ITEM 1. BUSINESS
AM General Corporation and its wholly owned subsidiaries, AM General Sales Corporation and Chippewa Corporation (collectively, the "Company" or "AM General" ) is the largest supplier of light Tactical Wheeled Vehicles ("TWVs") for the Department of Defense ("DoD"). AM General (including predecessors) has a history of over 50 years of successfully competing for government procurement contracts. AM General is the designer and sole manufacturer of the High Mobility Multipurpose Wheeled Vehicle ("HUMVEE "(R) or "HUMMER"(R)), which it sells to the US and foreign military services and to industrial and retail users through its commercial dealer network. From the introduction of the HUMMER/HUMVEE in 1984 and through October 31, 1998, the Company has delivered 126,032 HUMVEEs in a variety of configurations to the DoD for use by the US Armed Forces, 22,072 HUMVEEs to the military services of 40 foreign countries, and 6,402 Commercial HUMMERs. In fiscal 1998, the Company sold 4,145 HUMMER/HUMVEEs. In addition to HUMMER/HUMVEEs, the Company also remanufactures and modernizes used military vehicles and markets both technical support services and spare parts.
The Company classifies its operations into five business lines: (i) US and Foreign Military HUMVEEs, (ii) Commercial HUMMERs, (iii) Remanufacturing - Extended Service Program ("ESP"), (iv) Spare Parts Logistics Operations ("SPLO") and (v) Systems Technical Support ("STS"). Reference is hereby made to Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") contained elsewhere herein, in which the Company's net sales are summarized by business lines.
The Company recorded an $8.3 million net loss for fiscal 1998. Included in the loss is a $5.3 million pre-tax restructuring charge in connection with the anticipated closure of the ESP facility. On September 15, 1998, the Company issued a notice under the Worker Adjustment and Retraining Notification ("WARN") Act to the employees at the ESP facility advising them that the Company had insufficient orders to keep the plant in operation. Subsequent to that notice, the Company received orders that extended production through April 19, 1999 at the current production rate. On January 21, 1999 the Company issued another notice under the WARN Act to the employees at the ESP facility advising the employees that the facility would be closing in April of 1999.
All of the Company's issued and outstanding capital stock is owned by The Renco Group, Inc. ("Renco") which is 97.9% owned by trusts established by Mr. Ira Leon Rennert, the Chairman and sole director of the Company and Renco for himself and members of his family. As a result of such ownership, Mr. Rennert controls the Company.
The Company was incorporated in Delaware in 1991, and its executive offices are located at 105 North Niles Avenue, South Bend, Indiana 46617, telephone number: (219) 284-2907.
BUSINESS LINES
Military HUMVEE
Since its introduction in 1984, the HUMVEE has been sold to US and foreign militaries pursuant to contracts having firm fixed prices. Therefore, the Company assumes full risk of producing and delivering the specified number of vehicles for a fixed-price.
The HUMVEE has been upgraded since its introduction with improved components and added features. During 1994, the Company developed and produced a new series of HUMVEE models known as the A1-
Series which incorporated an increase in the payload capacity and various other enhancements. In 1995, the Company began production of an A2 Series under contracts with the DoD including the X001 Contract which is the Company's current contract with the DoD. See MD&A.
DOMESTIC SALES; GOVERNMENT CONTRACTS. Based upon currently available information from the Tank, automotive and Armaments Command ("TACOM"), which is an administrative agent for the US Army, management expects that the US Armed Forces will require at least the same number of HUMVEEs that were produced and delivered during fiscal 1998 (approximately 2,700 units) but significantly less than were required under prior contracts. However, the volume reduction has been partially offset by significantly higher unit prices received in fiscal 1998.
TACOM has indicated that the US Armed Forces will require HUMVEE purchases beyond the year 2020 and currently has no plan to change the HUMVEE's mission requirements. Further, the US Marines have asked for and received permission to accelerate delivery of its approximately 17,000-unit HUMVEE requirement. Should the US Marines obtain the necessary funding and accelerate this schedule, the production rate for HUMMER/HUMVEEs would likely increase beyond the current production rate of 16.5 units per day as early as fiscal year 2000.
The US Army has formed an Integrated Process Team ("IPT") to study the future generation of Light Tactical Vehicles ("LTV"). Members of the IPT consist of representatives from some of the major automotive manufacturing companies, including a representative of the Company. The purpose of the IPT is to establish the requirements for the next generation of LTV's. Senior members of the Army have decided that the LTV must meet the current mission profile of the HUMVEE. As a member of the IPT, the Company's representative will be working closely with the team to insure that all future requirements are met. Management believes that the next generation LTV will be an upgraded HUMVEE.
As of October 31, 1998, the Company had a total US military backlog of 247 military HUMVEEs valued at $12.0 million compared to 139 HUMVEEs valued at $9.1 million at October 31, 1997.
INTERNATIONAL SALES. Since November 1986, the Company has sold military HUMVEEs to foreign nations, either directly to the foreign nation or through the US Government's Foreign Military Sales ("FMS") program. The Company will continue to capitalize on the HUMVEE's proven combat performance with the US Armed Forces, the extensive offering of HUMVEE configurations and the Company's technical and logistical support services to increase sales to foreign military markets. To date, Taiwan, Saudi Arabia, Mexico, the United Arab Emirates and Thailand have been the five largest of the Company's 40 international military customers.
The Company sells HUMVEEs in various configurations to the military services of foreign nations through the FMS program and its direct sales force and local representatives. The FMS program is part of the US Government's security assistance program, which provides equipment and services to more than 100 nations and international organizations. Funding is provided either directly by the purchaser or with US-granted foreign aid credits or loans. As of October 31, 1998 and October 31, 1997, there were no significant FMS and direct sales backlogs. In fiscal 1998, international military HUMVEE sales accounted for approximately 9.2% of total HUMMER/HUMVEE unit sales and 9.6% of HUMMER/HUMVEE net sales revenue. Management believes that foreign military services will continue to purchase HUMVEEs because they are competitive in the market as evidenced by the fact that it is the only light TWV being purchased in quantity by the US military and they are the best vehicles available.
In fiscal 1997, the Company manufactured 231 HUMVEEs for a valued customer seeking to acquire HUMVEEs under the FMS program (the "FMS Customer"). Due to negotiation related difficulties in obtaining the order, these units remained in finished goods inventory at October 31, 1998. As a result, the Company's finished goods inventory was increased at October 31, 1997 and October 31, 1998 beyond normal operating levels. Moreover, such delay resulted in a higher than expected level of borrowing by the Company under its revolving credit facility. The Company continues to pursue an order with the FMS Customer for whom the units were built; additionally, the Company has expanded its efforts to find
alternative buyers. Management believes that the inventory will be sold in fiscal 1999. See MD&A-Liquidity and Capital Resources
Commercial HUMMERs
In October 1992, the Company broadened the market for the HUMMER by developing and introducing a commercial version of the HUMVEE. The Company's engineering staff has improved and adapted the military HUMVEE for industrial and commercial use by adding an array of options and additional comfort, convenience and sport utility features. Management believes the Commercial HUMMER's off-highway performance and specifications exceed those of all other commercially available four-wheel drive trucks and sport utility vehicles. Since 1992, the Company sold 6,402 Commercial HUMMERs through its network of approximately 89 domestic and international dealerships and distributors. As of October 31, 1998, AM General had a total backlog of 54 Commercial HUMMERs valued at $3.5 million compared to 52 valued at $2.8 million on October 31, 1997. In fiscal 1998, Commercial HUMMER sales accounted for approximately 25.5% of total HUMMER/HUMVEE unit sales and 28.0% of HUMMER/HUMVEE net sales revenue.
Commercial HUMMERs are functionally equivalent to the A2 Series military HUMVEE with modifications to comply with Federal Motor Vehicle Safety Standards ("FMVSS") for Class III (gross vehicle weight ("GVW") of 10,000 to 14,000 pounds) trucks and to satisfy commercial customer requirements relating to safety, comfort and convenience. In addition to the standard HUMMER models, Commercial HUMMERs have been configured as fire fighting and rescue vehicles, ambulances, snowplowing vehicles; and to carry a variety of equipment and tools such as man-lifts and backhoes.
The Company currently markets four models of the Commercial HUMMER, which include two-passenger and four-passenger hard-tops, a four-door wagon and an open-top sport model with suggested retail prices ranging from $65,000 to $92,000, depending on options. The Company provides customer service, spare parts and warranties to its commercial customers through its dealer network.
The commercial market consists of individuals, government agencies and industrial users located in the US and overseas which require or desire the HUMMER's enhanced off-highway mobility, durability and payload capacity. Targeted customers include businesses engaged in the mining, electric utility, fire and rescue, oil and gas exploration, and heavy construction industries. Additionally other customers include non-DoD government agencies such as Federal Emergency Management, in addition to state and local fire, police and park service departments.
The Company markets Commercial HUMMERs in the retail and fleet markets through a network of dealers located throughout the United States and international distributors primarily in the Middle East, South America and Canada. As of October 31, 1998, the Company had approximately 46 domestic dealerships and 43 international distributors. Management intends to strengthen its Commercial HUMMER distribution network by improving its dealer base.
To date, the Company has experienced modest sales in the fleet market. The Company attributes the lack of fleet sales to various issues including unit-selling price, lack of maintenance history on the vehicle, as well as competitive products available to prospective customers. Given the magnitude of the fleet market potential, management will continue to devote marketing resources to penetrate the fleet market.
Since February 1995, the Company has issued eight recalls regarding design problems with certain mechanical features of the Commercial HUMMER. The total cost to the Company of the eight recalls is estimated to be approximately $457,966 of which $354,940 has been incurred as of October 31, 1998. The Company reported all recalls to the National Institute of Highway Traffic Safety. Management does not expect that the recalls will have a material adverse effect on future Commercial HUMMER sales.
REMANUFACTURING
The Company entered the remanufacture and modernization market in September 1993, upon being awarded the contract for the DoD's ESP. That contract called for the Company to rebuild and deliver remanufactured and modernized 2-1/2-ton trucks by disassembling trucks provided by the DoD (the "ESP Contract"). The Company entered into this business in response to the US Government's declining defense budget and, as a result thereof, the US Government's desire to remanufacture and modernize existing vehicle fleets in lieu of procuring new vehicles. In the US Army's tests, the Company's ESP trucks met or exceeded all requirements and performed comparably to new US Army 2-1/2-ton trucks at a unit price of approximately 50% less than that of a new vehicle. As of October 31, 1998, the Company had remanufactured and delivered 4,776 units to the DoD. When the last unit is completed in April 1999, the Company will have delivered 5,483 remanufactured 2-1/2-ton vehicles to the US Army under this program.
Despite the economic advantage offered by the Company's re-manufactured 2-1/2 ton, the US Army has decided not to purchase any additional units beyond those that are already on contract. Accordingly, the Company issued a WARN act notice on January 21, 1999 to those employees affected by this decision advising them that the facility will be closed. The last unit of production is scheduled to occur on April 19, 1999 at which time production at the facility will cease and plant closure operations will commence.
MEDIUM TACTICAL TRUCKS
On November 20, 1996, the Company was awarded a $6.9 million Phase I contract by the DoD to build ten prototype vehicles for the Medium Tactical Truck Remanufacture ("MTTR") program for the US Army and Marine Corp. A competitor was awarded a similar contract. The Company delivered ten prototype vehicles for testing purposes under the Phase I contract in August 1997 and submitted its best and final proposal on November 30,1998. On December 18, 1998 the DoD advised the Company that the contract had been awarded to the Company's competitor.
On October 30, 1998, the Company was awarded a $2.4 million Phase I contract by the DoD to build three prototype vehicles for the Family of Military Tactical Vehicles ("FMTV") second source program for the US Army. A competitor was awarded a similar contract. Under this contract, the Company is to produce two new 5.0-ton vehicles and one new 2.5-ton vehicle for testing purposes. Upon successful testing of the vehicles, the Company will be asked to submit a production bid for approximately 700 vehicles to be built over three years. If successful in winning this low-rate production contract which is expected to be awarded in late 1999, upon its completion, the Company will be asked to compete with the current FMTV contract manufacturer for a share of the following FMTV multiyear contract.
SPLO AND STS
Since the 1940s, the Company and its predecessor companies have sold more than 1 million vehicles. Management estimates that over 250,000 of these vehicles are still in service, providing a large after-market base for potential SPLO and STS sales. In fiscal 1998, SPLO and STS accounted for approximately 12.9% and 3.2%, respectively, of net sales.
SPLO provides comprehensive after-market service, training and technical publications for Company products on a worldwide basis. The services include supplying spare parts for vehicles manufactured by the Company and for non-AM General manufactured vehicles, including HUMMER/HUMVEEs, 2-1/2- and 5-ton trucks and others. In addition, the Company provides expert training programs for off-road driving, as well as training for vehicle maintenance and repairs.
STS is a full service engineering organization providing comprehensive technical support and engineers to TACOM, with contracts on both wheeled and tracked vehicles, including medium and heavy trucks and the HUMVEE. Services include engineering, design and drafting, configuration and data management, translation, and integrated logistics support.
INDUSTRY
Since World War I, the US and foreign military forces have used TWVs for transporting personnel, supplies and equipment in battlefield conditions. The TWV fleet has evolved from numerous body styles and payloads to three basic classifications - light (less than 2-1/2 tons), medium (2-1/2 ton and 5-ton) and heavy (greater than 5 tons). Each of the three classifications serves basic utility functions on the battlefield. Generally, commercial trucks are not suited to military use or military procurement standards.
In the early 1980s, the US Army began its largest peacetime TWV fleet modernization program in history. The escalation in US Army truck requirements can be directly attributed to (i) a transition in the US Armed Forces' basic fighting strategy and (ii) newly established roles for trucks as weapon system platforms and as the transport component of medical, electronics and intelligence systems. The US Armed Forces fighting doctrine has shifted from "forward deployment" (i.e., maintaining large bases worldwide) in the Cold War Era to "force projection" (e.g., the Gulf War) which calls for rapid deployment and forced entry with fast moving main attacks on enemy fronts. As a result of this fighting doctrine, the US Army established two major hardware initiatives for ground attacks emphasizing speed and high mobility - the Bradley fighting vehicle and the M1 Abrams main battle tank. At the time, no military trucks (light, medium or heavy) existed that could match the expected speed and mobility of the Bradley and Abrams vehicles. This led to the development of the design specification for the HUMVEE. The HUMVEE is the only light TWV being acquired in quantity by the US Armed Forces.
At the present time, the medium tactical wheeled fleet is in poor condition measured by age and economic performance. As a result, the US Army commenced modernizing its medium TWV fleet by procuring new 2-1/2-ton and 5-ton trucks, and by obtaining remanufactured 2-1/2-ton vehicles through the Company under the ESP program.
AM General was the first company to be awarded a major remanufacturing contract by the US Army and is currently the only company rebuilding 2-1/2 ton vehicles for the US Army under its ESP program. Despite the economic advantage offered by the Company's re-manufactured 2-1/2 ton, the US Army has decided not to purchase any additional units beyond those that are already on contract and the Company's activities under this contract will cease in April 1999.
In an effort to accelerate the procurement of new 2-1/2 and 5-ton vehicles, TACOM announced its intention to stage a competition for and award a second source for the FMTV program. When selected in late 1999, the second source will be awarded approximately 700 vehicles to produce over a three-year period. At the conclusion of that contract, the second source will compete with the current source for a share of the remaining program requirements; the winner of which will receive the larger share of the following FMTV multiyear contract. As discussed above, the Company intends to compete vigorously for the FMTV second source award.
RESEARCH AND DEVELOPMENT
The Company believes that its technical expertise and engineering resources are a competitive advantage, which has enabled the Company to successfully procure business contracts with the US government. In addition to its STS operations, which are dedicated to TACOM, the Company also maintains an independent research and development ("R&D") department at its Livonia, Michigan facility to conduct R&D activities.
MANUFACTURING PROCESS AND RAW MATERIALS
At the Company's Mishawaka, Indiana facility, HUMMER/HUMVEE vehicles are manufactured on a highly automated truck-assembly production line. Major vehicle components and parts are procured from outside vendors and delivered to the Mishawaka facility. Stamped body parts are bonded, painted and treated for corrosion protection either at a body shop located within the Mishawaka facility or at outside vendors. HUMMER/HUMVEE chassis frames are assembled and joined with engine components on a chassis assembly line. The addition of all other body parts or trim (steering wheel, seats,
windshields, grill, etc.) to the chassis and engine platform, as well as painting operations, are conducted on separate assembly lines within the facility. All HUMMER/HUMVEE vehicles, both military and commercial, undergo testing before delivery to the customer.
Approximately 72.5% of the Company's cost of manufacturing HUMMER/HUMVEE vehicles consists of components purchased from over 550 suppliers. Component prices are generally negotiated annually based on, among other things, the Company's expected manufacturing volume. The Company places orders periodically for certain component requirements throughout the year and is only obligated to purchase components for which it has placed orders. Approximately 23% of the Company's total purchased materials are supplied by various divisions of General Motors Corporation. These materials include engines, transmissions, steering and electronic components. The Company believes that it has strong relationships with its suppliers and will continue to have a stable supply of its purchased materials and components to meet future production needs.
COMPETITION
As the sole manufacturer of the HUMVEE for the US Armed Forces for more than thirteen years, the Company believes that it is the dominant US manufacturer in supplying light TWVs to the DoD and is one of only a few manufacturers on a worldwide basis. Management believes that the HUMMER/HUMVEE offers enhanced mobility and dependability at a lower cost than any of its international competitors.
The Company's Commercial HUMMER competes as a highly specialized vehicle within an established, competitive four-wheel drive vehicle marketplace. There are a number of domestic and foreign manufacturers of four-wheel drive vehicles, which have recognized models and established distribution, sales, service and warranty administration systems in place. By virtue of its design, the Commercial HUMMER offers off-highway mobility and durability far beyond the capabilities of competing trucks, which are designed primarily for on-highway use. The Company's commercial marketing efforts attempt to demonstrate and exploit this value in order to penetrate the markets for Class II and Class III four-wheel drive trucks.
The Company is in competition for the FMTV second source contract to be awarded in late 1999. The Company anticipates a very high level of competition for this award. The Company's competitor is an experienced manufacturer of tactical wheeled vehicles and contractor with TACOM.
Competition in SPLO is highly fragmented among a large number of small independent suppliers and selected original equipment manufacturers.
SEASONALITY AND PAYMENT
The Company's business is generally not seasonal. The Company builds military vehicles subject to fixed- price medium and long term contracts. Therefore, the Company assumes full risk of producing and delivering the specified number of vehicles for a fixed price, normally with a specific delivery schedule. Payments are usually due thirty days after delivery, except in the case of direct international sales, for which payment is received shortly after shipment pursuant to letters of credit opened by the customer in favor of the Company at the time of the placement of the order.
Export sales to unaffiliated customers represent a significant portion of the Company's total net sales. See notes 1(a) and 16 of the notes to Consolidated Financial Statements contained herein. Currency and economic problems in certain parts of the world may adversely impact future export volume.
Payment for sales to Commercial HUMMER dealers are generally obtained within five days of delivery. Units wholesaled to dealers are subject to either voluntary or mandatory repurchase agreements. Such agreements either permit or require the Company to repurchase, at not more than dealer cost, new, unsold units in the dealers' inventories in the event of repossession by the dealers' floorplan lenders. At October 31, 1998, the mandatory repurchase agreements covered 82 Commercial HUMMERs with a total value at dealer cost of $5.9 million.
Since export sales are priced in US dollars, the Company does not expect any material adverse impact in connection with the introduction of the Euro currency.
EMPLOYEES
As of October 31, 1998, the Company had 437 salaried employees and 857 hourly employees. Of the 1,294 employees, 231 provide general administrative services including legal, finance, human resources, and other corporate functions. All of the Company's hourly employees are represented by the International Union, United Automobile, Aerospace and Agricultural Implement Workers of America ("UAW"). The Company's labor contract for the Mishawaka HUMMER/HUMVEE and SPLO operations which expired in September 1998 was re-negotiated and ratified by 83% of those members that voted. The current labor agreement expires in September of 2001. The Company believes that its relations with employees are satisfactory.
As a result of the WARN notice issued on January 21, 1999, the Company anticipates that the number of employees will be reduced by 277 hourly and 23 salaried employees when the ESP plant is closed.
ITEM 2.
ITEM 2. PROPERTIES
The Company operates two manufacturing facilities and five support locations which include its headquarters in South Bend, Indiana, as well as sales, warehouse, training, engineering, and other non-manufacturing operations.
The Company's principal manufacturing facility is the HUMMER/HUMVEE plant, situated on approximately 96 acres in Mishawaka, Indiana. The major tooling and materials handling equipment, assembly lines, robotics and computer controls involved in the manufacture of HUMMER/HUMVEE vehicles are located at the Mishawaka facility. The HUMMER/HUMVEE facility has a single shift capacity of between 50 and 70 units per day depending on the model configuration of orders currently being received by the Company. The Company reduced the production rate from 25 to 16.5 units per day effective February 3, 1997. See MD&A
The Commercial HUMMER finishing facility is also located in Mishawaka, adjacent to the HUMMER/HUMVEE plant. Mishawaka is also the site of a one-mile, asphalt-paved test track. Additionally, the Company's SPLO operations are located in Mishawaka at a separate facility.
The Company maintains a dedicated remanufacturing facility in South Bend for its ESP operations. The Company increased capacity at its ESP plant from 5 to 7 remanufactured vehicles per day. This facility is presently operating at 6.2 units per day and will continue to do so until April 19, 1999 when the last unit will be manufactured and all production at the facility will cease. Shortly thereafter, plant closure operations will commence.
The Company operates a test track in South Bend located near the ESP facility, which had been leased by the Company. The Company exercised its option to purchase the test track for a nominal amount. The acquired property was immediately transferred to the Chippewa Corporation ("Chippewa"), a wholly owned subsidiary of the Company, and leased by the Company from Chippewa. Prior to the purchase, the Company conducted environmental testing of the site, the conclusions of which indicated little if any contamination occurring during its occupancy. The Company has offered and the environmental agencies have accepted a plan by which the Company will provide assistance in the remediation of the adjacent properties. The remediation effort is not anticipated to have a material adverse impact on the Company's financial condition. Chippewa has agreed to participate in the state of Indiana's Voluntary Remediation Program for the pre-RICRA lagoons located on Chippewa's property.
In March 1997, the Company notified UAW Local #555 officials and the salaried employees at the Stamping and Assembly Plant in Indianapolis that, based on current and expected levels of business, it was closing the plant. In September 1997, the Company closed the facility. The machinery and equipment at the facility were sold at auction at a guaranteed price of $2.8 million. In July 1998, the land and building were sold for $1.2 million to a local developer. See MD&A.
The Company's STS and R&D operations are located in Livonia, Michigan, which is approximately 28 miles from TACOM's facility. In addition to providing convenience to its primary customer, TACOM, the personnel at the Livonia facility act as a liaison between the Company's management in South Bend and TACOM.
The Company considers its facilities and equipment generally to be in good operating condition. All of the Company's facilities are leased from unrelated third parties except for the Mishawaka Commercial HUMMER finishing facility and the test track in Mishawaka which the Company owns and the South Bend test track which is leased by the Company from the Chippewa Corporation, a wholly owned subsidiary of the Company.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
US ARMY PRICING CLAIM
On January 27, 1995, the Company received a final decision from the US Army asserting a claim against the Company for approximately $6.3 million plus interest from January 27, 1995 under the R034 Contract which was entered into in 1983. The claim was increased by $1.7 million in October 1996 to cover option quantities omitted from the original claim.
The US Army asserts that the Company failed to submit accurate, complete, and current cost or pricing data in the pricing of that contract and that such failure increased the negotiated contract price by the amount of the claim.
On December 18, 1995, the Company through its legal counsel filed a motion for summary judgment with respect to the claim. The Company's motion raised only one of the Company's affirmative defenses to the Government's claim. If successful, this affirmative defense would have completely offset the Government's claim and would have resolved the case without need for further proceedings. The Government responded by filing its own summary judgment motion, arguing that, given the factual circumstances, the relevant case law precludes the Company from pursuing this particular affirmative defense.
On November 10, 1998, the Board denied the Company's motion and granted the Government's motion. The ruling precludes the Company from arguing this particular affirmative defense throughout the remainder of the proceedings before the Board. The Company is free to argue all other affirmative defenses. The Board's summary judgment ruling is subject to appeal, but not until after the trial before the Board is completed.
The case is currently set for trial on September 14, 1999. The parties may take discovery until August 3, 1999. The parties are discussing the possibility of resolving this dispute through an alternate dispute resolution procedure wherein the parties would have the dispute decided by an arbitrator(s). In the meantime, the Government is auditing the Company's submission of conventional offsets. These offsets will nearly match the amount of the Government's claim. The Government's audit should be completed by April 1999.
If settlement discussions are unsuccessful, the Company believes that it will prevail in the litigation. However, there can be no assurance as to the outcome of such litigation, and an adverse decision on the claim could have a material adverse effect on the Company.
DJ-5 LITIGATION
In December 1998, an action was instituted in the United States District Court for the Southern District of West Virginia against the Company by the administrator of the estate of a woman who suffered fatal injuries while driving a DJ-5 vehicle. The action seeks damages of $5 million.
The DJ-5 driven by the decedent was manufactured, according to the complaint in 1974. The Company was not incorporated until 1991. The Company has never manufactured or sold DJ-5 vehicles or parts for such vehicles.
In the purchase agreement pursuant to which the Company purchased certain of the assets and assumed certain of the liabilities in April 1992 from a former AM General Corporation, in the Chapter 11 proceeding of that company and its parent, it was expressly provided that the Company was not acquiring any DJ-5 assets of the former company nor assuming any DJ-5 liabilities of the former company. This
agreement was approved by an order of the United States Bankruptcy Court for the Southern District of New York, which authorized the sale, that being the Court which had jurisdiction over the Chapter 11 proceedings of the former company and its parent.
Accordingly, the Company disclaims any liability on account of this matter.
BREACH OF CONTRACT
On December 30, 1991, Dial Machine & Tool, Inc. filed a complaint in the Starke County, Indiana Circuit Court alleging breach of Purchase Order Agreements by the Company's predecessor. The plaintiff asserts that it was forced into bankruptcy as the result of the alleged breach. The plaintiff seeks compensatory damages of $744,103 and punitive damages of $10,000,000. The judge suggested the parties mediate this dispute. The parties are engaged in settlement negotiations.
HMMWV PRODUCT LIABILITY CLAIM
On May 11, 1998, the family of a deceased Army Sergeant filed a complaint against AM General and the company that supplies seat belts for the HMMWV. The complaint was filed in the U.S. District Court for the District of Colorado. The complaint alleges that the Sergeant's seat belt released and allowed him to be thrown from the HMMWV while it was rolling over after leaving the road and traveling into a ditch. The Sergeant was a passenger in the vehicle, and died from his injuries. The complaint claims that the seat belt was defectively designed and that proper warnings were not issued. The Company has alleged the government contractor's defense as an affirmative defense and intends to file a summary judgment motion seeking to resolve the claims against the Company on that basis. A settlement conference is scheduled for February 2, 1999. If the settlement conference is unsuccessful, the Company will file its summary judgment motion. The summary judgment motion will be resolved by April 8, 1999. If the Company not successful on its summary judgment the case will proceed to trial. The Company expects to prevail in a trial on the merits. While the outcome of any jury trial is uncertain, the Company does not anticipate that an adverse decision would have a material adverse effect on the Company.
AGE DISCRIMINATION CLAIM
William Wilson filed an age discrimination suit against the Company on February 21, 1995 in the United States District Court for the Northern District of Indiana asserting that his termination in March 1994 was the result of age discrimination. A jury verdict against the Company was entered on the issue as to discrimination under the Age Discrimination in Employment Act, but in favor of the Company on the issue of willfulness. The jury awarded Mr. Wilson $238,902 in back-pay. The court awarded Mr. Wilson the following additional amounts: $13,604 in pre-judgement interest; $160,194 in front pay; and $56,890 in attorney's fees. The Company accrued the jury award and has appealed the judgement. The appellate court heard oral arguments in February 1998. As of January 1999, the appellate court had not issued its decision on the Company's appeal.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
There is no established public trading market for the Company's common stock. As of January 29, 1999, the Company had one stockholder. The Company paid no dividends on its common stock in fiscal 1997 and 1998. The payment of and amounts of dividends are restricted by the Company's long-term debt agreements. See note 8 of the Consolidated Financial Statements contained herein.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth certain summary financial and other data of the Company for each of the years in the five-year period ended October 31, 1998. The financial data set forth below should be read in conjunction with the Company's financial statements and the related notes thereto appearing elsewhere herein and MD&A.
(a) Gross Profit represents net sales less cost of sales (excluding depreciation and amortization).
(b) Operating Income represents earnings before interest and provision (benefit) for income taxes.
(c) Total Debt includes the revolving credit facility, the discounted value of the LTV Creditor Trust Obligations, Senior Notes issued at acquisition and the 12 7/8% Senior Notes due 2002 issued in 1995 (the "Refinancing").
(d) Represents a put obligation of the Company to repurchase the LTV Creditor Trust Stock which was purchased in the Refinancing.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
GENERAL
AM General is the largest supplier of light TWV's for the DoD. The Company is the original designer and sole manufacturer of the HUMMER/HUMVEE. The Company also sells HUMVEEs to foreign military services through the DoD's FMS program and on a direct sale basis. In 1993, the Company began selling to industrial and retail users through its commercial dealer network.
From 1990 through October 31, 1997, AM General sold 49,797 HUMVEEs under its A1 Series program with the DoD. All production under that contract was completed by April 30, 1996 at which time 768 vehicles were produced for a certain FMS customer and remained in finished inventory. In the fourth quarter of fiscal 1996, 167 of the vehicles were sold and the balance of 601 vehicles were sold in January 1997.
From November 1, 1993 through May 7, 1995, the Company's HUMMER/HUMVEE production rate was approximately 47 units per day, including 35 units per day for the US Military and its FMS customers. On May 8, 1995, the Company reduced its HUMMER/HUMVEE production rate to 25 units per day due to lower US and international military demand. On February 3, 1997, the Company further reduced its HUMMER/HUMVEE production rate from 25 to 16.5 units per day due to continued lower international military demand.
The Company began producing the latest generation of military HUMVEEs, the A2 Series, in August 1995. On December 23, 1995, the Company entered into a new multi-year annual requirements contract for A2 Series HUMVEEs known as the X001 Contract which provides a mechanism for the US Army to procure at least 2,350 HUMVEEs annually for the next five years. The X001 contract, however, does not require the Army to purchase the vehicles as funding for each of the respective years must be appropriated via the annual Defense Budget. Through December 1998, a total of 10,573 vehicles have been ordered on the X001 Contract. The FY99 Defense Bill currently contains the necessary funding for the fourth year of this contract.
The Company's SPLO operation sells after-market parts and support services for vehicles manufactured by the Company. Its STS operation performs engineering services related to the Company's military trucks and certain other military vehicles.
In September 1993, the Company was awarded the ESP Contract, the first multi-year contract to teardown and remanufacture aging 2-1/2-ton military trucks under the ESP program. Approximately three old trucks are completely disassembled - certain parts are reworked, others are scrapped and specific new parts are added - for every two remanufactured vehicles under this contract. As of October 31, 1998, a total of 4,776 trucks have been remanufactured and delivered to the US government at a total contract value of $283 million. Work under this contract is expected to be completed in April 1999.
The Company accounted for the base portion and contractual options of the ESP Contract on the Estimate At Completion ("EAC") basis which recognizes estimated profits in the same percentage as revenues are recognized over the term of the contract. Estimated contract costs and profits are reviewed periodically and adjustments recorded as necessary. Revenue under the short term follow-on ESP contracts is recorded when specific contract terms are fulfilled and title passes by either delivery or acceptance, with cost of sales recognized based upon unit cost.
In an effort to accelerate the procurement of new 2-1/2 and 5-ton vehicles, TACOM announced its intention to stage a competition for and award a second source for the FMTV program. When selected in late 1999, the second source will be awarded approximately 700 vehicles to produce over a three-year period. At the conclusion of that contract, the second source will compete with the current source for a share of the remaining program requirements; the winner of which will receive the larger share of the following FMTV multiyear contract. The Company intends to compete vigorously for the FMTV second source award.
RESULTS OF OPERATIONS
TWELVE MONTHS ENDED OCTOBER 31, 1998 ("FISCAL 1998") COMPARED WITH TWELVE MONTHS ENDED OCTOBER 31, 1997 ("FISCAL 1997")
(1) Includes FMS and Direct International Sales
NET SALES
The decrease in net sales was due primarily to lower international military, STS, Commercial HUMMER and US Military sales partially offset by higher ESP sales. SPLO sales were essentially the same as the prior year. International military sales were lower than the prior year due to continued softness in the international market for HUMVEEs partially offset by higher average selling prices. Further, the Company was unable to obtain a firm order for 231 units included in its finished goods inventory. Had this inventory been sold in fiscal 1998, the shortfall in sales would not have been as significant. The Company continues to pursue an order with the FMS customer for whom the units were built; additionally, the Company has expanded its efforts to find alternative buyers. Management believes that the inventory will be sold in fiscal 1999. STS sales were lower in fiscal 1998 due to higher than normal sales in fiscal 1997 primarily attributed to Phase I contract revenues in connection with the MTTR truck program, the delivery of technical data package drawings in connection with the ESP program and the delivery of technical manuals translated for a FMS customer. The decrease in Commercial HUMMER sales is attributed to lower demand partially offset by higher selling prices due to a general price increase.
The decrease in US Military HUMVEE sales is primarily attributed to a higher concentration of less expensive models partially offset by the sale of additional units. ESP sales were higher primarily due to higher negotiated selling prices in connection with additional units added and delivered at the completion of the base and option requirements of the initial contract.
AVERAGE HUMMER/HUMVEE UNIT SELLING PRICES
Average HUMMER/HUMVEE unit selling prices for all HUMMER/HUMVEEs in fiscal 1998 were essentially the same as fiscal 1997. Higher average selling prices for international HUMVEEs and Commercial HUMMERS were offset by a lower average selling price for US Military HUMVEEs.
Average selling prices for the US Military decreased 5.9% over fiscal 1997 due primarily to a higher concentration of basic and less expensive HUMVEE models in fiscal 1998 than in 1997. Average HUMVEE unit selling prices for international sales increased 15.7% primarily due to the less expensive 601 A1 HUMVEEs sold to the FMS customer during 1997. Commercial HUMMER average unit-selling prices increased 3.0% primarily due to a general price increase.
GROSS PROFIT
Gross profit was $48.5 million for fiscal 1998, an increase of $5.3 million from gross profit of $43.2 million for fiscal 1997. The Company's gross profit margin for fiscal 1998 was 12.3%, an increase of 3.0% over fiscal 1997 gross profit margin of 9.3%. The change in gross profit is primarily attributed to higher gross profit in connection with the final accounting for the initial ESP program and higher gross profit in connection with negotiated selling prices for additional ESP units partially offset by lower US Military HUMVEE gross profit due to model mix, lower FMS and international HUMVEE gross profit due to fewer units sold and lower Commercial HUMMER gross profit due to higher sales incentives, fewer units and higher warranty costs.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense was $13.2 million for fiscal 1998, an increase of $.5 million or 3.9% over depreciation and amortization expense of $12.7 million for fiscal 1997. The increase was primarily due to higher depreciation expense in connection with the write down of ESP assets in anticipation of the plant closing in April of 1999 partially offset by lower tooling amortization expense in connection with the Expanded Capacity Vehicle HUMVEE which was fully amortized in fiscal 1997 and lower depreciation expense in connection with reduced capital spending.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expense was $27.7 million for fiscal 1998, an increase of $1.5 million or 5.7% from SG&A expense of $26.2 million for fiscal 1997. The increase was primarily due to higher engineering expense in connection with the MTTR bid.
PLANT CLOSING/RESTRUCTURING CHARGES
During fiscal 1998, the Company recorded $5.2 million in connection with plant closing costs anticipated for the ESP facility. Due to a lack of orders for the remanufactured 2-1/2-ton, the Company issued a WARN act notice on January 21, 1999 and will close the facility in April of 1999. The $5.2 million charge includes all known costs related to closing the facility but does not include a provision for any gain on curtailment of Other Post Employment Benefit expense in connection with the plant closure. Any related gain will be recorded in fiscal 1999 when the plant closure is substantially complete.
During fiscal 1997, the Company recorded $3.5 million of restructuring charges in connection with the reduction in the HUMMER/HUMVEE production rate, a reduction in the Company's salaried workforce and outsourcing of the component parts manufactured at the Company's Indianapolis Stamping Facility.
OPERATING INCOME (LOSS)
The Company had operating income of $2.4 million for fiscal 1998, an increase of $1.7 million from operating income of $.7 million in fiscal 1997. The improvement in operating income was primarily due to higher gross margin and lower depreciation and amortization expense partially offset by higher restructuring charges and higher SG&A expense.
INTEREST INCOME AND EXPENSE
Interest expense for fiscal 1998 was $13.2 million, a decrease of $.3 million or 2.2% from interest expense of $13.5 million for fiscal 1997. Average debt outstanding for fiscal 1998 was $99.3 million at a weighted average interest rate of 12.2%. Average debt outstanding for fiscal 1997 was $102.3 million at a weighted average interest rate of 12.1%. The decrease in average debt outstanding is primarily due to lower borrowings under its revolving credit facility reflecting the overall reduction in inventory levels primarily due to the reduction in finished goods inventory. See "Liquidity and Capital Resources". Interest income remained essentially the same between the two years.
INCOME TAX BENEFIT
Income tax benefit was recorded at the statutory rate adjusted for permanent differences primarily resulting from the amortization of goodwill. Income tax benefit was a credit of $2.1 million for fiscal 1998, a decrease of $.9 million from an income tax benefit of $3.0 million for fiscal 1997. The decrease in income tax benefit was due to the increase of taxable income primarily attributed to higher operating income as discussed above.
NET LOSS
The net loss for fiscal 1998 was $8.3 million, a reduction of $1.2 million from a net loss of $9.5 million in fiscal 1997. As discussed above, the reduction in net loss is primarily due to the improvement in operating income and lower net interest expense partially offset by a lower income tax benefit.
RESULTS OF OPERATIONS
TWELVE MONTHS ENDED OCTOBER 31, 1997 ("FISCAL 1997") COMPARED WITH TWELVE MONTHS ENDED OCTOBER 31, 1996 ("FISCAL 1996")
(1) Includes FMS and Direct International Sales
NET SALES
The increase in net sales was due primarily to the increase in STS, SPLO, ESP and Commercial HUMMER sales partially offset by lower direct international and US Military sales. The increase in STS sales is primarily attributed to the Phase I contract revenues in connection with the MTTR truck re-manufacturing program, the delivery of technical data package drawings in connection with the ESP program and the delivery of technical manuals translated for a FMS customer. The increase in SPLO sales is primarily attributed to an increase in US Government Military spare parts contracts in connection with the Company's continued focus on this segment of its business. The increase in ESP sales is attributed to the delivery of more units in the current fiscal year than were delivered in the prior fiscal year. The increase in Commercial HUMMER sales is attributed to the increase in average selling prices due to a general price increase and lower sales incentives.
The decrease in direct international HUMVEE sales is attributed to continued softness in the demand for light tactical vehicles. The decrease in US Military HUMVEE sales is primarily attributed to fewer units sold due to the change in the production rate because of lower unit orders from the military partially offset by higher unit selling prices. The higher unit selling prices are attributed to engineering changes in connection with the A2 Series HUMVEE.
AVERAGE HUMMER/HUMVEE UNIT SELLING PRICES
Average HUMMER/HUMVEE unit selling prices for all HUMMER/HUMVEEs increased 6.3% from fiscal 1996 primarily due to increases in the average selling price for US Military HUMVEEs and Commercial HUMMERs partially offset by a reduction in the average selling price of direct international units. Average selling prices for the US Military increased 12.9% over fiscal 1996 due primarily to higher selling prices in connection with engineering changes for the A2 Series HUMVEE sold under the X001 Contract. Average HUMVEE unit selling prices for international sales decreased 15.9% primarily due to a higher priced model mix in fiscal 1996 which included highly modified vehicles for one direct international customer. Commercial HUMMER average unit selling prices increased 16.6% primarily due to lower sales incentives, a general price increase and a sales mix of more expensive models.
GROSS PROFIT
Gross profit was $43.2 million for fiscal 1997, an increase of $.3 million from gross profit of $42.9 million for fiscal 1996. The Company's gross profit margin for fiscal 1997 remained the same as that for fiscal 1996 at 9.3%. The change in gross margin is primarily attributed to improved gross margins with respect to US Military HUMVEE sales, an improvement in Commercial HUMMER gross margins and an improvement in US Military spare parts sales partially offset by higher costs in connection with unabsorbed overhead costs due to the reduction in the HUMMER/HUMVEE production line rate.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense was $12.7 million for fiscal 1997, a decrease of $4.1 million or 24.4% over depreciation and amortization expense of $16.8 million for fiscal 1996. The decrease was primarily due to lower tooling amortization expense in connection with the A2 Series HUMVEE which was fully amortized in the prior year, reduced depreciation expense associated with reduced capital spending and lower tooling amortization in connection with the reduction in the unit production rate from 25 to 16.5 units per day.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expense was $26.2 million for fiscal 1997, a decrease of $11.1 million or 29.8% from SG&A expense of $37.3 million for fiscal 1996. The decrease was primarily due to lower expenses in connection with merchandising and sales promotions, lower expenses resulting from the Company's restructuring plan and lower independent research and development expense with respect to the MTTR program.
SPECIAL TERMINATION BENEFITS
In connection with modifications in its labor agreement in fiscal 1996, the Company offered special retirement benefits to certain hourly employees who met specific service requirements. The Company recorded special
charges of $.1 million in fiscal 1997 and $3.2 million in fiscal 1996 to reflect the enhanced special termination benefits for pension and health care related costs.
RESTRUCTURING CHARGES
During fiscal 1997, the Company recorded $3.5 million of charges in connection with its restructuring plan; the objective of which was to significantly reduce the Company's variable and fixed costs, including corporate overhead. Specifically, in February 1997, the Company reduced its HUMMER/HUMVEE production rate from 25 to 16.5 units per day to better match unit production with sales. The Company reduced its salaried workforce by 139 employees and its hourly workforce by 209 employees. Additionally, the Company outsourced the production of certain components, closed its Indianapolis Stamping Plant and relocated its Washington D.C. office. There were no restructuring charges recorded in fiscal 1996.
OPERATING INCOME (LOSS)
The Company had operating income of $.7 million for fiscal 1997, an increase of $15.1 million from an operating loss of $14.4 million for fiscal 1996. The improvement in operating income was primarily due to lower SG&A expense, lower depreciation and amortization expense, lower charges in connection with special termination benefits and higher gross profit, partially offset by the restructuring charge.
INTEREST INCOME AND EXPENSE
Interest expense for fiscal 1997 was $13.5 million, a decrease of $3.0 million or 18.2% from interest expense of $16.5 million for fiscal 1996. Average debt outstanding for fiscal 1997 was $102.3 million at a weighted average interest rate of 12.1%. Average debt outstanding for fiscal 1996 was $128.6 million at a weighted average interest rate of 12.8%. The decrease in average debt outstanding is primarily due to the overall reduction in inventory levels primarily due to the completion of the sale of 601 units to an FMS customer during the first quarter of fiscal 1997. See "Liquidity and Capital Resources". Interest income decreased by $2.3 million primarily due to the higher level of interest income in fiscal 1996 in connection with the acceptance by the DoD and the FMS Customer of interest expense associated with the units held in inventory.
INCOME TAX BENEFIT
Income tax benefit was recorded at the statutory rate adjusted for permanent differences primarily resulting from the amortization of goodwill. Income tax benefit was a credit of $3.0 million for fiscal 1997, a decrease of $5.7 million from an income tax benefit of $8.7 million for fiscal 1996. The decrease in income tax benefit was due to the increase of taxable income primarily attributed to higher operating income as discussed above.
NET LOSS
The net loss for fiscal 1997 was $9.5 million, a reduction of $10.1 million from a net loss of $19.6 million in fiscal 1996. As discussed above, the improvement in net loss is primarily due to the improvement in operating income and lower net interest expense partially offset by a lower income tax benefit.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements result from capital investments, working capital requirements, postretirement health care and pension funding, interest expense, and, to a lesser extent, principal payments on its indebtedness. The Company has met these requirements in each fiscal year since 1992 from cash provided by operating activities and borrowings under its revolving credit facility.
Cash provided by operating activities was $7.1 million for fiscal 1998 compared to $38.7 million in fiscal 1997. The primary sources of cash flow in fiscal 1998 resulted from reductions in inventory, non-cash charges to operating income including depreciation, amortization and non-cash postretirement expenses, an increase in restructuring charges net of cash payments and an increase in accrued expenses. Cash flow provided from operations was partially offset by an increase in accounts receivable, reductions in accounts payable and other liabilities and funding the Company's net loss.
Accounts receivable levels at the end of fiscal 1998 were $21.5 million higher than levels at the end of fiscal 1997 primarily due to higher than normal sales at the end of the fiscal year and an increase of $8.4 in connection with unbilled receivables for the A2 HUMVEE. These unbilled receivables represent work performed by the Company for which a contract modification with the DoD has not yet been finalized.
Accounts payable levels at the end of fiscal 1998 were $1.3 million lower than levels at the end of fiscal 1997. Notwithstanding this reduction, accounts payable increased $8.0 million in connection with liabilities for contract modifications with the DoD which have not been finalized. Management anticipates completion of the contract modifications with DoD in fiscal 1999 and when completed will result in a cash receipt of $2.9 million.
Net inventory levels at the end of fiscal 1998 were $71.6 million or $15.7 million lower than net inventory levels of $87.3 million at end of fiscal 1997. The reduction in inventory is primarily attributed to the reduction of US Military HUMVEEs and Commercial HUMMER finished goods and in-process raw materials.
For fiscal 1998, the Company spent $4.5 million on capital expenditures primarily for the Company's Enterprise Resource Planning ("ERP") project and tooling costs in connection with vehicle production, as compared to $2.4 million for fiscal 1997. The Company expects an increase in total capital expenditures over that during fiscal 1998 of approximately $3.0 million in fiscal 1999. Part of the projected increase of capital is attributable to the Company's ERP project which will be used to convert the Company's information systems to Year 2000 compliant systems. The Company anticipates that all capital requirements will be funded from operating cash flow and availability under the revolving credit facility.
Management anticipates that cash flow from operations as well as availability under its revolving credit facility will be sufficient to finance the Company's liquidity needs for the foreseeable future. The unused availability under the revolving credit facility as of October 31, 1998 was $44.7 million.
Management continues to search for new business opportunities to improve operating performance and liquidity. The Company has been actively engaged in expanding its existing commercial product lines, developing military prototype vehicles and competing for new military contracts, seeking international co-production opportunities and acquiring other businesses.
The Company's revolving credit facility has a maximum borrowing limit of $60 million, is secured by eligible inventories and receivables, as defined in the applicable loan and security agreement, and expires on October 31, 2001. As of October 31, 1998, the Company had borrowings of $7.8 million outstanding under the revolving credit facility. As of January 20, 1999, the Company's loan balance under the revolving credit facility was $1.0 million. The decrease in the revolver from October 31, 1998 reflects a decrease in its accounts receivable.
The revolving credit agreement contains numerous covenants and prohibitions that will impose limitations on the liquidity of the Company, including requirements that the Company satisfy certain financial ratios and limitations on the incurrence of additional indebtedness.. The indenture governing the outstanding 12-7/8% Senior Notes also imposes limitations on the incurrence of additional indebtedness. The ability of the Company to meet its debt service requirements and to comply with such covenants will be dependent upon future operating
performance and financial results of the Company, which will be subject to financial, economic, political, competitive and other factors affecting the Company, many of which are beyond its control.
YEAR 2000 BUSINESS MATTERS
The Year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations.
In September 1997, the Company formed an internal committee to perform a comprehensive review of its computer systems, the purpose of which was to identify the systems that could be affected by the "Year 2000" issue. The committee evaluated three alternatives including fixing the defective code internally, outsourcing the project to a third party or purchasing new software. Factors affecting the committee's decision included the cost benefit analysis of fixing the code versus replacing the software with newer and more cost effective technology. Upon completion of its review, the committee reached a conclusion and recommended that the Company purchase and implement new software.
In June 1998, the committee reached a consensus on its choice of software and the implementation consultant and management approved its recommendation. The committee began the implementation process in July 1998. At October 31, 1998 the project was completed with respect to design and at January 21, 1999 the project is in the configuration stage. By March 1999, the project is anticipated to be in the testing stage with completion of the project scheduled for June 1999.
Based on recent cost estimates the project is estimated to cost approximately $5.4 million. The Company does not believe that such costs will have a material adverse impact on the Company's financial condition.
The risks associated with such a project are significant. To mitigate such risks, the Company has purchased state of the art software and has hired a nationally known information technology consulting group to assist in the implementation of the software. Additionally, the Company has assigned internal resources to assist in the implementation.
With an expected completion date for the project in June of 1999, the Company believes that it has ample time to recover from any time delays that might occur. In the unlikely event that the new software is not operational in time for the year 2000, the Company has developed a contingency plan that includes implementing certain programs for some of its more critical in-house systems and installing other software that will temporarily fix other systems.
INFLATION AND SEASONALITY
In general, the Company's cost of sales and SG&A expenses are affected by inflation and the effects of inflation may be experienced by the Company in future periods. Management believes that since 1992, such effects have not been material to the Company.
The Company's business generally is not seasonal except for a scheduled two-week plant closure during July to accommodate annual maintenance requirements.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information". The Statement is applicable to public entities and is effective for fiscal years beginning after December 15, 1997. SFAS 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders.
The Company will adopt SFAS 131 in fiscal 1999. Upon adoption, reclassification of financial statements for earlier periods may be required.
In April 1998, the AICPA Accounting Standards Executive committee issued Statement of Position 98-5, Reporting on the Costs of Start-up Activities (SOP 98-5). SOP 98-5 is applicable to all non-governmental entities and requires that costs of start-up activities, including organization costs, be expensed as incurred. All start-up costs previously capitalized are required to be fully amortized effective with adoption of SOP 98-5. Except for certain specified investment companies, SOP 98-5 is effective for financial statements for fiscal years beginning after December 15, 1998. Restatement of previously issued financial statements is not permitted. Except for certain specified investment companies, initial application of the SOP should be as of the beginning of the fiscal year in which the SOP is first adopted and should be reported as the cumulative effect of a change in accounting principle as described in APB Opinion No. 20, Accounting Changes. The Company plans to adopt SOP 98-5 in its fiscal year 2000 and has estimated that it will result in a cumulative effect expense of $1.1 million.
FORWARD-LOOKING STATEMENTS
This report includes "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, which involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of the Company to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks, uncertainties and other important factors include, among others: general economic and business conditions; funding for government HUMVEE orders; volume of international and commercial orders for HUMMER/HUMVEEs; the outcome of the FMTV competition; the outcome of pending litigation; the loss of any significant customers; the loss of any major supplier; and the availability of qualified personnel.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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Independent Auditors' Report 26
Consolidated Balance Sheets as of October 31, 1998 and 1997 27
Consolidated Statements of Operations For the years ended October 31, 1998, 1997, and 1996 28
Consolidated Statements of Stockholder's Deficit and Comprehensive Income (Loss) For the years ended October 31, 1998, 1997, and 1996 29
Consolidated Statements of Cash Flows For the years ended October 31, 1998, 1997, and 1996 30
Notes to Consolidated Financial Statements 31
INDEPENDENT AUDITORS' REPORT
The Board of Directors AM General Corporation:
We have audited the consolidated financial statements of AM General Corporation and subsidiaries as listed in the accompanying index to financial statements. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AM General Corporation and subsidiaries as of October 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 1998, in conformity with generally accepted accounting principles.
KPMG LLP
Indianapolis, Indiana December 11, 1998
AM GENERAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets October 31, 1998 and 1997 (Dollar amounts in thousands, except share information)
See accompanying notes to consolidated financial statements.
AM GENERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations For the years ended October 31, 1998, 1997, and 1996 (Dollar amounts in thousands, except share information)
See accompanying notes to consolidated financial statements.
AM GENERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholder's Deficit and Comprehensive Income (Loss) For the years ended October 31, 1998, 1997, and 1996 (Dollar amounts in thousands, except share information)
See accompanying notes to consolidated financial statements.
AM GENERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows For the years ended October 31, 1998, 1997, and 1996 (Dollar amounts in thousands, except share information)
See accompanying notes to consolidated financial statements.
AM GENERAL CORPORATION AND SUBSIDIARY Notes to Consolidated Financial Statements (Dollar amounts in thousands)
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(1)SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) DESCRIPTION OF BUSINESS
The primary business of AM General Corporation (the Company) is to manufacture Hummer(R) vehicles at its plant in Indiana. Currently, the Company is manufacturing Hummer(R) vehicles for the Department of Defense (DoD) under a multiple year requirements contract extending through October 31, 2000 (with funds appropriated through September 1999). The Company also sells Hummer(R) vehicles and parts to friendly foreign nations through the Department of Defense or on a direct basis. AM General Sales Corporation, a wholly owned subsidiary of the Company, sells Hummer(R) vehicles to the general public through its network of forty-six domestic dealers and forty-three international distributors at October 31, 1998. The Company also refurbishes two and one-half ton trucks, the Extended Service Program (ESP), for the Department of Defense; such arrangement extends into April, 1999 (See also note 16).
The mix of sales for each of the years in the three year period ended October 31, 1998 is as indicated in the following analysis:
All of the Company's common and preferred stock is owned by The Renco Group, Inc.
(B) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the financial statements of AM General Corporation and its wholly owned subsidiaries, AM General Sales Corporation and Chippewa Corporation. All significant intercompany balances and transactions have been eliminated in consolidation.
(C) CASH EQUIVALENTS
For purposes of the consolidated statement of cash flows, the Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
(D) INVENTORIES
Inventories, other than inventoried costs related to the initial ESP contract, are stated at the lower of standard cost or market. Standard cost approximates first-in, first-out cost.
Inventoried costs relating to the initial ESP contract which was completed in June, 1998, are stated at the actual production cost, including factory overhead, incurred to date reduced by amounts identified with revenue recognized on units delivered. General and administrative costs are not included in inventories applicable to the initial ESP contract. The costs attributed to units delivered under the initial ESP contract are based on the estimated average cost of all units expected to be produced. Inventories relating to the short-term, follow-on ESP contracts are stated at the lower of standard cost or market. Standard cost approximates first-in, first-out cost.
(E) PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are stated at cost. Depreciation on plant and equipment is calculated on the straight-line method over the estimated useful lives of the assets commencing in the year subsequent to acquisition. Leasehold improvements are amortized over the shorter of the lease terms or estimated useful lives of the assets using the straight-line method.
Useful lives for property, plant, and equipment are as follows:
Buildings 40 years Machinery, equipment, and fixtures 10 to 12 years Vehicles 5 years Dealer signage 10 years Tooling Units expected to be produced
(F) GOODWILL
Goodwill, which represents the excess of purchase price over fair value of net assets of the Hummer(R) and related businesses acquired on April 30, 1992, is amortized on a straight-line basis over 25 years. Accumulated amortization was $27,862 and $23,575 at October 31, 1998 and 1997, respectively. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through undiscounted future operating cash flows. The amount of goodwill impairment, if any, is measured based on projected discounted future operating cash flows. The assessments of the recoverability of goodwill will be impacted if estimated future operating cash flows are not achieved.
(G) OTHER ASSETS
The costs of the noncompete covenant and deferred loan costs (included in other assets, see note 5) are amortized on a straight-line basis over their estimated useful lives. The amortization of deferred loan costs is included in interest expense.
(H) ACCOUNTS PAYABLE
The Company utilizes a cash management system which incorporates a zero balance disbursement account funded as checks are presented for payment. Accounts payable includes checks issued in excess of book balance of $5,246 and $5,621 at October 31, 1998 and 1997, respectively.
(I) REVENUE RECOGNITION
Revenue under U.S. Government and foreign military fixed-price production contracts relating to the sale of Hummer(R) vehicles is recorded when specific contract terms are fulfilled and title passes by either delivery or acceptance, with cost of sales recognized based upon unit cost. Revenue under sales of commercial Hummer(R) vehicles is recorded when vehicles are shipped and title passes to dealers.
Revenue under cost-reimbursement contracts is recorded as costs are incurred and includes estimated earned fees in the proportion that costs incurred to date bear to total estimated costs. The fees under certain Government contracts may be increased or decreased in accordance with cost or performance incentive provisions which measure actual performance against established targets or other criteria. Such incentive fee awards or penalties are included in revenue at the time when realization is probable and the amounts can be reasonably determined. Estimated losses on long-term contracts are recorded when identified.
Sales and related cost of sales applicable to the fixed-price, initial ESP contract are recognized as specific contract terms are fulfilled under the percentage-of-completion method, measured on a units produced basis. See also footnote 1(d). Revenue under the short-term, follow-on ESP contracts is recorded when specific contract terms are fulfilled and title passes by either delivery or acceptance, with cost of sales recognized based upon unit cost.
(J) RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. Research and development costs amounted to $4,444, $1,856 and $5,643 for the years ended October 31, 1998, 1997 and 1996, respectively.
(K) INCOME TAXES
The Company and its subsidiaries are included in the consolidated Federal income tax return of The Renco Group, Inc. (the Parent). Federal income taxes are provided on a separate company basis and remitted to the Parent in accordance with the tax sharing agreement between the Company and its Parent. Under the tax sharing agreement with The Renco Group, Inc., the Company will not benefit from any net operating loss carryforwards unless the net operating loss carryforward is generated by temporary differences for Federal income tax purposes.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted Federal and state tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(L) PENSION AND OTHER POSTRETIREMENT PLANS
The Company has defined benefit pension plans covering substantially all of its employees. Benefits for salaried employees are accumulated each year at 1-1/2% of the participant's base salary for that year, up to the social security integration base plus 2-1/4% of any base salary in excess of the social security integration base for that same year. Benefits for hourly employees are based on a negotiated rate per years of service. The Company's policy is to fund the maximum amount allowable under the Government cost accounting standards.
The Company has defined contribution 401(k) savings plans for all nonunion salaried employees and substantially all hourly employees.
The Company has a welfare benefit plan which covers substantially all hourly paid employees. The plan provides benefits to employees while on layoffs or when working less than 40 compensated or available hours as defined by this plan. This plan provides for integration with state unemployment compensation programs.
The Company sponsors defined benefit health care plans for substantially all retirees and employees. The Company measures the costs of its obligation based on its best estimate. The net periodic costs are recognized as employees render the services necessary to earn the postretirement benefits.
(M) USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare these
financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
(N) IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
(2) ACCOUNTS RECEIVABLE
Components of accounts receivable are as follows:
Recoverable costs accrued--not billed--are comprised principally of revenue amounts recognized on deliveries under contracts which were not billable at the balance sheet date due to the timing provisions under the related contracts.
Unrecovered costs subject to future negotiation primarily includes revenues recognized on contracts under which changes were directed by customers. Prices for these changes and for other related contract claims are currently being negotiated with the customers.
Substantially all billed and unbilled receivables are expected to be collected within the next 12 months.
(3) INVENTORIES
Inventories consist of the following:
(4) PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment consist of the following:
Tooling, net of related amortization, of $10,098 and $10,668 at October 31, 1998 and 1997, respectively, was required for vehicles being sold to the general public. This tooling is being amortized over 20,000 commercial units expected to be sold which at the current rate of production will extend for another 14 years.
(5)OTHER ASSETS
Other assets consist of the following:
The noncompete covenant resulted from the acquisition of the Hummer(R) business on April 30, 1992, and is being amortized over ten years. Accumulated amortization was $6,690 and $5,661 at October 31, 1998 and 1997, respectively. Deferred loan costs were incurred in connection with the revolving line-of-credit and the senior notes due 2002 and are being amortized over three and seven years, respectively. Accumulated amortization was $3,636 and $2,675 at October 31, 1998 and 1997, respectively. Deferred loan costs include a $2,000 fee paid to The Renco Group, Inc. for services and assistance provided in connection with the amendment of the revolving line-of-credit and the issuance of senior notes due 2002.
Preproduction cost represents cost incurred prior to the production of the related vehicle and includes labor and overhead relating to developing production facilities. These costs are being amortized over the 20,000 estimated units to be sold to the general public. Accumulated amortization was $1,480 and $1,407 at October 31, 1998 and 1997, respectively.
(6) LEASES
The Company has several noncancelable operating leases for substantial portions of the Company's plant and office facilities and machinery and equipment. Leased plant and office facilities generally contain renewal options. Rental expense for operating leases (except those with lease terms of a month or less that were not renewed) for the years ended October 31, 1998, 1997 and 1996 aggregated approximately $5,388, $5,040, and $5,060, respectively.
Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) as of October 31, 1998 are:
(7) ACCRUED EXPENSES
Components of accrued expenses are as follows:
(8)LONG-TERM DEBT
Long-term debt consists of:
The revolving credit agreement (the Agreement) permits the Company to borrow amounts based on percentages of qualifying accounts receivable and inventories up to a maximum of $60,000. At October 31, 1997, the amount that was available was approximately $31,839; approximately $44,685 is available at October 31, 1998. The Agreement is secured by a first lien on all of the Company's accounts receivable, inventories and certain other assets. Interest is due monthly; there is a monthly commitment fee of one-half of 1% on the unused credit commitment and a prepayment penalty for early termination. Subsequent to October 31, 1998, the Company signed an amendment to its revolving credit agreement to extend the term to October 30, 2001, and to reduce the interest rate on outstanding borrowings to prime plus 3/4%. Accordingly, the amounts outstanding under the revolving line of credit at October 31, 1998, have been classified as long-term debt.
The senior notes are unsecured and are redeemable at a premium at the Company's option after May 1, 1999 and at the face amount after May 1, 2001. The Company will be obligated to offer to repurchase senior notes at a price of 101% of the face amount if there is a change in control or if at the end of each twelve month period ended April 30, the Company has excess cash flow, as defined. During fiscal 1996, senior notes with a face amount of $1,000 were repurchased as a result of an offer required because of excess cash flow, as defined, for the twelve-month period ended April 30, 1996. In fiscal 1998 and 1997, the Company was not required to repurchase any bonds.
The various debt agreements contain restrictions on mergers, incurring additional debt or liens, making investments, selling assets or making payments such as dividends, stock repurchases, or debt prepayments and payments of any kind to affiliates. The revolving credit agreement also contains various financial covenants such as working capital and net worth. At October 31, 1998, the Company was in compliance with all the financial covenants.
Under the most restrictive covenant in any agreement, no amount was available for payment of dividends at October 31, 1998 and 1997.
The Company's outstanding letters of credit totaled $6,663 and $4,505 at October 31, 1998 and 1997, respectively. Of this amount, $4,261 and $4,470 at October 31, 1998 and 1997, respectively, were securing advance deposits received from customers for foreign sales and other cash collateralized letters of credit. The cash received has been pledged as security for the letters of credit.
(9) OTHER LIABILITIES
(10) PREFERRED STOCK
The preferred stock of the Company, all of which is held by The Renco Group, Inc., is entitled to receive cumulative preferential cash dividends at an annual rate of 8%. Undeclared preferred stock dividends in arrears at October 31, 1998 and 1997 were $1,400 and $1,000, respectively. The shares have no voting rights on any matter, except as specifically required by law.
The preferred shares are redeemable by the Company at its option, subject to compliance with long-term debt covenants, at the par value thereof plus any accrued and unpaid dividends. Preferred shares have preference in liquidation or dissolution of the Company over common shares to the extent of the par value of the preferred shares plus any accrued and unpaid dividends thereon.
(11) INCOME TAX
Total income taxes were allocated as follows:
Income tax expense (benefit) consists of:
Income tax expense (benefit) differed from the amounts computed by applying the U.S. Federal income tax rate of 35% to pretax income as a result of the following:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at October 31, 1998, 1997, and 1996 are presented below:
There was no change in the valuation allowance for the years ended October 31, 1998, 1997 and 1996. Subsequently recognized tax benefits relating to the valuation allowance for deferred tax assets will be allocated to goodwill. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at October 31, 1998. The amount of the deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income are reduced.
Income taxes receivable represent amounts due from The Renco Group, Inc. for Federal income tax overpayments; it is anticipated such amount will be recovered through reductions in future estimated tax payments based on future taxable income.
(12) PENSION BENEFITS
The Company has defined benefit pension plans (Defined Benefit Plans) covering substantially all of its employees. The following table sets forth the Defined Benefit Plans' funded status and amounts recognized in the Company's consolidated balance sheet at October 31, 1998 and 1997:
Substantially all employees can participate in one of two defined contribution plans sponsored by the Company. Hourly employees may deposit the value of certain benefits and awards into their plan which the Company then matches. Salaried employees may make contributions which the Company matches at a rate of 50% to a maximum 3% of the employee's base compensation. Company contributions charged to expense were approximately $325, $380 and $340 for the years ended October 31, 1998, 1997 and 1996, respectively.
(13) OTHER POSTRETIREMENT BENEFIT PLANS
In addition to the Company's defined benefit pension plans, the Company sponsors defined benefit health care plans (Health Plans) that provide postretirement medical and life insurance benefits to employees who meet minimum age and service requirements. The Health Plans are noncontributory. The Health Plans contain other cost-sharing features such as deductibles and coinsurance. The Company's policy is to fund the cost of medical benefits as incurred.
The following table presents the related amounts recognized in the Company's consolidated balance sheets at October 31, 1998 and 1997:
For measurement purposes, a 7.5% annual rate of increase in the per capita cost of covered benefits was assumed for fiscal 1998 and 1997; the rate was assumed to decrease gradually to 5.5% by the year 2003 and remain at that level thereafter.
The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.00% and 7.50% at October 31, 1998 and 1997.
The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of October 31, 1998 by $22,189 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost would increase for the year ended October 31, 1998 by $2,004. Decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated postretirement benefit obligation by $17,908 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost would decrease for the year ended October 31, 1998 by $1,452.
(14) COMMITMENTS AND CONTINGENCIES
A portion of the Company's contracts and subcontracts contain terms which provide for price adjustments. Such adjustments, if any, are not expected to have a significant effect on the accompanying consolidated financial statements.
The Company has received a final decision from the U.S. Army asserting a claim against the Company for approximately $8.0 million, including the impact of option vehicles, plus interest from January 27, 1995. The claim relates to costs incurred under a prior Hummer(R) contract. Although the
parties have held discussions, they have been unable to resolve the matter. The Company has appealed the U.S. Army's final decision to the Armed Services Board of Contract Appeals. The U.S. Army has agreed to defer collection of the amount claimed until 30 days after final decision on the Company's appeal. The Company believes it has defenses and sufficient offsets to the U.S. Army's claim and intends to pursue the appeal vigorously. Management of the Company believes that the ultimate liability, if any, resulting from such claims would not materially affect the financial position of the Company.
The Company, in the ordinary course of business, is the subject of or party to various pending or threatened litigation. While it is not possible to predict with certainty the outcome of these matters, management of the Company believes that any liabilities resulting from such litigation would not materially affect the financial position of the Company.
Payment for sales to commercial Hummer(R) dealers are generally obtained within five days of delivery by drafts issued against the dealers' wholesale floorplan accounts. Units wholesaled by the Company under these accounts are subject to either voluntary or mandatory repurchase agreements between the Company and four wholesale floorplan creditors. Such agreements either permit or require the Company to repurchase, at not more than dealer cost, new, unsold units in the dealers' inventories in the event of repossession by the dealers' wholesale floorplan lenders. At October 31, 1998 and 1997, the mandatory repurchase agreements covered Hummers(R) with a total value at dealer cost of $5,907 and $7,148, respectively. The Company has not repurchased any vehicles under these arrangements.
The Company has arranged for a nationwide retail leasing program through an independent leasing company and has entered into an agreement with respect to this lease program which requires the Company to repurchase commercial Hummers(R) leased under this program for specified residual values in the event that the lessees or Hummer(R) dealers do not purchase the vehicles for the specified residual values. At October 31, 1998, there were 19 active Hummer(R) leases with a total residual value of $652.
In the ordinary course of business, the Company has entered into contractual commitments related to purchases of materials, capital expenditures, and leases.
(15) RELATED-PARTY TRANSACTIONS
During the years ended October 31, 1998, 1997 and 1996, the Company incurred management fees to The Renco Group, Inc. of $1,200, $1,200 and $1,200, respectively; $100 of which is included in accrued expenses at October 31, 1998 and October 31, 1997. Under the current management consultant agreement between the Company and The Renco Group, Inc., the monthly fee to Renco is $100 with the potential for additional amounts dependent on the Company achieving certain levels of earnings.
(16) BUSINESS AND CREDIT CONCENTRATIONS
The Company's largest customer is the United States Department of Defense. The Department of Defense accounted for 75%, 79% and 74% of the Company's sales for the years ended October 31, 1998, 1997 and 1996, respectively. At October 31, 1998, 1997 and 1996, accounts receivable with the Department of Defense were $62,811, $41,758 and $46,721, respectively.
Export sales to unaffiliated foreign customers, including sales to friendly foreign nations, were $42,509, $80,951 and $107,033 for the years ended October 31, 1998, 1997 and 1996, respectively.
The Company's business is significantly impacted by the United States defense budget. As the U.S. continues to reduce budget allocations for defense expenditures, sales are adversely affected. Foreign sales are dependent on periodic receipt of a relatively few, individually significant contracts and are negatively impacted by a reduction in foreign demand or material adverse changes in the U.S. Government foreign military sales program. The commercial market is impacted by the general economy and interest rates. Changes in the marketplace of any of the above may significantly effect management's estimates and the Company's performance.
The Company is dependent upon certain vendors for the manufacture of significant components of its Hummer(R) vehicles and two and one-half ton ESP trucks, including engines and body components. If these vendors were to become unwilling or unable to continue to manufacture these products in required volumes, the Company would have to identify and qualify acceptable alternative vendors. The inability to develop alternate sources, if required in the future, could result in delays or reductions in product shipments. However, the Company has not experienced any significant problems relative to timeliness, quality or availability of sole-sourced products. All of the Company's hourly employees are represented by the International Union, United Automobile, Aerospace and Agricultural Implement Workers of America ("UAW") under one of two collective bargaining agreements. Certain employees in the Company's remanufacturing operations (approximately 30% of the hourly employees) are included in a collective bargaining agreement expiring in September 2005 while the remaining 70% of the hourly employees are included in a collective bargaining agreement expiring in September, 2001.
(17) PLANT CLOSING AND RESTRUCTURING
The Company completed production under its initial ESP contract in July 1998 and received additional orders to continue production through April 1999. However, the U.S. Government has decided not to purchase any additional units beyond those that are already on contract. The last unit of production will occur on April 19, 1999, at which time production at the facility will cease and plant closure operations will commence. Accordingly, the Company has recorded a plant closing charge of $5,231 for the year ended October 31, 1998. The major components of the plant closing charge are $2,958 of severance benefits for 277 hourly and 23 salaried employees, $1,200 of additional pension expense due to curtailment of certain defined benefit pension plans, and $1,073 of plant shutdown and other charges. Included in accrued expenses at October 31, 1998, is the remaining plant closing reserve of $4,058. Upon completion of the plant closing, the Company expects to recognize a gain of approximately $7,800 on curtailment of the Company's other postretirement benefit plan due to the workforce reduction.
In recent years, the Company has also experienced reductions in the U.S. defense budget for Hummer(R) vehicles, reduced direct international sales of Hummer(R) vehicles, and lower sales volume and higher costs than expected in the commercial Hummer(R) vehicle program. In order to address these issues which impact operating results and liquidity, the Company reduced its Hummer(R) vehicle production rate in February, 1997, from 25 to 16.5 units per day, eliminated certain corporate overhead positions, outsourced production of certain components and closed its stamping plant, resulting in a restructuring charge of $3,495 for the year ended October 31, 1997. The major components of the restructuring charge were $2,820 for employee severance costs, $1,141 of additional pension expense due to curtailment of certain defined benefit pension plans, a $2,597 write-down to fair value of property, plant and equipment to be disposed of and $1,353 of plant shutdown and other charges. These costs were partially offset by a $4,416 gain on curtailment of the Company's other postretirement benefit plan due to the workforce reduction. The stamping facility equipment was sold during fiscal 1997. Included in prepaid expenses and other assets at October 31, 1997, is $1,144 which represents the property and plant of the stamping facility at its fair value less costs to sell. The Company sold the facility during fiscal 1998. Included in accrued expenses at October 31, 1997, was the remaining restructuring reserve of $1,927, related primarily to severance benefits.
(18) DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash, accounts receivable, income taxes receivable, accounts payable and accrued expenses approximates fair value because of the short maturity of these financial instruments.
The revolving line-of-credit approximates fair value because the interest rate fluctuates with prime. Management believes the fair value of the senior notes at October 31, 1998 and 1997, was approximately $74,300 and $80,500, respectively, based on management's informal discussions with an investment banker which makes a market in the senior notes.
(19) RECONCILIATION OF NET LOSS TO NET CASH PROVIDED BY OPERATING ACTIVITIES
The reconciliation of net loss to net cash provided by operating activities for the years ended October 31, 1998, 1997 and 1996 follows:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table lists the director and executive officers of the Company as of January 29, 1999:
Name Age Position - ------------------- --- ----------------------------------------------- Ira Leon Rennert 64 Chairman and sole Director of the Company James A. Armour 55 President and Chief Executive Officer Edmond L. Peters 54 Senior Vice President, Procurement and Business Development Adare Fritz 52 Senior Vice President, Operations Robert J. Gula 52 Senior Vice President, Engineering and Product Development Paul J. Cafiero 45 Vice President and Chief Financial Officer Francis R. Scharpf 60 Vice President, Medium Truck Programs and Business Development
Ira Leon Rennert has been the Chairman and sole Director of the Company since 1991.the acquisition of the HUMMER/HUMVEE business in 1992 (the "Acquisition") and has been Chairman, Chief Executive Officer and principal shareholder of Renco (including predecessors) since its first acquisition in 1975. Renco holds controlling interests in a number of manufacturing and distribution concerns operating in businesses not competing with the Company including WCI Steel, Inc. and Renco Metals, Inc.
James A. Armour has been President and Chief Executive Officer of the Company since April 30, 1992 when the Company acquired the HUMMER/HUMVEE business. Prior thereto, Mr. Armour was President of the former AM General Corporation since November 1988 and held various other positions prior thereto, including Vice President and HUMVEE Program Manager, Corporate Director, Quality Assurance, and Vice President, Materials and Quality Assurance. Mr. Armour has been with the Company and its predecessor companies for the past 26 years. Prior thereto, Mr. Armour held various positions with American Motors Corporation and Ford Motor Company.
Edmond L. Peters has been Senior Vice President Procurement and Business Development since November 1, 1997. Mr. Peters previously held the position of Senior Vice President, Contracts Materials and Washington Operations since October 1, 1996 and Vice President, Contracts & Subcontracts since April 30, 1992. Mr. Peters previously held the position of Director-Purchasing. Mr. Peters has been with the Company and its predecessor companies for the past 14 years.
Adare Fritz has been Senior Vice President, Operations since April 30, 1992. Mr. Fritz previously held the position of Vice President, Operations. Mr. Fritz has been with the Company and its predecessor companies for the past 30 years.
Robert J. Gula has been Senior Vice President, Engineering and Product Development since November 1, 1997. Mr. Gula previously held the position of Vice President, Engineering since April 30, 1992. Mr. Gula has been with the Company and its predecessor companies for the past 27 years. Prior to joining AM General, Mr. Gula held technical positions within several engineering services and automotive manufacturing companies.
Paul J. Cafiero has been Vice President and Chief Financial Officer since May 1, 1997. Mr. Cafiero previously held the position of Corporate Controller since April 30, 1992. Mr. Cafiero previously held the position of Assistant Controller. Mr. Cafiero has been with the Company and its predecessor companies for the past 14 years.
Francis R. Scharpf has been Vice President, Medium Truck Programs and Business Development since June 1, 1998. On March 18, 1996, he was named Executive Assistant to the President and CEO. Prior to this, he held various positions involving program management and business planning. Mr. Scharpf has been with the Company and its predecessor companies for the past sixteen years. Before joining AM General, Mr. Scharpf was a career military officer having served in the US Army in various command positions.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The following table lists all cash compensation paid or accrued by the Company for services rendered to it in all capacities during the fiscal years ended October 31, 1998, 1997, and 1996 to the Company's chief executive officer and its four other highest paid executive officers (excluding Mr. Rennert, the "Named Executive Officers").
(1) Mr. Rennert, the sole Director of the Company received no compensation directly from the Company. Mr. Rennert, together with certain trusts for his benefit and for the benefit of certain members of his family, is the principal shareholder of Renco, which receives a management fee from the Company pursuant to a management agreement (the "Management Consultant Agreement"). In fiscal 1998, Renco received a management fee of $1,200,000 from the Company.
(2) Value of perquisites and other personal benefits did not exceed the lesser of $50,000 or 10% of total salary and bonus per Named Executive Officer.
(3) Consisting principally of Company paid expenses for cars, clubs, travel and other expenses.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company had no compensation committee during the fiscal year ended October 31, 1998. The sole member of the board of directors was Mr. Rennert. The compensation for the Named Executive Officers for fiscal 1998 was fixed by their employment agreements and their Net Worth Appreciation Agreements and consultation between the Chairman of the Board and the President.
During fiscal 1998, no executive officer of the Company, served (a) as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served on the Company's board of directors, (b) as a director of another entity, one of whose executive officers served on the Company's board of directors or (c) as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served as a Director of the Company.
EMPLOYMENT AGREEMENTS
Mr. Armour, Mr. Fritz, Mr. Peters, Mr. Gula, Mr. Cafiero and Mr. Scharpf are each employed under employment agreements which, pursuant to the terms thereof, continue until October 31, 1998 and from year to year thereafter unless terminated by either party with 30 days' prior written notice. The compensation arrangements as of November 1, 1998 are as follows:
Mr. Armour-Minimum annual salary of $250,000 plus an annual bonus of $100,000 for each fiscal year in which the Company shall not have incurred a net loss before the bonus payments to all Named Executive Officers and charges for non-cash postretirement benefits other than pensions.
Mr. Fritz-Minimum annual salary of $135,000 plus an annual bonus of $40,000 subject to the same conditions as applicable to Mr. Armour.
Mr. Peters-Minimum annual salary of $175,000 plus an annual bonus of $60,000 subject to the same conditions as applicable to Mr. Armour.
Mr. Gula-Minimum annual salary of $155,000 plus an annual bonus of $40,000 subject to the same conditions as applicable to Mr. Armour.
Mr. Cafiero-Minimum annual salary of $125,000 plus an annual bonus of $25,000 subject to the same conditions as applicable to Mr. Armour.
Mr. Scharpf-Minimum annual salary of $102,000 plus an annual bonus of $25,000 subject to the same conditions as applicable to Mr. Armour.
Four former officers, three of whose employment terminated in December 1996 and January 1997, received their contractual compensation through the expiration of their contracts in October 1997.
NET WORTH APPRECIATION AGREEMENTS
The Named Executive Officers and one other officer are each parties to agreements ("Net Worth Appreciation Agreements") with the Company, where, upon termination of each person's employment with the Company, he will be entitled to receive a fixed percentage of the cumulative net income (available for common stock as defined in such agreements) of the Company from a base date until the end of the fiscal quarter preceding the date of termination. Such amount is payable without interest in 40 equal quarterly installments commencing three months after the date of termination of employment. Because of the net loss in fiscal 1997 and 1998, the amounts payable to each contract holder at October 31, 1998 have been reduced to zero.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Renco owns all of the outstanding capital stock of the Company. Certain trusts established by Mr. Rennert for his benefit and for the benefit of certain members of his family holds 97.9% of the capital stock of Renco. Mr. Rennert is Chairman of Renco and of the Company and may be deemed to be the beneficial owner of the Company's capital stock. The address of Renco and of Mr. Rennert is The Renco Group, Inc., 30 Rockefeller Plaza, New York, NY 10112. No other executive officer of the Company has any ownership interest in the Company.
By virtue of Renco's ownership of all the outstanding shares of capital stock of the Company, and Mr. Rennert's ownership of a majority of the capital stock of Renco, Mr. Rennert is in a position to control actions that require the consent of a majority of the holders of the Company's outstanding shares of capital stock, including the election of the board of directors.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Management Agreement
Renco provides management services to the Company under a management agreement (the "Management Agreement"). Such services include operational consulting, budget review, income tax consulting and contracting for insurance under master policies. Pursuant to the Management Agreement effective as of April 1, 1995, Renco provides such services to the Company for an annual management fee equal to $1.2 million. Additionally, Renco will receive an annual fee for each fiscal year, commencing with fiscal 1995, equal to the excess, if any, of (i) ten percent (10%) of the Company's consolidated net income before deductions for federal and state income taxes, fees associated with the Management Agreement and expenses related to the Company's Net Worth Appreciation Agreements, over (ii) the aggregate annual management fee of $1.2 million.
The Management Agreement provides that the Company shall not make any payment thereunder which would violate any of its agreements with respect to any of its outstanding indebtedness. Annual payments by the Company in excess of $1.2 million under the Management Consultant Agreement must comply with the restricted payments covenant of the Indenture governing the Senior Notes.
Management fees are paid monthly in arrears in installments of $100,000. The Company paid management fees of $1.2 million to Renco in the year ended October 31, 1998.
Insurance Sharing Program
To obtain the advantages of volume, Renco purchases certain insurance coverage for its subsidiaries, including the Company, and the actual cost of such insurance, without markup, is reimbursed by the covered subsidiaries. The major areas of the Company's insurance coverage obtained under the Renco programs are fidelity and special crime insurance The premiums for fidelity and special crime insurance are allocated by Renco substantially as indicated in the underlying policies. In fiscal 1998, the Company incurred costs of approximately $44,639 under the Renco insurance program. The Company believes that its insurance costs under this program were less than it would have incurred if it had obtained its insurance directly.
Tax Sharing Agreement.
Through fiscal year ended October 31, 1998 AM General is included in the consolidated federal income tax return of Renco. Under the terms of the tax sharing agreement with Renco, income taxes are allocated to AM General on a separate return basis except that transactions between AM General and Renco and its other subsidiaries are accounted for on a cash basis and not on an accrual basis. AM General is not entitled to the benefit of net tax loss carryforwards, unless such tax losses were a result of timing differences between AM General's
accounting for tax and financial reporting purposes. As of October 31, 1998, AM General had no net operating tax loss carryforwards. As of October 31, 1998, AM General had a long term receivable for income taxes of $1.6 million under this agreement, representing estimated tax payments made by the Company to Renco in excess of the Company's actual tax liability.
For periods subsequent to October 31, 1998 AM General will file its own consolidated federal and state income tax returns.
Other
The 5,000 outstanding shares of Preferred Stock of the Company, all of which is held by Renco, are entitled to receive cumulative preferential cash dividends at an annual rate of 8% from May 1, 1995.
The Preferred Stock is redeemable by the Company at its option, subject to compliance with long-term debt covenants, at the par value thereof plus any accrued and unpaid dividends thereon. The Preferred Stock has preference in liquidation or dissolution of the Company over common stock to the extent of the par value of the Preferred Stock plus any accrued and unpaid dividends thereon.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. and 2. List of Financial Statements and Financial Statement Schedules:
- ------------------------------------------------------------------------------ Page ---- Independent Auditors' Report................................... 26 Consolidated Statements of Operations for the years ended October 31, 1998, 1997 and 1996........................... 27 Consolidated Balance Sheets as of October 31, 1998 and 1997.... 28 Consolidated Statements of Stockholder's Equity for the years ended October 31, 1998, 1997 and 1996..................... 29 Consolidated Statements of Cash Flows for the years ended October 31, 1998, 1997 and 1996........................... 30 Notes to Consolidated Financial Statements..................... 31 through 46
All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission have been omitted from this Annual Report because they are not required, are not applicable, or the required information is included in the consolidated financial statements or the notes thereto.
(a) 3. Listing of Exhibits
Exhibit No. Description ----------- ------------------------------------------------------ *3.1 Certificate of Incorporation of Ren Acquisition Corp., filed with the Delaware Secretary of State on November 26, 1991.
*3.2 Certificate of Amendment, changing name to AM General Corporation, filed on April 30, 1992.
*3.3 Bylaws.
*4.1 Indenture dated as of April 27, 1995 between AM General Corporation as Issuer and Shawmut Bank Connecticut, National Association as Trustee relative to $75,500,000 in principal amount of 12-7/8% Senior Notes due 2002, with form of Series A Senior Note annexed as Exhibit A and form of Series B Senior Note annexed as Exhibit B.
*10.1 Loan and Security Agreement dated as of April 30, 1992 between Congress Financial Corporation and AM General Corporation, and amendments 1 through 8 thereto.
****10.1.1 Amendment No. 9 dated June 26, 1996 to Loan and Security Agreement, dated as of April 30, 1992 between Congress Financial Corporation and AM General Corporation
*****10.1.2 Amendment No. 10 dated August 22, 1996 to Loan and Security Agreement, dated as of April 30, 1992 between Congress Financial Corporation and AM General Corporation
*****10.1.3 Amendment No. 11 dated December 17, 1996 to Loan and Security Agreement, dated April 30, 1992 between Congress Financial Corporation and AM General Corporation.
*****10.1.4 Amendment No. 12 dated March 14, 1997 to Loan and Security Agreement, dated April 30, 1992 between Congress Financial Corporation and AM General Corporation.
******10.1.5 Amendment No. 13 dated dated October 30,1998 to Loan and Security Agreement, dated April 30, 1992 between Congress Financial Corporation and AM General Corporation.
*10.2 Employment Agreement with James A. Armour, dated May 1, 1992, as supplemented December 16, 1993 and September 1, 1994.
*10.3 Employment Agreements dated May 1, 1992 as supplemented December 16, 1993 with: Adare Fritz Gary L. Wuslich Robert J. Gula Edmond L. Peters
**10.3.1 Supplement No. 2, dated February 16, 1995, to Employment Agreements of Messrs. Fritz, Wuslich, Gula and Peters.
10.3.2 Employment Agreement with Paul J. Cafiero, dated May 1,
Exhibit No. Description ----------- ------------------------------------------------------ *10.6 Net worth appreciation agreements dated May 1, 1992 with:
James A. Armour Paul R. Schuchman Adare Fritz Kenneth M. Jordan Gary L. Wuslich Robert J. Gula
**10.6.1 Net worth appreciation agreement with Edmond L. Peters dated as of February 1, 1995
10.6.2 Net worth appreciation agreement with Paul J. Cafiero dated May 1, 1997
*10.7 Management Consultant Agreement effective as of April 1, 1995 with The Renco Group, Inc.
*10.9 Deferred Payment Agreement dated May 5, 1995 between the United States of America and the Corporation.
**10.10 Letter Agreement dated 23 December 1994 between the Company and Department of the Army-Tank-Automotive and Armaments Command (technical schedules omitted).
**10.11 Lease dated September 11, 1984 between Amland Properties, Inc. and AM General Corporation.
**10.12 Lease dated May 12, 1989 between Niles/Washington Associates Limited and AM General Corporation.
**10.13 Lease dated January 1, 1989 between WF Associates Limited Partnership and AM General Corporation as amended August 23, 1989, July 30, 1993 and December 31, 1993.
**10.14 Lease dated September 17, 1993 between Indiana GRQ, Inc. and AM General Corporation.
**10.15 Lease dated July 25, 1984 between Oppenheimer Livonia Associates and AM General Corporation.
**10.16 Intentionally Omitted
**10.17 Commercial lease dated April 28, 1992 between Amland Corporation and Ren Acquisition Corp.
***10.18 Contract dated December 14, 1995 between the Company and the Department of the Army-Tank -Automotive and Armaments Command (technical schedules omitted)
*****10.19 Commercial lease dated November 6, 1997 between the Company and Chippewa Corporation
21 Subsidiaries of Registrant.
*Filed with the Registration Statement No. 33-93302 filed June 9, 1995.
**Filed with Amendment No. 1 to Registration Statement No. 33-93302 filed August 9, 1995
*** Filed with Company's Form 10-K, No. 33-93302, filed January 28, 1996.
**** Filed with Company's Form 10-Q, No. 33-93302, filed September 16, 1996.
***** Filed with Company's Form 10-K, No. 33-93302, filed January 29, 1997
******Filed with Company's Form 10-K No. 33-93302, filed January 29, 1999
(b) No reports on Form 8-K were filed by the registrant during the last quarter of the period covered by this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Acts of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on January 29, 1999.
AM GENERAL CORPORATION
By: /s/ James A. Armour ---------------------------------- James A. Armour President and Chief Executive Officer
Pursuant to the requirements of Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on January 29, 1999.
Signature Title --------- -----
/s/ Ira Leon Rennert Chairman and sole Director - ---------------------------------- Ira Leon Rennert
/s/ James A. Armour President and Chief Executive Office - ---------------------------------- (Principal Executive Officer) James A. Armour
/s/ Paul J. Cafiero Vice President and Chief Financial Officer - ---------------------------------- (Principal Financial and Accounting Officer) Paul J. Cafiero
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(D) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
No annual report to security holders covering the registrant's last fiscal year and no proxy statement, form of proxy or other proxy soliciting material with respect to any annual or other meeting of security holders has been nor will be sent to security holders.