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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark one)
|x| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR
|_| 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: 333-58675
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KEY COMPONENTS, LLC
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(Exact Name of Registrant as Specified in its Charter)
Delaware 04-3425424
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
Wing Road RR1, Box 167D, Millbrook, New York 12545
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (914) 677-8383
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
10 1/2% Senior Notes due 2008
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Commission File Number: 333-58675
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KEY COMPONENTS FINANCE CORP.
----------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 14-1805946
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
Wing Road RR1, Box 167D, Millbrook, New York 12545
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (914) 677-8383
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
10 1/2% Senior Notes due 2008
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Indicate by check mark whether 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 registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. |X| Yes |_|
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
statements incorporated by reference in Part III of this Form 10-K or any other
amendment to this Form 10-K. |_|
At March 29, 1999, all of the membership interests in Key Components, LLC
were owned by Key Components, Inc., a privately-held New York corporation and
all of the shares of common stock of Key Components Finance Corp. were owned by
Key Components, LLC.
Documents Incorporated by Reference: None
Part I
Key Components Finance Corp. ("Finance Corp.") is a wholly-owned
subsidiary of Key Components, LLC ("KC LLC"). KC LLC is a wholly-owned
subsidiary of Key Components, Inc. and Key Components, Inc. has no material
assets other than its interest in KC LLC. Accordingly, all information in this
Form 10-K has been given for Key Components, Inc., of which KC LLC is a
wholly-owned subsidiary.
Item 1. Business.
Key Components, Inc. ("KCI" or the "Company"), a New York corporation
organized on April 30, 1997, maintains its principal office at Wing Road, RR1,
Box 167D, Millbrook, New York 12545 and its telephone number is (914) 677-8383.
KCI is a leading manufacturer of custom engineered essential componentry
for application in a diverse array of end-use products. The Company targets
original equipment manufacturer ("OEM") markets where KCI believes its
value-added engineering and manufacturing capabilities, along with its timely
delivery, reliability and customer service, enable it to differentiate the
Company from its competitors and enhance profitability. KCI, through its
subsidiaries Hudson Lock, Inc. ("Hudson") and ESP Lock Products, Inc. ("ESP"),
has been designing and manufacturing medium-security locks and related
accessories since 1963 and, through its subsidiary B. W. Elliott Manufacturing
Co., Inc. ("Elliott"), flexible shaft products since 1932. The Company's locks
and associated hardware are designed to be utilized in a wide range of end-use
markets including the office furniture, point of sale ("POS") terminal and bank
and postal accessory markets (the "Specialty Lock Business"). The Company's
flexible shaft products are produced for both rotary power transmission and
remote valve control applications in the industrial, aerospace and commercial
markets (the "Flexible Shaft Business"). The Company benefits from a diverse
customer base, with sales to approximately 1,500 customers in fiscal 1998 and
with the largest customer representing approximately 6.6% of consolidated net
sales. KCI's products are critical to the design and function of its customers'
products and management believes the majority of KCI's sales are to customers
for which the Company is the primary (greater than 70.0% of the customer's total
requirements for the particular product) supplier. Information concerning the
Company's industry segments for the three years ended December 31, 1998 is set
forth in Note 13 to the Consolidated Financial Statements of the Company
included elsewhere in this report.
Acquisition History
In 1992, KCI's management began an acquisition program to acquire small to
medium size manufacturers of essential niche components for use in various OEM
customer products. The 1992 acquisition of Elliott from certain individual
shareholders, including the current President of Elliott, George M. Scherer,
marked the first of such acquisitions. In 1993, the Company acquired the
flexible shaft division of Stow Manufacturing Company, Inc., as a consolidation
opportunity for Elliott. On May 15, 1997, the Company acquired all of the issued
and outstanding capital stock of Hudson from Jordan Industries, Inc. for a cash
purchase price of $39.1 million and assumed liabilities of $1.2 million. The
acquisition of Hudson marked the Company's entrance into the medium-security
lock
business. Such acquisition was financed through the proceeds of certain
indebtedness, which indebtedness was refinanced during fiscal 1998. See Notes
2 and 6 to the Consolidated Financial Statements of the Company contained
elsewhere in this report. On December 10, 1997, the Company acquired all of
the issued and outstanding capital stock of ESP from certain individual
shareholders, including the current President of ESP, August M. Boucher, as a
consolidation opportunity for Hudson. The ESP acquisition price consisted of
$16.3 million of cash and $10.4 million of assumed liabilities, and such
acquisition was financed through additional borrowings under the Company's
then existing loan agreement. Effective January 15, 1999, KC LLC, through a
wholly-owned subsidiary, acquired all of the issued and outstanding
securities of Valley Forge Corporation for approximately $84 million. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-- Acquisition of Valley Forge Corporation."
The Company has historically acquired complementary or related
manufacturing businesses and sought to integrate them into existing operations.
Following an acquisition, management seeks to rationalize operations, reduce
overhead costs, develop additional cross-selling opportunities and establish new
customer relationships. As a result of its integration efforts and internal
growth, the Company's consolidated net sales have increased from approximately
$9.1 million in fiscal year 1992 to approximately $61.9 million for fiscal 1998.
The Company continues to seek to make selective acquisitions of light
industrial manufacturing companies, but there are no written agreements
regarding any such acquisitions existing as of the date hereof.
General
The Specialty Lock Business. The Company, through its wholly-owned
subsidiaries, Hudson and ESP, is a leading domestic designer and manufacturer
of medium-security custom and specialty locks and locking systems. The
Specialty Lock Business products are engineered to meet OEM customers'
specifications for use in end products such as office furniture, electronic
cash registers, bank bags, post office boxes and storage lockers. The
Company's expertise in co-engineering product designs with its customers,
substantial manufacturing and testing capabilities and focus on customer
service, have enabled the Company to become the primary supplier to the
majority, in terms of sales, of its Specialty Lock Business customers.
Customers of the Specialty Lock Business include several industry leaders
such as Herman Miller, Inc., International Business Machines Corporation
("IBM"), Steelcase, Inc. and Knoll, Inc. During fiscal 1998, no single
customer represented more than 8.8% of segment net sales.
KCI management estimates the domestic market for locks to be over $3.0
billion, of which approximately $200 million is estimated to represent
medium-security locks. The Company targets the medium-security segment where it
believes its value-added design and manufacturing expertise, along with its
timely delivery, reliability and customer service, enable it to differentiate
itself from its competitors and enhance profitability. The office furniture and
POS terminal markets represent the two largest end-user market segments of the
Specialty Lock Business, constituting 41.1% and 8.8%, respectively, of fiscal
1998 segment net sales.
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The Flexible Shaft Business. The Company, through its wholly-owned
subsidiary, Elliott, is the leading domestic designer and manufacturer of
flexible shaft products, which are engineered to meet the particular design
specifications demanded by a variety of OEM customers. The Company designs
and manufactures more than 2,000 flexible shaft products, all of which
utilize wound wire assemblies to transmit rotary power when applications
render rigid shaft technology (such as universal joints) less efficient or
impossible. The Company's flexible shaft technology provides significant
advantages over traditional rigid shaft technology. Use of flexible shafts
improves existing OEM product designs, provides added flexibility in creating
new designs and eliminates the amount of required componentry, which can
lower overall weight and space requirements, reduce a product's manufacturing
costs, improve end product appearance and shorten assembly times. Product
applications are varied and diverse, limited only by the Company's ability to
develop and manufacture new applications. KCI has developed and introduced
over 100 flexible shaft products to the marketplace during the last three
years. The Company's flexible shaft products are currently used in weed
trimmers, lawn tractors, concrete vibrators, plant processing equipment and
aircraft carriers, as well as in aerospace, medical, industrial and other
products. The Company believes that its product innovation, engineering
expertise, proprietary manufacturing process and high standards of quality
and reliability have enabled KCI to differentiate itself from its
competitors, enhance profitability and become the primary supplier of
flexible shaft products to the majority, in terms of sales, of its customers.
Customers and Markets
The Specialty Lock Business. The lock manufacturing industry is divided
into three distinct market segments: high-security locks, medium-security locks
and low-security locks. The Company currently competes in the medium-security
lock segment where it believes its value-added design and manufacturing
expertise, along with its timely delivery, reliability and customer service,
enable it to differentiate itself from its competitors and enhance
profitability. Medium-security locks are used in applications that involve
non-life threatening situations or when articles of low to moderate financial
value are being secured. Medium-security locks are sold to OEM's across a wide
variety of end product industries, such as the office furniture, vending and
gaming, computer, POS terminal and post office box industries. Management
believes customers in this segment of the lock market are seeking custom lock
suppliers who provide quality products designed to meet precise customer
specifications with reliable service and on time delivery. The Company supplies
specialty lock products to a variety of customers and markets. The end-use
markets comprising the largest component of Specialty Lock Business sales are
the office furniture and POS terminal markets.
The Flexible Shaft Business. Flexible shaft products are a submarket
within the power transmission market. Management believes that the potential
market for flexible shaft products is limited only by a manufacturer's ability
to develop and manufacture new product applications, as flexible shafts can be
used in most low torque (less than 10 horsepower) rotary power transmission
applications of existing rigid shaft technology. Often the application of the
flexible shaft product entails the replacement of existing rigid shaft
technology (such as universal joints). The industry related to flexible shaft
products is therefore highly fragmented as a result of the broad range of
potential applications of both rigid and flexible shaft technology. There are
only three principal
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domestic manufacturers of flexible shafts and the Company currently competes
against the other two manufacturers in all segments of the industry except the
automotive market segment. The Company does not address the automotive market,
except in certain after-market applications, due to the high volume, commodity
nature of the market segment. The Company believes that OEM's will continue to
trend towards outsourcing, streamlining of end products and one piece assembly.
Therefore, the Company anticipates continued expansion of flexible shaft product
applications and overall acceptance. Management estimates that the total
industry sales for flexible shaft products to markets currently being served by
the Company will expand to approximately $38.0 million by 2000 as a result of
the successful introduction of applications for new markets, as well as growth
in existing markets. The Company currently supplies flexible shaft products to
the construction, lawn and garden power equipment, maritime, aerospace and
general industrial markets. However, the Company believes that since flexible
shafts can be used in most low torque applications (less than 10 horsepower) for
rotary transmission, the markets available to the Company are only limited by
KCI's innovation and ability to develop new applications. KCI's Flexible Shaft
Business has over 1,000 customers , only one of which, Poulan Weed Eater, Inc.,
represented greater than 10% of the Flexible Shaft Business net sales for fiscal
1998. Flexible Shaft Business sales to its three largest markets, lawn and
garden power equipment construction, and maritime, represented 28.6%, 22.6% and
15.6%, respectively, of fiscal 1998 segment net sales.
Products
Specialty Lock Products. The Company is a fully integrated manufacturer of
custom and specialty medium-security locks for use by OEM customers. The Company
custom designs and manufactures both pin- and wafer-tumbler locks. Tumbler locks
contain small movable parts, or tumblers, which must be brought to a particular
arrangement in order to enable the lock to be opened. In most cases, the
Company's lock products are small, low-cost but highly engineered essential
components of a much larger, more expensive end product. The primary markets
served by the Company's security products are the office furniture market and
the market relating to electronic retail devices such as POS registers and
computers.
The Company's primary lock product is its wafer-tumbler lock, which
consists of an outer cylinder that encases a rotating inner cylinder or plug.
Wafer-tumbler locks use a series of thin, flat movable metal wafers, engaged by
notches in one or both sides of a key. In a locked position, the wafers extend
partially within the plug, preventing the plug from turning. Insertion of the
correctly notched key lifts the wafers, which in turn raises the drivers to the
shear line between the plug and cylinder, allowing the plug to rotate and
release the locking bolt or turn the locking cam.
The Company also manufacturers and distributes pin-tumbler locks. This
type of lock uses rod-shaped movable pins, which are engaged by notches on one
or both sides of a key. Insertion of the correctly notched key retracts the pins
into the plug, allowing it to be turned. Except for the substitution of pins for
wafers, the mechanics of the pin-tumbler lock are identical to the wafer-tumbler
lock. The Company also produces the "Ultra-Track" locking system, a safety
feature used to prevent multiple drawers from being opened simultaneously in
filing cabinets and desks. In addition to wafer- and pin-tumbler locks, the
Company acts as a distributor of a small quantity of imported locks in the
United States and manufactures lock parts and related hardware for sale to its
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customers, including washers, nuts, screws, bolts, mounting clips, back plates
and dust covers, as well as a selection of keys.
All of the Company's specialty lock products can be manufactured with a
number of varying features to suit the customized requirements of each
particular customer and end product. The Company has the ability to manufacture
its products, including locks, keys and related hardware, out of a number of
different base metals. Available metals include zinc alloy, steel, brass,
stainless steel, and aluminum. Zinc alloy locks can also be finished with a
variety of metal coatings, including chromium, brass, nickel, zinc, cadmium, or
powder. In addition, customers can request a key changeable core. This feature
allows OEM's and end users to change the core or plug of a lock on-site to code
or recode high-volume applications. Key changeable lock cores provide end-users
with an efficient and versatile method to manage their individual security
levels. Other variables which customers can specify include the size, strength,
internal mechanisms, mounting, and operation of the products.
While the Company is not involved with research and design of new
specialty lock product technologies, the nature of the niche markets that the
Company serves has required the continual development of new products, such as
"anti-riffing" devices, as solutions to customers' problems and needs. The
Company also gives office furniture manufacturers the ability to purchase
customized, changeable core locks which allow furniture manufacturers to ship
desks and cabinets to their customers with only the lock housing in place and
the end-user to decide how to tailor its security needs. The Company has
consistently focused on its ability to adapt products to the customers' needs.
Flexible Shaft Products. The Company designs and manufactures
approximately 2,200 flexible shaft products, all of which utilize wound wire
assemblies to transmit rotary power when applications render the predominant
rigid shaft technology less efficient or impossible. Flexible shaft products are
used in connection with the transmission of rotary power when the source of the
rotary power being generated and desired destination of that power are not
aligned. This occurs frequently in many designs and has been dealt with
historically by using several rigid shafts connected by gear boxes, universal
joints, chains and sprockets or belts and pulleys in order to change the
direction of the rotary power being transmitted. While such systems are
functional, they tend to be cumbersome and include multiple exposed rotating
components. The Company's flexible shaft products, which are intended for use in
low torque applications (using 10 horsepower or less), require less space and
have no exposed rotating components. Assembly time of the shaft portion of an
OEM's product is also greatly reduced. Additionally, there are certain flexible
shaft product applications where the use of rigid shaft technology is not only
inefficient, but not physically feasible. For example, in the aerospace market,
the wing profile of new regional jets has been reduced to improve fuel
efficiency, virtually eliminating the possible use of rigid shaft technology.
Each flexible shaft product is made of wound wire covered with a sheath
and is used for transmitting rotary power around, above or below obstacles and
corners. Because the shaft itself is flexible, these products can be snaked
through and around obstacles, improving many existing designs and increasing the
ability to create new, more compact and more complex designs to effect the
transmission of the rotary power. Since this whole rotary power system consists
of one shaft, it is also less cumbersome, easier to assemble and install and is
often lighter and less expensive than the
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conventional system of multiple connecting rigid shafts which have a series of
joints at each turn. The Company's rotary power transmission products are
utilized in connection with the construction, lawn and garden power equipment,
maritime, aerospace and general industrial markets.
As with rotary power transmission, flexible shafts used for the remote
operation of valves are designed to be used when the valve and the mechanism for
controlling the valve are not aligned. Control valves in tight spaces or in
spaces where there are many obstacles to go around, such as on a ship, are not
easily accessed by rigid shafts. The flexible shafts can facilitate the control
of such valves from remote, hazardous or inaccessible locations as the shaft can
be snaked up and around obstacles. Currently, the three largest markets for the
Company's remote valve control products are ship building, including sales to
the United States Navy, power generation and miscellaneous industrial
applications. The Company designs and assembles valve control systems based upon
the needs of a customer for each specific application.
Elliott's engineers are focused on developing potential new applications
for its flexible shaft products. The Company's growth in the rotary power
transmission componentry market has been a function of both growth in its
current end-user markets as well as the Company's ability to expand applications
for flexible shaft products. The Company's success in this area has hinged on
the rapidity at which new applications can be created, accepted and implemented
by the customer. The Company has introduced over 100 flexible shaft products to
the marketplace over the last three years. New markets where flexible shaft
technology is rapidly gaining acceptance are in the production of steering shaft
assemblies in general industrial and lawn and garden power equipment markets, as
well as the use of flexible shaft technology for flap drives on smaller planes
in the aerospace market. The Company believes that it will be able to continue
to engineer and manufacture new and improved applications for its flexible shaft
technology, and that it will continue to be able to meet the precise design
specifications of its customers, which may vary as to weight, flexibility and
cost requirements.
Manufacturing and Operations
The Company's production processes are designed to reduce costs and
improve overall profitability. Using its operating strategy, the Company
endeavors to design its manufacturing process so that machine and labor
utilization are optimized and total costs are reduced. Cost savings are
generated through effective management of monthly product line profit and loss.
On a monthly basis, gross margins of every product line within each product
group are reviewed. The Company monitors the progress of its efficiency efforts
on an ongoing basis, both monthly and quarterly, and reacts quickly to resolve
problems or exploit unanticipated opportunities.
Custom products are sold at a premium to direct manufacturing costs, based
on factors such as lot size and availability. Management believes it has a
thorough understanding of the products and customers in the markets it serves,
enabling the Company to utilize aggressive but competitive pricing practices.
Sales and Marketing
The Company employs both salaried and commission-based sales personnel, as
well as independent sales representatives, to facilitate the marketing and sales
of its products. The
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Company's sales and marketing teams have adopted an integrated approach to
product development, marketing and sales. They seek to work closely with the
Company's engineers to address customer's specific design requirements and the
hurdles associated therewith, as well as potential product profitability. In
addition, the sales team is responsible for keeping the Company's engineering,
manufacturing and management personnel advised of possible future trends and
requirements of customers. The Company's sales and marketing personnel also
focus on bringing customers a level of personal service the Company believes to
be superior to its competitors.
Competition
The Specialty Lock Business. The lock industry is divided into three
segments, high-security, medium-security and low-security. In the
medium-security lock segment, the Company has four primary competitors.
Generally, these competitors are either divisions of larger entities or family
owned and run operations. Competition in this segment is based on cost, as well
as such value-added services as timely delivery, consistency in quality and
design. In order to compete effectively, suppliers must be focused on each
customer's specific needs and must have the level of sophistication necessary to
meet their particular requirements. The Company believes its ability to focus on
these niche markets, coupled with the level of sophistication provided by its
experienced management team, enables KCI to compete effectively in the
medium-security lock segment. In addition, due to its vertically integrated
manufacturing processes, the Company believes that it is able to manufacture its
products at a lower cost with a higher quality and faster turnaround time than
its competitors.
The high-security segment, which produces locks used in residential,
commercial and automotive doors, as well as other high-security applications, is
dominated by such companies as Schlage Lock Co., Master Lock, Inc. and Medeco
Security Locks Inc. The Company believes competition in the high-security
segment is principally based on name recognition. The low-security lock industry
is a commodity-type business, in which competition is principally based on low
cost and high volume delivery capabilities and not timely delivery or service.
Competitors in this segment are generally located outside the United States in
countries such as Mexico, China and Taiwan. Due to the dramatically different
competitive dynamics of each market segment, management does not anticipate that
the lock industry will experience significant shifts from one segment to
another.
The Flexible Shaft Business. KCI is the leading supplier to most of its
end user markets, evidencing its ability to differentiate itself from its
competitors based on quality as well as its design and manufacturing
capabilities. Currently, there are two primary competing manufacturers of
flexible shafts serving the segments addressed by KCI, one of which primarily
competes in the weed trimmer market and the other of which primarily competes in
the aerospace and general industrial markets. KCI management believes that KCI's
competitor in the weed trimmer market currently focuses its resources in the
automotive market, a high volume commodity-type market in which the Company
chooses not to compete. In the aerospace and general industrial markets, the
Company's principal competitor specializes in small diameter flexible shaft
products, representing only a small segment of these markets. Although it is
possible other competitors may seek to serve these markets, the Company believes
that there exists today significant barriers to entry, including the
availability of the Company's automatic winding machinery, which is not
available for purchase and must be individually constructed, the availability of
rubber covered casings for use in the construction market, which are only
manufactured by the Company and the capital investment required to purchase the
other capital
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equipment needed to manufacture products of similar quality. The Company also
faces competition from companies that use the alternate rigid shaft technology.
Typically, such companies either have in-house machine shops that manufacture
the individual components needed for the rigid shaft or look to small machine
shops to manufacture the components. Once the components are manufactured, the
OEMs then assemble the rigid shaft systems needed for the specific application
themselves.
Raw Materials and Suppliers
The primary raw materials used by the Company are brass, zinc, stainless
steel, steel wire and rubber, all of which are commodity items, readily
available from a wide range of sources. The Company has enjoyed and continues to
enjoy good relations with its suppliers and has not suffered any material
interruptions in the delivery of its required materials. Additionally, the
Company is not dependent on any single supplier. In the event a supply
arrangement is terminated, the Company would be forced to look elsewhere for its
raw materials which alternative sources management believes can be obtained with
minimal, if any, business interruption. However, the prices for such materials
can fluctuate, and such fluctuations can be material. A material increase in raw
material prices could materially adversely effect the results of operations of
the Company.
Employees
As of December 31, 1998, the Company employed 763 persons on a full-time
basis, including 4 persons who serve as executive officers. Of these employees,
190 are employed in the Flexible Shaft Business and 572 are employed in the
Specialty Lock Business. Neither the Company nor any of its subsidiaries has any
collective bargaining agreement and no employee of the Company or any of its
subsidiaries is represented by a labor union. In addition, neither the Company
nor any of its subsidiaries has ever had a work stoppage and each of the Company
and its subsidiaries considers its relationship with its employees to be
satisfactory.
Item 2. Properties.
The Company owns a five-story, 208,000 square foot building in Hudson,
Massachusetts, which it uses as the corporate headquarters, manufacturing and
warehouse facilities for Hudson. In addition, the Company leases approximately
2,500 square feet in Hudsonville, Michigan, to serve as a distribution center
for Specialty Lock Business products. The lease, which expires on August 31,
2001, provides for an annual rent of $45,000, payable monthly. The Company
leases a 55,000 square foot building in Leominster, Massachusetts, which it uses
as the corporate headquarters and manufacturing facilities of ESP. The lease,
which expires on May 31, 2003, provides that beginning on June 1, 1998, the base
rent shall be $200,000 plus annual increases based on the Consumer Price Index
("CPI"), not to exceed $10,000 per year. Rental payments for 1998 were $208,000.
The Company owns a 250,000 square foot facility in Binghamton, New York,
which serves as the corporate headquarters, manufacturing and warehouse
facilities for Elliott. In addition, the Company leases a 28,500 square foot
building in Binghamton, New York, which it formerly used as an office and
manufacturing facility. The lease, which expires on December 31, 2008, provides
for 5.0% annual increases. Rental payments for 1998 were $76,995. The Company
currently sublets
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8,947 square feet to an unrelated third party. In 1998, the sublet generated
$22,341 in lease revenue. The Company also leases an 18,125 square foot building
in Chenago Bridge, New York, which it currently uses as a manufacturing
facility. This lease, which expires June 30, 2000, provides for an annual rent
of $94,563, plus a 1.5% annual increase. Rental payments for 1998 were $94,563.
Item 3. Legal Proceedings.
There are no pending material legal proceedings to which the Company or
its properties is subject.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1998.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's no par value common stock is not a publicly traded security.
Item 6. Selected Financial Data.
The following selected financial data has been derived from the
financial statements of the Company. For the three fiscal years ended
December 31, 1996, the financial data set forth represents the results and
the balance sheet data of Elliott (predecessor to the Company). The Company
acquired Hudson on May 15, 1997 and ESP on December 10, 1997. The financial
data set forth with respect to the two fiscal years ended December 31, 1998
includes the results of Hudson and ESP from their respective acquisition
dates. The data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" and the Company's consolidated financial statements and notes
thereto.
Year ended December 31,
-----------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Revenue $61,862 $27,318 $13,449 $13,185 $13,612
Income from operations 11,953 5,115 447 2,372 1,880
Net income (a)(b)(c) 3 1,250 490 1,247 925
Total assets 93,144 79,757 11,454 10,709 11,445
Long term obligations
(including current
maturities) 81,278 66,856 3,428 3,608 5,005
(a) The Company elected to be treated as a subchapter S corporation under the
Internal Revenue Code effective May 31, 1997. As an S corporation, the
shareholders of the Company are personally liable for most taxes on the
income of the Company. Accordingly, subsequent to May 31, 1997, the
provision for income taxes includes only those taxes applicable to certain
states. Due to the change in tax status, the 1997 tax provision includes a
charge of $469 representing the write-off of net deferred tax assets.
(b) Effective January 1, 1996, Elliott changed the composition of costs
included in inventory. Accordingly, Elliott recorded an adjustment to
inventory cost at January 1, 1997 as the cumulative effect of a change
in accounting principle. Had the Company applied this new accounting
principle in the year ended December 31, 1995, income before income
taxes and net income would not have been materially affected.
(c) Net income for the year ended December 31, 1998 reflects an extraordinary
loss on early extinguishment of debt of $4,616.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
KCI is a leading manufacturer of custom engineered essential componentry
for application in a diverse array of end-use products. The Company targets OEM
markets where KCI believes its value-added engineering and manufacturing
capabilities, along with its timely delivery, reliability and customer service,
enable it to differentiate the Company from its competitors and enhance
profitability. KCI, through its subsidiaries, has been designing and
manufacturing medium-security locks and related accessories since 1963 and
flexible shaft products since 1932.
The Company designs and manufactures medium-security custom and specialty
locks and locking systems to meet OEM customers' specifications. The Company's
locks and associated hardware are designed to be utilized in a wide range of
end-use markets including the office furniture, POS terminal and bank and postal
accessory markets for use in products such as office furniture, electronic cash
registers, bank bags, post office boxes and storage lockers.
The Company's flexible shaft products are produced for both rotary power
transmission and remote valve control applications in the industrial, aerospace
and commercial markets. The Company designs and manufactures more than 2,000
flexible shaft products, all of which utilize wound wire
-9-
assemblies to transmit rotary power when applications render rigid shaft
technology (such as universal joints) less efficient or impossible. The
Company's flexible shaft technology provides significant advantages over
traditional rigid shaft technology. The Company's flexible shaft products are
currently used in weed trimmers, lawn tractors, concrete vibrators, plant
processing equipment and aircraft carriers, as well as in aerospace, medical,
industrial and other products.
On May 15, 1997, KCI acquired all of the issued and outstanding capital
stock of Hudson from Jordan Industries, Inc. for a cash purchase price of $39.1
million and assumed liabilities of $1.2 million. On December 10, 1997, KCI
acquired all of the issued and outstanding capital stock of ESP, which on June
22, 1997 had acquired the assets of RAD Lock, Inc., from certain individual
shareholders for a cash purchase price of $16.3 million and assumed liabilities
of approximately $10.4 million.
In April 1998, KC LLC and Finance Corp. were formed to facilitate an
offering of $80 million of senior secured notes, which was completed in May
1998. KC LLC is a wholly-owned subsidiary of the Company and owns 100% of
Hudson, ESP and Elliott. Finance Corp. is a wholly-owned subsidiary of KC LLC
and has no assets or operations.
Results of Operations
The following table sets forth, for the periods indicated, consolidated
statement of operations data for the Company expressed in dollar amounts (in
thousands) and as a percentage of net sales. The results of operations of Hudson
and ESP are included only from the date of their acquisition, May 15, 1997 and
December 10, 1997, respectively. Such acquisitions have been accounted for as
purchases.
Fiscal Year Ended December 31
-----------------------------
1996 1997 1998
---- ---- ----
Percentage of Percentage of Percentage of
Amount Net Sales Amount Net Sales Amount Net Sales
------ --------- ------ --------- ------ ---------
Consolidated Statement of Operations Data:
Net Sales $ 13,449 100.0% $ 27,318 100.0% $ 61,862 100.0%
Cost of goods sold 8,361 62.2 15,798 57.8 39,130 63.3
-------- -------- --------
Gross profit 5,088 37.8 11,520 42.2 22,732 36.7
Selling, general and administrative expenses(a) 4,641 34.5 6,405 23.4 10,779 17.4
-------- -------- --------
Income from operations 447 3.3 5,115 18.7 11,953 19.3
Other income 5 0.0 31 0.1 404 0.7
Interest expense (254) 1.9 (3,007) 11.0 (7,641) 12.4
-------- -------- --------
Income before taxes and change in accounting
principle 198 1.5 2,139 7.8 4,716 7.6
Provision for income taxes (21) 0.2 (889) 3.3 (97) 0.2
Extraordinary loss on early extinguishment of
debt -- -- -- -- 4,616 7.5
Cumulative effect of change in accounting
principle 313 2.3 -- -- -- --
-------- -------- --------
Net income $ 490 3.6% $ 1,250 4.6% $ 3 0.0
========= ======== ========
-10-
- ----------
(a) Selling, general and administrative expenses include salaries and other
compensation of customer service, sales, marketing, finance and
administrative personnel, as well as amortization of goodwill and deferred
financing costs, and other fees and expenses related to the management and
administration of the Company.
Year Ended December 31, 1998 compared to Year Ended December 31, 1997
Net Sales: Net sales increased by approximately $34.5 million, or 126.5%,
from approximately $27.3 million for fiscal 1997 to approximately $61.9 million
for fiscal 1998. Of this increase, approximately $32.5 million resulted from the
inclusion of net sales from the Specialty Lock Business from the dates of its
acquisition. Net sales for the Flexible Shaft Business increased by $2.0
million, or 14.2%, from $14.2 million for fiscal 1997 to $16.2 million for
fiscal 1998. This increase is primarily attributable to customer consolidation,
increased penetration and new product acceptance in the lawn and garden power
equipment market, and greater product acceptance in the maritime market.
Gross Profit: Gross profit increased by approximately $11.2 million, or
97.3%, from approximately $11.5 million for fiscal 1997 to approximately $22.7
million for fiscal 1998. Approximately $10.8 million of this increase is
attributable to the inclusion of the Specialty Lock Business from the dates of
its acquisition. The additional increase of approximately $389,000 was
attributable to the Flexible Shaft Business. Gross profit as a percentage of net
sales decreased from approximately 42.2% for fiscal 1997 to approximately 36.7%
for fiscal 1998. This decrease was primarily due to the inclusion, for the full
year in 1998, of the Specialty Lock Business, which historically has produced a
lower gross margin percentage than the Flexible Shaft Business. Gross profit
from the Specialty Lock Business, as a percentage of such segment's net sales
was 35.0% for fiscal 1998. Gross profit from the Flexible Shaft Business as a
percentage of such segment's net sales, decreased from approximately 44.6% for
fiscal 1997 to approximately 41.5% for fiscal 1998. This decrease in gross
profit as a percentage of net segment sales was the result of a change of
product mix in the lawn and garden power equipment market, with a substantial
portion of the increase in sales attributable to lower gross margin products.
Selling, General and Administrative Expenses: SG&A increased by
approximately $4.4 million, or 68.3%, from approximately $6.4 million for fiscal
1997 to approximately $10.8 million for fiscal 1998. Included in SG&A for fiscal
1998 is $2.1 million of amortization of goodwill and other intangibles
associated with the acquisition of the Specialty Lock Business. The comparable
amortization for the same period in 1997 was $665,000. The remaining increase is
primarily attributable to the inclusion of SG&A of the Specialty Lock Business
for the full 1998 period, as well as increased corporate expenses as a result of
adding professional staff and the incurrence of corporate level professional
fees. Management fees increased by $140,000 in accordance with a new management
agreement entered into as of May 28, 1998. SG&A as a percentage of net sales
decreased from approximately 23.4% in fiscal 1997 to approximately 17.4% in
fiscal 1998. This decrease is primarily attributable to the inclusion for the
full fiscal year in 1998 of the Specialty Lock Business, which has lower SG&A
expenses as a percentage of net sales. SG&A of the Flexible Shaft Business as a
percentage of such business segment's net sales decreased from approximately
24.6%
-11-
in fiscal 1997 to approximately 20.1% in fiscal 1998. This decrease is primarily
attributable to growth in Flexible Shaft Business net sale which exceeded growth
in such segment's SG&A expenses.
Income from Operations: Income from operations increased by approximately
$6.8 million, or 133.7% from approximately $5.1 million for fiscal 1997 to
approximately $12.0 million for fiscal 1998. Operating income of the Specialty
Lock Business increased by $7.0 million or 228.9% due to its inclusion in the
results for the full fiscal year 1998 and its inclusion in only a portion of the
comparable period in fiscal 1997. Operating income for the Flexible Shaft
Business increased by $266,000 or 9.4%, from approximately $2.8 million in
fiscal 1997 to approximately $3.1 million in fiscal 1998 due to factors
discussed above. The increases in income from operations, discussed above, were
partially offset by an increase in corporate expenses, also discussed above.
Interest Expense: Interest expense increased from approximately $3.0
million for fiscal 1997 to approximately $7.6 million for fiscal 1998. This
increase is primarily due to the incurrence of debt issued in connection with
the acquisition of the Specialty Lock Business and the issuance of Senior Notes
in May 1998.
Provision for Income Taxes: Effective May 31, 1997, the Parent elected to
be treated as a subchapter S corporation which causes the Shareholders to be
personally liable for taxes due on the income of the Company. The provision for
income taxes for fiscal 1998 of $97,000 is for taxes on income due in certain
states.
Net Income: Net income decreased from approximately $1.3 million for
fiscal 1997 to net income of approximately $3,000 for fiscal 1998, after an
extraordinary charge in 1998 of $4.6 million resulting from the early repayment
of debt. Income before the extraordinary charge increased by approximately $3.3
million, from approximately $1.3 million in fiscal 1997 to approximately $4.6
million in fiscal 1998. Of the total increase, approximately $6.9 million is
attributable to the inclusion of the Specialty Lock Business in the results of
the full fiscal year 1998. Net income of the Flexible Shaft Business, before the
extraordinary charge, increased by approximately $1.5 million due to factors
discussed above and a decrease in the provision for income taxes of
approximately $882,000. Offsetting the aforementioned increases was a $5.1
million increase in corporate expenses, primarily interest expense as discussed
above.
Year Ended December 31, 1997 compared to Year Ended December 31, 1996
Net Sales: Net sales increased by approximately $13.9 million, or 103.1%,
from approximately $13.4 million for fiscal 1996 to approximately $27.3 million
for fiscal 1997. Of this increase, approximately $13.1 million resulted from the
inclusion of net sales from the Specialty Lock Business from the dates of its
acquisition. Net sales for the Flexible Shaft Business increased by $724,000, or
5.4%, from $13.4 million for fiscal 1996 to $14.2 million for fiscal 1997. This
increase is primarily attributable to overall growth in the construction market
and greater product acceptance in the commercial segment of the aerospace
market. Increases in sales to customers in these markets were partially offset
by a decline in sales to the lawn and garden power equipment market due to the
temporary loss of a particular customer.
-12-
Gross Profit: Gross profit increased by approximately $6.4 million, or
126.4%, from approximately $5.1 million for fiscal 1996 to approximately $11.5
million for fiscal 1997. Approximately $5.2 million of this increase is
attributable to the inclusion of the Specialty Lock Business from the dates of
its acquisition. The additional increase of approximately $1.2 million was
attributable to the Flexible Shaft Business. Gross profit as a percentage of net
sales increased from approximately 37.8% for fiscal 1996 to approximately 42.2%
for fiscal 1997 due to increased margins in the Flexible Shaft Business, which
were slightly offset by the inclusion of the Specialty Lock Business which has
historically produced a lower gross margin. Gross profit from the Specialty Lock
Business as a percentage of such segment's, net sales was 39.6% for fiscal 1997.
Gross profit as a percentage of net sales for the Flexible Shaft Business
increased from approximately 37.8% for fiscal 1996 to approximately 44.6% for
fiscal 1997. This improvement in gross profit as a percentage of net sales was
due to (i) a write-off of obsolete inventory in fiscal 1996, (ii) changes in
product mix and (iii) improved efficiencies due to consolidation and vertical
integration.
Selling, General and Administrative Expenses: SG&A increased by
approximately $1.8 million, or 38.0%, from approximately $4.6 million for
fiscal 1996 to approximately $6.4 million for fiscal 1997. Of this increase,
$665,000 is attributable to the amortization of goodwill and other
intangibles associated with the acquisition of the Specialty Lock Business
and approximately $1.5 million is attributable to the SG&A of the Specialty
Lock Business since the dates of its acquisition. The remaining increase of
approximately $145,000 relates to increased corporate expenses, primarily
management fees. SG&A of the Flexible Shaft Business decreased by $510,000,
or 12.8%, from $4.0 million for fiscal 1996 to approximately $3.5 million for
fiscal 1997, primarily due to a $702,000 reduction in nonrecurring business
consolidation charges, partially offset by a $130,000 increase in occupancy
costs. SG&A as a percentage of net sales decreased from approximately 34.5%
in fiscal 1996 to approximately 23.5% for fiscal 1997, primarily due to the
inclusion of the Specialty Lock Business which has historically had lower
SG&A expenses as a percentage of net sales. SG&A of the Specialty Lock
Business as a percentage of such segment's net sales was 16.3% for fiscal
1997. SG&A as a percentage of Flexible Shaft Business net sales decreased
from approximately 29.7% for fiscal 1996 to approximately 24.6% for fiscal
1997, due to the factors discussed above.
Income from Operations: Income from operations increased by
approximately $4.7 million, or 1,044.3% from $447,000 for fiscal 1996 to
approximately $5.1 million for fiscal 1997. Approximately $3.1 million of
this increase is attributable to the inclusion of the Specialty Lock Business
from the dates of its acquisition. Income from operations of the Flexible
Shaft Business increased by approximately $1.7 million, or 360.4%, from
approximately $1.1 million for fiscal 1996 to approximately $2.8 million for
fiscal 1997, due to the factors discussed above. This increase was slightly
offset by an increase of approximately $145,000 in corporate expenses, as
discussed above.
Interest Expense: Interest expense increased from $254,000 for fiscal 1996
to approximately $3.0 million for fiscal 1997. This increase is primarily due to
the incurrence of debt issued in connection with the acquisition of the
Specialty Lock Business.
Provision for Income Taxes: Provision for income taxes increased from
$21,000 in fiscal 1996 to $889,000 in fiscal 1997. Effective May 31, 1997, the
Parent elected to be treated as a subchapter S corporation. Therefore, the
Company ceased accruing a provision for federal income taxes as of such date and
wrote off a net deferred tax asset in the amount of $469,000 in fiscal 1997, as
no future benefit will be derived therefrom.
-13-
Net Income: Net income increased from $490,000 for fiscal 1996 to
approximately $1.3 million for fiscal 1997, due to the factors discussed above,
and net of a $313,000 credit for the cumulative effect of a change in accounting
principle in fiscal 1996 relating to the allocation of costs to inventory.
Liquidity and Capital Resources
Historical
The Company has historically generated funds from its operations and its
working capital requirements generally do not fluctuate from quarter to quarter.
Cash flow provided by operating activities was approximately $8.7 million
and $4.0 million for the fiscal year ended December 31, 1998 and 1997,
respectively. The operating activities of the Company for 1998 and 1997 include
the operations of the Specialty Lock Business from the dates of its acquisition.
For the fiscal year ended December 31, 1998 and 1997, net cash used in
investing activities was approximately $2.7 million and approximately $56.1
million, respectively. Investing activities for the fiscal year ended
December 31, 1998 consisted primarily of expenditures for property, plant and
equipment. For the fiscal year ended December 31, 1997, investing activities
consisted of the acquisition of Hudson for $39.1 million, the acquisition of
ESP for $16.3 million and expenditures for property, plant and equipment for
approximately $695,000.
Financing activities provided net cash of approximately $5.7 million for
the fiscal year ended December 31, 1998 and approximately $53.2 million for the
same period of 1997. Included in financing activities for the fiscal year ended
December 31, 1998 was (i) the issuance in May 1998 by the Company of certain
senior secured notes in the amount of $80 million (the "Old Notes"), which notes
were subsequently exchanged in November 1998 for senior secured notes registered
under the Securities Act of 1933, with substantially identical terms (the
"Senior Notes"), (ii) the repayment of existing debt obligations of
approximately $66.2 million, and (iii) approximately $8.5 million in costs
associated with debt repayment, repurchase of warrants associated with previous
debt obligations and issuance costs for a new credit facility (the "New Credit
Facility") and the Senior Notes. For the fiscal year ended December 31, 1997,
financing activities were primarily related to the acquisition of the Specialty
Lock Business.
Prospective
As of December 31, 1998, the Company had a cash balance of approximately
$13.1 million. In addition, in July 1998 the Company entered into the New Credit
Facility, which provided for revolving credit borrowings of up to $15.0 million
and additional borrowings of up to $25.0 million for future acquisitions. Among
other provisions, the New Credit Facility provides that (i) availability of
revolving credit loans will be subject to a borrowing base, (ii) availability of
acquisition loans will be subject to various criteria, including pro forma
compliance with certain financial ratios and (iii) the Company will be required
to prepay outstanding balances out of excess cash flow and proceeds from certain
asset sales. This New Credit Facility was subsequently amended and restated by
the Company
-14-
in January 1999 in conjunction with the Company's acquisition of the Valley
Forge Corporation, whereby the revolving credit facility of $15.0 million and
acquisition credit facility of up to $25.0 million were replaced with a term
loan facility of $60.0 million and a revolving credit facility of up to $40.0
million of which the entire term loan and approximately $18.6 million of the
revolving loan is outstanding. See "Acquisition of Valley Forge Corporation"
and Note 14 "Subsequent Events" to the Consolidated Financial Statements of
the Company contained elsewhere in this report.
With the consummation of the senior note offering in May 1998, the Company
became required to make semiannual interest payments on the Old Notes, together
with interest and principal payments on other existing indebtedness including
indebtedness under the New Credit Facility, if any.
The Company's remaining liquidity demands will be for capital expenditures
and other general corporate purposes. As of December 31, 1998, the Company had
outstanding commitments for capital expenditures of approximately $500,000 and
anticipates further capital expenditures of approximately $2.0 million for 1999,
primarily to maintain its facilities, expand its production capacity in order to
take advantage of profitable market opportunities and to further automate its
production processes to maximize profitability. The Company expects that capital
expenditure requirements will decrease subsequent to 1999. To the extent cash
flow from operations is insufficient to cover the Company's capital
expenditures, debt service, and other general requirements, the Company would
seek to utilize its borrowing availability under the Credit Facility.
Management believes that the Company's cash flow from operations, together
with borrowing availability under the New Credit Facility, will be adequate to
meet its anticipated capital requirements for the foreseeable future.
Inflation
Inflation has not been material to the Company's operations for the
periods presented.
Backlog
The Company's backlog of orders as of December 31, 1998 and 1997 was
approximately $12.4 million and $11.6 million, respectively. The Company
includes in its backlog only those orders for which it has accepted purchase
orders. However, backlog is not necessarily indicative of future sales. A
substantial portion of the Company's sales have a three to eight week lead time
and, therefore, only a small portion of orders, in relation to the annual sales
of the Company, are in backlog at any point in time. In addition, purchase
orders can generally be canceled at any time without penalty.
Year 2000
The Year 2000 Problem
The Company is heavily dependent upon computer technology to effectively
carry out its day-to-day operations. In addition, the Company is dependent on
suppliers and customers who also use computer technology in the conduct of their
business. The terms "Year 2000 issues" or "Year 2000 problems," or words of a
similar nature, refer to the potential for failure of computer
-15-
applications as a result of the failure of programs to properly recognize and
handle dates beyond the year 1999. In the case of the Company, such computer
applications may include customer order processing, inventory management,
shipment of products, manufacturing process controllers, internal financial
systems and other information systems, among others.
Readiness
The Company's assessment of the possible consequences of Year 2000 issues
on its business, results of operations, or financial conditions is not complete,
but is continuing in accordance with a Year 2000 compliance plan (the "Year 2000
Plan"). The Year 2000 Plan includes (1) upgrading the Company's information
technology software and all applicable software and embedded technology
applications in its manufacturing equipment and systems to become year 2000
compliant, (2) assessing the Year 2000 readiness of suppliers and customers, and
(3) developing contingency plans, if practicable, for critical systems and
processes. Implementation of the Year 2000 Plan has been undertaken at the
Company's three operating subsidiaries and with respect to various operating and
information systems in varying degrees to date. The Year 2000 Plan is expected
to be fully implemented at all locations and with respect to all critical
information systems in 1999.
Progress to date includes the purchase of upgraded hardware and software
packages and reprogramming of existing systems. All internal systems are
expected to be Year 2000 compliant by mid 1999. Because the Company is dependent
on its suppliers and customers to successfully and profitably operate its
business, the Year 2000 Plan includes an assessment process with respect to
those vendors and customers deemed most critical to the operations and business
of the Company. To date, the Company has contacted certain vendors and
anticipates completing its vendor assessment process by the end of the first
quarter of 1999. The initial steps of a select analysis of the Company's
significant customers to determine the potential effect of Year 2000 issues on
these customers commenced in the fourth quarter of 1998 with expected completion
by mid 1999. The Year 2000 Plan requires continued assessment throughout 1999 in
these areas.
Costs
The costs of the Year 2000 Plan include the purchase price of computer
hardware and software packages, fees for contract programmers and the cost of
internal information technology resources. The costs of achieving Year 2000
compliance have not been material to date and are not expected to be material.
Risks
The Company expects no material adverse effect on its results of
operations, liquidity, or financial condition as a result of problems
encountered in its own business as a result of Year 2000 issues or as a result
of the impact of Year 2000 problems on its vendors or customers. However, the
risks to the Company associated with Year 2000 issues could be significant.
While the Company is undertaking its own evaluation and testing of its
information technology and non-information technology systems, it is dependent
to some extent on the assurances and guidance provided by suppliers of
technology and programming services as to Year 2000 compliance readiness.
-16-
Similarly, the Company's Year 2000 Plan calls for an ongoing analysis of
the possible effects of Year 2000 problems on its suppliers of materials and
non-information technology goods and services as well as its customers and the
demands for its products. The Company has limited ability to independently
verify the possible effects of Year 2000 issues on its customers and suppliers.
Therefore, the Company's assumptions concerning the effect of Year 2000 issues
on its results of operations, liquidity, and financial condition relies on its
ability to analyze the business and operations of each of its critical vendors
or customers. This process, by the nature of the problem, is limited to such
persons' public statements, their responses to the Company's inquiries, and the
information available to the Company from third parties concerning the
industries or particular vendors or customers involved.
Risk also exists that despite the Company's best efforts, critical systems
may malfunction due to Year 2000 problems and disrupt its operations. The
Company is unable to determine at this time the nature or length of time for
such possible disruption and therefore the potential materiality thereof to its
business or profitability.
Interruptions of communication services or power supply due to Year 2000
problems can cause affected locations to cease or curtail production or receipt
and shipment of materials and products. The Company is dependent on the
suppliers of power and communication services that no such disruptions occur.
Contingency Plans
As part of its Year 2000 Plan, the Company will continue to identify and
evaluate risks and possible alternatives should various contingencies arise. The
Company has prioritized remediation of its most critical information systems and
believes that they will be Year 2000 compliant by the end of the second quarter
of 1999. Should unforeseen circumstances result in substantial delay that may
lead to disruption of business, the Company will develop contingency plans where
possible and not cost prohibitive. To some extent the Company may not be able to
develop contingency plans, such as in the case of communication services or the
supply of power.
Acquisition of Valley Forge Corporation
On December 2, 1998, KCI Acquisition Corp. ("Acquisition Corp."), a
wholly-owned subsidiary of KC LLC, entered into an Agreement and Plan of
Merger with Valley Forge Corporation, a Delaware corporation ("VFC"), which
was amended by Amendment No. 1 on December 28, 1998, pursuant to which
Acquisition Corp. would be merged with and into VFC. On December 3, 1998,
pursuant to the Agreement and Plan of Merger, Acquisition Corp. announced a
tender offer with respect to all issued and outstanding shares of the common
stock, par value $.50, per share of VFC, for a purchase price of $19.00 per
share. The tender offer was completed on January 15, 1999 and pursuant
thereto the Company purchased approximately 94.6% of VFC's issued and
outstanding shares of common stock. On January 19, 1999, Acquisition Corp.
merged with and into VFC and pursuant to such merger the Company acquired the
remaining outstanding shares of VFC, also at $19.00 per share. The aggregate
purchase price for the VFC shares acquired in the tender offer and pursuant
to the merger was approximately $84 million. KC LLC and the Company obtained
the funds required to purchase the outstanding shares of VFC through cash on
hand and approximately $78 million of borrowings under the amended and
restated New Credit Facility. Through its subsidiaries, VFC designs,
manufactures and distributes a broad line of marine accessories and equipment
and
-17-
manufactures marine electrical shore power connectors, power inverters and other
electrical equipment. See "Liquidity and Capital Resources -- Prospective" and
Note 14 "Subsequent Events" to the Consolidated Financial Statements of the
Company contained elsewhere in this report.
New Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement requires companies to record derivatives
on the balance sheet as assets and liabilities, measured at fair value. Gains
and losses resulting from changes in the values of those derivatives would be
accounted for depending on the use of the derivative and whether it qualifies
for hedge accounting. This statement is not expected to have a material impact
on the Company's consolidated financial statements. This statement is effective
for fiscal years beginning after June 15, 1999, with earlier adoption
encouraged.
Forward Looking Information: Certain Cautionary Statements
Certain statements contained in this "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and elsewhere in this Form
10-K that are not related to historical results, are forward looking statements.
Actual results may differ materially from those projected or implied in the
forward looking statements. Further, certain forward looking statements are
based upon assumptions of future events, which may not prove to be accurate.
These forward looking statements involve risks and uncertainties, including but
not limited to the Company's dependence on regulatory approvals, its future cash
flows, sales, gross margins and operating costs, the effect of conditions in the
industry and the economy in general, and legal proceedings. Subsequent written
and oral forward looking statements attributable to the Company or persons
acting on its behalf are expressly qualified in their entirety by cautionary
statements in this paragraph and elsewhere in this Form 10-K, and in other
reports filed by the Company with the Securities and Exchange Commission.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information required by this item is set forth in the Consolidated
Financial Statements of the Company contained in this report and is incorporated
herein by reference.
Item 8. Financial Statements and Supplementary Data.
The Company's 1998 Consolidated Financial Statements, together with the
report of PricewaterhouseCoopers LLP dated February 19, 1999, are included
elsewhere herein. See Item 14 for a list of Financial Statements and Financial
Statement Schedules.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
-18-
PART III
Item 10. Directors, Executive Officers and Key Employees of the Company.
The following table sets forth information with respect to the directors,
executive officers and other key employees of the Company and its subsidiaries
as of December 31, 1998. All directors and officers of the Company and its
subsidiaries hold office until the annual meeting of stockholders next following
their election, or until their successors are elected and qualified.
Name Age Position
- ---- --- --------
John S. Dyson 56 Chairman of the Board of Directors of the
Company, KC LLC and Finance Corp., Director
of Hudson, Director of Elliott and Director
of ESP
Clay B. Lifflander 36 President and Director of the Company, KC
LLC and Finance Corp., Vice President and
Director of Hudson, Director of Elliott and
Vice President and Director of ESP
Alan L. Rivera 36 Vice President, Secretary and Director of
the Company, KC LLC and Finance Corp., Vice
President, Secretary and Director of Hudson,
Assistant Secretary and Director of Elliott
and Vice President, Secretary and Director
of ESP
David H. Bova 40 Vice President--Development and Director of
the Company, KC LLC and Finance Corp.,
Director of Hudson, Director of Elliott and
Director of ESP
George M. Scherer 45 Vice President--Manufacturing and Director
of the Company, KC LLC and Finance Corp.,
Vice President and Director of Hudson,
President and Director of Elliott and
Director of ESP
James D. Wilcox 49 Chief Financial Officer and Vice President
of the Company, KC LLC, Finance Corp.,
Elliott, Hudson and ESP and Treasurer of the
Company, KC LLC and Finance Corp., through
January 25, 1999
Michael L. Colecchi 49 President of Hudson
August M. Boucher 47 President of ESP
John S. Dyson has been Chairman of the Board of Directors of the Company,
KC LLC and Finance Corp. since their inception. Since 1996, Mr. Dyson has been
Chairman of the Board of Directors of Millbrook Capital Management
("Millbrook"), a management company providing executive level services to the
Company under the Management Agreement, and he currently serves as Chairman of
the Mayor of the City of New York's Council of Economic Advisors. From 1994 to
1996, Mr. Dyson served as Deputy Mayor for Finance and Economic Development for
the City of New York. From 1982 to 1993 Mr. Dyson was the Chairman of
Dyson-Sinclair Associates, a management company and the predecessor of
Millbrook. From 1976 to 1979, he served as Commissioner of the New York State
Department of Commerce. Mr. Dyson was Vice Chairman of Dyson-Kissner-Moran
Corporation from 1970 to 1975, at which time he was appointed to the position of
Commissioner of the New York State Department of Agriculture.
-19-
Clay B. Lifflander has been the President and a Director of the Company,
KC LLC and Finance Corp. since their inception. Mr. Lifflander has been
President of Millbrook since 1995, and from 1994 to 1995, Mr. Lifflander was
President of the New York City Economic Development Corporation. Previously, Mr.
Lifflander was Managing Director in the Mergers and Acquisitions Group at Smith
Barney Inc., where he worked from 1984 to 1994.
Alan L. Rivera has been the Vice President, Secretary and a Director of
the Company, KC LLC and Finance Corp. since their inception. Since September
1996, Mr. Rivera has also been employed by Millbrook, where he serves as Chief
Financial Officer and General Counsel. From 1994 to 1996, Mr. Rivera served as
Executive Vice President of Finance and Administration and General Counsel of
the New York City Economic Development Corporation. From 1990 to 1994, Mr.
Rivera was an associate with the New York City law firm of Townley & Updike,
specializing in corporate finance matters, and from 1987 to 1990, Mr. Rivera was
an associate with Mudge, Rose, Guthrie, Alexander and Ferdon, specializing in
public finance matters.
David H. Bova has been the Vice President--Development and a Director of
the Company, KC LLC and Finance Corp., since their inception. He has also served
as President of Millbrook Vineyards Winery, Inc., and Pebble Ridge Vineyards,
Inc. since 1994 and 1992, respectively, and he has been Vice
President--Development of Millbrook since 1995.
George M. Scherer has been the Vice President--Manufacturing and a
Director of the Company and KC LLC since their inception. Mr. Scherer has been
with Elliott since 1978 when he began as Engineering Manager. He has served as
the President and a Director of Elliott since 1982. Prior to joining Elliott,
Mr. Scherer was a product application engineer for Stow Manufacturing Company,
Inc. in Binghamton, N.Y. from 1975 to 1978. Prior to his position at Stow
Manufacturing Company, Inc., Mr. Scherer was a plant engineer at GAF Corporation
in Binghamton, N.Y. from 1973 to 1975.
James D. Wilcox joined the Company as Chief Financial Officer in April
1998. Before joining the Company, Mr. Wilcox had, since 1992, been the Chief
Financial Officer of Systems Engineering and Manufacturing Corp., an
international manufacturer of automated capital equipment. From 1990 to 1992,
Mr. Wilcox was the Vice President--Finance and Administration of Docktor Pet
Holdings, Ltd., a national chain of specialty retail and franchised stores and a
subsidiary of a publicly held company.
Michael L. Colecchi has been with Hudson since 1970, when he began as a
tool and die maker. He subsequently assumed various positions of responsibility
in Hudson's manufacturing department until 1980, when he was appointed Plant
Manager. In 1984, Mr. Colecchi was promoted to Vice President of Manufacturing.
In 1989, Mr. Colecchi was promoted to Vice President and General Manager. Mr.
Colecchi has served as President of Hudson since 1996.
August M. Boucher has been with ESP since 1972, when he began as a tool
designer and manufacturing manager. He subsequently assumed various positions of
responsibility in ESP's manufacturing department until 1979 when he was
appointed Plant Manager. In 1982, Mr. Boucher was promoted to Vice
President--Manufacturing. Mr. Boucher has served as President of ESP since 1993.
-20-
Robert B. Kay became Vice President and Chief Financial Officer of the
Company, KC LLC and Finance Corp. on February 1, 1999 and a director of the
Company in March 1999. From August 1998 through December, 1998, Mr. Kay was
the Senior Vice-President and Chief Financial Officer, as well as a director
of, Tiffen Manufacturing Corp., a manufacturer and distributor of
photographic and imaging products. From January 1994 through August 1998, Mr.
Kay was a Senior Vice-President and Chief Financial Officer of Oxford
Resources Corp. (renamed NationsBank Auto Leasing, Inc.), a publicly traded
consumer finance company.
Item 11. Executive Compensation.
SUMMARY COMPENSATION TABLE
The summary table sets forth information with respect to the compensation
of each of the named executive officers and key employees for services provided
in all capacities to the Company and its subsidiaries in the fiscal year ended
December 31, 1998, the only full year in which the Company paid compensation to
employees. No other executive officer, key employee or former executive officer
or key employee received more than $100,000 compensation in the fiscal year
ended December 31, 1998.
Long Term
Annual Compensation Compensation
------------------------------------------- ------------
Other Securities
Annual Underlying
Name and position Year Salary($) Bonus($) Compensation($) Options(#)
- ------------------- -------- --------- -------- -------------- ----------
James D. Wilcox
Vice President and
Chief Financial Officer 1998 $130,000 -- $ 17,500(1) .8
George M. Scherer
President of Elliot 1998 $302,994 --(2) $ 9,460(3) --
Michael L. Colecchi
President of Hudson 1998 $213,395 $149,029 -- 1.5
August M. Boucher
President of ESP 1998 $165,000 -- --(4) --
- ----------
(1) Consisted of cash payments made pursuant to Mr. Wilcox's employment
agreement with the Company for miscellaneous expenses, including a car
allowance.
(2) Mr. Scherer's bonus for 1998 is not yet determinable, however, Mr. Scherer
was paid his accrued 1997 bonus in 1998, which bonus totaled $38,928.
(3) Consisted of cash payments pursuant to Mr. Scherer's employment agreement
for miscellaneous expenses.
(4) Mr. Boucher received a total of $340,000of deferred compensation in
January 1998.
The salaries for the year ended December 31, 1998 of Clay B. Lifflander
and Alan L. Rivera were paid by Millbrook Capital Management, Inc. ("Millbrook")
pursuant to the terms of a
-21-
Management Agreement. See "Certain Relationships and Related Transactions --
Management Agreement."
The Company has employment agreements with the Presidents of each of
Elliott, Hudson and ESP and with Robert B. Kay, the current Chief Financial
Officer of the Company. The Company was party to an employment agreement with
James D. Wilcox, former Chief Financial Officer of the Company, which was
terminated effective March 19, 1999. See "Employment and Related Agreements."
OPTION GRANTS IN LAST FISCAL YEAR
The following table summarizes the options that were granted to named
executive officers and key employees of the Company and its subsidiaries in the
fiscal year ended December 31, 1998.
Potential Realizable
Value at Assumed
Annual Rates
Individual Grants for Option Term(1)(2)
-------------------------------------- ---------------------
Percent of
Number of Total Options
Securities Granted to Exercise
Underlying Employees in Price Expiration
Name Options Granted(#) Fiscal Year ($/sh) Date 5% 10%
- ---------------- ------------------ ------------ -------- ----------- ------- --------
James D. Wilcox .8(3) 34.8% $350,000 4/17/03 $77,359 $170,943
Michael Colecchi 1.5 65.2% $250,000 4/27/08 $480,170 $986,715
- ----------
(1) Assumes a fair market value of $350,000 per share of common stock, as
determined in good faith by the Company's Board of Directors.
(2) Amounts represent hypothetical gains that could be achieved for the
options if exercised at the end of the term of the options. These gains
are based on assumed rates of stock appreciation of 5% and 10% compounded
annually from the date the respective options were granted to their
expiration date and are not intended to forecast possible future
appreciation, if any, in the price of the Common Stock. The gains shown
are net of the option exercise price, but do not include deductions for
taxes or other expenses associated with the exercise of the options or
the sale of the underlying shares. The actual gains, if any, on the stock
option exercises will depend on the future performance of the Common
Stock, the holder's continued employment through applicable vesting
periods and the date on which the options are exercised. The potential
realizable value of the foregoing options is calculated by assuming that
the fair market value of the Common Stock on the date of grant of such
options equalled the exercise price of such options.
(3) Option canceled March 19, 1999
-22-
AGGREGATED OPTION EXERCISES DURING FISCAL 1998 AND
YEAR END OPTION VALUES
The following table provides information related to options exercised by
each of the named executive officers and key employees during the year ended
December 31, 1998 and the number and value of options held at December 31, 1998.
At December 31, 1998, the Company did not have any outstanding stock
appreciation rights.
Value of Unexercised
Number of Unexercised In-the-Money Options
Options at Year End(1) at Year End(1)
---------------------- ---------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- -------- ----------- ------------- ----------- -------------
James D. -- .8(2) -- --
Wilcox
Michael
Colecchi .4 1.1 $26,666 $73,334
- ----------
(1) Assumes a fair market value of $350,000 per share of common stock, as
determined in good faith by the Company's Board of Directors.
(2) Option canceled March 19, 1999
Employment and Related Agreements
The employment agreement with George M. Scherer, President of Elliott, is
dated January 16, 1996, terminates on January 16, 2001 and provides Mr. Scherer
with a base salary of $225,000 per year, as well as an annual cash bonus in the
event Elliott reaches certain targeted levels of earnings. This agreement also
provides that Mr. Scherer (i) will not compete with Elliott for three years
after termination of his agreement, (ii) will keep all proprietary information
confidential and (iii) will assign to Elliott all innovations that may be
developed by Mr. Scherer during his employment. The employment agreement with
Michael L. Colecchi, President of Hudson, is dated as of May 15, 1997,
terminates on December 30, 2001 and provides Mr. Colecchi with a base salary of
$205,000 per year, subject to a yearly increase based on the CPI, as well as an
annual cash bonus based on Hudson attaining certain earnings targets. Pursuant
to an amendment to Mr. Colecchi's employment agreement, the Parent has granted
Mr. Colecchi a ten year option to purchase 1.5 shares of the Parent's common
stock pursuant to the Parent's 1998 Long-Term Incentive Plan (the "1998 Plan"),
which shall vest and become exercisable over a period of four years at an
exercise price of $250,000 per share, in consideration for the elimination of
certain contingent bonus provisions contained in Mr. Colecchi's agreement. See
"Certain Transactions." The employment agreement with August M. Boucher,
President of ESP, is dated as of December 10, 1997, terminates on December 31,
2002, and provides Mr. Boucher with a base salary of $165,000 per year, subject
to a yearly increase based on the CPI. Mr. Boucher is also eligible for bonuses,
in such amounts and at such times as ESP's Board of Directors may, in its sole
discretion, determine. Included in Mr. Colecchi's and Mr. Boucher's
-23-
agreements are provisions that the officers are not to compete with their
respective employers for five years after termination of their respective
agreements as well as confidentiality provisions.
The employment agreement with James D. Wilcox, the former Chief Financial
Officer of the Company, is dated as of April 17, 1998. The employment agreement
terminates on March 29, 2003 and provides Mr. Wilcox with a base salary of
$130,000 per year, subject to a yearly increase based on the CPI, as well as an
annual cash bonus subject to the sole discretion of the Board of Directors of
the Company. Pursuant to such agreement, Mr. Wilcox has been granted a five year
option to purchase 0.8 shares of the Parent's common stock under the Parent's
1998 Plan, which shall vest and become exercisable over a period of four years
at an exercise price of $350,000 per share. Included in this agreement are
provisions that Mr. Wilcox is not to compete with the Company for two years
after termination of his agreement, as well as a confidentiality provision.
On March 9, 1999, KC LLC and Mr. Wilcox entered into an Agreement and
General Release, whereby Mr. Wilcox voluntarily and irrevocably resigned from
his employment with KC LLC and its subsidiaries. In consideration of his
resignation and in full discharge of any and all obligations to Mr. Wilcox, KC
LLC has agreed to pay Mr. Wilcox $17,500. Mr. Wilcox agreed to confidentiality
and non-solicitation provisions customary in agreements of this type. Mr.
Wilcox's option to acquire certain shares of stock in the Company terminated by
its terms contemporaneous with his resignation from KC LLC which was effective
March 19, 1999.
The employment agreement with Robert B. Kay, the current Chief Financial
Officer of the Company, is dated March 1, 1999, terminates March 1, 2004 and
provides for, among other things, a base salary of $250,000 per annum with
yearly increases based on the CPI, an annual incentive bonus in the event Mr.
Kay and the Company reach certain performance goals, a car allowance, and
vacation and benefits commensurate with the plans and programs generally offered
by the Company to employees of the same level and responsibility of Mr. Kay. The
agreement also provides that Mr. Kay will not compete with the Company for two
years after termination of his agreement and contains certain confidentiality
provisions.
Long-Term Incentive Plan
The Company's 1998 Plan was adopted to attract and retain the best
available personnel for positions of substantial responsibility, to provide
additional incentive to employees, directors and consultants of the Company, KC
LLC and its subsidiaries and to promote the success of the Company's business.
Options granted under the 1998 Plan may be either incentive stock options, as
defined in Section 422A of the Internal Revenue Code of 1986, as amended, or
non-qualified stock options. In addition, stock appreciation rights, and
restricted stock awards and other stock-based awards may be granted under the
1998 Plan. The Company has reserved 20 shares of its no par value common stock
(the "Common Stock") for issuance in respect of options and other awards granted
under the 1998 Plan. As of December 31, 1998, options to purchase an aggregate
of 2.3 shares were outstanding under the 1998 Plan at a weighted average
exercise price of $284,783, of which options to purchase 0.4 shares are
currently exercisable. Such outstanding options consisted of an option granted
to Michael L. Colecchi in April 1998 in connection with an amendment to his
employment
-24-
agreement and an option granted to James D. Wilcox pursuant to his employment
agreement with the Company. See " Executive Compensation."
The 1998 Plan is administered by the Board of Directors, which has the
power to determine the terms of any options or awards granted thereunder,
including the exercise price, the number of shares subject to the option or
award, and the exercisability thereof. Options and awards granted under the 1998
Plan are generally not transferable, and each option or award is exercisable
during the lifetime of the optionee only by such optionee. The exercise price of
all incentive stock options granted under the 1998 Plan must be at least equal
to the fair market value of the shares of Common Stock on the date of grant.
With respect to any participant who owns stock possessing more than 10% of the
voting power of all classes of stock of the Company, the exercise price of any
stock option granted must be equal to at least 110% of the fair market value on
the grant date and the maximum term of the option must not exceed five years.
The term of all other options or awards under the 1998 Plan may not exceed ten
years. The specific terms of each option grant or award are approved by the
Board of Directors and are reflected in a written stock option or award
agreement.
-25-
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Finance Corp is a wholly-owned subsidiary of KC LLC and KC LLC is a
wholly-owned subsidiary of the Company. The following table sets forth
information concerning the beneficial ownership of the Company's Common Stock as
of February 19, 1999 of (i) each person known to the Company to own beneficially
more than 5% of the Company's outstanding Common Stock, (ii) by each director,
executive officer and key employee of the Company and/or any of its subsidiaries
and (iii) all such directors, executive officers, and key employees as a group.
All shares are owned with sole voting and investment power, unless otherwise
indicated.
Beneficial Owner Common Stock Beneficially Owned
- ---------------- -------------------------------
Shares(1) %
---------------- -------------
John S. Dyson 69.7188(2) 66.6%
Charles H. Dyson Trust #1 11.8536(2) 10.6%
F/B/O John S. Dyson
U/A DTD 8/2/68
Charles H. Dyson Trust #1 11.8536(2) 10.6%
F/B/O John S. Dyson
U/A DTD 4/6/76
Margaret M. Dyson Trust #1 11.1390(2) 10.0%
F/B/O John S. Dyson
U/A DTD 3/26/68
Clay B. Lifflander 53.4803(3) 48.0%
George Scherer 10.00 9.5%
Alan L. Rivera 4.5412 4.1%
David H. Bova 3.1772 2.9%
August M. Boucher 2.00 1.8%
Michael Colecchi .4(4) *
James D. Wilcox 0.0(5) *
Robert B. Kay 1.0 *
All Officers and Directors (9 persons) 109.0713(6) 98.0%
- ----------
(1) Unless otherwise indicated, the Company believes that the beneficial
owners of the securities have sole investment and voting power with
respect to such securities, subject to community property laws where
applicable.
(2) Includes an aggregate of 34.8462 shares of Common Stock owned of record by
the Charles H. Dyson Trust #1 F/B/O John Dyson U/A DTD 8/2/68, Charles H.
Dyson Trust #1 F/B/O John Dyson U/A DTD 4/6/76 and the Margaret M. Dyson
Trust #1 F/B/O John Dyson U/A DTD 3/26/68 (the "Dyson Trusts"), of which
Mr. Dyson is a beneficiary and trustee.
(3) Consists of .1428 shares of Common Stock owned of record by trusts for the
benefit of Mr. Lifflander's minor children, or which Mr. Lifflander is a
trustee and 34.8462 shares of Common Stock owned of record by the Dyson
Trusts, of which Mr. Lifflander is a trustee.
(4) Consists of an option to purchase 1.5 shares of Common Stock, which is
currently exercisable as to .4 shares. See "Management-Employment
Agreements and Executive Compensation."
(5) Consists of an option to purchase .82 shares of Common Stock, which option
was canceled March 19, 1999. See "Management - Employment Agreements and
Executive Compensation."
(6) Includes 34.8462 shares of Common Stock owned of record by the Dyson
Trusts and .1428 shares of Common Stock owned of record by trusts for the
benefit of Mr. Lifflander's minor children, of which Mr. Lifflander is a
trustee.
-26-
Item 13. Certain Relationships and Related Transactions.
ESP Lease
The Company rents its Leominster, Massachusetts manufacturing facility
under an operating lease agreement entered into with a company that is co-owned
by an affiliate of August M. Boucher, an officer and shareholder of the Company.
The lease, which expires on May 31, 2003, provides for annual rent increase
based on the CPI. Rental payments amounted to $208,000, $225,000 and $225,000 in
each of 1998, 1997 and 1996, respectively.
Management Agreement
The Company pays management fees to Millbrook, a party related to John
S. Dyson, Chairman of the Board and a shareholder of the Company. These
management and other administrative fees totaled $800,000, $760,000 and
$643,329 in 1998, 1997 and 1996, respectively. Pursuant to the terms of a
Management Agreement, dated as of May 28, 1998, Millbrook provides the
Company with executive level services, for an annual base management fee
equal to $500,000 (the "Base Fee") payable in quarterly installments, plus an
additional fee of $300,000 per year (the "Additional Fee"), payable following
completion of the Company's audited financial statements for such year. No
portion of the Base Fee or the Additional Fee may be paid at the time that
any Event of Default (as defined therein) exists under the Company's
Indenture, dated as of May 28, 1998 (the "Indenture"). In addition, the
Additional Fee may only be paid to the extent that, after giving effect
thereto, the Company's Consolidated Coverage Ratio (as defined in the
Indenture) exceeds 2.0:1, for the fiscal years ending on or prior to December
31, 1999, and 2.25:1 for the fiscal years ending after December 31, 1999. The
Additional Fee may be increased, beginning with the fiscal year ending
December 31, 2000, by an amount up to 15% of the aggregate amount of the Base
Fee and the then current amount of the Additional Fee; provided, however,
that the percentage increase shall not exceed the percentage increase in pro
forma EBITDA (as defined in the Indenture) for such fiscal year as compared
to the prior fiscal year. Notwithstanding the foregoing, total management
fees payable under the Management Agreement may not exceed $1.2 million in
any fiscal year. Any management fees which are not permitted to be paid at
the time due will be deferred (without interest) and will be paid as soon as
permitted. Millbrook will also be entitled to be reimbursed for its out of
pocket expenses.
In 1997, the Company paid Millbrook $400,000 for advisory services
related to the acquisition of ESP. Pursuant to the Management Agreement, the
Company paid Millbrook an investment fee equal to $900,000 upon consummation
of the offering of the Company's Senior Secured Notes in May 1998 for
financial advisory and other services rendered to the Company in connection
with the such offering and the financing of ESP.
-27-
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Documents filed as part of the Form 10-K Form 10-K Page
(1) Financial Statements:
Report of Independent Accountants 29
Consolidated Balance Sheet at December
31, 1998 and 1997 30
Consolidated Statement of Income for the three
years ended December 31, 1998 31
Consolidated Statement of Stockholders' Equity
for the three years ended December 31, 1998 32
Consolidated Statement of Cash Flows for the
three years ended December 31, 1998 33
Notes to Consolidated Financial Statements 34
(2) Financial Statement Schedules:
Valuation and Qualifying Accounts and
Reserves (Schedule II) 47
(b) Reports on Form 8-K
There were no Reports on Form 8-K filed during
the quarter ended December 31, 1998.
(c) Exhibits
See list of exhibits on page 48
(d) Financial Statement Schedules
See (a)(2) above
-28-
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Key Components, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) and (2) on page 28 of the Annual Report on Form
10-K present fairly, in all material respects, the financial position of Key
Components, Inc. and its subsidiaries at December 31, 1998 and 1997 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
As discussed in Note 11 to the financial statements, the Company changed the
composition of costs included in inventory in 1997.
PricewaterhouseCoopers LLP
Syracuse, New York
February 19, 1999
-29-
Key Components, Inc.
Consolidated Balance Sheet
(in thousands except share amounts)
- --------------------------------------------------------------------------------
December 31,
1998 1997
Assets
Current assets
Cash $13,119 $ 1,440
Accounts receivable, net of allowance for doubtful accounts
of $175 and $81 in 1998 and 1997, respectively 7,989 7,763
Inventories (Note 3) 8,487 8,432
Prepaid expenses and other current assets 441 576
------- -------
Total current assets 30,036 18,211
------- -------
Property and equipment at cost less accumulated
depreciation (Notes 1 and 4) 12,222 11,980
------- -------
Deferred financing costs (Note 1) 4,616 2,101
Goodwill (Note 1) 44,378 45,206
Intangible (Note 1) 1,620 2,198
Other assets 272 61
------- -------
50,886 49,566
------- -------
Total assets $93,144 $79,757
======= =======
Liabilities and Stockholders' Equity:
Current liabilities
Notes payable - current (Note 6) $ 424 $ 3,395
Capital lease obligation (Note 7) 77 67
Accrued lease costs - current (Note 7) 17 15
Accounts payable 1,465 1,702
Accrued expenses 1,977 2,165
Accrued interest 750 186
------- -------
Total current liabilities 4,710 7,530
Notes payable - long term (Note 6) 80,036 62,558
Capital lease obligation (Note 7) 115 194
Accrued lease costs (Note 7) 609 627
------- -------
Total Liabilities 85,470 70,909
------- -------
Commitments (Note 7)
Stockholders' equity (Note 8)
Capital stock, non par value; 200 shares authorized;
102.4 and 100.4 shares issued and outstanding
at December 31, 1998 and 1997, respectively 1,536 1,036
Paid-in capital -- 739
Retained earnings 6,138 7,073
------- -------
Total stockholders' equity 7,674 8,848
------- -------
Total liabilties and stockholders' equity $93,144 $79,757
======= =======
The accompanying notes are an integral part of these financial statements.
-30-
Key Components, Inc.
Consolidated Statements of Income
(in thousands except share amounts)
- --------------------------------------------------------------------------------
For the year ended
December 31,
1998 1997 1996
Net sales $ 61,862 $ 27,318 $ 13,449
Cost of goods sold 39,130 15,798 8,361
-------- -------- --------
Gross profit 22,732 11,520 5,088
Selling, general and adminstrative expenses 9,979 5,561 3,212
Related party management fees (Note 10) 800 760 643
Non-recurring business consolidation
charges (Note 12) -- 84 786
-------- -------- --------
Income from operations 11,953 5,115 447
Other income (expense)
Other income 404 31 5
Interest expense (7,641) (3,007) (254)
-------- -------- --------
4,716 2,139 198
-------- -------- --------
Provision (benefit) for income taxes
(Notes 1 and 5)
Current 97 655 601
Deferred -- 234 (580)
-------- -------- --------
Total income taxes 97 889 21
-------- -------- --------
Income before extradordinary item and
cumulative effect of change in
accounting principle 4,619 1,250 177
Extraordinary loss on early
extinguishment of debt (Note 6) 4,616 -- --
Cumulative effect of change in
accounting principle (Note 11) -- -- 313
-------- -------- --------
Net income $ 3 $ 1,250 $ 490
======== ======== ========
The accompanying notes are an integral part of these financial statements.
-31-
Key Components, Inc.
Consolidated Statements of Stockholders' Equity
(in thousands except share amounts)
- --------------------------------------------------------------------------------
Total
Capital Paid-in Retained Treasury Stockholders
Stock Capital Earnings Stock Equity
December 31, 1995 $ 1,066 $ 13 $ 6,823 $(1,418) $ 6,484
Net income -- -- 490 -- 490
------- ------- ------- ------- -------
December 31, 1996 1,066 13 7,313 (1,418) 6,974
Issuance of warrants to
purchase 14.2857 shares -- 739 -- -- 739
Retirement of treasury
stock (30) (13) (1,375) 1,418 --
Stockholder distributions -- -- (115) -- (115)
Net income -- -- 1,250 -- 1,250
------- ------- ------- ------- -------
December 31, 1997 $ 1,036 $ 739 $ 7,073 $ -- $ 8,848
------- ------- ------- ------- -------
Repurchase of warrants -- (739) (911) -- (1,650)
Stockholder distributions -- -- (27) -- (27)
Issuance of common stock 500 -- -- -- 500
Net income -- -- 3 -- 3
------- ------- ------- ------- -------
December 31, 1998 $ 1,536 $ -- $ 6,138 $ -- $ 7,674
------- ------- ------- ------- -------
The accompanying notes are an integral part of these financial statements.
-32-
Key Components, Inc.
Consolidated Statement of Cash Flows
(in thousands except share amounts)
- --------------------------------------------------------------------------------
For the year ended
December 31,
1998 1997 1996
Cash flows from operating activities:
Net income $ 3 $ 1,250 $ 490
Adjustments to reconcile net income to net
cash provided by operating activities:
Extraordinary loss on early extinguishment of debt 4,616 -- --
Depreciation and amortization 4,145 1,817 741
Bond discount amortization 31 62 --
Deferred income taxes -- 233 (368)
Loss on disposal of assets 161 53 97
Net increase (decrease) in cash caused
by changes in assets and liabilities
(net of effects of acquisitions):
Accounts receivable (226) (212) (18)
Inventories (55) 597 (419)
Prepaid expenses and other assets (76) 260 (124)
Accounts payable (237) (474) 471
Accrued expenses 376 442 110
Accrured lease costs (16) -- 641
-------- -------- --------
Net cash provided by operating activities 8,722 4,028 1,621
-------- -------- --------
Cash flows from investing activities:
Non-compete agreement (231) -- --
Business acquisitions (Note 2) (312) (55,442) --
Capital expenditures (2,242) (695) (1,298)
Proceeds from sale of equipment 44 5 9
-------- -------- --------
Net cash used in investing activities (2,741) (56,132) (1,289)
-------- -------- --------
Cash flows from financing activities:
Payments of notes payable and other obligations (66,240) (12,468) (2,886)
Costs associated with early repayment of debt (1,979) -- --
Proceeds from issuance of debt 80,000 68,071 2,065
Deferred financing costs (4,906) (2,275) --
Stockholder distributions (27) (115) --
Proceeds from issuance of common stock 500 -- --
Repurchase of warrants (1,650) -- --
-------- -------- --------
Net cash provided (used) by financing activities 5,698 53,213 (821)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 11,679 1,109 (489)
Cash and cash equivalents, beginning of year 1,440 331 820
-------- -------- --------
Cash and cash equivalents, end of year $ 13,119 $ 1,440 $ 331
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year:
Interest $ 6,890 $ 2,632 $ 252
Income taxes 76 451 711
The accompanying notes are an integral part of these financial statements.
-33-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
1. Organization and Significant Accounting Policies
Basis of presentation
The consolidated financial statements as of and for the three years ended
December 31, 1998 relate to Key Components, Inc. (the Company), a parent
holding company of the wholly-owned subsidiary, Key Components, LLC
(KC,LLC), a parent holding company of the wholly-owned subsidiaries, B.W.
Elliott Manufacturing Co., Inc. (Elliott), Hudson Lock, Inc. (Hudson), ESP
Lock Products, Inc. (ESP) and Key Components Finance Corp. (Finance Corp).
All significant intercompany transactions have been eliminated.
KC, LLC and Finance Corp. were formed on April 1, 1998 to facilitate a
debt offering. The Company and KC, LLC have de minimis assets and no
operations other than their investments in their respective subsidiaries.
Finance Corp. has no assets or operations.
On May 15, 1997, in conjunction with the Hudson acquisition, all of the
Elliott shareholders exchanged their ownership interests for an interest
in the Company. The ownership transfer is between entities under common
control and accounted for at historical cost.
Nature of operations
The Company is engaged in the manufacturing of medium-security custom and
specialty locks, keys and locking systems, primarily for original
equipment manufacturers and flexible shafting and remote valve control
components used for power transmission applications.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Cash and cash equivalents
For the purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months
or less to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market, on a first-in,
first-out basis.
Property, plant and equipment
Property, plant and equipment are stated at cost and depreciated using the
straight-line method over useful lives of the assets as follows:
Buildings and building improvements 20 - 40 years
Equipment, furniture and fixtures 3 - 10 years
Leasehold improvements Term of lease
Expenditures for repairs and maintenance are charged to expense as
incurred. When assets are retired or otherwise disposed of, the cost and
related accumulated depreciation are removed from the accounts and any
resultant gain or loss is recognized.
-34-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
Income taxes
The Company has elected to be treated as a Subchapter S corporation under
the Internal Revenue Code effective May 31, 1997. As an S Corporation, the
Company generally does not pay income tax. Instead, the Company's income
and expenses are divided among and passed through to its shareholders.
Accordingly, no provision for income taxes has been recognized in the
financial statements subsequent to May 31, 1997, except for certain
franchise and income taxes which certain states impose on S Corporations.
Prior to the conversion to a subchapter S Corporation, Elliott provided
income taxes based on the liability method of accounting pursuant to
Statement of Financial Accounting Standards No. 109, Accounting for Income
Taxes. Deferred income taxes had been recorded to reflect the tax
consequences on future years of temporary differences between the tax
basis of assets and liabilities and their financial reporting amount at
each year end.
Intangibles
Intangibles at December 31, 1998 primarily consist of costs associated
with a licensing agreement and covenants not to compete arising from
business acquisitions. These assets are being amortized on a straight-line
basis over the life of the related agreements which range from five to
seven years. Amortization of intangibles amounted to $809, $541 and $250
for 1998, 1997 and 1996, respectively. Accumulated amortization at
December 31, 1998 and 1997 was $1,797 and $1,256, respectively.
Goodwill
Goodwill represents the excess of the cost of acquired businesses over the
fair market value of their net tangible assets. Goodwill is being
amortized on the straight-line method over forty years. Amortization
charged to continuing operations amount to $1,140 and $505 for the years
ended December 31, 1998 and 1997, respectively. Accumulated amortization
at December 31, 1998 and 1997 was $1,645 and $505, respectively. At each
balance sheet date, the Company evaluates the realizability of goodwill
based on expectations of non-discounted cash flows and operating income
for each operation having a material goodwill balance. Based on its most
recent analysis, the Company believes that no impairment of goodwill
exists at December 31, 1998.
Deferred financing costs
Debt issuance costs have been deferred and are being amortized on a
straight-line basis over ten years, the life of the senior notes.
Revenue recognition
The Company recognizes revenue upon shipment of products to customers.
Concentration of credit risk
Financial instruments which potentially expose the Company to
concentrations of credit risk consist primarily of trade accounts
receivable. The Company's customer base includes a significant number
involved with the domestic lawn and garden and furniture industries.
Although the Company is directly affected by the well-being of these
industries, management does not believe that a significant concentration
credit risk exists at December 31, 1998.
-35-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
Fair value of financial instruments
For certain of the Company's financial instruments, including cash,
accounts receivable, accounts payable and accrued expenses, management
believes that the carrying amounts approximate fair value due to their
short maturities. The estimated fair value of the Company's long-term debt
is based on the current rates offered to the Company for debt of similar
maturities and approximates carrying value at December 31, 1998.
2. Acquisitions of Businesses
During 1997, the Company acquired the entities described below, which were
accounted for by the purchase method of accounting, and the results of
operations have been included in the consolidated financial statements
since the date of acquisition.
On May 15, 1997, the Company acquired all of the outstanding shares of
Hudson Lock, Inc. (Hudson) for a cash purchase price of $39.1 million and
assumed liabilities of approximately $1.2 million. Hudson manufactures
medium-security custom and specialty locks, primarily for original
equipment manufacturers. The purchase price was allocated based on
estimated fair values at the date of acquisition. This resulted in an
excess of purchase price over assets acquired of $31 million, which is
being amortized on a straight-line basis over forty years.
On December 10, 1997, the Company acquired all of the outstanding shares
of ESP Lock Products, Inc. (ESP) for a cash purchase price of $16.3
million and assumed liabilities of approximately $10.4 million. ESP
primarily manufactures medium-security custom and specialty locks, and key
blanks. The purchase price was allocated based on estimated fair values at
the date of acquisition and included $1.2 million for a covenant not to
compete. This resulted in an excess of purchase price over assets acquired
of $14.7 million, which is being amortized on a straight-line basis over
forty years.
On an unaudited pro-forma basis, assuming the Hudson Lock and ESP
acquisitions had occurred as of the beginning of the periods presented,
the consolidated results of the Company would have been as follows:
1997 1996
Pro forma net sales $58,975 $53,019
Pro forma income (loss) before taxes
and change in accounting principle 3,760 (9)
The unaudited pro-forma financial information presented above is not
necessarily indicative of the results that would have actually occurred
had the companies been combined for the periods presented.
-36-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
3. Inventories
Inventories consist of the following:
1998 1997
Raw materials $ 2,642 $ 2,810
Work-in-process 3,982 3,610
Finished goods 1,863 2,012
-------- --------
Total inventory $ 8,487 $ 8,432
======== ========
4. Property, plant and equipment
Property, plant and equipment consists of the following:
1998 1997
Land, building and improvements $ 3,083 $ 3,266
Equipment, furniture and fixtures 14,176 12,345
Leasehold improvements 184 172
Construction-in-progress 292 341
-------- --------
17,735 16,124
Less accumulated depreciation (5,513) (4,144)
-------- --------
Total property, plant and equipment $ 12,222 $ 11,980
======== ========
Depreciation expense amounted to $1,796, $836 and $490 for the years ended
December 31, 1998, 1997 and 1996, respectively.
-37-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
5. Federal and State Income Taxes
Income tax expense (benefit) consists of the following:
1998 1997 1996
Federal taxes $ -- $ 782 $ 51
Various state taxes 97 107 (30)
------ ------ ------
Total income tax expense $ 97 $ 889 $ 21
====== ====== ======
A reconciliation between income taxes computed at the statutory federal
rate and income tax expense is as follows:
1998 1997 1996
Federal income tax rate 34.0% 34.0% 34.0%
State income taxes, net of federal 2.0 3.3 (9.8)
Write-off of net deferred tax asset -- 21.9 --
Income taxed directly to shareholders (34.0) (20.7) --
Adjustment to prior year tax
liabilities -- -- (15.4)
Other, net -- 3.0 1.9
------ ------ ------
2.0% 41.5% 10.7%
====== ====== ======
As discussed in Note 1, the Company elected to be treated as a subchapter
S Corporation effective May 31, 1997 and as such the stockholders are
generally liable for federal and state income taxes except for certain
franchise and income taxes which specific states impose on S Corporations.
Due to the change in tax status, the 1997 deferred tax provision includes
a charge of $469 representing net deferred tax assets that were
eliminated. At December 31, 1998 and 1997, the Company's net assets for
financial reporting purposes were approximately $13,597 and $11,997,
respectively, greater than the related tax basis of such net assets,
principally related to the goodwill generated from the acquisition of ESP
which is not deductible for tax purposes.
The Company has earned New York State investment tax credits and economic
development zone investment tax credits. The current tax provision was
reduced by $33 and $90 in 1997 and 1996, respectively, reflecting the
benefit of these credits.
-38-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
6. Long-Term Debt
Long-term debt consists of the following:
1998 1997
Senior notes, due June 1,2008;
interest paid semi-annually at 10.50% $ 80,000 $ --
Term loan, payable in quarterly instalments ranging
from $500,000 to $1,750,000 through May 2004 -- 29,000
Acquisition loan, payable in quarterly instalments
ranging from $250,000 to $1,500,000 through
June 30, 2004 -- 20,000
Senior Subordinated Notes, due May 15, 2005;
interest paid semi-annually at 11.25%, net
of unamortized discount of $677,050 -- 9,323
Revolving credit facility, payable at May 15, 2004 -- 6,771
Obligation under licensing agreement, discounted
at 7.85%, quarterly payments of $87,500,
including principal and interest through
December 1999 333 641
Obligation under covenant not to compete
agreement, monthly principal instalments
of $7,250 payable through June 2000 127 218
-------- --------
80,460 65,953
Less current portion (424) (3,395)
-------- --------
Total long-term debt $ 80,036 $ 62,558
======== ========
-39-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
On May 28, 1998, the Company issued $80,000 of 10.50% Senior Notes due
June 1, 2008, with interest payable semi-annually. The net proceeds from
the sale were used to repay the term loan, acquisition loan, senior
subordinated notes, revolving credit facility, to repurchase outstanding
warrants and for general corporate purposes. In connection with this
repayment, the Company recorded an extraordinary loss of $4,616 in 1998.
The extraordinary losses represent the payment of redemption premiums and
the write-off of deferred finance costs. As of December 31, 1998, the
Company has accrued interest on these notes in the amount of $750.
The notes are fully and unconditionally guaranteed, jointly and severally,
on an unsecured basis, by Elliott, Hudson and ESP (the Subsidiary
Guarantors). At December 31, 1998, the Company has de minimis assets and
no operations other than its investment in KC, LLC, the parent of the
Subsidiary Guarantors. Accordingly, the consolidated financial statements
present the combined assets and operations of KC, LLC and its
subsidiaries, including the Subsidiary Guarantors.
On July 27, 1998, the Company entered into a new credit agreement with
Societe Generale, an administrative agent for the lenders, to provide for
working capital needs, finance future acquisitions and other general
corporate purposes. The agreement provides for a six-year $15 million
revolving credit facility and a six-year $25 million acquisition facility.
Borrowings under the revolver are subject to a borrowing base limitation
measured by eligible inventory and accounts receivable. Availability under
the revolver was $8,889 at December 31, 1998. The credit agreement is
collateralized by all of the capital stock of the subsidiary guarantors,
receivables, inventories, equipment and certain intangible property.
The credit agreement provides for a continuation and conversion election
whereby the Company can elect to have the borrowings outstanding under a
base rate loan or a LIBOR based rate loan. The base rate loan bears
interest at a fluctuating interest rate determined by reference to the
agent's base rate plus 1.375% with respect to the revolving credit
facility, and 1.625% for the acquisition loan. The LIBOR based rate loan
bears interest during an applicable period not to exceed six months at a
fixed rate of interest determined by reference to the LIBOR rate, plus a
margin of 2.375% for the revolving credit facility and 2.625% for the
acquisition facility. In addition, a commitment fee is payable on the
unused portion of the credit line. As of December 31, 1998, the Company
has no borrowings outstanding under either facility. Commitment fees
payable at December 31, 1998 are $50.
The credit agreement and Senior Notes contain certain covenants and
restrictions which require the maintenance of financial ratios, and
restrict or limit dividends and other stockholder distributions,
transactions with affiliates, capital expenditures, rental obligations,
incurrence of indebtedness and the issuance of preferred stock, among
others. At December 31, 1998, the Company was in compliance with these
covenants and restrictions.
-40-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
At December 31, 1998, aggregate principal payments required on all amounts
due after one year are as follows:
Year Amount
2000 $ 36
2001 --
2002 --
2003 --
2004 --
Thereafter 80,000
-------
$80,036
=======
7. Lease Commitments
The Company rents several manufacturing and warehouse facilities under
operating lease agreements, one of which is with a related party (Note
10). Rental payments under all lease agreements amounted to $499, $253 and
$333 in 1998, 1997 and 1996, respectively.
The Company also leases certain machinery and equipment with a bargain
purchase option. These leases are classified as capital leases and expire
at various dates through 2002.
During 1996, the Company initiated a program to consolidate manufacturing
and administrative facilities (Note 12). As a result, the Company
determined that a leased facility would not be used for operating purposes
beyond 1997. Accordingly, the Company established a liability of $641
representing the discounted future rental payments net of estimated
sublease income.
-41-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
The following is a schedule of the future minimum lease payments (net of
sublease income) required under operating and capital leases:
Year Minimum Estimated
Ended Rental Sublease Capital
December 15, Payments Income Net Leases
1998 $ 588 $ 53 $ 535 $ 91
1999 518 54 464 77
2000 436 55 381 41
2001 400 56 344 7
2002 401 58 343 --
Thereafter 1,017 352 665 --
-------- -------- -------- --------
Total minimum lease payments $ 3,360 $ 628 $ 2,732 216
======== ======== ========
Less: Estimated amount
representing interest (24)
--------
Present value of net minimum
lease payments 192
Less: Current portion (77)
--------
Long-term obligation under
capital release $ 115
========
Accumulated amortization on the capital leases amounted to $174 and $67 in
1998 and 1997, respectively.
8. Stockholders' Equity
The Company's capital stock consists of 200 authorized shares of common
stock, without par value, of which 102.40 shares are issued and
outstanding at December 31, 1998.
On April 27, 1998, the Company and August M. Boucher, President of ESP,
entered into an agreement, pursuant to which Mr. Boucher purchased two
shares of the Company's common stock for an aggregate purchase price of
$500.
-42-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
In 1998, the Company adopted a Long-Term Incentive Plan (the Plan) to
attract, retain and provide additional incentive to employees. Awards
under the Plan may take the form of incentive stock options or
non-qualified stock options. In addition, stock appreciation rights and
restricted stock awards and other stock-based awards may be granted. As of
December 31, 1998, options to purchase an aggregate of 2.3 shares were
outstanding under the Plan, at a weighted average exercise price of $285
and a weighted average remaining contractual life of seven years. Options
to purchase 0.4 shares are currently exercisable at a weighted average
price of $250,000. The Plan is administered by the Board of Directors,
which has the power to determine the terms of any options or awards
granted, including the exercise price and the number of shares subject to
award.
The Company applies APB Opinion 25 and related Interpretations in
accounting for its plan. Accordingly, as the exercise price of options was
at or above the market value estimated by management at date of grant, no
compensation cost has been recognized.
Pro forma information regarding net income is required by SFAS No. 123,
Accounting for Stock-Based Compensation, and has been determined as if the
Company had accounted for its employee stock options under the minimum
value method with the following assumptions for 1998:
1998
Weighted average risk-free interest rate 5.5%
Dividend yield None
Weighted average expected life 8 years
Had compensation cost for the Company's stock-based compensation plan been
determined based on the fair values at the grant dates for fiscal 1998
awards, the Company's net income would have been reduced to the pro forma
amounts indicated below:
1998
Net income
As reported 3
Pro forma (37)
9. Retirement Plans
The Company has defined contribution plans covering substantially all
employees. The Company's contribution expense was $90, $47 and $47 in
1998, 1997 and 1996, respectively.
-43-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
10. Related Party Transactions
The Company rents one of its manufacturing facilities under an operating
lease agreement entered into with a company which is co-owned by one of
the Company's stockholders. The terms of the lease, which expires December
31, 2008, provide for annual rent increases of 5%. Rental payments
amounted to $137, $131 and $125 in 1998, 1997 and 1996, respectively.
The Company pays management fees to Millbrook Capital Management, Inc.,
(Millbrook) a party related to a Company stockholder. These management
fees amounted to $800, $660 and $643 in 1998, 1997 and 1996, respectively.
The Company paid $100 to Millbrook for administrative support services
in 1997. Additionally in 1997 Millbrook was compensated $400 for
advisory services related to the financing and acquisition of ESP Lock
Products Inc., which is included as part of the deferred financing and
acquisition costs.
11. Change in Accounting Principle
Effective January 1, 1996, Elliott changed the composition of costs
included in inventory. Prior to 1997, nonproductive time and benefit pay
related to production workers had not been included in the cost of
inventory. Elliott believes that including such costs more accurately
reflects inventory at cost. Accordingly, Elliott has recorded an
adjustment to inventory cost at January 1, 1997 as the cumulative effect
of a change in accounting principle. The effect of this adjustment was to
increase net income for the year ended December 31, 1996 by $313 (net of
income taxes of $212). This change had an immaterial effect on income
before income taxes for the year ended December 31, 1996. Had the Company
applied this new accounting principle in the year ended December 31, 1995,
income before income taxes and net income would not have been materially
affected.
12. Non-recurring Business Consolidation Charges
During 1996, the Company initiated a program at Elliott to consolidate
manufacturing and administrative facilities. In connection with the
program and in accordance with EITF 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)," the Company
recorded provisions during 1996 for the write-down of certain leasehold
improvements totaling $77 and the accrual of lease costs on facilities
which have no substantive future use to the Company of $641 (Note 7).
Additionally, the Company expensed as incurred moving costs of $84 and $68
during 1997 and 1996, respectively. Nonrecurring business consolidation
charges aggregated $84 and $786 in 1997 and 1996, respectively.
-44-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
13. Operating Segments
The Company's reportable segments are strategic business units that have
separate management teams and infrastructures and market their products to
different industries.
The Company has two reportable segments: The Specialty Lock business and
the Flexible Shaft business. The Company produces and markets
medium-security and low-security locks for sale to OEMs across a wide
variety of end product industries, through the Specialty Lock business.
The Flexible Shaft business segment produces and markets flexible shafts,
a submarket within the power transmission market, for sale to OEMs mostly
within the lawn and garden, aerospace and construction industries.
The Company evaluates performance based on operating earnings of the
respective business units. The specialty lock business was formed with the
1997 acquisitions of Hudson and ESP. The Flexible Shaft business was the
single operating segment of the Company prior to the acquisitions in 1997.
Accordingly, operating segment information for 1996 is not presented.
Segment information for 1998 and 1997 is as follows:
1998
----------------------------------------
Specialty Flexible Adjust- Consoli-
Locks Shaft ments dated
Revenue from external customers $45,679 $16,183 $ -- $61,862
Income from operations 10,055 3,098 (1,200) 11,953
Depreciation and amortization 3,064 788 293 4,145
Segment assets 64,647 13,537 14,960 93,144
Capital expenditures 1,446 779 17 2,242
1997
----------------------------------------
Specialty Flexible Adjust- Consoli-
Locks Shaft ments dated
Revenue from external customers $13,145 $14,173 $ -- $27,318
Income from operations 3,057 2,832 (774) 5,115
Depreciation and amortization 992 825 -- 1,817
Segment assets 67,492 12,260 5 79,757
Capital expenditures 276 419 -- 695
The adjustments represent interest income, management fees and other
corporate and administrative expenses and assets.
-45-
Key Components, Inc.
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(in thousands except share amounts)
- --------------------------------------------------------------------------------
14. Subsequent Events (unaudited)
On February 5, 1999, the Company's Flexible Shaft subsidiary (Elliott)
acquired certain compatible product lines for $4,100 and assumption of
certain liabilities. Elliott plans to transfer the assets to its Beckwith
Avenue facility in Binghamton, New York. The transaction is to be
accounted for using the purchase method of accounting. The pro forma
effect of this transaction is not material.
On January 19, 1999, the Company acquired all of the outstanding shares of
Valley Forge Corporation (VFC) for a cash purchase price of $84,689 and
assumed liabilities of approximately $25,476. VFC manufactures
recreational and industrial products sold to original equipment
manufacturers, dealers and distributors. The Company has decided to sell
two VFC subsidiaries.
The acquisitions were financed with available Company resources plus the
proceeds of $60 million from a term loan and of $18,638 from a $40 million
revolving line of credit. The term loan is payable in quarterly payments
through January 19, 2005. Both facilities bear interest at a fluctuating
interest rate determined by reference to the agent's base rate plus an
applicable margin which will vary from 1.50% to 2.25%. These facilities
replace the acquisition loan and revolver discussed in Note 6.
On an unaudited pro forma basis, assuming the VFC acquisition had occurred
as of the beginning of the periods presented, and excluding results for
the subsidiaries expecting to be sold, the consolidated results of the
Company would have been as follows:
1998
Pro Forma net sales $158,597
Pro Forma income before taxes, charge in
accounting principle and extraordinary loss
on early retirement of debt 6,222
The unaudited pro forma financial information presented above is not
necessarily indicative of the results that would have actually occurred
had the companies been combined for the periods presented.
-46-
KEY COMPONENTS, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Years ended December 31, 1998, 1997 and 1996
(in thousands)
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions
------------------------
Balance at Charged to Charged to Balance at
Beginning costs and other end of
Description of Period expenses accounts Deductions period
(2) (1)
ALLOWANCE FOR
DOUBTFUL ACCOUNTS -
deducted from
Accounts Receivable in
the balance sheet
1998 81 111 -- (17) 175
1997 36 27 37 (19) 81
1996 36 20 -- (20) 36
ALLOWANCE FOR EXCESS
AND OBSELETE
INVENTORY - deducted from
Inventory in the
balance sheet
1998 373 44 -- (6) 411
1997 387 (26) 174 (162) 373
1996 -- 387 -- -- 387
(1) Deductions primarily represent write-offs charged against the reserves
listed.
(2) Represents allowance account balances of companies acquired at the date of
acquisitions.
-47-
EXHIBIT INDEX
Exhibit Description
2.1 Agreement and Plan of Merger(1)
2.2 Amendment No. 1 to the Agreement and Plan of Merger, dated as of
December 28, 1998 (1)
3.1 Certificate of Formation of KC LLC.(2)
3.2 Limited Liability Company Agreement of KC LLC.(2)
3.3 Certificate of Incorporation of Finance Corp.(2)
3.4 By-Laws of Finance Corp.(2)
4.1 Indenture, dated as of May 28, 1998, by and among KC LLC, Finance
Corp, Elliot,Hudson, ESP and United States Trust Company of New York,
as trustee.(2)
4.2 Form of 10 1/2% Senior Notes, Due 2008 (filed as part of Exhibit 4.1).
(2)
4.3 Exchange and Registration Rights Agreement, dated May 20, 1998, among
KC LLC, Finance Corp, Elliot, Hudson, ESP and Societe Generale
Securities Corporation.(2)
10.1 Purchase Agreement among KC LLC, Finance Corp, Elliot, Hudson, ESP and
Societe Generale Securities Corporation, dated May 20, 1998.(2)
10.2 Form of 10 1/2% Senior Notes, issued by KC LLC and Finance Corp. to
certain purchasers, and dated as of May 28, 1998 (filed as part of
Exhibit 4.1).(2)
10.3 Employment Agreement between Elliott and George M. Scherer, dated as
of January 16, 1996, as amended March 16, 1996.(2)
10.4 Employment Agreement between Parent and Michael L. Colecchi, dated as
of May 15, 1997, as amended April 27, 1998.(2)
10.5 Employment Agreement between ESP and August M. Boucher, dated as of
December 10, 1997.(2)
10.6 Employment Agreement between the Company and James D. Wilcox, dated as
of April 17, 1998.(2)
10.7 1998 Long-Term Incentive Plan of the Parent.(2)
10.8 Management Agreement, dated May 28, 1998, with Millbrook Capital
Management Inc.(2)
10.9 Lease, dated January 1, 1989, between Elliot and Empire Realty
Company.(2)
-48-
Exhibit Description
10.10 Lease, dated December 1, 1992, between RAD and S&S Properties, Inc.(2)
10.11 Lease Agreement, dated June 7, 1990, between Elliott and Route 12A
Associates, as amended.(2)
10.12 Lease of Real Property, dated June 1, 1993, between ESP and
Massachusetts Colony Corporation.(2)
10.13 Commercial Lease and Deposit Receipt, dated August 27, 1998, between
Hudson and Jim Jelsema.(2)
10.14 Credit and Guaranty Agreement, dated as of July 27, 1998, among the
Issuers, Elliott, Hudson, ESP, Societe Generale, as agent and certain
financial institutions named therein.(2)
10.15 Guarantor Security Agreement, dated as of July 27, 1998, among Elliott,
Hudson, Finance Corp., ESP and Societe Generale.(2)
10.16 Borrower Security Agreement, dated as of July 27, 1998, between KC LLC
and Societe Generale.(2)
10.17 Pledge Agreement, dated as of July 27, 1998, between KC LLC and Societe
Generale.(2)
10.18 Form of Amended and Restated Credit and Guaranty Agreement, dated as of
January 19, 1999, by and among Key Components, LLC, as Borrower,
certain of its subsidiaries, as Guarantors, certain financial
institutions, as Lenders and Societe Generale, as Agent for Lenders.
(3)
10.19 Form of Valley Forge Pledge Agreement, dated as of January 19, 1999, by
Valley Forge Corporation and in favor of Societe Generale.(3)
10.20 Form of Amended and Restated Pledge Agreement, dated as of January 19,
1999, made by Key Components, LLC in favor of Societe Generale.(3)
10.21 Form of Amended and Restated Borrower Security Agreement, dated as of
January 19, 1999, made by Key Components, LLC in favor of Societe
Generale. (3)
10.22 Form of Amended and Restated Guarantor Security Agreement, dated as of
January 19, 1999, made by B.W. Elliott Manufacturing Co., Inc., Hudson
Lock, Inc., ESP Lock Products Inc., KCI Acquisition Corp., Valley Forge
Corporation, Cruising Equipment Company, Force 10 Marine Ltd., Gits
Manufacturing Company, Inc., Glendinning Marine Products, Inc.,
Atlantic Guest, Inc., Heart Interface Corporation, Marine Industries
Company, Multiplex Technology, Inc., Turner Electric Corporation, VFC
Acquisition Company, Inc., and Valley Forge International Corporation
in favor of Societe Generale. (3)
10.23 Agreement and General Release between KC LLC and James D. Wilcox, dated
March 9, 1999.(4)
-49-
Exhibit Description
10.24 Form of Employment Agreement between the Company, Millbrook and Robert
Kay, dated March 1, 1999. (4)
21.1 List of the Company's Subsidiaries. (4)
25.1 Form T-1 Statement of Eligibility of Trustee.(2)
27.1 Financial Data Schedule (4)
- ----------
(1) Previously filed with the Company's Schedule 14D-1, filed on December 9,
1998 (Commission File No.5-13949).
(2) Previously filed with the Company's registration statement on Form S-4
(File No. 333- 59675), which was declared effective on November 9, 1998.
(3) Previously filed with the Company's Current Report on Form 8-K (File No.
333-58675-01), filed February 3, 1999.
(4) Filed herewith.
-50-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this report to be signed on its behalf by the undersigned
thereunto duly authorized.
KEY COMPONENTS, LLC
Dated: March 30, 1999 By:/s/Clay B. Lifflander
-----------------------------
Clay B. Lifflander
Principal Executive Officer
Dated: March 30, 1999 By:/s/Robert B. Kay
-----------------------------
Robert B. Kay
Principal Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Dated: March 30, 1999 /s/ John S. Dyson
-----------------------------
John S. Dyson
Director
Dated: March 30, 1999 /s/ Clay B. Lifflander
-----------------------------
Clay B. Lifflander
Director
Dated: March 30, 1999 /s/ Alan L. Rivera
-----------------------------
Alan L. Rivera
Director
Dated: March 30, 1999 /s/ David H. Bova
-----------------------------
David H. Bova
Director
Dated: March 30, 1999 /s/ George M. Scherer
-----------------------------
George M. Scherer
Director
Dated: March 30, 1999 /s/ Robert B. Kay
-----------------------------
Robert B. Kay
Director
-51-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEY COMPONENTS FINANCE CORP.
Dated: March 30, 1999 By:/s/ Clay B. Lifflander
-----------------------------
Clay B. Lifflander
Principal Executive Officer
Dated: March 30, 1999 By:/s/ Robert B. Kay
-----------------------------
Robert B. Kay
Principal Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Dated: March 30, 1999 /s/John S. Dyson
-----------------------------
John S. Dyson
Director
Dated: March 30, 1999 /s/Clay B. Lifflander
-----------------------------
Clay B. Lifflander
Director
Dated: March 30, 1999 /s/ Alan L. Rivera
-----------------------------
Alan L. Rivera
Director
Dated: March 30, 1999 /s/ David H. Bova
-----------------------------
David H. Bova
Director
Dated: March 30, 1999 /s/ George M. Scherer
-----------------------------
George M. Scherer
Director
Dated: March 30, 1999 /s/ Robert B. Kay
-----------------------------
Robert B. Kay
Director
-52-