FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended DECEMBER 28, 1996 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission file number 1-7737 ARROW AUTOMOTIVE INDUSTRIES, INC. (Exact name of registrant as specified in its charter) MASSACHUSETTS (State or other jurisdiction of incorporation or organization) 04-1449115 (I.R.S. Employer I.D. No.) 3 SPEEN STREET, FRAMINGHAM, MASSACHUSETTS 01701 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (508) 872-3711 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 2,873,083 shares of the Company's Common Stock ($.10 par value) were outstanding as of February 5, 1997. ARROW AUTOMOTIVE INDUSTRIES, INC. INDEX Page NUMBER PART I FINANCIAL INFORMATION ITEM 1. Financial Statements (Unaudited): Condensed Balance Sheets - December 28, 1996 and June 29, 3 1996...................................... Condensed Statements of Operations - Three Months Ended December 28, 1996 and December 30, 4 1995............................. Condensed Statement of Operations - Six Months Ended December 28, 1996 and December 30, 5 1995............................. Condensed Statements of Cash Flows - Six Months Ended December 28, 1996 and December 30, 6 1995............................. Notes to Condensed Financial 7 Statements................................. ITEM 2. Management's Discussion and Analysis of the Financial Condition and Results of 8 Operations....................................... PART II OTHER INFORMATION ITEM 1. Legal 13 Proceedings...................................................................... ITEM 2. Changes in 13 Securities................................................................. ITEM 3. Default upon Senior 13 Securities................................................... ITEM 4. Submission of Matters to a Vote of Security 13 Holders.................. ITEM 5. Other 13 Information........................................................................ ITEM 6. Exhibits and Reports on Form 8- 13 K.............................................. SIGNATURES .................................................................................................... 14 1 PART I - ITEM 1 -- FINANCIAL INFORMATION ARROW AUTOMOTIVE INDUSTRIES, INC. CONDENSED BALANCE SHEETS (UNAUDITED) December 28, 1996 June 29, 1996 ASSETS CURRENT ASSETS Cash and equivalents $ 443,704 $ 850,537 Accounts receivable, less allowances 12,508,658 16,468,224 Inventories - Note B 38,001,704 37,312,671 Prepaid expenses and other current assets 3,574,936 3,164,661 TOTAL CURRENT ASSETS 54,529,002 57,796,093 PROPERTY, PLANT AND EQUIPMENT 36,246,339 35,727,256 Less allowances for depreciation 23,560,090 22,912,356 12,686,249 12,814,900 OTHER ASSETS 2,290,869 2,500,718 TOTAL ASSETS $ 69,506,120 $ 73,111,711 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Current portion of advances under revolving line of credit $ 3,420,670 $ 5,104,715 Accounts payable 6,850,827 6,647,237 Cash overdrafts 863,092 1,260,165 Other current liabilities - Note C 5,683,898 5,272,737 Current portion of long-term debt 1,379,575 1,385,672 TOTAL CURRENT LIABILITIES 18,198,062 19,670,526 LONG-TERM DEBT 17,287,722 17,969,339 DEFERRED INCOME TAXES 1,748,000 1,748,000 ACCRUED RETIREMENT BENEFITS 2,580,049 2,428,226 STOCKHOLDERS' EQUITY Common stock 296,887 296,887 Other stockholders' equity 29,844,724 31,448,057 Less cost of common stock in treasury 449,324 449,324 TOTAL STOCKHOLDERS' EQUITY 29,692,287 31,295,620 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 69,506,120 $ 73,111,711 See accompanying notes to the condensed financial statements. 2 ARROW AUTOMOTIVE INDUSTRIES, INC. CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS ENDED December 28, 1996 December 30, (13 Weeks) (13 Weeks) 1995 Net sales $ 21,230,177 $ 23,738,037 Cost and expenses: Cost of products sold 17,018,945 19,233,926 Selling, administrative and general 5,061,826 5,299,088 Interest 564,442 487,509 22,645,213 25,020,523 Loss before income taxes (1,415,036) (1,282,486) Benefit from income taxes (395,900) (489,000) NET LOSS $ (1,019,136) $ (793,486) Weighted average number of shares outstanding 2,873,083 2,873,083 NET LOSS PER SHARE $ (0.35) $ (0.28) See accompanying notes to the condensed financial statements. ARROW AUTOMOTIVE INDUSTRIES, INC. CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) SIX MONTHS ENDED December 28, 1996 December 30, (26 Weeks) (27 Weeks) 1995 Net sales $ 45,711,325 $ 52,875,236 Cost and expenses: Cost of products sold 36,045,923 42,100,268 Selling, administrative and general 9,714,244 10,485,363 Restructuring charge - Note C 1,200,000 0 Interest 1,108,491 1,034,913 48,068,658 53,620,544 Loss before income taxes (2,357,333) (745,308) Benefit from income taxes (754,000) (284,000) NET LOSS $ (1,603,333) $ (461,308) Weighted average number of shares outstanding 2,873,083 2,873,083 NET LOSS PER SHARE $ (0.56) $ (0.16) See accompanying notes to the condensed financial statements. ARROW AUTOMOTIVE INDUSTRIES, INC. CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) SIX MONTHS ENDED December 28, 1996 December 30, 1995 (26 Weeks) (27 Weeks) OPERATING ACTIVITIES Net cash provided by operating activities $ 2,286,639 $ 24,406 INVESTING ACTIVITIES Net cash used in investing activities (321,712) (405,704) FINANCING ACTIVITIES Payment of long-term debt and capital (687,715) (687,098) lease obligations (Decrease) increase in advances under (1,684,045) 915,362 revolving line of credit Proceeds from exercise of stock option 0 331 Net cash (used in) provided by financing activities (2,371,760) 228,595 DECREASE IN CASH AND EQUIVALENTS (406,833) (152,703) CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 850,537 753,010 CASH AND EQUIVALENTS AT END OF PERIOD $ 443,704 $ 600,307 See accompanying notes to the condensed financial statements. 3 ARROW AUTOMOTIVE INDUSTRIES, INC. NOTES TO CONDENSED FINANCIAL STATEMENT (UNAUDITED) NOTE A -- BASIS OF PRESENTATION The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for the fair presentation have been included. Operating results for the six month period ended December 28, 1996 are not necessarily indicative of the results that may be expected for the year ending June 28, 1997. For further information, refer to the financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended June 29, 1996. The balance sheet at June 29, 1996 has been derived from the audited financial statements at that date. NOTE B -- INVENTORIES The components of inventory consist of the following: December 28, 1996 June 29, 1996 Stated at cost on the first-in, first-out (FIFO) method: Finished goods $ 12,432,399 $ 11,522,643 Work in process and materials 31,943,305 32,260,028 44,375,704 43,782,671 Less reserve required to state inventory on the last-in, first-out (LIFO) method (6,374,000) (6,470,000) $ 38,001,704 $ 37,312,671 NOTE C -- RESTRUCTURING CHARGE In September, 1996, the Board of Directors of the Company approved a plan to restructure its operations by closing its Santa Maria, California production facility and transferring its manufacturing operations formerly conducted at that facility to the Morrilton, Arkansas plant. The action was taken to enhance profit margins by streamlining the Company's productive capacity to better match its production requirements. As a result, a $1.2 million restructuring charge was recorded in the first quarter of fiscal 1997. Of the total charge, $625,000 related to the disposal of the facility, $360,000 related to termination benefits for displacement of its 350-employee workforce, $150,000 relates to the write-off of machinery and equipment, and $65,000 to other closing expenses. During the second quarter of fiscal 1997, the Company paid $257,000 in termination benefits to its displaced employees. 4 PART I ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the financial statements and notes thereto. All forward looking statements contained in the following discussion and analysis and elsewhere in this report are qualified in their entirety by the cautionary statement appearing at the end of the discussion and analysis. RESTRUCTURING PLAN During the first quarter of fiscal 1997, the Board of Directors of the Company approved a plan to restructure its operations by closing its Santa Maria, California production facility and transferring its manufacturing operations to its Morrilton, Arkansas plant. Production at the Santa Maria, California facility ceased in early December, 1996. As a result of this plan, a $1.2 million restructuring charge was recorded in the first quarter of fiscal 1997. Of the total charge, $360,000 related to termination benefits for displacement of its 350-employee workforce and $840,000 related to closing the facility. In addition to recording the restructuring charge, the Company anticipates that during fiscal 1997 it will incur non-recurring period costs relating to the restructuring estimated at $1.5 million. These costs relate to ongoing operations and include such costs as the shipment of inventory and equipment, employee relocation and anticipated initial labor and production inefficiencies resulting from the consolidation of production facilities from three to two plants. One time period costs relating to the restructuring were incurred in the first and second quarters of fiscal 1997 of $10,000 and $880,000, respectively. OPERATING RESULTS Operations during the second quarter of fiscal 1997 resulted in a net loss of $1,019,000 compared to a net loss of $793,000 for the second quarter of fiscal 1996. The six months ended December 28, 1996, resulted in a net loss of $1,603,000 compared to a net loss of $461,000 for the comparable period in fiscal 1996. The operating results for the first quarter of fiscal 1997 include the previously discussed restructuring charge which reduced operating income before income taxes by $1,200,000. The second quarter's pre-tax loss included $880,000 of non-recurring costs related to the California plant closing. Net sales for the second quarter of fiscal 1997 of $21,230,000 were down 10.6% compared to net sales for the comparable period in fiscal 1996. Unit sales for the second quarter in the current fiscal year were down 10.5%, compared to the second quarter of the prior fiscal year. For the six months ended December 28, 1996 (26 weeks), net sales of $45,711,000 were down 13.5% (10.2% adjusted for the number of weeks differential) from net sales of the first six months in the prior fiscal year (27 weeks). Unit sales for the first six months in the current fiscal year are down 11.8% (8.4% adjusted for the number of weeks differential) from unit sales of the same period in fiscal 1996. The sales decline of $2,508,000 in the second quarter of fiscal 1997, compared to the second quarter of the prior fiscal year, is due to overall lower customer demand and the impact of the loss of a significant customer in the third quarter of fiscal 1996. The sales attributable to this customer in the second quarter of the prior fiscal year were approximately $2 million. The $4,656,000 decline in net sales in the first quarter of fiscal 1997, compared to the first quarter of fiscal 1996, was due to several factors. It is estimated that approximately $1.9 million of the decline was due to the number of weeks differential (14 weeks in 1995 /13 weeks in 1996) in the two periods. Of the remaining decrease in net sales approximately 25% was due to the adverse impact of higher levels of customer returns (which are deductions in calculating net sales) and 75% of the decline is attributable to lower customer demand. In the current fiscal year, the Company's mix of product sold reflects a higher level of mechanical product sales with a decline in electrical product sales. Net sales in the current fiscal year have been adversely impacted by this product mix because mechanical products have a lower average sales price than electrical products. During the current fiscal year, more so in the first quarter of the year, the Company experienced a higher level of customer returns compared to the comparable periods of the prior fiscal year. Customer returns are for re- usable "cores" (our basic raw material), warranty and stock adjustments received in the normal course of business. The Company believes that it has experienced a greater level of returns as our customers have excess inventories due to increased consolidation/merger activity, as discussed in the Management's Discussion and Analysis of the Financial Condition and Results of Operations in the 1996 Annual Report. The Company believes that to help rectify their surplus inventory issues, these businesses return as much of their excess inventory as possible to their vendors. The Company's gross margin percentage for the second quarter of fiscal 1997 was 19.8%, up slightly from corresponding period last fiscal year. For the six months ended December 28, 1996, the gross margin percentage was 21.1%, up from the prior year of 20.4%. The cost of goods sold in the current year included one-time period costs of $580,000 related to the closing of the California manufacturing facility. The gross margin percentage before the impact of these costs would have been 22.5% and 22.4%, for the second quarter and the first six months of fiscal 1997, respectively. These costs included underabsorbed overhead, additional overtime and inefficient labor costs as the production of the California plant was shifted to the Company's remaining manufacturing plants. The Company anticipates that it will continue to incur one-time period expenses related to the closing of the plant in the third quarter of fiscal 1997. The margin improvement in the second quarter of fiscal 1997 is due to several factors. Compared to fiscal 1996, the mix of products sold in the current quarter of fiscal 1997 had a higher level of mechanical products sold than electrical product . While mechanical products have a lower average selling price, they generally result in a higher average gross margin. As mentioned in the Management's Discussion and Analysis of the Financial Condition and Results of Operations in the 1996 Annual Report, in the fourth quarter of fiscal 1996, the Company expanded the recovery departments at all manufacturing locations to maximize the recovery (return to finished goods) of warranty returns. The Company's recovery dollars of these product returns increased 75% in the first quarter of fiscal 1997 and doubled in the second quarter of fiscal 1997, compared to the comparable periods of fiscal 1996. The improved recovery of warranty returns has mitigated the impact of the increased product returns and contributed to the improved gross margin in both the first and second quarters of the current fiscal year. Selling, general and administrative expenses in the second quarter of fiscal 1997 of $5,061,000 were down 4.5% or $237,000 from the same period in fiscal 1996. For the six months ended December 28, 1996, selling, general and administrative expenses of $9,714,000 declined 7.4% or $711,000 compared to the first six months of the prior fiscal year. These expenses for the second quarter of fiscal 1997 included non-recurring period costs related to the closing of the California facility of $300,000, including shipping costs to transport inventory and equipment, relocation costs and public relations costs. The Company expects that it will continue to incur non-recurring period expenses related to the closing of the plant in the third quarter of fiscal 1997. On a regular basis, the Company reviews its operations and during fiscal 1997 consolidated production operations and administrative functions, which have had a positive impact on operations. Interest expense increased 15.8% and 7.1% in the second quarter and the first six months of the current fiscal year, respectively, over the comparable period of the last fiscal year. The increases are due primarily to the higher interest rates in the current year compared to the prior year. CAPITAL RESOURCES Net cash of $2,287,000 was provided by operating activities for the six months ended December 28, 1996. This is down $862,000 from net cash of $3,148,000 provided by operating activities at the end of the first quarter of the current fiscal year. The six months ended December 30, 1995, provided net cash from operating activities of $24,000. In the current fiscal year, cash was primarily provided by a decrease in accounts receivable of approximately $4 million. The decline in accounts receivable is consistent with the lower sales volume in the second quarter of the current fiscal year. The net loss in the current fiscal year used cash from operating activities as did an increase in inventory of approximately $700,000 and an increase in income taxes receivable of approximately $400,000. The increase in inventory levels is due primarily to management's plan to maintain higher on-hand inventories during the transition of the production operations from the California manufacturing facility to the Company's remaining manufacturing facilities. Cash of $321,000 was used in investing activities, primarily in property, plant and equipment in the first six months of the current fiscal year compared to $406,000 used in the comparable period in the prior fiscal year. Cash was used in the first six months of the current fiscal year to reduce debt and advances under a revolving line of credit totaling $2,372,000. In the comparable period of the prior fiscal year, cash of $915,000 was provided by an increase in its borrowings under its revolving line of credit and cash of $687,000 was used to decrease long term debt. During the second quarter of fiscal 1997 a second commercial lender joined with the Company's primary lender to the extent of a one-third participation in the Company's line of credit and term loan. During the second quarter of the current fiscal year compliance with tangible net worth, debt service and operating performance covenants were waived such that the loss sustained by the Company did not result in a default under its financing agreement. Also, the Company's revolving line of credit which allows the Company to borrow up to $20 million through September 30, 1997, has been extended to December 31, 1997. The Company believes that its existing cash balance and cash generated from operations combined with its borrowing ability under the Company's financing agreements will provide sufficient funds to meet the Company's cash requirements for operations for the next twelve months and to complete the planned restructuring efforts. OUTLOOK Consolidations and mergers have been frequent recently within the automotive aftermarket. The Company, too, has mirrored the industry dynamics by consolidating its own production facilities. The restructuring plan announced by the Company in the first quarter of fiscal 1997 called for the closure of the Company's California plant in December of 1996. This consolidation was aimed at streamlining the Company's productive capacity to better match its production requirements. Improved manufacturing efficiencies and profit margins are expected to result from the restructuring. However, as anticipated, the restructuring has included significant non-recurring period costs that were expensed as incurred in the first six months of fiscal 1997. It is also anticipated that there remains approximately $600,000 of additional one-time period costs, to be incurred in the latter half of fiscal 1997. The Company's net sales have experienced large month to month fluctuations in the current year as well as during the last two years. It is believed that the consolidation and merger activity within the distribution sector of the industry has contributed to these swings. Consolidations and mergers result in excess inventory for our customers, thereby affecting the Company with reduced orders. Also, the consolidation of distribution frequently results in large product returns by customers as they streamline newly combined operations. The resulting larger customers in our marketplace employ inventory management techniques that negatively impact the Company with inconsistent ordering patterns. Finally, while over longer periods of time the relationship of returns to sales remains relatively constant, the timing of customer returns has been unpredictable and inconsistent in relation to the orders received from customers in a given time frame. The aftermarket continues to be fiercely competitive and price sensitive resulting in a dynamic customer base. These factors make revenue forecasting unpredictable, and could subject the Company to fluctuations in both revenue and earnings. Fluctuations in channel mix (retail versus traditional warehouse distributors, for example) and product mix in product sales can also be significant. All of these factors can have a significant impact on gross margins as a percentage of revenue. However, management believes that the streamlining of its manufacturing operations will position the Company competitively in the marketplace. During the month of January, 1997, the Company experienced unit sales 5% lower than those of the comparable period in fiscal 1996. However, it is uncertain at this time if the lower unit sales in the month of January will be indicative of the Company's performance for its third quarter. CAUTIONARY STATEMENT All statements in the foregoing discussion and analysis which are not historical fact are forward looking statements. In connection with the "Safe Harbor" provision of the Private Securities Litigation Reform Act of 1995, the Company is providing the following cautionary statement to identify some (but not necessarily all) of the important factors that could cause its actual results to differ materially from those anticipated in any forward looking statements made in this report or otherwise by or on behalf of the Company. Actual results of the Company may differ from those anticipated in any forward looking statement made by on behalf of the Company due to the following factors, among other risks and uncertainties affecting the Company's business: the inability to realize the cost savings as estimated in the Company's plan to restructure its operations, lack of availability to the Company of adequate funding sources and cash from operations, reduced product demand and industry over-capacity, the loss of or a material reduction in orders from the Company's largest customer or other material loss of business, new business acquisition costs, unseasonably mild weather patterns, the impact of inflation and various other factors identified in the discussion appearing under the heading "Outlook" above and elsewhere in this report. 5 ARROW AUTOMOTIVE INDUSTRIES, INC. PART II OTHER INFORMATION ITEM 1. Legal Proceedings. None. ITEM 2. Changes in Securities. None. ITEM 3. Default upon Senior Securities. None. ITEM 4. Submission of Matters to a Vote of Security Holders. None. ITEM 5. Other Information. None. ITEM 6. Exhibits and Reports on Form 8-K. A. Exhibits Exhibit 10.1 Amended and Restated Revolving Credit and Term Loan Agreement dated December 3, 1996 among Arrow Automotive Industries, Inc. and the First National Bank of Boston and BTM Capital Corporation. Pg 15 - 184 Exhibit 10.2 Waiver and First Amendment to Amended and Restated Revolving Credit and Term Loan Agreement dated December 28, 1996. Pg. 185-188 Exhibit 27 Financial Data Schedule 6 ARROW AUTOMOTIVE INDUSTRIES, INC. 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 thereunto duly authorized. ARROW AUTOMOTIVE INDUSTRIES, INC. (Registrant) February 7, 1997 /s/ Jim L. Osment Jim L. Osment President and Chief Executive Officer February 7, 1997 /s/ James F. Fagan James F. Fagan Executive Vice President, Treasurer and Chief Financial Officer 7