-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, V2QKBbR5sHdlllCktThcmbfSto/OYkm5WnSYOmj58BF8utim6DKl9txgrzQ0t6Jm X2CbqTvRQCbUxrapYSuzyQ== 0000034629-99-000004.txt : 19990331 0000034629-99-000004.hdr.sgml : 19990331 ACCESSION NUMBER: 0000034629-99-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990102 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FARR CO CENTRAL INDEX KEY: 0000034629 STANDARD INDUSTRIAL CLASSIFICATION: GENERAL INDUSTRIAL MACHINERY & EQUIPMENT, NEC [3569] IRS NUMBER: 951288401 STATE OF INCORPORATION: DE FISCAL YEAR END: 1229 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-04723 FILM NUMBER: 99577734 BUSINESS ADDRESS: STREET 1: 2201 PARK PLACE CITY: EL SEGUNDO STATE: CA ZIP: 90245 BUSINESS PHONE: (310) 727-6300 MAIL ADDRESS: STREET 2: 26161 MARQUERITE PARKWAY SUITE B CITY: MISSION VIEJO STATE: CA ZIP: 92692 10-K 1 FARR COMPANY 1998 10-K ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10K (Mark One) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES ( X ) EXCHANGE ACT OF 1934 For the fiscal year ended January 2, 1999 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 0-4723 FARR COMPANY (Exact name of registrant as specified in its charter) Delaware 95-1288401 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 2201 Park Place, El Segundo, CA 90245 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (310) 727-6300 Securities registered pursuant to Section 12 (g) of the Act: Title of Class Name of Exchange on Which Registered Common Stock, $.10 Par Value NASDAQ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __x__ No _____ Indicate by check mark 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__ The aggregate market value of voting common stock held by non-affiliates of Registrant on March 12, 1999, based on the closing sale price on such date, was $75,469,630. The number of shares of common stock outstanding on March 12, 1999 was 8,878,780. ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ DOCUMENTS INCORPORATED BY REFERENCE PART I AND II: The Annual Report to Stockholders for the fiscal year ended January 2, 1999. PART I AND III: The Proxy Statement for the Annual Meeting of Stockholders to be held May 4, 1999. PART I Item 1. Business ------- -------- Farr Company and its subsidiaries (hereinafter collectively referred to as the "Company" or "Registrant") are engaged in the design, development, manufacture, sale and service of filters and filtration systems. These products are used for a wide variety of applications, including heating, ventilation and air conditioning systems, manufacturing and process cleanrooms, special application filters for original equipment manufacturers, diesel-powered truck engines, railroad locomotives, dust collection systems and gas turbines. Air filter efficiencies range from 20 percent in disposable products to 99.9999+ percent in cleanroom products. Products are available as standard items or may be custom engineered. They range in size and complexity from a small throwaway air filter to large gas turbine systems with a single filter component module weighing in excess of twenty tons. All of the Company's filter products incorporate at least one of five basic methods of filtration. These include strainer type filters which block the passage of particles through the use of various types of materials such as paper, non-woven cotton fabric, fiberglass and metal screening; impingement and diffusion type filters which consist of layers of various types of screening materials sometimes with an oil coating that traps dust particles; inertial separators which filter high velocity air by changing its direction; and activated carbon filters which absorb odors and gases. Paper, fabric, fiberglass and carbon filters are disposable and the Company sells replacements. Many products manufactured by the Company are enclosed in hardware ranging from simple frames to large component modules weighing in excess of twenty tons. The percentage of the Company's total sales involving the fabrication of large enclosures used in special filtration was 6 percent, 5 percent and 7 percent in 1998, 1997 and 1996, respectively. These products are sold primarily for use with gas turbine installations in applications in the electrical generating, oil and gas industries. The Company also maintains and services air filtration systems and accessory equipment in buildings and industrial plants in Southern California, Detroit, Michigan and Phoenix, Arizona. Services include replacing disposable filters. The Company was organized in California in 1938 and reincorporated in Delaware in 1987. - 2 - Materials The principal materials used in manufacturing the Company's products are ferrous and non-ferrous materials, plastisols, urethanes, adhesives and certain finished and semi-finished filter materials, including screen, activated carbon, cotton fibers, paper and fiberglass. The Company does not depend on any single materials supplier for a significant portion of its raw materials. Product Engineering and Development At January 2, 1999, the Company employed approximately 47 engineers, draftsmen and technicians in the United States, Canada and England to improve and develop existing products, to design, develop and test new products and to improve production equipment and techniques. The Company spent approximately $2,530,000, $2,129,000 and $2,217,000 for product engineering and development in 1998, 1997, and 1996, respectively. The Company owns a number of United States and foreign patents. Although the Company considers these patents to be of value in its operations, its business is not dependent on any single patent or group of patents. Sales and Distribution The Company's products are sold throughout the United States and in over 40 foreign countries through salesmen working out of field sales offices and through various distributors and manufacturers' representatives. Certain of the Company's products are manufactured and sold under licensing agreements with manufacturers located in Argentina, Australia, France, Hong Kong, India, Indonesia, Italy, Japan, Malaysia, Mexico, New Zealand, Singapore, Taiwan and Venezuela. During 1998, no customer accounted for more than 10 percent of net sales. Backlog The Company's backlog at January 2, 1999 was $14,961,000 as compared to $14,631,000 at January 3, 1998. Historically, backlog has not been a significant measure of the Company's future business activities since the majority of orders are shipped within forty-five to sixty days of receipt. During 1998, approximately 14 percent of the Company's business was derived from products with lead times longer than 60 days. These products are primarily heavy fabrication products such as gas turbine equipment. The backlog of orders relating to heavy fabrication products was approximately $2,231,000 and $3,006,000 at January 2, 1999 and January 3, 1998, respectively. All of the January 2, 1999 backlog is scheduled for delivery during 1999. - 3 - International Operations The Company engages in operations in foreign countries as described above. For information regarding the geographic distribution of revenue and long-lived assets of the Company's domestic and international operations, see Note 12 of Notes to Consolidated Financial Statements, included in the Company's Annual Report to Stockholders, which is incorporated herein by reference. The Company's international operations are subject to the additional risks inherent in doing business in countries whose governments have policies different than those of the United States. To date the Company has experienced no material problems in foreign countries arising from political instability or currency restrictions or fluctuations. Competition The fields in which the Company operates are highly competitive with numerous other companies manufacturing and selling competing products. While information with respect to the industry ranking of the Company among manufacturers of similar products is not available, the Company believes that its principal competitors in most of its major product areas are Flanders Corporation, American Air Filter Company, Inc., a wholly owned subsidiary of Snyder General Corporation, Donaldson Company, Inc. and Clarcor, Inc. A number of the Company's competitors have greater financial and marketing resources than the Company. The Company believes the principal competitive factors in the sale of its products are technical competence, quality and the ability to respond to the individual requirements of its customers. Employees At March 12, 1999, the Company had approximately 1,285 employees as compared to approximately 1,319 on March 6, 1998. The Company's four drivers and warehouse operators at its El Segundo service office are covered by a collective bargaining agreement with the Teamsters Union that expires on February 6, 2000. Twenty-eight employees at the Company's Delano plant are covered by a collective bargaining agreement with the Sheet Metal Workers International Association that expires June 30, 2001. At January 2, 1999, 140 employees at the Company's Montreal, Canada plant were covered by a three year collective bargaining agreement expiring August 31, 2000, and 48 employees at the Company's Birmingham, England plant were covered by a collective bargaining agreement that expires on December 31, 1999. - 4 - Executive Officers of the Registrant - ------------------------------------ ================================================================================ Position Held and Business Experience During Name Age Past Five Years John C. Johnston 55 President and Chief Executive Officer of the Company (since February 1999), Director of the Company (since September 1996), President and Chief Operating Officer of the Company (from February 1996 to February 1999), Senior Vice President of the Company (from January 1995 to February 1996); President of Easton Aluminum, Inc. (from January 1986 to December 1994). Richard C. Larson 49 Senior Vice President of the Company (since February 1998), Vice President of the Company (from June 1997 to February 1998), President and Chief Executive Officer of Mac Equipment, Inc., from May 1994 to May 1997. H. Jack Meany 76 Chairman of the Board (since April 1994), Chief Executive Officer of the Company (from February 1996 to February 1999), President and Chief Executive Officer (from April 1994 to February, 1996) Director of the Company (from June 1976 to March 1994); Chairman of the Board and Chief Executive Officer (from October 1975 to March 1988) of NI Industries, Inc., a manufacturer of building, industrial, and defense products; Director, APS Corp. and BWP International, Inc. Steve Pegg 40 Senior Vice President, Secretary and Chief Financial Officer of the Company (since August 1998); Vice President and Chief Financial Officer of Mac Equipment, Inc., from June 1992 toAugust 1998. Myron G. Rasmussen 61 Vice President of the Company (since March 1990), Director of Engineering of the Company (from August 1977 to May 1990). John Vissers 49 Vice President, Controller, Assistant Secretary and Assistant Treasurer of the Company (since April 1998), Controller and Assistant Secretary of the Company (from March 1992 to April 1998). Philip L. Whitaker 35 Vice President of the Company (since September 1998); International Sales Manager of Crisparire Corporation (from June 1997 to September 1998); General Sales Manager of Airflow Company (from May 1992 to June 1997). ================================================================================ - 5 - Item 2. Properties ------- ---------- The location and general description of the Company's principal properties at March 12, 1999 are set forth in the following tables. All such properties are owned by the Company except as noted: Floor Area Location (Square Feet) Principal Uses Jonesboro, AR 220,000 Manufacturing El Segundo, CA 50,000 Closed El Segundo, CA 40,000 Corporate Offices Delano, CA 39,000 Manufacturing Corcoran, CA 80,000 Manufacturing Eatonton, GA (leased) 76,000 Closed Crystal Lake, IL 120,000 Manufacturing Holly Springs, MS 208,000 Manufacturing Conover, NC 107,000 Manufacturing Washington, NC (leased) 15,000 Manufacturing Montreal, Canada 146,000 Manufacturing Birmingham, England 82,000 Manufacturing Memphis, Tennessee 5,000 Sales/Engineering Office The Company leases sales office and warehouse space in or near San Diego, California; Phoenix, Arizona; Detroit, Michigan; Toronto, Ontario, Canada; British Columbia, Canada; Manitoba, Canada; Quebec, Canada; and Singapore. The Company believes that its facilities and manufacturing equipment are well maintained and adequate for current operations. During 1998, the Company believes that utilization of its various production facilities ranged from 50 to 90 percent. Item 3. Legal Proceedings ------- ----------------- The Company is involved in several claims and suits that arise out of the ordinary course of business, and has tax returns under review. Management believes that these matters are either adequately reserved, covered by its insurance, or would not have a material adverse effect on the financial position or operations of the Company if disposed of unfavorably. - 6 - Item 4. Submission of Matters to a Vote of Security Holders ------- --------------------------------------------------- Not applicable. Incorporation by Reference -------------------------- The following portion of the Company's Annual Report to Stockholders for the year ended January 2, 1999 ("Annual Report") is hereby incorporated by reference. Form 10-K Item No. Document Portion of Document ---------------------- ------------- ------------------- Part I -- Item 1 and 2 Annual Report Pages 7 through 19 - 7 - PART II Item 5. Market for Registrant's Common Equity and Related Stockholder ------- ------------------------------------------------------------- Matters ------- The Company's Common Stock trades on the Nasdaq National Market under the symbol FARC. At March 12, 1999, there were approximately 428 stockholders of record of the Company's Common Stock. Dividends --------- The Company did not pay any dividends on its Common Stock over the last two years. On April 29, 1998, The Company's Board of Directors declared a dividend to be paid in the form of a 3 for 2 stock split, payable on May 29, 1998, to stockholders of record on May 8, 1998. This Item 5 should be read in conjunction with information appearing under the captions "Consolidated Statements of Stockholders' Investment", "Selected Financial Data" and "Summary of Stock Quotations" on pages 8, 20 and 25, respectively, of the Annual Report. Item 6. Selected Financial Data ------- ----------------------- The five year summary under "Selected Financial Data" included on page 20 of the Annual Report is incorporated herein by this reference. The five-year summary should be read in conjunction with the Company's consolidated financial statements and accompanying notes included under Item 8, Consolidated Financial Statements and Supplementary Data. Item 7. Management's Discussion and Analysis of Financial Condition and ------- --------------------------------------------------------------- Results of Operations --------------------- "Management's Discussion and Analysis" on pages 21 through 24 of the Annual Report is incorporated herein by this reference. Item 8. Consolidated Financial Statements and Supplementary Data ------- -------------------------------------------------------- Pages 7 through 19 of the Annual Report, which include the consolidated financial statements, and the Report of Independent Public Accountants as listed in Item 14 (a) (1), are incorporated herein by this reference. Item 9. Changes in and Disagreements with Accountants on Accounting and ------- --------------------------------------------------------------- Financial Disclosure -------------------- Not applicable. - 8 - PART III Compliance with Section 16(a) of the Exchange Act Information appearing under the caption "Compliance With Section 16(a) of the Exchange Act" in the Company's 1999 Proxy Statement is incorporated herein by this reference. Item 10. Directors and Executive Officers of the Registrant. -------- --------------------------------------------------- Information appearing under the caption "Election of Directors" in the Company's 1999 Proxy Statement is incorporated herein by this reference. Item 11. Executive Compensation -------- ---------------------- Information appearing under the caption "Executive Compensation" in the Company's 1999 Proxy Statement is incorporated herein by this reference. Information appearing under the captions "Compensation Committee Report" and "Performance Graph" in the Company's 1999 Proxy Statement is not incorporated herein by this reference. Item 12. Security Ownership of Certain Beneficial Owners and Management -------- -------------------------------------------------------------- Information appearing under the caption "Ownership of the Company's Securities" in the Company's 1999 Proxy Statement is incorporated herein by this reference. Item 13. Certain Relationships and Related Transactions -------- ---------------------------------------------- Note 1 to the consolidated financial statements, included on pages 10 and 11 of the Annual Report, and the caption "Independent Public Accountants" in the Company's 1999 Proxy Statement contain information about certain relationships and are incorporated herein by this reference. - 9 - PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K -------- --------------------------------------------------------------- (a) Financial Statements, Schedules and Exhibits: (1) Index to Financial Statements and Supplementary Data. The financial statements listed below are set forth in the Annual Report for the fiscal year ended January 2, 1999 and are incorporated herein by this reference. Annual Report Page No. Consolidated Balance Sheets at January 2, 1999 and January 3, 1998. 7 Consolidated Statements of Income and Consolidated Statements of Stockholders' Investment for the three years ended January 2, 1999, January 3, 1998 and December 28, 1996. 8 Consolidated Statements of Cash Flows for the three years ended January 2, 1999, January 3, 1998 and December 28, 1996. 9 Notes to the Consolidated Financial Statements 10-19 Report of Independent Public Accountants 19 (2) The exhibits filed as part of this report are listed in the Exhibit Index which follows the Supplemental Schedules referred to above. Management contracts and compensatory plans and arrangements listed in the Exhibit Index are denoted with an asterisk (*). (b) 8-K Reports: None - 10 - SIGNATURES Pursuant to the requirements of Section 13 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. FARR COMPANY Dated: March 23, 1999 By: /s/ H. Jack Meany ---------------------- ------------------------------------ H. Jack Meany Chairman of the Board of Directors Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Dated: March 23, 1999 By: /s/ H. Jack Meany ---------------------- ------------------------------------- H. Jack Meany Chairman of the Board of Directors Dated: March 23, 1999 By: /s/ Robert G. Batinovich ---------------------- ------------------------------------- Robert G. Batinovich Director Dated: March 23, 1999 By: /s/ Richard P. Bermingham ---------------------- ------------------------------------- Richard P. Bermingham Director Dated: March 23, 1999 By: /s/ Denis R. Brown, Jr. ---------------------- ------------------------------------- Denis R. Brown, Jr. Director Dated: March 23, 1999 By: /s/ A. Frederick Gerstell ---------------------- ------------------------------------- A. Frederick Gerstell Director Dated: March 23, 1999 By: /s/ John C. Johnston ---------------------- ------------------------------------- John C. Johnston Director, President and Chief Executive Officer Dated: March 23, 1999 By: /s/ John J. Kimes ---------------------- ------------------------------------- John J. Kimes Director Dated: March 23, 1999 By: /s/ John A. Sullivan ---------------------- ------------------------------------- John A. Sullivan Director Dated: March 23, 1999 By: /s/ Steve Pegg ---------------------- ------------------------------------- Steve Pegg Sr. Vice President, Secretary, Treasurer and Chief Financial Officer FARR COMPANY AND SUBSIDIARIES List of Exhibits Item Description 3.1 Certificate of Incorporation of Registrant as currently in effect. Filed as Exhibit 3.1 on Form 10-K dated December 30, 1995 and incorporated herein by this reference. 3. Amended By-Laws of Registrant as currently in effect. Filed as Exhibit 3.2 on Form 10-K dated December 30, 1995 and incorporated herein by this reference. 4.31 Rights Agreement, dated as of April 3, 1989, between Farr Company and Chase Mellon Shareholder Services (formerly Bank of America NT & SA). Filed as Exhibit 1 on Form 8K dated April 18, 1989 and incorporated herein by this reference. 4.64 Credit Agreement dated February 15, 1996 between Farr Company, as borrower, and Bank of America National Trust and Savings Association, as lender. Filed as Exhibit 4.64 to Annual Report on Form 10-K for the year ended December 30, 1995 and incorporated herein by this reference. 4.65 Amendment, dated September 24, 1996 between Farr Company, as borrower, and Bank of America National Trust and Savings Association, as lender. Registrant agrees that it will furnish to the Commission upon request copies of any other instruments with respect to the long-term debt of Registrant and its subsidiaries; under none of such other instruments does the total amount of securities authorized exceed 10 percent of the total assets of Registrant and its subsidiaries on a consolidated basis. *10.1 Non-Qualified Deferred Compensation Plan, dated July 31, 1987. Filed as Exhibit 10.1 to Annual Report on Form 10-K for the year ended January 2, 1988 and incorporated herein by this reference. *10.3 Deferred Compensation Plan for Directors dated November 5, 1980. Filed as Exhibit 10.5 to Annual Report on Form 10-K for the year ended January 3, 1981 and incorporated herein by this reference. *10.4 Farr Company Management Incentive Bonus Plan. Filed as Exhibit 10.6 to Annual Report on Form 10-K for the year ended January 3, 1981 and incorporated herein by this reference. *10.5 Deferred Compensation Plan for Officers dated April 30, 1981. Filed as Exhibit 10.7 to Annual Report on Form 10-K for the year ended January 2, 1982 and incorporated herein by this reference. *10.6 Amendments to Stock Option Plan for Key Employees. Filed as Exhibit 10.8 to Annual Report on Form 10-K for the year ended January 2, 1982 and incorporated herein by this reference. *10.7 1983 Stock Option Plan for Key Employees as amended. Filed as Exhibit A to registrant's definitive proxy statement for the annual meeting of stockholders held on May 4, 1988 and incorporated herein by this reference. *10.12 Farr Company Supplemental Executive Benefits Plan dated July 24, 1990. Filed as Exhibit 10.12 on Form 10-K for the year ended December 29, 1990 and incorporated herein by this reference. *10.14 Non-Employee Directors Stock Option Plan. Filed as Exhibit 10.14 on Form 10-K for the year ended December 29, 1990 and incorporated herein by this reference. *10.21 The 1993 Stock Option Plan for Key Employees of Farr Company. Filed as Exhibit 10.21 on Form 10-K for the year ended December 31, 1994 and incorporated herein by this reference. *10.22 First Amendment to the 1993 Stock Option Plan by key employees of Farr Company dated September 20, 1994. Filed as Exhibit 10.22 on Form 10-Q for the quarter ended October 1, 1994 and incorporated herein by this reference. *10.23 Amendment to the Company's 1991 Stock Option Plan for Non-Employee Directors dated September 20, 1994, filed as Exhibit 10.23 on Form 10-Q for the quarter ended October 1, 1994 and incorporated herein by this reference. *10.33 Second Amendment to the 1991 Stock Option Plan for Non-Employee Directors dated September 12, 1995. Filed as Exhibit 10.33 on Form 10-K dated December 30, 1995 and incorporated herein by this reference. *10.34 Employee contract agreement between John Johnston and Farr Company dated Novembers 28, 1994. Filed as Exhibit 10.34 on Form 10-K dated December 30, 1995 and incorporated herein by this reference. *10.35 The Farr Company 401(k)/Retirement Plan dated December 15, 1995. Filed as Exhibit 10.35 on Form 10-K dated December 30, 1995 and incorporated herein by this reference. *10.36 The Farr Company Supplemental Executive Savings Plan Adoption Agreement, dated November 21, 1995. Filed as Exhibit 10.36 on Form 10-K dated December 30, 1995 and incorporated herein by this reference. *10.37 The Corporate Plan for Retirement Select Plan, Fidelity Basic Plan Document dated April 11, 1994 (SESP). Filed as Exhibit 10.37 on Form 10-K dated December 30, 1995 and incorporated herein by this reference. 10.38 Trust Agreement for Farr Company 401K/Retirement Plan, dated December 15, 1995. Filed as Exhibit 10.38 on Form 10-K dated December 30, 1995 and incorporated herein by this reference. 10.39 Trust Agreement for Farr Company Supplemental Executive Savings Plan between Farr Company as sponsor and Fidelity Management Trust Company as trustee dated November 21, 1995. Filed as Exhibit 10.39 on Form 10-K dated December 30, 1995 and incorporated herein by this reference. *10.40 Approved salary arrangement for Farr Company's Chairman and Chief Executive Officer compensation. Filed as Exhibit 10.40 on Form 10-Q dated June 29, 1996 and incorporated herein by this reference. 10.41 Joint Venture Agrement between Farr Company and Quest Technology SDN.BHD dated as of April 15, 1997. Filed as Exhibit 10.41 on Form 10-K dated January 3, 1998 and incorporated herein by this reference. 10.42 Metalcraft Stock Purchase Agreement datd October 28, 1997. Filed as Exhibit 10.42 on Form 10-K dated January 3, 1998 and incorporated herein by this reference. 13 Annual Report to Stockholders. With the exception of the information incorporated by reference into Items 1, 2, 5, 6, 7 and 8 of this Form 10-K, the 1998 Annual Report to Stockholders is not deemed to be filed as a part of this report. 21 A list of all subsidiaries of registrant. 23 Consent of Independent Public Accountants. 27 Financial Data Schedule * Management contract or compensatory arrangements. Copies of Exhibits are available, on prepayment of 15 cents per page, by writing to the Secretary of the Company at the address set forth on the cover page of this Annual Report and Form 10-K. EX-21 2 LIST OF SUBSIDIARIES Exhibit 21 List of Subsidiaries FARR COMPANY AND SUBSIDIARIES Jurisdiction Name of Subsidiary of Incorporation --------------------------- --------------------- Farr Filtration Limited England Farr Company International California Farr Inc. Canada Farr International U.S. Virgin Islands Farr Cayman Islands Cayman Islands EX-23 3 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS Exhibit 23 Consent of Independent Public Accountants As independent public accountants, we hereby consent to the incorporation of our report incorporated by reference in this Form 10-K, into Farr Company's previously filed Registration Statements on File Numbers 2-83890, 33-18897, 33-47836, 33-71400 and 33-64387. /s/ Arthur Andersen LLP Los Angeles, California March 30, 1999 EX-27 4 ART. 5 FDS 1998 10-K
5 12-MOS JAN-02-1999 JAN-03-1998 JAN-02-1999 6,083,000 0 19,433,000 370,000 10,816,000 39,090,000 57,054,000 39,027,000 59,901,000 14,565,000 0 0 0 813,000 41,241,000 59,901,000 122,285,000 122,285,000 91,160,000 91,160,000 20,029,000 0 103,000 10,993,000 3,788,000 7,205,000 0 0 0 7,205,000 .87 .86
EX-13 5 1998 ANNUAL REPORT FOR FARR COMPANY FARR The cover shows color clipart images that represent markets that Farr Company serves. The images are arranged around a circle and "The Markets We Serve" is in the center of the circle. The "F" symbol and "FARR" logo are at the top of the cover and "1998 Annual Report" is at the bottom. 1998 ANNUAL REPORT MISSION STATEMENT To be a highly successful company providing filtration products and services of premium value that protect people, equipment and their environment from contaminants. To produce acceptable rewards to those having a stake in the success of the enterprise. ===== TOTAL MARKET CAPITALIZATION SHORT-TERM & LONG TERM DEBT (bar graph showing 1995, 1996, (bar graph showing 1995, 1996, 1997 and 1998 quarterly 1997 and 1998 end of quarter market capitalization, debt, in millions) in millions) NET INCOME TREND SALES TREND (bar graph showing 1995, 1996, (bar graph showing 1995, 1996, 1997 and 1998 quarterly 1997 and 1998 end of quarter quarterly net income, quarterly sales, in millions) in thousands)
Short-Term Measurement Market & Long- Period Capitalization Term Debt Income Trend Sales Trend (quarter) (millions) (millions) (thousands) (millions) - --------- ---------- ---------- ------------ ---------- 1995 - Q1 $ 24.7 $17.7 $ 633 $27.3 - Q2 $ 27.0 $18.1 $ 675 $28.7 - Q3 $ 31.4 $16.7 $ 726 $28.4 - Q4 $ 29.5 $10.5 $1,090 $28.9 1996 - Q1 $ 35.2 $ 8.8 $1,178 $30.1 - Q2 $ 49.2 $ 6.6 $1,499 $31.4 - Q3 $ 53.8 $ 5.2 $1,595 $30.0 - Q4 $ 61.7 $ 3.0 $1,618 $29.6 1997 - Q1 $ 68.4 $ 1.7 $1,700 $30.3 - Q2 $ 89.0 $ .6 $1,826 $31.6 - Q3 $105.0 $ .4 $1,892 $31.9 - Q4 $ 82.7 $ .1 $1,957 $32.2 1998 - Q1 $105.6 $ .2 $1,918 $32.0 - Q2 $100.7 $ - $1,876 $30.4 - Q3 $ 70.0 $ - $1,784 $31.0 - Q4 $ 82.3 $ .1 $1,627 $28.9
- 2 -
FINANCIAL HIGHLIGHTS (In thousands, except per share items) 1998 1997 1996 - ---------------------------------------------------------------------------- Net sales ................................ $122,285 $125,762 $122,021 Income before income taxes ............... 10,993 11,240 9,680 Income tax provision ..................... 3,788 3,865 3,790 Net Income ............................... 7,205 7,375 5,890 Diluted earnings per common share ........ .86 .88 .71 Current assets ........................... 39,090 41,007 37,679 Current liabilities ...................... 14,565 19,270 17,873 Working capital .......................... 24,525 21,737 19,806 Long-term debt, net of current portion ... -- -- 2,068 Property, plant, and equipment, net ...... 18,027 17,619 15,611 Stockholders' Investment ................. 42,054 38,507 31,210 - ----------------------------------------------------------------------------
ABOUT THE COMPANY Farr Company's basic business is the control of particulate and vapor contaminants in air and liquids. The Company is engaged in the design, development, manufacture, sale and service of filters and filtration systems. These products are used for a wide variety of applications including heating, ventilation and air conditioning systems, manufacturing and process cleanrooms, special filters for original equipment manufacturers, natural gas, gasoline and diesel-powered engines, railroad locomotives, dust collection systems and gas turbines. Air filter efficiencies range from 20 percent (on outdoor air) in disposable products to 99.9999+ percent (@ .12 microns particulate) in cleanroom products. Products are available as standard items or may be custom engineered. They range in size and complexity from a small throwaway air filter to a large gas turbine system with a single filter component module weighing in excess of twenty tons. Products are sold in many locations of the world. Sales are made through direct Company salesmen, manufacturer's representatives, distributors and foreign licensees. - 3 - 1998 LETTER TO SHAREHOLDERS The year of 1998 was one of high activity in terms of planning and implementation of numerous projects and organizational structuring. We strongly believe these actions are paving the way for significant growth but regret to report that growth has not yet materialized. Both sales and net income for the year were disappointing at $122,285,000 and $7,205,000, equal to 86 cents per share, down from the prior year's $125,762,000 and $7,375,000, equal to 88 cents per share. Our continued restructuring and cost reduction programs have resulted in lower selling, general and administrative expenses, which partially offset the adverse effects of lower sales volume and gross margins. Lower sales and net income were partially attributable to an uneven accounting period which resulted in a 53-week fiscal year in 1997 versus the more traditional 52-week fiscal year in 1998, and declining foreign currency exchange rates. Adjusting for those two variables, sales were flat year-over-year, and net income increased 2 percent. The Asian financial crisis which was triggered in the last half of 1997 remained severe throughout 1998. This affected exports from our U.S. plants and caused our new, fully operational joint venture plant in Malaysia to significantly underachieve planned production. We are meeting these challenges in Asia with specific programs which are being implemented aggressively. Phil Whitaker has joined Farr as Vice President, International Sales and Marketing. He has specific education and experience in the Asian market and in our industry. His first objective is to revitalize and strengthen distribution in foreign markets to increase exports and to expand the output of the Malaysian facility. During 1998, our foreign subsidiary operations in Canada and England continued to perform exceptionally well. Both Canada and England increased net income in excess of 35 percent over the prior year. This was the third consecutive year of record profits in the Canadian subsidiary. Additionally, England improved its cash flow from operating activities by over 50 percent above the prior year through management programs for reducing working capital. We believe the introduction of a new line of utility filters which meets price competition and performance characteristics for specific market needs will continue to enhance performance in the U.K. - 4 - As previously reported, our Air Pollution Control (APC) and Engineered Systems in the U.S. have been organized into a business unit which is committed to a higher level of innovation and product performance in targeted markets than previously attained at any time by Farr. A major element of this is the new Farr Air Cleaning Test System (FACTS), a customer test and evaluation laboratory introduced in the second quarter of 1998. This enables application engineers to precisely evaluate customer air handling and filter applications using the actual contaminants from customer operations. The results are highly reliable equipment designs and selections to suit specific customer requirements. Interest in this innovation has attracted a number of qualified agents to represent Farr in areas of weak geographic representation and has also resulted in securing several major orders. The APC Business Unit is introducing a new product line this year which will provide customers with innovative, cost effective solutions and significantly reduce lead times. This product introduction incorporates filter cartridge technology which we believe to be unique to Farr. We are very enthusiastic about the growth opportunities for this product introduction. During 1998, a program was developed and implemented to form strategic partnerships with our HVAC distributors. It calls for strong commitments of mutual cooperation aimed at growing the distributors' sales. The objective is to ensure that our distributors have a complete line of top grade products to meet individual market needs as well as providing for a two-way exclusivity with Farr. We expect that this will stimulate sales across the entire HVAC line of products. In the fourth quarter, construction of our new U.S. Transportation and Engine products business unit facility was completed in Memphis, Tennessee. This encompasses product development, engineering, marketing, sales and customer service. This location fits the geography of most of our customers as well as the plants in Arkansas and Mississippi which produce most of the U.S. engine and railroad products. We are confident that positive effects of this organization and location will enhance our ability to continue double-digit growth in these markets. In sharp contrast to the strong double-digit growth we experienced in previous years from Custom OEM sales, severe competitive pricing resulted in a significant reduction in this business during 1998. Other products and markets will have to make up at least some of these losses until new opportunities can be identified and established. - 5 - While lack of growth in sales and net income was disappointing during 1998, operating performance remained solid. Return on average stockholder investment for 1998 was 18 percent and return on average assets was 12 percent. Our already strong balance sheet and financial condition continued to improve. At year-end we had over $6,000,000 in cash and no long-term debt. As we enter 1999, a strong financial condition and cash flow from operations continue to provide the Company a platform with which we can readily pursue new business opportunities and continue the stock repurchase authorization that was started in 1998. During 1998, we repurchased 360,550 shares or roughly 4 percent of the outstanding stock through the 500,000 share repurchase program that was increased to 1,000,000 shares in early 1999. This repurchase program adds long-term shareholder value by increasing earnings per share. As of the fourth quarter of 1998, the Company's domestic and foreign internal computer systems had been updated to be Year 2000 (Y2K) compliant. In addition, major customers and suppliers have advised the Company that their systems are scheduled to be Year 2000 ready by the end of 1999. The Farr organization is very strong, experienced and highly motivated. We believe that plans for growth are well founded and are being expertly implemented. Farr's suppliers, employees and distributors are highly supportive of our plans for which we express appreciation. The mission statement on page two calls for rewards to all stakeholders in the enterprise. We are dedicated to this goal on their behalf. /s/ H. Jack Meany /s/ John c. Johnston ----------------------- ------------------------- H. Jack Meany John C. Johnston Chairman of the Board President and Chief Executive Officer NOTE: The Board of Directors took a major step in Farr's succession plans at its February 16, 1999 regular meeting. John Johnston, President, was elected Chief Executive Officer, replacing Jack Meany, who remains Chairman of the Board, Chairman of the Executive Committee and an officer of the Company. - 6 -
CONSOLIDATED BALANCE SHEETS Farr Company and Subsidiaries December 31, 1998 1997 - ---------------------------------------------------------------------------------------- Assets Current Assets: Cash and cash equivalents ............................. $ 6,083,000 $ 5,109,000 Short term investments ................................ -- 2,031,000 Accounts receivable, less allowances of $370,000 in 1998 and $254,000 in 1997 ........................ 19,433,000 20,267,000 Inventories Raw materials ....................................... 4,629,000 4,812,000 Work in progress .................................... 3,413,000 3,307,000 Finished goods ...................................... 2,774,000 2,690,000 ----------------------------- 10,816,000 10,809,000 Prepaid expenses ...................................... 688,000 904,000 Income taxes receivable ............................... 849,000 666,000 Deferred income tax benefit ........................... 1,221,000 1,221,000 ----------------------------- Total current assets ................................ 39,090,000 41,007,000 ----------------------------- Property, plant and equipment at cost Land .................................................. 2,246,000 2,098,000 Buildings and improvements ............................ 18,468,000 17,429,000 Machinery and equipment ............................... 36,340,000 35,935,000 ----------------------------- 57,054,000 55,462,000 Less accumulated depreciation and amortization ........ 39,027,000 37,843,000 ----------------------------- 18,027,000 17,619,000 Investments and other ................................... 2,784,000 2,202,000 ----------------------------- $59,901,000 $60,828,000 ============================= Liabilities & Stockholders' Investment Current Liabilities: Notes payable to banks ................................. $ 145,000 $ 93,000 Accounts payable ....................................... 6,061,000 9,701,000 Accrued liabilities .................................... 7,072,000 8,726,000 Income taxes payable and current deferred income taxes . 1,287,000 750,000 ----------------------------- Total current liabilities .............................. 14,565,000 19,270,000 ----------------------------- Deferred income taxes .................................. 1,773,000 2,196,000 Other noncurrent liabilities ........................... 1,509,000 855,000 Commitments and contingencies .......................... -- -- Stockholders' investment Common stock, $.10 par value - Authorized - 10,000,000 shares Outstanding 8,874,468 shares at December 31, 1998 and 8,561,106 shares at December 31, 1997 ..... 813,000 827,000 Additional paid-in capital ............................. 8,480,000 11,785,000 Cumulative translation adjustments ..................... (2,405,000) (1,749,000) Retained earnings ...................................... 35,166,000 27,644,000 ----------------------------- Total stockholders' investment ......................... 42,054,000 38,507,000 ----------------------------- $59,901,000 $60,828,000 =============================
The accompanying notes are an integral part of these consolidated balance sheets. - 7 -
CONSOLIDATED STATEMENTS OF INCOME Farr Company and Subsidiaries For the Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------------------------------------- Net Sales ....................................... $122,285,000 $125,762,000 $122,021,000 Cost of Sales ................................... 91,160,000 92,792,000 91,276,000 -------------------------------------------- Gross Margin .................................... 31,125,000 32,970,000 30,745,000 Selling, general and administrative expenses .. 20,298,000 21,692,000 20,419,000 Interest expense .............................. 103,000 197,000 687,000 Interest income ............................... ( 269,000) ( 159,000) ( 41,000) -------------------------------------------- Total Expenses .................................. 20,132,000 21,730,000 21,065,000 -------------------------------------------- Income Before Income Taxes ...................... 10,993,000 11,240,000 9,680,000 Income Tax Provision .......................... 3,788,000 3,865,000 3,790,000 -------------------------------------------- Net Income ...................................... $ 7,205,000 $ 7,375,000 $ 5,890,000 ============================================ Diluted Earnings per Common Share ............... $ .86 $ .88 $ .71 ============================================ Basic Earnings per Common Share ................. $ .87 $ .90 $ .72 ============================================
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT Cumulative For the Years Ended December 31, 1998, Common Additional Retained Translation Comprehensive 1997 and 1996 Stock Paid-in Capital Earnings Adjustments Income - ---------------------------------------------------------------------------------------------------------------------- Balance-- December 31, 1995 ................... $ 815,000 $11,215,000 $14,379,000 ($1,624,000) Net Income .................................. -- -- 5,890,000 -- $ 5,890,000 Exercise of Stock Options ................... 3,000 96,000 -- -- -- Cumulative Translation Adjustment ........... -- -- -- 418,000 418,000 Treasury Stock Sold - 2,961 shares .......... -- 18,000 -- -- -- ------------- Comprehensive Income - 1996 ................. $ 6,308,000 --------------------------------------------------------------------- Balance-- December 31, 1996 ................... 818,000 11,329,000 20,269,000 ( 1,206,000) Net Income .................................. -- -- 7,375,000 -- $ 7,375,000 Exercise of Stock Options ................... 7,000 250,000 -- -- -- Cumulative Translation Adjustment ........... -- -- -- ( 543,000) ( 543,000) Treasury Stock Sold - 18,750 shares ......... 2,000 206,000 -- -- -- ------------- Comprehensive Income - 1997 ................. $ 6,832,000 --------------------------------------------------------------------- Balance-- December 31, 1997 ................... 827,000 11,785,000 27,644,000 ( 1,749,000) Net Income .................................. -- -- 7,205,000 -- $ 7,205,000 Exercise of Stock Options ................... 25,000 772,000 -- -- -- Stock Options Expired ....................... -- ( 12,000) -- -- -- Cumulative Translation Adjustment ........... -- -- -- ( 656,000) ( 656,000) Treasury Stock Acquired 386,110 shares ...... ( 39,000) ( 4,065,000) -- -- -- Tax Benefit from Exercise of Stock Options .. -- -- 317,000 -- -- ------------- Comprehensive Income - 1998 ................. $ 6,549,000 --------------------------------------------------------------------- Balance-- December 31, 1998 ................... $ 813,000 $ 8,480,000 $35,166,000 ($2,405,000) =======================================================
The accompanying notes are an integral part of these consolidated financial statements. - 8 -
CONSOLIDATED STATEMENTS OF CASH FLOWS Farr Company and Subsidiaries For the Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------------------------------------- Operating Activities: Net Income ......................................... $ 7,205,000 $ 7,375,000 $ 5,890,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ...................... 2,505,000 2,360,000 2,392,000 Provision for loss on accounts receivable .......... 171,000 206,000 109,000 Benefit retirement trust ........................... 669,000 635,000 186,000 Equity in loss of affiliate ........................ 35,000 30,000 -- Changes in deferred income taxes ................... ( 556,000) 402,000 86,000 Exchange loss (gain) ............................... 34,000 ( 131,000) 97,000 Net loss on sale/retirement of property, plant and equipment .................... 21,000 38,000 49,000 Change in assets and liabilities Inventories ...................................... ( 228,000) 1,586,000 3,048,000 Receivables and prepaid expenses ................. 690,000 ( 126,000) ( 600,000) Accounts payable and accrued expenses ............ ( 4,837,000) 2,250,000 ( 960,000) Income taxes payable ............................. 397,000 ( 603,000) 2,000 ----------------------------------------- Net cash provided by operating activities .......... 6,106,000 14,022,000 10,299,000 ----------------------------------------- Investing Activities: Purchases of property, plant and equipment ......... ( 2,985,000) ( 4,508,000) ( 1,465,000) Redemption (purchases) of short term investments ... 2,031,000 ( 2,031,000) -- Proceeds from sale of property, plant and equipment ........................................ -- -- 6,000 Investment in joint venture ........................ -- ( 250,000) -- Prepaid pension costs .............................. -- ( 586,000) -- Note receivable-affiliate .......................... ( 106,000) -- -- Purchase of investments, benefit trust ............. ( 669,000) ( 635,000) ( 186,000) ----------------------------------------- Net cash used in investing activities ............ ( 1,729,000) ( 8,010,000) ( 1,645,000) ----------------------------------------- Financing Activities: Proceeds from revolving line of credit and long-term debt ................................... 50,000 -- 8,603,000 Principal payments on revolving line of credit and long-term debt ............................... -- ( 3,114,000) (16,195,000) Proceeds from sale of stock, stock option plans .... 797,000 257,000 99,000 Treasury stock sold (acquired) ..................... ( 4,104,000) -- 18,000 Other .............................................. 10,000 28,000 7,000 ----------------------------------------- Net cash used in financing activities ............ ( 3,247,000) ( 2,829,000) ( 7,468,000) ----------------------------------------- Effect of Exchange Rate Changes on Cash .............. ( 156,000) ( 71,000) ( 1,000) Increase in cash and cash equivalents ................ 974,000 3,112,000 1,185,000 ----------------------------------------- Cash and Cash Equivalents at Beginning of Year ....... 5,109,000 1,997,000 812,000 ----------------------------------------- Cash and Cash Equivalents at End of Year ............. $ 6,083,000 $ 5,109,000 $ 1,997,000 =========================================
The accompanying notes are an integral part of these consolidated financial statements. - 9 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries 1. Significant Accounting Policies Farr Company and its wholly-owned subsidiaries (the "Company") has prepared its financial statements in accordance with generally accepted accounting principles. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Following are the Company's significant accounting policies: Basis of Presentation -- Farr Company is a multinational company engaged principally in the design, development, manufacture, sale and service of air and to a minor degree, liquid filters. The principal market for the Company's products and services are North American based commercial wholesale distributors, HVAC OEMs and contractors and transportation businesses. The accompanying consolidated financial statements include the accounts of Farr Company and its wholly-owned subsidiaries. A functional currency has been determined for each foreign entity of the Company, and the exchange gain or loss from translating the foreign currency statements to their U.S. dollar equivalents at the rates of exchange in effect at the end of each period is charged or credited to cumulative translation adjustments within stockholders' investment. Differences from converting nonfunctional to functional currencies and transaction gains and losses are included in income. During 1998, 1997 and 1996, $34,000 was charged to income, $131,000 was credited to income and $97,000 was charged to income, respectively. Accounting Period -- The Company's fiscal year ends on the Saturday closest to December 31. The fiscal years ended January 2, 1999, January 3, 1998 and December 28, 1996 comprise 52, 53 and 52 weeks, respectively. In the consolidated financial statements, all fiscal years are shown to begin as of January 1 and end as of December 31 for clarity of presentation. Cash and Cash Equivalents -- Cash includes currency on hand, demand deposits with financial institutions and investments with original maturities of three months or less. Short-Term Investments -- Short-term investments, consisting principally of certificates of deposit and repurchase agreements secured by government obligations, are held to maturity and are carried at cost, which approximates fair value. Inventories -- Inventories include material, labor and factory overhead. Domestic inventories are stated at cost, determined by the last-in, first-out method. All other inventories are stated at the lower of cost, using the first-in, first-out method, or market. Property, Plant and Equipment -- The cost of property, plant and equipment is depreciated over the estimated useful lives of the respective assets, using declining-balance and straight-line methods, based upon the following lives. Building and improvements 10 - 40 years Machinery and equipment 3 - 12 years Maintenance and repairs are charged to expense as incurred and the cost of additions and betterments are capitalized. When assets are retired or otherwise disposed of, the assets and the related accumulated depreciation accounts are relieved, and any resulting gains or losses from sales or retirements, are reflected in income. In 1995, the Financial Accounting Standards Board (FASB) issued Statement No. 121 - "Accounting for the Impairment of Long Lived Assets to Be Disposed Of" (FASB No. 121), effective for 1996. The Company's adoption of FASB No. 121 resulted in no impact on the Company's results of operations or financial position. Investments and Other -- Investments and other include intangible assets that are amortized on a straight-line basis over five years; retirement assets held under a rabbi trust covering supplemental executive savings plan benefits for certain employees; and a 50 percent ownership interest in a Malaysian joint venture which is accounted for under the equity method. Product Engineering and Development -- Engineering and development costs aggregating $2,530,000, $2,129,000 and $2,217,000 in 1998, 1997 and 1996, respectively, for new products or improvements of existing products, were expensed as incurred. Revenue Recognition -- Revenue is recognized at the time the product is shipped to the customer. Income Taxes -- The Company accounts for income taxes in accordance with the Statement of Financial Accounting Standards No. 109, "Accounting for Incomes Taxes," which requires the use of the liability method of accounting for deferred income taxes. The provision for income taxes includes Federal, foreign, state and local income taxes currently payable and those deferred because of temporary differences between the financial statement and tax bases of assets and liabilities. - 10 - During fiscal 1998, the Company adopted Financial Accounting Standard No.130, "Reporting Comprehensive Income", (SFAS No. 130), which established standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Accordingly, the Company has reported its comprehensive income within its Consolidated Statements of Stockholders' Investment to meet this new reporting requirement. For all periods presented, no income tax benefit or expense was associated with any component of other comprehensive income. Certain reclassifications have been made to the prior years' financial statements to conform with current year presentation. 2. Inventories Domestic inventories totaling $6,475,000 and $6,103,000 at December 31, 1998 and December 31, 1997, respectively, are stated at cost determined by the last-in, first-out method. If the first-in, first-out method of inventory valuation had been used, inventories would have been $6,751,000 and $6,613,000 higher than reported at December 31, 1998 and December 31, 1997, respectively. During 1997, domestic inventory quantities were reduced resulting in the deposition of last-in, first-out inventory quantities carried at cost prevailing in a prior year. Charging these lower costs to operations had no material effect on net income in 1997. 3. Restructuring Costs The Company recorded a restructuring charge of $1,500,000 in the fourth quarter of 1992 related to anticipated costs associated with the closures of two manufacturing plants. The two United States plants located in Pryor, Oklahoma and Eatonton, Georgia were closed in 1993 as part of the Company's efforts to consolidate manufacturing operations and increase production efficiency, asset utilization and profitability. The remaining $411,000 balance of this restructuring charge is included as a component of accrued liabilities in the accompanying Consolidated Balance Sheet as of December 31, 1998. If the present weak real estate market in Eatonton, Georgia continues beyond 2000, the Company may need to record an additional provision to cover the estimated costs of sub-leasing and maintaining the facility through the Company's lease commitment period. 4. Common Stock On April 3, 1989, the Company's Board of Directors declared a dividend distribution of one common share purchase right for each share of common stock outstanding on April 18, 1989. An exercisable right will, under certain conditions, entitle its holder to purchase from the Company one-half of one share of common stock at the exercise price, subject to adjustment, at a price of $40 per whole share, subject to adjustment. The exercise price as of December 31, 1998 is $14.222 per whole share of common stock. The rights will become exercisable ten days after any person acquires 20 percent or more of the Company's outstanding common stock, or announces an offer which would result in such person acquiring 30 percent or more of the Company's common stock. The rights will expire on April 3, 1999, and may be redeemed by the Company for $.01 per right at any time until ten business days after a person acquires 20 percent or more of the Company's common stock. Under certain circumstances after a person acquires 20 percent or more of the Company's common stock, or after a merger or other business combination involving the Company, an exercisable right will entitle its holder to purchase shares of common stock (or shares of an acquiring company) having a market value of twice the exercise price of one right. In 1997, the Company issued 18,750 treasury shares to acquire Metalcraft Air Filtration, Inc. In 1996, the Company transferred 2,961 shares to the Employee Stock Ownership Plan. As of December 31, 1998 and December 31,1997 the Company held in treasury 743,944 and 357,834 shares of its common stock at a cost of $5,295,000 and $1,191,000, respectively. Outstanding stock amounts are reflected net of outstanding treasury shares in the Consolidated Statements of Stockholders' Investment. Per share amounts and shares outstanding in the current and prior periods have been restated to reflect the 3-for-2 stock splits paid in the form of stock dividends (see note 5). 5. Dividend and Stock Split On April 29, 1998 and February 18, 1997, the Company's Board of Directors declared dividends that were paid in the form of 3-for-2 stock splits on May 29, 1998 and March 28, 1997, respectively. - 11 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries (continued) 6. Notes Payable and Long-term Debt The Company's foreign subsidiaries utilize overdraft facilities that aggregate to approximately $2,137,000 of which $145,000 was utilized as of December 31, 1998. As of December 31, 1997, total foreign overdraft facilities aggregated approximately $2,280,000 of which $93,000 was utilized. The weighted average interest rate was 8.6% in 1998 and 7.9% in 1997. The Company utilizes a $10,000,000 revolving credit facility for its domestic needs. As of December 31, 1998, the Company had no borrowings outstanding under this facility. This facility will expire on June 1, 1999 when the then outstanding loan balance, if any, will be due. Interest is payable on the loan at a floating rate equal to the Prime rate or the bank's Offshore rate plus 1.75 percent. As of 1998 and 1997 year end, no long term debt was outstanding. At December 31, 1998, no real, personal and intangible property was pledged as security for long-term debt commitments. Under the Company's domestic credit agreement, the Company is required to maintain certain financial covenants. Interest paid on outstanding debt and obligations net of amounts capitalized were $118,000, $210,000 and $788,000 in 1998, 1997, and 1996, respectively. No future principal payments are scheduled as no long-term debt was outstanding as of December 31, 1998. - 12 - 7. Income Taxes The provision for income taxes is summarized as follows:
For the Years Ended December 31, 1998 1997 1996 - --------------------------------------------------------------------------- Current -- Federal ........... $1,655,000 $2,441,000 $2,772,000 State ............. 266,000 231,000 432,000 Foreign ........... 1,311,000 791,000 282,000 -------------------------------------- 3,232,000 3,463,000 3,486,000 -------------------------------------- Deferred-- Federal ........... 484,000 429,000 ( 96,000) State ............. 124,000 16,000 -- Foreign ........... ( 52,000) ( 43,000) 400,000 -------------------------------------- 556,000 402,000 304,000 -------------------------------------- $3,788,000 $3,865,000 $3,790,000 ======================================
The following is a reconciliation of income taxes at the Federal statutory rate with income taxes recorded by the Company:
For the Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------------------------------------- Computed income taxes at statutory rate ................. $3,738,000 $3,618,000 $3,291,000 State income taxes, net of federal income tax benefit ... 258,000 163,000 285,000 Taxes on foreign subsidiaries' net income in excess of (less than) income taxes at statutory rates ........ 24,000 ( 61,000) 40,000 Other items, net ........................................ ( 232,000) 145,000 174,000 -------------------------------------- Provision for income taxes .............................. $3,788,000 $3,865,000 $3,790,000 ======================================
Deferred taxes are recorded based upon differences between the financial statement and tax bases of assets and liabilities and available tax credit carryforwards. Temporary differences and carryforwards which give rise to a significant portion of deferred tax assets and liabilities were as follows:
For the Years Ended December 31, 1998 1997 - -------------------------------------------------------------------- Depreciation and amortization ........ ($ 355,000) ($ 456,000) Employee compensation accruals ....... 1,138,000 567,000 Plant relocation and restructuring ... 140,000 168,000 DISC commission accrual .............. ( 1,386,000) ( 1,584,000) Acquisition reserves ................. ( 610,000) ( 526,000) Inventory ............................ 493,000 437,000 Other items, net ..................... 161,000 409,000 --------------------------- ($ 419,000) ($ 975,000) ===========================
Included in income taxes payable and current deferred income taxes at December 31, 1998 and December 31, 1997, were $369,000 and $ 365,000, respectively, of foreign deferred income taxes. - 13 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries (continued) The consolidated income before income tax, by domestic and foreign sources is as follows:
For the Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------------------- Domestic .......................... $ 7,362,000 $ 8,859,000 $7,792,000 Foreign ........................... 3,631,000 2,381,000 1,888,000 ---------------------------------------- $10,993,000 $11,240,000 $9,680,000 ========================================
Income taxes paid, net, were $3,683,000, $3,806,000 and $3,461,000 in 1998, 1997 and 1996, respectively. 8. Employee Benefit Plans The Company has defined contribution retirement plans covering domestic employees who meet eligibility requirements. Company contributions are based on a formula as specified in the respective plan agreements. Contributions, which aggregated $1,093,000 in 1998, $1,295,000 in 1997 and $851,000 in 1996 were charged to expense in accordance with the approved plan formulas. Under one of the Company's domestic defined contribution plans, covering key employees, Company contributions and employee compensation deferrals are made to a Company trust under provisions of the plan. The deferred compensation, contributions and earnings from the trust are included in the Company's Consolidated Balance Sheets both as a non-current asset and a non-current liability. The total plan non-current assets and non-current liabilities as of December 31, 1998 and 1997 were $1,490,000 and $855,000, respectively. Pension costs for the Company's defined benefit plans, covering eligible employees in foreign operations, are determined by independent actuarial valuations. The Company has two foreign defined benefit plans. The following table sets forth the change in benefit obligation, the change in plan assets, the funded status, the assumptions used in the accounting for the plans on an average weighted basis and the components of net periodic benefit cost for the years ended December 31, 1998 and 1997.
For the Years Ended December 31, 1998 1997 - ------------------------------------------------------------------------------- Change in benefit obligation Benefit obligation at beginning of year .......... $5,726,000 $5,092,000 Foreign currency exchange rate changes ........... ( 44,000) -- Service cost ..................................... 352,000 294,000 Interest cost .................................... 428,000 388,000 Net actuarial loss ............................... 274,000 135,000 Benefits paid .................................... ( 189,000) ( 183,000) ------------------------- Benefit obligation at end of year ................ 6,547,000 5,726,000 ------------------------- Change in plan assets Fair value of plan assets at beginning of year ... 6,813,000 6,015,000 Foreign currency exchange rate changes ........... ( 30,000) -- Actual return on plan assets ..................... 642,000 745,000 Employer contribution ............................ 143,000 163,000 Plan participants' contributions ................. 87,000 74,000 Benefits paid .................................... ( 189,000) ( 183,000) ------------------------- Fair value of plan assets at end of year ......... 7,466,000 6,814,000 ------------------------- Funded status .................................... 919,000 1,088,000 Unrecognized net actuarial gain .................. ( 294,000) ( 516,000) Unrecognized prior service cost .................. 54,000 45,000 ------------------------- Prepaid benefit cost ............................. $ 679,000 $ 617,000 =========================
- 14 -
For the Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------------------- Weighted average assumptions Discount rate ........................... 7.7% 7.7% 7.8% Expected return on plan assets .......... 9.5% 9.4% 9.8% Rate of compensation increase ........... 6.0% 6.0% 5.8% Components of net periodic benefit cost Service cost ............................ $352,000 $294,000 $232,000 Interest cost ........................... 431,000 389,000 337,000 Expected return on plan assets .......... ( 663,000) ( 572,000) ( 508,000) Amortization of prior service cost ...... ( 13,000) ( 12,000) ( 20,000) Recognized net actuarial gain ........... ( 3,000) ( 1,000) ( 10,000) ---------------------------------- Net periodic benefit cost ............... $104,000 $ 98,000 $ 31,000 ==================================
The projected benefit obligation, accumulated benefit obligation, and fair market value of plan assets for the pension plan with an accumulated benefit obligation in excess of plan assets were $1,191,000, $1,006,000 and $1,175,000 respectively, as of December 31, 1998, and $1,180,000, $1,006,000 and $1,175,000 respectively as of December 31, 1997. The Company provides no post-retirement health care and life insurance benefits or other post-employment benefits to its employees. 9. Stock Options Under the 1983 and 1993 stock option plans, the Company may grant non-qualified and incentive stock options to officers and employees. Options are contingent upon continued employment, and become exercisable from at least one year after date of grant at such times and installments as the Compensation Committee of the Board shall provide. All options outstanding at December 31, 1998 had an exercise price equal to 100 percent of the fair market value on the date the option was granted except for 99,000 shares that were granted in 1995. Compensation expense recorded under the plan was $17,000 in 1998 and $27,000 in both 1997 and 1996. Options expire ten years from the date of grant, subject to earlier expiration under the terms of the plan. The 1983 plan covered a total of 703,125 shares of the Company's common stock of which at December 31, 1998, 35,157 shares were subject to presently outstanding options. At December 31, 1998, 787,500 shares of common stock were reserved for distribution under the 1993 plan, of which 281,260 shares were subject to outstanding options. As permitted by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), effective for 1996, the Company continues to account for stock compensation costs in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Had compensation cost for the Company's stock plans been determined in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation", the Company's net income and earnings per share would have been reduced to the following pro forma amounts:
For the Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------------- Net Income As Reported $7,205,000 $7,375,000 $5,890,000 Pro Forma $6,896,000 $7,237,000 $5,814,000 Diluted EPS As Reported $ .86 $ .88 $ .71 Pro Forma $ .82 $ .86 $ .70
Because the SFAS No. 123 method of accounting has not been applied to options granted prior to December 31, 1994, the resulting pro forma compensation cost may not be representative of that to be expected in future years. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1998, 1997 and 1996: risk-free interest rate of 5.67 percent for options granted in 1998, 6.26 percent for options granted in 1997 and 6.28 and 6.76 percent for options granted in 1996; expected dividend yields of 0 percent, expected volatility of 42 percent, expected life of 7 years for 1998 options and expected dividend yields of 0 percent, expected volatility of 45 percent, expected life of 7 years for 1997 and 1996 options. - 15 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries (continued Activity under the 1983 and 1993 plans is summarized as follows:
1998 1997 1996 --------------------------- ---------------------------- ---------------------------- Weighted Weighted Weighted Shares Avg. Option Price Shares Avg. Option Price Shares Avg. Option Price ------- ----------------- ------- ----------------- ------- ----------------- Options outstanding beginning of year ............... 498,280 $ 3.79 500,875 $ 3.09 543,817 $ 3.13 Granted ........................... 68,000 12.16 70,500 8.68 5,625 4.11 Exercised ......................... 223,890 3.16 68,200 3.78 26,100 3.51 Cancelled and expired ............. 25,973 3.14 4,895 3.18 22,467 3.67 ------- ------- ------- ------- ------- ------- Options outstanding end of year ..................... 316,417 $ 6.09 498,280 $ 3.79 500,875 $ 3.09 ======= ======= ======= ======= ======= ======= End of year shares exercisable .... 92,038 $ 4.57 244,678 $ 3.41 250,846 $ 3.69 ======= ======= ======= ======= ======= =======
The following table summarizes information about fixed stock options outstanding as of December 31, 1998:
Options Outstanding Options Exercisable ----------------------------------------------------------------- ---------------------------- Weighted-Avg. Range of Number Remaining Weighted-Avg. Number Weighted-Avg. Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price --------------- ----------- ---------------- -------------- ----------- -------------- $ 3.91 - $ 4.00 17,999 .8 Years $ 3.99 17,999 $ 3.99 4.78 - 5.00 17,325 2.6 4.86 17,325 4.86 2.83 - 2.83 23,625 5.2 2.83 23,625 2.83 2.22 - 4.11 123,469 6.1 2.44 16,589 3.25 8.00 - 12.75 134,000 8.9 10.47 16,500 8.73 --------------- ------- --- ------ ------ ------ $ 2.22 - $12.75 316,417 6.7 $ 6.09 92,038 $ 4.57 =============== ======= === ====== ====== ======
On January 22, 1991, the Company's Board of Directors adopted and approved the 1991 Stock Option Plan for Non-Employee Directors. Under the 1991 Stock Option Plan, the Company is authorized to issue up to 225,000 shares of common stock to the Company's non-employee directors of which 121,500 shares are subject to presently outstanding options. Activity for fiscal years 1998, 1997 and 1996 under the 1991 Plan are summarized as follows:
1998 1997 1996 --------------------------- ---------------------------- ---------------------------- Weighted Weighted Weighted Shares Avg. Option Price Shares Avg. Option Price Shares Avg. Option Price ------- ----------------- ------- ----------------- ------- ----------------- Options outstanding beginning of year ............... 112,500 $ 4.51 85,500 $ 3.51 63,000 $ 3.17 Granted ........................... 31,500 11.29 27,000 7.67 22,500 4.42 Exercised ......................... 18,000 4.31 -- -- -- -- Cancelled and expired ............. 4,500 12.75 -- -- -- -- ------- ------- ------- ------- ------ ------- Options outstanding end of year ..................... 121,500 $ 6.05 112,500 $ 4.51 85,500 $ 3.51 ======= ======= ======= ======= ====== ======= End of year shares exercisable .... 94,500 $ 4.54 85,500 $ 3.51 63,000 $ 3.17 ======= ======= ======= ======= ====== =======
- 16 - The following table summarizes information about non-employee director fixed stock options outstanding as of December 31, 1998:
Options Outstanding Options Exercisable ----------------------------------------------------------------- ---------------------------- Weighted-Avg. Range of Number Remaining Weighted-Avg. Number Weighted-Avg. Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price --------------- ----------- ---------------- -------------- ----------- -------------- $4.06 - $ 4.11 18,000 2.8 Years $ 4.08 18,000 $ 4.08 2.22 - 2.83 22,500 4.9 2.50 22,500 2.50 3.06 - 5.72 31,500 6.9 4.03 31,500 4.03 7.67 - 13.00 49,500 8.7 9.67 22,500 9.67 -------------- ------- --- ------ ------ ------ $2.22 - $13.00 121,500 6.7 $ 6.05 94,500 $ 4.54 ============== ======= === ====== ====== ======
10. Per Share Amounts In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 (SFAS 128), "Earnings per Share" (EPS), which requires dual presentation of basic EPS and diluted EPS, simplifies existing computational guidelines, and increases the comparability of earnings per share on an international basis. SFAS 128 was effective for periods ending after December 15, 1997. All prior periods have been restated. Income, average weighted shares outstanding and earnings per share data as restated for SFAS No. 128 are as follows:
For the Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------------- Per Share Per Share Per Share Income Shares Amount Income Shares Amount Income Shares Amount ------ ------ ------ ------ ------ ------ ------ ------ ------ BASIC EARNINGS - -------------- Income available to common stockholders ....... $7,205,000 8,273,609 $ .87 $7,375,000 8,223,810 $ .90 $5,890,000 8,167,683 $ .72 ===== ===== ===== DILUTED EARNINGS PER SHARE - -------------------------- Assumed dilution for outstanding options ....... -- 108,146 -- 159,414 -- 97,228 ---------- --------- ---------- --------- ---------- -------- Income available to common stockholders plus assumed conversions .. $7,205,000 8,381,755 $ .86 $7,375,000 8,383,224 $ .88 $5,890,000 8,264,911 $ .71 ========== ========= ===== ========== ========= ===== ========== ========= =====
As a result of the 3-for-2 stock splits that were distributed on May 29, 1998 and March 28, 1997, per share amounts for the 1997 and prior years have been restated to reflect the weighted average number of shares of common stock outstanding increased by shares issued for the stock split. - 17 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Farr Company and Subsidiaries (continued) 11. Commitments and Contingencies The Company leases certain facilities and equipment under agreements, the majority of which expire at various dates through 2004. The majority of the Company's leases provide for the payment of real estate taxes and insurance. Net rental expense was $1,337,000 for the year ended December 31, 1998, $1,227,000 for the year ended December 31, 1997 and $1,145,000 for the year ended December 31, 1996. As of December 31, 1998, approximate minimum rental commitments under noncancelable leases which have not been capitalized were as follows: Year Ending Amount ----------- ----------- 1999 $ 1,037,000 2000 847,000 2001 619,000 2002 459,000 2003 285,000 Thereafter 144,000 ----------- Total $ 3,391,000 =========== The Company is involved in several claims and suits that arise out of the ordinary course of business, and has tax returns under review. Management believes that these matters are either adequately reserved, covered by insurance, or would not have a material adverse effect on the financial position or operations of the Company if disposed of unfavorably. 12. Segment Information The adoption of Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" does not alter the Company's business segment reporting disclosure requirements. While the Company manufactures a variety of filtration products, discrete financial information by product or market is not available. Therefore, operating decisions and operating performance assessments are not made based on aggregating within any particular filtration product or market. The Company is engaged in one line of business - filtration. The Company's basic business is manufacturing filters for the control of particulate and vapor contaminants in air and liquids. Information about the Company's operations in different geographic areas for the current year ended December 31, 1998 and the prior years ended December 31, 1997 and December 31, 1996 are presented based upon shipments from the scheduled countries as follows:
(In thousands) Net Sales to Unaffiliated Customers Long-Lived Assets - ----------------------------------------------------------------------------------------------------------------- For the Years Ended December 31, 1998 1997 1996 1998 1997 1996 -------------------------------- -------------------------------- United States $ 96,426 $101,352 $ 100,008 $ 16,973 $ 16,348 $ 13,350 Canada 14,723 13,162 11,632 1,764 1,961 1,528 Europe 11,136 11,248 10,381 2,046 2,095 1,713 -------------------------------- -------------------------------- Total Segments 122,285 125,762 122,021 20,783 20,404 16,591 Adjustments & Eliminations -- -- -- 28 ( 583) ( 583) -------------------------------- -------------------------------- Consolidated Totals $122,285 $125,762 $122,021 $ 20,811 $ 19,821 $ 16,008 ================================ ================================
Long-Lived assets are those of the Company that are identified with the operations in each geographic area. - 18 - 13. Business Combinations and Investments in Partnership In November 1997, the Company completed its acquisition of Metalcraft Air Filtration, Inc. (MCF), a small, high quality specialty filtration manufacturer of enclosed filter housings and bags used for filtering and then containing hazardous waste dust from certain biological, chemical, nuclear and medical facilities having special air handling and filtration system requirements. MCF is located in Washington, North Carolina. The Company issued 18,750 shares of its common stock in exchange for all the shares of MCF. The transaction was accounted for under the purchase method of accounting and the operating results of this business has been included in the consolidated financial statements since the date of acquisition. The purchase price exceeded the fair value of the tangible net assets acquired by approximately $412,000. In June 1997, the Company entered into a joint venture partnership with Quest Technology Sdn. Bhd., a Malaysian manufacturer and distributor of air filtration products and a licensee of certain Farr products. Under the agreement, the Company has a 50 percent ownership interest in the operations of QF Filter Sdn. Bhd., a manufacturing operation located in Malaysia and only has a limited ability to control partnership's activities. Accordingly, this investment is accounted for using the equity method of accounting. During 1998, the Company's equity in QF Filter Sdn. Bhd.'s loss was $35,000. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Farr Company: We have audited the accompanying consolidated balance sheets of Farr Company (a Delaware corporation) and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of income, stockholders' investment and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Farr Company and subsidiaries as of December 31, 1998 and 1997 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Arthur Andersen LLP Los Angeles, California January 28, 1999 - 19 - SELECTED FINANCIAL DATA Farr Company and Subsidiaries
Years Ended December 31 1998 1997 1996 1995 1994 =========================================================================================================== (In thousands except share and per share data) Net Sales ............................... $ 122,285 $ 125,762 $ 122,021 $ 113,275 $ 106,989 Net Income (Loss) (Note D) .............. 7,205 7,375 5,890 3,124 ( 355) Income (Loss) per diluted share (G) ..... .86 .88 .71 .38 ( .05) Total Assets (Notes A & B) .............. 59,901 60,828 53,687 55,570 59,269 Long-term Debt, net of current portion (Notes A, B, C, E & F) ................ -- -- 2,068 9,412 18,957 Cash Dividends per share ................ -- -- -- -- -- Weighted average number of shares (G) ... 8,381,755 8,383,224 8,264,911 8,330,095 8,275,990 Capital expenditures .................... 2,985 4,508 1,465 1,163 987 Net property, plant and equipment ....... 18,027 17,619 15,611 16,406 17,930 Working Capital (Notes A & B) ........... 24,525 21,737 19,806 20,183 21,782 ===========================================================================================================
Note A. In December 1985, the Company negotiated an agreement for $8,000,000 in Industrial Revenue Bonds to finance the Company's facility in Jonesboro, Arkansas. In December 1993 and February 1994, the Company redeemed a total of $2,615,000 of the bonds with surplus cash held in trust. In January 1996, the Company fully retired these bonds. Note B. In August 1991, the Company negotiated an agreement for $2,500,000 in Industrial Revenue Bonds to finance the Company's facility in Holly Springs, Mississippi. In August 1996, the Company fully retired these bonds. Note C. In February 1996, the Company completed refinancing of its domestic long-term debt with a new lending institution, including a $15,000,000 revolving credit facility that was subsequently amended and reduced to $10,000,000 commensurate with the Company's financing requirements. Note D. In 1995 and 1994, pretax income (loss) included provisions of $540,000 and $1,000,000 respectively for the estimated cost of closing and reorganizing U.S. manufacturing facilities. Note E. In 1994, the Company completed refinancing of its long-term debt with new lending institutions including a $22,000,000 revolving credit facility and $7,500,000 of term loan credit facilities. Note F. In November 1995, the Company sold its plant located in Rialto, California for $3,050,000 which resulted in a gain of $676,000. The entire amount of the net proceeds were received in cash and were primarily used to retire secured debt on the subject property. Note G. As a result of the 3-for-2 stock split declared on April 29, 1998 paid on May 29, 1998 and the 3-for-2 stock split declared on February 18, 1997 paid on March 28, 1997, per share amounts for prior years have been restated to reflect the weighted average number of shares of common stock outstanding, increased by shares to be issued for the stock split. = 20 - MANAGEMENT'S DISCUSSION AND ANALYSIS Farr Company and Subsidiaries RESULTS OF OPERATIONS - --------------------- 1998 COMPARED TO 1997 Sales for 1998 reached $122,285,000, down $3,477,000 or 2.8 percent from 1997 sales of $125,762,000. For the year, foreign subsidiary sales increased 5.9 percent while domestic sales decreased 4.9 percent. For making comparisons between 1998 and 1997 it should be noted 1997's fiscal year contained 53 weeks or one week more than 1998's fiscal year period. In addition, lower 1998 foreign exchange rates as compared to 1997 rates used to convert operating results of the Company's Canadian subsidiary to U.S. dollars reduced comparable 1998 sales by $1,474,000. Excluding the effects of both these items, sales for fiscal 1998 remained virtually unchanged compared to 1997. Net income for 1998 totaled $7,205,000, down $170,000 or 2.3 percent from $7,375,000 in 1997. After adjusting for the longer fiscal year period in 1997 and the unfavorable 1998 Canadian foreign exchange rates, 1998's comparable net income would reflect an improvement over 1997's net income of 2 percent. Gross margin for 1998 expressed as a percentage of sales, decreased to 25.5 percent, down .7 of a percent from 26.2 percent in 1997. The 1998 decrease in margin reflected higher warranty costs, unfavorable sales mix and lower sales while fixed manufacturing cost rose as a percentage of overall sales. The Company anticipates that gross margin percentage will improve during 1999 as a result of lower warranty cost and productivity improvements. Selling, general and administrative expenses expressed as a percentage of sales for 1998 were 16.6 percent, down .6 of a percent compared to 17.2 percent in 1997. 1998 spending totaled $20,298,000, down $1,394,000 compared to $21,692,000 in 1997. The 1998 decrease reflected cost reduction programs and lower selling and marketing expenses commensurate with 1998's lower level of sales volume. Interest expense continued to decline in 1998 and interest income continued to increase as average invested cash continued to increase during 1998. During 1999, the Company anticipates its cash flow from operating activities will continue to be strong and that interest income will continue to increase as average invested cash balances rise. The Company's effective tax rate for 1998 was 34.5 percent compared to 34.4 percent in 1997. The continued low effective tax rate is a result of tax benefits being generated by the Company's Foreign Sales Corporation and lower effective tax rates in Canada where taxable income increased significantly during 1998. During 1999, the Company anticipates that its tax rate will increase to approximately 36 percent as tax benefits decrease from the Company's Foreign Sales Corporation as a result of lower foreign sales, especially to Pacific rim countries. 1997 COMPARED TO 1996 Record 1997 sales of $125,762,000 were up $3,741,000 or 3.1 percent from prior year sales of $122,021,000. Foreign subsidiary sales increased 10.9 percent and domestic sales increased 1.3 percent in 1997. Net income reached record highs during 1997 totaling $7,375,000, up 25 percent or $1,485,000 from $5,890,000 reported in the prior year as sales continued to grow and improve productivity. Increased sales volume, improved operating efficiencies, lower interest expense and lower effective income tax rates were all major contributing factors in improving 1997's net income performance over the prior year. Gross margins for 1997 improved to 26.2 percent, up 1 percent from 25.2 percent in 1996. The improvement in gross margins was the result of continued improvement in operating efficiencies and a better sales mix of products with higher margins compared to the prior year. Selling, general and administrative expenses as a percentage of sales for 1997 and 1996 were 17.2 and 16.7 percent, respectively. 1997 spending totaled 21,692,000, up $1,273,000 compared to $20,419,000 in 1996. 1997's increase reflected higher spending in the area of selling and marketing related expenses directed toward increasing sales in existing and new product markets. - 21 - MANAGEMENT'S DISCUSSION AND ANALYSIS Farr Company and Subsidiaries (continued) Interest expense during 1997 was reduced to $197,000 from $687,000 in the prior year due to long and short-term borrowing reductions. As of the end of the second quarter of 1997 the Company's domestic operations retired all previously outstanding bank debt. In addition, due to the continued strong cash flow provided by operations, the Company generated $159,000 in interest income from investing cash. The effective income tax rate for 1997 was 34.4 percent compared with 39.2 percent in 1996. The decrease in 1997's tax rate was primarily related to lower effective tax rates being generated from the Company's Foreign Sales Corporation. 1996 COMPARED TO 1995 Record 1996 net sales of $122,021,000 were up $8,746,000 or 7.7 percent from prior year sales of $113,275,000. For the year, foreign subsidiary sales increased 9.6 percent and domestic sales increased 7.3 percent. Record net income for 1996 totaled $5,890,000, up significantly from $3,124,000 in the prior year. Increased sales volume, improved operating efficiencies and lower interest expense were the primary reasons for the gain in 1996. Foreign consolidated subsidiaries totaled approximately 20 percent of consolidated net income, down from 21 percent in the prior year. Gross margin for 1996 increased to 25.2 percent, up .7 percent from 24.5 percent in 1995. The increase in gross margins was the result of improved operating efficiencies and a better sales mix of products with higher margins compared to the prior year. Selling, general and administrative expenses as a percentage of sales for 1996 and 1995 were 16.7 and 18.5 percent, respectively. 1996 spending totaled $20,419,000 compared to $20,956,000 in 1995, which reflects a decrease of $537,000, or 3 percent. Most of the decreased expense related to lower loan fee amortization and sales and marketing related expenses. Interest expense declined $1,109,000, or 62 percent in the year primarily due to the significant decrease in long-term debt. - 22 - LIQUIDITY & CAPITAL RESOURCES - ----------------------------- FINANCIAL CONDITION As of December 31, 1998, the Company's capital structure included $145,000 of current debt and $42,054,000 of stockholders' investment. Stockholders' equity increased 9.2 percent during 1998 growing to $42,054,000 from $38,507,000 at the end of 1997. Farr Company's balance sheet continues to exhibit liquidity and financial strength. As of December 31, 1998, total assets were $59,901,000 down $927,000 from prior year end levels primarily as a result of decreases in short-term investments and accounts receivables. During 1998, the Company's domestic operations were financed through a long-term credit facility. The Company's domestic long-term credit facility is an unsecured $10,000,000 revolving line of credit facility. As of December 31, 1998, no borrowings were outstanding and unused borrowing availability was $10,000,000. The Company's foreign subsidiaries borrow under overdraft credit facilities. As of December 31, 1998, overdraft facilities amounted to $2,137,000 of which $145,000 was utilized. As of December 31, 1997, foreign overdraft facilities amounted to $2,280,000 of which $93,000 was utilized. MARKET RISK The Company's market risk is the potential loss arising from adverse changes in interest rates. The Company does not have any fixed long term debt obligations. The Company invests its cash in money market funds and short term investment funds that carry maturities of less than 180 days. Over ninety percent of these investments have their interest rates adjusted weekly or monthly and consequently, the cost of these securities approximates market value. Although the Company periodically evaluates derivative financial instruments, including forwards, swaps and purchased options, to manage foreign currency exchange rate exposures, the Company does not currently hold any derivatives for managing these risks or for trading purposes. EURO INTRODUCTION The Company does not expect the introduction of the EURO resulting from the European Monetary Union to have a significant impact on the competitive position or operations of the Company. YEAR 2000 The Company's internal business systems are Year 2000 (Y2K) compliant as of December 31, 1998. Major customers and suppliers have advised the Company that their systems either are Year 2000 compliant or were anticipated to be compliant by December 31, 1998. The Company does not anticipate material or significant external risks or exposures associated with Year 2000 issues. Unanticipated Year 2000 related problems will be addressed by a Y2K Task Force Team within the Company. The Company's estimate for external cost including consultants and software applications used to make the Company's internal business systems Y2K compliant are not material to the Company's business, operations or financial condition. The Company did not track internal cost incurred for the Y2K project that are principally related to payroll costs for its information systems group. - 23 - MANAGEMENT'S DISCUSSION AND ANALYSIS Farr Company and Subsidiaries (continued) CASH FLOW During 1998, cash flows from operating activities decreased to $6,106,000 compared to $14,022,000 in 1997 and $10,299,000 in 1996. The decrease in 1998 was primarily the result of a decrease in working capital associated with decreased accounts payable and accrued liabilities. Cash flow from operations were used to support $2,985,000 of capital expenditures and treasury stock repurchases totaling $4,104,000. Capital expenditures decreased to $2,985,000 from $4,508,000 in 1997. The decrease in capital spending was related to higher spending in 1997 related to warehouse expansion in Canada and remodeling of the Company's corporate offices. The Company's cash flow generated from operating activities combined with current cash balances are anticipated to generate adequate cash flow to meet planned operating needs, provide for capital spending, complete the stock repurchase program covering 1,000,000 shares and meet current debt service requirements. During 1997, the Company invested $250,000 as a 50 percent partner in a manufacturing joint-venture located in Malaysia. In 1998, it invested another $106,000 in the form of a long-term note to support working capital needs of the joint-venture. The joint-venture is anticipated to help the Company maintain competitive prices and support faster delivery of products in Malaysia and other Pacific Rim markets. During the fourth quarter of 1997, the Company acquired Metalcraft Air Filtration, Inc. (MCF) through a merger. Farr issued 18,750 shares of its common stock for all of MCF's stock. Inflation has not been a significant factor for the Company in a number of years. Cost increases for labor and material have been generally low, and any impact has been offset by productivity improvement and materials management. Safe Harbor for Forward-Looking Statements: Except for historical information contained herein, the statements in this annual report are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Act of 1995. Forward-looking statements and the business prospects of Farr Company are subject to a number of risks and uncertainties which may cause the Company's actual results in the future periods to differ materially from the forward-looking statements. These risks and uncertainties include, among other things, product supply and demand, competition, government regulation or action, litigation, operations performance, Y2K exposures, the Company's ability to implement its business plans, access to capital, and environmental risks. These are described in the Company's reports on Forms 10-K and 10-Q and other filings with the Securities and Exchange Commission. - 24 - SUMMARIZED QUARTERLY FINANCIAL DATA Farr Company and Subsidiaries (Unaudited)
(In thousands except per share data)* 1998 1997 1996 -------------------------------------- -------------------------------------- ------------------------------------- Net Gross Net Per Net Gross Net Per Net Gross Net Per Quarter Sales Margin Income Share Sales Margin Income Share Sales Margin Income Share ============================================================================================================================== First $ 31,989 $ 8,206 $ 1,918 $ .23 $ 30,341 $ 7,891 $ 1,700 $ .20 $ 31,079 $ 7,154 $ 1,178 $ .14 Second 30,434 7,900 1,876 .22 31,569 8,576 1,826 .22 31,356 8,072 1,499 .18 Third 31,011 7,897 1,784 .21 31,612 8,269 1,892 .23 29,951 7,533 1,595 .20 Fourth 28,851 7,122 1,627 .20 32,240 8,234 1,957 .23 29,635 7,986 1,618 .19 ------------------------------------------------------------------------------------------------------------------- Year $122,285 $ 31,125 $ 7,205 $ .86 $125,762 $ 32,970 $ 7,375 $ .88 $122,021 $ 30,745 $ 5,890 $ .71 ==============================================================================================================================
* Per share data has been restated for the 3-for-2 stock split declared in May 1998 and is presented on a diluted basis. SUMMARY OF STOCK QUOTATIONS
1998 1997 1996 -------------------- ------------------- -------------------- Quarter High Low High Low High Low ============================================================================================= First $13.00 $ 9.00 $ 8.67 $ 7.28 $ 4.46 $ 3.33 Second 14.33 10.50 11.00 8.00 6.63 4.00 Third 13.00 9.00 12.67 10.33 6.67 5.21 Fourth 10.44 8.25 12.00 9.67 8.33 6.50 ---------------------------------------------------------------------------- Year $14.33 $ 8.25 $12.67 $ 7.28 $ 8.33 $ 3.33 =============================================================================================
The above information was obtained from the National Association of Securities Dealers, Inc. (NASD) Monthly Statistical Report. The Company's stock is traded in the over-the-counter National Market System under the symbol FARC. Price per share has been restated for the 3 for 2 stock split declared in May 1998. No cash dividends were declared on the Company's common stock in 1998, 1997 or 1996. - 25 - CORPORATE INFORMATION Farr Company and Subsidiaries DIRECTORS - --------- FARR COMPANY Robert Batinovich Chairman and Chief Executive Officer Glenborough Realty Trust Incorporated NYSE, GLB Management of Commercial Real Estate (2) Richard P. Bermingham Chairman Bermingham Investment Company (1) (3) Denis R. Brown, Jr. President and Chief Executive Officer Pinkerton, Inc. Security & Investigation Services (2) A. Frederick Gerstell Vice Chairman, Director and Consultant Vulcan Materials Company (2) John C. Johnston President and Chief Executive Officer Farr Company John J. Kimes Chief Executive Officer and President Computerized Security Systems, Inc. Manufacturer of Electronic and Mechanical Lock Hardware and Systems (1) (3) H. Jack Meany Chairman of the Board of Directors Farr Company (3) John A. Sullivan Investment Advisor Relational Investors, LLL (1) (1) Audit Committee (2) Compensation Committee (3) Executive Committee OFFICERS - -------- FARR COMPANY H. Jack Meany Chairman of the Board of Directors John C. Johnston President and Chief Executive Officer Steve Pegg Senior Vice President, Chief Financial Officer, Treasurer and Secretary Richard Larson Senior Vice President, Sales and Marketing Myron G. Rasmussen Vice President, Corporate Technical Services John Vissers Vice President, Controller, Assistant Treasurer and Assistant Secretary Phil Whitaker Vice President, International Sales and Marketing FARR FILTRATION, LTD. (UNITED KINGDOM) Clive J. Jones Managing Director FARR, INC. (CANADA) Dominique Mignacco Vice President and General Manager - 26 - Corporate Offices Manufacturing Distributors 2201 Park Place Genmech Engineering, Singapore El Segundo, California 90245 310-727-6300 Internet address: http://www.farrco.com Company's Internet home page offers access to a variety of information including Farr's products and services, worldwide operations, financial data, and stockholder- related information. Subsidiaries and Joint Ventures Registrar and Transfer Agent Farr, Inc., Montreal, Canada Chemical Mellon Shareholder Services Farr Filtration, Ltd., Birmingham, England Los Angeles, California QF Filters, SDN BHD, Malaysia Manufacturing and Distribution Facilities Legal Counsel Jonesboro, Arkansas Gibson, Dunn & Crutcher LLP Corcoran, California Los Angeles, California Delano, California Crystal Lake, Illinois Auditors Holly Springs, Mississippi Conover, North Carolina Arthur Andersen LLP Washington, North Carolina Los Angeles, California Montreal, Canada Toronto, Canada Birmingham, England Singapore Paris, France Form 10-K Manufacturing Licensees Stockholders of record as of March 12, 1999 may obtain copies of the Anfilco Ltd., Curgaon, India Company's Annual Report on Form 10-K Antung Trading Corp., Taipei, Taiwan files with the Securities and Boart MSA (PTY) Ltd. South Africa Exchange Commission by writing to: Casiba S. A., Buenos Aires, Argentina Steve Pegg, 2201 Park Place, Clyde-Apac Ltd., Woodville, Australia El Segundo, California 90245-4900 Genmech Engineering, Singapore Industries Filvac S.A. de C.V., Mexico Nihon Spindle Mfg., Co., Ltd. Osaka, Japan QF Filters, SDN BHD, Malaysia (Joint Venture) Taymac Ltd., Christchurch, New Zealand Turbiparts, C.A., Caracas, Venezuela Vibran Engineering (M) SDN BHD, Petaling Jaya, Malaysia Wilectec Co., Ltd., Kwai Chung, N.T., Hong Kong - 27 - FARR 1998 Annual Report -----END PRIVACY-ENHANCED MESSAGE-----