UNITED COMPONENTS INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q


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

		For the quarterly period ended March 31, 2004


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

		For the transition period from to

Commission File Number: 333-107219

UNITED COMPONENTS, INC.

(Exact Name of Registrant as Specified in Its Charter)


Delaware
(State or Other Jurisdiction of Incorporation or Organization)		04-3759857 (I.R.S. Employer Identification No.)

14601 Highway 41 North
Evansville, Indiana		47725
(Address of Principal Executive Offices)		(Zip Code)

(812) 867-4156
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes o No x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes o No x

The registrant had 1,000 shares of its $0.01 par value common stock outstanding as of May 13, 2004.

Index

United Components, Inc.


Part I		FINANCIAL INFORMATION
Item 1.		Financial Statements (unaudited)
		Condensed balance sheets—March 31, 2004 and December 31, 2003
		Condensed income statements—Three months ended March 31, 2004 and 2003
		Condensed statements of cash flows—Three months ended March 31, 2004 and 2003
		Statement of changes in shareholder’s equity—December 31, 2003 and March 31, 2004
		Notes to condensed financial statements
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Qualitative and Quantitative Information About Market Risk
Item 4.		Controls and Procedures
Part II		OTHER INFORMATION
Item 6.		Exhibits and Reports on Form 8-K
Signatures
Exhibits

FORWARD-LOOKING STATEMENTS

In this periodic report on Form 10-Q, United Components. Inc. (“UCI”) makes some “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. These statements are included throughout this report on Form 10-Q and relate to, among other things, analyses and other information based on forecasts of future results and estimates of amounts not yet determinable. These forward-looking statements are identified by their use of terms and phrases such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “continue,” and other similar terms and phrases, including references to assumptions.

These forward-looking statements are based on UCI’s expectations and beliefs concerning future events affecting UCI. They are subject to uncertainties and factors relating to UCI’s operations and business environment, all of which are difficult to predict and many of which are beyond UCI’s control. Although UCI believes that the expectations reflected in its forward-looking statements are reasonable, it does not know whether the expectations will prove correct. They can be affected by inaccurate assumptions UCI might make or by known or unknown risks and uncertainties. Many factors mentioned in UCI’s discussion in this report will be important in determining future results.

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements

United Components, Inc. (“UCI”)

Condensed Balance Sheets
(in thousands)


	UCI			UCI
	Consolidated			Consolidated
	March 31, 2004			December 31, 2003
	(unaudited)
Assets
Current assets
Cash and cash equivalents	$	31,248		$	46,130
Accounts receivable, net		242,379			230,345
Inventories		173,203			168,797
Deferred tax		15,411			17,756
Other current assets		9,415			10,877

Total current assets		471,656			473,905
Property, plant and equipment, net		220,869			219,973
Goodwill		163,823			163,823
Other intangible assets, net		75,273			77,124
Deferred financing costs		9,148			10,146
Deferred tax		12,790			13,609
Pension and other assets		10,316			11,359

Total assets	$	963,875		$	969,939

Liabilities and shareholder’s equity
Current liabilities
Accounts payable	$	95,466		$	74,652
Notes payable		817			752
Current maturities of long-term debt		186			1,034
Accrued expenses and other current liabilities		69,887			66,729

Total current liabilities		166,356			143,167
Long-term debt, less current maturities		481,398			520,472
Pension and other postretirement liabilities		51,306			50,038
Other liabilities		2,772			2,172
Contingencies – Note J

Total liabilities		701,832			715,849
Shareholder’s equity
Common stock		—			—
Additional paid in capital		261,357			261,385
Retained deficit		(1,220	)		(8,755	)
Accumulated other comprehensive income		1,906			1,460

Total shareholder’s equity		262,043			254,090

Total liabilities and shareholder’s equity	$	963,875		$	969,939

The accompanying notes are an integral part of these statements.

United Components, Inc.

Condensed Income Statements (unaudited)
(in thousands)


	UCI			Predecessor
	Consolidated			Combined
	Three Months			Three Months
	Ended			Ended
	March 31, 2004			March 31, 2003
Net sales	$	256,811		$	236,325
Cost of sales		201,264			187,274

Gross profit		55,547			49,051

Operating expenses
Selling and warehousing		19,045			18,110
General and administrative		12,072			8,263
Amortization of intangible assets		1,851			30

Operating income		22,579			22,648

Other income (expense)
Interest income		65			995
Interest expense		(9,631	)		(237	)
Management fee expense		(500	)		(15	)
Miscellaneous, net		85			(153	)

Income before income taxes		12,598			23,238
Income tax expense		5,063			965

Net income	$	7,535		$	22,273

Pro forma (unaudited), adjusted solely for change in income tax filing status (Note C):
Historical income before provision for income taxes	$	12,598		$	23,238
Income tax expense		5,063			8,736

Pro forma net income	$	7,535		$	14,502

The accompanying notes are an integral part of these statements.

United Components, Inc.

Condensed Statements of Cash Flow (unaudited)
(in thousands)


	UCI			Predecessor
	Consolidated			Combined
	Three Months			Three Months
	Ended			Ended
	March 31, 2004			March 31, 2003
Cash flows from operating activities:
Net income (loss)	$	7,535		$	22,273
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		9,082			6,687
Amortization of intangible assets		1,851			30
Amortization of deferred financing fees and debt issuance costs		1,156			—
Loss on sale of assets, net		—			151
Changes in operating assets and liabilities
Accounts receivable		(12,034	)		(10,554	)
Inventories		(4,406	)		(4,373	)
Other current assets		3,807			(2,237	)
Accounts payable		20,814			5,706
Accrued expenses and other current liabilities		3,758			1,064
Other assets		1,022			(237	)
Other liabilities		1,268			(800	)

Net cash provided by operating activities		33,853			17,710

Cash flows from investing activities:
Capital expenditures		(8,931	)		(6,522	)
Proceeds from sale of assets		129			125

Net cash used in investing activities		(8,802	)		(6,397	)

Cash flows from financing activities:
Debt (repayments) borrowings		(40,015	)		587
Dividends and transfers to UIS, Inc., net		—			(9,195	)
Other		(28	)		—

Net cash used in financing activities		(40,043	)		(8,608	)

Effect of exchange rate changes on cash		110			(149	)

Net increase (decrease) in cash and cash equivalents		(14,882	)		2,556
Cash and cash equivalents at beginning of period		46,130			28,354

Cash and cash equivalents at end of period	$	31,248		$	30,910

The accompanying notes are an integral part of these statements

United Components, Inc.

Statements of Changes in Shareholder’s Equity (unaudited)
(in thousands)


														Accumulated
					Additional			Retained						Other			Total
	Preferred		Common		Paid-In			Earnings			Division			Comprehensive			Shareholder’s			Comprehensive
	Stock		Stock		Capital			(Deficit)			Equity			Income (loss)			Equity			Income (loss)
Predecessor combined balance at January 1, 2003	$	13	$	4,289	$	44,940		$	467,376		$	67,929		$	(16,512	)	$	568,035
Dividends paid									(17,913	)								(17,913	)
Liability to UIS contributed to capital						20,271												20,271
Transfers with UIS, Inc., net									(56,630	)		(10,120	)					(66,750	)
Comprehensive income
Net earnings									6,650			15,132						21,782		$	21,782
Other comprehensive income
Foreign currency adjustment															4,125			4,125			4,125

Total comprehensive income																				$	25,907


Predecessor combined balance at June 20, 2003	$	13	$	4,289	$	65,211		$	399,483		$	72,941		$	(12,387	)	$	529,550

UCI consolidated balance at June 20, 2003	$	—	$	—	$	260,000		$	—		$	—		$	—		$	260,000
Additions to paid-in capital						1,385												1,385
Comprehensive income
Net earnings (loss)									(8,755	)								(8,755	)	$	(8,755	)
Other comprehensive income (loss)
Interest rate swaps															(114	)		(114	)		(114	)
Foreign currency adjustment															1,574			1,574			1,574

Total comprehensive income (loss)																				$	(7,295	)


UCI consolidated balance at December 31, 2003	$	—	$	—	$	261,385		$	(8,755	)	$	—		$	1,460		$	254,090

UCI consolidated balance at December 31, 2003	$	—	$	—	$	261,385		$	(8,755	)	$	—		$	1,460		$	254,090
Partial return of additions to paid-in capital						(28	)											(28	)
Comprehensive income
Net earnings									7,535									7,535		$	7,535
Other comprehensive income (loss)
Interest rate swaps															(340	)		(340	)		(340	)
Foreign currency adjustment															786			786			786

Total comprehensive income																				$	7,981

UCI consolidated balance at March 31, 2004	$	—	$	—	$	261,357		$	(1,220	)	$	—		$	1,906		$	262,043

The accompanying notes are an integral part of these statements.

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE A — GENERAL AND BASIS OF FINANCIAL STATEMENT PRESENTATION

General

United Components, Inc. is a wholly owned subsidiary of UCI Acquisition Holdings, Inc. UCI Acquisition Holdings, Inc. and United Components, Inc. are corporations formed at the direction of The Carlyle Group (“Carlyle”). Affiliates of Carlyle own 99.3% of UCI Acquisition Holdings, Inc.’s common stock, and the remainder is owned by certain members of senior management and a member of the Company’s Board of Directors.

On June 20, 2003, United Components, Inc. (“UCI”) purchased, from UIS, Inc. and UIS Industries, Inc. (together “UIS”), the vehicle parts business of UIS, consisting of all of the issued and outstanding common stock or other equity interests in Champion Laboratories, Inc., Wells Manufacturing Corporation, Neapco Inc., Pioneer, Inc., Wells Manufacturing Canada Limited, UIS Industries Ltd. (which is the owner of 100% of the capital stock of Flexible Lamps, Ltd. and Airtex Products Ltd.), Mid-South Mfg., Inc., Airtex Products S.A., Airtex Products, Inc. (currently, Airtex Mfg., Inc.), Talleres Mecanicos Montserrat S.A. de C.V., Brummer Seal de Mexico, S.A. de C.V., Brummer Mexicana en Puebla, S.A. de C.V., Automotive Accessory Co. Ltd. and Airtex Products, LLC, a limited liability company that owns the assets of the Airtex Products business of UIS, Inc. (See Note B.)

The Company operates in one business segment through its subsidiaries. The Company manufactures and distributes vehicle parts primarily servicing the vehicle replacement parts market in North America and Europe.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of UCI and its subsidiaries. The accompanying combined financial statements include the accounts of the vehicle parts businesses of UIS, consisting of the aforementioned entities, which are collectively referred to in these financial statements as the “Predecessor Company” or “Predecessor.” In these notes to the financial statements, the term the “Company” refers to both UCI and the Predecessor Company. The aforementioned June 20, 2003 acquisition is referred to in these notes to the financial statements as the “Acquisition”.

The accompanying unaudited condensed consolidated and combined financial statements have been prepared in accordance with accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

The December 31, 2003 consolidated balance sheet has been derived from the audited financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2003. The financial statements at March 31, 2004 and for the three-month periods ended March 31, 2004 and 2003 are unaudited. In the opinion of the Company, these financial statements include all adjustments necessary for a fair presentation of the financial position and results of operations for such periods. Such adjustments include normal recurring adjustments and, in the case of the balance sheets and the income statement for the 2004 period, include the effects of the preliminary allocation of the Acquisition purchase price. The purchase price has been allocated based on preliminary estimates of the fair value of the assets acquired and the liabilities assumed. Purchase price allocations are subject to change until all pertinent information regarding the Acquisition and the assets and liabilities of the Company are obtained and fully evaluated. (See Note B.) All significant intercompany accounts and transactions have been eliminated.

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in determining the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period. The estimates and assumptions include estimates of the collectibility of accounts receivable and the realizability of inventory, goodwill and other intangible assets, cost accruals, insurance reserves, income taxes and other factors. Management has exercised reasonableness in deriving these estimates; however, actual results could differ from these estimates. In addition to estimates that are typically reflected in financial statements, the balance sheets and the income statement for the period include the effects of the preliminary allocation of the Acquisition purchase price. The purchase price has been allocated based on preliminary estimates of the fair value of the assets acquired and liabilities assumed. Purchase price allocations are subject to change until all pertinent information regarding the Acquisition and the assets and liabilities of the Company are obtained and fully evaluated. (See Note B.)

These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003.

Operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ended December 31, 2004.

The income statement for the 2003 period has been reclassified to conform to the 2004 presentation.

NOTE B — ACQUISITION

OVERVIEW

On June 20, 2003, UCI purchased from UIS the vehicle parts businesses of UIS, consisting of all of the issued and outstanding common stock or other equity interests of the Predecessor Company.

The acquisition purchase price was $808 million. In addition the Company assumed $2 million of debt and capital lease obligations. Fees and expenses associated with the acquisition (excluding financing fees) were approximately $18 million and are accounted for as additional purchase price. Financing for the acquisition was comprised of a $260 million equity contribution by Carlyle, proceeds from $585 million of debt, and an $8 million accrued liability, which was paid in January 2004. In addition to funding the purchase price, proceeds from the borrowings were also used to pay for approximately $40 million of acquisition-related transaction and financing fees.

CHANGE IN INCOME TAX FILING STATUS

As discussed in Note C, the Predecessor Company had elected for certain of its subsidiaries to be taxed as S Corporations pursuant to the Internal Revenue Code. In connection with the Acquisition, the Company terminated its S corporation elections and became a C corporation and, consequently, became subject to Federal and additional state and local income taxes. As part of the preliminary allocation of the Acquisition purchase price, net deferred tax assets have been increased in recognition of UCI’s higher effective tax rate. The pro forma information presented below includes adjustments for, among other things, the change in the Company’s income tax filing status. The pro forma income tax amounts include income taxes as if the Company had been filing as a C corporation for the entire period.

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

PRELIMINARY ALLOCATION OF THE ACQUISITION PURCHASE PRICE AND PRO FORMA INFORMATION

The Acquisition is accounted for under the purchase method of accounting, and accordingly, the results of operations of the acquired companies will be included in the results of UCI beginning on the acquisition date. The information included herein has been prepared based on a preliminary allocation of the Acquisition purchase price, which was based on preliminary estimates of the fair value of the assets acquired and liabilities assumed. The purchase price allocations are subject to change until all pertinent information regarding the Acquisition and the assets and liabilities of the Company are obtained and fully evaluated. Additional pertinent information that the Company is in the process of obtaining includes, but is not limited to, the tax basis of certain assets and independent third party appraisals of property, plant and equipment and intangible assets other than goodwill. Finalization of the allocation of the Acquisition purchase price could result in material changes to the balance sheet presented herein and the unaudited pro forma information presented below.

The following table summarizes the preliminary estimated fair value of the assets acquired and liabilities assumed at the date of acquisition.


	(in millions)
Current assets	$	487
Property, plant and equipment		220
Goodwill		164
Other intangible assets		80
Deferred taxes		18
Other long term assets		15

Total assets acquired		984

Current liabilities		100
Long-term debt, excluding borrowings to fund the Acquisition purchase price and related transaction fees		12
Pension and other postretirement liabilities		39
Other long-term liabilities		7

Total liabilities assumed		158

Net assets acquired	$	826

Of the $80 million of acquired intangible assets, approximately $40 million was assigned to trademarks that are not subject to amortization. $32 million was assigned to customer relationships and $8 was assigned to technologies. The preliminary estimated useful lives of the customer relationships and technologies are 5- 15 years. For the three months ended March 31, 2004, amortization expense was $1.9 million. Accumulated amortization at March 31, 2004 was $5.1 million.

The $164 million of goodwill resulting from the transaction and all the written-up values of the other assets are expected to be deductible for income tax purposes.

Below are unaudited pro forma data for the three months ended March 31, 2003, after giving effect to the Acquisition as if it had occurred on January 1, 2003. The pro forma adjustments give effect to (i) the preliminary allocation of the June 20, 2003 Acquisition purchase price, (ii) the Company’s capital structure after the effect of the Acquisition, (iii) the new Carlyle management fee (see Note I), and (iv) income tax expense based on a C corporation filing status. As more fully explained above, the allocation of the Acquisition purchase price is preliminary. Finalization of the allocation of the Acquisition purchase price could result in material changes to the pro forma information presented below. The pro forma earnings data does not purport to represent what the results of operations would have been if the Acquisition had occurred as of the dates indicated above, or what the results will be in future periods.

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)


	Pro Forma Data
	Three Months
	Ended,
	March 31, 2003
Net sales	$	236,325
Operating income		(5,009	)
Net income (loss)		(12,459	)

NOTE C — INCOME TAXES

Prior to June 21, 2003, the subsidiaries comprising the Predecessor Company were treated as disregarded entities for U.S. tax purposes (Qualified Subchapter S subsidiaries, or Q subs). As Q subs of UIS, the subsidiaries were included in the U.S. Federal and certain state S corporation income tax returns of UIS. As such, the income taxes on the earnings of the Predecessor Company were paid by the sole shareholder of UIS pursuant to an election for Federal income tax purposes not to be taxed as a corporation. No tax sharing arrangement existed for the subsidiaries comprising the Predecessor Company. Accordingly, no provision has been made in the accompanying financial statements for Federal income taxes on the net earnings of these companies for the periods prior to June 21, 2003. A provision for certain state franchise and income taxes has been made.

The Q sub status and the S corporation status terminated immediately prior to the Acquisition. (See Note B) The Company became a C corporation and will be subject to both Federal and state income taxes and will begin to file a consolidated Federal income tax return. UCI’s effective tax will increase accordingly. As part of the preliminary allocation of the Acquisition purchase price, net deferred tax assets have been increased in recognition of UCI’s higher effective tax rate.

NOTE D — INVENTORIES

The components of inventory consist of the following (in thousands):


	March 31,			Dec. 31,
	2004			2003
Raw Material	$	29,580		$	29,305
Work in process		50,348			47,056
Finished products		116,953			116,176
Valuation reserves		(23,678	)		(23,740	)

	$	173,203		$	168,797

Inventories are stated at the lower of cost or market. Cost is principally determined using the first-in, first-out method. Inventories are reduced by an allowance for excess and obsolete inventories, based on the Company’s review of on-hand inventories. The expense of inventory write-downs is included in cost of sales.

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE E — ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consist of the following (in thousands):


	March 31, 2004		December 31, 2003
Salaries and wages	$	4,020	$	2,464
Bonuses		2,213		5,712
Vacation pay		5,922		5,252
Pension and other postretirement liabilities		2,937		3,174
Profit sharing		554		1,546
Product returns		14,349		13,999
Customer’s rebates and discounts		5,374		4,902
Other credits due customers		2,461		4,518
Insurance		6,720		804
Interest		6,418		1,882
Final payment of Acquisition purchase price		—		8,000
Other		18,919		14,476

	$	69,887	$	66,729

NOTE F — GEOGRAPHIC INFORMATION

The Company had the following sales by country (in thousands):


	UCI		Predecessor
	Consolidated		Combined
	Three Months		Three Months
	Ended		Ended
	March 31, 2004		March 31, 2003
United States	$	209,134	$	198,394
Canada		9,187		7,614
United Kingdom		10,235		9,407
Mexico		7,217		5,154
Germany		3,690		3,463
Spain		1,213		179
Belgium		1,994		1,662
France		3,024		2,182
Other		11,117		8,270

	$	256,811	$	236,325

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

Net long-lived assets by country are presented below (in thousands):


	March 31,		December 31,
	2004		2003
United States	$	141,940	$	140,003
United Kingdom		33,094		32,207
Mexico		9,700		9,528
Spain		3,266		3,362
Canada		553		301
Preliminary allocation of acquisition purchase price, not yet allocated to operating entities (see note B)		303,666		310,633

	$	492,219	$	496,034

NOTE G — STOCK OPTION

The Company uses the “disclosure only” provision of SFAS 123. Accordingly, stock options are accounted for by the “intrinsic value method” of APB Opinion No. 25. Below is a reconciliation to the pro forma after tax effect of compensation expense for the stock options had such expense been determined in accordance with the “fair value method” prescribed by SFAS No. 123 (in thousands):


	Three Months
	Ended
	March 31, 2004
Net income as reported	$	7,535
Stock option cost included in net income as reported, net of tax		0
Stock option cost that would have been reported using the “fair value method”, net of tax		(520	)

Pro forma net income had the “fair value method” been used	$	7,015

NOTE H —PENSION

The following are the components of net periodic pension expense (in thousands):


	UCI			Predecessor
	Consolidated			Combined
	Three Months			Three Months
	Ended			Ended
	March 31, 2004			March 31, 2003
Service cost	$	2,035		$	2,033
Interest cost		2,947			2,684
Expected return on plan assets		(3,395	)		(3,537	)
Amortization of transition asset		—			(47	)
Amortization of prior services cost		—			143
Amortization of unrecognized gain		—			(49	)

	$	1,587		$	1,227

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE I — RELATED PARTY TRANSACTIONS

UIS maintained workers’compensation, general liability, product liability and comprehensive automobile insurance for all of its subsidiaries, including the Predecessor Company. UIS allocated premium expense to each subsidiary based on rates charged by the insurance carrier and predicated and adjusted on estimated losses. UIS is liable for the settlement of all claims on these policies. As of the Acquisition date, the Company is no longer covered by UIS.

UIS management fee expense charged to the Predecessor Company was $15,000 for the three months ended March 31, 2003. Occasionally, UIS extended financing to the Predecessor Company. Interest charges to the Predecessor Company on debt to UIS were $74,000 for the three months ended March 31, 2003. These charges are recorded as interest expense. In addition, the Predecessor Company extended financing to UIS. Interest income from UIS was $754,000 for the three months ended March 31, 2003. This income is recorded as interest income.

The Company has employment agreements with certain of its executive officers providing for annual compensation amounting to approximately $0.7 million per annum plus bonuses (as defined in the employment agreements) and severance pay under certain circumstances (as defined in the employment agreements).

In connection with the Acquisition, the Company entered into a management agreement with TC Group, L.L.C., an affiliate of Carlyle, for management and financial advisory services and oversight to be provided to the Company and its subsidiaries. Pursuant to this agreement, the Company will pay an annual management fee to Carlyle of $2 million and out-of-pocket expenses, and the Company may pay Carlyle additional fees associated with financial advisory and other future transactions. Carlyle also received a one-time transaction fee of $10 million upon consummation of the Acquisition. The agreement also provides for indemnification of Carlyle against liabilities and expenses arising out of Carlyle’s performance of services under the agreement. The agreement terminates either when Carlyle or its affiliates own less than 10% of the Company’s equity interest or when the company and Carlyle mutually agree to terminate the agreement.

NOTE J — CONTINGENCIES

Environmental

The Company is subject to contingencies pursuant to environmental laws and regulations that in the future may require the Company to take action to correct the effects on the environment of prior disposal practices or releases of chemical or petroleum substances by the Company or other parties. The Company has been identified as a potential responsible party for contamination at several sites. As a result, the Company has accrued liabilities for certain environmental testing and remediation activities included in the “accrued expenses and other current liabilities” line and the “other liabilities” line on the balance sheet. While there is inherent uncertainty in such matters, in management’s opinion, the amounts accrued are appropriate based on the facts and circumstances that are currently known. The Company believes that the ultimate outcome of these matters will not have a material adverse effect on the financial position of the Company.

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

Litigation

The Company is subject to various other contingencies, including routine legal proceedings and claims arising out of its business. These proceedings primarily involve commercial claims, product liability claims, personal injury claims and workers’ compensation claims. The outcome of these lawsuits, legal proceedings and claims cannot be predicted with certainty. Nevertheless, the Company believes that the outcome of any currently existing proceedings, even if determined adversely, would not have a material adverse effect on its business, financial condition and results of operations.

NOTE K – PRODUCT RETURNS LIABILITY

The product returns liability is included in accrued and other current liabilities. It includes accruals for parts returned due to manufacturing defect and for certain parts returned because of customer excess quantities. The changes in the Company’s product returns liability are as follows (in thousands):


	UCI			Predecessor
	Consolidated			Combined
	Three Months			Three Months
	Ended			Ended
	March 31, 2004			March 31, 2003
Liability, beginning of period	$	13,999		$	2,356
Loss on parts returned		(9,541	)		(8,684	)
Additional loss provision		9,891			8,874

Liability, end of period	$	14,349		$	2,546

NOTE L — NEW ACCOUNTING PRONOUNCEMENTS

In December 2003, SFAS No. 132R, “Employers’ Disclosure about Pensions and Other Postretirement Benefits” was issued. SFAS No. 132R requires additional disclosures about defined benefit pension plans and other postretirement benefit plans. The standard requires, among other things, additional disclosures about the assets held in employer sponsored pension plans, disclosures relating to plan asset investment policy and practices, disclosure of expected contributions to be made to the plans and expected benefit payments to be made by the plans. Annual disclosures applicable to our U.S. pension and postretirement plans were required to be made in our financial statements for the year ended December 31, 2003. The Company has adopted this pronouncement as of December 31, 2003 for all of its U.S. plans. Annual disclosures relating to its non-U.S. plans will be adopted for the year ending December 31, 2004. Interim disclosures relating to its non-U.S. plans will be adopted for the year ending December 31, 2005.

In March 2004, the FASB’s Emerging Issues Task Force concluded its discussion of Issue No. 03-01, The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments (“EITF 03-01”). EITF 03-01 provides guidance regarding the determination of when an impairment of debt and marketable equity securities and investments, which are accounted for under the cost method, should be considered other-than-temporary and recognized in earnings. EITF 03-01 also requires annual disclosures of certain quantitative and qualitative factors of debt and marketable equity securities, which are classified as available-for-sale or held-to-maturity, and which are in an unrealized loss position at the balance sheet date, but for which an other-than-temporary impairment has not been recognized. The disclosure requirements of EITF 03-01 were effective December 31, 2003 and had no effect on the Company’s financial statements. The accounting guidance of EITF 03-01 will be effective in the third quarter of 2004 and is not expected to have a material affect on the Company’s financial statements.

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE M — OTHER INFORMATION

Cash payments for interest and income taxes (net of refunds) (in thousands):


	UCI		Predecessor
	Consolidated		Combined
	Three Months		Three Months
	Ended		Ended
	March 31, 2004		March 31, 2003
Interest	$	3,935	$	5
Income taxes		1,899		72

On March 1, 2004, the Company made a voluntary prepayment of $40 million of outstanding senior credit facility term loan borrowings.

At March 31, 2004, 1,000 shares of common stock were authorized, issued and outstanding. The par value of each share of common stock is $0.01 per share.

NOTE N — GUARANTOR AND NONGUARANTOR FINANCIAL STATEMENTS

The senior credit facilities are secured by substantially all the assets of the Company. The senior subordinated notes (the “Notes”) are unsecured and rank equally in right of payment with any of the Company’s future senior subordinated indebtedness. The Notes are subordinated to indebtedness and other liabilities of UCI’s subsidiaries that are not guarantors of the Notes. The Notes and borrowings under the senior credit facilities are guaranteed on a full and unconditional and joint and several basis by UCI’s domestic subsidiaries.

The condensed financial information, which follows, includes the consolidated results of UCI subsequent to the June 20, 2003 Acquisition date and the combined results of the Predecessor Company prior to the Acquisition. This information includes condensed financial statements for (a) UCI, which is the issuer of the Notes and borrower under the senior credit facilities, (b) the domestic subsidiaries, which guarantee the Notes and borrowings under the senior credit facilities (the “Guarantors”), (c) the foreign subsidiaries (the “Non-Guarantors”), and (d) a consolidated UCI or a combined Predecessor Company, as applicable. Also included are consolidating entries, which principally consist of eliminations of investments in consolidated subsidiaries and intercompany balances and transactions.

The step-up amounts resulting from the preliminary allocation of the Acquisition purchase price are included with UCI and have not yet been allocated to its subsidiaries. Consequently, the Guarantor and Non-Guarantor are reported on the Predecessor’s historical basis. The purchase price allocations are based on preliminary estimates of the fair value of assets acquired and liabilities assumed. Purchase price allocations are subject to change until all pertinent information regarding the Acquisition and the assets and liabilities of the Company are obtained and fully evaluated.

Separate financial statements of the Guarantor subsidiaries are not presented because their guarantees are full and unconditional and joint and several, and the Company believes separate financial statements and other disclosure regarding the Guarantor subsidiaries are not material to investors.

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE N (continued)

Combining Condensed Balance Sheet
March 31, 2004
(in thousands)


	UCI												Non-
	Consolidated			Eliminations			UCI			Guarantor			Guarantor
Assets
Current assets
Cash and cash equivalents	$	31,248		$			$	22,029		$	(1,575	)	$	10,794
Accounts receivable, net		242,379									218,665			23,714
Inventories		173,203									157,271			15,932
Deferred tax		15,411						42,254			(27,827	)		984
Other current assets		9,415						(1,290	)		4,730			5,975

Total current assets		471,656						62,993			351,264			57,399
Property, plant and equipment, net		220,869						52,645			126,968			41,256
Due from parent		—			(175,585	)					172,611			2,974
Investment in subsidiaries					(583,365	)		570,591			12,774
Goodwill		163,823						163,823
Other intangible assets, net		75,273						74,723			550
Deferred financing costs		9,148						9,148
Deferred tax		12,790						12,790
Pension and other assets		10,316						(3,889	)		13,006			1,199

Total assets	$	963,875		$	(758,950	)	$	942,824		$	677,173		$	102,828

Liabilities and shareholder’s equity
Current liabilities
Accounts payable	$	95,466		$			$	65		$	80,596		$	14,805
Notes payable		817												817
Current maturities of long-term debt		186												186
Accrued expenses and other current liabilities		69,887						9,541			53,042			7,304

Total current liabilities		166,356						9,606			133,638			23,112
Long-term debt, less current maturities		481,398						481,167						231
Pension and other postretirement liabilities		51,306						31,853			19,453
Deferred tax		—						(2,575	)					2,575
Other liabilities		2,772									2,772
Intercompany payables					(175,585	)		160,730			3,039			11,816
Shareholder’s equity
Common stock		—
Additional paid-in capital		261,357			(529,661	)		261,357			468,764			60,897
Retained (deficit) earnings		(1,220	)		(51,605	)		(1,220	)		49,403			2,202
Accumulated comprehensive income (loss)		1,906			(2,099	)		1,906			104			1,995

Total shareholder’s equity		262,043			(583,365	)		262,043			518,271			65,094

Total liabilities and shareholder’s equity	$	963,875		$	(758,950	)	$	942,824		$	677,173		$	102,828

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE N (continued)

Consolidating Condensed Balance Sheet
December 31, 2003
(in thousands)


	UCI												Non-
	Consolidated			Eliminations			UCI			Guarantor			Guarantor
Assets
Current assets
Cash and cash equivalents	$	46,130		$			$	33,164		$	4,448		$	8,518
Accounts receivable, net		230,345									208,762			21,583
Inventories		168,797						471			152,506			15,820
Deferred tax		17,756						36,010			(19,472	)		1,218
Other current assets		10,877						(336	)		5,275			5,938

Total current assets		473,905						69,309			351,519			53,077
Property, plant and equipment, net		219,973						54,055			124,977			40,941
Intercompany receivables		—			(124,033	)					124,033
Investment in subsidiaries		—			(566,026	)		553,055			12,971
Goodwill		163,823						163,823
Other intangible assets, net		77,124						76,574			550
Deferred financing costs		10,146						10,146
Deferred tax		13,609						13,609
Pension and other assets		11,359						(4,301	)		14,380			1,280

Total assets	$	969,939		$	(690,059	)	$	936,270		$	628,430		$	95,298

Liabilities and shareholder’s equity
Current liabilities
Accounts payable	$	74,652		$			$			$	63,456		$	11,196
Notes payable		752												752
Current maturities of long-term debt		1,034						750						284
Accrued expenses and other current liabilities		66,729						19,072			41,895			5,762

Total current liabilities		143,167						19,822			105,351			17,994
Long-term debt, less current maturities		520,472						520,258						214
Pension and other post retirement liabilities		50,038						31,965			18,073
Deferred tax		—						(4,050	)		699			3,351
Other liabilities		2,172									2,172
Intercompany payables		—			(124,033	)		114,185						9,848
Shareholder’s equity
Common stock		—
Additional paid-in capital		261,385			(529,661	)		261,385			468,764			60,897
Retained (deficit) earnings		(8,755	)		(34,927	)		(8,755	)		33,507			1,420
Accumulated other comprehensive income (loss)		1,460			(1,438	)		1,460			(136	)		1,574

Total shareholder’s equity		254,090			(566,026	)		254,090			502,135			63,891

Total liabilities and shareholder’s equity	$	969,939		$	(690,059	)	$	936,270		$	628,430		$	95,298

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE N (continued)

Consolidating Condensed Income Statement
Three Months Ended March 31, 2004 (Unaudited)
(in thousands)


	UCI
	Consolidated			Eliminations			UCI			Guarantor			Non-Guarantor
Net sales	$	256,811		$	(4,023	)	$	—		$	227,542		$	33,292
Cost of sales		201,264			(4,023	)		1,971			177,091			26,225

Gross profit		55,547						(1,971	)		50,451			7,067
Operating expenses
Selling and warehousing		19,045									17,170			1,875
General and administrative		12,072						2,591			6,603			2,878
Amortization of intangibles		1,851						1,851

Operating income (loss)		22,579						(6,413	)		26,678			2,314
Other income (expense)
Interest income		65			(78	)		5			113			25
Interest expense		(9,631	)		78			(9,618	)		(17	)		(74	)
Management fee expense		(500	)					(500	)
Miscellaneous, net		85						—			1			84

Income (loss) before income taxes		12,598						(16,526	)		26,775			2,349
Income tax expense (benefit)		5,063						(6,293	)		10,442			914

Increase before equity in earnings of subsidiaries		7,535						(10,233	)		16,333			1,435
Equity in earnings of subsidiaries					(17,331	)		17,768			(437	)

Net income (loss)	$	7,535		$	(17,331	)	$	7,535		$	15,896		$	1,435

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE N (continued)

Combining Condensed Income Statement
Three Months Ended March 31, 2003 (unaudited)
(in thousands)


	Predecessor										Non-
	Combined			Eliminations			UCI	Guarantor			Guarantor
Net sales	$	236,325		$	(3,911	)	$	$	208,316		$	31,920
Cost of sales		187,274			(3,911	)			167,426			23,759

Gross profit		49,051							40,890			8,161
Operating expenses
Selling and warehousing		18,110							16,094			2,016
General and administrative		8,263							4,239			4,024
Amortization of intangible assets		30							30

Operating income		22,648							20,527			2,121

Other income (expense)
Interest income		995							824			171
Interest expense		(237	)						(10	)		(227	)
Management fee expense		(15	)						3			(18	)
Miscellaneous, net		(153	)						(141	)		(12	)

Income before income taxes		23,238							21,203			2,035
Income tax expense		965							233			732

Net income	$	22,273		$			$	$	20,970		$	1,303

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE N (continued)

Consolidating Condensed Statement of Cash Flows
Three months ended March 31, 2004 (unaudited)
(in thousands)


	UCI										Non-
	Consolidated			Eliminations	UCI			Guarantor			Guarantor
Net cash provided by operating activities	$	33,853		$	$	28,893		$	1,655		$	3,305

Cash flows from investing activities:
Acquisition and related fees		—										—
Capital expenditures		(8,931	)						(7,694	)		(1,237	)
Proceeds from sale of assets		129							16			113

Net cash used in investing activities		(8,802	)						(7,678	)		(1,124	)

Cash flows from financing activities:
Debt repayments		(40,015	)			(40,000	)					(15	)
Other		(28	)			(28	)

Net cash used in financing activities		(40,043	)			(40,028	)					(15	)

Effect of exchange rate changes on cash		110										110

Net increase (decrease) in cash and cash equivalents		(14,882	)			(11,135	)		(6,023	)		2,276
Cash and cash equivalents at beginning of period		46,130				33,164			4,448			8,518

Cash and cash equivalents at end of period	$	31,248		$	$	22,029		$	(1,575	)	$	10,794

United Components, Inc.

Notes to Condensed Financial Statements (unaudited)

NOTE N (continued)

Combining Condensed Statement of Cash Flows
Three months ended March 31, 2003 (unaudited)
(in thousands)


	Predecessor								Non-
	Combined			Eliminations	UCI	Guarantor			Guarantor
Net cash provided by operating activities	$	17,710		$	$	$	16,344		$	1,366

Cash flows from investing activities:
Capital expenditures		(6,522	)				(5,443	)		(1,079	)
Proceeds from sale of assets		125					14			111

Net cash used in investing activities		(6,397	)				(5,429	)		(968	)

Cash flows from financing activities:
Debt borrowings		587					1			586
Dividends and transfers to UIS, Inc., net		(9,195	)				(9,542	)		347

Net cash (used in) provided by financing activities		(8,608	)				(9,541	)		933

Effect of exchange rate changes on cash		(149	)							(149	)

Net increase in cash and cash equivalents		2,556					1,374			1,182
Cash and cash equivalents at beginning of period		28,354					7,237			21,117

Cash and cash equivalents at end of period	$	30,910		$	$	$	8,611		$	22,299

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

Overview

Sales. We are among North America’s largest and most diversified companies servicing the vehicle replacement parts market, or the aftermarket. We supply a broad range of filtration products, fuel and cooling systems, engine management systems, driveline components and lighting systems to the automotive, trucking, marine, mining, construction, agricultural and industrial vehicle markets. We estimate that about 80% of our net sales in 2003 were made in the aftermarket, to a customer base that includes some of the largest and fastest growing companies servicing the aftermarket. The aftermarket has grown at an annual rate of approximately 4.1% from 1997 to 2003. We believe it will continue to grow, at least in the near term. We believe we are well positioned to participate in that growth.

We believe we have leading market positions in our primary product lines. We continue to expand our product and service offerings to meet the needs of our customers, and we believe that we offer one of the most comprehensive lines of products in the vehicle replacement parts market consisting of approximately 60,000 part numbers. We believe our breadth of product offering is a key competitive advantage. This product breadth along with our extensive manufacturing and distribution capabilities, product innovation, and reputation for quality and service makes us a leader in our industry. We have established a network of manufacturing facilities, distribution centers and offices located in the United States, Europe, Mexico and China, with a global work force of approximately 6,700 employees as of March 31, 2004.

Because most of our sales are to the aftermarket, we believe that our sales are primarily driven by the number of vehicles on the road, the average number of miles driven per year, the average age of the vehicle, the mix of light trucks to passenger cars on the road and the relative strength of our sales channels. Historically, our sales have not been materially adversely affected by market cyclicality, as we believe that our aftermarket sales are less dependent on economic conditions than our sales to OEMs, due to the non-discretionary nature of vehicle maintenance and repair.

However, it is also important to note that in 2003 and 2002, 23% of our revenues were derived from our business with AutoZone, and our failure to maintain a healthy relationship with AutoZone would result in a significant decrease in our net sales. Even if we maintain our relationship, our net sales concentration as a result of this relationship increases the potential impact to our business that could result from any changes in the economic terms of this relationship. Any change in the terms of sales to this customer could have a material impact on our financial position and results of operations. Any changes could, for example, result in an increase in the time it takes for us to record net sales and collect on receivables. AutoZone has publicly announced its intent to transition its suppliers to a program where suppliers are paid when an AutoZone customer purchases the supplier’s product.

Cost of Sales. Cost of sales includes all costs of manufacturing required to bring a product to a ready-for-sale condition. Such costs include direct and indirect materials (net of vendor consideration), direct and indirect labor including fringe benefits, supplies, utilities, freight, depreciation, insurance, pension and postretirement benefits, information technology costs and other costs. Cost of sales also includes all costs to procure, package and ship products that we purchase and resell. The two largest components of our cost of sales are steel and labor.

In 2004, demand for steel is high and is resulting in supplier-imposed surcharges for this raw material. While we believe that we will be able to obtain sufficient quantities to satisfy our needs, we believe we will be required to pay significantly higher prices for the material. Our intent is to increase prices to reflect this increased cost. Our ability to do so is uncertain at this time.

Selling and Warehousing Expenses. Selling and warehousing expenses primarily include sales and marketing, warehousing and distribution costs. Our major cost elements include salaries and wages, pension and fringe benefits, depreciation, advertising and information technology costs.

Management intends to increase promotional spending to selectively expand the Company’s customer base and products. Management also intends to leverage the fixed portion of sales and warehousing as sales increase. In the long run, management thinks that sales and warehousing expense as a percentage of sales is a key measure and is working to reduce this percentage.

General and Administrative Expenses. General and administrative expenses primarily include executive, accounting and legal personnel salaries and fringe benefits, professional fees, pension benefits, insurance, provision for doubtful accounts and rent.

Preliminary allocation of Acquisition purchase price. As explained in Note B to the financial statements presented elsewhere in this Form 10-Q, the allocation of the Acquisition purchase price is preliminary and is subject to change until all pertinent information regarding the Acquisition and the assets and liabilities of the Company are obtained and fully evaluated. Finalization of the allocation of the Acquisition purchase price could result in material changes to the balance sheet presented elsewhere in this report.

Cash Generation. Net cash from operating activities was $33.9 million. Capital expenditures were $8.9 million. The net cash generated from these operating activities was $25 million.

Critical Accounting Policies

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. We evaluate our estimates and judgments on an on-going basis. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what we anticipate, and different assumptions or estimates about the future could change our reported results.

We believe the following accounting policies are the most critical to us, because they are important to our financial statements, and they require our most complex judgments in the preparation of the financial statements.

Accounts receivable. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. These allowances are based on a combination of an aging analysis and our analyses of our history of write-offs. In addition, we evaluate allowance requirements if the financial condition of a particular customer were to deteriorate.

Inventory. We record inventory at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method. Estimated market value is based on assumptions for future demand and related pricing. If actual market conditions are less favorable than those projected by management, reductions in the value of inventory may be required.

Revenue recognition. We record sales upon transfer of title of product, which occurs upon shipment to the customer. Because we enter into sales rebate programs with some of our customers that require us to make rebate payments to them from time to time, we estimate amounts due under these sales rebate programs at the time of shipment. Net sales relating to any particular shipment are based upon the amount invoiced for the shipped goods less estimated future rebate payments. These estimates are based upon our historical experience. Revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known.

Additionally, we enter into formal and informal agreements with our customers that provide for sales discounts, marketing allowances, provided return allowances and performance incentives. The discounts, allowances and incentives are expensed as a reduction to sales, based on estimates of the criteria that give rise to the discount or allowance, such as sales volume and marketing spending. We routinely review these criteria and our estimating process and make adjustments as facts and circumstances change. Historically we have not found material differences between our estimates and actual results.

Impairment of intangible assets and tangible fixed assets. Our intangible assets and tangible fixed assets are held at historical cost, net of depreciation and amortization, less any provision for impairment. We periodically evaluate the realizability of our intangible or tangible fixed assets. We also perform a review of these assets if an indicator of impairment, such as an operating loss or cash outflow from operating activities or a significant adverse change in the business or market place, exists. Estimates of future cash flows used to test the asset for impairment are based on current operating projections extended to the useful life of the asset group and are, by their nature, subjective.

We adopted SFAS 142 in 2002. In accordance with SFAS 142, we stopped amortizing goodwill on January 1, 2002. In lieu of amortization, we perform impairment analysis of our goodwill. Based on this analysis in the fourth quarters of 2003 and 2002, we have concluded that there has not been an impairment. If we determine that goodwill has been impaired, we will record the impairment as a charge against income. Estimates of future discounted cash flows used in the impairment test are based on current operating projections, which are by their nature subjective.

Retirement benefits. Pension obligations are actuarially determined and are affected by assumptions including discount rate, life expectancy, annual compensation increases and the expected rate of return on plan assets. Changes in the discount rate, and differences from actual results for each assumption, will affect the amount of pension expense we recognize in future periods.

Postretirement health obligations are actuarially determined and are based on assumptions including discount rate, life expectancy and health care cost trends. Changes in the discount rate, and differences from actual results for each assumption, will affect the amount of expense we recognize in future periods. A one percent increase or decrease in the assumed health care cost trends would result in an approximate $40,000 annual increase or decrease in annual postretirement health costs.

Insurance Reserves. Prior to the Acquisition, the Company had insurance under UIS’s master policies for group, worker’s compensation, automobile, product and general liability. These policies were subject to retrospective rating adjustments for which we were responsible. These adjustments were predicated upon paid losses, reserves and expenses. The projections involved in this estimate were subject to substantial uncertainty because of several unpredictable factors, including actual claims experience, regulatory changes, litigation trends and changes in inflation.

As of the June 20, 2003 Acquisition, the Company is no longer covered by the UIS master insurance policies. As of that date, the Company has purchased insurance, which does not include retrospective rating adjustments but does include high deductibles for which the Company is responsible. Consequently, the Company is subject to the same substantial uncertainties as those described in the preceding paragraph. Unpaid estimated losses, for which the Company is responsible, are recorded in accrued expenses in the March 31, 2004 and December 31, 2003 balance sheets.

Environmental Expenditures. Our aggregate expenditures (both capital and operating) for compliance with laws and regulations related to the protection of the environment were approximately $1.0 million in 2003, $0.8 million in 2002 and $0.7 million in 2001. The majority of our environmental expenditures relate to the proper disposal of environmentally sensitive waste. Management does not expect this disposal cost to change significantly in the near term, other than for volume fluctuations. Also, management does not expect capital spending on environmental matters to increase materially over the near term; however, changes in environmental regulations, or the outcome of litigation, could result in additional requirements that could necessitate increased spending.

Results of Operations

The following table was derived from the United Components, Inc. consolidated and the Predecessor Company combined income statements for the three months ended March 31, 2004 and 2003. The amounts are presented in millions of dollars.


	Three Months
	Ended
	March 31,
	2004			2003
Net sales	$	256.8		$	236.3
Cost of Sales		201.3			187.3

Gross profit		55.5			49.0

Operating expenses
Selling and warehousing		19.0			18.1
General and administrative		12.0			8.3
Amortization of intangible assets		1.9			—

Operating income		22.6			22.6

Interest, net		(9.6	)		.7
Management fee expense		(.5	)		—
Miscellaneous, net		.1			(.1	)

Income before income taxes		12.6			23.2
Income taxes		5.1			.9

Net income	$	7.5		$	22.3

Pro forma net income, adjusted only for change in tax filing status (1)	$	7.5		$	14.5

(1)

Prior to the Acquisition, the subsidiaries of UIS that we acquired operated as S corporations for Federal and state income tax purposes. The historical combined financial statements do not include a provision for Federal and certain state income taxes for such periods. A provision for state income taxes has been made for those states not recognizing S corporation status. Pro forma net income has been computed as if we had been fully subject to Federal and state income taxes based on the tax laws in effect during the respective periods. See Notes B and C to the financial statements.

Three Months Ended March 31, 2004 Compared with the Three Months Ended March 31, 2003

Net sales. Net sales increased $20.5 million, or 8.7%, from $236.3 million in the 2003 quarter to $256.8 million in the 2004 quarter. The increase was volume driven, primarily by sales to the traditional, OEM, OES and heavy duty channels.

Cost of sales. Cost of sales increased $14 million, or 7.5%, from $187.3 million in the 2003 quarter to $201.3 million in the 2004 quarter. The increase was primarily due to higher volume.

The 2004 and 2003 quarters were both adversely effected by one-time charges of $0.5 million and $1.5 million, respectively. The 2004 quarter also includes $1.5 million of additional non-cash depreciation expense resulting from the step-up of property, plant and equipment, which was part of the preliminary allocation of June 20, 2003 Acquisition purchase price.

The aforementioned $0.5 million one-time charge in 2004 is due to the sale of inventory that was written-up as part of the preliminary allocation of the Acquisition purchase price. The total preliminary write-up of the June 20, 2003 inventory was $28 million. Including the $0.5 million first quarter charge, all $28 million has now been expensed. Therefore, the effect of this inventory write-up will not adversely affect our reported results in the future.

The aforementioned $1.5 million one-time charges in 2003 include provisions for product line relocations, costs relating to the upgrade of the Albion, Illinois manufacturing facility, costs associated with the consolidation of our European filtration manufacturing operations, and inventory reserves.

Gross margin, as reported, increased from 20.7% in 2003 to 21.6% in 2004. Excluding the one-time charges from both periods, the increase is from 21.4% in 2003 to 21.8% in 2004. The aforementioned higher 2004 depreciation expense, caused by the Acquisition related step-up, will be a continuing non-cash charge. However, if that non-cash charge were excluded from 2004 results for the sake of better quarter-to-quarter comparability, the improvement would be from 21.4% in 2003 to 22.4% in the 2004 quarter.

Selling and warehousing expenses. Selling and warehousing expenses of $19 million for the 2004 quarter are $0.9 million higher than the 2003 quarter. In the 2004 quarter, this cost is 7.4% of sales compared to 7.7% in the 2003 quarter.

General and administrative expenses. General and administrative expense increased by $3.7 million, or 44.6%, to $12 million in the 2004 quarter. This increase is due to (i) the higher cost of operating as a stand-alone company after the Acquisition; (ii) the Company’s investment in processes and management talent necessary to drive improvements in future operational efficiency; (iii) higher performance-based incentive compensation; and (iv) the timing of the recognition of external audit costs.

Interest, net. Net interest changed from $0.7 million of net interest income in the 2003 quarter to $9.6 million of net interest expense in the 2004 quarter. The $10.3 million adverse shift includes (i) $0.6 million of accelerated write-off of debt issuance costs because of voluntary prepayments of debt; (ii) $8.8 million of interest expense on Acquisition-related debt; and (iii) $0.9 million lower interest income on loans to the Predecessor Company’s previous owner.

Income taxes. The change in income taxes is driven by changes in pre-tax income plus the use of a 40.2% incremental effective rate after the Acquisition in 2003. The higher rate is the result of the Company’s transition from S corporation filing status before the Acquisition to C corporation filing status after the Acquisition.

Net Income. Due to the factors described above, net income declined $14.8 million from $22.3 million in the 2003 quarter to $7.5 million in the 2004 quarter.

Liquidity and Capital Resources

At December 31, 2003, the Company had $46.1 million of cash and $528.3 million of debt outstanding. (The difference between this debt amount and the amount on the balance sheet is $6 million of unamortized debt issuance cost.) The Company’s December 31, 2003 debt included $297 million of senior credit facility term loans and its $230 million senior subordinated notes. On March 1, 2004, the Company made a voluntary prepayment of $40 million of term loan borrowings. The Company funded this $40 million prepayment with cash generated from operations. At March 31, 2004, the Company had $31.2 million of cash and $488.2 million of debt outstanding.

At the $488.2 million debt level, annual interest expense, including amortization of deferred financing costs and debt issuance cost, is approximately $35.2 million at March 31, 2004 borrowing rates. An increase in the interest rate of 0.25% in the variable interest rate would have increased the annual interest cost by $0.3 million. The Company’s significant debt service obligations could, under certain circumstances, have material consequences.

The Company’s primary source of liquidity is cash flow from operations and borrowings under its $75 million revolving credit facility. Borrowings under the revolving credit facility are available to fund the Company’s working capital requirements, capital expenditures and other general corporate purposes. $3.4 million of revolving credit borrowing capacity has been used to support outstanding letters of credit.

Because of voluntary pre-payments, the Company does not have any required repayments of its senior credit facility term loans until December 2005. The $230 million senior subordinated notes are due in 2013. The Company’s ability to make scheduled payments of principal on, or to pay interest on, or to refinance, its indebtedness or to fund planned capital expenditures will depend on its ability to generate cash in the future. Such cash generation is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond its control.

Based on the current level of operations, the Company believes that cash flow from operations and available cash, together with available borrowings under its revolving credit facility, will be adequate to meet liquidity needs and fund planned capital expenditures for the next two years. The Company may, however, need to refinance all or a portion of the principal amount of the senior subordinated notes and/or senior credit facility borrowings, on or prior to maturity, to meet liquidity needs in later years. If it is determined that refinancing is necessary, and the Company is unable to secure such financing on acceptable terms, then the Company may have insufficient liquidity to carry on its operations and meet its obligations at such time.

The Company can give no assurance that its business will generate sufficient cash flow from operations, that any revenue growth or operating improvements will be realized, or that future borrowings will be available under its revolving credit facilities in an amount sufficient to enable it to service its indebtedness or to fund other liquidity needs. In addition, the Company can give no assurance that it will be able to refinance any of its indebtedness, including its senior credit facilities and the senior subordinated notes, on commercially reasonable terms or at all.

Net cash provided by operating activities

Net cash provided by operating activities for the three months ended March 31, 2004 and 2003 was $33.9 million and $17.7 million, respectively. The $16.2 million increase in net cash provided by operating activities in the 2004 quarter as compared to the 2003 quarter was attributable to reductions in working capital, partially offset by lower net income.

Net cash used in investing activities

Historically, net cash used in investing activities has been for capital expenditures, offset by proceeds from the disposition of property, plant and equipment. Capital expenditures for the three months ended March 31, 2004 and 2003 were $8.9 million and $6.5 million, respectively. Approximately $4.4 and $2.2 million of the 2004 and 2003 quarters’ capital expenditures was related to the long-term capital investment plan to increase capacity and reduce cost at our filtration facilities. Capital expenditures for the 2003 full year were $43.4 million. For the full year 2004, capital expenditure are expected to be approximately $43 to $48 million.

Impact of the Acquisition and Related Financing Transactions

The Company incurred significant indebtedness in connection with the Acquisition. Accordingly, our interest expense is higher than it was prior to the Acquisition. As a result of the Acquisition, our assets and liabilities were adjusted to their preliminary estimated fair value as of the closing of the Acquisition. The excess of the total purchase price over the value of our net assets at closing of the Acquisition was allocated to goodwill and other intangible assets. These long-lived assets are subject to annual impairment review. Purchase price allocations are subject to adjustment until all pertinent information regarding the Acquisition is obtained and fully evaluated. See Note B to the Condensed Financial Statements for information regarding the preliminary status of the allocation of the Acquisition purchase price and the impact of the Acquisition and the financing thereof.

Recent Accounting Pronouncements

In December 2003, SFAS No. 132R, “Employers’ Disclosure about Pensions and Other Postretirement Benefits” was issued. SFAS No. 132R requires additional disclosures about defined benefit pension plans and other postretirement benefit plans. The standard requires, among other things, additional disclosures about the assets held in employer sponsored pension plans, disclosures relating to plan asset investment policy and practices, disclosure of expected contributions to be made to the plans and expected benefit payments to be made by the plans. Annual disclosures applicable to our U.S. pension and postretirement plans were required to be made in our financial statements for the year ended December 31, 2003. We have adopted this pronouncement as of December 31, 2003 for all of our U.S. plans. Annual disclosures relating to our non-U.S. plans will be adopted for the year ending December 31, 2004. Interim disclosures relating to our non-U.S. plans will be adopted for the year ending December 31, 2005.

Item 3. Quantitative And Qualitative Disclosures About Market Risk

Our exposure to market risk consists of foreign currency exchange rate fluctuations and changes in interest rates.

Foreign Currency Exposure

Currency translation. As a result of international operating activities, we are exposed to risks associated with changes in foreign exchange rates, principally exchange rates between the U.S. dollar and the Mexican peso, Spanish peseta, Canadian dollar and British pound. The results of operations of our foreign subsidiaries are translated into U.S. Dollars at the average exchange rates for each relevant period. This translation has no impact on our cash flow. However, as foreign exchange rates change, there are changes to the U.S. dollar equivalent of sales and expenses denominated in foreign currencies. During 2003, approximately 12% of our business was transacted in local currencies of foreign countries. While our international results of operations as measured in dollars are subject to foreign exchange fluctuations, we do not consider the related risk to be material to our financial condition or results of operation. If the exchange rate between the foreign currencies and the U.S. dollar were to decrease by 10%, our annual net income would have been lower by $0.3 million in 2003 due to the reduction in reported results form our foreign operations.

The balance sheets of foreign subsidiaries are translated into U.S. dollars at the closing exchange rates as of the relevant balance sheet date. Any adjustments resulting from the translation are recorded as other comprehensive income on our statement of shareholder’s equity. In the past the vehicle parts businesses of UIS have attempted to manage, and in the future we expect to continue to manage, this exposure primarily by balancing monetary assets and liabilities and maintaining cash positions only at levels necessary for operating purposes in those countries.

Currency transaction exposure. Currency transaction exposure arises where actual sales and purchases are made by a business in a currency other than its own functional currency. The majority of our businesses source raw materials and sell their products within their local markets’ currencies and, therefore, have limited transaction exposure.

In the future, we expect to continue to monitor our transaction exposure to currency rate changes and enter into currency forward and option contracts to limit the exposure, as appropriate. Gains and losses on contracts are deferred until the transaction being hedged is finalized. As of March 31, 2004, we had no outstanding foreign currency contracts. We do not engage in any speculative activities.

Interest rate risk

Borrowings under our senior credit facilities bear variable rates of interest. Under our senior credit facilities, we are required to provide interest rate protection on approximately $118 million of our senior term loan facilities borrowings. In August 2003, we entered into an interest rate swap for $118 million. This swap effectively converts $118 million of variable rate debt to fixed rate debt for the two years ended August 2005. The variable component of the interest rate on borrowings under the senior credit facilities is based on LIBOR. Under the swap we will pay 1.94% and will receive the then current LIBOR on $118 million.

We utilize, and we will continue to utilize, sensitivity analyses to assess the potential effect of our variable rate debt. If the variable interest rate were to increase by 0.25% per annum, the net impact would be a decrease of approximately $0.2 million on our annual net income and cash flow.

Treasury Policy

Our treasury policy seeks to ensure that adequate financial resources are available for the development of our businesses while managing our currency and interest rate risks. Our policy is not to engage in speculative transactions. Our policies with respect to the major areas of our treasury activity are set forth above.

Item 4. Controls And Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the quarter covered by this report, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

There has been no change in the Company’s internal controls over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II
OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits


Exhibit 31.1		Certification of Periodic Report by the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

Exhibit 31.2		Certification of Periodic Report by the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

Exhibit 32		Certification of Periodic Report by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002.*

* This certificate is being furnished solely to accompany the report pursuant to 18 U.S.C. 1350 and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

(b) Reports on Form 8-K filed during the quarter ended March 31, 2004.

The Company filed a current report on Form 8-K (under Items 5, 7 and 12) dated March 11, 2004 with respect to announcing financial results for the year ended December 31, 2003.


	UNITED COMPONENTS, INC.

Date: May 13, 2004	By:	/s/ CHARLES T. DICKSON

	Name:	Charles T. Dickson
	Title:	Chief Financial Officer