ITEM 1. BUSINESS
(a) General development of business. Sequa Corporation ("Sequa"), which was incorporated in 1929, is a diversified industrial company that produces a broad range of products through operating units in five business segments: Aerospace, Propulsion, Metal Coating, Specialty Chemicals and Other Products. Information with respect to material acquisitions and dispositions is included in Note 17 to the Consolidated Financial Statements on page 73 of this Annual Report on Form 10-K and is incorporated herein by reference.
(b) Financial information about business segments. Segment information is included in Note 23 to the Consolidated Financial Statements on pages 79 through 82 of this Annual Report on Form 10-K and is incorporated herein by reference.
(c) Narrative description of business. The following is a narrative description of the business segments of Sequa:
Aerospace
The Aerospace segment consists solely of Sequa's largest operating unit, Chromalloy Gas Turbine (Chromalloy). Chromalloy repairs and manufactures components for jet aircraft engines. A major independent supplier in the repair market, Chromalloy provides domestic and international airlines with technologically advanced repairs and coatings for turbine airfoils and other critical engine components. In addition, the unit repairs components for land-based turbine engines. The unit also supplies components to the manufacturers of jet engines and serves both the general aviation and military markets.
Chromalloy has built on its metallurgical process technologies to develop procedures that permit the repair and reuse of turbine engine components. Management believes Chromalloy has played a key role in the development of the repair market for certain jet engine parts. Over the years, Chromalloy has continued to invest in research and development projects that have led to ceramic coatings, vacuum plasma coatings, advanced
laser drilling and welding, and diffused precious metal/aluminide coatings. Chromalloy has introduced a series of innovative and in some cases proprietary processes that allow engines to perform at improved efficiency levels, at higher operating temperatures and under severe environmental conditions.
Chromalloy's strategy has included the active pursuit of joint venture opportunities aimed at strengthening its ties to certain original equipment manufacturers (OEMs) and its customers as well as ensuring close cooperation with respect to the dissemination of technical specifications and requirements.
Propulsion
The Propulsion segment consists solely of Atlantic Research Corporation (ARC), a supplier of solid rocket fuel propulsion systems since 1949. ARC is a leading developer and manufacturer of advanced rocket propulsion systems, gas generators and auxiliary rocket motors, and engages in research and development relating to new rocket propellants and advanced engineered materials. For the military contract market, ARC produces propulsion systems primarily for tactical weapons. For space applications, ARC produces small liquid fuel rocket engines designed to provide attitude and orbit control for a number of satellite systems worldwide.
ARC's expertise with propulsion systems has led to the development of other products for commercial markets. ARC pioneered the development of hybrid inflators for automotive airbags. ARC produces inflators for driver, passenger, side-impact and curtain model airbags.
Metal Coating
The Metal Coating segment consists solely of Precoat Metals (Precoat), which is a leader in the application of protective and decorative coatings to continuous steel and aluminum coils. Precoat's principal market is the building products industry, where coated steel is used for the construction of pre-engineered building systems, and as components in the industrial, commercial, agricultural and residential sectors. Precoat also serves the container industry, where the division has established a position in the application of coatings to steel and aluminum stock used to fabricate metal cans and can lids. In addition, the division has established a presence in other product markets, including heating, ventilating and air conditioning units, truck trailer panels and office equipment.
Specialty Chemicals
The Specialty Chemicals segment is composed solely of Warwick International, which is a leading producer and supplier of TAED, a bleach activator for laundry and dishwasher powdered and tablet detergent products. TAED is used in oxygen-
based bleaching systems to increase the cleaning power of
detergent at low wash temperatures. These bleaching systems are used primarily in international markets, principally in Europe. The unit is extending its TAED capabilities to large industrial markets, such as textile bleaching and pulp and paper processing, and continues to expand a network of European chemical distributors that supply specialty products for use in plastics, inks, resins, pharmaceuticals, petrochemicals, cosmetics and ceramics.
Other Products
This segment is composed of four ongoing businesses: MEGTEC Systems (MEGTEC), Sequa Can Machinery, Casco Products (Casco) and the After Six unit (formerly Men's Apparel).
MEGTEC Systems. MEGTEC's products include air flotation dryers for paper, printing and other uses and emission control systems for industrial applications. MEGTEC also supplies equipment for the web offset printing industry, including pasters and splicers, web guides, infeeds, chill stands and related equipment for high-speed web presses.
Sequa Can Machinery. Sequa Can Machinery designs and manufactures equipment for the two-piece can industry. Sequa Can Machinery manufactures high-speed equipment to coat and decorate two-piece beverage cans and has the largest installed base of equipment in the field. The units product development team has improved the technology of precision printing to achieve high speeds without compromising quality. In addition, the unit has developed products to broaden the range of metal containers to include aerosol and other specialty products such as oil cans, oil filters and non-round cans.
Casco Products. Casco, which has been serving the automotive products market since 1921, is the world's leading supplier of automotive cigarette lighters and power outlets. Casco also offers a growing line of automotive accessories, led by a series of electronic devices to monitor automotive fluid levels. These products are presently used for measurement and control of certain gases and for monitoring engine oil and engine coolant.
After Six.
The After Six unit designs and manufactures men's formalwear and accessories marketed under the After Six, Oscar de la Renta and Raffinati labels, all three of which are registered trademarks.
Markets and Methods of Distribution
The Aerospace segment markets its gas turbine engine component repair and manufacturing services primarily to the major airlines of the world, to the manufacturers of commercial jet engines and to the military. Chromalloy's products and services are marketed directly and through sales representatives working on a commission basis. A portion of Chromalloy's sales is made pursuant to contracts with various agencies of the United States Government, particularly the Air Force, with which Chromalloy has had a longstanding relationship. Further information with respect to Chromalloy is included in the discussion on pages 28 and 29 of this Annual Report on Form 10-K under the heading of "Risk/Concentration of Business," which is incorporated herein by reference.
The Propulsion segment markets its rocket propulsion systems generally on a subcontract basis under various defense programs of the United States Government. Among the programs currently in production are the Army Extended Range Multiple Launch Rocket System, Extended Range Army Tactical Rocket System, Javelin, Stinger, Tomahawk, Standard Missile, PAC-3 and Trident. In addition, the liquid propulsion unit operates in the world-wide commercial satellite market selling directly to the satellite manufacturers. ARC markets its automotive airbag inflators to automotive customers in the US and overseas. Through 2002, sales of airbag inflators will be largely dependent on ARC's largest customer, Breed Technologies, Inc. (Breed), which emerged from Chapter 11 proceedings in December 2000. Certain assets as well as the ongoing automotive inflator business of BAG S.p.A, a 50/50 joint venture with Breed, were acquired in February 2001 pursuant to an overall settlement with Breed in conjunction with its emergence from Chapter 11 proceedings. Further information with respect to annual sales to Breed is included in the discussion on pages 28 and 29 of this Annual Report on Form 10-K under the heading "Risk/Concentration of Business," which is incorporated herein by reference.
Sequa's Metal Coating segment sells its coating services to regional steel and aluminum producers and distributors, building product manufacturers, merchant can makers and manufacturers of other diverse products. Further information with respect to Precoat's major customers is included in the discussion on pages 28 and 29 of this Annual Report on Form 10-K under the heading "Risk/Concentration of Business," which is incorporated herein by reference.
The Specialty Chemicals segment sells TAED-based detergent chemicals directly to major producers of household and industrial cleaning products and to paper and textile manufacturers. Specialty products for use in plastics, inks, resins, pharmaceuticals, petrochemicals, cosmetics and ceramics are sold through a network of wholly owned chemical distributors.
Businesses in the Other Products segment serve distinct markets and have individual methods of distribution. MEGTEC Systems sells auxiliary press equipment directly to international web printing press manufacturers and to their customers, and markets emission control equipment and industrial drying systems directly to customers in the coating, converting and metal finishing industries. Sequa Can Machinery sells its can forming and decorating equipment through agents as well as directly to the international container manufacturing industry. Casco sells cigarette lighters, power outlets and various electronic monitoring devices directly to the automotive industry. The After Six unit sells its formalwear to wholesalers and retailers, principally serving the rental market, primarily through independent sales representatives.
Competition
There is significant competition in the industries in which Sequa operates, and, in several cases, the competition consists of larger companies having substantially greater resources than those of Sequa.
Sequa believes that it is currently the world's largest supplier of automotive cigarette lighters and power outlets; and the largest supplier of men's formalwear coats and pants in the United States.
Sequa, through its Chromalloy operations, is a leader in the development and use of advanced metallurgical and other processes to repair, manufacture and coat blades, vanes and other components of gas turbine engines used for commercial and military jet aircraft. Chromalloy's divisions compete for turbine engine repair business with a number of other companies, including OEMs. Such OEMs generally have obligations (contractual and otherwise) to approve vendors to manufacture components for their engines and/or perform repair services on their engines and components. Chromalloy has a number of such approvals, including licensing agreements, which allow it to manufacture and repair certain components of flight engines. The loss of approval by one of the major OEMs to manufacture or
repair components for such OEM's engines could have an adverse effect on Chromalloy, although management believes it has certain actions available to it to mitigate this effect.
Sequa's rocket propulsion business competes with several other companies for defense business. In some cases, these competitors are larger than Sequa and have substantially greater resources. Government contracts in this area are generally awarded on the basis of proven engineering capability and price. Sequa's ability to compete is enhanced by the US Government's need for alternative sources of supply under these contracts. The liquid propulsion unit operates primarily in the commercial satellite market and competes on the technical capabilities of its products and on price.
ARC is a second tier automotive supplier that supplies airbag inflators to first tier airbag module (airbag, inflator and covers) suppliers, certain of whom have their own inflator capabilities. The unit competes on product capabilities, energetics expertise, quality and price. Breed, ARC's largest customer, is supplied under the terms of a long-term contract. The long-term contract was modified pursuant to a January 2001 settlement with Breed in conjunction with its emergence from Chapter 11 proceedings. Further information with respect to annual sales to Breed is included in the discussion on pages 28 and 29 of this Annual Report on Form 10-K under the heading "Risk/Concentration of Business," which is incorporated herein by reference.
Sequa's Precoat Metals operation is a leading independent domestic coater of coiled steel for metal building panels. Precoat competes in all its markets based on price, quality, customer service and technical capabilities.
Sequa's Specialty Chemicals segment competes in each of its markets with several other manufacturers, one of which is larger and has greater resources than Sequa. This segment competes in the detergent additive market with its TAED products based on breadth of product offerings and performance characteristics, quality and price. In the European chemical distribution market, it competes primarily on the technical expertise of its sales force and the breadth of its product offerings.
MEGTEC is a major international supplier of auxiliary press equipment, air flotation dryers and emission control equipment. This unit has several major competitors (including certain press manufacturers in the graphic arts market) in each of its main product areas. It competes on the basis of price, quality and technical capabilities. Sequa believes its cylindrical can decorating and can forming equipment operations are world leaders in their markets. Sequa Can Machinery has one or two major competitors in each major product area, and the unit competes on the basis of price, quality, technical capabilities and equipment speed. Sequa believes its automotive products manufacturer is
the world's leading producer of cigarette lighters for both the original equipment market and the auto aftermarket and competes on the basis of price, quality and customer service. Sequa believes the After Six unit is the leading domestic producer of men's formalwear and competes on the basis of design, quality of manufacturing and price.
Raw Materials
Sequa's businesses use a wide variety of raw materials and supplies. Generally, these have been available in sufficient quantities to meet requirements, although occasional shortages have occurred. Precoat Metals uses natural gas to fire the curing ovens used in the coating process as well as for emission control devices. Increases in the price paid for natural gas adversely affected operating income for this unit by approximately $2.8 million in 2001 and $3.0 million in 2000.
Seasonal Factors
With the exception of the After Six business, which has stronger sales in the first six months of the year, Sequa's businesses are not considered seasonal to any significant extent.
Patents and Trademarks
Sequa owns and is licensed to manufacture and sell under a number of patents, including patents relating to its metallurgical processes. These patents and licenses were secured over a period of years and expire at various times. Sequa has also created and acquired a number of trade names and trademarks. While Sequa believes its patents, patent licenses, trade names and trademarks are valuable, it does not consider its business as a whole to be materially dependent upon any particular patent, license, trade name, or trademark. Sequa regards its technical and managerial knowledge and experience as more important to its business.
Major Customers
	No single commercial customer accounted for more than 10% of consolidated sales during the past three years. Prime and subcontracts with all government agencies accounted for approximately 11% of sales in 2001, 12% of sales in 2000 and 10% of sales in 1999. One customer accounted for approximately 33% of the Propulsion segment's 2001 sales. Further information with respect to annual sales to this customer is included in the discussion appearing on pages 28 and 29 of this Annual Report on Form 10-K under the heading "Risk/Concentration of Business," which is incorporated herein by reference. In the Metal Coating segment, one customer accounted for approximately 37% of the segment's 2001 sales. The customer is a major steel manufacturer that uses Precoat Metals as a toll coater. Further information
with respect to this customer is included in the discussion on pages 28 and 29 of this Annual Report on Form 10-K under the heading "Risk/Concentration of Business," which is incorporated herein by reference. In the Specialty Chemicals segment, one customer accounted for approximately 27% of the segment's 2001 sales, and the top three customers accounted for approximately 40% of the segment's 2001 sales. All of these customers are well-known international consumer products companies that Warwick International has been doing business with for many years.
Backlog
Backlog information is included in the Management's Discussion and Analysis of Financial Condition and Results of Operations on page 32 of this Annual Report on Form 10-K and is incorporated herein by reference.
Maintenance and Repairs
Expenditures for maintenance and repairs of $47.5 million in 2001, $45.7 million in 2000 and $47.8 million in 1999 were expensed as incurred, while betterments and replacements were capitalized.
Research and Development
Research and development costs, charged to expense as incurred, amounted to $20.1 million in 2001, $22.2 million in 2000 and $20.0 million in 1999.
Environmental Matters
Sequa has been notified that it has been named as a potentially responsible party under Federal and State Superfund laws and/or has been named as a defendant in suits by private parties (or governmental suits including private parties as co-defendants) with respect to sites currently or previously owned or operated by Sequa or to which Sequa may have sent hazardous wastes. Sequa is not presently aware of other such lawsuits or notices contemplated or planned by any private parties or environmental enforcement agencies. The aggregate liability with respect to these matters, net of liabilities already accrued in
the Consolidated Balance Sheet, will not, in the opinion of management, have a material adverse effect on the financial position of Sequa, although adjustments to estimates based on improved knowledge of site conditions and chemical interactions with humans or changes in environmental law could have a significant impact on Sequa's results of operations in a particular period. These environmental matters include the following:
Two propellant manufacturing facilities have soil and groundwater ammonium perchlorate (AP) contamination above the limit currently proposed by the US Environmental Protection
Agency for groundwater. AP is a raw material used in the manufacture of solid rocket propellant. Sequa has implemented a series of pilot tests to determine the feasibility and applicability of utilizing an emerging technology, biodegration to treat AP-affected soil and groundwater. In the fourth quarter of 2001, Sequa recorded an environmental charge that includes $9.7 million of estimated costs to remediate soil and groundwater contamination from AP.
A number of claims have been filed in connection with alleged groundwater contamination in the vicinity of a predecessor corporation site which operated during the 1960s and early 1970s in Dublin, Pennsylvania. In October 1987, a class action was filed by residents of Dublin against Sequa and two other defendants. The Borough of Dublin also filed suit seeking remediation of alleged contamination of the Borough's water supply and damages in an unspecified amount. A settlement was reached in the class action in which Sequa paid $1.8 million in 1997. The Borough action was settled in 1998 when Sequa agreed to transfer to the Borough the water treatment system it constructed, and $2.0 million was paid to the Borough.
The Pennsylvania Department of Environmental Protection entered into a Consent Decree with Sequa in 1990 providing for the performance of a remedial investigation and feasibility study with respect to the same alleged groundwater contamination in Dublin. The US Environmental Protection Agency placed the site on the Superfund List in 1990 and, in conjunction therewith, entered into a Consent Agreement with Sequa on December 31, 1990. The investigation for the final remedy is still in progress.
The State of Florida issued an Administrative Order in 1988 requiring TurboCombustor Technology, Inc. (TCT), a subsidiary of Chromalloy, to investigate and to take appropriate corrective action in connection with alleged groundwater contamination in Stuart, Florida. The contamination is alleged to have arisen from a 1985 fire which occurred at TCT's former facility in Stuart. The City of Stuart has subsequently constructed and is operating a groundwater remediation system. Sequa negotiated a conditional settlement with the City of Stuart in October 1994 whereby it would contribute its ratable share of the capital and operating costs for the groundwater treatment system. On February 14, 2000, the Stuart City Commission approved the execution of the settlement. Sequa estimates the amount to be paid in settlement plus additional groundwater sampling and analysis will be approximately $2 million to be paid over a ten-year period which began in the second quarter of 2000.
In September 1993, fourteen homeowners residing in West Nyack, New York served a complaint on Chromalloy and others alleging, among other things, that contamination from a former Chromalloy site caused damage to the plaintiffs' property. Chromalloy believes it has strong defenses under New York law to the plaintiffs' complaint. Chromalloy entered into a Consent Order with the New York Department of Environmental Conservation (DEC) on February 14, 1994 to undertake the remedial
investigation and feasibility study (RI/FS) relating to the alleged contamination in the vicinity of the former Gas Turbine site. The RI/FS was submitted to the DEC for its review in 1998. The DEC submitted their comments on the RI/FS to Sequa in 1999, and negotiations are still in progress.
It is Sequa's policy to accrue environmental remediation costs for identified sites when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. In the fourth quarter of 2001, Sequa recorded a charge of $13.3 million to increase its accruals for remediation costs. The charge includes the $9.7 million of estimated cost to remediate soil and groundwater contamination from AP. At December 31, 2001, the potential exposure for all remediation costs is estimated to range from $22 million to $35 million, and Sequa's balance sheet includes accruals of $30.8 million for remediation costs. These accruals are at undiscounted amounts and are included in accrued expenses and other noncurrent liabilities. Actual costs to be incurred at identified sites in future periods may vary from the estimates, given inherent uncertainties in evaluating environmental exposures.
With respect to all known environmental liabilities, Sequa's actual cash expenditures for remediation of previously contaminated sites were $4.0 million in 2001, $3.3 million in 2000 and $4.9 million in 1999. Sequa anticipates that remedial cash expenditures will be between $8 million and $12 million during 2002 and between $5 million and $9 million during 2003. Sequa's capital expenditures for projects to eliminate, control or dispose of pollutants were $2.4 million, $2.2 million and $1.6 million in 2001, 2000 and 1999, respectively. Sequa anticipates annual environmental-related capital expenditures to be approximately $3.1 million during 2002 and $2.0 million during 2003. Sequa's operating expenses to eliminate, control and dispose of pollutants were approximately $11 million in 2001 and $10 million per year in 2000 and 1999. Sequa anticipates that environmental operating expenses will be approximately $11 million per year during 2002 and 2003.
Employment
At December 31, 2001, Sequa employed approximately 10,700 people of whom approximately 3,050 were covered by union contracts.
(d) Foreign Operations. Sequa's consolidated foreign operations include Gas Turbine's operations in England, France, Israel, Mexico, Netherlands and Thailand within the Aerospace Segment; ARC's liquid rocket motor business in England and, from February 1, 2001, an automotive airbag inflator business in Italy within the Propulsion segment; detergent chemicals operations in Wales and chemical distribution operations in France, Italy, Spain, Portugal and South Africa within the Specialty Chemicals segment; the auxiliary press equipment suppliers in China, France, Germany, Singapore, Sweden and the United Kingdom; the can machinery operations in Brazil, and the automotive products operations in Germany, Italy, Brazil and Tunisia in the Other Products segment. Sales and long-lived assets attributable to foreign countries are set forth in Note 23 to the Consolidated Financial Statements on page 82 of this Annual Report on Form
10-K and are incorporated herein by reference.
ITEM 2.
ITEM 2. PROPERTIES
Aerospace
Chromalloy operates more than 40 plants in eleven states and six foreign countries, which have aggregate floor space of 3,100,000 square feet, of which 1,800,000 square feet is owned and 1,300,000 square feet is leased. The leases covering facilities used in this business have various expiration dates, and some have renewal or purchase options.
Facilities in this segment are adequate and suitable for the business being conducted and operate at a moderate to high level of utilization.
Propulsion
ARC operates 13 manufacturing and research facilities in seven states, one manufacturing facility in the United Kingdom and one manufacturing facility in Italy with aggregate floor space of 2,000,000 square feet. The segment owns 200,000 square feet and leases 1,800,000 square feet. The largest lease, expiring in 2002 with renewal options through 2014, is for a 941,000 square foot facility in Arkansas. The segment also holds a lease on a 270,000 square foot facility in Virginia that expires in 2012. Other leased production facilities are located in Tennessee, New York, California, West Virginia, the United Kingdom and Italy.
Facilities in this segment are suitable and adequate for the business. Utilization at various facilities ranges from moderate to high.
Metal Coating
The Precoat Metals operation owns seven manufacturing facilities in six states with a total of 1,300,000 square feet of manufacturing and office space. An additional 20,000 square feet of office space is leased in Missouri.
The properties in this segment are suitable and adequate for the business presently being conducted. Facilities within this segment operate at a moderate utilization rate.
Specialty Chemicals
Warwick International owns a plant on 55 acres in the United Kingdom with floor space of 203,000 square feet and a 22,000 square foot warehouse facility in France. The segment also leases 67,000 square feet of office and warehouse space in seven separate locations in Europe.
Facilities in this segment are adequate and suitable for the business being conducted. Facilities within this segment operate at a high utilization rate.
Other Products
MEGTEC owns manufacturing and office facilities in Wisconsin with aggregate floor space of 314,000 square feet, a facility in France with aggregate floor space of 62,000 square feet, and a facility in Sweden with aggregate floor space of 50,000 square feet. MEGTEC also leases three manufacturing plants and three sales offices in Europe with a total of 200,000 square feet. In addition, the unit leases 14,000 square feet of manufacturing and office space in China and leases a 3,200 square foot sales office in Singapore.
The Sequa Can Machinery operation owns two plants in the United States with aggregate floor space of 123,000 square feet and leases manufacturing, warehouse and office space of 56,000 square feet.
Casco leases a 168,000 square foot plant in Connecticut, a 2,300 square foot sales office in Michigan, a 37,500 square foot manufacturing facility in Italy, a 31,000 square foot facility in Tunisia and a 9,900 square foot facility in Brazil. Casco owns an 81,000 square foot plant in Germany and a 39,000 square foot plant in Kentucky.
The After Six unit owns manufacturing, warehouse and office facilities in Georgia with aggregate floor space of 158,000 square feet. This unit also leases approximately 1,250 square feet of office space in Hackensack, New Jersey.
Facilities in this segment are adequate and suitable for the business being conducted. MEGTEC and Casco facilities operate at high utilization rates. Sequa Can Machinery facilities currently operate at a low utilization rate due to economic difficulties in key markets. The After Six facilities operate at a low utilization rate as a result of restructuring measures taken to outsource production.
Corporate
Sequa leases 48,000 square feet of corporate office space in New York, New York and Hackensack, New Jersey.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Information with respect to Sequa's legal proceedings is included in Note 24 to the Consolidated Financial Statements on pages 82 and 83 of this Annual Report on Form 10-K and in Sequa's definitive proxy statement under the heading "Legal Proceedings" and is incorporated herein by reference. Additional information on environmental matters is covered in the Environmental Matters section on page 31 of this Annual Report on Form 10-K and is incorporated herein by reference.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following information is furnished pursuant to General Instruction G(3) of Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K with respect to the executive officers of the Company:
Name
Age
Position Held
Norman E. Alexander
Chairman of the Board, Chief Executive Officer, Director and member of the Executive Committee
John J. Quicke
President, Chief Operating Officer, Director and member of the Executive Committee
Stuart Z. Krinsly
Senior Executive Vice President, General Counsel, Director and member of the Executive Committee
Martin Weinstein
Executive Vice President, Gas Turbine Operations and Director
Howard M. Leitner
Senior Vice President, Finance
William P. Ksiazek
Vice President and Controller
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Operating Results 2001-2000
Sales
Overall sales of $1.8 billion for 2001 were virtually unchanged from 2000. Advances at the Propulsion and Metal Coating segments were offset by slight declines in the Aerospace and Specialty Chemicals segments and by a sharper decline in the Other Products segment. A detailed review of sales for each segment follows.
Sales of the Aerospace segment declined 2% in 2001. On a pro forma basis -- to exclude the prior year's sales from operations contributed to joint ventures during 2000, and the sales of Caval Tool, which was divested on February 28, 2001 -- aerospace sales advanced 5%. Engine component repair sales advanced 5% in 2001, despite the absence of sales from units contributed to joint ventures ($14.5 million) and the unfavorable effect of translating foreign sales to US dollars (approximately $2.6 million). The advance in the repair segment reflects higher sales to the commercial airline market and the industrial gas turbine market. In the fourth quarter of 2001, sales to the repair market declined 5%, primarily due to the impact on the commercial airlines of the September 11 terrorist attacks. The impact on sales was partially offset by work already in house. Sales to the original equipment market declined 17% in 2001, a reflection of the divestiture of Caval Tool ($27.2 million impact), weak market conditions, and the unfavorable effect of translating foreign sales to US dollars (approximately $3.4 million).
Sales of the Propulsion segment increased 5% in 2001, as sales of automotive airbag inflators rose 10% due to the February 1, 2001 acquisition by an ARC affiliate of certain assets and the automotive inflator business of BAG S.p.A., an Italian operation that was previously 50% owned by ARC. Domestic automotive inflator sales declined 16% because of the absence of sales to BAG S.p.A. in the last eleven months of 2001. Propulsion sales were on a par with 2000.
Sales of the Metal Coating segment increased 6% in 2001, primarily driven by a strong advance in sales to the building products market, and the consolidation of a former equity affiliate, Midwest Metal Coatings (MMC), for the last seven months of 2001. The increase in building products primarily reflects market share gains and strong demand from the component segment of the market. Sales to the container market registered a small advance, as the benefit derived from the temporary shutdown of coating capacity at a customer's facility more than offset general weakness in the container market. Sales to the
Sales
(cont'd)
manufactured products market were on a par with the prior year. The fourth quarter was particularly strong for the Metal Coating segment, with double digit increases in sales to each of the major markets served.
Sales of the Specialty Chemicals segment declined 1% in 2001, as a 4% increase in local currency sales was more than offset by the translation of local currency amounts to US dollars. The local currency increase was due entirely to the addition of two specialty chemicals marketing units acquired in 2001 and 2000. Sales of detergent chemicals declined 3% for the year, though a rebound in fourth quarter demand tempered the impact of mid-year market weakness. The marketing units were unfavorably affected by the weak Euro and a softening in demand which began in the second quarter.
Sales of the Other Products segment declined 9% in 2001, with each of the major units down from the preceding year. Sales of MEGTEC Systems declined 3% (8% excluding sales from the recently acquired roll handling group), with lower sales to all major markets: graphic arts, emission controls, and industrial products. Fourth-quarter sales declined 21% (34% excluding the impact of the roll handling group) reflecting both very weak market conditions and the effect of comparison against a particularly strong fourth quarter of 2000. Backlog at year-end was down 32% from year-end 2000, primarily reflecting weakness in demand from the graphic arts market. As a result, management expects that the first half of 2002 will be very weak. Sales of the can machinery unit declined 6% in 2001 with lower sales to the can forming and decorating equipment and spare parts markets tempered by a 7% increase in specialty can systems. Sales at automotive supplier Casco Products declined 12%, due primarily to a significant decline in sales to the North American market. Foreign units registered a small advance, as local currency increases were tempered by the impact of the stronger dollar on translation of the results ($1.5 million). Sales of the men's apparel unit, After Six, declined 33% for the year and 53% for the fourth quarter, due to a sharp decline in demand for formalwear. Backlog at this unit was down 45% from year-end 2000, although bookings in the first two months of 2002 were ahead of 2001.
Operating Income
Overall operating income declined $77.3 million or 75% in 2001. The major elements in the decline were: restructuring and related asset impairment charges of $22.4 million ($19.2 million higher than in 2000); a $13.3 million provision for environmental clean-up ($12.3 million higher than in 2000); and an unfavorable swing in results (exclusive of the restructuring and environmental provisions) of $20.9 million in the Propulsion segment and $27.7
Operating Income
(cont'd)
million in the Other Products segment. A detailed review of operating results for each segment follows.
Operating income in the Aerospace segment declined 3% in 2001. Results for 2001 include a restructuring charge of $4.0 million and related asset impairment charges of $0.4 million. These costs were for a 376 person (approximately 6%) reduction in Chromalloy Gas Turbine's workforce and the closing of a small facility. On a pro forma basis to exclude these charges, operating income increased 4% in 2001. The segment benefited from the absence of product development costs ($3.0 million in the first six months of 2000) at a component manufacturing unit now treated as an equity investment, and improved profitability at units engaged primarily in OEM activities. These benefits were tempered by lower profits at units primarily engaged in component repair for both the commercial airlines and industrial gas turbine aftermarkets. While declines at these repair units in the first nine months were due entirely to the absence of approximately $3.0 million of operating income from business transferred to joint ventures in 2000, the fourth-quarter decline reflected the dislocations in the commercial airline market following the September 11, 2001 terrorist attacks, partially offset by cost cutting actions and the resolution of certain contractual matters and cost estimates which allowed previously established reserves of $1.3 million to be reversed.
The fallout from September 11, 2001 will continue to affect the portion of Chromalloy Gas Turbine's business directed to the commercial airline industry. The extent of the impact will depend largely on the depth and duration of the airline industry downturn, neither of which can be estimated at this time. In the first two months of 2002, Chromalloy Gas Turbine sales declined 14% and operating income was 50% below the comparable 2001 period.
The Propulsion segment reported a $21.0 million loss in 2001, compared with a $10.0 million profit in 2000. The unfavorable swing primarily reflects losses at the automotive airbag inflator operations, a fourth-quarter environmental cleanup provision of $10.2 million, $3.2 million in asset impairment charges required by Statement of Financial Accounting Standards (SFAS) No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and a decline in profits in the rocket motor propulsion unit. Losses at the automotive airbag inflator operations primarily reflect three major factors: the consolidation of the Italian inflator operation beginning February 1, 2001; an unfavorable shift in the mix of domestic airbag inflator sales; and a $2.2 million asset impairment charge. The $10.2 million provision for environmental cleanup was primarily related to the establishment of a
Operating Income
(cont'd)
$9.7 million reserve to remediate soil and ground water contamination from ammonium perchlorate (AP), a raw material used in the production of solid rocket motor propellant. Although no federal or applicable state environmental standards have been finalized for AP, recent studies showing that the chemical can interfere with human thyroid function prompted the unit to begin cleanup actions at its two affected solid propellant facilities. Excluding the environmental provision, the decline in operating profit in the rocket propulsion portion of the business is primarily related to a $1.0 million asset impairment charge, and to lower margins in the liquid propulsion market primarily caused by cost overruns on a commercial satellite program in the second half of 2001.
Operating income in the Metal Coating segment declined 29% or $5.5 million in 2001. The decline was due entirely to $5.7 million of restructuring and related asset impairment charges to cover an early retirement program and the closing of a coating facility in Chicago, Illinois. Excluding these charges, results for 2001 were on a par with 2000, as strong operating results in the second half of the year offset the effect of a poor first quarter. On an operating basis, a 6% increase in sales (4% without the impact of MMC), the earnings added by the newly acquired MMC unit, improved productivity and income from a consulting agreement were offset by higher natural gas pricing (approximately $2.8 million) and by weakness in the secondary metal market.
Operating income in the Specialty Chemicals segment declined 17% in 2001. Both years were affected by restructuring charges related to early retirement programs ($1.1 million in 2001 and $3.2 million in 2000). The decline was primarily due to: lower profits at the marketing units, where the benefits of higher sales were largely offset by currency-driven margin pressures and weakness in a key product market; increased pension expense; and the impact of a declining pound sterling on reported US dollar results. At the larger detergent chemicals operation, the benefits of restructuring and other ongoing cost containment initiatives were largely offset by slightly lower sales and higher raw material costs. The impact on operating income of restructuring charges, net of same-year savings, was roughly equivalent in both years.
The Other Products segment posted a $19.7 million loss in 2001, whereas this segment had operating income of $19.2 million in 2000. Each of the four operating units recorded losses in 2001, whereas each recorded profits in 2000. Of the $38.9 million swing in operating results, $11.2 million reflects restructuring actions taken at the four units. MEGTEC had an unfavorable $7.8 million swing in operating results, which included a $3.2 million restructuring charge to reduce the work force by 5%. Without this charge the unit was at approximately
Operating Income
(cont'd)
breakeven in 2001, due to the impact of a sharp decline in sales in the fourth quarter and a shift to lower margined products. Due to the weak year-end 2001 backlog, this unit is expected to post a loss in the first quarter of 2002. The can machinery operation registered an unfavorable swing of $12.0 million in operating results. This was primarily attributable to: restructuring and related asset impairment charges of $2.6 million for headcount reductions and the closing of a facility; the impact of lower sales and a significantly lower level of manufacturing activity in can forming and decorating products on absorption and gross profit; increased provisions for slow moving inventory; and lower spare parts sales. Casco, the automotive products unit, recorded an $11.7 million unfavorable swing in operating results in 2001. This included a restructuring charge of $3.6 million and related asset impairment charges of $1.1 million to cover the impact of headcount reductions and the writedown of equipment used in processes being outsourced. The balance of the decline is attributable to a loss at the domestic operation, where sales declined sharply and pressure on costs and margins continued. Results at After Six, the men's apparel unit, were down $7.3 million, primarily due to a 33% drop in sales, manufacturing inefficiencies, and increased inventory markdowns and bad debt provisions. Restructuring and related asset impairment charges totaled $0.7 million for this unit which resulted from the decision to manufacture a large portion of the unit's products offshore.
Corporate expenses declined 9% in 2001, primarily a reflection of the absence of a bonus accrual, partially offset by increased environmental cleanup provisions for operations that are no longer part of Sequa ($3.1 million in 2001, $1.0 million in 2000) and higher pension costs.
Restructuring and Related Asset Impairment Charges
In response to difficult economic conditions, Sequa undertook a strategic restructuring program in 2001 that will enhance the Company's competitive position in its various markets. The restructuring program included an 867 person reduction in Sequa's employee base primarily at Chromalloy Gas Turbine (Aerospace segment) and After Six (a unit of the Other Products segment). In addition, Sequa closed a metal coating plant in Illinois, a can forming equipment plant in California and a small Chromalloy Gas Turbine facility in Alabama. The activities carried out in these plants were largely transferred to other facilities within the same operating unit. Also, two operations in the Other Products segment moved to substantially increase their use of outsourced manufacturing.
Restructuring and Related Asset Impairment Charges (cont'd)
disposal of property, plant and equipment available for sale as a result of the restructuring program. Efforts to sell these assets have begun, but Sequa can not forecast when they will be completed and the proceeds from disposition received.
The Consolidated Statement of Income for 2000 includes a restructuring charge of $3.2 million related to an early retirement program at the Specialty Chemicals segment, of which $1.3 million is included in cost of sales and $1.9 million is included in selling, general and administrative expense. Cash payments required under this early retirement program were completed in 2001.
First-Quarter Forecast/Outlook for 2002
For the first quarter ending March 31, 2002, Sequa expects that sales will be lower and operating income will be down sharply from the same quarter of 2001. The decreases primarily reflect softness in the Aerospace segment, largely due to the after effects on the worldwide commercial aviation market of both the September 11, 2001 terrorist attacks and the economic downturn. As a result, Sequa expects to post a loss in the range of $(0.85) and $(1.00) per basic share in the first quarter. Management currently expects that operating results will begin to improve gradually in the second quarter provided the overall economic environment strengthens and the commercial aviation market begins to recover.
Interest Expense
Interest expense increased $6.9 million from 2000 and reflects a higher level of average borrowings due to expanded working capital needs at Sequa's Chromalloy unit resulting from growth initiatives pursued in 2000 as well as other general corporate purposes. The increase also reflects a higher average interest rate resulting from the repayment of revolving credit debt using a portion of the proceeds of the $200 million 8 7/8% Senior Notes.
Equity in Loss of Unconsolidated Joint Ventures
Sequa's investments in unconsolidated joint ventures amounted to $46.4 million and $65.7 million at December 31, 2001 and 2000, respectively. The combination of income and losses of these joint ventures resulted in net equity losses of $0.7 million in 2001 and $2.0 million in 2000. The largest of these joint ventures are discussed in the following paragraphs.
Equity in Loss of Unconsolidated Joint Ventures (cont'd)
On February 1, 2001, ARC, through an affiliate, acquired certain assets and the ongoing automotive airbag inflator business of BAG S.p.A. pursuant to an overall settlement agreement with its former joint venture partner, Breed Technologies, Inc. The results of operations as they relate to the acquired assets and the ongoing inflator business of BAG S.p.A. have been fully consolidated with those of Sequa from the acquisition date. Sequa continues to have an equity investment in BAG S.p.A. reflecting underlying assets established for certain anticipated liabilities as the venture is wound down. Sequa's investment in BAG S.p.A. was $1.9 million at December 31, 2001 and $15.2 million at December 31, 2000. Sequa's equity share of the losses of the BAG S.p.A. joint venture was $1.9 million in 2001 and $2.0 million in 2000. The 2001 loss includes a $1.2 million write-down of an airbag inflator production line.
Chromalloy has a number of joint venture partnerships. In May 2000, Chromalloy reduced its majority ownership interest in a component manufacturing operation to 50%. Accounts of this operation are included in the Consolidated Statement of Income for the period of majority ownership. Sequa's investment in this operation was $6.3 million at December 31, 2001 and $5.5 million at December 31, 2000. Sequa's equity share of the losses was $2.2 million in 2001 and $0.1 million in 2000.
In May 2000, Chromalloy entered a joint venture agreement with Siemens Westinghouse whereby Chromalloy contributed certain assets and liabilities of two industrial turbine repair units in return for a 49% ownership interest in a new US company called Turbine Airfoil Coating & Repair LLC (TACR). Siemens Westinghouse contributed to TACR the stock of an existing operation in Germany. TACR coats new parts and repairs components for land-based industrial gas turbines. Sequa's investment in TACR was $18.0 million at December 31, 2001 and $14.6 million at December 31, 2000 and its equity share of net income from TACR was $3.4 million in 2001 and $0.8 million in 2000.
In June 2000, Chromalloy purchased a 49% ownership interest in an existing operation that operates as Masaood John Brown Ltd (MJB), with a facility in the United Arab Emirates. MJB is a partnership with Mohammed Bin Masaood & Sons and provides repair and maintenance services to industrial gas turbine operators. Sequa's investment in MJB was $7.8 million at December 31, 2001 and $4.7 million at December 31, 2000 and its equity share of net income from MJB was $1.2 million in 2001 and $0.3 million in 2000. At December 31, 2001, Sequa had guaranteed MJB's bank line of credit in the amount of $6.9 million.
Equity in Loss of Unconsolidated Joint Ventures (cont'd)
In August 2000, Chromalloy signed agreements with Rolls-Royce plc to form two 50/50 joint ventures: Turbine Surface Technologies Ltd (TST), which will provide advanced coatings for Rolls-Royce turbine components; and Turbine Repair Technologies Ltd (TRT), which provides advanced component repair services for certain Rolls-Royce engines. TST is not expected to generate sales until 2002, and the investment in this joint venture was $0.3 million at December 31, 2001. The equity share of start-up losses for TST was $0.2 million in 2001. Sequa's investment in TRT was $2.9 million at December 31, 2001 and $2.4 million at December 31, 2000. The equity share of net income from TRT was $1.2 million in 2001 and $0.1 million in 2000.
Two other Chromalloy 50/50 joint venture partnerships are significant. Advanced Coatings Technologies (ACT), a joint venture with United Technologies Corporation, owns and operates an electron beam ceramic coater for the application of Pratt & Whitney coatings to jet engine parts. Sequa's investment in ACT was $0.8 million at December 31, 2001 and $1.1 million at December 31, 2000. Sequa's equity share of net income from ACT was $1.9 million in 2001 and $1.0 million in 2000. Pacific Gas Turbine Center, LLC (PGT), was formed in 1999 to overhaul and test certain jet engines and operated from November 2000 as a partnership with the maintenance services subsidiary of SAir Group. Sequa's investment in PGT was $7.4 million at December 31, 2001 and $12.2 million at December 31, 2000. Sequa's equity share of losses from PGT was $4.7 million in 2001 and $2.4 million in 2000. At December 31, 2001, Sequa was contingently liable for letters of credit issued on behalf of PGT in the amount of $4.5 million.
In June 2001, Precoat Metals acquired the remaining 50% ownership interest in Midwest Metal Coatings (MMC) which coats coils of heavy gauge steel for structural components used in the building products market. The results of operations have been fully consolidated with those of Sequa from the acquisition date. Sequa's investment in MMC was $9.0 million at December 31, 2000. Sequa's equity share of net income from MMC was $0.5 million in 2001 and $0.3 million in 2000.
Other, Net
In 2001, Other, net included $4.6 million of income related to the demutualization of an issuer of corporate-owned life insurance policies and pension annuities; $4.3 million of gain on the sale of the Caval Tool Division of the Chromalloy Gas Turbine subsidiary; $4.1 million of discount expense related to the sale of accounts receivable; $3.6 million of expense on the fair market valuation of a natural gas swap and related option; $1.8 million of charges for the amortization of capitalized debt costs; $1.2 million of expense on the cash surrender value of corporate-owned life insurance; and $1.0 million of charges for letters of credit and commitment fees.
Other, Net (cont'd)
In 2000, Other, net included $7.5 million of discount expense related to the sale of accounts receivable; $1.6 million of expense on the cash surrender value of corporate-owned life insurance; $1.1 million of charges for the amortization of capitalized debt costs; $1.0 million of charges for letters of credit and commitment fees; $1.0 million of income related to the final resolution of matters associated with the sale of a Chromalloy Gas Turbine business in the United Kingdom; $1.0 million of income related to a minority interest in the component manufacturing operation for the period during which the operation was majority owned; and a $0.9 million gain related to the sale of a partial ownership interest in this operation.
Tax Settlement
On July 25, 2001, the Internal Revenue Service (IRS) notified Sequa that a settlement agreement concerning the 1989 restructuring of two subsidiaries was approved. The notification finalized Sequa's tax liability in the matter. Further notification is pending regarding the final amount of interest owed.
While management believed that its position in this matter was appropriate, it had taken the conservative position of providing reserves to cover an adverse outcome. The total amount involved was approximately $59 million, composed of the potential liability associated with the restructuring and related tax issues; interest expense, net of tax benefit, from the date of the resulting tax refund; and deferred tax assets for portions of tax loss and credit carryforwards which could be utilized in a settlement. In October 1998, Sequa deposited $24 million with the IRS against the expected liability for additional tax and interest that could have been assessed against Sequa related to certain of these tax matters. The deposit stopped the running of interest with respect to the amount deposited.
As a result of the settlement, no additional tax will be paid and $36.0 million, representing the reversal of income tax reserves no longer required, was recorded as income through a reduction in the income tax provision. An additional adjustment is possible pending notification of the final amount of interest owed. The impact of the settlement was to increase basic earnings per share by $3.47 in 2001.
Risk/Concentration of Business
On September 11, 2001, the United States was subject to terrorist attacks at the World Trade Center buildings in New York City and the Pentagon in Washington, D.C. These attacks had a severe impact on the airline industry, due to immediate airport closures and the longer term downturn in air travel. Chromalloy's volume of repair business is directly correlated to the number of hours jet engines have been flown. The economic impact on Chromalloy of the repercussions from terrorist attacks for the fourth quarter were offset by cost cutting measures and the favorable resolution of certain contractural matters and cost estimates, which allowed $3.0 million of previously established reserves to be reversed. At February 28, 2002, trade receivables due from major commercial airlines totaled approximately $39 million, and business conditions in the airline industry could adversely affect the ability of Chromalloy to realize some of these receivables.
Precoat Metals markets its coating services to steel and aluminum producers and distributors, building products manufacturers, merchant can makers and manufacturers of other diverse products. The steel industry is currently experiencing difficult economic pressures and Precoat Metals has worked to insulate its accounts receivable exposure by selling on terms of 30 days or less. Furthermore, Precoat Metals primarily acts as a toll coater for its steel mill customers and therefore does not own significant stores of coil inventory to service this market.
On March 6, 2002, National Steel filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. National Steel represents Precoat Metals' largest customer, accounting for approximately $89 million or 37% of 2001 sales. The pre-petition trade receivable balance with National Steel is not material to the operations of Precoat Metals and management does not anticipate that its operations will be adversely impacted in the near term.
Chromalloy competes for turbine engine repair business with a number of other companies, including the manufacturers of jet engines (OEMs). The OEMs generally have obligations (contractual and otherwise) to approve vendors to manufacture components for their engines and/or perform repair services on their engines and components. Chromalloy has a number of such approvals, including
Risk/Concentration of Business
(cont'd)
licensing agreements, which allow it to manufacture and repair certain components of flight engines. The loss of a major OEM's approval to manufacture or repair components for its engines could have an adverse effect on Chromalloy, although management believes it has certain actions available to it to mitigate this effect.
Sequa is engaged in the automotive airbag inflator business through ARC and, until February 2001, through ARC's 50% equity investment in BAG S.p.A. On February 1, 2001, ARC Automotive Italia purchased certain assets and the ongoing airbag inflator business of BAG S.p.A. ARC's major customer for airbag inflators is Breed Technologies, Inc. (Breed) and its subsidiaries which are supplied under long-term contracts. In 2001, Breed and its subsidiaries accounted for $95.5 million of ARC's sales.
Derivative and Other Financial Instruments
Sequa is exposed to market risk from changes in foreign currency exchange rates and from changes in the prices of certain commodities which impact its earnings, cash flows and financial condition. Sequa manages its exposure to this market risk through its regular operating and financial activities and, when appropriate, through the use of derivative financial instruments. Sequa has well-established policies and procedures governing the use of derivative financial instruments as risk management tools and does not buy, hold or sell derivative financial instruments for trading purposes. Sequa's primary foreign currency exposures relate to the British, French, German, Dutch and Italian currencies and to the Euro. To mitigate the short-term effect of changes in currency exchange rates, Sequa utilizes forward foreign exchange contracts and derivatives thereof, to manage its exposure to certain existing assets and liabilities and to hedge firm commitments and forecasted transactions denominated in currencies other than the functional currency. Depending on the volatility of the market, Sequa utilizes natural gas swap agreements to convert a portion of its natural gas requirements to fixed rates.
On January 1, 2001, Sequa adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 138. These statements require companies to record derivatives on the balance sheet as assets and liabilities, measured at fair value. Depending on the use of a derivative and whether it has been designated and qualifies as a hedge, gains and losses resulting from changes in the value of the derivative are recognized currently in earnings or reported in Accumulated Other Comprehensive Income (Loss), a separate component of shareholders' equity. The adoption of SFAS No. 133 as amended by SFAS No. 138 has not had a material effect on Sequa's consolidated financial
Derivative and Other Financial Instruments (cont'd)
statements with respect to the use of forward foreign exchange contracts and derivatives thereof. At December 31, 2001, Sequa was a party to a natural gas swap that includes a written option, the fair market valuation of which resulted in a $3.6 million charge recorded in Other, net in the Consolidated Statement of Income.
A hypothetical 10% uniform decrease in all foreign currency exchange rates relative to the US dollar would decrease the fair value of Sequa's financial instruments by approximately $10.6 million as of December 31, 2001 and $10.7 million as of December 31, 2000. The sensitivity analysis relates only to Sequa's exchange rate-sensitive financial instruments, which include cash and debt amounts denominated in foreign currencies and all open foreign forward exchange contracts at December 31, 2001 and 2000. The effect of this hypothetical change in exchange rates ignores the effect this movement may have on the value of net assets, other than financial instruments, denominated in foreign currencies and does not consider the effect this movement may have on anticipated foreign currency cash flows.
At December 31, 2001 and 2000, substantially all of Sequa's debt was at fixed rates, and Sequa currently does not hold interest rate derivative contracts. Accordingly, a change in market interest rates would not materially impact Sequa's interest expense but would affect the fair value of Sequa's debt. Generally, the fair market value of fixed-rate debt will increase as interest rates fall and decrease as interest rates rise. The estimated fair value of Sequa's total debt was approximately $660 million at December 31, 2001 and $592 million at December 31, 2000. A hypothetical 1% increase in interest rates would decrease the fair value of Sequa's total debt by approximately $32.1 million at December 31, 2001 and $28.4 million at December 31, 2000. A hypothetical 1% decrease in interest rates would increase the fair value of Sequa's total debt by approximately $34.3 million at December 31, 2001 and $30.7 million at December 31, 2000. The fair value of Sequa's total debt is based primarily upon quoted market prices of Sequa's publicly traded securities. The estimated changes in fair values of Sequa's debt are based upon changes in the present value of future cash flows as derived from the hypothetical changes in market interest rates.
Euro Conversion
On January 1, 2002, the European Union completed its transition to a common currency (Euro). The introduction of the Euro, including the total costs associated with the conversion, did not have a material adverse effect on Sequa's financial position, results of operations or cash flows.
Environmental Matters
Sequa's environmental department, under senior management's direction, manages all activities related to Sequa's involvement in environmental cleanup. This department establishes the projected range of expenditures for individual sites with respect to which Sequa may be considered a potentially responsible party under applicable federal or state laws. These projected expenditures, which are reviewed periodically, include: remedial investigation and feasibility studies; outside legal, consulting and remediation project management fees; the projected cost of remediation activities; and site closure and post-remediation monitoring costs. The assessments take into account currently available facts, existing technology, presently enacted laws, past expenditures, and other potentially responsible parties and their probable level of involvement. Outside technical, scientific and legal consulting services are used to support management's assessments of costs at significant individual sites.
It is Sequa's policy to accrue environmental remediation costs for identified sites when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. In the fourth quarter of 2001, Sequa recorded a charge of $13.3 million to increase its accruals for remediation costs. The charge includes $9.7 million of estimated cost to remediate soil and groundwater contamination from ammonium perchlorate (AP), a raw material used to produce missile and rocket fuel. Although no federal or state environmental standards have been finalized for AP, recent studies showing that the chemical can interfere with human thyroid function have prompted Sequa to begin cleanup actions at its solid propellant facilities. At December 31, 2001, the potential exposure for all remediation costs is estimated to range from $22 million to $35 million, and Sequa's Consolidated Balance Sheet includes accruals for remediation costs of $30.8 million. These accruals are at undiscounted amounts and are included in accrued expenses and other noncurrent liabilities. Actual costs to be incurred at identified sites in future periods may vary from the estimates, given inherent uncertainties in evaluating environmental exposures.
With respect to all known environmental liabilities, Sequa's actual cash expenditures for remediation of previously contaminated sites were $4.0 million in 2001, $3.3 million in 2000 and $4.9 million in 1999. Sequa anticipates that remedial cash expenditures will be between $8 million and $12 million during 2002 and between $5 million and $9 million during 2003. Sequa's capital expenditures for projects to eliminate, control or dispose of pollutants were $2.4 million, $2.2 million and $1.6 million in 2001, 2000 and 1999, respectively. Sequa anticipates annual environment related capital expenditures to be approximately $3.1 million during 2002 and $2.0 million during 2003. Sequa's operating expenses to eliminate, control and dispose of pollutants were approximately $11 million in 2001 and $10 million per year in 2000 and 1999. Sequa anticipates that environmental operating expenses will be approximately $11 million per year during 2002 and 2003.
Backlog
The businesses of Sequa for which backlogs are significant are the Turbine Airfoils, TurboCombustor Technology and Castings units of the Aerospace segment; the solid and liquid rocket motor operations of the Propulsion segment; and the can machinery, MEGTEC and After Six units of the Other Products segment. The aggregate dollar amount of backlog in these units at December 31, 2001 was $212.4 million ($281.2 million at December 31, 2000). All segments, including the individual operating units within the Other Products segment, have experienced a decline in backlog. Sales of the After Six unit are seasonal, with stronger sales in the first six months of the year; accordingly, this unit's backlog is normally higher at December 31 than at any other time of the year. Backlog values in both years exclude the Aerospace segment's Caval Tool unit, which was divested in February 2001.
Liquidity and Capital Resources
Net cash provided by operating activities was $88.1 million in 2001, compared with $42.3 million in 2000. The primary reasons for the $45.8 million increase were a lower level of working capital requirements partly offset by lower operating income and an increase in taxes paid that primarily reflects the absence of a Federal tax refund received in 2000. Cash used for investing activities was $57.8 million in 2001, compared with $115.8 million in 2000. The $58.0 million decrease primarily relates to the proceeds on the sale of the Caval Tool division of the Chromalloy Gas Turbine subsidiary, and a lower level of capital spending in 2001. Net cash from financing activities was $52.0 million in 2001, compared with $62.4 million in 2000. The $10.4 million decrease reflects the $196.8 million net proceeds from the April 2001 debt offering and the subsequent repayment of the $66.4 million 10.1% medium-term notes due in mid-May and amounts outstanding under Sequa's revolving credit and receivables purchase agreements.
On April 2, 2001, Sequa completed an offering of $200 million of 8 7/8% Senior Notes due April 1, 2008 through a private placement under Rule 144A of the Securities Act of 1933, as amended (the Securities Act). Net proceeds received on April 2, 2001 from the 8 7/8% Senior Notes offering amounted to $196.8 million. The proceeds were used to repay approximately $100 million outstanding under Sequa's revolving credit agreement; to redeem $66.4 million of 10.1% medium term notes when they matured in mid-May 2001; and for general corporate purposes. Concurrent with the completion of the 8 7/8% Senior Notes offering, Sequa's revolving credit facility was reduced to $75 million from $150 million.
Liquidity and Capital Resources (cont'd)
On July 12, 2001, Sequa completed its offer to exchange all outstanding 8 7/8% Senior Notes due April 1, 2008 for up to $200 million of registered Series B 8 7/8% Senior Notes due April 1, 2008. All $200 million of outstanding notes were exchanged. The terms of the new Series B 8 7/8% Senior Notes -- including principal amount, interest rate, maturity, security and ranking -- are substantially the same as the terms of the original notes, with the principal exception that the new notes are registered under the Securities Act.
At December 31, 2001, no amounts were outstanding under the $75 million revolving line of credit and the facility was not used in the fourth quarter of 2001. Adverse economic conditions in the fourth quarter precluded Sequa from being in compliance with certain financial covenants of the revolving credit agreement. In January 2002, Sequa cancelled the facility. Sequa is in discussions with a group of banks regarding a new credit facility.
Sequa Receivables Corp. (SRC), a wholly owned special purpose corporation, has a Receivables Purchase Agreement extending through November 2003 under which it is able to sell up to $120 million of an undivided percentage ownership interest in Sequa's eligible trade receivables through a bank sponsored facility. Under the terms of the agreement, SRC's assets will be available to satisfy its obligations to its creditors, which have security interests in certain of SRC's assets, prior to any distribution to Sequa. In accordance with SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125," transactions under the Receivables Purchase Agreement qualify as a sale of receivables. Trade receivables included in the December 31, 2001 Consolidated Balance Sheet are net of receivables sold under the agreement of $64.0 million.
At December 31, 2001, Sequa was contingently liable for $32.0 million of outstanding letters of credit and $17.8 million of surety bonds not reflected in the accompanying consolidated financial statements. In addition, Sequa has guaranteed a $6.9 million bank line of credit for its MJB joint venture. Sequa is not currently aware of any existing conditions that would cause risk of loss relative to the outstanding letters of credit, surety bonds or the guarantee.
Capital expenditures amounted to $77.2 million in 2001, with spending concentrated in the Aerospace segment. These funds were primarily used to upgrade existing facilities and equipment and to expand capacity. Sequa currently anticipates that capital spending in 2002 will be approximately $90 million and will be concentrated in the Aerospace and Propulsion segments.
Due to the present funded status of Sequa's qualified pension plans, management currently anticipates that 2002 pension contributions will be approximately $22.6 million although the required minimum contribution is $3.4 million as calculated under an asset smoothing methodology.
Liquidity and Capital Resources
(cont'd)
Management currently anticipates that cash flow from operations; the $45.0 million available at March 18, 2002 under the Receivables Purchase Agreement; the $127.1 million of cash and cash equivalents on hand at December 31, 2001; will be sufficient to fund Sequa's operations for the next year including the $62.8 million of interest payments due on the 9% and 8 7/8% Senior Notes, the $90 million of estimated capital expenditures and the $22.6 million of anticipated pension contributions. Sequa expects to conclude a new revolving credit facility that will add to available funds in 2002.
Other Information
On June 29, 2001, the Financial Accounting Standards Board formally approved the issuance of Statement No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). The statement changes the accounting for goodwill from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, will cease upon the effective date of the statement, which, for Sequa, is January 1, 2002. Amortization charged against earnings in 2001 was $13,471,000.
SFAS No. 142 establishes specific guidelines for use in evaluating the impairment of goodwill. Under SFAS No. 142, goodwill is considered impaired and an impairment loss must be recognized if the implied fair value of a reporting unit's goodwill is less than its carrying amount. The implied fair value of goodwill is determined by subtracting the fair value of the recognized assets of the reporting unit from the fair value of the reporting unit. The impairment loss is the amount by which the carrying amount of goodwill exceeds its implied fair value.
Sequa is assessing the impact of SFAS No. 142 and anticipates a significant impairment loss will be incurred upon adoption of the statement. In accordance with SFAS No. 142, a transitional impairment loss will be recognized as the effect of a change in accounting principle and will be presented in the Consolidated Statement of Income, net of related income tax effects, between the captions extraordinary items (if any) and net income.
Through December 2001, Sequa has evaluated the recoverability of goodwill at the operating unit level through an analysis of operating results and consideration of other significant events or changes in the business environment. If an operating unit has current operating losses, and, based upon projections, such operating losses are likely to continue, Sequa evaluates whether impairment exists over the remaining amortization period on the basis of undiscounted expected future
Other Information
(cont'd)
cash flows from operations before interest. If impairment exists, the carrying amount of the goodwill is reduced to net realizable value, using a discounted cash-flow methodology. No impairments were recorded in 2001 or 2000.
SFAS No. 143, "Accounting for Asset Retirement Obligations," was issued in June 2001 and requires the recognition of a liability regarding the existence of a legal obligation associated with the retirement of a tangible long-lived asset that results from the acquisition, construction, development or normal operation of the asset. This statement is not expected to have a material impact on Sequa's consolidated financial statements. This statement is effective for the fiscal years beginning after June 15, 2002, with earlier adoption encouraged. Sequa will adopt this accounting standard as required by January 1, 2003.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," was issued in August 2001 and supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." SFAS No. 144 requires that a single accounting model be applied to long-lived assets whether such assets are held and used, are to be disposed of other than by sale or disposed of by sale. The accounting model requires the long-lived asset to be recorded at the lower of its carrying amount or its fair value. The statement also broadens the presentation of discontinued operations to include more disposal transactions. This statement is not expected to have a material impact on Sequa's consolidated financial statements. This statement is effective for fiscal years beginning after December 15, 2001 and Sequa adopted this accounting standard on January 1, 2002.
Forward-Looking Statements
This document includes forward-looking statements made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. These statements are based on management's current expectations, estimates and projections that are subject to risks and uncertainties, including, but not limited to: political, currency, regulatory, competitive and technological developments. Consequently, actual results could differ materially from these forward-looking statements.
Operating Results 2000-1999
Sales
Overall sales increased 4% in 2000, with advances in the Aerospace and Metal Coating segments and at the MEGTEC Systems unit of the Other Products segment. Sales were also bolstered by an additional contribution of $27.5 million from businesses acquired during the year. These favorable factors more than offset the $47.6 million effect of unfavorable foreign exchange translation on reported US dollar results and the $14.6 million effect of deconsolidating the results of several Aerospace units transferred to joint ventures during 2000.
Sales of the Aerospace segment (Chromalloy) rose 3% in 2000. Sales to the engine component repair market increased 9%, whereas sales to the original equipment manufacturers (OEMs) declined. Sales were tempered by two factors: the translation effect created by a weakening Euro against the US dollar, which lowered reported sales of European entities by $20.5 million; and the absence of sales (approximately $14.6 million in the applicable 1999 periods) from operations contributed to joint ventures with Siemens Westinghouse and Rolls-Royce during 2000. Strength in sales to the commercial repair aftermarket reflects the benefit of long-term contracts with major airlines to provide repair services and inventory management. The advance in military repair sales reflects revenues from a contract to provide component repairs at Kelly Air Force Base. The Kelly business was a major contributor to the overall increase in repair sales. The lower level of OEM sales primarily reflects the continued effect of global outsourcing programs by the jet engine OEMs.
Sales of the Propulsion segment (Atlantic Research Corporation or ARC) were down 1% from a year earlier, as an advance at the liquid propulsion unit was offset by small declines in the solid rocket and automotive airbag inflator operations. The increase at the liquid propulsion unit was primarily attributable to a contract to refurbish the post boost control system of the Minuteman III missile. The decline in solid propulsion sales primarily reflects production stretch-outs and lower production levels on several programs. The decline in automotive airbag inflator sales is attributable to a sharp fourth-quarter reduction in demand from a major domestic OEM.
Sales in the Metal Coating segment (Precoat Metals) advanced 6% in 2000, with increases in each of its major market areas: building products, containers and manufactured products. The advance was tempered by softening customer demand in the fourth quarter in all major markets.
Sales
(cont'd)
Sales of the Specialty Chemicals segment (Warwick International) declined 10% (4% in local currency) in 2000, due to two principal factors: demand for the detergent additive TAED declined 4%; and the unfavorable effects of currency movements -- particularly the strengthening of the British pound sterling against the Euro and its decline against the US dollar. These factors more than offset the inclusion of sales from a French specialty chemicals distribution business acquired in February 2000.
Sales of the Other Products segment increased 15% in 2000 (8% excluding the impact of acquisitions), with each of the four operating units contributing to the increase. MEGTEC sales rose 19%, chiefly due to a 32% advance in the graphic arts product line. MEGTEC's increase was achieved despite the negative impact ($12.3 million) of the weakening Euro on reported US dollar sales of European operations. Sales of the can machinery unit advanced 33% (6% excluding a second-quarter acquisition), reflecting higher sales of can forming equipment and specialty can systems, including sales added through the acquisition of the business and certain assets of Formatec Inc. Sales of can decorating equipment declined, the result of the continuing worldwide slump in demand. Sales of Casco Products, the automotive products unit, advanced 6% in 2000, due entirely to the sales added by a German automotive products supplier acquired in June 1999. Excluding this contribution, sales registered a small decline, reflecting two factors: the impact of the weakening Euro on reported US dollar sales of the unit's Italian operations ($2.5 million) and the slowdown in North American demand, which began to affect sales in the fourth quarter of 2000. Sales of the After Six unit were up 2% in 2000, reflecting slightly higher demand for formal attire and improved market share.
Operating Income
Overall operating income increased 9% in 2000. A turnaround in performance at the MEGTEC unit of the Other Products segment and advances by the Aerospace and Propulsion segments more than offset the negative effects on individual business units of several external factors (i.e., unfavorable foreign exchange movements; sharp increases in the price of natural gas; and developing softness in certain market areas during the fourth quarter), as well as the costs to implement an early retirement program at the specialty chemicals business and to settle all outstanding issues with a customer for airbag inflators.
Operating income in the Aerospace segment advanced 4% in 2000, with units that primarily serve the repair aftermarket 10% ahead. This advance was tempered by two principal factors: the weakness of the Euro and the British pound on reported US dollar
Operating Income
(cont'd)
results of European repair units, which lowered results by $2.6 million; and the absence of profits from operations transferred to joint ventures in 2000 that had contributed operating income of $1.9 million in the applicable 1999 periods. Profits at units primarily serving the OEM market were down sharply on lower volume. In addition, product development costs incurred at a component manufacturing unit before Chromalloy reduced its ownership interest to 50% were $1.4 million higher in 2000 than in 1999.
Operating income in the Propulsion segment increased 59% over 1999. The solid rocket motor business advanced 62%, primarily due to improved performance on several major programs. Automotive airbag inflator results were down 27% from a year earlier, despite the benefits of extensive product cost reduction programs. Among the factors that reduced results for this unit were the cost to settle all outstanding issues with Breed; an unfavorable sales mix shift; increased spending on research and product development; and lower fourth-quarter sales. Profits at the liquid propulsion unit advanced in 2000, primarily due to lower bid and proposal costs and higher sales.
Operating income in the Metal Coating segment increased 1% in 2000. The benefits derived from increased sales and continuing quality improvement programs were largely offset by sharply higher natural gas prices ($3.0 million) and by an unfavorable sales mix shift.
Operating income in the Specialty Chemicals segment declined 28% (19% in local currency) in 2000. Profits were adversely affected by: a $3.2 million provision for an early retirement program implemented in the second quarter; the impact on margins and reported profits of changes in the value of the British pound versus the Euro and US dollar; and slightly lower volume of sales of the detergent additive TAED. These factors were partially offset by ongoing savings from the early retirement program; the benefit of other cost reduction efforts; and profits added by the February 2000 acquisition of a French specialty chemicals distribution business.
Operating income in the Other Products segment advanced 63%, driven by an $8.8 million improvement at the MEGTEC operation, which had incurred a loss in 1999. With higher sales and improved margins, MEGTEC benefited from programs to improve quality and lower manufacturing costs; from reduced research and selling and administrative expenses; and from the acquisition of its French dryer manufacturing subcontractor in 2000. Operating income at the can machinery unit declined sharply in 2000, as the benefits of higher sales were more than offset by the significant effect
Operating Income
(cont'd)
on margins of an unfavorable sales mix shift. Casco Products, the automotive products supplier, registered a 3% increase in profits for 2000. The benefit of a full year of profits from the German operation and improved performance at the Brazilian operation were partially offset by the impact of lower sales and continued margin pressure at the domestic operations, and by the unfavorable effects of the weakening of the Euro on the reported results of the European operations ($0.5 million). Profits were down 3% at the After Six unit, due to lower margins.
Interest Expense
Interest expense decreased $4.4 million from 1999, due to the additional interest costs in the earlier year that resulted from the issuance in July of $500 million of 9% Senior Notes and the subsequent fourth-quarter 1999 retirement of $357.5 million of principal amounts outstanding under public debt issues. The decrease in interest expense for 2000 was partially offset by higher debt levels required to support operations.
Interest Income
The decrease in interest income of $4.2 million was primarily due to the absence of income earned on the temporary investment in 1999 of a portion of the proceeds of the $500 million of 9% Senior Notes.
Equity in Loss of Unconsolidated Joint Ventures
Sequa's investments in unconsolidated joint ventures amounted to $65.7 million and $42.4 million at December 31, 2000 and 1999, respectively. The combination of income and losses of these joint ventures resulted in net equity losses of $2.0 million in 2000 and $2.9 million in 1999. The most significant of these joint ventures are discussed below.
ARC and Breed operated a 50/50 automotive airbag inflator joint venture in Italy, called BAG S.p.A. Sequa's investment in BAG S.p.A. was $15.2 million at December 31, 2000 and $18.5 million at December 31, 1999. Sequa's equity share in the losses of the BAG S.p.A. joint venture was $2.0 million in 2000 and $1.9 million in 1999.
Chromalloy has investments in a number of unconsolidated joint ventures, which amounted to $41.5 million and $14.4 million at December 31, 2000 and 1999, respectively. The combination of income and losses of these joint ventures resulted in net equity losses of $0.2 million in 2000 and net equity income of $0.2 million in 1999.
Precoat Metals had a 50/50 partnership with NCI Building Systems, Inc. in Midwest Metal Coatings (MMC). Sequa's investment in MMC was $9.0 million at December 31, 2000 and $9.5 million at December 31, 1999. Sequa's equity share was net income of $0.3 million in 2000 and a net loss of $0.5 million in 1999.
Other, Net
In 2000, Other, net included $7.5 million of discount expense related to the sale of accounts receivable; $1.6 million of expense on the cash surrender value of corporate-owned life insurance; $1.1 million of charges for the amortization of capitalized debt costs; $1.0 million of charges for letters of credit and commitment fees; $1.0 million of income related to the final resolution of matters associated with the sale of a Chromalloy business in the United Kingdom; $1.0 million of income related to a minority interest in the component manufacturing operation for the period during which the operation was majority owned; and a $0.9 million gain related to the sale of a partial ownership interest in this operation.
In 1999, Other, net included $3.9 million of gains on the sale of excess real estate; $2.7 million of income related to the demutualization of an issuer of corporate-owned life insurance policies; $2.2 million of income related to the adjustment of the gain on the sale of Sequa Chemicals recorded upon final settlement with the purchaser; $1.6 million of income related to the collection of a note receivable that was written off more than ten years ago; a $1.3 million gain on the sale of short-term investments; $1.0 million of income on the cash surrender value of corporate-owned life insurance; $2.3 million of discount expense related to the sale of accounts receivable; $1.5 million of charges for the amortization of capitalized debt costs; and $1.1 million of charges for letters of credit and commitment fees.
Liquidity and Capital Resources
Net cash provided by operating activities was $42.3 million in 2000, compared with $5.2 million in 1999. The major reason for the 2000 increase was a $33.5 million decrease in income taxes paid. Cash used for investing activities was $115.8 million, compared with $138.4 million in 1999. The decrease was primarily due to a $22.9 million decrease in cash invested in joint ventures, as well as a $16.9 million reduction in businesses purchased. These factors were tempered by the absence of proceeds from the sale of short-term investments and a reduction in sales of other assets. Net cash from financing activities was $62.4 million in 2000, compared with $121.4 million in 1999. The main reason for the decrease was the absence of $490.9 million in proceeds from the 1999 issuance of debt, as well as the related use of $439.4 million of the proceeds to retire amounts outstanding under other debt issues. A $22.0 million decrease in proceeds from accounts receivable sold also contributed to the decrease.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See discussion appearing on pages 29 and 30 of this Annual Report on Form 10-K under the heading "Derivative and Other Financial Instruments," which is incorporated herein by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and
the Board of Directors of
Sequa Corporation:
We have audited the accompanying consolidated balance sheets of Sequa Corporation (a Delaware corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, cash flows and shareholders' equity for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. 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, the financial statements referred to above present fairly, in all material respects, the financial position of Sequa Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
As explained in Notes 1 and 12 to the consolidated financial statements, effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities" as amended by SFAS No. 138.
ARTHUR ANDERSEN LLP
New York, New York
March 11, 2002
Sequa Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements of Sequa Corporation (Sequa) include the accounts of all majority-owned subsidiaries. Investments in 20% to 50% owned joint ventures are accounted for under the equity method. All material accounts and transactions between the consolidated subsidiaries have been eliminated in consolidation. Certain amounts in the 2000 Consolidated Balance Sheet have been reclassified for comparative purposes.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent 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.
Cash and Cash Equivalents
Sequa considers time deposits, certificates of deposit and marketable securities with original maturities of three months or less to be cash equivalents. Where the right of set-off exists, Sequa has netted overdrafts with unrestricted cash and cash equivalents.
Marketable Securities
Investments in common stock classified as available-for-sale securities are carried at fair value as determined by the most recently traded price of such securities, with the unrealized gains and losses, net of tax, reported in Accumulated Other Comprehensive Income (Loss), a separate component of shareholders' equity.
Inventories and Contract Accounting
Inventories are stated at the lower of cost or market. Sequa's non-contract inventories are currently valued primarily on a first-in, first-out (FIFO) basis. Inventoried costs relating to long-term contracts are stated at actual or average costs, including engineering and manufacturing labor and related overhead incurred, reduced by amounts identified with sales. The costs attributable to sales reflect the estimated costs of all items to be produced under the related contract.
Note 1. Summary of Significant Accounting Policies
(cont'd)
Property, Plant and Equipment, Net
In the fourth quarter of 2000, Sequa changed, for financial reporting purposes, its method of computing depreciation for new automotive airbag inflator component production lines. Management believes that the accounting change from a straight-line to a units of production methodology serves to match expense more closely to the period in which the related revenue is recognized. The effect of the change was immaterial to the 2000 consolidated results of operations including prior interim reporting periods. Sequa uses the straight-line method to amortize the cost of its remaining assets, including airbag inflator component lines placed in service prior to 2000, over their remaining useful lives.
Sequa reviews properties for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be fully recoverable. If the undiscounted future cash flows expected to result from the use of an asset and its eventual disposition are less than the carrying amount of the asset, the property is written down to net realizable value using a discounted cash-flow methodology.
Excess of Cost Over Net Assets of Companies Acquired
Excess of cost over net assets of companies acquired (goodwill) has been amortized on a straight-line basis over periods not exceeding forty years. The recoverability of goodwill is evaluated at the operating unit level by an analysis of operating results and consideration of other significant events or changes in the business environment. If an operating unit has current operating losses, and, based upon projections, there is a likelihood that such operating losses will continue, Sequa evaluates whether impairment exists over the remaining amortization period on the basis of undiscounted expected future cash flows from operations before interest. If impairment exists, the carrying amount of the goodwill is reduced to net realizable value using a discounted cash-flow methodology. Amortization charged against earnings in 2001, 2000 and 1999 was $13,471,000, $13,166,000 and $12,617,000, respectively. Accumulated amortization at December 31, 2001 and 2000 was $167,865,000 and $154,394,000, respectively.
On June 29, 2001, the Financial Accounting Standards Board formally approved the issuance of Statement No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). The statement changes the accounting for goodwill from an amortization method to an
Note 1. Summary of Significant Accounting Policies (cont'd)
impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, will cease upon the effective date of the statement, which, for Sequa, is January 1, 2002.
SFAS No. 142 establishes specific guidelines for use in evaluating the impairment of goodwill. Under SFAS No. 142, goodwill is considered impaired and an impairment loss must be recognized if the implied fair value of a reporting unit's goodwill is less than its carrying amount. The implied fair value of goodwill is determined by subtracting the fair value of the recognized assets of the reporting unit from the fair value of the reporting unit. The impairment loss is the amount by which the carrying amount of goodwill exceeds its implied fair value.
Sequa is assessing the impact of SFAS No. 142 and anticipates a significant impairment loss will be incurred upon the adoption of the statement. In accordance with SFAS No. 142, a transitional impairment loss will be recognized as the effect of a change in accounting principle and will be presented in the Consolidated Statement of Income, net of related income tax effects, between the captions extraordinary items (if any) and net income.
Foreign Currency Translation
The financial position and results of operations of Sequa's foreign subsidiaries are measured using local currency as the functional currency with the exception of certain investment holding companies for which the US dollar has been denoted as the functional currency. Assets and liabilities of operating units denominated in foreign currencies are translated into US dollars at exchange rates in effect at year-end, while revenues and expenses are translated at weighted average exchange rates prevailing during the year. The resulting translation gains and losses are charged or credited directly to Accumulated Other Comprehensive Income (Loss), a separate component of shareholders' equity, and are not included in net income until realized through sale or liquidation of the investment. Foreign exchange gains and losses incurred on foreign currency transactions are included in net income.
Derivative Financial Instruments
Derivative financial instruments are utilized to manage foreign exchange and natural gas price risks. Sequa has established a control environment which includes policies and procedures for risk assessment and the approval, reporting and monitoring of derivative financial instrument activities. Sequa does not buy, hold or sell derivative financial instruments for trading purposes.
Note 1. Summary of Significant Accounting Policies
(cont'd)
Derivative Financial Instruments (cont'd)
On January 1, 2001, Sequa adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 138. These statements require companies to record derivatives on the balance sheet as assets and liabilities, measured at fair value. Depending on the use of a derivative and whether it has been designated and qualifies as a hedge, gains and losses resulting from changes in the value of the derivative are recognized currently in earnings or reported in Accumulated Other Comprehensive Income (Loss), a separate component of shareholders' equity.
Gains and losses on short-term forward foreign exchange contracts and derivatives thereof, used by Sequa to manage its exposure to exchange rate fluctuations on certain recognized assets and liabilities denominated in a currency other than the functional currency, are recorded as offsets to the losses and gains reported in earnings upon remeasurement of such assets or liabilities into the functional currency. Gains and losses on short-term forward foreign exchange contracts used to hedge the fair value of certain firm sales commitments with third parties are recognized in earnings as are the losses and gains on the related firm commitment.
Short-term forward foreign exchange contracts are used to hedge the cash flows of certain forecasted sales and intercompany firm sales commitments. Gains and losses on these contracts representing the effective portion of the hedging activity are reported in Accumulated Other Comprehensive Income (Loss). These deferred gains and losses are recognized in operating income in the period in which the sale is recognized. Gains and losses resulting from the ineffective portion of the hedging activity are included in the Consolidated Statement of Income.
The adoption of SFAS No. 133 as amended by SFAS No. 138 has not had a material effect on Sequa's consolidated financial statements with respect to the use of forward foreign exchange contracts and derivatives thereof.
Gains and losses on the fair market value of natural gas swaps that include a written option are reported in earnings as a component of Other, net. Gains and losses on natural gas swaps that do not include a written option and which are highly effective in hedging the cash flow variability of certain anticipated purchases are deferred and included as a component of Accumulated Other Comprehensive Income (Loss) until the purchase is consummated.
Note 1. Summary of Significant Accounting Policies
(cont'd)
Environmental Remediation and Compliance
It is Sequa's policy to accrue environmental remediation costs for identified sites when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Accrued environmental remediation costs include remedial investigation and feasibility studies; outside legal, consulting and remediation project management fees; projected cost of remediation activities; and site closure and post-remediation monitoring costs. In the fourth quarter of 2001, Sequa recorded a charge of $13,281,000 to increase its accruals for remediation costs. The charge includes $9,700,000 of estimated cost to remediate soil and groundwater contamination from ammonium perchlorate (AP), a raw material used to produce missile and rocket fuel. Although no federal or state environmental standards have been finalized for AP, recent studies showing that the chemical can interfere with human thyroid function have prompted Sequa to begin cleanup actions at its solid propellant facilities. At December 31, 2001, the potential exposure for all remediation costs is estimated to range from $22,000,000 to $35,000,000, and Sequa's Consolidated Balance Sheet includes accruals for environmental remediation costs of $30,768,000. These accruals are at undiscounted amounts and are included in accrued expenses and other noncurrent liabilities. Actual costs to be incurred at identified sites in future periods may vary from the estimates, given inherent uncertainties in evaluating environmental exposures.
Revenue Recognition
Generally, sales are recorded when products are shipped and risk of loss has transferred to the customer or when services are rendered. Long-term contracts are accounted for under the percentage-of-completion method, whereby sales are primarily recognized based upon costs incurred as a percentage of estimated total costs, and gross profits are recognized under a more conservative "efforts-expended" method primarily based upon direct labor costs incurred as a percentage of estimated total direct labor costs. Changes in estimates for sales, costs and gross profits are recognized in the period in which they are determinable using the cumulative catch-up method. Any anticipated losses on contracts are charged to current operations as soon as they are determinable.
Research and Development
Research and development costs are charged to expense as incurred and amounted to $20,057,000 in 2001, $22,157,000 in 2000 and $20,005,000 in 1999.
Note 1. Summary of Significant Accounting Policies
(cont'd)
Stock-Based Compensation
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. Sequa has chosen to continue to account for stock-based compensation under Accounting Principles Board (APB) Opinion No. 25, which measures compensation cost for stock options as the excess, if any, of the quoted market price of a company's stock at the grant date over the amount an employee must pay to acquire the stock. As Sequa's stock option plans require the option price to be no less than the fair market value of the stock at the date of grant, no compensation expense is recognized for stock options granted.
Income Taxes
Income taxes are recognized during the year in which transactions enter into the determination of financial statement income, with deferred taxes provided for temporary differences between amounts of assets and liabilities recorded for tax and financial reporting purposes.
No provision has been made for US or additional foreign taxes on $282,450,000 of undistributed earnings of foreign subsidiaries, as those earnings are intended to be permanently reinvested. Such earnings would become taxable upon the sale or liquidation of these foreign subsidiaries or upon the remittance of dividends.
Note 2. Trade Receivables, Net
Sequa Receivables Corp. (SRC), a wholly owned special purpose corporation, has a Receivables Purchase Agreement extending through November 2003 under which it is able to sell up to $120,000,000 of an undivided percentage ownership interest in Sequa's eligible trade receivables through a bank sponsored facility. Under the terms of the agreement, SRC's assets will be available to satisfy its obligations to its creditors, which have security interests in certain of SRC's assets, prior to any distribution to Sequa. In accordance with SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125," transactions under the Receivables Purchase Agreement qualify as a sale of receivables. Trade receivables at December 31, 2001 and 2000 are net of receivables sold under the agreement of $64,000,000 and $118,000,000, respectively. Other, net in the Consolidated Statement of Income includes discount expense related to the sale of receivables of $4,102,000 in 2001, $7,493,000 in 2000 and $2,290,000 in 1999.
Trade receivables at December 31, 2001 and 2000 are reduced by allowances for doubtful accounts of $13,529,000 and $14,121,000, respectively.
Note 5. Investments and Other Receivables
(cont'd)
In May 2000, Chromalloy entered a joint venture agreement with Siemens Westinghouse whereby Chromalloy contributed certain assets and liabilities of two industrial turbine repair units in return for a 49% ownership interest in a new US company called Turbine Airfoil Coating & Repair LLC (TACR). Siemens Westinghouse contributed to TACR the stock of an existing operation in Germany. TACR coats new parts and repairs components for land-based industrial gas turbines. Sequa's investment in TACR was $18,026,000 at December 31, 2001 and $14,607,000 at December 31, 2000 and its equity share of net income from TACR was $3,420,000 in 2001 and $786,000 in 2000.
In June 2000, Chromalloy purchased a 49% ownership interest in an existing operation that operates as Masaood John Brown Ltd (MJB), with a facility in the United Arab Emirates. MJB is a partnership with Mohammed Bin Masaood & Sons and provides repair and maintenance services to industrial gas turbine operators. Sequa's investment in MJB was $7,849,000 at December 31, 2001 and $4,681,000 at December 31, 2000 and its equity share of net income from MJB was $1,210,000 in 2001 and $269,000 in 2000. At December 31, 2001, Sequa had guaranteed MJB's bank line of credit in the amount of $6,921,000.
In August 2000, Chromalloy signed agreements with Rolls-Royce plc to form two 50/50 joint ventures: Turbine Surface Technologies Ltd (TST), which will provide advanced coatings for Rolls-Royce turbine components; and Turbine Repair Technologies Ltd (TRT), which provides advanced component repair services for certain Rolls-Royce engines. TST is not expected to generate sales until 2002, and the investment in this joint venture was $258,000 at December 31, 2001. The equity share of start-up losses for TST was $176,000 in 2001. Sequa's investment in TRT was $2,879,000 at December 31, 2001 and $2,353,000 at December 31, 2000. The equity share of net income from TRT was $1,207,000 in 2001 and $75,000 in 2000.
Two other Chromalloy 50/50 joint venture partnerships are significant. Advanced Coatings Technologies (ACT), a joint venture with United Technologies Corporation, owns and operates an electron beam ceramic coater for the application of Pratt & Whitney coatings to jet engine parts. Sequa's investment in ACT was $843,000 at December 31, 2001 and $1,091,000 at December 31, 2000. Sequa's equity share of net income from ACT was $1,903,000 in 2001, $1,048,000 in 2000 and $913,000 in 1999. Pacific Gas Turbine Center LLC (PGT), was formed in 1999 to overhaul and test certain jet engines and operated from November 2000 as a partnership with the maintenance services subsidiary of Sair Group. Sequa's investment in PGT was $7,440,000 at December 31, 2001 and $12,177,000 at December 31, 2000. Sequa's equity
Note 8. Indebtedness
(cont'd)
On April 2, 2001, Sequa completed an offering of $200 million of 8 7/8% Senior Notes due April 1, 2008 through a private placement under Rule 144A of the Securities Act of 1933, as amended (the Securities Act). Net proceeds received on April 2, 2001 from the 8 7/8% Senior Notes offering amounted to $196,800,000. The proceeds were used to repay approximately $100,000,000 outstanding under Sequa's revolving credit agreement; to redeem $66,425,000 of 10.1% medium-term notes when they matured in mid-May 2001; and for general corporate purposes. Concurrent with the completion of the 8 7/8% Senior Notes offering, Sequa's revolving credit facility was reduced to $75,000,000 from $150,000,000.
On July 12, 2001, Sequa completed its offer to exchange all outstanding 8 7/8% Senior Notes due April 1, 2008 for up to $200,000,000 of registered Series B 8 7/8% Senior Notes due April 1, 2008. All $200,000,000 of outstanding notes were exchanged. The terms of the new Series B 8 7/8% Senior Notes -- including principal amount, interest rate, maturity, security and ranking -- are substantially the same as the terms of the original notes, with the principal exception that the new notes are registered under the Securities Act.
At December 31, 2001, no amounts were outstanding under the $75,000,000 revolving line of credit and the facility was not used in the fourth quarter of 2001. Adverse economic conditions in the fourth quarter precluded Sequa from being in compliance with certain financial covenants of the revolving credit agreement. In January 2002, Sequa cancelled the $75,000,000 revolving line of credit and is in discussions with a bank group regarding a new line of credit.
The aggregate maturities of total long-term debt during the next five years are $2,659,000 in 2002, $1,631,000 in 2003, $7,141,000 in 2004, $456,000 in 2005 and $0 in 2006.
Note 9. Income Taxes
(cont'd)
On July 25, 2001, the Internal Revenue Service (IRS) issued notification to Sequa that a settlement agreement concerning the 1989 restructuring of two subsidiaries was approved. The notification finalized Sequa's tax liability in the matter. Further notification is pending regarding the final amount of interest owed. While management believed that its position in this matter was appropriate, it had taken the conservative position of providing reserves to cover an adverse outcome. The total amount involved was approximately $59,000,000, composed of the potential liability associated with the restructuring and related tax issues; interest expense, net of tax benefit, from the date of the resulting tax refund; and deferred tax assets for portions of tax loss and credit carryforwards which could be utilized in a settlement. In October 1998, Sequa made a deposit of $24,000,000 with the IRS against the expected liability for additional tax and interest that could have been assessed against Sequa related to certain of these tax matters. The deposit stopped the running of interest with respect to the amount deposited. As a result of the settlement, no additional tax will be paid and $36,000,000, representing the reversal of income tax reserves no longer required, has been recorded as income through a reduction in the income tax provision. The amount is separately identified in the Consolidated Statement of Income. An additional adjustment is possible pending notification of the final amount of interest owed. The impact of the settlement was to increase basic earnings per share by $3.47.
A valuation allowance has been established to reduce the deferred tax asset recorded for certain tax credits that may expire unutilized in 2003 through 2019 and to reduce the tax benefit recorded for a portion of the cumulative losses of a French subsidiary. The AMT credit carryforward does not expire and can be carried forward indefinitely. Sequa has a domestic tax net operating loss carryforward of $134,364,000 at December 31, 2001 that expires in 2009 through 2021.
Note 13. Pension Plans and Postretirement Benefits
(cont'd)
The funded plans' assets consist primarily of listed common stock, pooled equity funds, index funds, debt instruments and real estate funds. At December 31, 2001 and 2000, the plans' assets included Sequa stock with market values of $25,485,000 and $19,512,000, respectively.
Assumptions used in accounting for all of Sequa's significant domestic and foreign defined benefit plans are:
Note 14. Capital Stock (cont'd)
that have one-third or more of the aggregate voting power of all outstanding shares of voting stock or (ii) ten days (or such later date determined by the Board of Directors in certain circumstances) following the commencement or announcement of an intention to make a tender or exchange offer which would result in the acquisition of (or the right to acquire) one-third or more of the aggregate voting power of all outstanding shares of voting stock. The Rights are nonvoting, pay no dividends, expire on October 31, 2010 and may be redeemed by Sequa for $.001 per Right at any time on or before the Distribution Date. The Rights have no effect on earnings per share until they become exercisable.
Once the Junior Preferred Stock is issued, in the event of any merger, consolidation, combination or other transaction in which shares of Class A and Class B common stock are exchanged for or changed into other stock, securities, cash and/or other property; each share of Junior Preferred Stock will be entitled to receive 1,000 times the aggregate amount of stock, securities, cash and/or other property into which or for which each share of Class A and Class B common stock is changed or exchanged, subject to certain adjustments.
At December 31, 2001, 4,297,413 shares of Sequa Class A common stock were reserved for the conversion of preferred and Class B common stock, and for the exercise of outstanding stock options.
Note 18. Restructuring and Related Asset Impairment Charges
(cont'd)
Sequa's Consolidated Balance Sheet at December 31, 2001 includes accruals of $11,340,000 relating to the restructuring actions. The original restructuring liability of $18,239,000 was reduced by involuntary termination and voluntary early retirement benefits paid outside of Sequa's qualified pension plans of $5,096,000 with additional payments of $488,000 principally relating to the closing of facilities. That portion of the restructuring liability relating to curtailment losses and the cost of early retirement windows afforded under Sequa's qualified pension plans of $1,315,000, are included in the related pension accruals in the Consolidated Balance Sheet. Sequa expects that cash expenditures for the restructuring program will total $16,924,000, with $5,584,000 paid in 2001, $10,400,000 expected to be paid in 2002 and the balance, primarily related to early retirement programs, to be paid in 2003 and beyond. Sequa expects to generate approximately $6,700,000 in cash from the disposal of property, plant and equipment available for sale as a result of the restructuring program. Efforts to sell these assets have begun but Sequa can not forecast when they will be completed and the proceeds from disposition received.
In 2000, a restructuring charge of $3,225,000 related to an early retirement program at the Specialty Chemicals segment was recorded of which $1,343,000 is included in cost of sales and $1,882,000 is included in selling, general and administrative expenses. Cash payments required under the early retirement program were completed in 2001.
Note 20. Operating Leases
Certain businesses of Sequa utilize leased premises or equipment under noncancellable agreements having initial or remaining terms of more than one year. The majority of the real property leases require Sequa to pay maintenance, insurance and real estate taxes. Rental expense totaled $22,275,000, $23,534,000 and $20,239,000 in 2001, 2000 and 1999, respectively.
At December 31, 2001, future minimum lease payments under noncancellable operating leases are as follows:
(Amounts in thousands)
$14,115
9,518
6,923
4,402
3,869
After 2006
11,504
$50,331
Note 21. Earnings Per Share
Basic earnings per share (EPS) for each of the respective years have been computed by dividing the net earnings, after deducting dividends on cumulative convertible preferred stock, by the weighted average number of common shares outstanding during the year.
Diluted EPS reflects the potential dilution that could occur if each share of the cumulative convertible preferred stock outstanding were converted into 1.322 shares of Class A common stock and the outstanding in the money options to purchase shares of Class A common stock were exercised.
Note 23. Segment Information and Geographic Data (cont'd)
The Other Products segment is composed of four ongoing businesses: MEGTEC Systems, Sequa Can Machinery, Casco Products and the After Six unit. MEGTEC Systems provides auxiliary press equipment for web offset printing, as well as dryers and emission control equipment for the international industrial, paper and printing markets. Sequa Can Machinery produces high speed equipment to form and decorate two-piece metal cans for the worldwide container industry. Casco Products manufactures cigarette lighters, power outlets and electronic monitoring devices primarily for North American and European automobile manufacturers. The After Six unit designs and manufactures men's formalwear and accessories for the North American market.
The accounting policies of the reportable segments are the same as those described in Note 1. Segment information amounts presented are the same measures reported internally to management for purposes of making decisions about allocating resources to the segments and assessing their performance. Operating profit, the measure of profit reported in the segment information, represents income before income taxes, interest, equity in unconsolidated joint ventures and other income (expense). The expenses and assets attributable to corporate activities are not allocated to the operating segments. Assets of corporate activities include cash and cash equivalents, short-term investments, deferred tax assets and net assets of discontinued operations. Investments in unconsolidated joint ventures are included in the appropriate segment. Prior year amounts have been restated accordingly.
Note 24. Contingencies
(cont'd)
The ultimate legal and financial liability of Sequa in respect to all claims, lawsuits and proceedings referred to above cannot be estimated with any certainty. However, in the opinion of management, based on its examination of these matters, its experience to date and discussions with counsel, the ultimate outcome of these legal proceedings, net of liabilities already accrued in Sequa's Consolidated Balance Sheet, is not expected to have a material adverse effect on Sequa's consolidated financial position, although the resolution in any reporting period of one or more of these matters could have a significant impact on Sequa's results of operations for that period.
ITEM 9.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEMS 10 THROUGH 13
The information required by Item 10