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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2002
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 33-29035
K & F Industries, Inc.
- ------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 34-1614845
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
600 Third Avenue, New York, New York 10016
- ------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code (212) 297-0900
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )
As of November 1, 2002, there were 740,398 shares of common stock outstanding.
PART I. FINANCIAL INFORMATION
K & F INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
2002 2001
------------- ------------
ASSETS:
Current Assets:
Cash and cash equivalents $ 7,097,000 $ 5,136,000
Accounts receivable, net 42,509,000 43,595,000
Inventory 62,756,000 60,510,000
Other current assets 692,000 666,000
------------ ------------
Total current assets 113,054,000 109,907,000
------------ ------------
Property, plant and equipment 170,101,000 170,172,000
Less, accumulated depreciation and amortization 104,234,000 100,131,000
------------ ------------
65,867,000 70,041,000
------------ ------------
Deferred charges, net of amortization 44,986,000 41,126,000
Goodwill 167,011,000 167,011,000
Intangible assets, net of amortization 15,006,000 15,923,000
------------ ------------
$405,924,000 $404,008,000
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY:
Current Liabilities:
Accounts payable, trade $ 15,308,000 $ 14,181,000
Current portion of senior term loans 1,000,000 1,500,000
Interest payable 7,894,000 3,712,000
Other current liabilities 51,348,000 51,291,000
------------ ------------
Total current liabilities 75,550,000 70,684,000
------------ ------------
Pension liabilities 5,685,000 5,685,000
Deferred income taxes 25,962,000 8,213,000
Postretirement benefit obligation other
than pensions 79,656,000 79,656,000
Other long-term liabilities 10,521,000 13,898,000
Senior revolving loan 4,000,000 --
Senior term loan A -- 47,375,000
Senior term loan B 48,000,000 51,750,000
9 1/4% senior subordinated notes due 2007 185,000,000 185,000,000
Stockholders' Deficiency:
Common stock, $.01 par value - authorized,
1,000,000 shares; issued and
outstanding, 740,398 shares 7,000 7,000
Additional paid-in capital (63,259,000) (63,259,000)
Retained earnings 50,952,000 21,273,000
Accumulated other comprehensive loss (16,150,000) (16,274,000)
------------ ------------
Total stockholders' deficiency (28,450,000) (58,253,000)
------------ ------------
$405,924,000 $404,008,000
============ ============
See notes to consolidated financial statements.
2
K & F INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Months Ended
-------------------------------------
September 30, September 30,
2002 2001
------------ -------------
Sales $251,979,000 $268,090,000
Costs and expenses 178,419,000 185,819,000
Amortization 2,930,000 6,463,000
------------ ------------
Operating income 70,630,000 75,808,000
Interest and investment income 64,000 174,000
Interest expense (19,520,000) (26,505,000)
------------ ------------
Income before income taxes 51,174,000 49,477,000
Income tax provision (21,495,000) (21,033,000)
------------ ------------
Net income $ 29,679,000 $ 28,444,000
============ ============
See notes to consolidated financial statements.
3
K & F INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
----------------------------------
September 30, September 30,
2002 2001
------------- -------------
Sales $93,210,000 $85,284,000
Costs and expenses 61,419,000 59,403,000
Amortization 1,004,000 2,207,000
----------- -----------
Operating income 30,787,000 23,674,000
Interest and investment income 29,000 50,000
Interest expense (6,640,000) (9,707,000)
----------- -----------
Income before income taxes 24,176,000 14,017,000
Income tax provision (10,155,000) (6,918,000)
----------- -----------
Net income $14,021,000 $ 7,099,000
=========== ===========
See notes to consolidated financial statements.
4
K & F INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
-----------------------------------------
September 30, September 30,
2002 2001
------------- -------------
Cash flows from operating activities:
Net income $ 29,679,000 $ 28,444,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 8,946,000 12,404,000
Non-cash interest expense - amortization
of deferred financing charges 1,206,000 1,260,000
Non-cash interest expense - change in fair
market value of interest rate swap 90,000 4,299,000
Deferred income taxes 17,757,000 18,520,000
Changes in assets and liabilities:
Accounts receivable, net 1,080,000 5,920,000
Inventory (2,254,000) (3,597,000)
Other current assets (26,000) (1,142,000)
Accounts payable, notes payable, interest
payable, and other current liabilities 5,060,000 (9,001,000)
Postretirement benefit obligation other
than pensions -- 650,000
Other long-term liabilities (3,031,000) (56,000)
------------ ------------
Net cash provided by operating
activities 58,507,000 57,701,000
------------ ------------
Cash flows from investing activities:
Capital expenditures (1,842,000) (3,565,000)
Deferred charges (7,079,000) (9,205,000)
------------ ------------
Net cash used in investing activities (8,921,000) (12,770,000)
------------ ------------
Cash flows from financing activities:
Payments of senior revolving loan (30,000,000) (50,000,000)
Payments of senior term loans (51,625,000) (41,125,000)
Borrowings under senior revolving loan 34,000,000 46,000,000
------------ ------------
Net cash used by financing activities (47,625,000) (45,125,000)
------------ ------------
Net increase (decrease) in cash and cash
equivalents 1,961,000 (194,000)
Cash and cash equivalents, beginning of
period 5,136,000 6,477,000
------------ ------------
Cash and cash equivalents, end of period $ 7,097,000 $ 6,283,000
============ ============
Supplemental cash flow information:
Interest paid during period $ 14,042,000 $ 17,045,000
============ ============
Income taxes paid during the period $ 3,453,000 $ 2,069,000
============ ============
See notes to consolidated financial statements.
5
K & F INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying unaudited consolidated financial statements have been
prepared by K & F Industries, Inc. and Subsidiaries (the "Company")
pursuant to the rules of the Securities and Exchange Commission
("SEC") and, in the opinion of the Company, include all adjustments
(consisting of normal recurring accruals) necessary for a fair
presentation of financial position, results of operations and cash
flows. Certain information and footnote disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such
SEC rules. The Company believes that the disclosures made are adequate
to make the information presented not misleading. The consolidated
statements of operations for the three and nine months ended September
30, 2002 are not necessarily indicative of the results to be expected
for the full year. It is suggested that these financial statements be
read in conjunction with the audited financial statements and notes
thereto included in the Company's December 31, 2001 Annual Report on
Form 10-K.
2. Accounting Changes
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 requires that goodwill no longer be amortized,
but instead be tested for impairment at least annually. SFAS No. 142
also requires that any recognized intangible asset determined to have
an indefinite useful life not be amortized, but instead be tested for
impairment in accordance with this Standard until its life is
determined to no longer be indefinite. The Company adopted SFAS No.
142 on January 1, 2002, at which time amortization of goodwill
ceased. During the three months ended March 31, 2002, the Company
completed its impairment analysis in accordance with SFAS No. 142.
The analysis did not result in an impairment charge.
The following table adjusts net income assuming the adoption of SFAS
No. 142 at the beginning of the periods presented:
Three Months Ended
-------------------------------
September 30, September 30,
2002 2001
------------- -------------
Reported net income $14,021,000 $7,099,000
Add back goodwill amortization,
net of tax -- 773,000
----------- ----------
Adjusted net income $14,021,000 $7,872,000
=========== ==========
6
K & F INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended
-----------------------------
September 30, September 30,
2002 2001
------------- -------------
Reported net income $29,679,000 $28,444,000
Add back goodwill amortization,
net of tax -- 2,634,000
----------- -----------
Adjusted net income $29,679,000 $31,078,000
=========== ===========
There was no change in the carrying amount of goodwill during the
three and nine months ended September 30, 2002. Goodwill at September
30, 2002 allocated to the Company's segments, Aircraft Braking Systems
and Engineered Fabrics, was $135,683,000 and $31,328,000,
respectively.
Effective January 1, 2002, the Company adopted SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS
No. 144 establishes a single accounting model based on the framework
established in SFAS No. 121 for long-lived assets to be disposed of by
sale, whether previously held and used or newly acquired. There was no
impact to the Company's financial position, results of operations or
cash flows related to the adoption of this Standard.
Effective January 1, 2001, the Company adopted SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133, as amended and interpreted, establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities. All derivatives, whether designated in hedging
relationships or not, are required to be recorded on the balance sheet
at fair value. SFAS No. 133 defines new requirements for designation
and documentation of hedging relationships as well as ongoing
effectiveness assessments in order to use hedge accounting. For a
derivative that does not qualify as a hedge, changes in fair value
will be recognized in earnings.
As a requirement of its credit facility, the Company entered into an
interest rate swap agreement in 1997 to reduce the impact of potential
increases in interest rates on the credit facility. This interest rate
swap agreement is the only financial instrument of the Company that is
required to be accounted for at fair value in accordance with SFAS No.
133.
The adoption of SFAS No. 133 on January 1, 2001 resulted in a
cumulative pre-tax reduction in other comprehensive income of $923,000
($550,000 after tax) during the nine months ended September 30, 2001,
related to the derivative designated in a cash flow-type hedge prior
to adopting SFAS No. 133. This amount is being amortized into interest
expense over three years which was the remaining life of the interest
rate swap
7
K & F INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
agreement at January 1, 2001. During the three months ended September
30, 2002 and 2001, the change in fair market value of this derivative
instrument resulted in a non-cash charge of $294,000 and $2,605,000,
respectively. During the nine months ended September 30, 2002 and
2001, the change in fair market value of this derivative instrument
resulted in a non-cash charge of $90,000 and $4,299,000, respectively.
These amounts were recorded in interest expense as this derivative was
not designated as a hedging instrument. The Company does not utilize
derivatives for speculative purposes.
3. Receivables are summarized as follows:
September 30, December 31,
2002 2001
------------- ------------
Accounts receivable, principally
from commercial customers $34,408,000 $37,266,000
Accounts receivable, on U. S.
Government and other long-term
contracts 8,913,000 6,976,000
Allowances (812,000) (647,000)
----------- -----------
$42,509,000 $43,595,000
=========== ===========
4. Inventory consists of the following:
September 30, December 31,
2002 2001
------------- ------------
Raw materials and work-in-process $29,935,000 $29,458,000
Finished goods 19,025,000 18,712,000
Inventoried costs related to U.S.
Government and other long-term
contracts 13,796,000 12,340,000
----------- -----------
$62,756,000 $60,510,000
=========== ===========
The Company customarily sells original wheel and brake equipment below
cost as an investment in a new airframe which is expected to be
recovered through the subsequent sale of replacement parts. These
commercial investments (losses) are recognized when original equipment
is shipped. Losses on U.S. Government contracts are immediately
recognized in full when determinable.
Inventory is stated at average cost, not in excess of net realizable
value. In accordance with industry practice, inventoried costs may
contain amounts relating to contracts with long production cycles, a
portion of which will not be realized within one year.
8
K & F INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. Other current liabilities consist of the following:
September 30, December 31,
2002 2001
------------- ------------
Accrued payroll costs $16,184,000 $18,086,000
Accrued property taxes and other taxes 2,715,000 3,264,000
Accrued costs on long-term contracts 3,856,000 3,420,000
Accrued warranty costs 14,719,000 12,619,000
Customer credits 2,666,000 2,766,000
Postretirement benefit obligation other
than pensions 3,000,000 3,000,000
Fair market value of interest rate swap 3,449,000 3,151,000
Other 4,759,000 4,985,000
----------- -----------
$51,348,000 $51,291,000
=========== ===========
6. Contingencies
There are various lawsuits and claims pending against the Company
incidental to its business. Although the final results in such suits
and proceedings cannot be predicted with certainty, in the opinion of
the Company's management, the ultimate liability, if any, will not
have a material adverse effect on the Company's financial position,
results of operations or cash flows.
7. Comprehensive Income
Three Months Ended
--------------------------------
September 30, December 31,
2002 2001
------------- ------------
Net income $14,021,000 $7,099,000
Other comprehensive income:
Cumulative translation adjustments (25,000) 32,000
Amortization of transition adjustment
included in interest expense 46,000 46,000
----------- ----------
Comprehensive income $14,042,000 $7,177,000
=========== ==========
9
K & F INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended
----------------------------------
September 30, September 30,
2002 2001
------------- -------------
Net income $29,679,000 $28,444,000
Other comprehensive income:
Cumulative translation adjustments (14,000) (122,000)
Cumulative effect of change in
accounting principle (SFAS No. 133) -- (550,000)
Amortization of transition adjustment
included in interest expense 138,000 138,000
----------- -----------
Comprehensive income $29,803,000 $27,910,000
=========== ===========
8. Segments
The following represents financial information about the Company's
segments:
Three Months Ended
--------------------------------------
September 30, September 30,
2002 2001
------------- -------------
Sales:
Aircraft Braking Systems $81,270,000 $72,102,000
Engineered Fabrics 11,940,000 13,182,000
----------- -----------
$93,210,000 $85,284,000
=========== ===========
Earnings Before Interest, Taxes,
Depreciation and Amortization:
Aircraft Braking Systems $31,823,000 $26,315,000
Engineered Fabrics 1,984,000 1,557,000
----------- -----------
$33,807,000 $27,872,000
=========== ===========
Operating Profits:
Aircraft Braking Systems $29,028,000 $22,598,000
Engineered Fabrics 1,759,000 1,076,000
----------- -----------
Operating income 30,787,000 23,674,000
Interest expense, net (6,611,000) (9,657,000)
----------- -----------
Income before income taxes $24,176,000 $14,017,000
=========== ===========
10
K & F INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended
--------------------------------------
September 30, September 30,
2002 2001
------------- -------------
Sales:
Aircraft Braking Systems $218,398,000 $229,357,000
Engineered Fabrics 33,581,000 38,733,000
------------ ------------
$251,979,000 $268,090,000
============ ============
Earnings Before Interest, Taxes,
Depreciation and Amortization:
Aircraft Braking Systems $ 75,282,000 $ 83,269,000
Engineered Fabrics 4,294,000 4,943,000
------------ ------------
79,576,000 $ 88,212,000
============ ============
Operating Profits:
Aircraft Braking Systems $ 67,051,000 $ 72,350,000
Engineered Fabrics 3,579,000 3,458,000
------------ ------------
Operating income 70,630,000 75,808,000
Interest expense, net (19,456,000) (26,331,000)
------------ ------------
Income before income taxes $ 51,174,000 $ 49,477,000
============ ============
September 30, December 31,
2002 2001
------------- ------------
Total Assets:
Aircraft Braking Systems $342,634,000 $338,636,000
Engineered Fabrics 59,288,000 60,451,000
Deferred financing costs not
allocated to segments 3,257,000 4,463,000
Corporate assets 745,000 458,000
------------ ------------
$405,924,000 $404,008,000
============ ============
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS AND FINANCIAL CONDITION
General
The Company is a supplier to manufacturers and operators of commercial, general
aviation and military aircraft. Results for the three and nine months ended
September 30, 2001 were adversely affected by the sluggish economy and the
events of September 11, 2001. The Company believes the impact was to lower sales
by approximately $7,000,000 during the three and nine months ended September 30,
2001. Results for the three and nine months ended September 30, 2002 continue to
be adversely affected by the sluggish economy.
Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of
Operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosures of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates, including those related to bad debts, inventories, intangible
assets, income taxes, warranty obligations, workers compensation liabilities,
pension and other postretirement benefits, and contingencies and litigation. The
Company bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates. The Company believes the
following critical accounting policies affect its more significant judgments and
estimates used in the preparation of the consolidated financial statements.
Inventory. Inventory is stated at average cost, not in excess of net realizable
value. In accordance with industry practice, inventoried costs may contain
amounts related to contracts with long production cycles, a portion of which
will not be realized within one year. Reserves for slow moving and obsolete
inventories are provided based on current assessments about future product
demand and production requirements for the next twelve months. The Company
evaluates the adequacy of these reserves quarterly.
Evaluation of Long-Lived Assets. Long-lived assets are assessed for
recoverability on an ongoing basis. In evaluating the value and future benefits
of long-lived assets, their carrying value is compared to management's estimate
of the anticipated undiscounted future net cash flows of the related long-lived
asset. Any necessary impairment charges are recorded when the Company does not
believe the carrying value of the long-lived asset will be recoverable.
Warranty. Estimated costs of product warranty are accrued when individual
claims arise with respect to a product. When the Company becomes aware of such
defects, the estimated costs of all potential warranty claims arising from such
defects are fully accrued.
Pension and Other Postretirement Benefits. The determination of the Company's
obligation and expense for pension and other postretirement benefits is
dependant on the Company's selection of certain assumptions used by actuaries
in calculating such amounts. Those assumptions include, among others, the
discount rate, expected long-term rate of return on plan assets and rates of
increases in compensation and health care costs. Actual results
12
that differ from the Company's assumptions would affect the pension and
postretirement obligations and future expense.
Comparison of Results of Operations for the Nine Months Ended September 30, 2002
and September 30, 2001
Sales for the nine months ended September 30, 2002 totaled $251,979,000,
reflecting a decrease of $16,111,000 compared with $268,090,000 for the same
period in the prior year. This decrease was principally due to lower commercial
transport sales of wheels and brakes of $16,308,000, primarily on the Fokker
FO-100, DC-9 and DC-10 programs. General aviation sales decreased $3,240,000 due
to lower sales of wheels, brakes and fuel tanks on various aircraft. Military
sales increased $3,437,000 due to higher sales of wheels and brakes on the B-1B
and various other military aircraft, partially offset by lower sales of fuel
tanks primarily on the F/A-18 program.
Operating income decreased $5,178,000 to $70,630,000, or 28.0% of sales for the
nine months ended September 30, 2002, compared with $75,808,000, or 28.3% of
sales for the same period in the prior year. Operating margins decreased
primarily due to the unfavorable overhead absorption effect relating to the
lower sales. Partially offsetting this decrease was the elimination of
$4,581,000 of goodwill amortization during the nine months ended September 30,
2002 due to the adoption of SFAS No. 142 (see Note 2 to the consolidated
financial statements), and lower research and development costs on various
programs.
Net interest expense decreased $6,875,000 for the nine months ended September
30, 2002 compared with the same period in the prior year. This decrease was due
to lower non-cash interest expense of $4,209,000 (non-cash interest expense of
$90,000 during the nine months ended September 30, 2002 compared with non-cash
interest expense of $4,299,000 for the same period in the prior year) relating
to the change in the fair market value of the Company's interest rate swap in
accordance with SFAS No. 133. Net interest expense also decreased due to a lower
average debt balance.
The Company's effective tax rate of 42.0% for the nine months ended September
30, 2002 differs from the statutory rate of 35% primarily due to state, local
and foreign income taxes. The effective tax rate of 42.5% for the nine months
ended September 30, 2001 differs from the statutory rate of 35% primarily due to
state, local and foreign taxes. The decrease in the effective rate in 2002 over
2001 is primarily due to higher tax benefits derived from foreign sales.
Comparison of Results of Operations for the Three Months Ended September 30,
2002 and September 30, 2001
Sales for the three months ended September 30, 2002 totaled $93,210,000,
reflecting an increase of $7,926,000 compared with $85,284,000 for the same
period in the prior year. This increase was due to higher military sales of
wheels and brakes of $6,370,000, primarily on the B-1B and various other
military aircraft. Commercial transport sales increased $1,589,000 primarily due
to higher sales of wheels and brakes on the Canadair Regional Jet and MD-80
programs. General Aviation sales were essentially even with the prior year.
Operating income increased $7,113,000 to $30,787,000, or 33.0% of sales for the
three months ended September 30, 2002, compared with $23,674,000, or 27.8% of
sales for the same period in the prior year. Operating margins increased
primarily due to a favorable overhead absorption effect relating to the higher
sales and the elimination of $1,527,000 of goodwill amortization during the
three months ended September 30, 2002 due to the adoption of SFAS No. 142 (see
Note 2 to the consolidated financial statements). Partially offsetting this
increase was higher program investments.
13
Net interest expense decreased $3,046,000 for the three months ended September
30, 2002 compared with the same period in the prior year. This decrease was due
to lower non-cash interest expense of $2,311,000, (non-cash interest expense of
$294,000 during the three months ended September 30, 2002 compared with non-cash
interest expense of $2,605,000 for the same period in the prior year) relating
to the change in the fair market value of the Company's interest rate swap in
accordance with SFAS No. 133. Net interest expense also decreased due to a lower
average debt balance.
The Company's effective tax rate of 42.0% for the three months ended September
30, 2002 differs from the statutory rate of 35% primarily due to state, local
and foreign income taxes. The effective tax rate of 49.4% for the three months
ended September 30, 2001 differs from the statutory rate of 35% primarily due to
state, local and foreign taxes. The decrease in the effective rate in 2002 over
2001 is primarily due to higher tax benefits derived from foreign sales.
Liquidity and Capital Resources
The Company expects that its principal use of funds for the next several years
will be to fund capital expenditures, to make investments in new airframes and
to pay interest and principal on indebtedness. The Company's primary source of
funds for conducting its business activities and servicing its indebtedness has
been cash generated from operations and borrowings under its revolving credit
facility. At September 30, 2002, the Company had $44.1 million available to
borrow under its $50 million revolving credit facility.
Cash Flows
During the nine months ended September 30, 2002, cash provided by operating
activities amounted to $58,507,000 and reflected $79,576,000 of earnings before
interest, taxes, depreciation and amortization ("EBITDA"), decreases in accounts
receivable of $1,080,000 and increases in accounts payable of $1,127,000,
partially offset by increases in inventory of $2,254,000, other current assets
of $26,000, other working capital of $221,000, decreases in other current
liabilities of $249,000, other long-term liabilities of $3,031,000, interest
payments of $14,042,000 and tax payments of $3,453,000. During the nine months
ended September 30, 2001, cash provided by operating activities amounted to
$57,701,000 and reflected $88,212,000 of EBITDA, decreases in accounts
receivable of $5,920,000 and increases in long-term liabilities of $594,000,
partially offset by increases in inventory of $3,597,000, other current assets
of $1,142,000, decreases in accounts payable of $1,073,000, notes payable of
$2,600,000, other current liabilities of $9,229,000, increases in other working
capital of $270,000, interest payments of $17,045,000 and tax payments of
$2,069,000.
During the nine months ended September 30, 2002, net cash used in investing
activities amounted to $8,921,000 due to $1,842,000 of capital expenditures and
$7,079,000 of program participation payments. During the nine months ended
September 30, 2001, net cash used in investing activities amounted to
$12,770,000 due to $3,565,000 of capital expenditures and $9,205,000 of program
participation payments.
During the nine months ended September 30, 2002 and 2001, net cash used by
financing activities amounted to $47,625,000 and $45,125,000, respectively, each
representing the repayment of indebtedness.
Accounting Changes
Effective January 1 ,2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires that goodwill no longer be amortized, but instead be tested for
impairment at least annually. SFAS No. 142 also
14
requires that any recognized intangible asset determined to have an indefinite
useful life not be amortized, but instead be tested for impairment in accordance
with this Standard until its life is determined to no longer be indefinite. The
Company adopted SFAS No. 142 on January 1, 2002, at which time amortization of
goodwill ceased. At September 30, 2002, goodwill net of accumulated amortization
was $167.0 million and goodwill amortization expense during the three and nine
months ended September 30, 2001 was $1,527,000 and $4,581,000, respectively.
Amortization of goodwill had been $6,108,000 per year prior to the adoption of
this Standard. During the three months ended March 31, 2002, the Company
completed its impairment analysis in accordance with SFAS No. 142. The analysis
did not result in an impairment charge. See Note 2 to the consolidated financial
statements.
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 establishes a single
accounting model based on the framework established in SFAS No. 121 for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired. There was no impact to the Company's financial position, results
of operations or cash flows related to the adoption of this Standard.
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133, as amended and
interpreted, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. All derivatives, whether designated in
hedging relationships or not, are required to be recorded on the balance sheet
at fair value. SFAS No. 133 defines new requirements for designation and
documentation of hedging relationships as well as ongoing effectiveness
assessments in order to use hedge accounting. For a derivative that does not
qualify as a hedge, changes in fair value will be recognized in earnings.
As a requirement of its credit facility, the Company entered into an interest
rate swap agreement in 1997 to reduce the impact of potential increases in
interest rates on the credit facility. This interest rate swap agreement is the
only financial instrument of the Company that is required to be accounted for at
fair value in accordance with SFAS No. 133.
The adoption of SFAS No. 133 on January 1, 2001 resulted in a cumulative pre-tax
reduction in other comprehensive income of $923,000 ($550,000 after tax) during
the nine months ended September 30, 2001, related to the derivative designated
in a cash flow-type hedge prior to adopting SFAS No. 133. This amount is being
amortized into interest expense over three years which was the remaining life of
the interest rate swap agreement at January 1, 2001. During the three months
ended September 30, 2002 and 2001, the change in fair market value of this
derivative instrument resulted in a non-cash charge of $294,000 and $2,605,000,
respectively. During the nine months ended September 30, 2002 and 2001, the
change in fair market value of this derivative instrument resulted in a non-cash
charge of $90,000 and $4,299,000, respectively. These amounts were recorded in
interest expense as this derivative was not designated as a hedging instrument.
The Company does not utilize derivatives for speculative purposes.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company had $238 million of total debt outstanding at September 30, 2002. Of
this amount, $185 million is borrowed at a fixed rate of 9 1/4% and the balance
is borrowed under the credit facility. The interest rate for borrowings under
the credit facility varies with LIBOR or the prime rate at the Company's option.
The Company entered into an interest rate swap agreement to reduce the impact of
potential increases in interest rates. The interest rate swap agreement
15
effectively fixes the Company's borrowing rate at 6.6% on all outstanding
borrowings under the credit facility, and expires on December 17, 2003.
Therefore, the Company has effectively fixed the interest rate on all of its
indebtedness at September 30, 2002. Given that all of the Company's borrowings
are at fixed interest rates, a 10% change in rates would not have a significant
impact on fair values, cash flows or earnings. The Company has no other
derivative financial instruments.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the participation of
the Company's management, including the Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), of the effectiveness of the design and operation of the
Company's disclosure controls and procedures within 90 days before the filing
date of this quarterly report. Based on that evaluation, the Company's
management, including the CEO and CFO, concluded that the Company's disclosure
controls and procedures were effective. There have been no significant changes
in the Company's internal controls or in other factors that could significantly
affect internal controls subsequent to their evaluation.
16
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
99.1 - Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 - Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
There were no reports on Form 8-K for the three months ended September
30, 2002.
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
K & F INDUSTRIES, INC.
----------------------
Registrant
/s/ DIRKSON R. CHARLES
------------------
Dirkson R. Charles
Chief Financial Officer
and
Registrant's Authorized
Officer
Dated: November 12, 2002
18
CERTIFICATION
I, Bernard L. Schwartz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of K & F Industries,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant, as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing of this quarterly report (the "Evaluation Date");
and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 12, 2002 /s/ BERNARD L. SCHWARTZ
-----------------------
Bernard L. Schwartz
Chief Executive Officer
19
CERTIFICATION
I, Dirkson R. Charles, certify that:
1. I have reviewed this quarterly report on Form 10-Q of K & F Industries,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing of this quarterly report (the "Evaluation Date");
and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 12, 2002 /s/ DIRKSON R. CHARLES
----------------------
Dirkson R. Charles
Chief Financial Officer
20