FARR
The cover shows color clipart images that represent markets that Farr Company
serves. The images are arranged around a circle and "The Markets We Serve" is in
the center of the circle. The "F" symbol and "FARR" logo are at the top of the
cover and "1998 Annual Report" is at the bottom.
1998 ANNUAL REPORT
MISSION STATEMENT
To be a highly successful company providing filtration products and services of
premium value that protect people, equipment and their
environment from contaminants.
To produce acceptable rewards to those having a stake in the
success of the enterprise.
=====
TOTAL MARKET CAPITALIZATION SHORT-TERM & LONG TERM DEBT
(bar graph showing 1995, 1996, (bar graph showing 1995, 1996,
1997 and 1998 quarterly 1997 and 1998 end of quarter
market capitalization, debt, in millions)
in millions)
NET INCOME TREND SALES TREND
(bar graph showing 1995, 1996, (bar graph showing 1995, 1996,
1997 and 1998 quarterly 1997 and 1998 end of quarter
quarterly net income, quarterly sales, in millions)
in thousands)
Short-Term
Measurement Market & Long-
Period Capitalization Term Debt Income Trend Sales Trend
(quarter) (millions) (millions) (thousands) (millions)
- --------- ---------- ---------- ------------ ----------
1995 - Q1 $ 24.7 $17.7 $ 633 $27.3
- Q2 $ 27.0 $18.1 $ 675 $28.7
- Q3 $ 31.4 $16.7 $ 726 $28.4
- Q4 $ 29.5 $10.5 $1,090 $28.9
1996 - Q1 $ 35.2 $ 8.8 $1,178 $30.1
- Q2 $ 49.2 $ 6.6 $1,499 $31.4
- Q3 $ 53.8 $ 5.2 $1,595 $30.0
- Q4 $ 61.7 $ 3.0 $1,618 $29.6
1997 - Q1 $ 68.4 $ 1.7 $1,700 $30.3
- Q2 $ 89.0 $ .6 $1,826 $31.6
- Q3 $105.0 $ .4 $1,892 $31.9
- Q4 $ 82.7 $ .1 $1,957 $32.2
1998 - Q1 $105.6 $ .2 $1,918 $32.0
- Q2 $100.7 $ - $1,876 $30.4
- Q3 $ 70.0 $ - $1,784 $31.0
- Q4 $ 82.3 $ .1 $1,627 $28.9
- 2 -
FINANCIAL HIGHLIGHTS
(In thousands, except per share items) 1998 1997 1996
- ----------------------------------------------------------------------------
Net sales ................................ $122,285 $125,762 $122,021
Income before income taxes ............... 10,993 11,240 9,680
Income tax provision ..................... 3,788 3,865 3,790
Net Income ............................... 7,205 7,375 5,890
Diluted earnings per common share ........ .86 .88 .71
Current assets ........................... 39,090 41,007 37,679
Current liabilities ...................... 14,565 19,270 17,873
Working capital .......................... 24,525 21,737 19,806
Long-term debt, net of current portion ... -- -- 2,068
Property, plant, and equipment, net ...... 18,027 17,619 15,611
Stockholders' Investment ................. 42,054 38,507 31,210
- ----------------------------------------------------------------------------
ABOUT THE COMPANY
Farr Company's basic business is the control of particulate and vapor
contaminants in air and liquids. The Company is engaged in the design,
development, manufacture, sale and service of filters and filtration systems.
These products are used for a wide variety of applications including heating,
ventilation and air conditioning systems, manufacturing and process cleanrooms,
special filters for original equipment manufacturers, natural gas, gasoline and
diesel-powered engines, railroad locomotives, dust collection systems and gas
turbines. Air filter efficiencies range from 20 percent (on outdoor air) in
disposable products to 99.9999+ percent (@ .12 microns particulate) in cleanroom
products. Products are available as standard items or may be custom engineered.
They range in size and complexity from a small throwaway air filter to a large
gas turbine system with a single filter component module weighing in excess of
twenty tons. Products are sold in many locations of the world. Sales are made
through direct Company salesmen, manufacturer's representatives, distributors
and foreign licensees.
- 3 -
1998 LETTER TO SHAREHOLDERS
The year of 1998 was one of high activity in terms of planning and
implementation of numerous projects and organizational structuring. We strongly
believe these actions are paving the way for significant growth but regret to
report that growth has not yet materialized.
Both sales and net income for the year were disappointing at $122,285,000 and
$7,205,000, equal to 86 cents per share, down from the prior year's $125,762,000
and $7,375,000, equal to 88 cents per share. Our continued restructuring and
cost reduction programs have resulted in lower selling, general and
administrative expenses, which partially offset the adverse effects of lower
sales volume and gross margins.
Lower sales and net income were partially attributable to an uneven accounting
period which resulted in a 53-week fiscal year in 1997 versus the more
traditional 52-week fiscal year in 1998, and declining foreign currency exchange
rates. Adjusting for those two variables, sales were flat year-over-year, and
net income increased 2 percent.
The Asian financial crisis which was triggered in the last half of 1997 remained
severe throughout 1998. This affected exports from our U.S. plants and caused
our new, fully operational joint venture plant in Malaysia to significantly
underachieve planned production.
We are meeting these challenges in Asia with specific programs which are being
implemented aggressively. Phil Whitaker has joined Farr as Vice President,
International Sales and Marketing. He has specific education and experience in
the Asian market and in our industry. His first objective is to revitalize and
strengthen distribution in foreign markets to increase exports and to expand the
output of the Malaysian facility.
During 1998, our foreign subsidiary operations in Canada and England continued
to perform exceptionally well. Both Canada and England increased net income in
excess of 35 percent over the prior year. This was the third consecutive year of
record profits in the Canadian subsidiary. Additionally, England improved its
cash flow from operating activities by over 50 percent above the prior year
through management programs for reducing working capital.
We believe the introduction of a new line of utility filters which meets price
competition and performance characteristics for specific market needs will
continue to enhance performance in the U.K.
- 4 -
As previously reported, our Air Pollution Control (APC) and Engineered Systems
in the U.S. have been organized into a business unit which is committed to a
higher level of innovation and product performance in targeted markets than
previously attained at any time by Farr. A major element of this is the new Farr
Air Cleaning Test System (FACTS), a customer test and evaluation laboratory
introduced in the second quarter of 1998. This enables application engineers to
precisely evaluate customer air handling and filter applications using the
actual contaminants from customer operations. The results are highly reliable
equipment designs and selections to suit specific customer requirements.
Interest in this innovation has attracted a number of qualified agents to
represent Farr in areas of weak geographic representation and has also resulted
in securing several major orders.
The APC Business Unit is introducing a new product line this year which will
provide customers with innovative, cost effective solutions and significantly
reduce lead times. This product introduction incorporates filter cartridge
technology which we believe to be unique to Farr. We are very enthusiastic about
the growth opportunities for this product introduction.
During 1998, a program was developed and implemented to form strategic
partnerships with our HVAC distributors. It calls for strong commitments of
mutual cooperation aimed at growing the distributors' sales. The objective is to
ensure that our distributors have a complete line of top grade products to meet
individual market needs as well as providing for a two-way exclusivity with
Farr. We expect that this will stimulate sales across the entire HVAC line of
products.
In the fourth quarter, construction of our new U.S. Transportation and Engine
products business unit facility was completed in Memphis, Tennessee. This
encompasses product development, engineering, marketing, sales and customer
service.
This location fits the geography of most of our customers as well as the plants
in Arkansas and Mississippi which produce most of the U.S. engine and railroad
products. We are confident that positive effects of this organization and
location will enhance our ability to continue double-digit growth in these
markets.
In sharp contrast to the strong double-digit growth we experienced in previous
years from Custom OEM sales, severe competitive pricing resulted in a
significant reduction in this business during 1998. Other products and markets
will have to make up at least some of these losses until new opportunities can
be identified and established.
- 5 -
While lack of growth in sales and net income was disappointing during 1998,
operating performance remained solid. Return on average stockholder investment
for 1998 was 18 percent and return on average assets was 12 percent. Our already
strong balance sheet and financial condition continued to improve. At year-end
we had over $6,000,000 in cash and no long-term debt.
As we enter 1999, a strong financial condition and cash flow from operations
continue to provide the Company a platform with which we can readily pursue new
business opportunities and continue the stock repurchase authorization that was
started in 1998. During 1998, we repurchased 360,550 shares or roughly 4 percent
of the outstanding stock through the 500,000 share repurchase program that was
increased to 1,000,000 shares in early 1999. This repurchase program adds
long-term shareholder value by increasing earnings per share.
As of the fourth quarter of 1998, the Company's domestic and foreign internal
computer systems had been updated to be Year 2000 (Y2K) compliant. In addition,
major customers and suppliers have advised the Company that their systems are
scheduled to be Year 2000 ready by the end of 1999.
The Farr organization is very strong, experienced and highly motivated. We
believe that plans for growth are well founded and are being expertly
implemented.
Farr's suppliers, employees and distributors are highly supportive of our plans
for which we express appreciation. The mission statement on page two calls for
rewards to all stakeholders in the enterprise. We are dedicated to this goal on
their behalf.
/s/ H. Jack Meany /s/ John c. Johnston
----------------------- -------------------------
H. Jack Meany John C. Johnston
Chairman of the Board President and Chief Executive Officer
NOTE:
The Board of Directors took a major step in Farr's succession plans at its
February 16, 1999 regular meeting. John Johnston, President, was elected Chief
Executive Officer, replacing Jack Meany, who remains Chairman of the Board,
Chairman of the Executive Committee and an officer of the Company.
- 6 -
CONSOLIDATED BALANCE SHEETS Farr Company and Subsidiaries
December 31, 1998 1997
- ----------------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents ............................. $ 6,083,000 $ 5,109,000
Short term investments ................................ -- 2,031,000
Accounts receivable, less allowances of $370,000
in 1998 and $254,000 in 1997 ........................ 19,433,000 20,267,000
Inventories
Raw materials ....................................... 4,629,000 4,812,000
Work in progress .................................... 3,413,000 3,307,000
Finished goods ...................................... 2,774,000 2,690,000
-----------------------------
10,816,000 10,809,000
Prepaid expenses ...................................... 688,000 904,000
Income taxes receivable ............................... 849,000 666,000
Deferred income tax benefit ........................... 1,221,000 1,221,000
-----------------------------
Total current assets ................................ 39,090,000 41,007,000
-----------------------------
Property, plant and equipment at cost
Land .................................................. 2,246,000 2,098,000
Buildings and improvements ............................ 18,468,000 17,429,000
Machinery and equipment ............................... 36,340,000 35,935,000
-----------------------------
57,054,000 55,462,000
Less accumulated depreciation and amortization ........ 39,027,000 37,843,000
-----------------------------
18,027,000 17,619,000
Investments and other ................................... 2,784,000 2,202,000
-----------------------------
$59,901,000 $60,828,000
=============================
Liabilities & Stockholders' Investment Current Liabilities:
Notes payable to banks ................................. $ 145,000 $ 93,000
Accounts payable ....................................... 6,061,000 9,701,000
Accrued liabilities .................................... 7,072,000 8,726,000
Income taxes payable and current deferred income taxes . 1,287,000 750,000
-----------------------------
Total current liabilities .............................. 14,565,000 19,270,000
-----------------------------
Deferred income taxes .................................. 1,773,000 2,196,000
Other noncurrent liabilities ........................... 1,509,000 855,000
Commitments and contingencies .......................... -- --
Stockholders' investment
Common stock, $.10 par value -
Authorized - 10,000,000 shares
Outstanding 8,874,468 shares at December
31, 1998 and 8,561,106 shares at December 31, 1997 ..... 813,000 827,000
Additional paid-in capital ............................. 8,480,000 11,785,000
Cumulative translation adjustments ..................... (2,405,000) (1,749,000)
Retained earnings ...................................... 35,166,000 27,644,000
-----------------------------
Total stockholders' investment ......................... 42,054,000 38,507,000
-----------------------------
$59,901,000 $60,828,000
=============================
The accompanying notes are an integral part of these consolidated balance
sheets.
- 7 -
CONSOLIDATED STATEMENTS OF INCOME Farr Company and Subsidiaries
For the Years Ended December 31, 1998 1997 1996
- -----------------------------------------------------------------------------------------------
Net Sales ....................................... $122,285,000 $125,762,000 $122,021,000
Cost of Sales ................................... 91,160,000 92,792,000 91,276,000
--------------------------------------------
Gross Margin .................................... 31,125,000 32,970,000 30,745,000
Selling, general and administrative expenses .. 20,298,000 21,692,000 20,419,000
Interest expense .............................. 103,000 197,000 687,000
Interest income ............................... ( 269,000) ( 159,000) ( 41,000)
--------------------------------------------
Total Expenses .................................. 20,132,000 21,730,000 21,065,000
--------------------------------------------
Income Before Income Taxes ...................... 10,993,000 11,240,000 9,680,000
Income Tax Provision .......................... 3,788,000 3,865,000 3,790,000
--------------------------------------------
Net Income ...................................... $ 7,205,000 $ 7,375,000 $ 5,890,000
============================================
Diluted Earnings per Common Share ............... $ .86 $ .88 $ .71
============================================
Basic Earnings per Common Share ................. $ .87 $ .90 $ .72
============================================
The accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT
Cumulative
For the Years Ended December 31, 1998, Common Additional Retained Translation Comprehensive
1997 and 1996 Stock Paid-in Capital Earnings Adjustments Income
- ----------------------------------------------------------------------------------------------------------------------
Balance-- December 31, 1995 ................... $ 815,000 $11,215,000 $14,379,000 ($1,624,000)
Net Income .................................. -- -- 5,890,000 -- $ 5,890,000
Exercise of Stock Options ................... 3,000 96,000 -- -- --
Cumulative Translation Adjustment ........... -- -- -- 418,000 418,000
Treasury Stock Sold - 2,961 shares .......... -- 18,000 -- -- --
-------------
Comprehensive Income - 1996 ................. $ 6,308,000
---------------------------------------------------------------------
Balance-- December 31, 1996 ................... 818,000 11,329,000 20,269,000 ( 1,206,000)
Net Income .................................. -- -- 7,375,000 -- $ 7,375,000
Exercise of Stock Options ................... 7,000 250,000 -- -- --
Cumulative Translation Adjustment ........... -- -- -- ( 543,000) ( 543,000)
Treasury Stock Sold - 18,750 shares ......... 2,000 206,000 -- -- --
-------------
Comprehensive Income - 1997 ................. $ 6,832,000
---------------------------------------------------------------------
Balance-- December 31, 1997 ................... 827,000 11,785,000 27,644,000 ( 1,749,000)
Net Income .................................. -- -- 7,205,000 -- $ 7,205,000
Exercise of Stock Options ................... 25,000 772,000 -- -- --
Stock Options Expired ....................... -- ( 12,000) -- -- --
Cumulative Translation Adjustment ........... -- -- -- ( 656,000) ( 656,000)
Treasury Stock Acquired 386,110 shares ...... ( 39,000) ( 4,065,000) -- -- --
Tax Benefit from Exercise of Stock Options .. -- -- 317,000 -- --
-------------
Comprehensive Income - 1998 ................. $ 6,549,000
---------------------------------------------------------------------
Balance-- December 31, 1998 ................... $ 813,000 $ 8,480,000 $35,166,000 ($2,405,000)
=======================================================
The accompanying notes are an integral part of these consolidated financial
statements.
- 8 -
CONSOLIDATED STATEMENTS OF CASH FLOWS Farr Company and Subsidiaries
For the Years Ended December 31, 1998 1997 1996
- -------------------------------------------------------------------------------------------------
Operating Activities:
Net Income ......................................... $ 7,205,000 $ 7,375,000 $ 5,890,000
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization ...................... 2,505,000 2,360,000 2,392,000
Provision for loss on accounts receivable .......... 171,000 206,000 109,000
Benefit retirement trust ........................... 669,000 635,000 186,000
Equity in loss of affiliate ........................ 35,000 30,000 --
Changes in deferred income taxes ................... ( 556,000) 402,000 86,000
Exchange loss (gain) ............................... 34,000 ( 131,000) 97,000
Net loss on sale/retirement of
property, plant and equipment .................... 21,000 38,000 49,000
Change in assets and liabilities
Inventories ...................................... ( 228,000) 1,586,000 3,048,000
Receivables and prepaid expenses ................. 690,000 ( 126,000) ( 600,000)
Accounts payable and accrued expenses ............ ( 4,837,000) 2,250,000 ( 960,000)
Income taxes payable ............................. 397,000 ( 603,000) 2,000
-----------------------------------------
Net cash provided by operating activities .......... 6,106,000 14,022,000 10,299,000
-----------------------------------------
Investing Activities:
Purchases of property, plant and equipment ......... ( 2,985,000) ( 4,508,000) ( 1,465,000)
Redemption (purchases) of short term investments ... 2,031,000 ( 2,031,000) --
Proceeds from sale of property, plant and
equipment ........................................ -- -- 6,000
Investment in joint venture ........................ -- ( 250,000) --
Prepaid pension costs .............................. -- ( 586,000) --
Note receivable-affiliate .......................... ( 106,000) -- --
Purchase of investments, benefit trust ............. ( 669,000) ( 635,000) ( 186,000)
-----------------------------------------
Net cash used in investing activities ............ ( 1,729,000) ( 8,010,000) ( 1,645,000)
-----------------------------------------
Financing Activities:
Proceeds from revolving line of credit and
long-term debt ................................... 50,000 -- 8,603,000
Principal payments on revolving line of credit
and long-term debt ............................... -- ( 3,114,000) (16,195,000)
Proceeds from sale of stock, stock option plans .... 797,000 257,000 99,000
Treasury stock sold (acquired) ..................... ( 4,104,000) -- 18,000
Other .............................................. 10,000 28,000 7,000
-----------------------------------------
Net cash used in financing activities ............ ( 3,247,000) ( 2,829,000) ( 7,468,000)
-----------------------------------------
Effect of Exchange Rate Changes on Cash .............. ( 156,000) ( 71,000) ( 1,000)
Increase in cash and cash equivalents ................ 974,000 3,112,000 1,185,000
-----------------------------------------
Cash and Cash Equivalents at Beginning of Year ....... 5,109,000 1,997,000 812,000
-----------------------------------------
Cash and Cash Equivalents at End of Year ............. $ 6,083,000 $ 5,109,000 $ 1,997,000
=========================================
The accompanying notes are an integral part of these consolidated financial
statements.
- 9 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries
1. Significant Accounting Policies
Farr Company and its wholly-owned subsidiaries (the "Company") has
prepared its financial statements in accordance with generally accepted
accounting principles. The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that effect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Following are the
Company's significant accounting policies:
Basis of Presentation -- Farr Company is a multinational company engaged
principally in the design, development, manufacture, sale and service
of air and to a minor degree, liquid filters. The principal market for
the Company's products and services are North American based commercial
wholesale distributors, HVAC OEMs and contractors and transportation
businesses. The accompanying consolidated financial statements include
the accounts of Farr Company and its wholly-owned subsidiaries. A
functional currency has been determined for each foreign entity of the
Company, and the exchange gain or loss from translating the foreign
currency statements to their U.S. dollar equivalents at the rates of
exchange in effect at the end of each period is charged or credited to
cumulative translation adjustments within stockholders' investment.
Differences from converting nonfunctional to functional currencies and
transaction gains and losses are included in income. During 1998, 1997
and 1996, $34,000 was charged to income, $131,000 was credited to
income and $97,000 was charged to income, respectively.
Accounting Period -- The Company's fiscal year ends on the Saturday closest
to December 31. The fiscal years ended January 2, 1999, January 3, 1998
and December 28, 1996 comprise 52, 53 and 52 weeks, respectively. In
the consolidated financial statements, all fiscal years are shown to
begin as of January 1 and end as of December 31 for clarity of
presentation.
Cash and Cash Equivalents -- Cash includes currency on hand, demand deposits
with financial institutions and investments with original maturities of
three months or less.
Short-Term Investments -- Short-term investments, consisting principally of
certificates of deposit and repurchase agreements secured by government
obligations, are held to maturity and are carried at cost, which
approximates fair value.
Inventories -- Inventories include material, labor and factory overhead.
Domestic inventories are stated at cost, determined by the last-in,
first-out method. All other inventories are stated at the lower of
cost, using the first-in, first-out method, or market.
Property, Plant and Equipment -- The cost of property, plant and equipment is
depreciated over the estimated useful lives of the respective assets,
using declining-balance and straight-line methods, based upon the
following lives.
Building and improvements 10 - 40 years
Machinery and equipment 3 - 12 years
Maintenance and repairs are charged to expense as incurred and the cost
of additions and betterments are capitalized. When assets are retired
or otherwise disposed of, the assets and the related accumulated
depreciation accounts are relieved, and any resulting gains or losses
from sales or retirements, are reflected in income.
In 1995, the Financial Accounting Standards Board (FASB) issued
Statement No. 121 - "Accounting for the Impairment of Long Lived Assets
to Be Disposed Of" (FASB No. 121), effective for 1996. The Company's
adoption of FASB No. 121 resulted in no impact on the Company's results
of operations or financial position.
Investments and Other -- Investments and other include intangible assets that
are amortized on a straight-line basis over five years; retirement
assets held under a rabbi trust covering supplemental executive savings
plan benefits for certain employees; and a 50 percent ownership
interest in a Malaysian joint venture which is accounted for under the
equity method.
Product Engineering and Development -- Engineering and development costs
aggregating $2,530,000, $2,129,000 and $2,217,000 in 1998, 1997 and
1996, respectively, for new products or improvements of existing
products, were expensed as incurred.
Revenue Recognition -- Revenue is recognized at the time the product is
shipped to the customer.
Income Taxes -- The Company accounts for income taxes in accordance with the
Statement of Financial Accounting Standards No. 109, "Accounting for
Incomes Taxes," which requires the use of the liability method of
accounting for deferred income taxes. The provision for income taxes
includes Federal, foreign, state and local income taxes currently
payable and those deferred because of temporary differences between the
financial statement and tax bases of assets and liabilities.
- 10 -
During fiscal 1998, the Company adopted Financial Accounting Standard No.130,
"Reporting Comprehensive Income", (SFAS No. 130), which established standards
for reporting and display of comprehensive income and its components in a full
set of general purpose financial statements. Accordingly, the Company has
reported its comprehensive income within its Consolidated Statements of
Stockholders' Investment to meet this new reporting requirement. For all periods
presented, no income tax benefit or expense was associated with any component of
other comprehensive income.
Certain reclassifications have been made to the prior years' financial
statements to conform with current year presentation.
2. Inventories
Domestic inventories totaling $6,475,000 and $6,103,000 at December 31,
1998 and December 31, 1997, respectively, are stated at cost determined
by the last-in, first-out method. If the first-in, first-out method of
inventory valuation had been used, inventories would have been
$6,751,000 and $6,613,000 higher than reported at December 31, 1998 and
December 31, 1997, respectively.
During 1997, domestic inventory quantities were reduced resulting in
the deposition of last-in, first-out inventory quantities carried at
cost prevailing in a prior year. Charging these lower costs to
operations had no material effect on net income in 1997.
3. Restructuring Costs
The Company recorded a restructuring charge of $1,500,000 in the fourth
quarter of 1992 related to anticipated costs associated with the
closures of two manufacturing plants. The two United States plants
located in Pryor, Oklahoma and Eatonton, Georgia were closed in 1993 as
part of the Company's efforts to consolidate manufacturing operations
and increase production efficiency, asset utilization and
profitability. The remaining $411,000 balance of this restructuring
charge is included as a component of accrued liabilities in the
accompanying Consolidated Balance Sheet as of December 31, 1998. If the
present weak real estate market in Eatonton, Georgia continues beyond
2000, the Company may need to record an additional provision to cover
the estimated costs of sub-leasing and maintaining the facility through
the Company's lease commitment period.
4. Common Stock
On April 3, 1989, the Company's Board of Directors declared a dividend
distribution of one common share purchase right for each share of
common stock outstanding on April 18, 1989. An exercisable right will,
under certain conditions, entitle its holder to purchase from the
Company one-half of one share of common stock at the exercise price,
subject to adjustment, at a price of $40 per whole share, subject to
adjustment. The exercise price as of December 31, 1998 is $14.222 per
whole share of common stock. The rights will become exercisable ten
days after any person acquires 20 percent or more of the Company's
outstanding common stock, or announces an offer which would result in
such person acquiring 30 percent or more of the Company's common stock.
The rights will expire on April 3, 1999, and may be redeemed by the
Company for $.01 per right at any time until ten business days after a
person acquires 20 percent or more of the Company's common stock. Under
certain circumstances after a person acquires 20 percent or more of the
Company's common stock, or after a merger or other business combination
involving the Company, an exercisable right will entitle its holder to
purchase shares of common stock (or shares of an acquiring company)
having a market value of twice the exercise price of one right.
In 1997, the Company issued 18,750 treasury shares to acquire
Metalcraft Air Filtration, Inc. In 1996, the Company transferred 2,961
shares to the Employee Stock Ownership Plan. As of December 31, 1998
and December 31,1997 the Company held in treasury 743,944 and 357,834
shares of its common stock at a cost of $5,295,000 and $1,191,000,
respectively. Outstanding stock amounts are reflected net of
outstanding treasury shares in the Consolidated Statements of
Stockholders' Investment. Per share amounts and shares outstanding in
the current and prior periods have been restated to reflect the 3-for-2
stock splits paid in the form of stock dividends (see note 5).
5. Dividend and Stock Split
On April 29, 1998 and February 18, 1997, the Company's Board of
Directors declared dividends that were paid in the form of 3-for-2
stock splits on May 29, 1998 and March 28, 1997, respectively.
- 11 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries
(continued)
6. Notes Payable and Long-term Debt
The Company's foreign subsidiaries utilize overdraft facilities that
aggregate to approximately $2,137,000 of which $145,000 was utilized as
of December 31, 1998. As of December 31, 1997, total foreign overdraft
facilities aggregated approximately $2,280,000 of which $93,000 was
utilized. The weighted average interest rate was 8.6% in 1998 and 7.9%
in 1997.
The Company utilizes a $10,000,000 revolving credit facility for its
domestic needs. As of December 31, 1998, the Company had no borrowings
outstanding under this facility. This facility will expire on June 1,
1999 when the then outstanding loan balance, if any, will be due.
Interest is payable on the loan at a floating rate equal to the Prime
rate or the bank's Offshore rate plus 1.75 percent. As of 1998 and 1997
year end, no long term debt was outstanding.
At December 31, 1998, no real, personal and intangible property was
pledged as security for long-term debt commitments.
Under the Company's domestic credit agreement, the Company is required
to maintain certain financial covenants.
Interest paid on outstanding debt and obligations net of amounts
capitalized were $118,000, $210,000 and $788,000 in 1998, 1997, and
1996, respectively.
No future principal payments are scheduled as no long-term debt was
outstanding as of December 31, 1998.
- 12 -
7. Income Taxes
The provision for income taxes is summarized as follows:
For the Years Ended December 31, 1998 1997 1996
- ---------------------------------------------------------------------------
Current -- Federal ........... $1,655,000 $2,441,000 $2,772,000
State ............. 266,000 231,000 432,000
Foreign ........... 1,311,000 791,000 282,000
--------------------------------------
3,232,000 3,463,000 3,486,000
--------------------------------------
Deferred-- Federal ........... 484,000 429,000 ( 96,000)
State ............. 124,000 16,000 --
Foreign ........... ( 52,000) ( 43,000) 400,000
--------------------------------------
556,000 402,000 304,000
--------------------------------------
$3,788,000 $3,865,000 $3,790,000
======================================
The following is a reconciliation of income taxes at the Federal
statutory rate with income taxes recorded by the Company:
For the Years Ended December 31, 1998 1997 1996
- -------------------------------------------------------------------------------------------------
Computed income taxes at statutory rate ................. $3,738,000 $3,618,000 $3,291,000
State income taxes, net of federal income tax benefit ... 258,000 163,000 285,000
Taxes on foreign subsidiaries' net income in excess
of (less than) income taxes at statutory rates ........ 24,000 ( 61,000) 40,000
Other items, net ........................................ ( 232,000) 145,000 174,000
--------------------------------------
Provision for income taxes .............................. $3,788,000 $3,865,000 $3,790,000
======================================
Deferred taxes are recorded based upon differences between the
financial statement and tax bases of assets and liabilities and
available tax credit carryforwards. Temporary differences and
carryforwards which give rise to a significant portion of deferred tax
assets and liabilities were as follows:
For the Years Ended December 31, 1998 1997
- --------------------------------------------------------------------
Depreciation and amortization ........ ($ 355,000) ($ 456,000)
Employee compensation accruals ....... 1,138,000 567,000
Plant relocation and restructuring ... 140,000 168,000
DISC commission accrual .............. ( 1,386,000) ( 1,584,000)
Acquisition reserves ................. ( 610,000) ( 526,000)
Inventory ............................ 493,000 437,000
Other items, net ..................... 161,000 409,000
---------------------------
($ 419,000) ($ 975,000)
===========================
Included in income taxes payable and current deferred income taxes at
December 31, 1998 and December 31, 1997, were $369,000 and $ 365,000,
respectively, of foreign deferred income taxes.
- 13 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries
(continued)
The consolidated income before income tax, by domestic and foreign
sources is as follows:
For the Years Ended December 31, 1998 1997 1996
- -----------------------------------------------------------------------------
Domestic .......................... $ 7,362,000 $ 8,859,000 $7,792,000
Foreign ........................... 3,631,000 2,381,000 1,888,000
----------------------------------------
$10,993,000 $11,240,000 $9,680,000
========================================
Income taxes paid, net, were $3,683,000, $3,806,000 and $3,461,000 in
1998, 1997 and 1996, respectively.
8. Employee Benefit Plans
The Company has defined contribution retirement plans covering domestic
employees who meet eligibility requirements. Company contributions are
based on a formula as specified in the respective plan agreements.
Contributions, which aggregated $1,093,000 in 1998, $1,295,000 in 1997
and $851,000 in 1996 were charged to expense in accordance with the
approved plan formulas.
Under one of the Company's domestic defined contribution plans,
covering key employees, Company contributions and employee compensation
deferrals are made to a Company trust under provisions of the plan. The
deferred compensation, contributions and earnings from the trust are
included in the Company's Consolidated Balance Sheets both as a
non-current asset and a non-current liability. The total plan
non-current assets and non-current liabilities as of December 31, 1998
and 1997 were $1,490,000 and $855,000, respectively.
Pension costs for the Company's defined benefit plans, covering
eligible employees in foreign operations, are determined by independent
actuarial valuations.
The Company has two foreign defined benefit plans. The following table
sets forth the change in benefit obligation, the change in plan assets,
the funded status, the assumptions used in the accounting for the plans
on an average weighted basis and the components of net periodic benefit
cost for the years ended December 31, 1998 and 1997.
For the Years Ended December 31, 1998 1997
- -------------------------------------------------------------------------------
Change in benefit obligation
Benefit obligation at beginning of year .......... $5,726,000 $5,092,000
Foreign currency exchange rate changes ........... ( 44,000) --
Service cost ..................................... 352,000 294,000
Interest cost .................................... 428,000 388,000
Net actuarial loss ............................... 274,000 135,000
Benefits paid .................................... ( 189,000) ( 183,000)
-------------------------
Benefit obligation at end of year ................ 6,547,000 5,726,000
-------------------------
Change in plan assets
Fair value of plan assets at beginning of year ... 6,813,000 6,015,000
Foreign currency exchange rate changes ........... ( 30,000) --
Actual return on plan assets ..................... 642,000 745,000
Employer contribution ............................ 143,000 163,000
Plan participants' contributions ................. 87,000 74,000
Benefits paid .................................... ( 189,000) ( 183,000)
-------------------------
Fair value of plan assets at end of year ......... 7,466,000 6,814,000
-------------------------
Funded status .................................... 919,000 1,088,000
Unrecognized net actuarial gain .................. ( 294,000) ( 516,000)
Unrecognized prior service cost .................. 54,000 45,000
-------------------------
Prepaid benefit cost ............................. $ 679,000 $ 617,000
=========================
- 14 -
For the Years Ended December 31, 1998 1997 1996
- -------------------------------------------------------------------------------
Weighted average assumptions
Discount rate ........................... 7.7% 7.7% 7.8%
Expected return on plan assets .......... 9.5% 9.4% 9.8%
Rate of compensation increase ........... 6.0% 6.0% 5.8%
Components of net periodic benefit cost
Service cost ............................ $352,000 $294,000 $232,000
Interest cost ........................... 431,000 389,000 337,000
Expected return on plan assets .......... ( 663,000) ( 572,000) ( 508,000)
Amortization of prior service cost ...... ( 13,000) ( 12,000) ( 20,000)
Recognized net actuarial gain ........... ( 3,000) ( 1,000) ( 10,000)
----------------------------------
Net periodic benefit cost ............... $104,000 $ 98,000 $ 31,000
==================================
The projected benefit obligation, accumulated benefit obligation, and
fair market value of plan assets for the pension plan with an
accumulated benefit obligation in excess of plan assets were
$1,191,000, $1,006,000 and $1,175,000 respectively, as of December 31,
1998, and $1,180,000, $1,006,000 and $1,175,000 respectively as of
December 31, 1997.
The Company provides no post-retirement health care and life insurance
benefits or other post-employment benefits to its employees.
9. Stock Options
Under the 1983 and 1993 stock option plans, the Company may grant
non-qualified and incentive stock options to officers and employees.
Options are contingent upon continued employment, and become
exercisable from at least one year after date of grant at such times
and installments as the Compensation Committee of the Board shall
provide. All options outstanding at December 31, 1998 had an exercise
price equal to 100 percent of the fair market value on the date the
option was granted except for 99,000 shares that were granted in 1995.
Compensation expense recorded under the plan was $17,000 in 1998 and
$27,000 in both 1997 and 1996. Options expire ten years from the date
of grant, subject to earlier expiration under the terms of the plan.
The 1983 plan covered a total of 703,125 shares of the Company's common
stock of which at December 31, 1998, 35,157 shares were subject to
presently outstanding options. At December 31, 1998, 787,500 shares of
common stock were reserved for distribution under the 1993 plan, of
which 281,260 shares were subject to outstanding options.
As permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS No. 123), effective for
1996, the Company continues to account for stock compensation costs in
accordance with the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees". Had compensation
cost for the Company's stock plans been determined in accordance with
SFAS No. 123, "Accounting for Stock-Based Compensation", the Company's
net income and earnings per share would have been reduced to the
following pro forma amounts:
For the Years Ended December 31, 1998 1997 1996
- -----------------------------------------------------------------------
Net Income As Reported $7,205,000 $7,375,000 $5,890,000
Pro Forma $6,896,000 $7,237,000 $5,814,000
Diluted EPS As Reported $ .86 $ .88 $ .71
Pro Forma $ .82 $ .86 $ .70
Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to December 31, 1994, the resulting pro forma
compensation cost may not be representative of that to be expected in
future years.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1998, 1997 and 1996:
risk-free interest rate of 5.67 percent for options granted in 1998,
6.26 percent for options granted in 1997 and 6.28 and 6.76 percent for
options granted in 1996; expected dividend yields of 0 percent,
expected volatility of 42 percent, expected life of 7 years for 1998
options and expected dividend yields of 0 percent, expected volatility
of 45 percent, expected life of 7 years for 1997 and 1996 options.
- 15 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries
(continued
Activity under the 1983 and 1993 plans is summarized as follows:
1998 1997 1996
--------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Shares Avg. Option Price Shares Avg. Option Price Shares Avg. Option Price
------- ----------------- ------- ----------------- ------- -----------------
Options outstanding
beginning of year ............... 498,280 $ 3.79 500,875 $ 3.09 543,817 $ 3.13
Granted ........................... 68,000 12.16 70,500 8.68 5,625 4.11
Exercised ......................... 223,890 3.16 68,200 3.78 26,100 3.51
Cancelled and expired ............. 25,973 3.14 4,895 3.18 22,467 3.67
------- ------- ------- ------- ------- -------
Options outstanding
end of year ..................... 316,417 $ 6.09 498,280 $ 3.79 500,875 $ 3.09
======= ======= ======= ======= ======= =======
End of year shares exercisable .... 92,038 $ 4.57 244,678 $ 3.41 250,846 $ 3.69
======= ======= ======= ======= ======= =======
The following table summarizes information about fixed stock options
outstanding as of December 31, 1998:
Options Outstanding Options Exercisable
----------------------------------------------------------------- ----------------------------
Weighted-Avg.
Range of Number Remaining Weighted-Avg. Number Weighted-Avg.
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
--------------- ----------- ---------------- -------------- ----------- --------------
$ 3.91 - $ 4.00 17,999 .8 Years $ 3.99 17,999 $ 3.99
4.78 - 5.00 17,325 2.6 4.86 17,325 4.86
2.83 - 2.83 23,625 5.2 2.83 23,625 2.83
2.22 - 4.11 123,469 6.1 2.44 16,589 3.25
8.00 - 12.75 134,000 8.9 10.47 16,500 8.73
--------------- ------- --- ------ ------ ------
$ 2.22 - $12.75 316,417 6.7 $ 6.09 92,038 $ 4.57
=============== ======= === ====== ====== ======
On January 22, 1991, the Company's Board of Directors adopted and
approved the 1991 Stock Option Plan for Non-Employee Directors. Under
the 1991 Stock Option Plan, the Company is authorized to issue up to
225,000 shares of common stock to the Company's non-employee directors
of which 121,500 shares are subject to presently outstanding options.
Activity for fiscal years 1998, 1997 and 1996 under the 1991 Plan are
summarized as follows:
1998 1997 1996
--------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Shares Avg. Option Price Shares Avg. Option Price Shares Avg. Option Price
------- ----------------- ------- ----------------- ------- -----------------
Options outstanding
beginning of year ............... 112,500 $ 4.51 85,500 $ 3.51 63,000 $ 3.17
Granted ........................... 31,500 11.29 27,000 7.67 22,500 4.42
Exercised ......................... 18,000 4.31 -- -- -- --
Cancelled and expired ............. 4,500 12.75 -- -- -- --
------- ------- ------- ------- ------ -------
Options outstanding
end of year ..................... 121,500 $ 6.05 112,500 $ 4.51 85,500 $ 3.51
======= ======= ======= ======= ====== =======
End of year shares exercisable .... 94,500 $ 4.54 85,500 $ 3.51 63,000 $ 3.17
======= ======= ======= ======= ====== =======
- 16 -
The following table summarizes information about non-employee director
fixed stock options outstanding as of December 31, 1998:
Options Outstanding Options Exercisable
----------------------------------------------------------------- ----------------------------
Weighted-Avg.
Range of Number Remaining Weighted-Avg. Number Weighted-Avg.
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
--------------- ----------- ---------------- -------------- ----------- --------------
$4.06 - $ 4.11 18,000 2.8 Years $ 4.08 18,000 $ 4.08
2.22 - 2.83 22,500 4.9 2.50 22,500 2.50
3.06 - 5.72 31,500 6.9 4.03 31,500 4.03
7.67 - 13.00 49,500 8.7 9.67 22,500 9.67
-------------- ------- --- ------ ------ ------
$2.22 - $13.00 121,500 6.7 $ 6.05 94,500 $ 4.54
============== ======= === ====== ====== ======
10. Per Share Amounts
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 (SFAS 128),
"Earnings per Share" (EPS), which requires dual presentation of basic
EPS and diluted EPS, simplifies existing computational guidelines, and
increases the comparability of earnings per share on an international
basis. SFAS 128 was effective for periods ending after December 15,
1997. All prior periods have been restated.
Income, average weighted shares outstanding and earnings per share data
as restated for SFAS No. 128 are as follows:
For the Years Ended December 31, 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
Per Share Per Share Per Share
Income Shares Amount Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------ ------ ------ ------
BASIC EARNINGS
- --------------
Income available to
common stockholders ....... $7,205,000 8,273,609 $ .87 $7,375,000 8,223,810 $ .90 $5,890,000 8,167,683 $ .72
===== ===== =====
DILUTED EARNINGS PER SHARE
- --------------------------
Assumed dilution for
outstanding options ....... -- 108,146 -- 159,414 -- 97,228
---------- --------- ---------- --------- ---------- --------
Income available to
common stockholders
plus assumed conversions .. $7,205,000 8,381,755 $ .86 $7,375,000 8,383,224 $ .88 $5,890,000 8,264,911 $ .71
========== ========= ===== ========== ========= ===== ========== ========= =====
As a result of the 3-for-2 stock splits that were distributed on May
29, 1998 and March 28, 1997, per share amounts for the 1997 and prior
years have been restated to reflect the weighted average number of
shares of common stock outstanding increased by shares issued for the
stock split.
- 17 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries
(continued)
11. Commitments and Contingencies
The Company leases certain facilities and equipment under agreements,
the majority of which expire at various dates through 2004. The
majority of the Company's leases provide for the payment of real estate
taxes and insurance. Net rental expense was $1,337,000 for the year
ended December 31, 1998, $1,227,000 for the year ended December 31,
1997 and $1,145,000 for the year ended December 31, 1996. As of
December 31, 1998, approximate minimum rental commitments under
noncancelable leases which have not been capitalized were as follows:
Year Ending Amount
----------- -----------
1999 $ 1,037,000
2000 847,000
2001 619,000
2002 459,000
2003 285,000
Thereafter 144,000
-----------
Total $ 3,391,000
===========
The Company is involved in several claims and suits that arise out of
the ordinary course of business, and has tax returns under review.
Management believes that these matters are either adequately reserved,
covered by insurance, or would not have a material adverse effect on
the financial position or operations of the Company if disposed of
unfavorably.
12. Segment Information
The adoption of Statement of Financial Accounting Standards No. 131,
"Disclosures About Segments of an Enterprise and Related Information"
does not alter the Company's business segment reporting disclosure
requirements. While the Company manufactures a variety of filtration
products, discrete financial information by product or market is not
available. Therefore, operating decisions and operating performance
assessments are not made based on aggregating within any particular
filtration product or market.
The Company is engaged in one line of business - filtration. The
Company's basic business is manufacturing filters for the control of
particulate and vapor contaminants in air and liquids. Information
about the Company's operations in different geographic areas for the
current year ended December 31, 1998 and the prior years ended December
31, 1997 and December 31, 1996 are presented based upon shipments from
the scheduled countries as follows:
(In thousands) Net Sales to Unaffiliated Customers Long-Lived Assets
- -----------------------------------------------------------------------------------------------------------------
For the Years Ended December 31, 1998 1997 1996 1998 1997 1996
-------------------------------- --------------------------------
United States $ 96,426 $101,352 $ 100,008 $ 16,973 $ 16,348 $ 13,350
Canada 14,723 13,162 11,632 1,764 1,961 1,528
Europe 11,136 11,248 10,381 2,046 2,095 1,713
-------------------------------- --------------------------------
Total Segments 122,285 125,762 122,021 20,783 20,404 16,591
Adjustments & Eliminations -- -- -- 28 ( 583) ( 583)
-------------------------------- --------------------------------
Consolidated Totals $122,285 $125,762 $122,021 $ 20,811 $ 19,821 $ 16,008
================================ ================================
Long-Lived assets are those of the Company that are identified with the
operations in each geographic area.
- 18 -
13. Business Combinations and Investments in Partnership
In November 1997, the Company completed its acquisition of Metalcraft
Air Filtration, Inc. (MCF), a small, high quality specialty filtration
manufacturer of enclosed filter housings and bags used for filtering
and then containing hazardous waste dust from certain biological,
chemical, nuclear and medical facilities having special air handling
and filtration system requirements. MCF is located in Washington, North
Carolina. The Company issued 18,750 shares of its common stock in
exchange for all the shares of MCF. The transaction was accounted for
under the purchase method of accounting and the operating results of
this business has been included in the consolidated financial
statements since the date of acquisition. The purchase price exceeded
the fair value of the tangible net assets acquired by approximately
$412,000.
In June 1997, the Company entered into a joint venture partnership with
Quest Technology Sdn. Bhd., a Malaysian manufacturer and distributor of
air filtration products and a licensee of certain Farr products. Under
the agreement, the Company has a 50 percent ownership interest in the
operations of QF Filter Sdn. Bhd., a manufacturing operation located in
Malaysia and only has a limited ability to control partnership's
activities. Accordingly, this investment is accounted for using the
equity method of accounting. During 1998, the Company's equity in QF
Filter Sdn. Bhd.'s loss was $35,000.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of Farr Company:
We have audited the accompanying consolidated balance sheets of Farr
Company (a Delaware corporation) and subsidiaries as of December 31,
1998 and 1997 and the related consolidated statements of income,
stockholders' investment and cash flows for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Farr
Company and subsidiaries as of December 31, 1998 and 1997 and the
results of their operations and their cash flows for each of the three
years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
Arthur Andersen LLP
Los Angeles, California
January 28, 1999
- 19 -
SELECTED FINANCIAL DATA Farr Company and Subsidiaries
Years Ended December 31 1998 1997 1996 1995 1994
===========================================================================================================
(In thousands except share and per share data)
Net Sales ............................... $ 122,285 $ 125,762 $ 122,021 $ 113,275 $ 106,989
Net Income (Loss) (Note D) .............. 7,205 7,375 5,890 3,124 ( 355)
Income (Loss) per diluted share (G) ..... .86 .88 .71 .38 ( .05)
Total Assets (Notes A & B) .............. 59,901 60,828 53,687 55,570 59,269
Long-term Debt, net of current portion
(Notes A, B, C, E & F) ................ -- -- 2,068 9,412 18,957
Cash Dividends per share ................ -- -- -- -- --
Weighted average number of shares (G) ... 8,381,755 8,383,224 8,264,911 8,330,095 8,275,990
Capital expenditures .................... 2,985 4,508 1,465 1,163 987
Net property, plant and equipment ....... 18,027 17,619 15,611 16,406 17,930
Working Capital (Notes A & B) ........... 24,525 21,737 19,806 20,183 21,782
===========================================================================================================
Note A. In December 1985, the Company negotiated an agreement for
$8,000,000 in Industrial Revenue Bonds to finance the Company's
facility in Jonesboro, Arkansas. In December 1993 and February
1994, the Company redeemed a total of $2,615,000 of the bonds with
surplus cash held in trust. In January 1996, the Company fully
retired these bonds.
Note B. In August 1991, the Company negotiated an agreement for
$2,500,000 in Industrial Revenue Bonds to finance the Company's
facility in Holly Springs, Mississippi. In August 1996, the
Company fully retired these bonds.
Note C. In February 1996, the Company completed refinancing of its
domestic long-term debt with a new lending institution, including
a $15,000,000 revolving credit facility that was subsequently
amended and reduced to $10,000,000 commensurate with the Company's
financing requirements.
Note D. In 1995 and 1994, pretax income (loss) included provisions of
$540,000 and $1,000,000 respectively for the estimated cost of
closing and reorganizing U.S. manufacturing facilities.
Note E. In 1994, the Company completed refinancing of its long-term
debt with new lending institutions including a $22,000,000
revolving credit facility and $7,500,000 of term loan credit
facilities.
Note F. In November 1995, the Company sold its plant located in Rialto,
California for $3,050,000 which resulted in a gain of $676,000.
The entire amount of the net proceeds were received in cash and
were primarily used to retire secured debt on the subject
property.
Note G. As a result of the 3-for-2 stock split declared on April 29,
1998 paid on May 29, 1998 and the 3-for-2 stock split declared on
February 18, 1997 paid on March 28, 1997, per share amounts for
prior years have been restated to reflect the weighted average
number of shares of common stock outstanding, increased by shares
to be issued for the stock split.
= 20 -
MANAGEMENT'S DISCUSSION AND ANALYSIS Farr Company and Subsidiaries
RESULTS OF OPERATIONS
- ---------------------
1998 COMPARED TO 1997
Sales for 1998 reached $122,285,000, down $3,477,000 or 2.8 percent from 1997
sales of $125,762,000. For the year, foreign subsidiary sales increased 5.9
percent while domestic sales decreased 4.9 percent. For making comparisons
between 1998 and 1997 it should be noted 1997's fiscal year contained 53 weeks
or one week more than 1998's fiscal year period. In addition, lower 1998 foreign
exchange rates as compared to 1997 rates used to convert operating results of
the Company's Canadian subsidiary to U.S. dollars reduced comparable 1998 sales
by $1,474,000. Excluding the effects of both these items, sales for fiscal 1998
remained virtually unchanged compared to 1997.
Net income for 1998 totaled $7,205,000, down $170,000 or 2.3 percent from
$7,375,000 in 1997. After adjusting for the longer fiscal year period in 1997
and the unfavorable 1998 Canadian foreign exchange rates, 1998's comparable net
income would reflect an improvement over 1997's net income of 2 percent.
Gross margin for 1998 expressed as a percentage of sales, decreased to 25.5
percent, down .7 of a percent from 26.2 percent in 1997. The 1998 decrease in
margin reflected higher warranty costs, unfavorable sales mix and lower sales
while fixed manufacturing cost rose as a percentage of overall sales. The
Company anticipates that gross margin percentage will improve during 1999 as a
result of lower warranty cost and productivity improvements.
Selling, general and administrative expenses expressed as a percentage of sales
for 1998 were 16.6 percent, down .6 of a percent compared to 17.2 percent in
1997. 1998 spending totaled $20,298,000, down $1,394,000 compared to $21,692,000
in 1997. The 1998 decrease reflected cost reduction programs and lower selling
and marketing expenses commensurate with 1998's lower level of sales volume.
Interest expense continued to decline in 1998 and interest income continued to
increase as average invested cash continued to increase during 1998. During
1999, the Company anticipates its cash flow from operating activities will
continue to be strong and that interest income will continue to increase as
average invested cash balances rise.
The Company's effective tax rate for 1998 was 34.5 percent compared to 34.4
percent in 1997. The continued low effective tax rate is a result of tax
benefits being generated by the Company's Foreign Sales Corporation and lower
effective tax rates in Canada where taxable income increased significantly
during 1998. During 1999, the Company anticipates that its tax rate will
increase to approximately 36 percent as tax benefits decrease from the Company's
Foreign Sales Corporation as a result of lower foreign sales, especially to
Pacific rim countries.
1997 COMPARED TO 1996
Record 1997 sales of $125,762,000 were up $3,741,000 or 3.1 percent from prior
year sales of $122,021,000. Foreign subsidiary sales increased 10.9 percent and
domestic sales increased 1.3 percent in 1997.
Net income reached record highs during 1997 totaling $7,375,000, up 25 percent
or $1,485,000 from $5,890,000 reported in the prior year as sales continued to
grow and improve productivity. Increased sales volume, improved operating
efficiencies, lower interest expense and lower effective income tax rates were
all major contributing factors in improving 1997's net income performance over
the prior year.
Gross margins for 1997 improved to 26.2 percent, up 1 percent from 25.2 percent
in 1996. The improvement in gross margins was the result of continued
improvement in operating efficiencies and a better sales mix of products with
higher margins compared to the prior year.
Selling, general and administrative expenses as a percentage of sales for 1997
and 1996 were 17.2 and 16.7 percent, respectively. 1997 spending totaled
21,692,000, up $1,273,000 compared to $20,419,000 in 1996. 1997's increase
reflected higher spending in the area of selling and marketing related expenses
directed toward increasing sales in existing and new product markets.
- 21 -
MANAGEMENT'S DISCUSSION AND ANALYSIS Farr Company and Subsidiaries
(continued)
Interest expense during 1997 was reduced to $197,000 from $687,000 in the prior
year due to long and short-term borrowing reductions. As of the end of the
second quarter of 1997 the Company's domestic operations retired all previously
outstanding bank debt. In addition, due to the continued strong cash flow
provided by operations, the Company generated $159,000 in interest income from
investing cash.
The effective income tax rate for 1997 was 34.4 percent compared with 39.2
percent in 1996. The decrease in 1997's tax rate was primarily related to lower
effective tax rates being generated from the Company's Foreign Sales
Corporation.
1996 COMPARED TO 1995
Record 1996 net sales of $122,021,000 were up $8,746,000 or 7.7 percent from
prior year sales of $113,275,000. For the year, foreign subsidiary sales
increased 9.6 percent and domestic sales increased 7.3 percent.
Record net income for 1996 totaled $5,890,000, up significantly from $3,124,000
in the prior year. Increased sales volume, improved operating efficiencies and
lower interest expense were the primary reasons for the gain in 1996. Foreign
consolidated subsidiaries totaled approximately 20 percent of consolidated net
income, down from 21 percent in the prior year.
Gross margin for 1996 increased to 25.2 percent, up .7 percent from 24.5 percent
in 1995. The increase in gross margins was the result of improved operating
efficiencies and a better sales mix of products with higher margins compared to
the prior year.
Selling, general and administrative expenses as a percentage of sales for 1996
and 1995 were 16.7 and 18.5 percent, respectively. 1996 spending totaled
$20,419,000 compared to $20,956,000 in 1995, which reflects a decrease of
$537,000, or 3 percent. Most of the decreased expense related to lower loan fee
amortization and sales and marketing related expenses.
Interest expense declined $1,109,000, or 62 percent in the year primarily due to
the significant decrease in long-term debt.
- 22 -
LIQUIDITY & CAPITAL RESOURCES
- -----------------------------
FINANCIAL CONDITION
As of December 31, 1998, the Company's capital structure included $145,000 of
current debt and $42,054,000 of stockholders' investment. Stockholders' equity
increased 9.2 percent during 1998 growing to $42,054,000 from $38,507,000 at the
end of 1997.
Farr Company's balance sheet continues to exhibit liquidity and financial
strength. As of December 31, 1998, total assets were $59,901,000 down $927,000
from prior year end levels primarily as a result of decreases in short-term
investments and accounts receivables.
During 1998, the Company's domestic operations were financed through a long-term
credit facility. The Company's domestic long-term credit facility is an
unsecured $10,000,000 revolving line of credit facility. As of December 31,
1998, no borrowings were outstanding and unused borrowing availability was
$10,000,000.
The Company's foreign subsidiaries borrow under overdraft credit facilities. As
of December 31, 1998, overdraft facilities amounted to $2,137,000 of which
$145,000 was utilized. As of December 31, 1997, foreign overdraft facilities
amounted to $2,280,000 of which $93,000 was utilized.
MARKET RISK
The Company's market risk is the potential loss arising from adverse changes in
interest rates. The Company does not have any fixed long term debt obligations.
The Company invests its cash in money market funds and short term investment
funds that carry maturities of less than 180 days. Over ninety percent of these
investments have their interest rates adjusted weekly or monthly and
consequently, the cost of these securities approximates market value.
Although the Company periodically evaluates derivative financial instruments,
including forwards, swaps and purchased options, to manage foreign currency
exchange rate exposures, the Company does not currently hold any derivatives for
managing these risks or for trading purposes.
EURO INTRODUCTION
The Company does not expect the introduction of the EURO resulting from the
European Monetary Union to have a significant impact on the competitive position
or operations of the Company.
YEAR 2000
The Company's internal business systems are Year 2000 (Y2K) compliant as of
December 31, 1998. Major customers and suppliers have advised the Company that
their systems either are Year 2000 compliant or were anticipated to be compliant
by December 31, 1998. The Company does not anticipate material or significant
external risks or exposures associated with Year 2000 issues. Unanticipated Year
2000 related problems will be addressed by a Y2K Task Force Team within the
Company. The Company's estimate for external cost including consultants and
software applications used to make the Company's internal business systems Y2K
compliant are not material to the Company's business, operations or financial
condition. The Company did not track internal cost incurred for the Y2K project
that are principally related to payroll costs for its information systems group.
- 23 -
MANAGEMENT'S DISCUSSION AND ANALYSIS Farr Company and Subsidiaries
(continued)
CASH FLOW
During 1998, cash flows from operating activities decreased to $6,106,000
compared to $14,022,000 in 1997 and $10,299,000 in 1996. The decrease in 1998
was primarily the result of a decrease in working capital associated with
decreased accounts payable and accrued liabilities. Cash flow from operations
were used to support $2,985,000 of capital expenditures and treasury stock
repurchases totaling $4,104,000.
Capital expenditures decreased to $2,985,000 from $4,508,000 in 1997. The
decrease in capital spending was related to higher spending in 1997 related to
warehouse expansion in Canada and remodeling of the Company's corporate offices.
The Company's cash flow generated from operating activities combined with
current cash balances are anticipated to generate adequate cash flow to meet
planned operating needs, provide for capital spending, complete the stock
repurchase program covering 1,000,000 shares and meet current debt service
requirements.
During 1997, the Company invested $250,000 as a 50 percent partner in a
manufacturing joint-venture located in Malaysia. In 1998, it invested another
$106,000 in the form of a long-term note to support working capital needs of the
joint-venture. The joint-venture is anticipated to help the Company maintain
competitive prices and support faster delivery of products in Malaysia and other
Pacific Rim markets.
During the fourth quarter of 1997, the Company acquired Metalcraft Air
Filtration, Inc. (MCF) through a merger. Farr issued 18,750 shares of its common
stock for all of MCF's stock.
Inflation has not been a significant factor for the Company in a number of
years. Cost increases for labor and material have been generally low, and any
impact has been offset by productivity improvement and materials management.
Safe Harbor for Forward-Looking Statements: Except for historical information
contained herein, the statements in this annual report are forward-looking
statements that are made pursuant to the safe harbor provisions of the Private
Securities Litigation Act of 1995. Forward-looking statements and the business
prospects of Farr Company are subject to a number of risks and uncertainties
which may cause the Company's actual results in the future periods to differ
materially from the forward-looking statements. These risks and uncertainties
include, among other things, product supply and demand, competition, government
regulation or action, litigation, operations performance, Y2K exposures, the
Company's ability to implement its business plans, access to capital, and
environmental risks. These are described in the Company's reports on Forms 10-K
and 10-Q and other filings with the Securities and Exchange Commission.
- 24 -
SUMMARIZED QUARTERLY FINANCIAL DATA Farr Company and Subsidiaries
(Unaudited)
(In thousands except per share data)*
1998 1997 1996
-------------------------------------- -------------------------------------- -------------------------------------
Net Gross Net Per Net Gross Net Per Net Gross Net Per
Quarter Sales Margin Income Share Sales Margin Income Share Sales Margin Income Share
==============================================================================================================================
First $ 31,989 $ 8,206 $ 1,918 $ .23 $ 30,341 $ 7,891 $ 1,700 $ .20 $ 31,079 $ 7,154 $ 1,178 $ .14
Second 30,434 7,900 1,876 .22 31,569 8,576 1,826 .22 31,356 8,072 1,499 .18
Third 31,011 7,897 1,784 .21 31,612 8,269 1,892 .23 29,951 7,533 1,595 .20
Fourth 28,851 7,122 1,627 .20 32,240 8,234 1,957 .23 29,635 7,986 1,618 .19
-------------------------------------------------------------------------------------------------------------------
Year $122,285 $ 31,125 $ 7,205 $ .86 $125,762 $ 32,970 $ 7,375 $ .88 $122,021 $ 30,745 $ 5,890 $ .71
==============================================================================================================================
* Per share data has been restated for the 3-for-2 stock split declared in May
1998 and is presented on a diluted basis.
SUMMARY OF STOCK QUOTATIONS
1998 1997 1996
-------------------- ------------------- --------------------
Quarter High Low High Low High Low
=============================================================================================
First $13.00 $ 9.00 $ 8.67 $ 7.28 $ 4.46 $ 3.33
Second 14.33 10.50 11.00 8.00 6.63 4.00
Third 13.00 9.00 12.67 10.33 6.67 5.21
Fourth 10.44 8.25 12.00 9.67 8.33 6.50
----------------------------------------------------------------------------
Year $14.33 $ 8.25 $12.67 $ 7.28 $ 8.33 $ 3.33
=============================================================================================
The above information was obtained from the National Association of Securities
Dealers, Inc. (NASD) Monthly Statistical Report. The Company's stock is traded
in the over-the-counter National Market System under the symbol FARC. Price per
share has been restated for the 3 for 2 stock split declared in May 1998.
No cash dividends were declared on the Company's common stock in 1998, 1997 or
1996.
- 25 -
CORPORATE INFORMATION Farr Company and Subsidiaries
DIRECTORS
- ---------
FARR COMPANY
Robert Batinovich
Chairman and Chief Executive Officer
Glenborough Realty Trust Incorporated NYSE, GLB
Management of Commercial Real Estate (2)
Richard P. Bermingham
Chairman
Bermingham Investment Company (1) (3)
Denis R. Brown, Jr.
President and Chief Executive Officer
Pinkerton, Inc.
Security & Investigation Services (2)
A. Frederick Gerstell
Vice Chairman, Director and Consultant
Vulcan Materials Company (2)
John C. Johnston
President and Chief Executive Officer
Farr Company
John J. Kimes
Chief Executive Officer and President
Computerized Security Systems, Inc.
Manufacturer of Electronic and
Mechanical Lock Hardware and Systems (1) (3)
H. Jack Meany
Chairman of the Board of Directors
Farr Company (3)
John A. Sullivan
Investment Advisor
Relational Investors, LLL (1)
(1) Audit Committee
(2) Compensation Committee
(3) Executive Committee
OFFICERS
- --------
FARR COMPANY
H. Jack Meany
Chairman of the Board of Directors
John C. Johnston
President and Chief Executive Officer
Steve Pegg
Senior Vice President, Chief Financial Officer, Treasurer and Secretary
Richard Larson
Senior Vice President, Sales and Marketing
Myron G. Rasmussen
Vice President, Corporate Technical Services
John Vissers
Vice President, Controller, Assistant Treasurer and Assistant Secretary
Phil Whitaker
Vice President, International Sales and Marketing
FARR FILTRATION, LTD. (UNITED KINGDOM)
Clive J. Jones
Managing Director
FARR, INC. (CANADA)
Dominique Mignacco
Vice President and General Manager
- 26 -
Corporate Offices Manufacturing Distributors
2201 Park Place Genmech Engineering, Singapore
El Segundo, California 90245
310-727-6300
Internet address: http://www.farrco.com
Company's Internet home page offers
access to a variety of information including
Farr's products and services, worldwide
operations, financial data, and stockholder-
related information.
Subsidiaries and Joint Ventures Registrar and Transfer Agent
Farr, Inc., Montreal, Canada Chemical Mellon Shareholder Services
Farr Filtration, Ltd., Birmingham, England Los Angeles, California
QF Filters, SDN BHD, Malaysia
Manufacturing and Distribution Facilities Legal Counsel
Jonesboro, Arkansas Gibson, Dunn & Crutcher LLP
Corcoran, California Los Angeles, California
Delano, California
Crystal Lake, Illinois Auditors
Holly Springs, Mississippi
Conover, North Carolina Arthur Andersen LLP
Washington, North Carolina Los Angeles, California
Montreal, Canada
Toronto, Canada
Birmingham, England
Singapore
Paris, France
Form 10-K
Manufacturing Licensees Stockholders of record as of March
12, 1999 may obtain copies of the
Anfilco Ltd., Curgaon, India Company's Annual Report on Form 10-K
Antung Trading Corp., Taipei, Taiwan files with the Securities and
Boart MSA (PTY) Ltd. South Africa Exchange Commission by writing to:
Casiba S. A., Buenos Aires, Argentina Steve Pegg, 2201 Park Place,
Clyde-Apac Ltd., Woodville, Australia El Segundo, California 90245-4900
Genmech Engineering, Singapore
Industries Filvac S.A. de C.V., Mexico
Nihon Spindle Mfg., Co., Ltd.
Osaka, Japan
QF Filters, SDN BHD, Malaysia (Joint Venture)
Taymac Ltd., Christchurch, New Zealand
Turbiparts, C.A., Caracas, Venezuela
Vibran Engineering (M) SDN BHD,
Petaling Jaya, Malaysia
Wilectec Co., Ltd., Kwai Chung, N.T.,
Hong Kong
- 27 -
FARR
1998 Annual Report