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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from        to

Commission File No. 1-7807

  CHAMPION PARTS, INC.       

(Exact name of Registrant as specified in its charter)

Illinois

36-2088911                         

    (State or other jurisdiction of incorporation or organization)

(IRS Employer Identification Number)

Registrant's telephone number, including area code:                     (870) 777-8821

Securities Registered Pursuant to Section 12(b) of the Act:            None

Securities Registered Pursuant to Section 12(g) of the Act:           Common Shares, $.10 Par Value

                                                         (Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]   No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this

Form 10-K.   [X]

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

Yes  [  ]   No [X]

As of March 31, 2005, 3,655,266 Common Shares were outstanding and the aggregate market value of the Common Shares held by non-affiliates of the Registrant, based on the closing price, was $2,330,374, and was $2,290,195 as of June 30, 2004.  For information as to persons considered to be affiliates for purposes of this calculation, see "Item 5, Market for the Company's Common Shares and Related Shareholder Matters".

Champion Parts, Inc.

Form 10-K

Cross Reference Index

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PART I

Item 1.      Business

Unless context indicates otherwise, the term “Company" as used herein means Champion Parts, Inc. and its subsidiaries.

Products

The Company remanufactures and sells replacement fuel system components (carburetors and diesel fuel injection components) and air conditioning compressors for substantially all makes and models of domestic and foreign automobiles, trucks and marine applications. It also remanufactures and sells replacement constant velocity drive assemblies, electrical and mechanical products for certain passenger car, agricultural, marine and heavy-duty truck original equipment applications. The Company is reporting one operating business segment in the same format as reviewed by the Company's senior management.

During the fiscal years ended December 31, 2004, 2003 and 2002, the Company's net sales of parts for automobiles (including light duty trucks) accounted for 86%, 83% and 87%, respectively, of the Company's total net sales; while sales of parts for heavy duty trucks, farm equipment and marine applications accounted for 14%, 17% and 13%, respectively, of total net sales.

The Company's largest product line is remanufactured carburetors, which accounted for 55% of 2004 net sales compared to 47% in 2003. The Company's main distribution channel is through two large retailers who accounted for 87% of net carburetor sales in 2004 and 95% in 2003.  The balance of the carburetor sales was to original equipment aftermarket customers and traditional warehouse distributors.

Marketing and Distribution

The Company's products are marketed throughout the continental United States and, in a limited way, in Canada and other countries.  The Company sells carburetors to aftermarket retail chains that distribute products through their stores. In addition, the Company sells it’s products for resale through their dealers. The Company also sells carburetors, air conditioning compressors, electrical and mechanical products to automotive and marine warehouse distributors, which in turn sell to jobber stores and through them to service stations, automobile and marine repair shops and individual motorists.

Of the Company's net sales in the year ended December 31, 2004, approximately 49% were to retailers; approximately 28% were to manufacturers of automobiles, trucks and farm equipment and heavy duty fleet specialists; and approximately 23% were to automotive warehouse distributors, marine distributors and other customers.

The Company exhibits its products at trade shows. The Company also publishes catalogs of its products, including a guide with information as to the various vehicle models for which the Company's products may be used and a pictorial product identification guide to assist customers in the return of used units.  The Company's sales representatives and sales agents call on customers and prospective customers to familiarize them with the Company's products, and the applications of its products.

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During the fiscal year ended December 31, 2004, the four largest customers of the Company accounted for approximately 74% of net sales (24%, 24%, 18% and 8%).  In 2003, the same customers of the Company accounted for approximately 77% of net sales (23%, 21%, 17% and 16%), and in 2002, they accounted for approximately 84% of net sales (26%, 23%, 18% and 17%).  No other customers accounted for more than 10% of net sales in any of the three years.

The Company has various methods available to its customers to place orders into the Company's order entry system. The Company also utilizes direct Electronic Data Interchange with its largest customers.

The Company's business is slightly seasonal in nature, primarily as a result of the impact of weather conditions and the agricultural cycle on the demand for certain automotive and agricultural replacement parts.  Historically, the Company's sales and profits are generally the highest in the first and second quarters, and then declining through the summer months.

Materials

In its remanufacturing operations, the Company obtains and utilizes used units, commonly known as "cores". A majority of the units remanufactured by the Company are acquired from customers as trade-ins, generally referred to as "core returns", which are encouraged by the Company in the sale of remanufactured units. The remainder of the core requirements is filled by purchasing cores on the open market.

The price of a finished product is usually comprised of a separately invoiced amount for the core included in the product ("core value") and an amount for remanufacturing.  Upon receipt of a core as a trade-in, credit is given to the customer for the then current core value of the part returned.  The Company limits trade-ins to cores for units included in its sales catalogs and in rebuildable condition, and credit for cores is allowed only against purchases by the customer of similar remanufactured products within a specified time period.  The dollar volume of the core sales further limits a customer's total allowable credit for core trade-ins.  The Company also permits warranty and stock adjustment returns (generally referred to as "product returns") pursuant to established policies.  The Company's product return policies are consistent with industry practice, where by remanufacturers accept product returns from current customers regardless of whether the remanufacturer actually sold the product.  The Company has no obligation to accept product returns from customers that no longer purchase units from the Company.

Patents, Trademarks, Etc.

The Company has no material patents, trademarks, licenses, franchises or concessions.

Backlog

The Company did not have a significant order backlog at December 31, 2004 and 2003.

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Competition

The remanufactured automotive parts industry is highly competitive as the Company competes with a number of other companies, including certain original equipment manufacturers that sell remanufactured automotive parts.  The Company competes with several large regional remanufacturers and with remanufacturers that are franchised by certain original equipment manufacturers to remanufacture their products for regional distribution.  The Company also competes with numerous remanufacturers that serve local areas. In addition, sales of remanufactured parts compete with sales of similar new replacement parts. Manufacturers of kits used by mechanics to rebuild carburetors may also be deemed to be competitors of the Company.

The Company competes in a number of ways, including price, quality, product performance, prompt order fill, service and warranty policy.  The Company believes its technical expertise in the niche product lines it sells has been an important factor in enabling the Company to compete effectively.

Engineering

Product engineers support each of the Company’s main product lines.  Engineers participate in product planning, product line structuring, cataloging and engineering of the Company's products and in developing manufacturing processes.  The primary activities of the product engineers include improving the quality of existing products, formulating specifications and procedures for remanufactured products for use on makes and models of vehicles for which they were originally designed, converting cores for use amongst different makes and models and developing specifications, supplies and procedures for remanufacturing newly introduced products.

The engineers also design and build new tools, machines and testing equipment for use in all the Company's plants and develop specifications for certain components manufactured by the Company for use in its remanufacturing operations.  Additionally, the engineer’s design and test new methods of reassembling components and cleaning parts and cores. The Company believes such activities improve the Company's ability to serve the needs of its customers.

Quality Assurance personnel conduct periodic quality audits of the Company's plants under its quality improvement program to test product quality and compliance with specifications.

Environmental Matters

The Company is subject to various federal, state and local environmental laws and regulations incidental to its business.  The Company continues to modify, on an ongoing basis, processes that may have an environmental impact. Although management believes that the current level of environmental reserves are adequate to satisfy the future compliance with the environmental laws, the ultimate outcome of its environmental matters and potential insurance settlements are undeterminable.  Accordingly, there can be no assurance that these reserves will be adequate. See Item 3, "Legal Proceedings - Environmental Matters" for additional discussion.  

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Employees

As of December 31, 2004, the Company employed 300 people including the corporate headquarters, plant and warehouse facilities.   

The Collective Bargaining Agreement between the Company and the International Brotherhood of Electrical Workers at the Company's Pennsylvania facilities was dissolved on August 31, 2002.  The Union signed a shutdown agreement on March 15, 2002 accepting the Company’s terms for closing the facility in Beech Creek, Pennsylvania (see Item 7). There are no Collective Bargaining Agreements in place at any of the Company’s present facilities.

Item 2.      Properties

The Company's corporate headquarters occupies office space at the Hope Division facility, 2005 West Avenue B, Hope, Arkansas.  This facility houses the Company's corporate office functions, including executive, administration, finance and data processing.  

The following table sets forth certain information with respect to each of the Company's remanufacturing, warehousing and service facilities other than the corporate headquarters:

The Company's facilities currently operating are well maintained and are in good condition and repair.

A substantial portion of the machinery and equipment has been designed by the Company for its particular purposes and, in many instances, has been built by it.

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Item 3.      Legal Proceedings

1.   Beech Creek, Pennsylvania Facility Soil and Groundwater Contamination  

In May 1991, the Pennsylvania Department of Environmental Protection ("PADEP") notified the Company that there was evidence of trichloroethylene and trichloroethane in the soil, and possibly the groundwater under the Beech Creek facility.  Further, PADEP was concerned that the contamination had migrated off site.  PADEP demanded that the Company conduct an investigation to determine the source and extent of the contamination, and perform any required cleanup.

The Company retained a qualified environmental consultant to prepare a site investigation plan.  In June of 1992 PADEP approved the investigation plan.  The plan, which included extensive soil testing and groundwater monitoring, was completed in 1995.

Cleanup commenced in 1995 at the Beech Creek plant.  Cleanup activities consist of the venting of volatile organic gases from soil, and the pumping and treating of groundwater. The maintenance and operation of the system has been approximately $26,000 per year.  In November 1998 the Company submitted a plan to PADEP to monitor groundwater and to stop operation of the remediation system under Pennsylvania's "Act Two."  PADEP approved the plan.  In January 2001, PADEP indicated that a minimum of eight quarterly rounds of sampling would be needed before an Act Two liability release could be considered by PADEP.

In June 2004 the Company entered into a consent order agreement with PADEP and the purchaser of the Beech Creek property, whereby the Company agreed to the remediation of the property under Pennsylvania’s Act 2 Program. A $200,000 escrow account was established at the closing of the sale of the property to cover EPA issues.

The Company also has demanded indemnity from its insurance carriers regarding this matter.  One of its carriers settled with the Company.  The Company plans to vigorously pursue all remaining applicable coverage.

2.   Spectron, Maryland Superfund Proceeding

On September 20, 1995, the USEPA notified the Company (along with several hundred other companies) of potential liability for response actions at the Spectron Superfund Site.  The USEPA letter asks the Company and the other PRPs to negotiate with USEPA for their performance of a remedial investigation/feasibility study at the Spectron Site.

In August 2002, the Company received a de minimis settlement offer from the USEPA for approximately $154,000.  The Company did not accept the settlement offer.

The Company has demanded defense and indemnity from its insurance carriers for any liability at the Spectron Site, and one of the carriers has settled with the Company.  The Company plans to vigorously pursue all remaining applicable coverage, if necessary.  Further, the Company believes that its former solvent supplier and waste solvent transporter are responsible for a share of any liability the Company incurs for the Spectron Site cleanup. The Company plans to vigorously pursue the transporter for this claim.

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3.   Double Eagle Superfund Proceeding

In January 2003, the Company received a "Notice of Liability" letter from the former owner and PRP at the Double Eagle Refinery Superfund Site (DER Site). The former owner is liable for remediation costs under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA). According to DER Site records, the Company sent approximately 46,000 gallons of waste oil to the DER Site from 1985 through 1988 and, as such, also faces potential PRP liability for DER Site remediation costs. The Company has been informed that 4,500 PRPs have been identified at the DER Site accounting for 8.5 million gallons of waste.  Many of these PRPs apparently are small companies which sent relatively small quantities of waste to the DER Site, but approximately 100 PRPs have been identified who sent more than 10,000 gallons each.  The USEPA has threatened the former own er and several other PRPs with whom USEPA has a tolling agreement with a $21-22 million cost recovery action concerning the USEPA's remediation of soil and groundwater contamination of the DER Site.  (The USEPA is barred from pursuing the Company, and many other PRPs, by the applicable statute of limitations.) In response to the threatened cost recovery action, the former owner sent Notice of Liability letters to approximately 100 PRPs and hosted a February 25, 2003 meeting asking the PRPs to form a PRP Group to negotiate with the USEPA and allocate liability.  The stated intent, in the absence of the formation of such a group, is to pursue, when appropriate, a private party contribution action against the PRPs.  To date, no PRP Group has been formed and private party contribution action has not been initiated.  The Company's liability at the DER Site, if any, will likely be based on an as yet undetermined volume allocation.

The Company has put its insurance carriers on notice of this potential claim. The primary carrier has denied coverage but the Company plans to vigorously pursue the carrier for coverage.

4.  Asbestos Litigation

In 2004 and certain prior years, the Company was one of numerous defendants named in suits for personal injuries caused by exposure to products containing asbestos. The Company put its insurance carriers on notice and its attorneys have filed answers denying the allegations in the complaints. The Company’s insurance carriers have agreed to defend the Company under a reservation of rights.

While it is not possible to predict the course these cases may take in the future, only three cases remain open, less than ten percent of the cases that were filed.

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Summary

From time to time, the Company may be named in lawsuits during the normal course of its business. Management intends to vigorously defend any lawsuits that may arise.  In the opinion of Management, the environmental legal matters now pending will not have a material adverse effect on the consolidated financial position of the Company.

The Company has available established reserves of $100,000, as of December 31, 2004, for potential environmental and other legal liabilities that it believes to be adequate.   However, there can be no assurance that the reserves will be adequate to cover actual costs incurred or that the Company will not incur additional environmental or other legal liabilities in the future.

Item 4.      Submission of Matters to a Vote of Shareholders  

None

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PART II

Item 5.      Market for the Registrant's Common Stock and Related Shareholder Matters

The Company's Common Shares are traded over the counter on the NASD Electronic Bulletin Board under the symbol "CREB.OB".  As of December 31, 2004, there were 631 holders of record of the Company's Common Shares.  This number does not include beneficial owners of Common Shares whose shares are held in the name of banks, brokers, nominees or other fiduciaries.

The information appearing in the following table on the range of high and low trade prices for the Company's Common Shares was obtained from NASDAQ quotations provided in the OTC Market Report published by the National Quotation Bureau. Such high and low bids reflect interdealer prices, without retail mark-up, markdown or commission and may not necessarily represent actual transactions.

Under the Company's credit agreement, the Company is not permitted to pay dividends.

Only for purposes of the calculation of aggregate market value of the Common Shares held by non-affiliates of the Company as set forth on the cover page of this report, the Common Shares held by RGP Holding, Inc., the Company's Employee Stock Ownership, and shares held by two of the Company's directors were included in the shares held by affiliates. Certain of such individuals and entities may not be affiliates.

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Item 6.      Selected Financial Data

Selected Financial Data - Notes

Note 1:   At the end of May 2004, the Company closed its warehouse distribution location in suburban Toronto, Ontario, Canada. A continual decline in sales revenues and profitability over the past several years did not warrant keeping the operation open.

Note 2:

In 2002, the Company incurred expenses totaling $582,000 for inventory and equipment relocation, severance and other restructuring costs, which could not be accrued in 2001, as they did not qualify as “exit costs”.  All restructuring expenditures were completed in 2002.

Included in the 2001 operating costs is a one time charge of $154,000 to establish a restructuring reserve for the expenses associated with the shut-down of the Beech Creek, Pennsylvania, facility.  It was determined in the second quarter of 2002 that the estimated restructuring charge was higher than needed, and consequently, a reversal of $127,000 was recorded in May 2002.

Note 3:

Included in the 2000 disposal of assets is a $26,000 gain from the sale of tooling.  

Note 4:

The Company realized a gain of $753,000 in 2000 resulting from the sale of the Company's 50% interest in an automotive engine remanufacturer that had been accounted for using the equity method.  The gain reflects net proceeds realized after legal expenses, other fees, and reversals of foreign translation adjustments and the reserves for guarantee of bank loans.

Note 5:

For this schedule, the current maturities of long-term debt are included in long-term debt obligations in order to reflect comparable numbers with all periods presented.

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Item 7.      Management's Discussion and Analysis of Financial

                 Condition and Results of Operations

Management Overview

Net sales for 2004 of $19,998,000 were 16.8% less than 2003 reflecting the continuing market decline of carburetor net sales combined with a soft market for air conditioning products and a large air conditioning customer losing one it’s primary customers. Costs of products sold in 2004 were also lower versus last year by $3,225,000, or 16.3%, slightly less than proportional with the net sales decline. Operating expenses were $341,000, or 12.6%, below the 2003 level reflecting lower administrative costs due the reduction of operating costs for the idle Pennsylvania facility that was sold on June 28th. Operating income was $1,052,000, a $474,000 decline versus $1,526,000 from 2003 primarily as a result of the decline in net sales. Interest cost for the year was up $138,000 over 2003, reflecting a two-percentage point interest increase that resulted from extending the expired loan facility until refinancing w as completed on August 10th, and slightly higher revolver loan balances towards the end of the year.  At the end of the first quarter of 2004, the Company met job expansion incentives under the City of Hope, Arkansas note agreement and the $250,000 note was forgiven. The Company also received during the year $151,000 in rebates from the State of Arkansas for meeting job expansion incentives under the State’s create rebate program. These two items primarily accounted for the $315,000 increase in non-operating income over the prior year. The Company’s net income for 2004 was $715,000, a decrease of $415,000, or 36.7%, versus the $1,130,000 reported in 2003.  The decline in net income principally reflects the significantly lower net sales combined with higher interest costs.  Partially mitigating this was the gain in non-operating income and lower administrative expenses.

At the end of May 2004, the Company closed its warehouse distribution location in suburban Toronto, Ontario, Canada. A continual decline in sales revenues and profitability over the past several years did not warrant keeping the operation open.

The Company entered into a three-year secured revolving credit facility on August 10, 2004, with PNC Bank, National Association, replacing the Congress Financial Corporation credit facility.  Maximum credit available under the new PNC facility is $14,000,000, including available letter of credit accommodations of $1,000,000.  The interest rate on the revolving debt facility was lender prime plus 1/4 % or LIBOR plus 2%, and for letters of credit, the rate is 3.25% per annum on the daily outstanding balance. On March 18, 2005, the Company entered into an amendment to the Credit, Loan and Security Agreement. Amendment No. 1 set forth the terms for temporary modification of the revolving interest rate to 1.25% above bank prime through April 12, 2005; the terms for temporary over-formula advances resulting from a change in the Lender’s interpretation of the formula for calculating Eligible Receivables ; definition of collateral monitoring fees; and redefinition of the fixed charge coverage ratio covenant from a quarterly basis to a rolling twelve month basis.

On August 10, 2004, the Company also entered into a commercial property loan on its Hope, Arkansas property with Elk Horn Bank and Trust Company acting as lead bank for a group of five lending institutions. The loan with Elk Horn is for $900,000, with seven-year amortization and an interest rate of New York prime plus 2% adjusted quarterly.

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The Company finances its working capital needs through the use of its bank credit facility and the cash flow generated from operations. At December 31, 2004, the total balance outstanding on the Company’s revolving loan facility with PNC Bank, National Association was $10,195,000 and letter of credit accommodations were $40,000.  Also at December 31, 2004, the balance outstanding on the Company's commercial mortgage loan with Elk Horn Bank was $866,000. The total of the loan balances was $11,061,000, which compares to a total loan balance at December 31, 2003 with Congress Financial Corporation of $9,988,000 and letter of credit accommodations of $50,000.

Results of Operations

2004 Compared to 2003

Net sales for the year ending December 31, 2004 were $19,998,000 versus net sales of $24,038,000 in 2003.  The $4,040,000, or 16.8%, decrease in net sales reflects the continued market decline of carburetor net sales combined with lower seasonal demand for air conditioning products and a large air conditioning customer losing one it’s primary customers.  Partially offsetting these declines were slightly higher sales in the traditional markets of heavy duty and agricultural product lines. Total product and core returns, which are accounted for as reductions to gross sales, were 23.7% and 20.3% of gross sales for the years 2004 and 2003, respectively. The higher percentage for the year of 2004 reflects the impact of product return credits issued declining less than the drop in gross sales.

Carburetor net sales were 54.6% and 46.5% of total net sales, respectively, for the year of 2004 and 2003. Even though new vehicles sold are no longer equipped with carburetors in the United States and Canada, the Company continues to sell replacement units for older vehicles that predominantly use carburetors.  Although carburetor net sales represented a larger share of the total net sales for the year, carburetor net sales declined slightly in 2004 compared to 2003. The Company expects that the trend in carburetor sales will continue to be a steady decline in future periods. In addition, carburetor margins may be negatively impacted in the future as customers accelerate product returns during periods of declining demand.

Cost of products sold were $16,588,000, or 82.9%, of net sales for 2004 as compared to $19,813,000, or 82.4%, for 2003.  The $3,225,000, or 16.3% decrease versus 2003 is primarily accounted for by the net sales decrease.

Selling, distribution and administrative expenses for 2004 were $2,358,000 compared to $2,699,000 in 2003. Administrative spending was significantly lower than 2003 reflecting the reduction of operating costs for the Pennsylvania facility (taxes and insurance) that was sold on June 28th combined with lower professional fees and payroll processing costs.

Operating income for the year was $1,052,000 compared to $1,526,000 in 2003, a $474,000, or 31.1% decline.  The operating income decline can be attributed to the significantly lower net sales.

Interest expense of $606,000 for the year was up $138,000 over 2003, reflecting a two-percentage point interest rate increase that resulted from extending the expired loan facility to until refinancing was completed on August 10^th, and higher revolver balances during the last quarter of the year.

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Non-operating income was $424,000 compared to $109,000 recorded in 2003. At the end of the first quarter of 2004, the Company met job expansion incentives under the City of Hope, Arkansas note agreement and the $250,000 note was forgiven. The Company also received during the year $151,000 in rebates from the State of Arkansas for meeting job expansion incentives under the State’s create rebate program. These two items more than accounted for the $315,000 increase in non-operating income over the prior year.

Net income was $715,000 versus $1,130,000 in 2003, a decrease of $415,000, or 36.7%.  As discussed earlier, significantly lower net sales accounted for the drop in net income versus 2003. Partially mitigating this was the increase in non-operating income reflecting the loan City of Hope note write-off and State of Arkansas rebates and lower administrative expenses.

2003 Compared to 2002

Net sales for the year ending December 31, 2003 were $24,038,000 versus net sales of $24,790,000 for the fiscal year 2002.  The $752,000, or 3.0%, decrease in net sales compared to 2002 reflected the continuing decline of carburetor net sales combined with lower demand in traditional markets of heavy duty, agricultural and domestic automotive product lines. These declines in net sales were partially offset by the significant gains in net sales recorded for the air conditioning compressor and CV axle product lines. Total product and core returns, which are accounted for as reductions to gross rebuilding sales, were 20.3% and 19.2% of gross sales for the years of 2003 and 2002, respectively. The higher percentage of returns for the year of 2003 reflects the impact of increased carburetor returns.

Carburetor net sales were 46.5% and 51.2% of total net sales, respectively, for the years of 2003 and 2002.

Cost of products sold were $19,813,000, or 82.4%, of net sales for 2003 as compared to $20,804,000, or 83.9%, for the year of 2002.  The $991,000, or 4.8% decrease versus 2002 is partially attributed to the net sales decrease, which amounts to $589,000. The remaining cost reduction of $402,000 reflects manufacturing improvements in materials, labor and overhead costs at the Hope facility. Higher manufacturing costs at the B & T facility, reflecting increased sales and production activity of air conditioning products, offset a portion of the cost decreases at the Hope operation.

Selling, distribution and administrative expenses for the year 2003 were $2,699,000 compared to $2,680,000 in 2002. The slight spending increase of $19,000 reflects the residual operating costs of the idle Pennsylvania facility (taxes, insurance and utilities) being recorded in administrative overhead in 2003.  S, G & A spending without these costs was down 4.6% reflecting the overhead savings being realized as a result of the plant consolidation.

Net relocation expense -There was no relocation expense recorded in 2003.  For the year ending December 31, 2002, net relocation and restructuring costs amounted to $455,000.

Operating income for the year was $1,526,000, a substantial gain of $675,000, compared to $851,000 for fiscal 2002. Plant relocation spending of $455,000 in 2002 accounts for part of the difference.  The balance of the improvement over 2002 can be attributed to the lower cost of products sold and reduced operating costs discussed in the preceding analysis.

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Non-operating expense was $359,000 for the year versus $479,000 recorded in 2002. Primarily accounting for the $120,000 decrease in non-operating expense were lower interest costs, down $61,000 from 2002, reflecting lower bank prime interest rates combined with lower term loan balances versus 2002.  The remainder of the decrease in non-operating expense reflects a small net gain realized from adjustments in long-term liabilities versus prepaid expense write-offs from prior periods.

Net income was $1,130,000 for the year versus net income of $367,000 for fiscal 2002, an increase of $763,000.  Net relocation costs of $455,000 in 2002, combined with the significant improvement in operating profit in 2003, as discussed earlier, accounted for the improvement.

Liquidity and Capital Resources

Liquidity Overview

On February 6, 2004, the Company entered into an amendment to the Loan and Security Agreement with Congress Financial Corporation extending the maturity date of its revolving line of credit and its term loan from February 8, 2004 to May 8, 2004. A Second Amendment was entered into on May 7, 2004 extending the expiration date to June 8, 2004 and a third amendment was entered into on June 6, 2004 extending the expiration date to August 8, 2004.  Under the terms of the amendments, the availability to borrow on the line of credit decreased from $14,000,000 to $10,500,000. The revolving loan interest and term loan interest rates increased to 2.75% and 3.00% in excess of the lender prime rate, respectively.

On June 28, 2004, the Company consummated the sale of its Beech Creek facility and property. The plant was vacated after consolidating operations in March of 2002.  The gross value of the transaction was $1.5 million and the net proceeds were used to pay-down term and revolver debt in the month of July 2004. A $200,000 escrow account was established at the closing of the sale of the property to cover future EPA issues.  Sale of the Beech Creek property allowed the Company to proceed with replacing the Congress loan facility with new lenders.

On August 10, 2004, the Company entered into a three-year credit facility with PNC Bank, National Association, replacing the Congress Financial Corporation credit facility.  Maximum credit available under the new PNC facility is $14,000,000, including available letter of credit accommodations of $1,000,000.  The interest rate on the revolving debt facility was lender prime plus 1/4 % or LIBOR plus 2%, and for letters of credit, the rate is 3.25% per annum on the daily outstanding balance. On March 18, 2005, the Company entered into an amendment to the Credit, Loan and Security Agreement. Amendment No. 1 that set forth the terms for temporary modification of the revolving interest rate to 1.25% above bank prime through April 12, 2005; the terms for temporary over-formula advances resulting from a change in the Lender’s interpretation of the formula for calculating Eligible Receivables; definition of collateral monitoring fees; and redefinition of the fixed charge coverage ratio covenant from a quarterly basis to a rolling twelve month basis.

Also on August 10, 2004, the Company entered into a commercial property loan on the Hope, Arkansas property with Elk Horn Bank and Trust Company acting as lead bank for a group of five lending institutions. The loan with Elk Horn is for $900,000, with seven-year amortization and an interest rate of New York prime plus 2% adjusted quarterly.

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Management believes that the Company will be able to finance its working capital needs in the current year and the foreseeable future through the use of borrowings and cash flows generated from operations.

Working Capital

Net working capital at December 31, 2004 was a positive $10,994,000 compared to negative $1,846,000 at December 31, 2003. The current ratio at December 31, 2004 was 1.82 versus 0.92 at December 31, 2003.The significant improvement in working capital primarily reflects the classification of term and revolver debt for the new loan facilities as long-term debt.  

Net trade accounts receivable at December 31, 2004 were $10,410,000, an increase of $454,000 versus the year-end 2003 balance of $9,956,000.  The increase in the Company's accounts receivable balance at year-end generally reflects the strong November and December sales to large retailers in 2004 versus 2003.

Net inventories of $12,710,000 at December 31, 2004 were $1,846,000 higher compared to the year-end 2003 balance of $10,864,000.  The increase in inventory reflects higher finished goods and parts inventories partially offset by lower raw and core work-in-process balances. The finished goods inventory increase is a result of a build-up of air conditioning products inventories to service normally anticipated seasonal sales that did not materialize due to a soft market. This finished goods inventory is expected to be utilized to satisfy 2005 orders.

Accounts payable at December 31, 2004 were $8,001,000 compared to a balance at year-end 2003 of $7,681,000. The $320,000 increase in accounts payable is primarily due to the higher net trade accounts payable which are up reflecting higher purchases of raw materials to support the increased production levels at the Hope facility in December 2004 and January 2005.

Accrued expenses of $4,833,000 were $30,000 greater than the fiscal year-end 2003 balance of $4,803,000, principally reflecting customer return credit accruals.  

Debt

On February 6, 2004, the Company entered into an amendment to the Loan and Security Agreement with Congress Financial Corporation extending the maturity date of its revolving line of credit and its term loan from February 8, 2004 to May 8, 2004. A Second Amendment was entered into on May 7, 2004 extending the expiration date to June 8, 2004 and a third amendment was entered into on June 6, 2004 extending the expiration date to August 8, 2004.  Under the terms of the amendments, the availability to borrow on the line of credit decreased from $14,000,000 to $10,500,000. The revolving loan interest and term loan interest rates increased to 2.75% and 3.00% in excess of the lender prime rate, respectively.

At March 28, 2004, the Company met job expansion incentives and the $250,000 City of Hope, Arkansas note was forgiven. The forgiveness of the debt was taken into non-operating income in March.

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Debt (Continued)

On June 28, 2004, the Company consummated the sale of its Beech Creek facility and property. The plant was vacated after consolidating operations in March of 2002.  The gross value of the transaction was $1.5 million and the net proceeds were used to reduce the property term loan and revolver debt in July.  A $200,000 escrow account was established at the closing of the sale of the property to cover future EPA issues. Sale of the Beech Creek property allowed the Company to proceed with replacing the Congress loan facility with new lenders.

On August 10, 2004, the Company entered into a three-year secure revolving credit facility with PNC Bank, National Association, replacing the Congress Financial Corporation credit facility.  Maximum credit available under the new PNC facility is $14,000,000, including available letter of credit accommodations of $1,000,000.  The interest rate on the revolving debt facility was lender prime plus 1/4 % or LIBOR plus 2%, and for letters of credit, the rate is 3.25% per annum on the daily outstanding balance.

Also on August 10, 2004, the Company entered into a commercial property loan on its Hope, Arkansas properties with Elk Horn Bank and Trust Company acting as lead bank for a group of five lending institutions.  The loan with Elk Horn is for $900,000, with seven-year amortization and an interest rate of New York prime plus 2% adjusted quarterly.

On March 18, 2005, the Company entered into an amendment to the Credit, Loan and Security Agreement dated August 10, 2004 with PNC Bank, National Association. The Amendment No. 1 set forth the terms for temporary modification of the revolving interest rate to 1.25% above bank prime, the terms for temporary over-formula advances resulting from a change in the Lender’s interpretation of the formula for calculating Eligible Receivables, definition of collateral monitoring fees and redefinition of the fixed charge coverage ratio covenant from a quarterly basis to a rolling twelve month basis.

At December 31, 2004, the balance outstanding on the Company’s revolver loan facility with PNC Bank, National Association was $10,195,000 and letter of credit accommodations were $40,000. Also at December 31, 2004, the balance outstanding on the Company’s commercial mortgage loan with Elk Horn Bank was $866,000. The total of the loan balances was $11,061,000, which compares to a total loan balance at December 31, 2003 with Congress Financial Corporation of $9,988,000 and letter of credit accommodations of $50,000. At December 31, 2004, the Company was in compliance with the amended fixed charge coverage ratio covenant.

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Future Outlook

The additional revenue from the sales of air conditioning products has partially mitigated the declining carburetor product line sales during the past three years. Management is pursuing other new products and new markets for existing products. This includes internal new product development as well as acquisition opportunities.

The Company's cash flow generated from operations together with borrowings, are expected to provide sufficient working capital to meet its needs over the next fiscal year and beyond.

Factors Which May Affect Future Results

This annual report contains forward-looking statements that are subject to risks and uncertainties, including but not limited to the statements under "Future Outlook" and to the following:

The competitive environment has caused and is continuing to cause changes in the distribution channels between volume retailers and traditional warehouse/distributors.  The Company has diversified its customer base and currently serves all major aftermarket segments, including large volume automotive retailers, original equipment manufacturers of automotive equipment and automotive warehouse distributors. The decline in carburetor product sales over the longer term could impact future results.  The Company expects the growth in air conditioning product sales to partially offset this impact. There is no assurance that the sales increases in air conditioning products will exceed the decreases in carburetor sales or the contribution of carburetor sales to net income.

The Company’s six largest customers accounted for a total of 84% of the Company’s net sales in the year ending December 31, 2004, with the four largest customers aggregating 74% of the total. For the same period in 2003, the Company’s six largest customers accounted for a total of 88% of the Company’s net sales, with the four largest customers comprising 77% of the total. A significant reduction in the level of net sales or the loss of a large customer could have a materially adverse impact on the Company’s financial condition and results of operations.

While the Company has established reserves for potential environmental liabilities that it believes to be adequate, there can be no assurance that the reserves will be adequate to cover actual costs incurred or that the Company will not incur additional environmental liabilities in the future. See “Legal Proceedings” for additional information.

Accordingly, actual results may differ materially from those set forth in forward-looking statements.

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Contractual Obligations

The following table provides a summary of our contractual obligations at December 31, 2004.

Notes to Contractual Obligations:

 (1)  The nature of our long-term debt obligations is described more fully in “Note 3 of the Consolidated Financial Statements.”

 (2)   The operating lease obligations are attributable to the leasing of facilities and equipment.

 (3)   The pension plan funding was determined by the Company's actuary using the expected return on plan assets, the relative weighting of the plan assets, and the historical performance of the plan assets and other economic indicators of future performance.  The Company has been advised by its Actuary that the future obligation may decline based on pending legislation. Based on this uncertainty, future period obligations have not been estimated