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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-Q
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 333-58675
KEY COMPONENTS, LLC
-------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 04-3425424
-------- ----------
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
200 WHITE PLAINS ROAD, TARRYTOWN NY 10591
----------------------------------- -----
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(914) 332-8088
--------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
COMMISSION FILE NUMBER 333-58675-01
KEY COMPONENTS FINANCE CORP. *
------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 14-1805946
-------- ----------
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
200 WHITE PLAINS ROAD, TARRYTOWN NY 10591
----------------------------------- -----
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(914) 332-8088
--------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
|_| Yes |X| No
As of August 12, 2004, all of the membership interests in Key Components,
LLC were owned by Key Components, Inc., a privately held New York corporation.
All of the shares of common stock of Key Components Finance Corp. were owned by
Key Components, LLC.
*Key Components Finance Corp. meets the conditions set forth in General
Instruction H (1) (a) and (b) of Form 10-Q and is therefore filing this Form
with reduced disclosure format.
===============================================================================
KEY COMPONENTS, LLC
FORM 10-Q INDEX
JUNE 30, 2004
PAGE
NUMBER
------
PART I
Item 1. -- Consolidated Financial Statements:
Balance Sheets............................................................. 2
Statements of Income....................................................... 3
Statements of Members' Equity.............................................. 4
Statements of Cash Flows................................................... 5
Statements of Comprehensive Income (Loss).................................. 6
Notes to Consolidated Financial Statements................................. 7
Item 2. -- Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................................. 13
Item 3.-- Quantitative and Qualitative Disclosures about Market Risk................. 23
Item 4.-- Controls and Procedures.................................................... 24
PART II
Item 6.-- Exhibits and Reports on Form 8-K........................................... 24
Signatures ........................................................................... 25
1
PART I -- FINANCIAL INFORMATION
ITEM 1 -- CONSOLIDATED FINANCIAL STATEMENTS
KEY COMPONENTS, LLC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
- ---------------------------------------------------------------------------------------------------------
JUNE 30, December 31,
2004 2003
- ---------------------------------------------------------------------------------------------------------
ASSETS: (unaudited)
Current
Cash $ 1,349 $ 3,872
Accounts receivable, net of allowance for doubtful
accounts of $1,843 and $1,702 in 2004 and 2003, respectively 27,528 23,989
Inventories 32,263 24,063
Prepaid expenses and other current assets 963 1,862
Deferred income taxes 5,149 5,308
Assets held for sale 16,349 20,464
- -------------------------------------------------------------------------------------------------------
Total current assets 83,601 79,558
Property, plant and equipment, net 18,442 18,149
Goodwill, net 86,483 80,165
Deferred financing costs, net 2,890 3,370
Prepaid pension cost 2,518 2,684
Other assets 659 779
- -------------------------------------------------------------------------------------------------------
Total assets $194,593 $184,705
=======================================================================================================
LIABILITIES AND MEMBER'S EQUITY:
Current
Current portion of long-term debt $ 13,301 $ 12,196
Accounts payable 16,492 11,010
Accrued compensation 4,106 4,170
Accrued expenses 8,972 6,541
Accrued income taxes 5,972 1,458
Accrued interest 1,141 1,102
Liabilities associated with assets held for sale 1,960 1,922
- -------------------------------------------------------------------------------------------------------
Total current liabilities 51,944 38,399
Long-term debt 113,401 120,561
Deferred income taxes 2,329 2,626
Other long-term liabilities 2,468 1,739
- -------------------------------------------------------------------------------------------------------
Total liabilities 170,142 163,325
Commitments and contingencies
Member's equity 24,451 21,380
- -------------------------------------------------------------------------------------------------------
Total liabilities and member's equity $194,593 $184,705
=======================================================================================================
The accompanying notes are an integral part of these
financial statements.
2
KEY COMPONENTS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS)
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- ----------------------
2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------------
NET SALES $ 105,828 $ 88,820 $ 54,960 $ 45,013
COST OF GOODS SOLD 65,172 54,757 33,753 27,340
- --------------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 40,656 34,063 21,207 17,673
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 21,398 18,761 10,892 9,527
- --------------------------------------------------------------------------------------------------------------------------
INCOME FROM OPERATIONS 19,258 15,302 10,315 8,146
INTEREST EXPENSE 6,004 6,278 2,987 3,135
- --------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE PROVISION FOR INCOME TAXES AND DISCONTINUED 13,254 9,024 7,328 5,011
OPERATIONS
PROVISION FOR INCOME TAXES 5,280 3,886 2,920 2,154
- --------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS 7,974 5,138 4,408 2,857
(LOSS) INCOME FROM DISCONTINUED OPERATIONS, NET OF
TAX OF $(3,137), $90, $(2,359) AND $9, RESPECTIVELY (5,090) 140 (3,899) 17
- --------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 2,884 $ 5,278 $ 509 $ 2,874
==========================================================================================================================
The accompanying notes are an integral part of these
financial statements.
3
KEY COMPONENTS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF MEMBER'S EQUITY
(IN THOUSANDS)
FOR THE SIX MONTHS For the Year
ENDED JUNE 30, 2004 Ended December 31, 2003
- ----------------------------------------------------------------------------------------------------
(UNAUDITED)
MEMBER'S EQUITY, BEGINNING OF PERIOD $21,380 $25,044
NET INCOME (LOSS) 2,884 (3,430)
MEMBER CONTRIBUTION 187 -
MEMBER WITHDRAWAL - (100)
MINIMUM PENSION LIABILITY, NET OF TAX - (134)
- ----------------------------------------------------------------------------------------------------
MEMBER'S EQUITY, END OF PERIOD $24,451 $21,380
====================================================================================================
The accompanying notes are an integral part of these
financial statements.
4
KEY COMPONENTS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
- ---------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30, 2004 2003
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,884 $ 5,278
Adjustments to reconcile net income to net cash provided
by operating activities:
Loss (income) of discontinued operations 5,090 (140)
Depreciation and amortization 1,807 1,824
Amortization of deferred finance costs 480 478
Deferred taxes 159 (254)
Provision for bad debts 335 67
Changes in assets and liabilities:
Accounts receivable (3,404) (1,917)
Inventories (7,819) (891)
Prepaid expenses and other assets 1,080 4,742
Accounts payable 5,422 (272)
Accrued expenses 5,646 473
- ---------------------------------------------------------------------------------------------
NET CASH PROVIDED BY CONTINUING OPERATIONS 11,680 9,388
NET CASH (USED IN) PROVIDED BY DISCONTINUED OPERATIONS (878) 1,151
- ---------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 10,802 10,539
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Business acquisition (6,067) (4,548)
Capital expenditures (1,293) (1,583)
- ---------------------------------------------------------------------------------------------
NET CASH USED IN CONTINUING OPERATIONS (7,360) (6,131)
NET CASH USED IN DISCONTINUED OPERATIONS (59) (401)
- ---------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (7,419) (6,532)
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt and capital lease obligations (14,593) (5,334)
Proceeds from long-term debt borrowings 8,500 2,000
Member contributions 187 -
Member withdrawal - (100)
- ---------------------------------------------------------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (5,906) (3,434)
- ---------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (2,523) 573
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,872 2,879
- ---------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,349 $ 3,452
=============================================================================================
5
KEY COMPONENTS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)
- ---------------------------------------------------------------------------------------------
FOR THE YEAR
FOR THE SIX MONTHS ENDED DECEMBER 31,
ENDED JUNE 30, 2004 2003
-------------------------------------------------------------------------------------------
(UNAUDITED)
NET INCOME (LOSS) $ 2,884 $ (3,430)
MINIMUM PENSION LIABILITY, NET OF TAX - (134)
-------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME (LOSS) $ 2,884 $ (3,564)
===========================================================================================
6
KEY COMPONENTS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements include the financial statements of Key
Components, LLC ("KCLLC"), and its subsidiaries, all of which are wholly owned
(collectively, the "Company"). All significant intercompany transactions have
been eliminated.
The Company is in the business of the manufacture and sale of custom engineered
essential componentry in a diverse array of end use markets. Through its two
business segments, mechanical engineered components and electrical components,
the Company targets its products to original equipment manufacturers. The
Company's electrical components business product offerings include power
conversion products, specialty electrical components and high-voltage utility
switches. The Company's mechanical engineered components business product
offerings consist primarily of flexible shaft and remote valve control
components and turbocharger components.
KCLLC's assets are limited to the Company's corporate office and its investments
in its subsidiaries. KCLLC's financial statements include the related expenses
of operating the Company's corporate office. KCLLC is wholly-owned by Key
Components, Inc. ("KCI"), a New York corporation. KCI holds no other assets
other than its investments in KCLLC and has no operations.
The accompanying unaudited financial statements of the Company contain all
adjustments that are, in the opinion of management, necessary for a fair
statement of results for the interim periods presented. While certain
information and footnote disclosures normally included in the financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted, the Company
believes that the disclosures herein are adequate to make the information not
misleading. The results of operations for the interim periods are not
necessarily indicative of the results for full years. These financial statements
should be read in conjunction with the consolidated financial statements and
notes thereto for the year ended December 31, 2003 included in the Company's
Annual Report on Form 10-K.
Certain reclassifications were made to conform the prior periods to the current
year presentation.
2. ACQUISITIONS AND DISPOSITIONS
ADVANCED DEVICES, INC.
On May 7, 2004, the Company acquired the net assets of Advanced Devices, Inc.
("ADI") for a purchase price of approximately $8.0 million and assumed
liabilities of approximately $62,000. The Company recorded the estimated excess
purchase price over net assets acquired of approximately $6.2 million as
goodwill. The value ascribed to the estimated excess purchase price over net
assets acquired is preliminary and is subject to change. Other intangibles are
not believed to be material. The ADI product line, which manufactures electrical
wiring devices, will be integrated into the Company's Napa Valley, CA
manufacturing facility. The Company paid approximately $6.1 million in cash at
closing and borrowed approximately $4.5 million on its revolving credit facility
to partially finance this acquisition. The acquisition calls for approximately
75% of the total purchase price to be paid at closing, 10% to be paid at the
earlier of the date when the product line is fully integrated into the Company's
Napa, California manufacturing facility or March 7, 2005, and the remainder over
the next four years annually.
ARENS CONTROLS, LLC
On March 3, 2003, the Company acquired the mechanical components business of
Arens Controls, LLC for a purchase price of approximately $4.5 million and
assumed liabilities of approximately $642,000. The Company recorded the
estimated excess purchase price over net assets acquired of approximately $2.0
million as goodwill. Other intangibles acquired in the transaction were not
material. The product line, which manufactures mechanical push-pull control
solutions, was fully integrated into the Company's Binghamton, New York
manufacturing facility in November 2003. The Company borrowed $2.0 million on
its revolving credit facility to partially finance this acquisition.
7
HUDSON LOCK, LLC
The Company's lock product line's net sales declined significantly during the
three years ended December 31, 2003. Net sales of the lock product line were
approximately $17.2 million, $21.8 million and $32.6 million for the years ended
December 31, 2003, 2002 and 2001, respectively. Management attributes such
decline to the downturn in the economy plus the impact of foreign competition,
both of which have led to the product line becoming a commodity over that
period. As the net sales eroded, the shift in manufacturing to Mexico has
negatively impacted customer service and quality. Further, the decline in sales
volume made it prohibitive to carry the dual overhead infrastructures of its
domestic and Mexico manufacturing facilities. As a result, the Company closed
the lock manufacturing facility in Mexico in February 2004. In closing the
facility, the Company recorded a charge of approximately $664,000 for severance,
closing costs and to adjust inventory and leaseholds to fair value. In addition,
the Company recorded a charge of approximately $605,000 to record the balance of
the lease of the facility on a present value basis, less any estimate for
sublease income.
In March 2004, after reviewing the lock product line's 2003 operating
performance, which in the past was included as part of the Company's MEC
business operating results, as well as its long-term strategic plan, the Board
of Directors of KCI and KCLLC concluded to sell Hudson Lock, LLC ("Hudson"). In
accordance with Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," the Company
recorded the assets and liabilities of Hudson as held for sale and reported the
results as discontinued operations. Based on initial indications of value from
prospective buyers, at June 30, 2004, the Company recorded a charge of
approximately $4.3 million (net of tax of approximately $2.6 million) to reduce
the carrying value of the assets held for sale to its fair value.
The following table summarizes the net assets of the lock product line
(unaudited):
---------------------------------------------------------------------------------------------------
(In thousands) JUNE 30, DECEMBER 31,
2004 2003
---------------------------------------------------------------------------------------------------
Accounts receivable $ 2,172 $ 2,011
Inventory 4,281 4,628
Other current assets and prepaid expenses - 524
Plant and equipment, net - 6,018
Deferred tax assets 9,896 7,283
---------------------------------------------------------------------------------------------------
ASSETS HELD FOR SALE 16,349 20,464
---------------------------------------------------------------------------------------------------
Accounts payable 718 845
Accrued wages and related expenses 276 562
Accrued expenses 966 515
---------------------------------------------------------------------------------------------------
LIABILITIES ASSOCIATED WITH ASSETS HELD FOR SALE 1,960 1,922
---------------------------------------------------------------------------------------------------
NET ASSETS OF LOCK PRODUCT LINE $14,389 $18,542
===================================================================================================
8
The summary of the operations of the lock business for the six and three months
ended June 30, 2004 and 2003 are as follows:
- ---------------------------------------------------------------------------------------------------------------------
(in thousands) SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------
Net sales $ 7,794 $9,264 $ 4,007 $4,234
- ---------------------------------------------------------------------------------------------------------------------
(Loss) income from operations of the lock business, net of tax of
$(3,137),$90, $(2,359), and $9, respectively $(5,090) $ 140 $ (3,899) $ 17
- ---------------------------------------------------------------------------------------------------------------------
3. INVENTORIES
Inventories consist of the following:
- ---------------------------------------------------------------------------
(In thousands) JUNE 30, DECEMBER 31,
2004 2003
- ---------------------------------------------------------------------------
(unaudited)
Raw materials $ 17,938 $12,805
Work-in-process 5,472 4,856
Finished goods 8,853 6,402
- ---------------------------------------------------------------------------
Total inventory $ 32,263 $24,063
- ---------------------------------------------------------------------------
4. PROVISION FOR INCOME TAXES
For the six months ended June 30, 2004 and 2003, the Company's provision for
income taxes primarily relates to the federal and state income taxes of its sole
member, KCI. Deferred income taxes have been recorded to reflect the tax
consequences on future years of temporary differences between the tax bases of
assets and liabilities and their financial reporting amounts at year-end.
Valuation allowances are recorded when necessary to reduce deferred tax assets
to expected realizable amounts.
5. MEMBER CONTRIBUTIONS AND WITHDRAWALS
During the six months ended June 30, 2004, KCLLC received a contribution of
$187,000 from KCI related to proceeds from stock options exercised to purchase
KCI common stock. During the six months ended June 30, 2003, KCLLC distributed
approximately $100,000 to its member, KCI, to enable KCI to repurchase common
stock from a shareholder.
6. WARRANTY COSTS
The Company records a liability for its expected claims under existing product
warranty policies. The accrual is based on the Company's historical warranty
experience. For the six months ended June 30, 2004 and 2003, the Company's
warranty accrual changed as follows:
- ------------------------------------------------------------------
(In thousands)
SIX MONTHS ENDED JUNE 30, 2004 2003
- ------------------------------------------------------------------
(unaudited)
Balance, beginning of period $1,372 $ 985
Additions 586 65
Charges - -
- ------------------------------------------------------------------
Balance, end of period $1,958 $1,050
==================================================================
9
7. OPERATING SEGMENTS
The Company conducts its continuing operations through its two businesses, the
manufacture and sale of electrical components and mechanical engineered
components. The electrical components business ("EC") product offerings include
power conversion products, specialty electrical components and high-voltage
utility switches. The mechanical engineered components business ("MEC")
manufactures flexible shaft products and turbo charger actuators.
The Company evaluates its operating segments' performance and allocates
resources among them based on profit or loss from continuing operations before
interest, taxes, depreciation and amortization ("EBITDA"). EBITDA is not based
on accounting principles generally accepted in the United States of America, but
is the performance measure used by Company management to analyze and monitor the
Company and is commonly used by investors and financial analysts to compare and
analyze companies. Corporate overhead expenses are not allocated to the
segments. In computation of all the financial maintenance covenants under the
Company's credit facility, the Company is allowed to adjust EBITDA for certain
charges as defined in the agreement. The Company's non-GAAP financial measures
may not necessarily be comparable to other companies.
- -------------------------------------------------------------------------------------------------------
(In thousands) MECHANICAL
ELECTRICAL ENGINEERED
COMPONENTS COMPONENTS TOTAL
- -------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 2004:
Net sales to external customers $ 64,179 $ 41,649 $ 105,828
Intersegment net sales - 47 47
Segment profit - EBITDA 12,460 10,928 23,388
Segment assets 118,281 59,472 177,753
Goodwill 65,386 21,097 86,483
Depreciation and amortization 1,214 572 1,786
=======================================================================================================
SIX MONTHS ENDED JUNE 30, 2003:
Net sales to external customers $ 58,633 $ 30,187 $ 88,820
Intersegment net sales - 35 35
Segment profit - EBITDA 11,021 7,679 18,700
Segment assets 108,433 51,894 160,327
Goodwill 59,192 20,973 80,165
Depreciation and amortization 1,250 567 1,817
=======================================================================================================
THREE MONTHS ENDED JUNE 30, 2004:
Net sales to external customers $ 32,698 $ 22,262 $ 54,960
Intersegment net sales - 34 34
Segment profit - EBITDA 6,294 6,173 12,467
Segment assets 118,281 59,472 177,753
Goodwill 65,386 21,097 86,483
Depreciation and amortization 614 290 904
=======================================================================================================
THREE MONTHS ENDED JUNE 30, 2003:
Net sales to external customers $ 29,187 $ 15,826 $ 45,013
Intersegment net sales - 21 21
Segment profit - EBITDA 5,859 4,127 9,986
Segment assets 108,433 51,894 160,327
Goodwill 59,192 20,973 80,165
Depreciation and amortization 624 314 938
=======================================================================================================
10
RECONCILIATION OF SELECTED SEGMENT INFORMATION TO THE COMPANY'S CONSOLIDATED
TOTALS:
(In thousands) SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
- --------------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
PROFIT OR LOSS:
Total profit from reportable segments- EBITDA $23,388 $18,700 $12,467 $ 9,986
Reconciling items:
Corporate expenses (2,322) (1,562) (1,237) (892)
Depreciation and amortization (1,808) (1,836) (915) (948)
Interest expense (6,004) (6,278) (2,987) (3,135)
- --------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes and discontinued
operations $13,254 $ 9,024 $ 7,328 $ 5,011
====================================================================================================================
December
JUNE 30, 31,
2004 2003
- --------------------------------------------------------------------------------------------------------------------
ASSETS:
Total assets for reportable segments $177,753 $160,223
Corporate assets 491 4,018
Discontinued assets 16,349 20,464
- --------------------------------------------------------------------------------------------------------------------
Total consolidated assets $194,593 $184,705
====================================================================================================================
- ----------------------------------------------------------------------------------------------------------------
(In thousands) SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
- ----------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------
GEOGRAPHICAL SALES INFORMATION:
United States $ 94,311 $77,470 $49,138 $39,496
England 2,775 2,884 1,349 1,600
Canada 2,397 2,280 1,170 1,196
China 2,389 2,082 1,299 922
Netherlands 1,028 745 647 275
Japan 527 713 263 456
Other 2,401 2,646 1,094 1,068
- ----------------------------------------------------------------------------------------------------------------
Total $105,828 $88,820 $54,960 $45,013
================================================================================================================
11
8. STOCK OPTIONS
The Company applies the provisions of Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," ("APB 25") in accounting for
stock-based compensation. In accordance with APB No. 25, compensation costs for
stock options is recognized in income based on the excess, if any, of the quoted
market price over the exercise price of the stock on the date of grant. The
exercise price for all stock option grants equals the fair market value on the
date of grant, therefore no compensation expense is recorded.
In accordance with the disclosure provisions of SFAS 148, "Accounting for
Stock-Based Compensation - transition and disclosure," which amended SFAS No.
123, "Accounting for Stock-Based Compensation", the following table illustrates
the effect on net income as if the Company had applied the fair value
recognition provisions for the three months ended June 30, 2004 and 2003:
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
- --------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------
(UNAUDITED) (in thousands)
Net income:
As reported $2,884 $5,278 $509 $2,874
Pro forma $2,883 $5,072 $508 $2,771
- --------------------------------------------------------------------------------------------------
9. PENSION PLANS
The components of the net periodic benefit cost for the six and three months
ended June 30, 2004 and 2003 related to the Company's pension plans were as
follows:
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
- --------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------
(UNAUDITED) (in thousands)
Service Cost $ 220 $ 222 $ 110 $123
Interest Cost 510 569 255 303
Expected return on plan assets (605) (662) (302) (352)
Amortization of net loss 40 67 20 48
- --------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 165 $ 196 $ 83 $122
- --------------------------------------------------------------------------------------------------
EMPLOYER CONTRIBUTIONS
The Company is not required to make any contributions in 2004 and did not make
any contributions in 2003.
12
ITEM 2-- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
GENERAL
KCLLC is the parent holding company of the wholly owned subsidiaries of the
Company. KCI, the sole member of KCLLC, holds no other assets other than its
investment in KCLLC and has no operations. The Company has two operating
business segments, its electrical components ("EC") business and mechanical
engineered components ("MEC") business. Through its two businesses, the Company
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 the Company 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. Further, as the Company
leverages itself in order to acquire additional product lines, management uses
free cash flow (a non-GAAP financial measure defined by the Company as cash flow
provided by operating activities of its continuing operations less cash flow
used in investing activities of its continuing operations) as a key indicator of
each product line. The EC business product lines include power conversion
products, specialty electrical components and high-voltage utility switches. The
product lines of the MEC business consist primarily of flexible shaft and remote
valve control components and turbo-charger actuators.
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 $197.3 million for fiscal year 2003.
The Company continues to seek to make selective acquisitions of light industrial
manufacturing companies (see Note 10 elsewhere in this Form 10-Q).
13
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 financial data set forth
includes the results of operations of its wholly owned subsidiaries from their
respective dates of acquisition. The data set forth below should be read in
conjunction with the Company's consolidated financial statements and notes
thereto contained elsewhere in this Form 10-Q.
SIX MONTHS ENDED JUNE 30, THREE MONTHS ENDED JUNE 30,
-------------------------------------- ---------------------------------------
2004 2003 2004 2003
-------------------------------------- ---------------------------------------
(In thousands) % OF % OF % OF % OF
NET NET NET NET
AMOUNT SALES AMOUNT SALES AMOUNT SALES AMOUNT SALES
---------- --------- --------- --------- ---------- -------- --------- ---------
Net Sales $ 105,828 100.0% $ 88,820 100.0% $ 54,960 100.0% $ 45,013 100.0%
Cost of Goods Sold 65,172 61.6 54,757 61.6 33,753 61.4 27,340 60.7
- ---------------------------------------------------------------------------------------------------------------------------
Gross Profit 40,656 38.4 34,063 38.4 21,207 38.6 17,673 39.3
Selling, general and
administrative expenses 21,398 20.2 18,761 21.1 10,892 19.8 9,527 21.2
- ---------------------------------------------------------------------------------------------------------------------------
Income from operations 19,258 18.2 15,302 17.2 10,315 18.8 8,146 18.1
Interest expense 6,004 5.7 6,278 7.0 2,987 5.4 3,135 7.0
- ---------------------------------------------------------------------------------------------------------------------------
Income before provision for
income taxes and discontinued 13,254 12.5 9,024 10.2 7,328 13.3 5,011 11.1
operations
Provision for income taxes 5,280 5.0 3,886 4.4 2,920 5.3 2,154 4.8
- ---------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 7,974 7.5 5,138 5.8 4,408 8.0 2,857 6.3
(Loss) income from discontinued
operations, net of tax of
$(3,137), $90, $(2,358), and
$9, respectively (5,090) (4.8) 140 0.2 (3,899) (7.1) 17
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 2,884 2.7% $ 5,278 5.9% $ 509 0.9% $ 2,874 6.4%
===========================================================================================================================
A summary of the Company's segments is as follows:
ELECTRICAL COMPONENTS BUSINESS
SIX MONTHS ENDED JUNE 30, THREE MONTHS ENDED JUNE 30,
-------------------------------------- ---------------------------------------
2004 2003 2004 2003
-------------------------------------- ---------------------------------------
(In thousands) % OF % OF % OF % OF
NET NET NET NET
AMOUNT SALES AMOUNT SALES AMOUNT SALES AMOUNT SALES
---------------------------------------- --------------------------------------
Net Sales $64,179 100.0% $58,633 100.0% $32,698 100.0% $29,187 100.0%
Cost of Sales 38,314 59.7 35,647 60.8 19,599 59.9 17,433 59.7
- ----------------------------------------------------------------------------------------------------------------------------
Gross Profit 25,865 40.3 22,986 39.2 13,099 40.1 11,754 40.3
Selling, general and
administrative expenses 14,619 22.8 13,215 22.5 7,419 22.7 6,519 22.3
- ----------------------------------------------------------------------------------------------------------------------------
Income from operations $11,246 17.5% $ 9,771 16.7% $ 5,680 17.4% $ 5,235 17.9%
============================================================================================================================
14
MECHANICAL ENGINEERED
COMPONENTS BUSINESS
SIX MONTHS ENDED JUNE 30, THREE MONTHS ENDED JUNE 30,
-------------------------------------- -------------------------------------
2004 2003 2004 2003
-------------------------------------- -------------------------------------
(In thousands) % OF % OF % OF % OF
NET NET NET NET
AMOUNT SALES AMOUNT SALES AMOUNT SALES AMOUNT SALES
---------------------------------------- -------------------------------------
Net Sales $41,649 100.0% $30,187 100.0% $22,262 100.0% $15,826 100.0%
Cost of Sales 26,858 64.5 19,110 63.3 14,154 63.6 9,907 62.6
- ---------------------------------------------------------------------------------------------------------------------------
Gross Profit 14,791 35.5 11,077 36.7 8,108 36.4 5,919 37.4
Selling, general and
administrative expenses 4,435 10.6 3,965 13.1 2,225 10.0 2,106 13.3
Other
- ---------------------------------------------------------------------------------------------------------------------------
Income from operations $10,356 24.9% $ 7,112 23.6% $ 5,883 26.4% $ 3,813 24.1%
===========================================================================================================================
SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2003
Net Sales: Net sales for the six months ended June 30, 2004 ("Six Months 2004")
increased by approximately $17.0 million, or 19.1%, from net sales for the six
months ended June 30, 2003 ("Six Months 2003"). This increase was the sum of the
approximately $11.5 million, or 38.0%, increase in the net sales of the MEC
business and the approximately $5.5 million, or 9.5%, increase in net sales of
the EC business.
The approximately $11.5 million increase in net sales of the MEC business for
the Six Months 2004 as compared to the Six Months 2003 was driven by continued
growth of both MEC product lines. Net sales of the flexible shaft product line
increased by approximately $3.9 million, or 30.3%, for the Six Months 2004 as
compared to the Six Months 2003. This increase was driven by new product
introductions as well as the acquisition of the mechanical components business
of Arens Controls, LLC ("Arens Controls"). The Company completed this
acquisition on March 3, 2003 (See Note 2 to the consolidated financials
elsewhere in this Form 10-Q), which resulted in having this product line in the
Company's results for four months during the Six Months 2003. Net sales of the
turbocharger components product line increased by approximately $7.6 million, or
43.6%, for the Six Months 2004 as compared to the Six Months 2003. This increase
was driven primarily by continued volume growth of a new product introduced in
December 2002.
The approximately $5.5 million or 9.5% increase in the EC business for the Six
Months 2004 as compared to the Six Months 2003 was driven primarily by the
growth in the Company's specialty electrical components product line, which had
net sales growth of approximately $3.6 million, or 14.8%. This growth was
generated through both its recreational and industrial channels as the increased
sales volume experienced in the fourth quarter of 2003 continued into the first
Six Months 2004. In addition, the power conversion product line posted net sales
growth from the Six Months 2003 to the Six Months 2004 of approximately $1.8
million, or 6.9%. This growth was generated primarily as a result of demand
through its direct OEM sales channel.
Gross Profit: Gross profit increased by approximately $6.6 million, or 19.4%,
for Six Months 2004 as compared to Six Months 2003, resulting from the sum of
the approximately $3.7 million, or 33.5%, increase in the gross profit of the
MEC business and the approximately $2.9 million, or 12.5%, increase in gross
profit of the EC business for the Six Months 2004.
15
The approximately $3.7 million, or 33.5%, increase in gross profit of the MEC
business for Six Months 2004 as compared to Six Months 2003 was driven by volume
increases of the flexible shaft and turbocharger components product lines.
The approximately $2.9 million, or 12.5% increase in gross profit of the EC
business for the Six Months 2004 as compared to the Six Months 2003 resulted
primarily from the volume increases of the specialty electrical components
product line for the Six Months 2004 as compared to the Six Months 2003. In
addition, continued productivity and negotiated material cost savings related to
the power conversion product line also increased gross profit for the EC
business for the Six Months 2004 as compared to the Six Months 2003.
The gross profit, as a percentage of net sales ("GP percentage"), for the MEC
business declined by approximately 1.2% for the Six Months 2004 as compared to
the Six Months 2003 related to price concessions of the Company's turbocharger
product line. For the EC business, the GP percentage increased by approximately
1.1% during the Six Months 2004 as compared to the Six Months 2003 as additional
volume was serviced without additional fixed cost as well as change in product
mix and the productivity gains as described above.
Selling, General and Administrative Expenses: Selling, general and
administrative ("SG&A") expenses increased approximately $2.6 million, or 14.1%,
for the Six Months 2004 as compared to the Six Months 2003. As a percentage of
net sales, SG&A declined to 20.2% for the Six Months 2004 from 21.1% for the Six
Months 2003. SG&A of the MEC business increased by approximately $470,000, or
11.9%, for the Six Months 2004 as compared to the Six Months 2003 and as a
percentage of net sales, decreased approximately 2.5%. SG&A of the EC business
increased by approximately $1.4 million, or 10.6%, for the Six Months 2004 as
compared to the Six Months 2003 and increased as a percentage of net sales by
approximately 0.2%.
The increase in SG&A of the MEC business is primarily the result of the Company
adding additional cost to the turbocharger product line to service its
continuing growth and maintain high quality levels. In addition, higher
incentive compensation costs drove the increase in SG&A of the turbocharger
product line, as a result of the growth in the operating performance of that
product line during the Six Months 2004 as compared to the Six Months 2003.
Commission and freight expense related to additional volume drove the increase
in SG&A for the EC business for the Six Months 2004 as compared to the Six
Months 2003. In addition certain costs were incurred as the Company continues to
explore migrating production off-shore as well as investing in new product
development. Corporate expenses were higher during the Six Months 2004 as
compared to the Six Months 2003, related to professional fees.
Income from Operations: The increase in income from operations of approximately
$4.0 million, or 25.9%, for the Six Months 2004 as compared to the Six Months
2003, resulted from the increase in gross profit of approximately $6.6 million,
offset by the increase in SG&A expenses of approximately $2.6 million.
Interest Expense: Interest expense decreased by approximately $274,000, or 4.4%,
during the Six Months 2004 as compared to the Six Months 2003. This decrease is
primarily due to lower levels of outstanding borrowings during the Six Months
2004 as compared to the Six Months 2003.
Provision for Income Taxes: The provision for income taxes increased by
approximately $1.4 million, or 35.9%, for the Six Months 2004 as compared to the
Six Months 2003. The Company's effective tax rate on income before provision for
income taxes and discontinued operations for the Six Months 2004 was
approximately 39.8%. The effective rate on income before provision for income
taxes and discontinued operations for the Six Months 2003 was approximately
43.1%. The decline in the effective rate from the Six Months 2003 to the Six
Months 2004 was primarily driven by the Company's foreign tax credits.
Income from Continuing Operations: Income from continuing operations increased
by approximately $2.8 million, or 55.2%, during the Six Months 2004 as compared
to the Six Months 2003. The increase resulted from the sum of the increase in
income from operations of approximately $4.0 million and the decrease in
interest expense of approximately $274,000 offset by the increase in provision
for income taxes of approximately $1.4 million, due to the factors discussed
above.
(Loss) Income from Discontinued Operations: In March 2004, after reviewing the
lock product line's 2003 operating performance as well as its long-term
strategic plan, the Board of Directors of KCI and KCLLC concluded to sell Hudson
Lock, LLC ("Hudson"). In accordance with Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," the Company recorded the assets and liabilities of Hudson as held for
sale and reported the results of operations, which were formerly included in the
results of the Company's MEC business, as discontinued operations. Based on
initial indications of value from prospective buyers, at June 30, 2004, the
Company recorded a charge of approximately $4.3 million (net of tax of
approximately $2.6 million) to reduce the carrying value of the assets held for
sale to its fair value. The Lock product line had a net loss from operations for
the Six Months 2004 of approximately $820,000 (net of tax benefit of
approximately $525,000). This compares to net income of approximately $140,000
(net of taxes of approximately $90,000) for the Six Months 2003. In February
2004, management concluded to close the lock manufacturing facility in Mexico as
the continuing decline in net sales volume of this product line made it
prohibitive to carry the dual overhead infrastructures of its domestic and
Mexico manufacturing facilities. The assets of Mexico were primarily inventory,
leasehold improvements and machinery and equipment. In closing down the
facility, the Company recorded a charge of approximately $664,000 for severance
and closing costs and to write down inventory and leaseholds. In addition, the
Company recorded a charge of approximately $605,000 to record the balance of the
lease on the facility on a present value basis, less any estimate for sublease
income.
16
Net Income: Net income decreased by approximately $2.4 million for the Six
Months 2004 as compared to the Six Months 2003. Income from continuing
operations increased approximately $2.8 million, as described above. This was
offset by the increase in loss from discontinued operations of approximately
$5.2 million, discussed above.
THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
2003
Net Sales: Net sales for the three months ended June 30, 2004 ("Quarter 2004")
increased by approximately $9.9 million, or 22.1%, from net sales for the three
months ended June 30, 2003 ("Quarter 2003"). This increase was the sum of the
approximately $6.4 million, or 40.7%, increase in the net sales of the MEC
business and the approximately $3.5 million, or 12.0%, increase in net sales of
the EC business.
The approximately $6.4 million increase in net sales of the MEC business for the
Quarter 2004 as compared to the Quarter 2003 was driven by continued growth of
both MEC product lines. Net sales of the flexible shaft product line increased
by approximately $1.7 million, or 25.2%, for the Quarter 2004 as compared to the
Quarter 2003. This increase was driven by new product introductions as well as
increased demand for the Arens Controls product line, which was acquired in
March of 2003. Net sales of the turbocharger components product line increased
by approximately $4.9 million, or 52.1%, for the Quarter 2004 as compared to the
Quarter 2003. This increase was driven primarily by continued volume growth of a
new product introduced in December 2002.
The approximately $3.5 million or 12.0% increase in the EC business for the
Quarter 2004 as compared to the Quarter 2003 was driven primarily by the growth
in the Company's specialty electrical components product line, which had net
sales growth of approximately $1.8 million, or 14.6%. This growth was generated
through both its recreational and industrial channels as the increased sales
volume experienced in the fourth quarter of 2003 continued into 2004. In
addition, the power conversion product line posted net sales growth from the
Quarter 2003 to the Quarter 2004 of approximately $1.9 million, or 14.5%. This
growth was generated primarily as a result of demand through its direct OEM
sales channel.
Gross Profit: Gross profit increased by approximately $3.5 million, or 20.0%,
for Quarter 2004 as compared to Quarter 2003, resulting from the sum of the
approximately $2.2 million, or 37.0%, increase in the gross profit of the MEC
business and the approximately $1.3 million, or 11.4%, increase in gross profit
of the EC business for the Quarter 2004.
The approximately $2.2 million, or 37.0%, increase in gross profit of the MEC
business for Quarter 2004 as compared to Quarter 2003 was driven by volume
increases of the flexible shaft and turbocharger components product lines.
The approximately $1.3 million, or 11.4% increase in gross profit of the EC
business for the Quarter 2004 as compared to the Quarter 2003 resulted primarily
from the volume increases of the specialty electrical components and power
conversion product lines for the Quarter 2004 as compared to the Quarter 2003.
The gross profit, as a percentage of net sales ("GP percentage"), for the MEC
business declined by approximately 1.0% for the Quarter 2004 as compared to the
Quarter 2003 related to price concessions of the Company's turbocharger product
line. For the EC business, the GP percentage decreased by approximately 0.2%
during the Quarter 2004 as compared to the Quarter 2003 primarily related to
product mix as well as the impact of commodity costs during the quarter. It is
expected that such commodity cost increases will not have a significant impact
on the Company's results for the remainder of the year, as price increases were
put in place in the late second quarter.
17
Selling, General and Administrative Expenses: Selling, general and
administrative ("SG&A") expenses increased approximately $1.4 million, or 14.3%,
for the Quarter 2004 as compared to the Quarter 2003. As a percentage of net
sales, SG&A declined to 19.8% for the Quarter 2004 from 21.2% for the Quarter
2003. SG&A of the MEC business increased by approximately $119,000, or 5.7%, for
the Quarter 2004 as compared to the Quarter 2003 and as a percentage of net
sales, decreased approximately 3.3%. SG&A of the EC business increased by
approximately $900,000, or 13.8%, for the Quarter 2004 as compared to the
Quarter 2003 and increased as a percentage of net sales by approximately 0.4%.
The increase in SG&A of the MEC business is primarily the result of the Company
adding additional cost to the turbocharger product line to service its
continuing growth and maintain high quality levels. In addition, higher
incentive compensation costs drove the increase in SG&A of the turbocharger
product line, as a result of the growth in the operating performance of that
product line during the Quarter 2004 as compared to the Quarter 2003. These
increases were mostly offset as the flexible shaft product line experienced a
decline in its SG&A for the Quarter 2004 as compared to the Quarter 2003. This
decline was driven by the excessive cost this product line experienced in 2003
related to the interim operating agreement it had in place with the seller of
Arens Controls, which was acquired in March 2003. The interim operating
agreement added duplicative cost until the manufacturing of that product line
was fully integrated into the Company's Binghamton, NY manufacturing facility,
which was not completed until November 2003. Commission and freight expense
related to additional volume were the main drivers of the increase in SG&A for
the EC business for the Quarter 2004 as compared to the Quarter 2003. In
addition certain costs were incurred as the Company continues to explore
migrating production off-shore as well as development costs related to new
products.
Income from Operations: The increase in income from operations of approximately
$2.2 million, or 26.6%, for the Quarter 2004 as compared to the Quarter 2003,
resulted from the increase in gross profit of approximately $3.5 million, offset
by the increase in SG&A expenses of approximately $1.4 million.
Interest Expense: Interest expense decreased by approximately $148,000, or 4.7%,
during the Quarter 2004 as compared to the Quarter 2003. This decrease is
primarily due to lower levels of outstanding borrowings during the Quarter 2004
as compared to the Quarter 2003.
Provision for Income Taxes: The provision for income taxes increased by
approximately $767,000, or 35.6%, for the Quarter 2004 as compared to the
Quarter 2003. The Company's effective tax rate on income before provision for
income taxes and discontinued operations for the Quarter 2004 was approximately
39.9%. The effective rate on income before provision for income taxes and
discontinued operations for the Quarter 2003 was approximately 43.0%. The
decline in the effective rate from the Quarter 2003 to the Quarter 2004 was
primarily driven by the Company's foreign tax credits.
Income from Continuing Operations: Income from continuing operations increased
by approximately $1.6 million, or 54.3%, during the Quarter 2004 as compared to
the Quarter 2003. The increase resulted from the sum of the increase in income
from operations of approximately $2.3 million and the decrease in interest
expense of approximately $148,000 offset by the increase in provision for income
taxes of approximately $767,000, due to the factors discussed above.
(Loss) Income from Discontinued Operations: In March 2004, after reviewing the
lock product line's 2003 operating performance as well as its long-term
strategic plan, the Board of Directors of KCI and KCLLC concluded to sell Hudson
Lock, LLC ("Hudson"). In accordance with Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," the Company recorded the assets and liabilities of Hudson as held for
sale and reported the results of operations, which were formerly included in the
results of the Company's MEC business, as discontinued operations. Based on
initial indications of value from prospective buyers, at June 30, 2004, the
Company recorded a charge of approximately $4.3 million (net of tax of
approximately $2.6 million) to reduce the carrying value of the assets held for
sale to its fair value. The Lock product line had net income from operations for
the Quarter 2004 of approximately $371,000 (net of taxes of approximately
$254,000). This compares to net income of approximately $17,000 (net of taxes of
approximately $26,000) for the Quarter 2003.
Net Income: Net income decreased by approximately $2.4 million for the Quarter
2004 as compared to the Quarter 2003. Income from continuing operations
increased approximately $1.6 million, as described above. This was offset by the
increase in loss from discontinued operations of approximately $3.9 million,
discussed above.
18
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically generated funds from its continuing operations and
its working capital requirements generally have not materially fluctuated from
quarter to quarter. The Company's other main sources of liquidity have
historically been the Company's $80.0 million of uncollateralized 10.5% senior
notes due 2008 and it's outstanding credit facilities. The credit facility
provides for a six-year $40.0 million revolving credit facility, which as a
result of the amendment discussed below was reduced to $25.0 million through
March 30, 2005, and a six-year $100.0 million term loan facility. The
obligations under the credit agreement governing the credit facilities are
guaranteed by the Company's subsidiaries and KCI, and are collateralized by all
of the capital stock of the subsidiaries, receivables, inventories, equipment
and certain intangible property. There was $1.7 million outstanding under the
revolving credit facility at June 30, 2004. The term loan is payable in
quarterly installments through September 2006. Both the term loan and revolving
credit facility bear interest at fluctuating interest rates determined by
reference to a base rate or the London interbank offered rate ("LIBOR") plus an
applicable margin which will vary from 1.0% to 3.75% and require the payment of
a commitment fee of ranging from 0.375% to 0.5% on the unused portion of the
facility as well as quarterly commitment fees.
The credit facility also allows for up to $5.0 million of outstanding letters of
credit. At June 30, 2004, the Company had two letters of credit outstanding for
approximately $1.5 million. The letters of credit primarily relate to the
Company's workman's compensation insurance programs. Currently, the Company
believes that the $5.0 million allowance for letters of credit is sufficient for
its needs.
The credit agreement contains certain covenants and restrictions, which require
the maintenance of financial ratios and restrict or limit dividends and other
shareholder distributions, transactions with affiliates, capital expenditures,
rental obligations and the incurrence of indebtedness.
In September 2002, the Company amended its credit agreement (the "Amendment") to
provide for revised financial covenant ratios from September 30, 2002 through
March 30, 2004 from the original covenant ratios stipulated in the credit
agreement. The Company anticipated that certain of the original covenants, which
became more stringent over the term of the agreement, would not be met due to
the general decline in the economy. In addition, the Amendment revised the
Company's applicable margin on borrowings, the maximum allowable capital
expenditures through March 29, 2004 and reduced the amount allowed for permitted
acquisitions (as defined in the credit agreement) from $15 million to $7.5
million through March 30, 2004. Concurrent with the Amendment, the Company
voluntarily reduced the availability under its revolving credit facility by $15
million from $40 million to $25 million until March 30, 2004.
As a result of the impact of the domestic economy on the Company's business
during 2003 coupled with the performance of the lock product line and cash spent
on an unsuccessful acquisition attempt during 2003, the Company would not have
been able to achieve the required step down in the financial covenants that was
to occur as of September 2003 in accordance with the Amendment. Accordingly, the
Company entered into a second amendment to its credit agreement (the "Second
Amendment"). The financial covenants as modified by the Second Amendment apply
from September 30, 2003 through March 30, 2005, at which time the financial
covenants return to the financial covenants in effect before the Amendment. At
June 30, 2004, the Company was in compliance with the credit agreement, as
amended.
The Company's remaining liquidity demands are for capital expenditures, general
corporate purposes, and principal and interest payments on its outstanding debt.
The Company's senior notes require semiannual interest payments on the
outstanding principal. The term loan requires quarterly principal payments. At
June 30, 2004, the Company had prepaid its next principal payment. Principal
payments required for the next 12 months will be approximately $13.3 million.
Under the revolving credit facility and term loan, the Company has the option to
lock in a specified interest rate by entering into a contract, for different
periods, which cannot exceed 180 days. As the underlying contract comes up for
renewal, the interest associated with the contract becomes due. The Company
anticipates its capital expenditures for the year ended December 31, 2004 to be
approximately $4.0 million. The expenditures are primarily needed to maintain
its facilities, expand its production capacity for new product introduction as
well as fund the Company's ongoing plan to expand foreign operations in order to
take advantage of profitable market opportunities. To the extent cash flow from
continuing 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 its existing revolving credit
facility, which it believes to be sufficient for any such purpose.
19
KCI has no operations and is dependent on KCLLC for financial resources in the
form of capital distributions to meet its obligations. KCI obligations include
the liquidation preferences of $107.0 million for its preferred stock plus any
dividends payable in arrears (at June 30, 2004 there were approximately $4.6
million in cumulative dividends in arrears, payable in kind), which are
redeemable for cash at the option of the holder after June 2, 2009, the
requirement to purchase shares from its common shareholders under certain
circumstances and its tax obligations. Repurchases of KCI Common Stock are made
at fair market value as defined in KCI's shareholder agreement. At June 30, 2004
approximately 1.3 million KCI common shares plus potentially 183,000 shares
covered by stock options were subject to repurchase by KCI. The ability of KCLLC
to make such capital distributions will be limited by its available resources
and is limited by restrictions of debt and other agreements. KCLLC reflects the
tax obligations of KCI in its tax provision.
Cash flows provided by operating activities were approximately $10.8 million and
$10.5 million for Six Months 2004 and 2003, respectively. The net increase in
cash flows of approximately $263,000 for Six Months 2004 was the result of
approximately $2.3 million of cash flows provided by continuing operations
offset by approximately $2.0 million of cash flows used in discontinued
operations. For the Six Months 2004 cash provided by operating activities of
continuing operations increased from approximately $9.4 million for the Six
Months 2003 to approximately $11.7 million for the Six Months 2004. This was
primarily driven by the growth in earnings offset by the investment in working
capital related to such growth. For the Six Months 2004, net income plus
non-cash charges totaled approximately $10.8 million as compared to the Six
Months 2003 of approximately $7.3 million. The Company's primary working capital
accounts (accounts receivable, inventory and accounts payable) used net cash in
its continuing operations of approximately $5.8 million for the Six Months 2004
as compared to Six Months 2003, when the working capital accounts used net cash
of approximately $3.1 million. Accrued expenses increased as the Company accrued
income taxes in the Six Months 2004 but has not made any estimated payments for
income taxes as it anticipates the sale of its lock product line to generate tax
losses which will offset most of the Company's current tax liability.
The approximately $2.0 million increase in cash used in operating activities of
discontinued operations was driven by the closure of the lock product
manufacturing facility in Mexico in February 2004. The decline in net sales
volume made it prohibitive to carry the dual overhead infrastructures of the
domestic and Mexico lock manufacturing facilities. As a result, management
concluded to close the lock manufacturing facility in Mexico. In closing down
the facility the Company recorded a charge of approximately $664,000 for
severance and closing costs and to write down inventory and leaseholds. In
addition the Company recorded a charge of approximately $605,000 to record the
balance on the lease of the facility on a present value basis, less any estimate
for sublease income. Further, the decline in net sales of approximately 15.9%
for the Six Months 2004 as compared to the Six Months 2003 also was a
contributing factor in the increase in cash used by the operating activities of
this product line for the Six Months 2004 as compared to the Six Months 2003
(see Note 2 to the consolidating financial statements elsewhere in this Form
10-Q).
Cash flows used in investing activities were approximately $7.4 million and $6.5
million for Six Months 2004 and the Six Months 2003, respectively. Cash flows
used in investing activities of continuing operations were approximately $7.4
million and $6.1 million for Six Months 2004 and the Six Months 2003,
respectively. Capital expenditures for continuing operations for the Six Months
2004 and 2003 were approximately $1.3 million and $1.6 million, respectively.
The decline in capital expenditures for Six Months 2004 as compared to the Six
Months 2003 was timing related.
On May 7, 2004, the Company acquired the net assets of Advanced Devices, Inc.
("ADI") for a purchase price of approximately $8.0 million and assumed
liabilities of approximately $62,000. The Company recorded the estimated excess
purchase price over net assets acquired of approximately $6.2 million as
goodwill. The value ascribed to the estimated excess purchase price over net
assets acquired is preliminary and is subject to change. Other intangibles are
not material. The ADI product line, which manufactures electrical wiring
devices, will be integrated into the Company's Napa Valley, CA manufacturing
facility. The Company paid approximately $6.1 million in cash at closing and
borrowed approximately $4.5 million on its revolving credit facility to
partially finance this acquisition. The acquisition calls for approximately 75%
of the total purchase price to be paid at closing, 10% to be paid at the earlier
of the date when the product line is fully integrated into the Company's Napa,
California manufacturing facility or March 7, 2005, and the remainder over the
next four years annually.
20
On March 3, 2003, the Company acquired the mechanical components business of
Arens Controls for a purchase price of approximately $4.4 million and assumed
liabilities of approximately $642,000. The Company recorded the estimated excess
purchase price over net assets acquired of approximately $2.0 million as
goodwill. Other intangibles acquired in the transaction were not material. The
product line, which manufactures mechanical push-pull control solutions, was
fully integrated into the Company's Binghamton, New York manufacturing facility
in November 2003. The Company borrowed $2.0 million on its revolving credit
facility to partially finance this acquisition.
Cash flows used in investing activities of discontinued operations were
approximately $59,000 and $401,000 for Six Months 2004 and the Six Months 2003,
respectively. These amounts relate to capital expenditures of the lock product
line for those periods.
Cash flows from financing activities used net cash for the Six Months 2004 of
approximately $5.9 million and $3.4 million, respectively. The net cash used in
financing activities for Six Months 2004 was primarily related to the Company's
repayment of debt under its existing credit facilities of approximately $14.6
million. In addition, the Company borrowed approximately $8.5 million against
its revolver during the Six Months 2004 to partially finance the ADI acquisition
and financing working capital growth due to the Company's revenue growth during
the three months June 2004. For the Six Months 2003, the cash used in financing
activities primarily related to the repayment of approximately $5.3 million in
debt as well as the borrowing of $2.0 million to particially finance the
acquisition of Arens Controls. At June 30, 2004, the Company was one payment
ahead of schedule under its current term debt facility.
Management believes that the Company's cash flow from continuing operations,
together with its borrowing availability under its existing credit facilities,
will be adequate to meet its anticipated capital requirements for the next
twelve months.
COMMITMENTS AND CONTINGENCIES
The following is a schedule of the Company's contractual obligations outstanding
at June 30, 2004:
(IN THOUSANDS) PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS LESS THAN 1 MORE THAN 5
TOTAL YEAR 1-3 YEARS 3-5 YEARS YEARS
- ---------------------------------------------------------------------------------------------------------------------
LONG-TERM DEBT OBLIGATIONS $126,702 $13,301 $32,716 $80,685 $ -
OPERATING LEASE OBLIGATIONS 8,327 1,678 2,643 1,788 2,218
ACCRUED LEASE COSTS 437 71 221 145 -
OTHER LONG-TERM LIABILITIES 1,292 - - - 1,292
ACQUISITION PURCHASE PRICE
LIABILITIES 894 223 447 224 -
STAND BY LETTERS OF CREDIT 1,468 - - - 1,468
- ---------------------------------------------------------------------------------------------------------------------
$139,120 $15,273 $36,027 $82,842 $4,978
=====================================================================================================================
CRITICAL ACCOUNTING POLICIES
The following is a brief discussion of the more significant accounting policies
and methods used by the Company.
Revenue recognition: The Company recognizes revenue upon shipment of
products to customers, when title passes and all risks and rewards of
ownership have transferred. The Company considers revenue realized or
realizable and earned when the product has been shipped, the sales price
is fixed or determinable and collectibility is reasonably assured. The
Company reduces revenue for estimated customer returns.
21
Inventory: Inventories are stated at the lower of cost or market, on a
first-in, first-out basis. The Company purchases materials for the
manufacture of inventory for sale in its various markets. The decision to
purchase a set quantity of a particular inventory item is influenced by
several factors including current and projected cost to produce certain
items, future estimated availability and existing and projected sales of
such items. The Company evaluates the net realizable value of its
inventories and establishes allowances to reduce the carrying amount of
these inventories as deemed necessary.
Goodwill and other intangible assets: At June 30, 2004, the Company has
recorded approximately $89.4 million in goodwill and other intangible
assets related to acquisitions made in 2003 and prior years. The
recoverability of these assets is subject to an impairment test based on
the estimated fair value of the underlying businesses. These estimated
fair values are determined using a valuation methodology that triangulates
the discounted cash flows, market multiples and transactional multiples of
the reporting units. Factors affecting these future cash flows include:
the continued market acceptance of the products and services offered by
the businesses; the development of new products and services by the
businesses and the underlying cost of development; the future cost
structure of the businesses; and future technological changes.
Pension Plans: The Company's assets and liabilities recorded in connection
with the Company's pension plans use estimates that include but are not
limited to expected return on assets and life expectancy of participants.
In preparation of the consolidated financial statements the Company
reviews these estimates by reviewing current market conditions and
internal information at its disposal.
MANAGEMENT'S ESTIMATES
The Company's discussion and analysis of its financial condition and results of
operations are based on the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses and related disclosure of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates, including those related to product returns, bad debts,
inventories, intangible assets, pensions and post-retirement benefits, warranty
obligations and contingencies and litigation. The Company bases its estimates on
historical experience, the use of external resources and various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
Significant estimates used by the Company that are subject to change include,
but are not limited to the following:
(i) The Company's allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required
payments for their open accounts receivable with the Company; if the
financial condition of the Company's customers were to deteriorate,
resulting in an impairment of their ability to make payments,
additional allowances could be required;
(ii) Allowances established against its inventory carrying value to
record its inventories at net realizable value; if actual market
conditions are less favorable than those projected by management,
additional inventory allowances may be required;
(iii) The Company's deferred tax assets primarily relate to deductible tax
intangibles resulting from the Company's acquisition transactions
and temporary differences in the basis of its working capital
accounts due to non-deductible reserves. The Company records as
necessary, valuation allowances against its deferred tax assets. To
date the Company believes that it will realize the benefits from its
deferred tax assets as it is expected to generate taxable income in
the future. If the Company were to determine that it would not be
able to realize its deferred tax assets in the future, valuation
allowances could be required;
(iv) The Company evaluates the carrying amounts of its long-lived assets
for recoverability; if the Company were to determine that the value
ascribed to any of its long-lived assets was not recoverable an
allowance could be required;
22
(v) The Company records the effects of its existing pension plans in its
financial statements using various assumptions and the use of
independent actuaries; if any of the underlying assumptions were to
change, the carrying value of the pension assets and obligations may
require adjustment; and,
(vi) The Company's financial covenants, as defined in its credit
facilities, were based, in part, by estimates of future results of
the Company's continuing operations; if actual results were not to
meet those expectations, the Company may not meet its financial
covenants and may be required to obtain waivers for those covenants.
INFLATION
Inflation has not been material to the Company's continuing operations for the
periods presented.
BACKLOG
The Company's backlog of orders as of June 30, 2004 was approximately $31.6
million. The Company includes in its backlog only accepted purchase orders.
However, backlog is not necessarily indicative of future sales. In addition,
purchase orders can generally be cancelled at any time without penalty.
OTHER MATTERS
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements based on current expectations
that involve a number of risks and uncertainties. Generally, forward-looking
statements include words or phrases such as "management anticipates," "the
Company believes," "the Company anticipates," and words and phrases of similar
impact, and include but are not limited to statements regarding future
operations and business environment. The forward-looking statements are made
pursuant to safe harbor provisions of the Private Securities Litigation Reform
Act of 1995. The factors that could cause actual results to differ materially
from the forward-looking statements include the following: (i) industry
conditions and competition, (ii) operational risks and insurance, (iii)
environmental liabilities which may arise in the future and not covered by
insurance or indemnity, (iv) the impact of current and future laws and
government regulations, and (v) the risks described from time to time in the
Company's reports to the Securities and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary exposure to market risk is related to the variability in
interest rates associated with the $48.0 million outstanding under its term loan
and with any amounts outstanding under its $25 million revolving credit
facility. Under both the term loan and the revolving credit facility, the
Company has the option to lock in a certain interest rate based on either the
base rate, which is equivalent to prime, or LIBOR plus an applicable margin
specified in the agreement. Principally all of the borrowings under the term
loan are locked in at approximately 4.5% until October 2004, when the underlying
LIBOR contract is up for renewal. At June 30, 2004, the Company had $1.7 million
outstanding under its line of credit, which is locked in at approximately 4.5%
until September 2004 and was one payment ahead of schedule on its term debt. A
1% change in the interest rate for the Company's credit facilities in place at
December 31, 2003 would have resulted in a change in the Company's annual
interest expense of approximately $603,000. The senior notes bear a fixed rate
of interest and therefore are not subject to market risk. The Company does not
hold derivative financial instruments or believe that material imbedded
derivatives exist within its contracts.
While the Company uses commodity metals in certain of its products, its exposure
to market risk is reduced by the pass-through of increased costs to its customer
base.
As the Company has operations outside the United States of America, it is
subject to foreign currency exchange risk. To date those risks have not had a
material impact on the Company's results of operations or financial position.
23
ITEM 4. CONTROLS AND PROCEDURES
The management of KCLLC carried out an evaluation, with the participation of its
President and Chief Financial Officer, of the effectiveness of its disclosure
controls and procedures as of June 30, 2004. Based upon that evaluation, KCLLC's
President and Chief Financial Officer concluded that KCLLC's disclosure controls
and procedures were effective to ensure that information required to be
disclosed by KCLLC in reports that it files or submits under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported, within the
time periods specified in the rules and forms of the Securities and Exchange
Commission.
There has not been any change in KCLLC's internal control over financial
reporting in connection with the evaluation required by Rule 15d-15(d) under the
Exchange Act that occurred during the quarter ended June 30, 2004 that has
materially affected, or is reasonably likely to materially affect, KCLLC's
internal control over financial reporting.
The management of Key Components Finance Corp. ("Finance Corp.") carried out an
evaluation, with the participation of its President and Chief Financial Officer,
of the effectiveness of its disclosure controls and procedures as of June 30,
2004. Based upon that evaluation, Finance Corp.'s President and Chief Financial
Officer concluded that Finance Corp.'s disclosure controls and procedures were
effective to ensure that information required to be disclosed by Finance Corp.
in reports that it files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported, within the time periods specified
in the rules and forms of the Securities and Exchange Commission.
There has not been any change in Finance Corp.'s internal control over financial
reporting in connection with the evaluation required by Rule 15d-15(d) under the
Exchange Act that occurred during the quarter ended June 30, 2004 that has
materially affected, or is reasonably likely to materially affect, Finance
Corp.'s internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
10.43 Employment Agreement between KCI and Robert B. Kay dated as of
July 1, 2004
10.44 Employment Agreement between KCI and Albert W. Weggeman dated as
of July 1, 2004
10.45 Employment Agreement between KCI and Keith A. McGowan dated as of
July 1, 2004
31.1 Rule 13a-14(a)/15d-14(a) Certifications
31.2 Rule 13a-14(a)/15d-14(a) Certifications
32 Section 1350 Certifications
(B) REPORTS ON FORM 8-K
The Company filed the following report on Form 8-K during the second
quarter of the year ending December 31, 2004:
DATE OF REPORT DATE REPORT FILED WITH SEC ITEMS REPORTED
--------------------------- ---------------------------------- ----------------------------------------------
May 17, 2004 May 17, 2004 Press Release dated May 17, 2004, announcing
financial results for the Quarter ending
March 31, 2004 (furnished pursuant to Item
12 of Form 8-K).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEY COMPONENTS, LLC
--------------------------------------------
Date: August 13, 2004 By: /s/ Robert. B. Kay
--------------------
Robert B. Kay
President
Date: August 13, 2004 By: /s/Keith A. McGowan
--------------------
Keith A. McGowan
Chief Financial Officer
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEY COMPONENTS FINANCE CORP.
--------------------------------------------
Date: August 13, 2004 By: /s/ Robert. B. Kay
--------------------
Robert B. Kay
President
Date: August 13, 2004 By: /s/ Keith A. McGowan
---------------------
Keith A. McGowan
Chief Financial Officer
25