Item 1. Business
OVERVIEW
We design, manufacture and sell air filters and related products. Historically, we have been a leading manufacturer of High Efficiency Particulate Air (HEPA) filters, specializing in high-end cleanroom and containment filters for end users in semiconductor manufacturing, nuclear processing, biotechnology, and other high technology applications. In 1995, we began a strategy of growth through acquisition, and acquired manufacturers of a broad range of additional air filtration products, growing from $39 million in sales in 1995 to approximately $171 million in sales in 1999. We now offer air filters ranging from spun-glass furnace filters through high-volume electrostatic precipitators and cleanroom laminar-flow HEPA filters.
Our air filters are utilized by many industries, including those associated with commercial and residential heating, ventilation and air conditioning systems (commonly known as "HVAC" systems), semiconductor manufacturing, ultra-pure materials, biotechnology, pharmaceuticals, synthetics, nuclear power and nuclear materials processing. We also design and manufacture much of our own production equipment to automate our processes in order to decrease labor costs associated with our standard products. We also produce glass-based air filter media for many of our products. Our customers include Abbott Laboratories, The Home Depot, Inc., Motorola, Inc., Merck & Co., Inc., Upjohn Co., Wal-Mart Stores, Inc., Westinghouse Electric Corp., and several large computer chip manufacturers.
The vast majority of our revenues come from the sale of after-market replacement filters, since air filters are typically placed in equipment designed to last much longer than the filters.
GENERAL DEVELOPMENT OF BUSINESS
Flanders Corporation was incorporated on July 2, 1986 in the State of Nevada, and is currently domiciled in North Carolina. Beginning in December 1995, we began to implement a strategy of growth through acquisition, acquiring several companies specializing in air filters and related products, including Flanders Filters, Inc., Charcoal Service Corporation, Air Seal Filter Housings, Inc., Precisionaire, Inc., and Eco-Air Products, Inc.
Effective April 1, 1999, we purchased the Tidewater group of companies for $1,750,000, and spent approximately $177,000 in legal, accounting and other expenses which were counted as part of the acquisition cost, for a total cost of acquisition of approximately $1,927,000. Tidewater is an air filter distributor and service organization, with some limited manufacturing capacity for specialty products. Prior to the acquisition, Tidewater was an exclusive distributor of a competitor's products.
Effective June 30, 1998, pursuant to a stock purchase agreement, we acquired substantially all the outstanding stock of Eco-Air Products, Inc. The purchase price, including expenses and net of cash received, was approximately $15,455,160, plus up to $5,000,000 payable in cash or common stock (at sellers' option) if certain performance criteria are met.
RECENT DEVELOPMENTS
On March 21, 2000, we announced that we had engaged the investment banking firm PaineWebber Incorporated to help us explore strategic alternatives, including the possible sale of the Company.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
This annual report, including all documents incorporated herein by reference, includes certain "forward-looking statements" within the meaning of that term in Section 27A of the Securities Act of 1933, and Section 21E of the Exchange Act, including, among others, those statements preceded by, following or including the words "believes," "expects," "anticipates" or similar expressions.
These forward-looking statements are based largely on the current expectations of management and are subject to a number of risks and uncertainties. Actual results could differ materially from these forward-looking statements. In addition to the other risks described in the "Factors That May Affect Future Results" discussion under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II of this annual report, important factors to consider in evaluating such forward-looking statements include risk of product demand, market acceptance, economic conditions, competitive products and pricing, difficulties in product development, commercialization and technology. In light of these risks and uncertainties, there can be no assurance that the events contemplated by the forward-looking statements contained in this annual report will, in fact, occur.
INDUSTRY BACKGROUND
The McIlvaine Company, a leading industry analyst, estimated that the worldwide air filtration market would be approximately $3.2 billion in 1999, with the United States being the largest market for air filters because of the prevalence of forced air heating and cooling. McIlvaine also estimated the air filtration market would grow at an annual rate of 8% per year through 2003. They indicated that the driving forces behind growth in the air filtration market would be using higher-performance filters in commercial and residential spaces instead of current low-efficiency models, and the use of air filters in new applications. Management believes the forces driving the air filtration market are evolving, beginning in the past decade and continuing for the next several years, from preserving machinery and equipment to maintaining indoor air quality. In addition, we expect many high-growth technology industries to increase their reliance on air filters to remove microscopic and gaseous contaminants from sensitive manufacturing processes associated with semiconductor manufacturing, pharmaceutical production, ultra-pure materials manufacturing and biotechnology. Companies are devoting resources to air filtration products to enhance process efficiency and employee productivity.
Air filters are used in many different applications, including the following:
o Commercial and Residential HVAC Systems. Replacement filters are an essential requirement for the efficient operation of commercial and residential HVAC systems.
o General Industrial. Air filters are used in standard industrial settings to provide cleaner work environments; for example, auto makers use air filtration systems to remove "oil mist" contaminants from the air in their plants, and industrial paint booth users utilize air filtration to remove paint particles from the air.
o Semiconductors. HEPA and carbon filters are necessary to meet the increasingly stringent manufacturing environment requirements of semiconductor manufacturers, where microscopic airborne contaminants can ruin microchips during production, having a large impact on manufacturing yield and profitability. Carbon filters are also being increasingly used to filter gaseous contaminants from semiconductor manufacturing areas.
o Pharmaceuticals. Pharmaceutical companies are increasingly using cleanrooms to prevent cross-contamination between different products and different lots of the same products being manufactured at the same facility. The increasing use of cultured microbes for drug production is also expected to increase demand for high-end containment environments.
o Biotechnology. Containment systems for the manipulation of viruses and bacteria using genetic engineering techniques are critical to the biotechnology industry.
o Nuclear Power and Materials Processing. Filtration systems are necessary to radioactive containment procedures for all nuclear facilities.
RECENT TRENDS
Recent trends in the air filter industry, as well as changes in laws and governmental regulations, all encourage an increased awareness of the benefits of the use of air filtration products. Some of these trends and changes are:
Indoor Air Quality and Health. We believe there is an increase in public concern regarding the effects of Indoor Air Quality on employee productivity and health, as well as an increase in interest in standards for detecting and solving IAQ problems. For example, the American Society of Heating Refrigeration and Air-Conditioning Engineers (ASHRAE) has recently established certain minimum standards for ventilation and indoor air quality for commercial and industrial settings. The World Health Organization has recently been studying the effects of air quality on human health, including widely publicized epidemiological studies indicating that airborne contaminants kill more people than automobile accidents.
Hazardous Working Environments. Several studies recognize that air quality in working facilities has an impact upon human health. OSHA regulations, in particular, have made IAQ a consideration in a wide variety of industries, ranging from those industries using spray-paint booths to those using automobile assembly lines.
Sick Building Syndrome. Sick Building Syndrome, which is characterized by lethargy, frequent headaches, eye irritation and fatigue, has recently been shown to be a valid concern, and is a major design consideration in new and renovated commercial and industrial buildings. The identification of "sick" buildings, and solutions for mitigation, involve complex issues which need to be examined on a case-by-case basis by qualified engineers; solutions typically include improving the HVAC and filtration systems of the "sick" buildings.
Hazardous Emission Regulation and Resultant Liability. Electrical utilities became subject to emissions regulations under Title 4 of the Clean Air Act. In addition, OSHA's Hazardous Communication Standard, the Toxic Release Inventory and community "right to know" regulations regarding liability for claims made by employees or neighboring communities have made many industries, in particular the chemical and semiconductor industries, more aware of clean air regulations. As a result, these industries have taken voluntary steps, including the utilization of air filtration systems, to bring emissions of potentially hazardous substances into line with regulatory standards.
STRATEGY
Our current business strategy seeks to increase earnings, and hence shareholder value, by improving operating efficiency and increasing our market share.
IMPROVE OPERATING EFFICIENCY
Eliminate Unprofitable Operations. During 1997, we established a new subsidiary, Airseal West, Inc., to serve as a manufacturer of industrial air handlers, custom housings, and related products for the western U.S. The market opportunities envisioned by this venture failed to materialize, and Airseal West focused its primary efforts on perceived opportunities in businesses and products unrelated to air filtration, including sporting goods, vending equipment and other general manufacturing. In December 1999, the Board of Directors adopted a formal plan to close Airseal West and sell its non air filter related assets. We estimate this will save approximately $2 million per year (see "Management's Discussions and Analysis of Financial Condition and Results of Operations - Discontinued Operations").
Vertical Integration. In December 1997, we acquired a small glass media manufacturing plant in Salt Lake City, Utah, which produced spun-glass media for our highest-volume products, flat panel filters, using traditional processes, supplying perhaps 5% of our demand for this material. This plant was also in the process of building a more efficient plant for producing the spun-glass media used in these filters. In 1998, we began to build the second generation of equipment for this purpose. By September 1999, we had completed, evaluated and replicated the second generation of equipment and begun building enough of this equipment to increase our production to the level required to supply our three plants in the western U.S. with media. This project should be completed in the second quarter of 2000. We plan to establish a duplicate plant in North Carolina to supply our plants in the rest of the U.S. With both plants in production, we estimate this process will decrease our costs associated with spun-glass materials by at least forty percent, representing approximately $2.5 million in annual cost savings at current rates of usage.
Strategic Acquisitions. We continue to search for opportunities to acquire new businesses, although our criteria for evaluating these businesses has moved toward acquiring regional distributors and resellers, and away from acquiring competing air filter manufacturers. We are looking for potential acquisitions with the
following characteristics: (i) dominant positions in local or regional markets, (ii) a stable customer base distinct from our existing customers, and (iii) a history of consistent and healthy earnings. Acquiring resellers and distributors with these characteristics allows us to increase operating margins by removing at least one layer of "middlemen," and their compounding mark-ups and commissions from the sales and distribution process, allowing us to charge higher prices while maintaining competitive pricing with end users. At the present time, we do not have any binding agreements with respect to future acquisitions.
Centralize Overhead Functions. During the fourth quarter of 1999, we consolidated all of the sales forces of our various subsidiaries into a single, consistent national sales team, eliminating overlapping territories, duplication of literature, centralizing travel coordination and adding focus to our sales efforts. We are continuing to centralize and eliminate duplication efforts between subsidiaries in the following areas: purchasing, production planning, shipping coordination, accounting, personnel management, risk management and benefit plan administration.
Expand Mexican Manufacturing. We expect to have completed an expansion of our Tijuana, Mexico, plant, which will produce our standard spun-glass and pleated filters, in all grades, for sale in the western U.S. We will be moving some of the production equipment from our plants in San Diego and Nevada to this expansion.
Electronic Commerce. We believe there are significant cost savings and error reduction opportunities in allowing our customers to enter orders, examine specifications, receive confirmations, and check on the status of their orders, via the Internet. In September 1999, we began an initiative to analyze all other areas of our business for plans to implement savings by using the Internet to automate communications with current customers, potential customers, end users and investors. We believe there are opportunities for significant cost reductions in customer service, shipping errors, orders administration, customer pre-qualification, lead generation and documentation storage. We anticipate completion of the first iteration and implementation of this process in the year 2000, and plan to make the Internet a central part of our future strategy for growth and cost minimization. We do not anticipate significant direct retail sales from electronic commerce in the foreseeable future, because shipping bulky packages of inexpensive filters in less than truckload quantities is prohibitively expensive.
Increase Market Share
Increase Sales to Existing and New Customers. We sell our products through a direct sales force and manufacturers' representatives. Historically, any given manufacturers' representative has only sold a small sub-set of our current complete product line. However, we now offer a much larger range of air filtration products, allowing these representatives to purchase their full line of air filtration products from us instead of buying a mix of air filtration products from a range of manufacturers.
Use Facilities Located Throughout the United States to Increase Market Share. Through acquisition and the establishment of new plants, we have placed facilities within one day's over-the-road shipping of most major population centers in the United States. We believe this ability to regionalize production and distribution will improve our business in several ways: (i) Decrease cost of sales by reducing the average distance between our plants and our customers, and hence decrease the cost of outbound freight; (ii) increase responsiveness by decreasing the average time required to ship products to customers; and (iii) increase our share of national accounts' total business by having manufacturing facilities in closer proximity to customers' regional distribution centers. The ability to service all major population centers with regional manufacturing centers is critical for our business, allowing us to compete on price against less broadly based competitors without sacrificing margins, as well as the ability to respond more rapidly than most of our competition.
Adapt Processes to New End User Requirements. During 1999, we established a complete line of air filtration products for the removal of airborne paint and associated solvents from the air. We were able to adapt our bulk manufacturing processes to the high-volume synthetic media required for this end use, and anticipate that revenues in this area will exceed $10 million in 2000. We continue to watch for applications where our competitive strengths can be readily adapted to new end users.
Offer Indoor Air Quality Diagnosis and Remediation Services. During 1999, as part of the acquisition of the Tidewater group of companies, we acquired a small engineering firm specializing in monitoring air quality using automated real-time data collection techniques over a period of months, diagnosing any potential indoor air quality problems and suggesting remediation programs. We believe we will be able to leverage this expertise into value-added sales to our existing industrial and commercial customers, and the filter sales and service companies which supply them, increasing our revenues by adding value-added consulting and monitoring services.
Continued Emphasis on Quality and Performance. A continued emphasis on product quality has allowed us to capture market share serving several industries in recent years.
MARKETING
During 1999, we restructured and centralized our sales and marketing structure, which we believe allows us to focus our marketing efforts more precisely, and ensures consistency of presentation and pricing across all customers. Previously, each subsidiary had its own sales and marketing infrastructure, which contributed to waste and inefficiency, and more importantly, market confusion. Our marketing efforts are targeted to the needs of individual customers and groups of customers, and may consist of mass marketing allowances and incentive programs for retailers, educational point of purchase materials and enhanced signage for consumers and industry-specific technical seminars for filter sales and service organizations.
Much of our marketing effort consists of personal visits to customers and distributors through an extensive tiered network of contract salespeople. Periodic visits are enhanced by mass mailings announcing new products, participation in trade shows for exposure and lead generation, technical articles and advertisements in trade periodicals, and a newly redesigned catalog containing all Flanders products. During 1999, we restructured and unified all of our product offerings, so that each subsidiary no longer generates its own marketing literature. We also re-wrote the bulk of our catalog and promotional materials to include all product lines in a consistent and easy-to-access format, which can be used by all of our customers.
Besides developing new sales leads and contacts, we are also focused on increasing the effectiveness of our existing distributors and contract salesmen, by allowing them to offer our products as a complete "single-source" for air filtration products. We believe this will allow them to increase their sales for the following reasons:
Dependability and Responsiveness. Our ability to express-ship via standard ground freight to any major population center within one day is a key competitive advantage. We also believe that our expansion program and general production capacity also allow us to handle relatively large orders with shorter lead times than any of our competitors.
Product Quality. We are known as a manufacturer of high performance air filtration products. We currently offer filters of 99.999997% on particles 0.1 microns or larger, which we believe is the highest efficiency rating available anywhere. We have also been recognized for consistency and quality of our products by several third-party rating organizations.
Name Recognition. We believe that each of our product lines has high name recognition in its target markets. Our representatives and distributors have indicated that they believe their sales will increase with additional products associated with Flanders.
Single-Source Supplier. We provide a broad spectrum of air filtration products. The ability to work with a single source for filters will enable representatives to operate more efficiently, only needing to be trained on one filtration system, maintain contacts with a single organization and order from a central source.
Product Promotion and Innovation. We plan to continue to introduce new applications we are developing for filtration products. Representatives and distributors will be able to take advantage of the additional name recognition and public knowledge associated with the marketing of the new products. We believe these representatives will see this as a competitive advantage to selling our products.
PRODUCTS
We design, manufacture and market a broad range of air filters and related products, including:
o High Efficiency Particulate Air (HEPA) filters (at least 99.97% efficient) in various grades, for use in semiconductor facilities, nuclear containment vessels, disease containment facilities, and other critical applications
o Absolute Isolation Barriers which are customized stand-alone units, typically manufactured of stainless steel, used in various industries which require absolute control over contaminants, atmospheric composition and containment
o Industrial mid-range specialty filters which fall under specifications which are categorized by efficiency ratings established by the American Society of Heating, Refrigeration and Air Conditioning Engineers (ASHRAE), used in a wide variety of industries, including paint facilities, automobile factories, chemical treatment plants, mushroom farms, coal mines, oil refineries and power plants
o Carbon filters, both in bonded panels and activated charcoal beds, used to remove gaseous contaminants, odors and toxic chemical vapors in various commercial and industrial applications
o Commercial and industrial filters for use in office and general manufacturing environments, typically sold through wholesalers and distributors
o Residential heating and air conditioning filters, typically sold through retailers
o Specialized air filter housings, for use in multi-stage filtration applications
o Other related products, including tubing insulation, ductwork and equipment cleaning chemicals, custom air handlers and specialized filter housings.
MANUFACTURING
We manufacture air filters, housings, Absolute Isolation Barriers and related equipment at several facilities in the United States, which range in size from 18,000 square feet to approximately 400,000 square feet.
o Precisionaire has seven separate manufacturing facilities located in Bartow, Florida, Terrell, Texas, Salt Lake City, Utah, Henderson, Nevada, Momence, Illinois, Smithfield, North Carolina and Auburn, Pennsylvania, which produce a broad range of commercial, residential and industrial filters.
o FFI's facility in Washington, North Carolina, produces high-end HEPA products for cleanrooms. Management believes that FFI's ability to manufacture its own HEPA filter media provides it with a significant competitive advantage, allowing more direct control over quality and composition than is generally available with outside suppliers.
o Flanders/CSC's facility, located in Bath, North Carolina, manufactures HEGA filters, high-end containment environments, housings, custom filter assemblies and other custom filtration products and systems which require extensive custom design, production and lot tracking. For example, CSC's products are used in the production and containment of potentially dangerous biologically engineered microorganisms.
o Air Seal's facility, located in Stafford, Texas, produces mid-range custom filter housings. o Eco-Air's facilities in San Diego, California, and Tijuana, Mexico, manufacture air filtration products ranging from standard-grade disposable filters through industrial HEPA filters.
In addition, we design, manufacture and assemble the majority of our automated production equipment.
Our manufacturing operations are subject to periodic inspection by regulatory authorities. Because of the nature of some of our products, these agencies include, in some cases, the Department of Energy, the Food and Drug Administration and other agencies responsible for overseeing sensitive technologies. One of the considerations in deciding which types of products each facility will manufacture is the segregation of highly-regulated products to a minimal number of facilities to reduce the overhead associated with regulatory monitoring and compliance.
Each of our manufacturing facilities utilizes testing and design strategies appropriate to the products manufactured. These range from standard statistical process quality controls for residential replacement filters to individual testing and certification with patented proprietary particle scanning technologies for each laminar-grade HEPA filter. We believe that our ability to comprehensively test and certify HEPA filters is a competitive advantage.
SOURCE AND AVAILABILITY OF RAW MATERIALS
Our principal raw materials are cardboard, fiberglass fibers, extruded glass, sheet metal, extruded aluminum, adhesives, resins and wood. These raw materials are readily available in sufficient quantities from many suppliers.
COMPETITION
The air-filtration market is fragmented and highly competitive. There are many companies which compete in our market areas. We believe that the principal competitive factors in the air filtration business include product performance, name recognition, price, product knowledge, reputation, customized design, timely delivery and product maintenance. We believe that we compete favorably in all of these categories. Competitors include successful companies with resources, assets, financial strength and market share which may be greater than ours. Major competitors include American Air Filter International, Farr Company, HEPA Corporation, Purolator Products Air Filtration Company, Donaldson Company, Inc. and Clark Corporation.
PATENTS, TRADEMARKS AND LICENSES
We currently hold 17 patents relating to filtration technology, including patents relating to HEPA filters and fabrication methods, filter leak testing methods and laminar flow cleanrooms. We also have patents pending for one of the components related to Absolute Isolation Barriers, and the impregnation method used in the manufacture of Arm & Hammer Pleated Filters.
We have obtained and own the following federal trademark registrations: PRECISIONAIRE(R), EZ FLOW(R), SMILIE(R), AIRVELOPE(R), CHANNEL-CEIL(R), CHANNEL-HOOD(R), PUREFORM(R), ECONO-CELL(R), GAS-PAK(R), PUREFRAME(R), DIMPLE PLEAT(R), BLU-JEL(R), VLSI(R), CHANNEL-SEAL-ADAPTER(R), SUPERFLOW(R), FLANDERS(R), CHANNEL-WALL(R), SUPERSEAL(R), AIRPURE(R) and PURESEAL(R). The Company also has applied for federal trademark protection for the following marks: FLANDERS ABSOLUTE ISOLATIONTM, FLANDERS/CSCTM, TECH-SORBTM and FUTUREFLOTM. Although management believes that the patents and trademarks associated with our various product lines and subsidiaries are valuable, we do not consider any of them to be essential to our business.
We currently license some of our products to specialty HVAC and ASHRAE filter manufacturers who produce products under their own name and with their own identifying labels.
CUSTOMERS
We are not dependent upon any single customer. One customer, Wal-Mart Stores, Inc., accounted for 10%, 10% and 11% of net sales during 1999, 1998 and 1997, respectively. Home Depot, Inc., accounted for 12%, 10% and 8% of net sales during 1999, 1998 and 1997, respectively. No other single customer accounted for 10% or more of net sales. Other significant customers include Abbott Laboratories, Motorola, Inc., Merck & Co., Inc., Upjohn Co., Westinghouse Electric Corp., and several large computer chip manufacturers.
BACKLOG
We had approximately $12,700,000 in firm backlog on December 31, 1999, compared to $11,084,000 on December 31, 1998. Firm backlog includes orders received and not begun and the unfinished and unbilled portion of contracts in progress. Orders are typically not cancelable without penalty, except for certain stable filter supply contracts to nuclear facilities operated by the United States government. Backlog varies from week to week, based on the timing and mix of orders received. All backlog at December 31, 1999, is expected to be shipped by the end of the second quarter of 2000.
EMPLOYEES
The Company employed 2,391 full-time employees on December 31, 1999; 1,986 in manufacturing, 29 in development and technical staff, 48 in sales and marketing, and the remaining 328 in support staff and administration. The Company believes that its relationship with its employees is satisfactory. Manufacturers' representatives are not employees of the Company.
RESEARCH AND DEVELOPMENT
Our research and development is focused in the following areas:
Automated equipment design, to increase the efficiency and profitability of production lines used for mass production of off-the-shelf filters.
Alternative filtration media types, including evaluation of new synthetic media products, which might either increase efficiency or decrease media costs; the Company's Arm & Hammer Pleated Filters are an application of this type of research.
Improved media production techniques, particularly at Precisionaire's spun fiberglass production facility in Salt Lake City, Utah, and FFI's HEPA paper mill in Washington, North Carolina; during the past ten years, the Company has increased the efficiency of its filters through advances in media formulation and production techniques from 99.97% to 99.999997%.
Application development, where new methods and products are developed from existing technologies.
Research and development costs for 1999, 1998 and 1997 were approximately $763,000, $2,250,000 and $373,000, respectively. Research and development costs were expensed and included in general and administration expenses during the period incurred. The large increase in research and development expense between 1998 and 1997 was primarily due to the development of three product lines: Arm & Hammer Pleated Filters, Environmental Tobacco Smoke Systems, and Retrofit Air Handlers.
GOVERNMENT REGULATION
Our operations are subject to certain federal, state and local requirements relating to environmental, waste management, health and safety regulations. We attempt to operate our business in compliance with all applicable government, environmental, waste management, health and safety regulations and we believe that our products meet standards from applicable government agencies. There can be no assurance that future regulations will not require us to modify our products to meet revised safety or other requirements.
SEASONALITY
Historically, our business has been seasonal, with a substantial percentage of sales occurring during the second and third quarters of each year. In addition, demand for our general commercial and industrial products appears to be highly influenced by the weather, with higher sales generally associated with extremes of either hot or cold weather, and lower sales generally associated with temperate weather. Because of these seasonal and weather-related demand fluctuations, quarter-to-quarter performance may not be a good predictor of future results.
EXPORT SALES
We sell products for and to end users outside of the United States through domestic specialty cleanroom contractors. These sales are counted as domestic sales. We also sell products through foreign distributors, primarily in Europe, and through Flanders International, Ltd., a wholly-owned subsidiary located in Singapore which sells to customers in the Far East. Sales through foreign distributors and Flanders International amounted to less than 5% of net sales for each of the last three fiscal years. Assets held outside the United States are negligible.
Item 2.
Item 2. Properties
The following table lists our principal facilities. Management believes that these properties are adequate for its current operational needs, but we may at some point relocate, reorganize or consolidate various facilities for reasons of operating efficiencies, or may open new plants to take advantage of perceived new economic opportunities.
Item 3.
Item 3. Legal Proceedings
The Company is involved in a dispute with a customer involving a purchase of approximately $5 million in air filters, with approximately $2.6 million of related accounts receivable currently uncollected, filed as Case No. CV 98-19817 on October 10, 1998 in the Superior Court of the State of Arizona in and for the County of Maricopa, Intel Corporation v. Flanders Filters, Inc. The customer contends that certain filters manufactured by the Company did not conform to specifications, and has asked for unspecified relief and damages. The Company has filed a counter-claim asking for the amount of its receivable and unspecified relief and damages. Independent testing and other information available to management indicate the filters did conform to specifications; therefore, management believes the receivable is fully collectible. However, it is reasonably possible the estimate of collection may change in the near term.
Additionally, from time to time, we are a party to various legal proceedings incidental to our business. None of these proceedings are material to our business, operations or financial condition.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
We held our annual meeting of shareholders on December 21, 1999. During the meeting, holders of 17,496,387 shares, representing approximately 68.8% of 25,435,583 shares outstanding on the record date, attended either in person or by proxy. Holders of 13,846,481 shares (approximately 79.1% of shares present) voted to elect as members of the Board of Directors Robert R. Amerson, Steven K. Clark, J. Russell Fleming and Linwood Allen Hahn, holders of 1,968 voted against; and holders of 3,647,938 shares abstained. As a result, Messrs. Amerson, Clark, Fleming and Hahn were elected for one-year terms as directors.
Holders of 13,858,772 shares (approximately 79.2% of shares present) voted to ratify the firm of Grant Thornton LLP as the Company's independent auditors for the fiscal year ended December 31, 1999, holders of 14,168 shares voted against the ratification and holders of 3,623,446 shares abstained. As a result, Grant Thornton's appointment was ratified.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Price Range of Common Stock
The Company's common stock is listed on the Nasdaq National Market System under the symbol "FLDR." The following table sets forth, for the periods indicated, the high and low closing prices of the Company's common stock as reported by the Nasdaq National Market System. Such quotations do not include retail mark-ups, mark-downs, or other fees or commissions.
Approximate Number of Equity Securityholders
On April 13, 2000, Flanders' common stock closed at $3 1/8. As of April 13, 2000, there were approximately 296 holders of record of the Company's common stock. The Company estimates there are approximately 2,400 beneficial owners of the Company's common stock.
Dividends
We have not declared or paid cash dividends on our common stock. Currently, we intend to retain any future earnings to finance the growth and development of the business, therefore we do not anticipate paying cash dividends in the foreseeable future. In the future, the Board of Directors may decide to change this policy, based upon its evaluation of our earnings, financial position, capital requirements and any factors the Board of Directors may consider to be relevant. Under the terms of our revolving credit line we cannot pay dividends without the prior written consent of the bank. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and "Notes to Consolidated Financial Statements - Note H."
SALES OF UNREGISTERED SECURITIES
The Company did not sell any unregistered common shares or other unregistered securities during 1997, 1998 and 1999.
Item 6.
Item 6. Selected Financial Data
The following financial data is an integral part of, and should be read in conjunction with, the "Consolidated Financial Statements" and notes thereto. Information concerning significant trends in the financial condition and results of operations is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Selected Historical Operations Data (In thousands, except per share data)
Selected Historical Balance Sheet Data (In thousands)
1 Long-term obligations include long-term notes payable, long-term debt, including current maturities, convertible debt, and committed capital.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with "Item 6 - Selected Consolidated Financial Data" and "Consolidated Financial Statements," all included elsewhere herein. The information set forth in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" includes forward-looking statements that involve risks and uncertainties. Many factors, including but not limited to those discussed below under "Factors That May Affect Future Results" could cause actual results to differ materially from those contained in the forward-looking statements below.
Overview
Flanders is a full-range air filtration product company engaged in designing, manufacturing and marketing high performance, mid-range and standard-grade air filtration products and certain related products and services. We focus on those products with high replacement potential. We also design and manufacture much of our own production equipment and also produce glass-based media for many of our air filtration products. From 1996 to 1999, we experienced significant growth from the acquisition of other air filtration related companies. As of March 30, 1999, we acquired the Taffco group, a regional air filter sales and service distributor headquartered in Virginia. As of June 30, 1998, we acquired Eco-Air. Eco-Air specializes in the manufacture and sale of air filtration products to markets on the West Coast ranging from high-end HEPA filters through standard-grade filters. The results of operations for the acquired businesses are included in our financial statements only from the applicable date of acquisition. As a result, historical results of operations for the periods presented should be evaluated specifically in the context of these acquisitions. Additionally, the historical results of operations do not reflect any future operating efficiencies and improvements from integrating and consolidating the acquired businesses into our operations. There can be no guarantee that we will be able to achieve these objectives and gains in efficiency. We believe the Acquisitions will have a positive impact on its future results of operations. Also in 1998, we established Sierra Ridge Filtration, Inc., a direct distributor of air filtration products with sales offices located in the western United States.
Results of Operations
1999 Compared to 1998
The following table summarizes the Company's results of operations as a percentage of net sales for 1999 and 1998.
Net Sales: Net sales for 1999 increased by $16,627,000 or 10.7%, to $171,392,000 for 1999, from $154,765,000 for 1998. The increase in net sales was due to: (i) the acquisitions of Eco-Air and the Tidewater group, which contributed approximately $15,334,000 of net sales; and (ii) the Company's success in attracting work and expanding its original core business, which grew by approximately 1% between 1999 and 1998 and contributed an additional $1,293,000 to net sales.
Gross Profit: Gross profit for 1999 increased $6,315,000, or 16.8%, to $43,975,000, which represented 25.7% of net sales, compared to $37,660,000, which represented 24.3% for 1998. This increase in gross margin percentage was primarily due to:
o Higher margins on sales made through our direct sales offices, which made significant contributions to sales of our products for the first time during the last half of 1999;
o Margin improvement from our ongoing automation projects;
o Operational efficiencies at our newest facilities in Nevada, Illinois and North Carolina, which are gradually increasing over time and should increase to the levels experienced historically at other plants during the next twelve to eighteen months; and
o Internally produced spun-glass media for our residential and commercial flat-panel furnace and air conditioning filters began in significant quantities during the fourth quarter of 1999, providing an estimated savings of approximately $100,000.
o Hurricane Floyd which caused us to close four of our plants in the eastern United States for periods ranging from 0.5 days to 5.5 days. There is an associated insurance claim whose amount has not yet been determined, which will be booked as "other income" during the period in which the amount becomes fully determined.
Operating Expenses: Operating expenses during 1999 increased $5,694,000, or 20.3% to $33,802,000, representing 19.7% of net sales, compared to $28,108,000 for 1998, which represented 18.2% of net sales. The increase in operating expenses was primarily due to the acquisitions of Eco-Air and the Tidewater group, which added approximately $5,031,000 in operating expenses. Excluding these acquisitions, operating expenses increased $663,000 from 1999 compared to 1998. This increase is primarily due to the establishment of direct sales offices during the last part of 1998 and all of 1999, which offset the increase in gross profit margin attributable to direct office operations. Other factors affecting operating expenses included decreased expenditures for new product development expenditures between 1999 and 1998, the consolidation and centralization of overhead functions, increased in outbound freight expenses related to increased sales and higher fuel costs, and increased sales commission expenses associated with increased sales.
Discontinued Operations: In December 1999, we adopted a formal plan to close Airseal West, a wholly-owned subsidiary, and sell its various assets and product lines to unrelated third parties. The anticipated date of closure is approximately April 30, 2000. All dispositions of assets are expected to be completed before December 31, 2000. The assets to be sold consist primarily of accounts receivable, inventories, manufacturing equipment, designs and other intellectual properties. The estimated net loss of the discontinued operations of approximately $2,686,000 represents approximately $1,793,000 of losses incurred during 1999 and $893,000 of estimated loss on the disposal of the assets of Airseal West (both figures net of income tax benefit). During 1998, operating losses from Airseal West were approximately $1,253,000, net of income tax benefit.
Provision for Taxes: Our income tax provision for 1999 increased $221,000, or 5.0%, to $4,671,000, from $4,450,000 for 1998, which represented 45.9% and 40.5% of earnings from continuing operations before income taxes, respectively. Our tax provision increased because of larger amounts of nondeductible expenses, primarily amortization of goodwill, and certain one-time adjustments related to estimated accrued income taxes. Our blended rate state and federal tax rate, excluding the effect of nondeductible expenses consisting primarily of amortization of goodwill of approximately $900,000 per year and one-time adjustments, is approximately 40.0%.
Earnings from Continuing Operations: Earnings from continuing operations for 1999 decreased $1,038,000, or 15.9%, to $5,503,000, or $0.22 per share basic ($0.21 diluted), compared to $6,541,000, or $0.26 per share basic ($0.24 diluted), for 1998. The decrease in earnings is primarily attributable to decreases in net nonoperating income (expense), consisting primarily of additional interest expense and reduced interest income, and an increase in our effective income tax rate.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
The following table summarizes the Company's results of operations as a percentage of net sales for the years ended December 31, 1998 and 1997.
Net Sales: Net sales for 1998 increased by $22,866,000, or 17.3%, to $154,765,000, from $131,899,000 for 1997. The increase in net sales was due to: (i) the acquisition of Eco-Air, which contributed approximately $12,718,000 of net sales; and (ii) the Company's success in attracting work and expanding its original core business, which grew by approximately 7.7% between 1998 and 1997 and contributed an additional $10,148,000 to net sales. The Company experienced reductions in sales of its laminar-flow HEPA products for cleanroom applications, which were balanced by increased sales of its ASHRAE-rated mid-range products for industrial and commercial applications.
Gross Profit: Gross profit for 1998 increased $4,780,000, or 14.5%, to $37,660,000, which represented 24.3% of net sales, compared to $32,880,000, which represented 24.9% for 1997. The primary reasons for the decrease in gross profit margin percentage were: (i) The consolidation of the Company's Airpure facility, located in Selma, North Carolina, into the Company's new facility in nearby Smithfield, North Carolina, which took place during the fourth quarter of 1998 and resulted in extended periods of downtime due to equipment movement, calibration and production flow refinement, as well as other direct costs associated with moving equipment and inventory from the old facility to the new plant; (ii) higher than normal costs, mostly during the first three quarters of 1998, associated with new facilities in Henderson, Nevada and Smithfield, North Carolina, consisting primarily of labor inefficiencies associated with training new production employees and installation of new equipment; (iii) higher than normal freight costs associated with shipping products from "established" facilities to meet demand from new geographical areas while additional equipment was installed in various plants; and (iv) inefficiencies associated with irregular orders and slowdowns at FFI's facility in Washington, North Carolina. These decreases in gross profit were partially balanced by efficiencies associated with the Company's ongoing automation project for stock product lines, which is substantially complete for the Company's highest volume products.
Operating Expenses: Operating expenses during 1998 increased $4,599,000, or 19.6% to $28,108,000, representing 18.2% of net sales, compared to $23,509,000 for 1997, which represented 17.8% of net sales. The increase in operating expenses was primarily due to the acquisition of Eco-Air, which added approximately $3,720,000 in operating expenses. Excluding Eco-Air, operating expenses increased $879,000 from the year ended December 31, 1998 compared to the year ended December 31, 1997. Major factors affecting operating expenses included approximately $2,250,000 in research and development expenditures for the development of new product lines, compared to approximately $373,000 in 1997, the consolidation and centralization of overhead functions, and increased sales commission expense associated with increase sales.
Net Income: Net income for 1998 decreased $550,000, or 9.4%, to $5,289,000, or $0.21 per share basic ($0.20 diluted), compared to $5,839,000, or $0.32 per share basic ($0.27 diluted), for 1997. The decrease in net income is primarily attributable to the Company's decrease in profit margin as a percentage of sales.
Effects of Inflation
The Company's business and operations have not been materially affected by inflation during the periods for which financial information is presented.
Liquidity and Capital Resources
Working capital was $45,889,000 at December 31, 1999, compared to $47,972,000 at December 31, 1998. This includes cash and cash equivalents of $824,000 and $13,763,000 at December 31, 1999 and 1998, respectively.
Trade receivables increased $2,352,000, or 8.8%, to $29,023,000 at December 31, 1999 from $26,671,000 at December 31, 1998. The increase in receivables is primarily due to increases associated with the increased volume of net sales (approximately $2,659,000) and timing differences in shipments and payments received.
Continuing operations generated $5,242,000 of cash during 1999, compared to generating $849,000 during 1998. The difference in cash flows was associated with smaller increases in inventories during 1999 compared to 1998, and an increase in accounts payable of $173,000 in 1999 compared to a decrease of $2,629,000 in 1998. Financing activities for continuing operations consumed $5,262,000 during 1999 of cash, primarily from payments on debt financing. Investing activities for continuing operations consumed $11,881,000 of cash during 1999, consisting primarily of the purchase of property, plant and equipment, and cash paid for the acquisition of the Tidewater group. The purchase price, including expenses and net of cash received, was approximately $1,787,000. The acquisition of Tidewater was funded from operating cash flow and the Company's revolving credit facility. The effective date of the acquisition for financial statement purposes was April 1, 1999, and financial statements include the operating activities and assets of the Tidewater group from that date.
On February 9, 2000, we completed the extension of our $45,000,000 revolving line of credit facility with SunTrust. Outstanding balances on the credit line bear interest at the option of the Company, at either (a) the "prime" rate of interest publicly announced by SunTrust Bank, which was 8.5% at December 31, 1999, or (b) the "LIBOR" rate as reported by the Wall Street Journal, which was 5.3% at December 31, 1999, plus an amount equal to 1.00% to 1.95%, depending on the ratio of total liabilities of the Company to its tangible net worth. As of December 31, 1999, the Company had used $11,370,000 of the revolving credit facility. Unless this line of credit is renewed, it will expire in June 2002.
As of April 1, 1998, we entered into a Loan Agreement and issued a Note to the Johnston County Industrial Facilities and Pollution Control Financing Authority and such authority issued Industrial Development Revenue Bonds (the "Bonds") for an aggregate of $4,500,000, the proceeds of which were loaned for the construction of a 400,000 square foot manufacturing facility in Johnston County, North Carolina. The Note extends for a term of fifteen (15) years and bears interest at a variable rate determined by the remarketing agent of the Bonds on a weekly basis equal to the minimum rate necessary to sell such Bonds at their par value which, as of December 31, 1999, was 3.2% per annum. The Bonds are collateralized by a $4,500,000 letter of credit which expires in June 2002.
Continuing expansion may require substantial capital investment for the manufacture of filtration products. Although we have been able to arrange debt facilities or equity financing to date, there can be no assurance that sufficient debt financing or equity will continue to be available in the future, or that it will be available on acceptable terms. Failure to obtain sufficient capital could materially adversely impact our growth strategy.
In 1998, the Board of Directors authorized the repurchase of up to two million shares of the Company's common stock. As of March 24, 2000, the Company had repurchased 1,014,650 shares of its common stock under this authorization; thus, as of this date, up to an additional 985,350 shares are available for repurchase. These shares may be acquired in the open market or through negotiated transactions. These repurchases may be made from time to time, depending on market conditions, share price and other factors. These repurchases are to be used primarily to satisfy the Company's obligations under its stock option and purchase plans or any other authorized incentive plans, or for issuance pursuant to future equity financing by the Company. Effective with the engagement of PaineWebber in March 2000, repurchases under the plan were suspended.
Outlook
During 1999, we saw the first signs that our newly established manufacturing facilities are beginning to complete their start-up phases. Efficiency at these new facilities is beginning to increase. We expect this process to continue for the next eighteen months, until the new plants reach our goals for material utilization, labor productivity and throughput. Critical to this process, however, will be our success in obtaining additional sales to more fully utilize the production capacity we have put into place.
In July 1999, we established a national contracts sales group. This group is focused on obtaining national supply agreements with major industrial end users, typically with purchases from us by each such customer expected to exceed $1 million per year. These types of customers are not typically accessible to our predominantly regional representative and distributor organizations, and so remain a largely untapped market for us. While it is difficult to predict the precise magnitude of sales that will actually result from this endeavor, we have targeted customers with aggregate annual air filtration requirements in excess of $100 million. To date, we have received our first major contract for this market segment, a three-year exclusive arrangement to provide filters to a major HVAC system manufacturer which is expected to contribute at least $5 million to annual sales, which began in the fourth quarter of 1999.
During the year, we negotiated joint venture agreements with major air filter distributors or manufacturers in several different areas in the Pacific Rim, including Australia, Korea, Malaysia, Singapore, Taiwan, Hong Kong and China. These arrangements are structured so that we sell the ventures proprietary materials and provide certain proprietary equipment. These agreements are not expected to have a material effect on our financial position or results of operations during the year 2000. However, we hope that the ventures will become a significant source of revenue and income in the future.
During 1999, we finished our internal verification of a new Indoor Air Quality system targeted toward commercial office buildings. This product, part of our engineered services group, uses air quality monitoring, computer models and automated data collection to develop a complete analysis of a building's air quality over time, which is then used to generate and verify solutions to air quality problems. While the installations of this technology currently in place are not material to our results, and sales from this product are not expected to be a material contributor in the year 2000, we believe this combination of filtration products and engineering services is the best way to address Indoor Air Quality problems, including Sick Building Syndrome, and believe the potential market for this application exceeds $5 million.
We believe the semiconductor industry has been experiencing a cyclical slowdown in capital spending for new facilities, and thus on spending for cleanroom filtration products, since the first quarter of 1997. While we expect capital spending for new semiconductor facilities to increase in the future, this was not a significant factor in our overall business during 1999 (less than 7% of our sales in 1999 and 1998 were from high-end products sold for use in the semiconductor industry). During the first quarter of 2000, we have seen definite signs that the semiconductor industry will require additional capacity in the near future, including price increases in commodity DRAM markets and several new facility announcements. Therefore, we expect sales for products used in semiconductor plants to increase through the rest of 2000.
We have collected data that indicates that residential filter users replace their filters, on average, approximately once per year. Manufacturers of residential furnace and air conditioning systems recommend that these filters be changed every month. A minor trend toward increased maintenance of these residential heating and cooling systems could have a positive impact on our business.
We believe there is currently a gradually increasing public awareness of the issues surrounding indoor air quality and that this trend will continue for the next several years. We also believe there is an increase in public concern regarding the effects of indoor air quality on employee productivity, as well as an increase in interest by standards-making bodies in creating specifications and techniques for detecting, defining and solving indoor air quality problems. We further believe there will be an increase in interest in our Absolute Isolation Barriers in the future because these products may be used in both semiconductor and pharmaceutical manufacturing plants to prevent cross-contamination between different lots and different processes being performed at the same facility. These products also increase production yields in many applications.
Our most common products, in terms of both unit and dollar volume, are residential throw-away spun glass filters, which usually sell for prices under $1.00. Any increase in consumer concern regarding air pollution, airborne pollens, allergens, and other residential airborne contaminants could result in replacement of some of these products with higher value products. Our higher value products include our NaturalAire higher-efficiency filters for residential use, with associated sales prices typically over $5.00 each. Any such trend would have a beneficial effect on our business.
Currently, the largest domestic market for air filtration products is for mid-range ASHRAE-rated products and HVAC systems, typically used in commercial and industrial buildings. To date, our penetration of this market has been relatively small. We believe our ability to offer a "one stop" supply of air filtration products to HVAC distributors and wholesalers may increase our share of this market. We also believe that our recently developed modular air handlers and environmental tobacco smoke systems will enable us to expand sales to these customers. We intend our new products to serve as high profile entrants with distributors and manufacturers' representatives, who can then be motivated to carry our complete product line.
This Outlook section, and other portions of this document, include certain "forward-looking statements" within the meaning of that term in Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, including, among others, those statements preceded by, following or including the words "believe," "expect," "intend," "anticipate" or similar expressions. These forward-looking statements are based largely on the current expectations of management and are subject to a number of assumptions, risks and uncertainties. Our actual results could differ materially from these forward-looking statements. Important factors to consider in evaluating such forward-looking statements include those discussed below under the heading "Factors That May Affect Future Results" as well as:
o the shortage of reliable market data regarding the air filtration market,
o changes in external competitive market factors or in our internal budgeting process which might impact trends in our results of operations,
o anticipated working capital or other cash requirements,
o changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the market,
o product obsolescence due to the development of new technologies, and
o various competitive factors that may prevent us from competing successfully in the marketplace.
In light of these risks and uncertainties, there can be no assurance that the events contemplated by the forward-looking statements contained in this Form 10-K will in fact occur.
Factors That May Affect Future Results
Our Failure to Manage Future Growth Could Adversely Impact Our Business Due to the Strain on Our Management, Financial and Other Resources
If our business continues to grow, the additional growth will place burdens on management to manage such growth while maintaining profitability. We have no guarantee that we will be able to do so. Due to our recent acquisitions and expansions, our net sales increased by approximately 344% from 1995 through 1999, (a compound annual growth rate of 45%). We may not continue to expand at this rate. Our ability to compete effectively and manage future growth depends on our ability to:
o recruit, train and manage our work force, particularly in the areas of corporate management, accounting, research and development and operations,
o manage production and inventory levels to meet product demand,
o manage and improve production quality,
o expand both the range of customers and the geographic scope of our customer base, and
o improve financial and management controls, reporting systems and procedures.
Any failure to manage growth effectively could have a material adverse effect on our business, financial condition and results of operations.
We Must Develop, Produce and Sell New Products That Keep Up With Rapid Technological Change to Maintain Approximately 20% of Our Revenues and Maintain Value of Our Inventory and Other Assets
As of December 31, 1999, approximately 20% of our revenues resulted from sales of high-end filtration products that are especially vulnerable to new technology development. Our ability to remain competitive in this area will depend in part upon our ability to:
o anticipate technological changes,
o develop new and enhanced filtration systems that meet our customers' needs, and
o introduce these systems at competitive prices in a timely and cost-efficient manner.
We have no assurance that we will successfully anticipate future technological changes or that technologies or systems developed by others will not render our technology obsolete. Additionally, we have no assurance that the products we develop will be commercially viable. A failure to successfully anticipate future technological changes could also require us to write down inventories, equipment or other assets associated with obsolete products or dispose of these assets at a price lower than book value, which could have a material adverse effect on our financial condition and results of operations.
Our Business May Suffer if Our Competitive Strategy is Not Successful
Our continued success depends on our ability to compete in an industry that is highly competitive. This competition may increase as new competitors enter the market. Several of these competitors may have longer operating histories and greater financial, marketing and other resources than we do. Additionally, our competitors may introduce new products or enhancements to products that could cause a decline in sales or loss of market acceptance of our existing products. Under our current competitive strategy, we endeavor to remain competitive by:
o increasing our market share,
o expanding our market through the introduction of new products which require periodic replacement, and
o improving operating efficiencies.
Although our executive management team continues to review and monitor our strategic plans, we have no assurance that we will be able to follow our current strategy or that this strategy will be successful.
Our Market Share May Not Continue to Increase if we are Unable to Acquire Additional Synergistic Businesses
In the past several years we have significantly increased our market share by acquiring synergistic businesses. Although we intend to continue to increase our market share in this manner, we have no assurance that future acquisition opportunities will be available. Additionally, in the future we may not have access to the substantial debt or equity financing to finance potential acquisitions. Moreover, these types of transactions may result in potentially dilutive issuances of equity securities, the incurrence of additional debt and amortization of expenses related to goodwill and intangible assets, all of which could adversely affect our profitability. Our strategy of growth through acquisition also exposes us to the potential risks inherent in assessing the value, strengths, weaknesses, and potential profitability of acquisition candidates and in integrating the operations of acquired companies. We do not currently have any binding agreements with respect to future acquisitions.
Our Business May Suffer if Our Strategy to Increase the Size and Customer Base of the Air Filtration Market is Unsuccessful
We are developing new products as part of our strategy to increase the size and customer base of the air filtration market. We have no assurance that this strategy will be successful. We have no guarantee that any new products we develop will gain acceptance in the marketplace, or that these products will be successful. Additionally, we have no assurance we will be able to recoup the expenditures associated with the development of these products. To succeed in this area we must:
o increase public awareness of the issues surrounding indoor air quality,
o adequately address the unknown requirements of the potential customer base,
o develop new products that are competitive in terms of price, performance and quality, and
o avoid significant increases in current expenditure levels in development, marketing and consumer education.
We May Experience Critical Equipment Failure Which Could Have a Material Adverse Effect on Our Business
If we experience extended periods of downtime due to the malfunction or failure of our automated production equipment, our business, financial condition and operations may suffer. We design, manufacture and assemble the majority of the automated production equipment used in our facilities. We also use other technologically advanced equipment for which manufacturers may have limited production capability or service experience. If we are unable to quickly repair our equipment or quickly obtain new equipment or parts from outside manufacturers, we could experience extended periods of downtime in the event of malfunction or equipment failure.
If Automation of Our Production Lines Fails to Produce the Projected Results, Our Business Will Suffer
We have only recently substantially completed a program to increase our gross margins by automating portions of our production lines. Although the designs have been extensively tested in the field, we have no assurance that the new equipment will produce the expected beneficial results on our gross margins. Additionally, we are not certain that any increases in efficiencies will not be offset in the marketplace by competitors making similar improvements to their facilities.
Our Plan to Centralize Overhead Functions May Not Produce the Anticipated Benefits to Our Operating Results
We are currently implementing plans to centralize and eliminate duplication of efforts between our subsidiaries in the following areas:
o purchasing, o production planning, o shipping coordination, o marketing, o accounting, o personnel management, o risk management, and o benefit plan administration.
We have no assurance that cutting overhead in this fashion will have the anticipated benefits to our operating results. Additionally, we have no assurance that these reorganizations will not significantly disrupt the operations of the affected subsidiaries.
Our Success Depends on Our Ability to Retain and Attract Key Personnel
Our success and future operating results depend in part upon our ability to retain our executives and key personnel, many of whom would be difficult to replace. Our success also depends on our ability to attract highly qualified engineering, manufacturing, technical, sales and support personnel for our operations. Competition for such personnel, particularly qualified engineers, is intense, and there can be no assurance that we will be successful in attracting or retaining such personnel. Our failure to attract or retain such persons could have a material adverse effect on our business, financial condition and results of operations.
Our Current Distribution Channels May be Unavailable if Our Manufacturers' Representatives Decide to Work Primarily With One of Our Competitors
We provide our manufacturers' representatives with the ability to offer a full product line of air filtration products to existing and new customers. Some of our competitors offer similar arrangements. We do not have exclusive relationships with most of our representatives. Consequently, if our representatives decide to work primarily with one of our competitors, our current distribution channels, and hence, our sales, could be significantly reduced.
Management Controls a Significant Percentage of Our Stock
As of December 31, 1999, our directors and executive officers beneficially held approximately 41.9% of our outstanding common stock. As a result, such shareholders effectively control or significantly influence all matters requiring shareholder approval. These matters include the election of directors and approval of significant corporate transactions. Such concentration of ownership may also have the effect of delaying or preventing a change in control.
We May be Required to Issue Stock in the Future That Will Dilute the Value of Our Existing Stock
If we issue the following securities, such securities may dilute the value of the securities that our existing stockholders now hold.
We have granted warrants to purchase of total of 612,239 of our shares of common stock to various parties with exercise prices ranging from $5.54 to $14.73 per share. All of the warrants are currently exercisable. As a result, if the warrant holders exercise these warrants, we will issue shares of stock that will generally be available for sale in the public market.
We have granted options to purchase a total of 7,005,700 shares of common stock to various parties with exercise prices ranging from $1.00 to $9.50 per share. The majority of these options are currently exercisable. Additionally, most of the common stock issuable upon the exercise of these options is registered on a Form S-8. As a result, if the option holders exercise these options, we will issue shares of stock that will generally be available for sale in the public market.
Our Shareholders May Not Realize Certain Opportunities Because of Our Charter Provisions and North Carolina Law
Our Articles of Incorporation and Bylaws contain provisions that are designed to provide our board of directors with time to consider whether a hostile takeover offer is in our best interest and the best interests of our shareholders. These provisions may discourage potential acquisition proposals and could delay or prevent a change of control in our business. Additionally, we are subject to the Control Shares Acquisition Act of the State of North Carolina. This act provides that any person who acquires "control shares" of a publicly held North Carolina corporation will not have voting rights with respect to the acquired shares unless a majority of the disinterested shareholders of the corporation vote to grant such rights. This could deprive shareholders of opportunities to realize takeover premiums for their shares or other advantages that large accumulations of stock would typically provide.
Our Business Can be Significantly Affected by Environmental Laws
The constantly changing body of environmental laws and regulations may significantly influence our business and products. These laws and regulations require that certain environmental standards be met and impose liability for the failure to comply with such standards. While we endeavor at each of our facilities to assure compliance with environmental laws and regulations, we cannot be certain that our operations or activities, or historical operations by others at our locations, will not result in civil or criminal enforcement actions or private actions that could have a materially adverse effect on our business. We have, in the past, and may, in the future, purchase or lease properties with unresolved potential violations of federal or state environmental regulations. In these transactions, we have been successful in obtaining sufficient indemnification and mitigating the impact of the issues without recognizing significant expenses associated with litigation and cleanup. However, purchasing or leasing these properties requires us to weigh the cost of resolving these issues and the likelihood of litigation against the potential economic and business benefits of the transaction. If we fail to correctly identify, resolve and obtain indemnification against these risks, they could have a material adverse impact on our financial position.
Because of the foregoing factors, as well as other variables affecting our operating results, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to various market risks, including changes in foreign currency exchange rates and interest rate risks. Market risk is the potential loss arising from adverse change in market rates and prices, such as foreign currency exchange and interest rates. For the Company, these exposures are primarily related to the sale of product to foreign customers and changes in interest rates. The Company does not have any derivatives or other financial instruments for trading or speculative purposes.
The fair value of the Company's total debt at December 31, 1999 was approximately $32,328,000. Market risk was estimated as the potential decrease (increase) in future earnings and cash flows resulting from a hypothetical 10% increase (decrease) in the Company's estimated weighted average borrowing rate at December 31, 1999. Although most of the interest on the Company's debt is indexed to a market rate, there would be no material effect on the future earnings or cash flows related to the Company's total debt for such a hypothetical change.
The Company's financial position is not materially affected by fluctuations in currencies against the U.S. dollar, since assets held outside the United States are negligible. The Company's sensitivity analysis of the effects of changes in foreign currency exchange rates does not factor in a potential change in sales levels of local currency prices, as the preponderance of its foreign sales occur over short periods of time or are demarcated in U.S. dollars.
Item 8.
Item 8. Financial Statements and Supplementary Data
Attached, beginning at page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
On November 23, 1999, the Board of Directors approved (i) the engagement of Grant Thornton LLP as the independent auditors for Flanders Corporation and (ii) the dismissal of McGladrey & Pullen LLP as such independent auditors. The shareholders ratified this selection in our annual meeting. See "Item 4 - Submission of Matters to a Vote of Security Holders."
During the three years ended December 31, 1998 and the subsequent interim period through November 23, 1999, (i) there were no disagreements with McGladrey & Pullen, LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements if not resolved to its satisfaction would have caused it to make reference in connection with its report to the subject matter of the disagreement, and (ii) McGladrey & Pullen, LLP did not advise the registrant regarding any "reportable events" as defined in Item 304 (a)(1)(v) of Regulation S-K.
The accountants' report of McGladrey & Pullen, LLP on the consolidated financial statements of Flanders Corporation and subsidiaries as of and for the years ended December 31, 1998, 1997 and 1996 did not contain any adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles.
Neither Grant Thornton LLP or its members has any financial interest, direct or indirect in the Company nor does Grant Thornton LLP or any of its members ever been connected with the Company as a promoter, underwriter, trustee, director, officer or employee.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Identification of Directors and Executive Officers
Set forth below is information regarding (i) the current directors of the Company, who will serve until the next annual meeting of shareholders or until their successors are elected or appointed and qualified, and (ii) the current executive officers of the Company, who are elected to serve at the discretion of the Board of Directors.
Name Age Title ------------------- --- --------------------------------
Robert R. Amerson 49 President, Chief Executive Officer and Director
C. W. "Andy" Wood 60 Vice President Sales
Steven K. Clark 47 Chief Operating Officer, Vice President Finance/Chief Financial Officer and Director
Leonard J. Fetcho 59 Vice President Operations
John L. Cherry 56 Vice President Engineered Products
John Houmis 52 Vice President Engineering
Linwood Allen Hahn 51 Director
J. Russell Fleming 50 Director
Robert R. Amerson. Mr. Amerson has been President and Chief Executive Officer since 1988. Mr. Amerson is also a Director, a position he has held since 1988. He joined us in 1987 as Chief Financial Officer. Mr. Amerson has a Bachelor of Science degree in Business Administration from Atlantic Christian College.
C.W. "Andy" Wood. Mr. Wood has been Vice President of Sales since 1998 and Vice President of Sales for Precisionaire, a wholly owned subsidiary, since 1982. Mr. Wood oversees all marketing and sales efforts of the Company. Mr. Wood has more than thirty years of experience in the air filtration industry. Mr. Wood has an Associates Degree in Industrial Management from the Georgia Institute.
Steven K. Clark. Mr. Clark was named as Vice President Finance, Chief Financial Officer and Director in December 1995 and Chief Operating Officer in November 1999. Mr. Clark acted as a consultant from November, 1995 through December, 1995. From July 1992 through October 1995, he was the Chief Financial Officer of Daw Technologies, Inc., a specialty cleanroom contractor and major customer of the Company. While Chief Financial Officer of Daw Technologies, Mr. Clark was late in filing a Form 3 amendment and certain Form 4s and Form 5s. He agreed to a cease and desist order with respect to these violations. No violations other than the timeliness of filing those reports were alleged by the Securities and Exchange Commission ("SEC"). Prior to this he was a senior partner of Miller and Clark, an accounting and management services firm. Mr. Clark spent four years with Price Waterhouse, and an additional four years with Arthur Andersen, both accounting firms. He is a Certified Public Accountant, has Bachelor of Arts degrees in Accounting and Political Science and a Master of Business Administration Degree, all from the University of Utah.
Leonard J. Fetcho. Mr. Fetcho has been Vice President Operations since December 1999. He is also President of Eco-Air Products, Inc., which was acquired by the Company in June 1998. Mr. Fetcho has held the position of President of Eco-Air Products Inc. since 1993. Mr. Fetcho has extensive experience in the air filtration industry,
including being manager of national accounts for Farr Corporation, and director of sales and marketing for Cambridge Filter Corporation, both competitors. Mr. Fetcho has a bachelor's degree in accounting from Morrisville College.
John L. Cherry. Mr. Cherry has been Vice President Engineered Products since December 1999. At that time, he was appointed General Manager of Flanders Filters, Inc., and Flanders/CSC, both wholly owned subsidiaries. Mr. Cherry served as President of Flanders/CSC from March 1997 through December 1999 and as Vice President/General Manager before that, beginning in 1980. Mr. Cherry has an Associates Degree in design technology from Thomas Nelson Community College.
John Houmis. Mr. Houmis has been Vice President Engineering since December 1998. He has direct responsibility for manufacturing engineering, quality control and production control systems. From May 1998 to December 1998, he was Director of Special Project - Plants for Precisionaire, a wholly owned subsidiary. From 1993 to October 1997, Mr. Houmis was the general manager of Precisionaire's main manufacturing facility in Florida. Mr. Houmis has Bachelor of Science and Master of Science degrees in engineering from the University of South Florida.
Linwood Allen Hahn. Mr. Hahn was elected as a Director in December 1999. Mr. Hahn practices Real Property Law, Estates, Municipal Law and Corporate Law in Greenville, North Carolina. Mr. Hahn graduated from he University of North Carolina at Chapel Hill with a BA degree in 1970, the University of Tennessee College of Law, JD degree in 1973. He is currently a member of the North Carolina State Bar Association and the North Carolina Trial Lawyer's Association as well as serving on the advisory boards of several private charitable organizations.
J. Russell Fleming. Mr. Fleming was elected as a Director in December 1999. Mr. Fleming is Owner/President of Cape Point Development Co., Inc., located in Greenville, North Carolina, specializing in land development and commercial/multi-family construction. Mr. Fleming Is also Owner/President of New East Management & Realty, Inc., also located in Greenville, NC, which manages residential and commercial rental properties. Mr. Fleming attended East Carolina University prior to obtaining his General Contractor and Real Estate Broker licenses.
Item 11.
Item 11. Executive Compensation
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Company's Board of Directors consists of Messrs. Hahn and Fleming, both non-employee directors, and Messr. Amerson, the Chief Executive Officer.
Summary Compensation Table
The following table sets forth the aggregate cash compensation paid by the Company for services rendered during the last three years to the Company's Chief Executive Officer and to each of the Company's other executive officers whose annual salary, bonus and other compensation exceeded $100,000 in 1999.
OPTIONS/SARs GRANTED IN LAST FISCAL YEAR
The following table sets forth information regarding all individual grants of options made during the last completed year to the named executive officers.
Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option/SAR Values
The following table sets forth the aggregate number and value of stock options and SAR's exercised during the last year by the Company's Chief Executive Officer and by each of the Company's other executive officers whose annual salary, bonus and other compensation exceed $100,000.
Compensation of Directors
Directors who are Company employees receive no additional or special remuneration for serving as directors. The Company's non-employee Directors are paid $500 plus out-of-pocket expenses for each meeting of the Board of Directors and upon meeting certain qualifications receive an option to purchase 5,000 shares of the Company's common stock at or above the market price of the common stock on the date of grant for every year they remain a director. During 1999, each of the non-employee directors received an option to purchase 50,000 shares of the Company's common stock at an exercise price of $2.50 per share.
Employment Agreements
Messrs. Amerson and Clark have employment agreements effective as of December 15, 1995 ("Employment Agreements"). The Employment Agreements, as amended, provide for an annual base salary of $250,000 for both Mr. Amerson and Mr. Clark and terminate in 2010. The Employment Agreements also provide that the executive shall be entitled to the following termination payments: (i) 100% of his current base salary if the employment is terminated as a result of his death or disability; (ii) up to 200% of his current base salary if the employment is terminated by the Company for any reason other than death, disability or for cause, or (iii) up to 250% of the executive's gross income during the year preceding his termination if the Employment Agreement is terminated by the executive for good reason or by the Company for any reason other than death, disability or cause and the termination occurs within two years after a change of control of the Company has occurred.
Messr. Fetcho has an employment agreement effective as of June 30, 1998, which provides for an annual base salary of $165,000 and terminates in 2003. Mr. Fetcho's employment agreement also provides that the executive shall be entitled to the following termination payments: (i) 100% of his current base salary if the employment is terminated as a result of his death or disability; (ii) up to 200% of his current base salary if the employment is terminated for any reason other than death, disability or for cause, or (iii) up to 250% of the executive's gross income during the year preceding his termination if the Employment Agreement is terminated by the executive for good reason or by the Company for any reason other than death, disability or cause and the termination occurs within two years after a change of control of the Company has occurred.
OTHER INFORMATION REGARDING THE BOARD OF DIRECTORS
Board Meetings and Committees
During 1999, the Board of Directors met two (2) times and also executed various resolutions and written actions in lieu of meetings. All directors were in attendance at each of these meetings. The Board of Directors has an Audit Committee and a Compensation Committee. The Audit Committee reviews the results and scope of the audit and other services provided by the Company's independent auditors, reviews and evaluates the Company's internal audit and control functions, and monitors transactions between the Company and its employees, officers and directors. The Compensation Committee administers the Company's equity incentive plans and designates compensation levels for officers and directors of the Company. The Audit Committee met two (2) times during 1999. The Compensation Committee met two (2) times during 1999.
Currently, the Audit Committee consists of Messrs. Hahn, Fleming and Clark. The Compensation Committee consists of Messrs. Hahn, Fleming and Amerson.
Long-Term Incentive Plan
During 1996, the Company adopted the Long Term Incentive Plan to assist the Company in securing and retaining key employees and consultants. The LTI Plan authorizes grants of incentive stock options, nonqualified stock options, stock appreciation rights ("SARs"), restricted stock performance shares and dividend equivalents to officers and key employees of the Company and outside consultants to the Company. There are 1,986,800 shares of Common Stock reserved for award under the LTI Plan. During 1999, 1998 and 1997, the Company awarded options to purchase 52,850, 316,850 and 95,600 shares of Common Stock under the LTI Plan, respectively.
The Plan is administered by the Compensation Committee. The Compensation Committee determines the total number and type of awards granted in any year, the number and selection of employees or consultants to receive awards, the
number and type of awards granted to each grantee and the other terms and provisions of the awards, subject to the limitations set forth in the LTI Plan.
Stock Option Grants. The Compensation Committee has the authority to select individuals who are to receive options under the LTI Plan and to specify the terms and conditions of each option so granted (incentive or nonqualified), the exercise price (which must be at least equal to the fair market value of the common stock on the date of grant with respect to incentive stock options), the vesting provisions and the option term. Unless otherwise provided by the Compensation Committee, any option granted under the LTI Plan expires the earlier of ten years from the date of grant or, three months after the optionee's termination of service with the Company if the termination of employment is attributable to (i) disability, (ii) retirement, or (iii) any other reason, or 15 months after the optionee's death. As of April 13, 2000, there are 503,870 options outstanding under the LTI Plan.
Stock Appreciation Rights. The Compensation Committee may grant SARs separately or in tandem with a stock option award. A SAR is an incentive award that permits the holder to receive (per share covered thereby) an equal amount by which the fair market value of a share of common stock on the date of exercise exceeds the fair market value of such share on the date the SAR was granted. Under the LTI Plan, the Company may pay such amount in cash, in common stock or a combination of both. Unless otherwise provided by the Compensation Committee at the time of grant, the provisions of the LTI Plan relating to the termination of employment of a holder of a stock option will apply equally, to the extent applicable, to the holder of a SAR. A SAR granted in tandem with a related option will generally have the same terms and provisions as the related option with respect to exercisability. A SAR granted separately will have such terms as the Compensation Committee may determine, subject to the provisions of the LTI Plan. As of April 13, 2000, no SARs are outstanding under the LTI Plan.
Performance Shares. The Compensation Committee is authorized under the LTI Plan to grant performance shares to selected employees. Performance shares are rights granted to employees to receive cash, stock, or other property, the payment of which is contingent upon achieving certain performance goals established by the Compensation Committee. As of April 13, 2000, no performance shares are outstanding under the LTI Plan.
Restricted Stock Awards. The Compensation Committee is authorized under the LTI Plan to issue shares of restricted common stock eligible participants on such terms and conditions and subject to such restrictions, if any, outstanding under the LTI Plan. As of April 13, 2000, no restricted shares have been awarded under the LTI Plan.
Dividend Equivalents. The Compensation Committee may also grant dividend equivalent rights to participants subject to such terms and conditions as may be selected by the Compensation Committee. Dividend equivalent rights entitle the holder to receive payments equal to dividends with respect to all or a portion of the number of shares of stock subject to an option award or SARs, as determined by the Committee. As of April 13, 2000, no dividend equivalents are outstanding under the LTI Plan.
REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS ON EXECUTIVE COMPENSATION
General
The Compensation Committee of the Board of Directors is composed of two independent directors who have no "interlocking relationships" (as defined by the SEC) and the Chief Executive Officer, who recuses himself from votes and discussions on his own compensation.
We are engaged in highly competitive businesses and compete nationally for personnel at the executive and technical staff level. Outstanding candidates are aggressively recruited, often at premium salaries. Highly qualified employees are essential to our success. We are committed to providing competitive compensation that helps attract, retain, and motivate the highly skilled people we require. We strongly believe that a considerable portion of the compensation for the Chief Executive Officer and other top executives must be tied to the achievement of business objectives, completing acquisitions, and to business unit and overall financial performance, both current and long-term.
Executive Compensation
Our executive compensation program is administered by the Compensation Committee. The role of the Compensation Committee is to review and approve salaries and other compensation of the executive officers of the Company, to administer the executive officer bonus plan and stock option plans, and to review and approve stock option grants to all employees including the executive officers of the Company.
General Compensation Philosophy
Our compensation philosophy is that total cash compensation should vary with the performance of the Company and any long-term incentive should be closely aligned with the interest of the stockholders. Total cash compensation for the executive officers consists of the following components:
o Base salary
o An executive officer bonus that is related to growth in sales and operating earnings of the Company.
Long-term incentives are realized through the granting of stock options to executives and key employees through the LTI Plan. We have also granted certain non-qualified options to our executive officers. We have no other long-term incentive plans for our officers and employees.
Base Salary and Executive Officer Bonus Target
Current base salaries for the executive officers were determined by arms' length negotiations with the Board of Directors. Certain executive officers have employment contracts with the Company. During 1998 and 1999, none of the executive officers, including the Chief Executive Officer, reached their bonus target, and hence no bonuses were awarded to executive officers in 1999, nor will bonuses be awarded in 2000 for performance in 1999.
Stock Options
Stock options are granted to aid in the retention of executive and key employees and to align the interests of executive and key employees with those of the stockholders. The level of stock options granted (i.e., the number of shares subject to each stock option grant) is based on the employee's ability to impact future corporate results. An employee's ability to impact future corporate results depends on the level and amount of job responsibility of the individual. Therefore, the level of stock options granted is proportional to the Compensation Committee's evaluation of each employee's job responsibility. For example, Robert R. Amerson, as the Chief Executive Officer, has the highest level of responsibility and would typically be awarded the highest level of stock options. Stock options are granted at a price not less than the fair market value on the date granted.
Comparative Stock Performance Graph
The following graph1 shows a comparison of cumulative total returns for the Company, the NASDAQ Stock Market -- U.S. Index and the NASDAQ Non-Financial Index during the period commencing February 26, 1996 and ending December 31, 1999. The comparison assumes $100 was invested on February 26, 1996 in the Company's common stock with the reinvestment of all dividends, if any. Total shareholder returns for prior periods are not an indication of future returns.
[GRAPHIC OMITTED]
- ------------------------------------
1 Flanders did not have a public market for its stock prior to its listing on the OTC Bulletin Board in February 1996.
Respectfully submitted,
COMPENSATION COMMITTEE:
Linwood Allen Hahn J. Russell Fleming Robert R. Amerson
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth all individuals known by the Company to beneficially own 5% or more of the Company's common stock, and all officers and directors of the registrant, with the amount and percentage of stock beneficially owned, as of April 13, 2000. Except as indicated in the following footnotes, each listed beneficial owner has sole voting and investment power over the shares of common stock held in their names.
- -------------------------------------
* Represents less than 1% of the total issued and outstanding shares of common stock.
Applicable percentage of ownership is based on 25,435,583 shares of common stock outstanding as of April 13, 2000, together with all applicable options for unissued securities for such shareholders exercisable within sixty days. Shares of common stock subject to options exercisable within sixty days are deemed outstanding for computing the percentage ownership of the person holding such options, but are not deemed outstanding for computing the percentage of any other person.
Includes 1,150,000 shares which are subject to an option to purchase such shares from the Company at $1.00 per share, 1,000,000 shares which are subject to an option to purchase such shares from the Company at $2.50 per share and 1,000,000 shares which are subject to an option to purchase such shares from the Company at $7.50 per share.
Includes 16,800 shares which are subject to an option to purchase such shares from the Company at $2.50 per share, 10,000 shares which are subject to an option to purchase such shares from the Company at $7.50 per share, and 10,000 shares which are subject to an option to purchase such shares from the Company at $7.125 per share.
Includes 10,000 shares which are subject to an option to purchase such shares from the Company at $6.94 per share, 10,000 shares which are subject to an option to purchase such shares from the Company at $7.13 per share, and 20,000 shares which are subject to an option to purchase such shares from the Company at $4.75 per share.
Includes 50,000 shares which are subject to an option to purchase such shares from the Company at $2.50 per share.
Includes 40,000 shares which are subject to an option to purchase such shares from the Company at $5.38 per share.
Item 13.
Item 13. Certain Relationships and Related Transactions
At April 13, 2000, Steven K. Clark owed the Company $2,743,014 (including accrued interest) which he previously borrowed to settle claims, to make certain payments under an indemnity agreement he entered into with the Company and to purchase certain shares from Thomas T. Allan, a former officer and director. To evidence the amount owed, effective February 11, 1997, Mr. Clark issued a note to the Company in the amount of $109,013 with interest at the variable rate of LIBOR plus 1.25% per annum, payable in full on February 10, 1999. On April 25, 1997, Mr. Clark issued a note to the Company in the amount of $250,000 at the above interest rate, payable in full on April 24, 1999. On September 5, 1997, Mr. Clark assumed a note between Thomas T. Allan for a principal amount of $409,750, at the above interest rate, payable in full on September 4, 1999. On April 15, 1998, Mr. Clark issued a note to the Company in the amount of $1,580,609 with interest at the rate of 7% per annum, payable in full on December 31, 2003. On April 24, 1999, the Board of Directors agreed to consolidate and refinance Mr. Clark's debts to the Company, whereby Mr. Clark issued a note to the Company in the amount of $2,569,871 with interest accruing at the rate of LIBOR plus 1%, payable in full on December 31, 2010 or upon demand by the Company, and canceled all of the other above-described notes.
At December 31, 1999, Robert R. Amerson owed the Company $1,657,392 (including accrued interest) which he previously borrowed to settle claims, to make certain payments under an indemnity agreement he entered into with the Company and to purchase certain shares from Thomas T. Allan, a former officer and director of the Company. To evidence the amount owed, effective February 11, 1997, Mr. Amerson issued a note to the Company in the amount of $109,013 with interest at the rate of LIBOR plus 1.25% per annum, payable in full on February 10, 1999. On April 25, 1997, Mr. Amerson issued a note to the Company in the amount of $250,000 at the above-described interest rate, payable in full on April 24, 1999. On September 25, 1997, Mr. Amerson assumed a note between Thomas T. Allan for a principal amount of $409,750, at the above interest rate, payable in full on September 4, 1999. On April 15, 1998, Mr. Amerson issued a note to the Company in the amount of $440,194 with interest at the rate of 7% per annum, payable in full on December 31, 2003. On April 24, 1999, the Board of Directors agreed to consolidate and refinance Mr. Amerson's debt to the Company, whereby Mr. Amerson issued a note to the Company in the amount of $1,555,802 with interest accruing at the rate of LIBOR plus 1%, payable in full on December 31, 2010 or upon demand by the Company, and canceled all of the other above-described notes.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
The following constitutes a list of Financial Statements, Financial Statement Schedules and Exhibits required to be used in this report.
(a)(1) Financial Statements: Financial Statements are included beginning at page as follows:
Report of Grant Thornton LLP Independent Certified Public Accountants......................................................F-2
Independent Auditor's Report of McGladrey & Pullen, LLP..........F-3
Consolidated Balance Sheets at December 31, 1999 and 1998........F-4
Consolidated Statements of Earnings for the years ended December 31, 1999, 1998 and 1997.................................F-5
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 1998 and 1997.....................F-6
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997.................................F-7
Notes to Consolidated Financial Statements......................F-10
(a)(2) Financial Statement Schedules
Report of Grant Thornton LLP Independent Certified Public Accountants.....................................................F-28
Independent Auditor's Report of McGladrey & Pullen, LLP.........F-29
Schedule II. Valuation and Qualifying Accounts.................F-30
All schedules not listed have been omitted because they are not applicable or the information has been otherwise supplied in the Registrant's financial statements and schedules.
(a)(3) Exhibits:
3.1 Articles of Incorporation for Flanders Corporation, filed with the Form 8-A dated March 8, 1996, incorporated herein by reference.
3.2 Bylaws of Flanders Corporation, filed with the Form 8-A dated March 8, 1996, incorporated herein by reference.
10.1 Indemnification Agreement between Flanders Corporation, Steven K. Clark, Robert Amerson and Thomas Allan, filed with the December 31, 1995 Form 10-K, incorporated herein by reference.
10.2 Stock Purchase Agreement between Flanders Corporation and the Shareholders of Eco-Air Products, Inc. dated May 7, 1998, filed with the June 30, 1998 Form 8-K, incorporated herein by reference.
10.3 Amendment dated May 20, 1998 to Stock Purchase Agreement by and between the Registrant and the Shareholders of Eco-Air Products, Inc. dated May 7, 1998, filed with the June 30, 1998 Form 8-K, incorporated herein by reference.
10.4 Promissory Note from Precisionaire, Inc. to SunTrust Bank, Tampa Bay, in the amount of $2,134,524 dated August 28, 1997, filed with the September 15, 1997 Form S-1 (Reg No. 333-33635), and incorporated herein by reference.
10.5 Assumption Agreement between POF Realty, Precisionaire, Inc., Polk County Industrial Development Authority and SunTrust Bank, dated August 1, 1997, filed with the September 15, 1997 Form S-1 (Reg No. 333-33635), and incorporated herein by reference.
10.6 Mortgage Deed and Security Agreement between Precisionaire, Inc. and Sun Trust Bank, Tampa Bay dated August 28, 1997, filed with the September 15, 1997 Form S-1 (Reg No. 333-33635), and incorporated herein by reference.
10.7 Credit Agreement between Flanders Corporation, SunTrust Bank, Tampa Bay and Zions First National Bank, dated November 10, 1997, filed with the December 31, 1997 Form 10-K, and incorporated herein by reference.
10.8 Loan Agreement between Will-Kankakee Regional Development Authority and Flanders Corporation dated December 15, 1997, filed with the December 31, 1997 Form 10-K, and incorporated herein by reference.
10.9 Letter of Credit Agreement between Flanders Corporation and SunTrust Bank, Tampa Bay, dated April 1, 1998, filed with the Form 10-Q dated March 31, 1998, and incorporated herein by reference.
10.10 Credit Agreement between Flanders Corporation, SunTrust Equitable Securities Corporation and SunTrust Bank, dated February 9, 2000, filed herewith.
10.11 Loan Agreement between Flanders Corporation and the Johnston County Industrial Facilities and Pollution Control Financing Authority, dated April 1, 1998, filed with the Form 10-Q dated March 31, 1998, and incorporated herein by reference.
10.12 Loan Agreement between Flanders Corporation and the Johnston County Industrial Facilities and Pollution Control Financing Authority, dated March 1, 2000, filed herewith.
10.13 Flanders Corporation 1996 Director Option Plan, filed with the Form 10-K dated December 31, 1995, and incorporated herein by reference.
10.14 Employment Agreement between Elite Acquisitions, Inc., Flanders Filters, Inc., and Steven K. Clark, filed with the December 31, 1995 Form 10-K, incorporated herein by reference.
10.15 Amendment to Employment Agreement between Elite Acquisitions, Inc., Flanders Filters, Inc., and Steven K. Clark, filed with Form S-1 dated October 21, 1996 (Reg. No. 333-14655) and incorporated herein by reference.
10.16 Amendment to Employment Agreement between Elite Acquisitions, Inc., Flanders Filters, Inc., and Steven K. Clark, filed with the Form 10-K dated December 31, 1997 and incorporated herein by reference.
10.17 Amendment to Employment Agreement between Elite Acquisitions, Inc., Flanders Filters, Inc., and Steven K. Clark, filed herewith.
10.18 Employment Agreement between Elite Acquisitions, Inc., Flanders Filters, Inc. and Robert R. Amerson, filed with the December 31, 1995 Form 10-K, incorporated herein by reference.
10.19 Amendment to Employment Agreement between Elite Acquisitions, Inc., Flanders Filters, Inc., and Robert R. Amerson, filed with Form S-1 dated October 21, 1996 (Reg. No. 333-14655) and incorporated herein by reference.
10.20 Amendment to Employment Agreement between Elite Acquisitions, Inc., Flanders Filters, Inc., and Robert R. Amerson, filed with the Form 10-K dated December 31, 1997 and incorporated herein by reference.
10.21 Amendment to Employment Agreement between Elite Acquisitions, Inc., Flanders Filters, Inc., and Robert R. Amerson, filed herewith.
10.22 Employment Agreement between Eco-Air Products, Inc., and Leonard J. Fetcho.
10.23 Stock Option Agreement between Elite Acquisitions, Inc. and Robert R. Amerson, filed with the December 31, 1995 Form 10-K, incorporated herein by reference.
10.24 Stock Option Agreement between Flanders Corporation and Robert R. Amerson dated February 22, 1996, filed with Form S-8 on July 21, 1997, incorporated herein by reference.
10.25 Amendment to Stock Option Agreement between Flanders Corporation and Robert R. Amerson dated December 22, 1999, filed herewith.
10.26 Stock Option Agreement between Flanders Corporation and Robert R. Amerson dated June 3, 1996, filed with Form S-8 on July 21, 1997, incorporated herein by reference.
10.27 Stock Option Agreement between Elite Acquisitions, Inc., and Steven K. Clark, filed with the December 31, 1995 Form 10-K, incorporated herein by reference.
10.28 Stock Option Agreement between Flanders Corporation and Steven K. Clark dated February 22, 1996, filed with Form S-8 on July 21, 1997, incorporated herein by reference.
10.29 Amendment to Stock Option Agreement between Flanders Corporation and Steven K. Clark dated December 22, 1999, filed herewith.
10.30 Stock Option Agreement between Flanders Corporation and Steven K. Clark dated June 3, 1996, filed with Form S-8 on July 21, 1997, incorporated herein by reference.
10.31 Note Agreement between Steven K. Clark and Flanders Corporation, dated April 24, 1999, filed herewith.
10.32 Note Agreement between Robert R. Amerson and Flanders Corporation, dated April 24, 1999, filed herewith.
21 Subsidiaries of the Registrant.
23.1 Consent of Grant Thornton LLP for incorporation by reference of their report into Form S-8 filed on July 21, 1997, filed herewith.
23.2 Consent of McGladrey & Pullen, LLP for incorporation by reference of their report into Form S-8 filed on July 21, 1997, filed herewith.
24 Power of Attorney (included on Signature page of this report).
27 Financial Data Schedule.
(b) Reports on Form 8-K.
None.
(c) Financial Statement Schedules: See (a)(2) above.
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated this 13th day of April, 2000.
FLANDERS CORPORATION
By /s/ Robert R. Amerson ----------------------------------------------- Robert R. Amerson President, Chief Executive Officer, and Director
By /s/ Steven K. Clark ----------------------------------------------- Steven K. Clark Vice President/Chief Financial Officer, Principal Accounting Officer, Chief Operating Officer and Director
KNOW ALL PERSONS BY THESE PRESENTS that each person whose signature appears below constitutes and appoints Steven K. Clark, his attorney-in-fact, to sign any amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Commission, hereby ratifying and confirming all the said attorney-in-fact may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ Robert R. Amerson President, Chief Executive Officer 4/13/00 - ------------------------- and Director ------------ Robert R. Amerson
Chief Operating Officer, Vice President/Chief Financial Officer, /s/ Steven K. Clark Principal Accounting Officer and 4/13/00 - ------------------------- Director ------------ Steven K. Clark
/s/ Linwood Allen Hahn - ------------------------- 4/13/00 Linwood Allen Hahn Director ------------
/s/ J. Russell Fleming - ------------------------- 4/13/00 J. Russell Fleming Director ------------
FLANDERS CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1999, 1998 and 1997
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors Flanders Corporation
We have audited the accompanying consolidated balance sheet of Flanders Corporation and Subsidiaries as of December 31, 1999, and the related consolidated statements of earnings, stockholders' equity, and cash flows for the year then ended. 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 audit.
We conducted our audit in accordance with generally accepted auditing standards. 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Flanders Corporation and Subsidiaries as of December 31, 1999, and the consolidated results of their operations and their consolidated cash flows for the year then ended in conformity with generally accepted accounting principles.
/s/ Grant Thornton LLP
Salt Lake City, Utah March 8, 2000
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors Flanders Corporation
We have audited the accompanying consolidated balance sheet of Flanders Corporation and subsidiaries as of December 31, 1998, and the related consolidated statements of income, stockholders' equity, and cash flows for the years ended December 31, 1998 and 1997. 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 generally accepted auditing standards. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Flanders Corporation and subsidiaries as of December 31, 1998, and the results of their operations and their cash flows for the years ended December 31, 1998 and 1997 in conformity with generally accepted accounting principles.
/s/ McGladrey & Pullen, LLP
New Bern, North Carolina March 12, 1999, except for item (A) in Note H and the last paragraph of Note H, as to which the date is March 31, 1999, and Note D, as to which the date is December 31, 1999.
FLANDERS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31,
The accompanying notes are an integral part of these financial statements.
FLANDERS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS Years Ended December 31,
The accompanying notes are an integral part of these financial statements.
FLANDERS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 1999, 1998 and 1997
The accompanying notes are an integral part of these financial statements.
FLANDERS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31,
- Continued -
The accompanying notes are an integral part of these financial statements.
FLANDERS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued Years Ended December 31,
- Continued -
The accompanying notes are an integral part of these financial statements.
FLANDERS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued Years Ended December 31,
The accompanying notes are an integral part of these financial statements.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A. Nature of Business and Significant Accounting Policies
A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.
1. Financial statement presentation
The accounting and reporting policies of Flanders Corporation and Subsidiaries (the Company) conform with generally accepted accounting principles and with general practices in the manufacturing industry.
2. Principles of consolidation
The consolidated financial statements include the accounts and operations of the Company and its subsidiaries, all of which are wholly owned, except for one subsidiary which was 80 percent owned for the year ended December 31, 1998. All material intercompany accounts and transactions have been eliminated in consolidation. Amounts of minority interest are insignificant.
3. Nature of business
The Company designs, manufactures and markets a broad range of air filtration products, including high-end High Efficiency Particulate Air ("HEPA") filters, with at least 99.97% efficiency, Absolute Isolation Barriers for the creation of synthesized atmospheres to control manufacturing environments and for the absolute control and containment of contaminants and toxic gases in certain manufacturing processes, mid-range filters for individual and commercial use, custom air filter housings, industrial air handlers and standard low cost residential and commercial furnace and air conditioning filters. The Company's air filtration products are utilized by many industries, including those associated with commercial and residential heating ventilation and air conditioning systems ("HVAC" systems), semiconductor manufacturing, ultra-pure materials, biotechnology, pharmaceuticals, synthetics, nuclear power and nuclear materials processing. The Company also designs and manufactures much of its own production equipment to allow for highly automated manufacturing of these products. Furthermore, the Company produces glass-based filter media for some of its products to maintain control over the quality and composition of such media.
The Company has only one segment, filtration products. The Company sells some products for end users outside of the United States through domestic specialty cleanroom contractors. These sales are accounted for as domestic sales. The Company also sells products through foreign distributors, primarily in Europe, and a wholly owned subsidiary, which sells to customers in the Far East. Sales through foreign distributors and its wholly owned foreign subsidiary total less than 5% of net sales. Assets held outside the United States are negligible.
4. Significant customers
Net sales for the years ended December 31, 1999, 1998 and 1997 included sales to the following major customers, together with the receivables due from those customers:
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A. Nature of Business and Significant Accounting Policies - Continued
5. Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
6. Cash and cash equivalents
The Company maintains its cash in bank deposit accounts, which at times exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents. For purposes of reporting cash flows, the Company considers all cash accounts which are not subject to withdrawal restrictions or designated for equipment acquisitions and certificates of deposit which have an original maturity of three months or less to be cash equivalents.
7. Fair value of financial instruments
The carrying amount of cash equivalents approximates fair value at December 31, 1999 and 1998 because of the short maturity of those instruments. Based on the borrowing rates currently available to the Company for bank loans with similar maturities and similar collateral requirements, the fair value of notes payable and long-term debt approximates the carrying amounts at December 31, 1999 and 1998.
8. Inventories
Inventories are valued at lower of cost (first-in, first-out method) or market.
9. Goodwill
The Company has classified as goodwill the cost in excess of fair value of the net assets (including tax attributes) of companies acquired in purchase transactions. Goodwill is being amortized on a straight line basis over 40 years. At each balance sheet date, the Company evaluates goodwill for impairment by comparing expectations of non-discounted future cash flows excluding interest costs with the carrying value of goodwill for each subsidiary having a material goodwill balance. Based upon its most recent analysis, the Company believes that no impairment of goodwill exists at December 31, 1999.
10. Trademarks and trade names
Trademarks and trade names are being amortized on a straight line basis over 17 years. At each balance sheet date, the Company evaluates the value of trademarks and tradenames for impairment by comparing expectations of non-discounted future cash flows excluding interest costs with the carrying value of trademarks and tradenames for each trademark or tradename having a material unamortized balance. Based upon its most recent analysis, the Company believes that no impairment of trademarks and tradenames exists at December 31, 1999.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A. Nature of Business and Significant Accounting Policies - Continued
11. Property and equipment
Property and equipment are stated at cost. Depreciation is computed by the straight-line method over estimated useful lives. Amortization of capital leases is included in depreciation expense. The carrying amount of all long-lived assets is evaluated periodically to determine if adjustment to the depreciation and amortization period or to the unamortized balance is warranted. Based upon its most recent analysis, the Company believes that no impairment of property and equipment exists at December 31, 1999.
12. Revenue recognition
All sales are recognized when shipments are made to customers.
13. Income taxes
Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
14. Research and development
Research and development expenses and ongoing costs associated with improving existing products and manufacturing processes are expensed in the period incurred. Costs associated with research and development amounted to approximately $763,000, $2,250,000 and $373,000 for 1999, 1998 and 1997, respectively.
15. Earnings (loss) per share
The Company follows the provisions of Statement of Financial Accounting Standards No. 128 "Earnings Per Share" (SFAS No. 128). SFAS No. 128 requires the presentation of basic and diluted EPS. Basic EPS are calculated by dividing earnings (loss) available to common shareholders by the weighted average number of common shares outstanding during each period. Diluted EPS are similarly calculated, except that the weighted average number of common shares outstanding includes common shares that may be issued subject to existing rights with dilutive potential.
16. Stock Options
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options rather than adoptiong the alternative fair value accounting provided for under FASB Statement 123, "Accounting for Stock-Based Compensation" (SFAS 123).
17. Advertising
The costs of advertising are expensed as incurred.
18. Warranty
The costs of warranties on the Company's products have not been historically significant and are expensed as incurred.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A. Nature of Business and Significant Accounting Policies - Continued
19. Reclassifications
Certain account balances for 1998 and 1997 have been reclassified with no effect on net income or retained earnings to be consistent with the classification adopted for the year ended December 31, 1999.
Note B. Mergers and Acquisitions
Effective April 1, 1999, the Company purchased the Tidewater group of companies, consisting of Tidewater Air Filter Fabrication Company, Inc., Newport Manufacturing, Inc., and Bio-Tec Inc., for a total cost of acquisition, net of cash received, of approximately $1,787,000 in a transaction which has been recorded as a purchase. Goodwill of approximately $647,000 has been recognized in this transaction. Tidewater is an air filter distributor and service organization. Prior to the acquisition, Tidewater was an exclusive distributor of a competitor's products. Newport Manufacturing is an air filter manufacturer with some limited manufacturing capacity for specialty products. Bio-Tec is an indoor air quality consulting firm. The Company's financial statements include the operating results of the Tidewater group of companies from April 1, 1999.
On May 7, 1998, the Company agreed to acquire substantially all of the outstanding stock of Eco-Air Products, Inc. ("Eco-Air") in a transaction which has been recorded as a purchase. The total cost of the acquisition, net of cash acquired, was approximately $15,455,160, plus the Company's common stock equivalent in value to $5,000,000 or cash if certain performance criteria are met. In connection with this purchase, the Company recorded approximately $11,107,000 of goodwill. Upon achieving certain performance criteria, common stock will be issued or a liability recorded for cash payment over a five year period and will be added to goodwill associated with the purchase transaction and amortized over the remaining amortization period of the respective goodwill asset. The acquisition of Eco-Air was funded by utilizing a revolving credit facility which provides a line of credit up to a maximum principal amount of $30,000,000. The effective date of the acquisition for financial statement purposes was June 30, 1998, and the Company's financial statements include the operating activities and assets of Eco-Air from that date. As of December 31, 1999, no shares have been issued or liability recorded to the Eco-Air sellers as a result of not having met the performance criteria.
Effective December 1, 1997, the Company acquired all the outstanding stock of Glass Fiber Industries, Inc. ("GFI"), a manufacturer of glass fiber, by exchanging 187,502 shares of the Company's stock for all the outstanding stock of GFI in a tax free merger in a transaction which has been recorded as a purchase. The total cost of acquisition was $1,394,639, based on the price of the Company's stock on November 26, 1997, of approximately $7.44. In connection with the purchase, the Company recorded approximately $547,000 of goodwill.
Summarized below are the unaudited pro forma results of operations of the Company as though Eco-Air had been acquired at the beginning of the fiscal year ended December 31, 1997.
Pro forma results of operations of the Company as though Tidewater had been acquired as of January 1, 1998 and GFI had been acquired as of January 1, 1997 are not presented because amounts of pro forma differences are not significant.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note C. Inventories
Inventories consists of the following at December 31:
Note D. Discontinued Operations
During 1997, the Company established a new subsidiary, Airseal West, Inc., to serve as a manufacturer of industrial air handlers, custom housings, and related products for the western U.S. The market opportunities envisioned by this venture failed to materialize, and Airseal West focused its primary efforts on perceived opportunities in businesses and products unrelated to air filtration, including sporting goods, vending equipment and other general manufacturing.
In December 1999, the Company adopted a formal plan to close Airseal West, a wholly owned subsidiary, and sell its various assets and product lines to unrelated third parties. The anticipated date of closure is approximately April 30, 2000. All dispositions of assets are expected to be completed December 31, 2000. The assets to be sold consist primarily of non-filtration assets consisting of inventories, manufacturing equipment, designs and intellectual properties.
Operating results of Airseal West for 1999 are shown separately in the accompanying statement of earnings. Revenues and expenses associated with Airseal West for 1998 and 1997 have been reclassified and combined into the heading, "Loss from operations of discontinued subsidiary."
The estimated loss on the disposal of the discontinued operations of approximately $893,000 (net of income tax benefit of approximately $566,000) represents the estimated loss on the disposal of the assets of Airseal West and the write-off of goodwill associated with Airseal West.
Net sales of Airseal West for 1999, 1998 and 1997 were approximately $2,354,000, $3,057,000 and $2,237,000, respectively. These amounts are not included in net sales in the accompanying statement of earnings.
Net assets of Airseal West at December 31, 1999 consisted of the following:
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note E. Other Assets
Other assets consist of the following at December 31:
Note F. Intangible Assets
Intangible assets consist of the following at December 31:
Note G. Property and Equipment
Property and equipment and estimated useful lives consist of the following at December 31:
Total depreciation expense charged to operations totaled $5,544,018, $4,435,744 and $3,103,271 for 1999, 1998 and 1997, respectively.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note H. Pledged Assets and Debt
A summary of the Company's debt, and collateral pledged thereon, consists of the following at December 31:
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note H. Pledged Assets and Debt - Continued
(A) These are amounts outstanding on revolving credit facilities with banks which provide lines of credit up to a maximum principal amount of $45,000,000 and $33,000,000 at December 31, 1999 and 1998, respectively. The lines of credit bear interest rates at the option of the Company at either 1) prime rate, which was 8.5% at December 31, 1999, or 2) LIBOR, which was 5.3% at December 31, 1999, plus an amount equal to 1.00% to 1.95%, depending on the ratio of total liabilities of the Company to its tangible net worth. The line of credit agreements expire June 28, 2002. The lines of credit are collateralized by the pledge of all common stock of the subsidiaries owned by the Company.
In connection with the line of credit agreements and notes payable to a regional development authority and bank, the Company has agreed to certain restrictive covenants which include, among other things, not paying dividends and maintenance of certain financial ratios at all times including a minimum current ratio, minimum tangible net worth, a maximum ratio of total liabilities to tangible net worth and a minimum fixed charge coverage ratio.
Aggregate maturities required on long-term debt as of December 31, 1999 are due in future years as follows:
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note I. Accounts Payable
Accounts payable consist of the following at December 31:
Note J. Accrued Expenses
Accrued expenses consist of the following at December 31:
Note K. Stockholders' Equity
During the year ended December 31, 1997, the Company raised $57,054,013, net of offering commissions and expenses of $6,052,237, through the sale of 8,320,000 shares of common stock by underwritten public offerings dated January 16, 1997 at $9.50 per share and October 16, 1997 at $7.00 per share and the private placement of 57,000 shares of Common Stock at a weighted average price of $4.67 per share. In conjunction with these offerings, the Company granted warrants to purchase a total of 540,000 shares to the underwriters with exercise prices between $8.40 and $14.725 per share, expiring at various periods between January 2002 and October 2002.
The President and Vice President/Chief Financial Officer of the Company had options to purchase 3,321,021 and 2,214,014 shares, respectively, of the Company's common stock from two stockholders of the Company at an option price of $2.50 per share. The President and Vice President/Chief Financial Officer of the Company exercised options to acquire 2,830,732 and 1,799,188 shares, respectively, of the common stock from the two stockholders on December 1, 1997. The remaining options were not exercised and expired on December 15, 1997.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note L. Income Taxes
The components of income tax expense (benefit) are as follows for the years ended December 31:
The income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate of 34% to pretax income due to the following for years ended December 31:
Net deferred tax assets and liabilities consist of the following components as of December 31:
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note L. Income Taxes - Continued
The components giving rise to the net deferred tax assets and liabilities described above have been included in the accompanying consolidated balance sheets at December 31:
Note M. Commitments and Contingencies
1. Employment Agreements:
The President and Chief Executive Officer, the Chief Operating Officer/Vice President Finance/Chief Financial Officer, and the Vice President Operations all have employment agreements which expire at various times from March 2003 to December 2010. In addition to a base salary and bonuses which may be paid at the discretion of the Board of Directors, the agreements provide for a termination payment ranging from one hundred percent of their base annual compensation to the minimum amount due under the employment contract if the officer had served their full term, in the event the officers' employment is terminated under various circumstances.
The Company pays discretionary cash bonuses to its officers and employees. The Company did not pay bonuses for 1999, 1998 and 1997.
2. Litigation
The Company is being sued by a customer regarding a purchase of approximately $5 million in laminar-flow cleanroom-grade HEPA filters, with approximately $2.6 million of related accounts receivable currently uncollected. The customer contends that these filters were manufactured using a defective urethane sealant and seeks reimbursement for replacement costs and damages. The Company contends that the filters meet all the specifications of the customer, and are not, in fact, defective. We believe that in the event of an adverse decision, it is reasonably likely that we would be able to successfully assert liability by the manufacturer of the sealant, and we have filed a cross-complaint against the sealant manufacturer. We also believe that any losses due to these lawsuits are fully insured under both our general liability insurance policy and the general liability policy of the sealant manufacturer. For these reasons, we do not believe that the resolution of this matter will have a material adverse impact upon our financial condition or results of operations.
From time to time, the Company is a party to various legal proceedings related to our normal business operations. Management of the Company does not believe that the ultimate outcome of this litigation will have a material impact on the Company's results of operations or financial condition.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note M. Commitments and Contingencies - Continued
3. Lease Commitments and Total Rental Expense
Certain equipment and buildings are leased under agreements expiring between 2000 and 2004. The following is a schedule for the total rental commitments under these leases as of December 31, 1999
The total rental expense charged to operations was approximately $2,900,000, $2,000,000 and $2,300,000 for 1999, 1998 and 1997, respectively.
Note N. Employee Benefit Plans
The Company has a defined contribution 401(k) salary reduction plan intended to qualify under section 401(a) of the Internal Revenue Code of 1986 ("Salary Savings Plan"). The Salary Savings Plan allows the eligible employees, as defined in the plan document, to defer up to 15 percent of their eligible compensation, with the Company contributing an amount determined at the discretion of the Company's Board of Directors. The Company contributed approximately $195,000, $168,000 and $145,000 to the Salary Savings Plan and the 401(k) Plans for the years ended December 31, 1999, 1998 and 1997, respectively.
The Company employee benefit program also includes health, accident, dental, life insurance and disability benefits. Substantially all the Company's subsidiaries have elected to self-insure the health and accident insurance at an individual maximum ranging from $30,000 to $90,000 per employee per claim year. A stop loss policy is maintained for subsidiaries that are self-insured, which covers 100 percent of liability over amounts ranging from $30,000 to $80,000 per occurrence per individual per plan year. The employer's portion of claims charged to operations totaled approximately $1,100,000, $1,160,000 and $650,000 for 1999, 1998 and 1997, respectively.
During 1996, the Company adopted the Long Term Incentive Plan ("LTI Plan") to assist the Company in securing and retaining key employees and consultants. The LTI Plan authorizes grants of incentive stock options, nonqualified stock options, stock appreciation rights ("SARs"), restricted stock performance shares and dividend equivalents to officers and key employees of the Company and outside consultants to the Company. There are 1,986,800 shares of Common Stock reserved for award under the LTI Plan. During 1999, 1998 and 1997, the Company awarded options to purchase 52,850, 316,850 and 95,600 shares of Common Stock under the LTI Plan, respectively (Note P).
During 1996, the Company also adopted the 1996 Director Option Plan which provides for the grant of stock options to outside directors of the Company who were elected or appointed after February 1, 1996, and who were not existing directors on the effective date of the plan. Each such outside director who is serving as a director on January 1 of each calendar year will automatically be granted an option to acquire up to 5,000 shares of Common Stock on such date, assuming such outside director had been serving for at least six months prior to the date of grant. The Company has reserved 500,000 shares of its Common Stock for issuance under the 1996 Director Option Plan which expires in 2006. During 1999, 1998 and 1997, the Company awarded options to purchase 105,000, 115,000 and 5,000 shares, respectively, of Common Stock under the 1996 Director Option Plan (Note P).
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note O. Related Party Transactions and Balances
At December 31, 1999 and 1998, the Company had notes receivable of $4,369,028 and $4,263,409, respectively, due from various directors, officers and employees with interest thereon varying between 6.31% and 8.75%, maturing at various dates to December 2010 and callable on demand by the Company (Note K).
Note P. Stock Options and Warrants
During 1999, the Company granted options to purchase 52,850 shares of common stock under its LTI Plan at a weighted average exercise price of $3.76 per share. The Company also granted options in 1999 to purchase 105,000 shares under the Director Option Plan, at a weighted average exercise price of $2.57 per share. All options granted during 1999 were non-qualified fixed price options, and all 157,850 options were not exercisable at December 31, 1999.
The following table summarizes the activity related to all Company stock options and warrants for 1999, 1998, and 1997:
During 1999, the expiration date of options to purchase 2,000,000 shares at $2.50 per share was extended from February 2001 to February 2006, which resulted in a new measurement date under interpretations to APB Opinion No. 25.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note P. Stock Options and Warrants - Continued
The warrants and options expire at various dates ranging from February 2000 to December 2008. A further summary of information related to fixed options outstanding at December 31, 1999 is as follows:
As permitted under generally accepted accounting principles, grants under the LTI Plan and other grants of options are accounted for following APB Opinion No. 25 and related interpretations. Accordingly, no compensation cost has been recognized for grants under the LTI Plan, since all options granted had an exercise price at or above the market price of the Company's common stock on the date of grant. Had compensation cost for the LTI Plan been determined based on the grant date fair values of awards using the Black-Scholes option pricing model (the method described in FASB Statement No. 123), reported net earnings and earnings per common share would have been reduced to the pro forma amounts shown below for the years ended December 31:
In determining the pro forma amounts above, the value of each grant is estimated at the grant date using the Black-Scholes option pricing method prescribed in FASB Statement No. 123, with the following assumptions: Dividend rate of 0%; risk-free interest rates based upon the zero-coupon rate on the date of grant for the expected life of the option; and expected price volatility on the date of grant. Weighted average assumptions for options granted in 1999, 1998 and 1997 were as follows: Dividend rate of 0%; average risk-free interest rate of 5.66%, 5.18% and 6.11%, respectively; average expected lives of 5, 4.3 and 2.5 years, respectively; and average expected price volatility of 67%, 40% and 40%, respectively.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note Q. Earnings per Share
The following data show the amounts used in computing net earnings per common share from continuing operations. The following data also show the weighted average number of shares and dilutive potential common stock.
FLANDERS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note R. Quarterly Financial Data (Unaudited)
FLANDERS CORPORATION FINANCIAL STATEMENT SCHEDULES
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON THE SUPPLEMENTAL SCHEDULE
Board of Directors Flanders Corporation
Our audit was made for the purpose of forming an opinion on the 1999 basic consolidated financial statements taken as a whole. The consolidated Supplemental Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in our 1999 audit of the basic consolidated financial statements and, in our opinion, the 1999 information is fairly stated in all material respects in relation to the 1999 basic consolidated financial statements taken as a whole.
/s/ Grant Thornton LLP
Salt Lake City, Utah March 8, 2000
INDEPENDENT AUDITOR'S REPORT ON THE SUPPLEMENTAL SCHEDULE
To the Board of Directors Flanders Corporation Washington, North Carolina
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The consolidated Supplemental Schedule II for the years ended December 31, 1998 and 1997 is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.
/s/ McGladrey & Pullen, LLP
New Bern, North Carolina March 12, 1999
FLANDERS CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 1999, 1998 and 1997
- ----------------------------- (1) Uncollected receivables written-off, net of recoveries. (2) Reduction in allowance. (3) Increase due to acquisition of subsidiary.