10-Q 1 d10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO _________ CII TECHNOLOGIES, INC. (Exact name of registrant as specified in its charter) North Carolina 56-182-82-70 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1200 Ridgefield Blvd., Suite 200, 28806 Asheville, North Carolina (Zip Code) (Address of principal executive offices) (828) 670-5300 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [_] No Part 1. Financial Information Item 1. Financial Statements CII TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands Except Share Amounts)

See notes to unaudited condensed consolidated financial statements CII TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (Unaudited) (In Thousands)

See notes to unaudited condensed consolidated financial statements CII TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In Thousands)

See notes to unaudited condensed consolidated financial statements CII Technologies, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) (In thousands) 1. Basis of Presentation The accompanying condensed consolidated financial statements include the accounts of CII Technologies, Inc. and its wholly owned subsidiaries (the "Company"). The Company and it's subsidiaries, Kilovac Corporation ("Kilovac"), Electro-Mech S.A. de C.V. ("Electro-Mech"), Corcom, Inc. ("Corcom"), and Products Unlimited Corporation ("Products"), operate facilities in Asheville and Fairview, NC, Carpenteria, California, Juarez, Mexico, Libertyville, Sterling and Prophetstown, Illinois, Sabula and Guttenburg, Iowa, Mansfield, Ohio and Munich, Germany. The interim financial data as of and for the nine months ended September 30, 2001 and September 30, 2000 is unaudited and has been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, the interim financial data does not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In management's opinion, all adjustments (consisting only of adjustments of a normal recurring nature) necessary for a fair presentation have been included. The December 31, 2000 financial information is derived from audited consolidated financial statements, but excludes certain disclosures included in the Company's audited consolidated financial statements. Certain reclassifications have been made to the 2000 financial information in order to conform with the 2001 presentation. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2000 as well as the other information included in the Company's annual report filed on Form 10-K. The results of operations and cash flows for the interim periods presented are not necessarily indicative of the results for the year ending December 31, 2001 or any other interim period. 2. Recapitalization and Joint Ventures Recapitalization On September 18, 1997, the Company entered into a series of recapitalization transactions (collectively the "Transactions"). The Transactions are described below. Code, Hennessy & Simmons III, L.P., certain members of Company management and certain other investors acquired approximately 87% of the capital stock of CIIT Holdings, Inc., a Delaware Corporation (the "Parent"). The Company is a wholly owned subsidiary of the Parent. Certain of the Parent's existing stockholders, including certain members of management, retained approximately 13% of the Parent's capital stock (collectively, the "Recapitalization"). Concurrently, the Company issued $95.0 million of 10% Senior Subordinated Notes due 2004 (the "Old Notes") pursuant to an Indenture, dated September 18, 1997, by and among The Company, Kilovac, Kilovac International, Inc. ("Kilovac International") and Norwest Bank Minnesota, National Association (the "Indenture") through a private placement offering permitted by Rule 144A of the Securities Act of 1933, as amended (the "Offering"). On January 30, 1998, the Company filed a registration statement with the Securities and Exchange Commission for the registration of its 10% Senior Subordinated Notes due 2004, Series "B" (the "Notes") to be issued in exchange for the Old Notes (the "Exchange"). The registration statement became effective on January 30, 1998 and the Exchange was completed on March 9, 1998. Additionally, the Company paid a dividend of approximately $59.4 million to the Parent. Joint Ventures In January 1999, the Company formed a joint venture, Shanghai CII Electronics Co. Ltd. with Shanghai CI Electric Appliance Co. Ltd. (the "Chinese Joint Venture"). Each party holds 50% of the shares of the company. The Company accounts for the Chinese Joint Venture using the equity method. The Chinese Joint Venture is a manufacturer and marketer of relay components. The Company's initial investment was approximately $144. The Chinese Joint Venture began production in March 1999. In February, 2001, the Company and Shanghai CI Electric Appliance Co., Ltd., each invested an additional $100. The outstanding investment in the Chinese Joint Venture at December 31, 2000 and September 30, 2001 was $266 and $436, respectively. In November 1995, the Company formed a joint venture in India with Guardian Controls Ltd., an Indian Company, a bank and certain financial investors. The Company has a 40% interest in the joint venture which was formed for the purpose of manufacturing relays, relay components, and sub-assemblies in India for the domestic Indian market and global markets. The Company accounts for the Indian joint venture using the equity method. The joint venture started production during the fourth quarter of 1996. The recorded value of the investment in the joint venture at December 31, 2000 and September 30, 2001 was $155 and $136, respectively. 3. Inventories Components of inventory are as follows: September 30, December 31, 2001 2000 ---- ---- Finished goods $ 8,045 $ 8,498 Work-in-process 8,611 9,600 Raw materials and supplies 16,534 18,894 Reserve for obsolescence (5,529) (5,959) -------- -------- Total $ 27,661 $ 31,033 ======== ======== 4. Long -Term Debt Long-term debt consists of: September 30, December 31, 2001 2000 ---- ---- 10% Senior Subordinated Notes $ 95,000 $ 95,000 Senior Credit Facility - Term 69,031 75,380 Senior Credit Facility - Revolver 12,900 13,900 Note Payable 25 50 --------- --------- 176,956 184,330 Less: Current Portion (9,298) (8,592) --------- --------- Total $ 167,658 $ 175,738 ========= ========= Interest on the 10% Senior Subordinated Notes (the "Notes") is payable semi-annually in arrears on March 15 and September 15 of each year. The Notes will mature on September 15, 2004, unless previously redeemed, and the Company will not be required to make any mandatory redemption or sinking fund payment prior to maturity except in connection with a change in ownership. Beginning September 15, 2001, the Notes may be redeemed, in whole or in part, at the option of the Company, at the redemption prices set forth in the Indenture, plus, in each case, accrued and unpaid interest and premium, if any, to the date of the redemption. The Company and its wholly owned subsidiaries, Kilovac, Kilovac International, Corcom, and Products have guaranteed the Notes on a full, unconditional, and joint and several basis, which guarantees are fully secured by the assets of such guarantors. The Senior Credit Facility provides for a maximum credit facility of $115.0 million limited by outstanding indebtedness under the initial $90.0 million term loan agreements (as amended) or availability on the borrowing base, as defined in the loan agreement. All funds may be borrowed as either a base rate loan or LIBOR loan. For base rate loans and LIBOR loans an applicable margin is added to the base rate interest rate or the LIBOR interest rate based on a Consolidated Senior Leverage Ratio Level (as defined in the Senior Credit Facility). The base rate interest rate is the higher of a Reference Rate (as defined) or the federal funds rate plus 1/2%. The weighted average borrowing rate, calculated based on borrowings outstanding at September 30, 2000 and September 30, 2001 under base rate and LIBOR loans was 9.973% and 6.795%, respectively. The terms of the Senior Credit Facility and the Notes place certain restrictions on the Company including, but not limited to, the Company's ability to incur additional indebtedness, incur liens, pay dividends or make certain other restricted payments (as defined), consummate certain asset sales, enter into certain transactions with affiliates, merge or consolidate with any person or sell, assign, transfer, lease, convey or otherwise dispose of the assets of the Company and its subsidiaries. The Senior Credit Facility has a Mandatory prepayment clause based upon a calculation of excess cash flow (as defined in the Senior Credit Facility). Excess cash payments of $850 and $398 were made on March 30, 2000 and 2001, respectively. The Senior Credit Facility also contains financial covenants including interest coverage ratios, leverage ratios, limitations on capital expenditures and minimum levels of earnings before interest, taxes, depreciation and amortization, as defined by the Senior Credit Facility. As of September 30, 2001, the Company was in compliance with all of the terms of the Notes and the covenants of the Senior Credit Facility. The Company, its wholly owned subsidiaries, including Kilovac, Kilovac International, Corcom, Products and the Parent have guaranteed the Senior Credit Facility on a full, unconditional, and joint and several basis which guarantees are fully secured by the assets of such guarantors. Letters of credit outstanding under the Senior Credit Facility were $100 at September 30, 2001 and December 31, 2000. As of September 30, 2001, the Company had available unused borrowing capacity of approximately $12.0 million under the Senior Credit Facility. 5. Contingencies Litigation - From time to time the Company is a party to certain lawsuits and administrative proceedings that arise in the conduct of its business. While the outcome of the lawsuits and proceedings cannot be predicted with certainty, management believes that the lawsuits and proceedings, either singularly or in the aggregate, will not have a material adverse effect on the financial condition, results of operations or cash flows of the Company. Environmental Remediation - The Company has been identified as a potentially responsible party ("PRP") for investigation and cleanup costs at two sites under the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended ("CERCLA"). CERCLA provides for joint and several liability for the costs of remediating a site, except under certain circumstances. However, the Company believes it will be allocated responsibility for a relatively small percentage of the cleanup costs at each of these sites, and in both instances other PRP's will also be required to contribute to such costs. Although the Company's total liability for cleanup costs at these sites cannot be predicted with certainty, the Company does not currently believe that its share of those costs will have a material adverse effect on the Company's financial position or results of operations. Soil and groundwater contamination has been identified at and about the Company's Fairview, North Carolina facility resulting in that site's inclusion in the North Carolina Department of Environmental, Health & Natural Resource's Inactive Hazardous Waste Sites Priority List. The Company believes that the Fairview contamination relates to the past activities of a prior owner of the Fairview property (the "Prior Owner"). On May 11, 1995, the Company entered into a settlement agreement (the "Settlement Agreement) with the Prior owner, pursuant to which the Prior Owner agreed to provide certain funds for the investigation and remediation of the Fairview contamination in exchange for a release of certain claims by the Company. In accordance with the Settlement Agreement, the Prior Owner has placed $3.0 million in escrow to fund further investigation, the remediation of contaminated soils and the installation and running of a groundwater remediation system at the Fairview facility. The Company has used escrowed funds to complete investigation and soil cleanup activities, construct a groundwater treatment system and run that system for the past four years. As of September 30, 2001, approximately $1.3 million remained in the interest bearing escrow account. The Company has entered into an Administrative Order on Consent with the State of North Carolina to clean up the site and is responsible for investigation, soil remediation and groundwater remediation costs in excess of the escrowed amount, if any. The Company does not believe that the total investigation and remediation costs will exceed the amounts along with the interest earned on those amounts that the Prior Owner has deposited pursuant to the Settlement Agreement, to such an extent that it will have a materially adverse affect on the Company's financial position or results of operations. The Company has accrued a liability for the total remediation costs of $1.5 million as of September 30, 2001. The Company, as the current owner of a contaminated property, could be held responsible for the entire cost of investigating and remediating the site. Assets recorded in relation to the above environmental liabilities are approximately $1.37 million at December 31, 2000 and $1.32 at September 30, 2001. In connection with the Company's purchase of certain assets and certain liabilities of Hartman Electrical Manufacturing ("Hartman"), a division of Figgie International, Inc., which is now known as Scott Technologies, Inc. ("STI") (the "Hartman Acquisition"), the Company entered into an agreement pursuant to which it leased from a wholly-owned subsidiary of STI a manufacturing facility in Mansfield, Ohio, (the "Mansfield Property") at which Hartman has conducted operations (the "Lease"). The Mansfield Property may contain contamination at levels that will require further investigation and may require soil and/or groundwater remediation. The Lease included an indemnity of the lessor to the Company, guaranteed by STI, for certain environmental liabilities in connection with the Mansfield Property, subject to a dollar limitation of $12.0 million. On or about January 5, 2000, the Company entered into an agreement with the Lessor in which it purchased the property and certain equipment. This agreement followed the decision by the Lessor's registered environmental consultant that no further environmental remediation was needed at the property so long as the property was restricted to industrial usage. The agreement preserves the Lease indemnity but reduces the indemnity cap to $1,000,000 over ten years if the former owner does not seek and obtain a covenant not to sue from the Ohio EPA relating to the site and reduces the cap to $0 over ten years if it obtains a covenant not to sue relating to the site from the Ohio EPA. In either event, the agreement leaves in place the Company's right to seek contribution or indemnity under common law or statute from STI for environmental problems. As an owner of the Mansfield Property, the Company may become subject to liability for remediation of such contamination at and/or from such property, which liability may be joint and several except under certain circumstances. The Company believes that actual remediation costs, if any, will not exceed STI's indemnification obligation. If there are remediation costs that the Company is held liable for and the Company is unable to obtain, or is delayed in obtaining indemnification from STI for any reason, the Company could be adversely affected. The Company does not maintain environmental impairment liability insurance. 6. Segment Disclosure The Company has five business units which have been aggregated into two reportable segments that are managed separately because each operating segment represents a strategic business platform that offers different products and serves different markets. The Company's two reportable operating segments are: (i) the High Performance Group ("HPG") and (ii) the Specialized Industrial Group ("SIG"). HPG includes Communications Instruments Division, Kilovac and Hartman. Products manufactured by HPG include high performance signal level relays and power relays, high voltage and power switching relays, solenoids and other electronic products. SIG includes Corcom, Products and the Midtex Brand. The SIG group manufactures RFI filters, general purpose relays, transformers and definite purpose contactors. The accounting policies of the operating segments are the same as those of the Company. Intersegment sales, which are eliminated in consolidation, are recorded at standard cost. In evaluating financial performance, management focuses on operating income as a segment's measure of profit or loss. Operating income is before interest expense, interest income, other income and expense, income taxes and extraordinary items. Financial information for the Company's operating segments and a reconciliation of reportable segment net sales, operating income, and assets to the Company's consolidated totals are as follows:

September 30, December 31, 2001 2000 ---- ---- Assets: High Performance Group $ 63,671 $ 63,460 Specialized Industrial Group 114,451 126,211 Corporate 3,480 5,871 ---------- ---------- Consolidated assets $ 181,602 $ 195,542 ========== ========== (1) - represents net sales between HPG and SIG (2) - included on the consolidated statements of cash flows as depreciation and amortization and included in the consolidated statement of operations as interest expense. Management does not consider these costs in managing the operations of the reportable segments. 7. Guarantor Subsidiaries The 10% Senior Subordinated Notes due on September 15, 2004 are fully and unconditionally guaranteed on a secured, joint and several basis by Kilovac, Kilovac International, Corcom, and Products, all of which are wholly owned subsidiaries of CII Technologies, Inc. (the "Guarantor Subsidiaries"). The following unaudited condensed consolidating financial data illustrates the composition of CII Technologies, Inc. (the "Primary Guarantor") and the Guarantor Subsidiaries as of September 30, 2000 and 2001. Investments in Guarantor Subsidiaries are accounted for by the Primary Guarantor on the equity method for purposes of the supplemental consolidating presentation. Earnings of Guarantor Subsidiaries are, therefore, reflected in the Primary Guarantor's investment accounts and earnings. The principal elimination entries eliminate the Primary Guarantor's investment in Guarantor Subsidiaries and intercompany balances and transactions. Condensed Consolidating Balance Sheet As of September 30, 2001 (In thousands) (Unaudited)

Condensed Consolidating Balance Sheet As of December 31, 2000 (In thousands)

Condensed Consolidated Statement of Income For the nine months ended September 30, 2001 (In thousands) (Unaudited)

Condensed Consolidated Statement of Income For the nine months ended September 30, 2000 (In thousands) (Unaudited)

Condensed Consolidated Statement of Income For the three months ended September 30, 2001 (In thousands) (Unaudited)

Condensed Consolidated Statement of Income For the three months ended September 30, 2000 (In thousands) (Unaudited)

Condensed Consolidated Statement of Cash Flows For the nine months ended September 30, 2001 (In thousands) (Unaudited)

Condensed Consolidated Statement of Cash Flows For the nine months ended September 30, 2000 (In thousands)

8. New Accounting Pronouncements The Financial Accounting Standards Board issued SFAS No. 133, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The new standard establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company has not engaged in the past and does not anticipate engaging in the future in derivative or hedging activities. Therefore, the adoption of SFAS No. 138 has not had a significant impact on its financial condition or results of operations. The Financial Accounting Standards Board issued SFAS No. 142, Goodwill and Other Intangible Assets, effective for all fiscal quarters of fiscal years beginning after January 1, 2002. The new standard discontinues amortization of goodwill and indefinite lived intangible assets, and requires an annual review for impairment. The Company has not yet measured the impact on its results of operations of the adoption of SFAS No. 142. Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Introduction Some of the matters discussed below and elsewhere herein contain forward-looking statements regarding the future performance of the Company and future events. These forward looking statements are identified by the use of words such as "plans", "will", "expects", "intends" and similar words indicating a discussion of something other than historical facts. These matters involve risks and uncertainties that could cause actual results to differ materially from the statements contained herein. The following discussion and analysis provides information which management believes is relevant to an understanding of the operations and financial condition of the Company. This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto included in this quarterly report as well as in the Registrant's Annual Report for the year ended December 31, 2000 on Form 10-K. Results of Operations The following table sets forth information derived from the condensed consolidated statements of operations expressed as a percentage of net sales for the periods indicated. There can be no assurance that the trends in operating results will continue in the future.

Discussion of Consolidated Results of Operations Nine months Ended September 30, 2001 Compared to Nine months Ended September 30, 2000 Net sales of the Company for the nine months ended September 30, 2001, decreased $10.1 million, or 6.5%, to $145.8 million from $155.9 million for the corresponding period in 2000. This decrease is due primarily to (i) a continued general economic slowdown in some of the Company's served markets and (ii) continued price pressure partially offset by (iii) strong demand in the military/defense and commercial airframe markets, (iv) introduction of new products, (v) expanded geographic marketing initiatives, and (vi) continued competitive share gain. Gross profit of the Company for the nine months ended September 30, 2001, increased $160,000, or less than 1%, to $39.9 million from $39.7 million for the corresponding period in 2000. Gross profit as a percentage of net sales increased to 27.4% from 25.5% for the same period in 2000. The increase in gross profit as a percentage of net sales is due primarily to continued strong cost reductions and manufacturing efficiencies partially offset by continued price pressure. Selling expenses for the Company for the nine months ended September 30, 2001, remained the same at $10.4 million for the corresponding period in 2000. Selling expenses as a percentage of net sales increased to 7.2% from 6.7% in the same period in 2000. This increase in selling expenses as a percentage of net sales is due primarily to the same expenses necessary to promote the Company's business during a low revenue period. General and administrative expenses for the Company for the nine months ended September 30, 2001, decreased $700,000, or 7.2%, to $8.8 million from $9.5 million in 2000. General and administrative expenses as a percentage of net sales decreased to 6.0% from 6.1% for the corresponding period in 2000. This decrease in general and administrative expenses as a percentage of net sales is due primarily to the control of costs and continued cost reductions. Research and development expenses for the Company for the nine months ended September 30, 2001, increased $172,000, or 11.5%, to $1.7 million from $1.5 million for the corresponding period in 2000. Research and development expenses as a percentage of net sales increased to 1.1% from 1.0% for the same period in 2000. Research and development expenses as a percentage of net sales increased primarily due to increased new product development activities. Amortization of goodwill and other intangibles for the Company for the nine months ended September 30, 2001, decreased to $3.4 million from $3.7 million for the corresponding period in 2000. Facility relocation charges for the nine months ended September 30, 2001 were $67,000 as compared to $821,000 for the same period in 2000. The charges in 2001 and in 2000 were in connection with the Company's planned relocation of its Midtex Facility. The facility relocation charges include but are not limited to employee separation charges and costs to relocate the product lines to the Company's Joint Ventures. The relocation of the Midtex Facility was completed by April 30, 2001. Interest expense of the Company for the nine months ended September 30, 2001, decreased $1.3 million or 8.6%, to $13.4 million from $14.7 million for the corresponding period in 2000. The decrease was due primarily to decreased interest rates and lower debt. The income tax expense of the Company for the nine months ended September 30, 2001 was 71.8% of income before income taxes as compared to an income tax expense of 44.8% of loss before income taxes for the corresponding period in 2000. The high effective tax rates are due primarily to a portion of the amortization of goodwill and intangibles not deductible for tax purposes. Three Months Ended September 30, 2001 Compared to Three Months Ended September 30, 2000 Net sales of the Company for the quarter ended September 30, 2001, decreased $10.4 million, or 19.1%, to $44.1 million from $54.5 million for the corresponding period in 2000. This decrease is due primarily to (i) a continued general economic slowdown in some of the Company's served markets, and (ii) continued price pressure, partially offset by (iii) strong demand in the military/defense and commercial airframe markets, (iv) introduction of new products, (v) expanded geographic marketing initiatives, and (vi) continued competitive share gain. Gross profit of the Company for the quarter ended September 30, 2001, decreased $1.3 million, or 9.5%, to $12.8 million from $14.1 million for the corresponding period in 2000. Gross profit as a percentage of net sales increased to 29.1% from 26.0% for the same period in 2000. The increase in gross profit as a percentage of net sales is due primarily to continued strong cost reductions and manufacturing efficiencies partially offset by continued price pressure. Selling expenses for the Company for the quarter ended September 30, 2001, decreased $672,000, or 18.2%, to $3.0 million from $3.7 million for the corresponding period in 2000. Selling expenses as a percentage of net sales remained the same at 6.8% in the same period in 2000. General and administrative expenses for the Company for the quarter ended September 30, 2001, decreased $523,000, or 16.2%, to $2.7 million from $3.2 million in 2000. General and administrative expenses as a percentage of net sales increased to 6.1% from 5.9% for the corresponding period in 2000. This increase in general and administrative expenses as a percentage of net sales is due primarily to lower net sales partially offset by the control of costs and continued cost reductions. Research and development expenses for the Company for the quarter ended September 30, 2001, remained the same at $555,000 for the corresponding period in 2000. Research and development expenses as a percentage of net sales increased to 1.3% from 1.0% for the corresponding period in 2000. Research and development expenses as a percentage of net sales increased primarily due to lower net sales and increased new product development activities. Amortization of goodwill and other intangibles for the Company for the quarter ended September 30, 2001, decreased $84,000 or 6.8% to $1.1 million from $1.2 million in 2000. There were no facility relocation charges for the three months ended September 30, 2001 as compared to $21,000 for the same period in 2000. The charges in 2000 were in connection with the Company's planned relocation of its Midtex Facility. The facility relocation charges include but are not limited to employee separation charges and costs to relocate the product lines to the Company's Joint Ventures. The relocation of the Midtex Facility was completed by April 30, 2001. Interest expense of the Company for the three months ended September 30, 2001, decreased $749,000, or 15.1%, to $4.2 million from $4.9 million for the corresponding period in 2000. The decrease was due primarily to decreased interest rates and lower debt. The income tax expense of the Company for the three months ended September 30, 2001 was 55.6% of profit before income taxes as compared to an income tax expense of 83.3% of income before income taxes for the corresponding period in 2000. The high effective tax rates are due primarily to a portion of the amortization of goodwill and intangibles not deductible for tax purposes. Segment Discussion Nine months Ended September 30, 2001 Compared to Nine months Ended September 30, 2000 High Performance Group Net sales of HPG for the nine months ended September 30, 2001 increased by $8.3 million, or 13.6%, to $69.1 million from $60.8 million for the corresponding period in 2000. This increase is due primarily to (i) strong demand in the military/defense and commercial airframe markets, (ii) the introduction of new products, (iii) expanded geographic marketing initiatives, and (iv) continued competitive share gain partially offset by (v) continued price pressure. Operating income of HPG for the nine months increased $6.3 million, or 68.8%, to $15.4 million from $9.1 million for the same period in 2000. Operating income of HPG as a percentage of HPG net sales increased to 22.3% from 15.0% for the same period in 2000. The increase in operating income as a percentage of net sales is due primarily to (i) the control of fixed costs, and (ii) continued strong cost reductions and manufacturing efficiencies partially offset by (iii) continued price pressure, and (iv) higher sales commission on higher revenues. Specialized Industrial Group Net sales of SIG for the nine months ended September 30, 2001 decreased $18.7 million or 19.6%, to $76.8 million from $95.5 million for the same period in 2000. This decrease is due primarily to (i) a continued general economic slowdown in some of the Company's served markets, and (ii) continued price pressure, partially offset by (iii) the introduction of new products, and (iv) continued competitive share gain. Operating income of SIG for the nine months ended decreased $4.5 million, or 62.4%, to $2.8 million from $7.3 million for the same period in 2000. Operating income of SIG as a percentage of SIG net sales decreased to 3.6% from 7.7% for the same period in 2000. This decrease in operating income as a percentage of net sales is due primarily to (i) a continued general economic slowdown in some of the Company's served markets, (ii) labor and material inflation, (iii) unfavorable currency exchange rates, (iv) continued competitive price pressures and (v) increased selling expenses necessary to promote the Company's business, partially offset by (vi) continued strong cost reductions and manufacturing efficiencies, and (vii) the control of fixed costs. Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000 High Performance Group Net sales of HPG for the quarter ended September 30, 2001 increased by $2.3 million, or 11.0%, to $23.2 million from $20.9 million for the corresponding period in 2000. This increase is due primarily to (i) strong demand in the military/defense and commercial airframe markets, (ii) introduction of new products, (iii) expanded geographic marketing initiatives, and (iv) continued competitive share gain partially offset by (v) continued price pressure. Operating income of HPG for the quarter ended September 30, 2001 increased $2.6 million, or 77.9%, to $5.8 million from $3.2 million for the same period in 2000. Operating income of HPG as a percentage of HPG net sales increased to 24.9% from 15.5% for the same period in 2000. The increase in operating income as a percentage of net sales is due primarily to (i) the control of fixed costs, and (ii) continued strong cost reductions and manufacturing efficiencies partially offset by (iii) continued price pressure, and (iv) higher sales commission on higher revenues. Specialized Industrial Group Net sales of SIG for the quarter ended September 30, 2001 decreased $12.7 million, or 37.9%, to $20.9 million from $33.6 million for the same period in 2000. This decrease is due primarily to (i) continued general economic slowdown in some of the Company's served markets compared to a prior year peak demand in those same served markets and (ii) continued price pressure, partially offset by (iii) the introduction of new products, and (iv) continued competitive share gain. Operating income of SIG for the quarter ended September 30, 2001 decreased $2.7 million, or 85.8%, to $444,000 from $3.1 million for the same period in 2000. Operating income of SIG as a percentage of SIG net sales decreased to 2.1% from 9.3% for the same period in 2000. This decrease in operating income as a percentage of net sales is due primarily to (i) a continued general economic slowdown in some of the Company's served markets, (ii) unfavorable currency exchange rates, (iii) continued competitive price pressure, partially offset (iv) continued strong cost reductions and manufacturing efficiencies, and (v) the control of fixed costs. Liquidity and Capital Resources Cash provided by operating activities for the nine months ended September 30, 2001 increased $4.0 million to $8.7 million from $4.7 million for the same period in 2000. This increase in cash provided by operations is due primarily to (i) an increase in income, (ii) lower interest payments, and (iii) continued focus and improvements on all elements of working capital and operating cash flows. The days' sales outstanding for accounts receivable was approximately 52.2 trade days at September 30, 2001 and 49.6 at December 31, 2000. The Company's inventories decreased from $31.0 million at December 31, 2000 to $27.7 million at September 30, 2001. Inventory turns were 4.6 at September 30, 2001 and 4.8 at December 31, 2000. The Company continually focuses on improving its inventory management. The Company has historically financed its operations through a combination of internally generated funds and secured borrowings. Capital expenditures were $3.0 million for the nine months ended September 30, 2001 and $3.8 million for the corresponding period in 2000. Additional investments in joint ventures was $100,000 for the nine months ended September 30, 2001. The Company has a borrowing arrangement with a bank which provides for a maximum credit facility of $115.0 million (including $3.0 million for stand-by letters of credit), limited by outstanding indebtedness under the initial $35.0 million term loan agreement ("Tranche A") and the $55.0 million term loan agreement ("Tranche B") or availability on the borrowing base, as defined in the loan agreement (the "Senior Credit Facility"). The amount available for borrowings under the Senior Credit Facility at September 30, 2001 was $12.0 million. All funds may be borrowed as either a base rate loan or LIBOR loan. For base rate loans and LIBOR loans an applicable margin is added to the base rate interest rate or the LIBOR interest rate based on a Consolidated Senior Leverage Ratio Level (as defined in the Senior Credit Facility). The base rate interest rate is the higher of a Reference Rate (as defined) or the federal funds rate plus 1/2%. The weighted average borrowing rate, calculated based on borrowings outstanding at September 30, 2001 and September 30, 2000 under base rate and LIBOR loans was 6.795% and 9.973%, respectively. The Senior Credit Facility requires the Company to pay commitment fees of 0.5% on the undrawn amount of the Senior Credit Facility, subject to adjustment based on the Consolidated Senior Leverage Ratio of the Company. Although there can be no assurances, the Company anticipates that its cash flow generated from operations and borrowings under the Senior Credit Facility will be sufficient to fund the Company's working capital needs, planned capital expenditures, scheduled interest payments and its business strategy for the next twelve months. However, the Company may require additional funds if it enters into strategic alliances, acquires significant assets or businesses or makes significant investments in furtherance of its growth strategy. The ability of the Company to satisfy its capital requirements will depend upon the future financial performance of the Company, which in turn will be subject to general economic conditions and to financial, business, and other factors, including factors beyond the Company's control. Instruments governing the Company's indebtedness, including the Senior Credit Facility and the Company's Senior Subordinated Notes (the "Notes"), contain financial and other covenants that restrict, among other things, the Company's ability to incur additional indebtedness, incur liens, pay dividends or make certain other restricted payments, consummate certain asset sales, enter into certain transactions with affiliates, merge or consolidate with any other person or sell, assign transfer, lease, convey or otherwise dispose of substantially all of the assets of the Company. Such limitations, together with the highly leveraged nature of the Company, could limit corporate and operating activities, including the Company's ability to respond to changing market conditions, to provide for unanticipated capital investments or to take advantage of business opportunities. The Company was in compliance with its financial covenants as of September 30, 2001. The Senior Credit Facility has a mandatory prepayment clause (the "Excess Cash Payment"), which requires that excess cash flow (as defined in the Senior Credit Facility) be used to prepay the Senior Credit Facility within 90 days after the last day of the fiscal year. The Excess Cash Payment was $850 and $398 for the years ended December 31, 1999 and 2000, respectively. Adjusted EBITDA Adjusted EBITDA represents income (loss) before interest expense (net), income taxes, depreciation and amortization, before any gain (loss) on disposal of assets, adjusted for extraordinary, unusual, and nonrecurring items, the non cash charges resulting from the Parent stock options granted in 2000 and in 2001, and facility relocation charges. Adjusted EBITDA is not intended to represent cash flow from operations or net income as defined by generally accepted accounting principles and should not be considered as a measure of liquidity or an alternative to, or more meaningful than, operating income or operating cash flow as an indication of the Company's operating performance. Adjusted EBITDA is included herein because management believes that certain investors find it a useful tool for measuring the Company's ability to service its debt. There are no significant commitments for expenditures of funds not contemplated by this measure of adjusted EBITDA. Adjusted EBITDA as presented may not be comparable to other similarly titled measures presented by other companies and could be misleading unless substantially all companies and analysts calculate adjusted EBITDA the same. Adjusted EBITDA for the nine months ended September 30, 2001 increased to $25.3 million from $24.5 million for the corresponding period in 2000. Adjusted EBITDA for the three months ended September 30, 2001 increased to $8.8 million from $8.7 million for the same period in 2000. Inflation --------- Management does not believe that inflation historically had a significant effect on the Company's business. While Management does believe that inflation began to have an unfavorable impact on the Company's business during 1999 and 2000 due to a tighter US labor market which Management believes has caused labor costs to increase at a higher percentage level than in previous years, the effect of this inflation has begun to dissipate in 2001. Disclosure Regarding Forward-Looking Statements ----------------------------------------------- Statements made by the Company which are not historical facts are forward looking statements that involve risks and uncertainties. Actual results could differ materially from those expressed or implied in forward looking statements. All such forward looking statements are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward looking statements are identified by the use of words such as "plans", "will", "expects", "intends" and similar words indicating a discussion of something other than historical facts. Important factors that could cause future financial performance to differ materially from past results and from those expressed or implied in this document, include, without limitation, the risks of acquisition of businesses (including limited knowledge of the businesses acquired and potential misrepresentations from sellers), changes in business strategy or development plans, dependence on independent sales representatives and distributors, environmental regulations, availability of financing, competition, reliance on key management personnel, ability to manage growth, loss of customers and a variety of other factors. The Company makes no commitment to update any forward looking statements or to disclose any facts, events, or circumstances after the date hereof that may affect the accuracy of any forward looking statement. Item 3: Quantitative and Qualitative Disclosures about Market Risk The Company is exposed to market risks from changes in interest rates and foreign currency exchange rates which may adversely affect its results of operations and financial condition. The Company seeks to minimize these risks through its regular operating and financing activities. The Company engages in neither speculative nor derivative financial or trading activities. Interest Rate Risk The Company has exposure to interest rate risk related to certain instruments entered into for other than trading purposes. Specifically, the Company has in place the Senior Credit Facility, which consists of two term loans, Tranche A with a balance of $16.1 million at September 30, 2001, Tranche B with a balance of $52.9 million at September 30, 2001 and $12.9 million outstanding on the Revolving Credit Facility all of which bear interest at variable rates. Borrowings under the Senior Credit Facility bear interest based on the Lenders' Reference Rate (as defined in the credit agreement) or LIBOR Rate plus an applicable margin. While changes in the Reference Rate or the LIBOR Rate could affect the cost of funds borrowed in the near future, only $1.4 million of the Revolving Credit Facility at September 30, 2001 was carried at a variable rate, with the remainder of the Senior Credit Facility on short term fixed rates. The Company, therefore, believes the effect, if any, of reasonable possible near-term changes in interest rates on the Company's consolidated financial position, results of operations and cash flows would not be material. The Company's 10% Senior Subordinated Notes ("the Notes") are at a fixed interest rate of 10%. As a result, a change in the fixed rate interest market would change the estimated fair market value of its fixed rate long-term bond debt. The Company believes that a 10% change in the long term interest rates would not have a material effect on the Company's financial conditions, results of operations or cash flows. While the Company historically has not used interest rate swaps, it may, in the future, use interest rate swaps to assist in managing the Company's overall borrowing costs and reduce exposure to adverse fluctuations in interest rates. Foreign Currency Exchange Risk The Company has seven foreign subsidiaries or divisions, located in Mexico, Germany, Jamaica, Barbados and Hong Kong as well as Joint Ventures in India and China. The Company generates about 18% of its net sales from customers located outside the United States. The Company's ability to sell its products in these foreign markets may be affected by changes in economic, political or market conditions in the foreign markets in which it does business. The Company experiences foreign currency translations gains and losses, which are reflected in the Company's consolidated statement of operations and comprehensive income and loss, due to the strengthening and weakening of the US dollar against the currencies of the Company's foreign subsidiaries or divisions and the resulting effect on the valuation of the intercompany accounts and certain assets of the subsidiaries which are denominated in US dollars. The net loss resulting from foreign currency translations was $41,000 in the nine months ended September 30, 2001 compared to a net loss of $134,000 in the comparable period of 2000. The net gain resulting from foreign currency translations was $85,000 in the three months ended September 30, 2001 compared to a net loss of $76,000 for the same period in 2000. The Company anticipates that it will continue to have exchange gains or losses from foreign operations in the future. Part II -Other Information Item 1. Legal Proceedings - None Item 2. Changes in Securities - None Item 3. Defaults Upon Senior Securities - None Item 4. Submission of Matters to a Vote of Security Holders - Not Applicable Item 5. Other Information - None Item 6. Exhibits and Reports on Form 8-K See Index of Exhibits. SIGNATURES CII Technologies, Inc. November 14, 2001 /s/ Michael A. Steinback ---------------------------- ------------------------------------------- Date Michael A. Steinback President and Chief Executive Officer November 14, 2001 /s/ Richard L. Heggelund ---------------------------- ------------------------------------------- Date Richard L. Heggelund Vice President and Chief Financial Officer INDEX TO EXHIBITS EXHIBIT NUMBER DESCRIPTION OF DOCUMENT -------------------------------------------------------------------------------- 2.1+ Agreement and Plan of Merger, dated as of March 10, 1998, by and among the Company, RF Acquisition Corp. and Corcom, Inc. is incorporated herein by reference to Report on Form 8-K (File Number 333-38209) 3.1 Articles of Incorporation of the Company is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 3.2 By-laws of the Company is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 4.1 Indenture dated as of September 18, 1997 by amd among the Company, Kilovac, Kilovac International and Norwest Bank Minnesota, National Association, is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 4.2 Purchase Agreement dated as of September 12, 1997 between the Company, Kilovac and Kilovac International and BancAmerica Securities, Inc., and Salomon Brothers, Inc., is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 4.3 Registration Rights Agreement dated as of September 18, 1997 between the Company, Kilovac and Kilovac International and BancAmerica Securities, Inc. and Salomon Brothers, Inc., is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 4.4 Supplemental Indenture, dated as of June 18, 1998 between Corcom, Inc. and Norwest Bank Minnesota, National Association is incorporated herein by reference to Report of Form 10-K (File Number 333-38209) 10.3 Employment Agreement dated as of May, 1993 between the Company and Michael A. Steinback is incorporated herein by reference to Registration Statement on Form S-4 10.4 Employment Agreement dated as of January 7, 1994 between the Company and David Henning is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.5 Management Agreement dated as of September 18, 1997 among the Company, Parent and CHS Management III, L.P. is incorporated by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.6 Tax Sharing Agreement dated as of September 18, 1997 between the Company, Parent, Kilovac International and Kilovac International FSC Ltd. is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.7+ Credit Agreement dated as of September 18, 1997 between the Company, Parent, various banks, Bank of American National Trust and Savings Association and BancAmerica Securities, Inc., is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.8 Pledge Agreements dated as of September 18, 1997 by Parent, the Company, Kilovac and Kilovac International in favor of Bank of America Trust and Savings Association, is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.9 Subsidiary Guarantee dated as of September 18, 1997 by Kilovac and Kilovac International in favor of Bank of American National Trust and Savings Association, is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.10 Security Agreement dated as of September 18, 1997 among Parent, the Company, Kilovac and Kilovac International in favor of Bank of America National Trust and Savings Association is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.11 Stock Subscription and Purchase Agreement dated as of September 20, 1995, by and among the Company, Kilovac and the stockholders and optionholders of Kilovac named therein, is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.12+ Asset Purchase Agreement dated as of June 27, 1996 between the Company and Figgie International Inc., is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.14 Lease Agreement dated as of July 2, 1996 by and between Figgie Properties, Inc. and Communications Instruments, Inc. d/b/a Hartman Division of CII Technologies, Inc. is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.15 Second Amendment to Stock Subscription and Purchase Agreement dated as of August 26, 1996, by and among the Company, Kilovac and certain selling stockholders, is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.16+ Recapitalization Agreement dated as of August 6, 1997 among Parent, certain investors and certain selling stockholders, is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.17 Amendment to the Recapitalization Agreement dated as of September 18, 1997 by and among Parent, certain investors and certain selling stockholders, is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.18 Indemnification and Escrow Agreement dated as of September 18, 1997 by and among Parent, certain investors, certain selling stockholders and American National Bank and Trust Company of Chicago, is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.19 Stockholders Agreement dated September 18, 1997 by and among Parent and certain of its stockholders, is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.20 Registration Agreement dated as of September 18, 1997 by and among Parent and certain of its stockers is incorporated by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.21 Form of Junior Subordinated Promissory Note of Parent is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.22 Employment Agreement dated as of October 11,1995 between Kilovac and Dan McAllister is incorporated herein by reference to Registration Statement on Form S-4 (File Number 333-38209) 10.26 Asset Purchase Agreement dated as of November 30, 1997 by and between the Company and Genicom Corporation is incorporated by reference to Report on Form 8-K (File Number 333-38209) 10.27+ Stock Purchase Agreement daed as of October 31, 1997 by and between the Company and Societe Financiere D'Investissements Dans L'Equipement et la Construction Electrique, S.A., the sole stockholder of ibex Aerospace Technologies, Inc. is incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 10.28+ Asset Purchase Agreement dated May 6, 1998, between Kilovac Corporation, Zerubavel Heifetz, Cesar Marestaing and Wilmar Electronics, Inc. is incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 10.29+ Asset Purchase Agreement dated as of July 24, 1998, by and between the Company and Cornell-Dubilier Electronics, Inc. 10.30 Voting Agreement dated as of March 10, 1998, by and among RF Acquisition Corp., Werner E. Newman and James A. Steinback is incororated herein by reference to Report on Form 10-K (File Number 333-38209) 10.31+ Credit Agreement dated as of June 19, 1998, among the Company, Parent, Bank of American National Trust and Savings Association and certain other lending institutions from time to time a party thereto is incorporated herein by reference to Report of Form 10-K (File Number 333-38209) 10.32+ Pledge Agreement dated as of June 19, 1998, among Parent, the Company, Kilovac and Kilovac International in favor of Bank of America National Trust and Savings Association is incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 10.33+ Subsidiary Guarantee dated as of June 19, 1998 by Kilovac, Kilovac International and Corcom, Inc. in favor of Bank of American National Trust and Savings Association is incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 10.34+ Security Agreement dated as of June 19, 1998, among Parent, the Company, Kilovac, Kilovac International and Corcom, Inc. in favor of Bank of American National Trust and Savings Association is incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 10.35+ Stock Purchase Agreement dated March 19, 1999, by and among Products Unlimited Corporation, the Stockholders of Products Unlimited Corporation and the Company is incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 10.36+ Amended and restated Credit Agreement among Parent, the Company, various lenders, NationsBank, N.A., as an Issuing Lender and Swingline Lender, and NationsBank, N.A. as the Administrative Agent, is incorporated herein by reference to Report on Form 8-K (File Number 333-38209) 10.37+ Amended and restated Subsidiary Guaranty by certain subsidiaries of the Company in favor of NationsBank, N.A. is incorporated herein by reference to Report on Form 8-K (File Number 333-38209) 10.38+ Amended and restated Security Agreement among Parent, the Company, certain subsidiaries of the Company and Bank of America National Trust and Savings Association, as collateral agent, is incorporated herein by reference to Report on Form 8-K (File Number 333-38209) 10.39+ Amended and restated Pledge Agreement by Parent, the Company and certain subsidiaries of the Company in favor of Bank of America National Trust and Savings Association, as collateral agent, is incorporated herein by reference to Report of Form 8-K (File Number 333-38209) 10.40 First Amendment and Waiver to Credit Agreement, among Parent, the Company, various lenders, Bank of America N.A. as Administrative Agent. 10.41 Second Amendment to Credit Agreement, among Parent, the Company various lenders, Bank of America N.A., as Administrative Agent, is incorporated herein by reference to Report on Form 10-Q (File Number 333-38209) 10.42 Employment Agreement dated as of May 22, 2000 between CII Technologies, Inc. and John J. Butler incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 10.43 Employment Agreement dated as of November 3, 2000 between CII Technologies, Inc. and Ramzi Dabbagh incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 10.44 1997 CII Technologies, Inc. Stock Option Plan incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 10.45 Property Transfer and Settlement Agreement dated January, 2000 by and between STI Properties, Inc., Scott Technologies, Inc. and Communications Instruments, Inc. incorporated herein by reference to Report on Form 10-K (File Number 333-38209) 11.1 Statement re-Computation of Per Share Earnings. Not required because the relevant computations can be clearly determined from the material contained in the financial statements included herein + The Company agrees to furnish supplementally to the Commission a copy of any omitted schedule to such agreement upon the request of the Commission in accordance with Item 601 of the Regulation S-K.

COMMUNICATIONS INSTRUMENTS INC 10-Q