-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WXU9RzSQTLoQkEJVtHtdBxbLp5DLru3jtDTgP6HbWJivAVD1GCUYUkCX+I2fLzKl Wc7OxX2V+y0sNV1loW93hQ== 0000950123-04-012997.txt : 20041104 0000950123-04-012997.hdr.sgml : 20041104 20041104165632 ACCESSION NUMBER: 0000950123-04-012997 CONFORMED SUBMISSION TYPE: 424B3 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 20041104 DATE AS OF CHANGE: 20041104 FILER: COMPANY DATA: COMPANY CONFORMED NAME: K&F INDUSTRIES INC CENTRAL INDEX KEY: 0000851797 STANDARD INDUSTRIAL CLASSIFICATION: AIRCRAFT PART & AUXILIARY EQUIPMENT, NEC [3728] IRS NUMBER: 341614845 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 424B3 SEC ACT: 1933 Act SEC FILE NUMBER: 333-40977 FILM NUMBER: 041120220 BUSINESS ADDRESS: STREET 1: 600 THIRD AVE CITY: NEW YORK STATE: NY ZIP: 10016 BUSINESS PHONE: 2122970900 MAIL ADDRESS: STREET 1: 600 THIRD AVE CITY: NEW YORK STATE: NY ZIP: 10016 424B3 1 y68294ae424b3.txt FILED PURSUANT TO RULE 424(B)(3) Filed Pursuant to Rule 424 (b)(3) of the Rules and Regulations Under the Securities Act of 1933 Registration Statement No. 333-40977 PROSPECTUS SUPPLEMENT (To Prospectus dated April 19, 2004) $185,000,000 K & F Industries, Inc. 9 1/4% Senior Subordinated Notes Due 2007 This Prospectus Supplement, together with Prospectus, is to be used by Lehman Brothers in connection with offers and sales of the above-referenced securities in market-making transactions at negotiated prices related to prevailing market prices at the time of sale. Lehman Brothers may act as principal or agent in such transactions. November 4, 2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------- FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number: 33-29035 K & F Industries, Inc. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) Delaware 34-1614845 - ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 600 Third Avenue, New York, New York 10016 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 297-0900 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of November 1, 2004, there were 740,398 shares of common stock outstanding. K & F INDUSTRIES, INC. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 INDEX
Page ---- Part I. Consolidated Financial Information Item 1. Consolidated Financial Statements (Unaudited) 1) Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003 3 b) Consolidated Statements of Operations for the nine months ended September 30, 2004 and 2003 4 3) Consolidated Statements of Operations for the three months ended September 30, 2004 and 2003 5 d) Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003 6 e) Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk 18 Item 4. Controls and Procedures 18 Part II. Other Information Item 6. Exhibits 19 Signatures 20
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS K & F INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, December 31, 2004 2003 ------------- ------------- ASSETS: Current Assets: Cash and cash equivalents $ 69,961,000 $ 24,464,000 Accounts receivable, net 42,170,000 41,595,000 Inventory 51,457,000 50,087,000 Other current assets 869,000 1,527,000 Income taxes receivable -- 851,000 ------------- ------------- Total current assets 164,457,000 118,524,000 ------------- ------------- Property, plant and equipment 176,375,000 175,107,000 Less, accumulated depreciation and amortization 116,046,000 111,527,000 ------------- ------------- 60,329,000 63,580,000 ------------- ------------- Deferred charges, net of amortization 56,506,000 54,232,000 Intangible assets, net of amortization 15,317,000 16,238,000 Goodwill 167,011,000 167,011,000 ------------- ------------- $ 463,620,000 $ 419,585,000 ============= ============= LIABILITIES AND STOCKHOLDERS' DEFICIENCY: Current Liabilities: Accounts payable, trade $ 14,695,000 $ 15,029,000 Interest payable 13,166,000 3,797,000 Other current liabilities 45,048,000 49,621,000 ------------- ------------- Total current liabilities 72,909,000 68,447,000 ------------- ------------- Pension liabilities 26,885,000 26,885,000 Deferred income taxes and other long-term liabilities 39,223,000 31,756,000 Postretirement benefit obligation other than pensions 83,871,000 84,468,000 9 1/4% senior subordinated notes due 2007 145,000,000 145,000,000 9 5/8% senior subordinated notes due 2010 250,000,000 250,000,000 Stockholders' Deficiency: Common stock, $.01 par value - authorized, 1,000,000 shares; issued and outstanding, 740,398 shares 7,000 7,000 Additional paid-in capital (263,259,000) (263,259,000) Retained earnings 136,689,000 104,039,000 Accumulated other comprehensive loss (27,705,000) (27,758,000) ------------- ------------- Total stockholders' deficiency (154,268,000) (186,971,000) ------------- ------------- $ 463,620,000 $ 419,585,000 ============= =============
See notes to consolidated financial statements. 3 K & F INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Nine Months Ended ------------------------------ September 30, September 30, 2004 2003 ------------- ------------- Sales $ 257,497,000 $ 247,842,000 Cost of sales 147,863,000 145,149,000 ------------- ------------- Gross margin 109,634,000 102,693,000 Independent research and development 10,226,000 11,321,000 Selling, general and administrative expenses 23,364,000 23,813,000 Amortization 3,552,000 3,174,000 ------------- ------------- Operating income 72,492,000 64,385,000 Interest and investment income 393,000 373,000 Interest expense (29,588,000) (32,864,000) ------------- ------------- Income before income taxes 43,297,000 31,894,000 Income tax provision (10,647,000) (8,356,000) ------------- ------------- Net income $ 32,650,000 $ 23,538,000 ============= =============
See notes to consolidated financial statements. 4 K & F INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended ----------------------------- September 30, September 30, 2004 2003 ------------- ------------- Sales $ 90,757,000 $ 87,821,000 Cost of sales 50,101,000 49,139,000 ------------ ------------ Gross margin 40,656,000 38,682,000 Independent research and development 3,441,000 3,963,000 Selling, general and administrative expenses 8,866,000 6,931,000 Amortization 1,212,000 1,075,000 ------------ ------------ Operating income 27,137,000 26,713,000 Interest and investment income 173,000 146,000 Interest expense (9,864,000) (10,930,000) ------------ ------------ Income before income taxes 17,446,000 15,929,000 Income tax provision (2,371,000) (3,740,000) ------------ ------------ Net income $ 15,075,000 $ 12,189,000 ============ ============
See notes to consolidated financial statements. 5 K & F INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended ----------------------------- September 30, September 30, 2004 2003 ------------- ------------- Cash flows from operating activities: Net income $ 32,650,000 $ 23,538,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 8,874,000 9,090,000 Non-cash interest expense - amortization of deferred financing charges 1,377,000 1,604,000 Non-cash interest income - change in fair market value of interest rate swap -- (2,590,000) Deferred income taxes 1,323,000 4,448,000 Changes in assets and liabilities: Accounts receivable, net (544,000) (4,731,000) Inventory (1,348,000) (7,093,000) Other current assets 1,509,000 629,000 Accounts payable, interest payable and other current liabilities 4,462,000 (265,000) Postretirement benefit obligation other than pensions (597,000) 2,324,000 Other long-term liabilities 6,144,000 6,230,000 ------------ ------------ Net cash provided by operating activities 53,850,000 33,184,000 ------------ ------------ Cash flows from investing activities: Capital expenditures (2,071,000) (2,384,000) Deferred charges (6,282,000) (3,049,000) ------------ ------------ Net cash used in investing activities (8,353,000) (5,433,000) ------------ ------------ Net increase in cash and cash equivalents 45,497,000 27,751,000 Cash and cash equivalents, beginning of period 24,464,000 22,735,000 ------------ ------------ Cash and cash equivalents, end of period $ 69,961,000 $ 50,486,000 ============ ============ Supplemental cash flow information: Interest paid during period $ 18,842,000 $ 23,323,000 ============ ============ Income taxes paid during the period $ 6,419,000 $ 3,117,000 ============ ============
See notes to consolidated financial statements. 6 K & F INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. The accompanying unaudited consolidated financial statements have been prepared by K & F Industries, Inc. and Subsidiaries (the "Company") pursuant to the rules of the Securities and Exchange Commission ("SEC") and, in the opinion of the Company, include all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of financial position, results of operations and cash flows. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such SEC rules. The Company believes that the disclosures made are adequate to make the information presented not misleading. The consolidated statements of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results to be expected for the full year. It is suggested that these financial statements be read in conjunction with the audited financial statements and notes thereto included in the Company's December 31, 2003 Annual Report on Form 10-K. 2. Accounting Pronouncements In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") was enacted. The Act introduced a plan sponsor subsidy based on a percentage of a beneficiary's annual prescription drug benefits, within defined limits, and the opportunity for a retiree to obtain prescription drug benefits under Medicare. In May 2004, the Financial Accounting Standards Board issued Staff Position No. 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" which supersedes Staff Position No. 106-1 of the same title. The Staff Position clarifies the accounting for the benefits attributable to new government subsidies for companies that provide prescription drug benefits to retirees. The Company had elected to defer any accounting for the effects of the Act pursuant to Staff Position No. 106-1. The Company adopted Staff Position No. 106-2 as of July 1, 2004, the beginning of its third quarter, retroactive to January 1, 2004. The Company and its actuarial advisors determined that benefits provided by the plan were at least actuarially equivalent to Medicare Part D. The Company remeasured the effects of the Act on the recorded Accumulated Plan Benefit Obligation ("APBO") as of January 1, 2004. The effect of the federal subsidy to which the Company is entitled has been estimated to decrease the APBO by $11.5 million. The decrease in the APBO was treated as a gain, which is being amortized prospectively from January 1, 2004. The table below details the reduction in net periodic postretirement cost by component, which is included in the three and nine months ended September 30, 2004, as a result of the Act and the adoption of Staff Position No. 106-2. 7 2. K & F INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Three Months Ended Nine Months Ended ------------------ ------------------ September 30, 2004 September 30, 2004 ------------------ ------------------ Service cost $ 60,000 $ 180,000 Interest cost 185,000 555,000 Recognized actuarial gain 230,000 690,000 -------- ---------- Net periodic postretirement benefit cost $475,000 $1,425,000 ======== ==========
3. Receivables are summarized as follows:
September 30, December 31, 2004 2003 ------------- ------------ Accounts receivable, principally from commercial customers $ 39,818,000 $ 35,306,000 Accounts receivable, on U. S. Government and other long-term contracts 3,593,000 7,505,000 Allowances (1,241,000) (1,216,000) ------------ ------------ $ 42,170,000 $ 41,595,000 ============ ============
4. Inventory consists of the following:
September 30, December 31, 2004 2003 ------------- ------------ Raw materials and work-in-process $26,393,000 $22,324,000 Finished goods 11,759,000 15,839,000 Inventoried costs related to U.S. Government and other long-term contracts 13,305,000 11,924,000 ----------- ----------- $51,457,000 $50,087,000 =========== ===========
The Company customarily sells original wheel and brake equipment below cost as an investment in a new airframe which is expected to be recovered through the subsequent sale of replacement parts. These commercial investments (losses) are recognized when original equipment is shipped. Losses on U. S. Government contracts are immediately recognized in full when determinable. 8 K & F INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Inventory is stated at average cost, not in excess of net realizable value. In accordance with industry practice, inventoried costs may contain amounts relating to contracts with long production cycles, a portion of which will not be realized within one year. Reserves for slow moving and obsolete inventories are provided based on current assessments about future product demand and production requirements for the next twelve months. The Company evaluates the adequacy of these reserves quarterly. 5. Other current liabilities consist of the following:
September 30, December 31, 2004 2003 ------------ ------------ Accrued payroll costs $12,482,000 $14,451,000 Accrued property taxes and other taxes 2,002,000 2,711,000 Accrued costs on long-term contracts 2,448,000 5,061,000 Accrued warranty costs 14,053,000 13,261,000 Customer credits 4,251,000 5,918,000 Postretirement benefit obligation other than pensions 3,000,000 3,000,000 Accrued income taxes 1,475,000 -- Other 5,337,000 5,219,000 ----------- ----------- $45,048,000 $49,621,000 =========== ===========
6. Income Taxes The Company's effective tax rate of 13.6% and 23.5% for the three months ended September 30, 2004 and 2003, respectively, differs from the statutory rate of 35% due to tax benefits derived from export sales and reversals of prior years tax reserves no longer needed. The decrease in the effective tax rate for the three months ended September 30, 2004, as compared with the same period in the prior year, is primarily due to a higher amount of tax reserves no longer needed and greater tax benefits derived from export sales. The Company's effective tax rate of 24.6% and 26.2% for the nine months ended September 30, 2004 and 2003, respectively, differs from the statutory rate of 35% due to tax benefits derived from export sales and reversals of prior years tax reserves no longer needed. 7. Contingencies There are various lawsuits and claims pending against the Company incidental to its business. Although the ultimate resolution of such suits cannot be predicted with certainty, in the opinion of the Company's management, the ultimate settlement, if any, will not have a material adverse effect on the Company's consolidated financial statements. 9 K & F INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 8. Comprehensive Income
Three Months Ended ----------------------------- September 30, September 30, 2004 2003 ------------- ------------- Net income $ 15,075,000 $12,189,000 Other comprehensive income: Cumulative translation adjustments (9,000) 55,000 Amortization of transition adjustment included in interest expense -- 46,000 ------------ ----------- Comprehensive income $ 15,066,000 $12,290,000 ============ ===========
Nine Months Ended ----------------------------- September 30, September 30, 2004 2003 ------------- ------------- Net income $32,650,000 $23,538,000 Other comprehensive income: Cumulative translation adjustments 53,000 94,000 Amortization of transition adjustment included in interest expense -- 138,000 ----------- ----------- Comprehensive income $32,703,000 $23,770,000 =========== ===========
9. Segments The following represents financial information about the Company's segments:
Three Months Ended ----------------------------- September 30, September 30, 2004 2003 ------------- ------------- Sales: Aircraft Braking Systems $75,166,000 $73,292,000 Engineered Fabrics 15,591,000 14,529,000 ----------- ----------- $90,757,000 $87,821,000 =========== =========== Operating Profit: Aircraft Braking Systems $24,738,000 $24,709,000 Engineered Fabrics 2,399,000 2,004,000 ----------- ----------- Operating income 27,137,000 26,713,000 Interest expense, net (9,691,000) (10,784,000) ---------- ----------- Income before income taxes $17,446,000 $15,929,000 =========== ===========
10 K & F INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Nine Months Ended ------------------------------ September 30, September 30, 2004 2003 ------------- ------------- Sales: Aircraft Braking Systems $ 213,205,000 208,010,000 Engineered Fabrics 44,292,000 39,832,000 ------------- ------------- $ 257,497,000 $ 247,842,000 ============= ============= Operating Profit: Aircraft Braking Systems $ 65,360,000 $ 59,946,000 Engineered Fabrics 7,132,000 4,439,000 ------------- ------------- Operating income 72,492,000 64,385,000 Interest expense, net (29,195,000) (32,491,000) ------------- ------------- Income before income taxes $ 43,297,000 $ 31,894,000 ============= =============
September 30, December 31, 2004 2003 ------------ ------------ Total Assets: Aircraft Braking Systems $384,302,000 $348,609,000 Engineered Fabrics 71,142,000 60,593,000 Deferred financing costs not allocated to segments 6,791,000 8,168,000 Corporate assets 1,385,000 1,364,000 Income taxes receivable not allocated to segments -- 851,000 ------------ ------------ $463,620,000 $419,585,000 ============ ============
10. Subsequent Event On October 15, 2004, K & F Industries, Inc. entered into a stock purchase agreement in which it agreed to be acquired by an affiliate of Aurora Capital Group, for a purchase price of $1.06 billion in cash. The transaction is expected to close in November 2004 and to be financed with a new credit facility, including a funded term loan facility of $480 million and an unfunded (at closing) $50 million revolving credit facility, $315 million of new senior subordinated notes and $315 million of equity capital. The cash consideration will be used to repay the Company's existing indebtedness, with the balance paid to the Company's existing stockholders and optionholders. In connection with the transaction, on October 20, 2004, the Company commenced cash tender offers for all of the existing senior subordinated notes. The acquisition will be accounted for using the purchase method of 11 accounting in accordance with SFAS No. 141, Business Combinations, pursuant to which the total purchase price of the acquisition, including related fees and expenses, will be allocated to the Company's net assets based upon its estimates of fair value. The preliminary results of the allocation of the excess of the purchase price over the fair value of net tangible assets acquired, would result in the recording of goodwill of approximately $951 million and intangible assets of $254 million. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General We are a manufacturer of aircraft wheels, brakes, brake control systems and flexible bladder fuel tanks for commercial, general aviation and military aircraft. We service a diversified portfolio of customers across the commercial transport, general aviation and military sectors, such that declines in any one market have often been offset by increased revenues in another. For example, the commercial transport and general aviation markets that we serve were adversely affected by the events of September 11, 2001, but the downturn in those markets was partially offset by an increase in military aircraft spending. We believe that conditions in the commercial transport and general aviation markets have improved and the regional jet market, in particular, will provide new opportunities for replacement part sales. Since the beginning of 2004, our sales and bookings in both commercial transport and general aviation sectors have shown recovery from this downturn. During the same period, our military business has leveled off, but we expect military aircraft spending to continue at current levels. The Acquisition On October 15, 2004, we entered into a stock purchase agreement in which we agreed to be acquired by an affiliate of Aurora Capital Group, for a purchase price of $1.06 billion in cash. The transaction is expected to close in November 2004 and to be financed with a new credit facility, including a funded term loan facility of $480 million and an unfunded (at closing) $50 million revolving credit facility, $315 million of new senior subordinated notes and $315 million of equity capital. The cash consideration will be used to repay our existing indebtedness, with the balance paid to our existing stockholders and optionholders. In connection with the transaction, on October 20, 2004, we commenced cash tender offers for all of our existing senior subordinated notes. The acquisition will be accounted for using the purchase method of accounting in accordance with SFAS No. 141, Business Combinations, pursuant to which the total purchase price of the acquisition, including related fees and expenses, will be allocated to our net assets based upon our estimates of fair value. The preliminary results of the allocation of the excess of the purchase price over the fair value of net tangible assets acquired, would result in the recording of goodwill of approximately $951 million and intangible assets of $254 million. Critical Accounting Policies and Estimates This section is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, intangible assets, income taxes, warranty obligations, workers compensation liabilities, pension and other postretirement benefits, and contingencies and litigation. We base our estimates on historical experience and on various 13 other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. We believe the following critical accounting policies involve our more significant judgments and estimates used in the preparation of the consolidated financial statements. Inventory. Inventory is stated at average cost, not in excess of net realizable value. In accordance with industry practice, inventoried costs may contain amounts related to contracts with long production cycles, a portion of which will not be realized within one year. Reserves for slow moving and obsolete inventories are provided based on current assessments about future product demand and production requirements for the next twelve months. These factors are impacted by market conditions, technology changes, and changes in strategic direction, and require estimates and management judgment that may include elements that are uncertain. We evaluate the adequacy of these reserves quarterly. Although we strive to achieve a balance between market demands and risk of inventory excess or obsolescence, it is possible that, should conditions change, additional reserves may be needed. Any changes in reserves will impact operating income during a given period. This policy is consistently applied to each of our operating segments and we do not anticipate any changes to our policy in the near term. Evaluation of Long-Lived Assets. Long-lived assets are assessed for recoverability on an ongoing basis in accordance with SFAS No. 144. In evaluating the value and future benefits of long-lived assets, their carrying value is compared to management's estimate of the anticipated undiscounted future net cash flows of the related long-lived asset. Any necessary impairment charges would be recorded when we do not believe the carrying value of the long-lived asset will be recoverable. Warranty. Estimated costs of warranty are accrued when individual claims arise with respect to a product or performance. When we become aware of those types of defects, the estimated costs of all potential warranty claims arising from those types of defects are estimated and accrued. Pension and Other Postretirement Benefits. We have significant pension and postretirement benefit costs and liabilities. The determination of our obligation and expense for pension and other postretirement benefits is dependent on our selection of certain assumptions used by actuaries in calculating those amounts. Assumptions are made about interest rates, expected investment return on plan assets, rate of increase in health care costs, total and involuntary turnover rates, and rates of future compensation increases. In addition, our actuarial consultants use subjective factors such as withdrawal rates and mortality rates to develop our valuations. We generally review and update these assumptions at the beginning of each fiscal year. We are required to consider current market conditions, including changes in interest rates, in making these assumptions. The actuarial assumptions that we may use may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. These differences may result in a significant impact on the amount of pension and postretirement benefits 14 expense we have recorded or may record. The discount rate enables us to state expected future cash flows at a present value on the measurement date. The rate represents the market rate of high-quality fixed income investments. A lower discount rate increases the present value of benefit obligations and increases pension expense. We used a 6 3/4% discount rate in 2003 and are using a 6 1/4% discount rate for 2004 to reflect market interest rate conditions. To determine the expected long-term rate of return on pension plan assets, we consider the current and expected asset allocations, as well as historical and expected returns on various categories of plan assets. We assumed that the long-term return on our pension plan assets was 9.0% in 2003 and will remain at 9.0% for 2004 to reflect market conditions. The annual postretirement expense was calculated using a number of actuarial assumptions, including a health care cost trend rate and a discount rate. Our discount rate assumption for postretirement benefits is consistent with that used in the calculation of pension benefits. The healthcare cost trend rate being used to calculate the calendar year 2004 postretirement expense is 10.0% in 2004 trending down to 4.5% for 2010. Comparison of Results of Operations for the Nine Months Ended September 30, 2004 and September 30, 2003 Our sales for the nine months ended September 30, 2004 totaled $257,497,000, reflecting an increase of $9,655,000, compared with $247,842,000 for the same period in the prior year. This increase was due to higher sales at Aircraft Braking Systems of $5,195,000 and higher sales at Engineered Fabrics of $4,460,000. Commercial sales at Aircraft Braking Systems increased $11,064,000, primarily on the Bombardier CRJ-700 and CRJ-100/200, the Embraer 170 and Boeing MD-90 programs, partially offset by lower sales on the Boeing MD-80 and B-707 programs. General aviation sales increased $7,019,000, primarily on Gulfstream, Lear, Israeli Aircraft Industries and Canadair aircraft. Military sales decreased $12,888,000, primarily on the Boeing B-1B, the Lockheed Martin C-130 and F-16, and the Northrop Grumman F-14 programs. Sales at Engineered Fabrics increased primarily due to higher military sales of fuel tanks for the Boeing F-15, the Northrop Grumman F-18 and T-38 and the Sikorsky Blackhawk programs, higher sales of iceguards on the Bell/Boeing V-22 program, partially offset by lower sales of oil containment booms. Our gross margin for the nine months ended September 30, 2004 was 42.6%, compared with 41.4% for the same period in the prior year. Aircraft Braking Systems' gross margin was $100,002,000, or 46.9% of sales for the nine months ended September 30, 2004, compared with $94,431,000 or 45.4% of sales for the same period in the prior year. Engineered Fabrics' gross margin was $9,632,000,or 21.7% of sales for the nine months ended September 30, 2004, compared with $8,262,0000, or 20.7% of sales for the same period in the prior year. Aircraft Braking Systems' gross margin increased primarily due to a favorable mix of products sold, lower operating costs and the favorable overhead absorption effect relating to the higher sales, partially offset by higher program investments. Engineered Fabrics' gross margin increased primarily due to the favorable overhead absorption effect relating to the higher sales and operating efficiencies. Independent research and development costs were $10,226,000 for the nine months ended September 30, 2004, compared with $11,321,000 for the same period in the prior year. This decrease was primarily due to lower costs associated with the Embraer 170 and various other 15 programs, partially offset by higher costs on the China ARJ 21 and Dassault Falcon 7X programs. Selling, general and administrative expenses for the nine months ended September 30, 2004 were level with the same period in the prior year. Our net interest expense was $29,195,000 for the nine months ended September 30, 2004, compared with $32,491,000 for the same period in the prior year. This decrease was primarily due to a lower average debt balance. Our effective tax rate of 24.6% and 26.2% for the nine months ended September 30, 2004 and 2003, respectively, differs from the statutory rate of 35% due to tax benefits derived from export sales and reversals of prior years tax reserves no longer needed. Comparison of Results of Operations for the Three Months Ended September 30, 2004 and September 30, 2003 Our sales for the three months ended September 30, 2004 totaled $90,757,000, reflecting an increase of $2,936,000, compared with $87,821,000 for the same period in the prior year. This increase was due to higher sales at Aircraft Braking Systems of $1,874,000 and Engineered Fabrics of $1,062,000. Commercial sales at Aircraft Braking Systems increased $6,176,000, primarily on the Bombardier CRJ-700 and Boeing DC-10 programs. General aviation sales increased $1,863,000, primarily on Israeli Aircraft Industries, Gulfstream and Lear aircraft. Military sales decreased $6,165,000, primarily on the Boeing B-1B, the Lockheed Martin F-16 and C-130, and the Northrop Grumman F-14 programs. Sales at Engineered Fabrics increased primarily due to higher military sales of fuel tanks on the Boeing F-15, Bell Helicopter UH-1H Huey and Northrop Grumman T-38 programs, partially offset by lower sales of oil containment booms. Our gross margin for the three months ended September 30, 2004 was 44.8%, compared with 44.0% for the same period in the prior year. Aircraft Braking Systems' gross margin was $37,355,000, or 49.7% of sales for the three months ended September 30, 2004, compared with $35,532,000, or 48.5% of sales for the same period in the prior year. Engineered Fabrics' gross margin was $3,301,000, or 21.2% of sales for the three months ended September 30, 2004, compared with $3,150,000, or 21.7% of sales for the same period in the prior year. Aircraft Braking Systems' gross margin increased primarily due to a favorable mix of products sold, lower operating costs and the favorable overhead absorption effect relating to the higher sales, partially offset by higher program investments. Engineered Fabrics' gross margin decreased primarily due to unfavorable mix of products sold, partially offset by the favorable overhead absorption effect relating to the higher sales and operating efficiencies. Independent research and development costs were $3,441,000 for the three months ended September 30, 2004, compared with $3,963,000 for the same period in the prior year. This decrease was primarily due to lower costs associated with the Embraer 170 and various other programs, partially offset by higher costs on the China ARJ 21. Selling, general and administrative expenses were $8,866,00 for the three months ended September 30, 2004, compared with $6,931,000 for the same period in the prior year. This increase was primarily due to higher costs associated with performance-related incentive compensation. 16 Our net interest expense was $9,691,000 for the three months ended September 30, 2004, compared with $10,784,000 for the same period in the prior year. This decrease was primarily due to a lower average debt balance. Our effective tax rate of 13.6% and 23.5% for the three months ended September 30, 2004 and 2003, respectively, differs from the statutory rate of 35% due to tax benefits derived from export sales and reversals of prior years tax reserves no longer needed. The decrease in the effective tax rate for the three months ended September 30, 2004, as compared with the same period in the prior year, is primarily due to a higher amount of tax reserves no longer needed and greater tax benefits derived from export sales. Liquidity and Capital Resources Our cash and cash equivalents totaled $70.0 million at September 30, 2004, compared with $24.5 million at December 31, 2003. Our total debt was $395.0 million at September 30, 2004 and December 31, 2003, and we had $28.0 million (which is net of letters of credit of $2.0 million) available to borrow under our $30.0 million revolving credit facility. In the past, the cash generated from operations has been sufficient to pay our indebtedness. We do not have to pay principal on our notes until 2007, when $145.0 million of our 9 1/4% notes mature. We expect that our principal use of funds for the next several years will be to pay interest and principal on indebtedness, fund capital expenditures and make program investments. Our primary source of funds for conducting our business activities and servicing our indebtedness has been cash generated from operations. The credit facility contains certain covenants and events of default, including limitations on additional indebtedness, liens, asset sales, making certain restricted payments, capital expenditures, creating guarantee obligations and material lease obligations. The credit facility also contains certain financial ratio requirements, including a cash interest coverage ratio and a leverage ratio. We were in compliance with all debt covenants at September 30, 2004. Our contractual obligations are detailed in our Annual Report on Form 10-K for the year ended December 31, 2003. As of September 30, 2004, our contractual obligations have not materially changed from December 31, 2003. Cash Flows During the nine months ended September 30, 2004, net cash provided by operating activities amounted to $53,850,000, compared with $33,184,000 for the same period in the prior year, an increase of $20,666,000. Our cash flow from operating activities increased from the prior year primarily due to payments made in 2003 to the holders of our stock options in connection with the 2002 recapitalization, lower increases in inventory and accounts receivable in 2004 versus 2003, and lower interest payments, partially offset by higher income tax payments. During the nine months ended September 30, 2004, net cash used in investing activities amounted to $8,353,000 versus $5,433,000 for the same period in the prior year, an increase of $2,920,000. This increase was primarily due to $6,282,000 of program participation payments made during the nine months ended September 30, 2004, compared with $3,049,000 made during the same period in the prior year. Accounting Pronouncements In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003, or the Act, was enacted. The Act introduced a 17 plan sponsor subsidy based on a percentage of a beneficiary's annual prescription drug benefits, within defined limits, and the opportunity for a retiree to obtain prescription drug benefits under Medicare. In May 2004, the Financial Accounting Standards Board issued Staff Position No. 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act, which supersedes Staff Position No. 106-1 of the same title. The Staff Position clarifies the accounting for the benefits attributable to new government subsidies for companies that provide prescription drug benefits to retirees. We had elected to defer any accounting for the effects of the Act pursuant to Staff Position No. 106-1. We adopted Staff Position No. 106-2 as of July 1, 2004, the beginning of our third quarter, retroactive to January 1, 2004. We and our actuarial advisors determined that benefits provided by the plan were at least actuarially equivalent to Medicare Part D. We remeasured the effects of the Act on the recorded Accumulated Plan Benefit Obligation ("APBO") as of January 1, 2004. The effect of the federal subsidy to which we are entitled has been estimated to decrease the APBO by $11.5 million. The decrease in the APBO was treated as a gain, which is being amortized prospectively from January 1, 2004. The table below details the reduction in net periodic postretirement cost by component, which is included in the three and nine months ended September 30, 2004, as a result of the Act and the adoption of Staff Position No. 106-2.
Three Months Ended Nine Months Ended ------------------ ------------------ September 30, 2004 September 30, 2004 ------------------ ------------------ Service cost $ 60,000 $ 180,000 Interest cost 185,000 555,000 Recognized actuarial gain 230,000 690,000 -------- ---------- Net periodic postretirement benefit cost $475,000 $1,425,000 ======== ==========
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have $395.0 million of total fixed rate debt outstanding at September 30, 2004. Borrowings under the credit facility bear interest that varies with LIBOR, for which no borrowings were outstanding at September 30, 2004. Given that all of our outstanding debt is at a fixed rate, a 10% change in interest rates would not have a significant impact on fair values, cash flows or earnings. We have no derivative financial instruments. ITEM 4. CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities and Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required 18 disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the designed control objectives. Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2004. Based upon that evaluation and subject to the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that the design and operation of our disclosure controls and procedures provided reasonable assurance that the disclosure controls and procedures are effective to accomplish their objectives. In addition, there was no change to our internal control over financial reporting that occurred during the quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 19 PART II. OTHER INFORMATION Item 6. Exhibits Exhibits 31.1 - Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a)of the Securities Exchange Act, as amended. 31.2 - Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a)of the Securities Exchange Act, as amended. 32.1 - Certification of Chief Executive Office pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 - Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Items 1, 2, 3, 4 and 5 are not applicable and have been omitted. 20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. K & F INDUSTRIES, INC. ----------------------------- Registrant /s/ DIRKSON R. CHARLES ----------------------------- Dirkson R. Charles Chief Financial Officer and Registrant's Authorized Officer Dated: November 4, 2004 21 -----END PRIVACY-ENHANCED MESSAGE-----