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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly period ended September 30, 2003
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 333-58675
KEY COMPONENTS, LLC
(Exact name of Registrant as Specified in its charter)
Delaware 04-3425424
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
200 White Plains Road, Tarrytown NY 10591
----------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
(914) 332-8088
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(Registrant's Telephone Number, Including Area Code)
Commission File Number 333-58675-01
KEY COMPONENTS FINANCE CORP. *
------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 14-1805946
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
200 White Plains Road, Tarrytown NY 10591
----------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
(914) 332-8088
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(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
/x/ Yes / / No
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
/ / Yes /x/ No
As of November 7, 2003, all of the membership interests in Key
Components, LLC were owned by Key Components, Inc., a privately held New York
corporation. All of the shares of common stock of Key Components Finance Corp.
were owned by Key Components, LLC.
*Key Components Finance Corp. meets the conditions set forth in General
Instruction H (1) (a) and (b) of Form 10-Q and is therefore filing this Form
with reduced disclosure format.
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KEY COMPONENTS, LLC
Form 10-Q Index
September 30, 2003
Page
Number
------
PART I
Item 1.-- Consolidated Financial Statements (unaudited):
Balance Sheets.................................................. 2
Statements of Operations........................................ 3
Statements of Member's Equity................................... 4
Statements of Cash Flows........................................ 5
Notes to Consolidated Financial Statements...................... 6
Item 2. -- Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 11
Item 3.-- Quantitative and Qualitative Disclosures about Market Risk...... 22
Item 4.-- Controls and Procedures......................................... 23
PART II
Item 6.-- Exhibits and Reports on Form 8-K................................ 23
Signatures ................................................................ 24
PART I -- FINANCIAL INFORMATION
Item 1 -- Consolidated Financial Statements
KEY COMPONENTS, LLC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
- ---------------------------------------------------------------------------------------------------
September 30, December 31,
2003 2002
- --------------------------------------------------------------------------------------------------
Assets: (Unaudited)
Current
Cash $5,046 $ 2,879
Accounts receivable, net of allowance for doubtful
accounts of $1,648 and $1,459 in 2003 and 2002,
respectively 25,405 21,447
Inventories 30,012 29,623
Prepaid expenses and other current assets 3,059 2,800
Prepaid income taxes - 3,400
Deferred income taxes 5,364 5,295
- --------------------------------------------------------------------------------------------------
Total current assets 68,886 65,444
Property, plant and equipment, net 24,292 23,883
Goodwill, net 97,539 95,554
Deferred financing costs, net 3,645 4,364
Prepaid pension cost 2,707 3,021
Other assets 717 448
- --------------------------------------------------------------------------------------------------
Total assets $197,786 $192,714
- --------------------------------------------------------------------------------------------------
Liabilities and Member's Equity:
Current
Current portion of long-term debt $ 11,646 $ 7,225
Accounts payable 10,388 9,940
Accrued compensation 4,762 4,098
Accrued expenses 8,642 7,087
Accrued interest 3,297 713
- --------------------------------------------------------------------------------------------------
Total current liabilities 38,735 29,063
Long-term debt 124,990 136,619
Accrued lease costs 421 469
Deferred income taxes 540 579
Other long-term liabilities 816 940
- --------------------------------------------------------------------------------------------------
Total liabilities 165,502 167,670
Commitments and contingencies
Member's equity 32,284 25,044
- --------------------------------------------------------------------------------------------------
Total liabilities and member's equity $197,786 $192,714
- --------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
2
KEY COMPONENTS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands)
Nine Months Ended Three Months Ended
September 30, September 30,
------------------------- ---------------------
2003 2002 2003 2002
----------------------------------------------------------------------------------------------------------------
Net sales $147,396 $144,378 $49,312 $47,981
Cost of goods sold 93,827 90,275 31,800 29,534
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Gross profit 53,569 54,103 17,512 18,447
Selling, general and administrative expenses 30,562 28,833 10,481 9,672
Other 1,009 803 565 453
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Income from operations 21,998 24,467 6,466 8,322
Interest expense (9,349) (10,083) (3,071) (3,311)
----------------------------------------------------------------------------------------------------------------
Income before provision for income taxes and
cumulative effect of change in accounting
principle 12,649 14,384 3,395 5,011
Provision for income taxes 5,309 6,341 1,333 2,060
----------------------------------------------------------------------------------------------------------------
Income before cumulative effect in change in
accounting principle 7,340 8,043 2,062 2,951
Cumulative effect in change of accounting
principle, net of taxes of $3,007 - (8,157) - -
----------------------------------------------------------------------------------------------------------------
Net income (loss) $ 7,340 $ (114) $2,062 $2,951
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The accompanying notes are an integral part of these financial statements.
3
KEY COMPONENTS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF MEMBER'S EQUITY
(In thousands)
For the Nine Months For the Year
Ended September 30, Ended December 31,
2003 2002
- --------------------------------------------------------------------------------------------
(Unaudited)
Member's Equity, beginning of period $25,044 $31,675
Net income (loss) 7,340 (6,631)
Member withdrawals (100) -
- --------------------------------------------------------------------------------------------
Member's Equity, end of period $32,284 $25,044
- --------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
4
KEY COMPONENTS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
For the Nine Months Ended September 30, 2003 2002
- --------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $ 7,340 $ (114)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Cumulative effect of change in accounting principle - 8,157
Depreciation and amortization 3,530 3,754
Amortization of deferred finance costs 719 665
Writedown of deferred finance costs - 145
Provision for bad debts 203 306
Deferred taxes (2) 60
Changes in operating assets and liabilities:
Accounts receivable (3,247) 516
Inventories 368 813
Prepaid expenses and other assets 3,527 2,324
Accounts payable 183 (728)
Accrued expenses 3,991 1,095
- --------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 16,612 16,993
- --------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Business acquisition (4,548) -
Capital expenditures (2,589) (2,100)
Proceeds from assets held for sale - 364
- --------------------------------------------------------------------------------------------------------
Net cash used in investing activities (7,137) (1,736)
- --------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Payments of long-term debt and capital lease obligations (9,208) (15,331)
Proceeds from debt issued 2,000 -
Member withdrawals (100) -
- --------------------------------------------------------------------------------------------------------
Net cash used in financing activities (7,308) (15,331)
- --------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 2,167 (74)
Cash and cash equivalents, beginning of period 2,879 5,080
- --------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 5,046 $ 5,006
- --------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
5
KEY COMPONENTS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The consolidated financial statements include the financial statements of Key
Components, LLC ("KCLLC"), and its subsidiaries, all of which are wholly owned
(collectively, the "Company"). All significant intercompany transactions have
been eliminated.
The Company is in the business of the manufacture and sale of custom engineered
essential componentry in a diverse array of end use markets. Through its two
business segments, mechanical engineered components and electrical components,
the Company targets its products to original equipment manufacturers. The
Company's electrical components business product offerings include power
conversion products, specialty electrical components and high-voltage utility
switches. The Company's mechanical engineered components business product
offerings consist primarily of flexible shaft and remote valve control
components, turbocharger components and medium security lock products and
accessories.
KCLLC's assets are limited to the Company's corporate office and its investments
in its subsidiaries. KCLLC's financial statements include the related expenses
of operating the Company's corporate office. KCLLC is wholly-owned by Key
Components, Inc. ("KCI"), a New York corporation. KCI holds no other assets
other than its investments in KCLLC and has no operations.
The accompanying unaudited financial statements of the Company contain all
adjustments that are, in the opinion of management, necessary for a fair
statement of results for the interim periods presented. While certain
information and footnote disclosures normally included in the financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted, the Company
believes that the disclosures herein are adequate to make the information not
misleading. The results of operations for the interim periods are not
necessarily indicative of the results for full years. These financial statements
should be read in conjunction with the consolidated financial statements and
notes thereto for the year ended December 31, 2002 included in the Company's
Annual Report on Form 10-K.
Certain reclassifications were made to conform the prior periods to the current
presentation.
2. Acquisitions and Dispositions
Arens Controls, LLC
On March 3, 2003, the Company acquired the mechanical components business of
Arens Controls, LLC for a purchase price of approximately $4.5 million and
assumed liabilities of approximately $642,000. The Company recorded the
estimated excess purchase price over net assets acquired of approximately $2.0
million as goodwill. Other intangibles acquired in the transaction were not
significant. The product line, which manufactures mechanical push-pull control
solutions, will be fully integrated into the Company's Binghamton, New York
manufacturing facility by the end of November, 2003. The Company borrowed $2.0
million on its revolving credit facility to partially finance this acquisition.
The product line acquired has historical annual revenues of approximately $7.5
million (unaudited).
Acme Electric Corporation
On November 21, 2000, the Company acquired all of the outstanding shares of Acme
Electric Corporation ("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 decided to sell the electronics division of
Acme ("Electronics"). Electronics is a contract electronics manufacturer for
data storage, telecommunications and medical electronic applications.
On February 15, 2002 the Company sold the Electronics division for $100,000 in
cash and a 7% per annum, $300,000 note that was due on February 15, 2006. The
agreement also provided for additional consideration to be paid to the Company
if certain future operating targets were achieved. In March 2003, Electronics
was sold to a new buyer and the Company collected the entire $300,000 note. The
Company does not anticipate receiving any additional consideration.
6
3. Inventories
Inventories consist of the following:
(In thousands) September 30, December 31,
2003 2002
- ----------------------------------------------------------------------------
(unaudited)
Raw materials $16,555 $14,342
Work-in-process 7,749 7,734
Finished goods 5,708 7,547
- ----------------------------------------------------------------------------
Total inventory $30,012 $29,623
- ----------------------------------------------------------------------------
4. Provision for Income Taxes
For the nine months and three months ended September 30, 2003 and 2002, the
Company's provision for income taxes primarily relates to the federal and state
income taxes of its sole member, KCI. Deferred income taxes have been recorded
to reflect the tax consequences on future years of temporary differences between
the tax bases of assets and liabilities and their financial reporting amounts at
year-end. Valuation allowances are recorded when necessary to reduce deferred
tax assets to expected realizable amounts.
5. Member Withdrawals
During the nine months ended September 30, 2003, KCLLC distributed approximately
$100,000 to its member, KCI, which used the funds to repurchase common stock
from a KCI shareholder.
6. Warranty Costs
The Company records a liability for its expected claims under existing product
warranty policies. The accrual is based on the Company's historical warranty
experience. For the nine months ended September 30, 2003 and 2002, the Company's
warranty accrual changed as follows:
Nine Months ended September 30, 2003 2002
- -----------------------------------------------------------------------
(In thousands-unaudited)
Balance, beginning of period $ 985 $821
Additions 123 94
Charges - -
- -----------------------------------------------------------------------
Balance, end of period $1,108 $915
- -----------------------------------------------------------------------
7
7. Operating Segments
The Company conducts its operations through its two businesses, the manufacture
and sale of electrical components and mechanical engineered components. The
electrical components business ("EC") product offerings include power conversion
products, specialty electrical components and high-voltage utility switches. The
mechanical engineered components business ("MEC") manufactures flexible shaft
products, turbo charger actuators and related componentry and specialty locks
and related accessories.
The Company evaluates its operating segments' performance and allocates
resources among them 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. Corporate overhead expenses are not allocated to the
segments. In computation of all the financial maintenance covenants under the
Company's credit facility, the Company is allowed to adjust EBITDA for certain
charges as defined in the agreement. Segment information is as follows:
- ---------------------------------------------------------------------------------------------
(In thousands) Mechanical
Electrical Engineered
Components Components Total
- ---------------------------------------------------------------------------------------------
Nine months ended September 30, 2003:
Net sales to external customers $ 88,507 $ 58,889 $ 147,396
Intersegment net sales - 53 53
Segment profit - EBITDA 16,695 11,559 28,254
Segment assets 105,865 84,508 190,373
Goodwill 59,192 38,347 97,539
Depreciation and amortization 1,872 1,635 3,507
- ---------------------------------------------------------------------------------------------
Nine months ended September 30, 2002:
Net sales to external customers $ 93,953 $ 50,425 $ 144,378
Intersegment net sales - 105 105
Segment profit - EBITDA 17,312 13,455 30,767
Segment assets 112,145 87,695 199,840
Goodwill 59,192 48,711 107,903
Depreciation and amortization 1,924 1,811 3,735
- ---------------------------------------------------------------------------------------------
Three months ended September 30, 2003:
Net sales to external customers $ 29,874 $ 19,438 $ 49,312
Intersegment net sales - 19 19
Segment profit - EBITDA 5,674 3,108 8,782
Segment assets 105,865 84,508 190,373
Goodwill 59,192 38,347 97,539
Depreciation and amortization 622 526 1,148
- ---------------------------------------------------------------------------------------------
Three months ended September 30, 2002:
Net sales to external customers $ 30,987 $ 16,994 $ 47,981
Intersegment net sales - 30 30
Segment profit - EBITDA 6,079 4,253 10,332
Segment assets 112,145 87,695 199,840
Goodwill 59,192 48,711 107,903
Depreciation and amortization 634 597 1,231
- ---------------------------------------------------------------------------------------------
8
Reconciliation of Selected Segment Information to the Company's Consolidated
Totals:
(In thousands) Nine Months Ended Three Months Ended
September 30, September 30,
- ----------------------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Profit or loss:
Total profit from reportable segments- EBITDA $28,254 $30,767 $8,782 $10,332
Reconciling items:
Corporate expenses (2,719) (2,543) (1,157) (774)
Depreciation and amortization (3,537) (3,757) (1,159) (1,236)
Interest expense (9,349) (10,083) (3,071) (3,311)
- ----------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes and cumulative
effect of change in accounting principle $12,649 $14,384 $3,395 $5,011
- ----------------------------------------------------------------------------------------------------------------------
(In thousands) September 30, December 31,
2003 2002
- -----------------------------------------------------------------------------------------
Assets:
Total assets for reportable segments $190,373 $199,840
Corporate assets 7,413 7,754
- -----------------------------------------------------------------------------------------
Total consolidated assets $197,786 $207,594
- -----------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
(In thousands) Nine Months Ended Three Months Ended
September 30, September 30,
- -------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------
Geographical Sales Information:
United States $128,978 $126,476 42,705 $41,665
England 4,491 3,331 1,676 1,261
Canada 3,252 2,664 927 952
China 3,357 3,759 1,267 1,261
Taiwan 2,026 1,146 1,102 488
Netherlands 1,387 1,725 602 427
Japan 1,064 790 351 316
Mexico 426 1,273 75 238
Other 2,415 3,214 607 1,373
- -------------------------------------------------------------------------------------------------------
Total $147,396 $144,378 $49,312 $47,981
- -------------------------------------------------------------------------------------------------------
8. Goodwill
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("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 required
that upon adoption of SFAS 142 the Company reclassify the carrying amount of
certain intangible assets.
9
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 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.
9. Stock Options
On January 1, 2003, the Company adopted the disclosure provisions of SFAS 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure," which
amended SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") to
provide alternative methods of transition for an entity that voluntarily changes
to the fair value based method of accounting for stock-based employee
compensation, effective as of the beginning of the fiscal year. The Company
continues to apply the provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," ("APB 25") in accounting for
stock-based compensation. In accordance with APB No. 25, compensation costs for
stock options is recognized in income based on the excess, if any, of the quoted
market price over the exercise price of the stock on the date of grant. The
exercise price for all stock option grants equals the fair market value on the
date of grant, therefore no compensation expense is recorded.
The following table illustrates the effect on net income (loss) as if the
Company had applied the fair value recognition provisions for the nine and three
months ended September 30, 2003 and 2002:
Nine Months ended Three Months Ended
September 30, September 30,
- --------------------------------------------------------------------------------------------
2003 2002 2003 2002
- --------------------------------------------------------------------------------------------
(unaudited) (in thousands)
Net income (loss):
As reported $ 7,340 $ (114) $ 2,062 $ 2,951
Pro forma $ 7,031 $ (453) $ 1,959 $ 2,837
- --------------------------------------------------------------------------------------------
10. Amendment to Credit Agreement
In October 2003, the Company consummated a second amendment (the "Second
Amendment") to its credit agreement primarily to provide for relief from the
financial covenant ratios under its amended credit agreement. The financial
covenants stipulated in the Second Amendment provide for relief from the
covenants as required under the amended credit agreement from September 30, 2003
until March 30, 2005 at which point the financial covenants return to the
financial covenant requirements as described in the original agreement.
10
11. New Accounting Pronouncements
In July 2002, 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 adoption of SFAS 146
did not have a material effect on the Company's 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's adoption of the interpretation and valuation of future guarantees had
no material impact on the Company's consolidated results of operations and
financial position. See Note 6 regarding disclosures about the Company's
warranty costs.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." FIN 46 requires variable interest entities to be
consolidated by their primary beneficiaries. A primary beneficiary is the party
that absorbs a majority of the entity's expected losses or residual benefits.
FIN 46 applies immediately to variable interest entities created after January
31, 2003 and to existing variable interest entities in the periods beginning
after December 15, 2003. The adoption of this FIN is not expected to have a
material impact on the consolidated operations or financial condition of the
Company.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under FASB
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This Statement is effective for contracts entered into or modified
after June 30, 2003, except as defined in the SFAS. The adoption of this SFAS is
not expected to have a material impact on the consolidated operations or
financial condition of the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were classified as equity. SFAS 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of this SFAS is not expected to have a material impact on the
consolidated operations or financial condition of the Company.
Item 2 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations
Introduction
GENERAL
Key Components, Inc. ("KCI"), the sole member of KCLLC, holds no other assets
other than its investment in Key Components, LLC ("KCLLC"), and has no
operations. KCLLC is the holding company of wholly owned subsidiaries, which
make up the Company's two operating business segments, its electrical components
("EC") business and mechanical engineered components business ("MEC"). 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 of flexible shaft and remote valve control
components, turbo-charger actuators and medium security lock products and
accessories.
11
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, but there are no agreements regarding any such
acquisitions existing as of the date hereof.
Results of Operations
The following table sets forth, for the periods indicated, consolidated
statement of operations data for the Company expressed in dollar amounts (in
thousands) and as a percentage of net sales. The financial data set forth
includes the results of operations of its wholly owned subsidiaries from their
respective dates of acquisition. The data set forth below should be read in
conjunction with the Company's consolidated financial statements and notes
thereto contained elsewhere in this Form 10-Q.
Nine months ended September 30, Three months ended September 30,
----------------------------------------- ---------------------------------------
2003 2002 2003 2002
----------------------------------------- ---------------------------------------
(In thousands) % of % of % of % of
Net Net Net Net
Amount Sales Amount Sales Amount Sales Amount Sales
----------------------------------------- ---------------------------------------
Net Sales $147,396 100.0% $144,378 100.0% $49,312 100.0% $47,981 100.0%
Cost of Goods Sold 93,827 63.7 90,275 62.5 31,800 64.5 29,534 61.6
- -------------------------------------------------------------------------------------------------------------------------
Gross Profit 53,569 36.3 54,103 37.5 17,512 35.5 18,447 38.4
Selling, general and
administrative expenses 30,562 20.7 28,833 20.0 10,481 21.3 9,672 20.2
Other 1,009 0.7 803 0.6 565 1.1 453 0.9
- -------------------------------------------------------------------------------------------------------------------------
Income from operations 21,998 14.9 24,467 16.9 6,466 13.1 8,322 17.3
Interest expense 9,349 6.3 10,083 7.0 3,071 6.2 3,311 6.9
- -------------------------------------------------------------------------------------------------------------------------
Income before provision for
income taxes and cumulative
effect in change of accounting
principle 12,649 8.6 14,384 10.0 3,395 6.9 5,011 10.4
Provision for income taxes 5,309 3.6 6,341 4.4 1,333 2.7 2,060 4.3
- -------------------------------------------------------------------------------------------------------------------------
Income before change in
accounting principle 7,340 5.0 8,043 5.6 2,062 4.2 2,951 6.2
Change in accounting principle,
net of taxes of $3,007 - - (8,157) (5.7) - - - -
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) $7,340 5.0% $ (114) (0.1)% $ 2,062 4.2% $2,951 6.2%
- -------------------------------------------------------------------------------------------------------------------------
12
A summary of the Company's segments is as follows:
Electrical Components Business
Nine Months Ended September 30, Three Months Ended September 30,
-------------------------------------------- --------------------------------------------
2003 2002 2003 2002
-------------------------------------------- --------------------------------------------
% of % of % of % of
Net Net Net Net
Amount Sales Amount Sales Amount Sales Amount Sales
- ----------------------------------------------------------------------------------------------------------------------------
(In thousands)
- ----------------------------------------------------------------------------------------------------------------------------
Net Sales $88,507 100.0% $93,953 100.0% $29,874 100.0% $30,987 100.0%
Cost of Sales 54,051 61.1 58,520 62.3 18,404 61.6 18,778 60.6
- ----------------------------------------------------------------------------------------------------------------------------
Gross Profit 34,456 38.9 35,433 37.7 11,470 38.4 12,209 39.4
Selling, general and
administrative expenses 19,633 22.2 20,045 21.3 6,418 21.5 6,764 21.8
- ----------------------------------------------------------------------------------------------------------------------------
Income from operations $14,823 16.7% $15,388 16.4% $5,052 16.9% $5,445 17.6%
- ----------------------------------------------------------------------------------------------------------------------------
Mechanical Engineered Components Business
Nine Months Ended September 30, Three Months Ended September 30,
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2003 2002 2003 2002
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% of % of % of % of
Net Net Net Net
Amount Sales Amount Sales Amount Sales Amount Sales
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(In thousands)
- ----------------------------------------------------------------------------------------------------------------------------
Net Sales $58,889 100.0% $50,425 100.0% $19,438 100.0% $16,994 100.0%
Cost of Sales 39,776 67.5 31,755 63.0 13,396 68.9 10,756 63.3
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Gross Profit 19,113 32.5 18,670 37.0 6,042 31.1 6,238 36.7
Selling, general and
administrative expenses 8,180 13.9 6,222 12.3 2,895 14.9 2,129 12.5
Other 1,009 1.7 803 1.6 565 2.9 453 2.7
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Income from operations $ 9,924 16.9% $11,645 23.1% $ 2,582 13.3% $ 3,656 21.5%
- ----------------------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2003 compared to the Nine months ended September
30, 2002
Net Sales: Net sales for the nine months ended September 30, 2003 ("Nine Months
2003") increased by approximately $3.0 million, or 2.1%, from net sales for the
nine months ended September 30, 2002 ("Nine Months 2002"). This increase was the
sum of the approximately $5.4 million, or 5.8%, decline in the net sales of the
EC business and the approximately $8.5 million, or 16.8%, increase in net sales
of the MEC business.
The approximately $5.4 million decline in net sales of the EC business for the
Nine Months 2003 as compared to the Nine Months 2002 was driven by continuing
soft economic conditions, which impacted the three product lines of the EC
business. The Company's specialty electrical components group experienced a
decline in net sales for the Nine Months 2003 of approximately $1.2 million or
3.1%, as both industrial and recreational channels were soft compared to the
Nine Months 2002. The Company's power conversion product line was down
approximately $3.0 million, or 6.8% for the Nine Months 2003 as compared to the
Nine Months 2002 as its construction, industrial and aerospace end markets
remain soft. The Company's utility product line, which began to experience a
decline in orders during the later half of the year ended December 31, 2002,
resulting from utilities reducing spending on new and replacement infrastructure
projects, continued to experience this trend as net sales for the Nine Months
2003 were below the Nine Months 2002 by approximately $1.3 million or 10.0%.
The approximately $8.5 million increase in net sales of the MEC business for the
Nine Months 2003 as compared to the Nine Months 2002 was driven by increased
sales of the flexible shaft and the turbocharger product lines. Net sales of the
flexible shaft product line increased by approximately $4.6 million, or 31.9%,
for the Nine Months 2003 as compared to the Nine Months 2002. This increase was
driven by new product introductions as well as the acquisition of the mechanical
components business of Arens Controls, LLC ("Arens Controls"). The Company
completed this acquisition on March 3, 2003 (See Liquidity and Capital
Resources), which increased net sales of the flexible shaft product line by
approximately $3.9 million for the Nine Months 2003 as compared to the Nine
Months 2002. Net sales of the turbocharger components product line increased by
approximately $7.2 million, or 36.7%, for the Nine Months 2003 as compared to
the Nine Months 2002. This increase was driven primarily by a new product
introduction. The net sales of the lock product line declined by approximately
$3.4 million, or 20.3%, driven by continued softness in their end markets as
well as a fire, at its Massachusetts facility, which closed production for the
last week in May 2003 and impacted order fulfillment in June.
13
Gross Profit: Gross profit declined by approximately $534,000, or 1.0%, for Nine
Months 2003 as compared to Nine Months 2002, resulting from the sum of the
approximately $977,000, or 2.8%, decline in the gross profit of the EC business
and the approximately $443,000, or 2.4%, increase in gross profit of the MEC
business for the Nine Months 2003.
The approximately $977,000, or 2.8% decline in gross profit of the EC business
for the Nine Months 2003 as compared to the Nine Months 2002 resulted primarily
from the loss of net sales during the Nine Months 2003, however, the loss of
gross profit resulting from the lower revenues was reduced by changes in product
mix as well as productivity improvement flow-through which improved gross margin
for the Nine Months 2003 as compared to the Nine Months 2002.
The approximately $443,000, or 2.4%, increase in gross profit of the MEC
business for Nine Months 2003 as compared to Nine Months 2002 was driven by
volume increases of the flexible shaft and turbocharger components product lines
offset by the volume decline of the lock product line. In addition, the gross
profit of the flexible shaft product line did not grow in line with its net
sales growth as its results were negatively impacted by a change in the product
mix sold as compared to the Nine Months 2002. Further, the acquisition of the
mechanical components product line of Arens Controls negatively impacted the
gross margin of the flexible shaft product line as the Company is currently
working under an interim operating agreement with the seller until that product
line has been fully integrated into the Company's Binghamton, New York facility,
which will be completed by the end of November 2003 (See Liquidity and Capital
Resources). While sales of the flexible shaft product line increased by
approximately $4.6 million for the Nine Months 2003 as compared to the Nine
Months 2002, gross profit only increased by approximately $654,000. The increase
in gross profit for the Nine Months 2003 as compared to the Nine Months 2002
resulting from the turbocharger components product line was approximately $2.4
million, or 35.8%. The lock product line experienced a decline in gross profit
of approximately $2.6 million, or 52.6%, resulting from lower revenues, carrying
a higher cost structure as it moves operations to Mexico, as well as the impact
of the fire in May 2003.
The gross profit, as a percentage of net sales ("GP percentage"), for the EC
business increased by approximately 1.2% for the Nine Months 2003 as compared to
the Nine Months 2002. For the MEC business, the GP percentage declined by
approximately 4.6% during the Nine Months 2003 as compared to the Nine Months
2002. The change in GP percentage for the EC business is the result of a change
in product mix and the productivity gains as described above. The change in GP
percentage for the MEC business is primarily related to the impact of the
acquisition of the mechanical components product line of Arens Controls, as well
as the margin decline of the lock product line, as described above.
Selling, General and Administrative Expenses: Selling, general and
administrative ("SG&A") expenses increased approximately $1.7 million, or 6.0%,
for the Nine Months 2003 as compared to the Nine Months 2002. As a percentage of
net sales, SG&A increased to 20.7% for the Nine Months 2003 from 20.0% of net
sales for the Nine Months 2002. SG&A of the EC business decreased by
approximately $412,000, or 2.1%, for the Nine Months 2003 as compared to the
Nine Months 2002 and as a percentage of net sales, increased approximately 0.8%.
SG&A of the MEC business increased by approximately $2.0 million, or 31.5%, for
the Nine Months 2003 as compared to the Nine Months 2002 and increased as a
percentage of net sales by approximately 1.6%.
14
The increase in SG&A expenses for the Nine Months 2003 as compared to the Nine
Months 2002 is primarily related to the increase in SG&A of the MEC business.
The increase in SG&A of the MEC business is primarily the result of the Company
operating under an interim operating agreement relating to the acquisition of
the mechanical components product line of Arens Controls, which was completed on
March 3, 2003 (see Liquidity and Capital Resources). The Company will be
operating under the interim operating agreement with the seller until that
product line has been integrated into the Company's Binghamton, New York
facility, which will be completed by the end of November 2003. Further this
product line expensed approximately $188,000 of moving costs related to
integrating the Arens Controls product line. In addition, higher compensation
costs drove the increase in SG&A of the turbocharger product line, as a result
of the growth in the operating performance of that product line during the Nine
Months 2003 as compared to the Nine Months 2002, as well as additional staffing
requirements related to getting its new operation in China ready to start
production. The lock product line had an increase in SG&A resulting from the
increased costs of operating its Mexico production facility as compared to the
Nine Months 2002.
The decline in the SG&A of the EC business was driven by lower commission and
compensation expenses, somewhat offset by unfavorable freight and commission mix
related to the 2003 product sales. Higher insurance costs for the Nine Months
2003 as compared to the Nine Months 2002 also impacted the SG&A of both the MEC
and EC business. Lastly, during the Nine Months 2003, the Company paid
approximately $314,000 of professional fees related to an unsuccessful
acquisition attempt.
Other Expenses: Other expenses increased by approximately $206,000 for the Nine
Months 2003 as compared to the Nine Months 2002. The increase is related to the
expenses incurred in moving manufacturing to the new lock production facility in
Mexico as well as start up expenses related to establishing a production
facility in China.
Income from Operations: The decline in income from operations of approximately
$2.5 million, or 10.1%, for the Nine Months 2003 as compared to the Nine Months
2002, resulted from the increase in gross profit of approximately $534,000
coupled with the increases in SG&A expenses of approximately $1.7 million and
other expenses of approximately $206,000.
Interest Expense: Interest expense decreased by approximately $734,000, or 7.3%,
during the Nine Months 2003 as compared to the Nine Months 2002. This decrease
is primarily due to lower levels of outstanding borrowings during the Nine
Months 2003 as compared to the Nine Months 2002.
Provision for Income Taxes: The provision for income taxes decreased by
approximately $1.0 million, or 16.3%, for the Nine Months 2003 as compared to
the Nine Months 2002. The Company's effective tax rate on income before
provision for income taxes and cumulative effect of change in accounting
principle for the Nine Months 2003 was approximately 42.0%. The effective rate
on income before provision for income taxes and cumulative effect of change in
accounting principle for the Nine Months 2002 was approximately 44.1%. The
decline in the effective rate from the Nine Months 2002 to the Nine Months 2003
was primarily driven by the Company's foreign tax credits.
Income before cumulative effect in change in accounting principle: Income before
cumulative effect in change in accounting principle decreased by approximately
$703,000, or 8.7%, during the Nine Months 2003 as compared to the Nine Months
2002. The decline resulted from the decrease in income from operations of
approximately $2.5 million offset by the declines in interest expense and
provision for taxes of approximately $734,000 and $1.0 million, respectively,
due to the factors discussed above.
Cumulative effect in Change of 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. 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 in change of 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 of 2002
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.
15
Net Income (loss): Net income (loss) increased by approximately $7.5 million for
the Nine Months 2003, from a net loss of approximately $114,000 for the Nine
Months 2002 to a net income of approximately $7.3 million for the Nine Months
2003. Income before cumulative effect in change in accounting principle
decreased by approximately $703,000 as described above. This was offset by the
approximately $8.2 million increase in net income for the Nine Months 2003 as
compared to the Nine Months 2002 resulting from the Company's cumulative effect
in change of accounting principle recorded during 2002.
Three months ended September 30, 2003 compared to the three months ended
September 30, 2002
Net Sales: Net sales for the three months ended September 30, 2003 ("Quarter
2003") increased by approximately $1.3 million, or 2.8%, from net sales for the
three months ended September 30, 2002 ("Quarter 2002"). This increase was the
sum of the approximately $1.1 million, or 3.6%, decline in the net sales of the
EC business and the approximately $2.4 million, or 14.4%, increase in net sales
of the MEC business.
The approximately $1.1 million decline in net sales of the EC business for the
Quarter 2003 as compared to the Quarter 2002 was driven by continuing soft
economic conditions, primarily impacting the power conversion product line,
which had a net sales decline of approximately $1.4 million, or 9.0% for the
Quarter 2003 as compared to the Quarter 2002 as its construction, industrial and
aerospace end markets remain soft. The Company's utility product line, which
began to experience a decline in orders during the later half of the year ended
December 31, 2002, resulting from utilities reducing spending on new and
replacement infrastructure projects, experienced net sales growth for the
Quarter 2003 over the Quarter 2002 of approximately $296,000 or 7.4% while the
specialty electrical product line held its net sales in line with Quarter 2002.
The approximately $2.4 million increase in net sales of the MEC business for the
Quarter 2003 as compared to the Quarter 2002 was driven by increased sales of
the flexible shaft and the turbocharger product lines. Net sales of the flexible
shaft product line increased by approximately $1.8 million, or 42.5%, for the
Quarter 2003 as compared to the Quarter 2002. This increase was driven by new
product introductions as well as the acquisition of the mechanical components
business of Arens Controls. The Company completed this acquisition on March 3,
2003 (See Liquidity and Capital Resources), which increased net sales of the
flexible shaft product line by approximately $1.6 million for the Quarter 2003
as compared to the Quarter 2002. Net sales of the turbocharger components
product line increased by approximately $2.0 million, or 26.5%, for the Quarter
2003 as compared to the Quarter 2002. This increase was driven primarily by a
new product introduction. The net sales of the lock product line declined by
approximately $1.4 million or 25.7% resulting from continuing soft conditions in
its end markets.
16
Gross Profit: Gross profit declined by approximately $935,000, or 5.1%, for
Quarter 2003 as compared to Quarter 2002, resulting from the sum of the
approximately $739,000, or 6.1%, decline in the gross profit of the EC business
and the approximately $196,000, or 3.1%, decline in gross profit of the MEC
business for the Quarter 2003.
The approximately $739,000, or 6.1% decline in gross profit of the EC business
for the Quarter 2003 as compared to the Quarter 2002 resulted primarily from the
lower net sales during the Quarter 2003, driven primarily by the results of the
power conversion product line, which had a net sales decline of approximately
$1.4 million, or 9.0% for the Quarter 2003 as compared to the Quarter 2002. In
addition, gross profit was adversely affected related to the sales product mix
of this product line.
The approximately $196,000, or 3.1%, decrease in gross profit of the MEC
business for Quarter 2003 as compared to Quarter 2002 was primarily driven by
volume and margin decline at the lock product line. The lock product line's
gross profit declined approximately $1.2 million or 75.5%, resulting from cost
structure increases related to carrying two production facilities as the Company
continues its move of production to Mexico. In September 2003, in reaction to
the poor performance of this product line, the Company changed the management
team of this product line in an effort to solidify the product line's
performance and to spearhead the completion of the move of production to Mexico.
Increases in gross profit of the flexible shaft and turbocharger components
product lines mostly offset the gross profit decline of the lock product line.
However, the gross profit of the flexible shaft product line did not grow in
line with its net sales growth as its results were negatively impacted by the
interim operating agreement the Company is currently working under with the
seller of the Arens Controls product line until that product line has been fully
integrated into the Company's Binghamton, New York facility, which is will be
completed by the end of November 2003 (See Liquidity and Capital Resources).
While sales of the flexible shaft product line increased by approximately $1.8
million for the Quarter 2003 as compared to the Quarter 2002, gross profit only
increased by approximately $244,000.
The gross profit, as a percentage of net sales ("GP percentage"), for the EC
business declined approximately 1.0% for the Quarter 2003 as compared to the
Quarter 2002. For the MEC business, the GP percentage declined by approximately
5.6% during the Quarter 2003 as compared to the Quarter 2002. The change in GP
percentage for the EC business is the result of a change in product mix
described above. The change in GP percentage for the MEC business is primarily
related to the volume and margin decline of the lock product line, as described
above.
Selling, General and Administrative Expenses: Selling, general and
administrative ("SG&A") expenses increased approximately $809,000, or 8.4%, for
the Quarter 2003 as compared to the Quarter 2002. As a percentage of net sales,
SG&A increased to 21.3% for the Quarter 2003 from 20.2% of net sales for the
Quarter 2002. SG&A of the EC business declined by approximately $346,000, or
5.1%, for the Quarter 2003 as compared to the Quarter 2002 and as a percentage
of net sales, decreased approximately 0.3%. SG&A of the MEC business increased
by approximately $766,000, or 36.0%, for the Quarter 2003 as compared to the
Quarter 2002 and increased as a percentage of net sales by approximately 2.4%.
The increase in SG&A expenses for the Quarter 2003 as compared to the Quarter
2002 is primarily related to the increase in SG&A of the MEC business. The
increase in SG&A of the MEC business is primarily the result of the Company
operating under an interim operating agreement relating to the acquisition of
the mechanical components product line of Arens Controls, which was completed on
March 3, 2003 (see Liquidity and Capital Resources). The Company will be
operating under the interim operating agreement with the seller until that
product line has been integrated into the Company's Binghamton, New York
facility, which will be completed by the end of November 2003. In addition, this
product line absorbed approximately $188,000 of travel costs related to moving
this product line.
Higher compensation costs drove the increase in SG&A of the turbocharger product
line, as a result of the growth in the operating performance of that product
line during the Quarter 2003 as compared to the Quarter 2002 as well as
additional staffing requirements related to getting its new operation in China
ready to start production. Lower commission and compensation expenses drove a
decline in the SG&A expenses of the EC business. In addition, during the Quarter
2003, the Company paid approximately $314,000 of professional fees related to an
unsuccessful acquisition attempt.
Other Expenses: Other expenses increased by approximately $112,000 for the
Quarter 2003 as compared to the Quarter 2002. The other expenses represent
non-benefit costs related to moving production to Mexico for the Company's lock
product line as well as expenses related to commencing a production facility in
China.
Income from Operations: The decrease in income from operations of approximately
$1.9 million, or 22.3%, for the Quarter 2003 as compared to the Quarter 2002,
resulted from the sum of the decrease in gross profit of approximately $935,000,
the increase in SG&A expenses of approximately $809,000 and increase in other
expenses of approximately $112,000.
Interest Expense: Interest expense decreased by approximately $240,000, or 7.2%,
during the Quarter 2003 as compared to the Quarter 2002. This decrease is
primarily due to lower levels of outstanding borrowings during the Quarter 2003
as compared to the Quarter 2002.
Provision for Income Taxes: The provision for income taxes declined by
approximately $727,000, or 35.3%, for the Quarter 2003 as compared to the
Quarter 2002. The Company's effective tax rate on income before provision for
income taxes for the Quarter 2003 was approximately 39.3%. The effective rate on
income before provision for income taxes for the Quarter 2002 was approximately
41.1%. The decline in the effective rate from the Quarter 2002 to the Quarter
2003 was primarily driven by the Company's foreign tax credits as well as
adjusting the Company's tax accrual related to returns filed for 2002.
Net Income: Net income decreased by approximately $889,000 for the Quarter 2003,
from approximately $3.0 million for the Quarter 2002 to approximately $2.1
million for the Quarter 2003. This decline was the sum of the decline in income
from operations of approximately $1.9 million, reduced by the declines in
interest expense and provision for income taxes of approximately $240,000 and
$727,000, respectively, as discussed above.
17
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
its 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 obligations under the credit agreement,
governing the credit facilities are 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 June 30, 2003. The
term loan is payable in quarterly installments through September 2006. Both the
term loan and revolving credit facility bear interest at fluctuating interest
rates determined by reference to a base rate or the London interbank offered
rate ("LIBOR") plus an applicable margin which will vary from 1.0% to 3.75% and
require the payment of a commitment fee of ranging from 0.375 to 0.5% on the
unused portion of the facility as well as quarterly commitment fees.
The credit facility also allows for up to $5.0 million of outstanding letters of
credit. At September 30, 2003, the Company had two letters of credit outstanding
for approximately $1.5 million. The letters of credit primarily relate to the
Company's workman's compensation insurance programs.
The credit agreement contains certain covenants and restrictions, which require
the maintenance of financial ratios and restrict or limit dividends and other
shareholder distributions, transactions with affiliates, capital expenditures,
rental obligations and the incurrence of indebtedness.
In September 2002, the Company amended its credit agreement (the "Amendment") to
provide for revised financial covenant ratios from September 30, 2002 through
March 30, 2004 from the original covenant ratios stipulated in the credit
agreement. The Company anticipated that certain of the original covenants, which
became more stringent over the term of the agreement, would not be met due to
the general decline in the economy. In addition, the Amendment revised the
Company's applicable margin on borrowings, the maximum allowable capital
expenditures through March 29, 2004 and reduced the amount allowed for permitted
acquisitions (as defined in the credit agreement) from $15 million to $7.5
million through March 30, 2004. Concurrent with the Amendment, the Company
voluntarily reduced the availability under its revolving credit facility by $15
million from $40 million to $25 million until March 30, 2004.
As a result of the impact the domestic economy has had on the Company's business
coupled with the performance of the lock product line as well as monies spent
related to an unsuccessful acquisition attempt during the Quarter 2003, the
Company realized that it would not be able to keep up with the required step
down in the financial covenants that was to occur as of September 2003. As a
result, the Company consummated a second amendment to its credit agreement (the
"Second Amendment"). The financial covenants stipulated in the Second Amendment
provide for relief from the covenants as required under the amended credit
agreement from September 30, 2003 until March 30, 2005 at which point the
financial covenants return to the financial covenant requirements as described
in the original agreement. The Company is in compliance with the credit
agreement, as amended.
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 September 30, 2003, the Company had prepaid its next
principal payment. Principal payments required for the next 12 months will be
approximately $11.6 million. Under the revolving credit facility and term loan,
the Company has the option to lock in a specified interest rate by entering into
a contract, for different periods, which cannot exceed 180 days. As the
underlying contract comes up for renewal, the interest associated with the
contract becomes due. The Company's outstanding commitments for capital
expenditures at September 30, 2003 were not material. The Company anticipates
its capital expenditures for the year ended December 31, 2003 to be
approximately $4.0 million. The expenditures are primarily needed to maintain
its facilities, expand its production capacity for new product introduction as
well as fund the Company's ongoing plan to expand foreign operations in order to
take advantage of profitable market opportunities. To the extent cash flow from
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.
18
KCI has no operations and is dependent on KCLLC for financial resources in the
form of capital distributions to meet its obligations. KCI obligations include
the liquidation preferences of $107.0 million for its preferred stock plus any
dividends payable in arrears (at September 30, 2003 there were approximately
$3.6 million in cumulative dividends in arrears, payable in kind), which are
redeemable for cash at the option of the holder after June 2, 2009, the
requirement to purchase shares from its common shareholders under certain
circumstances and its tax obligations. Repurchases of KCI Common Stock are made
at fair market value as defined in KCI's shareholder agreement. At September 30,
2003 approximately 1.3 million KCI common shares plus potentially 192,000 shares
covered by stock options were subject to repurchase by KCI. The ability of KCLLC
to make such capital distributions will be limited by its available resources
and is limited by restrictions of debt and other agreements. KCLLC reflects the
tax obligations of KCI in its tax provision.
Cash flows provided by operating activities were approximately $16.6 million and
$17.0 million for the Nine Months 2003 and the Nine Months 2002, respectively.
The net decrease of approximately $381,000 for the Nine Months 2003 resulted
primarily from the decline in net income plus non- cash charges of approximately
$1.2 million offset by the net increase in cash provided by the operating assets
of the business. For the Nine Months 2003, Net income plus non-cash charges
totaled approximately $11.8 million versus the Nine Months 2002 of approximately
$13.0 million. The main driver between the two periods being the decline in
income before cumulative effect in change in accounting principle of
approximately $703,000, discussed above. The Company's primary working capital
accounts (accounts receivable, inventory and accounts payable) used net cash of
approximately $2.7 million as compared to the Nine Months 2002, when the working
capital accounts provided net cash of approximately $601,000. The change in the
cash provided by the working capital accounts is primarily the result of
servicing the demand for new product introduction in certain product lines. In
addition, as a result of relocating production to Mexico, inventory levels of
the Company's lock product line slightly increased. The Company's prepaid
expenses provided cash of approximately $3.5 million primarily related to the
utilization of prior year tax overpayments to reduce current year estimated tax
payments. Accrued expenses provided net cash of approximately $4.0 million for
the Nine Months ended 2003 as compared to approximately $1.1 million for the
Nine Months ended 2002. The primary difference being the timing of interest
payments related to the LIBOR contracts underlying the Company's outstanding
term debt.
Cash flows used in investing activities were approximately $7.1 million and $1.7
million for the Nine Months 2003 and Nine Months 2002, respectively. Capital
expenditures for the Nine Months 2003 and the Nine Months 2002 were
approximately $2.6 million and $2.1 million, respectively. The increase in
capital expenditures from the Nine Months 2002 to the Nine Months 2003 was
primarily related to new tooling and machinery to service demand related to new
product introduction, add facility capacity for the product line acquisition of
Arens Controls and expand foreign manufacturing operations. Proceeds from the
assets held for sale was approximately $364,000 for the Nine Months 2002, which
was related to the sold electronics division of Acme Electric Corporation
compared to none for the Nine Months 2003.
On March 3, 2003, the Company acquired the mechanical components business of
Arens Controls for a purchase price of approximately $4.5 million and assumed
liabilities of approximately $642,000. The Company recorded the estimated excess
purchase price over net assets acquired of approximately $2.0 million as
goodwill. The value ascribed to the estimated excess purchase price over net
assets acquired is preliminary and is subject to change. Other intangibles
acquired in the transaction were not material. The product line, which
manufactures push pull cable and related components, is being integrated into
the Company's Binghamton, New York manufacturing facility. The Company borrowed
$2.0 million on its revolving credit facility to partially finance this
acquisition. The product line acquired has historical annual revenues of
approximately $7.5 million.
Cash flows from financing activities used net cash of approximately $7.3 million
and $15.3 million during the Nine Months 2003 and the Nine Months 2002,
respectively. The net cash used by financing activities was driven primarily by
repayment of debt of approximately $9.2 million and $15.3 million during the
Nine Months 2003 and the Nine Months 2002, respectively. During the Nine Months
2003, the Company borrowed $2.0 million under the Company's revolver to
partially finance the acquisition of the mechanical components product line of
Arens Controls. During the Nine Months 2003, KCLLC distributed approximately
$100,000 to its member, KCI, in order for KCI to repurchase common stock from a
shareholder.
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 next twelve
months.
19
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. 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 September 30, 2003, the Company
has recorded approximately $97.5 million in goodwill and other intangible
assets related to acquisitions made in 2003 and prior years. The
recoverability of these assets is subject to an impairment test based on
the estimated fair value of the underlying businesses. These estimated
fair values are determined using a valuation methodology that triangulates
the discounted cash flows, market multiples and transactional multiples of
the reporting units. Factors affecting these future cash flows include:
the continued market acceptance of the products and services offered by
the businesses; the development of new products and services by the
businesses and the underlying cost of development; the future cost
structure of the businesses; and future technological changes.
Pension Plans: The Company's assets and liabilities recorded in connection
with the Company's pension plans 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;
20
(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 September 30, 2003, was approximately
$27.6 million. The Company includes in its backlog only accepted purchase
orders. However, backlog is not necessarily indicative of future sales. In
addition, purchase orders can generally be cancelled at any time without
penalty.
New Accounting Pronouncements
In July 2002, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("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 adoption of
the SFAS did not have a material effect on the Company's 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's adoption of the interpretation and valuation of future guarantees had
no material impact on the Company's consolidated results of operations and
financial position.
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123." SFAS 148 amends SFAS No.123 "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for an entity that voluntarily changes
to the fair value based method of accounting for stock-based employee
compensation prescribed by SFAS 123. SFAS 148 also amends the disclosure
provisions of SFAS 123 to require disclosure in both annual and interim
financial statements about the effects on reported net income of an entity's
accounting policy decisions with respect to stock-based employee compensation.
The amendment relating to the additional disclosure requirements in the interim
financial statements are effective for interim periods beginning after December
15, 2002. The adoption of SFAS 148 did not have a material impact on the
operations or cash flows of the Company. However, additional disclosures have
been incorporated into the Company's interim consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." FIN 46 requires variable interest entities to be
consolidated by their primary beneficiaries. A primary beneficiary is the party
that absorbs a majority of the entity's expected losses or residual benefits.
FIN 46 applies immediately to variable interest entities created after January
31, 2003 and to existing variable interest entities in the periods beginning
after December 15, 2003. The adoption of this FIN is not expected to have a
material impact on the consolidated operations or financial condition of the
Company.
21
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under FASB
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This Statement is effective for contracts entered into or modified
after June 30, 2003, except as defined in the SFAS. The adoption of this SFAS is
not expected to have a material impact on the consolidated operations or
financial condition of the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were classified as equity. SFAS 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of this SFAS is not expected to have a material impact on the
consolidated operations or financial condition of the Company.
Forward-Looking Statements
This report contains forward-looking statements based on current expectations
that involve a number of risks and uncertainties. Generally, forward-looking
statements include words or phrases such as "management anticipates," "the
Company believes," "the Company anticipates," and words and phrases of similar
impact, and include but are not limited to statements regarding future
operations and business environment. The forward-looking statements are made
pursuant to safe harbor provisions of the Private Securities Litigation Reform
Act of 1995. The factors that could cause actual results to differ materially
from the forward-looking statements include the following: (i) industry
conditions and competition, (ii) operational risks and insurance, (iii)
environmental liabilities which may arise in the future and not covered by
insurance or indemnity, (iv) the impact of current and future laws and
government regulations, and (v) the risks described from time to time in the
Company's reports to the Securities and Exchange Commission.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's primary exposure to market risk is related to the variability in
interest rates associated with the $55.9 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 4.18% until January 2004, when the
underlying LIBOR contract is up for renewal. At September 30, 2003, the Company
had no amounts outstanding under its line of credit and was one payment ahead of
schedule on its term debt. A 1% change in the interest rate for the Company's
credit facilities in place at December 31, 2002 would have resulted in a change
in the Company's annual 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 4. Controls and Procedures
The management of KCLLC carried out an evaluation, with the participation of its
Chief Executive Officer and Chief Financial Officer, of the effectiveness of its
disclosure controls and procedures as of September 30, 2003. Based upon that
evaluation, KCLLC's Chief Executive Officer and Chief Financial Officer
concluded that KCLLC's disclosure controls and procedures were effective to
ensure that information required to be disclosed by KCLLC in reports that it
files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported, within the time periods specified in the
rules and forms of the Securities and Exchange Commission.
22
There has not been any change in KCLLC's internal control over financial
reporting in connection with the evaluation required by Rule 15d-15(d) under the
Exchange Act that occurred during the quarter ended September 30, 2003 that has
materially affected, or is reasonably likely to materially affect, KCLLC's
internal control over financial reporting.
The management of Key Components Finance Corp. ("Finance Corp.") carried out an
evaluation, with the participation of its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of its disclosure controls and
procedures as of September 30, 2003. Based upon that evaluation, Finance Corp.'s
Chief Executive Officer and Chief Financial Officer concluded that Finance
Corp.'s disclosure controls and procedures were effective to ensure that
information required to be disclosed by Finance Corp. in reports that it files
or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported, within the time periods specified in the rules and
forms of the Securities and Exchange Commission.
There has not been any change in Finance Corp.'s internal control over financial
reporting in connection with the evaluation required by Rule 15d-15(d) under the
Exchange Act that occurred during the quarter ended September 30, 2003 that has
materially affected, or is reasonably likely to materially affect, Finance
Corp.'s internal control over financial reporting.
Part II - Other Information
Item 6 -- Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number Exhibit Description
-------------- -------------------
10.42 Second Amendment to Credit Agreement
31.1 Rule 13a-14(a)/15d-14(a) Certifications of KCLLC
31.2 Rule 13a-14(a)/15d-14(a) Certifications of Finance Corp.
32 Section 1350 Certifications of KCLLC and Finance Corp.
(b) Reports on Form 8-K
During the quarter ended September 30, 2003, KCLLC and Finance Corp.
filed or furnished the following current reports on Form 8-K with the Securities
and Exchange Commission:
Current report on Form 8-K, dated August 14, 2003, was furnished on
August 14, 2003. The items reported were:
o Item 12 - Results of Operations and Financial Condition, which
reported the issuance of a press release announcing KCLLC's
financial results for the quarter ended June 30, 2003.
23
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEY COMPONENTS, LLC
--------------------------------------
Date: November 7, 2003 By: /s/Clay B. Lifflander
----------------------
Clay B. Lifflander
Chief Executive Officer
Date: November 7, 2003 By: /s/ Robert. B. Kay
--------------------
Robert B. Kay
President
Date: November 7, 2003 By: /s/Keith A. McGowan
--------------------
Keith A. McGowan
Chief Financial Officer
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEY COMPONENTS FINANCE CORP.
-------------------------------------
Date: November 7, 2003 By: /s/ Clay B. Lifflander
-----------------------
Clay B. Lifflander
Chief Executive Officer
Date: November 7, 2003 By: /s/ Robert. B. Kay
--------------------
Robert B. Kay
President
Date: November 7, 2003 By: /s/ Keith A. McGowan
---------------------
Keith A. McGowan
Chief Financial Officer
24