Item 1. Business
KCLLC, a Delaware limited liability corporation organized on May 15, 1998, maintains its principal office at 200 White Plains Road, Tarrytown, New York 10591 and its telephone number is (914) 332-8088. The Company files current, quarterly and annual reports on Form 8-K, Form 10-Q and Form 10-K, respectively. They can be accessed through the EDGAR database at www.sec.gov. Any debenture holder can request a copy of filings in writing to the Company's principal office.
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. The Company conducts its operations through its two businesses, its electrical components ("EC") business and its mechanical engineered components ("MEC") business. The EC business product offerings include power conversion products, specialty electrical wiring devices and connectors and high-voltage utility switches which are manufactured by its subsidiaries Acme Electric Corporation ("Acme"), Marine Industries, LLC ("Marinco"), Atlantic Guest, Inc. ("Guest") and Turner Electric, LLC ("Turner"). The product offerings of the MEC business consist primarily of flexible shaft and remote valve control components, turbo-charger components and medium security lock products and accessories, which are manufactured by its subsidiaries B.W. Elliott Manufacturing Co., LLC ("BWE"), Gits Manufacturing, LLC ("Gits"), Hudson Lock, LLC ("Hudson") and ESP Lock Products, LLC ("ESP"). No one customer accounted for more than ten percent of sales of the Company for any of the three years ended December 31, 2002. For the years ended December 31, 2002, 2001 and 2000, four customers, who are subsidiaries of one company, accounted for approximately 14%, 13% and 12% of sales, respectively, of the MEC business. (See Note 5 to the Company's consolidated financial statements elsewhere in this Form 10-K for information concerning the Company's business segments).
Acquisition History
The 1992 acquisition of BWE began the acquisition program of the Company to acquire small to medium size manufacturers of essential niche components for use in various OEM customer products. In 1993, the Company acquired the flexible shaft division of Stow Manufacturing Company, Inc., as a consolidation opportunity for BWE. During 1997 and 1998, the Company added to the MEC's product offerings with the acquisitions of Hudson and ESP. During 1999, the Company complemented its MEC product offerings and formed its EC business through its acquisition of Valley Forge Corporation ("VFC"). The Company expanded its EC business with the acquisition of Acme in November 2000 (see Note 2 to the consolidated financial statements contained elsewhere in this Form 10-K).
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 $187.9 million for fiscal year 2002.
The Company continues to seek to make selective acquisitions of light industrial manufacturing companies (see Note 13 to the Company's consolidated financial statements elsewhere in this Form 10-K).
Electrical Components
The Company's EC business features three major product lines: (i) power conversion products, (ii) specialty electrical components ("SPEC") and (iii) electric utility components.
Power Conversion Products
The Company's acquisition of Acme enabled the Company's EC business to enter into the production of power conversion products. Power conversion product net sales were approximately 30% of the Company's consolidated net sales for the year ended December 31, 2002. Acme's primary products are transformers that range in size from 1/4 KVA (1,000 volts x Amps) to 1,000 KVA. A transformer is an electrical device designed to convert alternating current from one voltage to another. A transformer has no moving parts and is a completely static solid-state device, which insures a long and maintenance-free life under normal operating conditions. It consists, in its simplest form, of two or more wires or coils wound on a laminated steel core. The Company has 1,400 active transformer models, which are sold through two primary sales channels, its wholesale distribution network and through direct sales to OEMs. Products sold through the wholesale distribution network are generally smaller sized transformer models. Due to the small size of the average order, the margins achieved are generally higher than those achieved selling to OEMs. In the OEM sales channel, customers are offered custom-built products, which generally achieve lower margins as products are price-reduced in anticipation of a higher volume of orders. The Company believes the OEM sales channel will drive the transformer product line's revenue growth. Transformer designs rarely change and most transformers have a long useful life.
Acme operates in a segment of the transformer market which was estimated by the National Electrical Manufacturers Association to be approximately $315 million for 2002. This segment is defined as being comprised of dry type transformers, which are less than 600 volts and range from 1/4 to 1,000 KVA. The competition in this segment is divided into two tiers: the large switch gear manufacturers, that sell transformers as part of a package of products, such as General Electric, Electrical Distribution Products, a division of Schneider Electric ("Square D"), Hammond Manufacturing Inc., Eaton Corporation and Siemens, and transformer specialists, such as Acme, Sola/Heavy-Duty, Jefferson Electric, Inc. and Federal Pacific. Acme supplies products that comprise approximately 15% of the total market, which is approximately one half that of General Electric and Square D's market share but twice that of any other competitor.
In June 2001, the Company determined to retain the aerospace division of Acme as part of the power conversion product line (see Note 2 to the consolidated financial statements elsewhere in this Form 10-K). This expanded the power conversion product line to include battery charger systems and the manufacturing of fibrous nickel cadmium batteries for use in such battery systems, power control systems, power supplies and converters used primarily in aerospace applications. Major customers of this product line include governmental defense manufacturers and OEM aerospace manufacturers. The aerospace aftermarket is an increasing share of the product line's revenues as the quantity of batteries and systems sold by the Company that are designed into OEM applications has grown over the last five years.
Specialty Electrical
Within the SPEC market, the Company's core market niches are the recreational and industrial markets, where the Company sells to both OEM customers and after-market retail customers under brand names such as Marinco, Guest, AFI, Nicro, Park Power, and various private labels. In the recreational marine market, where the Company sells the entire range of its product offerings, the Company specifically targets the blue water/leisure boating and inland fishing/bass boat market segments and has a strong market presence. Customers include OEMs and major after-market distributors. The Company's wiring devices and components are designed to withstand hostile weather and corrosive environments, while remaining easy to install in less than ideal conditions. SPEC products include; (i) weather and corrosion resistant wiring devices, such as ship-to-shore electrical connectors for marine and vehicle-to-outlet connectors for recreational vehicle applications; (ii) onboard "potted" (i.e., completely insulated) battery chargers for outdoor applications including bass boat and other marine applications; and (iii) various accessory products such as plugs, receptacles, electrical switches, solar ventilation products, and boat accessories such as horns, windshield wiper systems, lighting products, and teak accessories. Net sales of the Company's SPEC products accounted for approximately 24% of the Company's consolidated net sales for the year ended December 31, 2002. The SPEC product line enjoys a dominant market position in its core market where the Company's brands are highly regarded by both OEM and aftermarket customers.
The Company's SPEC product line also has products targeted for industrial applications. The market share of the Company's SPEC's products has grown dramatically since these products were targeted to the industrial marketplace approximately six years ago. The primary product offerings include; (i) onboard "potted" battery chargers for industrial and healthcare applications such as fork and "scissor" lifts, personal mobility carts, and electric wheelchairs; and (ii) specialty wiring devices designed for industrial applications where protection from water, chemicals, dust, or other elements is required. Growth in this market has resulted from the development of customized products for applications such as outdoor power generators, movie and theatrical production, and semiconductor equipment manufacturing.
Electric Utility Components
The Company dominates the design and manufacture of high-voltage switchgear for electric utilities in the power transmission segment of the electric utility industry. While the Company competes in the distribution and substation segments of the electric utility marketplace as well, it is in the transmission segment that the Company has, over time, secured its relative position through superior quality and service, and by creating high barriers to entry through specialization, reputation, and investments in machinery and equipment. Net sales of the Company's electric ulitilty products were approximately 9% of the Company's consolidated net sales for the year ended December 31, 2002. Significant customers include large utilities. The EC business switchgear products consist primarily of air break switches, load break interrupters, and accessory equipment. Air break switches are used for sectionalizing and routing power from one point to another. Load break interrupters allow the sectionalizing and routing of power under full load conditions. Accessory equipment enables the utility operator to program parameters and related functions that will automatically sectionalize and switch power flow in the event of a fault. Once switched, the faulted line can be repaired, re-energized, and returned to service with minimal downtime or loss of service revenue.
Mechanical Engineered Components
The MEC business features three major product lines: (i) flexible shafts for the transmission of rotary power, (ii) turbocharger components, including wastegate actuators, and (iii) medium-security locks and locking systems.
Flexible Shafts
The Company is the leading domestic designer and manufacturer of flexible shaft products and assemblies. Net sales of flexible shaft products were approximately 10% of the Company's net sales for the year ended December 31, 2002. Flexible shafting is constructed utilizing unique wire winding technology. Flexible shaft assemblies are custom designed for the transmission of rotary power at low torque levels (less than ten horsepower), and can be incorporated into almost any machine, product, or device replacing conventional power transmission components such as rigid shafts, gearboxes, universal joints, and couplings. Flexible shafts are integrally designed into the OEM's final product to offer benefits, such as lighter weight, fewer component parts, less assembly time, and greater freedom in design, resulting in a lower manufacturing cost for the OEM's final product. The flexible shaft assemblies are critical components utilized in weed trimmers, concrete vibrators, lawn tractors, aircraft engines and wings, plant processing equipment, large vessels such as Navy ships, nuclear power plants, and many other applications in a variety of industries. The potential applications for flexible shafting are limited only by the Company's ability to develop new solutions to integrate flexible shafts into new OEM designs or to displace conventional power transmission products in existing applications.
Turbocharger components
The Company is a primary outsource supplier of turbocharger components to the domestic and international market for turbocharged diesel engines. The Company's turbocharger components are essential components of diesel engine turbocharger systems which, through the use of flow valve controls, increase engine power, efficiency, and economy while reducing emissions. As the primary supplier of turbocharger components and exhaust gas systems to nearly every major OEM turbocharger manufacturer, the Company's products can be found on a variety of truck, pick-up, and heavy-duty diesel-operated platforms. End-use customers for the Company's products include high-end truck and vehicle manufacturers such as Ford Motor Company. Net sales of the Company's turbocharger components products accounted for approximately 14% of the Company's consolidated net sales. The Company holds multiple patents and is very active in the development of new products to expand the Company's product line, including related emission control products.
Medium-Security Locks and Locking Systems
The Company competes in the medium-security segment for cylindrical lock applications. 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. The Company produces highly engineered, custom, and specialty medium-security locks and locking systems to meet OEM customers' specifications for use in office furniture, point of sale terminals, bank bags, post office boxes, storage lockers, and other applications. Net sales of the Company's lock products were approximately 12% of the Company's consolidated net sales for the year ended December 31, 2002. The Company's lock products are typically small and low-cost but are precision-engineered and custom-designed critical components of a larger, more expensive end product. The Company also produces locking systems, which provide a safety feature used to prevent multiple drawers from being opened simultaneously in filing cabinets and desks. The Company is a sole or primary source for locks to leading furniture OEMs.
Sales and Marketing
The Company employs both salaried and commission-based sales personnel, as well as independent sales representatives and distributors to facilitate the marketing and sales of its products. The 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 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.
Raw Materials and Suppliers
The primary raw materials used by the Company are copper, 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 significant 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. Management believes these can be obtained with minimal, if any, business interruption. However, the prices for such materials can fluctuate, and such fluctuations can be material. A significant increase in raw material prices could adversely affect the results of operations of the Company.
Competition
While the Company faces competition in each of its business segments, management believes that its products are able to achieve a significant share of their related market niches due to a variety of factors. The Company's strategy is to differentiate its products from its competitors', by providing high product quality, customer service, superior design capabilities and proprietary, vertically integrated manufacturing processes. The Company's strategy of providing custom engineered solutions and a high level of service to its customer base it has protected and strengthened its market share in the markets that it serves. Although it is possible other competitors may seek to serve these markets, the Company believes significant barriers to entry exist, including the unwillingness of OEMs to expand their vendor relationships for the same products purchased, the availability of customized processes which enable the Company to service its customers' needs on an efficient basis and the capital investment required to purchase the equipment needed to manufacture products of similar quality.
Environmental and Safety Regulations
The Company's operations are subject to federal, state and local environmental laws and regulations, which impose limitations on the discharge of pollutants into the air and water and establish standards for treatment, storage and disposal of solid and hazardous wastes. The Company believes that it is in substantial compliance with applicable environmental laws and regulations. The Company also maintains environmental insurance at certain of its locations.
Employees
As of December 31, 2002, the Company employed 1,457 persons on a full-time basis. Of these employees, 722 were employed in the EC business, 727 were employed in the MEC business and the Company's corporate office had 8 employees as of December 31, 2002. One of the Company's subsidiaries had a collective bargaining agreement, which covered 67 employees. Neither KCLLC nor any of its subsidiaries has ever had a work stoppage and each of KCLLC and its subsidiaries considers its relationship with its employees to be satisfactory.
Item 2.
Item 2. Properties
At December 31, 2002 the Company's principal properties consisted of:
* The lease for ESP Facility terminates in May 2003. During 2002 the Company moved most of the production from this facility into its Hudson facility and into its lock product facility in Mexico. The Company does not intend to renew the lease for the ESP facility.
Item 3.
Item 3. Legal Proceedings
None.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2002.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
KCLLC's membership interests are not publicly traded (see "Certain Relationships and Related Transactions").
Item 6.
Item 6. Selected Financial Data
The following selected financial data has been derived from the consolidated financial statements of the Company included elsewhere in this Form 10-K. 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 "Management's Discussion and Analysis of Financial Condition and Results of Operation" and the Company's consolidated financial statements and notes thereto.
(a) Upon the adoption of SFAS 142, the Company stopped recording goodwill amortization effective January 1, 2002. In June 2002, the Company completed the assessment of its reporting units and its initial assessment of impairment upon adoption. As a result, the Company identified one reporting unit in the MEC business with a book value of goodwill that exceeded its fair market value, which was estimated using a valuation methodology that triangulates the discounted cash flows, market multiples and transactional multiples of the reporting units. In accordance with SFAS 142, the Company, during the second quarter 2002, estimated the amount of the impairment and recorded a cumulative effect of change in accounting principle, as of January 1, 2002, of approximately $7.8 million, net of taxes of approximately $3.4 million, to write down the goodwill associated with the Company's lock product line resulting from the market conditions of that product line. The Company, as prescribed by SFAS 142, finalized its impairment testing by comparing the implied fair value of the reporting unit's goodwill to its carrying value during the third quarter to determine the amount of the final impairment upon adoption of SFAS 142. As a result, the Company reduced the tax impact of the charge by approximately $353,000 to reflect the proper deferred tax basis of the adjusted goodwill. No further impairment charges were taken against the Company's goodwill.
In December 2002, in accordance with SFAS 142, the Company performed its required annual fair value testing of its recorded goodwill for its reporting units using a valuation approach consistent with the one used upon adoption of SFAS 142. As a result of the analysis, the Company recorded a charge of approximately $12.4 million, which is included in the Company's operating expenses, related to its lock reporting unit, which experienced a further decline of its fair value since the January 1, 2002 assessment, due to a deterioration in the current year of its results of operations compared to its operating plan and projected future financial results as well as a decline in the market multiple ascribed to the product line in its fair market valuation. Through December 31, 2002, the Company's cumulative impairment of goodwill was approximately $23.5 million, all of which related to its lock product line.
(b) Effective May 31, 1997, BWE, Hudson and ESP each elected to be treated as an S corporation, which caused the shareholders of their then parent company, KCI, to be personally liable for the taxes on the income of the Company. Through August 31, 1999, VFC was a C corporation and was responsible for paying taxes on its income. Effective August 31, 1999, VFC was merged into KCLLC and most of VFC's subsidiaries, as well as BWE, Hudson and ESP, were converted to limited liability company ("LLC"). Corporations that elect to be treated as S corporations and LLCs are not liable for the majority of taxes on their income, which are imposed instead on their shareholders or members. Accordingly, subsequent to May 31, 1997 through December 31, 1998, the provision for income taxes includes only those taxes applicable to certain states.
For the year ended December 31, 1999, the Company's provision for income taxes related primarily to VFC's consolidated taxable income (as a C corporation) and the taxable income of the subsidiaries not converted to LLC status. On May 22, 2000, KCI's S election terminated and KCI became responsible for taxes on the income of the Company (See Notes 1 and 9(a) to the consolidated financial statements)
(c) Net (loss) income for the years ended December 31, 2000 and 1998 reflects an extraordinary loss, net of tax, on early extinguishment of debt of approximately $1.2 million and $4.6 million, respectively.
(d) Net (loss) income for the years ended December 31, 2000 and 1999 reflects loss from discontinued operations, net of tax, of approximately $4.0 million and $28,000 respectively.
(e) Does not include approximately $5.9 million related to accrued stock appreciation rights as of December 31, 1999.
(f) Includes approximately $13.1 million of redeemable member's equity at December 31, 1999.
Item 7
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations
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. The EC business product offerings include power conversion products, specialty electrical components and high-voltage utility switches. The product offerings of the MEC business consist primarily of flexible shaft and remote valve control components, turbo-charger actuators and medium security lock products and accessories. The Company's EC business was formed through its acquisition of VFC in 1999. The Company expanded the product offerings of its EC business with the power conversion product lines it acquired through its acquisition of Acme in November 2000. (See Note 2 to the Company's consolidated financial statements contained elsewhere in this Form 10-K). The Company's MEC business, which was comprised of its flexible shaft and lock product lines prior to the VFC acquisition, was expanded with the addition of the Company's turbocharger line, which it acquired in 1999 when the Company completed its acquisition of VFC.
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 $187.9 million for fiscal year 2002.
The Company continues to seek to make selective acquisitions of light industrial manufacturing companies (see Note 13 to the Company's consolidated financial statements elsewhere in this Form 10-K).
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 KCLLC's wholly owned subsidiaries from their respective dates of acquisition (see Note 2 to the Company's consolidated financial statements elsewhere in this Form 10-K). 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-K.
Consolidated Statement of Operations Data:
A summary of the Company's segments is as follows:
Year ended December 31, 2002 compared to the year ended December 31, 2001
Net Sales: Net sales for the year ended December 31, 2002 ("Fiscal 2002") decreased by approximately $5.9 million, or 3.0%, from approximately $193.8 million for the year ended December 31, 2001 ("Fiscal 2001") to $187.9 million for Fiscal 2002. This decrease was the result of the approximately $650,000, or 0.5%, increase in the net sales of the EC business offset by the approximately $6.5 million, or 8.9%, decrease in net sales of the MEC business.
For the first five months of 2001, the results of operations of the aerospace division of Acme ("Aerospace") were excluded from the consolidated results of the Company due to its classification as being held for sale during that period. Net sales of the EC business, pro forma to include the net sales of Aerospace for the entire period in the results of operations for Fiscal 2001, declined by approximately $4.3 million, or 3.5% for Fiscal 2002. The primary driver of this decline was the decline in sales for the power conversion product line of the EC business. Net sales of the power conversion business for Fiscal 2002, pro forma to include the net sales of Aerospace for the entire period in the results of operations for Fiscal 2001, declined by approximately $6.2 million or 9.7%. This decline was the result of lower demand in the industrial and telecom markets for power distribution products. The decline in the power conversion product sales were slightly offset by growth in the Company's specialty electrical product sales, which increased by approximately $3.8 million or 9.0%. However, weakness in the utility marketplace resulted in the Company's utility product sales declining approximately $1.9 million or 10.0%.
Net sales in the MEC business decreased by approximately $6.5 million from approximately $73.4 million in Fiscal 2001 to approximately $66.9 million in Fiscal 2002. This decrease is primarily related to the decline in sales of the Company's lock product line, which has continued to experience softness in demand across its major markets.
Gross Profit: Gross profit decreased by approximately $465,000, or 0.7%, from approximately $70.8 million for Fiscal 2001 to approximately $70.4 million Fiscal 2002, resulting from the $2.9 million, or 6.9%, increase in the gross profit of the EC business less the decline in gross profit of the MEC business for Fiscal 2002 of approximately $3.4 million, or 12.0%.
Gross profit of the EC business, pro forma to include the results of operations of Aerospace for the entire period in the results of operations for Fiscal 2001, increased by approximately $887,000 for Fiscal 2002 as compared to Fiscal 2001. The gross profit gains resulted from productivity improvements experienced during Fiscal 2002 as well as from a sales product mix that resulted in higher margins.
The approximately $3.4 million decline in gross profit for the MEC business for Fiscal 2002 as compared to Fiscal 2001 is primarily due to the decline in sales of the lock product line of the MEC business for Fiscal 2002.
The gross profit, as a percentage of net sales ("GP percentage"), for the EC business increased by approximately 2.2% from 35.5% for Fiscal 2001 to 37.7% to Fiscal 2002. For the MEC business, the GP percentage declined by approximately 1.3% from 38.3% for Fiscal 2001 to 36.9% to Fiscal 2002. The GP percentage for the EC business, pro forma to include the results of operations of Aerospace for the entire period in the results of operations for Fiscal 2001, increased by approximately 2.0% from 35.7% for Fiscal 2001 to 37.7% for Fiscal 2002. The increase in GP percentage for the EC business is the result of product mix and productivity gains. The Company's power conversion product line benefited from high margin aftermarket aerospace produce sales and from significant productivity gains as it consolidated distribution operations, negotiated material cost savings and increased labor efficiency at its Mexico manufacturing facility. The Company's SPEC product line's margins benefited from an increase in sales volume during Fiscal 2002. The decline in GP percentage of the MEC business is primarily related to margin compression resulting from fixed overheads being absorbed by lower sales levels primarily related to the lock product line.
Selling, General and Administrative Expenses: Selling, general and administrative ("SG&A") expenses declined by approximately $2.6 million, or 6.3%, from approximately $41.2 million for Fiscal 2001 to approximately $38.6 million for Fiscal 2002. As a percentage of net sales, SG&A decreased by 0.7% from 21.3% for Fiscal 2001 to 20.6% for Fiscal 2002.
SG&A of the EC business increased by approximately $287,000, or 1.1%, for Fiscal 2002 as compared to Fiscal 2001 and, as a percentage of net sales, increased 0.1% for Fiscal 2002. SG&A of the EC business, pro forma to include the results of operations of Aerospace for the entire period in Fiscal 2001, declined by approximately $771,000, or 2.8%, for Fiscal 2002 as compared to Fiscal 2001, and, as a percentage of net sales, SG&A, pro forma to include the results of operations of Aerospace for the entire period in the results of operations for Fiscal 2001, increased 0.1% for Fiscal 2002.
SG&A of the MEC business, which declined by approximately $16,000, or 0.2%, for Fiscal 2002 as compared to Fiscal 2001, increased as a percentage of sales by 1.2% from 12.2% for Fiscal 2001 to 13.4% for Fiscal 2002.
The decrease in SG&A expenses for Fiscal 2002 as compared to Fiscal 2001 is primarily related to the expenses of the former corporate office of Acme, which was closed in October 2001. That office added approximately $2.3 million to the consolidated SG&A expenses of the Company during Fiscal 2001, including approximately $425,000 of depreciation. Upon the close of the Acme corporate office, all remaining related expenses of that office terminated.
The decrease in the SG&A of the EC business, pro forma to include the results of operations of Aerospace for the entire period in Fiscal 2001, was primarily related to the Company's cost reduction initiatives put in place during Fiscal 2001 in response to the downturn in the economy and lower commissions due to the lower sales volumes and commission mix of the sales volume.
Goodwill Impairment: In December 2002, in accordance with Statement of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets", the Company performed its required annual fair value testing of its recorded goodwill for its reporting units. The fair value assessment was estimated using a valuation methodology that triangulates the discounted cash flows, market multiples and transactional multiples of the reporting units. As a result of the analysis, the Company recorded a charge of approximately $12.4 million, related to its lock reporting unit, which experienced a further decline of its fair value since the January 1, 2002 assessment, due to a deterioration in the current year of its results of operations compared to its operating plan and projected future financial results as well as a decline in the market multiple ascribed to the product line in its fair market valuation. Through December 31, 2002, the Company's cumulative impairment of goodwill was approximately $23.5 million, all of which related to its lock product line.
Amortization of Goodwill: Goodwill amortization decreased by approximately $3.6 million during Fiscal 2002 as compared to Fiscal 2001, due to the Company ceasing the amortization of goodwill as of January 1, 2002 as required by SFAS 142 (See Cumulative Effect of Change in Accounting Principle).
Acme Aerospace Division Cumulative Adjustment: On September 1, 2001, the Company, based on management's conclusion that Aerospace, which had previously been held for sale, was more valuable than what current market conditions dictated, decided to retain rather than divest Aerospace. On that date and in accordance with EITF 90-6, "Accounting for Certain Events Not Addressed in Issue No. 87-11 Relating to an Acquired Operating Unit to be Sold," the Company reallocated the Acme purchase price as if Aerospace had never been held for sale and recorded a cumulative adjustment for the results of operations of Aerospace from the date of acquisition through May 31, 2001 of $721,000, which had been excluded from the results of operations of the Company and had been included in goodwill.
Other Expenses: Other expenses increased by approximately $1.8 million for Fiscal 2002 as compared to Fiscal 2001. For Fiscal 2002, the other expenses include approximately $1.4 million of redundant facility and start up expenses related to the Company's new lock production facility in Mexico. The Company expects that the remainder of the startup expenses related to moving production to Mexico to occur before the end of 2003. In addition, approximately $532,000 of expenses related to the Acme Pension Plan is primarily attributed to non-cash accelerated amortization of the deferred loss in the pension asset over a Plan life expectancy assuming termination of the plan. In addition, approximately $145,000 of deferred finance costs, which were written off when the Company amended its bank agreement in June (see Liquidity and Capital Resources) were included.
Income from Operations: Income from operations decreased by approximately $9.2 million, or 34.7%, from approximately $26.5 million for Fiscal 2001 to $17.3 million for Fiscal 2002. This decrease resulted from the decrease in gross profit of approximately $465,000 offset by the decreases in SG&A expenses of approximately $2.6 million and goodwill amortization of approximately $3.6 million. The decrease in operating expenses was reduced by the $12.3 million charge taken for impairment of goodwill and by $721,000 of cumulative income recorded during Fiscal 2001 related to the inclusion of Aerospace in the Company's reporting and the increase in other operating expenses of approximately $1.8 million discussed above.
Interest Expense: Interest expense declined by approximately $3.3 million, or 19.7%, during Fiscal 2002. This decrease is primarily due to lower levels of outstanding borrowings during Fiscal 2002 as compared to Fiscal 2001, as well as reduced rates of interest charged on the outstanding principal on the Company's variable rate term loan during Fiscal 2002 as compared to Fiscal 2001.
Provision for Income Taxes: The provision for income taxes declined by approximately $2.9 million, or 52.7%, for Fiscal 2002 as compared to Fiscal 2001. The decline is primarily related to the decline in pretax income. In addition, the Company was able to take advantage of certain foreign tax credits, which reduced the Company's tax liability. The Company's effective tax rate for Fiscal 2002, however, increased to 63.3% on income before taxes from Fiscal 2001 when the Company's effective tax rate was 54.0%. The increase in the effective tax rate is primarily related to the impairment charges taken against goodwill, which are not deductible for tax purposes.
Income from continuing operations: Income from continuing operations decreased by approximately $3.2 million from approximately $4.7 million for Fiscal 2001 to approximately $1.5 million for Fiscal 2002. The primary drivers of this decrease were the approximately $9.2 million decrease in income from operations, the approximately $3.3 million decrease in interest expense and the approximately $2.9 million decrease in Company's provision for taxes due to the factors discussed above.
Cumulative effect of Change in Accounting Principle: In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations" and SFAS No. 142, which were effective for fiscal years beginning after December 15, 2001.
The provisions of SFAS 141 provide specific criteria for the initial recognition and measurement of intangible assets apart from goodwill. SFAS 141 also requires that upon adoption of SFAS 142 the company reclassify the carrying amount of certain intangible assets.
The provisions of SFAS 142 (i) prohibit the amortization of goodwill and indefinite-lived intangible assets, (ii) require that goodwill and indefinite-lived intangible assets be tested annually for impairment (and in interim periods if certain events occur which would impact the carrying value of such assets), and (iii) require that the Company's operations be formally identified into reporting units for the purpose of assessing potential future impairments of goodwill.
In June 2002, the Company completed the assessment of its reporting units and its initial step one impairment test on January 1, 2002 financial information. As a result, the Company identified one reporting unit in the MEC business with a book value of goodwill that exceeded its fair market value, which was estimated using valuation methodology involving discounted cash flows and market and transactional multiples of the reporting units. In accordance with SFAS 142, the Company estimated the amount of the impairment and recorded a cumulative effect of change in accounting principle, as of January 1, 2002, of approximately $7.8 million, net of taxes of approximately $3.4 million, to write down the goodwill associated with the Company's lock product line resulting from the current market conditions of that product line. The Company finalized its impairment testing, as prescribed by SFAS 142, during the third quarter to determine the amount of final impairment. As a result, the Company reduced the tax impact of the charge by approximately $353,000 to reflect the proper deferred tax basis of the adjusted goodwill. No further impairment charges were taken against the Company's goodwill.
Net (Loss) income: Net loss increased by approximately $11.4 million from net income in Fiscal 2001 of approximately $4.7 million to a net loss in Fiscal 2002 of approximately $6.6 million. This increase resulted from the decline in Fiscal 2002 in income from continuing operations of approximately $3.2 million from Fiscal 2001, primarily driven by the 2002 goodwill impairment charge of approximately $12.4 million and the approximately $8.2 million charge taken to reduce the Company's carrying value of its goodwill as of January 1, 2002.
Year ended December 31, 2001 compared to the year ended December 31, 2000
Net Sales: Net sales for Fiscal 2001 increased by approximately $33.4 million, or 20.8% over net sales for the year ended December 31, 2000 ("Fiscal 2000"). This increase was the result of the sum of the $48.7 million, or 68.0%, increase in the net sales of the EC business less the $15.4 million, or 17.3%, decrease in net sales of the MEC business.
The growth within the EC business was primarily due to the full year inclusion of the results of operations of the transformer power conversion product line for Fiscal 2001 as compared to the one-month inclusion of sales for December of 2000 in the results for Fiscal 2000. The transformer power conversion product line contributed approximately $50.4 million in net sales for Fiscal 2001, representing an increase of $45.1 million over Fiscal 2000. This product line was acquired in November 2000 when the Company completed the acquisition of Acme. In addition, in June 2001, the Company decided to retain rather than sell Aerospace of Acme. Aerospace was merged into the power conversion product line of the Company. The Company recorded a $721,000 cumulative adjustment (see Note 2 to the consolidated financial statements elsewhere in this Form 10-K) representing the net result of Aerospace's operations from date of acquisition to June 1, 2001. Subsequent to June 1, 2001 the results of Aerospace's operations have been included in the respective categories of operations. Included in net sales for Fiscal 2001 is approximately $8.8 million of net sales from Aerospace for the period June 1, 2001 to December 31, 2001.
Net sales in the MEC business decreased approximately $15.4 million to approximately $73.4 million for Fiscal 2001. This decrease is primarily related to the decline in sales of the Company's lock and turbocharger product lines, which resulted from a downturn in the domestic economy and a reduction in customer demand.
Gross Profit: Gross profit increased $4.2 million, or 6.3%, in Fiscal 2001 as a result of an increase of approximately $12.0 million, or 39.1%, in the gross profit of the EC business less the decline in gross profit of the MEC business for Fiscal 2001 of approximately $7.8 million, or 21.7%.
The increase in the gross profit of the EC business is primarily related to the inclusion of the results of operations of the transformer power conversion product line for the full year in Fiscal 2001, as compared to Fiscal 2000, in which only the results of operations of this product line for the month of December 2000 were included due to the acquisition of this product line with Acme at the end of November 2000. The transformer power conversion product line contributed approximately $14.3 million in gross profit for Fiscal 2001, representing an increase of approximately $12.7 million over Fiscal 2000. In addition, the gross profit of the EC business for Fiscal 2001 increased approximately $2.9 million as a result of the operations of Aerospace, which was merged into the power conversion product line in June 2001 (see Note 2 to the consolidated financial statements elsewhere in this Form 10-K). These increases were slightly offset by a decline in gross profit of the specialty electrical components product line, which was primarily driven by a decline in sales due to the downturn in the domestic economy.
The approximately $7.8 million decline in gross profit of the MEC business for Fiscal 2001 is primarily due to the decline in sales of the lock and turbocharger product lines of MEC business for Fiscal 2001 that resulted from a downturn in the domestic economy and a reduction in customer demand.
The GP percentage, for the EC business declined approximately 7.4% for Fiscal 2001. For the MEC business the GP percentage declined approximately 2.1% during Fiscal 2001.
The decline in the GP percentage of the EC business was primarily the result of the inclusion of the results of the transformer power conversion product line for the full year in Fiscal 2001 as compared to Fiscal 2000, in which only the results of December 2000 were included. The gross margin profile of the transformer product line is lower than the margins experienced in the remainder of the product lines of the EC business. The decrease in GP percentage of the MEC business is primarily related to a change in product mix and margin compression due to lower sales levels.
Selling, General and Administrative Expenses: SG&A expenses increased approximately $10.9 million, or 36.0%, in Fiscal 2001. As a percentage of net sales, SG&A increased 2.4% from Fiscal 2000. SG&A of the EC business increased approximately $9.2 million, or 54.4%, for Fiscal 2001 and, as a percentage of net sales, declined 1.9% during Fiscal 2001. SG&A of the MEC business, which declined approximately $1.1 million during Fiscal 2001, increased as a percentage of net sales by approximately 0.9%.
The increase in SG&A expenses for Fiscal 2001 is primarily related to the acquisition of Acme, which resulted in the Company integrating the transformer and aerospace product lines of Acme into the EC business. The results of the transformer power conversion product line were included for the full year in Fiscal 2001 as compared to Fiscal 2000 where the results of this product line were only included for the month of December 2000. SG&A of the transformer power conversion product line for Fiscal 2001 was approximately $9.4 million, representing an increase of approximately $8.4 million over SG&A of the Company and the EC business for Fiscal 2001. Aerospace, which was merged into the power conversion product line in June 2001 (see Note 2 to the consolidated financial statements elsewhere in this Form 10-K), added approximately $1.6 million to SG&A for Fiscal 2001. In addition, the corporate office of Acme, which was closed in October 2001, added approximately $2.3 million of SG&A expenses for Fiscal 2001, including approximately $425,000 of depreciation. This is an increase over Fiscal 2000 of approximately $2.0 million. Upon the close of the Acme corporate office, all remaining related expenses of that office terminated.
The decline in SG&A of the EC business as a percentage of net sales and in SG&A of the MEC business was primarily related to the Company's cost reduction initiatives in response to the slowing economy. The increase in SG&A as a percentage of net sales of the MEC business primarily resulted from the impact of the sharper decline in the net sales of the MEC business as compared to the cost reductions made by the Company in SG&A. The Company's MEC business has a lower overhead structure than its EC business due to lower sales and marketing expenses of the MEC's business, which limits the ability of the Company to reduce the expenses of the MEC business beyond a certain level.
On a pro forma comparative basis, assuming that the effects of the Acme acquisition were reflected in Fiscal 2000 results, exclusive of the impact of the additional corporate office expenses of Acme, all the product lines, except for the Company's utility product line, which has experienced sales growth over Fiscal 2000, have experienced a reduction in operating expense levels for Fiscal 2001, primarily driven by the Company's cost reduction initiatives.
Amortization of Goodwill: Goodwill amortization increased by approximately $932,000 during Fiscal 2001, primarily related to the full year inclusion of amortization of goodwill acquired in the Acme acquisition.
Cumulative Adjustment for Aerospace: On June 1, 2001, the Company decided to retain Aerospace, which had been previously classified as held for sale. On that date the Company reallocated the purchase price paid for Acme as if Aerospace had never been held for sale and recorded a cumulative adjustment for the results of operations of Aerospace from the date of acquisition through May 31, 2001 of $721,000.
Other expenses: For the year ended December 31, 2001, the Company's nonrecurring charges primarily related to administrative expenses incurred in connection with the establishment of a production facility in Mexico for the Company's lock products. At December 31, 2001, the Company had not begun production at its new Mexico facility. For December 31, 2000 the nonrecurring charges primarily related to approximately $1.6 million recorded in connection with outstanding stock appreciation rights ("SARs"). The SARs were issued in conjunction with the VFC acquisition in lieu of cash consideration for the purchase of equity held by operating management of former VFC subsidiaries who continued with the Company. The Company was required to report any change in the valuation of the SARs as a charge against earnings. In connection with the Recapitalization (see Liquidity and Capital Resources), all of the SARs were exercised and the holders of the SARs purchased KCI Common Stock with a substantial portion of the after-tax proceeds of such exercise.
Income from Operations: The decline in income from operations of approximately $4.9 million, or 15.6%, resulted from the increase in gross profit of approximately $4.2 million offset by the increase in SG&A expenses of approximately $10.9 million and the increase in goodwill amortization of approximately $932,000. The increase in operating expenses were reduced by the $721,000 cumulative income adjustment for Aerospace and the decrease in stock appreciation compensation and other non-recurring expenses of approximately $2.0 million due to the factors discussed above.
Recapitalization expenses: In connection with the Recapitalization (see "Liquidity and Capital Resources") completed during Fiscal 2000, the Company incurred approximately $7.9 million of transaction fees.
Interest Expense: Interest expense increased by approximately $1.4 million, or 9.3%, during Fiscal 2001. This increase is primarily due to higher levels of outstanding borrowings during Fiscal 2001 as compared to Fiscal 2000, primarily due to the additional borrowings used to finance the acquisition of Acme in November 2000 (see Liquidity and Capital Resources below). The impact of the higher debt levels, however, was partially offset by the reduced rates of interest charged on the outstanding principal on the variable rate term loan and revolving credit facility due to declining interest rates of Fiscal 2001.
Provision for Income Taxes: The provision for income taxes increased approximately $386,000, or 7.5%, from approximately $5.2 million in Fiscal 2000. The Company's effective tax rate for Fiscal 2001 was approximately 54.0% on income before taxes, which resulted primarily from the Company's estimated additional foreign tax liabilities as well as non-deductible expenses relating primarily to goodwill amortization and non-deductible professional fees in connection with the Acme acquisition. The effective rate for Fiscal 2000 was 57.0% which resulted primarily due to the change in tax status of the Company during 2000 to a C corporation as well as non-deductibility of expenses relating primarily to the Reorganization expenses and goodwill amortization.
Income from Continuing Operations: Income from continuing operations increased by approximately $832,000, or 21.3%, during Fiscal 2001. The increase resulted from the decrease in income from operations of approximately $4.9 million, a decrease in other income of approximately $423,000, an increase in interest expense of approximately $1.4 million and a decrease in the Recapitalization expenses of approximately $7.9 million, due to the factors discussed above.
Loss from Discontinued Operations, net: In Fiscal 2000, the Company incurred a loss from discontinued operations of approximately $4.0 million. In April 2000, the Company consummated the sale of Heart Interface Corporation ("Heart") and Cruising Equipment Company ("Cruising"). The Company received approximately $9.0 million in proceeds before any transaction related expenses. Of the $9.0 million of proceeds, $600,000 was placed in escrow in accordance with the agreement. The Company recorded a loss on disposal of Heart and Cruising of approximately $3.3 million. In 2002, the escrow was settled with the buyer and the Company received approximately $148,000. In July 2001, the Company received notice of a claim against the escrow. The Company has responded to the claim and is awaiting further response from the new owners of Heart and Cruising. The Company believes that the escrow will cover any potential settlement of the claim.
On December 29, 2000, the Company sold its interests in Mastervolt B.V. and subsidiaries ("Mastervolt"), which had been acquired as part of VFC (see Note 2 to the consolidated financial statements elsewhere in this Form 10-K). The Company received approximately $2.3 million in proceeds and recorded a loss on disposal of approximately $525,000.
Extraordinary loss on early extinguishment of debt, net: In November 2000, the Company closed on its new credit facility (see Liquidity and Capital Resources). As a result, in Fiscal 2000, the Company wrote off the unamortized balance of the deferred financing costs relating to the prior credit facility of approximately $2.1 million. The expense is reflected, net of a tax benefit of approximately $828,000, as an extraordinary item.
Net Income (Loss): Net income increased by approximately $6.0 million for Fiscal 2001. The increase in net income is the result of the sum of an increase in income from continuing operations of approximately $832,000 and a decrease in loss from discontinued operations of approximately $4.0 million and the extraordinary charge of approximately $1.2 million, due to the factors discussed above.
Liquidity and Capital Resources
The Company has historically generated funds from its 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 2003, and a six-year $100.0 million term loan facility. The credit agreement, guaranteed by the Company's subsidiaries and KCI, is collateralized by all of the capital stock of the subsidiaries, receivables, inventories, equipment and certain intangible property. There were no amounts outstanding under the revolving credit facility at December 31, 2002. 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 3.5% and require the payment of a commitment fee of 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 December 31, 2002, the Company had one letter of credit outstanding for approximately $443,000. The letter of credit primarily relates to outstanding Acme workman's compensation claims.
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 June 2002, the Company amended its credit agreement (the "Amendment") to provide for revised financial covenant ratios from September 30, 2002 through December 31, 2003 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 2003 and reduced the amount allowed for permitted acquisitions (as defined in the credit agreement) from $15 million to $7.5 million through the end of 2003. Concurrent with the Amendment, the Company voluntarily reduced the availability under its revolving credit facility by $15 million from $40 million to $25 million through the end of 2003. At December 31, 2002, the Company was in compliance with the covenants of the credit agreement set forth in the Amendment. In connection with the Amendment and as a result of the Company voluntarily reducing its borrowing capacity through the end of 2003, the Company wrote off $145,000 of the deferred finance costs related to amending the Company's credit facility.
The Company's remaining liquidity demands will be 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 December 31, 2002, the Company had prepaid its next two principal payments. Principal payments required for the next 12 months will be approximately $7.2 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. As of December 31, 2002, the Company had no outstanding commitments for capital expenditures. The Company anticipates its capital expenditures for the year ended December 2003 to be approximately $3.5 million. The expenditures are primarily needed to maintain its facilities and expand its production capacity for the Company's ongoing plan to expand foreign operations in order to take advantage of profitable market opportunities. 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 its existing revolving credit facility.
In connection with the Company's desire to continue to grow through acquisition and remain a leading supplier of essential componentry, in May 2000, KCI and its shareholders consummated a Recapitalization of KCI with affiliates of Kelso & Company ("Kelso") pursuant to which, among other things:
o KCI was recapitalized with Common Stock and Preferred Stock;
o KCI shareholders exchanged approximately 862,000 shares of their Common Stock for Preferred Stock and KCI optionholders exercised options to purchase 20,533 shares of Common Stock, all of which were then exchanged for shares of Preferred Stock. All such Preferred Stock was immediately sold to Kelso for cash at approximately $117 per share;
o SGC Partners II LLC ("SG"), which owned all of the stock of Keyhold, Inc. ("Keyhold"), which owned approximately 11.1% of the membership interests of KCLLC prior to the Recapitalization, exchanged all of its Keyhold stock for shares of Preferred Stock which were immediately sold to Kelso for cash at approximately $117 per share, terminating Keyhold's right to require KCLLC to repurchase Keyhold's outstanding investment in KCLLC at the then current market value thereof;
o Holders of KCI SARs exercised their SARs and with a substantial portion of their after-tax proceeds from the exercise, purchased Common Stock;
o Kelso purchased an aggregate of approximately 35,000 shares of Preferred Stock from KCI at approximately $117 per share.
At the closing of the Recapitalization, KCI, Kelso and certain shareholders of KCI entered into a Shareholders Agreement and a Registration Rights Agreement and KCI and Kelso entered into an Advisory Agreement.
Effective upon the consummation of the Recapitalization, Kelso owns all of the Preferred Stock. The Preferred Stock is not entitled to vote for the election of directors but is entitled to designate two members of KCI's seven member Board of Directors. In addition, the Preferred Stock has certain approval rights and is convertible into Common Stock at the holder's option (upon conversion the Preferred Stock would constitute over 60% of the total outstanding common equity of KCI on a fully diluted basis). The Preferred Stock has a liquidation preference equal to its purchase price plus accrued dividends, bears a 1% cumulative annual dividend payable in kind and is redeemable at the option of the holder after June 2, 2009. All of the outstanding Common Stock and options to purchase Common Stock of KCI continue to be held by parties that held such securities prior to the Recapitalization and by the parties who purchased Common Stock with the after-tax proceeds from the exercise of their SARs. The aggregate purchase price of the Preferred Stock paid by Kelso was approximately $107.0 million of which approximately $4.1 million was paid to KCI. The Company paid fees in connection with the Recapitalization of $7.9 million during Fiscal 2000. All proceeds received by KCI from the Recapitalization were contributed to KCLLC for additional membership interest.
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 $107.0 million of its Preferred Stock plus any dividends payable in arrears (approximately $2.8 million in cumulative dividends in arrears, payable in kind, at December 31, 2002), 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 December 31, 2002 approximately 1.3 million KCI common shares plus potentially 191,000 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 in its tax provision the obligations of KCI.
Cash flows provided by operating activities were approximately $22.4 million, $21.9 million, and $7.7 million for Fiscal 2002, 2001 and 2000, respectively. The net increase in cash flows of approximately $444,000 for Fiscal 2002 resulted primarily from the increase in the cash provided by Net income plus non cash adjustments which year over year increased approximately $1.3 million offset by the year over year net use of cash from the operating assets of the business. The working capital accounts (accounts receivable, inventory and accounts payable) provided net cash to operations of approximately $5.0 million in Fiscal 2002 as compared to approximately $7.8 million in Fiscal 2001. The net cash flow decline from the working capital accounts is due to certain of the Company's product lines operations rebounding in Fiscal 2002 and the Company increasing inventory safety stock levels to maintain high customer satisfaction as it continues to move production to Mexico. Accrued expenses used net cash in operations of approximately $801,000 in Fiscal 2002 as compared to approximately $5.0 million in 2001, which is the result of accrued expenses returning to normalized levels at the end of Fiscal 2001. As a result, accrued expenses at December 31, 2002 were fairly constant as compared to accrued expenses as of December 31, 2001, however, accrued expenses at December 31, 2001 were significantly lower than accrued expenses as of December 31, 2000 primarily due to the Company having paid, during fiscal 2001, a substantial portion of the December 31, 2000 accrued expenses related to the acquisition of Acme.
The net increase in cash flows from operations of approximately $14.2 million for Fiscal 2001 over Fiscal 2000 resulted primarily from the decrease in use of cash by the operating assets of the business. During 2001 the Company, in response to the downturn in the economy, initiated cost cutting programs and focused on the Company's working capital accounts, specifically accounts receivable, inventory and accounts payable. In addition, as business declined during Fiscal 2001 less cash was used in accounts receivable and inventory. For Fiscal 2001, accounts receivable and inventory had a net decline of approximately $11.8 million as compared to Fiscal 2000 when accounts receivable and inventory resulted in a net increase of $6.6 million over Fiscal 1999. Prepaid expenses and other current assets declined by approximately $2.7 million, primarily driven by the Company's use of tax overpayments in the prior year. Offsetting these increases in cash flows from operations was a decrease in accounts payable and accrued expenses of approximately $8.4 million, reflecting lower levels of spending due to the current economic conditions.
Cash flows from operations of discontinued operations used approximately $99,000 for Fiscal 2000.
Cash flows used in investing activities were approximately $2.4 million, $3.5 million and $38.7 million for Fiscal 2002, 2001 and 2000, respectively. The decrease in cash used in investing activities of approximately $1.1 million for Fiscal 2002 as compared to Fiscal 2001 is primarily related to the decreased level of capital expenditures made by the Company. In Fiscal 2002, the Company spent approximately $2.7 million of capital expenditures as compared to Fiscal 2001 when the Company's capital expenditures were approximately $4.1 million.
The decline in cash used in investing activities of approximately $35.2 million for Fiscal 2001 as compared to Fiscal 2000, is primarily related to the acquisition of Acme made in 2000. On November 21, 2000, the Company acquired all of the outstanding shares of Acme for a purchase price of approximately $47.3 million and assumed liabilities of approximately $28.8 million. In addition, the Company realized $10.7 million of proceeds from the sale of Heart, Cruising and Mastervolt (See Note 2 to the consolidated financial statements elsewhere in this Form 10-K) during Fiscal 2000. Capital expenditures for Fiscal 2000 were approximately $3.1 million.
Cash flows from financing activities used net cash of approximately $22.2 million and $17.2 million during Fiscal 2002 and 2001, respectively. Cash flows from financing activities provided net cash of approximately $30.6 million in Fiscal 2000. The net cash used in financing activities for Fiscal 2002 and 2001 was primarily driven by the Company's net repayment of debt under its existing credit facilities of approximately $22.0 million and $16.3 million in Fiscal 2002 and 2001, respectively. At December 31, 2002, the Company was two payments ahead of schedule under its current term debt facility.
During Fiscal 2000 the Company acquired Acme, which resulted in the Company renegotiating its current debt facilities during that year. Proceeds received under the Company's existing credit facility for Fiscal 2001 totaled $103.7 million. The Company used such proceeds to repay its prior credit facility, finance the acquisition of Acme, which included repaying approximately $10.4 million of debt assumed in the Acme acquisition, and working capital purposes.
For Fiscal 2002 and 2000, the Company paid deferred financing costs of approximately $229,000 and $3.8 million, respectively, related to the Company's existing and previous credit facilities.
During Fiscal 2000 the Company was the recipient of approximately $7.1 million in capital contributions. The capital contributions received during Fiscal 2000 were contributed by KCI in connection with Recapitalization described above. Approximately $7.5 million was used to repay the outstanding SARs, including, approximately $420,000 related to outstanding vested SARs with certain members of operating management of Glendinning and the inverter business, which were divested in fiscal years 1999 and 2000, respectively. The remaining holders of the SAR's who were members of operating management purchased Common Stock as part of the Recapitalization with a substantial portion of their after-tax proceeds from the exercise of their SARs.
During Fiscal 2001 and 2000, the Company paid member withdrawals of approximately $906,000 and $1.4 million, respectively. KCI used approximately $906,000 and $1.1 million of the funds received during Fiscal 2001 and 2000, respectively, to repurchase outstanding shares of its common stock from former shareholders. The remaining withdrawals in 2000 of approximately $300,000 were for tax distributions to the members of KCLLC.
Management believes that the Company's cash flow from operations, together with its borrowing availability under its existing credit facilities, will be adequate to meet its anticipated capital requirements for the foreseeable future.
Critical Accounting Policies
Financial Reporting Release No. 60, requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Note 1 of the consolidated financial statements, included elsewhere in this Form 10-K, includes a summary of the significant accounting policies and methods used in the preparation of the Company's consolidated financial statements. 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.
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, future estimated availability and existing and projected sales to produce certain 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 December 31, 2002, the Company has recorded approximately $95.6 million in goodwill and other intangible assets related to acquisitions made in 2000 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 using 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 records as necessary, valuation allowances against its deferred tax assets; if the Company were to determine that it would not be able to realize its deferred tax assets in the future, additional 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;
(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 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 operations for the periods presented.
Backlog
The Company's backlog of orders as of December 31, 2002, was approximately $25.5 million. During Fiscal 2002 the Company changed the way it reports its backlog to include only those orders to be filled within the next 12 months. Comparable backlog at December 31, 2001 was $29.2 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.
New Accounting Pronouncements
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS 145 rescinds SFAS 4, which required all gains and losses from the extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect. SFAS 145 requires that most gains and losses from the extinguishment of debt no longer be classified as extraordinary items and that they be recorded as part of the results of operations. In additions, SFAS 145 amends SFAS 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. Lastly, SFAS 145 makes technical corrections to existing pronouncements. While those corrections are not substantive in nature, in some instances, they may change accounting practice. This statement is effective for all years beginning after December 15, 2002, with early adoption allowable. The Company plans on adopting this statement effective January 1, 2003 and does not expect the adoption of this statement to have a material effect on its future results of operations or its financial position. Had the Company adopted this standard, all prior extraordinary losses due to the early extinguishment of debt, would be reclassified to other losses in the statement of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". This statement sets forth various modifications to existing accounting guidance which prescribes the conditions which must be met in order for costs associated with contract terminations, facility consolidations, employee relocations and terminations to be accrued and recorded as liabilities in financial statements. This statement is effective for exit or disposal activities initiated after December 31, 2002. The Company is currently evaluating the impact of this statement to determine the effect, if any, it may have on its consolidated results of operations and financial position.
In November 2002, the FASB released Interpretation No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees it has issued. The Interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company has adopted the required disclosures of this Interpretation and has yet to assess the impact that the valuation of future guarantees may have on the financial statement in accordance with the Interpretation.
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 7A.
Item 7A. 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 $63.0 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 4.38% until March 27, 2003, when the underlying LIBOR contract is up for renewal. At December 31, 2002 the Company had no borrowings under its line of credit and was two payments ahead of schedule on its term debt. A 1% change in the interest rate for the Company's credit facilities in place in Fiscal 2002 would have resulted in a change in the Company's interest expense of approximately $736,000. 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.
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.
Item 8.
Item 8. Financial Statements and Supplementary Data
The Company's consolidated financial statements for the three years ended December 31, 2002, together with the report of PricewaterhouseCoopers LLP dated February 13, 2003, are included elsewhere herein. See Item 15 for a list of the consolidated financial statements and consolidated financial statement schedule.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
PART III
Item 10.
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 as of December 31, 2002. All directors and officers of the Company hold office until the annual meeting of stockholders next following their election, or until their successors are elected and qualified.
John S. Dyson has been Chairman of the Board of Directors of the KCI, KCLLC 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. From 1996 to December 2001 he served 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.
Clay B. Lifflander has served as a director of KCI and KCLLC since their inception. Mr. Lifflander was elected Chief Executive Officer in November 1999. Before November 1999, Mr. Lifflander had been President of KCI since its 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.
Robert B. Kay was elected President of KCLLC in November 1999. Prior to his election he had served as the Chief Financial Officer of KCLLC since February 1999. Mr. Kay became a director of KCI and KCLLC 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.
Alan L. Rivera has been the Vice President, Secretary and a Director of KCI, KCLLC and Finance Corp. since their inception. Since September 1996, Millbrook has employed Mr. Rivera, 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.
George M. Scherer has been the Vice President-Manufacturing and a Director of KCI and KCLLC since their inception. Mr. Scherer has been with BWE since 1978 when he began as Engineering Manager. He has served as the President and a Director of BWE since 1982. Prior to joining BWE, 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.
Philip E. Berney has served as a director since May 2000, and is a board designee of Kelso. Mr. Berney joined Kelso & Company, a private investment firm in 1999, as one of its Managing Directors. From 1986 to 1999, Mr. Berney worked at Bear, Stearns & Co. Inc. where he was promoted to Senior Managing Director. He also serves as a director of CDT Acquisition Corp. and Armkel, LLC.
Thomas R. Wall, IV has served as a director since May 2000, and is a board designee of Kelso. Mr. Wall has held various positions of increasing responsibility with Kelso & Company, a private investment firm, since 1983, and currently serves as one of its Managing Directors. Mr. Wall also serves as a director of AMF Bowling, Inc., Citation Corporation, Consolidated Vision Group, Inc., Cygnus Publishing, Inc., IXL Enterprises Inc., Mitchell Supreme Fuel Company, Mosler, Inc., Peebles Inc., and 21st Century Newspapers, Inc.
Mr. Albert W. Weggeman joined the Company in March 2001 as Senior Vice President of Operations. From November 1997 to March 2001, Mr. Weggeman held positions in General Electric Company ("GE") Industrial Systems division as Manager - Mergers & Acquisitions, and most recently as President and General Manager of Midwest Electric (a GE subsidiary). Prior to GE, Mr. Weggeman was the Director of Marketing for Norton Coated Abrasives.
Keith A. McGowan was appointed the Chief Financial Officer of KCLLC in November 1999. Prior to this promotion, he had served as KCLLC's Principal Accounting Officer since April 1999. From July 1997 to April 1998, he served as the Vice President of Finance of Digitec 2000, Inc., a distributor of prepaid phone products. From November 1985 to June 1997, Mr. McGowan was employed by BDO Seidman, LLP, an accounting and consulting firm, where he was promoted to Partner in July 1995.
J. Marty O'Donohue has been President of Marinco since 1991. Mr. O'Donohue managed his own marketing consulting firm, O'Donohue and Associates, from 1988 to 1991.
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.
Daryl Lilly has been the President of Gits since June of 2000. From February 1999 through June 2000, Mr. Lilly served as Executive Vice President, Vice President of Product Development and Engineering Manager for Gits. From January 1997 to February 1999, Mr. Lilly was the Plant Engineering Manager for Reman, Inc. In addition to his experience with the Company, Mr. Lilly has 15 years of experience in various automotive component manufacturing industries.
Item 11.
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 for the three years in the period ended December 31, 2002.
(1) The salaries of Clay B. Lifflander and Alan L. Rivera are paid by Millbrook Capital Management, Inc. ("Millbrook") pursuant to the terms of a Management Agreement. See "Certain Relationships and Related Transactions --Management Agreement." (2) Long terms awards related to options granted to purchase KCI common stock. (3) The Company is a party to employment agreements with certain of its key employees. (4) The 2002 bonuses for Robert B. Kay, Albert W. Weggeman, George M. Scherer and Keith McGowan have yet to be determined. The bonuses of these individuals are determined based on certain performance goals and are at the discretion of the Board of Directors of KCLLC.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table summarizes the options that were granted to named executive officers of the Company in the fiscal year ended December 31, 2002.
(1) Market value was determined by the Board of Directors to equal the exercise price at date of grant.
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 KCI 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 KCI 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 KCI common stock on the date of grant of such options equaled the exercise price of such options.
AGGREGATED OPTION/SAR EXERCISES DURING FISCAL 2002 AND YEAR END OPTION/SAR VALUES
The following table provides information related to the number and value of options held by the named executive officers at December 31, 2002.
(1) Assumes management's estimate of fair market value of $125.00 per share of common stock at December 31, 2002.
Employment and Related Agreements
The employment agreement with Robert B. Kay, President 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 consumer price index, an annual incentive bonus, at the discretion of the Board of Directors based upon Mr. Kay and the Company reaching 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. During July of 2002, the Company increased Mr. Kay's base compensation to $315,000. 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.
In March 2001, the Company signed an employment agreement with Albert W. Weggeman, the Company's Senior Vice President of Operations, which terminates in March 2006. The agreement provides for a base salary of $212,500 per annum and entitles Mr. Weggeman to merit increases in his compensation after one year of service. In addition, the agreement provides for incentive compensation based on the performance of the Company and Mr. Weggeman. The agreement provides for vacation and benefits commensurate with the plans and programs generally offered by the Company to employees of the same level and responsibility of Mr. Weggeman. The agreement also provides that Mr. Weggeman will not (i) compete with Company for two years after termination of his agreement, and (ii) at any time following the termination of the agreement directly or indirectly contact or do business with any customers of the Company as defined in the agreement. In connection with the execution of the agreement Mr. Weggeman received an option to purchase 5,000 shares of the Company's common stock at $125 per share. The option is exercisable for a period of ten years. One-third of the shares underlying the option vest over a period of three years, beginning at December 31, 2001. The remaining shares vest upon certain events as defined in the option agreement.
In December 2001, the Company signed a new employment agreement with George M. Scherer, President of Elliott and board member of KCI and KCLLC, which terminates in December 1, 2006. The agreement provides for a base salary of $254,000 per annum, incentive compensation, as defined in the agreement and the use of a company car. In addition, Mr. Scherer is entitled to vacation and other benefits commensurate with the plans and programs generally offered by the Company to employees of the same level and responsibility of Mr. Scherer. The agreement also provides that Mr. Scherer will not (i) compete with Company for three years after termination of his agreement, and (ii) for a period of three years after the termination of the agreement directly or indirectly contact or do business with any customers or former customers of the Company as defined in the agreement.
1998 Long-Term Incentive Plan
KCI's 1998 Incentive Compensation Plan (the "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 KCI, KCLLC 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. No further grants will be made under the 1998 Plan. As of December 31, 2002, options to purchase an aggregate of 51,803 shares were outstanding under the 1998 Plan at a weighted average exercise price of approximately $41 per share, of which options to purchase 48,945 shares are currently exercisable.
The 1998 Plan is administered by the Board of Directors of KCI, 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 KCI, 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 KCI's Board of Directors and are reflected in a written stock option or award agreement.
Key Components Stock Incentive Plan
In May 2000, the Company adopted the Key Components, Inc. Stock Incentive Plan (the "KCI Plan"). Approximately 205,000 shares of KCI's Common Stock have been reserved for options issued under the KCI Plan. 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. At December 31, 2002, the Company had options for approximately 140,000 shares of common stock at a weighted average exercise price of approximately $117 per share outstanding under the Plan. Options for approximately 78,000 were vested as of December 31, 2002. Options for 24,000 shares vest over the next three years. The options for the approximately 89,000 remaining shares vest only after a change in control of the Company and if KCI's Preferred Shareholders obtain a targeted return on their investment. The Company would take a charge to earnings for the accretion in value upon the date that the Company is reasonably assured that such criteria would be satisfied.
The KCI Plan is administered by a committee as determined by the Board of Directors of KCI and in accordance with the Shareholders Agreement. Any options granted under the KCI Plan must be assigned an exercise price equal to the market value of KCI Common Stock on the date of the grant of the option. Options and awards granted under the KCI Plan are generally not transferable, and each option or award is exercisable during the lifetime of the optionee only by such optionee. The term of the options under the KCI Plan may not exceed ten years. The specific terms of each option grant or award are approved by KCI's Board of Directors and are reflected in a written stock option or award agreement.
Stock Appreciation Rights
In connection with the VFC acquisition, KCI issued SARs to certain members of operating subsidiary management. The SARs, which were fully vested, entitle the holder to receive, in cash, the difference between the exercise price and market value of KCI stock as of the date of exercise. The Company was required to record as compensation expense any net accretion in the value of the SARs based on current market value of KCI stock. For Fiscal 2000, the Company included in continuing operations approximately $1.6 million in compensation expense related to the SARs. All of the SARs were exercised in connection with the Recapitalization, with the holders of the SARs using a substantial portion of their after-tax proceeds to purchase shares of KCI common stock.
KCLLC 401(k) Plan
Effective January 1, 2001, the Company merged the 401(k) plans covering substantially all the employees of the Company, other than those of Acme into one newly formed KCLLC 401(k) plan (the "KCLLC Plan"). The KCLLC plan covers all the employees of the Company, other than those of Acme and those covered by the Gits defined benefit plan. The KCLLC Plan provides for a match of 4% of employee's compensation up to 2% maximum employer match. The Company has the ability to make additional discretionary contributions. The benefits of the KCLLC Plan vest over five years.
The Company also has a 401(k) plan for the employees of Acme. There is no Company match in the plans, although the Company has the right to make discretionary contributions. All funds, which are participant contributions, are vested to the employee.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The Company is comprised of KCLLC, a Delaware corporation which is a parent holding company for its wholly owned subsidiaries, including Key Components Finance Corp. KCI holds the entire member interests in KCLLC. KCI has no material assets other than its interest in KCLLC and has no operations. The following table sets forth information concerning the beneficial ownership of KCLLC membership interests, as of February 27, 2003 of (i) each person known to own beneficially more than 5% of KCI'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.
(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) Share values and percentages of ownership are based on share ownership including dilutive effect of outstanding vested stock options exercisable within 60 days.
(3) Includes an aggregate of 113,279 shares of KCI 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.
(4) Includes 464 shares of KCI Common Stock owned of record by trusts for the benefit of Mr. Lifflander's minor children, or which Mr. Lifflander is a trustee and 113,279 shares of KCI Common Stock owned of record by the Dyson Trusts, of which Mr. Lifflander is a trustee. Also includes vested options to purchase 3,333 shares of KCI Common Stock.
(5) Represents vested options to purchase 26,666 shares of KCI Common Stock. See "Executive Compensation."
(6) Includes vested options to purchase 1,667 shares of KCI Common Stock. See "Executive Compensation."
(7) Includes vested options to purchase 888 shares of KCI Common Stock. See "Executive Compensation."
(8) Includes 918,065 shares of KCI Preferred Stock owned by Kelso and its affiliates, which are convertible at the option of the holder into 918,065 shares of KCI Common Stock.
(9) Represents vested options to purchase 1,387 shares of KCI Common Stock. See "Executive Compensation"
(10) Represents vested options to purchase 4,558 shares of KCI Common Stock. See "Executive Compensation"
(11) Includes 113,279 shares of KCI Common Stock owned of record by the Dyson Trusts and 464 shares of KCI common stock owned of record by trusts for the benefit of Mr. Lifflander's minor children, of which Mr. Lifflander is a trustee and 918,065 shares of KCI Preferred Stock owned by Kelso and its affiliates.
The following table provides information as of December 31, 2002 about KCI's common stock that may be acquired upon the exercise of options outstanding under existing compensation plans.
Item 13.
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 the former President of ESP and a shareholder of KCI. The lease, which expires on May 31, 2003, provides for annual rent increases based on the CPI. Rental payments amounted to $217,000, $213,000 and $208,000 for Fiscal 2002, 2001 and 1999, respectively.
BWE Lease
The Company rents one of its manufacturing facilities under an operating lease agreement entered into with a company which is co-owned by George Scherer who is a member of the Board of Directors of KCI and KCLLC, a shareholder of KCI and the President of BWE. The terms of the lease, which expires December 31, 2008, provide for annual rent increases of 5%. Rental payments amounted to $167,000, $159,000 and $151,000 in Fiscal 2002, 2001 and 2000, respectively.
Management Agreement
KCLLC pays management fees to Millbrook, a party related to John S. Dyson, Chairman of the Boards of KCI and KCLLC and a shareholder of KCI. The Company recorded management fees related to Millbrook of $175,000, $920,000 and $920,000 for Fiscal 2002, 2001 and 2000, 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 $420,000 per year (the "Additional Fee") for Fiscal 2001 and 2000, 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. For Fiscal 2000 the additional fee was increased by $20,000 as a result of the pro forma growth over Fiscal 1999 and in accordance with the management agreement. Any management fee not permitted to be paid at the time due will be deferred (without interest) and will be paid as soon as permitted. Millbrook is also entitled reimbursement for it's out of pocket expenses.
As part of the Recapitalization, Millbrook agreed with Kelso to a reduced management fee, commencing in Fiscal 2002, of $175,000 plus amounts paid to Kelso ($325,000 per annum) under the Advisory Agreement. Kelso agreed that amounts paid by Millbrook to Kelso out of management fees received by Millbrook from KCI or KCLLC would offset KCI's obligation to Kelso under the Advisory Agreement between Kelso and KCI.
During 2000, KCLLC paid Millbrook $825,000 and $400,000, respectively, for investment advisory services in connection with the acquisition of Acme and the sale of the inverter business.
Item 14.
Item 14. Control Procedures
Within 90 days prior to the date of this report, under the supervision and with the participation of management, including KCLLC's Chief Executive Officer, President and Chief Financial Officer, KCLLC evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 15d-14. Based upon that evaluation, KCLLC's Chief Executive Officer, President and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective in timely alerting the Chief Executive Officer, President and Chief Financial Officer to material information relating to KCLLC (including its consolidated subsidiaries and its parent company KCI) required to be included in its periodic SEC filings. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.
Within 90 days prior to the date of this report, under the supervision and with the participation of management, including Finance Corp.'s Chief Executive Officer, President and Chief Financial Officer, Finance Corp. evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 15d-14. Based upon that evaluation, Finance Corp.'s Chief Executive Officer, President and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective in timely alerting the Chief Executive Officer, President and Chief Financial Officer to material information relating to Finance Corp. required to be included in its periodic SEC filings. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(1) Previously filed with the Company's Schedule 14D-1, filed on December 9, 1998 (Commission File No.5-13949) and incorporated herein by reference. (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 and incorporated herein by reference. (3) Previously filed with the Company's Current Report on Form 8-K (File No. 333-58675-01), filed February 3, 1999 and incorporated herein by reference. (4) Previously filed with the Company's Form 10-K for the year ended December 31, 1998 and incorporated herein by reference. (5) Previously filed with the Company's Form 10-Q for the three months ended March 31, 1999 and incorporated herein by reference.
(6) Previously filed with the Company's Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. (7) Previously filed with the Company's Form 8-K filed on December 6, 2000 and incorporated herein by reference. (8) Previously filed with the Company's Form 8-K filed on April 19, 2000 and incorporated herein by reference. (9) Previously filed with the Company's Form 10-Q for the six months ended June 30, 2000 and incorporated herein by reference. (10) Previously filed with the Company's Form 10-Q for the nine months ended September 30, 2000 and incorporated herein by reference. (11) Previously filed with Schedule 14A of Acme, filed October 12, 2000 (Commission File No. 001-08277) and incorporated herein by reference. (12) Previously filed with the Company's Form 10-K for the year ended December 31, 2000 and incorporated herein by reference. (13) Previously filed with the Company's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. (14) Previously filed with the Companys Form 10-Q for the six months ended June 30, 2002 and incorporated herein by reference. (15) Filed herewith.
Report of Independent Accountants
To the Board of Directors and Member of Key Components, LLC:
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) on page 32 present fairly, in all material respects, the financial position of Key Components, LLC and its subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) on page 32 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, 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 audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002.
PricewaterhouseCoopers LLP
Stamford, Connecticut February 13, 2003, except for Note 13, as to which the date is March 3, 2003.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
1. Organization and Significant Accounting Policies
Basis of Presentation and Nature of Operations
The consolidated financial statements as of and for the three years ended December 31, 2002 include the financial statements of Key Components, LLC ("KCLLC"), a Delaware corporation and its wholly-owned subsidiaries (collectively the "Company") from their respective dates of acquisition. 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, whose product offerings include power conversion products, specialty electrical components and high-voltage utility switches, which are manufactured by its subsidiaries Acme Electric Corporation ("Acme"), Marine Industries, LLC ("Marinco"), Atlantic Guest, Inc. ("Guest") and Turner Electric, LLC ("Turner"). The Company's mechanical engineered components business, whose product offerings consist primarily of medium security lock products and accessories, flexible shaft and remote valve control components and turbocharger components, are manufactured by Hudson Lock, LLC ("Hudson"), ESP Lock Products, LLC ("ESP"), B.W. Elliott Manufacturing, LLC ("BWE") and Gits Manufacturing, LLC ("Gits").
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. At December 31, 2002, KCLLC was wholly-owned by Key Components, Inc. ("KCI"), a New York corporation. KCI holds no other assets other than its investment in KCLLC and has no operations.
From August 31, 1999 to December 31, 2000, Keyhold, Inc. ("Keyhold"), a Delaware corporation (Note 9(b)) held a minority membership in KCLLC. In connection with the Recapitalization (Note 9(a)) Keyhold was acquired by KCI in May 2000. On December 31, 2000, Keyhold was merged into KCI. From its date of acquisition by KCI to December 31, 2000, all transactions of or obligations related to Keyhold are reflected in the consolidated financial statements of KCLLC.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions 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. Significant estimates used by the Company that are subject to change include, but are not limited to, provision for doubtful accounts, inventory obsolecence, fair value estimates in conjunction with the Company's fair value testing of its recorded goodwill, warranty costs accrued, the Acme acquisition accruals (Note 2), and the estimated liabilities related to the pension plans of the Company (Note 10). Actual results could differ from the estimates used by the Company.
Cash and Cash Equivalents
For the purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with an original 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.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Major renewals and betterments are capitalized, while maintenance and repairs that do not improve or extend the life of the asset are expensed in the period they occur. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:
----------------------------------------------------------------------------- Buildings and improvements 20 - 40 years Equipment 3 - 10 years Furniture and fixtures 3 - 10 years Leasehold improvements Shorter of term of lease or useful life of the asset =============================================================================
Intangibles
Intangibles, which are included in other assets, 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 lives of the related agreements, which range from five to seven years. Amortization of intangibles charged to continuing operations amounted to approximately $284,000, 438,000 and $506,000 for 2002, 2001 and 2000, respectively. Accumulated amortization at December 31, 2002 and 2001 was approximately $3.9 million and $3.6 million, respectively.
Long-lived Assets
Whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, the Company evaluates the basis of its long-lived assets based on expectations of undiscounted cash flows related to those assets. Based on its most recent analysis, the Company believes that no impairment of its long-lived assets exists at December 31, 2002.
In October 2001, Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144 provides guidance on the accounting for long-lived assets to be held and used and for assets to be disposed of through sale or other means. SFAS 144 also broadens the definition of what constitutes a discontinued operation and how such results are to be measured and presented. SFAS 144 was effective for fiscal years beginning after December 15, 2001. The adoption of SFAS 144 did not have a material impact on the earnings or financial position of the Company.
Goodwill
Goodwill represents the excess of the cost of acquired businesses over the fair market value of their net tangible assets. Through December 31, 2001 goodwill was being amortized on the straight-line method over thirty-five to forty years. Goodwill amortization for the years ended December 31, 2001 and 2000 was approximately $3.6 million and $2.6 million. Accumulated amortization at December 31, 2001 was approximately $10.3 million.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
In July 2001, FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets" effective for fiscal years beginning after December 15, 2001.
The provisions of SFAS 141 provide specific criteria for the initial recognition and measurement of intangible assets apart from goodwill. SFAS 141 also requires that upon adoption of SFAS 142 the Company reclassify the carrying amount of certain intangible assets.
The provisions of SFAS 142 (i) prohibit the amortization of goodwill and indefinite-lived intangible assets, (ii) require that goodwill and indefinite-lived intangible assets be tested annually for impairment (and in interim periods if certain events occur which would impact the carrying value of such assets), and (iii) require that the Company's operations be formally identified into reporting units for the purpose of assessing potential future impairments of goodwill.
Upon the adoption of SFAS 142, the Company stopped recording goodwill amortization effective January 1, 2002. In June 2002, the Company completed the assessment of its reporting units and its initial assessment of impairment upon adoption. As a result, the Company identified one reporting unit in the mechanical engineered components ("MEC") business with a book value of goodwill that exceeded its fair market value, which was estimated using a valuation methodology that triangulates the discounted cash flows, market multiples and transactional multiples of the reporting units. In accordance with SFAS 142, the Company, during the second quarter 2002, estimated the amount of the impairment and recorded a cumulative effect of change in accounting principle, as of January 1, 2002, of approximately $7.8 million, net of taxes of approximately $3.4 million, to write down the goodwill associated with the Company's lock product line resulting from the market conditions of that product line. The Company, as prescribed by SFAS 142, finalized its impairment testing by comparing the implied fair value of the reporting unit's goodwill to its carrying value during the third quarter to determine the amount of the final impairment upon adoption of SFAS 142. As a result, the Company reduced the tax impact of the charge by approximately $353,000 to reflect the proper deferred tax basis of the adjusted goodwill. No further impairment charges were taken against the Company's goodwill.
In December 2002, in accordance with SFAS 142, the Company performed its required annual fair value testing of its recorded goodwill for its reporting units using a valuation approach consistent with the one used upon adoption of SFAS 142. As a result of the analysis, the Company recorded a charge of approximately $12.4 million, related to its lock reporting unit, which experienced a further decline of its fair value since the January 1, 2002 assessment, due to a deterioration in the current year of its results of operations compared to its operating plan and projected future financial results as well as a decline in the market multiple ascribed to the product line in its fair market valuation. Through December 31, 2002, the Company's cumulative impairment of goodwill was approximately $23.5 million, all of which related to its lock product line.
Deferred Financing Costs
Debt issuance costs have been deferred and are being amortized on a straight-line basis over the lives of the financings. Amortization charged to continuing operations amounted to approximately $977,000, $933,000 and $1,016,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Accumulated amortization at December 31, 2002 and 2001 was approximately $3.1 million and $2.2 million, respectively. In addition, during 2002 the Company amended certain aspects of its borrowing agreement and expensed $145,000 of deferred financing costs.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
Income Taxes
Prior to May 23, 2000, the members of KCLLC were responsible for the taxes due on the income of the Company, apart from the subsidiaries that remained C corporations. KCI, the majority member of KCLLC was an S corporation requiring its shareolders to be personally liable for the taxes on income passed through to KCI from KCLLC.
In order for the shareholders to pay for their tax liabilities related to the income passed through from KCLLC, distributed to its members the estimated amount of taxes owed on income of the Company. Upon the consummation of the Recapitalization (Note 9(a)), KCI automatically converted to a C corporation for tax purposes. At the same time, KCI acquired Keyhold, the minority member of KCLLC at that time, which was a C corporation for tax purposes. Beginning May 23, 2000, the Company reflects its tax provision as if it were a C corporation, the status of its member. KCLLC became wholly owned by KCI when Keyhold merged into KCI effective December 31, 2000.
For the three years ended December 31, 2002 the Company's provision primarily relates to the C corporation taxes that the Company is responsible for on the taxable income of the Company.
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 the amounts expected to be realized.
Revenue Recognition
The Company recognizes revenue principally upon shipment of products to customers, however no sooner than when title passes and all risk and rewards of ownership have been transferred.
Warranty
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 years ended December 31, 2002 and 2001 the Company's warranty accrual changed as follows:
Year ended December 31, 2002 2001 ---------------------------------------------------------------------------- Balance, beginning of period $821 $453 Additions 200 19 Addition of Aerospace - 349 Charges (36) - ---------------------------------------------------------------------------- Balance, end of period $985 $821 ============================================================================
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 customers in a multitude of industries. Some of its larger customers are focused in the marine, heavy truck, aerospace, lawn and garden and office furniture industries. Due to the distribution of its customer base amongst a large array of end user markets, management does not believe that a significant concentration of credit risk exists at December 31, 2002.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
Shipping costs
The Company includes the costs of shipping to its customers as part of its selling expenses.
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, 2001. The Company's Senior Notes (Note 6) are currently market listed at approximately 97% of the their face value, however the market for the notes is highly inactive.
New Accounting Pronouncements
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". SFAS 145 rescinds SFAS 4, which required all gains and losses from the extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect. SFAS 145 requires that most gains and losses from the extinguishment of debt no longer be classified as extraordinary items and that they be recorded as part of the results of operations. In additions, SFAS 145 amends SFAS 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. Lastly, SFAS 145 makes technical corrections to existing pronouncements. While those corrections are not substantive in nature, in some instances, they may change accounting practice. This statement is effective for all years beginning after December 15, 2002, with early adoption allowable. The Company plans on adopting this statement effective January 1, 2003 and does not expect the adoption of this statement to have a material effect on its future results of operations or its financial position. Had the Company adopted this standard, all prior extraordinary losses due to the early extinguishment of debt, would be reclassified to other losses in the statement of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement sets forth various modifications to existing accounting guidance which prescribes the conditions which must be met in order for costs associated with contract terminations, facility consolidations, employee relocations and terminations to be accrued and recorded as liabilities in financial statements. This statement is effective for exit or disposal activities initiated after December 31, 2002. The Company is currently evaluating the impact of this statement to determine the effect, if any, it may have on its consolidated results of operations and financial position.
In November 2002, the FASB released Interpretation No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees it has issued. The Interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee for guarantees issued or modified after December 31, 2002, a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company has adopted the required disclosures of this Interpretations and has yet to assess the impact of the valuation of future guarantees will have on the financial statement in accordance with the Interpretation.
Reclassifications
Certain reclassifications were made to conform prior periods to the current year presentation.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
2. Acquisitions and Dispositions
(a) Acme Electric Corporation
During the year ended December 31, 2000, the Company acquired Acme, which was accounted for by the purchase method of accounting. The results of operations of Acme have been included in the consolidated financial statements since the date of acquisition.
On November 21, 2000, the Company acquired all of the outstanding shares of Acme for a purchase price of approximately $47.3 million and assumed liabilities of approximately $28.8 million. In conjunction with the acquisition, the Company repaid approximately $10.4 million of Acme's outstanding long-term debt out of the approximately $28.8 million of liabilities assumed as part of the acquisition. The Company recorded the excess purchase price over net assets acquired of approximately $33.1 million as goodwill. Approximately $3.5 million was recorded to goodwill in 2001 related to the changes resulting from retaining Aerospace, from actual results of Electronics and other changes.
At the time of the acquisition, the Company decided to sell the Acme Aerospace ("Aerospace") division and the Acme Electronics ("Electronics") division. In accordance with Emerging Issues Task Force ("EITF") Bulletin 87-11, "Allocation of Purchase Price to Assets to be Sold," the Company recorded the anticipated net proceeds from the sale of these subsidiaries adjusted for the anticipated net cash inflows during the holding period (date of acquisition to date of sale) as assets held for sale. In addition, the net earnings from these subsidiaries during the holding period are excluded from the operations of the Company, in accordance with EITF 87-11. Such results and estimated sale proceeds plus the net cash inflows during the holding periods have been included in goodwill. Aerospace manufactures lightweight high power battery chargers and related power systems for aerospace applications. Electronics was a contract electronics manufacturer for data storage, telecommunications and medical electronic applications.
On June 1, 2001, based on the strength of the operating performance of Aerospace, the Company decided to retain Aerospace. On that date and in accordance with EITF 90-6, "Accounting for Certain Events Not Addressed in Issue No. 87-11 Relating to an Acquired Operating Unit to be Sold," the Company reallocated the purchase price of Acme as if Aerospace had never been held for sale and recorded a cumulative adjustment for the results of operations of Aerospace from the date of acquisition through May 31, 2001 of $721,000 comprised of the following:
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
In February 2002, the Company sold the Electronics division of Acme for $100,000 in cash and a 7% per annum $300,000 note receivable due on February 15, 2006. In addition, contingent consideration of up to $2.1 million could be earned, if the Electronics division meets certain annual revenue targets over the next 48 months following the sale. Contingent consideration earned, if any, including interest at 7% per annum, will be paid on the fourth anniversary from the date such contingent consideration is earned and will be recorded against goodwill. At December 31, 2001, the approximately $2.3 million recorded as assets held for sale consisted primarily of the tax deduction the Company received in 2002 from the tax loss generated from the sale. Based on operating performance of Electronics subsequent to the sale, the Company fully reserved the $300,000 note. To date, there have been no payments of the contingent consideration, nor does the Company expect any in the future.
As part of the Company's plan of integrating the Acme acquisition, the Company accrued approximately $1.8 million of severance and related costs and $266,000 of lease exit costs related to exiting Acme's corporate office (closed in October 2001). At December 31, 2002, $1.6 million of payments had been made related to these accruals.
On an unaudited pro forma basis, assuming that the Acme acquisition, the Recapitalization transaction (Note 9(a)) and the termination of KCI's S election (Note 1) for tax purposes, had occurred on January 1, 2000, the consolidated results of operations of the Company would have been as follows for the year ended December 31, 2000:
Year ended December 31, 2000 ----------------------------------------------------------------------------- (Unaudited)
Pro forma net sales $220,615
Pro forma income from continuing operations $ 12,666
Pro forma net income $ 7,451 =============================================================================
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 period presented.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
(b) Inverter business
In November 1999, management of the Company decided to withdraw from the business of the manufacture and sale of power inverters and related instrumentation by selling its interests in Heart Interface Corporation ("Heart"), Cruising Equipment Company ("Cruising") and Mastervolt International B.V. ("Mastervolt"), all of which were a part of Valley Forge Corporation ("VFC") which was acquired in January 1999. In accordance with Accounting Principles Board Opinion 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", the Company recorded the net assets of Heart, Cruising, and Mastervolt as net assets of discontinued operations and reported the results of operations as loss from discontinued operations. At December 31, 1999, the Company had made no accrual of costs of disposal related to the sale of their interests since it had been management's estimate that the Company would record gains from the sales at that time.
In April 2000, the Company consummated the sale of Heart and Cruising. The Company received approximately $9.0 million in proceeds before any transaction related expenses. Of the $9.0 million of proceeds, $600,000 was placed in escrow in accordance with the agreement. The Company recorded a loss on disposal of Heart and Cruising of approximately $3.3 million. During 2002, the escrow related to the sale of Heart and Cruising was settled with the buyer. The Company received approximately $148,000.
On December 29, 2000, the Company sold its interests in Mastervolt to the minority shareholders of Mastervolt. The Company received approximately $2.3 million before related expenses and recorded a loss on disposal of approximately $525,000.
The summary of the operations of the power inverter business for the years ended December 31, 2000 were as follows:
3. Inventories
Inventories consist of:
December 31, 2002 2001 ----------------------------------------------------------------------------- (in thousands) Raw materials $14,342 $15,566 Work-in-process 7,734 6,808 Finished goods 7,547 8,038 ----------------------------------------------------------------------------- Total inventory $29,623 $30,412 =============================================================================
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
4. Property, Plant and Equipment
Property, plant and equipment consists of the following:
Depreciation expense amounted to approximately $4.7 million, $5.1 million and $3.8 million for the years ended December 31, 2002, 2001, and 2000, respectively.
5. Operating Segments
The Company operates in two business segments, the mechanical engineered components business and the electrical components business. The electrical components business product offerings include power conversion products, specialty electrical components and high-voltage utility switches. The mechanical engineered components business manufactures flexible shaft products, turbo charger actuators and related componentry and specialty locks and related accessories.
The Company evaluates performance and allocates resources based on profit or loss from 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. In its calculation of EBITDA certain charges that management determines as investment related or non-cash are excluded. Adjusted EBITDA is used in the computation of all the financial maintenance covenants under the Company's credit facility. Segment information is as follows:
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
Reconciliation of Selected Segment Information to the Company's Consolidated Totals
In 2002 and 2001 the majority of the other expenses (approximately $1.4 million in 2002 and $288,000 in 2001) were the redundant facility costs, startup expenses and inefficiencies related to the Company's new lock production facility in Mexico. In 2001 the Company commenced its plan to move most of its lock production to Mexico over a three year period. In addition, the other expenses in 2002 include approximately $532,000 related to the Acme pension plan, almost all of which is related to the amortization of the deferred loss over a short useful life to match the Company's intention to terminate the plan (See Note 10). In 2000, the other expenses are related to the charges taken for the recapitalization and the stock appreciation rights (See Note 9).
Key Components, LLC and subsidiaries
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6. Long-Term Debt
Long-term debt consists of the following:
December 31, 2002 2001 ----------------------------------------------------------------------------- (in thousands) Senior notes $80,000 $ 80,000 Term loan and revolving credit facility 63,046 85,000 Mortgage 782 800 Other 16 37 ----------------------------------------------------------------------------- 143,844 165,837 Less: Current portion (7,225) (6,305) ----------------------------------------------------------------------------- Total long-term debt $136,619 $159,532 =============================================================================
(a) Senior Notes
On May 28, 1998, the Company issued $80,000,000 of 10.50% Senior Notes due June 1, 2008, with interest payable semi-annually. The net proceeds from the Senior Notes were used to repay debt, repurchase outstanding warrants and for general corporate purposes. At December 31, 2002 and 2001, the Company has accrued interest on these notes in the amount of $700,000.
The notes are fully and unconditionally guaranteed, jointly and severally, on a non-collateralized basis, by the subsidiaries of the Company (the "Subsidiary Guarantors"). At December 31, 2002, KCLLC has de minimus assets other than its investments in the Subsidiary Guarantors and cash and no operations other than those of the Company's corporate office. Accordingly, the consolidated financial statements present the combined assets and operations of the Subsidiary Guarantors.
The Senior Notes will be redeemable, at the Company's option, in whole or in part, at any time and from time to time, on or after June 1, 2003, and prior to maturity, upon not less than 30 nor more than 60 days prior notice to the holder, plus accrued and unpaid interest to the redemption date. The redemption price is set forth in the indenture and ranges from 105.25% at June 30, 2003 scaling down to 100.0% of the face value beginning in 2006. The holders of the Senior Notes can require the Company to repurchase the notes upon a change in control, as defined in the Indenture.
The Indenture requires certain limitations of indebtedness and certain payments related to dividends and common stock, as defined.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
(b) Term Loan and Revolving Credit Facility
On September 29, 2000, and in connection with the acquisition of Acme, the Company entered into its current credit facility. The credit facility provides for a six-year $40,000,000 revolving credit facility and a six-year $100,000,000 term loan facility. The credit agreement is guaranteed by KCI and the Company's subsidiaries, and is collateralized by all of the capital stock of the subsidiaries, receivables, inventories, equipment and certain intangible property. The Company closed on the credit agreement in November 2000. The term loan is payable in quarterly installments through September 2006 and the Company may pay the quarterly installments in advance. 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 1.00% to 2.75%. The Company has the option to lock in a rate based on the base or LIBOR rate. Rates determined by reference to the LIBOR rate can be set for 30, 90 or 180 days. Base rate and LIBOR were 4.25% and 1.43%, respectively, at December 31, 2002. The revolving credit facility also requires a commitment fee of 0.50% on the unused portion of the facility as well as quarterly facility commitment fees. The facility also allows for up to $5.0 million of outstanding letters of credit. At December 31, 2002 the Company had one outstanding letter of credit for approximately $443,000. In addition, 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 June 2002, the Company amended its credit agreement (the "Amendment") to provide for revised financial covenant ratios from September 30, 2002 through December 2003 from the original covenant ratios stipulated in the credit agreement. The Company anticipated that certain of the original covenants which become 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 2003 and reduced the amount allowed for permitted acquisitions (as defined in the credit agreement) from $15 million to $7.5 million through the end of 2003. Concurrent with the Amendment, the Company voluntarily reduced the availability under its revolving credit facility by $15 million from $40 million to $25 million through the end of 2003. At December 31, 2002, the Company was in compliance with the covenants of the credit agreement set forth in the Amendment. As a result of the Company voluntarily reducing its borrowing capacity through the end of 2003, the Company wrote off $145,000 of the deferred finance costs related to amending the Company's credit facility.
As of December 31, 2002, the Company had no borrowings outstanding under the revolving credit facility and had approximately $63.0 million outstanding under the term loan. Accrued interest payable at December 31, 2002 and 2001 was approximately $8,000 and $183,000, respectively.
(c) Mortgage
The Company has a mortgage collateralized by one of the Company's manufacturing facilities. The mortgage requires monthly payments of approximately $5,000 of principal and interest at approximately 7.7% per annum with the balance of the principal of approximately $657,000 due May 1, 2008.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
At December 31, 2002, aggregate principal payments required on all amounts due are as follows:
Year ending December 31, Amount ----------------------------------------------------------------------------- (in thousands) 2003 $7,225 2004 16,058 2005 19,931 2006 19,937 2007 27 Thereafter 80,666 ----------------------------------------------------------------------------- $143,844 =============================================================================
7. Federal and State Income Taxes
Income tax expense (benefit) consists of the following:
A reconciliation between income taxes computed at the statutory federal rate and income tax expense is as follows:
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
Taxable income earned outside the United States of America was approximately $1.7 million and $1.0 million for the years ended December 31, 2002 and 2001, respectively and was primarily generated from operations in Thailand. During the fourth quarter of 2002, upon final completion and assessment of the Company's reconciliation of prior year tax filing, the Company recognized a benefit for the treatment of certain 2001 tax benefits, which were not estimable at December 31, 2001.
The Company's net deferred assets and liabilities were as follows:
At December 31, 2001, the Company also had a $1,972,000 deferred tax asset with a 100% valuation allowance relating primarily to capital losses generated from the sales of the inverter business expiring through 2005. The Company recorded a 100% allowance since the Company does not believe that it can derive a benefit from this asset at this time.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
8. Commitments and Contingencies
(a) Operating leases
The Company rents several manufacturing and warehouse facilities under operating lease agreements, two of which are with related parties (Note 11). Rent expense under all lease agreements amounted to approximately $2.3 million, $2.1 million and $1.3 million in 2002, 2001 and 2000, respectively.
At December 31, 2002 and 2001, approximately $525,000 and $576,000, respectively, was recorded as accrued lease costs related to leased facilities no longer in use by one of the Company's subsidiaries (Note 11). The accrual represents the discounted future rental payments, net of estimated sublease income. At December 31, 2002 and 2001, approximately $56,000 and $51,000, respectively, were included in accrued expenses.
The following is a schedule of the future minimum lease payments under operating leases which expire through 2010.
Minimum rental Year ended December 31, payments ----------------------------------------------------------------------------- (in thousands) 2003 $1,865 2004 1,673 2005 1,222 2006 979 2007 837 Thereafter 1,388 ----------------------------------------------------------------------------- Total minimum lease payments $7,964 =============================================================================
(b) KCI Obligations
As 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 $105 million of its preferred stock (including any dividends in arrears which was approximately $2.8 million at December 31, 2002) (Note 9(a)), which is redeemable for cash at the option of the holder after June 2, 2009 and the requirement to purchase shares from its common shareholders under certain circumstances. Such repurchases are to be made at fair market value as defined in KCI's shareholder agreement. At December 31, 2002 approximately 1.3 million KCI common shares plus potentially 193,000 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.
(c) Other
Consistent with other entities its size, the Company is party to legal actions and claims, none of which individually or in the aggregate, in the opinion of management, are expected to have a material adverse effect on the Company's results of operations or financial position.
The Company has employment agreements with certain members of management that expire through 2006.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
9. Member's Equity
(a) Recapitalization
In May 2000, KCI and its shareholders consummated a Recapitalization (the "Recapitalization") with affiliates of Kelso & Company ("Kelso") pursuant to which, among other things:
o KCI was recapitalized with Common Stock and Preferred Stock;
o KCI shareholders exchanged approximately 862,000 shares of their Common Stock for Preferred Stock and KCI option holders exercised options to purchase 20,533 shares of Common Stock, all of which were then exchanged for shares of Preferred Stock. All such Preferred Stock was immediately sold to Kelso for cash at approximately $117 per share;
o SGC Partners II LLC ("SG"), which owned all of the stock of Keyhold, which owned approximately 11.1% of the membership interests of KCLLC prior to the Recapitalization, exchanged all of its Keyhold stock for shares of Preferred Stock which were immediately sold to Kelso for cash at approximately $117 per share, terminating Keyhold's right to require KCLLC to repurchase Keyhold's outstanding investment in KCLLC at the then current market value thereof;
o Holders of KCI stock appreciation rights ("SARs") exercised their SARs and, with a substantial portion of their after-tax proceeds from the exercise, purchased Common Stock from KCI;
Kelso purchased an aggregate of approximately 35,000 shares of Preferred Stock from KCI at approximately $117 per share.
At the closing of the Recapitalization, KCI, Kelso and certain shareholders of KCI entered into a Shareholders Agreement and a Registration Rights Agreement and KCI and Kelso entered into an Advisory Agreement. As part of Advisory Agreement, KCI is required to pay a $325,000 annual management fee to Kelso. Kelso agreed that amounts paid by Millbrook Capital Management ("Millbrook") (Note 11) to Kelso out of management fees received by Millbrook from KCI or KCLLC would offset KCI's obligation to Kelso under the Advisory Agreement between Kelso and KCI.
Effective upon the consummation of the Recapitalization, KCI has 1.1 million and 10.0 million, respectively, of authorized shares of Preferred and Common Stock. Kelso became the owner of all of the outstanding shares of Preferred Stock. The Preferred Stock is not entitled to vote for the election of directors but is entitled to designate two members of KCI's seven member Board of Directors. In addition, the Preferred Stock has certain approval rights and is convertible into Common Stock at the holder's option (upon conversion, the Preferred Stock would constitute approximately 61.1% of the total outstanding Common Stock of KCI, on a fully diluted basis).
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
The Preferred Stock has a liquidation preference equal to its purchase price plus accrued dividends (approximately $2.8 million in cumulative dividends in arrears at December 31, 2002), bears a 1% dividend payable in kind and is redeemable for cash at the option of the holder after June 2, 2009. All of the outstanding Common Stock and options to purchase Common Stock of KCI continue to be held by parties that held such securities prior to the Recapitalization and the parties who purchased Common Stock with the after-tax proceeds from the exercise of their SARs, which are primarily top management and employees of the Company. The aggregate purchase price of the Preferred Stock paid by Kelso was approximately $105,000,000 of which approximately $4,100,000 was paid to KCI. The Company paid approximately $7,900,000 of expenses in connection with the transaction.
As a result of the Recapitalization, KCI, through its direct majority interest in KCLLC, held directly and indirectly all of the membership interests in KCLLC. As a result of the merger of Keyhold into KCI (See Note 1), KCI now holds all of the membership interests in KCLLC. In addition all proceeds received by KCI from the Recapitalization were contributed to KCLLC for additional membership interest.
(b) Keyhold Membership Interest
On August 12, 1999, KCLLC entered into agreements (the "SG Agreements") with Keyhold and SG, to sell up to $20,000,000 of membership equity interests in KCLLC. On September 1, 1999, SG (through Keyhold) made a capital contribution to KCLLC of $10,000,000, before expenses of approximately $997,000. Keyhold received approximately an 11% membership equity interest in KCLLC. In connection with the Recapitalization (Note 9 (a)), SG was paid approximately $16,187,000 for their interest in Keyhold and Keyhold became a wholly owned subsidiary of KCI. On December 31, 2000, Keyhold was merged into KCI. The accretion in value had been recorded as a reduction in member's equity.
(c) Stock Incentive Plans of KCI
In 1998, KCI adopted a Long-Term Incentive Plan (the "1998 Plan") to attract, retain and provide additional incentive to employees. In 2000, the Company adopted the Key Components, Inc. Stock Incentive Plan (the "KCI Plan"). Awards under either plan may take the form of incentive stock options of KCI or non-qualified stock options of KCI. Upon the adoption of the KCI Plan, no further grants will be made under the 1998 Plan. Options for approximately 15,000 shares of common stock were vested at December 31, 2001. Options to purchase approximately 29,000 shares vest over the next three years. The options for the approximately 86,000 remaining shares vest only after a change in control of the Company and if KCI's preferred shareholders obtain a targeted return on their investment. The vesting event would allow the holder to be compensated for the net accretive value of the underlying shares. The Company would take a charge to earnings for the accretion in value upon the date that the Company is reasonably assured that such criteria would be satisfied. The holders of vested options under the KCI Plan can, under certain circumstances, require KCI to repurchase the shares acquired by exercise of the vested options at fair market value, as defined in the Shareholders Agreement.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
Information regarding outstanding stock options is as follows:
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
A summary of stock options at December 31, 2002 is as follows:
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, based on an independent appraisal, 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:
Had compensation cost for the stock options been determined based on the fair values at the grant dates, the Company's net income would have been reduced to the pro forma amounts indicated below:
Year ended December 31, 2002 2000 1999 ----------------------------------------------------------------------------- (in thousands) Net (loss) income As reported $(6,631) $ 4,731 $(1,316) Pro forma $(7,084) $4,367 $(1,427) =============================================================================
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
(d) Accrued Compensation Rights
In connection with the VFC acquisition, KCI issued SARs to certain members of operating subsidiary management. The Company is required to record as compensation expense any change in the value of the SARs based on current market value of KCI stock. For the years ended December 31, 2000, the Company included in continuing operations approximately $1.6 million, in compensation expense related to the SARs. The SARs were exercised in connection with the Recapitalization (Note 9(a)).
(e) Capital withdrawals
During the year ended December 31, 2001, KCLLC paid a capital withdrawal to KCI of approximately $906,000. The proceeds were used by KCI to redeem shares of common stock from a stockholder who is no longer employed by the Company. During 2000 KCLLC paid capital withdrawals of approximately $1.4 million, which $1.1 million was used to repurchase outstanding shares of its common stock from former shareholders. The remaining withdrawals in 2000 of approximately $300,000 were for tax distributions to the members of KCLLC.
10. Retirement Plans
(a) 401(k) Plans
At December 31, 2002, the Company had two 401(k) plans in effect. The Company's employees at domestic locations, other than those of Acme, are covered under the Key Components LLC Plan, which the Company matches 50% of the employees contributions up to 4% of each covered employee's annual compensation. The employees of Acme are covered by a separate 401(k) plan. Employer contributions to the Acme plans are discretionary. Employer contributions in the aggregate were approximately $358,000, $414,000 and $404,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
(b) Profit Sharing Plan
The Company sponsors a profit sharing plan for all non-union employees at two subsidiaries acquired as part of the VFC acquisition. Under this plan, contributions are discretionary and limited to a percentage of eligible employees' compensation. There was no profit sharing expense for this plan for the year ended December 31, 2002, 2001 and 2000. In December 2002 the plan was terminated and distributions were completed to the former participants.
(c) Pension Plans
The Company has a non-contributory defined benefit pension plan covering substantially all the employees of Acme (the "Acme Pension Plan"). The formula covering the employees of Acme provides pension benefits based upon the employee's individual yearly compensation. The Acme Pension Plan assets are managed and invested by a financial institution. Upon acquiring Acme, management had decided to terminate the Acme Pension Plan. At December 31, 2002 and 2001, the Company had recorded against the prepaid pension asset approximately $1.8 million and $2.3 million of anticipated excise tax liabilities and the estimated future employer 401(k) contribution liability related to the participant accounts of former Acme Pension Plan participants who participate in the Key Components, LLC 401(k) plan that will be paid using part of the Acme Pension Plan over funding.
In addition, Gits has a noncontributory defined benefit pension plan (the "Gits Plan") covering its union employees retiring after August 1, 1993. Pension benefits are based on a multiple of a fixed amount per month and years of service, as defined in the union agreement. Benefits of the Gits Plan generally vest over a seven-year period. The assets of the Gits Plan are managed and invested by an insurance company.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
It is the Company's funding policy for the Gits Plan and the Acme Pension Plan to fund at least an amount necessary to satisfy the minimum requirements of the Employee Retirement Income Security Act of 1974. The amount to be funded is subject to annual review by management and its consulting actuary. In recent years, funding contributions have been restricted due to application of Internal Revenue Code full-funding limitations. No funding has been required during the three years ended December 31, 2002.
At December 31, 2002, approximately 0.4% of the plans' assets are invested in cash and cash equivalents, 54.0% are invested in equities and 45.6% is invested in fixed income securities and annuities. At December 31, 2001, approximately 0.3% of the plans' assets are invested in cash and cash equivalents, 62.1% are invested in equities and 37.6% is invested in fixed income securities and annuities.
Summarized information of the Plans, which are reflected from the dates of acquisition (November 2000 for the Acme plans) to December 31, 2002 are shown below (in thousands):
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
In December 2002 and into the first quarter of 2003, the Acme Pension Plan paid out the current benefit obligations of the participants in the Acme Pension Plan that were formerly employed at Acme Electronics division within one year of the time of the sale.
(d) Other retirement liabilities
At December 31, 2002 and 2001, the Company had approximately $940,000 and $1.1 million recorded, respectively, as other long-term liabilities related to obligations under Acme's non-qualified Supplemental Executive Retirement Plan ("SERP") and a non-qualified post-retirement benefits plan for certain former officers of Acme. The SERP provides benefits based upon an executive's compensation in the last year of service and is reduced by benefits received from the salaried pension plan. The nonqualified benefits plan provides post retirement health care. Six participants of this plan are retired and receiving payments under the SERP. Due to certain provisions under the SERP, the Company was required to fund approximately $1.1 million to a trust account on behalf of certain of the SERP's participants. The assets in the trust remain a part of the books and records of the Company and are subject to the Company's creditors.
Key Components, LLC and subsidiaries
Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
11. Related Party Transactions
The Company rents one of its manufacturing facilities under an operating lease agreement entered into with a company that is co-owned by the President of BWE who also is a shareholder of KCI. The terms of the lease, which expires December 31, 2008, provide for annual rent increases of 5%. Rental payments amounted to $167,000, $159,000 and $151,000 for the three years ended December 31, 2002, 2001 and 2000, respectively.
The Company rents its Leominster, Massachusetts manufacturing facility under an operating lease agreement entered into with a company that is co-owned by the former President of ESP who also is a shareholder of KCI. The lease, which expires on May 31, 2003, provides for annual rent increase based on the CPI. Rental payments amounted to $217,000, $213,000 and $208,000 for the three years ended December 31, 2002, 2001 and 2000, respectively.
The Company pays management fees to Millbrook, a party related to certain shareholders of the Company. These management fees amounted to $175,000, $920,000 and $920,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Kelso agreed that amounts paid by Millbrook to Kelso out of management fees received by Millbrook from KCI or KCLLC would offset KCI's obligation to Kelso under the Advisory Agreement between Kelso and KCI.
During 2000, the Company paid Millbrook $400,000 and $825,000 for investment advisory services related to the sale of the inverter business and the acquisition of Acme, respectively. Such costs are either recorded as part of the respective transactions or are included in deferred financing costs.
12. Statement of Cash Flows
13. Subsequent Event
On March 3, 2003, KCLLC and BWE acquired a product line of Arens Controls, LLC for approximately $4.6 million. The product line, which manufactures push pull cable and other components, will be integrated into the Company's Binghamton, NY manufacturing facility. The product line acquired has (unaudited) annual revenues of approximately $7.5 million.
- -------------- (1) Deductions primarily represent write-offs charged against the allowances listed. (2) Represents allowance account balances of companies acquired at the date of acquisitions.
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 6, 2003 By: /s/ Clay B. Lifflander ---------------------- Clay B. Lifflander Chief Executive Officer (Principal Executive Officer)
Dated: March 6, 2003 By: /s/ Robert B. Kay ----------------- Robert B. Kay President (Principal Executive Officer)
Dated: March 6, 2003 By: /s/ Keith A. McGowan -------------------- Keith A. McGowan Chief Financial Officer (Principal Financial Officer and Principal Accounting 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 6, 2003 By: /s/ John S. Dyson ----------------- John S. Dyson Director
Dated: March 6, 2003 By: /s/ Clay B. Lifflander ---------------------- Clay B. Lifflander Director
Dated: March 6, 2003 By: /s/ Alan L. Rivera ------------------ Alan L. Rivera Director
Dated: March 6, 2003 By: /s/ Robert B. Kay ----------------- Robert B. Kay Director
Dated: March 6, 2003 By: /s/ George M. Scherer --------------------- George M. Scherer Director
Dated: March 6, 2003 By: /s/ Philip E. Berney -------------------- Philip E. Berney Director
Dated: March 6, 2003 By: /s/ Thomas R. Wall, IV ---------------------- Thomas R. Wall, IV Director
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 6, 2003 By: /s/ Clay B. Lifflander ---------------------- Clay B. Lifflander Chief Executive Officer (Principal Executive Officer)
Dated: March 6, 2003 By: /s/ Robert B. Kay ----------------- Robert B. Kay President (Principal Executive Officer)
Dated: March 6, 2003 By: /s/ Keith A. McGowan -------------------- Keith A. McGowan Chief Financial Officer (Principal Financial Officer and Principal Accounting 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 6, 2003 By: /s/ John S. Dyson ----------------- John S. Dyson Director
Dated: March 6, 2003 By: /s/ Clay B. Lifflander ---------------------- Clay B. Lifflander Director
Dated: March 6, 2003 By: /s/ Alan L. Rivera ------------------ Alan L. Rivera Director
Dated: March 6, 2003 By: /s/ Robert B. Kay ----------------- Robert B. Kay Director
Dated: March 6, 2003 By: /s/ George M. Scherer --------------------- George M. Scherer Director
Dated: March 6, 2003 By: /s/ Philip E. Berney -------------------- Philip E. Berney Director
Dated: March 6, 20030 By: /s/ Thomas R. Wall, IV ---------------------- Thomas R. Wall, IV Director
Certifications --------------
I, Clay B. Lifflander, certify that:
1. I have reviewed this annual report on Form 10-K of Key Components LLC;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ Clay B. Lifflander - ---------------------- Clay B. Lifflander Chief Executive Officer
I, Robert B. Kay, certify that:
1. I have reviewed this annual report on Form 10-K of Key Components LLC;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ Robert B. Kay - ---------------------- Robert B. Kay President
I, Keith A. McGowan, certify that:
1. I have reviewed this annual report on Form 10-K of Key Components LLC;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ Keith A. McGowan - ---------------------- Keith A. McGowan Chief Financial Officer
I, Clay B. Lifflander, certify that:
1. I have reviewed this annual report on Form 10-K of Key Components Finance Corp.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ Clay B. Lifflander - ---------------------- Clay B. Lifflander Chief Executive Officer
I, Robert B. Kay, certify that:
1. I have reviewed this annual report on Form 10-K of Key Components Finance Corp.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ Robert B. Kay - ---------------------- Robert B. Kay President
I, Keith A. McGowan, certify that:
1. I have reviewed this annual report on Form 10-K of Key Components Finance Corp.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ Keith A. McGowan - ---------------------- Keith A. McGowan Chief Financial Officer