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CIX > SEC Filings for CIX > Form 10-K on 5-Mar-2014All Recent SEC Filings

Show all filings for COMPX INTERNATIONAL INC

Form 10-K for COMPX INTERNATIONAL INC


5-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Business Overview

We are a leading manufacturer of engineered components utilized in a variety of applications and industries. Through our Security Products segment we manufacture mechanical and electrical cabinet locks and other locking mechanisms used in recreational transportation, postal, office and institutional furniture, cabinetry, tool storage and healthcare applications. We also manufacture stainless steel exhaust systems, gauges and throttle controls for the recreational marine and other industries through our Marine Components segment.

In December 2012, we completed the sale of our Furniture Components segment for proceeds (net of expenses) of approximately $58.0 million in cash. We recognized a pre-tax gain of approximately $29.6 million on the disposal of these operations ($27.6 million, net of income taxes of approximately $1.9 million) in the fourth quarter of 2012. Our Furniture Components segment primarily sold products with lower average margins and higher commodity raw material content than other segments of our business. We believe disposing of our Furniture Components segment has enabled us to focus more effort on continuing to develop the remaining portion of our business that we believe has greater opportunity for higher returns and with less volatility in the cost of commodity raw materials. See Note 2 to the Consolidated Financial Statements. Unless otherwise noted the results of operations in management's discussion and analysis is focused on continuing operations.

Operating Income Overview

We reported operating income of $9.3 million in 2013 compared to operating income of $5.4 million in 2012 and $6.4 million in 2011. The comparison between 2013 and 2012 was primarily impacted by:

the positive impact of higher demand for our Security Products segment's high security pin tumbler locks in 2013;

the assets held for sale write-down in 2012; and

the negative impact of an increase in self-insured medical expenses in 2013.

The comparison between 2012 and 2011 was primarily impacted by:

the positive impact of higher sales in 2012 from an increase in customer order rates across most markets due to somewhat improved economic conditions in North America;

the negative impact of an increase in self-insured medical costs in 2012; and

the negative impact of an increase in general and administrative expenses in 2012.

Our product offerings consist of a significantly large number of products that have a wide variation in selling price and manufacturing cost, which results in certain practical limitations on our ability to quantify the impact of changes in individual product sales quantities and selling prices on our net sales, cost of goods sold and gross profit. In addition, small variations in period-to-period net sales, cost of goods sold and gross profit can result from changes in the relative mix of our products sold.

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Results of Operations - 2013 Compared to 2012 and 2012 Compared to 2011



                                              Years ended December 31,                      %Change
                                         2011            2012          2013         2011-12         2012-13
                                               (Dollars in millions)
Net sales                              $    79.8       $   83.2      $   92.0              4 %            11 %
Cost of goods sold                          55.7           58.9          64.4              6 %            10 %

Gross profit                                24.1           24.3          27.6              1 %            13 %

Operating costs and expenses                16.6           17.7          18.3              7 %             3 %
Write-down and loss on disposal of
assets held for sale                         1.1            1.2             -              2 %           100 %

Operating income                       $     6.4       $    5.4      $    9.3            (16 %)           72 %

Percent of net sales:
Cost of goods sold                            70 %           71 %          70 %
Gross margin                                  30 %           29 %          30 %
Operating costs and expenses                  21 %           21 %          20 %
Write-down and loss on disposal of
assets held for sale                           1 %            1 %           - %
Operating income                               8 %            7 %          10 %

Net Sales. Net sales increased approximately $8.8 million in 2013 principally due to higher demand for high security pin tumbler locks within the Security Products segment, and to a lesser extent from an increase in Marine Component sales outside of the high performance boat market through gains in market share. Relative changes in selling prices did not have a material impact on net sales comparisons.

Net sales increased approximately $3.4 million in 2012 principally due to growth in customer demand within both of our segments resulting from somewhat improved economic conditions in North America. Additionally, Marine Components experienced a $900,000 increase in sales to the ski/wakeboard boat market. Relative changes in selling prices did not have a material impact on net sales comparisons.

Costs of Goods Sold and Gross Margin. Cost of goods sold and gross profit both increased from 2012 to 2013 primarily due to increased sales volumes. As a percentage of sales, cost of goods sold decreased 1% resulting in an increase in gross margin of 1% primarily due to improved cost efficiencies from higher sales, partially offset by higher self-insured medical costs in 2013 as discussed below.

Cost of goods sold and gross profit both increased from 2011 to 2012 primarily due to increased sales volumes. As a percentage of sales, cost of goods sold increased 1% resulting in a decrease in gross margin of 1% primarily due to the net effects of the increase in sales partially offset by higher self-insured medical costs as discussed below.

Operating Costs and Expenses. Operating costs and expenses consists primarily of sales and administrative related personnel costs, sales commissions and advertising expenses directly related to product sales and administrative costs relating to business unit and corporate management activities, as well as gains and losses on plant, property and equipment. Operating costs and expenses increased in 2013 compared to 2012, and increased in 2012 as compared to 2011, as a result of increased administrative support costs relating to the higher sales. Additionally, in 2012 we incurred higher costs relating to the assets held for sale.

Write-down and loss on disposal of assets held for sale. We recorded write-downs on assets held for sale of $1.1 million and $1.2 million (including a $757,000 loss on disposal of assets held for sale) in 2011 and 2012, respectively, relating to certain facilities held for sale that were no longer in use. The write-downs are included in corporate operating expense. See Note 7 to the Consolidated Financial Statements.

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Operating Income. As a percentage of net sales, operating income increased by 3% in 2013 compared to 2012, and decreased by 1% in 2012 compared to 2011 and was primarily impacted by the factors impacting cost of goods sold, gross margin and operating costs, and write-down and loss on disposal of assets held for sale discussed above.

General

Our profitability primarily depends on our ability to utilize our production capacity effectively, which is affected by, among other things, the demand for our products and our ability to control our manufacturing costs, primarily comprised of labor costs and materials. The materials used in our products consist of purchased components and raw materials some of which are subject to fluctuations in the commodity markets such as zinc, brass and stainless steel. Total material costs represented approximately 44% of our cost of sales in 2013, with commodity related raw materials accounting for approximately 11% of our cost of sales. Worldwide commodity raw material costs increased throughout 2011, although during 2012 and 2013 they were mostly stable. We occasionally enter into short-term commodity related raw material supply arrangements to mitigate the impact of future increases in commodity related raw material costs. These arrangements generally provide for stated unit prices based upon specified purchase volumes, which helps us to stabilize commodity related raw material purchase prices to a certain extent. We enter into such arrangements for zinc and brass. We expect commodity related raw material prices to moderately increase in 2014 in conjunction with higher demand as a result of the expected growth in the world wide economy. These raw materials purchased on the spot market are sometimes subject to unanticipated and sudden price increases. We generally seek to mitigate the impact of fluctuations in commodity raw material costs on our margins through improvements in production efficiencies or other operating cost reductions. In the event we are unable to offset cost increases for these raw materials with other cost reductions, it may be difficult to recover those cost increases through increased product selling prices or raw material surcharges due to the competitive nature of the markets served by our products. Consequently, overall operating margins may be affected by raw material cost pressures.

Interest income

Interest income was not significant in 2013 or 2012. Interest income decreased in 2012 compared to 2011 primarily due to the maturity of our $15 million promissory note receivable in October 2011 and lower cash balances available for investment. We expect our interest income to be insignificant in 2014.

Interest expense

Interest expense decreased in 2013 compared to 2012 due to the prepayment of the remaining outstanding principal amount of the note payable in July of 2013. See Note 9 to the Consolidated Financial Statements. Interest expense decreased in 2012 compared to 2011 as a result of the significant reduction in the principal balance of the note payable of $15.0 million in October of 2011 upon collection of the promissory note receivable discussed above. The average interest rate on the note payable at December 31, 2011 and 2012 was 1.3% and 1.5%, respectively. Our outstanding balance on the credit facility through October of 2012 was $2.0 million which was repaid in full in November of 2012 and terminated as of December 31, 2012. During 2011, we averaged $2.4 million outstanding on our revolving credit facility (4.4% at December 31, 2011). We expect our interest expense in 2014 to be insignificant.

Provision for income taxes

A tabular reconciliation between our effective income tax rate and the U.S. federal statutory income tax rate of 35% is included in Note 10 to the Consolidated Financial Statements. As a member of the group of companies consolidated for U.S. federal income tax purposes with Contran, the parent of our consolidated U.S. federal income tax group, we compute our provision for income taxes on a separate company basis, using the tax elections made by Contran.

Our effective income tax rate attributable to continuing operations increased from 29% in 2012 to 35% in 2013. Our effective income tax rate attributable to continuing operations decreased from 42% in 2011 to 29% in

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2012. The changes in our effective income tax rate is primarily related to changes in our deferred income tax asset valuation allowance, which resulted in an expense of $341,000 in 2011 and a benefit of $317,000 and $102,000 in 2012 and 2013, respectively. See Notes 10 and 13 to the Consolidated Financial Statements. We currently expect our effective income tax rate for 2014 to be comparable to our effective income tax rate for 2013.

Discontinued operations

On December 28, 2012, we completed the sale of our Furniture Components segment to a competitor of that segment for proceeds (net of expenses) of approximately $58.0 million in cash. We recognized a pre-tax gain of approximately $29.6 million on the disposal of these operations ($27.6 million, net of income taxes of approximately $1.9 million) in the fourth quarter of 2012. See Note 2 to the Consolidated Financial Statements.

Segment Results

The key performance indicator for our segments is the level of their operating
income (see discussion below). For additional information regarding our segments
refer to Note 3 to the Consolidated Financial Statements.



                                         Years ended December 31,                           % Change
                                    2011            2012           2013          2011 - 2012         2012 - 2013
                                               (In millions)
Net sales:
Security Products                 $    71.4       $   73.7       $   81.5                   3 %                11 %
Marine Components                       8.4            9.5           10.5                  13 %                11 %
Total net sales                   $    79.8       $   83.2       $   92.0                   4 %                11 %

Gross profit:
Security Products                 $    23.1       $   23.0       $   25.8                   -                  12 %
Marine Components                       1.0            1.3            1.8                  31 %                43 %
Total gross profit                $    24.1       $   24.3       $   27.6                   1 %                13 %

Operating income (loss):
Security Products                 $    14.4       $   14.1       $   16.1                  (2 %)               14 %
Marine Components                      (1.2 )         (0.8 )         (0.1 )                33 %                82 %
Corporate operating expenses           (6.8 )         (7.9 )         (6.7 )               (18 %)               16 %
Total operating income            $     6.4       $    5.4       $    9.3                 (16 %)               72 %

Operating income (loss) margin:
Security Products                        20 %           19 %           20 %
Marine Components                       (15 %)          (9 %)          (1 %)
Total operating income margin             8 %            7 %           10 %

Security Products. Security Products net sales increased 11% to $81.5 million in 2013 compared to $73.7 million in 2012. The increase in sales is primarily due to an increase in sales to certain high security pin tumbler lock customers of $7.6 million. Growth of our Security Products segment was aided by our ongoing efforts to diversify our products and customers. Gross margin and operating income percentages increased in 2013 compared to 2012 by one percentage point primarily due to improved cost efficiencies from higher sales, partially offset by higher self-insured medical costs of $598,000 in 2013, $507,000 of which impacted cost of goods sold and $91,000 of which impacted selling and administration expenses.

Security Products net sales increased 3% to $73.7 million in 2012 compared to $71.4 million in 2011. The increase in sales is primarily due to somewhat improved economic conditions in North America resulting in higher order rates across most markets. Gross margin and operating income percentages decreased in 2012 compared to 2011 by one percentage point primarily due to higher self-insured medical costs of $925,000 in 2012, $815,000 of which impacted cost of goods sold and $110,000 of which impacted selling and administration expenses. The impact of the higher medical costs on cost of goods sold was partially offset by a $300,000 decrease

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in depreciation expense relating to the timing of historical capital expenditures and retirements. The 2012 medical costs were more in line with the historical average annual medical costs as compared to an unusually favorable 2011.

Marine Components. Marine Components net sales increased 11% in 2013 as compared to 2012. The increase was primarily the result of a $787,000 increase in sales to the ski/wakeboard boat market and other non-high performance marine markets. As a percentage of net sales, gross margin and the operating loss percentage improved in 2013 compared to 2012 primarily due to increased leverage of fixed costs as a result of the higher sales.

Marine Components net sales increased 13% in 2012 as compared to 2011. The increase was primarily the result of a $900,000 increase in sales to the ski/wakeboard boat market in connection with new products developed for that market. As a percentage of net sales, gross margin and the operating loss percentage improved in 2012 compared to 2011 primarily due to increased leverage of fixed costs as a result of the higher sales and lower intangible amortization expense due to intangibles that became fully amortized in the first six months of 2011.

Outlook

Consistent with the current state of the North American economy, overall demand from our customers continues to be subject to instability. While we experienced some increase in customer demand across most markets in 2013, it is uncertain the extent that sales will continue to grow during 2014. While changes in market demand are not within our control, we are focused on the areas we can impact. Staffing levels are continuously evaluated in relation to sales order rates which may result in headcount adjustments, to the extent possible, to match staffing levels with demand. We expect our continuous lean manufacturing and cost improvement initiatives to positively impact our productivity and result in a more efficient infrastructure. Additionally, we continue to seek opportunities to gain market share in markets we currently serve, to expand into new markets and to develop new product features in order to mitigate the impact of changes in demand as well as broaden our sales base.

Volatility in the costs of commodity raw materials is ongoing. Our primary commodity raw materials are zinc, brass and stainless steel, which together represent approximately 11% of our total cost of goods sold. We generally seek to mitigate the impact of fluctuations in commodity raw material costs on our margins through improvements in production efficiencies or other operating cost reductions. In the event we are unable to offset commodity raw material cost increases with other cost reductions, it may be difficult to recover those cost increases through increased product selling prices or surcharges due to the competitive nature of the markets served by our products. Additionally, significant surcharges may negatively affect our margins as they typically only recover the increased cost of the raw material without adding margin dollars resulting in a lower margin percentage. Consequently, overall operating margins may be negatively affected by commodity raw material cost pressures.

Liquidity and Capital Resources

Summary.

Our primary source of liquidity on an on-going basis is our cash flow from operating activities, which is generally used to (i) fund capital expenditures,
(ii) repay short-term or long-term indebtedness incurred primarily for capital expenditures, business combinations or buying back shares of our outstanding stock and (iii) provide for the payment of dividends (if declared). From time-to-time, we will incur indebtedness to fund capital expenditures, business combinations or other investment activities. In addition, from time-to-time, we may also sell assets outside the ordinary course of business, the proceeds of which are generally used to repay indebtedness (including indebtedness which may have been collateralized by the assets sold) or to fund capital expenditures or business combinations.

Consolidated cash flows.

Operating activities. Trends in cash flows from operating activities, excluding changes in assets and liabilities, for the last three years have generally been similar to the trends in our earnings. Depreciation and amortization expense decreased in 2013 compared to 2012 due principally to the disposal of our Furniture Components segment in December 2012. The Consolidated Statements of Cash Flows for the years ended

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December 31, 2011 and 2012 have not been revised for discontinued operations resulting from the sale of our Furniture Components segment. Depreciation expense decreased in 2012 compared to 2011 due to lower capital expenditure requirements in recent years as well as the timing of certain assets that have become fully depreciated. See Notes 1 and 2 to the Consolidated Financial Statements.

Changes in assets and liabilities result primarily from the timing of production, sales and purchases. Such changes in assets and liabilities generally tend to even out over time. However, year-to-year relative changes in assets and liabilities can significantly affect the comparability of cash flows from operating activities. Cash used in operating activities was $4.1 million in 2013 compared to cash provided by operating activities of $13.8 million in 2012. The $18.0 million decrease in cash provided by both continuing and discontinued operating activities is primarily the net result of:

The negative impact of higher net cash paid for taxes in 2013 of $10.2 million for income taxes associated with our tax gain realized on the sale of our disposed operations recognized in the fourth quarter of 2012 and on the 2012 income of the disposed operations;

The negative impact of net cash provided by operating activities attributable to our discontinued operations in 2012 of $9.8 million, (exclusive of the impact of cash paid for income taxes in 2012 attributable to our discontinued operations, as discussed above); and

The negative impact of higher net cash used by relative changes in our inventories, receivables, payables and non-tax related accruals attributable to our continuing operations of $1.7 million in 2013.

Cash flows from operating activities resulted in a net use of cash in 2013 due primarily to a cash payment for taxes of approximately $11.6 million related to the sale of our disposed operations which was paid in the first quarter of 2013. Under GAAP, cash paid for income taxes on the disposal of a business unit is reported as a reduction of cash flows from operating activities, while the pre-tax proceeds from disposal are reported as a component of cash flows from investing activities. Consequently, we expect to generate positive cash flows from operating activities in 2014. In addition, the operating cash flow comparison for the year ended December 31, 2013 was negatively impacted by the sale, since the operating cash flows of the disposed operations are included in our total cash flows from operating activities in 2012, through the December 2012 date of sale. See Note 2 to the Consolidated Financial Statements.

Cash provided by operating activities was $13.8 million in 2012 compared to $16.0 million in 2011. The $2.1 million decrease in cash provided by both continuing and discontinued operating activities is primarily the net result of:

The negative impact of lower operating income in 2012 attributable to continuing operations of approximately $1.0 million, and lower operating income attributable to discontinued operations of $1.7 million;

The positive impact of higher net cash provided by relative changes in our inventories, receivables, payables and non-tax related accruals of $2.2 million in 2012;

The positive impact of lower cash paid for income taxes in 2012 of approximately $1.9 million; and

The positive impact of lower cash paid for interest in 2012 of $1.2 million due to the timing of interest payments discussed in Note 9 to the Consolidated Financial Statements.

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Relative changes in working capital can have a significant effect on cash flows from operating activities. As shown below, our total average days sales outstanding decreased from December 31, 2012 to December 31, 2013 primarily as a result of the timing of sales and collections in the last month of 2013 as compared to 2012. Marine Components experienced greater variability in their average days sales outstanding, however their receivable balances are not significant. For comparative purposes, we have provided 2011 numbers below.

                                 December 31,     December 31,     December 31,
       Days Sales Outstanding:       2011             2012             2013
       Security Products         39 Days          41 Days          35 Days
       Furniture Components*     38 Days          41 Days              N/A
       Marine Components         44 Days          32 Days          35 Days
       Total                     39 Days          40 Days          35 Days

* Denotes disposed operations. See Note 2 to the Consolidated Financial Statements.

As shown below, our average number of days in inventory increased from December 31, 2012 to December 31, 2013 primarily as a result of the increase in Marine Components average number of days in inventory relating to a more intentional build up of inventory in 2013 in advance of the 2014 boating season. The variability in days in inventory among our segments primarily relates to the complexity of the production processes and therefore the length of time it takes to produce end products. As a result, our overall December 31, 2013 days in inventory compared to December 31, 2012 is in line with our expectations. For comparative purposes, we have provided 2011 numbers below.

                                 December 31     December 31,     December 31,
         Days in Inventory:         2011             2012             2013
         Security Products       79 Days         71 Days          71 Days
         Furniture Components*   59 Days         66 Days              N/A
         Marine Components       114 Days        91 Days          110 Days
         Total                   71 Days         71 Days          76 Days

* Denotes disposed operations. See Note 2 to the Consolidated Financial Statements.

Investing activities. Net cash provided by investing activities totaled $7.2 million, $51.7 million and $1.0 million for the years ended December 31, 2011, 2012 and 2013, respectively. Capital expenditures have primarily emphasized improving our manufacturing facilities and investing in manufacturing equipment, which utilizes new technologies and increases automation of the manufacturing process to provide for increased productivity and efficiency. The significant items impacting cash provided by investing activities for the noted periods are as follows:

During 2013,

we collected $3.0 million in principal payments on a note receivable; and

we received $1.6 million in net proceeds on the sale of assets held for sale.

See Notes 2 and 7 to the Consolidated Financial Statements, respectively.

During 2012,

we sold our Furniture Components segment for net proceeds of $58.0 million less cash of the disposed operations of $5.4 million, and

we received $3.6 million in net proceeds on the sale of assets held for sale which were previously classified as assets held for sale.

See Notes 2 and 7 to the Consolidated Financial Statements, respectively.

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During 2011,

we received the $15.0 million principal amount due to us under our promissory note receivable, and

. . .

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