, and the write off of old debt facility unamortized debt issuance costs. See Note 11, Debt for a further description of debt refinancing transactions. (6) Consists of charges resulting from lump-sum payment settlements to retirees and former employees participating in several Company sponsored pension plans. (7) Consists primarily of costs related to significant process and systems redesign across multiple functions. (8) Consists of costs related to the Acquisition, including the $12.5 million Asset Purchase Agreement termination fee. (9) Other includes gains, losses or charges as specified in the Company’s debt agreements. The fiscal year 2015 balance consists primarily of a $16 million litigation settlement cost, and $16 million of brand re-launch and marketing costs, offset by a net insurance benefit of $11 million. The fiscal year 2014 balance includes $16 million of costs subject to coverage under the Company’s insurance policies. The following table presents the sales mix for the Company’s principal product categories for the last three fiscal years: No single customer accounted for more than 4% of the Company’s consolidated Net sales for fiscal years 2015, 2014 and 2013. However, customers purchasing through one group purchasing organization accounted for approximately 12%, of consolidated Net sales in fiscal years 2015, 2014 and 2013, respectively. 24. SUBSEQUENT EVENTS On January 8, 2016, the Company paid a $374 million one-time special cash distribution to its parent, US Foods. The distribution was funded with cash on hand and approximately $314 million of additional borrowings under the Company’s credit facilities. US Foods used the proceeds from this distribution, along with cash on hand to fund a $666 million one-time special cash distribution to its shareholders of record as of January 4, 2016, of which $657 million was paid to the Sponsors. In conjunction with the distribution, the following actions were also taken as provided by the Stock Incentive Plan: • the holders of any unvested RSUs were granted a total of 729,952 additional RSUs to offset the dilution caused by the distribution and • the exercise price for all outstanding Stock Option Awards and EARs were reduced by $1.35 per share, which represents the calculated change in fair value of the common stock resulting from the distribution. On March 4, 2016, the Company acquired a broadline foodservice distributor for cash of approximately $39 million plus contingent consideration of up to $7 million. The acquisition, funded with cash from operations, will be integrated into the Company’s foodservice distribution network. | I apologize, but the text you've provided appears to be incomplete or fragmented. It seems to be a portion of a financial statement, but without the full context or complete information, I cannot provide a meaningful summary.
To help you effectively, I would need:
1. The complete financial statement
2. Full details about the company
3. The complete context of the financial reporting period
If you can provide the full document or clarify the specific sections you'd like summarized, I'd be happy to assist you. | Claude |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Management’s Report on Internal Control over Financial Reporting The management of Materion Corporation and subsidiaries are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Materion Corporation and subsidiaries’ internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Materion Corporation and subsidiaries’ management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. In making this assessment, it used the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria) in Internal Control - Integrated Framework (2013). Based on our assessment we believe that, as of December 31, 2016, the Company’s internal control over financial reporting is effective. The effectiveness of our internal control over financial reporting as of December 31, 2016 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report. Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders of Materion Corporation We have audited Materion Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Materion Corporation and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Materion Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016 of Materion Corporation and subsidiaries and our report dated February 17, 2017 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Cleveland, Ohio February 17, 2017 Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders of Materion Corporation We have audited the accompanying consolidated balance sheets of Materion Corporation and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Materion Corporation and subsidiaries at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Materion Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 17, 2017 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Cleveland, Ohio February 17, 2017 Materion Corporation and Subsidiaries Years Ended December 31, 2016, 2015, and 2014 Consolidated Statements of Income The accompanying notes are an integral part of the consolidated financial statements. Materion Corporation and Subsidiaries Years Ended December 31, 2016, 2015, and 2014 Consolidated Statements of Comprehensive Income The accompanying notes are an integral part of the consolidated financial statements. Materion Corporation and Subsidiaries Years Ended December 31, 2016, 2015, and 2014 Consolidated Statements of Cash Flows The accompanying notes are an integral part of the consolidated financial statements. Materion Corporation and Subsidiaries December 31, 2016 and 2015 Consolidated Balance Sheets The accompanying notes are an integral part of the consolidated financial statements. Materion Corporation and Subsidiaries Years Ended December 31, 2016, 2015, and 2014 Consolidated Statements of Shareholders’ Equity The accompanying notes are an integral part of the consolidated financial statements. Materion Corporation and Subsidiaries Note A - Significant Accounting Policies (Dollars in thousands) Organization: Materion Corporation (the Company) is a holding company with subsidiaries that have operations in the United States, Europe, and Asia. These operations manufacture advanced engineered materials used in a variety of end markets, including consumer electronics, industrial components, defense, medical, automotive electronics, telecommunications infrastructure, energy, commercial aerospace, science, services, and appliance. The Company has four reportable segments: Performance Alloys and Composites, Advanced Materials, Precision Coatings, and Other. Other includes unallocated corporate costs. Refer to Note B of the Consolidated Financial Statements for additional segment details. The Company is vertically integrated and distributes its products through a combination of company-owned facilities and independent distributors and agents. Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates. Consolidation: The Consolidated Financial Statements include the accounts of Materion Corporation and its subsidiaries. All of the Company’s subsidiaries were wholly owned as of December 31, 2016. Intercompany accounts and transactions are eliminated in consolidation. Cash Equivalents: All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents. Accounts Receivable: An allowance for doubtful accounts is maintained for the estimated losses resulting from the inability of customers to pay amounts due. The allowance is based upon identified delinquent accounts, customer payment patterns, and other analyses of historical data and trends. The allowance for doubtful accounts was $857 and $1,197 at December 31, 2016 and 2015, respectfully. The Company extends credit to customers based upon their financial condition, and collateral is not generally required. Inventories: Inventories are stated at the lower of cost or market. The cost of the majority of domestic inventories is determined using the last-in, first-out (LIFO) method to reflect a better matching of costs and revenues. The remaining inventories are stated principally at average cost. Property, Plant, and Equipment: Property, plant, and equipment is stated on the basis of cost. Depreciation is computed principally by the straight-line method, except certain assets for which depreciation may be computed by the units-of-production method. The depreciable lives that are used in computing the annual provision for depreciation by class of asset are primarily as follows: An asset acquired under a capital lease will be recorded at the lesser of the present value of the projected lease payments or the fair value of the asset and will be depreciated in accordance with the above schedule. Leasehold improvements will be depreciated over the life of the improvement if it is shorter than the life of the lease. Repair and maintenance costs are expensed as incurred. Mineral Resources and Mine Development: Property acquisition costs are capitalized as mineral resources on the balance sheet and are depleted using the units-of-production method based upon total estimated recoverable proven reserves of the beryllium-bearing bertrandite ore body. The Company uses beryllium pounds as the unit of accounting measure, and depletion expense is recorded on a pro-rata basis based upon the amount of beryllium pounds extracted as a percentage of total estimated beryllium pounds contained in all ore bodies. Mine development costs at our open pit surface mines include drilling, infrastructure, other related costs to delineate an ore body, and the removal of overburden to initially expose an ore body. Costs incurred before mineralization is classified as proven and probable reserves are expensed and classified as Exploration expense. Capitalization of mine development project costs that meet the definition of an asset begins once mineralization is classified as proven and probable reserves. Drilling and related costs are capitalized for an ore body where proven and probable reserves exist, and the activities are directed at obtaining additional information on the ore body or converting mineralized material to proven and probable reserves. All other drilling and related costs are expensed as incurred. Drilling costs incurred during the production phase for operational ore control are allocated to inventory costs and then included as a component of costs applicable to sales. The costs of removing overburden and waste materials to access the ore body at an open-pit mine prior to the production phase are referred to as “development costs.” Development costs are capitalized during the development of an open-pit mine and are capitalized at each pit. These costs are amortized as the ore is extracted using the units-of-production method based upon total estimated recoverable proven reserves for the individual pit. The Company uses beryllium pounds as the unit of accounting measure for recording amortization. To the extent that the aforementioned costs benefit an entire ore body, the costs are amortized over the estimated useful life of the ore body. Costs incurred to access specific ore blocks or areas that only provide benefit over the life of that area are amortized over the estimated life of that specific ore block area. Goodwill and Other Intangible Assets: Goodwill is reviewed annually for impairment or more frequently if impairment indicators arise. Historically, the Company conducted its annual goodwill and indefinite-lived intangible asset impairment assessment as of December 31 of each fiscal year; however, in 2016, the Company changed the date of its assessment to the first day of the fourth quarter, or more frequently under certain circumstances. Goodwill is assigned to the reporting unit, which is the operating segment level or one level below the operating segment. Intangible assets with finite lives are amortized using the straight-line method or effective interest method, as applicable, over the periods estimated to be benefited, which is generally 20 years or less. Finite-lived intangible assets are also reviewed for impairment if facts and circumstances warrant. Asset Impairment: In the event that facts and circumstances indicate that the carrying value of long-lived assets may be impaired, an evaluation of recoverability is performed by comparing the carrying value of the assets to the associated estimated future undiscounted cash flow. If the carrying value exceeds that cash flow, then the assets are written down to their fair values. Derivatives: The Company recognizes all derivatives on the balance sheet at fair value. If the derivative is designated and effective as a cash flow hedge, changes in the fair value of the derivative are recognized in other comprehensive income (loss), a component of shareholders’ equity, until the hedged item is recognized in earnings. If the derivative is designated as a fair value hedge, changes in fair value are offset against the change in the fair value of the hedged asset, liability, or commitment through earnings. The ineffective portion of a derivative’s change in fair value, if any, is recognized in earnings immediately. If a derivative is not a hedge, changes in its fair value are adjusted through the income statement. Asset Retirement Obligation: The Company records a liability to recognize the legal obligation to remove an asset at the time the asset is acquired or when the legal liability arises. The liability is recorded for the present value of the ultimate obligation by discounting the estimated future cash flows using a credit-adjusted risk-free interest rate. The liability is accreted over time, with the accretion charged to expense. An asset equal to the fair value of the liability is recorded concurrent with the liability and depreciated over the life of the underlying asset. Unearned Income: Expenditures for capital equipment to be reimbursed under government contracts are recorded in property, plant, and equipment, while the reimbursements for those expenditures are recorded in unearned income, a liability on the balance sheet. When the assets subject to reimbursement are placed in service, the total cost is depreciated over the useful lives, and the unearned income liability is reduced and credited to cost of sales on the Consolidated Statements of Income ratably with the annual depreciation expense. Depreciation and amortization expense on the Consolidated Statements of Cash Flows is shown net of the associated period reduction in the unearned income liability. Revenue Recognition: The Company generally recognizes revenue when the goods are shipped and title passes to the customer. The Company requires persuasive evidence that a revenue arrangement exists, delivery of the product has occurred, the selling price is fixed or determinable, and collectibility is reasonably assured before revenue is realized and earned. Billings in advance of the shipment of the goods are recorded as unearned revenue, which is a liability on the balance sheet. Revenue is recognized for these transactions when the goods are shipped and all other revenue recognition criteria are met. Shipping and Handling Costs: The Company records shipping and handling costs for products sold to customers in cost of sales in the Consolidated Statements of Income. Advertising Costs: The Company expenses all advertising costs as incurred. Advertising costs were $1,163 in 2016, $1,285 in 2015, and $1,188 in 2014. Stock-based Compensation: The Company recognizes stock-based compensation expense based on the grant date fair value of the award over the period during which an employee is required to provide service in exchange for the award. The fair value of restricted stock units is based on the closing price of the Company's common shares on the grant date. Stock appreciation rights (SARs) are granted with an exercise price equal to the closing price of the Company's common shares on the date of grant. The fair value of SARs is determined using a Black-Scholes option-pricing model, which incorporates assumptions regarding the expected volatility, the expected option life, the risk-free interest rate, and the expected dividend yield. See Note O for additional information about stock-based compensation. Capitalized Interest: Interest expense associated with active capital asset construction and mine development projects is capitalized and amortized over the future useful lives of the related assets. Income Taxes: The Company uses the liability method in measuring the provision for income taxes and recognizing deferred tax assets and liabilities on the balance sheet. The Company will record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized, as warranted by current facts and circumstances. The Company applies a more-likely-than-not recognition threshold for all tax uncertainties and will record a liability for those tax benefits that have a less than 50% likelihood of being sustained upon examination by the taxing authorities. Net Income Per Share: Basic earnings per share (EPS) is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the assumed conversion of all dilutive common stock equivalents as appropriate using the treasury stock method. New Pronouncements Adopted: In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory. Inventory within the scope of this update is required to be measured at the lower of its cost or net realizable value, with net realizable value being the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This ASU is effective prospectively for fiscal years and interim periods beginning after December 15, 2016, with early adoption permitted. We early adopted this ASU effective January 1, 2016. The adoption did not have a material effect on the consolidated financial statements. In May 2015, the FASB issued ASU 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). Under this update, investments for which fair value is measured at net asset value (NAV) per share (or its equivalent) using the practical expedient will no longer be categorized in the fair value hierarchy. The guidance applies to investments for which there is not a readily determinable fair value (market quote) or the investment is in a mutual fund without a publicly available net asset value. We adopted this standard effective January 1, 2016 and have updated our presentation of investments measured at net asset value accordingly. Refer to Note M of the Consolidated Financial Statements for additional details. In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires companies to present debt issuance costs associated with a debt liability as a deduction from the carrying amount of that debt liability on the balance sheet rather than being capitalized as an asset. The Company adopted this ASU effective January 1, 2016, and applied the new guidance on a retrospective basis, which resulted in a decrease to Intangible assets, Short-term debt, and Long-term debt, at December 31, 2015, of $347, $8, and $339, respectively. New Pronouncements Issued: In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. The standard eliminates the second step in the goodwill impairment test which requires an entity to determine the implied fair value of the reporting unit’s goodwill. Instead, an entity should recognize an impairment loss if the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, with the impairment loss not to exceed the amount of goodwill allocated to the reporting unit. The standard is effective for annual and interim goodwill impairment tests conducted in fiscal years beginning after December 15, 2019, with early adoption permitted. The impact of adopting this new guidance is not expected to have a material effect on the consolidated financial statements. In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which impacts several aspects of accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under the new standard, income tax benefits and deficiencies are to be recognized as income tax expense or benefit in the income statement, and the tax effects of exercised or vested awards will be treated as discrete items in the reporting period in which they occur. An entity will also recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the reporting period. Excess tax benefits will be classified, along with other income tax cash flows, as an operating activity. In regard to forfeitures, the entity may make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures as they occur. The ASU, which is required to be applied on a modified retrospective basis, will be effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. The impact of adopting this new guidance is not expected to have a material effect on the consolidated financial statements. In February 2016, the FASB issued ASU 2016-02, Leases, which eliminates the off-balance-sheet accounting for leases. The new guidance will require lessees to report their operating leases as both an asset and liability on the balance sheet and disclose key information about leasing arrangements. The ASU, which is required to be applied on a modified retrospective basis, will be effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes previous revenue recognition guidance. The new standard requires that a company recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those goods or services. Companies will need to use more judgment and estimates than under the guidance currently in effect, including estimating the amount of variable revenue to recognize over each identified performance obligation. Additional disclosures will be required to help users of financial statements understand the nature, amount, and timing of revenue and cash flows arising from contracts. This ASU is effective beginning in fiscal year 2018 with a provision for early adoption in 2017. The standard can be adopted either retrospectively or as a cumulative-effect adjustment as of the date of adoption. To evaluate the impact of adopting this new guidance on the consolidated financial statements, we established a cross-functional implementation team to assess our revenue streams against the requirements of this ASU. In addition, we are in the process of identifying and implementing changes to our processes and controls to meet the standard's updated reporting and disclosure requirements. The Company continues to update our assessment of the impact of the standard and related updates to the consolidated financial statements, and will disclose material impacts, if any. No other recently issued ASUs are expected to have a material effect on the Company's results of operations, financial condition, or liquidity. Note B - Segment Reporting and Geographic Information The Company has the following operating segments: Performance Alloys and Composites, Advanced Materials, Precision Coatings, and Other. The Company’s operating segments represent components of the Company for which separate financial information is available that is utilized on a regular basis by the Chief Executive Officer, the Company's Chief Operating Decision Maker, in determining how to allocate the Company’s resources and evaluate performance. The segments are determined based on several factors, including the the availability of discrete financial information and the Company’s organizational and management structure. Previously, the Company aggregated its businesses into three reportable segments: Performance Alloys and Composites, Advanced Materials, and Other. Precision Coatings was included in the Other segment, which also included unallocated corporate costs. The Company reorganized its operating segments in the fourth quarter of 2016 to more appropriately align with the way its businesses are managed. The Company is now organized into four reportable segments: Performance Alloys and Composites, Advanced Materials, Precision Coatings, and Other. Performance Alloys and Composites produces strip and bulk form alloy products, strip metal products with clad inlay and overlay metals, beryllium-based metals, beryllium, and aluminum metal matrix composites, in rod, sheet, foil, and a variety of customized forms, beryllia ceramics, and bulk metallic glass materials. Advanced Materials produces advanced chemicals, microelectric packaging, precious metal, non-precious metal, and specialty metal products, including vapor deposition targets, frame lid assemblies, clad and precious metal preforms, high temperature braze materials, and ultra-fine wire. Precision Coatings produces thin film coatings, optical filter materials, sputter-coated, and precision-converted thin film materials. The Other reportable segment includes unallocated corporate costs and assets. Financial information for reportable segments, which has been recast for all periods presented to reflect the current organizational structure, was as follows: Intersegment sales are eliminated in consolidation. The primary measure of evaluating segment performance is operating profit. In addition to net sales, value-added sales is also reviewed. Value-added sales represents a non-GAAP measure which removes the impact of pass-through metal costs and allows for analysis without the distortion of the movement or volatility in pass-through metal prices. Value-added sales is a metric of particular importance to the Advanced Materials segment, since a significant portion of Advanced Materials' net sales are based on the value of precious metals which can fluctuate significantly from period to period. From a segment assets perspective, segments are evaluated based upon a return on assets metric, which includes inventory (excluding the impact of LIFO), accounts receivable, and property, plant, and equipment. Other geographic information includes the following: Net sales are based on the location of the selling group. No individual country, other than the United States, or customer accounted for 10% or more of the Company’s net sales for the years presented. Long-lived assets are comprised of property, plant, and equipment based on physical location. Note C - Other-net Other-net is summarized for 2016, 2015, and 2014 as follows: Note D - Cost Reduction Initiatives In 2016, the Company initiated a plan to close the Fukuya, Japan service center which is a part of the Performance Alloys and Composites segment. An asset impairment charge of $2.6 million was recorded relating to impairment of land and buildings. The fair value estimates were calculated using the market approach. In 2014, the Company incurred a charge of $0.7 million relating to a plan, which was announced in 2012, to consolidate various small facilities to improve efficiencies and reduce overhead costs in order to improve profitability and cash flows. The plan also involved a reduction in the hourly workforce and management group at other facilities. Costs associated with the consolidation plan, primarily within the Advanced Materials and Precision Coatings segments, included severance and related manpower costs, equipment write-downs, equipment relocations, and other related costs. These costs are presented in the Consolidated Statements of Income as follows: Note E - Interest The following chart summarizes the interest incurred, capitalized, and paid for 2016, 2015, and 2014: The difference in expense for 2016, 2015, and 2014 was primarily due to changes in the level of outstanding debt and capital leases and the average borrowing rate. Amortization of deferred financing costs within interest expense was $0.7 million in 2016, $0.7 million in 2015, and $0.8 million in 2014. Note F - Income Taxes Income before income taxes and income tax expense (benefit) are comprised of the following: A reconciliation of the U.S. federal statutory income tax rate to the Company's effective income tax rate is as follows: The impact of the foreign tax credit line item in the effective income tax rate reconciliation table increased to a benefit of 28.1% in 2016, primarily due to a benefit relating to dividends paid from foreign earnings of a Japanese subsidiary. In 2015, the Company estimated foreign tax credits of $1.2 million based on available historical information that was readily accessible in a timely manner without undue cost. In 2016, the Company recorded $4.6 million in foreign tax credits as a change in accounting estimate as the result of new information obtained from an examination of the Japanese subsidiary's historical records and resulted in a foreign tax credit carryforward of $3.7 million from 2015. The Company had domestic and foreign income tax payments of $3.0 million, $6.0 million, and $13.1 million in 2016, 2015, and 2014, respectively. Deferred tax assets and (liabilities) are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities. Deferred tax assets and (liabilities) recorded in the Consolidated Balance Sheets consist of the following: The Company had deferred income tax assets offset with a valuation allowance for certain state and foreign net operating losses and state investment tax credit carryforwards. The Company intends to maintain a valuation allowance on these deferred tax assets until a realization event occurs to support reversal of all or a portion of the allowance. At December 31, 2016, for income tax purposes, the Company had foreign net operating loss carryforwards of $4.3 million that do not expire, and $9.6 million that expire in calendar years 2017 through 2025, of which $1.2 million expires within the next twelve months. The Company also had state net operating loss carryforwards of $19.9 million that expire in calendar years 2018 through 2036 and state tax credits of $2.6 million that expire in calendar years 2017 through 2031. A valuation allowance of $4.0 million has been provided against certain foreign and state loss carryforwards and state tax credits due to uncertainty of their realization. The Company has an alternative minimum tax credit of $1.4 million that does not expire, research and development tax credits of $0.6 million that expire in calendar year 2036, and foreign tax credits of $4.5 million, comprised of $3.7 million and $0.8 million, that expire in calendar years 2025 and 2026, respectively. The Company files income tax returns in the U.S. federal jurisdiction, and in various state, local, and foreign jurisdictions. With limited exceptions, the Company is no longer subject to U.S. federal examinations for years before 2013, state and local examinations for years before 2012, and foreign examinations for tax years before 2010. A reconciliation of the Company’s unrecognized tax benefits for the year-to-date periods ending December 31, 2016 and 2015 is as follows: At December 31, 2016, the Company had $2.0 million of unrecognized tax benefits, of which $1.4 million would affect the Company’s effective tax rate if recognized. It is reasonably possible that the amount of unrecognized tax benefits will change in the next twelve months; however, we do not expect the change to have a material impact on the Consolidated Statement of Income or the Consolidated Balance Sheet. The Company recognizes interest and penalties related to unrecognized tax benefits on the income tax expense line in the accompanying Consolidated Statements of Income. Accrued interest and penalties are included on the related tax liability line in the Consolidated Balance Sheets. The amount of interest and penalties, net of related federal tax benefits, recognized in earnings was immaterial during 2016, 2015, and 2014. As of December 31, 2016 and 2015, accrued interest and penalties, net of related federal tax benefits, were immaterial. U.S. income tax has not been recognized on the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries that is indefinitely reinvested outside of the United States. This amount becomes taxable upon a repatriation of assets from the subsidiary or a sale or liquidation of the subsidiary. The amount of such unrepatriated earnings totaled $57.2 million as of December 31, 2016. Determination of the amount of any unrecognized deferred income tax liability on this temporary difference is not practicable because of the complexities of the hypothetical calculation. Note G - Earnings Per Share The following table sets forth the computation of basic and diluted EPS: SARs totaling 182,186 in 2016, 376,550 in 2015, and 328,611 in 2014 were excluded from the diluted EPS calculation as their effect would have been anti-dilutive. Note H - Inventories Inventories in the Consolidated Balance Sheets are summarized as follows: The liquidation of LIFO inventory layers reduced cost of sales by $4.1 million in 2016, $6.1 million in 2015, and $0.1 million in 2014. Note I - Property, Plant, and Equipment Property, plant, and equipment on the Consolidated Balance Sheets is summarized as follows: The Company received $63.5 million from the U.S. Department of Defense (DoD), in previous periods, for reimbursement of the DoD's share of the cost of equipment. This amount was recorded in property, plant, and equipment and the reimbursements are reflected in unearned income on the Consolidated Balance Sheets. The equipment was placed in service during 2012, and its full cost is being depreciated in accordance with Company policy. The unearned income liability is being reduced ratably with the depreciation expense recorded over the life of the equipment. Unearned income was reduced by $4.6 million and $5.8 million in 2016 and 2015, respectively, and credited to cost of sales in the Consolidated Statements of Income, offsetting the impact of the depreciation expense on the associated equipment on the Company's cost of sales and gross margin. We recorded depreciation and depletion expense of $41.2 million in 2016, $32.8 million in 2015, and $37.5 million in 2014. The expense is net of the above-referenced reductions in the unearned income liability. Depreciation, depletion, and amortization as shown on the Consolidated Statement of Cash Flows is also net of the reduction in the unearned income liability in 2016, 2015, and 2014. The net book value of capitalized software was $9.8 million and $9.5 million at December 31, 2016 and December 31, 2015, respectively. Depreciation expense related to software was $2.4 million in 2016, $2.3 million in 2015, and $1.8 million in 2014. Note J - Intangible Assets and Goodwill Intangible Assets The cost and accumulated amortization of intangible assets subject to amortization as of December 31, 2016 and 2015, is as follows: During 2016, the Company acquired $1.7 million in finite-lived intangible assets, consisting primarily of licenses and other, with a weighted average life of nine years. The aggregate amortization expense relating to intangible assets for the year ended December 31, 2016 and estimated amortization expense for each of the five succeeding years is as follows: Intangible assets also includes deferred financing costs relating to the Company's revolving credit and consignments lines of $2.8 million and $2.4 million at December 31, 2016 and 2015, respectively. Goodwill Goodwill arises from the purchase price for acquired businesses exceeding the fair value of tangible and intangible assets acquired less assumed liabilities. In 2016, the Company acquired one business for total consideration of $2.0 million. The business acquired is included in the Precision Coatings segment. The Company recorded $0.3 million of goodwill related to this acquisition. Goodwill is reviewed annually for impairment or more frequently if impairment indicators arise. Historically, the Company conducted its annual goodwill impairment assessment as of December 31 of each year; however, in 2016, the Company changed the date of its assessment to the first day of the fourth quarter, or more frequently under certain circumstances. Goodwill is assigned to the reporting unit, which is the operating segment level or one level below the operating segment. The balance of goodwill at December 31, 2016 and 2015 was $87.0 million and $86.7 million, respectively, and assigned to the following segments: The results of the Company's 2016, 2015, and 2014 goodwill impairment assessments indicated that no goodwill impairment existed. Note K - Debt Long-term debt in the Consolidated Balance Sheets is summarized as follows: Maturities on long-term debt instruments as of December 31, 2016 are as follows: In 2015, the Company entered into an Amended and Restated Credit Agreement (Credit Agreement) that matures in 2020 and provides for a $375.0 million revolving credit facility comprised of sub-facilities for revolving loans, swing-line loans, letters of credit, and foreign borrowings. The Credit Agreement provides the Company and its subsidiaries with additional capacity to enter into facilities for the consignment, borrowing, or leasing of precious metals and copper, and provides enhanced flexibility to finance acquisitions and other strategic initiatives.The Credit Agreement also provides for an uncommitted incremental facility whereby, under certain conditions, the Company may be able to borrow additional term loans in an aggregate amount not to exceed $300.0 million. The Credit Agreement is secured by substantially all of the assets of the Company and its direct subsidiaries, with the exception of non-mining real property and certain other assets. The Credit Agreement allows the Company to borrow money at a premium over LIBOR or prime rate and at varying maturities. The premium resets quarterly according to the terms and conditions available under the agreement. The Credit Agreement includes restrictive covenants relating to restrictions on additional indebtedness, acquisitions, dividends, and stock repurchases. In addition, the Credit Agreement includes covenants subject to a maximum leverage ratio and a minimum fixed charge coverage ratio. The Company was in compliance with all of its debt covenants as of December 31, 2016 and December 31, 2015. At December 31, 2016 and 2015, respectively, there was $28.5 million and $38.0 million outstanding against the letters of credit sub-facility. The Company pays a variable commitment fee that may reset quarterly (0.20% as of December 31, 2016) of the available and unborrowed amounts under the revolving credit line. The following table summarizes the Company’s short-term lines of credit. While the available borrowings under the individual existing credit lines total $355.4 million, the covenants in the domestic Credit Agreement restrict the aggregate available borrowings to $238.9 million as of December 31, 2016. The domestic line is committed and includes all sub-facilities in the $375.0 million maximum borrowing under the Credit Agreement. The Company has various foreign lines of credit, one of which for $2.0 million, is committed and secured. The remaining foreign lines are uncommitted, unsecured, and renewed annually. The average interest rate on short-term debt was 4.90% and 0.42% as of December 31, 2016 and 2015, respectively. In April 2011, the Company entered into an agreement with the Toledo-Lucas County Port Authority and the Dayton-Montgomery County Port Authority in Ohio to co-issue $8.0 million in taxable development revenue bonds, with a fixed amortization term that will mature in 2021. The interest rate on these bonds was fixed at 4.9%, and the unamortized balance of the bonds was $4.6 million at December 31, 2016. In November 2016, the Company retired the entire $8.3 million of variable rate industrial revenue bonds with the Lorain Port Authority in Ohio, at maturity. Note L - Leasing Arrangements The Company leases warehouse and manufacturing real estate, and manufacturing and computer equipment under operating leases with terms ranging up to 25 years. Operating lease expense amounted to $8.6 million, $8.3 million, and $8.7 million during 2016, 2015, and 2014, respectively. The future estimated minimum payments under capital leases and non-cancelable operating leases with initial lease terms in excess of one year at December 31, 2016, are as follows: Note M - Pensions and Other Post-Employment Benefits The obligation and funded status of the Company’s pension and other post-employment benefit plans are shown below. The Pension Benefits column aggregates defined benefit pension plans in the U.S., Germany, and England, and the U.S. supplemental retirement plans. The Other Benefits column includes the domestic retiree medical and life insurance plan. Components of net benefit cost and other amounts recognized in other comprehensive income (OCI) Summary of key valuation assumptions In determining the projected benefit obligation and the net benefit cost, as of a December 31 measurement date, the Company used the following weighted-average assumptions: Discount Rate. The discount rate used to determine the present value of the projected and accumulated benefit obligation at the end of each year is established based upon the available market rates for high quality, fixed income investments whose maturities match the plan’s projected cash flows. Beginning in 2017, the Company has elected to use a spot-rate approach to estimate the service and interest cost components of net periodic benefit cost for its defined benefit pension plans. The spot-rate approach applies separate discount rates for each projected benefit payment in the calculation. Historically, the Company used a weighted-average approach to determine the service and interest cost components. The change will be accounted for as a change in estimate and, accordingly, will be accounted for prospectively starting in 2017. The reductions in service and interest costs for 2017 associated with this change in estimate are expected to total approximately $1.0 million. Expected Long-Term Return on Plan Assets. Management establishes the domestic expected long-term rate of return assumption by reviewing historical trends and analyzing the current and projected market conditions in relation to the plan’s asset allocation and risk management objectives. Consideration is given to both recent plan asset performance as well as plan asset performance over various long-term periods of time, with an emphasis on the assumption being a prospective, long-term rate of return. Management consults with and considers the opinions of its outside investment advisers and actuaries when establishing the rate and reviews assumptions with the Audit Committee of the Board of Directors. Rate of Compensation Increase. The rate of compensation increase assumption was 4.0% in both 2016 and 2015 for the domestic defined benefit pension plan and the domestic retiree medical plan. Assumptions for the defined benefit pension plans in Germany and England are determined separately from the U.S. plan assumptions, based on historical trends and current and projected market conditions in Germany and England. The plan in Germany is unfunded. Assumed health care cost trend rates can have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: Plan Assets The following tables present the fair values of the Company’s defined benefit pension plan assets as of December 31, 2016 and 2015 by asset category. The Company has some investments that are valued using NAV as the practical expedient and have not been classified in the fair value hierarchy. Refer to Note P of the Consolidated Financial Statements for definitions of the fair value hierarchy. (a) Mutual funds that invest in various sectors of the U.S. market. (b) Mutual funds that invest in non-U.S. companies primarily in developed countries that are generally considered to be value stocks. (c) Mutual funds that invest in non-U.S. companies in emerging market countries. (d) Includes a mutual fund that employs a value-oriented approach to fixed income investment management and a mutual fund that invests primarily in investment-grade debt securities. (e) Includes a mutual fund that seeks a market rate of return for a fixed-income portfolio with low relative volatility of returns, investing generally in U.S. and foreign debt securities maturing in five years or less. (f) Mutual funds that invest in domestic and foreign sovereign securities, fixed income securities, mortgage-backed and asset-backed bonds, convertible bonds, high-yield bonds, and emerging market bonds. (g) Includes a mutual fund that typically invests at least 80% of its assets in equity and debt securities of companies in the real estate industry or related industries or in companies which own significant real estate assets at the time of investment. (h) Includes a mutual fund that tactically allocates assets to global equity, fixed income, and alternative strategies. (i) Includes a fund that invests in a broad portfolio of hedge funds. (j) Includes a hedge fund that employs multiple strategies to multiple asset classes with low correlations. Capital may be withdrawn from the multi-strategy hedge fund partnership on a monthly basis with a ten-day notice period. The Company’s domestic defined benefit pension plan investment strategy, as approved by the Governance and Organization Committee of the Board of Directors, is to employ an allocation of investments that will generate returns equal to or better than the projected long-term growth of pension liabilities so that the plan will be self-funding. The return objective is to maximize investment return to achieve and maintain a 100% funded status over time, taking into consideration required cash contributions. The allocation of investments is designed to maximize the advantages of diversification while mitigating the risk and overall portfolio volatility to achieve the return objective. Risk is defined as the annual variability in value and is measured in terms of the standard deviation of investment return. Under the Company’s investment policies, allowable investments include domestic equities, international equities, fixed income securities, cash equivalents, and alternative securities (which include real estate, private venture capital investments, hedge funds, and tactical asset allocation). Ranges, in terms of a percentage of the total assets, are established for each allowable class of security. Derivatives may be used to hedge an existing security or as a risk reduction strategy. Current asset allocation guidelines are to invest 30% to 60% in equity securities, 20% to 50% in fixed income securities and cash, and up to 25% in alternative securities. Management reviews the asset allocation on a quarterly or more frequent basis and makes revisions as deemed necessary. None of the plan assets noted above are invested in the Company’s common stock. Cash Flows Employer Contributions. The Company expects to contribute $16.0 million to its domestic defined benefit pension plan and $1.4 million to its other benefit plans in 2017. Effective in 2016, all plan participants with an accrued benefit may elect an immediate payout in lieu of their future monthly annuity if the lump sum amount does not exceed $100,000. Estimated Future Benefit Payments. The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Other Benefit Plans In addition to the plans shown above, the Company also has certain foreign subsidiaries with accrued unfunded pension and other post-employment arrangements. The liability for these arrangements was $2.4 million at December 31, 2016 and $2.3 million at December 31, 2015, and was included in retirement and post-employment benefits in the Consolidated Balance Sheets. The Company also sponsors defined contribution plans available to substantially all U.S. employees. The Company’s annual defined contribution expense, including the expense for the enhanced defined contribution plan, was $3.6 million in 2016, $3.1 million in 2015, and $3.0 million in 2014. Note N - Accumulated Other Comprehensive Income Changes in the components of accumulated other comprehensive income, including amounts reclassified out, for 2016, 2015, and 2014, and the balances in accumulated other comprehensive income as of December 31, 2016, 2015, and 2014 are as follows: Reclassifications from accumulated other comprehensive income of gains and losses on foreign currency cash flow hedges are recorded in Other-net in the Consolidated Statements of Income while gains and losses on precious metal cash flow hedges are recorded in Cost of sales in the Consolidated Statements of Income. Refer to Note P for additional details on cash flow hedges. Reclassifications from accumulated other comprehensive income for pension and post-employment benefits are included in the computation of the net periodic pension and post-employment benefit expense. Refer to Note M for additional details on pension and other post-employment expenses. Note O - Stock-based Compensation Stock incentive plans (the 2006 Stock Incentive Plan and the 2006 Non-employee Director Equity Plan) were approved at the May 2006 annual meeting of shareholders. These plans authorize the granting of option rights, stock appreciation rights (SARs), performance-restricted shares, performance shares, performance units, and restricted shares and replaced the 1995 Stock Incentive Plan and the 1997 Stock Incentive Plan for Non-employee Directors. The 2006 Stock Incentive Plan and the 2006 Non-employee Director Equity Plan were amended to, among other things, add additional shares to the plans. These amendments were approved by shareholders at the May 2014 annual meeting. Stock-based compensation expense, which includes awards settled in shares and in cash and is recognized as a component of SG&A expense, was $6.7 million, $6.2 million, and $9.0 million in 2016, 2015, and 2014, respectively. The Company derives a tax deduction measured by the excess of the market value over the grant price at the date stock-based awards are exercised. The related tax benefit is credited to Shareholders' Equity as the Company is currently in a windfall tax benefit position. The Company recognized less than $0.1 million of tax expense in 2016 and tax benefits of $0.4 million and $0.5 million in 2015 and 2014, respectively, relating to the issuance of common stock for the exercise/vesting of equity awards. The following sections provide information on awards settled in shares. Stock Options/SARs. The Company grants SARs to certain employees. Upon exercise of vested SARs, the participant will receive a number of shares of common stock equal to the spread (the difference between the market price of the Company’s common shares at the time of the exercise and the strike price established in the SARs agreement) divided by the common share price. The strike price of the SARs is equal to the market value of the Company’s common shares on the day of the grant. The number of SARs available to be issued is established by plans approved by the shareholders. The vesting period and the life of the SARs are established in the SARs agreement at the time of the grant. The exercise of the SARs will be satisfied by the issuance of treasury shares. The SARs vest three years from the date of grant. SARs granted prior to 2011 expire in ten years, while the SARs granted in 2011 and later expire in seven years. The following table summarizes the Company's SARs activity during 2016: A summary of the status and changes of shares subject to SARs and the related average price per share follows: As of December 31, 2016, $1.5 million of expense with respect to nonvested SARs has yet to be recognized as expense over a weighted-average period of approximately 23 months. The total fair value of shares vested during 2016, 2015, and 2014 was $1.7 million, $2.7 million, and $3.2 million. The weighted-average grant date fair value for 2016, 2015, and 2014 was $8.07, $13.27, and $12.48, respectively. The fair value will be amortized to compensation cost on a straight-line basis over the three-year vesting period, or earlier if the employee is retirement eligible as defined in the Plan. Stock-based compensation expense relating to SARs was $0.9 million in 2016 and $2.0 million in both 2015 and 2014. The fair value of the SARs was estimated on the grant date using the Black-Scholes pricing model with the following assumptions: The risk-free rate of return was based on U.S. Treasury yields with a maturity equal to the expected life of the award. The dividend yield was based on the Company's historical dividend rate and stock price. The expected volatility of stock was derived by referring to changes in the Company's historical common stock prices over a time-frame similar to the expected life of the award. In addition to considering the vesting period and contractual term of the award for the expected life assumption, the Company analyzes actual historical exercise experience for previously granted awards. Stock options may be granted to employees or non-employee directors of the Company. There were no stock options outstanding as of year end 2016 or 2015. The cash received from the exercise of stock options was $0.4 million in 2014. The total intrinsic value of options exercised during the year ended December 31, 2014 was $0.3 million. Restricted Stock Units. The Company may grant restricted stock units to employees and non-employee directors of the Company. These units are restricted and vest over a designated period of time as defined at the date of the grant and are forfeited should the holder’s employment terminate during the restriction period. The fair market value of the restricted shares is determined on the date of the grant and is amortized over the restriction period. The restriction period is typically three years unless the recipient is retirement eligible. The fair value of the restricted stock units settled in stock is based on the closing stock price on the date of grant. The weighted-average grant date fair value for 2016, 2015, and 2014 was $25.96, $37.17, and $33.29, respectively. Cash-settled RSUs are accounted for as liability-based compensation awards and adjusted based on the closing price of Materion’s common stock over the vesting period of three years. Stock-based compensation expense relating to restricted stock units was $1.3 million in 2016, $2.1 million in 2015, and $1.8 million in 2014. The unamortized compensation cost on the outstanding restricted stock was $1.2 million as of December 31, 2016 and is expected to be amortized over a weighted-average period of 19 months. The total fair value of shares vested during 2016, 2015, and 2014 was $1.9 million, $2.3 million, and $4.2 million. The following table summarizes the stock-settled restricted stock unit activity during 2016: Long-term Incentive Plans. Under long-term incentive compensation plans, executive officers and selected other employees receive restricted stock unit awards based upon the Company’s performance over the defined period, typically three years. Total units earned for grants made in 2016, 2015, and 2014, may vary between 0% and 200% of the units granted based on the attainment of performance targets during the related three-year period and continued service. For executive officers, attainment up to 100% is paid in Materion common shares and is equity classified, while the remainder is classified as a liability award and settled in cash. For all other employees, the entire award is settled in cash. Vesting of performance-based awards is contingent upon the attainment of threshold performance objectives. The following table summarizes the activity related to equity-based, performance-based restricted stock units during 2016: Compensation expense is based upon the performance projections for the three-year plan period, the percentage of requisite service rendered, and the fair market value of the Company’s common shares on the date of grant. The offset to the compensation expense for the portion of the award to be settled in shares is recorded within shareholders’ equity and was $1.0 million for 2016, $1.4 million for 2015, and $1.0 million for 2014. Directors' Deferred Compensation. Non-employee directors may defer all or part of their fees into the Company’s common stock. The fair value of the deferred shares is determined at the share acquisition date and is recorded within shareholders’ equity. Subsequent changes in the fair value of the Company’s common shares do not impact the recorded values of the shares. The following table summarizes the stock activity for the directors' deferred compensation plan during 2016: During the years ended December 31, 2016, 2015, and 2014, the weighted-average grant date fair value was $24.46, $37.08, and $33.46, respectively. Note P - Fair Value Information and Derivative Financial Instruments The Company measures and records financial instruments at fair value. A hierarchy is used for those instruments measured at fair value that distinguishes between assumptions based upon market data (observable inputs) and the Company's assumptions (unobservable inputs). The hierarchy consists of three levels: Level 1 - Quoted market prices in active markets for identical assets and liabilities; Level 2 - Inputs other than Level 1 inputs that are either directly or indirectly observable; and Level 3 - Unobservable inputs developed using estimates and assumptions developed by the Company, which reflect those that a market participant would use. The following table summarizes the financial instruments measured at fair value in the Consolidated Balance Sheets at December 31, 2016 and 2015: The Company uses a market approach to value the assets and liabilities for financial instruments in the table above. Outstanding contracts are valued through models that utilize market observable inputs, including both spot and forward prices, for the same underlying currencies and metals. The Company's deferred compensation investments and liabilities are based on the fair value of the investments corresponding to the employees’ investment selections, primarily in mutual funds, based on quoted prices in active markets for identical assets. Deferred compensation investments are primarily presented in Other assets. Deferred compensation liabilities are primarily presented in Other long-term liabilities. The carrying values of the other working capital items and debt in the Consolidated Balance Sheets approximate fair values at December 31, 2016 and 2015. The Company uses derivative contracts to hedge portions of its foreign currency exposures and may also use derivatives to hedge a portion of its precious metal exposures. The objectives and strategies for using derivatives in these areas are as follows: Foreign Currency. The Company sells a portion of its products to overseas customers in their local currencies, primarily the euro and yen. The Company secures foreign currency derivatives, mainly forward contracts and options, to hedge these anticipated sales transactions. The purpose of the hedge program is to protect against the reduction in the dollar value of foreign currency sales from adverse exchange rate movements. Should the dollar strengthen significantly, the decrease in the translated value of the foreign currency sales should be partially offset by gains on the hedge contracts. Depending upon the methods used, the hedge contracts may limit the benefits from a weakening U.S. dollar. The use of forward contracts locks in a firm rate and eliminates any downside from an adverse rate movement as well as any benefit from a favorable rate movement. The Company may from time to time choose to hedge with options or a tandem of options known as a collar. These hedging techniques can limit or eliminate the downside risk but can allow for some or all of the benefit from a favorable rate movement to be realized. Unlike a forward contract, a premium is paid for an option; collars, which are a combination of a put and call option, may have a net premium but can be structured to be cash neutral. The Company will primarily hedge with forward contracts due to the relationship between the cash outlay and the level of risk. Precious Metals. The Company maintains the majority of its precious metal production requirements on consignment in order to reduce its working capital investment and the exposure to metal price movements. When a precious metal product is fabricated and ready for shipment to the customer, the metal is purchased out of consignment at the current market price. The price paid by the Company forms the basis for the price charged to the customer. This methodology allows for changes in either direction in the market prices of the precious metals used by the Company to be passed through to the customer and reduces the impact changes in prices could have on the Company's margins and operating profit. The consigned metal is owned by financial institutions who charge the Company a financing fee based upon the current value of the metal on hand. In certain instances, a customer may want to establish the price for the precious metal at the time the sales order is placed rather than at the time of shipment. Setting the sales price at a different date than when the material would be purchased potentially creates an exposure to movements in the market price of the metal. Therefore, in these limited situations, the Company may elect to enter into a forward contract to purchase precious metal. The forward contract allows the Company to purchase metal at a fixed price on a specific future date. The price in the forward contract serves as the basis for the price to be charged to the customer. By doing so, the selling price and purchase price are matched, and the Company's price exposure is reduced. The Company refines precious metal-containing materials for its customers and typically will purchase the refined metal from the customer at current market prices. In limited circumstances, the customer may want to fix the price to be paid at the time of the order as opposed to when the material is refined. The customer may also want to fix the price for a set period of time. The Company may then elect to enter into a hedge contract, either a forward contract or a swap, to fix the price for the estimated quantity of metal to be purchased, thereby reducing the exposure to adverse movements in the price of the metal. The Company may from time to time elect to purchase precious metal and hold in inventory rather than on consignment due to potential credit line limitations or other factors. These purchases are typically held for a short duration. A forward contract will be secured at the time of the purchase to fix the price to be used when the metal is transferred back to the consignment line, thereby limiting any price exposure during the time when the metal was owned. A team consisting of senior financial managers reviews the estimated exposure levels, as defined by budgets, forecasts, and other internal data, and determines the timing, amounts, and instruments to use to hedge exposures. Management analyzes the effective hedged rates and the actual and projected gains and losses on the hedging transactions against the program objectives, targeted rates, and levels of risk assumed. Foreign currency contracts are typically layered in at different times for a specified exposure period in order to minimize the impact of market rate movements. The use of derivatives is governed by policies adopted by the Audit Committee of the Board of Directors. The Company will only enter into a derivative contract if there is an underlying identified exposure. Contracts are typically held to maturity. The Company does not engage in derivative trading activities and does not use derivatives for speculative purposes. The Company only uses hedge contracts that are denominated in the same currency or metal as the underlying exposure. The fair values of the outstanding derivatives are recorded as assets (if the derivatives are in a gain position) or liabilities (if the derivatives are in a loss position). The fair values will also be classified as short term or long term depending upon maturity dates. The following table summarizes the notional amount and the fair value of the Company’s outstanding derivatives and balance sheet classification at December 31, 2016 and 2015: All of the foreign currency derivative contracts outstanding at December 31, 2016 and 2015 were designated and effective as cash flow hedges. There were no precious metal derivative contracts outstanding at December 31, 2016 and 2015. There was no ineffectiveness associated with the derivative contracts outstanding at December 31, 2016 or 2015, and no ineffectiveness expense was recorded in 2016, 2015, or 2014. The fair value of derivative contracts recorded in accumulated other comprehensive income totaled $0.7 million as of December 31, 2016. The Company expects to relieve this balance to the Consolidated Statement of Income in 2017. The fair value of derivative contracts in accumulated other comprehensive income totaled $0.3 million at December 31, 2015. Note Q - Contingencies and Commitments Chronic Beryllium Disease (CBD) Claims The Company is a defendant from time to time in proceedings in various state and federal courts brought by plaintiffs alleging that they have contracted CBD or related ailments as a result of exposure to beryllium. Plaintiffs in CBD cases seek recovery under theories of negligence and various other legal theories and seek compensatory and punitive damages, in many cases of an unspecified sum. Spouses, if any, often claim loss of consortium. Employee cases, in which plaintiffs have a high burden of proof, have historically involved relatively small losses to the Company. Third-party plaintiffs (typically employees of customers) face a lower burden of proof than do the Company’s employees, but these cases have generally been covered by varying levels of insurance. Management has vigorously contested the CBD cases brought against the Company. Non-employee claims for CBD are covered by insurance, subject to certain limitations. The insurance covers defense costs and indemnity payments (resulting from settlements or court verdicts) and is subject to various levels of deductibles. In 2016 and 2015, defense and indemnity costs were less than the deductible. There was one CBD case outstanding as of December 31, 2015. This case was settled and paid out during 2016. The amount paid for the settlement of this case was not material to the Company's consolidated financial statements. One CBD case, originally filed and dismissed during 2015, but reversed and remanded in 2016 to the trial court, was outstanding as of December 31, 2016. The Company does not expect the resolution of this matter to have a material impact on the consolidated financial statements. Although it is not possible to predict the outcome of any pending litigation, the Company provides for costs related to litigation matters when a loss is probable, and the amount is reasonably estimable. Litigation is subject to many uncertainties, and it is possible that some of the actions could be decided unfavorably in amounts exceeding the Company’s reserves. An unfavorable outcome or settlement of a CBD case or adverse media coverage could encourage the commencement of additional similar litigation. The Company is unable to estimate its potential exposure to unasserted claims. Based upon currently known facts and assuming collectibility of insurance, the Company does not believe that resolution of the current or future beryllium proceedings will have a material adverse effect on the financial condition or cash flow of the Company. However, the Company’s results of operations could be materially affected by unfavorable results in one or more cases. Insurance Recoverable After recording and investigating a $7.4 million inventory loss in 2012, the Company filed a claim with its insurance provider under existing polices for theft. In 2014, the Company and the insurance company settled the claim, and the Company received a cash payment of $6.8 million and recognized the amount in Other-net in the Consolidated Statement of Income. The Company collected $5.6 million and $4.0 million during 2015 and 2014, respectively, as part of settlement agreements with contractors and insurance companies for outstanding disputes regarding construction of the Company's beryllium pebble facility located in Elmore, Ohio. The benefit of these settlements was recorded in Other-net in the Consolidated Statements of Income. Environmental Proceedings The Company has an active program for environmental compliance that includes the identification of environmental projects and estimating the impact on the Company’s financial performance and available resources. Environmental expenditures that relate to current operations, such as wastewater treatment and control of airborne emissions, are either expensed or capitalized as appropriate. The Company records reserves for the probable costs for identified environmental remediation projects. The Company’s environmental engineers perform routine ongoing analyses of the remediation sites and will use outside consultants to assist in their analyses from time to time. Accruals are based upon their analyses and are established based on the reasonably estimable loss or range of loss. The accruals are revised for the results of ongoing studies, changes in strategies, inflation, and for differences between actual and projected costs. The accruals may also be affected by rulings and negotiations with regulatory agencies. The timing of payments often lags the accrual, as environmental projects typically require a number of years to complete. The environmental reserves recorded represent the Company's best estimate of what is reasonably possible and cover existing or currently foreseen projects based upon current facts and circumstances. The Company does not believe that it is reasonably possible that the cost to resolve environmental matters for sites where the investigative work and work plan development are substantially complete will be materially different than what has been accrued while the ultimate loss contingencies for sites that are in the preliminary stages of investigation cannot be reasonably determined at the present time. As facts and circumstances change, the ultimate cost may be revised, and the recording of additional costs may be material in the period in which the additional costs are accrued. The Company does not believe that the ultimate liability for environmental matters will have a material impact on its financial condition or liquidity due to the nature of known environmental matters and the extended period of time during which environmental remediation normally takes place. The undiscounted reserve balance at the beginning of the year, the amounts expensed and paid, and the balance at December 31, 2016 and 2015 are as follows: The majority of spending in 2016 and 2015 was for various remediation projects at the Elmore, Ohio plant site. Asset Retirement Obligations The following represents a roll forward of our asset retirement obligation liability related to our mine located in Utah for the years ended December 31, 2016 and 2015: Other The Company is subject to various legal or other proceedings that relate to the ordinary course of its business. The Company believes that the resolution of these proceedings, individually or in the aggregate, will not have a material adverse impact upon the Company’s consolidated financial statements. At December 31, 2016, the Company has outstanding letters of credit totaling $28.5 million related to workers’ compensation, consigned precious metal guarantees, environmental remediation issues, and other matters. The majority of the Company's outstanding letters of credit expire in 2017 and are expected to be renewed. Note R - Quarterly Data (Unaudited) The following tables summarize selected quarterly financial data for the years ended December 31, 2016 and 2015: The Company follows a 13-week quarterly accounting cycle pursuant to which the first three fiscal quarters end on a Friday and the fiscal year always ends on December 31. | Here's a summary of the financial statement excerpt:
The document discusses various financial provisions and accounting practices:
1. Profit/Loss:
- Includes an allowance for doubtful accounts of $857
- Based on customer payment patterns and historical data analysis
2. Expenses:
- Mentions a valuation allowance for deferred tax assets
- Applies a recognition threshold for tax uncertainties
3. Assets:
- Discusses asset allocation guidelines
- Mentions potential use of derivatives for hedging and risk reduction
- Suggests a 30% allocation (incomplete percentage)
4. Liabilities:
- References new accounting standards for debt issuance costs
- Requires presenting debt issuance costs as a deduction from debt liability
- Adopted effective January 1st (year not specified)
The excerpt appears to be a partial financial statement focusing on accounting methods and provisions for various financial elements. | Claude |
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