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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 June 30, 2004
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
- --------------------------------------------------------------------------------
(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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No[X]
As of August 1, 2004, there were 740,398 shares of common stock outstanding.
K & F INDUSTRIES, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
INDEX
Page
-----
Part I. Consolidated Financial Information
Item 1. Consolidated Financial Statements (Unaudited)
a) Consolidated Balance Sheets
as of June 30, 2004 and December 31, 2003 3
b) Consolidated Statements of Operations for the six
months ended June 30, 2004 and 2003 4
c) Consolidated Statements of Operations
for the three months ended June 30, 2004 and 2003 4
d) Consolidated Statements of Cash Flows for the six
months ended June 30, 2004 and 2003 5
e) Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 16
Item 4. Controls and Procedures 16
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
K & F INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
2004 2003
------------- -------------
ASSETS:
Current Assets:
Cash and cash equivalents $ 44,241,000 $ 24,464,000
Accounts receivable, net 40,706,000 41,595,000
Inventory 50,203,000 50,087,000
Other current assets 1,531,000 1,527,000
Income taxes receivable -- 851,000
------------- -------------
Total current assets 136,681,000 118,524,000
------------- -------------
Property, plant and equipment 175,606,000 175,107,000
Less, accumulated depreciation and amortization 114,328,000 111,527,000
------------- -------------
61,278,000 63,580,000
------------- -------------
Deferred charges, net of amortization 56,120,000 54,232,000
Intangible assets, net of amortization 15,624,000 16,238,000
Goodwill 167,011,000 167,011,000
------------- -------------
$ 436,714,000 $ 419,585,000
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY:
Current Liabilities:
Accounts payable, trade $ 12,588,000 $ 15,029,000
Interest payable 3,797,000 3,797,000
Other current liabilities 45,686,000 49,621,000
------------- -------------
Total current liabilities 62,071,000 68,447,000
------------- -------------
Pension liabilities 26,885,000 26,885,000
Deferred income taxes 21,256,000 19,373,000
Postretirement benefit obligation other
than pensions 85,267,000 84,468,000
Other long-term liabilities 16,519,000 12,383,000
9 1/4% senior subordinated notes due 2007 145,000,000 145,000,000
9 5/8% senior subordinated notes due 2010 250,000,000 250,000,000
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 (263,259,000) (263,259,000)
Retained earnings 120,664,000 104,039,000
Accumulated other comprehensive loss (27,696,000) (27,758,000)
------------- -------------
Total stockholders' deficiency (170,284,000) (186,971,000)
------------- -------------
$ 436,714,000 $ 419,585,000
============= =============
See notes to consolidated financial statements.
3
K & F INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Six Months Ended
--------------------------------------
June 30, June 30,
2004 2003
------------ ------------
Sales $166,740,000 $160,021,000
Costs and expenses 119,995,000 120,250,000
Amortization 2,340,000 2,099,000
------------ ------------
Operating income 44,405,000 37,672,000
Interest and investment income 220,000 227,000
Interest expense (19,724,000) (21,934,000)
------------ ------------
Income before income taxes 24,901,000 15,965,000
Income tax provision (8,276,000) (4,616,000)
------------ ------------
Net income $ 16,625,000 $ 11,349,000
============ ============
See notes to consolidated financial statements.
4
K & F INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
------------------------------------
June 30, June 30,
2004 2003
----------- -----------
Sales $83,591,000 $77,946,000
Costs and expenses 60,693,000 60,362,000
Amortization 1,194,000 1,059,000
----------- -----------
Operating income 21,704,000 16,525,000
Interest and investment income 119,000 142,000
Interest expense (9,861,000) (10,851,000)
----------- -----------
Income before income taxes 11,962,000 5,816,000
Income tax provision (3,926,000) (1,883,000)
----------- -----------
Net income $ 8,036,000 $ 3,933,000
=========== ===========
See notes to consolidated financial statements.
5
K & F INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
-------------------------------------
June 30, June 30,
2004 2003
----------- ------------
Cash flows from operating activities:
Net income $16,625,000 $ 11,349,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 5,882,000 6,038,000
Non-cash interest expense - amortization
of deferred financing charges 918,000 1,069,000
Non-cash interest income - change in fair
market value of interest rate swap -- (1,615,000)
Deferred income taxes 1,883,000 1,209,000
Changes in assets and liabilities:
Accounts receivable, net 925,000 2,482,000
Inventory (90,000) (7,336,000)
Other current assets 847,000 59,000
Accounts payable, interest payable and
other current liabilities (6,376,000) (10,377,000)
Postretirement benefit obligation other
than pensions 799,000 1,550,000
Other long-term liabilities 4,136,000 4,122,000
----------- ------------
Net cash provided by operating
activities 25,549,000 8,550,000
----------- ------------
Cash flows from investing activities:
Capital expenditures (1,240,000) (1,037,000)
Deferred charges (4,532,000) (2,000,000)
----------- ------------
Net cash used in investing activities (5,772,000) (3,037,000)
----------- ------------
Net increase in cash and cash equivalents 19,777,000 5,513,000
Cash and cash equivalents, beginning of
period 24,464,000 22,735,000
----------- ------------
Cash and cash equivalents, end of period $44,241,000 $ 28,248,000
=========== ============
Supplemental cash flow information:
Interest paid during period $18,806,000 $ 22,279,000
=========== ============
Income taxes paid during the period $ 4,379,000 $ 3,117,000
=========== ============
See notes to consolidated financial statements.
6
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
six months ended June 30, 2004 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, 2003
Annual Report on Form 10-K.
2. Accounting Pronouncements
In May 2004, the Financial Accounting Standards Board (the "FASB") issued
Staff Position No. 106-2, "Accounting and Disclosure Requirements Related
to the Medicare Prescription Drug, Improvement and Modernization Act ("The
Act") of 2003" which supersedes Staff Position No. 106-1 of the same
title. The Staff Position clarifies the accounting for the benefits
attributable to new government subsidies for companies that provide
prescription drug benefits to retirees. The new accounting requirements
are not effective until the third quarter 2004. In accordance with Staff
Position No. 106-1, the Company elected to defer accounting for the
economic effects of the new Medicare Act. Accordingly, any measures of the
accumulated postretirement benefit obligation or net periodic
postretirement benefit cost in the financial statements or accompanying
notes do not reflect the effect of the subsidy because the Company is
still evaluating whether the benefits provided by the plan are actuarially
equivalent to Medicare Part D under the Act.
7
K & F INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. Receivables are summarized as follows:
June 30, December 31,
2004 2003
------------- ------------
Accounts receivable, principally
from commercial customers $ 36,578,000 $ 35,306,000
Accounts receivable, on U. S.
Government and other long-term
contracts 5,369,000 7,505,000
Allowances (1,241,000) (1,216,000)
------------- ------------
$ 40,706,000 $ 41,595,000
============= ============
4. Inventory consists of the following:
June 30, December 31,
2004 2003
------------- ------------
Raw materials and work-in-process $ 23,873,000 $ 22,324,000
Finished goods 13,207,000 15,839,000
Inventoried costs related to U.S.
Government and other long-term
contracts 13,123,000 11,924,000
------------- ------------
$ 50,203,000 $ 50,087,000
============= ============
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. 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.
8
K & F INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. Other current liabilities consist of the following:
June 30, December 31,
2004 2003
------------ ------------
Accrued payroll costs $ 11,341,000 $ 14,451,000
Accrued property taxes and other taxes 3,446,000 2,711,000
Accrued costs on long-term contracts 3,831,000 5,061,000
Accrued warranty costs 15,625,000 13,261,000
Customer credits 3,335,000 5,918,000
Postretirement benefit obligation other
than pensions 3,000,000 3,000,000
Other 5,108,000 5,219,000
------------ ------------
$ 45,686,000 $ 49,621,000
============ ============
6. Income Taxes
Our effective tax rate of 32.8% and 32.4% for the three months ended June
30, 2004 and 2003, respectively, differs from the statutory rate of 35%
due to tax benefits derived from export sales.
Our effective tax rate of 33.2% for the six months ended June 30, 2004
differs from the statutory rate of 35% due to tax benefits derived from
export sales. Our effective tax rate of 28.9% for the six months ended
June 30, 2003 differs from the statutory rate of 35% due to tax benefits
derived from export sales and reversal of prior years tax reserves no
longer needed.
7. Contingencies
There are various lawsuits and claims pending against the Company
incidental to its business. Although the ultimate resolution of such suits
cannot be predicted with certainty, in the opinion of the Company's
management, the ultimate settlement, if any, will not have a material
adverse effect on the Company's consolidated financial statements.
9
K & F INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. Comprehensive Income
Three Months Ended
----------------------------------------
June 30, June 30,
2004 2003
------------ -----------
Net income $ 8,036,000 $ 3,933,000
Other comprehensive income:
Cumulative translation adjustments (31,000) (33,000)
Amortization of transition adjustment
included in interest expense -- 46,000
------------ -----------
Comprehensive income $ 8,005,000 $ 3,946,000
============ ===========
Six Months Ended
----------------------------------------
June 30, June 30,
2004 2003
------------ -----------
Net income $ 16,625,000 $11,349,000
Other comprehensive income:
Cumulative translation adjustments 62,000 39,000
Amortization of transition adjustment
included in interest expense -- 92,000
------------ -----------
Comprehensive income $ 16,687,000 $11,480,000
============ ===========
9. Segments
The following represents financial information about the Company's
segments:
Three Months Ended
-----------------------------------------
June 30, June 30,
2004 2003
------------- ------------
Sales:
Aircraft Braking Systems $ 69,162,000 $ 63,560,000
Engineered Fabrics 14,429,000 14,386,000
------------- ------------
$ 83,591,000 $ 77,946,000
============= ============
Operating Profit:
Aircraft Braking Systems $ 19,474,000 $ 14,761,000
Engineered Fabrics 2,230,000 1,764,000
------------- ------------
Operating income 21,704,000 16,525,000
Interest expense, net (9,742,000) (10,709,000)
------------- ------------
Income before income taxes $ 11,962,000 $ 5,816,000
============= ============
10
Six Months Ended
-----------------------------------
June 30, June 30,
2004 2003
------------ ------------
Sales:
Aircraft Braking Systems $138,039,000 $134,718,000
Engineered Fabrics 28,701,000 25,303,000
------------ ------------
$166,740,000 $160,021,000
============ ============
Operating Profit:
Aircraft Braking Systems $ 39,972,000 $ 35,237,000
Engineered Fabrics 4,433,000 2,435,000
------------ ------------
Operating income 44,405,000 37,672,000
Interest expense, net (19,504,000) (21,707,000)
------------ ------------
Income before income taxes $ 24,901,000 $ 15,965,000
============ ============
June 30, December 31,
2004 2003
------------ ------------
Total Assets:
Aircraft Braking Systems $358,035,000 $348,609,000
Engineered Fabrics 69,896,000 60,593,000
Deferred financing costs not
allocated to segments 7,250,000 8,168,000
Corporate assets 1,533,000 1,364,000
Income taxes receivable
not allocated to segments -- 851,000
------------ ------------
$436,714,000 $419,585,000
============ ============
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
We are a supplier to manufacturers and operators of commercial, general aviation
and military aircraft. Since 2001, the commercial and general aviation segments
of the industry we serve, and our financial results, have been adversely
affected by the sluggish economy and the events of September 11, 2001. We
believe, however, that conditions have improved throughout the industry and that
prospects for us are good in each of the commercial, general aviation and
military market sectors. The growing number of regional jets in service should
lead to increased commercial transport business for us. The general aviation
marketplace, which had been stagnant, is showing signs of recovery with sales
increasing by over 20% for the six months ended June 30, 2004, compared with the
same period in the prior year. We expect military spending for new aircraft and
spare parts to continue at current levels. However, due to delays in receipt of
military orders at Aircraft Braking Systems, we expect military sales in 2004 to
be marginally lower than the prior year.
Critical Accounting Policies and Estimates
This section is based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
our management to make estimates and judgments that affect the reported amounts
of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
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. We base our
estimates on historical experience and on various other assumptions that we
believe 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. We believe the following critical accounting policies affect
our 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. These factors are
impacted by market conditions, technology changes, and changes in strategic
direction, and require estimates and management judgment that may include
elements that are uncertain. We evaluate the adequacy of these reserves
quarterly.
Although we strive to achieve a balance between market demands and risk of
inventory excess or obsolescence, it is possible that, should conditions change,
additional reserves may be needed. Any changes in reserves will impact operating
income during a given period. This policy is consistently applied to each of our
operating segments and we do not anticipate any
12
changes to our policy in the near term.
Evaluation of Long-Lived Assets. Long-lived assets are assessed for
recoverability on an ongoing basis in accordance with SFAS No. 144. 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 would be recorded when we do not believe the carrying value of the
long-lived asset will be recoverable.
Warranty. Estimated costs of warranty are accrued when individual claims arise
with respect to a product or performance. When we become aware of those types of
defects, the estimated costs of all potential warranty claims arising from those
types of defects are estimated and accrued.
Pension and Other Postretirement Benefits. We have significant pension and
postretirement benefit costs and liabilities. The determination of our
obligation and expense for pension and other postretirement benefits is
dependent on our selection of certain assumptions used by actuaries in
calculating those amounts. Assumptions are made about interest rates, expected
investment return on plan assets, rate of increase in health care costs, total
and involuntary turnover rates, and rates of future compensation increases. In
addition, our actuarial consultants use subjective factors such as withdrawal
rates and mortality rates to develop our valuations. We generally review and
update these assumptions at the beginning of each fiscal year. We are required
to consider current market conditions, including changes in interest rates, in
making these assumptions. The actuarial assumptions that we may use may differ
materially from actual results due to changing market and economic conditions,
higher or lower withdrawal rates or longer or shorter life spans of
participants. These differences may result in a significant impact on the amount
of pension and postretirement benefits expense we have recorded or may record.
The discount rate enables us to state expected future cash flows at a present
value on the measurement date. The rate represents the market rate of
high-quality fixed income investments. A lower discount rate increases the
present value of benefit obligations and increases pension expense. We used a 6
3/4% discount rate in 2003 and are using a 6 1/4% discount rate for 2004 to
reflect market interest rate conditions.
To determine the expected long-term rate of return on pension plan assets, we
consider the current and expected asset allocations, as well as historical and
expected returns on various categories of plan assets. We assumed that the
long-term return on our pension plan assets was 9.0% in 2003 and will remain at
9.0% for 2004 to reflect market interest rate conditions.
The annual postretirement expense was calculated using a number of actuarial
assumptions, including a health care cost trend rate and a discount rate. Our
discount rate assumption for postretirement benefits is consistent with that
used in the calculation of pension benefits. The healthcare cost trend rate
being used to calculate the calendar year 2004 postretirement expense is 10.0%
in 2004 trending down to 4.5% for 2010.
Comparison of Results of Operations for the Six Months Ended June 30, 2004 and
June 30, 2003
Our sales for the six months ended June 30, 2004 totaled $166,740,000,
13
reflecting an increase of $6,719,000, compared with $160,021,000 for the same
period in the prior year. This increase was due to higher sales at Aircraft
Braking Systems of $3,321,000 and higher sales at Engineered Fabrics of
$3,398,000.
Commercial sales at Aircraft Braking Systems increased $4,899,000, primarily on
the Boeing MD-90, the Bombardier CRJ-700 and CRJ-100/200 and the Embraer 170
programs, partially offset by lower sales on the Boeing MD-80 and B-707
programs. General aviation sales increased $5,145,000, primarily on Gulfstream,
Lear and Canadair aircraft. Military sales decreased $6,723,000, primarily on
the Boeing B-1B and Lockheed C-130 programs.
Sales at Engineered Fabrics increased primarily due to higher military sales of
fuel tanks, primarily for the Boeing F-15, the Northrop Grumman F-18 and the
Sikorsky Blackhawk programs.
Our operating income increased $6,733,000, or 26.6% of sales for the six months
ended June 30, 2004, compared with 23.5% of sales for the same period in the
prior year. Aircraft Braking Systems operating income was $39,972,000, or 29.0%
of sales for the six months ended June 30, 2004, compared with $35,237,000, or
26.2% of sales for the same period in the prior year. Engineered Fabrics
operating income was $4,433,000, or 15.4% of sales for the six months ended June
30, 2004, compared with $2,435,000, or 9.6% of sales for the same period in the
prior year.
Aircraft Braking Systems operating income margins increased primarily due to a
favorable mix of products sold, lower operating costs and the favorable overhead
absorption effect relating to the higher sales, partially offset by higher
program investments. Engineered Fabrics operating income margins increased
primarily due to the favorable overhead absorption effect relating to the higher
sales and operating efficiencies.
Our net interest expense decreased by $2,203,000 for the six months ended June
30, 2004, compared with the same period in the prior year. This decrease was
primarily due to a lower average debt balance.
Our effective tax rate of 33.2% for the six months ended June 30, 2004 differs
from the statutory rate of 35% due to tax benefits derived from export sales.
Our effective tax rate of 28.9% for the six months ended June 30, 2003 differs
from the statutory rate of 35% due to tax benefits derived from export sales and
reversal of prior years tax reserves no longer needed.
Comparison of Results of Operations for the Three Months Ended June 30, 2004 and
June 30, 2003
Our sales for the three months ended June 30, 2004 totaled $83,591,000,
reflecting an increase of $5,645,000, compared with $77,946,000 for the same
period in the prior year. This increase was due to higher sales at Aircraft
Braking Systems of $5,602,000, while Engineered Fabrics sales were level with
the prior year.
Commercial sales at Aircraft Braking Systems increased $6,313,000, primarily on
the Boeing MD-90 and the Bombardier CRJ-700 and CRJ-100/200 programs. General
aviation sales increased $2,781,000, primarily on Canadair and Gulfstream
aircraft. Military sales decreased $3,492,000, primarily on the Boeing B-1B, the
Northrop Grumman F-14 and various helicopter programs.
Sales at Engineered Fabrics, while level with the prior year, had higher
14
military sales of fuel tanks on the Boeing F-15 and Sikorsky Blackhawk programs,
offset by lower sales of oil containment booms.
Our operating income increased $5,179,000 to $21,704,000, or 26.0% of sales for
the three months ended June 30, 2004, compared with $16,525,000, or 21.2% of
sales for the same period in the prior year. Aircraft Braking Systems operating
income was $19,474,000, or 28.2% of sales for the three months ended June 30,
2004, compared with $14,761,000, or 23.2% of sales for the same period in the
prior year. Engineered Fabrics operating income was $2,230,000, or 15.5% of
sales for the three months ended June 30, 2004, compared with $1,764,000, or
12.3% of sales for the same period in the prior year.
Aircraft Braking Systems operating income margins increased primarily due to the
favorable overhead absorption effect relating to the higher sales, a favorable
mix of products sold and lower operating costs, partially offset by higher
program investments. Engineered Fabrics operating income margins increased
primarily due to operating efficiencies.
Our net interest expense decreased by $967,000 for the three months ended June
30, 2004, compared with the same period in the prior year. This decrease was
primarily due to a lower average debt balance.
Our effective tax rate of 32.8% and 32.4% for the three months ended June 30,
2004 and 2003, respectively, differs from the statutory rate of 35% due to tax
benefits derived from export sales.
Liquidity and Financial Position
Our cash and cash equivalents totaled $44.2 million at June 30, 2004, compared
with $24.5 million at December 31, 2003. Our total debt was $395.0 million at
June 30, 2004 and December 31, 2003, and we had $27.2 million (which is net of
letters of credit of $2.8 million) available to borrow under our $30.0 million
revolving credit facility. In the past, the cash generated from operations has
been sufficient to pay our indebtedness. We do not have to pay principal on our
notes until 2007, when $145.0 million of our 9 1/4% notes mature.
We expect that our principal use of funds for the next several years will be to
pay interest and principal on indebtedness, fund capital expenditures and make
program investments. Our primary source of funds for conducting our business
activities and servicing our indebtedness has been cash generated from
operations.
The credit facility contains certain covenants and events of default, including
limitations on additional indebtedness, liens, asset sales, making certain
restricted payments, capital expenditures, creating guarantee obligations and
material lease obligations. The credit facility also contains certain financial
ratio requirements, including a cash interest coverage ratio and a leverage
ratio. We were in compliance with all debt covenants at June 30, 2004.
Our contractual obligations are detailed in our Annual Report on Form 10-K for
the year ended December 31, 2003. As of June 30, 2004, our contractual
obligations have not materially changed from December 31, 2003.
15
================================================================================
Cash Flows
During the six months ended June 30, 2004, net cash provided by operating
activities amounted to $25,549,000, compared with $8,550,000 for the same period
in the prior year, an increase of $16,999,000. Our cash flow from operating
activities increased from the prior year primarily due to payments made in 2003
to the holders of our stock options in connection with the 2002
recapitalization, and lower increases in inventory in 2004 versus 2003.
During the six months ended June 30, 2004, net cash used in investing activities
amounted to $5,772,000 versus $3,037,000 for the same period in the prior year,
an increase of $2,735,000. This increase was primarily due to $4,532,000 of
program participation payments made during the six months ended June 30, 2004,
compared with $2,000,000 made during the same period in the prior year.
Accounting Pronouncements
In May 2004, the Financial Accounting Standards Board, or the FASB, issued Staff
Position No. 106-2, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act, or the Act, of
2003" which supersedes Staff Position No. 106-1 of the same title. The Staff
Position clarifies the accounting for the benefits attributable to new
government subsidies for companies that provide prescription drug benefits to
retirees. The new accounting requirements are not effective until the third
quarter 2004. In accordance with Staff Position No. 106-1, we elected to defer
accounting for the economic effects of the new Medicare Act. Accordingly, any
measures of the accumulated postretirement benefit obligation or net periodic
postretirement benefit cost in the financial statements or accompanying notes do
not reflect the effect of the subsidy because we are still evaluating whether
the benefits provided by the plan are actuarially equivalent to Medicare Part D
under the Act.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have $395.0 million of total fixed rate debt outstanding at June 30, 2004.
Borrowings under the credit facility bear interest that varies with LIBOR, for
which no borrowings were outstanding at June 30, 2004.
Given that all of our outstanding debt is at a fixed rate, a 10% change in
interest rates would not have a significant impact on fair values, cash flows or
earnings. We have no derivative financial instruments.
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports under the Securities and
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission's rules and
forms, and that such information is accumulated and communicated to our
management, including our Chief Executive Officer and our Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosures. Any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the designed
control objectives. Our management, with the participation of our Chief
Executive Officer and our Chief Financial Officer, have evaluated the
effectiveness of the design and operation of our disclosure controls and
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procedures as of June 30, 2004. Based upon that evaluation and subject to the
foregoing, our Chief Executive Officer and Chief Financial Officer concluded
that the design and operation of our disclosure controls and procedures provided
reasonable assurance that the disclosure controls and procedures are effective
to accomplish their objectives.
In addition, there was no change to our internal control over financial
reporting that occurred during the quarter ended June 30, 2004 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
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PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 - Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a)of the Securities Exchange Act, as
amended.
31.2 - Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a)of the Securities Exchange Act, as
amended.
32.1 - Certification of Chief Executive Office pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 - Certification of Chief Financial Officer 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
A report on Form 8-K dated May 7, 2004 was filed regarding the first
quarter 2004 earnings.
Items 1, 2, 3, 4 and 5 are not applicable and have been omitted.
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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: August 11, 2004
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