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Section 1: 10-KT/A (JEFFERIES FINANCIAL GROUP INC. FORM 10-KT/A)

JFG-2018 11.30.10KTA Combined Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________
FORM 10-K/A
(Amendment No. 1)
¨ 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
                                                               For the fiscal year ended ________________
or
x
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from January 1, 2018 to November 30, 2018
Commission file number:  1-5721
JEFFERIES FINANCIAL GROUP INC.
(Exact Name of Registrant as Specified in its Charter)
New York
13-2615557
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
520 Madison Avenue
New York, New York 10022
(212) 460-1900
(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Shares, par value $1 per share
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None.
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes ¨  No  x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes x   No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x     Accelerated filer ☐         Non-accelerated filer ☐
Smaller reporting company ☐     Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes ¨  No x
Aggregate market value of the voting stock of the registrant held by non-affiliates of the registrant at June 30, 2018 (computed by reference to the last reported closing sale price of the Common Shares on the New York Stock Exchange on such date):  $6,974,359,578.
On January 18, 2019, the registrant had outstanding 305,716,112 Common Shares.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the registrant's Definitive Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with the 2019 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.
LOCATION OF EXHIBIT INDEX
The index of exhibits is contained in Part IV on page 2.

1



Explanatory Note

In reliance on General Instruction A.(4) to Form 10-K, we are filing this Amendment No. 1 to our Transition Report on Form 10-K for the fiscal year ended November 30, 2018, filed with the U.S. Securities and Exchange Commission on January 29, 2019 ("Original Report") solely to add National Beef Packing Company, LLC ("National Beef") financial statements as of December 29, 2018 and December 30, 2017 and for the years ended December 29, 2018, December 30, 2017 and December 31, 2016 and Berkadia Commercial Mortgage Holding LLC ("Berkadia") financial statements as of December 31, 2018 and 2017, and for the years ended December 31, 2018, 2017 and 2016. The National Beef and Berkadia financial statements are included in Item 15(c), Financial Statement Schedule as required pursuant to Rule 3-09 of Regulation S-X.

This Amendment No.1 does not reflect events occurring after the filing of the Original Report and does not modify or update disclosures as originally filed, except as required to reflect the additional information provided herein.

PART IV
Item 15.
Exhibits and Financial Statement Schedules.
(a)(1)
Financial Statements.
Reports of Independent Registered Public Accounting Firms  
F-1***
Financial Statements:
 
Consolidated Statements of Financial Condition at November 30, 2018 and December 31, 2017
F-4***
Consolidated Statements of Operations for the eleven months ended November 30, 2018 and the twelve months ended December 31, 2017 and 2016
F-5***
Consolidated Statements of Comprehensive Income (Loss) for the eleven months ended November 30, 2018 and the twelve months ended December 31, 2017 and 2016
F-7***
Consolidated Statements of Cash Flows for the eleven months ended November 30, 2018 and the twelve months ended December 31, 2017 and 2016
F-8***
Consolidated Statements of Changes in Equity for the eleven months ended November 30, 2018 and the twelve months ended December 31, 2017 and 2016
F-10***
Notes to Consolidated Financial Statements
F-11***
(2)
Financial Statement Schedules.
Schedule I - Condensed Financial Information of Jefferies Financial Group Inc. (Parent Company Only) at November 30, 2018 and December 31, 2017 and for the eleven months ended November 30, 2018 and the twelve months ended December 31, 2017 and 2016.***
(3)
See Exhibit Index below for a complete list of Exhibits to this report.
(b)
Exhibits.
All documents referenced below were filed pursuant to the Securities Exchange Act of 1934 by the Company, file number 1-5721, unless otherwise indicated.
(c)    Financial Statement Schedules.
Jefferies Finance LLC financial statements as of November 30, 2018 and 2017, and for the years ended November 30, 2018, 2017 and 2016.***
National Beef Packing Company, LLC financial statements as of December 29, 2018 and December 30, 2017, and for the years ended December 29, 2018, December 30, 2017 and December 31, 2016.
Berkadia Commercial Mortgage Holding LLC financial statements as of December 31, 2018 and 2017, and for the years ended December 31, 2018, 2017 and 2016.


2


Item 16.
Form 10-K Summary.
None.
Exhibit Index
3.1
 
 
3.2
 
 
4.1
The Company undertakes to furnish the Securities and Exchange Commission, upon written request, a copy of all instruments with respect to long-term debt not filed herewith.
 
 
10.31
 
 
10.32
 
 
10.33
 
 
10.34
 
 
10.35
 
 
10.36
 
 
10.37
 
 
10.38
 
 
10.39
 
 
10.40
 
 
10.41
 
 
10.42
 
 
10.43
 
 

3


10.44
 
 
10.45
 
 
10.46
 
 
10.47
 
 
10.48
 
 
10.49
 
 
10.50
 
 
10.51
 
 
21
 
 
23.1
 
 
23.2
 
 
23.3
 
 
23.4
 
 
23.5
 
 
23.6
 
 
23.7
 
 
31.1
 
 
31.2
 
 
32.1
 
 
32.2
 
 

4


101
Financial statements from the Annual Report on Form 10-K of Jefferies Financial Group Inc. for the eleven months ended November 30, 2018, formatted in Extensible Business Reporting Language (XBRL):  (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income (Loss), (iv) the Consolidated Statements of Cash Flows, (v) the Consolidated Statements of Changes in Equity, (vi) the Notes to Consolidated Financial Statements and (vii) the Financial Statement Schedule.***
____________________________
+ 
Management/Employment Contract or Compensatory Plan or Arrangement.
*
Incorporated by reference.
**
Furnished herewith pursuant to item 601(b) (32) of Regulation S-K.
***
Included in Part IV in Jefferies Transition Report on Form 10-K for the fiscal year ended November 30, 2018, which was initially filed with the U.S. Securities and Exchange Commission on January 29, 2019.


SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 
 
 
JEFFERIES FINANCIAL GROUP INC.
 
 
 
 
Date:  March 28, 2019
By:
 
/s/        John M. Dalton
 
 
 
Name: John M. Dalton
 
 
 
Title:   Vice President and Controller


5
 

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Managers
National Beef Packing Company, LLC
We have audited the accompanying consolidated financial statements of National Beef Packing Company, LLC, (a Delaware limited liability company) and subsidiaries, which comprise the consolidated balance sheet as of December 29, 2018, and the related consolidated statements of operations, comprehensive income, cash flows, and members’ capital, for the year then ended, and the related notes to the financial statements.
Management's responsibility for the financial statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ responsibility
Our responsibility is to express an opinion on the consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Beef Packing Company, LLC and subsidiaries as of December 29, 2018, and the results of their operations and their cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP
Kansas City, Missouri
March 13, 2019

NB-1



INDEPENDENT AUDITORS’ REPORT
The Board of Managers and Members
National Beef Packing Company, LLC:
We have audited the accompanying consolidated financial statements of National Beef Packing Company, LLC and its subsidiaries (the "Company"), which comprise the consolidated balance sheet as of December 30, 2017, and the related consolidated statements of operations, comprehensive income (loss), members’ capital, and cash flows for the fiscal year then ended, and the related notes to the consolidated financial statements.

Management's Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Company's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Beef Packing Company, LLC and its subsidiaries as of December 30, 2017, and the results of their operations and their cash flows for the fiscal year then ended in accordance with accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Kansas City, Missouri
March 14, 2018

NB-2



Report of Independent Auditors
The Board of Managers and Members
National Beef Packing Company, LLC:
We have audited the accompanying consolidated financial statements of National Beef Packing Company, LLC, and its subsidiaries, which comprise the consolidated statement of operations, cash flows, members’ capital, and comprehensive income (loss) for the year ended December 31, 2016.
Management's Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on the consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of National Beef Packing Company, LLC and its subsidiaries for the year ended December 31, 2016 in accordance with accounting principles generally accepted in the United States of America.
/s/ PricewaterhouseCoopers LLP
Kansas City, Missouri
March 9, 2017, except as to the revision of the statement of cash flows described in Note 2, which is dated March 14, 2018.

NB-3


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES

Consolidated Balance Sheets
(in thousands) 
 
December 29, 2018
 
December 30, 2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
46,746

 
$
18,516

Accounts receivable, less allowance for returns and doubtful accounts of $2,584 and $4,211 respectively
215,318

 
186,837

Due from affiliates
803

 
786

Other receivables
4,718

 
9,302

Inventories
246,687

 
261,302

Other current assets
19,577

 
15,537

Total current assets
533,849

 
492,280

Property, plant and equipment, at cost:
 
 
 
Land and improvements
26,920

 
20,378

Buildings and improvements
214,586

 
182,100

Machinery and equipment
428,298

 
360,974

Trailers and automotive equipment
2,544

 
2,626

Furniture and fixtures
12,854

 
12,052

Construction in progress
59,540

 
71,934

 
744,742

 
650,064

Less accumulated depreciation
305,369

 
248,917

Net property, plant and equipment
439,373

 
401,147

Goodwill
14,991

 
14,991

Other intangibles, net of accumulated amortization of $316,782 and $271,519 respectively
494,286

 
539,549

Other assets
19,581

 
13,792

Total Assets
$
1,502,080

 
$
1,461,759

Liabilities and Members’ Capital
 
 
 
Current liabilities:
 
 
 
Current installments of long-term debt
$
18,198

 
$
13,247

Cattle purchases payable
109,083

 
116,732

Accounts payable — trade
71,980

 
71,213

Due to affiliates
150

 
762

Accrued compensation and benefits
111,046

 
82,640

Accrued insurance
24,515

 
14,661

Other accrued expenses and liabilities
31,909

 
20,668

Total current liabilities
366,881

 
319,923

Long-term debt, excluding current installments
161,639

 
185,973

Other liabilities
22,273

 
26,655

Total liabilities
550,793

 
532,551

 
 
 
 
Commitments and contingencies
 
 
 
 
 
 
 
Members’ capital:
 
 
 
Members’ capital
951,366

 
929,265

Accumulated other comprehensive loss
(79
)
 
(57
)
Total members’ capital
951,287

 
929,208

Total Liabilities and Members' capital
$
1,502,080

 
$
1,461,759

See accompanying notes to consolidated financial statements.

NB-4


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES

Consolidated Statements of Operations
(in thousands)
 
52 weeks ended
December 29, 2018
 
52 weeks ended
December 30, 2017
 
53 weeks ended
December 31, 2016
Net sales
$
7,487,272

 
$
7,353,662

 
$
7,021,902

Costs and expenses:
 
 
 
 
 
Cost of sales
6,701,222

 
6,764,057

 
6,513,767

Selling, general and administrative
73,754

 
77,459

 
71,849

Depreciation and amortization
105,028

 
98,515

 
94,483

Total costs and expenses
6,880,004

 
6,940,031

 
6,680,099

Operating income
607,268

 
413,631

 
341,803

Other income (expense):
 
 
 
 
 
Interest income
314

 
339

 
166

Interest expense
(10,465
)
 
(6,658
)
 
(12,946
)
Income before taxes
597,117

 
407,312

 
329,023

Income tax expense
2,607

 
2,238

 
2,166

Net income
$
594,510

 
$
405,074

 
$
326,857

See accompanying notes to consolidated financial statements.

NB-5


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income
(in thousands)
 
52 weeks ended
December 29, 2018
 
52 weeks ended
December 30, 2017
 
53 weeks ended
December 31, 2016
Net income
$
594,510

 
$
405,074

 
$
326,857

Other comprehensive income:
 
 
 
 
 
Foreign currency translation adjustments
(22
)
 
80

 
(14
)
Comprehensive income
$
594,488

 
$
405,154

 
$
326,843

See accompanying notes to consolidated financial statements.

NB-6


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES

Consolidated Statements of Cash Flows
(in thousands)
 
52 weeks ended
December 29,
2018
 
52 weeks ended
December 30,
2017
 
53 weeks ended
December 31,
2016
Cash flows from operating activities:
 
 
 
 
 
Net income
$
594,510

 
$
405,074

 
$
326,857

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
105,028

 
98,515

 
94,483

Provision for doubtful accounts
9,575

 
9,416

 
9,910

Deferred income tax provision
248

 
823

 
217

Gain on disposal of property, plant and equipment
(960
)
 
(1,144
)
 
(98
)
Amortization of debt issuance costs
722

 
766

 
692

Change in assets and liabilities:
 
 
 
 
 
Accounts receivable
(38,056
)
 
(29,370
)
 
26,847

Due from affiliates
(17
)
 
132

 
(399
)
Other receivables
4,584

 
(2,787
)
 
2,432

Inventories
14,615

 
14,051

 
(40,018
)
Other assets
(9,829
)
 
(4,598
)
 
(10,466
)
Cattle purchases payable
(7,649
)
 
24,460

 
20,761

Accounts payable
(1,851
)
 
7,485

 
7,913

Due to affiliates
(612
)
 
(251
)
 
231

Accrued compensation and benefits
28,406

 
13,930

 
53,567

Accrued insurance
9,854

 
(10,381
)
 
(6,580
)
Other accrued expenses and liabilities
6,611

 
27,905

 
(2,491
)
Net cash provided by operating activities
715,179

 
554,026

 
483,858

Cash flows from investing activities:
 
 
 
 
 
Capital expenditures, including interest capitalized
(96,530
)
 
(70,446
)
 
(62,010
)
Proceeds from sale of property, plant and equipment
2,122

 
2,791

 
16,788

Net cash used in investing activities
(94,408
)
 
(67,655
)
 
(45,222
)
Cash flows from financing activities:
 
 
 
 
 
Receipts under revolving credit lines
255,288

 
280,000

 
120,000

Payments under revolving credit lines
(290,288
)
 
(200,000
)
 
(241,961
)
Repayments of term note payable

 
(17,500
)
 
(35,000
)
Receipts under reducing revolving credit lines
300,000

 
197,500

 

Payments under reducing revolving credit lines
(285,000
)
 
(335,000
)
 

Net repayments of other indebtedness/capital leases
(105
)
 
(119
)
 
(6,688
)
Cash paid for financing costs

 
(2,769
)
 

Member distributions
(572,409
)
 
(427,739
)
 
(255,082
)
Net cash used in financing activities
(592,514
)
 
(505,627
)
 
(418,731
)
Effect of exchange rate changes on cash
(27
)
 
70

 
(16
)
Net increase (decrease) in cash
28,230

 
(19,186
)
 
19,889

Cash and cash equivalents at beginning of period
18,516

 
37,702

 
17,813

Cash and cash equivalents at end of period
$
46,746

 
$
18,516

 
$
37,702

Supplemental disclosures:
 
 
 
 
 
Cash paid during the period for interest
$
11,333

 
$
6,512

 
$
13,851

Cash paid during the period for taxes
$
1,906

 
$
792

 
$
1,094

Supplemental non-cash disclosures of investing and financing activities:
 
 
 
 
 
Non-cash additions to property, plant and equipment
$
3,677

 
$

 
$

Assets acquired through capital lease
$
147

 
$
137

 
$
305

See accompanying notes to consolidated financial statements.

NB-7


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES

Consolidated Statements of Members’ Capital
(in thousands)
 
Members’ Capital
 
Accumulated Other
Comprehensive
(Loss) Income
 
TOTAL
Balance at December 26, 2015
$
880,155

 
$
(123
)
 
$
880,032

Net income
326,857

 

 
326,857

Distributions
(255,082
)
 

 
(255.082
)
Foreign currency translation adjustments

 
(14
)
 
(14
)
Balance at December 31, 2016
$
951,930

 
$
(137
)
 
$
951,793

Net income
405,074

 

 
405,074

Distributions
(427,739
)
 

 
(427,739
)
Foreign currency translation adjustments

 
80

 
80

Balance at December 30, 2017
$
929,265

 
$
(57
)
 
$
929,208

Net income
594,510

 

 
594,510

Distributions
(572,409
)
 

 
(572.409
)
Foreign currency translation adjustments

 
(22
)
 
(22
)
Balance at December 29, 2018
$
951,366

 
$
(79
)
 
$
951,287

See accompanying notes to consolidated financial statements.

NB-8


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1.  DESCRIPTION OF BUSINESS
National Beef Packing Company, LLC (the Company) is a Delaware limited liability company.  The Company and its subsidiaries sell meat products to customers in the food service, international, further processor and retail distribution channels. The Company also produces and sells by-products that are derived from its meat processing operations and variety meats to customers in various industries.
The Company operates beef slaughter and fabrication facilities in Liberal and Dodge City, Kansas, and consumer-ready beef and pork processing facilities in Hummels Wharf, Pennsylvania, Moultrie, Georgia, and Kansas City, Kansas. National Carriers, Inc., or National Carriers, a wholly-owned subsidiary located in Dallas, Texas, provides trucking services to the Company and third parties and National Elite Transportation, LLC, or National Elite, a wholly-owned subsidiary located in Springdale, Arkansas, provides third-party logistics services to the transportation industry. National Beef Leathers, LLC, or NBL, a wholly-owned subsidiary located in St. Joseph, Missouri, provides wet blue hide tanning services for the Company. Kansas City Steak Company, LLC, or Kansas City Steak, includes a direct to consumer business and operates a warehouse and fulfilment facility in Kansas City, Kansas.  As of December 29, 2018 and December 30, 2017, approximately 63% of our employees were represented by collective bargaining agreements.  The Company makes certain contributions for the benefit of employees (see Note 6).
On June 5, 2018, Marfrig Global Foods S.A (Marfrig) acquired a 51% interest in the Company from certain existing members for aggregate net cash consideration of approximately $969.0 million.
NOTE 2.  BASIS OF PRESENTATION AND ACCOUNTING POLICIES
Basis of Presentation and Consolidation
The consolidated financial statements include the accounts of the Company and its direct and indirect subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
The 2016 and 2015 statement of cash flows have been revised to present borrowings and repayments under the revolving line of credit on a gross basis. This change in presentation does not affect previously reported cash flows (used in) provided by financing activities in the Consolidated Statements of Cash Flows.  This reclassification does not impact net income.  
Accounting Changes
Except for the changes discussed below, the Company has consistently applied the accounting policies to all periods presented in the consolidated financial statements.
Effective December 31, 2017, the beginning of our 2018 fiscal year, the Company adopted Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 606, "Revenue from Contracts with Customers" ("ASC 606"). We adopted this standard, using the cumulative effect adjustment, often referred to as modified retrospective approach. Under this method, we did not restate the prior financial statements presented. There was no cumulative effect to be recorded as an adjustment to the opening balance of retained earnings. The comparative information was not restated and continues to be presented under the accounting standards in effect for those periods. Additional information regarding revenue recognition is included in “Note 3. Revenue Recognition.”
Fiscal Year
The Company’s fiscal year consists of 52 or 53 weeks, ending on the last Saturday in December.  Fiscal 2018 and 2017 were 52 week fiscal years while fiscal 2016 was a 53 week fiscal year. All references to years in these notes to consolidated financial statements represent fiscal years unless otherwise noted.
Use of Estimates
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, using management’s best estimates and judgments where appropriate. These estimates and judgments affect the reported amounts of assets and liabilities and disclosure of the contingent assets and liabilities at the date of the financial statements. The estimates and judgments will also affect the reported amounts for certain revenues and expenses during the reporting period.  Actual results could differ materially from these estimates and judgments.

NB-9


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Allowance for Returns and Doubtful Accounts
The allowance for returns and doubtful accounts is the Company’s best estimate of the amount of probable returns and credit losses in the Company’s existing accounts receivable.  The Company determines these allowances based on historical experience, customer conditions and management’s judgments. Management considers factors such as changes in the economy and industry.  Specific accounts are reviewed individually for collectability.
The following table represents the rollforward of the allowance for returns and doubtful accounts for the fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016 (in thousands).
Period Ended
 
Beginning Balance
 
Provision
 
Charge Off
 
Ending Balance
December 31, 2016
 
$
(5,429
)
 
$
(9,910
)
 
$
11,395

 
$
(3,944
)
December 30, 2017
 
$
(3,944
)
 
$
(9,416
)
 
$
9,149

 
$
(4,211
)
December 29, 2018
 
$
(4,211
)
 
$
(9,575
)
 
$
11,202

 
$
(2,584
)
Inventories
Inventories consist primarily of beef and beef by-products and supplies, and are stated at the lower of cost or net realizable value, with cost principally determined under the first-in-first-out method for beef products and average cost for supplies. 
Inventories at December 29, 2018 and December 30, 2017 consisted of the following (in thousands):
 
December 29, 2018
 
December 30, 2017
Dressed and boxed beef products
$
181,032

 
$
190,103

Beef by-products
35,789

 
42,256

Supplies and other
29,866

 
28,943

Total inventory
$
246,687

 
$
261,302

Property, plant and equipment
Property, plant and equipment were recorded at fair value as of December 31, 2011 as a result of the Leucadia transaction.  Property, plant and equipment purchased subsequent to the transaction are recorded at cost.  Property, plant and equipment are depreciated principally on a straight-line basis over the estimated useful life of the individual asset by major asset class as follows:
Buildings and improvements
15 to 25 years
Machinery and equipment
2 to 15 years
Automotive equipment
2 to 4 years
Furniture and fixtures
3 to 5 years
Depreciation expense was $59.8 million, $53.3 million and $49.2 million for the fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016 respectively.
Upon disposition of these assets, any resulting gain or loss is included in selling, general, and administrative.  Major repairs and maintenance costs that extend the useful life of the related assets are capitalized.  Normal repairs and maintenance costs are charged to operations as incurred.
The Company capitalizes the cost of interest on borrowed funds which are used to finance the construction of certain property, plant and equipment.  Such capitalized interest costs are charged to the property, plant and equipment accounts and are amortized through depreciation charges over the estimated useful lives of the assets. Interest capitalized was $1.9 million, $1.0 million and $0.5 million for the fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016, respectively.

NB-10


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets held and used is assessed based on estimated undiscounted future cash flows.  Impairment, if any, is recognized based on fair value of the assets.  Assets to be disposed of are reported at the lower of cost or fair value less costs to sell, and are no longer depreciated. There were no events or circumstances which would indicate that the carrying amount of our property plant, and equipment may not be recoverable during 2018 or 2017.
Goodwill and Other Intangible Assets
ASC 350, Intangibles - Goodwill and Other, provides that goodwill shall not be amortized but shall be tested for impairment on an annual basis. Identifiable intangible assets with definite lives are amortized over their estimated useful lives.  The Company evaluates goodwill annually for impairment at the end of December and this test involves comparing the fair value of a reporting unit to the reporting unit’s book value to determine if any impairment exists.  Fair values are based on valuation techniques we believe market participants would use, although the valuation process requires significant judgment and often involves the use of significant estimates and assumptions. The Company calculates the fair value of the reporting unit using estimates of future cash flows and other market comparable information deemed appropriate. The estimates and assumptions used in determining fair value could have a significant effect on whether or not an impairment charge is recorded and the magnitude of such a charge.  If the book value of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. As a result of the testing performed on the Company’s goodwill the fair value exceeded the carrying value of the reporting unit and thus no impairment charge was recorded. Adverse market or economic events could result in impairment charges in future periods.
The amounts of goodwill are as follows (amounts in thousands):
 
December 29, 2018
 
December 30, 2017
Beginning balance
$
14,991

 
$
14,991

Adjustments

 

Ending balance
$
14,991

 
$
14,991

ASC 360, Impairment and Disposal of Long-Lived Assets, provides that we evaluate our long-lived assets for impairment whenever events or changes in circumstances indicate, in management’s judgment, that the carrying value of such assets may not be recoverable. When testing for impairment, we group our long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (or asset group). The determination of whether an asset group is recoverable is based on management’s estimate of undiscounted future cash flows directly attributable to the asset group as compared to its carrying value. If the carrying amount of the asset group is greater than the undiscounted cash flows, an impairment loss would be recognized for the amount by which the carrying amount of the asset group exceeds its estimated fair value. As a result of the review performed, no triggering events occurred during 2018 or 2017 related to the Company’s intangible assets, thus no impairment charge was recorded.
The amounts of other intangible assets are as follows (amounts in thousands):
 
Weighted
Average
Amortization
Period
 
December 29, 2018
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Intangible assets subject to amortization:
 
 
 
 
 
Customer relationships
18
 
$
406,530

 
$
158,095

Tradenames
20
 
260,108

 
91,093

Cattle supply contracts
15
 
143,600

 
67,013

Other
10
 
830

 
581

 
18
 
$
811,068

 
$
316,782

 
 
 
 
 
 
Total intangible assets
 
 
$
811,068

 
$
316,782


NB-11


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
Weighted
Average
Amortization
Period
 
December 30, 2017
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Intangible assets subject to amortization:
 
 
 
 
 
Customer relationships
18
 
$
406,530

 
$
135,510

Tradenames
20
 
260,108

 
78,071

Cattle supply contracts
15
 
143,600

 
57,440

Other
10
 
830

 
498

 
18
 
$
811,068

 
$
271,519

 
 
 
 
 
 
Total intangible assets
 
 
$
811,068

 
$
271,519

For the fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016 the Company recognized $45.3 million, $45.3 million and $45.3 million, respectively, of amortization expense on intangible assets. The following table reflects the anticipated amortization expense relative to intangible assets recognized in the Company’s consolidated balance sheet as of December 29, 2018, for each of the next five years and thereafter:
 
(Amounts in thousands)
Estimated amortization expense for fiscal years ended:
 
2019
$
45,245

2020
45,245

2021
45,245

2022
45,162

2023
45,159

Thereafter
268,230

Total
$
494,286

Overdraft Balances
The majority of the Company’s bank accounts are zero balance accounts where cash needs are funded as checks are presented for payment by the holder. Checks issued pending clearance that result in overdraft balances for accounting purposes are included in the trade accounts payable and cattle purchases payable balances, and the change in the related balances are reflected in operating activities on the Company’s consolidated statement of cash flows. 
Self-insurance
The Company is self-insured for certain losses relating to workers’ compensation, automobile liability, general liability and employee medical and dental benefits.  The Company has purchased stop-loss coverage in order to limit its exposure to any significant levels of claims. Self-insured losses are accrued in accrued insurance and other long-term liabilities in the Company’s consolidated balance sheets based upon the Company’s estimates of the aggregate uninsured claims incurred using actuarial assumptions accepted in the insurance industry and the Company’s historical experience rates.
Environmental Expenditures and Remediation Liabilities
Environmental expenditures that relate to current or future operations and which improve operational capabilities are capitalized at the time of expenditure. Expenditures that relate to an existing or prior condition caused by past operations, and do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated.

NB-12


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Foreign Currency Translation
The Company has representative offices located in Tokyo, Japan; Seoul, South Korea; and Hong Kong. The primary activity of these offices is to assist customers with product and order related issues. For foreign operations, the local currency is the functional currency. Translation into U.S. dollars is performed for assets and liabilities at the exchange rates as of the balance sheet date. Income and expense accounts are recorded at average exchange rates for the period.  Adjustments resulting from the translation are reflected as a separate component of other comprehensive income.
Income Taxes 
The provision for income taxes is computed on a separate legal entity basis.  Accordingly, as the Company is a limited liability company, the separate legal entity does not provide for income taxes, as the results of operations are included in the taxable income of the individual members. However, certain states impose privilege taxes on the apportioned taxable income or income related measurements of the Company.  To the extent that entities provide for income taxes, deferred tax assets and liabilities are recognized based on the differences between the financial statement and tax basis of assets and liabilities at each balance sheet date using enacted tax rates expected to be in effect in the year the differences are expected to reverse and are thus included in the consolidated financial statements of the Company.  Based on federal income tax statute of limitations, National Carriers remains subject to examination of its income taxes for calendar years 2018, 2017, 2016 and 2015.
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments, including cash and cash equivalents, short-term trade and other receivables and payables, approximate their fair values due to the short-term nature of the instruments. The carrying value of debt approximates its fair value at December 29, 2018 and December 30, 2017, as substantially all debt carries variable interest rates.
Selling, General and Administrative Costs
Selling expenses consist primarily of salaries, trade promotions, advertising, commissions and other marketing costs. General and administrative costs consist primarily of general management, insurance and professional expenses.  Selling, general and administrative costs consist of aggregated expenses that generally apply to multiple locations.
Shipping Costs
Pass-through finished goods delivery costs reimbursed by customers are reported in sales, while an offsetting expense is included in cost of sales.
Advertising
Advertising expenses are charged to operations in the period incurred and were $16.2 million, $20.8 million and $19.2 million for the fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016.
Comprehensive Income
Comprehensive income consists of net income and foreign currency translation adjustments. 
Derivative Activities
The Company uses futures contracts in order to reduce exposure associated with entering into firm commitments to purchase live cattle at prices determined prior to the delivery of the cattle as well as firm commitments to sell certain beef products at sales prices determined prior to shipment. In accordance with ASC 815, Derivatives and Hedging, the Company accounts for futures contracts and their related firm purchase commitments at fair value. Firm commitments for sales are treated as normal sales and therefore not marked to market. Certain firm commitments to purchase cattle, are marked to market when a price has been agreed upon, otherwise they are treated as normal purchases and, therefore, not marked to market.  ASC 815 imposes extensive recordkeeping requirements in order to treat a derivative financial instrument as a hedge for accounting purposes. Derivatives qualify for treatment as hedges when there is a high correlation between the change in fair value of the instrument and the related change in fair value of the underlying commitment. For derivatives that qualify as effective hedges, the change in fair value has no net effect on earnings until the hedged transaction is settled. For derivatives that are not designated as hedging instruments, or for the ineffective portion of a hedging instrument, the change in fair value does affect current period net earnings.

NB-13


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

While management believes each of these instruments help mitigate various market risks, they are not designated and accounted for as hedges under ASC 815 as a result of the extensive recordkeeping requirements of this statement. Accordingly, the gains and losses associated with the change in fair value of the instrument and the offsetting gains and losses associated with changes in the market value of certain of the firm purchase commitments related to the futures contracts are recorded to income and expense in the period of change. 
The fair value of derivative assets is recognized within other current assets, while the fair value of derivative liabilities is recognized within accrued liabilities.
NOTE 3.  REVENUE RECOGNITION
The Company recognizes revenue mainly through retail, foodservice, international, and other distribution channels. Our revenues primarily result from contracts with customers and are generally short term in nature with the delivery of product as the single performance obligation. We recognize revenue for the sale of the product at the point in time when our performance obligation has been satisfied and control of the product has transferred to our customer, which generally occurs upon shipment or delivery to a customer based on terms of the sale. In accordance with Topic 340, an entity may elect a practical expedient that allows the entity to recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that the entity otherwise would have recognized is one year or less. Our contracts are generally less than one year, therefore we have elected this practical expedient and have recognized costs paid to obtain contracts as expense when incurred. Additionally, items that are not material in the context of the contract are recognized as expense. Any taxes collected on behalf of government authorities are excluded from net revenues.
Revenue is measured by the transaction price, which is defined as the amount of consideration we expect to receive in exchange for providing goods to customers. The transaction price is adjusted for estimates of known or expected variable consideration, which includes consumer incentives, trade promotions, and allowances, such as discounts, rebates, volume-based incentives, cooperative advertising, and other programs. Variable consideration related to these programs is recorded as a reduction to revenue based on amounts we expect to pay. We base these estimates on current performance, historical utilization, and projected redemption rates of each program. We review and update these estimates regularly until the incentives or product returns are realized and the impact of any adjustments are recognized in the period the adjustments are identified. In many cases, key sales terms such as pricing and quantities ordered are established on a regular basis such that most customer arrangements and related incentives have a duration of less than one year. Amounts billed and due from customers are short term in nature and are classified as receivables since payments are unconditional and only the passage of time is required before payments are due. Additionally, we do not grant payment financing terms greater than one year.
Disaggregated Revenue
The following table further disaggregates our sales to customers by major revenue stream (in thousands):
 
December 29, 2018
Beef, pork & beef by-products
$
7,617,890

Other
229,931

Intercompany
(360,549
)
Net Sales
$
7,487,272

Contract Balances
Nearly all of the Company’s contracts with its customers are short-term, defined as less than one year. The Company receives payment from customers based on terms established with the customer. Payments are typically due within seven days of delivery. There are rarely contract assets related to costs incurred to perform in advance of scheduled billings. The Company, which ships internationally requires certain customers to pay in advance to avoid collection risk. Revenue contract liabilities relate to payments received in advance of satisfying the performance under the customer contract.
Changes in the contract liability balances during 2018 are as follows (in thousands):
 
December 29, 2018
 
December 31, 2017
 
Change
Contract liabilities
$
15,096

 
$
20,904

 
$
(5,808
)

NB-14


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Substantially all of the revenue was recognized in 2018 related to the prior year contract liability. The Company expects to recognize substantially all of the current year liability in 2019.
NOTE 4.  NEW ACCOUNTING PRONOUNCEMENTS
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), along with several updates, which, in an effort to increase transparency and comparability among organizations utilizing leasing, requires an entity that is a lessee to recognize the assets and liabilities arising from operating leases on the balance sheet. This guidance also requires disclosures about the amount, timing and uncertainty of cash flows arising from leases. In transition, the entity may elect to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach or the beginning of the period of adoption using a cumulative-effect adjustment approach. The provisions of the new guidance will be effective as of the beginning of our 2019 fiscal year. We will adopt the new standard as of December 30, 2018, the beginning of our 2019 fiscal year and recognize and measure leases at the beginning of the period of adoption. We will elect the package of practical expedients available under the transition guidance which, among other things, allows the carry-forward of historical lease classification. We will make an accounting policy election to not apply the new guidance to leases with a term of 12 months or less and will recognize those payments in the Consolidated Statement of Income on a straight-line basis over the lease term. We have implemented a system solution for administering our leases and facilitating compliance with the new guidance. Adoption of the standard is expected to result in an approximate $75 million increase in operating lease right of use assets and liabilities in our Consolidated Balance Sheet. However, we do not believe the standard will have a material impact on our Consolidated Statement of Operations.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which, in an effort to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments, replaces the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables and any other financial assets not excluded from the scope that have the contractual right to receive cash. The provisions of the new guidance will be effective as of the beginning of our 2020 fiscal year. Early adoption is permitted after our 2018 fiscal year. We are currently evaluating the impact of the new guidance on our financial statements and have not yet selected an adoption date.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, new accounting guidance to improve the effectiveness of disclosures related to fair value measurements. The new guidance removes certain disclosure requirements related to transfers between Level 1 and Level 2 of the fair value hierarchy along with the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements. Additions to the disclosure requirements include more quantitative information related to significant unobservable inputs used in Level 3 fair value measurements and gains and losses included in other comprehensive income. The new guidance will be effective as of our 2020 fiscal year with early adoption permitted. We are currently evaluating the impact of the new guidance on our financial statements and have not yet selected an adoption date.

NB-15


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5.  LONG-TERM DEBT AND LOAN AGREEMENTS 
The Company entered into various debt agreements in order to finance acquisitions and provide liquidity to operate the business on a going forward basis. As of December 29, 2018 and December 30, 2017, debt consisted of the following:
 
December 29, 2018
 
December 30, 2017
(in thousands)
Short-term debt:
 
 
 
Reducing revolver credit facility (a)
18,750

 
13,750

Current portion of loan costs (c)
(723
)
 
(724
)
Current portion of capital lease obligations (c)
171

 
221

 
18,198

 
13,247

Long-term debt:
 
 
 
Reducing revolver credit facility (a)
116,250

 
106,250

Industrial Development Revenue Bonds (b)
2,000

 
2,000

Revolving credit facility (a)
45,000

 
80,000

Long-term portion of loan costs (c)
(1,746
)
 
(2,468
)
Long-term capital lease obligations (c)
135

 
191

 
161,639

 
185,973

Total debt
$
179,837

 
$
199,220

___________________________________
(a)Senior Credit Facilities - In June 2017, the Company entered into a Third Amended and Restated Credit Agreement (the "Debt Agreement"). The Debt Agreement matures in June 2022. In March 2018, the Company amended the Debt Agreement to include a $375.0 million reducing revolver loan and a $275.0 million revolving credit facility. The reducing revolver loan commitment decreases by approximately $18.8 million on each annual anniversary of the Debt Agreement. The Debt Agreement is secured by a first priority lien on substantially all of the assets of the Company and its subsidiaries and includes customary covenants including a single financial covenant that requires the Company to maintain a minimum tangible net worth; at December 29, 2018, the Company was in compliance with the single financial covenant.
At December 29, 2018, the Company’s outstanding debt under the Debt Agreement consisted of a reducing revolver loan with an outstanding balance of $135.0 million and $45.0 million drawn on the revolving credit facility.  The reducing revolving loan and the revolving credit facility bear interest at the Base Rate or the LIBOR Rate (as defined in the credit facility), plus a margin ranging from 0.75% to 3.0% depending upon certain financial ratios and the rate selected.  At December 29, 2018, the interest rates on the outstanding reducing revolving loan and revolving credit facility were 4.1% and 4.2%, respectively. 
Borrowings under the reducing revolver loan and the revolving credit facility are available for the Company’s working capital requirements, capital expenditures and other general corporate purposes.  Unused capacity under the revolving credit facility can also be used to issue letters of credit; letters of credit aggregating $13.9 million were outstanding at December 29, 2018.  Amounts available under the revolving credit facility are subject to a borrowing base calculation primarily comprised of receivable and inventory balances; amounts available under the reducing revolver facility are constrained only by the annual reduction in the commitment amount.  At December 29, 2018, after deducting outstanding amounts and issued letters of credit, $165.9 million of the unused revolving credit facility and $240.0 million of the reducing revolver commitment was available to the Company.
(b)Industrial Development Revenue Bonds—Effective December 30, 2004, the Company entered into a transaction with the City of Dodge City, Kansas, designed to provide property tax savings.  Under the transaction, the City purchased the Company’s Dodge City facility, or the facility, by issuing $102.3 million in bonds due in December 2019, used the proceeds to purchase the facility and leased the facility to the Company for an identical term under a capital lease.  The Company purchased the City's bonds with proceeds of its term loan under the Debt Agreement.  Because the City has assigned the lease to the bond trustee for the benefit of the Company as the sole bondholder, the Company, effectively controls enforcement of the lease against itself.  As a result of the capital lease treatment, the facility will remain a component of property, plant and equipment in the Company’s consolidated balance sheets.  As a result of the legal right of offset, the capital lease obligation and the corresponding bond investments have been eliminated in consolidation.  The transaction provides the Company with property tax exemptions for the leased facility, that, after netting payments to the City and local school district under payment in lieu of tax agreements, result in an annual property tax savings of approximately 25%.  The facility remains subject to a prior mortgage and security interest in favor of the lenders under the Debt Agreement. 

NB-16


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Additional revenue bonds may be issued to cover the costs of certain improvements to this facility.  The total amount of revenue bonds authorized for issuance is $120.0 million.
The cities of Liberal and Dodge City, Kansas issued an aggregate of $13.9 million of industrial development revenue bonds on the Company’s behalf to fund the purchase of equipment and construction improvements at the Company’s facilities in those cities. These bonds were issued in four series of $1.0 million, $1.0 million, $6.0 million and $5.9 million. Of the four series of bonds, only the $1.0 million and $1.0 million due on demand or on February 1, 2029 and March 1, 2027, respectively remain outstanding. The bonds issued in 1999 and 2000 are variable rate demand obligations that bear interest at a rate that is adjusted weekly, which rate will not exceed 10% per annum.  The Company has the option to redeem a series of bonds at any time for an amount equal to the principal plus accrued interest to the date of such redemption. The holders of the bonds have the option to tender the bonds upon seven days’ notice for an amount equal to par plus accrued interest. To the extent that the remarketing agent for the bonds is unable to resell any of the bonds that are tendered, the remarketing agent could use the letter of credit to fund such tender. Because each series of bonds is backed by a letter of credit under our Debt Agreement, these due-on-demand bonds have been presented as non-current obligations until twelve months prior to their maturity.
On December 17, 2010, National Beef Leathers, LLC, or Leathers, a subsidiary of NBP, entered into various agreements with the city of St. Joseph, Missouri, designed to provide NBP property tax savings.  Under the transaction, the city of St. Joseph issued $10.2 million in bonds due in December 2022, used the proceeds to purchase the equipment within the Leathers facility and subsequently leased the equipment back to us for an identical term under a capital lease.  The Company purchased the City's bonds with proceeds of our term loan under the Debt Agreement.  Because the city of St. Joseph has assigned the lease to the bond trustee for our benefit as the sole bondholder, the Company, effectively controls enforcement of the lease against ourselves.  As a result of the capital lease treatment, the equipment will remain a component of property, plant and equipment in NBP’s consolidated balance sheets.  As a result of the legal right of offset, the capital lease obligation and the corresponding bond investments will be eliminated in consolidation. 
(c)Debt issuance costs — In June 2017, the Company incurred financing charges of approximately $2.8 million related to the Debt Agreement. The finance charges will be amortized over the life of the loan.
Amortization of $0.7 million, $0.8 million and $0.7 million was charged to interest expense during the fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016, respectively. The Company had unamortized costs of $0.7 million and $0.7 million included in current installments of long-term debt on the consolidated balance sheets at December 29, 2018 and December 30, 2017, respectively, and unamortized costs of $1.7 million and $2.5 million included in long-term debt, excluding current installments on the consolidated balance sheets at December 29, 2018 and December 30, 2017, respectively.
The aggregate minimum principal maturities of the long-term debt for each of the five fiscal years and thereafter following December 29, 2018, are as follows:
 
Minimum
Principal
Maturities
 
(in thousands)
Fiscal year ending December:
 
2019
$
18,200

2020
18,122

2021
18,057

2022
123,458

2023

Thereafter
2,000

Total minimum principal maturities
$
179,837


NB-17


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

___________________________________
(d)Capital and Operating Leases—the Company leases a variety of buildings and equipment, as well as tractors and trailers through its subsidiary National Carriers, under capital and operating lease agreements that expire in various years.  Future minimum lease payments required at December 29, 2018, under capital leases are as follows:
 
Capital
Lease
Obligations
(in thousands)
Fiscal year ending December:
 
2019
$
171

2020
93

2021
42

2022

2023

Thereafter

Net minimum lease payments
$
306

Less: Amount representing interest
(29
)
Present value of net minimum lease payments
$
277

Future minimum lease payments required at December 29, 2018, under non-cancelable operating leases with terms exceeding one year, are as follows:
 
Non-cancelable
Operating Lease
Obligations
 
Fiscal year ending December:
 
2019
$
20,530

2020
14,663

2021
11,886

2022
8,044

2023
4,891

Thereafter
3,364

Minimum lease payments
63,378

Less: sublease income
(1,060
)
Net minimum lease payments
$
62,318

Rent expense associated with operating leases (net of sublease rental income) was $24.5 million, $20.6 million and $18.9 million for fiscal years 2018, 2017 and 2016, respectively.  The Company expects that it will renew lease agreements or enter into new leases as the existing leases expire.
Other Commitments
Utilities Commitment - Effective December 30, 2004, the Company finalized an agreement with the City of Dodge City, Kansas, whereby in consideration of certain improvements made to the city water and wastewater systems, the Company committed to make a series of service charge payments totaling $19.3 million over a 20-year period, of which $0.8 million was paid in each of the fiscal years 2018, 2017 and 2016, respectively.  Payments under the commitment will be $0.8 million in each of the fiscal years 2019 through 2023.
NOTE 6.  RETIREMENT PLANS
The Company maintains tax-qualified employee savings and retirement plans, or the 401(k) Plans, covering certain of the Company’s employees. Pursuant to the 401(k) Plans, eligible employees may elect to reduce their current compensation by up to the lesser of 75% of their annual compensation or the statutorily prescribed annual limit and have the amount of such reduction

NB-18


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

contributed to the 401(k) Plans. The 401(k) Plans provide for additional matching contributions by the Company, based on specific terms contained in the 401(k) Plans. The trustees of the 401(k) Plans, at the direction of each participant, invest the assets of the 401(k) Plan in designated investment options.  The 401(k) Plans are intended to qualify under Section 401 of the Internal Revenue Code. Expenses related to the 401(k) Plans totaled approximately $1.5 million, $1.3 million and $1.2 million for the fiscal years 2018, 2017 and 2016, respectively.
During 2017, the Company bargained with the United Food and Commercial Workers International Union (UFCW) Local 2 for a complete withdrawal from the UFCW Plan. As a result, the Company is required to make withdrawal payments into the fund over a 20-year period. The Company recorded expenses related to the UFCW Plan withdrawal of approximately $18.6 million which is included in Cost of sales in the Consolidated Statements of Operations for the 52 week period ending December 20, 2017. Payments into the UFCW Plan began during 2018. The current portion of the withdrawal liability is approximately $0.7 million and is included in Other accrued expenses and liabilities on the Consolidated Balance Sheets. The long-term portion of the withdrawal liability is approximately $18.0 million and is included in Other liabilities on the Consolidated Balance Sheets.
NOTE 7.  INCOME TAXES
Income tax expense includes the following current and deferred provisions: 
 
52 weeks ended
December 29, 2018
 
52 weeks ended
December 30, 2017
 
53 weeks ended
December 31, 2016
 
(in thousands)
Current provision:
 
 
 
 
 
Federal
$
1,233

 
$
764

 
$
1,139

State
1,081

 
594

 
775

Foreign
45

 
57

 
35

Total current tax expense
2,359

 
1,415

 
1,949

Deferred provision:
 
 
 
 
 
Federal
200

 
707

 
184

State
48

 
116

 
33

Foreign

 

 

Total deferred tax expense
248

 
823

 
217

Total income tax expense
$
2,607

 
$
2,238

 
$
2,166

Income tax expense differed from the “expected” income tax (computed by applying the federal income tax rate of 21% in 2018 and 35% in 2017 and 2016 to earnings before income taxes) as follows:
 
52 weeks ended
December 29, 2018
 
52 weeks ended
December 30, 2017
 
53 weeks ended
December 31, 2016
(in thousands)
Computed “expected” income tax expense
$
125,395

 
$
142,559

 
$
115,158

Passthrough “expected” income tax expense
(124,152
)
 
(141,632
)
 
(113,462
)
State taxes, net of federal
1,129

 
710

 
815

Permanent differences
229

 
313

 
312

Rate Change

 
312

 

Other
6

 
(24
)
 
(657
)
Total income tax expense
$
2,607

 
$
2,238

 
$
2,166

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 29, 2018 and December 30, 2017 are presented below:

NB-19


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 


December 29, 2018
 
December 30, 2017
(in thousands)
Deferred tax assets:
 
 
 
Accounts receivable, due to allowance for doubtful accounts
$
18

 
$
30

Intangible assets
41

 
57

Self-insurance and workers’ compensation accruals
822

 
802

Employee benefit accruals
174

 
168

Total gross deferred tax assets
1,055

 
1,057

Deferred tax liabilities:
 
 
 
Plant and equipment, principally due to differences in depreciation
1,076

 
834

Other
65

 
61

Total gross deferred tax liabilities
1,141

 
895

Net deferred tax (liabilities) assets
$
(86
)
 
$
162

Net deferred tax liabilities at December 29, 2018 are included in the consolidated balance sheet as other liabilities. Net deferred tax assets at December 30, 2017 are included in the consolidated balance sheet as other current assets.
Deferred tax assets relate to the operations of National Carriers.
There were no valuation allowances provided for at December 29, 2018 and December 30, 2017.  Management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. There are no unrecognized tax benefits recorded in the Company’s Consolidated Financial Statements as of December 29, 2018 or December 30, 2017.
NOTE 8.  RELATED PARTY TRANSACTIONS
The Company entered into various transactions with a company affiliated with NBPCo Holdings in the ordinary course of business.
During fiscal years 2018, 2017 and 2016, the Company had sales and purchases with the following related parties (amounts in thousands):
 
52 weeks ended
December 29, 2018
 
52 weeks ended
December 30, 2017
 
53 weeks ended
December 31, 2016
Sales to:
 
 
 
 
 
Beef Products, Inc. (1)
$
28,360

 
$
31,672

 
$
30,879

Total sales to affiliate
$
28,360

 
$
31,672

 
$
30,879

Purchases from:
 
 
 
 
 
Beef Products, Inc. (1)
$
12,750

 
$
13,410

 
$
14,850

Total purchases from affiliate
$
12,750

 
$
13,410

 
$
14,850

___________________________________
(1)Beef Products, Inc. (BPI) is an affiliate of NBPCo Holdings
At December 29, 2018 and December 30, 2017, the amounts due from BPI for the sale of beef trimmings were approximately $0.8 million and $0.8 million, respectively.  At December 29, 2018 and December 30, 2017, the amounts due to BPI for the purchase of processed lean beef were approximately $0.2 million and $0.3 million, respectively.
In January 2007, we entered into an agreement with BPI for BPI to manufacture and install a grinding system in one of our plants.  In accordance with the agreement with BPI, we are to pay BPI a technology and support fee based on the number of pounds of product produced using the grinding system.  The installation of the grinding system was completed in fiscal year 2008.  We paid approximately $1.7 million during each of the fiscal years 2018, 2017 and 2016, to BPI in technology and support fees.
We participate in a cattle supply agreement with US Premium Beef, a minority owner.  Under this agreement we have agreed to purchase 735,385 head of cattle each year (subject to adjustment), from the members of US Premium Beef, with prices based on

NB-20


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

those published by the U.S. Department of Agriculture, subject to adjustments for cattle performance.  We obtained approximately 25% and 24% of our cattle requirements under this agreement during 2018 and 2017, respectively.
NOTE 9.  FAIR VALUE MEASUREMENTS
The Company determines fair value utilizing a three-level fair value hierarchy that prioritizes the inputs used to measure fair value.  The fair value hierarchy gives the highest priority to quoted market prices (Level 1) and the lowest priority to unobservable inputs (Level 3).  The three levels of inputs used to measure fair value are as follows:
Level 1 — quoted prices in active markets for identical assets or liabilities accessible by the reporting entity.
Level 2 — observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 — unobservable inputs for an asset or liability.  Unobservable inputs should only be used to the extent observable inputs are not available.
The following table details the assets and liabilities measured at fair value on a recurring basis as of December 29, 2018, and December 30, 2017 and also the level within the fair value hierarchy used to measure each category of assets (in thousands).
Description
 
December 29, 2018
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs (Level 2)
Significant
Unobservable
Inputs
(Level 3)
Other current assets — derivatives
 
$
571

 
$

$
571

$

Other accrued expenses and liabilities — derivatives
 
$
575

 
$
566

$
9

$

Description
 
December 30, 2017
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs (Level 2)
Significant
Unobservable
Inputs
(Level 3)
Other current assets — derivatives
 
$
2,880

 
$
2,122

$
758

$

Other current assets — promissory note
 
$
250

 
$

$

$
250

Other assets — promissory note
 
$
4,500

 
$

$

$
4,500

Other accrued expenses and liabilities — derivatives
 
$
2,100

 
$

$
2,100

$

NOTE 10.  DISCLOSURE ABOUT DERIVATIVE INSTRUMENTS
As part of the Company’s ongoing operations, the Company is exposed to market risks such as changes in commodity prices.  To manage these risks, the Company may enter into the following derivative instruments pursuant to our established policies:
Forward purchase contracts for cattle for use in our beef plants
Exchange traded futures contracts for cattle
Exchange traded futures contracts for agricultural products
While management believes each of these instruments help mitigate various market risks, they are not designated and accounted for as hedges as a result of the extensive recordkeeping requirements associated with hedge accounting.  Accordingly, the gains and losses associated with the change in fair value of the instruments are recorded to net sales and cost of goods sold in the period of change.  Certain firm commitments for live cattle purchases and all firm commitments for boxed beef sales are purchased in the normal course of business and are treated as normal purchases and sales and not recorded at fair value.
The Company enters into certain commodity derivatives, primarily with a diversified group of counterparties.  The maximum amount of loss due to the credit risk of the counterparties, should the counterparties fail to perform according to the terms of the contracts, is deemed to be immaterial as of December 29, 2018 and December 30, 2017.  The exchange-traded contracts have been entered into under a master netting agreement.  None of the derivatives entered into have credit-related contingent features. 

NB-21


NATIONAL BEEF PACKING COMPANY, LLC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the fair values as discussed in Note 8 and other information regarding derivative instruments not designated as hedging instruments as of December 29, 2018 and December 30, 2017 (in thousands of dollars):
 
Derivative Asset
As of December 29, 2018
 
Derivative Liability
As of December 29, 2018
 
Balance Sheet
Location
 
Fair Value
 
Balance Sheet
Location
 
Fair Value
Commodity contracts
Other current assets
 
$
571

 
Other accrued expenses and liabilities
 
$
575

Totals
 
 
$
571

 
 
 
$
575

 
Derivative Asset
As of December 30, 2017
 
Derivative Liability
As of December 30, 2017
 
Balance Sheet
Location
 
Fair Value
 
Balance Sheet
Location
 
Fair Value
Commodity contracts
Other current assets
 
$
2,880

 
Other accrued expenses and liabilities
 
$
2,100

Totals
 
 
$
2,880

 
 
 
$
2,100

The following table presents the unrealized and realized gains (losses) on derivative contracts as reflected in the Consolidated Statement of Operations for the fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016 (in thousands of dollars):
 
 
 
 
Amount of Gain or (Loss)
Recognized in
Income on Derivatives
Derivatives Not Designated as Hedging Instruments
 
Location of Gain or (Loss)
Recognized in Income
on Derivatives
 
Fiscal Year
Ended
December 29, 2018
 
Fiscal Year
Ended
December 30, 2017
 
Fiscal Year
Ended
December 31, 2016
Commodity contracts
 
Net sales
 
$
5,876

 
$
6,046

 
$
3,261

Commodity contracts
 
Cost of sales
 
4,936

 
(9,242
)
 
1,185

Totals
 
 
 
$
10,812

 
$
(3,196
)
 
$
4,446

NOTE 11.  LEGAL PROCEEDINGS AND CONTINGENCIES
In April 2014, the California Regional Water Quality Control Board Colorado River Basin Region (the “Regional Board”) issued an administrative civil liability complaint to the Company’s wholly-owned subsidiary, National Beef California, L.P. (“NBC”). The Complaint alleged that NBC violated federal National Pretreatment Standards regulations by introducing into the Brawley, California wastewater treatment plant (the “WWTP”) pollutants that caused “pass through” or “interference” with the WWTP. The complaint was assessed a penalty of approximately $3.8 million. A hearing before the Regional Board was scheduled for late October 2014, but the Regional Board withdrew its complaint in early October 2014 and requested the California State Water Resources Control Board (the “State Board”) to take up the matter. In response, the State Board issued an administrative civil liability complaint against NBC in January 2016, which sought a penalty of $1.65 million. The State Board withdrew its complaint in February 2016 and indicated that it intended to refile the complaint at a later date, but has yet to do so. The Company believes it has meritorious defenses to the State Board complaint and intends to defend against the complaint vigorously. There can be no assurances, however, as to the outcome of this matter or the impact on the Company’s consolidated financial position, results of operations and cash flows.
The Company is a party to a number of other lawsuits and claims arising out of the operation of its business. Management believes the ultimate resolution of such matters should not have a material adverse effect on the Company’s financial condition, results of operations or liquidity.
NOTE 12.  SUBSEQUENT EVENTS
On February 28, 2019 the Company acquired 100% of the ownership interests in Ohio Beef USA, LLC (Ohio Beef) from NBM US Holdings, Inc., a subsidiary of Marfrig, for $60 million. Ohio Beef is a fresh and frozen beef patty processor in North Baltimore, Ohio.
The Company evaluated subsequent events and transactions for potential recognition or disclosure in the financial statements through March 13, 2019, the date the financial statements were available for issuance.

NB-22

 


Berkadia Commercial
Mortgage Holding LLC
2018 Consolidated Financial Statements



Berkadia Commercial Mortgage Holding LLC
2018 Consolidated Financial Statements
Contents
 
Page(s)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Report of Independent Auditors
To the Berkadia Commercial Mortgage Holding LLC Board of Managers:
We have audited the accompanying consolidated financial statements of Berkadia Commercial Mortgage Holding LLC and its subsidiaries, which comprise the consolidated balance sheet as of December 31, 2018, and the related consolidated statements of income, comprehensive income, changes in members’ equity and cash flows for the year then ended.
Management's Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on the consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Berkadia Commercial Mortgage Holding LLC and its subsidiaries as of December 31, 2018, and the results of their operations and their cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.
Other Matter
The accompanying consolidated balance sheet of Berkadia Commercial Mortgage Holding LLC and its subsidiaries as of December 31, 2018, and the related consolidated statements of income, comprehensive income, changes in members’ equity and cash flows for the year then ended are presented for purposes of complying with Rule 3-09 of SEC Regulation S-X; however, Rule 3-09 does not require the 2017 or 2016 financial statements to be audited and they are therefore not covered by this report.


    /s/ PricewaterhouseCoopers LLP
McLean, Virginia
March 22, 2019


BRK-1



Berkadia Commercial Mortgage Holding LLC
Consolidated Balance Sheets
As of December 31, 2018 and 2017
(in thousands of dollars)
Audited
 
Unaudited
 
2018
 
2017
Assets
 
 
 
Cash and cash equivalents
$
29,497

 
$
43,816

Restricted cash
7,095

 
26,027

Servicing advances and other receivables
176,766

 
274,166

Investment securities available for sale
24,511

 
49,925

Investment security at fair value
111,326

 
139,087

Loans held for sale at fair value
1,298,109

 
909,082

Loans held for investment at fair value
94,476

 
104,240

Loans held for investment at amortized cost, net
527,406

 
717,533

Mortgage servicing rights, net of valuation allowance of $5.3 million and $19.7 million as of December 31, 2018 and 2017, respectively
874,644

 
752,968

Intangible assets, net
21,183

 
28,177

Other assets
107,897

 
69,351

Total assets
$
3,272,910

 
$
3,114,372

 
 
 
 
Liabilities
 
 
 
Financial guarantee liability
$
311,091

 
$
280,589

Accrued compensation and benefits
113,048

 
98,752

Accounts payable and other liabilities
73,573

 
75,701

Secured borrowings
771,037

 
716,072

Commercial paper
1,472,000

 
1,472,000

Total liabilities
2,740,749

 
2,643,114

 
 
 
 
Commitments and Contingencies (Note 21)

 

 
 
 
 
Equity
 
 
 
Members' equity
534,405

 
472,509

Accumulated other comprehensive loss, net of tax:
 
 
 
Net unrealized loss on investment securities
(599
)
 
(523
)
Net foreign currency translation adjustment
(1,645
)
 
(728
)
Total accumulated other comprehensive loss, net of tax
(2,244
)
 
(1,251
)
Total members' equity
532,161

 
471,258

Total liabilities and members' equity
$
3,272,910

 
$
3,114,372










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


BRK-2


Berkadia Commercial Mortgage Holding LLC
Consolidated Statements of Income
Years Ended December 31, 2018, 2017 and 2016
 
Audited
 
Unaudited
(in thousands of dollars)
2018
 
2017
 
2016
 
 
 
 
 
 
Revenues and Other Income
 
 
 
 
 
Mortgage servicing fees
$
190,933

 
$
160,822

 
$
138,842

Net gains
282,749

 
252,761

 
226,728

Interest income
158,843

 
137,832

 
109,193

Loan origination fees
162,760

 
149,104

 
127,110

Brokerage commission income
87,453

 
82,551

 
84,789

Other income
57,624

 
41,778

 
48,111

Total revenues and other income
940,362

 
824,848

 
734,773

 
 
 
 
 
 
Expenses
 
 
 
 
 
Salaries, incentive compensation and employee benefits
364,384

 
323,984

 
282,130

Depreciation and amortization
157,249

 
144,027

 
128,346

Recovery of mortgage servicing rights impairment, net
(14,344
)
 
(8,012
)
 
(35,866
)
Brokerage commission expense
64,165

 
55,994

 
58,974

Interest expense
54,479

 
42,282

 
27,440

Other expenses
76,658

 
72,671

 
66,688

Total expenses
702,591

 
630,946

 
527,712

 
 
 
 
 
 
Income before income tax provision
237,771

 
193,902

 
207,061

Income tax provision
3,064

 
3,172

 
1,987

Net income
$
234,707

 
$
190,730

 
$
205,074




























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


BRK-3


Berkadia Commercial Mortgage Holding LLC
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2018, 2017 and 2016
 
Audited
 
Unaudited
(in thousands of dollars)
2018
 
2017
 
2016
 
 
 
 
 
 
Net income
$
234,707

 
$
190,730

 
$
205,074

Other comprehensive income (loss):
 
 
 
 
 
Net unrealized holding gains (losses) on investments arising during the period, net of tax
675

 
(1,106
)
 
181

Less: reclassification adjustment for net gains(losses) included in net income (1), net of tax
(751
)
 
139

 

Net change in unrealized holding gains (losses) on investments, net of tax
(76
)
 
(967
)
 
181

 
 
 
 
 
 
Net foreign currency translation adjustments arising during the period, net of tax
(917
)
 
377

 
(130
)
Less: reclassification adjustment for foreign currency translation included in net income, net of tax

 

 

 
 
 
 
 
 
Net change in foreign currency translation adjustments, net of tax
(917
)
 
377

 
(130
)
Other comprehensive income (loss), net of tax
(993
)
 
(590
)
 
51

Comprehensive income
$
233,714

 
$
190,140

 
$
205,125

(1) 
Reported as a component of net gains in the consolidated statements of income.
















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


BRK-4


Berkadia Commercial Mortgage Holding LLC
Consolidated Statements of Changes in Members’ Equity
Years Ended December 31, 2018, 2017 and 2016
(in thousands of dollars)
Members'
Equity
 
Accumulated
Other
Comprehensive Income (Loss)
 
Total
 
 
 
 
 
 
Balance, January 1, 2016 (Unaudited)
$
436,295

 
$
(712
)
 
$
435,583

Net income
205,074

 

 
205,074

Other comprehensive income

 
51

 
51

Dividends paid
(213,613
)
 

 
(213,613
)
Balance, December 31, 2016 (Unaudited)
427,756

 
(661
)
 
427,095

 
 
 
 
 
 
Net income
190,730

 

 
190,730

Other comprehensive loss

 
(590
)
 
(590
)
Dividends paid
(145,977
)
 

 
(145,977
)
Balance, December 31, 2017 (Unaudited)
472,509

 
(1,251
)
 
471,258

 
 
 
 
 
 
Net income
234,707

 

 
234,707

Other comprehensive loss

 
(993
)
 
(993
)
Dividends paid
(172,811
)
 

 
(172,811
)
Balance, December 31, 2018 (Audited)
$
534,405

 
$
(2,244
)
 
$
532,161





























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


BRK-5


Berkadia Commercial Mortgage Holding LLC
Consolidated Statements of Cash Flows
Years Ended December 31, 2018, 2017 and 2016
(in thousands of dollars)
Audited
 
Unaudited
2018
 
2017
 
2016
 
 
 
 
 
 
Operating Activities
 
 
 
 
 
Net income
$
234,707

 
$
190,730

 
$
205,074

Adjustments to reconcile net income to net cash (used in) provided by operating activities:
 
 
 
 
 
Net gains
(282,749
)
 
(252,761
)
 
(226,728
)
Depreciation and amortization
157,249

 
144,027

 
128,346

Recovery of mortgage servicing rights impairment, net
(14,344
)
 
(8,012
)
 
(35,866
)
Other adjustments to net income
(69
)
 
3,936

 
2,724

Net change in assets and liabilities which (used) provided cash:
 
 
 
 
 
Servicing advances and other receivables
97,807

 
(51,920
)
 
289,742

Other assets
(29,956
)
 
1,808

 
(15,102
)
Accrued compensation and benefits
14,331

 
14,492

 
3,616

Accounts payable and other liabilities
(7,278
)
 
(6,595
)
 
867

Proceeds from sales of loans held for sale
17,918,376

 
17,416,515

 
15,832,286

Origination of loans held for sale
(18,240,030
)
 
(16,444,968
)
 
(13,120,103
)
Net cash (used in) provided by operating activities
(151,956
)
 
1,007,252

 
3,064,856

 
 
 
 
 
 
Investing Activities
 
 
 
 
 
Net purchases of property and equipment
(9,072
)
 
(7,135
)
 
(10,809
)
Proceeds from sales of and repayments of loans held for investment
600,527

 
519,882

 
446,960

Origination of loans held for investment
(403,832
)
 
(611,043
)
 
(254,091
)
Purchases of investment securities available for sale

 
(35,202
)
 

Proceeds from maturities of investment securities available for sale

 
17,536

 

Proceeds from sales of investment securities available for sale
24,483

 

 

Proceeds received from investment security at fair value
35,018

 
45,943

 
48,038

Purchases of equity-method investments
(14,000
)
 

 

Other investing activities, net
(100
)
 
(5,195
)
 
(4,432
)
Net cash provided by (used in) investing activities
233,024

 
(75,214
)
 
225,666

 
 
 
 
 
 
Financing Activities
 
 
 
 
 
Net increase (decrease) in secured borrowings
53,053

 
(843,814
)
 
(2,004,580
)
Repayments of notes payable

 

 
(4,624
)
Proceeds from issuance of commercial paper
1,472,000

 
1,472,000

 
1,472,000

Repayments of commercial paper
(1,472,000
)
 
(1,472,000
)
 
(2,470,000
)
Dividends paid
(172,811
)
 
(145,977
)
 
(213,613
)
Net cash used in financing activities
(119,758
)
 
(989,791
)
 
(3,220,817
)
 
 
 
 
 
 
Effect of Foreign Exchange Rates on Cash
5,439

 
(3,433
)
 
1,123

Net (Decrease) Increase in Cash and cash equivalents and Restricted cash
(33,251
)
 
(61,186
)
 
70,828

Cash and cash equivalents and Restricted cash, January 1
69,843

 
131,029

 
60,201

Cash and cash equivalents and Restricted cash, December 31
$
36,592

 
$
69,843

 
$
131,029

 
 
 
 
 
 
Supplemental Disclosures of Cash Flow Information
 
 
 
 
 
Income taxes paid
$
2,910

 
$
2,730

 
$
1,575

Interest paid
53,683

 
37,981

 
26,279




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


BRK-6

Berkadia Commercial Mortgage Holding LLC
Notes to Consolidated Financial Statements


1.
Organization and Operations
Berkadia Commercial Mortgage Holding LLC is a holding company of various subsidiaries (together with its subsidiaries, the “Company”) engaged in mortgage banking, investment sales, and servicing of commercial/multifamily real estate loans. The Company’s principal subsidiaries include Berkadia Commercial Mortgage LLC (“BCM”), Berkadia Proprietary LLC, and Berkadia Real Estate Advisors LLC.
The Company’s members are wholly-owned subsidiaries of Jefferies Financial Group Inc. (“Jefferies”) and Berkshire Hathaway Inc. (“Berkshire Hathaway”), with each member holding a 50% voting membership interest and a 45% economic interest in the Company. A privately-held equity firm holds the residual 10% economic interest with no voting membership interest in the Company.
The Company originates commercial/multifamily real estate loans for the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”), the Government National Mortgage Association (“Ginnie Mae”) and the Federal Housing Administration (“FHA”), individually an “Agency” and collectively the “Agencies,” using their underwriting guidelines, and sells the loans (or issues related mortgage-backed securities) after the loans are funded. Provided the Company adheres to established underwriting guidelines, the Agencies (or institutional investors) purchase the principal amount of the loans plus accrued interest (or related mortgage-backed securities), and the Company retains the servicing rights. With respect to FHA loans, institutional investors purchase related Ginnie Mae mortgage-backed securities and the U.S. Department of Housing and Urban Development (“HUD”) provides insurance coverage. In addition, the Company assumes a shared loss position throughout the term of each loan originated under Fannie Mae’s Delegated Underwriting and Servicing (“DUS™”) program. The Company also brokers loans for other third-party capital providers such as insurance companies, conduits, debt funds, banks and other financial institutions.
The Company is one of the largest servicers of commercial real estate loans in the United States with a servicing portfolio of approximately 18,000 loans and an unpaid principal balance of $235.4 billion as of December 31, 2018. BCM is a rated primary, master and special servicer for commercial mortgage-backed securities (“CMBS”) transactions, an approved servicer of Agency loans, and carries out servicing activities on a contracted basis for third parties such as insurance companies, banks and other financial institutions.
In addition, the Company originates commercial/multifamily real estate loans that are not intended to be sold or brokered to third parties (“proprietary loans”). Such loans include interim financing to borrowers who intend to refinance on a longer-term basis with a third party.
The Company provides an investment sales platform focused on commercial/multifamily real estate assets. The Company provides services related to the acquisition and disposition of commercial/multifamily real estate assets, including brokerage services, asset review, market research, financial analysis and due diligence support.
As of December 31, 2018, the Company had 1,787 employees, of which 671 were located in India.


BRK-7

Berkadia Commercial Mortgage Holding LLC
Notes to Consolidated Financial Statements (continued)

2.
Risks and Uncertainties
In the ordinary course of business, the Company faces a variety of risks and uncertainties, the most important of which are summarized below:
The Company is exposed to interest rate and other market risks associated with its portfolio of loans and investment securities. Changes in the level of interest rates or changes in yield curves, as well as changes in interest rate spreads, could adversely affect the estimated fair value of the Company’s portfolio of loans and investment securities and its net income.
The Company is exposed to liquidity risk associated with its ability to manage unplanned changes in funding sources and its ability to meet obligations when they come due. The Company’s mix of funding sources includes commercial paper and third-party financing arrangements as further discussed in Note 16. A portion of the Company’s operations is funded by commercial paper notes with minimum credit rating requirements. The ratings of the commercial paper notes are directly linked to that of Berkshire Hathaway, as guarantor of an unconditional and irrevocable surety bond issued by a wholly-owned subsidiary of Berkshire Hathaway. Unplanned changes or reductions in funding sources could adversely affect the Company’s ability to run its business and meet its obligations when they come due.
The Company’s ability to generate income through mortgage loan sales to institutional investors depends in part on programs sponsored by Fannie Mae, Freddie Mac and the FHA, which purchase loans from the Company and/or facilitate the issuance of mortgage-backed securities in the secondary market. In November 2018, the Federal Housing Finance Agency announced that Fannie Mae’s and Freddie Mac’s 2019 multifamily loan purchases would be capped at $35 billion for each GSE, with exceptions for loans to finance energy or water efficiency improvements and loans on affordable units in cost-burdened renter markets. Risk exists for failed loan deliveries and the Company may be required to repurchase a delivered loan if there were a breach in the Company’s representations and warranties, which could materially affect the Company’s results of operations and cash flows.
Fannie Mae, Freddie Mac and the FHA are subject to regulatory and legislative reform and could be substantially modified or eliminated in the future. Any discontinuation of, or significant reduction or change in the operations of these programs, including a change to the conservatorship of Fannie Mae and Freddie Mac, could materially affect the Company’s results of operations and cash flows.
In order to maintain its status as an approved seller/servicer for Fannie Mae and Freddie Mac and its status as an FHA-approved mortgagee and issuer of Ginnie Mae mortgage-backed securities, BCM must comply with certain requirements and standards, financial and otherwise. Failure to do so could result in the termination of BCM’s status as an approved seller/servicer, mortgagee or issuer. In addition, Fannie Mae and Freddie Mac retain broad discretion to terminate BCM as a seller/servicer without cause upon notice. Fee-for-service customers are also permitted to terminate BCM on short notice.
As further discussed in Note 19, the Company assumes a shared loss position throughout the term of each loan originated under the Fannie Mae DUS™ program. Negative trends in the financial position of related borrowers, values of collateral underlying related loans, loan delinquencies and loan defaults could materially affect the Company’s results of operations and cash flows.
BCM is required under its servicing agreements to maintain certain minimum servicer ratings from the credit rating agencies. A downgrade below a certain level may give rise to the right of a customer or trustee of a securitization transaction to terminate BCM as servicer. BCM currently maintains ratings from Fitch Ratings (“Fitch”), Standard & Poor’s Financial Services (“S&P”), and Morningstar Credit Ratings (“Morningstar”). BCM’s primary servicing operations are rated CPS1 from Fitch, Strong from


BRK-8

Berkadia Commercial Mortgage Holding LLC
Notes to Consolidated Financial Statements (continued)

S&P, and MOR CS1 from Morningstar. BCM’s master servicing operations are rated CMS2 from Fitch, Above Average from S&P, and MOR CS1 from Morningstar. BCM’s special servicing operations are rated Above Average from S&P and MOR CS3 from Morningstar. Fitch does not provide a special servicing rating. Each of the ratings currently exceeds the minimum ratings required by the related servicing agreements. Ratings issued by the rating agencies can be withdrawn or lowered at any time.
The Company’s growth and success are dependent on its ability to attract and retain talented mortgage bankers and investment sales advisors so that the Company may succeed in a competitive marketplace. Failure to attract and retain such talent could adversely impact the Company’s results of operations and cash flows.
The Company holds loans on its balance sheet for investment purposes. If a borrower defaults, the Company may be forced to foreclose on the property securing the defaulted loan and suffer a loss or may have to sell the loan to a third party at a discount, either of which could reduce the Company’s profitability and cash flows.
The Company’s business and earnings are affected by general economic conditions, particularly in the commercial/multifamily real estate industry. The Company’s business and earnings are sensitive to changes in supply and demand of real estate properties and fluctuations in real estate debt financing markets. Unfavorable economic conditions could have an adverse effect on the Company’s business, including decreased demand for new loans and servicing of loans originated by third parties.
If the Company fails to comply with laws and regulations regarding the privacy, use, and security of customer information, or if the Company falls victim to a successful cyber-attack, the Company may be subject to legal and regulatory actions and its reputation could be harmed.
3.
Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Management believes the estimates utilized in preparing the consolidated financial statements and accompanying notes are reasonable. Actual results could differ from these estimates and assumptions.
The accompanying consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, and Welsh Road Funding LLC (“Welsh Road Funding”), a consolidated variable interest entity (“VIE”) designed for the sole purpose of issuing commercial paper notes. The Company consolidates Welsh Road Funding as it is the primary beneficiary of this VIE.
VIEs are commonly used in CMBS transactions for which the Company is the primary, master, or in some instances, special servicer. The primary beneficiary is the party who has both (1) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance; and (2) who, through its interest in the VIE, has the obligation to absorb losses or a right to receive benefits from the VIE that could potentially be significant to the VIE. To assess whether the Company has either of the above, management considers all the facts and circumstances relevant to the Company’s role and responsibility as servicer of assets held within the VIE, including the right other decision makers have in certain instances to remove the Company as servicer. As a result of this assessment, management has concluded that the Company is not the primary beneficiary in relation to VIEs for which it is servicer of the underlying assets. Management performs periodic


BRK-9

Berkadia Commercial Mortgage Holding LLC
Notes to Consolidated Financial Statements (continued)

reassessments of whether changes in facts and circumstances regarding the Company’s involvement with a VIE cause the Company’s consolidation conclusion to change.
All material intercompany balances and transactions have been eliminated upon consolidation.
The Company’s operations include significant transactions conducted with affiliated entities as more fully described in Note 21.
Cash and Cash Equivalents
Cash and cash equivalents include cash in banks and in overnight investments. The Company also considers all highly liquid investments with an original maturity of 3 months or less to be cash equivalents. Cash equivalents are reported at cost, which approximates fair value. The Company had no cash equivalents as of December 31, 2018 and 2017.
Restricted Cash
Restricted cash represents cash that is restricted as to withdrawal or usage and primarily includes amounts required to meet certain regulatory liquidity ratios as more fully described in Note 4 and amounts required to be maintained in connection with a secured borrowing agreement as more fully described in Note 16. Restricted cash is reported at cost, which approximates fair value.
Servicing Advances and Other Receivables
Servicing advances and other receivables are reported at net realizable value in accordance with Accounting Standards codification (“ASC”) Topic 310 Receivables. As a master servicer, the Company is generally required to advance funds to a securitization trust to cover delinquent payments on securitized loans and any taxes and insurance premiums not paid by borrowers or covered by borrowers’ escrow funds, provided that the servicer determines that the advances will be recoverable from loan payments or liquidation proceeds in the future. In certain circumstances, the Company has similar obligations to advance funds in connection with loans under which the Company is a primary servicer. Servicing advances are subject to periodic review to ensure continued recoverability. Servicing advances, along with accrued interest thereon, have priority over the rights of other investors in a securitization. As a result, a reserve for uncollectible servicing advances was not required as of December 31, 2018 and 2017.
Interest income, mortgage servicing fees and related revenue are recognized on an accrual basis as earned. Amounts earned but not yet collected are reported as a component of servicing advances and other receivables in the consolidated balance sheets.
Investment Securities Available for Sale
The classification of investment securities is based on management’s intent with respect to such securities in accordance with ASC Topic 320, Investments – Debt and Equity Securities. Investment securities classified as available for sale are carried at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income, net of tax. Realized gains and losses on the sale of investment securities are determined using the specific identification method and recognized in current period earnings.
The Company’s investment securities available for sale in an unrealized loss position are reviewed quarterly to identify declines in value that are other-than-temporary. In evaluating whether a decline in value is other-than-temporary, the Company considers several factors including, but not limited to, the following: (1) the extent and duration of the decline; (2) the reason for the decline in value (e.g., credit event, currency or interest rate related, including general credit spread widening); and (3) the financial condition and near-term prospects of the issuer.
GAAP requires that other-than-temporary impairment be recognized in earnings for a debt security in an unrealized loss position when an entity either (1) has the intent to sell the security or (2) more


BRK-10

Berkadia Commercial Mortgage Holding LLC
Notes to Consolidated Financial Statements (continued)

likely than not will be required to sell the debt security before its anticipated recovery. For all debt securities that meet either of these two criteria, the Company recognizes an impairment, which represents the difference between the security’s amortized cost basis and its estimated fair value. If the Company intends to sell or it is more likely than not that it will be required to sell an impaired security prior to recovery of its amortized cost basis, the security is other-than-temporarily impaired, and the full amount of the impairment is recognized as a loss through earnings. Otherwise, losses on securities which are other-than-temporarily impaired are separated into: (1) the portion of loss which represents the credit loss; and (2) the portion which is due to other factors. GAAP requires that the Company analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The credit loss portion is recognized as a loss through earnings while the loss due to other factors is recognized in other comprehensive income, net of tax.
Investment Security at Fair Value
The Company owns a 14.3% beneficial interest in a trust that holds various types of first and second lien, performing and non-performing residential mortgage loans as well as home equity lines of credit that were initially purchased by Berkshire Hathaway from a third party and subsequently transferred into a trust. The Company and the other two beneficial owners (both subsidiaries of Berkshire Hathaway) have rights to the cash flows related to the underlying assets of the trust based on their percentage ownership of the trust. The transferability of the Company’s beneficial interest is subject to the approval of the other two beneficial owners. The Company has elected to carry the investment at fair value in accordance with ASC Topic 825, Financial Instruments (“ASC Topic 825”). The investment is valued using a discounted cash flow model for which significant inputs include discount rate, prepayment speeds and net expected credit losses. Changes in fair value are recognized in earnings as a component of net gains in the consolidated statements of income.
Loans Held for Sale at Fair Value
The Company originates loans for the Agencies using their underwriting guidelines, and typically sells such loans approximately 30 – 45 days after the loans are funded. The Company has elected to carry loans held for sale at fair value in accordance with ASC Topic 825 due to the short duration that such loans are held on the consolidated balance sheet. Prior to funding, the Company enters into a commitment to sell loans at a fixed price. Management utilizes the contractually agreed-upon related forward sales commitments to estimate fair value. Included in this classification are FHA loans in the process of being modified in accordance with established Agency guidelines pending issuance of new Ginnie Mae mortgage-backed securities.
Loan origination fees and direct loan origination costs are recognized in earnings as incurred. Interest income is recognized on an accrual basis. Realized gains and losses on the sale of loans and unrealized gains and losses on loans held for sale are reported as a component of net gains in the consolidated statements of income.
Loans Held for Investment at Fair Value
The Company owns a syndicated interest in certain unsecured commercial loans from one corporate issuer as of December 31, 2018 and 2017, and has elected the fair value option in accordance with ASC Topic 825, because the loans trade over-the-counter and management utilizes Bloomberg Finance to estimate fair value. Management has the intent and the ability to hold these loans for the foreseeable future or until their maturity or payoff. The Company also held one whole loan on its balance sheet as of December 31, 2017 for which it elected the fair value option. The syndicated interest in certain unsecured commercial loans had an aggregate unpaid principal balance of $98.8 million and $99.6 million as of December 31, 2018 and 2017, respectively, and an aggregate fair value of $94.5 million and $99.7 million as of December 31, 2018 and 2017, respectively. The whole loan was priced using an internal model and had an unpaid principal balance and a fair value of approximately $4.5 million as of December 31, 2017 and fully paid off in 2018.


BRK-11

Berkadia Commercial Mortgage Holding LLC
Notes to Consolidated Financial Statements (continued)

Interest income is recognized on an accrual basis. Unrealized gains and losses on loans held for investment are reported as a component of net gains in the consolidated statements of income.
Loans Held for Investment at Amortized Cost
The Company owns a portfolio of proprietary loans that are carried at amortized cost net of an allowance for loans losses. Management has the intent and ability to hold these loans for the foreseeable future or until their maturity or payoff. Loans held for investment are subject to the establishment of an allowance for loan losses in accordance with ASU 310-10 (impairment measured on an individual loan basis) and ASU 450-50 (impairment measured at a portfolio level). Impaired loans are defined as loans for which principal and interest will not be collected in accordance with the contractual terms of the loan. As of December 31, 2018 and 2017, all loans were current. Management did not identify any impaired loans and therefore did not record a specific allowance for loan losses in accordance with ASU 310-10. In accordance with ASU 450-50, the Company recorded an allowance for loan losses of $3.3 million and $4.0 million as of December 31, 2018 and 2017, respectively.
Derivative Financial Instruments
The Company enters into loan commitments to extend credit to third parties. The commitments to extend credit are for mortgage loans at a specific interest rate. These commitments generally have fixed expiration dates or other termination clauses and may require a fee. The Company is committed to extend credit to the counterparties as long as there is no violation of any condition established in the commitment contracts. The Company simultaneously enters into an agreement to sell such mortgages to third-party investors at a fixed price. Both the loan origination and forward sale commitments qualify as derivative financial instruments.
The Company accounts for its derivative activities in accordance with ASC Topic 815, Derivatives and Hedging. The Company recognizes all derivatives on the consolidated balance sheets as assets or liabilities, as appropriate, measured at fair value. The change in fair value of the derivatives is recognized in current period earnings as a component of net gains in the consolidated statements of income.
Mortgage Servicing Rights
In accordance with ASC Topic 860, Transfers and Servicing, the Company capitalizes originated mortgage servicing rights at estimated fair value when the related loans are sold. The Company records purchased mortgage servicing rights at their cost at the time of acquisition, which approximates the fair value of such assets. Subsequent to origination or acquisition, mortgage servicing rights are carried at the lower of amortized cost or fair value. Amortization expense is recorded for each stratum in proportion to, and over the period of, the projected net servicing cash flows and is reported as a component of depreciation and amortization in the consolidated statements of income.
Management evaluates mortgage servicing rights for impairment by stratifying the servicing portfolio according to predominant risk characteristics, primarily investor and loan type (e.g., CMBS, FHA/Ginnie Mae, government sponsored enterprise (“GSE”), and other). To the extent that the carrying value of an individual stratum exceeds its estimated fair value, management considers the mortgage servicing right asset to be impaired. Impairment is recognized through the establishment of a valuation allowance, with a corresponding charge to earnings in the period that the impairment is determined to have occurred, or as a direct write-down to the mortgage servicing right asset if the impairment is deemed to be other-than-temporary. The valuation allowance is adjusted to reflect changes in the measurement of impairment after the initial measurement of impairment. Fair value in excess of the carrying value for that stratum, however, is not recognized. See Note 11 for changes in the valuation allowance for the years ended December 31, 2018 and 2017.


BRK-12

Berkadia Commercial Mortgage Holding LLC
Notes to Consolidated Financial Statements (continued)

Management estimates the fair value of mortgage servicing rights based upon market transactions for comparable servicing assets if available or, in the absence of representative market information, based upon other available market evidence and modeled market expectations of the present value of future estimated net cash flows that market participants would expect to be derived from servicing. Because benchmark market data and quoted market prices related to specific transactions are generally not available, management estimates the fair value of mortgage servicing rights through a discounted cash flow analysis and evaluation of current market information. Cash flows are derived based upon internal operating assumptions that management believes would be used by market participants, such as prepayment speeds, default rates, interest rates, discount rates, costs to service and other assumptions (see Note 18 for significant unobservable inputs regarding “servicing value”). Actual prepayment speeds, default rates and costs to service may differ from those projected by management due to changes in a variety of economic factors; accordingly, the servicing assets actually realized, or the servicing liabilities actually incurred, as applicable, could differ from the amounts initially recorded. Management considers all available information and exercises significant judgment in estimating and assuming values for key variables in the modeling and discounting process.
Intangible Assets
The Company’s intangible assets consist of customer relationships. In accordance with ASC Topic 350, Intangibles – Goodwill and Other, the customer relationships are being amortized on a straight-line basis over their estimated useful lives ranging from 4 to 10 years. Management reviews intangible assets for impairment on an annual basis. Management may also review intangible assets for impairment more frequently if events or changes in circumstances indicate that the assets might be impaired.
Property, Equipment and Leasehold Improvements
Property, equipment and leasehold improvements are carried at cost net of accumulated depreciation, and are reported as a component of other assets in the consolidated balance sheets in accordance with ASC Topic 360, Property, Plant and Equipment. Depreciation is computed on the straight-line basis over the estimated useful lives of the assets. Software development costs associated with construction and improvement of internal systems are capitalized. Maintenance and repairs are expensed as incurred.
Financial Guarantee Liability
Certain mortgage loans are originated under the Fannie Mae DUS™ program. The Company assumes a shared loss position throughout the term of each loan originated under this program and receives a higher service fee in return. The Company accounts for its exposure to loss under the program with Fannie Mae as a guarantee in accordance with ASC Topic 460, Guarantees. The Company records a liability at inception for the estimated fair value of the guarantee. Management estimates the fair value of the guarantee based upon the present value of compensation expected to be received for providing the guarantee. Subsequent to inception, the liability is accreted back into earnings over the estimated life of the loans and is carried at the greater of the unamortized guarantee revenue or the estimated incurred loss. The net change in the financial guarantee liability is reported as a component of net gains in the consolidated statements of income.
Revenue Recognition
Revenue is recognized when it is realized or realizable, and earned in accordance with ASC Topic 605, Revenue Recognition. Mortgage servicing fees, loan origination fees, brokerage commission income, and other fees are recognized on an accrual basis as earned. Gains are primarily recognized on the sale of loans and upon the capitalization of originated mortgage servicing rights when the related loans are sold. Gains related to certain derivative financial instruments are recognized when the Company enters into loan commitments to extend credit. Interest income from interest-earning assets, including interest income on loans, investment securities and servicing advances, is


BRK-13

Berkadia Commercial Mortgage Holding LLC
Notes to Consolidated Financial Statements (continued)

recognized on an accrual basis over the life of the asset based on the contractual rates and terms of the relevant contract.
Income Taxes
The Company provides for income taxes on all transactions that have been recognized in the consolidated financial statements in accordance with ASC Topic 740, Income Taxes. Accordingly, deferred taxes are adjusted to reflect the tax rates at which future taxable amounts will likely be settled or realized. The effects of tax rate changes on future deferred tax liabilities and deferred tax assets, as well as other changes in income tax laws, are recognized in the period during which such changes are enacted. Deferred taxes are recognized subject to management’s judgment that the realization is more likely than not.
The Company is a pass-through entity for U.S. federal tax purposes and therefore does not provide for federal income taxes. On a standalone basis, federal income taxes are provided for by the Company’s wholly-owned U.S. subsidiaries Berkadia Commercial Mortgage Inc. and Berkadia Real Estate Advisors Inc.
Interest and penalties recognized in relation to uncertain tax positions are classified as income tax expense. The Company had no uncertain tax positions as of December 31, 2018 and 2017.
Comprehensive Income
ASC Topic 220, Comprehensive Income, establishes standards for reporting and presentation of comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income comprises all components of net income and other comprehensive income. Components of other comprehensive income for the Company relate to investment securities available for sale and foreign currency translation and are reported in the Company’s consolidated statements of comprehensive income.
Recently Issued and Adopted Accounting Standards
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017. Management adopted the amendments in this ASU and they did not have a material effect on the Company’s consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, new guidance on the Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments. The guidance provides eight targeted changes on the classification of certain cash receipts and payments in the statement of cash flows. In November 2016, the FASB issued ASU 2016-18, new guidance on restricted cash. The guidance requires the statement of cash flows to present and explain changes in restricted cash and restricted cash equivalents. The amendments in these ASU’s are effective for fiscal years beginning after December 15, 2017. Management adopted the amendments in these ASU’s and now reconciles Net income to Cash and cash equivalents and Restricted cash.
Recently Issued Accounting Standards Not Yet Adopted
In May 2014, the FASB amended their Accounting Standards Codification and created a new Topic 606, Revenue from Contracts with Customers. The objectives of Topic 606 are to remove inconsistencies and weaknesses in revenue requirements; provide a more robust framework for addressing revenue issues; improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; provide more useful information to users of financial statements through improved disclosure requirements; and simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. The guidance in this new Topic supersedes the revenue recognition requirements in Topic 605, Revenue Recognition,