ITEM 1. BUSINESS
GENERAL
Atchison Casting Corporation ("ACC", "Atchison" or the "Company") was formed in 1991 with the dual objectives of acting as a consolidator in the foundry industry and bringing new technology for casting design and manufacture to the foundries it acquires. While Atchison in its current form has been in operation since 1991, its operating units have been in continuous operation for much longer, in some cases for more than 100 years. The first foundry acquired by ACC, the steel-castings division of Rockwell International, has been in continuous operation since 1872. The period as a semi-captive foundry, under Rockwell, was characterized by high quality design and production, but less emphasis on outside customers and new markets.
Atchison manufactures highly engineered metal castings and forgings that are utilized in a wide variety of products, including cars, trucks, gas, steam and hydroelectric turbines, mining equipment, locomotives, passenger rail cars, pumps, valves, army tanks, navy ships, oil field equipment, reactor vessels for plastic manufacturing, computer peripherals, office furniture, home appliances, satellite receivers and consumer goods. Between June 1991 and February 1999, Atchison completed nineteen acquisitions. As a result of these acquisitions, the Company has the ability to produce castings from a wide selection of materials, including carbon, low-alloy and stainless steel, gray and ductile iron, aluminum and zinc as well as the ability to manufacture parts in a variety of sizes, ranging from small die cast components for the computer industry that weigh a few ounces to mill stands for the steel industry that weigh up to 280 tons. The Company believes that its broad range of capabilities, which addresses the needs of many different markets, provides a distinct competitive advantage in the casting and forging industry.
The Company did not make any acquisitions in fiscal 2000 or 2001, and is not currently contemplating any acquisitions in fiscal 2002. The Company's primary focus in fiscal 2002 will continue to be on the integration and improvement of existing operations and earnings.
Since 1991, the number of customers served by the Company has increased from 12 to more than 600, including companies such as Caterpillar, Gardner Denver, General Motors, General Electric, Siemens Westinghouse, General Dynamics, Shell, British Steel, Nucor, GEC-Alstom, Ingersoll-Dresser, John Deere, DaimlerChrysler, Corus (formerly British Steel), CICH, Parker Hannifin, Weirton Steel, Case New Holland, Babcock & Wilcox and Meritor (formerly Rockwell International). The Company has received supplier excellence awards for quality from, or has been certified by, substantially all of its principal customers.
The Company's favorable industry position is attributable to several factors, including: (i) its use of new and advanced casting technologies; (ii) its ability to cast substantially all types of iron and steel, as well as aluminum and zinc; (iii) the Company's emphasis on customer service and marketing; and (iv) the Company's position as a long-term supplier to many of its major customers.
The principal executive offices of the Company are located at 400 South Fourth Street, Atchison, Kansas 66002-0188, and the Company's telephone number is (913) 367-2121.
RECENT DEVELOPMENTS
FINANCING ARRANGEMENTS
In September 2001, the Company and its revolving credit lenders entered into the Eleventh Amendment and Forbearance Agreement to the Amended and Restated Credit Agreement (the "Credit Agreement"). The Eleventh Amendment provides that, among other things, these lenders will forbear from enforcing their rights with respect to certain existing defaults through October 12, 2001. This amendment also allowed Atchison Casting UK Limited ("ACUK"), a subsidiary of the Company, to enter into a new financing agreement (the "Facility Agreement") with Burdale Financial Limited ("Burdale"), an affiliate of Congress Financial Corporation, a portion of which will reduce the lenders' commitments thereunder.
In September, 2001, the Company and the insurance company holding the senior notes (the "Notes") entered into the Eighth Amendment and Forbearance Agreement to the Note Purchase Agreement (the "Note Purchase Agreement"). The Eighth Amendment provides that, among other things, the Noteholder will forbear from enforcing its rights with respect to certain existing defaults through October 12, 2001. This amendment also allows ACUK to enter the Facility Agreement, a portion of which will be used to reduce the principal amount of the Notes.
In September 2001, ACUK and Burdale Financial Limited entered into the Facility Agreement. This Facility Agreement provides for a 25 million British pound (approximately $35 million US ) facility to be used to fund working capital requirements at Sheffield, a subsidiary of ACUK, and up to $1.0 million British pounds for working capital at Fonderie d'Autun ("Autun"), the Company's subsidiary in France. In addition, the Facility Agreement will provide security for Sheffield's foreign currency exchange contracts and performance bond commitments, repay $5.0 million of intercompany working capital loans and may provide for a loan of up to $9.0 million of additional working capital funds in North America, subject to availability and other restrictions in the U.K. This facility matures on September 17, 2004 and is secured by substantially all of Sheffield's assets in the U.K. Loans under this Facility Agreement will bear interest at LIBOR plus 2.60%.
The Company is currently negotiating with new and existing lenders to extend its current arrangements while it attempts to establish a new credit facility with covenants that the Company believes it will be able to satisfy and additional borrowing capacity.
CLOSURE OF PENNSYLVANIA STEEL, PRIMECAST, INC. AND EMPIRE STEEL SUBSIDIARIES
Following the discovery of accounting irregularities, which revealed substantial operating losses at each of the Company's three steel foundries that comprise the Pennsylvania Foundry Group, the Company determined that the carrying value of certain long-lived assets of Pennsylvania Steel and Empire Steel had been impaired. Accordingly, the Company recorded, in the fourth quarter of fiscal 2000, a charge of $6.2 million primarily to reduce the carrying value of the fixed assets at Pennsylvania Steel to estimated fair value and to write-off the goodwill at Empire Steel. Subsequently, the Company committed to a plan to consolidate the three operations into two, thereby improving the capacity utilization of the remaining two and, on November 30, 2000, the Company announced plans to close Pennsylvania Steel. The closure was completed by February 28, 2001. Much of the work was transferred to the remaining two locations.
On January 23, 2001, the Company announced plans to close its PrimeCast, Inc. ("PrimeCast") foundry unit located in Beloit, Wisconsin and South Beloit, Illinois. The Company had previously announced a partial shutdown of the unit, following the closure of Beloit Paper Machinery Corporation, which had been PrimeCast's major customer and the former owner of the foundry. The closure was completed by March 31, 2001. As PrimeCast was the Company's only foundry that could
produce large iron castings, only a portion of PrimeCast's work can be transferred to other operations of the Company. PrimeCast has been merged with and into Kramer International Inc. ("Kramer"). The Company had previously recorded a charge of $6.9 million for the impairment of PrimeCast's fixed assets in the fourth quarter of fiscal 2000.
Following continued losses in fiscal 2001, the Company announced, on August 31, 2001, plans to close Empire. Accordingly, the carrying values of Empire's fixed assets were written down to the Company's estimate of fair value, which was based on discounted future cash flows. The resulting impairment charge of $1.6 million to reduce the carrying value of these fixed assets was recorded in the fourth quarter ended June 30, 2001. Actual results could vary significantly from such estimates. Prior to the impairment charge, these assets had a carrying value of $2.6 million. The Company plans to close Empire by November 30, 2001, and transfer as much work as possible to other Company locations.
LEGAL PROCEEDINGS
The Company, its chief executive officer, and its chief financial officer were named as defendants in five lawsuits filed following the Company's announcements concerning the discovery of accounting irregularities at the Pennsylvania Foundry Group. The cases have been consolidated before the U.S. District Court for the District of Kansas. An amended complaint filed after the consolidation alleges, among other things, that the defendants intentionally or recklessly issued materially false and misleading financial statements in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. That complaint seeks certification of a class of purchasers of the Company's common stock between December 10, 1997 and November 3, 2000 and asks for damages for the class in an unspecified amount. Discovery has been stayed pending the resolution of the defendants' anticipated motion to dismiss the amended complaint. The Company believes the claims are without merit and intends to defend them vigorously. There can be no assurance, however, that an adverse outcome with respect to the case will not have a material adverse impact on the Company's financial condition, results of operations or cash flows.
In addition, the Company understands that on or about November 29, 2000 the Securities and Exchange Commission issued a formal order of investigation as a result of the events underlying the Company's earlier disclosure of certain accounting irregularities. The Company is cooperating with the investigation.
PLANNED SALE OF LOS ANGELES DIE CASTING AND JAHN FOUNDRY CORP. ASSETS
The Company is negotiating the sale of substantially all of the assets of Los Angeles Die Castings Inc. ("LA Die Casting"). Under the terms of the proposed agreement, the Company would receive approximately $4.5 million in cash in exchange for certain assets and the assumption of certain liabilities by the buyer, subject to certain post-closing adjustments. There can be no assurance that a definitive agreement will ultimately be executed or consummated. If consummated, it is anticipated that this transaction would close during the second quarter of fiscal 2002.
In the fourth quarter of fiscal 2001, the Company recognized an impairment charge of $2.7 million to write-down the carrying value of the intangible assets at LA Die Casting to the Company's estimate of fair value. The Company considered its decision to realign its operations, resulting in its decision to dispose of LA Die Casting as the primary indicator of impairment. Prior to the impairment charge, the intangible assets had a carrying value of $3.5 million. For fiscal years 1999, 2000 and 2001, LA Die Casting recorded net sales of $9.6 million, $9.5 million and $8.2 million, respectively, and net income of $196,000, $280,000 and $61,000, respectively, excluding the impairment charge in the fourth quarter of fiscal 2001.
The Company is negotiating the sale of substantially all of the assets of Jahn Foundry Corp. ("Jahn Foundry"). Under the terms of the proposed agreement, the Company would receive approximately $500,000 in cash, $500,000 in preferred stock of the buyer and $1.0 million principal amount over ten years in exchange for certain assets and the assumption of up to approximately $4.0 million of certain liabilities by the buyer, subject to certain post-closing adjustments. There can be no assurance that a definitive agreement will ultimately be executed or consummated. If consummated, it is anticipated that this transaction would close during the second quarter of fiscal 2002.
In the fourth quarter of fiscal 2001, the Company recognized an impairment charge of $13.9 million to write-down the carrying value of the fixed assets at Jahn Foundry to the Company's estimate of fair value. The Company considered its decision to realign its operations, resulting in its decision to dispose of Jahn Foundry as the primary indicator of impairment. Prior to the impairment charge, the fixed assets had a carrying value of $15.9 million. For fiscal years 1999, 2000 and 2001, Jahn Foundry recorded net sales of $12.0 million, $10.7 million and $8.4 million, respectively, and net income (losses) of $124,000, $(113,000) and $(2.4) million, respectively, excluding the impairment charge in the fourth quarter of fiscal 2001 and a non-recurring gain of $10.9 million recorded in the second quarter of fiscal 2001 relating to insurance claims resulting from the industrial accident at Jahn Foundry on February 25, 1999.
COMPANY STRATEGY
Until fiscal 2000, ACC pursued growth and diversification through a two-pronged approach of: (i) making strategic acquisitions within the widely fragmented and consolidating foundry industry; and (ii) integrating the acquired foundries to achieve economies of scale, while strengthening marketing and promoting the use of new casting technology. ACC's primary focus since the beginning of fiscal 2000 has been on the integration and improvement of existing operations. No acquisitions are currently contemplated during fiscal 2002.
STRATEGIC ACQUISITIONS
ACQUIRE LEADERS AND BUILD CRITICAL MASS. The Company initially acquired foundries that were considered leaders in their respective sectors. After acquiring a leader in a new market, ACC would strive to make subsequent acquisitions that further penetrate that market and take advantage of the leader's technical expertise. Atchison Steel Casting & Machining is a leader in the field of large, complex steel castings. This acquisition in 1991 provided credibility for ACC's presence in the industry and established a base for add-on acquisitions. Following the Atchison Steel Casting & Machining acquisition, the Company added capacity and strengthened its base through the add-on acquisitions of Amite Foundry and Machine, Inc. ("Amite") in 1993 and Canadian Steel Foundries, Ltd. ("Canadian Steel") in 1994. As an additional example, Prospect Foundry, Inc. ("Prospect") was acquired in 1994 due to its leading position in gray and ductile iron casting production. The subsequent acquisition of La Grange Foundry Inc. ("La Grange") in 1995 further enhanced ACC's position in this market.
BROADEN PRODUCT OFFERINGS AND CAPABILITIES. The Company also acquired foundries that added a new product line or customer base that can be leveraged throughout ACC's network of foundries. For example, prior to the acquisition of Prospect in 1994, which expanded ACC's capabilities to include gray and ductile iron, the Company only produced carbon and low alloy steel castings. The acquisition of Quaker Alloy, Inc. ("Quaker Alloy") expanded ACC's stainless and high alloy steel capabilities to include a wider range of casting sizes. The acquisition of Sheffield Forgemasters Group Limited ("Sheffield") brings to ACC the ability to offer cast and forged rolls, larger steel castings and centrifically cast parts. London Precision Machine & Tool Ltd. ("London Precision") expanded ACC's capabilities in the machining of castings.
DIVERSIFY END MARKETS. The Company attempts to lessen the cyclical exposure at individual foundries by operating a diversified network of foundries that serve a variety of end markets. Kramer a supplier of pump impellers, was acquired in 1995, expanding ACC's sales to the energy and utility sectors. The Company believes ACC's presence in these markets somewhat offsets its exposure to the railroad and mining and construction markets, as energy and utility cycles do not necessarily coincide with railroad investment or mining and construction cycles. The acquisition of Prospect diversified the end markets served by the Company by providing access to both the agricultural equipment and trucking industries. Sheffield provided a strong position as a supplier to the steel industry, as well as substantial enhancement of ACC's presence in the oil and gas industry. Currently, the Company serves more than ten major end-user markets, compared to three in 1991.
DIVERSIFY GEOGRAPHICALLY. The Company sought to acquire foundries, which would expand the operations to other major world economies. Sheffield and Autun provide entry into the Euromarket.
The following table presents the Company's current operations and their primary strategic purpose.
INTEGRATION OF ACQUIRED FOUNDRIES
STRENGTHEN MARKETING FUNCTIONS. Many foundries, particularly those that operate as captive foundries or only rely on a small number of customers, do not have strong marketing capabilities. ACC views this industry-wide marketing weakness as an opportunity to establish a competitive advantage. The Company places great emphasis on maximizing new business opportunities by strengthening marketing capabilities, adding sales people and cross-selling between foundries.
One way in which ACC builds the marketing efforts of its foundries is to increase the number of sales personnel at its foundries. In addition to sales people added through acquisitions, the Company
has incrementally increased the sales force by 36%. Another element of the Company's marketing effort is to jointly develop castings with its customers. Joint development projects using new technology, and the resulting increased service and flexibility provided to customers, is an important marketing tool and has been instrumental in receiving several new orders. For example, a joint development project between Caterpillar and ACC led to the production of the boom tip casting for one of Caterpillar's new hydraulic excavators. Joint development projects have also taken place with General Motors, Nordberg, John Deere, Case New Holland, Bombardier and DaimlerChrysler, among others.
An increasingly important aspect of the Company's marketing strategy has been to develop its ability to cross-sell among its foundries. In acquiring new foundries and expanding into new markets, the Company has gained a significant advantage over smaller competitors since its sales force is able to direct its customers to foundries with different capabilities. This benefits ACC in that it enables foundries to use the Atchison name and relationships to gain new customers as well as helping customers to reduce their supplier base by providing "one-stop" shopping. The Company facilitates cross-selling by reinforcing the sales force's knowledge of Company-wide capabilities through visits to individual plants and providing sales incentive opportunities.
INTRODUCE ADVANCED TECHNOLOGY. The Company is systematically introducing new advanced technologies into each of its acquired foundries to enhance their competitive position. For example, the Company's capabilities in finite element analysis and three-dimensional solid modeling are having a beneficial impact on sales and casting production by helping customers to design lighter and stronger castings, shortening design cycles, lowering casting costs and, in some cases, creating new applications. These new technologies have enhanced the Company's ability to assist customers in the component design and engineering stages, strengthening the Company's relationships with its customers. New techniques involve computerized solid models that are used to simulate the casting process, to make patterns and auxiliary tooling and to machine the finished castings. The Company is in the process of implementing this technology in all of its foundries. The Company has established a Fabrication-to-Casting design center at its Atchison, Kansas facility. The focus of the design center is to help customers design new castings, especially those which can replace existing fabricated assemblies.
Investments by the Company in technology improvements include: (i) new solidification software and hardware for better casting design and process improvement; (ii) Computer Numerical Control ("CNC") machine tools, computer-assisted, laser measurement devices and new cutting head designs for machine tools to improve productivity and quality in the machining of castings; (iii) Argon-Oxygen Decarburization ("AOD") refining, which is used to make high-quality stainless steel; (iv) computer-controlled sand binder pumps to improve mold quality and reduce cost; (v) equipment for measuring the nitrogen content of steel, which helps in casting quality improvement; (vi) CNC pattern making; (vii) new die casting machines; and (viii) automated testing cells using resonate testing. ACC is one of the few foundry companies that uses its own scanning electron microscope to analyze inclusions in cast metal. The Company also participates in technical projects led by the Steel Founders' Society of America and the American Foundrymen's Society, which are exploring ways to melt and cast cleaner iron and steel, as well as U.S. government/industry specific projects to shorten and improve the casting design cycle.
INCREASE CAPACITY UTILIZATION. A principal objective of the Company in integrating and operating its foundries is to increase capacity utilization at both its existing and newly acquired facilities. Many of the Company's foundries at the time of their acquisition have been operating with underutilized capacity. The Company seeks to improve capacity utilization by introducing more effective marketing programs and applying advanced technologies as described above.
ACHIEVE PURCHASING ECONOMIES. ACC makes its volume purchasing programs available to its foundries. ACC has realized meaningful cost savings by achieving purchasing efficiencies for its foundries. By jointly coordinating the purchase of raw materials, negotiation of insurance premiums and procurement of freight services, ACC's individual foundries have, in some cases, realized savings of 10% to 30% of these specific costs.
LEVERAGE MANAGEMENT EXPERTISE. The Company believes that improvements can often be made in the way acquired foundries are managed, including the implementation of new technologies, advanced employee training programs, standardized budgeting processes and profit sharing programs and providing access to capital. In this view, ACC enhances management teams to add technical, marketing or production experience, if needed.
INDUSTRY TRENDS
The American Foundrymen's Society estimates that global casting production was 64.9 million metric tons in 1999 of which steel castings accounted for approximately 6.1 million tons, iron castings for approximately 49.3 million tons and nonferrous castings for approximately 9.5 million tons. It is further estimated that the top ten producing countries represent 80% of the total production, with the U.S. representing in excess of 20% of the world market.
The U.S. casting industry is estimated to have had shipments of approximately 13.7 million tons in 1999, of which steel castings accounted for approximately 1.4 million tons, iron castings for approximately 9.7 million tons and non-ferrous castings for approximately 2.6 million tons. Metal casting shipments are forecast to grow at an annual rate of 1.4% to 16.0 million tons by 2010. The Company has been able to grow principally as a result of its strategy and due to key trends affecting the casting industry, including the following:
INDUSTRY CONSOLIDATION
Although still highly fragmented, the U.S. foundry industry has consolidated from approximately 465 steel foundries and 1,400 iron foundries in 1982 to approximately 400 and 700 steel and iron foundries, respectively, in 1999. This consolidation trend has been accompanied by increased outsourcing of casting production and OEM supplier rationalization.
OUTSOURCING. Many OEMs are outsourcing the manufacture of cast components to independent foundries in an effort to reduce their capital and labor requirements and to focus on their core businesses. Management believes that captive foundries are often underutilized, inefficiently operated and lack the latest technology. Several of ACC's OEM customers, such as Caterpillar, General Motors, General Electric, Meritor (formerly Rockwell International), Ingersoll-Dresser, Gardner Denver, Compagnie Internationale du Chauffage and Beloit Corporation, have closed or sold one or more of their captive foundries during the past ten years and have outsourced the castings which they once made to independent suppliers such as the Company. As described above, the closure of these facilities has contributed to increased capacity utilization at the remaining foundries.
OEM SUPPLIER RATIONALIZATION. OEMs are rationalizing their supplier base to fewer foundries that are capable of meeting increasingly complex requirements. For example, OEMs are asking foundries to play a larger role in the design, engineering and development of castings. In addition, some customers have demanded that suppliers implement new technologies, adopt quality (ISO 9000 and QS 9000) standards and make continuous productivity improvements. As a result, many small, privately-owned businesses have chosen to sell their foundries because they are unwilling or unable to make investments necessary to remain competitive. Moreover, the EPA and OSHA require compliance with increasingly stringent environmental and governmental regulations.
NEW CASTING TECHNOLOGY
Recent advances in casting technology and pattern-making have created new opportunities for reducing costs while increasing efficiency and product quality. The combination of powerful, low cost computer workstations with finite element modeling software for stress analysis and metal solidification simulation is helping foundries and customers to design castings that are lighter, stronger and more easily manufactured at a competitive cost.
The Company believes new casting technologies have led to growth in casting shipments by replacing forgings and fabrications in certain applications. In the past, fabricated (welded) components have been used in order to reduce tooling costs and product development lead-time. New casting technology has helped to reduce the weight and cost, and shorten the lead-time, of castings and has therefore increased the relative attractiveness of cast components. For example, these improvements allowed an ACC customer to replace a fabricated steel boom that is used in a typical mining vehicle with one that is cast. The cast steel boom weighs 20% less than the fabricated component that it replaced, allowing an increase in payload. Product life is increased due to greater corrosion resistance. Another customer replaced the combination cast/fabricated body of a rock crusher with a one-piece casting, reducing labor for cutting, welding and machining as a result.
The Company has established a Fabrication-to-Casting Design Center at its Atchison, Kansas facility. The focus of the design center is to help customers design new castings, especially those which can replace existing fabricated assemblies.
MARKETS AND PRODUCTS
STEEL INDUSTRY. The steel industry uses rolls to form cast steel into sheets, bars, rods, beams and plates, which are then used to make end products such as car bodies, tin cans and bridges. Rolls are consumed as steel is rolled, so there is a steady demand for rolls. Customers in this market include Corus (formerly British Steel) and Nucor, among others. Sheffield Forgemasters Rolls Limited ("Forgemasters Rolls") is one of the world leaders in cast and forged rolls for the steel-making industry. Steel products produced by the Company accounted for approximately 18.8%, 18.5% and 20.2% of the Company's net sales in fiscal 1999, fiscal 2000 and fiscal 2001, respectively.
MINING AND CONSTRUCTION. ACC's castings are used in tractor-crawlers, mining trucks, excavators, drag lines, wheel-loaders, rock crushers, diesel engines, slurry pumps, coal mining machines and ore-processing equipment. Mining and construction equipment customers include Caterpillar, Nordberg, Meritor (formerly Rockwell International), Gardner Denver, John Deere, Komatsu and Euclid, among others. Products supplied to the mining and construction industry accounted for approximately 18.0%, 16.5% and 15.9% of the Company's net sales in fiscal 1999, fiscal 2000 and fiscal 2001, respectively.
RAILROAD. The Company supplies cast steel undercarriages for locomotives, among other parts, for this market. GM is ACC's largest locomotive customer, and has purchased locomotive castings from Atchison Steel Casting & Machining for over 60 years. The Company further penetrated this market through the purchase of London Precision. Rail products produced by the Company accounted for approximately 11.3%, 10.5% and 10.9% of the Company's net sales in fiscal 1999, fiscal 2000 and fiscal 2001, respectively.
AUTOMOTIVE. The automotive industry uses both iron and aluminum castings, as well as aluminum die castings. ACC entered this market through the purchase of Jahn Foundry in Springfield, Massachusetts and Inverness Castings Group, Inc. ("Inverness") in Dowagiac, Michigan. Customers in this market include General Motors and DaimlerChrysler, among others.
ENERGY. The Company's products for the energy market include pumps, valves and compressors for transmission and refining of petrochemicals, blow-out preventers and mud pumps for drilling and work-over of wells, lifting hooks and shackles for offshore installation of equipment, winch components for rig positioning, nodes for platform construction, subsea components and other oil field castings. Shell, Amoco, Aker-Verdal, Shaffer, Rolls Royce, Hydril, Solar Turbines, Nordstrom, Ingersoll-Dresser Pumps and Amclyde are among the Company's many energy-related customers.
UTILITIES. Many of ACC's castings are used in products for the utility industry, such as pumps, valves and gas compressors. ACC also makes steam, gas and hydroelectric turbine castings, nuclear plant components, sewage treatment parts and other castings for the utility industry. In addition, the Company manufactures replacement products that are used when customers perform refurbishments. Customers include Siemens Westinghouse, General Electric, Solar Turbines, GEC-Alsthom, Sulzer, Siemens, Kvaerner, Goulds Pumps and Neles Controls.
MASS TRANSIT. ACC began making undercarriages for passenger rail cars in 1992 and is a leading casting supplier to the mass transit market. The Company's castings are used on the BART system in San Francisco, METRA in Chicago, NCTD in San Diego, MARTA in Atlanta, and in Miami and Vancouver. La Grange casts components used in subway cars in several cities, including New York City, which is the largest user of subway cars in North America.
MILITARY. Weapons and equipment for the Army, Navy and Coast Guard employ many different types of castings. The Company makes components for ships, battle tanks, howitzers and other heavy weapons. The capabilities of Sheffield has allowed ACC to bid on a wider range of work for the U.S. Navy. The military casting market has declined sharply, but ACC has been able to replace this volume by targeting new products such as turbines, compressors, pumps and valves. Customers in this market include General Dynamics, Litton, Bath Iron Works, Boeing, SEI, the U.S. Army and Avondale Shipyards, among others.
TRUCKING. The Company manufactures components used on truck engines and suspension systems. Many of ACC's castings are used in aftermarket products to achieve better fuel economy or to enhance ride characteristics. Customers include Horton Industries, Detroit Diesel and others.
FARM EQUIPMENT. ACC makes a variety of castings for farm tractors, baling equipment, harvesters, sugar cane processors and other agricultural equipment for customers such as John Deere, Caterpillar and New Holland.
OTHER. Other markets include process equipment such as rubber mixers, plastic extruders, dough mixers, machine tools and a variety of general industrial applications. With the acquisition of LA Die Casting, the Company entered the consumer market. LA Die Casting supplies components used to make recreational vehicles, computer peripherals, direct satellite receivers, telescopes and pool tables. Customers include California Amplifier, RC Design, Celestron and Printronix. As discussed above, LA Die Casting may be sold.
For financial information about geographic areas, see Note 20 to the consolidated financial statements.
SALES AND MARKETING
New foundry technologies and the new applications resulting therefrom require a more focused and knowledgeable sales force. The Company pursues an integrated sales and marketing approach that includes senior management, engineering and technical professionals, production managers and others, all of whom work closely with customers to better understand their specific requirements and improve casting designs and manufacturing processes. The Company supplements its direct sales
effort with participation in trade shows, marketing videos, brochures, technical papers and customer seminars on new casting designs.
The Company's engineering and technical professionals are actively involved in marketing and customer service, often working with customers to improve existing products and develop new casting products and applications. They typically remain involved throughout the product development process, working directly with the customer to design casting patterns, build the tooling needed to manufacture the castings and sample the castings to ensure they meet customers' specifications. The Company believes that the technical assistance in product development, design, manufacturing and testing that it provides to its customers gives it an advantage over its competition.
Customers tend to develop long-term relationships with foundries that can provide high quality, machined castings delivered on a just-in-time basis that do not require on-site inspection. Frequently, the Company is the only current source for the castings that it produces. Maintaining duplicate tooling in multiple locations is costly, so customers prefer to rely on one supplier for each part number. Moving the tooling to another foundry is possible, however, such a move entails considerable time and expense on the customer's part. In addition, ACC is forming product development partnerships with a number of customers to develop new applications for castings.
BACKLOG
The Company's backlog is based upon customer purchase orders that the Company believes are firm and does not include purchase orders anticipated but not yet placed. At June 30, 2001, the Company's backlog was approximately $206.8 million, as compared to backlog of approximately $168.6 million at June 30, 2000. The backlog is scheduled for delivery in fiscal 2002 except for approximately $36.9 million, of which $27.8 million is scheduled for delivery in fiscal 2003. The level of backlog at any particular time is not necessarily indicative of the future operating performance of the Company. The Company historically has not experienced cancellation of any significant portion of customer orders.
COMPETITION
The Company competes with a number of foundries in one or more product lines, although none of the Company's competitors compete with it across all product lines. The principal competitive factors in the castings market are quality, delivery and price; however, breadth of capabilities and customer service have become increasingly important. The Company believes that it is able to compete successfully in its markets by: (i) offering high quality, machined castings; (ii) working with customers to develop and design new castings; (iii) providing reliable delivery and short lead-times; (iv) containing its manufacturing costs, thereby pricing competitively; and (v) offering a broad range of cast materials.
The Company believes that the market for iron and steel castings is attractive because of a relatively favorable competitive environment, high barriers to entry and the opportunity to form strong relationships with customers. New domestic competitors are unlikely to enter the foundry industry because of the high cost of new foundry construction, the need to secure environmental approvals at a new foundry location, the technical expertise required and the difficulty of convincing customers to switch to a new, unproven supplier.
ACC, and the foundry industry in general, competes with manufacturers of fabrications in some application areas. The Company believes that the relative advantages of castings, particularly in light of new casting design technology, which reduces weight, cost and leadtime while improving casting quality, will lead to increased replacement of fabrications by iron and steel castings. The Company competes with foundries in Asia, Europe and North America.
MANUFACTURING
CASTINGS. Casting is one of several methods, along with forging and fabricating, which shape metal into desired forms. Castings are made by pouring or introducing molten metal into a mold and allowing the metal to cool until it solidifies, creating a monolithic component. Some castings, such as die castings, are made with a permanent metal mold which can be used repeatedly. Others, such as sand castings, are made in a sand mold which is used only once. Forgings are made by shaping solid metal with pressure, usually in a die or with hammers. Fabrications are made by welding together separate pieces of metal. Castings may offer significant advantages over forgings and fabrications. A well-designed casting can be lighter, stronger and more stress and corrosion resistant than a fabricated part. Although castings and forgings are similar in several respects, castings are generally less expensive than forgings.
CASTING PROCESS. The steel casting manufacturing process involves melting steel scrap in electric arc or induction furnaces, adding alloys, pouring the molten metal into molds made of sand or iron and removing the solidified casting for cleaning, heat treating and quenching prior to machining the casting to final specifications. The manufacture of a steel casting begins with the molding process. Initially, a pattern constructed of wood, aluminum or plastic is created to duplicate the shape of the desired casting. The pattern, which has similar exterior dimensions to the final casting, is positioned in a flask and foundry sand is packed tightly around it. After the sand mold hardens, the pattern is removed. When the sand mold is closed, a cavity remains within it shaped to the contours of the removed pattern. Before the mold is closed, sand cores are inserted into the cavity to create internal passages within the casting. For example, a core would be used to create the hollow interior of a valve casing. With the cores in place, the mold is closed for pouring. Castings for rolls are sometimes made by stirring the mold while the liquid steel or iron is being poured into it.
Steel scrap and alloys are melted in an electric arc furnace at approximately 2,900 degrees Fahrenheit, and the molten metal is poured from a ladle into molds. After pouring and cooling, the flask undergoes a "shakeout" procedure in which the casting is removed from the flask and vibrated to remove sand. The casting is then moved to a blasting chamber for removal of any remaining foundry sand and scale. Next, the casting is sent to the cleaning room, where an extensive process removes all excess metal. Cleaned castings are put through a heat treating process, which improves properties such as hardness and tensile strength through controlled increases and decreases in temperature. A quench tank to reduce temperatures rapidly is also available for use in heat treatment. The castings are shot blasted again and checked for dimensional accuracy. Each casting undergoes a multi-stage quality control procedure before being transported to one of the Company's or the customer's machine shops for any required machining.
Iron castings are processed similarly in many respects to steel castings. Melting and pouring temperatures for molten iron are approximately 2,400 degrees Fahrenheit, and less cleaning and finishing is required for iron castings than is typically required for steel castings. Iron and steel scrap may both be used in making cast iron.
Die casting, as contrasted to sand casting, uses a permanent metal mold that is reused. Melting and pouring temperatures for aluminum and zinc are less than half that used for steel, and die castings normally require less cleaning than iron or steel castings.
FORGING PROCESS. The forging process applies pressure by hitting or pressing a heated ingot or wrought steel blank. The forged piece is then heat-treated and machined much in the same manner as a steel casting.
MATERIALS. Steel is more difficult to cast than iron, copper or aluminum because it melts at higher temperatures, undergoes greater shrinkage as it solidifies, causing the casting to crack or tear if the mold is not properly designed, and is highly reactive with oxygen, causing chemical impurities to form as it is poured through air into the mold. Despite these challenges, cast steel has become a vital material due to its superior strength compared to other ferrous metals. In addition, most of the beneficial properties of steel match or exceed those of competing ferrous metals. The Company's first foundry, which today forms Atchison Steel Casting & Machining, produced carbon and low alloy steel castings when it was acquired from Rockwell International in 1991. ACC added an AOD vessel for making stainless steel in order to better supply the pump and valve markets, which sometimes require stainless steel castings to be made from the same patterns used for carbon steel castings. Also in 1994, ACC purchased Quaker Alloy, which specializes in casting high alloy and stainless steels for valves, pumps and other equipment. Sheffield, Canadian Steel and Canada Alloy Castings, Ltd. ("Canada Alloy") also make high alloy and stainless castings, further reinforcing ACC's market position and skill base concerning the casting of stainless and specialty, high alloy steels.
In applications that do not require the strength, ductility and/or weldability of steel, iron castings are generally preferred due to their lower cost, shorter lead-times and somewhat simpler manufacturing processes. Ductile iron is stronger and more flexible than traditional cast iron, known as gray iron, and is easier and less expensive to cast than steel. Due to these qualities, the demand for ductile iron is increasing faster than for either traditional gray cast iron or cast steel. In 1994, ACC initiated manufacturing of gray and ductile iron through the acquisition of Prospect. ACC's presence in ductile iron was increased through the subsequent purchases of La Grange and The G&C Foundry Company ("G&C").
Aluminum castings (including die castings) generally offer lighter weight than iron or steel, and are usually easier to cast because aluminum melts at a lower temperature. These advantages, coupled with low prices for aluminum during the last decade, have led to a substantial increase in the use of aluminum castings, especially in motor vehicles. Aluminum's relative softness, lower tensile strength and poor weldability limit its use in many applications where iron and steel castings are currently employed. In 1996, ACC entered the nonferrous market with the purchase of LA Die Casting, which die casts aluminum and zinc.
Steel, unlike iron, can be forged as well as cast. Forging compresses steel, and is preferred for some critical applications like nuclear vessels, turbine shafts and pressure vessels, among others.
The ability to provide cast and forged components in a broad range of materials allows ACC to present itself as a "one-stop shop" for some customers and simplifies purchasing for others. Since customers in general have a goal of reducing their total number of suppliers, a broader range of materials and casting skills gives ACC an advantage over many other foundry operations.
MACHINING. The Company machines many of its steel castings, typically to tolerances within 30 thousandths of an inch. Some castings are machined to tolerances of one thousandth of an inch. Machining includes drilling, threading or cutting operations. The Company's Sheffield, St. Joe, Amite, Inverness and London Precision machine shops have a wide variety of machine tools, including CNC machine tools. The Company also machines some of its castings at Canadian Steel, Quaker Alloy and Kramer. The ability to machine castings provides a higher value-added product to the customer and improved quality. Casting imperfections, which are typically located near the surface of the casting, are usually discovered during machining and corrected before the casting is shipped to the customer.
NON-DESTRUCTIVE TESTING. Customers typically specify the physical properties, such as hardness and strength, which their castings are to possess. The Company determines how best to meet those specifications. Regular testing and monitoring of the manufacturing process are necessary to
maintain high quality and to ensure the consistency of the castings. Electronic testing and monitoring equipment for tensile, impact, radiography, ultrasonic, magnetic particle, dye penetrant and spectrographic testing are used extensively to analyze molten metal and test castings.
ENGINEERING AND DESIGN. The Company's process engineering teams assist customers in designing castings and work with manufacturing departments to determine the most cost effective manufacturing process. Among other computer-aided design techniques, the Company uses three-dimensional solid modeling and solidification software. This technology reduces the time required to produce sample castings for customers by several weeks and improves the casting design.
CAPACITY UTILIZATION. The following table shows the type and the approximate amount of available capacity, in tons, for each operating foundry and die caster. The actual number of tons that a foundry can produce annually is dependent on product mix. Complicated castings, such as those used for military applications or in steam turbines, require more time, effort and use of facilities, than do simpler castings such as those for the mining and construction market. Also, high alloy and stainless steel castings generally require more processing time and use of facilities than do carbon and low alloy steel castings.
* Estimated annual capacity and utilization are based upon management's estimate of the applicable manufacturing unit's theoretical capacity assuming a certain product mix and assuming such unit operated five days a week, three shifts per day and assuming normal shutdown periods for maintenance. Actual capacities will vary, and such variances may be material, based upon a number of factors, including product mix and maintenance requirements.
RAW MATERIALS
The principal raw materials used by the Company include scrap iron and steel, aluminum, zinc, molding sand, chemical binders and alloys, such as manganese, nickel and chrome. The raw materials utilized by the Company are available in adequate quantities from a variety of sources. From time to time the Company has experienced fluctuations in the price of scrap steel, which accounts for approximately 4% of net sales, and alloys, which account for less than 2% of net sales. The Company has generally been able to pass on the increased costs of raw materials and has escalation clauses for scrap with certain of its customers. As part of its commitment to quality, the Company issues rigid specifications for its raw materials and performs extensive inspections of incoming raw materials.
QUALITY ASSURANCE
The Company has adopted sophisticated quality assurance techniques and policies which govern every aspect of its operations to ensure high quality. During and after the casting process, the Company performs many tests, including tensile, impact, radiography, ultrasonic, magnetic particle, dye penetrant and spectrographic tests. The Company has long utilized statistical process control to measure and control dimensions and other process variables. Analytical techniques such as Design of Experiments and the Taguchi Method are employed for troubleshooting and process optimization.
As a reflection of its commitment to quality, the Company has been certified by, or won supplier excellence awards from, substantially all of its principal customers. Of 600 suppliers to General Motors' Electromotive Division, the Company was the first supplier to receive the prestigious Targets of Excellence award. Reflecting its emphasis on quality, Atchison Steel Casting & Machining was certified to ISO 9001 in August 1995, which represents compliance with international standards for quality assurance. Quaker Alloy, La Grange, Canada Alloy, Jahn Foundry, G & C, Inverness, London Precision, Forgemasters Rolls and Canadian Steel have each been certified to ISO 9002. Sheffield Forgemasters Engineering Ltd. ("Forgemasters Engineering") has been certified to ISO 9001. Other ACC foundries are preparing for ISO certification.
EMPLOYEE AND LABOR RELATIONS
As of June 30, 2001, the Company had approximately 3,800 full-time employees. Since its inception, the Company has had two work stoppages. The Company's hourly employees are covered by collective bargaining agreements with several unions at fifteen of its locations. These agreements expire at varying times over the next several years. The following table sets forth a summary of the principal unions and term of the principal collective bargaining agreements at the respective locations in operation. The labor laws of France prevent the Company from learning the number of employees in the union at Autun.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to the executive officers of the Company.
HUGH H. AIKEN has been the Chairman of the Board, President, Chief Executive Officer and a Director since June 1991. From 1989 to 1991, Mr. Aiken served as an Associate of Riverside Partners, Inc., an investment firm located in Boston, Massachusetts, and from 1985 to 1989, Mr. Aiken served as General Manager for AMP Keyboard Technologies, Inc., a manufacturer of electromechanical assemblies located in Milford, New Hampshire. Mr. Aiken previously served as a Director and Chief Operating Officer of COMNET Incorporated and as a Director and Chief Executive Officer of General Computer Systems, Inc., both public companies.
THOMAS K. ARMSTRONG, JR. has been Chief Operating Officer - North America since March 1999. From 1987 to 1999, Mr. Armstrong served as President of Texas Steel Co., a Citation Corp. company. From 1979 to 1986, Mr. Armstrong held positions at Texas Steel of Executive Vice President, Information Systems and Engineering Manager. In addition, Mr. Armstrong served as Chief Executive Officer of Southwest Steel Casting Corp., a Texas Steel subsidiary, from 1984 through 1989. Mr. Armstrong began his career as an engineer with E.I. DuPont from 1976 through 1979. From 1997 to 1999 he has served as President of the Steel Founders' Society of America.
DAVID FLETCHER has been Vice President and Chairman and CEO of Atchison Casting UK Limited and the Sheffield Forgemasters Group since April 1998. Prior to this he was Chief Executive Officer of the Sheffield Forgemasters Group in Sheffield, England, having joined the group in 1986 as the main board director responsible for the Engineering group of companies comprising Forgemasters Steel & Engineering Limited, River Don Castings Limited, Forged Rolls (UK) Limited and British Rollmakers Corporation. From 1977 to 1986, Mr. Fletcher was Managing Director of various subsidiaries of the Aurora Group, including Darwin Alloy Castings, Edgar Allen Foundry, Willen Metals and Aurora Steels.
JOHN R. KUJAWA has been Vice President - Large Steel Castings since August 1999. Prior to this he was Vice President - Atchison/St. Joe and Amite from November 1996 to August 1999 and Vice President-Atchison/St. Joe from August 1994 to November 1996. He served as Executive Vice President-Operations of the Company from July 1993 to August 1994, Vice President-Foundry of the Company from June 1991 to July 1993, Assistant Foundry Manager of the Company from 1990 to
1991 and as Senior Process Engineer of the Company from 1989 to 1990. He served as Operations Manager for Omaha Steel Castings, a foundry in Omaha, Nebraska, from 1984 to 1989.
KEVIN T. MCDERMED has been Vice President, Chief Financial Officer and Treasurer of the Company since June 1991 and has served as Secretary of the Company since May 1992. He served as the Controller of the Company from 1990 to June 1991 and as its Finance Manager from 1986 to 1990. Mr. McDermed has been with the Company since 1981.
JAMES STOTT has been Vice President - Kramer since May 1998. He served as Vice President - Empire, Kramer, Pennsylvania Steel and Quaker Alloy from November 1996 to May 1998 and Vice President - Kramer from January 1995 to November 1996. He has served as President, Chief Executive Officer and Chief Operating Officer of Kramer International, Inc. (the predecessor of Kramer) since 1980.
PRODUCT WARRANTY
The Company warrants that every product will meet a set of specifications, which is mutually agreed upon with each customer. The Company's written warranty provides for the repair or replacement of its products and excludes contingency costs. Often, the customer is authorized to make the repair within a dollar limit, in order to minimize freight costs and the time associated therewith. In fiscal 2001, warranty costs amounted to less than one percent of the Company's net sales.
ENVIRONMENTAL REGULATIONS
Companies in the foundry industry must comply with numerous federal, state and local (and, with respect to Canadian, France and U.K. operations, federal, provincial and local) environmental laws and regulations relating to air emissions, solid waste disposal, stormwater runoff, landfill operations, workplace safety and other matters. The Clean Air Act, as amended, the Clean Water Act, as amended, and similar provincial, state and local counterparts of these federal laws regulate air and water emissions and discharges into the environment. The Resource Conservation and Recovery Act, as amended, and the Comprehensive Environmental Response, Compensation and Liability Act, as amended ("CERCLA"), among other laws, address the generation, storage, treatment, transportation and disposal of solid and hazardous waste and releases of hazardous substances into the environment, respectively. The Company believes that it is in material compliance with applicable environmental laws and regulations, other than violations or citations, the resolution of which would not have a material adverse effect on the Company's financial condition and results of operations.
A Phase I environmental assessment of each of the Company's facilities has been performed, and no significant or widespread contamination has been identified at any Company facility. A Phase I assessment includes an historical review, a public records review, a preliminary investigation of the site and surrounding properties and the preparation and issuance of a written report, but it does not include soil sampling or subsurface investigations. There can be no assurance that these Phase I assessments have identified, or could be expected to identify, all areas of contamination. As the Company evaluates and updates the environmental compliance programs at foundry facilities recently acquired, the Company may become aware of matters of noncompliance that need to be addressed or corrected. In addition, there is a risk that material adverse conditions could have developed at the Company's facilities since such assessments. Groundwater testing confirmed that solvent and metals contamination is migrating off of a property owned by Inverness. Current estimates suggest that corrective action costs could be in excess of $400,000.
The chief environmental issues for the Company's foundries are air emissions and solid waste disposal. Air emissions, primarily dust particles, are handled by dust collection systems. The
Company anticipates that it will incur additional capital and operating costs to comply with the Clean Air Act Amendments of 1990 and the regulations that are in the process of being promulgated thereunder. The Company is currently in the process of obtaining permits under the new regulations and estimating the cost of compliance with these requirements and the timing of such costs. Such compliance costs, however, could have a material adverse effect on the Company's results of operations and financial condition.
The solid waste generated by the Company's foundries generally consists of nonhazardous foundry sand that is reclaimed for reuse in the foundries until it becomes dust. Nonhazardous foundry dust waste is then disposed of in landfills, two of which are owned by the Company (one in Atchison County, Kansas, and one in Myerstown, Pennsylvania). No other parties are permitted to use the Company's landfills, which are both in material compliance with all applicable regulations to the Company's knowledge. Costs associated with the future closure of the landfills according to regulatory requirements could be material. In the event a foundry generates waste that is identified as hazardous, then a hazardous waste permit is obtained and the Company complies in all material respects with its provisions for the collection, storage and disposal of hazardous waste.
The Company also operates pursuant to regulations governing work place safety. The Company samples its interior air quality to ensure compliance with OSHA requirements. To the Company's knowledge, it currently operates in material compliance with all OSHA and other regulatory requirements governing work place safety, subject to Jahn Foundry's compliance with the settlement agreement with OSHA in connection with the industrial accident at Jahn Foundry on February 25, 1999.
The Company continues to evaluate its manufacturing processes and equipment (including its recently acquired facilities) to ensure compliance with the complex and constantly changing environmental laws and regulations. Although the Company believes it is currently in material compliance with such laws and regulations, the operation of casting manufacturing facilities entails environmental risks, and there can be no assurance that the Company will not be required to make substantial additional expenditures to remain in or achieve compliance in the future.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal facilities are listed in the accompanying table, together with information regarding their location, size and primary function. The two landfills are used solely by the Company and contain nonhazardous materials only, principally foundry sand. All of the Company's principal facilities are owned.
The following table sets forth certain information with respect to the Company's principal facilities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
An accident, involving an explosion and fire, occurred on February 25, 1999, at Jahn Foundry, located in Springfield, Massachusetts. Nine employees were seriously injured and there were three fatalities. The damage was confined to the shell molding area and boiler room. The other areas of the foundry remained operational. Molds were being produced at other foundries, as well as Jahn Foundry, while repairs were made. The new shell molding department became operational in November 2000.
The Company carries insurance for property and casualty damages (over $475 million of coverage), business interruption (approximately $115 million of coverage), general liability ($51 million of coverage) and workers' compensation (up to full statutory liability) for itself and its subsidiaries. The Company recorded charges of $750,000 during the third quarter of fiscal 1999, primarily reflecting the deductibles under the Company's various insurance policies. At this time there can be no assurance that the Company's ultimate costs and expenses resulting from the accident will not exceed available insurance coverage by an amount which could be material to its financial condition or results of operations and cash flows.
In November 2000, the Company and its insurance carrier settled the Jahn Foundry property portion of the Company's claim. The settlement provided, among other things, for (i) additional payments from the carrier in the amount of $2.6 million, (ii) that of the payments received to date, totaling $26.8 million, the insurance carrier will allocate no more than $9.5 million for property damage, (iii) that the remaining proceeds of $17.3 million will be allocated to business interruption losses and will not be subject to recovery by the insurance carrier and (iv) that the Company shall not be entitled to any additional payments unless it is determined by reference, appraisal, arbitration, litigation or otherwise that the Company's business interruption losses exceed $17.3 million. The Company disagrees with the insurance carrier regarding the duration and amount of the business interruption losses. The Company plans to seek additional insurance payments through arbitration. There can be no assurance that the Company will ultimately receive any additional insurance payments or that the excess of the Company's costs and expenses resulting from the accident over the insurance payments received will not be material to its financial condition or results of operations and cash flows.
A civil action has been commenced in Massachusetts Superior State Court on behalf of the estates of deceased workers, their families, injured workers and their families, against the supplier of a chemical compound used in Jahn Foundry's manufacturing process. The supplier of the chemical compound, Borden Chemical, Inc., filed a Third Party Complaint against Jahn Foundry in Massachusetts Superior State Court on February 2, 2000 seeking indemnity for any liability it has to the plaintiffs in the civil action. The Company's comprehensive general liability insurance carrier has retained counsel on behalf of Jahn Foundry, and the Company and is aggressively defending Jahn Foundry in the Third Party Complaint. It is too early to assess the potential liability to Jahn Foundry for the Third Party Complaint, which in any event Jahn Foundry will aggressively defend. In addition, Jahn Foundry has brought a Third Party Counterclaim against Borden and the independent sales representative of the chemical compound, J.R. Oldhan Company, seeking compensation for losses sustained in the explosion, including amounts covered by insurance.
On February 26, 2001, Borden filed a Third Party Complaint against the Company seeking contribution, under Massachusetts law, from the Company in the event that the plaintiffs prevail against Borden. The Third Party Complaint alleges that the Company undertook a duty to oversee industrial hygiene, safety and maintenance at Jahn Foundry and that the Company designed, installed and maintained equipment and machinery at Jahn Foundry, and that the Company's carelessness, negligence or gross negligence caused the explosion and resulting injuries. It is too early to assess the potential liability for such a claim, which in any event the Company will aggressively defend.
On March 30, 2001, the plaintiffs amended their complaint by adding the Company as a third party defendant. The plaintiffs allege that the Company undertook a duty to oversee industrial hygiene, safety and maintenance at Jahn Foundry and that the Company's carelessness, negligence or gross negligence
caused the explosion and resulting injuries. The plaintiffs seek an unspecified amount of damages and punitive damages. It is too early to assess the potential liability to the Company for such claims, which in any event the Company will aggressively defend. The Company has filed a cross-claim for contribution against Borden and J.R. Oldhan Company.
The Company, its chief executive officer, and its chief financial officer were named as defendants in five lawsuits filed following the Company's announcements concerning the discovery of accounting irregularities at the Pennsylvania Foundry Group. The cases have been consolidated before the U.S. District Court for the District of Kansas. An amended complaint filed after the consolidation alleges, among other things, that the defendants intentionally or recklessly issued materially false and misleading financial statements in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. That complaint seeks certification of a class of purchasers of the Company's common stock between December 10, 1997 and November 3, 2000 and asks for damages for the class in an unspecified amount. Discovery has been stayed pending the resolution of the defendants' motion to dismiss the amended complaint. The Company believes the claims are without merit and intends to defend them vigorously. There can be no assurance, however, that an adverse outcome with respect to the case will not have a material adverse impact on the Company's financial condition, results of operations, or cash flows.
The Company understands that on or about November 29, 2000 the Securities and Exchange Commission issued a formal order of investigation as a result of the events underlying the Company's earlier disclosure of certain accounting irregularities. The Company is cooperating with the investigation.
In addition to these matters, from time to time, the Company is the subject of legal proceedings, including employee matters, commercial matters, environmental matters and similar claims. There are no other material claims pending. The Company maintains comprehensive general liability insurance, which it believes to be adequate for the continued operation of its business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on June 29, 2001.
Stockholders owning 7,166,639 shares voted in favor of David D. Colburn as a Class I director. There were 743,955 shares withheld. Stockholders owning 7,138,812 shares voted in favor of Hugh H. Aiken as a Class I director. There were 771,781 shares withheld. Accordingly, Mr. Colburn and Mr. Aiken were elected as Class I directors for a term of three years. Previously elected and continuing to serve their terms are David L. Belluck, Ray H. Witt and Stuart Z. Uram.
Stockholders owning 3,886,859 shares voted in favor of adopting the Shareholder Rights Plan and the Rights Agreement dated as of March 28, 2000 between the Company and American Stock Transfer & Trust Company, as amended. There were 1,891,944 shares voted against, 9,181 shares abstained and 1,901,363 broker non-votes. Accordingly, the Shareholders Rights Plan and the Rights agreement has been adopted.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK
The Common Stock is traded on the New York Stock Exchange under the symbol "FDY." The following table sets forth the high and low sales prices for the shares of Common Stock on the New York Stock Exchange for the periods indicated.
As of October 9, 2001, there were over 2,200 holders of the Common Stock, including shares held in nominee or street name by brokers.
DIVIDEND POLICY
The Company has not declared or paid cash dividends on shares of its Common Stock. The Company does not anticipate paying any cash dividends or other distributions on its Common Stock in the foreseeable future. The current policy of the Company's Board of Directors is to reinvest all earnings to finance the expansion of the Company's business. The agreements governing the Company's credit facility and $20 million senior notes contain limitations on the Company's ability to pay dividends. See Note 10 to the consolidated financial statements.
UNREGISTERED SECURITIES TRANSACTIONS
In lieu of cash compensation for services rendered in their capacity, as Directors of the Company, Mr. David Belluck, Mr. David D. Colburn, Mr. Ray Witt, and Mr. Stuart Uram were each provided at their election 8,421 shares of common stock on September 10, 2001, with a then-current market value of $2.85 per share. Such transactions were exempt from registration under the Securities Act of 1993, as amended (the "Act"), pursuant to Section 4(2) of the Act.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table contains certain selected historical consolidated financial information and is qualified by the more detailed Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K. The information below should be read in conjunction with the Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.
(1) Other income consists of a $3.5 million gain resulting from a revision to the flood damage reconstruction reserve, partially offset by a charge of $750,000 recorded in connection with an industrial accident that occurred on February 25, 1999 at Jahn Foundry.
(2) Impairment charges consist of a $3.4 million charge relating to the Company's planned closure of Claremont Foundry, Inc. ("Claremont"), a $6.9 million charge relating to an impairment of long-lived assets at PrimeCast, Inc., a $3.4 million charge relating to the impairment of long-lived assets at Pennsylvania Steel Foundry & Machine Company and a $2.7 million charge relating to an impairment of goodwill at Empire Steel Castings, Inc ("Empire Steel").
(3) Other income consists primarily of gains of $1.1 million on the termination of interest rate swap agreements.
(4) Includes a $7.8 million deferred income tax benefit relating to the resolution of the Company's tax treatment of certain flood insurance proceeds received in fiscal 1995 and 1996.
(5) Impairment charges consist of a $1.6 million charge relating to the Company's planned closure of Empire Steel, a $2.7 million charge relating to an impairment of goodwill at Los Angeles Die Casting ("LA Die Casting" and a $13.9 million charge relating to the impairment of long-lived assets at Jahn Foundry Corp ("Jahn Foundry").
(6) Includes a $10.9 million gain relating to the industrial accident that occurred on February 25, 1999 at Jahn Foundry
(7) There have been no cash dividends paid during fiscal year 1997 through 2001.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Prior to fiscal 2000, the Company pursued an active acquisition program designed to take advantage of consolidation opportunities in the widely fragmented foundry industry. The Company has acquired nineteen foundries, closed, or is in the process of closing, four foundries and is in the process of selling two foundries since its inception. The Company did not make any acquisitions in fiscal 2000 or 2001 and is not currently contemplating any acquisitions in fiscal 2002. The Company's primary focus in fiscal 2002 will be on the integration and improvement of existing operations.
Due to the large size of certain orders, the timing for deliveries of orders and the number and types of castings produced, the Company's net sales and net income may fluctuate materially from quarter to quarter. Generally, the first fiscal quarter is seasonally weaker than the other quarters as a result of plant shutdowns for maintenance at most of the Company's foundries as well as at many customers' plants. See "Supplemental Quarterly Information."
RESULTS OF OPERATIONS
The following discussion of the Company's financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto and other financial information included elsewhere in this Report.
FISCAL YEAR ENDED JUNE 30, 2001 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2000
Net sales for fiscal 2001 were $428.2 million, representing a decrease of $32.9 million, or 7.1%, from net sales of $461.1 million in fiscal 2000. This 7.1% decrease in net sales was due primarily to decreases in net sales to the offshore oil and gas, military, mining, automotive and power generation markets. Net sales of Sheffield Forgemasters Group Limited ("Sheffield") for fiscal 2001 decreased $6.6 million from net sales in fiscal 2000. In addition to the weak market conditions, net sales have also been impacted by the bankruptcy and subsequent cessation of operations of a major customer at the Company's PrimeCast, Inc. ("PrimeCast") subsidiary. Through fiscal 2000, PrimeCast aggressively worked at replacing the volume lost from Beloit Corporation ("Beloit"), which filed for bankruptcy in June 1999. During February 2000, Beloit was sold at auction, in parts, and as a result, the plants to which PrimeCast supplied castings subsequently ceased operations. For fiscal 2001, PrimeCast's net sales decreased $9.7 million from net sales in fiscal 2000. In addition, the Company closed Claremont Foundry, Inc. ("Claremont") in November 2000. Claremont's net sales for fiscal 2001 decreased $3.1 million from net sales in fiscal 2000.
Gross profit for fiscal 2001 decreased by $13.9 million, or 33.3%, to $27.9 million, or 6.5% of net sales, compared to $41.8 million, or 9.1% of net sales, for fiscal 2000. The decrease in gross profit and gross profit as a percentage of net sales was primarily due to lower net sales and reduced absorption of overhead at the Company's subsidiaries which primarily serve the mining, offshore oil and gas, automotive, power generation and military markets. In addition, increased fuel costs decreased gross profit by approximately $7.0 million in fiscal 2001 compared to fiscal 2000.
Gross profit at Jahn Foundry Corp. ("Jahn Foundry") in fiscal 2001 decreased $4.5 million, to a gross loss of $3.3 million, or 39.4% of net sales, compared to a gross profit of $1.2 million, or 11.2% of net sales, in fiscal 2000. The negative impact to gross profits primarily resulted from the industrial accident in February 1999 that shut down the shell mold department until the second quarter of fiscal 2001.
The loss of Beloit as a major customer also had a negative effect on gross profit. PrimeCast's gross profit for fiscal 2001 decreased by $3.8 million to a gross loss of $4.3 million, compared to a gross loss of $582,000 for fiscal 2000. The Company completed the closure of PrimeCast by March 31, 2001. As PrimeCast was the Company's only foundry that could produce large iron castings, only a portion of PrimeCast's work was transferred to other operations of the Company.
During fiscal 2001, the Company's reserve for warranty expense decreased to $9.0 million at June 30, 2001 from $9.8 million at June 30, 2000. The decrease in the warranty reserve during fiscal 2001 primarily related to the Company's Sheffield subsidiary located in the United Kingdom. The Company maintains reserves for warranty charges based on specific claims made by customers, for which management estimates a final settlement of the claim, and for expected claims not yet received. The estimate for claims not yet received is based on historical results and is estimated monthly. During fiscal 2001, the Company's warranty reserve requirement declined primarily due to better than expected results relative to the historical estimates for cast back-up rolls.
During fiscal 2001, the Company's reserve for workers' compensation and employee health care increased to $4.0 million at June 30, 2001 from $3.8 million at June 30, 2000. Workers' compensation and employee health care expense was $16.8 million for fiscal 2001, compared to $17.4 million in fiscal 2000. The increase in the reserve for workers' compensation and employee health care primarily reflects changes in the amount and timing of actual payments.
Selling, general and administrative expense ("SG&A") for fiscal 2001 was $44.2 million, or 10.3% of net sales, compared to $44.5 million, or 9.7% of net sales, in fiscal 2000. The increase in SG&A expense as a percentage of net sales is primarily due to the decrease in net sales. Included in SG&A in fiscal 2001 were expenses of approximately $1.3 million relating to fees and audit and appraisal expenses incurred by the Company in pursuing various options to refinance its bank credit facility. Also included in fiscal 2001 were expenses of approximately $800,000, relating to the investigation of the accounting irregularities at the Company's Pennsylvania Foundry Group of operations.
Amortization of certain intangibles for fiscal 2001 was $1.4 million, or 0.3% of net sales, compared to $1.5 million, or 0.3% of net sales, in fiscal 2000. The intangible assets consist of goodwill recorded in connection with certain of the Company's acquisitions. The Company has also recorded a liability, consisting of the excess of acquired net assets over cost ("negative goodwill"), in connection with the acquisitions of Canadian Steel Foundries Ltd. ("Canadian Steel") and Fonderie d'Autun ("Autun"). The amortization of negative goodwill was a credit to income in fiscal 2001 of $1.6 million, or 0.4% of net sales, as compared to $1.9 million, or 0.4% of net sales, in fiscal 2000. The liability recorded in connection with the acquisition of Canadian Steel became fully amortized in the second quarter of fiscal 2000.
Impairment charges for fiscal 2001 were $18.1 million, which consisted of a $1.6 million fixed asset impairment charge relating to the Company's planned closure of Empire Steel Castings, Inc. ("Empire Steel"), a $13.9 million fixed asset impairment charge relating to the Company's intent to sell Jahn Foundry Corp. ("Jahn Foundry"), and a $2.7 million intangible asset impairment charge relating to the Company's intent to sell Los Angeles Die Casting Inc. ("LA Die Casting"). (See below).
Following continued losses in fiscal 2001, the Company announced, on August 31, 2001, plans to close Empire. Accordingly, the carrying values of Empire Steel's fixed assets were written down to the Company's estimate of fair value, which was based on discounted future cash flows. The resulting impairment charge of $1.6 million to reduce the carrying value of these fixed assets was recorded in the fourth quarter ended June 30, 2001. Actual
results could vary significantly from such estimates. Prior to the impairment charge, these assets had a carrying value of $2.6 million. The Company plans to close Empire Steel by November 30, 2001, and transfer as much work as possible to other Company locations. The Company will terminate approximately 130 employees and will recognize a charge for severance benefits of approximately $89,000 in the quarter ended December 31, 2001.
The Company is negotiating the sale of substantially all of the assets of LA Die Casting. Under the terms of the proposed agreement, the Company would receive approximately $4.5 million in cash in exchange for certain assets and the assumption of certain liabilities by the buyer, subject to certain post-closing adjustments. There can be no assurance that a definitive agreement will ultimately be executed or consummated. If executed and consummated, it is anticipated that this transaction would close during the second quarter of fiscal 2002.
In the fourth quarter of fiscal 2001, the Company recognized an impairment charge of $2.7 million to write-down the carrying value of the intangible assets at LA Die Casting to the Company's estimate of fair value. The Company considered its decision to realign its operations, resulting in its decision to dispose of LA Die Casting as the primary indicator of impairment. Prior to the impairment charge, the intangible assets had a carrying value of $3.5 million. For fiscal years 1999, 2000 and 2001, LA Die Casting recorded net sales of $9.6 million, $9.5 million and $8.2 million, respectively, and net income of $196,000, $280,000 and $61,000, respectively, excluding the impairment charge in the fourth quarter of fiscal 2001.
The Company is negotiating the sale of substantially all of the assets of Jahn Foundry. Under the terms of the proposed agreement, the Company would receive approximately $500,000 in cash, $500,000 in preferred stock of the buyer and $1.0 million principal amount over ten years in exchange for certain assets and the assumption of up to approximately $4.0 million of certain liabilities by the buyer, subject to certain post-closing adjustments. There can be no assurance that a definitive agreement will ultimately be executed or consummated. If executed and consummated, it is anticipated that this transaction would close during the second quarter of fiscal 2002.
In the fourth quarter of fiscal 2001, the Company recognized an impairment charge of $13.9 million to write-down the carrying value of the fixed assets at Jahn Foundry to the Company's estimate of fair value. The Company considered its decision to realign its operations, resulting in its decision to dispose of Jahn Foundry as the primary indicator of impairment. Prior to the impairment charge, the fixed assets had a carrying value of $15.9 million. For fiscal years 1999, 2000 and 2001, Jahn Foundry recorded net sales of $12.0 million, $10.7 million and $8.4 million, respectively, and net income (losses) of $124,000, $(113,000) and $(2.4) million, respectively, excluding the impairment charge in the fourth quarter of fiscal 2001 and a non-recurring gain of $10.9 million recorded in the second quarter of fiscal 2001 relating to insurance claims resulting from the industrial accident at Jahn Foundry on February 25, 1999.
Other income for fiscal 2001 primarily consisted of $10.9 million of non-recurring gains relating to the Jahn Foundry industrial accident which occurred in 1999. This gain consisted of a $3.7 million business interruption insurance gain and a $7.2 million property insurance gain. The property insurance gain primarily represents the difference between the net proceeds received for the property damage and the property's net book value immediately before the accident (See Note 23). See Liquidity and Capital Resources. Other income for fiscal 2000 primarily consisted of non-recurring gains of $1.1 million on the termination of interest rate swap agreements. The net gains were triggered by the Company's early retirement of a term loan.
Interest expense for fiscal 2001 increased to $11.3 million, or 2.6% of net sales, from $9.5 million, or 2.0% of net sales, in fiscal 2000. The increase in interest expense primarily reflects higher average interest rates on the Company's outstanding indebtedness.
The Company recorded income tax expense of $1.9 million in fiscal 2001. Due to the Company's current income tax position, no income tax benefit was recorded in connection with the fixed asset impairment charges discussed above. In addition, the Company recorded a $6.1 million valuation allowance related to certain foreign net operating loss carryforwards. This valuation allowance reduces the deferred tax assets to the amounts that management believes are more likely than not to be realized. Excluding the $7.8 million deferred income tax benefit discussed below, the income tax benefit for fiscal 2000 reflected an effective rate of approximately 29%. The effective tax rate is lower than the combined federal, state and provincial statutory rates primarily due to the impact of non-deductible goodwill and foreign dividends. The Company's income tax expense and benefit reflect the combined effective tax rates of the different federal, state and provincial jurisdictions in which the Company operates, and the proportion of taxable income earned in each of those tax jurisdictions.
Effective July 1, 2000, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of FASB Statement No. 133." SFAS Nos. 133 and 138 require companies to record derivative instruments as assets or liabilities, measured at fair value. The recognition of gains or losses resulting from changes in the values of those derivative instruments is based on the use of each derivative instrument and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows.
At July 1, 2000, the Company had derivatives in the form of foreign exchange contracts ("FX contracts") to buy and sell various currencies. The Company uses FX contracts as an economic hedge of trade receivables and payables denominated in foreign currencies, as well as anticipated sales to foreign customers in the customers' local currency. On July 1, 2000, the Company recorded its FX contracts at their fair value, which resulted in a charge to income of approximately $910,000 ($546,000 net of deferred income tax benefit). This is presented in the Company's consolidated financial statements as the cumulative effect of a change in accounting principle.
On June 30, 2001 the Company recorded its FX contracts at their fair value of approximately ($844,000). This resulted in a gain of approximately $66,000. Additionally, the translation of the foreign denominated trade receivables resulted in a decrease in the value of the receivables and the Company recorded a currency translation loss of approximately $249,000.
As a result of the foregoing, the net loss increased to $37.0 million in fiscal 2001 from a net loss of $11.7 million in fiscal 2000.
FISCAL YEAR ENDED JUNE 30, 2000 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1999
Net sales for fiscal 2000 were $461.1 million, representing a decrease of $16.3 million, or 3.4%, from net sales of $477.4 million in fiscal 1999. The operations acquired by the Company since September 1, 1998 generated net sales of $26.4 million and $39.2 million in fiscal 1999 and fiscal 2000, respectively, as follows:
Excluding net sales attributable to the operations acquired since September 1, 1998, net sales for fiscal 2000 were $421.9 million, representing a decrease of $29.1 million, or 6.5%, from net sales of $451.0 million in fiscal 1999. This 6.5% decrease in net sales was due primarily to decreases in net sales to the offshore oil and gas, steel, mining and power generation markets, partially offset by increases in net sales to the military markets. Net sales of Sheffield for fiscal 2000 decreased $18.0 million from net sales in fiscal 1999. In addition to the weak market conditions, net sales have also been impacted by the bankruptcy and subsequent cessation of operations of a major customer at the Company's PrimeCast subsidiary. Through fiscal 2000, PrimeCast has aggressively worked at replacing the volume lost from Beloit Corporation, which filed for bankruptcy in June 1999. During February 2000, Beloit was sold at auction, in parts, and as a result, the plants to which PrimeCast supplied castings subsequently ceased operations. For fiscal 2000, PrimeCast's net sales were $24.5 million compared to net sales of $27.5 million in fiscal 1999. Included in this $3.0 million decrease was a $3.8 million decrease in net sales to Beloit Corporation.
Gross profit for fiscal 2000 decreased by $17.8 million, or 29.9%, to $41.8 million, or 9.1% of net sales, compared to $59.6 million, or 12.5% of net sales, for fiscal 1999. The decrease in gross profit and gross profit as a percentage of net sales was primarily due to lower net sales and reduced absorption of overhead at the Company's subsidiaries which primarily serve the mining, offshore oil and gas, power generation and steel markets. The largest impact of these weak market conditions was at Sheffield, where its gross profit for fiscal 2000 decreased by $10.2 million to $10.2 million, or 8.9% of net sales, compared to $20.4 million, or 15.4% of net sales, in fiscal 1999.
The bankruptcy of a major customer at PrimeCast and, with a lesser impact, the loss of a major customer at Claremont have also had a negative effect on gross profit. Lower sales volume, coupled with the costs of developing new customers and training employees on new work has resulted in lower gross profits at these operations. PrimeCast's gross profit for fiscal 2000 decreased by $2.4 million to a gross loss of $582,000, compared to a gross profit of $1.8 million for fiscal 1999. Claremont's gross profit in fiscal 2000 was a loss of $1.5 million on net sales of $4.0 million, compared to a loss of $1.0 million on net sales of $7.1 million in fiscal 1999. The Company closed Claremont, and transferred much of the work to other Company operations. The Company completed the closure of PrimeCast by March 31, 2001. As PrimeCast was the Company's only foundry that could produce large iron castings, only a portion of PrimeCast's work can be transferred to other operations of the Company.
Lower net sales to the energy and utility markets at the Company's Pennsylvania steel foundries also had a negative effect on gross profit. Pennsylvania Steel's gross profit for fiscal 2000 decreased by $1.0 million to a gross loss of $3.7 million, compared to a gross loss of $2.7 million from fiscal 1999. Empire Steel's gross profit from fiscal 2000 decreased by $1.9 million to a gross loss of $1.7 million, compared to a gross profit of $197,000 for fiscal 1999. On November 30, 2000, the Company announced plans to close Pennsylvania Steel. The closure was completed by February 28, 2001. Much of Pennsylvania Steel's work was transferred to the Company's other foundries.
During fiscal 2000, the Company's reserve for warranty expense decreased to $10.2 million at June 30, 2000 from $11.8 million at June 30, 1999. Warranty expense recorded by the Company in
fiscal 2000 was a credit to income of $685,000 compared to a credit to income of $1.7 million in fiscal 1999. The decrease in the warranty reserve during fiscal 2000 primarily related to the Company's Sheffield subsidiary located in the United Kingdom. The Company maintains reserves for warranty charges based on specific claims made by customers, for which management estimates a final settlement of the claim, and for expected claims not yet received. The estimate for claims not yet received is based on historical results and is estimated monthly. During fiscal 2000, the Company's warranty reserve requirement and related expense declined primarily due to the resolution of specific warranty claims with three different customers whose products were replaced or determined by the customer to be satisfactory.
During fiscal 2000, the Company's reserve for workers' compensation and employee health care increased to $3.8 million at June 30, 2000 from $3.2 million at June 30, 1999. Workers' compensation and employee health care expense was $17.4 million for fiscal 2000, compared to $14.6 million in fiscal 1999, primarily reflecting higher health care costs. The increase in the reserve for workers' compensation and employee health care primarily reflects changes in the amount and timing of actual payments.
Selling, general and administrative expense ("SG&A") for fiscal 2000 was $44.5 million, or 9.7% of net sales, compared to $45.3 million, or 9.5% of net sales, in fiscal 1999. The decrease in SG&A was primarily attributable to the consolidation of four operating units into two at Sheffield, partially offset by expenses associated with Autun, which was acquired on February 25, 1999.
Amortization of certain intangibles for fiscal 2000 was $1.5 million, or 0.3% of net sales, compared to $1.4 million, or 0.3% of net sales, in fiscal 1999. The intangible assets consist of goodwill recorded in connection with certain of the Company's acquisitions. The Company has also recorded a liability, consisting of the excess of acquired net assets over cost ("negative goodwill"), in connection with the acquisitions of Canadian Steel and Autun. The amortization of negative goodwill was a credit to income in fiscal 2000 of $1.9 million, or 0.4% of net sales, as compared to $870,000, or 0.2% of net sales, in fiscal 1999.
Impairment charges for fiscal 2000 were $16.4 million. This $16.4 million reflects a $3.4 million charge relating to the Company's closure of Claremont and a $6.9 million fixed asset impairment charge at PrimeCast, a $3.4 million charge relating to the fixed asset impairment charge at Pennsylvania Steel and a $2.7 million charge relating to an impairment of goodwill at Empire Steel.
Other income for fiscal 2000 primarily consisted of non-recurring gains of $1.1 million on the termination of interest rate swap agreements. Other income for fiscal 1999 was $2.8 million. Following the July 1993 Missouri River flood, the Company established a reserve to repair long-term damage caused by the flood to the Company's plant. During fiscal 1999, the Company revised this estimate downward resulting in a non-recurring gain of $3.5 million. Partially offsetting this 1999 gain was a charge of $750,000 related to an industrial accident at Jahn Foundry (see Liquidity and Capital Resources).
During fiscal 2000, the Board of Directors committed to a plan for the closure of Claremont due to continued operating losses. The Company recorded a charge of $3.4 million primarily to reduce the carrying value of the Claremont fixed assets to estimated fair value. The Company transferred as much work as possible to other ACC foundries by November 30, 2000 and closed the plant. The Company terminated approximately 45 employees and recognized a charge for severance benefits of approximately $113,000 in the quarter ended September 30, 2000.
On July 1, 1997, a newly formed subsidiary of the Company, PrimeCast, acquired the foundry division of Beloit for $8.2 million. Simultaneous with the purchase, PrimeCast entered a five-year supply agreement to supply castings to Beloit. As a captive supplier, historically over 40% of this
operation's sales had been to Beloit. In June 1999, Beloit declared bankruptcy, in combination with the bankruptcy of its parent, Harnischfeger Industries. Beloit continued to operate in bankruptcy, and the court granted Beloit's request to re-instate the five-year casting supply agreement. In February 2000, Beloit was sold at auction, in parts. Expectations were that the new owners would continue to operate the former Beloit business which PrimeCast primarily served. This business consisted primarily of paper mill equipment and was located in Beloit, Wisconsin. However, ultimately these parts of the former Beloit were closed, resulting in the elimination of this work for PrimeCast, and the termination of the five-year supply agreement. These events have caused PrimeCast to operate at a substantial loss, due to much lower production volume and a less profitable mix of work. As a result, the carrying value of PrimeCast's long-lived assets have been determined to be impaired. The Company recorded an impairment charge of $6.9 million relating to the fixed assets at PrimeCast. Following continued losses in the first half of fiscal 2001, the Company announced on January 23, 2001 plans to close PrimeCast. The closure was completed by March 31, 2001. As PrimeCast was the Company's only foundry that could make large iron castings, only a portion of PrimeCast's work can be transferred to other ACC locations. The Company terminated approximately 225 employees and will recognize a charge for severance benefits of approximately $175,000 in the quarter ended March 31, 2001.
The Company acquired Quaker Alloy, Empire Steel and Pennsylvania Steel on June 1, 1994, February 1, 1995 and October 31, 1996, respectively. Each primarily serves the energy and utility markets. The operations and management of these three Pennsylvania steel foundries were subsequently combined to achieve operating and marketing synergies. The three locations were marketed as the Pennsylvania Foundry Group. Following the discovery of the accounting irregularities, which revealed substantial operating losses at each of the three operations, the Company evaluated each operation for potential impairment. As a result, the carrying value of certain of Pennsylvania Steel's and Empire Steel's long-lived assets have been determined to be impaired. The Company recorded, in the fourth quarter of fiscal 2000, a charge of $6.2 million primarily to reduce the carrying value of the fixed assets of Pennsylvania Steel to estimated fair value and to write-off the impaired value of goodwill at Empire Steel. On November 30, 2000, the Company announced plans to close Pennsylvania Steel. The closure was completed by February 28, 2001. Much of the work was transferred to the remaining two locations. The Company terminated approximately 75 employees and will recognize a charge for severance benefits of approximately $20,000 in the quarter ended March 31, 2001.
Interest expense for fiscal 2000 increased to $9.5 million, or 2.0% of net sales, from $8.4 million, or 1.7% of net sales, in fiscal 1999. The increase in interest expense primarily reflects higher average interest rates on the Company's outstanding indebtedness.
The Company has recorded a $7.8 million deferred income tax benefit in fiscal 2000 with respect to the reinvestment of certain flood insurance proceeds received in 1995 and 1996. The Company recorded pretax gains of approximately $20.1 million in 1995 and 1996 related to insurance proceeds resulting from flood damage to the Company's Atchison, Kansas foundry in July 1993. For federal income tax purposes, the Company treated the flood as an involuntary conversion event under the Internal Revenue Code ("Code") and related Treasury Regulations.
The Code provides generally that if certain conditions are met, gains on insurance proceeds from an involuntary conversion are not taxable if the proceeds are reinvested in qualified replacement property within two years after the close of the first taxable year in which any part of the conversion gain is realized. The Company believed that its treatment of certain foundry subsidiary stock acquisitions as qualified replacement property was subject to potential challenge by the Internal Revenue Service ("Service") and, accordingly, the Company recorded income tax expense on the insurance gains in 1996 pending review of its position by the Service or the expiration of the statute
of limitations under the Code for the Service to assess income taxes with respect to the Company's position.
The Company's treatment of certain foundry subsidiary stock acquisitions as qualified replacement property creates differing basis in the foundry subsidiary stock for financial statement and tax purposes. These differences have not been recognized as taxable temporary differences under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," since the subsidiary basis differences can be permanently deferred through subsidiary mergers or tax-free liquidations. On March 15, 2000, the statute of limitations for the Service to assess taxes with respect to the Company's position expired. The deferred taxes recorded in the consolidated financial statements in prior years were no longer required.
Excluding this $7.8 million deferred income tax benefit, the income tax benefit for fiscal 2000 reflected an effective rate of approximately 29%, which is lower than the combined federal, state and provincial statutory rate primarily due to the impact of nondeductible goodwill and foreign dividends. Income tax expense for fiscal 1999 reflected an effective rate of approximately 59%. The Company's combined effective tax rate reflects the different federal, state and provincial statutory rates of the various jurisdictions in which the Company operates, and the proportion of taxable income earned in each of those tax jurisdictions.
As a result of the foregoing, net income decreased from $3.1 million in fiscal 1999 to a net loss of $11.7 million in fiscal 2000.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed operations with internally generated funds, proceeds from the sale of senior notes and available borrowings under its bank credit facilities. Cash provided by operating activities for fiscal 2001 was $3.3 million, a decrease of $11.7 million from fiscal 2000. This decrease was primarily attributable to the net loss incurred by the Company. Partially offsetting this was the accelerated collection of trade receivable balances and more aggressive management of trade payable balances.
Working capital was a negative $52.9 million at June 30, 2001, as compared to $5.7 million at June 30, 2000. The working capital levels primarily reflect the reclassification of $105.3 million and $72.8 million of the Company's bank credit facility, term loan and senior notes with an insurance company as current at June 30, 2001 and June 30, 2000, respectively. The Company has not been in compliance with certain financial covenants under the Credit Agreement, Note Purchase Agreement and the GE Financing, as defined below, and, accordingly, such amounts have been classified as current liabilities.
During fiscal 2001, the Company made capital expenditures of $11.2 million, as compared to $20.5 million for fiscal 2000. Included in fiscal 2001 and fiscal 2000 were capital expenditures of $4.1 million and $7.7 million, respectively, to rebuild the shell molding area and boiler room damaged in the industrial accident in 1999 at Jahn Foundry. (see below) Fiscal 2000 also included $2.7 million to expand Autun's product line capabilities in the manufacture of gray and ductile iron castings. The balance of capital expenditures in both periods were used for routine projects at each of the Company's facilities. The Company currently expects to make approximately $10.0 million of capital expenditures during fiscal 2002.
As described above, the Company has closed Pennsylvania Steel and PrimeCast and is in the process of closing Empire Steel. Much of the work at Pennsylvania Steel and Empire was transferred to Quaker Alloy. As PrimeCast was the Company's only foundry that could make large iron castings, only a portion of PrimeCast's work was transferred to other Company operations.
As discussed above, the Company is also in the process of selling substantially all of the assets of LA Die Casting and Jahn Foundry. If definitive agreements are executed and consummated, the Company currently expects the sales will be completed during the second quarter of fiscal 2002.
The Company has four primary credit facilities: a revolving credit facility with Harris Trust and Savings Bank, as agent for several lenders (the "Credit Agreement"); senior notes (the "Notes") with an insurance company issued under a note purchase agreement (the "Note Purchase Agreement"); a term loan with General Electric Capital Corporation (the "GE Financing"); and a receivables program combined with a revolving credit facility with Burdale Financial Limited pursuant to a facility agreement (the "Facility Agreement"). Each of these facilities require compliance with various covenants, including, but not limited to, financial covenants related to equity levels, cash flow requirements, fixed charge coverage ratios and ratios of debt to equity.
The Credit Agreement, as amended, currently consists of a $75.5 million revolving credit facility, which is secured by substantially all of the Company's North American assets. In addition to the financial covenants, the Credit Agreement contains customary restrictions on, among other things, acquisitions, additional indebtedness, further investments in Autun and the use of net proceeds from the sale of assets (other than inventory), insurance settlements and other non-recurring items . Loans under this revolving credit facility bear interest at fluctuating rates of (1) the agent bank's corporate base rate plus 1.75 % (for loans up to $70 million less outstanding letters of credit) and the agent bank's corporate base rate plus 1.25% (for loans in excess of such amount); or (2) LIBOR plus 4.25%.
At June 30, 2001, Notes with an aggregate principal amount of $11.4 million were outstanding with interest accruing at 10.19% per year. The Note Purchase Agreement provides for annual principal payments of $2.9 million, the most recent of which has not been paid. The Notes are secured by the same assets that secure the Credit Agreement and contain similar restrictions to those described above under the Credit Agreement.
In September 2001, the Company entered into the Eleventh Amendment and Forbearance Agreement to the Credit Agreement and the Eighth Amendment and Forbearance Agreement to the Note Purchase Agreement. These amendments provide that, among other things, these lenders will forbear from enforcing their rights with respect to certain existing defaults through October 12, 2001. These amendments also allowed ACUK to enter into the Facility Agreement.
At June 30, 2001, the balance of the term loan under the GE Financing was $29.8 million. This loan provides for monthly principal payments of $291,667 plus accrued interest. The GE Financing is secured by certain of the Company's fixed assets, real estate, equipment, furniture and fixtures located in Atchison, Kansas and St. Joseph, Missouri, matures in December 2004 and bears interest at a fixed rate of 9.05% per year. General Electric Capital Corporation has agreed to forbear from enforcing its rights with respect to certain events of default under the GE Financing through September 30, 2001.
In September 2001, ACUK, a subsidiary of the Company and its subsidiaries, and Burdale Financial Limited entered into the Facility Agreement This Facility Agreement provides for a 25 million British pound facility (approximately $35 million US) to be used to fund working capital requirements at Sheffield, a subsidiary of ACUK, and up to $1.0 million British pounds for working capital at Autun, the Company's subsidiary in France. In addition, the Facility Agreement will provide security for Sheffield's foreign currency exchange contracts and performance bond commitments, repay $5.0 million of an intercompany working capital loan ($1.1 million of which was paid to certain of the lenders as principal payments) and may provide for a loan of up to $9.0 million of some additional working capital funds in North America, subject to availability and other restrictions in the U.K. This facility matures on September 17, 2004 and is secured by substantially
all of Sheffield's assets in the U.K. Loans under this Facility Agreement will bear interest at LIBOR plus 2.60%. The Company is currently in compliance with the covenants under the Facility Agreement.
Cash requirements for fiscal 2001 have been negatively affected by (1) significantly higher fuel costs (approximately $7.0 million higher than fiscal 2000), (2) the fees and expenses related to the investigation of the accounting irregularities discovered at the Pennsylvania Foundry Group and the related litigation (approximately $800,000 through June 30, 2001), and (3) nonrecurring fees and appraisal and audit expenses (approximately $1.3 million through June 30, 2001) paid by the Company in pursuing various options to refinance its bank credit facility.
The Company has been in default under the Credit Agreement, Note Purchase Agreement and the GE Financing. To date the lenders under the Credit Agreement and the Note Purchase Agreement have foregone their rights to accelerate their debt and foreclose on their collateral through October 12, 2001. Although the lenders have agreed not to accelerate their debt to date, there can be no assurance that they will not do so in the future if future defaults occur. During much of fiscal 2001 and to date in fiscal 2002, the Company borrowed the full amount of the revolving credit facility under the Credit Agreement and managed its cash position accordingly. To date, the Company has been able to meet its cash needs by traditional cash management procedures in addition to: (1) the collection of tax refunds resulting from the restatement of its financial statements related to the accounting irregularities at the Pennsylvania Foundry Group, (2) accelerated payments of receivables from certain longstanding customers from time to time, (3) the reduction of expenses after closing locations operating with a negative cash flow, and (4) recently, funds available through the Facility Agreement, particularly for its operations in the U.K. and France. The Company is also seeking the recovery under various insurance policies for losses due to the accounting irregularities at the Pennsylvania Foundry Group and the industrial accident at Jahn Foundry. In addition, the Company is pursuing other responsible parties. There can be no assurance that such actions will be successful in recovering funds or that they will allow the Company to operate without additional borrowing capacity.
Compliance with certain financial covenants under the Credit Agreement, Note Purchase Agreement and the GE Financing is determined on a "trailing-twelve-month" basis. The results for fiscal 2001 were below results needed to achieve compliance with these covenants under the Credit Agreement, Note Purchase Agreement and the GE Financing. Accordingly, the Company is currently negotiating with new and existing financial institutions to extend its current arrangements while it attempts to establish a new credit facility with covenants that the Company believes it will be able to satisfy and additional borrowing capacity. During the past several years, the Company has been able to negotiate operating flexibility with its lenders, although future success in achieving any such renegotiations or refinancings, or the specific terms thereof, including interest rates, capital expenditure limits or borrowing capacity, cannot be assured. The Company believes that its operating cash flow and amounts available for borrowing under its existing credit facility and the Facility Agreement will be adequate to fund its capital expenditure and working capital requirements through June 2002. However, the level of capital expenditure and working capital requirements may be greater than currently anticipated as a result of unforeseen expenditures such as compliance with environmental laws, the accident at Jahn Foundry, the investigation and related litigation in connection with the accounting irregularities at the Pennsylvania Foundry Group and substantially higher fuel costs that arose during this past winter, which could recur. In addition, future revenue may be negatively affected if the markets that the Company serves weaken as a result of terrorist activities on and after September 11, 2001 and any related military responses. If the Company fails to achieve compliance with the terms of its Credit Agreement or, in the absence of such compliance, if the Company fails to amend such financial covenants on terms favorable to the Company, the Company will continue to be in default under such covenants. Accordingly, the lenders could accelerate the debt under the Credit Agreement which, in turn, would permit acceleration of the Notes under the Note Purchase Agreement and the indebtedness under the GE Financing. If the lenders accelerate
their indebtedness, there can be no assurance that the Company would be able to locate alternative sources of financing.
Total indebtedness of the Company at June 30, 2001 was $121.5 million, as compared to $117.6 million at June 30, 2000. This increase of $3.9 million primarily reflects indebtedness incurred to fund the Company's capital expenditures and operating losses. At June 30, 2001 the Company had fully utilized its revolving credit facility.
An accident, involving an explosion and fire, occurred on February 25, 1999, at Jahn Foundry, located in Springfield, Massachusetts. Nine employees were seriously injured and there were three fatalities. The damage was confined to the shell molding area and boiler room. The other areas of the foundry remained operational. Molds were being produced at other foundries, as well as Jahn Foundry, while the repairs were made. The new shell molding department became fully operational in November 2000.
The Company carries insurance for property and casualty damages (over $475 million of coverage), business interruption (approximately $115 million of coverage), general liability ($51 million of coverage) and workers' compensation (up to full statutory liability) for itself and its subsidiaries. The Company recorded charges of $750,000 during the third quarter of fiscal 1999, primarily reflecting the deductibles under the Company's various insurance policies. At this time there can be no assurance that the Company's ultimate costs and expenses resulting from the accident will not exceed available insurance coverage by an amount which could be material to its financial condition or results of operations and cash flows.
In November 2000, the Company and its insurance carrier settled the Jahn Foundry property portion of the Company's claim. The settlement provided, among other things, for (i) additional payments from the carrier in the amount of $2.6 million, (ii) that of the payments received to date, totaling $26.8 million, the insurance carrier will allocate no more than $9.5 million for property damage, (iii) that the remaining proceeds of $17.3 million, will be allocated to business interruption losses and will not be subject to recovery by the insurance carrier and (iv) that the Company shall not be entitled to any additional payments unless it is determined by reference, appraisal, arbitration, litigation or otherwise that the Company's business interruption losses exceed $17.3 million. The Company disagrees with the insurance carrier regarding the duration and amount of the business interruption losses. The Company plans to seek additional insurance payments through arbitration. There can be no assurance that the Company will ultimately receive any additional insurance payments or that the excess of the Company's costs and expenses resulting from the accident over the insurance payments received will not be material to its financial condition or results of operations and cash flows.
As a result of the above settlement, the Company recorded a non-recurring gain of $10.9 million in the second quarter of fiscal 2001, which consisted of a $3.7 million business interruption insurance gain and a $7.2 million property insurance gain. The property insurance gain primarily represents the difference between the net proceeds received for the property damage and the property's net book value immediately before the accident. These net proceeds were used to rebuild the damaged property and were accounted for as capital expenditures.
Following the accident, OSHA conducted an investigation of the accident. On August 24, 1999, OSHA issued a citation describing violations of the Occupational Safety and Health Act of 1970, which primarily related to housekeeping, maintenance and other specific, miscellaneous items. Neither of the two violations specifically addressing conditions related to the explosion and fire were classified as serious or willful. Without admitting any wrongdoing, Jahn Foundry entered into a
settlement with OSHA that addresses the alleged work place safety issues and agreed to pay $148,500 in fines.
A civil action has been commenced in Massachusetts Superior State Court on behalf of the estates of deceased workers, their families, injured workers and their families, against the supplier of a chemical compound used in Jahn Foundry's manufacturing process. The supplier of the chemical compound, Borden Chemical, Inc., filed a Third Party Complaint against Jahn Foundry in Massachusetts Superior State Court on February 2, 2000 seeking indemnity for any liability it has to the plaintiffs in the civil action. The Company's comprehensive general liability insurance carrier has retained counsel on behalf of Jahn Foundry, and the Company and is aggressively defending Jahn Foundry in the Third Party Complaint. It is too early to assess the potential liability to Jahn Foundry for the Third Party Complaint, which in any event Jahn Foundry will aggressively defend. In addition, Jahn Foundry has brought a Third Party Counterclaim against Borden and the independent sales representative of the chemical compound, J. R. Oldhan Company, seeking compensation for losses sustained in the explosion, including amounts covered by insurance.
On February 26, 2001, Borden filed a Third Party Complaint against the Company seeking contribution, under Massachusetts law, from the Company in the event that the plaintiffs prevail against Borden. The Third Party Complaint alleges that the Company undertook a duty to oversee industrial hygiene, safety and maintenance at Jahn Foundry and that the Company designed, installed and maintained equipment and machinery at Jahn Foundry, and that the Company's carelessness, negligence or gross negligence caused the explosion and resulting injuries. It is too early to assess the potential liability for such a claim, which in any event the Company will aggressively defend.
On March 30, 2001, the plaintiffs amended their complaint by adding the Company as a defendant. The plaintiffs allege that the Company undertook a duty to oversee industrial hygiene, safety and maintenance at Jahn Foundry and that the Company's carelessness, negligence or gross negligence caused the explosion and resulting injuries. The plaintiffs seek an unspecified amount of damages and punitive damages. It is too early to assess the potential liability to the Company for such claims, which in any event the Company will aggressively defend. The Company has filed a cross-claim for contribution against Borden and J.R. Oldhan Company.
The Company, its chief executive officer, and its chief financial officer were named as defendants in five lawsuits filed following the Company's announcements concerning the discovery of accounting irregularities at the Pennsylvania Foundry Group. The cases have been consolidated before the U.S. District Court for the District of Kansas. An amended complaint filed after the consolidation alleges, among other things, that the defendants intentionally or recklessly issued materially false and misleading financial statements in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. That complaint seeks certification of a class of purchasers of the Company's common stock between December 10, 1997 and November 3, 2000 and asks for damages for the class in an unspecified amount. Discovery has been stayed pending the resolution of the defendants' motion to dismiss the amended complaint. The Company believes the claims are without merit and intends to defend them vigorously. There can be no assurance, however, that an adverse outcome with respect to the case will not have a material adverse impact on the Company's financial condition, results of operations, or cash flows.
MARKET RISK
The Company operates manufacturing facilities in the U.S., Canada and Europe and utilizes fixed and floating rate debt to finance its global operations. As a result, the Company is subject to business risks inherent in non-U.S. activities, including political and economic uncertainty, import and export limitations, and market risk related to changes in interest rates and foreign currency exchange rates. The Company believes the political and economic risks related to its foreign operations are mitigated
due to the stability of the countries in which its largest foreign operations are located.
In the normal course of business, the Company uses derivative financial instruments including interest rate swaps and foreign currency forward exchange contracts to manage its market risks, although, at June 30, 2001, the Company had no outstanding interest rate swap agreements. Additional information regarding the Company's financial instruments is contained in Note 12 to the Company's consolidated financial statements. The Company's objective in managing its exposure to changes in interest rates is to limit the impact of such changes on earnings and cash flow and to lower its overall borrowing costs. The Company's objective in managing its exposure to changes in foreign currency exchange rates is to reduce volatility on earnings and cash flow associated with such changes. The Company's principal currency exposures are in the major European currencies and the Canadian dollar. The Company does not hold derivatives for trading purposes.
For 2001 and 2000, the Company's exposure to market risk has been estimated using sensitivity analysis, which is defined as the change in the fair value of a derivative or financial instrument assuming a hypothetical 10% adverse change in market rates or prices. The Company used current market rates on its debt and derivative portfolio to perform the sensitivity analysis. Certain items such as lease contracts, insurance contracts, and obligations for pension and other post-retirement benefits were not included in the analysis. The results of the sensitivity analyses are summarized below. Actual changes in interest rates or market prices may differ from the hypothetical changes.
The Company's primary interest rate exposures relate to its cash and short-term investments and fixed and variable rate debt. The potential loss in fair values is based on an immediate change in the net present values of the Company's interest rate-sensitive exposures resulting from a 10% change in interest rates. The potential change in cash flows and earnings is based on the change in the net interest income/expense over a one-year period due to an immediate 10% change in rates. A hypothetical 10% change in interest rates would impact the Company's earnings by approximately $900,000 and $500,000 in fiscal 2001 and 2000, respectively.
The Company's exposure to fluctuations in currency rates against the British pound sterling and Canadian dollar result from the Company's holdings in cash and short-term investments and its utilization of foreign currency forward exchange contracts to hedge customer receivables and firm commitments. The potential loss in fair values is based on an immediate change in the U.S. dollar equivalent balances of the Company's currency exposures due to a 10% shift in exchange rates versus the British pound sterling and Canadian dollar. The potential loss in cash flows and earnings is based on the change in cash flow and earnings over a one-year period resulting from an immediate 10% change in currency exchange rates versus the British pound sterling and Canadian dollar. Based on the Company's holdings of financial instruments at June 30, 2001 and 2000, a hypothetical 10% depreciation in the pound sterling and the Canadian dollar versus all other currencies would impact the Company's earnings by approximately $3.7 million and $1.7 million in fiscal 2001 and 2000, respectively. This analysis does not include the offsetting impact from the Company's underlying hedged exposures (customer receivables and firm commitments). If the Company included these underlying hedged exposures in its sensitivity analysis, these exposures would substantially offset the financial impact of its foreign currency forward exchange contracts due to changes in currency rates.
INFLATION
Management does not believe that the Company's operations have been materially adversely affected by inflation or changing prices.
FORWARD-LOOKING STATEMENTS
Statements above in the subsections entitled "General," "Legal Proceedings," "Liquidity and Capital Resources" and "Market Risk," and in the Letter to Stockholders, such as "expects," "intends," "contemplating" and statements regarding quarterly fluctuations, statements regarding the adequacy of funding for capital expenditure and working capital requirements for the next twelve months and similar expressions that are not historical are forward-looking statements that involve risks and uncertainties. Such statements include the Company's expectations as to future performance. Among the factors that could cause actual results to differ materially from such forward-looking statements are the following: costs of closing foundries, success in selling Jahn Foundry and LA Die Casting, the impact that terrorist activities on and after September 11, 2001 may have on the markets served by the Company, business conditions and the state of the general economy, particularly the capital goods industry, the strength of the U.S. dollar, British pound sterling and the Euro, interest rates, the Company's ability to renegotiate or refinance its lending arrangements, utility rates, the availability of labor, the successful conclusion of union contract negotiations, the results of any litigation arising out of the accident at Jahn Foundry, results of any litigation or regulatory proceedings arising from the accounting irregularities at the Pennsylvania Foundry Group, the competitive environment in the casting industry and changes in laws and regulations that govern the Company's business, particularly environmental regulations.
NEW ACCOUNTING STANDARDS
For a discussion of new accounting standards, see Note 1 of the Company's Notes to Consolidated Financial Statements.
SUPPLEMENTAL QUARTERLY INFORMATION
The Company's business is characterized by large unit and dollar volume customer orders. As a result, the Company has experienced and may continue to experience fluctuations in its net sales and net income from quarter to quarter. Generally, the first fiscal quarter is seasonally weaker than the other quarters as a result of plant shutdowns for maintenance at most of the Company's foundries as well as at many customers' plants. In addition, the Company's operating results may be adversely affected in fiscal quarters immediately following the consummation of an acquisition while the operations of the acquired business are integrated into the operations of the Company.
The selected unaudited supplemental quarterly results for fiscal 2000 and fiscal 2001 are included in Note 15 to the consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is incorporated herein by reference to the section entitled "Market Risk" in the Company's Management's Discussion and Analysis of Financial Condition and Results of Operations in this Annual Report on Form 10-K.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company are filed under this Item, beginning on page of this Report. The financial statement schedule required to be filed under Regulation S-X. is filed on page 49 of this report.
Selected quarterly financial data required under this item is included in Note 15 to the consolidated financial statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item with respect to directors and compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference to the Registrant's Proxy Statement for the 2001 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A. The required information as to executive officers is set forth in Part I hereof.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the Registrant's Proxy Statement for the 2001 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this item is incorporated herein by reference to the Registrant's Proxy Statement for the 2001 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this item is incorporated herein by reference to the Registrant's Proxy Statement for the 2001 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Financial Statement Schedules - Valuation and Qualifying Accounts Schedule (in thousands)
ACCOUNTS RECEIVABLE ALLOWANCE
RESERVE FOR FLOOD REPAIRS
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized.
ATCHISON CASTING CORPORATION (Registrant)
By: /s/ Hugh H. Aiken --------------------------- Hugh H. Aiken Principal Executive Officer
Dated: October 9, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
EXHIBIT INDEX
EXHIBIT INDEX
EXHIBIT INDEX
EXHIBIT INDEX
* Represents a management contract or a compensatory plan or arrangement.
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS AS OF JUNE 30, 2001 AND 2000, AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 2001, AND INDEPENDENT AUDITORS' REPORT
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders of Atchison Casting Corporation and Subsidiaries Atchison, Kansas
We have audited the accompanying consolidated balance sheets of Atchison Casting Corporation and subsidiaries (the "Company") as of June 30, 2001 and 2000 and the related consolidated statements of operations, comprehensive income (loss), stockholders' equity and cash flows for each of the three years in the period ended June 30, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2001 in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 10 to the consolidated financial statements, at June 30, 2001, the Company was not in compliance with certain covenants of its loan agreements and has entered into various amendments and forbearance agreements with its lenders. The Company is attempting to renegotiate the terms and covenants of the loan agreements and also is seeking other sources of long-term financing. The Company's difficulties in meeting its loan covenants and financing needs, its recurring losses from operations and its negative working capital position discussed in Note 24 raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 24. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ DELOITTE & TOUCHE LLP
September 28, 2001 Kansas City, Missouri
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
-F-2-
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
-F-3-
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
See notes to consolidated financial statements.
-F-4-
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
See notes to consolidated financial statements.
-F-5-
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
See notes to consolidated financial statements.
-F-6-
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
See notes to consolidated financial statements.
-F-7-
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 1999, 2000 AND 2001 (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS - Atchison Casting Corporation and subsidiaries ("ACC" or the "Company") was organized in 1991 for the purpose of becoming a broad-based manufacturer of metal castings, producing iron, steel and non-ferrous castings ranging in size from a few ounces to 280 tons. A majority of the Company's sales are to U.S. customers, however, the Company also has sales to Canadian, European and other foreign customers.
PERVASIVENESS OF ESTIMATES - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
BASIS OF PRESENTATION - The consolidated financial statements present the financial position of the Company and its subsidiaries, Amite Foundry and Machine, Inc. ("AFM"), Prospect Foundry, Inc. ("Prospect Foundry"), Quaker Alloy, Inc. ("Quaker"), Canadian Steel Foundries, Ltd. ("Canadian Steel"), Kramer International, Inc. ("Kramer"), Empire Steel Castings, Inc. ("Empire"), La Grange Foundry Inc. ("La Grange Foundry"), The G&C Foundry Company ("G&C"), Los Angeles Die Casting Inc. ("LA Die Casting"), Canada Alloy Castings, Ltd. ("Canada Alloy"), Pennsylvania Steel Foundry & Machine Company ("Pennsylvania Steel"), Jahn Foundry Corp. ("Jahn Foundry"), PrimeCast, Inc. ("PrimeCast"), Inverness Castings Group, Inc. ("Inverness"), Atchison Casting UK Limited ("ACUK"), Claremont Foundry, Inc. ("Claremont"), London Precision Machine & Tool Ltd. ("London Precision") and Fonderie d'Autun SA ("Autun"). AFM, Quaker, Canadian Steel, Kramer, Empire, La Grange Foundry, Canada Alloy, Pennsylvania Steel, Jahn Foundry, PrimeCast, Claremont, London Precision and Autun are wholly owned subsidiaries. The Company owns 96.0%, 98.9%, 95.0%, 96.7% and 95.5% of the outstanding capital stock of Prospect Foundry, G&C, LA Die Casting, Inverness and ACUK, respectively. Sheffield Forgemasters Group, Ltd. ("Sheffield") is a wholly-owned subsidiary of ACUK. All significant intercompany accounts and balances have been eliminated.
STATEMENT OF CASH FLOWS - Cash and cash equivalents include cash on hand, amounts due from banks and temporary investments with original maturities of 90 days or less at the date of purchase.
REVENUE RECOGNITION - Sales and related cost of sales are recognized upon shipment of products. The Company provides for estimated product warranty costs based on historical experience at the time the product is sold and accrues for specific items at the time their existence is known and the amounts are determinable.
-F-8-
CUSTOMER ACCOUNTS RECEIVABLE - Approximately 16%, 16%, and 17% of the Company's revenue in 1999, 2000 and 2001, respectively, was with two major customers who operate in the automotive, locomotive and general industrial markets. As of June 30, 2000 and 2001, 8% of accounts receivable were with these two major customers. The Company generally does not require collateral or other security on accounts receivable. Credit risk is controlled through credit approvals, limits and monitoring procedures.
INVENTORIES - Approximately 18% of the Company's inventory is valued at the lower of cost, determined on the last-in, first-out ("LIFO") method, or market. The remaining inventory is valued at the lower of cost, determined on the first-in, first-out ("FIFO") method, or market.
PRE-PRODUCTION COSTS - The Company's long-term supply arrangements typically provide for specific reimbursement of pre-production costs, which include tooling, dies, fixtures, patterns and drawings, among other items, by the customer. As of June 30, 2000 and 2001, the Company had $8,038 and $7,136 of capitalized pre-production costs recorded within other current assets within the consolidated balance sheets. Generally, the supply arrangements entered into by ACC provide the Company the noncancelable right to use the tooling during the supply arrangement even though the customer owns the tooling.
PROPERTY, PLANT AND EQUIPMENT - Major renewals and betterments are capitalized while replacements, maintenance and repairs which do not improve or extend the life of the respective assets are charged to expense as incurred. Upon sale or retirement of assets, the cost and related accumulated depreciation applicable to such assets are removed from the accounts and any resulting gain or loss is reflected in operations.
Property, plant and equipment is carried at cost less accumulated depreciation. Plant and equipment is depreciated over the estimated useful lives of the assets using the straight-line method.
Applicable interest charges incurred during the construction of new property, plant and equipment are capitalized as one of the elements of cost and are amortized over the assets' estimated useful lives. There was no interest capitalized during fiscal year 1999, while $82 and $411 was capitalized in fiscal years 2000 and 2001.
INTANGIBLE ASSETS - Intangible assets acquired, primarily goodwill, are being amortized over their estimated lives of 25 years using the straight-line method.
DEFERRED FINANCING COSTS - Costs incurred in connection with obtaining or amending financing are capitalized and amortized over the remaining term of the related debt instrument on a method approximating the interest method.
FOREIGN CURRENCY TRANSLATION - Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at the rate of exchange at the balance sheet date. Revenues and expenses are translated into U.S. dollars at average monthly exchange rates prevailing during the year. Resulting translation adjustments are recorded in the accumulated foreign currency translation adjustment account, which is a component of other comprehensive income and a separate component of stockholders' equity. Foreign currency transaction gains and losses are included in the results of operations as incurred.
LONG-LIVED ASSETS - The Company periodically evaluates the carrying value of long-lived assets to be held and used, including goodwill and other intangible assets, when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In
-F-9-
that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset.
ACCRUED INSURANCE EXPENSE - The accrual for employee medical benefits and casualty insurance programs includes estimates for claims incurred but not reported.
At June 30, 2001, the Company had letters of credit aggregating $1,870 and a certificate of deposit of $200 which support claims for workers' compensation benefits.
INCOME TAXES - Deferred income taxes are provided on temporary differences between the financial statement and tax basis of the Company's assets and liabilities in accordance with the liability method. SFAS No. 109, "ACCOUNTING FOR INCOME TAXES," requires a valuation allowance against deferred tax assets if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
STOCK OPTION PLANS - The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION," in October 1995. SFAS No. 123 allows companies to continue under the approach set forth in Accounting Principles Board Opinion ("APB") No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES," for recognizing stock-based compensation expense in the financial statements, but encourages companies to adopt provisions of SFAS No. 123 based on the estimated fair value of employee stock options. Companies electing to retain the approach under APB No. 25 are required to disclose pro forma net income and net income per share in the notes to the financial statements, as if they had adopted the fair value accounting method under SFAS No. 123. The Company has elected to retain its current accounting approach under APB No. 25.
EARNINGS PER SHARE - Basic earnings per share ("EPS") is computed by dividing net income by the weighted-average number of common shares outstanding for the year. Diluted EPS reflects the potential dilution that could occur if dilutive securities, such as stock options, were exercised.
DERIVATIVE INSTRUMENTS - The Company adopted SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES," as amended effective July 1, 2000 to record derivative instruments. At July 1, 2000, the Company had derivatives in the form of foreign exchange contracts ("FX contracts") to buy and sell various currencies. The Company uses FX contracts as an economic hedge of trade receivables and payables denominated in foreign currencies, as well as anticipated sales to foreign customers in the customers' local currency. On July 1, 2000, the Company recorded its FX contracts at their fair value of approximately $(910). This resulted in a charge to income of approximately $910 ($546 net of deferred income tax benefit). Additionally, the translation of the foreign denominated trade receivables resulted in the increase in value of the receivables and the Company recorded a currency translation gain of approximately $435. The impact of the adoption of SFAS No. 133 is presented in the Company's fiscal year 2001 consolidated financial statements as the cumulative effect of a change in accounting principle.
On June 30, 2001, the Company recorded its FX contracts at their fair value of approximately ($844). This resulted in a gain of approximately $66. Additionally, the translation of the foreign denominated trade receivables resulted in a decrease in the value of the receivables and the Company recorded a currency translation loss of approximately $249.
-F-10-
NEW ACCOUNTING STANDARDS - The FASB has recently issued SFAS No. 141, "BUSINESS COMBINATIONS", SFAS No. 142 "GOODWILL AND OTHER INTANGIBLE ASSETS", SFAS No. 143 "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS" and SFAS No. 144 "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS". SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 and that the use of the pooling-of-interest method is no longer allowed. SFAS No. 142 requires that upon adoption, amortization of goodwill will cease and instead, the carrying value of goodwill will be evaluated for impairment on an annual basis. Identifiable intangible assets will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 121 "ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF". SFAS No. 143 establishes accounting standards for recognition and measurement of a liability for an asset retirement obligation and the associated asset retirement cost. SFAS No. 144 supercedes SFAS No. 121 and establishes accounting standards for long-lived assets and long-lived assets to be disposed of. SFAS Nos. 142 and 144 are effective for fiscal years beginning after December 15, 2001 and SFAS No. 143 is effective for fiscal years beginning after June 15, 2002, so the Company will adopt these standards as of July 1, 2002. The Company is evaluating the impact of the adoption of these standards and has not yet determined the effect of adoption on its financial position and results of operations.
RECLASSIFICATIONS - Certain reclassifications have been made in the 1999 and 2000 financial statements to conform with current year presentation.
2. PLANT CLOSURES AND ASSET IMPAIRMENTS
CLAREMONT
During fiscal year 2000, the Company recorded an impairment loss associated with the planned closure of the Claremont foundry. The resulting impairment charge of $3,373 to reduce the carrying value of these fixed assets was recorded in the fourth quarter ended June 30, 2000. During the fourth quarter of fiscal year 2000, the Company's Board of Directors committed to a plan for the closure of Claremont as a result of continued operating losses. As such, the carrying values of Claremont's fixed assets were written down to the Company's estimates of fair value, which was based on discounted future cash flows. Accordingly, actual results could vary significantly from such estimates. Prior to the impairment charge, these assets had a carrying value of $3,534. The Company transferred as much work as possible to other ACC foundries, and closed the foundry by November 30, 2000. For fiscal years 1999, 2000, and 2001, Claremont recorded net sales of $7,068, $3,958, and $816, respectively, and incurred net losses of $1,554, $1,819, and $519, respectively, excluding the impairment charge in the fourth quarter of fiscal year 2000.
In addition to the long-lived asset impairment, in the first half of fiscal year 2001 the Company recognized approximately $113 in severance benefits when such benefit arrangements were communicated to the approximately 45 affected employees related to the Claremont closure.
PENNSYLVANIA STEEL
Following the discovery of accounting irregularities which revealed substantial operating losses at the Company's three Pennsylvania foundry operations, the Company recognized an impairment loss as the future undiscounted cash flows of Pennsylvania Steel were estimated to be insufficient to recover the carrying value of the fixed assets. Accordingly, in the fiscal year 2000 financial statements, the carrying values of Pennsylvania Steel's fixed assets were written down to the Company's estimates of fair value,
-F-11-
which was based on discounted future cash flows. The resulting impairment charge of $3,450 to reduce the carrying value of these fixed assets was recorded in the fourth quarter ended June 30, 2000. Actual results could vary significantly from such estimates. Prior to the impairment charge, these assets had a carrying value of $4,774. Subsequently, on February 28, 2001 the Company closed Pennsylvania Steel and transferred work to the other two Pennsylvania foundries. For fiscal years 1999, 2000 and 2001, Pennsylvania Steel recorded net sales of $12,269, $11,582, and $4,916, respectively, and incurred net losses of $3,525, $4,080, and $2,821, respectively, excluding the impairment charge in the fourth quarter of fiscal year 2000.
In addition to the long-lived asset impairment, the Company recognized certain other exit costs associated with the closure of Pennsylvania Steel in fiscal 2001 related to employee termination costs. The Company terminated approximately 75 employees and recognized a charge for severance benefits of approximately $20 in the quarter ended March 31, 2001.
PRIMECAST
The Company recognized an impairment charge of $6,883 to reduce the carrying value of fixed assets at its PrimeCast foundry in the fourth quarter ended June 30, 2000. The Company considered continued operating losses, caused primarily by the bankruptcy of PrimeCast's major customer in June 1999 and subsequent closure of facilities to which PrimeCast supplied a significant amount of castings, as the primary indicator of impairment. An impairment loss was recognized as the future undiscounted cash flows of PrimeCast were estimated to be insufficient to recover the carrying values of the fixed assets. As such, the carrying values of these assets were written down to the Company's estimates of fair value, which was based upon discounted future cash flows of PrimeCast. Following continued losses in 2001, the Company announced, on January 23, 2001, plans to close PrimeCast. The closure was completed by March 31, 2001. Prior to the impairment charge, these assets had a remaining carrying amount of $8,248. For fiscal years 1999, 2000, and 2001, PrimeCast recorded net sales of $27,531, $24,464, and $14,835, respectively, and incurred net losses of $644, $2,188, and $4,137, respectively, excluding the impairment charge in the fourth quarter of fiscal year 2000.
In addition to the long-lived asset impairment, the Company recognized certain other exit costs associated with the closure of PrimeCast in fiscal year 2001 related to employee termination costs. The Company terminated approximately 225 employees and recognized a charge for severance benefits of approximately $175 in the quarter ended March 31, 2001.
EMPIRE
In the fourth quarter of fiscal 2000, following discovery of accounting irregularities which revealed substantial operating losses at the Company's three Pennsylvania foundry operations, the Company recognized an impairment charge of $2,708 to write-off the intangible assets (goodwill) at its Empire Steel foundry. An impairment loss was recognized as the estimated future undiscounted cash flows of Empire Steel were insufficient to recover the carrying value of the intangible assets.
Following continued losses in fiscal 2001, the Company announced, on August 31, 2001, plans to close Empire. Accordingly, the carrying values of Empire's fixed assets were written down to the Company's estimates of fair value, which was based on discounted future cash flows. The resulting impairment charge of $1,610 to reduce the carrying value of these fixed assets was recorded in the fourth quarter ended June 30, 2001. Actual results could vary significantly from such estimates. Prior to the impairment charge, these assets had a carrying value of $2,610. The Company plans to close Empire by
-F-12-
November 30, 2001, and transfer as much work as possible to other locations. For fiscal years 1999, 2000 and 2001, Empire recorded net sales of $10,414, $9,935 and $10,086, respectively, and incurred net losses of $1,204, $2,726 and $2,583, respectively, excluding the impairment charges in the fourth quarter of fiscal 2000 and the fourth quarter of fiscal 2001.
In addition to the long-lived asset impairment, the Company will recognize certain other exit costs associated with the closure of Empire in fiscal 2002 related to employee termination costs. The Company will terminate approximately 130 employees and will recognize a charge for severance benefits of approximately $89 in the quarter ending December 31, 2001.
Other costs directly related to the closure of Claremont, Pennsylvania Steel, PrimeCast and Empire which are not yet eligible for recognition will be expensed as incurred under EITF 94-3, "LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)."
3. PENDING SALES AND ASSET IMPAIRMENTS
LA DIE CASTING
The Company is negotiating the sale of substantially all of the assets of LA Die Casting. Under the terms of the proposed agreement, the Company would receive approximately $4,500 in cash in exchange for certain assets and the assumption of certain liabilities by the buyer, subject to certain post-closing adjustments. There can be no assurance that a definitive agreement will ultimately be executed. If executed and consummated, it is anticipated that this transaction would close during the second quarter of fiscal 2002.
In the fourth quarter of fiscal 2001, the Company recognized an impairment charge of $2,658 to write-down the carrying value of the intangible assets at LA Die Casting to the Company's estimate of fair value. The Company considered its decision to realign its operations, resulting in its intent to dispose of LA Die Casting as the primary indicator of impairment. Prior to the impairment charge, the intangible assets had a carrying value of $3,512. For fiscal years 1999, 2000 and 2001, LA Die Casting recorded net sales of $9,557, $9,483 and $8,233, respectively, and net income of $196, $280 and $61, respectively, excluding the impairment charge in the fourth quarter of fiscal 2001.
JAHN FOUNDRY
In September, 2001, the Company entered into a non-binding letter of intent with a third party to sell substantially all of the assets of Jahn Foundry. Under the terms of the proposed agreement, the Company would receive approximately $500 in cash, $500 in preferred stock of the buyer and $1,000 principal amount over ten years in exchange for certain assets and the assumption of certain liabilities by the buyer, subject to certain post-closing adjustments. There can be no assurance that a definitive agreement will ultimately be executed. If executed and consummated, it is anticipated that this transaction would close during the second quarter of fiscal 2002.
In the fourth quarter of fiscal 2001, the Company recognized an impairment charge of $13,871 to write-down the carrying value of the fixed assets at Jahn Foundry to the Company's estimate of fair value. The Company considered its decision to realign its operations, resulting in its intent to dispose of Jahn Foundry as the primary indicator of impairment. Prior to the impairment charge, the fixed assets had a carrying value of $15,936. For fiscal years 1999, 2000 and 2001, Jahn Foundry recorded net sales of
-F-13-
$11,988, $10,697 and $8,364, respectively, and net income (losses) of $124, $(113) and $(2,412), respectively, excluding the impairment charge in the fourth quarter of fiscal 2001 and a non-recurring gain of $10,920 recorded in the second quarter of fiscal 2001 relating to insurance claims resulting from the industrial accident at Jahn Foundry on February 25, 1999.
4. ACQUISITIONS
Effective September 1, 1998, the Company purchased 90% of the outstanding shares of London Precision for $13,663 in cash and $124 of related expenses. On June 16, 1999, the Company purchased the remaining 10% of the outstanding shares of London Precision for $1,847 in cash. London Precision, located in London, Ontario, Canada, is an industrial machine shop which serves the locomotive, mining and construction, pulp and paper markets, among others. The Company financed this transaction with funds available under its revolving credit facility.
On February 25, 1999, Autun purchased the foundry division assets of Compagnie Internationale du Chauffage ("CICH") located in Autun, France. Autun received certain assets of the foundry, including $5,847 in cash and $5,505 in inventory, in exchange for the assumption of potential environmental and employment liabilities if the facility is ever closed. CICH is a subsidiary of Blue Circle Industries plc, headquartered in London, England. Autun specialized in the manufacture of cast iron radiators and boiler castings.
The acquisitions have been accounted for by the purchase method of accounting, and accordingly, the purchase price including the related acquisition expenses has been allocated to the assets acquired based on the estimated fair values at the date of the acquisitions. For the London Precision acquisition, the excess of purchase price over estimated fair values of the net assets acquired has been included in "Intangible Assets" on the Consolidated Balance Sheets. For the Autun acquisition, the fair value of the net assets acquired exceeded the purchase price. Accordingly, the excess fair value was subtracted from identifiable long-term assets ratably based on their relative fair values as a percentage of total long-term assets. The purchase of Autun resulted in remaining excess fair value after allocation to long-term assets, which was recorded as negative goodwill and included in "Excess of Fair Value of Acquired Net Assets Over Cost" on the Consolidated Balance Sheets.
Amortization of negative goodwill was $870, $1,897, and $1,607 for the years ended June 30, 1999, 2000, and 2001, respectively.
-F-14-
The estimated fair values of assets and liabilities acquired in the 1999 acquisitions are summarized as follows:
The operating results of the acquired companies are included in ACC's consolidated statements of operations from the dates of acquisition. The following unaudited pro forma summary presents the 1999 consolidated results of operations as if the acquisitions occurred at July 1, 1998, after giving effect to certain adjustments, including amortization of goodwill, interest expense on the acquisition debt and related income tax effects: net sales - $496,426; net income - $5,849; basic and diluted net earnings per common and equivalent share - $0.75. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisitions been made as of that date or of results which may occur in the future.
5. INVENTORIES
Inventories as of June 30, 2000 and 2001 would have been higher by $416 and $710, respectively, had the Company used the FIFO method of valuing those inventories valued using the LIFO method.
-F-15-
6. PROPERTY, PLANT AND EQUIPMENT
Depreciation expense was $12,663, $14,345, and $13,489 for the years ended June 30, 1999, 2000 and 2001, respectively.
As of June 30, 2001, property, plant and equipment with a remaining net carrying value of $7,724 are related to the foundries discussed in Notes 2 and 3 and are included in the amounts above.
7. INTANGIBLE ASSETS
Amortization expense was $1,429, $1,489, and $1,345 for the years ended June 30, 1999, 2000 and 2001, respectively.
8. DEFERRED FINANCING COSTS
-F-16-
Amortization of such costs, included in interest expense, was $194, $261, and $357 for the years ended June 30, 1999, 2000 and 2001, respectively.
9. ACCRUED EXPENSES
-F-17-
10. LONG-TERM OBLIGATIONS
Long-term obligations consist of the following as of June 30, 2000 and 2001:
The Company has three primary credit facilities: a revolving credit facility with Harris Trust and Savings Bank, as agent for several lenders (referred to as the Credit Agreement with Harris or merely the Credit Agreement); senior notes with an insurance company (referred to as the Senior Notes or the Note Purchase Agreement); and a term loan with General Electric Capital Corporation (referred to as the Master Security Agreement with GECC). Each of these credit facilities require compliance with various covenants, including, but not limited to, financial covenants related to equity levels, cash flow requirements, fixed charge coverage ratios and ratios of debt to equity.
-F-18-
The Credit Agreement and the Note Purchase Agreement, including certain of the financial and other covenants, have been amended at various times since their originations and waivers of compliance with certain financial covenants have been granted by the lenders. At June 30, 2000, absent the waivers obtained from the lenders, the Company would not have been in compliance with various financial covenants contained in the Credit Agreement and the Note Purchase Agreement. Accordingly, amounts due under such agreements have been classified as current in the fiscal 2000 financial statements.
In fiscal 2001, the Company has continued to be in violation of virtually all of the financial covenants of the Credit Agreement and the Note Purchase Agreement. At various dates throughout and subsequent to fiscal 2001, the Company and these lenders have entered into amendments and forbearance agreements wherein the lenders have agreed to forbear from enforcing their rights with respect to certain events of default under the debt agreements. These forbearance agreements currently expire on October 12, 2001, after which the lenders could exercise their rights to demand payment of the amounts due under the debt agreements. The Company was also in violation of certain financial covenants contained in the Master Security Agreement with GECC. GECC agreed to forbear from enforcing its rights with respect to certain events of default under the Master Security Agreement through September 30, 2001. Accordingly, all of the debt under these agreements is classified as current in the accompanying consolidated financial statements.
Virtually all assets of the Company in North America are pledged as collateral under the various debt agreements and proceeds from the sales of assets other than inventory, insurance settlements and other non-recurring items may only be used by Atchison for purposes approved by these secured lenders. Terms of the Credit Agreement, the Note Purchase Agreement and the Master Security Agreement, as amended, prohibit the Company from paying dividends and incurring additional debt, except for the new debt as discussed below. As of June 30, 2001 the Company has no available borrowing capacity under the Credit Agreement.
In September 2001, ACUK, a subsidiary of the Company, and its subsidiaries, and Burdale Financial Limited, an affiliate of Congress Financial Corporation, entered into a Facility Agreement ("Facility Agreement"). This Facility Agreement provides for a 25 million British pound (approximately $35 million US) facility to be used to fund working capital requirements at Sheffield, a subsidiary of ACUK, and up to $1.0 million British pounds for working capital at Autun, the Company's subsidiary in France. In addition, the Facility Agreement will provide security for Sheffield's foreign currency exchange contracts and performance bond commitments, repay $5.0 million of an intercompany working capital loan and may provide for some additional working capital funds in North America, subject to availability and other restrictions in the U.K. This facility matures on September 17, 2004 and is secured by substantially all of Sheffield's assets in the U.K. Loans under this Facility Agreement will bear interest at LIBOR plus 2.60%. To date, $5.0 million has been made available to the Company in the United States as a repayment of an intercompany working capital loan, $1.1 million of which was paid to certain of the lenders as principal payments.
-F-19-
The amounts of long-term obligations outstanding as of June 30, 2001 are payable as follows, after giving effect to reclassification due to covenant violations:
The amounts of interest expense for the years ended June 30, 1999, 2000 and 2001 consisted of the following:
11. INCOME TAXES
Income (loss) before income taxes is comprised of the following:
-F-20-
Income taxes for the years ended June 30, 1999, 2000 and 2001 are comprised of the following:
-F-21-
Following is a reconciliation between total income taxes and the amount computed by multiplying income (loss) before income taxes (including the cumulative effect of the change in accounting) plus the minority interest in net income of subsidiaries by the statutory federal income tax rate:
-F-22-
Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The 2000 deferred tax asset balances for net operating loss carryforwards, foreign tax credit and AMT credit have been adjusted with an offsetting adjustment to the valuation allowance. These adjustments have no net affect on the net deferred tax asset at June 30, 2000. Deferred income taxes as of June 30, 2000 and 2001 are comprised of the following:
In general, it is the practice and intention of the Company to reinvest the earnings of its non - U.S. subsidiaries in those operations on a permanent basis. Applicable U.S. federal taxes are provided only on amounts actually or deemed to be remitted to the Company as dividends. U.S. income taxes have not been provided on $1,850 and $1,468 of cumulative undistributed earnings from United Kingdom operations for 2000 and 2001, respectively. U.S. income taxes on such earnings, if ultimately remitted to the U.S., may be recoverable as foreign tax credits.
The Company has federal net operating loss carryforwards that were acquired during previous years totaling approximately $7,225 at June 30, 2001, which expire in the years 2007 through 2012. These federal net operating loss carryforwards that were acquired during previous years are subject to the ownership change rules defined by section 382 of the Internal Revenue Code (the "Code"). As a result of this event, the Company will be limited in its ability to use such net operating loss carryforwards. The amount of taxable income that can be offset by pre-change tax attributes in any annual period is limited to approximately $500.
-F-23-
The Company has additional federal net operating loss carryforwards totaling approximately $23,452 at June 30, 2001 which will expire in the year 2021. The utilization of such net operating loss carryforwards is restricted to the earnings of the U.S. consolidated group. The Company also has foreign net operating loss carryforwards totaling approximately $53,323 at June 30, 2001, which have no expiration date. The utilization of such net operating loss carryforwards are restricted to the earnings of specific foreign subsidiaries. As a result of such restrictions, the Company has established a valuation allowance of $17,152 and $30,579 in 2000 and 2001, respectively, related to the federal, state and foreign net operating loss carryforwards to reduce the deferred tax assets to the amounts that management believe are more likely than not to be realized.
The Company has recorded a $7,786 deferred income tax benefit in fiscal year 2000 with respect to the reinvestment of certain flood insurance proceeds received in 1995 and 1996. The Company recorded pretax gains of approximately $20,100 in 1995 and 1996 related to insurance proceeds resulting from flood damage to the Company's Atchison, Kansas foundry in July 1993. For federal income tax purposes, the Company treated the flood as an involuntary conversion event under the Code and related Treasury Regulations.
The Code provides generally that if certain conditions are met, gains on insurance proceeds from an involuntary conversion are not taxable if the proceeds are reinvested in qualified replacement property within two years after the close of the first taxable year in which any part of the conversion gain is realized. The Company believed that its treatment of certain foundry subsidiary stock acquisitions as qualified replacement property was subject to potential challenge by the Internal Revenue Service (the "Service") in 1996 (the first year in which involuntary conversion gain was deferred for federal income tax purposes). The Company recorded income tax expense on the insurance gains in 1996 pending review of its position by the Service or the expiration of the statute of limitations under the Code for the Service to assess income taxes with respect to the Company's position.
The Company's treatment of certain foundry subsidiary stock acquisitions as qualified replacement property creates differing basis in the foundry subsidiary stock for financial statement and tax purposes. These differences have not been recognized as taxable temporary differences under SFAS No. 109 since the subsidiary basis differences can be permanently deferred through subsidiary mergers or tax-free liquidations. On March 15, 2000, the statute of limitations for the Service to assess taxes with respect to the Company's position expired. The deferred taxes recorded in the consolidated financial statements in prior years were no longer required.
12. FINANCIAL INSTRUMENTS
The Company's financial instruments include cash and cash equivalents, customer accounts receivable, accounts payable, debt obligations, and derivative financial instruments, including interest rate swap agreements, forward foreign exchange contracts and a foreign currency swap agreement.
The derivative financial instruments are used by the Company to manage its exposure to interest rate and foreign currency risk. The Company does not intend to use such instruments for trading or speculative purposes. The counterparties to these instruments are major financial institutions with which the Company has other financial relationships. The Company is exposed to credit loss in the event of nonperformance by these counterparties. However, the Company does not anticipate nonperformance by the counter parties, and no material loss would be expected from their nonperformance. The Company's financial instruments also expose it to certain additional market risks as discussed below.
-F-24-
INTEREST RATE RISK - The Company's floating rate debt obligations (Note 10) expose the Company to interest rate risk, such that when LIBOR, EURIBOR or Prime rates increase or decrease, so will the Company's interest expense. To manage this potential risk, the Company may use interest rate swap agreements to limit the effect of increases in interest rates on any of the Company's U.S. dollar floating rate debt by fixing the rate without the exchange of the underlying principal or notional amount. Net amounts paid or received are added to or deducted from interest expense in the period accrued.
At June 30, 2000 and 2001, the Company had $62,855 and $72,359, respectively, of floating rate debt tied to LIBOR, EURIBOR or Prime rates. In April 1998, the Company entered into a $15,000 notional amount interest rate swap agreement under which the Company paid a fixed rate of 5.92% and received a LIBOR floating rate (5.0% at June 30, 1999). This agreement was a hedge against $15,000 of the $88,817 outstanding on the Company's revolving credit facility as of June 30, 1999. At June 30, 1999, the fair value of this agreement based on a quote received from the counterparty, indicating the amount the Company would pay or receive to terminate the agreement, was a payment of $67. This agreement was terminated on June 23, 2000, with the Company receiving $402 upon termination. Such amount is included within other income on the accompanying consolidated statements of income for fiscal year 2000.
In September 1998, the Company entered into a $40 million notional amount interest rate swap agreement under which the Company paid a fixed rate of 5.00% and received a LIBOR floating rate (5.3275% at June 30, 1999). Under this agreement, the notional amount was amortized at $1,429 per quarter beginning March 31, 1999. At June 30, 1999, this agreement was a hedge against $37,142 of the $88,817 outstanding on the Company's revolving credit facility. At June 30, 1999, the fair value of this agreement based on a quote received from the counterparty, indicating the amount the Company would pay or receive to terminate the agreement, was a receipt of $965. This agreement was terminated on December 29, 1999, with the Company receiving $1,238 upon termination. Such amount is included within other income on the accompanying consolidated statements of income for fiscal year 2000.
FOREIGN CURRENCY RISK - The Company's British subsidiary, Sheffield, generates significant sales to customers outside of Great Britain whereby Sheffield invoices and receives payment from those customers in their local currencies. This creates foreign currency risk for Sheffield as the value of such currencies in British Pounds may be higher or lower when such transactions are actually settled. To manage this risk, Sheffield uses forward foreign exchange contracts to hedge receipts and payments of foreign currencies related to sales to its customers and purchases from its vendors outside of Great Britain. When Sheffield accepts an order from a customer that will be invoiced in a currency other than British Pounds (anticipated sales), it enters into a forward foreign exchange contract to sell such currency and receive British Pounds at a fixed rate during some specified future period that is expected to approximate the customer's payment date. Upon shipment of the product to the customer, the sale and receivable are recorded in British Pounds in the amount of the contract. When Sheffield purchases materials or equipment from a vendor that bills it in foreign currency, Sheffield will also enter into a forward foreign exchange contract to sell British Pounds and purchase that foreign currency to settle the payable.
-F-25-
At June 30, 2000 and 2001, the Company's foreign subsidiaries, primarily Sheffield, have the following net contracts to sell the following currencies and has no significant un-hedged foreign currency exposure related to sales and purchase transactions:
(1) The approximate value is the value of the local currencies translated first into the foreign subsidiaries' functional currency, at the June 30, 2000 and 2001 spot rates, respectively, and then translated to U.S. dollars at the June 30, 2000 and 2001 spot rates.
The Company also has foreign currency exposure with respect to its net investment in Sheffield. This exposure is to changes in the British Pound and affects the translation of the investment into U.S. Dollars in consolidation. To manage a portion of this exposure, the Company entered into a combined interest rate currency swap ("CIRCUS") in April 1998. The CIRCUS was an amortizing principal swap that fixed the exchange rate on the periodic and final principal cash exchanges and initially required the payment of interest on 24,002 British Pounds by the Company at a fixed rate of 6.82% and the receipt of interest on 40,000 U.S. Dollars at a floating rate tied to LIBOR rates. The currency portion of the CIRCUS was designated as an effective hedge of a portion of the Company's net investment in Sheffield. The interest portion of the CIRCUS was also effective and was designated as a hedge of the 40,000 U.S. Dollars LIBOR debt.
In September 1998, the Company terminated the CIRCUS and entered into a separate interest rate swap (described in INTEREST RATE RISK above) and a separate amortizing principal currency swap. The termination of the CIRCUS resulted in a loss of $900 on the interest portion, which was deferred and amortized to interest expense over the remaining term of the underlying debt obligation to which it was originally designated until such debt was retired on December 29, 1999. The retirement of this debt triggered the recognition of the remaining $557 of deferred loss. This loss was recorded as a reduction of other income in fiscal year 2000.
-F-26-
This currency swap entered into in September 1998, like the currency portion of the CIRCUS, was an amortizing principal swap that fixed the exchange rate on the periodic and final principal cash exchanges. The currency swap initially required the payment of interest on 24,002 British Pounds by the Company at a fixed rate of 6.82% and the receipt of interest by the Company on 40,000 U.S. Dollars at a fixed rate of 5.00%. The currency swap was designated as an effective hedge of a portion of the Company's net investment in Sheffield and was recorded as an adjustment to the accumulated foreign currency translation adjustment account and as a component of other assets. At June 30, 1999, the currency swap had a carrying value of $1,513 and a fair value, based on amounts that would be paid or received by the Company to terminate the swap, of $(188). On June 23, 2000, the Company terminated the currency swap, with the Company receiving $1,549 upon termination. This payment was recorded as a deferred gain within the accumulated foreign currency translation adjustment account. This deferred gain will only be recognized within operations if and when the Company sells the Sheffield subsidiary.
FAIR VALUE OF FINANCIAL INSTRUMENTS - As of June 30, 2000 and 2001, the carrying value of cash and cash equivalents approximates fair value of those instruments due to their liquidity and short-term nature.
Based on borrowing rates currently available to the Company and the remaining terms, the carrying value of debt obligations as of June 30, 2000 and 2001 approximates fair value.
The estimated fair values of the Company's financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgement is required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
13. STOCKHOLDERS' EQUITY
In fiscal year 2000, the Company's Board of Directors established a Stockholder Rights Plan and distributed to stockholders, one preferred stock purchase right for each outstanding share of common stock. Under certain circumstances, a right may be exercised to purchase one one-thousandth of a share of Series A Participating Cumulative Preferred Stock at an exercise price of $30 per share, subject to adjustment. The rights become exercisable on the business day following the tenth business day after the commencement of a tender offer for at least 20% of the Company's common stock or a public announcement that a party or group has acquired at least 20% of the Company's common stock. Generally, after the rights become exercisable, the holders may purchase that number of preferred shares having a market value equal to twice the exercise price, for an amount in cash equal to the exercise price. If the Company's Board of Directors elects, it may exchange all of the outstanding rights for shares of common stock on a one-for-one basis. If the Company is a party to certain merger or business combination transactions, or transfers 50% or more of its assets or earnings power, and certain other events occur, each right will entitle its holders, other than the acquiring person, to buy for the exercise price a number of shares of common stock of the Company, or of the other party to the transaction, having a value equal to twice the exercise price of the right. The rights expire on March 28, 2010, and may be redeemed by the Company for $.01 per right at any time until ten business days following the date of the public announcement of the acquisition of 20% or more of the Company's common stock or the commencement date of a tender offer for at least 20% of the Company's common stock. The Company is authorized by the Board of Directors to issue 2,000,000 shares of preferred stock, none of which have been issued. The Company has designated 10,000 shares of the preferred stock as Series A Participating
-F-27-
Cumulative Preferred Stock for the purpose of the Stockholder Rights Plan. The Stockholder Rights Plan was ratified by stockholders at the Company's annual meeting on June 29, 2001.
In August 1998, the Company announced that its Board of Directors had authorized a stock repurchase program of up to 1,200,000 shares of the Company's common stock. During the remainder of fiscal year 1999, the Company repurchased 586,700 shares under this program for $6,048. The Company accounts for these shares as treasury stock and has recorded them at cost. On February 18, 2000, the Board of Directors terminated the stock repurchase program. The Company's Credit Agreement and the Note Purchase Agreement (Note 10) each restrict certain payments by the Company, such as stock repurchases, from exceeding certain limits.
The 1993 Atchison Casting Corporation Employee Stock Purchase Plan (the "Purchase Plan") was adopted by the Board of Directors on August 10, 1993 and approved by the Company's stockholders on September 27, 1993. An aggregate of 400,000 shares of common stock were initially made available for purchase by employees upon the exercise of options under the Purchase Plan. On the first day of every option period (option periods are three-month periods beginning on January 1, April 1, July 1 or October 1 and ending on the next March 31, June 30, September 30 or December 31, respectively), each eligible employee is granted a nontransferable option to purchase common stock from the Company on the last day of the option period. As of the last day of an option period, employee contributions (authorized payroll deductions) during such option period will be used to purchase full and partial shares of common stock. The price for stock purchased under each option is 90% of the stock's fair market value on the first day or the last day of the option period, whichever is lower. During the years ended June 30, 1999, 2000, and 2001 33,033, 36,371 and 16,075 common shares, respectively, were purchased by employees under the Purchase Plan. At June 30, 2001, 237,594 shares remained available for grant. After accounting irregularities were discovered in the second quarter of fiscal 2001, purchases of shares under the Purchase Plan were temporarily suspended. The Purchase Plan was still frozen as of June 30, 2001.
-F-28-
The Atchison Casting 1993 Incentive Stock Plan (the "Incentive Plan") was adopted by the Board of Directors on August 10, 1993 and approved by the Company's stockholders on September 27, 1993. At the annual meeting in November 1997, the Company's stockholders approved increasing the number of options available for grant under the Incentive Plan by 400,000. The Incentive Plan allows the Company to grant stock options to employees to purchase up to 700,000 shares of common stock at prices that are not less than the fair market value at the date of grant. The options vest equally over a three year period from the date of grant and remain exercisable for a term of not more than 10 years after the date of grant. The Incentive Plan provides that no options may be granted more than 10 years after the date of approval by the stockholders. Activity in the Incentive Plan for the three years ended June 30, 2001, is summarized in the following table:
As of June 30, 1999, 2000 and 2001, there were 191,633, 235,067 and 266,733 options, respectively, exercisable under the Incentive Plan. The weighted-average exercise price for options exercisable at June 30, 1999, 2000 and 2001 were $14.09, $13.91 and $13.25, respectively.
At June 30, 2001, options to purchase 168,607 shares were authorized but not granted. The weighted average remaining contractual life of options outstanding under the Incentive Plan at June 30, 1999, 2000 and 2001 was 7.1 years, 6.7 years and 6.5 years, respectively.
-F-29-
On November 18, 1994, the Company's stockholders approved the Atchison Casting Non-Employee Director Option Plan (the "Director Option Plan"). The Director Option Plan provides that each non-employee director of the Company who served in such capacity on April 15, 1994 and each non-employee director upon election or appointment to the Board of Directors thereafter shall automatically be granted an option to purchase 10,000 shares of the Company's common stock. No person shall be granted more than one such option pursuant to the Director Option Plan. An aggregate of 100,000 shares were reserved for purchase under the plan. The price for stock purchased under the plan is the fair market value at the date of grant. The options under this plan have a 6 month vesting period from the date of grant and remain exercisable for a term of not more than 10 years after the date of grant. Activity in the Director Option Plan for the three years ended June 30, 2001, is summarized in the following table:
As of June 30, 1999, 2000 and 2001, there were 40,000, 40,000 and 50,000 options exercisable, respectively, under the Director Option Plan. The weighted-average exercise price for options exercisable at June 30, 1999, 2000 and 2001 was $14.81, $13.60 and $13.60, respectively.
At June 30, 2001, options to purchase 30,000 shares were authorized but not granted. The weighted average remaining contractual life of options outstanding under the Director Option Plan at June 30, 1999, 2000 and 2001 was 5.6 years, 5.6 years and 4.6 years, respectively.
-F-30-
The following table illustrates the range of exercise prices and the weighted average remaining contractual lives for options outstanding under both the Incentive Plan and Director Option Plan as of June 30, 2001:
The Company applies APB No. 25 in accounting for its stock option and stock purchase plans, under which no compensation cost has been recognized for such awards. Had compensation cost for the stock option and stock purchase plans been determined in accordance with the fair value accounting method prescribed under SFAS No. 123, the Company's net income (loss) and net earnings (loss) per share on a pro forma basis would have been as follows:
The SFAS No. 123 fair value method of accounting is not required to be applied to options granted prior to July 1, 1995, therefore, the pro forma compensation cost may not be representative of that to be expected in future years.
-F-31-
For the purpose of computing the pro forma effects of stock option grants under the fair value accounting method, the fair value of each stock option grant was estimated on the date of the grant using the Black Scholes option pricing model. For the Incentive Plan, the weighted average grant-date fair value of stock options granted during fiscal year 1999, 2000 and 2001 was $6.87, $5.92 and $5.23 per share, respectively. For the Director Option Plan, the weighted average grant-date fair value of stock options granted during fiscal year 2000 was $5.66 per share, respectively. No options were issued under the Director Option Plan in fiscal year 2001. The following weighted average assumptions were used for grants under both option plans during the years ended June 30, 1999, 2000 and 2001:
For the Purchase Plan, the weighted average grant-date fair value of options granted under the plan was $1.81, $1.57 and $1.47, respectively, for the years ended June 30, 1999, 2000 and 2001. The following weighted average assumptions were used for grants under the Purchase Plan during the years ended June 30, 1999, 2000 and 2001:
14. EARNINGS PER SHARE
Following is a reconciliation of basic and diluted EPS for the years ended June 30, 1999, 2000 and 2001, respectively.
-F-32-
15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(1) The second quarter of fiscal 2000 contains a $681 gain on the termination of an interest rate swap agreement, which increased net income by $412 or $.05 per share (Note 12).
(2) The third quarter of fiscal 2000 contains a $7,786 deferred income tax benefit relating to the resolution of the Company's tax treatment of certain flood insurance proceeds received in 1995 and 1996, which increased net income by $7,786, or $1.02 per share (Note 11).
(3) The fourth quarter of fiscal 2000 contains the following charges: a) a $3,373 impairment charge and $227 of other costs recorded in connection with the closure of Claremont, which decreased net income by $2,268 or $.30 per share (Note 2); b) a $6,883 impairment charge recorded in connection with the write-down of PrimeCast fixed assets, which decreased net income by $4,336 or $.57 per share (Note 2); c) a $3,450 impairment charge and $400 of other costs recorded in connection with the closure of Pennsylvania Steel, which decreased net income by $2,348 or $0.31 per share (Note 2); d) a $2,708 impairment charge recorded in connection with the write-off of Empire Steel goodwill, which decreased net income by $2,708 or $0.35 per share (Note 2). In addition, the fourth quarter contains a $402 gain on the termination of an interest rate swap agreement, which increased net income by $243 or $.03 per share (Note 12).
(4) The second quarter of fiscal 2001 contains a $10,920 insurance gain recorded in connection with an industrial accident that occurred on February 25, 1999 at the Company's subsidiary, Jahn Foundry, which increased net income by $6,552 or $0.87 per share (Notes 3 and 23).
(5) The fourth quarter of fiscal 2001 contains the following charges: a) a $13,871 impairment charge recorded in connection with the planned sale of Jahn Foundry, which decreased net income by $1.80 per share (Note 3) ; b) a $1,610 impairment charge recorded in connection with the closure of Empire, which decreased net income by $0.21 per share (Note 2); c) a $2,658 impairment charge recorded in connection with the planned sale of LA Die Casting, which decreased net income by $0.35 per share (Note 3).
-F-33-
16. EMPLOYEE BENEFIT PLANS
The Company sponsors separate defined benefit pension plans for certain of its salaried and hourly employees. Employees are eligible to participate on the date of employment with vesting after five years of service. Benefits for hourly employees are determined based on years of credited service and employee earnings.
Pension expense for the defined benefit plans is presented below:
-F-34-
The pension plans' assets (primarily U.S. Government securities, common stock and corporate bonds) are deposited with a bank. A comparison of the projected benefit obligation and plan assets at fair value as of June 30, 2000 and 2001 is presented below.
-F-35-
In accordance with SFAS No. 87, "EMPLOYERS' ACCOUNTING FOR PENSIONS", the Company has recorded an additional minimum pension liability for underfunded plans of $122 and $887 at June 30, 2000 and 2001, respectively, representing the excess of unfunded accumulated benefit obligations over previously recorded pension cost liabilities. A corresponding amount is recognized as an intangible asset except to the extent that these additional liabilities exceed related unrecognized prior service cost and net transition obligation, in which case the increase in liabilities is charged directly to stockholders' equity as a component of other comprehensive income.
In addition, the Company sponsors a defined contribution 401(k) benefit plan covering certain of its employees who have attained age 21 and have completed one year of service. The Company matches 75% of employee contributions up to 8% of an employee's salary. Employees vest in the Company matching contributions after five years. The Company's contribution was $519, $1,387 and $1,230 for the years ended June 30, 1999, 2000 and 2001, respectively.
The Company's subsidiaries, Prospect Foundry, LA Die Casting and Jahn Foundry contributed $302, $320 and $256 for the years ended June 30, 1999, 2000 and 2001, respectively, to multiemployer pension plans for employees covered by a collective bargaining agreement. These plans are not administered by the Company and contributions are determined in accordance with provisions of negotiated labor contracts. Information with respect to the Company's proportionate share of the excess of the actuarially computed value of vested benefits over the total of the pension plans' net assets is not available from the plans' administrators. The Multiemployer Pension Plan Amendments Act of 1980 (the "Act") significantly increased the pension responsibilities of participating employers. Under the provisions of the Act, if the plans terminate or the Company withdraws, the Company may be subject to a substantial "withdrawal liability". As of the date of the most current unaudited information submitted by the plan's administrators (December 31, 2000), no withdrawal liabilities exist.
The Company also has various other profit sharing plans. Costs of such plans charged against earnings were $1,234, $907 and $862 for the years ended June 30, 1999, 2000 and 2001, respectively.
-F-36-
17. POSTRETIREMENT OBLIGATION OTHER THAN PENSIONS
The Company provides certain health care and life insurance benefits to certain of its retired employees. SFAS No. 106, "EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS," requires the Company to accrue the estimated cost of retiree benefit payments during the years the employee provides services. The Company funds these benefits on a pay-as-you-go basis. The accumulated postretirement benefit obligation and fair value of plan assets as of June 30, 2000 and 2001 are as follows:
Net postretirement benefit cost for the years ended June 30, 1999, 2000 and 2001 consisted of the following components:
The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation for pre-age 65 and post-age 65 benefits as of June 30, 2001 was 9.14% decreasing each successive year until it reaches 5.25% in 2021, after which it remains constant. A one-percentage-point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of June 30, 2001 by approximately $2,064 (14.8%) and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost for the year then ended by approximately $239 (16.7%). A one-percentage-point decrease in the assumed health care cost trend rate for each year would decrease the accumulated postretirement benefit obligation as of June 30,
-F-37-
2001 by approximately $1,662 (11.9%) and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost for the year then ended by approximately $190 (13.3%). The assumed discount rates used in determining the accumulated postretirement benefit obligation, the service costs and interest costs as of and for the years ended June 30, 1999, 2000 and 2001 were 7.5%, 8.0% and 7.25%, respectively.
18. OPERATING LEASES
The Company leases certain buildings, equipment, automobiles and trucks, all accounted for as operating leases, on an as needed basis to fulfill general purposes. Total rental expense was $1,675, $3,862 and $5,462 for the years ended June 30, 1999, 2000 and 2001, respectively. Long-term, noncancellable operating leases having an initial or remaining term in excess of one year require minimum rental payments as follows:
19. MAJOR CUSTOMERS
Net sales to and customer accounts receivable from major customers are as follows:
20. SEGMENT AND GEOGRAPHIC INFORMATION
Each of the Company's subsidiaries and its Atchison Steel Casting & Machining division is a separate operating segment. Due to the similarity of the Company's products and services, its production processes, the type or class of customer for its products and services, and the methods used to distribute products and provide services, the Company has aggregated these operating segments into a single
-F-38-
reportable segment for reporting purposes. Due to the many casting products produced by the Company, it is not practicable to disclose revenues by casting or forging product.
The Company operates in four countries, the United States, Great Britain, Canada and France. Revenues from external customers derived from operations in each of these countries for the years ended June 30, 1999, 2000 and 2001 are as follows and long-lived assets located in each of these countries as of June 30, 2000 and 2001 are as follows:
21. ADDITIONAL CASH FLOWS INFORMATION
22. FLOOD RESERVE
In 1996, the Company received an insurance settlement for losses incurred as a result of the July 1993 Missouri River flood. At that time the Company established a reserve to be used for future repairs due to long-term flood damage to the Company's foundry. Since that time the Company has been charging the reserve balance for costs incurred resulting from those repairs.
During 1999, management updated its analysis of the required repairs by performing its periodic re-evaluation of the effects of the flood based on current information. As a result, management committed to a revised repair plan, which included several remaining projects. These projects and their final estimated costs to complete represent the remaining flood reserve balance that is considered necessary. The amount of the reserve balance, over and above the estimated costs of such identified projects, was considered to be excess and was reversed. Such excess amounted to $3,500 and was included in other income in the fourth quarter of fiscal year 1999. Any future repairs outside the scope of the projects identified, if any, will be
-F-39-
charged to repairs and maintenance as incurred. As of June 30, 2000 and 2001, the Company has $645 and $597 recorded, respectively, as reserves for future flood repairs, which have been classified as accrued expenses.
23. CONTINGENCIES
An accident, involving an explosion and fire, occurred on February 25, 1999 at Jahn Foundry, located in Springfield, Massachusetts. Nine employees were seriously injured and there were three fatalities. The damage was confined to the shell molding area and the boiler room. The other areas of the foundry remained operational. Molds were being produced at other foundries, as well as Jahn Foundry, while the repairs are made. The new shell molding department became operational in November 2000.
The Company carries insurance for property and casualty damages (over $475 million of coverage), business interruption (approximately $115 million of coverage), general liability ($51 million of coverage) and workers' compensation (up to full statutory liability) for itself and its subsidiaries. The Company recorded charges of $750 ($450 after tax) during the third quarter of fiscal year 1999, primarily reflecting the deductibles under the Company's various insurance policies. At this time, there can be no assurance that the Company's ultimate costs and expenses resulting from the accident will not exceed available insurance coverage by an amount which could be material to its consolidated financial statements.
In November 2000, the Company and its insurance carrier settled the Jahn Foundry property portion of the Company's claim. The settlement provided, among other things, for (i) additional payments from the carrier in the amount of $2.6 million, (ii) that of the payments received to date, totaling $26.8 million, the insurance carrier will allocate no more than $9.5 million for property damage, (iii) that the remaining proceeds of $17.3 million, will be allocated to business interruption losses and will not be subject to recovery by the insurance carrier and (iv) that the Company shall not be entitled to any additional payments unless it is determined by reference, appraisal, arbitration, litigation or otherwise that the Company's business interruption losses exceed $17.3 million. The Company plans to seek additional insurance payments through arbitration. There can be no assurance that the Company will ultimately receive any additional insurance payments or that the excess of the Company's costs and expenses resulting from the accident over the insurance payments received will not be material to its financial condition or results of operations and cash flows.
As a result of the above settlement, the Company recorded a non-recurring gain of $10.9 million in the second quarter of fiscal 2001, which consisted of $3.7 million business interruption insurance gain and a $7.2 million property insurance gain. The property insurance gain primarily represents the difference between the net proceeds received for the property damage and the property's net book value immediately before the accident. These net proceeds were used to rebuild the damaged property and were accounted for as capital expenditures.
A civil action has commenced in the Massachusetts Superior State Court on behalf of the estates of deceased workers, their families, injured workers and their families, against the supplier of a chemical compound used in Jahn Foundry's manufacturing process. The supplier of the chemical compound, Borden Chemical, Inc., filed a Third Party Complaint against Jahn Foundry in the Massachusetts Superior State Court on February 2, 2000 seeking indemnity for any liability it has to the plaintiffs in the civil action. The Company's comprehensive general liability insurance carrier has retained counsel on behalf of Jahn Foundry and the Company and is aggressively defending Jahn Foundry in the Third Party Complaint. It is too early to assess the potential liability to Jahn Foundry for the Third Party Complaint, which in any event the Jahn Foundry would aggressively defend. In addition, Jahn Foundry has brought a
-F-40-
Third Party Counterclaim against Borden and the independent sales representative of the chemical compound, J.R. Oldhan Company, seeking compensation for losses sustained in the explosion, including amounts covered by insurance.
On February 26, 2001, Borden filed a Third Party Complaint against the Company seeking a contribution, under Massachusetts law, from the Company in the event that the plaintiffs prevail against Borden. The Third Party Complaint alleges that the Company undertook a duty to oversee industrial hygiene, safety and maintenance at Jahn Foundry and that the Company designed, installed and maintained equipment and machinery at Jahn Foundry, and that the Company's carelessness, negligence or gross negligence caused the explosion and resulting injuries. It is too early to assess the potential liability for such a claim, which in any event the Company would aggressively defend.
On March 30, 2001, the plaintiffs amended their complaint by adding the Company as a third party defendant. The plaintiffs allege that the Company undertook a duty to oversee industrial hygiene, safety and maintenance at Jahn Foundry and that the Company's carelessness, negligence or gross negligence caused the explosion and resulting injuries. The plaintiffs seek an unspecified amount of damages and punitive damages. It is too early to assess the potential liability to the Company for such claims, which in any event the Company would aggressively defend. The Company has filed a cross-claim for contribution against Borden and J.R. Oldhan.
The Company, its chief executive officer, and its chief financial officer were named as defendants in five lawsuits filed following the Company's announcements concerning the discovery of accounting irregularities at the Pennsylvania Foundry Group. The cases have been consolidated before the U.S. District Court for the District of Kansas. An amended complaint filed after the consolidation alleges, among other things, that the defendants intentionally or recklessly issued materially false and misleading financial statements in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. That complaint seeks certification of a class of purchasers of the company's common stock between December 10, 1997 and November 3, 2000 and asks for damages for the class in an unspecified amount. Discovery has been stayed pending the resolution of the defendant's motion to dismiss the amended complaint. The Company believes the claims are without merit and intends to defend them vigorously. There can be no assurance, however, that an adverse outcome with respect to the case will not have a material adverse impact on the Company's financial condition, results of operations or cash flows.
The Company understands that on or about November 29, 2000, the Securities and Exchange Commission issued a formal order of investigation as a result of the events underlying the Company's earlier disclosure of certain accounting irregularities. The Company is cooperating with the investigation.
In addition to these matters, from time to time, the Company is the subject of legal proceedings, including employee matters, commercial matters, environmental matters and similar claims in the normal course of business. In the opinion of management, the resolution of these matters will not have a material effect on the Company's consolidated financial statements.
-F-41-
24. FINANCIAL RESULTS AND MANAGEMENT PLANS
In fiscal 2000 and fiscal 2001, the Company incurred pre-tax losses of $27.6 million ($11.2 million excluding impairment charges of $16.4 million) and $34.5 million ($16.4 million excluding impairment charges of $18.1 million), respectively, and, has not been in compliance with certain financial covenants included in its debt agreements (See Note 10). At June 30, 2001, the Company had a deficiency in working capital of $52,925. These conditions have continued subsequent to June 30, 2001.
To address these conditions, management has taken or is in the process of taking the following actions:
OPERATIONS
As discussed in Note 2, the Company has closed three unprofitable foundries during fiscal 2001 and is in the process of closing a fourth. Operations from these four foundries have been a major factor in the Company's pre-tax losses, producing combined pre-tax losses of $32.7 million ($16.3 million before impairment charges of $16.4 million) and $17.1 million ($15.5 million before impairment charges of $1.6 million) in fiscal 2000 and fiscal 2001, respectively. Management believes it can continue to transfer a significant portion of the work previously performed by these locations to other foundries, thereby increasing the utilization and profitability of these other foundries.
PLANNED SALE OF OPERATIONS
Jahn Foundry has been unable to achieve the productivity and earnings levels experienced prior to the industrial accident that occurred there on February 25, 1999 (Note 23). Jahn Foundry had pre-tax losses of $187 (after insurance payments) and $7.0 million ($4.0 million excluding an impairment charge of $13.9 million and a non-recurring gain of $10.9 million relating to insurance claims resulting from the industrial accident at Jahn Foundry on February 25, 1999) in fiscal 2000 and fiscal 2001, respectively. To improve operating results, Jahn Foundry began focusing on 1) only one type of molding process, transferring work requiring a different process to G&C and La Grange and 2) a smaller number of key customers, with a significantly reduced workforce. While Jahn Foundry has made some gradual improvement as a result of these actions, the Company has decided to try to sell Jahn Foundry. The Company is negotiating the sale of substantially all of the assets of Jahn Foundry (Note 3). If a definitive agreement is executed and consummated, it is expected this transaction would close during the second quarter of fiscal 2002.
The Company is negotiating the sale of substantially all of the assets of LA Die Casting (Note 3). If consummated, it is expected that this transaction would close during the second quarter of fiscal 2002. LA Die Casting recorded pre-tax income of $488 and $64 (excluding an impairment charge of $2.7 million) for fiscal 2000 and fiscal 2001, respectively.
OTHER ACTIONS
Management continues to pursue new or revised long-term debt arrangements with terms and covenants acceptable to the Company and to the lenders. As discussed in Note 10, over the past few years the Company has successfully negotiated with its lenders to obtain waivers for violations of various covenants of its loan agreements, and the lenders have demonstrated a history of working with the Company in providing an adequate credit facility to meet its ongoing needs, and the Company currently has forbearance agreements which expire September 30, 2001 and October 12, 2001. The Company believes that its operating cash flow and amounts available for borrowing under its existing credit facility and the
-F-42-
Facility Agreement will be adequate to fund its capital expenditure and working capital requirements through June 2002.
On September 17, 2001, the Company's 95% owned U.K. subsidiary, ACUK, entered into a new financing agreement with Burdale Financial Limited, an affiliate of Congress Financial Corporation (Note 10). This 25 million British pound (approximately $35 million U.S.) facility will provide additional working capital to fund future growth. The purpose of the facility is to fund working capital requirements at Sheffield, a subsidiary of ACUK, as well as up to 1.0 million British pounds in working capital funds at the Company's subsidiary in France, Autun. It also provided for up to $9 million additional working capital funds in North America if certain conditions are met.
Management believes, however, that certain of the existing loan arrangements will need to be revised or replaced to provide the Company with additional borrowing capacity and with financial covenants within such arrangements that are achievable by the Company. Management is currently in negotiations with various financial institutions to extend, renegotiate or replace the current credit agreements with a long-term credit facility, but there can be no assurance that management will be successful in these negotiations.
* * * * * *
-F-43