10-Q 1 donnelly10q2.txt SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q QUARTERLY REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarter ended June 30, 2001 Commission File Number 1-9716 DONNELLY CORPORATION (Exact Name of Registrant as Specified in its Charter) Michigan 38-0493110 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 49 West Third Street, Holland, Michigan 49423-2813 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (616) 786-7000 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 ____ 6,279,994 shares of Class A Common Stock and 4,098,314 shares of Class B Common Stock were outstanding as of July 31, 2001. DONNELLY CORPORATION INDEX NOTE: On August 20, 2001, the Registrant announced that it will restate its financial statements for all periods beginning with fiscal 1998 to reflect a change in its accounting for its investments in Donnelly Electronics, Inc. and Donnelly Hohe GmbH & Co. K.G. See Note 1 and Note 10 to the accompanying Condensed Combined Consolidated Financial Statements. The results of prior periods as reflected in this Form 10-Q differ adversely from previously filed financial information. The accounting change did not have any material impact on the Registrant's net income for the quarter ended June 30, 2001, and is not expected to have a material impact on the Registrant's net income or cash flow in any future period. Page Numbering PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed Combined Consolidated Balance Sheets - June 30, 2001 and December 31, 2000 (as restated) 3 Condensed Combined Consolidated Statements of Income - Three and six months ended June 30, 2001 and July 1, 2000 (as restated) 4 Condensed Combined Consolidated Statements of Cash Flows - Six months ended June 30, 2001 and July 1, 2000 (as restated) 5 Notes to Condensed Combined Consolidated Financial Statements 6-11 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 11-16 Item 3. Quantitative and Qualitative Disclosures About Market Risk 16 PART II. OTHER INFORMATION Item 1. Legal Proceedings 17 Item 4. Submission of Matters to Vote of Security Holders 18 Item 6. Exhibits and Reports on Form 8-K 18 Signatures 19 2 PART I ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA DONNELLY CORPORATION AND SUBSIDIARIES CONDENSED COMBINED CONSOLIDATED BALANCE SHEETS (UNAUDITED) June 30, December 31, 2001 2000 In thousands (as restated) ------------------------------------------------------------------------- --------- ------------- ASSETS Current assets: Cash and cash equivalents $ 3,533 $ 4,599 Accounts receivable, less allowance of $1,735 and $1,837 83,954 82,802 Inventories 61,947 55,933 Prepaid expenses and other current assets 29,961 28,990 --------- --------- Total current assets 179,395 172,324 --------- --------- Property, plant and equipment 356,347 345,700 Less accumulated depreciation 142,478 133,566 --------- --------- Net property, plant and equipment 213,869 212,134 Investments in and advances to affiliates 7,578 24,483 Other assets 23,617 15,055 --------- --------- Total assets $ 424,459 $ 423,996 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 91,747 $ 89,163 Other current liabilities 45,283 39,817 --------- --------- Total current liabilities 137,030 128,980 --------- --------- Long-term debt, less current maturities 117,117 132,608 Deferred income taxes and other liabilities 52,039 46,430 --------- --------- Total liabilities 306,186 308,018 --------- --------- Minority interest 2,872 1,353 Shareholders' equity: Preferred stock 531 531 Common stock 1,041 1,024 Other shareholders' equity 113,829 113,070 --------- --------- Total shareholders' equity 115,401 114,625 --------- --------- Total liabilities and shareholders' equity $ 424,459 $ 423,996 ========= =========
The accompanying notes are an integral part of these statements. 3 DONNELLY CORPORATION AND SUBSIDIARIES CONDENSED COMBINED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended Six Months Ended ------------------------------- ---------------------------- June 30, July 1, June 30, July 1, 2001 2000 2001 2000 In thousands, except share data (as restated) (as restated) ------------------------------------------------------------------ -------------- --------------- ------------- ------------- Net sales $ 227,276 $ 227,492 $ 447,277 $ 464,896 Cost of sales 189,646 188,698 376,800 384,822 -------------- --------------- ------------- ------------- Gross profit 37,630 38,794 70,477 80,074 Operating expenses: Selling, general and administrative 20,110 21,301 41,070 42,182 Research and development 10,535 7,829 19,979 17,591 -------------- --------------- ------------- ------------- Total operating expenses 30,645 29,130 61,049 59,773 -------------- --------------- ------------- ------------- Operating income 6,985 9,664 9,428 20,301 -------------- --------------- ------------- ------------- Non-operating (income) expenses: Interest expense 1,683 2,025 3,787 3,808 Interest income (418) (390) (536) (582) Royalty income (723) (950) (1,449) (1,197) Other (income) expense, net 487 (26) 966 126 -------------- --------------- ------------- ------------- Total non-operating expenses 1,029 659 2,768 2,155 -------------- --------------- ------------- ------------- Income before taxes on income 5,956 9,005 6,660 18,146 Taxes on income 1,101 2,409 916 4,971 -------------- --------------- ------------- ------------- Income before minority interest and equity earnings 4,855 6,596 5,744 13,175 Minority interest in (income) losses of subsidiaries, net (131) (63) (117) (136) Equity in earnings (losses) of affiliated companies, net 316 (1,003) (657) (1,942) -------------- --------------- ------------- ------------- Net income $ 5,040 $ 5,530 $ 4,970 $ 11,097 ============== =============== ============= ============= Per share of common stock: Basic net income per share $ 0.49 $ 0.54 $ 0.48 $ 1.09 Diluted net income per share $ 0.48 $ 0.54 $ 0.48 $ 1.09 Cash dividends declared $ 0.10 $ 0.10 $ 0.20 $ 0.20 Average common shares outstanding 10,369,569 10,162,983 10,312,735 10,158,266
The accompanying notes are an integral part of these statements. 4 DONNELLY CORPORATION AND SUBSIDIARIES CONDENSED COMBINED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended June 30, July 1, 2001 2000 In thousands (as restated) ---------------------------------------------------------------------------- ----------- ------------ Cash Flows From Operating Activities Net income $ 4,970 $ 11,097 Adjustments to reconcile net income to net cash from operating activities: Depreciation and amortization 16,048 15,861 Gain on sale of property and equipment (22) (5) Deferred pension cost and postretirement benefits 3,365 3,035 Change in deferred income taxes 94 (586) Minority interest in income (losses) of subsidiaries, net (26) (56) Equity in losses of affiliated companies, net 657 1,942 Changes in operating assets and liabilities, net of acquisitions: (Refund) sales of accounts receivable (1,524) 2,292 Accounts receivable 1,848 (16,671) Inventories (4,925) (1,565) Prepaid expenses and other current assets 5,477 (2,429) Accounts payable and other current liabilities 10,464 19,875 Other 4,304 287 ------------ ------------ Net cash from operating activities 40,730 33,077 ------------ ------------ Cash Flows From Investing Activities Capital expenditures (17,649) (23,330) Proceeds from sale of property and equipment 131 518 Investments in and advances to affiliates (9,075) (4,028) Other (1,371) (716) ------------ ------------ Net cash for investing activities (27,964) (27,556) ------------ ------------ Cash Flows From Financing Activities Net proceeds from long-term debt 4,017 - Repayments on long-term debt (15,672) (3,575) Redemption of minority interest in subsidiary - (946) Common stock issuance 278 172 Dividends paid (2,093) (2,052) Other financing (185) - ------------ ------------ Net cash for financing activities (13,655) (6,401) ------------ ------------ Effect of foreign exchange rate changes on cash (177) (159) Increase (decrease) in cash and cash equivalents (1,066) (1,039) Cash and cash equivalents, beginning of period 4,599 4,153 ------------ ------------ Cash and cash equivalents, end of period $ 3,533 $ 3,114 ============ ============ Supplemental disclosures of cash flow information Interest paid $ 4,163 $ 3,253 Income taxes paid 392 6,510 Significant non-cash transactions: Issuance of class A common stock to acquire business 2,250 -
The accompanying notes are an integral part of these statements. 5 NOTES TO CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AND RESTATEMENT The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six month period ended June 30, 2001, should not be considered indicative of the results that may be expected for the year ending December 31, 2001. On August 20, 2001, the Company announced that it would restate its historical financial statements to revise the accounting treatment of certain investments in and advances to affiliates. During a detailed review of the accounting treatment of its less than wholly owned affiliates, the Company determined that certain revisions to the accounting treatment of its investments in Donnelly Electronics, Inc. ("Donnelly Electronics") and Donnelly Hohe Gmbh & Co. KG ("Hohe") were necessary. The investment in Donnelly Electronics had been accounted for under the cost method since initial investment in the first quarter of fiscal 1997, and was subsequently consolidated upon the Company's acquisition of the remaining outstanding common stock on February 28, 2001. Prior to consolidation, Donnelly Electronics incurred operating losses, which were not reflected in the net income of the Company under the cost method of accounting. Upon further review, it was determined that this investment should have been accounted for in accordance with the equity method prior to February 28, 2001. Under the equity method, substantially all of the operating losses incurred by Donnelly Electronics prior to consolidation has been included in the Company's restated net income. The investment in Hohe had initially been accounted for under the equity method since its acquisition in April 1995 and was subsequently consolidated beginning in October 1996. Hohe incurred operating losses through fiscal 2000, of which the Company absorbed 66 2/3% based upon its ownership percentage. Upon further review of the accounting treatment of this investment, it was determined that the Company should have included 100% of the losses in its net income during this period as the minority partner's equity basis had been exhausted at the initial investment date, and subsequent funding has been provided by the Company. In the accompanying financial statements and notes, the Income Statements for the three and six month periods ended July 1, 2000 and the Balance Sheet as of December 31, 2000 reflect the restated amounts. Also refer to Note 10. 2. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES On February 28, 2001, the Company acquired all of the outstanding common stock of Donnelly Electronics, not then owned by the Company for $4.5 million, paid equally in cash and through the issuance of shares of the Company's Class A Common Stock. The acquisition has been accounted for under the purchase method of accounting, and the goodwill and intangibles recorded on a preliminary basis as a result of the acquisition are being amortized over 20 years. Due to the acquisition of the remaining interest, the Company began consolidating Donnelly Electronics' financial statements beginning in March 2001. Prior to the acquisition of the remaining interest, the Company owned 18.2% of the common stock of Donnelly Electronics and had advanced funds for its operations. Donnelly Electronics designs and manufactures circuit board assemblies for a variety of electronic products and sub-assemblies. It produces many of the electronic components that the Company uses for products such as Electrochromic rearview mirrors and electronic compass systems, and also produces products for other automotive suppliers and non-automotive customers. The pro-forma impact of the acquisition and summarized financial information of Donnelly Electronics have not been provided since the impact on revenues is not material and substantially all of the losses of Donnelly Electronics have been reflected in the Company's financial statements as described in Note 1. 3. NATURE OF OPERATIONS The Company is a technology-driven, customer-focused, growth-oriented global supplier to the automotive and information display industries through manufacturing operations and various joint ventures in North and South America, Europe and 6 Asia. The Company primarily supplies automotive customers around the world with rear vision systems, modular window systems and handle products, which incorporate increasing electronic capabilities. The Company has been managed primarily on a geographical basis. The Company has two reportable segments: North American Operations ("NAO") and European Operations ("EO"). The operating segments have been managed separately as they each represented regional operational components, which offer the Company's product lines in different geographic markets. During 2001, the Company is transitioning to a global, product-based management structure, split into two main operating groups: Electronic Systems and Exterior Systems. The Company believes that this organizational evolution will help position it to achieve even stronger performance with its products in the global marketplace. A summary of the Company's operations by business segments is as follows: Other Intersegment Total In thousands NAO EO Segments* Eliminations Segments ----------------------------------------- --------------- --------------- --------------- ----------------- ----------------- Three months ended June 30, 2001: Revenues $ 158,460 $ 70,603 $ 4,068 $ (5,855) $ 227,276 Segment profit (loss) 15,115 1,843 (151) -- 16,807 Six months ended June 30, 2001: Revenues $ 300,403 $ 149,401 $ 7,004 $ (9,531) $ 447,277 Segment profit (loss) 23,682 7,467 (169) -- 30,980 Three months ended July 1, 2000 (as restated): Revenues $ 153,128 $ 70,761 $ 7,220 $ (3,617) $ 227,492 Segment profit 17,651 3,602 302 -- 21,555 Six months ended July 1, 2000 (as restated): Revenues $ 308,970 $ 146,715 $ 15,193 $ (5,982) $ 464,896 Segment profit 34,819 7,907 210 -- 42,936
* Other segments category includes the Company's majority owned Asian & South American operations, and automotive joint ventures. Profit (loss) of other segments as reported does not include the losses of Donnelly Electronics, which have been recognized under the equity method of accounting through February 28, 2001. The losses, net of tax, attributable to Donnelly Electronics under the equity method of accounting for the six months ended June 30, 2001, is $(1,461) and for the three and six months ended July 1, 2000, are $(1,224) and $(2,383) respectively. Reconciliation of the totals reported for the operating segments' profit to consolidated income before income taxes in the combined consolidated financial statements is shown below: Three Months Ended Six Months Ended June 30, July 1, June 30, July 1, (In thousands) 2001 2000 2001 2000 (as restated) (as restated) -------------------------------------------- ------------------ ----------------- ----------------- ------------------ Segment profit from reportable segments $ 16,958 $ 21,253 $ 31,149 $ 42,726 Segment profit (loss) from other segments (151) 302 (169) 210 Interest, net (1,265) (1,635) (3,251) (3,226) Depreciation and amortization (8,068) (8,197) (16,048) (15,861) Corporate and other expenses* (1,518) (2,718) (5,021) (5,703) ------------------ ----------------- ----------------- ------------------ Income before taxes on income $ 5,956 $ 9,005 $ 6,660 $ 18,146 ================== ================= ================= ==================
7 * Corporate and other expenses category includes centralized corporate functions including those for advanced research, corporate administration including information technology, human resources and finance and other costs associated with corporate development and financing initiatives. 4. RESTRUCTURING CHARGES European Restructuring On July 9, 2001, the Company announced a European restructuring initiative ("the 2001 plan") to further enhance the efficiency and profitability of its European operations through a combination of margin improvements and overhead reductions. Objectives of the 2001 plan will be achieved through outsourcing of "non-core" operations including work currently performed in the Company's Tool Shop and Zinc Diecasting operations. Personnel cutbacks will also be made in the Paint Shop and in Manufacturing Overhead. The total cost of the plan is estimated at $2.1 million pre-tax, or $1.4 million at net income, related to termination benefits for approximately 125 production, engineering and support personnel. Costs will be recognized as specific actions are defined and approved beginning in the third quarter of 2001. The plan is anticipated to be completed in 2002. While the Company believes that further restructuring actions may be appropriate in Europe and continues to evaluate these operations for improvements, the assessment of possible actions has not yet been completed. The Company has substantially completed two earlier restructuring plans to improve the operating efficiency and profitability of its European exterior mirror business. In February 1999, the Company announced a restructuring plan ("the 1999 plan") based on a strategy to consolidate and streamline manufacturing operations in Germany. An $8.8 million pre-tax restructuring charge, or $4.7 million at net income, was recorded for the 1999 plan, including $1.4 million for impairment of assets and $7.4 million for anticipated incremental cash expenditures related to the severance and voluntary retirement programs for approximately 200 production, sales, engineering and support personnel. In May 1997, the Company announced a plan ("the 1997 plan") for the elimination of redundant operations and outsourcing of inefficient operations throughout Europe, which resulted in a $10.0 million pre-tax restructuring charge, or $5.3 million at net income. A reduction of $1.1 million was recorded to the restructuring reserve in 1998 associated with changes to the 1997 plan. Remaining actions of the 1997 plan were included in the 1999 plan. As required by generally accepted accounting principles for restructuring charges, the Company reduced its total restructuring reserve by $3.8 million pre-tax, or $2.4 million at net income, in the fourth quarter of 2000. The reduction was attributable to (1) higher than anticipated voluntary employee attrition and (2) changing circumstances within the market and operations, which made the outcome of some aspects of the plans uncertain. Details of the European restructuring reserves are as follows: Severance and Asset Impairment Restructuring (In thousands) Benefits Total ------------------------------------------------------ ------------------ ------------------ ------------------ 1997 plan 9,965 -- 9,965 1999 plan 7,426 1,351 8,777 1998 reserve reduction (1,117) -- (1,117) 2000 reserve reduction (3,448) (348) (3,796) Amounts utilized (9,201) (530) (9,731) Impact of foreign currency changes (2,032) (154) (2,186) ------------------ ------------------ ------------------ Accrued Restructuring Costs at June 30, 2001 1,593 319 1,912 ================== ================== ==================
As of June 30, 2001, the Company has experienced a reduction of 224 employees under the combined plans. The Company also funded approximately $3.1 million of capital expenditures to support the 1999 and 1997 plans, which were included in the Company's capital expenditures. These costs do not qualify as restructuring under current accounting guidelines. North American Restructuring On July 9, 2001 the Company announced a North American overhead reduction plan to enhance its competitive position and improve overall corporate profitability while maintaining focus on customers and products. The total cost of the plan is 8 estimated at $3.0 million pre-tax, or $2.0 million at net income, related primarily to severance benefits for 100 administrative and support personnel. Completion of the plan is anticipated during the third quarter of 2001. 5. INVENTORIES Inventories consist of: June 30, December 31, (In thousands) 2001 2000 ------------------------------------------------ ------------------ ----------------- Finished products and work in process........ $ 25,779 $ 18,124 Raw materials................................ 36,168 37,809 ------------------ ----------------- $ 61,947 $ 55,933 ================== =================
6. FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives in the balance sheet at fair value. It also requires that unrealized gains and losses resulting from changes in fair value be included in income or comprehensive income, depending on whether the instrument qualifies as a hedge transaction and, if so, the type of hedge transaction. The Company has examined and updated its current derivative use policy, and identified hedge arrangements, along with their anticipated treatment on an ongoing basis under the provisions of SFAS No. 133. The implementation of this new standard as of January 1, 2001, did not have a material impact on the Company's results of operations or financial position. 7. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share for each period reported: Three Months Ended Six Months Ended ---------------------------------------------------------------- June 30, July 1, June 30, July 1, 2001 2000 2001 2000 (In thousands, except per share data) (as restated) (as restated) --------------------------------------------- ------------ -------------- --------------- ----------------- Net Income................................... $ 5,040 $ 5,530 $ 4,970 $ 11,097 Less: Preferred stock dividends............. (10) (10) (20) (20) ------------ -------------- --------------- ----------------- Income available to common shareholders...... $ 5,030 $ 5,520 $ 4,950 $ 11,077 ============ ============== =============== ================= Weighted-average shares - basic.............. 10,370 10,163 10,313 10,158 Plus: Effect of dilutive stock options...... 29 24 22 17 ------------ -------------- --------------- ----------------- Adjusted weighted-average shares - diluted... 10,399 10,187 10,335 10,175 ============ ============== =============== ================= Basic earnings per share..................... $ 0.49 $ 0.54 $ 0.48 $ 1.09 ============ ============== =============== ================= Diluted earnings per share................... $ 0.48 $ 0.54 $ 0.48 $ 1.09 ============ ============== =============== =================
Options to purchase 592,183 shares of common stock at various prices per share were outstanding during the quarter but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares and, therefore, the effect would be antidilutive. 9 8. COMPREHENSIVE INCOME (LOSS) Comprehensive income includes net income and all changes to shareholders' equity, except those due to investments by owners and distributions to owners. Comprehensive income consists of the following: Three Months Ended Six Months Ended ---------------------------------- ---------------------------------- June 30, July 1, June 30, July 1, 2001 2000 2001 2000 (In thousands) (as restated) (as restated) ------------------------------------------------ --------------- ---------------- -------------- ----------------- Net income...................................... $ 5,040 $ 5,530 $ 4,970 $ 11,097 Other comprehensive income (loss): Foreign currency translation and transaction adjustments............ (1,108) (263) (4,311) (2,306) Unrealized loss on interest rate swaps and foreign exchange contracts... -- -- (220) -- --------------- ---------------- -------------- ----------------- Comprehensive income (loss)..................... $ 3,932 $ 5,267 $ 439 $ 8,791 =============== ================ ============== =================
Translation and transaction adjustments are recorded directly in a component of shareholders' equity in the accompanying Condensed Combined Consolidated Balance Sheets. These result from changes in the foreign currency translation adjustments of the Company's net investments in its foreign subsidiaries, as well as foreign currency denominated long-term advances to affiliates caused by fluctuations in exchange rates. The Company had total accumulated other comprehensive losses of $19.2 million and $14.7 million at June 30, 2001, and December 31, 2000, respectively. 9. COMMITMENTS AND CONTINGENCIES The Company and its subsidiaries are involved in certain legal actions and claims incidental to its business, including those arising out of alleged defects, breach of contracts, product warranties, employment-related matters and environmental matters. Reserves established for these potential liabilities are reviewed quarterly. An estimated loss from a legal action or claim is accrued when events exist that make the loss probable and the loss can be reasonably estimated. Although the Company maintains accruals for such claims when warranted, there can be no assurance that such accruals will continue to be adequate. The Company believes that accruals related to such litigation and claims are sufficient and that these items will be resolved without material effect on the Company's financial position, results of operations and liquidity, individually and in the aggregate. 10 10. RESTATEMENT OF FINANCIAL STATEMENTS As described in Note 1, the Company's financial statements for the relevant periods have been restated to properly reflect financial position and net income. The following tables detail the effects of the restatement (in thousands, except per share data): Three Months Ended Six Months Ended Income Statement Data July 1, 2000 July 1, 2000 ------------------------------------------------------------------------------------------------------------------ As Previously As Restated As Previously As Restated Reported Reported ------------------------------------------------------------------- Net sales $227,492 $227,492 $464,896 $464,896 Gross profit 38,794 38,794 80,074 80,074 Net income 7,137 5,530 13,911 11,097 Basic and diluted net income per share $ 0.70 $ 0.54 $ 1.37 $ 1.09
Balance Sheet Data As of December 31, 2000 ------------------------------------------------------------------------------- As Previously As Restated Reported ------------------------------------ Current assets $172,741 $172,324 Total assets 464,020 423,996 Current liabilities 128,980 128,980 Total liabilities and minority interest 329,239 309,371 Shareholders' equity 134,781 114,625
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SECOND QUARTER REPORT FOR THE SIX MONTHS ENDED JUNE 30, 2001 FORWARD-LOOKING STATEMENTS This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The terms "believe," "anticipate," "intend," "goal," "expect," and similar expressions may identify forward-looking statements. Investors are cautioned that any forward-looking statements, including statements regarding the intent, belief or current expectations of the Company or its management, are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those in forward-looking statements as a result of various factors including, but not limited to (i) general economic conditions in the markets in which the Company operates, (ii) fluctuation in worldwide or regional automobile and light truck production, (iii) changes in practices and/or policies of the Company's significant customers including forced price reduction, (iv) market development of specific products of the Company, including electrochromic mirrors, (v) whether the Company restructures its European operations, (vi) fluctuations in foreign currencies and (vii) other risks and uncertainties. The Company does not intend to update these forward-looking statements. In this Item 2, references to the results of operations for the three and six month periods ended July 1, 2000 and to balances as of December 31, 2000 relate to restated amounts for certain investments in and advances to affiliates. See Notes 1 and 10 of the Notes to the accompanying Condensed Combined Consolidated Financial Statements. OVERVIEW The Company is a technology-driven, customer-focused, growth-oriented, global supplier to the automotive and information display industries. The Company has been managed primarily on a geographic basis. The Company has two reportable segments: North American Operations ("NAO") and European Operations ("EO "). These have been managed separately as they each represent regional operational components, which offer the Company's product lines in different geographical markets. During 2001, the Company is transitioning to a global, product-based management structure, split into two main 11 operating groups: Electronic Systems and Exterior Systems. The Company believes that this organizational evolution will help position it to achieve even stronger performance with its products in the global marketplace. The Company's net sales and net income are subject to significant fluctuations attributable primarily to production schedules of the Company's major automotive customers. In addition, the Company has strong product content on light trucks, including minivans and sport utility vehicles, as compared to automobiles. These factors cause results to fluctuate from period to period and year to year. Investment in new product lines, acquisitions, and the formation and disposition of subsidiaries, joint ventures and alliances also affect the comparability of results on a period-to-period basis. Acquisitions, Mergers, Joint Ventures and Sale of Investments In June 2001, the Schott-Donnelly LLC Smart Glass Solutions ("Schott-Donnelly"), a 50-50 joint venture with Schott, a German based specialty glass producer, decided to liquidate. The liquidation is not expected to have a material effect on the Company's revenue or net income and is expected to be completed during the third quarter of 2001. In April 2001, the Company announced that it has signed a non-binding letter of intent with Eaton Corporation, a diversified industrial manufacturer, to sell certain assets of the Donnelly subsidiary, Donnelly Vision Systems Europe Ltd., located in Manorhamilton, Ireland, a manufacturer of mirrors and mirror actuators. Under the terms of the agreement, Eaton will assume control and responsibility for manufacturing the Company's actuator currently used for exterior mirrors on certain vehicles in Europe. It is anticipated that the transaction will be finalized during the third quarter of 2001. In February 2001, the Company acquired all of the outstanding common stock of Donnelly Electronics not then owned by the Company, see Note 2, "Investments In and Advances to Unconsolidated Affiliates", for further discussion and analysis. 12 RESULTS OF OPERATIONS Comparison of the three- and six-month periods ended June 30, 2001, and July 1, 2000 North American Operations ("NAO") For the three- and six-month period s ended June 30, 2001, NAO net sales increased 3.5%, and decreased 2.8%, respectively, compared to the same periods in 2000. Despite decreases in the North American car and light truck build of 10% and 13% for the three and six-month periods, respectively, NAO net sales continued to remain strong due to new programs launched in 2000. NAO gross profit margins remained relatively flat for the three-month period ended June 30, 2001, compared to the same period in the previous year. Yield issues on certain products offset gains from plant improvement initiatives. Gross profit margins were down for the current six-month period compared to the same period in 2000. The decrease in gross profit margin is due primarily to a general deterioration in the automotive industry; irregular and reduced Original Equipment Manufacturer ("OEM") production schedules; higher launch costs associated with products and continued costs associated with the integration of Donnelly Electronics. The success of the Company in maintaining gross profit margins is dependent upon its ability to successfully launch newly booked business and to offset continued customer pricing pressures. In addition, the Company may experience changes in gross profit margins based on its mix of lower-margin and higher-margin products. NAO operating margins were below previous year levels for both the three- and six-month periods. Relatively flat gross profit margins for the three-month period and slightly lower gross profit margins for the six-month period, combined with an overall increase in operating expenses (including increased research and development expenses due to the integration of Donnelly Electronics) and continued support of new programs, were primarily responsible for the declines. Selling, general and administrative expenses remained relatively flat due largely to the benefits of continued focus on cost reduction in North America. The Company anticipates that its acquisition of Donnelly Electronics will result in higher research and development expense both in absolute terms and as a percent of sales. However, in the future, the Company anticipates a favorable impact to both its operating and gross profit margins from this acquisition. European Operations ("EO") EO net sales remained relatively flat for the three-month period and increased by 1.8% for the six-month period ended June 30, 2001, compared to the same periods in 2000. The continued strengthening of the dollar compared to the euro reduced the reported sales level for Europe. Stated in local currencies, EO net sales increased approximately 7.2% and 8.6% for the three- and six-month periods ended June 30, 2001, respectively, compared to the same periods in 2000. The increase in net sales is primarily due to product launches begun in 2000 running at full production volumes in 2001, combined with a relatively stable car build in Western Europe compared to the prior year. EO gross profit margins and operating income decreased during the three- and six-month periods ended June 30, 2001 compared to the same periods in 2000. Unfavorable changes in product mix were only partially offset by positive warranty experience and continued efforts to reduce costs. Company Net sales were $227.3 million and $447.3 for the three- and six-month periods ended June 30, 2001, respectively, compared to $227.5 million and $464.9 in the same periods last year, representing decreases of 0.1% and 3.8%. This decrease is due primarily to a general decline in the automotive industry. North American industry production declined 13% for the six-month period; however; this decline was largely offse t by stronger sales related to new programs launched in 2000. European sales remained flat as relatively stronger production volumes were offset by unfavorable foreign exchange rates. Gross profit margin was 16.6% and 15.8% for the three- and six-month periods ended June 30, 2001, respectively, compared to 17.1% and 17.2%, for the same periods last year. Reduced gross profit margins are primarily the result of irregular and reduced OEM production schedules, increased costs associated with new product launches, and costs associated with the integration of Donnelly Electronics. Margin reductions were offset slightly by a change in the Company's estimated warranty reserves based on favorable warranty experience. Selling, general and administrative expenses were $20.1 million and $41.1 million, or 8.9% and 9.2% of net sales, for the three- and six-month periods ended June 30, 2001, compared to $21.3 million and $42.2 million, or 9.4% and 9.1% of net sales, for the same periods last year. These expenses remained consistent for most of the current six-month period but began to decline during the three-month period due to a continued focus on cost reductions in North America and Europe. 13 Research and development expenses increased from prior year levels, at $10.5 million and $20.0 million, or 4.6% and 4.5% of net sales, for the three- and six-month periods ended June 30, 2001, compared to $7.8 million and $17.6 million, or 3.4% and 3.8% of net sales, respectively, in the comparable periods of last year. The increase in current year expenses is primarily attributable to the acquisition of Donnelly Electronics as well as continued support of new programs, including Electrochromic Mirrors and Camera Vision. Operating income was $7.0 million and $9.4 million for the three- and six-month periods ended June 30, 2001, compared to $9.7 million and $20.3 million for the same periods last year. Operating income represented 2.1% of net sales for the six months ended June 30, 2001, compared to 4.4% for the comparable period in the prior year. This decrease is due to reduced gross profit margins combined with increased research and development costs which were only partially offset by lower selling, general, and administrative expenses during the period. Interest expense was $1.7 million and $3.8 million for the three- and six-month periods ended June 30, 2001, compared to $2.0 million and $3.8 million for the same periods last year. The decrease for the three-month period is the result of reduced levels of debt and lower interest rates. Other (income), net was $(0.7) million and $(1.0) million for the three- and six-month periods ended June 30, 2001, compared to $(1.4) million and $(1.7) million, respectively, for the comparable periods last year, primarily due to an increase in foreign transaction losses. The Company's effective tax rate was approximately 18.5% and 13.8% for the three- and six-month periods compared to 27% in both the respective periods of 2000. The low effective tax rate reflects the realization of certain tax credits and export sale tax benefits recognized for refunds on prior year amended filings. Equity in earnings (losses) of affiliated companies, net for the first six-months of 2001 was $(0.7) million, an improvement of $1.3 million as compared to the first six months of 2000. The improvements relate to the Company's investment in Donnelly Electronics and its Brazilian joint venture. While both are still operating at losses, these entities are no longer treated as equity investments but were consolidated with the Company as of October 2000 for the Brazilian joint venture and as of March 2001 for Donnelly Electronics. The Company's joint ventures in China continue to be profitable. The Company is committed to improving shareholder value with a strategic plan focused on the following key areas: developing core automotive products, primarily by increasing dollar content per vehicle through the expansion of market share of existing products; introduction of new technologies and products and increasing volume through penetration into new and emerging markets; improving the overall operating performance of the Company's European Operations; extending the Company's capabilities in value-added electronics technologies; and repositioning non-core businesses, as appropriate, through merger or divestiture. LIQUIDITY AND CAPITAL RESOURCES The Company believes that the revised accounting, as discussed above, and restated financial statements will not have a material impact on the Company's liquidity or capital resource availability. The Company's current ratio was 1.3 at June 30, 2001 and December 31, 2000. Working capital was $42.4 million at June 30, 2001, compared to $43.3 million at December 31, 2000. Increased current assets were more than offset by increased accrued liabilities, primarily related to health insurance benefits. At June 30, 2001, and December 31, 2000, $37.0 million and $38.5 million, respectively, had been sold under the Company's accounts receivable securitization agreement. Proceeds received under this agreement are used to reduce revolving lines of credit. The sales are reflected as a reduction of accounts receivable and an increase to operating cash flows. The agreement expires in December 2001, however it is renewable for one-year periods. The Company expects to extend the current agreement or replace it on comparable terms. Capital expenditures for the six months ended June 30, 2001, and July 1, 2000, were $17.6 million and $23.3 million, respectively, excluding funds expended for the acquisition of Donnelly Electronics. Capital spending was primarily to support new business orders, the ramp up of new electrochromic and electronic mirror products, information technology, the 1999 and 1997 European Restructurings and continuous improvement activities of the Company. Reduced capital spending is the result of continued efforts by management to improve profitability and cash flows. 14 The Company announced significant restructuring plans in fiscal 1997 and 1999 to improve the overall profitability of EO (see Note 4). The remaining reserve balance for these plans was $1.9 million at June 30, 2001. In July 2001, the Company announced restructuring plans in Europe and North America intended to streamline operations, reduce overhead and improve profitability (See Note 4). The total cost of the 2001 European and North American plans is estimated at $3.4 million (at net income), primarily related to termination benefits. On-going annual savings from the combined plans is estimated at $7 - $10 million, primarily through reduced salaries, wages and benefits and reduced discretionary expenditures, partially offset by outsourcing costs. The Company believes that its long-term liquidity and capital resource needs will continue to be provided principally by funds from operating activities, supplemented by borrowings under existing credit facilities. The Company also considers equity offerings to properly manage the Company's total capitalization position. The Company considers, from time to time, new joint ventures, alliances, divestitures and acquisitions, the implementation of which could impact the liquidity and capital resource requirements of the Company. For the six-month period ended June 30, 2001, the Company made $9.1 million of cash investments in and advances to affiliates. The Company's $160 million multi-currency global revolving credit agreement had borrowings against it of $67.2 million and $77.1 million as of June 30, 2001, and December 31, 2000, respectively. The Company's primary foreign investments are in Germany, Ireland, Spain, France, Mexico, China, Brazil and Malaysia. Except for the Company's subsidiary in Mexico, whose functional currency is the United States dollar, financial statements of international companies are translated into United States dollar equivalents at exchange rates as follows: (1) balance sheet accounts at period-end rates and (2) income statement accounts at weighted average monthly exchange rates prevailing during the year. Translation gains and losses are reported as a separate component of shareholders' equity and are included in accumulated other comprehensive income. For the subsidiary in Mexico, transaction and translation gains or losses are reflected in net income for all accounts other than intercompany balances of a long-term investment nature for which the translation gains or losses are reported as a separate component of shareholders' equity. Foreign currency transaction gains and losses included in other income are not material. The Company utilizes interest rate swaps and foreign exchange contracts, from time to time, to manage exposure to fluctuations in interest and foreign currency exchange rates. The risk of loss in the event of nonperformance by any party under these agreements is not material. Recently Issued Accounting Standards In June 2001, the Financial Accounting Standards Board issued Statements No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that the Company recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria, and that upon adoption of SFAS 142, the Company reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141. SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that the Company identify reporting units for the purpose of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized. SFAS 142 requires the Company to complete a transitional goodwill impairment test within six months of the date of adoption. The Company is also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142. The Company's previous business combinations were accounted for using the purchase method. As of June 30, 2001, the net carrying amount of goodwill and other intangible assets is $11.3 million. Amortization expense during the six-month period ended June 30, 2001 was $0.4 million. Currently, the Company is assessing but has not yet determined how adoption of SFAS 141 and SFAS 142 will impact its financial position and results of operations. 15 The Company implemented SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" as described in Note 6. There have been no other recently issued accounting standards that are expected to have a material impact on the Company. Euro Conversion Effective January 1, 1999, eleven of fifteen member countries of the European Union established permanent rates of exchange between the members' national currency and a new common currency, the "euro." In this first phase, the euro is available for non-cash transactions in the monetary, capital, foreign exchange and inter-bank markets. National currencies will continue to exist as legal tender and may continue to be used in commercial transactions until the euro currency is issued in January 2002 and the participating members' national currency is withdrawn by July 2002. The Company's significant European operations are all located in member countries participating in this monetary union. The Company created an internal, pan-European, cross-functional team, as well as internal teams at each operation affected by the change, to address operational implementation issues and investigate strategic opportunities due to the introduction of the euro. The Company has established action plans that are currently being implemented to address the euro's impact on information systems, currency exchange risk, taxation, contracts, competition and pricing. The Company anticipates benefiting from the introduction of the euro through a reduction of foreign currency exposure and administration costs on transactions within Europe and increased efficiency in centralized European cash management. The Company has commenced conversion of its European operations from national currency to the euro. The change in functional currency is proceeding as planned and is expected to be completed in 2001. The Company does not presently expect that the introduction and use of the euro will materially affect the Company's foreign exchange hedging activities or the Company's use of derivative instruments. Any costs associated with the introduction of the euro will be expensed as incurred. The Company does not believe that the introduction of the euro will have a material impact on its results of operations or financial position. ITEM 3 (a) QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to changes in interest rates and foreign currency exchange primarily in its cash, debt, foreign currency transactions and operating results of the Company's foreign affiliates. The Company holds derivative instruments, including interest rate swaps and forward foreign currency contracts. Derivative instruments used by the Company in its hedging activities are viewed as risk management tools and are not used for trading or speculative purposes. Analytical techniques are used to manage and monitor foreign exchange and interest rate risk and include market valuation. The Company believes it is, to a lesser degree, subject to commodity risk for price changes that relate to certain manufacturing operations that utilize raw commodities. The Company manages its exposure to changes in those prices primarily through its procurement and sales practices. This exposure is not considered material to the Company. A discussion of the Company's accounting policies for derivative financial instruments is included in Note 1 - Summary of Significant Accounting Policies, in the Notes to the Combined Consolidated Financial Statements, which are included in Item 8 of the Form 10-K report for the year ended December 31, 2000. Additional information relating to financial instruments and debt is included in Note 9 - Financial Instruments and Note 7 - Debt and Other Financing Arrangements, which are also included in Item 8 of the Form 10-K report for the year ended December 31, 2000. International operations are primarily based in Europe and, excluding U.S. export sales which are principally denominated in U.S. dollars, constitute a significant portion of the revenues and identifiable assets of the Company. A predominant portion of these international revenues and identifiable assets are based in German marks. The Company has significant loans to foreign affiliates, which are denominated in foreign currencies. Foreign currency changes against the U.S. dollar affect the foreign currency transaction adjustments on these long-term advances to affiliates and the foreign currency translation adjustment of the Company's net investment in these affiliates, which impact consolidated equity of the Company. International operations result in a large volume of foreign currency commitment and transaction exposures and significant foreign currency net asset exposures. Since the Company manufactures its products in a number of locations around the world, it has a cost base that is diversified over a number of different currencies, as well as the U.S. dollar, which serves to counterbalance partially its foreign currency transaction risk. Selective foreign currency commitments and transaction exposures are partially hedged. The Company does not hedge its exposure to translation gains and losses relating to foreign currency net asset exposures; however, when possible, it borrows in local currencies to reduce such exposure. The Company is also exposed to fluctuations in other currencies including: Brazilian reals, British pounds, Chinese renminbi, European euros, Japanese yen, Malaysian ringgit and Mexican pesos. The 16 Company is also exposed to potential costs associated with repatriation timing and risk from some of its foreign affiliates. The fair value of the foreign currency contracts outstanding has been immaterial each of the last two years. The Company's cash position includes amounts denominated in foreign currencies. The Company manages its worldwide cash requirements considering available funds amongst its subsidiaries and the cost effectiveness with which these funds can be accessed. The repatriation of cash balances from certain of the Company's affiliates could have adverse tax consequences. However, those balances are generally available without legal restrictions to fund ordinary business operations. The Company has and will continue to transfer cash from those affiliates to the parent and to other international affiliates when it is cost effective to do so. The Company manages its interest rate risk in order to balance its exposure between fixed and variable rates while attempting to minimize interest costs. Thirty percent of the Company's long-term debt is fixed and an additional $15 million is effectively fixed through interest rate swaps. See the Company's Form 10-K report for the year ended December 31, 2000; Item 7 (a), for quantitative and qualitative disclosures about market risk as of December 31, 2000. There have been no material changes in the nature of the market risk exposures facing the Company since December 31, 2000. PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS On May 23, 2001, Schefenacker Vision Systems USA, Inc. ("Schefenacker") filed a lawsuit in St. Clair County Circuit Court of Michigan against the Company and two Company employees formerly employed by Schefenacker. Schefenacker seeks unspecified damages and injunctive relief and alleges misappropriation of trade secrets, breach of contract, breach of fiduciary duty, interference with contractual relations and unfair competition. An answer was filed on behalf of all defendants on June 27, 2001, in which the defendants denied all liability and asserted several affirmative defenses. On October 5, 2000, the Company filed a complaint against Reitter & Schefenacker USA Limited Partnership and Reitter & Schefenacker GmbH Co., KG in the U.S. District Court for the Western District of Michigan. The complaint alleges that the defendants have infringed three of the Company's patents relating to interior rearview mirror assemblies incorporating lighting features. The complaint seeks unspecified damages and an injunction against further infringement. Defendant Reitter & Schefenacker USA Limited Partnership has filed an answer denying infringement and alleging that the patents at issue are invalid and/or unenforceable. Defendant Reitter & Schefenacker GmbH & Co., KG has not yet filed an answer but has filed a motion to dismiss based on a lack of personal jurisdiction. Trial is currently scheduled for October 2002. Neither the outcome of this suit nor the amount of any potential recovery or any potential liability can be ascertained at present. The Company and its subsidiaries are involved in certain other legal actions and claims incidental to its business, including those arising out of alleged defects, breach of contracts, product warranties, employment-related matters and environmental matters. An estimated loss from a legal action or claim is accrued when events exist that make the loss probable and the loss can be reasonably estimated. Although the Company maintains accruals for such claims when warranted, there can be no assurance that such accruals will continue to be adequate. The Company believes that accruals related to such litigation and claims are sufficient and that these items will be resolved without material effect on the Company's financial position, results of operations and liquidity, individually and in the aggregate. 17 ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS At the Annual Shareholders' Meeting held May 11, 2001, the shareholders voted on one proposal presented in the Company's 2001 definitive proxy statement. All Nominees for director were elected, each to serve until the 2002 annual meeting of shareholders, by the following votes: Class A Common Stock For Withheld -------------------- --- -------- John A. Borden 5,443,894 12,359 R. Eugene Goodson 5,447,612 8,641 Donald R. Uhlmann 5,448,273 7,980 Class B Common Stock For Withheld -------------------- --- -------- Dwane Baumgardner 26,865,210 -- Arnold F. Brookstone 26,865,210 -- B. Patrick Donnelly, III 26,865,210 -- Joan E. Donnelly 26,865,210 -- Thomas E. Leonard 26,865,210 -- Gerald T. McNeive Jr. 26,865,210 -- Rudolph B. Pruden 26,865,210 -- Item 6. Exhibits and Reports on Form 8-K (a) EXHIBITS Exhibit 10.1 Letter from Donnelly Corporation to Mr. Kevin L. Brown dated March 5, 2001. Exhibit 10.2 Letter from Donnelly Corporation to Mr. Steve Crandall dated February 12, 2001. (b) REPORTS ON FORM 8-K The Registrant filed Form 8-K, dated February 27, 2001, in which the registrant disclosed, in Item 2, the acquisition of Donnelly Electronics, Inc., a Michigan Corporation, and subsequently an amended Form 8-K was filed on May 11, 2001 and is hereby incorporated by reference. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized. DONNELLY CORPORATION Date: August 20, 2001 /s/ J. Dwane Baumgardner J. Dwane Baumgardner Chairman, Chief Executive Officer and President Date: August 20, 2001 /s/ Kevin L. Brown Kevin L. Brown Senior Vice President and Chief Financial Officer 19