ITEM 1. BUSINESS
GENERAL
Atchison Casting Corporation ("Atchison" or "ACC") was formed in 1991 with the dual objectives of acting as a consolidator in the foundry industry and bringing new technology for casting design and manufacture to the foundries it acquires. While Atchison in its current form has been in operation since 1991, its operating units have been in continuous operation for much longer, in some cases for more than 100 years. The first foundry acquired by ACC, the steel-castings division of Rockwell International, has been in continuous operation since 1872. The period as a semi-captive foundry, under Rockwell, was characterized by high quality design and production, but less emphasis on outside customers and new markets.
Atchison manufactures highly engineered metal castings and forgings that are utilized in a wide variety of products, including cars, trucks, gas, steam and hydroelectric turbines, mining equipment, locomotives, passenger rail cars, pumps, valves, army tanks, navy ships, paper-making machinery, oil field equipment, reactor vessels for plastic manufacturing, computer peripherals, office furniture, home appliances, satellite receivers and consumer goods. Having completed nineteen acquisitions since 1991, the Company has established itself as a leading consolidator in the casting industry. As a result of these acquisitions, the Company has the ability to produce castings from a wide selection of materials, including carbon, low-alloy and stainless steel, gray and ductile iron, aluminum and zinc as well as the ability to manufacture parts in a variety of sizes, ranging from small die cast components for the computer industry that weigh a few ounces to mill stands for the steel industry that weigh up to 280 tons. The Company believes that its broad range of capabilities, which addresses the needs of many different markets, provides a distinct competitive advantage in the casting and forging industry.
The Company was founded to make acquisitions in the highly fragmented foundry industry and to implement new casting design technology to make the foundries more competitive. Following the initial acquisition of the steel casting operations of Rockwell International in 1991, the Company has continued to acquire foundries in the U.S., Canada and Europe. As a result of these acquisitions, as well as internal growth, ACC's net sales have increased from approximately $54.7 million in its first fiscal year ended June 30, 1992, to $475.6 million for the fiscal year ended June 30, 1999, resulting in a compound annual growth rate of 36.2%. The Company is not currently contemplating any major acquisitions. The Company's primary focus in fiscal 2000 will be on the integration and improvement of existing operations.
Since 1991, the number of customers served by the Company has increased from 12 to more than 500, including companies such as Caterpillar, Gardner Denver, General Motors, General Electric, Siemens (formerly Westinghouse), General Dynamics, Shell, British Steel, Nucor, GEC-Alstom, Ingersoll-Dresser, John Deere, DaimlerChrysler, and Meritor (formerly Rockwell International). The Company has received supplier excellence awards for quality from, or has been certified by, substantially all of its principal customers.
The Company's favorable industry position is attributable to several factors, including: (i) its use of new and advanced casting technologies; (ii) its ability to cast substantially all types of iron and
steel, as well as aluminum and zinc; (iii) the Company's emphasis on customer service and marketing; and (iv) the Company's position as a long-term supplier to many of its major customers.
The principal executive offices of the Company are located at 400 South Fourth Street, Atchison, Kansas 66002-0188, and the Company's telephone number is (913) 367-2121.
COMPANY STRATEGY
ACC is pursuing growth and diversification through a two-pronged approach of: (i) making strategic acquisitions within the widely fragmented and consolidating foundry industry; and (ii) integrating the acquired foundries to achieve economies of scale, while strengthening marketing and promoting the use of new casting technology. No major acquisitions are currently contemplated during fiscal 2000. ACC's primary focus during fiscal 2000 will be on the integration and improvement of existing operations.
STRATEGIC ACQUISITIONS
ACQUIRE LEADERS AND BUILD CRITICAL MASS. The Company initially seeks to acquire foundries that are considered leaders in their respective sectors. After acquiring a leader in a new market, ACC strives to make subsequent acquisitions that further penetrate that market and take advantage of the leader's technical expertise. The Atchison/St. Joe Division is a leader in the field of large, complex steel castings. This acquisition in 1991 provided credibility for ACC's presence in the industry and established a base for add-on acquisitions. Following the Atchison/St. Joe Division acquisition, the Company added capacity and strengthened its base through the add-on acquisitions of Amite Foundry and Machine, Inc. ("Amite") in 1993 and Canadian Steel Foundries, Ltd. ("Canadian Steel") in 1994. As an additional example, Prospect Foundry, Inc. ("Prospect") was acquired in 1994 due to its leading position in gray and ductile iron casting production. The subsequent acquisition of La Grange Foundry Inc. ("La Grange") in 1995 further enhanced ACC's position in this market.
BROADEN PRODUCT OFFERINGS AND CAPABILITIES. The Company also seeks to acquire foundries that add a new product line or customer base that can be leveraged throughout ACC's network of foundries. For example, prior to the acquisition of Prospect in 1994, which expanded ACC's capabilities to include gray and ductile iron, the Company only produced carbon and low alloy steel castings. The acquisition of Quaker Alloy, Inc. ("Quaker Alloy") expanded ACC's stainless and high alloy steel capabilities to include a wider range of casting sizes. Los Angeles Die Casting Inc. ("LA Die Casting"), a leading die caster of aluminum and zinc components for the computer and recreation markets, provides ACC with an entry into the aluminum and zinc die casting markets. PrimeCast, Inc. ("PrimeCast") (formerly the Beloit Castings Division of Beloit Corporation) expanded ACC's capabilities to produce large iron castings. The acquisition of Sheffield Forgemasters Group Limited ("Sheffield") brings to ACC the ability to offer cast and forged rolls, larger steel castings and centrifically cast parts. London Precision Machine & Tool Ltd. ("London Precision") expanded ACC's capabilities in the machining of castings.
DIVERSIFY END MARKETS. The Company attempts to lessen the cyclical exposure at individual foundries by creating a diversified network of foundries that serve a variety of end markets. Kramer International, Inc. ("Kramer"), a supplier of pump impellers, was acquired in 1995, expanding ACC's sales to the energy and utility sectors. The Company believes ACC's presence in these markets somewhat offsets its exposure to the railroad and mining and construction markets, as energy and utility cycles do not necessarily coincide with railroad investment or mining and construction cycles. The acquisition of Prospect diversified the end markets served by the Company by providing access to both the agricultural equipment and trucking industries. Sheffield provided a strong position as a supplier to the steel industry, as well as substantial enhancement of ACC's presence in the oil and gas
industry. Currently, the Company serves more than ten major end-user markets, compared to three in 1991.
DIVERSIFY GEOGRAPHICALLY. The Company also seeks to acquire foundries which would expand the operations to other major world economies. Sheffield and Founderie d'Autun ("Autun") provide entry into the Euromarket.
The following table presents the Company's nineteen acquisitions and their primary strategic purpose.
INTEGRATION OF ACQUIRED FOUNDRIES
STRENGTHEN MARKETING FUNCTIONS. Many foundries, particularly those that operate as captive foundries or only rely on a small number of customers, do not have strong marketing capabilities. ACC views this industry-wide marketing weakness as an opportunity to establish a competitive advantage. The Company places great emphasis on maximizing new business opportunities by strengthening marketing capabilities, adding sales people and cross-selling between foundries.
One way in which ACC builds the marketing efforts of its foundries is to increase the number of sales personnel at both existing and acquired foundries. In addition to sales people added through acquisitions, the Company has incrementally increased the sales force by 31%. Another element of the Company's marketing effort is to jointly develop castings with its customers. Joint development projects using new technology, and the resulting increased service and flexibility provided to customers, is an important marketing tool and has been instrumental in receiving several new orders. For example, a joint development project between Caterpillar and ACC led to the production of the boom tip casting for one of Caterpillar's new hydraulic excavators. Joint development projects have also taken place with General Motors, Nordberg, John Deere, New Holland and DaimlerChrysler, among others.
An increasingly important aspect of the Company's marketing strategy has been to develop its ability to cross-sell among its foundries. In acquiring new foundries and expanding into new markets, the Company has gained a significant advantage over smaller competitors since its sales force is able to direct its customers to foundries with different capabilities. This benefits ACC in that it enables foundries to use the Atchison name and relationships to gain new customers as well as helping customers to reduce their supplier base by providing "one-stop" shopping. The Company facilitates cross-selling by reinforcing the sales force's knowledge of Company-wide capabilities through visits to individual facilities.
INTRODUCE ADVANCED TECHNOLOGY. As part of its acquisition strategy, the Company is systematically introducing new advanced technologies into each of its acquired foundries to enhance their competitive position. For example, the Company's capabilities in finite element analysis and three-dimensional solid modeling are having a beneficial impact on sales and casting production by helping customers to design lighter and stronger castings, shortening design cycles, lowering casting costs and in some cases creating new applications. These new technologies have enhanced the Company's ability to assist customers in the component design and engineering stages, strengthening the Company's relationships with its customers. New techniques involve computerized solid models that are used to simulate the casting process, to make patterns and auxiliary tooling and to machine the
finished castings. The Company intends to implement this new technology in all of its foundries and, to date, fourteen of ACC's foundries have implemented or are in the process of implementing this technology. The Company has established a Fabrication-to-Casting Design Center at its Atchison, Kansas facility. The focus of the design center is to help customers design new castings, especially those which can replace existing fabricated assemblies.
Investments by the Company in technology improvements include: (i) new solidification software and hardware for better casting design and process improvement; (ii) Computer Numerical Control ("CNC") machine tools, computer-assisted, laser measurement devices and new cutting head designs for machine tools to improve productivity and quality in the machining of castings; (iii) Argon-Oxygen Decarburization ("AOD") refining, which is used to make high-quality stainless steel; (iv) computer-controlled sand binder pumps to improve mold quality and reduce cost; and (v) equipment for measuring the nitrogen content of steel, which helps in casting quality improvement. ACC is one of the few foundry companies that uses its own scanning electron microscope to analyze inclusions in cast metal. The Company also participates in technical projects led by the Steel Founders' Society of America and the American Foundrymen's Society, which are exploring ways to melt and cast cleaner iron and steel, as well as U.S. government/industry specific projects to shorten and improve the casting design cycle.
INCREASE CAPACITY UTILIZATION. A principal objective of the Company in integrating and operating its foundries is to increase capacity utilization at both its existing and newly acquired facilities. Many of the Company's foundries at the time of their acquisition have been operating with underutilized capacity. The Company seeks to improve capacity utilization by introducing more effective marketing programs and applying advanced technologies as described above.
ACHIEVE PURCHASING ECONOMIES. Once an acquisition has been completed, ACC makes its volume purchasing programs available to the newly acquired foundry. ACC has realized meaningful cost savings by achieving purchasing efficiencies for acquired foundries. By jointly coordinating the purchase of raw materials, negotiation of insurance premiums and procurement of freight services, ACC's individual foundries have, in some cases, realized savings of 10% to 30% of these specific costs.
LEVERAGE MANAGEMENT EXPERTISE. The Company believes that improvements can often be made in the way acquired foundries are managed, including the implementation of new technologies, advanced employee training programs, standardized budgeting processes and profit sharing programs and providing access to capital. In this view, ACC enhances management teams by adding technical, marketing or production experience, if needed. For example, ACC was able to significantly improve the profitability of Canadian Steel by adding new members to management, entering new markets, installing finite element solidification modeling and providing capital. As another example, under ACC ownership, La Grange was able to negotiate a new labor agreement, create profit sharing for all employees, broaden its customer base and install solidification modeling.
INDUSTRY TRENDS
The American Foundrymen's Society estimates that global casting production was 60.9 million metric tons in 1997 of which steel castings accounted for approximately 5.5 million tons, iron castings for approximately 46.8 million tons and nonferrous castings for approximately 8.6 million tons. It is further estimated that the top ten producing countries represent 80% of the total production, with the U.S. representing in excess of 23% of the world market.
The U.S. casting industry is estimated to have had shipments of approximately 14.9 million tons in 1998, of which steel castings accounted for approximately 1.4 million tons, iron castings for approximately 10.8 million tons and non-ferrous castings for approximately 2.7 million tons. Recent estimates forecast an approximate 2-3% decline in shipments in each of 1999 and 2000. Forecasts for years 2002 and 2003 project the shipments to grow to 14.2 million tons and 14.9 million tons, respectively. The Company has been able to grow at a rate substantially in excess of the overall industry principally as a result of its strategy and due to key trends affecting the casting industry, including the following:
INDUSTRY CONSOLIDATION
Although still highly fragmented, the U.S. foundry industry has consolidated from approximately 465 steel foundries and 1,400 iron foundries in 1982 to approximately 400 and 700 steel and iron foundries, respectively, in 1998. As the industry has consolidated, capacity utilization has increased from approximately 45% in 1982 to more than 85% in 1998. This consolidation trend has been accompanied by increased outsourcing of casting production and OEM supplier rationalization.
OUTSOURCING. Many OEMs are outsourcing the manufacture of cast components to independent foundries in an effort to reduce their capital and labor requirements and to focus on their core businesses. Management believes that captive foundries are often underutilized, inefficiently operated and lack the latest technology. Several of ACC's OEM customers, such as Caterpillar, General Motors, General Electric, Meritor (formerly Rockwell International), Ingersoll-Dresser, Gardner Denver, Compagnie Internationale du Chauffage and Beloit Corporation, have closed or sold one or more of their captive foundries during the past ten years and have outsourced the castings which they once made to independent suppliers such as the Company. As described above, the closure of these facilities has contributed to increased capacity utilization at the remaining foundries.
OEM SUPPLIER RATIONALIZATION. OEMs are rationalizing their supplier base to fewer foundries that are capable of meeting increasingly complex requirements. For example, OEMs are asking foundries to play a larger role in the design, engineering and development of castings. In addition, some customers have demanded that suppliers implement new technologies, adopt quality (ISO 9000 and QS 9000) standards and make continuous productivity improvements. As a result, many small, privately-owned businesses have chosen to sell their foundries because they are unwilling or unable to make investments necessary to remain competitive. Moreover, the EPA and OSHA require compliance with increasingly stringent environmental and governmental regulations.
NEW CASTING TECHNOLOGY
Recent advances in casting technology and pattern-making have created new opportunities for reducing costs while increasing efficiency and product quality. The combination of powerful, low cost computer workstations with finite element modeling software for stress analysis and metal solidification simulation is helping foundries and customers to design castings that are lighter, stronger and more easily manufactured at a competitive cost.
The Company believes new casting technologies have led to growth in casting shipments by replacing forgings and fabrications in certain applications. In the past, fabricated (welded) components have been used in order to reduce tooling costs and product development lead-time. New casting technology has helped to reduce the weight and cost, and shorten the lead-time, of castings and has therefore increased the relative attractiveness of cast components. For example, these improvements allowed an ACC customer to replace a fabricated steel boom that is used in a typical mining vehicle with
one that is cast. The cast steel boom weighs 20% less than the fabricated component that it replaced, allowing an increase in payload. Product life is increased due to greater corrosion resistance. Another customer replaced the combination cast/fabricated body of a rock crusher with a one-piece casting, reducing labor for cutting, welding and machining as a result.
The Company has established a Fabrication-to-Casting Design Center at its Atchison, Kansas facility. The focus of the design center is to help customers design new castings, especially those which can replace existing fabricated assemblies.
MARKETS AND PRODUCTS
STEEL INDUSTRY. The steel industry uses rolls to form cast steel into sheets, bars, rods, beams and plates, which are then used to make end products such as car bodies, tin cans and bridges. Rolls are consumed as steel is rolled, so there is a steady demand for rolls. Customers in this market include British Steel and Nucor, among others. Sheffield Forgemasters Rolls Ltd. ("Forgemasters Rolls") is one of the world leaders in cast and forged rolls for the steel making industry. Steel products produced by the Company accounted for 4.1%, 7.0% and 18.7% of the Company's net sales in fiscal 1997, fiscal 1998 and fiscal 1999, respectively.
MINING AND CONSTRUCTION. ACC's castings are used in tractor-crawlers, mining trucks, excavators, drag lines, wheel-loaders, rock crushers, diesel engines, slurry pumps, coal mining machines and ore-processing equipment. Mining and construction equipment customers include Caterpillar, Nordberg, Meritor (formerly Rockwell International), Gardner Denver, John Deere, Komatsu and Euclid, among others. Products supplied to the mining and construction industry accounted for 31.4%, 23.1% and 18.0% of the Company's net sales in fiscal 1997, fiscal 1998 and fiscal 1999, respectively.
RAILROAD. The Company supplies cast steel undercarriages for locomotives, among other parts, for this market. GM is ACC's largest locomotive customer, and has purchased locomotive castings from the Atchison/St. Joe Division for over 50 years. The Company further penetrated this market through the purchase of London Precision. Rail products produced by the Company accounted for 5.2%, 6.6% and 11.4% of the Company's net sales in fiscal 1997, fiscal 1998 and fiscal 1999, respectively. In fiscal 1999, General Motors accounted for more than 10% of net sales.
ENERGY. The Company's products for the energy market include pumps, valves and compressors for transmission and refining of petrochemicals, blow-out preventers and mud pumps for drilling and work-over of wells, lifting hooks and shackles for offshore installation of equipment, winch components for rig positioning, nodes for platform construction, subsea components and other oil field castings. Shell, Amoco, Aker-Verdal, Shaffer, Cooper Energy, Hydril, Solar, Nordstrom, Ingersoll-Dresser Pumps and Amclyde are among the Company's many energy-related customers. Energy products produced by the Company accounted for 14.3%, 8.9% and 8.8% of the Company's net sales in fiscal 1997, fiscal 1998 and fiscal 1999, respectively.
AUTOMOTIVE. The automotive industry uses both iron and aluminum castings, as well as aluminum die castings. ACC entered this market through the purchase of Jahn Foundry Corp. ("Jahn Foundry") in Springfield, Massachusetts and Inverness Castings Group, Inc. ("Inverness") in Dowagiac, Michigan. Customers in this market include General Motors and DaimlerChrysler, among others. Automotive products produced by the Company accounted for 1.6%, 10.4% and 8.7% of the Company's net sales in fiscal 1997, fiscal 1998 and fiscal 1999, respectively.
UTILITIES. Many of ACC's castings are used in products for the utility industry, such as pumps, valves and gas compressors. ACC also makes steam, gas and hydroelectric turbine castings, nuclear plant components, sewage treatment parts and other castings for the utility industry. In addition, the Company manufactures replacement products that are used when customers perform refurbishments. Customers include Westinghouse, General Electric, GEC-Alsthom, Sulzer, Siemens, Kvaerner, Goulds Pumps and Neles Controls. Utility products produced by the Company accounted for 13.1%, 9.9% and 6.6% of the Company's net sales in fiscal 1997, fiscal 1998 and fiscal 1999, respectively.
MILITARY. Weapons and equipment for the Army, Navy and Coast Guard employ many different types of castings. The Company makes components for ships, battle tanks, howitzers and other heavy weapons. The military casting market has declined sharply, but ACC has been able to replace this volume by targeting new products such as turbines, compressors, pumps and valves. Customers in this market include General Dynamics, Litton, Bath Iron Works, Boeing, the U.S. Army and Avondale Shipyards, among others.
TRUCKING. The Company manufactures components used on truck engines and suspension systems. Many of ACC's castings are used in aftermarket products to achieve better fuel economy or to enhance ride characteristics. Customers include Horton Industries, Detroit Diesel and others.
FARM EQUIPMENT. ACC makes a variety of castings for farm tractors, baling equipment, harvesters, sugar cane processors and other agricultural equipment for customers such as John Deere, Caterpillar and New Holland.
PAPER-MAKING MACHINERY. The paper-making machinery industry uses a variety of iron, steel and non-ferrous castings, both in original equipment and for the aftermarket. ACC has been a minor supplier to this market since 1992. The acquisition of the castings division of Beloit Corporation in July 1997 made ACC a significant supplier of castings to this market.
MASS TRANSIT. ACC began making undercarriages for passenger rail cars in 1992 and is a leading casting supplier to the mass transit market. The Company's castings are used on the BART system in San Francisco, METRA in Chicago, NCTD in San Diego, MARTA in Atlanta, and in Miami and Vancouver. La Grange and Claremont Foundry, Inc. ("Claremont") cast components used in subway cars in several cities, including New York City, which is the largest user of subway cars in North America.
OTHER. Other markets include process equipment such as rubber mixers, plastic extruders, dough mixers, machine tools and a variety of general industrial applications. With the acquisition of LA Die Casting, the Company entered the consumer market. LA Die Casting supplies components used to make recreational vehicles, computer peripherals, direct satellite receivers and pool tables. Customers include California Amplifier, RC Design, Care Free of Colorado and Printronix.
For financial information about geographic areas, see footnote 18 of the notes to the Company's Consolidated Financial Statements.
SALES AND MARKETING
New foundry technologies and the new applications resulting therefrom require a more focused and knowledgeable sales force. The Company pursues an integrated sales and marketing approach that includes senior management, engineering and technical professionals, production managers and
others, all of whom work closely with customers to better understand their specific requirements and improve casting designs and manufacturing processes. The Company supplements its direct sales effort with participation in trade shows, marketing videos, brochures, technical papers and customer seminars on new casting designs.
The Company's engineering and technical professionals are actively involved in marketing and customer service, often working with customers to improve existing products and develop new casting products and applications. They typically remain involved throughout the product development process, working directly with the customer to design casting patterns, build the tooling needed to manufacture the castings and sample the castings to ensure they meet customers' specifications. The Company believes that the technical assistance in product development, design, manufacturing and testing that it provides to its customers gives it an advantage over its competition.
Customers tend to develop long-term relationships with foundries that can provide high quality, machined castings delivered on a just-in-time basis that do not require on-site inspection. Frequently, the Company is the only current source for the castings that it produces. Maintaining duplicate tooling in multiple locations is costly, so customers prefer to rely on one supplier for each part number. Moving the tooling to another foundry is possible, however, such a move entails considerable time and expense on the customer's part. In addition, ACC is forming product development partnerships with a number of customers to develop new applications for castings.
BACKLOG
The Company's backlog is based upon customer purchase orders that the Company believes are firm and does not include purchase orders anticipated but not yet placed. At June 30, 1999, the Company's backlog was approximately $178.9 million, as compared to backlog of approximately $198.2 million at June 30, 1998. The backlog is scheduled for delivery in fiscal 2000 except for approximately $21.2 million, of which $14.7 million is scheduled for delivery in fiscal 2001. The level of backlog at any particular time is not necessarily indicative of the future operating performance of the Company. The Company historically has not experienced cancellation of any significant portion of customer orders.
COMPETITION
The Company competes with a number of foundries in one or more product lines, although none of the Company's competitors compete with it across all product lines. The principal competitive factors in the castings market are quality, delivery and price; however, breadth of capabilities and customer service have become increasingly important. The Company believes that it is able to compete successfully in its markets by: (i) offering high quality, machined castings; (ii) working with customers to develop and design new castings; (iii) providing reliable delivery and short lead-times; (iv) containing its manufacturing costs, thereby pricing competitively; and (v) offering a broad range of cast materials.
The Company believes that the market for iron and steel castings is attractive because of a relatively favorable competitive environment, high barriers to entry and the opportunity to form strong relationships with customers. New domestic competitors are unlikely to enter the foundry industry because of the high cost of new foundry construction, the need to secure environmental approvals at a new foundry location, the technical expertise required and the difficulty of convincing customers to switch to a new, unproven supplier.
ACC, and the foundry industry in general, competes with manufacturers of fabrications in some application areas. The Company believes that the relative advantages of castings, particularly in light of new casting design technology, which reduces weight, cost and leadtime while improving casting quality, will lead to increased replacement of fabrications by iron and steel castings. The Company competes with foundries in Asia, Europe and North America.
MANUFACTURING
CASTINGS. Casting is one of several methods, along with forging and fabricating, which shape metal into desired forms. Castings are made by pouring or introducing molten metal into a mold and allowing the metal to cool until it solidifies, creating a monolithic component. Some castings, such as die castings, are made with a permanent metal mold which can be used repeatedly. Others, such as sand castings, are made in a sand mold which is used only once. Forgings are made by shaping solid metal with pressure, usually in a die or with hammers. Fabrications are made by welding together separate pieces of metal. Castings may offer significant advantages over forgings and fabrications. A well-designed casting can be lighter, stronger and more stress and corrosion resistant than a fabricated part. Although castings and forgings are similar in several respects, castings are generally less expensive than forgings.
CASTING PROCESS. The steel casting manufacturing process involves melting steel scrap in electric arc or induction furnaces, adding alloys, pouring the molten metal into molds made of sand or iron and removing the solidified casting for cleaning, heat treating and quenching prior to machining the casting to final specifications. The manufacture of a steel casting begins with the molding process. Initially, a pattern constructed of wood, aluminum or plastic is created to duplicate the shape of the desired casting. The pattern, which has similar exterior dimensions to the final casting, is positioned in a flask and foundry sand is packed tightly around it. After the sand mold hardens, the pattern is removed. When the sand mold is closed, a cavity remains within it shaped to the contours of the removed pattern. Before the mold is closed, sand cores are inserted into the cavity to create internal passages within the casting. For example, a core would be used to create the hollow interior of a valve casing. With the cores in place, the mold is closed for pouring. Castings for rolls are sometimes made by rotating the mold while the liquid steel or iron is being poured into it.
Steel scrap and alloys are melted in an electric arc furnace at approximately 2,900 degrees Fahrenheit, and the molten metal is poured from a ladle into molds. After pouring and cooling, the flask undergoes a "shakeout" procedure in which the casting is removed from the flask and vibrated to remove sand. The casting is then moved to a blasting chamber for removal of any remaining foundry sand and scale. Next, the casting is sent to the cleaning room, where an extensive process removes all excess metal. Cleaned castings are put through a heat treating process, which improves properties such as hardness and tensile strength through controlled increases and decreases in temperature. A quench tank to reduce temperatures rapidly is also available for use in heat treatment. The castings are shot blasted again and checked for dimensional accuracy. Each casting undergoes a multi-stage quality control procedure before being transported to one of the Company's or the customer's machine shops for any required machining.
Iron castings are processed similarly in many respects to steel castings. Melting and pouring temperatures for molten iron are approximately 2,400 degrees Fahrenheit, and less cleaning and finishing is required for iron castings than is typically required for steel castings. Iron and steel scrap may both be used in making cast iron.
Die casting, as contrasted to sand casting, uses a permanent metal mold that is reused. Melting and pouring temperatures for aluminum and zinc are less than half that used for steel, and die castings normally require less cleaning than iron or steel castings.
FORGING PROCESS. The forging process applies pressure by hitting or pressing a heated ingot or wrought steel blank. The forged piece is then heat-treated and machined much in the same manner as a steel casting.
MATERIALS. Steel is more difficult to cast than iron, copper or aluminum because it melts at higher temperatures, undergoes greater shrinkage as it solidifies, causing the casting to crack or tear if the mold is not properly designed, and is highly reactive with oxygen, causing chemical impurities to form as it is poured through air into the mold. Despite these challenges, cast steel has become a vital material due to its superior strength compared to other ferrous metals. In addition, most of the beneficial properties of steel match or exceed those of competing ferrous metals. The Company's first foundry, which today forms the Atchison/St. Joe Division, produced carbon and low alloy steel castings when it was acquired from Rockwell International in 1991. ACC added an AOD vessel for making stainless steel in order to better supply the pump and valve markets, which sometimes require stainless steel castings to be made from the same patterns used for carbon steel castings. Also in 1994, ACC purchased Quaker Alloy, which specialized in casting high alloy and stainless steels for valves, pumps and other equipment. Sheffield, Canadian Steel and Canada Alloy Castings, Ltd. ("Canada Alloy") also make high alloy and stainless castings, further reinforcing ACC's market position and skill base concerning the casting of stainless and specialty, high alloy steels.
In applications that do not require the strength, ductility and/or weldability of steel, iron castings are generally preferred due to their lower cost, shorter lead-times and somewhat simpler manufacturing processes. Ductile iron is stronger and more flexible than traditional cast iron, known as gray iron, and is easier and less expensive to cast than steel. Due to these qualities, the demand for ductile iron is increasing faster than for either traditional gray cast iron or cast steel. In 1994, ACC initiated manufacturing of gray and ductile iron through the acquisition of Prospect. ACC's presence in ductile iron was increased through the subsequent purchases of La Grange, The G&C Foundry Company ("G&C") and PrimeCast.
Aluminum castings (including die castings) generally offer lighter weight than iron or steel, and are usually easier to cast because aluminum melts at a lower temperature. These advantages, coupled with low prices for aluminum during the last decade, have led to a substantial increase in the use of aluminum castings, especially in motor vehicles. Aluminum's relative softness, lower tensile strength and poor weldability limit its use in many applications where iron and steel castings are currently employed. In 1996, ACC entered the nonferrous market with the purchase of LA Die Casting, which die casts aluminum and zinc.
Steel, unlike iron, can be forged as well as cast. Forging compresses steel, and is preferred for some critical applications like nuclear vessels, turbine shafts and pressure vessels, among others.
The ability to provide cast and forged components in a broad range of materials allows ACC to present itself as a "one-stop shop" for some customers and simplifies purchasing for others. Since customers in general have a goal of reducing their total number of suppliers, a broader range of materials and casting skills gives ACC an advantage over many other foundry operations.
MACHINING. The Company machines many of its steel castings, typically to tolerances within 30 thousandths of an inch. Some castings are machined to tolerances of one thousandth of an inch.
Machining includes drilling, threading or cutting operations. The Company's Sheffield, St. Joe, Amite, Inverness and London Precision machine shops have a wide variety of machine tools, including CNC machine tools. The Company also machines some of its castings at Canadian Steel, Quaker Alloy, Empire Steel Castings, Inc. ("Empire") and Kramer. The ability to machine castings provides a higher value-added product to the customer and improved quality. Casting imperfections, which are typically located near the surface of the casting, are usually discovered during machining and corrected before the casting is shipped to the customer.
NON-DESTRUCTIVE TESTING. Customers typically specify the physical properties, such as hardness and strength, which their castings are to possess. The Company determines how best to meet those specifications. Regular testing and monitoring of the manufacturing process are necessary to maintain high quality and to ensure the consistency of the castings. Electronic testing and monitoring equipment for tensile, impact, radiography, ultrasonic, magnetic particle, dye penetrant and spectrographic testing are used extensively to analyze molten metal and test castings.
ENGINEERING AND DESIGN. The Company's process engineering teams assist customers in designing castings and work with manufacturing departments to determine the most cost effective manufacturing process. Among other computer-aided design techniques, the Company uses three-dimensional solid modeling and solidification software. This technology reduces the time required to produce sample castings for customers by several weeks and improves the casting design. The new Fabrication-to-Casting Design Center at its Atchison, Kansas faciltiy is a leading example for the use and benefits of new casting design technology.
CAPACITY UTILIZATION. The following table shows the type and the approximate amount of available capacity, in tons, for each foundry and die caster. The actual number of tons that a foundry can produce annually is dependent on product mix. Complicated castings, such as those used for military applications or in steam turbines, require more time, effort and use of facilities, than do simpler castings such as those for the mining and construction market. Also, high alloy and stainless steel castings generally require more processing time and use of facilities than do carbon and low alloy steel castings.
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* Estimated annual capacity and utilization are based upon management's estimate of the applicable manufacturing unit's theoretical capacity assuming a certain product mix and assuming such unit operated five days a week, three shifts per day and assuming normal shutdown periods for maintenance. Actual capacities will vary, and such variances may be material, based upon a number of factors, including product mix and maintenance requirements.
RAW MATERIALS
The principal raw materials used by the Company include scrap iron and steel, aluminum, zinc, molding sand, chemical binders and alloys, such as manganese, nickel and chrome. The raw materials utilized by the Company are available in adequate quantities from a variety of sources. From time to time the Company has experienced fluctuations in the price of scrap steel, which accounts for approximately 4% of net sales, and alloys, which account for less than 2% of net sales. The Company has generally been able to pass on the increased costs of raw materials and has escalation clauses for scrap with certain of its customers. As part of its commitment to quality, the Company issues rigid specifications for its raw materials and performs extensive inspections of incoming raw materials.
QUALITY ASSURANCE
The Company has adopted sophisticated quality assurance techniques and policies which govern every aspect of its operations to ensure high quality. During and after the casting process, the Company performs many tests, including tensile, impact, radiography, ultrasonic, magnetic particle, dye penetrant and spectrographic tests. The Company has long utilized statistical process control to measure and control dimensions and other process variables. Analytical techniques such as Design of Experiments and the Taguchi Method are employed for troubleshooting and process optimization.
As a reflection of its commitment to quality, the Company has been certified by, or won supplier excellence awards from, substantially all of its principal customers. Of 600 suppliers to General Motors' Electromotive Division, the Company was the first supplier to receive the prestigious Targets of Excellence award. Reflecting its emphasis on quality, the Atchison/St. Joe Division was certified to ISO 9001 in August 1995, Sheffield Forgemasters Engineering Ltd. ("Forgemasters Engineering") has also been certified to ISO 9001, which represents compliance with international standards for quality assurance. Quaker Alloy, La Grange, Canada Alloy, Jahn Foundry, Pennsylvania Steel Foundry & Machine Company ("Pennsylvania Steel"), Inverness, London Precision, Forgemasters Rolls and Canadian Steel have each been certified to ISO 9002. Other ACC foundries are preparing for ISO certification.
EMPLOYEE AND LABOR RELATIONS
As of June 30, 1999, the Company had approximately 4,500 full-time employees. Since its inception, the Company has had one work stoppage. The Company's hourly employees are covered by collective bargaining agreements with several unions at fifteen of its locations. These agreements expire at varying times over the next several years. The following table sets forth a summary of the principal unions and term of the principal collective bargaining agreements at the respective locations. Several of the contracts at the Company's U.K. facilities have expired. The Company is not aware of any threat of work stoppage at the present time. The labor laws of France prevent the Company from learning the number of employees in the union at Autun.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to the executive officers of the Company.
HUGH H. AIKEN has been the Chairman of the Board, President, Chief Executive Officer and a Director since June 1991. From 1989 to 1991, Mr. Aiken served as an Associate of Riverside Partners, Inc., an investment firm located in Boston, Massachusetts, and from 1985 to 1989, Mr. Aiken served as General Manager for AMP Keyboard Technologies, Inc., a manufacturer of electromechanical assemblies located in Milford, New Hampshire. Mr. Aiken previously served as a Director and Chief Operating Officer of COMNET Incorporated and as a Director and Chief Executive Officer of General Computer Systems, Inc., both public companies.
THOMAS K. ARMSTRONG, JR. has been Chief Operating Officer - North America since March 1999. From 1987 to 1999, Mr. Armstrong served as President of Texas Steel Co., a Citation Corp. company. From 1979 to 1986, Mr. Armstrong held positions at Texas Steel of Executive Vice President, Information Systems and Engineering Manager. In addition, Mr. Armstrong served as Chief Executive Officer of Southwest Steel Casting Corp., a Texas Steel subsidiary, from 1984 through 1989. Mr. Armstrong began his career as an engineer with E.I. DuPont from 1976 through 1979. From 1997 to 1999 he has served as President of the Steel Founders' Society of America.
DAVID FLETCHER has been Group Vice President and Chairman and CEO of Atchison Casting UK Limited and the Sheffield Forgemasters Group since April 1998. Prior to this he was Chief Executive Officer of the Sheffield Forgemasters Group in Sheffield, England, having joined the group in 1986 as the main board director responsible for the Engineering group of companies comprising Forgemasters Steel & Engineering Limited, River Don Castings Limited, Forged Rolls (UK) Limited and British Rollmakers Corporation. From 1977 to 1986, Mr. Fletcher was Managing Director of various subsidiaries of the Aurora Group, including Darwin Alloy Castings, Edgar Allen Foundry, Willen Metals and Aurora Steels.
JOHN R. KUJAWA has been Group Vice President - Large Steel Castings Group since August 1999. Prior to this he was Group Vice President - Atchison/St. Joe and Amite from November 1996 to August 1999 and Vice President-Atchison/St. Joe from August 1994 to November 1996. He served as Executive Vice President-Operations of the Company from July 1993 to August 1994, Vice President-Foundry of the Company from June 1991 to July 1993, Assistant Foundry Manager of the Company from 1990 to 1991 and as Senior Process Engineer of the Company from 1989 to 1990. He served as Operations Manager for Omaha Steel Castings, a foundry in Omaha, Nebraska, from 1984 to 1989.
DONALD J. MARLBOROUGH has been Group Vice President - Iron Castings Group since August 1999. Prior to this he was Group Vice President-Canadian Steel, La Grange and Canada Alloy from November 1996 to August 1999, Vice President-Corporate Development and Canadian Steel from December 1994 to November 1996 and Vice President-La Grange from December 1995 to November 1996. From May 1991 to October 1994, Mr. Marlborough served as Vice President-Manufacturing and Plant Manager for American Steel Foundries, a foundry in Chicago, Illinois, and served as President and Director of Manufacturing for Racine Steel Castings, a foundry in Racine, Wisconsin, from 1985 to June 1990.
KEVIN T. MCDERMED has been Vice President, Chief Financial Officer and Treasurer of the Company since June 1991 and has served as Secretary of the Company since May 1992. He served as the Controller of the Company from 1990 to June 1991 and as its Finance Manager from 1986 to 1990. Mr. McDermed has been with the Company since 1981.
JAMES STOTT has been Vice President - Kramer since May 1998. He served as Group Vice President Empire, Kramer, Pennsylvania Steel and Quaker Alloy from November 1996 to May 1998 and Vice President - Kramer from January 1995 to November 1996. He has served as President, Chief Executive Officer and Chief Operating Officer of Kramer International, Inc. (the predecessor of Kramer) since 1980.
PRODUCT WARRANTY
The Company warrants that every product will meet a set of specifications, which is mutually agreed upon with each customer. The Company's written warranty provides for the repair or replacement of its products and excludes contingency costs. Often, the customer is authorized to make the repair within a dollar limit, in order to minimize freight costs and the time associated therewith. Although the warranty period is 90 days, this time limit is not strictly enforced if there is a defect in the casting. In fiscal 1999, warranty costs amounted to less than one percent of the Company's net sales.
ENVIRONMENTAL REGULATIONS
Companies in the foundry industry must comply with numerous federal, state and local (and, with respect Canadian, France and U.K. operations, federal, provincial and local) environmental laws and regulations relating to air emissions, solid waste disposal, stormwater runoff, landfill operations, workplace safety and other matters. The Clean Air Act, as amended, the Clean Water Act, as amended, and similar provincial, state and local counterparts of these federal laws regulate air and water emissions and discharges into the environment. The Resource Conservation and Recovery Act, as amended, and the Comprehensive Environmental Response, Compensation and Liability Act, as amended ("CERCLA"), among other laws, address the generation, storage, treatment, transportation and disposal of solid and hazardous waste and releases of hazardous substances into the environment,
respectively. The Company believes that it is in material compliance with applicable environmental laws and regulations and is not aware of any material outstanding violations or citations with respect thereto at any of its facilities, which would have a material adverse effect on the Company's financial condition and results of operations.
A Phase 1 environmental site assessment has been performed at each of the Company's facilities prior to acquisition, and no environmental condition has been identified that the Company believes would cause a material adverse effect on the Company's results of operations and financial condition. A Phase I assessment includes an historical review, a public records review, a preliminary investigation of the site and surrounding properties and the preparation and issuance of a written report, but it does not include soil sampling or subsurface investigations. There can be no assurance that these Phase I assessments have identified, or could be expected to identify, all areas of contamination. As the Company evaluates and updates the environmental compliance programs at facilities recently acquired, the Company may become aware of matters of noncompliance that need to be addressed or corrected. In addition, there is a risk that material adverse conditions could have developed at the Company's facilities since such assessments.
The chief environmental issues for the Company's foundries are air emissions and solid waste disposal. Air emissions, primarily dust particles, are handled by dust collection systems. The Company anticipates that it will incur additional capital and operating costs to comply with the Clean Air Act Amendments of 1990 and the regulations that are in the process of being promulgated thereunder. The Company is currently in the process of obtaining permits under the new regulations and estimating the cost of compliance with these requirements and the timing of such costs. Such compliance costs, however, could have a material adverse effect on the Company's results of operations and financial condition.
The solid waste generated by the Company's foundries generally consists of nonhazardous foundry sand that is reclaimed for reuse in the foundries until it becomes dust. The nonhazardous foundry dust waste is then disposed of in landfills, two of which are owned by the Company (one in Atchison County, Kansas, and one in Myerstown, Pennsylvania). No other parties are permitted to use the Company's landfills, which are both in material compliance with all applicable regulations to the Company's knowledge. Costs associated with the future closure of the landfills according to regulatory requirements could be material.
The Company also operates pursuant to regulations governing work place safety. The Company samples its interior air quality to ensure compliance with OSHA requirements. To the Company's knowledge, it currently operates in material compliance with all OSHA and other regulatory requirements governing work place safety, subject to Jahn Foundry's compliance with the settlement agreement with OSHA in connection with the industrial accident at Jahn Foundry on February 25, 1999.
The Company continues to evaluate its manufacturing processes and equipment (including its recently acquired facilities) to ensure compliance with the complex and constantly changing environmental laws and regulations. Although the Company believes it is currently in material compliance with such laws and regulations, the operation of casting manufacturing facilities entails environmental risks, and there can be no assurance that the Company will not be required to make substantial additional expenditures to remain in or achieve compliance in the future.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal facilities are listed in the accompanying table, together with information regarding their location, size and primary function. The two landfills are used solely by the Company and contain nonhazardous materials only, principally foundry sand. All of the Company's principal facilities are owned.
The following table sets forth certain information with respect to the Company's principal facilities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
An accident, involving an explosion and fire, occurred on February 25, 1999, at Jahn Foundry Corp., a wholly-owned subsidiary of the Company located in Springfield, Massachusetts. Nine employees were injured and there have been three fatalities. The damage was confined to the shell molding area and boiler room. The other areas of the foundry are operational. Molds are currently being produced at other foundries as well as Jahn Foundry while the repairs are made.
Although no lawsuits have been filed, a number of attorneys representing the injured and deceased employees have contacted Jahn Foundry regarding possible litigation. The Company carries insurance for property and casualty damages, business interruption, general liability and worker's compensation for itself and its subsidiaries. The Company, its property insurance carrier and its insurance broker dispute the amount of property insurance available for property damages suffered in this accident. If this dispute cannot be resolved amicably, the Company would vigorously pursue its remedies against both parties. The Company recorded a charge of $450,000 ($750,000 before tax) during the third quarter of fiscal 1999, primarily reflecting the deductibles under the Company's various insurance policies. At this time there can be no assurance that the Company's ultimate costs and expenses resulting from the accident will not exceed available insurance coverage by an amount which could be material to its financial condition or results of operations.
Following the accident, the Occupational Safety and Health Administration ("OSHA") conducted an investigation of the accident. On August 24, 1999, OSHA issued a citation describing violations of the Occupational Safety and Health Act of 1970, which primarily related to housekeeping, maintenance and other specific, miscellaneous items. Neither of the two violations specifically addressing conditions related to the explosion and fire were classified as serious or willful. Without admitting any wrongdoing, Jahn Foundry entered into a settlement with OSHA that addresses the alleged work place safety issues and agreed to pay $148,500 in fines.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK
The Common Stock is traded on the New York Stock Exchange under the symbol "FDY." The following table sets forth the high and low sales prices for the shares of Common Stock on New York Stock Exchange for the periods indicated.
As of September 9, 1999, there were over 2,200 holders of the Common Stock, including shares held in nominee or street name by brokers.
DIVIDEND POLICY
The Company has not declared or paid cash dividends on shares of its Common Stock. The Company does not anticipate paying any cash dividends or other distributions on its Common Stock in the foreseeable future. The current policy of the Company's Board of Directors is to reinvest all earnings to finance the expansion of the Company's business. The agreements governing the Company's credit facility and $20 million senior notes contain limitations on the Company's ability to pay dividends. See Note 8 of Notes to Consolidated Financial Statements.
UNREGISTERED SECURITIES TRANSACTIONS
In lieu of cash compensation for services rendered in their capacity as Directors of the Company, Mr. David Belluck, Mr. Ray Witt, Mr. John Whitney and Mr. Stuart Uram were each provided at their election 1,240, 620, 1,240 and 620 shares, respectively, of common stock on December 7, 1998, with a then-current market value of $9.69 per share. Mr. David Belluck was provided at his election 805 shares of common stock on February 25, 1999, with a then-current market value of $9.94 per share. Such transactions were exempt from registration under the Securities Act of 1933, as amended (the "Act"), pursuant to Section 4(2) of the Act.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table contains certain selected historical consolidated financial information and is qualified by the more detailed Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K. The selected consolidated financial information for the fiscal years ended June 30, 1995, 1996, 1997, 1998 and 1999 has been derived from audited consolidated financial statements. The information below should be read in conjunction with Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.
* Includes other income of $6.4 million and $27.0 million for fiscal 1995 and fiscal 1996, respectively, consisting primarily of insurance proceeds related to the July 1993 Missouri River flood.
(1) Other income consists of $6.4 million and $27.0 million ($3.9 million and $16.2 million net of tax or $0.71 and $2.95 per share), for fiscal 1995 and fiscal 1996, respectively, consisting primarily of insurance proceeds related to the July 1993 Missouri River flood. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-General."
(2) During fiscal 1995, fiscal 1996, fiscal 1997, fiscal 1998 and fiscal 1999, the Company made capital expenditures of $8.1 million, $1.8 million, $1.4 million, $589,000 and $791,000 respectively, in connection with the refurbishment of Amite. This 282,000 square foot facility was acquired in February 1993 and had been inactive for several years.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company has pursued an active acquisition program designed to take advantage of consolidation opportunities in the widely fragmented foundry industry. The Company has acquired nineteen foundries since its inception. As a result of these completed transactions as well as internal growth, the Company's net sales have increased from approximately $54.7 million for its first full fiscal year ended June 30, 1992 to $475.6 million for the fiscal year ended June 30, 1999.
The Company is not currently contemplating any major acquisitions. The Company's primary focus in fiscal 2000 will be on the integration and improvement of existing operations.
Due to the large size of certain orders, the timing for deliveries of orders and the number and types of castings produced, the Company's net sales and net income may fluctuate materially from quarter to quarter. Generally, the first fiscal quarter is seasonally weaker than the other quarters as a result of plant shutdowns for maintenance at most of the Company's foundries as well as at many customers' plants. See "-Supplemental Quarterly Information."
RESULTS OF OPERATIONS
The following discussion of the Company's financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto and other financial information included elsewhere in this Report.
FISCAL YEAR ENDED JUNE 30, 1999 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1998
Net sales for fiscal 1999 were $475.6 million, representing an increase of $101.8 million, or 27.2%, over net sales of $373.8 million in fiscal 1998. The operations acquired by the Company since October 6, 1997 generated net sales of $80.8 million and $213.8 million in fiscal 1998 and fiscal 1999, respectively, as follows:
Excluding net sales attributable to the operations acquired since October 6, 1997, net sales for fiscal 1999 were $261.8 million, representing a decrease of $31.2 million, or 10.6%, over net sales of $293.0 million in fiscal 1998. This 10.6% decrease in net sales was due primarily to decreases in net sales to the offshore oil and gas, steel, mining, power generation, agriculture and petrochemical markets, partially offset by an increase in net sales to the rail market.
Gross profit for fiscal 1999 increased by $12.3 million, or 22.2%, to $67.8 million, or 14.3% of net sales, compared to $55.5 million, or 14.9% of net sales, for fiscal 1998. The increase in gross profit was primarily due to increased sales volume levels resulting from the acquisitions of Sheffield Forgemasters Group Limited ("Sheffield") and London Precision Machine and Tool Ltd. ("London Precision"). The contribution from London Precision and improved results at the Amite Foundry and Machine, Inc. ("Amite") due to increased sales volume levels, improved productivity and reduced employee turnover and training positively impacted gross profit as a percentage of net sales. Offsetting these factors were: (i) decreased absorption of overhead resulting from lower net sales to the offshore oil and gas, mining, steel, power generation, petrochemical and agricultural markets, (ii) delays in the scheduled delivery of orders by customers in the mining, construction and rail markets, (iii) continued productivity and scrap problems at Inverness Castings Group, Inc. ("Inverness") and Claremont Foundry, Inc. ("Claremont"), (iv) increased warranty costs at Canada Alloy Castings, Ltd. ("Canada Alloy") and (v) increased training costs, higher employee turnover and increased overtime due to the generally tight labor markets. In addition, gross profit as a percentage of net sales was impacted by (i) reduced productivity and excessive overtime due to power curtailments under the Company's interruptible electricity contracts resulting from the extreme heat during the first quarter and (ii) higher plant maintenance shutdown costs at Atchison/St. Joe and Prospect Foundry, Inc. ("Prospect").
Selling, general and administrative expense ("SG&A") for fiscal 1999 was $41.9 million, or 8.8% of net sales, compared to $28.8 million, or 7.7% of net sales, in fiscal 1998. The increase in SG&A was primarily attributable to expenses associated with the operations acquired by the Company in fiscal 1998 and fiscal 1999. The increase in SG&A as a percentage of net sales was primarily due to higher average SG&A as a percentage of net sales at Sheffield. Following the July 1993 Missouri River flood, insurance proceeds related to property damage were reserved for estimated future repairs. During the fourth quarter, the Company revised this estimate downward resulting in a non-recurring gain of $3.5 million ($2.1 million, net of tax). Also included in SG&A was a charge of $750,000 ($450,000, net of tax) related to an industrial accident at the Company's subsidiary, Jahn Foundry Corp. ("Jahn") (see Liquidity and Capital Resources). Excluding these non-recurring factors, SG&A for fiscal 1999 was $44.7 million, or 9.4% of net sales.
Amortization of certain intangibles for fiscal 1999 was $544,000 or 0.1% of net sales, compared to $850,000, or 0.2% of net sales, in fiscal 1998. The intangible assets consist of goodwill recorded in connection with certain of the Company's acquisitions. Partially offsetting the expense relating to the amortization of these assets is the amortization of the excess of acquired net assets over cost (negative goodwill) recorded by the Company in connection with the acquisitions of Canadian Steel Foundries, Ltd. ("Canadian Steel") and Founderie d'Autun ("Autun").
Interest expense for fiscal 1999 increased to $8.4 million, or 1.8% of net sales, from $3.9 million, or 1.0% of net sales, in fiscal 1998 The increase in interest expense primarily reflects an increase in the average amount of outstanding indebtedness during fiscal 1999 primarily incurred to finance the Company's acquisitions.
Income tax expense for fiscal 1999 and fiscal 1998 reflected the combined federal, state and provincial statutory rate of approximately 41% and 40%, respectively, which is higher than the combined federal, state and provincial statutory rate because of the provision for the tax benefits at lower effective rates on losses at certain subsidiaries. The Company's combined effective tax rate reflects the different federal, state and provincial statutory rates of the various jurisdictions in which the Company operates, and the proportion of taxable income earned in each of those tax jurisdictions.
As a result of the foregoing, net income decreased from $12.8 million in fiscal 1998 to $9.8 million in fiscal 1999.
FISCAL YEAR ENDED JUNE 30, 1998 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1997
Net sales for fiscal 1998 were $373.8 million, representing an increase of $128.0 million, or 52.0%, over net sales of $245.8 million in fiscal 1997. The operations acquired by the Company since the beginning of fiscal 1997 generated net sales of $33.8 million and $163.0 million in fiscal 1997 and fiscal 1998, respectively, as follows:
Excluding net sales attributable to the operations acquired in fiscal 1997 and fiscal 1998, net sales for fiscal 1998 were $210.8 million, representing a decrease of $1.2 million, or 0.6%, from net sales of $212.0 million in fiscal 1997. This 0.6% decrease in net sales was due primarily to decreases in net sales to the energy, utility and military markets, partially offset by an increase in net sales to the rail market.
Gross profit for fiscal 1998 increased by $13.1 million, or 30.9%, to $55.5 million, or 14.9% of net sales, compared to $42.4 million, or 17.2% of net sales, for fiscal 1997. The increase in gross profit was primarily attributable to the increase in net sales. The decrease in gross profit as a percentage of net sales is primarily attributable to: (i) a decrease in the absorption of overhead resulting from a reduction in net sales at PrimeCast, Inc. ("PrimeCast"), La Grange Foundry Inc. ("La Grange"), Canadian Steel and Canada Alloy, (ii) above average training expenses associated with the startup of new customer jobs at Amite and (iii) increased warranty costs at Pennsylvania Steel Foundry and Machine, Inc. ("Pennsylvania Steel"). In addition to these factors were non-recurring costs associated with the installation of a new sand system at the Atchison / St. Joe Division and a new molding line at Prospect.
SG&A for fiscal 1998 was $28.8 million, or 7.7% of net sales, compared to $21.6 million, or 8.8% of net sales, in fiscal 1997. The increase in SG&A was primarily attributable to expenses associated with the operations acquired by the Company in fiscal 1997 and fiscal 1998. The decrease in SG&A as a percentage of net sales was primarily due to decreased expenses related to the Company's management incentive bonus plans and decreased expenditures for outside professional services.
Amortization of certain intangibles for fiscal 1998 was $850,000 or 0.2% of net sales, compared to $632,000, or 0.3% of net sales, in fiscal 1997. The intangible assets consist of goodwill recorded in connection with the acquisitions of Prospect, Kramer International, Inc. ("Kramer"), Empire Steel Castings, Inc. ("Empire"), The G&C Foundry Company ("G&C"), Los Angeles Die Casting, Inc. ("LA Die Casting") and Inverness. Partially offsetting the expense relating to the amortization of these assets is the amortization of the excess of acquired net assets over cost (negative goodwill) recorded by the Company in connection with the acquisition of Canadian Steel.
Interest expense for fiscal 1998 increased to $3.9 million, or 1.0% of net sales, from $3.2 million, or 1.3% of net sales, in fiscal 1997. The increase in interest expense is primarily the result of an increase in the average amount of indebtedness outstanding during fiscal 1998.
Income tax expense for fiscal 1998 and fiscal 1997 reflected the combined federal, state and provincial statutory rate of approximately 40% and 41%, respectively. The Company's combined effective tax rate reflects the different federal, state and provincial statutory rates of the various jurisdictions in which the Company operates, and the proportion of taxable income earned in each of those tax jurisdictions.
As a result of the foregoing, net income increased from $9.7 million in fiscal 1997 to $12.8 million in fiscal 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed operations with internally generated funds, proceeds from the sale of senior notes and available borrowings under its bank credit facilities. Cash provided by operating activities for fiscal 1999 was $7.7 million, a decrease of $8.2 million from fiscal 1998. This decrease was primarily attributable to other current asset balances primarily relating to insurance claim receivables and cash advances to certain manufactures of specialized equipment.
Working capital was $85.6 million at June 30, 1999, as compared to $76.8 million at June 30, 1998. The increase primarily resulted from net additional working capital of $9.1 million associated with the acquisitions of London Precision and Autun.
During fiscal 1999, the Company made capital expenditures of $20.0 million, as compared to $18.5 million for fiscal 1998. Included in fiscal 1999 were capital expenditures of $2.1 million on upgrading the 1,500 ton forging press to 2,500 tons at Sheffield. The balance of capital expenditures was used for routine projects at each of the Company's facilities, primarily related to productivity enhancing equipment, such as CNC pattern-cutting machines, machine tools, sand reclamation systems and computer hardware and software modeling systems. The Company expects to make approximately $24.0 million of capital expenditures during fiscal 2000, including a new emission control system at the Atchison/St. Joe Division, the modification of the mold line at Autun and routine projects at each of the Company's facilities.
On August 12, 1998, the Company announced that its Board of Directors had authorized a stock repurchase program of up to 1.2 million common shares of its then outstanding 8.2 million common shares. The stock repurchases may be made from time to time at prevailing prices in the open market or in privately negotiated transactions, depending on market conditions, the price of Company's common stock and other factors. The Company will make such stock repurchases using internally generated funds and borrowings under its credit facility. The Company's Note Purchase Agreement
allows repurchases of up to nearly $2.5 million of Company common stock during fiscal 2000. Any share repurchases will be added to the Company's treasury shares and will be available for reissuance in connection with the Company's acquisitions, employee benefit plans or for other corporate purposes. Through June 30, 1999, the Company had repurchased 586,700 shares at a cost of $6.0 million.
On October 7, 1998, the Company and its lenders entered into the First Amendment to the Amended and Restated Credit Agreement (the "Credit Agreement"). The Credit Agreement consists of a $40 million term loan and a $70 million revolving credit facility. This amendment permits the Company to repurchase up to $24 million of its common stock, subject to a limitation of $10 million in any fiscal year unless certain financial ratios are met, and provides for an option to increase the revolving portion of the credit facility to $100 million if the Company issues senior subordinated notes. Proceeds from the issuance of any senior subordinated notes must be used to permanently pre-pay the $40 million term loan portion of the credit facility.
On April 23, 1999, the Company and its lenders entered into the Second Amendment to the Credit Agreement. This amendment provides that the Company maintain a ratio of earnings before interest, taxes and amortization to fixed charges ("Fixed Charge Coverage Ratio") of at least 1.10 increasing to 1.25 on March 31, 2000 and 1.50 on March 31, 2001. The amendment also provides that the Company must maintain a ratio of total senior debt to earnings before interest, taxes, amortization and depreciation of not more than 3.2 prior to the issuance by the Company of any subordinated debt, and not more than 3.0 after the issuance of any subordinated debt. In addition, this amendment provides that the Company may not make acquisitions prior to May 1, 2000 and, from and after May 1, 2000, the Company may not make acquisitions unless the Fixed Charge Coverage Ratio is at least 1.50, among other existing restrictions. Loans under this revolving credit facility will bear interest at fluctuating rates of either: (i) the agent bank's corporate base rate or (ii) LIBOR plus 1.85% subject, in the case of the LIBOR rate option, to a reduction of up to 0.50% (50 basis points) if certain financial ratios are met. Loans under this revolving credit facility may be used for general corporate purposes, permitted acquisitions and approved investments.
The Company preciously announced that it is contemplating the issue of up to $60 million aggregate principal amount of unsecured, senior subordinated notes through a private placement. The Company has currently placed the issue on hold due to unfavorable market conditions. If consummated, the Company would use the net proceeds of the offering to retire its bank term loan and to reduce outstanding borrowings under its revolving credit facility
Total indebtedness of the Company at June 30, 1999 was $113.4 million, as compared to $93.3 million at June 30, 1999. This increase of $20.1 million primarily reflects indebtedness incurred of $13.8 million to finance the acquisition of London Precision and $6.0 million to repurchase 586,700 shares of the Company's common stock. At June 30, 1999, $9.9 million was available for borrowing under the Company's revolving credit facility.
Effective September 1, 1998, the Company purchased 90% of the outstanding capital stock of London Precision for U.S. $13.8 million in cash and related expenses. On June 16, 1999, the Company purchased the remaining 10% of the outstanding capital stock of London Precision for U.S. $1.8 million in cash. London Precision, located in London, Ontario, Canada, is an industrial machine shop which serves the locomotive, mining and construction, pulp and paper markets, among others. The Company financed this transaction with funds available under its revolving credit facility.
On February 25, 1999, Founderie d'Autun, a subsidiary of Atchison Casting UK Limited, a 95% owned subsidiary of the Company, purchased the foundry division assets of Compagnie Internationale du Chauffage ("CICH") located in Autun, France. The Company received U.S. $5.8 million in cash and U.S. $5.5 million in inventory in exchange for the assumption of potential environmental and employment liabilities if the facility is ever closed. CICH is a subsidiary of Blue Circle Industries plc, headquartered in London, England. Autun specializes in the manufacture of cast iron radiators and boiler castings.
An accident, involving an explosion and fire, occurred on February 25, 1999, at Jahn Foundry Corp., a wholly-owned subsidiary of the Company located in Springfield, Massachusetts. Nine employees were injured and there have been three fatalities. The damage was confined to the shell molding area and boiler room and other areas of the foundry are operational. Molds are currently being produced at other foundries as well as Jahn Foundry while the repairs are made.
Although no lawsuits have been filed, a number of attorneys representing the injured and deceased employees have contacted Jahn Foundry regarding possible litigation. The Company carries insurance for property and casualty damages, business interruption, general liability and worker's compensation for itself and its subsidiaries. The Company, its property insurance carrier and its insurance broker dispute the amount of property insurance available for property damages suffered in this accident. If this dispute cannot be resolved amicably, the Company would vigorously pursue its remedies against both parties. The Company recorded a charge of $450,000 ($750,000 before tax) during the third quarter of fiscal 1999, primarily reflecting the deductibles under the Company's various insurance policies. At this time there can be no assurance that the Company's ultimate costs and expenses resulting from the accident will not exceed available insurance coverage by an amount which could be material to its financial condition or results of operations.
Following the accident, the Occupational Safety and Health Administration ("OSHA") conducted an investigation of the accident. On August 24, 1999, OSHA issued a citation describing violations of the Occupational Safety and Health Act of 1970, which primarily related to housekeeping, maintenance and other specific, miscellaneous items. Neither of the two violations specifically addressing conditions related to the explosion and fire were classified as serious or willful. Without admitting any wrongdoing, Jahn Foundry entered into a settlement with OSHA that addresses the alleged work place safety issues and agreed to pay $148,500 in fines.
The Company believes that its operating cash flow and amounts available for borrowing under its revolving credit facility will be adequate to fund its capital expenditure and working capital requirements for the next two years. However, the level of capital expenditure and working capital requirements may be greater than currently anticipated as a result of the size and timing of future acquisitions, or as a result of unforeseen expenditures relating to compliance with environmental laws or the accident at Jahn. Acquisitions have been financed with borrowings under the Company's bank credit facilities and occasionally with common stock.
MARKET RISK
The Company operates manufacturing facilities in the U.S., Canada and Europe and utilizes fixed and floating rate debt to finance its global operations. As a result, the Company is subject to business risks inherent in non-U.S. activities, including political and economic uncertainty, import and export limitations, and market risk related to changes in interest rates and foreign currency exchange rates. The Company believes the political and economic risks related to its foreign operations are mitigated
due to the stability of the countreis in which its largest foreign operations are located.
In the normal course of business, the Company uses derivative financial instruments including interest rate swaps and foreign currency forward exchange contracts to manage its market risks. Additional information regarding the Compan'ys financial instruments is contained in Notes 8 and 10 to the Company's consolidated financial statements. The Company's objective in managing its exposure to changes in interest rates is to limit the impact of such changes on earnings and cash flow and to lower its overall borrowing costs. The Company's objective in managing its exposure to changes in foreign currency exchange rates is to reduce volatility on earnings and cash flow associated with such changes. The Company's principal currency exposures are in the major European currencies and the Canadian dollar. The Company does not hold derivatives for trading purposes.
For 1999 and 1998, the Company's exposure to market risk has been estimated using sensitivity analysis, which is defined as the change in the fair value of a derivative or financial instrument assuming a hypothetical 10% adverse change in market rates or prices. The Company believes that the sensitivity analysis is a better portrayal of its value at risk and is more readily understood than the tabular presentation used in 1998, and, as a result, has changed to the sensitivity analysis presented. The Company used current market rates on its debt and derivative portfolio to perform the sensitivity analysis. Certain items such as lease contracts, insurance contracts, and obligations for pension and other post-retirement benefits were not included in the analysis. The results of the sensitivity analyses are summarized below. Actual changes in interest rates or market prices may differ from the hypothetical changes.
The Company's primary interest rate exposures relate to its cash and short-term investments, fixed and variable rate debt and interest rate swaps, which are mainly exposed to changes in short-term interest rates (e.g., USD LIBOR). The potential loss in fair values is based on an immediate change in the net present values of the Company's interest rate-sensitive exposures resulting from a 10% change in interest rates. The potential loss in cash flows and earnings is based on the change in the net interest income/expense over a one-year period due to an immediate 10% change in rates. A hypothetical 10% change in interest rates would have a material impact on the Company's earnings of approximately $200,000 in both fiscal 1999 and 1998.
The Company's exposure to fluctuations in currency rates against the pound sterling and Canadian dollar result from the Company's holdings in cash and short-term investments and its utilization of foreign currency forward exchange contracts to hedge customer receivables and firm commitments. The potential loss in fair values is based on an immediate change in the U.S. dollar equivalent balances of the Company's currency exposures due to a 10% shift in exchange rates versus the pound sterling and Canadian dollar (1999 only). The potential loss in cash flows and earnings is based on the change in cash flow and earnings over a one-year period resulting from an immediate 10% change in currency exchange rates versus the pound sterling and Canadian dollar (1999 only). Based on the Company's holdings of financial instruments at June 30, 1999 and 1998, a hypothetical 10% depreciation in the pound sterling (1998 and 1999) and the Canadian dollar (1999 only) versus all other currencies would have a material impact on the Company's earnings of approximately $2.7 million and $3.6 million in fiscal 1999 and 1998, respectively. The Company's analysis does not include the offsetting impact from its underlying hedged exposures (customer receivables and firm commitments). If the Company included these underlying hedged exposures in its sensitivity analysis, these exposures would substantially offset the financial impact of its foreign currency forward exchange contracts due to changes in currency rates.
INFLATION
Management believes that the Company's operations have not been adversely affected by inflation or changing prices.
YEAR 2000 COMPUTER ISSUES
The Company has conducted a comprehensive review of its hardware and software systems to identify those systems that could be affected by the "Year 2000" issue and has developed an implementation plan to resolve the identified issues. The Company believes that, with replacement or modification of its existing computer systems, updates by vendors and conversion to new software, the Year 2000 issue will not pose significant operational problems for the Company's computer systems. The Company expects to complete implementation of computer systems that are Year 2000 compliant in the first quarter of fiscal 2000, although testing may continue in the second quarter of fiscal 2000. Based on its review of non-information technology systems to date, the Company does not anticipate the need to develop an extensive contingency plan for such systems or to incur material costs in that regard.
The Company relies on a number of customers and suppliers, including banks, telecommunication providers, utilities, and other providers of goods and services. The inability of these third parties to conduct their business for a significant period of time due to the Year 2000 issue could have a material adverse impact on the Company's operations. The Company is currently assessing the Year 2000 compliance of its significant customers and suppliers. To date, the Company has been advised by over two-thirds of its significant customers that they will be Year 2000 compliant by the end of calendar 1999. There can be no assurance that the systems of other companies that interact with the Company will be sufficiently Year 2000 compliant. The Company's reliance on single source suppliers, however, is minimal, and the Company seeks to limit sole source supply relationships. The Company, however, has entered into national service agreements for the supply of certain raw materials and freight service from single sources. If the Company does not identify or fix all year 2000 problems in critical operations, or if a major supplier or customer is unable to supply raw materials or receive the Company's product, the Company's results of operations or financial condition could be materially impacted.
Year 2000 project expenditures to date total approximately $2.2 million. The Company expects to incur an additional $600,000 of additional costs. The Company presently anticipates that it will complete its Year 2000 assessment and remediation by September 30, 1999. However, there can be no assurance that the Company will be successful in implementing its Year 2000 implementation plan according to the anticipated schedule due to the potential lack of availability of trained personnel and their ability to identify relevant computer codes, among other uncertainties.
FORWARD-LOOKING STATEMENTS
Statements above in the subsections entitled "General," "Liquidity and Capital Resources," "Market Risk " and "Year 2000 Computer Issues" such as "believes," "expects," "intends," "contemplating" and statements regarding quarterly fluctuations, statements regarding the adequacy of funding for capital expenditure and working capital requirements for the next two years and similar expressions that are not historical are forward-looking statements that involve risks and uncertainties. Such statements include the Company's expectations as to future performance. Among the factors that could cause actual results
to differ materially from such forward-looking statements are the following: the size and timing of future acquisitions, business conditions and the state of the general economy, particularly the capital goods industry and the markets served by the Company, the strength of the U.S. dollar, Canadian dollar, British pound and the Euro, interest rates, inflation, the availability of labor, the successful conclusion of contract negotiations, the results of any litigation arising out of the accident at Jahn, the competitive environment in the casting industry and changes in laws and regulations that govern the Company's business, particularly environmental regulations.
NEW ACCOUNTING STANDARDS
For a discussion of new accounting standards, see Note 1 of the Company's Notes to Consolidated Financial Statements.
SUPPLEMENTAL QUARTERLY INFORMATION
The Company's business is characterized by large unit and dollar volume customer orders. As a result, the Company has experienced and may continue to experience fluctuations in its net sales and net income from quarter to quarter. Generally, the first fiscal quarter is seasonally weaker than the other quarters as a result of plant shutdowns for maintenance at most of the Company's foundries as well as at many customers' plants. In addition, the Company's operating results may be adversely affected in fiscal quarters immediately following the consummation of an acquisition while the operations of the acquired business are integrated into the operations of the Company.
The following table presents selected unaudited supplemental quarterly results for fiscal 1998 and fiscal 1999.
(1) The third quarter contains a charge recorded in connection with an industrial accident that occurred on February 25, 1999 at the Company's subsidiary, Jahn Foundry, which decreased net income by $450,000, or $.06 per share.
(2) The fourth quarter contains a revision to the flood damage reconstruction reserve which increased net income by $2,086, or $.27 per share. The flood damage reconstruction reserve related to the July 1993 Missouri River flood.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is incorporated herein by reference to the section entitled "Market Risk" in the Company's Management's Discussion and Analysis of Results of Operations and Financial Condition in this Form 10-K.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company are filed under this Item, beginning on page of this Report. No financial statement schedules are required to be filed under Regulation S-X.
Selected quarterly financial data required under this item is included in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations.
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 information required by this item with respect to directors and compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference to the Registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A. The required information as to executive officers is set forth in Part I hereof.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the Registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this item is incorporated herein by reference to the Registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this item is incorporated herein by reference to the Registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(2) No Financial Statement Schedules are required to be filed.
(3) List of Exhibits:
Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index which is incorporated herein by reference.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the quarter ended June 30, 1999
(c) EXHIBITS
The response to this portion of Item 14 is submitted as a separate section to this report.
(d) FINANCIAL STATEMENTS SCHEDULES
The consolidated financial statement schedules required by this Item are listed under Item 14(a)(2).
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ATCHISON CASTING CORPORATION (Registrant)
By: /S/ HUGH H. AIKEN --------------------- Hugh H. Aiken Principal Executive Officer
Dated: Sept. 14, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dated indicated:
- ------------------------------------------------------------------------------- ATCHISON CASTING CORPORATION AND SUBSIDIARIES ---------------------------------------------- CONSOLIDATED FINANCIAL STATEMENTS AS OF JUNE 30, 1998 AND 1999, AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1999, AND INDEPENDENT AUDITORS' REPORT
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders of Atchison Casting Corporation Atchison, Kansas
We have audited the accompanying consolidated balance sheets of Atchison Casting Corporation and subsidiaries (the "Company") as of June 30, 1998 and 1999 and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1999. 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 1998 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 1999 in conformity with generally accepted accounting principles.
August 13, 1999 (August 24, 1999 with respect to the third paragraph of Note 21)
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS JUNE 30, 1998 AND 1999 (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) - -------------------------------------------------------------------------------
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS JUNE 30, 1998 AND 1999 (Dollars in thousands, except share data) - -------------------------------------------------------------------------------
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED JUNE 30, 1997, 1998 AND 1999 (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) - -------------------------------------------------------------------------------
See notes to consolidated financial statements.
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME YEARS ENDED JUNE 30, 1997, 1998 AND 1999 (IN THOUSANDS) - -------------------------------------------------------------------------------
See notes to consolidated financial statements.
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED JUNE 30, 1997, 1998 AND 1999 (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
See notes to consolidated financial statements.
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 1997, 1998 AND 1999 (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------
See notes to consolidated financial statements.
ATCHISON CASTING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 1997, 1998 AND 1999 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) - -------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS - Atchison Casting Corporation and subsidiaries ("ACC" or the "Company") was organized in 1991 for the purpose of becoming a broad based manufacturer of metal castings, producing iron, steel and non-ferrous castings ranging in size from a few ounces to 280 tons. A majority of the Company's sales are to U.S. customers, however, the Company also has sales to Canadian, European and other foreign customers.
PERVASIVENESS OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
BASIS OF PRESENTATION - The consolidated financial statements present the financial position of the Company and its subsidiaries, Amite Foundry and Machine, Inc. ("AFM"), Prospect Foundry, Inc. ("Prospect Foundry"), Quaker Alloy, Inc. ("Quaker"), Canadian Steel Foundries, Ltd. ("Canadian Steel"), Kramer International, Inc. ("Kramer"), Empire Steel Castings, Inc. ("Empire"), La Grange Foundry Inc. ("La Grange Foundry"), The G&C Foundry Company ("G&C"), Los Angeles Die Casting Inc. ("LA Die Casting"), Canada Alloy Castings, Ltd. ("Canada Alloy"), Pennsylvania Steel Foundry & Machine Company ("Pennsylvania Steel"), Jahn Foundry Corp. ("Jahn Foundry"), PrimeCast, Inc. ("PrimeCast"), Inverness Castings Group, Inc. ("Inverness"), Atchison Casting UK Limited ("ACUK"), Claremont Foundry, Inc. ("Claremont") and London Precision Machine & Tool Ltd. ("London Precision"). AFM, Quaker, Kramer, Empire, La Grange Foundry, Canada Alloy, Pennsylvania Steel, Jahn Foundry, PrimeCast, Claremont and London Precision are wholly owned subsidiaries. The Company owns 91.8%, 95.7%, 93.9%, 90.6%, 96.1% and 95.4% of the outstanding capital stock of Prospect Foundry, Canadian Steel, G&C, LA Die Casting, Inverness and ACUK, respectively. Sheffield Forgemasters Group, Ltd. ("Sheffield") and Fonderie d'Autun SA ("Autun") are wholly-owned subsidiaries of ACUK. All significant intercompany accounts and balances have been eliminated.
STATEMENT OF CASH FLOWS - For purposes of cash flow reporting, cash and cash equivalents include cash on hand, amounts due from banks and temporary investments with original maturities of 90 days or less at the date of purchase.
REVENUE RECOGNITION - Sales and related cost of sales are recognized upon shipment of products.
CUSTOMER ACCOUNTS RECEIVABLE - Approximately 17%, 18% and 17% of the Company's business in 1997, 1998 and 1999, respectively, was with two major customers in the automotive, locomotive and general industrial markets. As of June 30, 1998 and 1999, 13% and 12%, respectively, of accounts receivable were with these two major customers. The Company generally does not require collateral or other security on accounts receivable. Credit risk is controlled through credit approvals, limits and monitoring procedures.
INVENTORIES - Approximately 14% of the Company's inventory is valued at the lower of cost, determined on the last-in, first-out ("LIFO") method, or market. The remaining inventory is valued at the lower of cost, determined on the first-in, first-out ("FIFO") method, or market.
PROPERTY, PLANT AND EQUIPMENT - Major renewals and betterments are capitalized while replacements, maintenance and repairs which do not improve or extend the life of the respective assets are charged to expense as incurred. Upon sale or retirement of assets, the cost and related accumulated depreciation applicable to such assets are removed from the accounts and any resulting gain or loss is reflected in operations.
Property, plant and equipment is carried at cost less accumulated depreciation. Plant and equipment is depreciated over the estimated useful lives of the assets using the straight-line method.
INTANGIBLE ASSETS - Intangible assets acquired, primarily goodwill, are being amortized over their estimated lives of 25 years using the straight-line method.
LONG-LIVED ASSETS - The Company periodically reviews the continuing value of long-lived assets to determine if there has been an impairment. The basis of this valuation includes the continuing profitability of the acquired operations, their expected future undiscounted cash flows, the maintenance of a significant customer base and similar factors.
ACCRUED INSURANCE EXPENSE - Costs estimated to be incurred in the future for employee medical benefits and casualty insurance programs resulting from claims which have occurred are accrued currently.
At June 30, 1999, the Company has letters of credit aggregating $2,903 and a certificate of deposit of $200 which support claims for workers' compensation benefits.
INCOME TAXES - Deferred income taxes are provided on temporary differences between the financial statements and tax basis of the Company's assets and liabilities in accordance with the liability method.
STOCK PLANS - The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION," in October 1995. SFAS No. 123 allows companies to continue under the approach set forth in Accounting Principles Board Opinion ("APB") No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES," for recognizing stock-based compensation expense in the financial statements, but encourages companies to adopt provisions of SFAS No. 123 based on the estimated fair value of employee stock options. Companies electing to retain the approach under APB No. 25 are required to disclose pro forma net income and net income per share in the notes to the financial statements, as if they had adopted the fair value accounting method under SFAS No. 123. The Company has elected to retain its current accounting approach under APB No. 25.
EARNINGS PER SHARE - Basic earnings per share ("EPS") is computed by dividing net income by the weighted-average number of common shares outstanding for the year. Diluted EPS reflects the potential dilution that could occur if dilutive securities, such as options, were exercised.
NEW ACCOUNTING STANDARDS - SFAS No. 130, "REPORTING COMPREHENSIVE INCOME," was issued in June 1997. This Statement established standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. The Company adopted SFAS No. 130 in fiscal 1999 and has restated all prior years for the adoption of this standard.
In June 1997, the FASB issued SFAS No. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION". The Statement 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. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company adopted SFAS No. 131 in fiscal 1999.
SFAS No. 132, "EMPLOYERS' DISCLOSURES ABOUT PENSION AND OTHER POSTRETIREMENT BENEFITS," was issued by the FASB in February 1998. This Statement revises employers' disclosures about pension and other postretirement benefit plans, but does not change the measurement or recognition of such plans. This Statement is effective for fiscal years beginning after December 15, 1997, including restatement of prior periods provided for comparative purposes. The Company adopted SFAS No. 132 in fiscal 1999.
In June 1998, the FASB issued SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES." SFAS No. 133 requires companies to record derivative instruments as assets or liabilities, measured at fair value. The recognition of gains or losses resulting from changes in the values of those derivative instruments is based on the use of each derivative instrument and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. The Company has not yet completed its evaluation of the impact of SFAS No. 133 on the consolidated financial statements. The Company will be required to adopt SFAS No. 133 on July 1, 2000.
2. ACQUISITIONS
On July 1, 1997, the Company purchased the Beloit Castings Division ("BCD") of Beloit Corporation for $8,209 in cash and $102 of related expenses. BCD now operates under the name PrimeCast, as a subsidiary of ACC. PrimeCast is a group of four foundries in Beloit, Wisconsin and South Beloit, Illinois, including two iron foundries, a steel foundry and a non-ferrous foundry, that produce castings for the paper-machinery, pump, valve, mining and construction markets. The Company financed this acquisition with available cash balances.
On October 6, 1997, the Company acquired approximately 91.5% of the outstanding capital stock of Inverness, a Delaware corporation, for $5,882 in cash and $202 of related expenses, in addition to the assumption of $587 of outstanding indebtedness. Contemporaneous with the consummation of this acquisition, the Company retired approximately $11,602 of Inverness' outstanding indebtedness. The remaining 8.5% of Inverness capital stock was retained by Inverness management. During fiscal 1999, the Company purchased additional shares from Inverness management. Inverness, located in Dowagiac, Michigan, produces aluminum die castings for the automotive, furniture and appliance markets. The Company financed this transaction with available cash balances and funds available under its revolving credit facility.
On April 6, 1998, ACUK, a subsidiary of the Company, acquired all of the outstanding capital stock , consisting of 76,987,733 ordinary shares of capital stock, of Sheffield, incorporated in England and Wales, from the stockholders of Sheffield for approximately $54,931 in cash, 1,040,000 ordinary shares of ACUK valued at $915 and $226 of related expenses. The 1,040,000 ordinary shares, consisting of 5.0% of the outstanding stock, of ACUK were issued to Sheffield management in exchange for 1,267,477 shares of Sheffield instead of cash consideration. Sheffield includes Forgemasters Steel & Engineering Limited, River Don Castings Limited, Forged Rolls (UK) Limited and British Rollmakers Limited, among other operating units. The companies' products serve a variety of markets and end users, including steel rolling mills, paper and plastic processing, oil and gas exploration and production, fossil and nuclear electricity generation and forging ingots. The Company financed this transaction with funds available under its bank credit facility.
On May 31, 1996, the Company purchased approximately 21.0% of the outstanding shares of capital stock of Claremont for $330 in cash and $17 of related expenses. On November 29, 1996, the Company purchased an additional 4.5% of the outstanding capital stock of Claremont for $40 in cash. On May 1, 1998, the Company purchased the balance of Claremont's outstanding capital stock for $1 in cash, the contribution of equipment with a fair market value of $300, the forgiveness of a subordinated note payable to the Company of $2,924 and related expenses of $7. Contemporaneous with the consummation of this acquisition, the Company retired $165 of Claremont's outstanding indebtedness. Claremont, located in Claremont, New Hampshire, is a foundry that produces steel castings for the mining and mass transit industries, among others. The Company financed this transaction with funds available under its revolving credit facility.
Effective September 1, 1998, the Company purchased 90% of the outstanding shares of London Precision for U.S. $13,663 in cash and $124 of related expenses. On June 16, 1999, the Company purchased the remaining 10% of the outstanding shares of London Precision for U.S. $1,847 cash. London Precision, located in London, Ontario, Canada, is an industrial machine shop which serves the locomotive, mining and construction, pulp and paper markets, among others. The Company financed this transaction with funds available under its revolving credit facility.
On February 25, 1999, Autun purchased the foundry division assets of Compagnie Internationale du Chauffage ("CICH") located in Autun, France. Autun received U.S. $5,847 in cash and U.S. $5,505 in inventory in exchange for the assumption of potential environmental and employment liabilities if the facility is ever closed. CICH is a subsidiary of Blue Circle Industries plc, headquartered in London, England. Autun specializes in the manufacture of cast iron radiators and boiler castings.
The acquisitions have been accounted for by the purchase method of accounting, and accordingly, the purchase price including the related acquisition expenses has been allocated to the assets acquired based on the estimated fair values at the date of the acquisitions. For the Inverness and London Precision acquisitions, the excess of purchase price over estimated fair values of the net assets acquired has been included in "Intangible Assets, net" on the Consolidated Balance Sheets. For the PrimeCast, Sheffield, Claremont and Autun acquisitions, the fair value of the net assets acquired exceeded the purchase price. Accordingly, the excess fair value was subtracted from identifiable long-term assets ratably based on their relative fair values as a percentage of total long-term assets with any remaining excess recorded as negative goodwill and included in "Excess of Fair Value of Acquired Net Assets Over Cost" on the Consolidated Balance Sheet. This amount is being amortized over 4 years.
The estimated fair values of assets and liabilities acquired in the 1997, 1998 and 1999 acquisitions are summarized as follows:
The operating results of the acquired companies are included in ACC's Consolidated Statements of Income from the dates of acquisition. The following unaudited pro forma summary presents the consolidated results of operations as if the acquisitions occurred at July 1, 1997, after giving effect to certain adjustments, including amortization of goodwill, interest expense on the acquisition debt and related income tax effects. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisitions been made as of that date or of results which may occur in the future.
3. INVENTORIES
Inventories as of June 30, 1998 and 1999 would have been higher by $314 and $381, respectively, had the Company used the first-in, first-out method of valuing those inventories valued using the last-in, first-out method.
4. PROPERTY, PLANT AND EQUIPMENT
Depreciation expense was $7,903, $10,656 and $12,647 for the years ended June 30, 1997, 1998 and 1999, respectively.
5. INTANGIBLE ASSETS
Amortization expense was $911, $1,108 and $1,429 for the years ended June 30, 1997, 1998 and 1999, respectively.
6. DEFERRED FINANCING COSTS
Amortization of such costs, included in interest expense, was $129, $188 and $194 for the years ended June 30, 1997, 1998 and 1999, respectively.
7. ACCRUED EXPENSES
8. LONG-TERM OBLIGATIONS
On May 1, 1996, the Company's La Grange Foundry subsidiary entered into a Loan Agreement with the Missouri Development Finance Board (the "Board"), providing for a loan of $5,100 to La Grange Foundry using the proceeds of the Board's Industrial Development Revenue Bonds, Series 1996 (La Grange Foundry Inc. Project). Loans under the Loan Agreement will bear interest at rates that fluctuate weekly based upon the then-prevailing market rates for such securities. Loans under this Loan Agreement were used to finance the costs of acquiring, reconstructing, improving and equipping certain additions and improvements to the Company's La Grange Foundry manufacturing facilities. The Loan Agreement terminates on November 1, 2011.
On April 3, 1998, the Company and the insurance company holding the Company's $20,000 aggregate principal amount of unsecured, senior notes entered into the Third Amendment to the Note Purchase Agreement (the "Note Purchase Agreement") providing for an increase in permitted subsidiary indebtedness from $3,500 to $8,000.
On April 3, 1998, the Company and Harris Trust and Savings Bank ("Harris"), as agent for the lenders, entered into the Amended and Restated Credit Agreement (the "Credit Agreement") providing for an increase in unsecured loans from $60,000 to $110,000 and an extension of the maturity date to April 3, 2003. This Credit Agreement consists of a $40,000 term loan and a $70,000 revolving credit facility. The term loan began amortizing on March 31, 1999, with a final maturity of April 3, 2003. Loans under the Credit Agreement will bear interest at fluctuating rates of either: (i) the agent bank's corporate base rate subject to a reduction of 0.25% (25 basis points) if certain financial ratios are met or (ii) LIBOR plus 1.50% subject, in the case of the LIBOR rate option, to a reduction of up to 0.50% (50 basis points) if certain financial ratios are met. Loans under this revolving credit facility may be used for general corporate purposes, acquisitions and approved investments.
On October 7, 1998 the Company and Harris entered into the First Amendment to the Credit Agreement. This amendment permits the Company to repurchase up to $24,000 of its common stock, subject to a limitation of $10,000 in any fiscal year unless certain financial ratios are met, and provides for an option to increase the revolving portion of the credit facility to $100,000 if the Company issues senior subordinated notes. Proceeds from the issuance of any senior subordinated notes must be used to permanently pre-pay the $40,000 term loan portion of the credit facility.
As of April 23, 1999, the Company and Harris entered into the Second Amendment to the Credit Agreement. This amendment provides that the Company maintain a ratio of earnings before interest, taxes and amortization to fixed charges ("Fixed Charge Coverage Ratio") of at least 1.10, increasing to 1.25 on March 31, 2000 and 1.50 on March 31, 2001. The amendment also provides that the Company must maintain a ratio of total senior debt to earnings before interest, taxes, amortization and depreciation of not more that 3.2 prior to the issuance by the Company of any subordinated debt, and not more than 3.0 after the issuance of any subordinated debt. In addition, this amendment provides that the Company may not make acquisitions prior to May 1, 2000 and, from and after May 1, 2000, the Company may not make acquisitions unless the Fixed Charge Coverage Ratio is at least 1.50, among other existing restrictions. Loans under this revolving credit facility will bear interest at fluctuating rates of either: (i) Harris' corporate base rate subject to a reduction of 0.25% (25 basis points) if certain financial ratios are met or (ii) LIBOR plus 1.85% subject, in the case of the LIBOR rate option, to a reduction of up to 0.50% (50 basis points) if certain financial ratios are met. Loans under this revolving credit facility may be used for general corporate purposes, permitted acquisitions and approved investments. At June 30, 1998 and 1999, $35,102 and $9,866, respectively, was available for borrowing under this facility after consideration of outstanding advances of $65,000 and $88,817 and letters of credit of $9,898 and $8,460, respectively (see Note 10).
Long-term obligations consist of the following as of June 30, 1998 and1999:
The Credit Agreement with Harris and the Note Purchase Agreement with an insurance company limit the Company's ability to pay dividends in any fiscal year to an amount not more than 25% of net earnings in the preceding fiscal year.
The amounts of long-term obligations outstanding as of June 30, 1999 mature as follows:
The amounts of interest expense for the years ended June 30, 1997, 1998 and 1999 consisted of the following:
9. INCOME TAXES
Income taxes for the years ended June 30, 1997, 1998 and 1999 are comprised of the following:
Following is a reconciliation between the total income taxes and the amount computed by multiplying income before income taxes plus the minority interest in net income of subsidiaries by the statutory federal income tax rate:
Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. Deferred income taxes as of June 30, 1998 and 1999 are comprised of the following:
SFAS No. 109 requires a valuation allowance against deferred tax assets if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. An allowance of $12,959 and $13,410 had been recorded as of June 30, 1998 and 1999, respectively. The principal reason for the increase in the valuation allowance is attributable to separate company net operating losses which cannot be utilized for state income tax purposes.
In general, it is the practice and intention of the Company to reinvest the earnings of its non - U.S. subsidiaries in those operations on a permanent basis. Applicable U.S. federal taxes are provided only on amounts actually or deemed to be remitted to the Company as dividends. U.S. income taxes have not been provided on $1,470 and $9,505 of cumulative undistributed earnings of ACUK and London Precision for 1998 and 1999, respectively. U.S. income taxes on such earnings, if ultimately remitted to the U.S., might be recoverable as foreign tax credits.
The Company has federal net operating loss carryforwards totaling approximately $7,816 at June 30, 1999, which expire in the years 2007 through 2012. The federal net operating loss carryforwards were acquired during the current year and are subject to the ownership change rules defined by section 382 of the Internal Revenue code. As the result of this event, the Company will be limited in its ability to use such net operating loss carry forwards. The amount of taxable income that can be offset by pre-change tax attributes in any annual period is limited to approximately $500.
The Company has foreign net operating loss carryforwards totaling approximately $48,036 at June 30, 1999, which have no expiration date. The utilization of such net operating loss carryforwards are restricted to the earnings of specific foreign subsidiaries.
10. FINANCIAL INSTRUMENTS
The Company's financial instruments include cash, accounts receivable, accounts payable, debt obligations, and derivative financial instruments, including interest rate swap agreements, forward foreign exchange contracts and a foreign currency swap agreement.
The derivative financial instruments are used by the Company to manage its exposure to interest rate and foreign currency risk. The Company does not intend to use such instruments for trading or speculative purposes. The counterparties to these instruments are major financial institutions with which the Company has other financial relationships. The Company is exposed to credit loss in the event of nonperformance by these counterparties. However, the Company does not anticipate nonperformance by the other parties, and no material loss would be expected from their nonperformance. The Company's financial instruments also expose it to certain additional market risks as discussed below.
INTEREST RATE RISK - The Company's floating rate debt obligations (see Note 8) expose the Company to interest rate risk, such that when LIBOR or Prime rates increase or decrease, so will the Company's interest expense. To manage this potential risk, the Company may use interest rate swap agreements to limit the effect of increases in interest rates on any of the Company's U.S. dollar floating rate debt by fixing the rate without the exchange of the underlying principal or notional amount. Net amounts paid or received are added to or deducted from interest expense in the period accrued.
A June 30, 1998 and 1999, Company had $65,000 and $88,817, respectively, of floating rate debt tied to LIBOR or Prime rates. In April 1998, the Company entered into a $15,000 notional amount interest rate swap agreement under which the Company will pay a fixed rate of 5.92% and receive a LIBOR floating rate (5.67188% and 5.0000% at June 30, 1998 and 1999, respectively). This agreement is a hedge against $15,000 of the $65,000 and $88,817 outstanding on the Company's unsecured revolving credit facility as of June 30, 1998 and 1999, respectively. At June 30, 1998 and 1999, the fair value of this agreement based on a quote received from the counterparty, indicating the amount the Company would pay or receive to terminate the agreement, is a payment of $77 and $67, respectively.
In September 1998, the Company entered into a $40 million notional amount interest rate swap agreement under which the Company will pay a fixed rate of 5.00% and receive a LIBOR floating rate (5.3275% at June 30, 1999). Under this agreement, the notional amount is amortized at $1,429 per quarter beginning March 31, 1999. At June 30, 1999, this agreement is a hedge against $37,142 of the $88,817 outstanding on the Company's unsecured revolving credit facility. At June 30, 1999, the fair value of this agreement based on a quote received from the counterparty, indicating the amount the Company would pay or receive to terminate the agreement, is a receipt of $965.
FOREIGN CURRENCY RISK - The Company's British subsidiary, Sheffield, generates significant sales to customers outside of Great Britain whereby Sheffield invoices and receives payment from those customers in their local currencies. This creates foreign currency risk for Sheffield as the value of such currencies in British Pound terms may be higher or lower when such transactions are actually settled. To manage this risk, Sheffield uses forward foreign exchange contracts to hedge receipts and payments of foreign currencies related to sales to its customers and purchases from its vendors outside of Great Britain. When Sheffield accepts an order from a customer that will be invoiced in a currency other than British Pounds (anticipated sales), it enters into a forward foreign exchange contract to sell such currency and receive British Pounds at a fixed rate during some specified future period that is expected to approximate the customer's payment date. Upon shipment of the product to the customer, the sale and receivable are recorded in British Pounds in the amount of the contract. When Sheffield purchases materials or equipment from a vendor that bills it in foreign currency, Sheffield will also enter into a forward foreign exchange contract to sell British Pounds and purchase that foreign currency to settle the payable.
At June 30, 1998 and 1999, the Company's foreign subsidiaries, primarily Sheffield, have the following net contracts to sell the following currencies and has no significant un-hedged foreign currency exposure related to sales and purchase transactions:
(1) The approximate value is the value of the local currencies translated first into the foreign subsidiaries' functional currency, at the June 30, 1998 and 1999 spot rates, respectively, and then translated to U.S. dollars at the June 30, 1998 and 1999 spot rates.
The Company also has foreign currency exposure with respect to its net investment in Sheffield. This exposure is to changes in the British Pound and affects the translation of the investment into U.S. Dollars in consolidation. To manage a portion of this exposure, the Company entered into a combined interest rate currency swap ("CIRCUS") in April 1998. The CIRCUS is an amortizing principal swap that fixes the exchange rate on the periodic and final principal cash exchanges and initially requires the payment of interest on 24,002 British Pounds by the Company at a fixed rate of 6.82% and the receipt of interest on 40,000 U.S. Dollars at a floating rate tied to LIBOR rates (5.67% at June 30, 1998). At June 30, 1998, the foreign currency portion of the CIRCUS is an effective hedge of a portion of the net investment in Sheffield, has a carrying value of $7, and is recorded as an adjustment to the cumulative translation adjustment account in other comprehensive income and in other assets. The fair value of the foreign currency portion of the CIRCUS, based on amounts that would be paid or received by the Company to terminate the currency portion of the CIRCUS is a payment of $90 at June 30, 1998. The interest portion of the CIRCUS does not qualify for hedge treatment and therefore is required to be marked-to-market through current earnings as other income or expense. At June 30, 1998, the interest portion of the CIRCUS has a fair value of $55 that is included in other assets and other income and represents the amount the Company would receive on the interest portion if the CIRCUS were terminated.
In September 1999, the Company terminated the CIRCUS and entered into a separate interest rate swap (described in INTEREST RATE RISK above) and a separate amortizing principal currency swap. The termination of the CIRCUS resulted in a loss of $900 on the interest portion, which was deferred and is being amortized to interest expense over the remaining term of the underlying debt obligation to which it was originally designated.
This currency swap entered into in September 1998, like the currency portion of the CIRCUS, is an amortizing principal swap that fixes the exchange rate on the periodic and final principal cash exchanges. The currency swap initially requires the payment of interest on 24,002 British Pounds by the Company at a fixed rate of 6.82% and the receipt of interest by the Company on 40,000 U.S. Dollars at a fixed rate of 5.00%. The currency swap is designated as an effective hedge of a portion of the Company's net investment in Sheffield and is recorded as an adjustment to the cumulative translation adjustment account and as a component of other assets. At June 30, 1999, the currency swap has a carrying value of $1,513 and a fair value, based on amounts that would be paid or received by the Company to terminate the swap, of ($188).
FAIR VALUE OF FINANCIAL INSTRUMENTS - As of June 30, 1998 and 1999, the carrying value of cash and cash equivalents approximates fair value of those instruments due to their liquidity and short-term nature.
Based on borrowing rates currently available to the Company and the remaining terms, the carrying value of debt obligations as of June 30, 1998 and 1999 approximates fair value.
The estimated fair values of the Company's financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgement is necessarily required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
11. STOCKHOLDERS' EQUITY
In August 1998, the Company announced that its Board of Directors had authorized a stock repurchase program of up to 1,200,000 shares of the Company's common stock. During the remainder of fiscal 1999, the Company repurchased 586,700 shares under this program for $6,048. The Company accounts for these shares as treasury stock and has recorded them at cost. The Company's Credit Agreement and the Note Purchase Agreement (see Note 8) each restrict certain payments by the Company, such as stock repurchases, from exceeding certain limits.
The Atchison Casting 1993 Incentive Stock Plan (the "Incentive Plan") was adopted by the Board of Directors on August 10, 1993 and approved by the Company's stockholders on September 27, 1993. At the annual meeting in November 1997, the Company's stockholders approved increasing the number of options available for grant under the Incentive Plan by 400,000. The Incentive Plan allows the Company to grant stock options to employees to purchase up to 700,000 shares of common stock at prices that are not less than the fair market value at the date of grant. The options become exercisable with respect to one-third of the shares subject to the options each year from the date of grant and remain exercisable for a term of not more than 10 years after the date of grant. The Incentive Plan provides that no options may be granted more than 10 years after the date of approval by the stockholders. The changes in outstanding options were as follows:
At June 30, 1999, options to purchase 346,307 shares were authorized but not granted.
The weighted average exercise price of options outstanding under the Incentive Plan at June 30, 1997, 1998 and 1999 is $14.124, $14.536, and $13.227, respectively. The weighted average remaining life of options outstanding under the Incentive Plan at June 30, 1997, 1998 and 1999 is 7.5 years, 7.0 years, and 7.1 years, respectively.
The 1993 Atchison Casting Corporation Employee Stock Purchase Plan (the "Purchase Plan") was adopted by the Board of Directors on August 10, 1993 and approved by the Company's stockholders on September 27, 1993. An aggregate of 400,000 shares of common stock were initially made available for purchase by employees upon the exercise of options under the Purchase Plan. On the first day of every option period (option periods are three-month periods beginning on January 1, April 1, July 1 or October 1 and ending on the next March 31, June 30, September 30 or December 31, respectively), each eligible employee is granted a nontransferable option to purchase common stock from the Company on the last day of the option period. As of the last day of an option period, employee contributions (authorized payroll deductions) during such option period will be used to purchase full and partial shares of common stock. The price for stock purchased under each option is 90% of the stock's fair market value on the first day or the last day of the option period, whichever is lower. During the years ended June 30, 1997, 1998 and 1999, 11,179, 15,793 and 33,033 common shares, respectively, were purchased by employees under the Purchase Plan. At June 30, 1999, 290,040 shares remained available for grant.
On November 18, 1994, the Company's stockholders approved the Atchison Casting Non-Employee Director Option Plan (the "Director Option Plan"). The Director Option Plan provides that each non-employee director of the Company who served in such capacity on April 15, 1994 and each non-employee director upon election or appointment to the Board of Directors thereafter shall automatically be granted an option to purchase 10,000 shares of the Company's common stock. No person shall be granted more than one such option pursuant to the Director Option Plan. An aggregate of 100,000 shares were reserved for purchase under the plan. The price for stock purchased under the plan is the fair market value at the date of grant. The changes in outstanding options were as follows:
At June 30, 1999, options to purchase 40,000 shares were authorized but not granted.
The weighted average exercise price of options outstanding under the Director Option Plan at June 30, 1997, 1998 and 1999 is $13.375, $14.813, and $14.813, respectively. The weighted average remaining life of options outstanding under the Director Option Plan at June 30, 1997, 1998 and 1999 is 6.8 years, 6.6 years, and 5.6 years, respectively.
The Company applies APB No. 25 in accounting for its stock option plans, under which no compensation cost has been recognized for stock option awards. Had compensation cost for the stock option plans been determined in accordance with the fair value accounting method prescribed under SFAS No. 123, the Company's net earnings per share on a pro forma basis would have been as follows:
The SFAS No. 123 fair value method of accounting is not required to be applied to options granted prior to July 1, 1995, therefore, the pro forma compensation cost may not be representative of that to be expected in future years. Compensation cost for 1999 includes options granted during the three-year period ended June 30, 1999.
For the purpose of computing the pro forma effects of stock option grants under the fair value accounting method, the fair value of each stock option grant was estimated on the date of the grant using the Binomial Method pricing model. The weighted-average fair value of stock options granted during 1997, 1998 and 1999 was $10.40, $10.07 and $6.87 per share, respectively. The following weighted average assumptions were used for grants during the years ended June 30, 1997, 1998 and 1999:
12. EARNINGS PER SHARE
In February 1997, the FASB issued SFAS No. 128, "EARNINGS PER SHARE". This Statement established new standards for computing and presenting earnings per share ("EPS") and applies to entities with publicly held common stock or potential common stock. It replaces the presentation of primary EPS with a presentation of basic EPS and also requires that entities with simple capital structures, that is, those with only common stock outstanding, shall present basic per-share amounts for income from continuing operations and for net income on the face of the statement of income. In addition the Statement requires dual presentation of basic and diluted EPS on the face of the statement of income for entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation.
The Company was required to adopt SFAS No. 128 effective for the year ended June 30, 1998. EPS for the prior periods have been restated according to the new standard. Following is a reconciliation of basic and diluted EPS for the years ended June 30, 1997, 1998 and 1999, respectively.
13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for the periods ended June 30, 1999 and 1998 are as follows:
(1) The third quarter contains a $750 charge recorded in connection with an industrial accident that occurred on February 25, 1999 at the Company's subsidiary, Jahn Foundry, which decreased net income by $450 or $0.06 per share (see Note 21).
(2) The fourth quarter contains a $3,500 revision to the flood damage reconstruction reserve which increased net income by $2,086 or $0.27 per share. The flood damage reconstruction reserve relates to the July 1993 Missouri River Flood (see Note 20).
The aggregate total of the individual quarterly amounts may not equal the amount reported for the fiscal year due to rounding.
14. PENSION PLANS
The Company sponsors separate defined benefit pension plans for certain of its salaried and hourly employees. Employees are eligible to participate on the date of employment with vesting after five years of service. Benefits for hourly employees are determined based on years of credited service and employee earnings.
Pension expense for the defined benefit plans is presented below:
The pension plans' assets (primarily U.S. Government securities, common stock and corporate bonds) are deposited with a bank. A comparison of the projected benefit obligation and plan assets at fair value as of June 30, 1998 and 1999 is presented below.
In accordance with SFAS No. 87, the Company has recorded an additional minimum pension liability for underfunded plans of $407 and $828 at June 30, 1998 and 1999, respectively, representing the excess of unfunded accumulated benefit obligations over previously recorded pension cost liabilities. A corresponding amount is recognized as an intangible asset except to the extent that these additional liabilities exceed related unrecognized prior service cost and net transition obligation, in which case the increase in liabilities is charges directly to stockholders' equity.
In addition, the Company sponsors a defined contribution 401(k) benefit plan covering certain of its salaried employees who have attained age 21 and have completed one year of service. The Company matches 75% of employee contributions up to 8% of an employee's salary. Employees vest in the Company matching contributions after five years. The cost of the Company's contribution was $452, $535 and $519 for the years ended June 30, 1997, 1998 and 1999, respectively.
The Company's subsidiaries, Prospect Foundry, LA Die Casting and Jahn Foundry contributed $274, $345 and $302 for the fiscal years ended June 30, 1997, 1998 and 1999, respectively, to multiemployer pension plans for employees covered by a collective bargaining agreement. These plans are not administered by the Company and contributions are determined in accordance with provisions of negotiated labor contracts. Information with respect to the Company's proportionate share of the excess of the actuarially computed value of vested benefits over the total of the pension plans' net assets is not available from the plans' administrators. The Multiemployer Pension Plan Amendments Act of 1980 (the "Act") significantly increased the pension responsibilities of participating employers. Under the provisions of the Act, if the plans terminate or the Company withdraws, the Company may be subject to a substantial "withdrawal liability". As of the date of the most current unaudited information submitted by the plan's administrators (December 31, 1998), no withdrawal liabilities exist.
The Company also has various other profit sharing plans. Costs of such plans charged against earnings were $553, $913 and $1,234 for the years ended June 30, 1997, 1998 and 1999, respectively.
15. POSTRETIREMENT OBLIGATION OTHER THAN PENSION
The Company provides certain health care and life insurance benefits to certain of its retired employees. SFAS No. 106, "EMPLOYER'S ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS," requires the Company to accrue the estimated cost of retiree benefit payments during the years the employee provides services. The Company funds these benefits on a pay-as-you-go basis. The accumulated postretirement benefit obligation and fair value of plan assets as of June 30, 1998 and 1999 is as follows:
Net postretirement benefit cost for the years ended June 30, 1997, 1998 and 1999 consisted of the following components:
The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation for pre-age 65 benefits as of June 30, 1999 was 8.4% decreasing each successive year until it reaches 5.5% in 2019, after which it remains constant. The assumed rate used for post-age 65 benefits was 8.4% decreasing each successive year until it reaches 5.5% in 2019. A one-percentage-point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of June 30, 1999 by approximately $1,497 (15.2%) and the
aggregate of the service and interest cost components of the net periodic postretirement benefit cost for the year then ended by approximately $200 (17.8%). A one-percentage-point decrease in the assumed health care cost trend rate for each year would decrease the accumulated postretirement benefit obligation as of June 30, 1999 by approximately $1,206 (12.2%) and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost for the year then ended by approximately $159 (14.2%). The assumed discount rate used in determining the accumulated postretirement obligation as of June 30, 1997, 1998 and 1999 was 7.75%, 6.75% and 7.5%, respectively, and the assumed discount rate used in determining the service cost and interest cost for the years ended June 30, 1997, 1998 and 1999 was 7.5%, 7.75% and 7.5%, respectively.
16. OPERATING LEASES
The Company leases certain buildings, equipment, automobiles and trucks, all accounted for as operating leases, on an as needed basis to fulfill general purposes. Total rental expense was $657, $1,006 and $1,675 for the years ended June 30, 1997, 1998 and 1999, respectively. Long-term, noncancelable operating leases having an initial or remaining term in excess of one year require minimum rental payments as follows:
17. MAJOR CUSTOMERS
Net sales to and customer accounts receivable from major customers are as follows:
18. SEGMENT AND GEOGRAPHIC INFORMATION
Due to the nature of the Company's products and services, its production processes, the type or class of customer for its products and services, and the methods used to distribute products and provide services, the Company is considered to have a single operating segment for reporting purposes.
The Company operates in four countries, the United States, Great Britain, Canada and France. Revenues from external customers derived from operations in each of these countries for the years ended June 30, 1999, 1998 and 1997 are as follows:
Long-lived assets located in each of these countries as of June 30, 1999 and 1998 are as follows:
19. ADDITIONAL CASH FLOWS INFORMATION
20. FLOOD RESERVE
In 1996, the Company received an insurance settlement for losses incurred as a result of the July 1993 Missouri River flood. At that time the Company used a portion of the insurance proceeds to establish a reserve to be used for future repairs due to flood damage. Since that time the Company has been charging the reserve balance for costs incurred resulting from those repairs.
During 1999, management updated its analysis of the required repairs by performing its periodic reevaluation of the effects of the flood based on current information. As a result, management committed to a revised repair plan, which included several remaining projects. These projects and their final estimated costs to complete represent the remaining flood reserve balance that is necessary. The amount of the reserve balance, over and above the estimated costs of such identified projects, was considered to be excess and was reversed. Such excess amounted to $3,500 and was included as a reduction of selling, general and administrative expense in the fourth quarter of 1999. Any future repairs outside the scope of the projects identified, if any, will be charged to repairs and maintenance as incurred. As of June 30, 1998 and 1999, the Company has $5,932 and $1,197 recorded, respectively, as reserves for future flood repairs, which have been classified as accrued expenses.
21. CONTINGENCIES
An accident, involving an explosion and fire, occurred on February 25, 1999 at Jahn Foundry located in Springfield, Massachusetts. Nine employees were injured and there have been three fatalities. The damage was confined to the shell molding area and the boiler room. Other areas of the foundry are operational. Molds are currently being produced at other foundries until repairs are made.
Although no lawsuits have been filed, a number of attorneys representing the injured and deceased employees have contacted Jahn Foundry regarding possible litigation. The Company carries insurance for property and casualty damages, business interruption, general liability and worker's compensation for itself and its subsidiaries. The Company, its property insurance carrier and its insurance broker dispute the amount of property insurance coverage for property damages suffered in this accident. If this dispute cannot be resolved amicably, the Company would vigorously pursue its remedies against both parties. The Company recorded a charge of $450 ($750 before tax) during the third quarter of fiscal 1999, primarily reflecting the deductibles under the Company's various insurance policies. At this time there can be no assurance that the Company's ultimate costs and expenses resulting from the accident will not exceed available insurance coverage by an amount which could be material to its financial condition, results of operations, or cash flows.
Following the accident, the Occupational Safety and Health Administration ("OSHA") conducted an investigation of the accident. On August 24, 1999, OSHA issued a citation describing violations of the Occupational Safety and Health Act of 1970, which primarily related to housekeeping, maintenance and other specific, miscellaneous items. Neither of the two violations, specifically addressing conditions related to the explosion and fire, were classified as serious or willful. Without admitting any wrongdoing Jahn Foundry entered into a settlement with OSHA that addresses the alleged work place safety issues and agreed to pay $149 in fines.
The Company is a defendant in various matters and is exposed to claims encountered in the normal course of business. In the opinion of management, the resolution of these matters will not have a material effect on the Company's financial position, results of operations, or cash flows.
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* Represents a management contract or a compensatory plan or arrangement.