UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

Commission file number 0-21803

AFTERMARKET TECHNOLOGY CORP.

(Exact name of Registrant as specified in its charter)

 

Registrant’s telephone number, including area code:  (630) 455-6000

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value

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 ý No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

The aggregate market value of the voting stock held by non-affiliates of the Registrant (based on the closing price of such stock, as reported by The Nasdaq National Market, on March 1, 2002) was $120.0 million.

The number of shares outstanding of the Registrant’s Common Stock, as of March 1, 2002, was 20,839,562 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

AFTERMARKET TECHNOLOGY CORP.

ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report contains forward–looking statements (as such term is defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) and information relating to us that are based on the current beliefs of our management as well as assumptions made by and information currently available to management, including statements related to the markets for our products, general trends in our operations or financial results, plans, expectations, estimates and beliefs.  In addition, when used in this Annual Report, the words “may,” “could,” “should,” “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “predict” and similar expressions and their variants, as they relate to us or our management, may identify forward–looking statements.  These statements reflect our judgment as of the date of this Annual Report with respect to future events, the outcome of which is subject to risks, which may have a significant impact on our business, operating results or financial condition.  Readers are cautioned that these forward–looking statements are inherently uncertain.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein.  We undertake no obligation to update forward–looking statements.  The risks identified in the section of Item 1 entitled “Certain Factors Affecting the Company,” among others, may impact forward–looking statements contained in this Annual Report.

PART I

ITEM 1.                                         BUSINESS

Overview

We are a leading remanufacturer and distributor of drivetrain products used in the repair of automobiles and light trucks in the automotive aftermarket.  Our Logistics business is a provider of value added warehouse and distribution services as well as returned material reclamation and disposition services.  Our Logistics business also remanufactures and distributes electronic components.

Our Drivetrain Remanufacturing business sells factory–approved remanufactured drivetrain products directly to automobile manufacturers (known as OEMs).  Our Drivetrain business products consist principally of remanufactured transmissions and also include remanufactured torque converters, valve bodies and engines.  The OEMs primarily use the remanufactured products as replacement parts for their domestic dealers during the warranty and post-warranty periods following the sale of a vehicle.  Remanufactured products offer several advantages to customers relative to comparable rebuilt products.  Generally, remanufactured products are lower cost, are of higher quality consistency and have shorter delivery times.  Our principal customers for remanufactured transmissions are DaimlerChrysler Corporation, Ford Motor Company, General Motors Corporation and a number of foreign OEMs.  In addition, our Drivetrain business sells select remanufactured engines to several European OEMs.

Demand for our products within the Drivetrain business is largely a function of the number of vehicles in operation, the average age of vehicles and the average number of miles driven per vehicle.  These factors have generally increased over time, thereby increasing demand for our remanufactured products.  Other factors that influence demand for our remanufactured products include product complexity and reliability, the length of OEM warranty periods and the severity of weather conditions.  Because these factors are not directly dependent on new automotive sales levels, demand for remanufactured products within our Drivetrain business has been largely non-cyclical.

Our Drivetrain business has been our primary business since our formation.  For the year ended December 31, 2001, revenue from our Drivetrain business was $266.3 million, or 67% of our total revenue.  In addition, in the United States we also sell remanufactured engines in the independent aftermarket.  For the year ended December 31, 2001, revenue from this engines business was $21.9 million, or 6% of our total revenue.

1

 

Our Logistics business consists of three operating units: Logistics Services, a provider of value added warehouse and distribution services, turnkey order fulfillment and information services for AT&T Wireless Services; Material Recovery, a provider of returned material reclamation and disposition services and management services for failed components, commonly referred to as cores, primarily for Ford and, to a lesser extent, General Motors; and Autocraft Electronics, an automotive electronic remanufacturing and distribution business.  Services within our Logistics business are designed to meet the specialized needs of our customers.

The logistics industry has evolved over the last 20 years due to dramatic improvements in technology and increased demand in customer service requirements.  Growth in our logistics business with AT&T Wireless is primarily dependent on cellular telephone handset demand and AT&T Wireless’ share of new cellular telephone sales volume.  Our logistics business benefits from upgrades in cellular telephone technology through increased replacement demand for more advanced handsets, from any increases in the number of AT&T Wireless subscribers and from any expansion of our service offering with AT&T Wireless.  Because we do not take actual ownership of our cellular telephone inventory, we do not face the risk of inventory obsolescence.  Other growth drivers within our Logistics business include our ability to leverage our expertise in logistics in other industries.  For the year ended December 31, 2001, revenue from our Logistics business was $105.2 million, or 27% of our total revenue, of which AT&T Wireless accounted for 66%.

Industry Background

Automotive Aftermarket

The automotive aftermarket in the United States, which consists of sales of parts and services for vehicles after their original purchase, has been largely non-cyclical and has generally experienced steady growth over the past nine years, unlike the market for new vehicle sales.  According to materials published by the Automotive Aftermarket Industry Association, between 1991 and 2000 (the most recent period for which data is available), estimated U.S.  automotive aftermarket sales increased from approximately $101.8 billion to $168.4 billion.  This consistent growth is due principally to an increase in the number of vehicles in operation, an increase in the average age of vehicles, and an increase in the average number of miles driven per vehicle.  According to these same materials, the aftermarket segment for drivetrain parts is estimated to have been $5.5 billion in 2000.  We believe that within this segment, the market for remanufactured drivetrain products has grown faster than the overall automotive aftermarket.

Remanufacturing Process

Remanufacturing is a process through which used assemblies are returned to a central facility where they are disassembled and their component parts are cleaned, refurbished and tested.  The usable component parts are then combined with new parts in a high volume, precision assembly line or cellular manufacturing process to create remanufactured assemblies.

When an assembly such as a transmission or engine fails, there are generally three alternatives available to return the vehicle to operating condition.  The dealer or independent repair shop may:

·                  remove the assembly, disassemble it into its component pieces, replace worn or broken parts with remanufactured or new components, and reinstall the assembly in the vehicle;

·                  replace the assembly with an assembly from a remanufacturer such as us; or

·                  in rare instances, replace the assembly with a new assembly manufactured by the OEM.

In our remanufacturing operations, we obtain used transmissions, engines and related components, commonly known as cores, from the OEMs.  We then sort the cores by vehicle make and model and either place them into immediate production or store them until needed.  In the remanufacturing process, we evaluate the cores, disassemble them into their component parts and clean, refurbish and test the components that can be incorporated into the remanufactured product.  We replace components that we determine to be not reusable or repairable with other remanufactured or new components.  We conduct inspection and testing at various stages of the remanufacturing process, and we test each finished assembly on equipment designed to simulate performance under operating conditions.  After testing, we generally package completed products for immediate delivery.

2

 

There are four primary benefits of using remanufactured components in the repair of vehicles:

·                  First, costs to the OEM associated with remanufactured assemblies generally are substantially less than new or dealer–rebuilt assemblies due to our use of high volume manufacturing techniques and salvage methods that enable us to refurbish and reuse a high percentage of original components, as well as our lower cost of production.  The cost savings produced by remanufactured assemblies helps the OEMs manage their warranty expenses.

·                  Second, remanufactured assemblies are generally of consistent high quality due to the precision manufacturing techniques, technical upgrades and rigorous inspection and testing procedures we employ in remanufacturing.  By contrast, the quality of rebuilt assemblies generally is less consistent because it is heavily dependent on the skill level of the particular mechanic as well as the availability of adequate tooling and testing equipment.  In addition, the proliferation of transmission and engine designs, the increasing complexity of transmissions and engines that incorporate electronic components and the shortage of highly trained mechanics qualified to rebuild assemblies are leading to what management believes is a trend toward the use of remanufactured assemblies for aftermarket repairs.  For warranty repairs, consistent quality is important to the OEM providing the applicable warranty, because once installed, the remanufactured product is usually covered by the OEM’s warranty for the balance of the original warranty period.

·                  Third, replacement of a component with a remanufactured component generally takes considerably less time than the time needed to rebuild the component, thereby significantly reducing the time the vehicle is at the dealer or repair shop and allows the dealer and repair shops to increase their volume of business.

·                  Fourth, the environmental benefits of remanufacturing may be significant to OEMs.  Remanufacturing in our facilities, when compared to rebuilding at various dealers, generally results in a more efficient re–utilization of parts and a more controlled recycling of scrap materials and excess fluids.  This in turn leads to associated cost savings.  We estimate that we annually re–process thousands of tons of materials that would otherwise have been discarded.

We believe that because of this combination of high quality, low cost and efficiency, the use of remanufactured assemblies for repairs is growing compared to the use of new or rebuilt assemblies.

Logistics Industry

Logistics can generally be defined as the management and transportation of materials and inventory throughout the supply chain as well as the provision of value added services such as assembly, packaging, programming and testing.  The logistics industry has evolved over the last 20 years due to dramatic improvements in technology and increased demand in customer service requirements.  As companies’ logistics decisions involve greater emphasis on cost efficiency and increased focus on core competencies, companies are increasingly reevaluating their in-house logistics functions.  Many companies have decided to outsource the management of all or part of their supply chain as a means to reduce costs, increase asset and labor flexibility and improve customer service.  As a result, third–party logistics providers have become extensively involved in the full range of customer supply chain functions.  The operational efficiencies of a third–party provider enable companies to reduce investments in facilities, information technology, inventory and personnel.  Third–party services include order fulfillment, product labeling and packaging, inventory and warehouse management, product return and repair, reverse logistics and the actual physical movement of goods.

3

 

The market for third party logistics providers is highly fragmented.  According to Armstrong & Associates, Inc., the third party logistics market in 2000 was estimated to be $56.4 billion.  Approximately $20.4 billion, or 36% of the estimated third party logistics market in 2000, represents value added warehouse and distribution services.  This segment of the estimated third party logistics market grew by approximately 23% in 2000.  The majority of our Logistics business with AT&T Wireless includes value added warehouse and distribution services.

Logistics Process

Our logistics process is determined in close consultation with our customers.  For instance, for AT&T Wireless, our supply chain management services include warehousing, picking, packing, shipping and delivery of wireless handsets, including wireless data devices, and accessories.  Our integrated logistics services include inventory management, private labeling, kitting and customized packaging, the management and distribution of time sensitive marketing materials and product warranty and returns processing.

Our Competitive Strengths

We believe our core competencies include the following factors:

Our Remanufacturing Technology

We specialize in volume remanufacturing of high-quality automotive transmissions, torque converters, engine long blocks and automotive electronics.  Our remanufacturing process is completed by testing products using state-of-the-art equipment such as sophisticated test stands that enable us to replicate OEM test procedures.

Our High Quality Products with a Sound ISO Quality Foundation

Our remanufactured products are of consistent high quality due to the precision manufacturing techniques, technical upgrades and rigorous inspection and testing procedures employed in our remanufacturing processes.  We are dedicated to upholding the quality of our customers’ products and hold QS 9000 Certification, ISO-9002 Certification and Ford’s Q1 Certification.

Our Fulfillment and Customer Service Capabilities

Our Logistics business provides high-speed, same day, technology driven fulfillment.  Our logistics approach involves our team of specialists who work with the client to understand deliverables, understand communication points within the supply chain, design solutions, establish operational and business metrics, eliminate waste and improve efficiencies.

Our Information Technology Management and Response Skills

In our Logistics business, we use state-of-the-art software and computer systems to meet customers’ needs in product security and confidentiality, product qualification and identification, inventory management, interactive electronic communication, authorized product sales and commodity recycling, as well as providing customers with solutions for their supply chain management, reverse logistics, product tracking and product history needs, while maintaining service and quality levels.

Our Customer Relationships

In recognition of our consistently high level of service and product quality throughout our relationship with DaimlerChrysler, in each of the eight years prior to and including 2000, we have received the highest award bestowed by Chrysler to its suppliers for which we were eligible.  Additionally, over the past two years, we have strengthened our relationship with many other of our customers, as evidenced by the award of new business with Ford, Jaguar, Isuzu, Kia and General Motors.  To strengthen our customer relationships and improve all aspects of customer service and operations, we have implemented our “Lean and Continuous Improvement” and “Customer Delight” programs.  Under these programs, we have installed a number of training and operating initiatives aimed at improving efficiency and productivity.

4

 

Our Growth Strategies

Our strategy is to be a world–class provider of remanufacturing and logistics products and services.  We are pursuing the following growth strategies:

·                  increasing sales to existing customers;

·                  introducing new products;

·                  establishing new customer relationships; and

·                  pursuing potential future acquisitions.

Increasing Sales to Existing Customers

Drivetrain Customers.  We intend to increase our business with our existing Drivetrain customers by working with OEMs to increase dealer utilization of remanufactured transmissions in both the warranty and post-warranty periods.  We are working in tandem with OEMs to highlight to dealers the quality and cost advantages of using remanufactured assemblies versus rebuilding.  We are also working with OEMs to reduce the lag time prior to the introduction of a remanufacturing program for new transmission models and model years.  In addition, the post-warranty repair market, which we believe is significantly larger than the OEM dealer warranty repair market, presents a growth opportunity.  We believe that most post-warranty repairs are performed by aftermarket repair specialists rather than by OEM dealers.  Given the relatively low cost and high quality of remanufactured components, OEM dealers may enhance their cost competitiveness, when compared to independent service centers, through the increased use of remanufactured components as well as providing end customers with a high quality product.  To the extent that OEM dealers increase their level of post-warranty repairs, we are well positioned, given our existing OEM relationships, to capitalize on this market growth.

Logistics Customers.  We intend to increase penetration of our existing Logistics business customer base by broadening our offering of Logistics products and services and by marketing our core competencies as solutions to our customers’ needs.  In 2000, AT&T Wireless awarded us additional programs covering the packaging and distribution of cellular telephone accessories and the distribution of point-of-sale and other marketing materials.  Also, in September 2001, Ford awarded us additional logistics business related to the control and management of Ford core inventory supporting Ford’s remanufactured products for automobiles and light trucks in North America.

Introducing New Products

Drivetrain Business.  We continue to work with our OEM customers to identify additional remanufactured products and services where we can provide value to the OEM.  In this way, we believe that we will be able to leverage our customer relationships and remanufacturing competency.  In 2000, Ford selected us to supply remanufactured transmissions for use in Ford’s new Focus, and to supply a new line of Motorcraft­branded remanufactured transmissions.  In 2001, Chrysler awarded us new contracts for remanufacturing torque converters and valve bodies.

Logistics Business.  We also intend to leverage our core competencies in logistics and electronics remanufacturing by working with our existing and new customers to identify products and services where we can add value in satisfaction of our customers’ needs.  General Motors has awarded us a pilot national material recovery program.

Establishing New Customer Relationships

Drivetrain Customers.  We believe that opportunities for growth exist with select foreign OEMs regarding United States­based remanufacturing programs.  We believe that this represents an opportunity for growth and we are currently working to develop programs with these OEMs.  In October 2001, Saturn Corporation awarded us a contract to remanufacture transmissions, valve body assemblies and pump assemblies.

5

 

We also look to obtain new customers for our drivetrain products in the independent aftermarket.  In July 2001, we began a program with the National AAMCO Dealers Association, which represents most of the AAMCO dealers across the United States.  Under this program, we provide select remanufactured domestic transmissions to AAMCO dealers.  These dealers currently face a shrinking base of technicians who are qualified to work with the increasing number of transmission types and their increasing technological complexity.  Through this program, we provide various incentives for dealers to purchase remanufactured transmissions directly from us.  We believe that the AAMCO dealers represent a substantial portion of the post-warranty transmission repair market in the United States.

Logistics Customers.  We plan to leverage our existing relationships with automobile OEMs into new logistics customer relationships.  We believe that our logistics services business should be attractive to new customers who recognize that outsourcing this function will enable them to both focus on their core competencies and have an efficient product distribution system.  We also believe that the ability to sell product via Internet auctions, as well as cost savings and environmental benefits provided by our material recovery business, will be attractive to other OEMs.  In June 2001, Mazda North America Operations awarded us a logistics pilot program contract under which we will harvest and consolidate used or excess product and then ship it to Mazda authorized dealers.

Pursuing Future Acquisitions

An important element of our growth strategy is the acquisition and integration of complementary businesses in order to broaden product offerings, capture market share and improve profitability.  We have made various acquisitions in the past and, to the extent suitable acquisition candidates, acquisition terms and financing are available, we intend to make acquisitions in the future.  We currently expect that there may be more acquisition opportunities available in the logistics industry than the automotive drivetrain remanufacturing industry.

Our Drivetrain Remanufacturing Business

Our Drivetrain business consists of five operating units that primarily remanufacture and sell transmissions directly to automobile manufacturers.  Drivetrain segment sales accounted for 77.3%, 73.6%, 68.3% and 67.7% of our 1998, 1999, 2000 and 2001 revenues, respectively.

We remanufacture factory–approved transmissions for warranty and post-warranty replacement of transmissions for DaimlerChrysler, Ford, General Motors and several foreign OEMs, including Mitsubishi, Isuzu, Subaru and Kia, primarily for their United States dealer networks, and Hyundai for its Canadian network.  The number of transmission models we remanufacture has been increasing to accommodate the greater number of models currently used in vehicles manufactured by our OEM customers.

We operate a facility in England that remanufactures factory–approved engines for several European OEMs, including Jaguar and the European divisions of Ford and General Motors.  These engines are used for warranty and post-warranty replacement.  The facility in England also does assembly and modification of new production engines for a number of our OEM customers.

Our largest Drivetrain segment customers are DaimlerChrysler and Ford, to whom we primarily supply remanufactured transmissions for use in Chrysler and Ford automobiles and light trucks.  Additionally, we provide remanufactured components to several other OEMs including transmissions to General Motors, Kia, Mitsubishi, Subaru and Isuzu and engines to Jaguar, Land Rover, Aston Martin and the European divisions of Ford and General Motors.  In general, the OEMs retain ownership of cores.  We generally sell products to each OEM pursuant to supply arrangements for individual transmission or engine models, which supply arrangements typically may be terminated by the OEM on 90 days notice or less.

6

 

Historically, we have developed and maintained strong relationships at many levels in both the corporate and factory organizations of the Chrysler division of DaimlerChrysler.  In recognition of our consistently high level of service and product quality throughout our relationship with DaimlerChrysler, in each of the eight years prior to and including 2000, we have received the highest award bestowed by Chrysler to its suppliers for which we were eligible.  We are one of a select group of Chrysler’s suppliers to receive these awards for the eight-year period.  Additionally, over the past two years, we have strengthened our relationships with many of our other Drivetrain customers, as evidenced by the award of new business with Ford, Jaguar, Isuzu and General Motors.  In February 2001, we received an award from Ford for “Dedication to Customer Satisfaction.”

All of our facilities that remanufacture transmissions have QS-9000 certification, a complete quality management system developed for manufacturers who subscribe to the ISO 9002 quality standards.  The system is designed to help suppliers, such as us, develop a quality system that emphasizes defect prevention and continuous improvement in manufacturing processes.  Ford has also awarded us its Q1 quality certification.

DaimlerChrysler began implementing remanufacturing programs for its Chrysler transmission models in 1986 and has utilized us as its sole supplier of remanufactured transmissions since 1989.  DaimlerChrysler has advised us that, by implementing a remanufacturing program for Chrysler vehicles, DaimlerChrysler has realized substantial warranty cost savings, standardized the quality of its dealers’ aftermarket repairs and reduced its own inventory of replacement parts.  We presently do not provide remanufactured transmissions or other components to DaimlerChrysler’s Mercedes Benz division.

We began remanufacturing transmissions for Ford in 1989 and for General Motors in 1985.  We believe that we are the largest provider of remanufactured transmissions to Ford for automobiles and light trucks in North America and we are one of three suppliers of remanufactured transmissions to General Motors.

Our Logistics Business

Our Logistics business provides supply chain management to our customers.  Our operations consist of a warehouse, distribution and turnkey order fulfillment and information services business, an automotive electronic parts remanufacturing and distribution business and a material recovery parts processing, or reverse logistics, and Internet–based auction business.  We acquired our Logistics business as part of the Autocraft acquisition in 1998.

Logistics Customers

AT&T Wireless Services.  The logistics services operating unit provides value added warehouse and distribution services, turnkey order fulfillment and information services for AT&T Wireless.  As part of our product offering, we provide bulk and direct fulfillment of cellular telephones and accessories to AT&T Wireless subscribers and partners and point-of-sale and other marketing materials to AT&T Wireless partners.  We deliver products both to AT&T Wireless retail locations and directly to individuals who order a cellular phone.  Our arrangement with AT&T Wireless originally focused primarily on cellular telephones and we then expanded our relationship to include accessories and promotional items.  We also provide accessory packaging services and inventory tracking and management and process all warranty–service exchanges.  We do not take title to any telephones or accessories and do not reflect any of these items as inventory.

Automotive Electronic Components.  The automotive electronic components operating unit remanufactures and distributes radios and instrument and display clusters for General Motors, Delphi and Ford, and remanufactures and distributes various cellular products (e.g., navigation systems) primarily for Ford and General Motors.

Material Recovery.  We provide returned material reclamation and disposition services to assist automobile OEMs with the management of their dealer parts inventory, thereby reducing the OEMs’ parts costs and assisting them in being more environmentally responsible.  Under this program, dealers send their excess and obsolete parts inventory to our facility in Oklahoma City.  We then sort the parts and redistribute the useful parts on behalf of the OEM to other dealers to fill back orders or to the OEM’s product distribution centers for restocking.  Useful parts that are not needed by other dealers or the OEM distribution centers are sold to remanufacturers, wholesale distributors and other aftermarket customers or through an innovative on-line Internet auction process.  Parts that are no longer useful are scrapped and recycled.  The parts remain the property of the OEM, and we receive a fee for our redistribution services.

7

 

We developed this program primarily with Ford as a way to substantially improve the rate of recycling of automotive parts.  As a result of the material recovery program, the number of Ford parts that are sent to landfills has been significantly reduced.  We recently expanded the scope of this business by providing similar services, currently on a more limited scale, to General Motors.  We believe that the opportunity to provide material recovery services for other OEMs will arise in the future as OEMs recognize the benefits of this program.

As part of our material recovery program, we have developed an Internet–enabled interactive system that allows an OEM to track the availability, condition and value of core, and to produce dealer credits and facilitate logistics.  Our system also allows an OEM and its dealers and vendors to track product on a real time basis and provides system-wide inventory management, cross–docking and product redistribution capabilities.

Competition

In our Drivetrain business, we primarily compete in the market for remanufactured transmissions sold to the automotive aftermarket through the OEM dealer networks.  This market, narrowly defined, is one in which the majority of industry supply comes from a limited number of participants.  Competition is based primarily on product quality, service, delivery, technical support and price and tends to be split along customer lines.  We believe that we have established excellent relationships with our customers and believe we are well positioned to enhance our competitive position by expanding our product line through the development of new products or acquisition of new businesses.

In our Logistics business, we primarily compete in a fragmented market as a niche participant offering a specialized value–added service requiring severe service level requirements.  Based on our performance levels, we believe we are well positioned to compete in this market.  However, some of our competitors in this segment are larger and have greater financial and other resources.

8

 

Corporate History

Since our formation in 1994 at the direction of Aurora Capital Group, we have completed the following acquisitions:

 

(1)          Includes transaction fees and related expenses.

(2)          Excludes subsequent payments totaling $19 million due on each of the first 14 anniversaries of the closing date, of which a total of $4.4 million has been paid through December 31, 2001.

In August 2000, we adopted a plan to discontinue and sell a segment of our business that we referred to as our independent aftermarket.  This independent aftermarket segment consisted of two parts.  The first part was the ATC Distribution Group, Inc., which sold transmission parts to automotive aftermarket customers such as independent transmission rebuilders, general repair shops, distributors and retail automotive parts stores.  This group consisted of various companies that we purchased between 1994 and 1999.  We completed the sale of the Distribution Group in October 2000.  The ATC Distribution Group has been reflected as discontinued operations in the consolidated financial statements and related discussion and analysis included in this annual report.

The second part of the segment was the independent aftermarket engine business that remanufactured domestic and foreign engines primarily for sale not to OEMs, as is the case in our Drivetrain business, but instead through a branch distribution network into the independent aftermarket.  In preparing this independent aftermarket engine business for sale, we restructured the business by eliminating our branch distribution network and selling directly to customers on an overnight basis from four regional distribution centers in the eastern half of the United States, and by applying lean manufacturing techniques to improve productivity, reduce manufacturing costs and improve product quality.  These efforts returned the independent aftermarket engine business to profitability.  However, efforts to identify an interested buyer placing sufficient value on this business were unsuccessful and we ultimately elected to retain our independent aftermarket engine business.

Employees

As of December 31, 2001, we had approximately 3,400 full-time employees.  We believe our employee and labor relations are good.  We have not experienced any work stoppage, and none of our employees are members of any labor union.

9

 

Environmental

We are subject to various evolving federal, state, local and foreign environmental laws and regulations governing, among other things, emissions to air, discharge to waters and the generation, handling, storage, transportation, treatment and disposal of a variety of hazardous and non-hazardous substances and wastes.  These laws and regulations provide for substantial fines and criminal sanctions for violations and impose liability for the costs of cleaning up, and damages resulting from, past spills, disposals or other releases of hazardous substances.

In connection with the acquisition of our subsidiaries, some of which have been subsequently divested or relocated, we conducted certain investigations of these companies’ facilities and their compliance with applicable environmental laws.  The investigations, which included Phase I assessments by independent consultants of all manufacturing and various distribution facilities, found that a number of these facilities have had or may have had releases of hazardous materials that may require remediation and also may be subject to potential liabilities for contamination from off-site disposal of substances or wastes.  These assessments also found that reporting and other regulatory requirements, including waste management procedures, were not or may not have been satisfied.  Although there can be no assurance, we believe that, based in part on the investigations conducted, in part on remediation completed prior to or since the acquisitions, and in part on the indemnification provisions of the agreements entered into in connection with our acquisitions, we will not incur any material liabilities relating to these matters.

One of our former subsidiaries, RPM, leased several facilities in Azusa, California located within what is part of the San Gabriel Valley Superfund Site (the Superfund Site).  Neither Aftermarket Technology Corp. nor RPM has been named as a Potentially Responsible Party (PRP) for the Superfund Site, but the entity that leased the facilities to RPM has been named as one of approximately nineteen PRPs.  Under the Comprehensive Environmental Response Compensation and Liability Act (Superfund), PRPs, which include current and former owners and operators of a contaminated site, as well as persons who sent or transported waste to the site, are responsible for the clean–up of the site and for damage to natural resources caused by contamination at the site.  The United States Environmental Protection Agency (EPA) has preliminarily estimated that it will cost between $150 million and $200 million to construct and operate for an indefinite period an interim groundwater remediation system for the portion of the Superfund Site where the leased properties are located.  The actual cost of this remediation could vary substantially from this estimate and additional costs associated with the Superfund Site are likely to be assessed.  RPM moved all manufacturing operations out of the Superfund Site area in 1995.  Since June 1995, RPM’s only real property interest in this area has been the lease of a 6000 square foot warehouse.  The company that sold us RPM and that company’s shareholders indemnified us from liabilities for conditions in existence on or before our acquisition of RPM.  There can be no assurance, however, that we would be able to obtain any recovery under this indemnity.  Since our acquisition of RPM, we have engaged in negotiations with EPA to settle any liability that RPM may have for the Superfund Site.  Although there can be no assurance, we believe that we will not incur any material liability as a result of RPM’s lease of properties within the Superfund Site.

In connection with the October 2000 sale of our Distribution Group, we have agreed to indemnify the buyer against environmental liability at former Distribution Group facilities that had been closed prior to the Distribution Group sale, including the former facilities in Azusa, California within the Superfund site mentioned above and former manufacturing facilities in Mexicali, Mexico and Dayton, Ohio.  We also agreed to indemnify the buyer against any other environmental liability of the Distribution Group relating to periods prior to the closing of the Distribution Group sale.  Our indemnification obligations to the buyer are, in most cases, subject to a $750,000 deductible and a $12.0 million cap except with respect to closed facilities.

Certain Factors Affecting the Company

We rely on a few major customers for a significant majority of our business and the loss of any of those customers, or significant changes in prices or other terms with any of our major customers, could reduce our net income and operating results.

10

 

A few customers account for a significant majority of our net revenues each year.  In 2001, we had three customers that individually accounted for more than 10% of our revenues.  Ford accounted for approximately 29.6%, 30.0% and 34.6% of our net sales for 1999, 2000 and 2001, respectively, DaimlerChrysler accounted for 31.6%, 29.6% and 24.7% of our net sales in 1999, 2000 and 2001, respectively, and AT&T Wireless accounted for 6.3%, 14.1% and 17.6% of our net sales during 1999, 2000 and 2001, respectively.  If we lose any of these customers, or if any of them reduces or cancels a significant order, our net sales and operating results could decrease significantly.

DaimlerChrysler and Ford, like other North American OEMs, generally require that their dealers using remanufactured products for warranty application use only products from approved suppliers.  Although we are currently the only factory–approved supplier of remanufactured transmissions for Chrysler automobiles and light trucks and one of two suppliers to Ford, DaimlerChrysler and Ford are not obligated to continue to purchase our products and generally may terminate our agreements on 90 days notice or less.  They may approve other suppliers in the future and we may not be able to maintain or increase our sales to them.  Within the last five years the standard new vehicle warranty provided by our customers has varied and shorter warranty periods could be implemented in the future.  Any shortening of warranty periods could reduce the amount of warranty work performed by dealers and reduce the demand for our services.

Substantially all of our contracts or arrangements with our customers are terminable on 90 days notice or less.  In addition, we periodically renegotiate the prices and other terms of our products with our customers.  For instance, in 2001, we reduced our prices to Chrysler, as requested, by approximately 5%.  In addition, our arrangements with AT&T Wireless will expire, and may be subject to a price renegotiation, within the next year.  Because of the short termination periods and periodic price negotiations, we cannot give any assurances of the stability of the prices for our products and, therefore, our revenue streams.  Significant price fluctuations could materially affect our business.

Interruptions or delays in obtaining transmission cores and component parts could impair our business.

In our remanufacturing operations, we obtain used transmissions, engines and related components, commonly known as cores, which are sorted and either placed into immediate production or stored until needed.  The majority of the cores we remanufacture are obtained from OEMs.  Our ability to obtain cores of the types and in the quantities we require is critical to our ability to meet demand and expand production.  With the increased acceptance in the aftermarket of remanufactured assemblies, the demand for cores has increased.  We have periodically experienced situations in which the inability to obtain sufficient cores has limited our ability to accept orders.  We may experience core shortages in the future.  In addition, from time to time, we experience shortages of components manufactured by our OEM customers that we require for our transmission remanufacturing process.  If we experience such shortages for an extended period of time, it could have a material adverse effect on our business and negatively impact our competitive position.

Our financial results are affected by transmission failure rates, which are outside our control.

Our quarterly and annual operating results are affected by transmission failure rates, and a drop in rates could adversely affect sales or profitability or lead to variability of our operating results.  Generally, if transmissions last longer, there will be less demand for our remanufactured transmissions.  Transmission failure rates could drop due to a number of factors outside our control, including:

·                  consumers retaining automobiles for shorter periods, which could occur in periods of economic growth or stability;

·                  transmission design that results in greater reliability;

·                  consumers driving fewer miles per year, which could occur if gasoline prices were to increase; and

·                  mild weather, such as that being experienced in early 2002.

11

 

Our financial results are affected by our customers’ policies, which are outside our control.

Our financial results are also affected by the policies of our OEM customers.  Changes to our key OEM customers’ policies that could materially affect our business include:

·                  shortened warranty periods that could reduce the demand for our products;

·                  reductions in the amount of inventory our OEM customers elect to retain;

·                  longer time periods before remanufactured transmissions are introduced for use with a particular automobile; and

·                  guidelines that affect dealer decisions to rebuild units at the dealer rather than install remanufactured transmissions.

Our Logistics business is dependent on the strength of our customers.

AT&T Wireless, our principal Logistics customer, operates in a highly competitive technology market.  The number of cell phones sold by AT&T Wireless, whether to new subscribers or as replacement phones to existing subscribers, is dependent on its ability to keep pace with technological advancements and to provide service programs and prices that are attractive to current and potential customers.  Our Logistics revenue from AT&T Wireless is substantially related to the number of phones sold by AT&T Wireless.  Consequently, any material decrease in phones sold by AT&T Wireless will materially and adversely affect our Logistics revenue.

We may incur material liabilities under various federal, state, local and foreign environmental laws.

We are subject to various evolving federal, state, local and foreign environmental laws and regulations governing, among other things, emissions to air, discharge to waters and the generation, handling, storage, transportation, treatment and disposal of a variety of hazardous and non-hazardous substances and wastes.  These laws and regulations provide for substantial fines and criminal sanctions for violations and impose liability for the costs of cleaning up, and the damages resulting from, past spills, disposals or other releases of hazardous substances.  In connection with our acquisition activity, we have conducted certain investigations of facilities we have acquired and their compliance with applicable environmental laws.  Similarly, in the course of lease terminations, we have generally conducted investigations into potential environmental impacts resulting from our operations.  These investigations revealed various environmental matters and conditions that could expose us to liability or which have required us to undertake compliance–related improvements or remedial activities.  Furthermore, one of our former subsidiaries, RPM, leased several facilities in Azusa, California located within what is now a federal Superfund site.  The entity that leased the facilities to RPM has been identified by the United States Environmental Protection Agency as one of the many potentially responsible parties for environmental liabilities associated with that Superfund site.  Any liability we may have from this site or otherwise under environmental laws could materially affect our business.

Substantial competition could reduce our market share and significantly harm our financial performance.

While we believe that our business is well positioned to compete in our two primary market segments, transmission remanufacturing and logistics, our industry segments are highly competitive.  We may not be successful in competing against other companies, some of which are larger than us and have greater financial and other resources available to them than we do.  Increased competition could require us to reduce prices or take other actions which may have an adverse effect on our operating results.

12

 

Our stock price is volatile, and investors may not be able to recover their investment if our stock price declines.

The stock price of our common stock has been volatile and can be expected to be affected by factors such as:

·                  quarterly variations in our results of operations, which may be impacted by, among other things, price renegotiations with our customers;

·                  quarterly variations in the results of operations or stock prices of comparable companies;

·                  announcements of new products or services offered by us or our competitors;

·                  changes in earnings estimates or buy/sell recommendations by financial analysts;

·                  the stock price performance of our customers; and

·                  general market conditions or market conditions specific to particular industries.

In addition to the factors listed above affecting us, our competitors and the economy generally, the stock price of our common stock may be affected by any significant sale of shares by our principal stockholders.  As of March 1, 2002, Aurora Equity Partners L.P. and Aurora Overseas Equity Partners I, L.P. collectively owned 9,761,478 shares of our common stock.  Any significant sales by the Aurora partnerships of these shares could have a negative impact on our stock price.

Our future operating results may fluctuate significantly.

We may experience significant variations in our future quarterly results of operations.  These fluctuations may result from many factors, including the condition of our industry in general and shifts in demand and pricing for our products.  Our operating results are also highly dependent on our level of gross profit as a percentage of net sales.  Our gross profit percentage fluctuates due to numerous factors, some of which may be outside of our control. These factors include:

·                  pricing strategies;

·                  changes in product costs from vendors;

·                  the risk of some of the items in our inventory becoming obsolete;

·                  the relative mix of products sold during the period; and

·                  general market and competitive conditions.

Results of operations in any period, therefore, should not be considered indicative of the results to be expected for any future period.

Our success depends on our ability to retain our senior management and to attract and retain key personnel.

Our success depends to a significant extent on the efforts and abilities of our senior management team.  We have various programs in place to motivate, reward and retain our management team, including bonus and stock option plans.  However, the loss of one or more of these persons could have an adverse effect on our business.  Our success and plans for future growth will also depend on our ability to hire, train and retain skilled workers in all areas of our business.  We currently do not have key executive insurance relating to our senior management team.

13

 

We cannot predict the impact of unionization efforts or labor shortages on our business.

From time to time, labor unions have indicated their interest in organizing our workforce.  Given that our OEM customers are in the highly unionized automotive industry, our business is likely to continue to attract the attention of union organizers.  While these efforts have not been successful to date, we cannot give any assurance that we will not experience additional union activity in the future.  Any union organization activity, if successful, could result in increased labor costs and, even if unsuccessful, could result in a temporary disruption of our production capabilities and a distraction to our management.  Additionally, we need qualified managers and a number of skilled employees with technical experience in order to operate our business successfully.  From time to time, there may be a shortage of skilled labor which may make it more difficult and expensive for us to attract and retain qualified employees.  If we are unable to attract and retain qualified individuals or our costs to do so increase significantly, our operations would be materially adversely affected.

We are subject to risks associated with future acquisitions.

An important element of our growth strategy is the acquisition and integration of complementary businesses in order to broaden product offerings, capture market share and improve profitability.  We will not be able to acquire other businesses if we cannot identify suitable acquisition opportunities, obtain financing on acceptable terms or reach mutually agreeable terms with acquisition candidates.  The negotiation of potential acquisitions as well as the integration of an acquired business could require us to incur significant costs and cause diversion of our management’s time and resources.  Future acquisitions by us could result in:

·                  dilutive issuances of equity securities;

·                  reductions in our operating results;

·                  incurrence of debt and contingent liabilities;

·                  future impairment of goodwill and other intangibles; and

·                  other acquisition–related expenses.

Some or all of these items could have a material adverse effect on our business.  The businesses we acquire in the future may not achieve sales and profitability that justify our investment.  In addition, to the extent that consolidation becomes more prevalent in our industry, the prices for suitable acquisition candidates may increase to unacceptable levels and limit our growth.

We may encounter problems in integrating the operations of companies that we acquire.

We may encounter difficulties in integrating any businesses we acquire with our operations.  The success of these transactions depends on our ability to:

·                  retain key management members and technical personnel of acquired companies;

·                  successfully merge corporate cultures and operational and financial systems; and

·                  realize sale and cost reduction synergies.

Furthermore, we may not realize the benefits we anticipated when we entered into these transactions.  In addition, after we have completed an acquisition, our management must be able to assume significantly greater responsibilities, and this in turn may cause them to divert their attention from our existing operations.  Any of the foregoing could have a material adverse effect on our business and results of operations.

14

 

Our level of indebtedness and the terms of our indebtedness could adversely affect our business and liquidity position.

As of December 31, 2001, our outstanding indebtedness was $197.8 million.  While the proceeds from our public offering that was completed on March 8, 2002 have been used to reduce our outstanding indebtedness, we expect that our indebtedness, including borrowings under our new credit facility, may increase from time to time in the future for various reasons, including fluctuations in operating results, capital expenditures and possible acquisitions.  Our consolidated indebtedness level could materially affect our business because:

·                  a substantial portion of our cash flow from operations must be dedicated to interest payments on our indebtedness and is not available for other purposes, which amount would increase if prevailing interest rates rise;

·                  it may materially limit or impair our ability to obtain financing in the future;

·                  it may reduce our flexibility to respond to changing business and economic conditions or take advantage of business opportunities that may arise; and

·                  our ability to pay dividends is limited.

In addition, our new credit facility requires us to meet specified financial ratios and limits our ability to enter into various transactions.  The terms of our current outstanding 12% senior subordinated notes, which will be fully redeemed on April 8, 2002, limit our ability to incur additional indebtedness.

If we default on any of our indebtedness, or if we are unable to obtain necessary liquidity, our business could be adversely affected.

Our significant stockholders have the ability to influence all matters requiring the approval of our board of directors and our stockholders.

As of March 1, 2002, the Aurora partnerships held approximately 66% of our voting power, through direct ownership of shares and voting arrangements, and four of the nine members of our Board of Directors are affiliated with the Aurora partnerships.  As a result, they are able to exercise substantial control over us.  As a result, it may be more difficult for a third party to acquire us.  See Item 12. “Security Ownership of Certain Beneficial Owners and Management” and Item 13. “Certain Relationships and Related Transactions.”

Our certificate of incorporation contains provisions that may hinder or prevent a change in control of our company.

Provisions of our certificate of incorporation could make it more difficult for a third party to obtain control of us, even if such a change in control would benefit our stockholders.  Our Board of Directors can issue preferred stock without stockholder approval.  The rights of common stockholders could be adversely affected by the rights of holders of preferred stock that we issue in the future.  These provisions could discourage a third party from obtaining control of us.  Such provisions may also impede a transaction in which our stockholders could receive a premium over then current market prices and our stockholders’ ability to approve transactions that they consider in their best interests.

15

ITEM 2.           PROPERTIES

We conduct our business from the following facilities:

 

Location		Approx. Sq. Feet		Lease Expiration   Date		Products Produced/Services Provided
Joplin, MO		264,000		2008		transmissions and transfer cases (1)
Springfield, MO		280,800		2004		transmissions (1)
Springfield, MO		200,000		2006		engines (1)
Gastonia, NC		130,000		2002		transmissions and valve bodies (1)
Mahwah, NJ		160,000		2003		transmissions, transfer cases and assorted components (1)
Oklahoma City, OK		98,000		owned		returned material reclamation and disposition (2)
Oklahoma City, OK		207,000		owned		transmissions (1)
Carrollton (Dallas), TX		39,000		2006		radios and instrument and display clusters (2)
Ft. Worth, TX		220,000		2008		cellular phone and accessory distribution (2)
Ft. Worth, TX		108,000		2005		cellular phone accessory packaging and returns processing (2)
Houston, TX		50,000		2002		radios (2)
Grantham, England		120,000		owned		engines and related components(2)

 

(1)          This facility is used by the Drivetrain business.

(2)          This facility is used by the Logistics business.

We also lease assorted warehouses and space for our corporate offices and computer services centers.  We believe that our current facilities are adequate for the current level of our activities. In the event we were to require additional facilities, we believe that we could procure acceptable facilities.

ITEM 3.                                         LEGAL PROCEEDINGS

From time to time, we have been, and currently are, involved in various legal proceedings.  Management believes that all of our litigation is routine in nature and incidental to the conduct of our business, and that none of our litigation, if determined to be adverse to us, would have a material adverse effect, individually or in the aggregate, on us.

ITEM 4.                                         SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the stockholders of the Company during the quarter ended December 31, 2001.

 

16

PART II

ITEM 5.                                                     MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock has been traded on the Nasdaq National Market under the symbol “ATAC” since our initial public offering in December 1996.  As of March 1, 2002, there were approximately 84 record holders of our common stock.  The following table sets forth for the periods indicated the range of high and low sale prices of the common stock as reported by Nasdaq:

 

On March 1, 2002, the last sale price of the common stock, as reported by Nasdaq, was $17.09 per share.

We have not paid cash dividends on the common stock to date.  Because we currently intend to retain any earnings to provide funds for the operation and expansion of our business and for the servicing and repayment of indebtedness, we do not intend to pay cash dividends on the common stock in the foreseeable future.  Furthermore, as a holding company with no independent operations, the ability of Aftermarket Technology Corp. to pay cash dividends is dependent upon the receipt of dividends or other payments from its subsidiaries.  The agreement for our bank credit facility contains certain covenants that, among other things, prohibit the payment of dividends.  See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”  Any determination to pay cash dividends on the common stock in the future will be at the sole discretion of our Board of Directors.

On June 23, 2000, September 17, 2001 and September 21, 2001, we issued 114,218 shares, 61,775 shares and 120,146 shares, respectively, of our common stock in transactions that were not registered under the Securities Act of 1933, as amended.  The shares were issued upon the exercise of warrants that had been issued by us in 1994 to two individuals in exchange for services rendered in connection with our original acquisitions.  The warrant exercise price of $1.67 per share was paid in each case by us withholding a number of the warrant shares having a fair market value equal to the aggregate exercise price.  We relied on Section 4(2) of the Securities Act as an exemption from registration, based on the private nature of the offering and the limited number of offerees.

 

17

 

ITEM 6.                                         SELECTED FINANCIAL DATA

The selected financial data presented below with respect to the statements of operations data for the years ended December 31, 2001, 2000 and 1999 and the balance sheet data as of December 31, 2001 and 2000 are derived from the Consolidated Financial Statements of the Company that have been audited by Ernst & Young LLP, independent auditors, and are included elsewhere herein, and are qualified by reference to such financial statements and notes related thereto.  The selected financial data with respect to the statement of operations data for the years ended December 31, 1998 and 1997 and the balance sheet data as of December 31, 1999, 1998 and 1997, are derived from the Consolidated Financial Statements of the Company that have been audited by Ernst & Young LLP, independent auditors, but are not included herein.  The data provided should be read in conjunction with the Consolidated Financial Statements, related notes and other financial information included in this Annual Report.  The results of the Distribution Group, Inc. subsidiary, which was sold in October 2000, are classified as discontinued operations in the selected financial data presented below.

		Year Ended December 31,
		2001			2000			1999			1998			1997
		(In thousands, except per share data)
Statement of Operations Data:
Net sales		$	393,381		$	372,493		$	365,563		$	300,723		$	191,058
Cost of sales		255,360			248,438			246,224			219,539			114,956
Special charges (1)		216			9,134			2,965			1,347			—
Gross profit		137,805			114,921			116,374			79,837			76,102
Selling, general and administrative expenses		59,939			57,331			56,736			47,496			30,430
Amortization of intangible  assets		5,028			5,255			5,527			5,038			3,273
Special charges (1)		5,114			23,450			4,345			5,327			—
Income from operations		67,724			28,885			49,766			21,976			42,399
Interest income		1,524			234			—			—			—
Interest expense and other, net		(21,623		)	(24,830		)	(23,251		)	(21,917		)	(15,213		)
Income tax expense		(18,098		)	(1,883		)	(9,739		)	(974		)	(10,902		)
Income (loss) from continuing operations (2)(3)		$	29,527		$	2,406		$	16,776		$	(915	)	$	16,284
Income (loss) from continuing operations per share (4)		$	1.40		$	0.11		$	0.79		$	(0.05	)	$	0.84
Shares used in computation of income from continuing operations per share (4)		21,059			21,163			21,164			19,986			19,335
Other Data:
Capital expenditures (5)		$	13,516		$	11,682		$	10,072		$	10,764		$	6,293

 

18

 

		As of December 31,
		2001			2000			1999			1998			1997
		(In thousands)
Balance Sheet Data:
Working capital, continuing operations		$	52,700		$	53,457		$	29,744		$	36,128		$	44,855
Property, plant and equipment, net		52,577			46,276			47,897			45,830			16,737
Total assets		396,858			407,499			577,782			517,794			360,477
Long-term liabilities, less current portion		181,694			213,537			302,491			258,051			152,571
Common stockholders’ equity		109,335			80,239		(6)	176,144			168,011			175,429

 

(1)          See Item 8. “Consolidated Financial Statements and Supplementary Data-Note 19” for a description of special charges.

(2)          Income (loss) from continuing operations for the years ended December 31, 2001, 2000, 1999, 1998 and 1997 excludes income (loss) from discontinued operations, net of income taxes, of $(959), $(99,289), $(9,969), $(6,200) and $6,719, respectively.

(3)          Income (loss) from continuing operations for the year ended December 31, 1998 excludes an extraordinary item in the amount of $703 ($1,172 less related income tax benefit of $469).  In addition, income (loss) from continuing operations for the year ended December 31, 1997 excludes an extraordinary item in the amount of $3,749 ($6,269 less related income tax benefit of $2,520).

(4)          See Item 8. “Consolidated Financial Statements and Supplementary Data-Note 14” for a description of the computation of earnings per share.

(5)          Excludes capital expenditures made by certain of the Company’s subsidiaries prior to such subsidiaries’ respective acquisitions and any capital expenditures made in connection with such acquisitions.

(6)          Common stockholders’ equity as of December 31, 2000 reflects the loss on the sale of our Distribution Group business and from the initial discontinuance of, and subsequent election to retain, our independent aftermarket engine business.

 

19

 

ITEM 7.                                                     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Consolidated Financial Statements of the Company and notes thereto included elsewhere in this Annual Report.  See Item 8. “Consolidated Financial Statements and Supplementary Data.”

Readers are cautioned that the following discussion contains certain forward-looking statements and should be read in conjunction with the “Special Note Regarding Forward-Looking Statements” appearing at the beginning of this Annual Report.

Overview

We are a leading remanufacturer and distributor of drivetrain products used in the repair of automobiles and light trucks in the automotive aftermarket.  Our Logistics business is a provider of value added warehouse and distribution services as well as returned material reclamation and disposition services. Our Logistics business also remanufactures and distributes electronic components.

Demand for our products within the Drivetrain business is largely a function of the number of vehicles in operation, the average age of vehicles and the average number of miles driven per vehicle.  These factors have generally increased over time, thereby increasing demand for our remanufactured products.  Other factors that influence demand for our remanufactured products include product complexity and reliability, the length of OEM warranty periods and the severity of weather conditions.  Because these factors are not directly dependent on new automotive sales levels, demand for remanufactured products within our Drivetrain business has been largely non-cyclical.

Our Drivetrain business has been our primary business since our formation.  For the year ended December 31, 2001, revenue from our Drivetrain business was $266.3 million, or 67.7% of our total revenue.  In addition, in the United States we also sell remanufactured engines in the independent aftermarket.  For the year ended December 31, 2001, revenue from this engines business was $21.9 million, or 5.6% of our total revenue.

Growth in our logistics business with AT&T Wireless is primarily dependent on cellular telephone handset demand and AT&T Wireless’ share of new cellular telephone sales volume. Our logistics business benefits from upgrades in cellular telephone technology through increased replacement demand for more advanced handsets, from any increases in the number of AT&T Wireless subscribers and from any expansion of our service offering with AT&T Wireless. Because we do not take actual ownership of our cellular telephone inventory, we do not face the risk of inventory obsolescence. Other growth drivers within our Logistics business include our ability to leverage our expertise in logistics in other industries. For the year ended December 31, 2001, revenue from our Logistics business was $105.2 million, or 26.7% of our total revenue, of which AT&T Wireless accounted for 65.7%.

Components of Income and Expense

Revenue.  In our Drivetrain Remanufacturing segment and independent aftermarket engines business, we recognize revenues, primarily from the sale of remanufactured transmissions and remanufactured engines, at the time of shipment to the customer and, to a lesser extent, upon the completion or performance of a service. In our Logistics segment, revenue is primarily related to providing;

·                  value added warehouse and distribution services;

·                  turnkey order fulfillment and information services;

·                  returned material reclamation and disposition services;

·                  core management services; and

·                  automotive electronic components remanufacturing and distribution services,

and is generally recognized upon completion or performance of those services.

 

20

 

Cost of Sales.  Cost of sales represents the actual cost of purchased components and other materials, direct labor, indirect labor and warehousing cost and manufacturing overhead costs, including depreciation, utilized directly in the production of products or performance of services for which revenue has been recognized.

 

Selling, General & Administrative Expense.  Selling, general and administrative (“SG&A”) expenses generally are those costs not directly related to the production process or the performance of a revenue generating service and include all selling, marketing and customer service expenses as well as expenses related to general management, finance and accounting, information services, human resources, legal, and corporate overhead expense.

 

Amortization of Intangibles.  Amortization of intangibles consists primarily of the amortization of goodwill. In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, which no longer permits the amortization of goodwill and indefinite–lived intangible assets.  Instead, these assets must be reviewed annually (or more frequently under specified conditions) for impairment in accordance with SFAS No. 142.  We are required to adopt SFAS No. 142 effective January 1, 2002.  The effect of not amortizing goodwill is expected to result in an increase to income from operations in fiscal 2002 of approximately $5.0 million.  The adoption of the impairment provisions of SFAS No. 142 is not expected to have a significant effect on the Company’s results of operations or its financial position.

 

Special Charges.  We have periodically identified areas where cost reductions and efficiencies could be achieved through consolidation of redundant facilities, outsourcing functions or changing processes or systems. Some of these cost reduction or process improvement initiatives result in costs which we have described as special charges and include, but are not limited to, severance benefits for terminated employees, lease termination and other facility exit costs, losses on the disposal of fixed assets, impairment of goodwill and write–down of inventories.

 

Critical Accounting Policies

 

Our financial statements are based on the selection and application of significant accounting policies, some of which require management to make estimates and assumptions.  We believe that the following are some of the more critical judgment areas in the application of our accounting policies that currently affect our financial condition and results of operations.

Reserve for Inventory Obsolescence.  We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about market conditions, future demand and expected usage rates.  If actual market conditions are less favorable than those projected by management causing usage rates to vary from those estimated, additional inventory write-downs may be required.

Warranty Liability.  We provide an allowance for the estimated cost of product warranties at the time revenue is recognized.  While we engage in extensive product quality programs and processes, including inspection and testing at various stages of the remanufacturing process and the testing of each finished assembly on equipment designed to simulate performance under operating conditions, our warranty obligation is affected by product failure rates.  Should actual product failure rates differ from our estimates, revisions to the estimated warranty liability may be required.

Deferred Tax Assets.  We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.  While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made.  Likewise, should we determine that we would not be able to realize all or part of our deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

 

21

 

Allowance for Doubtful Accounts.  We maintain allowances for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments.  We evaluate the adequacy of our allowance for doubtful accounts and make judgments and estimates in determining the appropriate allowance at each reporting period.  If a customer’s financial condition were to deteriorate, additional allowances may be required.

 

Segment Reporting

We have two reportable segments in continuing operations: the Drivetrain Remanufacturing segment and the Logistics segment. The Drivetrain Remanufacturing segment consists of five operating units that primarily sell remanufactured transmissions directly to DaimlerChrysler, Ford, General Motors and several foreign OEMs, primarily for use as replacement parts by their domestic dealers during the warranty and post-warranty periods following the sale of a vehicle. In addition, the Drivetrain Remanufacturing segment sells select remanufactured and newly assembled engines to European OEMs including Ford’s and General Motor’s European operations and Jaguar. Our Logistics segment consists of three operating units:

·                  a provider of value added warehouse and distribution services, turnkey order fulfillment and information services for AT&T Wireless;

·                  a provider of returned material reclamation and disposition services and core management services primarily to Ford and to a lesser extent, General Motors; and

·                  an automotive electronic components remanufacturing and distribution business, including components for the OnStar program, primarily for Delphi and Visteon.

Our independent aftermarket engine business, which is not a separate reportable segment and is shown as “Other,” remanufactures and distributes domestic and foreign engines and recently began distributing select remanufactured domestic transmissions from four regional distribution centers primarily to independent aftermarket customers.

We evaluate the performance of each segment based upon income from operations. The reportable segments and the “other” business unit are each managed and measured separately primarily due to the differing customers, production processes, products sold and distribution channels.

 

Results of Operations

 

The following table sets forth financial statement data expressed as a percentage of net sales.

 

		Year Ended December 31,
		2001		2000		1999
Net sales		100.0	%	100.0	%	100.0	%
Cost of sales		64.9		66.7		67.4
Special charges		0.1		2.5		0.8
Gross profit		35.0		30.8		31.8
SG&A expenses		15.2		15.4		15.5
Amortization of intangible assets		1.3		1.4		1.5
Special charges		1.3		6.2		1.2
Income from operations		17.2		7.8		13.6
Interest income		0.4		0.1		—
Interest expense and other, net		5.5		6.7		6.4
Income from continuing operations, before income taxes		12.1		1.2		7.2
Income tax expense		4.6		0.6		2.6
Income from continuing operations		7.5	%	0.6	%	4.6	%

 

22

 

Year Ended December 31, 2001 Compared to the Year Ended December 31, 2000

 

Income from continuing operations increased $27.1 million, to $29.5 million in 2001 from $2.4 million in 2000.  During 2001, we recorded pre-tax special charges of $5.3 million, primarily related to initiatives designed to improve operating efficiencies and reduce costs (see “Special Charges” below) and a non-recurring gain of $0.9 million related to the sale of the preferred stock of the Distribution Group, which we received in 2000 as partial consideration for the sale of that business. Additionally, in 2000, we recorded $32.6 million (pre-tax) of special charges primarily related to the write-off of goodwill and the recording of valuation allowances for specified assets associated with our decision to discontinue our independent aftermarket engine business.  This business was subsequently retained (see “Discontinued Operations”).  Excluding the special charges and non-recurring gain, income from continuing operations increased $9.5 million, or 41.7%, to $32.3 million for the year ended December 31, 2001 from $22.8 million in 2000.  This increase was primarily attributable to substantial growth in the Logistics segment, productivity improvements resulting from our lean and continuous improvement program and other cost reduction initiatives and increased profitability in the independent aftermarket engine business, partially offset by reduced margins in the Drivetrain Remanufacturing segment largely related to price and inventory reduction initiatives at certain OEM customers.  Income from continuing operations per diluted share was $1.40 for 2001 as compared to $0.11 for 2000.  Excluding the special charges and non-recurring gain, income from continuing operations per diluted share was $1.53 for 2001 as compared to $1.08 for 2000.

 

Net Sales.  Net sales increased $20.9 million, or 5.6%, to $393.4 million for 2001 from $372.5 million for 2000.  This increase was driven primarily by:

·                  growth in the Logistics segment, attributable to an increase in sales for value-added warehouse and distribution services, driven by the growth in the market for cellular phones and services;

·                  growth in the Logistics segment attributable to the ramp up of the two new programs we were awarded by AT&T Wireless in early 2000, covering the packaging and distribution of cell phone accessories and the distribution of point-of-sale and other marketing materials, which began generating revenue for us in the second half of 2000; and

·                  growth in the Drivetrain Remanufacturing segment, primarily related to an increase in sales of remanufactured transmissions to Ford.

 

This increase was partially offset by a decline in remanufactured transmissions sold to DaimlerChrysler as a result of its inventory reduction initiative, a decline in revenue in the independent aftermarket engine business resulting from a change in the distribution channel for this business and a decline in revenue in the Logistics segment related to the termination of its remanufactured electronic control module product line.

 

Sales to DaimlerChrysler accounted for 24.7% and 29.6%, Ford accounted for 34.6% and 30.0% and AT&T Wireless accounted for 17.6% and 14.1% of our revenues for 2001 and 2000, respectively.

 

Gross Profit.  Gross profit increased $22.9 million, or 19.9%, to $137.8 million for 2001 from $114.9 million for 2000.  Excluding special charges of $0.2 million recorded during 2001 and $9.1 million of special charges related to the independent aftermarket engine business recorded during 2000, gross profit increased $14.0 million, or 11.3%.  This increase was primarily the result of increased sales in the Logistics segment and improved productivity as a result of our lean and continuous improvement program and other cost reduction initiatives, partially offset by a decline in gross profit in the Drivetrain Remanufacturing segment resulting from:

·                  price concessions provided to DaimlerChrysler as a result of their request for supplier participation in their cost reduction initiatives;

·                  the sales mix of remanufactured transmissions; and

23

 

·                  production inefficiencies resulting from the impact of DaimlerChrysler’s and GM’s inventory reduction initiatives.

As a percentage of net sales, gross profit before special charges increased to 35.1% in 2001 from 33.3% for 2000.

 

SG&A Expenses.  SG&A expenses increased $2.6 million, or 4.5%, to $59.9 million for 2001 from $57.3 million for 2000.  The increase was primarily the result of an increase in spending in support of growth initiatives in the Logistics segment and on our Lean and Continuous Improvement and Customer Delight initiatives, partially offset by a decrease in cost in the independent aftermarket engine business resulting from the elimination of our branch distribution network.  As a percentage of net sales, SG&A expenses decreased slightly to 15.2% for 2001 from 15.4% for 2000.

 

Amortization of Intangible Assets.  Amortization of intangible assets decreased $0.3 million, or 5.7%, to $5.0 million for 2001 from $5.3 million for 2000, primarily attributable to the write–off of goodwill related to the independent aftermarket engine business on June 30, 2000.

 

Special Charges.  During 2001, we recorded $5.3 million of special charges ($3.3 million net of tax) including $2.4 million for the Drivetrain Remanufacturing segment, $2.4 million for the Logistics segment and $0.5 million for consolidation of our two information systems groups.  The $2.4 million related to the Drivetrain Remanufacturing segment consists of $1.6 million of severance and related costs for 35 people, primarily associated with the de-layering of certain management functions and $0.8 million of facility exit and idle capacity costs associated with facility consolidations and implementation of cellularized manufacturing within the segment.  The $2.4 million of special charges in the Logistics segment are primarily related to a decision to exit an unprofitable product line and include the following:

·                  $1.9 million of costs related to the shut-down of our remanufactured automotive electronic control modules operation including:

o                 $0.7 million of severance and related costs for 118 people;

o                 $0.6 million related to the write-down of fixed assets;

o                 $0.3 million of facility exit and other costs related to the shutdown;

o                 $0.2 million related to inventory write–downs (classified as Cost of Sales-Special Charges); and

o                 $0.1 million for the write-down of uncollectible accounts receivable balances; and

·                  $0.5 million of severance and related costs for eight people primarily associated with the upgrade of certain management functions within the segment.

             The $0.5 million related to our two information systems groups is related to severance costs for four people primarily associated with the consolidation of those functions.

 

             During 2000, we recorded $32.6 million of special charges related to the reorganization of our independent aftermarket engine business. These charges included the following:

·                  $15.6 million for the impairment of goodwill;

·                  $5.8 million for the write-down of fixed assets to estimated net realizable value;

·                  $5.4 million for the write-down of inventory to estimated net realizable value (classified as Cost of Sales-Special Charges);

·                  $3.8 million for product warranty costs of units remanufactured and sold prior to 2000 (classified as Cost of Sales-Special Charges);

·                  $0.9 million for the write-down of uncollectible accounts receivable balances; and

24

 

·                  $0.7 million of exit costs and $0.4 million of severance costs for 56 people primarily associated with the shutdown of our branch distribution network.

 

As an on-going part of our planning process, we continue to identify and evaluate areas where cost efficiencies can be achieved through consolidation of redundant facilities, outsourcing functions or changing processes or systems.  Implementation of any of these could require us to incur special charges, which would be offset over time by the projected cost savings.

 

Income from Operations.  Income from operations increased $38.8 million, to $67.7 million for 2001 from $28.9 million for 2000.  Excluding special charges of $5.3 million recorded in 2001 and $32.6 million of special charges related to the independent aftermarket engine business recorded in 2000, income from operations increased $11.5 million, or 18.7%, to $73.0 million for 2001 from $61.5 million for 2000.  As a percentage of net sales, income from operations before special charges increased to 18.6% from 16.5%, between the two periods.

 

Interest Income.  Interest income of $1.5 million and $0.2 million was recorded during 2001 and 2000, respectively, on the 18% senior subordinated promissory note received by us as partial consideration for the sale of the Distribution Group on October 27, 2000.

 

Other Income (Expense), Net.  Other income (expense), net increased $0.9 million to income of $0.8 million in 2001 from a loss of $0.1 million in 2000. This increase was the result of a non-recurring gain on the sale of the preferred stock of the Distribution Group, which was received in 2000 as partial consideration for the sale of that business.

 

Interest Expense.  Interest expense decreased $2.4 million, or 9.7%, to $22.4 million for 2001 from $24.8 million for 2000.  This decrease was the result of a general decline in interest rates combined with a reduction in debt outstanding.  Interest expense for 2000 of $5.2 million was allocated to discontinued operations based on the actual consideration received from the sale of the Distribution Group.

 

Discontinued Operations.  On August 3, 2000, we adopted a plan to discontinue a segment of our business that we referred to as our independent aftermarket. This segment consisted of the Distribution Group and the independent aftermarket engine business. We planned to sell the Distribution Group by December 31, 2000 and the independent aftermarket engine business by June 30, 2001. Management believed that the planned exit from these businesses, which provided the opportunity to reduce debt and generated a significant tax shelter, offered a strategic opportunity to focus resources on our businesses that were profitable and had greater growth potential. As a result of the decision to exit these businesses, we recorded a charge for the loss on disposal of discontinued operations.

 

             On October 27, 2000, we completed the sale of the Distribution Group to an affiliate of The Riverside Company. Our plan with respect to the independent aftermarket engine business was to restructure and return it to profitability prior to finding a buyer. Our restructuring of our independent aftermarket engine business, which

·                  eliminated our 21 branch distribution network and replaced it with a business model that sells and distributes remanufactured engines directly to independent aftermarket customers on an overnight delivery basis from four regional distribution centers;

·                  applied lean manufacturing techniques to improve productivity and reduce manufacturing cost; and

·                  significantly improved product quality to reduce product warranty cost,

 

was successful in returning this business to profitability.  However, efforts to identify an interested buyer placing sufficient value on this business were unsuccessful.  Consequently, on June 25, 2001, we elected to retain our independent aftermarket engine business.  As a result of this decision and in accordance with EITF 90-16, Accounting for Discontinued Operations Subsequently Retained, the results of the remanufactured engines business have been reclassified from discontinued operations to continuing operations for all periods presented.

25

 

During 2001, we recorded a charge of $1.0 million related to discontinued operations, net of tax benefits of $0.6 million. This charge included the following on a pre-tax basis: $2.7 million in expense for the increase to the estimated loss on the sale of the Distribution Group, $2.1 million in income for the reversal of the estimated accrued loss on disposal of our independent aftermarket engine business and $1.0 million in expense for the reclassification of the operating results of our independent aftermarket engine business from discontinued operations to continuing operations, as required per EITF No. 90-16.

 

During the year ended December 31, 2000, we recorded a charge of $94.5 million for the loss on disposal of discontinued operations ($92.8 million for the Distribution Group and $1.7 million for our independent aftermarket engine business), net of income tax benefits of $46.9 million.  The charge of $94.5 million included the write-off of goodwill, valuation allowances for specified assets, provisions for anticipated operating losses until disposal, and anticipated costs of disposal, including lease terminations, severance, retention and other employee benefits and professional fees.  Additionally, the loss from discontinued operations included a loss of $6.4 million, net of income tax benefits of $3.1 million, from the operations of the Distribution Group during the six months ended June 30, 2000, partially offset by $1.6 million of income (net of tax) for the reclassification of the operating results of our independent aftermarket engine business from discontinued operations to continuing operations, as required per EITF No. 90-16.

 

Drivetrain Remanufacturing Segment

 

The following table presents net sales, special charges and segment profit expressed in millions of dollars and as a percentage of net sales:

 

		Year Ended December 31,
		2001					2000
Net sales		$	266.3		100.0	%	$	254.3		100.0	%
Special charges		$	2.4		0.9	%	$	—		—	%
Segment profit		$	40.0		15.0	%	$	49.0		19.3	%

 

Net Sales.  Net sales increased $12.0 million, or 4.7%, to $266.3 million for 2001 from $254.3 million for 2000.  This increase was primarily due to an increase in sales of remanufactured transmissions to Ford and Kia and growth in our engine remanufacturing program with Jaguar, partially offset by a decrease in sales of remanufactured transmissions to DaimlerChrysler due to price concessions provided to DaimlerChrysler as a result of their request for supplier participation in DaimlerChrysler’s cost reduction initiatives and reduced volume resulting from DaimlerChrysler’s inventory reduction initiatives, which reduced their targeted inventories by nearly 50% (from about 13 to 7 weeks). Sales of remanufactured transmissions to General Motors, which increased slightly, were also dampened as a result of their inventory reduction initiatives, which further reduced GM’s targeted inventories from about 45 days to 30 days.

 

Sales to DaimlerChrysler accounted for 35.6% and 42.5% of segment revenues for 2001 and 2000, respectively.  Sales to Ford accounted for 47.6% and 40.8% of segment revenues 2001 and 2000, respectively.

 

Special Charges.  During 2001, we recorded $2.4 million of special charges.  The special charges include $1.6 million of severance and related costs primarily associated with the de-layering of certain management functions and $0.8 million of facility exit and idle capacity costs associated with facility consolidations and implementation of cellularized manufacturing within the segment.

 

26

 

Segment Profit.  Segment profit decreased $9.0 million, or 18.4%, to $40.0 million (15.0% of segment net sales) for 2001 from $49.0 million (19.3% of segment net sales) for 2000.  Excluding 2001 special charges of $2.4 million, segment profit decreased $6.6 million, or 13.5%, between the two periods.  The decrease was primarily the result of the changes in sales volume, price and mix of remanufactured transmissions as referenced above, combined with production inefficiencies resulting from the impact of DaimlerChrysler’s inventory reduction initiatives and project costs related to the re-engineering of our least efficient, highest cost remanufacturing facility, which we believe will drive productivity improvements in the future, partially offset by cost reductions resulting from our lean and continuous improvement program and other cost reduction initiatives.

 

Logistics Segment

 

The following table presents net sales, special charges and segment profit expressed in millions of dollars and as a percentage of net sales:

 

		Year Ended December 31,
		2001					2000
Net sales		$	105.2		100.0	%	$	89.1		100.0	%
Special charges		$	2.4		2.3	%	$	—		—	%
Segment profit		$	26.5		25.2	%	$	17.4		19.5	%

 

Net Sales.  Net sales increased $16.1 million, or 18.1%, to $105.2 million for 2001 from $89.1 million for 2000.  This increase was primarily attributable to

·                  an increase in sales for value–added warehouse and distribution services, driven by the growth in the market for cellular phones and services;

·                  an increase in sales attributable to the two new programs we were awarded in early 2000 by AT&T Wireless covering the packaging and distribution of cell phone accessories and the distribution of point-of-sale and other marketing materials, which began generating revenue in the second half of 2000;

·                  an increase in sales to General Motors and Delphi for electronics remanufacturing and logistics support associated with a telematics program that we were awarded in 2001; and

·                  an increase in sales to Ford for core management services under the new program we were awarded in 2001,

partially offset by a decrease in sales of  remanufactured electronic control modules as a result of our exit from that operation.  Sales to AT&T Wireless accounted for 65.7% and 59.1% of segment revenues for 2001 and 2000, respectively.

 

Special Charges.  The $2.4 million of special charges recorded during 2001, included the following:

·                  $1.9 million of costs related to the shut-down of the segment’s remanufactured automotive electronic control modules operation including $0.7 million of severance and related costs; $0.6 million related to the write-down of fixed assets; $0.3 million of facility exit and other costs related to the shutdown; $0.2 million related to inventory write–downs; $0.1 for the write-down of uncollectible accounts receivable balances; and

·                  $0.5 million of severance and related costs primarily associated with the upgrade of certain management functions within the segment.

 

27

 

Segment Profit.  Segment profit increased $9.1 million, or 52.3%, to $26.5 million (25.2% of segment net sales) for 2001 from $17.4 million (19.5% of segment net sales) for 2000.  Excluding special charges of $2.4 million recorded in 2001, segment profit increased $11.5 million, or 66.1%, between the two periods.  The increase was primarily the result of changes in sales volume and mix as referenced above combined with cost reductions and other productivity improvements resulting from the increased use of automation and the implementation of lean manufacturing concepts, partially offset by an increase in spending in support of our key growth initiatives in the segment.

 

Other

 

The following table presents net sales, special charges and segment profit (loss) for the independent aftermarket engine business expressed in millions of dollars and as a percentage of net sales:

 

		Year Ended December 31,
		2001					2000
Net sales		$	21.9		100.0	%	$	29.1		100.0	%
Special charges		$	—		—	%	$	32.6		112.0	%
Segment profit (loss)		$	1.7		7.8	%	$	(37.5	)	(128.9%	)

 

Net Sales.  Net sales decreased $7.2 million, or 24.7%, to $21.9 million for 2001 from $29.1 million for  2000. This decrease was attributable to a decline in sales of remanufactured engines, resulting primarily from a change in our distribution method from a branch network to regional distribution centers.

 

Special Charges.  During 2000, we recorded $32.6 million of special charges related to the original decision to discontinue the independent aftermarket engines business. These charges included the following:

·                  $15.6 million for the impairment of goodwill;

·                  $5.8 million for the write-down of fixed assets to estimated net realizable value;

·                  $5.4 million for the write-down of inventory to estimated net realizable value (classified as Cost of Sales-Special Charges);

·                  $3.8 million for product warranty costs of units remanufactured and sold prior to 2000 (classified as Cost of Sales-Special Charges);

·                  $0.9 million for the write-down of uncollectible accounts receivable balances; and

·                  $0.7 million of exit costs and $0.4 million of severance costs for 56 people primarily associated with the shutdown of our branch distribution network.

 

Segment Profit (Loss).  Segment profit (loss) increased $6.6 million, to a profit of $1.7 million for 2001 from a loss of $4.9 million before special charges of $32.6 million for 2000.  This increase was primarily the result of cost reduction initiatives implemented in the independent aftermarket engine business in the later part of 2000 and the first half of 2001 including the application of lean manufacturing techniques to improve productivity and reduce manufacturing cost, a change in the distribution method from a branch network to regional distribution centers and a reduction of product warranty expense.  During 2001, we recognized a reduction in cost of goods sold of approximately $0.8 million, primarily associated with the remaining inventory valuation allowances that were established in 2000 related to our original decision to discontinue the independent aftermarket engines business in 2000.

 

 

28

Year Ended December 31, 2000 Compared to Year Ended December 31, 1999

 

Income from continuing operations decreased $14.4 million, or 85.7%, to $2.4 million in 2000 from $16.8 million in 1999.  During 1999, we recorded pre-tax special charges of $7.3 million, primarily related to initiatives designed to improve operating efficiencies and reduce costs (see “Special Charges” below).  Additionally, in 2000, we recorded $32.6 million (pre-tax) of special charges primarily related to the write-off of goodwill and the recording of valuation allowances for specified assets associated with our decision to discontinue our independent aftermarket engine business.  This business was subsequently retained (see “Discontinued Operations”). Excluding special charges, income from continuing operations increased $1.5 million, or 7.0%, to $22.8 million for the year ended December 31, 2000 from $21.3 million in 1999.  This increase was primarily attributable to a significant increase in revenues in the Logistics segment, partially offset by a decline in revenues in the Drivetrain Remanufacturing segment. Income from continuing operations per diluted share decreased to $0.11 in 2000 from $0.79 in 1999.  Excluding special charges, income from continuing operations per diluted share increased $0.07, to $1.08 for the year ended December 31, 2000 from $1.01 in 1999.

 

Net Sales.  Net sales increased $6.9 million, or 1.9%, to $372.5 million in 2000 from $365.6 million in 1999.  This increase is attributable to increased sales in our Logistics segment partially offset by a decrease in revenues in the Drivetrain Remanufacturing segment and our independent aftermarket engine business.  See “Drivetrain Remanufacturing Segment,” “Logistics Segment” and “Other” for a discussion of net sales.

 

Sales to DaimlerChrysler accounted for 29.6% and 31.6%, Ford accounted for 30.0% and 29.6% and AT&T Wireless accounted for 14.1% and 6.3% of our revenues for the years ended December 31, 2000 and 1999, respectively.

 

Gross Profit.  Gross profit decreased $1.5 million, or 1.3%, to $114.9 million in 2000 from $116.4 million in 1999.  Excluding the component of special charges reflected in cost of sales of $9.1 million and $3.0 million in 2000 and 1999, respectively, gross profit increased $4.6 million, or 3.9%, to $124.0 million in 2000 from $119.4 million in 1999.  This increase is principally due to increased revenues in the Logistics segment, improved yield and favorable mix of remanufactured transmissions, favorable material variances and the benefit of cost reduction initiatives implemented during 2000 and 1999, partially offset by a decrease in volume in the Drivetrain Remanufacturing segment and our independent aftermarket engine business.  As a result, gross profit (excluding special charges) as a percentage of net sales increased to 33.3% from 32.6% between the two periods.

 

SG&A Expenses.  SG&A expenses increased $0.6 million, or 1.1%, to $57.3 million in 2000 from $56.7 million in 1999.  The increase is due primarily to an increase in expense supporting increased sales volume and growth initiatives in the Logistics segment, partially offset by a decrease in expense in the Drivetrain Remanufacturing segment and the independent aftermarket engine business.  As a percentage of net sales, SG&A expenses decreased slightly to 15.4% in 2000 from 15.5% in 1999.

 

Amortization of Intangible Assets.  Amortization of intangible assets decreased slightly to $5.3 million in 2000 from $5.5 million in 1999, primarily related to the write-off of goodwill associated with the independent aftermarket engine business.

 

Special Charges. During 2000, we recorded $32.6 million of special charges related to the reorganization of our independent aftermarket engine business.  These charges included the following:

·                  $15.6 million for the impairment of goodwill;

·                  $5.8 million for the write-down of fixed assets to estimated net realizable value;

·                  $5.4 million for the write-down of inventory to estimated net realizable value (classified as Cost of Sales-Special Charges);

·                  $3.8 million for product warranty costs of units remanufactured and sold prior to 2000 (classified as Cost of Sales-Special Charges);

·                  $0.9 million for the write-down of uncollectible accounts receivable balances; and

·                  $0.7 million of exit costs and $0.4 million of severance costs for 56 people primarily associated with the shutdown of our branch distribution network.

29

 

During 1999, we recorded $7.3 million of special charges, of which $3.0 million was included as a component of cost of sales.  These charges consisted of $3.3 million of costs associated with the narrowing of the product offering of our independent aftermarket engine business, $2.6 million of severance and other costs related to the reorganization of management functions, $0.8 million of costs to exit a plant within our Drivetrain Remanufacturing segment, and $0.6 million of severance, exit and other costs related to our Logistics segment.

 

Income from Operations.  Principally as a result of the factors described above, income from operations decreased $20.9 million, to $28.9 million in 2000 from $49.8 million in 1999.  Excluding the special charges of $32.6 million and $7.3 million recorded in 2000 and 1999, respectively, income from operations increased $4.4 million, to $61.5 million in 2000 from $57.1 million in 1999.  As a percentage of net sales, income from operations (excluding special charges) increased to 16.5% from 15.6%, between the two periods.

 

Interest Expense and Other, Net.  Interest expense and other, net increased $1.5 million, or 6.4%, to $24.8 million in 2000 from $23.3 million in 1999.  The increase primarily resulted from an overall increase in interest rates in 2000 as compared to 1999.  Interest expense of $5.2 million for the year ended December 31, 2000 has been allocated to discontinued operations based on the total consideration received from the sale of the Distribution Group.  Interest expense of $3.3 million for the year ended December 31, 1999 has been allocated to the discontinued operations based on the total consideration received from the sale of the Distribution Group less the amount of debt attributable to the acquisition of All Trans (part of the Distribution Group) in the fourth quarter of 1999.

 

Discontinued Operations.  On August 3, 2000, we adopted a plan to discontinue a segment of our business that we referred to as our independent aftermarket.  This independent aftermarket segment consisted of the Distribution Group and the independent aftermarket engine business.  We planned to sell the Distribution Group by December 31, 2000 and the independent aftermarket engine business by June 30, 2001. Management believed that the planned exit from these businesses, which provided the opportunity to reduce debt and generated a significant tax shelter, offered a strategic opportunity to focus resources on our businesses that were profitable and had greater growth potential.  As a result of the decision to exit these businesses, we recorded a charge for the loss on disposal of discontinued operations.

 

On October 27, 2000, we completed the sale of the Distribution Group to an affiliate of The Riverside Company.  Our plan with respect to the independent aftermarket engine business was to restructure and return it to profitability prior to finding a buyer. Our restructuring of our independent aftermarket engine business, which:

·                  eliminated our 21 branch distribution network and replaced it with a business model that sells and distributes remanufactured engines directly to independent aftermarket customers on an overnight delivery basis from four regional distribution centers;

·                  applied lean manufacturing techniques to improve productivity and reduce manufacturing cost; and

·