<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
- --- OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 1998
-------------------------------------------------
OR
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 0-13940
-----------------
CENTRAL SPRINKLER CORPORATION
-----------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2328106
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
451 North Cannon Avenue, Lansdale, PA 19446
-------------------------------------------
(Address of principal executive offices)
(Zip Code)
(215) 362-0700
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at September 18, 1998
----- ---------------------------------
Common Stock, $.01 Par Value 3,845,637
1
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CENTRAL SPRINKLER CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
July 31, October 31,
1998 1997
------ ------
(Amounts in thousands,
except per share)
ASSETS
Current Assets:
Cash and cash equivalents $ 7,609 $ 6,568
Short-term investments 4,630 14,288
Accounts receivable, less allowance
for doubtful receivables of $6,484
in 1998 and $5,949 in 1997 44,572 48,048
Inventories 45,303 50,450
Deferred income taxes 6,526 8,227
Prepaid expenses and other assets 5,381 3,414
Total current assets -------- --------
114,021 130,995
-------- --------
Property, Plant and Equipment 74,880 73,412
Less - Accumulated depreciation (28,741) (25,480)
-------- --------
46,139 47,932
-------- --------
Goodwill, less accumulated amortization of
$3,703 in 1998 and $3,514 in 1997 2,319 2,508
-------- --------
Other Assets 9,015 6,592
-------- --------
Deferred Income Taxes 9,281 --
-------- --------
$180,775 $188,027
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Short-term borrowings $ 1,026 $ 2,403
Current portion of long-term debt 3,046 2,854
Accounts payable 19,776 27,626
Accrued expenses 19,208 12,713
Accrued income taxes 239 409
-------- --------
Total current liabilities 43,295 46,005
-------- --------
Long-Term Debt 78,204 79,918
-------- --------
Long-Term Omega Liabilities 29,755 8,700
-------- --------
Other Noncurrent Liabilities 268 310
-------- --------
Deferred Income Taxes -- 196
-------- --------
Shareholders' Equity:
Common stock, $.01 par value; shares
authorized - 15,000; issued -
5,568 in 1998 and 1997 56 56
Additional paid-in capital 31,191 31,059
Retained earnings 20,266 44,160
Cumulative translation adjustments 10 184
Deferred cost - Employee Stock Ownership
Plan ("ESOP") (5,361) (5,652)
-------- --------
46,162 69,807
Less - Common stock in treasury, at
cost - 1,722 shares in 1998 and 1997 (16,909) (16,909)
-------- --------
29,253 52,898
-------- --------
$180,775 $188,027
======== ========
See accompanying notes to financial statements.
2
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CENTRAL SPRINKLER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
July 31, July 31,
1998 1997 1998 1997
---- ---- ---- ----
(Amounts in thousands,
except per share)
<S> <C> <C> <C> <C>
Net Sales $57,168 $58,918 $167,441 $160,971
Cost of Sales 42,286 42,940 121,817 112,756
------- ------- ------- -------
Gross profit 14,882 15,978 45,624 48,215
------- ------- ------- -------
Operating Expenses:
Selling, general
and administrative 9,858 11,718 32,786 33,192
Research and development 1,590 1,873 5,079 5,065
------- ------- ------- -------
11,448 13,591 37,865 38,257
------- ------- ------- -------
Unusual Omega TM charge 38,015 - 38,015 -
------- ------- ------- -------
Operating income (loss) (34,581) 2,387 (30,256) 9,958
------- ------- ------- -------
Interest Expense (Income):
Interest expense 1,428 1,290 4,393 3,599
Interest (income) (83) (141) (500) (387)
------- ------- ------- -------
1,345 1,149 3,893 3,212
------- ------- ------- -------
Income (loss) before income
taxes (35,926) 1,238 (34,149) 6,746
Income Tax Provision (Benefit) (10,799) 370 (10,255) 2,421
------- ------- ------- -------
Net Income (Loss) ($25,127) $ 868 ($23,894) $ 4,325
======= ======= ======= =======
Net Income (Loss) Per Common Share:
Basic $ (7.65) $ .27 $ (7.29) $ 1.34
======= ======= ======= =======
Diluted $ (7.65) $ .26 $ (7.29) $ 1.29
======= ======= ======= =======
</TABLE>
See accompanying notes to financial statements.
3
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CENTRAL SPRINKLER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
July 31,
1998 1997
------ ------
(Amounts in thousands)
Operating activities:
Net income (loss) $(23,894) $ 4,325
Noncash items included in net income (loss):
Depreciation and amortization 6,258 4,983
Deferred income taxes (7,776) (734)
Deferred costs 381 558
Unusual Omega TM charge 38,015 -
Decrease (increase) in -
Accounts receivable, net 3,476 (7,686)
Inventories 3,147 (5,376)
Prepaid expenses and other assets (1,967) (107)
Increase (decrease) in -
Accounts payable (7,850) 4,339
Accrued expenses and other noncurrent
liabilities (7,725) (1,078)
Accrued income taxes (170) (920)
------- -------
Cash provided by (used for) operating activities 1,895 (1,696)
------- -------
Investing activities:
Acquisition of property, plant and equipment (4,276) (11,363)
Sales of short-term investments 14,340 2,000
Purchases of short-term investments (4,682) (3,707)
Repurchase of subsidiary bond issue (7,500) -
Other long term assets 5,077 113
------- -------
Cash provided by (used for) investing activities 2,959 (12,957)
------- -------
Financing activities:
Short-term (repayments) borrowings, net (1,377) 7,557
Proceeds from long-term debt - 7,500
Repayments of long-term debt (2,262) (2,741)
Proceeds from exercised stock options - 6
Other - net (174) (124)
------- -------
Cash (used for) provided by financing activities (3,813) 12,198
------- -------
Increase (decrease) in cash and cash equivalents 1,041 (2,455)
Cash and cash equivalents at beginning of period 6,568 2,884
------- -------
Cash and cash equivalents at end of period $ 7,609 $ 429
======= =======
See accompanying notes to financial statements.
4
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CENTRAL SPRINKLER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(continued)
Nine Months Ended
July 31,
1998 1997
------ ------
(Amounts in thousands)
Supplemental disclosures of cash flow
information:-
Cash paid (received) during the period for:
Interest expense $4,288 $3,078
====== ======
Income taxes $ 253 $4,075
====== ======
Interest income $ (532) $ (383)
====== ======
Supplemental schedule of non-cash
investing and financing activities:-
Refinancing of short-term borrowings
with long-term debt $7,500 $6,500
====== ======
See accompanying notes to financial statements.
5
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CENTRAL SPRINKLER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share)
(1) Basis of Presentation:
---------------------
The condensed financial statements included herein have been prepared
by the Company without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. These statements include all adjustments that, in the
opinion of management, are necessary to provide a fair statement of the results
for the periods covered. These financial statements should be read in
conjunction with the audited financial statements and the notes thereto included
in the Company's Form 10-K for the year ended October 31, 1997. The results of
operations for the interim periods presented are not necessarily indicative of
the results for the full year.
(2) Inventories:
-----------
Inventories are stated at the lower of cost (first-in, first-out) or
market, and consist of the following:
July 31, October 31,
1998 1997
------- -------
Raw Materials and Work in Process $14,346 $16,053
Finished Goods 30,957 34,397
------- -------
$45,303 $50,450
======= =======
(3) Net Income (Loss) Per Common Share:
----------------------------------
In the first quarter of fiscal 1998, the Company adopted SFAS No. 128
"Earnings Per Share". In accordance with SFAS No. 128, the Company's prior year
reported net income per share amounts were restated to comply with SFAS No. 128.
Basic net income (loss) per common share is computed using the weighted
average number of shares of common stock outstanding. Diluted net income (loss)
per common share is computed using the weighted average number of shares of
common stock and common stock equivalents outstanding (dilutive stock options)
unless the inclusion of common stock equivalents would have an antidilutive
impact. Unreleased shares of the Company's stock in the ESOP are excluded from
the average number of common shares outstanding when computing basic and diluted
net income (loss) per share. The weighted average common and common equivalent
shares outstanding for purposes of calculating net income (loss) per common
share are computed as follows -
6
<PAGE>
<TABLE>
<CAPTION>
Three Nine
Months Ended Months Ended
July 31, July 31,
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net income (loss) used for basic
and diluted net income (loss)
per share $(25,127) $ 868 $(23,894) $4,325
======== ====== ======== ======
Weighted average number of
common shares outstanding 3,846 3,846 3,846 3,842
Adjustment to exclude average
unreleased common shares
in ESOP (560) (600) (570) (609)
------- ----- ------- ------
Weighted average common shares
outstanding for basic net
income (loss) per common share 3,286 3,246 3,276 3,233
Dilutive effect of common stock
options outstanding - 108 - 116
------- ------ ------ ------
Weighted average common and
common equivalent shares
outstanding for diluted net
income (loss) per common share 3,286 3,354 3,276 3,349
======= ====== ====== ======
</TABLE>
(4) Unusual Omega TM Charge, Commitments and Contingencies:
-------------------------------------------------------
As disclosed separately, the Company has been involved in seven
class action lawsuits as well as a lawsuit filed on March 4, 1998 by the United
States Consumer Product Safety Commission ("Commission") related to the
Company's Omega TM sprinklers. The Company is in the process of negotiating a
recall and replacement program to settle the Commission's action as well as a
settlement of class action litigation. A settlement of the Commission's action
is contingent upon the approval by the presiding judge and the Commission as a
whole. Settlement of the class action litigation is contingent upon receiving
approval from the court. In accordance with SFAS No. 5 "Accounting for
Contingencies" and based on current information, the Company has revised its
estimate of the probable future cost of settling these matters and has recorded
a $38,015 ($26,610 net of tax) charge in the third quarter to reflect the total
estimated additional future cost. The Company believes this additional accrual
will be adequate to cover the probable settlement of these actions and that no
additional charge is likely.
7
<PAGE>
The estimated charge assumes a recall of Omega TM sprinklers, the
replacement of sprinklers and parts, payment of certain consequential damages to
the owners of Omega TM sprinklers, administration of the recall program and
payment of legal and defense fees as required.
In addition, the Company has discontinued the manufacturing and sale of
Omega TM sprinklers. Included in the $38,015 charge is approximately $2,000
related to the write off of Omega TM sprinkler finished goods and component
parts inventory.
In an effort to recover a portion of the cost of a potential Omega TM
settlement, the Company filed suit on August 19, 1998 against the twelve
product liability insurance carriers with which the Company had coverage over
the past 15 years. No insurance or third party recoveries have been considered
in the Company's accrual analysis and the amount of such recoveries, if any, is
uncertain at this time.
The final negotiated settlement of these matters will determine the
extent and terms of the recall. It is anticipated that the payments required to
be made under this program will be done over a four-year period and $12,000 has
been included as a current liability in accrued expenses at July 31, 1998.
In August 1997, a lawsuit was filed against the Company in the State of
California on behalf of a class of building owners who have Omega TM sprinkler
heads installed in their buildings. In December 1997, a similar lawsuit was
filed in California on behalf of the County of Santa Clara, seeking to represent
a class of public entities and commercial building owners who have installed
Omega TM sprinkler heads. Since the filing of these class actions, the Company
has been named as a defendant in five additional class actions raising virtually
identical allegations, captioned Rebecca Adams v. Central Sprinkler Co. (filed
on February 11, 1998 in the Superior Court of California for the County of San
Bernadino), James T. Perona v. Central Sprinkler Corp. (filed March 13, 1998 in
the Superior Court of California for the County of Los Angeles), South Royal
Corp. v. Central Sprinkler Corp. (filed March 27, 1998 in the United States
District Court for the Southern District of Florida), Roy F. Smith v. Central
Sprinkler Corp. (filed March 20 1998 in the United States District Court for the
Eastern District of Pennsylvania), and Sangiacomo v. Central Sprinkler Corp.
(filed April 3, 1998 in the United States District Court for the Eastern
District of Pennsylvania). The complaints do not specify a dollar amount the
plaintiffs are seeking. The Company has moved to dismiss each of the above
actions which it has been served with process. Earlier in 1998, the court
dismissed the South Royal complaint for failure to state a claim. Plaintiff
thereafter voluntarily dismissed its actions. Motions to dismiss remain pending
in the other actions.
8
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As previously disclosed by the Company in it's Annual Report on Form
10-K for the fiscal year ended October 31, 1997 and its quarterly reports on
Form 10-Q for the quarters ended April 30, 1998 and January 31, 1998
(collectively, the "Reports"), the Commission has been investigating problems
regarding the Company's Omega TM sprinkler heads since 1996. On March 4, 1998,
the Commission filed the administrative complaint against the Company and one of
its subsidiaries. A report on Form 8-K was filed by the Company with the
Securities and Exchange Commission on March 6, 1998 which provided certain
information relating to the administrative action that was commenced by the
Commission against the Company and the Company's press release dated March 4,
1998 included the Company's response to the administrative action.
In the fourth quarter of fiscal 1997, a charge of $13,200 ($8,976 net
of tax) was recorded to cover the estimated future costs associated with the
expansion of a voluntary program over the next several years which was initiated
by the Company to encourage the testing and possible replacement of certain
Omega TM fire sprinklers. A similar Omega TM charge was recorded in fiscal 1996
of $3,750 ($2,362 net of tax). These amounts were based on estimates of the
number of Omega TM sprinklers, the action plan the Company believed was
necessary to remediate these sprinklers and various other assumptions.
On June 23, 1998, the Company filed a Report on Form 8-K with the
Securities and Exchange Commission in which the Company reported that in
connection with settlement meetings with the United States Consumer Product
Safety Commission ("Commission"), the Company believed that the amount
previously accrued for the Omega TM sprinkler issues most likely would have to
be increased to cover the costs that the Company may incur to resolve the
Commission's action and other lawsuits concerning the Omega TM sprinklers.
The Company believes that the third quarter fiscal 1998 charge along
with remaining balances previously accrued totaling $41,755 will be sufficient
to cover the total estimated additional costs of the Omega TM sprinkler matters.
The third quarter fiscal 1998 charge is based on estimates of the number of
Omega TM sprinklers to be located, the number of parties who will elect not to
participate in the settlements, estimated legal expenses and various other
assumptions and on information available at this time. In addition, the third
quarter fiscal 1998 charge is based on settlement discussions with the
Commission and certain class action lawsuit litigants and are subject to being
finalized. It is possible that additional litigation may ensue. In the event
additional information becomes available in the future which changes
management's estimates, additional provisions may be necessary.
(5) Subsequent Event:
-----------------
On September 18, 1998, the Company entered into a Loan and Security
Agreement ("Agreement") with its bank as part of a debt refinancing and debt
consolidation. As part of the refinancing, the Company received gross loan
proceeds of approximately $62,100 and repaid outstanding debt including the
previous Revolver Credit Agreement, several term notes and mortgage notes with a
total outstanding balance of approximately $62,100 as of the date of the
refinancing (total outstanding balance of $62,248 as of July 31, 1998). These
repaid debt instruments were canceled as part of the refinancing. The borrowing
commitment and availability in the Agreement, including term equipment notes,
revolving credit facilities and letters of credit, are subject to borrowing base
formulas as defined in the Agreement. The maximum borrowing availability under
the revolving credit facility portion is $77,600 less the outstanding portion of
any term notes issued under the agreement. The borrowing base as defined in the
Agreement is based on the appraised value of certain pledged property, plant and
equipment, a percentage of eligible accounts receivable and inventories and the
amount of pledged cash and short term investments. The Agreement expires on
March 30, 2001, subject to renewal, and outstanding borrowings under the
Agreement will bear the interest rate at the lower of the Eurodollar rate plus
1.75% or the banks prime rate. The Agreement requires the Company to maintain a
minimum adjusted tangible net worth and comply with other affirmative and
negative covenants.
9
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CENTRAL SPRINKLER CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
(Amounts in thousands, except per share)
RESULTS OF OPERATIONS
The following table summarizes the impact of the unusual Omega TM
charge on the reported operating income (loss), net income (loss) and net income
(loss) per share for the respective reporting periods:
<TABLE>
<CAPTION>
Three Nine
Months Ended Months Ended
July 31, July 31,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating income before unusual
Omega TM charge $ 3,434 $2,387 $ 7,759 $9,958
Unusual Omega TM charge (38,015) - (38,015) -
-------- ------ ------- -----
Operating income (loss) $(34,581) $2,387 $(30,256) $9,958
======== ====== ======== ======
Net income before unusual
Omega TM charge $ 1,483 $ 868 $ 2,716 $4,325
Unusual Omega TM charge
(net of tax) (26,610) - (26,610) -
-------- ------ ------- ------
Net income (loss) $(25,127) $ 868 $(23,894) $4,325
======== ====== ======== ======
Diluted net income per share $ .45 $ .26 $ .83 $ 1.29
before unusual Omega TM charge
Unusual Omega TM charge (after tax) (8.10) - (8.12) -
-------- ------ ------- ------
Diluted net income (loss)
per share $ (7.65) $ .26 $ (7.29) $ 1.29
======== ====== ======= ======
</TABLE>
Unusual Omega TM Charge. See Note 4 of the Notes To Consolidated Financial
Statements relating to the additional charge for potential settlement of
the litigation related to the Company's Omega TM sprinklers.
10
<PAGE>
Net Sales. Net sales for the third quarter of fiscal 1998 decreased 3.0% to
$57,168. Such sales were $1,750 less than the $58,918 recorded in the third
quarter of fiscal 1997. Net sales for the first nine months of fiscal 1998 were
$167,441, 4.0% greater than the sales for the comparable nine-month period of
fiscal 1997. The sales decrease for the three-month period of fiscal 1998 is due
in part to price competition on virtually all of its product lines, partially
resulting from the publicity surrounding litigation and governmental
investigations into the Company's Omega TM sprinkler products. The sales
increase for the nine-month period of fiscal 1998 is due to continued growth of
the overall market for fire sprinkler products, unit sales increases in many
fire sprinkler system products, and new fire sprinkler and fittings products
offset by the third quarter sales decline. The new construction market and the
retrofit of existing buildings drive the worldwide demand for the Company's fire
sprinklers and related products. The Glass Bulb fire sprinkler models continue
to lead the Company's sprinkler unit sales gains. Sales declines were
experienced for the Omega TM and other sprinkler models. The Company experienced
sales gains in CPVC pipe and fittings and grooved fittings for the nine months
ended July 31, 1998 as compared to the same prior year period. Sales increases
were realized in most U.S. markets. International sales for the nine months
ended July 31, 1998 were comparable to the same period of the prior year. The
Company continues to experience very competitive conditions worldwide in the
sprinkler market through price competition which has continued to depress sales
prices and overall sales. The decision to discontinue the sales of the Omega TM
sprinkler heads is not expected to have a material adverse impact on future
sales results.
Cost of Sales and Gross Profit. Cost of sales, in terms of dollars of expense,
decreased 1.5% and increased 8.0% for the three-month and nine-month periods
ended July 31, 1998, respectively, over the same periods for fiscal 1997. The
decrease for the three months ended July 31, 1998 in cost of sales is due to
11
<PAGE>
lower sales. The increase in cost of sales for the nine months ended July 31,
1998 is due to increased costs of manufacturing related to the higher nine month
sales volume, increased costs for raw material, labor and overhead, and higher
product warranty claims. The Company's cost of sales for the three-month and
nine-month periods ended July 31, 1998, respectively, were 74.0% and 72.8% of
net sales as compared to 72.9% and 70.0% of net sales for the comparable prior
year periods. This resulted in a gross profit margin percentage of 26.0% and
27.2% for the three-month and nine-month periods ended July 31, 1998,
respectively, as compared to 27.1% and 30.0% for the three-month and nine-month
periods ended July 31, 1997. Lower sales prices were the primary reason for the
lower gross profit margins in both the three- and nine-month periods ended July
31, 1998. The Company has faced continued price competition on most of its
products. The gross profit margin percentage also declined due to a less
favorable sales mix, somewhat higher manufacturing costs and product warranty
claims. In the first quarter of fiscal 1998, the Company initiated programs to
increase margins for the purpose of improving operating results which partially
offset the declines in the gross profit percentage for the three-month period
ended July 31, 1998.
Operating Expenses. Operating expenses for the third quarter of fiscal 1998
decreased 15.8%, or $2,143, to $11,448 from the third quarter of fiscal 1997.
Total operating expenses decreased 1.0%, or $392, to $37,865 for the nine months
ended July 31, 1998 compared to $38,257 for the same period for fiscal 1997.
Operating expenses were 20.0% and 22.6% of net sales for the three- and
nine-month periods ended July 31, 1998 compared to 23.1% and 23.8% for the
comparable periods of the prior year. Selling, general and administrative
expenses decreased 15.9% and 1.2% for the three- and nine-month periods ended
July 31, 1998 compared to the same periods of the prior year. The decrease in
selling, general and administrative expenses was due to the Company's cost
reduction programs initiated early in fiscal 1998 but primarily realized in the
third quarter of fiscal 1998. Research and development expenses decreased 15.1%,
or $283, to $1,590 in the third fiscal quarter of 1998 as compared to the same
period in fiscal 1997. This was also due to cost reduction programs implemented
in fiscal 1998. The research and development expenses for the nine months ended
July 31, 1998 were virtually unchanged from the same period in fiscal 1997.
Research and development expenses rose sharply in the first fiscal quarter of
1998, in connection with the development and final approvals of a new line of
ESFR fire sprinklers, which drove the research and development expenses higher
through the first nine-months of 1998. Research and development expenses in the
fourth fiscal quarter are expected to increase over the third quarter level of
fiscal 1998 as the Company increases its efforts to bring new and improved
products to the market.
12
<PAGE>
Interest Expense (Income). Interest expense of $1,428 and $4,393 was incurred in
the three-month and nine-month periods ending July 31, 1998, respectively,
compared to interest expense of $1,290 and $3,599 for the same periods of fiscal
1997. The higher interest expense was due to the increased average level of debt
and higher effective borrowing rate for the three- and nine-month periods ended
July 31, 1998 compared to the same periods of the prior year. Short and
long-term debt totaled $82,276 at July 31, 1998. The debt was required to
finance the Company's working capital needs and increased growth in the
Company's business including manufacturing capital expenditures. Interest income
for the three- and nine-month periods ended July 31, 1998 was $83 and $500,
respectively, compared to $141 and $387 for the same periods ended July 31,
1997. The lower interest income level in the third fiscal quarter of 1998 was
due to a lower average investment balance as compared to the prior year period.
The higher interest income level for the first nine months of fiscal 1998 was
the result of a higher average investment balance in fiscal 1998.
Income Tax Provision (Benefit). The Company's effective income tax rate for the
third quarter of fiscal 1998 was a benefit of 30.1% compared to a provision of
29.9% in the comparable period of 1997. For the nine-month period of fiscal
1998, the effective income tax rate was a benefit of 30.0% compared to a
provision of 35.9% in the comparable period in 1997. The change in the overall
effective income tax rate is primarily a result of the estimated income tax rate
used to record the tax benefit of the unusual Omega TM charge in the third
quarter of fiscal 1998 and the impact of the nondeductible expenses on the lower
level of income in fiscal 1997.
Seasonal Aspects of Business. The Company's sales are affected by seasonal
factors and the weather as well as the level of new construction activity,
remodeling and retrofitting of older properties in the industrial, commercial,
residential and institutional real estate markets. The Company's sales tend to
increase the most when there is a high level of new construction activity in all
such real estate markets. In addition, as a result of relatively higher levels
of new construction during the warmer spring and summer months, the demand for
sprinkler system components tends to be greater during the summer and fall than
during other seasons.
13
<PAGE>
FINANCIAL CONDITION
July 31, 1998 Compared to October 31, 1997
Cash, Cash Equivalents and Short-Term Investments. Cash, cash
equivalents and short-term investments totaled $12,239 as of July 31, 1998 as
compared to $20,856 at October 31, 1997. The decrease was due to fluctuations in
operations, funds used for or provided by investing and financing activities
including the repurchase of $7,500 tax exempt bonds discussed below and cash
used to fund the Omega TM remediation.
Inventories. Inventories totaled $45,303 at July 31, 1998 as compared to $50,450
at October 31, 1997. The $5,147 decrease in inventories was comprised of a
decrease of $1,707 in raw materials and work in process and a decrease of $3,440
in finished goods. The decrease in inventories was primarily due to two factors.
The first was an inventory reduction program initiated by the Company. This
included reducing lead, production, and distribution times to increase inventory
turnover rates and the implementation of temporary production cutbacks at
certain facilities to reduce excess inventory in certain product lines. The
second was a charge of $2,000 to write-off certain raw material, work in process
and finished goods related to the Omega TM fire sprinklers. The inventory
write-off was included in the unusual Omega TM charge discussed elsewhere
herein.
Property, Plant and Equipment. The Company's property, plant and equipment rose
to $74,880 at July 31, 1998. The capital expenditures for the nine months ended
July 31, 1998 totaling $4,276 were primarily due to expanding certain
manufacturing capabilities for fire sprinklers, associated components, and
grooved fittings product lines.
Total Debt. The Company's total debt decreased to $82,276 at July 31, 1998 as
compared to $85,175 at October 31, 1997. The Company made net repayments of debt
during the first nine months of fiscal 1998 in accordance with normal debt
repayment schedules. In December 1997, a term loan was refinanced through the
issuance of First Mortgage Industrial Development Revenue Bonds Series 1997,
principal amount $7,500 issued by the Industrial Development Board of the City
of Huntsville, Alabama ("IDB's"). The IDB's have a 15 year term and are payable
in 52 equal quarterly installments, beginning in the third year. In April 1998,
the Company repurchased these $7,500 of tax-exempt bonds. In 1998, they are
classified as an other noncurrent assets as the Company is in the process of
remarketing these bonds. It is anticipated that the bonds will be remarketed by
the end of the calendar year.
14
<PAGE>
Liquidity and Capital Resources. The Company's primary sources of long-term and
short-term liquidity are its current financial resources, projected cash from
operations and its borrowing capacity. The Company's Revolver Credit Agreement
was amended several times in the first nine months of fiscal 1998 in order to
revise certain covenants. As part of these amendments, the Company agreed to pay
a higher interest rate and provide certain additional collateral in certain
assets of the Company's subsidiaries and certain additional covenants were
required going forward under the Revolver Credit Agreement.
On September 18, 1998, the Company entered into a Loan and Security Agreement
("Agreement") with its existing bank as part of a debt refinancing and debt
consolidation. As part of the refinancing, the Company received gross loan
proceeds of approximately $62,100 and repaid outstanding debt including the
previous Revolver Credit Agreement, several term notes and mortgage notes with a
total outstanding balance of approximately $62,100 as of the date of the
refinancing. The borrowing commitment and availabiliy in the Agreement,
including term equipment notes, revolving credit facilities and letters of
credit, are subject to borrowing base formulas as defined in the Agreement. The
maximum borrowing availability under the revolving credit facility portion is
$77,600 less the outstanding portion of any term notes issued under the
Agreement. The borrowing base as defined in the Agreement is based on the
appraised value of certain pledged property, plant and equipment, a percentage
of eligible accounts receivable and inventories and the amount of pledged cash
and short term investments. As of the closing date of the Agreement, the Company
borrowed $12,600 as term equipment notes and $49,635 under the revolving credit
facility. The Company had available borrowing capacity in excess of the required
minimum of $2,665 as of the closing date. The Agreement expires on March 30,
2001, subject to renewal, and outstanding borrowings under the Agreement will
bear interest at the lower of the Eurodollar rate plus 1.75% or the banks prime
rate. The Agreement requires the Company to maintain a minimum adjusted tangible
net worth.
Cash provided by operating activities in the first nine months of fiscal 1998
was $1,895 as a compared to cash used for operating activities of $1,696 in the
same period of 1997. Net income (loss) plus non-cash items generated $12,984 of
cash in the first nine months of fiscal 1998 as compared to $9,132 in the first
nine months of fiscal 1997. Cash used for working capital was $11,089 in the
nine months ended July 31, 1998 as compared to cash used of $10,828 in the same
period of 1997. Anticipated future increases in sales growth will continue to
require the use of operating cash flow.
Cash provided by investing activities was $2,959 in the nine months ended July
31, 1998 as compared to cash used for investing activities of $12,957 in the
comparable 1997 period. Cash was provided by the net sales of investments in the
nine months ended July 31, 1998 totaling $9,658 as compared to a net purchase of
$1,707 of additional short-term investments in the comparable prior year period.
Cash was also used to repurchase the $7,500 tax-exempt bonds that the Company
intends to remarket by the end of the calendar year. A letter of credit
commitment incorporated in the new financing facility is expected to
significantly improve the marketability of these bonds. Another significant use
of cash was for the acquisition of property, plant and equipment during these
periods. These capital expenditures were primarily for machinery and equipment
to expand the manufacturing capacity and improve the operations for the
Company's various product lines. The capital expenditures in the first nine
months of fiscal 1997 were for additional manufacturing machinery and equipment
and the construction of the Company's CPVC plastic pipe and fittings facility.
Cash used for financing activities in the nine months ended July 31, 1998 was
$3,813 as compared to cash provided by financing activities of $12,198 in the
comparable prior year period. The primary use of cash in the nine months ended
July 31, 1998 was net short-term and long-term debt repayments. The primary
source of cash in the prior year period was additional long-term
15
<PAGE>
borrowings of $7,500 and short-term borrowings of $7,557 under the Company's
lines of credit. The borrowings in the comparable prior year periods were needed
to finance the increased growth in the Company's business, including capital
expenditures and working capital.
The Company purchases property, plant and equipment from time to time as
required to maintain and expand its offices, manufacturing and research
facilities and distribution centers. The Company has expanded and improved its
operations over the years with such purchases and the Company intends to
continue this policy in the future. The Company has commitments in the ordinary
course of business for such expansions of facilities and equipment and for
research and other contracts.
As described in Note 4 of the Notes To Consolidated Financial Statements, the
Company also expects to replace its Omega TM sprinklers under the potential
product recall settlement with the Commission and the class action litigation.
The ultimate funding of this liability will be determined once the terms of the
settlement of the Commission investigation and the class action lawsuits are
finalized. It is anticipated that approximately $12,000 of funding will be
required in fiscal year 1999.
The Company's cash, cash equivalents and short-term investments, future
operating results, the expected resale of the $7,500 of tax-exempt bonds, and
the Company's borrowing capacity is expected to provide adequate liquidity to
meet the Company's obligations, including the funding of future growth and the
expected settlement of the Omega TM sprinkler matters.
Unusual Omega TM Charge. See Note 4 of the Notes To Consolidated Financial
Statements relating to the additional charge for potential settlement of the
litigation related to the Company's Omega TM sprinklers.
16
<PAGE>
Year 2000 Compliance. The Company has been and continues to be in the process of
evaluating its information technology infrastructure for the Year 2000
compliance. The Company has modified certain systems to be Year 2000 compliant.
The Company does not expect that the cost to modify its information technology
infrastructure to be Year 2000 compliant will be material to its financial
condition or results of operations. The Company does not anticipate any material
disruption in its operations as a result of any failure by the Company to be in
compliance. The Company does not currently have information concerning Year 2000
compliance status of its suppliers and customers. In the event that any of the
Company's significant suppliers or customers does not successfully and timely
achieve Year 2000 compliance, the Company's business or operations could be
adversely affected.
Forward Looking Statements. This document contains certain forward-looking
statements that are subject to risks and uncertainties. Forward-looking
statements include certain information relating to the Company's product recall
and litigation regarding its Omega TM sprinklers, the growth expected in the
construction market, liquidity,
17
<PAGE>
information relating to the litigation matters involving the Company (including
the adequacy of the charge recorded to cover the recall and lawsuits relating to
the Omega TM sprinklers) and matters relating to the Year 2000 issues, as well
as information contained elsewhere in this document where statements are
preceded by, following by or include the words "believes," "expects,"
"estimates," "anticipates" or similar expressions. For such statements, the
Company claims the protection of the safe harbor for forward-looking statements
contained in the Private Securities Litigation Reform Act of 1995. Actual events
or results may differ materially from those discussed in forward-looking
statements as a result of various factors, including without limitation, those
discussed elsewhere in the various documents filed by the Company with the
Securities and Exchange Commission.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 4 of the Notes To Consolidated Financial Statements relating
to the additional charge for potential settlement of the litigation related to
the Company's Omega TM sprinklers.
18
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following document is filed as an Exhibit and attached as follows:
Exhibit 27 -- Financial Data Schedule
(b) Reports on Form 8-K
On June 23, 1998, the Company filed a Report on Form 8-K with the
Securities and Exchange Commission in which the Company reported that
in connection with settlement meetings with the United States Consumer
Product Safety Commission (the "Commission"), the Company believed that
the amount previously reserved for the Omega TM sprinkler issues most
likely would have to be increased to cover the costs that the Company
may incur to resolve the Commission's action as well as other lawsuits
and class actions.
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CENTRAL SPRINKLER CORPORATION
-----------------------------
(Registrant)
/s/ E. Talbot Briddell
-----------------------------
E. Talbot Briddell
Chief Executive Officer
DATE: September 21, 1998
- --------------------------------
/s/ Albert T. Sabol
-----------------------------
Albert T. Sabol
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
20
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