UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended October 3, 1999 Commission File Number 1-6560 THE FAIRCHILD CORPORATION (Exact name of Registrant as specified in its charter) Delaware 34-0728587 (State or other jurisdiction of (I.R.S. Employer Identification No.) Incorporation or organization) 45025 Aviation Drive, Suite 400 Dulles, VA 20166 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (703) 478-5800 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 threety (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. Outstanding at Title of Class October 3, 1999 Class A Common Stock, $0.10 Par Value 22,198,516 Class B Common Stock, $0.10 Par Value 2,621,652 THE FAIRCHILD CORPORATION AND CONSOLIDATED SUBSIDIARIES INDEX Page PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Balance Sheets as of October 3, 1999 (Unaudited) and June 30, 1999 3 Consolidated Statements of Earnings (Unaudited) for the Three Months ended October 3, 1999 and September 27, 1998 5 Condensed Consolidated Statements of Cash Flows (Unaudited) for the Three Months ended October 3, 1999 and September 27, 1998 6 Notes to Condensed Consolidated Financial Statements (Unaudited) 7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 18 Item 3. Quantitative and Qualitative Disclosure About Market Risk 28 PART II. OTHER INFORMATION Item 1. Legal Proceedings 29 Item 5. Other Information 29 Item 6. Exhibits and Reports on Form 8-K 29 All references in this Quarterly Report on Form 10-Q to the terms ''we,'' ''our,'' ''us,'' the ''Company'' and ''Fairchild'' refer to The Fairchild Corporation and its subsidiaries. All references to ''fiscal'' in connection with a year shall mean the 12 months ended June 30. PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS THE FAIRCHILD CORPORATION AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS October 3, 1999 (Unaudited) and June 30, 1999 (In thousands) ASSETS October 3, June 30, 1999 1999 (*) CURRENT ASSETS: Cash and cash equivalents, $13,982 and $15,752 restricted $ 53,190 $ 54,860 Short-term investments 6,489 13,094 Accounts receivable-trade, less allowances 123,527 130,121 of $4,334 and $6,442 Inventories: Finished goods 159,935 137,807 Work-in-process 33,698 38,316 Raw materials 10,699 14,116 204,332 190,239 Prepaid expenses and other current assets 74,373 73,926 Total Current Assets 461,911 462,240 Property, plant and equipment, net of accumulated depreciation of $113,030 and $103,556 186,840 184,065 Net assets held for sale 19,899 21,245 Cost in excess of net assets acquired (Goodwill), less accumulated amortization of $43,073 and 433,310 447,722 $40,307 Investments and advances, affiliated 16,572 31,791 companies Prepaid pension assets 64,113 63,958 Deferred loan costs 14,181 13,077 Real estate investment 89,240 83,791 Long-term investments 16,220 15,844 Other assets 5,081 5,053 TOTAL ASSETS $1,307,367$1,328,786 *Condensed from audited financial statements. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. THE FAIRCHILD CORPORATION AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS October 3, 1999 (Unaudited) and June 30, 1999 (In thousands) LIABILITIES AND STOCKHOLDERS' EQUITY October 3, June 30, 1999 1999 CURRENT LIABILITIES: (*) Bank notes payable and current maturities of long-term debt $ 28,192 $ 28,860 Accounts payable 43,096 72,271 Accrued liabilities: Salaries, wages and commissions 45,287 43,095 Employee benefit plan costs 6,448 5,204 Insurance 10,455 14,216 Interest 13,173 7,637 Other accrued liabilities 53,962 50,984 129,325 121,136 Net current liabilites of discontinued operations 12,585 10,999 Total Current Liabilities 213,198 233,266 LONG-TERM LIABILITES: Long-term debt, less current maturities 480,971 495,283 Other long-term liabilities 27,769 25,963 Retiree health care liabilities 45,289 44,813 Noncurrent income taxes 121,107 121,961 TOTAL LIABILITIES 888,334 921,286 STOCKHOLDERS' EQUITY: Class A common stock, $0.10 par value; authorized 40,000 shares, 29,820 (29,754 in June) shares issued and 22,198 (22,259 in June) shares 2,982 2,975 outstanding Class B common stock, $0.10 par value; authorized 20,000 shares, 2,622 shares issued and 262 262 outstanding Paid-in capital 229,732 229,038 Retained earnings 270,140 252,030 Cumulative other comprehensive income (9,357) (2,703) Treasury stock, at cost, 7,622 (7,496 in (74,726) (74,102) June) shares of Class A common stock TOTAL STOCKHOLDERS' EQUITY 419,033 407,500 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,307,367 $1,328,786 *Condensed from audited financial statements The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. THE FAIRCHILD CORPORATION AND CONSOLIDATED SUBSIDIARIES CONDENSED STATEMENTS OF EARNINGS (Unaudited) For The Three (3) Months Ended October 3, 1999 and September 27, 1998 (In thousands, except per share data) For the Three Months Ended 10/03/99 9/27/98 REVENUE: Net sales $164,509 $148,539 Other income, net 4,828 419 169,337 148,958 COSTS AND EXPENSES: Cost of goods sold 121,362 113,867 Selling, general & administrative 31,828 28,174 Amortization of goodwill 3,096 1,278 Restructuring 3,017 - 159,303 143,319 OPERATING INCOME 10,034 5,639 Interest expense 12,209 7,436 Interest income (735) (583) Net interest expense 11,474 6,853 Investment income 880 1,861 Nonrecurring income 28,003 - Earnings from continuing operations before taxes 27,443 647 Income tax provision (9,132) (291) Equity in earnings (loss) of affiliates, net (201) 1,037 Minority interest, net - (203) NET EARNINGS $18,110 $1,190 Other comprehensive income (loss), net of tax: Foreign currency translation adjustments (1,648) 5,246 Unrealized holding changes on securities arising during the period (5,006) (30,388) Other comprehensive income (loss) (6,654) (25,142) COMPREHENSIVE INCOME (LOSS) $11,456 $(23,952) NET EARNINGS PER SHARE: Basic $ 0.73 $ 0.05 Diluted $ 0.72 $ 0.05 Weighted average shares outstanding: Basic 24,862 22,401 Diluted 25,026 23,001 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. THE FAIRCHILD CORPORATION AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For The Three (3) Months Ended October 3, 1999 and September 27, 1998 (In thousands) For the Three Months Ended 10/03/1999 09/27/1998 Cash flows from operating activities: Net earnings $ 18,110 $1,190 Depreciation and amortization 9,968 5,538 Amortization of deferred loan fees 413 286 Accretion of discount on long-term liabilities 897 1,072 Net gain on divestiture of investment in affiliate (25,747) - Net gain on divestiture of subsidiary (2,256) - Loss on sale of property, plant, and equipment 90 46 Distributed (undistributed) earnings of affiliates, net 310 226 Minority interest - 203 Change in assets and liabilities (12,154) (9,089) Non-cash charges and working capital changes of discontinued operations (10,930) (6,523) Net cash used for operating activities (21,299) (7,051) Cash flows from investing activities: Purchase of property, plant and equipment (11,879) (6,551) Net proceeds received from investment securities (3,933) (3,113) Net proceeds received from divestiture of investment in affiliate 43,103 - Net proceeds received from divestiture of subsidiary 4,906 - Changes in real estate investment (5,329) (2,145) Changes in net assets held for sale 1,346 288 Other, net - 156 Investing activities of discontinued operations 7,100 (165) Net cash provided by (used for) investing activities 35,314 (11,530) Cash flows from financing activities: Proceeds from issuance of debt 126,691 41,362 Debt repayments (142,279) (6,282) Issuance of Class A common stock 90 158 Purchase of treasury stock (624) (18,657) Financing activities of discontinued operations - (15) Net cash provided by (used for) financing activities (16,122) 16,566 Effect of exchange rate changes on cash 437 1,842 Net change in cash and cash equivalents (1,670) (173) Cash and cash equivalents, beginning of the year 54,860 49,601 Cash and cash equivalents, end of the period $53,190 $49,428 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. THE FAIRCHILD CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (In thousands, except share data) FINANCIAL STATEMENTS The consolidated balance sheet as of October 3, 1999 and the consolidated statements of earnings and cash flows for the three months ended October 3, 1999 and September 27, 1998 have been prepared by us, without audit. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows at October 3, 1999, and for all periods presented, have been made. The balance sheet at June 30, 1999 was condensed from the audited financial statements as of that date. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our June 30, 1999 Annual Report on Form 10-K. The results of operations for the period ended October 3, 1999 are not necessarily indicative of the operating results for the full year. Certain amounts in the prior year's quarterly financial statements have been reclassified to conform to the current presentation. DIVESTITURES On September 3, 1999, we completed the disposal of our Camloc Gas Springs division to a subsidiary of Arvin Industries Inc. for approximately $2.7 million. In addition, we received $2.4 million for a covenant not to compete. We recognized a $2.3 million nonrecurring gain from this disposition. On July 29, 1999, we sold our 31.9% interest in Nacanco Paketleme to American National Can Group, Inc. for approximately $48.2 million. In the quarter ended October 3, 1999, we recognized a $25.7 million nonrecurring gain from this divestiture. We also agreed to provide consulting services over a three-year period, at an annual fee of approximately $1.5 million. We used the net proceeds from the disposition to reduce our indebtedness. DISCONTINUED OPERATIONS Based on our formal plan for the disposition of Fairchild Technologies, we have liquidated a significant portion of Fairchild Technologies, mostly consisting of our semiconductor equipment group through several transactions. On April 14, 1999, we disposed of our photoresist deep ultraviolet track equipment machines, spare parts and testing equipment to Apex Co., Ltd. in exchange for 1,250,000 shares of Apex stock valued at approximately $5.1 million. On June 15, 1999, we received $7.9 million from Suess Microtec AG and the right to receive 350,000 shares of Suess Microtec stock (or approximately $3.5 million) by September 2000 in exchange for certain inventory, fixed assets, and intellectual property our semiconductor equipment group. On May 1, 1999, we sold Fairchild CDI for a nominal amount. In July 1999, we received approximately $7.1 million from Novellus in exchange for our Low-K dielectric product line and certain intellectual property. We are also exploring several alternative transactions regarding the disposition of our optical disc equipment group, but we have not made any definitive arrangements for its ultimate disposition. As of October 3, 1999, we have a remaining accrual of $5.6 million, net of an income tax benefit of $3.9 million, for our current estimate of the remaining losses in connection with the disposition of Fairchild Technologies. While we believe that $5.6 million is a reasonable estimate for the remaining losses to be incurred from Fairchild Technologies, there can be no assurance that this estimate is adequate. PRO FORMA FINANCIAL STATEMENTS The following table sets forth the derivation of the unaudited pro forma results, representing the impact of our acquisition of Kaynar Technologies (completed in April 1999), our merger with Banner Aerospace (completed in April 1999), and our disposition of Solair (completed in December 1998), as if these transactions had occurred at the beginning of fiscal 1999. The pro forma information is based on the historical financial statements of these companies, giving effect to the aforementioned transactions. In preparing the pro forma data, certain assumptions and adjustments have been made which increase interest expense based on revised debt structures, increase goodwill amortization expense for the acquisition of Kaynar Technologies, and reduce minority interest as a result of our merger with Banner Aerospace. The unaudited pro forma information is not intended to be indicative of either future results of our operations or results that might have been achieved if these transactions had been in effect since the beginning of fiscal 1999. For the three months ended: Sept. 27, 1998 Net sales $186,280 Gross profit 47,522 Net earnings 122 Net earnings, per basic and diluted share $ 0.00 EQUITY SECURITIES We had 22,198,516 shares of Class A common stock and 2,621,652 shares of Class B common stock outstanding at October 3, 1999. Class A common stock is traded on both the New York and Pacific Stock Exchanges. There is no public market for the Class B common stock. The shares of Class A common stock are entitled to one vote per share and cannot be exchanged for shares of Class B common stock. The shares of Class B common stock are entitled to ten votes per share and can be exchanged, at any time, for shares of Class A common stock on a share-for-share basis. For the three months ended October 3, 1999, 21,863 shares of Class A common stock were issued as a result of the exercise of stock options. In accordance with the terms of our acquisition of Special-T, as amended, we issued 44,079 restricted shares of our Class A common stock during the three months ended October 3, 1999, as additional merger consideration. In addition, our Class A common stock outstanding was reduced as a result of 67,000 shares purchased during the quarter, which are considered as treasury stock for accounting purposes. During the three months ended October 3, 1999, we issued 67,994 deferred compensation units pursuant to our stock option deferral plan as a result the exercise of 127,000 stock options. Each deferred compensation unit is represented by one share of our treasury stock and is convertible into one share of our Class A common stock after a specified period of time. RESTRICTED CASH On October 3, 1999 and June 30, 1999, we had restricted cash of $13,982 and $15,752, respectively, all of which is maintained as collateral for certain debt facilities and escrow arrangements. EARNINGS PER SHARE The following table illustrates the computation of basic and diluted earnings per share: (In thousands, except per share data) For the Three Months Ended 10/3/99 9/27/98 Basic earnings per share: Net earnings $ 18,110 $ 1,190 Weighted average common shares outstanding 24,862 22,401 Basic earnings per share: Basic earnings from continuing operations per share $ 0.73 $ 0.05 Diluted earnings per share: Net earnings $ 18,110 $ 1,190 Weighted average common shares outstanding 24,862 22,401 Options 10 416 Warrants 154 184 Total shares outstanding 25,026 23,001 Diluted earnings from continuing operations per share $ 0.72 $ 0.05 Stock options entitled to purchase 1,767,986 shares of Class A common stock were antidilutive and not included in the earnings per share calculation for the three months ended October 3, 1999. These shares could be dilutive in subsequent periods. RESTRUCTURING CHARGES In the three months ended October 3, 1999, we recorded $3.0 million of restructuring charges as a result of the continued integration of Kaynar Technologies into our aerospace fasteners segment. All of the charges recorded during the current quarter were a direct result of product integration costs incurred as of October 3, 1999. These costs were classified as restructuring and were the direct result of formal plans to close plants and to terminate employees. Such costs are nonrecurring in nature. Other than a reduction in our existing cost structure, none of the restructuring charges resulted in future increases in earnings or represented an accrual of future costs. As of October 3, 1999, the majority of the integration plans have been executed. During the next nine months, we expect to incur modest additional restructuring charges for product integration costs at our aerospace fasteners segment. We anticipate that our integration process will be substantially complete by the end of fiscal 2000. CONTINGENCIES Government Claims The Corporate Administrative Contracting Officer (the "ACO"), based upon the advice of the United States Defense Contract Audit Agency, has made a determination that a former subsidiary of ours did not comply with Federal Acquisition Regulations and Cost Accounting Standards in accounting for (i) the 1985 reversion of certain assets of terminated defined benefit pension plans, and (ii) pension costs upon the closing of segments of our former subsidiaries business. The ACO has directed us to prepare cost impact proposals relating to such plan terminations and segment closings and, following receipt of such cost impact proposals, may seek adjustments to contract prices. The ACO alleges that substantial amounts will be due if such adjustments are made, however, an estimate of the possible loss or range of loss from the ACO's assertion cannot be made. We believe that management of our former subsidiary properly accounted for the asset reversions in accordance with applicable accounting standards. We intend to enter into mediation with the government to attempt to resolve these pension accounting issues. Environmental Matters Our operations are subject to stringent government imposed environmental laws and regulations concerning, among other things, the discharge of materials into the environment and the generation, handling, storage, transportation and disposal of waste and hazardous materials. To date, such laws and regulations have not had a material effect on our financial condition, results of operations, or net cash flows, although we have expended, and can be expected to expend in the future, significant amounts for the investigation of environmental conditions and installation of environmental control facilities, remediation of environmental conditions and other similar matters, particularly in our aerospace fasteners segment. In connection with our plans to dispose of certain real estate, we must investigate environmental conditions and we may be required to take certain corrective action prior or pursuant to any such disposition. In addition, we have identified several areas of potential contamination at or from other facilities owned, or previously owned, by us, that may require us to either to take corrective action or to contribute to a clean-up. We are also a defendant in certain lawsuits and proceedings seeking to require us to pay for investigation or remediation of environmental matters and we have been alleged to be a potentially responsible party at various "superfund" sites. We believe that we have recorded adequate reserves in our financial statements to complete such investigation and take any necessary corrective actions or make any necessary contributions. No amounts have been recorded as due from third parties, including insurers, or set off against, any environmental liability, unless such parties are contractually obligated to contribute and are not disputing such liability. As of October 3, 1999, the consolidated total of our recorded liabilities for environmental matters was approximately $10.1 million, which represented the estimated probable exposure for these matters. It is reasonably possible that our total exposure for these matters could be approximately $17.3 million. Other Matters On January 12, 1999, AlliedSignal made indemnification claims against us for $18.9 million, arising from the disposition to AlliedSignal of Banner Aerospace's hardware business. We believe that the amount of the claim is far in excess of any amount that AlliedSignal is entitled to recover from us. We are involved in various other claims and lawsuits incidental to our business, some of which involve substantial amounts. We, either on our own or through our insurance carriers, are contesting these matters. In the opinion of management, the ultimate resolution of the legal proceedings, including those mentioned above, will not have a material adverse effect on our financial condition, future results of operations or net cash flows. CONSOLIDATING FINANCIAL STATEMENTS The following unaudited financial statements separately show The Fairchild Corporation and the subsidiaries of The Fairchild Corporation. These financial statements are provided to fulfill public reporting requirements and separately present guarantors of the 10 3/4% senior subordinated notes due 2009 issued by The Fairchild Corporation (the "Parent Company"). The guarantors are primarily composed of our domestic subsidiaries, excluding Fairchild Technologies, a real estate development venture, and certain other subsidiaries. CONSOLIDATING BALANCE SHEET October 3, 1999 Parent Non Elimi- Fairchild Company Guarantors Guarantors nations Historical Cash $ 74 $ 42,465 $ 10,651 $ - $ 53,190 Short-term investments 71 6,418 - - 6,489 Accounts receivable, less allowances 1,608 79,196 42,723 - 123,527 Inventory, net - 158,542 45,790 - 204,332 Prepaid and other current assets 532 67,253 6,588 - 74,373 Total current assets 2,285 353,874 105,752 - 461,911 Investment in subsidiaries 958,071 - - (958,071) - Net fixed assets 585 138,816 47,439 - 186,840 Net assets held for sale - 19,899 - - 19,899 Investments in affiliates 1,300 15,272 - - 16,572 Goodwill 5,427 388,279 39,604 - 433,310 Deferred loan costs 13,605 25 551 - 14,181 Prepaid pension assets - 64,113 - - 64,113 Real estate investment - - 89,240 - 89,240 Long-term investments - 16,220 - - 16,220 Other assets 16,881 (12,198) 398 - 5,081 Total assets $998,154 $984,300 $282,984 $(958,071)$1,307,367 Bank notes & current maturities of debt $ 2,250 $ 2,445 $ 23,497 $ - $ 28,192 Accounts payable - 24,077 19,019 - 43,096 Other accrued expenses (11,740) 118,405 22,660 - 129,325 Net current liabilities of discontinued operation - - 12,585 - 12,585 Total current liabilities (9,490) 144,927 77,761 - 213,198 Long-term debt, less current maturities 465,893 9,159 5,919 - 480,971 Other long-term liabilieies 405 19,045 8,258 - 27,708 Noncurrent income taxes 122,313 (1,450) 244 - 121,107 Retiree health care liabilities - 40,460 4,829 - 45,289 Minority interest in subsidiaries - 9 52 - 61 Total liabilities 579,121 212,150 97,063 - 888,334 Class A common stock 2,781 201 5,084 (5,084) 2,982 Class B common stock 262 - - - 262 Pain-in-capital 2,834 226,898 232,554 (232,554) 229,732 Retained earnings 488,022 550,894 (48,343)(720,433) 270,140 Cumulative other comprehensive income (764) (5,219) (3,374) - (9,357) Treasury stock, at cost (74,102) (624) - - (74,726) Total stockholders' equity 419,033 772,150 185,921 (958,071) 419,033 Total liabilities & stockholders' equity $998,154 $984,300 $282,984 $(958,071)$1,307,367 CONSOLIDATING STATEMENTS OF EARNINGS For the Three Months Ended Parent Non Elimi- Fairchild October 3, 1999 Company Guarantors Guarantors nations Historical Net Sales $ - $ 123,893 $ 41,645 $(1,029)$ 164,509 Cost and expenses Cost of sales - 91,623 30,768 (1,029) 121,362 Selling, general & administrative 1,008 20,357 5,635 - 27,000 Restructuring - 3,017 - - 3,017 Amortization of goodwill 128 2,680 288 - 3,096 1,136 117,677 36,691 (1,029) 154,475 Operating income (loss) (1,136) 6,216 4,954 - 10,034 Net interest expense 12,425 (2,569) 1,618 - 11,474 Investment (income)loss, net - (880) - - (880) Intercompany dividends - - 117 (117) - Nonrecurring (income) from divestitures - - (28,003) - (28,003) Earnings (loss) before taxes (13,561) 9,665 31,222 117 27,443 Income tax (provision) benefit (8,853) (117) (162) - (9,132) Equity in earnings of affiliates & subsidiaries 40,524 (201) - (40,524) (201) Earnings (loss) from continuting operations 18,110 9,347 31,060 (40,407) 18,110 Earnings (loss) from discontinued operations - (206) 206 - - Net earnings (loss) $ 18,110 $ 9,141 $31,266 $(40,407) $18,110 CONSOLIDATING STATEMENTS OF CASH FLOWS For the Three Months Ended Parent Non Elimi- Fairchild October 3, 1999 Company Guarantors Guarantors nations Historical Cash Flows from Operating Activities: Net earnings (loss) $ 18,110 $ 9,141 $ 31,266 $(40,407)$ 18,110 Depreciation & amortization 137 6,980 2,851 - 9,968 Amortizatin of deferred loan fees 413 - - - 413 Accretion of discount on long-term liabilities 897 - - - 897 Net (gain) on divestitures - - (28,003) - (28,003) Loss on sale of PP&E - 70 20 - 90 Undistributed loss of affiliates - 310 - - 310 Change in assets and liabilities (4,638) (47,695) (434) 40,613 (12,154) Non-cash charges and working capital changes of discontinued - - (10,930) - (10,930) operations Net cash (used for) provided by operating activities 14,919 (31,194) (5,230) 206 (21,299) Cash Flows from Investing Activities: Proceeds received from (used for) investment securities, net - (3,933) - - (3,933) Purchase of PP&E (5) (9,388) (2,486) - (11,879) Gross proceeds from divestitures - - 48,009 - 48,009 Change in real estate investment - - (5,329) - (5,329) Change in net assets held for sale - 1,346 - - 1,346 Investing activities of discontinued operations - - 7,100 - 7,100 Net cash (used for) provided by investing activities (5) (11,975) 47,294 - 35,314 Cash Flows from Financing Activities: Proceeds from issuance of debt 14,500 110,459 1,732 - 126,691 Debt repayments (including intercompany), net (29,457) (66,240)(46,582) - (142,279) Issuance of Class A common stock 90 - - - 90 Purchase of treasury stock - (624) - - (624) Net cash (used for) provided by financing activities (14,867) 43,595 (44,850) - (16,122) Effect of exchange rate changes on cash - 40 397 - 437 Net change in cash 47 466 (2,389) 206 (1,670) Cash, beginning of the year 27 41,793 13,040 - 54,860 Cash, end of period $ 74 $ 42,259 $ 10,651 $206 $53,190 CONSOLIDATING BALANCE SHEET June 30, 1999 Parent Non Elimi- Fairchild Company Guarantors Guarantors nations Historical Cash $ 27 $ 41,793$ 13,040 $- $ 54,860 Short-term investments 71 13,023 - - 13,094 Accounts receivable, less allowances 549 52,929 76,643 - 130,121 Inventory, ent (182) 145,080 45,341 - 190,239 Prepaid and other current assets 1,297 69,000 3,629 - 73,926 Total current assets 1,762 321,825 138,653 - 462,240 Investment in subsidiaries 841,744 - - (841,744) - Net fixed assets 611 137,852 45,602 - 184,065 Net assets held for sale - 21,245 - - 21,245 Investments in affiliates 1,300 13,135 17,356 - 31,791 Goodwill 5,533 402,595 39,594 - 447,722 Deferred loan costs 13,029 26 22 - 13,077 Prepaid pension assets - 63,958 - - 63,958 Real estate investment - - 83,791 - 83,791 Long-term investments - 15,844 - - 15,844 Other assets 16,244 (11,865) 674 - 5,053 Total assets $880,223 $964,615 $325,692 $(841,744)$1,328,786 Bank notes & current maturities of debt $ 2,250 $ 2,548 $ 24,062 $ - $ 28,860 Accounts payable 972 12,824 58,475 - 72,271 Other accrued expenses 7,272 99,669 14,195 - 121,136 Net current liabilities of discontinued operations - - 10,999 - 10,999 Total current liabilities 10,494 115,041 107,731 - 233,266 Long-term debt, less current maturities 480,850 9,908 4,525 - 495,283 Other long-term liabilities 405 18,138 7,361 - 25,904 Noncurrent income taxes (19,026) 140,749 238 - 121,961 Retiree health care liabilities - 40,189 4,624 - 44,813 Minority interest in subsidiaries - 9 50 - 59 Total liabilities 472,723 324,034 124,529 - 921,286 Class A common stock 2,775 200 5,085 (5,085) 2,975 Class B common stock 262 - - - 262 Paid-in-capital 2,138 226,900 263,058 (263,058) 229,038 Retained earnings 477,191 413,483 (65,043) (573,601) 252,030 Cumulative other comprehensive income (764) (2) (1,937) - (2,703) Treasury stock, at cost (74,102) - - - (74,102) Total stockholders' equity 407,500 640,581 201,163 (841,744) 407,500 Total liabilities & stockholders' equity $880,223 $964,615$325,692 $(841,744)$1,328,786 CONSOLIDATING STATEMENTS OF EARNINGS For the Three Months Ended Parent Non Elimi Fairchild September 27, 1998 Company Guarantors Guarantors nations Historical Net Sales $ - $113,023 $ 35,654 $ (138) $148,539 Costs and expenses Cost of sales - 87,514 26,491 (138) 113,867 Selling, general & administrative 777 21,329 5,649 - 27,755 Amortization of goodwill 57 979 242 - 1,278 834 109,822 32,382 (138) 142,900 Operating income (loss) (834) 3,201 3,272 - 5,639 Net interest expense 5,189 1,018 646 - 6,853 Investment (income)loss, net - (1,861) - - (1,861) Earnings (loss) before taxes (6,023) 4,044 2,626 - 647 Income tax (provision) benefit 642 (973) 40 - (291) Equity in earnings of affiliates and subsidiaries 6,571 (781) 1,818 (6,571) 1,037 Minority interest - (203) - - (203) Net earnings (loss) $ 1,190 $ 2,087 $ 4,484 $ (6,571) $ 1,190 CONSOLIDATING STATEMENTS OF CASH FLOWS For the Three Months Ended Parent Non Elimi- Fairchild September 27, 1998 Company Guarantors Guarantors nations Historical Cash Flows from Operating Activities: Net earnings (loss) $ 1,190 $ 2,087 $ 4,484 $(6,571)$ 1,190 Depreciation & amortization 30 3,705 1,803 - 5,538 Amortizaton of deferred loan fee 286 - - - 286 Accretion of discount on long-term liabilities 1,072 - - - 1,072 Loss on sale of PP&E - 15 31 - 46 Distributed earnings of affiliates - 226 - - 226 Minority interest - 203 - - 203 Change in assets and liabilities 17,832 (18,460) (15,032) 6,571 (9,089) Non-cash charges and working capital changes of discontinued - - (6,523) - (6,523) operations Net cash (used for) provided by operating activities 20,410 (12,224) (15,237) - (7,051) Cash Flows from Investing Activities: Proceeds received from (used for) investment securities, net - (3,113) - - (3,113) Purchase of PP&E (6) (4,466) (2,079) - (6,551) Change in real estate investment - - (2,145) - (2,145) Change in net assets held for sale - 288 - - 288 Other (1,905) 2,061 - - 156 Investing activities of discontinued operations - - (165) - (165) Net cash (used for) provided by investing activities (1,911) (5,230) (4,389) - (11,530) Cash Flows from Financing Activities: Proceeds from issuance of debt - 14,001 27,361 - 41,362 Debt repayments, net - - (6,282) - (6,282) Issuance of Class A common stock 158 - - - 158 Purchase of treasury stock (18,657) - - - (18,657) Financing activities of discontinued operations - - (15) - (15) Net cash (used for) provided by financing activities (18,499) 14,001 21,064 - 16,566 Effect of exchange rate changes on cash - - 1,842 - 1,842 Net change in cash - (3,453) 3,280 - (173) Cash, beginning of the year - 42,175 7,426 - 49,601 Cash, end of the period $ - $ 38,722 $10,706 $ - $49,428 SUBSEQUENT EVENTS On October 25, 1999, we announced that we signed a definitive agreement with United Technologies Corporation to sell substantially all of the assets and certain liabilities of our Dallas Aerospace, Inc. subsidiary for approximately $57 million in cash. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The Fairchild Corporation was incorporated in October 1969, under the laws of the State of Delaware, under the name of Banner Industries, Inc. On November 15, 1990, we changed our name from Banner Industries, Inc. to The Fairchild Corporation. We are the owner of 100% of RHI Holdings, Inc. and Banner Aerospace, Inc. RHI is the owner of 100% of Fairchild Holding Corp. Our principal operations are conducted through FHC and Banner Aerospace. The following discussion and analysis provide information which management believes is relevant to assessment and understanding of our consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and notes thereto. GENERAL We are a leading worldwide aerospace and industrial fastener manufacturer and distribution logistics manager and, through Banner Aerospace, an international supplier to airlines and general aviation businesses, distributing a wide range of aircraft parts and related support services. Through internal growth and strategic acquisitions, we have become one of the leading suppliers of fasteners to aircraft OEMs, such as Boeing, Lockheed Martin, Northrop Grumman, and the Airbus consortium of Aerospatiale, DaimlerChrysler Aerospace, British Aerospace and CASA. Our aerospace business consists of two segments: aerospace fasteners and aerospace distribution. The aerospace fasteners segment manufactures and markets high performance fastening systems used in the manufacture and maintenance of commercial and military aircraft. The aerospace distribution segment stocks and distributes a wide variety of aircraft parts to commercial airlines and air cargo carriers, fixed-base operators, corporate aircraft operators and other aerospace companies. CAUTIONARY STATEMENT Certain statements in this financial discussion and analysis by management contain certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to our financial condition, results of operation and business. These statements relate to analyses and other information which are based on forecasts of future results and estimates of amounts not yet determinable. These statements also relate to our future prospects, developments and business strategies. These forward- looking statements are identified by their use of terms and phrases such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan," "predict," "project," "will" and similar terms and phrases, including references to assumptions. These forward-looking statements involve risks and uncertainties, including current trend information, projections for deliveries, backlog and other trend projections, that may cause our actual future activities and results of operations to be materially different from those suggested or described in this Quarterly Report on Form 10- Q. These risks include: product demand; our dependence on the aerospace industry; reliance on Boeing and the Airbus consortium of companies; customer satisfaction and quality issues; labor disputes; competition, including recent intense price competition; our ability to integrate and realize anticipated synergies relating to the acquisition of Kaynar Technologies Inc.; our ability to achieve and execute internal business plans; worldwide political instability and economic growth; and the impact of any economic downturns and inflation, including recent weaknesses in the currency, banking and equity markets of countries in South America and in the Asia/Pacific region. If one or more of these risks or uncertainties materializes, or if underlying assumptions prove incorrect, our actual results may vary materially from those expected, estimated or projected. Given these uncertainties, users of the information included in this financial discussion and analysis by management, including investors and prospective investors are cautioned not to place undue reliance on such forward-looking statements. We do not intend to update these forward-looking statements in this Quarterly Report, even if new information, future events or other circumstances have made them incorrect or misleading. RESULTS OF OPERATIONS Business Transactions The following summarizes certain business combinations and transactions which significantly affect the comparability of the period to period results presented in this Management's Discussion and Analysis of Results of Operations and Financial Condition. Fiscal 2000 Transactions On July 29, 1999, we sold our 31.9% interest in Nacanco Paketleme to American National Can Group, Inc. for approximately $48.2 million. In the quarter ended October 3, 1999, we recognized a $25.7 million nonrecurring gain from this divestiture. We also agreed to provide consulting services over a three-year period, at an annual fee of approximately $1.5 million. We used the net proceeds from the disposition to reduce our indebtedness. On September 3, 1999, we completed the disposal of our Camloc Gas Springs division to a subsidiary of Arvin Industries Inc. for approximately $2.7 million. In addition, we received $2.4 million for a covenant not to compete. We recognized a $2.3 million nonrecurring gain from this disposition. Fiscal 1999 Transactions On December 31, 1998, Banner Aerospace consummated the sale of Solair, Inc., its largest subsidiary in the rotables group of the aerospace distribution segment, to Kellstrom Industries, Inc., in exchange for approximately $60.4 million in cash and a warrant to purchase 300,000 shares of common stock of Kellstrom. In December 1998, Banner Aerospace recorded a $19.3 million pre-tax loss from the sale of Solair. This loss was included in cost of goods sold as it was primarily attributable to the bulk sale of inventory at prices below the carrying amount of inventory. On February 22, 1999, we used available cash to acquire 77.3% of SNEP S.A. By June 30, 1999, we had purchased significantly all of the remaining shares of SNEP. The total amount paid was approximately $8.0 million, including $1.1 million of debt assumed, in a business combination accounted for as a purchase. The total cost of the acquisition exceeded the fair value of the net assets of SNEP by approximately $4.3 million, which is preliminarily being allocated as goodwill, and amortized over 40 years using the straight-line method. SNEP is a French manufacturer of precision machined self-locking nuts and special threaded fasteners serving the European industrial, aerospace and automotive markets. On April 8, 1999, we acquired the remaining 15% of the outstanding common and preferred stock of Banner Aerospace, Inc. not already owned by us, through the merger of Banner Aerospace with one of our subsidiaries. Under the terms of the merger with Banner Aerospace, we issued 2,981,412 shares of our Class A common stock to acquire all of Banner Aerospace's common and preferred stock (other than those already owned by us). Banner Aerospace is now our wholly-owned subsidiary. On April 20, 1999, we completed the acquisition of all the capital stock of Kaynar Technologies Inc. for approximately $222 million and assumed approximately $103 million of Kaynar Technologies existing debt, the majority of which was refinanced at closing. In addition, we paid $28 million for a covenant not to compete from Kaynar Technologies largest preferred shareholder. The total cost of the acquisition exceeded the fair value of the net assets of Kaynar Technologies by approximately $269.7 million, which is preliminarily being allocated as goodwill, and amortized over 40 years using the straight-line method. The acquisition was financed with existing cash, the sale of $225 million of 10 3/4% senior subordinated notes due 2009 and proceeds from a new bank credit facility. On June 18, 1999, we completed the acquisition of Technico S.A. for approximately $4.1 million and assumed approximately $2.2 million of Technico's existing debt. The total cost of the acquisition exceeded the fair value of the net assets of Technico by approximately $2.9 million, which is preliminarily being allocated as goodwill, and amortized over 40 years using the straight-line method. The acquisition was financed with additional borrowings from our credit facility. Consolidated Results We currently report in two principal business segments: aerospace fasteners and aerospace distribution. The results of the Gas Springs division, prior to its disposition, are included in the Corporate and Other classification. The following table illustrates the historical sales and operating income of our operations for the three months ended October 3, 1999 and September 27, 1998, respectively. (In thousands) Three Months Ended 10/3/99 9/27/98 Sales by Segment: Aerospace Fasteners $134,420 $ 96,558 Aerospace Distribution 29,350 50,528 Corporate and Other 739 1,453 TOTAL SALES $164,509 $148,539 Operating Results by Segment: Aerospace Fasteners (a) $ 8,875 $ 7,830 Aerospace Distribution 2,257 1,718 Corporate and Other (1,098) (3,909) OPERATING INCOME $ 10,034 $ 5,639 (a) - Includes restructuring charges of $3.0 million in the quarter ended October 3, 1999. The following table illustrates sales and operating income of our operations by segment, on an unaudited pro forma basis, for the three months ended September 27, 1998, as if we had operated in a consistent manner in each of the reported periods. The pro forma results represent the impact of our acquisition of Kaynar Technologies (completed in April 1999), our merger with Banner Aerospace (completed in April 1999), and our disposition of Solair (completed in December 1998), as if these transactions had occurred at the beginning of fiscal 1999. The pro forma information is based on the historical financial statements of these companies, giving effect to the aforementioned transactions. The pro forma information is not necessarily indicative of the results of operations, that would actually have occurred if the transactions had been in effect since the beginning of fiscal 1999, nor are they necessarily indicative of our future results. (In thousands) 9/27/98 Sales by Segment: Aerospace Fasteners $150,668 Aerospace Distribution 34,159 Corporate and Other 1,453 TOTAL SALES $186,280 Operating Results by Segment: Aerospace Fasteners $ 14,104 Aerospace Distribution 1,788 Corporate and Other (3,909) OPERATING INCOME $ 11,983 Net sales of $164.5 million in the first quarter of fiscal 2000 increased by $16.0 million, or 10.8%, compared to sales of $148.5 million in the first quarter of fiscal 1999. The improvement is attributable primarily to the increase in revenues provided by the acquisition of Kaynar Technologies offset partially from the disposition of Solair. On a pro forma basis, net sales decreased 11.7% for the three months ended October 3, 1999 compared to the same period ended September 27, 1998, reflecting softness in the United States commercial aerospace industry. Gross margin as a percentage of sales was 26.2% and 23.3% for the three months ended October 3, 1999 and September 27, 1998, respectively. The higher margins in the fiscal 2000 period are attributable to cost improvement initiatives, somewhat offset by lower prices. In addition, our Aerospace Fasteners segment also as a result of the acquisition of Kaynar Technologies and efficiencies achieved from our merger integration process. Our Aerospace Distribution segment benefited as a result of the disposition of Solair. Selling, general & administrative expense as a percentage of sales was 19.3% and 19.0% in the three-month period of fiscal 2000 and 1999, respectively. Other income increased $4.4 million in the first three months of fiscal 2000, compared to the first three months of fiscal 1999, due primarily to income recognized from the disposition of non-core property during the current period. In the three months ended October 3, 1999, we recorded $3.0 million of restructuring charges as a result of the continued integration of Kaynar Technologies into our aerospace fasteners segment. All of the charges recorded during the current quarter were a direct result of product integration costs incurred as of October 3, 1999. These costs were classified as restructuring and were the direct result of formal plans to close plants and to terminate employees. Such costs are nonrecurring in nature. Other than a reduction in our existing cost structure, none of the restructuring charges resulted in future increases in earnings or represented an accrual of future costs. As of October 3, 1999, the majority of the integration plans have been executed. During the next nine months, we expect to incur modest additional restructuring charges for product integration costs at our aerospace fasteners segment. We anticipate that our integration process will be substantially complete by the end of fiscal 2000. Operating income of $10.0 million for the three months ended October 3, 1999 increased by $4.4 million from the comparable prior year first quarter. The increase in the current period is due primarily to cost improvement initiatives, the acquisition of Kaynar Technologies, and efficiencies achieved from the integration of Kaynar Technologies into our Aerospace Fasteners segment, and the increase in other income, offset partially by restructuring charges incurred in the current period. Net interest expense increased $4.6 million in the first quarter of fiscal 2000, compared to the first quarter of fiscal 1999. We expect the trend of reporting increased interest expense to continue throughout fiscal 2000 as a result of additional debt we incurred to finance the acquisition of Kaynar Technologies. Nonrecurring income of $28.0 million in the three months ended October 3, 1999 resulted from the disposition of our investment in Nacanco Paketleme and the disposition of our Camloc Gas Springs division. An income tax provision of $9.1 million in the first three months of fiscal 2000 represented a 33.3% effective tax rate on pre-tax earnings from continuing operations. The tax provision was slightly lower than the statutory rate because of lower tax rates at some of our foreign operations. Comprehensive income (loss) includes foreign currency translation adjustments and unrealized holding changes in the fair market value of available for-sale investment securities. Since June 30, 1999, foreign currency translation adjustments decreased by $1.6 million in the three months ended October 3, 1999. The fair market value of unrealized holding securities declined by $5.0 million in the three months ended October 3, 1999 reflecting a decrease in the market value of our investment portfolio since June 30, 1999. Segment Results Aerospace Fasteners Segment Sales in our Aerospace Fasteners segment increased by $37.9 million in the first three months of fiscal 2000, as compared to the same period of fiscal 1999, reflecting growth from acquisitions, partially offset by softness in the United States commercial aerospace industry. Internal growth declined 12.1% in the current quarter. On October 3, 1999, backlog was $208 million compared to $220 million at June 30, 1999. On a pro forma basis, including the results from acquisitions in the prior period, sales decreased by 10.8% in the first three months of fiscal 2000, as compared to the same period of the prior year, reflecting a softness in the United States commercial aerospace industry and the affect of inventory reduction efforts by Boeing. Operating income improved by $1.0 million, or 13.3%, in the first three months of fiscal 2000, compared to the fiscal 1999 period. Included in our current quarter results are restructuring charges of $3.0 million incurred in the integration of Kaynar Technologies into our Aerospace Fasteners business. Excluding restructuring charges, operating income increased $4.1 million in the first three months of fiscal 2000, compared to the fiscal 1999 period reflecting cost improvement initiatives and acquisitions made during fiscal 1999. On a pro forma basis and excluding restructuring charges, operating income decreased by 15.7% for the quarter ended October 3, 1999, compared to the quarter ended September 27, 1998 due to lower sales levels associated with the softness in the United States commercial aerospace industry. We believe the demand for aerospace fasteners in fiscal 2000 will increase slightly in Europe and will continue to be soft in the United States commercial aerospace market. We anticipate that the negative impact on us of Boeing's inventory reduction program will subside in the latter part of fiscal 2000. We expect that our merger integration savings and production efficiency improvements will offset the softness in the United States commercial aerospace industry. Aerospace Distribution Segment Sales in our aerospace distribution segment decreased by $21.2 million, or 41.9%, in the first quarter ended October 3, 1999, compared to the first quarter ended September 27, 1998, due primarily to the loss of revenues as a result of the disposition of Solair. On a pro forma basis, sales decreased $4.8 million, or 14.1%, in the current period. Operating income increased by 31.4%, in the first quarter ended October 3, 1999, compared to the first quarter ended September 27, 1998, reflecting increases in margins and a reduction in corporate overhead. On a pro forma basis, operating income increased 26.2% in the first quarter ended October 3, 1999, compared to the first quarter ended September 27, 1998. Corporate and Other The Corporate and Other classification included the Camloc Gas Springs division, prior to its disposition, and corporate activities. The group reported a decrease in sales in the first quarter of fiscal 2000, compared to first quarter of fiscal 1999 as a result of the disposition of Camloc Gas Springs division in the current period. An operating loss of $1.1 million in the first three months of fiscal 2000 was a $2.8 million improvement compared to the operating loss of $3.9 million reported in the first three months of fiscal 1999. The current period included other income of $4.4 million due primarily to income recognized from the disposition of non-core property. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES Total capitalization as of October 3, 1999 and June 30, 1999 amounted to $928.2 million and $931.6 million, respectively. The changes in capitalization included a decrease of $15.0 million in debt and an increase of $11.5 million in equity. The decrease in debt was a result of the proceeds received from the divestiture of Nacanco. The increase in equity was due primarily to our reported net earnings, offset partially by a reduction in comprehensive income. We maintain a portfolio of investments classified primarily as available- for-sale securities, which had a fair market value of $22.7 million at October 3, 1999. The market value of these investments decreased $5.0 million in the quarter ended October 3, 1999. While there is risk associated with market fluctuations inherent in stock investments, and because our portfolio is not diversified, large swings in its value should be expected. We have an 88-acre site in Farmingdale, New York, which we are developing as a shopping center. We invested approximately $5.3 million into this project in the quarter ended October 3, 1999. We estimate funding of approximately $16.0 million is needed to complete the parcels currently under development. Net cash used by operating activities for the three months ended October 3, 1999 and September 27, 1998 was $21.3 million and $7.1 million, respectively. The primary use of cash for operating activities in the first quarter of fiscal 2000 was an increase in inventories of $14.1 million. The primary use of cash for operating activities in the first quarter of fiscal 1999 was an increase in inventories of $20.8 million and a decrease in accounts payable and accrued liabilities of $10.8 million, which were partially offset by a $20.7million decrease in accounts receivable and other current assets. Net cash provided by (used for) investing activities for the three months ended October 3, 1999 and September 27, 1998, amounted to $35.3 million and $(11.5) million, respectively. In the first quarter of fiscal 2000, the primary source of cash from investing activities was $48.0 million of net proceeds received from the dispositions of Nacanco and the Camloc Gas Springs division, partially offset by capital expenditures of $11.9 million. In the first quarter of fiscal 1999, capital expenditures were the primary use of cash from investing activities. Net cash provided by (used for) financing activities for the three months ended October 3, 1999 and September 27, 1998, amounted to $(16.1) million and $16.6 million, respectively. Cash used for financing activities in the first quarter of fiscal 2000 included a $15.0 million net reduction in debt and the $0.6 million purchase of treasury stock. Cash provided by financing activities in the first quarter of fiscal 1999 included a $41.4 million net increase from the issuance of additional debt, offset partially by the repayment of debt and the $18.7 million purchase of treasury stock. Our principal cash requirements include debt service, capital expenditures, acquisitions, real estate development, and payment of other liabilities. Other liabilities that require the use of cash include postretirement benefits, environmental investigation and remediation obligations, and litigation settlements and related costs. We expect that cash on hand, cash generated from operations, and cash from borrowings and asset sales will be adequate to satisfy our cash requirements in fiscal 2000. Discontinued Operations Based on our formal plan for the disposition of Fairchild Technologies, we have liquidated a significant portion of Fairchild Technologies, mostly consisting of our semiconductor equipment group through several transactions. On April 14, 1999, we disposed of our photoresist deep ultraviolet track equipment machines, spare parts and testing equipment to Apex Co., Ltd. in exchange for 1,250,000 shares of Apex stock valued at approximately $5.1 million. On June 15, 1999, we received $7.9 million from Suess Microtec AG and the right to receive 350,000 shares of Suess Microtec stock (or approximately $3.5 million) by September 2000 in exchange for certain inventory, fixed assets, and intellectual property our semiconductor equipment group. On May 1, 1999, we sold Fairchild CDI for a nominal amount. In July 1999, we received approximately $7.1 million from Novellus in exchange for our Low-K dielectric product line and certain intellectual property. We are also exploring several alternative transactions regarding the disposition of our optical disc equipment group, but we have not made any definitive arrangements for its ultimate disposition. As of October 3, 1999, we have a remaining accrual of $5.6 million, net of an income tax benefit of $3.9 million, for our current estimate of the remaining losses in connection with the disposition of Fairchild Technologies. While we believe that $5.6 million is a reasonable estimate for the remaining losses to be incurred from Fairchild Technologies, there can be no assurance that this estimate is adequate. Uncertainty of the Spin-Off In order to focus our operations on the aerospace industry, we have been considering for some time distributing to our stockholders certain of our assets via distribution of all of the stock of a new entity, which may own all or a part of our non-aerospace operations. We are still in the process of deciding the exact composition of the assets and liabilities to be included in the spin- off. Our ability to consummate the spin-off, if we should choose to do so, may be contingent, among other things, on attaining certain milestones under our credit facility, or waivers thereof, and all necessary governmental and third party approvals. There is no assurance that we will be able to reach such milestones or obtain the necessary waivers from our lenders. In addition, we may encounter unexpected delays in effecting the spin-off, and we can make no assurance as to the timing thereof, or as to whether the spin-off will ever occur. Depending on the ultimate structure and timing of the spin-off, it may be a taxable transaction to our stockholders and could result in a material tax liability to us as well as our stockholders. The amount of the tax to us is uncertain, and if the tax is material to us, we may elect not to consummate the spin-off. Because circumstances may change and provisions of the Internal Revenue Code of 1986, as amended, may be further amended from time to time, we may, depending on various factors, restructure or delay the timing of the spin- off to minimize the tax consequences to us and our stockholders, or elect not to consummate the spin-off. Under the spin-off, the newly created entity may assume certain of our liabilities, including contingent liabilities, and may indemnify us for such liabilities. If this entity is unable to satisfy liabilities assumed in connection with the spin-off, we may have to satisfy such liabilities. Year 2000 As the end of the century nears, there is a widespread concern that many existing data processing devices that use only the last two digits to refer to a year will not properly recognize a year that begins with the digits "20" instead of "19." If not properly modified, these data processing devices could fail, create erroneous results, or cause unanticipated systems failures, among other problems. In response, we have developed a worldwide Year 2000 readiness plan that is divided into a number of interrelated and overlapping phases. These phases include corporate awareness and planning, readiness assessment, evaluation and prioritization of solutions, implementation of remediation, validation testing, and contingency planning. Each is discussed below. Awareness. In the corporate awareness and planning phase, we formed a Year 2000 project group under the direction of our Chief Financial Officer and Chief Information Officer, identified and designated key personnel within the company to coordinate our Year 2000 efforts, and retained the services of outside technical review and modification consultants. The project group prepared an overall schedule and working budget for our Year 2000 plan. We have completed this phase of our Year 2000 plan. We evaluate our information technology applications regularly, and based on such evaluation revise the schedule and budget to reflect the progress of our Year 2000 readiness efforts. The Chief Financial Officer and Chief Information Officer regularly report to our management and to our audit committee on the status of the Year 2000 project. Assessment. In the readiness assessment phase, we, in coordination with our technical review consultants, have been evaluating our Year 2000 preparedness in a number of areas, including our information technology infrastructure, external resources, physical plant and production facilities, equipment and machinery, products and inventory. We have completed this phase of our Year 2000 Plan. Pending the completion of all validation testing, we continue to review on a regular basis all aspects of our Year 2000 preparedness. In this respect, we have designated officers at each of our business segments to provide regular assessment updates to our Chief Information Officer and outside consultants, who have assimilated a range of alternative methods to complete each phase of our Year 2000 plan and are reporting regularly their findings and conclusions to our management. Evaluation. In the evaluation and prioritization of solutions phase, we seek to develop potential solutions to the Year 2000 issues identified in our readiness assessment phase, consider those solutions in light of our other information technology and business priorities, prioritize the various remediation tasks, and develop an implementation schedule. This phase is largely complete. However, we will continue to evaluate our Year 2000 readiness status through December 1, 1999, when all validation testing is anticipated to be complete. However, identified problems will be corrected as soon as practicable after identification. To date, we have not identified any major information technology system or non-information technology system that must be replaced in its entirety for Year 2000 reasons. We have also determined that most of the Year 2000 issues identified in the assessment phase can be addressed satisfactorily through system modifications, component upgrades and software patches. Thus, we do not presently anticipate incurring any material systems replacement costs relating to the Year 2000 issues. Implementation. In the implementation of remediation phase, we, with the assistance of our technical review and modification consultants, began to implement the proposed solutions to any identified Year 2000 issues. The solutions include equipment and component upgrades, systems and software patches, reprogramming and resetting machines, and other modifications. Substantially all of the material systems within the aerospace fasteners and aerospace distribution segments of our business are currently Year 2000 ready. However, we are continuing to evaluate and implement Year 2000 modifications to embedded data processing technology in certain manufacturing equipment used in our aerospace fasteners segment. Testing. In the validation testing phase, we seek to evaluate and confirm the results of our Year 2000 remediation efforts. In conducting our validation testing, we are using, among other things, proprietary testing protocols developed internally and by our technical review and modification consultants, as well as testing tools such as Greenwich Mean Time's Check 2000 and SEMATECH's Year 2000 Readiness Testing Scenarios Version 2.0. The Greenwich tools identify potential Year 2000-related software and data problems, and the SEMATECH protocols validate the ability of data processing systems to rollover and hold transition dates. Testing for both the aerospace fasteners segment and the aerospace distribution segment is approximately 98 percent complete. To date, the results of our validation testing have not revealed any new and significant Year 2000 issues or any ineffective remediation. We have completed testing of our most critical information technology and related systems. Contingency Planning. In the contingency planning phase, we, together with our technical review consultants, are assessing the Year 2000 readiness of our key suppliers, distributors, customers and service providers. Toward that objective, we have sent letters, questionnaires and surveys to our business partners, inquiring about their Year 2000 readiness arrangements. The average response rate has been approximately 55 percent, including our most significant business partners have responded to our inquiries. In this phase, we have evaluated the risks that our failure or the failure of others to be Year 2000 ready would cause a material disruption to, or have a material effect on, our financial condition, business or operations. So far, we have identified only our aerospace fasteners MRP system as being both mission critical and potentially at risk. In mitigation of this concern, we have engaged a consultant to test, evaluate and implement the manufacturer-designed Year 2000 patches for the system. We are also developing and evaluating contingency plans to deal with events arising from significant Year 2000 issues outside of our infrastructure. In this regard, we are considering the advisability of augmenting our inventories of certain raw materials and finished products, securing additional sources for certain supplies and services, arranging for back-up utilities, and exploring alternate distribution and sales channels, among other things. The following chart summarizes our progress, by phase and business segment, in completing the Year 2000 plan: Percentage of Year 2000 Plan Completed (By Phase and Business Segment) Quarter Ended June Sept. Dec. Mar. June Oct. Work 30, 27, 27, 28, 30, 3, Remaining 1998 1998 1998 1999 1999 1999 Awareness: Aerospace 100% 100% 100% 100% 100% 100% 0% Fasteners Aerospace 100 100 100 100 100 100 0 Distribution Assessment: Aerospace 75 100 100 100 100 100 0 Fasteners Aerospace 0 50 100 100 100 100 0 Distribution Evaluation: Aerospace 0 70 100 100 100 0 Fasteners Aerospace 20 100 100 100 100 0 Distribution Implementation: Aerospace 50 60 90 98 2 Fasteners Aerospace 40 75 95 98 2 Distribution Testing: Aerospace 20 35 90 98 2 Fasteners Aerospace 30-40 70 90 98 2 Distribution Contingency Planning: Aerospace 0 20 35 90 98 2 Fasteners Aerospace 25 50 65 90 98 2 Distribution The chart below summarizes costs we incurred through October 3, 1999, by segment, to address Year 2000 issues, and the total costs we reasonably anticipate incurring during the remainder of 1999 relating to the Year 2000 issue. (In thousands) Year 2000 Costs as of Anticipated Year 2000 Costs October 3, 1999 During the Next Three Months Aerospace Fasteners $885 $200 Aerospace Distribution $600 $20 We have funded the costs of our Year 2000 plan from general operating funds, and all such costs have been deducted from income. To date, the costs associated with our Year 2000 efforts have not had a material effect on, and have caused no delays with respect to, our other information technology programs or projects. We anticipate that we will complete our Year 2000 preparations by December 1, 1999. Although our Year 2000 implementation, testing and contingency planning phases are not yet complete, we do not currently believe that Year 2000 issues will materially affect our business, results of operations or financial condition. However, in some international markets in which we conduct business, the level of awareness and remediation efforts by third parties, utilities and infrastructure managers relating to the Year 2000 issue may be less advanced than in the United States, which could, despite our efforts, have an adverse effect on us. If our mission critical systems are not Year 2000 ready, we could be subject to significant business interruptions, and could be liable to customers and other third parties for breach of contract, breach of warranty, misrepresentation, unlawful trade practices and other claims. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes a new model for accounting for derivatives and hedging activities and supersedes and amends a number of existing accounting standards. It requires that all derivatives be recognized as assets and liabilities on the balance sheet and measured at fair value. The corresponding derivative gains or losses are reported based on the hedge relationship that exists, if any. Changes in the fair value of derivative instruments that are not designated as hedges or that do not meet the hedge accounting criteria in SFAS 133, are required to be reported in earnings. Most of the general qualifying criteria for hedge accounting under SFAS 133 were derived from, and are similar to, the existing qualifying criteria in SFAS 80 "Accounting for Futures Contracts." SFAS 133 describes three primary types of hedge relationships: fair value hedge, cash flow hedge, and foreign currency hedge. In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137 to defer the required effective date of implementing SFAS 133, from fiscal years beginning after June 15, 1999 to fiscal years beginning after June 15, 2000. We will adopt SFAS 133 in fiscal 2001 and we are currently evaluating the financial statement impact. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The table below provides information about our derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, which include interest rate swaps. For interest rate swaps, the table presents notional amounts and weighted average interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contract. Weighted average variable rates are based on implied forward rates in the yield curve at the reporting date. Expected Fiscal Year 2008 (a) Maturity Date Interest Rate Swaps: Variable to Fixed 100,000 Average cap rate 6.49% Average floor rate 6.24% Weighted average rate 6.39% Fair Market Value (2,789) (a) - On February 17, 2003, the bank that we entered into the interest rate swap agreement with will have a one-time option to elect to cancel the hedge agreement. PART II. OTHER INFORMATION Item 1. Legal Proceedings The information required to be disclosed under this Item is set forth in Footnote 9 (Contingencies) of the Consolidated Financial Statements (Unaudited) included in this Report. Item 2. Changes in Securities and Use of Proceeds The company's stock option deferral plan allows officers and directors who are accredited investors to defer the gain upon exercise of stock options by receiving deferred compensation units instead of shares of stock. The deferred compensation units may be deemed securities issued by the company. The shares issued to an officer or director upon expiration of the deferral period (in exchange for deferred compensation units) have been registered pursuant to a registrations statement on form S-8. Under the company's stock option deferral plan, an aggregate of 67,994 deferred compensation units were issued in September 1999 to the following officers: Donald Miller (12,518 deferred compensation units), Eric Steiner (12,994 deferred compensation units), John Flynn (8,496 deferred compensation units), and Jeffrey Steiner (33,896 deferred compensation units). On September 3, 1999, in accordance with the terms of the Special-T Acquisition, we issued 44,079 restricted shares of the company's class a common stock to Robert E. Edwards as additional merger consideration. Information regarding the Special-T Acquisition is set forth in Footnote 2 (Business Combinations) of the Consolidated Financial Statements (Unaudited) included in our Annual Report on Form 10-K for the period ended June 30, 1999. Item 5. Other Information Articles have appeared in the French press reporting an inquiry by a French magistrate into certain allegedly improper business transactions involving Elf Acquitaine, a French petroleum company, its former chairman and various third parties, including Maurice Bidermann. In connection with this inquiry, the magistrate has made inquiry into allegedly improper transactions between Mr. Steiner and that petroleum company. In response to the magistrate's request that Mr. Steiner appear in France as a witness, Mr. Steiner submitted written statements concerning the transactions and appeared in person before the magistrate and others. Mr. Steiner, who has been put under examination (mis en examen) by the magistrate, with respect to this matter, has not been charged. Mr. Steiner appeared before the Tribunal de Grande Instance de Paris to answer a charge of knowingly benefiting in 1990 from a misuse by Mr. Bidermann of corporate assets of Societe Generale Mobiliere et Immobiliere, a French corporation in which Mr. Bidermann is believed to have been the sole shareholder. Mr. Steiner was assessed a fine of two million French Francs in connection therewith. Both Mr. Steiner and the prosecutor (parquet) have appealed the decision. Item 6. Exhibits and Reports on Form 8-K Exhibits: *27 Financial Data Schedules. * - Filed herewith Reports on Form 8-K: On August 12, 1999, the Company filed a Form 8-K to report on Item 5 and Item 7 regarding the disposition of our interest in Nacanco Paketleme. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to the signed on its behalf by the undersigned hereunto duly authorized. For THE FAIRCHILD CORPORATION (Registrant) and as its Chief Financial Officer: By: Colin M. Cohen Senior Vice President and Chief Financial Officer Date: November 17, 1999