UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended November 30, 2005
OR
Commission File No. 1-11288
ACTUANT CORPORATION
(Exact name of registrant as specified in its charter)
6100 NORTH BAKER ROAD
MILWAUKEE, WISCONSIN 53209
Mailing address: P. O. Box 3241, Milwaukee, Wisconsin 53201
(Address of principal executive offices)
(414) 352-4160
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
The number of shares outstanding of the registrant’s Class A Common Stock as of December 30, 2005 was 27,124,763.
TABLE OF CONTENTS
Part I -Financial Information
Item 1 -Financial Statements (Unaudited)
Actuant Corporation-
Condensed Consolidated Statements of Earnings
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Cash Flows
Notes to Condensed Consolidated Financial Statements
Item 2 -Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3 -Quantitative and Qualitative Disclosures about Market Risk
Item 4 -Controls and Procedures
Part II -Other Information
Item 6 -Exhibits
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FORWARD LOOKING STATEMENTS AND CAUTIONARY FACTORS
This quarterly report on Form 10-Q contains certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. The terms “may,” “should,” “could,” “anticipate,” “believe,” “estimate,” “expect,” “objective,” “plan,” “project” and similar expressions are intended to identify forward-looking statements. Such forward-looking statements are subject to inherent risks and uncertainties that may cause actual results or events to differ materially from those contemplated by such forward-looking statements. In addition to the assumptions and other factors referred to specifically in connection with such statements, factors that may cause actual results or events to differ materially from those contemplated by such forward-looking statements include, without limitation, general economic conditions, variation in demand from customers, the impact on the economy of terrorist attacks and other geopolitical activity, continued market acceptance of the Company’s new product introductions, the successful integration of business unit acquisitions and related restructuring, operating margin risk due to competitive pricing and operating efficiencies, supply chain risk, material and labor cost increases, foreign currency fluctuations, interest rate risk and other factors that may be referred to or noted in the Company’s reports filed with the Securities and Exchange Commission from time to time.
When used herein, the terms “Actuant,” “we,” “us,” “our,” and the “Company” refer to Actuant Corporation and its subsidiaries.
Actuant Corporation provides free-of-charge access to its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments thereto, through its website, www.actuant.com, as soon as reasonably practical after such reports are electronically filed with the Securities and Exchange Commission.
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PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
November 30,
Net sales
Cost of products sold
Gross profit
Selling, administrative and engineering expenses
Amortization of intangible assets
Operating profit
Financing costs, net
Other expense (income), net
Earnings before income tax expense and minority interest
Income tax expense
Minority interest, net of income taxes
Net earnings
Earnings per share:
Basic
Diluted
Weighted average common shares outstanding:
See accompanying Notes to Condensed Consolidated Financial Statements
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CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
2005
August 31,
Current assets:
Cash and cash equivalents
Accounts receivable, net of allowances for losses of $7,758 and $7,859, respectively
Inventories, net of allowances for losses of $15,360 and $15,318, respectively
Deferred income taxes
Other current assets
Total current assets
Gross property, plant and equipment
Less: Accumulated depreciation
Property, plant and equipment, net
Goodwill
Other intangible assets, net
Other long-term assets
Total assets
Current liabilities:
Short-term borrowings
Trade accounts payable
Accrued compensation and benefits
Income taxes payable
Current maturities of long-term debt
Other current liabilities
Total current liabilities
Long-term debt, less current maturities
Pension and postretirement benefit liabilities
Other long-term liabilities
Shareholders’ equity:
Class A common stock, $0.20 par value, authorized 42,000,000 shares, issued and outstanding 27,116,169 and 27,047,107 shares, respectively
Additional paid-in capital
Retained earnings
Restricted stock awards
Stock held in trust
Deferred compensation liability
Accumulated other comprehensive loss
Total shareholders’ equity
Total liabilities and shareholders’ equity
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Operating Activities
Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation and amortization
Amortization of debt discount and debt issuance costs
Stock-based compensation expense
Provision for deferred income taxes
Gain on disposal of assets
Changes in operating assets and liabilities, excluding the effects of business acquisitions:
Accounts receivable
Inventories
Prepaid expenses and other assets
Reimbursement of tax refund to former subsidiary.
Other accrued liabilities
Net cash provided by (used in) operating activities
Investing Activities
Proceeds from sale of property, plant and equipment
Capital expenditures
Cash paid for business acquisitions, net of cash acquired
Net cash used in investing activities
Financing Activities
Net (repayments) borrowings on revolving credit facilities and short-term borrowings
Principal payments on term loans
Cash dividend
Tax benefit from stock-based compensation
Stock option exercises and other
Net cash (used in) provided by financing activities
Effect of exchange rate changes on cash
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents – beginning of period
Cash and cash equivalents – end of period
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share amounts)
Note 1. Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements of Actuant Corporation (“Actuant,” or the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial reporting and with the instructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The condensed consolidated balance sheet data as of August 31, 2005 was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. The Company’s significant accounting policies are disclosed in its fiscal 2005 Annual Report on Form 10-K. For additional information, refer to the consolidated financial statements and related footnotes in the Company’s fiscal 2005 Annual Report on Form 10-K.
In the opinion of management, all adjustments considered necessary for a fair presentation of financial results have been made. Except as otherwise discussed, such adjustments consist of only those of a normal recurring nature. Operating results for the three months ended November 30, 2005 are not necessarily indicative of the results that may be expected for the entire fiscal year ending August 31, 2006.
Prior year financial statements have been reclassified where appropriate to conform to current year presentations. In addition, prior year financial statements have been restated due to the adoption of SFAS No. 123(R) “Accounting for Stock Based Compensation” in the fourth quarter of fiscal 2005. See Note 9, “Stock Based Compensation” for further information.
Note 2. Acquisitions
The Company completed five business acquisitions during fiscal 2005, all of which resulted in the recognition of goodwill in the Company’s Consolidated Financial Statements. The Company is continuing to evaluate the initial purchase price allocations for the acquisitions completed in fiscal 2005, and will adjust the allocations as additional information relative to the fair values of the assets and liabilities of the acquired businesses become known.
On December 27, 2004, the Company acquired all of the outstanding stock of Key Components, Inc. (“KCI” or the “KCI Acquisition”) for approximately $316.9 million (including the assumption of $80.8 million of debt less $2.2 million of acquired cash). During the first quarter of fiscal 2006, a purchase accounting adjustment was made when the Company collected a fully reserved note receivable that had been acquired as part of the KCI acquisition. The amount assigned to goodwill decreased by $1.2 million to $197.8 million as a result of this purchase accounting adjustment.
The following unaudited pro forma results of operations of the Company for the three months ended November 30, 2005 and 2004, respectively, give effect to all acquisitions completed since September 1, 2004 as though the transactions had occurred on September 1, 2004.
As reported
Pro forma
Net earnings from continuing operations
Basic earnings per share
Diluted earnings per share
The first quarter of fiscal 2005 includes a $2.0 million pre-tax gain in “Other expense (income), net” in the Consolidated Statement of Earnings. In November 2004, the Company entered an agreement with a former subsidiary related to funds it held to reimburse itself for certain estimated costs arising for the Company’s spin-off of the subsidiary. Under this agreement, the Company agreed to reimburse $15.8 million to fully satisfy the former subsidiary’s interest in the funds, and retain $2.0 million of the funds for its own use, resulting in the $2.0 million pre-tax gain. This gain impacts the comparability of the pro forma results presented above.
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Note 3. Restructuring Reserves
The Company committed to integration plans to restructure portions of the German electrical operations upon its acquisition in the first quarter of fiscal 2003. These plans were designed to reduce administrative and operational costs. The remaining $1.2 million of accrued severance costs at November 30, 2005 will be paid to former employees over the next two years as dictated by contractual arrangements with those employees.
A rollforward of the severance reserve follows (in thousands):
Accrued severance costs as of August 31, 2005
Cash payments
Currency impact
Accrued severance costs as of November 30, 2005
Note 4. Accounts Receivable Financing
The Company maintains an accounts receivable securitization program whereby it sells certain of its trade accounts receivable to a wholly owned, bankruptcy-remote special purpose subsidiary which, in turn, sells participating interests in its pool of receivables to a third-party financial institution (the “Purchaser”). The Purchaser receives an ownership and security interest in the pool of receivables. New receivables are purchased by the special purpose subsidiary and participation interests are resold to the Purchaser as collections reduce previously sold participation interests. The Company has retained collection and administrative responsibilities on the participation interests sold. The Purchaser has no recourse against the Company for uncollectible receivables; however, the Company’s retained interest in the receivable pool is subordinate to the Purchaser and is recorded at fair value. Due to a short average collection cycle of approximately 60 days for such accounts receivable and the Company’s collection history, the fair value of the Company’s retained interest approximates book value. The retained interest recorded at November 30, 2005 and August 31, 2005 is $31.1 million and $29.9 million, respectively, and is included in accounts receivable in the accompanying Condensed Consolidated Balance Sheets. The securitization program has a final maturity in May 2006, subject to annual renewal by the Purchaser. The Company amended its securitization program in February 2005 to increase capacity from $35 million to $55 million, and to include trade accounts receivable from certain of the domestic entities acquired. Trade accounts receivables sold and being serviced by the Company totaled $46.6 million and $43.8 million at November 30, 2005 and August 31, 2005, respectively.
Sales of trade receivables from the special purpose subsidiary to the Purchaser totaled $95.2 million and $51.7 million for the three months ended November 30, 2005 and 2004, respectively. Cash collections of trade accounts receivable balances in the total receivable pool, which includes participating interests sold to the Purchaser and the retained interest, totaled $145.7 million and $83.0 million for the three months ended November 30, 2005 and 2004 respectively.
Sales of trade receivables are reflected as a reduction of accounts receivable in the accompanying Condensed Consolidated Balance Sheets and the proceeds received are included in cash flows from operating activities in the accompanying Condensed Consolidated Statements of Cash Flows. The table below provides additional information about delinquencies and net credit losses for trade accounts receivable subject to the accounts receivable securitization program.
Balance Outstanding 60
Days or More Past Due
2004
Trade accounts receivable subject to securitization program
Trade accounts receivable balances sold
Retained interest
Accounts receivable financing costs of $0.5 million and $0.2 million for the three months ended November 30, 2005 and 2004, respectively, are included in financing costs in the accompanying Condensed Consolidated Statements of Earnings.
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Note 5. Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the three months ended November 30, 2005 are as follows:
Tools &
Supplies
Segment
Engineered
Solutions
Balance as of August 31, 2005
Purchase accounting adjustments
Foreign currency impact
Balance as of November 30, 2005
The gross carrying amount and accumulated amortization of the Company’s intangible assets that have defined useful lives and are subject to amortization as of November 30, 2005 and August 31, 2005 are as follows:
Gross
Carrying
Amount
Accumulated
Amortization
Net
Book
Value
Customer Relationships
Patents
Trademarks
Non-compete agreements
Other
Total
Amortization expense recorded on the intangible assets listed above was $1.8 million and $0.6 million for the three months ended November 30, 2005 and 2004, respectively. The Company estimates that amortization expense will approximate $7.3 million for fiscal 2006. Amortization expense for future years is estimated as follows: $7.3 million in fiscal 2007, $7.0 million in both fiscal 2008 and 2009, $6.8 million in fiscal 2010, $6.5 million in fiscal 2011 and $44.8 million thereafter.
The gross carrying amount of the Company’s intangible assets that have indefinite lives and are not subject to amortization as of November 30, 2005 and August 31, 2005 are $87.4 million and $88.4 million, respectively. These assets are comprised of acquired tradenames.
Note 6. Accrued Product Warranty Costs
The Company recognizes the cost associated with product warranties at the time of sale. The amount recognized is based on historical claims rates and current claim cost experience. The following is a reconciliation of the changes in accrued product warranty during the three months ended November 30, 2005 and 2004:
Beginning balance
Provision for warranties
Warranty payments and costs incurred
Warranty reserves of acquired business
Ending balance
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Note 7. Debt
The Company’s indebtedness, as of November 30, 2005 and August 31, 2005 was as follows:
Senior credit facility
Revolving credit facility (“Revolver”)
Term loan
Commercial paper
Euro denominated term loans
Sub-total – Senior indebtedness
Convertible senior subordinated debentures (“2% Convertible Notes”), due 2023
Total debt, excluding short-term borrowings
Less: current maturities of long-term debt
Total long-term debt, less current maturities
Of the $250 million in outstanding term loans under the senior credit facility, $150.0 million bore interest at a rate of 5.67%, which represented LIBOR plus a borrowing spread of 1.25%. As discussed in Note 8, “Derivatives,” the remaining $100.0 million of term loans bear a fixed rate of interest of 4.10% plus the applicable borrowing spread until maturity. Borrowings under the Revolver bear interest at LIBOR plus a borrowing spread of 1.50%, resulting in an interest rate of 5.92% at November 30, 2005. All senior credit facility borrowings are subject to a pricing grid, which can result in further increases or decreases to the borrowing spread on a quarterly basis, depending on the Company’s leverage ratios. In addition, a non-use fee is payable quarterly on the average unused credit line under the Revolver. At November 30, 2005, the non-use fee was 0.35%. The senior credit facility contains customary limits and restrictions concerning investments, sales of assets, liens on assets, fixed charge coverage ratios, maximum leverage, dividends and other restricted payments. As of November 30, 2005 the Company was in compliance with all debt covenants.
There were $15.9 million of commercial paper borrowings outstanding at November 30, 2005, all of which had original maturity terms of 91 days or less and were at a weighted interest rate of 4.56%, including issuance fees. Total commercial paper outstanding cannot exceed $75.0 million under the terms of the senior credit facility. The Revolver provides the liquidity backstop for outstanding commercial paper. Accordingly, the combined outstanding balance of the Revolver and commercial paper cannot exceed $250.0 million. The unused and available credit line under the Revolver at November 30, 2005 was approximately $228 million.
Note 8. Derivatives
All derivatives are recognized on the balance sheet at their estimated fair value. In January 2005, the Company entered into interest rate swap contracts that have a total notional value of $100.0 million and have maturity dates of December 22, 2009. These interest rate swap contracts will pay the Company variable interest at the three month LIBOR rate, and the Company will pay the counterparties a fixed interest rate of 4.10%. These interest rate swap contracts were entered into to convert $100.0 million of the $250.0 million variable rate term loan under the senior credit facility into fixed rate debt. Based on the terms of the interest rate swap contracts and the underlying debt, these interest rate contracts were determined to be effective, and thus qualify as a cash flow hedge. As such, any changes in the fair value of these interest rate swaps are recorded in other comprehensive income on the accompanying Condensed Consolidated Balance Sheets until earnings are affected by the variability of cash flows. The total fair value of these interest rate swap contracts is $2.6 million at November 30, 2005, which the Company has recorded as a long-term asset in the accompanying Condensed Consolidated Balance Sheets.
The Company is not party to any other material derivative contracts at November 30, 2005.
Note 9. Stock Based Compensation
The Company adopted SFAS No. 123(R) “Accounting for Stock Based Compensation” in the fourth quarter of fiscal 2005, utilizing the modified retrospective method of adoption. Under this adoption method, the first three quarters of fiscal 2005 were restated in the fourth quarter to reflect expense for stock based compensation. Stock based compensation is calculated by estimating the fair value of incentive stock options granted and amortizing the estimated value over the stock options’
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vesting period. Consolidated financial results included in this report for the three months ended November 30, 2005 and November 30, 2004 are accounted for in accordance with the provisions of SFAS No. 123(R) “Accounting for Stock Based Compensation”. Stock based compensation was $1.1 million and $0.9 million for the three months ended November 2005 and 2004, respectively.
Note 10. Employee Benefit Plans
The Company provides defined benefit pension and other postretirement benefits to certain employees of domestic businesses it acquired that were entitled to those benefits prior to acquisition. At November 30, 2005 and August 31, 2005, the defined benefit plans consisted of three plans. Most of the domestic defined benefit pension plans are frozen, and as a result, the majority of the plan participants no longer earn additional benefits.
At November 30, 2005 and August 31, 2005 the postretirement medical plans consisted of four plans, all of which are unfunded. Two of the plans require individuals receiving medical benefits under the plan to make contributions to defray a portion of the cost, and these retiree contributions are adjusted annually. The other two plans do not require retiree contributions.
The Company maintains defined benefit pension plans for certain employees in various foreign countries. At November 30, 2005 and August 31, 2005, the defined benefit pension plans consisted of eight separate plans. Unlike existing U.S. pension plans, future benefits are earned with respect to the foreign plans.
Components of net periodic benefit costs were as follows:
Domestic Defined Benefit Pension Plans
Service cost
Interest cost
Expected return on assets
Amortization of actuarial loss
Net periodic benefit cost
Domestic Postretirement Medical Benefit Plans
Amortization of actuarial gain
Net periodic benefit (credit) cost
Foreign Defined Benefit Pension Plans
Amortization of actuarial loss (gain)
For domestic defined benefit pension plans, the Company expects to contribute approximately $0.1 million in aggregate during fiscal 2006. No contributions were made to a domestic defined benefit pension plan during the three months ended November 2004. Postretirement medical claims and a majority of foreign defined pension benefits are paid as incurred.
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Note 11. Earnings Per Share
The reconciliations between basic and diluted earnings per share are as follows:
Numerator:
Net earnings, as reported, for basic earnings per share
Plus: 2% Convertible Notes financing costs, net of taxes
Net earnings, for diluted earnings per share
Denominator:
Weighted average common shares outstanding for basic earnings per share
Net effect of stock options based on the treasury stock method using average market price
Net effect of 2% Convertible Notes based on the if-converted method
Weighted average common and equivalent shares outstanding for diluted earnings per share
Note 12. Common Stock
In December 2004, the Company sold, pursuant to an underwritten public offering, 2,875,000 shares of previously unissued Class A Common Stock at a price of $49.50 per share. Cash proceeds from the offering, net of underwriting discounts, commissions and other expenses, were approximately $134.4 million. The proceeds were used to fund the retirement of the $80.8 million KCI 10.5% Notes assumed in the KCI Acquisition and pay down outstanding borrowings on the Company’s Revolver and commercial paper facility.
Note 13. Segment Information
The Company has two reportable segments: Tools & Supplies and Engineered Solutions, with separate and distinct operating management and strategies. The Tools & Supplies segment is primarily involved in the design, manufacture and distribution of tools and supplies to the retail home center, construction, electrical wholesale, industrial, oil & gas, production automation, and marine markets. In addition, this segment provides manpower services and product rental to the global bolting market. The Engineered Solutions segment focuses on developing and marketing value-added, customized motion control systems for original equipment manufacturers in the recreational vehicle, automotive, truck, and industrial markets. The Company has not aggregated individual operating segments within these reportable segments. The Company evaluates segment performance based primarily on net sales and earnings (loss) from continuing operations before income tax expense and minority interest.
The following tables summarize financial information by reportable segment.
Net Sales:
Tools & Supplies
Engineered Solutions
Earnings (Loss) Before Income Taxes and Minority Interest:
General Corporate and Other
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Assets:
The comparability of the segment data is impacted by the acquisitions completed in fiscal 2005. Yvel is included in the Engineered Solutions segment and Sperry, Hedley Purvis, and Hydratight Sweeney are included in the Tools & Supplies segment. Of the six businesses acquired in the KCI acquisition, four are included in the Engineered Solutions segment and two are included in the Tools & Supplies segment.
Corporate assets, which are not allocated, principally represent capitalized debt issuance costs, deferred income taxes, and the retained interest in trade accounts receivable (subject to the accounts receivable securitization program discussed in Note 4, “Accounts Receivable Financing”).
Note 14. Contingencies and Litigation
The Company had outstanding letters of credit of $5.2 million and $6.6 million at November 30, 2005 and August 31, 2005, respectively. The letters of credit secure self-insured workers compensation liabilities and contingent payments related to indemnifications provided to purchasers of divested businesses.
The Company is a party to various legal proceedings that have arisen in the normal course of its business. These legal proceedings typically include product liability, environmental, labor, patent claims, and indemnification disputes. The Company has recorded reserves for loss contingencies based on the specific circumstances of each case. Such reserves are recorded when it is probable that a loss has been incurred as of the balance sheet date and such loss can be reasonably estimated. In the opinion of management, the resolution of these contingencies will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
The Company, in the normal course of business, enters into certain real estate and equipment leases or guarantees such leases on behalf of its subsidiaries. In conjunction with the spin-off of a former subsidiary in fiscal 2000, the Company assigned its rights in the leases used by the former subsidiary, but was not released as a responsible party from all such leases by the lessors. All of these businesses were subsequently sold, or are in the process of being sold to third parties. The Company remains contingently liable for those leases if any of these businesses are unable to fulfill their obligations thereunder. The discounted present value of future minimum lease payments for such leases totals, assuming no offset for sub-leasing, approximately $7.9 million at November 30, 2005. The future undiscounted minimum lease payments for these leases are as follows: $0.1 million in the balance of calendar 2005; $1.1 million in calendar 2006 through 2009; and $7.2 million thereafter. During the quarter ended November 30, 2005, the Company was released from its guarantee on one building lease, resulting in a decrease in both the discounted future minimum lease payments and the undiscounted minimum lease payments.
The Company has facilities in numerous geographic locations that are subject to a range of environmental laws and regulations. Environmental costs that have no future economic value are expensed. Liabilities are recorded when environmental remediation is probable and the costs are reasonably estimable. Environmental expenditures over the last three years have not been material. Management believes that such costs will not have a material adverse effect on the Company’s financial position, results of operations or cash flows. Environmental remediation accruals of $2.5 million and $2.6 million were included in the Condensed Consolidated Balance Sheets at November 30, 2005 and August 31, 2005, respectively.
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Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
We are a diversified global service provider and manufacturer of a broad range of industrial products and systems, organized into two business segments, Tools & Supplies and Engineered Solutions. Our Tools & Supplies segment is primarily involved in the design, manufacture and distribution of branded hydraulic and electrical tools and supplies to the retail, construction, electrical wholesale, industrial, oil & gas, production automation and marine markets. Tools & Supplies also provides manpower services and tool rental to the global bolting market. Our Engineered Solutions segment primarily focuses on developing and marketing highly engineered position and motion control systems for original equipment manufacturers in the recreational vehicle, automotive, truck, and other industrial markets. We believe that our strength in these product categories is the result of a combination of our brand recognition, proprietary engineering and design competencies, dedicated service philosophy, and global manufacturing and distribution capabilities.
Our long-term goal is to grow annual diluted earnings per share excluding unusual or non-recurring items (“EPS”) by 15% to 20% per year. We intend to leverage our leading market positions to generate annual internal sales growth that exceeds the annual growth rates of the gross domestic product in the geographic regions in which we operate. In addition to internal sales growth, we are focused on acquiring complementary businesses. Following an acquisition, we seek to drive cost reductions, develop additional cross-selling opportunities and deepen customer relationships. We also focus on profit margin expansion and cash flow generation to achieve our EPS growth goal. Our LEAD (“Lean Enterprise Across Disciplines”) process utilizes various continuous improvement techniques to drive out costs and improve efficiencies across all locations and functions worldwide, thereby expanding profit margins. Strong cash flow generation is achieved by maximizing returns on assets and minimizing primary working capital needs. The cash flow that results from efficient asset management and improved profitability is used to reduce debt and fund additional acquisitions and internal growth opportunities.
Results of Operations for the Three Months Ended November 30, 2005 and 2004
The comparability of the operating results for the three months ended November 30, 2005 to the prior year has been significantly impacted by acquisitions. Listed below are the acquisitions completed since September 1, 2004.
Business
Acquisition Date
Power Distribution Products – Acme
Aerospace & Defense – Acme
Air Handling / Turbocharger Components – Gits
Electrical Utility – Turner Electric
Flexible Shafts – B.W. Elliott
Specialty Electrical – Marinco and Guest
The results of operations for acquired businesses are included in the Company’s reported results of operations only since their respective acquisition dates. In addition to the impact of acquisitions on operating results, currency translation rates can influence our reported results given that approximately 49% of our sales are denominated in currencies other than the US dollar. The strengthening of the US dollar has negatively impacted comparisons of fiscal 2006 results to the prior year due to the translation of non-US dollar denominated subsidiary results.
Consolidated net sales increased by $84.2 million, or 42%, from $199.7 million for the three months ended November 30, 2004 to $283.9 million for the three months ended November 30, 2005. Excluding the $89.6 million of sales from acquired businesses (defined as businesses owned less than twelve months) and the $5.0 million unfavorable impact of foreign currency exchange rate changes on translated results, fiscal 2006 first quarter consolidated net sales were flat with fiscal 2005 first quarter consolidated net sales. Excluding foreign currency exchange rate changes, fiscal 2006 first quarter core sales increased approximately 1% over the comparable prior year period. We define core sales growth as the year-over-year sales growth in both existing and acquired businesses. Net sales fluctuations at the operating segment level are discussed in further detail below.
Consolidated earnings before income taxes and minority interest for the three months ended November 30, 2005 was $31.4 million, compared with $25.7 million for the three months ended November 30, 2004. The comparability between periods is impacted by acquisitions and the related financing activities, as well as foreign currency exchange rate changes. The changes in consolidated earnings before income taxes and minority interest at the operating segment level are discussed in further detail below.
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Tools & Supplies Segment Results
Gross profit margin
Selling, administrative and engineering expenses (“SAE”)
SAE as a percentage of net sales
Operating profit margin
Other expense, net
Net sales increased by $68.8 million, or 61%, from $112.5 million for the three months ended November 30, 2004 to $181.3 million for the three months ended November 30, 2005. Excluding the $59.7 million of sales from acquired businesses and the $2.6 million unfavorable impact of foreign currency rate changes on translated results, sales grew 11% as a result of increased demand in both the industrial tools and the North American electrical businesses. Excluding the impact of foreign currency exchange rate changes, Tools & Supplies segment core sales (as previously defined) grew 9%.
Gross profit increased by $30.2 million, or 71%, from $42.7 million for the three months ended November 30, 2004 to $72.9 million for the three months ended November 30, 2005 primarily due to higher sales. Excluding the $0.8 million unfavorable impact of foreign currency rate changes on translated results, gross profit increased 73%. Gross profit margins increased from 37.9% during the three months ended November 30, 2004 to 40.2% for the three months ended November 30, 2005, as a result of favorable sales mix and cost reductions.
SAE increased by $16.5 million, or 67%, from $24.8 million for the three months ended November 30, 2004 to $41.3 million for the three months ended November 30, 2005. Acquired businesses accounted for $14.1 million of this increase. Additionally, the impact of foreign currency rate changes on translated results reduced SAE by $0.5 million during the three months ended November 30, 2005. Excluding the impact of acquisitions and changes in foreign currency exchange rates, SAE increased 12% during the three months ended November 30, 2005 due primarily to increased incentive compensation expense and variable selling expense on incurred sales levels.
Amortization expense increased in the current year due to expense recognized on the amortizable intangible assets added with the business acquisitions.
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Engineered Solutions Segment Results
Engineered Solutions net sales increased by $15.5 million, or 18%, from $87.1 million for the three months ended November 30, 2004 to $102.6 million for the three months ended November 30, 2005. Excluding the $29.9 million of sales from acquired businesses and the $2.4 million unfavorable impact of foreign currency rate changes on translated results, sales decreased 14% due to expected declines in the recreational vehicle (“RV”) and automotive convertible top market sales. Sales to the RV market decreased 25% during the fiscal 2006 first quarter versus the comparable period in fiscal 2005 due to lower RV original equipment manufacturer (“OEM”) production levels as the OEM’s and retail dealers work to reduce inventories. The automotive convertible top actuation business realized a year-over-year sales decline of 29% during the three months ended November 30, 2005 due to high OEM production levels in the comparable prior year in conjunction with the launch of new convertible top automobiles. We expect growth in automotive sales in fiscal 2006 given two convertible top platform launches in the first quarter of fiscal 2006 and the anticipated launch of two additional platforms in the second quarter. Excluding the impact of foreign currency exchange rate changes, Engineered Solutions segment core sales (as previously defined) decreased 11%, reflecting lower RV, automotive convertible top and flexible shaft market sales somewhat offset by increased shipments to the electrical utility, heavy duty truck, industrial cylinder and hardware markets.
Gross profit increased by $5.4 million, or 26%, from $21.1 million for the three months ended November 30, 2004 to $26.5 million for the three months ended November 30, 2005 primarily due to increased sales. Excluding the $0.5 million unfavorable impact of foreign currency rate changes on translated results, gross profit increased 28%. Gross profit margins increased from 24.3% during the three months ended November 30, 2004 to 25.9% for the three months ended November 30, 2005 due to the impact of higher combined gross profit margins at acquired businesses more than offsetting lower gross profit margins in the RV and automotive businesses. The lower margins in the RV and automotive businesses resulted from automotive start-up costs associated with the four new platforms being introduced and reduced fixed cost absorption from the decrease in production volumes.
SAE increased by $5.3 million, or 60%, from $8.9 million for the three months ended November 30, 2004 to $14.2 million for the three months ended November 30, 2005. Acquired businesses accounted for $4.1 million of the increase in SAE during the months ended November 30, 2005. Additionally, the unfavorable impact of foreign currency rate changes on translated results deducted $0.2 million from the increase in SAE during the three months ended November 30, 2005. Excluding the impact of acquisitions and changes in foreign currency exchange rates, SAE increased 16% during the three months ended November 30, 2005, as a result of increased spending to support the new automotive platforms and growth initiatives in this segment.
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General Corporate Results
Other income, net
Loss before income tax expense and minority interest
Current year-to-date general corporate SAE increased due to additional corporate expenses to support acquisition and Sarbanes-Oxley compliance activities, as well as higher incentive compensation expense.
All debt is considered to be for general corporate purposes, thus, financing costs have not been allocated to the reportable segments. The significant increase in financing costs during the three months ended November 30, 2005 versus the comparable prior year period reflects the interest expense on the debt incurred for fiscal 2005 acquisitions and higher rates of interest on variable rate debt. See “Liquidity and Capital Resources” below for further information.
Other income decreased during the three months ended November 30, 2005 due to a $2.0 million gain related to the resolution of a dispute with a former subsidiary, which was recorded in the first quarter of fiscal year 2005.
Income Taxes
The Company’s income tax expense is impacted by a number of factors, including the amount of taxable earnings derived in foreign jurisdictions with tax rates that are higher or lower than the U.S. federal statutory rate, state tax rates in the jurisdictions where we do business, and our ability to utilize various tax credits and net operating loss carryforwards. The effective income tax rate for the three months ended November 30, 2005, was 32.5% compared to 34.3% during the three months ended November 30, 2004. The effective income tax rate was lower in the three months ended November 30, 2005 as a result of a reduction in statutory rates in Holland, a comparatively lower 30% tax rate in the United Kingdom where both the Hydratight Sweeney and Hedley Purvis businesses are based, and the realization of benefits on certain net operating losses that previously had not been benefited in various countries.
Restructuring Reserves
The Company committed to integration plans to restructure portions of Kopp’s operations during the first quarter of fiscal 2003. These plans were designed to reduce administrative and operational costs. The remaining $1.2 million of accrued severance costs at November 30, 2005 will be paid to former employees over the next two years as dictated by contractual arrangements with those employees.
Liquidity and Capital Resources
Cash and cash equivalents totaled $7.5 million and $10.4 million at November 30, 2005 and August 31, 2005, respectively. Our goal is to maintain low cash balances, utilizing excess cash to reduce debt in an effort to minimize financing costs.
The Company generated cash from operating activities of $21.0 million during the three months ended November 30, 2005 and used $9.7 million during the three months ended November 30, 2004. The operating cash flows for the first three months of fiscal 2006 were primarily the result of strong earnings during the quarter. The operating cash flows for the first three months of fiscal 2005 include the impact of the $15.8 million reimbursement of funds to a former subsidiary. Our operating cash flow during the final two quarters of each fiscal year is typically stronger than the first two fiscal quarters due to the seasonal build-up of primary working capital during the first half of the fiscal year.
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Cash used in investing activities totaled $5.0 million and $11.8 million during the three months ended November 30, 2005 and November 30, 2004, respectively. During the three months ended November 30, 2005, capital expenditures were $5.1 million as compared to $3.2 million during the three months ended November 30, 2004. Capital expenditures have increased during fiscal 2006 due to continued growth in the automotive business to support the introduction of new convertible models as well as businesses acquired during the current year. During the first three months of fiscal 2005, the Company used $9.0 million to fund the closing of the Yvel acquisition.
Net cash used by financing activities totaled $18.7 million during the three months ended November 30, 2005. During the three months ended November 30, 2005, cash used to pay down revolving credit facilities and short-term debt totaled $17.1 million, while an additional $2.2 million was used to fund the cash dividend paid in the first quarter of fiscal 2006. Net cash provided by financing activities totaled $22.2 million during the three months ended November 30, 2004. The Company utilized borrowings of $17.6 million on its revolving credit facilities during the three months ended November 30, 2004 to fund the cash used in operating and investing activities.
Commitments and Contingencies
The Company leases certain facilities, computers, equipment and vehicles under various operating lease agreements, generally over periods from one to twenty years. Under most arrangements, the Company pays the property taxes, insurance, maintenance and expenses related to the leased property. Many of the leases include provisions that enable the Company to renew the lease based upon fair value rental rates on the date of expiration of the initial lease. See the “Timing of Commitments” table below for further information.
As more fully discussed in Note 4, “Accounts Receivable Financing” in the Notes to Condensed Consolidated Financial Statements, the Company is party to an accounts receivable securitization program. Trade receivables sold and being serviced by the Company were $46.6 million and $43.8 million at November 30, 2005 and August 31, 2005, respectively. If the Company had discontinued this securitization program at November 30, 2005 it would have been required to borrow approximately $46.6 million to finance the working capital increase. Total capacity under the securitization program is $55.0 million.
Timing of Commitments
The timing of payments due under the Company’s commitments is as follows:
Contractual Obligations (a)
Years Ended August 31,
Debt
Obligations
Operating Lease
Obligations (b)
2006
2007
2008
2009
2010
Thereafter
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Item 3 – Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risk from changes in foreign currency exchange rates and interest rates and, to a lesser extent, commodities. To reduce such risks, the Company selectively uses financial instruments and other proactive management techniques. All hedging transactions are authorized and executed pursuant to clearly defined policies and procedures, which strictly prohibit the use of financial instruments for trading or speculative purposes.
A discussion of the Company’s accounting policies for derivative financial instruments is included within Note 1, “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements in the Company’s fiscal 2005 Annual Report on Form 10-K.
Currency Risk—The Company has exposure to foreign currency exchange fluctuations. Approximately 49% and 51% of its revenues for the three months ended November 30, 2005 and the year ended August 31, 2005, respectively, were denominated in currencies other than the U.S. dollar. Of those non-U.S. dollar denominated amounts, approximately 84% were denominated in euros, with the majority of the remainder denominated in various Asian and other European currencies. The Company does not hedge the translation exposure represented by the net assets of its foreign subsidiaries. Foreign currency translation adjustments are recorded as a component of shareholders’ equity.
The Company’s identifiable foreign currency exchange exposure results primarily from the anticipated purchase of product from affiliates and third party suppliers and from the repayment of intercompany loans between subsidiaries denominated in foreign currencies. The Company periodically identifies areas where it does not have naturally occurring offsetting positions and then may purchase hedging instruments to protect against anticipated exposures. There are no material hedging instruments in place as of the date of this filing.
Interest Rate Risk —The Company has earnings exposure related to interest rate changes on its outstanding floating rate debt instruments that are based on LIBOR and EURIBOR interest rates. The Company has periodically utilized interest rate swap agreements to manage overall financing costs and interest rate risk. At November 30, 2005 the Company was a party to interest rate swap agreements that convert $100 million of floating rate debt to a fixed rate of interest. An increase or decrease of 25 basis points in the applicable interest rates on unhedged variable rate debt at November 30, 2005 would result in a change in pre-tax interest expense of approximately $0.6 million on an annual basis.
Commodity Risk —We source a wide variety of materials and components from a network of global suppliers. While such goods are typically available from numerous suppliers, commodity raw materials, such as steel, plastic resin, and copper, are subject to price fluctuations, which could have a negative impact on the Company’s results. The Company strives to pass along such commodity price increases to customers to avoid profit margin erosion. In addition, LEAD initiatives further mitigate the impact of commodity raw material price fluctuations as improved efficiencies across all locations are achieved. The Company has not entered into any derivative contracts to hedge its exposure to commodity risk in fiscal years 2006 or 2005.
Item 4 – Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
Under the supervision and with the participation of our senior management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based on this evaluation, our chief executive officer and chief financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to the Company, including consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
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Changes in Internal Control Over Financial Reporting.
There have been no changes in our internal control over financial reporting that occurred during the quarter ended November 30, 2005 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 6 – Exhibits
See “Index to Exhibits” on page 22, which is incorporated herein by reference.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Andrew G. Lampereur
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(the “Registrant”)
(Commission File No. 1-11288)
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED November 30, 2005
INDEX TO EXHIBITS
Description
Incorporated Herein
By Reference To
Filed
Herewith
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