SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Mark one
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarterly period ended July 4, 1999 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 1-302
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ARVIN INDUSTRIES, INC.
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(Exact name of registrant as specified in its charter)
Indiana 35-0550190
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
One Noblitt Plaza, Box 3000
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Columbus, IN 47202-3000
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(Address of principal executive offices) (Zip Code)
812-379-3000
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(Registrant's telephone number including area code)
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 July 4, 1999, the Registrant had outstanding 25,827,617 Common Shares
(including employee stock benefit trust shares and excluding treasury shares),
$2.50 par value.
1
Table of Contents
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Part I. Financial Information Page No.
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Item 1. Financial Statements
Consolidated Statement of Operations for the Three Months and Six
Months Ended July 4, 1999 and June 28, 1998 3
Consolidated Statement of Financial Condition at July 4, 1999
and January 3, 1999 4
Consolidated Statement of Cash Flows for the Six Months Ended
July 4, 1999 and June 28, 1998 5
Condensed Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Part II. Other Information
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Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8K 17
2
Part I
Item 1: Financial Statements
Arvin Industries, Inc.
Consolidated Statement of Operations
(Dollars in millions, except per share amounts)
Unaudited
Three Months Ended Six Months Ended
------------------ ----------------
7/4/99 6/28/98 7/4/99 6/28/98
------ ------- ------ -------
Net Sales $ 839.3 $ 643.3 $ 1,577.7 $ 1,236.7
Costs and Expenses:
Cost of goods sold 711.2 538.7 1,352.8 1,051.2
Selling, operating general and administrative 59.0 46.9 112.4 91.2
Corporate general and administrative 6.0 6.2 14.3 10.5
Interest expense 13.7 9.2 24.2 17.9
Other expense, net 3.3 3.4 6.0 6.1
----- ----- ------- -------
793.2 604.4 1,509.7 1,176.9
----- ----- ------- -------
Earnings Before Income Taxes 46.1 38.9 68.0 59.8
Income taxes (16.8) (12.2) (23.6) (19.8)
Minority share of (income)/loss .5 (.6) .9 (.9)
Equity income of affiliates 2.6 1.6 5.5 2.1
----- ----- ------ ------
Earnings before Cumulative Effect of
Accounting Change 32.4 27.7 50.8 41.2
Cumulative effect of accounting change, net
of tax benefit of $.3 - - (.5) -
--------- ---------- --------- ---------
Net Earnings $ 32.4 $ 27.7 $ 50.3 $ 41.2
========= ========== ========= =========
Earnings Per Common Share
Basic:
Before cumulative effect of accounting change $ 1.34 $ 1.16 $ 2.10 $ 1.74
Cumulative effect of accounting change - - (.02) -
--------- ---------- --------- -------
Total Basic $ 1.34 $ 1.16 $ 2.08 $ 1.74
========= ========== ========= =========
Diluted:
Before cumulative effect of accounting change $ 1.32 $ 1.14 $ 2.07 $ 1.71
Cumulative effect of accounting change - - (.02) -
--------- ---------- --------- ---------
Total Diluted $ 1.32 $ 1.14 $ 2.05 $ 1.71
========= ========== ========= =========
Average Common Shares Outstanding (000's)
Basic 24,237 23,787 24,194 23,658
Diluted 24,536 24,217 24,500 24,099
Dividends Declared per Common Share $ .21 $ .20 $ .42 $ .40
<FN>
See notes to consolidated financial statements.
</FN>
3
Arvin Industries, Inc.
Consolidated Statement of Financial Condition
(Dollars in millions, except per share amounts)
Unaudited
As of As of
7/4/99 1/3/99
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Assets
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Current Assets:
Cash and cash equivalents $ 47.6 $ 107.0
Receivables, net of allowances of $14.7 and $8.1,
respectively 483.2 319.0
Inventories 208.4 151.3
Other current assets 120.3 103.7
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Total current Assets 859.5 681.0
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Non-Current Assets:
Property, plant and equipment:
Land, buildings, machinery & equipment 1,364.9 1,289.8
Less: Allowance for depreciation 712.0 704.0
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652.9 585.8
Goodwill, net of accumulated amortization of
$43.3 and $42.5, respectively 278.2 170.2
Investment in affiliates 156.8 148.2
Other assets 61.8 61.3
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Total non-current assets 1,149.7 965.5
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$ 2,009.2 $ 1,646.5
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Liabilities and Shareholders' Equity
- ------------------------------------
Current Liabilities:
Short-term debt $ 125.0 $ 10.1
Accounts payable 385.7 337.9
Employee-related costs 64.3 63.3
Accrued expenses 128.0 105.6
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Total current liabilities 703.0 516.9
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Long-term debt 454.5 307.7
Long-term employee benefits 82.4 70.4
Other long-term liabilities 62.0 41.6
Minority interest 55.6 57.1
Company-obligated mandatorily redeemable preferred
capital securities of subsidiary trust holding solely
subordinated debentures of the Company 89.1 89.1
Shareholders' Equity:
Common shares ($2.50 par value) 68.8 68.8
Capital in excess of par value 306.5 305.2
Retained earnings 374.6 334.3
Cumulative translation adjustment (87.9) (41.3)
Employee stock benefit trust (60.8) (64.7)
Common shares held in treasury (at cost) (38.6) (38.6)
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Total shareholders' equity 562.6 563.7
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$ 2,009.2 $ 1,646.5
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<FN>
See notes to consolidated financial statements.
</FN>
4
Arvin Industries, Inc.
Consolidated Statement of Cash Flows
(Dollars in millions)
Unaudited
Six Months Ended
----------------
7/4/99 6/28/98 (1)
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Operating Activities:
Net earnings $ 50.3 $ 41.2
Adjustments to reconcile net earnings to
net cash (used for)/provided by operating activities:
Depreciation 53.5 42.3
Amortization 4.1 3.0
Minority interest (.9) .9
Gain on sale of investment (7.3) (5.5)
Change in deferred income tax benefit, net (.8) .5
Other 8.1 8.9
Changes in operating assets and liabilities:
Receivables (120.1) (94.2)
Inventories and other current assets (30.2) (16.3)
Accounts payable and other accrued expenses 32.0 36.4
Income taxes payable 8.5 (2.2)
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Net Cash (Used for)/Provided by Operating Activities (2.8) 15.0
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Investing Activities:
Purchase of property, plant and equipment (49.0) (44.3)
Proceeds from sale of property, plant and equipment 1.0 3.2
Proceeds from sale of investment 12.4 9.6
Investments in affiliates (2.1) (3.2)
Business acquisitions, net of cash acquired (267.0) (8.7)
Other 1.3 .6
--- ---
Net Cash Used for Investing Activities (303.4) (42.8)
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Financing Activities:
Change in short-term debt, net 105.2 10.2
Proceeds from long-term financings 156.2 99.0
Principal payments on long-term financings (4.0) (46.2)
Dividends paid (10.2) (9.4)
Exercise of stock options 2.1 7.6
Other (.7) (3.8)
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Net Cash Provided by Financing Activities 248.6 57.4
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Cash and Cash Equivalents:
Effect of exchange rate changes on cash (1.8) (1.3)
---- ----
Net (decrease)/increase (59.4) 28.3
Beginning of the year 107.0 108.9
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End of the period $ 47.6 $ 137.2
========= =========
<FN>
(1) Certain amounts have been reclassified to conform with current year
presentation.
See notes to consolidated financial statements.
</FN>
5
ARVIN INDUSTRIES, INC.
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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------
Note 1. The accompanying unaudited consolidated 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 and should be read in conjunction with the financial
statements and notes thereto appearing in the Company's annual report on Form
10-K for the year ended January 3, 1999.
In the opinion of management, all adjustments considered necessary for a fair
presentation of the results of operations for the periods reported have been
included and all such adjustments are of a normal recurring nature.
The results of operations for the three and six months ended July 4, 1999 are
not necessarily indicative of the results to be expected for the full year
ending January 2, 2000.
Note 2. Basic earnings per share are based on the weighted-average number of
common shares outstanding during the period. Diluted earnings per share are
based on the weighted- average number of common and common equivalent shares
(principally stock option related) outstanding during the period.
The following illustrates the reconciliation of the numerators and denominators
of the basic and diluted EPS computations for net earnings (shares in 000's):
Second Quarter Six Months
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1999 1998 1999 1998
------------ ------------ ------------ ------------
Denominator for basic earnings
per share - weighted-average shares 24,237 23,787 24,194 23,658
Effect of dilutive securities 299 430 306 441
------------ ------------ ------------ ------------
Denominator for diluted earnings
per share - adjusted for weighted-average
shares and assumed conversions 24,536 24,217 24,500 24,099
============ ============ ============ ============
Note 3. The Company and its consolidated subsidiaries are defending various
environmental claims and legal actions that arise in the normal course of
business or from previously owned businesses. Where reasonable estimates of
environmental liabilities are possible, Arvin has provided for the undiscounted
costs of study, cleanup, remediation, and certain other costs, taking into
account, as applicable, available information regarding site conditions,
potential cleanup methods and the extent to which other parties can be expected
to bear those costs. Management regularly reviews pending environmental and
legal proceedings with its legal counsel and adjusts its accruals to reflect the
current best estimate of its exposure. Where no best estimate is determinable,
the Company has accrued for the minimum amount of the most probable range of its
liability. Given the inherent uncertainties in evaluating legal and
environmental exposures, actual costs to be incurred in future periods may vary
from the currently recorded estimates. Arvin expects that any sum it may be
required to pay in connection with legal and environmental matters in excess of
the amounts recorded will not have a material adverse effect on its results of
operations, cash flows or financial condition.
6
Note 4. On January 29, 1999 Arvin acquired certain operating assets and assumed
certain liabilities from WorldSource Coil Coating, Inc., a coil coating facility
in Hawesville, Kentucky. Coil coating is the pre-painting of metals to be
fabricated in the construction, home appliance, and automotive industries. The
purchase price, subject to adjustment, was $1.6 million. Additional
consideration, up to $5.0 million over a three-year period, is contingent upon
future sales volume. This acquisition was accounted for under the purchase
method and the results of the acquired operations are included in the
consolidated financial statements as of the date of acquisition.
On February 26, 1999 Arvin acquired the Purolator Products automotive
filter business (Purolator) from Mark IV Industries, Inc. for approximately $272
million, subject to further adjustment. This transaction included the assumption
of $6 million in debt. Included in the Statement of Financial Condition are
estimated purchase liabilities of $9.7 million associated with a plan to exit
certain activities of Purolator including severance and related costs, and costs
associated with the consolidation of certain acquired facilities. The Company
expects to complete its plan by February 2000. The acquisition was accounted for
under the purchase method and, accordingly, results of Purolator's operations
are included in the consolidated financial statements as of the date of
acquisition. The purchase price has been preliminarily allocated based upon
estimated fair values at the date of acquisition, pending final determination by
an independent appraisal. Goodwill resulting from this transaction is being
amortized using the straight-line method over a 40-year period.
The following unaudited pro forma information presents a summary of the
Company's consolidated results of operations as if the acquisitions of
WorldSource and Purolator had taken place on December 29, 1997:
(Dollars in millions, except per share amounts) Six months ended
------------------------------
7/4/99 6/28/98
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Net sales $ 1,636.0 $ 1,445.7
Net earnings before cumulative effect of
accounting change 51.7 42.2
Net earnings 51.2 42.2
Per share data:
Basic:
Before cumulative effect of accounting change$ 2.14 $ 1.78
Cumulative effect of accounting change (.02) -
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Total $ 2.12 $ 1.78
====== =======
Diluted:
Before cumulative effect of accounting change$ 2.11 $ 1.75
Cumulative effect of accounting change (.02) -
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Total $ 2.09 $ 1.75
====== =======
These unaudited pro form results have been prepared for comparative
purposes only and include certain adjustments, such as additional amortization
expense as a result of goodwill, increased interest expense on acquisition debt,
and certain other minor adjustments. They do not purport to be indicative of the
results of operations which would have actually resulted had the acquisitions
been in effect on December 29, 1997, or of future results of operations.
7
Note 5. On March 12, 1999 Arvin issued $150 million of 7 1/8 percent notes,
maturing on March 15, 2009. Proceeds from this issue were used to repay a
portion of short-term debt incurred in connection with Arvin's acquisition of
Purolator.
During the first quarter of 1999, Arvin also obtained a $125 million
committed bank facility to provide liquidity needed to finance the Purolator
acquisition. As of July 4, 1999, $100 million was being borrowed from this
facility. Furthermore, Arvin entered into an interest-rate swap during the first
quarter of 1999 in which Arvin receives a fixed rate of interest and pays a
LIBOR-based floating rate. The swap has a notional value of $50 million and
matures on March 15, 2004.
Note 6. Other expense, net for the first six months of 1999 includes a pre-tax
gain of $7.3 million relating to the sale of the Company's entire 40 percent
equity investment in a Latin American shock absorber affiliate. The effective
tax rate for the gain was 26.2 percent, which reflects the utilization of an
available capital loss carryforward of $6.8 million.
Other expense, net for the first six months of 1999 also includes a
non-recurring charge, before tax benefits, of $7.1 million in connection with a
voluntary early retirement program for certain North American employees. The
terms of the program allowed the employees to elect, prior to March 30, 1999, to
retire during 1999 and to receive medical coverage and pension benefits without
the normal reduction for early retirement. The charge, net of tax benefits, was
equal to $4.3 million.
Note 7. Arvin adopted the provisions of Statement of Position 98-5, "Reporting
on the Costs of Start-Up Activities," as of January 4, 1999. This statement
requires costs of start-up activities to be expensed as incurred. The statement
further requires that capitalized costs related to start-up activities be
expensed as a cumulative effect of a change in accounting principle when the
statement is adopted. Accordingly, the Company wrote off $.5 million, net of
taxes, of previously capitalized costs related to start-up activities and
reported this expense as a cumulative effect of a change in accounting principle
for the first quarter of 1999.
Note 8. Comprehensive income for the three and six months ended July 4, 1999 of
$21.1 and $3.7 million and for the three and six months ended June 28, 1998 of
$25.6 and $34.8 million, respectively, includes reported net income adjusted by
the non-cash effect of changes in the cumulative translation adjustment.
8
Note 9. The reconciliation of segment profit to the Company's consolidated
earnings before income taxes is as follows:
Segment Information For the Three For the Six
(Dollars in millions) Months Ended Months Ended
------------------------------ ------------------------------
7/4/99 6/28/98 7/4/99 6/28/98
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Net Sales:
Automotive Original Equipment $ 515.3 $ 426.2 $ 1,011.0 $ 833.2
Automotive Replacement 273.2 188.6 476.0 348.8
Other 50.8 28.5 90.7 54.7
------------- ------------- ------------- -------------
Net sales $ 839.3 $ 643.3 $ 1,577.7 $ 1,236.7
============= ============= ============= =============
Operating Income:
Automotive Original Equipment $ 36.3 $ 26.0 $ 66.3 $ 48.2
Automotive Replacement 28.8 23.4 42.8 36.9
Other 5.6 1.7 7.5 (0.6)
------------- ------------- ------------- -------------
Operating income 70.7 51.1 116.6 84.5
Less: Equity income of affiliates (2.6) (1.6) (5.5) (2.1)
Interest expense (13.7) (9.2) (24.2) (17.9)
Corporate general and administrative (6.0) (6.2) (14.3) (10.5)
Gain on investment - 5.5 - 5.5
Other non-operating income/(expense) (2.3) (0.7) (4.6) 0.3
------------- ------------- ------------- -------------
Earnings before income taxes $ 46.1 $ 38.9 $ 68.0 $ 59.8
============= ============= ============= =============
Note 10. In June 1999, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 137, "Accounting for Derivatives
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133--an Amendment of FASB Statement No. 133." Statement No. 137
defers the effective date of Statement No. 133 by one year to fiscal years
beginning after June 15, 2000. Accordingly, the Company plans to adopt Statement
No. 133 at the beginning of fiscal year 2001. Implementation of this statement
is not expected to have a material impact on the Company's results of
operations.
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- -------------------------------------------------------------------------------
of Operations
- -------------
Financial Review
(Dollars in millions, except per share amounts)
Overview
Record sales of $839.3 million and record earnings of $32.4 million were
reported for the second quarter of 1999. Sales for the six months ended July 4,
1999 of $1,577.7 million improved $341.0 million over a strong comparable 1998
period. Top line growth was achieved as a result of both recent acquisitions and
strength in the original equipment market. Year-to-date earnings before
cumulative effect of accounting change increased by 23 percent to $50.8 million,
or $2.07 per diluted share, compared to earnings of $41.2 million, or $1.71 per
diluted share for the first six months of 1998.
Two significant non-recurring items were recorded during the first six months of
1999. First, an after-tax gain of $5.4 million on the sale of an investment in a
Latin American shock absorber affiliate increased diluted earnings per share by
$.22. An after-tax charge of $4.3 million for a voluntary early retirement
program for certain North American employees reduced diluted earnings per share
by $.18. Two significant non-recurring items were also recorded during the first
six months of 1998. First, an after-tax gain of $5.5 million on the early
redemption of preferred stock increased diluted earnings per share by $.23. An
after-tax charge of $4.5 million for realignment of OE exhaust operations
reduced diluted earnings per share by $.19. Excluding the impact of these
non-recurring items, year-to-date 1999 earnings before cumulative effect of
accounting change increased by 24 percent to $49.7 million, or $2.03 per diluted
share, compared to year-to-date 1998 earnings of $40.2 million, or $1.67 per
diluted share.
Results of Operations
Second Quarter First Six Months
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
Net Sales:
Automotive Original Equipment $ 515.3 $ 426.2 $ 1,011.0 $ 833.2
Automotive Replacement 273.2 188.6 476.0 348.8
Other 50.8 28.5 90.7 54.7
------------ ------------ ------------ ------------
Net sales $ 839.3 $ 643.3 $ 1,577.7 $ 1,236.7
============ ============ ============ ============
Operating Income: *
Automotive Original Equipment $ 36.3 $ 26.0 $ 66.3 $ 48.2
Automotive Replacement 28.8 23.4 42.8 36.9
Other 5.6 1.7 7.5 (0.6)
------------ ------------ ------------ ------------
Operating income $ 70.7 $ 51.1 $ 116.6 $ 84.5
============ ============ ============ ============
<FN>
* Operating income reflects: (1) income from consolidated operations prior to
Corporate expenses, interest, and other non-operational items, and (2) Arvin's
share of net income from unconsolidated subsidiaries.
</FN>
10
Automotive Original Equipment (OE): Net sales in the OE segment of $515.3
million for the second quarter of 1999 increased by $89.1 million or 21 percent
over strong sales in the second quarter of 1998. The net effect of entities
consolidated over an entity divested added $8.3 million to revenues. An increase
in OE exhaust pass-through sales contributed $43.9 million to sales. A strong
U.S. dollar had a negative effect on the translation of the quarter's OE sales.
On a constant dollar basis, OE sales grew 23 percent. Selective price
concessions, which averaged one percent of sales, were more than offset by
volume gains (excluding pass-through sales) and a favorable product mix of $41.6
and $8.8 million, respectively.
OE sales for the six-month period increased by $177.8 million, or 21 percent
over sales for the first six months of 1998. Sales increased by $14.7 million
due to the net effect of acquisitions offset by a divestiture. An increase in OE
exhaust pass-through sales contributed $90.2 million to revenues. Net sales were
boosted by favorable market conditions in North America and Western Europe.
Vehicle production in the U.S. and Canada increased by 13 percent, and new car
registrations in Western Europe improved by 8 percent as compared to the first
six months of 1998. Selective price concessions averaged nearly one percent of
OE sales. Volume gains (excluding pass-through sales) and a favorable product
mix contributed $72.1 and $13.9 million, respectively.
Comparison of the effect of changes in volume from period to period is subject
to a number of limitations, principally centered around what constitutes a unit
for volume measurement. The appropriate measure of a unit varies over time as
products develop, varies among the different countries in which the Company
operates, and varies within each operating unit of the Company. As a result,
there is a degree of imprecision and subjectivity in estimating the impact of
volume changes.
OE operating income for the second quarter of 1998 included a $6.6 million
charge for the realignment of OE exhaust operations. Excluding the impact of
this non-recurring item, OE operating profit of $36.3 million for the second
quarter of 1999 increased by 11 percent as compared to the second quarter of
1998. The benefit of volume gains and a favorable product mix exceeded the
impact of selective price concessions by $12.1 million. Negotiated raw material
price decreases contributed $3.5 million to operating profit. The net effect of
acquisitions and dispositions reduced operating profit by $2.5 million, while
equity in unconsolidated subsidiary income increased operating profit by $.8
million. OE operating income was adversely affected by labor inflation of $4.4
million and productivity declines of $6.1 million. Major reasons for the
productivity declines include the delayed launch of a key customer
platform in Europe, and a downturn in European demand for certain customer
models.
OE operating income for the first six months of 1999 included two significant
non-recurring items: 1) a $7.3 million gain on the sale of the Company's equity
investment in a Latin American shock absorber affiliate, and 2) a $3.2 million
charge for a voluntary early retirement program for certain North American
employees. Excluding the effect of these non-recurring items and also the
non-recurring item reported during the first six months of 1998 (as mentioned in
the preceding paragraph), year-to-date OE operating profit increased by 14
percent over the comparable period in 1998. Volume gains and a favorable product
mix outpaced the effect of selective price concessions by $17.6 million.
Negotiated raw material price decreases and reduced warranty costs contributed
$7.0 and $1.5 million, respectively, to operating profit. The net impact of
acquisitions and dispositions reduced operating profit by $6.9 million, while
equity in unconsolidated subsidiary income increased operating profit by $3.0
million. OE operating income was adversely affected by labor inflation of $7.7
million and productivity declines of $6.8 million, the major reasons for which
were previously discussed.
11
OE operating margins, adjusted for previously discussed non-recurring
items, were 7.0 and 6.2 percent for the second quarter and first six months
of 1999, respectively, and were 7.6 and 6.6 percent for the second quarter and
first six months of 1998, respectively. These operating margins were adversely
affected by the increase of OE exhaust pass-through sales, which typically have
very low margins. Excluding non-recurring items and the negative impact of
increased pass-through sales, OE operating margins for the second quarter and
first six months of 1999 were 8.2 and 7.2 percent, respectively, and were 8.3
and 7.1 percent for the second quarter and the first six months of 1998,
respectively.
Automotive Replacement (Replacement): Replacement sales in the second quarter of
1999 of $273.2 million increased by $84.6 million or 45 percent compared to net
sales in the second quarter of 1998. The acquisition of Purolator Products
(Purolator) and a favorable product mix contributed $86.7 and $7.8 million,
respectively. Price increases, averaging one percent of sales, were more than
offset by volume reductions of $9.9 million in the North American exhaust
market. The trend of lower volumes continues for the Replacement segment due to
improved original equipment exhaust systems and the evolution of light vehicle
designs. Despite overall softness in the replacement market, Arvin believes that
it continues to gain market share.
Replacement sales for the first six months of 1999 increased by $127.2 million,
or 36 percent over sales for the first six months of 1998. The acquisition of
Purolator on February 26, 1999 accounted for 95 percent of this increase. In
addition, price increases, averaging one percent of sales, and a favorable
product mix of $18.0 million exceeded volume reductions of $12.9 million and the
negative effect of the strong U.S. dollar on the translation of earnings, which
equated to $4.0 million.
Operating units in the Replacement segment sell their product through a variety
of different customer channels including merchandisers, installers, and
wholesale distributors. As a result of period to period variations in this
channel mix, in addition to normal variations in product mix, the average price
of units sold may not correspond to price changes. As in the OE segment, there
is also a degree of imprecision and subjectivity in estimating the impact of
period to period volume changes, principally because of questions as to what
constitutes a unit for volume measurement. The appropriate measure of a unit
varies over time as products develop, varies among the different countries in
which the Company operates, and varies within each operating unit of the
Company.
Operating income in the second quarter of 1999 for the Replacement segment
increased by $5.4 million or 23 percent compared to the second quarter of 1998.
This increase was mainly attributable to the acquisition of Purolator. Other
variances included price increases and a favorable product mix totaling $7.8
million, which were offset by volume reductions of $10.1 million. Productivity
improvements and negotiated raw material price decreases contributed a total of
$6.0 million, while labor inflation and costs to obtain new business reduced
operating profit by a total of $3.7 million.
Replacement operating income for the first six months of 1999 included a $3.2
million non-recurring charge for a voluntary early retirement program for
certain North American employees. Excluding the effect of this program,
operating income for the Replacement segment increased by $9.1 million or 25
percent. The acquisition of Purolator accounted for almost 90 percent of the
increase in operating profit. Price increases and a favorable product mix
totaling $17.6 million offset volume reductions of $17.3 million. Productivity
improvements and negotiated raw material price decreases contributed a total of
$8.6 million, while labor inflation and costs to obtain new business reduced
operating profit by a total of $7.9 million.
12
Other: Other sales in the second quarter and for the first six months of 1999
increased by 78 and 66 percent, respectively, as compared to the respective
periods in 1998. The acquisition of WorldSource accounted for approximately 55
percent of the increase in both periods, and other incremental volume made up
the rest of the gain.
Other operating profit in the second quarter of 1999 increased by $3.9 million
compared to the second quarter of 1998. Total volume gains, including the
acquisition of WorldSource, contributed $4.4 million, which was partially offset
by minor variances for selective price concessions, an unfavorable product mix,
and labor inflation totaling $.6 million.
Excluding non-recurring items recorded during the first six months of 1999 (a
$.4 million charge for a voluntary early retirement program) and during the
first six months of 1998 (a $3.5 million increase in reserves for legal and
environmental issues), Other operating income increased by $5.0 million. Total
volume gains, including the acquisition of WorldSource, contributed $7.0
million. Minor variances for selective price concessions, unfavorable product
mix, and increased labor costs accounted for the remainder of the change.
Corporate General and Administrative expenses as a percent of sales were
relatively flat for both the quarter-to-quarter and year-to-date comparisons.
Year-to-date expenses were $3.8 million higher due to increases in compensation,
professional services, and other general expenses.
Interest Expense increased by 49 and 35 percent in the second quarter and first
six months of 1999, respectively, when compared to the same periods in 1998. The
increases were a result of additional interest-bearing obligations issued during
1999 in connection with the acquisition of Purolator (see Note 5 to the
Consolidated Financial Statements).
Equity income of affiliates increased by $1.0 and $3.4 million in the second
quarter and during the first six months of 1999 compared to the same periods in
1998. The increase is primarily attributable to gains from the Company's Latin
American shock absorber affiliate, higher earnings reported for the Company's
U.S. OE exhaust affiliate and European OE ride control affiliate, and equity
income for two new affiliates acquired through the purchase of Purolator.
Other expense, net was essentially flat for both the quarter-to-quarter and
year-to-date comparisons. Other expense for the first six months of 1999
includes two offsetting non-recurring items as follows: 1) a pre-tax gain of
$7.3 million for the sale of an investment in a Latin American shock absorber
affiliate, and 2) a pre-tax charge of $7.1 million for a voluntary early
retirement program for certain North American employees. For both the second
quarter and the first six months of 1998, other expense includes the $6.6
million charge for realignment expenses discussed above in the OE operating
profit section, and a gain of $5.5 million relating to the early redemption of
preferred stock received in conjunction with the Company's 1995 sale of its
Schrader Automotive unit. The year-to-date comparison is also affected by a $3.5
million increase in legal and environmental reserves that was reported during
the first six months of 1998. In contrast, interest income was $1.2 and $2.2
million lower in the second quarter and during the first six months of 1999 as
compared to the same periods in 1998. Finally, foreign exchange transactions
resulted in a loss of $1.0 million during the first six months of 1999 as
compared to a gain of $1.0 million during the first six months of 1998.
Income Taxes: The effective tax rates for the second quarter and year-to-date
1999 periods were 36.4 and 34.7 percent, respectively. The effective tax rates
for the second quarter and year-to-date 1998 periods were 31.4 and 33.1 percent,
respectively. The lower rates for both 1998 periods reflect the impact of the
$5.5 million gain on the early redemption of the Company's investment in
preferred stock on which no tax expense was recorded. The year-to-date 1999 rate
reflects the utilization of an available capital loss carryforward.
13
Financial Condition
Liquidity: Working capital decreased by $7.6 million during the first six months
of 1999, which caused the current ratio to drop from 1.3 at the end of fiscal
year 1998 to 1.2 as of July 4, 1999. Current liabilities increased at a higher
rate than current assets due to the issuance of short-term debt to acquire
Purolator (see Notes 4 and 5 to the Consolidated Financial Statements).
Key elements of the Consolidated Statement of Cash Flows for the first six
months of 1999 and 1998 were as follows:
1999 1998
---- ----
Net Cash (Used for)/Provided by Operating Activities (2.8) 15.0
Net Cash Used for Investing Activities (303.4) (42.8)
Net Cash Provided by Financing Activities 248.6 57.4
Investing cash flows include $49.0 and $44.3 million for the purchase of
property, plant and equipment for the first six months of 1999 and 1998,
respectively. The Company expects increased levels of capital expenditures in
1999 to support new business requirements and process improvements. Investing
cash flows for the first six months of 1999 include proceeds of $12.4 million
from the sale of the Company's investment in a Latin American shock absorber
affiliate (see Note 6 to the Consolidated Financial Statements). Investing cash
flows also include $267.0 million paid for the purchase of Purolator, net of
cash acquired (see Note 4 to the Consolidated Financial Statements).
Year-to-date 1998 investing cash flows include proceeds of $9.6 million for the
redemption of the Company's investment in preferred stock received in connection
with the 1995 sale of Schrader. The Company also purchased the remaining shares
of Autocomponents and Arvin Suspension Systems during the first six months of
1998, resulting in a cash outflow of $8.7 million.
Financing cash flows for the first six months of 1999 include changes in the
Company's debt structure, which are more fully described in Note 5 to the
Consolidated Financial Statements. The proceeds from long-term financings
reflect the issuance of $150.0 million 7 1/8 percent notes due in 2009, which
were used to re-pay a portion of the short-term debt incurred with the
acquisition of Purolator. Furthermore, the change in short-term debt includes
borrowing on a bank facility arrangement established in February 1999 related to
the acquisition of Purolator. As of July 4, 1999, $100.0 million was being
borrowed from this facility. Financing cash flows for the first six months of
1998 include $99.0 million proceeds from 6.75 percent notes due in 2008, $46.0
million of which was used for debt retirement. Finally, financing cash flows
include Arvin's quarterly dividend to shareholders, which was increased five
percent during 1998 from 20 cents to 21 cents.
Capital Resources: Based on the Company's projected cash flow from operations
and existing investments and financing credit facility arrangements, management
believes that sufficient liquidity is available to meet anticipated operating,
capital, and dividend requirements over the next 12 months.
Interest Rate Risk Management: Arvin relies significantly on long-term
fixed-rate debt in its capital structure. An increase in short-term bank
borrowings and the addition of $50 million of interest rate swaps during the
first six months of 1999, however, have lessened that reliance somewhat (see
Note 5 to the Consolidated Financial Statements for further details on the
increase in debt). Under Arvin's current capital structure, if interest rates
rise immediately by a 10 percent increment across the entire yield curve,
Arvin's interest expense will increase, and thus pre-tax earnings will decrease,
by approximately $1.1 million over a one-year period.
14
Hedging: The Company uses derivative financial instruments from time to time to
hedge certain financial and operating transactions denominated in currencies
other than functional currencies. The Company believes that adequate controls
are in place to monitor these activities, which are not financially material. In
June 1998, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" and then in June 1999, the FASB issued SFAS
No. 137, "Accounting for Derivatives Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133--an
Amendment of FASB Statement No. 133." SFAS No. 137 defers the effective date of
SFAS No. 133 by one year to fiscal years beginning after June 15, 2000.
Accordingly, the Company plans to adopt SFAS No. 133 at the beginning of fiscal
year 2001. This statement is not expected to have a material impact on the
Company's results of operations.
Year 2000: During 1997, Arvin named a task force and began actively working with
customers, suppliers, and employees on Arvin's plan to address both information
technology (IT) and non-IT related Year 2000 issues. Non-IT systems include, but
are not limited to, those systems that are not commonly thought of as IT
systems, such as manufacturing equipment, building access, telephone systems and
other miscellaneous systems. Except for one location where new systems are being
implemented, the Company had essentially completed the remediation, testing and
implementation phase of the Year 2000 project at the end of 1998 for both IT and
non-IT systems. (The implementation of the new systems noted above is planned
for the end of the third quarter.) These phases represent 90 percent of Arvin's
Year 2000 project and involved taking an inventory of all potentially affected
systems, identifying potential Year 2000 issues, fixing or replacing such
problems, and testing and implementing the changes made. The final 10 percent of
the Year 2000 project, auditing, is scheduled for completion before the end of
the third quarter of 1999. This phase consists of Arvin conducting internal
audit reviews, performing comprehensive tests of the IT systems in a Year 2000
simulated environment, reviewing the results of such testing, and putting in
place any necessary contingency plans.
The Company has developed a Year 2000 process for dealing with its key
suppliers. The process generally involves the following steps: (1) an initial
supplier survey, (2) risk assessment, and (3) auditing critical suppliers. The
first two steps are essentially complete and the audits are expected to be
completed before the end of the third quarter of 1999. Contingency plans for
non-compliant suppliers will be developed as the audits are completed. These
activities provide a means of managing risk, but cannot eliminate the potential
for disruption due to third party failure. The Company continues to work with
key suppliers and major customers on ensuring that its electronic exchanges of
data will continue to work.
The Company believes it has an effective program in place to address possible
Year 2000 problems in a timely manner. At this time, the Company believes its
"reasonably likely worst case scenario" would be the failure of its third party
business partners to address Year 2000 issues. Current contingency plan focus is
on thorough testing, alternate supplier sources, manual backup for critical
processes, and build-up of safety stock in limited cases.
Expenses of the Year 2000 project are expensed as incurred. To date,
approximately three million dollars has been expensed for this project. The
Company expects that an additional one million dollars will be expensed during
the remainder of 1999 to complete this project. Capital expenditures are
generally replacing fully depreciated assets and have not had a material effect
on the Company's results of operations, cash flows, or financial condition and
are not expected to in the future.
15
Legal/Environmental Matters: The Company and its consolidated subsidiaries are
defending various environmental claims and legal actions that arise in the
normal course of business or from previously owned businesses. Where reasonable
estimates of environmental liabilities are possible, Arvin has provided for the
undiscounted costs of study, cleanup, remediation, and certain other costs,
taking into account, as applicable, available information regarding site
conditions, potential cleanup methods and the extent to which other parties can
be expected to bear those costs. Management regularly reviews pending
environmental and legal proceedings with its legal counsel and adjusts its
accruals to reflect the current best estimate of its exposure. Where no best
estimate is determinable, the Company has accrued for the minimum amount of the
most probable range of its liability. Given the inherent uncertainties in
evaluating legal and environmental exposures, actual costs to be incurred in
future periods may vary from the currently recorded estimates. Arvin expects
that any sum it may be required to pay in connection with legal and
environmental matters in excess of the amounts recorded will not have a material
adverse effect on its results of operations, cash flows or financial condition.
Certain information and statements included or implied are forward looking and
involve certain risks and uncertainties that could cause actual results to
differ materially from those expressed or implied by these statements. These
forward-looking statements are identified by their use of terms and phrases such
as "expected," "expect," "should," "plans," "estimated earnings," "anticipate,"
"believe," and "intend." Information about potential factors identified by the
Company, which would affect the actual financial results, are included in the
Company's Form 10-K for the year ended January 3, 1999.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- ------------------------------------------------------------------
See "Interest Rate Risk Management" under the Financial Condition section of
Item 2.
16
Part II
Item 4. Submission of Matters to a Vote of Security Holders
- -----------------------------------------------------------
Arvin held its Annual Meeting of Shareholders on April 15, 1999 at which
security holders elected four directors nominated for three-year terms expiring
in 2002 and ratified the Board of Directors' appointment of
PricewaterhouseCoopers LLP as Arvin's independent certified public accountants
for the current year.
The results of the voting in connection with the above items were as follows:
Voting on Directors For Withheld
- ------------------- ---------- --------
Robert E. Fowler 22,560,649 404,550
William D. George, Jr. 22,570,223 394,976
Arthur R. Velasquez 22,573,119 392,080
Carolyn Y. Woo 22,547,343 417,856
Broker
For Against Abstain Non-Vote
----------- ------- ------- --------
Ratify appointment of
PricewaterhouseCoopers LLP as
auditors
22,850,003 60,353 54,843 0
Item 5. Other Information
- -------------------------
Effective July 12, 1999 National City Bank succeeded Harris Trust and Savings
Bank as the Transfer Agent for the Company's common shares and as the Rights
Agent under the Rights Agreement dated as of May 29, 1986, as amended.
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
a. Exhibits
- -- --------
27 Financial Data Schedule filed herewith as Exhibit 27
b. Reports Filed on Form 8-K
- -- -------------------------
Amendment #1 to Form 8-K dated May 12, 1999
- -------------------------------------------
Item 7 reported
- ---------------
On February 26, 1999 the Registrant acquired the Purolator Products automotive
filter business from Mark IV Industries, Inc.
In connection with the Registrant's acquisition of Purolator, the Registrant
filed financial statements and combined pro forma financial information as an
amendment to Form 8-K Current Report dated March 12, 1999.
Amendment #2 to Form 8-K dated June 22, 1999
- --------------------------------------------
Item 7 reported
- ---------------
In connection with the Registrant's acquisition of Purolator, the Registrant
filed combined pro forma financial information for the quarter ended April 4,
1999 as a second amendment to Form 8-K Current Report dated March 12, 1999.
17
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused the report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Arvin Industries, Inc.
-----------------------------------------
Richard A. Smith
Vice President-Finance & Chief
Financial Officer
-----------------------------------------
William M. Lowe, Jr.
Vice President - Financial Operations
(Chief Accounting Officer)
Date: July 27, 1999
18