10-K 1 form10-k.htm ATC FORM 10-K FOR 2005
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
__________________
 
FORM 10-K
 
   (Mark One)
x

 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
  
 
For the fiscal year ended December 31, 2005

OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
  
 
SECURITIES EXCHANGE ACT OF 1934
 
  
 
For The Transition Period From ____________ To ______________
  
 
Commission file number 0-21803
__________________
 

AFTERMARKET TECHNOLOGY CORP.
(Exact name of registrant as specified in its charter)
 
 
DELAWARE
95-4486486
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
  
1400 Opus Place, Suite 600, Downers Grove, IL
60515
(Address of principal executive offices)
(Zip Code)
 
 
Registrant's telephone number, including area code: (630) 271-8100
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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o Nox

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No 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. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o    Accelerated filer x     Non-accelerated filer o 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o Nox

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 June 30, 2005) was $370.5 million.

The number of shares outstanding of the Registrant's Common Stock, as of February 10, 2006, was 21,801,711 shares.

DOCUMENTS INCORPORATED BY REFERENCE

None.
 



ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005

   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
 


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 Item 1A. “Risk Factors,” among others, may impact forward-looking statements contained in this Annual Report.

PART I
ITEM 1.

Overview

We provide outsourced engineering solutions and supply chain logistics services to the light and medium/heavy-duty vehicle aftermarket and consumer electronics industries. Through our Drivetrain Business, we provide customized remanufacturing services focused on complex light vehicle drivetrain products, such as automatic transmissions and engines, that are primarily sold through the service, repair and parts organizations of our customers. Through our Logistics Business, we offer value-added supply-chain services to the consumer electronics and light vehicle aftermarket industries, including fulfillment, returns management, reverse logistics, test, repair and other related services. We generally provide services under contractual relationships with customers that distribute high-value, complex products.

We believe our service offerings are differentiated from those of our competitors by the degree of customization we provide coupled with our focus on quality and the consistency of our performance. We have developed business processes, technical capabilities and information technology systems that allow us to design flexible and scaleable solutions that help our customers reduce their costs, improve their supply chain efficiency and enhance their profitability. We manage, monitor and communicate detailed information about our processes and our customers’ shipments, returns, products and inventory on a real-time basis. This information is readily accessible to our customers, easy-to-use, and customized to fit their needs. We also use this information to analyze and improve the performance of our businesses and to help us achieve our exacting quality and service benchmarks.

Our Drivetrain Business 

Our Drivetrain Business remanufactures drivetrain products, which we distribute primarily to Original Equipment Service (“OES”) organizations and their outlets. As our OES customers are the service and repair organizations of automotive Original Equipment Manufacturers (“OEMs”), we are not subject to the same market trends, such as the cyclical nature of new light vehicle sales, as “Tier 1” suppliers to the automotive industry. We believe we are the largest independent light vehicle automatic transmission remanufacturer in the world. Our drivetrain products consist principally of remanufactured automatic transmissions and also include remanufactured torque converters, valve bodies and engines. Our principal drivetrain customers are the North American service, repair and parts organizations of Ford, Honda, DaimlerChrysler, Allison and the European division of Ford. In addition, we have also sold to customers in the independent aftermarket, including AAMCO dealers, AutoZone and Cottman Transmission, but in February 2006 we decided to discontinue this portion of our business. See Item 8. “Consolidated Financial Statements and Supplementary Data - Note 20” for a discussion of our exit from the independent aftermarket business.

 
Drivetrain Business net sales accounted for 65.3%, 73.6%, 76.0%, 70.9% and 72.4% of our 2005, 2004, 2003, 2002 and 2001 net sales, respectively. Net sales from the independent aftermarket business, which we will discontinue in 2006, accounted for 5.0% of our total net sales for each of 2005, 2004 and 2003.

Remanufactured products are used in the repair of vehicles by dealers and other service outlets during both the warranty and post-warranty periods following the sale of a vehicle. Remanufacturing is a process through which used cores are returned to a central facility where they are disassembled and the parts are inspected, cleaned, refurbished and tested. We then combine the reusable parts with new parts, primarily in a high-volume cellular assembly process, to create remanufactured components that are of comparable quality to new components. We remanufacture some of the most complex components of a vehicle, such as the transmission and engine. Generally, our customers and their designated suppliers provide transmission parts and cores to us. However, our launch of a medium/heavy-duty remanufacturing program with Allison requires taking title to the core. In cases where we do not take ownership of the cores, our working capital requirements are reduced. Furthermore, because we use salvaged parts from cores or new parts sourced from our customers and their designated suppliers, we are not directly subject to material pricing fluctuations. We believe remanufactured products are generally lower in cost than new replacement components and frequently facilitate a faster, more reliable repair when compared to components that are rebuilt at service outlets. In addition, remanufactured components efficiently reuse existing parts and are less damaging to the environment.

We remanufacture factory-approved transmissions for warranty and/or post-warranty replacement of transmissions for Ford, Honda, DaimlerChrysler and select foreign OEMs, primarily for use in the United States service and repair organizations of their dealer networks. We added Allison Transmissions as a customer for remanufactured medium/heavy-duty transmissions during 2005.  Additionally, our European facility remanufactures factory-approved gas and diesel engines for several European OEMs, including Jaguar and the European divisions of Ford and GM.  These engines are used for warranty and post-warranty replacement, and we also provide certain machining services for some of our customers.

We generally sell our products to each customer pursuant to a supply arrangement for individual transmission or engine models, which supply arrangement typically may be terminated by the customer on 90 days notice or less. Our existing contracts for transmission remanufacturing with Ford and DaimlerChrysler both expired on December 31, 2005. We have reached agreement on terms and conditions for contract renewals through 2008 with both Ford and DaimlerChrysler and expect to finalize these contracts in the near term.

We work to develop and maintain strong relationships at many levels, in both the corporate and factory organizations of our drivetrain customers. We began remanufacturing transmissions for DaimlerChrysler’s Chrysler division and Ford in 1989, and Honda in 2002.  Over the past few years, we have strengthened our relationships with many of our other Drivetrain Business customers, as evidenced by the award of new business with Honda, Ford, Jaguar, and Isuzu. We believe that we are the largest provider of remanufactured transmissions to DaimlerChrysler, Ford and Honda for light vehicles in North America. 

Our facilities that remanufacture transmissions for OEMs have QS-9000 or ISO-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.

Our Logistics Business

Our Logistics Business provides a number of value-added services that generate operational efficiencies for our customers through the outsourcing of certain supply chain functions. Specifically, our Logistics Business provides value-added warehousing and distribution, reverse logistics, turnkey order fulfillment, electronic equipment testing, and refurbishment and repair services. We generally do not take ownership of inventory. As a result, we do not face the risk of inventory obsolescence, and we require relatively less working capital than logistics service providers who take ownership of inventory. Our principal customers are currently in the consumer electronics and automotive industries and include Cingular, Nokia, LG, T-Mobile, Delphi, Visteon, GM and Thales. Logistics Business segment sales accounted for 34.7%, 26.4%, 24.0%, 29.1% and 27.6% of our 2005, 2004, 2003, 2002 and 2001 net sales, respectively.


We determine our logistics process in close consultation with our customers. Our information technology systems allow rapid integration with our customers’ systems and, in conjunction with our customized processes, help us to meet demanding logistics and repair requirements. By improving our customers’ inventory turns and speed of repair and refurbishments, as well as enabling our customers to realize value from returned products, we believe we help our customers increase their profitability, reduce their capital investments and enhance their opportunities for growth. We customize our products and services to meet the specific individual needs of customers instead of offering one standard suite of products and services.

Our logistics customers market and distribute complex and serialized consumer electronics such as cellular phones, wireless devices, navigation devices, and light vehicle audio systems and instrument clusters. As part of our service offering, we remanufacture, repair and distribute light vehicle audio systems and instrument and display clusters primarily for Delphi, Visteon, and GM, and various mobile electronics products, such as navigation systems, primarily for Delphi, GM and Thales. We also offer returned material reclamation and core management and disposition services.

We provide bulk and direct fulfillment of cellular telephones to Cingular and its partners.  We deliver products both to Cingular retail locations and directly to individuals who order a cellular phone, and provide inventory tracking and management, process all warranty-service exchanges and perform handset testing and repair. Growth in our Logistics Business has largely been with Cingular (historically through AT&T Wireless, which was acquired by Cingular in October 2004). Since Cingular’s acquisition of AT&T Wireless, we have expanded on certain lines of service we previously provided to AT&T Wireless. Revenue for these services grew significantly in 2005, more than offsetting the loss of the accessory packaging services that we previously provided to AT&T Wireless, and we expect them to grow further in 2006. In addition to new business from Cingular, we signed agreements and launched new business with a number of new logistics customers in 2004 and 2005 that we expect to generate additional sales in 2006.

Industry Background

Automotive Aftermarket

Demand for replacement or repair of drivetrain products is a function of numerous factors, such as the number of vehicles in operation, the average age of vehicles and the average number of miles driven per vehicle. Within this overall market, factors that influence demand for our remanufactured products, when compared to repair services, include product complexity, OEM warranty policies governing repair-versus-replace decisions made by their dealers, and the length of warranty periods. In addition, we believe increasing demand for our remanufacturing services, when compared to repair services, is also driven by the relatively limited number of qualified repair technicians and repair test equipment, and the increase in customer service demands. The demand for our products is generally not tied to the cyclical nature of new light vehicle sales. We supply our products to the automotive aftermarket, which consists of parts and services for light vehicles after their original purchase. According to the Frost & Sullivan report dated February 2005, the North American replacement and repair component of this market for transmissions was approximately $2.7 billion in 2004 and expected to grow at a compound annual rate of 4.4% from 2004 to 2011 due to the increasing number of vehicles in operation, the average age of vehicles and the average number of miles driven per vehicle.

Remanufacturing Process

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:

 
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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;

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

 
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replace the assembly with a new assembly manufactured by the OEM.

 
In our remanufacturing process, we generally obtain used transmissions and engines (“cores”) from our customers or their designated suppliers.  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 inspect, 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.

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

 
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First, costs to the customers associated with remanufactured assemblies generally are substantially less than costs associated with either assemblies that have been rebuilt by the dealer following a severe failure or new assemblies.  This is due primarily to our lower labor costs and our use of high volume manufacturing techniques and salvage methods that enable us to refurbish and reuse a high percentage of original components.  The cost savings produced by remanufactured assemblies help our customers manage their warranty expenses.

 
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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.   For warranty repairs, consistent quality is important to the customer providing the applicable warranty, because once installed, the remanufactured product is usually covered by the customer’s warranty for the balance of the original warranty period.

 
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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 allowing the dealer and repair shops to increase their volume of business.

 
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Fourth, the environmental benefits of remanufacturing may be significant.  We annually re-process thousands of tons of materials that would otherwise have been discarded. Remanufacturing in our facilities, when compared to rebuilding at various dealers, generally results in a more efficient reuse of parts and a more controlled recycling of scrap materials and excess fluids.  This in turn leads to associated cost savings and benefits to customers that are increasingly focused on environmental compliance issues. 


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, testing and repair.  The logistics industry has expanded rapidly over the last 15 years due to dramatic improvements in technology, increased demand in customer service requirements, and the significant value proposition provided to companies by third party logistics (3PL) providers. As more companies focus on core competencies, 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, 3PL providers have become extensively involved in the full range of customer supply chain functions.  The operational efficiencies of a 3PL provider enable companies to reduce investments in facilities, information technology, inventory and personnel.  Third-party services include turnkey supply chain services, such as order fulfillment, product labeling and packaging, inventory and warehouse management, product return, refurbishment and repair, electronics equipment testing, reverse logistics and the physical movement of goods. According to Armstrong & Associates, Inc., the 3PL market grew at a 14.1% compound annual rate from $45.3 billion in 1999 to $76.9 billion in 2003.


We compete in the value-added warehousing market, a subset of the 3PL market, which we believe is fragmented, with no dominant industry player, and growing rapidly. According to the Armstrong & Associates, Inc. report dated December 2004, this market size was estimated to be $19.8 billion of gross revenues in 2003.


Our Competitive Strengths

We believe we offer products and solutions that improve our customers’ profits and operations as a result of our competitive strengths, which include the following:

Customized Service Offering

We are recognized by our customers for our high level of service and our flexibility in providing product and service solutions. Our logistics approach involves our team of specialists who work with the client to understand the specific deliverables required by that client, understand communication points within the supply chain, design solutions, establish operational and business metrics, eliminate waste and improve efficiencies. We offer a broad array of products and services to our logistics customers, which allows us to work with the customer to customize our products and services to meet the specific individual needs of the customer instead of offering one standard suite of products and services. We believe our “One-Size-Fits-One” approach helps us attract and retain customers. For instance, for Cingular, our supply chain management services include product warranty and returns, order entry processing, testing and repair, warehousing, picking, kitting, customized packaging, shipping and delivery of wireless handsets, including wireless data devices.  Our integrated logistics services also include inventory management and private labeling. This customized approach has allowed us to add Nokia, T-Mobile, LG and Thales as new customers.


High Quality Through Engineering and Technical Know-How

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 partner with our customers to design processes that help ensure that our remanufacturing of complex products such as automatic transmissions, valve bodies, torque converters, engines and automotive electronics replicates OEM quality and test procedures.  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. We are committed to upholding the quality of our customers’ products and hold QS-9000 Certification, ISO-9000 Certification and Ford’s Q1 Certification. We monitor our procedures and processes, which allows us to identify and to quickly correct situations that could impact our product quality. We have a team of engineers dedicated to enhancing and adding new products, sharing innovative solutions and reducing our customers’ expenses. Our engineering capabilities include developing new products.


Information Technology Capabilities

We use information technology to help meet customers’ needs in product security and confidentiality, product qualification and identification, inventory management, and interactive electronic communication. We also provide customers with solutions for their supply chain management, reverse logistics, product tracking and product history needs, while maintaining service and quality levels. Our use of information technology allows us to provide flexible, accurate, customized logistics solutions to help meet customer requirements while providing full visibility across the supply chain. Our solutions can reduce customer-required investment in information technology, and can improve the efficiency of our customers’ inventory and supply chains by providing enhanced traceability and visibility of inventory, resulting in market-leading performance metrics and improved customer profitability. In addition, our information technology systems allow for rapid integration with our customers’ systems, enhancing the quality of our services.

 
Strong, Experienced Management Team

Our executive and operations management team has extensive experience. Our Chief Executive Officer, Donald T. Johnson, Jr., has 32 years of experience in the logistics and automotive industries, including five years as Global Director of Parts, Supply and Logistics for Ford and 26 years within Caterpillar’s Parts and Service and Logistics organizations where he became Vice President, Caterpillar Logistics. Our Vice President and Chief Financial Officer, Todd R. Peters, has 21 years of financial, acquisition and integration, and automotive operations experience. The President of our ATC Logistics Business, William L. Conley, Jr., has 27 years of logistics experience, and the Vice President of our North American Remanufacturing Operations, Brett O. Dickson, has 16 years of operational and supply chain management experience.


Our Growth Strategies

Our strategy is to be a valued partner that provides remanufacturing, logistics, return and repair services for customers that distribute high-value, complex products in various markets. We will grow by leveraging our strong customer relationships while we develop new customers and products.

Growth Within Our Drivetrain Business

Expand Our Product Offering and Product Application. Our business and product development teams are working to identify new products and processes that enable us to compete for additional business with our OES dealer customers by helping them to increase their penetration of the drivetrain repair market and/or reduce their total warranty costs. For example, we are working with certain of our OES customers to (i) develop and implement products and strategies designed to enable them to penetrate, or increase their penetration of, the post-warranty replacement market for automotive transmissions that we remanufacture on their behalf, (ii) re-introduce remanufactured transmissions as a transmission repair alternative in warranty applications, and (iii) develop a transmission repair kit product that we will market for their use with failed transmissions that are repaired rather than totally replaced.

Enter Additional Markets for our Services. We are seeking drivetrain remanufacturing opportunities in markets outside our primary light vehicle aftermarket, including the commercial vehicle market. For example, in 2005 we were awarded a remanufacturing program by Allison for medium/heavy-duty automatic transmissions, which we expect will generate $30 million of annualized revenue. We believe that our expertise in drivetrain remanufacturing will be directly transferable to these other markets over time.  

Expand Our International Presence. In 2005, we generated approximately 94% of our total net sales in North America. We believe that our expertise in drivetrain remanufacturing will be directly transferable to foreign markets, which generally have a less developed drivetrain remanufacturing market than North America. As such we are actively pursuing additional opportunities with both new and existing customers to provide remanufacturing services in both Europe and Asia. We believe that these areas represent an opportunity for growth. We are currently working to develop programs with OEMs in the growing Chinese automotive market (where we do not currently have a presence).  We continue to explore opportunities in the global automotive industry for our products and services in order to capture new business opportunities and improve profitability.

Emerging Technology. We will continue to modestly invest in the NuVinci™ Continuously Variable Planetary (CVP) Drive technology to further diversify our products, markets, customers and revenues. Initially we are focusing on the bicycle, light electric vehicle, recreation/garden vehicle and commercial vehicle markets. We intend to utilize the strengths, capabilities and capacity in our Drivetrain business to develop and commercialize the CVP product.



Growth Within Our Logistics Business

Target New Customers and Broaden Services Provided to Customers. We believe we are well positioned to capitalize on growth in the 3PL services market, particularly with existing and new customers in the consumer electronics and vehicle industries, by offering customized, reliable and cost effective solutions for customers with complex logistics requirements involving high-value products. In 2005, we were awarded new logistics business that we expect to generate $37 million of annualized revenue. We recently expanded our business development and marketing teams and are more actively marketing our offerings to new and existing 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 meet our customers’ needs.  Under our “One-Size-Fits-One” philosophy, we will continue to leverage our broad range of services to target new customers that provide serialized products across a variety of industries and provide them with customized products and services to meet their specific needs instead of offering one standard suite of products and services. We also intend to leverage our core competencies in logistics and electronics refurbishment by working with our existing and new customers to identify products and services where we can add value in satisfaction of our customers’ specific needs. We intend to further expand our penetration of the market for logistics services and electronics repair through the addition of other wireless carriers to our customer base and through penetration into other vertical markets, including broadband/cable, electronics and computers, and medical equipment. We have also identified and targeted several new market segments, including additional classes of consumer electronics.

Additional Corporate Initiatives

Leverage Operating Efficiency and Productivity Gains. We regularly evaluate our operating efficiency and productivity in order to increase our profitability and cash flows. Over the last five years, we have completed numerous lean manufacturing, six sigma and continuous improvement projects that have resulted in significant cost savings and increased capacity utilization. Our “Lean and Continuous Improvement” program has helped us achieve margin improvements and further enhancement of quality. We believe there are additional opportunities to further improve our cost base and increase earnings.

Selectively Pursue Acquisitions. From time to time we evaluate potential acquisitions of complementary businesses that we believe will broaden our product offerings, diversify our customer base or provide us access to new markets. We have established criteria by which we evaluate potential acquisitions, which we use to identify and pursue only those that we believe will enhance long-term shareholder value. We have made various acquisitions in the past and, to the extent suitable acquisition candidates, acquisition terms and financing are available, we intend to pursue acquisitions in the future.



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.

In our Logistics Business, we primarily compete in a fragmented market as a niche participant offering a specialized value-added service requiring stringent 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 such as Caterpillar Logistics and UPS Logistics are larger and have greater financial and other resources.





Employees

As of December 31, 2005, we had approximately 3,300 full-time and temporary employees.  We believe our employee and labor relations are good.  We have not experienced any work stoppage to date and currently none of our employees is represented by a labor union.


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 certain 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.

In connection with the October 2000 sale of our Distribution Group, we agreed to indemnify the buyer against environmental liability at former Distribution Group facilities that had been closed prior to the Distribution Group sale, including former facilities in Azusa, California, 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 subject to a $750,000 deductible and a $12.0 million cap, except with respect to the closed facilities. We also have an additional $100,000 deductible applicable to all Distribution Group claims for indemnification.


Segment Reporting

We have two reportable segments: the Drivetrain Remanufacturing segment and the Logistics segment. Our independent aftermarket business is reflected as “Other” and is not reportable for segment reporting purposes. See Item 8. “Consolidated Financial Statements and Supplementary Data-Note 20” for a discussion of our exit from the independent aftermarket business. Also See Item 8. “Consolidated Financial Statements and Supplementary Data” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”


Available Information

Our internet website is www.goATC.com. We make available free of charge on our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any other filings we make with the Securities and Exchange Commission as soon as reasonably practicable. This information may also be obtained by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission also maintains an internet website that contains reports, and other information regarding issuers like us that file electronically with the Securities and Exchange Commission at www.sec.gov. We will provide a copy of any of the foregoing documents to shareholders upon request. The contents of our website are not part of this annual report.



ITEM 1A.   RISK FACTORS

We believe that the following are the material risks currently facing our business, but additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations. Our financial condition, results of operations or stock price could be materially adversely affected by these risks. Readers should also refer to the other information included in this Annual Report, including our consolidated financial statements and related notes thereto.


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

A few customers account for a significant majority of our net sales each year. In 2005, we had four customers that individually accounted for more than 10% of our net sales. Cingular (including sales to the former AT&T Wireless) accounted for 28.3%, 22.3% and 17.2% of our net sales during 2005, 2004 and 2003, respectively, Ford accounted for 23.1%, 29.6% and 38.6% of our net sales for 2005, 2004 and 2003, respectively, Honda accounted for 18.3%, 19.4% and 7.5% of our net sales during 2005, 2004 and 2003, respectively, and DaimlerChrysler accounted for 14.6%, 14.7% and 20.6% of our net sales in 2005, 2004 and 2003, 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.

Our significant OEM customers generally require that their dealers using remanufactured products for warranty application use only products from approved suppliers. Although we are a factory approved supplier of our customers, they generally are not obligated to continue to purchase our products and may switch some or all of their business to other suppliers in the future and we may not be able to maintain or increase our sales to them. Most of our contracts or arrangements with our customers are terminable by the customer subject to a notice period that ranges from 90 days or less to 180 days. Pursuant to such an arrangement, in 2004 General Motors elected to resource all our remanufactured transmission production to one of our competitors. In addition, we periodically renegotiate the prices and other terms of our products with our customers. Because of the short termination periods and periodic price negotiations, we cannot give any assurances of the stability of the demand or prices for our products and, therefore, our revenue streams. Significant demand or price fluctuations could materially affect our business.



Since Cingular's acquisition of AT&T Wireless, we have been working with Cingular as they rationalize their supply chain.  This resulted in the loss in 2004 of the accessory packaging services that we previously provided to AT&T Wireless but has also resulted in the expansion of our core logistics services with Cingular.  This process will continue and could result in further gains and/or losses of business with Cingular.

Loss of a significant customer could also result in us incurring asset impairment charges and exit costs associated with the closure of the plant that serviced that customer. In connection with the loss of the General Motors transmission business in 2004, we recorded goodwill and other asset impairment charges totaling $26.4 million and incurred $3.4 million of exit costs to close the Gastonia, North Carolina facility where we had produced units for General Motors.

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 products. Additionally, our customers may vary their policies that determine when their dealers may use remanufactured products for warranty applications, which could reduce the demand for our products. Our results, most recently in 2005, have been adversely affected by certain customers changing the policies that govern their dealer warranty repair-versus-replace decisions, which have resulted in dealers repairing more transmissions and consequently replacing fewer transmissions with remanufactured units.


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 increasing 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 these 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 designs that result in greater reliability;

 
•
consumers driving fewer miles per year due to high gasoline prices; and

 
•
mild weather.




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:

 
•
guidelines that affect dealer decisions to rebuild units at the dealer rather than install remanufactured transmissions;

 
•
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

 
•
pricing strategies.


Our Logistics Business is dependent on the strength of Cingular Wireless.

Cingular Wireless, which accounted for 81.5% of our Logistics segment net sales for 2005, operates in a highly competitive technology market. The number of cell phones sold by Cingular, 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 net sales to Cingular are substantially related to the number of phones sold by Cingular. Consequently, any material decrease in phones sold by Cingular will materially and adversely affect our Logistics net sales.


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. Any liability we may have 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 that may have an adverse effect on our operating results.




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

The trading 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, or loss of, 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.


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 to our customers’ warranty policies;

 
•
changes in product costs from vendors;

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

 
•
the availability and quality of cores;

 
•
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 incentive 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.

 
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 a portion of 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 except in the case of our former Mahwah, New Jersey facility (which we closed in December 2003), 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 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.


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

As of December 31, 2005, our outstanding indebtedness was $90.8 million, and we had cash and cash equivalents on hand of $45.5 million. We expect that our indebtedness may increase substantially 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 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 credit facility requires us to meet specified financial ratios and limits our ability to enter into various transactions. If we default on any of our indebtedness, or if we are unable to obtain necessary liquidity, our business could be adversely affected.


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.




None.

 
ITEM 2.

We conduct our business from the following facilities:


Location
  
Approx.
Sq. Feet
  
Lease
Expiration
Date
  
Products Produced/Services Provided
Springfield, MO
  
280,800
  
2008
  
transmissions, transfer cases and assorted components (1)
Springfield, MO
  
200,000
  
2006
  
engines and transmissions (2)
Oklahoma City, OK
  
100,000
  
2019
  
transmissions, transfer cases and assorted components (1)
Oklahoma City, OK
  
200,000
  
owned
  
transmissions and assorted components (1)
Oklahoma City, OK
  
94,000
  
2008
  
returned material reclamation and disposition, core management (3)
Carrollton (Dallas), TX
  
39,000
  
2006
  
radios, telematics and instrument and display clusters (3)
Ft. Worth, TX
  
221,000
  
2008
  
cellular phone and accessory distribution (3)
Ft. Worth, TX
  
264,000
  
2010
  
cellular phone accessory packaging, returns processing, test and repair (3)
Grantham, England
  
120,000
  
owned
  
engines and related components (1)
___________
(1)
This facility is used by the Drivetrain Remanufacturing segment.
(2)
This facility is used by our Independent Aftermarket business and will be closed during 2006 in connection with the discontinuation of that business.
(3)
This facility is used by the Logistics segment.

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.



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.




No matters were submitted to a vote of the stockholders of the Company during the quarter ended December 31, 2005.


PART II


Our common stock has been traded on the Nasdaq National Market (which recently changed its name to the Nasdaq Global Market) under the symbol "ATAC" since our initial public offering in December 1996. As of February 10, 2006, there were 69 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:

   
High
  
Low
  
2005
              
First quarter
 
$
16.70
 
$
13.53
 
Second quarter
 
 
17.68
 
 
13.80
 
Third quarter
 
 
18.84
 
 
15.96
 
Fourth quarter
    
21.71
    
16.15
  
2004
              
First quarter
 
$
15.50
 
$
13.08
 
Second quarter
 
 
17.30
 
 
13.98
 
Third quarter
 
 
16.75
 
 
11.35
 
Fourth quarter
    
18.36
    
12.01
  

On February 10, 2006, the last sale price of our common stock, as reported by Nasdaq, was $20.24 per share.

During November 2005, certain employees of the Company delivered to us 2,014 shares of our outstanding common stock in payment of $40,924 of withholding tax obligations arising from the vesting of restricted stock previously awarded under our stock incentive plans. Per the stock incentive plans, the shares delivered to us were valued at $20.32 per share, the closing price of our common stock on the vesting date of the restricted stock.

Following is a summary of treasury stock acquisitions made pursuant to our stock incentive plans during the three month period ended December 31, 2005:
 
Period
    
Total number of Shares Purchased
    
Price Paid per Share
    
Total Number of Shares Purchased as Part of a Publicly Announced Plan
    
Maximum Number of Shares that May Yet Be Purchased Under the Plan
  
October 1-31, 2005
    
-
  
$
−
    
-
    
-
  
November 1-30, 2005
    
2,014
  
$
20.32
    
2,014
    
-
  
December 1-31, 2005
    
-
  
$
−
    
-
    
-
  

On February 16, 2006, we announced our intention to commence a program for the repurchase of up to 2% of our outstanding common stock during the balance of 2006. It is our intent to repurchase shares, from time to time, to offset the potential dilutive impact of stock option exercises and restricted stock grants under our stock incentive plans.

We have never paid cash dividends on our common stock. 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 our 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.



The selected financial data presented below with respect to the statements of income data for the years ended December 31, 2005, 2004 and 2003 and the balance sheet data as of December 31, 2005 and 2004 are derived from the Consolidated Financial Statements of the Company that have been audited by Ernst & Young LLP, independent registered public accounting firm, 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 statements of income data for the years ended December 31, 2002 and 2001 and the balance sheet data as of December 31, 2003, 2002 and 2001, are derived from the Consolidated Financial Statements of the Company that have been audited by Ernst & Young LLP, independent registered public accounting firm, but are not included herein. The data provided should be read in conjunction with the Consolidated Financial Statements and related notes, Management’s Discussion and Analysis of Financial Condition and Results of Operations and other financial information included in this Annual Report.

   
Year Ended December 31,
  
   
2005
  
2004
  
2003
  
2002
  
2001
  
   
(In thousands, except per share data)
  
Statements of Income Data:
                                
Net sales
  
$
441,963
  
$
395,577
  
$
339,709
  
$
392,453
  
$
381,633
  
Cost of sales
    
335,286
    
293,630
    
244,997
    
256,621
    
248,362
  
Exit, disposal, certain severance and other charges (1)
    
−
    
−
    
200
    
−
    
216
  
Gross profit
    
106,677
    
101,947
    
94,512
    
135,832
    
133,055
  
Selling, general and administrative expense
    
53,385
    
51,598
    
50,987
    
56,618
    
57,315
  
Amortization of intangible assets
    
125
    
125
    
299
    
333
    
4,376
  
Exit, disposal, certain severance and other charges (credits) (1)
    
492
    
4,031
    
8,273
    
(277
)
  
5,114
  
Operating income
    
52,675
    
46,193
    
34,953
    
79,158
    
66,250
  
Interest income
    
2,026
    
2,658
    
2,863
    
2,769
    
1,524
  
Interest expense
    
(7,696
)
  
(7,271
)
  
(8,169
)
  
(12,280
)
  
(22,377
)
Other income (expense), net
    
585
    
170
    
371
    
(491
)
  
747
  
Redemption of senior notes
    
−
    
−
    
−
    
(3,022
)
  
−
  
Termination of credit facility
    
−
    
−
    
−
    
(1,480
)
  
−
  
Income tax expense
    
(15,711
)
  
(14,955
)
  
(11,146
)
  
(22,174
)
  
(17,517
)
Income from continuing operations (2)
  
$
31,879
  
$
26,795
  
$
18,872
  
$
42,480
  
$
28,627
  
Income from continuing operations per diluted share (3)
  
$
1.48
  
$
1.25
  
$
0.77
  
$
1.76
  
$
1.36
  
Shares used in computation of income from continuing operations
  per diluted share (3)
    
21,579
    
21,411
    
24,486
    
24,119
    
21,059
  
Other Data:
                                
Capital expenditures
  
$
17,185
  
$
11,081
  
$
13,439
  
$
12,476
  
$
13,256
  


   
As of December 31,
  
   
2005
  
2004
  
2003
  
2002
  
2001
  
   
(In thousands)
  
Balance Sheet Data:
                                
Cash and cash equivalents
  
$
45,472
  
$
18,085
  
$
59,628
  
$
65,504
  
$
555
  
Working capital, continuing operations
    
123,283
    
103,879
    
119,062
    
132,053
    
50,527
  
Property, plant and equipment, net
    
55,015
    
52,835
    
55,022
    
52,910
    
51,211
  
Total assets
    
407,779
    
389,995
    
447,284
    
448,085
    
395,969
  
Current and long-term debt outstanding
    
90,779
    
112,406
    
127,351
    
164,613
    
197,789
  
Long-term liabilities, less current portion
    
107,098
    
122,225
    
134,545
    
159,561
    
181,694
  
Total stockholders' equity
    
221,230
    
186,373
    
229,251
    
206,435
    
109,335
  
_______________

 
(1)
See Item 8. “Consolidated Financial Statements and Supplementary Data - Note 18” for a description of exit, disposal, certain severance and other charges (credits).

 
(2)
Income from continuing operations for the years ended December 31, 2005, 2004, 2003, 2002 and 2001 excludes gain (loss) from discontinued operations, net of income taxes, of $(871), $(21,019), $1,639, $3,947 and $(59), respectively.

 
(3)
See Item 8. “Consolidated Financial Statements and Supplementary Data - Note 13” for a description of the computation of earnings per share.

 


 The following discussion should be read in conjunction with our consolidated financial statements 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

Operations. We provide remanufacturing, third-party logistics and electronics repair services to the light vehicle and medium/heavy-duty aftermarket and consumer electronics industries. Through our Drivetrain Business, we provide customized remanufacturing services focused on complex light and medium/heavy duty vehicle drivetrain products, such as automatic transmissions and engines, that are primarily sold through the service, repair and parts organizations of our customers. Through our Logistics Business, we offer value-added supply-chain services to the consumer electronics and light vehicle aftermarket industries, including fulfillment, returns management, reverse logistics, repair and other related services. We generally provide our services under contractual relationships with customers that distribute high-value, complex products.

Demand for replacement or repair of drivetrain products is a function of numerous factors, such as the number of vehicles in operation, the average age of vehicles and the average number of miles driven per vehicle. Within this overall market, factors that influence demand for our remanufactured products, when compared to repair services, include product complexity, OEM warranty policies governing replace versus repair decisions made by their dealers, and the length of warranty periods. In addition, we believe demand for our remanufacturing services, when compared to repair services, is also increased by the relatively limited number of qualified repair technicians and repair test equipment, and the increase in customer service demands. The demand for our products is not tied to the cyclical nature of new light vehicle sales. However, our OEM customers periodically revise their policies governing warranty repair-versus-replace decisions that can impact, either positively or negatively, the demand for our remanufactured products as dealers utilize a greater or lesser number of remanufactured transmissions. Policy revisions that negatively impacted demand for our products occurred in late 2002 and early 2003 and again in late 2004. We believe that any material impact related to these policy decisions has been reflected in our results of operations for the year ended December 31, 2005. More recently, one of our domestic automotive OEM customers again modified their policies impacting warranty repair-versus-replace decisions in a modest manner that is expected to positively impact the demand for our remanufactured drivetrain products in 2006.

Our Drivetrain Business has been our primary business since our formation. For the year ended December 31, 2005, net sales from our Drivetrain Remanufacturing segment were $266.4 million, or 60.3% of our total net sales. In addition, we also sell remanufactured transmissions and engines directly to independent aftermarket customers domestically. For the year ended December 31, 2005, net sales from this portion of our business, which is not a reportable segment, was $22.3 million, or 5.0% of our total net sales. However, on February 15, 2006 we decided to discontinue this part of our business. See Item 8. “Consolidated Financial Statements and Supplementary Data - Note 20” for a discussion of the exit from our independent aftermarket business.

Our Logistics Business provides a number of value-added services that generate operational efficiencies for our customers through the outsourcing of certain supply chain functions. Specifically, our Logistics Business provides value-added warehousing and distribution, reverse logistics, turnkey order fulfillment, electronic equipment testing, and refurbishment and repair services. We generally do not take ownership of inventory. As a result, we do not face the risk of inventory obsolescence and we face relatively less working capital needs than other logistics service providers who take ownership of inventory. Additionally, we do not make substantial capital investments in transportation equipment or facilities.


Sales and growth in our Logistics segment have largely: (i) been related to services we provide for Cingular Wireless (including AT&T Wireless, which was acquired by Cingular in October 2004), (ii) been dependent on demand for cellular phones and services and Cingular’s share of cellular service volume and (iii) benefited from upgrades in cellular telephone technology through increased replacement demand for more advanced handsets, from any increases in the number of Cingular’s subscribers and from any expansion of our service offerings. In mid-2003, shifts in supply chain management strategy by AT&T Wireless resulted in their decision to consolidate their printing requirements and re-source the bulk fulfillment of their collateral (marketing) materials from us to the printer of those materials. Since Cingular’s acquisition of AT&T Wireless, we have launched additional business with Cingular, expanding on certain lines of service previously provided. These services have grown in 2005 but were partially offset by the loss of the accessory packaging services that we had previously provided to AT&T Wireless. In addition to new business from Cingular, we have signed agreements with a number of new logistics customers in 2004 and 2005 that have generated additional sales in 2005 and will generate incremental sales in 2006. We continue to believe our Logistics Business represents a key growth opportunity and we are actively pursuing customer diversification. For the year ended December 31, 2005, net sales from our Logistics Business were $153.2 million, or 34.7% of our total net sales, of which Cingular accounted for 81.5%.

Financing. During 2005 we strengthened our balance sheet with cash flows from operations of $54.9 million, lowered our total debt outstanding by $21.6 million and increased our cash balances by $27.4 million. As of December 31, 2005, we had cash and cash equivalents on hand of $45.5 million and $37.3 million available to borrow on our $40.0 million revolving credit facility. We are currently evaluating the establishment of a new credit facility that is expected to provide improved financing terms and less restrictive covenants and expect this new facility to be in place by March 31, 2006.


Components of Income and Expense

Net Sales. In our Drivetrain Remanufacturing segment and independent aftermarket business, we recognize sales, 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, sales are primarily related to providing:

 
•
value-added warehouse and distribution services;

 
•
turnkey order fulfillment and information services;

 
•
returned material reclamation, disposition, test and repair services;

 
•
core management services; and

 
•
automotive electronic components remanufacturing and distribution services,

and are recognized upon completion or performance of those services.

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 sales have 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 service generating sales 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 Intangible Assets. Expense for amortization of intangibles primarily relates to the amortization of definite lived intangible assets.

Exit, Disposal, Certain Severance and Other Charges (Credits). As part of our lean and continuous improvement philosophy, we have periodically identified opportunities to right-size, rationalize and consolidate operations or manufacturing capacity, alter our processes in an effort to improve customer service, and fix or discontinue lower-margin product lines, the purpose of which is to improve profitability, reduce costs, streamline operations and improve efficiency. As a result of this process, we may incur certain costs, primarily associated with restructuring and other initiatives that include consolidation of operations or facilities, management reorganization and delayering, rationalization of certain products, product lines and services and asset impairments. In management’s opinion these costs are generally incremental to our ongoing operation and are separated on our statements of income in order to improve the clarity of our reported operations.

Examples of these costs include severance benefits for terminated employees, lease termination and other facility exit costs, moving and relocation costs, losses on the disposal of fixed assets and write down of inventories. The components of these charges are computed based on actual cash payouts, our estimate of the realizable value of the affected tangible and intangible assets and estimated exit costs including severance and other employee benefits.

These charges can vary significantly from period to period and as a result, we may experience fluctuations in our reported net income and earnings per share due to the timing of these actions. See Item 8. “Consolidated Financial Statements and Supplementary Data - Note 18” for a further discussion of these costs.


Critical Accounting Policies and Estimates

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 judgmental areas in the application of our accounting policies that currently affect our financial condition and results of operations.

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 based on historical experience, credit evaluations, specific customer collection issues and the length of time a receivable is past due. Since our accounts receivable are often concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse impact on our financial statements. For the years ended December 31, 2005, 2004 and 2003, our write-offs were approximately $0.2 million, $1.3 million and $10 thousand, respectively. As of December 31, 2005, we had $75.3 million of accounts receivable, net of allowance for doubtful accounts of $1.2 million.

Inventory Valuation. We make adjustments to write down our inventories for estimated excess and obsolete inventory equal to the difference between the cost of the inventory and the estimated market value based on assumptions about market conditions, future demand and expected usage rates. Changes in economic conditions, customer demand, product introductions or pricing changes can affect the carrying value of our inventory. Demand for our products has fluctuated in the past and may do so in the future, which could result in an increase in excess quantities on hand. 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. Although no assurance can be given, these write-downs would not be expected to have a material adverse impact on our financial statements. For the years ended December 31, 2005, 2004 and 2003, we recorded charges for excess and obsolete inventory of approximately $1.5 million, $2.0 million and $1.2 million, respectively. As of December 31, 2005, we had inventory of $65.2 million, net of a reserve for excess and obsolete inventory of $6.6 million.


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 the number of products sold, historical and anticipated rates of warranty claims and costs per unit and actual product failure rates. Additionally, we participate in the tear-down and analysis of returned products with certain of our customers to assess responsibility for product failures. For the years ended December 31, 2005 and 2004, we (i) recorded charges for estimated warranty costs of approximately $3.8 million and $5.6 million, respectively and (ii) paid and/or settled warranty claims of approximately $4.2 million and $6.2 million, respectively. Should actual product failure rates differ from our estimates, revisions to the estimated warranty liability may be required. Although no assurance can be given, these revisions would not be expected to have a material adverse impact on our financial statements.

Goodwill and Indefinite Lived Intangible Assets. Effective with the adoption of SFAS No. 142, goodwill and indefinite lived intangible assets are no longer amortized, however they are tested annually, or more frequently if events or changes in circumstances indicate that goodwill may be impaired, and if the carrying value is greater than the fair value an impairment loss is recorded. Impairment is tested at a level of reporting referred to as a reporting unit, which generally is an operating segment or a component of an operating segment as defined in paragraph 10 of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. In accordance with paragraph 30 of SFAS No. 142, certain components of an operating segment with similar economic characteristics are aggregated and deemed a single reporting unit. In estimating the fair value of our reporting units, we utilize a valuation technique based on multiples of projected cash flow, giving consideration to unusual items, cost reduction initiatives, new business initiatives and other factors that generally would be considered in determining value. Actual results may differ from these estimates under different assumptions or conditions. If we were to lose a key customer within a particular operating segment or its sales were to decrease materially, impairment adjustments that may be required could have a material adverse impact on our financial statements. As of December 31, 2005, we have recorded goodwill of approximately $147.6 million.

Deferred Income Taxes and Valuation Allowances. Tax law requires items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, our annual tax rate reflected in our consolidated financial statements is different than that reported in our tax return. Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on the evaluation of all available information, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not.

We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry-back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset.

Segment Reporting

We have two reportable segments: the Drivetrain Remanufacturing segment and the Logistics segment. Our Drivetrain Remanufacturing segment primarily sells remanufactured transmissions directly to Ford, Honda, DaimlerChrysler, Allison and certain other 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 engines primarily to certain European OEMs. Through our Logistics segment, we are:

 
•
a provider of value-added warehouse, distribution and reverse logistics, test and repair services, turnkey order fulfillment and information services primarily for Cingular, and to a lesser extent, Nokia, LG, T-Mobile and certain other customers in the wireless electronics industry;

 
•
a provider of logistics and reverse logistics services and automotive electronic components remanufacturing, primarily for General Motors, Delphi, Visteon and Thales; and

 
•
a provider of returned material reclamation and disposition services and core management services to General Motors and, from time to time and to a lesser extent, certain other domestic and foreign OEMs.

The Company’s independent aftermarket business, which is not reportable for segment reporting purposes, remanufactures and distributes domestic and foreign engines and distributes domestic transmissions to independent aftermarket customers and is reported as “Other.” See Item 8. “Consolidated Financial Statements and Supplementary Data - Note 20” for a discussion of our exit from the independent aftermarket business.

We evaluate the performance of each business based upon operating income. Our reportable segments and our independent aftermarket business are each managed and measured separately primarily due to the differing customers and distribution channels.



Results of Operations

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


   
Year Ended December 31,
  
   
2005
  
2004
  
2003
  
Net sales
  
$
442.0
    
100.0
%
$
395.6
    
100.0
%
$
339.7
    
100.0
%
Gross profit
    
106.7
    
24.1
    
101.9
    
25.8
    
94.5
    
27.8
  
SG&A expense
    
53.4
    
12.1
    
51.6
    
13.0
    
51.0
    
15.0
  
Exit, disposal, certain severance and other charges (1)
    
0.5
    
0.1
    
4.0
    
1.0
    
8.5
    
2.5
  
Operating income
    
52.7
    
11.9
    
46.2
    
11.7
    
35.0
    
10.3
  
Interest income
    
2.0
    
0.5
    
2.7
    
0.7
    
2.9
    
0.8
  
Other income, net
    
0.6
    
0.1
    
−
    
−
    
0.1
    
−
  
Interest expense
    
(7.7
)
  
(1.7
)
  
(7.3
)
  
(1.9
)
  
(8.2
)
  
(2.4
)
Income from continuing operations
    
31.9
    
7.2
    
26.8
    
6.8
    
18.9
    
5.6
  
 
 
(1)
Includes $0.2 million of inventory write-downs classified as cost of sales in the statement of income for 2003.




Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004

Income from continuing operations increased $5.1 million, or 19.0%, to $31.9 million in 2005 from $26.8 million in 2004. Income from continuing operations per diluted share was $1.48 in 2005 as compared to $1.25 in 2004. Our results for 2005 included (i) a gain of $0.9 million (net of tax) related to $1.4 million of research and development tax credits, net of fees and related expenses of $0.5 million, net of tax, (ii) a gain of $0.4 million (net of tax) from the early redemption of the note receivable from the Distribution Group, (iii) exit, disposal, certain severance and other charges of $0.3 million (net of tax) and (iv) a gain of $0.2 million (net of tax) related to an investment tax credit from the state of Oklahoma. For 2004, our results included (i) exit, disposal, certain severance and other charges of $2.5 million (net of tax) and (ii) an income tax benefit of $0.4 million related to the favorable resolution of an IRS audit of our 1999 tax year. Excluding these items, income from continuing operations increased primarily as a result of:
 
•  
  benefits from our on-going lean and continuous improvement program and other cost reduction initiatives;

•  
  new business wins in our Logistics segment, including our test and repair program with Cingular and, to a lesser extent, Nokia, LG and T-Mobile;

•
  an increase in our base logistics business with Cingular; and

•
  
  an increase in volume of Honda remanufactured transmissions as we realized the full-year benefit of that program, which did not fully ramp up until the second quarter
  of 2004,
 
partially offset by:
 
• 
  scheduled price reductions to certain customers in our Drivetrain Remanufacturing and Logistics segments pursuant to contracts entered into primarily in 2003;

•  
  a reduction in volume of remanufactured engines for certain older European engine programs;

•  
  an increase in costs related to new business and product development in our Drivetrain Remanufacturing segment; and

•  
  a reduction in volume of Ford remanufactured transmissions that is believed to result from repair cost-cap adjustments on certain transmission models.
 
Net Sales. Net sales increased $46.4 million, or 11.7%, to $442.0 million for 2005 from $395.6 million for 2004. This increase was primarily due to:

•  
  new business wins in our Logistics segment, including our test and repair program and other programs with Cingular and, to a lesser extent, Nokia, LG and T-Mobile;

•  
  increases in our base logistics volume with Cingular;

•  
  a one-time sale of $12.5 million of transmission components at cost in 2005, relating to end-of-life support for an OEM transmission program that ceased production
  in late 2000 and from which we do not expect any future sales; and

•  
  an increase in volume of Honda remanufactured transmissions as we realized the full-year benefit of that program, which did not fully ramp up until the second quarter
  of 2004,
  
 
 
partially offset by:
 
•  
scheduled price reductions to certain customers in our Drivetrain Remanufacturing and Logistics segments pursuant to contracts entered into primarily in 2003;
   
•  
a reduction in volume of remanufactured engines for certain older European engine programs;
   
•  
a reduction in volume of Ford remanufactured transmissions that is believed to result from repair cost-cap adjustments on certain transmission models; and
   
•  
a reduction in sales for certain remanufacturing-related services and certain other low volume remanufacturing programs.
 
 
      Of our net sales for 2005 and 2004, Cingular accounted for 28.3% and 22.3%, Ford accounted for 23.1% and 29.6%, Honda accounted for 18.3% and 19.4% and DaimlerChrysler accounted for 14.6% and 14.7%, respectively.

Gross Profit. Gross profit increased $4.8 million, or 4.7%, to $106.7 million for 2005 from $101.9 million for 2004. The increase was primarily the result of benefits from our lean and continuous improvement program and other cost reduction initiatives, which were largely offset by the factors described above under “Net Sales.” Additionally, gross profit as a percentage of net sales decreased to 24.1% for 2005 from 25.8% for 2004. This decrease in gross profit as a percentage of net sales was primarily due to (i) the scheduled price reductions, (ii) the change in mix of new business in our Logistics segment, and (iii) the unwinding of the end-of-life support for the out-of-production OEM transmission program, which resulted in a one-time sale of $12.5 million of transmissions components at cost in 2005, which reduced gross profit as a percentage of net sales for 2005 by 0.7%, partially offset by benefits from our on-going lean and continuous improvement program and other cost reduction initiatives. In the fourth quarter of 2005, we launched a remanufacturing program for medium/heavy-duty transmissions and expect to realize growth resulting from the ramp-up of that program. Unlike our light vehicle remanufacturing programs, the terms of this medium/heavy-duty remanufacturing contract require us to take title to the core. As a result, the core value is reflected in both revenue and cost of goods sold and is expected to reduce gross profit margins.
 
SG&A Expense. SG&A expense increased $1.8 million, or 3.5%, to $53.4 million for 2005 from $51.6 million for 2004. The net increase is primarily the result of an increase in costs associated with revenue growth in our Logistics Segment as well as for new business and product development in our Drivetrain Remanufacturing segment, partially offset by benefits from our on-going lean and continuous improvement program and other cost reduction initiatives. As a percentage of net sales, SG&A expense decreased to 12.1% for 2005 from 13.0% for 2004. The one-time sale of transmission components at cost as described above under “Net Sales” reduced SG&A expense as a percentage of net sales for 2005 by 0.3%.

Exit, Disposal, Certain Severance and Other Charges. During 2005, we recorded $0.5 million ($0.3 million net of tax) of exit, disposal, certain severance and other charges primarily related to the closure of an old facility and the move to a new larger facility as part of our capacity expansion within the Logistics segment.

During 2004, we recorded $4.0 million ($2.5 million net of tax) of these costs including (i) $3.3 million of certain non-cash stock-based compensation costs related to modifications to unexercised stock options previously granted to our former Chief Executive Officer and former Chief Financial Officer, per the provisions of the Financial Accounting Standards Board’s Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation (an Interpretation of APB Opinion No. 25), (ii) $0.8 million of facility exit and other costs, (iii) $0.5 million of certain non-cash stock-based compensation costs related to the hiring of our current CEO, (iv) $0.3 million of severance and related costs associated with the reorganization and upgrade of certain management functions and other cost reduction initiatives, and (v) $0.3 million of relocation costs related to the hiring of our current CFO, partially offset by a gain of $1.2 million attributed to the reversal of a previously established provision related to the Drivetrain Remanufacturing segment for a potential non-income state tax liability upon the finalization of an audit by the state tax authorities.

 
As the result of our decision to discontinue our independent aftermarket business we currently expect to record pre-tax non-cash charges primarily in the first quarter of 2006 of approximately $10.0 million, which includes (i) $7.1 million for the write-down of inventory to estimated net realizable value, (ii) $1.5 million for the write-down of fixed assets and accounts receivable and (iii) $1.4 million for the impairment of goodwill. In addition, we expect to incur pre-tax cash charges of approximately $1.1 million for severance, termination benefits and facility exit costs in the first and second quarters of 2006. We expect to reclassify the operations of this business from “Other” to discontinued operations upon its disposal. See Item 8. “Consolidated Financial Statements and Supplementary Data - Note 20.”

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 additional costs of a nature described above, which would be offset over time by the projected cost savings.

Operating Income. Operating income increased $6.5 million, or 14.1%, to $52.7 million for 2005 from $46.2 million for 2004. This increase is primarily the result of the factors described above under “Net Sales,” “Gross Profit” and “Exit, Disposal, Certain Severance and Other Charges.” As a percentage of net sales, operating income increased to 11.9% from 11.7%. The one-time sale of transmission components at cost as described above under “Net Sales” adversely affected operating income as a percentage of net sales for 2005 by 0.3%.  

Interest Income. Interest income decreased $0.7 million, or 25.9%, to $2.0 million for 2005 from $2.7 million for 2004. This decrease was primarily due to the early redemption of the note receivable from the Distribution Group (see Item 8. “Consolidated Financial Statements and Supplementary Data - Note 2”), partially offset by higher cash balances invested in cash and equivalents during 2005 as compared to 2004 and a general increase in interest rates. 

Other Income, net. Other income increased to $0.6 million for 2005 from a gain of $24 thousand for 2004. This increase was due to a gain recorded from the early redemption of the note receivable from the Distribution Group. See Item 8. “Consolidated Financial Statements and Supplementary Data - Note 2.” 

Interest Expense. Interest expense increased $0.4 million, or 5.5%, to $7.7 million for 2005 from $7.3 million for 2004. This increase was primarily due to a general increase in interest rates in 2005 as compared to 2004, partially offset by a reduction in total debt outstanding. 

Income Tax Expense. Our effective incom