ITEM 1. BUSINESS(1)
GENERAL
The Company is a manufacturer and distributor of brake rotors, drums, disc brake pads, relined brake shoes, wheel cylinders and brake hoses for the automotive aftermarket. The Company markets approximately 50% of its product under its UBP trademark (Universal Brake Parts) and the balance under its customers' private labels. The Company believes it is the leading North American supplier of "value line" brake parts (brake parts sold at prices significantly below those of certain leading national brand name brake parts) to mass-market retailers, traditional warehouse distributors and specialty undercar distributors. Many of the Company's "value line" competitors specialize in only one category of brake parts. By offering a full line of "value line" brake products, the Company believes it has an advantage over those competitors offering "value line" products in fewer brake part categories in light of the industry trend to consolidate the number of suppliers.
The Company also markets a premium line of brake rotors and friction products under its Ultimate trademark. The Ultimate product line is designed to compete at the high end of the market by providing exceptional quality and features at slightly lower prices than the established premium brands. The Ultimate product line, since its launch in 1997 has experienced double digit growth. All the friction product and the majority of the rotors in the Ultimate line are manufactured at the Company's manufacturing facilities.
The Company commenced operations in 1981 as a warehouse distributor of a wide variety of automotive aftermarket replacement parts servicing the Chicagoland area. In the early 1990's, the Company started shifting its focus to the brake parts segment of the business, and in the second half of 1996 liquidated its non-brake parts warehouse distributor business due to the lower margin and declining growth prospects of this segment of the business.
The Company is one of four U.S. based aftermarket disc brake rotor and drum manufacturers. The Company operates a facility in Laredo, Texas, which finishes raw rotor castings into finished products. In addition, the Company researches and develops proprietary friction formulations that are used at Toronto, Canada. In October 1995, it acquired a foundry in Budapest, Hungary which presently makes iron castings for numerous industries, but which could be capable of supplying brake rotors for the Company's internal requirements should certain significant additional equipment investment be made.
- ---------------- (1) Some of the statements included in Item 1, Business, and Item 7, Management's Discussion and Analysis of Financial Conditions and Results of Operations may be considered to be "forward looking statements" since such statements relate to matters which have not yet occurred. For example, phrases such as "the Company anticipates," "believes" or "expects" indicate that it is possible that the event anticipated, believed or expected may not occur. Should such event not occur, then the result which the Company expected also may not occur or occur in a different manner, which may be more or less favorable to the Company. The Company does not undertake any obligation to publicly release the result of any revisions to these forward looking statements that may be made to reflect any future events or circumstances.
Readers should carefully review the items included under the subsection Risks Affecting Forward Looking Statements and Stock Prices, as they relate to forward looking statements, as actual results could differ materially from those projected in the forward looking statement.
The Company also conducts a wholesale "commodities" operation from its headquarters in Chicago, Illinois, purchasing certain automotive replacement parts and maintenance items in large volume, at favorable prices, and reselling such products at slightly higher prices.
The Company has experienced significant growth in sales of brake rotors and other brake parts. Due to overall improvement of its brake parts business, sales in this category increased by $10.9 million or 26% to $53.1 million in 1998 compared to $42.1 million in 1996, the year the non-brake parts warehouse distributor business was liquidated. No assurance can be given that this percentage increase in sales will continue at such level in the future. The Company currently markets its UBP Universal Brake Parts line to warehouse distributors, mass market retailers, specialty, "under-the-car" distributors and national franchise and chain installers located throughout the United States and Canada, principally through the Company's salespeople, independent sales representatives and telemarketing. The Company has been named a primary private label brake rotor and drum supplier to several national buying groups.
Net sales of brake parts and the related gross profit as a percentage of total net sales and gross profit increased to 83% and 87%, respectively, in 1998 compared to 66% and 81%, respectively, in 1996, the year the non-brake parts warehouse distribution business was liquidated.
In October 1995 the Company acquired the assets of Csepel Iron Foundry Works, a producer of high quality gray iron and ductile iron casting products, located in Budapest, Hungary. The Company manufactures iron casting products at its Hungarian foundry primarily for the European automotive and machine tool industries. The foundry is not presently equipped to manufacture high volume, smaller-sized items such as brake rotors. The Company may at some time in the future upgrade the foundry (including additional equipment purchases) to produce iron castings for brake rotors, although the Company has no present plans to make such upgrades. All of the foundry's sales are in Europe.
The Company's strategy is to capitalize on the increasing demand for brake parts and the higher gross margins on sales of such brake parts by expanding its brake parts manufacturing and distribution business. The Company believes that it can implement its expansion strategy by: (i) gaining additional market share of friction brake products; (ii) being a complete "value line" brake part supplier; (iii) possibly acquiring other specialty brake parts distributors; (iv) being a low cost producer of brake parts; (v) increasing its SKU coverage to existing customers; and (vi) building brand recognition through the Company's "Ultimate" brand brake parts (a premium product line). The Company may seek additional debt or equity financing to finance this expansion.
As part of the Company's strategy to expand its specialty brake parts distribution business and increase its focus on this segment, the Company has taken the following actions:
(i) April 1995 - the Company purchased the brake rotor and drum inventory and customer list of the passenger car division of MHD Automotive, an Illinois-based distributor of brake parts;
(ii) June 1995 - the Company acquired the inventory and customer list of North American Rotor, Inc., a distributor of brake drums and rotors;
(iii) October 1995 - the Company acquired the assets of Csepel Iron Foundry Works, with a view toward potential future upgrading in order to eventually produce brake rotors for internal requirements;
(iv) January 1996 - the Company, which owned 50% of the outstanding stock of UBP Friction, Inc., a Canadian-based specialty manufacturer of brake friction parts, acquired the remaining 50% of the outstanding capital stock;
(v) March 1996 - the Company acquired the brake parts inventory and customer list of MPW Brake Supply of Cambridge, Massachusetts, an aftermarket brake parts distributor on the east coast;
(vi) June 1996 - the Company acquired the assets and goodwill of North American Friction Inc., a Canadian manufacturer of a brake friction component used in the Company's brake friction manufacturing process;
(vii) September 1996 - the Company substantially liquidated its non-brake parts ware house/distribution division which enabled the Company to utilize the financial, warehouse and personnel resources previously used by such division in the Company's higher margin brake parts business. Liquidation was substantially completed by December 31, 1996;
(viii) November 1996 - the Company acquired all of the assets of the MCI Automotive Division of Excel Industries which was in bankruptcy. Inventory was acquired at values substantially less than current market values and has been substantially sold. The Company also acquired a substantial number of additional brake rotor patterns and additional equipment to increase its manufacturing capacity; and
(ix) The Company launches its premium brake category, Ultimate Brake Parts(TM) in November, 1997.
The Company was incorporated in Delaware in January 1994 to act as a holding company for its direct and indirect subsidiaries including: (i) Universal Automotive, Inc., an Illinois corporation and the predecessor of the Company ("Universal"); (ii) UBP Canholdings, Inc., an Ontario, Canada corporation (which changed its name from 547647 Ontario Limited) which is the parent of Universal Brake Parts, Inc., an Ontario, Canada corporation (which changed its name from Aaron Automotive Industries, Inc.) (together, "UBP Canholdings") and International Discus Corporation, an Ontario, Canada corporation ("IDC"); and (iii) UBP Hungary Inc., a Delaware corporation, which is the parent company of UBP-Csepel Iron Foundry Kft., a Hungarian limited liability company ("UBP Hungary"). The Company conducts all of its operations through its subsidiaries. The Company's principal executive offices are located at 3350 North Kedzie, Chicago, Illinois 60618-5722, and its telephone number is (773) 478-2323. Unless the context otherwise requires, the term the "Company" includes Universal Automotive Industries, Inc. and its direct and indirect subsidiaries, including its predecessor, Universal Automotive, Inc.
INDUSTRY OVERVIEW
General
The automotive aftermarket is a mature industry undergoing rapid changes. Over the last seven years, there has been significant consolidation at the manufacturer and distributor level including several bankruptcies. Industry experts believe that consolidation activity will remain at a high level over the next several years.
The automotive aftermarket will benefit from consolidation by enjoying improved operating efficiencies through reduction of duplicate overhead costs, improved absorption at manufacturing plants and reduced manufacturing costs. Aftermarket consumers will have less leverage as the number of suppliers diminishes. Domestic suppliers will have greater ability to compete with low cost offshore suppliers.
Due to the rapid introduction of model changes by car manufacturers, the number of different parts to service the vehicle population has grown substantially. This benefits the manufacturer with the necessary capital resources to invest in additional tooling. The aftermarket distributors are forced to increase their inventory investment to service the timely requirements of their customers for parts. Parts proliferation benefits those companies in the aftermarket that are well capitalized with excellent management information systems capabilities.
Vehicle operating systems have become increasingly complex. This factor has led to a shrinking of the "Do It Yourself" market and a benefit to traditional distributors and those retailers targeting commercial business. Better installers will gain market share and car manufacturers may begin to operate free standing repair centers.
Programmed distribution groups will have increased purchasing power. Traditional warehouse distributors aligned with major groups will prosper as a result of groups' "all or nothing" attitude when group members support a single manufacturer for given categories. This additional market power will lead to further consolidation as manufacturers' profit margins are compressed.
National wholesale and retail chains will have increased purchasing power. Aggressive marketing by large, well financed chains results in reduced market prices, and an erosion of business to those traditional warehouse distributors and jobbers without a commercial base. These factors, in turn, fuel additional consolidation within the industry.
Management expects private label brands will grow and erode traditional brand name equity. This movement should favor low cost producers who operate with a "value line" concept.
The size of the automotive aftermarket will grow as the number of vehicles on the road increases due to improved engineering and increasing costs of vehicles. The average age of vehicles in use is increasing; the average age of all vehicles in 1997 was 9.3 years compared to 7.8 years in 1990. Also, the average number of miles driven per vehicle continues to grow.
The Company believes that consolidation and related shifts in the automotive aftermarket offer substantial opportunity for the Company's "value line" concept of high quality, low cost replacement parts offered to a broad cross section of the market. The Company believes that it is well positioned to become the only acceptable full brake parts value line alternative to the three remaining major branded suppliers in the market segments served.
Brake System Replacement Parts
The brake parts segment of the automotive aftermarket is the segment of the industry experiencing the most growth. While the overall market is growing at a rate of around 2.75% per year (following the total growth in the number of vehicles), the brake portion of the industry is enjoying growth of 5% to 6% per year. This larger growth rate is supported by several factors, including increasing wear and tear on brakes, changes in vehicle design, improved components (e.g., front wheel drive, semi-metallic disc pads, ABS braking systems), increased speed limits and an overall increase in the miles driven per year.
Changes in vehicle design are the result of the introduction of front wheel drive vehicles in 1980. The mix of front to rear braking changed over the years from 60% front - 40% rear to as high as 85% front - 15% rear. This equates to much higher heat on the front rotors as they are forced to do much more of the braking, and as a result, increased wear on rotors.
The government has mandated targets for improving fuel economy and imposed sizable taxes for not attaining such targets. Car manufacturers have generally chosen reducing vehicle weight as the short-term method of improving fuel economy. One of the prime targets has been the braking system which has always been over designed and, therefore, overweight. Rotors and calipers were reduced in size to help achieve these new weight targets, which reduces rotor and disc pad life. Lighter weight rotors are less costly than heavier rotors, and upon wearing down it is generally more cost effective to discard, rather than refurbish the rotors.
Increased speed limits have increased braking system usage. Speed limits in several sates have been increased from the 55 mph of the mid 1970's to as high as 75 in some states. This 36% increase in speed requires almost 300% more braking power to achieve the same stopping distance. In response to these increased demands placed on braking systems, vehicle manufacturers created anti-lock braking systems which electronically monitor the performance of each wheel to assure that is does not lock and skid, thus reducing the braking power of that wheel. This system rapidly activates and releases pressure on a wheel to keep it from locking up and skidding. This rapid action on the brake system tends to increase wear of the brake components.
Specifications for bringing a vehicle to a complete stop from 60 mph have been reduced from 150 feet to 90 feet. To achieve this result, car manufacturers specify metallic brake pads which have shorter life and which, in turn, shorten the life of the brake rotor.
Demands on the braking systems associated with these factors have increased dramatically (300% to 500%) while the basic design of the systems has remained relatively constant. The Company believes that the brakes category of the automotive aftermarket will continue to grow at the 5% to 6% level well into the next decade.
PRODUCTS
The Company supplies a wide range of brake components to all levels of distribution. Company owned manufacturing facilities in both the U.S. and Canada produce brake drums and rotors as well as a full range of friction products, primarily disc brake pads and brake shoes. The Company purchases from unaffiliated vendors those products required to complete the product offering. The Company is one of four U.S. based aftermarket disc brake rotor and drum manufacturers and the only "value line" supplier with basic manufacturing capability. The Company's "value line" competitors do not have the breadth or scope of manufacturing capacity of the Company, and are, therefore, subject to the competitive disadvantages inherent in dependence upon third party suppliers.
The development of this basic manufacturing capability has positioned the Company to compete with the established brand names in the industry by marketing a premium line of brake rotors and friction products under its Ultimate Brake Parts(TM) label. Consolidation in the distribution and manufacturing segments of the brake aftermarket has left customers with fewer and fewer alternatives. The Company believes that this will offer substantial opportunities for increasing market penetration in the future.
MARKETING AND DISTRIBUTION
Marketing
The Company currently markets products to all levels of distribution under the name "UBP Universal Brake Parts" as well as under a number of private label programs for large buying groups, national franchise programs and installer chains. The long term strategy, while growing the private label program, is to improve UBP brand recognition in the market place and position the Company's product lines to compete with established branded products. Branded products generally are offered by the Company's competitors at a premium price, thus offering customers who choose UBP products substantial opportunity for improved margin performance. This group of competitors also currently commands approximately 55% of the total brake market, making them a prime competitive target.
The Company employs a sales force that directs the Company's independent sales representative network and the other brake marketing activities. Arrangements with the Company's independent sales representatives may be terminated at any time by either party. The Company also performs telemarketing operations directed at national franchise and chain installers.
Distribution
United States distribution is through two distribution facilities with the Chicago facility acting as the primary facility, and a redistribution warehouse in Southern California. Continuing growth in the distribution business will require additional space for the primary facility. Presently under consideration is possible relocation to a larger space within the Chicago area in 1999. The California facility was upgraded in 1997 to better service the growing west coast distribution.
Canadian distribution is serviced through a primary facility in the Toronto metropolitan area, with small fee warehouse facilities servicing the west coast. A larger primary facility was leased in February 1999, to better service the Canadian program.
The Company conducts a wholesale commodities operation from its headquarters facility in Chicago, Illinois, purchasing certain automotive replacement parts and maintenance items in large volume, at favorable prices, and reselling such products at slightly higher prices. The Company makes large volume purchases of products on the open market, generally buying from foreign and domestic manufacturers and other warehouse distributors, and resells such products to other warehouse distributors, mass market retailers and jobbers. Such operations result in gross margins that are significantly lower than gross margins from the Company's other operations. However, they generally require minimal resources of the Company and do contribute to overall gross profit. There can be no assurance that future market conditions will be favorable to the Company's wholesale commodities operations or that the Company will continue to generate sufficient revenues or acceptable profit margins from such wholesale operations. For the years ended December 31, 1996, 1997, and 1998, net sales from the Company's wholesales commodities operations accounted for approximately 15%, 7% and 8% of the Company's total net sales, respectively, and 4%, 3% and 5% of the Company's total gross profits, respectively.
MANUFACTURING
The Laredo, Texas rotor machining facility has a current capacity of approximately 750,000 units on a two shift basis. Through the acquisition of Excel Industries' MCI operation in 1996, approximately 200 foundry tools were acquired, which provided the base to manufacture approximately 210 different part numbers representing approximately 80% of the Company's total volume in the drum and rotor category.
The Company established a relationship with Waupaca Foundry, Inc. ("Waupaca") to supply raw castings as a result of its MCI acquisition. Waupaca is the premier rotor casting vendor in North America.
The Company acquired North American Friction in 1996 to provide a basic friction manufacturing capability. The Company now offers a full line of a variety of friction grades in both riveted and integrally molded disc brake pads, which are the two largest segments of the friction segment of the brake industry.
The Hungarian foundry acquired by the Company in late 1995 is not presently equipped to produce raw iron casting for use in the manufacture of brake rotors. The Company would need to upgrade the foundry to produce rotors, which the Company estimates would cost approximately $4,000,000. At present, the Company has no plans to upgrade the foundry for this purpose. A variety of factors, including demand for non-rotor products in Europe and the desire to continue supplying existing foundry customers and the availability of funding for upgrading, could limit the desirability or ability of the foundry to supply castings to the Company.
SUPPLIERS AND RAW MATERIALS
Suppliers
Product selection and purchasing functions for the Company's U.S. brake parts business are centralized at the Company's headquarters in Chicago, Illinois. The Company purchases the brake part SKUs that it does not manufacture from over a dozen suppliers located throughout the world. Currently, the Company imports approximately 50% of its brake part inventories from suppliers located in the People's Republic of China, with the balance from various suppliers in Taiwan, Italy, the United States and Canada.
Although certain suppliers may provide a majority or all of the Company's requirements for a particular product or product subcategory, no supplier accounted for more than 16% of the Company's U.S. total product purchases during 1998. The Company believes that the loss of any one or more of its suppliers would not have a material adverse effect on the Company and that alternative sources of supply are readily available at comparable prices in all product categories. The Company believes that its relationships with its suppliers are good.
Tariff
The International Trade Commission ruled rotors sales from China materially injured U.S. rotor manufacturers. As a result of this affirmative determination, the U.S. Customs Service has imposed anti- dumping duties on certain Chinese suppliers. The dumping duties can be reviewed yearly if requested by a Chinese manufacturer or by a U.S. brake rotor manufacturer. Depending on the results of the investigation, the tariff may be decreased or increased. The dumping margins are plant specific and are retroactive to the importer of record; however, the Company is not the importer of record for this purpose.
Warranties
The manufacturers of automotive aftermarket products typically provide replacement warranties, which the Company extends to its customers. In general, the Company is able to return to its suppliers' slower moving or overstocked items for full credit, and the Company typically exercises its discretion to extend this same policy to its customers.
Raw Materials
The main components used in the Company's brake rotor manufacturing operations are raw iron castings. The Company primarily purchases raw castings from Waupaca. Waupaca is the largest producer of automotive rotor castings in North America. In addition to Waupaca, the Company purchases castings from several foundries in Canada.
The Company duplicates certain raw iron casting patterns used for the production of its better selling brake rotors and places such patterns at different foundries to assure a supply of the raw iron castings produced from such patterns. Although the Company believes that it has developed good relationships with the foundries that supply the Company's raw iron castings, any of such foundries could discontinue producing such castings for the Company at any time. The Company believes that the number of foundries equipped to produce raw iron castings such as the ones used by the Company in its manufacturing operations is limited. The loss of any major foundry as a supplier of raw iron castings and an inability of the Company to identify new foundries for the production of raw iron castings in a timely manner could have a material adverse effect on the Company's business. In addition, there can be no assurance that the foundries currently producing the Company's raw iron castings will be able to accommodate the anticipated expansion of the Company's manufacturing capabilities. The Company is continuously seeking to locate additional foundries that would be suitable for the production of its raw iron castings. The Hungarian foundry acquired by the Company is not presently equipped to produce raw iron castings for use in the manufacture of brake rotors and the Company has no present intention to upgrade the foundry for this purpose.
COMPETITION
The Company's markets are highly competitive. As a brake parts manufacturer and distributor, the Company competes directly with other brake part manufacturers and brake parts distributors, including Aimco and Raybestos/Brake Products (divisions of Dana Corporation), Wagner Brake Products (a division of Federal Mogul) and Bendix (a division of Allied Signal Co.), as well as numerous value line distributors specializing in one specific brake category.
The Company competes primarily on the basis of price, inventory availability, delivery time and service. Many of the Company's competitors in both the jobber and the specialty brake parts distribution markets are larger and have greater capital, management and other resources than the Company. No assurance can be given that the Company will continue to compete successfully with such other competitors.
The Company's foundry operations in Budapest, Hungary compete in the European automotive and machine tool market. The foundry's largest customer has halted orders for castings used in end product destined for ultimate sale in Russia. The Company has been successful in replacing a portion of this volume and believes that it will secure the balance in 1999, although there can be no assurances that this volume will be completely replaced. The Company believes that there are fewer foundries competing in the European machine tool die casting business than in other areas of production.
TRADEMARK
The Company believes that its labels, UBP (Universal Brake Parts) and Ultimate are important to its marketing efforts and a significant portion of the Company's net sales are derived from sales of brake parts which it markets under them. The UBP Universal Brake Parts and Ultimate Braking Power trademarks have been registered with the United States Patent and Trademark Office and Canadian Trademarks Office. There can be no assurance that prior registrations and/or uses of the trademark (or a confusingly similar mark) do not exist in the United States, in which case the Company might thereby be precluded from using
such trademark in the United States. The Company can offer no assurance that the Company's trademark would be upheld if challenged or that the Company would not be prevented from using its trademark, both of which could have an adverse effect on the Company.
EMPLOYEES
As of December 31, 1998, there were 457 full-time employees (161 in the United States, 123 in Canada and 173 in Hungary) employed at the Company's places of business in the United States, Canada and Hungary.
RISKS AFFECTING FORWARD LOOKING STATEMENTS AND STOCK PRICES
In addition to those matters already set forth in Item 1, Business, the following may result in the Company not achieving certain results included in any statement that may be considered a forward looking statement. The Company cautions the reader that the following risk factors may not be exhaustive.
EXPANSION; POSSIBLE NEED FOR ADDITIONAL FINANCING
The continued growth and financial performance of the Company will depend in part on the Company's ability to continue to expand its business through: (i) gaining additional market share for friction brake products; (ii) the purchase of additional manufacturing machinery and brake rotor patterns to increase the number of brake rotor SKUs the Company manufactures; (iii) the possible acquisition of other brake parts manufacturers or distributors on favorable terms; (iv) additional sales penetration of current customers; and (v) the successful operation of the Company's Hungarian foundry facility. While the Company regularly evaluates and discusses possible acquisitions, it has not entered into any binding agreement with any potential acquisition candidates, and there can be no assurance that it will be successful in locating suitable acquisition candidates or that any additional acquisitions will be consummated in the future. In addition, there can be no assurance that any operations that may be acquired can be effectively and profitably integrated into the Company. The Company's future results will be affected by its ability to manage its operations and growth effectively and to continue to obtain an adequate supply of quality brake parts on a timely and cost-effective basis to meet the growing demand for the Company's UBP Universal Brake Parts products. The Company can offer no assurance that any future expansion of its operations or acquisitions will not have an adverse effect on the Company's operating results, particularly during the periods immediately following any such expansion or acquisition. The Company will be required to seek additional financing to fund its expansion through acquisitions or the upgrade of existing facilities. The Company has no current commitments or arrangements for additional financing and there can be no assurance that additional financing will be available on acceptable terms, or at all. The Company may also issue Common Stock or other securities in connection with future acquisitions, resulting in additional dilution to existing stockholders.
LEGAL PROCEEDINGS
Set forth in Item 4, Legal Proceedings below is a summary of the legal proceedings between the Company and First National Parts Exchange, Inc. (the "Estate"). The Company has reserved $301,000 as a loss reserve with respect to such lawsuit. There can be no assurance that such reserve is adequate. In the event a judgment in excess of such sum is entered in favor of the Estate pursuant to the Trustees' appeal, the Company will be required to pay or bond over (on appeal) against such judgment. There can be no assurance that the Company will have sufficient resources to cover any judgment in excess of its resources.
BANK FINANCING
The Company has incurred significant indebtedness in connection with its operations. As of December 31, 1998 the Company's total consolidated indebtedness was approximately $21.4 million. A substantial portion of this indebtedness is secured by substantially all of the Company's assets (except the Hungarian foundry assets) and by a pledge of all of the outstanding capital stock of the Company's subsidiaries. As a result of such indebtedness, the Company (i) is prohibited from paying cash dividends pursuant to certain covenants and restrictions contained in the loan agreements governing such indebtedness, (ii) could be hindered in its efforts to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate or other purposes, and (iii) would be vulnerable to increases in interest rates since substantially all of the Company's borrowings are at floating rates of interest.
On July 14, 1997, the Company entered into a credit agreement with LaSalle National Bank for (i) a revolving line of credit of up to $20,000,000 based on eligible accounts receivable and inventory and (ii) a term loan in the initial amount of $4,450,000.
The revolving credit facility, which is for an initial term ending May 1, 1999 bears interest at the bank's announced of prime rate plus 0.5% per annum, subject to an ongoing option to convert to an interest rate at LIBOR plus 2.5% per annum. The term loan is payable in monthly principal installments of $24,722, with a balloon payment of $2,966,666 due on May 1, 2002, and bears interest at prime plus 0.75% per annum.
On July 14, 1997, the Company sold a $4,500,000 subordinated debenture to Tandem Capital, Inc. (an affiliate of Sirrom Capital Corporation and now known as Finova Mezzanine Capital Corporation), calling for payments of interest at 12.25% per annum through maturity on July 14, 2002. The Company issued Tandem a warrant to purchase 450,000 shares of the Company's common stock at an exercise price equal to 80% of the average closing bid price of the Company's common stock for the 20 days preceding the first anniversary of the debenture closing date, computed to be $.83 per share. On each of August 14, 1998 and February 14, 1999, Tandem received warrants to purchase an additional 225,000 shares of common stock. Tandem will also receive warrants to purchase an additional 225,000 shares of common stock on August 14, 1999, August 14, 2000 and August 14, 2001; provided, that if the debenture is prepaid before any scheduled warrant issue date, than all subsequent warrants will not be issued. In each instance, the exercise price for the warrants is 80% of the average closing bid price of the Company's common stock for the 20 days preceding each such warrant issue date.
DEPENDENCE UPON KEY PERSONNEL
The Company's continued success will depend to a significant degree upon the efforts and abilities of its senior management, in particular, Arvin Scott, its President and Chief Executive Officer, and Yehuda Tzur, its Chairman of the Board, respectively. The loss of the services of Mr. Tzur or Mr. Scott could have a material adverse effect on the Company. The Company has employment agreements with each of these individuals. The Company maintains, and intends to continue to maintain, key man term life insurance policies covering the life of each of Mr. Tzur or Mr. Scott in the amount of $1,000,000 each, the proceeds of which would be payable to the Company.
ACQUISITION OF HUNGARIAN FOUNDRY
In October 1995 the Company acquired the assets of Csepel Iron Foundry Works, a producer of high quality gray iron and ductile iron casting products, located in Budapest, Hungary. Csepel Iron Foundry Works has been a supplier of gray iron and ductile castings to the machine tool, transport and automotive
industries in Europe for over 50 years. The Company is operating the foundry facility in its existing location and retained the existing management and manufacturing staff. The Company has renovated the foundry to improve its existing manufacturing facilities. The Company can offer no assurance that its foundry operations will not require the Company to expend a substantial amount of funds to be successful.
The Company's investment in the Hungarian facility involves certain special risks not usually associated with an investment in a U.S. company, including risks related to: (i) greater social, economic and political uncertainty and instability of its customer base; (ii) certain restrictions on foreign investment and repatriation of capital; (iii) exchange control regulations; (iv) currency exchange rate fluctuations, which may increase the costs associated with conversion of the investment principal and income from one currency to another; (v) higher rates of inflation; (vi) greater governmental involvement in the economy; and (vii) the application of certain environmental regulations to the foundry property.
INSURANCE
Although the Company currently has general liability insurance for all its operations, prior to September 1994 the Company did not have general or products liability insurance for its brake rotor manufacturing operations. The Company would be adversely affected if it should incur liability for a general or products liability claim relating to an incident which occurred prior to the time the Company obtained general and products liability coverage for its manufacturing operations. To date, no such claim has been asserted against the Company. In addition, the Company would be adversely affected by the incurrence of liability which is not covered by insurance or is in excess of policy limits.
NO DIVIDENDS
The Company does not currently intend to declare or pay any cash dividends on its Common Stock in the foreseeable future and anticipates that earnings, if any, will be used to finance the development and expansion of its business. Moreover, the Company's bank lines of credit prohibit the declaration and payment of cash dividends. Prospective investors should not expect the Company to pay dividends on its Common Stock until such time, if any, that the Company is able, if at all, to obtain a release of the prohibition on the payments of dividends imposed by the terms of its credit facilities. Any payment of future dividends and the amounts thereof will be dependent upon the Company's earnings, financial requirements and other factors deemed relevant by the Company's Board of Directors, including the Company's contractual obligations.
EXERCISE OF WARRANTS
The 1,495,000 Units sold by the Company in connection with its initial public offering ("IPO") in December 1994 were comprised of one share of Common Stock and one Redeemable Common Stock Purchase Warrant (the "Warrants") entitling the holder thereof to purchase one share of Common Stock at an exercise price of $7.00 per Share, subject to certain adjustments, at any time until December 15, 1999, unless previously redeemed. In connection with the IPO, the Company issued warrants (the "Underwriter's Warrants") entitling the Underwriter to purchase from the Company, at an exercise price per Underwriter's Warrant of $7.25, up to 130,000 Units comprised of one share of Common Stock and one Warrant. On January 24, 1996, the Underwriter and its assignees exercised the Underwriter's Warrants then held (an aggregate of 130,000 Warrants). Based on the Underwriting Agreement, the holders of such Underwriter's Warrants elected to exchange shares of Common Stock (78,675 shares) whose then current market value was equal to the total required exercise price of $942,500 (130,000 units at $7.25). Thus, an additional 51,325 shares of Common Stock were issued to the Underwriter, (or certain employees thereof, who had been assigned certain of such Underwriter's Warrants) without any cash consideration to the Company. The
exercise price of the Underwriter's Warrants included in such units is 160% of the exercise price $(7.00) of the aforementioned warrants issued to the public (or $11.20). Such Warrants have not yet been exercised.
For the life of the Warrants, the holders thereof are given the opportunity to profit from a rise in the market price for the Company's securities without assuming the risk of ownership, with a resulting dilution in the interest of other security holders. As long as such Warrants remain unexercised, the terms under which the Company could obtain additional capital may be adversely affected. Moreover, the holders of such Warrants may be expected to exercise them at a time when the Company would, in all likelihood, be able to obtain any needed capital by a new offering of its securities on terms more favorable than those provided by such Warrants.
ITEM 2.
ITEM 2. PROPERTIES
The following table sets forth the general location, principal uses and approximate size of the Company's principal properties and whether such properties are leased or owned:
The Company's headquarters facility located in Chicago, Illinois, which is owned by the Company, is mortgaged to secure borrowing under the Company's revolving credit facility and certain other indebtedness. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." The warehouse portion of the Company's headquarters facility (approximately 110,000 square feet) is currently fully utilized. The Company believes that it has outgrown its headquarters facility and is negotiating to lease a larger facility and to sell its Chicago facility. There can be no assurance that negotiations will be successful or that a larger facility can be obtained or leased on cost effective terms.
The Company leases the North York, Ontario executive office and warehouse facility from an unaffiliated party for approximately $173,000 per year, originally expiring in February 1999. This North York, Ontario lease was renewed for approximately $180,000 per year, expiring in April, 2000 and will be used for friction manufacturing. In February, 1999, the Company leased a 45,000 square foot facility in
Mississauga, Ontario to serve as an executive office and distribution facility. This facility is leased from an unaffiliated party for approximately $180,000 per year, expiring in December, 2002.
The Company leases its specialty brake parts warehouse facility located in Los Angeles, California, from an unaffiliated party for approximately $135,000 per year, expiring in August 1999. The Company leases the North York, Ontario brake pad manufacturing facility from an unaffiliated party for approximately $140,000 per year, expiring in June 2000.
The Company leases its Laredo, Texas manufacturing facility from an unaffiliated party for approximately $121,500 per year, expiring in December 2000. The Company believes that this facility will provide adequate capacity for the Company's currently anticipated brake rotor manufacturing operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
During 1995, a lawsuit was filed against the Company in the United States Bankruptcy Court by a Trustee of the bankrupt estate of First National Parts Exchange, Inc. (the "Estate") with which the Company had transacted both purchases and sales of certain automotive parts in 1992 and 1993. The Company recorded a provision of $650,000 in the first quarter of 1997 to reflect a settlement agreement with the Trustee. The settlement agreement lapsed as of July 31, 1997.
On July 10, 1998, after a trial held in the Bankruptcy Court, the Bankruptcy Court ruled that the vast majority of the Trustee's claims were invalid. The Company's liability for the claims held as valid was approximately $499,000, for which the Company paid approximately $198,000 in 1998. As a result, the Company recorded benefit for lawsuit settlement of $151,000 (pre-tax) in the second quarter of 1998. The Trustee has appealed certain portions of the judgement and the Company has appealed certain portions of the $499,000 judgement against it, seeking a reduction of its liabilities. While the Trustee's claim involves substantial amounts, it is the opinion of management that the ultimate resolution of this matter will not have a material adverse effect on the Company's financial position or results of operations. There can be no assurances as to the outcome of the appeal.
All other legal proceedings and actions to which the Company is a party are of an ordinary and routine nature incidental to the operations of the Company. The Company believes that such proceedings will not, individually or in the aggregate, have a material adverse effect on the Company's business or financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders during the fourth quarter of the year ended December 31, 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock is listed on the Nasdaq SmallCap Market under the symbol "UVSL" and on The Chicago Stock Exchange under the symbol "UVS." The Redeemable Common Stock Purchase Warrants
are listed on the Nasdaq SmallCap Market under the symbol "UVSLW" and on The Chicago Stock Market under the symbol "UVSWS." The following table sets forth, for the periods indicated, the high and low sale prices per share for the Common Stock and for the Redeemable Common Stock Purchase Warrants as reported by the Nasdaq SmallCap Market on a quarterly basis, for the years 1997 and 1998. The Common Stock and the Redeemable Common Stock Purchase Warrants were initially listed on the Nasdaq SmallCap Market and on The Chicago Stock Exchange on December 15, 1994.
As of March 23, 1999, there were approximately 850 beneficial holders of the Common Stock.
The Company has not paid any cash dividends on its Common Stock. The Company does not intend to declare or pay any cash dividends on the Common Stock in the foreseeable future and anticipates that earnings, if any, will be used to finance the development of and expansion of its business. Moreover, the Company's bank lines of credit prohibit the declaration and payment of cash dividends. Any payment of future dividends and the amounts thereof will be dependent upon the Company's earnings, financial requirements, and other factors deemed relevant by the Company's Board of Directors, including the Company's contractual obligations. See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
The following selected financial data should be read in conjunction with the financial statements and notes thereto and Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K. The statement of operations data for the years ended December 31, 1998, 1997 and 1996 and the balance sheet data at December 31, 1998 and 1997 are derived from the audited financial statements of the Company included elsewhere in this Form 10-K. The statement of operations data for the years ended December 31, 1995 and 1994 and the balance sheet data at December 31, 1996, 1995 and 1994 are derived from audited financial statements not included herein. The pro forma data are based on the circumstances described in the accompanying footnotes.
(1) The financial data as of and for the year ended December 31, 1995 include, on a consolidated basis, the operations of Universal IDC and UBP Canholdings and, for the period from October 2, 1995 through December 31, 1995, also include the operations of UBP Hungary which was acquired by the Company effective October 2, 1995. Pro forma information for UBP Hungary is not included because no financial statements for periods prior to acquisition of the predecessor entity are available. See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Note 1 of the Notes to the Company's Consolidated Financial Statements.
(2) For the period beginning on and after January 1, 1992 and terminating on April 30, 1994, Universal elected to be treated as an "S Corporation" under the Internal Revenue Code of 1986, as amended, whereby income or loss of the Company is allocated to its stockholders, by inclusion in their respective individual income tax returns. Accordingly, no liability or provision for federal income taxes is reflected for Universal for the period from January 1, 1994 through April 30, 1994. The pro forma income per share adjustment for the year ended December 31, 1994 reflects a provision for federal income taxes as if the Company were a "C Corporation" rather than an S Corporation for such periods. See Item 5, Market for Registrant's Common Equity and Related Stockholder Matters, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 2 and Note 7 of the Notes to the Company's Consolidated Financial Statements.
(3) For the year ended December 31, 1994, common shares outstanding are based on the weighted average number of shares outstanding during the year. For the years ended December 31, 1995, 1996, 1997 and 1998, "Basic Earnings per Share" is computed by dividing net income (loss) available to common stockholders by the weighted average number of shares of common stock outstanding during the period. "Diluted Earnings per Share" reflects the potential dilution that could occur if warrants and options or other contracts to issue common stock were exercised and resulted in the issuance of additional common shares. For the years ended December 31, 1996, 1997 and 1998, diluted earnings per share and basic earnings per share are identical because of the losses incurred during those years. All options and warrants are omitted from the computation of diluted earnings (loss) per share because the options and warrants are antidilutive when net losses are reported. See Note 2 of the Notes to the Company's Consolidated Financial Statements.
(4) In 1994 the Company changed its method of determining inventory costs for financial reporting purposes to include capitalization of inbound customs and transportation costs. The cumulative effect on prior years of this change was $47 (net of income taxes of $29).
(5) Certain 1995 and 1994 selling, general and administrative expenses have been reclassified to cost of sales to conform to 1996, 1997 and 1998 classifications, without affecting income from operations. Other reclassifications of certain 1995 items have been made to conform to 1996, 1997 and 1998 classifications.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company is a manufacturer and distributor of brake rotors, drums, disc brake pads, relined brake shoes and wheel cylinders. The Company believes it is the leading supplier of "value line" brake parts (brake parts sold at prices significantly below those of certain leading national brand name brake parts) to mass-market retailers, traditional warehouse distributors and specialty undercar distributors in North America.
RESULTS OF OPERATIONS
Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997
Net sales for the year ended December 31, 1998 increased by $2,601,527 or 4% to $63,868,466 from $61,266,939 in 1997. The Company's sales of the core brake parts business increased by 3% compared to 1997, due to increased penetration of the friction products segment of the automotive aftermarket, rapid customer acceptance of the Company's "Ultimate" brake products and aggressive pricing which secured new customers.
Gross profit for the year ended December 31, 1998 was $13,072,283, an increase of $56,141, or essentially flat when compared to 1997 gross profit of $13,016,142. Gross profit margin for the year ended December 31, 1998 decreased to 20.5% from the 1997 level of 21.2%. This decrease is attributable to operating the Hungarian foundry at lower levels in the fourth quarter of 1998 compared to 1997 due to reduced orders from a major foundry customer for product destined to Russia and to aggressive pricing to attract new customers.
Selling, general and administrative expenses for year ended December 31, 1998 decreased to $11,244,410 from $13,763,676 in 1997 or 18%. The decrease is due principally to lower bad debt provision in 1998 compared to 1997 which included a bad debt provision for APS, Inc., once a major customer, which filed for bankruptcy in February, 1998.
Income (loss) from operations for the year ended December 31, 1998 increased $2,575,407 to income of $1,827,873 from a loss of $747,534 in 1997. This increase is due to higher sales in 1998 and lower selling, general, and administrative expenses due primarily to a lower provision for bad debts in 1998.
Other expenses for the year ended December 31, 1998 decreased $313,801 to $2,094,437 from $2,408,238 in 1997. Interest expense increased $423,509 or 25% to $2,150,882 from $1,727,373 in 1997. This increase is due to increased borrowings in 1998 compared to 1997 used for working capital purposes to support increased brake sales. Other expense includes a provision for settlement of a lawsuit initially recorded in the first quarter of 1997 in the amount of $650,000 (pretax) and a reduction $151,000 (pretax) recorded in the second quarter of 1998 reflecting the verdict rendered. The lawsuit is more fully described in the Company's Notes to Consolidated Financial Statements.
(Loss) before provision for income taxes for the year ended December 31, 1998 decreased by $2,889,208 to a loss of $266,564 from a loss of $3,155,772 in 1997. Net loss for the year ended December 31, 1998 decreased by $1,905,249 to a net loss of $180,643 from a loss of $2,085,892 in 1997. These changes result from the factors discussed above.
Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996
Net sales for the year ended December 31, 1997 decreased by $1,792,576 or 3% to $61,266,939 from $63,059,515 in 1996. The Company's increase in brake sales of approximately $9,200,000 (22%) was not quite sufficient to make up for non-brake warehouse distribution sales discontinued in 1996 and a decrease in sales in the wholesale "commodities" operation.
Gross profit for the year ended December 31, 1997 increased by $1,741,363 or 15% to $13,016,142 from $11,274,779 in 1996. Gross profit margin increased to 21.2% in 1997 from 17.9% in 1996. The increase in gross profit and gross profit margin is attributable to a more favorable sales mix as the proportion of higher margin brake sales to total sales increased in 1997 compared to 1996.
Selling, general and administrative expenses for the year ended December 31, 1997 increased to $13,763,676 from $10,599,238 in 1996 or 30%. Approximately $2.3 million of the increase is attributable to unusual, non recurring bad debt charges as a result of bankruptcy filings by several major customers due to continued consolidation in the automotive aftermarket. The remainder of the increase is due to increased variable sales expenses as brake sales carry relatively higher variable sales costs as compared to non-brake sales.
Income (loss) from operations for the year ended December 31, 1997 decreased $1,423,075 to a loss of $747,534 in 1997 from income of $675,541 in 1996. This decrease is due to the bad debt charges due to industry consolidation described above, offset by higher gross profit attributable to a higher proportion of brake parts sales to total sales than in 1996.
Other expenses for the year ended December 31, 1997 increased $1,337,985 to $2,408,238 from $1,070,253 in 1996. Interest expense increased 46% to $1,727,373 in 1997 from $1,184,018 in 1996. This increase is due to an increase in subordinated and bank borrowings during 1997. Total borrowings at December 31, 1997 were $20.7 million compared to $18.8 million at December 31, 1996. The increased borrowings were used for working capital purposes to support increased brake sales. Also the average interest rate increased due to the 12.25% subordinated debenture issued in July 1997. Other expense also includes a one time provision for settlement of a lawsuit as more fully described in Note 11 of the Company's Notes to Consolidated Financial Statements. This $650,000 pretax provision was recorded in the first quarter of 1997.
Loss before provision for income taxes and cumulative effect of accounting change for the year ended December 31, 1997 increased by $2,761,060 to a loss of $3,155,772 from a loss of $394,712 in 1996. Net loss for the year ended December 31, 1997 increased $1,592,472 to a net loss of $2,085,892 from a loss of $394,712 in 1996. These changes result from the factors discussed above.
Year Ended December 31, 1996 Compared to the Year Ended December 31, 1995
Net sales for the year ended December 31, 1996 increased by $16,244,688 or 35% to $63,059,515 from $46,814,827 in 1995. Such increase was due to a 60% increase in sales in the Company's brake parts business and a full year's revenue of the Company's Hungarian foundry which was acquired in October 1995. This increase was achieved despite a 49% sales decrease in the Company's non-brake parts warehouse distribution business which was liquidated in 1996.
Gross profit for the year ended December 31, 1996 increased by $3,208,112 or 40% to $11,274,779 from $8,066,667 in 1995. Gross profit margin increased from 17.2% in 1995 to 17.9% in 1996. The increase in gross profit was attained as sales of higher margin brake related product continued to replace sales of discontinued non-brake warehouse distribution business and inclusion of a full year of operations of the Company's Hungarian foundry. The increase in gross profit margin was attained due to the fact that sales of brake related product is at a higher margin than the sales of non brake parts which it replaced and despite significantly lower margins reported by the Hungarian foundry.
Selling, general and administrative expenses for the year ended December 31, 1996 were $10,599,238 or a 47% increase over the 1995 year of $7,219,126. Such increase was due primarily to: (i) an approximately $2,100,000 increase in selling and distribution expenses of a mostly variable nature related to the sales increase in the UBP Brake Parts business; (ii) an approximately $955,000 increase due to the inclusion of a full year's results for the Company's Hungarian foundry; (iii) an approximately $221,000 increase due to the acquisition in June 1996 of the North American Friction brake pad manufacturing business; and (iv) a charge of $195,000 to increase the reserve for bad debts to reflect collection risks associated with a certain customer.
Income from operations for the year ended December 31, 1996 decreased by $172,000 or 20% to $675,541 from $847,541 in 1995. This decrease resulted from an increased loss from operations for the Hungarian foundry of approximately $572,000, which was not offset by increased income from operations in the Company's UBP Brake Parts business.
Interest expense for the year ended December 31, 1996 increased by $340,785 or 40% to $1,184,018 from $843,233 in 1995. Such an increase resulted in an overall increase in the Company's borrowing under its bank line of credit and other subordinated borrowings which were used to finance: (i) the overall increase in sales and related increases in working capital requirements; and (ii) purchase of equipment and improvements for the manufacturing facilities and the Hungarian foundry. Also, subordinated borrowings bear interest at higher rates than bank borrowings.
Income (loss) before provision for income taxes and cumulative effect of accounting change for the year ended December 31, 1996 decreased by $426,299 to a loss of $394,712 in 1996 from income of $31,587 in 1995. Net income (loss) for the year ended December 31, 1996 decreased by $557,670 to a net loss of $493,420 from net income of $64,250 in 1995. These decreases resulted from the factors discussed above.
CAPITAL EXPENDITURES
For the year ended December 31, 1996, capital expenditures totaled approximately $3,973,000, consisting primarily of: (i) the acquisition of brake friction manufacturing machinery and equipment for approximately $2,300,000; (ii) the acquisition of machinery, equipment and additional brake rotor patterns to expand the brake rotor manufacturing capacity for approximately $600,000; and (iii) upgrade and renovation of the Hungarian foundry for approximately $1,000,000.
For the year ended December 31, 1997, capital expenditures totaled approximately $574,000, consisting primarily of (i) the acquisition of brake friction manufacturing machinery and equipment and (ii) the acquisition of machinery, equipment, and additional brake rotor patterns.
For the year ended December 31, 1998, capital expenditures totaled approximately $511,000, consisting primarily of (i) the acquisition of brake friction manufacturing machinery and equipment and (ii) the acquisition of machinery, equipment, and additional brake rotor patterns.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary liquidity needs are associated with carrying accounts receivable and maintaining inventories. The Company relies on internally generated funds, credit made available from suppliers and senior and subordinated lines of credit. The Company's working capital needs are generally not seasonal in nature, although business slows down slightly during the winter months.
The Company has incurred significant indebtedness to date in connection with its operations. As of December 31, 1998 the Company's total consolidated indebtedness was approximately $21.4 million. A substantial portion of this indebtedness is secured by substantially all of the Company's assets (except the Hungarian foundry assets) and by a pledge of all of the outstanding capital stock of the Company's subsidiaries. As a result of such indebtedness, the Company (i) is prohibited from paying cash dividends pursuant to certain covenants and restrictions contained in the loan agreements governing such indebtedness, (ii) could be hindered in its efforts to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate or other purposes, and (iii) would be vulnerable to increases in interest rates since substantially all of the Company's borrowings are at floating rates of interest.
On July 14, 1997, the Company closed a line of credit with LaSalle National Bank of up to $20,000,000 based on eligible accounts receivable and inventory and a $4,450,000 term loan. The line of credit bears interest at prime plus 0.5% per annum, subject to an ongoing option to convert to LIBOR plus 2.5% per annum. The revolving credit facility is for an initial term ending May 1, 1999. The term loan amortizes through May 1, 2002 and bears interest at a prime plus 0.75% per annum, with an ongoing to option to convert to LIBOR plus 2.75% per annum.
On July 14, 1997, the Company sold a $4,500,000 subordinated debenture to Tandem Capital, Inc. (an affiliate of Sirrom Capital Corporation and now known as Finova Mezzanine Capital, Inc.), calling for payments of interest only at 12.25% per annum through maturity on July 14, 2002. The Company issued Tandem a warrant to purchase 450,000 shares of the Company's common stock at an exercise price equal to 80% of the average closing bid price of the Company's common stock for the 20 days preceding the first anniversary of the debenture closing date, computed to be $0.83 per share. On each of August 14, 1998 and February 14, 1999, Tandem received warrants to purchase an additional 225,000 shares of common stock. Tandem will also receive warrants to purchase an additional 225,000 shares of common stock on the 14th of each of the following months: August 1999; August 2000; and August 2001; provided that if the debenture is prepaid before any scheduled warrant issue date except August 1998, then all subsequent warrants will not be issued. In each instance, the exercise price for the warrants is 80% of the average closing bid price of the Company's common stock for the 20 days preceding each such warrant issue date. The warrants are exercisable at any time through the sixth anniversary of the debenture issue date.
The Company believes that cash generated from operations, borrowings under the Company's bank line of credit and credit from its suppliers is sufficient to fund its working capital requirements and capital expenditures through 1999.
SEASONALITY
The Company's business is slightly seasonal in nature, primarily as a result of the impact of weather conditions on the demand for automotive replacement parts. Historically, the Company's sales and profits have been slightly higher in the second and third calendar quarters of each year than in the first or fourth quarters.
EFFECTS OF INFLATION
The Company historically has been able to diminish the effects of inflationary cost expenses through increased prices to customers and productivity improvements. Non-inventory cost increases, such as payroll, supplies and services, have generally been offset through price increases.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133) was issued, which the Company was required to adopt effective January 1, 1999. SFAS 133 requires the Company to record all derivatives on the balance sheet at fair value. Because the Company's use of derivatives in the past has been limited, management does not believe the effect of adopting SFAS 133 will have any material effect in its financial position or results of operations.
"YEAR 2000" COMPLIANCE
The Company has reviewed the information technology ("IT") and non-IT systems and related software in use throughout its operations is that could be affected by the Year 2000 issue. The Year 2000 issue the result of computer programs being written using two digits rather than four to define the applicable year. Thus, time sensitive software may recognize a date using the digits "00" as the year 1900 rather than the year 2000. This could result in system failure or miscalculation.
IT SYSTEMS
The Company has three major IT systems, the software for which has been licensed from various IT vendors: a system that processes and controls sales, inventory, and warehouse operations for its North American distribution business; an accounting system for its North American business; and an integrated business/accounting system for its Hungarian foundry.
The distribution business IT system requires a software upgrade from the vendor to be Year 2000 compliant. The Company chose to upgrade its computer hardware and operating system prior to installing the software upgrades to take advantage of more efficient computer operations and robust capabilities the new operating system offers. The new hardware and operating system has been installed and migration to the fully Year 2000 compliant software upgrades are scheduled to be completed by June 30, 1999. The cost of the new hardware and operating system software is approximately $75,000. The upgrade version of the software is provided by the vendor under a maintenance agreement.
The accounting system in use for the North American business has been certified as Year 2000 compliant by the software publisher for the versions in use. No additional costs are anticipated for this system.
The Year 2000 upgrade needed for the integrated business/accounting system in use at the Hungarian foundry has been installed and has been provided by the software vendor under a maintenance agreement.
NON-IT SYSTEMS
The Company has considered the risk that the Year 2000 issue may adversely affect non-IT systems in use. In several instances, the provider of outside services has certified Year 2000 compliance (i.e. banking, payroll processing, etc.) The Company believes that the manufacturing processes are not subject to Year 2000 risk due to the nature of the processes and machines in use. The Company also believes that the impact of other non-IT systems not being Year 2000 compliant would be minimal.
THIRD PARTY ISSUES
The Company is currently addressing the Year 2000 readiness of third parties whose business interruption could have a material adverse affect on our business. Significant vendors and customers are being surveyed to ascertain their plans for Year 2000 readiness. The survey is planned to be complete and results evaluated by June 30, 1999.
In a highly unlikely worst case scenario in which a portion of the Company's computer system fails to produce accurate data due to Year 2000, a temporary manual/personal computer system would be used until the software is corrected or until replacement software is installed.
Despite diligent preparation, unanticipated third-party failures, more general public infrastructure failures or failure to successfully conclude our Year 2000 readiness efforts as planned could have a material adverse impact on the Company's results of operations, financial condition and cash flows in 2000 and beyond.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial data required by this Item 8 are included as Part IV, Item 14 of this Annual Report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The response to this Item 10 is set forth in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on June 7, 1999 (the "1999 Proxy Statement") under the sections captioned "Election of Directors," "Executive Officers," "Certain Information Regarding the Board of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934," which sections are incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The response to this Item 11 is set forth in the Company's 1999 Proxy Statement under the section captioned "Executive Compensation and Related Information," which section is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this Item 12 is set forth in the Company's 1999 Proxy Statement under the section captioned "Share Ownership of Certain Beneficial Owners and Management," which section is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this Item 13 is set forth in the Company's 1999 Proxy Statement under the section captioned "Certain Transactions," which section is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) List of documents filed:
(1) Financial Statements:
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.:
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
3.1 Restated Certificate of Incorporation of Universal Automotive Industries, Inc. ("UAI") (Exhibit 3.1 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
3.2 Restated Bylaws of UAI (Exhibit 3.2 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
4.1 Specimen Certificate for Common Stock (Exhibit 4.1 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
4.2 Specimen Certificate for Warrant (Exhibit 4.2 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
4.3 Form of Warrant Agreement (including form of Warrant) (Exhibit 4.3 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
4.4 Form of Underwriter's Warrant (Exhibit 4.4 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
4.5 Restated Certificate of Incorporation of the Company (Included as Exhibit 3.1) (Exhibit 4.5 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
4.6 Restated Bylaws of UAI (Included as Exhibit 3.2) (Exhibit 4.6 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.1 Form of UAI Share Option Plan (Exhibit 10.1 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.2 Amended and Restated Loan and Security Agreement, dated May 12, 1994, between American National Bank and Trust Company of Chicago and Universal Automotive, Inc. ("UA") (Exhibit 10.2 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.3 Consent Agreement, dated October 12, 1994 by and between American National Bank and Trust Company of Chicago and UAI and UA (Exhibit 10.3 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.4 Letter Agreement, dated October 19, 1993 between Neelon Casting Ltd. and IDC (Exhibit 10.5 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.5 Collective Bargaining Agreement, effective March 12, 1994 by and between International Discus Corporation ("IDC") and United Steel Workers of America (Exhibit 10.6 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.6 Shareholder's Agreement, dated May 5, 1994, by and between UAI, Yehuda Tzur, Reuben Gabay, Sami Israel, Arvin Scott and Eric Goodman (Exhibit 10.7 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.7 Asset Purchase Agreement, dated April 30, 1994, by and between UBP Canholdings Industries, Inc. and UA (without exhibits) (Exhibit 10.8 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.8 Stock Exchange Agreement, dated May 5, 1994, by and between UAI, and Yehuda Tzur, Reuben Gabay, Sami Israel and Arvin Scott (Exhibit 10.9 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.9 Stock Exchange Agreement, dated April 30, 1994, by and between UAI and Yehuda Tzur, Reuben Gabay, Sami Israel, Arvin Scott and Eric Goodman (Exhibit 10.10 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.10 Replacement Demand Note, dated May 12, 1994, in the amount of $8,500,000 from UA to American National Bank and Trust Company of Chicago (Exhibit 10.11 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.11 Commercial Mortgage, dated February 6, 1992, by LaSalle National Bank as Trustee under Trust No. 10-06203-09 to American National Bank and Trust Company of Chicago (Exhibit 10.12 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.12 Letter Loan Agreement, dated June 4, 1993, by and between UBP Canholdings Industries Inc. and Howard Winick (Exhibit 10.13 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.13 Lease Agreement, dated September 12, 1989, by and between Lion's Roar Builders Inc. and UBP Canholdings Industries Inc. (Exhibit 10.14 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.14 Lease Agreement, dated July 29, 1993, by and between Joel Marfield and UA (Exhibit 10.15 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.15 Lease Agreement, dated February 5, 1991, by and between Sun Life Assurance Company of Canada and IDC (Exhibit 10.16 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.16 Lease Agreement, dated July 16, 1992 by and between Manabal Rochester Road and UBP Canholdings Industries Inc. (Exhibit 10.17 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.17 Lease Agreement, dated July 1, 1994, by and between Clayson Road Industrial Park and UBP Canholdings Industries Inc. (Exhibit 10.18 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.18 Lease Agreement, dated September 1, 1994 between Newcorp Properties Ltd. and UBP Canholdings Industries Inc. (Exhibit 10.19 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.19 Lease Agreement, dated June 1994, between 2800 Talman and UA. (Exhibit 10.22 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.20 Staff Leasing Agreement, dated February 1, 1994 by and between UA and Alternative Employment Strategies, Inc. (Exhibit 10.24 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.21 Amendment to Staff Leasing Agreement, dated September 1, 1994, by and between UA. and Alternative Employment Strategies, Inc. (Exhibit 10.25 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.22 Merchandizing and Service Agreement, dated March 1992, by and between UA and the Association of Muffler Dealers, Inc. (Exhibit 10.26 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.23 Employment Agreement, dated May 5, 1994, by and between UA and Yehuda Tzur (Exhibit 10.27 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.24 First Amendment to Employment Agreement, dated December 14, 1994, between UA and Yehuda Tzur (Exhibit 10.28 to the Company's Registration Statement on Form S-1 (No. 33- 85162) as filed with the SEC on October 14, 1994)*
10.25 Employment Agreement, dated May 5, 1994, by and between UA and Arvin Scott (Exhibit 10.29 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.26 First Amendment to Employment Agreement, dated December 14, 1994, between UA and Arvin Scott (Exhibit 10.30 to the Company's Registration Statement on Form S-1 (No. 33- 85162) as filed with the SEC on October 14, 1994)*
10.27 Employment Agreement, dated May 5, 1994, by and between UBP Canholdings Industries Inc. and Eric Goodman (Exhibit 10.31 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.28 First Amendment to Employment Agreement, dated December 14, 1994, by and between UBP Canholdings Industries Inc. and Eric Goodman (Exhibit 10.32 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.29 Employment Agreement, dated May 5, 1994 by and between UA and Reuben Gabay (Exhibit 10.33 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.30 First Amendment to Employment Agreement, dated December 14, 1994 by and between UA and Reuben Gabay (Exhibit 10.34 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.31 Employment Agreement, dated May 5, 1994 by and between UA and Sami Israel (Exhibit 10.35 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.32 First Amendment to Employment Agreement, dated December 14, 1994 by and between UA and Sami Israel (Exhibit 10.36 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.33 Letter Loan Agreement, dated August 31, 1994, by and between NBD Bank, Canada and IDC, IDC Holdings Corporation, and UA (Exhibit 10.37 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.34 Demand Promissory Note, dated as of September 1, 1994 given by UBP Canholdings Industries Inc. in favor of NBD Bank, Canada in the principal amount of $1,250,000-CDN (Exhibit 10.40 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.35 Agreement of Purchase and Sale, dated September 30, 1993 by and between John Corrigan, Jr. and IDC Holdings Corporation with respect to shares in the capital stock of IDC (without schedules and exhibits). (Exhibit 10.41 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.36 IDC Share Purchase Agreement, dated September 9, 1992 by and between Seyho Investment Inc. and Douglas A. Dempsey and IDC and IDC Holdings Corporation (without schedules and exhibits). (Exhibit 10.42 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.37 Amendment to IDC Share Purchase Agreement, dated January 6, 1993 by and between Seyho Investments Inc. and IDC and IDC Holdings Corporation. (Exhibit 10.43 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.38 IDC Share Purchase Agreement, dated September 31, 1992 by and between John Corrigan, Jr. and IDC and IDC Holdings Corporation (without schedules and exhibits) (Exhibit 10.44 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.39 Commercial Mortgage, dated December 29, 1993 by UA to American National Bank and Trust Company of Chicago (Exhibit 10.45 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.40 Agreement, dated January 6, 1994, by and between Kelsey-Hayes Canada Limited and UBP Canholdings Industries Inc. (Exhibit 10.46 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
10.41 Form of Letter Consulting Agreement between UAI and Kensington Wells Incorporated (Exhibit 10.48 to the Company's Registration Statement on Form S-1 (No. 33-85162) as filed with the SEC on October 14, 1994)*
21 Subsidiaries of the Registrant
23 Consent of Altschuler Melvoin & Glasser LLP
- ---------------
* These exhibits are incorporated herein by reference to the registration statement referenced after each exhibit next to which an asterisk appears.
+ Indicates executive compensation plans and arrangements.
(b) Reports on Form 8-K
The Company filed no reports of Form 8-K during the fourth quarter of 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
By: /s/ Arvin Scott ------------------------------------ Arvin Scott, Chief Executive Officer
Date: March 30, 1999
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated and on the dates indicated.
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FINANCIAL STATEMENTS AND SCHEDULES
December 31, 1998
FORMING A PART OF ANNUAL REPORT PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934
FORM 10-K OF UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Page
INDEPENDENT AUDITORS' REPORT F - 2 to F - 3
FINANCIAL STATEMENTS: Consolidated Balance Sheets, December 31, 1998 and 1997 (Exhibit A) F - 4
Consolidated Statement of Operations, Years Ended December 31, 1998, 1997 and 1996 (Exhibit B) F - 5
Consolidated Statements of Changes in Stockholders' Equity, Years Ended December 31, 1998, 1997 and 1996 (Exhibit C) F - 6
Consolidated Statement of Cash Flows, Years Ended December 31, 1998, 1997 and 1996 (Exhibit D) F - 7 to F - 8
Notes to the Financial Statements F - 9 to F - 21
ADDITIONAL FINANCIAL DATA:
Independent Auditors' Report on Schedules S - 1
Condensed Financial Information of Registrant (Schedule I) S - 2 to S - 4
Valuation and Qualifying Accounts (Schedule II) S - 5
F - 1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Universal Automotive Industries, Inc.
We have audited the accompanying consolidated balance sheets of UNIVERSAL AUTOMOTIVE INDUSTRIES, INC. as of December 31, 1998 and 1997, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. 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 did not audit the financial statements of certain of the Company's wholly owned foreign subsidiaries (Note 1) which statements reflect aggregate total assets of $4,301,530 and $4,099,889 as of December 31, 1998 and 1997 and aggregate total revenue of $5,616,393, $5,446,085 and $16,250,090 for each of the respective three years in the period ended December 31, 1998. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for such subsidiaries is based solely on the reports of the other auditors.
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 and the reports of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Universal Automotive Industries, Inc. as of December 31, 1998 and 1997, and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
Chicago, Illinois March 12, 1999
F - 2 [ARTHUR ANDERSEN LETTERHEAD]
THIS IS THE ENGLISH TRANSLATION OF THE HUNGARIAN ORIGINAL (NOTE 0)
INDEPENDENT AUDITORS' REPORT
To the quotaholder of UBP-Csepel Iron Foundry Kft.:
We have audited the accompanying balance sheet of UBP-Csepel Iron Foundry Kft. ("the Company") as at 31 December 1998, which shows total assets of HUF'000 643,688 and a retained result for the year of HUF'000 317,422 profit, the related statement of operations for the year then ended and the supplement (collectively "the financial statements") included in the Company's 1998 Annual Report. The Annual Report, comprising the financial statements and a Business Report, is the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audit. In addition, it is our responsibility to assess whether the accounting information in the Business Report is consistent with that contained in the financial statements.
We have also audited the Company's Annual Report for the year ended 31 December 1997 and issued an unqualified opinion. Reference is made to our Auditors' Report dated 13 February 1998.
We conducted our audit in accordance with the International Standards on Auditing and applicable laws and regulations in Hungary. 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. Our work with respect to the Business Report was limited to checking it within the aforementioned scope, and did not include a review of any information other than that drawn from the audited accounting records of the Company. We believe that our audit provides a reasonable basis for our opinion.
This Annual Report has been prepared for the consideration of the owner at the forthcoming Quotaholder's Meeting, and does not reflect the effects, if any, of resolutions that might be adopted at that meeting.
In our opinion, except for the effects, if any, of resolutions that might be adopted at the forthcoming Quotaholder's Meeting, the Annual Report has been prepared in accordance with the provisions of the Act on Accounting and accounting principles generally accepted in Hungary and gives a true and fair view of the financial position of the UBP-Csepel Iron Foundry Kft. as of 31 December 1998 and of the results of its operations for the year then ended.
Budapest, 19 February 1999
(The original Hungarian language version has been signed.)
Judit Szilagyi Hajnalka Szarvas Arthur Andersen Audit Kft. Registered Auditor MKVK-000023 MKVK-005105
Exhibit A
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Consolidated Balance Sheets December 31, 1998 and 1997
The accompanying notes are an integral part of this statement.
F - 4
Exhibit B
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Consolidated Statements of Operations Years Ended December 31, 1998, 1997 and 1996
The accompanying notes are an integral part of this statement.
F - 5 Exhibit C UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Consolidated Statements of Changes in Stockholders' Equity
Years Ended December 31, 1998, 1997 and 1996
The accompanying notes are an integral part of this statement.
F - 6
Exhibit D
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Consolidated Statements of Cash Flows Years Ended December 31, 1998, 1997 and 1996
F - 7
Exhibit D, Continued
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Consolidated Statements of Cash Flows Years Ended December 31, 1998, 1997 and 1996
The accompanying notes are an integral part of this statement.
F - 8
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 1---STRUCTURE - ------------------
Universal Automotive Industries, Inc. (the Company) acts as a holding company for its wholly-owned direct and indirect subsidiaries which as of December 31, 1998 are as follows:
Universal Automotive, Inc. (Universal), a United States Corporation.
Canadian Corporations:
UBP Canholdings, Inc. (Canholdings) and its wholly owned subsidiaries: Universal Brake Parts, Inc. International Discus Corporation (Inactive) (IDC)
UBP Hungary, Inc. (Hungary), a United States Corporation and its wholly owned subsidiary, UBP Csepel Iron Foundry, KFT, a Hungarian limited liability company.
NOTE 2--NATURE OF ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ---------------------------------------------------------------------------
Universal Automotive Industries, Inc. is engaged principally in the manufacture and distribution of automotive brake parts operating from facilities in Chicago, Illinois; Los Angeles, California; Laredo, Texas; and Toronto, Canada. Sales are made throughout the United States and Canada. The Company's Hungarian subsidiary is engaged in the manufacture of iron casting products, primarily for the automotive and machine tool industries. All of its sales are in Europe.
A summary of significant accounting policies is as follows:
PRINCIPLES OF CONSOLIDATION--The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
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 disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from the estimates.
FOREIGN CURRENCY TRANSLATION--For Canholdings, the local currency is the functional currency and translation adjustments are accumulated in a separate component of stockholders' equity entitled "Accumulated Other Comprehensive Loss" (consisting solely of such translation adjustments). The Company determined that the country of Hungary's economy qualifies as a "highly inflationary economy" and, thus, Hungary's financial statements have been remeasured as if the functional currency is the U.S. dollar. Such remeasurement creates adjustments which are included in the determination of net income or loss.
INVENTORIES--Inventories are stated at the lower of cost or market value with cost generally determined using the weighted average method, which approximates the first-in, first-out (FIFO) method.
DEPRECIATION--Depreciation of property and equipment has been computed under accelerated and straight-line methods for financial reporting purposes, and accelerated methods for income tax reporting purposes, over the estimated useful lives of the assets.
F - 9
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 2--NATURE OF ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, - --------------------------------------------------------------------------- CONTINUED - ---------
COST OF SALES--The Company considers warehousing (including certain salaries, occupancy costs, supplies) and buying expenses as an integral component of cost of sales.
GOODWILL--Goodwill represents the excess of the cost of various companies acquired, over the fair value of the net assets at their respective dates of acquisition. Such goodwill is being amortized over 20 to 40 years using the straight-line method.
DERIVATIVES--The Company had previously utilized only limited derivative financial instruments and did not use them for trading purposes. At December 31, 1998, there were no such instruments.
INCOME TAXES--Deferred income tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income tax assets and liabilities are determined based on the financial statement and tax bases of assets and liabilities (Note 7).
ADVERTISING--All costs associated with advertising are charged to operations by inclusion in selling, general and administrative expenses when incurred.
RECLASSIFICATION--Certain amounts reported in the 1997 and 1996 financial statements have been reclassified to conform with the 1998 presentation without affecting previously reported net losses.
EARNINGS PER SHARE--The Company computes earnings per share under Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). Under SFAS 128, "Basic Earnings per Share" is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. "Diluted Earnings per Share" reflects the potential dilution that could occur if warrants and options (Note 11) or other contracts to issue common stock were exercised and resulted in the issuance of additional common shares. For the years ended December 31, 1998, 1997 and 1996 diluted earnings per share and basic earnings per share are identical because of the losses incurred during those years. All options and warrants were omitted from the computation of diluted earnings per share because the options and warrants are antidilutive when net losses are reported.
FAIR VALUE OF FINANCIAL INSTRUMENTS--The fair value of financial instruments, other than debt instruments, closely approximates their carrying value. Because the interest rate of the revolving loan and the term loan with LaSalle National Bank adjusts with changes in the market rate of interest, management believes the fair value is equivalent to the carrying value. Management believes that the interest rate of 12.25% on the subordinated debenture is approximately equal to the current rate available for similar debt. Accordingly, the fair value of these debentures approximates their carrying value.
F - 10
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 2--NATURE OF ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, - ---------------------------------------------------------------------------- CONTINUED - ---------
ACCOUNTING CHANGE--In 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income," which requires the components of comprehensive income to be disclosed in the financial statements, and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which requires certain information to be reported about operating segments on a basis consistent with the Company's internal organizational structure. Required disclosures have been made and prior years' information has been reclassified for the impact of SFAS 130 and 131.
RECENT ACCOUNTING PRONOUNCEMENTS--In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133) was issued, which the Company is required to adopt effective January 1, 1999. SFAS 133 will require the Company to record all derivatives on the balance sheet at fair value. Because the Company's use of derivatives in the past has been limited, management does not believe the effect of adopting SFAS 133 will have any material effect on its financial position or results of operations.
NOTE 3--SELECTED FINANCIAL STATEMENT DATA - -----------------------------------------
F - 11 UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 3--SELECTED FINANCIAL STATEMENT DATA, CONTINUED - ----------------------------------------------------
1998 1997 1996 ---------- --------- --------- Depreciation expense $ 773,988 $ 877,968 $ 663,746 Advertising expense 299,525 136,274 191,704
NOTE 4--SUBORDINATED DEBENTURE - ------------------------------
On July 14, 1997, the Company sold a $4,500,000 subordinated debenture to Tandem Capital, Inc. (an affiliate of Sirrom Capital Corporation), calling for payments of interest at 12.25% per annum through maturity on July 14, 2002. The Company issued Tandem a warrant to purchase 450,000 shares of the Company's common stock at an exercise price equal to 80% of the average closing bid price of the Company's common stock for the 20 days preceding the first anniversary of the debenture closing date, computed to be ($.83 per share). On August 14, 1998, Tandem received warrants to purchase an additional 225,000 shares of common stock, and will also receive warrants to purchase an additional 225,000 shares of common stock on: February 14, 1999, August 14, 1999, August 14, 2000 and August 14, 2001 except, however, that if the debenture is prepaid before any scheduled warrant issue date, then all subsequent warrants will not be issued. In each instance, the exercise price for the warrants is 80% of the average closing bid price of the Company's common stock for the 20 days preceding each such warrant issue date. The warrants are exercisable at any time through the sixth anniversary of the debenture issue date. In 1997, $225,000 was allocated to such warrants which approximates the amount of increased interest the buyer would have required without a warrant feature. Such amount is being amortized to interest expense with a corresponding increase in the reported liability for such debentures.
NOTE 5--LASALLE NATIONAL BANK INDEBTEDNESS - ------------------------------------------
On July 14, 1997, the Company entered into a credit agreement with LaSalle National Bank (LaSalle) for (a) a revolving line of credit of up to $20,000,000 based on eligible accounts receivable and inventory and (b) a term loan in the initial amount of $4,450,000.
The revolving credit facility, which is for an initial term ending May 1, 1999 bears interest of prime plus 0.5% per annum, subject to an ongoing option to convert to LIBOR plus 2.5% per annum. The term loan is payable in monthly principal installments of $24,722, with a balloon payment of $2,966,666 due on May 1, 2002, and bears interest at prime plus 0.75% per annum.
At December 31, 1998 and 1997, respectively, amounts of $12,910,000 and $11,975,000 were due on the revolving credit line and amounts of $4,054,448 and $4,276,946 were due on the term loan (see Note 6). LaSalle has informed the Company that it intends to renew the revolving credit facility, under similar terms, to mature subsequent to December 31, 1999 and, as such, the balance as of December 31, 1998 has been classified as noncurrent.
The LaSalle agreement contains certain limitations on dividends and capital expenditures and requires the Company to satisfy certain financial tests concerning defined minimum tangible net worth and ratios of liabilities to tangible net worth. At December 31, 1998, the Company was in compliance with all loan covenants (or had received waivers). The entire credit facility is secured by a first lien on substantially all of the Company's North American assets. At December 31, 1998, approximately $1,104,000 was available for borrowing under the revolving credit line.
The weighted average interest rates on the aforementioned borrowings were 8.67%, 8.22% and 7.54% for the years ended December 31, 1998, 1997, and 1996, respectively.
F - 12
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 6--LONG-TERM INDEBTEDNESS - ------------------------------
NOTE 7--INCOME TAXES - --------------------
Income tax expense (benefit) consisted of the following:
F - 13
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 7--INCOME TAXES, CONTINUED - -------------------------------
The components of the domestic net deferred tax assets are as follows:
A reconciliation of the provision for income taxes and the amount computed by applying the federal statutory rate to income (loss) before income tax expense is as follows:
F - 14
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 7--INCOME TAXES, CONTINUED - ------------------------------- Income taxes refundable consist of:
The United States entities' consolidated federal income tax returns filed for the years 1995 and 1996 are currently under examination by the Internal Revenue Service. No significant deficiencies are expected to result from such examination.
NOTE 8--LEASES AND OTHER COMMITMENTS - ------------------------------------
The Company leases from unaffiliated parties all of its facilities except for the Chicago headquarters and Hungarian foundry both of which are owned. The lease terms range from month-to-month to long-term leases, the latest of which expires in 2002. Annual rents for the facilities range from $123,000 to $135,000.
Aggregate rent expense for all facilities was approximately $729,000, $725,000 and $527,000 for 1998, 1997 and 1996, respectively.
The Company leases certain equipment under capital leases payable in aggregate monthly installments of $5,200 with the latest expiring in 2003. The net book value of such equipment under capital lease is $23,000. Certain vehicles and equipment are also leased under operating leases, the latest expiring in 2001.
Approximate minimum lease payments due over the remaining terms of the leases are as follows:
Capital Operating Leases Leases -------- ---------- 1999 $ 33,142 $ 715,319 2000 9,624 459,292 2001 5,582 226,956 2002 5,582 136,362 2003 3,256 0 -------- ---------- 57,186 1,537,929 Less interest portion 5,794 0 -------- ---------- $ 51,392 $1,537,929 ======== ==========
F - 15
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 9--GEOGRAPHICAL SEGMENT/MAJOR CUSTOMER DATA - ------------------------------------------------
The Company's operations primarily involve three geographic segments. The United States and Canada operations involve the design, manufacture, sale and support of automotive brake parts. The European operation (Hungary) involves the manufacture of iron casting products, primarily for the automotive and machine tool industries. Financial information, summarized by geographical area follows:
F - 16
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 9--GEOGRAPHICAL SEGMENT/MAJOR CUSTOMER DATA, CONTINUED - -----------------------------------------------------------
In 1998 and 1997, one customer accounted for 12% and 17% of total consolidated sales. Purchases from one vendor accounted for approximately 16% of consolidated cost of sales in each year.
F - 17
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 10--CONTINGENCIES - ----------------------
During 1995, a lawsuit was filed against the Company in the United States Bankruptcy Court (the Court) by a Trustee of the bankruptcy estate of First National Parts Exchange, Inc. ("the Estate") with which the Company had transacted both purchases and sales of certain automotive parts in 1992 and 1993. The Company recorded a provision of $650,000 in the first quarter of 1997 to reflect a settlement agreement with the Trustee. The settlement agreement lapsed as of July 31, 1997.
On July 10, 1998, after a trial held in the Bankruptcy Court, the Court ruled that the vast majority of the trustee's claims were invalid. The Company's liability for the claims held as valid was approximately $499,000, for which the Company paid approximately $198,000 in 1998. As a result, the Company recorded benefit for lawsuit settlement of $151,000 (pre-tax) in the second quarter of 1998. The Trustee has appealed certain portions of the judgement and the Company has appealed certain portions of the $499,000 judgement against it, seeking a reduction of its liabilities. While the Trustee's claim involves substantial amounts, it is the opinion of management that the ultimate resolution of this matter will not have a material adverse effect on the Company's financial position or results of operations.
NOTE 11--STOCK WARRANTS AND OPTIONS - -----------------------------------
The Company has outstanding 1,495,000 redeemable common stock purchase warrants. Each warrant entitles the holder to purchase one share of the Company's common stock at an exercise price of $7.00 per share, subject to certain adjustments, at any time until December 15, 1999. The warrants may be redeemed, in whole or in part, at the Company's option, if the closing bid price of the Company's common stock exceeds 175% of the exercise price (or $12.25 per share) for 20 consecutive trading days, as defined. Such warrants have not been exercised or redeemed.
The underwriting agreement entered into in connection with the Company's 1994 initial public offering granted the underwriter a warrant to purchase 130,000 units (consisting of one common share and a warrant to purchase one common share) at an exercise price of $7.25 per unit.
On January 24, 1996, these underwriter warrants were exercised. Holders elected to exchange 78,675 shares of common stock (whose then current market value was equal to the total required exercise price) in return for the 130,000 common shares and the 130,000 warrants. Thus, 51,325 shares of Company stock were issued without cash consideration to the Company. The Company, therefore, also has outstanding 130,000 common stock purchase warrants. The exercise price of the warrants is $11.20. Such warrants have not yet been exercised. Also, see Note 4 for warrants issued in connection with subordinated debentures.
F - 18
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 11--STOCK WARRANTS AND OPTIONS, CONTINUED - ----------------------------------------------
The Company maintains a Stock Option Plan (as amended and restated effective June 9, 1998) for defined key employees and others. Options granted may be either incentive stock options as specified by the Internal Revenue Code or nonstatutory options. The Company has reserved 700,000 shares of common stock for issuance under the Stock Option Plan. Following is a table indicating the activity during 1998, 1997 and 1996 for such Stock Option Plan:
Weighted Average Stock Exercise Options Price ------------ -------- Options granted in 1995 and outstanding at December 31, 1995 $ 57,000 $ 1.07 1996: Options granted 84,526 5.00 Options exercised (1,400) (5.00) Options forfeited (2,100) (5.00) ---------- Balance, December 31, 1996 138,026 $ 3.38 ======= 1997: Options granted 41,500 $ 4.86 ---------- ======= Balance, December 31, 1997 179,526 $ 3.72 ======= 1998: Options granted 213,150 $ 1.54 Options forfeited (44,700) (3.02) Options canceled (70,000) (2.48) ----------
Balance, December 31, 1998 $ 277,976 $ 2.47 ========== =======
Options exercisable, December 31, 1998 $ 137,036 $ 2.86 ========== =======
The weighted average fair values of options granted during the years ended December 31, 1996, 1997 and 1998 were $7.69, $2.75 and $1.42, respectively.
F - 19
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 11--STOCK WARRANTS AND OPTIONS, CONTINUED - ----------------------------------------------
The following table summarizes information about the outstanding and exercisable stock options as of December 31, 1998:
Options Outstanding ------------------- Weighted- Weighted- Range of Remaining Average Exercise Number Contractual Exercise Prices Outstanding Life Price ------------ ----------- ----------- -------- $ 1.00 11,000 91 months $ 1.00 1.09 - 1.20 114,350 113 months 1.16 2.03 - 2.23 75,600 108 months 2.22 3.00 5,000 105 months 3.00 5.00 72,026 104 months 5.00 ----------- 277,976 ===========
Options Exercisable ------------------- Weighted- Range of Average Exercise Number Exercise Prices Exercisable Price ------------ ----------- -------- $ 1.00 11,000 $ 1.00 1.09 - 1.20 25,080 1.16 2.03 - 2.23 51,240 2.22 3.00 5,000 3.00 5.00 44,716 5.00 ----------- 137,036 ===========
Effective January 1998, 44,000 of the 55,000 options previously granted at a $1.00 exercise price were cancelled and replaced with options to purchase 60,000 shares at 110% of market value at the date of such grant.
Compensation expense is being recorded over the respective service periods required of the optionees, based on the difference between the grant price and the market price of the stock on the dates of such grants, as required by APB Opinion 25, Accounting for Stock Issued to Employees. In 1998, 1997 and 1996, amounts of $39,509, $158,097 and $147,947, respectively, have been provided for such compensation expense (with offsetting credits to additional paid-in capital).
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UNIVERSAL AUTOMOTIVE INDUSTRIES, INC.
Notes to the Consolidated Financial Statements December 31, 1998 and 1997
NOTE 11--STOCK WARRANTS AND OPTIONS, CONTINUED - ----------------------------------------------
The Company has adopted only the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123) and continues to account for stock options in accordance with APB Opinion 25. The foregoing amount of compensation expense for 1998, 1997 and 1996 differs by less than $.01 per share from that which would have been recorded using the Black-Scholes option valuation method. Accordingly, the pro forma disclosures required by SFAS 123 have been omitted.
NOTE 12--QUARTERLY RESULTS (UNAUDITED) - --------------------------------------
The fourth quarter 1998 loss was attributable to (a) lower operating levels at the Hungarian foundry in such quarter due to a reduction in orders from a customer shipping primarily to Russia and (b) aggressive pricing in North America as part of a strategy to attract new customers.
The fourth quarter of 1997 loss was attributable to a one time increase in the bad debt reserve of approximately $2 million which related to the bankruptcy filing of a major customer and recognition of further consolidation in the automotive aftermarket.
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INDEPENDENT AUDITORS' REPORT ON SCHEDULES
To the Board of Directors of Universal Automotive Industries, Inc.
In connection with our audit of the consolidated financial statements of UNIVERSAL AUTOMOTIVE INDUSTRIES, INC. referred to in our report dated March 12, 1999 which is included in this Form 10-K, we have also audited Schedules I and II as of and for the years ended December 31, 1998, 1997 and 1996. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.
Chicago, Illinois March 12, 1999
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Schedule I, Page 1
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC. (An S Corporation)
Balance Sheets (Not Consolidated) December 31, 1998 and 1997
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Schedule I, Page 2
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC. (An S Corporation)
Statement of Operations and Retained Earnings (Deficit) (Not Consolidated) Years Ended December 31, 1998, 1997 and 1996
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Schedule I, Page 3
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC. (An S Corporation)
Statement of Cash Flows (Not Consolidated) Years Ended December 31, 1998, 1997 and 1996
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Schedule II
SCHEDULE II
UNIVERSAL AUTOMOTIVE INDUSTRIES, INC. (An S Corporation)
Valuation and Qualifying Accounts Years Ended December 31, 1998, 1997 and 1996
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